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International Rectifier 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

Form 10-Q

 

(MARK ONE)

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

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

 

OR

 

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

 

FOR THE TRANSITION PERIOD FROM                                          TO                                           

 

COMMISSION FILE NUMBER:      1-7935

 

International Rectifier Corporation

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

DELAWARE

 

95-1528961

(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)

 

(IRS EMPLOYER IDENTIFICATION
NUMBER)

 

 

 

233 KANSAS STREET

 

 

EL SEGUNDO, CALIFORNIA

 

90245

(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)

 

(ZIP CODE)

 

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

 

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

 

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

 

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

 

 



 

Table of Contents

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

Financial Statements

 

 

 

 

 

Unaudited Consolidated Statement of Income for the Three and Nine Months Ended March 31, 2005 and 2004

 

 

 

 

 

Unaudited Consolidated Statement of Comprehensive Income for the Three and Nine Months Ended March 31, 2005 and 2004

 

 

 

 

 

Unaudited Consolidated Balance Sheet as of March 31, 2005 and June 30, 2004

 

 

 

 

 

Unaudited Consolidated Statement of Cash Flows for the Nine Months Ended March 31, 2005 and 2004

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

 

 

 

 

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

ITEM 4.

Controls and Procedures

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

ITEM 6.

Exhibits

 

 

2



 

PART I. FINANCIAL INFORMATION

 

ITEM 1.  Financial Statements.

 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF INCOME

(In thousands except per share amounts)

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

281,871

 

$

275,411

 

$

892,656

 

$

761,854

 

Cost of sales

 

156,604

 

166,236

 

504,571

 

473,653

 

Gross profit

 

125,267

 

109,175

 

388,085

 

288,201

 

Selling and administrative expense

 

40,756

 

43,005

 

128,034

 

117,717

 

Research and development expense

 

27,323

 

24,221

 

80,379

 

67,274

 

Amortization of acquisition-related intangible assets

 

1,473

 

1,421

 

4,369

 

4,218

 

Impairment of assets, restructuring and severance charges

 

8,077

 

9,907

 

21,599

 

24,026

 

Other income (expense), net

 

169

)

(6,174

)

825

 

(5,647

)

Interest (income) expense, net

 

(638

)

1,512

 

1,728

 

1,095

 

Income before income taxes

 

48,107

 

35,283

 

151,151

 

79,518

 

Provision for income taxes

 

12,434

 

8,538

 

38,384

 

19,155

 

Net income

 

$

35,673

 

$

26,745

 

$

112,767

 

$

60,363

 

 

 

 

 

 

 

 

 

 

 

Net income per common share – basic

 

$

0.53

 

$

0.41

 

$

1.68

 

$

0.93

 

 

 

 

 

 

 

 

 

 

 

Net income per common share – diluted

 

$

0.48

 

$

0.39

 

$

1.55

 

$

0.89

 

 

 

 

 

 

 

 

 

 

 

Average common shares outstanding – basic

 

67,795

 

65,826

 

67,080

 

65,166

 

 

 

 

 

 

 

 

 

 

 

Average common shares and potentially dilutive securities outstanding - diluted

 

77,322

 

69,132

 

76,559

 

68,184

 

 

The accompanying notes are an integral part of this statement.

 

3



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(In thousands)

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

35,673

 

$

26,745

 

$

112,767

 

$

60,363

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(9,421

)

10,435

 

14,124

 

29,840

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) on available-for-sale securities, net of tax effect of ($465), ($2,902), $6,780 and ($11,891), respectively

 

794

 

4,944

 

(11,544

)

20,249

 

Unrealized holding gains (losses) on foreign currency forward contract, net of tax effect of ($1,061), $425, $185 and $4,054, respectively

 

1,807

 

(723

)

(315

)

(6,902

)

Less: Reclassification adjustments of net losses on available-for-sale securities and foreign currency forward contract

 

57

 

(7,855

)

609

 

(7,709

)

Other comprehensive income, net

 

(6,763

)

6,801

 

2,874

 

35,478

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

28,910

 

$

33,546

 

$

115,641

 

$

95,841

 

 

The accompanying notes are an integral part of this statement.

 

 

4



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED BALANCE SHEET

(In thousands)

 

 

 

March 31,

 

June 30,

 

 

 

2005

 

2004

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

312,039

 

$

339,024

 

Short-term cash investments

 

244,036

 

221,130

 

Trade accounts receivable, net

 

167,030

 

154,911

 

Inventories

 

171,748

 

159,908

 

Deferred income taxes

 

48,447

 

44,141

 

Prepaid expenses and other receivables

 

67,379

 

34,096

 

Total current assets

 

1,010,679

 

953,210

 

Long-term cash investments

 

296,341

 

276,055

 

Property, plant and equipment, net

 

477,767

 

393,919

 

Goodwill

 

156,643

 

139,919

 

Acquisition-related intangible assets, net

 

37,172

 

28,605

 

Long-term deferred income taxes

 

78,340

 

74,366

 

Other assets

 

115,988

 

150,932

 

Total assets

 

$

2,172,930

 

$

2,017,006

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Bank loans

 

$

20,003

 

$

18,866

 

Long-term debt, due within one year

 

224

 

274

 

Accounts payable

 

73,175

 

78,164

 

Accrued salaries, wages and commissions

 

27,382

 

36,510

 

Other accrued expenses

 

104,705

 

81,222

 

Total current liabilities

 

225,489

 

215,036

 

Long-term debt, less current maturities

 

547,128

 

560,019

 

Other long-term liabilities

 

33,214

 

22,950

 

Deferred income taxes

 

 

14,789

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

68,109

 

66,358

 

Capital contributed in excess of par value of shares

 

802,664

 

757,169

 

Retained earnings

 

410,452

 

297,685

 

Accumulated other comprehensive income

 

85,874

 

83,000

 

Total stockholders’ equity

 

1,367,099

 

1,204,212

 

Total liabilities and stockholders’ equity

 

$

2,172,930

 

$

2,017,006

 

 

The accompanying notes are an integral part of this statement.

5



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS

(In thousands)

 

 

 

Nine Months Ended

 

 

 

March 31,

 

 

 

2005

 

2004

 

 

 

 

 

 

 

Cash flow from operating activities:

 

 

 

 

 

Net income

 

$

112,767

 

$

60,363

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

51,852

 

41,870

 

Amortization of acquisition-related intangible assets

 

4,369

 

4,218

 

Unrealized gains on swap transactions

 

(1,176

)

(519

)

Deferred income taxes

 

(15,106

)

2,147

 

Tax benefit from options exercised

 

11,405

 

12,215

 

Change in operating assets and liabilities, net

 

(21,852

)

(37,102

)

Net cash provided by operating activities

 

142,259

 

83,192

 

 

 

 

 

 

 

Cash flow from investing activities:

 

 

 

 

 

Additions to property, plant and equipment

 

(98,745

)

(52,153

)

Proceeds from sale of property, plant and equipment

 

265

 

420

 

Acquisition of business

 

(39,633

)

 

Acquisition of technologies

 

(11,500

)

 

Sale or maturities of cash investments

 

332,131

 

478,855

 

Purchase of cash investments

 

(375,889

)

(502,713

)

Change in other investing activities, net

 

(12,907

)

960

 

Net cash used in investing activities

 

(206,278

)

(74,631

)

 

 

 

 

 

 

Cash flow from financing activities:

 

 

 

 

 

Proceeds from short-term debt, net

 

49

 

1,926

 

Repayments of long-term debt

 

 

(118

)

Repayments of capital lease obligations, net

 

(172

)

(776

)

Proceeds from exercise of stock options and stock purchase plan

 

35,842

 

40,319

 

Other, net

 

(1,193

)

(280

)

Net cash provided by financing activities

 

34,526

 

41,071

 

Effect of exchange rate changes on cash and cash equivalents

 

2,508

 

(3,257

)

Net (decrease) increase in cash and cash equivalents

 

(26,985

)

46,375

 

Cash and cash equivalents, beginning of period

 

339,024

 

216,823

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

312,039

 

$

263,198

 

 

The accompanying notes are an integral part of this statement.

 

6



 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2005

 

1.         Basis of Consolidation

 

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

 

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

 

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

 

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

 

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

 

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

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

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

 

7



 

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

 

2.         Net Income Per Common Share

 

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

 

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

 

 

 

Net Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2005:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

35,673

 

67,795

 

$

0.53

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

2,088

 

(0.02

)

Conversion of subordinated notes

 

1,552

 

7,439

 

(0.03

)

Net income per common share – diluted

 

$

37,225

 

77,322

 

$

0.48

 

 

 

 

 

 

 

 

 

Three months ended March 31, 2004:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

26,745

 

65,826

 

$

0.41

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

3,306

 

(0.02

)

Net income per common share – diluted

 

$

26,745

 

69,132

 

$

0.39

 

 

 

 

 

 

 

 

 

 

 

Nine months ended March 31, 2005:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

112,767

 

67,080

 

$

1.68

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

2,040

 

(0.05

)

Conversion of subordinated notes

 

6,250

 

7,439

 

(0.08

)

Net income per common share – diluted

 

$

119,017

 

76,559

 

$

1.55

 

 

 

 

 

 

 

 

 

Nine months ended March 31, 2004:

 

 

 

 

 

 

 

Net income per common share – basic

 

$

60,363

 

65,166

 

$

0.93

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

3,018

 

(0.04

)

Net income per common share – diluted

 

$

60,363

 

68,184

 

$

0.89

 

 

8



 

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

 

3.         Cash and Investments

 

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

 

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

 

9



 

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

 

 

 

March 31,

 

June 30,

 

 

 

2005

 

2004

 

Cash and cash equivalents

 

$

312,039

 

$

339,024

 

Short-term cash investments

 

244,036

 

221,130

 

Long-term cash investments

 

296,341

 

276,055

 

Total cash, cash equivalents and cash investments

 

$

852,416

 

$

836,209

 

 

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

 

Short-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

153,754

 

$

1

 

$

(1,570

)

$

(1,569

)

$

152,185

 

U.S. government and agency obligations

 

86,718

 

 

(629

)

(629

)

86,089

 

Other debt

 

5,764

 

 

(2

)

(2

)

5,762

 

Total short-term cash investments

 

$

246,236

 

$

1

 

$

(2,201

)

$

(2,200

)

$

244,036

 

 

Long-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

136,089

 

$

198

 

$

(963

)

$

(765

)

$

135,324

 

U.S. government and agency obligations

 

80,487

 

157

 

(238

)

(81

)

80,406

 

Other debt

 

80,748

 

44

 

(181

)

(137

)

80,611

 

Total long-term cash investments

 

$

297,324

 

$

399

 

$

(1,382

)

$

(983

)

$

296,341

 

 

10



 

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

 

Short-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
Loss

 

Market
Value

 

Corporate auction rate preferred securities

 

$

100,600

 

$

 

$

 

$

 

$

100,600

 

Corporate debt

 

81,960

 

5

 

(299

)

(294

)

81,666

 

U.S. government and agency obligations

 

21,639

 

2

 

(48

)

(46

)

21,593

 

Other debt

 

17,282

 

 

(11

)

(11

)

17,271

 

Total short-term cash investments

 

$

221,481

 

$

7

 

$

(358

)

$

(351

)

$

221,130

 

 

Long-Term Cash Investments:

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Net
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

159,280

 

$

33

 

$

(1,689

)

$

(1,656

)

$

157,624

 

U.S. government and agency obligations

 

87,420

 

9

 

(517

)

(508

)

86,912

 

Other debt

 

31,798

 

21

 

(300

)

(279

)

31,519

 

Total long-term cash investments

 

$

278,498

 

$

63

 

$

(2,506

)

$

(2,443

)

$

276,055

 

 

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

 

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

 

 

 

Amortized
Cost

 

Estimated Fair
Value

 

Due in 1 year or less

 

$

246,236

 

$

244,036

 

Due in 1-2 years

 

135,805

 

134,711

 

Due in 2-5 years

 

122,529

 

122,641

 

Due after 5 years

 

38,990

 

38,989

 

Total cash investments

 

$

543,560

 

$

540,377

 

 

11



 

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

 

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

 

4.         Derivative Financial Instruments

 

Foreign Currency Risk

 

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

 

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

 

12



 

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

 

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

 

Interest Rate Risk

 

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

 

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

 

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

 

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

 

13



 

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

 

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

 

5.         Inventories

 

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

 

 

 

March 31,

 

June 30,

 

 

 

2005

 

2004

 

Raw materials

 

$

39,231

 

$

30,906

 

Work-in-process

 

77,011

 

69,702

 

Finished goods

 

55,506

 

59,300

 

Total inventories

 

$

171,748

 

$

159,908

 

 

6.         Goodwill and Acquisition-Related Intangible Assets

 

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

 

14



 

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

 

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

 

 

 

 

 

March 31, 2005

 

June 30, 2004

 

 

 

Amortization
Periods
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Goodwill

 

 

 

$

156,643

 

$

 

$

139,919

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition-related intangible assets:

 

 

 

 

 

 

 

 

 

 

 

Completed technology

 

4 – 12

 

$

37,323

 

$

(11,400

)

$

24,293

 

$

(8,831

)

Distribution rights and customer lists

 

5 – 12

 

15,667

 

(6,852

)

15,454

 

(5,681

)

Intellectual property and other

 

5 – 12

 

7,313

 

(4,879

)

7,313

 

(3,943

)

Total acquisition-related intangible assets

 

 

 

$

60,303

 

$

(23,131

)

$

47,060

 

$

(18,455

)

 

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

 

 

 

Total

 

Balance, June 30, 2003

 

$

136,818

 

New acquisition

 

266

 

Foreign exchange impact

 

2,835

 

Balance, June 30, 2004

 

139,919

 

New acquisitions

 

13,345

 

Foreign exchange impact

 

3,379

 

Balance, March 31, 2005

 

$

156,643

 

 

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

 

15



 

7.         Other accrued expenses

 

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

 

 

 

March 31,

 

June 30,

 

 

 

2005

 

2004

 

Accrued taxes

 

$

62,286

 

$

36,934

 

Short-term severance liability

 

6,848

 

11,784

 

Other accrued expenses

 

35,571

 

32,504

 

Total accrued expenses

 

$

104,705

 

$

81,222

 

 

8.         Bank Loans and Long-Term Debt

 

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

 

 

 

March 31,

 

June 30,

 

 

 

2005

 

2004

 

Convertible subordinated notes at 4.25% due in 2007 ($550,000 principal amount, plus accumulated fair value adjustment of ($3,592) and $9,173 at March 31, 2005 and June 30, 2004, respectively)

 

$

546,408

 

$

559,173

 

Other loans and capitalized lease obligations

 

1,699

 

1,120

 

Debt, including current portion of long-term debt ($224 and $274 at March 31, 2005 and June 30, 2004, respectively)

 

548,107

 

560,293

 

Credit facility and other foreign revolving bank loans at rates from 1.38% to 2.14%

 

19,248

 

18,866

 

Total debt

 

$

567,355

 

$

579,159

 

 

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

 

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

 

16



 

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

 

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

 

9.         Impairment of Assets, Restructuring and Severance

 

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

 

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

 

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

 

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

 

17



 

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

 

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

 

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

 

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

 

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

 

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

 

18



 

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

 

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

 

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

 

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

 

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

 

19



 

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

 

 

 

June
2001
Restructuring

 

December
2002
Restructuring

 

TechnoFusion
Severance
Liability

 

Total
Severance
Liability

 

Accrued severance, June 30, 2003

 

$

1,030

 

$

5,634

 

$

9,876

 

$

16,540

 

Costs incurred or charged to “impairment of assets, restructuring and severance”

 

 

15,450

 

 

15,450

 

Costs paid

 

(333

)

(13,935

)

(4,390

)

(18,658

)

Foreign exchange impact

 

 

31

 

581

 

612

 

Accrued severance, June 30, 2004

 

$

697

 

$

7,180

 

$

6,067

 

$

13,944

 

Costs incurred or charged to “impairment of assets, restructuring and severance”

 

 

4,804

 

 

4,804

 

Costs paid

 

(248

)

(5,531

)

(3,450

)

(9,229

)

Foreign exchange impact

 

 

620

 

(17

)

603

 

Accrued severance, March 31, 2005

 

$

449

 

$

7,073

 

$

2,600

 

$

10,122

 

 

20



 

10.       Geographical Information

 

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

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

North America

 

$

94,873

 

$

77,734

 

$

276,749

 

$

226,080

 

Asia

 

119,280

 

122,928

 

392,234

 

330,966

 

Europe

 

57,205

 

63,989

 

192,604

 

173,823

 

Total product revenues

 

271,358

 

264,651

 

861,587

 

730,869

 

Unallocated royalties

 

10,513

 

10,760

 

31,069

 

30,985

 

Total revenues

 

$

281,871

 

$

275,411

 

$

892,656

 

$

761,854

 

 

 

 

March 31,
2005

 

June 30,
2004

 

Long-Lived Assets

 

 

 

 

 

North America

 

$

355,125

 

$

358,243

 

Asia

 

22,996

 

17,728

 

Europe

 

215,634

 

168,880

 

Total

 

$

593,755

 

$

544,851

 

 

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

 

21



 

11.       Stock-Based Compensation

 

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

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Net income, as reported

 

$

35,673

 

$

26,745

 

$

112,767

 

$

60,363

 

Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax

 

(12,343

)

(12,816

)

(38,382

)

(36,226

)

Pro forma net income

 

$

23,330

 

$

13,929

 

$

74,385

 

$

24,137

 

 

 

 

 

 

 

 

 

 

 

Net income per common share-basic, as reported

 

$

0.53

 

$

0.41

 

$

1.68

 

$

0.93

 

Net income per common share-basic, pro forma

 

$

0.34

 

$

0.21

 

$

1.11

 

$

0.37

 

 

 

 

 

 

 

 

 

 

 

Net income per common share-diluted, as reported

 

$

0.48

 

$

0.39

 

$

1.55

 

$

0.89

 

Net income per common share-diluted, pro forma

 

$

0.32

 

$

0.20

 

$

1.05

 

$

0.37

 

 

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

 

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

 

 

22



 

The Company expects a non-cash compensation charge as a result of the accelerated vesting of approximately $6 million in the June 2005 quarter, of which $4 million is related to the excess of the intrinsic value over the fair market value of the Company’s stock on the acceleration date of those options that would have been forfeited or expired unexercised had the vesting not been accelerated, and $2 million is related to the amortization of outstanding RSUs, including $0.3 million for the excess of the intrinsic value over the fair market value of the Company’s 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 will be adjusted in future period financial results as actual forfeitures are realized.

 

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 Company’s 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 Company’s results of operations, financial position or cash flows, as could any failure by the Company to comply with environmental laws and regulations.

 

International Rectifier Corporation 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

 

23



 

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 Company’s 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 Company’s results of operations or 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 UDT’s properties in Hawthorne, California.  The letter alleges that the Company operated a manufacturing business at that location in the 1970’s and/or 1980’s 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.

 

13.       Litigation

 

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 Company’s 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 trebled 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 attorney’s 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 Company’s 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 will also have the effect of vacating the damages judgment obtained against IXYS. The Federal Circuit affirmed the District Court’s rulings in the Company’s favor regarding the validity and enforceability of the three Company patents. Upon remand, the Company continues to vigorously pursue its claims for damages and other relief based on IXYS’ infringement of the asserted patents, and trial on certain matters is set for later this year.

 

24



 

14.       Income Taxes

 

The Company’s effective tax provision was 25.8 percent and 24.2 percent for the three months ended March 31, 2005 and 2004, respectively, and 25.4 percent and 24.1 percent for the nine months ended March 31, 2005 and 2004, 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.

 

No taxes have been provided on undistributed foreign earnings that are planned to be indefinitely reinvested.  If future events, including material changes in estimates of cash, working capital and long-term investment requirements necessitate that these earnings be distributed, an additional provision for withholding taxes may apply, which could materially affect the Company’s future effective tax rate.

 

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” (“AJCA”) (“FAS No. 109-2”), 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 has not begun evaluating the impact of FSP No. 109-2, pending further clarification regarding certain key elements of the provision by the Congress or the Treasury Department.

 

As a matter of course, the Company is regularly audited by various taxing authorities.  Unfavorable settlement of any particular issue would require use of cash.  Favorable resolution would be recognized as a reduction to the effective tax rate in the year of resolution, or a reduction of goodwill if it relates to purchased tax liabilities.  The Company’s tax reserves are included in accrued taxes.  While it is often difficult to predict the final outcome or the timing of any particular tax matter, the Company believes the results of these audits will not have a material impact on its financial position or results of operations.

 

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 March 31, 2005 and June 30, 2004, the Company owned approximately 17.5 percent of the outstanding shares of Nihon.  As previously reported, the Company’s Chief Financial Officer is the Chairman of the Board and a director of Nihon until June 28, 2005.  In addition, the general manager of the Company’s Japan subsidiary is a director of Nihon.  Although the Company has representation 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).

 

In June 2002, the Company entered into agreements to license certain technology to Nihon and to contract Nihon to manufacture certain products.  The values of the licensing and manufacturing agreements are approximately $5.4 million and $2.0 million, respectively.  Revenues from these agreements were $0 and $0.8 million for the three months ended March 31, 2005 and 2004, respectively, and $0.2

 

25



 

million and $2.4 million for the nine months ended March 31, 2005 and 2004, respectively.

 

16.       Acquisition

 

In July 2004, the Company acquired the specialty silicon epitaxial services business from Advanced Technology Materials, Inc. (“ATMI”) for $39.5 million in cash, net of claim settlement as described below, in order to lower certain production costs and to gain certain key intellectual property for epitaxial silicon substrate manufacturing.  During the fiscal quarter ended December 31, 2004, the Company and ATMI settled the claim regarding certain processes transferred as part of the purchase transaction that failed to qualify in accordance with contract specifications, and $1.8 million was reimbursed to the Company.

 

The Company accounted for the acquisition under the purchase method of accounting.  The purchase price of $39.6 million was allocated as follows: $25.0 million for fixed assets, $0.8 million for inventory, $1.0 million for acquisition-related intangible assets, $0.3 million for other current assets and $12.5 million for goodwill.  The financial results of the acquisition have been included in the consolidated financial statements from the date of the acquisition.  The Company’s consolidated pro forma net sales, income and earnings per share would not have been materially different from the reported amount for the nine months ended March 31, 2005 and the three and nine months ended March 31, 2004, had the acquisition occurred at the beginning of those periods.

 

17.       Stock Options Exchange Program

 

In November 2004, at the annual meeting of the shareholders of International Rectifier Corporation, the Company’s shareholders approved the Company’s offer to exchange certain outstanding employee stock options for new options (the “Exchange Offer”), which would have presented eligible employees with the opportunity to exchange outstanding options with an exercise price equal to or greater than $40.00 per share for new options that would be granted at least six months and one day after the cancellation of the exchanged options.  Since the Company’s annual meeting in November 2004, the average closing share price of the Company’s stock has been about $43, approximately 20 percent higher than the average closing price over the month prior to the annual meeting.  The Company has determined that the Exchange Offer would not be effective under these market conditions, and has decided not to proceed with the Exchange Offer.

 

26



 

ITEM 2.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 us.  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

 

We are a leading designer, manufacturer and marketer of power management products.  The technology advancements of power management products increase system efficiency, allow more compact end products, improve features and functionality and extend battery life.  Our products are used in a range of end markets, including information technology, automotive, consumer electronics, aerospace/defense and industrial.

 

Our strategy continues to be to transform the Company from a commodity component orientation to a proprietary product focus.  Over the past eight quarters, we have increased our proprietary product mix from about 57 percent of revenues to about 70 percent.  For the three months ended March 31, 2005, our proprietary product revenues increased by approximately 19 percent compared to a year ago.  Our gross margin in the current quarter ended March 31, 2005, was 44.4 percent compared to 39.6 percent four quarters ago and 33.5 percent eight quarters ago.  Our proprietary products refer to our Analog ICs, Advanced Circuit Devices and Power Systems. We include in our reference to proprietary products, those products that are value-added or are provided under reduced competition due to their technological content or our customer relationship.  We periodically review products to determine their classification as proprietary products.

 

Revenues increased by 2.3 percent and 17.2 percent for the three and nine months ended March 31, 2005, respectively, compared to the prior-year three and nine months ended March 31, 2004, reflecting continued success of our proprietary products and further improvements in the semiconductor industry.  We continue to grow our proprietary product business for energy-conserving applications.  We saw a significant increase in the demand for our power management products that are used in energy-conserving appliances and lighting systems, which represented more than half of the revenues into the consumer sector for the nine months ended March 31, 2005.  During this period, sales of our products to original equipment manufacturers (“OEMs”) that are used in energy-conserving appliances and lighting increased by 58 percent compared to the prior-year nine months ended March 31, 2004.  As governments and consumers demand greater energy conservation, especially if high oil prices persist, we believe there may be significant growth in this business.

 

27



 

Sales levels in the semiconductor industry are higher than they were a year ago, but overall economic conditions remain somewhat uncertain and difficult to predict.  We continue to implement initiatives which are consistent with our proprietary product focus to increase our gross margin, while lowering manufacturing costs.  During the fiscal 2004 second quarter ended December 31, 2003, we announced the divestiture or discontinuation of certain commodity products representing approximately $100 million of annual revenues.  Under this plan, we have discontinued approximately $56 million of annual revenues and expect to divest approximately $44 million of annual revenues by selling our Hi-Power product group, for which we are in serious discussions with several qualified interested buyers.

 

In January 2005, we announced our plans to discontinue or divest over the next six quarters an additional $150 million in annual revenues that are not consistent with our business objectives to expand our proprietary product portfolio and target gross margin of greater than 50 percent by the end of this time period. In achieving this goal, we are targeting approximately $50 million in revenues from discontinuing products or deciding not to pursue certain revenue generating business opportunities, with the remaining approximately $100 million in targeted revenues arising from structured divestiture. In reviewing the business opportunities, products or product groups to be discontinued or divested, we are considering any components, analog and mixed signal ICs, advanced circuit devices or power systems that are sold in our various end-market applications, including information technology, automotive, consumer, defense/aerospace and industrial sectors, that are no longer consistent with our business or gross margin objectives, whether on an interim or long term basis.  In the March quarter, we have discontinued products or decided not to pursue opportunities representing approximately $9 million in revenues for that quarter.

 

In the upcoming June 2005 quarter, we expect revenues to be consistent with the March 2005 quarter, plus or minus four percent.  We also expect our gross margin to be consistent with the March 2005 quarter, plus or minus one percent.

 

We have substantially completed our restructuring initiatives previously announced in the December 2002 quarter, to consolidate and capitalize on lower cost manufacturing facilities and close several older facilities and legacy operations.  We expect to complete the remaining activities, primarily the move of a fabrication line from El Segundo, California to the Newport, Wales facility and the transition of certain assembly of our high-reliability products from Leominster, Massachusetts to Tijuana, Mexico, by calendar year-end 2005.  Total charges associated with the December 2002 restructuring plan are expected to be approximately $261 million.  These charges are expected to consist of approximately $210 million for asset impairment, plant closure costs and other charges, $6 million for raw material and work-in-process inventory charges, and $45 million for severance-related charges.  As of March 31, 2005, we have achieved over $73 million in annualized savings from the restructuring activities, with more than 70 percent of the savings affecting cost of goods sold.

 

Our research and development program focuses on our proprietary products and the advancement and diversification of certain of our power MOSFET (metal oxide semiconductor field effect transistor) and IGBT (insulated gate bipolar transistors) product lines.  We generated royalties primarily from the licensing of our power MOSFET technologies or patents of $10.5 million and $10.8 million for the three months ended March 31, 2005 and 2004, respectively, and $31.1 million and $31.0 million for the nine months

 

28



 

ended March 31, 2005 and 2004, respectively.  In the June 2005 quarter, we expect royalty revenues to be approximately $10 million, plus or minus $1 million.  Our licensed MOSFET patents expire between 2005 and 2010, with the broadest remaining in effect until 2007 and 2008.  For technologies other than our licensed MOSFET technologies, we are concentrating on incorporating our technologies into proprietary products and exploring licensing opportunities we believe meet our overall business strategies.

 

Our capital spending in the current period was primarily related to increasing wafer fabrication and component assembly capacity.  For the nine months ended March 31, 2005, $34.9 million of the $98.7 million in capital expenditures were related to our Newport, Wales facility.  We purchased the Newport facility at the bottom of the last market cycle in fiscal 2002, and are in the process of recommissioning a 200mm wafer fabrication line there.  This facility provides our most advanced and cost-effective manufacturing capabilities and offers us significant capacity to support our growth over the next several years.  For fiscal 2005, we target capital expenditures of around ten percent of revenues.

 

For the nine-months ended March 31, 2005, we generated $142.3 million cash from operations and ended the quarter at $852.4 million in total cash and cash investments.  Including our $131.6 million of unused credit facilities, we have $984.0 million in total liquidity.  This offers us the flexibility to take advantage of strategic opportunities as they arise and to invest in the future.  In July 2004, we completed the acquisition of the specialty silicon epitaxial services assets from Advanced Technology Materials, Inc., for $39.6 million in cash, net of claim settlement.  This acquisition is expected to lower certain production costs and provide certain key intellectual property for epitaxial silicon substrate manufacturing.

 

29



 

Results of Operations for the Three and Nine Months Ended March 31, 2005 Compared with the Three and Nine Months Ended March 31, 2004

 

The following table summarizes our operating results as a percentage of revenues for the three and nine months ended March 31, 2005 and 2004 ($ in millions):

 

 

 

Three Months Ended
March 31,

 

Nine Months Ended
March 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

Revenues

 

$

281.9

 

100.0

%

$

275.4

 

100.0

%

$

892.7

 

100.0

%

$

761.9

 

100.0

%

Cost of sales

 

156.6

 

55.6

 

166.2

 

60.4

 

504.6

 

56.5

 

473.7

 

62.2

 

Gross profit

 

125.3

 

44.4

 

109.2

 

39.6

 

388.1

 

43.5

 

288.2

 

37.8

 

Selling and administrative expense

 

40.7

 

14.4

 

43.0

 

15.6

 

128.0

 

14.3

 

117.7

 

15.4

 

Research and development expense

 

27.3

 

9.7

 

24.2

 

8.8

 

80.4

 

9.1

 

67.3

 

8.8

 

Amortization of acquisition-related intangible assets

 

1.5

 

0.5

 

1.4

 

0.5

 

4.4

 

0.5

 

4.2

 

0.6

 

Impairment of assets, restructuring and severance charges

 

8.1

 

2.9

 

9.9

 

3.6

 

21.6

 

2.4

 

24.0

 

3.2

 

Other (income) expense, net

 

0.2

 

0.0

 

(6.1

)

(2.2

)

0.8

 

0.1

 

(5.6

)

(0.7

)

Interest (income) expense, net

 

(0.6

)

(0.2

)

1.5

 

0.5

 

1.7

 

0.2

 

1.1

 

0.1

 

Income before income taxes

 

48.1

 

17.1

 

35.3

 

12.8

 

151.2

 

16.9

 

79.5

 

10.4

 

Provision for income taxes

 

12.4

 

4.4

 

8.6

 

3.1

 

38.4

 

4.3

 

19.1

 

2.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

35.7

 

12.7