UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 25, 2004
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 0-17795
CIRRUS LOGIC, INC.
2901 Via Fortuna Austin, Texas 78746(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code:(512) 851-4000
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 accelerated filer (as defined in Exchange Act Rule 12b-2). YES x NO o
The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of October 15, 2004 was 84,734,052.
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FORM 10-Q QUARTERLY REPORT
QUARTERLY PERIOD ENDED SEPTEMBER 25, 2004
TABLE OF CONTENTS
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PART I
ITEM 1. FINANCIAL STATEMENTS
The accompanying notes are an integral part of these consolidated condensed financial statements.
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1. Basis of Presentation
The consolidated condensed financial statements have been prepared by Cirrus Logic, Inc. (“we,” “us,” “our,” or the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The accompanying unaudited consolidated condensed financial statements do not include complete footnotes and financial presentations. As a result, these financial statements should be read along with our audited consolidated financial statements and notes thereto for the year ended March 27, 2004, included in our 2004 Annual Report on Form 10-K. In our opinion, the financial statements reflect all adjustments, including normal recurring adjustments, necessary for a fair presentation of the financial position, operating results and cash flows, for those periods presented. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect reported assets, liabilities, revenues and expenses, as well as disclosure of contingent assets and liabilities. Actual results could differ from those estimates and assumptions. Moreover, the results of operations for the interim periods presented are not necessarily indicative of the results that may be expected for the entire year. We maintain a web site at www.cirrus.com, which makes available free of charge our recent annual report and other filings with the SEC.
Certain reclassifications have been made to the fiscal year 2004 financial statements to conform to the fiscal year 2005 presentation. These reclassifications had no effect on the results of operations or stockholders’ equity.
2. New Accounting Pronouncements
The Financial Accounting Standard Board (“FASB”) issued an exposure draft entitled “Share-Based Payment, an Amendment of FASB Statements Nos. 123 and 95.” This exposure draft would require stock-based compensation to employees to be recognized as a cost in the financial statements and that such cost be measured according to the fair value of the stock options. In the absence of an observable market price for the stock awards, the fair value of the stock options would be based upon a valuation methodology that takes into consideration various factors, including the exercise price of the option, the expected term of the option, the current price of the underlying shares, the expected volatility of the underlying share price, the expected dividends on the underlying shares and the risk-free interest rate. The proposed requirements in the exposure draft would be effective for the first fiscal year beginning after June 15, 2005. The FASB intends to issue a final Statement in late 2004. We will continue to monitor communications on this subject from the FASB in order to determine the impact on our consolidated financial statements.
3. Inventories
Inventories are comprised of the following (in thousands):
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4. Assets Held for Sale
On June 26, 2003, we agreed to sell our test operation assets for $3.5 million, which consist primarily of analog and mixed-signal testers, handlers and wafer probes, to ChipPAC, Inc. (“ChipPAC”), a provider of semiconductor packaging design, assembly, test and distribution services. The transaction closed and we received the cash on June 30, 2003. We expect to complete the transfer of assets by the end of this calendar year. As a result of the planned transfer of these assets to ChipPAC, we recorded an impairment charge of $0.7 million in cost of sales during the first quarter of fiscal year 2004 and reclassified the related assets to assets held for sale, a component of other current assets. On August 4, 2004, ChipPAC merged with ST Assembly Test Services, Ltd and renamed the new combined entity STATS ChipPAC Ltd. ChipPAC continues to operate as a wholly-owned subsidiary of the new entity. As of September 25, 2004, we have transferred to ChipPAC assets with a net book value totaling approximately $2.1 million. On September 25, 2004, we had $1.4 million in assets held for sale and $1.4 million in accrued liabilities related to proceeds associated with the assets held for sale. In addition to the transfer of assets, we have entered into a long-term outsourcing agreement pursuant to which ChipPAC will provide package development, wafer probe, assembly, final test and distribution services to us.
5. Marketable Securities
Our investments that have original maturities greater than ninety days have been classified as available-for-sale securities in accordance with Statement of Financial Accounting Standards No. 115 (“SFAS 115”), “Accounting for Certain Investments in Debt and Equity Securities.” Marketable securities are categorized on the Balance Sheet as Restricted Cash, Marketable Securities and Long-term Marketable Securities, as appropriate.
The following table is a summary of available-for-sale securities as of September 25, 2004 (in thousands):
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The following table is a summary of available-for-sale securities as of March 27, 2004 (in thousands):
The cost and estimated fair value of available-for-sale investments by contractual maturity were as follows:
During the first six months of fiscal year 2005, we realized a gain of $0.7 million related to the sale of our investment in Silicon Laboratories, Inc., which resulted from their acquisition of Cygnal Integrated Products, Inc. in which we had an investment. We received $1.2 million, net of commissions for this sale of securities. Further, in the first six months of fiscal year 2004, we realized a gain of $10.1 million related to our investment in SigmaTel, Inc. (“SigmaTel”). In November 2000, we entered into a litigation settlement with SigmaTel in which we received shares of common stock, guaranteed to be valued at $10.5 million should SigmaTel complete an initial public offering (“IPO”) in the future. On September 16, 2003, SigmaTel completed their IPO. We sold all of our shares and received $5.6 million, net of selling commissions. We also received a payment of $4.5 million from SigmaTel, which was the difference between the guaranteed $10.5 million value and the gross IPO value of our shares.
6. Intangibles, net
The following information details the gross carrying amount and accumulated amortization of our intangible assets (in thousands):
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Amortization expense for all intangibles in the second quarter of fiscal years 2005 and 2004 was $4.3 million and $4.7 million, respectively. Amortization expense for the first six months of fiscal years 2005 and 2004 was $8.8 million and $9.4 million, respectively.
The following table details the estimated aggregate amortization expense for all of our intangibles as of September 25, 2004 for the remainder of fiscal year 2005 and for each of the five succeeding fiscal years (in thousands):
7. Income Taxes
We incurred income tax expense of $66 thousand for the second quarter of fiscal year 2005 and $90 thousand for the first six months of fiscal year 2005. The income tax expense for both periods consisted primarily of foreign withholding and foreign income taxes. We realized an income tax benefit of $7.1 million for both the second quarter and the first six months of fiscal year 2004, primarily as a result of a one-time benefit of $7.2 million resulting from the expiration of the statute of limitations for the years in which certain potential state tax liabilities existed. The income tax benefit was partially offset by approximately $0.1 million of income tax expense that consisted primarily of foreign withholding and foreign income taxes.
Our taxes payable balance is comprised primarily of tax contingencies that are recorded to address potential exposures involving tax positions we have taken that could be challenged by taxing authorities. These exposures result from the varying application of statutes, rules, regulations and interpretations. Our tax contingencies are established based on past experiences and judgments about potential actions by taxing jurisdictions. Our tax contingencies relate, in large part, to transfer pricing positions we have taken in a variety of countries in which we operate. We have also accrued tax contingencies for certain domestic tax matters. The ultimate resolution of these matters may be materially greater or less than the amount that we have accrued.
Statement of Financial Accounting Standard No. 109 (“SFAS 109”), “Accounting for Income Taxes,” provides for the recognition of deferred tax assets if realization of such assets is more likely than not. We have provided a valuation allowance equal to our net deferred tax assets due to uncertainties regarding their realization. We evaluate the realizability of our deferred tax assets on a quarterly basis.
8. Restructuring and Other Costs
During the second quarter of fiscal year 2005, we recorded a charge of $1.5 million in operating expenses for severance and facility related items associated with our August 25, 2004 workforce reductions, which affected approximately 55 individuals worldwide. In connection with this reduction, we recorded an impairment charge of $3.2 million for the abandonment of certain computer aided design (“CAD”) software tools that will no longer be utilized. These charges were partially offset by the release of a $0.5 million accrual as a result of a lease buyout that we completed in the second quarter of fiscal year 2005. The cost for this leased facility had been partially accrued when a portion of the space was vacated during our fiscal year 2002 workforce reductions. During the first quarter of fiscal 2005, the remaining cost was accrued when the leased space was completely vacated. The total buyout amount of $4.3 million was less than the recorded liability and hence, we recognized the benefit from this transaction against the restructuring expenses incurred during the second quarter of fiscal year 2005.
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In addition to the transactions recorded during the second quarter of fiscal 2005, as mentioned above, during the first quarter of fiscal year 2005, we recorded a charge of $1.6 million for the remainder of the facility consolidation activities related to our workforce reduction that began in the fourth quarter of fiscal year 2004. Additionally, we recorded an impairment charge of $0.1 million for property and equipment associated with our Pune, India facility closure.
During the second quarter of fiscal year 2004, we recorded a charge of $0.5 million in operating expenses for severance primarily related to the outsourcing of a portion of our test operations, partially offset by a release of $0.1 million related to an excess severance accrual from a prior year. As a result of this outsourcing agreement, we expected to eliminate approximately 120 test operations positions in Austin, Texas and expected to record a total severance amount of approximately $0.8 million during fiscal year 2004. We eliminated 17 of these positions during the second quarter of fiscal year 2004.
During the first six months of fiscal year 2004, we recorded a restructuring charge of $5.8 million in operating expenses for facility consolidations in California and Texas, and an impairment charge of $1.5 million for property and equipment associated with our Austin, Texas facility consolidation. Additionally, we recorded a net charge of $0.7 million related to workforce reductions.
As of September 25, 2004, we had a remaining accrual from all of our past restructurings of $6.5 million, primarily related to net lease expenses that will be paid over their respective lease terms through fiscal year 2013, along with other anticipated lease termination costs. We have classified $3.5 million of this restructuring accrual as long term.
The following table details the changes in all of our restructuring accruals during the six months ended September 25, 2004:
9. Earnings Per Share
Basic net income (loss) per share is based on the weighted effect of common shares issued and outstanding and is calculated by dividing net income (loss) by the basic weighted average shares outstanding during the period. Diluted net income (loss) per share is calculated by dividing net income (loss) by the basic weighted average number of common shares used in the basic net income (loss) per share calculation plus the number of common shares that would be issued assuming exercise or conversion of all potentially dilutive common shares outstanding.
Incremental weighted average common shares attributable to the assumed exercise of outstanding options of 1,320,000 as of September 25, 2004 were excluded from the computation of diluted net loss per share because the effect would be anti-dilutive due to our net loss during the second quarter of fiscal year 2005. The weighted outstanding options excluded from our diluted calculation as of September 25, 2004 and September 27, 2003 were 7,757,000 and 6,368,000 respectively, as the exercise price exceeded the average market price during the respective three-month periods.
Incremental weighted average common shares attributable to the assumed exercise of outstanding options of 1,683,000 and 781,000 as of September 25, 2004 and September 27, 2003 were excluded from
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the computation of diluted net loss per share because the effect would be anti-dilutive due to our net loss during the first six months of fiscal years 2005 and 2004, respectively. The weighted outstanding options excluded from our diluted calculation as of September 25, 2004 and September 27, 2003 were 7,390,000 and 6,741,000 respectively, as the exercise price exceeded the average market price during the respective six-month periods.
10. Contingencies
Fujitsu
On October 19, 2001, we filed a lawsuit against Fujitsu, Ltd. (“Fujitsu”) in the United States District Court for the Northern District of California. We are asserting claims for breach of contract and anticipatory breach of contract and we are seeking damages in excess of $46 million. The basis for our complaint is Fujitsu’s refusal to pay for hard disk drive-related chips delivered to and accepted by it in fiscal year 2002. On December 17, 2001, Fujitsu filed an answer and a counterclaim. Fujitsu alleges claims for breach of contract, breach of warranty, quantum meruit/equitable indemnity and declaratory relief. The basis for Fujitsu’s counterclaim is the allegation that certain chips that we sold to Fujitsu were defective and allegedly caused Fujitsu’s hard disk drives to fail. The counterclaim does not specify the damages Fujitsu seeks, other than to allege it has sustained “tens of millions” of dollars in damages. To facilitate the resolution of all claims in one lawsuit, including our claims against potentially responsible third parties, we agreed with Fujitsu to realign our claims so that Fujitsu is the plaintiff and we are the defendant and counterclaimant. This realignment allowed Fujitsu and us to file in the same lawsuit third-party claims alleging breach of contract and warranty against Amkor Technology, Inc., (“Amkor”) the company that recommended and sold to us the packaging materials that caused the alleged defects in our chips. Amkor filed an answer to our third-party claim and a third-party complaint for implied contractual indemnity and breach of warranties against Sumitomo Bakelite Co., Ltd., (“Sumitomo”) the company that sold the allegedly defective molding compound used in these packaging materials.
On December 5, 2003, for reasons related to the potential lack of jurisdiction for certain claims in federal district court, Fujitsu filed a complaint in California state court alleging claims substantially similar to those filed against us in district court and, in addition, alleging fraud and other related claims against Amkor and Sumitomo. On December 23, 2003, we filed a cross-complaint in California state court alleging the same claims against Fujitsu as we alleged in federal district court and further alleging fraud and other related claims against Amkor and Sumitomo based on their alleged knowledge that the molding compound used in the packaging materials sold to us was defective. On May 10, 2004, the state court issued an order finding the facts supporting the new fraud and negligent misrepresentation causes of action against Amkor and Sumitomo set forth in our cross-complaint insufficient. On June 18, 2004, we filed an amended cross complaint asserting the same fraud and negligent misrepresentation claims against Amkor and Sumitomo in more detail. On August 24, 2004, the court again found the fraud and negligent misrepresentation claims in our cross-complaint were insufficient and granted 30 days for us to file another amended cross-complaint. We filed a second amended cross complaint on October 4, 2004, in which we alleged additional factual detail in support of these claims.
To address the claims of all parties and for reasons of judicial economy, the parties jointly moved to stay the federal district court action pending resolution of the state court action. The trial in state court was originally set for January 31, 2005, but was rescheduled by the court on September 21, 2004 for May 2, 2005.
Since filing its original counterclaim, Fujitsu has indicated that it intends to seek hundreds of millions of dollars in damages, although, as of this date, Fujitsu has not indicated how it will substantiate this amount of damages and we are unable to reasonably estimate the amount of damages. We intend to defend and prosecute our lawsuit vigorously. Further, we believe that we have valid claims against Amkor and Sumitomo in the event we are found to be liable to Fujitsu and that insurance may cover defense costs and some or all of any liability to Fujitsu. However, we cannot predict the ultimate outcome of this litigation and we are unable to estimate any potential liability we may incur. An adverse outcome in this litigation could materially harm our financial condition or results of operations.
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St. Paul Fire and Marine Insurance Company
On June 9, 2004, we filed a complaint for declaratory relief against St. Paul Fire and Marine Insurance Co. (“St. Paul”) in the United States District Court, Northern District of California. Specifically, the complaint seeks a judicial determination and declaration that the Technology Commercial General Liability Protection (“CGL”) under an insurance policy issued to us by St. Paul provides Cirrus with insurance coverage for Cirrus’s defense of claims brought by Fujitsu in the previously referenced matter. On August 23, 2004, St. Paul answered the complaint, denying that it was obligated to defend us under the CGL policy.
Despite filing this lawsuit, we continue to believe that we have valid claims in the Fujitsu litigation against Amkor and Sumitomo in the event we are found to be liable to Fujitsu and that our insurance coverage provided by St. Paul and excess carriers will cover defense costs and any potential liability to Fujitsu. However, as previously indicated, we cannot predict the ultimate outcome of the Fujitsu litigation and we are unable to estimate any potential liability we may incur.
Wolfson Microelectronics
On October 9, 2003, we filed a lawsuit against Wolfson Microelectronics, plc, a United Kingdom company and Wolfson Microelectronics Ltd., a Delaware corporation, (collectively “Wolfson”) in the U.S. District Court for the Southern District of California. We are alleging that several Wolfson products that incorporate digital-to-analog converters (“DACs”) infringe on our U.S. Patent Nos. 6,492,928 and 6,011,501. We are seeking damages and requesting a permanent injunction against Wolfson from making, using, offering to sell or selling in the U.S. or importing into the U.S. any infringing products. On December 2, 2003, in response to our complaint, Wolfson filed an answer and a counterclaim against us alleging, among other things, unfair competition, tortious interference with prospective economic advantage and tortious interference with contractual relationships. Wolfson’s claims were based primarily on our alleged bad faith in filing suit against Wolfson with the alleged knowledge that one of the two asserted patents was invalid. On April 2, 2004, the district court dismissed Wolfson’s counterclaims for failure to state a claim, although the district court granted leave to amend their complaint. On April 30, 2004, Wolfson amended its counterclaims to include additional allegations concerning alleged communications by Cirrus Logic with Bose Corporation and Argus Electronics relating to Wolfson’s ability to continue to provide Wolfson audio DACs to these customers in the future. Based on the information available to us at this time, we believe that we will ultimately succeed in defending against these allegations.
In addition, on October 14, 2003, we filed a complaint requesting that the U.S. International Trade Commission (the “ITC”) initiate an investigation of Wolfson Microelectronics, plc, for violation of Section 337 of the Tariff Act of 1930, in the importation, sale for importation and sale in the U.S. after importation of certain digital-to-analog converters and other products containing these converters. In our complaint, we asked the ITC to investigate whether certain Wolfson products infringe on one or more of the claims of U.S. Patent No. 6,492,928. On November 10, 2003, the ITC instituted an investigation into Wolfson’s actions based on our allegations. On December 9, 2003, we also requested the ITC to further investigate whether certain Wolfson products infringed on one or more of the claims of U.S. Patent No. 6,011,501. On December 29, 2003, the ITC included our allegations of infringement with respect to U.S. Patent No. 6,011,501 into its investigation. With respect to both patents, we are seeking a permanent exclusion order banning the importation into the U.S. of the allegedly infringing products and a cease-and-desist order halting the sale of these infringing products, as well as other relief the ITC deems appropriate. A hearing on the matter before the ITC was held between August 3-11, 2004. We anticipate that the ITC will make an initial determination with respect to our claims against Wolfson before the end of December 2004.
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Facilities Under Operating Lease Agreements
We lease our facilities under operating lease agreements. Our principal facility, located in Austin, Texas, is 197,000 square feet and houses our headquarters and engineering facility. Pursuant to the operating lease agreement for this facility, we have a potential obligation to enter into another lease agreement for a period of 10 years for an additional 64,000 square feet in a new building to be built on property next to our current facility. This obligation is contingent upon construction beginning on the new facility before November 10, 2004. On September 14, 2004, our landlord provided us notice that it had elected to construct the new building. However, as of October 22, 2004, construction on the new building had not commenced. In the event that the owner of the property strictly complies with all notices and conditions precedent to entering a new lease, we believe that construction will be completed in July 2006 and that the yearly minimum future lease payments could be as much as $1.7 million. In addition, we may be required to provide a cash deposit of approximately $200,000 and segregate and restrict an additional $3 million of our available cash balance in the form a letter of credit.
Other Claims
On June 3, 2003, the Inland Revenue Authority of Singapore (“IRAS”) notified us that it disagreed with our classification of sales to certain disk drive customers from May 1997 to March 1998, resulting in additional goods and services taxes owed by us. We have contested this claim with the IRAS and are in ongoing discussions regarding this matter. In the event we do not prevail, we could owe approximately $5 million, plus interest and penalties and, if necessary, will pursue reimbursement from these customers. We are unable at this time to make a determination regarding the outcome of this matter and thus, no amount has been accrued.
From time to time, other various claims, charges and litigation are asserted or commenced against us arising from, or related to, contractual matters, intellectual property, employment disputes, as well as other issues. Frequent claims and litigation involving these types of issues are not uncommon in the IC industry. As to any of these claims or litigation, we cannot predict the ultimate outcome with certainty.
11. Comprehensive Income
The components of comprehensive income, net of tax, are as follows (in thousands):
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12. Stock-Based Compensation
The following table illustrates the effect on net income (loss) and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (in thousands, except per share data):
13. Segment Information
We operate in one operating segment – Consumer Entertainment Electronics. However, we continue to track our revenue by product line. In the first quarter of fiscal year 2005, we renamed our “Audio” product line “Analog” to provide better clarity as to our numerous components in this broad product line, including audio converters, industrial analog, digital-signal processors and embedded processors. In accordance with SFAS 131, below is a summary of our product line information (in thousands):
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read along with the unaudited consolidated condensed financial statements and notes thereto included in Item 1 of this Quarterly Report, as well as the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended March 27, 2004, contained in our 2004 Annual Report
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on Form 10-K. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements regarding future events and our future results that are based on current expectations, estimates, forecasts and projections and the beliefs and assumptions of our management including, without limitation, our expectations regarding third quarter sales, gross margins, combined research and development and selling, general and administrative expenses, restructuring activities and charges, amortization of acquired intangibles, and the transfer of our test operation assets to ChipPAC, Inc. (“ChipPAC”). Words such as “expect,” “anticipate,” “target,” “project,” “believe,” “goals,” “estimates,” “intend” and variations of these types of words and similar expressions are intended to identify these forward-looking statements. Readers are cautioned that these forward-looking statements are predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements.
Among the important factors that could cause actual results to differ materially from those indicated by our forward-looking statements are those discussed below under the subheading “Factors That May Affect Future Operating Results” and elsewhere in this report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason. Readers should carefully review the risk factors described in “Factors That May Affect Future Operating Results” below, as well as in the documents filed by us with the Securities and Exchange Commission, specifically the most recent reports on Form 10-K, 10-Q and 8-K, each as it may be amended from time to time.
Overview
Cirrus Logic, Inc. (“we,” “us,” “our,” or the “Company”) is a leader in digital audio, video and high-performance analog and mixed-signal integrated circuits (“ICs”) for consumer entertainment, automotive entertainment and industrial applications. We develop and market ICs and system and embedded software used by original design manufacturers and original equipment manufacturers. We also provide complete system reference designs based on our technology that facilitate our customers’ ability to bring products to market in a timely and cost-effective manner.
Our analog product line includes our analog and mixed-signal products for digital home audio processors and digital portable processors; commercial audio processors; automotive audio solutions; and embedded processors. Our analog ICs are used in a number of consumer applications such as amplifiers, audio/video receivers (“AVRs”), DVD players and recorders, DVD receivers, set-top boxes, game consoles, car audio systems and satellite radios. The balance of our analog and mixed-signal IC components are primarily sold into industrial measurement applications, such as temperature gauges for industrial use, seismic devices for energy exploration and high-precision weigh scales for commercial and scientific use.
Our video product line includes our digital video encoding and decoding ICs. During fiscal year 2004, we began volume shipment of ICs to manufacturers of DVD recording applications. Our video ICs are primarily used in the following consumer applications: DVD recorders, DVD receivers and USB PC peripherals that enable PCs to perform video recording. DVD recorders are expected to become one of the fastest growing segments in digital entertainment during the next several years. As reported by the market research firm inStat in their January 2004 report entitled “DVD: Recorders Coming On Strong, Players Subsiding,”, worldwide unit sales for all forms of DVD recorders are projected to be up from approximately 4 million units in 2003 to potentially over 50 million units by 2007.
We maintain sales, design and technical support personnel in the U.S. and other locations near our customers. To better support our customer base, most of which maintain design and/or manufacturing sites in Asia, we increased our Pacific Rim workforce from 167 at the end of the first quarter of fiscal year 2005 to 176 at the end of the second fiscal quarter of fiscal year 2005.
We also contract with third parties, which are located close to our Asian-based customers, for all of our wafer fabrication and assembly. In addition, we are transitioning a substantial portion of our test operations to Asian third parties. Our manufacturing organization qualifies each product, participates in process and package development, defines and controls the manufacturing process at our suppliers,
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develops test programs and performs production testing of products in accordance with our ISO-certified quality management system. Our fabless manufacturing strategy allows us to concentrate on our design strengths, to minimize fixed costs and capital expenditures, to access advanced manufacturing facilities and provides flexibility on sourcing through multiple qualified vendors.
Critical Accounting Policies
Our discussion and analysis of the financial condition and results of operations are based upon the consolidated condensed financial statements included in this report, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts. We evaluate the estimates on an on-going basis. We base these estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different circumstances. We also have policies that we consider to be key accounting policies, such as our policies for revenue recognition, including the deferral of revenues and gross profit on sales to certain of our distributors; however, these policies do not meet the definition of critical accounting estimates because they do not generally require us to make estimates or judgments that are difficult or subjective.
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements:
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Results of Operations
The following table summarizes the results of our operations for the second quarter and first six months of fiscal years 2005 and 2004, as a percentage of net sales. All percentage amounts were calculated using the underlying data in thousands:
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Net Sales
In the first quarter of fiscal year 2005, we renamed our “Audio” product line “Analog” to provide better clarity as to the numerous components in this broad product line, including audio converters, industrial analog, digital-signal processors and embedded processors.
During the second quarter of fiscal year 2005, our net sales were $51.3 million, up 2 percent from net sales of $50.1 million from the second quarter of fiscal year 2004. The $1.2 million increase was primarily due to an increase in sales of our analog products, partially offset by a decrease in our video products. Net sales from our analog products were up $4.3 million in the second quarter of fiscal year 2005, compared with the second quarter of fiscal year 2004. The year-over-year revenue increase was primarily due to an increase in demand for our audio converters for the DVD player market coupled with stronger demand for our industrial products. Sales of our audio ICs used in personal computers, and our ICs used in the Home Theater applications also increased during the quarter. Net sales from our video products of $5.0 million were down $3.1 million in the second quarter of fiscal year 2005 from the second quarter of fiscal year 2004. The year-over-year decline in video ICs was in large part due to slower than expected consumer product adoption, particularly in the North American market. We believe this slow rate of consumer adoption, combined with changes and delays in our customer’s product plans and the reluctance of consumers to buy products from other than top tier manufacturers led to significantly lower demand for our video ICs in the September quarter. Towards the end of the second fiscal quarter, we began shipping video product to several top tier manufacturers.
At the end of the second quarter of fiscal year 2005, we maintained a larger inventory level than we had expected at the start of the second quarter primarily due to weaker-than-expected demand from Chinese DVD manufacturers for audio converters and from manufacturers of DVD recorders for video ICs. We expect our inventory to decline during the third and fourth fiscal quarters as inventory levels in the supply chain for audio converters begin to deplete and as we increase shipments to customers producing DVD recording products for top tier branded consumer companies.
During the first six months of fiscal year 2005, our net sales were $110.4 million, up $19.5 million, or 22 percent from net sales of $90.9 million during the first six months of fiscal year 2004. During this period, sales of our analog product line increased by $17.3 million, or 22 percent, in fiscal year 2005 from fiscal year 2004. The year-over-year revenue increase was primarily due to increases in sales of our analog products including audio converters and certain industrial products, partially offset by decreases in sales of our digital signal processors. Sales for our video product line increased by $2.3 million, or 21 percent, to $13.4 million, as shipments to new video customers increased during the period.
We expect our total sales in the third quarter of fiscal year 2005 to be between $50 million and $55 million.
Export sales, principally to Asia, including sales to U.S.-based customers with manufacturing plants overseas, were 63 percent and 72 percent of net sales during the second quarter of fiscal years 2005 and 2004, respectively. Export sales were 67 percent and 71 percent of total sales in the first six months of fiscal years 2005 and 2004, respectively. Our sales are denominated primarily in U.S. dollars. As a result, we have not entered into foreign currency forward exchange and option contracts.
We had no direct customers that accounted for more than 10 percent of our sales. Sales to our distributors represented 63 percent and 64 percent of our fiscal year 2005 and 2004, respectively, net sales. The following table summarizes sales to distributors that represent more than 10 percent of our consolidated net sales.
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Gross Margin
Gross margin was 44.7 percent in the second quarter of fiscal year 2005, compared with 51.9 percent in the second quarter of fiscal year 2004. During the second quarter of fiscal year 2005, we recorded a net charge to cost of sales of approximately $3.9 million, or a 7.6 percent negative effect on gross margin, to write-down inventories to an estimation of net realizable value. Included in this net charge was a benefit from the sale of product that had been written down in prior periods of $0.9 million, or a 1.7 percent positive effect on gross margin.
Gross margin was 49.4 percent and 50.3 percent in the first half of fiscal years 2005 and 2004, respectively. On a year-to-date basis, the decrease in the second quarter of fiscal year 2005 gross margin percentage was nearly offset by the increase achieved in the first quarter of fiscal year 2005. We expect our margins to return to our targeted range of 51 percent to 53 percent range for the third quarter of fiscal year 2005.
Research and Development Expense
Research and development expense (“R&D”) decreased 12.9 percent in the second quarter of fiscal year 2005 to $17.8 million, compared with $20.4 million in the second quarter of fiscal year 2004. Research and development expense for the first six months of fiscal year 2005 totaled $36.5 million, a decrease of $4.6 million from $41.1 million during the comparable period in fiscal year 2004. The R&D workforce decreased on a year-over-year basis as we better align our resources with our customer needs. Additionally, costs for both the second quarter and the first six months of 2005 decreased due to a refinement in our research and development activities, including terminating certain efforts related to video playback capabilities needed for stand-alone DVD players.
Selling, General and Administrative Expense
Selling, general and administrative expense (“SG&A”) increased slightly in the second quarter of fiscal year 2005 to $13.2 million, compared with $12.2 million in the second quarter of fiscal year 2004. SG&A for the first six months of fiscal year 2005 totaled $25.7 million, an increase of $1.0 million from $24.7 million during the comparable period in fiscal year 2004. Although our SG&A workforce decreased on a quarter-over-quarter and year-over-year basis due to planned staffing reductions and other cost cutting measures, the $1.0 million increase in SG&A was due primarily to additional legal fees, primarily associated with our Wolfson litigation.
We expect our combined R&D and SG&A to be between $28 million and $29 million for our third fiscal quarter.
Restructuring and Other Costs
During the second quarter of fiscal year 2005, we recorded a charge of $4.6 million in operating expenses for severance activity during the quarter and for an abandonment of computer aided design (“CAD”) software tools that will not be used due to our workforce reductions. This charge was partially offset by a $0.5 million favorable outcome related to a long-term lease buyout during the quarter. On a year-to-date basis, in addition to the amounts recorded during the second quarter of 2005, during the first quarter of fiscal year 2005, we recorded a restructuring charge of $1.6 million in operating expenses for
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facility consolidations. Also, an impairment charge of $0.1 million was recorded in the first quarter of fiscal year 2005 related to property and equipment associated with our Pune, India facility closure.
During the second quarter of fiscal year 2004, we recorded a charge of $0.5 million in operating expenses for severance primarily related to the outsourcing of our test operations, partially offset by a release of $0.1 million related to an excess severance accrual from a prior year. During the first six months of fiscal year 2004, we recorded a restructuring charge of $5.8 million in operating expenses for facility consolidations in California and Texas, and an impairment charge of $1.5 million for property and equipment associated with our Austin, Texas facility consolidation. Additionally, we recorded a net charge of $0.7 million related to workforce reductions.
Amortization of Acquired Intangibles
During the second quarter of fiscal years 2005 and 2004, we recorded $3.4 million and $3.8 million, respectively, in amortization of acquired intangibles related to acquisitions completed in fiscal years 2002 and 2000. For the first six months of fiscal years 2005 and 2004, our amortization expense was $6.8 million and $7.6 million, respectively. The decrease for both the second quarter and the first six months was attributable to the completion of the amortization of the acquired intangibles from our AudioLogic, Inc. acquisition. We expect this amount to remain at the $3.4 million level per quarter for the remainder of fiscal year 2005.
Patent Infringement Settlements, Net
On May 16, 2003, we initiated a lawsuit against NVIDIA Corporation (“NVIDIA”) and ATI Technologies, Inc. (“ATI”) for infringement of our United States Patent No. 5,841,418. As part of our complaint, we sought damages and a permanent injunction against further infringement by certain graphics processors made, used, sold, offered for sale, or imported into the United States by NVIDIA and ATI. NVIDIA filed counterclaims against us on July 11, 2003, for infringement of U.S. Patent Nos. 5,768,628; 5,968,148; and 6,292,854. NVIDIA sought damages and a permanent injunction against further infringement by certain products made, used, sold, offered for sale, or imported into the United States by us.
On August 11, 2003, we entered into a Patent Sale, Assignment and Cross-License Agreement with NVIDIA and NVIDIA International, Inc. to settle the pending claims against them. As a result of this agreement, NVIDIA paid us $9 million. On September 23, 2003, we entered into a Patent Sale, Assignment and Cross-License Agreement with ATI and ATI International SRL to settle the pending claims against them. As a result of this agreement, ATI agreed to pay us $9 million on October 2, 2003. Under the terms of a contingency fee arrangement, we were obligated to pay outside counsel a percentage of these settlements. Both the settlements and the contingent legal fees were recorded in the second quarter of fiscal year 2004. These settlements, net of associated expenses, were recorded as a separate line in operating expenses totaling $14.4 million.
Realized Gain on Marketable Equity Securities
During the first six months of fiscal year 2005, we realized a gain of $0.7 million related to the sale of our investment in Silicon Laboratories, Inc., which we acquired from our earlier private investment in Cygnal Integrated Products, Inc. Total proceeds from the sale were $1.2 million. In the second quarter of fiscal year 2004, we realized a gain of $10.1 million related to our investment in SigmaTel, Inc. (“SigmaTel”). In November 2000, we entered into a litigation settlement with SigmaTel in which we received shares of common stock, guaranteed to be valued at $10.5 million should SigmaTel complete an initial public offering (“IPO”) in the future. On September 16, 2003, SigmaTel completed their IPO. We sold all of our shares and received $5.6 million, net of selling commissions. We also received a payment of $4.5 million from SigmaTel, which was the difference between the guaranteed $10.5 million value and the IPO value of our investment.
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Interest Income and Other, Net
Interest income and other, net increased during the second fiscal quarter of 2005 to $0.6 million from $0.3 million for the second quarter of fiscal year 2004. This increase of $0.3 million was due primarily to overall greater cash and cash equivalent balances, coupled with higher yields on our investments. Interest income and other, net for the first six months of fiscal year 2005 was $1.2 million compared to $0.8 million in the first six months of fiscal year 2004. The increase of $0.4 million was due primarily to the receipt of interest on a tax refund coupled with greater cash and cash equivalent balances on which interest was earned.
Income Taxes
We incurred income tax expense of $66 thousand for the second quarter of fiscal year 2005 and $90 thousand the first six months of fiscal year 2005. The income tax expense for both periods consisted primarily of foreign withholding and foreign income taxes. We realized an income tax benefit of $7.1 million for both the second quarter and the first six months of fiscal year 2004, primarily as a result of a one-time benefit of $7.2 million from the reversal of previously accrued state taxes. The tax reversal was a result of the expiration of the statute of limitations for the years in which certain potential state tax liabilities existed. The income tax benefit was partially offset by approximately $0.1 million of income tax expense that consisted primarily of foreign withholding and foreign income taxes.
SFAS 109, “Accounting for Income Taxes,” provides for the recognition of deferred tax assets if realization of such assets is more likely than not. We have provided a valuation allowance equal to our net deferred tax assets due to uncertainties regarding their realization. We evaluate the realizability of our deferred tax assets on a quarterly basis.
Liquidity and Capital Resources
We used approximately $18.8 million of cash and cash equivalents in our operating activities during the first half of fiscal year 2005, primarily due to the cash elements of our net loss coupled with an increase in inventory and accounts receivable. Further, during the second quarter of fiscal year 2005, we completed a $4.3 million buyout of a multi-year lease for one of our domestic facilities. In the comparable period of fiscal year 2004, we used approximately $0.3 million of cash and cash equivalents primarily due to the cash elements of our net loss, which includes the net proceeds from the NVIDIA settlement, partially offset by the increase in accounts payable and accrued liabilities.
We used $40.6 million of cash in investing activities during the first six months of fiscal year 2005. This includes purchases of $52.8 million in fixed-income marketable securities, $2.8 million in equipment, primarily used for testing, and $2.4 million in software licenses. These uses of cash were partially offset by $16.3 million received from the sale of marketable securities. In the first six months of fiscal year 2004, we generated $7.9 million of cash from investing activities primarily from the sale of common stock of SigmaTel and the sale of assets related to our manufacturing test floor, partially offset by the purchase of technology licenses, including multi-year CAD tool licenses, property and equipment.
We generated $1.5 million and $0.5 million in cash from financing activities during the first six months of fiscal year 2005 and fiscal year 2004, respectively, related to the issuance of common stock in connection with option exercises and our employee stock purchase plan.
As of September 25, 2004, we have restricted cash of $7.2 million, a decrease of $1.0 million, which primarily secures certain obligations under our lease agreement for our principal facility, located in Austin, Texas, as the restrictions on our cash decrease over the life of the lease. This facility is 197,000 square feet and houses our headquarters and engineering operations. Pursuant to the lease agreement for this facility, we have a potential obligation to enter into another lease agreement for a period of 10 years for an additional 64,000 square feet in a new building to be built on property next to our current facility. This obligation is contingent upon construction beginning on the new facility before November 10, 2004. On
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September 14, 2004, our landlord provided us notice that it had elected to construct the new building. However, as of October 22, 2004, construction on the new building had not commenced. In the event that the owner of the property strictly complies with all notices and conditions precedent to entering a new lease, we believe that construction will be completed in July 2006 and that our landlord may require that we provide a cash deposit of approximately $200,000 and segregate and restrict an additional $3 million of our available cash balance in the form a letter of credit.
We have not paid cash dividends on our common stock and currently intend to continue our policy of retaining any earnings for reinvestment in our business. Although we cannot assure that we will be able to generate cash in the future, we anticipate that our existing capital resources and cash flow generated from future operations will enable us to maintain our current level of operations for at least the next 12 months.
Factors That May Affect Future Operating Results
Our business faces significant risks. The risk factors set forth below may not be the only risks that we face. Additional risks that we are not aware of yet or that currently are not material may adversely affect our business operations. You should read the following cautionary statements in conjunction with the factors discussed elsewhere in this and other of Cirrus Logic’s filings with the Securities and Exchange Commission (“SEC”). These cautionary statements are intended to highlight certain factors that may affect the financial condition and results of operations of Cirrus Logic and are not meant to be an exhaustive discussion of risks that apply to companies such as ours.
We operate in a highly cyclical and volatile industry.
We are subject to business cycles and it is difficult to predict the timing, length, or volatility of these cycles. During downturns, customers usually reduce purchases, delay delivery of products, shorten lead times on orders and/or cancel orders. During upturns, our third party suppliers and contract manufacturers may have supply constraints that result in higher costs, longer lead times, and/or an inability to meet customer demand. These business cycles may create pressure on our net sales, gross margins and operating income.
We cannot assure you that any future downturn or upturn will not have a material adverse effect on our business and results of operations. We cannot assure you that we will not experience substantial period-to-period fluctuations in revenue due to general semiconductor industry conditions or other factors.
Our business is highly dependent on the expansion of the consumer digital entertainment electronics market.
The major focus of our business is the consumer digital entertainment electronics market. Our ICs are used in AVRs, compressed personal audio players, DVD players and recorders, digital automotive audio applications and set-top boxes. We expect the consumer digital market to expand over time. A decline in consumer confidence and consumer spending relating to economic conditions, terrorist attacks, armed conflicts, global health conditions and/or the political stability of countries in which we operate or sell into, however, could have a material adverse effect on our business.
Our products are complex and could contain defects, which could reduce sales of those products or result in claims against us.
Product development in the markets we serve is becoming more focused on the integration of multiple functions on individual devices. There is a general trend towards increasingly complex products. The greater integration of functions and complexity of operations of our products increases the risk that our customers or end users could discover latent defects or subtle faults after volumes of product have been shipped. This could result in:
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In addition, any defects or other problems with our products could result in financial or other damages to our customers who could seek damages from us for their losses. A product liability claim brought against us, even if unsuccessful, would likely be time consuming and costly to defend. In particular, the sale of systems and components into certain applications for the automotive industry involves a high degree of risk that such claims may be made.
While we believe that we are reasonably insured against these risks and contractually limit our financial exposure, we cannot assure you that we will be able to obtain insurance in amounts or of sufficient scope to provide us with adequate coverage against all potential liability. See Part II “Item 1 – Legal Proceedings” for further information regarding outstanding litigation.
Our success depends on our ability to introduce new products on a timely basis.
Our success depends upon our ability to develop new products for new and existing markets, to introduce these products in a timely and cost-effective manner and to have these products gain market acceptance. The development of new products is highly complex and from time to time, we have experienced delays in developing and introducing these new products. Successful product development and introduction depend on a number of factors, including:
Although we seek to design products that have the potential to become industry standard products, we cannot assure you that the market leaders will adopt any products introduced by us, or that any products initially accepted by our customers that are market leaders will become industry standard products. Both revenues and margins may be materially affected if new product introductions are delayed, or if our products are not designed into successive generations of our customers’ products. We cannot assure you that we will be able to meet these challenges, or adjust to changing market conditions as quickly and cost-effectively as necessary to compete successfully. Our failure to develop and introduce new products successfully could harm our business and operating results.
Successful product design and development is dependent on our ability to attract, retain and motivate qualified design engineers, of which there is a limited number. Due to the complexity and variety of analog and high-precision analog and mixed-signal circuits, the limited number of qualified integrated circuit designers and the limited effectiveness of computer-aided design systems in the design of analog and
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mixed-signal ICs, we cannot assure you that we will be able to successfully develop and introduce new integrated products on a timely basis.
We have historically experienced fluctuations in our operating results and expect these fluctuations to continue in future periods.
Our quarterly and annual operating results are affected by a wide variety of factors that could materially and adversely affect our net sales, gross margins and operating income. These factors include:
We may incur inventory charges or write-downs as a result of shifts in industry-wide capacity and our practice of purchasing our products based on sales forecasts.
Shifts in industry-wide capacity from shortages to oversupply, or from oversupply to shortages, may result in significant fluctuations in our quarterly and annual operating results. We may order wafers and build inventory in advance of receiving purchase orders. Because our industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand, order cancellations, or technological obsolescence, there is a risk that we will forecast inaccurately and produce excess inventories of particular products.
In addition, we generally order our products through non-cancelable orders from third-party foundries based on our sales forecasts and our customers can generally cancel or reschedule orders they place with us without significant penalties. If we do not receive orders as anticipated by our forecasts, or customers cancel orders that are placed, we may experience increased inventory levels.
Due to the product manufacturing cycle characteristic of IC manufacturing and the inherent imprecision by our customers to accurately forecast their demand, product inventories may not always correspond to product demand, leading to shortages or surpluses of certain products. As a result of such inventory imbalances, future inventory write-downs or charges may occur due to lower of cost or market accounting, excess inventory, or inventory obsolescence.
We need to manage the transition of the sale of our test operations assets to ChipPAC.
On June 26, 2003, we agreed to sell our test operation assets, consisting of analog and mixed-signal testers, handlers and wafer probes, to ChipPAC, a provider of IC packaging design, assembly, test and distribution services. On August 4, 2004, ChipPAC merged with ST Assembly Test Services, Ltd and renamed the new combined entity STATS ChipPAC Ltd. ChipPAC continues to operate as a wholly-owned subsidiary of the new entity. ChipPAC will transfer these test assets to its China facility over the remainder of calendar year 2004. This asset transfer may involve a number or risks, including but not limited to:
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Strong competition in the semiconductor market may harm our business.
The IC industry is intensely competitive and is frequently characterized by rapid technological change, price erosion and design and other technological obsolescence. Because of shortened product life cycles and even shorter design-in cycles in a number of the markets that we serve, particularly consumer entertainment, our competitors have increasingly frequent opportunities to achieve design wins in next-generation systems. In the event that competitors succeed in supplanting our products, our market share may not be sustainable and our net sales, gross margins and results of operations would be adversely affected.
We compete in a number of fragmented markets. Our principal competitors in these markets include AKM Semiconductors, ALi Semiconductor, AMD, ATMEL, Analog Devices, Broadcom, Conexant, ESS Technologies, Freescale Semiconductor, Fujitsu DSP, Intel, Linear Technology, LSI Logic, Maxim, MediaTek, Micronas, Philips, Samsung Semiconductor, Sharp Semiconductor, SigmaTel, ST Microelectronics, Sunplus, Texas Instruments, Tripath, Wolfson and Zoran, many of whom have substantially greater financial, engineering, manufacturing, marketing, technical, distribution and other resources, broader product lines, greater intellectual property rights and longer relationships with customers than we have. We also expect intensified competition from emerging companies and from customers who develop their own IC products. In addition, some of our current and future competitors maintain their own fabrication facilities, which could benefit them in connection with cost, capacity and technical issues.
Increased competition could adversely affect our business. We cannot assure you that we will be able to compete successfully in the future or that competitive pressures will not adversely affect our financial condition and results of operations. Competitive pressures could reduce market acceptance of our products and result in price reductions and increases in expenses that could adversely affect our business and our financial condition.
Our products may be subject to average selling prices that decline over short time periods; if we are unable to increase our volumes, introduce new or enhanced products with higher selling prices or reduce our costs, our business and operating results could be harmed.
Historically in the semiconductor industry, average selling prices of products have decreased over time, while manufacturing costs remained fixed. If the average selling price of any of our products declines and we are unable to increase our unit volumes, introduce new or enhanced products with higher margins and/or reduce manufacturing costs to offset anticipated decreases in the prices of our existing products, our operating results may be adversely affected. In addition, because of procurement lead times, we are limited in our ability to reduce total costs quickly in response to any revenue shortfalls. Because of these factors, we may experience material adverse fluctuations in our future operating results on a quarterly or annual basis.
We have significant international sales, and risks associated with these sales could harm our operating results.
Export sales, principally to Asia, include sales to U.S-based customers with manufacturing plants overseas and accounted for 63 percent and 72 percent of our net sales in the second quarter of fiscal years 2005 and 2004, respectively. We expect export sales to continue to represent a significant portion of
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product sales. This reliance on sales internationally subjects us to the risks of conducting business internationally, including political and economic stability and global health conditions, especially in Asia. For example, the financial instability in a given region, such as Asia, may have an adverse impact on the financial position of end users in the region, which could affect future orders and harm our results of operations. Our international sales operations involve a number of other risks, including:
In addition, we may buy hedging instruments to reduce our exposure to currency exchange rate fluctuations and our competitive position can be affected by the exchange rate of the U.S. dollar against other currencies. Consequently, increases in the value of the dollar would increase the price in local currencies of our products in foreign markets and make our products relatively more expensive. Alternatively, decreases in the value of the dollar will increase the relative cost of our and our vendors’ operations that are based overseas. We cannot assure you that regulatory, political and other factors will not adversely affect our operations in the future or require us to modify our current business practices.
The expansion of our international operations subjects our business to additional political and economic risks that could have an adverse impact on our business.
In addition to export sales constituting a majority of our net sales, we are expanding our international operations. Specifically, we have recently focused our efforts on expanding in the People’s Republic of China by employing design, sales and technical support personnel. In addition, we are also using contract manufacturers in the region for foundry, assembly and/or test operations. Expansion into this region has required and will continue to require significant management attention and resources. We may not succeed in expanding our presence into this market or other international markets. Failure to do so could harm our business. In addition, there are risks inherent in expanding our presence into foreign regions, including, but not limited to:
Our sales may fluctuate due to seasonality of customer demand.
As our sales to the consumer entertainment market increase, we are more likely to be affected by seasonality in the sales of our products. In particular, a significant portion of consumer electronics products are sold worldwide during the back-to-school and fourth calendar quarter holiday seasons. As a
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result, we expect stronger sales of ICs into the consumer entertainment market to occur in our second and third fiscal quarters in anticipation of these seasons.
If we fail to attract, hire and retain qualified personnel, we may not be able to develop, market, or sell our products or successfully manage our business.
Competition for personnel in our industry is intense. The number of technology companies in the geographic areas in which we operate is greater than it has been historically and we expect competition for qualified personnel to intensify. There are only a limited number of people in the job market with the requisite skills. Our human resources organization focuses significant efforts on attracting and retaining individuals in key technology positions. For example, start-up companies generally offer larger equity grants to attract individuals from more established companies. The loss of the services of key personnel or our inability to hire new personnel with the requisite skills could restrict our ability to develop new products or enhance existing products in a timely manner, sell products to our customers, or manage our business effectively.
We rely on independent foundries to manufacture our products, which subject us to increased risks.
We rely on independent foundries to manufacture all of our wafers. Our reliance on these foundries involves risks and uncertainties, including:
Market conditions could result in wafers being in short supply and prevent us from having adequate supply to meet our customer requirements. In addition, any prolonged inability to utilize third-party foundries because of fire, natural disaster, or otherwise, would have a material adverse effect on our financial condition and results of operations. If we are not able to obtain additional foundry capacity as required, our relationships with our customers would be harmed and, consequently, our sales would likely be reduced and we may be forced to purchase wafers from higher-cost suppliers or to pay expediting charges to obtain additional supply, if we are able to acquire wafers at all.
In order to secure additional foundry capacity, we may enter into contracts that commit us to purchase specified quantities of wafers over extended periods. In the future, we may not be able to secure sufficient capacity with foundries in a timely fashion or at all and such arrangements, if any, may not be on terms favorable to us. Moreover, if we are able to secure foundry capacity, we may be obligated to utilize all of that capacity or incur penalties. These penalties may be expensive and could harm our financial results.
We are dependent on our subcontractors in Asia to perform key manufacturing functions for us.
We depend on third-party subcontractors in Asia for the assembly, packaging and testing of our products. International operations and sales may be subject to political and economic risks, including changes in current tax laws, political instability, global health conditions, currency controls, exchange rate fluctuations and changes in import/export regulations, tariff and freight rates, as well as the risks of natural disaster. Although we seek to reduce our dependence on our limited number of subcontractors, this concentration of subcontractors and manufacturing operations in Asia subjects us to the risks of conducting business internationally, including political and economic conditions in Asia. Disruption or termination of the assembly, packaging or testing of our products could occur and such disruptions could harm our business and operating results.
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Failure to manage our distribution channel relationships could adversely affect our business.
In the second quarter of fiscal years 2005 and 2004, sales to our distributors accounted for 63 percent and 64 percent, respectively, of our net sales. The future of our business, as well as the future growth of our business, will depend in part on our ability to manage our relationships with current and future distributors and external sales representatives and to develop additional channels for the distribution and sale of our products. The inability to successfully manage these relationships could adversely affect our business.
We may need to acquire other companies or technologies and successfully integrate them into our business to compete in our industry.
We continue to consider future acquisitions of other companies, or their technologies or products, to improve our market position, broaden our technological capabilities and expand our product offerings. However, we may not be able to acquire, or successfully identify, the companies, products or technologies that would enhance our business.
In addition, if we are able to acquire companies, products or technologies, we could experience difficulties in integrating them. Integrating acquired businesses involves a number of risks, including, but not limited to:
If we are unable to successfully address any of these risks, our business could be harmed.
We may be unable to protect our intellectual property rights from third-party claims and litigation.
Our success depends on our ability to obtain patents and licenses and to preserve our other intellectual property rights covering our manufacturing processes, products and development and testing tools. We seek patent protection for those inventions and technologies for which we believe such protection is suitable and is likely to provide a competitive advantage to us. We also rely substantially on trade secrets, proprietary technology, non-disclosure and other contractual agreements, and technical measures to protect our technology and manufacturing knowledge. We work actively to foster continuing technological innovation to maintain and protect our competitive position. We cannot assure you that steps taken by us to protect our intellectual property will be adequate, that our competitors will not independently develop or patent substantially equivalent or superior technologies or be able to design around our patents, or that our intellectual property will not be misappropriated. In addition, the laws of some foreign countries may not protect our intellectual property as well as the laws of the United States. See Part II, Item 1. “Legal Proceedings – Wolfson Microelectronics.”
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Potential intellectual property claims and litigation could subject us to significant liability for damages and could invalidate our proprietary rights.
The IC industry is characterized by frequent litigation regarding patent and other intellectual property rights. We may find it necessary to initiate a lawsuit to assert our patent or other intellectual property rights. These legal proceedings could be expensive, take significant time and divert management’s attention from other business concerns. We cannot assure you that we will ultimately be successful in any lawsuit. Nor can we assure you that any patent owned by us will not be invalidated, circumvented, or challenged, that rights granted under the patent will provide competitive advantages to us, or that any of our pending or future patent applications will be issued with the scope of the claims sought by us, if at all.
As is typical in the IC industry, we and our customers have from time to time received and may in the future receive, communications from third parties asserting patents, mask work rights, or copyrights. In the event third parties were to make a valid intellectual property claim and a license was not available on commercially reasonable terms, our operating results could be harmed. Litigation, which could result in substantial cost to us and diversion of our management, technical and financial resources, may also be necessary to defend us against claimed infringement of the rights of others. An unfavorable outcome in any such suit could have an adverse effect on our future operations and/or liquidity.
Some of our products must conform to industry standards in order to be accepted by end users in our markets.
Generally, our products comprise only a part of a customers product. All components of such devices must comply with industry standards in order to operate efficiently together. We depend on companies that provide other components of the devices to support prevailing industry standards. Many of these companies are significantly larger and more influential in affecting industry standards than we are. Some industry standards may not be widely adopted or implemented uniformly and competing standards may emerge that may be preferred by our customers or end users. If larger companies do not support the same industry standards that we do, or if competing standards emerge, market acceptance of our products could be adversely affected and our business would be harmed.
The emergence of new industry standards could render our products incompatible with products developed by other suppliers. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our products to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards for a significant period of time, we could miss opportunities to achieve crucial design wins. We may not be successful in developing or using new technologies or in developing new products or product enhancements that achieve market acceptance. Our pursuit of necessary technological advances may require substantial time and expense.
If we are unable to make continued substantial investments in research and development, we may not be able to develop and sell new products.
We make significant investments in research and development activities to develop new and enhanced products and solutions. If we fail to make sufficient investments in research and development programs, new technologies could render our current and planned products obsolete, and our business could be harmed.
Our stock price may be volatile.
The market price of our common stock fluctuates significantly. This fluctuation is the result of numerous factors, including:
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We have provisions in our charter, and are subject to certain provisions of Delaware law, which could prevent, delay or impede a change of control of our company.
Certain provisions of our Certificate of Incorporation and By-Laws, and Delaware law could make it more difficult for a third party to acquire us, even if our stockholders support the acquisition. These provisions include:
We are also subject to the anti-takeover laws of Delaware that may prevent, delay or impede a third party from acquiring or merging with us, which may adversely affect the market price of our common stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risks associated with interest rates on our investments in debt securities and currency movements on non-U.S. dollar denominated assets and liabilities. We assess these risks on a regular basis and have established policies to protect against the adverse effects of these and other potential exposures. There have been no significant changes in our interest or foreign exchange risk since we filed our latest Form 10-K on June 9, 2004.
ITEM 4. CONTROLS AND PROCEDURES
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PART II
ITEM 1. LEGAL PROCEEDINGS
On October 19, 2001, we filed a lawsuit against Fujitsu, Ltd. (“Fujitsu”) in the United States District Court for the Northern District of California. We are asserting claims for breach of contract and anticipatory breach of contract and we are seeking damages in excess of $46 million. The basis for our complaint is Fujitsu’s refusal to pay for hard disk drive-related chips delivered to and accepted by it in fiscal year 2002. On December 17, 2001, Fujitsu filed an answer and a counterclaim. Fujitsu alleges claims for breach of contract, breach of warranty, quantum meruit/equitable indemnity and declaratory relief. The basis for Fujitsu’s counterclaim is the allegation that certain chips that we sold to Fujitsu were defective and, allegedly caused Fujitsu’s hard disk drives to fail. The counterclaim does not specify the damages Fujitsu seeks, other than to allege it has sustained “tens of millions” of dollars in damages. To facilitate the resolution of all claims in one lawsuit, including our claims against potentially responsible third parties, we agreed with Fujitsu to realign our claims so that Fujitsu is the plaintiff and we are the defendant and counterclaimant. This realignment allowed Fujitsu and us to file in the same lawsuit third-party claims alleging breach of contract and warranty against Amkor Technology, Inc., (“Amkor”) the company that recommended and sold to us the packaging materials that caused the alleged defects in our chips. Amkor filed an answer to our third-party claim and a third-party complaint for implied contractual indemnity and breach of warranties against Sumitomo Bakelite Co., Ltd., (“Sumitomo”) the company that sold the allegedly defective molding compound used in these packaging materials.
On December 5, 2003, for reasons related to the potential lack of jurisdiction for certain claims in federal district court, Fujitsu filed a complaint in California state court alleging claims substantially similar to those filed against us in district court and, in addition, alleging fraud and other related claims against Amkor and Sumitomo. On December 23, 2003, we filed a cross-complaint in California state court alleging the same claims against Fujitsu as we alleged in federal district court and further alleging fraud and
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other related claims against Amkor and Sumitomo based on their alleged knowledge that the molding compound used in the packaging materials sold to us was defective. On May 10, 2004, the state court issued an order finding the facts supporting the fraud and negligent misrepresentation causes of action against Amkor and Sumitomo set forth in our cross-complaint insufficient. The breach of contract and warranty claims asserted by us against Fujitsu and Amkor have always been sufficiently pleaded. On June 18, 2004, we filed an amended cross complaint asserting the same fraud and negligent misrepresentation claims against Amkor and Sumitomo in more detail. On August 24, 2004, the court again found the fraud and negligent misrepresentation claims in our cross-complaint were insufficient and granted 30 days for us to file another amended cross-complaint. We filed a second amended cross complaint on October 4, 2004, in which we alleged additional factual detail in support of these claims.
Despite filing this lawsuit, we continue to believe that we have valid claims in the Fujitsu litigation against Amkor and Sumitomo in the event we are found to be liable to Fujitsu and that our insurance coverage provided by St. Paul and excess carriers will cover defense costs and any liability to Fujitsu. However, as previously indicated, we cannot predict the ultimate outcome of the Fujitsu litigation and we are unable to estimate any potential liability we may incur.
On October 9, 2003, we filed a lawsuit against Wolfson Microelectronics, plc, a United Kingdom company and Wolfson Microelectronics Ltd., a Delaware corporation, (collectively “Wolfson”) in the U.S. District Court for the Southern District of California. We are alleging that several Wolfson products that incorporate digital-to-analog converters (“DACs”) infringe on our U.S. Patent Nos. 6,492,928 and 6,011,501. We are seeking damages and requesting a permanent injunction against Wolfson from making, using, offering to sell or selling in the U.S. or importing into the U.S. any infringing products. On December 2, 2003, in response to our complaint, Wolfson filed an answer and a counterclaim against us alleging, among other things, unfair competition, tortious interference with prospective economic advantage and tortious interference with contractual relationships. Wolfson’s claims were based primarily on our alleged bad faith in filing suit against Wolfson with the alleged knowledge that one of the two asserted patents was invalid. On April 2, 2004, the district court dismissed Wolfson’s counterclaims for
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failure to state a claim, although the district court granted leave to amend their complaint. On April 30, 2004, Wolfson amended its counterclaims to include additional allegations concerning alleged communications by Cirrus Logic with Bose Corporation and Argus Electronics relating to Wolfson’s ability to continue to provide Wolfson audio DACs to these customers in the future. Based on the information available to us at this time, we believe that we will ultimately succeed in defending against these allegations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the annual meeting of stockholders of Cirrus Logic, Inc. on July 29, 2004, the stockholders voted on three proposals as reflected below:
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ITEM 5. OTHER INFORMATION
We have been made aware that affiliates of our Independent Registered Public Accounting Firm, Ernst & Young LLP (“Ernst & Young”), in Taiwan and China performed certain tax remittance services that are not permitted under the auditor independence rules. Company management, the audit committee, and Ernst & Young have considered the impact that providing these services may have had on Ernst & Young’s independence with respect to its audit services and concluded that there has been no impairment. The services were administrative in nature and have been discontinued. The associated fees over the period fiscal 2001 through September 25, 2004 were $1,500 in the aggregate.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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