International Rectifier 10-Q 2005
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
International Rectifier Corporation
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES ý NO o
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES ý NO o
INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT). YES o NO ý
THERE WERE 70,794,310 SHARES OF THE REGISTRANTS COMMON STOCK, PAR VALUE $1.00 PER SHARE, OUTSTANDING ON NOVEMBER 8, 2005.
Table of Contents
INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
(In thousands except per share amounts)
The accompanying notes are an integral part of these statements.
INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these statements.
INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these statements.
INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
The accompanying notes are an integral part of these statements.
INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
September 30, 2005
1. Basis of Consolidation
The consolidated financial statements include the accounts of International Rectifier Corporation and its subsidiaries (the Company), which are located in North America, Europe and Asia. Intercompany transactions have been eliminated in consolidation.
The consolidated financial statements included herein are unaudited; however, they contain all normal recurring adjustments which, in the opinion of the Companys management, are necessary to state fairly the consolidated financial position of the Company at September 30, 2005, and the consolidated results of operations and the consolidated cash flows for the three months ended September 30, 2005 and 2004. The results of operations for the three months ended September 30, 2005 are not necessarily indicative of the results to be expected for the full year.
The accompanying unaudited consolidated financial statements should be read in conjunction with the Annual Report on Form 10-K for the fiscal year ended June 30, 2005.
The Company operates on a 52-53 week fiscal year under which the three months ended September 2005 and 2004 consisted of 13 weeks ending October 2, 2005 and October 3, 2004, respectively. For ease of presenting the accompanying consolidated financial statements, the fiscal quarter-end for all periods presented is shown as September 30 or June 30. Fiscal 2006 will consist of 52 weeks ending July 2, 2006.
Certain reclassifications have been made to the September 30, 2004 (i) cash flow from investing activities, (ii) net decrease in cash and cash equivalents, and (iii) ending cash and cash equivalents, as a result of reclassification of auction rate securities (ARS) from cash and cash equivalents to short-term investments. Previously, the Companys investments in ARS were recorded in cash and cash equivalents rather than short-term cash investments. The Company reclassified ARS from cash and cash equivalents to short-term investments because the underlying instruments have maturity dates exceeding ninety days. As a result of the reclassifications, the Companys consolidated cash flows were affected as follows:
net cash used for the purchase of cash investments decreased by $51.0 million for the three months ended September 30, 2004; and
net change in cash and cash equivalents increased by $51.0 million for the three months ended September 30, 2004.
The reclassifications had no impact on the Companys total current assets, stockholders equity, cash flows provided by operating activities or total
consolidated results reported in any period presented. At September 30, 2005 and June 30, 2005, the Company had no investments in these securities.
2. Net Income Per Common Share
Net income per common share - basic is computed by dividing net income available to common stockholders (the numerator) by the weighted average number of common shares outstanding (the denominator) during the period. The computation of net income per common share - diluted is similar to the computation of net income per common share - basic except that the denominator is increased to include the number of additional common shares that would have been outstanding for the exercise of stock options using the treasury stock method and the conversion of the Companys convertible subordinated notes using the if-converted method. The Companys use of the treasury stock method reduces the gross number of dilutive shares by the number of shares purchasable from the proceeds of the options assumed to be exercised. The Companys use of the if-converted method increases reported net income by the interest expense related to the convertible subordinated notes when computing net income per common share diluted.
The following table provides a reconciliation of the numerator and denominator of the basic and diluted per-share computations for the three months ended September 30, 2005 and 2004 (in thousands except per share amounts):
The conversion effect of the Companys outstanding convertible subordinated notes into 7,439,000 shares of common stock was not included in the computation of diluted income per share for the three months ended September 30, 2005, since such effect would be anti-dilutive.
3. Cash and Investments
The Company classifies all highly liquid investments purchased with original or remaining maturities of ninety days or less at the date of purchase as cash equivalents. The cost of these investments approximates fair value.
The Company invests excess cash in marketable securities consisting primarily of commercial paper, corporate notes, corporate bonds and U.S. government securities. At September 30, 2005 and June 30, 2005, all of the Companys marketable securities are classified as available-for-sale. In accordance with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, unrealized gains and losses on these investments are included in accumulated other comprehensive income, a separate component of stockholders equity, net of any related tax effect. Realized gains and losses and declines in value considered to be other than temporary are included in interest income and expense. At September 30, 2005 and June 30, 2005, no investment was in a material loss position for greater than one year.
Cash, cash equivalents and cash investments as of September 30, 2005 and June 30, 2005 are summarized as follows (in thousands):
Available-for-sale securities as of September 30, 2005 are summarized as follows (in thousands):
Short-Term Cash Investments:
Long-Term Cash Investments:
Available-for-sale securities as of June 30, 2005 are summarized as follows (in thousands):
Short-Term Cash Investments:
Long-Term Cash Investments:
The Company holds as strategic investments the common stock of two publicly-traded Japanese companies, one of which is Nihon Inter Electronics Corporation (Nihon), a related party as further disclosed in Note 15. The Company accounts for these available-for-sale investments under SFAS 115. These stocks are traded on the Tokyo Stock Exchange. The market values of the equity investments at September 30, 2005 and June 30, 2005 were $66.6 million and $71.2 million, respectively, compared to their purchased cost of $24.2 million. Mark-to-market losses, net of tax, of $2.9 million and $9.8 million for the three months ended September 30, 2005 and 2004, respectively, were included in accumulated other comprehensive income, a separate component of equity.
The amortized cost and estimated fair value of cash investments at September 30, 2005, by contractual maturity, are as follows (in thousands):
In accordance with the Companys investment policy which limits the length of time that cash may be invested, the expected disposal dates may be less than the contractual maturity dates as indicated in the table above.
Gross realized gains were $0.01 million and gross realized losses were $0.3 million for the three months ended September 30, 2005. Gross realized gains were $0.01 million and gross realized losses were $0.05 million for the three months ended September 30, 2004. The cost of marketable securities sold is determined by the weighted average cost method.
4. Derivative Financial Instruments
Foreign Currency Risk
The Company conducts business on a global basis in several foreign currencies, and at various times, is exposed to fluctuations with the British Pound Sterling, the Euro and the Japanese Yen. The Companys risk to the European currencies is partially offset by the natural hedge of manufacturing and selling goods in both U.S. dollars and the European currencies. Considering its specific foreign currency exposures, the Company has the greatest exposure to the Japanese Yen, since it has significant yen-based revenues without the yen-based manufacturing costs. The Company has established a foreign-currency hedging program using foreign exchange forward contracts, including the Forward Contract described below, to hedge certain foreign currency transaction exposures. To protect against reductions in value and volatility of future cash flows caused by changes in currency exchange rates, it has established revenue, expense and balance sheet hedging programs. Currency forward contracts and local Yen and Euro borrowings are used in these hedging programs. The Companys hedging programs reduce, but do not always eliminate, the impact of currency exchange rate movements.
In March 2001, the Company entered into a five-year foreign exchange forward contract (the Forward Contract) for the purpose of reducing the effect of exchange rate fluctuations on forecasted intercompany purchases by the Companys subsidiary in Japan. The Company has designated the Forward Contract as a cash flow hedge under which mark-to-market adjustments are recorded in accumulated other comprehensive income, a separate component of stockholders equity, until the forecasted transactions are recorded in earnings. Under the terms of the Forward Contract, the Company is required to exchange
1.2 billion yen for $11.0 million on a quarterly basis from June 2001 to March 2006. At September 30, 2005, two quarterly payments of 1.2 billion yen remained to be swapped at a forward exchange rate of 109.32 yen per U.S. dollar. The market value of the forward contract was $0.5 million and $0.1 million at September 30, 2005 and June 30, 2005, respectively. Mark-to-market gains, included in other comprehensive income, net of tax, were $0.3 million and $0.8 million for the three months ended September 30, 2005 and 2004, respectively. At September 30, 2005, based on effectiveness tests comparing forecasted transactions through the Forward Contract expiration date to its cash flow requirements, the Company does not expect to incur a material charge as a result of the Forward Contract to income during the next six months through its maturity.
The Company had approximately $111.7 million and $75.9 million in notional amounts of forward contracts not designated as accounting hedges under SFAS No. 133 at September 30, 2005 and June 30, 2005, respectively. Net realized and unrealized foreign-currency net gains recognized in earnings were less than $1 million for the three months ended September 30, 2005 and 2004.
Interest Rate Risk
In December 2001, the Company entered into an interest rate swap transaction (the Transaction) with an investment bank, JP Morgan Chase Bank (the Bank), to modify the Companys effective interest payable with respect to $412.5 million of its $550 million outstanding convertible debt (the Debt) (see Note 8, Bank Loans and Long-Term Debt). In April 2004, the Company entered into an interest rate swap transaction (the April 2004 Transaction) with the Bank to modify the effective interest payable with respect to the remaining $137.5 million of the Debt. The Company will receive from the Bank fixed payments equal to 4.25 percent of the notional amount, payable on January 15 and July 15. In exchange, the Company will pay to the Bank floating rate payments based upon the London InterBank Offered Rate (LIBOR) multiplied by the notional amount. At the inception of the Transaction, interest rates were lower than that of the Debt and the Company believed that interest rates would remain lower for an extended period of time. The variable interest rate paid since the inception of the swaps has averaged 2.36 percent, compared to a coupon of 4.25 percent on the Debt. During the three months ended September 30, 2005 and 2004, this arrangement reduced interest expense by $0.9 million and $2.2 million, respectively.
Accounted for as fair value hedges under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, the mark-to-market adjustments of the Transaction and April 2005 Transaction were offset by the mark-to-market adjustments on the Debt, resulting in no material impact to earnings. The market value of the Transaction was a liability of $3.9 million and $0.3 million at September 30, 2005 and June 30, 2005, respectively. The market value of the April 2005 Transaction was a liability of $3.8 million and a $3.4 million at September 30, 2005 and June 30, 2005, respectively.
Both Transactions terminate on July 15, 2007 (Termination Date), subject to certain early termination provisions. On or after July 18, 2004 and prior to July 14, 2007, if the ten-day average closing price of the Companys common stock equals or exceeds $77.63, both transactions will terminate. Depending on the timing of
the early termination event, the Bank would be obligated to pay the Company an amount equal to the redemption premium called for under the terms of the Debt.
In support of the Companys obligation under the two transactions, the Company is required to obtain irrevocable standby letters of credit in favor of the Bank, totaling $7.5 million plus a collateral requirement for the Transaction and the April 2005 Transaction, as determined periodically. At September 30, 2005, $15.8 million in letters of credit were outstanding related to both transactions.
The Transaction and the April 2005 Transaction qualify as fair value hedges under SFAS No. 133. To test effectiveness of the hedge, regression analysis is performed quarterly comparing the change in fair value of the two transactions and the Debt. The fair values of the Transaction, the April 2005 Transaction and the Debt are calculated quarterly as the present value of the contractual cash flows to the expected maturity date, where the expected maturity date is based on probability-weighted analysis of interest rates relating to the five-year LIBOR curve and the Companys stock prices. For the three months ended September 30, 2005 and 2004, the hedges were highly effective and therefore, the ineffective portion did not have a material impact on earnings.
In April 2002, the Company entered into an interest rate contract (the Contract) with an investment bank, Lehman Brothers (Lehman), to reduce the variable interest rate risk of the Transaction. The notional amount of the Contract is $412.0 million, representing approximately 75 percent of the Debt. Under the terms of the Contract, the Company has the option to receive a payout from Lehman covering its exposure to LIBOR fluctuations between 5.5 percent and 7.5 percent for any four designated quarters. The market value of the Contract at September 30, 2005 and June 30, 2005, was $0.2 million and $0.1 million, respectively, and was included in other long-term assets. Mark-to-market gains (losses) of $0.1 million and ($0.3) million for the three months ended September 30, 2005 and 2004, respectively, were charged to interest expense.
Inventories are stated at the lower of cost (principally first-in, first-out) or market. Inventories are reviewed for excess and obsolescence based upon demand forecast within a specific time horizon and reserves are established accordingly. Inventories at September 30, 2005 and June 30, 2005 were comprised of the following (in thousands):
6. Goodwill and Acquisition-Related Intangible Assets
The Company accounts for goodwill and acquisition-related intangible assets in accordance with SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. The Company classifies the difference between the purchase price and the fair value of net assets acquired at the date of acquisition as goodwill. The Company classifies intangible assets apart from goodwill if the assets have contractual or other legal rights or if the assets can be separated and sold, transferred, licensed, rented or exchanged. Depending on the nature of the assets acquired, the amortization period may range from four to twelve years for those acquisition-related intangible assets subject to amortization.
The Company evaluates the carrying value of goodwill and acquisition-related intangible assets, including the related amortization period, in the fourth quarter of each fiscal year. In evaluating goodwill and intangible assets not subject to amortization, the Company completes the two-step goodwill impairment test as required by SFAS No. 142. The Company identified its reporting units and determined the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units, in order to assess goodwill for impairment. A reporting unit is the lowest level of the Company for which there is discrete information and whose results are regularly reviewed by the Company.
In the first of a two-step impairment test, the Company determined the fair value of these reporting units using a discounted cash flow valuation model. The Company compared the discounted cash flows for the reporting unit to its carrying value. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is considered not impaired and no further testing is required. If the fair value does not exceed the carrying value, the second step of the goodwill impairment test shall be performed to measure the amount of impairment loss, if any. The second step compared the implied fair value of the reporting unit with the carrying amount of that goodwill. Based on its annual impairment test in the fourth quarter of fiscal year ended June 30, 2005, the Company determined that goodwill was not impaired.
At September 30, 2005 and June 30, 2005 acquisition-related intangible assets included the following (in thousands):
As of September 30, 2005, estimated amortization expense for the next five years is as follows (in thousands): remainder of fiscal 2006: $3,015; fiscal 2007: $2,899; fiscal 2008: $2,527; fiscal 2009: $2,489, fiscal 2010: $2,489 and fiscal 2011: $1,710.
The carrying amount of goodwill by business segment as of September 30, 2005, is as follows (in thousands):
As of September 30, 2005 and June 30, 2005, $43.3 million of goodwill is deductible for income tax purposes.
The changes in the carrying amount of goodwill for the period ended September 30, 2005 and June 30, 2005 are as follows (in thousands):
New acquisitions in the fiscal year ended June 30, 2005, primarily relates to the acquisition of the specialty silicon epitaxial services business from Advanced Technology Materials, Inc. The goodwill associated with this acquisition has been assigned to the Computing and Communications, Energy-Saving Products and Intellectual Property segments based on revenues.
7. Other accrued expenses
Other accrued expenses at September 30, 2005 and June 30, 2005 were comprised of the following (in thousands):
8. Bank Loans and Long-Term Debt
A summary of the Companys long-term debt and other loans at September 30, 2005 and June 30, 2005 is as follows (in thousands):
In July 2000, the Company sold $550 million principal amount of 4.25 percent Convertible Subordinated Notes due 2007. The interest rate is 4.25 percent per year on the principal amount, payable in cash in arrears semi-annually on January 15 and July 15. The notes are subordinated to all of the Companys existing and future debt. The notes are convertible into shares of the Companys common stock at any time on or before July 15, 2007, at a conversion price of $73.935 per share, subject to certain adjustments. The Company may redeem any of the notes, in whole or in part, subject to certain call premiums on or after July 18, 2004, as specified in the notes and related indenture agreement. In December 2001 and April 2005, the Company entered into two transactions with JP Morgan Chase Bank for $412.5 million and $137.5 million in notional amounts, respectively, which had the effect to the Company of converting the interest rate to variable and requiring that the convertible notes be marked to market (see Note 4, Derivative Financial Instruments).
In November 2003, the Company entered into a three-year syndicated multi-currency revolving credit facility, led by BNP Paribas, expiring in November 2006 (the Facility). The Facility provides a credit line of $150 million of which up to $150 million may be used for standby letters of credit. The Facility bears interest at (i) local currency rates plus (ii) a margin between 0.75 percent and 2.0 percent for base rate advances and a margin of between 1.75 percent and 3.0 percent for euro-currency rate advances. Other advances bear interest as set forth in the credit agreement. The annual commitment fee for the Facility is subject to a leverage ratio as determined by the credit agreement and was 0.375 percent of the unused portion of the total facility at each period-end. The Company pledged as collateral shares of certain of its subsidiaries. The Facility also contains certain financial and other covenants, with which the Company was in compliance at September 30, 2005. At September 30, 2005, the Company had $16.9 million borrowings and $20.2 million letters of credit outstanding under the Facility. At June 30, 2005, the Company had $17.1 million borrowings and $16.4 million letters of credit outstanding under the Facility. Of the letters of credit outstanding, $15.8
million and $12.0 million were related to the interest rate swap transactions (see Note 3) at September 30, 2005 and June 30, 2005, respectively.
At September 30, 2005, the Company had $166.6 million in total revolving lines of credit, of which $38.2 million had been utilized, consisting of $20.2 million in letters of credit and $18.0 million in foreign revolving bank loans, which are included in the table above.
9. Impairment of Assets, Restructuring and Severance
During fiscal 2003 second quarter ended December 31, 2002, the Company announced its restructuring initiatives. Under these initiatives, the goal was to reposition the Company to better fit the market conditions and de-emphasize its commodity business. The Companys restructuring plan included consolidating and closing certain manufacturing sites, upgrading equipment and processes in designated facilities and discontinuing production in a number of others that cannot support more advanced technology platforms or products within its Focus Product segments. The Company also planned to lower overhead costs across its support organizations. The Company has substantially completed these restructuring activities as of September 30, 2005. The Company expects to complete the remaining activities, primarily the closing of a fabrication line at El Segundo, California by fiscal year end 2006 or sooner.
Total charges associated with the December 2002 initiatives are expected to be approximately $280 million. These charges will consist of approximately $220 million for asset impairment, plant closure and other charges, $6 million of raw material and work-in-process inventory, and $54 million for severance-related costs.
For the three months ended September 30, 2005, the Company recorded $4.3 million in total restructuring-related charges, consisting of: $3.1 million for asset impairment, plant closure costs and other charges, and $1.2 million for severance-related costs. For the three months ended September 30, 2004, the Company recorded $6.7 million in total restructuring-related charges, consisting of: $4.9 million for impairment, plant closure costs and other charges, and $1.8 million for severance-related costs. Restructuring-related costs were charged as incurred in accordance with SFAS No. 146, Accounting for the Costs Associated with Exit or Disposal Activities. Asset impairments were calculated in accordance with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets. In determining the asset groups, the Company grouped assets at the lowest level for which independent identifiable cash flows were available. In determining whether an asset was impaired the Company evaluated undiscounted future cash flows and other factors such as changes in strategy and technology. The undiscounted cash flows from the Companys initial analyses were less than the carrying amount for certain of the asset groups, indicating impairment losses. Based on this, the Company determined the fair value of these asset groups using the present value technique, by applying a discount rate to the estimated future cash flows that was consistent with the rate used when analyzing potential acquisitions.
As of September 30, 2005, the Company had recorded $265.7 million in total charges, consisting of: $213.2 million for asset impairment, plant closure costs and
other charges, $6.0 million for raw material and work-in-process inventory charges, and $46.5 million for severance-related costs. Components of the $213.2 million asset impairment, plant closure and other charges included the following items:
As the Company emphasizes more advanced generation planar products, it expects the future revenue stream from its less advanced facilities in Temecula, California to decrease significantly. These facilities had a net book value of $138.3 million and were written down by $77.7 million. It is expected that these facilities will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period. It is assumed that salvage value will equal disposition costs.
As the Company emphasizes more advanced generation trench products, it expects the future revenue stream from its less advanced facility in El Segundo, California to decrease significantly. This facility had a net book value of $59.5 million and was written down by $57.2 million. This facility had significantly reduced production as of fiscal year ended June 30, 2003 and is used primarily for research and development activities.
As the Company emphasizes more advanced generation Schottky products, it expects the future revenue stream from its less advanced facility in Borgaro, Italy to decrease significantly. This facility had a net book value of $20.5 million and was written down by $13.5 million. It is expected that this facility will continue in use until approximately December 2007 and the remaining basis is being depreciated over units of production during this period. It is assumed that salvage value will equal disposition costs.
The Company restructured its manufacturing activities in Europe. Based on a review of its Swansea, Wales facility, a general-purpose module facility, the Company determined in the December 2002 quarter that this facility would be better suited to focus only on automotive applications. The general-purpose module assets at this facility, with a net book value of $13.6 million, were written down by $8.2 million. In addition, the Company has completed the move of its manufacturing activities from its automotive facility in Krefeld, Germany to its Swansea, Wales and Tijuana, Mexico facilities as of September 30, 2005. The Company has also moved the production from its Venaria, Italy facility to its Borgaro, Italy and Mumbai, India facilities, which was completed as of December 31, 2003. The Company stopped manufacturing products at its Oxted, England facility as of September 30, 2003.
The Company has eliminated the manufacturing of its non-space military products in its Santa Clara, California facility as of July 31, 2004. Currently, subcontractors handle the Companys non-space qualified products previously manufactured in this facility. The Company is also transitioning the assembly and test of non-space Power Components from its Leominster, Massachusetts facility to its Tijuana, Mexico facility, and expects to complete this activity by calendar year end 2005. Associated with these reductions in manufacturing activities, certain assets with a net book value of $4.0 million were written down by $2.0 million.
$54.6 million in other miscellaneous items were charged, including $45.8 million in relocation costs and other impaired asset charges and $8.8 million in contract termination and settlement costs.
As a result of the restructuring initiatives, certain raw material and work-in-process inventories were impaired, including products that could not be completed in other facilities, materials that were not compatible with the processes used in the alternative facilities, and materials such as gases and chemicals that could not readily be transferred. Based on these factors the Company wrote down these inventories, with a carrying value of $98.2 million, by $6.0 million. For the three months ended September 30, 2005 and 2004, the Company disposed of $0 and $0.5 million, respectively, of these inventories, which did not have a material impact on gross margin for the periods then ended. As of September 30, 2005, $1.2 million of these inventories remained to be disposed.
As of September 30, 2005, the Company has recorded $46.5 million in severance-related charges: $41.3 million in severance termination costs related to approximately 1,200 administrative, operating and manufacturing positions, and $5.1 million in pension termination costs at its manufacturing facility in Oxted, England. The severance charges associated with the elimination of positions, which included the persons notified to date, had been and will continue to be recognized over the future service period, as applicable, in accordance with SFAS No. 146. The Company measured the total termination benefits at the communication date based on the fair value of the liability as of the termination date. A change resulting from a revision to either the timing or the amount of estimated cash over the future service period will be measured using the credit-adjusted risk-free rate that was used to initially measure the liability. The cumulative effect of the change will be recognized as an adjustment to the liability in the period of the change.
During fiscal 2002, the Company had recorded an estimated $5.1 million in severance costs associated with the acquisition of TechnoFusion GmbH in Krefeld, Germany. In fiscal 2003, the Company finalized its plan and determined that total severance would be approximately $10 million, and accordingly, the Company adjusted purchased goodwill by $4.8 million. The Company communicated the plan and the elimination of approximately 250 positions primarily in manufacturing to its affected employees at that time. The associated severance is expected to be paid by calendar year end 2005.
The following summarizes the Companys severance accrual related to the June 2001 restructuring, the TechnoFusion acquisition and the December 2002 restructuring plan for the three months ended September 30, 2005 and the fiscal year ended June 30, 2005. Severance activity related to the elimination of 29 administrative and operating personnel as part of the previously reported restructuring in the fiscal quarter ended June 30, 2001, is also disclosed. The remaining June 2001 severance relates primarily to certain legal accruals associated with that restructuring, which will be paid or released as the outcome is determined (in thousands):
10. Segment and Geographic Information
Revenues for the three months ended September 30, 2005 and 2004, by the three broad product categories, are as follows (in thousands):
Segment results for the three months ended September 30, 2005 and 2004 and as of September 30, 2005 and June 30, 2005, are as follows (in thousands except percentages):
Product revenues from unaffiliated customers are based on the location in which the sale originated. The Company includes in long-lived assets, all long-term assets excluding long-term cash investments, long-term deferred income taxes, goodwill and acquisition-related intangibles.
Geographic information for the Company on an aggregate basis, for the three months ended September 30, 2005 and 2004, is presented below (in thousands):
No single original equipment manufacturer (OEM), customer, distributor or subcontract manufacturer accounted for more than ten percent of the Companys consolidated revenues for the three months ended September 30, 2005 or 2004. For its Focus Product segments as a whole, the Company primarily sells direct to OEM customers. Three distributors accounted for approximately 41 percent of Computing and Communications segment revenues for the three months ended September 30, 2005. One distributor accounted for approximately 17 percent of Commodity Products segment revenues for the three months ended September 30, 2005. Two OEM customers, individually accounting for greater than 10 percent of Non-Aligned Products (NAP) revenues, accounted for approximately 35 percent of NAP revenues for the three months ended September 30, 2005. No single OEM customer, distributor or subcontract manufacturer accounted for more than ten percent of the Companys other reportable segments revenues for the quarter. No customer accounted for more than 10 percent of the Companys accounts receivable at September 30, 2005 and June 30, 2005.
11. Stock-Based Compensation
For the three months ended September 30, 2005, equity-based compensation awards were granted under one of two stock option plans: the 1997 Employee Stock Incentive Plan (1997 Plan) and the 2000 Incentive Plan (2000 Plan). Options granted before November 22, 2004, generally became exercisable in annual installments of 25 percent beginning on the first anniversary date, and expire after seven years. Options granted after November 22, 2004, generally became exercisable in annual installments of 33 percent beginning on the first anniversary date, and expire after five years.
Under the 1997 Plan, options to purchase shares of the Companys common stock may be granted to the Companys employees and consultants. In addition, other stock-based awards (e.g., restricted stock units (RSUs), SARs and performance shares) may also be granted. During the three months ended September 30, 2005 and 2004, non-qualified options and RSUs were issued under the 1997 Plan. As noted below, on November 22, 2004, the Companys stockholders approved an amendment to the 2000 Plan to increase the authorized number of shares from 7,500,000 to 12,000,000, at which point no awards may be granted under the 1997 Plan.
Under the 2000 Plan, options to purchase shares of the Companys common stock and other stock-based awards may be granted to the Companys employees, consultants, officers and directors. The terms of the 2000 Plan were substantially similar to those under the 1997 Plan. On November 22, 2004, the Companys shareholders approved an amendment to the 2000 Plan which increased the authorized number of shares to be granted from 7,500,000 to 12,000,000. The amendment changed the options expiration term on future grants to five years, and contained certain limitations on the maximum number of shares that may be awarded to an individual. No awards may be granted under the 2000 Plan after August 24, 2014. As of September 30, 2005, there were 4,097,698 shares available for future grants.
The following table summarizes the stock option activities for the period ended September 30, 2005 (in thousands except per share data):
The following table summarizes the RSU activities for the period ended September 30, 2005 (in thousands except per share data):
The following table summarizes the non-vested stock option and RSU activities for the period ended September 30, 2005 (in thousands):
The following table summarizes the stock options and RSUs outstanding at September 30, 2005, and related weighted average price and life information (in thousands except years and price data):
Additional information relating to the stock option plans, including employee stock options and RSUs, at September 30, 2005 and June 30, 2005 is as follows (in thousands):
Beginning in the fiscal year 2006, the Company adopted SFAS No. 123(R), Share-Based Payments (SFAS No. 123(R)) on a modified prospective transition method to account for its employee stock options. The adoption of SFAS No. 123(R) did not affect the stock-based compensation associated with the Companys RSUs, which were already based on the market price of the stock at date of grant and recognized over the service period. Under the modified prospective transition method, fair value of new and previously granted but unvested equity awards are recognized as compensation expense in the income statement, and prior period results are not restated. As a result of the adoption, the Companys income from continuing operations, which is the same as income before income taxes, decreased by $0.4 million, net income was decreased by $0.3 million, and basic and diluted earnings per share were negatively impacted by $0.01.
For the three months ended September 30, 2005, stock-based compensation expense recognized in the income statement is as follows (in thousands):
The total compensation expense for outstanding stock options and RSUs was $7.9 million as of September 30, 2005, which will be recognized over a weighted average of approximately three years. The fair value of the options associated with the above compensation expense for the three months ended September 30, 2005, was determined at the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:
In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB No. 107) that provided the Staffs views regarding valuation of share-based payments pursuant to SFAS No. 123(R). With respect to volatility, SAB No. 107 clarified that there is not a particular method of estimating volatility and to the extent that the Company has traded financial instruments from which it can derive the implied volatility, it may be appropriate to use only implied volatility in its assumptions. The Company has certain financial instruments that are publicly traded from which it can derive the implied volatility. Therefore, beginning in January 2005, the Company used implied volatility for valuing its stock options, whereas previously, it had used historical volatility. The Company believes implied volatility is a better indicator of expected volatility because it is generally reflective of both historical volatility and expectations of how future volatility will differ from historical volatility.
SAB No. 107 also provided certain simplified method for determining expected life in valuing stock options. To the extent that an entity cannot rely on its historical exercise data to determine the expected life, SAB No. 107 has prescribed a simplified plain-vanilla formula. Subsequent to the 2000 Plan amendments on November 22, 2004, the Company issued stock options having five-year expiration with generally a three-year annual vesting term, whereas, prior to then, the Company granted stock options having seven or ten-year expiration with generally a four or five-year annual vesting term. Therefore, beginning in January 2005, the Company applied SAB No. 107 plain-vanilla method for determining the expected life, whereas previously, it had used historical exercise data to determine the expected life.
Had the Company accounted for stock-based compensation plans using the fair value based accounting method described by SFAS No. 123 for the periods prior to fiscal year 2006, the Companys diluted net income per common sharebasic and diluted for the three months ended September 30, 2004, would have approximated the following (in thousands except per share data):
On April 17, 2005, the Company accelerated the vesting of all then outstanding equity awards, including employee stock options and restricted stock units, primarily to avoid recognizing in its income statement approximately $108 million in associated compensation expense in future periods, of which approximately $60 million would have been recognized in fiscal year 2006 upon the adoption of SFAS No. 123(R). As a result of the accelerated vesting, the Company recorded $6.0 million in non-cash compensation charge, of which $3.9 million is related to the excess of the intrinsic value over the fair market value of the Companys stock on the acceleration date of those options that would have been forfeited or expired unexercised had the vesting not been accelerated, and $2.1 million is related to the recognition of outstanding RSUs, including $0.3 million for the excess of the intrinsic value over the fair market value of the Companys stock on the acceleration date. In determining the forfeiture rates of the stock options, the Company reviewed the unvested options original life, time remaining to vest and whether these options were held by officers and directors of the Company. The compensation charge is adjusted in future period financial results as actual forfeitures are realized. For the three months ended September 30, 2005, there were no material changes in actual forfeitures from estimates.
12. Environmental Matters
Federal, state, foreign and local laws and regulations impose various restrictions and controls on the storage, use and discharge of certain materials, chemicals and gases used in semiconductor manufacturing processes. The Company does not believe that compliance with such laws and regulations as now in effect will have a material adverse effect on the Companys results of operations, financial position or cash flows.
However, under some of these laws and regulations, the Company could be held financially responsible for remedial measures if properties are contaminated or if waste is sent to a landfill or recycling facility that becomes contaminated. Also, the Company may be subject to common law claims if it releases substances that damage or harm third parties. The Company cannot make assurances that changes in environmental laws and regulations will not require additional investments in capital equipment and the implementation of additional compliance programs in the future, which could have a material adverse effect on the Companys results of operations, financial position or cash flows, as could any failure by the Company to comply with environmental laws and regulations.
The Company and Rachelle Laboratories, Inc. (Rachelle), a former operating subsidiary of the Company that discontinued operations in 1986, were each named a potentially responsible party (PRP) in connection with the investigation by the United States Environmental Protection Agency (EPA) of the disposal of allegedly hazardous substances at a major superfund site in Monterey Park, California (OII Site). Certain PRPs who settled certain claims with the EPA under consent decrees filed suit in Federal Court in May 1992 against a number of other PRPs, including the Company, for cost recovery and contribution under the provisions of the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). IR has settled all outstanding claims that have arisen against it out of the OII Site. No claims against Rachelle have been settled. The Company has taken the position that none of the wastes generated by Rachelle were hazardous.
Counsel for Rachelle received a letter dated August 2001 from the U.S. Department of Justice, directed to all or substantially all PRPs for the OII Site, offering to settle claims against such parties for all work performed through and including the final remedy for the OII Site. The offer required a payment from Rachelle in the amount of approximately $9.3 million in order to take advantage of the settlement. Rachelle did not accept the offer.
In as much as Rachelle has not accepted the settlement, the Company cannot predict whether the EPA or others would attempt to assert an action for contribution or reimbursement for monies expended to perform remedial actions at the OII Site. The Company cannot predict the likelihood that the EPA or such others would prevail against Rachelle in any such action. It remains the position of Rachelle that its wastes were not hazardous. The Companys insurer has not accepted liability, although it has made payments for defense costs for the lawsuit against the Company. The Company has made no accrual for potential loss, if any; however, an adverse outcome could have a material adverse effect on the Companys results of operations and cash flows.
The Company received a letter in June 2001 from a law firm representing UDT Sensors, Inc. relating to environmental contamination (chlorinated solvents such as trichlorethene) assertedly found in UDTs properties in Hawthorne, California. The letter alleges that the Company operated a manufacturing business at that location in the 1970s and/or 1980s and that it may have liability in connection with the claimed contamination. The Company has made no accrual for any potential losses since there has been no assertion of specific facts on which to form the basis for determination of liability.
In June 2000, the Company filed suit in Federal District Court in Los Angeles, California against IXYS Corporation, alleging infringement of its key U.S. patents 4,959,699; 5,008,725 and 5,130,767. The suit sought damages and other relief customary in such matters. The Federal District Court entered a permanent injunction, effective on June 5, 2002, barring IXYS from making, using, offering to sell or selling in, or importing into the United States, MOSFETs (including IGBTs) covered by the Companys U.S. patents 4,959,699; 5,008,725 and/or 5,130,767. In August 2002, the Court of Appeals for the Federal Circuit stayed that injunction, pending appeal on the merits. In that same year, following trial on damages issues, a Federal District Court jury awarded the Company $9.1 million in compensatory damages. The Federal District Court subsequently tripled the damages, increasing the award from $9.1 million to approximately $27.2 million, and ruled that the Company is entitled to an additional award of reasonable attorneys fees for a total monetary judgment of about $29.5 million. In March 2004, the U.S. Court of Appeals for the Federal Circuit reversed the summary judgment granted the Company by the Federal District Court in Los Angeles of infringement by IXYS of the Companys U.S. patents 4,959,699; 5,008,725 and 5,130,767. The Federal Circuit reversed in part and vacated in part infringement findings of the District Court, granted IXYS the right to present certain affirmative defenses, and vacated the injunction against IXYS entered by the District Court. The ruling by the Federal Circuit had the effect of vacating the damages judgment obtained against IXYS. The Federal Circuit affirmed the District Courts rulings in the Companys favor regarding the validity and enforceability of the three Company patents. Following remand, a federal court jury in Los Angeles, California held on September 15, 2005, that IXYS elongated octagonal MOSFETs and IGBTs infringed the Companys 4,959,699 patent but did not infringe the Companys 5,008,725 and 5,130,767 patents. On October 6, 2005 the jury awarded the Company $6.2 million in damages. Further proceedings are required in the trial court before final judgment can be entered. The Company anticipates that IXYS will appeal the judgment. No amount has been recognized in the income statement from the pending litigation for the three months ended September 30, 2005.
14. Income Taxes
The Companys effective tax provision for the three months ended September 30, 2005 and 2004 was 27.5 percent and 24.0 percent, respectively, rather than the U.S. federal statutory tax provision of 35 percent as a result of lower statutory tax rates in certain foreign jurisdictions, the benefit of foreign tax credits and research
and development credits, partially offset by state taxes and certain foreign losses without foreign tax benefit.
In December 2004, the FASB issued FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004, which introduces a limited time 85 percent dividends received deduction on the repatriation of certain foreign earnings to a U.S. tax payer (repatriation provision), provided certain criteria are met. The Company is currently evaluating the range of possible amounts of unremitted earnings that may be repatriated as a result of the repatriation provision; the related range of income tax effects of such repatriation cannot be reasonably estimated at this time.
15. Related Party Transactions
As discussed in Note 3, the Company holds as strategic investment common stock of Nihon Inter Electronics Corporation (Nihon), a related party. At September 30, 2005 and June 30, 2005, the Company owned approximately 17.5 percent of the outstanding shares of Nihon. As previously reported, the Companys Chief Financial Officer was the Chairman of the Board and a director of Nihon until June 28, 2005. In addition, the general manager of the Companys Japan subsidiary is a director of Nihon. Although the Company has a member on the Board of Directors of Nihon, it does not exercise significant influence, and accordingly, the Company records its interest in Nihon based on readily determinable market values in accordance with SFAS No. 115 (see Note 3, Cash and Investments).
16. Subsequent Event
On November 1, 2005, the Companys Board of Directors authorized and the Company announced a stock repurchase program, under which up to $100 million of the Companys common shares may be repurchased without prior notice, through block trades or otherwise. The Company intends that any shares repurchased will be held as treasury shares that may be used for general corporate purposes. From the date of the repurchase through the following thirty days, no amounts under the Companys $150 million credit facility will be available. Shares repurchased will be paid with the Companys existing cash and cash investments. As of November 11, 2005, no shares had been repurchased under the program.
The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and notes to consolidated financial statements included elsewhere in this Form 10-Q. Except for historic information contained herein, the matters addressed in this Item 2 constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements may be identified by the use of terms such as anticipate, believe, expect, intend, project, will, and similar expressions. Such forward-looking statements are subject to a variety of risks and uncertainties, including those discussed under the heading Statement of Caution Under the Private Securities Litigation Reform Act of 1995 and elsewhere in this Quarterly Report on Form 10-Q, that could cause actual results to differ materially from those anticipated by the Company. We undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes.
Overview of Results of Operations for the Three Months Ended September 30, 2005
We report our results in six segments: Computing and Communications (C&C), Energy-Saving Products (ESP), Aerospace and Defense (A&D), Intellectual Property (IP), Commodity Products (CP) and Non-Aligned Products (NAP). We include our C&C, ESP, A&D and IP segments in our Focus Product group, and our CP and NAP segments in our Non-Focus Product group.
For the three months ended September 30, 2005, consolidated revenues were $272.6 million compared to $312.2 million in the prior year three months ended September 30, 2004. Revenues for our Focus Products were $201.9 million (74.1 percent of revenues) and $221.4 million (70.9 percent of revenues) for the three months ended September 30, 2005 and 2004, respectively. Revenues for our Non-Focus Products were $70.7 million (25.9 percent of revenues) and $90.8 million (29.1 percent of revenues) for the three months ended September 30, 2005 and 2004, respectively. Revenues for the three months ended September 30, 2005 were lower than the prior year. Some of the factors that adversely affected revenues for the quarter ended September 30, 2005 included price pressure on certain component products, changes in distributor purchasing patterns and a logistics bottleneck that delayed certain shipments at the end of the fiscal quarter in our A&D segment. Additionally, in our C&C and ESP segments, revenues were inhibited by and lower due to capacity constraints and an inventory mix that was different than the demand for certain products. For the three months ended December 31, 2005, we expect our overall revenues to increase by only one to four percent, in part, reflecting continuing capacity limitations in our C&C and ESP segments.
For the quarter ended September 30, 2005, total inventory increased by $16.2 million to $193.8 million from $177.6 million at June 30, 2005. Finished goods increased by $13.3 million as a result of an inventory build that was different than the demand for certain products principally within our C&C and ESP segments in the fiscal first quarter.
For the three months ended September 30, 2005, gross profit margin was 40.7 percent compared to 42.7 percent for the prior year three months ended September 30, 2004. Gross profit margin for our Focus Products were 48.8 percent and 49.2 percent for the three months ended September 30, 2005 and 2004, respectively. Gross profit margin for our Non-Focus Products was 17.4 percent and 27.0 percent for the three months ended September 30, 2005 and 2004, respectively. The gross profit margin declined primarily due to price declines, product mix, and profit sharing and employee stock option expense. We expect our overall Company gross margin for the three months ended December 31, 2005 to be approximately two percentage points lower than the three months ended September 30, 2005, largely due to pricing pressures, product mix and costs associated with our Newport, Wales facility.
Revenues as a percentage of total product revenues based on sales location were approximately 28 percent, 50 percent and 22 percent for North America (primarily United States), Asia and Europe, respectively, for the three months ended September 30, 2005. Revenues as a percentage of total product revenues based on sales location were approximately 30 percent, 47 percent and 23 percent for North America (primarily United States), Asia and Europe, respectively, for the three months ended September 30, 2004.
As of September 30, 2005, we have substantially completed our restructuring activities previously announced in 2002 and 2003. For the three months ended September 30, 2005, we recorded $4.3 million in total restructuring-related charges, consisting of: $3.1 million for asset impairment, plant closure costs and other charges and $1.2 million for severance-related costs. We estimate that charges associated with the restructuring will be approximately $280 million. These charges will consist of approximately $220 million for asset impairment, plant closure costs and other charges, $6 million of raw material and work-in-process inventory, and approximately $54 million for severance-related charges. Of the $280 million in total charges, we expect cash charges to be approximately $110 million. As of September 30, 2005, we have realized annualized savings of approximately $80 million from the restructuring activities, with approximately 70 percent of that savings affecting cost of goods sold. We are also continuing with our plan to review product lines and products not aligned with our long-term objectives to increase our overall gross margins.
As of September 30, 2005, demand for our Focus Products, primarily those reported in our C&C and ESP segments, exceeded our worldwide capacity. To help address our capacity limitations, we are starting production on our new eight-inch sub-micron wafer fabrication facility in Newport, Wales in the December 2005 quarter. During the three months ended September 30, 2005, we spent $37.0 million in capital expenditure, of which $13.9 million was at the Newport, Wales facility. We anticipate that nearly 70 percent of capital expenditures for fiscal year 2006 will be in the first half of the year.
We adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment (SFAS No. 123(R)) that became effective for us in the fiscal first quarter ended September 30, 2005. SFAS No. 123(R) required that we recognize the fair value of equity awards granted to our employees as compensation expense in the income statement over the requisite service period. For the three months ended September 30, 2005, we recognized $0.4 million in stock-based compensation expense as a result of the adoption of SFAS No. 123(R). As a consequence of SFAS No. 123(R), we have reduced