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International Rectifier 10-Q 2006

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)

x                              Quarterly Report pursuant to section 13 or 15(d) of the securities exchange act of 1934

For the quarterly period ended  September 30, 2006

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

 

(IRS employer identification

incorporation or organization)

 

number)

 

 

 

233 Kansas Street

 

90245

El Segundo, California

 

(Zip Code)

(Address of principal executive offices)

 

 

 

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  x     No o

Indicate by check mark whether the registrant is an a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in rule 12b-2 of the exchange act. (check one):

Large accelerated filer x

 

Accelerated filer o

 

Non-accelerated filer 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 x

There were 72,159,715 shares of the registrant’s common stock, par value $1.00 per share, outstanding on November 7, 2006.

 

 




Table of Contents

 

 

 

 

 

 

 

 

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

ITEM 1.

 

Financial Statements

 

 

 

 

 

 

 

 

 

Unaudited Consolidated Statements of Income for the Three Months Ended September 30, 2006 and 2005

 

 

 

 

 

 

 

 

 

Unaudited Consolidated Statements of Comprehensive Income for the Three Months Ended September 30, 2006 and 2005

 

 

 

 

 

 

 

 

 

Unaudited Consolidated Balance Sheets as of September 30, 2006 and June 30, 2006

 

 

 

 

 

 

 

 

 

Unaudited Consolidated Statements of Cash Flows for the Three Months Ended September 30, 2006 and 2005

 

 

 

 

 

 

 

 

 

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 1A.

 

Risk Factors

 

 

 

 

 

 

 

ITEM 6.

 

Exhibits

 

 

2




 

PART I. FINANCIAL INFORMATION

ITEM 1.  Financial Statements.

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

(In thousands except per share amounts)

 

 

Three Months Ended
September 30

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Revenues

 

$

344,243

 

$

272,573

 

Cost of sales

 

205,826

 

161,680

 

Gross profit

 

138,417

 

110,893

 

 

 

 

 

 

 

Selling and administrative expense

 

53,498

 

45,166

 

Research and development expense

 

32,049

 

25,212

 

Amortization of acquisition-related intangibles

 

926

 

1,453

 

Impairment of assets, restructuring and severance charges

 

5,237

 

4,293

 

Other expense, net

 

801

 

124

 

Interest income, net

 

(2,504

)

(1,552

)

Income before income taxes

 

48,410

 

36,197

 

 

 

 

 

 

 

Provision for income taxes

 

14,281

 

9,954

 

Net income

 

$

34,129

 

$

26,243

 

 

 

 

 

 

 

Net income per common share — basic

 

$

0.47

 

$

0.37

 

 

 

 

 

 

 

Net income per common share — diluted

 

$

0.47

 

$

0.36

 

 

 

 

 

 

 

Average common shares outstanding — basic

 

72,052

 

70,329

 

 

 

 

 

 

 

Average common shares and potentially dilutive securities outstanding — diluted

 

72,630

 

72,277

 

 

The accompanying notes are an integral part of these statements.

3




 

INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME

(In thousands)

 

 

 

Three Months Ended
September 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Net income

 

$

34,129

 

$

26,243

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

Foreign currency translation adjustments

 

8,985

 

(5,136

)

 

 

 

 

 

 

Unrealized gains (losses) on securities:

 

 

 

 

 

Unrealized holding gains on available-for-sale securities, net of tax effect of ($2,305) and $1,686, respectively

 

3,986

 

(2,872

)

Unrealized holding gains on foreign currency forward contract, net of tax effect of ($1,375) and ($154), respectively

 

2,553

 

263

 

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

 

(419

)

(23

)

 

 

 

 

 

 

Other comprehensive income (loss)

 

15,105

 

(7,768

)

 

 

 

 

 

 

Comprehensive income

 

$

49,234

 

$

18,475

 

 

The accompanying notes are an integral part of these statements.

4




INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED BALANCE SHEETS

(In thousands)

 

 

 

September 30,

 

June 30,

 

 

 

2006

 

2006(1)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

446,261

 

$

482,907

 

Short-term cash investments

 

117,999

 

120,872

 

Trade accounts receivable, less allowance for doubtful accounts

 

210,605

 

182,774

 

Inventories, net

 

218,833

 

214,094

 

Short-term deferred income taxes

 

22,539

 

23,353

 

Prepaid expenses and other receivables

 

59,408

 

51,456

 

 

 

 

 

 

 

Total current assets

 

1,075,645

 

1,075,456

 

Long-term cash investments

 

512,997

 

488,849

 

Property, plant and equipment, net

 

596,647

 

576,380

 

Goodwill

 

155,460

 

155,148

 

Acquisition-related intangible assets, net

 

31,022

 

31,994

 

Long-term deferred income taxes

 

83,193

 

85,754

 

Other assets

 

97,840

 

91,442

 

Total assets

 

$

2,552,804

 

$

2,505,023

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Bank loans

 

$

3,591

 

$

6,501

 

Long-term debt, due within one year

 

539,005

 

627

 

Accounts payable

 

86,606

 

85,009

 

Accrued salaries, wages and commissions

 

40,221

 

57,643

 

Other accrued expenses

 

124,603

 

104,870

 

Total current liabilities

 

794,026

 

254,650

 

Long-term debt, less current maturities

 

81,805

 

617,540

 

Other long-term liabilities

 

18,322

 

28,501

 

Total liabilities

 

894,153

 

900,691

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock

 

72,111

 

71,988

 

Capital contributed in excess of par value of shares

 

930,584

 

925,603

 

Retained earnings

 

576,411

 

542,301

 

Accumulated other comprehensive income

 

79,545

 

64,440

 

Total stockholders’ equity

 

1,658,651

 

1,604,332

 

Total liabilities and stockholders’ equity

 

$

2,552,804

 

$

2,505,023

 

The accompanying notes are an integral part of these statements.


(1)             The consolidated balance sheet as of June 30, 2006 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

5




INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

 

 

 

Three Months Ended

 

 

 

September 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

34,129

 

$

26,243

 

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

 

 

 

 

 

Depreciation and amortization

 

20,580

 

20,043

 

Amortization of acquisition-related intangible assets

 

926

 

1,453

 

Stock compensation expense

 

2,031

 

491

 

Unrealized gains on derivatives

 

(625

)

(1,175

)

Deferred income taxes

 

3,732

 

4,270

 

Tax benefits from options exercised

 

552

 

6,980

 

Excess tax benefits from options exercised

 

(150

)

(4,083

)

Change in operating assets and liabilities, net

 

(49,922

)

(44,477

)

Net cash provided by operating activities

 

11,253

 

9,745

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Additions to property, plant and equipment

 

(34,818

)

(37,009

)

Proceeds from sale of property, plant and equipment

 

21

 

2

 

Sale or maturities of cash investments

 

83,555

 

110,987

 

Purchase of cash investments

 

(99,481

)

(105,277

)

Change in other investing activities, net

 

(1,268

)

(3,785

)

Net cash used in investing activities

 

(51,991

)

(35,082

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

(Repayments of) proceeds from short-term debt, net

 

(2,824

)

2,457

 

Repayments of capital lease obligations, net

 

(129

)

(59

)

Proceeds from exercise of stock options and stock purchase plan

 

2,520

 

21,782

 

Excess tax benefits from options exercised

 

150

 

4,083

 

Other, net

 

147

 

(4,492

)

Net cash (used in) provided by financing activities

 

(136

)

23,771

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

4,228

 

726

 

Net decrease in cash and cash equivalents

 

(36,646

)

(840

)

Cash and cash equivalents, beginning of period

 

482,907

 

359,978

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

446,261

 

$

359,138

 

 

The accompanying notes are an integral part of these statements.

6




INTERNATIONAL RECTIFIER CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006

1.         Certain Accounting Policies

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 September 30, 2006, and the consolidated results of operations and the consolidated cash flows for the three months ended September 30, 2006 and 2005.  The results of operations for the three months ended September 30, 2006 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, 2006.

The Company operates on a 52-53 week fiscal year under which the three months ended September 2006 and 2005 consisted of 13 weeks ending October 1, 2006 and October 2, 2005, 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 2007 will consist of 52 weeks ending July 1, 2007.

Certain previous year’s presentation has been restated to conform to current year presentation. As part of the planned Power Control Systems divestiture (see Note 15, “Divestiture”), approximately $6 million of product revenues previously disclosed in the Focus Products group have been restated as Non-Focus Products, reflecting how our Chief Operating Decision Maker reviews the segments as of September 30, 2006.

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

7




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 months ended September 30, 2006 and 2005 (in thousands except per share amounts):

 

Net Income
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

 

 

 

 

 

 

Three months ended September 30, 2006:

 

 

 

 

 

 

 

Net income per common share — basic

 

$

34,129

 

72,052

 

$

0.47

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

578

 

 

Net income per common share — diluted

 

$

34,129

 

72,630

 

$

0.47

 

Three months ended September 30, 2005:

 

 

 

 

 

 

 

Net income per common share — basic

 

$

26,243

 

70,329

 

$

0.37

 

Effect of dilutive securities:

 

 

 

 

 

 

 

Stock options

 

 

1,948

 

(0.01

)

Net income per common share — diluted

 

$

26,243

 

72,227

 

$

0.36

 

 

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 months ended September 30, 2006 and 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, 2006 and June 30, 2006, 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 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

8




included in interest income and expense.  At September 30, 2006 and June 30, 2006, no investment was in a material loss position for greater than one year.

Cash, cash equivalents and cash investments as of September 30, 2006 and June 30, 2006 are summarized as follows (in thousands):

 

September 30,

 

June 30,

 

 

 

2006

 

2006

 

Cash and cash equivalents

 

$

446,261

 

$

482,907

 

Short-term cash investments

 

117,999

 

120,872

 

Long-term cash investments

 

512,997

 

488,849

 

Total cash, cash equivalents and cash investments

 

$

1,077,257

 

$

1,092,628

 

 

Available-for-sale securities as of September 30, 2006 are summarized as follows (in thousands):

Short-Term Cash Investments:

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

62,930

 

$

 

$

(267

)

$

62,663

 

U.S. government and agency obligations

 

55,669

 

 

(333

)

55,336

 

Other debt

 

 

 

 

 

Total short-term cash investments

 

$

118,599

 

$

 

$

(600

)

$

117,999

 

 

Long-Term Cash Investments:

 


Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 


Market
Value

 

Corporate debt

 

$

191,358

 

$

 

$

(259

)

$

191,099

 

U.S. government and agency obligations

 

158,631

 

 

(855

)

157,776

 

Other debt

 

164,388

 

 

(266

)

164,122

 

Total long-term cash investments

 

$

514,377

 

$

 

$

(1,380

)

$

512,997

 

 

Available-for-sale securities as of June 30, 2006 are summarized as follows (in thousands):

Short-Term Cash Investments:

 


Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 


Market
Value

 

Corporate debt

 

$

66,233

 

$

 

$

(551

)

$

65,682

 

U.S. government and agency obligations

 

50,914

 

 

(492

)

50,422

 

Corporate auction rate preferred securities

 

4,508

 

 

 

4,508

 

Other debt

 

260

 

 

 

260

 

Total short-term cash investments

 

$

121,915

 

$

 

$

(1,043

)

$

120,872

 

 

9




Long-Term Cash Investments:

 

Amortized
Cost

 

Gross
Unrealized
Gain

 

Gross
Unrealized
Loss

 

Market
Value

 

Corporate debt

 

$

165,598

 

$

40

 

$

(1,973

)

$

163,665

 

U.S. government and agency obligations

 

184,882

 

 

(3,125

)

181,757

 

Other debt

 

144,457

 

37

 

(1,067

)

143,427

 

Total long-term cash investments

 

$

494,937

 

$

77

 

$

(6,165

)

$

488,849

 

 

The Company holds as strategic investments the common stock of two Japanese companies traded on the Tokyo Stock Exchange.  The Company accounts for these available-for-sale investments under SFAS No. 115.  Dividend income from the two companies was $0.4 million and $0.3 million during the three months ended September 30, 2006 and 2005, respectively.  The market values of the equity investments included in other long-term assets at September 30, 2006 and June 30, 2006 were $54.1 million and $52.9 million, respectively, compared to their purchase cost of $18.8 million.  Mark-to-market gains (losses), net of tax, for the three months ended September 30, 2006 and 2005, were $0.7 million and ($2.9) million, respectively, and were included in other comprehensive income, a separate component of equity.

The amortized cost and estimated fair value of cash investments at September 30, 2006, by contractual maturity, are as follows (in thousands):

 

Amortized
Cost

 

Estimated Fair
Value

 

Due in 1 year or less

 

$

120,399

 

$

119,798

 

Due in 1-2 years

 

175,619

 

174,726

 

Due in 2-5 years

 

176,504

 

176,366

 

Due after 5 years

 

160,454

 

160,106

 

Total cash investments

 

$

632,976

 

$

630,996

 

 

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 $0.1 million and gross realized losses were $0.3 million for the three months ended September 30, 2006.  Gross realized gains were $0.01 million and gross realized losses were $0.3 million for the three months ended September 30, 2005.  The cost of marketable securities sold is determined by the weighted average cost method.

10




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 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 Company’s hedging programs reduce, but do not always eliminate, the impact of currency exchange rate movements.

In May 2006, the Company entered into a five-year foreign exchange forward contract (“the Forward Contract”) with BNP Paribas for the purpose of reducing the effect of exchange rate fluctuations on forecasted intercompany purchases by its Japan subsidiary.  The Company has designated the May 2006 Forward Contract as a cash flow hedge.  Under the terms of the May 2006 Forward Contract, the Company is required to exchange 507.5 million Yen for $5.0 million on a quarterly basis starting in June 2006 and expiring in the March 2011.  At September 30, 2006, 18 quarterly payments of 507.5 million Yen remained to be swapped at a forward exchange rate of 101.5 Yen per U.S. dollar.  The market value of the May 2006 Forward Contract was $4.5 million at September 30, 2006, included in other assets.  The mark-to-market gains, net of tax, of $2.6 million for the three months ended September 30, 2006, have been included in other comprehensive income.  Based on effectiveness tests comparing forecasted transactions through the May 2006 Forward Contract expiration date to its cash flow requirements, the Company does not expect to incur a material charge to income during the next twelve months as a result of the May 2006 Forward Contract.

The Company had approximately $123.8 million and $103.1 million in notional amounts of forward contracts not designated as accounting hedges under SFAS No. 133 at September 30, 2006 and June 30, 2006, respectively.  Net realized and unrealized foreign-currency losses recognized in earnings were less than $1 million for the three months ended September 30, 2006 and 2005.

Interest Rate Risk

In December 2001, the Company entered into an interest rate swap transaction (the “December 2001 Transaction”) with the 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, “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

11




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 3.03 percent, compared to a coupon of 4.25 percent on the Debt.  During the three months ended September 30, 2006, the LIBOR was 5.51 percent, and including certain spreads and mark-to-market adjustments associated with the interest swaps, this arrangement increased interest expense by $1.6 million. During the three months ended September 30, 2005, the LIBOR was 3.60 percent, and including certain spreads and mark-to-market adjustments associated with the interest swaps, this arrangement reduced interest expense by $0.9 million.

Accounted for as fair value hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, the mark-to-market adjustments of the December 2001 and April 2004 Transactions were offset by the mark-to-market adjustments on the Debt, resulting in no material impact to earnings.  The market value of the December 2001 Transaction was a liability of $4.7 million and $7.0 million at September 30, 2006 and June 30, 2006, respectively.  The market value of the April 2004 Transaction was a liability of $3.0 million and a $4.6 million at September 30, 2006 and June 30, 2006, 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 two Transactions, as determined periodically.  At September 30, 2006, $16.8 million in letters of credit were outstanding related to the Transactions.

The December 2001 and the April 2004 Transactions 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 Transactions 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 months ended September 30, 2006 and 2005, 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 the 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

12




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, 2006 and June 30, 2006, was $0.1 million and $0.6 million, respectively, and was included in other long-term assets.  Mark-to-market (losses) gains of ($0.5) million and $0.1 million for the three months ended September 30, 2006 and 2005, 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.  In accordance with SFAS No. 151, “Inventory Cost” the Company allocates fixed production overheads to inventory based on the normal capacity of the production facilities and abnormal amounts of idle facility expense are recognized as current period charges. Inventories at September 30, 2006 and June 30, 2006 were comprised of the following (in thousands):

 

September 30,

 

June 30,

 

 

 

2006

 

2006

 

Raw materials

 

$

37,542

 

$

37,268

 

Work-in-process

 

94,401

 

93,534

 

Finished goods

 

86,890

 

83,292

 

 

 

 

 

 

 

Total inventories

 

$

218,833

 

$

214,094

 

 

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.

13




 

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, 2006, the Company determined that goodwill was not impaired.

At September 30, 2006 and June 30, 2006 acquisition-related intangible assets included the following (in thousands):

 

 

 

 

 

September 30, 2006

 

June 30, 2006

 

 

 

Amortization
Periods
(Years)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Acquisition-related intangible assets:

 

 

 

 

 

 

 

 

 

 

 

Complete technology

 

4 - 12

 

$

38,281

 

$

(15,295

)

$

38,324

 

$

(14,881

)

Distribution rights and customer lists

 

5 - 12

 

15,454

 

(9,111

)

15,446

 

(8,744

)

Intellectual property and other

 

5 - 12

 

7,963

 

(6,270

)

7,963

 

(6,114

)

Total acquisition-related intangible assets

 

 

 

$

61,698

 

$

(30,676

)

$

61,733

 

$

(29,739

)

 

As of September 30, 2006, estimated amortization expense for the next five years is as follows (in thousands): remainder of fiscal 2007: $2,939; fiscal 2008: $3,503; fiscal 2009: $3,503; fiscal 2010: $3,503, fiscal 2011: $2,715 and fiscal 2012: $1,708.

The carrying amount of goodwill by business segment as of September 30, 2006, is as follows (in thousands):

 

Energy-Saving Products

 

$

48,423

 

Computing and Communications

 

43,089

 

Intellectual Property

 

20,114

 

Aerospace and Defense

 

18,997

 

Commodity Products

 

15,275

 

Non-Aligned Products

 

9,562

 

Goodwill balance, September 30, 2006

 

$

155,460

 

 

As of September 30, 2006 and June 30, 2006, $43.3 million of goodwill is deductible for income tax purposes, respectively.

14




The changes in the carrying amount of goodwill for the period ended September 30, 2006 are as follows (in thousands):

 

 

 

Goodwill

 

Balance, June 30, 2006

 

$

155,148

 

Foreign exchange impact

 

312

 

Balance, September 30, 2006

 

$

155,460

 

 

7.         Other accrued expenses

Other accrued expenses at September 30, 2006 and June 30, 2006 were comprised of the following (in thousands):

 

 

September 30,
2006

 

June 30,
2006

 

Accrued taxes

 

$

65,230

 

$

54,497

 

Short-term severance liability

 

8,438

 

7,055

 

Interest rate swap liability

 

7,692

 

 

Accrued Interest

 

7,455

 

14,579

 

Other accrued expenses

 

35,788

 

28,739

 

Total accrued expenses

 

$

124,603

 

$

104,870

 

 

8.         Bank Loans and Long-Term Debt

A summary of the Company’s long-term debt and other loans at September 30, 2006 and June 30, 2006 is as follows (in thousands):

 

 

September 30,

 

June 30,

 

 

 

2006

 

2006

 

Convertible subordinated notes at 4.25 percent due in 2007 ($550,000 principal amount, plus accumulated fair value adjustment of ($11,675) and ($14,443) at September 30, 2006 and June 30, 2006, respectively)

 

$

538,325

 

$

535,557

 

Other loans and capitalized lease obligations

 

82,380

 

82,610

 

Debt, including current portion of long-term debt ($539,005 and $627 at September 30, 2006 and June 30, 2006, respectively)

 

620,809

 

618,167

 

Foreign revolving bank loans at rates from 1.12% to 3.88%

 

3,592

 

6,501

 

 

 

 

 

 

 

Total debt

 

$

624,401

 

$

624,668

 

 

In July 2000, the Company sold $550 million principal amount of 4.25 percent Convertible Subordinated Notes due July 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, 2004, as specified in the notes and related indenture agreement.  In December

15




2001 and April 2006, 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”).

The Company had been a party to a three-year syndicated multi-currency revolving credit facility, led by BNP Paribas, that expires 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, 2006.  At September 30, 2006, the Company had no borrowings and $21.1 million letters of credit outstanding under the Facility.  At June 30, 2006, the Company had no borrowings and $25.0 million letters of credit outstanding under the Facility.  Of the letters of credit outstanding, $16.8 million and $20.7 million were related to the interest rate swap transactions (see Note 4) at September 30, 2006 and June 30, 2006, respectively.

At September 30, 2006, the Company had $169.1 million in total revolving lines of credit, of which $24.7 million had been utilized, consisting of $21.1 million in letters of credit and $3.6 million in foreign revolving bank loans, which are included in the table above.

On November 6, 2006, the Company entered into a new five-year multi-currency revolving credit facility, with a syndicate of lenders including JP Morgan Chase Bank, Bank of America, N.A., HSBC Bank USA, and Deutsche Bank AG, to replace the BNP Paribas revolving credit facility that would otherwise have expired in November 2006 (the “November 2006 Facility”).  The November 2006 Facility expires in November 2011, and provides a credit line of $150 million with an option to increase the facility limit to $250 million.  Up to $75 million of the November 2006 Facility may be used for standby letters of credit and up to $10 million may be used for swing-line loans.  The November 2006 Facility bears interest at (i) local currency rates plus (ii) a margin between 0 percent and 0.25 percent for base rate advances and a margin between 0.875 percent and 1.25 percent for Euro-currency rate advances, based on the Company’s senior leverage ratio.  Other advances bear interest as set forth in the credit agreement.  The annual commitment fee for the November 2006 Facility ranges between 0.175 and 0.25 percent of the unused portion of the total facility, depending upon the Company’s senior leverage ratio.  The Company is required to pledge as collateral shares of certain of its subsidiaries and certain of the Company’s subsidiaries are required to guarantee the credit facility.  The Company has no obligation to pledge the securities and the subsidiaries have no obligation to guarantee the facility until December 31, 2006.

9.         Impairment of Assets, Restructuring and Severance

During fiscal 2003 second quarter ended December 31, 2002, the Company announced certain restructuring initiatives. Under these initiatives, the goal was to

16




reposition the Company to better fit the market conditions and de-emphasize its commodity business.  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 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, 2006.

Total charges associated with the December 2002 restructuring were $277.9 million. These charges consisted of $219.0 million for asset impairment, plant closure and other charges, $6.0 million of raw material and work-in-process inventory, and $52.9 million for severance-related costs.

As discussed in Note 15, “Divestiture”, on November 8, 2006, the Company entered into definitive agreements with Vishay Intertechnology Inc. to sell its Power Control Systems (“PCS”) business, consisting of the Company’s Non-Focus Product segments (see Note 10, “Segment and Geographic Information”), for approximately $290 million (the “PCS Divestiture”).  Associated with the PCS Divestiture, the Company plans to realign its sales, distribution and product development functions to a business based solely on its Focus Products.  It also plans to configure its manufacturing and support infrastructure to address the initially lower revenue levels following the PCS Divestiture.  The Company expects that restructuring-related charges related to these plans will be approximately $10 million to $15 million (including the $4.6 million recorded to date), primarily severance-related costs, which will be recorded as incurred through calendar year-end 2007.

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.  The severance charges 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.

For the three months ended September 30, 2006, the Company recorded $5.2 million in total restructuring-related charges, consisting of: $0.6 million for plant closure costs and other charges, and $4.6 million for severance-related costs related to the PCS Divestiture and reorganization activities.   For the three months ended September 30, 2005, the Company recorded $4.3 million in total restructuring-related charges related to the December 2002 restructuring initiatives, consisting of: $3.1 million for asset impairment, plant closure costs and other charges, and $1.2 million for severance-related costs.

17




As of September 30, 2006, including the costs associated with the PCS Divestiture and associated reorganization, the Company had recorded $282.5 million in total charges, consisting of: $219.0 million for asset impairment, plant closure costs and other charges, $6.0 million for raw material and work-in-process inventory charges, and $57.6 million for severance-related costs.   Components of the $219.0 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.  Certain equipment at this facility is being sold as part of the PCS Divestiture.  It is expected that these facilities will continue in use to support certain transitional service level agreements as part of the PCS Divestiture until approximately March 2008, and the remaining basis is being depreciated over units of production during this period.

·                  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 $13.9 million.  This facility is being sold as part of the PCS Divestiture.

·                  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 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 June 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 Swansea, Wales; Krefeld, Germany; Borgaro, Italy and Mumbai, India facilities are being sold as part of the PCS Divestiture.

·                  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 has also transitioned the assembly and test of non-space power components from its Leominster, Massachusetts facility to its Tijuana, Mexico facility as of December 31, 2005.  Associated with

18




these reductions in manufacturing activities, certain assets with a net book value of $4.0 million were written down by $2.1 million.

·                  $59.9 million in other miscellaneous items were charged, including $50.7 million in relocation costs and other impaired asset charges and $9.2 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 to their net realizable value. For the three months September 30, 2006 and 2005, the Company disposed of $0.1 million and $0, respectively, of these inventories, which did not have a material impact on gross margin for the period then ended.  As of September 30, 2006, no inventory remained to be disposed.

As of September 30, 2006, the Company has recorded $57.5 million in severance-related charges:  $44.4 million in severance termination costs related to the December 2002 restructuring and the elimination of approximately 1,300 administrative, operating and manufacturing positions, $8.5 million in pension termination costs at its manufacturing facility in Oxted, England, and $4.6 million for severance-related costs related to the PCS Divestiture and reorganization activities.

The following summarizes the Company’s severance accrual related to the June 2001 restructuring, the December 2002 restructuring,  the TechnoFusion acquisition, and the PCS Divestiture for the three months ended September 30, 2006 (in thousands):

 

 

 

June
2001
Restructuring

 

December
2002
Restructuring

 

TechnoFusion
Acquisition

 

PCS
Divestiture

 

Total
Severance
Liability

 

Accrued severance, June 30, 2006

 

$

235

 

$

6,538

 

$

282

 

$

 

$

7,055

 

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

 

 

 

 

4,656

 

4,656

 

Costs paid

 

(24

)

(3,250

)

(1

)

 

(3,275

)

Foreign exchange impact

 

 

 

2

 

 

2

 

Accrued severance, September 30, 2006

 

$

211

 

$

3,288

 

$

283

 

$

4,656

 

$

8,438

 

 

The June 2001 severance liability is primarily related to certain legal accruals associated with the termination of 29 administrative and operating personnel, which will be paid or released as the outcome is determined.  The December 2002 severance liability is primarily related to severance-related costs of approximately 130 operating personnel, who have been notified and targeted to be terminated as

19




a result of the final transition of the manufacturing to the Newport, Wales facility, expected to be completed and paid by calendar year-end 2007.  The TechnoFusion severance liability is related to restructuring of the Company’s Krefeld, Germany facility associated with the acquisition of TechnoFusion GmbH, which is contemplated to be paid or released pending the sale of the PCS business.  The PCS Divestiture severance liability relates to approximately 100 operating and finance personnel who have been notified to be impacted by the PCS Divestiture.  The associated liability is expected to be paid by calendar year-end 2007.

10.       Segment and Geographic Information

As part of the planned Power Control Systems Divestiture (see Note 15, “PCS Divestiture”), approximately $6 million of product revenues for the three months ended September 30, 2006, previously accounted for in the Focus Products group, has been restated in the Non-Focus Products group reflecting how the Chief Operating Decision Maker reviews the segments in light of the pending divestiture of the Company’s Non-Focus Products business.  Previous year’s presentation has been restated to conform to current year presentation (in thousands except percentages):

 

 

 

September 30,
2006

 

September 30,
2005

 

Business Segment

 

Revenues

 

Gross
Profit

 

Revenues

 

Gross
Profit

 

Computing and Communications (“C&C”)

 

$

133,492

 

40.3

%

$

86,967

 

41.4

%

Energy-Saving Products (“ESP”)

 

75,420

 

49.5

 

69,262

 

53.8

 

Aerospace and Defense (“A&D”)

 

38,428

 

50.1

 

29,401

 

43.8

 

Intellectual Property (“IP”)

 

11,010

 

100.0

 

10,440

 

100.0

 

Subtotal Focus Products

 

258,350

 

47.0

 

196,070

 

49.2

 

 

 

 

 

 

 

 

 

 

 

Commodity Products (“CP”)

 

57,501

 

20.8

 

47,949

 

21.2

 

Non-Aligned Products (“NAP”)

 

28,392

 

17.8

 

28,554

 

14.6

 

Subtotal Non-Focus Products

 

85,893

 

19.8

 

76,503

 

18.7

 

 

 

 

 

 

 

 

 

 

 

Consolidated total

 

$

344,243

 

40.2

%

$

272,573

 

40.7

%

 

Product revenues from unaffiliated customers are based on the location in which the sale originated. One distributor accounted for approximately 11 percent of the Company’s consolidated revenues for the three months ended September 30, 2006.  No single original equipment manufacturer (“OEM”), customer, distributor or subcontract manufacturer accounted for more than ten percent of the Company’s consolidated revenues for the three months ended September 30, 2005.  One distributor accounted for approximately 23 percent and 12 percent of the Company’s accounts receivable at September 30, 2006 and June 30, 2006, respectively.

The majority of the Company’s products in the Focus Product segments, including those in the C&C, ESP and A&D segments, are sold directly to OEM customers.  Two distributors, individually accounting for greater than ten percent of the C&C

20




segment revenue, accounted for approximately 38 percent of C&C revenue for the three months ended September 30, 2006.  One distributor accounted for approximately 11 percent of A&D segment revenue for the three months ended September 30, 2006.

Two OEM customers, individually accounting for greater than ten percent of NAP segment revenue, accounted for approximately 33 percent of NAP revenue for the three months ended September 30, 2006.  Two distributors, individually accounting for greater than ten percent of the CP segment revenue, accounted for approximately 21 percent of CP revenue for the three months ended September 30, 2006.  No single OEM customer, distributor or subcontract manufacturer accounted for more than ten percent of the Energy-Saving Products segment revenues for the quarter.

Geographic information for the Company on an aggregate basis, for the three months ended September 30, 2006 and 2005, and June 30, 2006 is presented below (in thousands):

 

 

September 30,
2006

 

September 30,
2005

 

Revenues from Unaffiliated Customers

 

 

 

 

 

The United States

 

$

88,416

 

$

74,611

 

Asia

 

168,734

 

129,628

 

Europe

 

76,083

 

57,894

 

Subtotal

 

333,233

 

262,133

 

Royalties (unallocated)

 

11,010

 

10,440

 

 

 

 

 

 

 

Total

 

$

344,243

 

$

272,573

 

 

 

 

September 30,
2006

 

June 30,
2006

 

Long-Lived Assets

 

 

 

 

 

The United States

 

$

357,698

 

$

348,478

 

Asia

 

47,653

 

45,061

 

Europe

 

289,136

 

274,284

 

 

 

 

 

 

 

Total

 

$

694,487

 

$

667,823

 

 

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.

21




 

11.       Stock-Based Compensation

The Company issues new shares to fulfill the obligations under all of its stock-based compensation awards.  The following table summarizes the stock option activities for the three months ended September 30, 2006 (in thousands except per share price data):

 

 


Shares

 

Weighted Average
Option Exercise
Price Per Share

 

Weighted Average
Grant Date Fair
Value Per Share

 

Aggregate Intrinsic Value

 

Outstanding, June 30, 2006

 

12,075

 

$

40.35

 

 

$

45,981

 

Granted

 

668

 

$

35.29

 

$

13.36

 

 

Exercised

 

(111

)

$

21.25

 

 

$

1,510

 

Expired

 

(128

)

$

48.43

 

 

 

Outstanding, September 30, 2006

 

12,504

 

$

40.18

 

 

$

29,910

 

 

For the three months ended September 30, 2006 and 2005 the Company received $2.5 million and $21.8 million, respectively, for stock options exercised.  Total tax benefit realized for the tax deductions from stock options exercised was $0.6 million and $7.0 million for three months ended September 30, 2006 and 2005, respectively.

The following table summarizes the Restricted Stock Unit (“RSU”) activities for the three months ended September 30, 2006 (in thousands except per share data):

 

 

 

Restricted
Stock Units

 

Weighted
Average
Grant Date
Fair Value
Per Share

 

Aggregate

Intrinsic
Value

 

Outstanding, June 30, 2006

 

23

 

$

49.09

 

$

909

 

Vested

 

(2

)

$

35.30

 

$

71

 

Expired

 

(6

)

$

33.61

 

 

Outstanding, September 30, 2006

 

15

 

$

49.07

 

$

510

 

 

22




 

The following table summarizes the stock options and RSUs outstanding at September 30, 2006, and related weighted average price and life information (in thousands except years and price data):

 

 

 

September 30, 2006

 

 

 

Outstanding

 

Exercisable

 

Range of Exercise
Price per Share

 

Number
Outstanding

 

Weighted
Average
Remaining
Life (Years)

 

Weighted
Average
Exercise
Price

 

Number
Exercisable

 

Weighted
Average
Remaining
Life (Years)

 

Weighted
Average
Exercise
Price

 

$0.00 to $14.13

 

404

 

2.54

 

$

11.31

 

390

 

2.49

 

$

11.73

 

$15.62 to $25.35

 

1,385

 

2.88

 

$

20.65

 

1,385

 

2.88

 

$

20.65

 

$26.00 to $35.90

 

2,032

 

4.73

 

$

34.39

 

1,309

 

4.67

 

$

33.96

 

$36.39 to $45.87

 

6,449

 

3.71

 

$

42.71

 

5,859

 

3.63

 

$

42.82

 

$46.19 to $54.69

 

1,351

 

3.85

 

$

50.37

 

936

 

3.83

 

$

51.32

 

$55.31 to $63.88

 

898

 

4.17

 

$

62.28

 

898

 

4.17

 

$

62.28

 

 

 

12,519

 

3.79

 

$

40.13

 

10,777

 

3.68

 

$

40.13

 

 

Additional information relating to the stock option plans, including employee stock options and RSUs, at September 30, 2006 and June 30, 2006 is as follows (in thousands):

 

 

 

September 30,
2006

 

June 30,
2006

 

Options exercisable

 

10,777

 

10,813

 

Options available for grant

 

3,109

 

3,696

 

Total reserved common stock shares for stock option plans

 

15,628

 

15,794

 

 

For the three months ended September 30, 2006 and 2005, stock-based compensation expense associated with the Company’s stock options is as follows (in thousands):

 

 

 

September 30,
2006

 

September 30,
2005

 

Selling and administrative expense

 

$

1,199

 

$

258

 

Research and development expense

 

528

 

82

 

Cost of sales

 

200

 

30

 

 

 

 

 

 

 

Total stock option expense

 

$

1,927

 

$

370

 

 

For the three months ended September 30, 2006 and 2005, stock-based compensation expense associated with the Company’s RSUs is as follows (in thousands):

 

 

September 30,
2006

 

September 30,
2005

 

Research and development expense

 

$

52

 

$

52

 

Selling and administrative expense

 

44

 

61

 

Cost of sales

 

8

 

8

 

 

 

 

 

 

 

Total RSU expense

 

$

104

 

$

121

 

 

23




 

The total unrecognized compensation expense for outstanding stock options and RSUs was $20.4 million as of September 30, 2006, and will be recognized, in general, over three years.  The weighted average number of years to recognize the compensation expense is 1.2 years.

The fair value of the options associated with the above compensation expense for the three months ended September 30, 2006 and June 30, 2006, was determined at the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions:

 

 

 

September 30,
2006

 

June 30,
2006

 

 

Expected life

 

3.5 years

 

3.5 years

 

 

Risk free interest rate

 

4.7

%

4.3

%

 

Volatility

 

44.3

%

34.3

%

 

Dividend yield

 

0.0

%

0.0

%

 

 

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.

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

24




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 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 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 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 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 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 to the Company by the Federal District Court in Los Angeles of infringement by IXYS of its 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

25




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 Court’s rulings in the Company’s favor regarding the validity and enforceability of the three IR patents. Following remand a federal court jury in Los Angeles, California, held on September 15, 2005, that IXYS elongated octagonal MOSFETs and IGBTs infringed on the 4,959,699 patent but did not infringe on the 5,008,725 and 5,130,767 patents. On October 6, 2005, the jury awarded the Company $6.2 million in damages.  Based on the jury’s verdict, on February 14, 2006, the District Court entered its final judgment (including permanent injunctions prohibiting IXYS from further infringing sales for the remaining life of the 4,959,699 patent) and found that the Company is entitled to $6.2 million in compensatory damages for infringement through September 30, 2005, plus an additional 6.5 percent of infringing sales after September 30, 2005.  On July 14, 2006, the Federal Circuit entered an order vacating that judgment and remanded the IR v. IXYS action so that the District Court could consider whether to reissue a permanent injunction in light of the Supreme Court’s decision in eBay Inc. v. MercExchange, L.L.C., _ U.S. _, 126 S.Ct. 1837, 164 L.Ed.2d 641 (2006).  The Company then requested that the District Court re-enter the final judgment (and permanent injunction).  On September 14, 2006, the District Court granted the Company’s motion and re-entered the final judgment.  IXYS failed to timely file notice of appeal of the final judgement and has filed a motion with the District Court seeking additional time in which to file notice of appeal.  The Company is opposing the IXYS motion.  The Company believes that it is reasonably assured that the value of the judgment is at least $2.5 million.

14.       Income Taxes

The Company’s effective tax provision for the three months ended September 30, 2006 and 2005 was 29.5 percent and 27.5 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 state research and development credits, partially offset by state taxes and certain foreign losses without foreign tax benefit.

15.       Divestiture

On November 8, 2006, the Company entered into definitive agreements with Vishay Intertechnology, Inc. (“Vishay”), a manufacturer of discrete semiconductors and passive electronic components, to sell its Power Control Systems (“PCS”) business for approximately $290 million (the “PCS Divestiture”).  The PCS business consists of the Company’s Non-Focus Product segments (see Note 10, “Segment and Geographic Information”), which include operations at the Company’s Mumbai, India; Borgaro, Italy; Xian, China; Krefeld, Germany; Swansea, Wales; and Halifax, Canada sites.  The PCS Divestiture will also include certain wafer manufacturing, product assembly and research and development equipment currently located at the Company’s Temecula, California; Tijuana, Mexico; and El Segundo, California locations.  The PCS Divestiture is expected to close in February 2007, subject to

26




various closing conditions including obtaining all necessary governmental approvals or clearances.

As part of the PCS Divestiture, the Company will be involved in the transition of certain of the divested business and assets with Vishay, including providing certain manufacturing, sales, marketing and administrative support services for a period of up to three years.

27




 

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 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, 2006

We report our results in six segments that generally reflect our products’ end-markets: 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 further summarize our segments in two groups, our Focus Products and Non-Focus Products, to reflect our strategic goals and the allocation of our critical resources.  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, 2006, consolidated revenues were $344.2 million compared to $272.6 million in the prior year three months ended September 30, 2005.  Revenues for the three months ended September 30, 2006 increased by 26.3 percent compared to the prior year, reflecting growth in Computing and Communications, Energy-Saving Products, Aerospace and Defense and Commodity Products segments, which increased 53.5 percent, 8.9 percent, 30.7 percent, and 19.9 percent, respectively, from the prior year three months ended September 30, 2005.

Revenues for our Focus Products were $258.3 million and $196.1 million for the three months ended September 30, 2006 and 2005, respectively. Focus Product revenues accounted for 75.0 percent of consolidated revenues for the three months ended September 30, 2006, compared to 71.9 percent of consolidated revenues for the three months ended September 30, 2005.  Revenues for our Non-Focus Products were $85.9 million and $76.5 million for the three months ended September 30, 2006 and 2005, respectively.  Non-Focus Product revenues for the fiscal quarter ended September 30, 2006, included approximately $6 million of product revenues previously accounted for in the Focus Products group and restated in the Non-Focus Products group, to align with how we review the segments, in light of the pending divestiture of our Non-Focus Products business.  Prior period has been restated to conform to current year presentation.

28




 

Revenues as a percentage of total product revenues based on sales location were approximately 27 percent, 51 percent and 22 percent for the United States, Asia and Europe, respectively, for the three months ended September 30, 2006.  Revenues as a percentage of total product revenues based on sales location were approximately 28 percent, 50 percent and 22 percent for the United States, Asia and Europe, respectively, for the three months ended September 30, 2005.

We operated at over 90 percent of our worldwide in-house wafer fabrication and assembly manufacturing capacities, without considering subcontract or foundry capacity.  We have added capacity during calendar year 2006 and are planning to add incremental production capacity of $100 million to $150 million in annual revenue potential by June 2007. As part of our expansion plans, we announced in October 2006 a foundry agreement with Tower Semiconductor for capacity capable of addressing many of our Focus Products.

Gross profit margin was 40.2 percent for the three months ended September 30, 2006, and 40.7 percent for the prior year three months ended September 30, 2005.  The gross profit margin declined primarily due to product mix.  Gross margin decline also reflected increased costs associated with the ramp-up of major new product families at our Newport, Wales facility. Gross profit margin for our Focus Products was 47.0 percent for the three months ended September 30, 2006, and 49.2 percent for the prior year three months ended September 30, 2005.  Gross profit margin for our Non-Focus Products was 19.8 percent and 18.7 percent for the three months ended September 30, 2006 and 2005, respectively.

For the three months ended September 30, 2006, selling and administrative expense was $53.5 million (15.5 percent of revenues) compared to $45.2 million (16.7 percent of revenues) for the prior year three months ended September 30, 2005, reflecting variable costs paid on a higher revenue base such as sales commissions, and profit sharing, stock option and other employee benefit expenses.

For the three months ended September 30, 2006, research and development expense was $32.0 million (9.3 percent of revenues) compared to $25.2 million (9.2 percent of revenues) for the prior year three months ended September 30, 2005, reflecting our continued commitment to developing our power management ICs and new architectures for the next-generation applications, including new game stations, digital televisions, high-performance servers, hybrid vehicles and energy-efficient appliances.

During fiscal 2003 second quarter ended December 31, 2002, we announced certain restructuring initiatives. We have substantially completed the December 2002 restructuring activities as of September 30, 2006.  For the three months ended September 30, 2006, we recorded $5.2 million in total restructuring-related charges, consisting of: $0.6 million for plant closure costs and other charges related to the completion of the December 2002 restructuring plans, and $4.6 million for severance-related costs related to the divestiture of our Non-Focus Products business and related reorganization activities (see “Divestiture” below).

During the three months ended September 30, 2006, operating activities generated cash flow of $11.3 million.  Our cash, cash equivalents and cash investments totaled $1,077.3 million at September 30, 2006.  As of September 30, 2006, we had $144.3 million in unused credit facilities for operating needs.  Our Credit Facility with BNP

29




Paribas was scheduled to expire in November 2006.  On November 6, 2006, we replaced this facility with a new five-year multi-currency revolving credit facility with a syndicate of lenders including JP Morgan Chase Bank, Bank of America, N.A., HSBC Bank USA, and Deutsche Bank AG, for $150 million, with an option to increase the facility limit to $250 million.

Our $550 million convertible subordinated notes are due in July 2007.  We anticipate that these subordinated notes will be refinanced through public or private offerings of debt or equity, or be paid down with our existing cash and cash investments.

Divestiture

On November 8, 2006, we entered into definitive agreements with Vishay Intertechnology, Inc. (“Vishay”), a manufacturer of discrete semiconductors and passive electronic components, to sell our Power Control Systems (“PCS”) business for approximately $290 million (the “PCS Divestiture”).  The PCS business consists of our Non-Focus Product segments, which include operations at our Mumbai, India; Borgaro, Italy; Xian, China; Krefeld, Germany; Swansea, Wales; and Halifax, Canada sites.  The PCS Divestiture will also include certain wafer manufacturing, product assembly and research and development equipment currently located at our Temecula, California; Tijuana, Mexico; and El Segundo, California locations.  The PCS Divestiture is expected to close in February 2007, subject to various closing conditions including obtaining all necessary governmental approvals or clearances.

When the PCS Divestiture is completed, it is our goal that within the next couple of years, the remaining revenues from our Focus Products would grow faster and the remaining business would be more profitable.  We do not believe that the completion of the PCS Divestiture will substantially alter the customer base that we serve or the competition that we face currently.  However, to achieve our goals, for a few quarters following a successful completion of the PCS Divestiture, we plan to more fully develop our Focus Products by realigning our sales, distribution and product development functions to a business based solely on our Focus Products.  We also plan to configure our manufacturing and support infrastructure to address the initially lower revenue levels following the PCS Divestiture.  We expect that restructuring-related charges with regards to these plans will be approximately $10 million to $15 million (including the $4.6 million recorded to date), consisting of primarily severance-related costs, which will be recorded as incurred in accordance with SFAS No. 146 through approximately calendar year-end 2007.

As part of the PCS Divestiture, we will be involved in the transition of certain of the divested business and assets with Vishay, including providing certain manufacturing, sales, marketing and administrative support services for up to three years.

30




 

Results of Operations for the Three Months Ended September 30, 2006 Compared with the Three Months Ended September 30, 2005

The following table sets forth certain items as a percentage of revenues (in millions except percentages):

 

 

Three Months Ended
September 30,

 

 

 

2006

 

2005

 

Revenues

 

$

344.2

 

100.0

%

$

272.6

 

100.0

%

Cost of sales

 

205.8

 

59.8

 

161.7

 

59.3

 

Gross profit

 

138.4

 

40.2

 

110.9

 

40.7

 

Selling and administrative expense

 

53.5

 

15.5

 

45.2

 

16.7

 

Research and development expense

 

32.0

 

9.3

 

25.2

 

9.2

 

Amortization of acquisition-related intangible assets

 

1.0

 

0.3

 

1.5

 

0.5

 

Impairment of assets, restructuring and severance charges

 

5.2

 

1.5

 

4.3

 

1.6

 

Other expense, net

 

0.8

 

0.2

 

0.1

 

0.0

 

Interest income, net

 

(2.5

)

(0.7

)

(1.6

)

(0.6

)

Income before income taxes

 

48.4

 

14.1

 

36.2

 

13.3

 

Provision for income taxes

 

14.3

 

4.2

 

10.0

 

3.7

 

Net income

 

$

34.1

 

9.9

%

$

26.2

 

9.6

%

 

Revenues and Gross Margin

For the three months ended September 30, 2006, consolidated revenues were $344.2 million compared to $272.6 million in the prior year three months ended September 30, 2005.  Revenues for the three months ended September 30, 2006 increased by 26.3 percent compared to the prior year, reflecting growth in Computing and Communications, Energy-Saving Products, Aerospace and Defense and Commodity Products segments, which increased 53.5 percent, 8.9 percent, 30.7 percent, and 19.9 percent, respectively, from the prior year three months ended September 30, 2005.

Revenues for our Focus Products were $258.3 million and $196.1 million for the three months ended September 30, 2006 and 2005, respectively. Focus Product revenues accounted for 75.0 percent of consolidated revenues for the three months ended September 30, 2006, compared to 71.9 percent of consolidated revenues for the three months ended September 30, 2005.  Revenues for our Non-Focus Products were $85.9 million and $76.5 million for the three months ended September 30, 2006 and 2005, respectively.  Non-Focus Product revenues for the fiscal quarter ended September 30, 2006, included approximately $6 million of certain complementary products previously accounted for in the Focus Products group and restated in Non-Focus Products, to align with how we review the segments in light of the pending divestiture of our Non-Focus Products business.  Prior period has been restated to conform to current year presentation.

Revenues as a percentage of total product revenues based on sales location were approximately 27 percent, 51 percent and 22 percent for the United States, Asia and Europe, respectively, for the three months ended September 30, 2006.  Revenues as a percentage of total product revenues based on sales location were approximately

31




28 percent, 50 percent and 22 percent for the United States, Asia and Europe, respectively, for the three months ended September 30, 2005.

Gross profit margin was 40.2 percent for the three months ended September 30, 2006, and 40.7 percent for the prior year three months ended September 30, 2005.  The gross profit margin declined primarily due to product mix.  Gross margin decline also reflected increased costs associated with the ramp-up of major new product families at our Newport, Wales facility. Gross profit margin for our Focus Products was 47.0 percent for the three months ended September 30, 2006, and 49.2 percent for the prior year three months ended September 30, 2005.  Gross profit margin for our Non-Focus Products was 19.8 percent and 18.7 percent for the three months ended September 30, 2006 and 2005, respectively.

Segment results for the three months ended September 30, 2006 and 2005 are as follows (in thousands except percentages):

 

 

Three Months Ended

 

 

 

September 30, 2006

 

September 30, 2005

 

Business Segment

 

Revenues

 

Percentage
of Total

 

Gross
Margin

 

Revenues

 

Percentage
of Total

 

Gross
Margin

 

Computing and Communications

 

$

133,492

 

38.8

%

40.3

%

$

86,967

 

31.9

%

41.4

%

Energy-Saving Products

 

75,420

 

21.9

 

49.5

 

69,262

 

25.4

 

53.8

 

Aerospace and Defense

 

38,428

 

11.1

 

50.1

 

29,401

 

10.8

 

43.8

 

Intellectual Property

 

11,010

 

3.2

 

100.0

 

10,440

 

3.8

 

100.0

 

Subtotal Focus Products