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 September 28, 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 October 31, 2003, there were 29,090,045 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 facility 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, Z8Encore!® and eZ80Acclaim!™ are registered trademarks of ZiLOG, Inc.
Extreme Connectivity © ZiLOG, Inc. 1999.
ZiLOG, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 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 September 30, 2003, and three months ended September 30, 2002 |
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Unaudited Condensed Consolidated Statements of Operations for the nine months ended September 30, 2003, five months ended September 30, 2002 and four months ended April 30, 2002 |
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Unaudited Condensed Consolidated Balance Sheets at September 30, 2003 and December 31, 2002 |
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Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2003, five months ended September 30, 2002 and four months ended April 30, 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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ZiLOG, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions except per share data)
Three Months Ended
September 30,
-------------------------
2003 2002
------------ ------------
Net sales......................................... $26.0 $36.0
Cost of sales..................................... 13.3 19.9
------------ ------------
Gross margin...................................... 12.7 16.1
Operating expenses:
Research and development....................... 4.5 4.1
Selling, general and administrative............ 7.2 8.2
Special charges and reorganization items....... 1.3 0.8
Amortization of intangible assets.............. 1.7 3.0
------------ ------------
Total operating expenses..................... 14.7 16.1
------------ ------------
Operating loss.................................... (2.0) --
Other income (expense):
Interest income................................ 0.1 0.1
Interest expense........................ ...... (0.1) (0.1)
Other, net..................................... -- 0.4
------------ ------------
Income (loss) before provision for income taxes... (2.0) 0.4
Provision for income taxes........................ -- 0.2
------------ ------------
Net income (loss)................................. ($2.0) $0.2
============ ============
Basic and diluted net income (loss) per share..... ($0.07) $0.01
============ ============
Weighted-average shares used in computing basic
and diluted net income (loss) per share......... 28.6 28.7
============ ============
See accompanying notes to condensed consolidated financial statements.
ZiLOG, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions except per share data)
Predecessor
Successor Company Company
------------------------- -----------
Nine Months Five Months Four Months
Ended Ended Ended
Sep. 30, Sep. 30, April 30,
2003 2002 2002
------------ ------------ -----------
Net sales......................................... $76.9 $64.1 $46.0
Cost of sales..................................... $41.9 35.3 26.1
Cost of sales - fresh-start inventory
adjustment..................................... -- 3.9 --
------------ ------------ -----------
Gross margin...................................... 35.0 24.9 19.9
Operating expenses:
Research and development....................... 13.1 7.3 6.8
Selling, general and administrative............ 20.4 15.4 10.8
Special charges and reorganization items....... 3.2 1.2 6.9
Amortization of intangible assets.............. 5.1 4.9 --
In-process research and development............ -- 18.7 --
------------ ------------ -----------
Total operating expenses..................... 41.8 47.5 24.5
------------ ------------ -----------
Operating loss.................................... (6.8) (22.6) (4.6)
------------ ------------ -----------
Other income (expense):
Fresh-start adjustments........................ -- -- 83.7
Net gain on discharge of debt.................. -- -- 205.7
Interest income................................ 0.2 0.1 0.1
Interest expense (1)........................... (0.3) (0.4) (5.0)
Other, net..................................... 0.2 0.5 0.1
------------ ------------ -----------
Income (loss) before reorganization items and
provision for income taxes..................... (6.7) (22.4) 280.0
Reorganization items.............................. -- -- 4.0
Provision for income taxes........................ 0.2 0.7 0.1
------------ ------------ -----------
Net income (loss)................................. ($6.9) ($23.1) $275.9
============ ============ ===========
Preferred stock dividends accrued................. -- -- 1.9
------------ ------------ -----------
Net income (loss) attributable to common
stockholders................................... ($6.9) ($23.1) $274.0
============ ============ ===========
Basic and diluted net loss per share.............. ($0.24) ($0.81)
============ ============
Weighted-average shares used in computing
basic and diluted net loss per share............ 28.6 28.6
============ ============
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(1) Excludes contractual interest of $4.2 million in the four months ended
April 30, 2002 not recorded during reorganization.
See accompanying notes to condensed consolidated financial statements.
ZiLOG, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions)
September 30, December 31,
2003 2002
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents................................ $22.0 $29.4
Accounts receivable, less allowance for doubtful
accounts of $0.4 at September 30, 2003 and $0.5
at December 31, 2002................................... 11.0 10.8
Inventories.............................................. 9.9 10.6
Prepaid expenses and other current assets................ 2.7 3.4
-------------- --------------
Total current assets.............................. 45.6 54.2
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MOD III, Inc. assets held for sale.......................... 30.0 30.0
Net property, plant and equipment........................... 18.9 21.9
Goodwill.................................................... 34.6 34.6
Intangible assets, net...................................... 13.2 18.3
Other assets................................................ 8.0 9.8
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$150.3 $168.8
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LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS'EQUITY
Current liabilities:
Short-term debt.......................................... $5.0 $6.9
Accounts payable......................................... 8.9 10.2
Income taxes payable..................................... 1.3 --
Accrued compensation and employee benefits............... 4.1 7.4
Other accrued liabilities................................ 2.6 2.6
Accrued special charges.................................. 0.5 0.6
Deferred income on shipments to distributors............. 5.5 7.4
-------------- --------------
Total current liabilities......................... 27.9 35.1
-------------- --------------
Deferred income taxes....................................... 18.5 22.4
Other non-current liabilities............................... 14.5 14.5
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Total liabilities................................. 60.9 72.0
-------------- --------------
Minority interest in MOD III assets......................... 30.0 30.0
Stockholders' equity:
Common Stock............................................. 0.3 0.3
Deferred stock compensation.............................. (2.4) (4.6)
Additional paid-in capital............................... 96.1 97.1
Treasury stock........................................... (1.8) --
Accumulated deficit...................................... (32.8) (26.0)
-------------- --------------
Total stockholders' equity........................ 59.4 66.8
-------------- --------------
Total liabilities and stockholders' equity.................. $150.3 $168.8
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See accompanying notes to condensed consolidated financial statements.
ZiLOG, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Predecessor
Successor Company Company
-------------------------------------
Nine Months Five Months Four Months
Ended Ended Ended
Sep. 30, Sep. 30, April 30,
2003 2002 2002
------------ ------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................................... ($6.9) ($23.1) $275.9
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
In-process research and development........................ -- 18.7 --
Net gain on discharge of debt.............................. -- -- (205.7)
Amortization of fresh-start adjustments.................... -- -- (83.7)
Fresh-start inventory adjustment........................... -- 3.9 --
Amortization of fresh-start intangible assets.............. 5.1 5.0 --
Depreciation and amortization.............................. 4.3 2.8 2.5
Impairment of equity investment............................ 0.2 -- --
Impairment of long lived assets............................ 0.2 -- 2.7
Stock-based compensation................................... 1.2 2.6 0.1
Changes in operating assets and liabilities:
Accounts receivable, net................................... (0.2) (1.4) 2.1
Inventories................................................ 0.8 2.9 2.9
Prepaid expenses and other current and
non-current assets....................................... 1.7 (1.7) 0.1
Accounts payable........................................... (1.2) 0.4 (0.1)
Accrued compensation and employee benefits................. (3.3) 1.3 (1.8)
Liabilities subject to comprise............................ -- -- 6.6
Other accrued liabilities, deferred income on shipments
to distributors, deferred income taxes, income
taxes payable and accrued special charges............. (4.6) (2.8) (6.8)
------------ ------------ -----------
Net cash provided (used) by operations before
reorganization items................................. (2.7) 8.6 (5.2)
Reorganization items - professional fees paid................ -- -- (2.3)
------------ ------------ -----------
Net cash provided (used) by operating activities........ (2.7) 8.6 (7.5)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................................ (1.6) (0.8) (1.0)
------------ ------------ -----------
Cash used by investing activities....................... (1.6) (0.8) (1.0)
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of short-term debt............................... (1.9) (2.5) (3.4)
Proceeds from issuance of common stock...................... -- 0.3 --
Payments for stock redemptions.............................. (1.2) (0.2) --
------------ ------------ -----------
Cash used by financing activities....................... (3.1) (2.4) (3.4)
------------ ------------ -----------
Increase (decrease) in cash and cash equivalents................ (7.4) 5.4 (11.9)
Cash and cash equivalents at beginning of period................ 29.4 18.8 30.7
------------ ------------ -----------
Cash and cash equivalents at end of period...................... $22.0 $24.2 $18.8
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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 for the fiscal year ended December 31, 2002, filed on April 1, 2003 (Commission File Number 333-98529).
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 that 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 a 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 (April 30, 2002, for financial reporting purposes). 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." The effect of the Plan of Reorganization included conversion of the Company's $280 million senior secured notes to common stock.
A black line has been drawn in the accompanying financial statements to distinguish, for accounting purposes, between the Successor Company and the Predecessor Company. The Company's results of operations after April 30, 2002 and the consolidated balance sheets at December 31, 2002 and September 30, 2003 are not comparable to the results of operations prior to April 30, 2002 and historical balance sheets prior to April 30, 2002, due to the adoption of "fresh-start" reporting upon emergence from bankruptcy. However, such differences in the results of operations relate to depreciation of property, plant and equipment, amortization of intangible assets, in-process research and development, interest expense and restructuring and reorganization expenses. Additionally, these differences in the balance sheets relate to inventories, property, plant and equipment, intangible assets, conversion of senior notes into common stock and minority interest. Certain figures, such as net sales and certain expenses, were not affected by the adoption of fresh-start accounting and, accordingly, the Company believes 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 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 deferred cost of sales on shipments to distributors are reflected in the consolidated balance sheets on a net basis under the caption, "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. As of September 30, 2003, the Company reviewed these assets for impairment and no adjustment to the carrying value was indicated. 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, in May 2002, 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 of six years for current technology and ten years for brand name.
The separable intangible assets identified in connection with fresh-start accounting and included in the condensed consolidated balance sheets are as follows (in millions):
Current Brand
Technology Name Total
------------ ----------- -----------
Gross carrying amount................. $17.0 $9.2 $26.2
Accumulated amortization.............. 11.0 2.0 13.0
------------ ----------- -----------
Book value at September 30, 2003...... $6.0 $7.2 $13.2
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The anticipated remaining amortization schedule for these assets is as follows (in millions):
Current Brand Total
Year Technology Name Amortization
------------ ----------- ----------- ------------
October to Dec-
ember 2003 $1.3 $0.4 $1.7
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
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Total $6.0 $7.2 $13.2
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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, sales returns and allowances and asset impairments.
Actual results could differ from those estimates.
Research and Development Expenses. ZiLOG's policy is to record all research and development expenditures for items 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 and accounts receivable. The Company maintains its cash and cash equivalents with high quality financial institutions. The Company's customer base consists primarily 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 September 30, 2003, there were two customers with net accounts receivable comprising more than 10% of total net accounts receivable. Future Electronics, Inc. and Thomson Consumer Electronics each had net accounts receivable at September 30, 2003, of approximately $1.3 million.
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).
Predecessor
Successor Company Company
------------------------------------------------ ----------
Three Three Nine Five Four
Months Months Month Months Month
Ended Ended Ended Ended Ended
Sep. 30, Sep. 30, Sep. 30, Sep. 30, April 30,
2003 2002 2003 2002 2002
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Net income (loss) as reported............... ($2.0) $0.2 ($6.9) ($23.1) $275.9
Add stock-based employee compensation
expense included in reported net
income (loss), net of tax................ 0.4 0.6 1.2 2.6 0.1
Deduct total stock-based employee
compensation expense determined
under fair-value based method
for all awards, net of tax............... (0.3) (0.3) (1.3) (2.7) (0.3)
------------ ------------ ----------- ---------- ----------
Proforma net income (loss).................. ($1.9) $0.5 ($7.0) ($23.2) $275.7
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The fair value of options granted in 2002 and 2003 under the 2002 Omnibus Stock Incentive Plan was estimated at the date of grant using the Black-Scholes option-pricing model. The following weighted average assumptions were used:
Predecessor
Successor Company Company
--------------------------------------------- ----------
Three Three Nine Five Four
Months Months Month Months Month
Ended Ended Ended Ended Ended
Sep. 30, Sep. 30, Sep. 30, Sep. 30, April 30,
2003 2002 2003 2002 2002
----------- ---------- ----------- ---------- ----------
Annual average risk free interest rate.... 3.0% 3.0% 3.0% 3.0% 3.5%
Estimated life in years................... 5 5 5 5 5
Dividend yield............................ 0.0% 0.0% 0.0% 0.0% 0.0%
Volatility................................ 84.2% 88.9% 84.2% 88.9% 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
("FIN 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 for variable interest entities created before February 1,
2003, and is effective in the fourth quarter of 2003. The adoption of FIN 46
did not have an impact on the Company's unaudited condensed consolidated
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 impact from the adoption of EITF Issue 00-21 did not
have a material impact on the Company's unaudited condensed consolidated
financial statements.
In April 2003, the FASB issued FAS 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." FAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FAS 133, "Accounting for Derivative Instruments and Hedging Activities." FAS 149 provides greater clarification of the characteristics of a derivative instrument so that contracts with similar characteristics will be accounted for consistently. In general, FAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. As the Company does not currently have any derivative financial instruments, the adoption of FAS 149 did not have an impact on the Company's unaudited condensed consolidated financial statements.
In May 2003, the FASB issued FAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." FAS 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. Previously, many of those financial instruments were classified as equity. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. As the Company does not have any of these financial instruments, the adoption of FAS 150 did not have any impact on the Company's unaudited condensed consolidated financial statements.
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):
Sep. 30, December 31,
2003 2002
------------ ------------
Raw materials........................ $0.4 $0.5
Work-in-process...................... 6.5 7.5
Finished goods....................... 3.0 2.6
------------ ------------
$9.9 $10.6
============ ============
NOTE 4. SPECIAL CHARGES AND REORGANIZATION ITEMS
The components of special charges are as follows (in millions):
Predecessor
Successor Company Successor Company Company
------------------------- ---------------------- ----------
Three Three Nine Five Four
Months Months Month Months Month
Ended Ended Ended Ended Ended
Sep. 30, Sep. 30, Sep. 30, Sep. 30, April 30,
2003 2002 2003 2002 2002
------------ ------------ ----------- ---------- ----------
Asset impairments:
Austin Texas assets...................... $ -- $ -- $ -- $ -- $1.7
Internal use software.................... -- -- -- -- 0.8
Nampa, Idaho assets...................... -- -- 0.2 -- --
Goodwill write-offs...................... -- -- -- -- 0.2
Equity investment write-down............. 0.2 -- 0.2 -- --
Restructuring of operations:
Employee severance and
termination benefits................... 0.6 -- 1.3 -- 1.2
MOD III closure costs.................... 0.4 0.3 1.0 0.6 2.3
Lease termination costs.................. -- -- -- -- 0.7
Professional fees for debt
restructuring and S-1 filings............ 0.1 0.5 0.5 0.6 4.0
------------ ------------ ----------- ---------- ----------
$1.3 $0.8 $3.2 $1.2 $10.9
============ ============ =========== ========== ==========
The following table summarizes activity in accrued special charges (in millions):
Severance
and MOD III Debt
Termination Closure Restructur-
Total Benefits Costs ing
------------ ----------- ----------- ------------
Balance at December 31, 2002...... $0.6 $0.5 $0.1 $ --
Total charged to special
charges........................ 2.8 1.3 1.0 0.5
Cash paid......................... (2.9) (1.5) (1.1) (0.3)
------------ ----------- ----------- ------------
Balance at September 30, 2003..... $0.5 $0.3 $ -- $0.2
============ =========== =========== ============
During the three months ended September 30, 2003, ZiLOG incurred approximately $1.3 million of special expenses, which included severance and termination benefits of $0.6 million relating to a reduction-in-force at the Company's Philippine's test facility, and severance costs associated with elimination of certain administrative positions, primarily in San Jose. Approximately $0.4 million of special charges for the period relate to continuing 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 sale of the property. Approximately $0.1 million of special charges relate to third-party professional service fees for legal and accounting services to register 11.7 million shares of common stock as required by the Company's 2002 Plan of Reorganization and 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. Additionally, asset impairments consisted of approximately $0.2 million of a non-cash impairment loss recognized on the write-down of an equity investment.
Restructuring of operations during the nine-month period ended September 30, 2003 of $3.2 million included severance and termination benefits of $1.3 million, which primarily related to a reduction-in-force at the Company's Nampa, Idaho manufacturing plant and Philippine's test facility, eliminating a total of approximately 86 positions. Approximately $1.0 million of special charges for the nine-month 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 $0.5 million of special charges relate to third-party professional fees for legal and accounting services to register 11.7 million shares of common stock as required by the Company's 2002 Plan of Reorganization and 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.
Asset impairments of $0.4 million included computer equipment with a net book value of $0.2 million that was retired in connection with an information system upgrade that included new equipment purchases. The redundant equipment was written off to special charges. Additionally, approximately $0.2 million impairment loss was recognized on an equity investment.
During the three months ended September 30, 2002, ZiLOG incurred special charges of $0.8 million for restructuring of operations. Approximately $0.3 million of special charges relate to activities associated with the closure of the MOD III eight-inch wafer fabrication facility in Idaho, referred to as the "MOD III facility." These charges related to post-closure maintenance costs related to utilities, taxes, insurance and other maintenance costs required to maintain the facility in a condition required for the sale of the property. Approximately $0.5 million of special charges relate to third party professional service fees for legal and financial advisors who were assisting with the Company's debt and equity restructuring activities.
During the five months ended September 30, 2002, ZiLOG incurred special charges and reorganization items of $1.2 million for restructuring of operations. Approximately $0.6 million of special charges relate to the MOD III closure and $0.6 million represent third party professional service fees for debt and equity restructuring activities. During the Chapter 11 filing of the Reorganization Plan, such costs were classified as "Reorganization Items."
In connection with the closure of the Company's Austin, Texas design center in the four-month period ended April 30, 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 four-month period ended April 30, 2002. Approximately $0.8 million of computer aided design software was impaired in the four-month period ended April 30, 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, $2.3 million of special charges incurred during the four-month period ended April 30, 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 $4.0 million for debt restructuring were recorded as non-operating 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 32-bit microprocessors for 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, also referred to as micrologic, and standard products. The following table represents the net sales by business line for each for the periods indicated (dollars in millions):
Predecessor
Successor Company Successor Company Company
------------------------ ------------------------ -----------
Three Three Nine Five Four
Months Months Month Months Month
Ended Ended Ended Ended Ended
Sep. 30, Sep. 30, Sep. 30, Sep. 30, April 30,
Products 2003 2002 2003 2002 2002
- -------------------------------------------- ------------ ----------- ----------- ------------ -----------
Embedded control products include:
8-bit Microcontrollers
and Microprocessors................. $15.8 $22.5 $48.9 $41.5 $29.1
------------ ----------- ----------- ------------ -----------
Total............................... $15.8 $22.5 $48.9 $41.5 $29.1
------------ ----------- ----------- ------------ -----------
Standared products include:
Serial Communications
Controllers.......................... $3.9 $3.6 $10.4 $6.7 $5.0
Modems................................. 1.3 2.4 2.3 5.0 4.7
IrDA transceivers...................... 0.7 0.6 1.8 1.3 0.5
Televesion, PC peripherals and other... 1.1 2.6 4.0 4.9 5.8
Foundry services....................... 3.2 4.3 9.5 4.7 0.9
------------ ----------- ----------- ------------ -----------
Total............................... $10.2 $13.5 $28.0 $22.6 $16.9
------------ ----------- ----------- ------------ -----------
Net sales................................ $26.0 $36.0 $76.9 $64.1 $46.0
============ =========== =========== ============ ===========
The following table summarizes ZiLOG's net sales by region and by channel (in millions):
Predecessor
Successor Company Successor Company Company
------------------------ ------------------------ -----------
Three Three Nine Five Four
Months Months Month Months Month
Ended Ended Ended Ended Ended
Sep. 30, Sep. 30, Sep. 30, Sep. 30, April 30,
2003 2002 2003 2002 2002
------------ ----------- ----------- ------------ -----------
Net sales by region:
Americas.................................... $15.6 $21.8 $43.8 $38.7 $25.2
Asia........................................ 7.3 10.4 23.2 18.4 13.8
Europe...................................... 3.1 3.8 9.9 7.0 7.0
------------ ----------- ----------- ------------ -----------
Total.................................... $26.0 $36.0 $76.9 $64.1 $46.0
============ =========== =========== ============ ===========
Net sales by channel:
OEM......................................... $14.5 $21.3 $40.6 $36.9 $25.8
Distributor................................. 11.5 14.7 36.3 27.2 20.2
------------ ----------- ----------- ------------ -----------
Total.................................... $26.0 $36.0 $76.9 $64.1 $46.0
============ =========== =========== ============ ===========
Major Customers. During the three months and nine months ended September 30, 2003, one customer, Future Electronics, Inc., accounted for approximately 17.7% and 17.6% of the Company's net sales, respectively, and a second customer, Globespan Virata, Inc. accounted for approximately 12.2% and 12.3% of net sales, respectively during the same periods. During the three months ended September 30, 2002, two customers, Pioneer-Standard Electronics and Globespan Virata, Inc. accounted for 14.4% and 11.6%, respectively. During the five-month period ended September 30, 2002 and the four-month period ended April 30, 2002, one customer, Pioneer-Standard Electronics, accounted for approximately 16.0% and 10.5% of net sales, respectively.
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 September 30, 2003, the Company had borrowings outstanding of $5.0 million at a LIBOR-based rate of 3.6% and had additional borrowing capacity available of $0.8 million. The Facility is scheduled to expire on May 13, 2005. As of September 30, 2003, the Company also had $0.3 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 net asset value and fixed charge coverage ratio, only if the total of the Company's cash, cash equivalents and availability on the facility are less than $7.5 million at any month end.
NOTE 7. CONTINGENCIES
The Company is participating in litigation and responding to claims arising in the ordinary course of its 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 nine- and three-month periods ended September 30, 2003, the five-month period ended September 30, 2002 and the four-month period ended April 30, 2002, reflects estimated income tax rates 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 period ended December 31, 2002 to reflect the net tax effect of assets that have a book basis in excess of their tax basis.
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 to a buyer. As of September 30, 2003, the Company has expensed a total of approximately $1.0 million in order to maintain the facility in saleable condition. In the event the MOD III assets are sold for less than $30 million, or external factors indicate that the MOD III assets have a fair value less than $30 million, the Company will recognize an impairment charge.
NOTE 10. NET INCOME (LOSS) PER SHARE
The following table presents the calculation of basic and diluted net income (loss) per share of common stock (in millions, except per share data):
Successor Company
------------------------------------------------
Three Three Nine Five
Months Months Months Months
Ended Ended Ended Ended
Sep. 30, Sep. 30, Sep. 30, Sep. 30,
2003 2002 2003 2002
------------ ------------ ----------- ----------
Net income (loss)......................... ($2.0) $0.2 ($6.9) ($23.1)
============ ============ =========== ==========
Weighted-average shares
outstanding............................ 29.1 29.9 29.2 29.7
Less: Weighted-average shares
subject to repurchase.................. 0.5 1.2 0.6 1.1
------------ ------------ ----------- ----------
Weighted-average shares used in
computing basic and diluted
net income (loss) per share............ 28.6 28.7 28.6 28.6
============ ============ =========== ==========
Basic and diluted net income
(loss) per share....................... ($0.07) $0.01 ($0.24) ($0.81)
============ ============ =========== ==========
At September 30, 2003 and 2002, options to purchase approximately 2.6 million and 1.9 million shares of common stock, respectively, were excluded from the determination of diluted net income (loss) per share, as the effect of such options were anti-dilutive. As of September 30, 2003, the weighted average exercise price of the options was $2.74. As of September 30, 2002, the weighted average exercise price of the options was $2.76. At September 30, 2003, there were 29,090,045 million shares of common stock issued and outstanding.
NOTE 11. STOCK AND STOCK REPURCHASES
On April 17, 2003, the Company's Board of Directors approved a stock repurchase plan under which the Company may repurchase up to one million shares of its outstanding common stock.
The Company generally has the right of first refusal to repurchase common shares of common stock issued under the Company's stock plan to certain employees, former employees and contractors. The Company's right of first refusal generally may be exercised when such shares are offered for sale or upon termination from employment.
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, purchases under the stock repurchase plan 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 on the open market 250,000 shares of its common stock at $2.00 per share, which resulted in a net cash outlay of $0.5 million. On May 30, 2003, ZiLOG's Board of Directors approved the repurchase of 100,000 shares of common stock from ZiLOG's President, Michael Burger, at the closing price on that day of $3.25 per share. Mr. Burger continues to own 400,000 shares of restricted common stock. The net cash paid to repurchase these 350,000 shares was approximately $664,000, which is net of certain loan repayments made to the Company by Mr. Burger. As of September 30, 2003, under the stock repurchase plan, the Company repurchased an additional 341,500 shares of restricted common stock from former employees for approximately $485,000, which is net of certain loan repayments made to the Company by these former employees. In connection with the above repurchases of shares from employees and former employees, the Company retired approximately $623,000 of employee loans receivable. Additionally, during the third quarter, the Company repurchased 8,827 shares of common stock from employee stock option exercises for approximately $34,000. All of these shares are reflected in the financial statements of the Company as treasury stock as of September 30, 2003. There were no repurchases of common stock over the nine-month period ending September 30, 2002.
The Company granted 229,418 shares of common stock issuable upon exercise of stock options to Mr. Thorburn on April 24, 2003 at an exercise price of $1.00 per share and vested May 13, 2003. On April 24, 2003, the compensation committee of the Board of Directors cancelled the grant of 176,465 shares of restricted stock to which Mr. Thorburn, the Company's Chief Executive Officer, would have been entitled in accordance with his employment agreement. These shares were to be fully vested on May 13, 2003 and have a purchase price of $0.01 per share. Additionally, Mr. Thorburn's employment agreement also provides for a loan guarantee to finance the tax implications of the share issuance. This arrangement is no longer permitted pursuant to the Sarbanes- Oxley Act of 2002 and this necessitated a change from restricted shares to stock options.
NOTE 12. SUBSEQUENT EVENT
The Company renewed its lease in the 54,000 square foot facility in the Philippines. The original lease was due to expire March 31, 2004. The new lease runs through March 31, 2009. The base annual rent and a security deposit of six months rent for approximately $0.5 million was paid in October 2003. A majority of the Company's final test, inventory warehousing and logistics resides at this facility. Future commitments under this new lease are as follows:
Year
Ending
Dec. 31, $
------------ -----------
2004 0.3
2005 0.3
2006 0.4
2007 0.4
2008 0.5
Beyond 0.1
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 nine-month and three-month periods ended September 30, 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 herein and in our 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 information disclosed in our quarterly earnings releases and investor calls, and read the associated reconciliations.
A black line has been drawn in the accompanying financial statements to distinguish, for accounting purposes, between the Successor Company and the Predecessor Company. The Company's results of operations after April 30, 2002 and the consolidated balance sheets at December 31, 2002 and September 30, 2003 are not comparable to the results of operations prior to April 30, 2002 and historical balance sheets prior to April 30, 2002, due to the adoption of "fresh-start" reporting upon emergence from bankruptcy. However, such differences in the results of operations relate to depreciation of property, plant and equipment, amortization of intangible assets, in-process research and development, interest expense and restructuring and reorganization expenses. Additionally, these differences in the balance sheets relate to inventories, property, plant and equipment, intangible assets, conversion of senior notes into common stock and minority interest. Certain figures, such as net sales and certain expenses, were not affected by the adoption of fresh-start accounting and, accordingly, the Company believes 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.
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., (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, although 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, $325.7 million of liabilities were extinguished, 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 Predecessor Company's 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 ongoing 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 Zarlink (formerly
Mitel), amongt 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, but is tested for impairment at least annually, as required by FAS 142.
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 performed the annual impairment test for goodwill in the third quarter of 2003, and no impairment charge was recorded as no impairment of the carrying value was indicated. We plan to perform this test in the third quarter 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 September 30, 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, in-process research and development, interest expense and restructuring and reorganization expenses. Additionally, these differences in our balance sheets relate to inventory, 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 successor company's operations for the three and nine months ended September 30, 2003 to the predecessor and successor company's results for the three and nine months ended September 30, 2002. The combined results are not meant to be a presentation in accordance with generally accepted accounting principles.
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):
Predecessor
Successor Company Successor Company Company
------------------------ ------------------------ -----------
Three Three Nine Five Four
Months Months Month Months Month
Ended Ended Ended Ended Ended
Sep. 30, Sep. 30, Sep. 30, Sep. 30, April 30,
2003 2002 2003 2002 2002
------------ ----------- ----------- ------------ -----------
Net sales by region:
Americas.................................... $15.6 $21.8 $43.8 $38.7 $25.2
Asia........................................ 7.3 10.4 23.2 18.4 13.8
Europe...................................... 3.1 3.8 9.9 7.0 7.0
------------ ----------- ----------- ------------ -----------
Total by region.......................... $26.0 $36.0 $76.9 $64.1 $46.0
============ =========== =========== ============ ===========
Net sales by channel:
OEM......................................... $14.5 $21.3 $40.6 $36.9 $25.8
Distributor................................. 11.5 14.7 36.3 27.2 20.2
------------ ----------- ----------- ------------ -----------
Total by channel......................... $26.0 $36.0 $76.9 $64.1 $46.0
============ =========== =========== ============ ===========
Net sales by busines line:
Embedded control products
8-bit Microcontrollers
and Microprocessors................. $15.8 $22.5 $48.9 $41.5 $29.1
------------ ----------- ----------- ------------ -----------
Total............................... $15.8 $22.5 $48.9 $41.5 $29.1
------------ ----------- ----------- ------------ -----------
Standared products
Serial Communications
Controllers.......................... $3.9 $3.6 $10.4 $6.7 $5.0
Modems................................. 1.3 2.4 2.3 5.0 4.7
IrDA transceivers...................... 0.7 0.6 1.8 1.3 0.5
Televesion, PC peripherals and other... 1.1 2.6 4.0 4.9 5.8
Foundry services....................... 3.2 4.3 9.5 4.7 0.9
------------ ----------- ----------- ------------ -----------
Total............................... $10.2 $13.5 $28.0 $22.6 $16.9
------------ ----------- ----------- ------------ -----------
Total by business line................... $26.0 $36.0 $76.9 $64.1 $46.0
============ =========== =========== ============ ===========
During the past two years, we have implemented a series of business restructuring programs aimed at refocusing the Company 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 the entire $280.0 in million principal value of our 9.5% Senior Secured Notes due 2005, which had required us to pay semiannual interest payments of $13.3 million each March 15 and September 15.
Nine-Month Periods Ended September 30, 2003 and September 30, 2002
Net Sales. Beginning in 2000 we experienced a trend of reduced demand for many of our products that has in certain market areas continued through the first nine months of 2003. During this time, we have refocused our business on our core 8-bit micrologic portfolio of embedded control products and de-emphasized certain product offerings in our standard products area.
Our net sales of $76.9 million in the first nine months of 2003 represents a decrease of 30.2% from net sales of $110.1 million in the first nine months of 2002. This decrease in net sales reflects lower unit shipments in both our embedded control and standard products. Our net sales decline during the first nine months of 2003 compared to the same period in 2002 reflects 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 eZ80Acclaim!™ products that are focussed on the embedded flash market, with a strategy of recapturing sales to these customers and entering new markets. Although we have experienced significant customer interest in our new Z8 Encore!® and eZ80Acclaim!™ products and related design tool-kits, we do not expect significant volume shipments of these products during 2003.
Net sales of our standard products for the nine months ended September 30, 2003 decreased $11.5 million or 29.1% to $28.0 million from $39.5 million in the same period of 2002. This decrease reflects:
Gross Margin. Our cost of sales primarily represents the cost of producing our products, including wafer fabrication, assembly and test expenditures. 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 increased to 45.5% in the first nine months of 2003, up from 40.7% in the same period of 2002. This improvement in our gross margin percentage during 2003 reflects a $3.9 million charge for amortization of fresh-start reporting inventory adjustments during the first nine months of 2002. (See Note 3, "Fresh-Start Reporting," on Notes to Consolidated Financial Statements in our 2002 Annual Report filed on Form 10-K.) Although our "gross margin as adjusted" is a non-GAAP measure, we believe it is meaningful to investors as excluding the bankruptcy-related inventory adjustment provides a more accurate reflection of comparable performance. Exclusive of this one-time amortization charge, our gross margin as adjusted was 44.2% of net sales for the nine months ended September 30, 2002. Lower revenue have resulted in lower wafer production needs, although for the nine months ended September 30, 2003 we have improved our gross margin compared to the same period in 2002. The improved margin is a result of lower manufacturing costs driven by improved yields, production efficiencies and lower vendor pricing. We have continued to rationalize our manufacturing cost structure in response to these lower demand requirements including a reduction in force of approximately 55 positions in our 5" MOD II Nampa, Idaho facility in February 2003, and approximately 30 positions in our assembly plant in the Philippines in September 2003. We purchase our wafer requirements for 0.35-micron technologies from our foundry suppliers primarily in Taiwan including our new embedded flash-based Z8 Encore!® and eZ80Acclaim!™ products.
Research and Development Expenses. Research and development expenses were $13.1 million in the first nine months of 2003, reflecting a 7.1% decrease from the $14.1 million of research and development expenses reported in the first nine months of 2002. The decrease in research and development expense primarily reflects lower payroll-related costs as a result of headcount reductions, reflecting the closure, in 2002, of our Austin, Texas design center and the related termination of all product development activities in connection with our development-stage CarteZian line of 32-bit microprocessors. Our R&D efforts during 2003 have been and will continue to be primarily directed towards development of core micrologic products and tool support, particularly for our Z8 Encore!® and eZ80Acclaim!™ families of 8-bit embedded-flash microcontrollers.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $20.4 million in the first nine months of 2003 from $26.2 million in the first nine months of 2002. The decrease in our selling, general and administrative spending in the first nine months of 2003 reflects lower payroll-related costs as a result of lower headcount, a decline of stock-based compensation expense, reduced sales commissions and elimination of bonus compensation as a result of lower sales levels.
Special Charges. Special charges for each period indicated were as follows (in millions):
Three Months Ended Nine Months Ended
------------------------ ------------------------
Sep. 30, Sep. 30, Sep. 30, Sep. 30,
2003 2002 2003 2002
------------ ----------- ----------- ------------
Asset impairments:
Austin, Texas assets..................... $ -- $ -- $ -- $1.7
Internal use software.................... -- -- -- 0.8
Nampa, Idaho assets...................... -- -- 0.2 --
Goodwill write-offs...................... -- -- -- 0.2
Equity investment write-down............. 0.2 -- 0.2 --
Restructuring of operations:
Employee severance and
termination benefits.................. 0.6 -- 1.3 1.2
MOD III closure costs.................... 0.4 0.3 1.0 2.9
Lease termination costs.................. -- -- -- 0.7
Professional fees for debt
restructuring and S-1 filings............ 0.1 0.5 0.5 4.6
------------ ----------- ----------- ------------
$1.3 $0.8 $3.2 $12.1
============ =========== =========== ============
- ------------------------
Note: The period ended September 30, 2002 reflects combined results of the Predecessor and the
Successor Company. The three-months ended September 30, 2003 and 2002, and the nine-month
period ended September 30, 2003, reflect only the results of the Successor Company.
The following table summarizes activity in accrued special charges (in millions):
Severance
and MOD III Debt
Termination Closure Restructur-
Total Benefits Costs ing
------------ ----------- ----------- ------------
Balance at December 31, 2002...... $0.6 $0.5 $0.1 $ --
Total charged to special
charges........................ 2.8 1.3 1.0 0.5
Cash paid......................... (2.9) (1.5) (1.1) (0.3)
------------ ----------- ----------- ------------
Balance at September 30, 2003..... $0.5 $0.3 $ -- $0.2
============ =========== =========== ============
During the nine months ended September 30, 2003, special charges totaled $3.2 million, which was comprised of $2.3 million of restructuring of operations expenses, long-lived asset impairments of $0.2 million, and equity investment impairment of $0.2 million and professional fees of $0.5 million in connection with the registration of common stock required by our reorganization plan. The restructuring of operations relates to severance and benefit costs in connection with the reduction of a total of approximately 86 positions that were eliminated in our MOD II wafer fabrication facility and our Philippine assembly plant, and, the ongoing costs of maintaining our MOD III facility which is being held for sale.
In connection with the closure of our Austin, Texas design center in the first nine months of 2002, we abandoned 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. Approximately $0.8 million of computer aided design software was impaired in the first nine months of 2002 as a result of our decision to cancel development of the CarteZian family of 32-bit RISC microprocessors. Additionally, we incurred $2.9 million of special charges during the first nine months of 2002 in connection with the closure of our MOD III eight-inch wafer fabrication facility in Idaho as well as $0.7 million of lease termination costs related to the closure and relocation of certain sales offices. These costs include relocation of production to alternative manufacturing sites and the cost of closing of the facilities. Chapter 11 reorganization-related costs of $4.6 million for the nine months ended September 30, 2002 relate primarily to legal and other professional service fees. In addition $0.2 million of unamortized goodwill relating to our 2000 acquisition of PLC Corporation was deemed to be of no future value and was written off during the nine months ended September 30, 2002.
Stock-Based Compensation. During the nine-month periods ended September 30, 2003 and 2002, we recognized $1.2 and $2.6 million of stock-based compensation, respectively, in connection with the award of restricted stock and stock options to certain executives, employees and consultants. These non-cash charges are primarily included in our selling, general and administrative expenses. Our right to repurchase shares of restricted stock for $0.01 per share generally lapses 25% on the award date and 25% on each of the first three anniversaries following the award date. Compensation expense for employee stock awards was measured on the award date and will be recognized over each of the next three years as these restrictions lapse. Charges for stock awards to consultants is measured as the awards vest and will be recognized over the periods that the restrictions lapse. Based on the employee stock and option awards we made during May 2002, we anticipate that we will recognize stock compensation charges of $1.6 million, $1.4 million and $0.7 million for the years ending December 31, 2003 through 2005, respectively
In-Process Research and Development. During the first nine months of 2002, we recorded an $18.7 million charge for in-process research and development relating to our fair value allocation of the Company's reorganization value determined by an independent appraiser. The projects related to the research and development (partially developed semiconductor product designs), had not reached technological feasibility as of the effective date of our reorganization and have no alternative future use. The nature of efforts required to develop the in-process technology into commercially viable products primarily relates to completion of design, prototyping and testing to ensure the products can be produced to meet customer design specifications, including functions, features and performance requirements. There can be no assurance that these products will ever achieve commercial success.
Factors considered in valuing in-process research and development included the stage of development of each project, target markets and associated risks of achieving technological feasibility and market acceptance of the products. The value of the in-process technology was determined by estimating the projected net cash flows after deducting the costs to complete the projects arising from commercialization of the products over periods ranging from four to six years. These cash flows were then discounted to their net present value using a discount rate of 25%. The estimated stage of completion was applied to the net present value of future discounted cash flows to arrive at the in-process research and development amount that was immediately expensed subsequent to the adoption of fresh-start reporting.
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 of six years for current technology and ten years for brand name. 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 performed the annual impairment test for goodwill in the third quarter of 2003, and no impairment change was recorded as no impairment of the carrying value was indicated. We plan to perform this test in the third quarter each year unless the existence of triggering events indicates that an earlier review should be performed.
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.............. 11.0 2.0 13.0
------------ ----------- -----------
Book value at September 30, 2003...... $6.0 $7.2 $13.2
============ =========== ===========
The anticipated remaining amortization schedule for these assets is as follows (in millions):
Current Brand Total
Year Technology Name Amortization
------------ ----------- ----------- ------------
October to Dec-
ember 2003 $1.3 $0.4 $1.7
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 $6.0 $7.2 $13.2
=========== =========== ============
Other Income (Expense). During the nine-month period ended September 30, 2002, our other income and expense was primarily comprised of $205.7 million of net gain on discharge of debt and $83.7 million of fresh-start adjustments.
Pursuant to the 2002 financial restructuring and reorganization, we 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 the reorganization plan, which became effective on May 13, 2002. 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 our 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. These debts were offset by the $30.0 million of minority interest in MOD III, Inc. assets, acquired by the former bondholders, and $90.0 million of reorganization equity value. 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" accounting principles prescribed by the American Institute of Certified Public Accountants' Statement of Position 90-7, " Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," or SOP 90-7. As a result, we recorded a gain of $83.7 million in the Predecessor Company's financial statements, consisting of the effect of fresh-start adjustments of $66.7 million and the revaluation of fixed and tangible assets to fair value of $17.0 million.
Interest Expense. During the nine-month period ended September 30, 2002, our interest expense was primarily accrued in connection with our 9.5% senior secured notes payable, which notes and related accrued interest were extinguished in connection with our reorganization effective May 13, 2002.
Income Taxes. Our provision for income taxes during the nine- month periods ended September 30, 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 period ended December 31, 2002 to reflect the net tax effect of our assets that have a book basis in excess of their tax basis.
Three Month Periods Ended September 30, 2003 and September 30, 2002
Net Sales. Overall, our net sales during the three months ended September 30, 2003 were $26.0 million, which represents a 27.8% decline from our net sales of $36.0 million during the same period of 2002. This decrease in net sales is the result of lower unit shipments in both our embedded control and standard product offerings. Our quarterly net sales decline reflects the overall lower market demand as well as continued conversion of our older Z80 and Z8 micrologic products to alternative technologies, primarily microcontrollers with embedded flash technology. In November 2002 and February 2003 we released our new Z8 Encore!® and eZ80Acclaim!™ products that are focused on the embedded flash market, with a strategy of recapturing sales to these customers and entering new markets. Although we have experienced significant customer interest in our new Z8 Encore!® and eZ80Acclaim™ products and related design tool-kits, we do not expect volume shipments of these products during 2003.
Net sales of our standard products for the three months ended September 30, 2003 were $10.2 million, reflecting a $3.3 million or 24.4% decline from net sales of $13.5 million in the same period of 2002. This decrease reflects:
Gross Margin. Our gross margin as a percentage of net sales increased to 48.8% in the third quarter of 2003 as compared to 44.7% in the same period of 2002. The increase in our gross margin as a percentage of sales for the three months ended September 30, 2003 as compared to the same period in 2002, reflects our continued rationalization of our manufacturing cost structure including our 5" MOD II Nampa, Idaho facility and our test facility in the Philippines. We continue to purchase our wafer requirements for 0.35-micron wafer technologies from our foundry suppliers primarily in Taiwan, including our new embedded flash-based Z8 Encore!® and eZ80Acclaim!™ products.
Research and Development Expenses. Research and development expenses were $4.5 million in the third quarter of 2003 and $4.1 million in the third quarter of 2002. Our R&D efforts during 2003 have been and will continue to be primarily directed towards development of products and tool support for our Z8 Encore!® and eZ80Acclaim!™ families of 8-bit embedded-flash microcontrollers.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $7.2 million in the third quarter of 2003, reflecting a 12.2% decrease from the $8.2 million in the third quarter of 2002. This decrease in our selling, general and administrative spending in the third quarter of 2003 reflects lower payroll-related costs as a result of lower headcount, a decline of stock-based compensation expenses, reduced sales commissions and elimination of bonus compensation as a result of lower sales levels compared to the third quarter of 2002.
Special Charges. During the quarter ended September 30, 2003, we incurred special charges $1.3 million. Approximately $0.6 million of these special charges related to restructuring of operations for severance and benefits costs in connection with the reduction-in-force at our Philippine assembly plant and contractual obligations to a former Company vice president. Approximately $0.4 million of these special charges relate to activities associated with maintaining the assets of our idle MOD III eight-inch wafer fabrication facility in Idaho. These costs included post-closure maintenance as well as utilities, taxes, insurance and other costs required to maintain the facility in a condition required for the sale of the property in saleable condition. During the three months ended September 30, 2003 we also recorded a $0.2 million charge for impairment in the value of an equity investment and approximately $0.1 million professional service fees for legal and accounting services to register shares of common stock as required by our 2002 Plan of Reorganization.
During the three months ended September 30, 2002 our special charges totaled $0.8 million. This amount included $0.3 million of MOD III closure costs and professional service fees of $0.5 million in connection with our reorganization.
Amortization of Intangible Assets for the three-month periods ended September 30, 2003 and 2002, relate to our fresh-start reporting and is described in the previous section entitled "Nine-Month Periods Ended September 30, 2003 and September 30, 2002."
Other Income/(Expense) Net. During the quarter ended September 30, 2002, our other income and expense was primarily comprised of miscellaneous income from sales of scrap equipment.
Income TaxesOur provision for income taxes during the three- month periods ended September 30, 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 period ended December 31, 2002 to reflect the net tax effect of our assets that have a book basis in excess of their tax basis.
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 described in Note 1, 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 previous revolving credit facility and capital expenditure line was cancelled. Our current credit facility is a three-year $15.0 million senior secured revolving line of credit facility. Borrowings on the facility 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 bears interest on borrowings at 3.6% per annum as of September 30, 2003. As of September 30, 2003, we had outstanding borrowings of $5.0 million and standby letters of credit of $0.3 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. As of September 30, 2003, our availability for additional borrowing under the facility totaled $0.8 million. If we were to pay the necessary fees to qualify certain foreign accounts receivable in our borrowing base, we could theoretically borrow up to an additional $2.1 million under our revolving credit facility as of September 30, 2003.
We are subject to certain financial covenants under this facility, including tangible net asset balance and fixed charge coverage ratios. Such covenants are only tested 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 September 30, 2003, we had cash and cash equivalents of $22.0 million, compared to $29.4 million at December 31, 2002. Cash used by operating activities was $2.1 million for the nine months ended September 30, 2003, compared to $1.1 million of cash provided by operating activities in the nine months ended September 30, 2002.
During the nine-month period ended September 30, 2003, cash used by operating activities of $2.7 million primarily reflects our net loss of $6.9 million offset by non-cash charges of $11.0 million. Non-cash charges include $5.1 million for amortization of fresh-start intangible assets, $4.3 million in depreciation and other amortization charges, $0.2 million of asset impairments, $0.2 million of equity investment impairment and stock-based compensation expense of $1.2 million. The primary use of cash for operating activities in the nine months ended September 30, 2003 was a result of changes in working capital driven by:
Cash provided by operating activities of $1.1 million in the nine-month period ended September 30, 2002, primarily reflects adjustments to the net loss of the Successor Company of $23.1 million and the net income of the Predecessor Company of $275.9 million by items originating from our financial restructuring and reorganization activities. The Successor Company net loss of $23.1 million was adjusted for an in-process research and development charge of $18.7 million and a fresh-start inventory charge of $3.9 million. The Predecessor Company net income of $275.9 million was adjusted by reductions for a net gain on discharge of debt of $205.7 million and positive fresh-start adjustments of $83.7 million. The nine-month period ended September 30, 2002 was further adjusted for depreciation and amortization of $10.3 million. During the nine-month period ended September 30, 2002, our significant use of operating cash included cash payments for special charges of $18.3 million.
Cash used by investing activities was $1.6 million and $1.8 million for the nine-month periods ended September 30, 2003 and 2002, respectively. Cash used by investing activities in both the 2003 and 2002 nine-month periods reflects capital expenditures.
Cash used by financing activities was $3.1 million and $5.8 million for the nine-month periods ended September 30, 2003 and 2002, respectively. Cash used for financing activities in both periods reflects repayments of borrowings under our revolving line of credit, and payments of $1.2 million for stock purchases during the nine-month period ended September 30, 2003.
On April 17, 2003, the Company's Board of Directors approved a stock repurchase plan under which the Company may repurchase up to one million shares of its outstanding common stock.
On May 1, 2003, the Company repurchased 250,000 shares at $2.00 per share. On May 30, 2003, ZiLOG's Board of Directors approved the repurchase of 100,000 shares of common stock from ZiLOG's President, Michael Burger, at the closing price on that day of $3.25 per share. Mr. Burger sold these shares for personal financial reasons and he continues to hold 400,000 shares of restricted common stock. The net cash paid to repurchase these 350,000 shares was approximately $0.7 million, which is net of certain loan repayments made to the Company by Mr. Burger. Additionally, the Company repurchased 350,327 shares of common stock from former employees for net cash of approximately $0.5 million, which is net of certain loan repayments made to the Company by these former employees. In connection with the above repurchases of shares from Mr. Burger and the former employees, the Company retired approximately $0.6 million of employee loans receivable. All of the shares repurchased are reflected in the accompanying financial statements as treasury stock as of September 30, 2003.
In addition to GAAP measures of liquidity, we also use internally defined measures of liquidity called adjusted EBITDA and EBITDA. The EBITDA figures presented below reflect a non-GAAP measure of our liquidity. These figures reflect our net income (loss) 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 by our creditors as part of our plan of reorganization. EBITDA is presented because the Company believes it is a measure of liquidity, which provides its investors with better compatibility and additional insights into its underlying operating results and cash flows. We may not define EBITDA the same as other companies and it should not be used to replace GAAP measures such as cash flow from operations.
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):
Three Months Ended Nine Months Ended
------------------------ ------------------------
Sep. 30, Sep. 30, Sep. 30, Sep. 30,
2003 2002 2003 2002
------------ ----------- ----------- ------------
Reconciliation of cash provided (used)
by operations to EBITDA:
Cash flow from operations............. $1.1 $8.9 ($2.1) $1.1
Interest paid......................... 0.1 0.1 0.3 0.8
Income taxes paid..................... 0.8 0.1 1.7 0.3
Changes in operating assets and
liabilities........................ (0.3) (3.4) 4.5 5.4
------------ ----------- ----------- ------------
EBITDA...................................... $1.7 $5.7 $4.4 $7.6
============ =========== =========== ============
- ------------------------
Note: The period ended September 30, 2002 reflects combined results of the Predecessor and
the Successor Company. Figures for the September 30, 2003 period reflect only the
Successor Company.
Our cash needs for 2003 include working capital and capital expenditures. In March 2003, we announced and completed a restructuring of our MOD II wafer fabrication operations that resulted in the elimination of approximately 56 positions and cost approximately $0.6 million in severance benefits. In September 2003, we also completed a further restructuring of our Philippine assembly plant that resulted in the elimination of approximately 30 positions and cost approximately $0.3 million in severance benefits. These actions were intended to more closely align our production output capacity with current customer demand. Based on our current business outlook, 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, we used approximately $0.5 million in cash to repurchase 250,000 shares of stock as of September 30, 2003. 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. In addition, we used approximately $0.7 million of cash to repurchase 456,500 restricted shares and 8,827 common shares from four current and former employees, net of approximately $0.6 million of related employee loans receivable retired during the nine-month period ended September 30, 2003.
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 worldwide 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 fourth quarter of 2003 for
variable interest entities created before February 1, 2003. The Company does
not expect the Interpretation to have a material impact on the Company's
consolidated 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 determined that the impact from the
adoption of EITF Issue 00-21 will not have a material impact on its consolidated
financial statements.
In April 2003, the FASB issued FAS 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". FAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FAS 133, "Accounting for Derivative Instruments and Hedging Activities." FAS 149 provides greater clarification of the characteristics of a derivative instrument so that contracts with similar characteristics will be accounted for consistently. In general, FAS 149 is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. As the Company does not currently have any derivative financial instruments, the adoption of FAS 149 did not have an impact on the Company's consolidated financial statements.
In May 2003, the FASB issued FAS 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." FAS 150 clarifies the accounting for certain financial instruments with characteristics of both liabilities and equity and requires that those instruments be classified as liabilities in statements of financial position. Previously, many of those financial instruments were classified as equity. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. As the Company does not have any of these financial instruments, the adoption of FAS 150 did not have any impact on the Company's consolidated financial statements.
RISK FACTORS
Risks Related to the Restructuring
On May 13, 2002 we 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 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 September 30, 2003, we had additional borrowing capacity of approximately $ 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 reasonably estimated, 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 required us to reset our assets and liabilities to current fair values, our financial condition and results of operations disclosed in our financial statements for periods after May 2002 are not comparable to the financial condition or results of operations reflected in our historical financial statements prior to that date.
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 the effects are continuing 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 from us in previous years. This decline in revenue has been accentuated by our decision in 2000 to de-emphasize certain product offerings in the television, military and PC peripheral markets. We are uncertain how long this decline in our net sales will last. Additionally, we have in the past and may be in the future 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 future results of operations and 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 semiconductor 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 nine-month period ended September 30, 2003 and for each of the years in the five-year period ended December 31, 2002, excluding the accounting effects of our reorganization in 2002. If our new business strategy 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 sucessfully, 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, our business is still depressed compared to previous years. Our revenues and future profitability could be harmed seriously. It is uncertain for how long this slowdown in our business 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. Continuing 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 68% of our net sales for the nine-month period ended September 30, 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 other locations in Asia. 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.
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 nine months ended September 30, 2003, Future Electronics purchased approximately $13.5 million of our products. We expect that Future Electronics will take over the majority of the business that we previously conducted with Pioneer Standard. 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 approximately 47% of our net sales for the nine-month period ended September 30, 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 approximately 65% and 62% of our net sales for the three-month period and nine- month period September 30, 2003, respectively. Future Electronics, Inc. and Globespan Virata, Inc. accounted for approximately 18% and 12%, respectively, of our net sales for the nine-month period ended September 30, 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 $0.7 million for the nine-month period ended September 30, 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 were required to make awards of 176,365 shares of restricted common stock on each of May 13, 2002, 2003, 2004 and 2005. The restricted stock award of May 13, 2003 was cancelled and replaced with 209,418 options to purchase common stock at an exercise price of $1.00. We still have an obligation to award Mr. Thorburn restricted stock on May 13, 2004 and May 13, 2005. We committed to loan Mr. Thorburn the funds to pay the income taxes due with respect to his restricted stock awards, as we have done with other employees that previously received awards of restricted stock. In July 2002, however, Congress enacted the Sarbanes-Oxley Act of 2002, which prohibits such loans. As a result of this development, we 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 as it pertains to his future awards of restricted stock. There can be no assurance that we will be able to reach a mutually satisfactory arrangement with Mr. Thorburn.
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. 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 capital 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:
Our ability to comply with these borrowing terms may be affected by events beyond our control, including prevailing economic, financial and industry conditions. The breach of any of such covenants or restricitons could result in a default, which would permit our lender to cause all amounts we owe them to accelerate and become due and payable, together with accrued and unpaid interest. In the future, we may not be able to repay all of our borrowings if they were accelerated, and in such event, our business may be harmed materially and the value of our common stock could decrease significantly.
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 cash equivalents 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 September 30, 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 for our cash equivalents and debt obligations as of September 30, 2003 (dollars in millions):
Carrying
Value Fair Value
------------ ------------
Cash Equivalents:
Fixed rate ..................................... $19.2 $19.2
Average interest rate .......................... 0.80% --
Short Term Debt:
Variable-rate debt.............................. $5.0 $5.0
Interest rate................................... 3.6% --
Item 4. Controls and Procedures
Disclosure Controls and Procedures. The Company's management, with the participation of the Company's Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d- 15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report. Based on such evaluation, the Company's Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company's disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act.
Internal Control Over Financial Reporting. There have not been any changes in the Company's internal control over financial reporting (as such item is defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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.
10.1 Contract of Lease, dated October 16, 2003, by and between Zilog Electronics
Philippines, Inc. and Fruehauf Electronics Phils. Corporation.
31 Certification of Chief Executive Officer and Chief Financial Officer pursuant
to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 dated November 11, 2003.
32 Certification of Chief Executive Officer and Chief Financial Officer pursuant
to section 18 U.S.C. section 1350, as Adoptrd Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 dated November 11, 2003.
- -----------------------------
(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: November 11, 2003