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 March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 333-98529
ZiLOG, INC. (Exact name of Registrant as specified in its charter)
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532 Race Street
San Jose, California 95126
(Address of principal executive offices)
(408) 558-8500
(Registrant's telephone number, including area code)
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 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 [ ] NO [X]
The Company has voluntarily filed all reports required by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months in accordance with terms agreed to in its previous indenture and its plan of reorganization.
As of April 30, 2003, there were 29,781,545 shares of the Company's Common Stock, $.01 par value outstanding.
This Report on Form 10-Q and other oral and written statements we make contain and incorporate forward-looking statements regarding future events and our plans and expectations that involve risks and uncertainties. When used in this Report, the words "estimate," "project," "intend," "expect," "anticipate," "believe," "may," "will," and similar expressions are intended to identify such forward-looking statements. Forward-looking statements in this report include, but are not limited to, those relating to the general direction of our business, our expected liquidity, capital expenditures and expense levels in future periods. Although we believe our plans, intentions, and expectations reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions, or expectations will be achieved. Actual results, performance, or achievements could differ materially from those contemplated, express or implied, by the forward-looking statements contained in this report. Factors that may cause or contribute to differences include, but are not limited to: continued availability of third-party foundry and assembly services at commercially reasonable quality and prices; under-absorption of manufacturing costs in our wafer fabrication facilities from under-utilization of production capacity; our distributors and customers significantly reducing their existing inventories before ordering new products; and those factors discussed in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors," as well as those discussed elsewhere in this Report and in other reports filed with the Securities and Exchange Commission. These factors are not intended to represent a complete list of the general or specific factors that affect us. Other factors, including general economic factors and business strategies, may be significant, presently or in the future, and the factors set forth in this report may affect us to a greater extent than indicated. We caution the reader not to place undue reliance on the forward-looking statements contained herein, which reflect our position as of the date of this report. We undertake no obligation to publicly release updates or revisions to these statements.
Based in San Jose, California, we were incorporated in California in October 1981 and reincorporated in Delaware in April 1997. In this report, "ZiLOG," "the Company," "our," "us," "we," and similar expressions refer to ZiLOG, Inc. and its subsidiaries. However, when these expressions are used throughout this report in connection with ZiLOG, Inc.'s reorganization under Chapter 11 of the U.S. bankruptcy code, they are referring only to the parent company, ZiLOG, Inc., and not to any of its subsidiaries. ZiLOG and Z80 are registered trademarks of ZiLOG, Inc.
Extreme Connectivity © ZiLOG, Inc. 1999.
ZiLOG, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED MARCH 31, 2003
TABLE OF CONTENTS
| PART I. FINANCIAL INFORMATION | Page No. |
| Item 1. Interim Condensed Consolidated Financial Statements (unaudited): |
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Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2003 and three months ended March 31, 2002 |
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| Unaudited Condensed Consolidated Balance Sheets at March 31, 2003, and December 31, 2002 |
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Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2003, and three months ended March 31, 2002 |
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| Notes to Unaudited Condensed Consolidated Financial Statements |
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| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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| Item 4. Controls and Procedures |
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| PART II. OTHER INFORMATION |
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| Item 1. Legal Proceedings |
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| Item 6. Exhibits and Reports on Form 8-K |
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| Signature |
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PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements
ZiLOG, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions except per share data)
Sucessor Predecessor
Company Company
------------- -------------
Three Months Three Months
Ended Ended
March 31, March 31,
2003 2002
------------- -------------
Net sales......................................... $25.2 $36.0
Cost of sales..................................... 14.9 20.3
------------- -------------
Gross margin...................................... 10.3 15.7
Operating expenses:
Research and development........................ 3.9 5.2
Selling, general and administrative............. 6.2 8.1
Special charges and reorganization items........ 1.3 5.6
Amortization of intangible assets............... 1.7 --
------------- -------------
Total operating expenses..................... 13.1 18.9
------------- -------------
Operating loss.................................... ($2.8) ($3.2)
Other income (expense):
Interest income................................. 0.1 0.1
Interest expense (1)............................ (0.1) (5.0)
Other, net...................................... -- 0.1
------------- -------------
Loss before reorganization items and provision
for income taxes................................ (2.8) (8.0)
Reorganization items.............................. -- (3.8)
Provision for income taxes........................ 0.1 0.1
------------- -------------
Net loss.......................................... ($2.9) ($11.9)
============= =============
Preferred stock dividends accrued................. -- 1.4
------------- -------------
Net loss attributable to common stockholders...... ($2.9) ($13.3)
============= =============
Basic and diluted net income per share............ ($0.10)
=============
Weighted-average shares used in computing
basic and diluted net income per share.......... 28.7
=============
- -----------------
(1) Excludes contractual interest of $2.1 in the period ended March 31, 2002 no
recorded during reorganization.
See accompanying notes to condensed consolidated financial statements.
ZiLOG, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
Sucessor Company
-----------------------
Mar. 31, Dec. 31,
2003 2002
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents......................... $23.0 $29.4
Accounts receivable, less allowance for doubtful
accounts of $0.3 at March 31, 2003, $0.5 at
December 31, 2002............................... 12.3 10.8
Inventories....................................... 9.8 10.6
Prepaid expenses and other current assets......... 3.3 3.4
----------- -----------
Total current assets...................... 48.4 54.2
----------- -----------
MOD III assets held for sale........................ 30.0 30.0
Net property, plant and equipment................... 20.9 21.9
Goodwill............................................ 34.6 34.6
Intangible assets, net.............................. 16.6 18.3
Other assets........................................ 9.5 9.8
----------- -----------
$160.0 $168.8
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LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS'EQUITY
Current liabilities:
Short-term debt................................... $5.0 $6.9
Accounts payable.................................. 11.5 10.2
Income taxes payable.............................. 0.9 --
Accrued compensation and employee benefits........ 3.5 7.4
Other accrued liabilities......................... 2.7 3.2
Deferred income on shipments to distributors...... 6.5 7.4
----------- -----------
Total current liabilities................. 30.1 35.1
----------- -----------
Deferred income taxes............................... 21.1 22.4
Other non-current tax liabilities................... 14.5 14.5
----------- -----------
Total liabilities......................... 65.7 72.0
----------- -----------
Minority interest in MOD III assets................. 30.0 30.0
Stockholders' equity:
Common Stock...................................... 0.3 0.3
Additional paid-in capital........................ 97.0 97.1
Deferred stock compensation....................... (4.1) (4.6)
Accumulated deficit............................... (28.9) (26.0)
----------- -----------
Total stockholders' equity................ 64.3 66.8
----------- -----------
Total liabilities and stockholders' equity.......... $160.0 $168.8
=========== ===========
See accompanying notes to condensed consolidated financial statements.
ZiLOG, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Sucessor Predecessor
Company Company
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Three Months Three Months
Ended Ended
March 31, March 31,
2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................... ($2.9) ($11.9)
Adjustments to reconcile net income (loss) to cash
used by operating activities:
Amortization of fresh-start intangible assets.......... 1.7 --
Depreciation and other amortization.................... 1.5 1.9
Impairment of long lived assets........................ 0.2 2.5
Stock-based compensation............................... 0.4 0.1
Changes in assets and liabilities:
Accounts receivable.................................... (1.5) 0.5
Inventories............................................ 0.8 2.7
Prepaid expenses and other current and
noncurrent assets.................................... 0.4 (0.4)
Accounts payable....................................... 1.3 (0.2)
Accrued compensation and employee benefits............. (3.9) (1.7)
Liabilities subject to compromise...................... -- 6.1
Other accrued liabilities, deferred income on
shipments to distributors and deferred income
taxes................................................ (1.8) (6.9)
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Net cash used by operations before reorganization
items............................................ (3.8) (7.3)
Reorganization items - professional fees paid............... -- (2.2)
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Net cash used by operating activities............... (3.8) (9.5)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................... (0.7) (0.9)
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Cash used by investing activities................... (0.7) (0.9)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of short-term debt............................ (1.9) (2.8)
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Cash used by financing activities................... (1.9) (2.8)
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Decrease in cash and cash equivalents....................... (6.4) (13.2)
Cash and cash equivalents at beginning of period............ 29.4 30.7
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Cash and cash equivalents at end of period.................. $23.0 $17.5
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See accompanying notes to condensed consolidated financial statements.
ZiLOG, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. BASIS OF PRESENTATION
The accompanying interim financial information is unaudited. In the opinion of ZiLOG, Inc.'s ("ZiLOG" or the "Company") management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of interim results have been included. The results for interim periods are not necessarily indicative of results to be expected for the entire year. These condensed consolidated financial statements and notes should be read in conjunction with the Company's annual consolidated financial statements and notes thereto contained in the Company's 2002 Annual Report filed on Form 10-K Commission File Number 333-98529 for the fiscal year ended December 31, 2002, filed on April 1, 2003.
ZiLOG's interim results are based on fiscal quarters of thirteen weeks in duration ending on the last Sunday of each calendar quarter. The first and second fiscal month of each quarter is four weeks in duration and the third month is five weeks. Each of ZiLOG's interim periods end on Sunday except for the last fiscal period of each year which ends on December 31. However, for financial reporting purposes, interim fiscal periods are labeled as ending on calendar month-end. The operating results for any interim period are not necessarily indicative of results for any subsequent period or the full fiscal year.
The condensed consolidated balance sheet at December 31, 2002 has been derived from audited financial statements at that date, but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
On February 28, 2002, ZiLOG and its subsidiary, MOD III, Inc., filed the Reorganization Plan with the United States Bankruptcy Court for the Northern District of California under Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy court subsequently confirmed the Reorganization Plan by its order entered on April 30, 2002. The Reorganization Plan became effective on May 13, 2002. The Company prior to emergence from bankruptcy is referred to as the "Predecessor Company" and the reorganized company is referred to as the "Successor Company."
A black line has been drawn between the accompanying financial statements to distinguish, for accounting purposes, between the Successor Company and the Predecessor Company. Our results of operations after April 30, 2002 and our consolidated balance sheets at December 31, 2002 and March 31, 2003 are not comparable to the results of operations prior to April 30, 2002 and the historical balance sheet at December 31, 2001, due to our adoption of "fresh-start" reporting upon our emergence from bankruptcy. However, such differences in our results of operations relate to depreciation of property, plant and equipment, amortization of intangible assets, interest expense and restructuring and reorganization expenses. Additionally, these differences in our balance sheets relate to inventory, in- process research and development, property, plant and equipment, intangible assets, conversion of senior notes to common stock, and minority interest. Certain figures, such as net sales and certain expenses were not affected by our adoption of fresh-start accounting and, accordingly, we believe them to be comparable. Details of the events associated with the May 2002 reorganization are included in the Company's 2002 Annual Report on Form 10-K.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition. Revenue from product sales to OEM customers is recognized upon transfer of legal title, which occurs at time of shipment or upon delivery to the customer, depending upon the FOB terms. Revenue on these sales is reported net of appropriate allowances for returns and warranty costs which are recorded at the time of revenue recognition and represent the Company's only post-sale obligations. Revenue on shipments to distributors who have rights of return and price protection on unsold merchandise held by them, is deferred until products are resold by the distributors to end users. Although revenue is deferred until resale, title of products sold to distributors transfers upon shipment. Accordingly, shipments to distributors are reflected in the consolidated balance sheets as accounts receivable and a reduction of inventories at the time of shipment. Deferred revenue and the corresponding cost of sales on shipments to distributors are reflected in the consolidated balance sheet on a net basis as "Deferred income on shipments to distributors."
Goodwill and Intangible Assets. Effective January 1, 2002, ZiLOG adopted the provisions of FASB Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). Under FAS 142, goodwill and intangible assets with indefinite lives are not amortized, but are reviewed annually or more frequently if impairment indicators arise. Separable intangible assets that are deemed to have defined lives will continue to be amortized over their useful lives (but with no maximum life). Intangible assets acquired prior to July 1, 2001 were being amortized on a straight-line basis over lives ranging from three to five years. In connection with the Company's fresh-start reporting, separable intangible assets based on independent valuations were created with deemed defined lives. These intangible assets are being amortized utilizing the pattern-of-use method over their estimated useful lives ranging from 5 to 10 years.
The separable intangible assets identified in connection with fresh-start accounting and included in the consolidated balance sheet are as follows (in millions):
Current Brand
Technology Name Total
------------- ------------- -----------
Gross carrying amount....................... $17.0 $9.2 $26.2
Accumulated amortization.................... 8.2 1.4 9.6
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Book value March 31, 2003................... $8.8 $7.8 $16.6
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The anticipated remaining amortization schedule for these assets is as follows (in millions):
Current Brand Total
Year Technology Name Amortization
-------------- -------------- ------------ --------------
2003 $4.1 $1.0 $5.1
2004 2.9 1.3 4.2
2005 1.1 1.1 2.2
2006 0.4 1.0 1.4
2007 0.2 0.8 1.0
Thereafter 0.1 2.6 2.7
-------------- ------------ --------------
Total $8.8 $7.8 $16.6
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Use of Estimates: The preparation of consolidated
financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of financial statements and the reported amounts of
revenues and expenses during the reporting period. Significant estimates made in
preparing these financial statements include excess and obsolete inventories,
allowance for doubtful accounts and sales returns and allowances. Actual results
could differ from those estimates.
Research and Development Expenses. ZiLOG's policy is to record all research and development expenditures with no future alternative use as period expenses when incurred. In-process research and development charges relate to partially developed semiconductor product designs that had not reached technological feasibility and have no alternative future use on the date they were acquired or valued for fresh-start reporting.
Fair Value of Financial Instruments and Concentration of Credit Risk. The carrying value of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and short-term debt, approximates fair value. Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, investments and accounts receivable. The Company maintains its cash and cash equivalents and investments with high quality financial institutions. The Company's customer base consists of businesses in North America, Europe and Asia. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company maintains allowances for potential credit losses. As of March 31, 2003, there were no individual customers with net accounts receivable comprising more than 10% of total net accounts receivable.
Stock-based Compensation. The Company accounts for employee stock awards in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations including FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an Interpretation of APB No. 25", issued in March 2000, to account for its fixed plan options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. SFAS 123, "Accounting for Stock- Based Compensation," as amended by SFAS 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure," established accounting and disclosure requirements using a fair-value method of accounting described above. The Company has adopted only the disclosure requirements of SFAS 148. For purposes of both financial statement and pro forma disclosure, the amortization of the stock-based compensation is allocated over the vesting period on a straight-line basis. The table below illustrates the effect on net loss if the fair-value based method had been applied to all outstanding and unvested awards in each period (in millions):
Sucessor Predecessor
Company Company
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Three Months Three Months
Ended Ended
Mar. 31, Mar. 31,
2003 2002
------------- -------------
Net loss as reported........................ ($2.9) ($11.9)
Add stock-based employee compensation
expense included in reported net
loss, net of tax........................ 0.4 0.1
Deduct total stock-based employee
compensation expense determined
under fair-value-based method for
all rewards, net of tax................. (0.3) (0.2)
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Pro forma net loss.......................... ($2.8) ($12.0)
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The fair value of options granted in 2002 and 2003 under the 2002 Omnibus Stock Incentive Plan were estimated at the date of grant using the Black-Scholes option pricing model. The following weighted average assumptions were used:
Sucessor Predecessor
Company Company
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Three Months Three Months
Ended Ended
Mar. 31, Mar. 31,
2003 2002
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Annual average risk free interest rate...... 3.0% 3.0%
Estimated life in years..................... 5 5
Dividend yield.............................. 0.0% 0.0%
Volatility.................................. 89.9% N/A
Adoption of Accounting Standards. In November
2002, the FASB issued Interpretation No. 45 (FIN 45), "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others", which clarifies disclosure and recognition/measurement
requirements related to certain guarantees. The disclosure requirements are
effective for financial statements issued after December 15, 2002 and the
recognition/measurement requirements are effective on a prospective basis for
guarantees issued or modified after December 31, 2002. The application of the
requirements of FIN 45 did not have a material impact on the Company's financial
position or results of operations.
Recent Accounting Pronouncements. In January 2003, the Financial
Accounting Standards Board issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities," which addresses consolidation by a business of
variable interest entities in which it is the primary beneficiary. The
Interpretation is effective immediately for certain disclosure requirements and
variable interest entities created after January 31, 2003, and will be effective
in the third quarter of 2003 for variable interest entities created before
February 1, 2003. The Company is reviewing the provisions of the Interpretation
and complies with the disclosure requirements, but does not expect the
Interpretation to have a material impact on the Company's financial statements.
Effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003, Emerging Issues Task Force ("EITF") Issue 00-21,
"Revenue Arrangements with Multiple Deliverables," addresses the accounting, by
a vendor, for contractual arrangements in which multiple revenue-generating
activities will be performed by the vendor. In some situations, the different
revenue-generating activities (deliverables) are sufficiently separable and
there exists sufficient evidence of fair values to account separately for the
different deliverables (that is, there are separate units of accounting). In
other situations, some or all of the different deliverables are interrelated
closely or there is not sufficient evidence of fair value to account separately
for the different deliverables. EITF Issue 00-21 addresses when and, if so, how
an arrangement involving multiple deliverables should be divided into separate
units of accounting. The Company has not yet determined the impact of the
adoption of EITF Issue 00-21 on its consolidated financial
statements.
SFAS No. 146 revises the accounting for specified employee and contract terminations that are part of restructuring activities. Companies will be able to record a liability for a cost associated with an exit or disposal activity only when the liability is incurred and can be measured at fair value. Commitment to an exit plan or a plan of disposal expresses only management's intended future actions and therefore, does not meet the requirement for recognizing a liability and related expense. This statement only applies to termination benefits offered for a specific termination event or a specified period. It will not affect accounting for the costs to terminate a capital lease. ZiLOG adopted this statement for exit and/or disposal activities initiated on or after May 1, 2002.
NOTE 3. INVENTORIES
Inventories are stated at the lower of cost on a first-in-first-out basis, or market. Provisions, when required, are made to reduce excess and obsolete inventories to their estimated realizable values. It is possible that estimates of realizable value can change in the short-term. Inventories, net of provisions, consist of the following (in millions):
Mar. 31, Dec. 31,
2003 2002
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Raw materials........................ $0.4 $0.5
Work-in-process...................... 7.1 7.5
Finished goods....................... 2.3 2.6
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$9.8 $10.6
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NOTE 4. SPECIAL CHARGES AND REORGANIZATION ITEMS
The components of special charges are as follows (in millions):
Sucessor Predecessor
Company Company
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Three Months Three Months
Ended Ended
Mar. 31, Mar. 31,
2003 2002
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Asset impairments:
Austin Texas assets.................... $ -- $1.7
Internal use software.................. -- 0.8
Nampa, Idaho assets.................... 0.2 --
Restructuring of operations:
Employee severance and
termination benefits................. 0.6 1.2
MOD III closure costs.................. 0.3 1.9
Professional fees for debt
restructuring.......................... 0.2 --
------------- -------------
$1.3 $5.6
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The following table summarizes activity in accrued special charges (in millions) which is included in other accrued liabilities in the condensed consolidated balance sheet:
Severance and MOD III
Termination Closure Debt
Total Benefits Costs Restructuring
------------- ------------- ----------- ------------
Balance at December 31, 2002............ $0.6 $0.5 $0.1 $ --
Total charge to special charges......... $1.1 0.6 0.3 0.2
Cash paid............................... ($1.5) (1.1) (0.4) --
------------- ------------- ----------- ------------
Balance at March 31, 2003............... $0.2 $ -- $ -- $0.2
============= ============= =========== ============
During the first quarter of 2003, computer equipment with a net book value of $0.2 million was retired in connection with an information system upgrade that included new equipment purchases. The redundant equipment was written-off to special charges.
Restructuring of operations during the three-month period ended March 31, 2003 included severance and termination benefits of $0.6 million related to a reduction-in-force at the Company's Nampa, Idaho manufacturing plant affecting approximately 56 employees who were terminated during the quarter. Approximately $0.3 million of special charges for the period relate to post- closure maintenance costs of the MOD III eight-inch wafer fabrication facility in Idaho consisting of utilities, taxes, insurance, and other maintenance costs required to maintain the facility in a condition required for the sale of the property. Approximately $0.2 million of special charges during the first quarter of 2003 relate to third-party professional service fees for legal and financial advisors associated with actions required to be taken as a result of the Company's May, 2002 debt and equity restructuring activities.
In connection with the closure of the Company's Austin, Texas design center in the first quarter of 2002, furniture, fixtures, and equipment with a book value of approximately $1.7 million were surrendered to the lessor in partial exchange for lease termination considerations. Also in connection with this action and the streamlining of ZiLOG's sales force, severance and termination benefits of approximately $1.2 million were paid in the first quarter of 2002. Approximately $0.8 million of computer aided design software was impaired in the first quarter of 2002 as a result of the Company's decision to cancel development of its Cartezian family of 32-bit RISC microprocessors focused on network routing and associated data packeting technologies. Additionally, $1.9 million of special charges incurred during the first quarter of 2002 relate to the closure of the MOD III eight-inch wafer fabrication facility in Idaho. These costs include relocation of production activities to alternative manufacturing sites and the closure of the MOD III facility.
In addition, professional fees of $3.8 million for debt restructuring were recorded as reorganization items during the entire duration of the Company's Chapter 11 proceedings.
NOTE 5. GEOGRAPHIC AND SEGMENT INFORMATION
The Company operates in one operating segment and engages primarily in the design, development, manufacture and marketing of semiconductor products. The Company sells its products to distributors and original equipment manufacturers (OEMs) in a broad range of market segments, performs on-going credit evaluations of its customers and generally requires no collateral. The Company's operations outside the United States consist of a final test facility in the Philippines, sales and support centers and design centers in certain foreign countries. Domestic operations are responsible for the design, development and wafer fabrication of all products, as well as the coordination of production planning and shipping to meet worldwide customer commitments. The Philippine test facility is reimbursed in relation to value added with respect to test operations and other functions performed, and certain foreign sales offices receive a commission on export sales within their territory. Accordingly, for financial statement purposes, it is not meaningful to segregate sales or operating profits for the test and foreign sales office operations.
Prior to the consummation of the Company's reorganization, there were two reportable business segments called communications and embedded control. The prior reporting structure was based on a previous operating and reporting organization that was focused largely on development of new products targeted on the communications and networking sectors. ZiLOG is now organized and focused on its core business, which is based on 8-bit micrologic product solutions. The Company operates in one reporting segment and engages primarily in the design, development, manufacture and marketing of semiconductor products. ZiLOG has two broad business lines called embedded control and standard products. The following table represents the Net Sales by business line for each for the periods indicated (dollars in millions):
Sucessor Predecessor
Company Company
------------- -------------
Three Months Three Months
Ended Ended
March 31, March 31,
Products 2003 2002
- -------------------------------------------- ------------- --------------
Embedded control products
Core 8-bit Microcontrollers and
microprocessors......................... $18.4 $23.2
Standard Products
Serial Communications Controllers....... 3.4 3.7
Modems.................................. 0.4 3.7
IrDA transceivers....................... 0.6 0.3
Television, PC peripheral products
and foundry services................. 2.4 5.1
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Net sales................................... $25.2 $36.0
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The following table summarizes ZiLOG's net sales by region and by channel (in millions):
Sucessor Predecessor
Company Company
------------- -------------
Three Months Three Months
Ended Ended
March 31, March 31,
2003 2002
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Net sales by region:
Americas.................................... $13.8 $19.8
Asia........................................ 7.3 10.9
Europe...................................... 4.1 5.3
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Total.................................... $25.2 $36.0
============= =============
Net sales by channel:
OEM......................................... $13.1 $19.9
Distributor................................. 12.1 16.1
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Total.................................... $25.2 $36.0
============= =============
Major customers: During the three months ended March 31, 2003, two customers, Future Electronics, Inc. and Thomson Consumer Electronics accounted for approximately 20.1% and 10.4% of net sales, respectively. During the three months ended March 31, 2002, one customer, Pioneer-Standard Electronics accounted for approximately 10% of net sales.
NOTE 6. SHORT-TERM DEBT
Upon consummation of the Reorganization Plan, ZiLOG entered into a senior secured financing facility (the "Facility") with a commercial lender, dated May 13, 2002, for a new three-year $15.0 million senior secured revolving credit facility. Borrowings on the Facility are secured primarily against certain North American accounts receivable and bear interest at a rate per annum equal, at ZiLOG's option, to the commercial lender's stated prime rate or LIBOR, plus 2.5%. At March 31, 2003, the Company had borrowings outstanding of $5.0 million at a LIBOR-based rate of 3.9% and had additional borrowing capacity available of $0.8 million. The Facility is scheduled to mature on May 13, 2005. As of March 31, 2003, the Company had $0.2 million of standby letters of credit issued to vendors under the Facility.
The Company is subject to certain financial covenants under this Facility including tangible asset and fixed charge coverage ratio only if the total of the Company's cash, cash equivalents and availability on the revolver are less than $7.5 million at any month end.
NOTE 7. CONTINGENCIES
On July 29, 1996, ZiLOG filed an action in the Superior Court of the State of California in and for Santa Clara against Pacific Indemnity Company, Federal Insurance Company and Chubb & Son Inc. In that action, the Company sought a declaration that its former insurers, Pacific and Federal, had an unconditional duty to defend and indemnify it in connection with two lawsuits brought in 1994: (1) in Santana v. ZiLOG and, (2) in Ko v. ZiLOG. ZiLOG's complaint in the Santa Clara County action also alleged that Chubb, which handled the defense of Santana and Ko on behalf of Pacific and Federal, was negligent. Pacific cross-complained against the Company, seeking reimbursement of defense costs for both underlying lawsuits and a payment it contributed to the settlement of Ko. On February 26, 2002, ZiLOG agreed to pay $300,000 to fully settle these lawsuits.
On August 5, 2002, ZiLOG reached a settlement agreement, mutual release of claims and indemnity agreement with one of its vendors relating to a 1997 purchase of wafer fabrication equipment that ZiLOG believed was defective. The Company had recorded accounts payable of $1.1 million as of May 1, 2002 reflecting this disputed liability. Under the terms of the agreement, ZiLOG received $200,000 in cash and was released from all claims by the vendor.
The Company is participating in other litigation and responding to claims arising in the ordinary course of business. ZiLOG intends to defend itself vigorously in these matters. The Company's management believes that it is unlikely that the outcome of these matters will have a material adverse effect on its financial statements, although there can be no assurance in this regard.
NOTE 8. INCOME TAXES
The Company's provision for income taxes during the three-month periods ended March 31, 2003 and 2002 reflects the estimated income tax rate for the year, including foreign income taxes for the jurisdictions in which the Company was profitable as well as foreign withholding taxes and state minimum taxes.
In connection with the May, 2002 Reorganization Plan, the subsequent cancellation of debt and issuance of new common shares to primarily new stockholders, the Company generated significant income for book and tax purposes. The taxable income was offset by the use of all available net operating losses, both current and carryforward, with remaining taxable income offset by the reduction in tax attributes of certain of the Company's non- current assets. Deferred tax liabilities were recorded in the year ended December 31, 2002 and reflect the net tax effect of assets that have a book basis in excess of their tax basis. For the three months ended March 31, 2003 deferred tax liabilities of approximately $0.9 million were reclassified to current income taxes payable to reflect estimated taxes payable for U.S. Federal and State taxes based on taxable income generated during the three-month period ended March 31, 2003.
NOTE 9. MINORITY INTEREST
Minority interest of approximately $30.0 million is recorded on the consolidated balance sheet in order to reflect the share of MOD III, Inc. held by minority investors. The minority interest share represents their entitlement to receive an aggregate liquidation preference of the first $30.0 million plus any accrued but unpaid dividends on the MOD III, Inc. series A preferred stock from the net proceeds from the sale of the MOD III, Inc. assets currently held for sale. The Company will be entitled to recoup from the net proceeds of any sale all costs it has or will incur to sell the facility or to maintain the facility in saleable condition subsequent to its closure and prior to transfer of title.
NOTE 10. NET LOSS PER SHARE
The following table presents the calculation of basic and diluted net loss per share of common stock (in millions, except per share data):
Sucessor
Company
-------------
Three
Months
Ended
March 31,
2003
-------------
Net loss.................................. ($2.9)
=============
Weighted-average shares outstanding....... 29.8
Less: Weighted-average shares subject
to repurchase.......................... 1.1
-------------
Weighted-average shares used in
computing basic and diluted
net loss per share..................... 28.7
-------------
Basic and diluted net loss per
share.................................. ($0.10)
=============
At March 31, 2003, options to purchase approximately 2.3 million shares of common stock at a weighted-average exercise price of $2.81 were excluded from the determination of diluted net loss per share, as the effect of such shares are anti-dilutive. At March 31, 2003, there were 29.8 million common shares issued and outstanding.
NOTE 11. COMPREHENSIVE INCOME
The Company had no items of other comprehensive income to report in either of the three-month periods ended March 31, 2003 or March 31, 2002.
NOTE 12. SUBSEQUENT EVENT
Stock Repurchase Program: On April 17, 2003, the Company's Board of Directors approved a stock repurchase program authorizing the repurchase of up to one million shares of its common stock.
The Company's common stock trades on the OTC bulletin
board with a ticker symbol of ZiLG. Purchases under the program may be made,
from time-to-time, in the open market, through block trades or otherwise.
Depending upon market conditions and other factors, these purchases may be
commenced or suspended at any time or from time-to-time without prior notice by
the Company.
On May 1, 2003, the Company repurchased 250,000 shares at $2.00 per share. These shares will be reflected in the financial statements of the Company as treasury stock in the period ending June 30, 2003.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS
Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth in the section entitled "Risk Factors" and in other sections of this annual report.
Overview
The following is management's discussion and analysis of financial condition and results of operations of the Company and its subsidiaries for the three-month periods ended March 31, 2003 and 2002. This discussion and analysis should be read in conjunction with the section entitled the condensed consolidated financial statements and notes thereto included elsewhere herein and the Company's 2002 annual report on form 10-K. Management's discussion and analysis provides information concerning our business environment, consolidated results of operations and liquidity and capital resources.
We prepare and release quarterly unaudited financial statements prepared in accordance with generally accepted accounting principles or GAAP. We also disclose and discuss EBITDA as a measure of liquidity in our filings with the Securities and Exchange Commission investor conference calls. We believe the disclosure of such information helps investors more meaningfully evaluate the results of our liquidity. However, we recommend that investors carefully review the GAAP financial information included as part of our Quarterly Reports on Form 10-Q, our Annual Reports on Form 10-K, and our quarterly earnings releases, compare GAAP financial information with the pro forma financial results disclosed in our quarterly earnings releases and investor calls, and read the associated reconciliation.
Our interim results are based on fiscal quarters of thirteen weeks in duration ending on the last Sunday of each calendar quarter. However, for ease of reading our financial reports, we have labeled our interim fiscal periods as ending on calendar month-end. The operating results for any interim period are not necessarily indicative of results for any subsequent period or the full fiscal year, which ends on December 31 of each year.
2002 Financial Restructuring and Reorganization
Prior to February 1998, our common stock had been publicly traded on the New York Stock Exchange under the symbol "ZLG." On February 27, 1998, we consummated a merger with an affiliate of Texas Pacific Group, and in connection with that transaction, we issued $280.0 million of registered senior secured notes and we ceased having publicly traded equity. Since 2000, our business and financial growth had been negatively affected by the extremely difficult business climate in which we have been operating. We explored a number of strategic alternatives with the assistance of our financial advisor, Lazard Frères & Co., LLC, and an informal group of holders of our senior notes.
During the course of discussions, we concluded that the best vehicle to achieve a restructuring of our senior notes was through consummation of a voluntary pre-packaged plan of reorganization under Chapter 11 of the United States Bankruptcy Code.
On February 28, 2002, we and our subsidiary, ZiLOG-MOD III, Inc., which we call MOD III, Inc., filed voluntary petitions with the United States Bankruptcy Court for the Northern District of California for reorganization under Chapter 11. The bankruptcy court subsequently confirmed MOD III, Inc.'s and our joint reorganization plan by its order entered on April 30, 2002. The joint plan of reorganization became effective on May 13, 2002, but for financial reporting purposes we use May 1, 2002, as the date of emergence from bankruptcy. We refer to the company prior to emergence from bankruptcy as the "Predecessor Company" and to the reorganized company as the "Successor Company."
Pursuant to the joint reorganization plan, we extinguished $325.7 million of liabilities, which included $280.0 million principal amount of our 9.5% Senior Secured Notes due 2005, $27.2 million in accrued interest due on the notes and $18.5 million of dividends payable on our former series A preferred stock. The former noteholders received substantially all of our new common stock and a liquidation preference in the net proceeds on the sale of the assets held by MOD III, Inc. The former equity holders received an aggregate $200,000 in cash. All debt and equity securities of the Predecessor Company were cancelled. As a consequence of these events, the Predecessor Company recorded a $205.7 million net gain on discharge of debt.
On May 1, 2002, we adopted "fresh-start" reporting prescribed by the American Institute of Certified Public Accountant's Statement of Position 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," or SOP 90-7. Fresh-start reporting was appropriate because our former noteholders received substantially all of our new common stock and the reorganization value of the assets of the Successor Company were less than the total pre-petition liabilities plus post-petition liabilities.
Critical Accounting Policies
We believe our critical accounting policies are as follows:
On an on-going basis, we evaluate our estimates, including those related to sales returns, allowance for doubtful accounts, inventory write-downs and asset impairments. We base our estimates on historical trends and various other assumptions that we believe to be reasonable at the time the estimates are made. Actual results could differ from those estimates. A brief description of each of these policies is set forth below.
Fresh-start reporting. Upon emerging from Chapter 11 proceedings, we
adopted fresh-start reporting in accordance with SOP 90-7. Accordingly, for
financial reporting purposes, we valued our assets and liabilities at fair
value. With the assistance of our independent financial advisor, Lazard Freres
& Co., LLC, and in reliance upon various valuation methods, and other
applicable ratios and economic industry information relevant to our industry and
through negotiations with various creditor parties in interest, we estimated our
equity value to be $90.0 million. This estimate of equity value was derived from
a weighted average of three valuations results based on comparable public
company, precedent transaction and discounted cash flow analyses. For the
purposes of the comparable public company analysis, Lazard analyzed the trading
multiples of numerous public companies in the semiconductor industry, including
Semtech, Globespan and Mitel, amongst others. The comparable public company
analysis yielded a valuation range of $70 - $87 million; Lazard weighted this
analysis 35% in its estimated valuation. The precedent transaction analysis
yielded a valuation range of $88 - $109 million; Lazard weighted this analysis
30% in its estimated valuation. The discounted cash flow analysis yielded a
valuation range of $82 - $106 million; Lazard weighted this analysis 35% in its
estimated valuation. These valuations were based on the underlying assumptions
and limitations set forth in their report. These assumptions include: the
successful reorganization of our business and finances in a timely manner; the
implementation of our business plan as a reorganized entity; the accuracy of
information supplied by management about our business and our prospects;
achievement of forecasted projections; market conditions as of December 31, 2001
continuing through an assumed effective date of March 31, 2002; and the plan of
reorganization becoming effective in accordance with the estimates and
assumptions upon which the valuation was based.
In connection with the overall revaluation of the company, described above, we
recorded increases in the carrying value of our assets of $83.7 million to
reflect the fair value of those assets under SOP 90-7. These increases in the
carrying value of our intangible assets were based on three valuation
approaches, depending on the specific intangible asset to be valued: the income
approach, the cost approach and the market approach. These increases in carrying
value of our tangible assets were based on physical inspections and written
appraisals that included market data and cost approaches. Results would have
varied under different assumptions or conditions.
Estimating sales returns and allowances. Our net sales from OEM customers consist of gross product sales reduced by expected future sales returns and allowances. To estimate sales returns and price allowances, we analyze historical returns and allowance activity to establish a baseline reserve level. Then we evaluate whether there are any underlying product quality or other customer specific issues that require additional specific reserves above the baseline level. Because the reserve for sales returns and allowances is based on our judgments and estimates, our reserves may not be adequate to cover actual sales returns and other allowances. If our reserves are not adequate, our net revenues and accounts receivable could be adversely affected.
Allowance for doubtful accounts. We maintain an allowance for losses we may incur as a result of our customers' inability to make required payments. Any increase in the allowance results in a corresponding increase in our selling, general and administrative expenses. In establishing this allowance, and then evaluating the adequacy of the allowance for doubtful accounts, we consider the aging of our accounts receivable, historical bad debts, customer concentrations, and customer credit-worthiness and, to a lesser extent, current economic trends and changes in our customer payment terms. Historically, we have not experienced material bad debt write-offs. If the financial condition of one or more of our customers unexpectedly deteriorated, resulting in their inability to make payments, or if we otherwise underestimate the losses we incur as a result of our customers' inability to pay us, we could be required to increase our allowance for doubtful accounts which could adversely affect our operating results.
Estimating write-downs of excess and obsolete inventories. Each inventory component is assessed for excess or obsolescence by using an algorithm that we established. This algorithm is based on historical trends, demand forecasts and inventory age. We review the result of this algorithm and generally write-off all work-in-process inventory more than one year old and finished goods inventory quantities in excess of our current backlog. Write- offs of excess and obsolete inventories are reflected as a reduction to inventory values in the accompanying consolidated balance sheets, and an increase in cost of sales. If actual market conditions or customer demand patterns are less favorable than, or inconsistent with our assumptions, we may be required to take further write-downs of our inventory value, which could adversely impact our cost of sales and operating results.
Asset impairments. We apply the provisions of Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" and Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors we consider important which could trigger an impairment review include the following:
When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, and the undiscounted cash flows estimated to be generated by those assets are less than the asset's carrying value, the carrying value of the assets are reduced to their estimated fair value. The estimated fair value is usually determined based on an estimate of future discounted cash flows. Asset impairments are recorded as a reduction in the asset value in our consolidated balance sheets and as special charges in our consolidated statements of operations.
The intangible assets created by the adoption of fresh-start accounting on our emergence from bankruptcy consist of existing technology, brand name as well as excess enterprise value, or goodwill. The existing technology and brand name are being amortized based on a pattern-of-use method in proportion to the discounted cash flows from such assets. The goodwill is not subject to amortization.
We evaluate the existing technology and brand name at each reporting period to determine whether events and circumstances continue to support the current carrying value as well as the remaining useful life. Additionally, goodwill is tested for impairment at least annually and more often if events and circumstances indicate that its fair value may be less than its carrying value. We expect to perform the annual impairment test for goodwill in the third quarter of each year, unless the existence of triggering events indicates that an earlier review should be performed.
Adjustments to record impairment of long-lived assets or intangible assets could have a material adverse impact on our financial condition and results of operations in the period or periods in which such impairment is identified.
Reporting Segments
Beginning in May 2002, we consolidated our business segments into one reportable segment to reflect the manner in which our chief operating decision- maker allocates resources and assesses the performance of our business.
Period Comparisons
Our results of operations after April 30, 2002 and our consolidated balance sheets at December 31, 2002 and March 31, 2003 are not comparable to the results of operations prior to April 30, 2002 and the historical balance sheet at December 31, 2001, due to our adoption of "fresh-start" reporting upon our emergence from bankruptcy. However, such differences in our results of operations relate to depreciation of property, plant and equipment, amortization of intangible assets, interest expense and restructuring and reorganization expenses. Additionally, these differences in our balance sheets relate to inventory, in-process research and development, property, plant and equipment, intangible assets, conversion of senior notes to common stock, and minority interest. Certain figures, such as net sales and certain expenses were not affected by our adoption of fresh-start accounting and, accordingly, we believe them to be comparable. To provide a more meaningful analysis, in the following discussion we have compared results of our predecessor and successor company's operations for the three months ended March 31, 2003 to the predecessor company's results for the three months ended March 31,2002.
Results of Operations
Our net sales by region, by channel, and by business line are summarized in dollars and as a percentage of total net sales for each period indicated, as follows (in millions):
Sucessor Predecessor
Company Company
------------- -------------
Three Months Three Months
Ended Ended
March 31, March 31,
2003 2002
------------- -------------
Net sales by region:
Americas.................................... $13.8 $19.8
Asia........................................ 7.3 10.9
Europe...................................... 4.1 5.3
------------- -------------
Total.................................... $25.2 $36.0
============= =============
Net sales by channel:
OEM......................................... $13.1 $19.9
Distributor................................. 12.1 16.1
------------- -------------
Total.................................... $25.2 $36.0
============= =============
Net sales by busines line:
Embedded control............................ $18.4 $23.2
Standard Products........................... 6.8 12.8
------------- -------------
Total.................................... $25.2 $36.0
============= =============
During the past two years, we have implemented a series of business restructuring programs aimed at refocusing on our core 8-bit micrologic product portfolio. In connection with these actions, we have eliminated a significant amount of fixed costs from our business operations. Additionally, pursuant to our plan of reorganization, which became effective on May 13, 2002, we extinguished $280.0 in million principal value of our 9.5% Senior Secured Notes due 2005, which required $13.3 million in interest payments each March 15 and September 15.
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002
Net Sales. Overall, similar to the semiconductor industry as a whole, we have experienced reduction in demand for many of our products that has persisted into the first quarter of 2003. Our net sales of $25.2 million in the three months ended March 31, 2003 represents a decrease of 30% from net sales of $36.0 million in the same period of 2002.
Net sales of our embedded control products declined 21% to $18.4 million in the three months ended March 31, 2003 compared to $23.2 million in the three months ended March 31, 2002. This decrease reflects lower unit shipments in both our microprocessor and microcontroller product families. The decline reflects the overall lower market demand as well as continued conversion of our older Z80 microprocessors and Z8 microcontrollers to alternative technologies, primarily microcontrollers with embedded flash technology. In November 2002 and February 2003 we released our new Z8 Encore! and eZ80 Acclaim! products that are focused on the embedded flash market, with a strategy of recapturing sales to these customers and entering new markets.
Net sales of our standard products for the three months ended March 31, 2003 decreased $6.0 million or 47% to $6.8 million from $12.8 million in the same period of 2002. This decrease reflects:
Gross Margin. Our cost of sales primarily represents manufacturing costs relating to wafer fabrication, package assembly and product testing operations. Cost of sales fluctuates, depending on materials and services prices from our vendors, manufacturing productivity, product mix, equipment utilization and depreciation. Gross margin as a percent of net sales was 41% in the three months ended March 31, 2003, down from 44% in the same period of 2002. During the first quarter of 2003 our gross margin was adversely impacted by underutilization of our MOD II wafer manufacturing facility, reflecting lower demand for wafer capacity consistent with our decline in net sales. We have continued to rationalize our manufacturing cost structure in response to these lower demand requirements, which included a reduction in force of approximately 55 positions in our MOD II facility in February 2003. We continue to purchase our wafer requirements for 0.35 micron wafer technologies from our foundry partners primarily in Taiwan including our new embedded flash based Z8 Encore! and eZ80 Acclaim! products.
Research and Development Expenses. Research and development expenses were $3.9 million in the three months ended March 31, 2003, reflecting a 25% decrease from the $5.2 million of research and development expenses reported in the three months ended March 31, 2002. The decrease in research and development expense primarily reflects lower payroll-related costs as a result of headcount reductions in connection with the closing of our Austin, Texas design center and the related termination of all product development activities in connection with our CarteZian line of 32-bit network communications microprocessors. Subsequent to January 2002, the primary focus of our research and development has been product design efforts relating to our Z8Encore! and eZ80Acclaim! flash-memory enabled microcontrollers offered in our core micrologic business.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $6.2 million in the three months ended March 31, 2003 from $8.1 million in the three months ended March 31, 2002. The decrease in our selling, general and administrative spending reflects lower payroll-related costs as a result of lower headcount and reduced incentive compensation and commissions commensurate with lower sales levels.
Special Charges. Special charges for each period indicated were as follows (in millions):
Sucessor Predecessor
Company Company
------------- -------------
Three Months Three Months
Ended Ended
Mar. 31, Mar. 31,
2003 2002
------------- -------------
Asset impairments:
Austin Texas assets.................... $ -- $1.7
Internal use software.................. -- 0.8
Nampa, Idaho assets.................... 0.2 --
------------- -------------
0.2 2.5
------------- -------------
Restructuring of operations:
Employee severance and
termination benefits................. 0.6 1.2
MOD III closure costs.................. 0.3 1.9
------------- -------------
0.9 3.1
------------- -------------
Professional fees for debt
restructuring.......................... 0.2 --
------------- -------------
$1.3 $5.6
============= =============
The following table summarizes activity in accrued special charges (in millions):
Severance and MOD III
Termination Closure Debt
Total Benefits Costs Restructuring
------------- ------------- ----------- ------------
Balance at December 31, 2002............ $0.6 $0.5 $0.1 $ --
Total charge to special charges......... $1.1 0.6 0.3 0.2
Cash paid............................... ($1.5) (1.1) (0.4) --
------------- ------------- ----------- ------------
Balance at March 31, 2003............... $0.2 $ -- $ -- $0.2
============= ============= =========== ============
During the three months ended March 31, 2003, special charges totaled $1.3 million, which was comprised of $0.9 million of restructuring of operations expenses, asset impairments of $0.2 million and professional fees of $0.2 million. The restructuring of operations relates to severance and benefit costs in connection with the reduction of approximately 56 positions that were eliminated during the quarter in our MOD II wafer fabrication facility and the ongoing costs of maintaining our MOD III facility which is being held for sale.
During the three months ended March 31, 2002, special charges totaled $5.6 million, which were comprised of $2.5 million of asset impairments and $3.1 million of restructuring of operations expenses. In connection with the closure of our Austin, Texas design center in the first quarter of 2002, we surrendered to the lessor in partial exchange for lease termination considerations, furniture, fixtures and equipment with a book value of approximately $1.7 million. Also in connection with this action and the streamlining of our sales force, we paid severance and termination benefits of approximately $1.2 million in the first quarter of 2002. Approximately $0.8 million of computer aided design software was impaired in the first quarter of 2002 as a result of our decision to cancel development of the Cartezian family of 32-bit RISC microprocessors. Additionally, we incurred $1.9 million in special charges during the first quarter of 2002 associated with the closure of our Mod III eight-inch wafer fabrication facility in Idaho. These charges included the costs of relocation of production to alternative manufacturing sites and the closure of the facility.
Stock-Based Compensation. We classify stock-based compensation within the various operating expenses to which it relates, principally selling, general and administrative expense. Compensation expense for employee stock awards and in-the-money stock option grants are measured on the grant date. Compensation expense is recognized over the vesting period for options or over the periods that the restrictions lapse for restricted stock.
Amortization of Intangible Assets. Effective January 1, 2002, we adopted the provisions of FASB Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"). Under FAS 142, goodwill and intangible assets with indefinite lives are not amortized, but are reviewed annually or more frequently if impairment indicators arise. Separable intangible assets that are deemed to have defined lives will continue to be amortized over their useful lives (but with no maximum life). Intangible assets acquired prior to July 1, 2001 were being amortized on a straight-line basis over lives ranging from three to five years. In connection with the Company's fresh-start reporting, separable intangible assets based on independent valuations were created with deemed defined lives. These intangible assets are being amortized utilizing the pattern-of-use method over their estimated useful lives ranging from 5 to 10 years.
The separable intangible assets identified in connection with fresh-start accounting and included in the consolidated balance sheet are as follows (in millions):
Current Brand
Technology Name Total
------------- ------------- -----------
Gross carrying amount....................... $17.0 $9.2 $26.2
Accumulated amortization.................... 8.2 1.4 9.6
------------- ------------- -----------
Book value March 31, 2003................... $8.8 $7.8 $16.6
============= ============= ===========
The anticipated remaining amortization schedule for these assets is as follows (in millions):
Current Brand Total
Year Technology Name Amortization
-------------- -------------- ------------ --------------
2003 $4.1 $1.0 $5.1
2004 2.9 1.3 4.2
2005 1.1 1.1 2.2
2006 0.4 1.0 1.4
2007 0.2 0.8 1.0
Thereafter 0.1 2.6 2.7
-------------- ------------ --------------
Total $8.8 $7.8 $16.6
============== ============ ==============
Interest Expense. In the first quarter of 2002, our interest expense was primarily accrued in connection with our 9.5% senior secured notes payable, which notes and accrued interest were extinguished in connection with our reorganization effective May 13, 2002.
Income Taxes. Our provision for income taxes during the three-month periods ended March 31, 2003 and 2002 reflects the estimated income tax rate for the year, including foreign income taxes for the jurisdictions in which our business was profitable as well as foreign withholding taxes and state minimum taxes. In connection with the May, 2002 Reorganization Plan, the subsequent cancellation of debt and issuance of new common shares to primarily new stockholders, we generated significant income for book and tax purposes. This taxable income was offset by the use of all available net operating losses, both current and carryforward, with remaining taxable income offset by the reduction in tax attributes of certain of our non-current assets. Deferred tax liabilities were recorded in the year ended December 31, 2002 and reflect the net tax effect of our assets that have a book basis in excess of their tax basis. For the three months ended March 31, 2003 deferred tax liabilities of approximately $0.9 million were reclassified to current income taxes payable to reflect our estimated taxes payable for U.S. Federal and State taxes based on taxable income generated during the three-month period ended March 31, 2003.
Liquidity and Capital Resources
As a result of the economic downturn and decline in our results of operations that began in 2000, we became unable to continue servicing the interest on our debt. As noted previously, on February 28, 2002, we filed a voluntary prepackaged plan of reorganization pursuant to Chapter 11 of the United States Bankruptcy Code. The bankruptcy court confirmed our reorganization plan on April 30, 2002. The plan of reorganization became effective on May 13, 2002 and resulted in the extinguishment of $325.7 million of liabilities.
Upon emergence from bankruptcy, we entered into a new credit facility with the same commercial lender as our previous credit facility. The new facility is a three-year $15.0 million senior secured revolving credit facility. The new facility is on substantially similar terms as our previous revolving credit facility, except that borrowings bear interest at a rate per annum equal, at our option, to the commercial lender's stated prime rate or LIBOR, plus 2.5%. We have elected the LIBOR interest rate option, which, as of December 31, 2002 was 4.4%. The previous revolving credit facility and capital expenditure line was cancelled. As of March 31, 2003, we had outstanding borrowings of $5.0 million and standby letters of credit of $0.2 million. Our ability to borrow under the facility is based on a monthly borrowing base calculation that is determined as a percentage of eligible accounts receivable. If we decide to pay the necessary fee to qualify certain foreign accounts receivable in our borrowing base, we could borrow up to an additional $2.6 million under our revolving credit facility as of March 31, 2003.
We are subject to certain financial covenants under this facility, including tangible net asset balance and fixed charge coverage ratios only if the total of our cash, cash equivalents and availability on the revolving credit facility are less than $7.5 million at any month end.
At March 31, 2003, we had cash and cash equivalents of $23.0 million, compared to $29.4 million at December 31, 2002. Cash used by operating activities was $3.8 million for the three months ended March 31, 2003, compared to $9.5 million of cash used by operating activities in the first quarter of 2002.
During the three-month period ended March 31, 2003, cash used by operating activities of $3.8 million primarily reflects our net loss of $2.9 million offset by non-cash charges of $3.8 million. Non-cash charges include $1.7 million for amortization of Fresh Start Intangible assets, $1.5 million in depreciation and other amortization charges, impairment of long lived assets of $0.2 million and stock-based compensation expense of $0.4 million. The primary use of cash for operating activities was a result of changes in working capital driven by:
The use of cash by operating activities in the first quarter of 2002 primarily reflects our net loss of $11.9 million, adjusted for depreciation and amortization of $1.9 million. During the three-month period ended March 31, 2002, our significant use of operating cash included cash payments for special charges of $10.1 million.
Cash used by investing activities was $0.7 million and $0.9 million for the three-month periods ended March 31, 2003 and 2002, respectively. Cash used for investing activities in both the 2003 and 2002 first quarter periods reflects capital expenditures.
Cash used by financing activities was $1.9 million and $2.8 million for the three-month periods ended March 31, 2003 and 2002, respectively. Cash used for financing activities in both periods reflects repayments of borrowings under our revolving line of credit.
The EBITDA figures presented below reflect a non-GAAP measure of our liquidity. These figures reflect our net income adjustment for non-cash items, interest and income taxes. Our management uses separate "adjusted EBITDA" calculations for purposes of determining certain employees' incentive compensation and, subject to meeting specified adjusted EBITDA amounts, for accelerating the vesting of EBITDA-linked stock options. This measure of adjusted EBITDA was approved as part of our plan of reorganization. Adjusted EBITDA, as we define it, excludes interest, income taxes, effects of changes in accounting principles and equity adjustments and non-cash charges such as depreciation, amortization, in-process research and development, and stock-based compensation expense. It also excludes cash and non-cash charges associated with reorganization items and special charges, which represent operational restructuring charges, including asset write-offs, employee termination costs, and lease termination costs. EBITDA is presented because management uses EBITDA as a measure of cash earnings for budgeting and financial performance measurement. Adjusted EBITDA is presented because it is a defined measure for determining employee incentive compensation and potentially for acceleration of certain stock option vesting.
The differences between the EBITDA figures below and our adjusted EBITDA relate to the following cash-settled reorganization and special items that are added-back in our adjusted EBITDA computations:
Our EBITDA, reconciled to cash provided (used) by operations (the most directly comparable measure of liquidity under generally accepted accounting principles) for each period presented, is as follows (in millions):
Sucessor Predecessor
Company Company
------------- -------------
Three Months Three Months
Ended Ended
March 31, March 31,
2003 2002
------------- -------------
Reconciliation of cash used by operations
to EBITDA:
Cash flow from operations................ ($3.8) ($9.5)
Interest paid............................ 0.1 0.1
Income taxes paid........................ 0.1 0.1
Change in operating assets and
liabilities........................... 4.6 6.9
------------- -------------
EBITDA...................................... $1.0 ($2.4)
============= =============
Our cash needs for 2003 include working capital, professional fees in connection with the finalization of our registration statement on Form S-1 and capital expenditures. In March 2003, we announced and completed a further restructuring of our MOD II wafer fabrication operations that resulted in the elimination of approximately 55 positions and cost approximately $0.6 million in severance benefits. This action was intended to more closely align our production output capacity with current customer demand. The 2003 business climate is expected to continue to be difficult. However, we currently anticipate that available cash and cash provided by operating activities will be adequate to satisfy our cash requirements for at least the next twelve months.
We expect fiscal 2003 capital expenditures will total approximately $2.0 million, primarily for test equipment, building improvements and internal use software. Decisions related to cash requirements for investing activities are influenced by our expected cash provided by operations. Additionally, the Company has used approximately $0.5 million in cash to repurchase 250,000 shares of stock during the current quarter. Further cash may be used for stock repurchases in the future in accordance with the program approved by the Board of Directors although the maximum number of shares that may be repurchased is one million.
Effects of Inflation and Changing Prices
We believe that inflation and/or deflation had a minimal impact on our overall operations during the periods included in these financial statements.
Seasonality
Sales typically increase in the second quarter and peak in the third quarter driven by increased holiday demand from our customers in the home entertainment and consumer products markets. Our revenues are generally lower in the first and fourth quarters compared to the rest of the year. We believe that this historical seasonal trend could be impacted by general economic conditions and reduction in sales of our previously de-emphasized products. Additionally, general world-wide economic, political and regional instabilities may impact our results of operations in any given period.
Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities," which
addresses consolidation by a business of variable interest entities in which it
is the primary beneficiary. The Interpretation is effective immediately for
certain disclosure requirements and variable interest entities created after
January 31, 2003, and will be effective in the third quarter of 2003 for
variable interest entities created before February 1, 2003. The Company is
reviewing the provisions of the Interpretation and complies with the disclosure
requirements, but does not expect the Interpretation to have a material impact
on the Company's financial statements.
Effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003, Emerging Issues Task Force ("EITF") Issue 00-21,
"Revenue Arrangements with Multiple Deliverables," addresses the accounting, by
a vendor, for contractual arrangements in which multiple revenue-generating
activities will be performed by the vendor. In some situations, the different
revenue-generating activities (deliverables) are sufficiently separable and
there exists sufficient evidence of fair values to account separately for the
different deliverables (that is, there are separate units of accounting). In
other situations, some or all of the different deliverables are interrelated
closely or there is not sufficient evidence of fair value to account separately
for the different deliverables. EITF Issue 00-21 addresses when and, if so, how
an arrangement involving multiple deliverables should be divided into separate
units of accounting. The Company has not yet determined the impact of the
adoption of EITF Issue 00-21 on its consolidated financial
statements.
SFAS No. 146 revises the accounting for specified employee and contract terminations that are part of restructuring activities. Companies will be able to record a liability for a cost associated with an exit or disposal activity only when the liability is incurred and can be measured at fair value. Commitment to an exit plan or a plan of disposal expresses only management's intended future actions and therefore, does not meet the requirement for recognizing a liability and related expense. This statement only applies to termination benefits offered for a specific termination event or a specified period. It will not affect accounting for the costs to terminate a capital lease. We adopted this statement for exit and/or disposal activities initiated on or after May 1, 2002.
RISK FACTORS
Risks Related to the Restructuring
We recently effectuated a reorganization pursuant to a prepackaged plan under Chapter 11 of the United States Bankruptcy Code, which does not assure our continued success.
On February 28, 2002, we filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. The United States Bankruptcy Court for the Northern District of California confirmed our prepackaged plan of reorganization on April 30, 2002 and we emerged from bankruptcy on May 13, 2002. Pursuant to the financial restructuring, our formerly publicly traded 9.5% Senior Secured Notes due 2005, accrued interest related to such notes, and all of our previously existing equity securities were canceled. Our completion of bankruptcy proceedings does not assure our continued success.
Our new revolving credit facility restricts our ability to take certain actions that we may determine to be in our best interests.
In connection with our reorganization, we replaced our previous credit facility with a three-year $15.0 million senior secured revolving credit facility. Borrowings under this credit facility are secured by substantially all of our assets. This facility places various restrictions on us, including, but not limited to, restrictions on our ability to incur indebtedness and engage in certain corporate transactions, and requires us to maintain financial ratios. As of March 31, 2003, we had additional borrowing capacity of $0.8 million under this facility. This credit facility is scheduled to expire on May 13, 2005, at which time we may be required to renew, refinance, or modify the credit facility with our lender or locate alternative financing. These restrictions and provisions could have an adverse impact on our future liquidity and ability to implement our business plan.
Our reorganization may have negatively affected some of our relationships with our customers, suppliers and employees.
The effect, if any, of our Chapter 11 case and plan of reorganization may have had, and may continue to have, upon our continued operations cannot be predicted or quantified. Some entities may be uncomfortable doing business with a company that has recently emerged from bankruptcy. Our Chapter 11 case could adversely affect our relationships with our customers, suppliers and employees.
As a result of the adoption of "fresh-start" accounting, you will not be able to compare our historical financial statements with the financial results disclosed in this quarterly report.
As a result of the consummation of our plan of reorganization and the transactions contemplated thereby, we are operating our business under a new capital structure. In addition, we adopted fresh-start reporting in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7 upon emerging from bankruptcy. Because SOP 90-7 requires us to reset our assets and liabilities to current fair values, our financial condition and results of operations disclosed in future filings will not be comparable to the financial condition or results of operations reflected in our historical financial statements contained in this quarterly report.
Risk Related to Our Business and Industry
Our quarterly operating results are likely to fluctuate and may fail to meet expectations, which may cause the price of our securities to decline.
Our quarterly operating results have fluctuated in the past and will likely continue to fluctuate in the future. Our future operating results will depend on a variety of factors and they may fail to meet expectations. Any failure to meet expectations could cause the price of our securities to fluctuate or decline significantly. In addition, high proportions of our costs are fixed, due in part to our significant sales, research and development and manufacturing costs. Therefore, small declines in revenue could disproportionately affect our operating results in a quarter. A variety of factors could cause our quarterly operating results to fluctuate, including:
We are currently experiencing a downturn in the business cycle and our revenues, cash generation and profitability are being adversely affected.
The semiconductor industry is highly cyclical and has experienced significant economic downturns at various times in the last three decades, characterized by diminished product demand, erosion of average selling prices and production over-capacity. In the fourth quarter of 2000, another downturn in our business cycle began and continues today. The terrorist acts of September 2001 in New York City, Washington, D.C. and Pennsylvania, and the United States' military response, have exacerbated the downturn and created an uncertain economic environment. We cannot predict the impact of these events, any subsequent terrorist acts or of any related military action, on our customers or business. We believe that, in light of these events, some of our customers have curtailed and may in the future delay or further curtail spending on technology, which could also negatively affect our quarterly results or financial condition in the future.
We are experiencing a decline in revenues, as our customers are not ordering product from us in the quantities that they previously ordered in 2000 and 2001. This decline in revenue has been accentuated by our decision in 2000 to de- emphasize certain product offerings in the television and PC peripheral markets. We are uncertain how long this decline will last. Additionally, we may be required to reduce selling prices in response to competition, which could lower our gross margin. Such a decline in selling prices would have a negative impact on our financial condition. As a result of our under-utilization of our manufacturing capacity, in January 2002 we closed one of our two wafer fabrication facilities. We are currently, and will likely in the future experience substantial period-to-period fluctuations in future operating results that are attributable to general industry conditions or events occurring in the general economy. Any economic downturn could pressure us to reduce our prices and decrease our revenues, cash generation and profitability.
We have a history of losses, and we may not be profitable in the future.
We have a history of losses including for the three-month period ended March 31, 2003 and for each of the years in the five-year period ended December 31, 2002, excluding the accounting effects of our reorganization. If our new business plan is not successful, we may not be profitable in the future.
We have implemented significant cost cutting measures, and we may be required to implement additional cost cutting measures depending upon our future revenues and operating results.
Similar to other semiconductor companies, we have implemented significant cost cutting measures in the past. These cost cutting efforts have included:
Cost cutting measures may not increase our efficiency or future profitability and our reduction in research and development spending could harm our ability to introduce new products in the future. If our revenue or operating results significantly decline in the future, we may be required to institute further cost reduction measures.
If we are unable to implement our business strategy, our revenues and future profitability may be harmed materially.
Our future financial performance and success are largely dependent on our ability to implement our business strategy. In third quarter of 2001 we revised our business strategy to refocus on our core 8-bit micrologic business and to increase our use of external wafer fabrication facilities. We may be unable to implement this new business strategy, including planning for and responding to lack of external wafer fabrication capacity and dealing with unforeseen quality issues, and, even if we do implement our strategy successfully, our results of operations may fail to improve.
In addition, although the semiconductor micrologic market has grown in prior years, it is currently in a significant downturn. Our revenues and future profitability could be harmed seriously. It is uncertain for how long this slowdown will last.
We may not be able to introduce and sell new products, and our inability to do so may harm our business materially.
Our operating results depend on our ability to introduce and sell new products. Rapidly changing technologies and industry standards, along with frequent new product introductions, characterize the industries that are currently the primary end-users of semiconductors. As these industries evolve and introduce new products, our success will depend on our ability to adapt to such changes in a timely and cost-effective manner by designing, developing, manufacturing, marketing and providing customer support for new products and technologies. Our ability to introduce new products successfully depends on several factors, including:
We cannot assure you that the design and introduction schedules for any new products or any additions or modifications to our existing products will be met, that these products will achieve market acceptance or that we will be able to sell these products at prices that are favorable to us.
Acts of war or terrorism could harm our business.
The September 11, 2001 terrorist attacks on the United States created immediate significant economic and political uncertainty. The long-term effects of such attacks on the world economy and our business are unknown, but could be material to our business. Further terrorists acts or acts of war, whether in the United States or abroad, also could cause damage or disruption to our business, our suppliers, our freight carriers, or our customers, or could create political or economic instability, any of which could have a material adverse effect on our business. Escalated tensions between India and Pakistan particularly pose an increased risk to our design operations in India, which could be disrupted in the event of the outbreak of war between the two countries.
Our industry is highly competitive and we cannot assure you that we will be able to compete effectively.
The semiconductor industry is intensely competitive and is characterized by price erosion, rapid technological change and heightened competition in many markets. The industry consists of major domestic and international semiconductor companies, many of which have substantially greater financial and other resources than we do with which to pursue engineering, manufacturing, marketing and distribution of their products. Emerging companies are also increasing their participation in the semiconductor industry. Our current and future products compete with, or may compete with, products offered by Advanced Micro Devices, ARM, Atmel, Conexant, Intel, Lucent Technologies, Microchip, Motorola, NEC, Philips, Sharp, ST Microelectronics, Texas Instruments and Toshiba, among others. Some of our principal products such as the Z80 microprocessor are licensed by our competitors or are in the public domain and can be manufactured and sold to our customers by our competitors, possibly with added features or at lower prices than we charge. Our ability to compete successfully in our markets depends on factors both within and outside of our control, including:
To the extent that our products achieve market acceptance, competitors typically seek to offer competitive products or embark on pricing strategies, which, if successful, could harm our results of operations and financial condition materially.
Unless we maintain manufacturing efficiency and avoid manufacturing difficulties, our future profitability could be harmed.
Our semiconductors are highly complex to manufacture and our production yields are sensitive. Our production yields may be inadequate in the future to meet our customers' demands. Production yields are sensitive to a wide variety of factors, including the level of contaminants in the manufacturing environment, impurities in the materials used and the performance of personnel and equipment. From time to time, we have experienced difficulties in effecting transitions to new manufacturing processes and have suffered delays in product deliveries or reduced yields. We may experience similar difficulties or suffer similar delays in the future, and our operating results could be harmed as a result.
For example, we may experience problems that make it difficult to manufacture the quantities of our products that we anticipate producing in our wafer fabrication facility. These difficulties may include:
If we are unable to obtain adequate production capacity, our business will be harmed.
We rely on independent third-party foundry manufacturers to fabricate an increasing percentage of our products. Industry-wide shortages in foundry capacity could harm our financial results. For example, a significant amount of our sales are of products which cannot be manufactured at our Nampa, Idaho wafer fabrication facility. Should we be unable to obtain the requisite foundry capacity to manufacture our complex new products, or should we have to pay high prices to foundries in periods of tight capacity, our ability to increase our revenues might be impaired. Any delay in initiating production at third-party facilities, any inability to have new products manufactured at foundries or any failure to meet our customers' demands could damage our relationships with our customers and may decrease our sales.
Other significant risks associated with relying on these third-party manufacturers include:
We depend on third-party assemblers and the failure of these third parties to continue to provide services to us on sufficiently favorable terms could harm our business.
We use outside contract assemblers for packaging our products. If we are unable to obtain additional assembly capacity on sufficiently favorable terms, our ability to achieve continued revenue growth might be impaired. Shortages in contract assembly capacity could cause shortages in our products and could also result in the loss of customers. Because we rely on these third parties, we also have less control over our costs, delivery schedules and quality of our products and our intellectual property is at greater risk of misappropriation.
Our international operations subject us to risks inherent in doing business in foreign countries that could impair our results of operations.
Approximately 66% of our net sales for the three-month period ended March 31, 2003 were made to foreign customers and we expect that international sales will continue to represent a significant portion of our net sales in the future. We maintain significant operations or rely on a number of contract manufacturers in the Philippines, Indonesia, Taiwan and India. We cannot assure you that we will be successful in overcoming the risks that relate to or arise from operating in international markets. Risks inherent in doing business on an international level include:
In addition, our activities outside the United States are subject to risks associated with fluctuating currency values and exchange rates, hard currency shortages and controls on currency exchange. While our sales are primarily denominated in U.S. dollars, worldwide semiconductor pricing is influenced by currency rate fluctuations, and such fluctuations could harm our operating results materially.
The risks inherent in our international operations have been increased by the terrorist attacks of September 2001. These attacks, coupled with the international military response, have created an uncertain economic environment and we cannot predict the impact of these events, any subsequent terrorist acts or of any related military action, on our customers or our business.
The lease of the facility housing our Philippines operations expires in March 2004; if we are unable to negotiate an extension of this lease or relocate these operations on commercially reasonable terms, our results of operations could be harmed.
The majority of our final product testing, inventory warehousing and logistics operations reside in a 54,000 square foot facility located in the Philippines. We have occupied this site with inexpensive rental payments since 1979 and the lease is presently due to expire on March 31, 2004. Accordingly, if we are unable to negotiate an extension of the lease or effectively relocate these operations to another site on commercially reasonable terms, our results of operations could be harmed.
We have changed our North American distributors, and we may lose some of our customers as a result.
In September 2002, we announced our intention to terminate our existing relationship with our Pioneer Standard, our full-service distributor in North America. We completed the termination of our relationship with Pioneer Standard in the fourth quarter of 2002. For the year ended December 31, 2002, Pioneer Standard purchased approximately $17.9 million of our products. In their place, we have franchised Future Electronics as our sole exclusive full-service distributor in North America. For three months ended March 31, 2003, Future Electronics purchased approximately $5.1 million of our products. We expect that Future Electronics will take over the majority of the business that we previously conducted with Pioneer Standard, but this transition may not occur smoothly. Pioneer Standard may try to direct their customers to purchase competing products instead of ours. Other customers may not wish to transfer their business to Future Electronics. As a result, we may lose some of the business that we used to sell through our prior distributor, which could harm our operating results materially. Future Electronics also distributes products of our competitors that may directly compete with our product offerings. If Future electronics chooses to promote those products over our products, our operating results could be harmed significantly. In addition, if Future Electronics were to terminate our distribution agreement, we could experience a period of significant interruption of our business while we obtained other distribution channels.
A significant amount of our revenues comes from relatively few of our customers and distributors, and any decrease of revenues from these customers and distributors, or the loss of their business, could significantly harm our financial results.
Historically we have been, and we expect to continue to be, dependent on a relatively small number of customers and distributors for a significant portion of our revenues. We depend on third-party distributors to market and sell our products and these third-party distributors accounted for approximately 44% of our net sales for the year ended December 31, 2002 and 48% of our net sales for the three month period ended March 31, 2003. Our distributors may not continue to effectively market, sell or support our products. Our ten largest customers, including our distributors, accounted for approximately 54% of our net sales for the year ended December 31, 2002, and 61% of our net sales for the three month period ended March 31, 2003. Future Electronics, Inc. and Thompson Conumer Electronics accounted for approximately 20% and 10% of our net sales for the three-month period ended March 31, 2003. Concentration of net sales to particular customers may change from period to period, but we expect that sales to a limited number of customers will continue to account for a significant percentage of our revenues in any particular period for the foreseeable future. The loss of one or more major customers or any reduction, delay or cancellation of orders by any of these customers or our failure to market successfully to new customers could harm our business materially.
We have very few long-term contracts with our customers and, like us, our customers typically compete in cyclical industries. In the future, these customers may decide not to purchase our products at all, to purchase fewer products than they did in the past, or to alter their purchasing patterns, particularly because substantially all of our sales are made on a purchase order or sales order acknowledgment basis, which permits our customers to cancel, change or delay product purchase commitments upon 30 days notice for standard products and 60 days notice for custom products. Customers may still cancel or reschedule within these time periods, however they routinely incur a cancellation or rescheduling charge. This risk is increased because our customers can purchase some similar products from our competitors.
Changes in technologies or consumption patterns could reduce the demand for our products
As a result of technological changes, from time to time our customers design our products out of some devices. Any resulting decreased sales could reduce our profitability. For example, in 1999 and 2000, a number of our customers changed the designs of computer mouse pointing devices that they manufacture, and as a result, these devices no longer contain our products. Because we do not have long-term supply contracts with most of our customers, changes in the designs of their products can have sudden and significant impacts on our sales. For example, net sales of our computer mouse pointing devices and other computer peripheral products decreased substantially from approximately $15.4 million in 2000 to approximately $4.9 million in 2001, to approximately $2.4 million for the year ended December 31, 2002 and to approximately $0.4 million for the three month period ended March 31, 2003. These reduced sales due to design changes have harmed us in the past and additional design changes could harm our operating results in the future.
We depend on key personnel, and the loss of our current personnel or our failure to hire and retain additional personnel could affect our business negatively.
We depend on our ability to attract and retain highly skilled technical and managerial personnel. We believe that our future success in developing marketable products and achieving a competitive position will depend in large part on our ability to identify, recruit, hire, train, retain and motivate highly skilled technical, executive, managerial, marketing and customer service personnel. Competition for these personnel is intense, especially in Northern California, where our headquarters are located, and we may not be able to successfully recruit, assimilate or retain sufficiently qualified personnel. Our failure to recruit and retain necessary technical, executive, managerial, merchandising, marketing and customer service personnel could harm our business and our ability to obtain new customers and develop new products. In addition, our current financial condition could have a negative impact on our ability to recruit and retain employees.
In January 2002, we entered into an employment agreement with James M. Thorburn, our Chairman and Chief Executive Officer, pursuant to which we will make grants of stock options on each of May 13, 2003, and restricted stock grants on May 13, 2004 and May 13, 2005. We intended to loan Mr. Thorburn the funds to pay the income taxes due with respect to these grants, as we have done with other employees that received grants of restricted stock. In July 2002, however, Congress enacted the Sarbanes-Oaxley Act of 2002, which prohibits these loans. As a result of this development, we have converted Mr. Thorburn's May 13, 2003 restricted stock grant to stock options and will need to revisit the terms of our employment arrangement with Mr. Thorburn. There can be no assurance that we will be able to reach a mutually satisfactory arrangement.
We may fail to protect our proprietary rights and the cost of protecting those rights, whether we are successful or not, may harm our ability to compete.
The measures we take to protect our intellectual property rights may be inadequate to protect our proprietary technologies and processes from misappropriation, and these measures may not prevent independent third party development of competitive products. We may not be able to detect the unauthorized use of, or take appropriate steps to enforce our intellectual property rights. Despite our efforts to protect our proprietary rights in both the United States and in foreign countries, existing intellectual property laws in the United States provide only limited protection and, in some cases, the laws of foreign countries provide even less protection.
Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets or to determine the validity and scope of our proprietary rights or the proprietary rights of others. Any such litigation could require us to incur substantial costs and divert significant valuable resources, including the efforts of our technical and management personnel, which may harm our business materially.
We could be subject to claims of infringement of third-party intellectual property rights, which could be time-consuming and expensive for us to defend.
The semiconductor industry is characterized by frequent claims and related litigation regarding patent and other intellectual property rights. Third parties may assert claims or initiate litigation against us, our licensors, our foundries, our service providers, or our customers with respect to existing or future products. Any intellectual property litigation initiated against us could subject us to significant liability for damages and attorneys' fees, invalidation of our proprietary rights, injunctions or other court orders that could prevent us from using specific technologies or engaging in specific business activities. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management's time and attention from our business. Any potential intellectual property litigation could also force us to do one or more of the following:
Implementation of any of these alternatives could be costly and time- consuming and might not be possible at all. An adverse determination in any litigation to which we were a party could harm our business, our results of operations and financial condition. In addition, we may not be able to develop or acquire the technologies we need, and licenses to such technologies, if available, may not be obtainable on commercially reasonable terms. Any necessary development or acquisition could require us to expend substantial time and other resources.
If an infringement against us is successful and we are unable to license the infringed technology, our business and operating results would be harmed significantly.
We may engage in acquisitions that could adversely affect our operating results, dilute our stockholders' equity, or cause us to incur additional debt or assume contingent liabilities.
To grow our business and maintain our competitive position, we have made acquisitions in the past and may do so in the future. For example, in April 1999, we acquired substantially all of the assets and assumed the operating liabilities of Seattle Silicon Corporation and in July 2000, we acquired Calibre, Inc.
Acquisitions involve a number of risks that could harm our business and result in the acquired business not performing as expected, including:
In addition, acquisitions could require investment of significant financial resources and may require us to obtain additional equity financing, which may dilute our stockholders' equity, or to incur additional indebtedness.
Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.
We prepare our financial statements in conformity with accounting principles generally accepted in the United States. These accounting principles are subject to interpretation by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the Securities and Exchange Commission and various bodies formed to interpret and create appropriate accounting policies. A change in these policies or interpretations could have a significant effect on our reported financial results, and could affect the reporting of transactions completed before the announcement of a change. For example, while current accounting rules allow us to exclude the expense of stock options from our financial statements, influential business policy groups, including the Financial Accounting Standards Board, have suggested that the rules be changed to require these options to be expensed. Technology companies generally, and our company, specifically, rely heavily on stock options as a major component of our employee compensation packages. If we are required to expense options, we may be less likely to achieve profitability or we may have to decrease or eliminate options grants. Decreasing or eliminating option grants may negatively impact our ability to attract and retain qualified employees.
We are subject to a variety of environmental laws and regulations and our failure to comply with present or future laws and regulations could harm our business materially.
Our manufacturing processes require us to use various hazardous substances and, as a result, we are subject to a variety of governmental laws and regulations related to the storage, use, emission, discharge and disposal of such substances. Specifically, the existing process of manufacturing silicon wafers is based on use of large amounts of corrosive chemicals and huge quantities of distilled, de-ionized water. Our failure to comply with present or future laws and regulations or the loss of any permit required to conduct our business could result in fines being imposed on us, the limitation or suspension of production or cessation of our operations. Compliance with any future environmental laws and regulations could require us to acquire additional equipment or to incur substantial other expenses. Any failure by us to control the use of, or adequately restrict the discharge of, hazardous materials could subject us to future liabilities that could materially harm our business. In addition, we may be required to incur significant expense in connection with governmental investigations and/or environmental employee health and safety matters.
Recently enacted and proposed changes in securities laws regulations will increase our costs.
The Sarbanes-Oxley Act of 2002 that became law in July 2002 requires changes in some of our corporate governance practices. The Act also requires the SEC to promulgate new rules on a variety of subjects. In addition to final rules and rule proposals already made by the SEC, NASDAQ has proposed revisions to its requirements for companies such as us that are OTCBB-listed. We expect these new rules and regulations to increase our legal and financial compliance costs, and to make some activities more difficult, time consuming and/or more costly. We also expect that these new rules and regulations may make it more costly to obtain director and officer liability insurance coverage, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. These new rules and regulations could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee, and qualified executive officers.
Risks Related to Our Capital Structure
The agreements governing our credit facility may limit our ability to finance future operations or capial needs or engage in business activities that may be in our interest.
The terms of our credit facility contain restrictive covenants that may impair our ability to take corporate actions that we believe to be in the best interests of our stockholders, including restricting the ability to:
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our short-term investment portfolio and borrowings under our revolving credit facility. We do not use derivative financial investments in our investment portfolio. Our primary investment objectives are to preserve capital and maintain liquidity. These objectives are met by investing in high-quality credit issuances and limiting the amount of credit exposure to any one company. Our policy is to mitigate default risk by investing in only the highest quality securities and monitoring the credit ratings of such investments. As of March 31, 2003, our cash equivalents were invested in bank time deposits and money market funds. We have no significant cash flow exposure due to rate changes for our cash equivalents as these instruments have very short maturities.
The table below presents principal amounts and related average rates by year of maturity for our cash equivalents and debt obligations as of March 31, 2003 (dollars in millions):
Carrying
Value Fair Value
------------- -------------
Cash Equivalents:
Fixed rate ..................................... $19.3 $19.3
Average interest rate .......................... 0.98% --
Short Term Debt:
Variable-rate debt.............................. $5.0 $5.0
Interest rate................................... 3.9% --
Item 4. Controls and Procedures
Evaluation of Controls and Procedures
We maintain disclosure controls and procedures, which we have designed to ensure that material information related to the Company, including our consolidated subsidiaries, is made known to the persons preparing our periodic reports on a regular basis.
Within 90 days before the filing of this report, the Company's management carried out an evaluation, under the supervision and with the participation of the Company's Chief Executive Officer, James Thorburn, and the Company's Chief Financial Officer, Perry Grace, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, Mr. Thorburn and Mr. Grace concluded that the Company's disclosure controls and procedures are effective in causing material information to be collected, communicated and analyzed by management of the Company on a timely basis and to ensure that the quality and timeliness of the Company's public disclosures complies with its SEC disclosure obligations.
Changes in Controls and Procedures
There were no significant changes in the Company's internal controls or in other factors that could significantly affect these internal controls after the date of our most recent evaluation.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
We are participating in litigation and responding to claims arising in the ordinary course of business. We intend to defend ourselves vigorously in these matters. Our management believes that it is unlikely that the outcome of these matters will have a material adverse effect on our financial statements, although there can be no assurance in this regard.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits are filed or incorporated herein by reference as indicated below:
Exhibit
Number Description
- ---------- ------------------------------------------------------------------------------
2.1 (a) Joint Reorganization Plan, as confirmed by order of the U.S. Bankruptcy
Court for the Nothern District of California, dated April 30, 2002.
3.1 (b) Amended and Restated Certificate of Incorporation of ZiLOG, Inc.
3.2 (b) Amended and Restated Bylaws of ZiLOG, Inc.
4.1 (c) Form of Restricted Stock Purchase Agreement.
4.2 (c) Form of Non-Qualified EBITDA-Linked Option Grant Agreement.
4.3 (c) Form of Non-Qualified Non-EBITDA-Linked Option Grant Agreement.
99.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act.
- -----------------------------
(a) Incorporated herein by reference to Exhibit 99.1 to the Company's current report
on Form 8-K filed with the Commission on May 15, 2002.
(b) Incorporated herein by reference to the item of the same name filed as an exhibit
to the Company's registration statement on Form S-8 (File No. 333-88416) filed
with the Commission on May 15, 2002.
(c) Incorporated herein by reference to the item of the same name filed as an exhibit
to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002.
b) Reports on Form 8-K:
ZiLOG, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| ZiLOG, INC. |
| (Registrant) |
| By: | /s/ Perry J. Grace |
|
| |
| Perry J. Grace | |
| Vice President and Chief Financial Officer | |
| (Duly Authorized Officer) |
| By: | /s/ James M. Thorburn |
|
| |
| James M. Thorburn | |
| Chairman, Chief Executive Officer and Director | |
| (Duly Authorized Officer) |
Date: May 14, 2003
CERTIFICATIONS
I, James M. Thorburn, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ZiLOG, Inc.:
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures 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 quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, 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 in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/James M. Thorburn
James M. Thorburn
Chairman and Chief Executive Officer
CERTIFICATIONS
I, Perry J. Grace, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ZiLOG, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures 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 quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, 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 in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ Perry J. Grace
Perry J. Grace
Vice President and Chief Financial Officer