UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended August 24, 2003
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: 1-6453
NATIONAL SEMICONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-2095071
-------- ----------
(State of incorporation) (I.R.S. Employer Identification Number)
2900 Semiconductor Drive, P.O. Box 58090
Santa Clara, California 95052-8090
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 721-5000
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 .
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X
No__.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of Each Class Outstanding at August 24, 2003
------------------- ------------------------------
Common stock, par value $0.50 per share 185,383,175
NATIONAL SEMICONDUCTOR CORPORATION
INDEX
Page No.
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Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations (Unaudited) for
the Three Months Ended August 24, 2003 and August 25, 2002 3
Condensed Consolidated Statements of Comprehensive Income (Loss)
(Unaudited)for the Three Months Ended August 24, 2003 and
August 25, 2002 4
Condensed Consolidated Balance Sheets (Unaudited) as of
August 24, 2003 and May 25, 2003 5
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the Three Months Ended August 24, 2003 and August 25, 2002 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7-15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16-23
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24
Item 4. Controls and Procedures 24
Part II. Other Information
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 25-26
Signature 27
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three Months Ended
Aug. 24, 2003 Aug. 25, 2002
(In Millions, Except Per Share Amounts)
--------------- ---------------
Net sales $ 424.8 $ 420.6
Operating costs and expenses:
Cost of sales 224.4 238.3
Research and development 92.1 110.7
Selling, general and administrative 68.4 69.9
Special items 12.6 -
--------------- ---------------
Total operating costs and expenses 397.5 418.9
--------------- ---------------
Operating income 27.3 1.7
Interest income, net 3.1 4.1
Other income (expense), net 5.5 (1.5)
--------------- ---------------
Income before income taxes and cumulative effect of a change
in accounting principle 35.9 4.3
Income tax expense 4.3 3.0
--------------- ---------------
Income before cumulative effect of a change in accounting
principle 31.6 1.3
Cumulative effect of a change in accounting principle (1.9) -
--------------- ---------------
Net income $ 29.7 $ 1.3
=============== ===============
Earnings per share:
Income before cumulative effect of a change in accounting
principle:
Basic $ 0.17 $ 0.01
Diluted $ 0.16 $ 0.01
Net income:
Basic $ 0.16 $ 0.01
Diluted $ 0.15 $ 0.01
Weighted-average shares used to calculate earnings per share:
Basic 184.5 180.7
Diluted 191.9 187.1
Pro forma amounts assuming the change in accounting
principle is applied retroactively:
Net income $ 31.6 $ 1.2
Earnings per share:
Basic $ 0.17 $ 0.01
Diluted $ 0.16 $ 0.01
See accompanying Notes to Condensed Consolidated Financial Statements
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE
INCOME (LOSS) (Unaudited)
Three Months Ended
Aug. 24, Aug. 25,
(In Millions) 2003 2002
-------------- ---------------
Net income $ 29.7 $ 1.3
Other comprehensive income (loss), net of tax:
Reclassification adjustment for net realized gain on available-
for-sale securities included in net income - (0.7)
Unrealized loss on available-for-sale securities (3.1) (28.1)
Derivative instruments:
Unrealized gain on cash flow hedges 0.1 0.4
-------------- ---------------
Comprehensive income (loss) $ 26.7 $(27.1)
============== ===============
See accompanying Notes to Condensed Consolidated Financial Statements
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
Aug. 24, May 25,
(In Millions) 2003 2003
------------------------ -----------------------
ASSETS
Current assets:
Cash and cash equivalents $ 721.4 $ 802.2
Short-term marketable investments 193.9 113.2
Receivables, less allowances of $23.3 in fiscal 2004
and $38.2 in fiscal 2003 156.5 137.1
Inventories 155.1 142.2
Deferred tax assets 66.0 66.0
Other current assets 37.4 20.5
------------------------ -----------------------
Total current assets 1,330.3 1,281.2
Net property, plant and equipment 660.9 680.7
Goodwill 173.3 173.3
Other assets 100.5 109.4
------------------------ -----------------------
Total assets $2,265.0 $2,244.6
======================== =======================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 1.4 $ 2.3
Accounts payable 97.1 107.0
Accrued expenses 185.1 208.5
Income taxes payable 46.5 49.6
------------------------ -----------------------
Total current liabilities 330.1 367.4
Long-term debt 20.6 19.9
Other noncurrent liabilities 159.4 151.3
------------------------ -----------------------
Total liabilities 510.1 538.6
------------------------ -----------------------
Commitments and contingencies
Shareholders' equity:
Common stock 92.7 91.8
Additional paid-in capital 1,472.6 1,451.3
Retained earnings 306.9 277.2
Accumulated other comprehensive loss (117.3) (114.3)
------------------------ -----------------------
Total shareholders' equity 1,754.9 1,706.0
------------------------ -----------------------
Total liabilities and shareholders' equity $2,265.0 $2,244.6
======================== =======================
See accompanying Notes to Condensed Consolidated Financial Statements
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Three Months Ended
Aug. 24, Aug. 25,
(In Millions) 2003 2002
------------------------ --------------------
Cash flows from operating activities:
Net income $ 29.7 $ 1.3
Adjustments to reconcile net income with net cash
provided by operating activities:
Cumulative effect of a change in accounting principle 1.9 -
Depreciation and amortization 55.2 55.5
Gain on investments (2.3) (0.7)
Share in net losses of equity-method investments 4.8 3.6
Loss on disposal of equipment 2.2 1.2
Noncash special items 3.9 -
Other, net 0.7 2.4
Changes in certain assets and liabilities, net:
Receivables (11.8) (12.1)
Inventories (17.5) (13.6)
Other current assets (10.3) (13.6)
Accounts payable and accrued expenses (34.2) (11.5)
Income taxes payable (3.1) (1.6)
Other noncurrent liabilities 6.0 4.5
------------------------ --------------------
Net cash provided by operating activities 25.2 15.4
------------------------ --------------------
Cash flows from investing activities:
Purchase of property, plant and equipment (41.5) (60.9)
Sale and maturity of available-for-sale securities 244.8 130.8
Purchase of available-for-sale securities (327.6) (47.5)
Sale of investments - 1.1
Investment in nonpublicly traded companies - (7.2)
Funding of benefit plan (2.7) (2.5)
Other, net 1.3 (0.3)
------------------------ --------------------
Net cash provided by (used by) investing activities (125.7) 13.5
------------------------ --------------------
Cash flows from financing activities:
Repayment of debt (0.9) (2.1)
Issuance of common stock 20.6 10.9
------------------------ --------------------
Net cash provided by financing activities 19.7 8.8
------------------------ --------------------
Net change in cash and cash equivalents (80.8) 37.7
Cash and cash equivalents at beginning of period 802.2 681.3
------------------------ --------------------
Cash and cash equivalents at end of period $721.4 $719.0
======================== ====================
See accompanying Notes to Condensed Consolidated Financial Statements
NATIONAL SEMICONDUCTOR CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Summary of Significant Accounting Policies
In the opinion of our management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to present
fairly the financial position and results of operations of National
Semiconductor Corporation and our majority-owned subsidiaries. You should not
expect interim results of operations to necessarily be indicative of the results
for the full fiscal year. This report should be read in conjunction with the
consolidated financial statements and the accompanying notes included in our
annual report on Form 10-K for the fiscal year ended May 25, 2003.
Earnings Per Share:
A reconciliation of the shares used in the computation of basic and diluted
earnings per share follows:
Three Months Ended
Aug. 24, Aug. 25,
(In Millions) 2003 2002
------------- -------------
Numerator:
Income before cumulative effect of a change in
accounting principle $31.6 $1.3
============= =============
Net income $29.7 $1.3
============= ==============
Denominator:
Weighted-average common shares outstanding used
for basic earnings per share 184.5 180.7
Effect of dilutive securities:
Stock options 7.4 6.4
------------- --------------
Weighted-average common and potential common
shares outstanding used for diluted earnings
per share 191.9 187.1
============= ==============
For the first quarter of fiscal 2004, we did not include options
outstanding to purchase 28.0 million shares of common stock with a
weighted-average exercise price of $36.24 in diluted earnings per share since
their effect was antidilutive because their exercise price exceeded the average
market price during the quarter. These shares could, however, potentially dilute
basic earnings per share in the future. For the first quarter of fiscal 2003, we
did not include options outstanding to purchase 26.1 million shares of common
stock with a weighted-average exercise price of $37.90 in diluted earnings per
share since their effect was antidilutive because their exercise price exceeded
the average market price during the quarter.
Employee Stock Plans
We account for our employee stock option and stock purchase plans in accordance
with the intrinsic method of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees." For more complete information on our
stock-based compensation plans, see Note 10 to the Consolidated Financial
Statements included in our annual report on Form 10-K for the year ended May 25,
2003.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, "Accounting for Stock-Based Compensation," as amended
by SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and
Disclosure." This information illustrates the effect on net income and earnings
per share as if we had accounted for stock-based awards to employees under the
fair value method specified by SFAS No. 123. The weighted-average fair value of
stock options granted during the first quarter of fiscal 2004 and 2003 was
$20.14 and $17.50 per share, respectively. The weighted-average fair value of
rights granted under the stock purchase plans was $4.28 and $7.58 per share for
the first quarter of fiscal 2004 and 2003, respectively. We estimated the fair
value of these employee stock-based awards using a Black-Scholes option pricing
model that assumes no expected dividends and uses the following weighted-average
assumptions:
Three Months Ended
Aug. 24, Aug. 25,
2003 2002
------------------- ------------------
Stock Option Plans
Expected life (in years) 5.1 5.0
Expected volatility 76% 77%
Risk-free interest rate 3.3% 2.7%
Stock Purchase Plans
Expected life (in years) 0.3 0.3
Expected volatility 51% 54%
Risk-free interest rate 1.0% 1.1%
For pro forma purposes, the estimated fair value of employee stock-based
awards is amortized on a straight-line basis over the options' vesting period
for options and the three-month purchase period for stock purchases under the
stock purchase plans. The pro forma information follows:
Three Months Ended
Aug. 24, Aug. 25,
(In Millions, Except Per Share Amounts) 2003 2002
-------------------- ------------------
Net income - as reported $ 29.7 $ 1.3
Add back: Stock compensation charge included in the
net income determined under the intrinsic value method,
net of tax 0.7 0.8
Deduct: Total stock-based employee compensation
expense determined under the fair value method,
net of tax (45.3) (46.8)
-------------------- ------------------
Net loss - pro forma $ (14.9) $ (44.7)
==================== ==================
Basic earnings per share - as reported $ 0.16 $ 0.01
Basic loss per share - pro forma $ (0.08) $ (0.25)
Diluted earnings per share - as reported $ 0.15 $ 0.01
Diluted loss per share - pro forma $ (0.08) $ (0.25)
New Accounting Pronouncements:
At the beginning of fiscal 2004, we adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The impact from the adoption
of this statement is discussed in Note 5 to the condensed consolidated financial
statements.
Reclassifications:
Certain amounts reported in fiscal 2003 have been reclassified to conform to the
fiscal 2004 presentation. Net operating results have not been affected by the
reclassification.
Note 2. Consolidated Financial Statements Detail
Balance sheets:
Aug. 24, May 25,
(In Millions) 2003 2003
---------------------- ---------------------
Inventories:
Raw materials $ 9.0 $ 8.1
Work in process 94.4 89.2
Finished goods 51.7 44.9
---------------------- ---------------------
Total inventories $155.1 $142.2
====================== =====================
Statements of operations:
Three Months Ended
Aug. 24, Aug. 25,
(In Millions) 2003 2002
----------- -----------
Special items (See Note 4):
Cost reduction charges $ 8.6 $ -
Net charges associated with the exit and sale of
the information appliance business 4.0 -
----------- -----------
Total special items $12.6 $ -
=========== ===========
Interest income, net:
Interest income $ 3.2 $ 4.5
Interest expense (0.1) (0.4)
----------- -----------
Interest income, net $ 3.1 $ 4.1
=========== ===========
Other income (expense), net:
Net intellectual property income $ 8.0 $ 1.6
Net gain on investments 2.3 0.7
Share of loss from equity-method investments (4.8) (3.6)
Other - (0.2)
---------- -----------
Total other income (expense), net $ 5.5 $(1.5)
========== ===========
Note 3. Statement of Cash Flows Information
Three Months Ended
Aug. 24, Aug. 25,
(In Millions) 2003 2002
----------------------- -------------------
Supplemental Disclosure of Cash Flow Information:
Cash paid for: $ 0.1 $ 0.5
Interest $ 8.4 $ 5.6
Income taxes
Supplemental Schedule of Non-cash Investing and
Financing Activities:
Issuance of stock for employee benefit plans $ 0.9 $ 0.8
Unearned compensation relating to restricted stock issuance $ 1.0 $ 0.2
Change in unrealized gain on cash flow hedges $ 0.1 $ 0.4
Change in unrealized gain on available-for-sale securities $ (3.1) $ (28.8)
Note 4. Cost Reduction Programs and Restructuring of Operations
In late August 2003, we completed the exit and sale of our information appliance
business as part of a series of strategic profit-improvement actions that were
initially launched in February 2003. This action included the sale to Advanced
Micro Devices, Inc. of certain intellectual property and assets of the
information appliance business. As part of the transaction, AMD hired 125 former
National employees who were mostly located in Longmont, Colorado. However,
certain assets and employees that were directly supporting the information
appliance business were not included in this sale transaction. The corresponding
severance and asset impairments that were incurred resulted in net charges of
$4.0 million for the exit and sale of the information appliance business.
Included in this net amount are proceeds of $10.1 million from the sale of
assets that had a carrying value of $7.5 million less transaction costs of $1.3
million. We also recorded an additional $8.6 million charge for other
supplemental profit-improvement actions, primarily related to workforce
reductions in various manufacturing, product development and support areas.
Included in the charge are severance costs, as well as asset write-offs and
lease obligations we incurred when we vacated certain design centers in the
quarter as planned with the closure of the cellular baseband business. A total
of 142 employees were terminated as a combined result of the information
appliance business exit and the supplemental actions. Total charges related to
cost reduction actions, including the exit of the information appliance
business, are presented in the following table:
Information Enterprise Enhanced
Analog Appliance Networking Solutions
(In Millions) Segment Segment Segment Segment All Others Total
-------------- -------------- -------------- --------------- ------------- --------------
Severance $ 1.7 $ 1.1 $ - $ - $ 3.6 $ 6.4
Exit related costs 2.2 0.1 - - - 2.3
Asset write-off 1.1 4.1 - - - 5.2
-------------- -------------- -------------- --------------- ------------- --------------
$ 5.0 $ 5.3 $ - $ - $ 3.6 $13.9
============== ============== ============== =============== ============= ==============
Noncash charges included in the table above relate to the write-off of
assets, primarily equipment and a technology license that were dedicated to the
information appliance and cellular baseband businesses. As part of the sale
transaction to AMD discussed above, we also entered into a separate supply
agreement where we will manufacture product for AMD at prices specified by the
terms of the agreement. This agreement is effective for three years unless
terminated earlier as permitted under the terms of the agreement.
The following table provides a summary of the activities related to our
cost reduction and restructuring actions included in accrued liabilities for the
three months ended August 24, 2003:
(In Millions) Severance Other Exit Costs Total
------------- ----------------- -------------
Balance at beginning of fiscal year $ 17.5 $ 7.8 $ 25.3
Cash payments (10.9) (1.8) (12.7)
August 2003 cost reduction charge 6.4 2.3 8.7
------------- ----------------- -------------
Ending Balance $ 13.0 $ 8.3 $ 21.3
============= ================= =============
During the first quarter of fiscal 2004 we paid severance to 210 employees
in connection with workforce reductions announced in fiscal 2003, as well as in
the recent fiscal 2004 first quarter. Amounts paid for other exit-related costs
during the first quarter of fiscal 2004 were primarily for payments under lease
obligations associated with previous restructuring and cost reduction actions.
Note 5. Accounting for Asset Retirement Obligations
We adopted SFAS No. 143, "Accounting for Asset Retirement Obligations," at the
beginning of fiscal 2004. This statement requires that the fair value of a legal
liability for an asset retirement obligation be recorded in the period in which
it is incurred if a reasonable estimate of fair value can be made. Upon
recognition of a liability, the asset retirement cost is recorded as an increase
in the carrying value of the related long-lived asset and then depreciated over
the life of the asset. Our asset retirement obligations arise primarily from
contractual commitments to decontaminate machinery and equipment used at our
manufacturing facilities at the time we dispose or replace them. We also have
some leased facilities where we have asset retirement obligations from
contractual commitments to remove leasehold improvements and return the property
to a certain specified condition when the lease terminates. We recorded a $2.1
million noncurrent liability for these asset retirement obligations and a $0.4
million increase in the carrying value of the related assets, net of $1.0
million of accumulated depreciation. The cumulative effect upon adoption of this
accounting standard was a charge of $1.9 million including a tax effect of $0.2
million.
We were unable to recognize any asset retirement obligations associated
with the closure or abandonment of the manufacturing facilities we own. We
currently intend to operate these facilities indefinitely and are therefore
unable to reasonably estimate the fair value of any legal obligations we may
have because of the indeterminate closure dates.
The following table presents the activity for the asset retirement
obligations for the three months ended August 24, 2004:
(In Millions)
Balance at beginning of fiscal 2004 $ 2.1
Accretion expense 0.1
-----------------------
Ending balance $ 2.2
=======================
The following table presents net income and earnings per share for the
first quarter of fiscal 2004 and 2003, as if the provisions of SFAS No. 143 had
been applicable in fiscal 2003:
Three Months Ended
Aug. 24, Aug. 25,
(In Millions, Except Per Share Amounts) 2003 2002
----------------------- -------------------
Net income, as reported $ 29.7 $ 1.3
Add back:
Cumulative effect of a change in accounting principle
including tax effect of $0.2 million 1.9 -
Deduct:
Accretion and depreciation, net of tax - 0.1
----------------------- -------------------
----------------------- -------------------
Net income, as adjusted $ 31.6 $ 1.2
======================= ===================
======================= ===================
Net income per share, as adjusted: -
Basic $ 0.17 $ 0.01
Diluted $ 0.16 $ 0.01
Note 6. Segment Information
The following table presents information related to our reportable segments:
Information Enterprise Enhanced
Analog Appliance Networking Solutions
(In Millions) Segment Segment Segment Segment All Others Eliminations Total
--------- --------- -------- -------- ------- ------------ -------------
Three months ended August 24, 2003:
Sales to unaffiliated customers $334.1 $ 55.9 $ 5.3 $11.0 $18.5 $ 424.8
========= ========= ======== ======== ======= ============ =============
Segment income (loss) before income
taxes and cumulative effect of a change
in accounting principle: $ 54.3 $(14.8) $ (3.9) $ 4.6 $(4.3) - $ 35.9
========= ========= ======== ======== ======= ============ =============
Three months ended August 25, 2002:
Sales to unaffiliated customers $327.1 $ 55.8 $ 5.5 $11.4 $20.8 $ 420.6
========= ========= ======== ======== ======= ============ =============
Segment income (loss) before income taxes: $ 13.9 $(12.4) $(10.4) $ 2.9 $10.3 - $ 4.3
========= ========= ======== ======== ======= ============ =============
Note 7. Contingencies - Legal Proceedings
We have been named to the National Priorities List for our Santa Clara,
California, site and have completed a remedial investigation/feasibility study
with the Regional Water Quality Control Board, acting as an agent for the
Federal Environmental Protection Agency. We have agreed in principle with the
RWQCB to a site remediation plan. In addition to the Santa Clara site, from time
to time we have been designated as a potentially responsible party (PRP) by
federal and state agencies for certain environmental sites with which we may
have had direct or indirect involvement. These designations are made regardless
of the extent of our involvement. These claims are in various stages of
administrative or judicial proceedings and include demands for recovery of past
governmental costs and for future investigations and remedial actions. In many
cases, the dollar amounts of the claims have not been specified, and in the case
of the PRP cases, claims have been asserted against a number of other entities
for the same cost recovery or other relief as is sought from us. We accrue costs
associated with environmental matters when they become probable and can be
reasonably estimated. The amount of all environmental charges to earnings,
including charges for the Santa Clara site remediation (excluding potential
reimbursements from insurance coverage), were not material during the first
quarter of fiscal 2004.
As part of the disposition in fiscal 1996 of the Dynacraft assets and
business, we retained responsibility for environmental claims connected with
Dynacraft's Santa Clara, California, operations and for other environmental
claims arising from our conduct of the Dynacraft business prior to the
disposition. As part of the Fairchild disposition in fiscal 1997, we also agreed
to retain liability for remediation projects and environmental matters arising
from our prior operation of Fairchild's plants in South Portland, Maine; West
Jordan, Utah; Cebu, Philippines; and Penang, Malaysia; and Fairchild agreed to
arrange for and perform the remediation and cleanup. We prepaid to Fairchild the
estimated costs of the remediation and cleanup and remain responsible for costs
and expenses incurred by Fairchild in excess of the prepaid amounts. To date,
our liability for these excess costs has not been material.
In January 1999, a class action suit was filed against us and our chemical
suppliers by former and present employees claiming damages for personal
injuries. The complaint alleges that cancer and reproductive harm were caused to
employees exposed to chemicals in the workplace. Plaintiffs are presently
seeking to certify a medical monitoring class, which we are opposing. Discovery
in the case is proceeding.
In November 2000, a derivative action was brought against us and other
defendants by a shareholder of Fairchild Semiconductor International, Inc.
Plaintiff seeks recovery of alleged "short-swing" profits under section 16(b) of
the Securities Exchange Act of 1934 from the sale by the defendants in January
2000 of Fairchild common stock. The complaint alleges that Fairchild's
conversion of preferred stock held by the defendants at the time of Fairchild's
initial public offering in August 1999 constitutes a "purchase" that must be
matched with the January 2000 sale for purposes of computing the "short-swing"
profits. Plaintiff seeks from National alleged recoverable profits of $14.1
million. In February 2002, the judge in the case granted the motion to dismiss
filed by us and our co-defendants and dismissed the case, ruling that the
conversion was done pursuant to a reclassification which is exempt from the
scope of Section 16(b). Plaintiff appealed the dismissal of the case and upon
appeal, the appeals court reversed the lower court's dismissal. Our petition for
a panel rehearing and/or rehearing en banc was denied by the appeals court in
April 2003. Our motion to stay the issuance of the appeals court mandate to the
district court pending our petition to the U.S. Supreme Court was denied in May
2003. We have filed a petition for a writ of certiorari with the U.S. Supreme
Court and we intend to continue to contest the case through all available means.
Our tax returns for certain years are under examination in the U.S. by the
IRS and in other countries by local authorities. The IRS has completed examining
our tax returns for fiscal years 1997 through 2000 and on July 29, 2003 issued a
notice of proposed adjustment seeking additional taxes of approximately $19
million (exclusive of interest) for those years. The issues giving rise to most
of the proposed adjustments relate to R&D credits, inventory and depreciation
deductions. We intend to contest the adjustments administratively. We believe we
have made adequate tax payments and/or accrued adequate amounts in our financial
statements to cover the amounts sought by the IRS, as well as any other
deficiencies that other governmental agencies may find in their audits.
In addition to the foregoing, we are a party to other suits and claims that
arise in the normal course of business. Based on current information, we do not
believe that it is probable that losses associated with the proceedings
discussed above that exceed amounts already recognized will be incurred in
amounts that would be material to our consolidated financial position or results
of operations.
Contingencies -- Other
In connection with divestitures we have done in the past, we have routinely
provided indemnities to cover the indemnified party for matters such as
environmental, tax, product and employee liabilities. We also routinely include
intellectual property indemnification provisions in our terms of sale,
development agreements and technology licenses with third parties. Since maximum
obligations are not explicitly stated in these indemnification provisions, the
potential amount of future maximum payments cannot be reasonably estimated. To
date we have incurred minimal losses associated with these indemnification
obligations and as a result, we have not recorded any liability in our
consolidated financial statements.
Note 8. Subsequent Event
In September 2003, we completed the repurchase of approximately 7.5 million
shares of our common stock for $202.2 million. This share repurchase was made
pursuant to the $400 million stock buy-back program that we announced in July
2003. We completed the repurchase through a privately negotiated transaction
with a major financial institution. All of the shares were immediately retired.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly 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. These statements relate to, among other things,
sales, gross margins, operating expenses, capital expenditures, and acquisitions
and investments in other companies and are indicated by words or phrases such as
"expect," "outlook," "foresee," "we believe," "we intend," and similar words or
phrases. These statements are based on our current plans and expectations and
involve risks and uncertainties that could cause actual results to differ
materially from expectations. These forward-looking statements should not be
relied upon as predictions of future events as we cannot assure you that the
events or circumstances reflected in these statements will be achieved or will
occur. The following are among the principal factors that could cause actual
results to differ materially from the forward-looking statements: general
business and economic conditions in the semiconductor industry and the growth
rate in the wireless, PC and communications infrastructure industries; pricing
pressures and competitive factors; delays in the introduction of new products or
lack of market acceptance for new products; our success in integrating
acquisitions and achieving operating improvements with acquisitions; risks of
international operations; legislative and regulatory changes; the outcome of
legal, administrative and other proceedings that we are involved in; the results
of our programs to control or reduce costs; and the general worldwide
geopolitical situation. For a discussion of some of the factors that could cause
actual results to differ materially from our forward-looking statements, see the
discussion on Risk Factors that appears below and other risks and uncertainties
detailed in this and our other reports and filings with the Securities and
Exchange Commission. We undertake no obligation to update forward-looking
statements to reflect developments or information obtained after the date hereof
and disclaim any obligation to do so.
This discussion should be read in conjunction with the consolidated
financial statements and the accompanying notes included in this Form 10-Q and
in our annual report on Form 10-K for the fiscal year ended May 25, 2003.
o Critical Accounting Policies
- ---------------------------------
We believe the following critical accounting policies are those policies that
have a significant effect on the determination of our financial position and
results of operations. These policies also require us to make our most difficult
and subjective judgments:
1. Revenue Recognition
We recognize revenue from the sale of semiconductor products upon shipment,
provided title and risk of loss have passed to the customer, the amount is
fixed or determinable and collection of the revenue is reasonably assured.
Service revenues are recognized as the services are provided or as
milestones are achieved, depending on the terms of the arrangement. We
record a provision for estimated future returns at the time of shipment.
Approximately 53 percent of our semiconductor product sales are currently
made through distributors. We have agreements with our distributors that
cover various programs, including pricing adjustments based on resales,
scrap allowances and volume incentives. The revenue we record for these
distribution sales is net of estimated provisions for these programs. When
determining this net distribution revenue, we must make significant
judgments and estimates. Our estimates are based upon historical experience
rates, inventory levels in the distribution channel, current economic
trends, and other related factors. To date, the actual distributor activity
has been materially consistent with the provisions we have made based on
our estimates. However, because of the inherent nature of estimates, there
is always a risk that there could be significant differences between actual
amounts and our estimates. Our financial condition and operating results
are dependent on our ability to make reliable estimates and we believe that
our estimates are reasonable. However, different judgments or estimates
could result in variances that might be significant to reported operating
results.
Intellectual property income is not classified as revenue. This income
is classified as non-operating income and is recognized when the license is
delivered, the fee is fixed or determinable, collection of the fee is
reasonably assured and no further obligations to the other party exist.
2. Inventories
Inventories are stated at the lower of standard cost, which approximates
actual cost on a first-in, first-out basis, or market. We reduce the
carrying value of inventory for estimated obsolescence or unmarketable
inventory by an amount that is the difference between its cost and the
estimated market value based upon assumptions about future demand and
market conditions. Our products are classified as either custom, which are
those products manufactured with customer-specified features or
characteristics, or non-custom, which are those products that do not have
customer-specified features or characteristics. We evaluate obsolescence by
analyzing the inventory aging, order backlog and future customer demand on
an individual product basis. If actual demand were to be substantially
lower than what we have estimated, we may be required to write down
inventory below the current carrying value. While our estimates require us
to make significant judgments and assumptions about future events, we
believe our relationships with our customers, combined with our
understanding of the end-markets we serve, provide us with the ability to
make reliable estimates. To date the actual amount of obsolete or
unmarketable inventory has been materially consistent with previously
estimated write-downs we have recorded. We also evaluate the carrying value
of inventory for lower-of-cost-or-market on an individual product basis,
and these evaluations are intended to identify any difference between net
realizable value and standard cost. Net realizable value is determined as
the selling price of the product less the estimated cost of disposal. When
necessary, we reduce the carrying value of inventory to net realizable
value. If actual market conditions and resulting product sales were to be
less favorable than what we have projected, additional inventory
write-downs may be required.
3. Impairment of Goodwill, Intangible Assets and Other Long-lived Assets
We assess the impairment of long-lived assets whenever events or changes in
circumstances indicate that their carrying value may not be recoverable
from the estimated future cash flows expected to result from their use and
eventual disposition. Our long-lived assets subject to this evaluation
include property, plant and equipment and amortizable intangible assets. We
assess the impairment of goodwill annually in our fourth fiscal quarter and
whenever events or changes in circumstances indicate that it is more likely
than not that an impairment loss has been incurred. Intangible assets other
than goodwill are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying value may not be fully
recoverable. Other intangible assets subject to this evaluation include
developed technology we have acquired, patents and technology licenses. We
are required to make judgments and assumptions in identifying those events
or changes in circumstances that may trigger impairment. Some of the
factors we consider include:
o Significant decrease in the market value of an asset
o Significant changes in the extent or manner for which the asset is
being used or in its physical condition
o A significant change, delay or departure in our business strategy
related to the asset
o Significant negative changes in the business climate, industry or
economic conditions
o Current period operating losses or negative cash flow combined with a
history of similar losses or a forecast that indicates continuing
losses associated with the use of an asset
Our evaluation includes an analysis of estimated future undiscounted
net cash flows expected to be generated by the assets over their remaining
estimated useful lives. If the estimated future undiscounted net cash flows
are insufficient to recover the carrying value of the assets over the
remaining estimated useful lives, we will record an impairment loss in the
amount by which the carrying value of the assets exceeds the fair value. We
determine fair value based on discounted cash flows using a discount rate
commensurate with the risk inherent in our current business model. If, as a
result of our analysis, we determine that our amortizable intangible assets
or other long-lived assets have been impaired, we will recognize an
impairment loss in the period in which the impairment is determined. Any
such impairment charge could be significant and could have a material
adverse effect on our financial position and results of operations. Major
factors that influence our cash flow analysis are our estimates for future
revenue and expenses associated with the use of the asset. Different
estimates could have a significant impact on the results of our evaluation.
We perform an annual review for goodwill impairment in our fiscal
fourth quarter or whenever potential indicators of impairment exist. Our
impairment review is based on comparing the fair value to the carrying
value of the reporting units with goodwill. The fair value of a reporting
unit is measured at the business unit level using a discounted cash flow
approach that incorporates our estimates of future revenues and costs for
those business units. Reporting units with goodwill include our wireless,
displays, power management and data conversion business units, which are
operating segments within our Analog reportable segment, and our Enterprise
Networking reporting unit, which is a separate reportable segment. Our
estimates are consistent with the plans and estimates that we are using to
manage the underlying businesses. If we fail to deliver new products for
these business units, or if the products fail to gain expected market
acceptance, or market conditions for these businesses fail to improve, our
revenue and cost forecasts may not be achieved and we may incur charges for
goodwill impairment, which could be significant and could have a material
adverse effect on our net equity and results of operations.
4. Deferred Income Taxes
We determine deferred tax liabilities and assets based on the future tax
consequences that can be attributed to net operating loss and credit
carryovers and differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases, using
the tax rate expected to be in effect when the taxes are actually paid or
recovered. The recognition of deferred tax assets is reduced by a valuation
allowance if it is more likely than not that the tax benefits will not be
realized. The ultimate realization of deferred tax assets depends upon the
generation of future taxable income during the periods in which those
temporary differences become deductible. We consider past performance,
expected future taxable income and prudent and feasible tax planning
strategies in assessing the amount of the valuation allowance. Our forecast
of expected future taxable income is based over such future periods that we
believe can be reasonably estimated. Changes in market conditions that
differ materially from our current expectations and changes in future tax
laws in the U.S. and international jurisdictions may cause us to change our
judgments of future taxable income. These changes, if any, may require us
to adjust our existing tax valuation allowance higher or lower than the
amount we have recorded.
o Overview
- -------------
During the first quarter of fiscal 2004, we continued to take steps consistent
with the objectives of the strategic profit-improvement actions that were first
announced in February 2003. We completed the exit and sale of our information
appliance business, consisting primarily of the GeodeTM family of integrated
processor products (See Note 4). This included the sale of certain assets of the
business to Advanced Micro Devices, Inc. In addition, AMD hired a majority of
the employees in that business unit. With this sale now complete, we are
concentrating our R&D investments on analog capabilities and focusing our
efforts towards growing our analog sales and increasing our profitability.
Net sales for the first quarter of fiscal 2004 were $424.8 million. This
represents a slight increase over sales of $420.6 million for the first quarter
of fiscal 2003. The increase came from higher demand, particularly for power
management products, as business conditions for the semiconductor industry have
gradually improved from a year ago.
For the first quarter of fiscal 2004, we earned net income of $29.7
million, compared to net income of $1.3 million for the first quarter of fiscal
2003. This improvement in our operating results for fiscal 2004 compared to
fiscal 2003 was driven by reduced operating expenses achieved from the
implementation of the strategic profit-improvement actions launched in February
2003, as well as higher gross margins.
Net income for the first quarter of fiscal 2004 included $12.6 million of
special items for net charges related to cost reduction actions and the exit and
sale of the information appliance business (See Note 4). Net income for the
first quarter of fiscal 2004 also included a $1.9 million charge (including a
tax effect of $0.2 million) for the cumulative effective of a change in
accounting principle as a result of the adoption of SFAS No. 143, "Accounting
for Asset Retirement Obligations" (See Note 5). No special items were included
in net income for the first quarter of fiscal 2003.
o Sales
- ----------
The following discussion is based on our operating segments described in Note 13
to the consolidated financial statements included in our Annual Report on Form
10-K for the year ended May 25, 2003.
The Analog segment, which represents 79 percent of our total sales,
recorded a slight increase in sales of 2 percent for the first quarter of fiscal
2004 compared to the first quarter of fiscal 2003. The increase came primarily
from higher volume as unit shipments increased 5 percent from the same period
last year. At the same time, average selling prices declined 2 percent from the
first quarter of fiscal 2003, which came from a shift in unit mix toward lower
priced products and some modest price declines. These lower priced products
included a variety of high performance analog products offered in very small
form factors, made possible by our advanced chip-packaging technologies. Within
the Analog segment, sales of power management and amplifier products contributed
to the growth in sales for the first quarter of fiscal 2004 with increases of 37
percent and 13 percent, respectively, over sales in the first quarter of fiscal
2003. Products for wireless handsets largely drove the sales growth in power
management products. Sales for the first quarter of fiscal 2004 of
application-specific wireless products, primarily radio frequency building
blocks, remained flat while sales of remaining analog product areas declined in
general compared to last year's first quarter.
Sales for the first quarter of fiscal 2004 for the Information Appliance
segment were flat compared to the first quarter of fiscal 2003. Higher average
selling prices on flat unit volume for GeodeTM integrated processor products
were offset by lower average selling prices on lower unit volume of integrated
DVD products. The GeodeTM product family is the primary component of the
information appliance segment that was sold to Advanced Micro Devices, Inc. in
late August 2003 (See Note 4).
o Gross Margin
- -----------------
Gross margin as a percentage of sales was 47 percent for the first quarter of
fiscal 2004 compared to 43 percent in the first quarter of fiscal 2003. This
increase was primarily driven by higher factory utilization, as well as a net
improvement in product mix and pricing. Wafer fabrication capacity utilization
during the first quarter of fiscal 2004, based on wafer starts, was 87 percent,
compared to 74 percent for the first quarter of fiscal 2003 when production
activity was lower due to weaker business conditions.
o Research and Development
- -----------------------------
Our research and development expenses for the first quarter of fiscal 2004 were
$92.1 million, or 22 percent of sales, compared to $110.7 million, or 26 percent
of sales, for the first quarter of fiscal 2003. Lower R&D expenses reflect the
impact of actions we launched in February 2003 to reduce our R&D as a percent of
sales. These actions included exits of businesses, headcount reductions and
restructuring of a licensing agreement with TSMC. Ongoing R&D spending is
heavily focused on anlog products and underlying analog capabilities. Because we
made significant reductions in total R&D spending compared to fiscal 2003,
spending for the first quarter of fiscal 2004 for new product development was
down by 11 percent and for process and support technology was down by 38
percent. We continue to invest in the development of new analog and mixed-signal
technology-based products for applications such as wireless handsets, displays,
notebook PCs, other portable devices and other applications that require analog.
o Selling, General and Administrative
- ----------------------------------------
Our selling, general and administrative expenses in the first quarter of fiscal
2004 were $68.4 million, or 16 percent of sales, compared to $69.9 million, or
17 percent of sales, in the first quarter of fiscal 2003. The overall decrease
in SG&A expenses was mainly due to the cost reduction actions that were
implemented in fiscal 2003 as part of our strategic profit-improvement plan.
These actions reduced SG&A headcount, as well as discretionary selling and
marketing program expenses.
o Interest Income and Interest Expense
- -----------------------------------------
For the first quarter of fiscal 2004, we earned net interest income of $3.1
million compared to $4.1 million in the first quarter of fiscal 2003. This
decrease in net interest income was due to lower average interest rates,
although average cash balances were higher. Offsetting interest expense was
slightly lower during the quarter as we continued to reduce our outstanding debt
balances.
o Other Income (Expense), Net
- ---------------------------------
We recorded other income, net, of $5.5 million for the first quarter of fiscal
2004 compared to other expense, net, of $1.5 million for the first quarter of
fiscal 2003. The components of other income, net, include $8.0 million of net
intellectual property income and a $2.3 million gain from the sale of an
investment, which were offset by a $4.8 million charge for our share in net
losses of equity-method investments. The components of other expense, net, for
the first quarter of fiscal 2003 included $1.6 million of net intellectual
property income, a $0.7 million gain from the sale of an investment, a $3.6
million charge for our share in net losses of equity-method investments and $0.2
million of other miscellaneous losses.
o Income Tax Expense
- ---------------------------
We recorded income tax expense before the cumulative effect of a change in
accounting principle of $4.3 million in the first quarter of fiscal 2004,
compared to $3.0 million in the first quarter of fiscal 2003. The effective tax
rate was 12 percent for the first quarter of fiscal 2004. Fiscal 2004 tax
expense consists primarily of U.S. alternative minimum tax, net of operating
loss carryforwards, and non-U.S. income taxes. The fiscal 2003 tax expense
represents non-U.S. income taxes on international income. We did not incur U.S.
income taxes in fiscal 2003.
o Liquidity and Capital Resources
- ----------------------------------------
During the first quarter of fiscal 2004, cash and cash equivalents decreased
$80.8 million compared to an increase of $37.7 million in the first quarter of
fiscal 2003. The primary factors contributing to these changes are described
below:
We generated cash from operating activities of $25.2 million in the first
quarter of fiscal 2004 compared to $15.4 million in the first quarter of fiscal
2003. Cash was generated from operating activities because net income, after
adjusting for noncash items (primarily depreciation and amortization), was
greater than the negative impact that came from changes in working capital
components. The negative changes from working capital components for the first
quarter of fiscal 2004 came primarily from decreases in accounts payable and
accrued expenses combined with increases in receivables, inventories and other
current assets. Cash from operating activities in the first quarter of fiscal
2003 was also generated because net income, after adjusting for noncash items
(primarily depreciation and amortization), was greater than the negative impact
that came from changes in working capital components.
Our investing activities used cash of $125.7 million in the first quarter
of fiscal 2004, while generating cash of $13.5 million in the first quarter of
fiscal 2003. Major uses of cash in fiscal 2004 included net purchases of
available-for-sale securities of $82.8 million combined with investment in
property, plant and equipment of $41.5 million, primarily for machinery and
equipment. Cash provided by investing activities in the first quarter of fiscal
2003 came from the net sale and maturity of available-for-sale securities of
$83.3 million, which was partially offset by investment in property, plant and
equipment of $60.9 million.
Our financing activities generated cash of $19.7 million in the first
quarter of fiscal 2004 compared to $8.8 million in the first quarter of fiscal
2003. The primary source of cash in the first quarter of fiscal 2004 came from
the issuance of common stock under employee benefit plans in the amount of $20.6
million, which was slightly offset by a $0.9 million repayment of our
outstanding debt balances. The primary source of cash in the first quarter of
fiscal 2003 came from the issuance of common stock under employee benefit plans
of $10.9 million, which was slightly offset by a $2.1 million repayment of our
outstanding debt balances.
After the end of the first quarter of fiscal 2004, we completed the
repurchase of approximately 7.5 million shares of our common stock for $202.2
million in September 2003 pursuant to the $400 million stock buy-back program
authorized by the board of directors in July 2003.
We foresee continuing cash outlays for plant and equipment in fiscal 2004,
with our primary focus on developing new capabilities that support our target
growth markets and improve our manufacturing efficiency and productivity. We are
continuing with the construction of an assembly and test facility in China that
was begun in fiscal 2003 as part of our effort to increase assembly and test
capacity, as well as expand our business presence in Asia markets. We currently
expect our fiscal 2004 capital expenditure amount to be higher than the fiscal
2003 amount. However, we will continue to manage capital expenditures in light
of business conditions. We expect existing cash and investment balances,
together with existing lines of credit, to be sufficient to finance planned
capital investments in fiscal 2004.
Our cash and investment balances are dependent on continued collection of
customer receivables and the ability to sell inventories. Although we have not
experienced major problems with our customer receivables, significant declines
in overall economic conditions could lead to deterioration in the quality of
customer receivables. In addition, major declines in financial markets would
likely cause reductions in our cash equivalents and marketable investments.
The following table provides a summary of the effect on liquidity and cash
flows from our contractual obligations as of August 24, 2003:
Fiscal Year: 2009 and
(In Millions) 2004 2005 2006 2007 2008 thereafter Total
--------------- ---------- --------- --------- -------- ------------- ----------
Contractual obligations:
Debt obligations $ 1.4 $20.6 $ - $ - $ - $ - $ 22.0
Noncancellable
operating leases 16.1 15.7 10.6 8.7 6.5 6.3 63.9
Purchase obligations under:
CAD software licensing
Agreements 18.5 20.2 9.0 7.7 - - 55.4
Fairchild manufacturing
Agreement 4.3 - - - - - 4.3
Other 1.1 1.5 0.8 - - - 3.4
--------------- ---------- --------- --------- -------- ------------- ----------
Total $41.4 $58.0 $20.4 $16.4 $6.5 $6.3 $149.0
=============== ========== ========= ========= ======== ============= ============
Commercial Commitments:
Standby letters of credit
under bank multicurrency
agreement $ 8.6 - - - - - $ 8.6
=============== ========== ========= ========= ======== ============= ============
In addition, as of August 24, 2003, capital purchase commitments were $32.2
million.
o Outlook
- ------------
Although overall economic conditions continue to be somewhat uncertain and
difficult to predict, demand levels for the first quarter of fiscal 2004 were
slightly better as we have seen market conditions in the semiconductor industry
gradually improve from a year ago. New orders in the fiscal 2004 first quarter
showed a slight seasonal decline from the preceding fiscal 2003 fourth quarter,
but order rates improved as the quarter progressed. Despite the overall decline
in new orders, our Analog segment experienced sequential quarterly growth in new
orders in the first quarter of fiscal 2004, as new orders for power management
and wireless products grew substantially. As a result of the recent improvement
in the weekly run rate of total orders, including turns orders, which are orders
received with delivery requested in the same quarter, our opening 13-week
backlog entering the second quarter of fiscal 2004 was higher than it was
entering the first quarter of fiscal 2004. We also usually experience sequential
quarterly sales growth in our second fiscal quarter, as our customers prepare to
meet the upcoming holiday demand. Based on these factors, we anticipate that
sales for the second quarter of fiscal 2004 will grow 4 to 7 percent from the
fiscal 2004 first quarter. If, however, a normal level of turns orders is not
achieved or the rate of new orders declines, we may not be able to achieve this
increase. Dependent upon the level of revenue achieved, we also expect gross
margin percentage in the second quarter of fiscal 2004 to be higher by 1 to 1.5
percentage points from gross margin achieved in the fiscal 2004 first quarter,
as wafer fabrication utilization is expected to continue running at high levels
during the second quarter based on expected demand. We believe we have the
ability to adjust the level of production activity in our manufacturing
facilities to align with changes in order levels and economic conditions during
the quarter, if necessary. However, the mix of available product may not exactly
match the mix of product requested on a short-term basis.
In late August 2003, we completed the exit and sale of our information
appliance business, representing a key step in a series of profit-improvement
actions launched in February 2003 designed to improve our return on investment
and streamline our cost structure. Accordingly, we expect R&D expenses in the
second quarter of fiscal 2004 to be in the range of $86-$88 million, with SG&A
expenses in the range of $66-$68 million. As noted above, we expect our
investment in property, plant and equipment in total for fiscal 2004 to be
higher than fiscal 2003.
o Risk Factors
- -----------------
CONDITIONS INHERENT IN THE SEMICONDUCTOR INDUSTRY CAUSE PERIODIC FLUCTUATIONS IN
OUR OPERATING RESULTS. Rapid technological change and frequent introduction of
new technology leading to more complex and integrated products characterize the
semiconductor industry. The result is a cyclical environment with short product
life cycles, price erosion and high sensitivity to the overall business cycle.
Substantial capital and R&D investment are also required to support products and
manufacturing processes. As a result of these industry conditions, we have
experienced in the past and expect to experience in the future periodic
fluctuations in our operating results. Shifts in product mix toward, or away
from, higher margin products can also have a significant impact on our operating
results. As a result of these and other factors, our financial results can
fluctuate significantly from period to period.
OUR BUSINESS WILL BE HARMED IF WE ARE UNABLE TO COMPETE SUCCESSFULLY IN OUR
MARKETS. Competition in the semiconductor industry is intense. We compete with a
number of major corporations in the high-volume segment of the industry. These
include several multinational companies whose semiconductor business may be only
part of their overall operations, such as Koninklijke (Royal) Philips
Electronics, Matsushita, Motorola, NEC, Samsung and Toshiba. We also compete
with a large number of corporations such as Texas Instruments, ST
Microelectronics, Maxim, Analog Devices and Linear Technology that sell
competing products into some of the same markets that we target. Competition is
based on design and quality of products, product performance, price and service,
with the relative importance of these factors varying among products and
markets.
We cannot assure you that we will be able to compete successfully in the
future against existing or new competitors or that our operating results will
not be adversely affected by increased price competition. We may also compete
with several of our customers, particularly customers in the networking and
personal systems markets.
The wireless handset market continues to be important to our future growth
plans. New products are being developed to address new features and
functionality in handsets, such as color displays, advanced audio, lighting
features and image capture. Due to high levels of competition, as well as
complex technological requirements, there is no assurance that we will
ultimately be successful in this targeted market. Although the worldwide handset
market is large, near-term growth trends are uncertain and difficult to predict
with accuracy. Delayed introduction of next-generation wireless base stations
also negatively impacts potential growth in the wireless handset market.
IF DEVELOPMENT OF NEW PRODUCTS IS DELAYED OR MARKET ACCEPTANCE IS BELOW
EXPECTATIONS, FUTURE OPERATING RESULTS MAY BE UNFAVORABLY AFFECTED. We believe
that continued focused investment in research and development, especially the
timely development and market acceptance of new analog products, is a key factor
to our successful growth and our ability to achieve strong financial
performance. Successful development and introduction of new products are
critical to our ability to maintain a competitive position in the marketplace.
We will continue to invest resources to develop more highly integrated solutions
and building block products, both primarily based on our analog capabilities.
These products will continue to be targeted towards applications such as
wireless handsets, displays, notebook PCs, other portable devices and other
applications that require analog.
INVESTMENTS AND ACQUISITIONS. We have made and will continue to consider making
strategic business investments and alliances and acquisitions, if necessary, to
gain access to key technologies that we believe augment our existing technical
capability or enable us to achieve faster time to market. These activities
involve risks and uncertainties that may unfavorably impact our future financial
performance. We may not be able to integrate and develop the technologies we
acquire as expected. If the technology is not developed in a timely manner, we
may be unsuccessful in penetrating target markets. In addition, with any
acquisition there are risks that future operating results may be unfavorably
affected by acquisition related costs, including in-process R&D charges and
incremental R&D spending.
EXPANSION OF OUR BUSINESS IN THE ASIA MARKETS. As noted in our discussion of
planned capital expenditures, as part of our efforts to expand our business
presence in the Asia markets, we began construction of an assembly and test
facility in China's Suzhou Industrial Park in the Jiangsu Province of China
during the second quarter of fiscal 2003. We expect the facility to provide
analog products quickly and cost effectively to our customers in Asia, as well
as other regions as necessary. The facility will also increase our overall
assembly and test capacity to support increasing product volume. Increases in
product volume are dependent upon demand from our customers. If we do not
increase product volume, lower than expected factory utilization, which results
in higher manufacturing cost per unit, will unfavorably impact operating
results. In addition, unexpected start-up expenses, inefficiencies and delays in
the start of production in the facility may reduce our expected future gross
margin.
WE FACE RISKS FROM OUR INTERNATIONAL OPERATIONS. We conduct a substantial
portion of our operations outside the United States, and our business is subject
to risks associated with many factors beyond our control. These factors include:
- - fluctuations in foreign currency rates;
- - instability of foreign economies;
- - emerging infrastructures in foreign markets;
- - support required abroad for demanding manufacturing requirements;
- - foreign government instability and changes; and
- - U.S. and foreign laws and policies affecting trade and investment.
Although we did not experience any materially adverse effects from our
foreign operations as a result of these factors in the last year, one or more of
these factors has had an adverse effect on us in the past and they could
adversely affect us in the future. In addition, although we seek to hedge our
exposure to currency exchange rate fluctuations, our competitive position
relative to non-U.S. suppliers can be affected by the exchange rate of the U.S.
dollar against other currencies, particularly the Japanese yen and euro.
TAXES. From time to time, we have received notices of tax assessments from
certain governments of countries in which we operate. These governments or other
government entities may serve future notices of assessments on us and the
amounts of these assessments or our failure to favorably resolve such
assessments may have a material adverse effect on our financial condition or
results of operations.
CURRENT WORLD EVENTS. Recent unrest in the many parts of the world including the
continuing hostilities in Iraq and terrorist activities worldwide have resulted
in additional uncertainty on the overall state of the world economy. There is no
assurance that the consequences from these events will not disrupt our
operations either in the U.S. or other regions of the world where we have
operations. Although the SARS illness appears to have been contained, if it or
another such illness emerges, our business in Asia could be adversely affected.
The spread of such illnesses beyond Asia could also negatively impact other
aspects of our operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to Part II, Item 7A, Quantitative and Qualitative Disclosures About Market
Risk, in our Annual Report on Form 10-K for the year ended May 25, 2003 and to
the subheading "Financial Market Risks" under the heading "Management's
Discussion and Analysis of Financial Condition and Results of Operations" on
page 26 of our Annual Report on Form 10-K for the year ended May 25, 2003 and in
Note 1, "Summary of Significant Accounting Policies," and Note 2, "Financial
Instruments," in the Notes to the Consolidated Financial Statements included in
Item 8 of our 2003 Form 10-K. There have been no material changes in market risk
from the information reported in these sections.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
We maintain disclosure controls and procedures that are intended to ensure
that the information required to be disclosed in our Exchange Act filings
is properly and timely recorded, processed, summarized and reported. In
designing and evaluating our disclosure controls and procedures, our
management recognizes that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving
the desired control objectives, and that management necessarily is required
to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures. Since we have investments in certain
unconsolidated entities which we do not control or manage, our disclosure
controls and procedures with respect to such entities are necessarily
substantially more limited than those we maintain for our consolidated
subsidiaries.
We have a disclosure controls committee comprised of key individuals
from a variety of disciplines in the company that are involved in the
disclosure and reporting process. The committee meets regularly to ensure
the timeliness, accuracy and completeness of the information required to be
disclosed in our filings. The committee reviewed this Form 10-Q and also
met with the Chief Executive Officer and the Chief Financial Officer to
review this Form 10-Q and the required disclosures and the effectiveness of
the design and operation of our disclosure controls and procedures. As
required by SEC Rule 13a-15(b), the committee performed an evaluation,
under the supervision and with the participation of management, including
our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of the end of the quarter covered by this report. Based on
that evaluation and their supervision of and participation in the process,
our Chief Executive Officer and Chief Financial Officer have concluded that
our disclosure controls and procedures were effective at the reasonable
assurance level.
(b) Changes in internal controls.
There has been no change in our internal controls over financial reporting
during our most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal controls over
financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
o Tax Matters
The IRS has completed examining our tax returns for fiscal years 1997 through
2000 and on July 29, 2003 issued a notice of proposed adjustment seeking
additional taxes of approximately $19 million (exclusive of interest) for those
years. The issues giving rise to most of the proposed adjustments relate to R&D
credits, inventory and depreciation deductions. We intend to contest the
adjustments administratively. We are also in the process of undergoing a tax
audit in the Netherlands and from time to time our tax returns are audited in
the U.S. by state agencies and at international locations by local tax
authorities. We believe we have made adequate tax payments and/or accrued
adequate amounts in our financial statements to cover the amounts sought by the
IRS, as well as any other deficiencies that other governmental agencies may find
in their audits.
o Other
In November 2000, a derivative action was filed in the U.S. District Court in
Delaware against us, Fairchild Semiconductor International, Inc. and Sterling
Holding Company, LLC, by Mark Levy, a Fairchild stockholder. The action was
brought under Section 16(b) of the Securities Exchange Act of 1934 and the rules
issued under that Act by the Securities and Exchange Commission. The plaintiff
seeks disgorgement of alleged short-swing insider trading profits. We had
originally acquired Fairchild common and preferred stock in March 1997 at the
time we disposed of the Fairchild business. Prior to its initial public offering
in August 1999, Fairchild had amended its certificate of incorporation to
provide that all Fairchild preferred stock would convert automatically to common
stock upon completion of the initial public offering. As a result, our shares of
preferred stock converted to common stock in August 1999. Plaintiff has alleged
that the acquisition of common stock through the conversion constituted an
acquisition that should be "matched" against our sale in January 2000 of
Fairchild common stock for purposes of computing short-swing trading profits.
The action seeks to recover from us on behalf of Fairchild alleged recoverable
profits of approximately $14 million. In February 2002, the judge in the case
granted the motion to dismiss filed by us and our co-defendants and dismissed
the case, ruling that the conversion was done pursuant to a reclassification
which is exempt from the scope of Section 16(b). Plaintiff appealed the
dismissal of the case and upon appeal, the U.S. Court of Appeals for the third
circuit reversed the District Court's dismissal. Our petition for a panel
rehearing and/or rehearing en banc was denied by the Appeals Court in April
2003. Our motion to stay the issuance of the Appeals Court mandate to the
District Court pending our petition to the U.S. Supreme Court was denied in May
2003. We have filed a petition for a writ of certiorari with the U.S. Supreme
Court and we intend to continue to contest the case through all available means.
You should also refer to the Legal Proceedings section in our Form 10-K for
the fiscal year ended May 25, 2003 for a complete description of our other
existing material legal proceedings.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Second Restated Certificate of Incorporation of the Company as amended
(incorporated by reference from the Exhibits to our Registration Statement
on Form S-3 Registration No. 33-52775, which became effective March 22,
1994); Certificate of Amendment of Certificate of Incorporation dated
September 30, 1994 (incorporated by reference from the Exhibits to our
Registration Statement on Form S-8 Registration No. 333-09957, which became
effective August 12, 1996); Certificate of Amendment of Certificate of
Incorporation dated September 22, 2000 (incorporated by reference from the
Exhibits to our Registration Statement on Form S-8 Registration No.
333-48424, which became effective October 23, 2000).
3.2 By Laws of the Company, as amended effective October 30, 2001.
(incorporated by reference from the Exhibits to our Form 10-K for the year
ended May 26, 2002 filed August 16, 2002).
4.1 Form of Common Stock Certificate (incorporated by reference from the
Exhibits to our Registration Statement on Form S-3 Registration No.
33-48935, which became effective October 5, 1992).
4.2 Rights Agreement (incorporated by reference from the Exhibits to our
Registration Statement on Form 8-A filed August 10, 1988); First Amendment
to the Rights Agreement dated as of October 31, 1995 (incorporated by
reference from the Exhibits to our Amendment No. 1 to the Registration
Statement on Form 8-A filed December 11, 1995); Second Amendment to the
Rights Agreement dated as of December 17, 1996 (incorporated by reference
from the Exhibits to our Amendment No. 2 to the Registration Statement on
Form 8-A filed January 17, 1997).
10.1 Agreement with Ralph V. Whitworth; Relational Investors, L.P.; and
Relational Investors LLC dated July 21, 2003 (incorporated by reference
from the Exhibits to our Form 8-K filed July 23, 2003.)
10.2 Management Contract or Compensatory Plan or Arrangement: Fiscal Year 2004
Executive Officer Incentive Plan Agreement
10.3 Management Contract or Compensatory Plan or Agreement: Fiscal year 2004 Key
Employee Incentive Plan
31. Rule 13a - 14(a)/15d - 14(a) Certifications
32. Section 1350 Certifications
(b) Reports on Form 8-K
During the quarter ended August 24, 2003, we filed the following reports on
Form 8-K:
1. A report on Form 8-K was filed on June 5, 2003 furnishing to the
Securities and Exchange Commission as part of Regulation FD disclosure
our press release issued on June 5, 2003 announcing our earnings for
the quarter ended May 25, 2003. The news release contained financial
statements consisting of Condensed Consolidated Statements of
Operations, Balance Sheets and Statements of Cash Flows prepared in
accordance with GAAP. Certain reconciliations which were not prepared
in accordance with GAAP were also included in the press release.
2. A report on Form 8-K was filed on July 23, 2003 reporting as
Regulation FD disclosure our agreement with Ralph V. Whitworth,
Relational Investors, L.P., Relational Investors, LLC and other funds
and partnerships controlled by Relational Investors, L.P. and
Relational Investors, LLC (collectively, "Relational"). The agreement
provides, inter alia, for the withdrawal of Relational's nomination of
its candidates for election to National's board and access to
National's management being made available to Relational. A copy of
the agreement was included in the Form 8-K. No financial statements
were included in the Form 8-K.
3. A report on Form 8-K was filed on July 31, 2003 reporting as
Regulation FD disclosure that our board of directors had authorized a
program to repurchase up to $400 million of our stock. The press
release announcing the program was included in the Form 8-K. No
financial statements were included in the Form 8-K.
4. A report on Form 8-K was filed on August 7, 2003 reporting as
Regulation FD disclosure that we had signed a definitive agreement to
sell our Information Appliance business unit to Advanced Micro
Devices, Inc. The press release announcing the signing of the
agreement was included in the Form 8-K. No financial statements were
included in the Form 8-K.
SIGNATURE
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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.
NATIONAL SEMICONDUCTOR CORPORATION
Date: October 2, 2003 \s\Robert E. DeBarr
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Robert E. DeBarr
Controller
Signing on behalf of the registrant
and as principal accounting officer