Fairchild Semiconductor International 10-K 2011
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 26, 2010
For the transition period from to
Commission File Number 001-15181
Fairchild Semiconductor International, Inc.
(Exact name of Registrant as specified in its charter)
Registrants telephone number, including area code: (408) 822-2000
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $.01 per share
(Title of each class)
New York Stock Exchange
(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No x
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 27, 2010 was $1,103,580,632
The number of shares outstanding of the Registrants Common Stock as of February 21, 2011 was 126,338,813.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 5, 2011 are incorporated by reference into Part III.
TABLE OF CONTENTS
Except as otherwise indicated in this Annual Report on Form 10-K, the terms we, our, the company, Fairchild and Fairchild International refer to Fairchild Semiconductor International, Inc. and its consolidated subsidiaries, including Fairchild Semiconductor Corporation, our principal operating subsidiary. We refer to individual subsidiaries where appropriate.
The companys fiscal year ends on the last Sunday in December. The companys results for the years ended December 26, 2010, December 27, 2009 and December 28, 2008 each consist of 52 weeks.
We are focused on developing, manufacturing and selling power analog, power discrete and certain non-power semiconductor solutions to a wide range of end market customers. We are a leading supplier of power analog products, power discrete products and energy-efficient solutions, according to iSuppli. Our products are used in a wide variety of electronic applications, including sophisticated computers and internet hardware; communications; networking and storage equipment; industrial power supply and instrumentation equipment; consumer electronics such as digital cameras, displays, audio/video devices and household appliances; and automotive applications. We believe that our focus on the power market, our diverse end market exposure, and our strong penetration into the growing Asian region provide us with excellent opportunities to expand our business.
With a history dating back approximately 50 years, the original Fairchild was one of the founders of the semiconductor industry. Established in 1959 as a provider of memory and logic semiconductors, the Fairchild Semiconductor business was acquired by Schlumberger Limited in 1979 and by National Semiconductor Corporation in 1987. In March 1997, as part of its recapitalization, much of the Fairchild Semiconductor business was sold to a new, independent companyFairchild Semiconductor Corporation.
Products and Technology
Our product groups are organized by the end markets they support and include: (1) Mobile, Computing, Consumer and Communication (MCCC), (2) Power Conversion, Industrial and Automotive (PCIA). Our third reportable segment is Standard Discrete and Standard Linear (SDT), which contains a wide array of mature, standard products.
We strive to invest in the latest wafer fabrication power semiconductor technology and successfully qualified a number of new processes including low and mid voltage PowerTrench®, advanced insulated gate bipolar transistor (IGBT), as well as advanced high power metal oxide semiconductor field effect transistors (MOSFET) fabrication technologies. Our new South Portland, Maine 8-inch wafer fabrication line is focused on process technologies specifically tailored to the high performance analog market. We are also converting our Salt Lake fab to 8 and have plans to expand and convert much of the Bucheon, Korea fab to 8 wafers as well. The process flows are modular in nature and thus provide a wide range of capabilities including low voltage control and power switching. Additional passive devices and programmable elements may be combined with these active devices to create innovative, highly integrated analog solutions.
Mobile, Computing, Consumer and Communication (MCCC)
We design, manufacture and market high-performance analog and mixed signal integrated circuits, low voltage power MOSFETs for mobile, consumer, computing, and communication applications. We have a leadership position in the power MOSFET market by leveraging our industry leading portfolio of PowerTrench® products. Our analog and mixed signal products focused on the Mobile end- markets represent 35 percent of revenue and are the primary growth engine for the MCCC group.
We offer analog and mixed signal devices in a number of proprietary part types with an emphasis on serving the mobile market. The development of proprietary parts is largely driven by evolving end-system requirements such as extending battery life, improving audio quality, and USB connections. The drive for smaller and smaller mobile devices results in the need for higher integration and smaller components with higher performance levels. Major competitors include Analog Devices, Linear Technology, Maxim, Micrel, National Semiconductor, ON Semiconductor, ST Microelectronics, Intersil, International Rectifier, Infineon, and Texas Instruments.
Analog products monitor, interpret, and control continuously variable functions such as light, color, sound, and energy. Frequently, they form the interface with the digital world. We provide a wide range of analog products that perform such tasks as voltage regulation and system management. Analog voltage regulation circuits are used to provide constant voltages as well as step up or step down voltage levels on a circuit board. These products enable improvements in power efficiency, lighting management, and improve charge times in ultraportable products. These products are used in a variety of mobile, computing, communications, and consumer applications.
In addition to the power analog and interface products we also offer signal path products. These include analog and digital switches, USB switches, video encoders and decoders, video filters and high performance audio amplifiers. The analog switch functions are typically found in cellular handsets and other ultra portable applications. The video products provide a single chip solution to video filtering and amplification. Video filtering applications include set top boxes and digital television.
We believe our analog and mixed signal product portfolio is further enhanced by a broad offering of packaging solutions that we have developed. These solutions include surface mount, tiny packages, chip scale packages, and leadless carriers.
We also design, manufacture, and market power semiconductor solutions for computing, communications, mobile, consumer and industrial applications. Power semiconductor solutions include, power discrete MOSFETs, analog integrated circuits, and fully integrated multi-chip and monolithic power solutions.
Our power MOSFETs are primarily used in power delivery and power control applications. Power delivery and power control applications are ubiquitous across data consumption, processing and communication applications and enable our customers to deliver increasing content and mobility to the consumer, business to business, and industrial markets. We produce advanced low power MOSFETs under our PowerTrench® brands. Examples of applications where our advanced power MOSFETs are used include smartphones, tablets, notebook PCs, high performance gaming, home entertainment systems, servers, data communication, and routers.
Fully integrated multi-chip and monolithic power solutions are devices that integrate analog and power discrete functions into a single module, offering further improvements in power consumption and critical space savings.
Power Conversion, Industrial and Automotive (PCIA)
We design, manufacture and market power discrete semiconductors, analog and mixed signal integrated circuits (ICs) for the broad power conversion/power management, industrial, and automotive applications. Our products are building blocks that help convert a semi-regulated energy source (ACalternating current or DCdirect current) to a regulated output for electronic systems (AC-DC, DC-AC, and DC-DC conversion). Our discrete devices are individual diodes or transistors that perform power switching, power conditioning and signal amplification functions in electronic circuits. Our analog and mixed signal ICs are used to control discrete semiconductors in applications such as power switching, conditioning, signal amplification, power distribution, and power consumption. Driving the demand and growth of our business is the increasing need for higher efficiency and higher power density for space savings. We are also seeing strong demand for our solutions which reduce the consumption of power when electronic devices are in standby mode. We manufacture discrete products using state of the art vertical DMOS MOSFETs, Insulated Gate Bipolar Transistors (IGBT), Bipolar,
and ultrafast rectifier technologies. We manufacture analog and mixed signal ICs using a variety of bipolar (Bi), complementary metal oxide (CMOS), BiCMOS, and bipolar/cmos/dmos (BCDMOS) state of the art processes up to 1200V and down to 0.35µm (microns) minimum geometry. Major competitors include Infineon, ST Microelectronics, International Rectifier, Power Integrations, ON Semiconductor, NXP, and Vishay.
Power MOSFETs are used in applications to switch, shape or transfer energy. These products are used in a variety of high-growth applications including solar inverters, uninterruptible power supplies (UPS), data centers & communications, motors, lighting, automotive, computing, displays, and industrial supplies. We produce advanced power MOSFETs under our SupreMOS, SuperFET, PowerTrench®, UNIFET and QFET/CFET brands. MOSFETs enable various end applications to achieve their design needs and efficiency goals.
IGBTs are high-voltage power discrete devices. They are used in switching applications for solar inverters, UPS, data centers & communications, motors, industrial, power supplies, displays, TVs, and automotive ignition systems. These applications require lower switching frequencies, higher power, and/or higher voltages than a power MOSFET can provide. We are a leading supplier of IGBTs. We feature various planar and trench IGBT technologies for these applications.
Rectifier products work with IGBTs and MOSFETs in many applications to provide power conversion and conditioning. Our premier product is the Stealth rectifier, providing industry leading performance and efficiencies in data communications, industrial power supply, displays, TVs, and motor applications.
Leveraging our Power MOSFET and IGBT technologies, we also design and manufacture modules for the industrial, automotive, and home appliance end markets which are growing with the worldwide need to improve efficiency, increase power density, and conserve energy.
We design and develop a line of proprietary, high-performance smart power modules or SPM products targeted to various end applications in consumer white goods and industrial applications: room air conditioners, industrial power supplies, inverters, pumps, and industrial motors. These are multi-chip modules containing up to 28 components in a single package that includes diodes, power discrete IGBTs or MOSFETs, high voltage power management driver ICs, and current and temperature sensors. Similar modules, called APM, are used in automotive applications. These innovative products provide customers with a fully integrated power management solution designed to increase power efficiency, power density, system reliability, system functionality, and reduce engineering development time.
We sell custom and standard analog and mixed signal ICs to enable management of power systems. We design and manufacture power management semiconductors for line-powered and off-line powered systems that integrate or complement our Power MOSFETs to simplify engineering challenges to increase efficiency, increase power density for space savings, and reduce energy consumption. The integration improves system reliability by reducing the total number of components, while offering comparable robustness. We sell and market off-line and isolated DC-DC ICs, MOSFET and IGBT gate driver ICs, and power factor correction ICs to the consumer, computing, displays, TVs, lighting, and industrial segments.
Off-line and isolated DC to DC IC products address power conversion from less than one watt output up to 1kW. The solutions target space saving by improving overall system efficiency and reducing the total number of components. Additionally, our devices help the designer conserve system power. The product families primarily target the high volume consumer and computing markets with a smaller percentage aimed towards the lower volume, diversified industrial markets.
MOSFET and IGBT Gate Drivers IC products complement our off-line and isolated DC to DC, power MOSFETs, and IGBTs for applications from less than one hundred watts output to greater than 2kW. These gate drivers are often required for higher power MOSFETs and IGBTs applications, higher efficiency, additional system functionality, and reduced design complexity.
Power Factor Correction (PFC) ICs complement our off-line and isolated DC to DC, power MOSFETs, rectifiers, and IGBTs for applications from less than one hundred watts output to 2kW. Undesired by-products of electronic equipment include inefficient power usage from an AC source, higher AC noise and undesired harmonics. PFC ICs are needed to improve the power efficiency and to lower noise or harmonics to government and industry mandated levels.
Optoelectronics covers a wide range of semiconductor devices that emit and sense both visible and infrared light. We participate in the optocouplers and infrared device segments of the optoelectronics market. Optocouplers incorporate infrared emitter and detector combinations in a single package. These products are used to transmit signals between two electronic circuits while maintaining a safe electrical isolation between them. Major applications for these devices include power supplies, UPS, solar inverters, motor controls and power modules & industrial control system. Our focus in optoelectronics is aligned with our power management business, as these products are used extensively in power supplies and AC to DC power conversion applications. Major competitors for this business include Vishay and Liteon.
Standard Linear and Standard Discrete (SDT)
SDT combines the management of mature and multiple market products which provide generic solutions from the two product divisions discussed below.
Standard Diode & Transistor Products (SDT) devices cover a wide range of semiconductor products including: MOSFET, junction field effect transistor (JFET), high power bipolar, discrete small signal transistors, TVS, Zeners, rectifiers, bridge rectifiers, Schottky and diodes. Our parts can be found in almost every circuit with our portfolio focus geared towards meeting the needs of general power switching, power conditioning, circuit protection, and signal amplification functions in electronic circuits of computing, industrial, mobile, ultraportable, and consumer markets. The portfolio is enhanced with single and multichip solutions in industry leading small packages that add value with performance and minimal footprint on the PCB. Major competitors include International Rectifier, Diodes Incorporated, NXP Semiconductors, ST Microelectronics, ON Semiconductor and Vishay.
We design, manufacture and market analog integrated circuits for computing, consumer, communications, ultra-portable and industrial applications. These products are manufactured using bipolar, CMOS and BiCMOS technologies. Standard Linear solutions range from bipolar regulators, shunt regulators, low drop out regulators, standard op-amp/comparators, low voltage op-amp, and others. Analog voltage regulator circuits are used to provide constant voltages as well as to step up or step down voltage levels on a circuit board. Op-amps/comparators are designed specifically to operate from a single power supply over a wide range of voltages. We also offer low-voltage op-amps that provide a combination of low power, rail-to-rail performance, low voltage operation, and tiny package options which are well suited for use in personal electronics equipment.
There is continued growth for analog solutions as digital solutions require a bridge between real world signals and digital signals. Our product portfolio is further enhanced by a broad offering of packaging solutions that we have developed. These solutions include surface mount, tiny packages and leadless carriers. Major competitors include National Semiconductor, ST Microelectronics, ON Semiconductor and Texas Instruments.
Sales, Marketing and Distribution
For the year ended December 26, 2010, we derived approximately 65%, 29% and 6% of our net sales from distributors, original equipment manufacturers (OEMs), and electronic design and manufacturing services (EMS) customers, respectively, through our regional sales organizations. We operate regional sales organizations in Europe, with principal offices in Fuerstenfeldbruck, Germany; the Americas, with principal offices in Dallas, Texas; the Asia/Pacific region (which for these purposes excludes Japan and South Korea), with principal offices in Singapore; Japan, with principal offices in Tokyo; and South Korea, with principal offices in Seoul. A discussion of revenue by geographic region for each of the last three years can be found in Item 8, Note 17 of this
report. Each of the regional sales organizations is supported by logistics organizations, which manage independently operated warehouses. Product orders flow to our manufacturing facilities, where products are made. Products are then shipped either directly to customers or indirectly to customers through warehouses that are owned and operated by us or by a third party provider.
We have dedicated direct sales organizations operating in Europe, the Americas, the Asia/Pacific region, Japan and Korea that serve our major original equipment manufacturer and electronic design and manufacturing services customers. We also have a large network of distributors and independent manufacturers representatives to distribute and sell our products around the world. We believe that maintaining a small, highly focused, direct sales force selling products for all of our businesses, combined with an extensive network of distributors and manufacturers representatives, is the most efficient way to serve our multi-market customer base. Our dedicated marketing organization consists of a central marketing group that coordinates marketing, advertising, and media activities for all products within the company. Additionally, product line marketing specifically focuses on tactical and strategic marketing for their product and application focus, and marketing personnel located in each of the sales regions provides regional direction and support for products and end applications as applicable for their region.
Typically, distributors handle a wide variety of products and fill orders for many customers. Some of our sales to distributors are made under agreements allowing for market price fluctuations and the right of return on unsold merchandise, subject to time and volume limitations. Many of these distribution agreements contain a standard stock rotation provision allowing for minimum levels of inventory returns. In our experience, these inventory returns can usually be resold, although often at a discount. Manufacturers representatives generally do not offer products that compete directly with our products, but may carry complementary items manufactured by others. Manufacturers representatives, who are compensated on a commission basis, do not maintain a product inventory; instead, their customers place larger quantity orders directly with us and are referred to distributors for smaller orders.
Research and Development
Our expenditures for research and development for 2010, 2009 and 2008 were $120.2 million, $99.7 million and $112.9 million, respectively. These expenditures represented 7.5%, 8.4% and 7.2% of sales for 2010, 2009 and 2008, respectively. Advanced silicon processing technology is a key determinant in the improvement of semiconductor products. Each new generation of process technology has resulted in products with higher speed, higher power density and greater performance, produced at lower cost. We expect infrastructure investments made in recent years to enable us to continue to achieve high volume, high reliability and low-cost production using leading edge process technology for our classes of products. Our R&D efforts continue to be focused in part on new and innovative packaging solutions that make use of new assembly methods and new high performance packaging materials, as well as in exclusive and patent protected transistor structure development. We are also using our R&D resources to characterize and apply new materials in both our packaging and semiconductor device processing efforts.
Each of our product groups maintains independent product, process and package research and development organizations, which work closely with our manufacturing groups to bring new technologies to market. These groups are located throughout the world in our factories and research centers. We work closely with our major customers in many research and development situations in order to increase the likelihood that our products will be designed directly into customers products and achieve rapid and lasting market acceptance.
We operate seven manufacturing facilities, four of which are front-end wafer fabrication plants in the United States (U.S.) and South Korea, and three of which are back-end assembly and test facilities in Asia. Information about our property, plant and equipment by geographic region for each of the last three years can be found in Item 8, Note 17 of this report.
Our products are manufactured and designed using a broad range of manufacturing processes and certain proprietary design methods. We use all of the prevalent function-oriented process technologies for wafer fabrication, including CMOS, Bipolar, BiCMOS, DMOS and RF. We use primarily mature through-hole and advanced surface mount technologies in our assembly and test operations. We have fully implemented a lead free packaging initiative and all products currently manufactured use a lead free finish in full compliance with RoHS industry environmental requirements.
The table below provides information about our manufacturing facilities and products.
Our Mountaintop, Pennsylvania location is scheduled for closure in the fourth quarter of 2012. Most of the products currently manufactured in Pennsylvania will be transferred to other internal sites.
We subcontract a minority portion of our wafer fabrication needs, primarily to Taiwan Semiconductor Manufacturing Company, Advanced Semiconductor Manufacturing Corporation, Central Semiconductor Manufacturing Corporation, Jilin Magic Semiconductor, Macronix International Co. Ltd., and Phenitec
Semiconductor. In order to maximize our production capacity, some of our back-end assembly and testing operations are also subcontracted. Primary back-end subcontractors include Amkor, ASE, AUK, GEM Services, Hana Semiconductor, Liteon, Tak Cheong Electronics, Greatek, Etrend, AIC and UTAC Thai Ltd.
Our manufacturing processes use many raw materials, including silicon wafers, gold, copper and aluminum wire, Alloy 42/Cu lead frames, mold compound, ceramic and other substrate material and some chemicals and gases. We obtain our raw materials and supplies from a large number of sources, adopting vendor-managed inventory and just-in-time delivery. Although supplies for the raw materials used by us are currently adequate, shortages could occur in various essential materials due to interruption of supply or increased demand in the industry.
Backlog at December 26, 2010 was approximately $915 million, up from approximately $586 million at December 27, 2009. We define backlog as firm orders or customer-provided forecasts with a customer requested delivery date within 26 weeks. In periods of depressed demand, customers tend to rely on shorter lead times available from suppliers, including us. In periods of increased demand, there is a tendency towards longer lead times that has the effect of increasing backlog and, in some instances, we may not have manufacturing capacity sufficient to fulfill all orders. We are currently in a period of increased demand. Additionally, backlog is impacted by our manufacturing lead times, which have increased on average from December 27, 2009 to December 26, 2010. As is customary in the semiconductor industry, we allow orders to be canceled or deliveries delayed by customers within agreed upon parameters. Accordingly, our backlog at any time should not be used as an indication of future revenues.
Overall, our sales are closely linked to semiconductor and related electronics industry supply chain and channel inventory trends.
Markets for our products are highly competitive. Although only a few companies compete with us in all of our product lines, we face significant competition within each of our product lines from major international semiconductor companies. Some of our competitors may have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing and distribution of their products. Competitors include manufacturers of standard semiconductors, application-specific integrated circuits and fully customized integrated circuits.
We compete in different product lines to various degrees on the basis of price, technical performance, product features, product system compatibility, customized design, availability, quality and sales and technical support. Our ability to compete successfully depends on elements both within and outside of our control, including successful and timely development of new products and manufacturing processes, product performance and quality, manufacturing yields and product availability, capacity availability, customer service, pricing, industry trends and general economic trends.
Trademarks and Patents
As of December 26, 2010 we held 1,117 issued U.S. patents and 1,204 issued non-U.S. patents with expiration dates ranging from 2010 through 2030. We also have trademarks that are used in the conduct of our business to distinguish genuine Fairchild products. We believe that while our patents may provide some advantage, our competitive position is largely determined by such factors as system and application knowledge, ability and experience of our personnel, the range and number of new products being developed by us, our market brand recognition, ongoing sales and marketing efforts, customer service, technical support and our manufacturing capabilities.
It is generally our policy to seek patent protection for significant inventions that may be patented, though we may elect, in certain cases, not to seek patent protection even for significant inventions, if other protection, such as maintaining the invention as a trade secret, is considered more advantageous. Also, the laws of countries in which we design, manufacture and market our products may afford little or no effective protection of our proprietary technology.
Our operations are subject to environmental laws and regulations in the countries in which we operate that regulate, among other things, air and water emissions and discharges at or from our manufacturing facilities; the generation, storage, treatment, transportation and disposal of hazardous materials by our company; the investigation and remediation of environmental contamination; and the release of hazardous materials into the environment at or from properties operated by our company and at other sites. As with other companies engaged in like businesses, the nature of our operations exposes our company to the risk of liabilities and claims, regardless of fault, with respect to such matters, including personal injury claims and civil and criminal fines.
Our facilities in South Portland, Maine, and, to a lesser extent, West Jordan, Utah, have ongoing remediation projects to respond to releases of hazardous materials that occurred prior to our separation from National Semiconductor. National Semiconductor has agreed to indemnify Fairchild for the future costs of these projects and other environmental liabilities that existed at the time of our acquisition of those facilities from National Semiconductor in 1997. The terms of the indemnification are without time limit and without maximum amount. The costs incurred to respond to these conditions were not material to the consolidated financial statements for any period presented.
Our facility in Mountaintop, Pennsylvania has an ongoing remediation project to respond to releases of hazardous materials that occurred prior to our acquisition of that facility from Intersil Corporation in 2001. Intersil has agreed to indemnify us for specific environmental issues. The terms of the indemnification are without time limit and without maximum amount.
A property we previously owned in Mountain View, California is listed on the National Priorities List under the Comprehensive Environmental Response, Compensation, and Liability Act. We acquired that property as part of the acquisition of The Raytheon Companys semiconductor business in 1997. Under the terms of the acquisition agreement, Raytheon retained responsibility for, and has agreed to indemnify us with respect to, remediation costs or other liabilities related to pre-acquisition contamination. We sold the Mountain View property in 1999. The purchaser received an environmental indemnity from us similar in scope to the one we received from Raytheon. The purchaser and subsequent owners of the property can hold us liable under our indemnity for any claims, liabilities or damages they may incur as a result of the historical contamination, including any remediation costs or other liabilities. We are unable to estimate the potential amounts of future payments; however, we do not expect any future payments to have a material impact on our earnings or financial condition.
Although we believe that our Bucheon, South Korea operations, which we acquired from Samsung Electronics in 1999, have no significant environmental liabilities, Samsung Electronics agreed to indemnify us for remediation costs and other liabilities related to historical contamination, up to $150 million, arising out of the business we acquired from Samsung Electronics, including the Bucheon facilities. We are unable to estimate the potential amounts of future payments, if any; however, we do not expect any future payments to have a material impact on our earnings or financial condition.
We believe that our operations are in substantial compliance with applicable environmental laws and regulations. Our costs to comply with environmental regulations were immaterial for 2010, 2009 and 2008. Future laws or regulations and changes in existing environmental laws or regulations, however, may subject our operations to different, additional or more stringent standards. While historically the cost of compliance with
environmental laws has not had a material adverse effect on our results of operations, business or financial condition, we cannot predict with certainty our future costs of compliance because of changing standards and requirements.
Our worldwide workforce consisted of 8,977 full and part-time employees as of December 26, 2010. We believe that our relations with our employees are satisfactory.
At December 26, 2010, 120 of our employees were covered by a collective bargaining agreement. These employees are members of the Communication Workers of America/International Union of Electronic, Electrical, Salaried Machine and Furniture Workers, AFL-CIO, Local 88177. The current agreement with the union ends June 1, 2011 and provides for guaranteed wage and benefit levels as well as employment security for union members. If a work stoppage were to occur, it could impact our ability to operate. Also, our profitability could be adversely affected if increased costs associated with any future contracts are not recoverable through productivity improvements or price increases. We believe that relations with our unionized employees are satisfactory.
Our wholly owned Korean subsidiary, which we refer to as Fairchild Korea, sponsors a Korean Labor Council consisting of seven representatives from the non-management workforce and seven members of the management workforce. The Labor Council, under Korean law, is recognized as a representative of the workforce for the purposes of consultation and cooperation. The Labor Council has no right to take a work action or to strike and is not party to any labor or collective bargaining agreements with Fairchild Korea. We believe that relations with Fairchild Korea employees and the Labor Council are satisfactory.
On November 26, 2010, the employees in our facility in Suzhou, China approved the creation of a labor union that was officially established on January 26, 2011 under applicable local law. While the All China Federal Trade Union (ACFTU) has indicated its desire that local unions should work towards the goal of executing collective bargaining agreements at companies that have established labor unions, there is currently no collective bargaining agreement between the company and the employees in Suzhou.
The following table provides information about the executive officers of our company. There is no family relationship among any of the named executive officers.
Mark S. Thompson, Chairman of the Board of Directors, President and Chief Executive Officer (CEO). Mr. Thompson joined Fairchild Semiconductor in November 2004 as Executive Vice President, Manufacturing and Technology group. He became President and Chief Executive Officer in May 2005 and was elected Chairman of the Board in May 2008. He has over 25 years of high technology experience. Prior to joining the company, Mr. Thompson had been Chief Executive Officer of Big Bear Networks since August 2001. He was previously Vice President and General Manager of Tyco Electronics, Power Components Division and, prior to its acquisition by Tyco, was Vice President of Raychem Corporations Electronics OEM division. Mr. Thompson is a director of American Science and Engineering, Inc. and Cooper Industries, Ltd.
Mark S. Frey, Executive Vice President, Chief Financial Officer (CFO) and Treasurer. Mr. Frey joined Fairchild Semiconductor in March 2006. Prior to joining the company, Mr. Frey had been the Vice President, Finance and Corporate Controller for Lam Research Corporation since 1999. He was previously the Vice President of Finance for Raychem Corporations Electronics OEM division and he previously held financial positions with Activision and Memorex.
Allan Lam, Executive Vice President, Worldwide Sales and Marketing. Mr. Lam joined Fairchild Semiconductor in August 2005 as Senior Vice President and General Manager, Standard Products Group. He assumed his current position in July 2007. He was previously employed by Vishay Intertechnology and Temic Semiconductor since 1996, most recently as Vice President of Sales, Asia, and before that as Area Vice President of Sales, Asia-Pacific and Vice President, Standard Products Unit. He previously held management positions in quality, marketing, sales, and engineering with BBS Electronics, Cinergi Technology & Devices, SGS-Thomson Microelectronics and National Semiconductor.
Robert J. Conrad, Executive Vice President and General Manager, Mobile, Computing, Communications and Consumer Products Group. Mr. Conrad joined Fairchild Semiconductor in September 2003 as Senior Vice President and General Manager of the Analog Products Group. He became Executive Vice President in May 2006, and assumed his current position in December 2007. Mr. Conrad has over 27 years of semiconductor industry experience. His experience prior to joining Fairchild includes twelve years at Texas Instruments in a variety of engineering and business management roles, six years at Analog Devices where he was Vice President and General Manager of the DSP Division, and most recently as CEO and President of Trebia Networks, a private fabless semiconductor company, since April 2001. Mr. Conrad is on the board of directors of Mindspeed Technologies, Inc.
Justin Chiang, Executive Vice President and General Manager, Power Conversion, Industrial and Automotive Products Group. Mr. Chiang joined Fairchild Semiconductor in May 2005 as Vice President of System Power in the Analog Products Group, and was promoted to Senior Vice President and General Manager, Power Conversion, Industrial and Automotive Product Group in December 2007 and to his current position in December 2008. He has over 18 years of experience in the electronic and semiconductor industry. Prior to joining the company, Mr. Chiang was the General Manager of Tyco Electronics, Power Components Division from 2003 to 2005. He was previously Director of Tyco Electronics, Silicon Products Group, Circuit Protection Division from 2000 to 2003 and prior to that he held a variety of technical and senior management positions with Raychem Corporation from 1994.
Daniel A. Chandler, Senior Vice President, Quality Assurance and Operational Excellence. Mr. Chandler joined Fairchild in February of 2006 and is responsible for Global Quality and Operational Excellence, and management of the Standard Linear and Standard Discrete Group. He has 25 years of experience working in electronics related industries. Before joining Fairchild, Mr. Chandler was Corporate Director of Engineering Excellence at Tyco Electronics. Prior to that, he was the Director of Marketing and Business Development for the Circuit Protection Division at Tyco. Mr. Chandler also held various positions at Raychem Corporation including Director of Product Development, Interconnect Division and later for the Circuit Protection Division.
Robin Goodwin, Executive Vice President, Manufacturing and Supply Chain. Mr. Goodwin joined Fairchild Semiconductor as part of its founding in 1997, as the Director of Finance. He transitioned to supply chain
management in 2001 and assumed the leadership position in developing Fairchilds first global planning organization. He became Senior Vice President, Supply Chain Management in November 2005, and was promoted to his current position in May 2008. He has 28 years in the high technology industry in a combination of financial and supply chain management roles. Mr. Goodwins experience spans across OEMs, EMS and component suppliers.
Paul D. Delva, Senior Vice President, General Counsel and Corporate Secretary. Mr. Delva joined Fairchild Semiconductor in 1999. He served as the companys assistant general counsel following the companys initial public offering in 1999. Mr. Delva was promoted to Vice President and General Counsel in April 2003 and became Corporate Secretary in May 2005. He became Senior Vice President in August 2005. He has advised Fairchild on all its acquisitions and securities offerings, as well as on general corporate matters since the companys founding in 1997. Prior to joining Fairchild, he was an associate in the corporate department at Dechert, Price & Rhoads (now Dechert LLP).
Kevin B. London, Senior Vice President, Human Resources and Administration. Mr. London became Vice President of Human Resources in July 2002 and was promoted to Senior Vice President in August 2005. He has over 30 years experience in the semiconductor industry. Prior to becoming Vice President, he held various Human Resources and production management positions in the company.
Robin A. Sawyer, Vice President, Corporate Controller and Chief Accounting Officer. Ms. Sawyer has served as the companys Vice President and Corporate Controller since November 2002. She was previously Manager of Financial Planning and Analysis since joining the company in August 2000. Prior to joining the company, Ms. Sawyer was employed by Cornerstone Brands, Inc. from 1998 to 2000 as Director of Financial Planning and Reporting. Prior to that Ms. Sawyer was employed by Baker, Newman and Noyes, LLC and its predecessor firm, Ernst & Young, and is a Certified Public Accountant. Ms. Sawyer is a director of Camden National Corporation.
We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (SEC). You may read and copy any reports, statements and other information we file at the SECs Public Reference Room at 100F Fifth Street, N.E., Washington, D.C. 20549. Please call (800) SEC-0330 for further information on the Public Reference Room. The SEC maintains an Internet web site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. Our filings are also available to the public at the web site maintained by the SEC, http://www.sec.gov.
The address for our company website is http://www.fairchildsemi.com. We make available, free of charge, through our investor relations web site, our reports on Forms 10-K, 10-Q and 8-K, amendments to those reports, and other SEC filings, as soon as reasonably practicable after they are filed with the SEC. The address for our investor relations web site is http://investor.fairchildsemi.com (click on SEC filings).
We also make available, free of charge, through our corporate governance website, our corporate charter, bylaws, Corporate Governance Guidelines, charters of the committees of our board of directors, code of business conduct and ethics and other information and materials, including information about how to contact our board of directors, its committees and their members. To find this information and materials, visit our corporate governance website at http://governance.fairchildsemi.com.
A description of the risk factors associated with our business is set forth below. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business operations and financial condition.
The price of our common stock has fluctuated widely in the past and may fluctuate widely in the future.
Our common stock is traded on The New York Stock Exchange and significantly increased in value during 2010. Additionally, our stock has experienced and may continue to experience significant price and volume fluctuations that could adversely affect its market price without regard to our operating performance. We believe that factors such as quarterly fluctuations in financial results, earnings below analysts estimates and financial performance and other activities of other publicly traded companies in the semiconductor industry could cause the price of our common stock to fluctuate substantially. In addition, our common stock, the stock market in general and the market for shares of semiconductor industry-related stocks in particular have experienced extreme price fluctuations which have often been unrelated to the operating performance of the affected companies. Similar fluctuations in the future could adversely affect the market price of our common stock.
We maintain a backlog of customer orders that is subject to cancellation, reduction or delay in delivery schedules, which may result in lower than expected revenues.
We manufacture products primarily pursuant to purchase orders for current delivery or to forecast, rather than pursuant to long-term supply contracts. The semiconductor industry is occasionally subject to double booking and rapid changes in customer outlooks or unexpected build ups of inventory in the supply channel as a result of shifts in end market demand and macro economic conditions. Accordingly, many of these purchase orders or forecasts may be revised or canceled without penalty. As a result, we must commit resources to the production of products without binding purchase commitments from customers. Even in cases where our standard terms and conditions of sale or other contractual arrangements do not permit a customer to cancel an order without penalty, we may from time to time accept cancellations to maintain customer relationships or because of industry practice, custom or other factors. Our inability to sell products after we devote significant resources to them could have a material adverse effect on both our levels of inventory and revenues. While we currently believe our inventory levels are appropriate for the current economic environment, continued global economic uncertainty may result in lower than expected demand. While we anticipate increasing demand in many of our markets, lower demand than anticipated may impact our customers target inventory levels. During 2010 we successfully lowered channel inventory and we continue to carefully manage our inventory in 2011; however our current business forecasting is still qualified by the risk that our backlog may deteriorate as a result of customer cancellations.
Downturns in the highly cyclical semiconductor industry or changes in end user market demands could reduce the profitability and overall value of our business, which could cause the trading price of our stock to decline or have other adverse effects on our financial position.
The semiconductor industry is highly cyclical, and the value of our business may decline as a result of market response to this cyclicality. As we have experienced in the past, uncertainty in global economic conditions may continue to negatively affect us and the rest of the semiconductor industry, by causing us to experience backlog cancellations, higher inventory levels and reduced demand for our products. We may experience renewed, possibly severe and prolonged, downturns in the future as a result of this cyclicality. Even as demand increases following such downturns, our profitability may not increase because of price competition and supply shortages that historically accompany recoveries in demand. In addition, we may experience significant fluctuations in our profitability as a result of variations in sales, product mix, end user markets, the costs associated with the introduction of new products, and our efforts to reduce excess inventories that may have
built up as a result of any of these factors. The markets for our products depend on continued demand for consumer electronics such as personal computers, cellular telephones, tablet devices, digital cameras, and automotive, household and industrial goods. Deteriorating global economic conditions may cause these end user markets to experience decreases in demand that could adversely affect our business and future prospects.
Our failure to execute on our cost reduction initiatives and the impact of such initiatives could adversely affect our business.
We continue to take cost reduction initiatives to keep pace with the evolving economic and competitive conditions. These actions include plans to streamline and consolidate wafer manufacturing by closing our wafer manufacturing facility in Pennsylvania, closing our four-inch manufacturing line in South Korea and converting to 8 inch wafers in Salt Lake City, Utah, Bucheon, South Korea and South Portland, Maine. Additionally, we initiated several insourcing programs to replace higher-cost outside subcontractors with internal manufacturing, we lowered our materials costs and implemented workforce reductions in an effort to simplify operations, improve productivity and reduce costs.
We cannot guarantee that we will successfully implement any of these actions, or if these actions and other actions we may take will help reduce costs. Because restructuring activities involve changes to many aspects of our business, the cost reductions could adversely impact productivity and sales to an extent we have not anticipated. Even if we fully execute and implement these activities and they generate the anticipated cost savings, there may be other unforeseeable and unintended factors or consequences that could adversely impact our profitability and business.
We may not be able to develop new products to satisfy changing customer demands or we may develop the wrong products.
Our success is largely dependent upon our ability to innovate and create revenues from new product introductions. Failure to develop new technologies, or react to changes in existing technologies, could materially delay development of new products and lead to decreased revenues and a loss of market share to our competitors. The semiconductor industry is characterized by rapidly changing technologies and industry standards, together with frequent new product introductions. Our financial performance depends on our ability to identify important new technology advances and to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. While new products often command higher prices and higher profit margins, we may not successfully identify new product opportunities and develop and bring new products to market or succeed in selling them for use in new customer applications in a timely and cost-effective manner. Products or technologies developed by other companies may render our products or technologies obsolete or noncompetitive. Many of our competitors are larger, older and more established companies with greater engineering and research and development resources than us. If we fail to identify a fundamental shift in technologies or in our product markets such failure could have material adverse effects on our competitive position within the industry. In addition, to remain competitive, we must continue our efforts to reduce die sizes, develop new packages and improve manufacturing yields. We cannot assure you that we can accomplish these goals.
If some original equipment manufacturers do not design our products into their equipment, our revenue may be adversely affected.
We depend on our ability to have OEMs, or their contract manufacturers, choose our products. Frequently, an OEM will incorporate or specifically design our products into the products it produces. In such cases the OEM may identify our products, with the products of a limited number of other vendors, as approved for use in particular OEM applications. Without design wins, we may only be able to sell our products to customers as a secondary source, if at all. If an OEM designs another suppliers product into one of its applications, it is more difficult for us to achieve future design wins for that application because changing suppliers involves significant
cost, time, effort and risk for the OEM. Even if a customer designs in our products, we are not guaranteed to receive future sales from that customer. We may be unable to achieve these design wins because of competition or a products functionality, size, electrical characteristics or other aspect of its design or price. Additionally, we may be unable to service expected demand from the customer. In addition, achieving a design win with a customer does not ensure that we will receive significant revenue from that customer and we may be unable to convert design into actual sales.
We depend on demand from the consumer, original equipment manufacturer, contract manufacturing, industrial, automotive and other markets we serve for the end market applications which incorporate our products. Reduced consumer or corporate spending due to increased energy and commodity prices or other economic factors could affect our revenues.
If we provide revenue, margin or earnings per share guidance, it is generally based on certain assumptions we make concerning the health of the overall economy and our projections of future consumer and corporate spending. If our projections of these expenditures are inaccurate or based upon erroneous assumptions, our revenues, margins and earnings per share could be adversely affected. For example, beginning in the third quarter and continuing into the fourth quarter of 2008, we observed progressively weakening order rates which we attributed to uncertainty and deterioration of global economic conditions. While order rates and profitability improved throughout 2010, we cannot be certain that a change in consumer demand will not have a adverse effect on our business.
Our failure to protect our intellectual property rights could adversely affect our future performance and growth.
Failure to protect our intellectual property rights may result in the loss of valuable technologies. We rely on patent, trade secret, trademark and copyright law to protect such technologies. These laws are subject to legislative and regulatory change or through changes in court interpretations of those laws and regulations. For example, there have been recent developments in the laws and regulations governing the issuance and assertion of patents in the U.S., including modifications to the rules governing patent prosecution. There have also been court rulings on the issues of willfulness, obviousness and injunctions, that may affect our ability to obtain patents and/or enforce our patents against others. Some of our technologies are not covered by any patent or patent application. With respect to our intellectual property generally, we cannot assure you that:
In addition, effective patent, trademark, copyright and trade secret protection may be unavailable, limited or not applied for in some countries. We cannot assure that we will be able to effectively enforce our intellectual property rights in every country in which our products are sold or manufactured.
We also seek to protect our proprietary technologies, including technologies that may not be patented or patentable, in part by confidentiality agreements and, if applicable, inventors rights agreements with our collaborators, advisors, employees and consultants. We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach or that such persons or institutions will not assert rights to intellectual property arising out of such research. We have non-exclusive licenses to some of our technology from National Semiconductor, Infineon, Samsung Electronics and other companies. These companies may license such technologies to others, including our competitors or may compete with us directly. In addition, National Semiconductor and Infineon have limited royalty-free, worldwide license rights to some of our technologies. If necessary or desirable, we may seek licenses under patents or intellectual property rights claimed by others. However, we cannot assure you that we will obtain such licenses or that the terms of any offered
licenses will be acceptable to us. The failure to obtain a license from a third party for technologies we use could cause us to incur substantial liabilities and to suspend the manufacture or shipment of products or our use of processes requiring the technologies.
Our failure to obtain or maintain the right to use some technologies may negatively affect our financial results.
Our future success and competitive position depend in part upon our ability to obtain or maintain proprietary technologies used in our principal products. From time to time we are required to defend against claims by competitors and others of intellectual property infringement. Claims of intellectual property infringement and litigation regarding patent and other intellectual property rights are commonplace in the semiconductor industry and are frequently time consuming and costly. From time to time, we may be notified of claims that we may be infringing patents issued to other companies. Such claims may relate both to products and manufacturing processes. We may engage in license negotiations regarding these claims from time to time. Even though we maintain procedures to avoid infringing others rights as part of our product and process development efforts, it is impossible to be aware of every possible patent which our products may infringe, and we cannot assure you that we will be successful in our efforts to avoid infringement claims. Furthermore, even if we conclude our products do not infringe anothers patents, others may not agree. We have been and are involved in lawsuits, and could become subject to other lawsuits, in which it is alleged that we have infringed upon the patent or other intellectual property rights of other companies. For example, since October 2004, we have been in litigation with Power Integrations, Inc. See Item 3, Legal Proceedings. Our involvement in this litigation and future intellectual property litigation, or the costs of avoiding or settling litigation by purchasing licenses rights or by other means, could result in significant expense to our company, adversely affecting sales of the challenged products or technologies and diverting the efforts and attention of our technical and management personnel, whether or not such litigation is resolved in our favor. We may decide to settle patent infringement claims or litigation by purchasing license rights from the claimant, even if we believe we are not infringing, in order to reduce the expense of continuing the dispute or because we are not sufficiently confident that we would eventually prevail. In the event of an adverse outcome as a defendant in any such litigation, we may be required to:
We cannot assure you that we would be successful in such development or acquisition or that such licenses would be available under reasonable terms. Any such development, acquisition or license could require the expenditure of substantial time and other resources.
We may not be able to consummate future acquisitions or successfully integrate acquisitions into our business.
We have made numerous acquisitions of various sizes since we became an independent company in 1997 and we plan to pursue additional acquisitions of related businesses. The costs of acquiring and integrating related businesses, or our failure to integrate them successfully into our existing businesses, could result in our company incurring unanticipated expenses and losses. In addition, we may not be able to identify or finance additional acquisitions or realize any anticipated benefits from acquisitions we do complete.
We are constantly evaluating acquisition opportunities and consolidation possibilities and are frequently conducting due diligence or holding preliminary discussions with respect to possible acquisition transactions, some of which could be significant.
If we acquire another business, the process of integrating an acquired business into our existing operations may result in unforeseen operating difficulties and may require us to use significant financial resources on the acquisition that may otherwise be needed for the ongoing development or expansion of existing operations. Some of the risks associated with acquisitions include:
In addition, we may encounter unforeseen obstacles or costs in the integration of other businesses we acquire.
Possible future acquisitions could result in the incurrence of additional debt, contingent liabilities and amortization expenses related to intangible assets, all of which could have a material adverse effect on our financial condition and operating results.
We may face risks associated with dispositions of assets and businesses.
From time to time we may dispose of assets and businesses in an effort to grow our more profitable product lines. When we do so, we face certain risks associated with these exit activities, including but not limited the risk that we will disrupt service to our customers, the risk of inadvertently losing other business not related to the exit activities, the risk that we will be unable to effectively continue, terminate, modify and manage supplier and vendor relationships, and the risk that we may be subject to consequential claims from customers or vendors as a result of eliminating, or transferring the production of affected products or the renegotiation of commitments related to those products.
We depend on suppliers for timely deliveries of raw materials of acceptable quality. Production time and product costs could increase if we were to lose a primary supplier or if we experience a significant increase in the prices of our raw materials. Product performance could be affected and quality issues could develop as a result of a significant degradation in the quality of raw materials we use in our products.
Our manufacturing processes use many raw materials, including silicon wafers, gold, copper lead frames, mold compound, ceramic packages and various chemicals and gases. Our manufacturing operations depend upon our ability to obtain adequate supplies of raw materials on a timely basis. Our results of operations could be adversely affected if we were unable to obtain adequate supplies of raw materials in a timely manner or if the costs of raw materials increased significantly. If the prices of these raw materials rise significantly we may be unable to pass on our increased operating expenses to our customers. This could result in decreased profit margins for the products in which the materials are used. Results could also be adversely affected if there is a significant degradation in the quality of raw materials used in our products, or if the raw materials give rise to compatibility or performance issues in our products, any of which could lead to an increase in customer returns or product warranty claims. Although we maintain rigorous quality control systems, errors or defects may arise from a supplied raw material and be beyond our detection or control. For example, some phosphorus-containing
mold compound received from one supplier and incorporated into our products in the past resulted in a number of claims for damages from customers. We purchase some of our raw materials such as silicon wafers, lead frames, mold compound, ceramic packages and chemicals and gases from a limited number of suppliers on a just-in-time basis. From time to time, suppliers may extend lead times, limit supplies or increase prices due to capacity constraints or other factors. We subcontract a minority of our wafer fabrication needs, primarily to Taiwan Semiconductor Manufacturing Company, Advanced Semiconductor Manufacturing Corporation, Central Semiconductor Manufacturing Corporation, Jilin Magic Semiconductor, Macronix International Co. Ltd., and Phenitec Semiconductor. In order to maximize our production capacity, some of our back-end assembly and testing operations are also subcontracted. Primary back-end subcontractors include Amkor, ASE, AUK, GEM Services, Hana Semiconductor, Liteon, Tak Cheong Electronics, Greatek, Etrend, AIC and UTAC Thai Ltd. Our operations and ability to satisfy customer obligations could be adversely affected if our relationships with these subcontractors were disrupted or terminated.
Delays in expanding capacity at existing facilities, implementing new production techniques, or incurring problems associated with technical equipment malfunctions, all could adversely affect our manufacturing efficiencies.
Our manufacturing efficiency is an important factor in our profitability, and we cannot assure you that we will be able to maintain our manufacturing efficiency or increase manufacturing efficiency to the same extent as our competitors. Our manufacturing processes are highly complex, require advanced and costly equipment and are continuously being modified in an effort to improve yields and product performance. Impurities or other difficulties in the manufacturing process can lower yields. We are constantly looking for ways to expand capacity or improve efficiency at our manufacturing facilities. For example, we are currently in the process of converting our facilities in South Korea, Utah and Maine from 6 inch wafers to 8 inch wafers. As is common in the semiconductor industry, we may experience difficulty in completing transitions to new manufacturing processes at existing facilities. As a consequence, we have suffered delays in product deliveries or reduced yields in the past and may experience such delays again in the future.
We may experience delays or problems in bringing new manufacturing capacity to full production. Such delays, as well as possible problems in achieving acceptable yields, or product delivery delays relating to existing or planned new capacity could result from, among other things, capacity constraints, construction delays, upgrading or expanding existing facilities or changing our process technologies, any of which could result in a loss of future revenues. Our operating results could also be adversely affected by the increase in fixed costs and operating expenses related to increases in production capacity if revenues do not increase proportionately.
We rely on subcontractors to reduce production costs and to meet manufacturing demands, which may adversely affect our results of operations.
Many of the processes we use in manufacturing our products are complex requiring, among other things, a high degree of technical skill and significant capital investment in advanced equipment. In some circumstances, we may decide that it is more cost effective to have some of these processes performed by qualified third party subcontractors. In addition, we may utilize a subcontractor to fill unexpected customer demand for a particular product or process or to guaranty supply of a particular product that may be in great demand. More significantly, as a result of the expense incurred in qualifying multiple subcontractors to perform the same function, we may designate a subcontractor as a single source for supplying a key product or service. If a single source subcontractor were to fail to meet our contractual requirements, our business could be adversely affected and we could incur production delays and customer cancellations as a result. We would also be required to qualify other subcontractors, which would be time consuming and cause us to incur additional costs. In addition, even if we qualify alternate subcontractors, those subcontractors may not be able to meet our delivery, quality or yield requirements, which could adversely affect our results of operations. In addition to these operational risks, some of these subcontractors are smaller businesses that may not have the financial ability to acquire the advanced tools and equipment necessary to fulfill our requirements. In some circumstances, we may find it necessary to
provide financial support to our subcontractors in the form of advance payments, loans, loan guarantees, equipment financing and similar financial arrangements. In those situations, we could be adversely impacted if the subcontractor failed to comply with its financial obligations to us.
Approximately two-thirds of our sales are made to distributors who can terminate their relationships with us with little or no notice. The termination of a distributor could reduce sales and result in inventory returns.
Distributors accounted for 65% of our net sales for the year ended December 26, 2010. Our top five distributors worldwide accounted for 19% of our net sales for the year ended December 26, 2010. As a general rule, we do not have long-term agreements with our distributors, and they may terminate their relationships with us with little or no advance notice. Distributors generally offer competing products. The loss of one or more of our distributors, or the decision by one or more of them to reduce the number of our products they offer or to carry the product lines of our competitors, could have a material adverse effect on our business, financial condition and results of operations. The termination of a significant distributor, whether at our or the distributors initiative, or a disruption in the operations of one or more of our distributors, could reduce our net sales in a given quarter and could result in an increase in inventory returns.
The semiconductor business is very competitive, especially in the markets we serve, and increased competition could reduce the value of an investment in our company.
We participate in the standard component or multi-market segment of the semiconductor industry. While the semiconductor industry is generally highly competitive, the multi-market segment is particularly so. Our competitors offer equivalent or similar versions of many of our products, and customers may switch from our products to our competitors products on the basis of price, delivery terms, product performance, quality, reliability and customer service or a combination of any of these factors. Competition is especially intense in the multi-market semiconductor segment because it is relatively easy for customers to switch between suppliers of more standardized, multi-market products like ours. In the past we have experienced decreases in prices during down cycles in the semiconductor industry, and this may occur again as a result of the recent downturn in global economic conditions. Even in strong markets, price pressures may emerge as competitors attempt to gain a greater market share by lowering prices. We compete in a global market and our competitors are companies of various sizes in various countries around the world. Many of our competitors are larger than us and have greater financial resources available to them. As such, they tend to have a greater ability to pursue acquisition candidates and can better withstand adverse economic or market conditions. Additionally, companies with whom we do not currently compete may introduce new products that may cause them to compete with us in the future.
We may not be able to attract or retain the technical or management employees necessary to remain competitive in our industry.
Our continued success depends on our ability to attract, motivate and retain skilled personnel, including technical, marketing, management and staff personnel. In the semiconductor industry, the competition for qualified personnel, particularly experienced design engineers and other technical employees, is intense, particularly when the business cycle is improving. During such periods competitors may try to recruit our most valuable technical employees. While we devote a great deal of our attention to designing competitive compensation programs aimed at accomplishing this goal, specific elements of our compensation programs may not be competitive with those of our competitors and there can be no assurance that we will be able to retain our current personnel or recruit the key personnel we require.
If we must reduce our use of equity awards to compensate our employees, our competitiveness in the employee marketplace could be adversely affected. Our results of operations could vary as a result of the methods, estimates and judgments we use to value our stock-based compensation.
Like most technology companies, we have a history of using employee stock based incentive programs to recruit and retain our workforce in a competitive employment marketplace. Our success will depend in part upon
the continued use of stock options, restricted stock units, deferred stock units and performance-based equity awards as a compensation tool. We are currently seeking and we plan to seek stockholder approval in the future for increases in the number of shares available for grant under the Fairchild Semiconductor 2007 Stock Plan as well as other amendments that may be adopted from time to time which require stockholder approval. If these proposals do not receive stockholder approval, we may not be able to grant stock options and other equity awards to employees at the same levels as in the past, which could adversely affect our ability to attract, retain and motivate qualified personnel, and we may need to increase cash compensation in order to attract, retain and motivate employees, which could adversely affect our results of operations. Additionally, since 2009 we have relied almost exclusively on grants of restricted stock units, deferred stock units and performance based equity awards in place of stock options. We expect to continue that practice in 2011. While we believe that our compensation policies are competitive with our peers, we cannot provide any assurance that we have not, and will not continue in the future to lose opportunities to recruit and retain key employees as a result of these changes.
Changes in forecasted stock-based compensation expense could impact our gross margin percentage, research and development expenses, marketing, general and administrative expenses and our tax rate.
We may face product warranty or product liability claims that are disproportionately higher than the value of the products involved.
Our products are typically sold at prices that are significantly lower than the cost of the equipment or other goods in which they are incorporated. For example, our products that are incorporated into a personal computer may be sold for several dollars, whereas the personal computer might be sold by the computer maker for several hundred dollars. Although we maintain rigorous quality control systems, we manufacture and sell approximately 16 billion individual semiconductor devices per year to customers around the world, and in the ordinary course of our business we receive warranty claims for some of these products that are defective or that do not perform to published specifications. Since a defect or failure in our product could give rise to failures in the goods that incorporate them (and consequential claims for damages against our customers from their customers), we may face claims for damages that are disproportionate to the revenues and profits we receive from the products involved. We attempt, through our standard terms and conditions of sale and other customer contracts, to limit our liability by agreeing only to replace the defective goods or refund the purchase price. Nevertheless, we have received claims for other charges, such as for labor and other costs of replacing defective parts or repairing the products into which the defective products are incorporated, lost profits and other damages. In addition, our ability to reduce such liabilities, whether by contracts or otherwise, may be limited by the laws or the customary business practices of the countries where we do business. And, even in cases where we do not believe we have legal liability for such claims, we may choose to pay for them to retain a customers business or goodwill or to settle claims to avoid protracted litigation. Our results of operations and business could be adversely affected as a result of a significant quality or performance issue in our products, if we are required or choose to pay for the damages that result. For example, from 2001 to 2008 we received claims from a number of customers seeking damages resulting from certain products manufactured with a phosphorus-containing mold compound, and we were named in lawsuits relating to these mold compound claims.
Our operations and business could be significantly harmed by natural disasters.
Our manufacturing facilities in China, South Korea, Malaysia, the Philippines and the many of the third party contractors and suppliers that we currently use are located in countries that are in seismically active regions of the world where earthquakes and other natural disasters, such as floods and typhoons may occur. While we take precautions to mitigate these risks, we cannot be certain that they will be adequate to protect our facilities in the event of a major earthquake, flood, typhoon or other natural disaster. Although we maintain insurance for some of the damage that may be caused by natural disasters, our insurance coverage may not be sufficient to cover all of our potential losses and would not cover us for lost business. As a result, a natural disaster in one of these regions could severely disrupt the operation of our business and have a material adverse effect on our financial condition and results of operations.
Our international operations subject our company to risks not faced by domestic competitors.
Through our subsidiaries we maintain significant operations and facilities in the Philippines, Malaysia, China, South Korea and Singapore. We have sales offices and customers around the world. Approximately 72% of our revenues in fiscal year 2010 were from Asia. The following are some of the risks inherent in doing business on an international level:
We acquired significant operations and revenues when we acquired a business from Samsung Electronics and, as a result, are subject to risks inherent in doing business in Korea, including political risk, labor risk and currency risk.
As a result of the acquisition of the power device business from Samsung Electronics in 1999, we have significant operations and sales in South Korea and are subject to risks associated with doing business there. Korea accounted for approximately 13% of our revenue for the year ended December 26, 2010.
Relations between South Korea and North Korea have been tense over most of South Koreas history, and more recent concerns over North Koreas nuclear capability, and relations between the U.S. and North Korea, have created a global security issue that may adversely affect Korean business and economic conditions. We cannot assure you as to whether or when this situation will be resolved or change abruptly as a result of current or future events. An adverse change in economic or political conditions in South Korea or in its relations with North Korea could have a material adverse effect on our Korean subsidiary and our company. In addition to other risks disclosed relating to international operations, some businesses in South Korea are subject to labor unrest.
Our Korean sales are increasingly denominated primarily in U.S. dollars while a significant portion of our Korean operations costs of goods sold and operating expenses are denominated in South Korean won. Although we have taken steps to fix the costs subject to currency fluctuations and to balance won revenues and won costs as much as possible, a significant change in this balance, coupled with a significant change in the value of the won relative to the dollar, could have a material adverse effect on our financial performance and results of operations (see Item 7a, Quantitative and Qualitative Disclosures about Market Risk).
A change in foreign tax laws or a difference in the construction of current foreign tax laws by relevant foreign authorities could result in us not recognizing any anticipated benefits.
Some of our foreign subsidiaries have been granted preferential income tax or other tax holidays as an incentive for locating in those jurisdictions. A change in the foreign tax laws or in the construction of the foreign tax laws governing these tax holidays, or our failure to comply with the terms and conditions governing the tax holidays, could result in us not recognizing the anticipated benefits we derive from them, which would decrease our profitability in those jurisdictions. We continue to monitor the tax holidays, the income tax laws governing the tax holidays, and our compliance with the terms and conditions of the tax holidays, to ensure that the current and future tax impacts on our subsidiaries in these countries are anticipated and refined.
We have significantly expanded our manufacturing operations in China and, as a result, will be increasingly subject to risks inherent in doing business in China, which may adversely affect our financial performance.
We expect a significant portion of our production from our Suzhou, China facility will be exported out of China, however, we are hopeful that a significant portion of our future revenue will result from the Chinese markets in which our products are sold, and from demand in China for goods that include our products. Our ability to operate in China may be adversely affected by changes in that countrys laws and regulations, including those relating to taxation, foreign exchange restrictions, import and export tariffs, environmental regulations, land use rights, property and other matters. In addition, our results of operations in China are subject to the economic and political situation there. We believe that our operations in China are in compliance with all applicable legal and regulatory requirements. However, there can be no assurance that Chinas central or local governments will not impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures. Changes in the political environment or government policies could result in revisions to laws or regulations or their interpretation and enforcement, increased taxation, restrictions on imports, import duties or currency revaluations. In addition, a significant destabilization of relations between China and the U.S. could result in restrictions or prohibitions on our operations or the sale of our products in China. The legal system of China relating to foreign trade is relatively new and continues to evolve. There can be no certainty as to the application of its laws and regulations in particular instances. Enforcement of existing laws or agreements may be sporadic and implementation and interpretation of laws inconsistent. Moreover, there is a high degree of fragmentation among regulatory authorities resulting in uncertainties as to which authorities have jurisdiction over particular parties or transactions.
We are subject to many environmental laws and regulations that could affect our operations or result in significant expenses.
Increasingly stringent environmental regulations restrict the amount and types of pollutants that can be released from our operations into the environment. While the cost of compliance with environmental laws has not had a material adverse effect on our results of operations historically, compliance with these and any future regulations could require significant capital investments in pollution control equipment or changes in the way we make our products. In addition, because we use hazardous and other regulated materials in our manufacturing processes, we are subject to risks of liabilities and claims, regardless of fault, resulting from our use, transportation, emission, discharge, storage, recycling or disposal of hazardous materials, including personal injury claims and civil and criminal fines, any of which could be material to our cash flow or earnings. For example:
Although most of our known environmental liabilities are covered by indemnification agreements with Raytheon Company, National Semiconductor, Samsung Electronics and Intersil Corporation, these indemnities are limited to conditions that occurred prior to the consummation of the transactions through which we acquired facilities from those companies. Moreover, we cannot assure you that their indemnity obligations to us for the covered liabilities will be available, or, if available, adequate to protect us.
Our senior credit facility limits our flexibility and places restrictions on the manner in which we run our operations.
At December 26, 2010, we had total debt of $320.7 million and the ratio of this debt to equity was approximately 0.3 to 1. As of December 26, 2010, our senior credit facility includes $320.7 million in term loans
and the $100 million revolving line of credit. Adjusted for outstanding letters of credit, we had up to $98.8 million available under the revolving loan portion of the senior credit facility. In addition, there is a $150 million uncommitted incremental term loan feature. Despite the significant reductions we have made in our long-term debt, we continue to carry indebtedness which could have significant consequences on our operations. For example, it could:
We may not be able to generate the necessary amount of cash to service our indebtedness, which may require us to refinance our indebtedness or default on our scheduled debt payments. Our ability to generate cash depends on many factors beyond our control.
Our historical financial results have been, and we anticipate that our future financial results may be subject to substantial fluctuations. While we currently have sufficient cash flow to satisfy all of our current obligations, we cannot assure you that our business will continue to generate sufficient cash flow from operations to enable us to pay our indebtedness or to fund our other liquidity needs in the future. Further, we can make no assurances that our currently anticipated cost savings and operating improvements will be realized on schedule or at all, or that future borrowings will be available to us under our senior credit facility in an amount sufficient to satisfy our liquidity needs. In addition, because our senior credit facility has a variable interest rate, our cost of borrowing will increase if market interest rates increase. If we are unable to meet our expenses and debt obligations, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or raise equity. We cannot assure you that we would be able to renew or refinance any of our indebtedness, sell assets or raise equity on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Restrictions imposed by the credit agreement relating to our senior credit facility restrict or prohibit our ability to engage in or enter into some business operating and financing arrangements, which could adversely affect our ability to take advantage of potentially profitable business opportunities.
The operating and financial restrictions and covenants in the credit agreement relating to our senior credit facility may limit our ability to finance our future operations or capital needs or engage in other business activities that may be in our interests. The credit agreement imposes significant operating and financial restrictions on us that affect our ability to incur additional indebtedness or create liens on our assets, pay dividends, sell assets, engage in mergers or acquisitions, make investments or engage in other business activities. These restrictions could place us at a disadvantage relative to our competitors many of which are not subject to such limitations.
In addition, the senior credit facility also requires us to maintain specified financial ratios. Our ability to meet those financial ratios can be affected by events beyond our control, and we cannot assure you that we will meet those ratios. As of December 26, 2010, we were in compliance with these ratios. A breach of any of these covenants, ratios or restrictions could result in an event of default under the senior credit facility. Upon the occurrence of an event of default under the senior credit facility, the lenders could elect to declare all amounts outstanding under the senior credit facility, together with accrued interest, to be immediately due and payable. If we were unable to repay those amounts, the lenders could proceed against our assets, including any collateral granted to them to secure the indebtedness. If the lenders under the senior credit facility accelerate the payment of the indebtedness, we cannot assure you that our assets would be sufficient to repay in full that indebtedness and our other indebtedness.
We have investments in auction rate securities that subject us to market risk which could adversely affect our liquidity and financial results.
As of December 26, 2010, we owned auction rate securities with a par value of $49.5 million and market value of $28.0 million. We originally purchased these securities believing them to be safe, short-term and highly liquid investments. However, as a result of the systemic failure of the auction rate securities market, these securities are no longer liquid. While we continue to accrue and receive interest on these securities at the contractual rate, there can be no assurance that there will ever be an active market for our auction rate securities. Uncertainties in the credit and capital markets could lead to further downgrades of our auction rate securities and additional impairments. Additionally, auction failures have limited our ability to fully recover the par value of our investment in the short term and even if we hold the securities to maturity, the long-term value of the auction rate securities may potentially be impacted by issuer defaults. We do not anticipate that the lack of liquidity or future downgrades and impairments will materially impact our ability to fund out working capital needs, capital expenditures or other business requirements.
We have no unresolved comments from the Securities and Exchange Commission as of February 24, 2011.
We maintain manufacturing and office facilities around the world including the U.S., Asia and Europe. The following table provides information about these facilities at December 26, 2010.
Leases affecting the Penang, Suzhou and Cebu facilities are generally in the form of long-term ground leases, while we own improvements on the land. In some cases we have the option to renew the lease term, while in others we have the option to purchase the leased premises. We also have the ability to cancel these leases at any time. In addition to the facilities listed above we maintain smaller offices in leased spaces around the world.
We believe that our facilities around the world, whether owned or leased, are well maintained and are generally suitable and adequate to carry on the companys business. Our manufacturing facilities contain sufficient productive capacity to meet our needs for the foreseeable future.
There are four outstanding proceedings with Power Integrations.
POWI 1: On October 20, 2004, we and our wholly owned subsidiary, Fairchild Semiconductor Corporation, were sued by Power Integrations, Inc. in the U.S. District Court for the District of Delaware. Power Integrations alleged that certain of our pulse width modulation (PWM) integrated circuit products infringed four Power Integrations U.S. patents, and sought a permanent injunction preventing us from manufacturing, selling or offering the products for sale in the U.S., or from importing the products into the U.S., as well as money damages for past infringement.
The trial in the case was divided into three phases. In the first phase of the trial that occurred in October of 2006, a jury returned a verdict finding that thirty-three of our PWM products willfully infringed one or more of seven claims asserted in the four patents and assessed damages against us. We voluntarily stopped U.S. sales and importation of those products in 2007 and have been offering replacement products since 2006. Subsequent phases of the trial conducted during 2007 and 2008 focused on the validity and enforceability of the patents. In December of 2008, the judge overseeing the case reduced the jurys 2006 damages award from $34 million to approximately $6.1 million and ordered a new trial on the issue of willfulness. The new trial was held in June of 2009 and then in January of 2011 the court awarded Power Integrations final damages in the amount of $12.2 million. We have challenged the final damages award, willfulness finding, injunction, and other issues on appeal. As a result of the appeal, we likely will be required to post a bond or provide other security in an amount equal to the final damages award for the duration of the appeal process.
POWI 2: On May 23, 2008, Power Integrations filed another lawsuit against us, Fairchild Semiconductor Corporation and our wholly owned subsidiary System General Corporation in the U.S. District Court for the District of Delaware, alleging infringement of three patents. Of the three patents claimed in this lawsuit, two are patents that were asserted against us and Fairchild Semiconductor Corporation in the October 2004 lawsuit described above. As mentioned below, the majority of the claims asserted in the first lawsuit from these two patents have now received final rejections from the patent office, and the third patent has also received preliminary rejections. We believe we have strong defenses against Power Integrations claims and intend to vigorously defend this second lawsuit.
On October 14, 2008, Fairchild Semiconductor Corporation and System General Corporation filed a patent infringement lawsuit against Power Integrations in the U.S. District Court for the District of Delaware, alleging that certain PWM integrated circuit products infringe one or more claims of three U.S. patents owned by System General. The lawsuit seeks monetary damages and an injunction preventing the manufacture, use, sale, offer for sale or importation of Power Integrations products found to infringe the asserted patents.
Both lawsuits have been consolidated and will be heard together in Delaware District Court.
POWI 3: On November 4, 2009, Power Integrations, Inc. filed a complaint for patent infringement against us and two of our subsidiaries in the United States District Court for the Northern District of California alleging that several of our products infringe three of Power Integrations patents. One of those patents has since been dropped from the case. We intend to put on a vigorous defense against these claims. In the same lawsuit we have filed counterclaims against Power Integrations, alleging Power Integrations products infringe certain claims of one of our patents.
Reexaminations: Parallel to the above federal court proceedings, we also petitioned the U.S. Patent and Trademark Office (USPTO) for reexamination of all unexpired patents claims asserted in POWI 1 and POWI 2 (those being all asserted claims from three of the four patents asserted in POWI 1 (the fourth patent has expired) and all of the patent claims asserted in POWI 2). Of the 24 claims at issue in the three patents from POWI 1, 22 have received final rejection from the USPTO. In POWI 2, all claims from the third patent which was asserted against us (from the patent which was not previously asserted in POWI 1) have been initially rejected by the USPTO.
POWI 4: On February 10, 2010 Fairchild and System General filed a lawsuit in Suzhou, China against four Power Integrations entities and seven vendors. The lawsuit claims that Power Integrations violates four Fairchild/System General patents. Fairchild is seeking an injunction against the Power Integration products and over $17.0 million in damages. Power Integrations is currently seeking to invalidate the Fairchild/System General patents in proceedings before the Chinese patent office.
Other Legal Claims. From time to time we are involved in legal proceedings in the ordinary course of business. We believe that there is no such ordinary-course litigation pending that could have, individually or in the aggregate, a material adverse effect on our business, financial condition, results of operations or cash flows.
We have analyzed the potential litigation outcomes from our current litigation in accordance with the Contingency Topic of the FASB ASC. While the exact amount of these losses is not known, we have recorded net reserves for potential litigation outcomes in the consolidated statement of operations, based upon our assessments of the potential liability using an analysis of the claims and historical experience in defending and/or resolving these claims. As of December 26, 2010, the balance for potential litigation outcomes was $14.7 million. There was a ruling on damages for $6.1 million and in January 2011, the judge in the case awarded POWI an additional $6.1 million on the willfulness portion of the trial.
There were no matters submitted to a vote of security holders during the period beginning September 27, 2010 and ending on December 26, 2010.
Our common stock trades on the New York Stock Exchange under the trading symbol FCS. The following table sets forth, for the periods indicated, the high and low intraday sales prices per share of Fairchild Semiconductor International, Inc. Common Stock, as quoted on the NYSE.
As of February 21, 2011 there were approximately 159 holders of record of our Common Stock. We have not paid dividends on our common stock in any of the years presented above and have no present intention of doing so. Certain agreements, pursuant to which we have borrowed funds, contain provisions that limit the amount of dividends and stock repurchases that we may make. See Item 7, Liquidity and Capital Resources and Note 7 to our Consolidated Financial Statements contained in Item 8 of this report, for further information about restrictions to our ability to pay dividends.
Securities Authorized for Issuance Under Equity Compensation Programs
The following table provides information about the number of stock options, deferred stock units (DSUs), restricted stock units (RSUs) and performance units (PUs) outstanding and authorized for issuance under all equity compensation plans of the company on December 26, 2010. The notes under the table provide important additional information.
The material terms of the 2000 Executive Plan, the Stock Plan and the 2007 Stock Plan are described in Note 8 to the companys Consolidated Financial Statements contained in Item 8 of this report, and the three plans are included as exhibits to this report.
Unregistered Sales of Equity Securities and Use of Proceeds
There were no sales of unregistered equity securities in the fourth quarter of 2010. The company also did not make any purchases of its own common stock during the fourth quarter of 2010.
Stockholder Return Performance
The following graph compares the change in total stockholder return on the companys common stock against the total return of the Standard & Poors 500 Index and the Philadelphia Stock Exchange Semiconductor Index from December 23, 2004, the last day our common stock was traded on the New York Stock Exchange before the beginning of our fifth preceding fiscal year, to December 24, 2010, the last trading day in our fiscal year ended December 26, 2010. Total return to stockholders is measured by dividing the per-share price change for the period by the share price at the beginning of the period. The graph assumes that investments of $100 were made on December 23, 2005 in our common stock and in each of the indexes.
The following table sets forth our selected historical consolidated financial data. The historical consolidated financial data as of December 26, 2010 and December 27, 2009 and for the years ended December 26, 2010, December 27, 2009, and December 28, 2008 are derived from our audited Consolidated Financial Statements, contained in Item 8 of this report. The historical consolidated financial data as of December 28, 2008, December 30, 2007 and December 31, 2006 and for the years ended December 30, 2007 and December 31, 2006 are derived from our audited Consolidated Financial Statements, which are not included in this report. This information should be read in conjunction with our audited Consolidated Financial Statements and Managements Discussion and Analysis of Financial Condition and Results of Operations.
Adjusted net income and loss, adjusted gross margin, and free cash flow are also included in the table below and are non-GAAP financial measures and should not be considered replacement for GAAP results. We present the adjusted results because we use them as additional measures of our operating performance, and believe the adjusted financial information is useful to investors because it illuminates underlying operational trends by excluding significant non-recurring or otherwise unusual transactions not related to our base business. Our criteria for determining adjusted results may differ from methods used by other companies and should not be considered as alternatives to net income or loss, gross margin, or other measures of consolidated operations and cash flow data prepared in accordance with US GAAP as indicators of our operating performance or as alternatives to cash flow as a measure of liquidity.
Our results for the years ended December 26, 2010, December 27, 2009, December 28, 2008, and December 30, 2007 each consist of 52 weeks, while results for the year ended December 31, 2006 consists of 53 weeks.
We did not pay cash dividends on our common stock in any of the years presented above.
This discussion and analysis of financial condition and results of operations is intended to provide investors with an understanding of our past performance, financial condition and prospects. We will discuss and provide our analysis of the following:
We entered 2010 as a leaner and more focused company positioned to gain market share and accelerate the improvement of our business in 2010 and beyond. During the year, we delivered strong financial performance and significantly strengthened our balance sheet. We also built a combination of technologies, products and supply chain capabilities to support our target markets as we continue to develop innovative analog and power management solutions that enable greater energy efficiency and wireless mobility.
We continue to proactively take actions to keep inventory as lean as possible while maintaining customer service. We prefer to maintain maximum flexibility by adjusting internal inventories in response to higher demand before adding more inventory to our distribution channels. We continue to manage our production output to maintain channel inventories within our new lower target range of 7.5 to 8.5 weeks. We ended 2010 with channel inventories at 8 weeks. Internal inventories increased by $43.2 million during 2010, however days of internal inventory decreased by almost 12 days during the same time frame.
MCCCs main focus is to supply the mobile, computing, consumer and communication end market segments with innovative power and signal path solutions including our low voltage MOSFETs, Power Management ICs, Mixed Signal Analog and Logic products. We seek to deliver exceptional product performance by optimizing silicon processes and application specific design to satisfy specific requirements for our customers. This enables us to deliver solutions with greater energy efficiency and smaller footprint than is commonly available. We expect a steady acceleration of new product sales especially for solutions targeted to the handset and ultraportable market.
PCIAs focus is to capitalize on the growing demand for greater energy efficiency in power supplies, consumer electronics, battery chargers, electric motors, industrial electronics and automobiles. We are a leader in power factor correction, low standby power consumption designs, innovative switching techniques and power module technology that enable greater efficiency and better performance. Improving the efficiency of our customers products is vital to meeting new energy efficiency regulations. Effectively managing the power conversion and initial voltage regulation in power supplies is one of the greatest opportunities we have to improve overall system efficiency. We believe the growing global focus on energy efficiency will continue to drive growth in this product line.
SDT products are core building block components for many electronic applications. This segment is moving to a more simplified and focused operating model to make the selling and support of these products easier and more profitable. The right operational structure and part portfolio should enable our standard products group to continue to generate solid cash flow with minimal investment.
Our results for the years ended December 26, 2010, December 27, 2009, and December 28, 2008 each consist of 52 weeks.
Results of Operations
The following table summarizes certain information relating to our operating results as derived from our audited consolidated financial statements as well as certain unaudited non-GAAP financial measures.
Year Ended December 26, 2010 Compared to Year Ended December 27, 2009
Total Revenues. Total revenues for 2010 increased $412.2 million, or 35%, as compared to 2009. The increase in revenue was primarily driven by an increase in unit sales as a result of stronger demand and an increase in average selling prices when compared to 2009.
Geographic revenue information is based on the customer location within the indicated geographic region. The following table presents, as a percentage of sales, geographic sales for the Americas, Europe, China, Taiwan, Korea and Other Asia/Pacific (which for our geographic reporting purposes includes Japan and Singapore) for 2010 and 2009. We made solid progress increasing our industrial and automotive sales in the U.S. during 2010,
leading to the increased revenue as a percentage of sales over the same periods in 2009. Taiwan and China showed decreases in their percentage of sales over the same periods of 2009 resulting primarily from price erosion. All other locations had minimal percentage changes.
Gross Margin. During 2010 gross margin dollars increased by $272.7 million and gross margin percent improved from 24.4% to 35.2% as compared to 2009. The increase in gross margin is due to increased revenue, higher unit volumes, improvement in product mix, and lower manufacturing unit costs as a result of higher factory utilization due to higher demand.
Adjusted Gross Margin. In 2010, adjusted gross margin dollars increased by $266.2 million and adjusted gross margin percent improved from 25.2% to 35.4% as compared to 2009 for the reasons listed above. Adjusted gross margin does not include the accelerated depreciation due to the planned closure of the Mountaintop facility. See reconciliation of gross margin to adjusted gross margin above.
Operating Expenses. Research and development (R&D) expenses increased during 2010 as compared to 2009 primarily due to increases in variable compensation and as a result of increased investment in R&D programs, including the establishment of a new design center in Irvine, California and the acquisition of a small early stage micro-electromechanical system (MEMS) company. Increases in selling expenses were driven by higher variable compensation, increased travel expenses as well as higher sales commissions. General and administrative (G&A) expenses also increased during 2010 as compared to the 2009 due to increases in variable compensation, increases in equity compensation, and other payroll related increases including merit and headcount increases. Increased travel, higher legal expenses and the reinstatement of benefits that were temporarily suspended in early 2009 also drove the increase in G&A.
Restructuring and Impairments. During 2010, we recorded restructuring and impairment charges, net of releases, totaling $7.0 million. The charges include $3.9 million of employee separation costs associated with the 2010 Infrastructure Realignment Program. In addition, during 2010, we recorded $4.5 million of employee separation costs, $1.7 million of fab closure costs, and $0.4 million in reserve releases, all associated with the 2009 Infrastructure Realignment Program. The company also recorded $0.3 million in reserve releases associated with the 2008 Infrastructure Realignment Program. During 2010, we also reversed $2.4 million of restructuring expense associated with the 2008 Infrastructure Realignment Program. The reversal of $2.4 million of restructuring expense relates to the fourth quarter of 2008 and the first six months of 2009 as pension payments to severed employees were recorded as restructuring expense instead of offsetting the net pension asset. At the time, these pension payments were paid out of operating cash instead of the pension fund. In the second quarter of 2010, we were reimbursed by the pension fund. We have evaluated this out of period adjustment and determined it to be immaterial.
The 2010 Infrastructure Realignment Program includes costs to simplify and realign some activities within the MCCC segment, costs for the continued refinement of the companys manufacturing strategy, and costs associated with centralizing the companys accounting functions.
During 2009, we recorded restructuring and impairment charges, net of releases, totaling $27.9 million. The charges included $15.4 million in employee separation costs, $1.6 million in asset impairment costs, $4.0 million in facility closure costs and $0.1 million in reserve releases, all associated with the 2009 Infrastructure Realignment Program. In addition during 2009, we recorded $7.0 million in employee separation costs, $0.7 million lease impairment costs and $0.6 million in reserve releases associated with the 2008 Infrastructure Realignment Program as well as $0.01 million in reserve releases associated with the 2007 Infrastructure Realignment Program.
The 2009 Infrastructure Realignment Program includes costs associated with the planned closure of the Mountaintop, Pennsylvania manufacturing facility and the four-inch manufacturing line in Bucheon, South Korea, both of which were announced in the first quarter of 2009. The 2009 Program also includes charges for a smaller worldwide cost reduction plan to further right-size our company and remain financially healthy.
The consolidation of the South Korea fabrication processes and the planned closure of the Mountaintop facility were expected to be completed during the second quarter of 2011. During the third quarter of 2010, we decided to extend the Mountaintop closure until the end of 2012 to better support strong customer demand and our significant pipeline of new products. Once the planned closure of the Mountaintop facility and the consolidation of South Korea fabrication process are complete we expect to achieve annualized cost savings ranging from $20 to $25 million from the 2008 baseline. We anticipate that the financial impact of higher revenues as a result of extending the Mountaintop closure will more than offset the cost savings delayed from continuing to operate the facility. We expect to transfer the majority of Mountaintops manufacturing capacity to other Fairchild facilities and support similar revenue levels upon closure.
The 2009 worldwide restructuring action, excluding facility closures, is substantially complete and reduced headcount by 270 employees. We achieved annual savings associated with these employee separations of $13.8 million by the end of 2009.
Charge (Release) for Litigation. In 2010, we increased our reserves for potential litigation outcomes by $8.0 million as a result of the recent willfulness ruling in the POW1 litigation. In 2009, we paid $6.0 million to settle patent litigation with Infineon. (see Item 8, Note 15 of this report for additional information).
Other Expense, net. The following table presents a summary of Other expense, net for 2010 and 2009, respectively.
Interest expense. Interest expense in 2010 decreased $11.4 million as compared to 2009, primarily due to lower interest rates on outstanding debt and lower debt balances.
Interest income. Interest income in 2010 decreased $0.6 million as compared to 2009, as a result of lower rates of return.
Income Taxes. Income tax expense in 2010 was $21.5 million on income before taxes of $174.7 million, as compared to income tax benefit of $3.1 million on loss before taxes of $63.3 million for 2009. The effective tax rate for 2010 was 12.3 % compared to 4.9% for 2009. The change in effective tax rate is primarily due to shifts of income and loss among jurisdictions with differing tax rates, foreign currency revaluations of tax assets and liabilities, foreign tax withholding liabilities and discrete tax benefits as a result of finalization of certain tax
filings in the prior year. In 2010, we decreased unrecognized tax benefits by $10.4 million representing the settlement of a Korea income tax audit. The decrease was due to cash payments payable to the taxing authority along with the effective settlement of other unrecognized tax benefits. There was no net material impact to the effective tax rate as a result of the settlement of the Korea income tax audit. In 2010, the valuation allowance on our deferred tax assets decreased by $3.5 million. The overall decrease did not impact our results of operations.
In accordance with the Income Taxes Topic in the FASB Accounting Standards Codification (ASC), deferred taxes have not been provided on undistributed earnings of foreign subsidiaries which are reinvested indefinitely. Certain non-U.S. earnings, which have been taxed in the U.S. but earned offshore, have and continue to be part of our repatriation plan. As of December 26, 2010, we have recorded a deferred tax liability of $1.1 million, with no impact to the consolidated statement of operations as we have a full valuation allowance against our net U.S. deferred tax assets.
Free Cash Flow. Free cash flow is a non-GAAP financial measure. To determine free cash flow, we subtract capital expenditures from cash provided by operating activities. Free Cash flow increased approximately $45.9 million in 2010 as a result of increased cash provided by operating activities offset by an increase in capital expenditures of $98.2 million. See Free Cash Flow reconciliation in Item 6.
Reportable Segments. The following table represents comparative disclosures of revenue and gross margin of our reportable segments.
MCCC revenues increased $131.9 million or approximately 25% in 2010 as compared to 2009. Higher revenue was due to stronger unit demand with improvements in overall market conditions, business gained on newly released higher value parts, and additional market share with several customers. We also continued to see solid growth in our MOSFET and Mobile products. Average selling prices in 2010 were fairly flat when compared to 2009. Gross margin dollars increased $100.2 million in 2010, as compared to 2009. Increased gross margin was attributable to higher revenue, lower manufacturing unit costs as a result of increased factory utilization, and the introduction of new products at higher gross margins.
MCCC had operating income of $155.7 million in 2010, as compared to $74.2 million in 2009. Higher operating income from better gross margin was offset in part by additional operating expenses from higher variable costs on stronger unit demand as well as an increase in R&D and SG&A expense due to increased variable compensation, the reinstatement of certain employee benefits which were temporarily suspended in early 2009, the establishment of a new design center, and acquisition of a small early stage MEMS company.
PCIA revenues increased $231.2 million or approximately 43% in 2010 as compared to 2009. Revenue was higher in all product lines due to increased overall unit demand and to a lesser degree higher average selling prices, offset in part by continued reduction in distribution channel inventory. Gross margin dollars increased $142.6 million in 2010, as compared to 2009. Increased gross margin was driven by higher revenue, improved product mix, and lower manufacturing unit costs as a result of increased factory utilization somewhat offset by an unfavorable impact from a strengthening of the Korean Won.
PCIA had operating income of $204.1 million in 2010, as compared to $71.6 million in 2009. Increased operating income was mainly attributed to higher gross margin as mentioned above. The increase was partially offset by higher R&D and SG&A expense due to increased variable compensation and the reinstatement of certain employee benefits which were temporarily suspended in early 2009. In addition, there was further investment in R&D programs, increased travel, and an unfavorable impact from a strengthening of the Korean Won.
SDT revenues increased $49.2 million or approximately 38% in 2010 as compared to 2009. The improvement in revenue was driven by increased unit demand and higher average selling prices as well as new design wins in lighting, power supply, motor control and consumer applications going into production. Gross margin dollars was increased by $28.0 million in 2010, as compared to 2009. Increased gross margin was driven mainly by better unit demand and improved product mix, as lower margin products were mixed out to make room for new design wins.
SDT had operating income of $37.1 million in 2010, compared to $9.8 million in 2009. The improvement in operating income was due to higher gross margin as well as lower overall operating expenses as a percentage of revenue. In total, operating expenses were up slightly year to date with marketing expenses higher as a result of variable compensation and other volume related marketing expenses, mitigated in part by lower R&D and G&A expenses as a result of a reallocation of resources.
Year Ended December 27, 2009 Compared to Year Ended December 28, 2008
Total Revenues. Total revenues for 2009 decreased $386.7 million, or 24.6%, as compared to 2008. The decline in revenue was primarily driven by a decrease in unit volumes due to reduced market demand as a result of the global recession.
Geographic revenue information is based on the customer location within the indicated geographic region. The following table presents, as a percentage of sales, geographic sales for the Americas, Europe, China, Taiwan, Korea and Other Asia/Pacific (which for our geographic reporting purposes includes Japan and Singapore) for 2009 and 2008. The decrease in the percentage of revenue in Taiwan resulted from a reduction in demand for desktop and notebook computers. The percentage of revenue in China increased as a result of new design wins and stronger demand for our smart power module products and high performance MOSFETS. This increase in demand was driven by a government sponsored household appliance subsidy program for the rural Chinese population.
Gross Margin. Gross margin dollars decreased approximately 36.3% in 2009 as compared to 2008 due to decreased revenue, lower unit volumes and higher manufacturing unit costs as a result of lower factory utilization. This lower factory utilization was a result of lower demand as well as efforts to reduce internal and distribution inventory. In addition, gross margin in 2009 was impacted by accelerated depreciation due to the closure of the Mountaintop facility.
Adjusted Gross Margin. Adjusted gross margin is a non-GAAP financial measure. Adjusted gross margin dollars decreased approximately 34.2% in 2009 as compared to 2008 due the reasons listed above. However, adjusted gross margin in 2009 does not included the impact of accelerated depreciation due to the closure of the Mountaintop facility. See reconciliation of gross margin to adjusted gross margin in Item 6.
Operating Expenses. Research and development (R&D) and sales, general and administrative (SG&A) expenses decreased in 2009, as compared to 2008. R&D and SG&A expenses decreased due to cost reduction efforts implemented in 2008 and the first half of 2009. Our employee base was reduced, discretionary spending was cut and a number of temporary benefit reductions were implemented. Several of these benefit reductions were reinstated in the third quarter of 2009. In addition, equity and variable compensation expense was reduced in 2009.
Restructuring and Impairments. During 2009, we recorded restructuring and impairment charges, net of releases, of $27.9 million. The charges included $15.4 million in employee separation costs, $1.6 million in asset impairment costs, $4.0 million in facility closure costs and $0.1 million in reserve releases, all associated with the 2009 Infrastructure Realignment Program. In addition during 2009, we recorded $7.0 million in employee separation costs, $0.7 million lease impairment costs and $0.6 million in reserve releases associated with the 2008 Infrastructure Realignment Program as well as $.01 million in reserve releases associated with the 2007 Infrastructure Realignment Program.
The closure of the Mountaintop, Pennsylvania manufacturing facility and the four-inch manufacturing line in Bucheon, South Korea was announced in the first quarter of 2009 and the charges associated with those programs are included in the 2009 Infrastructure Realignment Program. The 2009 Infrastructure Realignment Program also includes charges for a smaller worldwide cost reduction plan to further right-size our company and remain financially healthy.
The 2009 worldwide restructuring action, excluding facility closures, is complete and reduced headcount by 270 employees. We achieved annual savings associated with these employee separations of $13.8 million by the end of 2009. Once the planned closure of the Mountaintop facility and the consolidation of South Korea fabrication process are complete we expect to achieve annualized cost savings ranging from $20 to $25 million from the 2008 baseline. We anticipate that the financial impact of higher revenues as a result of extending the Mountaintop closure will more than offset the cost savings delayed from continuing to operate the facility. We expect to transfer the majority of Mountaintops manufacturing capacity to other Fairchild facilities and support similar revenue levels upon closure.
During 2008, we recorded restructuring and impairment charges, net of releases, totaling $29.2 million. The charges included $14.0 million in employee separation costs, $1.9 million lease impairment costs for the streamlining of warehouse operations, $12.2 million in asset impairment costs, $0.1 million in office closure costs and $0.3 million in reserve releases, all associated with the 2008 Infrastructure Realignment Program. In addition, we recorded $1.3 million in employee separation costs associated with the 2007 Infrastructure Realignment Program.
The majority of charges in 2008 related to several asset impairments for non-industry standard packaging capacity and simplification of our supply chain planning systems. We also adjusted the workforce mix in our Maine fab as we converted to a more automated and technologically advanced eight-inch wafer production process. In addition, we reduced headcount in certain sales and marketing activities to further streamline selling, general and administration costs.
We have completed payment of the employee severance accruals related to the 2008 Infrastructure Realignment Program. This action impacted approximately 1,051 manufacturing and non-manufacturing personnel. We achieved annualized cost savings associated with the employee separation costs of approximately $30.7 million. Payouts associated with the 2008 lease impairment will be made on a regular basis and will be complete by the fourth quarter of 2011.
Charge (Release) for Litigation. In 2009, we paid $6.0 million to settle patent litigation with Infineon. In 2008, we reduced our reserves for potential litigation outcomes by $3.3 million due to a court ruling that reduced the damages awarded in the ongoing Power Integrations lawsuit (see Item 8, Note 15 of this report for additional information).
Goodwill Impairment Charge. In 2008, after completing step one of the impairment test, we determined that the estimated fair value of our PCIA and SPG reporting units was less than the net book value of those reporting units which required us to complete the second step of the impairment test. Upon completion of step two of the analysis, we wrote off the entire goodwill balance for PCIA and what was then our SPG segment. This resulted in a $203.3 million impairment loss as of December 28, 2008. The goodwill impairment charge is non-cash in nature and does not affect our liquidity, cash flows from operating activities or debt covenants and will not have a material impact on future operations (See Critical Accounting Polices and Estimates and Item 8, Note 2 and Note 6 of this report for additional information).
Impairment of Investments. As of December 28, 2008, we concluded that the impairment of our auction rate securities was other-than-temporary and recognized a loss of $19.0 million (see Critical Accounting Policies and Estimates and Item 8, Note 2 and Note 4 for further information).
Other Expense, net. The following table presents a summary of Other expense, net for 2009 and 2008, respectively.
Interest expense. Interest expense in 2009 decreased $12.6 million as compared to 2008, primarily due to lower interest rates on outstanding debt and lower debt balances.
Interest income. Interest income in 2009 decreased $8.3 million as compared to 2008, as a result of lower rates of return.
Income Taxes. Income tax benefit in 2009 was $3.1 million on loss before taxes of $63.3 million, as compared to income tax benefit of $1.2 million on loss before taxes of $168.6 million for 2008. The effective tax rate for 2009 was 4.9% compared to 0.7% for 2008. The change in effective tax rate is primarily due to shifts of income and loss among jurisdictions with differing tax rates, foreign currency revaluations, discrete tax expenses and benefits as a result of finalization of certain tax filings, the impact of goodwill impairment in multiple jurisdictions in 2008 as well as a net tax benefit of $1.6 million recorded in the fourth quarter of 2009 relating to a partial release of the valuation allowance on the Malaysian cumulative reinvestment allowance and manufacturing incentives deferred tax asset. In 2009, the valuation allowance on our deferred tax assets increased by $13.9 million
In accordance with the Income Taxes Topic in the FASB Accounting Standards Codification (ASC), deferred taxes have not been provided on undistributed earnings of foreign subsidiaries which are reinvested indefinitely. Certain non-U.S. earnings, which have been taxed in the U.S. but earned offshore, have and continue to be part of our repatriation plan. As of December 27, 2009, we have recorded a deferred tax liability of $0.1 million, with no impact to the consolidated statement of operations as we have a full valuation allowance against our net U.S. deferred tax assets.
Free Cash Flow. Free cash flow is a non-GAAP financial measure. To determine free cash flow, we subtract capital expenditures from cash provided by operating activities. Free Cash flow increased approximately $112 million in 2009 as a result of reduced capital expenditures and a net reduction in working capital. See Free Cash Flow reconciliation in Item 6.
Reportable Segments. The following table represents comparative disclosures of revenue and gross margin of our reportable segments.
MCCC. MCCC revenues decreased approximately 30% in 2009 as compared to 2008. During 2009, decreases in unit volumes contributed approximately 19% of the revenue decrease due to overall market decline for semiconductors, specifically in the MOSFET markets, as well as a reduction in distribution channel inventory. Demand for power analog products has remained stable despite market conditions due to market share gains and less inventory drain for mobile products. The remaining decrease in revenue of 11% was driven by changes in product mix and decreases in pricing. Gross margin dollars declined due to decreased revenue as a result of lower overall market demand as well as higher manufacturing unit costs due to lower factory utilization.
MCCC had operating income of $74.2 million in 2009, as compared to $171.0 million in 2008. The decrease in operating income was due to lower gross margin as discussed above. This was partially offset by decreased SG&A expenses due to reductions in our employee base, discretionary spending, and variable compensation as well as other temporary benefit reductions. Several of these benefit reductions were reinstated in the third quarter of 2009 as a result of improved market conditions. R&D expenses increased slightly due to a reallocation of R&D resources.
PCIA. PCIA revenues decreased approximately 19% in 2009 as compared to 2008. The decline in revenue was driven primarily by decreases in unit volumes as a result of weaker demand for high voltage and power conversion products as well as general weakening in the automotive industry in North America and Europe. Unit volumes were also impacted by a reduction in distribution channel inventory. In addition, changes in mix and
decreases in average selling prices due to continued pricing pressure contributed approximately 5% to the decline in revenue. Gross margin dollars declined due to lower revenue and unit volumes and higher manufacturing unit costs as the result of lower factory utilization partially offset by a favorable currency translation impact.
PCIA had operating income of $71.6 million in 2009, as compared to $107.6 million in 2008. The decrease in operating income was due to lower gross margin as discussed above. This was partially offset by decreased R&D and SG&A expenses due to reductions in our employee base, discretionary spending, and variable compensation as well as other temporary benefit reductions. Several of these benefit reductions were reinstated in the third quarter of 2009 as a result of improved market conditions. In addition, there was a favorable impact from the weakening of the Korean Won.
SDT. SDT revenues decreased approximately 24% in 2009 as compared to 2008. The decline in revenue was primarily driven by decreases in unit volumes due to reduced demand as a result of the worldwide economic downturn. Gross margin dollars declined due to lower revenue and unit volumes, increased competition and higher manufacturing unit costs as the result of lower factory utilization. However, gross margin percent improved year over year as a result of the mix out of lower margin products and material cost reductions on major packages.
SDT had operating income of $9.8 million in 2009, compared to $9.4 million in 2008. The slight increase in operating income was due improved gross margin as well as reduced R&D and SG&A expenses. R&D and SG&A expenses decreased due to reductions in our employee base, discretionary spending, and variable compensation as well as other temporary benefit reductions. Several of these benefit reductions were reinstated in the third quarter of 2009 as a result of improved market conditions. R&D expense also decreased as a result of a reallocation of R&D resources.
Liquidity and Capital Resources
Our main sources of liquidity are our cash flows from operations, cash and cash equivalents and revolving credit facility.
Our senior credit facility consists of a $320.7 million term loan facility and a $100.0 million revolving line of credit (Revolving Credit Facility). As of December 26, 2010, Standard and Poors rates our debt at BB+. The senior credit facility imposes various restrictions upon us that could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities. It also includes restrictive covenants that limit our ability to consolidate, merge or enter into acquisitions, create liens, pay dividends or make similar restricted payments, sell assets, invest in capital expenditures and incur indebtedness. The senior credit facility also limits our ability to modify our certificate of incorporation and bylaws, or enter into shareholder agreements, voting trusts or similar arrangements. In addition, the affirmative covenants in the senior credit facility also require our financial performance to comply with certain financial measures, as defined by the credit agreement. These financial covenants require us to maintain a minimum interest coverage ratio of 2.5 to 1.0, a maximum net leverage ratio of 4.0 to 1.0 and to maintain four quarter trailing EBITDA (earnings before interest, taxes, depreciation and amortization) less capital expenditures of at least $30.0 million. It defines the interest coverage ratio as the ratio of annualized interest expense to the cumulative four quarter trailing EBITDA and defines the maximum net leverage ratio as the ratio of debt, less up to $100 million (to the extent our unrestricted cash on hand exceeds $200 million), to the cumulative four quarter trailing EBITDA. EBITDA, as defined by the senior credit facility excludes restructuring, non-cash equity compensation and other adjustments as defined by the credit agreement.
At December 26, 2010, we were in compliance with these covenants. Based on our current models, we expect to remain in compliance with our senior credit facility covenants. This expectation is subject to various risks and uncertainties discussed more thoroughly in Item 1A, and include, among others, the risk that our assumptions and expectations about business conditions, expenses and cash flows for the remainder of the year may be inaccurate.
The variable interest rate on the term loan and Revolving Credit Facility is at the London Interbank Offered Rate (LIBOR) plus 1.25% and 1.00% respectively. Both the term loan and Revolving Credit Facility have a step down feature based on senior leverage ratios. As of November 2010 our rates were reduced from LIBOR plus 1.50% on both the term loan and Revolving Credit Facility to LIBOR plus 1.25% for the term loan and LIBOR plus 1.00% for the Revolving Credit Facility after achieving less than 1.00:1.00 senior leverage ratios.
While our senior credit facility places restrictions on the payment of dividends, it does not restrict the subsidiaries of Fairchild Semiconductor Corporation, except to a limited extent, from paying dividends or making advances to Fairchild Semiconductor Corporation. As a result, we believe that funds generated from operations, together with existing cash and funds from our senior credit facility will be sufficient to meet our debt obligations, operating requirements, capital expenditures and research and development funding needs over the next twelve months. In 2010, we incurred capital expenditures of $158 million.
Under our senior credit facility, we have revolving borrowing capacity of $100.0 million for working capital and general corporate purposes, including acquisitions. At December 26, 2010, the revolver was undrawn and, after adjusting for outstanding letters of credit, we had $98.8 million available under the revolving credit facility. We had additional outstanding letters of credit of $1.1 million that do not fall under the senior credit facility. We also had $1.3 million of undrawn credit facilities at certain of our foreign subsidiaries. These outstanding amounts do not impact available borrowings under the senior credit facility.
We frequently evaluate opportunities to sell additional equity or debt securities, obtain credit facilities from lenders or restructure our long-term debt to further strengthen our financial position. Additional borrowing or equity investment may be required to fund future acquisitions. The sale of additional equity securities could result in additional dilution to our stockholders.
During the second quarter of 2009, we amended (the Amendment) our senior credit facility to enable us to voluntarily prepay and retire a portion of our term loan facility to take advantage of potentially favorable conditions in the credit markets that may occur from time to time. The Amendment permits us to prepay up to $100 million (net of interest and fees) of term loans for a 12 month period following the effective date of the Amendment subject to certain minimum liquidity and customary financial conditions. During the second quarter of 2009, pursuant to the terms of the Amendment, we completed a tender offer to buyback a portion of our term loan below par. As a result of this debt buyback we reduced our debt by $14.7 million, paying $13.8 million in cash and recognizing a $0.8 million gain, net of fees on the transaction. Additionally during the fourth quarter 2009, we completed three additional tender offers, as allowed under the previously executed amendment. As a result of this additional debt buyback, we further reduced debt by $23.7 million, paying $22.1 million in cash and recognizing a $1.2 million gain, net of the write-off of associated deferred financing fees and other fees on the transaction. This Discounted Voluntary Prepayment period ended in May 2010.
As of December 26, 2010, we have not recorded any net unrecognized tax benefits, compared to approximately $10.4 million at December 27, 2009. In 2010, we decreased unrecognized tax benefits by $10.4 million representing the settlement of a Korea income tax audit. The decrease was due to cash payments payable to the taxing authority along with the effective settlement of other unrecognized tax benefits. There was no net material impact to the effective tax rate as a result of the settlement of the Korea income tax audit.
As of December 26, 2010, our cash, cash equivalents and short-term and long-term securities were $435.0 million, a decrease of $16.7 million from December 27, 2009. Included in long-term securities as of December 26, 2010 and December 27, 2009 are $28.0 million and $33.4 million of auction rate securities, respectively. The auction rate security market has failed and is currently inactive. However, the company continues to accrue and receive interest on these securities based on a contractual rate.
During 2010, our cash provided by operating activities was $332.5 million compared to $188.4 million in 2009. The following table presents a summary of net cash provided by operating activities during 2010 and 2009, respectively.
Cash provided by operating activities in 2010 increased when compared to 2009, increasing $144.1 million from $188.4 in 2009. The increase was mainly due to increased net income in 2010, offset partially by increases changes in our net working capital accounts.
Cash used in investing activities during 2010 totaled $172.2 million compared to $62.6 million in 2009. The increase in the use of cash is primarily the result of higher capital expenditures in 2010. Our capital expenditures during 2010 were $158.0 million compared to $59.8 million in 2009.
Cash used in financing activities totaled $171.5 million in 2010 as compared to $61.5 million in 2009. The increase in the use of cash was primarily due to the pay down of $151.5 million of debt in 2010, compared to only $60.6 million in 2009. In addition, we purchased $25.6 million of treasury stock in 2010. There were no purchases of treasury stock in 2009.
The table below summarizes our significant contractual obligations as of December 26, 2010 and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
It is customary practice in the semiconductor industry to enter into guaranteed purchase commitments or take or pay arrangements for purchases of certain equipment and raw materials. Obligations under these arrangements are included in (5) above.
Contractual obligations that are contingent upon the achievement of certain milestones are not included in the table above. These obligations include contingent funding/payment obligations and milestone-based equity investment funding. These arrangements are not considered contractual obligations until the milestone is met by the third party.
We also enter into contracts for outsourced services; however, the obligations under these contracts were not significant at December 26, 2010 and the contracts generally contain clauses allowing for cancellation without significant penalty.
The expected timing of payment of the obligations discussed above is estimated based on current information. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.
Liquidity and Capital Resources of Fairchild International, Excluding Subsidiaries
Fairchild Semiconductor International, Inc. is a holding company, the principal asset of which is the stock of its sole subsidiary, Fairchild Semiconductor Corporation. Fairchild Semiconductor International, Inc. on a stand-alone basis had no cash flow from operations and has no cash requirements for the next twelve months.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The U.S. Securities and Exchange Commission has defined critical accounting policies as those that are both most important to the portrayal of our financial condition and results and which require our most difficult, complex or subjective judgments or estimates. Based on this definition, we believe our critical accounting policies include the policies of revenue recognition, sales reserves, inventory valuation, fair value of financial instruments, impairment of long-lived assets, income taxes and loss contingencies. For all financial statement periods presented, there have been no material modifications to the application of these critical accounting policies.
On an ongoing basis, we evaluate the judgments and estimates underlying all of our critical accounting policies. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures, and reported amounts of revenues and expenses. These estimates and assumptions are based on our best estimates and judgment. We evaluate our estimates and assumptions using historical experience and other
factors, including the current economic environment, which we believe to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. Illiquid credit markets, volatile equity, foreign currency, and energy markets, and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.
Revenue Recognition and Sales Reserves. No revenue is recognized unless there is persuasive evidence of an arrangement, the price to the buyer is fixed or determinable, delivery has occurred and collectability of the sales price is reasonably assured. Revenue from the sale of semiconductor products is recognized when title and risk of loss transfers to the customer, which is generally when the product is received by the customer. In some cases, title and risk of loss do not pass to the customer when the product is received by them. In these cases, we recognize revenue at the time when title and risk of loss is transferred, assuming all other revenue recognition criteria have been satisfied. These cases include several inventory locations where we manage consigned inventory for our customers, some of which is at customer facilities. In such cases, revenue is not recognized when products are received at these locations; rather, revenue is recognized when customers take the inventory from the location for their use. Shipping costs billed to our customers are included within revenue with associated costs classified in cost of goods sold.
Approximately 65% of our revenue is generated through sales to distributors. Distributor payments are due under agreed terms and are not contingent upon resale or any other matter other than the passage of time. We have agreements with some distributors and customers for various programs, including prompt payment discounts, pricing protection, scrap allowances and stock rotation. Sales to these distributors and customers, as well as the existence of sales incentive programs, are in accordance with terms set forth in written agreements with these distributors and customers. In general, credits allowed under these programs are capped based upon individual distributor agreements. We record charges associated with these programs as a reduction of revenue based upon historical activity and our expectation of future activity. We also have volume based incentives with certain distributors to encourage stronger resales of our products. Reserves are recorded as a reduction to revenue as they are earned by the distributor. Our policy is to use both a three to six month rolling historical experience rate as well as a prospective view of products in the distributor channel for distributors who participate in an incentive program in order to estimate the necessary allowance to be recorded. In addition, the products sold by us are subject to a limited product quality warranty. We accrue for estimated incurred but unidentified quality issues based upon historical activity and known quality issues if a loss is probable and can be reasonably estimated. The standard limited warranty period is one year. Quality returns are accounted for as a reduction of revenue. Historically, we have not experienced material differences between our estimated sales reserves and actual results.
Inventory Valuation. In determining the net realizable value of our inventories, we review the valuations of inventory considered excessively old, and therefore subject to, obsolescence and inventory in excess of customer backlog and historical rate of demand. We also value inventory at the lower of cost or market. Once established, write-downs of inventory are considered permanent adjustments to the cost basis of inventory.
Fair Value of Financial Instruments. Securities and derivatives are financial instruments that are recorded at fair value on a recurring basis. The Fair Value Measurements and Disclosures Topic of the FASB ASC, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. On January 1, 2008, we partially adopted the fair value measurements and disclosures provisions. We deferred adoption of the fair value measurements and disclosure provisions for nonfinancial assets and liabilities including intangible assets, reporting units measured at fair value in the first step of a goodwill impairment test, and asset retirement obligations. We fully adopted the fair value measurements and disclosure provisions for nonfinancial assets and liabilities on the first day of fiscal year 2009.
In accordance with the requirements of the Fair Value Measurements and Disclosures Topic of the FASB ASC, we group our financial assets and liabilities measured at fair value on a recurring basis in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements. When available, we use quoted market prices to measure fair value. If market prices are not available, fair value measurements are based on models that use primarily market based parameters including interest rate yield curves, option volatilities, and currency rates. In certain cases where market rate assumptions are not available, we are required to make judgments about assumptions market participants would use to estimate the fair value of a financial instrument. The only financial instruments we hold which are not classified as either Level 1 or Level 2 are auction rate securities. There has been insufficient demand for these types of investments and as a result the investments are not currently liquid. Since observable market prices and parameters are not currently available, judgment is necessary to estimate fair value. Changes in the underlying assumptions used, including discount rates and estimates of future cash flows could significantly affect the results of current or future values. A discounted cash flow (DCF) calculation is used to determine the estimated fair value of the auction rate securities. The assumptions used in preparing the DCF model included estimates for the amount and timing of future interest and principal payments and the rate of return required by investors to own these securities in the current environment. In making these assumptions, relevant factors that were considered included: the formula applicable to each security which defines the interest rate paid to investors in the event of a failed auction; forward projections of the interest rate benchmarks specified in such formulas; the likely timing of principal repayments; the probability of full repayment considering guarantees by third parties and additional credit enhancements provided through other means. The estimate of the rate of return required by investors to own these securities also considers the current reduced liquidity for auction rate securities. The inputs for our DCF were based upon input from third parties as well as our own estimates. The primary unobservable input to the valuation was the maturity assumption which ranged from six to twelve years depending on the individual auction rate security. The maturity assumptions were based on the terms of the underlying instrument and the potential for restructuring the auction rate security. The results of these fair value calculations are imprecise and may not be realized in an actual sale. Changes in market conditions may also reduce the availability of other quoted prices or observable data. If this were to occur, we would need to use valuation techniques requiring more judgment to estimate the appropriate fair value measurement.
At December 26, 2010 approximately 1.8% of total assets, or $33 million, consisted of financial instruments recorded at fair value on a recurring basis. Approximately 85% of these assets were classified as Level 3 assets. All Level 3 assets consist of auction rate securities. Approximately, 0% of total liabilities or $0.2 million consisted of financial liabilities recorded at fair value.
In the valuation of our derivative instruments, we consider our credit risk and the credit risk of our counterparties. Based on our current credit standing and the credit standing of our counterparties credit risk has not had a material impact in the valuation of our derivatives.
See Item 8, Note 3 for a complete discussion on our use of fair valuation of financial instruments, our related measurement techniques, and its impact to our financial statements.
Impairment of Long-Lived Assets. We assess the impairment of long-lived assets, including goodwill, on an ongoing basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
Goodwill is subject to an annual impairment test, or more frequently, if indicators of potential impairment arise. Our annual impairment review is based on a combination of the income approach, which estimates the fair value of our reporting units based on a discounted cash flow approach, and the market approach which estimates the fair value of our reporting units based on comparable market multiples. The comparable companies utilized in our evaluation are primarily the major competitors listed in Item 1 of this report. As part of the market multiple analysis, a control premium is also factored in. The control premiums utilized in 2010 and 2009 ranged from 0 % to 40 % based on the reporting unit. The discount rates utilized in the 2010 and 2009 discounted cash flows ranged from approximately 12% to 16.5 %, reflecting market based estimates of capital costs and discount rates adjusted for a market participants view with respect to execution, concentration, and other risks associated with the projected cash flows of the individual segments. The average fair value is reconciled to our market capitalization with an appropriate control premium.
The determination of the fair value of the reporting units requires us to make significant estimates and assumptions. These estimates and assumptions primarily include but are not limited to; the selection of appropriate peer group companies, control premiums appropriate for acquisitions in the industries in which we compete, the discount rate, terminal growth rates, forecasts of revenue and expense growth rates, changes in working capital, depreciation and amortization, and capital expenditures. Due to the inherent uncertainty involved in making these estimates, actual financial results could differ from those estimates. Changes in assumptions concerning future financial results or other underlying assumptions would have a significant impact on either the fair value of the reporting unit or the amount of the goodwill impairment charge. We use judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological change or competitive activities, loss of key personnel and acts by governments and courts, may signal that an asset has become impaired.
In 2010 and 2009, there were no goodwill impairments and the fair values of the reporting units were substantially in excess of book values. In 2008, after completing step one of the impairment test, we determined that the estimated fair value of our PCIA and SPG reporting units was less than the carrying value of those reporting units. The fair value of MCCC exceeded the book value by 14% so step two was not necessary. The fair value for PCIA was 63% less than the carrying value. The fair value for SPG was 66% less than the carrying value. This required us to complete the second step of the impairment test for both of these reporting units. To measure the amount of impairment, we determined the implied fair value of goodwill in the same manner as if we had acquired those reporting units. Specifically, we must allocate the fair value of the reporting unit to all of the assets of that unit, including unrecognized intangible assets, in a hypothetical calculation that would yield the implied fair value of goodwill. The impairment loss is measured as the difference between the book value of the goodwill and the implied fair value of the goodwill computed in step two. Upon completion of step two of the analysis, we wrote off the entire goodwill balance for PCIA and SPG. This resulted in an impairment loss of $203.3 million as of December 28, 2008. See Item 8, Note 6 for more details on goodwill.
For all other long-lived assets, our impairment review process is based upon an estimate of future undiscounted cash flows. Factors we consider that could trigger an impairment review include the following:
Recoverability of assets that will continue to be used in our operations is measured by comparing the carrying value to the future net undiscounted cash flows expected to be generated by the asset or asset group. Future undiscounted cash flows include estimates of future revenues, driven by market growth rates, and estimated future costs. There were no trigger events in 2010 or 2009 that caused us to evaluate our other long lived assets for impairment.
Income Taxes. Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred taxes are not provided for the undistributed earnings of our foreign subsidiaries that are considered to be indefinitely reinvested outside of the U.S. We plan to repatriate certain non-U.S. earnings which have been taxed in the U.S. but earned offshore as well as any non-U.S. earnings that are not considered to be indefinitely invested outside the U.S.
We make judgments regarding the realizability of our deferred tax assets. In accordance with the Income Tax topic of the ASC, the carrying value of the net deferred tax assets is based on the belief that it is more likely than not that we will generate sufficient future taxable income in certain jurisdictions to realize these deferred tax assets after consideration of all available positive and negative evidence. Future realization of the tax benefit of existing deductible temporary differences or carryforwards ultimately depends on the existence of sufficient taxable income of the appropriate character within the carryback and carryforward period available under the tax law. Future reversals of existing taxable temporary differences, projections of future taxable income excluding reversing temporary differences and carryforwards, taxable income in prior carryback years, and prudent and feasible tax planning strategies that would, if necessary, be implemented to preserve the deferred tax asset may be considered to identify possible sources of taxable income.
Valuation allowances have been established for U.S. deferred tax assets, which we believe do not meet the more likely than not criteria established by the Income Tax topic of the ASC. In 2005, we established a full valuation allowance against our net U.S. deferred tax assets excluding certain deferred tax liabilities related to indefinite-lived goodwill. We recorded a valuation allowance in 2005 and continue to carry the valuation allowance in 2010 as our trend of positive evidence does not currently support such a release. In 2008, a deferred tax asset and full valuation allowance was recorded in the amount of $24.8 million relating to our Malaysian cumulative reinvestment allowance and manufacturing incentives. In 2009, the deferred tax asset increased to $27.9 million. In 2010, the deferred tax asset increased to $31.3 million. Based on an update of the jurisdictional financial history and current forecast in 2009, it was managements belief that we did meet the standard of more likely than not that is required for measuring the likelihood of a realization of net deferred tax assets which was reflected in a partial release of the valuation allowance in the amount of $1.6 million. In 2010, there was no material change to the partial release of the valuation allowance. The 2010 ending valuation allowance was $29.8 million. As of December 26, 2010 the companys valuation allowance for Taiwan deferred tax assets totaled $4.3 million relating to the companys Taiwanese R&D investment tax credits. We will continue to evaluate book and taxable income trends, and their impact on the amount and timing of valuation allowance adjustments.
If we are able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been established, the related portion of the valuation allowance is released to income from continuing operations, additional paid-in capital or to other comprehensive income.
The calculation of our tax liabilities includes addressing uncertainties in the application of complex tax regulations in a multitude of jurisdictions. The Income Tax topic of the ASC clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements. The topic prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our recognition threshold and measurement attribute of whether it is more likely than not that the positions we have taken in tax filings will be sustained upon tax audit, and the extent to which, additional taxes would be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period in which it is determined the liabilities are no longer necessary. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.
Loss Contingencies. The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. The Contingency topic of the ASC requires that an estimated loss from a loss contingency such as a legal proceeding or claim should be accrued by a charge to income if it is probable that an asset has been impaired or a liability has been incurred and the amount of the loss can be reasonably estimated. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. We regularly evaluate current information available to us to determine whether such accruals should be adjusted. Changes in our evaluation could materially impact our financial position or our results of operations.
Forward Looking Statements
This annual report, including but not limited to the section entitled Status of First Quarter Business, contains forward-looking statements as that term is defined in Section 21E of the Securities Exchange Act of 1934. Forward-looking statements can be identified by the use of forward-looking terminology such as we believe, we expect, we intend, may, will, should, seeks, approximately, plans, estimates, anticipates, or hopeful, or the negative of those terms or other comparable terms, or by discussions of our strategy, plans or future performance. For Example, the Outlook section below contains numerous forward-looking statements. All forward-looking statements in this report are made based on managements current expectations and estimates, which involve risks and uncertainties, including those described below and more specifically in the Risk Factors section. Among these factors are the following: current economic uncertainty, including disruptions in the credit markets, as well as future economic conditions; changes in demand for our products; changes in inventories at our customers and distributors; changes in regional or global economic or political conditions (including as a result of terrorist attacks and responses to them); technological and product development risks, including the risks of failing to maintain the right to use some technologies or failing to adequately protect our own intellectual property against misappropriation or infringement; availability of manufacturing capacity; the risk of production delays; the inability to attract and retain key management and other employees; risks related to warranty and product liability claims; risks inherent in doing business internationally; changes in tax regulations or the migration of profits from low tax jurisdictions to higher tax jurisdictions; availability and cost of raw materials; competitors actions; loss of key customers, including but not limited to distributors; order cancellations or reduced bookings; changes in manufacturing yields or output; and significant litigation. Factors that may affect our operating results are described in the Risk Factors section in the quarterly and annual reports we file with the Securities and Exchange Commission. Such risks and uncertainties could cause actual results to be materially different from those in the forward-looking statements. Readers are cautioned not to place undue reliance on the forward-looking statements.
Policy on Business Outlook Disclosure
Financial information relating to any current quarter should be considered to be speaking as of the date of the press release or other announcement only. Following the date of the press release or other announcement, the information should be considered to be historical and not subject to update. We undertake no obligation to update any such information, although we may choose to do so by press release, SEC filing or other public announcement. Consistent with this policy change, Fairchild Semiconductor representatives will no longer comment about the business outlook of our financial results or expectations for the quarter in question.
Status of First Quarter Business
We expect sales to be $405 to $420 million in the first quarter. Our current scheduled backlog, as of January 20, 2011, is sufficient to achieve this range. We expect gross margin to be flat to down 100 basis points sequentially due primarily to the impact of lower utilization in the fourth quarter as well as modest seasonal increases in costs. We anticipate R&D and SG&A spending of $94 to $96 million in the first quarter as we modestly ramp up our investment in new product development. Net interest expense is expected to be roughly $2 million per quarter going forward. The adjusted tax rate is forecast at 15 percent plus or minus 3 percent for the quarter. As with last quarter, we are not assuming any obligation to update this information, although we may choose to do so before we announce first quarter results.
Recently Issued Financial Accounting Standards
In January 2010, the FASB issued Accounting Standards Update No. 2010-06 (ASU 2010-06), Improving Disclosures about Fair Value Measurements. This ASU amends ASC 820, Fair Value Measurements and Disclosures Topic to provide further guidance on fair value disclosures. This statement is effective as of the beginning of the first reporting period beginning after issuance. The adoption of ASU 2010-06 did not have a material effect on our consolidated financial position and results of operations and statements of cash flows.
In March 2010, the FASB issued Accounting Standards Update No. 2010-11 (ASU 2010-11), Scope Exceptions Related to Embedded Credit Derivative. This ASU amends ASC 815, Derivatives and Hedging Topic to amend the embedded derivative scope exceptions for credit derivatives. This statement is effective as of the first fiscal quarter beginning after June 15, 2010. The adoption of ASU 2010-11 did not have a material effect on our consolidated financial position and results of operations and statements of cash flows.
In April 2010, the FASB issued Accounting Standards Update No. 2010-17 (ASU 2010-17), Revenue RecognitionMilestone Method. This ASU provided guidance on applying the milestone method to milestone payments for achieving specified performance measures when those payments are related to uncertain future events. This statement is effective for milestones achieved in interim and annual periods beginning on or after June 15, 2010. ASU 2010-17 did not have an effect on our consolidated financial position and results of operations and statements of cash flows.
In December 2010, the FASBs Emerging Issues Task Force (EITF) issued EITF 10-A, IntangiblesGoodwill and Other (Topic 350), When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amount. This EITF modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it more likely than not that a goodwill impairment exists. This statement is effective for fiscal years and interim periods beginning after December 10, 2010. This EITF is not expected to have a material effect on our consolidated financial position and results of operations.
We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. To mitigate these risks, we utilize derivative financial instruments. We do not use derivative financial instruments for speculative or trading purposes. All of the potential changes noted below are based on sensitivity analyses performed on our financial position at December 26, 2010. Actual results may differ materially.
We use a combination of currency forward and option contracts to hedge a portion of our forecasted foreign exchange denominated revenues and expenses. Gains and losses on these foreign currency exposures would generally be offset by corresponding losses and gains on the related hedging instruments, resulting in negligible net exposure to us. A majority of our revenue, expense and capital purchasing activities are transacted in U.S. dollars. However, we do conduct these activities by way of transactions denominated in other currencies,
primarily the Korean won, Malaysian ringgit, Philippine peso, Chinese yuan, Japanese yen, Taiwanese dollar, British pound and the Euro. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, we have established hedging programs. We utilize currency option contracts and forward contracts in these hedging programs. Our hedging programs reduce, but do not always entirely eliminate, the short-term impact of foreign currency exchange rate movements. For example, during the twelve months ended December 26, 2010, an adverse change (defined as a 20% unfavorable move in every currency where we have exposure) in the exchange rates of all currencies over the course of the year would have resulted in an adverse impact on income before taxes of approximately $14.6 million.
We have interest rate exposure with respect to the senior credit facility due to the variable LIBOR pricing for both the term loan and the Revolving Credit Facility. For example, a 50 basis point increase in interest rates would result in increased annual interest expense of $0.5 million for the Revolving Credit Facility, assuming all borrowing capability was utilized. For the year ended 2010, a 50 basis point increase in interest rates would result in increased annual interest expense of $2.0 million. The increased annual interest expense due to a 50 basis point increase in LIBOR rates would be offset by an increase in interest income of $1.6 million on the cash and investment balances at 2010 year-end. At December 26, 2010, the revolver was undrawn and after adjusting for outstanding letters of credit we had up to $98.8 million available under this senior credit facility.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Fairchild Semiconductor International, Inc.:
We have audited the accompanying consolidated balance sheets of Fairchild Semiconductor International, Inc. and subsidiaries (the Company) as of December 26, 2010 and December 27, 2009, and the related consolidated statements of operations, comprehensive income (loss), cash flows and stockholders equity for each of the years in the three-year period ended December 26, 2010. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in Item 15(b) of the 2010 Form 10-K. We also have audited Fairchild Semiconductor International, Inc.s internal control over financial reporting as of December 26, 2010, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Fairchild Semiconductor International, Inc.s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule, and an opinion on the Companys internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fairchild Semiconductor International, Inc. and subsidiaries as of December 26, 2010 and December 27, 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 26, 2010, in conformity with U.S. generally accepted accounting principles. Also, in
our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, Fairchild Semiconductor International, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 26, 2010, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ KPMG LLP
February 24, 2011
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY