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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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|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
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Commission file number 1-10079
CYPRESS SEMICONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 94-2885898
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3901 North First Street, San Jose, California 95134-1599
(Address of principal executive offices and zip code)
(408) 943-2600
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
outlined in Rule 12b-2 of the Exchange Act): Yes |X| No |_|
The total number of shares of the registrant's common stock outstanding as of
November 4, 2003 was 120,256,352.
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INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements ............................................................................ 3
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ........... 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk ...................................... 41
Item 4. Controls and Procedures ......................................................................... 43
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ............................................................................... 43
Item 2. Changes in Securities and Use of Proceeds ....................................................... 43
Item 3. Defaults Upon Senior Securities ................................................................. 43
Item 4. Submission of Matters to a Vote of Security Holders ............................................. 44
Item 5. Other Information ............................................................................... 44
Item 6. Exhibits and Reports on Form 8-K ................................................................ 44
Signatures ............................................................................................... 45
2
ITEM 1. FINANCIAL STATEMENTS
CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
September 28, December 29,
2003 2002
--------------- ---------------
ASSETS
Current assets:
Cash and cash equivalents ................................................... $ 172,445 $ 87,200
Short-term investments ...................................................... 32,632 40,737
--------------- ---------------
Total cash, cash equivalents and short-term investments ................. 205,077 127,937
Accounts receivable, net .................................................... 115,810 83,054
Inventories.................................................................. 71,743 92,721
Other current assets ........................................................ 198,090 210,235
--------------- ---------------
Total current assets .................................................... 590,720 513,947
Property, plant and equipment, net ............................................. 445,441 496,566
Goodwill ....................................................................... 322,008 321,669
Other intangible assets ........................................................ 62,716 89,615
Other assets ................................................................... 191,608 150,851
--------------- ---------------
Total assets ................................................................... $ 1,612,493 $ 1,572,648
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................................ $ 58,545 $ 59,431
Accrued compensation and employee benefits .................................. 38,087 39,151
Other current liabilities ................................................... 105,790 84,112
Current portion of long-term debt ........................................... 7,017 -
Deferred income on sales to distributors .................................... 13,908 15,774
Income taxes payable ........................................................ 2,026 1,292
--------------- ---------------
Total current liabilities ............................................... 225,373 199,760
Convertible subordinated notes ................................................. 668,652 468,900
Deferred income taxes and other tax liabilities ................................ 168,652 177,404
Other long-term liabilities .................................................... 19,016 52,961
--------------- ---------------
Total liabilities ....................................................... 1,081,693 899,025
--------------- ---------------
Commitments and contingencies (See Note 6)
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized; none issued and
outstanding .................................................................... -- --
Common stock, $.01 par value, 650,000 and 650,000 shares authorized; 139,164
and 139,164 issued; 119,014 and 123,743 outstanding at September 28, 2003
and December 29, 2002 ...................................................... 1,391 1,391
Additional paid-in-capital ..................................................... 1,114,633 1,172,654
Deferred stock compensation .................................................... (7,462) (25,283)
Accumulated other comprehensive income ......................................... 1,350 2,376
Accumulated deficit ............................................................ (265,360) (155,916)
--------------- ---------------
844,552 995,222
Less: shares of common stock held in treasury, at cost; 20,150 shares
and 15,421 shares at September 28, 2003 and December 29, 2002 .................. (313,752) (321,599)
--------------- ---------------
Total stockholders' equity .............................................. 530,800 673,623
--------------- ---------------
Total liabilities and stockholders' equity ..................................... $ 1,612,493 $ 1,572,648
=============== ===============
The accompanying notes are an integral part of these
Condensed Consolidated Financial Statements.
3
CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three months ended Nine months ended
----------------------- ------------------------
September 28, September 29, September 28, September 29,
2003 2002 2003 2002
--------- --------- --------- ---------
Revenues ........................................................ $ 216,642 $ 205,021 $ 600,725 $ 600,297
Cost of revenues ................................................ 111,499 111,096 320,520 340,214
--------- --------- --------- ---------
Gross margin .................................................... 105,143 93,925 280,205 260,083
--------- --------- --------- ---------
Operating expenses:
Research and development ..................................... 62,028 70,987 190,642 224,588
Selling, general and administrative .......................... 33,139 48,551 96,079 119,296
Restructuring ................................................ (5,523) 2,433 (2,348) (6,277)
Acquisition-related costs .................................... 9,444 10,658 28,274 32,145
--------- --------- --------- ---------
Total operating expenses ................................... 99,088 132,629 312,647 369,752
--------- --------- --------- ---------
Operating income (loss) ......................................... 6,055 (38,704) (32,442) (109,669)
Interest income ................................................. 2,930 3,339 11,255 15,699
Interest expense ................................................ (3,249) (4,886) (13,055) (14,515)
Other income and (expense), net ................................. 12,251 (14,749) 8,170 (13,573)
--------- --------- --------- ---------
Income (loss) before income taxes ............................... 17,987 (55,000) (26,072) (122,058)
Provision for income taxes ...................................... (720) (89) (2,422) (883)
--------- --------- --------- ---------
Net income (loss) .......................................... $ 17,267 $ (55,089) $ (28,494) $(122,941)
========= ========= ========= =========
Basic net income (loss) per share ............................... $ 0.15 $ (0.45) $ (0.23) $ (1.00)
Diluted net income (loss) per share ............................. $ 0.12 $ (0.45) $ (0.23) $ (1.00)
Weighted average common and common equivalent shares outstanding:
Basic ...................................................... 118,116 123,634 122,021 122,907
Diluted .................................................... 163,175 123,634 122,021 122,907
The accompanying notes are an integral part of these
Condensed Consolidated Financial Statements.
4
CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
----------------------------
September 28, September 29,
2003 2002
------------- -------------
Cash flow from operating activities:
Net loss ........................................................................ $ (28,494) $ (122,941)
Adjustments to reconcile net loss to net cash generated from (used for)
operating activities:
Depreciation and amortization ................................................... 126,738 130,670
Amortization of deferred stock compensation ..................................... 9,667 28,257
(Gain) loss on sales of property, plant and equipment, net ...................... 395 (368)
Employee stock purchase assistance plan interest ................................ (2,622) (3,993)
Acquired in-process research and development .................................... - 500
Net (gain) loss on early retirement of debt ..................................... 7,513 (5,946)
Unrealized (gain) loss on foreign currency derivatives .......................... 877 (368)
Asset impairment and other ...................................................... (15,058) 29,048
Restructuring ................................................................... (5,323) (13,528)
Minority interest ............................................................... (1,045) -
Deferred income taxes ........................................................... (101) 2,832
Changes in operating assets and liabilities, net of effects of acquisitions:
Accounts receivable ........................................................... (29,666) (8,374)
Inventories ................................................................... 20,978 (16,255)
Other assets .................................................................. 6,048 (3,818)
Accounts payable, accrued liabilities and other liabilities ................... (30,509) (25,125)
Deferred income ............................................................... (1,866) 905
Income taxes payable .......................................................... 734 124
---------- ----------
Net cash generated from (used for) operating activities ..................... 58,266 (8,380)
---------- ----------
Cash flow from investing activities:
Purchase of investments ......................................................... (76,602) (45,150)
Sale or maturities of investments ............................................... 49,696 157,917
Cash refunded from (used for) acquisitions, net ................................. 1,442 (582)
Acquisition of property, plant and equipment .................................... (49,024) (123,546)
(Issuance) repayment of notes to employees, net ................................. 1,614 16,582
Proceeds from the sale of equipment ............................................. 3,684 2,406
Proceeds from sale of NVE investment............................................. 23,354 (8,319)
Other investment ................................................................ (2,911) (16,513)
---------- ----------
Net cash generated from (used for) investing activities ..................... (48,747) (17,205)
---------- ----------
Cash flow from financing activities:
Proceeds from borrowings, net of issuance costs ................................. 17,293 -
Proceeds from issuance of convertible debt, net of issuance costs ............... 581,550 -
Redemption of convertible debt .................................................. (404,283) (42,124)
Issuance (repurchase) of common shares, net ..................................... (72,712) 19,184
Purchase of call spread on common stock ......................................... (49,300) -
Premiums received from stock put options ........................................ - 198
Maturity of structured options, net ............................................. - 1,574
Issuance (repayment) of stockholder notes receivable, net ....................... 60 (295)
Other long-term liabilities ..................................................... 3,118 (1,837)
---------- ----------
Net cash generated from (used for) financing activities ..................... 75,726 (23,300)
---------- ----------
Net increase (decrease) in cash and cash equivalents ............................... 85,245 (48,885)
---------- ----------
Cash and cash equivalents, beginning of period ..................................... 87,200 109,999
---------- ----------
Cash and cash equivalents, end of period ........................................... $ 172,445 $ 61,114
=========== ===========
Supplemental Disclosure of Non-Cash Information
Common stock issued for acquisitions................................................ $ - $ 2,318
Customer prior advances used for equipment.......................................... $ 5,500 $ -
The accompanying notes are an integral part of these
Condensed Consolidated Financial Statements.
5
CYPRESS SEMICONDUCTOR CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended September 28, 2003
(Unaudited)
Note 1 - Summary of Significant Accounting Policies
Fiscal Year
Cypress Semiconductor Corporation ("Cypress") reports on a fiscal year basis and
ends its quarters on the Sunday closest to the end of the applicable calendar
quarter. The three month periods ended September 28, 2003 ("Q3 2003"), June 29,
2003 ("Q2 2003"), March 30, 2003 ("Q1 2003"), September 29, 2002 ("Q3 2002"),
June 30, 2002 ("Q2 2002") and March 31, 2002 ("Q1 2002") all included thirteen
weeks.
Basis of Presentation
In the opinion of the management of Cypress, the accompanying unaudited
condensed consolidated financial statements contain all adjustments (consisting
solely of normal recurring adjustments) necessary to present fairly the
financial information included therein. Certain prior year amounts have been
reclassified to conform to current year presentation. Cypress believes that the
disclosures are adequate so that the information is not misleading. However,
this financial data should be read in conjunction with the audited consolidated
financial statements and related notes thereto included in Cypress's Annual
Report on Form 10-K for the fiscal year ended December 29, 2002.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the condensed consolidated financial statements
and accompanying notes. Actual results could differ from those estimates,
although such differences are not expected to be material to the financial
statements.
The results of operations for the three and nine months ended Q3 2003 are not
necessarily indicative of the results to be expected for the full year.
Recent Accounting Pronouncements
Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), was issued in January
2003. FIN 46 requires that if an entity is the primary beneficiary of a variable
interest entity, the assets, liabilities and results of operations of the
variable interest entity should be included in the condensed consolidated
financial statements of the entity. The provisions of FIN 46 are effective
immediately for all arrangements entered into after January 31, 2003. Cypress
has not invested in any variable interest entities after January 31, 2003. For
those arrangements entered into prior to January 31, 2003, the FASB recently
delayed the required implementation date such that the provisions of FIN 46 are
required to be adopted at the beginning of the first interim or annual period
beginning after December 15, 2003. On June 27, 2003, Cypress entered into a new
operating lease to refinance its then existing operating leases with respect to
certain manufacturing and office facilities located in Minnesota and California
(see Note 6). Cypress refinanced these leases in a manner that best met its
financing strategy. The new operating lease is not subject to the consolidation
provisions of FIN 46. Cypress does not expect the finalization of FIN 46 by the
FASB relating to variable interest entities created prior to January 31, 2003 to
impact the condensed consolidated financial statements as the issues currently
under discussion do not impact Cypress.
In April 2003, the FASB issued Statement of Financial Accounting Standards
("SFAS") No. 149, "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities" ("SFAS 149"). SFAS 149 amends and clarifies accounting for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities under SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS 133"). The new guidance
amends SFAS 133 for decisions made: (a) as part of the Derivatives
Implementation Group process that effectively required amendments to SFAS 133;
(b) in connection with other FASB projects dealing with financial instruments;
and (c) regarding implementation issues raised in relation to the application of
the definition of a derivative, particularly regarding the meaning of
"underlying" and the characteristics of a derivative that contains financing
components. The amendments set forth in SFAS 149 improve financial reporting by
requiring that contracts with comparable characteristics be accounted for
similarly. SFAS 149 is generally effective for contracts entered into or
modified after June 30, 2003 (with a few exceptions) and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 had no
impact on Cypress's condensed
6
consolidated financial statements. Cypress is applying the provisions of SFAS
149 prospectively to transactions entered into and or modified after June 30,
2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in certain circumstances). Many of these instruments
were previously classified as equity. Although some of the provisions of this
statement are consistent with the current definition of liabilities in FASB
Concepts Statement No. 6, "Elements of Financial Statements", the remainder are
consistent with FASB's intention to revise that definition to encompass certain
obligations that a reporting entity can or must settle by issuing its own
shares. This statement 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. There was no impact to the
condensed consolidated financial statements related to SFAS 150 for the nine
months ended Q3 2003.
Accounting for Stock-Based Compensation
Cypress has a number of stock-based employee compensation plans. Cypress
accounts for those plans under the recognition and measurement principles of
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25") and the related Interpretation. In certain instances,
Cypress reflects stock-based employee compensation cost in net income (loss). If
there is any compensation under the rules of APB 25, the expense is amortized
using an accelerated method prescribed under the rules of FASB Interpretation
No. 28, "Accounting for Stock Appreciation Rights and Other Variable Stock
Option or Award Plans" ("FIN 28"). The following table illustrates the effect on
net income (loss) and related per share amounts if Cypress had applied the fair
value recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), to stock-based employee compensation.
Three months ended Nine months ended
- --------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands, except per share amounts) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ 17,267 $ (55,089) $ (28,494) $(122,941)
Add: Total stock-based employee compensation expense
reported in net income (loss), net of taxes $ 1,025 $ 3,517 $ 4,359 $ 12,884
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards, net of
related tax effects (16,051) (26,688) (45,472) (93,234)
---------- ---------- --------- ---------
Pro forma net income (loss) $ 2,241 $ (78,260) $ (69,607) $(203,291)
========== ========== ========= =========
Income (loss) per share:
Basic--as reported $ 0.15 $ (0.45) $ (0.23) $ (1.00)
Diluted--as reported $ 0.12 $ (0.45) $ (0.23) $ (1.00)
Basic--pro forma $ 0.02 $ (0.63) $ (0.57) $ (1.65)
Diluted--pro forma $ 0.03 $ (0.63) $ (0.57) $ (1.65)
- --------------------------------------------------------------------------------------------------------------------------
Note 2 - Consolidation of SunPower Corporation ("SunPower")
Cypress gained effective control over SunPower in Q1 2003. As a result,
effective the beginning of fiscal 2003, Cypress consolidated the results of
SunPower, which was previously accounted for under the equity method in fiscal
2002 due to the existence of substantive participating rights of the minority
shareholders. Cypress and its Chief Executive Officer ("CEO"), own preferred
stock of SunPower which is convertible into common stock. As of Q3 2003, Cypress
and its CEO own approximately 57% and 6%, respectively, of SunPower on an
as-converted basis.
Minority interest in the losses of SunPower are included in Other income and
(expense), net. As the minority shareholder's investment in SunPower, which was
included in Other long-term liabilities, had been reduced to zero at the end of
Q2 2003, Q3 2003 losses attributable to the minority shareholders' of SunPower
were born solely by Cypress. The minority interest in losses of SunPower were
zero and $1.0 million for the three and nine months ended Q3 2003, respectively.
Pro forma statement of operations information has not been presented because the
effect of the SunPower consolidation was not material.
7
As of the end of Q3 2003, Cypress had loaned SunPower $2.4 million for operating
cash f1ow needs, which loans bear interest at the applicable federal rates. In
October 2003, the Cypress Board of Directors authorized the exercise of a
convertible preferred stock warrant ("Preferred Stock Warrant"), issued by
SunPower to Cypress, as a result of SunPower meeting certain product efficiency,
quality deliverables and marketability requirements. The Preferred Stock Warrant
is exercisable for cash of $16.0 million. Upon the exercise of the Preferred
Stock Warrant, the cumulative amount loaned for operating cash flow needs would
be due within one year.
The exercise of the Preferred Stock Warrant, by Cypress, gives rise to a $16.0
million put and call option, exercisable for 30 days from the date of the
exercise of the Preferred Stock Warrant. Under the put option, SunPower
shareholders would be entitled to sell up to 6.4 million shares of common stock
of SunPower to Cypress at $2.50 per share. Under the call option, Cypress would
be entitled to purchase the same 6.4 million shares of common stock from
SunPower shareholders at $2.50 per share. Settlement of both the put and call
options would be in Cypress common stock. Should the put or call option be
exercised, Cypress and its CEO could own as much as approximately 92% and 4%,
respectively, of SunPower on an as-converted basis. If Cypress and its CEO own
on a combined basis greater than 92.5% of the outstanding common stock of
SunPower, as any time, either Cypress or the non-Cypress shareholders may call
upon the other party to acquire all, and no less than all, the non-Cypress
shareholders outstanding common shares and securities convertible into common
shares at fair market value (the "Buy-out"). The Buy-out may be settled in
Cypress stock or cash or any combination thereof, at Cypress's option.
At the end of Q3 2003, Cypress had an outstanding loan of $2.5 million to
SunPower in connection with the facilitation of a fabrication facility. The loan
bears interest at 7% and SunPower is repaying the loan monthly through fiscal
2008.
At the end of Q3 2003, Cypress was in the process of negotiating final terms on
an additional $30.0 million loan facility to SunPower. Cypress will become
obligated to provide this loan facility upon exercise the Preferred Stock
Warrant discussed above. Cypress had advanced a total of $15.5 million against
this loan facility as at the end of Q3 2003. Subsequent to Q3 2003, Cypress
advanced an additional $7.6 million against the $30.0 million loan facility. As
part of the terms of the loan facility, Cypress will be granted a warrant to
purchase approximately 4.3 million shares of SunPower common stock at a price of
$0.07 per share.
All SunPower intercompany loans and transactions have been eliminated from the
condensed consolidated financial statements.
Note 3 - Goodwill and Intangibles
Goodwill
Cypress's goodwill is reported in the Non-memory business segment. The following
is a rollforward for the goodwill balance in this segment in fiscal 2003:
Balance at Balance at
December 29, September 28,
(In thousands) 2002 Reclassified Other 2003
-----------------------------------------------------------------
Non-memory $321,669 $2,683 $(2,344) $322,008
As a result of Cypress's consolidation of SunPower during Q1 2003, a total of
$2.7 million was reclassified from Other assets to Goodwill. Other represents
other miscellaneous adjustments to Goodwill primarily as a result of Cypress's
prior acquisition escrow closings.
Purchased Intangibles
The following tables present details of Cypress's total purchased intangible
assets:
As of September 28, 2003
- --------------------------------------------------------------------------------------------------------------
Accumulated
(In thousands) Gross Amortization Net
- --------------------------------------------------------------------------------------------------------------
Purchased technology $ 192,656 $ (140,961) $ 51,695
Non-compete agreements 18,650 (12,861) 5,789
Patents, licenses and trademarks 6,703 (3,399) 3,304
Other 4,605 (2,677) 1,928
- --------------------------------------------------------------------------------------------------------------
Total $ 222,614 $ (159,898) $ 62,716
- --------------------------------------------------------------------------------------------------------------
8
As of December 29, 2002
- --------------------------------------------------------------------------------------------------------------
Accumulated
(In thousands) Gross Amortization Net
- --------------------------------------------------------------------------------------------------------------
Purchased technology $ 191,700 $ (119,133) $ 72,567
Non-compete agreements 18,650 (8,243) 10,407
Patents, licenses and trademarks 6,350 (2,233) 4,117
Under market leases 1,850 (1,850) --
Other 4,600 (2,076) 2,524
- --------------------------------------------------------------------------------------------------------------
Total $ 223,150 $ (133,535) $ 89,615
- --------------------------------------------------------------------------------------------------------------
Amortization expense for three and nine months ended Q3 2003 of $9.4 million and
$28.3 million, respectively, associated with these acquired intangibles is
included in Acquisition-related costs in the condensed consolidated statement of
operations. The estimated annual amortization expense of purchased intangible
assets, as of the end of Q3 2003, is as follows:
- -----------------------------------------------------------------------------------------
(In thousands) Amount
- -----------------------------------------------------------------------------------------
2003 (remaining three months) $ 9,451
2004 33,045
2005 14,655
2006 2,882
2007 562
2008 and beyond 2,121
- -----------------------------------------------------------------------------------------
Total $ 62,716
- -----------------------------------------------------------------------------------------
Note 4 - Restructuring
The semiconductor industry has historically been characterized by wide
fluctuations in demand for, and supply of, semiconductors. In some cases,
industry downturns have lasted more than a year. Prior experience has shown that
restructuring of operations, resulting in significant restructuring charges, may
become necessary if an industry downturn persists. Cypress currently has two
active restructuring plans - one initiated in the third quarter of fiscal 2001
("Fiscal 2001 Restructuring Plan") and the other initiated in the fourth quarter
of fiscal 2002 ("Fiscal 2002 Restructuring Plan"). Cypress recorded initial
restructuring charges in fiscal 2002 and fiscal 2001 based on assumptions that
it deemed appropriate for the economic environment that existed at the time
these estimates were made. However, due to continued changes in the
semiconductor industry and in specific business conditions, Cypress took
additional actions and made appropriate adjustments to both the Fiscal 2001
Restructuring Plan and the Fiscal 2002 Restructuring Plan for property, plant
and equipment, leased facilities and personnel costs.
Fiscal 2002 Restructuring Plan:
On October 17, 2002, Cypress announced a restructuring plan that included the
resizing of Cypress's manufacturing facilities and the reduction of operating
expenses, including research and development and selling, general and
administrative. In the fourth quarter of fiscal 2002 ("Q4 2002"), Cypress
recorded a charge of $45.4 million which consisted of $36.0 million related to
equipment removed from service and held for sale, $8.2 million for workforce
reductions for approximately 380 employees, including severance and benefits
costs, and $1.2 million for leased facilities. To date, Cypress has disposed of
equipment with a net book value of $10.7 million. The net book value of the
remaining unsold equipment as of Q3 2003 was $20.2 million. The proceeds from
the sales of the assets approximated their carrying values. The majority of the
workforce reduction affected the United States, with some reductions in Europe
and the Philippines and sales offices that were closed in Europe and the United
States. As of the end of Q2 2003, all of these employees had left Cypress.
A restructuring charge of $3.4 million was recorded in Q1 2003 for additional
opportunities identified as part of the personnel portion of the Fiscal 2002
Restructuring Plan. The charge relates to the severance and related employee
benefit costs for the termination of approximately 150 additional employees, the
majority of whom were located in the United States at Cypress's facilities in
San Jose, Texas and Minnesota. As of the end of Q2 2003, all of these employees
had left Cypress.
9
In Q2 2003, Cypress placed back into service certain of these assets previously
recorded as held for sale. The assets were needed to meet increased production
requirements resulting from a substantial increase in unit demand versus
Cypress's initial assumptions at the time of the restructuring in Q4 2002. When
the assets were put back into service, they were recorded at their fair value in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"), and the related impairment reserve of $3.2
million was reversed. This resulted in an excess recovery of the reserves
initially established for these assets. This amount was not material.
A net restructuring charge of $2.5 million was recorded in Q3 2003. This charge
consisted of $2.4 million for additional opportunities identified as part of the
personnel and leased facility portion of the Fiscal 2002 Restructuring Plan, in
addition to a net $0.1 million charge for additional costs resulting from prior
quarters change in estimate. Of the $2.4 million charge for additional
opportunities identified, the personnel portion of the charge relates to
severance and related employee benefit costs for the termination of
approximately 62 additional employees, the majority of whom were located in the
United States at Cypress's facilities in San Jose, and Europe. As of the end of
Q3 2003, all of these employees had left Cypress. The net leased facility charge
of $0.8 million consists of $0.9 million resulting from the cessation of use of
Cypress's U.K. Design Center facility offset by $0.1 million reversal of a Q4
2002 restructuring charge for the U.K. Sales facility that was vacated in Q4
2002. The termination of employees in the U.K. resulted in the need for a
smaller facility and the U.K. Sales facility was accordingly put back into use.
In Q3 2003, Cypress placed back into service assets previously recorded as held
for sale. The assets were needed to meet increased production requirements
resulting from an increase in customer unit demand forecast, versus Cypress's
initial assumptions at the time of the restructuring in Q4 2002. When the assets
were put back into service, they were recorded at their fair value in accordance
with SFAS 144.
In the fourth quarter of fiscal 2003 ("Q4 2003"), Cypress is planning a bid sale
of the remaining equipment held for sale under the Fiscal 2002 Restructuring
Plan, and expects to have final disposition of the remaining equipment by the
end of Q4 2003.
The following table summarizes the activity associated with the restructuring
liabilities and asset write-downs since the inception of the Fiscal 2002
Restructuring Plan:
- --------------------------------------------------------------------------------
Property, plant Leased
(In thousands) & equipment Facilities Personnel Total
- --------------------------------------------------------------------------------
Q4 2002 Provision $ 35,959 $ 1,211 $ 8,188 $ 45,358
Non-cash charges (39) -- (40) (79)
Cash charges (50) (524) (5,276) (5,850)
- --------------------------------------------------------------------------------
Balance at December 29, 2002 35,870 687 2,872 39,429
Q1 2003 Provision -- -- 3,360 3,360
Non-cash charges (2,413) -- -- (2,413)
Cash charges (98) (2) (2,263) (2,363)
- --------------------------------------------------------------------------------
Balance at March 30, 2003 33,359 685 3,969 38,013
Non-cash charges (3,161) -- -- (3,161)
Cash charges (225) (51) (3,224) (3,500)
Other adjustments (3,191) -- -- (3,191)
- --------------------------------------------------------------------------------
Balance at June 29, 2003 26,782 634 745 28,161
Q3 2003 Provision -- 788 1,752 2,540
Non-cash charges (2,740) 113 -- (2,627)
Cash charges (137) (123) (688) (948)
Other adjustments (4,138) -- -- (4,138)
- --------------------------------------------------------------------------------
Balance at September 28, 2003 $ 19,767 $ 1,412 $ 1,809 $ 22,988
- --------------------------------------------------------------------------------
Fiscal 2001 Restructuring Plan:
On July 16, 2001, Cypress announced a restructuring plan that involved resizing
its manufacturing facilities, reducing its workforce and combining facilities.
The restructuring was precipitated by the worldwide economic slowdown,
particularly in the business areas in which Cypress operates. The intended
effect of the plan was to size the manufacturing operations and facilities to
meet future demand and reduce expenses in all operations areas. During the third
quarter of fiscal 2001 ("Q3 2001"), Cypress recorded restructuring charges of
$132.1 million related to property, plant and equipment, leased facilities and
personnel.
10
In connection with the July 16, 2001 announcement, in Q3 2001, Cypress removed
from service and held for sale equipment with a net book value of $116.9
million, resulting in a charge of $113.4 million. Cypress has actively marketed
the equipment. Through Q3 2003, Cypress has disposed of equipment with a net
book value of $67.5 million. The proceeds from the sales of the assets generally
approximated their carrying values. In Q2 2002 and Q3 2002, Cypress placed back
into service certain of these assets previously recorded as held for sale. The
assets were needed to meet increased production requirements resulting from a
substantial increase in unit demand versus Cypress's initial assumptions at the
time of the restructuring in Q3 2001. When the assets were put back into
service, they were written up to their prior cost basis (an adjustment of $13.2
million and $9.6 million in Q2 2002 and Q3 2002, respectively), reduced for
depreciation expense that would have been recorded during the period the asset
was removed from service (an adjustment of $2.9 million and $2.6 million in Q2
2002 and Q3 2002, respectively), as required by SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed of"
("SFAS 121"). The net effect of the restructuring adjustment was a credit to the
Restructuring line on the condensed consolidated statement of operations of
$10.3 million and $7.0 million in Q2 2002 and Q3 2002, respectively. In Q1 2002,
Cypress also sold and then leased back certain other pieces of equipment
classified as held for sale. The proceeds from the sales of the assets
approximated their net carrying values. In Q1 2002, Cypress recorded an
additional charge of $1.6 million for additional cost reductions identified as
part of the personnel portion of the Fiscal 2001 Restructuring Plan. The charge
related to severance and related employee benefit costs for the termination of
employees, the majority of whom were located in the Philippines facility.
In Q3 2002, as a result of the continued drive to lower Cypress's cost structure
and break-even sales, Cypress further expanded the scope of the restructuring
and recorded net restructuring costs of $2.4 million, which was comprised of a
charge of $9.4 million offset by a $7.0 million reversal for previously
written-down equipment put back into service discussed above. The charge of $9.4
million consisted of $3.3 million for work force reductions, and included
severance, benefit costs and stock compensation, $3.4 million for capital
equipment removed from service and held for sale and $2.7 million for the
exiting of facility leases.
In Q4 2002, Cypress recorded a credit of $0.7 million related to the revised
estimate of personnel costs. All the personnel related charges and actions taken
by Cypress in Q3 2001, Q1 2002 and Q3 2002 resulted in the termination of
approximately 890 employees, all of whom had left Cypress as of the end of Q2
2003.
In Q3 2003, Cypress held a bid sale on the remaining equipment held for sale
under the Fiscal 2001 Restructuring Plan. As a result, an $8.1 million credit
was recorded associated with the release of prior reserves. At the end of Q3
2003, all but one piece of equipment with a carrying value of $0.5 million
remained unsold. Cypress expects to dispose of this equipment in Q4 2003. The
remaining reserve balance at the end of Q3 2003 of $16.0 million will be settled
in Q4 2003 with the disposition of the related equipment with no impact to the
condensed consolidated statement of operations.
The following table summarizes the activity associated with the restructuring
liabilities and asset write-downs since the inception of the Fiscal 2001
Restructuring Plan:
11
- ----------------------------------------------------------------------------------------------------------------
Property, plant Leased
(In thousands) & equipment Facilities Personnel Total
- ----------------------------------------------------------------------------------------------------------------
Initial provision in September 30, 2001 $ 113,350 $ 4,079 $ 14,684 $ 132,113
Non-cash charges (5,145) -- (8,970) (14,115)
Cash charges (380) (53) (3,836) (4,269)
- ----------------------------------------------------------------------------------------------------------------
Balance at September 30, 2001 107,825 4,026 1,878 113,729
Non-cash charges (2,124) -- (86) (2,210)
Cash charges (1,239) (160) (407) (1,806)
- ----------------------------------------------------------------------------------------------------------------
Balance at December 30, 2001 104,462 3,866 1,385 109,713
Provision -- -- 1,595 1,595
Non-cash charges (5,096) -- -- (5,096)
Cash charges (147) (375) (1,581) (2,103)
- ----------------------------------------------------------------------------------------------------------------
Balance at March 31, 2002 99,219 3,491 1,399 104,109
Cash charges (151) (503) (553) (1,207)
Other adjustments (13,217) -- -- (13,217)
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 85,851 2,988 846 89,685
Provision 3,378 2,761 3,251 9,390
Non-cash charges (12,316) -- (924) (13,240)
Cash charges (484) (502) (1,039) (2,025)
Other adjustments (9,545) -- -- (9,545)
- ----------------------------------------------------------------------------------------------------------------
Balance at September 29, 2002 66,884 5,247 2,134 74,265
Provision -- -- (701) (701)
Non-cash charges (12,786) -- -- (12,786)
Cash charges (419) (582) (799) (1,800)
- ----------------------------------------------------------------------------------------------------------------
Balance at December 29, 2002 53,679 4,665 634 58,978
Non-cash charges (16,046) -- -- (16,046)
Cash charges (862) (674) (540) (2,076)
- ----------------------------------------------------------------------------------------------------------------
Balance at March 30, 2003 36,771 3,991 94 40,856
Non-cash charges (1,206) -- -- (1,206)
Cash charges (471) (739) (115) (1,325)
Other adjustments (64) -- 21 (43)
- ----------------------------------------------------------------------------------------------------------------
Balance at June 29, 2003 35,030 3,252 -- 38,282
Provision (8,063) -- -- (8,063)
Non-cash charges (10,915) -- -- (10,915)
Cash charges (74) (520) -- (594)
- ----------------------------------------------------------------------------------------------------------------
Balance at September 28, 2003 $ 15,978 $ 2,732 $ -- $ 18,710
- ----------------------------------------------------------------------------------------------------------------
12
Note 5 - Balance Sheet Components
Inventories
- -----------------------------------------------------------------------------------------
September 28, December 29,
(In thousands) 2003 2002
- -----------------------------------------------------------------------------------------
Raw materials $ 3,626 $ 3,185
Work-in-process 43,587 54,668
Finished goods 24,530 34,868
- -----------------------------------------------------------------------------------------
Inventories $ 71,743 $ 92,721
- -----------------------------------------------------------------------------------------
Other Current Assets
- -----------------------------------------------------------------------------------------
September 28, December 29,
(In thousands) 2003 2002
- -----------------------------------------------------------------------------------------
Employee stock purchase assistance plan, net $ 91,387 $ 90,636
Deferred tax assets 76,588 85,041
Prepaid assets 21,123 24,962
Other 8,992 9,596
- -----------------------------------------------------------------------------------------
Other current assets $ 198,090 $ 210,235
- -----------------------------------------------------------------------------------------
Other Assets
- -----------------------------------------------------------------------------------------
September 28, December 29,
(In thousands) 2003 2002
- -----------------------------------------------------------------------------------------
Long-term marketable securities $ 51,417 $ 16,574
Key employee deferred compensation plan 17,312 15,574
Restricted cash 62,821 62,380
Deferred tax asset 25,724 26,037
Other 34,334 30,286
- -----------------------------------------------------------------------------------------
Other assets $ 191,608 $ 150,851
- -----------------------------------------------------------------------------------------
Other Current Liabilities
- -----------------------------------------------------------------------------------------
September 28, December 29,
(In thousands) 2003 2002
- -----------------------------------------------------------------------------------------
Customer advances $ 37,431 $ 3,950
Interest payable 3,528 8,216
Key employee deferred compensation plan 21,676 16,785
Accrued royalties 3,447 4,098
Accrued rep commissions 6,129 4,291
Other 33,579 46,772
- -----------------------------------------------------------------------------------------
Other current liabilities $ 105,790 $ 84,112
- -----------------------------------------------------------------------------------------
13
Note 6 - Commitments and Contingencies
Guarantees and Product Warranties
Cypress applies the disclosure provisions of FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45") to its agreements that
contain guarantee or indemnification clauses. These disclosure provisions expand
those required by SFAS No. 5, "Accounting for Contingencies," by requiring that
guarantors disclose certain types of guarantees, even if the likelihood of
requiring the guarantor's performance is remote. As of Q3 2003, Cypress has
accrued its estimate of liability incurred under these indemnification
arrangements and guarantees, as applicable. Cypress maintains self-insurance for
certain liabilities of its officers and directors. The following is a
description of significant arrangements in which Cypress is a guarantor.
Indemnification Obligations
Cypress is a party to a variety of agreements pursuant to which it may be
obligated to indemnify the other party with respect to certain matters.
Typically, these obligations arise in the context of contracts entered into by
Cypress, under which Cypress customarily agrees to hold the other party harmless
against losses arising from a breach of representations and covenants related to
such matters as title to assets sold, certain intellectual property rights,
specified environmental matters and certain income taxes. In each of these
circumstances, payment by Cypress is conditioned on the other party making a
claim pursuant to the procedures specified in the particular contract, which
procedures typically allow Cypress to challenge the other party's claims.
Further, Cypress's obligations under these agreements may be limited in terms of
time and/or amount, and in some instances, Cypress may have recourse against
third parties for certain payments made by it under these agreements.
It is not possible to predict the maximum potential amount of future payments
under these or similar agreements due to the conditional nature of Cypress's
obligations and the unique facts and circumstances involved in each particular
agreement. Historically, payments made by Cypress under these agreements did not
have a material effect on its business, financial condition or results of
operations. Cypress believes that if it were to incur a loss in any of these
matters, such loss would not have a material effect on its business, financial
condition, cash flows or results of operations.
Product Warranties
Cypress estimates its warranty costs based on historical warranty claim
experience and applies this estimate to the revenue stream for products under
warranty. Included in Cypress's warranty accrual are costs for limited
warranties and extended warranty coverage. Future costs for warranties
applicable to revenue recognized in the current period are charged to Cost of
revenues. The warranty accrual is reviewed quarterly to verify that it properly
reflects the remaining obligations based on the anticipated expenditures over
the balance of the obligation period. Adjustments are made when actual warranty
claim experience differs from estimates. As of the end of Q3 2003, warranty
reserve was $2.4 million. Warranty costs have not historically been significant
as a percentage of revenue.
SunPower Corporation
See Note 2 for discussion of Cypress's funding obligations to SunPower.
Synthetic Lease Transactions
On June 27, 2003, Cypress entered into a synthetic operating lease agreement
with a new lessor for manufacturing and office facilities located in Minnesota
and California. This transaction, which qualifies for operating lease accounting
treatment, replaced the three existing synthetic leases associated with these
two facilities. There was no impact to Cypress's results of operations as a
result of terminating the former leases and entering into the new lease. Lease
obligations related to the replaced synthetic leases, totaling $61.4 million,
were extinguished with existing restricted cash collateral and a new synthetic
lease obligation of $62.7 million was established as of the end of Q2 2003. The
new synthetic lease requires Cypress to purchase the property or to arrange for
the property to be acquired by a third party at lease expiration. If Cypress had
exercised its right to purchase all the properties subject to the new synthetic
lease at the end of Q3 2003, Cypress would have been required to make a payment
and record assets totaling $62.7 million. Cypress's management believes that
proceeds from the sale of properties under the new synthetic lease would equal
or exceed the payment obligation and therefore no liability to Cypress currently
exists. Cypress is required to maintain restricted cash or investments to serve
as collateral for this lease. As of Q3 2003, the amount of restricted cash
recorded was $62.8 million and was classified within Other assets in the
condensed
14
consolidated balance sheet. As of Q3 2003, Cypress was in compliance with the
financial covenant required by the new lessor. As of Q3 2003, the maximum
potential exposure to residual value guarantees was approximately $54.5 million
and Cypress does not expect to have a loss on such guarantees.
In accordance with FIN 45, Cypress determined that the fair value associated
with the residual value guarantee imbedded in the synthetic operating lease was
$2.0 million. This amount was recorded in Other assets and Other long-term
liabilities and is being amortized over the term of the synthetic operating
lease.
Legal Matters
In January 2002, Cypress was contacted by Syndia Corporation ("Syndia"), which
alleged that Cypress infringed two patents on which Jerome Lemelson was named as
the inventor (see the Lemelson Partnership discussion below). These two patents
are related to three of the non-stayed patents in the Lemelson Partnership
litigation in Arizona. In Q1 2003, Cypress was informed that the United States
Patent and Trademark Office is reexamining these two patents. Furthermore,
Cypress was informed in Q2 2003 that Syndia had been sued by Taiwan
Semiconductor Manufacturing Corporation ("TSMC") in the United States District
Court of the Northern District of California, in a declaratory judgment action
alleging these two Syndia patents are invalid, unenforceable and not infringed.
Cypress has reviewed and investigated the allegations by Syndia. Cypress
believes that it has meritorious defenses to these allegations, and will
vigorously defend itself in this matter. However, because of the nature and
inherent uncertainties of litigation, should Syndia sue Cypress and should the
outcome of the action be unfavorable, Cypress's business, financial condition,
results of operations and cash flows could be materially and adversely affected.
In January 1998, an attorney representing the estate of Mr. Jerome Lemelson
contacted Cypress and charged that Cypress infringed certain patents owned by
Mr. Lemelson and/or a partnership controlled by Mr. Lemelson's estate. On
February 26, 1999, the Lemelson Partnership sued Cypress and 87 other companies
in the United States District Court for the District of Arizona for infringement
of 16 patents. In May 2000, the Court stayed litigation on 14 of the 16 patents
in view of concurrent litigation in the United States District Court, District
of Nevada on the same 14 patents, in which the plaintiffs allege that the
patents are invalid, unenforceable and not infringed. The Nevada trial
proceedings concluded in January 2003, post-trial briefing has concluded, and
the matter is under submission with the judge. In October 2001, the Lemelson
Partnership amended its Arizona complaint to add allegations that two more
patents were infringed. Thus, there are currently four patents that are not
stayed in this litigation. A bench trial (i.e. a trial with no jury) on only the
defenses relating to Lemelson's alleged fraud in obtaining the four non-stayed
patents was held on February 4, 2003. In the judge's proposed findings following
the trial, it appears that the judge does not intend to find that any of the
patents are unenforceable due to fraud. However, the parties filed their
objections to the proposed findings on August 29, 2003 and are awaiting the
final order. In Q3 2003, TSMC settled with Lemelson, and as a result one of the
fraud defenses asserted only by TSMC at trial will not be decided by the judge.
The case is proceeding in the "claim construction" (i.e. patent claim
interpretation) phase on the four non-stayed patents, and the date for
conclusion of the claim construction briefing is expected to be delayed until
the first quarter of fiscal 2004 in part due to TSMC's settlement with Lemelson.
After the claim construction briefing has concluded, the judge may request a
claim construction hearing or may take the matter under submission on the
briefs. Cypress has reviewed and investigated the allegations in both Lemelson's
original and amended complaints. Cypress believes that it has meritorious
defenses to these allegations and will vigorously defend itself in this matter.
However, because of the nature and inherent uncertainties of litigation, should
the outcome of this action be unfavorable, Cypress's business, financial
condition, results of operations and cash flows could be materially and
adversely affected.
In February 2002, Cypress was contacted by an attorney representing Mr. Peng
Tan, alleging that Cypress infringed a patent owned by Mr. Tan. Cypress has
reviewed and investigated Mr. Tan's allegations. Cypress believes it has
meritorious defenses to these allegations, and will vigorously defend itself in
this matter. However, because of the nature and inherent uncertainties of
litigation, should Mr. Tan sue Cypress and should the outcome of the action be
unfavorable, Cypress's business, financial condition, results of operations and
cash flows could be materially and adversely affected.
Cypress is currently a party to various other legal proceedings, claims,
disputes and litigation arising in the ordinary course of business, including
those noted above. Cypress currently believes that the ultimate outcome of these
proceedings, individually and in the aggregate, will not have a material adverse
affect on Cypress's financial position, results of operation or cash flows.
However, because of the nature and inherent uncertainties of litigation,
15
should the outcome of these actions be unfavorable, Cypress's business,
financial condition, results of operations and cash flows could be materially
and adversely affected.
Note 7 - Debt and Equity Transactions
Option Contracts
At the end of Q3 2003, Cypress had outstanding a series of equity options on
Cypress common stock with an initial cost of $26.0 million, which is classified
in stockholders' equity in the accompanying condensed consolidated balance
sheet. The contracts, which were extended during Q2 2003, require physical
settlement and expire in December 2003. Upon expiration of the options, if
Cypress's stock price is above the threshold price of $20.00 per share, Cypress
will receive a settlement value totaling $28.9 million. If Cypress's stock price
is below the threshold price of $20.00 per share, Cypress will receive 1.4
million shares of its common stock. Alternatively, the contract may be renewed
and extended.
In conjunction with the 1.25% convertible subordinated notes offering in June
2003, Cypress purchased a call spread option on Cypress's common stock ("Call
Spread Option") maturing in July 2004 for $49.3 million. The Call Spread Option,
including fees and costs, has been accounted for as an equity transaction in
accordance with Emerging Issues Task Force No. 00-19, "Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company's Own
Stock." The Call Spread Option covers approximately 32.0 million shares of
Cypress common stock. The Call Spread Option is designed to mitigate dilution
from conversion of the 1.25% convertible subordinated notes in the event that
the market price per share of Cypress's common stock upon exercise of the Call
Spread Option is greater than $15.00 per share and is less than or equal to
$24.50 per share. The Call Spread Option may be settled at Cypress's option in
either net shares or in cash. Settlement of the Call Spread Option in net shares
on the expiration date would result in Cypress receiving a number of shares, not
to exceed 12.4 million, of Cypress's common stock with a value equal to the
amount otherwise receivable on cash settlement. Should there be an early unwind
of the Call Spread Option, the amount of cash or net shares potentially received
by Cypress will be dependent upon the then existing overall market conditions,
on Cypress's stock price, the volatility of Cypress's stock and the amount of
time remaining on the Call Spread Option.
Deferred Stock-Based Compensation
Cypress records provisions for deferred stock compensation related to
acquisitions. There was no such provision recorded in either the three or nine
months ended Q3 2003. Deferred stock compensation expense is amortized over the
vesting period of the individual stock options or restricted stock, generally a
period of four to five years. Deferred stock compensation expense, included in
Cost of revenues, Selling, general and administrative expense and Research and
development expense in the condensed consolidated statements of operations,
totaled approximately $1.4 million and $8.7 million for the three and nine
months ended Q3 2003, respectively, and approximately $7.8 million and $28.1
million for the three and nine months ended Q3 2002, respectively. Deferred
compensation is lower in the three and nine months of fiscal 2003 compared to
the three and nine months of fiscal 2002 as a result of employee terminations
and accelerated amortization in accordance with FIN 28.
Convertible Subordinated Notes
During Q2 2003, Cypress issued $600.0 million of five-year convertible
subordinated notes, maturing June 2008, with a coupon of 1.25% ("1.25% Notes"),
with interest payable on June 15 and December 15 beginning December 15, 2003.
Each note, which may be converted at anytime by the holders prior to maturity,
is convertible into 55.172 shares of Cypress stock plus a cash payment of
$300.00. Cypress, at its option, may satisfy the $300.00 cash payment by issuing
common stock if the then current stock price exceeds $11.65. The 1.25% Notes are
callable at anytime on or after June 20, 2006. At anytime prior to maturity,
Cypress may, at its option, elect to terminate the holders' conversion rights if
the closing price of Cypress's common stock exceeds $21.75 (subject to certain
adjustments) for 20 days out of a 30 consecutive trading day period. If Cypress
issues a notice of termination of conversion rights prior to June 20, 2006,
Cypress will pay additional interest in an amount equal to three years of
interest, less any interest actually paid prior to the conversion date, to
holders who convert their 1.25% Notes.
As of the end of Q2 2003, of the $600.0 million of 1.25% Note proceeds, Cypress
had used approximately $75.1 million to repurchase and retire portions of its
existing 4.0% convertible subordinated notes (the "4.0% Notes") and 3.75%
convertible subordinated notes (the "3.75% Notes") in privately negotiated
transactions, $95.3 million to
16
repurchase 9.0 million shares of Cypress common stock, $49.3 million to
purchase an issuer call spread option and $18.0 million for transaction costs.
The issuer call spread option was recorded in stockholders' equity.
In Q3 2003, Cypress redeemed the remaining $255.2 million outstanding principal
amount of the 4.0% Notes and $70.0 million of the 3.75% Notes, from the proceeds
of the 1.25% Notes. As of the end of Q3 2003, there were no 4.0% Notes
outstanding, $68.7 million of 3.75% Notes outstanding and $600.0 million of the
1.25% Notes outstanding, all classified as long-term debt. In Q3 2003, Cypress
recorded a $6.3 million loss on redemption related to the $325.2 million
redemption of the 4.0% Notes and 3.75% Notes, consisting of premiums paid and
the write-off of a proportionate share of the related issuance costs.
On June 30, 2003, Cypress filed a resale shelf registration statement on Form
S-3 for the registration of the 1.25% Notes and the shares of Cypress common
stock underlying the 1.25% Notes. The registration statement was declared
effective by the Securities and Exchange Commission on September 10, 2003.
Collateralized Debt Instruments
During Q1 2003, Cypress entered into long-term loan agreements with two lenders
with an aggregate principal amount equal to $24.8 million. These agreements are
collateralized by specific equipment located at Cypress's U.S. manufacturing
facilities. Principal amounts are to be repaid in monthly installments inclusive
of accrued interest, over a three to four year period. The applicable interest
rates are variable based on changes to LIBOR rates. Both loans are subject to a
financial covenant. As of the end of Q3 2003, the aggregate principal
outstanding was $21.9 million and Cypress was in compliance with the financial
covenants.
Line of Credit
In September 2003, Cypress entered into a $50.0 million twenty-four month
revolving line of credit with Silicon Valley Bank. As of the end of Q3 2003,
there was no amount outstanding under the line of credit. Loans made under the
line of credit bear interest based upon the Wall Street Journal Prime Rate or
LIBOR plus 175 basis points at Cypress's election. The line of credit agreement
includes a variety of covenants binding on Cypress and its subsidiaries,
including restrictions in the incurrence of indebtedness, incurrence of loans,
and transfers of assets and financial covenants with respects to tangible net
worth and a quick ratio. Cypress obligations under the line of credit are
guaranteed and secured by the stock of certain of its subsidiaries. Cypress
intends to use the line of credit on an as needed basis to fund working capital
and capital expenditures including Cypress's obligations under the SunPower
agreements.
Stock Option Plans
Cypress has two stock option plans: the 1994 stockholder approved Stock Option
Plan ("1994 Plan") and the 1999 non-stockholder approved Stock Option Plan
("1999 Plan"). The 1999 Plan does not allow for the issuance of options to
officers and directors but the 1994 Plan does. The 1994 Plan expires in April
2004.
Cypress believes that stock option grants are critical to its ability to attract
and retain personnel. As a result, in order to secure sufficient options for
issuance to non-officers and directors, Cypress's Board of Directors, in Q2
2003, approved an increase of 20.0 million shares for issuance under the 1999
Plan. While Cypress continues to evaluate its overall compensation structure,
Cypress is planning to submit for stockholder approval, in its 2004 Proxy
statement, a new stock option plan that will cover employees, officers and
directors.
Note 8 - Comprehensive Income (Loss) and Accumulated Other Comprehensive Income
The components of accumulated other comprehensive income, net of tax, were as
follows:
- ----------------------------------------------------------------------------------------
September 28, December 29,
(In thousands) 2003 2002
- ----------------------------------------------------------------------------------------
Accumulated net unrealized gain on available-for-
sale investments $ 369 $ 1,033
Accumulated net unrealized gain on derivatives 981 1,343
- ----------------------------------------------------------------------------------------
Total accumulated other comprehensive income $ 1,350 $ 2,376
- ----------------------------------------------------------------------------------------
17
The components of comprehensive income (loss) are as follows:
Three months ended Nine months ended
- ----------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 17,267 $(55,089) $(28,494) $(122,941)
Unrealized gain (loss) on available-for-sale securities (3,912) (340) (664) (1,947)
Unrealized gain (loss) on derivatives (681) (197) (362) 749
- ----------------------------------------------------------------------------------------------------------------------
Comprehensive income (loss) $ 12,674 $(55,626) $(29,520) $(124,139)
- ----------------------------------------------------------------------------------------------------------------------
Note 9 - Foreign Currency Derivatives
Cypress purchases capital equipment using foreign currencies and has foreign
subsidiaries that operate and sell Cypress's products in various global markets.
As a result, Cypress is exposed to risks associated with changes in foreign
currency exchange rates. At any point in time, Cypress might use various hedge
instruments, primarily forward contracts, to manage the exposures associated
with forecasted purchases of equipment and net asset or liability positions.
Cypress does not enter into derivative financial instruments for speculative or
trading purposes.
Cypress estimates the fair value of its forward contracts based on changes in
forward rates from published sources. Cypress accounts for its hedges of
committed purchases of equipment as cash flow hedges, such that changes in the
fair value of the effective portion of hedge contracts, if material, are
recorded in Accumulated other comprehensive income in stockholders' equity.
Amounts deferred in Accumulated other comprehensive income will be recorded in
the condensed consolidated statement of operations in the period in which the
underlying transactions impact earnings. At the end of Q3 2003, the effective
portion of unrealized gains on cash flow hedges recorded in Accumulated other
comprehensive income was $1.0 million net of tax. Ineffective hedges are
recorded in Other income and (expense), net and were $1.0 and $0.7 million for
the three and nine months ended Q3 2003 and $(0.1) and $0.4 for the three and
nine months ended Q3 2002. As of the end of Q3 2003, Cypress had forward
contracts for Euro exposures with an aggregate notional value of $6.5 million.
Cypress records its hedges of foreign currency denominated assets and
liabilities at fair value with the related gains or losses recorded in Other
income and (expense), net. The gains and losses on these contracts are
substantially offset by transaction gains and losses on the underlying balances
being hedged. As of the end of Q3 2003, Cypress held forward contracts with an
aggregate notional value of $4.0 million to hedge the risks associated with Yen
foreign currency denominated assets and liabilities. Aggregate net foreign
exchange gains (losses) on these hedging transactions and foreign currency
remeasurement gains (losses) were $1.0 million and $0.4 million for the three
and nine months ended Q3 2003 compared to $0.4 million and $(1.5) million for
the three and nine months ended Q3 2002. The $1.0 million gain recorded in Q3
2003 was primarily associated with the settlement of a Euro forward contract
associated with the cancellation of a purchase order for wafer fabrication
equipment no longer required for operations. The amounts are included in Other
income and (expense), net in the condensed consolidated statements of
operations.
Note 10 - Income Taxes
Cypress's effective rates of income tax expense for Q3 2003 and Q3 2002 were
4.0% and 0.2%, respectively. For the nine months ended Q3 2003 and Q3 2002,
Cypress's effective rates of income tax expense were 9.3% and 0.7%,
respectively. A tax provision of $0.7 million was recorded during Q3 2003
compared to a tax provision of $0.1 million during Q3 2002. The tax provision
for each fiscal year is attributable to foreign withholding tax on royalty
income and income earned in certain countries that is not offset by current year
net operating losses in other countries. The future tax benefit of certain
losses is not currently recognized due to Cypress's assessment of the likelihood
of realization of these benefits. Cypress's effective tax rate may vary from the
U.S. statutory rate primarily due to utilization of future benefits, the
earnings of foreign subsidiaries taxed at different rates, tax credits and other
business factors.
Note 11 - 2001 Employee Stock Purchase Assistance Plan
On May 3, 2001, Cypress stockholders approved the adoption of the 2001 Employee
Stock Purchase Assistance Plan (the "Plan"). The Plan allowed for loans to
employees to purchase shares of Cypress common stock on the open market.
Employees of Cypress and its subsidiaries, including executive officers but
excluding the CEO and the Board of Directors of Cypress, were allowed to
participate in the Plan. Each loan was evidenced by a full recourse,
18
promissory note executed by the employee in favor of Cypress and was secured by
a pledge of the shares of Cypress's common stock purchased with the proceeds of
the loan. If a participant sells the shares of Cypress common stock purchased
with the proceeds from the loan(s), the proceeds of the sale must first be used
to repay the interest and then the principal on the loan(s) before being
received by the Plan participant. The loans are callable by Cypress at any time
and currently bear interest at a minimum rate of 4.0% per annum compounded
annually, except for loans to executive officers, who are also named corporate
officers, whose loans bear interest at the rate of 5.0% per annum, compounded
annually. As the loans are at interest rates below the estimated market rate,
Cypress recorded compensation expense of $0.9 million in Q3 2003 and $0.9
million in Q3 2002 to reflect the difference between the rate charged and an
estimated market rate for each loan outstanding. In addition, Cypress is
recording interest income on the outstanding loan balances. Accrued interest
outstanding at the end of Q3 2003 totaled $8.7 million. The Plan became
effective on May 3, 2001 and will terminate on the earlier of May 3, 2011, or
such time as determined by the Board of Directors. As of the end of Q3 2003,
loans (including accrued interest) outstanding under the Plan net of loss
reserve were $91.4 million, as compared to $90.6 million at the end of Q4 2002.
This balance is classified on the condensed consolidated balance sheet within
Other current assets. Cypress has established a loss reserve, which represents
an amount for estimated uncollectible balances, with changes in the loss reserve
recognized in Selling, general and administrative expense. In determining this
loss reserve, Cypress considered various factors, including an independent fair
value analysis of the loans and the underlying collateral. At the end of Q3
2003, the net carrying value of the loans of $91.4 million is $2.9 million more
than the underlying common stock collateral. To date, there have been immaterial
write-offs. At the end of Q3 2003 and Q3 2002, the loss reserve was $16.2
million and $15.9 million, respectively. Cypress is willing to pursue every
available avenue, including those covered under the Uniform Commercial Code, to
recover these loans by pursuing employees' personal assets should the employees
not repay these loans. In October 2003, Cypress announced a program aimed at
minimizing any losses to employees as a result of Cypress's common stock price
fluctuations. Under this program, a stop loss order is placed on the common
stock purchased by each employee with the loan proceeds once the common stock
price exceeds that employee's break-even point. If the common stock price
declines to the stop loss price, the common stock purchased by the employee
under the Plan will be automatically sold and the proceeds utilized to repay the
employee's outstanding loan to Cypress. From the end of Q3 2003 to the end of
October 2003, Cypress collected $7.0 million from employees who had settled
their loan obligations.
Note 12 - Segment Reporting
Historically, Cypress has disclosed two reportable business segments, Memory
Products and Non-memory Products. The Memory Products business segment includes
Static Random Access Memories ("SRAMs") and is characterized by high unit sales
volume and generally subject to greater pricing pressures. The Non-memory
Products business segment includes data communication devices, programmable
logic products, specialty memories, timing and interface products.
In October 2000, Cypress announced the formation of new divisions in order to
enhance its focus on communications market segments. The Wide Area Networks
("WAN") and Storage Area Networks ("SAN") divisions help to provide product
definition in the networking arena. Similarly, the Wireless Terminals ("WIT")
and Wireless Infrastructure ("WIN") divisions help focus Cypress's efforts in
the wireless space. The Computation and Consumer market segment includes
products used in computers, peripherals and other applications. Cypress
periodically reviews its customer and product portfolio and makes corresponding
changes to its segment data alignment as appropriate. Based on that review,
during Q1 2003, Cypress began disclosing its subsidiaries Silicon Light
Machines, Silicon Magnetic Systems, Cypress Microsystems and SunPower
Corporation as a separate segment called Cypress Subsidiaries. The prior year
market segment data has been restated to conform with current presentation. The
market focus is expected to provide systems knowledge, cross-product-line
product portfolio definition, early engagement with strategic accounts and added
management of research and development ("R&D") spending.
Cypress evaluates the performance of its segments based on profit or loss from
operations before income taxes, excluding acquisition-related costs,
restructuring costs, interest income, interest expense and other income and
(expense), net.
Business Segment Information
Cypress's reportable business segments are business units that offer different
products. Products that fall under the two business segments differ in nature,
are manufactured utilizing different technologies and have a different
end-purpose. As such, they are managed separately. Memory Products are
characterized by high unit sales volume and
19
are generally subject to greater pricing pressures. These products are
manufactured using more advanced technology. A significant portion of the wafers
produced for Memory Products are manufactured at Cypress's technologically
advanced, eight-inch wafer production facility located in Minnesota. Memory
Products are used by a variety of end-users generally for the storage and
retrieval of information. In contrast to Memory Products, unit sales of
Non-memory Products are generally lower than Memory Products, but sell at higher
gross margins. Some Non-memory Products are manufactured utilizing less
technologically advanced processes. A majority of wafers for Non-memory Products
are manufactured at Cypress's six-inch wafer production facility located in
Texas, while some wafers are procured from foundries. Products in the Non-memory
segment perform functions such as timing management, data transfer and routing
in computer, communications and storage systems. Products range from high volume
Universal Serial Bus ("USB") interfaces for personal computers to high value
products such as Cypress's OC-48 Serializer/Deserializer ("SERDES") device for
optical communications systems.
The tables below set forth information about the reportable business segments
for the three and nine months ended Q3 2003 and Q3 2002, respectively. Cypress
does not allocate interest income and expense, income taxes, acquisition-related
costs or restructuring charges to its segments. Cypress does not allocate assets
to segments. In addition, business segments do not have significant non-cash
items other than depreciation and amortization in reported profit or loss.
Business Segment Net Revenues
Three months ended Nine months ended
- -------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
Memory $ 87,305 $ 83,339 $ 235,895 $ 240,493
Non-memory 129,337 121,682 364,830 359,804
- -------------------------------------------------------------------------------------------------------------------------
Total consolidated revenues $ 216,642 $ 205,021 $ 600,725 $600,297
- -------------------------------------------------------------------------------------------------------------------------
Business Segment Income (Loss) before Provision for Income Taxes
Three months ended Nine months ended
- -----------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------
Memory $ (4,091) $ 4,848 $ (15,710) $ (8,728)
Non-memory 14,067 (30,461) 9,194 (75,073)
Restructuring and acquisition costs (3,921) (13,091) (25,926) (25,868)
Interest income 2,930 3,339 11,255 15,699
Interest expense (3,249) (4,886) (13,055) (14,515)
Other income and (expense), net 12,251 (14,749) 8,170 (13,573)
- -----------------------------------------------------------------------------------------------------------------------------
Income (Loss) before provision for income taxes $ 17,987 $ (55,000) $ (26,072) $ (122,058)
- -----------------------------------------------------------------------------------------------------------------------------
Market Segment Information
Cypress does not allocate interest income and expense, income taxes,
acquisition-related costs or restructuring charges to segments. Cypress does not
allocate assets to segments. In addition, market segments do not have
significant non-cash items other than depreciation and amortization in reported
profit or loss.
Market Segment Net Revenues
Three months ended Nine months ended
- -------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
Wide area networks/storage area networks $ 66,784 $ 66,096 $ 187,418 $191,409
Wireless terminals/wireless infrastructure 64,670 73,273 180,861 199,648
Computation and consumer 76,206 60,605 208,012 195,242
Cypress subsidiaries 8,982 5,047 24,434 13,998
- ------------------------------------------------------------------------------------------------------------------------
Total consolidated revenues $ 216,642 $ 205,021 $ 600,725 $600,297
- ------------------------------------------------------------------------------------------------------------------------
20
Market Segment Income (Loss) Before Provision for Income Taxes
Three months ended Nine months ended
- -------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
Wide area networks/storage area networks $ (2,398) $ (11,562) $ (15,441) $ (39,375)
Wireless terminals/wireless infrastructure 4,169 172 2,214 (14,464)
Computation and consumer 13,770 (7,688) 26,720 (9,830)
Cypress subsidiaries (5,565) (6,535) (20,009) (20,132)
Restructuring and acquisition costs (3,921) (13,091) (25,926) (25,868)
Interest income 2,930 3,339 11,255 15,699
Interest expense (3,249) (4,886) (13,055) (14,515)
Other income and (expense), net 12,251 (14,749) 8,170 (13,573)
- -------------------------------------------------------------------------------------------------------------------------
Income (Loss) before provision for income taxes $ 17,987 $ (55,000) $ (26,072) $ (122,058)
- -------------------------------------------------------------------------------------------------------------------------
International revenues accounted for 67.5% and 63.3% for the three and nine
months ended Q3 2003 compared to 58.2% and 56.8% for the corresponding periods
ended Q3 2002.
No individual customer accounted for greater than 10.0% of total revenues for
the three and nine months ended Q3 2003. Sales to Motorola, Inc. accounted for
13.1% and 10.5% for the three and nine months ended Q3 2002.
Sales to FE Global, one of Cypress's distributors, accounted for 12.7% for the
three months ended Q3 2003. For the nine months ended Q3 2003 and the three
months and the nine months ended Q3 2002, no individual distributor accounted
for greater than 10.0% of total revenues.
Note 13 - Earnings (Loss) Per Share
Basic net income (loss) per common share is computed using the weighted-average
common shares outstanding for the period. Diluted net income (loss) per common
share is computed as though all potential dilutive common shares were
outstanding during the period. Dilutive securities include stock options and
shares issuable upon the conversion of convertible debt. The following table
sets forth the computation of basic and diluted net income per share (In
thousands, except per share amounts):
Three months ended Nine months ended
- -------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
BASIC:
Net income (loss) attributable to common shareholders $ 17,267 $ (55,089) $(28,494) $(122,941)
========= ========== ========= =========
Weighted-average common shares 118,116 123,634 122,021 122,907
========= ========== ========= =========
Basic net income (loss) per share $ 0.15 $ (0.45) $ (0.23) $ (1.00)
========= ========== ========= =========
DILUTIVE:
Net income (loss) attributable to common shareholders $ 17,267 $ (55,089) $ (28,494) $(122,941)
Interest on 1.25% Notes, net of taxes 1,312 - - -
Bond issuance costs on 1.25% Notes, net of taxes 646 - - -
--------- ---------- ---------- ---------
Net income (loss) for diluted computation $ 19,225 $ (55,089) $ (28,494) $(122,941)
========= ========== ========= =========
Weighted-average common shares 118,116 123,634 122,021 122,907
Effect of dilutive securities:
Stock options 11,956 - - -
1.25% Notes 33,103 - - -
--------- ---------- ---------- ---------
Adjusted weighted average common shares and assumed
conversions 163,175 123,634 122,021 122,907
========= ========== ========= =========
Diluted net income (loss) per share $ 0.12 $ (0.45) $ (0.23) $ (1.00)
========= ========== ========= =========
21
For the nine months ended Q3 2003 and for the three and nine months ended Q3
2002, outstanding options were excluded from the calculation of diluted net loss
per share, as the effect would be anti-dilutive. Total outstanding options to
purchase common stock at the end of Q3 2003 were 41.7 million shares at a
weighted-average exercise price of $13.32. Total outstanding options to purchase
common stock at the end of Q3 2002 were 37.3 million shares at a
weighted-average exercise price of $15.18.
For the three months ended Q3 2003, diluted earnings per share included
approximately 33.1 million shares assuming conversion of the 1.25% Notes and
payment of the $300 portion of each note in cash rather than common stock. Each
$1,000 principal value 1.25% Notes issued in June 2003, is convertible at any
time prior to maturity into 55.172 shares of common stock, subject to certain
adjustments, plus $300 of cash. Cypress, at its option may pay the $300 in
shares of common stock, subject to certain conditions. Cypress currently intends
to pay the $300 in cash rather than shares of common stock. As a result, for
purposes of determining Cypress's diluted earnings per share calculation, it is
presumed that the $300 payment will be settled in cash. Therefore, earnings in
the diluted earnings per share calculation are adjusted by 70% of the interest
expense and bond issuance costs.
For the three months ended Q3 2002 and for the nine months ended Q3 2003 and Q3
2002, the shares of common stock issuable upon the assumed conversion of
convertible subordinated notes were excluded from the calculation of diluted net
loss per share as the effect would be anti-dilutive.
Note 14 - Subsequent Event
In October 2003, Cypress announced the signing of a definitive agreement to
acquire the outstanding stock of Cascade Semiconductor Corporation. The
acquisition which is not material to Cypress, is expected to close in Q4 2003
and will be accounted for under purchase accounting rules. Cascade specializes
in 1T Pseudo-SRAM products for wireless applications.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CYPRESS SEMICONDUCTOR CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For the Three and Nine Month Periods Ended September 28, 2003
The discussion in this report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 that involve risks and uncertainties, including,
but not limited to, statements as to future operating results and business
plans, our prospects and the prospects of the semiconductor industry generally,
the impact of new product development and improvements in manufacturing
technologies and yields on variances, pressure on and trends for average selling
prices, our intention to seek intellectual property protection for our
manufacturing processes, expected capital expenditures, future acquisitions, the
financing of SunPower Corporation ("SunPower"), the repayment of loans by
SunPower, or the intention to exercise the SunPower preferred stock warrant, the
dependence of future success on our ability to develop and introduce new
products, the general economy and its impact to the market segments we serve,
changing environment and the cycles of the semiconductor industry, competitive
pricing and the rate at which new products are introduced, successful
integration and achieving the objectives of the acquired businesses, cost goals
emanating from manufacturing efficiencies, expected financing and investment
cash outlays, adequacy of cash and working capital, when we expect to generate
positive cash flow from operations, the expected disposition of equipment and
the settlement of reserves, expected proceeds if properties subject to synthetic
lease were sold, our expected use of our line of credit, our intention with
respect to payment of the $300.00 payable on conversion of our convertible
subordinated notes with a coupon of 1.25% ("1.25% Notes"), risks related to
investing in development stage companies, and other liquidity risks. We use
words such as "anticipates," "believes," "expects," "future," "intends" and
similar expressions to identify forward-looking statements. Our actual results
could differ materially from those projected in the forward-looking statements
for any reason, including the factors set forth in "Risk Factors" below and
elsewhere in this report.
Results of Operations
Business Segment Net Revenues
Revenues for the three and nine months ended September 28, 2003 ("Q3 2003") were
$216.6 and $600.7 million, respectively, an increase of $11.6 million or 5.7%
and an increase of $0.4 million or 0.1%, respectively, compared to revenues for
the three and nine months ended September 29, 2002 ("Q3 2002") of $205.0 and
$600.3 million. We derive our revenues from the sale of Memory products and
Non-memory products, which are targeted primarily to the data communications,
wireless, computation and consumer markets.
Three months ended Nine months ended
- -------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
Memory $ 87,305 $ 83,339 $ 235,895 $ 240,493
Non-memory 129,337 121,682 364,830 359,804
- -------------------------------------------------------------------------------------------------------------------------
Total consolidated revenues $ 216,642 $ 205,021 $ 600,725 $ 600,297
- -------------------------------------------------------------------------------------------------------------------------
Revenues from the sale of Memory products for the three and nine months ended Q3
2003 increased $4.0 million or 4.8% and decreased $4.6 million or 1.9% versus
revenues from the sale of these products for the three and nine months ended Q3
2002, respectively. In Q2 2003, we acquired Micron Technology, Inc.'s
Synchronous Static Random Access Memory ("SRAM") product portfolio, which
contributed $9.9 million and $19.5 million of revenue to the Memory product
group for the three and nine months ended Q3 2003, respectively. Excluding the
effects of the acquisition of Micron's SRAM product portfolio, revenue declined
for both periods compared to the three and
23
nine months ended Q3 2002. Memory product units increased 8.7% for the three
months ended Q3 2003 versus Q3 2002, with increases in the Sync and Micropower
family products being partially offset by decreases in the Fast family of
products. Average selling prices ("ASPs") for the three months ended Q3 2003
decreased from Q3 2002 although the average density (Mbits/Unit) of SRAM
products sold continued to increase. We use ASP/Mbit as an indication of the
magnitude of price change for Memory Products. This metric reflects changes in
product mix and density as well as market price. ASP/Mbit declined 28.8% in the
three months ended Q3 2003 from the three months ended Q3 2002.
Memory product units decreased 2.2% for the nine months ended Q3 2003 versus the
nine months ended Q3 2002, with declines in the Fast and Micropower family
products being partially offset by increases in the Sync family of products.
ASPs for the nine months ended Q3 2003 were flat compared to the nine months
ended Q3 2002 although the average density (Mbits/Unit) of SRAM products sold
continued to increase. ASP/Mbit declined 28.6% in the nine months ended Q3 2003
from the nine months ended Q3 2002.
For the three months ended Q3 2003, revenue from the sale of Non-memory products
increased $7.7 million or 6.3% versus the three months ended Q3 2002. The
increase was driven by Universal Serial Bus ("USB") 2.0, Network Search Engines
("NSEs"), Programmable Logic Devices ("PLDs") and Programmable System on a Chip
("PSoC") products offset by reduced revenue from our Frequency Timing Generators
("FTG"), Neuron and VME products. Non-memory product unit sales increased for
the three months ended Q3 2003 by 15.8% compared to the three months ended Q3
2002. This reflects an increase in unit sales from our USB family of products,
NSE, PSoC, Programmable Clocks and FTG products offset by reduced unit demand
for Neuron.
Non-memory revenue for the nine months ended Q3 2003 increased by $5.0 million
or 1.4% versus the nine months ended Q3 2002. The change resulted from increased
revenue from our subsidiaries Cypress MicroSystems, Inc. ("CMS"), SunPower and
Silicon Light Machines ("SLM"). Also, increases by NSEs, USB 2.0, physical layer
("PHY") and adoption of our multi-PORT ("MPORT") products offset reduced demand
for our Programmable Clocks and Neuron products. Non-memory product unit sales
increased for the nine months ended Q3 2003 by 5.9% compared to the nine months
ended Q3 2002. This reflects an increase in unit sales from our USB family of
products, PSoC, MPORT and FTG products offset by reduced unit demand for
Programmable Clocks and Neuron.
As is typical in the semiconductor industry, ASPs of products generally decline
over the lifetime of the products. To increase revenues, we seek to expand our
market share in the markets we currently serve and to introduce and sell new
products with higher ASPs.
Cost of Revenues/Gross Margin
Costs of revenues for the three and nine months ended Q3 2003 were $111.5
million and $320.5 million, respectively, compared to $111.1 and $340.2 million,
respectively, for the three and nine months ended Q3 2002. This equates to gross
margins for the three and nine months ended Q3 2003 of 48.5% and 46.6%,
respectively, compared to 45.8% and 43.3%, respectively, for the three and nine
months ended Q3 2002.
The gross margin of Memory products for the three and nine months ended Q3 2003
were 26.1% and 25.3%, respectively, compared to 36.1% and 27.4%, respectively,
for the three and nine months ended Q3 2002. Gross margin for both periods
declined as a result of ASP erosion and lower sales of previously reserved
inventory in an amount representing the reserves previously recognized.
The gross margin of Non-memory products for the three and nine months ended Q3
2003 were 63.6% and 60.5%, respectively, compared to 52.4% and 54.0%,
respectively, for the three and nine months ended Q3 2002. The Non-memory
products gross margin improved due to a shift to higher margin MPORT, PHY and
PLD product sales as well as a transition to USB 2.0 for the three and nine
months ended Q3 2003 as compared to the three and nine months ended Q3 2002.
In the three and nine months ended Q3 2003 compared to three and nine months
ended Q3 2002, we were able to offset the impact of declining prices on our
gross margin by implementing cost cutting measures including reducing
manufacturing capacity and related headcount. In addition, we continued to
reduce manufacturing cycle times, reduce die size, improve labor productivity,
improve efficient use of capital resources, improve defect densities, improve
yields and ultimately lower manufacturing costs.
During the three and nine months ended Q3 2003, our gross margin benefited as a
result of the sale of previously reserved inventory in an amount representing
the reserves previously recognized. The incremental gross margin
24
benefit recognized was 1.1% and 1.7%, respectively, for the three and nine
months ended Q3 2003 and 2.9% and 2.1%, respectively, for the three and nine
months ended Q3 2002.
In January 2002, the Department of Commerce revoked a 1998 antidumping order
that had been imposed on SRAMs fabricated in Taiwan and imported into the United
States. The United States Customs Service was ordered to refund, with interest,
all duties deposited under the 1998 antidumping order. Between 1998 and 2001, we
charged $10.3 million to Cost of revenues for such duties. During Q1 2002, we
received $11.8 million in refunds, of which $9.9 million was recorded as an
offset to Cost of revenues for Memory products and $1.9 million was recorded in
Interest income. This benefit to our gross margin was substantially offset by
certain other items, including a change in estimate for deferred income on sales
to distributors.
International revenues accounted for 67.5% and 63.3% for the three and nine
months ended Q3 2003 compared to 58.2% and 56.8% for the corresponding periods
ended Q3 2002.
No individual customer accounted for greater than 10.0% of total revenues for
the three and nine months ended Q3 2003. Sales to Motorola, Inc. accounted for
13.1% and 10.5% for the three and nine months ended Q3 2002.
Sales to FE Global, one of Cypress's distributors, accounted for 12.7% for the
three months ended Q3 2003. For the nine months ended Q3 2003 and the three
months and the nine months ended Q3 2002, no individual distributor accounted
for greater than 10.0% of total revenues.
Research and Development
Three months ended Nine months ended
- --------------------------------------------------------------------------------------------------------------------
September 28, September 29, % September 28, September 29, %
(In thousands) 2003 2002 Change 2003 2002 Change
- --------------------------------------------------------------------------------------------------------------------
Revenues $ 216,642 $ 205,021 5.7% $ 600,725 $ 600,297 0.1%
Research and development 62,028 70,987 (12.6)% 190,642 224,588 (15.1)%
R&D as a percent of revenues 28.6% 34.6% (6.0)% 31.7% 37.4% (5.7)%
- --------------------------------------------------------------------------------------------------------------------
Research and development ("R&D") expenditures in the three and nine months ended
Q3 2003 decreased from the three and nine months ended Q3 2002 due to closing
down of design centers, headcount reductions in existing locations and a
reduction in non-cash deferred stock compensation. To keep up with changing
business conditions and with our customer needs, we have scaled back on some of
our process and design projects and refocused our attention on fewer projects
that are critical to our success. The design center closures and headcount
reductions contributed a cost reduction of $5.8 million and $16.4 million,
respectively, for the three and nine months ended Q3 2003 compared to the three
and nine months ended Q3 2002. During the three and nine month periods ended Q3
2003, we recorded $0.9 million and $10.6 million, respectively, in non-cash
deferred stock compensation and cash compensation related to
milestone/revenue-based compensation from acquisitions as compared to $7.6
million and $36.1 million, respectively, for the three and nine months ended Q3
2002. The decrease in these acquisition-related compensation charges is
attributed to the reduction in non-cash deferred compensation amortization
(resulting from the headcount reduction) and milestones not being achieved in
the three and nine months ended Q3 2003.
We believe that our future success will depend on our ability to develop and
introduce new products that will compete effectively on the basis of price,
performance and ability to address customer needs. Our process technology
research focuses primarily on the continuous migration to smaller geometries.
During Q3 2003, we continued ramping our latest 0.13-micron technology in
manufacturing. Our transfer of 90 nanometer technology from our eight-inch R&D
facility in San Jose, California to our eight-inch manufacturing facility in
Minnesota is progressing on schedule with 27.0% improvements in 72 Megabit SRAM
yields demonstrated in Q3 2003.
Selling, General and Administrative
Three months ended Nine months ended
- ---------------------------------------------------------------------------------------------------------------------
September 28, September 29, % September 28, September 29, %
(In thousands) 2003 2002 Change 2003 2002 Change
- ---------------------------------------------------------------------------------------------------------------------
Revenues $ 216,642 $ 205,021 5.7% $ 600,725 $ 600,297 0.1%
Selling, general and administrative 33,139 48,551 (31.7)% 96,079 119,296 (19.5)%
SG&A as a percent of revenues 15.3% 23.7% (8.4)% 16.0% 19.9% (3.9)%
- ---------------------------------------------------------------------------------------------------------------------
25
Selling, general and administrative ("SG&A") expenses for the three and nine
months ended Q3 2003 decreased $15.4 million and $23.2 million, respectively,
compared to the three and nine months ended Q3 2002. In Q3 2002, we had a $14.7
million charge to increase the reserve against outstanding loans to employees
under the shareholder-approved 2001 Employee Stock Purchase Assistance Program.
The remaining reduction for both the three and nine months ended Q3 2003
compared to the three and nine months ended Q3 2002 is the result of the
restructuring and spending reduction efforts at the end of fiscal 2002 and
beginning of fiscal 2003. These efforts have led to reduced labor charges
through reduced headcount and hiring in favorable labor markets. Decreases in
general spending levels include lower commissions, advertising, conferences and
travel expenses. Legal spending in fiscal 2003 has also declined due to the
settlement of litigation with Integrated Circuit Systems, Inc. which was settled
in Q3 2002.
For the three and nine months ended Q3 2003, we recorded $0.1 million and $0.4
million, respectively, in non-cash deferred compensation from acquisitions and
cash compensation related to milestone/revenue-based compensation from
acquisitions compared to $0.9 million and $3.5 million, respectively, for the
comparable three and nine months ended Q3 2002.
Restructuring
The semiconductor industry has historically been characterized by wide
fluctuations in demand for, and supply of, semiconductors. In some cases,
industry downturns have lasted more than a year. Prior experience has shown that
restructuring of operations, resulting in significant restructuring charges, may
become necessary if an industry downturn persists. We currently have two active
restructuring plans - one initiated in the third quarter of fiscal 2001 ("Fiscal
2001 Restructuring Plan") and the other initiated in the fourth quarter of
fiscal 2002 ("Fiscal 2002 Restructuring Plan"). We recorded initial
restructuring charges in fiscal 2002 and fiscal 2001 based on assumptions that
we deemed appropriate for the economic environment that existed at the time
these estimates were made. However, due to continued changes in the
semiconductor industry and in specific business conditions, we took additional
actions and made appropriate adjustments to both the Fiscal 2001 Restructuring
Plan and the Fiscal 2002 Restructuring Plan for property, plant and equipment,
leased facilities and personnel costs.
Fiscal 2002 Restructuring Plan:
On October 17, 2002, we announced a restructuring plan that included the
resizing of our manufacturing facilities and the reduction of operating
expenses, including research and development and selling, general and
administrative. In the fourth quarter of fiscal 2002 ("Q4 2002"), we recorded a
charge of $45.4 million which consisted of $36.0 million related to equipment
removed from service and held for sale, $8.2 million for workforce reductions
for approximately 380 employees, including severance and benefits costs, and
$1.2 million for leased facilities. To date, we have disposed of equipment with
a net book value of $10.7 million. The net book value of the remaining unsold
equipment as of Q3 2003 was $20.2 million. The proceeds from the sales of the
assets approximated their carrying values. The majority of the workforce
reduction affected the United States, with some reductions in Europe and the
Philippines and sales offices that were closed in Europe and the United States.
As of the end of Q2 2003, all of these employees had left Cypress.
A restructuring charge of $3.4 million was recorded in the first quarter of
fiscal 2003 ("Q1 2003") for additional opportunities identified as part of the
personnel portion of the Fiscal 2002 Restructuring Plan. The charge relates to
the severance and related employee benefit costs for the termination of
approximately 150 additional employees, the majority of whom were located in the
United States at our facilities in San Jose, Texas and Minnesota. As of the end
of Q2 2003, all of these employees had left Cypress.
In the second quarter of fiscal 2003 ("Q2 2003"), we placed back into service
certain of these assets previously recorded as held for sale. The assets were
needed to meet increased production requirements resulting from a substantial
increase in unit demand versus our initial assumptions at the time of the
restructuring in Q4 2002. When the assets were put back into service, they were
recorded at their fair value in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS 144"), and the related impairment reserve
of $3.2 million was reversed. This resulted in an excess recovery of the
reserves initially established for these assets. This amount was not material.
A net restructuring charge of $2.5 million was recorded in Q3 2003. This charge
consisted of $2.4 million for additional opportunities identified as part of the
personnel and leased facility portion of the Fiscal 2002 Restructuring Plan, in
addition to a net $0.1 million charge for additional costs resulting from prior
quarters change in estimate. Of the $2.4 million charge for additional
opportunities identified, the personnel portion of the charge relates to
severance and related employee benefit costs for the termination of
approximately 62 additional employees, the majority of whom were located in the
United States at Cypress's facilities in San Jose, and Europe. As of the end of
Q3 2003, all of these employees had left Cypress. The net leased facility charge
of $0.8 million consists of
26
$0.9 million resulting from the cessation of use of Cypress's U.K. Design Center
facility offset by $0.1 million reversal of a Q4 2002 restructuring charge for
the U.K. Sales facility that was vacated in Q4 2002. The termination of
employees in the U.K. resulted in the need for a smaller facility and the U.K.
Sales facility was accordingly put back into use.
In Q3 2003, we placed back into service assets previously recorded as held for
sale. The assets were needed to meet increased production requirements resulting
from an increase in customer unit demand forecast, versus our initial
assumptions at the time of the restructuring in Q4 2002. When the assets were
put back into service, they were recorded at their fair value in accordance with
SFAS No. 144.
In the fourth quarter of fiscal 2003 ("Q4 2003"), we are planning a bid sale of
the remaining equipment held for sale under the Fiscal 2002 Restructuring Plan,
and expects to have final disposition of the remaining equipment by the end of
Q4 2003.
The following table summarizes the activity associated with the restructuring
liabilities and asset write-downs since the inception of the Fiscal 2002
Restructuring Plan:
- -----------------------------------------------------------------------------------------------------------------
Property, plant Leased
(In thousands) & equipment Facilities Personnel Total
- -----------------------------------------------------------------------------------------------------------------
Q4 2002 Provision $ 35,959 $ 1,211 $ 8,188 $ 45,358
Non-cash charges (39) -- (40) (79)
Cash charges (50) (524) (5,276) (5,850)
- -----------------------------------------------------------------------------------------------------------------
Balance at December 29, 2002 35,870 687 2,872 39,429
Q1 2003 Provision -- -- 3,360 3,360
Non-cash charges (2,413) -- -- (2,413)
Cash charges (98) (2) (2,263) (2,363)
- -----------------------------------------------------------------------------------------------------------------
Balance at March 30, 2003 33,359 685 3,969 38,013
Non-cash charges (3,161) -- -- (3,161)
Cash charges (225) (51) (3,224) (3,500)
Other adjustments (3,191) -- -- (3,191)
- -----------------------------------------------------------------------------------------------------------------
Balance at June 29, 2003 26,782 634 745 28,161
Q3 2003 Provision -- 788 1,752 2,540
Non-cash charges (2,740) 113 -- (2,627)
Cash charges (137) (123) (688) (948)
Other adjustments (4,138) -- -- (4,138)
- -----------------------------------------------------------------------------------------------------------------
Balance at September 28, 2003 $ 19,767 $ 1,412 $ 1,809 $ 22,988
- -----------------------------------------------------------------------------------------------------------------
Fiscal 2001 Restructuring Plan:
On July 16, 2001, we announced a restructuring plan that involved resizing our
manufacturing facilities, reducing our workforce and combining facilities. The
restructuring was precipitated by the worldwide economic slowdown, particularly
in the business areas in which we operate. The intended effect of the plan was
to size the manufacturing operations and facilities to meet future demand and
reduce expenses in all operations areas. During the third quarter of fiscal 2001
("Q3 2001"), we recorded restructuring charges of $132.1 million related to
property, plant and equipment, leased facilities and personnel.
In connection with the July 16, 2001 announcement, in Q3 2001, we removed from
service and held for sale equipment with a net book value of $116.9 million,
resulting in a charge of $113.4 million. We have actively marketed the
equipment. Through Q3 2003, we have disposed of equipment with a net book value
of $67.5 million. The proceeds from the sales of the assets generally
approximated their carrying values. In the second quarter of fiscal 2002 ("Q2
2002") and Q3 2002, we placed back into service certain of these assets
previously recorded as held for sale. The assets were needed to meet increased
production requirements resulting from a substantial increase in unit demand
versus our initial assumptions at the time of the restructuring in Q3 2001. When
the assets were put back into service, they were written up to their prior cost
basis (an adjustment of $13.2 million and $9.6 million in Q2 2002 and Q3 2002,
respectively), reduced for depreciation expense that would have been recorded
during the period the asset was removed from service (an adjustment of $2.9
million and $2.6 million in Q2 2002 and Q3 2002, respectively), as required by
SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of" ("SFAS 121"). The net effect of the
restructuring adjustment was a credit to the Restructuring line on the condensed
consolidated statement of operations of $10.3 million and $7.0
27
million in Q2 2002 and Q3 2002, respectively. In the first quarter of fiscal
2002 ("Q1 2002"), we also sold and then leased back certain other pieces of
equipment classified as held for sale. The proceeds from the sales of the assets
approximated their net carrying values.
In Q1 2002, we recorded an additional charge of $1.6 million for additional cost
reductions identified as part of the personnel portion of the Fiscal 2001
Restructuring Plan. The charge related to severance and related employee benefit
costs for the termination of employees, the majority of whom were located in the
Philippines facility.
In Q3 2002, as a result of the continued drive to lower our cost structure and
break-even sales, we further expanded the scope of the restructuring and
recorded net restructuring costs of $2.4 million, which was comprised of a
charge of $9.4 million offset by a $7.0 million reversal for previously
written-down equipment put back into service discussed above. The charge of $9.4
million consisted of $3.3 million for work force reductions, and included
severance, benefit costs and stock compensation, $3.4 million for capital
equipment removed from service and held for sale and $2.7 million for the
exiting of facility leases.
In Q4 2002, we recorded a credit of $0.7 million related to the revised estimate
of personnel costs. All the personnel related charges and actions we took in Q3
2001, Q1 2002 and Q3 2002 resulted in the termination of approximately 890
employees, all of whom had left Cypress as of the end of Q2 2003.
In Q3 2003, we held a bid sale on the remaining equipment held for sale under
the Fiscal 2001 Restructuring Plan. As a result, an $8.1 million credit was
recorded associated with the release of prior reserves. At the end of Q3 2003,
all but one piece of equipment with a carrying value of $0.5 million remained
unsold. We expect to dispose of this equipment in the fourth quarter of fiscal
2003 ("Q4 2003"). The remaining reserve balance at the end of Q3 2003 of $16.0
million will be settled in Q4 2003 with the disposition of the related equipment
with no impact to the condensed consolidated statement of operations.
The following table summarizes the activity associated with the restructuring
liabilities and asset write-downs since the inception of the Fiscal 2001
Restructuring Plan:
28
- ----------------------------------------------------------------------------------------------------------------
Property, plant Leased
(In thousands) & equipment Facilities Personnel Total
- ----------------------------------------------------------------------------------------------------------------
Initial provision in September 30, 2001 $ 113,350 $ 4,079 $ 14,684 $ 132,113
Non-cash charges (5,145) -- (8,970) (14,115)
Cash charges (380) (53) (3,836) (4,269)
- ----------------------------------------------------------------------------------------------------------------
Balance at September 30, 2001 107,825 4,026 1,878 113,729
Non-cash charges (2,124) -- (86) (2,210)
Cash charges (1,239) (160) (407) (1,806)
- ----------------------------------------------------------------------------------------------------------------
Balance at December 30, 2001 104,462 3,866 1,385 109,713
Provision -- -- 1,595 1,595
Non-cash charges (5,096) -- -- (5,096)
Cash charges (147) (375) (1,581) (2,103)
- ----------------------------------------------------------------------------------------------------------------
Balance at March 31, 2002 99,219 3,491 1,399 104,109
Cash charges (151) (503) (553) (1,207)
Other adjustments (13,217) -- -- (13,217)
- ----------------------------------------------------------------------------------------------------------------
Balance at June 30, 2002 85,851 2,988 846 89,685
Provision 3,378 2,761 3,251 9,390
Non-cash charges (12,316) -- (924) (13,240)
Cash charges (484) (502) (1,039) (2,025)
Other adjustments (9,545) -- -- (9,545)
- ----------------------------------------------------------------------------------------------------------------
Balance at September 29, 2002 66,884 5,247 2,134 74,265
Provision -- -- (701) (701)
Non-cash charges (12,786) -- -- (12,786)
Cash charges (419) (582) (799) (1,800)
- ----------------------------------------------------------------------------------------------------------------
Balance at December 29, 2002 53,679 4,665 634 58,978
Non-cash charges (16,046) -- -- (16,046)
Cash charges (862) (674) (540) (2,076)
- ----------------------------------------------------------------------------------------------------------------
Balance at March 30, 2003 36,771 3,991 94 40,856
Non-cash charges (1,206) -- -- (1,206)
Cash charges (471) (739) (115) (1,325)
Other adjustments (64) -- 21 (43)
- ----------------------------------------------------------------------------------------------------------------
Balance at June 29, 2003 35,030 3,252 -- 38,282
Provision (8,063) -- -- (8,063)
Non-cash charges (10,915) -- -- (10,915)
Cash charges (74) (520) -- (594)
- ----------------------------------------------------------------------------------------------------------------
Balance at September 28, 2003 $ 15,978 $ 2,732 $ -- $ 18,710
- ----------------------------------------------------------------------------------------------------------------
Acquisition-related Costs
Acquisition costs consist primarily of the amortization of acquired intangible
assets and expensed in-process research and development charges. Amortization of
intangible assets was $9.4 million and $28.3 million for the three and nine
months ended Q3 2003, respectively, compared to $10.7 million and $32.1 million
for the three and nine months ended Q3 2002, respectively. Amortization costs
were lower for both periods due to impairment write-offs which lowered the
balance needed to be amortized.
29
Interest Income, Interest Expense and Other Income and (Expense), Net
Three months ended Nine months ended
- ---------------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------------
Interest income $ 2,930 $ 3,339 $ 11,255 $ 15,699
Interest expense (3,249) (4,886) (13,055) (14,515)
Other income and (expense), net 12,251 (14,749) 8,170 (13,573)
- ---------------------------------------------------------------------------------------------------------------------------------
Interest and other income and (expense), net $ 11,932 $ (16,296) $ 6,370 $ (12,389)
- ---------------------------------------------------------------------------------------------------------------------------------
Interest income decreased by $0.4 million or 12.2% in the three months ended Q3
2003 versus the three months ended Q3 2002 due to lower cash and investment
balances and lower investment yields. For the nine months ended Q3 2003 versus
the nine months ending Q3 2002, interest income decreased by $4.4 million.
Approximately $2.0 million of this decrease was due to a duty refund that we
received from the United States Custom Service during fiscal 2002. The remaining
decrease is due primarily to lower investment yields.
Interest expense decreased by $1.6 million in Q3 2003 to $3.2 million versus Q3
2002 primarily due to the full redemption of our 4.0% convertible subordinated
notes on July 8, 2003 and the partial redemption of our 3.75% convertible
subordinated notes on July 1, 2003. Interest expense is primarily associated
with our 4.0%, 3.75% and 1.25% convertible subordinated notes issued in January
2000, June 2000 and June 2003, respectively.
Other income and (expense), net was $12.3 million and $8.2 million,
respectively, for the three and nine months ended Q3 2003 compared to $(14.7)
million and $(13.6) million, respectively, for the three and nine months ended
Q3 2002. Below is a summary of the major components:
Three months ended Nine months ended
- -----------------------------------------------------------------------------------------------------------------------------
September 28, September 29, September 28, September 29,
(In thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------
Amortization of bond issuance costs $ (1,016) $ (687) $ (2,667) $ (2,144)
Gain (loss) on repurchase of bonds (6,277) -- (7,524) 5,946
Gain on sale of investment in NVE Corporation 17,126 -- 17,126 --
Investment impairment charges 750 (14,108) (262) (16,209)
Foreign exchange gain (loss) 2,003 262 1,108 (1,012)
Minority interest -- -- 1,045 --
Other (335) (216) (656) (154)
- -----------------------------------------------------------------------------------------------------------------------------
Other income and (expense), net $ 12,251 $ (14,749) $ 8,170 $(13,573)
- -----------------------------------------------------------------------------------------------------------------------------
Income Taxes
Our effective rates of income tax expense for Q3 2003 and Q3 2002 were 4.0% and
0.2%, respectively. For the nine months ended Q3 2003 and Q3 2002, our effective
rates of income tax expense were 9.3% and 0.7%, respectively. A tax provision of
$0.7 million was recorded during Q3 2003 compared to a tax provision of $0.1
million during Q3 2002. The tax provision for each fiscal year is attributable
to foreign withholding tax on royalty income and income earned in certain
countries that is not offset by current year net operating losses in other
countries. The future tax benefit of certain losses is not currently recognized
due to our assessment of the likelihood of realization of these benefits. Our
effective tax rate may vary from the U.S. statutory rate primarily due to
utilization of future benefits, the earnings of foreign subsidiaries taxed at
different rates, tax credits and other business factors.
30
Liquidity and Capital Resources
- -----------------------------------------------------------------------------------------
September 28, December 29,
(In thousands) 2003 2002
- -----------------------------------------------------------------------------------------
Cash, cash equivalents and short-term investments $ 205,077 $ 127,937
Long-term marketable securities 51,417 16,574
Restricted cash 62,821 62,380
Long-term debt (excluding current portion) 685,768 469,875
- -----------------------------------------------------------------------------------------
Key Components of Cash Flow
Our cash, cash equivalents and short-term investments totaled $205.1 million at
the end of Q3 2003, a $77.1 million increase from the end of Q4 2002 and a
$102.1 million increase from the end of Q3 2002. The increase over both periods
is primarily due to financing activities in the nine months ended Q3 2003.
Cash generated from operations was $58.3 million in the nine months ended Q3
2003 compared to a use of $8.4 million in the nine months ended Q3 2002. Lower
operating losses and working capital requirements contributed $94.4 million and
$18.3 million, respectively. These contributions were partially offset by $46.1
million relating to changes in non-cash items.
Investment activities used cash of $48.7 million in the nine months ended Q3
2003 compared to a use of cash of $17.2 million in the nine months ended Q3
2002. We were a net purchaser versus seller of available-for-sale investments,
which accounted for an additional $139.7 million of cash utilization. This was
partially offset by lower capital expenditures of $74.5 million, and an increase
in cash generated from investments of $45.3 million. This increase in cash from
investments was primarily due to the sale of our NVE Corporation ("NVE")
investment for $23.4 million in Q3 2003.
Financing activities generated $75.7 million in the nine months ended Q3 2003
compared to a use of cash of $23.3 million in the nine months ended Q3 2002.
This change was primarily driven by new convertible debt proceeds net of
issuance cost of $581.6 million, offset by repayment of existing convertible
debt of $404.3 million, and the purchase of a call spread option of $49.3
million. See Note 7 to the condensed consolidated financial statements for a
detailed discussion related to changes in our convertible debt.
Liquidity
Based on our current plan, we expect to generate positive cash flow from
operations in the fiscal years ending December 2003 and 2004. Our expected
significant investment and financing cash outlays for the fiscal years ending
December 2003 and 2004 include capital expenditures for investment in our
product development and technology initiatives and investments in SunPower. The
Board of Directors has approved programs authorizing the repurchase of our
common stock and convertible subordinated notes (the "Subordinated Notes") in
the open market or in privately negotiated transactions at anytime. However, the
timing and actual number of shares or principal amount to be repurchased is
limited to $15.0 million, is at the discretion of management and is contingent
on numerous factors including cash flow.
In September 2003, we entered into a $50.0 million twenty-four month revolving
line of credit with Silicon Valley Bank. As of the end of Q3 2003, there was no
amount outstanding under the line of credit. Loans made under the line of credit
bear interest based upon the Wall Street Journal Prime Rate or LIBOR plus 175
basis points at our election. The line of credit agreement includes a variety of
covenants binding on Cypress and its subsidiaries, including restrictions in the
incurrence of indebtedness, incurrence of loans, and transfers of assets and
financial covenants with respects to tangible net worth and a quick ratio. Our
obligations under the line of credit are guaranteed and secured by the stock of
certain of its subsidiaries. We intend to use the line of credit on an as needed
basis to fund working capital and capital expenditures including our obligations
under the SunPower agreements.
In September 2003, we sold our investment in NVE common stock for $23.4 million,
resulting in a gain of $17.1 million. At the end of Q3 2003, we continued to
hold a warrant to purchase 0.4 million shares of common stock of NVE with an
aggregate exercise price of $6.0 million.
We have $668.7 million of aggregate principal amount in subordinated notes that
are due in July 2005 and June 2008 in the amount of $68.7 million and $600.0
million, respectively. Through the end of Q3 2003, we had repurchased all of our
outstanding 4.0% convertible notes and all but $68.7 million of our 3.75%
convertible notes, totaling $400.3 million principal repurchases. In June 2003,
we issued $600.0 million principle 1.25% subordinated
31
convertible notes. The remaining subordinated notes are subject to compliance
with certain covenants that do not contain financial ratios. As of Q3 2003, we
were in compliance with these covenants. If we failed to be in compliance with
these covenants beyond any applicable grace period, the trustee of the
subordinated notes, or the holders of a specific percentage thereof, would have
the ability to demand immediate payment of all amounts outstanding.
In Q2 2003, we entered into a five year new master synthetic operating lease
agreement, to replace two then existing synthetic operating lease agreements,
for manufacturing and office facilities with one lessor. This lease requires us
to purchase the property or to arrange for the property to be acquired by a
third party at lease expiration. If we had exercised our right to purchase all
the properties subject to this lease at the end of Q3 2003, we would have been
required to make a payment and record assets totaling $62.7 million. We are
required to maintain restricted cash or investments to serve as collateral for
this lease. As of the end of Q3 2003, the amount of restricted cash recorded was
$62.8 million, which was classified as a non-current asset in our condensed
consolidated balance sheet.
At June 29, 2003, we had an outstanding note with Sumitomo Bank Japan. The
principal amount including accrued interest was $3.9 million (denominated in
Yen). This amount was paid on June 30, 2003. As of Q3 2003, the maximum
potential exposure to residual value guarantees related to the synthetic
operating lease agreement was approximately $54.5 million and we do not expect
to have a loss on such guarantees.
As of the end of Q3 2003, we had loaned SunPower $2.4 million for operating cash
flow needs, which loans bear interest at the applicable federal rates. In
October 2003, our Board of Directors authorized the exercise of a convertible
preferred stock warrant ("Preferred Stock Warrant"), issued by SunPower to us,
as a result of SunPower meeting certain product efficiency, quality deliverables
and marketability requirements. The Preferred Stock Warrant is exercisable for
cash of $16.0 million. Upon the exercise of the Preferred Stock Warrant, the
cumulative amount loaned for operating cash flow needs would be due within one
year.
The exercise of the Preferred Stock Warrant, by us, gives rise to a $16.0
million put and call option, exercisable for 30 days from the date of the
exercise of the Preferred Stock Warrant. Under the put option, SunPower
shareholders would be entitled to sell up to 6.4 million shares of common stock
of SunPower to us at $2.50 per share. Under the call option, we would be
entitled to purchase the same 6.4 million shares of common stock from SunPower
shareholders at $2.50 per share. Settlement of both the put and call options
would be in our common stock.
At the end of Q3 2003, we had an outstanding loan of $2.5 million to SunPower in
connection with the facilitation of a fabrication facility. The loan bears
interest at 7% and SunPower is repaying the loan monthly through fiscal 2008.
At the end of Q3 2003, we were in the process of negotiating final terms on an
additional $30.0 million loan facility to SunPower. We will became obligated to
provide this loan facility upon exercise of the Preferred Stock Warrant
discussed above. We had advanced a total of $15.5 million against this loan
facility as at the end of Q3 2003. Subsequent to Q3 2003, we advanced an
additional $7.6 million against the $30.0 million loan facility. As part of the
terms of the loan facility, we will be granted a warrant to purchase
approximately 4.3 million shares of SunPower common stock at a price of $0.07
per share.
As disclosed in Note 7, we entered into long-term loan agreements with two
lenders with an aggregate principal equal to $24.8 million in Q1 2003. These
agreements are collateralized by specific equipment located at our U.S.
manufacturing facilities. Principal amounts are to be repaid with monthly
installments inclusive of accrued interest, over a 3 to 4 year period. The
applicable interest rates are variable based on changes to LIBOR rates. Both
loans are subject to financial and non-financial covenants and we were in
compliance with these covenants as of Q3 2003. As of Q3 2003, the total
remaining principal amount was $21.9 million.
We currently plan for approximately $90.0 million in expenditures on equipment
in fiscal 2003 and anticipate significant continuing capital expenditures in
subsequent years.
Capital Resources and Financial Condition
As of the end of Q3 2003, we had cash, cash equivalents and investments totaling
$205.1 million. We also had an additional $62.8 million of restricted cash held
as collateral for real estate synthetic leases.
We believe that liquidity provided by existing cash, cash equivalents,
investments, our borrowing arrangements described above and cash generated from
operations, will provide sufficient capital to meet our requirements for at
least the next twelve months. However, should prevailing economic conditions
and/or financial, business and other factors beyond our control adversely affect
our estimates of our future cash requirements (including our debt
32
obligations), we would be required to fund our cash requirements by alternative
financing. There can be no assurance that additional financing, if needed, would
be available on terms acceptable to us or at all.
We may choose at any time to raise additional capital to strengthen our
financial position, facilitate growth, refinance and/or restructure our debt and
provide us with additional flexibility to take advantage of business
opportunities that arise.
Recent Accounting Pronouncements
Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), was issued in January
2003. FIN 46 requires that if an entity is the primary beneficiary of a variable
interest entity, the assets, liabilities and results of operations of the
variable interest entity should be included in the condensed consolidated
financial statements of the entity. The provisions of FIN 46 are effective
immediately for all arrangements entered into after January 31, 2003. We have
not invested in any variable interest entities after January 31, 2003. For those
arrangements entered into prior to January 31, 2003, the FASB recently delayed
the required implementation date such that the provisions of FIN 46 are required
to be adopted at the beginning of the first interim or annual period beginning
after December 15, 2003. On June 27, 2003, we entered into a new operating lease
to refinance our then existing operating leases with respect to certain
manufacturing and other facilities located in Minnesota and California (see Note
6). We refinanced these leases in a manner that best met our financing strategy.
The new operating lease is not subject to the consolidation provisions of FIN
46. We do not expect the final approval of FIN 46 by the FASB relating to
variable interest entities created prior to January 31, 2003 to impact the
condensed consolidated financial statements as the issues currently under
discussion do not impact us.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities" ("SFAS 149"). SFAS 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). The new guidance amends SFAS 133 for decisions made: (a) as part of the
Derivatives Implementation Group process that effectively required amendments to
SFAS 133; (b) in connection with other FASB projects dealing with financial
instruments; and (c) regarding implementation issues raised in relation to the
application of the definition of a derivative, particularly regarding the
meaning of "underlying" and the characteristics of a derivative that contains
financing components. The amendments set forth in SFAS 149 improve financial
reporting by requiring that contracts with comparable characteristics be
accounted for similarly. SFAS 149 is generally effective for contracts entered
into or modified after June 30, 2003 (with a few exceptions) and for hedging
relationships designated after June 30, 2003. The adoption of SFAS 149 had no
impact on our condensed consolidated financial statements. We are applying the
provisions of SFAS 149 prospectively to transactions entered into and or
modified after June 30, 2003.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS 150").
SFAS 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in certain circumstances). Many of these instruments
were previously classified as equity. Although some of the provisions of this
statement are consistent with the current definition of liabilities in FASB
Concepts Statement No. 6, "Elements of Financial Statements", the remainder are
consistent with FASB's intention to revise that definition to encompass certain
obligations that a reporting entity can or must settle by issuing its own
shares. This statement 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. There was no impact to the
condensed consolidated financial statements related to SFAS 150 for the nine
months ended Q3 2003.
Risk Factors
The discussion in this report contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities Exchange Act of 1934 that involve risks and uncertainties, including,
but not limited to, statements as to future operating results and business
plans, our prospects and the prospects of the semiconductor industry generally,
the impact of new product development and improvements in manufacturing
technologies and yields on variances, pressure on and trends for average selling
prices, our intention to seek intellectual property protection for our
manufacturing processes, expected capital expenditures, future acquisitions, the
financing of SunPower Corporation, the repayment of loans by SunPower, or the
intention to
33
exercise the SunPower preferred stock warrant, the dependence of future success
on our ability to develop and introduce new products, the general economy and
its impact to the market segments we serve, changing environment and the cycles
of the semiconductor industry, competitive pricing and the rate at which new
products are introduced, successful integration and achieving the objectives of
the acquired businesses, cost goals emanating from manufacturing efficiencies,
expected financing and investment cash outlays, adequacy of cash and working
capital, when we expect to generate positive cash flow from operations, the
expected disposition of equipment and the settlement of reserves, expected
proceeds if properties subject to synthetic lease were sold, our expected use of
our line of credit, our intention with respect to payment of the $300.00 payable
on conversion of our 1.25% Notes, risks related to investing in development
stage companies, and other liquidity risks. We use words such as "anticipates,"
"believes," "expects," "future," "intends" and similar expressions to identify
forward-looking statements. Our actual results could differ materially from
those projected in the forward-looking statements for any reason, including the
factors set forth in "Risk Factors" below and elsewhere in this report.
We are exposed to the risks associated with the slowdown in the U.S. and
worldwide economy.
Among other factors, concerns about inflation, decreased consumer confidence and
spending and reduced corporate profits and capital spending have resulted in a
downturn in the U.S. economy generally and in the semiconductor industry in
particular. As a result of the downturn, our volumes initially declined and were
followed by significant reductions in our average selling prices. We expect
continued pressure on average selling prices in the future. As a consequence of
the continued economic downturn in fiscal 2002, during Q4 2002, we announced a
restructuring plan that resized our manufacturing facilities, reduced our
workforce and combined facilities. In Q1 2003, we took an additional charge for
personnel related to the Fiscal 2002 Restructuring Plan. In fiscal 2002, we
recorded a charge for the impairment of goodwill and intangibles related to
Silicon Light Machines as well as the impairment of certain other investments in
development stage companies. If the adverse economic conditions continue or
worsen, additional restructuring of operations may be required, and our
business, financial condition and results of operations may be seriously harmed.
We face periods of industry-wide semiconductor over-supply that harm our
results.
The semiconductor industry has historically been characterized by wide
fluctuations in the demand for, and supply of, semiconductors. These
fluctuations have helped produce many occasions when supply and demand for
semiconductors have not been in balance. In the past, these industry-wide
fluctuations in demand, which have resulted in under-utilization of our
manufacturing capacity, have seriously harmed our operating results. In some
cases, industry downturns with these characteristics have lasted more than a
year. Prior experience has shown that restructuring of the operations, resulting
in significant restructuring charges, may become necessary if an industry
downturn persists. In response to the current significant downturn, we
restructured our manufacturing operations and administrative areas in Q3 2001
and Q4 2002 to increase cost efficiency while still maintaining an
infrastructure that will enable us to grow when sustainable economic recovery
begins. When these cycles occur, however, they will likely seriously harm our
business, financial condition and results of operations and we may need to take
further action to respond to them.
Our future operating results are likely to fluctuate and therefore may fail to
meet expectations.
Our operating results have varied widely in the past and may continue to
fluctuate in the future. In addition, our operating results may not follow any
past trends. Our future operating results will depend on many factors and may
fluctuate and fail to meet our expectations or those of others for a variety of
reasons, including the following:
o the intense competitive pricing pressure to which our products are
subject, which can lead to rapid and unexpected declines in average
selling prices;
o the complexity of our manufacturing processes and the sensitivity of
our production costs to declines in manufacturing yields, which make
yield problems both possible and costly when they occur; and
o the need for constant, rapid, new product introductions which present
an ongoing design and manufacturing challenge, which can be
significantly impacted by even relatively minor errors, and which may
result in products never achieving expected market demand.
As a result of these or other factors, we could fail to achieve our expectations
as to future revenues, gross profit and income from operations. Any downward
fluctuation or failure to meet expectations will likely adversely affect the
value of your investment in Cypress.
34
In addition, because we recognize revenues from sales to certain distributors
only when these distributors make a sale to customers, we are highly dependent
on the accuracy of their resale estimates. The occurrence of inaccurate
estimates also contributes to the difficulty in predicting our quarterly revenue
and results of operations and we can fail to meet expectations if we are not
accurate in our estimates.
Our financial results could be seriously harmed if the markets in which we sell
our products do not grow.
Our continued success depends in large part on the continued growth of various
electronics industries that use our semiconductors, including the following
industries:
o networking equipment;
o wireless telecommunications equipment;
o computers and computer-related peripherals; and
o consumer electronics, automotive electronics and industrial controls.
Many of our products are incorporated into data communications and
telecommunications end products. Any reduction in the growth of, or decline in
the demand for, networking applications, mass storage, telecommunications,
cellular base stations, cellular handsets and other personal communication
devices that incorporate our products could seriously harm our business,
financial condition and results of operations. In addition, certain of our
products, including USB microcontrollers and high-frequency clocks, are
incorporated into computer and computer-related products, which have
historically and may in the future experience significant fluctuations in
demand. We may also be seriously harmed by slower growth in the other markets in
which we sell our products.
We are affected by a general pattern of product price decline and fluctuations,
which can harm our business.
Even in the absence of an industry downturn, the average selling prices of our
products have historically decreased during the products' lives and we expect
this trend to continue. In order to offset selling price decreases, we attempt
to decrease the manufacturing costs of our products and to introduce new, higher
priced products that incorporate advanced features. If these efforts are not
successful or do not occur in a timely manner, or if our newly introduced
products do not gain market acceptance, our business, financial condition and
results of operations could be seriously harmed.
In addition to following the general pattern of decreasing average selling
prices, the selling prices for certain products, particularly commodity
products, fluctuate significantly with real and perceived changes in the balance
of supply and demand for these products. In the event we are unable to decrease
per unit manufacturing costs at a rate equal to or faster than the rate at which
selling prices continue to decline, our business, financial condition and
results of operations will be seriously harmed. Furthermore, we expect our
competitors to invest in new manufacturing capacity and achieve significant
manufacturing yield improvements in the future. These developments could
dramatically increase the worldwide supply of competitive products and result in
further downward pressure on prices.
We may be unable to protect our intellectual property rights adequately and may
face significant expenses as a result of ongoing or future litigation.
Protection of our intellectual property rights is essential to keep others from
copying the innovations that are central to our existing and future products.
Consequently, we may become involved in litigation to enforce our patents or
other intellectual property rights, to protect our trade secrets and know-how,
to determine the validity or scope of the proprietary rights of others or to
defend against claims of invalidity. This type of litigation can be expensive,
regardless of whether we win or lose.
We are now and may again become involved in litigation relating to alleged
infringement by us of others' patents or other intellectual property rights.
This type of litigation is frequently expensive to both the winning party and
the losing party and could take up significant amounts of management's time and
attention. In addition, if we lose such a lawsuit, a court could require us to
pay substantial damages and/or royalties or prohibit us from using essential
technologies. For these and other reasons, this type of litigation could
seriously harm our business, financial condition and results of operations.
Also, although in certain instances we may seek to obtain a license under a
third party's intellectual property rights in order to bring an end to certain
claims or actions asserted against us, we may not be able to obtain such a
license on reasonable terms or at all.
35
For a variety of reasons, we have entered into technology license agreements
with third parties that give those parties the right to use patents and other
technology developed by us and that gives us the right to use patents and other
technology developed by them. We anticipate that we will continue to enter into
these kinds of licensing arrangements in the future. It is possible however,
that licenses we want will not be available to us on commercially reasonable
terms or at all. If we lose existing licenses to key technology, or are unable
to enter into new licenses that we deem important, our business, financial
condition and results of operations could be seriously harmed.
It is critical to our success that we are able to prevent competitors from
copying our innovations. We, therefore, intend to continue to seek patent, trade
secret and mask work protection for our semiconductor manufacturing
technologies. The process of seeking patent protection can be long and expensive
and we cannot be certain that any currently pending or future applications will
actually result in issued patents, or that, even if patents are issued, they
will be of sufficient scope or strength to provide meaningful protection or any
commercial advantage to us. Furthermore, others may develop technologies that
are similar or superior to our technology or design around the patents we own.
We also rely on trade secret protection for our technology, in part through
confidentiality agreements with our employees, consultants and third parties.
However, these parties may breach these agreements and we may not have adequate
remedies for any breach. Also, others may come to know about or determine our
trade secrets through a variety of methods. In addition, the laws of certain
countries in which we develop, manufacture or sell our products may not protect
our intellectual property rights to the same extent as the laws of the United
States.
Our financial results could be adversely impacted if we fail to develop,
introduce and sell new products or fail to develop and implement new
manufacturing technologies.
Like many semiconductor companies, which frequently operate in a highly
competitive, quickly changing environment marked by rapid obsolescence of
existing products, our future success depends on our ability to develop and
introduce new products that customers choose to buy. We introduce significant
numbers of products each year, which are an important source of revenue for us.
If we fail to introduce new product designs in a timely manner or are unable to
manufacture products according to the requirements of these designs, or if our
customers do not successfully introduce new systems or products incorporating
ours or market demand for our new products does not exist as anticipated, our
business, financial condition and results of operations could be seriously
harmed.
For us and many other semiconductor companies, introduction of new products is a
major manufacturing challenge. The new products the market requires tend to be
increasingly complex, incorporating more functions and operating at faster
speeds than prior products. Increasing complexity generally requires smaller
features on a chip. This makes manufacturing new generations of products
substantially more difficult than prior generations. Ultimately, whether we can
successfully introduce these and other new products depends on our ability to
develop and implement new ways of manufacturing semiconductors. If we are unable
to design, develop, manufacture, market and sell new products successfully, our
business, financial condition and results of operations would be seriously
harmed.
Our ability to meet our cash requirements depends on a number of factors, many
of which are beyond our control.
Our ability to meet our cash requirements (including our debt service
obligations) is dependent upon our future performance, which will be subject to
financial, business and other factors affecting our operations, many of which
are beyond our control. We cannot assure that our business will generate
sufficient cash flows from operations to fund our cash requirements. If we were
unable to meet our cash requirements from operations, we would be required to
fund these cash requirements by alternative financing. The degree to which we
may be leveraged could materially and adversely affect our ability to obtain
financing for working capital, acquisitions or other purposes, could make us
more vulnerable to industry downturns and competitive pressures or could limit
our flexibility in planning for, or reacting to, changes and opportunities in
our industry, which may place us at a competitive disadvantage compared to our
competitors. There can be no assurance that we will be able to obtain
alternative financing, that any such financing would be on acceptable terms or
that we will be permitted to do so under the terms of our existing financing
arrangements. In the absence of such financing, our ability to respond to
changing business and economic conditions, make future acquisitions, react to
adverse operating results, meet our debt service obligations or fund required
capital expenditures or increased working capital requirements may be adversely
affected.
36
Interruptions in the availability of raw materials can seriously harm our
financial performance.
Our semiconductor manufacturing operations require raw materials that must meet
exacting standards. We generally have more than one source available for these
materials, but for certain of our products there are only a limited number of
suppliers capable of delivering the raw materials that meet our standards. If we
need to use other companies as suppliers, they must go through a qualification
process, which can be difficult and lengthy. In addition, for certain of our
products the raw materials we need for our business could become more scarce as
worldwide demand for semiconductors increases. Interruption of our sources of
raw materials could seriously harm our business, financial condition and results
of operations.
Problems in the performance of other companies we hire to perform certain
manufacturing tasks can seriously harm our financial performance.
A high percentage of our products are assembled, packaged and tested at our
manufacturing facility located in the Philippines. We rely on independent
subcontractors to assemble, package and test the balance of our products. This
reliance involves certain risks, because we have less control over manufacturing
quality and delivery schedules, whether these companies have adequate capacity
to meet our needs and whether or not they discontinue or phase-out assembly
processes we require. We cannot be certain that these subcontractors will
continue to assemble, package and test products for us and it might be difficult
for us to find alternatives if they do not do so.
The complex nature of our manufacturing activities makes us highly susceptible
to manufacturing problems and these problems can have substantial negative
impact on us when they occur.
Making semiconductors is a highly complex and precise process, requiring
production in a tightly controlled, clean environment. Even very small
impurities in our manufacturing materials, difficulties in the wafer fabrication
process, defects in the masks used to print circuits on a wafer or other factors
can cause a substantial percentage of wafers to be rejected or numerous chips on
each wafer to be nonfunctional. We may experience problems in achieving an
acceptable success rate in the manufacture of wafers and the likelihood of
facing such difficulties is higher in connection with the transition to new
manufacturing methods. The interruption of wafer fabrication or the failure to
achieve acceptable manufacturing yields at any of our facilities would seriously
harm our business, financial condition and results of operations. We may also
experience manufacturing problems in our assembly and test operations and in the
introduction of new packaging materials.
We may not be able to use all of our existing or future manufacturing capacity,
which can negatively impact our business.
We have in the past spent, and will continue to spend, significant amounts of
money to upgrade and increase our wafer fabrication, assembly and test
manufacturing capability and capacity. If we do not need some of this capacity
and capability for any of a variety of reasons, including inadequate demand or a
significant shift in the mix of product orders that makes our existing capacity
and capability inadequate or in excess of our actual needs, our fixed costs per
semiconductor produced will increase, which will harm our business, financial
condition and results of operations. In addition, if the need for more advanced
products requires accelerated conversion to technologies capable of
manufacturing semiconductors having smaller features or requires the use of
larger wafers, we are likely to face higher operating expenses and may need to
write-off capital equipment made obsolete by the technology conversion, either
of which could seriously harm our business, financial condition and results of
operations. For example, in response to various downturns and changes in our
business, we have not been able to use all of our existing equipment and we have
restructured our operations. These restructurings have resulted in material
charges, which have negatively affected our business. If the downturn continues,
we could incur additional restructuring charges, which could further negatively
affect our business.
Our operations and financial results could be severely harmed by certain natural
disasters.
Our headquarters, some manufacturing facilities and some of our major vendors'
facilities are located near major earthquake faults. We have not been able to
maintain earthquake insurance coverage at reasonable costs. Instead, we rely on
self-insurance and preventative/safety measures. If a major earthquake or other
natural disaster occurs, we may need to spend significant amounts to repair or
replace our facilities and equipment and we could suffer damages that could
seriously harm our business, financial condition and results of operations.
37
Our business, financial condition and results of operations will be seriously
harmed if we fail to compete successfully in our highly competitive industry and
markets.
The semiconductor industry is intensely competitive. This intense competition
results in a difficult operating environment for us and most other semiconductor
companies that is marked by erosion of average selling prices over the lives of
each product, rapid technological change, limited product life cycles and strong
domestic and foreign competition in many markets. A primary cause of this highly
competitive environment is the strength of our competitors. The industry
consists of major domestic and international semiconductor companies, many of
which have substantially greater financial, technical, marketing, distribution
and other resources than we do. We face competition from other domestic and
foreign high-performance integrated circuit manufacturers, many of which have
advanced technological capabilities and have increased their participation in
markets that are important to us.
Our ability to compete successfully in the rapidly evolving high performance
portion of the semiconductor technology industry depends on many factors,
including:
o our success in developing new products and manufacturing technologies;
o the quality and price of our products;
o the diversity of our product line;
o the cost effectiveness of our design, development, manufacturing and
marketing efforts;
o our customer service;
o our customer satisfaction;
o the pace at which customers incorporate our products into their systems;
o the number and nature of our competitors and general economic conditions;
and
o our access to and the availability of capital.
Although we believe we currently compete effectively in the above areas to the
extent they are within our control, given the pace of change in the industry,
our current abilities are not a guarantee of future success. If we are unable to
compete successfully in this environment, our business, financial condition and
results of operations will be seriously harmed.
We must build semiconductors based on our forecasts of demand, and if our
forecasts are inaccurate, we may have large amounts of unsold products or we may
not be able to fill all orders.
We order materials and build semiconductors based primarily on our internal
forecasts and secondarily on existing orders, which may be cancelled under many
circumstances. Consequently, we depend on our forecasts as a principal means to
determine inventory levels for our products and the amount of manufacturing
capacity that we need. Because our markets are volatile and subject to rapid
technological and price changes, our forecasts may be wrong and we may make too
many or too few of certain products or have too much or too little manufacturing
capacity. Also, our customers frequently place orders requesting product
delivery almost immediately after the order is made, which makes forecasting
customer demand even more difficult, particularly when supply is abundant. These
factors also make it difficult to forecast quarterly operating results. If we
are unable to predict accurately the appropriate amount of product required to
meet customer demand, our business, financial condition and results of
operations could be seriously harmed, either through missed revenue
opportunities because inventory for sale was insufficient or through excessive
inventory that would require write-offs.
We must spend heavily on equipment to stay competitive and will be adversely
impacted if we are unable to secure financing for such investments.
In order to remain competitive, semiconductor manufacturers generally must spend
heavily on equipment to maintain or increase technology and design development
and manufacturing capacity and capability. We currently plan for approximately
$90.0 million in expenditures on equipment in fiscal 2003 and anticipate
significant continuing capital expenditures in subsequent years. In the past, we
have reinvested a substantial portion of our cash flow from operations in
technology, design development and capacity expansion and improvement programs.
If we are unable to decrease costs for our products at a rate at least as fast
as the rate of the decline in selling prices for such products, we may not be
able to generate enough cash flow from operations to maintain or increase
manufacturing capability and capacity as necessary. In such a situation, we
would need to seek financing from external sources to satisfy our needs for
manufacturing equipment and, if cash flow from operations declines too much, for
operational cash needs as well. Such financing, however, may not be available on
terms that are
38
satisfactory to us or at all, in which case our business, financial condition
and results of operations would be seriously harmed.
We compete with others to attract and retain key personnel, and any loss of, or
inability to attract, such personnel would harm us.
To a greater degree than most non-technology companies, we depend on the efforts
and abilities of certain key management and technical personnel. Our future
success depends, in part, upon our ability to retain such personnel and to
attract and retain other highly qualified personnel, particularly product and
process engineers. We compete for these individuals with other companies,
academic institutions, government entities and other organizations. Competition
for such personnel is intense and we may not be successful in hiring or
retaining new or existing qualified personnel.
We believe that stock option grants are critical to our ability to attract and
retain personnel. The New York Stock Exchange implemented rules effective June
30, 2003 that would require, subject to certain exceptions, stockholder approval
for equity compensation plans, including stock option plans. Our ability to hire
or retain highly qualified personnel may be seriously impacted due to an
inability to grant stock options and other equity based compensation if we are
unable to obtain stockholder approval for such new plans in a timely manner or
at all.
If we lose existing qualified personnel or are unable to hire new qualified
personnel as needed, our business, financial condition and results of operations
could be seriously harmed.
We face additional problems and uncertainties associated with international
operations that could seriously harm us.
International revenues accounted for 67.5% of our total revenues in Q3 2003 and
63.3% in the first nine months of fiscal 2003. Long-lived assets are held
primarily in the United States with 10.3% held in the Philippines and 0.5% in
other foreign countries. Our Philippine assembly and test operations, as well as
our international sales offices, face risks frequently associated with foreign
operations including:
o currency exchange fluctuations;
o the devaluation of local currencies;
o political instability;
o changes in local economic conditions;
o import and export controls; and
o changes in tax laws, tariffs and freight rates.
To the extent any such risks materialize, our business, financial condition and
results of operations could be seriously harmed.
We are subject to many different environmental regulations and compliance with
them may be costly.
We are subject to many different governmental regulations related to the
storage, use, discharge and disposal of toxic, volatile or otherwise hazardous
chemicals used in our manufacturing process. Compliance with these regulations
can be costly. In addition, over the last several years, the public has paid a
great deal of attention to the potentially negative environmental impact of
semiconductor manufacturing operations. This attention and other factors may
lead to changes in environmental regulations that could force us to purchase
additional equipment or comply with other potentially costly requirements. If we
fail to control the use of, or to adequately restrict the discharge of,
hazardous substances under present or future regulations, we could face
substantial liability or suspension of our manufacturing operations, which could
seriously harm our business, financial condition and results of operations.
We depend on third parties to transport our products.
We rely on independent carriers and freight haulers to move our products between
manufacturing plants and our customers. Any transport or delivery problems
because of their errors or because of unforeseen interruptions in their
activities due to factors such as strikes, political instability, terrorism,
natural disasters and accidents could seriously harm our business, financial
condition and results of operations and ultimately impact our relationship with
our customers.
39
We may fail to integrate our business and technologies with those of companies
that we have recently acquired and that we may acquire in the future.
We completed one acquisition in fiscal 2002, six acquisitions in fiscal 2001 and
four acquisitions in fiscal 2000 and may pursue additional acquisitions in the
future. If we fail to integrate these businesses successfully or properly, our
quarterly and annual results may be seriously harmed. Integrating these
businesses, people, products and services with our existing business could be
expensive, time-consuming and a strain on our resources. Specific issues that we
face with regard to prior and future acquisitions include:
o integrating acquired technology or products;
o integrating acquired products into our manufacturing facilities;
o assimilating the personnel of the acquired companies;
o coordinating and integrating geographically dispersed operations;
o our ability to retain customers of the acquired company;
o the potential disruption of our ongoing business and distraction of
management;
o the maintenance of brand recognition of acquired businesses;
o the failure to successfully develop acquired in-process technology,
resulting in the impairment of amounts currently capitalized as
intangible assets;
o unanticipated expenses related to technology integration;
o the development and maintenance of uniform standards, corporate
cultures, controls, procedures and policies;
o the impairment of relationships with employees and customers as a
result of any integration of new management personnel; and
o the potential unknown liabilities associated with acquired businesses.
We may incur losses in connection with loans made under our stock purchase
assistance plan.
We have outstanding loans, consisting of principal and cumulative accrued
interest, of $107.6 million to employees and former employees under the
shareholder-approved 2001 Employee Stock Purchase Assistance Plan. (See Note 11
to our condensed consolidated financial statements included in this report for a
further description of this plan.) We made the loans to employees for the
purpose of purchasing Cypress common stock. Each loan is evidenced by a full
recourse promissory note executed by the employee in favor of Cypress and is
secured by a pledge of the shares of Cypress's common stock purchased with the
proceeds of the loan. The primary benefit to us from this program is increased
employee retention. In accordance with the plan, the CEO and the Board of
Directors do not participate in this program. To date, there have been
immaterial write-offs. As of Q3 2003, we have a loss reserve against these loans
of $16.2 million. In determining this reserve requirement, management considered
various factors, including an independent fair value analysis of these loans and
the underlying collateral. At the end of Q3 2003, the net carrying value of the
loans of $91.4 million is $2.9 million more than the underlying common stock
collateral. While the loans are secured by the shares of our stock purchased
with the loan proceeds, the value of this collateral would be adversely affected
if our stock price declined significantly.
Our results of operations would be adversely affected if a significant amount of
these loans were not repaid. Similarly, if our stock price were to decrease, our
employees bear greater repayment risk and we would have increased risk to our
results of operations. However, we are willing to pursue every available avenue,
including those covered under the Uniform Commercial Code, to recover these
loans by pursuing employees' personal assets should the employees not repay
these loans. In October 2003, we announced a program aimed at minimizing any
losses to employees as a result of our common stock price fluctuations. Under
this program, a stop loss order is placed on the common stock purchased by each
employee with the loan proceeds once the common stock price exceeds that
employee's break-even point. If the common stock price declines to the stop loss
price, the common stock purchased by the employee under the Plan will be
automatically sold and the proceeds utilized to repay the employee's outstanding
loan to us. From the end of Q3 2003 to the end of October 2003, we collected
$7.0 million from employees who had settled their loan obligations.
We maintain self-insurance for certain liabilities of our officers and
directors.
Our certificate of incorporation, by-laws and indemnification agreements require
us to indemnify our officers and directors for certain liabilities that may
arise in the course of their service to us. We self-insure with respect to
potential indemnifiable claims. If we were required to pay a significant amount
on account of these liabilities for which we self-insure, our business,
financial condition and results of operations could be seriously harmed.
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ITEM III. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest and Foreign Currency Exchange Rates
Cypress is exposed to financial market risks, including changes in interest
rates and foreign currency exchange rates. A majority of Cypress's revenue and
capital spending is transacted in U.S. dollars. However, Cypress does enter into
these transactions in other currencies, primarily the Japanese Yen and the Euro.
To protect against reductions in value and the volatility of future cash flows
caused by changes in foreign exchange rates, Cypress has established hedging
programs for balance sheet exposures and exposures to exchange rate changes for
purchases of capital equipment. Cypress's hedging programs reduce, but do not
always eliminate, the impact of foreign currency exchange rate movements. To
mitigate these risks, Cypress utilizes derivative financial instruments. Based
on Cypress's overall currency rate exposure at the end of Q3 2003, a near-term
10% appreciation or depreciation in the U.S. dollar, relative to the Japanese
Yen or the Euro, would have an immaterial effect on Cypress's financial
position, results of operations and cash flows over the next fiscal year.
Cypress does not use derivative financial instruments for speculative or trading
purposes.
A 100 basis point increase or decrease in interest rates would not materially
impact the fair market value of Cypress's investment portfolio nor Cypress's
statement of operations due to the short-term nature of Cypress's investment
portfolio and the variable interest rate characteristics of Cypress's debt and
synthetic lease obligations. At the end of Q3 2003, Cypress's debt and synthetic
lease obligations containing variable interest rate characteristics amounted to
$21.9 million and $62.7 million, respectively.
Equity Options
At the end of Q3 2003, Cypress had outstanding a series of equity options on
Cypress common stock with an initial cost of $26.0 million, which is classified
in stockholders' equity in the accompanying condensed consolidated balance
sheet. The contracts, which were extended during Q2 2003, require physical
settlement and expire in December 2003. Upon expiration of the options, if
Cypress's stock price is above the threshold price of $20.00 per share, Cypress
will receive a settlement value totaling $28.9 million. If Cypress's stock price
is below the threshold price of $20.00 per share, Cypress will receive 1.4
million shares of its common stock. Alternatively, the contract may be renewed
and extended. In conjunction with the 1.25% convertible subordinated notes
offering in June 2003, Cypress purchased a call spread option on Cypress's
common stock ("Call Spread Option") maturing in July 2004 for $49.3 million. The
Call Spread Option, including fees and costs, has been accounted for as an
equity transaction in accordance with Emerging Issues Task Force No. 00-19,
"Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Company's Own Stock." The Call Spread Option covers approximately
32 million shares of Cypress common stock. The Call Spread Option is designed to
mitigate dilution from conversion of the 1.25% convertible subordinated notes in
the event that the market price per share of the Company's common stock upon
exercise of the call spread options is greater than $15 per share and is less
than or equal to $24.50 per share. The call spread option may be settled at the
Cypress's option in either net shares or in cash. Settlement of the Call Spread
Option in net shares on the expiration date would result in Cypress receiving a
number of shares, not to exceed 12.4 million shares, of our common stock with a
value equal to the amount otherwise receivable on cash settlement. Should there
be an early unwind of the Call Spread Option, the amount of cash or net shares
potentially received by Cypress will be dependent upon then existing overall
market conditions, on the Cypress's stock price, the volatility of the Cypress's
stock and the amount of time remaining on the Call Spread Option.
Investments in Development Stage Companies
Cypress has invested in several privately held companies, all of which can be
considered in the startup or development stages. These investments are
inherently risky as the market for the technologies or products they have under
development are typically in the early stages and may never materialize. As of
the end of Q3 2003, Cypress had invested $25.9 million in development stage
companies, all of which could be lost if the companies are not successful.
As Cypress's equity investments generally do not permit Cypress to exert
significant influence or control over the entity in which Cypress is investing,
these amounts generally represent Cypress's cost of the investment, less any
adjustments Cypress makes when it determines that an investment's net realizable
value is less than its carrying cost.
The process of assessing whether a particular equity investment's net realizable
value is less than its carrying cost requires a significant amount of judgment.
In making this judgment, Cypress carefully considers the investee's cash
position, projected cash flows (both short-and long-term), financing needs,
most recent valuation data, the current
41
investing environment, management/ownership changes and competition. This
evaluation process is based on information that Cypress requests from these
privately held companies. This information is not subject to the same disclosure
and audit requirements as the reports required of U.S. public companies, and as
such, the reliability and accuracy of the data may vary. Based on its
evaluation, Cypress previously recorded impairment charges related to Cypress's
investments in privately held companies in the aggregate of $19.6 million in
fiscal years 2002 and 2001. Cypress has recorded impairment charges of $0.3
million in Q3 2003 and $1.3 million for the nine months ended Q3 2003. In Q3
2003, we sold our investment in NVE Corporation common stock for $23.4 million,
resulting in a gain of $17.1 million. At the end of Q3 2003, we continued to
hold a warrant to purchase 0.4 million shares of common stock of NVE with an
aggregate exercise price of $6.0 million.
Estimating the net realizable value of investments in privately held early-stage
technology companies is inherently subjective and may contribute to volatility
in Cypress's reported results of operations. For example, if the current weak
investing environment continues throughout fiscal 2003, Cypress may incur
additional impairments to its equity investments in privately held companies.
Stock Purchase Assistance Plan
Included in Other current assets at Q3 2003, Cypress has outstanding loans,
consisting of principal and cumulative accrued interest, of $107.6 million to
employees and former employees under the shareholder-approved 2001 Employee
Stock Purchase Assistance Plan. As of the end of Q4 2002, the outstanding
principal and cumulative accrued interest totaled $106.6 million. Cypress made
the loans to employees for the purpose of purchasing Cypress common stock. Each
loan is evidenced by a full recourse promissory note executed by the employee in
favor of Cypress and is secured by a pledge of the shares of Cypress's common
stock purchased with the proceeds of the loan. The primary benefit to Cypress
from this program is increased employee retention. In accordance with the plan,
the CEO and the Board of Directors do not participate in this program. To date,
there have been immaterial write-offs. As of Q3 2003, Cypress had a loss reserve
against these loans of $16.2 million. In determining the reserve, management
considered various factors, including an independent fair value analysis of the
loans and the underlying collateral. At the end of Q3 2003, the net carrying
value of the loans of $91.4 million is $2.9 million more than the underlying
common stock collateral.
If there were an additional 10% decline in the stock price, the difference
between the carrying value of the loans and the underlying common stock
collateral would be $11.5 million. If the stock continues at the same level, or
does not increase, Cypress may have to further evaluate the reserve level.
However, Cypress is willing to pursue every available avenue, including those
covered under the Uniform Commercial Code, to recover these loans by pursuing
employees' personal assets should the employees not repay these loans. In
October 2003, Cypress announced a program aimed at minimizing any losses to
employees as a result of Cypress's common stock price fluctuations. Under this
program, a stop loss order is placed on the common stock purchased by each
employee with the loan proceeds once the common stock price exceeds that
employee's break-even point. If the common stock price declines to the stop loss
price, the common stock purchased by the employee under the Plan will be
automatically sold and the proceeds utilized to repay the employee's outstanding
loan to Cypress. From the end of Q3 2003 to the end of October 2003, Cypress
collected $7.0 million from employees who had settled their loan obligations.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. Cypress's management
has evaluated, under the direction and with the participation of the
Cypress's Chief Executive Officer and Chief Financial Officer, the
effectiveness of Cypress's disclosure controls and procedures (as
defined in Rule 13a-15(e) under the Securities Exchange Act of 1934,
as amended (the "Exchange Act")), as of the end of the fiscal quarter
covered by this Quarterly Report on Form 10-Q. Based on the foregoing
evaluation, Cypress's Chief Executive Officer and Chief Financial
Officer have concluded that as of the end of the fiscal quarter
covered by this Quarterly Report on Form 10-Q, Cypress's disclosure
controls and procedures are effective to ensure that information
required to be disclosed by Cypress in reports that Cypress files or
submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and
Exchange Commission's rules and forms.
(b) Changes in internal control over financial reporting. There were no
changes in Cypress's internal control over financial reporting
identified in connection with the evaluation required by Exchange Act
Rule 13a-15(d) that occurred during the most recent fiscal quarter
that has materially affected or is reasonably likely to materially
affect Cypress's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information required by this item is included in Part I in Note 6 to the
Condensed Consolidated Financial Statements and is incorporated herein by
reference.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(1) Exhibits
Exhibit 10.1 Loan and Security Agreement, dated as of
September 25, 2003, by and between Silicon Valley
Bank and Cypress Semiconductor Corporation.
Exhibit 31.1 Certification of Chief Executive Officer Pursuant to
Exchange Act Rule 13a-14(a).
Exhibit 31.2 Certification of Chief Financial Officer Pursuant to
Exchange Act Rule 13a-14(a).
Exhibit 32.1 Certification of Chief Executive Officer Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2 Certification of Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(2) Reports on Form 8-K
Filing Date Item Reported On
July 17, 2003 Item 9. We furnished a copy of our press release
announcing our results for the fiscal quarter ending
June 29, 2003, including a reconciliation between
GAAP and non-GAAP measures discussed in the press
release
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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.
CYPRESS SEMICONDUCTOR CORPORATION
By /s/ Emmanuel T. Hernandez
------------------------------------
Emmanuel Hernandez
Vice President, Finance and
Administration and Chief Financial Officer
Dated: November 10, 2003
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