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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 February 27, 2005
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 February 27, 2005
------------------- --------------------------------
Common stock, par value $0.50 per share 349,078,971
NATIONAL SEMICONDUCTOR CORPORATION
INDEX
Page No.
--------
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Statements of Operations (Unaudited) for
the Three Months and Nine Months Ended February 27, 2005 and
February 29, 2004 3
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
for the Three Months and Nine Months Ended February 27, 2005 and
February 29, 2004 4
Condensed Consolidated Balance Sheets (Unaudited) as of
February 27, 2005 and May 30, 2004 5
Condensed Consolidated Statements of Cash Flows (Unaudited) for
the Nine Months Ended February 27, 2005 and February 29, 2004 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7-16
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 17-30
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 31
Part II. Other Information
Item 1. Legal Proceedings 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33
Item 6. Exhibits 34
Signature 35
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(In Millions, except per share amounts)
Three Months Ended Nine Months Ended
-------------------------- -------------------------
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
2005 2004 2005 2004
------------ ------------- ------------ ------------
Net sales $ 449.2 $ 513.6 $ 1,446.1 $ 1,411.9
Operating costs and expenses:
Cost of sales 212.6 249.5 680.9 710.4
Research and development 80.7 87.5 248.5 265.0
Selling, general and administrative 62.1 71.1 193.8 210.1
Cost reduction and restructuring charges (credit) 20.1 (1.9) 21.3 16.7
Other operating income, net (7.4) (0.7) (28.5) (8.0)
------------ ------------- ------------ ------------
Total operating costs and expenses 368.1 405.5 1,116.0 1,194.2
------------ ------------- ------------ ------------
Operating income 81.1 108.1 330.1 217.7
Interest income, net 4.3 2.1 10.4 7.7
Other non-operating expense, net (0.6) (1.9) (3.8) (6.4)
------------ ------------- ------------ ------------
Income before taxes and cumulative
effect of a change in accounting principle 84.8 108.3 336.7 219.0
Income tax expense 7.4 15.2 51.6 28.5
------------ ------------- ------------ ------------
Income before cumulative effect of a
change in accounting principle 77.4 93.1 285.1 190.5
Cumulative effect of a change in accounting
principle including tax effect of $0.2 million - - - (1.9)
------------ ------------- ------------ ------------
Net income $ 77.4 $ 93.1 $ 285.1 $ 188.6
============ ============= ============ ============
Earnings per share:
Income before cumulative effect of a
change in accounting principle:
Basic $ 0.22 $ 0.26 $ 0.80 $ 0.53
Diluted $ 0.21 $ 0.24 $ 0.76 $ 0.49
Cumulative effect of a change in accounting
principle including tax effect of $0.2 million:
Basic $ - $ - $ - $ (0.01)
Diluted $ - $ - $ - $ (0.01)
Net income:
Basic $ 0.22 $ 0.26 $ 0.80 $ 0.52
Diluted $ 0.21 $ 0.24 $ 0.76 $ 0.49
Weighted-average shares used to calculate earnings per share:
Basic 353.2 357.4 355.5 362.2
Diluted 374.0 389.4 376.6 388.0
See accompanying Notes to Condensed Consolidated Financial Statements
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME (Unaudited)
(In Millions)
Three Months Ended Nine Months Ended
--------------------------- ----------------------------
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
2005 2004 2005 2004
------------- ------------- ------------- --------------
Net income $ 77.4 $ 93.1 $ 285.1 $ 188.6
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on
available-for-sale securities (0.5) 0.6 (0.3) (1.7)
Unrealized gain on cash flow hedges - - - 0.2
------------- ------------- ------------- --------------
Comprehensive income $ 76.9 $ 93.7 $ 284.8 $ 187.1
============= ============= ============= ==============
See accompanying Notes to Condensed Consolidated Financial Statements
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(In Millions)
Feb. 27, May 30,
2005 2004
------------------------ ---------------------
ASSETS
Current assets:
Cash and cash equivalents $ 732.7 $ 642.9
Short-term marketable investments 138.1 139.3
Receivables, less allowances of $33.3 in fiscal 2005
and $46.7 in fiscal 2004 145.1 198.9
Inventories 185.4 200.1
Other current assets 43.4 64.6
------------------------ ---------------------
Total current assets 1,244.7 1,245.8
Net property, plant and equipment 638.3 699.6
Goodwill 173.3 173.3
Deferred tax assets 89.2 73.3
Other assets 105.1 88.4
------------------------ ---------------------
Total assets $2,250.6 $2,280.4
======================== =====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ - $ 22.1
Accounts payable 68.7 141.0
Accrued expenses 151.9 234.8
Income taxes payable 50.7 63.4
------------------------ ---------------------
Total current liabilities 271.3 461.3
Long-term debt 23.6 -
Other noncurrent liabilities 144.4 138.6
------------------------ ---------------------
Total liabilities 439.3 599.9
------------------------ ---------------------
Commitments and contingencies
Shareholders' equity:
Common stock 174.5 178.8
Additional paid-in capital 887.5 1,030.1
Retained earnings 838.0 560.0
Accumulated other comprehensive loss (88.7) (88.4)
------------------------ ---------------------
Total shareholders' equity 1,811.3 1,680.5
------------------------ ---------------------
Total liabilities and shareholders' equity $2,250.6 $2,280.4
======================== =====================
See accompanying Notes to Condensed Consolidated Financial Statements
NATIONAL SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(In Millions)
Nine Months Ended
--------------------------------------
Feb. 27, Feb. 29,
2005 2004
--------------- ---------------
Cash flows from operating activities:
Net income $ 285.1 $ 188.6
Adjustments to reconcile net income with net cash
provided by operating activities:
Cumulative effect of a change in accounting principle - 1.9
Depreciation, amortization, and accretion 147.6 160.9
Gain on investments (0.7) (4.2)
Share in net losses of equity-method investments 4.0 10.8
Tax benefit associated with stock options 3.9 -
Loss on disposal of equipment 1.0 6.0
Impairment of technology license 0.5 -
Noncash cost reduction charges (credit) and other operating
income, net (19.4) 1.4
Other, net 2.5 3.1
Changes in certain assets and liabilities, net:
Receivables 55.5 (17.3)
Inventories 14.6 (49.0)
Other current assets 8.3 (35.0)
Accounts payable and accrued expenses (131.6) 3.1
Income taxes (16.3) 18.3
Other noncurrent liabilities 5.8 16.5
--------------- ---------------
Net cash provided by operating activities 360.8 305.1
--------------- ---------------
Cash flows from investing activities:
Purchase of property, plant and equipment (83.3) (153.8)
Sale and maturity of available-for-sale securities - 339.0
Purchase of available-for-sale securities - (386.7)
Sale of investments 0.7 9.3
Sale of business 10.0 -
Investment in nonpublicly traded companies (0.3) (1.8)
Security deposits on leased equipment (17.4) (2.8)
Funding of benefit plan (7.1) (4.8)
Other, net 0.4 0.5
--------------- ---------------
Net cash used by investing activities (97.0) (201.1)
--------------- ---------------
Cash flows from financing activities:
Payments on software license obligations (13.6) (21.0)
Repayment of debt - (2.1)
Issuance of common stock 72.2 149.3
Purchase and retirement of treasury stock (225.5) (400.0)
Cash dividends declared and paid (7.1) -
--------------- ---------------
Net cash used by financing activities (174.0) (273.8)
--------------- ---------------
Net change in cash and cash equivalents 89.8 (169.8)
Cash and cash equivalents at beginning of period 642.9 802.2
--------------- ---------------
Cash and cash equivalents at end of period $ 732.7 $ 632.4
=============== ===============
See accompanying Notes to Condensed Consolidated Financial Statements
Note 1. Summary of Significant Accounting Policies
Basis of Presentation:
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and in the opinion of management, 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 accompanying notes included in
our annual report on Form 10-K for the fiscal year ended May 30, 2004.
Earnings Per Share:
A reconciliation of the shares used in the computation of basic and diluted
earnings per share follows:
Three Months Ended Nine Months Ended
------------------------ -----------------------
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
(In Millions) 2005 2004 2005 2004
------------ ----------- ----------- -----------
Numerator:
Income before cumulative effect of a
change in accounting principle $ 77.4 $ 93.1 $ 285.1 $ 190.5
============ =========== =========== ===========
Net income $ 77.4 $ 93.1 $ 285.1 $ 188.6
============ =========== =========== ===========
Denominator:
Weighted-average common shares outstanding
used for basic earnings per share 353.2 357.4 355.5 362.2
Effect of dilutive securities:
Stock options 20.8 32.0 21.1 25.8
------------ ----------- ----------- -----------
Weighted-average common and potential
common shares outstanding used for
diluted earnings per share 374.0 389.4 376.6 388.0
============ =========== =========== ===========
For the third quarter of fiscal 2005, we did not include options
outstanding to purchase 22.2 million shares of common stock with a
weighted-average exercise price of $24.81 in diluted earnings per share since
their effect was antidilutive because the exercise price of these options
exceeded the average market price of the common stock during the quarter. For
the first nine months of fiscal 2005, we did not include options outstanding to
purchase 33.5 million shares of common stock with a weighted-average exercise
price of $22.22 in diluted earnings per share since their effect was
antidilutive because the exercise price of these options exceeded the average
market price of the common stock during the same period. However, these shares
could potentially dilute earnings per share in the future.
For the third quarter of fiscal 2004, we did not include options
outstanding to purchase 13.2 million shares of common stock with a
weighted-average exercise price of $29.16 in diluted earnings per share since
their effect was antidilutive because the exercise price of these options
exceeded the average market price of the common stock during the quarter. For
the first nine months of fiscal 2004, we did not include options outstanding to
purchase 28.2 million shares of common stock with a weighted-average exercise
price of $22.93 in diluted earnings per share since their effect was
antidilutive because the exercise price of these options exceeded the average
market price of the common stock during the same period. However, these shares
could potentially dilute earnings per share in the future.
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 11 to the Consolidated Financial
Statements included in our annual report on Form 10-K for the year ended May 30,
2004.
Pro forma information regarding net income and earnings per share is
required by Statement of Financial Accounting Standard 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 third quarter and first nine months of fiscal 2005 was $11.04
and $11.78 per share, respectively. The weighted-average fair value of stock
options granted during the third quarter and first nine months of fiscal 2004
was $12.27 and $8.62 per share, respectively. The weighted-average fair value of
rights granted under the stock purchase plan was $5.15 and $5.61 per share for
the third quarter and first nine months of fiscal 2005, respectively. The
weighted-average fair value of rights granted under the stock purchase plans was
$3.74 and $2.58 per share for the third quarter and first nine months of fiscal
2004, respectively. We estimated the fair value of these employee stock-based
awards using a Black-Scholes option pricing model that uses the following
weighted-average assumptions:
Three Months Ended Nine Months Ended
----------------------------- ----------------------------
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
2005 2004 2005 2004
-------------- -------------- ------------- --------------
Stock Option Plans
Expected life (in years) 5.5 5.4 5.2 5.2
Expected volatility 71% 74% 72% 76%
Risk-free interest rate 4.0% 3.1% 3.4% 3.2%
Dividend yield 1.3% - 1.2% -
Stock Purchase Plans
Expected life (in years) 0.4 0.3 0.5 0.3
Expected volatility 49% 41% 47% 48%
Risk-free interest rate 1.7% 1.0% 1.4% 0.9%
Dividend yield 0.1% - 0.1% -
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 purchase period for stock purchases under the stock purchase
plans. The pro forma information follows:
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
Feb. 27, 2005 Feb. 29, 2004 Feb. 27, Feb. 29, 2004
(In Millions, Except Per Share Amounts) 2005
-------------- -------------- ------------- ---------------
Net income - as reported $ 77.4 $ 93.1 $ 285.1 $ 188.6
Add back: Stock compensation charge included in
net income determined under the intrinsic value
method, net of tax 0.6 0.6 1.8 1.8
Deduct: Total stock-based employee compensation
expense determined under the fair value method,
net of tax (50.0) (42.6) (108.3) (125.8)
-------------- -------------- ------------- ---------------
Net income - pro forma $ 28.0 $ 51.1 $ 178.6 $ 64.6
============== ============== ============= ===============
Basic earnings per share - as reported $ 0.22 $ 0.26 $ 0.80 $ 0.52
Basic earnings per share - pro forma $ 0.08 $ 0.14 $ 0.50 $ 0.18
Diluted earnings per share - as reported $ 0.21 $ 0.24 $ 0.76 $ 0.49
Diluted earnings per share - pro forma $ 0.07 $ 0.13 $ 0.47 $ 0.17
Reclassifications:
Certain amounts reported in fiscal 2004 have been reclassified to conform to the
fiscal 2005 presentation. Net operating results have not been affected by the
reclassification.
Note 2. Consolidated Financial Statement Details
Balance sheets:
(In Millions) Feb. 27, May 30,
2005 2004
----------------------------- ----------------------------
Inventories:
Raw materials $ 12.6 $ 13.9
Work in process 115.5 122.6
Finished goods 57.3 63.6
----------------------------- ----------------------------
Total inventories $ 185.4 $ 200.1
============================= ============================
Statements of operations:
Three Months Ended Nine Months Ended
--------------------------- -------------------------
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
(In Millions) 2005 2004 2005 2004
-------------- ------------ ------------ ------------
Other operating (income) expense:
Release of litigation accrual $ - $ - $ (10.0) $ -
Sale of business - - (8.8) -
Manufacturer's Investment Credit refund (7.4) - (7.4) -
Net intellectual property income (1.7) (0.7) (4.0) (8.7)
Intellectual property settlements 1.7 - 1.7 0.7
-------------- ------------ ------------ ------------
Total other operating income, net $ (7.4) $ (0.7) $ (28.5) $ (8.0)
============== ============ ============ ============
Interest income (expense):
Interest income $ 4.7 $ 2.6 $ 11.6 $ 8.5
Interest expense (0.4) (0.5) (1.2) (0.8)
-------------- ------------ ------------ ------------
Interest income, net $ 4.3 $ 2.1 $ 10.4 $ 7.7
============== ============ ============ ============
Other non-operating income (expense):
Net gain on investments:
Gain from sale of available-for-sale securities $ - $ 0.2 $ - $ 0.2
Non-marketable investments
Gain from sale 0.1 0.9 0.7 3.9
Impairment losses - (0.3) - (0.3)
Other investment gain - 0.4 - 0.4
-------------- ------------ -- ------------ ------------
Total net gain on investments 0.1 1.2 0.7 4.2
Share in net losses of equity-method
investments (0.7) (3.1) (4.0) (10.8)
Other - - (0.5) 0.2
-------------- ------------ ------------ ------------
Total other non-operating expense, net $ (0.6) $ (1.9) $ (3.8) $ (6.4)
============== ============ ============ ============
During the third quarter of fiscal 2005, we received a $7.4 million refund from
the State of California as a result of the State's decision to grant our claim
for a refund that we had previously filed for under the California
Manufacturer's Investment Credit.
We adopted the provisions of Emerging Issues Task Force Issue No. 02-14,
"Whether an Investor Should Apply the Equity Method of Accounting to Investments
Other Than Common Stock," at the beginning of our fiscal 2005 third quarter. In
EITF Issue No. 02-14, the Task Force reached a consensus that when an investor
has the ability to exercise significant influence over the operating and
financial policies of an investee, the investor should apply the equity method
of accounting only when it has an investment in common stock and/or an
investment that is in-substance common stock. The Task Force also reached a
consensus on the definition of in-substance common stock and provided related
guidance. We evaluated our investments subject to this EITF and determined that
substantially all investments that were previously accounted for under the
equity method of accounting should continue to be accounted for under the equity
method of accounting. As a result, the adoption of EITF 02-14 had no material
impact on our consolidated financial statements.
Note 3. Consolidated Statement of Cash Flows Information
Nine Months Ended
----------------------------------------
Feb. 27, Feb. 29,
(In Millions) 2005 2004
-------------------- -------------------
Supplemental Disclosure of Cash Flows Information:
Cash paid for:
Interest $ 1.2 $ 0.8
Income taxes $ 72.0 $ 12.4
Supplemental Schedule of Non-cash Investing
and Financing Activities:
Issuance of stock for employee benefit plans $ - $ 0.9
Issuance of common stock to directors $ 1.0 $ 0.4
Unearned compensation relating to restricted stock issuance $ 1.2 $ 2.1
Restricted stock cancellation $ 1.4 $ 1.1
Change in unrealized gain on cash flow hedges $ - $ 0.2
Change in unrealized (gain) loss on available-for-sale securities $ (0.3) $ (1.7)
Acquisition of software license under long-term contracts $ - $ 20.7
Repurchase of common stock upon settlement of an advance
repurchase contract $ 30.0 $ -
Note 4. Cost Reduction and Restructuring Programs
In January 2005, we announced actions to reduce expenses and streamline
manufacturing in line with the lower utilization of our manufacturing facilities
that we have recently experienced. This resulted in a reduction-in-force of 525
employees, consisting of 421 employees working in our manufacturing facilities
worldwide and 104 employees from product lines and support functions at various
sites, including our headquarters in Santa Clara. These actions are consistent
with our strategy of focusing on higher value-added analog products in order to
consistently generate a high return on capital. The majority of the affected
employees departed during the third quarter with the remainder expected to
depart by the end of fiscal 2005. Severance payments are generally paid 30-60
days after the employee's actual departure date. The total charge was $21.2
million, primarily related to severance, which was recorded in the third quarter
of fiscal 2005. This charge was partially offset by a $1.1 million credit
recognized upon the completion of activities related to prior cost reduction
actions. The credit included a $0.6 million release of an accrual for other
exit-related costs, primarily coming from lease obligations where we were able
to obtain subleases on more favorable terms than originally estimated and a $0.5
million release of an accrual for residual severance costs representing the
difference between the actual amounts paid and our original estimated amounts.
As a result, operating results for the third quarter of fiscal 2005 include a
net charge of $20.1 million for cost reduction programs.
We recorded a gain of $8.8 million during the first nine months of fiscal
2005 upon completion of the sale of certain intellectual property, inventory and
equipment of our imaging business to Eastman Kodak Company in September 2004.
The carrying value of the assets sold was $0.9 million. As part of the
transaction, Kodak also hired 47 former National employees. The divestiture of
this business is consistent with our ongoing effort to focus on our core analog
areas that generate higher gross margins and produce higher returns on invested
capital. Since an intangible asset and certain employees that directly supported
the imaging business were not included in the sale, we incurred cost reduction
charges for severance for those employees and for the impairment of the asset at
the time we announced the sale of the imaging business in late August 2004.
Operating results for the first nine months of fiscal 2005 also include a $1.2
million cost reduction charge for the imaging severance and impairment loss as
well as severance charges related to other cost reduction actions in the first
quarter.
Further detail related to cost reduction charges discussed above is
presented in the following tables:
Three Months Ended February 27, 2005
---------------------------------------------
Analog
(In Millions) Segment All Others Total
-------------- --------------- --------------
Cost reduction charges:
Streamline operations:
Severance costs $ 1.6 $19.6 $21.2
Release of reserves:
Severance costs - (0.5) (0.5)
Other exit-related costs - (0.6) (0.6)
-------------- --------------- --------------
Total cost reduction charges $ 1.6 $18.5 $20.1
============== =============== ==============
Nine Months Ended February 27, 2005
---------------------------------------------
Analog
(In Millions) Segment All Others Total
-------------- --------------- --------------
Cost reduction charges:
Streamline operations:
Severance costs $ 1.6 $19.6 $21.2
Imaging business divestiture:
Severance costs 0.3 0.4 0.7
Asset write-off 0.5 - 0.5
Release of reserves:
Severance costs - (0.5) (0.5)
Other exit-related costs - (0.6) (0.6)
-------------- --------------- --------------
Total cost reduction charges $ 2.4 $18.9 $21.3
============== =============== ==============
Noncash charges of $0.5 million included in the above table relate to the
write-off of the intangible asset that was a part of the imaging business. In
connection with the imaging disposition, we also entered into separate
agreements with Kodak where we will manufacture product for them at prices
specified by the terms of the agreement, which we believe approximate market
prices, and provide certain transition services at rates that approximate fair
market value. These agreements are effective for one year unless terminated
earlier as permitted under their terms.
The following table provides a summary of the activities for the nine
months ended February 27, 2005 related to our cost reduction and restructuring
actions that are included in accrued expenses:
Cost Reduction and
Restructuring Actions in
Fiscal 2005 Actions Prior Years
-------------------------------- ---------------------------
Imaging
Streamline Business
Operations Divestiture
---------------- ------------
Other Exit
(In Millions) Severance Severance Severance Costs Total
---------------- ------------ ------------ -------------- ----------
Balance at
May 30, 2004 $ - $ - $ 3.4 $ 7.5 $ 10.9
Cost reduction charges 21.2 0.7 - - 21.9
Release of reserves - - (0.5) (0.6) (1.1)
Cash payments (13.9) (0.5) (2.5) (2.1) (19.0)
---------------- ------------ ------------ -------------- ----------
Balance at
February 27, 2005 $ 7.3 $ 0.2 $ 0.4 $ 4.8 $ 12.7
================ ============ ============ ============== ==========
During the first nine months of fiscal 2005 we paid severance to 452
employees in connection with workforce reductions related to actions that
occurred in fiscal 2005 and 2004. Amounts paid for other exit-related costs
during the first nine months of fiscal 2005 were primarily for payments under
lease obligations associated with actions taken in prior years.
Payments for the remaining $7.3 million and $0.2 million severance balances
for fiscal 2005 cost reduction actions are expected to be completed by early
fiscal 2006, except for certain individuals where separate termination
agreements permit payment over specified time periods that do not exceed one
year. The remaining $0.4 million severance balance for cost reduction actions in
prior years is expected to be paid by early fiscal 2006. Other exit costs of
$4.8 million primarily relate to lease obligations, which are expected to be
paid through lease expiration dates that range from May 2005 through July 2009.
In March 2005, we announced that we have entered into an agreement to sell
our PC Super I/O business to Winbond Electronics Corporation, a Taiwanese
company. The PC Super I/O business was a part of our Advanced PC operating
segment that was reported under "All Others." This sale is consistent with our
ongoing strategy to focus on our analog capabilities. Under the terms of the
agreement, Winbond will acquire intellectual property and certain assets. The
assets, primarily machinery and equipment with a carrying value of $1.5 million,
have been classified as "Assets Held for Sale" and are included in Other Assets
on the condensed consolidated balance sheet as of February 27, 2005. In
addition, Winbond has agreed to hire approximately 150 employees, most of whom
are based at our research and design center in Herzlia, Israel. The sale is
expected to close during the fourth quarter of fiscal 2005 at which time we
expect to record a gain after determining final costs of the transaction.
Note 5. Long term Debt
On August 25, 2004, we amended an existing credit agreement with a bank to
extend the due date of our unsecured promissory note denominated in Japanese yen
($23.4 million at February 27, 2005). Under the terms of the amended agreement,
the promissory note will become due in August 2007 and bears interest at 1.375
percent over the 3-month Japanese LIBOR rate and is reset quarterly. We are also
required to comply with the covenants set forth under our multicurrency credit
agreement, which was renewed on October 20, 2004.
Note 6. Defined Benefit Pension Plans
Net periodic pension costs for fiscal 2005 for our defined benefit pension plans
maintained in the U.K., Germany, Japan and Taiwan are presented in the following
table:
Three Months Ended Nine Months Ended
--------------------------- -------------------------
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
(In Millions) 2005 2004 2005 2004
-------------- ------------ ------------ ------------
Service cost of benefits earned during the period $ 1.6 $ 1.7 $ 4.6 $ 4.4
Plan participant contributions (0.4) (0.3) (1.1) (0.7)
Interest cost on projected benefit obligation 3.3 3.4 9.7 8.8
Expected return on plan assets (2.5) (1.7) (7.4) (4.6)
Net amortization and deferral 1.3 1.6 3.8 4.3
-------------- ------------ ------------ ------------
Net periodic pension cost $ 3.3 $ 4.7 $ 9.6 $12.2
============== ============ ============ ============
Total contributions paid to these plans during fiscal 2005 were $0.8
million in the third quarter and $2.5 million in the first nine months. We
currently expect our fiscal 2005 contribution to total approximately $28
million.
Note 7. Shareholders' Equity
o Stock Repurchase Program
We continued our stock repurchase program during the third quarter of fiscal
2005. So far in fiscal 2005 in connection with the $400 million stock repurchase
program announced in March 2004, we have repurchased a total of 15.4 million
shares of our common stock for $255.5 million. Of these shares, 1.5 million
shares were repurchased for $30.0 million in June 2004 upon the final settlement
of an advance repurchase contract originally entered into with a financial
institution in April 2004. Under the terms of the advance repurchase contract,
we made an advance cash payment of $60.0 million in May 2004 that enabled us to
repurchase shares of our common stock at a fixed price on four specified
settlement dates. The advance payment was recorded as a note receivable and a
credit to additional paid-in capital. The remaining 13.9 million shares of
common stock were repurchased in the open market for $225.5 million during the
second and third quarters of fiscal 2005. As of February 27, 2005, we had $2.0
million remaining for future common stock repurchases under this program. In
March 2005, we announced that our Board of Directors had approved another $400
million stock repurchase program similar to our prior stock repurchase programs.
o Dividends
In March 2005, the Board of Directors declared a cash dividend of $0.02 per
outstanding share of common stock. The dividend will be paid on April 11, 2005
to shareholders of record at the close of business on March 21, 2005 and will be
recorded in the fourth quarter of fiscal 2005. We previously paid cash dividends
of $7.1 million during the first nine months of fiscal 2005.
Note 8. Segment Information
The following table presents information related to our reportable segments:
Analog
(In Millions) Segment All Others Total
-------------- ------------ -------------
Three months ended February 27, 2005:
Sales to unaffiliated customers $ 400.6 $ 48.6 $ 449.2
============== ============ =============
Segment income (loss) before taxes $ 99.8 $ (15.0) $ 84.8
============== ============ =============
Three months ended February 29, 2004:
Sales to unaffiliated customers $ 438.7 $ 74.9 $ 513.6
============== ============ =============
Segment income (loss) before taxes $ 110.1 $ (1.8) $ 108.3
============== ============ =============
Nine months ended February 27, 2005:
Sales to unaffiliated customers $ 1,254.3 $ 191.8 $ 1,446.1
============== ============ =============
Segment income before taxes $ 319.6 $ 17.1 $ 336.7
============== ============ =============
Nine months ended February 29, 2004:
Sales to unaffiliated customers $ 1,193.5 $ 218.4 $ 1,411.9
============== ============ =============
Segment income (loss) before taxes and
cumulative effect of a change in accounting
principle $ 247.0 $ (28.0) $ 219.0
============== ============ =============
Note 9. Income Taxes
On October 22, 2004 the American Jobs Creation Act (AJCA) was signed into law.
The AJCA provides for a deduction of 85% of certain non-U.S. earnings that are
repatriated, as defined in the AJCA. We may elect to apply this provision to
qualifying earnings repatriations in either fiscal 2005 or 2006. We have started
an evaluation of the effects of the repatriation provision; however, we do not
expect to complete this evaluation until after Congress and the U.S. Treasury
Department provide additional clarifying language on key elements of the
provision. We expect to complete our evaluation within a reasonable period of
time following the publication of the additional clarifying language. The range
of possible amounts that we are considering for repatriation under this
provision is between zero and $500 million. The potential range of related
income tax that may be incurred as a result of the repatriation is between zero
and $45 million.
Note 10. Contingencies - Legal Proceedings
o Environmental Matters
We have been named to the National Priorities List for our Santa Clara,
California site and we have completed a remedial investigation/feasibility study
with the Regional Water Quality Control Board (RWQCB), acting as an agent for
the Federal Environmental Protection Agency. We have agreed in principle with
the RWQCB to a site remediation plan and we are conducting remediation and
cleanup efforts at the site. In addition to the Santa Clara site, from time to
time we have been designated as a potentially responsible party (PRP) by
international, 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 fiscal periods covered in these condensed consolidated financial
statements.
As part of our disposition 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, we also agreed to retain liability for current
remediation projects and environmental matters arising from our prior operation
of certain Fairchild plants while Fairchild agreed to arrange for and perform
the remediation and cleanup. We prepaid to Fairchild the estimated costs of the
remediation and cleanup and we remain responsible for costs and expenses
incurred by Fairchild in excess of the prepaid amounts. To date, the costs
associated with the liabilities we have retained in these dispositions have not
been material and there have been no related legal proceedings.
o Tax Matters
The IRS has completed the field examinations of 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 $19.1 million (exclusive of interest)
for those years. We are contesting the adjustments through the IRS'
administrative process. Our tax returns are also audited in the U.S. by state
agencies and at international locations by local tax authorities from time to
time. We believe we have made adequate tax payments and/or accrued adequate
amounts in our financial statements to cover tax amounts sought by the IRS, as
well as any other deficiencies that other governmental agencies may find in the
audits.
o Other Matters
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' efforts to certify
a medical monitoring class were denied by the court. Discovery in the case is
continuing.
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. We have completed discovery in the case in the district court. In June
2004, the Securities and Exchange Commission proposed clarifying amendments to
its section 16(b) rules which we believe would be dispositive of the case. In
September 2004, the district court ordered a stay of the case pending the SEC's
adoption of the proposed amendments. We intend to continue to contest the case
through all available means should the SEC's proposed amendments not resolve the
case.
In April 2002, ZF Micro Solutions, Inc. brought suit against us alleging a
number of contract and tort claims related to an agreement we had entered into
in 1999 to design and manufacture a custom integrated circuit device for ZF
Micro Devices. ZF Micro Devices ceased business operations in February 2002 and
the case was brought by ZF Micro Solutions as successor to ZF Micro Devices.
Trial began in May 2004 and a verdict was rendered in June 2004. The jury found
for ZF Micro Solutions, Inc. on a claim of intentional misrepresentation,
awarding damages of $28.0 million, and on a claim of breach of the implied
covenant of good faith and fair dealing, awarding damages of $2.0 million. The
jury found for us on seven other of the plaintiff's claims and also found for us
on our cross-claim for breach of contract, awarding us damages of $1.1 million.
Subsequent to the trial, the court ordered the case to be retried in its
entirety. At a settlement conference held on December 16, 2004, the case was
settled. We paid to the plaintiff the sum of $20.0 million and granted to the
plaintiff a royalty free license for the manufacture and sale of the custom
device at issue in the case. All settlement documents have now been completed
and the case has been dismissed in its entirety. We originally recorded a loss
accrual of $30.0 million in fiscal 2004, which represented our best estimate at
the time of the loss that could be incurred. As a result of the settlement, we
recorded a credit of $10.0 million that was included in other operating income,
net, for the first nine months of fiscal 2005 to adjust the loss accrual to
equal the agreed settlement amount.
We are currently a party to various claims and legal proceedings, including
those noted above. We make provisions for a liability when it is both probable
that a liability has been incurred and the amount of the loss can be reasonably
estimated. We believe we have made adequate provisions for potential liability
in litigation matters. We review these provisions at least quarterly and adjust
these provisions to reflect the impact of negotiations, settlements, rulings,
advice of legal counsel and other information and events pertaining to a
particular case. Based on the information that is currently available to us, we
believe that the ultimate outcome of litigation matters, individually and in the
aggregate, will not have a material adverse effect on our results of operations
or consolidated financial position. However, litigation is inherently
unpredictable. If an unfavorable ruling or outcome were to occur, there is a
possibility of a material adverse effect on results of operations or our
consolidated financial position.
o Contingencies - Other
In connection with our past divestitures, 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 liabilities in our consolidated financial
statements.
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, R&D efforts and
asset dispositions and are indicated by words or phrases such as "anticipate,"
"expect," "outlook," "foresee," "believe," "could," "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 in various
markets such as wireless, PC and displays; pricing pressures and competitive
factors; delays in the introduction of new products or lack of market acceptance
for new products; risks of international operations; our success in integrating
acquisitions and achieving operating improvements with acquisitions; legislative
and regulatory changes; the outcome of legal, administrative and other
proceedings that we are involved in; the results of our programs to control and
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 30, 2004.
o Critical Accounting Policies and Estimates
------------------------------------------
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 we have persuasive evidence of an arrangement typically in the
form of a purchase order, title and risk of loss have passed to the
customer, the amount is fixed or determinable and collection of the revenue
is reasonably assured. We record a provision for estimated future returns
at the time of shipment. Approximately 47 percent of our semiconductor
product sales were made through distributors in the first nine months of
fiscal 2005. We have agreements with our distributors that cover various
programs, including pricing adjustments based on resale pricing and volume,
price protection for inventory, discounts for prompt payment and scrap
allowances. 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 by geography and
product family, inventory levels in the distribution channel, current
economic trends, and other related factors. 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.
Service revenues are recognized as the services are provided or as
milestones are achieved, depending on the terms of the arrangement. These
revenues are included in net sales and are not a material component of our
total net sales.
Intellectual property income is not classified as net sales since it
is not considered a source of revenue from our primary operations. This
income is classified as a component of other operating income, net, in the
consolidated statement of operations 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. Valuation of 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 inventory
down 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. 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.
Amortizable intangible assets subject to this evaluation include developed
technology we have acquired, patents and technology licenses. 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. 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 impairment evaluation of long-lived assets 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.
Our impairment evaluation of goodwill is based on comparing the fair
value to the carrying value of our 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 and device connectivity business
units, which are not reportable segments and are included in "All Others."
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 sustain
improvement, 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 assets and liabilities 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 enacted tax rate expected to be applied 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 on those 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 currently have recorded; such adjustment could have a material
impact on the tax expense for the fiscal year.
We account for income tax contingencies in accordance with SFAS No. 5,
"Accounting for Contingencies." The calculation of tax liabilities involves
significant judgment in estimating the impact of uncertainties in the
application of complex tax laws. Resolution of these uncertainties in a
manner inconsistent with our expectations could have a material impact on
our results of operations.
o Overview
--------
Through the first nine months of fiscal 2005, we have continued to pursue our
strategy of focusing on our analog product capabilities, particularly in the
standard linear segments. The World Semiconductor Trade Statistics (WSTS) define
"standard linear" as amplifiers, data converters, regulators and references
(power management products), and interface. As a part of this focus, we
periodically identify opportunities to divest or reduce involvement in product
areas that are not in line with our business objectives. For example, we
completed the sale of our imaging business in September 2004 and we announced
the signing of an agreement for the sale of our PC Super I/O business in March
2005. In addition, we also announced in March 2005 that we are seeking a buyer
for our assembly and test facility in Singapore, which is geared more towards
complex, digitally focused high-pin count products than analog products.
We achieved higher gross margins and profit in the first nine months of
fiscal 2005 over the same nine months of the last fiscal year, despite market
weakness in the two most recent quarters. This improved performance reflects our
shift toward a richer analog product mix, combined with ongoing cost controls.
In January 2005, we initiated a program to reduce expenses and streamline
manufacturing operations as we saw wafer fabrication utilization rates decline
in the second quarter of fiscal 2005 to the mid-60s due to significant inventory
reductions in the distribution channel and lower demand than expected in some
markets. For the remainder of fiscal 2005, we expect to continue our focus on
gross margin relative to sales with research and development investments aimed
primarily at high value analog growth areas.
In reviewing our performance we consider several key financial measures.
When reviewing our net sales performance, we look at sales growth rates, new
order rates (including turns orders), blended-average selling prices, sales of
new products and market share in the standard linear category as defined by
WSTS. We generally define new products as those introduced within the last three
years. We gauge our operating income performance based on gross margin trends,
product mix, blended-average selling prices, factory utilization rates and
operating expenses relative to sales. We are focused on generating a return on
invested capital that consistently exceeds our cost of capital by concentrating
on operating income, working capital management, capital expenditures and cash
management. We determine return on invested capital based on net operating
income after tax divided by invested capital, which generally consists of total
assets less goodwill and non-interest bearing liabilities.
We continued our stock repurchase program during the third quarter of
fiscal 2005. So far in fiscal 2005 in connection with the $400 million stock
repurchase program announced in March 2004, we have repurchased a total of 15.4
million shares of our common stock for $255.5 million. Of these shares, 1.5
million shares were repurchased for $30.0 million in June 2004 upon the
settlement of an advance repurchase contract entered into with a financial
institution in April 2004. The other 13.9 million shares of common stock were
repurchased in the open market for $225.5 million during the second and third
quarters of fiscal 2005. This stock repurchase program is one element of our
overall effort to improve our return on invested capital, which we believe
improves shareholder value. As of February 27, 2005, we had $2.0 million
remaining for future common stock repurchases under this program. In March 2005,
we announced that our Board of Directors had approved another $400 million stock
repurchase program similar to our prior stock repurchase programs. Our Board of
Directors has also declared a cash dividend of $0.02 per outstanding share of
common stock. The dividend is payable on April 11, 2005 to shareholders of
record at the close of business on March 21, 2005.
The following table and discussion provides an overview of our operating
results for the current fiscal year and recently completed third quarter (the
third quarter of last year contained an extra calendar week):
------------------------------------- -----------------------------------------
Three Months Ended Nine Months Ended
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
2005 % Change 2004 2005 % Change 2004
---------- -------------- ----------- ------------- --------------- -----------
Net sales $ 449.2 (13%) $ 513.6 $1,446.1 2% $1,411.9
Operating
Income $ 81.1 $ 108.1 $ 330.1 $ 217.7
As a % of net sales 18% 21% 23% 15%
Net income $ 77.4 $ 93.1 $ 285.1 $ 188.6
As a % of net sales 17% 18% 20% 13%
Sales for the first nine months of fiscal 2005 were higher than sales for
the first nine months of fiscal 2004 due to overall higher industry demand and
our market share gains in key standard linear markets, particularly for power
management products. Nevertheless, in recent months, we have seen distributors
and customers reduce inventory levels and end demand grow less rapidly than it
did in the first half of calendar year 2004. As a result, we experienced a drop
in sales in the third quarter of fiscal 2005 from sales in the third quarter of
fiscal 2004, even taking into consideration the extra week in the fiscal 2004
third quarter. During the third quarter of fiscal 2005, we continued to see
distributors reduce inventory levels, but to a lesser extent than in the prior
quarter, so sales in the third quarter stayed flat sequentially with the second
quarter of fiscal 2005. For the company overall, our unit shipments were down 16
percent in the third quarter and 5 percent in the first nine months of fiscal
2005 over the corresponding periods of fiscal 2004. However, our blended-average
selling prices were up in fiscal 2005 by 5 percent in the third quarter and 8
percent in the first nine months over the same corresponding periods of fiscal
2004. This blended-average is affected by product mix as well as changes in
product prices. The improvement in year-to-date net income was driven by these
higher blended-average selling prices, higher gross margin and lower operating
expenses. Foreign currency exchange rate fluctuations had a minimal favorable
impact on our foreign currency-denominated sales for the third quarter and first
nine months of fiscal 2005.
Net income for fiscal 2005 included cost reduction charges of $20.1 million
in the third quarter and $21.3 million in the first nine months of fiscal 2005
(See Note 4 to the Condensed Consolidated Financial Statements). Net income for
fiscal 2005 also includes other operating income, net of $7.4 million in the
third quarter and $28.5 million in the first nine months. Other operating
income, net for the third quarter of fiscal 2005 includes a refund of $7.4
million for the California Manufacturer's Investment Credit (See Note 2 to the
Condensed Consolidated Financial Statements) and net intellectual property
income of $1.7 million, offset by a $1.7 million charge related to an
intellectual property settlement. Other operating income, net for the first nine
months of fiscal 2005 includes a gain of $8.8 million from the sale of assets
associated with the imaging business that was completed in September 2004 (See
Note 4 to the Condensed Consolidated Financial Statements) and a credit of $10.0
million to adjust the loss accrual related to the ZF Micro Solutions, Inc.
litigation that was settled in December 2004 (See Note 10 to the Condensed
Consolidated Financial Statements). Other operating income, net for the first
nine months of fiscal 2005 also includes $4.0 million of net intellectual
property income, as well as the $7.4 million refund of the California
Manufacturer's Investment Credit and the $1.7 million charge related to an
intellectual property settlement.
Net income for fiscal 2004 included a $1.9 million credit in the third
quarter and a $16.7 million charge in the first nine months related to cost
reduction activities. The cost reduction charge for the first nine months of
fiscal 2004 included $18.6 million for charges connected with cost reduction
actions and the impact from the exit and sale of the information appliance
business completed in August 2003, offset by a $1.9 million credit arising from
the completion of prior cost reduction actions. Net income for fiscal 2004 also
included other operating income, net of $0.7 million in the third quarter and
$8.0 million in the first nine months. Other operating income in the third
quarter of fiscal 2004 included $0.7 million of net intellectual property
income. Other operating income, net in the first nine months of fiscal 2004
included $8.7 million of net intellectual property income that was offset by a
$0.7 million charge related to an intellectual property settlement. Net income
for the first nine months of fiscal 2004 also included a $1.9 million charge
(including a tax effect of $0.2 million) for the cumulative effect of a change
in accounting principle as a result of the adoption of SFAS No. 143, "Accounting
for Asset Retirement Obligations."
o Net Sales
---------
-------------------------------------- --------------------------------------
Three Months Ended Nine Months Ended
Feb. 27, Feb. 29, Feb. 27, Feb. 29,
2005 % Change 2004 2005 % Change 2004
---------- -------------- ------------ ------------ ------------ ------------
Analog $ 400.6 (9%) $ 438.7 $ 1,254.3 5% $ 1,193.5
As a % of net sales 89% 85% 87% 85%
All others 48.6 (35%) 74.9 191.8 (12%) 218.4
---------- ------------ ------------ ------------
As a % of net sales 11% 15% 13% 15%
Total net sales $ 449.2 $ 513.6 $ 1,446.1 $ 1,411.9
========== ============ ============ ============
100% 100% 100% 100%
The chart above and the following discussion are based on our reportable
segments described in Note 14 to the Consolidated Financial Statements included
in our annual report on Form 10-K for the year ended May 30, 2004.
The trends we have seen in sales for the company overall in the third
quarter and first nine months of fiscal 2005 were primarily attributable to the
Analog segment, which represents 87 percent of our total sales through the first
nine months of fiscal 2005. Analog segment sales for the first nine months of
fiscal 2005 were higher than sales for the first nine months of fiscal 2004,
driven by higher consumer demand for products such as wireless handsets and
notebook computers, and a general trend towards increased analog semiconductor
content in a variety of electronic products. However, efforts by distributors
and customers to reduce inventories combined with lower than expected demand
patterns caused sales in the third quarter to decrease from the level in the
corresponding quarter of fiscal 2004, even taking into consideration the extra
week in the fiscal 2004 third quarter. Although distributors have been reducing
inventories over the past two quarters, we did see inventory levels at
distributors stabilize in general towards the end of the recently completed
third quarter. Our analog unit shipments were down 16 percent in the third
quarter and 5 percent in the first nine months of fiscal 2005 over the
corresponding periods of fiscal 2004, but blended-average analog selling prices
were up by 9 percent in the third quarter and 11 percent in the first nine
months of fiscal 2005 over the same fiscal 2004 periods, reflecting both a mix
of higher value products as well as some actual price increases.
Within the Analog segment, sales from the power management area continued
to grow for fiscal 2005 with a 16 percent increase in the first nine months of
fiscal 2005 over the corresponding fiscal 2004 period, despite a decline of 3
percent in the fiscal 2005 third quarter from the fiscal 2004 third quarter.
Increased activity in wireless handsets largely drove the sales growth in power
management products. Sales from the audio amplifier and data conversion business
units increased 11 percent and 7 percent, respectively, in the first nine months
of fiscal 2005 over the corresponding fiscal 2004 period. However, sales from
these business units declined in the third quarter of fiscal 2005 compared to
the third quarter of fiscal 2004 by 9 percent and 7 percent, respectively. Sales
from the application-specific wireless (including radio frequency building
blocks) and non-audio amplifier business units declined in both the third
quarter of fiscal 2005 by 12 percent and 7 percent, respectively, and in the
first nine months of fiscal 2005 by 9 percent and 3 percent, respectively, from
the corresponding periods of fiscal 2004.
o Gross Margin
------------
------------------------------------ --------------------------------------
Three Months Ended Nine Months Ended
Feb. 27, Feb 29, Feb. 27, Feb 29,
2005 % Change 2004 2005 % Change 2004
---------- -------------- ---------- ----------- -------------- -----------
Net sales $ 449.2 (13%) $ 513.6 $ 1,446.1 2% $ 1,411.9
Cost of sales 212.6 (15%) 249.5 680.9 (4%) 710.4
---------- ---------- ----------- -----------
Gross margin $ 236.6 $ 264.1 $ 765.2 $ 701.5
========== ========== =========== ===========
As a % of net sales 53% 51% 53% 50%
The increase in the gross margin percentage for the third quarter and first nine
months of fiscal 2005 compared to the same periods of fiscal 2004 was mainly
driven by improvements in product mix and selling prices. In an effort to reduce
some manufacturing costs to mitigate the unfavorable impact from lower factory
utilization, which declined significantly in the fiscal 2005 second quarter, we
implemented mandatory factory shutdowns and we also initiated an action in
January 2005 to reduce the number of manufacturing personnel by 421. Wafer
fabrication capacity utilization during the first nine months of fiscal 2005 was
73 percent, based on wafer starts, compared to 92 percent for the first nine
months of fiscal 2004. As discussed in the Net Sales section above, our product
mix has improved through active efforts to increase the portion of our business
that comes from high value, higher performance analog products, which are more
proprietary in nature and can generate higher margins than products that are
less proprietary or are multi-sourced. Since these analog products generally
have higher margins than non-analog products, the growth in Analog segment sales
to 87 percent of total net sales in the first nine months of fiscal 2005 from 85
percent of total net sales in the first nine months of fiscal 2004 also had a
positive impact on gross margin.
o Research and Development
------------------------
------------------------------------ --------------------------------------
Three Months Ended Nine Months Ended
Feb. 27, Feb 29, Feb. 27, Feb 29,
2005 % Change 2004 2005 % Change 2004
---------- -------------- ---------- ----------- -------------- -----------
Research and
development $ 80.7 (8%) $ 87.5 $ 248.5 (6%) $ 265.0
As a % of net sales 18% 17% 17% 19%
Lower research and development expenses in the third quarter and first nine
months of fiscal 2005 compared to the same periods of fiscal 2004 largely
reflect reduced spending that is the result of our sale and exit of the
information appliance business in August 2003 and the completion in fiscal 2004
of other actions aimed at reducing our research and development expenses as a
percentage of sales. R&D expenses for fiscal 2005 also reflect reductions
beginning in the second quarter due to the sale of the imaging business. We are
continuing to focus our ongoing research and development spending on our analog
products and our underlying analog capabilities. Total company spending through
the first nine months of fiscal 2005 compared to the first nine months of fiscal
2004 was down 6 percent for new product development, as well as down 6 percent
for process and support technology. Although research and development spending
for the year is down as a whole and as a percentage of sales, research and
development spending on our key focus areas in the Analog segment increased as
we continue to invest in the development of new analog and mixed-signal
technology-based products for wireless handsets, displays, notebook PCs, other
portable devices, as well as applications for the broader markets requiring
analog technology. A significant portion of our research and development is
directed at power management technology.
o Selling, General and Administrative
-----------------------------------
------------------------------------ --------------------------------------
Three Months Ended Nine Months Ended
Feb. 27, Feb 29, Feb. 27, Feb 29,
2005 % Change 2004 2005 % Change 2004
---------- -------------- ---------- ----------- -------------- -----------
Selling, general and
administrative $ 62.1 (13%) $ 71.1 $ 193.8 (8%) $ 210.1
As a % of net sales 14% 14% 13% 15%
The reductions in selling, general and administrative expenses for the third
quarter and first nine months of fiscal 2005 compared to the same periods of
fiscal 2004 reflect our efforts to manage our cost structure. We also continue
to focus on reducing expenses through the implementation and maintenance of
discretionary cost control programs.
o Interest Income, Net
--------------------
-------------------------- -------------------------
Three Months Ended Nine Months Ended
Feb. 27, Feb 29, Feb. 27, Feb 29,
2005 2004 2005 2004
------------- ------------ ------------ ------------
Interest income $ 4.7 $ 2.6 $ 11.6 $ 8.5
Interest expense (0.4) (0.5) (1.2) (0.8)
------------- ------------ ------------ ------------
Interest income, net $ 4.3 $ 2.1 $ 10.4 $ 7.7
============= ============ ============ ============
The increase in interest income, net, for the third quarter and first nine
months of fiscal 2005 compared to the same periods of fiscal 2004 was due to an
increase in interest income from higher average cash balances and higher
interest rates. Interest expense in fiscal 2005 also includes the accretion of
interest associated with software license obligations.
o Other Non-Operating Expense, Net
--------------------------------
-------------------------- -------------------------
Three Months Ended Nine Months Ended
Feb. 27, Feb 29, Feb. 27, Feb 29,
2005 2004 2005 2004
------------- ------------ ------------ ------------
Net gain on investments $ 0.1 $ 1.2 $ 0.7 $ 4.2
Share in net losses of equity-method
investments (0.7) (3.1) (4.0) (10.8)
Other - - (0.5) 0.2
------------- ------------ ------------ ------------
Total other non-operating expense, net $ (0.6) $ (1.9) $ (3.8) $ (6.4)
============= ============ ============ ============
The components of other non-operating expense, net are primarily derived from
activities related to our investments. Net gain on investments in the third
quarter and first nine months of fiscal 2005 relates to the sale of shares in a
nonpublicly traded company. The net gain on investments in the third quarter and
first nine months of fiscal 2004 comes from the sale of shares in nonpublicly
traded companies and available for sale securities (See Note 2 to the Condensed
Consolidated Financial Statements). The share of net losses in equity-method
investments was lower in the third quarter and first nine months of fiscal 2005
than the corresponding fiscal 2004 periods since we now hold fewer equity-method
investments in nonpublic companies.
o Income Tax Expense
------------------
We recorded income tax expense of $7.4 million in the third quarter of fiscal
2005 compared to $15.2 million in the third quarter of fiscal 2004, and $51.6
million in the first nine months of fiscal 2005 compared to $28.5 million in the
first nine months of fiscal 2004. The effective tax rate for the third quarter
of fiscal 2005 is approximately 9 percent compared to approximately 14 percent
for the third quarter of fiscal 2004 primarily as a result of additional foreign
tax credits and $8.1 million of additional tax benefits that are now expected to
be realized.
The fiscal 2005 tax expense consists primarily of U.S. alternative minimum
tax, net of tax credit carryforwards and non-U.S. income taxes. It also includes
a benefit of $4.2 million from the resolution of a contingency related to a
foreign tax matter and a $1.8 million tax expense on the gain from sale of a
business that were both recorded in the second quarter and a $5.0 million tax
benefit arising from a change in prior tax provision estimates upon the filing
of our fiscal 2004 tax returns that was recorded in the third quarter. The
fiscal 2004 tax expense consisted primarily of U.S. alternative minimum tax, net
of operating loss and credit carryforwards, and non-U.S. income taxes.
o Liquidity and Capital Resources
-------------------------------
------------------------------
Nine Months Ended
Feb. 27, Feb. 29,
2005 2004
------------ --- -------------
Net cash provided by operating activities $ 360.8 $ 305.1
Net cash used by investing activities (97.0) (201.1)
Net cash used by financing activities (174.0) (273.8)
------------ -------------
Net change in cash and cash equivalents $ 89.8 $(169.8)
============ =============
The primary factors contributing to the changes in cash and cash equivalents in
the first nine months of fiscal 2005 and 2004 are described below:
The improvement in net income has been the primary contributor to the
increase in cash generated from operating activities in fiscal 2005. In the
first nine months of fiscal 2005, cash from operating activities was generated
primarily from net income, adjusted for noncash items (primarily depreciation
and amortization), which substantially offset the negative impact that came from
changes in working capital components, primarily from decreases in accounts
payable and accrued expenses. The decrease in the allowance for receivables in
the first nine months of fiscal 2005 comes from activity under distributor
incentive programs and lower receivables associated with the reduced level of
sales in the period. We also generated cash from operating activities in the
first nine months of fiscal 2004. The positive impact from net income, when
adjusted for noncash items (primarily depreciation and amortization), was
greater than the negative impact from changes in working capital components in
the first nine months of fiscal 2004.
Major uses of cash for investing activities during the first nine months of
fiscal 2005 included investment in property, plant and equipment of $83.3
million, primarily for the purchase of machinery and equipment, the payments of
$17.4 million for security deposits on leased equipment and $7.1 million for
funding of benefit plans, which was offset by proceeds of $10.0 million from the
sale of assets. Major uses of cash for investing activities for the first nine
months of fiscal 2004 included investment in property, plant and equipment of
$153.8 million, primarily for the purchase of machinery and equipment, and net
purchases of available-for-sale securities of $47.7 million.
The primary use of cash from our financing activities in the first nine
months of fiscal 2005 was for our repurchase of 13.9 million shares of our
common stock in the open market for $225.5 million, payments of $13.6 million on
software license obligations and $7.1 million for cash dividends. These amounts
were partially offset by proceeds of $72.2 million from the issuance of common
stock under employee benefit plans. The primary use of cash from financing
activities in the first nine months of fiscal 2004 was for our repurchase of
25.4 million shares of our common stock for $400.0 million and payments of $21.0
million on software license obligations. These amounts were partially offset by
proceeds of $149.3 million from the issuance of common stock under employee
benefit plans.
In March 2005, we announced that our Board of Directors had approved a $400
million stock repurchase program similar to the previous two programs approved
in fiscal 2004. The stock repurchase program is consistent with our current
business model which focuses on higher value analog products and, therefore, is
less capital intensive than it has been historically. In addition to the $400
million available for future common stock repurchases under this latest program,
there was $2.0 million remaining at the end of the third quarter of fiscal 2005
under the program approved in March 2004. Our Board of Directors has also
declared a cash dividend of $0.02 per outstanding share of common stock which
will be paid on April 11, 2005 to shareholders of record at the close of
business on March 21, 2005.
We foresee continuing cash outlays for plant and equipment in fiscal 2005
and into fiscal 2006, with our primary focus on analog capabilities at our
existing sites. Our fiscal 2005 capital expenditure amount should be less than
the fiscal 2004 amount. Our capital expenditures do not include internal-use
software acquired under long-term obligations or equipment obtained for use
under operating leases. We are managing the level of capital expenditures in
light of sales levels and capacity utilization and capital expenditures for the
rest of fiscal 2005 and into 2006 will be dependent upon business conditions. In
our fiscal 2005 fourth quarter, we also expect to fund a $24 million
contribution to one of our defined benefit pension plans. We expect existing
cash and investment balances, together with existing lines of credit and cash
generated by operations, to be sufficient to finance the capital investments
currently planned for the remainder of fiscal 2005, as well as the dividend, the
stock repurchase programs and the pension contribution.
Our cash and investment balances are dependent in part 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 most 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 February 27, 2005:
Fiscal Year: 2010 and
(In Millions) 2005 2006 2007 2008 2009 thereafter Total
-------------- ---------- ---------- ---------- ---------- ----------- -------------
Contractual obligations
recorded as liabilities:
Debt obligations $ - $ - $ - $ 23.4 $ - $ 0.2 $ 23.6
CAD software licensing
agreements 2.5 10.2 8.2 - - - 20.9
Other contractual
obligations under:
Noncancellable
operating leases 8.4 30.6 23.4 10.9 5.8 5.7 84.8
Other 1.1 4.5 3.5 2.3 0.2 - 11.6
-------------- ---------- ---------- ---------- ---------- ----------- -------------
Total $ 12.0 $ 45.3 $ 35.1 $ 36.6 $ 6.0 $ 5.9 $ 140.9
============== ========== ========== ========== ========== =========== =============
Commercial Commitments:
Standby letters of credit
under bank multicurrency
agreement $ 9.2 - - - - - $ 9.2
============== ========== ========== ========== ========== =========== =============
In addition, as of February 27, 2005, capital purchase commitments were
$12.0 million.
We do not currently have any relationships with unconsolidated entities or
financial partnerships, such as entities often referred to as structured finance
or special purpose entities, which might be established for the purpose of
facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes. We do not engage in trading activities involving non-exchange
traded contracts. As a result, we do not believe that we are materially exposed
to financing, liquidity, market or credit risk that could arise if we had
engaged in these relationships.
o Recently Issued Accounting Pronouncements
-----------------------------------------
In March 2004, the Financial Accounting Standards Board reached a consensus
on Emerging Issues Task Force Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments."
EITF 03-1 provides new guidance for evaluating impairment losses on debt and
equity investments, as well as new disclosure requirements for investments that
are determined to be other-than-temporarily impaired. In September 2004, the
Financial Accounting Standards Board approved the issuance of a FASB Staff
Position which delays the requirement to record impairment losses under EITF
03-1. The delay applies to all securities within the scope of EITF 03-1 and is
expected to end when new guidance is issued and comes into effect. Pending
issuance of new guidance, we have not yet evaluated the requirements of EITF
03-1 nor determined its impact on our consolidated financial statements.
In November 2004, the Financial Accounting Standards Board issued SFAS No.
151, "Inventory Costs, an amendment of ARB 43, Chapter 4," which amends the
guidance in ARB No. 43, Chapter 4, "Inventory Pricing." This Statement is the
result of a broader effort by the FASB working with the International Accounting
Standards Board to reduce differences between U.S. and international accounting
standards. SFAS No. 151 eliminates the "so abnormal" criterion in ARB No. 43 and
companies will no longer be permitted to capitalize inventory costs on their
balance sheets when the production defect rate varies significantly from the
expected rate. It also makes clear that fixed overhead should be allocated based
on "normal capacity." The provisions of this Statement are effective for
inventory costs incurred during our fiscal year 2007. We are currently analyzing
this statement and have not yet determined its impact on our consolidated
financial statements.
In December 2004, The Financial Accounting Standards Board issued SFAS No.
153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 20,
Accounting for Nonmonetary Transactions." The amendments made by this Statement
are based on the principle that exchanges of nonmonetary assets should be
measured based on the fair value of the assets exchanged. This Statement also
eliminates the exception for nonmonetary exchanges of similar productive assets
and replaces it with a broader exception for exchanges of nonmonetary assets
that do not have commercial substance. The Statement is effective for
nonmonetary asset exchanges beginning in our fiscal year 2007 and we will apply
its provisions prospectively upon adoption.
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123 (revised 2004), "Share-Based Payment." This Statement is a revision of SFAS
No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion
No. 25, "Accounting for Stock Issued to Employees," and its related
implementation guidance. SFAS No. 123(R) requires that compensation cost
relating to share-based payment transactions be recognized in financial
statements. That cost will be measured based on the fair value of the equity or
liability instruments issued. This statement is effective beginning with our
fiscal 2006 second quarter ending November 27, 2005. We are currently evaluating
the requirements of SFAS No. 123(R) and although we have not yet determined
whether the impact to our financial statements will be in a range similar to the
amounts currently presented in our pro forma information under the current SFAS
No. 123, we believe the adoption of SFAS No. 123(R) will have a material effect
on the reported results of our operations. In March 2005, the U.S. Securities
and Exchange Commission's Office of the Chief Accountant and its Division of
Corporation Finance released Staff Accounting Bulletin No. 107, "Share-Based
Payment," which expresses the view of the SEC staff regarding the application of
SFAS No. 123(R). SAB 107 provides interpretive guidance related to the
interaction between SFAS No. 123(R) and certain SEC rules and regulations. It
also provides the staff's views regarding the valuation of share-based payment
arrangements for public companies. The interpretive guidance is intended to
assist companies in applying the provisions of SFAS No. 123 (R) and investors
and users of the financial statements in analyzing the information provided.
In March 2005, the Financial Accounting Standards Board published FASB
Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations," which clarifies that the term, conditional asset retirement
obligation, as used in SFAS No. 143, "Accounting for Asset Retirement
Obligations," refers to a legal obligation to perform an asset retirement
activity in which the timing and (or) method of settlement are conditional on a
future event that may or may not be within the control of the entity. The
uncertainty about the timing and (or) method of settlement of a conditional
asset retirement obligation should be factored into the measurement of the
liability when sufficient information exists. The interpretation also clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. This interpretation is effective no
later than the end of our fiscal 2006. We are currently analyzing the
interpretation and have not yet determined its impact on our consolidated
financial statements.
o Outlook
-------
Although sales levels for the first nine months of fiscal 2005 were higher than
they were in the first nine months of fiscal 2004, sales levels were flat in the
third quarter of fiscal 2005 compared to the second quarter of fiscal 2005 and
were down in the third quarter of fiscal 2005 compared to the third quarter of
fiscal 2004. Overall economic conditions in the semiconductor industry continue
to be difficult to predict. Our business over the first nine months of fiscal
2005 has been affected by slower orders than we originally anticipated,
particularly from our distributors. The order slowdown was caused by a
combination of shorter lead times and higher inventory levels at our
distributors and customers. We were also affected by a slowdown in demand for
our products in the Asian handset market and the flat-panel displays market.
Distributors continued to reduce inventory levels during the third quarter of
fiscal 2005, but to a lesser extent than in the immediately preceding second
quarter. Distributor inventory levels in most regions returned to more desired
levels by the end of the quarter, with the exception of Asia where some excess
inventory still exists. Turns orders in this fiscal year, which are orders
received with delivery requested in the same quarter, have been unusually low
relative to past history. However, turns orders in the third quarter of fiscal
2005 were the highest in the past three quarters. New orders also grew
sequentially in the third quarter of fiscal 2005, arising more from OEM
customers than distributors, indicating that distributors continued to be
cautious about restocking inventories. Our orders for products in key analog
standard linear market areas grew at rates higher than the company's overall
average. Our opening 13-week backlog entering the fourth quarter of fiscal 2005
is about the same as it was when we began the third quarter of fiscal 2005.
Considering all factors, including those discussed above, we expect net sales
for the fourth quarter of fiscal 2005 to increase 2 to 4 percent over the level
achieved in our fiscal 2005 third quarter. However, if backlog orders are
cancelled or if the level of turns orders is less than expected, we may not be
able to achieve this increase. In March 2005, we announced that we have entered
into an agreement to sell our PC Super I/O business. The sale is expected to
close during the fourth quarter of fiscal 2005. We have factored into our sales
range the estimated drop-off in sales that will occur during the fourth quarter
assuming we consummate the disposition of our PC Super I/O business. We
anticipate our gross margin percentage to increase to just over 53 percent in
the fourth quarter of fiscal 2005. In recent months, we have slowed our
production volumes in order to manage inventory levels. As a result, wafer
fabrication capacity utilization has declined to the mid-60 percent range since
the second quarter and is not expected to change substantially in the near term.
In March 2005, we also announced that we are seeking a buyer for our
assembly and test facility in Singapore. Current manufacturing activities at the
Singapore facility will continue during the sale process. If we successfully
complete the sale of this facility, we expect some future reduction in our total
manufacturing costs.
SFAS No. 109, "Accounting for Income Taxes," requires that deferred tax
assets are to be reduced by a valuation allowance if the weight of available
evidence indicates that it is more likely than not that some portion of the
deferred tax assets will not be realized. We achieved profitability in the prior
fiscal year and the first nine months of the current fiscal year. We continue to
evaluate the future realization of our deferred tax assets based on expectations
of future taxable income. Depending on our continued ability to achieve these
levels of profitability, we may have sufficient evidence in the fourth quarter
of fiscal 2005 to conclude that realization of additional deferred tax assets is
more likely than not and thus realize a tax benefit in that period from a
reduction of our deferred tax asset valuation allowance.
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.
Although less capital investment is needed for analog products than for many
other semiconductor products, substantial capital and R&D investment are
required to support products and manufacturing processes in the semiconductor
industry. We have experienced in the past and expect to experience in the future
periodic fluctuations in our operating results. Market 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. Our major
competitors include Analog Devices, Linear Technology, Maxim, ST
Microelectronics and Texas Instruments. These companies sell competing products
into some of the same markets that we target. In some cases, we may also compete
with our customers. Competition is based on design and quality of products,
product performance, price and service, with the relative importance of these
factors varying among products, markets and customers. 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 competition.
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 battery management that can adequately handle the demands of these
advanced features. Due to high levels of competition, as well as complex
technological requirements, there is no assurance that we will continue to 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.
If our development of new products is delayed or market acceptance is below our
expectations, our 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 applications in other broad markets that require analog technology.
We cannot assure you that we will develop and introduce successful new products
and our failure to bring these products to market may harm our operating
results.
We face risks from our international operations. We conduct a substantial
portion of our operations outside the United States. Our new assembly and test
facility in China that commenced operations in fiscal 2005 has expanded our
international operations to include China, where we have not previously
conducted manufacturing operations. International operations subject our
business 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 twelve months, one
or more of these factors has had an adverse effect on us in the past and could
adversely affect us in the future. In addition, although we have a program 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 the
euro.
Investments and Acquisitions. We have made and will continue to consider making
strategic business investments, alliances and acquisitions we consider necessary
to gain access to key technologies that we believe augment our existing
technical capability and support our business model objectives (which include
gross margin, operating margin, and return on invested capital objectives).
Acquisitions and investments 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.
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. The continuing hostilities in Iraq and terrorist
activities worldwide have resulted in additional uncertainty on the overall
state of the world economy. Our operations and activities in the Middle East are
fairly limited, but we have no assurance that the consequences from these events
will not disrupt our operations in the U.S. or other regions of the world in the
future. The emergence of varying illnesses in Asia over the past few years that
have the potential for becoming pandemic could also adversely affect our
business. The spread of any such illnesses beyond Asia could also negatively
impact other aspects of our operations. Although oil is not a major factor in
our cost structure, continued wide fluctuations and large increases in oil
prices may impact our cost structure in the future. In addition to disrupting
operations, any of these factors may also have an unfavorable impact on future
demand for our products.
Sarbanes-Oxley Section 404 concerns. The Securities and Exchange Commission, as
directed by Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules
requiring public companies to include in their annual reports on Form 10-K a
report of management on their internal controls over financial reporting. This
requirement will first apply to our Annual Report on Form 10-K for the fiscal
year ending May 29, 2005. The report needs to include an assessment by
management of the effectiveness of our internal controls over financial
reporting. In addition, our independent registered public accounting firm must
attest to and report on management's assessment of the effectiveness of these
internal controls. We are expending significant resources in developing the
necessary documentation and testing procedures required by Section 404 and we
expect to be able to provide the assessment and that our independent registered
accounting firm will provide the appropriate attestation. Nevertheless, there is
a risk that we may not be able to complete our assessment or our independent
registered accounting firm may not be able to complete its procedures to allow
it to provide its report on our assessment or that our assessment or our
independent registered accounting firm may find that our internal controls are
not designed or operating effectively. In such case our independent registered
accounting firm may either disclaim an opinion as it relates to management's
assessment of the effectiveness of our internal controls or may issue an adverse
opinion on the effectiveness of our internal controls. This could result in an
adverse reaction in the financial markets.
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 30, 2004 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 30, 2004 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 2004 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. As required by SEC Rule 13a-15(b), 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. The committee performed an evaluation, under the supervision of 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.
We are currently working on a review of our internal controls over financial
reporting as part of our efforts to ensure compliance with the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002. The review is an ongoing process
and it is possible that we may institute additional or new internal controls
over financial reporting as a result of the review. During the third quarter of
fiscal 2005 which is covered by this report we did not make any changes in our
internal controls over financial reporting 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
We currently are a party to various legal proceedings. Information on our
existing material legal proceedings is provided in our 2004 Form 10-K and in our
Form 10-Q for the quarters ended August 29, 2004 and November 28, 2004. Except
as described below, there have been no material developments in the legal
proceedings described in these filings.
In April 2002, ZF Micro Solutions, Inc. brought suit against us in the
California Superior Court alleging a number of contract and tort claims related
to an agreement we entered into in 1999 to design and manufacture a custom
integrated circuit device for ZF Micro Devices. ZF Micro Devices ceased business
operations in February 2002 and the case was brought by ZF Micro Solutions as
successor to ZF Micro Devices. The case began trial in May 2004 and on June 14,
2004, the jury in the case found for ZF Micro Solutions on a claim of
intentional misrepresentation, awarding damages of $28.0 million, and on a claim
of breach of the implied covenant of good faith and fair dealing, awarding
damages of $2.0 million. On seven other claims brought by the plaintiff, the
jury found for us. The jury also found for us on our breach of contract
cross-claim, awarding damages of $1.1 million. In response to our challenges to
the verdicts in favor of ZF Micro Solutions in post-trial motions, the court
ordered a new trial on all issues. During a settlement conference held December
16, 2004, the case was settled. We paid to plaintiff the sum of $20.0 million
and granted the plaintiff a royalty free license for the manufacture and sale of
the custom device at issue in the case. All settlement documents have now been
completed and the case has been dismissed in its entirety.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) The following table summarizes purchases we made of our common stock during
the third quarter of fiscal 2005:
Maximum Dollar
Total Number of Shares Value of Shares that May
Purchased as Part of Yet Be Purchased Under
Total Number of Publicly Announced the Plans or Programs
Shares Purchased Average Price Paid Per Plans or Programs (2)
Period (1) Share
- -------------------------- -------------------- ---------------------- ---------------------- ------------------------
Month #1
November 30, 2004 -
December 30, 2004 1,000,000 $17.58 1,000,000 $135.0 million
Month #2
December 31, 2004 -
January 31, 2005 4,069,600 $16.66 4,069,600 $ 67.2 million
Month #3
February 1, 2005 -
February 27, 2005 3,930,400 $16.60 3,930,400 $ 2.0 million
Total 9,000,000 9,000,000
(1) During the quarter ended February 27, 2005, we also reacquired 42,972
shares through the withholding of shares to pay employee tax obligations upon
the vesting of restricted stock. Additionally, during the quarter ended February
27, 2005, 6,083 shares were purchased by the rabbi trust utilized by our
Deferred Compensation Plan which permits participants to "invest" in our stock
in accordance with the instructions of plan participants.
(2) Purchases during the third quarter were made under a program announced
March 11, 2004. The total dollar amount approved for the repurchase program was
$400 million.
- --------------------------------------------------------------------------------
Our $20 million multicurrency credit agreement with a bank that provides
for multicurrency loans, letters of credit and standby letters of credit was
renewed in October 2004. This agreement contains restrictive covenants,
conditions and default provisions that, among other terms, restrict payment of
dividends. At February 27, 2005, $251.2 million of tangible net worth was
unrestricted and available for payment of dividends on common stock.
ITEM 6. EXHIBITS
Exhibits
- --------
(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); Certificate of Adjusted Purchase Price on
Number of Shares dated April 23, 2004 filed by National Semiconductor
Corporation with the Rights Agent (incorporated by reference to the
Exhibits to our Amendment No. 3 to the Registration Statement on Form 8-A
filed April 24, 2004).
31. Rule 13a - 14(a)/15d - 14(a) Certifications
32. Section 1350 Certifications
SIGNATURE
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: April 6, 2005 \s\Robert E. DeBarr
-------------------------------------
Robert E. DeBarr
Controller
Signing on behalf of the registrant
and as principal accounting officer
Exhibit 31
CERTIFICATION
I, Brian L. Halla, certify that:
1. I have reviewed this quarterly report on Form 10-Q of National
Semiconductor Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weakness in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: April 6, 2005
\s\ Brian L. Halla
-------------------------------------
Brian L. Halla
President and Chief Executive Officer
Exhibit 31
CERTIFICATION
I, Lewis Chew, certify that:
1. I have reviewed this quarterly report on Form 10-Q of National
Semiconductor Corporation;
2. Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
(a) All significant deficiencies and material weakness in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: April 6, 2005
\s\ Lewis Chew
-----------------------------------
Lewis Chew
Senior Vice President, Finance and
Chief Financial Officer
Exhibit 32
CERTIFICATION PURSUANT TO
18 U.S.C SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of National Semiconductor Corporation
(the "Company") on Form 10-Q for the period ended February 27, 2005 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, Brian L. Halla, President and Chief Executive Officer for the Company,
certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of the
Sarbanes-Oxley Act of 2002, that, to my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or
Section 15(d), as applicable, of the Securities Exchange Act of 1934,
and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Dated: April 6, 2005
\s\ Brian L. Halla
--------------------------------------
Brian L. Halla
President and Chief Executive Officer
Exhibit 32
CERTIFICATION PURSUANT TO
18 U.S.C SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of National Semiconductor Corporation
(the "Company") on Form 10-Q for the period ended February 27, 2005 as filed
with the Securities and Exchange Commission on the date hereof (the "Report"),
I, Lewis Chew, Senior Vice President, Finance and Chief Financial Officer for
the Company, certify, pursuant to 18 U.S.C. 1350, as adopted pursuant to 906 of
the Sarbanes-Oxley Act of 2002, that, to my knowledge:
(1) The Report fully complies with the requirements of Section 13(a) or
Section 15(d), as applicable, of the Securities Exchange Act of 1934,
and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
Dated: April 6, 2005
\s\ Lewis Chew
-----------------------------------
Lewis Chew
Senior Vice President, Finance and
Chief Financial Officer