Quarterly Report on 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 July 1, 2007

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 of the Exchange Act).    Yes  ¨    No  x

As of August 1, 2007, the registrant had 52,800,784.0470 of the registrant’s common units outstanding.

 



Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

TABLE OF CONTENTS

 

          Page No.

PART I FINANCIAL INFORMATION

   1

Item 1.

  

Financial Statements (Unaudited)

   1
  

Condensed Consolidated Statements of Operations

   1
  

Condensed Consolidated Balance Sheets

   2
  

Condensed Consolidated Statements of Changes in Unitholders’ Equity

   3
  

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

   25

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   35

Item 4T.

  

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

   41

SIGNATURES

   42


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     Six months ended  
     July 1, 2007     July 2, 2006     July 1, 2007     July 2, 2006  

Net sales

   $ 194,053     $ 197,613     $ 345,836     $ 410,756  

Cost of sales

     166,299       177,342       303,159       350,157  
                                

Gross profit

     27,754       20,271       42,677       60,599  
                                

Selling, general and administrative expenses

     25,531       22,025       48,260       43,556  

Research and development expenses

     32,534       33,934       67,652       63,852  

Restructuring and impairment charges

     12,084       93,684       12,084       93,684  
                                

Operating loss

     (42,395 )     (129,372 )     (85,319 )     (140,493 )
                                

Other income (expenses)

        

Interest expense, net

     (14,952 )     (14,352 )     (29,368 )     (29,085 )

Foreign currency gain (loss), net

     13,868       14,520       6,477       38,757  
                                

Loss before income taxes

     (43,479 )     (129,204 )     (108,210 )     (130,821 )
                                

Income tax expenses (benefits)

     1,845       2,859       4,096       5,133  
                                

Net loss

   $ (45,324 )   $ (132,063 )   $ (112,306 )   $ (135,954 )
                                

Dividends accrued on preferred units

     2,983       2,706       5,853       5,339  
                                

Net loss attributable to common units

   $ (48,307 )   $ (134,769 )   $ (118,159 )   $ (141,293 )
                                

Net loss per common units

        

- Basic and diluted

   $ (0.92 )   $ (2.54 )   $ (2.24 )   $ (2.66 )
                                

Weighted average number of units

        

- Basic and diluted

     52,772,652       53,098,537       52,746,718       53,101,546  

The accompanying notes are an integral part of these financial statements

 

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Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Condensed Consolidated Balance Sheets

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

 

     July 1, 2007     December 31, 2006  

Assets

    

Current assets

    

Cash and cash equivalents

   $ 54,734     $ 89,173  

Accounts receivable, net

     117,212       76,665  

Inventories, net

     71,723       57,846  

Other receivables

     7,178       6,754  

Other current assets

     19,646       13,626  
                

Total current assets

     270,493       244,064  
                

Property, plant and equipment, net

     278,529       336,279  

Intangible assets, net

     123,495       139,729  

Other non-current assets

     49,328       49,981  
                

Total assets

   $ 721,845     $ 770,053  
                

Liabilities and Unitholders’ Equity

    

Current liabilities

    

Accounts payable

   $ 80,629     $ 62,399  

Other accounts payable

     33,474       32,423  

Accrued expenses

     24,167       23,647  

Short-term borrowings

     40,000       —    

Other current liabilities

     3,259       2,980  
                

Total current liabilities

     181,529       121,449  
                

Long-term borrowings

     750,000       750,000  

Accrued severance benefits, net

     68,453       62,836  

Other non-current liabilities

     7,198       2,935  
                

Total liabilities

     1,007,180       937,220  
                

Commitments and contingencies

    

Series A redeemable convertible preferred units; 60,000 units authorized, 50,091 units issued and 0 unit outstanding at July 1, 2007 and December 31, 2006

     —         —    

Series B redeemable convertible preferred units; 550,000 units authorized, 450,692 units issued and 93,997 units outstanding at July 1, 2007 and December 31, 2006

     123,227       117,374  
                

Total redeemable convertible preferred units

     123,227       117,374  
                

Unitholders’ equity

    

Common units; 65,000,000 units authorized, 52,800,784 and 52,720,784 units issued and outstanding at July 1, 2007 and December 31, 2006, respectively

     52,801       52,721  

Additional paid-in capital

     2,521       2,451  

Accumulated deficit

     (490,027 )     (370,314 )

Accumulated other comprehensive income

     26,143       30,601  
                

Total unitholders’ equity

     (408,562 )     (284,541 )
                

Total liabilities, redeemable convertible preferred units and unitholders’ equity

   $ 721,845     $ 770,053  
                

The accompanying notes are an integral part of these financial statements

 

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Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Condensed Consolidated Statements of Changes in Unitholders’ Equity

(In thousands of US dollars, except unit data)

 

     Common Units    

Additional
Paid-In

Capital

    Accumulated
deficit
    Accumulated
Other
Comprehensive
Income
   Total  
     Units     Amount           

Three months ended July 2, 2006

             

Balance at April 2, 2006

   53,130,445     $ 53,130     $ 2,279     $ (136,616 )   $ 34,263    $ (46,944 )

Exercise of unit options

   2,812       3       5            8  

Repurchase of units issued

   (412,473 )     (412 )     (1 )          (413 )

Unit-based compensation

         28            28  

Dividends accrued on preferred units

           (2,706 )        (2,706 )

Comprehensive income:

             

Net loss

           (132,063 )        (132,063 )

Fair valuation of derivatives

             1,140      1,140  

Foreign currency translation adjustments

             1,143      1,143  
                   

Total comprehensive income

                (129,780 )
                                             

Balance at July 2, 2006

   52,720,784     $ 52,721     $ 2,311     $ (271,385 )   $ 36,546    $ (179,807 )
                                             

Six months ended July 2, 2006

             

Balance at January 1, 2006

   53,091,570     $ 53,092     $ 2,169     $ (130,092 )   $ 28,347    $ (46,484 )

Exercise of unit options

   41,687       41       41            82  

Repurchase of units issued

   (412,473 )     (412 )     (1 )          (413 )

Unit-based compensation

         102            102  

Dividends accrued on preferred units

           (5,339 )        (5,339 )

Comprehensive income:

             

Net loss

           (135,954 )        (135,954 )

Fair valuation of derivatives

             3,309      3,309  

Foreign currency translation adjustments

             4,890      4,890  
                   

Total comprehensive income

                (127,755 )
                                             

Balance at July 2, 2006

   52,720,784     $ 52,721     $ 2,311     $ (271,385 )   $ 36,546    $ (179,807 )
                                             

The accompanying notes are an integral part of these financial statements

 

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Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Condensed Consolidated Statements of Changes in Unitholders’ Equity

(In thousands of US dollars, except unit data)

 

     Common Units   

Additional
Paid-In

Capital

   Accumulated
deficit
    Accumulated
Other
Comprehensive
Income
    Total  
     Units    Amount          

Three months ended July 1, 2007

               

Balance at April 1, 2007

   52,720,784    $ 52,721    $ 2,476    $ (441,720 )   $ 31,538     $ (354,985 )

Exercise of unit options

   80,000      80      —        —         —         80  

Unit-based compensation

   —        —        45      —         —         45  

Dividends accrued on preferred units

   —        —        —        (2,983 )     —         (2,983 )

Comprehensive income (loss):

               

Net loss

   —        —        —        (45,324 )     —         (45,324 )

Fair valuation of derivatives

   —        —        —        —         (17 )     (17 )

Foreign currency translation adjustments

   —        —        —        —         (5,378 )     (5,378 )
                     

Total comprehensive loss

                  (50,719 )
                                           

Balance at July 1, 2007

   52,800,784    $ 52,801    $ 2,521    $ (490,027 )   $ 26,143     $ (408,562 )
                                           

Six months ended July 1, 2007

               

Balance at January 1, 2007

   52,720,784    $ 52,721    $ 2,451    $ (370,314 )   $ 30,601     $ (284,541 )

Exercise of unit options

   80,000      80      —        —         —         80  

Unit-based compensation

   —        —        70      —         —         70  

Dividends accrued on preferred units

   —        —        —        (5,853 )     —         (5,853 )

Retained earnings carried over from prior year (FIN 48)

   —        —        —        (1,554 )     —         (1,554 )

Comprehensive income (loss):

               

Net loss

   —        —        —        (112,306 )     —         (112,306 )

Fair valuation of derivatives

   —        —        —        —         (934 )     (934 )

Foreign currency translation adjustments

   —        —        —        —         (3,524 )     (3,524 )
                     

Total comprehensive loss

                  (116,764 )
                                           

Balance at July 1, 2007

   52,800,784    $ 52,801    $ 2,521    $ (490,027 )   $ 26,143     $ (408,562 )
                                           

The accompanying notes are an integral part of these financial statements

 

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Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited; in thousands of US dollars)

 

     Six months ended  
     July 1, 2007     July 2, 2006  

Cash flows from operating activities

    

Net loss

   $ (112,306 )   $ (135,954 )

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

    

Depreciation and amortization

     89,974       102,509  

Provision for severance benefits

     9,379       5,357  

Amortization of debt issuance costs

     1,929       1,833  

(Gain) loss on foreign currency translation, net

     (6,326 )     (42,367 )

Impairment charges

     10,106       92,540  

Other

     110       465  

Changes in operating assets and liabilities

    

Accounts receivable

     (40,442 )     25,007  

Inventories

     (13,237 )     31,539  

Other receivables

     (411 )     3,114  

Accounts payable

     18,857       (47,177 )

Other accounts payable

     (8,135 )     (15,996 )

Accrued expenses

     392       (2,088 )

Other current assets

     3,430       (821 )

Other current liabilities

     347       (5,570 )

Payment of severance benefits

     (4,402 )     (4,559 )

Other

     768       2,637  
                

Net cash provided by (used in) operating activities

     (49,967 )     10,469  
                

Cash flows from investing activities

    

Purchase of plant, property and equipment

     (24,399 )     (19,332 )

Purchase of intangible assets

     (561 )     (1,178 )

Proceeds from disposal of plant, property and equipment

     322       2,202  

Proceeds from disposal of intangible assets

     —         2,794  

Decrease in restricted cash

     —         1,876  

Other

     512       (927 )
                

Net cash used in investing activities

     (24,126 )     (14,565 )
                

Cash flows from financing activities

    

Exercise of unit options

     80       82  

Repurchase of common units

     —         (414 )

Proceeds from short-term borrowings

     40,000       —    
                

Net cash provided by financing activities

     40,080       (332 )

Effect of exchange rates on cash and cash equivalents

     (426 )     4,342  
                

Net increase (decrease) in cash and cash equivalents

     (34,439 )     (86 )
                

Cash and cash equivalents

    

Beginning of the period

     89,173       86,574  
                

End of the period

   $ 54,734     $ 86,488  
                

The accompanying notes are an integral part of these financial statements

 

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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, 2006, which was filed with the SEC on March 30, 2007. The results of operations for the six-month period ended July 1, 2007 are not necessarily indicative of the results to be expected for a full year or for any other periods.

Recent accounting pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statements of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which provides companies with an option to report selected financial assets and liabilities at fair value in an attempt to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. This Statement is effective as of the beginning of an entity’s first fiscal year 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 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.

 

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Table of Contents

MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

2. Inventories

Inventories as of July 1, 2007 and December 31, 2006 consist of the following:

 

     July 1, 2007     December 31, 2006  

Finished goods

   $ 9,160     $ 16,169  

Semi-finished goods and work-in-process

     60,327       39,492  

Raw materials

     11,127       11,774  

Materials in-transit

     810       2,063  

Less: valuation allowances

     (9,701 )     (11,652 )
                

Inventories, net

   $ 71,723     $ 57,846  
                

3. Property, Plant and Equipment

Property, plant and equipment as of July 1, 2007 and December 31, 2006 comprise the following:

 

     July 1, 2007     December 31, 2006  

Buildings and related structures

   $ 153,110     $ 162,383  

Machinery and equipment

     383,696       369,683  

Vehicles and others

     50,263       42,772  
                
     587,069       574,838  

Less: accumulated depreciation

     (321,121 )     (252,814 )

Land

     12,581       12,481  

Construction in-progress

     —         1,774  
                

Property, plant and equipment, net

   $ 278,529     $ 336,279  
                

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

4. Intangible Assets

Intangible assets as of July 1, 2007 and December 31, 2006 are as follows:

 

     July 1, 2007     December 31, 2006  

Technology

   $ 21,460     $ 21,289  

Customer relationships

     171,286       170,209  

Goodwill

     15,095       15,095  

Intellectual property assets

     9,553       9,742  

Less: accumulated amortization

     (93,899 )     (76,606 )
                

Intangible assets, net

   $ 123,495     $ 139,729  
                

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     Six months ended  
     July 1, 2007     July 2, 2006     July 1, 2007     July 2, 2006  

Beginning balance

   $ 87     $ 1,027     $ 112     $ 1,036  

Addition to (reversal of) warranty reserve

     251       (693 )     306       (575 )

Payments made

     (162 )     (140 )     (241 )     (308 )

Translation adjustments

     4       13       3       54  
                                

Ending balance

   $ 180     $ 207     $ 180     $ 207  
                                

6. Short-term borrowings

On December 23, 2004, the Company and its subsidiaries, including MagnaChip Semiconductor S.A. and MagnaChip Semiconductor Finance Company, as borrowers, entered into a 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.

Under the senior secured revolving credit facility, among other things, on the last day of each fiscal month, the Company is required to maintain the sum of (A) the unutilized and available revolving commitments and (B) the qualified and unrestricted cash and cash equivalents held by the borrowers and the guarantors to be not less than $ 75,000,000 (“Liquidity Requirement”). Presently, borrowings under the credit agreement bear interest equal to the 3-month LIBOR plus 4.75% or Alternate Base Rate (“ABR”) plus 3.75%. Additionally, the Company is required to pay the administrative agent for the account of each lender a commitment fee equal to 0.5% on the average daily unused amount of the commitment of each Lender during the period from December 23, 2004 to but excluding the date on which such commitments terminate. At July 1, 2007, the Company had borrowed $40.0 million under this credit agreement.

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

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

On June 28, 2007, the Company entered into the Seventh Amendment to Credit Agreement, dated as of June 28, 2007 (the “Seventh Amendment”), with MagnaChip Semiconductor S.A. and MagnaChip Semiconductor Finance Company, as borrowers, the Subsidiary Guarantors party thereto, the Lenders party thereto, and UBS AG, Stamford Branch, as administrative agent and collateral agent. Under the Seventh Amendment, among other things, the use of proceeds provision under Section 3.12 of the Credit Agreement was revised to provide increased flexibility for MagnaChip Semiconductor S.A. to use proceeds of any borrowing under the Credit Agreement.

Details of short-term borrowings as of July 1, 2007 are presented as below:

 

     Maturity    Annual interest rate (%)    Amount of
principal

Euro dollar Revolving Loan

   2007-09-21    3 month LIBOR + 4.75    $ 7,000

Euro dollar Revolving Loan

   2007-09-24    3 month LIBOR + 4.75      13,000

ABR Revolving Loan

   2007-07-03    ABR + 3.75      20,000
            
         $ 40,000
            

Subsequent to quarter end, on July 3, 2007, we repaid the ABR Revolving Loan in the amount of $20 million from cash on hand.

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

7. 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.

Details of long-term borrowings as of July 1, 2007 and December 31, 2006 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

6 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.

As of July 1, 2007, 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 July 1, 2007, 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 the Second Priority Senior Secured Notes and Senior Subordinated Notes.

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 June 15, 2008.

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

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 six-month period ended July 1, 2007, the Company recorded changes in the fair value of the Swap amounting to $934 thousand, under other comprehensive income in the accompanying condensed consolidated financial statements. In addition, during the same period, the Company recognized interest income of $1,901 thousand, which represents the differences between fixed and variable rates.

8. 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 July 1, 2007, 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     Six months ended  
     July 1, 2007     July 2, 2006     July 1, 2007     July 2, 2006  

Beginning balance

   $ 65,101     $ 59,249     $ 64,642     $ 56,967  

Provisions

     5,198       2,320       9,379       5,357  

Severance payments

     (1,438 )     (1,701 )     (4,402 )     (4,559 )

Effect of foreign currency translation and other

     1,321       925       563       3,028  
                                

Ending balance

     70,182       60,793       70,182       60,793  
                                

Less: Cumulative contributions to the National Pension Fund

     (816 )     (888 )     (816 )     (888 )

 Group Severance insurance plan

     (913 )     (947 )     (913 )     (947 )
                                
   $ 68,453     $ 58,958     $ 68,453     $ 58,958  
                                

The severance benefits are funded approximately 2.46% and 3.02% as of July 1, 2007 and July 2, 2006, 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

2008

   $ —  

2009

     71

2010

     217

2011

     76

2012

     152

2013 – 2017

     5,110

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.

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

9. Redeemable Convertible Preferred Units

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 some of the Series B were redeemed by cash on December 15, 2004 and December 27, 2004.

Changes in Series B for the three and six months ended July 1, 2007 are as follows:

 

     Three months ended
     July 1, 2007    July 2, 2006
     Units    Amount    Units    Amount

Beginning of period

   93,997    $ 120,244    93,997    $ 109,095

Accrual of preferred dividends

   —        2,983    —        2,706
                       

End of period

   93,997    $ 123,227    93,997    $ 111,801
                       

 

     Six months ended
     July 1, 2007    July 2, 2006
     Units    Amount    Units    Amount

Beginning of period

   93,997    $ 117,374    93,997    $ 106,462

Accrual of preferred dividends

   —        5,853    —        5,339
                       

End of period

   93,997    $ 123,227    93,997    $ 111,801
                       

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.

10. Earnings per Unit

The following table illustrates the computation of basic and diluted loss per common unit for the three-month and six-month periods ended July 1, 2007 and July 2, 2006:

 

     Three months ended     Six months ended  
     July 1, 2007     July 2, 2006     July 1, 2007     July 2, 2006  

Net loss

   $ (45,324 )   $ (132,063 )   $ (112,306 )   $ (135,954 )

Dividends to preferred unitholders

     2,983       2,706       5,853       5,339  
                                

Net loss attributable to common units

   $ (48,307 )   $ (134,769 )   $ (118,159 )   $ (141,293 )
                                

Weighted-average common units outstanding

     52,772,652       53,098,537       52,746,718       53,101,546  
                                

Basic and diluted loss per unit

   $ (0.92 )   $ (2.54 )   $ (2.24 )   $ (2.66 )
                                

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

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:

 

     Six months ended
     July 1, 2007    July 2, 2006

Redeemable convertible preferred units

   93,997    93,997

Options

   4,725,871    5,107,886

Warrant

   —      5,079,254

In connection with the acquisition of the Company’s business from Hynix Semiconductor Inc. on October 6, 2004, the Company issued a warrant to Hynix which enabled 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.

 

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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

Assets impairment

During the three months ended July 1, 2007, the Company recognized impairment charges of $10,106 thousand under SFAS No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (“SFAS No. 144”). The impairment charges were recorded related to the closure of one of the Company’s 5-inch wafer fabrication facilities that has generated losses and no longer supported the Company’s strategic technology roadmap. During the six months ended July 2, 2006, the Company recorded impairment charges of $92,540 thousand under SFAS No. 144. The impairment charges were recorded against one of our fabrication facilities and certain related technology and customer-based intangible assets (the “asset group”).

SFAS No. 144 requires the Company to evaluate the recoverability of certain long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The net book value of the asset group before the impairment charges as of July 1, 2007 and July 2, 2006 were approximately $10,228 and $185,985 thousand, respectively.

The impairment charge was measured as an excess of the carrying value of the asset group over its fair value. The fair value of the asset group was estimated using a present value technique, where expected future cash flows from the use and eventual disposal of the asset group were discounted by an interest rate commensurate with the risk of the cash flows.

Restructuring

During the three months ended July 1, 2007, the Company recognized $1,978 thousand of restructuring under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”). The restructuring charges were related to the closure of the Company’s 5-inch wafer fabrication facilities to be completed by the end of 2007. These charges consist of one-time termination benefits, transfer of machinery and other associated costs.

During the three months ended July 2, 2006, the Company recorded restructuring charges of $1,144 thousand in accordance with SFAS No. 146. These charges were incurred in association with changes in the Company’s management judgment.

12. Uncertainty in Income Taxes

The Company, including its subsidiaries files income tax returns in Korea, Japan, Taiwan, U.S. and various other jurisdictions. The Company is subject to income tax examinations by tax authorities of these jurisdictions for all years since the beginning of its operation in October 2004.

The Company adopted the provisions of FIN No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of SFAS No. 109, on January 1, 2007. As a result of the implementation of FIN No. 48, the Company recognized a $ 1,554 thousand increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007, balance of retained earnings. Total amount of unrecognized tax benefits as of the date of adoption was $6,908 thousand and it related to temporary difference arising from timing of expensing certain inventories. There was no change in total amount of unrecognized tax benefits during the three months ended July 1, 2007.

The Company recognizes interest and penalties accrued related to unrecognized tax benefits as income tax expenses. The Company recognized $40 thousand and $80 thousand of interest and penalties, respectively, for the three and six months ended July 1, 2007. Total interest and penalties accrued as of July 1, 2007 and as of the adoption date were $622 thousand and $581 thousand respectively.

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

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 operating expense, interest income or expense, other income or expense, or income tax to the segments. Management does not evaluate segments based on these criteria.

The following sets forth information relating to the reportable segments:

 

     Three months ended  
     July 1, 2007    July 2, 2006  

Net Sales

     

Display Solutions

   $ 85,113    $ 73,292  

Imaging Solutions

     17,371      15,596  

Semiconductor Manufacturing Services

     75,086      97,023  

All other

     16,483      11,702  
               

Total segment net sales

   $ 194,053    $ 197,613  
               

Gross Profit (Loss)

     

Display Solutions

   $ 8,136    $ 8,089  

Imaging Solutions

     1,272      (3,642 )

Semiconductor Manufacturing Services

     11,716      16,635  

All other

     6,630      (811 )
               

Total segment gross profit

   $ 27,754    $ 20,271  
               

 

     Six months ended  
     July 1, 2007     July 2, 2006  

Net Sales

    

Display Solutions

   $ 143,983     $ 159,060  

Imaging Solutions

     29,143       35,000  

Semiconductor Manufacturing Services

     132,841       196,398  

All other

     39,869       20,298  
                

Total segment net sales

   $ 345,836     $ 410,756  
                

Gross Profit (Loss)

    

Display Solutions

   $ 15,225     $ 26,069  

Imaging Solutions

     (148 )     (8,010 )

Semiconductor Manufacturing Services

     14,563       41,222  

All other

     13,037       1,318  
                

Total segment gross profit

   $ 42,677     $ 60,599  
                

 

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MagnaChip Semiconductor LLC and Subsidiaries

Notes to Condensed Consolidated Financial Statements – (Continued)

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

 

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 July 1, 2007 and December 31, 2006, condensed consolidating statements of operations for the three months and six months ended July 1, 2007 and July 2, 2006 and condensed consolidating statement of cash flows for the six months ended July 1, 2007 and July 2, 2006 of those entities that guarantee the Senior Subordinated Notes, those that do not, MagnaChip Semiconductor LLC, and the co-issuers.

 

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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 July 1, 2007

 

    

MagnaChip
Semiconductor
LLC

(Parent)

    Co-Issuers    

Non-

Guarantors

    Guarantors     Eliminations     Consolidated  

Net sales

   $ —       $ —       $ 188,651     $ 80,257     $ (74,855 )   $ 194,053  

Cost of sales

     —         —         165,326       69,832       (68,859 )     166,299  
                                                

Gross profit

     —         —         23,325       10,425       (5,996 )     27,754  
                                                

Selling, general and administrative expenses

     189       229       21,905       3,271       (63 )     25,531  

Research and development expenses

     —         —         32,778       5,641       (5,885 )     32,534  

Restructuring and impairment charge

     —         —         12,084       —         —         12,084  
                                                

Operating income (loss)

     (189 )     (229 )     (43,442 )     1,513       (48 )     (42,395 )
                                                

Other income (expenses)

     —         (1,524 )     (27 )     467       —         (1,084 )
                                                

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

     (189 )     (1,753 )     (43,469 )     1,980       (48 )     (43,479 )
                                                

Income tax expenses

     —         42       1       1,802       —         1,845  
                                                

Loss before equity in loss of related investment

     (189 )     (1,795 )     (43,470 )     178       (48 )     (45,324 )
                                                

Loss of related investment

     (45,135 )     (43,557 )     —         (43,079 )     131,771       —    
                                                

Net loss

   $ (45,324 )   $ (45,352 )   $ (43,470 )   $ (42,901 )   $ 131,723     $ (45,324 )
                                                

Dividends accrued on preferred units

     2,983       —         —         —         —         2,983  
                                                

Net loss attributable to common units

   $ (48,307 )   $ (45,352 )   $ (43,470 )   $ (42,901 )   $ 131,723     $ (48,307 )
                                                

 

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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 six months ended July 1, 2007

 

    

MagnaChip
Semiconductor
LLC

(Parent)

    Co-Issuers    

Non-

Guarantors

    Guarantors     Eliminations     Consolidated  

Net sales

   $ —       $ —       $ 335,257     $ 137,099     $ (126,520 )   $ 345,836  

Cost of sales

     —         —         301,040       117,832       (115,713 )     303,159  
                                                

Gross profit

     —         —         34,217       19,267       (10,807 )     42,677  
                                                

Selling, general and administrative expenses

     245       561       40,707       6,683       64       48,260  

Research and development expenses

     —         —         68,076       10,225       (10,649 )     67,652  

Restructuring and impairment charge

     —         —         12,084       —         —         12,084  
                                                

Operating income (loss)

     (245 )     (561 )     (86,650 )     2,359       (222 )     (85,319 )
                                                

Other expenses

     —         (2,630 )     (20,015 )     (246 )     —         (22,891 )
                                                

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

     (245 )     (3,191 )     (106,665 )     2,113       (222 )     (108,210 )
                                                

Income tax expenses

     —         85       34       3,977       —         4,096  
                                                

Loss before equity in loss of related investment

     (245 )     (3,276 )     (106,699 )     (1,864 )     (222 )     (112,306 )
                                                

Loss of related investment

     (112,061 )     (109,002 )     —         (106,669 )     327,732       —    
                                                

Net loss

   $ (112,306 )   $ (112,278 )   $ (106,699 )   $ (108,533 )   $ 327,510     $ (112,306 )
                                                

Dividends accrued on preferred units

     5,853       —         —         —         —         5,853  
                                                

Net loss attributable to common units

   $ (118,159 )   $ (112,278 )   $ (106,699 )   $ (108,533 )   $ 327,510     $ (118,159 )
                                                

 

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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 July 2, 2006

 

    

MagnaChip
Semiconductor
LLC

(Parent)

    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  

Net sales

   $ —       $ —       $ 189,395     $ 101,591     $ (93,373 )   $ 197,613  

Cost of sales

     —         —         174,434       93,489       (90,581 )     177,342  
                                                

Gross profit

     —         —         14,961       8,102       (2,792 )     20,271  
                                                

Selling, general and administrative expenses

     35       269       19,115       2,606       —         22,025  

Research and development expenses

     —         —         34,003       3,573       (3,642 )     33,934  

Restructuring and Impairment charges

     —         —         93,459       225       —         93,684  
                                                

Operating income (loss)

     (35 )     (269 )     (131,616 )     1,698       850       (129,372 )
                                                

Other income (expenses)

     —         6,106       2,058       (7,996 )     —         168  
                                                

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

     (35 )     5,837       (129,558 )     (6,298 )     850       (129,204 )
                                                

Income tax expenses

     —         41       —         2,818       —         2,859  
                                                

Income (loss) before equity in loss of related Investment

     (35 )     5,796       (129,558 )     (9,116 )     850       (132,063 )
                                                

Loss of related investment

     (132,028 )     (138,126 )     —         (129,642 )     399,796       —    
                                                

Net loss

   $ (132,063 )   $ (132,330 )   $ (129,558 )   $ (138,758 )   $ 400,646     $ (132,063 )
                                                

Dividends accrued on preferred units

     2,706       —         —         —         —         2,706  
                                                

Net loss attributable to common units

   $ (134,769 )   $ (132,330 )   $ (129,558 )   $ (138,758 )   $ 400,646     $ (134,769 )
                                                

 

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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 six months ended July 2, 2006

 

    

MagnaChip
Semiconductor
LLC

(Parent)

    Co-Issuers     Non-Guarantors     Guarantors     Eliminations     Consolidated  

Net sales

   $ —       $ —       $ 397,823     $ 200,385     $ (187,452 )   $ 410,756  

Cost of sales

     —         —         346,877       185,853       (182,573 )     350,157  
                                                

Gross profit

     —         —         50,946       14,532       (4,879 )     60,599  
                                                

Selling, general and administrative expenses

     68       517       37,772       5,199       —         43,556  

Research and development expenses

     —         —         62,745       6,985       (5,878 )     63,852  

Restructuring and Impairment charges

     —         —         93,459       225       —         93,684  
                                                

Operating income (loss)

     (68 )     (517 )     (143,030 )     2,123       999       (140,493 )
                                                

Other income (expenses)

     —         10,421       13,268       (14,017 )     —         9,672  
                                                

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

     (68 )     9,904       (129,762 )     (11,894 )     999       (130,821 )
                                                

Income tax expenses

     —         82       —         5,051       —         5,133  
                                                

Income (loss) before equity in loss of related Investment

     (68 )     9,822       (129,762 )     (16,945 )     999       (135,954 )
                                                

Loss of related investment

     (135,886 )     (144,867 )     —         (130,138 )     410,891       —    
                                                

Net loss

   $ (135,954 )   $ (135,045 )   $ (129,762 )   $ (147,083 )   $ 411,890     $ (135,954 )
                                                

Dividends accrued on preferred units

     5,339       —         —         —         —         5,339  
                                                

Net loss attributable to common units

   $ (141,293 )   $ (135,045 )   $ (129,762 )   $ (147,083 )   $ 411,890     $ (141,293 )
                                                

 

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

July 1, 2007

 

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

Assets

            

Current assets

            

Cash and cash equivalents

   $ 267     $ 21,044     $ 31,496     $ 1,927     $ —       $ 54,734  

Accounts receivable, net

     —         —         120,070       54,161       (57,019 )     117,212  

Inventories, net

     —         —         69,796       2,005       (78 )     71,723  

Other receivables

     —         717       6,166       21,389       (21,094 )     7,178  

Short-term inter-company loans

     —         20,000       —         20,000       (40,000 )     —    

Other current assets

     21       9,901       19,901       5,950       (16,127 )     19,646  
                                                

Total current assets

     288       51,662       247,429       105,432       (134,318 )     270,493  
                                                

Property, plant and equipment, net

     —         —         276,217       2,312       —         278,529  

Intangible assets, net

     —         —         102,759       20,922       (186 )     123,495  

Investments in subsidiaries

     (285,549 )     (360,143 )     —         (189,009 )     834,701       —    

Long-term inter-company loans

     —         795,808       —         633,527       (1,429,335 )     —    

Other non-current assets

     —         18,972       42,372       9,419       (21,435 )     49,328  
                                                

Total assets

     (285,261 )     506,299       668,777       582,603       (750,573 )     721,845  
                                                

Liabilities and Unitholders’ equity

            

Current liabilities

            

Accounts payable

   $ —       $ —       $ 91,119     $ 46,529     $ (57,019 )   $ 80,629  

Other accounts payable

     —         6       50,293       4,269       (21,094 )     33,474  

Accrued expenses

     74       3,234       22,502       11,262       (12,905 )     24,167  

S/T Borrowings

     —         40,000       20,000       20,000       (40,000 )     40,000  

Other current liabilities

     —         418       1,369       4,694       (3,222 )     3,259  
                                                

Total current liabilities

     74       43,658       185,283       86,754       (134,240 )     181,529  
                                                

Long-term borrowings

     —         750,000       621,000       808,335       (1,429,335 )     750,000  

Accrued severance benefits, net

     —         —         68,112       341       —         68,453  

Other non-current liabilities

     —         —         5,557       23,076       (21,435 )     7,198  
                                                

Total liabilities

     74       793,658       879,952       918,506       (1,585,010 )     1,007,180  

Commitments and contingencies

            

Series A redeemable convertible preferred units

     —         —         —         —         —         —    

Series B redeemable convertible preferred units

     123,227       —         —         —         —         123,227  
                                                

Total redeemable convertible preferred units

     123,227       —         —         —         —         123,227  
                                                

Unitholders’ equity

            

Common units

     52,801       136,229       39,005       55,778       (231,012 )     52,801  

Additional paid-in capital

     2,521       1,464       155,478       108,310       (265,252 )     2,521  

Accumulated deficit

     (490,027 )     (451,944 )     (431,611 )     (522,575 )     1,406,130       (490,027 )

Accumulated other comprehensive income

     26,143       26,892       25,953       22,584       (75,429 )     26,143  
                                                

Total unitholders’ equity

     (408,562 )     (287,359 )     (211,175 )     (335,903 )     834,437       (408,562 )
                                                

Total liabilities, redeemable convertible preferred units and unitholders’ equity

   $ (285,261 )   $ 506,299     $ 668,777     $ 582,603     $ (750,573 )   $ 721,845  
                                                

 

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 Balance Sheet

December 31, 2006

 

    

MagnaChip
Semiconductor
LLC

(Parent)

    Co-Issuers    

Non-

Guarantors

    Guarantors     Eliminations     Consolidated  

Assets

            

Current assets

            

Cash and cash equivalents

   $ 321     $ 892     $ 72,608     $ 15,352     $ —       $ 89,173  

Accounts receivable, net

     —         —         86,488       34,971       (44,794 )     76,665  

Inventories, net

     —         —         55,676       2,208       (38 )     57,846  

Other receivables

     —         718       5,244       28,133       (27,341 )     6,754  

Other current assets

     58       15,862       12,843       6,692       (21,829 )     13,626  
                                                

Total current assets

     379       17,472       232,859       87,356       (94,002 )     244,064  
                                                

Property, plant and equipment, net

     —         —         334,809       1,470       —         336,279  

Intangible assets, net

     —         —         117,101       22,628       —         139,729  

Investments in subsidiaries

     (167,545 )     (246,126 )     —         (77,489 )     491,160       —    

Long-term inter-company loans

     —         791,648       —         633,987       (1,425,635 )     —    

Other non-current assets

     —         21,349       41,972       9,702       (23,042 )     49,981  
                                                

Total assets

   $ (167,166 )   $ 584,343     $ 726,741     $ 677,654     $ (1,051,519 )   $ 770,053  
                                                

Liabilities and Unitholders’ equity

            

Current liabilities

            

Accounts payable

   $ —       $ —       $ 67,002     $ 40,191     $ (44,794 )   $ 62,399  

Other accounts payable

     —         6       51,803       7,955       (27,341 )     32,423  

Accrued expenses

     1       3,135       22,040       17,078       (18,607 )     23,647  

Other current liabilities

     —         333       1,844       4,025       (3,222 )     2,980  
                                                

Total current liabilities

     1       3,474       142,689       69,249       (93,964 )     121,449  
                                                

Long-term borrowings

     —         750,000       621,000       804,635       (1,425,635 )     750,000  

Accrued severance benefits, net

     —         —         62,550       286       —         62,836  

Other non-current liabilities

     —         —         1,191       24,786       (23,042 )     2,935  
                                                

Total liabilities

     1       753,474       827,430       898,956       (1,542,641 )     937,220  

Commitments and contingencies

            

Series A redeemable convertible preferred units

     —         —         —         —         —         —    

Series B redeemable convertible preferred unites

     117,374       —         —         —         —         117,374  
                                                

Total redeemable convertible preferred units

     117,374       —         —         —         —         117,374  
                                                

Unitholders’ equity

            

Common units

     52,721       136,229       39,005       55,778       (231,012 )     52,721  

Additional paid-in capital

     2,451       1,401       155,415       108,239       (265,055 )     2,451  

Accumulated deficit

     (370,314 )     (338,112 )     (323,358 )     (412,488 )     1,073,958       (370,314 )

Accumulated other comprehensive income

     30,601       31,351       28,249       27,169       (86,769 )     30,601  
                                                

Total unitholders’ equity

     (284,541 )     (169,131 )     (100,689 )     (221,302 )     491,122       (284,541 )
                                                

Total liabilities, redeemable convertible preferred units and unitholders’ equity

   $ (167,166 )   $ 584,343     $ 726,741     $ 677,654     $ (1,051,519 )   $ 770,053  
                                                

 

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 six months ended July 1, 2007

 

    

MagnaChip
Semiconductor
LLC

(Parent)

    Co-Issuers    

Non-

Guarantors

    Guarantors     Eliminations     Consolidated  

Cash flow from operating activities:

            

Net loss

   $ (112,306 )   $ (112,278 )   $ (106,699 )   $ (108,533 )   $ 327,510     $ (112,306 )

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

            

Depreciation and amortization

     —         —         87,890       2,084       —         89,974  

Provision for severance benefits

     —         —         9,312       67       —         9,379  

Amortization of debt issuance costs

     —         1,443       486       —         —         1,929  

(Gain) loss on foreign currency translation, net

     —         (4,160 )     (5,495 )     3,329       —         (6,326 )

Loss of related investment

     112,061       109,002       —         106,669       (327,732 )     —    

Impairment charges

     —         —         10,106       —         —         10,106  

Other

     —         —         55       55       —         110  

Changes in operating assets and liabilities:

            

Accounts receivable

     —         —         (33,036 )     (19,630 )     12,224       (40,442 )

Inventories

     —         —         (13,509 )     233       39       (13,237 )

Other receivables

     —         —         (871 )     6,707       (6,247 )     (411 )

Accounts payable

     —         —         24,099       6,982       (12,224 )     18,857  

Other accounts payable

     —         —         (10,740 )     (3,642 )     6,247       (8,135 )

Accrued expenses

     74       99       331       (5,814 )     5,702       392  

Other current assets

     39       5,961       3,915       886       (7,371 )     3,430  

Other current liabilities

     —         85       (480 )     (660 )     1,402       347  

Payment of severance benefits

     —         —         (4,402 )     —         —         (4,402 )

Other

     —         —         640       829       (701 )     768  
                                                

Net cash provided by (used in) operating activities

     (132 )     152       (38,398 )     (10,438 )     (1,151 )     (49,967 )
                                                

Cash flows from investing activities:

            

Purchase of plant, property and equipment

     —         —         (23,176 )     (1,223 )     —         (24,399 )

Payment for intellectual property registration

     —         —         (721 )     (34 )     194       (561 )

Proceeds from disposal of plant, property and equipment

     —         —         314       8       —         322  

Other

     —         (20,000 )     1,081       (20,569 )     40,000       512  
                                                

Net cash used in investing activities

       (20,000 )     (22,502 )     (21,818 )     40,194       (24,126 )
                                                

Cash flows from financing activities:

            

Exercise of unit options

     80       —         —         —         —         80  

Proceeds of short-term borrowings

     —         40,000       20,000       20,000       (40,000 )     40,000  
                                                

Net cash provided by financing activities

     80       40,000       20,000       20,000       (40,000 )     40,080  

Effect of exchange rate on cash and cash equivalents

     (2 )     —         (212 )     (1,169 )     957       (426 )
                                                

Net increase (decrease) in cash and cash equivalents

     (54 )     20,152       (41,112 )     (13,425 )     —         (34,439 )
                                                

Cash and cash equivalents:

            

Beginning of the period

     321       892       72,608       15,352       —         89,173  
                                                

End of the period

   $ 267     $ 21,044     $ 31,496     $ 1,927     $ —       $ 54,734  
                                                

 

23


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 six months ended July 2, 2006

 

    

MagnaChip
Semiconductor
LLC

(Parent)

    Co-Issuers     Non-
Guarantors
    Guarantors     Eliminations     Consolidated  

Cash flow from operating activities:

            

Net loss

   $ (135,954 )   $ (135,045 )   $ (129,762 )   $ (147,083 )   $ 411,890     $ (135,954 )

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

            

Depreciation and amortization

     —         —         100,410       2,099       —         102,509  

Provision for severance benefits

     —         —         5,315       42       —         5,357  

Amortization of debt issuance costs

     —         1,384       449       —         —         1,833  

Gain on foreign currency translation, net

     —         (12,067 )     (42,554 )     12,254       —         (42,367 )

Impairment charges

     —         —         92,540       —         —         92,540  

Loss of related investment

     135,886       144,867       —         130,138       (410,891 )     —    

Other

     —         —         651       (1,802 )     1,616       465  

Changes in operating assets and liabilities:

            

Accounts receivable

     —         —         14,306       5,275       5,426       25,007  

Inventories

     —         —         30,250       2,247       (958 )     31,539  

Other receivables

     434       —         2,689       (1,739 )     1,730       3,114  

Accounts payable

     —         —         (43,676 )     1,925       (5,426 )     (47,177 )

Other accounts payable

     35       (435 )     (14,954 )     1,088       (1,730 )     (15,996 )

Accrued expenses

     —         193       (412 )     (2,596 )     727       (2,088 )

Other current assets

     —         807       (676 )     (225 )     (727 )     (821 )

Other current liabilities

     —         82       (1,852 )     (3,800 )     —         (5,570 )

Payment of severance benefits

     —         —         (4,559 )     —         —         (4,559 )

Other

     —         (186 )     5,462       (1,023 )     (1,616 )     2,637  
                                                

Net cash provided by (used in) operating activities

     401       (400 )     13,627       (3,200 )     41       10,469  
                                                

Cash flows from investing activities:

            

Purchase of plant, property and equipment

     —         —         (18,890 )     (442 )     —         (19,332 )

Purchase of intangible assets

     —         —         (1,178 )     —         —         (1,178 )

Proceeds from disposal of plant, property and equipment

     —         —         2,201       1       —         2,202  

Proceeds from disposal of intangible assets

     —         —         2,794       —         —         2,794  

Decrease in restricted cash

     —         —         1,876       —         —         1,876  

Increase in short-term inter-company loans

     —         —         —         (5,500 )     5,500       —    

Other

     —         —         (946 )     19       —         (927 )
                                                

Net cash used in investing activities

     —         —         (14,143 )     (5,922 )     5,500       (14,565 )
                                                

Cash flows from financing activities:

            

Proceeds from short-term inter-company borrowings

     —         —         —         5,500       (5,500 )     —    

Exercise of unit options

     82       —         —         —         —         82  

Repurchase of common units

     (414 )     —         —         —         —         (414 )
                                                

Net cash provided by (used in) financing activities

     (332 )     —         —         5,500       (5,500 )     (332 )

Effect of exchange rate on cash and cash equivalents

     —         —         2,893       1,490       (41 )     4,342  
                                                

Net increase (decrease) in cash and cash equivalents

     69       (400 )     2,377       (2,132 )     —         (86 )
                                                

Cash and cash equivalents:

            

Beginning of the period

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

End of the period

   $ 278     $ 441     $ 65,812     $ 19,957     $ —       $ 86,488  
                                                

 

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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.

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 handsets, handheld gaming devices, PDAs, displays for desktop and mobile computer monitors and flat panel televisions. 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 address a broad spectrum of consumer electronics products ranging from camera-equipped mobile handsets to personal computer webcams, offering VGA, 1.3, 2.1 and 3.2 mega pixel CMOS image sensors. Our highly integrated image sensors are designed to be cost effective and to provide brighter, sharper and more colorful image quality for use primarily in applications that require small form factors, low power consumption, effective heat dissipation and high reliability.

 

   

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 specialty markets that utilize high-voltage, embedded memory, analog 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.

 

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Table of Contents

Results of Operations – Comparison of Three-Month Periods Ended July 1, 2007 and July 2, 2006.

The following table sets forth consolidated result of operations for the three months ended July 1, 2007 and July 2, 2006:

 

    

Three months ended

July 1, 2007

   

Three months ended

July 2, 2006

    Change  
     Amount    

% of

net sales

    Amount    

% of

net sales

    Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 194.1     100.0     $ 197.6     100.0     $ (3.5 )   (1.8 )

Cost of sales

     166.3     85.7       177.3     89.7       (11.0 )   (6.2 )
                              

Gross profit

     27.8     14.3       20.3     10.3       7.5     36.9  
                              

Selling, general and administrative expenses

     25.6     13.2       22.0     11.1       3.6     16.4  

Research and development expenses

     32.5     16.7       33.9     17.2       (1.4 )   (4.1 )

Restructuring and impairment charges

     12.1     6.2       93.7     47.4       (81.6 )   (87.1 )
                              

Operating loss

     (42.4 )   (21.8 )     (129.3 )   (65.4 )     86.9     (67.2 )

Interest expense, net

     (15.0 )   (7.7 )     (14.4 )   (7.3 )     (0.6 )   4.2  

Foreign currency gain, net

     13.9     7.2       14.5     7.3       (0.6 )   (4.1 )
                              

Loss before income taxes

     (43.5 )   (22.3 )     (129.2 )   (65.4 )     85.7     (66.3 )

Income tax expenses

     1.8     0.9       2.9     1.5       (1.1 )   (37.9 )
                              

Net loss

   $ (45.3 )   (23.2 )   $ (132.1 )   (66.9 )   $ 86.8     (65.7 )
                              

Net Sales

 

     Three months ended
July 1, 2007
   Three months ended
July 2, 2006
   Change  
     Amount   

% of

Total

   Amount   

% of

total

   Amount     %  
     (in millions of US dollars; %)  

Display solutions

   $ 85.1    43.8    $ 73.3    37.1    $ 11.8     16.1  

Imaging solutions

     17.4    9.0      15.6    7.9      1.8     11.5  

Semiconductor Manufacturing Services

     75.1    38.7      97.0    49.1      (21.9 )   (22.6 )

All other

     16.5    8.5      11.7    5.9      4.8     41.0  
                              
   $ 194.1    100.0    $ 197.6    100.0    $ (3.5 )   (1.8 )
                              

We derive a majority of our net sales from three operating segments: Display Solutions, Imaging Solutions and Semiconductor Manufacturing Services. The “All other” category represents certain business activities other than these business segments, principally composed of rental and unit processing.

Total net sales for the three months ended July 1, 2007 decreased $3.5 million, or 1.8% compared to the three months ended July 2, 2006. Net sales generated in the three operating segments during the most recently completed quarter were $177.6 million, a decrease of $8.3 million or 4.5% from the net sales of three operating segments for the prior-year quarter.

Display Solutions. Net sales from Display Solutions for the three months ended July 1, 2007 were $85.1 million, a $11.8 million or 16.1% increase from $73.3 million for the three months ended July 2, 2006. This sales increase in our display driver business was primarily attributable to higher volume driven from both current and the new products.

Imaging Solutions. Imaging Solutions net sales increased $1.8 million in the most recently completed quarter, or 11.5% compared to net sales generated in the prior-year quarter. This sales increase in our imaging solution business was primarily attributable to an increase in small form factor VGA product sales and 1.3 mega pixel designs wins.

Semiconductor Manufacturing Services. Net sales from Semiconductor Manufacturing Services for the second quarter of 2007 were $75.1 million, a $21.9 million or 22.6% decrease compared to net sales of $97.0 million for the prior-year quarter. This decrease was mainly due to decrease in end-market demand, coupled with continued average selling price erosion.

All other. Net sales from All other for the three months ended July 1, 2007 were $16.5 million compared to $11.7 million for the three months ended July 2, 2006.

 

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Gross Profit

 

     Three months ended
July 1, 2007
   Three months ended
July 2, 2006
    Change  
     Amount   

% of

net sales

   Amount    

% of

net sales

    Amount     %  
     (in millions of US dollars; %)  

Display solutions

   $ 8.2    9.6    $ 8.1     11.1     $ 0.1     1.2  

Imaging solutions

     1.3    7.5      (3.6 )   (23.1 )     4.9     —    

Semiconductor Manufacturing Services

     11.7    15.6      16.6     17.1       (4.9 )   (29.5 )

All other

     6.6    40.0      (0.8 )   (6.8 )     7.4     —    
                              
   $ 27.8    14.3    $ 20.3     10.3     $ 7.5     36.9  
                              

Total gross profit increased $7.5 million in the second quarter of 2007, or 36.9%, compared to the gross profit generated in the second quarter of 2006. Gross margin percentage for the most recently completed quarter was 14.3% of net sales, an increase of 4.0% from 10.3% for the prior-year quarter. This increase in gross margin percentage was mainly attributable to a volume increase in both unit processing and imaging solutions.

Display Solutions. Gross margin percentage for Display Solutions for the three months ended July 1, 2007 declined to 9.6% compared to 11.1% for the three months ended July 2, 2006. This decline in gross margin percentage was primarily attributable to average selling price erosion.

Imaging Solutions. Gross margin percentage for the most recently completed quarter was improved compared to the prior-year quarter mainly due to a decrease in depreciation cost resulting from impairment charges taken in the second quarter of 2006.

Semiconductor Manufacturing Services. Gross margin for Semiconductor Manufacturing Services declined to 15.6% in the second quarter of 2007 from 17.1% in the second quarter of 2006. A decrease in average selling price compared to the previous year’s second quarter resulted in a decline of gross margin for the segment.

All other. Gross margin percentage for All other for current period increased to 40.0% from (6.8)% in the second quarter of 2006. This improvement in gross margin percentage is mainly due to the volume increase from unit processing, which resulted in lower fixed cost per unit.

Operating Expenses

Selling, General and Administrative Expenses. Selling, general, and administrative expenses were $25.6 million or 13.2% of net sales for the three months ended July 1, 2007, compared to $22.0 million or 11.1% for the three months ended July 2, 2006. The increase of $3.6 million or 16.4% from the prior-year quarter was mainly attributable to employee related expenses such as salaries and benefits, and other expenses that included a special charge for a settlement with former subcontractors.

Research and Development Expenses. Research and development expenses for the most recently completed quarter were $32.5 million, a decrease of $1.4 million or 4.1% from $33.9 million for the prior year quarter. As a percentage of net sales, research and development expenses for the most recently completed quarter decreased to 16.7% compared to 17.2% for the prior-year quarter.

Restructuring and Impairment Charges. During the second quarter ended July 1, 2007, we recognized restructuring and impairment charges of $12.1 million which consisted of $10.1 million of impairment under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”) and $2.0 million of restructuring under SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”). The impairment charges were recorded related to the closure of our 5-inch wafer fabrication facilities that has generated losses and no longer supported to our strategic technology roadmap.

During the three months ended July 2, 2006, we recorded restructuring and impairment charges totaling $93.7 million, which included $92.5 million of impairment under SFAS No. 144 and $1.2 million of restructuring under SFAS No. 146. 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 incurred in association with changes in certain of our management.

 

27


Table of Contents

Net Interest Expense and Net Foreign Currency Gain or Loss

Net Interest Expense. Net interest expense was $15.0 million during the three-month period ended July 1, 2007, relatively consistent with $14.4 million for the three-month period ended July 2, 2006. Substantially all of our interest expense is to service our long-term borrowings of $750.0 million at a weighted-average interest rate of 7.4%. The increase in net interest expense was mainly due to a decrease in interest income from financial assets including cash and cash equivalents.

Net Foreign Currency Gain or Loss. Net foreign currency gain for the three months ended July 1, 2007 was $13.9 million, compared to net foreign exchange gain of $14.5 million for the three months ended July 2, 2006. A substantial portion of our net foreign currency gain or loss is non-cash translation gain or loss recorded for intercompany borrowings at our Korea subsidiary and is affected by changes in the exchange rate between Korea won and U.S. dollar.

Income Tax Expenses

Income Tax Expenses. Income tax expenses for the most recently completed quarter were $1.8 million, compared to income tax expenses of $2.9 million for the same quarter of 2006. Our income tax expenses are mostly composed of withholding taxes on inter-company interest payments and changes in deferred tax assets. Due to the uncertainty of utilization of foreign tax credits, we treated this withholding tax as a current tax expense.

 

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Table of Contents

Results of Operations – Comparison of Six-Month Periods Ended July 1, 2007 and July 2, 2006.

The following table sets forth consolidated result of operations for the six months ended July 1, 2007 and July 2, 2006:

 

    

Six months ended

July 1, 2007

   

Six months ended

July 2, 2006

    Change  
     Amount    

% of

net sales

    Amount    

% of

net sales

    Amount     %  
     (in millions of US dollars; %)  

Net sales

   $ 345.8     100.0     $ 410.8     100.0     $ (65.0 )   (15.8 )

Cost of sales

     303.1     87.7       350.2     85.2       (47.1 )   (13.4 )
                              

Gross profit

     42.7     12.3       60.6     14.8       (17.9 )   (29.5 )
                              

Selling, general and administrative expenses

     48.2     13.9       43.6     10.6       4.6     10.6  

Research and development expenses

     67.7     19.6       63.9     15.6       3.8     5.9  

Restructuring and impairment charges

     12.1     3.5       93.7     22.8       (81.6 )   (87.1 )
                              

Operating loss

     (85.3 )   (24.7 )     (140.6 )   (34.2 )     55.3     (39.3 )

Interest expense, net

     (29.4 )   (8.5 )     (29.1 )   (7.1 )     (0.3 )   1.0  

Foreign currency gain, net

     6.5     1.9       38.8     9.4       (32.3 )   (83.2 )
                              

Loss before income taxes

     (108.2 )   (31.3 )     (130.9 )   (31.9 )     22.7     (17.3 )

Income tax expenses

     4.1     1.2       5.1     1.2       (1.0 )   (19.6 )
                              

Net loss

   $ (112.3 )   (32.5 )   $ (136.0 )   (33.1 )   $ 23.7     (17.4 )
                              
Net Sales             
     Six months ended
July 1, 2007
    Six months ended
July 2, 2006
    Change  
     Amount    

% of

Total

    Amount    

% of

total

    Amount     %  
     (in millions of US dollars; %)  

Display solutions

   $ 144.0     41.6     $ 159.1     38.7     $ (15.1 )   (9.5 )

Imaging solutions

     29.1     8.4       35.0     8.5       (5.9 )   (16.9 )

Semiconductor Manufacturing Services

     132.8     38.4       196.4     47.8       (63.6 )   (32.4 )

All other

     39.9     11.6       20.3     5.0       19.6     96.6  
                              
   $ 345.8     100.0     $ 410.8     100.0     $ (65.0 )   (15.8 )
                              

We derive a majority of our net sales from three operating segments: Display Solutions, Imaging Solutions and Semiconductor Manufacturing Services. The “All other” category represents certain business activities other than these business segments, principally composed of rental and unit processing.

Total net sales for the six months ended July 1, 2007 decreased $65.0 million, or 15.8% compared to the six months ended July 2, 2006. Net sales generated in the three operating segments during the current period were $305.9 million, a decrease of $84.6 million or 21.7% from the net sales of our three operating segments for the prior-year period.

Display Solutions. Net sales from Display Solutions for the six months ended July 1, 2007 were $144.0 million, a $15.1 million or 9.5% decrease from $159.1 million for the six months ended July 2, 2006. This sales decrease was primarily attributable to a decline in average selling price.

Imaging Solutions. Imaging Solutions net sales decreased $5.9 million in the current period, or 16.9% compared to net sales generated in the prior-year period. This decrease was primarily attributable to the delays in transition to new mega-pixel products, which was expected to substitute our VGA products.

Semiconductor Manufacturing Services. Net sales from Semiconductor Manufacturing Services for the six months ended July 1, 2007, were $132.8 million, a $63.6 million or 32.4% decrease compared to net sales of $196.4 million for the six months ended July 2, 2006. This decrease was mainly due to a decrease in end-market demand, coupled with continued average selling price erosion.

All other. Net sales from All other for the six months ended July 1, 2007 were $39.9 million compared to $20.3 million for the six months ended July 2, 2006. This increase of $19.6 million substantially represents the revenue increase from our unit processing service.

 

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Table of Contents

Gross Profit

 

     Six months ended
July 1, 2007
    Six months ended
July 2, 2006
    Change  
     Amount    

% of

net sales

    Amount    

% of

net sales

    Amount     %  
     (in millions of US dollars; %)  

Display solutions

   $ 15.3     10.6     $ 26.1     16.4     $ (10.8 )   (41.4 )

Imaging solutions

     (0.2 )   (0.7 )     (8.0 )   (22.9 )     7.8     (97.5 )

Semiconductor Manufacturing Services

     14.5     10.9       41.2     21.0       (26.7 )   (64.8 )

All other

     13.1     32.8       1.3     6.4       11.8     907.7  
                              
   $ 42.7     12.3     $ 60.6     14.8     $ (17.9 )   (29.5 )
                              

Total gross profit decreased $17.9 million in the six months ended July 1, 2007, or 29.5%, compared to the gross profit generated in the six months ended July 2, 2006. Gross margin percentage for the six months ended July 1, 2007 was 12.3% of net sales, a decrease of 2.5% from 14.8% for the six months ended July 2, 2006. This decline in gross margin percentage was primarily attributable to an overall decrease in average selling prices.

Display Solutions. Gross margin percentage for Display Solutions for the six months ended July 1, 2007 declined to 10.6% compared to 16.4% for the six months ended July 2, 2006. This decline in gross margin percentage was primarily attributable to lower average selling price.

Imaging Solutions. Gross margin percentage for the current period was improved compared to the prior period mainly due to a decrease in depreciation costs resulting from impairment charges taken in the second quarter of 2006.

Semiconductor Manufacturing Services. Gross margin for Semiconductor Manufacturing Services declined to 10.9% in the six months ended July 1, 2007 from 21.0% in the six months ended July 2, 2006. The year-over-year decrease was mainly due to a decrease in end-user market demand and a decline in average selling price.

All other. Gross margin percentage for All other for current period increased to 32.8% from 6.4% for the prior period. This improvement in gross margin percentage is mainly attributable to sales volume increase for unit processing.

Operating Expenses

Selling, General and Administrative Expenses. Selling, general, and administrative expenses were $48.2 million or 13.9% of net sales for the six months ended July 1, 2007 compared to $43.6 million or 10.6% for the six months ended July 2, 2006. The increase of $4.6 million or 10.6% from the prior-year period was mainly attributable to employee related expenses, including other expenses such as the special charge for a settlement with former subcontractors, that was partially offset by decreases in depreciation and amortization expenses resulting from impairment charges taken during the second quarter of 2006.

Research and Development Expenses. Research and development expenses for the current period were $67.7 million, an increase of $3.8 million or 5.9% from $63.9 million for the prior year period. This increase in research and development expenses essentially represented our focus on the introduction of new products, especially for the Imaging Solutions and Semiconductor Manufacturing Services segments. As a percentage of net sales, research and development expenses for the current period increased to 19.6% compared to 15.6% for the prior-year period.

Restructuring and Impairment Charges. During the second quarter ended July 1, 2007, we recognized restructuring and impairment charges of $12.1 million which consisted of $10.1 million of impairment under SFAS No. 144 and $2.0 million of restructuring under SFAS No. 146. The impairment charges were recorded related to the closure of our 5-inch wafer fabrication facilities that has generated losses and no longer supported to our strategic technology roadmap.

During the six months ended July 2, 2006, we recorded restructuring and impairment charges totaling $93.7 million, which included $92.5 million of impairment under SFAS No. 144 and $1.2 million of restructuring under SFAS No. 146. 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 incurred in association with changes in certain of our management.

Net Interest Expense and Net Foreign Currency Gain or Loss

Net Interest Expense. Net interest expense was $29.4 million during the six months period ended July 1, 2007, relatively consistent with $29.1 million for the six months ended July 2, 2006. Substantially all of our interest expense is to

 

30


Table of Contents

service our long-term borrowings of $750.0 million at a weighted-average interest rate of 7.4%. The increase in net interest expense was mainly due to a decrease in interest income from financial assets including cash and cash equivalents.

Net Foreign Currency Gain or Loss. Net foreign currency gain for the six months ended July 1, 2007 was $6.5 million, compared to net foreign exchange gain of $38.8 million for the six months ended July 2, 2006. A substantial portion of our net foreign currency gain or loss is non-cash translation gain or loss recorded for intercompany borrowings at our Korea subsidiary and is affected by changes in the exchange rate between the Korea won and U.S. dollar.

Income Tax Expenses

Income Tax Expenses. Income tax expenses for the current period were $4.1 million, compared to income tax expenses of $5.1 million for the same period of 2006. Our income tax expenses are mostly composed of withholding taxes on inter-company interest payments and changes in deferred tax assets. Due to the uncertainty of the utilization of foreign tax credits, we treated this withholding tax as a current tax expense.

Liquidity and Capital Resources

Our principal capital requirements are to fund working capital needs, to meet required debt payments, including debt service payments on the notes and the senior credit facility, and to invest in research and development and capital equipment. 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, our research and development and capital expenditures needs and service requirements on our debt obligations for the foreseeable future. As of July 1, 2007, we had total outstanding long-term debt of $750.0 million.

Our principal sources of liquidity are our cash, cash equivalents and available borrowings under our senior credit facility of $100 million. As of July 1, 2007, our cash and cash equivalents balance was $54.7 million or 7.6% of our total assets, a $34.5 million decrease from $89.2 million or 11.6% of total assets as of December 31, 2006. The decrease in cash and cash equivalents during the first half of 2007 was primarily attributable to cash outflow of $50.0 million in operating activities, coupled with cash outflow related to six months capital expenditures of $25.0 million.

During the six-month period ended July 1, 2007, net cash used in operating activities was $50.0 million, compared to $10.5 million of net cash generated by operating activities during the year-ago period. This decrease in cash from operating activities between the two periods was primarily attributable to a reduction in gross profit of $17.9 million resulting mainly from lower revenue. The net operating cash outflow for the current period principally reflects our net loss of $112.3 million adjusted by $105.2 million which mostly consisted of costs related to depreciation, impairment and amortization charges and an increase in working capital of $42.9 million. </