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Results of Operations
National Semiconductor Corporation ("National" or the "Company") recorded sales of $2.6 billion in fiscal 1996 compared to $2.4 billion in fiscal 1995 and $2.3 billion in fiscal 1994. Net income for fiscal 1996 was $185.4 million compared to $264.2 million in fiscal 1995 and $264.0 million in fiscal 1994.
The decrease in earnings was primarily attributable to a combination of lower than expected revenues and higher costs associated with reduced factory utilization experienced in the second half of the year as the Company and the global semiconductor industry experienced much slower order activity due to over-inventory conditions at its customers and distributors. Results for fiscal 1996 also included one-time charges of $11.4 million related to the acquisition of Sitel Sierra, B.V., a Netherlands company that designs and supplies components and subsystems for the wireless market, and a charge of $19.3 million associated with various cost reduction programs announced in late fiscal 1996 taken to align costs with current market conditions.
The increase in net income for fiscal 1995 over fiscal 1994 was primarily due to increased sales and improved gross margins offset partially by a higher effective tax rate.
Sales
Sales increased overall by 10 percent in fiscal 1996 over fiscal 1995. While sales growth for the first half of fiscal 1996 was 24 percent over sales for the first half of fiscal 1995, sales for the second half of fiscal 1996 remained flat with sales for the second half of fiscal 1995. Increases in both unit shipments and prices contributed to first half sales growth for fiscal 1996, while decreased unit shipments, primarily to customers in the personal computer and peripherals industry and distributors, together with some modest price declines resulted in lower sales for the second half of the year. Sales for the second half of fiscal 1996 declined 14 percent from sales for the first half of the year. This decline was caused primarily by a general slowdown in new orders as customers and distributors reduced inventories.
During fiscal 1996, the largest sales growth was in Analog and Mixed Signal products, which increased 17 percent over fiscal 1995. These products continued to drive the overall growth in sales, increasing to 60 percent of total sales in fiscal 1996 as compared to 56 percent in fiscal 1995. Within the Analog and Mixed Signal category, sales for Local Area Network and Wide Area Network markets, including wireless communication products, were major contributors to fiscal 1996 sales growth with increases of 21 percent and 52 percent, respectively,over fiscal 1995 sales. Although sales in fiscal 1996 for other Analog and Mixed Signal products grew by 13 percent overall, sales growth for these products was offset by a decrease in product sales from read channel applications in the Mass Storage market, an area the Company has de-emphasized.
Sales of Bipolar Logic, CMOS Logic and Memory products were flat compared to fiscal 1995 as the Company continues its strategy to de-
emphasize Logic and EPROM Memory products. Sales of these products represented 20 percent of total sales, down from 22 percent for fiscal 1995. Sales for all remaining product lines also represented 20 percent of total sales, down from 22 percent in fiscal 1995. Further discussion is contained in the "Outlook" section relating to the Company's future plans which affect a large portion of these product areas.
Fiscal 1996 sales increased in all geographic regions over fiscal 1995. The increases were 8 percent for the Americas, 14 percent for Europe, 13 percent for Japan and 9 percent for Asia. The dollar value of foreign currency denominated sales was minimally affected by exchange rates as favorable currency movements in the first half of the year were offset in the second half of the year as the dollar began to strengthen against the Japanese yen and major European currencies. In fiscal 1996, sales in the Americas declined to 42 percent of total sales, while sales for Japan grew to 10 percent of total sales and sales remained consistent at 24 percent each for Europe and Asia.
During fiscal 1995, sales increased 4 percent over fiscal 1994. Sales in the first half of fiscal 1995 were comparable to the first half of fiscal 1994. During the second half of fiscal 1995, sales grew 8 percent over the second half of fiscal 1994 as additional manufacturing capacity came on line to support increased demand. In addition, customer orders significantly increased in fiscal 1995, especially in the second half of the year, when orders booked ran at rates significantly ahead of revenues.
Fiscal 1995 sales increased 13 percent and 8 percent in Europe and Japan, respectively, over fiscal 1994. Half of this increase in sales in Europe and Japan resulted from currency movements. Sales in the Americas and Asia were essentially flat with fiscal 1994. Overall, the Americas, Europe, Japan and Asia regions accounted for 43%, 24%, 9% and 24% of total fiscal 1995 sales, respectively.
Gross Margin
Gross margin as a percentage of sales declined to 41 percent in fiscal 1996 from 42 percent in each of fiscal 1995 and 1994 (see Note 1). The primary factor contributing to the decline was reduced factory utilization in the second half of the year due to a slowdown in new orders as customers and distributors reduced inventories coupled with a general increase in operating expenses, including increases in depreciation expense as new equipment was placed in service. As the Company entered fiscal 1996, gross margin for the first half of the year increased to 44 percent due to high product demand, particularly in the higher margin Analog products. Wafer fab capacity utilization reached 91 percent, despite some capacity constraints. In the second half of the year, wafer fab capacity utilization declined to approximately 72 percent as the Company reduced production output in an effort to keep inventories in balance with decreasing demand. This resulted in a decline in gross margin to 37 percent for the second half of the year. The decline in unit volume in the second half of the year was accompanied by modest price declines in older commodity products and some multimarket Analog products such as amplifiers and voltage regulators.
Fiscal 1995 gross margins remained essentially flat with fiscal 1994 at 42 percent as higher unit volumes and firm pricing in Analog and Mixed Signal products were offset by pricing declines in older, commodity products and, in some cases, declines in unit shipments as well. Overall gross margins remained relatively constant for most operating divisions. Wafer capacity utilization approached 90 percent for most of the year; however, margins were impacted by the Company's difficulties in growing manufacturing capacity to match rapidly rising product demand.
Research and Development
Research and development ("R&D") expenses were $361.3 million for fiscal 1996, or 14 percent of sales, compared to $283.1 million in fiscal 1995, or 12 percent of sales and $257.8 million in fiscal 1994, or 11 percent of sales. The increase in fiscal 1996 reflects the Company's accelerated investment in advanced submicron CMOS process technology, as well as continued investment in the development of new Analog and Mixed Signal based products for applications in the personal systems, communications, consumer and industrial markets. Fiscal 1996 R&D expenses also include an $11.4 million charge for in-process R&D related to the acquisition of Sitel Sierra B.V. during the year.
Selling, General and Administrative
Selling, general and administrative ("SG&A") expenses increased to $486.8 million, or 19 percent of sales in fiscal 1996 from $433.3 million, or 18 percent of sales in fiscal 1995 and $429.4 million, or 19 percent of sales in fiscal 1994. The increase is primarily attributable to increases in sales support costs and marketing activities proportional to increased sales in the first half of the year, together with increases in contributions to employee compensation and benefit plans, including the employee retirement and savings program and the success sharing incentive plan that commenced in fiscal 1996 for all employees worldwide not already in other bonus or incentive plans. Fiscal 1996 SG&A expenses also include $9.5 million of the $19.3 million one-time charge related to the implementation of various cost reduction programs announced in late fiscal 1996. Although SG&A expenses for the first half of fiscal 1996 increased 22 percent over the first half of fiscal 1995, beginning in the second half of fiscal 1996, the Company reduced SG&A expenses by 11 percent from the first half of the year as certain cost reduction programs were implemented in response to the slowdown in market conditions.
Interest Income and Interest Expense
Net interest income was $13.3 million for fiscal 1996 compared to $14.6 million in fiscal 1995 and $10.9 million in fiscal 1994. While interest income increased in fiscal 1996 primarily due to higher cash balances, the increase was offset by a greater increase in interest expense associated with the $258.8 million convertible subordinated notes issued by the Company in September 1995, as well as other borrowings related to the Company's continued investment in plant and equipment. Net interest income was higher in fiscal 1995 over fiscal 1994 primarily due to an increase in interest income earned from higher average rates on investments, offset partially by $2.5 million of prepayment premiums paid in conjunction with the early retirement of debt.
Income Tax Expense
Income tax expense for fiscal 1996 was $61.8 million compared to $65.0 million in fiscal 1995 and $44.4 million in fiscal 1994. The effective tax rate in fiscal 1996 was 25 percent as compared to approximately 20 percent and 15 percent in fiscal 1995 and 1994, respectively. The increases in the effective tax rates over the last three years are primarily attributable to the exhaustion of certain net operating loss carryovers in various tax jurisdictions.
Foreign Operations
The Company has manufacturing facilities in Southeast Asia and Europe and sales offices throughout the United States, Southeast Asia, Europe and Japan. A portion of the transactions at these facilities are denominated in local currency, which exposes the Company to risk from exchange rate fluctuations. The Company's risk exposure from expenses at foreign manufacturing facilities is concentrated in pound sterling, Singapore dollar and Malaysian ringgit. Net non-U.S. dollar denominated asset and liability positions are hedged, where practical, using forward exchange and purchased option contracts. The Company's risk exposure from foreign revenue is limited to the Japanese yen and major European currencies, primarily German deutsche marks, French francs and Italian lira. The Company hedges up to 100 percent of the notional value of
outstanding customer orders denominated in foreign currency using forward
exchange contracts and over-the-counter foreign currency options. A
portion of anticipated foreign sales commitments is, at times, hedged
using purchased option contracts that have an original maturity of one
year or less.
Financial Condition
As of May 26, 1996, cash and short-term investments increased to a total $504.3 million from a total of $467.4 million at May 28, 1995. Cash generated from operating activities was $361.4 million in fiscal 1996, down from $438.6 million in fiscal 1995 and $433.7 million in fiscal 1994, principally as a result of the decline in net income in fiscal 1996.
Cash used for investing activities was $579.0 million in fiscal 1996 compared to $455.0 million in fiscal 1995 and $295.5 million in fiscal 1994. Capital expenditures increased in fiscal 1996 over fiscal 1995 from $476.8 million to $628.1 million as the Company continued to invest in property, plant and equipment to expand its manufacturing capabilities and modernize existing plants. Capital expenditures in fiscal 1996 included continued expansion of a CMOS wafer fabrication facility in Arlington, Texas, construction of an eight-inch 0.35 micron pilot wafer fabrication line at its research and development facility in Santa Clara, expansion of the Company's BiCMOS six-inch wafer fabrication facility in South Portland, Maine and commencement of construction of an eight-inch wafer fabrication facility, also in South Portland.
The Company's financing activities provided cash of $239.7 million in fiscal 1996 primarily due to proceeds of $253.3 million, net of issuance costs, from the private placement of convertible subordinated notes and $42.4 million from the issuance of common stock, offset by the repurchase of 2,450,000 shares of common stock on the open market for $63.0 million. In fiscal 1995, cash provided by financing activities of $38.6 million was provided by debt proceeds of $157.8 million and $29.4 million from issuance of common stock, offset by $83.0 million of debt repayment and the repurchase of 3,115,600 of common stock on the open market for $54.4 million. The Company also repurchased 500,000 shares of common stock on the open market for $9.5 million in 1994. During 1994, net cash used in financing activities was $17.5 million which consisted primarily of debt repayments, purchases of treasury stock and payment of preferred dividends, offset by issuances of common stock.
Management foresees significant cash outlays for plant and equipment throughout fiscal 1997. The fiscal 1997 capital expenditure rate is expected to be approximately at the same level as fiscal 1996. Existing cash and investment balances, together with existing lines of credit, are felt to be sufficient to finance fiscal 1997 capital investments.
The statements contained in this Outlook and in the Financial Condition section of Management's Discussion and Analysis are forward looking based on current expectations and management's estimates. Actual results may differ materially from those set forth in such forward looking statements.
The semiconductor industry is characterized by rapid technological change and frequent introduction of new technology leading to more complex and more integrated products. The result is a cyclical environment with short product life, price erosion and high sensitivity to the overall business cycle. In addition, substantial capital and R&D investment is required to support products and manufacturing processes. As a result of industry conditions, the Company may experience periodic fluctuations in its operating results.
Business conditions for the semiconductor industry weakened throughout the second half of fiscal 1996. Distributors and personal computer manufacturers continue to work through inventory corrections. The duration of this inventory correction process is unknown and may have a significant ongoing impact on the Company's future operating results. We have recently seen improving resales in the semiconductor distribution channel in the U.S. market and some improvement in orders from personal computer manufacturers. It appears that the order rates in the industry may have reached the bottom of a down cycle, but the
timing and extent of a recovery in revenue growth rates is uncertain.
Should the current business conditions continue indefinitely, revenue
growth rates expected for fiscal 1997 will be affected and operating
results may not achieve levels recorded in fiscal 1996.
The Company will continue to focus on major customers in the personal systems, communications, industrial and consumer markets. In fiscal 1997, the Company expects to continue its emphasis in Analog and Mixed Signal market opportunities. The Company expects to grow at or above market rates of growth in particular segments of Analog and Mixed Signal, but may not necessarily achieve growth in the more mature commodity markets for Logic and Memory products. Sales growth may also be affected by product pricing, especially in these commodity areas.
The Company has also experienced a general decline in the rate of growth in orders since the end of fiscal 1995 and the normal seasonal upturn generally experienced by the semiconductor industry during the spring did not materialize in fiscal 1996. Unless the rate of new orders increases, the Company may not be able to achieve the level of sales expected for fiscal 1997. The Company faces the risks that either an upturn for the semiconductor industry may be delayed or that an upturn will not provide new orders at a level sufficient to generate revenue growth. Additionally, the rate of orders and product pricing may be affected by continued and increasing competition and by the growth rates in the personal computer industry.
While business conditions and overall market pricing have a major influence on gross margin, the Company's planned expansion and modernization of current facilities, improvements in manufacturing efficiency, focus on Analog and Mixed Signal products and introduction of new products are expected to result in gross margin improvement. The Company has committed substantial capital investments to bring new manufacturing capacity on line for fiscal 1997. While management expects to more fully utilize wafer capacity as business conditions return to more normal levels, there is no certainty that the level of demand will be sufficient to fully utilize the additional new capacity when it is brought on line. Failure to improve manufacturing capacity utilization will lead to flat or decreased gross margin for fiscal 1997. In addition, unexpected start-up expenses, inefficiencies and delays in the start of production in the Company's new eight-inch wafer fabrication facility in South Portland or the wafer fabrication facility expansion in Arlington may result in lower than expected gross margin for fiscal 1997. The Company experienced pricing declines in Logic and Analog commodity products during fiscal 1996 and if this trend continues or some of the Company's other products also become exposed to pricing pressure, the effect may cause deterioration in gross margin in fiscal 1997. The Company's focus is to continue to introduce new products, particularly higher margin Analog and Mixed Signal based products, to reposition its product portfolio so that its is less exposed to the pricing declines of older commodity products. If the development of new products is delayed or their market acceptance is below expectations, there may be a decrease in the Company's gross margin for fiscal 1997.
Although the Company believes that continued focused investment in research and development is a key factor to the Company's successful growth, ongoing research and development spending for fiscal 1997 is not currently expected to exceed fiscal 1996 levels. National's product portfolio, particularly products in the personal systems and communications area, have short product life cycles and successfully developing and introducing new products is critical to the Company's ability to maintain a competitive position in the marketplace. The Company's ability to achieve strong financial performance is also dependent on the development of new manufacturing processes and the timely development and market acceptance of new products. The Company also expects overall SG&A expenses for fiscal 1997 to be lower than fiscal 1996 as management continues to evaluate strategies to align its cost structure with current market conditions.
National continues to pursue opportunities to leverage its intellectual property. However, the timing and amount of future licensing income cannot be forecast with certainty at this time. In addition, the Company continues to pursue opportunities to develop joint venture partnerships or potential acquisitions which enhance its product portfolio in Analog and Mixed Signal applications. The Company's joint venture in the People's Republic of China ("China") to design, manufacture and market subscriber line interface modules and other products using similar technologies is dependent on the development of a telecommunication infrastructure in China. The Company's success in this joint venture is subject to the risk of market acceptance, as well as the general economic conditions and political environment in China. The Company continues to critically evaluate product lines and divisions where short or long term prospects do not coincide with its overall strategic direction. In these cases, the Company will consider dispositions of assets or business entities as necessary. No assurance can be given that the Company will be successful in these endeavors or that such endeavors will provide financial growth.
Because of significant international operations, overall, the Company benefits from a weaker dollar and is adversely affected by a stronger dollar relative to major currencies worldwide. As such, changes in exchange rates, and in particular a strengthening of the U.S. dollar, may unfavorably affect the Company's consolidated sales and net income. The Company attempts to hedge the short-term exposures to foreign currency fluctuations, but there can be no assurance that the Company's risk management activities will offset more than a portion of the adverse financial impact resulting from unfavorable movements in foreign exchange.
In June 1996, the Company announced that it had formed a new organization, consisting of its family logic, memory and discrete businesses, to be called Fairchild Semiconductor. The Company is pursuing a number of alternatives with respect to Fairchild Semiconductor, including a sale or partial financing of all or a portion of the businesses or related assets. The Company expects to record a one-time charge of $280 million to $320 million in the first quarter of fiscal 1997, primarily to reflect the write down of assets to estimated realizable value. A portion of the estimated charge is associated with staffing reductions and other expenses necessary to reduce the Company's associated infrastructure in both Fairchild Semiconductor and the continuing National core business areas (see Note 15). Since the nature and timing of the ultimate strategy selected for these businesses is not known and cannot be forecast at this time, it is difficult to predict the future impact of such transactions on the Company's financial condition or operating results for fiscal 1997. The Company faces the risk that it may not be able to sell or finance all or a portion of the businesses or related assets. Retaining these businesses or related assets may result in an unfavorable impact to the Company's operating results. The Company also faces the risk that the Fairchild businesses, as well as the Company's other businesses, may be disrupted and experience lower performance levels during the process of evaluating alternatives. In addition, the actual net realizable value of the assets of these businesses may be lower or higher than amounts initially estimated. The effect of the Company's announced reorganization and the potential disposition of these businesses are expected to significantly reduce the Company's profitability for fiscal 1997. The Company has also reorganized the structure of its other businesses by consolidating its original six divisions down to three divisions. The Company's future operating results and financial condition could be affected by how it manages the transition to a new organizational structure.
In addition to the risks and uncertainties discussed above, other risks and uncertainties that may cause actual results to differ materially include, but are not limited to, the general economy, regulatory and international economic conditions, changing environment of the semiconductor industry, competitive products and pricing, growth in the personal computer and communications industries, the effects of legal and administrative cases and proceedings, and such other risks and uncertainties as detailed from time to time in the Company's SEC reports and filings. |
