UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

Form 10-Q

 

(MARK ONE)

ý           QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

 

OR

 

o           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM                                          TO                                           

 

COMMISSION FILE NUMBER:      1-7935

 

International Rectifier Corporation

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

DELAWARE		95-1528961
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)		(IRS EMPLOYER IDENTIFICATION NUMBER)
233 KANSAS STREET
EL SEGUNDO, CALIFORNIA		90245
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)		(ZIP CODE)

 

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:  (310) 726-8000

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS.     YES  ý     NO  o

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12b-2 OF THE EXCHANGE ACT).     YES  ý     NO  o

 

THERE WERE 64,483,988 SHARES OF THE REGISTRANT’S COMMON STOCK, PAR VALUE $1.00 PER SHARE, OUTSTANDING ON MAY 11, 2005.

 

 

Table of Contents

 

 

PART I.	FINANCIAL INFORMATION
ITEM 1.	Financial Statements
	Unaudited Consolidated Statement of Income for the Three and Nine Months Ended March 31, 2005 and 2004
	Unaudited Consolidated Statement of Comprehensive Income for the Three and Nine Months Ended March 31, 2005 and 2004
	Unaudited Consolidated Balance Sheet as of March 31, 2005 and June 30, 2004
	Unaudited Consolidated Statement of Cash Flows for the Nine Months Ended March 31, 2005 and 2004
	Notes to Unaudited Consolidated Financial Statements
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
ITEM 3.	Quantitative and Qualitative Disclosures about Market Risk
ITEM 4.	Controls and Procedures
PART II.	OTHER INFORMATION
ITEM 6.	Exhibits

 

2

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements.

 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF INCOME

(In thousands except per share amounts)

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2005			2004			2005			2004
Revenues		$	281,871		$	275,411		$	892,656		$	761,854
Cost of sales		156,604			166,236			504,571			473,653
Gross profit		125,267			109,175			388,085			288,201
Selling and administrative expense		40,756			43,005			128,034			117,717
Research and development expense		27,323			24,221			80,379			67,274
Amortization of acquisition-related intangible assets		1,473			1,421			4,369			4,218
Impairment of assets, restructuring and severance charges		8,077			9,907			21,599			24,026
Other income (expense), net		169		)	(6,174		)	825			(5,647		)
Interest (income) expense, net		(638		)	1,512			1,728			1,095
Income before income taxes		48,107			35,283			151,151			79,518
Provision for income taxes		12,434			8,538			38,384			19,155
Net income		$	35,673		$	26,745		$	112,767		$	60,363
Net income per common share – basic		$	0.53		$	0.41		$	1.68		$	0.93
Net income per common share – diluted		$	0.48		$	0.39		$	1.55		$	0.89
Average common shares outstanding – basic		67,795			65,826			67,080			65,166
Average common shares and potentially dilutive securities outstanding - diluted		77,322			69,132			76,559			68,184

 

The accompanying notes are an integral part of this statement.

 

3

 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(In thousands)

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2005			2004			2005			2004
Net income		$	35,673		$	26,745		$	112,767		$	60,363
Other comprehensive income:
Foreign currency translation adjustments		(9,421		)	10,435			14,124			29,840
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) on available-for-sale securities, net of tax effect of ($465), ($2,902), $6,780 and ($11,891), respectively		794			4,944			(11,544		)	20,249
Unrealized holding gains (losses) on foreign currency forward contract, net of tax effect of ($1,061), $425, $185 and $4,054, respectively		1,807			(723		)	(315		)	(6,902		)
Less: Reclassification adjustments of net losses on available-for-sale securities and foreign currency forward contract		57			(7,855		)	609			(7,709		)
Other comprehensive income, net		(6,763		)	6,801			2,874			35,478
Comprehensive income		$	28,910		$	33,546		$	115,641		$	95,841

 

The accompanying notes are an integral part of this statement.

 

 

4

 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEET

(In thousands)

 

		March 31,			June 30,
		2005			2004
ASSETS
Current assets:
Cash and cash equivalents		$	312,039		$	339,024
Short-term cash investments		244,036			221,130
Trade accounts receivable, net		167,030			154,911
Inventories		171,748			159,908
Deferred income taxes		48,447			44,141
Prepaid expenses and other receivables		67,379			34,096
Total current assets		1,010,679			953,210
Long-term cash investments		296,341			276,055
Property, plant and equipment, net		477,767			393,919
Goodwill		156,643			139,919
Acquisition-related intangible assets, net		37,172			28,605
Long-term deferred income taxes		78,340			74,366
Other assets		115,988			150,932
Total assets		$	2,172,930		$	2,017,006
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Bank loans		$	20,003		$	18,866
Long-term debt, due within one year		224			274
Accounts payable		73,175			78,164
Accrued salaries, wages and commissions		27,382			36,510
Other accrued expenses		104,705			81,222
Total current liabilities		225,489			215,036
Long-term debt, less current maturities		547,128			560,019
Other long-term liabilities		33,214			22,950
Deferred income taxes		—			14,789
Stockholders’ equity:
Common stock		68,109			66,358
Capital contributed in excess of par value of shares		802,664			757,169
Retained earnings		410,452			297,685
Accumulated other comprehensive income		85,874			83,000
Total stockholders’ equity		1,367,099			1,204,212
Total liabilities and stockholders’ equity		$	2,172,930		$	2,017,006

 

The accompanying notes are an integral part of this statement.

5

 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands)

 

		Nine Months Ended
		March 31,
		2005			2004
Cash flow from operating activities:
Net income		$	112,767		$	60,363
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		51,852			41,870
Amortization of acquisition-related intangible assets		4,369			4,218
Unrealized gains on swap transactions		(1,176		)	(519		)
Deferred income taxes		(15,106		)	2,147
Tax benefit from options exercised		11,405			12,215
Change in operating assets and liabilities, net		(21,852		)	(37,102		)
Net cash provided by operating activities		142,259			83,192
Cash flow from investing activities:
Additions to property, plant and equipment		(98,745		)	(52,153		)
Proceeds from sale of property, plant and equipment		265			420
Acquisition of business		(39,633		)	—
Acquisition of technologies		(11,500		)	—
Sale or maturities of cash investments		332,131			478,855
Purchase of cash investments		(375,889		)	(502,713		)
Change in other investing activities, net		(12,907		)	960
Net cash used in investing activities		(206,278		)	(74,631		)
Cash flow from financing activities:
Proceeds from short-term debt, net		49			1,926
Repayments of long-term debt		—			(118		)
Repayments of capital lease obligations, net		(172		)	(776		)
Proceeds from exercise of stock options and stock purchase plan		35,842			40,319
Other, net		(1,193		)	(280		)
Net cash provided by financing activities		34,526			41,071
Effect of exchange rate changes on cash and cash equivalents		2,508			(3,257		)
Net (decrease) increase in cash and cash equivalents		(26,985		)	46,375
Cash and cash equivalents, beginning of period		339,024			216,823
Cash and cash equivalents, end of period		$	312,039		$	263,198

 

The accompanying notes are an integral part of this statement.

 

6

 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2005

 

1.         Basis of Consolidation

 

The consolidated financial statements include the accounts of International Rectifier Corporation and its subsidiaries (“the Company”), which are located in North America, Europe and Asia.  Intercompany transactions have been eliminated in consolidation.

 

The consolidated financial statements included herein are unaudited; however, they contain all normal recurring adjustments which, in the opinion of the Company’s management, are necessary to state fairly the consolidated financial position of the Company at March 31, 2005, and the consolidated results of operations for the three and nine months ended March 31, 2005 and 2004, and the consolidated cash flows for the nine months ended March 31, 2005 and 2004.  The results of operations for the three and nine months ended March 31, 2005 are not necessarily indicative of the results to be expected for the full year.

 

The accompanying unaudited consolidated financial statements should be read in conjunction with the Annual Report on Form 10-K for the fiscal year ended June 30, 2004.

 

The Company operates on a 52-53 week fiscal year under which the three months ended March 2005 and 2004 consisted of 13 weeks ending April 3, 2005 and April 4, 2004, respectively.  For ease of presenting the accompanying consolidated financial statements, fiscal quarter-end and fiscal year-end is shown as March 31 and June 30, respectively, for all periods presented.  Fiscal 2005 will consist of 52 weeks ending July 3, 2005.

 

Certain reclassifications have been made to the June 30, 2004 cash equivalent and short-term cash investment balances.  Previously, the Company’s investments in auction rate preferred securities were recorded in cash and cash equivalents rather than short-term cash investments.  The Company reclassified auction rate securities from cash and cash equivalents to short-term investments because the underlying instruments have maturity dates exceeding ninety days.  As of March 31, 2005, the Company had no investments in these securities.  As a result of the reclassifications, the Company’s consolidated balance sheet and cash flows from investing activities were affected as follows:

 

•      cash and cash equivalents decreased and short-term cash investments increased by $100.6 million as of June 30, 2004;

•      net cash used for the purchase of cash investments increased by $67.4 million for the nine months ended March 31, 2004; and

•      net change in cash and cash equivalents decreased by $67.4 million for the nine months ended March 31, 2004.

 

7

 

The reclassifications had no impact on the Company’s total current assets, stockholders’ equity, cash flows provided by operating activities or total consolidated results reported in any period presented.

 

2.         Net Income Per Common Share

 

Net income per common share - basic is computed by dividing net income available to common stockholders (the numerator) by the weighted average number of common shares outstanding (the denominator) during the period. The computation of net income per common share - diluted is similar to the computation of net income per common share - basic except that the denominator is increased to include the number of additional common shares that would have been outstanding for the exercise of stock options using the treasury stock method and the conversion of the Company’s convertible subordinated notes using the if-converted method.  The Company’s use of the treasury stock method reduces the gross number of dilutive shares by the number of shares purchasable from the proceeds of the options assumed to be exercised.  The Company’s use of the if-converted method increases reported net income by the interest expense related to the convertible subordinated notes when computing net income per common share – diluted.

 

The following table provides a reconciliation of the numerator and denominator of the basic and diluted per-share computations for the three and nine months ended March 31, 2005 and 2004 (in thousands except per share amounts):

 

		Net Income (Numerator)				Shares (Denominator)		Per Share Amount
Three months ended March 31, 2005:
Net income per common share – basic		$		35,673		67,795		$		0.53
Effect of dilutive securities:
Stock options		—				2,088		(0.02			)
Conversion of subordinated notes		1,552				7,439		(0.03			)
Net income per common share – diluted		$		37,225		77,322		$		0.48
Three months ended March 31, 2004:
Net income per common share – basic		$		26,745		65,826		$		0.41
Effect of dilutive securities:
Stock options		—				3,306		(0.02			)
Net income per common share – diluted		$		26,745		69,132		$		0.39
Nine months ended March 31, 2005:
Net income per common share – basic		$		112,767		67,080		$		1.68
Effect of dilutive securities:
Stock options		—				2,040		(0.05			)
Conversion of subordinated notes		6,250				7,439		(0.08			)
Net income per common share – diluted		$		119,017		76,559		$		1.55
Nine months ended March 31, 2004:
Net income per common share – basic		$		60,363		65,166		$		0.93
Effect of dilutive securities:
Stock options		—				3,018		(0.04			)
Net income per common share – diluted		$		60,363		68,184		$		0.89

 

8

 

The conversion effect of the Company’s outstanding convertible subordinated notes into 7,439,000 shares of common stock was not included in the computation of diluted income per share for the three and nine months ended March 31, 2004, since such effect would have been anti-dilutive.

 

3.         Cash and Investments

 

The Company classifies all highly liquid investments purchased with original or remaining maturities of ninety days or less at the date of purchase as cash equivalents.  The cost of these investments approximates fair value.  As indicated in Note 1, “Basis of Consolidation”, certain reclassifications have been made to the June 30, 2004 cash equivalent and short-term cash investment balances.  Previously, the Company’s investments in auction rate preferred securities were recorded in cash and cash equivalents rather than short-term cash investments.  Auction rate securities are securities with an underlying component of a long-term debt or an equity instrument.  These auction rate securities trade or mature on a shorter term than the underlying instrument based on an auction bid that resets the interest rate of the security.  The auction or reset dates occur at intervals that are typically less than three months, providing high liquidity to otherwise longer term investments.  As of March 31, 2005, the Company had no investments in these securities.

 

The Company invests excess cash in marketable securities consisting primarily of commercial paper, corporate notes, corporate bonds and U.S. government securities.  At March 31, 2005 and June 30, 2004, all of the Company’s marketable securities are classified as available-for-sale.  In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities”, unrealized gains and losses on these investments are included in other comprehensive income, a separate component of stockholders’ equity, net of any related tax effect.  Realized gains and losses and declines in value considered to be other than temporary are included in interest income and expense.  As of March 31, 2005 and June 30, 2004, no investment was in a material loss position for greater than one year.

 

9

 

Cash, cash equivalents and cash investments as of March 31, 2005 and June 30, 2004 are summarized as follows (in thousands):

 

		March 31,			June 30,
		2005			2004
Cash and cash equivalents		$	312,039		$	339,024
Short-term cash investments		244,036			221,130
Long-term cash investments		296,341			276,055
Total cash, cash equivalents and cash investments		$	852,416		$	836,209

 

Available-for-sale securities as of March 31, 2005 are summarized as follows (in thousands):

 

Short-Term Cash Investments:

 

		Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Net Unrealized Loss			Market Value
Corporate debt		$	153,754		$	1		$	(1,570	)	$	(1,569	)	$	152,185
U.S. government and agency obligations		86,718			—			(629		)	(629		)	86,089
Other debt		5,764			—			(2		)	(2		)	5,762
Total short-term cash investments		$	246,236		$	1		$	(2,201	)	$	(2,200	)	$	244,036

 

Long-Term Cash Investments:

 

		Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Net Unrealized Loss			Market Value
Corporate debt		$	136,089		$	198		$	(963	)	$	(765	)	$	135,324
U.S. government and agency obligations		80,487			157			(238		)	(81		)	80,406
Other debt		80,748			44			(181		)	(137		)	80,611
Total long-term cash investments		$	297,324		$	399		$	(1,382	)	$	(983	)	$	296,341

 

10

 

Available-for-sale securities as of June 30, 2004 are summarized as follows (in thousands):

 

Short-Term Cash Investments:

 

		Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Net Unrealized Loss			Market Value
Corporate auction rate preferred securities		$	100,600		$	—		$	—		$	—		$	100,600
Corporate debt		81,960			5			(299		)	(294		)	81,666
U.S. government and agency obligations		21,639			2			(48		)	(46		)	21,593
Other debt		17,282			—			(11		)	(11		)	17,271
Total short-term cash investments		$	221,481		$	7		$	(358	)	$	(351	)	$	221,130

 

Long-Term Cash Investments:

 

		Amortized Cost			Gross Unrealized Gain			Gross Unrealized Loss			Net Unrealized Loss			Market Value
Corporate debt		$	159,280		$	33		$	(1,689	)	$	(1,656	)	$	157,624
U.S. government and agency obligations		87,420			9			(517		)	(508		)	86,912
Other debt		31,798			21			(300		)	(279		)	31,519
Total long-term cash investments		$	278,498		$	63		$	(2,506	)	$	(2,443	)	$	276,055

 

The Company holds as strategic investments the common stock of two publicly-traded Japanese companies, one of which is Nihon Inter Electronics Corporation (“Nihon”), a related party as further disclosed in Note 15.  The Company accounts for these available-for-sale investments under SFAS No. 115.  These stocks are traded on the Tokyo Stock Exchange.  The market values of the equity investments at March 31, 2005 and June 30, 2004 were $76.4 million and $94.1 million, respectively, and were included in other long-term assets.  Mark-to-market gains (losses), net of tax, of $1.1 million and $4.0 million for the three months ended March 31, 2005 and 2004, respectively, and ($11.1) million and $21.7 million for the nine months ended March 31, 2005 and 2004, respectively, were included in other comprehensive income, a separate component of equity.

 

The amortized cost and estimated fair value of cash investments at March 31, 2005, by contractual maturity, are as follows (in thousands):

 

		Amortized Cost			Estimated Fair Value
Due in 1 year or less		$	246,236		$	244,036
Due in 1-2 years		135,805			134,711
Due in 2-5 years		122,529			122,641
Due after 5 years		38,990			38,989
Total cash investments		$	543,560		$	540,377

 

11

 

In accordance with the Company’s investment policy which limits the length of time that cash may be invested, the expected disposal dates may be less than the contractual maturity dates as indicated in the table above.

 

Gross realized gains were $0.01 million and $0.03 million for the three and nine months ended March 31, 2005, respectively, and gross realized losses were ($0.2) million and ($0.3) million for the three and nine months ended March 31, 2005, respectively.  Gross realized gains were $0.5 million and $2.6 million for the three and nine months ended March 31, 2004, respectively, and gross realized losses were ($0.1) million and ($0.2) million for the three and nine months ended March 31, 2004, respectively.  The cost of marketable securities sold is determined by the weighted average cost method.

 

4.         Derivative Financial Instruments

 

Foreign Currency Risk

 

The Company conducts business on a global basis in several foreign currencies, and at various times, is exposed to fluctuations with the British Pound Sterling, the Euro and the Japanese Yen.  The Company’s risk to the European currencies is partially offset by the natural hedge of manufacturing and selling goods in the European currencies.  Considering its specific foreign currency exposures, the Company has the greatest exposure to the Japanese Yen, since it has significant Yen-based revenues without Yen-based manufacturing costs.  The Company has established a foreign currency hedging program using foreign exchange forward contracts, including the Forward Contract described below, to hedge certain foreign currency transaction exposures.  To protect against reductions in value and volatility of future cash flows caused by changes in currency exchange rates, the Company has established revenue, expense and balance sheet hedging programs.  Currency forward contracts and local Yen and Euro borrowings are used in these hedging programs.  The Company’s hedging programs reduce, but do not eliminate, the impact of currency exchange rate movements.

 

In March 2001, the Company entered into a five-year foreign exchange forward contract (the “Forward Contract”) for the purpose of reducing the effect of exchange rate fluctuations on forecasted intercompany purchases by its subsidiary in Japan.  The Company has designated the Forward Contract as a cash flow hedge under which mark-to-market adjustments are recorded in other comprehensive income, a separate component of stockholders’ equity, until the forecasted transactions are recorded in earnings.  Under the terms of the Forward Contract, the Company is required to exchange 1.2 billion Yen for $11.0 million on a quarterly basis from June 2001 to March 2006.  At March 31, 2005, four quarterly payments of 1.2 billion Yen remained to be swapped at a forward exchange rate of 109.32 Yen per U.S. dollar.  The market value of the forward contract was a liability of $1.8 million and $2.2 million at March 31, 2005 and June 30, 2004, respectively.  Mark-to-market gains (losses), included in other comprehensive income, net of tax, were $1.8 million and ($0.7) million for the three months ended March 31, 2005 and 2004, respectively, and ($0.3) million and ($6.9) million for the nine months ended March 31, 2005 and 2004, respectively.  At March 31, 2005, based on effectiveness tests comparing forecasted transactions through the Forward Contract expiration date to its cash flow requirements, the Company does not

 

12

 

expect to incur a material charge to income during the next twelve months as a result of the Forward Contract.

 

The Company had approximately $101.9 million and $62.4 million in notional amounts of forward contracts not designated as accounting hedges at March 31, 2005 and June 30, 2004, respectively.  Net unrealized and realized exchange gains (losses) recognized in earnings were less than $1 million for the three and nine months ended March 31, 2005 and 2004.

 

Interest Rate Risk

 

In December 2001, the Company entered into an interest rate swap transaction (the “Transaction”) with an investment bank, JP Morgan Chase Bank (the “Bank”), to modify the Company’s effective interest payable with respect to $412.5 million of its $550 million outstanding convertible debt (the “Debt”) (see Note 8).  In April 2004, the Company entered into an interest rate swap transaction (the “April 2004 Transaction”) with the Bank to modify the effective interest payable with respect to the remaining $137.5 million of the Debt.  The Company will receive from the Bank fixed payments equal to 4.25 percent of the notional amount, payable on January 15 and July 15.  In exchange, the Company will pay to the Bank floating rate payments based upon the London InterBank Offered Rate (“LIBOR”) multiplied by the notional amount.  At the inception of the Transaction, interest rates were lower than that of the Debt and the Company believed that interest rates would remain lower for an extended period of time.  The variable interest rate paid since the inception of the swap has averaged 2.39 percent, compared to a coupon of 4.25 percent on the Debt.  This arrangement reduced interest expense by $2.6 million and $3.1 million, for the three months ended March 31, 2005 and 2004, respectively, and $7.3 million and $9.3 million for the nine months ended March 31, 2005 and 2004, respectively.

 

Accounted for as fair value hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, the mark-to-market adjustments of the Transaction and April 2004 Transaction were significantly offset by the mark-to-market adjustments on the Debt, resulting in no material impact to earnings.  The market value of the Transaction was $0.9 million liability at March 31, 2005, and $13.1 million asset at June 30, 2004.  The market value of the April 2004 Transaction was $3.3 million and $1.3 million liability at March 31, 2005 and June 30, 2004, respectively.

 

Both Transactions terminate on July 15, 2007 (“Termination Date”), subject to certain early termination provisions.  On or after July 18, 2003 and prior to July 14, 2007, if the ten-day average closing price of the Company’s common stock equals or exceeds $77.63, both transactions will terminate.  Depending on the timing of the early termination event, the Bank would be obligated to pay the Company an amount equal to the redemption premium called for under the terms of the Debt.

 

In support of the Company’s obligation under the two transactions, the Company is required to obtain irrevocable standby letters of credit in favor of the Bank, totaling $7.5 million plus a collateral requirement for the Transaction and the April 2004 Transaction, as determined periodically.  At March 31, 2005, $12.0 million in letters of credit were outstanding related to both transactions.

 

13

 

The Transaction and the April 2004 Transaction qualify as fair value hedges under SFAS No. 133.  To test effectiveness of the hedge, regression analysis is performed quarterly comparing the change in fair value of the two transactions and the Debt.  The fair values of the Transaction, the April 2004 Transaction and the Debt are calculated quarterly as the present value of the contractual cash flows to the expected maturity date, where the expected maturity date is based on probability-weighted analysis of interest rates relating to the five-year LIBOR curve and the Company’s stock prices.  For the three and nine months ended March 31, 2005 and 2004, the hedges were highly effective and therefore, the ineffective portion did not have a material impact on earnings.

 

In April 2002, the Company entered into an interest rate contract (the “Contract”) with an investment bank, Lehman Brothers (“Lehman”), to reduce the variable interest rate risk of the Transaction.  The notional amount of the Contract is $412.0 million, representing approximately 75 percent of the Debt.  Under the terms of the Contract, the Company has the option to receive a payout from Lehman covering its exposure to LIBOR fluctuations between 5.5 percent and 7.5 percent for any four designated quarters.  The market value of the Contract at March 31, 2005 and June 30, 2004, was $0.5 million and $0.9 million, respectively, and was included in other long-term assets.  Mark-to-market gains (losses) of $0.2 million and ($0.6) million for the three months ended March 31, 2005 and 2004, respectively, and ($0.4) million and ($0.4) million for the nine months ended March 31, 2005 and 2004, respectively, were charged to interest expense.

 

5.         Inventories

 

Inventories are stated at the lower of cost (principally first-in, first-out) or market.  Inventories are reviewed for excess and obsolescence based upon demand forecast within a specific time horizon and reserves are established accordingly.  Inventories at March 31, 2005 and June 30, 2004 were comprised of the following (in thousands):

 

		March 31,			June 30,
		2005			2004
Raw materials		$	39,231		$	30,906
Work-in-process		77,011			69,702
Finished goods		55,506			59,300
Total inventories		$	171,748		$	159,908

 

6.         Goodwill and Acquisition-Related Intangible Assets

 

The Company accounts for goodwill and acquisition-related intangible assets in accordance with SFAS No. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets”.  The Company classifies the difference between the purchase price and the fair value of net assets acquired at the date of acquisition as goodwill.  The Company classifies intangible assets apart from goodwill if the assets have contractual or other legal rights or if the assets can be separated and sold, transferred, licensed, rented or exchanged.  Depending on the nature of the assets acquired, the amortization period may range from four to twelve years for those acquisition-related intangible assets subject to amortization.  The Company evaluates the carrying value of goodwill and acquisition-related intangible assets, including the related amortization period, in the fourth quarter of each fiscal

 

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year, and when events and circumstances indicate that the assets may be impaired.  In evaluating goodwill and intangible assets not subject to amortization, the Company compares the total carrying value of goodwill and intangible assets not subject to amortization to the Company’s fair value as determined by its market capitalization.  In evaluating intangible assets subject to amortization, the carrying value of each intangible asset is assessed in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

 

At March 31, 2005 and June 30, 2004, goodwill and acquisition-related intangible assets were comprised of the following (in thousands):

 

				March 31, 2005						June 30, 2004
		Amortization Periods (Years)		Gross Carrying Amount			Accumulated Amortization			Gross Carrying Amount			Accumulated Amortization
Goodwill				$	156,643		$	—		$	139,919		$	—
Acquisition-related intangible assets:
Completed technology		4 – 12		$	37,323		$	(11,400	)	$	24,293		$	(8,831	)
Distribution rights and customer lists		5 – 12		15,667			(6,852		)	15,454			(5,681		)
Intellectual property and other		5 – 12		7,313			(4,879		)	7,313			(3,943		)
Total acquisition-related intangible assets				$	60,303		$	(23,131	)	$	47,060		$	(18,455	)

 

The changes in the carrying amount of goodwill for the periods ended March 31, 2005 and June 30, 2004 are as follows (in thousands):

 

		Total
Balance, June 30, 2003		$	136,818
New acquisition		266
Foreign exchange impact		2,835
Balance, June 30, 2004		139,919
New acquisitions		13,345
Foreign exchange impact		3,379
Balance, March 31, 2005		$	156,643

 

As of March 31, 2005, estimated amortization expense of acquisition-related intangible assets for the next five years are as follows (in thousands): remainder of fiscal 2005: $1,263; fiscal 2006: $4,239; fiscal 2007: $2,899; fiscal 2008: $2,527; fiscal 2009: $2,489; fiscal 2010: $2,489.

 

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7.         Other accrued expenses

 

Other accrued expenses at March 31, 2005 and June 30, 2004 were comprised of the following (in thousands):

 

		March 31,			June 30,
		2005			2004
Accrued taxes		$	62,286		$	36,934
Short-term severance liability		6,848			11,784
Other accrued expenses		35,571			32,504
Total accrued expenses		$	104,705		$	81,222

 

8.         Bank Loans and Long-Term Debt

 

A summary of the Company’s long-term debt and other loans at March 31, 2005 and June 30, 2004 is as follows (in thousands):

 

		March 31,			June 30,
		2005			2004
Convertible subordinated notes at 4.25% due in 2007 ($550,000 principal amount, plus accumulated fair value adjustment of ($3,592) and $9,173 at March 31, 2005 and June 30, 2004, respectively)		$	546,408		$	559,173
Other loans and capitalized lease obligations		1,699			1,120
Debt, including current portion of long-term debt ($224 and $274 at March 31, 2005 and June 30, 2004, respectively)		548,107			560,293
Credit facility and other foreign revolving bank loans at rates from 1.38% to 2.14%		19,248			18,866
Total debt		$	567,355		$	579,159

 

In July 2000, the Company sold $550 million principal amount of 4.25 percent Convertible Subordinated Notes due 2007. The interest rate is 4.25 percent per year on the principal amount, payable in cash in arrears semi-annually on January 15 and July 15.  The notes are subordinated to all of the Company’s existing and future debt. The notes are convertible into shares of the Company’s common stock at any time on or before July 15, 2007, at a conversion price of $73.935 per share, subject to certain adjustments.  The Company may redeem any of the notes, in whole or in part, subject to certain call premiums on or after July 18, 2003, as specified in the notes and related indenture agreement.  In December 2001 and April 2004, the Company entered into two transactions with JP Morgan Chase Bank for $412.5 million and $137.5 million in notional amounts, respectively, which had the effect to the Company of converting the interest rate to variable and requiring that the convertible notes be marked to market (see Note 4).

 

In November 2003, the Company entered into a three-year syndicated multi-currency revolving credit facility led by BNP Paribas (the “Facility”).  The Facility expires in November 2006 and provides a credit line of $150 million of which up to $150 million may be used for standby letters of credit.  The Facility bears interest at (i) local currency rates plus (ii) a margin between 0.75 percent and 2.0 percent for base rate advances and a margin of between 1.75 percent and 3.0 percent for

 

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euro-currency rate advances.  Other advances bear interest as set forth in the credit agreement.  The annual commitment fee for the Facility is subject to a leverage ratio as determined by the credit agreement and was 0.375 percent of the unused portion of the Facility at March 31, 2005.  The Facility also contains certain financial and other covenants, with which the Company was in compliance at March 31, 2005.  The Company pledged as collateral shares of certain of its subsidiaries.  At March 31, 2005, under the Facility, the Company had $18.3 million borrowings and $16.4 million letters of credit outstanding.  At June 30, 2004, under the Facility, the Company had $17.2 million borrowings and $14.4 million in letters of credit outstanding.  Of the letters of credit outstanding, $12.0 million were related to the interest rate swap transactions (see Note 4) at March 31, 2005 and June 30, 2004.

 

At March 31, 2005, the Company had $167.2 million in total revolving lines of credit, of which $35.6 million had been utilized, consisting of $16.4 million in letters of credit and $19.2 million under the Facility and other foreign revolving bank loans, which are included in the table above.

 

9.         Impairment of Assets, Restructuring and Severance

 

During the fiscal 2003 second quarter ended December 31, 2002, the Company announced its restructuring initiatives. Under these initiatives, the goal was to reposition the Company to better fit the market conditions, de-emphasize its commodity business and accelerate the Company’s move to proprietary products.  Proprietary products refer to the Company’s Analog ICs, Advanced Circuit Devices and Power Systems, which includes those products that are value-added or are provided under reduced competition due to their technological content or the Company’s customer relationship.  The Company periodically reviews products to determine their classification as proprietary products.  The Company’s restructuring plan included consolidating and closing certain manufacturing sites, upgrading equipment and processes in designated facilities and discontinuing production in a number of others that cannot support more advanced technology platforms or products.  The Company also planned to lower overhead costs across its support organizations.  The Company has substantially completed these restructuring activities as of March 31, 2005.  The Company expects to complete the remaining activities, primarily the move of a fabrication line from El Segundo, California to the Newport, Wales facility and the transition of certain assembly of a government and space products from Leominster, Massachusetts to Tijuana, Mexico, by calendar year-end 2005.

 

Total charges associated with the December 2002 initiatives are expected to be approximately $261 million. These charges will consist of approximately $210 million for asset impairment, plant closure and other charges, $6 million for raw material and work-in-process inventory, and $45 million for severance-related costs.

 

For the three months ended March 31, 2005, the Company recorded $8.1 million in total restructuring-related charges, consisting of: $6.3 million for plant closure and relocation costs and other impaired assets charges, and $1.8 million for severance costs.  For the three months ended March 31, 2004, the Company recorded $9.9 million in total charges: $3.2 million in relocation and other asset impairment charges and $6.7 million in severance-related costs.

 

For the nine months ended March 31, 2005, the Company recorded $21.6 million in total restructuring-related charges, consisting of: $16.8 million for plant closure and relocation costs and other impaired assets charges, and $4.8 million for severance costs.  For the nine months ended March 31, 2004, the Company recorded $24.0

 

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million in total charges: $10.5 million in relocation and other asset impairment charges and $13.5 million in severance-related costs.  Restructuring-related costs were charged as incurred in accordance with SFAS No. 146, “Accounting for the Costs Associated with Exit or Disposal Activities”.  Asset impairments were calculated in accordance with SFAS No. 144.

 

As of March 31, 2005, the Company had recorded $249.0 million in total restructuring-related charges, consisting of: $201.6 million for asset impairment, plant closure costs and other charges, $6.0 million for raw material and work-in-process inventory charges, and $41.4 million for severance-related costs.  Components of the $201.6 million asset impairment, plant closure and other charges included the following items:

 

•      As the Company emphasizes more advanced generation planar products, it expects the future revenue stream from its less advanced facilities in Temecula, California to decrease significantly.  These facilities had a net book value of $138.3 million and were written down by $77.7 million.  It is expected that these facilities will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period. It is assumed that salvage value will equal disposition costs.

 

•      As the Company emphasizes more advanced generation trench products, it expects the future revenue stream from its less advanced facility in El Segundo, California to decrease significantly. This facility had a net book value of $59.5 million and was written down by $57.2 million.  This facility had significantly reduced production as of fiscal year-end June 30, 2003, and is used primarily for research and development activities.

 

•      As the Company emphasizes more advanced generation Schottky products, it expects the future revenue stream from its less advanced facility in Borgaro, Italy to decrease significantly. This facility had a net book value of $20.5 million and was written down by $13.5 million.  It is expected that this facility will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period.  It is assumed that salvage value will equal disposition costs.

 

•    The Company restructured its manufacturing activities in Europe.  Based on a review of its Swansea, Wales facility, a general-purpose module facility, the Company determined this facility would be better suited to focus only on automotive applications.  The general-purpose module assets at this facility, with a net book value of $13.6 million, were written down by $8.2 million.  In addition, the Company has substantially completed the move of its manufacturing activities from its automotive facility in Krefeld, Germany to its Swansea, Wales and Tijuana, Mexico facilities as of March 31, 2005. The Company has also moved the production from its Venaria, Italy facility to its Borgaro, Italy and Mumbai, India facilities, which was completed as of December 31, 2003. The Company stopped manufacturing products at its Oxted, England facility as of September 30, 2003, and the remaining inventory was transferred to the Tijuana, Mexico assembly facility.

 

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•      The Company has eliminated the manufacturing of its non-space military products in its Santa Clara, California facility as of July 31, 2004. Currently, subcontractors handle the Company’s non-space qualified products previously manufactured in this facility. The Company is also transitioning certain assembly of government and space products from its Leominster, Massachusetts facility to its Tijuana, Mexico facility, and expects to complete this activity by fiscal year-end 2005.  Associated with these reductions in manufacturing activities, certain assets with a net book value of $4.0 million were written down by $2.0 million.

 

•      $43.0 million in other miscellaneous items were charged, including $36.1 million in plant closure and relocation costs and other impaired asset charges and $6.9 million in contract termination and settlement costs.

 

As a result of the restructuring initiatives, certain raw material and work-in-process inventories were impaired, including products that could not be completed in other facilities, materials that were not compatible with the processes used in the alternative facilities, and materials such as gases and chemicals that could not readily be transferred. Based on these factors the Company wrote down these inventories, with a carrying value of $98.2 million, by $6.0 million in December 2002.  The Company had disposed of none and $0.3 million of these inventories, for the three months ended March 31, 2005 and 2004, respectively, and $0.7 million and $0.3 million for the nine months ended March 31, 2005 and 2003, respectively, which did not materially impact gross margin.  As of March 31, 2005, the Company had disposed of $3.7 million of these inventories.

 

As of March 31, 2005, the Company has recorded $41.4 million in total severance-related charges:  $36.2 million in severance termination costs related to approximately 1,100 administrative, operating and manufacturing positions, and $5.1 million in pension termination costs at our manufacturing facility in Oxted, England.  The severance charges associated with the elimination of positions, which included the persons notified to date, had been and will continue to be recognized ratably over the future service period, as applicable, in accordance with SFAS No. 146.  The Company measured the total termination benefits at the communication date based on the fair value of the liability as of the termination date.  A change resulting from a revision to either the timing or the amount of estimated cash over the future service period will be measured using the credit-adjusted risk-free rate that was used to initially measure the liability.  The cumulative effect of the change will be recognized as an adjustment to the liability in the period of the change.

 

In fiscal 2002, the Company had recorded an estimated $5.1 million in severance costs associated with the acquisition of TechnoFusion GmbH in Krefeld, Germany.  In fiscal 2003, the Company finalized its plan and determined that total severance would be approximately $10 million, and accordingly, the Company adjusted purchased goodwill by $4.8 million.  The Company communicated the plan and the elimination of approximately 250 positions primarily in manufacturing to its affected employees at that time.  The associated severance is expected to be paid by fiscal year-end 2005.

 

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The following summarizes the Company’s severance accrual related to the TechnoFusion acquisition and the December 2002 restructuring plan for the periods ended March 31, 2005 and June 30, 2004.  Severance activity related to the elimination of 29 administrative and operating personnel during the June 2001 restructuring is also disclosed.  The remaining June 2001 severance relates primarily to certain legal accruals associated with that restructuring, which will be paid or released as the outcome is determined (in thousands):

 

		June 2001 Restructuring			December 2002 Restructuring			TechnoFusion Severance Liability			Total Severance Liability
Accrued severance, June 30, 2003		$	1,030		$	5,634		$	9,876		$	16,540
Costs incurred or charged to “impairment of assets, restructuring and severance”		—			15,450			—			15,450
Costs paid		(333		)	(13,935		)	(4,390		)	(18,658		)
Foreign exchange impact		—			31			581			612
Accrued severance, June 30, 2004		$	697		$	7,180		$	6,067		$	13,944
Costs incurred or charged to “impairment of assets, restructuring and severance”		—			4,804			—			4,804
Costs paid		(248		)	(5,531		)	(3,450		)	(9,229		)
Foreign exchange impact		—			620			(17		)	603
Accrued severance, March 31, 2005		$	449		$	7,073		$	2,600		$	10,122

 

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10.       Geographical Information

 

The Company operates in one business segment.  Revenues from unaffiliated customers are based on the location in which the sale originated.  The Company includes in long-lived assets, all long-term assets excluding long-term cash investments, long-term deferred income taxes, goodwill and acquisition-related intangibles.  Geographic information for March 31, 2005 and 2004, and June 30, 2004, is presented below (in thousands):

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2005			2004			2005			2004
North America		$	94,873		$	77,734		$	276,749		$	226,080
Asia		119,280			122,928			392,234			330,966
Europe		57,205			63,989			192,604			173,823
Total product revenues		271,358			264,651			861,587			730,869
Unallocated royalties		10,513			10,760			31,069			30,985
Total revenues		$	281,871		$	275,411		$	892,656		$	761,854

 

		March 31, 2005			June 30, 2004
Long-Lived Assets
North America		$	355,125		$	358,243
Asia		22,996			17,728
Europe		215,634			168,880
Total		$	593,755		$	544,851

 

No customer accounted for more than 10 percent of the Company’s consolidated net revenues for the three and nine months ended March 31, 2005 and 2004, or more than 10 percent of the Company’s accounts receivable at March 31, 2005 and June 30, 2004.

 

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11.       Stock-Based Compensation

 

The Company accounts for stock-based compensation plans using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees.”  Under the intrinsic value method, the Company does not recognize a compensation expense for stock options granted with an exercise price equaled to the fair market value on the grant date.  Had the Company recorded compensation expense using the Black-Scholes option-pricing model under the fair value based method described in SFAS No. 123, “Accounting for Stock-Based Compensation”, net income and net income per common share–basic and diluted would approximate the following (in thousands, except per share data):

 

		Three Months Ended March 31,						Nine Months Ended March 31,
		2005			2004			2005			2004
Net income, as reported		$	35,673		$	26,745		$	112,767		$	60,363
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax		(12,343		)	(12,816		)	(38,382		)	(36,226		)
Pro forma net income		$	23,330		$	13,929		$	74,385		$	24,137
Net income per common share-basic, as reported		$	0.53		$	0.41		$	1.68		$	0.93
Net income per common share-basic, pro forma		$	0.34		$	0.21		$	1.11		$	0.37
Net income per common share-diluted, as reported		$	0.48		$	0.39		$	1.55		$	0.89
Net income per common share-diluted, pro forma		$	0.32		$	0.20		$	1.05		$	0.37

 

The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts.  SFAS No. 123 does not apply to awards prior to 1996.

 

In April 2005, the Company accelerated the vesting of all outstanding unvested equity-based compensation awards, including employee stock options and restricted stock units (“RSUs”). Unvested awards to purchase 6.9 million shares, 1.2 million held by officers and directors, became exercisable as a result of the vesting acceleration.  The intrinsic value of the options and RSUs on the acceleration date was $41.4 million, of which $5.1 million were related to awards held by officers and directors. The purpose of the accelerated vesting was to enable the Company to avoid recognizing in its income statement compensation expense associated with these options in future periods, primarily as a result of FASB Statement No. 123R, “Share-Based Payment” (“SFAS No. 123R”), which becomes effective for the Company in July 2005. Compensation expense that would have been recorded absent the accelerated vesting, was approximately $108 million of which approximately $60 million would have been in fiscal year 2006.

 

 

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