ITEM 1. BUSINESS
Except as otherwise indicated in this Annual Report on Form 10-K, the terms “we,” “our,” the “company,” “Fairchild” and “Fairchild International” refer to Fairchild Semiconductor International, Inc. and its consolidated subsidiaries, including Fairchild Semiconductor Corporation, our principal operating subsidiary. We refer to individual corporations where appropriate.
The company’s fiscal year ends on the last Sunday in December. The company’s results for the years ended December 30, 2007 and December 25, 2005 consists of 52 weeks, while results from the year ended December 31, 2006 consists of 53 weeks.
General
We are focused on developing, manufacturing and selling power analog, power discrete and certain non-power semiconductor solutions to a wide range of end market customers. In 2007, 74% of our sales were from power discrete and power analog semiconductor products used directly in applications such as power conversion, regulation, distribution and management. We are a leading supplier of power analog products, power discrete products and energy-efficient solutions, according to iSuppli. Our products are used in a wide variety of electronic applications, including sophisticated computers and internet hardware; communications; networking and storage equipment; industrial power supply and instrumentation equipment; consumer electronics such as digital cameras, displays, audio/video devices and household appliances; and automotive applications. We believe that our focus on the fast-growing power market, our diverse end market exposure, and our strong penetration into the rapidly growing Asian region provide us with excellent opportunities to expand our business.
With a history dating back approximately 50 years, the original Fairchild was one of the founders of the semiconductor industry. Established in 1959 as a provider of memory and logic semiconductors, the Fairchild Semiconductor business was acquired by Schlumberger Limited in 1979 and by National Semiconductor Corporation in 1987. In March 1997, as part of its recapitalization, much of the Fairchild Semiconductor business was sold to a new, independent company-Fairchild Semiconductor Corporation.
Products and Technology
Our products are used in consumer, communications, computer, industrial and automotive applications and are organized into the following three principal product groups that are reportable segments: (1) Analog Products, (2) Functional Power and (3) Standard Products.
We continue to invest in the latest wafer fabrication power semiconductor technology and successfully qualified a number of new processes including PowerTrench® V, advanced insulated gate bipolar transistor (IGBT), as well as advanced high power metal oxide semiconductor field effect transistors (MOSFET) fabrication technologies.
Analog Products
We design, manufacture and market high-performance analog and mixed signal integrated circuits for computing, consumer, communications, industrial and automotive applications. These products are manufactured using leading-edge bipolar, CMOS, BiCMOS and BCDMOS technologies. Analog and mixed signal products represent a potential long-term opportunity for us.
We offer analog and mixed signal device products in a fast growing number of proprietary part types. The development of proprietary parts is largely driven by evolving end-system requirements and needs for higher
integration, which in turn are driven by trends toward smaller components having higher performance levels. Major competitors include Analog Devices, Linear Technology, Maxim, Intersil Corporation, National Semiconductor, ST Microelectronics, ON Semiconductor and Texas Instruments.
Analog products monitor, interpret and control continuously variable functions such as light, color, sound and energy. Frequently, they form the interface with the digital world. We provide a wide range of analog products that perform such tasks as power conversion, interface, voltage regulation, system management, power factor correction and high voltage lighting. Our FPS™ power switch products, including Green FPS™, are a series of proprietary, multi-chip or monolithic devices with integrated MOSFETs, which provide complete off-line (AC-DC) power converter designs for use in power supplies and battery chargers. Green FPS™ products are referred to as “green” because of their environmentally friendly low power consumption. Analog voltage regulator circuits are used to provide constant voltages as well as to step up or step down voltage levels on a circuit board. These products are used in a variety of computing, communications, industrial and consumer applications.
Interface products generally connect signals from one part of a system to another part of a system. Typical interface applications include backplane driving, bus driving, clock driving and “box-to-box” or system-to-system interconnects. These applications all require high speed, high current drive and low noise attributes. These types of products are mixed signal in nature and require a high level of analog wave shaping techniques on the output structures. Our latest entrance to the interface market is the µSerDes™ (micro Serializer Deserializer). The µSerDes™ serializes analog signals and drives them over a ribbon connector in applications such as clam shell handsets and pop-up LCD viewers on photo printers. By serializing the data stream the number of transmission lines feeding the video display can be dramatically reduced, which reduces the overall system cost and simplifies the mechanical interface. This device utilizes unique competencies and patented circuit techniques along with advanced process technology.
In addition to the power analog and interface products, we also offer signal path products. These include analog and digital switches, video encoders and decoders, video filters and high performance amplifiers. The analog switch functions are typically found in cellular handsets and other ultra portable applications. The video products provide a single chip solution to video filtering and amplification. Video filtering applications include set top boxes and digital television.
We believe our analog and mixed signal product portfolio is further enhanced by a broad offering of packaging solutions that we have developed. These solutions include surface mount, tiny packages, chip scale packages (CSP) and leadless carriers.
Functional Power
We design, manufacture and market power discrete semiconductors for computing, communications, industrial and automotive applications. Discrete devices are individual diodes or transistors that perform power switching, power conditioning and signal amplification functions in electronic circuits. More than 85% of Fairchild’s discrete products are power discrete, which handle greater than one watt of power and are used extensively in power applications. Driving the long-term growth of discrete products is the increasing need to power the latest electronic equipment as well as the need to conserve energy. In 2005 Fairchild launched IntelliMAX™, one of its new product initiatives. Each IntelliMAX™ load switch replaces multiple active and passive components used in MOSFET power switch approaches and traditional analog integrated circuit control functions. Fairchild also expanded its series of SPM™ products. This key product is a multi-chip module containing up to 23 die in a single package, including diodes, power MOSFETs, and power controllers used in high power, high voltage consumer white goods and industrial applications. We manufacture discrete products using DMOS and Bipolar technologies. Major competitors include International Rectifier, NXP, Infineon, ON Semiconductor and Siliconix/Vishay.
Power MOSFETs. Power MOSFETs are used in applications to switch, shape or transfer electricity under varying power requirements. We are the world’s No. 1 supplier of discrete power transistors, according to the Gartner Group. These products are used in a variety of high-growth applications including computers, communications, automotive and industrial supplies, across the voltage spectrum. We produce advanced low power MOSFETs under our PowerTrench®, UltraFET® and QFET™ brands. MOSFETs enable computers, automobiles, handsets, power supplies and other products to operate under harsh conditions while providing efficient operation. We are particularly strong in low voltage power MOSFETs.
Insulated Gate Bipolar Transistors. IGBTs are high-voltage power discrete devices. They are used in switching applications for motor control, power supplies and automotive ignition systems, which require lower switching frequencies or higher voltages than a power MOSFET can provide. We are a leading supplier of IGBTs. We feature the switch mode power supply (SMPS) IGBT for power supplies, offering fast, cost-effective operation. We also manufacture modules for home appliances such as air conditioners and refrigerators-applications that are growing with the worldwide need to conserve energy.
Rectifiers. Rectifier products work with IGBTs and MOSFETs in many applications to provide signal conditioning. Our premier product is the Stealth™ rectifier, providing industry leading performance and efficiencies in power supply and motor applications.
Standard Products
The Standard Products Group combines the management of mature and multiple market products and is comprised of the four product groups discussed below.
Logic Products. We design, develop, manufacture and market high-performance standard logic devices utilizing three wafer fabrication processes: CMOS, BiCMOS and bipolar. Within each of these production processes, we manufacture products that possess advanced performance characteristics, as well as mature products that provide high performance at low cost to customers.
Logic products perform a variety of functions in a system, mostly in the interface between larger application-specific integrated circuits, microprocessors, memory components or connectors. Products are typically categorized into mature segments and advanced logic segments. Mature products are generally more than five years old, while advanced products tend to be newer. Since market adoption rates of new standard logic families have historically spanned several years, we continue to generate significant revenues from our mature products. Customers are typically slow to move from an older product to a newer one. Further, for any given product, standard logic customers use several different generations of logic products in their designs. As a result, typical life cycles for logic families are often between 20 and 25 years. Major competitors include Texas Instruments, Toshiba and NXP.
Standard Diode & Transistor Products (SDT). These devices cover a wide range of semiconductor products including: MOSFET, high power bipolar, discrete small signal transistors and diodes. Our parts can be found in almost every circuit with our portfolio focus geared towards meeting the needs of power switching, power conditioning, protection, and signal amplification functions in electronic circuits of computing, industrial, and consumer markets. Major competitors include International Rectifier, NXP, ST Microelectronics, ON Semiconductor and Siliconix/Vishay.
Optoelectronic Products. Optoelectronics covers a wide range of semiconductor devices that emit and sense both visible and infrared light. Of the six segments of the optoelectronics market, we participated in two during 2007: optocouplers and infrared devices. Our focus in optoelectronics is aligned with our power management business, as these products are used extensively in power supply and AC to DC power conversion applications.
Optocouplers-Optocouplers incorporate infrared emitter and detector combinations in a single package. These products are used to transmit signals between two electronic circuits while maintaining electrical isolation between them. Major applications for these devices include power supplies, solar inverters, motor controls and power modules & industrial control system.
Infrared Products-These devices emit and detect infrared energy instead of visible energy. This product line offers a wide variety of products including plastic emitters and detectors, metal can emitters and detectors, slotted switches and reflective switches. In addition, custom products address specific types of customer applications. Typical applications for infrared products include object detection (for example, objects on a conveyor belt and hook switch on a phone), media sensing (in printers and copiers), motor control and light control for mobile applications.
Standard Linear Products. We design, manufacture and market analog integrated circuits for computing, consumer, communications, ultra-portable and industrial applications. These products are manufactured using leading-edge bipolar, CMOS and BiCMOS technologies.
Standard Linear solutions can range from bipolar regulators, shunt regulators, low drop out regulators, standard op-amp/comparators, low voltage op-amp, audio amplifiers and others. Analog voltage regulator circuits are used to provide constant voltages as well as to step up or step down voltage levels on a circuit board. Op-amps/comparators are designed specifically to operate from a single power supply over a wide range of voltages. We also offer low-voltage op-amp that provide a combination of low power, rail-to-rail performance, low voltage operation, and tiny package options which is well suited for use in personal electronics equipment. Audio amp products provide good audio performance in tiny packages which are optimized for notebook and portable applications such as PDAs and cell phones.
There is continued growth for analog solutions as digital solutions require a bridge between real world signals and digital signals. Our product portfolio is further enhanced by a broad offering of packaging solutions that we have developed. These solutions include surface mount, tiny packages and leadless carriers. Major competitors include National Semiconductor, ST Microelectronics, ON Semiconductor and Texas Instruments.
Sales, Marketing and Distribution
For the year ended December 30, 2007, we derived approximately 66%, 27% and 6% of our net sales from distributors, original equipment manufacturers (OEMs), and electronic design and manufacturing services (EMS) customers, respectively, through our regional sales organizations. We operate regional sales organizations in Europe, with principal offices in Fuerstenfeldbruck, Germany; the Americas, with principal offices in San Jose, California; the Asia/Pacific region (which for these purposes excludes Japan and Korea), with principal offices in Hong Kong; Japan, with principal offices in Tokyo; and Korea, with principal offices in Seoul, South Korea. A discussion of revenue by geographic region for each of the last three years can be found in Item 8, Note 16 of this report. Each of the regional sales organizations is supported by logistics organizations, which manage independently operated warehouses. Product orders flow to our manufacturing facilities, where products are made. Products are then shipped either directly to customers or indirectly to customers through warehouses that are owned and operated by us or by a third party provider.
We have dedicated direct sales organizations operating in Europe, the Americas, the Asia/Pacific region, Japan and Korea that serve our major original equipment manufacturer and electronic design and manufacturing services customers. We also have a large network of distributors and independent manufacturer’s representatives to distribute and sell our products around the world. We believe that maintaining a small, highly focused, direct sales force selling products for all of our businesses, combined with an extensive network of distributors and
manufacturer’s representatives, is the most efficient way to serve our multi-market customer base. Fairchild’s dedicated marketing organization consists of a central marketing group that coordinates marketing, advertising, and media activities for all products within the company. Additionally, product line marketing specifically focuses on tactical and strategic marketing for their product and application focus, and marketing personnel located in each of the sales regions provides regional direction and support for products and end applications as applicable for their region.
Typically, distributors handle a wide variety of products and fill orders for many customers. Some of our sales to distributors are made under agreements allowing for market price fluctuations and the right of return on unsold merchandise, subject to time and volume limitations. Many of these distribution agreements contain a standard stock rotation provision allowing for minimum levels of inventory returns. In our experience, these inventory returns can usually be resold, although often at a discount. Manufacturer’s representatives generally do not offer products that compete directly with our products, but may carry complementary items manufactured by others. Manufacturer’s representatives, who are compensated on a commission basis, do not maintain a product inventory; instead, their customers place larger quantity orders directly with us and are referred to distributors for smaller orders.
Research and Development
Our expenditures for research and development for 2007, 2006 and 2005 were $109.8 million, $107.5 million and $77.6 million, respectively. These expenditures represented 6.6%, 6.5% and 5.4% of sales for 2007, 2006 and 2005, respectively. Advanced silicon processing technology is a key determinant in the improvement of semiconductor products. Each new generation of process technology has resulted in products with higher speed, higher power density and greater performance, produced at lower cost. We expect infrastructure investments made in recent years to enable us to continue to achieve high volume, high reliability and low-cost production using leading edge process technology for our classes of products. Our R&D efforts continue to be focused in part on new and innovative packaging solutions that make use of new assembly methods and new high performance packaging materials, as well as in exclusive and patent protected transistor structure development. We are also using our R&D resources to characterize and apply new materials in both our packaging and semiconductor device processing efforts.
Each of our product groups maintains independent product, process and package research and development organizations, which work closely with our manufacturing groups to bring new technologies to market. These groups are located throughout the world in our factories and research centers. We work closely with our major customers in many research and development situations in order to increase the likelihood that our products will be designed directly into customers’ products and achieve rapid and lasting market acceptance.
Manufacturing
We operate eight manufacturing facilities, five of which are “front-end” wafer fabrication plants in the United States, South Korea and Singapore, and three of which are “back-end” assembly and test facilities in Asia. Information about our property, plant and equipment by geographic region for each of the last three years can be found in Item 8, Note 16 of this report.
Our products are manufactured and designed using a broad range of manufacturing processes and certain proprietary design methods. We use all of the prevalent function-oriented process technologies for wafer fabrication, including CMOS, Bipolar, BiCMOS, DMOS and RF. We use primarily mature through-hole and advanced surface mount technologies in our assembly and test operations. In 2003, we announced our lead-free packaging initiative, replacing lead with tin which is considered to be environmentally friendly. Since January 1, 2006 all standard product IDs are sold with lead-free plating.
The table below provides information about our manufacturing facilities, products and technologies.
Manufacturing Facilities
We subcontract a minority of our wafer fabrication needs, primarily to Advanced Semiconductor Manufacturing Corporation, Central Semiconductor Manufacturing Corporation, Jilin Magic Semiconductor, More Power Electric Corporation, New Japan Radio Corporation, Phenitec Semiconductor and Taiwan Semiconductor Manufacturing Company. In order to maximize our production capacity, some of our back-end assembly and testing operations are also subcontracted. Primary back-end subcontractors include Amkor, AUK,
Enoch, GEM Services, Hana Semiconductor, Liteon, SP Semiconductor, Tak Cheong Electronics, Carsem and UTAC Thai Ltd. We continue to explore in-sourcing opportunities, particularly for our back-end facilities where it makes financial sense.
Our manufacturing processes use many raw materials, including silicon wafers, copper lead frames, mold compound, ceramic packages and various chemicals and gases. We obtain our raw materials and supplies from a large number of sources on a just-in-time basis. Although supplies for the raw materials used by us are currently adequate, shortages could occur in various essential materials due to interruption of supply or increased demand in the industry.
Backlog
Backlog at December 30, 2007 was approximately $550 million, down from approximately $627 million at December 31, 2006. We define backlog as firm orders or customer-provided forecasts with a customer requested delivery date within 26 weeks. In periods of depressed demand, customers tend to rely on shorter lead times available from suppliers, including us. In periods of increased demand, there is a tendency towards longer lead times that has the effect of increasing backlog and, in some instances, we may not have manufacturing capacity sufficient to fulfill all orders. Additionally, backlog is impacted by our manufacturing lead times, which have decreased by approximately two weeks on average from December 31, 2006 to December 30, 2007. As is customary in the semiconductor industry, we allow orders to be canceled or deliveries delayed by customers within agreed upon parameters. Accordingly, our backlog at any time should not be used as an indication of future revenues.
Seasonality
Overall, our sales are closely linked to semiconductor and related electronics industry supply chain and channel inventory trends.
Competition
Markets for our products are highly competitive. Although only a few companies compete with us in all of our product lines, we face significant competition within each of our product lines from major international semiconductor companies. Some of our competitors may have substantially greater financial and other resources with which to pursue engineering, manufacturing, marketing and distribution of their products. Competitors include manufacturers of standard semiconductors, application-specific integrated circuits and fully customized integrated circuits.
We compete in different product lines to various degrees on the basis of price, technical performance, product features, product system compatibility, customized design, availability, quality and sales and technical support. Our ability to compete successfully depends on elements both within and outside of our control, including successful and timely development of new products and manufacturing processes, product performance and quality, manufacturing yields and product availability, capacity availability, customer service, pricing, industry trends and general economic trends.
Trademarks and Patents
As of December 30, 2007 we held 865 issued United States patents and 1,017 issued non-U.S. patents with expiration dates ranging from 2008 through 2026. We also have trademarks that are used in the conduct of our business to distinguish genuine Fairchild products. We believe that while our patents may provide some advantage, our competitive position is largely determined by such factors as system and application knowledge, ability and experience of our personnel, the range and number of new products being developed by us, our market brand recognition, ongoing sales and marketing efforts, customer service, technical support and our manufacturing capabilities.
It is generally our policy to seek patent protection for significant inventions that may be patented, though we may elect, in certain cases, not to seek patent protection even for significant inventions, if other protection, such as maintaining the invention as a trade secret, is considered more advantageous. Also, the laws of countries in which we design, manufacture and market our products may afford little or no effective protection of our proprietary technology.
Environmental Matters
Our operations are subject to environmental laws and regulations in the countries in which we operate that regulate, among other things, air and water emissions and discharges at or from our manufacturing facilities; the generation, storage, treatment, transportation and disposal of hazardous materials by our company; the investigation and remediation of environmental contamination; and the release of hazardous materials into the environment at or from properties operated by our company and at other sites. As with other companies engaged in like businesses, the nature of our operations exposes our company to the risk of liabilities and claims, regardless of fault, with respect to such matters, including personal injury claims and civil and criminal fines.
Our facilities in South Portland, Maine, and, to a lesser extent, West Jordan, Utah, have ongoing remediation projects to respond to releases of hazardous materials that occurred prior to our separation from National Semiconductor. National Semiconductor has agreed to indemnify Fairchild for the future costs of these projects and other environmental liabilities that existed at the time of our acquisition of those facilities from National Semiconductor in 1997. The terms of the indemnification are without time limit and without maximum amount. The costs incurred to respond to these conditions were not material to the consolidated financial statements for any period presented.
Our facility in Mountaintop, Pennsylvania has an ongoing remediation project to respond to releases of hazardous materials that occurred prior to our acquisition of that facility from Intersil Corporation in 2001. Intersil has agreed to indemnify us for specific environmental issues. The terms of the indemnification are without time limit and without maximum amount.
A property we previously owned in Mountain View, California is listed on the National Priorities List under the Comprehensive Environmental Response, Compensation, and Liability Act. We acquired that property as part of the acquisition of The Raytheon Company’s semiconductor business in 1997. Under the terms of the acquisition agreement, Raytheon retained responsibility for, and has agreed to indemnify us with respect to, remediation costs or other liabilities related to pre-acquisition contamination. We sold the Mountain View property in 1999. The purchaser received an environmental indemnity from us similar in scope to the one we received from Raytheon. The purchaser and subsequent owners of the property can hold us liable under our indemnity for any claims, liabilities or damages they may incur as a result of the historical contamination, including any remediation costs or other liabilities. We are unable to estimate the potential amounts of future payments; however, we do not expect any future payments to have a material impact on our earnings or financial condition.
Although we believe that our Bucheon, South Korea operations, which we acquired from Samsung Electronics in 1999, have no significant environmental liabilities, Samsung Electronics agreed to indemnify us for remediation costs and other liabilities related to historical contamination, up to $150 million, arising out of the business we acquired from Samsung Electronics, including the Bucheon facilities. We are unable to estimate the potential amounts of future payments, if any; however, we do not expect any future payments to have a material impact on our earnings or financial condition.
We believe that our operations are in substantial compliance with applicable environmental laws and regulations. Our costs to comply with environmental regulations were immaterial for 2007, 2006 and 2005. Future laws or regulations and changes in existing environmental laws or regulations, however, may subject our operations to different, additional or more stringent standards. While historically the cost of compliance with
environmental laws has not had a material adverse effect on our results of operations, business or financial condition, we cannot predict with certainty our future costs of compliance because of changing standards and requirements.
Employees
Our worldwide workforce consisted of 9,691 full and part-time employees as of December 30, 2007. We believe that our relations with our employees are satisfactory.
At December 30, 2007, 143 of our employees were covered by a collective bargaining agreement. These employees are members of the Communication Workers of America/International Union of Electronic, Electrical, Salaried Machine and Furniture Workers, AFL-CIO, Local 88177. The current agreement with the union ends June 1, 2011 and provides for guaranteed wage and benefit levels as well as employment security for union members. If a work stoppage were to occur, it could impact our ability to operate. Also, our profitability could be adversely affected if increased costs associated with any future contracts are not recoverable through productivity improvements or price increases. We believe that relations with our unionized employees are satisfactory.
Our wholly owned Korean subsidiary, which we refer to as Fairchild Korea, sponsors a Korean Labor Council consisting of eight representatives from the non-management workforce and eight members of the management workforce. The Labor Council, under Korean law, is recognized as a representative of the workforce for the purposes of consultation and cooperation. The Labor Council has no right to take a work action or to strike and is not party to any labor or collective bargaining agreements with Fairchild Korea. We believe that relations with Fairchild Korea employees and the Labor Council are satisfactory.
Executive Officers
The following table provides information about the executive officers of our company. There is no family relationship among any of the named executive officers.
Mark S. Thompson, President and Chief Executive Officer (CEO), and Director. Mr. Thompson joined Fairchild Semiconductor in November 2004 as Executive Vice President, Manufacturing and Technology group. He became President and Chief Executive Officer in May 2005. He has over 22 years of high technology experience. Prior to joining the company, Mr. Thompson had been Chief Executive Officer of Big Bear Networks since August 2001. He was previously Vice President and General Manager of Tyco Electronics, Power Components Division and, prior to its acquisition by Tyco, was Vice President of Raychem Corporation’s Electronics OEM division. Mr. Thompson is a director of American Science and Engineering, Inc. and Cooper Industries, Ltd.
Mark S. Frey, Executive Vice President, Chief Financial Officer (CFO) and Treasurer. Mr. Frey joined Fairchild Semiconductor in March 2006. Prior to joining the company, Mr. Frey had been the Vice President, Finance and Corporate Controller for Lam Research Corporation since 1999. He was previously the Vice President of Finance for Raychem Corporation’s Electronics OEM division and he previously held financial positions with Activision and Memorex.
Laurenz Schmidt, Executive Vice President, Global Operations. Mr. Schmidt served as Senior Vice President, Global Operations since October 2001 and was promoted to Executive Vice President in February 2004. He has over 30 years of experience in the semiconductor industry. Prior to assuming his current role, he held various management positions over the preceding eight years, including Vice President of Wafer Fabrication Manufacturing, Vice President of Operations for Discrete Products Group and Managing Director of the South Portland, Maine wafer fabrication facility. Prior to joining Fairchild in 1983, he spent six years with Texas Instruments.
Robert J. Conrad, Executive Vice President and General Manager, Mobile, Computing, Communications and Consumer Products Group. Mr. Conrad joined Fairchild Semiconductor in September 2003 as Senior Vice President and General Manager of the Analog Products Group. He became Executive Vice President in May 2006, and assumed his current position in December 2007 pursuant to the reorganization of our internal reporting and management structure, as discussed further under Item 9B, Other Information. Mr. Conrad has over 24 years of semiconductor industry experience. His experience prior to joining Fairchild includes twelve years at Texas Instruments in a variety of engineering and business management roles, six years at Analog Devices where he was Vice President and General Manager of the DSP Division, and most recently as CEO and President of Trebia Networks, a private fabless semiconductor company, since April 2001.
Allan Lam, Executive Vice President, Worldwide Sales and Marketing. Mr. Lam joined Fairchild Semiconductor in August 2005 as Senior Vice President and General Manager, Standard Products Group. He was previously employed by Vishay Intertechnology and Temic Semiconductor since 1996, most recently as Vice President of Sales, Asia, and before that as Area Vice President of Sales, Asia-Pacific and Vice President, Standard Products Unit. He previously held management positions in quality, marketing, sales, and engineering with BBS Electronics, Cinergi Technology & Devices, SGS-Thomson Microelectronics and National Semiconductor.
Justin Chiang, Senior Vice President and General Manager, Power Conversion, Industrial and Automotive Products Group. Mr. Chiang joined Fairchild Semiconductor in May 2005 as Vice President of System Power in the Analog Products Group, and was promoted to his current position in December 2007 pursuant to the reorganization of our internal reporting and management structure, as discussed further under Item 9B, Other Information. He has over 15 years of experience in the electronic and semiconductor industry. Prior to joining the company, Mr. Chiang was the General Manager of Tyco Electronics, Power Components Division from 2003 to 2005. He was previously Director of Tyco Electronics, Silicon Products Group, Circuit Protection Division from 2000 to 2003 and prior to that he held a variety of technical and senior management positions with Raychem Corporation from 1994.
Adrian Chu, Senior Vice President and General Manager, Standard Products Group. Mr. Chu joined Fairchild Semiconductor in February 2008 as Senior Vice President and General Manager, Standard Products Group. He was previously employed by NXP Semiconductors and its predecessor, Philips Semiconductors, most recently as Vice President for Sales, China/HK, since 2002. He has over 20 years of experience in the semiconductor industry in a variety of executive, sales and technical marketing positions.
Robin Goodwin, Senior Vice President, Supply Chain Management. Mr. Goodwin joined Fairchild Semiconductor as part of its founding in 1997, as the Director of Finance. He transitioned to supply chain management in 2001 and assumed the leadership position in developing Fairchild’s first global planning organization. He has 23 years in the high technology industry in a combination of financial and supply chain management roles. Mr. Goodwin’s experience spans across OEMs, EMS and component suppliers.
Paul D. Delva, Senior Vice President, General Counsel and Corporate Secretary. Mr. Delva joined Fairchild Semiconductor in 1999. He served as the company’s assistant general counsel following the company’s initial public offering in 1999. Mr. Delva was promoted to Vice President, General Counsel and Secretary in April 2003. He became Senior Vice President in August 2005. He has advised Fairchild on all its acquisitions and securities offerings, as well as on general corporate matters since the company’s founding in 1997. Prior to joining Fairchild, he was an associate in the corporate department at Dechert, Price & Rhoads (now Dechert LLP).
Kevin B. London, Senior Vice President, Human Resources and Administration. Mr. London became Vice President of Human Resources in July 2002 and was promoted to Senior Vice President in August 2005. He has over 27 years experience in the semiconductor industry. Prior to becoming Vice President, he held various Human Resource management positions in the company.
Robin A. Sawyer, Vice President, Corporate Controller. Ms. Sawyer has served as the company’s Vice President and Corporate Controller since November 2002. She was previously Manager of Financial Planning and Analysis since joining the company in August 2000. Prior to joining the company, Ms. Sawyer was employed by Cornerstone Brands, Inc. from 1998 to 2000 as Director of Financial Planning and Reporting. Prior to that Ms. Sawyer was employed by Baker, Newman and Noyes, LLC and its predecessor firm, Ernst & Young, and is a Certified Public Accountant. Ms. Sawyer is a director of Camden National Corporation.
Available Information
We file annual, quarterly and special reports, proxy statements and other information with the Securities and Exchange Commission (SEC). You may read and copy any reports, statements and other information we file at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call (800) SEC-0330 for further information on the Public Reference Room. The SEC maintains an Internet web site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. Our filings are also available to the public at the web site maintained by the SEC, http://www.sec.gov.
The address for our company website is http://www.fairchildsemi.com. We make available, free of charge, through our investor relations web site, our reports on Forms 10-K, 10-Q and 8-K, amendments to those reports, and other SEC filings, as soon as reasonably practicable after they are filed with the SEC. The address for our investor relations web site is http://investor.fairchildsemi.com (click on “SEC filings”).
We also make available, free of charge, through our corporate governance website, our corporate charter, bylaws, Corporate Governance Guidelines, charters of the committees of our board of directors, code of business conduct and ethics and other information and materials, including information about how to contact our board of directors, its committees and their members. To find this information and materials, visit our corporate governance website at http://governance.fairchildsemi.com.
ITEM 1A.
ITEM 1A. RISK FACTORS
A description of the risk factors associated with our business is set forth below. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial also may impair our business operations and financial condition.
The price of our common stock has fluctuated widely in the past and may fluctuate widely in the future.
Our common stock, which is traded on The New York Stock Exchange, has experienced and may continue to experience significant price and volume fluctuations that could adversely affect the market price of our common stock without regard to our operating performance. In addition, we believe that factors such as quarterly fluctuations in financial results, earnings below analysts’ estimates and financial performance and other activities of other publicly traded companies in the semiconductor industry could cause the price of our common stock to fluctuate substantially. In addition, in recent periods, our common stock, the stock market in general and the market for shares of semiconductor industry-related stocks in particular have experienced extreme price fluctuations which have often been unrelated to the operating performance of the affected companies. Any similar fluctuations in the future could adversely affect the market price of our common stock.
We maintain a backlog of customer orders that is subject to cancellation, reduction or delay in delivery schedules, which may result in lower than expected revenues.
We manufacture products primarily pursuant to purchase orders for current delivery or to forecast, rather than pursuant to long-term supply contracts. The semiconductor industry is subject to rapid changes in customer outlooks or unexpected build ups of inventory in the supply channel as a result of shifts in end market demand. Accordingly, many of these purchase orders or forecasts may be revised or canceled without penalty. As a result, we must commit resources to the production of products without any advance purchase commitments from customers. Even in cases where our standard terms and conditions of sale or other contractual arrangements do not permit a customer to cancel an order without penalty, we may from time to time accept cancellations because of industry practice or custom or other factors. Our inability to sell products after we devote significant resources to them could have a material adverse effect on both our levels of inventory and revenues.
Downturns in the highly cyclical semiconductor industry or changes in end user market demands could reduce the profitability and overall value of our business, which could cause the trading price of our stock to decline or have other adverse effects on our financial position.
The semiconductor industry is highly cyclical, and the value of our business may decline during the “down” portion of these cycles. In the past, we and the rest of the semiconductor industry have experienced backlog cancellations and reduced demand for our products, resulting in significant revenue declines, due to excess inventories at computer and telecommunications equipment manufacturers and general economic conditions, especially in the technology sector. We may experience renewed, possibly more severe and prolonged, downturns in the future as a result of such cyclical changes. Even as demand increases following such downturns, our profitability may not increase because of price competition that historically accompanies recoveries in demand. In addition, we may experience significant changes in our profitability as a result of variations in sales, changes in product mix, changes in end user markets and the costs associated with the introduction of new products, and our efforts to reduce excess inventories that may have built up as a result of any of these factors. The markets for our products depend on continued demand for consumer electronics such as personal computers, cellular telephones, and digital cameras, and automotive, household and industrial goods. These end user markets may experience changes in demand that could adversely affect our prospects.
We may not be able to develop new products to satisfy changing demands from customers.
Our failure to develop new technologies, or react to changes in existing technologies, could materially delay development of new products, which could result in decreased revenues and a loss of market share to our competitors. The semiconductor industry is characterized by rapidly changing technologies and industry
standards, together with frequent new product introductions. Our financial performance depends on our ability to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. New products often command higher prices and, as a result, higher profit margins. We may not successfully identify new product opportunities and develop and bring new products to market or succeed in selling them into new customer applications in a timely and cost-effective manner. Products or technologies developed by other companies may render our products or technologies obsolete or noncompetitive. Many of our competitors are larger, older and well established international companies with greater engineering and research and development resources than us. A fundamental shift in technologies in our product markets that we fail to identify correctly or adequately, or that we fail to capitalize on, in each case relative to our competitors, could have material adverse effects on our competitive position within the industry. In addition, to remain competitive, we must continue to reduce die sizes, develop new packages and improve manufacturing yields. We cannot assure you that we can accomplish these goals.
If some original equipment manufacturers do not design our products into their equipment, our revenue may be adversely affected.
The success of our products often depends on whether OEMs, or their contract manufacturers, choose to incorporate or “design in” our products, or identify our products, with those from a limited number of other vendors, as approved for use in particular OEM applications. Even receiving “design wins” from a customer does not guarantee future sales to that customer. We may be unable to achieve these “design wins” due to competition over the subject product’s functionality, size, electrical characteristics or other aspect of its design, price, or due to our inability to service expected demand from the customer or other factors. Without design wins, we would only be able to sell our products to customers as a second source, if at all. If an OEM designs another supplier’s product into one of its applications, it is more difficult for us to achieve future design wins with that application because, for the customer, changing suppliers involves significant cost, time, effort and risk. In addition, achieving a design win with a customer does not ensure that we will receive significant revenue from that customer and we may be unable to convert design into actual sales.
We depend on demand from the consumer, original equipment manufacturer, contract manufacturing, industrial, automotive and other markets we serve for the end market applications which incorporate our products. Reduced consumer or corporate spending due to increased oil prices or other economic factors could affect our revenues.
Our revenue and gross margin guidance are based on certain levels of consumer and corporate spending. If our projections of these expenditures fail to materialize, due to reduced consumer or corporate spending from increased oil prices or otherwise, our revenues and gross margins could be adversely affected.
Our failure to protect our intellectual property rights could adversely affect our future performance and growth.
Failure to protect our existing intellectual property rights may result in the loss of valuable technologies. We rely on patent, trade secret, trademark and copyright law to protect such technologies. These laws are subject to change. For instance, there have been recent developments in the laws and regulations governing the issuance and assertion of patents in the U.S., such as modifications to the rules governing patent prosecution and court rulings on the issues of willfulness, obviousness and injunctions, that may affect our ability to obtain patents and/or enforce our patents against others. Some of our technologies are not covered by any patent or patent application, and we cannot assure you that:
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the patents owned by us or numerous other patents which third parties license to us will not be invalidated, circumvented, challenged or licensed to other companies; or
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any of our pending or future patent applications will be issued within the scope of the claims sought by us, if at all.
In addition, effective patent, trademark, copyright and trade secret protection may be unavailable, limited or not applied for in some countries.
We also seek to protect our proprietary technologies, including technologies that may not be patented or patentable, in part by confidentiality agreements and, if applicable, inventors’ rights agreements with our collaborators, advisors, employees and consultants. We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach or that such persons or institutions will not assert rights to intellectual property arising out of such research. Some of our technologies have been licensed on a non-exclusive basis from National Semiconductor, Samsung Electronics and other companies which may license such technologies to others, including our competitors. In addition, under a technology licensing and transfer agreement, National Semiconductor has limited royalty-free, worldwide license rights (without right to sublicense) to some of our technologies. If necessary or desirable, we may seek licenses under patents or intellectual property rights claimed by others. However, we cannot assure you that we will obtain such licenses or that the terms of any offered licenses will be acceptable to us. The failure to obtain a license from a third party for technologies we use could cause us to incur substantial liabilities and to suspend the manufacture or shipment of products or our use of processes requiring the technologies.
Our failure to obtain or maintain the right to use some technologies may negatively affect our financial results.
Our future success and competitive position depend in part upon our ability to obtain or maintain proprietary technologies used in our principal products, which is achieved in part by defending claims by competitors and others of intellectual property infringement. The semiconductor industry is characterized by claims of intellectual property infringement and litigation regarding patent and other intellectual property rights. From time to time, we may be notified of claims (often implicit in offers to sell us a license to another company’s patents) that we may be infringing patents issued to other companies, and we may subsequently engage in license negotiations regarding these claims. Such claims relate both to products and manufacturing processes. Even though we maintain procedures to avoid infringing others’ rights as part of our product and process development efforts, it is impossible to be aware of every possible patent which our products may infringe, and we cannot assure you that we will be successful. Furthermore, even if we conclude our products do not infringe another’s patents, others may not agree. We have been and are involved in lawsuits, and could become subject to other lawsuits, in which it is alleged that we have infringed upon the patent or other intellectual property rights of other companies. For example, since October 2004, we have been in litigation with Power Integrations, Inc. See Item 3, Legal Proceedings. Our involvement in this lawsuit and future intellectual property litigation, or the costs of avoiding or settling litigation by purchasing licenses rights or by other means, could result in significant expense to our company, adversely affecting sales of the challenged products or technologies and diverting the efforts and attention of our technical and management personnel, whether or not such litigation is resolved in our favor. We may decide to settle patent infringement claims or litigation by purchasing license rights from the claimant, even if we believe we are not infringing, in order to reduce the expense of continuing the dispute or because we are not sufficiently confident that we would eventually prevail. In the event of an adverse outcome as a defendant in any such litigation, we may be required to:
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pay substantial damages;
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indemnify our customers for damages they might suffer if the products they purchase from us violate the intellectual property rights of others;
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stop our manufacture, use, sale or importation of infringing products;
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expend significant resources to develop or acquire non-infringing technologies;
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discontinue manufacturing processes; or
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obtain licenses to the intellectual property we are found to have infringed.
We cannot assure you that we would be successful in such development or acquisition or that such licenses would be available under reasonable terms. Any such development, acquisition or license could require the expenditure of substantial time and other resources.
We may not be able to consummate future acquisitions or successfully integrate acquisitions into our business.
We have made thirteen acquisitions of various sizes since we became an independent company in 1997, including our recent acquisition of System General Corporation completed in August 2007, and we plan to pursue additional acquisitions of related businesses. The costs of acquiring and integrating related businesses, or our failure to integrate them successfully into our existing businesses, could result in our company incurring unanticipated expenses and losses. In addition, we may not be able to identify or finance additional acquisitions or realize any anticipated benefits from acquisitions we do complete.
We are constantly pursuing acquisition opportunities and consolidation possibilities and are frequently conducting due diligence or holding preliminary discussions with respect to possible acquisition transactions, some of which could be significant. No material potential acquisition transactions are subject to a letter of intent or otherwise so far advanced as to make the transaction reasonably certain.
If we acquire another business, the process of integrating acquired operations into our existing operations may result in unforeseen operating difficulties and may require significant financial resources that would otherwise be available for the ongoing development or expansion of existing operations. Some of the risks associated with acquisitions include:
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unexpected losses of key employees, customers or suppliers of the acquired company;
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conforming the acquired company’s standards, processes, procedures and controls with our operations;
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coordinating new product and process development;
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hiring additional management and other critical personnel;
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negotiating with labor unions; and
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increasing the scope, geographic diversity and complexity of our operations.
In addition, we may encounter unforeseen obstacles or costs in the integration of other businesses we acquire.
Possible future acquisitions could result in the incurrence of additional debt, contingent liabilities and amortization expenses related to intangible assets, all of which could have a material adverse effect on our financial condition and operating results.
We may face risks associated with dispositions of assets and businesses.
From time to time we may dispose of assets and businesses as part of our efforts to grow our most profitable product lines. When we do so, we face risks associated with those exit activities, including but not limited to risks relating to service disruptions at our customers, risks of inadvertently losing other business not related to the exit activities, risks associated with our inability to effectively continue, terminate, modify and manage supplier and vendor relationships or commitments that may be affected by those exit activities, and the risks of consequential claims from customers or vendors resulting from the elimination, or transfer of production of, affected products or the renegotiation of commitments.
We depend on suppliers for timely deliveries of raw materials of acceptable quality. Production time and product costs could increase if we were to lose a primary supplier or if a primary supplier increased the prices of raw materials. Product performance could be affected and quality issues could develop as a result of a significant degradation in the quality of raw materials we use in our products.
Our manufacturing operations depend upon obtaining adequate supplies of raw materials on a timely basis. Our results of operations could be adversely affected if we were unable to obtain adequate supplies of raw materials in a timely manner or if the costs of raw materials increased significantly. Results could also be
adversely affected if there is a significant degradation in the quality of raw materials used in our products, or if the raw materials give rise to compatibility or performance issues in our products, any of which could lead to an increase in customer returns or product warranty claims. Although we maintain rigorous quality control systems, errors or defects may arise from a supplied raw material and be beyond our detection or control. For example, some phosphorus-containing mold compound received from one supplier and incorporated into our products has resulted in a number of claims for damages from customers. We purchase raw materials such as silicon wafers, lead frames, mold compound, ceramic packages and chemicals and gases from a limited number of suppliers on a just-in-time basis. From time to time, suppliers may extend lead times, limit supplies or increase prices due to capacity constraints or other factors. We subcontract a minority of our wafer fabrication needs, primarily to Advanced Semiconductor Manufacturing Corporation, Central Semiconductor Manufacturing Corporation, Jilin Magic Semiconductor, More Power Electric Corporation, New Japan Radio Corporation, Phenitec Semiconductor and Taiwan Semiconductor Manufacturing Company. In order to maximize our production capacity, some of our back-end assembly and testing operations are also subcontracted. Primary back-end subcontractors include Amkor, AUK, Enoch, GEM Services, Hana Semiconductor, Liteon, SP Semiconductor, Tak Cheong Electronics, Carsem and UTAC Thai Ltd.
Our operations and ability to satisfy customer obligations could be adversely affected if our relationships with these subcontractors were disrupted or terminated.
Delays in beginning production at new facilities, expanding capacity at existing facilities, implementing new production techniques, or incurring problems associated with technical equipment malfunctions, all could adversely affect our manufacturing efficiencies.
Our manufacturing efficiency is an important factor in our profitability, and we cannot assure you that we will be able to maintain our manufacturing efficiency or increase manufacturing efficiency to the same extent as our competitors. Our manufacturing processes are highly complex, require advanced and costly equipment and are continuously being modified in an effort to improve yields and product performance. Impurities or other difficulties in the manufacturing process can lower yields. In 2003, we began initial production at a new assembly and test facility in Suzhou, China. We are transferring some production from subcontractors to this facility. Delays or technical problems in completing these transfers could lead to order cancellations and lost revenue. In addition, we are currently engaged in an effort to expand capacity at some of our manufacturing facilities. As is common in the semiconductor industry, we have from time to time experienced difficulty in beginning production at new facilities or in completing transitions to new manufacturing processes at existing facilities. As a consequence, we have suffered delays in product deliveries or reduced yields.
We may experience delays or problems in bringing our factory in Suzhou, China or other new manufacturing capacity to full production. Such delays, as well as possible problems in achieving acceptable yields, or product delivery delays relating to existing or planned new capacity could result from, among other things, capacity constraints, construction delays, upgrading or expanding existing facilities or changing our process technologies, any of which could result in a loss of future revenues. Our operating results could also be adversely affected by the increase in fixed costs and operating expenses related to increases in production capacity if revenues do not increase proportionately.
Approximately two-thirds of our sales are made to distributors who can terminate their relationships with us with little or no notice. The termination of a distributor could reduce sales and result in inventory returns.
Distributors accounted for 66% of our net sales for the year ended December 30, 2007. Our top five distributors worldwide accounted for 20% of our net sales for the year ended December 30, 2007. As a general rule, we do not have long-term agreements with our distributors, and they may terminate their relationships with us with little or no advance notice. Distributors generally offer competing products. The loss of one or more of our distributors, or the decision by one or more of them to reduce the number of our products they offer or to carry the product lines of our competitors, could have a material adverse effect on our business, financial
condition and results of operations. The termination of a significant distributor, whether at our or the distributor’s initiative, or a disruption in the operations of one or more of our distributors, could reduce our net sales in a given quarter and could result in an increase in inventory returns.
The semiconductor business is very competitive, especially in the markets we serve, and increased competition could reduce the value of an investment in our company.
The semiconductor industry is, and the standard component or “multi-market” semiconductor product markets in particular are, highly competitive. Competitors offer equivalent or similar versions of many of our products, and customers may switch from our products to competitors’ products on the basis of price, delivery terms, product performance, quality, reliability and customer service or a combination of any of these factors. Competition is especially intense in the multi-market semiconductor segment because it is relatively easier for customers to switch suppliers of more standardized, multi-market products like ours, compared to switching suppliers of more highly integrated or customized semiconductor products such as processors or system-on-a-chip products, which we do not manufacture. Even in strong markets, price pressures may emerge as competitors attempt to gain a greater market share by lowering prices. Competition in the various markets in which we participate comes from companies of various sizes, many of which are larger and have greater financial and other resources than we have and thus are better able to pursue acquisition candidates and can better withstand adverse economic or market conditions. In addition, companies not currently in direct competition with us may introduce competing products in the future.
We may not be able to attract or retain the technical or management employees necessary to remain competitive in our industry.
Our continued success depends on the retention and recruitment of skilled personnel, including technical, marketing, management and staff personnel. In the semiconductor industry, the competition for qualified personnel, particularly experienced design engineers and other technical employees, is intense, particularly in the “up” portions of our business cycle, when competitors may try to recruit our most valuable technical employees. There can be no assurance that we will be able to retain our current personnel or recruit the key personnel we require.
If we must reduce our use of stock options and other equity awards, our competitiveness in the employee marketplace could be adversely affected. Our results of operations could vary as a result of the methods, estimates and judgments we use to value our stock-based compensation.
Like most technology companies, we have a history of using broad-based employee stock option programs to recruit and retain our workforce in a competitive employment marketplace. Although we have reduced our use of traditional stock options in the past several years in favor of restricted stock units, deferred stock units and performance-based equity awards, we still use stock options and expect to continue to use them as one component of our stock-based compensation program. As a result, our success will depend in part upon the continued use of stock options as a compensation tool. We plan to seek stockholder approval for increases in the number of shares available for grant under the Fairchild Semiconductor 2007 Stock Plan as well as other amendments that may be adopted from time to time which require stockholder approval. If these proposals do not receive stockholder approval, we may not be able to grant stock options and other equity awards to employees at the same levels as in the past, which could adversely affect our ability to attract, retain and motivate qualified personnel, and we may need to increase cash compensation in order to attract, retain and motivate employees, which could adversely affect our results of operations.
The calculation of stock-based compensation expense under Statement of Financial Accounting Standards (SFAS) 123(R) requires us to use valuation methodologies and a number of estimates, assumptions and conclusions regarding matters such as the expected volatility of our share price, the expected life of our options, the expected dividend rate with respect to our common stock, expected forfeitures and the exercise behavior of our employees. See Item 8, Note 8 of this report for further information. There are no means, under applicable
accounting principles, to compare and adjust this expense if and when we learn of additional information that may affect the estimates that we previously made, with the exception of changes in expected forfeitures of stock-based awards. Certain factors may arise over time that lead us to change our estimates and assumptions with respect to future stock-based compensation, resulting in variability in our stock-based compensation expense over time. Changes in forecasted stock-based compensation expense could impact our gross margin percentage, research and development expenses, marketing, general and administrative expenses and our tax rate.
We may face product warranty or product liability claims that are disproportionately higher than the value of the products involved.
Our products are typically sold at prices that are significantly lower than the cost of the equipment or other goods in which they are incorporated. For example, our products that are incorporated into a personal computer may be sold for several dollars, whereas the personal computer might be sold by the computer maker for several hundred dollars. Although we maintain rigorous quality control systems, we manufacture and sell approximately 18 billion individual semiconductor devices per year to customers around the world, and in the ordinary course of our business we receive warranty claims for some of these products that are defective or that do not perform to published specifications. Since a defect or failure in our product could give rise to failures in the goods that incorporate them (and consequential claims for damages against our customers from their customers), we may face claims for damages that are disproportionate to the revenues and profits we receive from the products involved. We attempt, through our standard terms and conditions of sale and other customer contracts, to limit our liability by agreeing only to replace the defective goods or refund the purchase price. Nevertheless, we have received claims for other charges, such as for labor and other costs of replacing defective parts or repairing the products into which the defective products are incorporated, lost profits and other damages. In addition, our ability to reduce such liabilities, whether by contracts or otherwise, may be limited by the laws or the customary business practices of the countries where we do business. And, even in cases where we do not believe we have legal liability for such claims, we may choose to pay for them to retain a customer’s business or goodwill or to settle claims to avoid protracted litigation. Our results of operations and business could be adversely affected as a result of a significant quality or performance issue in our products, if we are required or choose to pay for the damages that result.
For example, from time to time since late 2001, we have received claims from a number of customers seeking damages resulting from certain products manufactured with a phosphorus-containing mold compound. Mold compound is the plastic resin used to encapsulate semiconductor chips. This particular mold compound causes some chips to short in some situations, resulting in chip failure. We have been named in lawsuits relating to these mold compound claims. On August 6, 2007, we settled a lawsuit brought against us by Lucent Technologies Inc. in January 2005 in New Jersey state court claiming breach of warranty and fraud. The settlement payment occurred in the third quarter of 2007. On January 5, 2007, White Rock Networks sued us and two distributors, Arrow Electronics and All American Semiconductor, in the U.S. District Court for the Eastern District of Texas, for violations of the Texas Deceptive Trade Practices Act relating to the mold compound issue, claiming unspecified damages. On May 17, 2007 White Rock amended their complaint to include fraud, negligence, and breach of contract claims and removed All American as a defendant. White Rock served us on May 25, 2007. We believe we have strong defenses against White Rock Networks’ claims and intend to vigorously defend the lawsuit.
Several other customers have made claims for damages or threatened to begin litigation as a result of the mold compound issue if their claims are not resolved according to their demands, and we may face additional lawsuits as a result. We have resolved similar claims with several of our leading customers. We have exhausted insurance coverage for such customer claims. While the exact amount of these losses is not known, we have recorded a charge for estimated potential litigation outcomes relating to the mold compound issue in our Consolidated Statement of Operations. The charge is included in our total reserves for potential litigation outcomes of $11.0 million as of December 30, 2007. If we continue to receive additional claims for damages from customers beyond the period of time normally observed for such claims, if more of these claims proceed to litigation, or if we choose to settle claims in settlement of or to avoid litigation, then we may incur a liability in excess of the current balance.
Our international operations subject our company to risks not faced by domestic competitors.
Through our subsidiaries we maintain significant operations and facilities in the Philippines, Malaysia, China, South Korea and Singapore. We have sales offices and customers around the world. Approximately 76% of our revenues in fiscal year 2007 were from Asia. The following are some of the risks inherent in doing business on an international level:
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economic and political instability;
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foreign currency fluctuations;
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transportation delays;
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trade restrictions;
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changes in laws and regulations relating to, amongst other things, import and export tariffs, taxation, environmental regulations, land use rights and property,
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work stoppages; and
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the laws of, including tax laws, and the policies of the United States toward, countries in which we manufacture our products.
We acquired significant operations and revenues when we acquired a business from Samsung Electronics and, as a result, are subject to risks inherent in doing business in Korea, including political risk, labor risk and currency risk.
As a result of the acquisition of the power device business from Samsung Electronics in 1999, we have significant operations and sales in South Korea and are subject to risks associated with doing business there. Korea accounted for 13% of our revenue for the year ended December 30, 2007.
Relations between South Korea and North Korea have been tense over most of South Korea’s history, and more recent concerns over North Korea’s nuclear capability, and relations between the United States and North Korea, have created a global security issue that may adversely affect Korean business and economic conditions. We cannot assure you as to whether or when this situation will be resolved or change abruptly as a result of current or future events. An adverse change in economic or political conditions in South Korea or in its relations with North Korea could have a material adverse effect on our Korean subsidiary and our company. In addition to other risks disclosed relating to international operations, some businesses in South Korea are subject to labor unrest.
Our Korean sales are increasingly denominated primarily in U.S. dollars while a significant portion of our Korean operations’ costs of goods sold and operating expenses are denominated in South Korean won. Although we have taken steps to fix the costs subject to currency fluctuations and to balance won revenues and won costs as much as possible, a significant change in this balance, coupled with a significant change in the value of the won relative to the dollar, could have a material adverse effect on our financial performance and results of operations (see Item 7A, Quantitative and Qualitative Disclosures about Market Risk).
A change in foreign tax laws or a difference in the construction of current foreign tax laws by relevant foreign authorities could result in us not recognizing any anticipated benefits.
Our Korean subsidiary, Fairchild Korea Semiconductor Ltd, was granted a ten-year tax holiday under Korean law in 1999. The first seven years are tax-free, followed by three years of income taxes at 50% of the statutory rate. In 2000, the tax holiday was extended such that the exemption amounts were increased to 78% in the eighth year and a 28% exemption was added to the eleventh year.
Our Chinese subsidiary, Fairchild Semiconductor (Suzhou), Co. Ltd, was granted a 10 year preferential income tax holiday by the Chinese government as one of the incentives for locating in the Suzhou Industrial Park. On March 16, 2007, the Chinese government passed the unified enterprise income tax law to unify the
taxing structure among foreign invested enterprises and domestic. The new legislation, effective January 1, 2008, “grandfathers” enterprises currently enjoying tax incentives for a maximum period of five years. Fairchild Semiconductor (Suzhou), Co. Ltd will continue to enjoy these tax incentives through 2012, with the new statutory rate of 25% to take affect in 2013. The gradual transitioning of the statutory rate commences in 2008.
The corporate tax rate of our German subsidiary, Fairchild Semiconductor GmbH, will be reduced effective January 1, 2008. In July 2007, the Upper House of the German Parliament (Bundesrat) passed the 2008 Business Tax Reform Act, reducing the corporate tax rate (i.e., including income tax/trade tax/solidarity surcharge) from approximately 39% down to approximately 30%. The enactment of the reform became effective January 1, 2008.
The corporate tax rate of our United Kingdom subsidiary, Fairchild Semiconductor Limited, will be reduced from 30% to 28%, effective April 1, 2008. The Finance bill released in March 2007 as part of the UK budget report included a reduction of the corporate tax rate down to 28%. The Finance bill received Royal Assent and became law on July 19, 2007.
Our Singapore subsidiary, Fairchild Semiconductor Pte. Ltd., has been granted a Development and Expansion Incentive reducing the statutory tax rate down from 18% to 10% for a period of fifteen years, effective January 1, 2005. The incentive, and accompanying reduced statutory tax rate, is subject to specific terms and conditions involving varying levels of categorization of qualifying income, employment levels and revenue management.
We continue to monitor the Korean tax holiday, compliance with the Singapore tax incentive, changes to the income tax laws in the People’s Republic of China and the tax reforms enacted in Germany and the United Kingdom, to help ensure that the current and future tax impacts on our subsidiaries in these countries are anticipated and refined.
We have significantly expanded our manufacturing operations in China and, as a result, will be increasingly subject to risks inherent in doing business in China, which may adversely affect our financial performance.
In 2003, we began construction of a new assembly and test facility in Suzhou, China. The factory began production in July 2003 and is steadily increasing its output. Although we expect a significant portion of our production from this facility will be exported out of China, especially initially, we are hopeful that a significant portion of our future revenue will result from the Chinese markets in which our products are sold, and from demand in China for goods that include our products. Our ability to operate in China may be adversely affected by changes in that country’s laws and regulations, including those relating to taxation, import and export tariffs, environmental regulations, land use rights, property and other matters. In addition, our results of operations in China are subject to the economic and political situation there. We believe that our operations in China are in compliance with all applicable legal and regulatory requirements. However, there can be no assurance that China’s central or local governments will not impose new, stricter regulations or interpretations of existing regulations that would require additional expenditures. Changes in the political environment or government policies could result in revisions to laws or regulations or their interpretation and enforcement, increased taxation, restrictions on imports, import duties or currency revaluations. In addition, a significant destabilization of relations between China and the United States could result in restrictions or prohibitions on our operations or the sale of our products in China. The legal system of China relating to foreign trade is relatively new and continues to evolve. There can be no certainty as to the application of its laws and regulations in particular instances. Enforcement of existing laws or agreements may be sporadic and implementation and interpretation of laws inconsistent. Moreover, there is a high degree of fragmentation among regulatory authorities resulting in uncertainties as to which authorities have jurisdiction over particular parties or transactions.
We are subject to many environmental laws and regulations that could affect our operations or result in significant expenses.
Increasingly stringent environmental regulations restrict the amount and types of pollutants that can be released from our operations into the environment. While the cost of compliance with environmental laws has not had a material adverse effect on our results of operations historically, compliance with these and any future regulations could require significant capital investments in pollution control equipment or changes in the way we make our products. In addition, because we use hazardous and other regulated materials in our manufacturing processes, we are subject to risks of liabilities and claims, regardless of fault, resulting from our use, transportation, emission, discharge, storage, recycling or disposal of hazardous materials, including personal injury claims and civil and criminal fines, any of which could be material to our cash flow or earnings. For example:
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we currently are remediating contamination at some of our operating plant sites;
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we have been identified as a potentially responsible party at a number of Superfund sites where we (or our predecessors) disposed of wastes in the past; and
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significant regulatory and public attention on the impact of semiconductor operations on the environment may result in more stringent regulations, further increasing our costs.
Although most of our known environmental liabilities are covered by indemnification agreements with Raytheon Company, National Semiconductor, Samsung Electronics and Intersil Corporation, these indemnities are limited to conditions that occurred prior to the consummation of the transactions through which we acquired facilities from those companies. Moreover, we cannot assure you that their indemnity obligations to us for the covered liabilities will be available, or, if available, adequate to protect us.
We are a leveraged company with a ratio of debt to equity at December 30, 2007 of approximately 0.5 to 1, which could adversely affect our financial health and limit our ability to grow and compete.
At December 30, 2007, we had total debt of $589.6 million and the ratio of this debt to equity was approximately 0.5 to 1. On June 22, 2006 we reduced the outstanding balance on the term loan by $50 million to $394 million. On June 26, 2006 we refinanced the existing senior credit facility consisting of a term loan of $375 million, replacing the previous $450 million term loan and replacing the previous $180 million revolving line of credit with a $100 million revolving line of credit, of which $78.5 million remained undrawn as of December 30, 2007, adjusted for outstanding letters of credit. In addition, there is a $300 million uncommitted incremental term loan feature. Despite reducing some of our long-term debt, we continue to carry substantial indebtedness which could have significant consequences. For example, it could:
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require us to dedicate a portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts and other general corporate purposes;
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increase the amount of our interest expense, because certain of our borrowings (namely borrowings under our senior credit facility) are at variable rates of interest, which, if interest rates increase, could result in higher interest expense;
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increase our vulnerability to general adverse economic and industry conditions;
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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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restrict us from making strategic acquisitions, introducing new technologies or exploiting business opportunities;
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make it more difficult for us to satisfy our obligations with respect to the instruments governing our indebtedness;
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place us at a competitive disadvantage compared to our competitors that have less indebtedness; or
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limit, along with the financial and other restrictive covenants in our debt instruments, among other things, our ability to borrow additional funds, dispose of assets, repurchase stock or pay cash dividends. Failing to comply with those covenants could result in an event of default which, if not cured or waived, could have a material adverse effect on our business, financial condition and results of operations.
Despite current indebtedness levels, we may still be able to incur substantially more indebtedness. Incurring more indebtedness could exacerbate the risks described above.
We may be able to incur substantial additional indebtedness in the future. The indenture governing Fairchild Semiconductor Corporation’s outstanding 5% Convertible Senior Subordinated Notes Due 2008 does not limit the amount of additional debt that we may incur. Although the terms of the credit agreement relating to the senior credit facility contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of qualifications and exceptions and, under certain circumstances, additional indebtedness incurred in compliance with these restrictions or upon further amendment of the credit facility could be substantial. The senior credit facility, from June 2006, permits borrowings of up to $100 million in revolving loans under the line of credit and up to $300 million under the uncommitted incremental term loan feature, in addition to the outstanding $375 million term loan that is currently outstanding under that facility. As of December 30, 2007, adjusted for outstanding letters of credit, we had up to $78.5 million available under the revolving loan portion of the senior credit facility. If new debt is added to our subsidiaries’ current debt levels, the substantial risks described above would intensify.
We may not be able to generate the necessary amount of cash to service our indebtedness, which may require us to refinance our indebtedness or default on our scheduled debt payments. Our ability to generate cash depends on many factors beyond our control.
Our historical financial results have been, and our future financial results are anticipated to be, subject to substantial fluctuations. We cannot assure you that our business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule or at all, or that future borrowings will be available to us under our senior credit facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. In addition, because our senior credit facility has variable interest rates, the cost of those borrowings will increase if market interest rates increase. If we are unable to meet our expenses and debt obligations, we may need to refinance all or a portion of our indebtedness on or before maturity, sell assets or raise equity. We cannot assure you that we would be able to refinance any of our indebtedness, sell assets or raise equity on commercially reasonable terms or at all, which could cause us to default on our obligations and impair our liquidity. Restrictions imposed by the credit agreement relating to our senior credit facility restrict or prohibit our ability to engage in or enter into some business operating and financing arrangements, which could adversely affect our ability to take advantage of potentially profitable business opportunities.
The operating and financial restrictions and covenants in the credit agreement relating to our senior credit facility may limit our ability to finance our future operations or capital needs or engage in other business activities that may be in our interests. The credit agreement imposes significant operating and financial restrictions that affect our ability to incur additional indebtedness or create liens on our assets, pay dividends, sell assets, engage in mergers or acquisitions, make investments or engage in other business activities. These restrictions could place us at a disadvantage relative to competitors not subject to such limitations.
In addition, the senior credit facility also requires us to maintain specified financial ratios. Our ability to meet those financial ratios can be affected by events beyond our control, and we cannot assure you that we will meet those ratios. As of December 30, 2007, we were in compliance with these ratios. A breach of any of these covenants, ratios or restrictions could result in an event of default under the senior credit facility. Upon the occurrence of an event of default under the senior credit facility, the lenders could elect to declare all amounts outstanding under the senior credit facility, together with accrued interest, to be immediately due and payable. If
we were unable to repay those amounts, the lenders could proceed against our assets, including any collateral granted to them to secure the indebtedness. If the lenders under the senior credit facility accelerate the payment of the indebtedness, we cannot assure you that our assets would be sufficient to repay in full that indebtedness and our other indebtedness.
We invest in auction rate securities that subject us to market risk which could adversely affect our liquidity and financial results.
We invest our excess cash in marketable securities consisting primarily of commercial paper, U.S. Government securities, and auction rate securities. As of the end of fiscal year 2007, we owned $51.3 million of auction rate securities. These securities are AAA rated, by Moody’s and Standard and Poor’s, and are primarily used for managing our on-going liquidity needs, while maximizing interest income. In the third quarter of 2007, we experienced failures on the auction rate securities we held related to disruptions in the credit market, as there were more sellers than buyers of our auction rate securities. If an auction fails, our investments will not be liquid until the auction is successfully reset or is called by the issuer, and therefore a failure could impair our liquidity needs. As of December 30, 2007, there were no credit rating changes on these securities. If the credit rating on these securities is downgraded, or we otherwise assess a triggering event of other than temporary impairment of these assets, we may be required to adjust the carrying value of these investments through an impairment charge in our financial statements. As of December 30, 2007, no investments are considered other than temporarily impaired. Therefore, in accordance with SFAS 115, Accounting for Certain Investments in Debt and Equity Securities, unrealized losses of $2.5 million relating to these securities have been recorded in other comprehensive income.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
We have no unresolved comments from the Securities and Exchange Commission as of February 28, 2008.
ITEM 2.
ITEM 2. PROPERTIES
We maintain manufacturing and office facilities around the world including the United States, Asia and Europe. The following table provides information about these facilities at December 30, 2007.
Location
Owned
Leased
Use
Business Segment
Bucheon, South Korea
X
Manufacturing, office facilities and design center.
Functional Power, Analog Products, Standard Products
Cebu, Philippines
X
X
Manufacturing, warehouse and office facilities.
Functional Power, Analog Products, Standard Products
Fuerstenfeldbruck, Germany
X
Office facilities.
-
Hwasung City, South Korea
X
Warehouse space.
-
Kowloon, Hong Kong
X
Office facilities.
-
Loveland & Colorado Springs, Colorado
X
Office facilities and design center.
Analog Products
Mountaintop, Pennsylvania
X
Manufacturing and office facilities.
Functional Power
Oulu, Finland
X
Office facilities and design center.
Analog Products
Penang, Malaysia
X
X
Manufacturing, warehouse and office facilities.
Functional Power, Analog Products, Standard Products
San Jose, California
X
Office facilities and design center.
Functional Power, Analog Products, Standard Products
Seoul, South Korea
X
Office facilities.
-
Shanghai, China
X
Office facilities.
-
Singapore
X
Manufacturing and office facilities.
Standard Products
South Portland, Maine
X
Corporate headquarters.
-
South Portland, Maine
X
X
Manufacturing, office facilities and design center.
Functional Power, Analog Products, Standard Products
Suzhou, China
X
Manufacturing, warehouse and office facilities.
Functional Power, Analog Products, Standard Products
Taipei, Taiwan
X
Office facilities and design center.
Analog Products
Tokyo, Japan
X
Office facilities.
-
West Jordan, Utah
X
Manufacturing and office facilities.
Functional Power
Wooton-Bassett, England
X
Office facilities.
-
Leases affecting the Penang and Cebu facilities are generally in the form of long-term ground leases, while we own improvements on the land. In some cases we have the option to renew the lease term, while in others we have the option to purchase the leased premises. We also have the ability to cancel these leases at any time.
We believe that our facilities around the world, whether owned or leased, are well maintained and are generally suitable and adequate to carry on the company’s business. Our manufacturing facilities contain sufficient productive capacity to meet our needs for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Phosphorus Mold Compound Litigation and Claims. From time to time since late 2001, we have received claims from a number of customers seeking damages resulting from certain products manufactured with a phosphorus-containing mold compound. Mold compound is the plastic resin used to encapsulate semiconductor chips. This particular mold compound causes some chips to short in some situations, resulting in chip failure. We have been named in lawsuits relating to these mold compound claims. On August 6, 2007, we settled a lawsuit brought against us by Lucent Technologies Inc. in January 2005 in New Jersey state court claiming breach of warranty and fraud. The settlement payment occurred in the third quarter of 2007. On January 5, 2007, White Rock Networks sued us and two distributors, Arrow Electronics and All American Semiconductor, in the U.S. District Court for the Eastern District of Texas, for violations of the Texas Deceptive Trade Practices Act relating to the mold compound issue, claiming unspecified damages. On May 17, 2007 White Rock amended its complaint to include fraud, negligence, and breach of contract claims and removed All American as a defendant. White Rock served us on May 25, 2007. We believe we have strong defenses against White Rock’s claims and intend to vigorously defend the lawsuit. Several other customers have made claims for damages or threatened to begin litigation as a result of the mold compound issue if their claims are not resolved according to their demands, and we may face additional lawsuits as a result. We have resolved similar claims with several of our leading customers. We have exhausted insurance coverage for such customer claims.
Patent Litigation with Power Integrations, Inc. On October 20, 2004, we and our wholly owned subsidiary, Fairchild Semiconductor Corporation, were sued by Power Integrations, Inc. in the United States District Court for the District of Delaware. Power Integrations alleges that certain of our pulse width modulation (PWM) integrated circuit products infringe four Power Integrations U.S. patents, and seeks a permanent injunction preventing us from manufacturing, selling or offering the products for sale in the United States, or from importing the products into the United States, as well as money damages for past infringement. We have analyzed the Power Integrations patents in light of our products and, based on that analysis, do not believe our products violate Power Integrations’ patents. Accordingly, we are vigorously contesting this lawsuit. The trial in the case has been divided into three phases. The first phase, held October 2-10, 2006, was on infringement, the willfulness of any infringement, and damages. On October 10, 2006, a jury returned a verdict finding that 33 of our PWM products infringe one or more of seven claims of the four patents being asserted. The jury also found that our infringement was willful, and assessed damages against us of approximately $34 million. That verdict remains subject to our appeal. The second phase of the trial, held September 17-21, 2007 before a different jury was on the validity of the Power Integrations patents being asserted. On September 21, 2007 a jury returned a verdict in the second phase, finding that the four Power Integrations patents asserted in the lawsuit are valid. The third phase of the trial covers the enforceability of the patents. The third phase began on September 21, 2007 and is still pending before the court. Rulings from the enforceability phase of the litigation may overturn parts of the jury verdict on the second phase.
Power Integrations must prevail on all three phases of the trial to receive a judgment for damages and an injunction against us. Power Integrations may seek an injunction to prevent us from making, selling or offering to sell in the United States, or from importing into the United States, products that infringe patents that are found valid and enforceable. Power Integrations has announced its intention to seek such an injunction in such event.
The jury in the first phase of the trial assessed damages against us of approximately $34 million. Because the jury also found that our infringement was willful, the judge in the case will have discretion to increase the damages award by up to three times the amount of the final damages award. The final damages award would be determined after the third phase of the trial. Damages may be increased by the judge to account for certain sales by us after October 20, 2006 and as a result of the willful infringement finding. It is also possible that we could be required to pay Power Integrations’ attorney’s fees and pre-judgment interest.
The results of litigation are difficult to predict and no assurance can be given that we will succeed in proving the patents unenforceable. As discussed above, the judge overseeing the case has discretion over the amount of damages awarded, and over the granting and scope of any injunction against us. Any damages award
or injunction would be subject to appeal and we expect to contest several aspects of the litigation and would carefully consider an appeal at the appropriate time. We believe one aspect of the jury’s verdict finding that we had willfully infringed the Power Integrations patents should be dismissed or put to a new trial because of an August 20, 2007 decision by the U.S. Court of Appeals for the Federal Circuit that significantly changed the law of willfulness as applied to patent infringement cases. We also expect to request a reduction in the level of damages awarded in the first phase of the litigation because of errors that we believe were made in the calculation of damages. We also plan to contest the jury’s finding in the second (validity) phase of the case as well as other decisions made by the court during the course of the litigation, including the division of the trial into several phases, rulings construing the claims of the patents involved and limitations on the evidence we were permitted to present. If we choose to appeal, we would likely be required to post a bond or provide other security for some or the entire amount of the final damages award during the pendency of the appeal. Should we ultimately lose the lawsuit, or if an injunction is issued while an appeal is pending, such result could have an adverse impact on our ability to sell products found to be infringing, either directly or indirectly in the U.S.
In a separate action, we filed a lawsuit on April 11, 2006, against Power Integrations in the United States District Court for the Eastern District of Texas, asserting that Power Integrations’ PWM products infringe U.S. Patent No. 5,264,719. The lawsuit was transferred to the United States District Court for the District of Delaware. Intersil Americas owns U.S. Patent No. 5,264,719, for High Voltage Lateral Semiconductor Devices, and is a co-plaintiff with us in the lawsuit. We have held license rights under the patent since acquiring Intersil’s power discrete business in 2001, and we more recently secured exclusive rights to assert the patent against Power Integrations. The court dismissed the lawsuit on December 21, 2007 because of legal standing issues relating to the license arrangement between us and Intersil Americas. The court left open the possibility for the standing issues to be addressed and the suit reinstituted. The underlying merits of Intersil and Fairchild’s patent infringement case against Power Integrations were not addressed in the court’s ruling. We are exploring options to address the standing issues raised by the court.
Our wholly owned subsidiary, System General Corporation, is a defendant in a patent infringement lawsuit in the U.S. District Court for the Northern District of California. System General had appealed to the U.S. Court of Appeals for the Federal Circuit on the outcome of proceedings before the U.S. International Trade Commission (ITC) involving allegations of patent infringement. The ITC order banned some System General parts, and downstream products incorporating the System General parts, from being imported into the United States. Both the ITC proceeding and the lawsuit were initiated by Power Integrations. The district court action was stayed at least until the appeals court issued its decision on System General’s appeal of the ITC’s final determination. On November 20, 2007, the appeals court affirmed the ITC’s decision. Some System General products were specifically carved out of the ITC’s U.S. import ban, and System General has fully replaced the banned products with replacement products not covered by the ITC ban. There has been no activity in the district court action since the appeals court decision. Fairchild has petitioned the U.S. patent office for reexamination of the patents involved. As in all litigation, it is difficult to predict the result of the district court action and no assurance can be given as to the outcome of this lawsuit. Should we ultimately lose the lawsuit, such result could have an adverse impact on our ability to sell products found to be infringing, either directly or indirectly in the U.S.
Patent Litigation with Alpha & Omega Semiconductor, Inc. On May 17, 2007, Alpha & Omega Semiconductor, Inc. (AOS) filed suit against us in the U.S. District Court for the Northern District of California alleging that we are infringing two of its patents. AOS is seeking unspecified damages and an injunction against us. We in turn filed suit against AOS in the same court on May 18, 2007, alleging that AOS is infringing four of our patents. We are also seeking unspecified damages and an injunction. The cases were consolidated on July 31, 2007. On October 2, 2007, the parties were granted leave to amend their complaints to assert additional patents. We asserted two additional patents against AOS, and AOS asserted one additional patent against us. The lawsuit is currently in the discovery phase.
We intend to take all possible steps to seek a court order to stop AOS from making, using, selling, offering for sale or importing any infringing products in the U.S. and to obtain monetary damages for any infringing activities. Although we believe, based on the prior art we have identified and our knowledge of our products, that we have invalidity, non-infringement and other defenses to AOS’ patent claims, the results of litigation are difficult to predict and no assurance can be given that we will succeed in proving the AOS patents invalid, not infringed or unenforceable. Any damages award or injunction would be subject to appeal and we would expect to carefully consider an appeal at the appropriate time. In such a case, if we choose to appeal, we would likely be required to post a bond or provide other security for some or the entire amount of the final damages award during the pendency of the appeal. Should we ultimately lose the lawsuit, such result could have an adverse impact on our ability to sell products found to be infringing, either directly or indirectly in the U.S.
We have analyzed the potential litigation outcomes from all the abovementioned claims in accordance with SFAS 5, Accounting for Contingencies. While the exact amount of these losses is not known, we have recorded net reserves for potential litigation outcomes in our Consolidated Statement of Operations, based upon our assessments of the potential liability using an analysis of the claims and historical experience in defending and/or resolving these claims. As of December 30, 2007 our balance for potential litigation outcomes was $11.0 million. If we continue to receive additional claims, if more of these claims proceed to litigation or if we choose to settle claims in settlement of or to avoid litigation, then we may incur liabilities in excess of the current reserves.
From time to time we are involved in legal proceedings in the ordinary course of business. We believe that there is no such ordinary-course litigation pending that could have, individually or in the aggregate, a material adverse effect on our business, financial condition, results of operations or cash flows.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the period beginning October 1, 2007 and ending on December 30, 2007.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the New York Stock Exchange under the trading symbol “FCS”. The following table sets forth, for the periods indicated, the high and low intraday sales prices per share of Fairchild Semiconductor International, Inc. Common Stock, as quoted on the NYSE.
As of February 27, 2008 there were approximately 189 holders of record of our Common Stock. We have not paid dividends on our common stock in any of the years presented above and have no present intention of doing so. Certain agreements, pursuant to which we have borrowed funds, contain provisions that limit the
amount of dividends and stock repurchases that we may make. See Item 7, Liquidity and Capital Resources and Note 6 to our Consolidated Financial Statements contained in Item 8 of this report, for further information about restrictions to our ability to pay dividends.
Securities Authorized for Issuance Under Equity Compensation Programs
The following table provides information about the number of stock options, deferred stock units (DSUs), restricted stock units (RSUs) and performance units (PUs) outstanding and authorized for issuance under all equity compensation plans of the company on December 30, 2007. The notes under the table provide important additional information.
(1) Other than as described here, the company had no warrants or rights outstanding or available for issuance under any equity compensation plan at December 30, 2007.
(2) Does not include shares subject to DSUs, RSUs or PUs, which do not have an exercise price.
(3) Represents 37,430 shares under the 2000 Executive Stock Option Plan (2000 Executive Plan) and 6,531,880 shares under the Fairchild Semiconductor 2007 Stock Plan (2007 Stock Plan). There were no shares remaining available for future issuance under the Fairchild Semiconductor Stock Plan (Stock Plan) on December 30, 2007.
(4) Shares issuable include 1,626,964 options under the 2000 Executive Plan, 18,751,595 options, 236,684 DSUs, 736,313 RSUs, and 643,897 PUs under the Stock Plan and 87,550 options, 59,000 DSUs, 101,195 RSUs, and 52,014 PUs under the 2007 Stock Plan.
(5) Represents 200,000 options and 12,500 DSUs granted in December 2004 to Mark S. Thompson, our President and CEO, and 75,000 options, 26,800 PUs and 15,000 RSUs granted to Mark S. Frey, our Executive Vice President, CFO and Treasurer in March 2006, as recruitment-related grants. These equity awards were made under the NYSE exemption for employment inducement awards. The equity awards are covered by separate award agreements. The options granted to Mr. Thompson and Mr. Frey vest over the four-year period following their grant date, have an eight-year term and have an exercise price per share equal to the fair market value of the company’s common stock on the grant date. The DSUs granted to Mr. Thompson vest over the four-year period following their grant date. The PUs granted to Mr. Frey vest over the three-year period following their grant date. Mr. Frey’s RSUs vest over the four-year period following their grant date.
The material terms of the 2000 Executive Plan, the Stock Plan and the 2007 Stock Plan are described in Note 8 to the company’s Consolidated Financial Statements contained in Item 8 of this report, and the three plans are included as exhibits to this report.
Unregistered Sales of Equity Securities and Use of Proceeds
There were no sales of unregistered equity securities in the fourth quarter of 2007. The following table provides information with respect to purchases made by the company of its own common stock during the fourth quarter of 2007.
(1) All of these shares were purchased by the company in open-market transactions to satisfy its obligations to deliver shares under the company’s employee stock purchase plan or for other board of director authorized transactions. The purchase of these shares satisfied the conditions of the safe harbor provided by the Securities Exchange Act of 1934.
Stockholder Return Performance
The following graph compares the change in total stockholder return on the company’s common stock against the total return of the Standard & Poor’s 500 Index and the Philadelphia Stock Exchange Semiconductor Index from December 27, 2002, the last day our common stock was traded on the New York Stock Exchange before the beginning of our fifth preceding fiscal year, to December 28, 2007, the last trading day in our fiscal year ended December 30, 2007. Total return to stockholders is measured by dividing the per-share price change for the period by the share price at the beginning of the period. The graph assumes that investments of $100 were made on December 27, 2002 in our common stock and in each of the indexes.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected historical consolidated financial data. The historical consolidated financial data as of December 30, 2007 and December 31, 2006 and for the years ended December 30, 2007, December 31, 2006, and December 25, 2005 are derived from our audited Consolidated Financial Statements, contained in Item 8 of this report. The historical consolidated financial data as of December 25, 2005, December 26, 2004 and December 28, 2003 and for the years ended December 26, 2004 and December 28, 2003 are derived from our audited Consolidated Financial Statements, which are not included in this report. This information should be read in conjunction with our audited Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Our results for the years ended December 30, 2007, December 25, 2005, December 26, 2004 and December 28, 2003 each consist of 52 weeks, while results for the year ended December 31, 2006 consists of 53 weeks.
We did not pay cash dividends on our common stock in any of the years presented above.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Introduction
This discussion and analysis of financial condition and results of operations is intended to provide investors with an understanding of the company’s past performance, its financial condition and its prospects. We will discuss and provide our analysis of the following:
•
Overview
•
Results of Operations
•
Liquidity and Capital Resources
•
Liquidity and Capital Resources of Fairchild International, Excluding Subsidiaries
•
Critical Accounting Policies and Estimates
•
Forward Looking Statements
•
Policy on Business Outlook Disclosure and Quiet Periods
•
Outlook
•
Recently Issued Financial Accounting Standards
Overview
Our primary business goal for 2007 was to focus on new product development in order to increase our mix of more proprietary, higher margin products while continuing to deemphasize lower margin products. We target annual capital expenditures to be in the range of 6 to 8% of sales as we focus on opportunities to increase capacity at our factories. When opportunity for rapid payback exists, we may exceed the high end of this range. In 2007, our capital expenditures as a percentage of sales was 8.4%. Another important business goal was to decrease the volatility of our sales and earnings across the semiconductor business cycle. We controlled our production output to match end market demand through tight control of our inventory by maintaining a foundation of strong supply chain and inventory channel management. This included our target of keeping our distribution inventory on hand at 11 weeks, plus or minus a week. At the end of 2007, distribution inventory on hand was approximately 11.4 weeks, within our acceptable level and slightly less than the end of 2006. We also continue to manage our internal inventories, with a target range of 10 weeks of internal inventory, plus or minus a week. Our internal inventory was within the target range at just under 11 weeks at the end of 2007. By tightly controlling inventories, we reduce the impact that inventory corrections can have on our shipments and revenues.
The Analog Products Group strategy is to develop leading edge products that provide performance and cost advantages to our customers. As part of this strategy, we have accelerated investments in research and development for continued development of advanced process and package technology. We provide differentiated products with clear performance advantages by working closely with our customers to understand their system needs, and delivering products on time with stable lead times. We believe our R&D investments in the Analog Products group will generate sales growth opportunities in the future. In addition, we completed our acquisition of System General Corporation (System General) in August 2007. We believe the integration of System General into the Analog Products Group will contribute to sales and gross margin increases across our entire power conversion business.
The Functional Power Group continues to develop leading edge MOSFET silicon technology, state of the art packaging technologies and integrated custom power system solutions. By integrating our technology, expertise and packaging technologies into a complete solution for our customers, we expect to steadily improve gross margins and at the same time, the value proposition to our customers. In our low voltage product line, we
seek to deliver exceptional product performance by optimizing silicon processes to satisfy specific application requirements for our customers. This enables us to deliver solutions with greater energy efficiency than is commonly available. Our high voltage solutions are designed to provide improved energy efficiency and higher performance in consumer, industrial, and automotive applications. We produce a wide range of Smart Power Modules that enable the transition from single speed AC motors to variable speed AC and DC motors which are up to 60% more energy efficient. We believe the growing global focus on energy efficiency will continue to drive strong growth in this product line.
The Standard Products Group continues to follow our “asset-light” investment strategy for many of our standard products, which typically have lower gross margins and lower or negative long-term sales growth potential. Through this strategy we are gradually transferring the manufacturing for these mature products to third-party subcontractors, where appropriate, thereby allowing our own manufacturing facilities to focus on building higher growth, higher margin and more proprietary products. This strategy should improve return on invested capital by minimizing the operating expenses required to support the business. We believe that by following this long term “asset-light” approach for mature products, we will improve our return on invested capital and lessen our exposure to falling prices on commodity products during industry downturns.
Our results for the years ended December 30, 2007 and December 25, 2005 consists of 52 weeks, while results for the year ended December 31, 2006 consisted of 53 weeks.
Results of Operations
The following table summarizes certain information relating to our operating results as derived from our audited consolidated financial statements.
Year Ended December 30, 2007 Compared to Year Ended December 31, 2006
Total Revenues. Total revenues for 2007 increased $19.1 million, or 1%, as compared to 2006, primarily due to the acquisition of System General. Our results for 2007 consist of 52 weeks as compared to 53 weeks in 2006.
Geographic revenue information is based on the customer location within the indicated geographic region. The following table presents, as a percentage of sales, geographic sales for the Americas, Europe, China, Taiwan, Korea and Other Asia/Pacific (which for our geographic reporting purposes includes Japan and Singapore) for 2007 and 2006.
Gross Margin. Gross margin decreased approximately 1% in 2007 as compared to 2006 due to decreased factory utilization and unit volumes, increases in raw materials and unfavorable currency trends. The unfavorable trends were partially offset by increased revenue, improved product mix and reduced variable compensation accruals of approximately $20.2 million. Also included in gross margin in 2007 was a $3.7 million purchase accounting charge related to the System General acquisition for the recognition of the step-up of inventory to fair market value at the acquisition date (see Item 8, Note 17 for further information).
Operating Expenses. Research and development (R&D) expenses were flat as a percentage of sales in 2007 and 2006. Increases in R&D dollars, which is in alignment with our strategic decision to increase new product development in 2007, as well as incremental expense relating to the System General acquisition, was offset by a $10.6 million decrease in variable compensation accruals during 2007. Selling, general and administrative (SG&A) expenses were slightly lower as a percentage of sales during 2007, as compared to 2006. Decreases in SG&A were due to tighter spending controls and decreased variable compensation accruals of approximately $17.3 million, offset by increased promotional spending and incremental spending due to the acquisition of System General.
Acquisition amortization was flat in 2007 as compared to 2006. The incremental expense related to the amortizable intangible assets acquired as part of the System General acquisition (see Item 8, Note 17 for additional information) was offset by certain intangibles becoming fully amortized.
Restructuring and Impairments. During 2007, we recorded restructuring and impairment charges, net of releases, totaling $10.8 million. The charges included $6.8 million in employee separation costs, $0.2 million in contract cancellation costs, $3.1 million in asset impairment costs and $0.2 million in reserve releases, all associated with the 2007 Infrastructure Realignment Program. In addition, we recorded an additional $0.9 million in employee separation costs associated with the 2006 Infrastructure Realignment Program.
The 2007 Infrastructure Realignment Program is expected to be substantially complete by the second quarter of 2008 and impacts approximately 97 manufacturing and non-manufacturing personnel. We anticipate annual cost savings associated with the employee separation of approximately $4.8 million beginning in the first quarter of 2008 and $1.2 million beginning in the second quarter of 2008. In addition, we expect depreciation cost savings of $0.8 million relating to the asset impairment charges. Effective in the fourth quarter of 2007, we achieved annualized cost savings associated with the employee separation of approximately $1.8 million.
During 2006, we recorded restructuring and impairment charges totaling $3.2 million. The charges included $1.0 million in employee separation costs and $2.2 million in asset impairment costs.
The 2006 Infrastructure Realignment Program was substantially complete as of the third quarter of 2007 and impacted approximately 33 non-manufacturing personnel. We achieved annualized cost savings associated with the employee separation of approximately $3.4 million beginning in the third quarter of 2007. In addition, we achieved annualized depreciation savings of $0.3 million related to the asset impairment charge.
Charge for Potential Litigation Outcomes, net. In 2007, we recorded a net charge of $9.5 million for potential litigation outcomes. In the fourth quarter of 2006, we recorded an $8.2 million reserve for potential losses as a result of an unfavorable judgment in our legal proceeding with Zhongxing Telecom Ltd. (ZTE). The charges were based on our analysis of the claims and our historical experience in defending and/or resolving these claims (see Item 8, Note 14 of this report for additional information).
(Gain) Loss on Sale of Product Line, net. In the third quarter of 2007, we announced the sale of selected assets of the Radio Frequency (RF) product line to ANADIGICS, Inc. as these RF assets did not fit with our strategic direction. As a result of the sale, we recorded a net loss of $0.4 million during the third quarter of 2007. In 2006, we announced the sale of the light-emitting diode (LED) lamps and displays product line to Everlight International Corporation, a U.S. subsidiary of Everlight Electronics Company Ltd., of Taiwan, as the LED lamps and displays product line does not fit our strategic direction. As a result of the sale, we recorded a net gain of $6.0 million on the sale.
Purchased In-Process Research and Development (IPR&D). In 2007, we recorded $3.9 million of IPR&D as a result of the acquisition of System General (see Item 8, Note 17 of this report for additional information).
Other Expense, net.
The following table presents a summary of Other expense, net for 2007 and 2006, respectively.
Interest expense. Interest expense in 2007 decreased $3.8 million, as compared to 2006, due to the refinancing of our variable rate term loan in the second quarter of 2006 and lower term loan balances. In addition, there was an extra week of interest expense in the first quarter of 2006.
Interest income. Interest income in 2007 decreased $3.9 million, as compared to 2006, as a result of lower levels of invested cash balances, offset by improved rates of return earned on cash and marketable securities. In addition, there was an extra week of interest income in the first quarter of 2006.
Other (income) expense, net. In 2007, we recorded $0.6 million of net other expense principally relating to charitable donations and contributions. In 2006, we recorded $0.2 million of net other expense. This includes a gain of $(0.6) million on the sale of a strategic investment, $0.5 million of fees associated with the refinancing of the senior credit facility, and $0.3 of expense relating to charitable donations and contributions.
Income Taxes. The effective tax rate for 2007 was 22.0% compared to 15.6% for 2006. The change in effective tax rate is primarily due to shifts of income among jurisdictions with differing tax rates, a change in the Korean holiday tax rate from 6.16% in 2006 to 13.75% in 2007 and the impact of the first quarter 2006 net tax benefit as a result of the finalization of certain tax filings and audit outcomes compared to the first quarter 2007
net tax expense. Income taxes for 2007 were $18.1 million on income before taxes of $82.1 million as compared to income taxes of $15.4 million on income before taxes of $98.8 million for 2006. In 2007, the valuation allowance on our deferred tax assets was reduced by $29.1 million.
In accordance with Accounting Principles Board (APB) Opinion 23, Accounting of Income Taxes-Special Areas, deferred taxes have not been provided on undistributed earnings of foreign subsidiaries which are reinvested indefinitely. Certain non-U.S. earnings, which have been taxed in the U.S. but earned offshore, have and continue to be part of our repatriation plan. After further analysis of our APB 23 position regarding the February 2007 acquisition of System General in Taiwan, a decision was made not to be permanently reinvested as the local laws incent companies to declare and distribute annual dividends. In addition, with the anticipated closing of one of our foreign operations, which ultimately will result in the repatriating of undistributed earnings, a decision was made not to be permanently reinvested at that site. For the year ending December 30, 2007, we recorded a deferred tax liability of $0.1 million, with no impact to the consolidated statement of operations as we have a full valuation allowance against our net U.S. deferred tax assets.
Reportable Segments.
Beginning in the first quarter of 2007, we transferred responsibility for our bipolar transistors product line from the Functional Power Group (FPG) to the Standard Products Group (SPG). Management believes that the opportunities and challenges facing this business are better suited to the management focus and capabilities of the SPG management team. The financial performance of FPG and SPG has been restated for 2006 to reflect this change.
The following table represents comparative disclosures of revenue and gross margin of our reportable segments.
(1) Operating loss in 2007 includes $24.8 million of stock-based compensation expense, $10.8 million of restructuring and impairments expense, $9.5 million in charges for potential litigation outcomes, net (see Item 8, Note 14), a net loss of $0.4 million on the sale of a product line and $0.3 million of other expense. Operating loss in 2006 includes $26.7 million of stock-based compensation expense, $8.2 million in charges for potential litigation outcomes, net (see Item 8, Note 14 for further information), $3.2 million for restructuring and impairments, and a net gain of $6.0 million on the sale of a product line.
Functional Power. Functional Power revenues increased approximately 3% in 2007 as compared to 2006. Our results for 2007 include 52 weeks compared to 53 weeks in 2006. The overall increase in revenue during 2007 was driven by increases in average selling prices of approximately 2% due to product mix and price related improvements, while increases in unit volumes contributed the remaining approximately 1%. Revenue increases were primarily driven by strong market demand for our high voltage and auto products. Gross margin increased in 2007 due to increased revenue, improved product mix, demand for high voltage and auto products and lower manufacturing costs, offset somewhat by increases in raw material costs and unfavorable currency trends.
Functional Power had operating income of $136.9 million in 2007, as compared to $124.9 million in 2006. The increase in operating income was due to the gross margin increase described above, slightly offset by higher SG&A expenses. R&D expenses were roughly flat. SG&A expenses increased due to increased spending and promotional expenses, which was slightly offset by lower variable compensation accruals. The decrease in amortization of acquisition-related intangibles was due to certain intangibles becoming fully amortized.
Analog Products. Analog Products revenues increased approximately 8% in 2007 as compared to 2006. Our results for 2007 include 52 weeks compared to 53 weeks in 2006. The increase in revenue in 2007 was mainly the result of the acquisition of System General, offset by lower unit volumes in the computing business and efforts to improve distribution channel inventory turns. Gross margin decreased in 2007 mainly due to lower factory utilization as a result of our efforts to reduce inventory and increases in raw material costs. Also, included in gross margin in 2007 was a $3.7 million purchase accounting charge related to the incremental expense for the recognition of the step-up of inventory to fair value at the acquisition date as part of the System General acquisition (see Item 8, Note 17 for further information).
Analog Products had an operating loss of $25.6 million in 2007, compared to $13.1 million in 2006. The increase in operating loss during 2007 was due to lower gross margin as described above, higher R&D expenses and a charge of $3.7 million for IPR&D related to the acquisition of System General. R&D expenses increased primarily due to the acquisition of System General, which was slightly offset by lower variable compensation accruals. SG&A expenses were roughly flat with decreased spending due to lower variable compensation accruals, offset by increased spending due to the acquisition of System General. The increase in amortization of acquisition-related intangibles during 2007 was related to intangible assets acquired from System General, which was partially offset by certain intangibles becoming fully amortized.
Standard Products. Standard Products revenues decreased approximately 8% in 2007 as compared to 2006. Our results for 2007 include 52 weeks compared to 53 weeks in 2006. In 2007, decreases in unit volumes driven by weaker demand contributed approximately 6% to the revenue decline, while decreases in average selling prices due to product mix and price contributed the remaining approximately 2%. Generally, we anticipate that Standard Products as a percentage of total revenue will continue to decrease, as we expect to experience faster growth in our Analog Products and Functional Power segments. While we anticipate revenue will continue to decline as a percentage of our total revenue, our strategy is to manage Standard Products more selectively, while maintaining or increasing our margins in this business. Gross margin decreased due to lower unit volumes, higher manufacturing costs as the result of lower factory utilization and increases in raw material costs.
Standard Products had operating income of $36.8 million in 2007, compared to $38.8 million in 2006. The decrease in operating income in 2007 was due to lower gross margin as described above, slightly offset by lower R&D and SG&A spending. R&D and SG&A expenses decreased due to lower spending and lower variable compensation accruals. The decrease in amortization of acquisition-related intangibles was due to certain intangibles becoming fully amortized.
Year Ended December 31, 2006 Compared to Year Ended December 25, 2005
Total Revenues. Total revenues for 2006 increased $226.0 million, or 16%, as compared to 2005. In 2006, increases in unit volumes contributed approximately 21% of the increase, offset by product mix and price related decreases in average selling prices of 5%. Throughout 2005, our strategy was to focus on reducing the levels of inventory in our distribution channel and as a result, we constrained sales to our distributors. In 2006, this allowed us to deliver higher, more stable earnings. The increase in revenue was seen across all segments. In addition, our 2006 fiscal year consisted of 53 weeks compared to 52 weeks for our 2005 fiscal year. This extra week had the effect of increasing sales by approximately 2%.
Geographic revenue information is based on the customer location within the indicated geographic region. The following table presents, as a percentage of sales, geographic sales for the Americas, Europe, China, Taiwan, Korea and Other Asia/Pacific (which for these geographic reporting purposes includes Japan and Singapore) for 2006 and 2005.
Gross Margin. Gross margin increased approximately 58% in 2006, as compared to 2005. Our strategy to reduce distributor inventory levels in 2005 allowed us to increase factory utilization and improve product mix in 2006. We also had $20.8 million of lower depreciation expense in 2006 as a result of a change in certain useful life estimates of machinery and equipment from five years to eight years in the third quarter of 2005. These gross margin improvements were partially offset by increases in variable compensation accruals of $23.3 million and $5.5 million of stock-based compensation expense. Included in 2005 gross margin was a charge of $0.8 million for accelerated depreciation on assets to be abandoned, recorded in cost of sales.
Stock-Based Compensation Expense. On December 26, 2005 (first day of fiscal 2006), we adopted SFAS 123(R) using the modified prospective application method. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values at the date of grant. Pro forma disclosure is no longer an alternative. Under the modified prospective application method, stock-based compensation cost recognized in 2006 includes: (a) compensation cost for all share-based awards granted prior to but not yet vested as of December 25, 2005, based on the grant-date fair value estimated in accordance with SFAS 123, Accounting for Stock-Based Compensation (SFAS 123), and (b) compensation cost for all share-based awards granted subsequent to December 25, 2005, based on the grant-date fair value estimated in accordance with SFAS 123(R). In accordance with the modified prospective method of adoption, the company’s results of operations and financial position for prior periods have not been restated.
Compensation cost for stock options is calculated on the date of grant using the fair value of the options as determined by the Black-Scholes valuation model. The Black-Scholes valuation model requires us to make several assumptions, two of which are expected volatility and expected life. For expected volatility, we utilized historical volatility given that options in our stock are not actively traded and calculated the volatility based on the time period that is commensurate with the option’s expected life assumption. For expected life, we evaluated terms based on history and exercise patterns across our demographic population to determine a reasonable assumption. We estimated these assumptions considering the guidance in SFAS 123(R) and Staff Accounting Bulletin (SAB) 107.
In 2006, we recognized $26.7 million of stock-based compensation expense. As of December 31, 2006, $0.7 million of stock-based compensation expense was included in inventory. Included in total stock-based compensation costs (including capitalized costs) of $27.4 million in 2006, was $12.4 million relating to DSUs, RSUs and PUs that would have been recorded under Accounting Principles Board (APB) 25, Accounting for Stock Issued to Employees, even if SFAS 123(R) had not been adopted.
The adoption of SFAS 123(R) impacted diluted earnings per share for the year ended December 31, 2006 by $0.11. We expected stock-based compensation expense to be between $6.5 million and $7.5 million per quarter in 2007.
As of December 31, 2006, the total stock-based compensation cost related to unvested awards not yet recognized in the statement of operations was $17.2 million for options, $3.1 million for DSUs, $4.4 million for RSUs and $6.7 million for PUs. The related weighted average remaining recognition period (in years) was 1.4 for options, 1.0 for DSUs, 1.7 for RSUs and 2.0 for PUs.
Prior to the adoption of SFAS 123(R), we accounted for stock-based compensation awards using the intrinsic value method in accordance with APB 25. Under the intrinsic value method, no stock-based compensation expense was recognized when the exercise price of the company’s stock options equaled or exceeded the fair market value of the underlying stock at the date of grant. Instead, we disclosed in a footnote the effect on net income (loss) and net income (loss) per share as if the company had applied the fair value based method of SFAS 123, to record the expense.
Prior to the adoption of SFAS 123(R), we recognized expense over the service period for each separately vesting option tranche for the pro forma footnote disclosures required by SFAS 123. The company switched to a straight-line attribution method on December 26, 2005 for all grants that include only service vesting conditions. Due to the performance criteria associated with our performance units, our performance units are expensed over the service period for each separately vesting tranche. The expense associated with the unvested portion of the pre-adoption PU grants will continue to be expensed over the service period for each separately vesting tranche.
In recent years we have shifted our equity compensation program to one that is more performance-based, and have moved from using primarily stock option awards to a combination of stock options, RSUs and PUs. By making this shift we are able to strengthen our “pay for performance” philosophy by linking equity and variable cash compensation to our performance goals, while at the same time reducing our future equity compensation expense.
On February 18, 2005, we announced the acceleration of certain unvested and “out-of-the-money” stock options previously awarded to employees and officers that had exercise prices per share of $19.50 or higher. Options to purchase approximately 6 million shares of our common stock became exercisable as a result of the vesting acceleration. Based on our closing stock price of $16.15 on February 18, 2005, none of these options had economic value on the date of acceleration. In connection with the modification of the terms of these options to accelerate their vesting, approximately $33.1 million, on a pre-tax basis, was included in the pro forma net income (loss) table for 2005, representing the remaining unamortized value of the impacted, unvested options just prior to the acceleration. Because the exercise price of all the modified options was greater than the market price of the company’s underlying common stock on the date of their modification, no compensation expense was recorded in the statement of operations in accordance with APB 25. The primary purpose for modifying the terms of these options to accelerate their vesting was to eliminate the need to recognize remaining unrecognized non-cash compensation expense as measured under SFAS 123(R) as the future expense associated with these options would have been disproportionately high compared to the economic value of the options as of the date of modification. As a result of the acceleration, non-cash stock option expense in accordance with SFAS 123(R) was reduced by approximately $12 million in 2006, $4 million in 2007 and will be reduced by $1 million in 2008 on a pre-tax basis.
See Item 8, Note 8 of this report for further information regarding our adoption of SFAS 123(R).
Operating Expenses. Research and development (R&D) expenses were 7% of revenues for 2006 as compared to 5% of revenues for 2005. The increase was in line with our strategy to increase our focus on R&D as we develop new higher value products. Additionally in 2006, R&D includes an increase in variable compensation accruals of approximately $11.1 million, $4.3 million of stock-based compensation expense and
approximately $3.0 million of higher salary and benefits expense related to R&D headcount increases. Selling, general and administrative (SG&A) expenses were 15% of revenues for 2006 as compared to 14% of revenues for 2005 due primarily to increased variable compensation accruals of $22.9 million, $4.9 million of increased costs relating to field application engineers and $16.9 million of stock-based compensation expense.
Acquisition amortization was roughly flat in 2006 as compared to 2005. During the second quarter of 2006, we completed our acquisition of the design team and certain assets of Orion Design Technologies (Orion). As part of this acquisition, we acquired $1.0 million in assembled workforce, which is being amortized over the estimated useful life of 5 years. The increase related to this acquisition was offset by a decrease due to certain intangibles becoming fully amortized during the second quarter of 2005 and the impairment loss recorded in the third quarter of 2005.
Gain on sale of product line, net. In 2006, we announced the sale of the light-emitting diode (LED) lamps and displays product line to Everlight International Corporation, a U.S. subsidiary of Everlight Electronics Company Ltd., of Taiwan, as the LED lamps and displays product line does not fit our strategic direction. As a result of the sale, we recorded a net gain of $6.0 million on the sale.
Restructuring and Impairments. During the fourth quarter of 2006, we recorded restructuring and impairment charges of $3.2 million. These charges include $1.0 million in employee separation costs and $2.2 million in asset impairment costs.
The 2006 Infrastructure Realignment Program was substantially complete as of the third quarter of 2007 and impacted approximately 33 non-manufacturing personnel. We achieved annualized cost savings associated with the employee separation of approximately $3.4 million beginning in the third quarter of 2007. In addition, we achieved annualized cost savings of $0.3 million related to the asset impairment charge.
We recorded restructuring and impairment charges of $16.9 million in 2005. These charges included $10.2 million in employee separation costs, $0.7 million in office closure costs, $7.1 million in asset impairment costs and $0.2 million in other charges associated with our 2005 Infrastructure Realignment Program. In addition, we released $1.3 million in reserves primarily associated with the Second Quarter 2003 and 2004 Infrastructure Realignment Programs.
The 2005 Infrastructure Realignment Program commenced during the first quarter of 2005 and was substantially complete by the fourth quarter of 2006. This program impacted approximately 180 manufacturing and non-manufacturing personnel. We achieved annual cost savings associated with employee separation of approximately $12.8 million beginning in the first quarter of 2006. In addition, we achieved annualized cost savings of $1.2 million associated with depreciation savings related to the second quarter 2005 asset impairment charge.
Charge for Potential Litigation Outcomes, net. In the fourth quarter of 2006, we recorded an $8.2 million reserve for potential losses as a result of an unfavorable judgment in our legal proceeding with Zhongxing Telecom Ltd. (ZTE). In the fourth quarter of 2005, we recorded $6.9 million as an additional reserve for potential settlement losses related to legal proceedings for phosphorus mold compound litigation and claims. The reserve was based on our analysis of the claims and our historical experience in defending and/or resolving these claims. (See Item 8, Note 14 of this report for additional information).
Other Expense, net.
The following table presents a summary of Other expense, net for 2006 and 2005, respectively.
Interest expense. Interest expense in 2006 increased $1.0 million, as compared to 2005, due to rising interest rates on our variable rate term loan. In addition, there was an extra week of interest expense in 2006, offset by lower debt balances.
Interest income. Interest income in 2006 increased $9.6 million, as compared to 2005, due to improved rates of return earned on cash and short-term marketable securities as well as higher average cash balances. In addition, there was an extra week of interest income in 2006.
Other (income) expense, net. In 2006, we recorded $0.2 million of net other expense. This includes a gain of $(0.6) million on the sale of a strategic investment, $0.5 million of fees associated with the refinancing of the senior credit facility, and $0.3 of expense relating to charitable donations and contributions. During 2005, we recorded $2.9 million of net other expense. This includes $(20.3) million of net lawsuit settlement gains, a net $(0.7) million recovery of strategic investment write-offs and $23.9 million for costs associated with the redemption of our 10 1/2% Notes.
Income Taxes. The effective tax rate for 2006 was 15.6%. The effective tax rate for 2006 included a net tax benefit of $3.5 million recorded in the first quarter as a result of finalization of certain tax filings and audit outcomes. It also included $4.3 million of combined tax benefits recorded in 2006 as a result of Fairchild Korea Semiconductor Ltd. adjusting certain tax assets and liabilities to reflect the gradual increase in the Korean tax holiday rate. Income taxes for 2006 were $15.4 million, on income before taxes of $98.8 million, as compared to $204.7 million, on loss before taxes of $36.5 million, for 2005. Included in the $204.7 million tax expense in 2005 was a non-cash charge of $207.1 million for a valuation allowance on our deferred tax assets. In 2006, the valuation allowance on our deferred tax assets was reduced by $18.5 million.
Changes in the location of taxable income and losses could result in significant changes in the underlying effective tax rate.
Reportable Segments.
Beginning in the first quarter of 2007, we transferred responsibility for our bipolar transistors product line from the Functional Power Group (FPG) to the Standard Products Group (SPG). We believe the opportunities and challenges facing this business are better suited to the management focus and capabilities of the SPG management team. The financial performance of FPG and SPG has been restated for 2006 to reflect this change.
The following table represents comparative disclosures of revenue and gross margin of our reportable segments.
(1) Operating loss in 2006 includes $26.7 million of stock-based compensation expense, $8.2 million for a reserve for potential litigation outcomes, net (see Item 8, Note 14 for further information), $3.2 million for restructuring and impairments, and a net gain of $6.0 million on the sale of a product line. Operating loss in 2005 includes $16.9 million for restructuring and impairments and $6.9 million for a reserve for potential litigation outcomes, net (See Item 8, Note 14 for further information).
Functional Power. Functional Power revenues increased approximately 23% in 2006 as compared to 2005. Our results for 2006 include 53 weeks compared to 52 weeks in 2005. During 2006, an increase in unit volumes grew revenues approximately 24%, offset by a price and product mix related decline in average selling prices of approximately 1%. Our low voltage MOSFET sales were particularly strong in 2006 with a 27% increase in sales over 2005. Gross margin increased due to higher factory utilization, improved product mix, better management of channel and internal inventory and lower depreciation expense, slightly offset by increased variable compensation accruals. Gross margin was also positively impacted as the result of a sales reserve adjustment between the product lines.
Functional Power had operating income of $124.9 million in 2006, as compared to $49.0 million in 2005. The increase in operating income was due to higher gross margin partially offset by higher R&D and SG&A expenses. R&D expenses increased due to higher variable compensation accruals and our continued focus on developing new products. SG&A expenses increased mainly due to increased variable compensation accruals and increased spending to support continued growth. Included in SG&A during 2005 was a charge of $2.6 million for accelerated depreciation on certain assets to be abandoned.
Analog Products. Analog Products revenues increased approximately 20% in 2006 as compared to 2005. Our results for 2006 include 53 weeks compared to 52 weeks in 2005. During 2006, unit volumes increased revenues approximately 25%, while product mix and price related decreases in average selling prices reduced revenue by approximately 5%. Both analog switches and video filters experienced strong growth with 55% and 26% increases, respectively. Gross margin increased due to higher factory utilization, improved mix of higher margin products, improved inventory management and lower depreciation expenses, slightly offset by increased variable compensation accruals. Gross margin was negatively impacted as the result of a sales reserve adjustment between the product lines.
Analog products had an operating loss of $13.1 million in 2006, as compared to $39.3 million in 2005. The improvement in operating loss was due to higher gross margin, partially offset by higher R&D and SG&A expenses. R&D expenses increased due to continued investment in product, process and package development and additional design teams to help accelerate the introduction of new products in order to drive high margin growth. Lastly, higher variable compensation accruals contributed to the R&D increase. SG&A expenses increased due to higher variable compensation accruals, increased legal expenses, and higher sales expense related to the expansion of field application engineering activities. Included in SG&A during 2005 was a charge of $1.2 million for accelerated depreciation on certain assets to be abandoned. Acquisition amortization decreased due to certain intangibles becoming fully amortized during the second quarter of 2005, offset slightly by an increase as a result of the Orion acquisition during the second quarter of 2006.
Standard Products. Standard Products revenues increased approximately 1% in 2006 as compared to 2005. Our results for 2006 include 53 weeks compared to 52 weeks in 2005. During 2006, increases in unit volumes grew revenues by 15%, while product mix and price related decreases in average selling prices reduced revenue 14%. During the first quarter of 2006, we sold our LED lamps and displays product line, which resulted in a decrease in revenue of $29.1 million in 2006 as compared to 2005. Generally, we anticipate that Standard Products as a percentage of total revenue will continue to decrease, as our strategic focus shifts to the Analog Products and Functional Power segments. While we anticipate revenues will continue to decline as a percentage of our total revenues, our strategy is to manage Standard Products more selectively, maximizing cash flow and operating income contribution. Gross margin, excluding the effect of the sale of the LED lamps and displays product line, which was approximately $3.6 million, increased due to product mix improvements, lower costs, lower depreciation expense and improved inventory management and factory utilization, offset slightly by increased variable compensation accruals. Gross margin was positively impacted by $1.4 million due to the recovery of costs relating to a subcontractor settlement and as the result of a sales reserve adjustment between the product lines.
Standard Products had operating income of $38.8 million in 2006, compared to $8.6 million in 2005. The increase in operating income was primarily due to higher gross margin, decreased R&D expenses due to the LED lamps and displays product line divestiture and the reduction of certain factory R&D efforts, offset somewhat by higher variable compensation accruals. SG&A expenses decreased due to the LED lamps and displays divestiture, offset by increased variable compensation accruals. Included in SG&A during 2005 was a charge of $1.7 million for accelerated depreciation on certain assets to be abandoned. Acquisition amortization decreased due to certain intangibles becoming fully amortized in the second quarter of 2005.
Liquidity and Capital Resources
Our senior credit facility consists of a $375.0 million term loan and $100.0 million line of credit (Revolving Credit Facility). In addition, the senior credit facility includes a $300.0 million uncommitted incremental term loan feature. The variable interest rate on the term loan and Revolving Credit Facility is at LIBOR (London Interbank Offered Rate) plus 1.50%. Both the term loan and Revolving Credit Facility have a step down feature based on senior leverage ratios. As a result of meeting the step down requirements, the interest rate on the Revolving Credit Facility has been reduced and is currently at LIBOR plus 1.25%.
We have a borrowing capacity of $100.0 million on a revolving basis for working capital and general corporate purposes, including acquisitions, under our senior credit facility. At December 30, 2007, $19.4 million was drawn on the revolver and after adjusting for outstanding letters of credit we had up to $78.5 million available under this senior credit facility. We had additional outstanding letters of credit of $1.1 million that do not fall under the senior credit facility. We also had $15.5 million of undrawn credit facilities at certain of our foreign subsidiaries. These amounts outstanding do not impact available borrowings under the senior credit facility.
On October 31, 2001, we issued $200 million aggregate principal amount of 5.0% Convertible Senior Subordinated Notes (Notes) due November 1, 2008. Interest on the Notes is paid semi-annually on May 1 and November 1 of each year. The Notes are guaranteed by the company and its domestic subsidiaries. The Notes are unsecured obligations and convertible, at the option of the holder, into common stock of the company at a conversion price of $30.00 per share, subject to certain adjustments. The Notes and the guarantees ranked pari passu in right of payment with our then existing senior subordinated Notes and the guarantees thereof, and with any future senior subordinated indebtedness. We are currently evaluating payoff alternatives for the maturity of the November 1, 2008 Notes, including the use of cash, the use of funds from the Revolving Credit Facility or the uncommitted incremental term loan feature and/or other market alternatives.
Our senior credit facility, which includes the $375.0 million term loan and the $100.0 million revolving line of credit, the indenture governing our 5% Convertible Senior Subordinated Notes (Notes), and other debt instruments we may enter into in the future, impose various restrictions and contain various covenants that could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities. The restrictive covenants include limitations on consolidations, mergers and
acquisitions, creating liens, paying dividends or making other similar restricted payments, asset sales, capital expenditures and incurring indebtedness, among other restrictions. The covenants in the senior credit facility also include financial measures such as a minimum interest coverage ratio, a maximum net leverage ratio and a minimum EBITDA (earnings before interest, taxes, depreciation and amortization) less capital expenditures measure. At December 30, 2007, we were in compliance with these covenants. The senior credit facility also limits our ability to modify our certificate of incorporation and bylaws, or enter into shareholder agreements, voting trusts or similar arrangements. Under our debt instruments, the subsidiaries of Fairchild Semiconductor Corporation cannot be restricted, except to a limited extent, from paying dividends or making advances to Fairchild Semiconductor Corporation. We believe that funds to be generated from operations, together with existing cash, will be sufficient to meet our interest and term loan debt obligations over the next twelve months. We expect that existing cash and available funds from our senior credit facility and funds generated from operations will be sufficient to meet our anticipated operating requirements and to fund our research and development and planned capital expenditures over the next twelve months. We had capital expenditures of $140.4 million in 2007.
While we currently have substantial amounts of cash to fund operations, we are currently evaluating the jurisdictional location of available cash in comparison to anticipated long-term liquidity needs in those jurisdictions. Based upon the completion of our analysis, it may become necessary for us to change our election with regards to our indefinitely reinvested earnings of certain foreign subsidiaries. As noted in our Management’s Discussion and Analysis, we have elected to begin repatriation back to the United States of previously undistributed earnings of certain foreign locations. The completion of this analysis and any tax implications are not expected to be material to our near term effective tax rate as there are full valuation allowances on net operating loss carryforwards in the United States.
We frequently evaluate opportunities to sell additional equity or debt securities, obtain credit facilities from lenders or restructure our long-term debt to further strengthen our financial position. The sale of additional equity or convertible securities could result in additional dilution to our stockholders. Additional borrowing or equity investment may be required to fund future acquisitions. We funded our acquisition of System General Corporation with cash (see Item 8, Note 17 for additional information).
As of December 30, 2007, our cash, cash equivalents and short-term and long-term marketable securities were $462.1 million, a decrease of $124.3 million from December 31, 2006. This decrease resulted primarily from our acquisition of System General in the first quarter of 2007. As of December 30, 2007, $51.3 million of auction rate securities are included in long-term marketable securities. In the third quarter of 2007, we experienced failures on the auction rate securities we held related to disruptions in the credit market, as there were more sellers than buyers of our auction rate securities. If an auction fails, our investments will not be liquid until the auction is successfully reset or is called by the issuer. However, we have the ability and intent to hold these investments until there is a full recovery of the fair value, which may be at maturity.
During 2007, our cash provided by operating activities was $190.6 million compared to $184.9 million in 2006. The following table presents a summary of net cash provided by operating activities during 2007 and 2006, respectively.
Cash provided by operating activities was slightly higher during 2007 as compared to 2006. The decrease in net income during 2007 was offset by increases in depreciation and amortization and other non-cash charges against income. Cash inflows due to declining inventory balances was offset by cash outflows related to payments on our variable compensation accruals.
Cash used in investing activities during 2007 totaled $312.8 million compared to cash provided by investing activities of $46.9 million in 2006. The increase in the use of cash is primarily the result of the net cash payment of $179.8 million for the acquisition of System General, lower turn-over in marketable securities due to lower invested balances and higher capital expenditures. Our capital expenditures as a percent of sales during 2007 was 8.4% compared to 6.8% in 2006.
Cash provided by financing activities during 2007 totaled $6.0 million compared to cash used in financing activities of $37.3 million in 2006. The increase was primarily due to 2007 including only scheduled debt payments of $2.8 million versus total debt payments of $54.1 million including voluntary debt payments of $50.0 million during 2006. Additionally, the increase was impacted by proceeds received from the purchase of stock by three executives of a subsidiary and their designees, offset by an increase in cash paid for the purchase of treasury stock.
The table below summarizes our significant contractual obligations as of December 30, 2007 and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
(1) In addition to the above, we have an obligation under Korean law to pay lump-sum payments to employees upon termination of their employment (see Item 8, Note 9 for further detail). This retirement liability was $19.6 million as of December 30, 2007.
(2) We also have obligations for variable interest payments in conjunction with the senior credit facility (see Item 8, Note 6 for additional information).
(3) Represents future minimum lease payments under noncancelable operating leases.
(4) Capital purchase obligations represent commitments for purchase of plant and equipment. They are not recorded as liabilities on our balance sheet as of December 30, 2007, as we have not yet received the related goods or taken title to the property.
(5) For the purposes of this table, contractual obligations for purchase of goods or services are defined as agreements that are enforceable and legally binding on the company and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are based on our current manufacturing needs and are fulfilled by our vendors within short time horizons.
(6) We had $13.8 million of unrecognized tax benefits at December 30, 2007, of which $0.8 million is classified as a current liability and is expected to be settled within the next year. The timing of the expected cash outflow relating to the remaining balance is not reliably determinable at this time.
(7) Total does not include contractual obligations recorded on the balance sheet as current liabilities other than debt obligations, or certain purchase obligations as discussed below.
It is customary practice in the semiconductor industry to enter into guaranteed purchase commitments or “take or pay” arrangements for purchases of certain equipment and raw materials. Obligations under these arrangements are included in (5) above.
We also enter into contracts for outsourced services; however, the obligations under these contracts were not significant at December 30, 2007 and the contracts generally contain clauses allowing for cancellation without significant penalty.
The expected timing of payment of the obligations discussed above is estimated based on current information. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.
Liquidity and Capital Resources of Fairchild International, Excluding Subsidiaries
Fairchild Semiconductor International, Inc. is a holding company, the principal asset of which is the stock of its sole subsidiary, Fairchild Semiconductor Corporation. Fairchild Semiconductor International, Inc. on a stand-alone basis had no cash flow from operations and has no cash requirements for the next twelve months.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The U.S. Securities and Exchange Commission has defined critical accounting policies as those that are both most important to the portrayal of our financial condition and results and which require our most difficult, complex or subjective judgments or estimates. Based on this definition, we believe our critical accounting policies include the policies of revenue recognition, sales reserves, inventory valuation, impairment of long-lived assets, income taxes and loss contingencies. For all financial statement periods presented, there have been no material modifications to the application of these critical accounting policies.
On an ongoing basis, we evaluate the judgments and estimates underlying all of our accounting policies, including those related to revenue recognition, sales reserves, inventory valuation, impairment of long-lived assets, income taxes and loss contingencies. We base our estimates on historical experience and on various other assumptions that are believed 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. Materially different results in the amount and timing of our actual results for any period could occur if our management made different judgments or utilized different estimates.
Revenue Recognition and Sales Reserves. No revenue is recognized unless there is persuasive evidence of an arrangement, the price to the buyer is fixed or determinable, delivery has occurred and collectibility of the sales price is reasonably assured. Revenue from the sale of semiconductor products is recognized when title and risk of loss transfers to the customer, which is generally when the product is received by the customer. In some cases, title and risk of loss do not pass to the customer when the product is received by them. In these cases, we recognize revenue at the time when title and risk of loss is transferred, assuming all other revenue recognition criteria have been satisfied. These cases include several inventory locations where we manage consigned inventory for our customers, some of which is at customer facilities. In such cases, revenue is not recognized when products are received at these locations; rather, revenue is recognized when customers take the inventory from the location for their use.
We also receive revenues from manufacturing wafers under contracts with other semiconductor suppliers, such as National Semiconductor and Samsung Electronics, who have sold us their wafer manufacturing facilities and require a continued source of wafer supply after the sales. Contract manufacturing revenue is recorded at the time title to the wafer and risk of loss passes to the customer, assuming all other revenue recognition criteria have been satisfied. Shipping costs billed to our customers are included within revenue. Associated costs are classified in cost of goods sold.
Approximately 66% of our revenue is generated through the use of distributors. Distributor payments are due under agreed terms and are not contingent upon resale or any other matter other than the passage of time. We have agreements with some distributors and customers for various programs, including prompt payment discounts, pricing protection, scrap allowances and stock rotation. Sales to these distributors and customers, as well as the existence of sales incentive programs, are in accordance with terms set forth in written agreements with these distributors and customers. In general, credits allowed under these programs are capped based upon individual distributor agreements. We record charges associated with these programs as a reduction of revenue based upon historical activity. We also have volume based incentives with certain distributors to encourage stronger resales of our products. Reserves are recorded as a reduction to revenue as they are earned by the distributor. Our policy is to use a three to six month rolling historical experience rate in order to estimate the necessary allowance to be recorded. In addition, the products sold by us are subject to a limited product quality warranty. We accrue for estimated incurred but unidentified quality issues based upon historical activity and known quality issues if a loss is probable and can be reasonably estimated. The standard limited warranty period is one year. Quality returns are accounted for as a reduction of revenue. Historically, we have not experienced material differences between our estimated sales reserves and actual results.
Inventory Valuation. In determining the net realizable value of our inventories, we review the valuations of inventory considered excessively old, and therefore subject to, obsolescence and inventory in excess of customer backlog and historical rate of demand. We also adjust the valuation of inventory when estimated actual cost is significantly different than standard cost and to value inventory at the lower of cost or market. Once established, write-downs of inventory are considered permanent adjustments to the cost basis of inventory.
Impairment of Long-Lived Assets. We assess the impairment of long-lived assets, including goodwill, on an ongoing basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
As required by SFAS 142, Goodwill and Other Intangible Assets, goodwill is subject to annual impairment tests, or more frequently, if indicators of potential impairment arise. Our impairment review process is based upon a discounted cash flow analysis, which uses our estimates of revenues, driven by market growth rates and estimated costs, as well as a market discount rate.
For all other long-lived assets, our impairment review process is based upon an estimate of future undiscounted cash flows. Factors we consider that could trigger an impairment review include the following:
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significant underperformance relative to expected historical or projected future operating results,
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significant changes in the manner of our use of the acquired assets or the strategy for our overall business,
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significant negative industry or economic trends, and
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significant technological changes, which would render equipment and manufacturing processes obsolete.
Recoverability of assets that will continue to be used in our operations is measured by comparing the carrying value to the future net undiscounted cash flows expected to be generated by the asset or asset group. Future undiscounted cash flows include estimates of future revenues, driven by market growth rates, and estimated future costs.
Income Taxes. Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred taxes are not provided for the undistributed earnings of our foreign subsidiaries that are considered to be indefinitely reinvested outside of the U.S. in accordance with APB Opinion 23, Accounting for Income Taxes-Special Areas. We plan to repatriate certain non-U.S. earnings which have been taxed in the U.S. but earned offshore as well as any non-U.S. earnings in which APB Opinion 23 has not been elected.
We make judgments regarding the realizability of our deferred tax assets. In accordance with SFAS 109, Accounting for Income Taxes, the carrying value of the net deferred tax assets is based on the belief that it is more likely than not that we will generate sufficient future taxable income in certain jurisdictions to realize these deferred tax assets after consideration of all available positive and negative evidence. Future realization of the tax benefit of existing deductible temporary differences or carryforwards ultimately depends on the existence of sufficient taxable income of the appropriate character within the carryback and carryforward period available under the tax law. Future reversals of existing taxable temporary differences, projections of future taxable income excluding reversing temporary differences and carryforwards, taxable income in prior carryback years, and prudent and feasible tax planning strategies that would, if necessary, be implemented to preserve the deferred tax asset may be considered to identify possible sources of taxable income.
Valuation allowances have been established for U.S. deferred tax assets, which we believe do not meet the “more likely than not” criteria established by SFAS 109. In 2005, we established a full valuation allowance against our net U.S. deferred tax assets excluding certain deferred tax liabilities related to indefinite-lived goodwill. We recorded a valuation allowance in 2005 and continue to carry the valuation allowance in 2007 as our trend of positive evidence does not currently support such a release. Our jurisdictional financial history and current forecast provides enough uncertainty that it is management’s belief that we do not meet the standard of “more likely than not” that is required for measuring the likelihood of realization of net deferred tax assets under SFAS 109. We will continue to evaluate book and taxable income trends, and their impact on the amount and timing of valuation allowance adjustments.
If we are able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been established, the related portion of the valuation allowance will be released to income from continuing operations, additional paid-in capital or to other comprehensive income.
The calculation of our tax liabilities includes addressing uncertainties in the application of complex tax regulations in a multitude of jurisdictions. With the implementation effective January 1, 2007, Financial Accounting Standards Board (FASB) Interpretation (FIN) 48, Accounting for Uncertainty in Income Taxes, clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.
We recognize liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our recognition threshold and measurement attribute of whether it is more likely than not that the positions we have taken in tax filings will be sustained upon tax audit, and the extent to which, additional taxes would be due. If payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period in which it is determined the liabilities are no longer necessary. If the estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.
Loss Contingencies. The outcomes of legal proceedings and claims brought against us are subject to significant uncertainty. SFAS 5 requires that an estimated loss from a loss contingency such as a legal proceeding or claim should be accrued by a charge to income if it is probable that an asset has been impaired or a liability
has been incurred and the amount of the loss can be reasonably estimated. Disclosure of a contingency is required if there is at least a reasonable possibility that a loss has been incurred. In determining whether a loss should be accrued we evaluate, among other factors, the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. We regularly evaluate current information available to us to determine whether such accruals should be adjusted. Changes in our evaluation could materially impact our financial position or our results of operations.
Forward Looking Statements
This annual report includes “forward-looking statements” as that term is defined in Section 21E of the Securities Exchange Act of 1934. Forward-looking statements can be identified by the use of forward-looking terminology such as “we believe,” “we expect,” “we intend,” “may,” “will,” “should,” “seeks,” “approximately,” “plans,” “estimates,” “anticipates,” or “hopeful,” or the negative of those terms or other comparable terms, or by discussions of our strategy, plans or future performance. For example, the Outlook section below contains numerous forward-looking statements. All forward-looking statements in this report are made based on management’s current expectations and estimates, which involve risks and uncertainties, including those described below and more specifically in the Risk Factors section. Among these factors are the following: changes in regional or global economic or political conditions (including as a result of terrorist attacks and responses to them); changes in demand for our products; changes in inventories at our customers and distributors; technological and product development risks; including the risks of failing to maintain the right to use some technologies or failing to adequately protect our own intellectual property against misappropriation or infringement; availability of manufacturing capacity; the risk of production delays; the inability to attract and retain key management and other employees; risks related to warranty and product liability claims; risks inherent in doing business internationally; changes in tax regulations or the migration of profits from low tax jurisdictions to higher tax jurisdictions; availability of raw materials; competitors’ actions; loss of key customers, including but not limited to distributors; order cancellations or reduced bookings; changes in manufacturing yields or output; and significant litigation. Factors that may affect our operating results are described in the Risk Factors section in the quarterly and annual reports we file with the Securities and Exchange Commission. Such risks and uncertainties could cause actual results to be materially different from those in the forward-looking statements. Readers are cautioned not to place undue reliance on the forward-looking statements.
Policy on Business Outlook Disclosure and Quiet Periods
It is our current policy to update our business outlook near the beginning of each quarter, within the press release that announces the previous quarter’s results. The business outlook below is consistent with the business outlook included in our January 24, 2008 press release announcing fourth quarter and full year results. The current business outlook is accessible at the Investor Relations section of our website at http://investor.fairchildsemi.com. Toward the end of each quarter, and until that quarter’s results are publicly announced, we observe a “quiet period,” when the business outlook is not updated to reflect management’s current expectations. The quiet period for the first quarter of 2008 will be from March 15, 2008 until April 17, 2008 when we plan to release our first quarter 2008 results. Except during quiet periods, the business outlook posted on our website reflects current guidance unless and until updated through a press release, SEC filing or other public announcement. During quiet periods, our business outlook, as posted on our website, announced in press releases and provided in quarterly, annual and special reports or other filings with the SEC, should be considered to be historical, speaking as of prior to the quiet period only and not subject to update by the company. During quiet periods, Fairchild Semiconductor representatives will not comment about the business outlook of the company’s financial results or expectations for the quarter in question.
Outlook
We expect our first quarter revenue to decrease approximately 2% to 6% and gross margin to be approximately 100 to 150 basis points lower than the fourth quarter of 2007 due to lower factory loadings and changes in variable compensation accruals. At the start of the first quarter of 2008, we had approximately 85% of
our sales guidance booked and scheduled to ship. Although we continue to exercise strict controls over spending, we expect R&D and SG&A expenses to increase to approximately $87-$90 million in the first quarter of 2008 due to the resumption of FICA and other payroll taxes as well as changes in variable compensation accruals. Net interest and other expenses are expected to be $5.0-$5.5 million for the first quarter of 2008.
Recently Issued Financial Accounting Standards
In September 2006, the FASB issued SFAS 157, Fair Value Measurements. This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value. This statement is effective for financial statements issued for fiscal years and interim periods within those fiscal years, beginning after November 15, 2007. The adoption of SFAS 157 will not have a material impact on our consolidated financial position and results of operations.
In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement 115. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is effective as of the beginning of the fiscal year that begins after November 15, 2007. We have yet to determine the impact, if any, of SFAS 159 on our consolidated financial position and results of operations.
In December 2007, the FASB issued SFAS 141(R), Business Combinations. This statement replaces SFAS 141, Business Combinations, but retains the fundamental requirements of the statement that the acquisition method of accounting be used for all business combinations and for an acquirer to be identified for each business combination. The statement seeks to improve financial reporting by establishing principles and requirements for how the acquirer: a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase option and c) determines what information to disclose. This statement is effective prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We have yet to determine the impact, if any, of SFAS 141(R) on our consolidated financial position and results of operations.
In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements-an Amendment of ARB 51. This statement amends Accounting Research Bulletin (ARB) 51, Consolidated Financial Statements, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The statement clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. This statement is effective for fiscal years and interim periods within those fiscal years, beginning on or after December 15, 2008. We have yet to determine the impact, if any, of SFAS 160 on our consolidated financial position and results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. To mitigate these risks, we utilize derivative financial instruments. We do not use derivative financial instruments for speculative or trading purposes. All of the potential changes noted below are based on sensitivity analyses performed on our financial position at December 30, 2007. Actual results may differ materially.
We use currency forward and combination option contracts to hedge a portion of our forecasted foreign exchange denominated revenues and expenses. Gains and losses on these foreign currency exposures would generally be offset by corresponding losses and gains on the related hedging instruments, resulting in negligible net exposure to us. A majority of our revenue, expense and capital purchasing activities are transacted in
U.S. dollars. However, we do conduct these activities by way of transactions denominated in other currencies, primarily the Korean won, Malaysian ringgit, Philippine peso, Chinese yuan, Japanese yen, Taiwanese dollar, British pound and the Euro. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, we have established hedging programs. We utilize currency option contracts and forward contracts in these hedging programs. Our hedging programs reduce, but do not always entirely eliminate, the short-term impact of foreign currency exchange rate movements. For example, during the twelve months ended December 30, 2007, an adverse change (defined as a 20% unfavorable move in every currency where we have exposure) in the exchange rates of all currencies over the course of the year would have resulted in an adverse impact on income before taxes of approximately $10.5 million.
We have no interest rate exposure due to rate changes for the 5% Convertible Senior Subordinated Notes. However, we do have interest rate exposure with respect to the senior credit facility due to the variable LIBOR pricing for both the term loan and the revolving credit facility. We have entered into an interest rate swap to reduce our variable interest rate exposure on $150 million of the outstanding term loan. For example, a 50 basis point increase in interest rates would result in increased annual interest expense of $0.5 million for the revolving credit facility, assuming all borrowing capability was utilized. A 50 basis point increase in interest rates would result in increased annual interest expense of $1.1 million for the remaining balance of the $375 million term loan, excluding $150 million fixed with an interest rate swap. The increased annual interest expense due to a 50 basis point increase in LIBOR rates would be offset by an increase in interest income of $2.3 million on the cash and investment balances at 2007 year-end. At December 30, 2007, $19.4 million was drawn on the revolver and after adjusting for outstanding letters of credit we had up to $78.5 million available under this senior credit facility.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Cash Flows
Consolidated Statements of Stockholders’ Equity
Notes to Consolidated Financial Statements
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Fairchild Semiconductor International, Inc.:
We have audited the accompanying consolidated balance sheets of Fairchild Semiconductor International, Inc. as of December 30, 2007 and December 31, 2006, and the related consolidated statements of operations, comprehensive income (loss), cash flows and stockholders’ equity for each of the years in the three-year period ended December 30, 2007. In connection with our audit of the consolidated financial statements, we also have audited the financial statement schedule listed in Item 15(b) of the 2007 Form 10-K. We also have audited Fairchild Semiconductor International, Inc.’s internal control over financial reporting as of December 30, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Fairchild Semiconductor International Inc.’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule, and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fairchild Semiconductor International, Inc. as of December 30, 2007 and December 31, 2006, and the results of its operations and its cash flows for each of the years in the three-year period ended December 30, 2007, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, Fairchild Semiconductor International, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 30, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
As discussed in Note 8 to the consolidated financial statements, Fairchild Semiconductor International, Inc. adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, effective December 26, 2005.
/s/ KPMG LLP
Boston, Massachusetts
February 28, 2008
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
See accompanying notes to consolidated financial statements.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
See accompanying notes to consolidated financial statements.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In millions)
See accompanying notes to consolidated financial statements.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
See accompanying notes to consolidated financial statements.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In millions)
See accompanying notes to consolidated financial statements.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-BACKGROUND AND BASIS OF PRESENTATION
Background
Fairchild Semiconductor International, Inc. (“Fairchild International” or the “company”) designs, develops and markets power analog, power discrete and certain non-power semiconductor solutions through its wholly-owned subsidiary Fairchild Semiconductor Corporation (“Fairchild”). The company is focused primarily on power analog and discrete products used directly in power applications such as voltage conversion, power regulation, power distribution, and power and battery management. The company’s products are building block components for virtually all electronic devices, from sophisticated computers and internet hardware to telecommunications equipment to household appliances. Because of their basic functionality, these products provide customers with greater design flexibility and improve the performance of more complex devices or systems. Given such characteristics, the company’s products have a wide range of applications and are sold to customers in the personal computer, industrial, communications, consumer electronics and automotive markets.
The company is headquartered in South Portland, Maine and has manufacturing operations in South Portland, Maine, West Jordan, Utah, Mountaintop, Pennsylvania, Cebu, the Philippines, Penang, Malaysia, Singapore, Bucheon, South Korea, and Suzhou, China. The company sells its products to customers worldwide.
The accompanying financial statements of the company have been prepared in conformity with accounting principles generally accepted in the United States of America. Certain amounts for prior periods have been reclassified to conform to current presentation.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
The company’s fiscal year ends on the last Sunday in December. The company’s results for the years ended December 30, 2007 and December 25, 2005 consists of 52 weeks, while results for the year ended December 31, 2006 consist of 53 weeks.
Principles of Consolidation
The consolidated financial statements include the accounts and operations of the company and its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated.
Revenue Recognition
Revenue is not recognized unless there is persuasive evidence of an arrangement, the price to the buyer is fixed or determinable, delivery has occurred and collectibility of the sales price is reasonably assured. Revenue from the sale of semiconductor products is recognized when title and risk of loss transfers to the customer, which is generally when the product is received by the customer. Shipping costs billed to customers are included within revenue. Associated costs are classified in cost of goods sold.
Approximately 66% of the company’s revenues are received from distributors. Distributor payments are due under agreed terms and are not contingent upon resale or any other matter other than the passage of time. The company has agreements with some distributors and customers for various programs, including prompt payment discounts, pricing protection, scrap allowances and stock rotation. Sales to these distributors and customers, as well as the existence of sales incentive programs, are in accordance with terms set forth in written agreements with these distributors and customers. In general, credits allowed under these programs are capped based upon
individual distributor agreements. The company records charges associated with these programs as a reduction of revenue based upon historical activity. The company’s policy is to use a three to six month rolling historical experience rate in order to estimate the necessary allowance to be recorded. In addition, under our standard terms and conditions of sale, the products sold by the company are subject to a limited product quality warranty. The standard limited warranty period is one year. The company may, and often does, receive warranty claims outside the scope of our standard terms and conditions. The company accrues for the estimated cost of incurred but unidentified quality issues based upon historical activity and known quality issues if a loss is probable and can be reasonably estimated. Quality returns are accounted for as a reduction of revenue.
In some cases, title and risk of loss do not pass to the customer when the product is received by them. In these cases, the company recognizes revenue at the time when title and risk of loss is transferred, assuming all other revenue recognition criteria have been satisfied. These cases include several inventory locations where we manage consigned inventory for our customers, some of which inventory is at customer facilities. In such cases, revenue is not recognized when products are received at these locations; rather, revenue is recognized when customers take the inventory from the location for their use.
Advertising
Advertising expenditures are charged to expense as incurred. Advertising expenses for the years ended December 30, 2007, December 31, 2006 and December 25, 2005 were not material to the consolidated financial statements.
Research and Development Costs
The company’s research and development expenditures are charged to expense as incurred.
Cash, Cash Equivalents and Marketable Securities
The company invests excess cash in marketable securities consisting primarily of commercial paper, corporate notes and bonds, U.S. Government securities, and auction rate securities.
The company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Highly liquid investments with maturities greater than three months are classified as short-term marketable securities. All other investments with maturities that exceed one year are classified as long-term marketable securities, except for auction rate securities which were classified as short-term marketable securities as of December 31, 2006. In the third quarter of 2007, the company experienced failures on the auction rate securities it held related to disruptions in the credit market, where there were more sellers than buyers of the auction rate securities. If an auction fails, the company’s investments will not be liquid until the auction is successfully reset or is called by the issuer. As a result, at December 30, 2007 auction rate securities have been reclassified as long term marketable securities. At December 30, 2007 and December 31, 2006, all of the company’s marketable securities are classified as available-for-sale. In accordance with Statement of Financial Accounting Standards (SFAS) 115, Accounting for Certain Investments in Debt and Equity Securities, available-for-sale securities are carried at fair value with unrealized gains and losses included as a component of other comprehensive income within stockholders’ equity, net of any related tax effect. Realized gains and losses and declines in value judged by management to be other than temporary on these investments are included in other income and expense. For the purpose of computing realized gains and losses, cost is identified on a specific identification basis.
Cash, cash equivalents and marketable securities as of December 30, 2007 and December 31, 2006 are as follows:
Inventories
Inventories are stated at the lower of actual cost on a first-in, first-out basis, or market.
Property, Plant and Equipment
Property, plant and equipment are recorded at cost and are generally depreciated based upon the following estimated useful lives: buildings and improvements, ten to thirty years, and machinery and equipment, three to ten years. Depreciation is principally provided under the straight-line method. Software is depreciated over estimated useful lives ranging from three to ten years. During the third quarter of 2005, the company completed an analysis of the useful life assumptions on certain factory machinery and equipment. As a result, the estimated useful life assumptions for certain machinery and equipment were adjusted effective for the third quarter to better align depreciation expense to the actual historical useful lives. As a result, the company had a reduction in depreciation expense of approximately $30.0 million in 2005, which was offset by approximately $18.3 million of cost of sales of inventory manufactured under previous depreciation costs. This resulted in a net favorable impact to net income (loss) of approximately $11.7 million during 2005, or approximately $0.10 per share.
Investments
The company has certain strategic investments that are typically accounted for on a cost basis as they are less than 20% owned, and the company does not exercise significant influence over the operating and financial policies of the investee. Under the cost method, investments are held at historical cost, less impairments. The company periodically assesses the need to record impairment losses on investments and records such losses when the impairment of an investment is determined to be other than temporary in nature. A variety of factors is considered when determining if a decline in fair value below book value is other than temporary, including, among others, the financial condition and prospects of the investee. In 2005, the company recorded a $1.1 million charge to other expense for the partial write-down of a strategic investment.
During the third quarter of 2005, one of the company’s strategic investments completed its initial public offering. This investment was classified as available-for sale and was carried at fair market value with unrealized gains and losses included as a component of other comprehensive income within stockholders’ equity, net of any related tax effect. The fair value based on the ending stock price as of December 25, 2005 was $5.4 million, which was included in other current assets on the balance sheet. The investment was sold in the third quarter of 2006 and as a result, the company recognized a $0.6 million gain on the sale.
The total cost basis for strategic investments, which are included in other assets on the balance sheet, as of December 30, 2007 and December 31, 2006 are $4.5 million, net of write-offs.
Other Assets
Other assets include deferred financing costs, which represent costs incurred related to the issuance of the company’s long-term debt. The costs are being amortized using the straight-line method, which approximates the effective interest method, over the related term of the borrowings, which ranges from five to ten years, and are included in interest expense. Also included in other assets are mold and tooling costs. Molds and tools are amortized over their expected useful lives, generally one to three years.
Goodwill and Intangible Assets
Goodwill is recorded when the consideration paid for acquisitions exceeds the fair value of net tangible and intangible assets acquired. Goodwill and other intangible assets with indefinite useful lives are not amortized, but rather are tested at least annually for impairment. Intangible assets with estimable lives are amortized over one to fifteen years.
Goodwill and intangible assets with indefinite lives are tested annually for impairment or more frequently if there is an indication that an impairment may have occurred. The company’s impairment review is based on a discounted cash flow approach at the reporting unit level that requires significant management judgment with respect to revenue and expense growth rates, changes in working capital and the selection and use of an appropriate discount rate. The company uses its judgment in assessing whether assets may have become impaired between annual impairment tests. Indicators such as unexpected adverse business conditions, economic factors, unanticipated technological change or competitive activities, loss of key personnel and acts by governments and courts, may signal that an asset has become impaired. See Item 8, Note 5 for the results of testing performed related to goodwill during 2007.
Intangible assets with estimable lives and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Recoverability of intangible assets with estimable lives and other long-lived assets is measured by a comparison of the carrying amount of an asset or asset group to future net undiscounted pretax cash flows expected to be generated by the asset or asset group. If these comparisons indicate that an asset or asset group is not recoverable, the impairment loss recognized is the amount by which the carrying amount of the asset or asset group exceeds the related estimated fair value. Estimated fair value is based on either discounted future pretax operating cash flows or appraised values, depending on the nature of the asset or asset group. The company determines the discount rate for this analysis based on the expected internal rate of return for the related business and does not allocate interest charges to the asset or asset group being measured. Considerable judgment is required to estimate discounted future operating cash flows.
Currencies
The company’s functional currency for all operations worldwide is the U.S. dollar. Accordingly, gains and losses from translation of foreign currency financial statements are included in current results. In addition, cash conversion of foreign currency and foreign currency transactions are included in current results. Realized foreign currency gains (losses) related to the translation and cash conversion of foreign currencies were $0.2 million, $(2.1) million, and $(3.6) million for the years ended December 30, 2007, December 31, 2006 and December 25, 2005, respectively.
Foreign Currency Hedging
The company utilizes various derivative financial instruments to manage market risks associated with the fluctuations in foreign currency exchange rates. It is the company’s policy to use derivative financial instruments to protect against market risk arising from the normal course of business. The criteria the company uses for
designating an instrument as a hedge is the instrument’s effectiveness in risk reduction. To receive hedge accounting treatment, hedges must be highly effective at offsetting the impact of the hedged transaction.
All derivatives, whether designated as hedging relationships or not, are recorded at fair value and are included in either other current assets or other current liabilities on the balance sheet. The company utilizes cash flow hedges to hedge certain foreign currency forecasted revenue and expense streams. For derivatives designated as cash flow hedges, the effective portions of changes in fair value of the derivative are recorded in other comprehensive income (OCI) and are recognized in the income statement when the hedged item affects earnings, and within the same income statement line as the impact of the hedged transaction. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings. Effectiveness is assessed at the hedge’s inception and on an ongoing quarterly basis. If the hedge fails to meet the requirements for using hedge accounting treatment or the hedged transaction is no longer likely to occur by the end of the originally specified time period or within an additional two-month period of time thereafter, the changes in fair value of the hedge would be included in earnings. The maturities of the cash flow hedges are twelve months or less. For derivative instruments that are not designated as hedged transactions, the initial fair value, if any, and any subsequent gains or losses on the change in the fair value are reported in earnings within the same income statement line as the impact of the hedged transactions.
Interest Rate Hedging
Effective December 29, 2006, the company entered into an interest rate swap agreement to hedge interest rate exposure for $150 million notional amount of its floating rate debt. The swap will effectively fix the interest rate for the $150 million portion of the term loan at 4.99% for three years. This hedge of interest rate risk was designated and documented at inception as a cash flow hedge and will be evaluated for effectiveness quarterly. Effectiveness of this hedge is calculated by comparing the fair value of the derivative to a hypothetical derivative that would be a perfect hedge of floating rate debt. On a quarterly basis, the fair value of the swap is determined based on quoted market prices and, assuming effectiveness, the differences between the fair value and the book value of the swap is recognized in OCI, a component of shareholders’ equity. Any ineffectiveness of the swap is required to be recognized in earnings as a component of interest expense.
Concentration of Credit Risk
Financial instruments that potentially subject the company to concentrations of credit risk consist principally of investments and trade accounts receivable. The company maintains cash, cash equivalents and marketable securities with high credit quality financial institutions based upon the company’s analysis of that financial institution’s relative credit standing. The company sells its products to distributors and original equipment manufacturers involved in a variety of industries including computing, consumer, communications, automotive and industrial. The company has adopted credit policies and standards to accommodate industry growth and inherent risk. The company performs continuing credit evaluations of its customers’ financial condition and requires collateral as deemed necessary. Reserves are provided for estimated amounts of accounts receivable that may not be collected.
The company also is exposed to credit-related losses in the event of non-performance by counterparties to hedging instruments. The counterparties to all derivative transactions are major financial institutions with investment grade credit ratings. However, this does not eliminate the company’s exposure to credit risk with these institutions. This credit risk is generally limited to the unrealized gains in such contracts should any of these counterparties fail to perform as contracted. The company considers the risk of counterparty default to be minimal.
Fair Value of Financial Instruments
The carrying values of cash and cash equivalents, accounts receivable and payable, and accrued liabilities approximate fair value due to the short-term maturities of these assets and liabilities. Fair values of long term debt, currency options, and interest rate swaps are based on quoted market prices at the date of measurement. The fair value of marketable securities are based on quoted market prices at the date of measurement, except for auction rate securities. The fair value of auction rate securities are based on market prices provided by our brokers who apply standard business valuation methodologies to calculate the present value of the securities on an individual basis (see Note 3 & 15.)
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Income Taxes
Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The realizability of deferred tax assets must also be assessed. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. A valuation allowance must be established for deferred tax assets which we do not believe will more likely than not be realized in the future. Deferred taxes are not provided for the undistributed earnings of the company’s foreign subsidiaries that are considered to be indefinitely reinvested outside of the U.S. in accordance with Accounting Principles Board (APB) Opinion 23, Accounting for Income Taxes-Special Areas. The company plans to repatriate certain non-U.S. earnings which have been taxed in the U.S. but earned offshore as well as any non-U.S. earnings in which APB Opinion 23 has not been elected.
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation (FIN) 48, Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This statement also provides guidance on derecognition, classification, interest and penalties, accounting in the interim periods, disclosure, and transition. The company adopted FIN 48 on January 1, 2007. Penalties and interest relating to uncertain tax positions are recognized as a component of income tax expense. To the extent penalties and interest are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
Stock-Based Compensation
On December 26, 2005 (first day of fiscal 2006), the company adopted SFAS 123 (revised 2004), Share-Based Payment, using the modified prospective application method. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values at the date of grant. The fair value of deferred stock units (DSUs), restricted stock units (RSUs) and performance units (PUs) is calculated based upon the fair market value of the company’s stock at the date of grant. The fair value of stock options and ESPP awards is estimated using the Black-Scholes valuation
model. This model requires the input of highly subjective assumptions, including the expected volatility of our stock price and the expected life of the award. The assumptions used to value stock-based compensation awards can significantly impact the amount of stock-based compensation expense recognized over the requisite service period, typically the vesting period.
The fair value of stock-based awards is amortized over the requisite service period, which is defined as the period during which an employee is required to provide service in exchange for an award. Prior to the adoption of SFAS 123(R), we used the expense recognition method in FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, to recognize expense. The company switched to a straight-line attribution method on December 26, 2005 for all grants that include only a service condition. Due to the performance criteria, PUs are expensed over the service period for each separately vesting tranche. The expense associated with the unvested portion of the pre-adoption grants will continue to be expensed over the service period for each separately vesting tranche.
Computation of Net Income (Loss) Per Share
Basic net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per share is computed using the weighted-average number of common shares outstanding during the period, plus the dilutive effect of potential future issuances of common stock relating to stock options and other potentially dilutive securities. Potentially dilutive common equivalent securities consist of stock options, shares represented by outstanding PUs, DSUs, RSUs and shares obtainable upon the conversion of the 5% Convertible Senior Subordinated Notes, due November 1, 2008. In calculating diluted earnings per share, the dilutive effect of stock options is computed using the average market price for the respective period. Potential shares related to certain of the company’s outstanding stock options were excluded because they were anti-dilutive, but could be dilutive in the future. The following table sets forth the computation of basic and diluted earnings per share.
In addition, the computation of diluted earnings per share did not include the assumed conversion of the 5% Convertible Senior Subordinated Notes because the effect would have been anti-dilutive. As a result, $11.0 million of interest expense was not added back to the numerator for 2007, 2006 and 2005. Potential common shares of 6.7 million were not included in the denominator for all periods presented.
NOTE 3-MARKETABLE SECURITIES
Marketable securities are categorized as available-for-sale and are summarized as follows as of December 30, 2007:
Marketable securities are categorized as available-for-sale and are summarized as follows as of December 31, 2006:
The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at December 30, 2007 are as follows:
As of December 30, 2007, $51.3 million of securities with contractual maturities due after ten years are auction rate securities. In the third quarter of 2007, the company experienced failures on the auction rate securities it held related to disruptions in the credit market, as there were more sellers than buyers of our auction rate securities. If an auction fails, our investments will not be liquid until the auction is successfully reset or is called by the issuer, and therefore a failure could impair our liquidity needs. As a result, at December 30, 2007 auction rate securities have been reclassified as long term marketable securities and in accordance with SFAS 115 unrealized losses of $2.5 million relating to these securities have been recorded in other comprehensive income.
Proceeds from sales of available-for-sale securities totaled $172.7 million in 2007, $249.3 million in 2006, and $899.5 million in 2005. The proceeds are primarily composed of sales of auction rate securities. In 2006 and 2005, realized losses of $0.3 million and $0.2 million, respectively, were recognized.
Unrealized losses on the company’s investments in marketable securities in 2007 were primarily caused by reset failures experienced on auction rate securities as discussed above. The company has the ability and intent to hold these investments until there is a full recovery of the fair value, which may be maturity. Due to the short length of time and the extent to which the current market conditions have existed the company currently believes that it will be able to collect all of the amounts due on the securities held by the company. As a result, the company does not consider these investments to be other than temporarily impaired at December 30, 2007.
All investments in an unrealized loss position at December 30, 2007 have been in an unrealized loss position for less than twelve months. There were no investments in an unrealized loss position in 2006.
NOTE 4-FINANCIAL STATEMENT DETAILS
NOTE 5-GOODWILL AND INTANGIBLE ASSETS
In order to complete the two-step goodwill impairment tests as required by SFAS 142, Goodwill and Other Intangible Assets, the company identifies its reporting units and determines 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 accordance with the provisions of SFAS 142, the company designates reporting units for purposes of assessing goodwill impairment. The standard defines a reporting unit as the lowest level of an entity that is a business and that can be distinguished, physically and operationally and for internal reporting purposes, from the other activities, operations, and assets of the entity. Goodwill is assigned to reporting units of the company that are expected to benefit from the synergies of the acquisition. Based on the provisions of the standard, the company has determined that it has three reporting units for purposes of goodwill impairment testing: Analog Products, Functional Power and Standard Products.
The company’s valuation methodology requires management to make judgments and assumptions based on historical experience and projections of future operating performance. If these assumptions differ materially from future results, the company may record impairment charges in the future. Additionally, the company’s policy is to perform its annual impairment testing for all reporting units in the fourth quarter of each fiscal year. The company performed its annual impairment test as of December 30, 2007 and concluded goodwill was not impaired.
The following table presents a summary of acquired intangible assets.
Amortization expense for intangible assets, excluding goodwill, was $23.5 million, $23.5 million and $23.9 million for 2007, 2006 and 2005, respectively.
During 2007, the change to the carrying amount of goodwill was due to the acquisition of System General Corporation (System General), the total of which was assigned to the Analog Products group (see Item 8, Note 17 for further information).
The company assesses the impairment of long-lived assets on an ongoing basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. During the third quarter of 2005, we determined that certain products acquired no longer fit the overall strategy of our business, which triggered an intangible asset impairment review. The recoverability of these assets was measured by comparing the carrying value to the future undiscounted cash flows. The test determined that the undiscounted cash flows were less than the carrying amounts, so an impairment loss was recorded to the extent that the carrying amount exceeded the fair value. As a result, we recognized a $1.6 million impairment of developed technology during the third quarter of 2005, which was recorded in restructuring and impairments in the accompanying consolidated statement of operations.
The following table presents the carrying amount of goodwill by reporting unit.
The estimated amortization expense for intangible assets for each of the five succeeding fiscal years is as follows:
NOTE 6-LONG-TERM DEBT
Long-term debt consists of the following at:
Senior Credit Facility
On June 22, 2006, the company used $50.0 million of cash to pay down the term loan on its senior credit facility from $444.4 million to $394.4 million. Subsequently, on June 26, 2006, the company refinanced the senior credit facility and replaced the $394.4 million term loan with a $375.0 million term loan due June 26, 2013. The $180.0 million revolving line of credit was replaced with a $100.0 million line of credit (Revolving Credit Facility) due June 26, 2012. In addition, the new senior credit facility includes a $300.0 million uncommitted incremental term loan feature. The refinancing reduced the variable interest rate on the term loan from LIBOR (London Interbank Offered Rate) plus 1.75% to LIBOR plus 1.50% and reduced the variable interest rate on the Revolving Credit Facility from LIBOR plus 2.25% to LIBOR plus 1.50%. Both the term loan and Revolving Credit Facility have step down features based on senior leverage ratios. The Revolving Credit Facility is currently at LIBOR plus 1.25%. The company incurred cash charges of $1.9 million in the second quarter of 2006 related to the refinancing, of which $1.4 million was deferred.
As of December 30, 2007, $19.4 million was drawn on the Revolving Credit Facility. Borrowings under the senior credit facility are secured by a pledge of common stock of the company and certain subsidiaries. At December 30, 2007, Fairchild had outstanding letters of credit under the Revolving Credit Facility totaling $2.1 million. These outstanding letters of credit reduce the amount available under the Revolving Credit Facility to $78.5 million. Fairchild pays a commitment fee of 0.375% per annum on the unutilized commitments under the Revolving Credit Facility.
In January 2005, the company increased its senior credit facility to $630 million, consisting of a term loan of $450 million replacing the previous $300 million term loan, and a $180 million revolving line of credit. In addition, the refinancing reduced the interest rate by 0.50% to a new rate approximating LIBOR plus 1.75%, which was approximately 5.6% as of December 25, 2005. The company used the proceeds of the $150 million increase of the term loan together with approximately $216 million of existing cash, to complete the redemption of its 10 1/2% Senior Subordinated Notes due 2009, which included a call premium of 5.25%, on February 13, 2005. The refinancing reduced the company’s debt by approximately $200 million, net of the term loan increase, during the quarter ended March 27, 2005.
Convertible Senior Subordinated Notes
On October 31, 2001, Fairchild issued $200 million aggregate principal amount of 5.0% Convertible Senior Subordinated Notes (Notes) due November 1, 2008. Interest on the Notes is paid semi-annually on May 1 and November 1 of each year. The Notes are guaranteed by the company and Fairchild’s domestic subsidiaries. The Notes are unsecured obligations and convertible, at the option of the holder, into common stock of the company at a conversion price of $30.00 per share, subject to certain adjustments. The Notes and the guarantees ranked pari passu in right of payment with Fairchild’s then existing senior subordinated Notes and the guarantees thereof, and with any future senior subordinated indebtedness. The conversion option embedded in the Notes would be classified as equity, in accordance with Emerging Issues Task Force (EITF) 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, if it was a stand alone financial instrument. Therefore, the conversion option is not considered to be a derivative and does not need to be measured at fair value.
Senior Subordinated Notes
On January 31, 2001, Fairchild issued $350.0 million of 10 1/2% Senior Subordinated Notes due February 1, 2009 (10 1/2% Notes) at face value. On January 13, 2005, the company gave notice to redeem the $350.0 million of the 10 1/2% Notes, therefore as of December 31, 2006 and December 25, 2005 there were no outstanding 10 1/2% Notes. The company incurred a cash charge of approximately $19.6 million in the first quarter of 2005 for the call premium and accrued and unpaid interest through the date of redemption. The company also incurred
a non-cash charge of approximately $5.4 million for the write-off of deferred financing fees associated with the redeemed 10 1 /2% Notes.
The payment of principal and interest on the senior credit facility and the Notes is fully and unconditionally guaranteed by Fairchild International. Fairchild International is the parent company of Fairchild and currently conducts no business and has no significant assets other than the capital stock of Fairchild. Fairchild has twenty direct subsidiaries and fifteen indirect subsidiaries, of which six subsidiaries, Fairchild Semiconductor Corporation of California (“Fairchild California”), KOTA Microcircuits, Inc., QT Optoelectronics, Inc., QT Optoelectronics, Fairchild Energy, LLC and ROCTOV, LLC are guarantors on the senior credit facility and the Notes. The guarantees of the guarantor subsidiaries as well as that of Fairchild International are joint and several. The remaining direct and indirect subsidiaries are foreign-based and do not guarantee either the senior credit facility or the Notes.
The company’s senior credit facility and the indentures under which the Notes were issued contain various restrictions and covenants including limitations on consolidations, mergers and acquisitions, creating liens, paying dividends or making other similar restricted payments, asset sales, capital expenditures, incurring indebtedness and the ability of the company’s subsidiaries to pay dividends or make advances to the company. The covenants in the senior credit facility also include financial measures such as a minimum interest coverage ratio, a maximum net leverage ratio and a minimum EBITDA (earnings before interest, taxes, depreciation and amortization) less capital expenditures measure. At December 30, 2007, the company was in compliance with these covenants. The senior credit facility also limits the company’s ability to modify its certificate of incorporation and bylaws, or enter into shareholder agreements, voting trusts or similar arrangements.
Aggregate maturities of long-term debt for each of the next five years and thereafter are as follows:
* Includes the $200.0 million Convertible Senior Subordinated Notes.
At December 30, 2007, the company also has approximately $15.5 million of undrawn credit facilities at certain of its foreign subsidiaries.
NOTE 7-INCOME TAXES
Total income tax provision was allocated as follows:
Income tax provision attributable to income (loss) before income taxes for the years ended December 30, 2007, December 31, 2006 and December 25, 2005 consisted of the following:
The reconciliation between the income tax rate computed by applying the U.S. federal statutory rate and the reported worldwide effective tax rate on net income (loss) before income taxes is as follows:
In conjunction with the acquisition of the power device business in 1999, the Korean government granted a ten-year tax holiday to Fairchild Korea Semiconductor Ltd. The original exemption was 100% for the first seven years of the holiday and 50% for the remaining three years of the holiday. In 2000, the tax holiday was extended such that the exemption amounts were increased to 78% in the eighth year and a 28% exemption was added to the eleventh year. The first year of the tax holiday in which Fairchild Korea Semiconductor Ltd. started providing for taxes was 2006. The following schedules the tax rates for the remaining years of the Korean tax holiday: 2007-13.75%, 2008-13.75%, and 2009-19.91%. Taxes exempted include income taxes, dividend withholding taxes, acquisition tax, registration tax, property tax and aggregate land tax.
As one of the incentives for locating in the Suzhou Industrial Park, the Chinese government granted a ten year preferential income tax holiday to Fairchild Semiconductor (Suzhou) Co., Ltd. The holiday provides 100% exemption for the first five years of the holiday and 7.5% reduced rate from years six to ten commencing in the first year in which Fairchild Semiconductor (Suzhou) Co. Ltd. is profitable. In 2005, no provision for income taxes for Fairchild Semiconductor (Suzhou) Co., Ltd. was provided. In 2006 and 2007, a current provision for income taxes was provided for at the 7.5% rate. Although the unified enterprise income tax law passed in March 2007, changing the Chinese statutory rate to 25% effective 2008, the new law grandfathered enterprises currently enjoying tax incentives for a maximum period of five years. Fairchild Semiconductor (Suzhou) Co., Ltd., will continue to enjoy its tax incentives with a gradual transitioning over the next five years to the enacted statutory rate of 25%.
The tax holidays increased net income by $5.4 million, or $0.04 per basic and diluted common share for the year ended December 30, 2007, increased net income by $6.6 million, or $0.05 per basic and diluted common share for the year ended December 31, 2006 and decreased net loss by $9.5 million, or $0.08 per basic and diluted common share for the year ended December 25, 2005.
The tax effects of temporary differences in the recognition of income and expense for tax and financial reporting purposes that give rise to significant portions of the deferred tax assets and the deferred tax liabilities at December 30, 2007 and December 31, 2006 are presented below:
Net deferred tax assets (liabilities) by jurisdiction are as follows:
Deferred tax assets and liabilities are classified in the consolidated balance sheet based on the classification of the related asset or liability. The deferred tax valuation allowance decreased $29.1 million during the year ending December 30, 2007. The deferred tax valuation allowance decreased for year ending December 31, 2006 by $18.5 million.
Gross carryforwards as of December 30, 2007 and December 31, 2006, respectively, for U.S. net operating losses totaled $140.9 million and $180.6 million, for foreign tax credits totaled $47.4 million and $44.8 million, and for research and development credits totaled $3.1 million and $3.1 million. The net operating losses expire in 2018 through 2026. The foreign tax credits expire in 2009 through 2017. The research and development credits expire in varying amounts in 2010 through 2027. The company has Malaysian unabsorbed capital allowances totaling approximately $13.1 million and $8.8 million as of December 30, 2007 and December 31, 2006, respectively, which can be used to offset future year’s taxable income of those Malaysian subsidiaries. In addition, the company has alternative minimum tax credit carryforwards of $0.8 million as of December 30, 2007, which are available to reduce future federal regular income taxes, if any, over an indefinite period.
The company’s ability to utilize its net operating loss and credit carryforwards may be limited in the future if the company experiences an ownership change, as defined by the Internal Revenue Code. An ownership change occurs when the ownership percentage of 5% or greater stockholders changes by more than 50% over a three year period. In August 1999, the company experienced an ownership change as a result of its initial public offering; such ownership change did not result in a material limitation on the utilization of the loss and credit carryforwards. As of December 30, 2007, the company has not undergone a second ownership change.
Significant management judgment is required in determining our provision for income taxes and in determining whether deferred tax assets will be realized. When it is more likely than not that all or some portion of specific deferred tax assets will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not likely to be realizable. Realization is based on our ability to generate sufficient future taxable income. A valuation allowance is determined in accordance with SFAS 109, Accounting for Income Taxes, which requires an assessment of both positive and negative evidence when determining whether it is more likely than not that deferred tax assets are recoverable. Such assessment is required on a jurisdiction-by-jurisdiction basis. In 2005, a full valuation allowance on net U.S. deferred tax assets was recorded. The company continues to maintain a full valuation allowance on its net U.S. deferred tax assets until sufficient positive evidence exists to support reversal of the valuation allowance. Until such time that some or all of the valuation allowance is reversed, future income tax expense (benefit) in the U.S., excluding any tax expense generated by our indefinite life intangibles, will be offset by adjustments to the valuation allowance to effectively eliminate any income tax expense or benefit in the United States. Income taxes will continue to be recorded for other tax jurisdictions subject to the need for valuation allowances in those jurisdictions.
As of December 30, 2007, the company’s valuation allowance for U.S. deferred tax assets totaled $166.5 million, which consists of the beginning of the year allowance of $195.6 million, a 2007 benefit of $31.7 million to income from continuing operations and a charge of $2.6 million to other comprehensive income. The valuation allowance reduces the carrying value of temporary differences generated by capital losses, capitalized research and development expenses, foreign tax credits, reserves and accruals, and net operating loss (NOL) carryforwards, which would require sufficient future capital gains and future ordinary income in order to realize the tax benefits. If the company is ultimately able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been established, then the related portion of the valuation allowance will be released to income from continuing operations, additional paid in capital or other comprehensive income.
Deferred income taxes have not been provided for the undistributed earnings of the company’s foreign subsidiaries that are reinvested indefinitely. Deferred income taxes have been provided for the undistributed earnings of the company’s foreign subsidiaries that are part of the repatriation plan, which aggregated to approximately $0.1 million at December 30, 2007. In addition, certain non-U.S. earnings, which have been taxed in the U.S. but earned offshore have and will continue to be part of the company’s repatriation plan. At December 30, 2007, the undistributed earnings of the company’s subsidiaries approximated $412.7 million, which if provided for, would result in deferred income taxes of $156.8 million.
In June 2006, the FASB issued FIN 48, Accounting for Uncertainty in Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This statement also provides guidance on derecognition, classification, interest and penalties, accounting in the interim periods, disclosure, and transition. The company adopted FIN 48 on January 1, 2007. With the implementation of FIN 48, the company recognized a cumulative effect adjustment increasing January 1, 2007 retained earnings by $1.9 million. The company also recognized a $1.8 million increase to deferred tax assets; however, due to a full valuation allowance against the company’s U.S. deferred taxes, there was no retained earnings impact. At the date of adoption, the company had $62.7 million of unrecognized tax benefits which increased to $67.3 million as of December 30, 2007. Of the total unrecognized tax benefits at the date of adoption and December 30, 2007, $10.5 million and $13.8 million, respectively, would impact the effective tax rate, if recognized. The remaining unrecognized tax benefits would not impact the effective tax rate, if recognized, as the company has a full valuation allowance against its U.S. deferred taxes.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in millions):
As of December 30, 2007, $0.8 million was recorded in other current liabilities in anticipation of a resolution of some of the company’s income tax recognition exposures within the next twelve months.
The company’s major tax jurisdictions as of the adoption of FIN 48 are the U.S. and Korea. For the U.S., the company has open tax years dating back to 1999 due to the carryforward of tax attributes. In Korea, the company has five open tax years dating back to 2002.
As of December 30, 2007, the company had accrued for penalties and interest relating to uncertain tax positions totaling $2.1 million, consisting of the beginning of the year total of $2.3 million and a decrease of $0.2 million during the year related to the lapse of statute, which was recognized as a component of income tax expense. To the extent penalties and interest are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.
NOTE 8-STOCK-BASED COMPENSATION
In December 2004, the FASB issued SFAS 123(R), which supersedes APB Opinion 25, Accounting for Stock Issued to Employees, and amends SFAS 95, Statement of Cash Flows. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values at the date of grant. Pro forma disclosure is no longer an alternative.
Previously, the company accounted for stock-based compensation awards using the intrinsic value method in accordance with APB 25. Under the intrinsic value method, no stock-based compensation expense was recognized when the exercise price of the company’s stock options equaled or exceeded the fair market value of the underlying stock at the date of grant. Instead, the company disclosed in a footnote the effect on net income (loss) and net income (loss) per share as if the company had applied the fair value based method of SFAS 123, Accounting for Stock-Based Compensation, to record the expense. Under SFAS 123, this included expense for deferred stock units (DSUs), restricted stock units (RSUs) and performance units (PUs).
On December 26, 2005 (first day of fiscal 2006), the company adopted SFAS 123(R) using the modified prospective method. Under this transition method, stock-based compensation cost recognized during 2006 and 2007 includes: (a) compensation cost for all share-based awards granted prior to but not yet vested as of December 25, 2005, based on the grant-date fair value estimated in accordance with SFAS 123, and (b) compensation cost for all share-based awards granted subsequent to December 25, 2005, based on the grant-date fair value estimated in accordance with SFAS 123(R). In accordance with the modified prospective method of adoption, the company’s results of operations and financial position for 2005 and prior periods have not been restated.
The company currently grants equity awards under two equity compensation plans-the Fairchild Semiconductor 2007 Stock Plan and the 2000 Executive Stock Option Plan. The company also maintains the Fairchild Semiconductor Stock Plan and an employee stock purchase plan. The Fairchild Semiconductor 2007 Stock Plan replaced the Fairchild Semiconductor Stock Plan when the company’s stockholders approved the new plan on May 2, 2007. On that date the shares that remained available for grant under the Fairchild Semiconductor Stock Plan were assumed by the new plan and no further awards were granted under the Fairchild Semiconductor Stock Plan after that date. In addition, the company has occasionally granted equity awards outside its equity compensation plans when necessary.
Fairchild Semiconductor 2007 Stock Plan. Under this plan, officers, employees, non-employee directors, and certain consultants may be granted stock options, stock appreciation rights, restricted stock including RSUs, PUs, DSUs, and other stock-based awards. The plan has been approved by stockholders. The maximum number of shares of common stock that may be delivered under the plan is equal to 3,380,305 shares, plus shares available for issuance as of May 2, 2007, under the Fairchild Semiconductor Stock Plan or shares subject to outstanding awards under the Fairchild Semiconductor Stock Plan as of May 2, 2007, that cease for any reason to be subject to such awards. The maximum life of any option is ten years from the date of grant for incentive stock options and non-qualified stock options. Actual terms for outstanding non-qualified stock options are eight years, although options may be granted under the plan with up to ten year terms. Options granted under the plan are exercisable at the determination of the compensation committee, generally vesting ratably over four years. PUs are contingently granted depending on the achievement of certain predetermined performance goals. DSUs, RSUs and PUs entitle participants to receive one share of common stock for each DSU, RSU or PU awarded. For
RSUs and PUs, the settlement date is the vesting date. For DSUs, the settlement date is selected by the participant at the time of the grant. Grants of PUs generally vest under the plan over a period of three years, and DSUs and RSUs generally vest over a period of three or four years.
Fairchild Semiconductor Stock Plan. The Fairchild Semiconductor Stock Plan authorizes shares of common stock to be issued upon the exercise of equity awards granted under the plan. The plan has been approved by stockholders. The plan was frozen when the Fairchild Semiconductor 2007 Stock Plan was approved on May 2, 2007, and awards are no longer granted under this plan. Under this plan, executives, key employees, non-employee directors and certain consultants were granted non-qualified stock options and RSUs, PUs, and DSUs. Options generally vest over four years with maximum terms ranging from eight to ten years. DSUs, RSUs and PUs entitle participants to receive one share of common stock for each DSU, RSU or PU awarded. For RSUs and PUs, the settlement date is the vesting date. For DSUs, the settlement date is selected by the participant at the time of the grant. Grants of PUs generally vest under the plan over a period of three years, and DSUs and RSUs generally vest over a period of three or four years.
The 2000 Executive Stock Option Plan. The 2000 Executive Stock Option Plan authorizes up to 1,671,669 shares of common stock to be issued upon the exercise of options under the plan. The plan has been approved by stockholders. Individuals receiving options under the plan may not receive in any one year options to purchase more than 1,500,000 shares of common stock. Options generally vest over four years with a maximum term of ten years.
Employee Stock Purchase Plan (ESPP). The company has maintained the Fairchild Semiconductor International, Inc. Employee Stock Purchase Plan since April 1, 2000. The ESPP has been approved by stockholders. The ESPP authorizes the issuance of up to 4,000,000 shares of common stock in quarterly offerings to eligible employees at a price that is equal to 85 percent of the lower of the common stock’s market price at the beginning or the end of a quarterly calendar period. A participating employee may withdraw from a quarterly offering anytime before the purchase date at the end of the quarter, and obtain a refund of the amounts withheld through the employee’s payroll deductions.
Equity Awards Made Outside Stockholder-Approved Plans. The company has granted equity awards representing a total of 820,000 shares outside its equity compensation plans. As of December 30, 2007, equity awards representing 329,300 shares remain outstanding, including 275,000 options, 12,500 DSUs, 15,000 RSUs and 26,800 PUs.
On February 18, 2005, the company announced the acceleration of certain unvested and “out-of-the-money” stock options previously awarded to employees and officers that had exercise prices per share of $19.50 or higher. Options to purchase approximately 6 million shares of the company’s common stock became exercisable as a result of the vesting acceleration. Based upon the company’s closing stock price of $16.15 on February 18, 2005, none of these options had economic value on the date of acceleration. In connection with the modification of the terms of these options to accelerate their vesting, approximately $33.1 million, on a pre-tax basis, was included in the pro forma net income (loss) table for 2005, representing the remaining unamortized value of the impacted, unvested options just prior to the acceleration. Because the exercise price of all the modified options was greater than the market price of the company’s underlying common stock on the date of their modification, no compensation expense was recorded in the statement of operations in accordance with APB 25. The primary purpose for modifying the terms of these options to accelerate their vesting was to eliminate the need to recognize remaining unrecognized non-cash compensation expense as measured under SFAS 123(R) as the future expense associated with these options would have been disproportionately high compared to the economic value of the options as of the date of modification. As a result of the acceleration, non-cash stock option expense in accordance with SFAS 123(R) was reduced by approximately $12 million in 2006, $4 million in 2007 and will be reduced by $1 million in 2008 on a pre-tax basis.
The following table presents a summary of the company’s stock options for the year ended December 30, 2007.
The weighted average grant-date fair value for options granted during the years ended December 30, 2007, December 31, 2006 and December 25, 2005 was $7.80, $8.33 and $7.19, respectively.
The following table presents a summary of the company’s DSUs for the year ended December 30, 2007.
The weighted average grant-date fair value for DSUs granted during the years ended December 31, 2006 and December 25, 2005 was $20.81 and $15.41, respectively. The total grant-date fair value for DSUs vested during the years ended December 30, 2007, December 31, 2006, and December 25, 2005 was $1.3 million, $7.0 million and $2.0 million, respectively. The number, weighted-average exercise price, aggregate intrinsic value and weighted average remaining contractual term for DSUs vested and outstanding is 113,761 units, zero (as these are zero strike price awards), $1.6 million and 1.8 years, respectively.
The company’s plan documents governing DSUs contain contingent cash settlement provisions upon a change of control. Accordingly, in conjunction with the adoption of SFAS 123(R) the company now presents previously recorded expense associated with unvested and unsettled DSUs under the balance sheet caption “Temporary equity-deferred stock units” as required by Securities and Exchange Commission (SEC) Accounting Series Release 268 and Emerging Issues Task Force (EITF) Topic D-98.
The following table presents a summary of the company’s RSUs for the year ended December 30, 2007.
The weighted average grant-date fair value for RSUs granted during the years ended December 31, 2006 and December 25, 2005 was $18.45 and $16.41, respectively. The total grant-date fair value for RSUs vested during the year ended December 30, 2007, December 31, 2006, and December 25, 2005 was $1.5 million, $0.1 million, and zero, respectively.
The following table presents a summary of the company’s PUs for the year ended December 30, 2007.
The weighted average grant-date fair value for PUs granted during the years ended December 31, 2006 and December 25, 2005 was $18.47 and zero, respectively. The total grant-date fair value for PUs vested during the year ended December 30, 2007, December 31, 2006, and December 25, 2005 was $5.0 million, zero and zero, respectively.
The following table summarizes the total intrinsic value for stock options exercised and DSUs, RSUs and PUs vested (i.e. the difference between the market price at exercise and the price paid by employees to exercise the award) for 2007, 2006 and 2005, respectively.
The company’s practice is to issue shares of common stock upon exercise or settlement of options, DSUs, RSUs and PUs from previously unissued shares and to issue shares in connection with the ESPP from treasury shares. The company expects to repurchase approximately 800,000 to 1,200,000 shares in 2008 to satisfy ESPP participation. For the year ended December 30, 2007, $20.0 million of cash was received from exercises of stock-based awards.
Valuation and Expense Information under SFAS 123(R)
The following table summarizes stock-based compensation expense under SFAS 123(R) by financial statement line, for the years ended December 30, 2007 and December 31, 2006.
The company also capitalized $(0.1) million and $0.7 million of stock-based compensation into inventory for the years ended December 30, 2007 and December 31, 2006, respectively. In addition, due to the valuation allowance for U.S. deferred income tax assets recorded by the company, no tax benefit on U.S. based stock compensation expense was recognized in the years ended December 30, 2007 and December 31, 2006. The income tax benefit from foreign tax jurisdictions was approximately $0.2 million and $0.3 million for the years ended December 30, 2007 and December 31, 2006, respectively.
Included in total stock-based compensation costs of $24.7 million for the year ended December 30, 2007, is $12.8 million of cost related to DSUs, RSUs and PUs that would have been included in expense under APB 25 even if the company had not adopted SFAS 123(R) in the first quarter of 2006.
Prior to SFAS 123(R), the company calculated stock-based compensation expense (primarily DSUs and RSUs) for retirement eligible equity award recipients over the stated vesting period. Upon adoption of SFAS 123(R), the company changed its policy and now follows the requisite service period guidance for all new awards, which requires that compensation cost attributable to equity awards be recognized over the requisite service period, which is defined as the period during which an employee is required to provide service in exchange for an award. The impact of this change in policy was $2.0 million and $1.3 million for years ended December 30, 2007 and December 31, 2006, respectively.
The following table summarizes total compensation cost related to nonvested awards not yet recognized and the weighted average period over which it is expected to be recognized at December 30, 2007.
The fair value of each option grant for the company’s plans is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions, utilizing the guidance provided in SFAS 123(R) as well as SEC Staff Accounting Bulletin (SAB) 107. The fair value of each DSU, RSU and PU is equal to the closing market price of the company’s common stock on the date of grant.
Expected volatility. The company utilizes an average of implied volatility and the most recent historical volatility commensurate with expected life. Effective for fiscal year 2007, the company modified its volatility assumption to include an implied volatility factor. The company determined during the annual review of its volatility assumption that it would be appropriate to include implied volatility, as described in SAB 107. The change in assumption was immaterial to stock-based compensation expense during 2007.
Dividend yield. The company does not pay a dividend, therefore this input is not applicable.
Risk-free interest rate. The company estimated the risk-free interest rate based on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected life assumption.
Expected life. The company has evaluated expected life based on history and exercise patterns across its demographic population. The company believes that this historical data is the best estimate of the expected life of a new option, and that generally all groups of our employees exhibit similar exercise behavior. Effective for fiscal year 2007, the company performed an annual review of the expected life assumption and determined that an expected life of 5.0 years is more indicative of actual exercise behavior than the previous 3.9 years. Accordingly, all grants for 2007 were assigned an expected life of 5.0 years. The change in assumption was immaterial to stock-based compensation expense during 2007.
Forfeiture rate. The amount of stock-based compensation recognized is based on the value of the portion of the awards that are ultimately expected to vest as SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term “forfeitures” is distinguished from “cancellations” or “expirations” and represents only the unvested portion of the surrendered option. The company has applied an annual forfeiture rate of 6.7%, 5.9%, 0.6% and 4.6% to all unvested options, RSUs, DSUs and PUs, respectively, during 2007. This analysis is re-evaluated at least annually and the forfeiture rate is adjusted as necessary.
As discussed above, prior to the adoption of SFAS 123(R), the company used the expense recognition method in FASB FIN 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans, to recognize expense. The company switched to a straight-line attribution method on December 26, 2005 for all grants that include only a service condition. Due to the performance criteria, the company’s performance units will be expensed over the service period for each separately vesting tranche. The expense associated with the unvested portion of the pre-adoption grants will continue to be expensed over the service period for each separately vesting tranche.
Prior to December 26, 2005, the company accounted for stock-based compensation under APB 25 and related Interpretations. The following table illustrates the effect on net loss and net loss per common share for 2005 as if the company had applied the fair value based method of SFAS 123 to record stock-based compensation expense.
The fair values of options granted during 2005 were estimated on the date of grant using the Black-Scholes option pricing model, with the following weighted average assumptions.
NOTE 9-RETIREMENT PLANS
The company sponsors the Fairchild Personal Savings and Retirement Plan (the “Retirement Plan”), a contributory savings plan which qualifies under section 401(k) of the Internal Revenue Code. The Retirement Plan covers substantially all employees in the United States. As of January 1, 2007, the company provided a discretionary matching contribution equal to 100% of employee elective deferrals on the first 3% of pay that is contributed to the Retirement Plan and 50% of the next 2% of pay contributed. (Prior to January 1, 2007 the company match was equal to 50% of employee elective deferrals up to a maximum of 6% of an employee’s annual compensation.) The company also maintains a non-qualified Benefit Restoration Plan, under which certain eligible employees who have otherwise exceeded annual IRS limitations for elective deferrals can continue to contribute to their retirement savings. The company matches employee elective deferrals to the Benefit Restoration Plan on the same basis as the Retirement Plan. Total expense recognized under these plans was $5.6 million, $4.3 million and $3.6 million, for 2007, 2006 and 2005, respectively.
Employees in Korea who have been with the company for over one year are entitled by Korean law to receive lump-sum payments upon termination of their employment. The payments are based on current rates of pay and length of service through the date of termination. It is the company’s policy to accrue for this estimated liability as of each balance sheet date. $13.2 million and $14.3 million were included within other liabilities and
$6.4 million and $7.2 million were included in current liabilities as of December 30, 2007 and December 31, 2006, respectively. Amounts recognized as expense were $10.1 million, $11.6 million and $8.8 million, for 2007, 2006 and 2005, respectively.
Employees in Malaysia participate in a defined contribution plan. The company has funded accruals for this plan in accordance with statutory regulations in Malaysia. Amounts recognized as expense for contributions made by the company under this plan were $1.8 million, $1.8 million and $1.5 million, for 2007, 2006 and 2005, respectively.
Employees in the United Kingdom, Italy, Germany, Hong Kong, China, the Philippines, Singapore, Japan and Taiwan are also covered by a variety of defined benefit or defined contribution pension plans that are administered consistent with local statutes and practices. The expense under each of the respective plans for 2007, 2006 and 2005 was not material to the consolidated financial statements.
In September 2006, the FASB issued SFAS 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans-An Amendment of FASB Statements No. 87, 88, 106, and 132(R). This statement requires an employer to recognize the over-funded or under-funded status of a defined postretirement plan as an asset or liability in its statement of financial position. The company currently has defined benefit pension plans in Germany, Japan, the Philippines, Hong Kong and Taiwan. The net funded status for our foreign defined benefit plans was $3.7 million and $2.2 million at December 30, 2007 and December 31, 2006, respectively, and was recognized in the consolidated statements of financial position. In accordance with adoption of SFAS 158, as of December 31, 2006 the net impact of recording the funded status through accumulated other comprehensive income was $1.1 million. The company measures plan assets and benefit obligations as of the date of the fiscal year-end.
Certain former executives of the company are eligible for post-retirement health benefits, which were accrued for ratably over the term of the related employment agreements entered into by the executives with the company in 2000. At December 30, 2007 and December 31, 2006, the accrual for post-retirement health benefits was $1.6 million.
NOTE 10-LEASE COMMITMENTS
Rental expense related to certain facilities and equipment of the company’s plants was $24.0 million, $22.6 million and $22.1 million, for 2007, 2006 and 2005, respectively.
Certain facility and land leases contain renewal provisions. Future minimum lease payments under noncancelable operating leases as of December 30, 2007 are as follows:
NOTE 11-STOCKHOLDERS’ EQUITY
Preferred Stock
Under the company’s restated certificate of incorporation, the company’s Board of Directors has the authority to issue up to 100,000 shares of $0.01 par value preferred stock, but only in connection with the adoption of a stockholder rights plan. At December 30, 2007 and December 31, 2006, no shares were issued.
Common Stock
The company has authorized 340,000,000 shares of Common Stock at a par value of $.01 per share. The holders of Common Stock are entitled to cumulative voting rights in the election of directors and to one vote per share on all other matters submitted to a vote of the stockholders.
Under a shelf registration statement filed with the Securities and Exchange Commission on December 18, 2000, the company may issue up to 10,000,000 shares of additional common stock. Shares of stock covered by this shelf registration statement may be issued from time to time by Fairchild International in connection with strategic acquisitions of other businesses, assets or securities, authorized by the company’s board of directors. The amounts, prices and other terms of share issuances would be determined at the time of particular transactions.
The company accounts for treasury stock acquisitions using the cost method. At December 30, 2007 and December 31, 2006, there were approximately 1,700,000 and 400,000 treasury shares held by the company, respectively.
NOTE 12-RESTRUCTURING AND IMPAIRMENTS
The company assesses the need to record restructuring and impairment charges in accordance with SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities, SFAS 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, SFAS 112, Employers’ Accounting for Postemployment Benefits-an amendment of FASB Statement 5 and 43, SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, EITF Issue 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination, and SAB 100, Restructuring and Impairment Charges.
2005 Infrastructure Realignment Program
During 2005, the company recorded restructuring and impairment charges totaling $16.9 million. The charges included $10.2 million in employee separation costs, $0.7 million in office closure costs, $7.1 million in asset impairment costs associated with software, equipment and an acquisition intangible, $0.2 million in other costs and $1.3 million in reserve releases due to revised estimates associated with the Second Quarter 2003 Restructuring Program, 2004 Infrastructure Realignment and 2005 Infrastructure Realignment Programs.
2006 Infrastructure Realignment Program
During 2006, the company recorded restructuring and impairment charges totaling $3.2 million. The charges included $1.0 million in employee separation costs and $2.2 million in asset impairment costs.
2007 Infrastructure Realignment Program
During 2007, the company recorded restructuring and impairment charges, net of releases, totaling $10.8 million. The charges included $6.8 million in employee separation costs, $0.2 million in contract cancellation costs, $3.1 million in asset impairment costs and $0.2 million in reserve releases, all associated with the 2007 Infrastructure Realignment Program. In addition, there were $0.9 million in employee separation costs recorded during 2007 associated with the 2006 Infrastructure Realignment Program.
The following tables summarize the previously mentioned restructuring and impairment charges for 2005 through 2007 (in millions).
The company expects to complete payment of substantially all 2007 restructuring accruals by the second quarter of 2008.
NOTE 13-RELATED PARTY TRANSACTIONS
On September 8, 2004, the company entered into a trust agreement with H.M. Payson & Co., as Trustee, to secure the funding of post-retirement health insurance benefits previously granted under the employment agreements executed in 2000 with three former executive officers who retired from the company in 2005. The company contributed $2.25 million to the trust upon its creation. Each former executive is entitled to health care benefits for himself and his eligible dependents until the later of his or his spouse’s death. The trust will be used to pay health insurance premiums and reimbursable related expenses to satisfy these obligations. Upon a change in control, the company or its successor is obligated to contribute additional funds to the trust, if and to the extent necessary to provide all remaining health care benefits required under the employment agreements. The trust will terminate when the company’s obligation to provide the health care benefits ends, at which time any remaining trust assets will be returned to the company.
NOTE 14-COMMITMENTS AND CONTINGENCIES
The company has future commitments to purchase chemicals for certain wafer fabrication facilities. In the event the company was to end the agreements, the company would be required to pay future minimum payments of approximately $10.2 million.
The company’s facilities in South Portland, Maine and West Jordan, Utah have ongoing environmental remediation projects to respond to certain releases of hazardous substances that occurred prior to the leveraged recapitalization of the company from National Semiconductor. Pursuant to the Asset Purchase Agreement with National Semiconductor, National Semiconductor has agreed to indemnify the company for the future costs of these projects. The terms of the indemnification are without time limit and without maximum amount. The costs incurred to respond to these conditions were not material to the consolidated financial statements for any period presented. The carrying value of the liability at December 30, 2007 was $0.2 million.
The company’s former Mountain View, California, facility is located on a contaminated site under the Comprehensive Environmental Response, Compensation and Liability Act. Under the terms of the Acquisition Agreement with Raytheon Company, Raytheon Company has assumed responsibility for all remediation costs or other liabilities related to historical contamination. The purchaser of the Mountain View, California property received an environmental indemnity from us similar in scope to the one we received from Raytheon. The purchaser and subsequent owners of the property can hold us liable under our indemnity for any claims, liabilities or damages it incurs as a result of the historical contamination, including any remediation costs or other liabilities related to the contamination. The company is unable to estimate the potential amounts of future payments; however, any future payments are not expected to have a material impact on the company’s earnings or financial condition.
Pursuant to the 1999 asset agreement to purchase the power device business of Samsung Electronics Co., Ltd., Samsung agreed to indemnify the company for remediation costs and other liabilities related to historical contamination, up to $150 million. The company is unable to estimate the potential amounts of future payments, if any; however, any future payments are not expected to have a material impact on the company’s earnings or financial condition.
The company’s facility in Mountaintop, Pennsylvania has an ongoing remediation project to respond to releases of hazardous materials that occurred prior to acquisition of the DPP business from Intersil Corporation. Under the Asset Purchase Agreement with Intersil, Intersil indemnified the company for specific environmental issues. The terms of the indemnification are without time limit and without maximum amount.
Phosphorus Mold Compound Litigation and Claims. From time to time since late 2001, the company has received claims from a number of customers seeking damages resulting from certain products manufactured with
a phosphorus-containing mold compound. Mold compound is the plastic resin used to encapsulate semiconductor chips. This particular mold compound causes some chips to short in some situations, resulting in chip failure. The company has been named in lawsuits relating to these mold compound claims. On August 6, 2007, the company settled a lawsuit brought against the company by Lucent Technologies Inc. in January 2005 in New Jersey state court claiming breach of warranty and fraud. The settlement payment occurred in the third quarter of 2007. On January 5, 2007, White Rock Networks sued the company and two distributors, Arrow Electronics and All American Semiconductor, in the U.S. District Court for the Eastern District of Texas, for violations of the Texas Deceptive Trade Practices Act relating to the mold compound issue, claiming unspecified damages. On May 17, 2007 White Rock amended its complaint to include fraud, negligence, and breach of contract claims and removed All American Semiconductor as a defendant. White Rock served the company on May 25, 2007. The company believes it has strong defenses against White Rock’s claims and intends to vigorously defend the lawsuit. Several other customers have made claims for damages or threatened to begin litigation as a result of the mold compound issue if their claims are not resolved according to their demands, and the company may face additional lawsuits as a result. The company has resolved similar claims with several of its leading customers. The company has exhausted insurance coverage for such customer claims.
Patent Litigation with Power Integrations, Inc. On October 20, 2004, the company and its wholly owned subsidiary, Fairchild Semiconductor Corporation, were sued by Power Integrations, Inc. in the United States District Court for the District of Delaware. Power Integrations alleges that certain of the company’s pulse width modulation (PWM) integrated circuit products infringe four Power Integrations U.S. patents, and seeks a permanent injunction preventing the company from manufacturing, selling or offering the products for sale in the United States, or from importing the products into the United States, as well as money damages for past infringement. The company has analyzed the Power Integrations patents in light of the company’s products and, based on that analysis, does not believe the company’s products violate Power Integrations’ patents. Accordingly, the company is vigorously contesting this lawsuit. The trial in the case has been divided into three phases. The first phase, held October 2-10, 2006, was on infringement, the willfulness of any infringement, and damages. On October 10, 2006, a jury returned a verdict finding that 33 of the company’s PWM products infringe one or more of seven claims of the four patents being asserted. The jury also found that the company’s infringement was willful, and assessed damages against the company of approximately $34 million. That verdict remains subject to the company’s appeal. The second phase of the trial, held September 17-21, 2007 before a different jury, was on the validity of the Power Integrations patents being asserted. On September 21, 2007 a jury returned a verdict in the second phase, finding that the four Power Integrations patents asserted in the lawsuit are valid. The third phase of the trial covers the enforceability of the patents. The third phase began on September 21, 2007 and is still pending before the court. Rulings from the enforceability phase of the litigation may overturn parts of the jury verdict on the second phase.
Power Integrations must prevail on all three phases of the trial to receive a judgment for damages and an injunction against the company. Power Integrations may seek an injunction to prevent the company from making, selling or offering to sell in the United States, or from importing into the United States, products that infringe patents that are found valid and enforceable. Power Integrations has announced its intention to seek such an injunction in such event.
The jury in the first phase of the trial assessed damages against the company of approximately $34 million. Because the jury also found that the company’s infringement was willful, the judge in the case will have discretion to increase the damages award by up to three times the amount of the final damages award. The final damages award would be determined after the third phase of the trial. Damages may be increased by the judge to account for certain sales by the company after October 20, 2006 and as a result of the willful infringement finding. It is also possible that the company could be required to pay Power Integrations’ attorney’s fees and pre-judgment interest.
The results of litigation are difficult to predict and no assurance can be given that the company will succeed in proving the patents unenforceable. As discussed above, the judge overseeing the case has discretion over the
amount of damages awarded, and over the granting and scope of any injunction against the company. Any damages award or injunction would be subject to appeal and the company expects to contest several aspects of the litigation and would carefully consider an appeal at the appropriate time. The company believes one aspect of the jury’s verdict finding that the company had willfully infringed the Power Integrations patents should be dismissed or put to a new trial because of an August 20, 2007 decision by the U.S. Court of Appeals for the Federal Circuit that significantly changed the law of willfulness as applied to patent infringement cases. The company also expects to request a reduction in the level of damages awarded in the first phase of the litigation because of errors that the company believes were made in the calculation of damages. The company also plans to contest the jury’s finding in the second (validity) phase of the case as well as other decisions made by the court during the course of the litigation, including the division of the trial into several phases, rulings construing the claims of the patents involved and limitations on the evidence the company was permitted to present. If the company chooses to appeal, the company would likely be required to post a bond or provide other security for some or the entire amount of the final damages award during the pendency of the appeal. Should the company ultimately lose the lawsuit, or if an injunction is issued while an appeal is pending, such result could have an adverse impact on the company’s ability to sell products found to be infringing, either directly or indirectly in the U.S.
In a separate action, the company filed a lawsuit on April 11, 2006, against Power Integrations in the United States District Court for the Eastern District of Texas, asserting that Power Integrations’ PWM products infringe U.S. Patent No. 5,264,719. The lawsuit was transferred to the United States District Court for the District of Delaware. Intersil Americas owns U.S. Patent No. 5,264,719, for High Voltage Lateral Semiconductor Devices, and is a co-plaintiff with the company in the lawsuit. The company has held license rights under the patent since acquiring Intersil’s power discrete business in 2001, and the company more recently secured exclusive rights to assert the patent against Power Integrations. The court dismissed the lawsuit on December 21, 2007 because of legal standing issues relating to the license arrangement between the company and Intersil Americas. The court left open the possibility for the standing issues to be addressed and the suit reinstituted. The underlying merits of Intersil and Fairchild’s patent infringement case against Power Integrations were not addressed in the court’s ruling. The company is exploring options to address the standing issues raised by the court.
The company’s wholly owned subsidiary, System General Corporation, is a defendant in a patent infringement lawsuit in the U.S. District Court for the Northern District of California. System General had appealed to the U.S. Court of Appeals for the Federal Circuit on the outcome of proceedings before the U.S. International Trade Commission (ITC) involving allegations of patent infringement. The ITC order banned some System General parts, and downstream products incorporating the System General parts, from being imported into the United States. Both the ITC proceeding and the lawsuit were initiated by Power Integrations. The district court action was stayed at least until the appeals court issues its decision on System General’s appeal of the ITC’s final determination. On November 20, 2007, the appeals court affirmed the ITC’s decision. Some System General products were specifically carved out of the ITC’s U.S. import ban, and System General has fully replaced the banned products with replacement products not covered by the ITC ban. There has been no activity in the district court action since the appeals court decision. Fairchild Corporation has petitioned the U.S. patent office for reexamination of the patents involved. As in all litigation, it is difficult to predict the result of the district court action and no assurance can be given as to the outcome of this lawsuit. Should the company ultimately lose the lawsuit, such result could have an adverse impact on the company’s ability to sell products found to be infringing, either directly or indirectly in the U.S.
ZTE Corporation v. Fairchild Semiconductor Corporation. On December 30, 2004, the company’s wholly owned subsidiary, Fairchild Semiconductor Corporation, was sued by Zhongxing Telecom Ltd. (ZTE), a communications equipment manufacturer, in the Intermediate People’s Court of Shenzhen, Guangdong Province, People’s Republic of China. ZTE alleged that certain of the company’s products were defective and caused personal injury and/or property loss to ZTE. ZTE claimed 65,733,478 Chinese yuan as damages. The company contested the lawsuit in a trial held on October 20, 2005. On December 29, 2006, the company was informed that
the court had ruled in favor of ZTE and had ordered Fairchild to pay RMB 65,733,478 (equivalent to approximately $8.6 million U.S. dollars based on exchange rates at December 30, 2007) to ZTE. The company appealed to the Higher People’s Court of Guangdong Province. On August 22, 2007, the company settled the lawsuit for approximately $4.0 million U.S. dollars.
Patent Litigation with Alpha & Omega Semiconductor, Inc. On May 17, 2007, Alpha & Omega Semiconductor, Inc. (AOS) filed suit against the company in the U.S. District Court for the Northern District of California alleging that the company is infringing two of its patents. AOS is seeking unspecified damages and an injunction against the company. The company in turn filed suit against AOS in the same court on May 18, 2007, alleging that AOS is infringing four of the company’s patents. The company is also seeking unspecified damages and an injunction. The cases were consolidated on July 31, 2007. On October 2, 2007, the parties were granted leave to amend their complaints to assert additional patents. The company asserted two additional patents against AOS, and AOS asserted one additional patent against the company. The lawsuit is currently in the discovery phase.
The company intends to take all possible steps to seek a court order to stop AOS from making, using, selling, offering for sale or importing any infringing products in the U.S. and to obtain monetary damages for any infringing activities. Although the company believes, based on the prior art it has identified and the company’s knowledge of its products, that the company has invalidity, non-infringement and other defenses to AOS’ patent claims, the results of litigation are difficult to predict and no assurance can be given that the company will succeed in proving the AOS patents invalid, not infringed or unenforceable. Should the company ultimately lose the lawsuit, such result could have an adverse impact on the company’s ability to sell products found to be infringing, either directly or indirectly in the U.S. Any damages award or injunction would be subject to appeal and the company would expect to carefully consider an appeal at the appropriate time. In such a case, if the company chose to appeal, the company would likely be required to post a bond or provide other security for some or the entire amount of the final damages award during the pendency of the appeal.
The company has analyzed the potential litigation outcomes from all the above mentioned claims in accordance with Statement of Financial Accounting Standards (SFAS) 5, Accounting for Contingencies. While the exact amount of these losses is not known, the company has recorded a charge for potential litigation outcomes in the Consolidated Statement of Operations, based upon the company’s assessments of the potential liability using an analysis of the claims and historical experience in defending and/or resolving these claims. As of December 30, 2007 the company’s balance for potential litigation outcomes was $11.0 million. If the company continues to receive additional claims, if more of these claims proceed to litigation or if the company chooses to settle claims in settlement of or to avoid litigation, then the company may incur liabilities in excess of the current reserves.
From time to time the company is involved in legal proceedings in the ordinary course of business. The company believes that there is no such ordinary-course litigation pending that could have, individually or in the aggregate, a material adverse effect on the company’s business, financial condition, results of operations or cash flows.
NOTE 15-FINANCIAL INSTRUMENTS
Fair Value and Notional Principal of Derivative Financial Instruments
The company uses derivative instruments to manage exposures to changes in foreign currency exchange rates and interest rates. In accordance with SFAS 133, Accounting for Certain Derivative Instruments and Certain Hedging Activities, the fair value of these hedges is recorded on the balance sheet.
Foreign Currency Derivatives. The company uses currency forward and combination option contracts to hedge a portion of its forecasted foreign exchange denominated revenues and expenses. The company monitors
its foreign currency exposures to maximize the overall effectiveness of its foreign currency hedge positions. Currencies hedged include the euro, Japanese yen, Philippine peso, Malaysian ringgit, Korean won and Chinese yuan. The company’s objectives for holding derivatives are to minimize the risks using the most effective methods to eliminate or reduce the impacts of these exposures.
Changes in the fair value of derivative instruments related to time value are included in the assessment of hedge effectiveness. Hedge ineffectiveness, determined in accordance with SFAS 133 and SFAS 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities-an amendment of FASB Statement 133, did not have a material impact on earnings for the years ended December 30, 2007, December 31, 2006 and December 25, 2005. Three cash flow hedges were discontinued for the year ended December 25, 2005. The $0.1 million favorable impact of terminating the hedges was recorded in the statement of operations in accordance with SFAS 133. No cash flow hedges were derecognized or discontinued in 2007 and 2006.
Derivative gains and losses included in other comprehensive income (OCI) are reclassified into earnings at the time the forecasted transaction is recognized. The company estimates that the entire $1.2 million of net unrealized derivative losses included in OCI will be reclassified into earnings within the next twelve months.
Interest Rate Derivatives. The company’s variable-rate debt exposes the company to variability in interest payments due to changes in interest rates. The company uses a forward interest rate swap to mitigate the interest rate risk on a portion of its variable-rate borrowings in order to manage fluctuations in cash flows resulting from changes in interest rates on variable-rate debt.
Effectiveness of this hedge is calculated by comparing the fair value of the derivative to a hypothetical derivative that would be a perfect hedge of floating rate debt. The value of the hedge at inception was zero and there was no ineffectiveness as of December 30, 2007 and December 31, 2006.
Derivative gains and losses included in OCI are reclassified into earnings at the time the forecasted transaction is recognized. There is currently $3.4 million of unrealized losses included in OCI. The amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the floating-rate debt obligations affect earnings.
The table below shows the fair value and notional principal of the company’s derivative financial instruments as of December 30, 2007 and December 31, 2006. The estimated fair value as of December 30, 2007 and December 31, 2006 is recorded in other liabilities and other assets, respectively, on the balance sheet. The notional principal amounts for these instruments provide one measure of the transaction volume outstanding as of year end and do not represent the amount of the company’s exposure to credit or market loss. The estimates of fair value are based on applicable and commonly used pricing models using prevailing financial market information as of December 30, 2007 and December 31, 2006. Although the following table reflects the notional principal and fair value of amounts of derivative financial instruments, it does not reflect the gains or losses associated with the exposures and transactions that these financial instruments are intended to hedge. The amounts ultimately realized upon settlement of these financial instruments, together with the gains and losses on the underlying exposures will depend on actual market conditions during the remaining life of the instruments.
Fair Value of Financial Instruments
A summary table of estimated fair values of other financial instruments is as follows:
NOTE 16-OPERATING SEGMENT AND GEOGRAPHIC INFORMATION
Fairchild designs, develops, manufactures and markets high performance multi-market semiconductors. Effective December 26, 2005 (first day of fiscal year 2006), the company changed the titles of its operating segments to align the segment presentation with the way management manages the business. This change had no material impact on the historical financial results of the segments presented in this report. As of December 30, 2007, the company was organized into three reportable segments: Functional Power, Analog Products, previously known as Power Discrete and Power Analog, respectively, and Standard Products. Functional Power includes high voltage, low voltage, automotive and radio frequency products. Analog Products includes system power, power conversion, signal conditioning, switches and interface products. Standard Products includes optoelectronics lighting, standard linear, logic, standard diode and transistors, bipolar and foundry products.
In addition to the operating segments mentioned above, the company also operates global operations, sales and marketing, information systems, finance and administration groups that are led by vice presidents who report to the Chief Executive Officer. The expenses of these groups are generally allocated to the operating segments based upon their percentage of total revenue and are included in the operating results reported below. The company does not allocate income taxes or interest expense to its operating segments as the operating segments are principally evaluated on operating profit before interest and taxes.
The company does not specifically identify and allocate all assets by operating segment. It is the company’s policy to fully allocate depreciation and amortization to its operating segments. Operating segments do not sell products to each other, and accordingly, there are no inter-segment revenues to be reported. The accounting policies for segment reporting are the same as for the company as a whole.
The following table presents selected statement of operations information on reportable segments for 2007, 2006 and 2005.
(1) Operating loss in 2007 includes $24.8 million of stock-based compensation expense, $10.8 million of restructuring and impairments expense, $9.5 million in charges for potential litigation outcomes, net (see Note 14), a net loss of $0.4 million on the sale of a product line and $0.3 million of other expense. Operating loss in 2006 includes $26.7 million of stock-based compensation expense, $8.2 million for a reserve for potential litigation outcomes, net (see Note 14), $3.2 million for restructuring and impairments, and a net gain of $6.0 million on the sale of a product line. Operating loss in 2005 includes $16.9 million for restructuring and impairments, and also includes $6.9 million in charges for potential litigation outcomes, net (see Note 14).
Depreciation and amortization by reportable operating segment were as follows:
Geographic revenue information is based on the customer location within the indicated geographic region. Revenue by geographic region was as follows:
Other Asia/Pacific includes Japan, Singapore, and Malaysia.
Geographic property, plant and equipment balances as of December 30, 2007 and December 31, 2006 are based on the physical locations within the indicated geographic areas and are as follows:
NOTE 17-ACQUISITIONS AND DIVESTURES
On January 2, 2007, the company launched a tender offer in Taiwan to acquire 100% of the outstanding shares of Taipei-based System General. System General is a leading supplier of analog power management semiconductors for AC/DC offline power conversion in computers, LCD monitors, printers, chargers, and consumer products. At the closing of the tender offer on February 5, 2007, 65,459,517 shares of System General stock were acquired, representing approximately 95.6% of System General’s outstanding shares. The company acquired the remaining System General shares effective August 3, 2007. The total amount paid in cash for the 100% interest, net of cash acquired, was approximately $179.8 million.
As of August 3, 2007, the operating results of System General are included in the accompanying consolidated financial statements based on 100% ownership of System General. From February 5, 2007 to August 3, 2007, the operating results of System General were included in the accompanying consolidated financial statements based on the 95.6% ownership interest. In connection with the acquisition, the company recorded a charge of $3.9 million for in-process research and development during 2007. The company also acquired goodwill of approximately $123.3 million with the remainder of the purchase price in excess of the fair value of net tangible assets allocated to various other intangible assets. The purchase price allocation as of December 30, 2007 is based on the company’s estimate of the fair value of identifiable intangible and net tangible assets acquired. The final purchase price allocation will be completed upon completion of this analysis.
No proforma results of operations are presented because System General does not constitute a significant subsidiary.
On September 5, 2007, the company announced the sale of selected assets of the Radio Frequency (RF) product line to ANADIGICS, Inc. for approximately $1.5 million, net of cash expended for transaction fees. As a result of the sale, the company recorded a net loss of $0.4 million during the third quarter of 2007.
On May 1, 2006, the company completed its acquisition of the design team and certain assets of Orion Design Technologies, an analog design center located in Lee, New Hampshire, for approximately $1.2 million in cash. The acquisition was made to augment the company’s Analog Power design resources. The transaction was accounted for as an asset purchase without assumption of existing liabilities. The purchase price was allocated to various tangible assets and assembled workforce, which is being amortized over the estimated useful life of 5 years.
On January 3, 2006, the company announced the sale of the light-emitting diode (LED) lamps and displays product line to Everlight International Corporation, a U.S. subsidiary of Everlight Electronics Company, Ltd., of Taiwan. The company decided to sell the LED lamps and displays product line as it does not fit the strategic direction of the company. The company retained the optocoupler and infrared product lines, as these products are closer to and complement the company’s core strategy. The company intends to grow these product lines through focused research and development.
As part of the sale agreement, the company assisted Everlight with transitioning the product line by directly supporting the sale of LED lamps and displays products to its customers for an appropriate period of time. As a result of the sale, the company recorded a net gain on the sale of $6.0 million during 2006 and net cash proceeds of $6.6 million. The divestiture is considered immaterial and, therefore, no pro forma results of operations have been presented.
NOTE 18-CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The company operates through its wholly owned subsidiary Fairchild Semiconductor Corporation and other indirect wholly owned subsidiaries. Fairchild Semiconductor International, Inc. and certain of Fairchild Semiconductor Corporation’s subsidiaries are guarantors under the company’s senior credit facility and Fairchild Semiconductor Corporation’s 5% Convertible Senior Subordinated Notes. These guarantees are joint and several. Accordingly, presented below are condensed consolidating balance sheets of Fairchild Semiconductor International, Inc. as of December 30, 2007 and December 31, 2006 and related condensed consolidating statements of operations and cash flows for 2007, 2006 and 2005.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING BALANCE SHEETS
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING BALANCE SHEETS
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
NOTE 19-UNAUDITED QUARTERLY FINANCIAL INFORMATION
The following is a summary of unaudited quarterly financial information for 2007 and 2006 (in millions, except per share amounts):
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of December 30, 2007, the end of the period covered by this report. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of December 30, 2007 at a reasonable assurance level.
Last year, we filed the CEO and CFO certifications required under Section 302 of the Sarbanes-Oxley Act as exhibits to our Form 10-K filed on March 1, 2007. Last year, we submitted a Section 303A.12(a) CEO certification to the New York Stock Exchange on May 21, 2007.
Management Report on Internal Control over Financial Reporting
Management, including the Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Fairchild Semiconductor’s management assessed the effectiveness of the company’s internal control over financial reporting as of December 30, 2007. In making this assessment, management used the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that assessment, management believes that, as of December 30, 2007, the company’s internal control over financial reporting was effective.
KPMG LLP, our independent registered public accounting firm, has audited the effectiveness of Fairchild’s internal control over financial reporting as of December 30, 2007, and has issued a report which is included herein.
Changes in Internal Control over Financial Reporting
There were no changes in the company’s internal controls over financial reporting during our quarter ended December 30, 2007 that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
Izak Bencuya resigned from the company on October 19, 2007. Mr. Bencuya was Executive Vice President and General Manager, Functional Power Group and one of the company’s named executive officers (as defined in Item 402(a)(3) of Regulation S-K). On October 24, 2007, the company entered into a consulting agreement with Mr. Bencuya whereby Mr. Bencuya agreed to provide consulting services to the company for nine months after his resignation date. In exchange for his consulting services the company agreed to pay Mr. Bencuya $125,000 in one lump sum within ten days of his resignation date. In addition, the company agreed to pay Mr. Bencuya an additional $75,000 one year after his resignation date if he has performed his consulting duties to the satisfaction of the company and has not engaged in employment with certain specified companies.
Thomas Beaver retired from the company on December 31, 2007. Mr. Beaver was Executive Vice President, Worldwide Sales and Marketing, and one of the company’s named executive officers (as defined in Item 402(a)(3) of Regulation S-K). On December 3, 2007, the company entered into a consulting agreement with Mr. Beaver whereby Mr. Beaver agreed to provide consulting services to the company for twelve months after his retirement date. Mr. Beaver also agreed to an extension of the non-competition provisions of the company’s Executive Severance Policy under which he is subject by an additional twelve months, such that he will be bound by the same non-competition provisions under that policy up to and including December 31, 2009. In exchange the company agreed to pay Mr. Beaver $100,000 in two equal lump sums, provided Mr. Beaver has performed his obligations under the agreement. The first payment of $50,000 will be paid on or before July 15, 2008, and the second payment of $50,000 will be due on or before December 15, 2008.
At the end of 2007, the company announced the reorganization of the company’s internal reporting and management structure and, accordingly the company’s segment reporting effective at the beginning of 2008. The new segments, Power Conversion, Industrial and Auto (PCIA) and Mobile, Computing, Consumer and Communications (MCCC) replace the FPG and APG segments, while the SPG segment remains unchanged. The reorganization was done in order to improve the company’s end-market intimacy and segment focus in order to accelerate growth within key end markets.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Code of Business Conduct and Ethics
We have adopted a Code of Business Conduct and Ethics for our senior officers which we believe satisfies the standards promulgated by the Securities and Exchange Commission and the New York Stock Exchange. Our code applies to all directors, officers and employees, including our chief executive officer, our chief financial officer and our principal accounting officer and controller. Our current Code of Business Conduct and Ethics was filed as an exhibit to our current report on Form 8-K on January 31, 2006. Our Code of Business Conduct and Ethics is posted on our website, and can be accessed by visiting our investor relations web site at http://investor.fairchildsemi.com and clicking on “Corporate Governance.”
The information regarding directors set forth under the caption “Proposal 1-Election of Directors” appearing in our definitive proxy statement for the Annual Meeting of Stockholders to be held on May 7, 2008, which will be filed with the Securities and Exchange Commission not later than 120 days after December 30, 2007 (the “2008 Proxy Statement”), is incorporated by reference.
The information regarding executive officers set forth under the caption “Executive Officers” in Item 1 of this Annual Report on Form 10-K is incorporated by reference.
The information set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the 2008 Proxy Statement is incorporated by reference.
The information regarding our Audit Committee, and its members, as set forth under the heading “Corporate Governance, Board Meetings and Committees” in the 2008 Proxy Statement is incorporated by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the captions “Compensation Discussion and Analysis,” “Executive Compensation” and “Director Compensation” in the 2008 Proxy Statement is incorporated by reference.
The information regarding our Compensation Committee, and its members, as set forth under the heading “Corporate Governance, Board Meetings and Committees” in the 2008 Proxy Statement is incorporated by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information set forth under the caption “Stock Ownership by 5% Stockholders, Directors and Certain Executive Officers” in the 2008 Proxy Statement is incorporated by reference.
The information regarding our equity compensation plans as set forth under the caption “Securities Authorized for Issuance Under Equity Compensation Programs” in Item 5 of this annual report on Form 10-K is incorporated by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information set forth under the captions “Transactions with Related Persons” and “Policies and Procedures for Approval of Related Party Transactions” in the 2008 Proxy Statement is incorporated by reference.
The information regarding director independence set forth under the caption “Corporate Governance, Board Meetings and Committees” in the 2008 Proxy Statement is incorporated by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT’S FEES AND SERVICES
The information set forth under the caption “Independent Registered Public Accounting Firm” included under the proposal entitled “Proposal 3--Ratify Appointment of KPMG LLP as Independent Registered Public Accounting Firm of the Company for 2008” in the 2008 Proxy Statement is incorporated by reference.
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1) Financial Statements. Financial Statements included in this annual report are listed under Item 8.
(2) Financial Statement Schedules. Financial Statement schedules included in this report are listed under Item 15(b).
(3) List of Exhibits. See the Exhibit Index beginning on page 111 of this annual report.
(b) Financial Statement Schedules.
Schedule II-Valuation and Qualifying Accounts
Schedule II-Valuation and Qualifying Accounts.
All other schedules are omitted because of the absence of the conditions under which they are required or because the information required by such omitted schedules are set forth in the financial statements or the notes thereto.
EXHIBIT INDEX
* Management contracts or compensation plans or arrangements in which directors or executive officers are eligible to participate.
SIGNATURES
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.
FAIRCHILD SEMICONDUCTOR INTERNATIONAL, INC.
/s/ MARK S. THOMPSON
Mark S. Thompson
President and Chief Executive Officer
Date: February 28, 2008
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.