Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


FORM 10-Q

 


(Mark one)

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended October 1, 2006

or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from              to              .

Commission file number 333-126019-09

 


MAGNACHIP SEMICONDUCTOR LLC

(Exact name of Registrant as specified in its charter)

 


 

Delaware   83-0406195

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

c/o MagnaChip Semiconductor S.A.

74, rue de Merl, B.P. 709, L-2017

Luxembourg, Grand Duchy of Luxembourg

  Not Applicable
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (352) 45-62-62

 


Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non accelerated filer. See the definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨            Accelerated filer  ¨            Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 ofthe Exchange

Act).    Yes  ¨    No  x

As of November 1, 2006, the registrant had 52,720,784.0470 of the registrant’s common units outstanding.

 



Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

TABLE OF CONTENTS

 

    

Page No.

PART I FINANCIAL INFORMATION   

3

        Item 1.   Financial Statements (Unaudited)   

3

  Condensed Consolidated Statements of Operations   

3

  Condensed Consolidated Balance Sheets   

4

  Condensed Consolidated Statements of Cash Flows   

5

  Notes to Condensed Consolidated Financial Statements   

6

        Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations   

24

        Item 3.   Quantitative and Qualitative Disclosures About Market Risk   

34

        Item 4.   Controls and Procedures   

35

PART II OTHER INFORMATION   

36

        Item 1A.   Risk Factors   

36

        Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds   

41

        Item 6.   Exhibits   

42

SIGNATURES   

43

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

MagnaChip Semiconductor LLC and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited; in thousands of US dollars, except unit data)

 

     Three months ended     Nine months ended  
     October 1,
2006
    October 2,
2005
    October 1,
2006
    October 2,
2005
 

Net sales

   $ 171,283     $ 243,089     $ 582,039     $ 692,502  

Cost of sales

     150,422       181,177       500,579       544,234  
                                

Gross profit

     20,861       61,912       81,460       148,268  
                                

Selling, general and administrative expenses

     22,812       28,166       66,368       89,163  

Research and development expenses

     32,016       27,043       95,868       80,630  

Restructuring and impairment charges

     264       —         93,948       8,720  
                                

Operating income (loss)

     (34,231 )     6,703       (174,724 )     (30,245 )
                                

Other income (expenses)

        

Interest expense, net

     (13,946 )     (14,944 )     (43,031 )     (42,836 )

Foreign currency gain (loss), net

     2,157       (5,473 )     40,914       (4,667 )
                                

Loss before income taxes

     (46,020 )     (13,714 )     (176,841 )     (77,748 )
                                

Income tax expenses (benefits)

     1,698       (472 )     6,831       256  
                                

Net loss

   $ (47,718 )   $ (13,242 )   $ (183,672 )   $ (78,004 )
                                

Dividends accrued on preferred units

     2,731       2,506       8,070       7,379  
                                

Net loss attributable to common units

   $ (50,449 )   $ (15,748 )   $ (191,742 )   $ (85,383 )
                                

Net loss per common unit

- Basic and diluted

   $ (0.96 )   $ (0.30 )   $ (3.62 )   $ (1.62 )
                                

Weighted average number of units

- Basic and diluted

     52,720,976       53,037,320       52,975,152       52,848,430  

The accompanying notes are an integral part of these financial statements

 

3


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited; in thousands of US dollars, except unit data)

 

     October 1,
2006
    December 31,
2005
 
Assets     
Current assets     

Cash and cash equivalents

   $ 107,489     $ 86,574  

Restricted cash

     —         2,837  

Accounts receivable, net

     82,187       112,053  

Inventories, net

     59,289       88,677  

Other receivables

     6,709       9,501  

Other current assets

     12,728       10,148  
                

Total current assets

     268,402       309,790  
                
Property, plant and equipment, net      355,431       485,077  
Intangible assets, net      145,784       191,389  
Other non-current assets      51,917       54,391  
                

Total assets

   $ 821,534     $ 1,040,647  
                
Liabilities and Unitholders’ Equity     
Current liabilities     

Accounts payable

   $ 59,151     $ 93,911  

Other accounts payable

     28,030       35,368  

Accrued expenses

     33,589       28,968  

Other current liabilities

     5,108       10,102  
                

Total current liabilities

     125,878       168,349  
                
Long-term borrowings      750,000       750,000  
Accrued severance benefits, net      61,778       55,124  
Other non-current liabilities      4,406       7,196  
                

Total liabilities

     942,062       980,669  
                
Commitments and contingencies     

Series A redeemable convertible preferred units; 60,000 units authorized, 50,091 units issued and 0 unit outstanding at October 1, 2006 and December 31, 2005

     —         —    

Series B redeemable convertible preferred units; 550,000 units authorized, 450,692 units issued and 93,997 units outstanding at October 1, 2006 and December 31, 2005

     114,532       106,462  
                

Total redeemable convertible preferred units

     114,532       106,462  
                
Unitholders’ equity     

Common units; 65,000,000 units authorized, 52,720,784 and 53,091,570 units issued and outstanding at October 1, 2006 and December 31, 2005, respectively

     52,721       53,092  

Additional paid-in capital

     2,378       2,169  

Accumulated deficit

     (321,834 )     (130,092 )

Accumulated other comprehensive income

     31,675       28,347  
                

Total unitholders’ equity

     (235,060 )     (46,484 )
                

Total liabilities, redeemable convertible preferred units and unitholders’ equity

   $ 821,534     $ 1,040,647  
                

The accompanying notes are an integral part of these financial statements

 

4


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited; in thousands of US dollars)

 

     Nine months ended  
     October 1, 2006     October 2, 2005  

Cash flows from operating activities

    

Net loss

   $ (183,672 )   $ (78,004 )

Adjustments to reconcile net loss to net cash provided by operating activities

    

Depreciation and amortization

     145,481       154,748  

Provision for severance benefits

     10,031       12,189  

Amortization of debt issuance costs

     2,760       2,561  

Loss (gain) on foreign currency translation, net

     (43,297 )     5,451  

Impairment of long-lived assets

     92,540       7,996  

Other

     1,443       (2,522 )

Changes in operating assets and liabilities

    

Accounts receivable

     36,804       (31,257 )

Inventories

     34,495       2,637  

Other receivables

     3,230       65,323  

Deferred tax assets

     1,405       (12,853 )

Accounts payable

     (39,955 )     12,233  

Other accounts payable

     (16,870 )     (76,377 )

Accrued expenses

     2,879       4,564  

Other current assets

     (1,255 )     2,684  

Other current liabilities

     (5,100 )     (438 )

Payment of severance benefits

     (7,116 )     (10,664 )

Other

     2,768       (1,065 )
                

Net cash provided by operating activities

     36,571       57,206  
                

Cash flows from investing activities

    

Purchase of plant, property and equipment

     (26,274 )     (39,839 )

Payments for intellectual property registration

     (1,746 )     (1,614 )

Acquisition of business, net of cash acquired of $4,620 thousand

     —         (11,831 )

Proceeds from disposal of plant, property and equipment

     2,748       537  

Proceeds from disposal of intangible assets

     2,801       —    

Decrease in restricted cash

     2,985       7,876  

Other

     (700 )     2,583  
                

Net cash used in investing activities

     (20,186 )     (42,288 )
                

Cash flows from financing activities

    

Repayment of short-term borrowings

     —         (12,400 )

Exercise of unit options

     88       —    

Repurchase of common units

     (420 )     —    

Proceeds from short-term borrowings

     —         10,578  

Other

     —         (80 )
                

Net cash used in financing activities

     (332 )     (1,902 )

Effect of exchange rates on cash and cash equivalents

     4,862       (385 )
                

Net increase in cash and cash equivalents

     20,915       12,631  
                

Cash and cash equivalents

    

Beginning of the period

     86,574       58,396  
                

End of the period

   $ 107,489     $ 71,027  
                

The accompanying notes are an integral part of these financial statements

 

5


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited; tabular dollars in thousands, except unit data)

1. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements of MagnaChip Semiconductor LLC and its subsidiaries (the “Company”) have been prepared in accordance with Accounting Principle Board (“APB”) Opinion No. 28, Interim Financial Reporting regarding interim financial information and, accordingly, do not include all of the information and note disclosures required by generally accepted accounting principles in the United States of America for complete financial statements. In the opinion of the Company’s management, the unaudited interim condensed consolidated financial statements include all normal recurring adjustments necessary to fairly present the information required to be set forth therein. All inter-company accounts and transactions have been eliminated. These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, which was filed with the SEC on March 31, 2006. The results of operations for the three-month and nine-month periods ended October 1, 2006 are not necessarily indicative of the results to be expected for a full year or for any other periods.

Recent accounting pronouncements

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statements of Financial Accounting Standards (“SFAS”) No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plan – an amendment of SFAS No.87, 88, 106 and 132(R). This Statement requires an employer to recognize the over funded or under funded status of a defined benefit post retirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position, and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS 158 is effective for fiscal years ending after December 15, 2008. The Company does not expect that the implementation of SFAS No. 158 will have a material impact on its financial position and results of operations.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. SFAS 157 requires companies to disclose the fair value of their financial instruments according to a fair value hierarchy, as defined and may be required to provide additional disclosures based on that hierarchy. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact that the adoption may have on its consolidated financial statements.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108 which provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The guidance is applicable for fiscal years ending after November 15, 2006. The Company does not expect that adoption of SAB 108 will have a material impact on its consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of SFAS No. 109. FIN 48 clarifies the accounting for uncertain income tax positions accounted for in accordance with SFAS No. 109. The Interpretation stipulates recognition and measurement criteria in addition to classification, interim period accounting and significantly expanded disclosure provisions for uncertain tax positions that are expected to be taken in a company’s tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect that adoption of this Interpretation will have a material impact on its consolidated financial statements.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140. This Statement addresses the accounting for recognized servicing assets and liabilities related to certain transfers of the servicer’s financial assets and for acquisitions or assumptions of obligations to service financial assets that do not relate to the financial assets of the servicer and its related parties. SFAS 156 requires that all recognized servicing assets and liabilities are initially measured at fair value, and subsequently measured at either fair value or by applying an amortization method for each class of recognized servicing assets and liabilities. SFAS 156 is effective in fiscal years beginning after September 15, 2006. The adoption of SFAS 156 is not expected to have a material impact on the Company’s consolidated financial statements.

 

6


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No. 133 and 140. This Statement amends SFAS No. 133 and SFAS No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting. Specifically, this Statement allows fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. This Statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The Company does not expect that adoption of this Statement will have a material impact on its consolidated financial statements.

2. Inventories

Inventories as of October 1, 2006 and December 31, 2005 consist of the following:

 

     October 1, 2006     December 31, 2005  
Finished goods    $ 20,471     $ 28,414  
Semi-finished goods and work-in-progress      43,904       60,095  
Raw materials      7,756       5,814  
Materials in-transit      1,306       1,966  
Less: Valuation allowance      (14,148 )     (7,612 )
                
Inventories, net    $ 59,289     $ 88,677  
                

3. Property, plant and equipment

Property, plant and equipment as of October 1, 2006 and December 31, 2005 comprise the following:

 

     October 1, 2006     December 31, 2005  
Buildings and related structures    $ 159,612     $ 149,236  
Machinery and equipment      358,319       472,388  
Vehicles and others      38,657       32,438  
                
     556,588       654,062  
Less: Accumulated depreciation      (213,564 )     (181,806 )
Land      12,270       11,492  
Construction in-progress      137       1,329  
                
Property, plant and equipment, net    $ 355,431     $ 485,077  
                

Assets held-for-sale

In connection with the sale of the Company’s application processor business, which was finalized in January 2006, the Company identified and segregated related tangible assets as “held-for-sale” and ceased depreciating for such assets. As of October 1, 2006, the remaining amount of held-for-sale assets was $4,193 thousand in total.

4. Intangible Assets

Intangible assets as of October 1, 2006 and December 31, 2005 are as follows:

 

     October 1, 2006     December 31, 2005  

Technology

   $ 20,929     $ 23,911  

Customer relationships

     167,681       193,958  

Goodwill

     15,095       15,095  

Intellectual property assets

     9,555       10,969  

Less: Accumulated amortization

     (67,476 )     (52,544 )
                

Intangible assets, net

   $ 145,784     $ 191,389  
                

 

7


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

5. Product Warranties

The Company records, in other current liabilities, warranty liabilities for the estimated costs that may be incurred under its basic limited warranty. This warranty covers defective products, and related liabilities are accrued when product revenues are recognized. Factors that affect the Company’s warranty liability include historical and anticipated rates of warranty claims and repair costs per claim to satisfy the Company’s warranty obligation. As these factors are impacted by actual experience and future expectations, the Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts when necessary.

Changes in accrued warranty liabilities are as follows:

 

     Three months ended     Nine months ended  
     October 1,
2006
    October 2,
2005
    October 1,
2006
    October 2,
2005
 
Beginning balance    $ 207     $ 2,925     $ 1,036     $ 1,448  
Addition to (reversal of) warranty reserve      12       (1,518 )     (563 )     1,500  
Payments made      (69 )     (187 )     (377 )     (1,705 )
Translation adjustments      2       17       56       (6 )
                                
Ending balance    $ 152     $ 1,237     $ 152     $ 1,237  
                                

6. Long-term Borrowings

On December 23, 2004, two of the Company’s subsidiaries, MagnaChip Semiconductor S.A. and MagnaChip Semiconductor Finance Company issued $500 million aggregate principal amount of Second Priority Senior Secured Notes consisting of $300 million aggregate principal amount of Floating Rate Second Priority Senior Secured Notes and $200 million aggregate principal amount of 6 7/8% Second Priority Senior Secured Notes. At the same time, such subsidiaries issued $250 million aggregate principal amount of 8% Senior Subordinated Notes.

Concurrently with the issuance of the Second Priority Senior Secured Notes, the Company entered into a new senior credit agreement with a syndicate of banks, financial institutions and other entities providing for a $100 million senior secured revolving credit facility. Interest is charged at current rates when drawn upon.

Details of long-term borrowings as of October 1, 2006 and December 31, 2005 are presented as below:

 

     Maturity    Annual interest rate (%)    Amount of
principal

Floating Rate Second Priority Senior Secured Notes

   2011    3 month LIBOR + 3.250    $ 300,000

 7/8% Second Priority Senior Secured Notes

   2011    6.875      200,000

8% Senior Subordinated Notes

   2014    8.000      250,000
            
         $ 750,000
            

The senior secured revolving credit facility and Second Priority Senior Secured Notes are collateralized by substantially all of the assets of the Company. The notes will be paid in full upon maturity.

Each indenture governing the notes contains covenants that limit the ability of the Company and its subsidiaries to (i) incur additional indebtedness, (ii) pay dividends or make other distributions on its capital stock or repurchase, repay or redeem its capital stock, (iii) make certain investments, (iv) incur liens, (v) enter into certain types of transactions with affiliates, (vi) create restrictions on the payment of dividends or other amounts to the Company by its subsidiaries, and (vii) sell all or substantially all of its assets or merge with or into other companies.

 

8


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Borrowings under the senior secured credit facility are subject to significant conditions, including compliance with financial ratios and other covenants and obligations.

As of October 1, 2006, the Company and all of its subsidiaries except for MagnaChip Semiconductor (Shanghai) Company Limited have jointly and severally guaranteed each series of the Second Priority Senior Secured Notes on a second priority senior secured basis. As of October 1, 2006, the Company and its subsidiaries except for MagnaChip Semiconductor Ltd. (Korea) and MagnaChip Semiconductor (Shanghai) Company Limited have jointly and severally guaranteed the Senior Subordinated Notes on an unsecured, senior subordinated basis. In addition, the Company and each of its current and future direct and indirect subsidiaries (subject to certain exceptions) will be guarantors of Second Priority Senior Secured Notes and Senior Subordinated Notes.

During the third quarter, the Company entered into the Fourth Amendment to Credit Agreement (as amended, the “Credit Agreement”), dated as of July 26, 2006 (the “Amendment”), with MagnaChip Semiconductor S.A. and MagnaChip Semiconductor Finance Company, as borrowers, the Subsidiary Guarantors party thereto, the Lenders party thereto (the “Lenders”), UBS AG, Stamford Branch, as administrative agent and collateral agent (the “Agent”), and U.S. Bank National Association (“US Bank”).

Under the Amendment, among other things, (i) the Company agreed to furnish to the Agent and the Lenders monthly financial statements along with an officer’s certificate with respect to the occurrence of any events of default under the Credit Agreement, (ii) certain restrictions were imposed on the Company’s ability to make acquisitions and capital expenditures, (iii) the financial covenants set forth in Section 6.10 of the Credit Agreement were revised, (iv) the schedule of applicable margins under the Credit Agreement was revised, (v) the Lenders, the Agent and US Bank waived certain defaults and obligations, and (vi) the Agent consented to the Company’s voting in favor of increasing the share capital of one of the Company’s subsidiaries.

Interest Rate Swap

Effective June 27, 2005, the Company entered into an interest rate swap agreement (the “Swap”) that converted the variable interest rate of three-month London Inter-bank Offering Rate (“LIBOR”) plus 3.25% to a fixed interest rate of 7.34% on the Company’s Floating Rate Second Priority Senior Secured Notes (the “Notes”). This Swap will be in effect until 15 June, 2008.

The Swap qualifies as an effective cash flow hedge under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The Company is utilizing the “hypothetical derivative method” to measure the effectiveness by comparing the changes in value of the actual derivative versus the change in fair value of the “hypothetical derivative.” Under this methodology, the actual swap was effective when compared to the hypothetical hedge.

For the nine-month period ended October 1, 2006, the Company recorded changes in the fair value of the Swap amounting to $87 thousand, under other comprehensive income in the accompanying condensed consolidated financial statements. In addition, during the same period, the Company recognized interest income of $1,973 thousand, which represents the differences between fixed and variable rates.

 

9


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

7. Accrued Severance Benefits

The majority of accrued severance benefits is for employees in the Company’s Korean subsidiary. Pursuant to the Labor Standards Act of Korea, most employees and executive officers with one or more years of service are entitled to severance benefits upon the termination of their employment based on their length of service and rate of pay. As of October 1, 2006, 97% of all employees of the Company were eligible for severance benefits.

Changes in the carrying value of accrued severance benefits are as follows:

 

     Three months ended     Nine months ended  
     October 1,
2006
    October 2,
2005
    October 1,
2006
    October 2,
2005
 
Beginning balance    $ 60,793     $ 53,870     $ 56,967     $ 52,925  
Provisions      4,675       4,063       10,031       12,189  
Transferred from acquired company      —         —         —         196  
Severance payments      (2,557 )     (3,201 )     (7,116 )     (10,664 )
Effect of foreign currency translation and other      669       (694 )     3,698       (608 )
                                
Ending balance      63,580       54,038       63,580       54,038  
                                

Less: Cumulative contributions to the National Pension Fund

     (866 )     (950 )     (866 )     (950 )

Group severance insurance plan

     (936 )     (922 )     (936 )     (922 )
                                
   $ 61,778     $ 52,166     $ 61,778     $ 52,166  
                                

The severance benefits are funded approximately 2.83% and 3.46% as of October 1, 2006 and October 2, 2005, respectively, through the Company’s National Pension Fund and group severance insurance plan which will be used exclusively for payment of severance benefits to eligible employees. These amounts have been deducted from the accrued severance benefit balance.

In addition, the Company expects to pay the following future benefits to its employees upon their normal retirement age:

 

     Severance benefit
2006 – 2008    $ —  
2009      70
2010      213
2011 – 2015      1,705

The above amounts were determined based on the employees’ current salary rates and the number of service years that will be accumulated upon their retirement dates. These amounts do not include amounts that might be paid to employees that will cease working with the Company before their normal retirement ages.

 

10


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

8. Redeemable Convertible Preferred Unit

The Company issued 49,727 units as Series A redeemable convertible preferred units (the “Series A”) and 447,420 units as Series B redeemable convertible preferred units (the “Series B”) on September 23, 2004 and additionally issued 364 units of Series A and 3,272 units of Series B on November 30, 2004, respectively. All of Series A were redeemed by cash on December 27, 2004 and parts of Series B were redeemed by cash on December 15, 2004 and December 27, 2004.

Changes in Series B for the three and nine months ended October 1, 2006 are as follows:

 

     Three months ended
     October 1, 2006    October 2, 2005
     Units    Amount    Units    Amount

Beginning of period

   93,997    $ 111,801    93,997    $ 101,407

Accrual of preferred dividends

   —        2,731    —        2,506
                       

End of period

   93,997    $ 114,532    93,997    $ 103,913
                       

 

     Nine months ended
     October 1, 2006    October 2, 2005
     Units    Amount    Units    Amount

Beginning of period

   93,997    $ 106,462    93,997    $ 96,534

Accrual of preferred dividends

   —        8,070    —        7,379
                       

End of period

   93,997    $ 114,532    93,997    $ 103,913
                       

The Series B were issued to the original purchasers of the Company in 2004. Holders of Series B receive dividends which are cumulative, whether or not earned or declared by the board of directors. The cumulative cash dividends accrue at the rate of 10% per unit per annum on the Series B original issue price, compounded semi-annually.

9. Earnings per Unit

The following table illustrates the computation of basic and diluted loss per common unit for the three and nine months ended October 1, 2006 and October 2, 2005:

 

     Three months ended     Nine months ended  
     October 1,
2006
    October 2,
2005
    October 1,
2006
    October 2,
2005
 

Net loss

   $ (47,718 )   $ (13,242 )   $ (183,672 )   $ (78,004 )

Dividends to preferred unitholders

     2,731       2,506       8,070       7,379  
                                

Net loss attributable to common units

   $ (50,449 )   $ (15,748 )   $ (191,742 )   $ (85,383 )
                                

Weighted-average common units outstanding

     52,720,976       53,037,320       52,975,152       52,848,430  
                                

Basic and diluted loss per unit

   $ (0.96 )   $ (0.30 )   $ (3.62 )   $ (1.62 )
                                

The following outstanding redeemable convertible preferred units issued, options granted and warrants issued were excluded from the computation of diluted loss per unit as they would have an anti-dilutive effect on the calculation:

 

     October 1,
2006
   October 2,
2005

Redeemable convertible preferred units

   93,997    93,997

Options

   4,909,152    3,536,080

Warrant (subsequently expired)

   5,079,254    5,079,254

 

11


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

In connection with the acquisition of the Company’s business from Hynix Semiconductor Inc. on October 6, 2004, by Citigroup Venture Capital Equity Partners, L.P., or CVC, Francisco Partners L.P., or Francisco Partners, CVC Asia Pacific Limited, or CVC Asia Pacific (the “Original Acquisition”), the Company issued a warrant to Hynix which enables Hynix to purchase 5,079,254 common units of the Company at an exercise price of $1.00 per unit. This warrant expired unexercised in accordance with its terms on October 6, 2006.

10. Equity Incentive Plans

The Company adopted two equity incentive plans effective October 6, 2004 and March 21, 2005, respectively, which are administered by the Compensation Committee designated by the board of directors. Employees, consultants and non-employee directors are eligible for the grant of options to purchase the Company’s common units or restricted common units subject to terms and conditions determined by the Committee. The term of options in no event exceed ten years from the date of grant. As of October 1, 2006, an aggregate maximum of 7,890,864 common units were authorized and reserved for all future and outstanding grants of options.

Unit options are generally granted with exercise prices of no less than the fair market value of the Company’s common units on the grant date. Generally, options vest and become exercisable in periodic installments, with 25% of the options vesting on the first anniversary of the grant date and 6.25% of options vesting on the last day of each calendar quarter thereafter. In most cases, the requisite service period, or the period during which a grantee is required to provide service in exchange for option grants, coincides with the vesting period.

Restricted units are issued upon the exercise of certain options to purchase restricted common units. Restricted units issued are subject to restrictions which generally lapse in installments over a four-year period.

The following summarizes unit option and restricted unit activities for the three and nine months ended October 1, 2006:

 

     Number of
restricted units
   Number of
options
  

Weighted average
exercise price

(in US dollars)

   Weighted average
remaining
contractual life
Outstanding at January 1, 2006    1,726,062    3,780,643    1.6   

Granted

   —      1,808,500    1.4   

Exercised

   n/a    41,688    2.0   

Forfeited / Repurchased

   409,348    439,569    1.6   

Released from restriction

   517,936    n/a      
               
Outstanding at July 2, 2006    798,778    5,107,886    1.5   
               

Granted

   —      41,000    3.0   

Exercised

   n/a    4,375    1.4   

Forfeited

   —      235,359    1.3   

Released from restriction

   88,406    n/a      
               
Outstanding at October 1, 2006    710,372    4,909,152    1.5    8.7 years
               
Exercisable at October 1, 2006    n/a    1,409,701    1.6    8.1 years

Effective January 1, 2006, the Company adopted SFAS 123(R), Share-Based Payment (revised 2004). As the Company elected to use the modified prospective application method, no restatement was made to the condensed consolidated statements of operations for prior interim periods or fiscal years. Under SFAS 123(R), the Company is required to measure compensation cost for all unit-based awards at fair value on the date of grant and recognize compensation expense over the grantee’s requisite service period. As permitted under SFAS No. 123(R), the Company elected to recognize compensation expense for all options with graded vesting based on the graded attribution method.

 

12


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Total unit option related compensation expense for the three and nine months ended October 1, 2006 was $67 thousand and $170 thousand, respectively. As of October 1, 2006, total unrecognized compensation cost of $458 thousand is expected to be recognized over a weighted average future period of 1.54 years.

Prior to the first quarter of 2006, the Company accounted for its unit-based compensation using the intrinsic value method prescribed in APB Opinion No. 25, Accounting for Stock Issued to Employees, and provided the required pro forma disclosures of SFAS No. 123, Accounting for Stock-Based Compensation. The following presents pro forma net loss and per unit data as if the fair value based method had been applied to account for the unit-based compensation for three and nine months ended October 2, 2005:

 

     Three months ended
October 2, 2005
   

Nine months ended

October 2, 2005

 

As reported net loss

   $ (13,242 )   $ (78,004 )

Add: Amortization of non-cash deferred unit compensation expense determined under the intrinsic value method as reported in net loss, net of tax

     —         —    

Deduct: Total unit-based compensation expense determined under the fair value method for all awards, net of tax

     (109 )     (327 )
                

Pro forma net loss

   $ (13,351 )   $ (78,331 )
                

Pro forma loss per unit

   $ (0.30 )   $ (1.62 )
                

The Company utilizes the Black-Scholes option-pricing model to measure the fair value of each option grant. The following summarizes the grant-date fair value of options granted during the specified periods and assumptions used in the Black-Scholes option-pricing model on a weighted average basis:

 

     Three months ended  
     October 1, 2006     October 2, 2005  
Grant-date fair value of options (in US dollars)    0.05     0.09  
Expected term    2.3Years     2.3Years  
Risk-free interest rate    5.1 %   3.9 %
Expected volatility    44.9 %   53.7 %
Expected dividends    —       —    

 

     Nine months ended  
     October 1, 2006     October 2, 2005  
Grant-date fair value of options (in US dollars)    0.25     0.22  
Expected term    2.3Years     2.2Years  
Risk-free interest rate    4.9 %   3.0 %
Expected volatility    46.7 %   60.3 %
Expected dividends    —       —    

The expected term of each option grant was based on employees’ expected exercises and post-vesting employment termination behavior and the risk free interest rate was based on the U.S. Treasury yield curve for the period corresponding to the expected term at the time of grant. The expected volatility was estimated using historical volatility of share prices of similar public entities. No dividends were assumed for this calculation of option value.

The total cash received from employees as a result of option exercises was $6 thousand and $88 thousand for the three and nine months ended October 1, 2006, respectively. None of the options exercised during these periods had any intrinsic value.

 

13


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

11. Restructuring and Impairment Charges

In the second quarter of 2006, the Company recorded impairment charges of $92,540 thousand related to one of its fabrication facilities and certain related technology and customer-based intangible assets in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-lived assets. During the same quarter, the Company recorded restructuring charges of $1,144 thousand in association with changes in certain of the Company’s management and related severance agreements. In addition, during the third quarter of 2006, the Company executed an early retirement for certain qualified employees and, as a result, recognized restructuring charges of $264 thousand.

12. Comprehensive Income

Comprehensive income is as follows:

 

     Three months ended     Nine months ended  
    

October 1,

2006

    October 2,
2005
    October 1,
2006
    October 2,
2005
 

Net loss

   $ (47,718 )   $ (13,242 )   $ (183,672 )   $ (78,004 )

Change in fair value of derivatives

     (3,223 )     2,962       87       3,045  

Foreign currency translation effect

     (1,648 )     (1,246 )     3,241       1,286  
                                

Comprehensive loss

   $ (52,589 )   $ (11,526 )   $ (180,344 )   $ (73,673 )
                                

13. Segment Information

The Company has determined, based on the nature of its operations and products offered to customers, that its reportable segments are Display Solutions, Imaging Solutions, and Semiconductor Manufacturing Services. The Display Solutions segment’s primary products are flat panel display drivers and the Imaging Solutions segment’s primary products are CMOS image sensors. The Semiconductor Manufacturing Service segment provides for wafer foundry services to clients. Net sales and gross profit for the “All other” category primarily relates to certain business activities that do not constitute operating or reportable segments.

The Company’s chief operating decision maker (“CODM”) as defined by SFAS 131, Disclosure about Segments of an Enterprise and Relate Information, allocates resources to and assesses the performance of each segment using information about its revenue and gross profit. The Company does not identify or allocate assets by segments, nor does the CODM evaluate operating segments using discrete asset information. In addition, the Company does not allocate interest income or expense, other income or expense, or income tax to the segments. Management does not evaluate segments based on these criteria.

Prior to the third quarter of 2006, the Company had a single reportable segment. During the third quarter of 2006, subsequent to the appointment of new CODM, the Company changed the manner in which the CODM reviewed the Company’s operational results and made significant business decisions to include disaggregated financial information of its three primary business units. Segment information for the third quarter of 2005 was prepared in conformity with the current segment structure.

 

14


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

The following sets forth information relating to the reportable segments:

 

     Three months ended    Nine months ended
     October 1,
2006
   October 2,
2005
   October 1,
2006
    October 2,
2005
Net Sales           

Display Solutions

   $ 56,056    $ 92,638    $ 215,116     $ 223,715

Imaging Solutions

     12,691      36,952      47,691       130,418

Semiconductor Manufacturing Services

     84,440      92,069      280,838       250,723

All other

     18,096      21,430      38,394       87,646
                            

Total segment net sales

   $ 171,283    $ 243,089    $ 582,039     $ 692,502
                            
Gross Profit           

Display Solutions

   $ 5,238    $ 23,260    $ 31,308     $ 45,251

Imaging Solutions

     2,708      7,231      (5,302 )     22,986

Semiconductor Manufacturing Services

     5,037      30,059      46,259       76,466

All other

     7,878      1,362      9,195       3,565
                            

Total segment gross profit

   $ 20,861    $ 61,912    $ 81,460     $ 148,268
                            

14. Condensed Consolidating Financial Statements

The senior secured credit facility and Second Priority Senior Secured Notes are each fully and unconditionally guaranteed by the Company and all of its subsidiaries, except for MagnaChip Semiconductor (Shanghai) Company Limited. The Senior Subordinated Notes are fully and unconditionally guaranteed by the Company and all of its subsidiaries, except for MagnaChip Semiconductor, Ltd. (Korea) and MagnaChip Semiconductor (Shanghai) Company Limited. The Senior Subordinated Notes are structurally subordinated to the creditors of our principal manufacturing subsidiary, MagnaChip Semiconductor, Ltd. (Korea), which accounts for a majority of our net sales and substantially all of our assets.

Below are condensed consolidating balance sheets as of October 1, 2006 and December 31, 2005, condensed consolidating statements of operations for the three and nine months ended October 1, 2006 and October 2, 2005 and condensed consolidating statements of cash flows for the nine months ended October 1, 2006 and October 2, 2005 of those entities that guarantee the Senior Subordinated Notes, those that do not, MagnaChip Semiconductor LLC, and the co-issuers.

 

15


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Statement of Operations

For the three months ended October 1, 2006

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  
Net sales    $ —       $ —       $ 163,459     $ 90,972     $ (83,148 )   $ 171,283  
Cost of sales      —         —         147,484       77,306       (74,368 )     150,422  
                                                
Gross profit      —         —         15,975       13,666       (8,780 )     20,861  
                                                
Selling, general and administrative expenses      18       231       19,197       3,420       (54 )     22,812  
Research and development expenses      —         —         37,053       3,828       (8,865 )     32,016  
Restructuring and impairment charges      —         —         264       —         —         264  
                                                
Operating income (loss)      (18 )     (231 )     (40,539 )     6,418       139       (34,231 )
                                                
Other income (expenses)      2       (4,287 )     (10,787 )     3,283       —         (11,789 )
                                                

Income (loss) before income taxes, equity in loss of related equity investment

     (16 )     (4,518 )     (51,326 )     9,701       139       (46,020 )
                                                
Income tax expenses      —         40       50       1,608       —         1,698  
                                                

Income (loss) before equity in loss of related Investment

     (16 )     (4,558 )     (51,376 )     8,093       139       (47,718 )
                                                
Loss of related investment      (47,702 )     (48,981 )     —         (51,473 )     148,156       —    
                                                
Net loss    $ (47,718 )   $ (53,539 )   $ (51,376 )   $ (43,380 )   $ 148,295     $ (47,718 )
                                                
Dividends accrued on preferred units      2,731       —         —         —         —         2,731  
                                                
Net loss attributable to common units    $ (50,449 )   $ (53,539 )   $ (51,376 )   $ (43,380 )   $ 148,295     $ (50,449 )
                                                

 

16


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Statement of Operations

For the nine months ended October 1, 2006

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  
Net sales    $ —       $ —       $ 561,282     $ 291,357     $ (270,600 )   $ 582,039  
Cost of sales      —         —         494,361       263,159       (256,941 )     500,579  
                                                
Gross profit      —         —         66,921       28,198       (13,659 )     81,460  
                                                
Selling, general and administrative expenses      86       748       56,969       8,619       (54 )     66,368  
Research and development expenses      —         —         99,798       10,813       (14,743 )     95,868  
Restructuring and impairment charges      —         —         93,723       225       —         93,948  
                                                
Operating income (loss)      (86 )     (748 )     (183,569 )     8,541       1,138       (174,724 )
                                                
Other income (expenses)      2       6,134       2,481       (10,734 )     —         (2,117 )
                                                

Income (loss) before income taxes, equity in loss of related equity investment

     (84 )     5,386       (181,088 )     (2,193 )     1,138       (176,841 )
                                                
Income tax expenses      —         122       50       6,659       —         6,831  
                                                

Income (loss) before equity in loss of related Investment

     (84 )     5,264       (181,138 )     (8,852 )     1,138       (183,672 )
                                                
Loss of related investment      (183,588 )     (193,848 )     —         (181,611 )     559,047       —    
                                                
Net loss    $ (183,672 )   $ (188,584 )   $ (181,138 )   $ (190,463 )   $ 560,185     $ (183,672 )
                                                
Dividends accrued on preferred units      8,070       —         —         —         —         8,070  
                                                
Net loss attributable to common units    $ (191,742 )   $ (188,584 )   $ (181,138 )   $ (190,463 )   $ 560,185     $ (191,742 )
                                                

 

17


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Statement of Operations

For the three months ended October 2, 2005

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  
Net sales    $ —       $ —       $ 239,454     $ 115,232     $ (111,597 )   $ 243,089  
Cost of sales      —         —         182,430       105,692       (106,945 )     181,177  
                                                
Gross profit      —         —         57,024       9,540       (4,652 )     61,912  
                                                
Selling, general and administrative expenses      238       822       26,595       3,675       (3,164 )     28,166  
Research and development expenses      —         —         24,123       3,723       (803 )     27,043  
Restructuring and impairment charges      —         —         —         —         —         —    
                                                
Operating income (loss)      (238 )     (822 )     6,306       2,142       (685 )     6,703  
                                                
Other income (expenses)      1       5,764       (18,495 )     (7,687 )     —         (20,417 )
                                                

Income (loss) before income taxes, equity in loss of related equity investment

     (237 )     4,942       (12,189 )     (5,545 )     (685 )     (13,714 )
                                                
Income tax expenses (benefits)      —         15       —         (487 )     —         (472 )
                                                

Income (loss) before equity in loss of related Investment

     (237 )     4,927       (12,189 )     (5,058 )     (685 )     (13,242 )
                                                
Loss of related investment      (13,005 )     (17,464 )     —         (8,752 )     39,221       —    
                                                
Net loss    $ (13,242 )   $ (12,537 )   $ (12,189 )   $ (13,810 )   $ 38,536     $ (13,242 )
                                                
Dividends accrued on preferred units      2,506       —         —         —         —         2,506  
                                                
Net loss attributable to common units    $ (15,748 )   $ (12,537 )   $ (12,189 )   $ (13,810 )   $ 38,536     $ (15,748 )
                                                

 

18


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Statement of Operations

For the nine months ended October 2, 2005

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  
Net sales    $ —       $ —       $ 673,969     $ 318,381     $ (299,848 )   $ 692,502  
Cost of sales      —         —         540,155       299,970       (295,891 )     544,234  
                                                
Gross profit      —         —         133,814       18,411       (3,957 )     148,268  
                                                
Selling, general and administrative expenses      353       1,408       77,369       12,058       (2,025 )     89,163  
Research and development expenses      —         —         75,731       6,841       (1,942 )     80,630  
Restructuring and impairment charges      —         —         8,720       —         —         8,720  
                                                
Operating loss      (353 )     (1,408 )     (28,006 )     (488 )     10       (30,245 )
                                                
Other income (expenses)      6       (11,065 )     (43,147 )     6,703       —         (47,503 )
                                                

Income (loss) before income taxes, equity in loss of related equity investment

     (347 )     (12,473 )     (71,153 )     6,215       10       (77,748 )
                                                
Income tax expenses      —         123       —         133       —         256  
                                                

Income (loss) before equity in loss of related Investment

     (347 )     (12,596 )     (71,153 )     6,082       10       (78,004 )
                                                
Loss of related investment      (77,657 )     (60,600 )     —         (68,916 )     207,173       —    
                                                
Net loss    $ (78,004 )   $ (73,196 )   $ (71,153 )   $ (62,834 )   $ 207,183     $ (78,004 )
                                                
Dividends accrued on preferred units      7,379       —         —         —         —         7,379  
                                                
Net loss attributable to common units    $ (85,383 )   $ (73,196 )   $ (71,153 )   $ (62,834 )   $ 207,183     $ (85,383 )
                                                

 

19


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Balance Sheet

October 1, 2006

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  

Assets

            

Current assets

            

Cash and cash equivalents

   $ 413     $ 1,489     $ 88,220     $ 17,367     $ —       $ 107,489  

Restricted cash

     —         —         —         —         —         —    

Accounts receivable, net

     —         —         95,847       40,648       (54,308 )     82,187  

Inventories, net

     —         —         55,294       4,205       (210 )     59,289  

Other receivables

     —         718       4,188       36,205       (34,402 )     6,709  

Other current assets

     —         26,160       12,714       11,178       (37,324 )     12,728  
                                                

Total current assets

     413       28,367       256,263       109,603       (126,244 )     268,402  
                                                

Property, plant and equipment, net

     —         —         354,084       1,347       —         355,431  

Intangible assets, net

     —         —         122,279       23,505       —         145,784  

Investments in subsidiaries

     (120,923 )     (195,731 )     —         (33,468 )     350,122       —    

Long-term inter-company loans

     —         785,080       —         634,101       (1,419,181 )     —    

Other non-current assets

     —         22,341       43,171       10,249       (23,844 )     51,917  
                                                

Total assets

   $ (120,510 )   $ 640,057     $ 775,797     $ 745,337     $ (1,219,147 )   $ 821,534  
                                                

Liabilities and Unitholders’ equity

            

Current liabilities

            

Accounts payable

   $ —       $ —       $ 63,263     $ 50,196     $ (54,308 )   $ 59,151  

Other accounts payable

     —         6       54,462       7,964       (34,402 )     28,030  

Accrued expenses

     18       11,596       28,023       27,608       (33,656 )     33,589  

Other current liabilities

     —         285       2,229       6,262       (3,668 )     5,108  
                                                

Total current liabilities

     18       11,887       147,977       92,030       (126,034 )     125,878  
                                                

Long-term borrowings

     —         750,000       621,000       798,181       (1,419,181 )     750,000  

Accrued severance benefits, net

     —         —         61,506       272       —         61,778  

Other non-current liabilities

     —         —         2,621       25,629       (23,844 )     4,406  
                                                

Total liabilities

     18       761,887       833,104       916,112       (1,569,059 )     942,062  
                                                

Commitments and contingencies

            

Series A redeemable convertible preferred units

     —         —         —         —         —         —    

Series B redeemable convertible preferred unites

     114,532       —         —         —         —         114,532  
                                                

Total redeemable convertible preferred units

     114,532       —         —         —         —         114,532  
                                                

Unitholders’ equity

            

Common units

     52,721       136,229       39,005       55,773       (231,007 )     52,721  

Additional paid-in capital

     2,378       1,338       155,352       108,165       (264,855 )     2,378  

Accumulated deficit

     (321,834 )     (291,514 )     (280,804 )     (362,501 )     934,819       (321,834 )

Accumulated other comprehensive income

     31,675       32,117       29,140       27,788       (89,045 )     31,675  
                                                

Total unitholders’ equity

     (235,060 )     (121,830 )     (57,307 )     (170,775 )     349,912       (235,060 )
                                                

Total liabilities, redeemable convertible preferred units and unitholders’ equity

   $ (120,510 )   $ 640,057     $ 775,797     $ 745,337     $ (1,219,147 )   $ 821,534  
                                                

 

20


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Balance Sheet

December 31, 2005

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  
Assets             
Current assets             

Cash and cash equivalents

   $ 209     $ 841     $ 63,435     $ 22,089     $ —       $ 86,574  

Restricted cash

     —         —         2,837       —         —         2,837  

Accounts receivable, net

     —         —         131,669       55,057       (74,673 )     112,053  

Inventories, net

     —         —         82,348       7,638       (1,309 )     88,677  

Other receivables

     35,013       718       7,792       20,097       (54,119 )     9,501  

Other current assets

     —         22,382       9,987       6,063       (28,284 )     10,148  
                                                

Total current assets

     35,222       23,941       298,068       110,944       (158,385 )     309,790  
                                                
Property, plant and equipment, net      —         —         484,019       1,058       —         485,077  
Intangible assets, net      —         —         165,369       26,020       —         191,389  
Investments in subsidiaries      25,756       (38,942 )     —         144,131       (130,945 )     —    
Long-term inter-company loans      —         774,199       —         621,311       (1,395,510 )     —    
Other non-current assets      —         24,153       45,370       11,131       (26,263 )     54,391  
                                                

Total assets

   $ 60,978     $ 783,351     $ 992,826     $ 914,595     $ (1,711,103 )   $ 1,040,647  
                                                
Liabilities and Unitholders’ equity             
Current liabilities             

Accounts payable

   $ —       $ —       $ 94,581     $ 74,003     $ (74,673 )   $ 93,911  

Other accounts payable

     1,000       440       68,703       19,344       (54,119 )     35,368  

Accrued expenses

     —         3,139       24,560       26,331       (25,062 )     28,968  

Other current liabilities

     —         162       3,746       9,416       (3,222 )     10,102  
                                                

Total current liabilities

     1,000       3,741       191,590       129,094       (157,076 )     168,349  
                                                
Long-term borrowings      —         750,000       621,311       774,199       (1,395,510 )     750,000  
Accrued severance benefits, net      —         —         54,854       270       —         55,124  
Other non-current liabilities      —         —         5,272       28,187       (26,263 )     7,196  
                                                

Total liabilities

     1,000       753,741       873,027       931,750       (1,578,849 )     980,669  
                                                
Commitments and contingencies             

Series A redeemable convertible preferred units

     —         —         —         —         —         —    

Series B redeemable convertible preferred unites

     106,462       —         —         —         —         106,462  
                                                

Total redeemable convertible preferred units

     106,462       —         —         —         —         106,462  
                                                
Unitholders’ equity             

Common units

     53,092       102,986       39,005       58,364       (200,355 )     53,092  

Additional paid-in capital

     2,169       1,027       155,212       71,989       (228,228 )     2,169  

Accumulated deficit

     (130,092 )     (102,930 )     (99,666 )     (172,038 )     374,634       (130,092 )

Accumulated other comprehensive income

     28,347       28,527       25,248       24,530       (78,305 )     28,347  
                                                

Total unitholders’ equity

     (46,484 )     29,610       119,799       (17,155 )     (132,254 )     (46,484 )
                                                

Total liabilities, redeemable convertible preferred units and unitholders’ equity

   $ 60,978     $ 783,351     $ 992,826     $ 914,595     $ (1,711,103 )   $ 1,040,647  
                                                

 

21


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Statement of Cash Flows

For the nine months ended October 1, 2006

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  
Cash flow from operating activities             
Net loss    $ (183,672 )   $ (188,584 )   $ (181,138 )   $ (190,463 )   $ 560,185     $ (183,672 )

Adjustments to reconcile net loss to net cash provided by (used in) operating activities

            

Depreciation and amortization

     —         —         142,376       3,105       —         145,481  

Provision for severance benefits

     —         —         10,029       2       —         10,031  

Amortization of debt issuance costs

     —         2,084       676       —         —         2,760  

Loss (gain) on foreign currency translation, net

     —         (10,882 )     (43,674 )     11,259       —         (43,297 )

Impairment of long-lived assets

     —         —         92,540       —         —         92,540  

Loss of related investment

     183,588       193,848       —         181,611       (559,047 )     —    

Other

     —         —         1,687       (2,663 )     2,419       1,443  
Changes in operating assets and liabilities             

Accounts receivable

     —         —         42,450       14,719       (20,365 )     36,804  

Inventories

     —         —         32,150       3,444       (1,099 )     34,495  

Other receivables

     1,603       —         4,070       4,173       (6,616 )     3,230  

Deferred tax assets

     —         —         —         1,405       —         1,405  

Accounts payable

     —         —         (36,691 )     (23,629 )     20,365       (39,955 )

Other accounts payable

     (1,000 )     (435 )     (23,807 )     1,756       6,616       (16,870 )

Accrued expenses

     17       8,457       1,721       1,278       (8,594 )     2,879  

Other current assets

     —         (3,778 )     (320 )     (6,197 )     9,040       (1,255 )

Other current liabilities

     —         122       (1,794 )     (2,982 )     (446 )     (5,100 )

Payment of severance benefits

     —         —         (7,116 )     —         —         (7,116 )

Other

     —         (184 )     5,533       (162 )     (2,419 )     2,768  
                                                

Net cash provided by (used in) operating activities

     536       648       38,692       (3,344 )     39       36,571  
                                                
Cash flows from investing activities             

Purchase of plant, property and equipment

     —         —         (25,574 )     (700 )     —         (26,274 )

Payments for intellectual property registration

     —         —         (1,687 )     (59 )     —         (1,746 )

Proceeds from disposal of plant, property and equipment

     —         —         2,748       —         —         2,748  

Proceeds from disposal of intangible assets

     —         —         2,801       —         —         2,801  

Decrease in restricted cash

     —         —         2,985       —         —         2,985  

Other

     —         —         (704 )     4       —         (700 )
                                                
Net cash used in investing activities      —         —         (19,431 )     (755 )     —         (20,186 )
                                                
Cash flows from financing activities             

Exercise of unit options

     88       —         —         —         —         88  

Repurchase of common units

     (420 )     —         —         —         —         (420 )
                                                
Net cash used in financing activities      (332 )     —         —         —         —         (332 )

Effect of exchange rate on cash and cash equivalents

     —         —         5,524       (623 )     (39 )     4,862  
                                                

Net increase (decrease) in cash and cash equivalents

     204       648       24,785       (4,722 )     —         20,915  
                                                
Cash and cash equivalents             
Beginning of the period      209       841       63,435       22,089       —         86,574  
                                                
End of the period    $ 413     $ 1,489     $ 88,220     $ 17,367     $ —       $ 107,489  
                                                

 

22


Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

(Unaudited; tabular dollars in thousands, except unit data)

Condensed Consolidating Statement of Cash Flows

For the nine months ended October 2, 2005

 

     MagnaChip
Semiconductor
LLC (Parent)
    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  
Cash flow from operating activities             
Net loss    $ (78,004 )   $ (73,196 )   $ (71,153 )   $ (62,834 )   $ 207,183     $ (78,004 )

Adjustments to reconcile net loss to net cash provided by (used in) operating activities

            

Depreciation and amortization

     —         —         149,561       5,187       —         154,748  

Provision for severance benefits

     —         —         12,117       72       —         12,189  

Amortization of debt issuance costs

     —         1,955       606       —         —         2,561  

Loss (gain) on foreign currency translation, net

     —         19,059       4,181       (17,789 )     —         5,451  

Impairment of long-lived assets

     —         —         7,996       —         —         7,996  

Loss of related investment

     77,657       60,600       —         68,916       (207,173 )     —    

Other

     —         —         (2,589 )     67       —         (2,522 )
Changes in operating assets and liabilities             

Accounts receivable

     —         —         (30,556 )     (11,105 )     10,404       (31,257 )

Inventories

     —         —         87       2,029       521       2,637  

Other receivables

     (241 )     826       65,289       (33,970 )     33,419       65,323  

Deferred tax assets

     —         —         —         (12,853 )     —         (12,853 )

Accounts payable

     —         —         16,567       6,070       (10,404 )     12,233  

Other accounts payable

     (160 )     183       (72,206 )     29,225       (33,419 )     (76,377 )

Accrued expenses

     —         10,403       3,644       19,777       (29,260 )     4,564  

Other current assets

     —         (21,100 )     2,285       (7,761 )     29,260       2,684  

Other current liabilities

     —         123       (5,455 )     4,894       —         (438 )

Payment of severance benefits

     —         —         (10,653 )     (11 )     —         (10,664 )

Other

     —         —         (31,611 )     32,458       (1,912 )     (1,065 )
                                                

Net cash provided by (used in) operating activities

     (748 )     (1,147 )     38,110       22,372       (1,381 )     57,206  
                                                
Cash flows from investing activities             

Purchase of plant, property and equipment

     —         —         (39,729 )     (511 )     401       (39,839 )

Payments for intellectual property registration

     —         —         (1,614 )     —         —         (1,614 )

Acquisition of business

     (1,870 )     —         —         (9,961 )     —         (11,831 )

Proceeds from disposal of plant, property and equipment

     —         —         425       513       (401 )     537  

Increase in short-term inter-company loans

     —         —         —         (14,000 )     14,000       —    

Increase in long-term inter-company loans

     —         (1,009 )     —         (1,009 )     2,018       —    

Decrease in restricted cash

     —         —         7,876       —         —         7,876  

Other

     —         —         2,572       11       —         2,583  
                                                
Net cash used in investing activities      (1,870 )     (1,009 )     (30,470 )     (24,957 )     16,018       (42,288 )
                                                
Cash flows from financing activities             

Proceeds from short-term inter-company borrowings

     —         —         —         14,000       (14,000 )     —    

Proceeds from short-term borrowings

     —         —         10,578       —         —         10,578  

Proceeds from long-term inter-company borrowings

     —         —         1,009       1,009       (2,018 )     —    

Repayment of short-term borrowings

     —         —         —         (12,400 )     —         (12,400 )

Other

     513       (378 )     (215 )     —         —         (80 )
                                                

Net cash provided by (used in) financing activities

     513       (378 )     11,372       2,609       (16,018 )     (1,902 )

Effect of exchange rate on cash and cash equivalents

     —         —         68       (1,834 )     1,381       (385 )
                                                

Net increase (decrease) in cash and cash equivalents

     (2,105 )     (2,534 )     19,080       (1,810 )     —         12,631  
                                                
Cash and cash equivalents             
Beginning of the period      2,386       3,201       29,671       23,138       —         58,396  
                                                
End of the period    $ 281     $ 667     $ 48,751     $ 21,328     $ —       $ 71,027  
                                                

 

23


Table of Contents

PART I. Financial Information – (continued)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contain forward-looking statements within the meaning of the federal securities laws that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors set forth elsewhere in this Form 10-Q and in prior Company public filings with the SEC. In addition, other factors have been or may be discussed from time to time in the Company’s SEC filings. These forward–looking statements are made based on management’s expectations and beliefs concerning future events impacting the Company and, therefore, involve a number of risks and uncertainties. The Company’s management cautions that forward–looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward–looking statements. The following discussion should be read in conjunction with the unaudited condensed consolidated interim financial statements and related notes included elsewhere in this Form 10-Q. While the Company periodically reassesses material trends and uncertainties affecting the Company’s results of operations and financial condition in connection with the preparation of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and certain other sections contained in the Company’s quarterly, annual or other reports filed with the SEC, the Company does not intend to review or revise any particular forward–looking statement in light of future events.

Overview

We are a leading designer, developer and manufacturer of mixed-signal and digital multimedia semiconductors addressing the convergence of consumer electronics and communication devices. We focus our core business on CMOS image sensors and flat panel display drivers, which are complex, high-performance mixed-signal semiconductors that capture images and enable and enhance the features and capabilities of both small and large flat panel displays. We also provide wafer foundry services whereby we leverage our specialized process technologies and low cost manufacturing facilities to produce semiconductors for third parties using their product designs. Our solutions are used in a wide variety of consumer and commercial mass market applications, such as mobile handsets, including camera-equipped mobile handsets, flat panel monitors and televisions, mobile displays, portable computer displays, handheld gaming devices, PDAs and audio-visual equipment such as DVD players.

Our business was named MagnaChip Semiconductor when it was acquired from Hynix Semiconductor Inc. on October 6, 2004, by CVC, Francisco Partners, CVC Asia Pacific, certain members of management and other investors.

We have three separate business segments: Display Solutions, Imaging Solutions and Semiconductor Manufacturing Services.

 

    Display Solutions: Our Display Solutions segment offers flat panel display drivers for the entire product range of small to large panel displays, including mobile phones, digital still cameras, photo printers, games, monitors, and LCD TVs. Our products also cover a broad range of technologies and interfaces including LTPS, TFT, CSTN, OLED technologies, RSDS and mini-LVDS interfaces.

 

    Imaging Solutions: Our Imaging Solutions segment is focused on the high growth camera phone market, offering video graphics adapter (“VGA”), 1.3, 2.1 and 3.1 megapixel CMOS image sensors. Our highly integrated image sensors are designed to be more cost effective and to provide brighter, sharper and more colorful image quality.

 

    Semiconductor Manufacturing Services: Our Semiconductor Manufacturing Services segment uses our process technology and manufacturing facilities to manufacture semiconductor wafers for third parties based on their designs. We provide our services to niche markets such as high-voltage, embedded memory and power processes. We offer customized services for clients globally at our state-of-the-art fabrication facilities located in Cheongju and Gumi, Korea. Our fabs provide us with large scale, cost-effective and flexible capacity enabling us to rapidly scale to high volume to meet shifts in demand by our end customers.

 

24


Table of Contents

Results of Operations—Comparison of Three-Month Periods Ended October 1, 2006 and October 2, 2005

The following table sets forth consolidated result of operations for the three months ended October 1, 2006 and October 2, 2005:

 

     Three months ended
October 1, 2006
    Three months ended
October 2, 2005
    Change  
     Amount     % of
net sales
    Amount     % of
net sales
    Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 171.3     100.0     $ 243.1     100.0     $ (71.8 )   (29.5 )

Cost of sales

     150.4     87.8       181.2     74.5       (30.8 )   (17.0 )
                              

Gross profit

     20.9     12.2       61.9     25.5       (41.0 )   (66.2 )
                              

Selling, general and administrative expenses

     22.8     13.3       28.2     11.6       (5.4 )   (19.1 )

Research and development expenses

     32.0     18.7       27.0     11.1       5.0     18.5  

Restructuring and impairment charges

     0.3     0.2       —       —         0.3     100  
                              

Operating income (loss)

     (34.2 )   (20.0 )     6.7     2.8       (40.9 )   (610.4 )

Interest expense, net

     (13.9 )   (8.1 )     (14.9 )   (6.1 )     1.0     (6.7 )

Foreign currency gain (loss), net

     2.1     1.2       (5.5 )   (2.3 )     7.6     (138.2 )
                              

Loss before income taxes

     (46.0 )   (26.9 )     (13.7 )   (5.6 )     (32.3 )   235.8  

Income tax expenses (benefits)

     1.7     1.0       (0.5 )   (0.2 )     2.2     (440.0 )
                              

Net loss

   $ (47.7 )   (27.9 )   $ (13.2 )   (5.4 )   $ (34.5 )   261.4  
                              

Net Sales and Gross Profit for Display Solutions

 

     Three months ended
October 1, 2006
   Three months ended
October 2, 2005
   Change  
     Amount    % of
net sales
   Amount   

% of

net sales

   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 56.1    100.0    $ 92.6    100.0    $ (36.5 )   (39.4 )

Cost of sales

     50.8    90.6      69.4    74.9      (18.6 )   (26.8 )
                              

Gross profit

   $ 5.3    9.4    $ 23.2    25.1    $ (17.9 )   (77.2 )
                              

Display Solutions’ net sales for the three months ended October 1, 2006 were $56.1 million, a $36.5 million or 39.4% decrease from $92.6 million for the three months ended October 2, 2005. The year-over-year decrease in net sales is primarily due to a lower market demand resulting mainly from inventory adjustments and product transition in our major customers. Declines in average selling price also had a negative impact on net sales.

Gross profit in the third quarter of 2006 was $5.3 million or 9.4% of net sales, compared to $23.2 million or 25.1% of net sales in the prior-year quarter. Decrease in gross profit both on an absolute dollar basis and on a percentage basis was primarily attributable to average selling price erosion year over year and an increase in overhead costs per unit driven by a volume decline during the current quarter.

 

25


Table of Contents

Net Sales and Gross Profit for Imaging Solutions

 

     Three months ended
October 1, 2006
   Three months ended
October 2, 2005
   Change  
     Amount    % of
net sales
   Amount   

% of

net sales

   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 12.7    100.0    $ 37.0    100.0    $ (24.3 )   (65.7 )

Cost of sales

     10.0    78.7      29.7    80.3      (19.7 )   (66.3 )
                              

Gross profit

   $ 2.7    21.3    $ 7.3    19.7    $ (4.6 )   (63.0 )
                              

Imaging Solutions’ net sales for the three months ended October 1, 2006 were $12.7 million, a $24.3 million or 65.7% decrease from $37.0 million for the three months ended October 2, 2005. Continued average selling price pressure for VGA products, which accounts for 77% of total Imaging Solutions revenue, coupled with the timing of new design wins in megapixel products ramping into volume production, resulted in the revenue decrease in this segment.

Gross profit for the three months ended October 1, 2006 was $2.7 million or 21.3% of net sales, compared to $7.3 million or 19.7% of net sales for the three months ended October 2, 2005. The improvement in gross profit, on a percentage basis, was mainly attributable to reduced depreciation expenses that resulted from impairment charges taken against one of our fabrication facilities during the second quarter of 2006.

Net Sales and Gross Profit for Semiconductor Manufacturing Services

 

     Three months ended
October 1, 2006
   Three months ended
October 2, 2005
   Change  
     Amount    % of
net sales
   Amount   

% of

net sales

   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 84.4    100.0    $ 92.1    100.0    $ (7.7 )   (8.4 )

Cost of sales

     79.4    94.1      62.0    67.3      17.4     28.1  
                              

Gross profit

   $ 5.0    5.9    $ 30.1    32.7    $ (25.1 )   (83.4 )
                              

Semiconductor Manufacturing Services’ net sales in the third quarter of 2006 were $84.4 million, a $7.7 million or 8.4% decline from net sales of $92.1 million in the prior year period. This decline in quarterly net sales was primarily attributable to lower demand in the analog and display driver portion of our foundry business as well as a shift in mix to older generation services.

Gross profit for the three months ended October 1, 2006 was $5.0 million or 5.9% of net sales, compared to $30.1 million or 32.7% of net sales for the three months ended October 2, 2005. Decrease in average selling price and lower margin mix compared to the prior year’s third quarter resulted in a decline of gross profit for the segment.

Net Sales and Gross Profit for All Other

 

     Three months ended
October 1, 2006
   Three months ended
October 2, 2005
   Change  
     Amount    % of
net sales
   Amount    % of
net sales
   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 18.1    100.0    $ 21.4    100.0    $ (3.3 )   (15.4 )

Cost of sales

     10.2    56.4      20.1    94.0      (9.9 )   (49.3 )
                              

Gross profit

   $ 7.9    43.6    $ 1.3    6.0    $ 6.6     (507.7 )
                              

The All other category represents certain business activities other than business segments, such as rental fees and unit processing fees. All other in the third quarter of 2005 also included certain business activities discontinued in late 2005 or early 2006. Net sales were $18.1 million and $21.4 million in the third quarter of 2006 and 2005, respectively. The decline of $3.3 million represents the revenue from the discontinued application processor and DRAM foundry business, partially offset by increase in revenue from unit processing.

 

26


Table of Contents

Gross profit in the third quarter of 2006 was $7.9 million, an increase of $6.6 million from the gross profit of $1.3 million during the prior year quarter. The improvement in gross profit is mainly attributable to the discontinuation of the less profitable application processor and DRAM foundry business.

Operating Expenses

Selling, General and Administrative Expenses. Selling, general, and administrative expenses were $22.8 million or 13.3% of net sales for the three months ended October 1, 2006 compared to $28.2 million or 11.6% for the three months ended October 2, 2005. The decrease of $5.4 million or 19.1% from the prior-year quarter was primarily attributable to reduced professional fees related to consulting and infrastructure build-out as well as decreased warranty expenses related to customer claims. In addition, lower amortization costs of intangible assets due to impairment charges in the prior quarter resulted in a decrease in selling, general, and administrative expenses for the current period.

Research and Development Expenses. Research and development expenses for the current quarter were $32.0 million, an increase of $5.0 million or 18.5% from $27.0 million for the prior year quarter. This increase in research and development expenses was mainly attributable to higher manufacturing cost for products used in our R&D activities, coupled with higher professional fees. As a percentage of net sales, research and development expense in the third quarter of 2006 increased to 18.7% from 11.1% of net sales in the third quarter of 2005.

Restructuring and Impairment Charges. During the three months ended October 1, 2006, we recorded restructuring charges of $0.3 million in accordance with SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities. The restructuring charges relate to termination benefits provided for certain employees under an early retirement program.

Net Interest Expense and Income Tax Expenses

Net Interest Expense. Net interest expense was $13.9 million during the three-month period ended October 1, 2006, a decline of $1.0 million from $14.9 million for the three-month period ended October 2, 2005. The decline in net interest expense was mainly due to an increase in interest income from financial assets including cash and cash equivalents. Our interest expense is mostly to serve the long-term borrowings of $750.0 million, which include $300 million of Floating Rate Second Priority Senior Secured Notes. As a result of an interest rate swap entered into in the second quarter of 2005, the variable interest rate of such Notes was effectively converted to a fixed rate and we are not exposed to changes in interest rates until the interest rate swap is unwound on June 15, 2008. Refer to “Note 6. Long-term Borrowings” for details.

Income Tax Expenses. Income tax expenses for the current quarter were $1.7 million compared to income tax benefits of $0.5 million for the same quarter of 2005. The income tax benefits in the third quarter of 2005 were primarily attributable to the effect of deferred tax accounting, where we recognized deferred tax assets for certain temporary differences between taxable and accounting income. Excluding this deferred tax effect, our income tax expenses are mostly composed of withholding taxes on inter-company interest payments and, therefore, consistent among periods.

 

27


Table of Contents

Results of Operations - Comparison of Nine-Month Periods Ended October 1, 2006 and October 2, 2005

The following table sets forth consolidated result of operations for the nine months ended October 1, 2006 and October 2, 2005:

 

     Nine months ended
October 1, 2006
   

Nine months ended

October 2, 2005

    Change  
     Amount     % of
net sales
    Amount    

% of

net sales

    Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 582.0     100.0     $ 692.5     100.0     $ (110.5 )   (16.0 )

Cost of sales

     500.6     86.0       544.2     78.6       (43.6 )   (8.0 )
                              

Gross profit

     81.4     14.0       148.3     21.4       (66.9 )   (45.1 )
                              

Selling, general and administrative expenses

     66.4     11.4       89.2     12.9       (22.8 )   (25.6 )

Research and development expenses

     95.9     16.5       80.6     11.6       15.3     19.0  

Restructuring and impairment charges

     93.9     16.1       8.7     1.3       85.2     979.3  
                              

Operating loss

     (174.8 )   (30.0 )     (30.2 )   (4.4 )     (144.6 )   478.8  

Interest expense, net

     (43.0 )   (7.4 )     (42.8 )   (6.2 )     (0.2 )   0.5  

Foreign currency gain (loss), net

     40.9     7.0       (4.7 )   (0.7 )     45.6     (970.2 )
                              

Loss before income taxes

     (176.9 )   (30.4 )     (77.7 )   (11.3 )     (99.2 )   127.7  

Income tax expenses

     6.8     1.2       0.3     0.0       6.5     2,166.7  
                              

Net loss

   $ (183.7 )   (31.6 )   $ (78.0 )   (11.3 )   $ (105.7 )   135.5  
                              

Net Sales and Gross Profit for Display Solutions

 

     Nine months ended
October 1, 2006
  

Nine months ended

October 2, 2005

   Change  
     Amount    % of
net sales
   Amount    % of
net sales
   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 215.1    100.0    $ 223.7    100.0    $ (8.6 )   (3.8 )

Cost of sales

     183.8    85.4      178.5    79.8      5.3     3.0  
                              

Gross profit

   $ 31.3    14.6    $ 45.2    20.2    $ (13.9 )   (30.8 )
                              

Display Solutions’ net sales for the nine months ended October 1, 2006 were $215.1 million, a $8.6 million or 3.8% decrease from $223.7 million for the nine months ended October 2, 2005. The decrease in year-to-date net sales for Display Solutions resulted from a relatively steep sales decrease during the third quarter of 2006, which is primarily attributable to a reduction in market demand. A decrease in average selling price also had an impact on the net sales decrease.

Gross profit for the nine-month period ended October 1, 2006 was $31.3 million or 14.6% of net sales, compared to $45.2 million or 20.2% of net sales for the nine-month period ended October 2, 2005. A decrease in gross profit both on an absolute dollar and a percentage basis was primarily attributable to average selling price erosion and an increase in per-unit overhead costs driven by a volume decrease.

 

28


Table of Contents

Net Sales and Gross Profit for Imaging Solutions

 

     Nine months ended
October 1, 2006
    Nine months ended
October 2, 2005
   Change  
     Amount     % of
net sales
    Amount   

% of

net sales

   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 47.7     100.0     $ 130.4    100.0    $ (82.7 )   (63.4 )

Cost of sales

     53.0     111.1       107.4    82.4      (54.4 )   (50.7 )
                              

Gross profit (loss)

   $ (5.3 )   (11.1 )   $ 23.0    17.6    $ (28.3 )   (123.0 )
                              

Imaging Solutions’ net sales for the nine months ended October 1, 2006 were $47.7 million, an $82.7 million or 63.4% decrease from $130.4 million for the nine months ended October 2, 2005. Continued average selling price pressure for VGA products and delayed transition to new megapixel products resulted in the revenue decrease in this segment.

Gross loss for the nine months ended October 1, 2006 was $5.3 million, compared to gross profit of $23.0 million for the nine months ended October 2, 2005. This decline in gross profit was mainly attributable to average selling price erosion as well as charges under SFAS No. 151, Inventory Costs. In accordance with SFAS No. 151, certain manufacturing overhead costs were expensed rather than being capitalized as inventory due to under-utilization of certain fabrication facilities.

Net Sales and Gross Profit for Semiconductor Manufacturing Services

 

     Nine months ended
October 1, 2006
   Nine months ended
October 2, 2005
   Change  
     Amount    % of
net sales
   Amount   

% of

net sales

   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 280.8    100.0    $ 250.7    100.0    $ 30.1     12.0  

Cost of sales

     234.6    83.5      174.3    69.5      60.3     34.6  
                              

Gross profit

   $ 46.2    16.5    $ 76.4    30.5    $ (30.2 )   (39.5 )
                              

Net sales for Semiconductor Manufacturing Services, during the nine-month period ended October 1, 2006, were $280.8 million, a $30.1 million or 12.0% increase compared to net sales of $250.7 million in the year ago period. The decrease in average selling price was more than offset by an increase in sales volume driven by expanded market demand.

Gross profit for the nine months ended October 1, 2006 was $46.2 million or 16.5% of net sales, compared to $76.4 million or 30.5% of net sales for the nine months ended October 2, 2005. The year-over-year decrease of $30.2 or 39.5% was primarily attributable to average selling price erosion, coupled with lower margin mix within the business segment.

Net Sales and Gross Profit for All other

 

     Nine months ended
October 1, 2006
   Nine months ended
October 2, 2005
   Change  
     Amount    % of
net sales
   Amount   

% of

net sales

   Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 38.4    100.0    $ 87.7    100.0    $ (49.3 )   (56.2 )

Cost of sales

     29.2    76.0      84.0    95.8      (54.8 )   (65.2 )
                              

Gross profit

   $ 9.2    24.0    $ 3.7    4.2    $ 5.5     148.6  
                              

The All other category represents certain business activities other than business segments, such as rental fees and unit processing fees. All other in the prior-year period also included certain business activities discontinued in late 2005 or early 2006. Net sales for the current period were $38.4 million compared to net sales of $87.7 million in the prior-year period. The decline of $49.3 million represents the revenue from the discontinued application processor and DRAM foundry business, partially offset by an increase in revenue from unit processing.

 

29


Table of Contents

Gross profit for the nine-month period ended October 1, 2006 was $9.2 million, an increase of $5.5 million from the gross profit of $3.7 million during the prior-year period. The improvement in gross profit is mainly attributable to the discontinuation of the less profitable application processor and DRAM foundry business.

Operating Expenses

Selling, General and Administrative Expenses. Selling, general, and administrative expenses were $66.4 million or 11.4% of net sales for the nine months ended October 1, 2006 compared to $89.2 million or 12.9% for the nine months ended October 2, 2005. This decrease of $22.8 million or 25.6% from the prior-year period was primarily attributable to lower amortization of intangible assets resulting from impairment charges taken during prior quarters, coupled with a decrease in professional service fees and reserve provisions for customer claims and returns.

Research and Development Expenses. Research and development expenses for the current period were $95.9 million, a $15.3 million or 19.0% increase from $80.6 million for the prior-year period. This increase in research and development expenses represents increased technology license fees and additional research and development staffing and activity from the acquisition of ISRON Corporation and IC Media Corporation. As a percentage of net sales, research and development expense increased 16.5% in the current period compared to 11.6% in the prior-year period.

Restructuring and Impairment Charges. During the nine months ended October 1, 2006, we recorded a one-time charge of $93.9 million as restructuring and impairment charges. The amount included $92.5 million of impairment charges under SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived assets and $1.4 million of restructuring charges under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. The impairment charges were recorded against one of our fabrication facilities and certain related technology and customer-based intangible assets, and the restructuring charges were taken in association with changes in certain of our management and employee early retirements. In the prior-year period, $8.7 million of restructuring and impairment charges were recorded in connection with an impairment of certain tangible assets and an early retirement program.

Net Interest Expenses and Income Tax Expenses

Net Interest Expense. Net interest expense was $43.0 million during the nine-month period ended October 1, 2006, consistent with $42.8 million for the nine-month period ended October 2, 2005. Our interest expense is mostly to serve the Company’s long-term borrowings of $750.0 million, which includes $300 million of Floating Rate Second Priority Senior Secured Notes. As a result of an interest rate swap entered into in the second quarter of 2005, the variable interest rate of such Notes was effectively converted to a fixed rate and we are not exposed to changes in interest rates until the interest rate swap is unwound on June 15, 2008. Refer to “Note 6. Long-term Borrowings” for details.

Income Tax Expenses. Income tax expenses for the nine months ended October 1, 2006 were $6.8 million while income tax expenses were $0.3 million for the prior year period. The lower income tax expenses in the prior-year period were primarily attributable to the effect of deferred tax accounting, where we recognized deferred tax assets for certain temporary differences between taxable and accounting income. Excluding the impact from deferred tax accounting, our income tax expenses are mostly composed of withholding taxes on the interest paid by one of our subsidiaries to its parent company and consistent over the periods.

Liquidity and Capital Resources

Our principal capital requirements are to fund working capital needs, meet required debt payments, including debt service payments on our notes and, if drawn upon, the senior credit facility, to invest in research and development and capital equipment expenditures. We anticipate that operating cash flow, together with available borrowing capacity under our senior credit facility, will be sufficient to meet our working capital needs, and fund our research and development expenses, capital expenditures and service requirements on our debt obligations for the foreseeable future. As of October 1, 2006, we had total long-term debt outstanding of $750.0 million.

During the nine-month period ended October 1, 2006, we generated cash from operating activities of $36.6 million, an $20.6 million or 36.0% decrease from operating cash inflow of $57.2 million during the third quarter of 2005. The operating cash inflows for the nine-month period reflected our net loss of $183.7 million adjusted by non-cash items of $209.0 million which consisted mostly of impairment charges, depreciation costs and amortization costs. On top of these cash inflows on an adjusted basis, we had a cash increase of $11.3 million resulting primarily from a decrease in working capital requirements during the nine months ended October 1, 2006.

 

30


Table of Contents

Our working capital balance was $142.5 million as of October 1, 2006, relatively consistent with $141.4 million as of December 31, 2005. Excluding cash and cash equivalents, the working capital balance was decreased by $19.8 million, from $54.9 million to $35.1 million. The decrease was driven mainly by reductions in accounts receivable and inventories totaling $59.3 million, partially offset by a decrease of $42.1 million in accounts and other payable.

For investing activities, we used cash of approximately $20.2 million for the nine months ended October 1, 2006. This cash outlay principally represented $28.0 million of capital expenditures on tangible and intangible assets, partially offset by a cash inflow from the sale of our application processor business and other tangible assets. During the prior-year quarter, the net cash outlay for investing activities was $42.3 million.

For the nine months ended October 1, 2006, there were no significant financing activities. During the first nine months of 2005, we used approximately $1.9 million in financing activities.

Capital Expenditures. For the nine months ended October 1, 2006, capital expenditures were $28.0 million, a $13.5 million or 32.5% decrease from $41.5 million for the nine months ended October 2, 2005 as a result of the management of the timing of capital expenditures. We will continue to manage the timing of our capital expenditures to support the growth of business from new customers and to optimize return on our investment.

Future Financing Activities. Our primary future capital requirements include funding of our working capital needs, meeting our required debt payments, and funding of research and development as well as capital equipment expenditures. We plan to add design resources in low cost locations in Asia. We anticipate that our operating cash flows, together with available borrowings under our senior credit facility, will be sufficient to meet these capital requirements for the foreseeable future.

From time to time, we may need to incur additional debt or issue equity to make strategic acquisitions and investments. However, we cannot assure you that such financing will be available to us on acceptable terms or that such financing will be available at all.

Contractual Obligations

Summarized in the table below are our obligations and commitments to make future payments under debt obligations and minimum lease payment obligations as of October 1, 2006.

 

     Payments Due by Period  
     Total    2006    2007    2008    2009    2010    Thereafter   

Interest

expense

 
     (in millions of US dollars)  

Revolving credit facility

   —      —      —      —      —      —