SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003 COMMISSION FILE NO. 0-24790
--------------------
TOWER SEMICONDUCTOR LTD.
(Exact name of registrant as specified in its charter and translation of
registrant's name into English)
---------------------------------------------
ISRAEL
(Jurisdiction of incorporation or organization)
RAMAT GAVRIEL INDUSTRIAL PARK
P.O. BOX 619, MIGDAL HAEMEK, ISRAEL 23105
(Address of principal executive offices)
-----------------------------------------------
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED OR TO BE REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
ORDINARY SHARES, PAR VALUE NEW ISRAELI SHEKELS 1.00 PER SHARE
(Title of Class)
Warrants
(Title of Class)
SECURITIES FOR WHICH THERE IS A REPORTING OBLIGATION PURSUANT TO
SECTION 15(D) OF THE ACT:
None
Indicate the number of outstanding shares of each of the issuer's classes
of capital or common stock as of the close of the period covered by the annual
report:
51,696,097 Ordinary Shares
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 which financial statement item the registrant has
elected to follow:
Item 17 [_] Item 18 [X]
1
This annual report on Form 20-F includes certain "forward-looking"
statements within the meaning of Section 21E of the Securities Exchange Act of
1934. The use of the words "projects," "expects," "may," "plans" or "intends,"
or words of similar import, identifies a statement as "forward-looking." There
can be no assurance, however, that actual results will not differ materially
from our expectations or projections. Factors that could cause actual results to
differ from our expectations or projections include the risks and uncertainties
relating to our business described in this annual report at "Item 3. Risk
Factors."
------------
We have prepared our consolidated financial statements in United States
dollars and in accordance with accounting principles generally accepted in
Israel ("Israeli GAAP"). Israeli GAAP varies in certain significant respects
from accounting principles generally accepted in the United States of America
("U.S. GAAP"). The effect of the application of the latter on the financial
position and results of operations as of the dates and for the years presented
herein is summarized in Note 20 to our consolidated financial statements
included herein. All references herein to "dollars" or "$" are to United States
dollars, and all references to "Shekels" or "NIS" are to New Israeli Shekels.
------------
Manufacturing capacity refers to installed equipment capacity in our
facilities and is a function of the process technology and product mix being
manufactured because certain processes require more processing steps than
others. All information herein with respect to the wafer start capacity of our
manufacturing facilities is based upon our estimate of the effectiveness of the
manufacturing equipment and processes in use or expected to be in use during a
period and the actual or expected process technology mix for such period. Unless
otherwise specifically stated, all references herein to "wafers" in the context
of capacity in Fab 1 are to 150-mm wafers and in Fab 2 are to 200-mm wafers.
------------
References to "Israel Corporation" or "Israel Corp." include its
wholly-owned subsidiary Israel Corporation Technologies (ICTech) Ltd.
("ICTech").
------------
microFLASH(R) is a registered trademark of Tower and N-ROM(TM) is a
trademark of Saifun Semiconductor Ltd.
2
PART I
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT
AND ADVISORS 5
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 5
ITEM 3. KEY INFORMATION 5
SELECTED FINANCIAL DATA 5
RISK FACTORS 7
RISKS AFFECTING OUR BUSINESS 7
RISKS RELATED TO OUR ORDINARY SHARES 17
RISKS RELATED TO OUR OPERATIONS IN ISRAEL 20
ITEM 4. INFORMATION ON THE COMPANY 23
HISTORY AND DEVELOPMENT OF THE COMPANY 23
BUSINESS OVERVIEW 24
PROPRIETARY RIGHTS 34
ORGANIZATIONAL STRUCTURE 38
PROPERTY, PLANTS AND EQUIPMENT 38
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 41
OPERATING RESULTS 41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 41
LIQUIDITY AND CAPITAL RESOURCES 49
FAB 2 AGREEMENTS 52
RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES 62
TREND INFORMATION 62
OFF-BALANCE SHEET ARRANGEMENTS 63
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS 64
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 66
DIRECTORS AND SENIOR MANAGEMENT 66
COMPENSATION 69
BOARD PRACTICES 70
EMPLOYEES 72
SHARE OWNERSHIP 73
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 73
MAJOR SHAREHOLDERS 73
RELATED PARTY TRANSACTIONS 75
INTERESTS OF EXPERTS AND COUNSEL 76
ITEM 8. FINANCIAL INFORMATION 77
CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION 77
LEGAL PROCEEDINGS 77
SIGNIFICANT CHANGES 77
ITEM 9. THE OFFER AND LISTING 78
MARKETS AND SHARE PRICE HISTORY 78
ITEM 10. ADDITIONAL INFORMATION 80
ARTICLES OF ASSOCIATION; ISRAEL COMPANIES LAW 80
MATERIAL CONTRACTS 83
EXCHANGE CONTROLS 84
TAXATION 84
DOCUMENTS ON DISPLAY 87
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 88
RISK OF INTEREST RATE FLUCTUATION 88
FOREIGN EXCHANGE RISK 89
IMPACT OF INFLACTION 90
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 91
3
PART II
ITEM 13. DEFAULTS, DIVIDEND AVERAGES AND DELINQUENCIES 91
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS
AND USE OF PROCEEDS 91
ITEM 15. CONTROLS AND PROCEDURES 91
ITEM 16. [RESERVED] 91
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 91
ITEM 16B. CODE OF ETHICS 91
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 92
PART III
ITEM 17. FINANCIAL STATEMENTS 92
ITEM 18. FINANCIAL STATEMENTS 92
ITEM 19. EXHIBITS 92
4
PART I.
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not applicable.
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable.
ITEM 3. KEY INFORMATION
SELECTED FINANCIAL DATA
This section presents our selected historical financial data. You should
read carefully the financial statements included in this annual report,
including the notes to the financial statements. The selected data in this
section is not intended to replace the financial statements.
We derived the statement of operations data for the years ended December
31, 2003, 2002 and 2001, and balance sheet data as of December 31, 2003 and 2002
from the audited financial statements in this annual report. Those financial
statements were prepared in accordance with Israeli GAAP and audited by
Brightman Almagor & Co., a member firm of Deloitte Touche Tohmatsu, independent
auditors. We derived the statement of operations data for the years ended
December 31, 2000 and 1999 and the balance sheet data as of December 31, 2001,
2000 and 1999 from our audited financial statements that are not included in
this annual report, which have been prepared in accordance with Israel GAAP.
Statements of operations and selected operations data in accordance with US GAAP
would not have materially differed from respective data in accordance with
Israel GAAP. Other than as indicated below, balance sheet data in accordance
with US GAAP would not have materially differed from respective data in
accordance with Israel GAAP. Our management believes that the financial
statements contain all adjustments needed to present fairly the information
included in those statements and that the adjustments made consist only of
normal recurring adjustments.
5
Year Ended December 31,
-----------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
STATEMENT OF OPERATIONS DATA:
Sales $ 61,368 $ 51,801 $ 52,372 $ 104,775 $ 69,815
Cost of sales 122,395 67,022 76,733 88,787 77,033
--------- --------- --------- --------- ---------
Gross profit (loss) (61,027) (15,221) (24,361) 15,988 (7,218)
Research and development 20,709 17,031 9,556 8,965 9,238
Marketing, general and administrative 22,615 17,091 14,489 11,428 8,710
--------- --------- --------- --------- ---------
Operating loss (104,351) (49,343) (48,406) (4,405) (25,166)
Financing income (expense), net (9,826) (2,104) 1,465 1,394 2,277
Other income (expense), net (84) 45 8,419 (478) 17
--------- --------- --------- --------- ---------
Loss before income tax benefit (expense) (114,261) (51,402) (38,522) (3,489) (22,872)
Income tax benefit (expense) -- -- -- (500) 2,405
--------- --------- --------- --------- ---------
Loss for the period $(114,261) $ (51,402) $ (38,522) $ (3,989) $ (20,467)
========= ========= ========= ========= =========
Basic loss per ordinary share $ (2.40) $ (1.63) $ (1.92) $ (0.26) $ (1.54)
========= ========= ========= ========= =========
OTHER FINANCIAL DATA:
Depreciation and amortization $ 54,611 $ 18,821 $ 21,721 $ 25,917 $ 26,643
Capital expenditures before Investment Center 164,187 243,431 364,347 79,060 15,152
grants
AS OF DECEMBER 31,
----------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
SELECTED BALANCE SHEET DATA IN
ACCORDANCE WITH ISRAEL GAAP:
Cash and cash equivalents, including short-term deposits
and designated cash $ 56,490 $ 69,695 $ 33,202 $ 18,707 $ 41,880
Working capital 50,492 21,927 (16,335) 28,635 56,001
Total assets 788,335 716,261 472,054 179,298 155,211
Long-term debt 431,000 253,000 115,000 12,064 12,106
Convertible debentures 25,783 24,121 -- -- --
Long-term liabilities in respect of customers' advances 46,347 47,246 17,910 -- --
Shareholders' equity 229,457 298,334 252,805 134,648 122,121
Weighted average number of ordinary shares
outstanding (in thousands) 47,608 31,523 20,020 13,676 13,156
Number of shares issued and outstanding, as of
December 31, (*) (in thousands) 51,696 43,436 24,997 12,263 11,964
(*) Net of 1,300,000 Ordinary Shares held by the Company as of such dates.
6
AS OF DECEMBER 31,
-----------------------------------
2003 2002 2001 2000 1999
--------- --------- --------- --------- ---------
SELECTED BALANCE SHEET DATA IN
ACCORDANCE WITH US GAAP:
TOTAL ASSETS
According to Israel GAAP $ 788,335 $ 716,261 $ 472,054 $ 179,298 $ 155,211
The effect of:
Presentation of long-term liabilities in respect
of employees 14,607 12,368 10,334 7,952 7,088
Hedging activities (5,947) (5,727) (4,564) -- --
Sale of securities (*) (196) (196) -- -- --
Presentation of securities -- -- -- 12,563 --
--------- --------- --------- --------- ---------
According to US GAAP 796,799 $ 722,706 $ 477,824 $ 199,813 $ 162,299
========= ========= ========= ========= =========
SHAREHOLDERS' EQUITY
According to Israel GAAP $ 229,457 $ 298,334 $ 252,805 $ 134,648 $ 122,121
The effect of:
Hedging activities (15,867) (17,807) (8,169) -- --
Proceeds on account of share capital (16,428) -- -- -- --
Sale of securities (**) 2,363 2,363 -- -- --
Presentation of securities -- -- -- 12,563 --
--------- --------- --------- --------- ---------
According to US GAAP $ 199,525 $ 282,890 $ 244,636 $ 147,211 $ 122,121
========= ========= ========= ========= =========
(**) The allocation of a portion of the total proceeds from the sale of
securities issued in January 2002.
RISK FACTORS
This annual report and statements that we may make from time to time may
contain forward-looking information. There can be no assurance that actual
results will not differ materially from our expectations, statements or
projections. Factors that could cause actual results to differ from our
expectations, statements or projections include the risks and uncertainties
relating to our business described below.
7
RISKS AFFECTING OUR BUSINESS
IF WE DO NOT COMPLETE THE EQUIPMENT INSTALLATION, TECHNOLOGY TRANSFER AND
RAMP-UP OF PRODUCTION IN FAB 2, OUR BUSINESS WILL BE MATERIALLY ADVERSELY
AFFECTED.
We have completed the construction of Fab 2 but not the acquisition,
installation and equipping necessary for production at our planned full capacity
of 33,000 200-mm wafer starts per month, which we expect to reach by the end of
2006. We will also need to transfer 0.13 micron technology from Motorola to Fab
2 and develop new process technologies for Fab 2 in order to suit our customers'
needs. The ramp-up of Fab 2 is a substantial and complex project. We are
experiencing difficulties customary for projects of this type in the
installation, functionality and operation of the Fab 2 equipment during its
early manufacturing period. Failures or delays in obtaining and installing the
necessary equipment, technology and other resources may delay the completion of
the ramp-up of Fab 2 and add to its cost, which would have a material adverse
effect on our business and results of operations.
IF WE DO NOT HAVE SUFFICIENT FUNDS TO COMPLETE THE FAB 2 PROJECT, OUR BUSINESS
WILL BE MATERIALLY ADVERSELY AFFECTED.
We estimate that we will need approximately an additional $280 million to
finance the total cost of Fab 2 until we reach full capacity. Additionally, the
actual cost of Fab 2 may exceed our estimates. If we cannot successfully raise
sufficient funding to complete the ramp-up to 33,000 wafer starts per month, we
will be required to scale back our equipment purchases and capacity forecasts,
and, as a result, we will not fully utilize the substantial investment made in
constructing Fab 2, which will adversely affect our financial results.
THE CYCLICAL NATURE OF THE SEMICONDUCTOR INDUSTRY AND THE RESULTING PERIODIC
OVERCAPACITY HAVE ADVERSELY AFFECTED OUR BUSINESS IN THE PAST, RESULTING IN A
HISTORY OF LOSSES; DOWNWARD PRICE PRESSURE MAY SERIOUSLY HARM OUR BUSINESS.
The semiconductor industry has historically been highly cyclical.
Historically, companies in the semiconductor industry have expanded aggressively
during periods of increased demand. This expansion has frequently resulted in
overcapacity and excess inventories, leading to rapid erosion of average sale
prices. We expect this pattern to repeat itself in the future. Although the
semiconductor industry appears to be recovering and our sales in 2003 improved
in comparison with 2002, we cannot be assured that this overall recovery will
continue or that we will benefit from it through an increase in demand for our
products, resulting in an improvement in our financial results.
WE HAVE A RECENT HISTORY OF OPERATING LOSSES AND EXPECT TO OPERATE AT A LOSS
THROUGH THE FORESEEABLE FUTURE. OUR FACILITIES MUST OPERATE AT HIGH UTILIZATION
RATE FOR US TO BE PROFITABLE.
We operated at a loss for the last five years and expect to operate at a
loss for the foreseeable future. Fab 1 operated significantly below capacity
from 1996 through 2003. Because fixed costs represent a substantial portion of
the operating costs of semiconductor manufacturing operations, we must operate
our facilities at a high utilization rate. We are currently operating Fab 1 at a
capacity utilization of approximately 50%. During the third quarter of 2003, we
completed the construction of Fab 2, the qualification of process technologies
and the start of ramp-up of production These technologies and other Fab 2 assets
have started to incur significant operating expenses as well as depreciation and
amortization expenses.
8
WE MAY NOT BE ABLE TO CAPITALIZE ON AN INCREASE IN DEMAND FOR FOUNDRY SERVICES.
We are ramping-up Fab 2 based on our expectations of customer demand. In
order for demand for our wafer fabrication services to increase, the markets for
the end products using these services must develop and expand. For example, the
success of our imaging process technologies will depend, in part, on the growth
of markets for digital photography and video. Because our services may be used
in many new applications, it is difficult to forecast demand. If demand is lower
than expected, we may have excess capacity, which may adversely affect our
financial results. If demand is higher than expected, we may be unable to fill
all of the orders we receive, which may result in the loss of customers and
revenues.
IF WE DO NOT MEET CONDITIONS TO RECEIVE THE ISRAELI GOVERNMENT GRANTS AND TAX
BENEFITS APPROVED FOR FAB 2, WE MAY BE REQUIRED TO SEEK ALTERNATIVE FINANCING
SOURCES.
In connection with Fab 2, we received approval for grants and tax benefits
from the Investment Center of the government of Israel under its Approved
Enterprise Program. Under the terms of the approval, we are eligible to receive
grants of 20% of up to $1.25 billion invested in Fab 2 plant and equipment, or
an aggregate of up to $250 million. As of December 31, 2003, we had received
approximately $118 million in grants from the Investment Center. The Investment
Center requires that we complete our Fab 2 investments and achieve full
production capacity of 33,000 wafer starts per month by the end of 2005, and
Israeli law limits the ability of the Investment Center to extend this time
limitation, unless an exempting amendment to this law is adopted by the Israeli
parliament. We have notified the Investment Center of our revised investment
schedule and lower than initially projected expectations for Fab 2 sales; this
information is currently being evaluated by the Investment Center. While the
Investment Center has continued to fund the grant to us under our Approved
Enterprise Program, we cannot assure you that it will continue to do so if it
does not accept our revised investment schedule. In addition, even if the
Investment Center accepts our revised schedule, any failure by us to meet the
conditions of our grant may result in the cancellation of all or a portion of
our grants and tax benefits and in the Investment Center requiring us to repay
all or a portion of previous grants, which total $118 million as of December 31,
2003. If this were to happen, we would be required to seek alternative financing
sources to complete the ramp-up of Fab 2, which may have an adverse effect on
our operations.
IF WE DO NOT ATTRACT ADDITIONAL CUSTOMERS, OUR BUSINESS WILL BE ADVERSELY
AFFECTED.
For the year ended December 31, 2003, approximately 55% of our business was
generated by three customers, National Semiconductor (24%), SanDisk Corporation
(20%) and Motorola (11%). We expect to continue to receive a significant
portion of our revenue from a limited number of customers, with SanDisk, our
largest Fab 2 customer, accounting for a significant portion of the revenues we
expect to generate from Fab 2 in 2004. In 2003, SanDisk was instrumental in
ramping up our business and accounted for approximately 80% of our Fab 2
revenues. While we currently expect that SanDisk will continue to be a
significant customer of Fab 2, the percentage of Fab 2 revenues represented by
sales to SanDisk is expected to decrease as additional customers commence or
increase their purchase orders following the qualification of their products in
Fab 2. Loss or cancellation of business from, or decreases in, the sales volume
or sales prices to these customers including SanDisk could seriously harm our
financial results and business. Since the sales cycle for our services typically
exceeds one year, if our customers order significantly fewer wafers than
forecasted, we will have excess capacity that we may not be able to sell in a
short period of time, resulting in lower utilization of our facilities. We may
have to reduce prices in order to try to sell the excess capacity. In addition
to the revenue loss that could result from unused capacity or lower sales
prices, we might have difficulty adjusting our costs to reflect the lower
revenues, which could harm our financial results.
9
IF WE DO NOT RECEIVE ORDERS FROM OUR WAFER PARTNERS AND TECHNOLOGY PROVIDERS WE
MAY HAVE EXCESS CAPACITY.
We have entered into wafer partner agreements and agreements with
technology providers under which we have committed a portion of our Fab 2
capacity for future orders from these parties. During the ramp-up of Fab 2, our
capacity commitments are limited to approximately 50% of our Fab 2 capacity.
These parties are generally not obligated to utilize or pay for all or any
portion of their allocated capacity, and generally must confirm their orders to
us only three months in advance. If these parties do not place orders with us,
we may have unutilized capacity, which we may be unable to fill and could harm
our financial results. In addition, in connection with their investments in the
Fab 2 project, our wafer partners have been issued credits which may be used to
reduce the cash amounts to be paid by them when paying for wafers manufactured
in Fab 2. Our major wafer partners have recently agreed to defer the use of
their credits until 2007.
IF WE DO NOT MAINTAIN AND DEVELOP OUR TECHNOLOGY PROCESSES AND SERVICES, WE WILL
LOSE CUSTOMERS AND MAY NOT BE ABLE TO ATTRACT NEW ONES.
The semiconductor market is characterized by rapid change, including the
following:
o rapid technological developments;
o evolving industry standards;
o changes in customer requirements;
o frequent new product introductions and enhancements; and
o short product life cycles with declining prices as products mature.
10
In order to maintain our current customer base and attract new customers,
we must continue to advance our manufacturing process technologies. We are
developing and introducing to production specialized process technologies. We
have also licensed 0.18-micron technology from Toshiba and are in the process of
transferring the 0.13-micron technology from Motorola. We are also working on
other independent and joint development projects of technologies for Fab 2. Our
ability to achieve and maintain profitable operations depends on the successful
development and introduction to production of these processes.
IF WE DO NOT COMPETE EFFECTIVELY, WE WILL LOSE BUSINESS TO OUR COMPETITORS.
The semiconductor foundry industry is highly competitive. We compete with
approximately ten independent dedicated foundries, all of which are located in
Asia-Pacific, including new foundries based in Taiwan, China, Korea and
Malaysia, and with over 20 integrated semiconductor and end-product
manufacturers that allocate a portion of their manufacturing capacity to foundry
operations. The foundries with which we compete benefit from their close
proximity to other companies involved in the design and manufacture of ICs. Many
of our competitors have one or more of the following competitive advantages over
us:
o greater manufacturing capacity;
o multiple and more advanced manufacturing facilities;
o more advanced technological capabilities;
o a more diverse and established customer base;
o greater financial, marketing, distribution and other resources; and/or
o a better cost structure.
IF WE DO NOT COMPETE EFFECTIVELY, OUR RESULTS OF OPERATIONS WILL BE MATERIALLY
AFFECTED.
We have a large amount of debt, which could have significant negative
consequences. As of December 31, 2003, we had $431 million of bank debt. Our
current and future indebtedness could have significant negative consequences,
including:
o requiring the dedication of a substantial portion of our expected cash
flow from operations to service our indebtedness;
o increasing our vulnerability to general adverse economic and industry
conditions;
o limiting our ability to obtain additional financing;
o limiting our flexibility in planning for, or reacting to, changes in
our business and the industry in which we compete;
o placing us at competitive disadvantage to less leveraged competitors
and competitors that have better access to capital resources; and
o affecting our abilities to make interest payments on our indebtedness.
11
IF WE FAIL TO SATISFY THE COVENANTS SET FORTH IN OUR AMENDED CREDIT FACILITY,
OUR BANKS WILL BE ABLE TO CALL OUR LOANS.
Our credit facility, under which we have drawn down $431 million as of
December 31, 2003, requires that we maintain certain financial, capital raising
and production milestone covenants. In the past, we failed to meet certain of
the requirements of the credit facility. We cannot assure you that we will be
successful in satisfying these covenants in the future. Any failure by us to
observe covenants or satisfy conditions under the credit facility, some of which
are not in our control, may result in the banks accelerating our obligations,
which would obligate us to immediately repay all loans made by the banks plus
penalties, and the banks would be entitled to exercise the remedies available to
them under the credit facility, including enforcement of their lien against all
our assets. This would have a material adverse effect on our company.
ISRAELI BANKING LAWS MAY IMPOSE RESTRICTIONS ON THE TOTAL DEBT THAT WE MAY
BORROW FROM OUR BANKS.
Pursuant to a recent amendment to a directive published by the Israel
Supervisor of Banks, which becomes effective on March 31, 2004, we may be deemed
part of a group of borrowers comprised of the Ofer Brothers Group, The Israel
Corporation, and other companies which are also included in such group of
borrowers pursuant to the directive, including companies under the control or
deemed control of these entities. The directive provides that an entity will be
subject to limitations on the amount of bank financing available to it if such
entity is included within a group of borrowers, to which the amount of debt
financing that has been extended from such bank amounts to 30% of such bank's
capital, or is a member of one of the bank's six largest borrowers or groups of
borrowers to which, collectively, the amount of debt financing that has been
extended from a bank amounts to 150% of such bank's capital (gradually reduced
to 135% between April 2005 and June 2006). Should our banks exceed these
limitations, they may limit our ability to draw on our remaining Fab 2 bank
facility ($69 million) and may require us to return some or all of our
outstanding borrowings (which were $431 million as of December 31, 2003), each
of which may have a material adverse effect on our business, financial condition
and results of operations. The directive provides that a bank may request that
the Israel Supervisor of Banks exempt certain entities from the scope of the
definition of a group of borrowers. Since we do not know whether the directive
will impact us, we do not currently intend to request that our banks seek an
exemption on our behalf from the Israel Supervisor of Banks. Should we decide to
make such a request of our banks, there can be no assurance that our banks would
agree to request an exemption from the Israel Supervisor of Banks on our behalf
or that the Israel Supervisor of Banks would grant an exemption, if requested.
12
IF WE EXPERIENCE DIFFICULTY IN ACHIEVING ACCEPTABLE DEVICE YIELDS, PRODUCT
PERFORMANCE AND DELIVERY TIMES AS A RESULT OF MANUFACTURING PROBLEMS, OUR
BUSINESS WILL BE ADVERSELY AFFECTED.
The process technology for the manufacture of semiconductor wafers is
highly complex, requires advanced and costly equipment and is constantly being
modified in an effort to improve device yields, product performance and delivery
times. Microscopic impurities such as dust and other contaminants, difficulties
in the production process, defects in the key materials and tools used to
manufacture a wafer and other factors can cause wafers to be rejected or
individual semiconductors on specific wafers to be non-functional. We have from
time to time experienced production difficulties that have caused delivery
delays or returns and lower than expected device yields. We may also experience
difficulty achieving acceptable device yields, product performance and product
delivery times in the future as a result of manufacturing problems. Any of these
problems could seriously harm our financial results and business.
IF WE ARE UNABLE TO PURCHASE EQUIPMENT AND RAW MATERIALS, WE WILL NOT BE ABLE TO
MANUFACTURE OUR PRODUCTS IN A TIMELY FASHION, WHICH MAY RESULT IN A LOSS OF
EXISTING AND POTENTIAL NEW CUSTOMERS.
To complete the ramp-up of our Fab 2 facility and to maintain the quality
of production in our facilities, we must procure new equipment. In periods of
high market demand, the lead times from order to delivery of manufacturing
equipment could be as long as 12 to 18 months. In addition, our manufacturing
processes use many raw materials, including silicon wafers, chemicals, gases and
various metals. Manufacturing equipment and raw materials generally are
available from several suppliers. In many instances, however, we purchase
equipment and raw materials from a single source. Although supplies for
manufacturing equipment and raw materials are adequate, shortages could occur
due to an interruption of supply or increased industry demand. Any such
shortages could result in production delays that could have a material adverse
effect on our business and financial condition.
WE MUST CONTINUE TO REDUCE OUR EXPOSURE TO CURRENCY EXCHANGE AND INTEREST RATE
FLUCTUATIONS, OR OUR COST OF OPERATIONS WILL INCREASE.
Almost all of our cash generated from operations and from our financing and
investing activities is denominated in dollars and New Israeli Shekels, or NIS.
Our expenses and costs are denominated in NIS, dollars, Japanese Yen and Euros.
We are, therefore, exposed to the risk of currency exchange rate fluctuations.
13
Our borrowings, including the loans contemplated under our Fab 2 credit
facility, provide for interest based on a floating LIBOR rate, and we are
therefore subject to exposure to interest rate fluctuations. Furthermore, if our
banks incur increased costs in financing our Fab 2 credit facility due to
changes in law or the unavailability of foreign currency, our banks may exercise
their right to increase the interest rate on our Fab 2 credit facility as
provided for in the credit facility, as they did pursuant to its recent
amendment.
We regularly engage in various hedging strategies to reduce our exposure to
some, but not all, of these risks and intend to continue to do so in the future.
However, despite any such hedging activity, we are likely to remain exposed to
interest rate and exchange rate fluctuations, which may increase the cost of our
activities and, following the ramp-up of Fab 2, will increase our financing
expenses.
WE DEPEND ON INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES AND FAILURE TO
MAINTAIN OR ACQUIRE LICENSES COULD HARM OUR BUSINESS.
We depend on third party intellectual property in order for us to provide
foundry and design services to our clients. We believe that we are in compliance
with the licensing agreements with the owners of these rights and that the
licensing agreements adequately protect our rights. If problems or delays arise
with respect to the timely development, quality and provision of such
intellectual property to us, our customers' design and production could be
delayed, resulting in underutilization of our capacity. Failure to maintain or
acquire licenses could harm our business. In addition, license fees and
royalties payable under these agreements may impact our margins and operating
results.
FAILURE TO COMPLY WITH THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES OR
DEFEND OUR INTELLECTUAL PROPERTY RIGHTS COULD HARM OUR BUSINESS.
Our ability to compete successfully depends on our ability to operate
without infringing on the proprietary rights of others and defend our
intellectual property rights. Because of the complexity of the technologies used
and the multitude of patents, copyrights and other overlapping intellectual
property rights, it is often difficult for semiconductor companies to determine
infringement. Therefore, the semiconductor industry is characterized by frequent
litigation regarding patent, trade secret and other intellectual property
rights. There are no lawsuits currently pending against us regarding the
infringement of patents or intellectual property rights of others. However, we
have been a party to such claims in the past and because of the nature of the
industry, we may continue to receive such claims in the future. We and some of
our customers have recently received a notice from a technology company claiming
that we and our customers are infringing its patent rights. This notice was
followed by an offer to license the technology company's patents for an
immaterial one-time license payment, and we entered into a license agreement
with this company. All other prior claims against us have been resolved through
license agreements, the terms of which have not had a material effect on our
business. One of these agreements expires at the end of 2005, and we may be
unable to extend or renew it on similar terms. In the event any third party were
to assert infringement claims against us or our customers, we may have to
consider alternatives including, but not limited to:
14
o negotiating cross-license agreements;
o seeking to acquire licenses to the allegedly infringed patents, which
may not be available on commercially reasonable terms, if at all;
o discontinuing using certain process technologies, architectures, or
designs, which could cause us to stop manufacturing certain integrated
circuits if we were unable to design around the allegedly infringed
patents;
o fighting the matter in court and paying substantial monetary damages
in the event we were to lose; or
o seeking to develop non-infringing technologies, which may not be
feasible.
Any one or several of these developments could place substantial financial
and administrative burdens on us and hinder our business. Litigation, which
could result in substantial costs to us and diversion of our resources, may also
be necessary to enforce our patents or other intellectual property rights or to
defend us or our customers against claimed infringement of the rights of others.
If we fail to obtain certain licenses and if litigation relating to alleged
patent infringement or other intellectual property matters occurs, it could
prevent us from manufacturing particular products or applying particular
technologies, which could reduce our opportunities to generate revenues.
As of December 31, 2003, we held 48 patents worldwide. We intend to
continue to file patent applications when appropriate to protect our proprietary
technologies. The process of seeking patent protection may take a long time and
be expensive. We cannot assure you that patents will be issued from pending or
future applications or that, if patents are issued, they will not be challenged,
invalidated or circumvented or that the rights granted under the patents will
provide us with meaningful protection or any commercial advantage. In addition,
we cannot assure you that other countries in which we market our services will
protect our intellectual property rights to the same extent as the United
States. Further, we cannot assure you that we will at all times enforce our
patents or other intellectual property rights or that the rights granted under
our patents will provide us with a commercial advantage, which could reduce our
opportunities to generate revenues.
15
WE COULD BE SERIOUSLY HARMED BY FAILURE TO COMPLY WITH ENVIRONMENTAL
REGULATIONS.
Our business is subject to a variety of laws and governmental regulations
in Israel relating to the use, discharge and disposal of toxic or otherwise
hazardous materials used in our production processes. We are currently operating
under a conditional permit from the Israeli Ministry of Environmental Affairs
concerning the concentration of fluoride in our wastewater. We believe that we
are currently in compliance with the terms of our permit, with one exception: we
are monitoring the levels of fluoride in accordance with an oral understanding
with the Israeli Ministry of Environmental Affairs, which is less frequent than
required by the written terms of our permit. If we do not comply with our
permit's conditions or with our other understandings with the Ministry, we may
be required to allocate financial resources for the implementation of an
infrastructure solution in order to be in compliance with all the conditions. We
estimate that such an infrastructure solution would be immaterial. While we
believe that we currently comply in all other material respects with applicable
environmental laws and regulations, if we fail to use, discharge or dispose of
hazardous materials appropriately, or if applicable environmental laws or
regulations change in the future, we could be subject to substantial liability
or could be required to suspend or adversely modify our manufacturing
operations.
WE MAY BE SUBJECT TO THE RISK OF LOSS DUE TO FIRE BECAUSE THE MATERIALS WE USE
IN OUR MANUFACTURING PROCESSES ARE HIGHLY FLAMMABLE.
We use highly flammable materials such as silane and hydrogen in our
manufacturing processes and may therefore be subject to the risk of loss arising
from fires. The risk of fire associated with these materials cannot be
completely eliminated. We maintain insurance policies to reduce losses caused by
fire, including business interruption insurance. If any of our fabs were to be
damaged or cease operations as a result of a fire, it would reduce manufacturing
capacity and reduce revenues.
POSSIBLE PRODUCT RETURNS COULD HARM OUR BUSINESS.
Products manufactured by us are subject to return for specified periods if
they are defective or otherwise fail to meet customers' specifications. Although
we establish what we believe to be reasonable reserves against possible product
returns based on our past experience, product returns in excess of such reserves
may have an adverse effect on our business and financial condition.
WE MAY BE REQUIRED TO REPAY GRANTS TO THE ISRAEL INVESTMENT CENTER THAT WE
RECEIVED IN CONNECTION WITH FAB 1.
We received grants and tax benefits for Fab 1 under the government of
Israel Approved Enterprise program. As of December 31, 2001, we completed our
investments under our Fab 1 program and are no longer entitled to any further
investment grants for future capital investments in Fab 1. We have agreed that
if we do not achieve Fab 1 revenues of $90 million for 2003 and $100 million for
2004 and maintain at Fab 1 at least 600 employees for 2003 and 625 employees for
2004, subject to prevailing market conditions, we will, if demanded by the
Investment Center, be required to repay the Investment Center up to
approximately $2.5 million. Based on our actual level of Fab 1 revenues and
employees for 2003 and the expected level of revenues and employees for 2004, we
may be required to repay the Investment Center up to approximately $2.5 million.
16
WE ARE SUBJECT TO RISKS RELATED TO OUR INTERNATIONAL OPERATIONS.
In 2003 and 2002, we made substantial sales to customers located in
Asia-Pacific and in Europe. Because of our international operations, we are
vulnerable to the following risks:
o we price our products primarily in U.S. Dollars. If the Euro, Yen and
other currencies weaken relative to the U.S. Dollar, our products may
be relatively more expensive in these regions, which could result in a
decrease in our sales;
o the need to comply with foreign government regulation;
o general geopolitical risks such as political and economic instability,
potential hostilities and changes in diplomatic and trade
relationships;
o natural disasters affecting the countries in which we conduct our
business, such as the earthquakes experienced in China, Japan and
Taiwan;
o reduced sales to our customers or interruption in our manufacturing
processes in Asia Pacific that may arise from regional issues in Asia;
o imposition of regulatory requirements, tariffs, import and export
restrictions and other barriers and restrictions;
o adverse tax rules and regulations;
o weak protection of our intellectual property rights; and
o delays in product shipments due to local customs restrictions.
RISKS RELATED TO OUR ORDINARY SHARES
OUR STOCK PRICE MAY BE VOLATILE IN THE FUTURE.
The stock market, in general, has experienced extreme volatility that often
has been unrelated to the operating performance of particular companies. These
broad market and industry fluctuations may adversely affect the trading price of
our ordinary shares, regardless of our actual operating performance. In
particular, the stock prices for many companies in the semiconductor industry
have experienced wide fluctuations, which have often been unrelated to the
operating performance of such companies. Such fluctuations may adversely affect
the market price of our ordinary shares.
17
ISSUANCE OF ADDITIONAL SHARES PURSUANT TO FAB 2 FINANCING ARRANGEMENTS WILL
DILUTE THE INTEREST OF OUR SHAREHOLDERS; WE HAVE ALSO ISSUED WARRANTS TO OUR
BANKS, THE FAB 2 BUILDING CONTRACTOR AND ONE OF OUR SHAREHOLDERS AND OPTIONS TO
OUR EMPLOYEES THAT ARE EXERCISABLE INTO OUR ORDINARY SHARES BELOW OUR CURRENT
MARKET PRICE.
In connection with the Fab 2 project, we have issued as of February 21,
2004 53,288,624 ordinary shares to our wafer and equity partners and other
shareholders. In January 2001, we issued warrants to our banks exercisable into
400,000 ordinary shares with an exercise price of $6.20. In December 2003, we
issued to our banks and to one of our shareholders warrants exercisable into
896,596 and 58,906 ordinary shares, respectively, with an exercise price of
$6.17. Up to approximately 8.6 million additional ordinary shares may be issued
upon the conversion of our outstanding convertible debentures and upon exercise
of warrants held by some of our shareholders, our debenture holders and our Fab
2 contractor.
In addition, as of December 31, 2003, we had outstanding employee options
to purchase up to 6.8 million shares, of which 3.7 million shares have an
exercise price below $7.00. We have also entered into a number of agreements
which may result in our issuing large numbers of shares, particularly if we
complete the transactions contemplated by these agreements at a time when our
share price is low. For example, we have agreed that our wafer partners may
elect to convert, on a quarterly basis through 2006, wafer credits we have
issued them which may be used to reduce the cash payments to be paid by them
when paying for wafers manufactured in Fab 2 into our ordinary shares, based on
the average trading price of our ordinary shares during the 15 consecutive
trading days preceding the relevant quarter. If our major wafer partners
purchase an amount of wafers which would otherwise result in their using the
full amount of credits available to them and they elect to convert all of these
credits into ordinary shares, we will issue them an aggregate of 8.3 million
shares, assuming the average trading price of our ordinary shares during the 15
consecutive trading days preceding the last relevant quarter is $5.00; if the
average trading price of our ordinary shares is $10.00, we will issue an
aggregate of 4.2 million shares. Issuances of these shares will have a
substantial dilutive effect on our shareholders.
MARKET SALES OF LARGE AMOUNTS OF OUR SHARES ELIGIBLE FOR FUTURE SALE MAY LOWER
THE PRICE OF OUR ORDINARY SHARES.
Of our 65,582,383 outstanding ordinary shares as of February 29, 2004,
23,434,532 are freely tradable and held by non-affiliates, and an additional
1,073,905 shares held by non-affiliates are eligible for sale pursuant to Rule
144 under the Securities Act of 1933, subject to the time, volume and manner of
sale limitations of Rule 144. Of these shares, 476,213 and 597,692 shares will
be freely tradable under Rule 144(k) by April 2004 and October 2004,
respectively. An additional 80,456, 67,046 and 41,905 shares held by
non-affiliates will be eligible for sale under Rule 144(k) by May 2004, December
2004 and January 2005, respectively.
18
In addition, certain of our affiliates (Israel Corporation Technologies -
ICTech, SanDisk, Alliance Semiconductor, and Macronix International) hold
40,884,539 of our shares, of which 9,766,526 are freely tradable and 20,700,069
are currently eligible for sale subject to the time, volume and manner of sale
limitations of Rule 144. An additional 4,425,076, 838,082, 2,849,905 and
2,304,881 shares held by these affiliates will be eligible for sale under Rule
144 by May 2004, August 2004, December 2004 and January 2005, respectively, and
subject to the share transfer restrictions set forth in the shareholders
agreement to which they are a party and which remain in effect through January
2008. ICTech and our large wafer partners and additional shareholders and
warrant holders, as well as our directors and officers, have agreed under
written "lock-up" agreements that, for a period of 90-180 days from the date of
the effectiveness of the January 2004 prospectus, they will not sell their
shares. Shares purchased by OTPP in 2002 are registered pursuant to an effective
shelf registration statement. The sales of large amounts of our ordinary shares
(or the potential for those sales even if they do not actually occur) may
depress the market price of our ordinary shares. This could also impair our
ability to raise capital through the sale of our equity securities.
OUR PRINCIPAL SHAREHOLDERS OWN A CONTROLLING INTEREST IN US AND WILL BE ABLE TO
EXERCISE IT IN WAYS WHICH MAY BE ADVERSE TO YOUR INTERESTS.
Our wafer partners and ICTech own approximately 65% of our outstanding
shares. Under our articles of association, two shareholders holding together 33%
of our outstanding shares constitute a quorum for conducting a shareholders
meeting. Our wafer partners and ICTech could constitute a quorum for purposes of
conducting a shareholders meeting. While we have always solicited proxies from
our shareholders prior to our shareholders meetings, we would have a sufficient
quorum with two large shareholders even if none of our other shareholders were
to participate in our shareholder meetings. If only two large shareholders were
to participate in one of our shareholder meetings, these shareholders would
determine the outcome of our shareholder meetings without the benefit of the
participation of our other shareholders. In addition, even if our other
shareholders were to participate in our shareholders meeting in person or by
proxy, our wafer partners and The Israel Corporation effectively control our
company and may exercise this control in a manner adverse to the interests of
our other shareholders.
19
RISKS RELATED TO OUR OPERATIONS IN ISRAEL
INSTABILITY IN ISRAEL MAY HARM OUR BUSINESS.
All of our manufacturing facilities and our corporate and primary sales
offices are located in Israel. Accordingly, political, economic and military
conditions in Israel may directly affect our business.
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, as well as
incidents of civil unrest. In addition, Israel and companies doing business with
Israel have, in the past, been the subject of an economic boycott. Although
Israel has entered into various agreements with Egypt, Jordan and the
Palestinian Authority, there has been an increase in unrest and terrorist
activity, which began in September 2000 and which has continued with varying
levels of severity into 2004. Parties with whom we do business have sometimes
declined to travel to Israel during periods of heightened unrest or tension,
forcing us to make alternative arrangements where necessary. In addition, the
political and security situation in Israel may result in parties with whom we
have agreements claiming that they are not obligated to perform their
commitments under those agreements pursuant to force majeure provisions. We do
not believe that the political and security situation has had any material
impact on our business to date; however, we can give no assurance that security
and political conditions will have no such effect in the future. Any hostilities
involving Israel or the interruption or curtailment of trade between Israel and
its present trading partners could adversely affect our operations and could
make it more difficult for us to raise capital. Furthermore, our manufacturing
facilities are located exclusively in Israel, which is currently experiencing
civil unrest, terrorist activity and military action. Since we do not have a
detailed disaster recovery plan that would allow us to quickly resume
manufacturing, we could experience serious disruption of our manufacturing if
acts associated with this conflict result in any serious damage to our
manufacturing facilities. In addition, our business interruption insurance may
not adequately compensate us for losses that may occur, and any losses or
damages incurred by us could have a material adverse effect on our business.
OUR OPERATIONS MAY BE NEGATIVELY AFFECTED BY THE OBLIGATIONS OF OUR PERSONNEL TO
PERFORM MILITARY SERVICE.
In the event of severe unrest or other conflict, individuals could be
required to serve in the military for extended periods of time. In response to
the increase in terrorist activity and the renewed Palestinian uprising, there
has been a significant call up of military reservists, and it is possible that
there will be additional call-ups in the future. Most male Israeli citizens,
including our employees, are subject to compulsory military service through
middle age. Our operations could be disrupted by the absence for a significant
period of time of one or more of our key employees or a significant number of
our other employees due to military service. Such disruption could harm our
operations.
20
OUR OPERATIONS MAY BE AFFECTED BY NEGATIVE ECONOMIC CONDITIONS IN ISRAEL.
Israel has been going in recent years through a period of recession in
economic activity, resulting in low growth rates and growing unemployment. Our
operations could be adversely affected if the economic conditions in Israel
continue to deteriorate. In addition, due to significant economic measures
proposed by the Israeli Government, there have been several general strikes and
work stoppages in 2003 and 2004, affecting all banks, airports and ports. These
strikes have had an adverse effect on the Israeli economy and on business,
including our ability to deliver products to our customers or to receive raw
materials from our suppliers in a timely manner. Following the passing by the
Israeli Parliament of laws to implement the economic measures, the Israeli trade
unions have threatened further strikes or work-stoppages, and these may have a
material adverse effect on the Israeli economy and us.
IF WE DO NOT RECEIVE A FINAL BUSINESS LICENSE, WE MAY BE REQUIRED TO CEASE OUR
OPERATIONS.
The construction of our Fab 2 facility has required us to renew our
business license, and we are currently operating under a temporary business
license, which will expire at the end of May 2004. We are currently in the
process of implementing the conditions for the receipt of a final business
license. In the event that we do not receive a final business license, we may be
required to pay penalties and if we cannot implement the conditions for the
receipt of a final business license, we may be required to modify or cease our
operations.
IF THE EXEMPTION ALLOWING US TO OPERATE OUR MANUFACTURING FACILITIES SEVEN DAYS
A WEEK IS NOT RENEWED, OUR BUSINESS WILL BE ADVERSELY AFFECTED.
We operate our manufacturing facilities seven days a week pursuant to an
exemption from the law that requires businesses in Israel to be closed from
sundown on Friday through sundown on Saturday. This exemption, which has been
renewed several times in the past, expires on December 31, 2004. In addition, a
significant increase in the number of employees permitted to work under this
exemption will be needed as we ramp-up production at Fab 2. We expect the
exemption to be renewed, but if the exemption is not renewed and we are forced
to close any or all of the facilities for this period each week, our financial
results and business will be harmed.
21
IF WE ARE CONSIDERED TO BE A PASSIVE FOREIGN INVESTMENT COMPANY, EITHER
PRESENTLY OR IN THE FUTURE, U.S. HOLDERS WILL BE SUBJECT TO ADVERSE U.S. TAX
CONSEQUENCES.
We will be a passive foreign investment company, or PFIC, if 75% or more of
our gross income in a taxable year, including our pro rata share of the gross
income of any company, U.S. or foreign, in which we are considered to own,
directly or indirectly, 25% or more of the shares by value, is passive income.
Alternatively, we will be considered to be a PFIC if at least 50% of our assets
in a taxable year, averaged over the year and ordinarily determined based on
fair market value and including our pro rata share of the assets of any company
in which we are considered to own, directly or indirectly, 25% or more of the
shares by value, are held for the production of, or produce, passive income. If
we were to be a PFIC, and a U.S. Holder does not make an election to treat us as
a "qualified electing fund," or QEF, or a "mark to market" election, "excess
distributions" to a U.S. Holder, and any gain recognized by a U.S. Holder on a
disposition or our ordinary shares, would be taxed in an unfavorable way. Among
other consequences, our dividends would be taxed at the regular rates applicable
to ordinary income, rather than the 15% maximum rate applicable to certain
dividends received by an individual from a qualified foreign corporation. The
tests for determining PFIC status are applied annually and it is difficult to
make accurate predictions of future income and assets, which are relevant to the
determination of PFIC status. In addition, under the applicable statutory and
regulatory provisions, it is unclear whether we would be permitted to use a
gross loss from sales (sales less cost of goods sold) to offset our passive
income in the calculation of gross income. In light of the uncertainties
described above, we have not obtained an opinion of counsel with respect to our
PFIC status and no assurance can be given that we will not be a PFIC in any
year. If we determine that we have become a PFIC, we will then notify our U.S.
Holders and provide them with the information necessary to comply with the QEF
rules. If the IRS determines that we are a PFIC for a year with respect to which
we have determined that we were not a PFIC, however, it might be too late for a
U.S. Holder to make a timely QEF election, unless the U.S. Holder qualifies
under the applicable Treasury regulations to make a retroactive (late) election.
U.S. Holders who hold ordinary shares during a period when we are a PFIC will be
subject to the foregoing rules, even if we cease to be a PFIC, subject to
exceptions for U.S. Holders who made a timely QEF or mark-to-market election.
IT MAY BE DIFFICULT TO ENFORCE A U.S. JUDGMENT AGAINST US, OUR OFFICERS AND
DIRECTORS AND SOME OF THE EXPERTS NAMED IN THIS ANNUAL REPORT OR TO ASSERT U.S.
SECURITIES LAW CLAIMS IN ISRAEL.
We are incorporated in Israel. Most of our executive officers and directors
and our Israeli accountants and attorneys are nonresidents of the United States,
and a majority of our assets and the assets of these persons are located outside
the United States. Therefore, it may be difficult to enforce a judgment obtained
in the United States, against us or any of these persons, in U.S. or Israeli
courts based on the civil liability provisions of the U.S. Federal securities
laws. Additionally, it may be difficult for you to enforce civil liabilities
under U.S. Federal Securities laws in original actions instituted in Israel.
22
ITEM 4. INFORMATION ON THE COMPANY
A. History and Development of the Company
We are a pure-play independent wafer foundry dedicated to the manufacture
of semiconductors. Pure-play foundries do not offer any products of their own,
but focus on producing integrated circuits, or ICs, based on the design
specifications of their customers. We manufacture semiconductors using advanced
production processes for our customers primarily based on third party designs
and our own proprietary designs. We currently manufacture ICs, with geometries
ranging from 1.0 to 0.18 microns and plan to initiate volume production in
geometries of 0.13 microns during 2005. ICs manufactured by us are incorporated
into a wide range of products in diverse markets, including consumer
electronics, personal computer and office equipment, communications, automotive,
professional photography and medical device products.
We are focused on establishing leading market share in high-growth
specialized markets by providing our customers with high-value wafer foundry
services. Our historical focus has been standard digital complementary metal
oxide semiconductor, or CMOS, process technology, which is the most widely used
method of producing ICs. We currently are focused on the emerging opportunities
surrounding CMOS image sensors, embedded flash and mixed-signal technologies.
Through our expertise and experience gained over a decade of operations, we
differentiate ourselves in these areas by creating a high level of value for our
clients through innovative technological processes, competitive manufacturing
indices, such as cycle times and yields, and dedicated customer service.
Our Company was founded in 1993, when we acquired National Semiconductor's
150-mm wafer fabrication facility, or Fab 1, and commenced operations as an
independent foundry with a production capacity of approximately 5,000 wafer
starts per month. Since then, we have significantly modernized our Fab 1
facility and equipment, which has improved our process geometries from 1.0
microns to 0.35 microns and enhanced our process technologies to include CMOS
image sensors, embedded flash and mixed-signal technologies. We have also
expanded our capacity through increased production in Fab 1 to approximately
16,000 wafer starts per month to meet additional customer demand. Fab 1 has been
cash flow positive since the second quarter of 2002.
We have completed the construction of the building and infrastructure and
commenced the initial ramp-up of a second manufacturing facility, or Fab 2. Fab
2 is designed to operate in geometries of 0.18 microns and below, using advanced
materials and advanced CMOS technology licensed from Motorola and Toshiba and
other technologies that we might acquire or develop independently. Production
capacity at the end of December 2003 was 8,500 wafer starts per month. We
currently expect to have production capacity ranging between 13,000 and 15,000
wafer starts per month by the end of 2004. When the production ramp-up is
completed, Fab 2 is expected to have a capacity of 33,000 200-mm wafer starts
per month. While we expect to continue to operate Fab 1, we anticipate Fab 2 to
be the core of our future business.
23
On December 30, 2003, we signed a memorandum of understanding with
Siliconix incorporated, an 80.4% owned subsidiary of Vishay Intertechnology,
Inc., for a long-term manufacturing and supply arrangement between the parties.
Pursuant to the terms of the memorandum of understanding, Siliconix will place
with us orders valued at approximately $200 million for the purchase of
semiconductor wafers to be manufactured at our Fab 1 facility over a seven to
ten year period, of which approximately $53 million is guaranteed and will be
delivered over the three year period starting at the first anniversary of the
definitive agreement. Siliconix will advance to us $20 million to be used for
the purchase of additional equipment required to satisfy Siliconix's orders,
which will be credited towards the purchase price of the wafers. The transaction
is subject to the approval of both companies' boards of directors, our lending
banks and the Israeli Investment Center and the negotiation of definitive
documentation. A definitive agreement is expected to be signed during the first
quarter of 2004. We can offer no assurance that we will receive the necessary
approvals for the transaction from either company's board of directors, our
lending banks or the Israeli Investment Center or that, even if such approvals
are obtained, a definitive agreement will be reached
In January 2004, we completed an underwritten public offering of 11 million
of our ordinary shares at a price to the public of $7.00 per share. Pursuant to
this offering, our underwriters partially exercised their over-allotment option
and purchased 444,500 of our ordinary shares at a price of $7.00 per share. The
underwritten public offering, including the partial exercise of the
over-allotment option, resulted in net proceeds of approximately $75.2 million.
Our legal and commercial name is Tower Semiconductor Ltd. We were
incorporated under the laws of Israel. Our manufacturing facilities and
executive offices are located in the Migdal Haemek Industrial Park, Post Office
Box 619, Migdal Haemek, 23105 Israel, and our telephone number is
972-4-650-6611. Our worldwide web site is located at http://www.towersemi.com.
Information on our web site is not incorporated by reference in this annual
report.
B. Business Overview
INDUSTRY OVERVIEW
Semiconductor devices are responsible for the rapid growth of the
electronics industry over the past fifty years. They are critical components in
a variety of applications, from computers, consumer electronics and
communications, to industrial, military, medical and automotive. The
semiconductor industry is characterized by rapid changes in technology,
frequently resulting in the obsolescence of recently introduced products. As
performance has increased and size and cost have decreased, the use of
semiconductors and the number of their applications have grown significantly.
24
Historically, the semiconductor industry was composed primarily of
companies that designed and manufactured integrated circuits, or ICs, in their
own fabrication facilities. These companies, such as Intel and IBM, are known as
integrated device manufacturers, or IDMs. In the mid-1980s, fabless IC
companies, which focused on IC design and used external manufacturing capacity,
began to emerge. Fabless companies initially outsourced production to IDMs,
which filled this need through their excess capacity. As the semiconductor
industry continued to grow, increasing competition forced fabless companies and
IDMs to seek reliable and dedicated sources of IC manufacturing services. This
need has been met by the development of independent companies, known as
foundries, that focus primarily on providing IC manufacturing services to
semiconductor suppliers. Foundry services are now used by nearly every major
semiconductor company in the world, including IDMs as part of a dual-source,
risk-diversification strategy.
Semiconductor suppliers face increasing demands for new products that
provide higher performance, greater functionality and smaller form factors at
lower prices, which require increasingly complex ICs. To compete successfully,
semiconductor suppliers must also minimize the time it takes to bring a product
to market. As a result, fabless companies and IDMs are focusing more on their
core competencies -- design and intellectual property -- and outsourcing
manufacturing to foundries. In addition to the increased complexity of designs,
there has also been a dramatic increase in the number of applications for
semiconductors.
The consumer sector is expanding worldwide with new applications and
multi-functional devices, including those that incorporate CMOS image sensors,
embedded flash and mixed-signal ICs. Increasingly, emerging applications, such
as camera-equipped cell phones, digital still cameras and flat panel displays,
are enabled by ICs manufactured using advanced process technologies.
As the semiconductor industry continues its expansion, the cost of building
new fabrication facilities, or fabs, is becoming increasingly prohibitive for
all but a very few companies. For example, the total cost of our Fab 2 is
currently expected to be approximately $1.5 billion. We believe that new 300-mm
wafer fabs cost approximately twice that amount. For companies to justify the
enormous investment in a new fab, a high level of capacity utilization is
essential to ensure that fixed costs are fully absorbed.
The enormous costs associated with modern fabs, combined with the
increasing demand for complex ICs, has created an expanding market for
outsourced manufacturing offered by foundries. Foundries can cost-effectively
supply the technologies involved in manufacturing advanced ICs to even the
smallest fabless companies by creating economies of scale through pooling the
demand of numerous customers. In addition, customers whose IC designs require
process technologies other than standard digital CMOS have created a market for
independent foundries that focus on providing specialized process technologies,
such as CMOS image sensors, embedded flash and mixed-signal technologies.
Foundries also offer competitive customer service through design, testing, and
information services, often at a level previously found only at an IDM's
internal facilities.
25
These trends have led to the rapid growth in demand in recent years for
advanced semiconductor manufacturing services provided by independent foundries.
SPECIALIZED TECHNOLOGIES
We provide wafer fabrication services and technologies to fabless IC
companies and IDMs and enable smooth integration of the semiconductor design and
manufacturing processes. By doing so, we enable our customers to bring
high-performance, highly integrated ICs to market rapidly and cost effectively.
We believe that our technological strengths and emphasis on customer service
have allowed us to develop strong positions in large, high-growth specialized
markets for CMOS image sensors, embedded flash memory and mixed signal ICs. We
serve as a sole source or alternative provider of foundry services.
We believe that we are a trusted, customer-oriented service provider that
has built a solid reputation in the foundry industry over the last ten years. We
have built strong relationships with customers, who continue to use our
services, even as their demands evolve to smaller form factors and new
applications. Our consistent focus on providing high-quality, value added
services, including engineering and design support, has allowed us to attract
customers for both our Fab 1 and Fab 2 facilities who seek to work with a proven
provider of foundry services. As a result, we have a high customer retention
rate, which is illustrated by our long-standing relationships with leading
semiconductor suppliers such as Motorola and National Semiconductor.
We derived approximately 43% of our revenues for the year ended December
31, 2003 from our target specialized markets: CMOS image sensors, embedded flash
and mixed-signal ICs. We are focusing on these markets because they provide a
relatively high gross margin and have high growth characteristics. In addition,
we are highly experienced in these markets, being an early entrant and having
developed unique proprietary technologies, primarily through licensing and joint
development efforts with our customers and other technology companies.
CMOS IMAGE SENSORS
CMOS image sensors are ICs used to capture an image in a wide variety of
consumer, commercial and industrial mass market applications, including
camera-equipped cell phones, digital still and video cameras, security and
surveillance cameras and video game consoles. We are currently actively involved
in this mass market as well as the high-end sensor and applications specific
markets, which includes applications such as studio quality megapixel digital
cameras, machine vision medical equipment and automative sensors. While CMOS
image sensors for advanced optical applications are an emerging technology, we
believe that they are gradually becoming the preferred technology to traditional
charge coupled devices, or CCDs. CCDs have historically provided superior image
quality; however, advances in semiconductor manufacturing processes and design
techniques have led to significant improvements in CMOS image sensor performance
and image quality. These advances have resulted in smaller size circuits and
better current control, making it possible to design CMOS image sensors that
provide high image quality at a significantly lower cost.
26
As early as 1997, we recognized the market potential of using CMOS process
technology for a digital camera-on-a-chip, which would integrate a CMOS image
sensor, filters and digital circuitry. In entering the CMOS image sensor foundry
business, we utilized research and development work that had been ongoing since
1993. Our services include a broad range of turnkey solutions and services,
including sensor design services, optical characterization of a CMOS process,
innovative stitching manufacturing technique and optical testing and packaging.
CMOS image sensors manufactured by us deliver outstanding image quality for a
broad spectrum of digital imaging applications. Currently, we are one of select
foundries that manufacture CMOS image sensors and, as such, believe that we have
developed leading market position.
EMBEDDED FLASH
Flash memory is a constantly powered nonvolatile memory that can be erased
and reprogrammed in units of memory called blocks. The IC of flash memory is
organized so that a section of memory cells may be erased in a single action (or
"flash"). Applications for flash memory products range from most types of
portable electronic equipment devices to high volume mass storage of data. Flash
is particularly suitable for applications such as handheld devices, combining
the need for portability, high density, ruggedness and lower power requirements.
Flash memory products are also well-suited for audio products such as digital
answering machines and MP3 players, as well as other applications including
networking devices, digital cameras, personal computer motherboards and portable
memory devices.
Embedded flash is the combination of flash memory with other components,
such as other memory, logic and analog, on a single IC to provide speed,
functionality and form factor advantages and reduce system cost. Embedded flash
memory products are used in communications, consumer, industrial, military and
automotive applications. End products include networks, base stations, servers,
microcontrollers, toys, set-top boxes, DVD players, cell phones and smart cards.
In 1997 we entered into a strategic investment and technology agreement
with Saifun, pursuant to which we currently own approximately a 10% equity stake
in Saifun. Together we brought to market a new non-volatile memory technology,
NROM(TM). NROM technology enables the implementation of ultra high-density flash
arrays usiNg 0.5-micron CMOS process, and is particularly suitable for embedding
flash arrays with standard CMOS logic, as well as for commodity memories. We
have continued to strengthen our specialized technology service offering and
leadership position in the embedded flash market, by partnering with Matsushita
for joint development of 0.18-micron embedded microFLASH technology. Our
microFLASH technology, based on Saifun's patented NROM technology, provides
greater memory cell density than other currently available flash architectures
for given design rule generation, permitting an approximately four-fold
reduction in the size of the memory cell for stand-alone memories and embedded
applications in a given geometry.
27
MIXED SIGNAL
Mixed-signal ICs are an essential part of any electronic system that
interacts with the real world. Analog ICs monitor and manipulate real world
signals such as sound, light, pressure, motion, temperature and electrical
current and are used in a wide variety of electronic products such as PCs, cell
phones, DVD players, automotive electronics and medical imaging equipment.
Digital ICs perform arithmetic functions on data represented by a series of ones
and zeroes, provide critical processing power and have enabled many of the
computing and communication advances of recent years. Mixed-signal ICs combine
analog and digital semiconductor functionality on a single IC to enable digital
systems to interface with the real world. As these digital systems proliferate,
there is a growing need for analog functionality to enable them to interface
with the real world.
We focus on providing high-quality mixed-signal capabilities, as this
technology is a cornerstone to both CMOS image sensor and embedded flash
applications. Our expertise in mixed signal has been further enhanced through
several strategic initiatives. In 1998, Motorola transferred its 0.6- and
0.8-micron analog and mixed-signal processes to our Fab 1 facility. In May 2003,
we licensed a wide array of intellectual property from Chipidea, whereby
Chipidea will port its IP to our Fab 2. Our customers can now use Chipidea's
extensive IP portfolio with our advanced technology for a state-of-the-art
solution that meets their analog and mixed-signal design needs.
CUSTOMERS, MARKETING AND SALES
Our marketing and sales strategy seeks to aggressively expand our global
customer base to take advantage of the current upswing in the semiconductor
industry. To achieve this objective, we match our standard digital CMOS
technology to the industry benchmark and differentiate ourselves based on
customer service, design support and expertise in specialized technologies, such
as CMOS image sensors, embedded flash and mixed signal. We have marketing and
sales personnel in the United States and Israel. Our marketing and sales staff
is supported by independent sales representatives, located throughout the world,
who have been selected based on their understanding of the semiconductor
marketplace.
28
Our sales cycle is generally 18-24 months for new customers and can be as
short as 9-12 months for existing customers. The typical stages in the sales
process from initial contact until production are:
o technical evaluation;
o product design to our specifications including integration of third
party intellectual property;
o photomask design specification;
o silicon prototyping;
o assembly and test;
o validation and qualification; and
o production.
The primary customers of our foundry services are fabless semiconductor
companies and IDMs. A significant portion of our product sales are made pursuant
to long-term contracts with our customers, under which we have agreed to reserve
manufacturing capacity at our production facilities for such customers. When we
commenced business in March 1993, our only customer was National Semiconductor.
Since then, we have succeeded in adding a significant number of new customers,
including many industry leaders and a number of Taiwanese companies who
preferred our solution to that offered locally. During the year ended December
31, 2003, National Semiconductor, SanDisk and Motorola contributed 24%, 20%, and
11% of our revenues, respectively. In 2002, National Semiconductor, Matsushita
and Motorola contributed 31%, 16% and 13% of our revenues, respectively. In
2001, National Semiconductor and Motorola contributed 30% and 17% of our
revenues, respectively. In 2004, we expect that SanDisk, which currently is our
largest customer in Fab 2, will account for a significant portion of our Fab 2
revenues. As foundry utilization rates peak with the industry recovery, we
expect to attract additional customers as available capacity decreases at
leading Asian foundries.
In addition to further developing our customer base, we have also made a
concentrated effort to expand the geographical diversity of our sales. The
percentage of our sales from customers located outside the United States was
31%, 38% and 27% in the years ended December 31, 2001, 2002 and 2003,
respectively. As we have successfully expanded our customer base with customers
located in Asia-Pacific and in Europe, we believe that a substantial portion of
our sales will continue to come from customers located outside the United
States. We experienced a significant increase in our Asia-Pacific sales in 2002
due to payments made to us by Matsushita in connection with our technology
agreement with them. The following table sets forth the geographical
distribution, by percentage, of our net sales for the periods indicated:
29
Year ended December 31,
2003 2002 2001
United States 73% 62% 69%
Asia-Pacific 10 25 18
Europe 15 11 10
Israel 2 2 3
Total 100% 100% 100%
=== === ===
We currently allocate a portion of our wafer manufacturing capacity in Fab
2 to certain customers under several types of agreements. We are also obligated
to make capacity available to customers under certain other agreements (see
"Item 5 - Management's Discussion and Analysis of Financial Condition and
Results of Operations - Fab 2 Agreements"). Some of our primary customers are
also our shareholders.
COMPETITION
The global semiconductor foundry industry is highly competitive. We compete
with more than 10 independent dedicated foundries, including Taiwan
Semiconductor Manufacturing Corporation, United Microelectronics and Chartered
Semiconductor Manufacturing; emerging and existing Chinese, Korean, Malaysian
and Taiwanese foundries, including Semiconductor Manufacturing International
Corp., DongBu, Anam, Hynix, Powerchip Semiconductor and Silterra; other
specialized foundries, such as AMI Semiconductor, Jazz Semiconductor and X-Fab;
and over 20 IDMs and end-product manufacturers that produce ICs for their own
use and/or allocate a portion of their manufacturing capacity to foundry
operations. The foundries with which we compete are located in Asia-Pacific and
benefit from their close proximity to other companies involved in the design and
manufacture of ICs. We believe that the principal elements of competition in the
wafer foundry market are:
o technical competence;
o production quality;
o time-to-market;
o device and end-product price;
o available capacity;
o device yields;
o design and customer support services;
o access to intellectual property; and
o research and development capabilities.
30
Many of our competitors have greater manufacturing capacity, multiple
manufacturing facilities, more advanced technological capabilities, a more
diverse and established customer base, greater financial, marketing,
distribution and other resources and a better cost structure than ours.
We seek to compete primarily on the basis of technology, production
quality, device yields and service. We believe we have a differentiated service
offering in specialized markets, which enables us to effectively compete with
larger IC manufacturers.
WAFER FABRICATION SERVICES
Wafer fabrication is an intricate process that consists of constructing
layers of conducting and insulating materials on raw wafers in intricate
patterns that give the IC its function. IC manufacturing requires hundreds of
interrelated steps performed on different types of equipment, and each step must
be completed with extreme accuracy for finished ICs to work properly. The
process can be summarized as follows:
Circuit Design. IC production begins when a fabless IC company or IDM
designs the layout of a device's components and designates the interconnections
between each component. The result is a pattern of components and connections
that defines the function of the IC. In highly complex circuits, there may be
more than 35 layers of electronic patterns. After the IC design is complete, we
provide these companies with IC manufacturing services.
Mask Making. The design for each layer of a semiconductor wafer is
imprinted on a photographic negative, called a reticle or mask. The mask is the
blueprint for each specific layer of the semiconductor wafer.
IC Manufacturing. Transistors and other circuit elements comprising an IC
are formed by repeating a series of processes in which a photosensitive material
is deposited on the wafer and exposed to light through a mask. Advanced IC
manufacturing processes consist of hundreds of steps, including
photolithography, oxidation, etching and stripping of different layers and
materials, ion implantation, deposition of thin film layers, chemical mechanical
polishing and thermal processing. The final step in the IC manufacturing process
is wafer probe, which involves visually and electronically inspecting each
individual IC in order to identify those that are operable for assembly.
Assembly and Test. After IC manufacture, the wafers are transferred to
assembly and test facilities. In the assembly process, each wafer is cut into
dies, or individual semiconductors, and tested. Defective dies are discarded,
while good dies are packaged and assembled. Assembly protects the IC,
facilitates its integration into electronic systems and enables the dissipation
of heat. Following assembly, the functionality, voltage, current and timing of
each IC is tested. After testing, the completed IC is shipped to the IC supplier
or directly to its final destination.
31
MANUFACTURING PROCESSES
We manufacture ICs on silicon wafers, generally using the customer's
proprietary circuit designs. In some cases we use third-party designs or our own
proprietary product design. The end product of our manufacturing process is a
silicon wafer containing multiple identical ICs. In most cases, our customer
assumes responsibility for dicing and assembly. Although we are an independent
foundry specializing in wafer fabrication, we offer our customers the option to
purchase from us finished semiconductor products that have been assembled and
tested. In these cases, we take responsibility for the production and delivery
of finished IC products to our customer on a turnkey basis and subcontract some
or all of the dicing, assembly and testing functions to third parties. We also
maintain limited assembly capabilities for manufacturing prototype units to
facilitate customer evaluation and thereby accelerate new product introduction.
We manufacture ICs using CMOS process technology. CMOS is currently the
dominant semiconductor manufacturing process because it requires lower power
than other technologies and allows dense placement of components onto a single
IC. The low power consumption and high-density characteristics of the CMOS
process allow the continued development of high performance ICs that are smaller
and faster. We believe that our specialized process technology distinguishes our
IC manufacturing services and attracts many industry-leading customers. The
specific process technologies that we currently focus on include:
CMOS IMAGE SENSORS. Our advanced CMOS image sensor process is intended to
meet the established growing demand for optical sensors used in consumer,
industrial, medical and automotive applications. Our dedicated manufacturing and
testing processes assure consistently high electro-optical performance of the
integrated sensor through wafer-level characterization. Our CMOS image sensor
process has demonstrated superior optical characteristics, excellent spectral
response and high resolution and sensitivity. The ultra-low dark current, high
efficiency and accurate spectral response to our photodiode enable faithful
color reproduction and acute detail definition.
In addition, our innovative "stitching" technology enables semiconductor
exposure tools to manufacture single ultra high-resolution CMOS image sensors
containing millions of pixels at sizes far larger than their existing field. Our
0.5-and 0.35-micron CMOS image sensor processes permit the customer to create
high-quality solutions and integrate a product's CMOS analog and logic circuitry
together with the sensor pixel array all on one chip, thereby facilitating
miniaturization, reducing power consumption and increasing performance. We are
currently developing a 0.18-micron CMOS image sensor process to address the
rapidly growing market for camera-embedded cell phones and low end digital
cameras.
32
EMBEDDED FLASH. Our microFLASH technology, based on Saifun's patented NROM
technology, provides greater memory cell density than other currently available
flash architectures for given design rule generation, permitting an
approximately four-fold reduction in the size of the memory cell for stand-alone
memories and embedded applications in a given geometry. The relative simplicity
of our microFLASH manufacturing process enables the technology to offer cost
advantages over competing flash technologies for high density memories. Using
our 0.5-micron technology, we have introduced the first of our microFLASH
processes into production with the manufacture of a 2 megabit stand-alone memory
device and embedded multi-time programming modules, with a limited number of
rewrite cycles. We are currently introducing into Fab 2 the 0.18 embedded flash
that was jointly developed with Matsushita in their facilities in Japan.
MIXED SIGNAL. We have developed the Tower Mixed-Signal Design Kit, which
contains a comprehensive characterization of a wide range of analog devices,
providing our customers with the ability to design mixed-signal ICs for their
specific needs. In addition, we developed certain mixed-signal features for use
in Fab 2 with our 0.18-micron process (such as high and medium poly-resistors
and MIM capacitors) and are working to develop more features.
PROCUREMENT AND SOURCING
Our manufacturing processes use many raw materials, including silicon
wafers, chemicals, gases and various metals. These raw materials generally are
available from several suppliers. In many instances, we purchase raw materials
from a single source. In connection with our technology advancement plans,
including our Fab 2 business plan, we expect to continue to make purchases of
semiconductor manufacturing equipment.
RESEARCH AND DEVELOPMENT
Our future success depends, to a large degree, on our ability to continue
to successfully develop and introduce to production, advanced process
technologies that meet our customers' needs. Our process development strategy
relies on CMOS process technologies that we primarily license and transfer from
third parties, we develop at our customers' request or in cooperation with our
customers; and internally develop utilizing intellectual property licensed from
third parties.
33
The completion of the construction of Fab 2 in the third quarter of 2003
and qualification of advanced CMOS process technologies in geometries of 0.18
microns have enabled us to focus on development of process technologies in the
specialized CMOS image sensor, embedded flash and mixed-signal markets. Our
technology alliances with leading semiconductor suppliers contribute to our
development of new process technologies in Fab 2. For example, our joint
development alliance with Matsushita in May 2002 has accelerated the development
of our 0.18-micron microFLASH technology, which is expected to begin prototyping
in the middle of 2004 and be offered in Fab 2 in 2005. In addition, our
technology transfer and licensing agreement entered into in January 2002 with
IMEC enables us to offer certain advanced analog and mixed-signal technologies
for use in Fab 2 in geometries of 0.18 microns for the manufacture of components
used in products such as cell phones.
From time to time, at a customer's request, we develop a specialty process
module, which we use for such customer on an exclusive basis, and, if permitted
under our agreements with our customers, we then add it to our process offering.
In 2001 and 2002, in cooperation with a customer, and using its know-how and IP,
we developed an enhanced 0.35-micron CMOS image sensor process to be used
exclusively for this customer. Production ramp on this process is currently
expected to start by the end of 2004.
Our research and development activities have related primarily to our
process development efforts and have been sponsored and funded by us with some
participation by the Israeli Office of the Chief Scientist, or OCS. Accordingly,
we are subject to restrictions set forth in Israeli law which limit the ability
of a company to manufacture products, or to transfer technologies outside of
Israel, if such products or technologies were developed with OCS funding.
Research and development expenses for the years ended December 31, 2001, 2002,
2003 were $9.6 million, $17.0 million and $20.7 million, net of government
participation of $1.4 million, $1.2 million and $1.1 million, respectively. In
addition, we have paid, as of December 31, 2003, a total of $41.0 million to
Toshiba and Motorola in connection with the transfer of process technologies for
use in Fab 2.
As of December 31, 2003, we employed 160 professionals in our research and
development department, 27 of whom have PhDs. In addition to our research and
development department, located at our facilities in Migdal Haemek, we maintain
a design center in Netanya, Israel.
PROPRIETARY RIGHTS
INTELLECTUAL PROPERTY AND LICENSING AGREEMENTS
Our success depends in part on our ability to obtain patents, licenses and
other intellectual property rights covering our production processes. To that
end, we have acquired certain patents and patent licenses and intend to continue
to seek patents on our production processes. As of December 31, 2003, we held 48
patents.
We have also entered into various patent licenses and cross-licenses with
other technology companies including Toshiba, Motorola, Synopsys, Artisan
Components, ARM, Ceva, IMEC, Cadence Design Systems, Chipidea Microelectronics,
Matsushita and Virage Logic. We may choose to renew our present licenses or to
obtain additional technology licenses in the future. There can be no assurance
that any such licenses could be obtained on commercially reasonable terms. In
addition, we cannot assure you that other countries in which we market our
services will protect our intellectual property rights to the same extent as the
United States or Israel.
34
We constantly seek to strengthen our technological expertise through
relationships with technology companies and silicon suppliers. We seek to expand
our core strengths in CMOS image sensors, embedded flash and mixed-signal
technologies by combining our proprietary technology with those of other
technology companies. A main component of our process development strategy is to
acquire licenses to standard CMOS technologies and cell libraries from leading
designers, such as Motorola and Toshiba, and further develop specialized process
through our internal design teams. The licensing of these technologies has
enormously reduced our internal development costs.
CMOS PROCESS TECHNOLOGY PLATFORM
We have licensed an array of process technologies through the following
arrangements:
o TOSHIBA. In April 2000, we entered into a technology transfer
agreement with Toshiba, pursuant to which Toshiba has and will
transfer to us certain advanced CMOS technologies for use in Fab 2. In
exchange for certain license and technology transfer fees and
royalties, Toshiba has and will provide us with recipes, know-how and
patent licenses and has trained a group of our engineers and managers.
Subject to prior termination for cause by Toshiba, our licenses under
the agreement with Toshiba are perpetual. Based on Toshiba's
0.18-micron CMOS process technology, we have internally developed an
enhanced industry compatible version of the process technology.
o MOTOROLA. In September 2002, we entered into a technology transfer and
development agreement with Motorola, pursuant to which Motorola has
and will transfer to us its 0.13-micron HiPerMOS7 CMOS process
technology for Fab 2 as well as co-develop with us an
industry-standard compatible version of the process technology.
Subject to prior termination for cause by Motorola, our licenses under
the technology transfer agreement with Motorola are perpetual.
FOUNDATION IP (LIBRARIES)
To better serve our customers design needs in advanced CMOS processes, we
have entered into a series of agreements with leading providers of physical
design libraries. These libraries are basic design building blocks, such as
standard cells, interface input-output (I/O) cells and software compilers for
the generation of on-chip embedded memories arrays. To achieve optimal
performance, these libraries must be customized to work with our manufacturing
process and are used in virtually every digital chip design of our customers.
35
o SYNOPSYS. In June 2001, we entered into an agreement with Synopsys
(formerly, Avant!) under which Synopsys has developed libraries for
our 0.18-micron process technology. The Synopsys libraries are
available to our customers free of charge, and multiple customers use
them in producing their ICs at Tower.
o ARTISAN COMPONENTS. In June 2002, we entered into a master services
and license agreement with Artisan Components. Under this agreement,
Artisan Components has developed a suite of library products for our
0.18-micron process technology. Artisan Components is licensing its
libraries to our customers free of charge and multiple customers are
using the Artisan Components libraries in their chip design for
manufacturing at Tower.
EMBEDDED PROCESSORS
To give our customers a low-risk, low-cost, fast time-to-market solution
for their system-on-chip, or SoC, designs, we offer them process-optimized
silicon-proven embedded processors from world leaders in embedded processors.
o ARM. In November 2002, we joined ARM's Foundry License Program.
Through the ARM Program, our customers have gained access to two of
ARM's most widely used 32-bit embedded microprocessor cores, or
elements, which have been optimized and tested to work on our
0.18-micron manufacturing process. As ARM cores are the most widely
used embedded microprocessors today, our agreement with ARM provides
our customers a low-risk, low-cost solution for designing and
manufacturing advanced ARM-based SoCs at Tower.
o CEVA. In December 2001, we signed an agreement with Ceva for the
customization of their Teak and XperTeak DSP-core for Tower's
0.18-micron manufacturing process. Under this agreement, Ceva has
developed DSP macrocells, which are available for the use of our
customers' SoCs from Ceva.
MIXED-SIGNAL TECHNOLOGIES
To address a variety of applications for mixed-signal ICs, such as use in
cell phones, we have developed strong mixed-signal process capabilities as well
as proven mixed-signal IP components.
o IMEC. In January 2002, we entered into a technology transfer and
licensing agreement with IMEC pursuant to which we acquired certain
advanced analog and mixed-signal process technologies to complement
our CMOS process technology capabilities in the 0.18-micron geometry.
Pursuant to this agreement, we received a non-exclusive,
non-transferable license to manufacture or have manufactured
integrated circuits utilizing the technology licensed by IMEC. The
mixed-signal offering developed pursuant to this agreement is
available to our customers.
36
o CHIPIDEA MICROELECTRONICS. In January 2003, we entered into a
non-exclusive, perpetual, royalty-free license and design agreement
with Chipidea Microelectronics, a Portuguese corporation that designs
and sells various types of analog and mixed-signal semiconductor
intellectual property cores or elements. Several Chipidea cores are
currently being utilized by our customers.
o CADENCE DESIGN SYSTEMS. In order to help our customers meet
time-to-market constraints, we are providing them with a seamless
transition from design to silicon using Cadence Design Systems Process
Design Kit, or PDK. Under our agreement with Cadence Design Systems
signed in 2001, Cadence Design Systems has developed a mixed-signal
PDK for the use of our mixed-signal customers. PDK is a process
specific analog-mixed signal library designed to work with the Cadence
Design Systems custom IC tools and can be used to create analog
mixed-signal ICs.
EMBEDDED NON-VOLATILE MEMORIES
To enhance our strength in embedded non-volatile memories in the
0.18-micron process node, we are collaborating with leaders in embedded
non-volatile memory technologies to address the market needs in both the
high-end and the low-end of the spectrum.
o MATSUSHITA. In June 2002, we entered into an agreement with our
development partner, Matsushita, for the joint development of
0.18-micron embedded MICROFLASH technology.
o VIRAGE LOGIC. In March 2002, we entered into a development agreement
with Virage Logic, a company specializing in embedded memory
technology. Under this agreement, Virage Logic has successfully
developed a suite of SRAM and ROM memory compilers for our 0.18-micron
process technology, which are available for licensing by our
customers. Presently, multiple customers' products that use Virage
Logic's memory products are in production at Fab 2.
37
Our ability to compete also depends on our ability to operate without
infringing the proprietary rights of others. The semiconductor industry is
characterized by frequent litigation regarding patent, trade secret and other
intellectual property rights. There are no lawsuits currently pending against us
regarding the infringement of patents or intellectual property rights of others.
However, we have been a party to such claims in the past and because of the
nature of the industry, we may continue to receive such communications in the
future. We have recently received a notice from a technology company claiming
that we and our customers are infringing its patent rights. This notice was
followed by an offer to license the technology company's patents for an
immaterial one-time license payment, and we have currently concluded a license
agreement with this technology company. All other prior claims against us have
been resolved through license agreements, the terms of which have not had a
material effect on our business. One of these agreements expires at the end of
2005, and we may be unable to extend or renew it on similar terms. In the event
any third party were to assert infringement claims against us or our customers,
we may have to consider alternatives including, but not limited to:
o negotiating cross-license agreements;
o seeking to acquire licenses to the allegedly infringed patents, which
may not be available on commercially reasonable terms, if at all;
o discontinuing using certain process technologies, architectures, or
designs, which could cause us to stop manufacturing certain
semiconductors if we were unable to design around the allegedly
infringed patents;
o fighting the matter in court and paying substantial monetary damages
in the event we were to lose; or
o seeking to develop non-infringing technologies, which may not be
feasible.
In the event that any third party causes us or any of our customers to
discontinue using certain process technologies, we believe that such an outcome
would not have a long-term material and adverse effect, as we could design
around such technologies.
C. ORGANIZATIONAL STRUCTURE
The legal and commercial name of our company is Tower Semiconductor Ltd. We were
incorporated under the laws of the State of Israel in 1993. We have one
subsidiary incorporated in the United States under the name Tower Semiconductor
USA, Inc.
D. PROPERTY, PLANTS AND EQUIPMENT
MANUFACTURING FACILITIES
FAB 1
We acquired our Fab 1 facility from National Semiconductor in March 1993
when National Semiconductor, which had operated the facility since 1986, sold
the facility as part of a worldwide restructuring of its manufacturing
operations. We occupy the facility pursuant to a long-term lease from the Israel
Lands Authority that expires in 2032.
38
Due to the sensitivity and complexity of the semiconductor manufacturing
process, a semiconductor manufacturing facility requires a special "clean room"
in which most of the manufacturing functions are performed. Our Fab 1 facility
includes an approximately 51,900 square foot clean room.
Since we commenced manufacturing at Fab 1, we have increased our
manufacturing capacity from 5,000 wafer starts per month, using 1.25-micron and
1.0-micron processes, to approximately 16,000 wafer starts per month based on
our current product mix, which is primarily concentrated on our 0.35-micron,
0.5-micron and other specialized processes. However, our exact capacity is
variable and depends on the combination of the processes being used and may be
significantly lower at certain times as a result of certain of our combinations.
In general, our ability to increase our manufacturing capacity has been achieved
through the addition of equipment, improvement in equipment utilization, the
reconfiguration and expansion of the existing clean room area and the
construction of an additional clean room area within the building shell of Fab
1. Approximately 60% of our Fab 1 facility is capable of 0.5-micron and below
process technology.
FAB 2
In January 2001, we commenced construction of Fab 2, our new advanced wafer
fab adjacent to Fab 1 in Migdal Haemek. Fab 2 offers integrated circuits
manufacturing services utilizing advanced materials and a 0.18-micron process
technology we licensed from Toshiba. We have also licensed 0.13-micron process
technology from Motorola, which we are implementing in Fab 2 and expect to offer
in the future. The overall clean room area in Fab 2 is approximately 100,000
square feet. We began volume production at Fab 2 during the third quarter of
2003. Production capacity at the end of December 2003 was 8,500 wafer starts per
month, and we currently expect to have production capacity ranging between
13,000 and 15,000 wafer starts per month by the end of 2004. We expect the
production ramp to be completed by the end of 2006, at which time Fab 2 is
expected to have the capacity to produce 33,000 wafer starts per month. We
currently expect that the total cost of the construction, equipping of the
facility and ramp-up of the manufacturing line will be approximately $1.5
billion, of which approximately $900 million has been expended through December
31, 2003. The land on which Fab 2 is located is subject to a long-term lease
from the Israel Lands Authority that expires in 2049.
Since 2000, we have invested significantly in the purchase of fixed assets,
primarily in connection with the construction of Fab 2, technology advancement
and capacity expansion. Capital expenditures in fiscal 2003, 2002 and 2001 were
approximately $164 million, $243 million and $364 million, respectively, before
related Investment Center grants of $27 million, $37 million and $67 million,
respectively.
39
ENVIRONMENTAL MATTERS
Our operations are subject to a variety of laws and governmental
regulations in Israel relating to the use, discharge and disposal of toxic or
otherwise hazardous materials used in our production processes. Failure to
comply with these laws and regulations could subject us to material costs and
liabilities, including costs to clean up contamination caused by our operations.
We are currently operating under a conditional permit from the Israeli
Ministry of Environmental Affairs concerning the concentration of fluoride in
our wastewater. We believe that we are currently in compliance with the terms of
our permit with one exception: we are monitoring the levels of fluoride in
accordance with an oral understanding with the Israeli Ministry of Environmental
Affairs concerning how often we monitor the levels of fluoride, resulting in our
monitoring the levels of fluoride less frequently than required by the written
terms of our permit. There have been instances in the past where we were not in
compliance with these restrictions, and, despite our best efforts, there may be
future instances of non-compliance. We are also in discussions with the Israeli
Ministry of Environmental Affairs regarding the possibility of easing of
conditions set forth in our permit. If we cannot maintain our compliance with
the conditions set forth in our permit or in our other understandings with the
Ministry, we may be required to allocate financial resources for the
installation of a waste treatment system in order to be in compliance with all
the conditions. We estimate that such a waste treatment system would cost
approximately $100,000. We believe that we are currently in compliance in all
other material respects with applicable environmental laws and regulations.
40
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A. OPERATING RESULTS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
THE INFORMATION CONTAINED IN THIS SECTION SHOULD BE READ IN CONJUNCTION WITH OUR
CONSOLIDATED FINANCIAL STATEMENTS AND RELATED NOTES AND THE INFORMATION
CONTAINED ELSEWHERE IN THIS ANNUAL REPORT. OUR FINANCIAL STATEMENTS HAVE BEEN
PREPARED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP") IN
ISRAEL. MATERIAL DIFFERENCES BETWEEN ISRAEL GAAP AND US GAAP AS THEY RELATE TO
OUR FINANCIAL STATEMENTS ARE DESCRIBED IN NOTE 20 TO OUR AUDITED ANNUAL
CONSOLIDATED FINANCIAL STATEMENTS.
OVERVIEW
We are a pure-play independent wafer foundry dedicated to the manufacture
of semiconductors. Pure-play foundries do not offer any products of their own,
but focus on producing integrated circuits, or ICs based on the design
specifications of their customers. We manufacture semiconductors using advanced
production processes for our customers primarily based on third party designs
and our own proprietary designs. We currently manufacture integrated circuits,
or ICs, with geometries ranging from 1.0 to 0.18 microns and plan to initiate
volume production in geometries of 0.13 microns during 2005.
Our primary source of revenue is from the fabrication of ICs, using CMOS
process technology. We are currently focused on the emerging opportunities
involving CMOS image sensors, embedded flash and mixed-signal technologies. ICs
manufactured by us are incorporated into a wide range of products in diverse
markets, including consumer electronics, personal computer and office equipment,
communications, automotive, professional photography and medical device
products.
The primary customers for our products are fabless IC companies and
integrated device manufacturers, or IDMs. Most of our product sales are made
pursuant to long-term contracts with our customers, under which we have agreed
to reserve manufacturing capacity at our production facilities. Our sales cycle
is generally 18-24 months for new customers and can be as short as 9-12 months
for existing customers. The typical stages in the sales process, from initial
contact until production, are: technical evaluation; photomask design
specification; silicon prototyping; assembly and testing; validation and
qualification; and production.
During the year ended December 31, 2003, National Semiconductor, SanDisk
and Motorola contributed 24%, 20% and 11% of our revenues, respectively. In
2002, National Semiconductor, Matsushita and Motorola contributed 31%, 16% and
13% of our revenues, respectively. In 2001, National Semiconductor and Motorola
contributed 30% and 17% of our revenues, respectively. In 2004, we expect that
SanDisk, currently our largest Fab 2 customer, will continue to account for a
significant portion of our Fab 2 revenues. In 2003, SanDisk was instrumental in
ramping up our business and accounted for approximately 80% of our Fab 2
revenues. While we currently expect that SanDisk will continue to be a
significant customer of Fab 2, the percentage of Fab 2 revenues represented by
sales to SanDisk is expected to decrease as additional customers commence or
increase their purchase orders following the qualification of their products in
Fab 2. As foundry utilization rates peak with the industry recovery, we expect
to attract additional customers as available capacity decreases worldwide,
including at leading Asian foundries.
In addition to further developing our customer base, we have also made a
concentrated effort to expand the geographical diversity of our sales. The
percentage of our sales from customers located outside the United States was
31%, 38% and 27% in the years ended December 31, 2001, 2002 and 2003,
respectively. As we have successfully expanded our customer base with customers
located in Asia-Pacific and in Europe, we believe that a substantial portion of
our sales will continue to come from customers located outside the United
States.
41
Our Company was founded in 1993, when we acquired National Semiconductor's
150-mm wafer fabrication facility, or Fab 1, and commenced operations as an
independent foundry with a production capacity of approximately 5,000 wafer
starts per month. Since then, we have significantly modernized our facilities
and equipment, which has improved our process geometries from 1.0 microns to
0.35 microns and enhanced our process technologies to include CMOS image
sensors, embedded flash and mixed-signal technologies. We have also expanded our
capacity through increased production in Fab 1 to approximately 16,000 wafer
starts per month to meet additional customer demand. Fab 1 has been cash flow
positive since the second quarter of 2002.
During the third quarter of 2003, we completed the construction of the
building and infrastructure and commenced the initial ramp-up of a second
manufacturing facility, or Fab 2. Fab 2 is designed to operate in geometries of
0.18 microns and below, using advanced materials and advanced CMOS technology
licensed from Motorola and Toshiba, as well as other technologies that we might
acquire or develop independently. We began volume production at Fab 2 during the
third quarter of 2003. Production capacity of Fab 2 as of the end of December
2003 was 8,500 wafer starts per month, and we currently expect to have
production capacity ranging between 13,000 and 15,000 wafer starts per month by
the end of 2004. When the production ramp is completed, Fab 2 is expected to
have the capacity to produce 33,000 200-mm wafer starts per month. While we
expect to continue to operate Fab 1, we expect Fab 2 to form the core of our
future business.
CRITICAL ACCOUNTING POLICIES
NON-CAPITALIZABLE COSTS. In accordance with generally accepted accounting
principles, we capitalized through the third quarter of 2003 most of our costs
relating to the establishment of Fab 2, primarily for property and equipment and
other assets. Following commencement of operations of Fab 2 in the third quarter
of 2003, most of the direct costs related to the construction and equipping of
Fab 2 and to the transfer of the Fab 2 technologies that were capitalizable
until Fab 2 came into production, are no longer capitalizable. Capitalizable Fab
2 costs were only incremental direct costs that related to the establishment and
equipping of Fab 2 and to the integration and transfer of technology to be
implemented in Fab 2.
Direct internal costs consisted primarily of payroll-related costs, and
allocated payroll costs, on the basis of management's estimates and assumptions
and methodologies, including timesheet inputs. Most of the capitalized
payroll-related costs consisted of wages to employees dedicated solely to the
establishment of Fab 2. In addition, other direct related expenses such as
import costs, transportation, installation and consulting fees were also
capitalized. Under different assumptions relating to these costs and their being
attributable to the Fab 2 project, the classification and accounting recognition
of these costs may be different, which may significantly affect our financial
position and results of operations. The effect, if any, under Israel GAAP and US
GAAP would be similar.
42
REVENUE RECOGNITION. In accordance with generally accepted accounting
principles, our revenues are recognized upon shipment or as services are
rendered when title has been transferred, collectibility is reasonably assured
and acceptance criteria are satisfied, based on tests performed prior to
customer on-site testing. Prior to commencement of our production, both our
customers and our personnel test and pre-approve the prototype, on the basis of
which specifications and features the ordered products will be produced.
Electronic, functional and quality tests are performed on the products prior to
shipment and customer on-site testing. Such testing reliably demonstrates that
the products meet all of the specified criteria prior to formal customer
acceptance and that product performance upon customer on-site testing can
reasonably be expected to conform to the specified acceptance provisions. Our
revenue recognition policy is significant because our revenues are a key
component of our results of operations. We follow very specific and detailed
guidelines in measuring revenue; however an accrual for estimated returns, which
is computed primarily on the basis of historical experience, is recorded. Any
changes in assumptions for determining the accrual for returns may affect mainly
the timing of our revenue recognition and cause our operating results to vary
from quarter to quarter.
Accordingly, our financial position and results of operations may be
affected. That effect, if any, under Israel GAAP and US GAAP would be similar.
DEPRECIATION AND AMORTIZATION OF FAB 2 ASSETS. During the third quarter of
2003, we commenced depreciating the Fab 2 property and equipment and amortizing
the 0.18-micron technology, based on the straight-line method. Currently, we
estimate that the expected economic life of the Fab 2 assets will be as follows:
(i) prepaid perpetual land lease and buildings - 14 to 25 years; (ii) machinery
and equipment - 5 years; and (iii) the 0.18-micron technology - 4 years, while
amortization will phase in commencing on the dates on which each of the Fab 2
manufacturing lines is ready for use. We expect that the depreciation and
amortization expenses relating to Fab 2 facilities will be in 2004 approximately
$30 million per quarter due to the Fab 2 ramp-up. Changes in our estimates
regarding the expected economic life of Fab 2 assets, or a change in the dates
on which each of the Fab 2 manufacturing lines is ready for use, might
significantly affect our depreciation and amortization expenses. That effect, if
any, under Israel GAAP and US GAAP would be similar.
43
IMPAIRMENT OF ASSETS. In January 2003, the Israeli Accounting Standards
Board issued Standard No. 15, "Impairment of Assets," which is effective for
financial statements for reporting periods commencing January 1, 2003 or
thereafter. This standard addresses the accounting treatment and presentation of
impairment of assets, and establishes procedures to be implemented in order to
ensure that assets are not presented in amounts exceeding their recoverable
value. Though according to US GAAP, e.g. FASB 144 and FASB 142, recoverability
tests are performed based on undiscounted expected cash flows, Standard No. 15
indicates that an asset's recoverable value is the higher of the asset's net
selling price and the asset's value in use, the latter being equal to the
asset's discounted expected cash flows. While the adoption of the provisions of
Standard No. 15 as of December 31,, 2003 and 2002, had no effect on our
financial position and results of operations as of such dates, the use of
different assumptions with respect to the expected cash flows from our assets
and other economic variables, primarily the discount rate, may lead to different
conclusions regarding the recoverability of our assets' carrying values and to
the potential need to record an impairment loss for our long-lived assets.
RECENT ACCOUNTING PRONOUNCEMENTS UNDER US GAAP AS THEY APPLY TO US
AMENDMENT OF SFAS 133. In May 2003, the FASB issued SFAS No. 149,
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities."
SFAS No. 149 amends and clarifies accounting for derivative instruments
including certain derivative instruments embedded in other contracts and hedging
activities under SFAS No. 133. It is effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. The adoption of this standard had no impact on our financial position
or results of operations.
ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF BOTH
LIABILITIES AND EQUITY. In May 2003, the FASB issued SFAS No. 150, "Accounting
For Certain Financial Instruments with Characteristics of Both Liabilities and
Equity" which establishes standards for how an issuer of financial instruments
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. SFAS 150 requires that an issuer classify a
financial instrument that is within its scope as a liability (or an asset in
some circumstances) if, at inception, the monetary value of the obligation is
based solely or predominantly on a fixed monetary amount known at inception,
variations in something other than the fair value of the issuer's equity shares
or variations inversely related to changes in the fair value of the issuer's
equity shares. This statement is effective in connection with our activities for
financial instruments entered into at the beginning of the third quarter of
2003. Regarding the impact of adopting SFAS 150 on our financial position as of
December 31, 2003, see Note 20F to the financial statements which are included
in this annual report.
SAB-104. -- Revenue Recognition. In December 2003, the Securities and
Exchange Commission ("SEC") issued Staff Accounting Bulletin 104 ("SAB-104") --
Revenue Recognition. This SAB revises or rescinds portions of the interpretative
guidance included in Topic 13 of the codification of staff accounting bulletins
in order to make this interpretive guidance consistent with current
authoritative accounting guidance. The principal revisions relate to the
rescission of material no longer necessary because of developments outside of
the SEC in U.S. generally accepted accounting principles, and the incorporation
of certain sections of the SEC's "Revenue Recognition in Financial Statements --
Frequently Asked Questions and Answers" document into Topic 13. The adoption of
SAB-104 had no impact on our financial position and results of operations.
44
RECENT ACCOUNTING PRONOUNCEMENTS UNDER ISRAEL GAAP AS THEY APPLY TO US
IMPAIRMENT OF ASSETS ACCORDING TO STANDARD NO. 15 OF THE ISRAELI ACCOUNTING
STANDARDS BOARD. In January 2003, the Israeli Accounting Standards Board issued
Standard No. 15, "Impairment of Assets". This standard is the initial formal
accounting pronouncement in Israel addressing the accounting treatment and
presentation of impairment of assets, which establishes procedures to be
implemented in order to ensure that assets are not presented in amounts
exceeding their recoverable value. An asset's recoverable value is the higher of
the asset's net selling price and the asset's value in use, the latter being
equal to the asset's discounted expected cash flows. Prior to issuing Standard
No. 15, we tested the recoverability of our assets based on undiscounted
expected cash flows, a method that under Standard No. 15 will no longer be
acceptable. Initial application of this standard will generally be on a
prospective basis. Standard No. 15 is effective for financial statements for
reporting periods commencing January 1, 2003 or thereafter, with early
application encouraged. The adoption of the provisions of Standard No. 15 as of
December 31, 2002 and September 30, 2003, would not have a material effect on
our financial position and results of operations as of such dates.
RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial
condition and results of operations in conjunction with the financial statements
and the related notes thereto included in this annual report. The following
table sets forth certain statement of operations data as a percentage of sales
for the years indicated.
YEAR ENDED DECEMBER 31,
---------------------------------
2003 2002 2001
-------- ------- -------
STATEMENT OF OPERATIONS DATA:
Sales 100.00% 100.0% 100.0%
Cost of sales 199.4 129.4 146.5
-------- ------- -------
Gross profit (99.4) (29.4) (46.5)
Research and development expenses, net 33.7 32.8 18.2
Marketing, general and administrative expenses 36.9 33.0 27.7
-------- ------- -------
Operating loss (170.0) (95.2) (92.4)
Financing income (expense), net (16.1) (4.0) 2.8
Other income (0.1) -- 16.0
-------- ------- -------
Loss (186.2)% (99.2)% (73.6)%
======== ======= =======
45
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
SALES. Sales in the year ended December 31, 2003 increased by 18.5% to
$61.4 million from $51.8 million in 2002. This $9.6 million increase was
attributable to a higher volume of wafer shipments, which resulted in an
increase in Fab 1 sales of $2.9 million, and a $6.6 million increase in Fab 2
revenues. Fab 2 revenues in 2003, which derived from the sale of wafer products,
were $14.7 million, in comparison with Fab 2 revenues of $8.1 million in 2002,
all of which was attributable to our joint development agreement with Matsushita
for the development of 0.18-micron embedded microFLASH technology.
COST OF SALES. Cost of sales in the year ended December 31, 2003 totaled
$122.4 million, compared with $67.0 million in 2002. This increase was due
mainly to the commencement of Fab 2 operations in the third quarter of 2003,
which resulted in (i) an increase of $37.3 million in depreciation and
amortization expenses related to Fab 2 assets; and (ii) an increase of $25.5
million attributable to the commencement of Fab 2 operations and the
discontinuation of capitalization of costs that had been capitalized prior to
the commencement of Fab 2 operations.
GROSS LOSS. Gross loss in the year ended December 31, 2003 was $61.0
million compared to a gross loss of $15.2 million in 2002. The increase in gross
loss was primarily attributable to an increase of $58.0 million in 2003 in
expenses related to Fab 2 (mainly due to an increase of $37.3 million in
depreciation and amortization costs and an increase of $11.4 million in payroll
costs). This increase was offset by a moderate increase in revenues of $9.6
million, which was primarily attributable to the commencement of production
operations of Fab 2 that amounted to $6.6 million.
RESEARCH AND DEVELOPMENT. Research and development expenses in the year
ended December 31, 2003 increased to $20.7 million from $17.0 million in 2002.
The increase was primarily due to increased research and development activities
related to the technologies we licensed from Motorola and Toshiba for Fab 2.
Research and development expenses are reflected net of participation grants
received from the Israeli government ($1.1 million and $1.2 million,
respectively).
MARKETING, GENERAL AND ADMINISTRATION. Marketing, general and
administrative expenses in the year ended December 31, 2003 increased to $22.6
million from $17.1 million in 2002, primarily due to an increase of $4.3 million
associated with the expansion of our worldwide marketing and sales efforts in
connection with the commencement of production in Fab 2.
46
OPERATING LOSS. Operating loss in the year ended December 31, 2003 was
$104.4 million, compared to $49.3 million in 2002, attributable primarily to the
commencement of Fab 2 operations during the third quarter of 2003. The $55.1
million increase in the operating loss reflects the increase in gross loss of
$45.8 million, increase in research and development expenses of $3.7 million and
increase in marketing and sales, general and administrative expenses of $5.5
million.
FINANCING EXPENSES, NET. Financing expenses in the year ended December 31,
2003 were $9.8 million compared to financing expenses of $2.1 million in 2002.
This increase is mainly due to an increase of $9.2 million in connection with
our Fab 2 activities and is attributable to (i) an increase during 2003 in the
total amount of long-term loans which financed the construction and equipping of
Fab 2, and (ii) the discontinuation of capitalization of financing costs that
had been capitalized prior to the commencement of operations of Fab 2.
LOSS. Our loss in the year ended December 31, 2003 was $114.3 million,
compared to $51.4 million in 2002. This increase is primarily attributable to
the increased operating loss of $55.0 million and the increase in financing
expenses, net, of $7.7 million.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
SALES. Sales in 2002 decreased by 1.1% to $51.8 million from $52.4 million
in 2001. This decrease is attributable to 10% lower wafer shipments in Fab 1 as
well as a reduction of 9% in the average price per wafer in Fab 1 as a result of
weakening demand in the semiconductor industry that was offset by $8 million in
revenue associated with our joint development agreement with Matsushita for the
development of 0.18-micron embedded micro-FLASH technology in Fab 2.
COST OF SALES. Cost of sales in 2002 was $67.0 million, compared with $76.7
million in 2001. A decrease of $21.5 million in the cost of sales of Fab 1 was
attributable to cost saving initiatives that were implemented in Fab 1, offset
by fixed manufacturing costs and increased uncapitalized expenses of $11.8
million related to the establishment of Fab 2.
GROSS LOSS. Gross loss in 2002 was $15.2 million compared with a gross loss
of $24.4 million in 2001. Our gross loss in 2002 was lower than our gross loss
in 2001 due to reduced gross loss in Fab 1 of $12.9 million resulting from
reduced sales and cost savings activities offset by our increased gross loss in
Fab 2 of $3.8 million, which resulted from $10.0 million in increased
uncapitalized expenses related to the establishment of Fab 2 offset by $6.2
million in gross profits from the joint development agreement with Matsushita.
RESEARCH AND DEVELOPMENT. Research and development expenses in 2002
increased to $17.0 million from $9.6 million in 2001. The increase was due to
increased research and development activities for technologies to be implemented
in Fab 2. Research and development expenses are reflected net of participation
grants received from the Israeli government ($1.2 million and $1.4 million,
respectively).
47
MARKETING, GENERAL AND ADMINISTRATION. Marketing, general and
administrative expenses in 2002 increased to $17.1 million from $14.5 million in
2001 due to higher deployment for Fab 2 activities of $2.5 million and higher
marketing efforts among new and potential Fab 2 customers during 2002 amounting
to $2.7 million offset by $2.6 million decreased sales, general and
administration expenses related to Fab 1.
OPERATING LOSS. Operating loss in 2002 was $49.3 million, compared to $48.4
million in 2001. The increase was due to $7.5 million in higher research and
development expenses in connection with Fab 2, as well as $2.6 million in higher
marketing expenses, offset by $9.1 million in lower gross loss.
FINANCING INCOME (EXPENSES), NET. Financing expenses in 2002 were $2.1
million compared with $1.5 million financing income in 2001. The majority of our
financing costs in 2002 and 2001, amounting to $11.0 million and $2.3 million,
respectively, were not included in our results of operations since they were
capitalized to Fab 2 assets during the establishment of Fab 2. The capitalized
financing expenses were primarily comprised of bank loans interest, amounting to
$10.6 million and $1.5 million, respectively, as well as expenses in 2002
related to convertible debentures, amounting to $ 1.2 million. In 2001,
non-capitalized financial expenses were offset by financial income, primarily
attributable to bank interest on proceeds from our Fab 2 investors, resulting in
net financial income, while in 2002, financial expenses exceeded financial
income due to the decrease in cash and cash equivalents.
OTHER INCOME, NET. Other income, net, in 2002 was $0.045 million, compared
to other income, net, of $8.4 million in 2001, due to the sale of our
shareholding in Virage Logic in 2001 for a capital gain of $9.5 million, offset
by a $1.1 million write off of our investment in Azalea Microelectronics in
2001.
TAXES ON INCOME. Due to our recent history of operating losses, in 2002 and
2001 we established valuation allowances against all deferred tax assets, except
with respect to existing deferred tax liabilities; therefore, we recognized no
income tax benefit attributable to our net operating loss.
LOSS. Our loss in 2002 was $51.4 million compared to a loss of $38.5
million in 2001. The increased loss was primarily attributable to the increase
in our Fab 2 operating loss of $19.4 million, comprised of increased
non-capitalized expenses, research, development and marketing expenses, and
offset by the $9.5 million capital gain generated from the sale of our holdings
in Virage Logic.
48
IMPACT OF INFLATION AND CURRENCY FLUCTUATIONS
The dollar cost of our operations in Israel is influenced by the timing of
any change in the rate of inflation in Israel and the extent to which such
change is not offset by the change in valuation of the NIS in relation to the
dollar. During 2003, the dollar was devalued against the NIS by 7.6%, and the
consumer price index in Israel decreased by 1.9%. During 2002, the NIS was
devalued against the dollar by 7.3%, while the consumer price index in Israel
increased by 6.5%.
We believe that the rate of inflation in Israel has had a minor effect on
our business to date. However, our dollar costs in Israel will increase if
inflation in Israel exceeds the devaluation of the NIS against the dollar or if
the timing of such devaluation lags behind inflation in Israel.
Almost all of our cash generated from operations and from our financing and
investing activities is denominated in dollars and NIS. Our expenses and costs
are denominated in NIS, dollars, Japanese Yen and Euros. We are, therefore,
exposed to the risk of currency exchange rate fluctuations.
Our borrowings under our Fab 2 credit facility, which comprise the majority
of our long-term liabilities, provide for interest based on a floating Libor
rate, and we are therefore subject to exposure to interest rate fluctuations. We
regularly engage in various hedging strategies to reduce our exposure to some,
but not all, of these risks and intend to continue to do so in the future.
However, despite any such hedging activity, we are likely to remain exposed to
interest rate and exchange rate fluctuations, which may increase the cost of our
activities, particularly our financing expenses.
The quantitative and qualitative disclosures about market risk are in Item
11 of this annual report.
B. LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2003, we had an aggregate of $56.5 million in cash, cash
equivalents, and short-term interest-bearing deposits, of which $44.0 million
was contractually restricted for Fab 2 use only. This compares to $69.7 million
in cash, cash equivalents, and short-term and interest-bearing deposits, of
which $51.3 million was contractually restricted for Fab 2 use only, as of
December 31, 2002. In addition, as of December 31, 2003, we had $4.8 million (as
of December 31, 2002, $11.9 million) in long-term interest-bearing deposits,
which were contractually restricted for Fab 2 use only.
During the year ended December 31, 2003, we generated cash from the
following sources: $174.0 million from bank loans, net of $13.0 million in
repayments; $24.4 million in net proceeds from our issuance of ordinary shares
and $16.4 million in net proceeds on account of our ordinary shares issued in
January 2004; and $33.8 million from Investment Center grants. These liquidity
resources financed our investments made during the year ended December 31, 2003,
which aggregated approximately $201 million in connection with construction,
equipment and other assets of Fab 2, including our purchase and transfer of
technology from Motorola and Toshiba and construction and equipping of Fab 2.
49
Our Fab 2 operating activities in 2003 and 2002 generated negative cash
flows of $75.3 million and $1.8 million, respectively, and $5.7 million of
positive cash flows in 2001. We expect our Fab 2 operating expenses in 2004 to
result in negative cash flows in the amount of approximately $40 million. Our
Fab 1 operating activities generated positive cash flows since the second
quarter of 2002, and we expect such activities to generate positive cash flows
from operating activities in 2004 as well.
As of December 31, 2003, we had loans in the amount of $431 million in
connection with the loans we obtained during 2003, 2002 and 2001 for the
establishment of Fab 2. As of December 31, 2003, we had no loans in connection
with Fab 1, following the repayment and termination of our remaining $10.0
million in loans in December 2003.
We recently completed the construction of the building and infrastructure and
commenced the initial ramp-up of Fab 2, our new advanced wafer facility adjacent
to Fab 1 in Migdal Haemek, Israel and have begun wafer production for our
customers in Fab 2 during the third quarter of 2003. Production capacity at the
end of December 2003 was 8,500 wafer starts per month. We currently expect to
have production capacity ranging between 13,000 and 15,000 wafer starts per
month by the end of 2004. When the ramp-up is completed, Fab 2 is expected to
have the capacity of 33,000 200-mm wafer starts per month. We expect to complete
our ramp-up of Fab 2 by December 2006. We expect the total cost of the
construction, equipping of the Fab 2 facility and ramp-up of production will be
approximately $1.5 billion. As of December 31, 2003, we received a total of $941
million for the Fab 2 project, as set forth below in tabular form. The remainder
of the Fab 2 project can be funded by additional grants available from the
Investment Center, debt financing made available from our banks, sales of our
securities, proceeds from the sale of securities we own in certain companies,
including Saifun Semiconductors, wafer prepayments from our customers, payments
we receive from Matsushita and cash flow from operations.
We expect to have adequate liquidity for our Fab 1 activities in 2004,
which shall be generated mainly from its operating activities. In the event that
our contemplated transaction with Siliconix is completed (see "Item 4: History
and Development of the Company"), the funding of the required assets for Fab 1
and the execution of this transaction is expected to be provided to us by
Siliconix.
We expect to have adequate liquidity for our Fab 2 activities in 2004. In
2004, we expect to make capital investments of approximately $160 million in Fab
2 and to have negative cash flow from Fab 2 operations of approximately $40
million. We expect to fund our Fab 2 activities during 2004 from the following
sources: (1) additional loans under the Fab 2 credit facility of approximately
$69 million; (2) Investment Center grants of approximately $30 million; and (3)
sales of our securities.
50
During the years 2003, 2002 and 2001, the majority of our liquidity and
capital resources and expenditures were in connection with our Fab 2 project, in
which we have invested as of December 31, 2003 approximately $900 million
(primarily in 2003 and 2002). The following chart illustrates the various
financial sources available to us to fund the construction and ramp-up to
completion of Fab 2, the amounts received to date and the amounts expected or
required to be received from various sources. We cannot assure you that we will
be able to obtain funds from these sources as expected, due to existing or
potential defaults under our Fab 2 agreements, poor conditions in capital
markets, failure to benefit from a recovery in the semiconductor market, failure
to achieve milestones and other factors, any or all of which may affect our
ability to raise funds. If we do not satisfy our need for funds for Fab 2 or if
the timing of the receipt of financing lags behind the timing of expenses, we
may from time to time experience lack of liquidity for our activities.
Amounts
expected
or required
to
Received be received
as of after
December December Total
31, 2003 31, 2003 (5)
Financial Sources (in millions)
Wafer Partners and other equity investors $306 $ 0 $306
Israel Government Investment Center 118 132(1) 250
Credit facility 431 69(2)(4) 500
Other financing sources 86 152(3)(4) 238
51
(1) Under the requirements of Israeli Law, we are required to complete our
approved investment program for Fab 2 by the end of 2005 (see "-- Investment
Center Grants" below). Failure to meet this requirement may result in the
cancellation of all or a portion of our grants. See "Risk Factors -- If we do
not meet conditions to receive the Israeli government grants and tax benefits
approved for Fab 2, we may be required to seek alternative financing sources."
(2) Our banks' obligation to fund the loans is subject to the satisfaction
of minimum production capacity milestones, the required maintenance of financial
ratios and to additional conditions and covenants.
(3) Under the November 2003 amendment to our Fab 2 credit facility, we are
required to raise additional financing from specified sources by various
prescribed dates and to raise an aggregate amount of $152.0 million by no later
than the end of 2005 (see "Material Agreements -- Credit Facility"). The gross
proceeds of our recent offering, amounting to $80.1 million, will be applied
toward our compliance with this contractual obligation. We expect to raise the
remaining funding through: (i) equity investments, including the sale of
convertible securities; (ii) proceeds from the sale of securities we own in
certain companies, including Saifun Semiconductors Ltd.; (iii) wafer prepayments
from customers; (iv) a portion of payments we receive from Matsushita and (v)
proceeds from the exercise of employee options.
(4) We have agreed with our banks and TIC to complete a rights offering on
pre-determined terms if we do not complete a required fundraising. This
arrangement may result in an increase of our credit facility by up to $43
million.
(5) We will be required to make capital investments and implement and
acquire advanced technologies of an aggregate of approximately $1.5 billion in
order to ramp-up Fab 2 to 33,000 wafer starts per month. All of our capital
investments in 2004 will be made in Fab 2. In addition to the amounts listed in
footnote 3 above, we will require additional cash to complete the full ramp-up
of Fab 2; we expect to fund these cash needs through cash generated from
operations.
FAB 2 AGREEMENTS
In January 2001, we commenced construction of Fab 2, our new advanced wafer
fab adjacent to Fab 1 in Migdal Haemek. Fab 2 offers integrated circuit, or IC
manufacturing services utilizing advanced materials and a 0.18-micron process
technology we licensed from Toshiba. We have also licensed 0.13-micron process
technology from Motorola, which we are implementing in Fab 2 and expect to offer
in the future. The overall clean room area in Fab 2 is approximately 100,000
square feet. We began volume production at Fab 2 during the third quarter of
2003. Production capacity at the end of December 2003 was 8,500 wafer starts per
month, and we currently expect to have production capacity ranging between
13,000 and 15,000 wafer starts per month by the end of 2004. We expect the
production ramp to be completed by the end of 2006, at which time Fab 2 is
expected to have the capacity to produce 33,000 wafer starts per month. We
currently expect that the total cost of the construction, equipping of the
facility and ramp-up of the manufacturing line will be approximately $1.5
billion, of which approximately $900 million has been expended through December
31, 2003.
52
WAFER PARTNER AGREEMENTS. During 2000, we entered into a series of
agreements with four wafer partners: SanDisk, Alliance Semiconductor, Macronix
International and QuickLogic Corporation. The wafer partners agreed to invest
$250 million in us; SanDisk, Alliance Semiconductor and Macronix each committed
to invest $75 million, and QuickLogic committed to invest $25 million in
exchange for our ordinary shares and credits towards the purchase of wafers from
Fab 2 under the terms set forth in the agreements. We also agreed to reserve
approximately 50% of our Fab 2 capacity for our wafer partners for a 10-year
period, including during the ramp-up of Fab 2. In addition, these agreements
generally provide for a five percent discount on wafer purchases made by the
wafer partners of up to 80% of the maximum Fab 2 wafer fabrication capacity
committed to the wafer partners, subject to minimum holdings of our ordinary
shares.
In April 2002, our shareholders approved amendments to our agreements with
our wafer partners and financial investors relating to their third and fourth
milestone payments, and in May 2003, our shareholders approved an amendment to
our agreements with our wafer partners and financial investors relating to their
fifth milestone payments, which was re-approved by our shareholders after a
further amendment in December 2003 (see -- "Amendment to Fifth Milestone Payment
Schedule" below).
To date, we have received an aggregate of $246.8 million from our wafer
partners, of which $199.6 million was invested in consideration for 26,125,712
of our ordinary shares, and the remaining $47.2 million was established as wafer
credits.
INVESTMENT BY ISRAEL CORPORATION TECHNOLOGIES (ICTECH) LTD. AND OTHER
FINANCIAL INVESTORS. In December 2000, Israel Corporation Technologies (ICTech)
Ltd., our current principal shareholder and one of Israel's major holding
companies, agreed to invest $50.0 million contemporaneous with the investments
by the wafer partners. In consideration of ICTech's aggregate investment of $50
million, we issued ICTech a total of 6,749,669 of our ordinary shares through
January 2004.
In February 2001, the Challenge Fund-Etgar II agreed to invest $5.0 million
in our company on substantially the same terms as ICTech. In consideration of
Challenge's aggregate investment of $5.0 million, we issued Challenge a total of
670,166 of our ordinary shares through January 2004.
53
INVESTMENT BY ONTARIO TEACHERS' PENSION PLAN BOARD. In July 2002, Ontario
Teachers' Pension Plan Board (OTPP), agreed to purchase from us for $15.0
million, 3,000,000 ordinary shares and 1,350,000 warrants with an exercise price
of $7.50, exercisable for four years from the date of issuance. The investment
of OTPP was conditioned upon our raising at least an additional $15.0 million by
October 31, 2002, which we satisfied through our sale of ordinary shares and
warrants pursuant to a distribution of rights to our shareholders and certain
employee option holders in September 2002. Pursuant to the share purchase
agreement with OTPP, we filed in September 2003 a registration statement with
the SEC to register the resale of the shares and warrants issued to OTPP, which
was declared effective on September 30, 2003.
AMENDMENT TO FIFTH MILESTONE PAYMENT SCHEDULE. In February 2003, we reached
an agreement with our Fab 2 investors, SanDisk, Alliance, Macronix, ICTech and
Challenge, to advance the fifth and final Fab 2 milestone payment in two
installments. A portion of the first installment amounting to $15.9 million was
invested by the Fab 2 investors in May 2003, and they were issued ordinary
shares at a purchase price of $2.983 per share.
The remaining $25.1 million due in connection with the fifth milestone was
paid in December 2003. These parties were issued ordinary shares with respect to
the remainder of the first installment ($8.7 million) at the purchase price per
share agreed to in the first quarter of 2003 ($2.983 per share) and, with
respect to the second installment ($16.4 million), they were issued 2,346,786
ordinary shares based on the $7.00 offering price in the January 2004
underwritten offering of ordinary shares to the public. In addition, they
undertook to perform all actions necessary to bring about the rights offering
and/or the rescue offer, which may be initiated by our banks (see "Credit
Facility" below).
54
WAFER CREDITS. In connection with their investments in our Fab 2 project,
we issued to our wafer partners non-transferable credits which may be used to
reduce the cash amounts to be paid by them when paying for wafers manufactured
in Fab 2. These credits could generally be used at a rate of 7.5% for purchases
made through June 2005 and 15% for purchases made thereafter. Our major wafer
partners, SanDisk, Alliance and Macronix, have recently agreed that they will
not utilize any of their credits, which amount to $41.7 million as of December
31, 2003, for purchase orders of our wafer products from November 11, 2003 until
December 31, 2006. From January 1, 2004 to December 31, 2006, each wafer partner
is entitled, every quarter, to convert into our ordinary shares those wafer
credits that could have been utilized by such wafer partner against the actual
payment of wafers manufactured at Fab 2 during such quarter; otherwise, these
credits will bear interest payable every quarter at three-month LIBOR plus 2.5%
through December 31, 2007. On December 31, 2007, the remaining wafer credits
that could have been utilized during this period and that were not converted
into shares will be paid to all of the wafer partners who are parties to this
amendment. Should the wafer partners elect to convert their wafer credits into
our ordinary shares, they will be issued ordinary shares at the average trading
price of our ordinary shares during the 15 consecutive trading days preceding
the last day of the relevant quarter. For example, if our major wafer partners
purchase an amount of wafers which would otherwise result in their using the
full amount of credits available to them and they elect to convert all of these
credits into ordinary shares, we will issue them an aggregate of 8.3 million
shares, assuming the average trading price of our ordinary shares during the 15
consecutive trading days preceding the last relevant quarter is $5.00; if the
average trading price of our ordinary shares is $10.00, we will issue an
aggregate of 4.2 million shares. We have also agreed to allow our wafer partners
to convert, during January 2006, their remaining wafer credits issued in
connection with their fourth milestone payment up to an aggregate of $13.2
million, which they may have as of December 31, 2005, into our ordinary shares,
at the average trading price of our ordinary shares during the 15 consecutive
trading days preceding December 31, 2005. If the wafer partners exercise this
right and are issued more than 5%, in the aggregate, of our shares on January
31, 2006, we have agreed to offer all of our other shareholders rights to
purchase our shares at the same price per share.
The ordinary shares issued with respect to the fifth milestone payment are
also subject to (i) the restrictions on transfer applicable to the investors'
other holdings of our ordinary shares in connection with their committed
investments, and (ii) registration rights. The transfer restrictions applicable
to each of the investors' holdings in our ordinary shares in connection with its
committed investments have been extended by two years to January 2006 with
respect to ordinary shares that represent 70% of its holdings in our ordinary
shares in connection with (a) its committed investments which are held in
January 2004, (b) our September 2002 rights offering, and (c) ordinary shares
issued upon the conversion of its wafer credits as described above.
TECHNOLOGY AGREEMENT WITH TOSHIBA. In April 2000, we entered into a
technology transfer agreement with Toshiba Corporation of Japan, pursuant to
which Toshiba has and will transfer to us certain advanced CMOS technologies for
use in Fab 2. In exchange for license and technology fees and royalties, Toshiba
has and will provide us with recipes, know-how and patent licenses and has
trained a group of our engineers and managers. Based on Toshiba's 0.18-micron
CMOS process technology, we have internally developed an enhanced industry
compatible version of the process technology. Subject to prior termination for
cause by Toshiba, our licenses under our agreement with Toshiba are perpetual.
Our agreement with Toshiba does not include any non-competition arrangements.
Toshiba has invested $10 million in our equity and acquired 772,667 ordinary
shares as part of its technology partnership agreement. We also agreed to
reserve a portion of our Fab 2 capacity for Toshiba.
55
TECHNOLOGY TRANSFER AND DEVELOPMENT AGREEMENT WITH MOTOROLA. In September
2002, we entered into a technology transfer and development agreement with
Motorola, Inc., pursuant to which Motorola has and will transfer to us its 0.13
micron HiPerMOS7 CMOS process technology for Fab 2 as well as co-develop with us
an industry-standard compatible version of the process technology. Subject to
prior termination for cause by Motorola, our licenses under our technology
transfer agreement with Motorola are perpetual. Our agreement with Motorola does
not include any non-competition arrangements.
JOINT DEVELOPMENT AGREEMENT WITH MATSUSHITA. In June 2002, we entered into
an agreement with Matsushita Electronic Inc., for the joint development of
0.18-micron embedded microFLASH technology. Matsushita granted to us the
non-exclusive right to utilize, on a royalty-free basis, our jointly developed
technology, which is based on Matsushita's 0.18 micron process technology, for
foundry services or for the manufacture and sale of our own proprietary
products. We granted Matsushita royalty-free, non-exclusive license with respect
to our microFLASH technology for manufacturing semiconductor devices that
utilize our jointly developed technology for its own semiconductor business.
LICENSE AGREEMENT WITH DSPG. In January 2002, we licensed from DSP Group,
Inc. their Teak(R) Digital Signal Processing (DSP) core for use with our 0.18
micron process technology. Our royalty-bearing license is generally
non-exclusive. Subject to DSP Group's termination of the agreement for cause,
the term of our license is through December 31, 2007.
CREDIT FACILITY. In January 2001, we entered into a credit facility with
two leading Israeli banks, Bank Hapoalim and Bank Leumi, pursuant to which the
banks committed to make available to us up to $550 million of loans for the Fab
2 project. As a result of our reduction of the total project cost of Fab 2
through the renegotiation of equipment prices and a change of equipment
suppliers, we and our banks have agreed to amend the credit facility such that
the total amount of loans committed by the banks has been reduced to $500
million. Pursuant to the comprehensive amendment to the credit facility signed
on November, 11, 2003, the loans may be drawn down through December 2004 and are
repayable as follows: (i) with respect to loans received by us through December
31, 2003, we repaid our banks on December 31, 2003 all payments due by such
date, amounting to $431 million and, concurrently, drew down an equivalent
amount from our banks on such date to be repaid in 12 quarterly installments
commencing on March 31, 2007 and bearing interest, payable quarterly, at LIBOR
plus 2.5%, and (ii) with respect to loans received after December 31, 2003, we
will repay our banks, in 12 quarterly installments, or before the maturity date
of the facility, commencing three years from the drawdown date of each loan and
bearing interest, payable quarterly, at LIBOR plus 2.5%. As of December 31,
2003, we have drawn $431 million in loans. We pay the banks an annual commitment
fee of 0.25% of any unused portion of the facility. The banks' obligation to
fund the loans is subject to the satisfaction of the following revised Fab 2
production capacity milestones: (i) successful production of 10,000 wafer starts
per month by June 30, 2004 (or February 15, 2005, when taking into account a
seven and a half month grace period) and (ii) full manufacturing capacity of
33,000 wafer starts per month by December 31, 2007, as well as to additional
conditions and covenants, including restrictions on debt, prohibition on the
issuance of dividends prior to 2008, limitations on a change of ownership (which
generally requires that, through January 2006, our three largest wafer partners
not sell the shares they purchased in connection with each of their $75 million
investments in our shares other than a portion of their holdings which may be
sold prior to this date and that Israel Corporation Technologies (ICTech) Ltd.
hold during this period at least the higher of (i) eight million of our ordinary
shares or (ii) 16.5% of our issued share capital less two million ordinary
shares, with portions of the shares held by our wafer partners being released
from these restrictions through January 2008 and January 2009 with respect to
ICTech).
56
Under the terms of the amended facility agreement, we must also meet
certain financial ratios. For any quarter, the ``life of loan coverage ratio''
(which is the ratio of our Fab 2 net cash flow to our total debt related to Fab
2 in any quarter) is not permitted to be less than 1.3 at any time. In addition,
our ratio of equity to assets is not permitted to be less than 0% until the end
of 2006, 20% during 2007 and 30% thereafter, until the termination of the
facility agreement. The facility agreement also provides that we must comply
with additional financial covenants relating to quarterly sales and quarterly
earnings before interest, taxes, depreciation and amortization (quarterly
EBITDA). As of the second quarter of 2004, our Fab 2 quarterly sales and Fab 2
quarterly EBITDA must be no lower than certain amounts set forth in the facility
agreement, as amended. As of the second quarter of 2005, we must comply with
additional financial covenants relating to annual EBITDA, EBITDA over Debt
Service and Debt over EBITDA. We are currently in compliance with all of the
above financial covenants.
Pursuant to the amendment, we have to raise an aggregate amount of $152
million from specified financial sources by the following dates, and were to
raise $24.6 million from our Fab 2 investors in connection with their fifth
milestone payment by December 11, 2003 (see ``Amendment to Fifth Milestone
Payment Schedule'' above):
o $28.0 million by March 11, 2004;
o $25.5 million by June 30, 2004;
o $25.5 million by December 31, 2004;
o $36.5 million by June 30, 2005; and
o $36.5 million by December 31, 2005.
57
As of the date of this annual report, we have raised $80.8 million out of
the abovementioned $152 million. The amendment to the credit facility provides
that, should we fail to meet any of these fundraising obligations, the banks
will have the option to demand that we consummate a rights offering under the
following terms:
o The amount of the rights offering shall equal to the difference
between the amount actually raised towards the failed financing
obligation and what was to be raised;
o We will offer convertible securities to all of our shareholders in
units comprised of convertible debentures, convertible into, and
warrants exercisable for, our ordinary shares so that each unit will
include 45% warrant coverage of the amount of shares that may be
issued on the basis of an assumed conversion of the convertible
debentures;
o Each convertible debenture will bear interest at the rate of 6% per
year; 1% interest will be payable once a year, and the balance of such
interest (5%) will accrue until the maturity of the convertible
debentures on a compound basis, which maturity shall be a date no
earlier than December 31, 2009;
o The convertible debentures (principal and compounded interest) will be
convertible into our ordinary shares at a rate equal to the amount
that was to be raised plus the accumulated interest at such time of
conversion divided by the lower of a (i) 50% discount of the market
price of our shares at the close of trading, on the trading day
immediately prior to the date of the prospectus relating to the rights
offering or (ii) 50% discount of the average market price of our
ordinary shares during the 15 consecutive trading days prior to the
date of prospectus relating to the rights offering;
o Each warrant will be exercisable into one of our ordinary shares at
such exercise price, which is equivalent to 80% of the lower of (i)
the trading price for our ordinary shares at the close of trading on
the trading day immediately prior to the date of prospectus relating
to the rights offering or (ii) the average trading price for our
shares during the 15 consecutive trading days preceding the date of
the prospectus relating to the rights offering; and
o The warrants shall expire five years from their date of issuance.
58
If our banks exercise this option, The Israel Corporation Ltd. (``TIC''),
the parent company of our current major shareholder (``ICTech''), has undertaken
to our banks to exercise all of the rights ICTech receives in the rights
offering. In addition, as part of TIC's commitment, it will purchase from us
additional securities in a private placement on the same terms as the rights
offering, in an amount equal to 50/93 of the difference between what we actually
raised towards the failed financing obligation and what was to be raised, less
amounts raised in the rights offering, if any (including less any amounts
invested in the rights offering in connection with TIC's exercise of its own
rights). TIC's undertaking to our banks is limited to an aggregate of $50
million. If certain of our shareholders participate in the above investments,
then their investments will be deemed to be investments made by TIC towards its
$50 million commitment. In the event that the rights offering cannot be
completed, TIC has undertaken to purchase from us in a private placement 50/93
of the amount we were to raise in the rights offering. TIC may fulfill its
investment commitments through ICTech.
TIC's commitment and our obligation to consummate a rights offering expires
on the earlier of: (i) such time that we will fulfill our fundraising obligation
to raise an aggregate of $152 million under the credit facility, (ii) such time
as TIC has invested $50 million as described above, or (iii) June 30, 2006.
Under certain conditions, the term of TIC's commitment and our corresponding
obligations may be reduced.
Following the receipt of the above described investments from TIC, our
banks will increase the total amount which may be drawn under the credit
facility at a ratio of $43 for every $50 invested by TIC, up to $43 million in
the aggregate, which will be repayable by the earlier of (i) December 31, 2007
and (ii) three years from the date the loan is drawn. Should we draw down loans
using this increased amount of our credit facility, our banks will be issued 30%
warrant coverage of the amount drawn down, based on the average closing price of
our ordinary shares during the 15 consecutive trading days prior to the time we
draw down such loans.
In consideration for TIC's commitment to complete this investment, we have
agreed to issue warrants to ICTech comprised of a commitment fee and a
subscription fee:
The commitment fee will be 1.0% of the $50 million commitment less TIC's
portion of a theoretical rights offering if held on November 11, 2003 (the date
we signed the amendment to the credit facility). We therefore issued warrants
for the purchase of 58,906 of our ordinary shares at an exercise price of $6.17
(the 15 day average closing price of our shares or Nasdaq prior to the date the
amendment was signed with our banks).
The subscription fee will be 5% of the total amount of money invested by
TIC in consideration for all of the unsubscribed rights that it actually
purchases.
The exercise price for the warrants to be issued with respect to the
subscription fee will be the 15 day average closing price of our shares prior to
the date of the rights offering prospectus. All the warrants shall expire five
years from their date of issuance.
59
We have agreed to indemnify ICTech and TIC for any liabilities they incur
with respect to these arrangements, following the utilization of TIC's
undertaking, up to a maximum of $100 million as follows: up to $25 million cash
and any amount exceeding such $25 million limit will earn interest at LIBOR plus
2.5% and will be paid on the same terms that we repay our loans to our banks. In
addition, we have agreed to use our best efforts to insure this indemnification
undertaking.
Our revised amendment to the credit facility further provides that in the
event of certain triggering events, such as the commencement of bankruptcy or
receivership, proceedings against us ordered by a court of competent
jurisdiction or the prior determination of an arbitrator that bankruptcy or
receivership proceedings would be issued by a court against us were a petition
to be filed with a court seeking reorganization or arrangement under applicable
bankruptcy law or our requesting creditor protection, our banks will be able to
bring a firm offer made by a potential investor to purchase our shares at the
price provided in the offer. In such case, we shall be required thereafter to
procure a rights offering to invest up to 60% of the amount of this offer on the
same terms. If the offeror intends to purchase a majority of our outstanding
share capital, the rights offering will be limited to allow for this, unless
ICTech and the wafer partners (excluding QuickLogic) agree to exercise in a
rights offering rights applicable to their shareholdings and agree to purchase
in a private placement enough shares to ensure that the full amount of the offer
is invested.
If, as a result of any default, our banks were to accelerate our
obligations, we would be obligated to immediately repay all loans made by the
banks, plus penalties, and the banks would be entitled to exercise the remedies
available to them under the credit facility, including enforcement of their lien
against all our assets. An event of default under the credit facility and the
subsequent enforcement by the banks of their remedies under the credit facility
may allow our wafer partners, financial investors and the Investment Center of
the State of Israel to declare a breach of our obligations to them and entitle
them to exercise the remedies available under our agreements with them.
In January 2001, we also issued the banks warrants to purchase an aggregate
of 400,000 ordinary shares at a purchase price of $6.20 per share, exercisable
until January 2006. Pursuant to the amendment to the credit facility, we issued
our banks additional five year warrants to purchase an aggregate of 896,596
ordinary shares at a purchase price of $6.17 per share, exercisable until
December 2008. In addition, in the event that our banks increase our credit
facility as described above, we will issue our banks additional five-year
warrants equivalent to 30% of the amount drawn down based on the average closing
price of our ordinary shares during the 15 trading days prior to the time we
draw down such loan.
60
We have registered liens in favor of our banks on substantially all of our
present and future assets. The agreements with our banks restrict our ability to
place liens on our assets (other than to the State of Israel in respect of
investment grants) without the prior consent of the banks.
INVESTMENT CENTER GRANTS. In December 2000, the Israeli government's
Investment Center approved an investment program in connection with Fab 2. The
approval certificate provides for government grants at a rate of 20% of
qualified investments up to $1.25 billion (i.e., up to $250 million), subject
to customary conditions and other conditions, including a requirement that
approximately $400 million of our Fab 2 funding consist of paid-in-capital and
that $550 million of our Fab 2 funding be obtained by way of a credit facility
from commercial banks (which amount was subsequently reduced to $500 million).
We have registered a lien on our assets for the benefit of the Investment Center
which ranks subordinate to our banks. The approval certificate also provides for
a tax holiday on all taxable income related to Fab 2 for the first two years of
undistributed profitable operations. As of December 31, 2003, we had received
approximately $118 million in grants from the Investment Center, and raised
$302.1 million as paid in capital towards the $400 million requirement described
above. Subsequent to December 31, 2003, we raised an additional $80.8 million
that has been allocated towards the $400 million. As long as we comply with the
terms of our approval certificate, we are not required to make royalty payments
or other payments under the terms of our Investment Center grants.
Consistent with the requirements of Israeli law, our investment grant
requires that we complete our investment program within five years, meaning by
no later than the end of 2005. We do not expect to complete our Fab 2
investments and achieve full production capacity of 33,000 wafer starts per
month by the end of 2005. Israeli law limits the ability of the investment
center to extend the five-year investment limitation, unless an exempting
amendment to this law is adopted by the Israeli parliament. We have notified the
Investment Center of our revised investment schedule, and it is currently being
evaluated by the investment center. We have also informed the investment center
of our reduced rate of annual investments and our lower than projected
expectations for Fab 2 sales.
61
Since the inception of our financing activity for Fab 2, we have completed
the following public offerings:
SALE OF UNITS. In January 2002, we completed a sale of units in Israel,
composed of NIS 110,579,800 principle amount of convertible unsecured
subordinated debentures and 2,211,596 options, resulting in net proceeds of
approximately $21.5 million. Each debenture is NIS 1 in principal amount, and is
adjusted to reflect increases in the Israeli Consumer Price Index and bears
interest at a rate of 4.7% per annum, payable yearly commencing January 20,
2003. Principal is payable in four installments beginning in January of 2006
through 2009. Prior to December 31, 2008, the debentures are convertible into
ordinary shares at a conversion rate of one ordinary share per NIS 41 principal
amount of debentures linked to the Israel Consumer Price Index. Each option is
exercisable into one ordinary share until January 20, 2006 at an exercise price
of NIS 39 (as of December 31, 2003 - NIS 40.83, $9.32), linked to the Israel
Consumer Price Index.
RIGHTS OFFERING. In September 2002, we distributed to our shareholders and
certain of our employees in Israel and the United States rights to purchase
ordinary shares and warrants to purchase our ordinary shares. Substantially all
of the rights exercised in connection with the rights offering were made by
ICTech and our major wafer partners. The rights offering resulted in net
proceeds of approximately $19.7 million.
UNDERWRITTEN PUBLIC OFFERING. In January 2004, we completed an underwritten
public offering in the United States of 11 million of our ordinary shares at a
price to the public of $7.00 per share. Pursuant to this offering, our
underwriters partially exercised their over-allotment option and purchased
444,500 of our ordinary shares at a price of $7.00 per share. The underwritten
public offering, including the partial exercise of the over-allotment option,
resulted in net proceeds of approximately $75.2 million.
C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES
Our research and development activities have related primarily to our
process development and microFLASH module design efforts, and have been
sponsored and funded by us with some participation by the Israeli government.
Research and development expenses for the years ended December 31, 2003, 2002
and 2001 were $20.7 million, $17.0 million and $9.6 million net of government
participation of $1.1 million, $1.2 million and $1.4 million, respectively. We
have also incurred costs in connection with the transfer of Toshiba and Motorola
technology for use in Fab 2, some of which have been amortized over the
estimated life of the technology following the commencement of production in Fab
2 during the third quarter of 2003 (see also in this Item "Critical Accounting
Policies - Depreciation and Amortization of Fab 2 Assets"). For a description of
our research & development policies and our patents and licenses, see "Item 4.
Information on the Company--4.B. Business Overview."
D. TREND INFORMATION
The semiconductor industry has historically been highly cyclical on a
seasonal and long-term basis. On a long-term basis, the market has fluctuated,
cycling through periods of weak demand, production overcapacity, excess
inventory and lower sales prices and periods of strong demand, full capacity
utilization, product shortages and higher sales prices. Although there can be no
assurance that this trend will continue, the semiconductor industry now appears
to be in the midst of a cyclical upswing.
62
There is a trend within the semiconductor industry toward ever-smaller
features. State-of-the-art fabs are currently using process geometries of 0.18
microns and below. As demand for smaller geometries increases, there is downward
pressure on the pricing of larger geometry products and increasing
underutilization of fabs that are limited to manufacturing larger geometry
products, which results in less profitability for manufacturers of larger
geometry products. Fab 1 is limited to geometries of 0.35 microns and above and
Fab 2 currently operates at process geometries of 0.18 microns and produces
200-mm wafers. In order for an independent wafer foundry to successfully
compete, it must decrease the process geometries with which it manufactures
wafers every 18 to 24 months, and it must purchase or develop suitable
technology, which typically costs between $30 million and $50 million per
generation. A new generation of process technology will also require the
purchase of manufacturing equipment, which currently costs approximately $20
million to provide capacity to produce 1,000 wafer starts per month. In order
for us to successfully compete over the long term, we must be capable of
manufacturing wafers with increasingly smaller geometries. We have already begun
the transfer to us of 0.13 micron process technology which we licensed from
Motorola, and our Fab 2 business plan contemplates the purchase of manufacturing
equipment necessary to manufacture wafers with a process geometry of 0.13
microns. We plan to initiate volume production in geometries of 0.13 microns at
Fab 2 during 2005.
E. OFF-BALANCE SHEET ARRANGEMENTS
We are not a party to any material off-balance sheet arrangements. In addition,
we have no unconsolidated special purpose financing or partnership entities that
are likely to create material contingent obligations.
63
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations and commercial
commitments as of December 31, 2003:
PAYMENT DUE
----------------------------------------------------------------
LESS
CONTRACTUAL TOTAL THAN 1 2 YEARS 3 YEARS 4 YEARS 5 YEARS AFTER
OBLIGATIONS YEAR 5 YEARS
-------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS)
Short-term debt and
other current
liabilities (1 $ 47,701 $ 47,701 $ - $ - $ - $ - $ -
Long-term debt (2) 552,381 22,601 25,096 26,410 168,137 159,924 150,213
Convertible
debentures (3) 32,031 1,243 1,243 7,852 7,542 7,231 6,920
Operating leases 8,504 3,481 2,954 1,474 425 170 -
Purchase obligations
in connection with
the construction and
Equipping of Fab 2
(4) 99,035 95,535 3,500 - - - -
Other long-term
liabilities 4,435 -- -- -- -- -- 4,435
Purchase obligations 40,532 4,819 3,823 3,053 2,724 2,724 23,389
-------- -------- -------- -------- -------- -------- --------
Total contractual
obligations $784,619 $175,380 $ 36,616 $ 38,789 $178,828 $170,049 $184,957
-------- -------- -------- -------- -------- -------- --------
(1) Short-term debt and other current liabilities include our trade accounts
payable for equipment and services that have already been supplied.
(2) Long-term debt includes principal and interest payments in accordance with
the terms of the credit facility amended in November 2003, as well as the
impact of our hedging transactions.
(3) Total amounts include expected principal and interest payments for the
presented periods.
(4) These amounts primarily consist of ordered equipment that has not yet been
received. In addition to these agreements, we have committed approximately
$0.6 million in standby letters of credit and guarantees to secure our Fab
2 construction and equipment obligations.
64
The above table does not include other contractual obligations or
commitments we have, such as undertakings pursuant to royalty agreements,
commissions and service agreements. We are unable to reasonably estimate the
total amounts to be paid under the terms of these agreements, as the royalties,
commissions and required services are a function of future sales revenues, the
volume of business and hourly-based fees. In addition, the above table does not
include our long-term liability with respect of our wafer partner advances,
which as of December 31, 2003, amounted to $46.3 million that may be utilized by
them against future purchases of Fab 2 products. We are unable to reasonably
estimate the total amounts that may be utilized by our wafer partners since we
can not reasonably estimate their future orders in the periods set forth in the
above chart; and even if we could reasonably estimate our wafer partners' future
orders, we are unable to determine which portion of the advances they are
entitled to utilize against purchases will be converted into our fully paid
ordinary shares, as provided under the recent amendment with our wafer partners
(see "Fab 2 Agreements").
65
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
DIRECTORS AND SENIOR MANAGEMENT
Set forth below is information regarding the members of our administrative,
supervisory or management bodies and our directors.
NAME Age TITLE
Carmel Vernia 51 Chief Executive Officer
Amir Harel 42 Vice President and Chief Financial Officer
Doron Simon 38 President, Tower Semiconductor USA, V.P. Marketing, Tower
Semiconductor Ltd.
Dr. Itzhak Edrei 44 Vice President of Research and Development
Rafi Nave 54 Vice President of Customer Services
Erez Taoz 49 Vice President, Fab 2 General Manager
Eli Lazar 53 Vice President of Human Resources, Logistics and
Information Systems
Rafi Mor 40 Vice President, Fab 1 Manager
DIRECTORS
Carmel Vernia 51 Chairman of the Board
Idan Ofer 48 Director
Ehud Hillman 51 Vice Chairman
Dr. Eli Harari 58 Director
Miin Wu 55 Director
N.D Reddy 64 Director
Hans Rohrer 54 Independent Director
Zehava Simon 45 Independent Director
Carmel Vernia has served as the Chairman of our Board of Directors and
Chief Executive Officer since June 1, 2003. From 2000 to 2002, Mr. Vernia served
as the Chief Scientist in the Government of Israel's Ministry of Industry and
Trade. Following his service as Chief Scientist, Mr. Vernia was subject to a
mandatory cooling period under Israeli law. Prior to that, he spent 16 years
with Comverse Technology in various positions, culminating with his appointment
to the dual positions of Chief Operating Officer of Comverse (Nasdaq: CMVT) and
Chief Executive Officer of Verint Systems (Nasdaq: VRNT). Mr. Vernia earned an
MS in electrical and computer engineering from the University of California,
Davis and a BS in electrical engineering from the Technion - Israel Institute of
Technology. Mr. Vernia also serves as a director of Saifun Semiconductors and
Persay.
Idan Ofer joined our Board of Directors in June 1999 and served as Chairman
of the Board from January 2000 until May 2003. Mr. Ofer serves on the Stock
Option and Compensation Committee. Mr. Ofer has served as Chairman of the Board
of Directors of Israel Corp., which wholly owns our current principal
shareholder, since April 1999. Mr. Ofer also serves as a director of several
public subsidiaries of Israel Corp. In addition to his positions within Israel
Corp., Mr. Ofer currently serves as a director of several companies engaged in
venture capital and energy projects.
66
Ehud Hillman served on our Board from October 1996 through August 1999 and
was reappointed to the Board in January 2000. In January 2001, Mr. Hillman was
appointed Vice Chairman of the Board. Mr. Hillman serves on the Tender
Committee. Since March 2001, Mr. Hillman has served as President and Chief
Executive Officer of ICTech, the technology subsidiaries holding company of
Israel Corp., which is our current principal shareholder. Mr. Hillman served as
Chief Financial Officer of Israel Corp. from September 1996 to 1997 and as
Executive Vice President and Chief Financial Officer of Israel Corp. from May
1997 to 2001. Mr. Hillman served as a director of several subsidiaries of Israel
Corp., including Israel Chemicals Ltd., ZIM Israel Navigation Company and
others. Prior to that time, Mr. Hillman was Vice President and Controller of
Clal Industries Ltd. and a director of several companies in the Clal Group.
Dr. Eli Harari joined our Board in January 2001. Dr. Harari serves on the
Stock Option and Compensation Committee. Dr. Harari, the founder of SanDisk
Corporation, has served as President and Chief Executive Officer and as a
director of SanDisk since 1988. In 1983, Dr. Harari founded Wafer Scale
Integration, or WSI, a semiconductor company acquired by STMicroelectronics in
2000, serving as WSI's President and Chief Executive Officer from 1983 to 1986
and as Chairman and Chief Technical Officer from 1986 to 1988.
Miin Wu joined our Board in January 2001. Mr. Wu serves as President and
Chief Executive Officer of Macronix International and has been an executive
officer of Macronix since its formation in 1989. Mr. Wu received both a B.S. and
an M.S. in Electrical Engineering from National Cheng-Kung University in Taiwan
as well as an M.S. in Material Science & Engineering from Stanford University.
N. Damodary Reddy joined our Board in January 2001. Mr. Reddy serves on the
Audit Committee. Mr. Reddy is the co-founder of Alliance Semiconductor
Corporation and has served as its Chairman, President and Chief Executive
Officer since its inception in February 1985. Mr. Reddy also served as Chief
Financial Officer of Alliance Semiconductor from June 1998 to January 1999 and
from May 2001 until April 2002. From September 1983 to February 1985, Mr. Reddy
served as President and Chief Executive Officer of Modular Semiconductor, Inc.,
and from 1980 to 1983, he served as manager of Advanced CMOS Technology
Development at Synertek, Inc., a subsidiary of Honeywell, Inc. Prior to that
time, Mr. Reddy held various research and development and management positions
at Four Phase Systems, a subsidiary of Motorola, Inc., Fairchild Semiconductor
and RCA Technology Center. He holds an MS degree in Electrical Engineering from
North Dakota State University and an MBA from Santa Clara University.
67
Hans Rohrer joined our Board in April 2002 as an independent director. Mr.
Rohrer serves as a member of our Audit Committee. From 1999 to 2002, Mr. Rohrer
served as President of Taiwan Semiconductor Manufacturing Company -- Europe. Mr.
Rohrer has held various engineering, marketing, sales and general management
positions, including Vice President and General Manager, Europe, with National
Semiconductor between 1980 and 1998. Mr. Rohrer started his career in the
semiconductor industry with Texas Instruments. Mr. Rohrer serves as an
independent director on our Board for a fixed term which expires in 2005 and can
be extended for an additional 3 years fixed term.
Zehava Simon joined our Board in September 1999. Ms. Simon serves as
Chairperson of our Audit Committee and serves as a member of our Stock Option
and Compensation Committee and Tender Committee. Since 2002, Ms. Simon has
served as Chief Executive Officer for BMC Software Israel after having served in
various positions at BMC from 2000 to 2002. From 1998 to 2000, Ms. Simon was the
Israel Business Development Manager for Intel. From 1993 to 1998, Ms. Simon
served as Intel's Finance and Administration Manager for Israel. Ms. Simon
serves as an independent director on our Board for a fixed term which expires in
2004.
Amir Harel joined Tower in December 1998 and assumed the office of Vice
President and Chief Financial Officer in January 1999. From July 1994 through
November 1998, Mr. Harel was Secretary and Chief Financial Officer of Elbit
Vision Systems Ltd. From December 1988 through June 1994, Mr. Harel held various
finance management positions at Elbit Ltd.
Doron Simon was appointed Vice President of Marketing on November 2003 and
has been President of Tower Semiconductor USA since April 2001. Since 1993, Mr.
Simon has served in various capacities, including Director of Customer Service,
Director of Planning and Turnkey Operations and Director of Worldwide Sales
Operations. Prior to 1993, Mr. Simon was employed by National Semiconductor in
Migdal Haemek as their Production Control Manager.
Dr. Itzhak Edrei was appointed Vice President of Research and Development
in August 2001, having served as Director of Research and Development since
1996. From 1994 to 1996, Dr. Edrei served as our Device and Yield Department
Manager. Prior to joining Tower, Dr. Edrei was employed by National
Semiconductor as Device Section Head.
68
Rafi Nave was appointed Vice President of Customer Services in August 2003.
From 1996 to 2003, Mr. Nave served as Vice President of Research and Development
for NDS Group. From 1974 to 1995, Mr. Nave was employed by Intel Corporation in
a variety of positions of increasing responsibility, among them chip design
engineer and General Manager of Intel's design center in Israel. Mr. Nave earned
master and bachelor degrees in electrical engineering from the Technion.
Erez Taoz was appointed Vice President and Fab 2 General Manager in March
2003, having served as VP and Fab 1 General Manager since August 2001 and as
Director of Fab 1 since 1999. Mr. Taoz joined Tower in 1996 as our Director of
Manufacturing. Prior to that time, Mr. Taoz served as Director of Manufacturing
at Cyclone Aviation Products.
Eli Lazar was appointed Vice President of Human Resources, Logistics and
Information Systems, having served as Director of that department since 1996.
Prior to that time, Mr. Lazar had over 15 years of experience as Vice General
Manager at the College of Management and as Human Resources Manager at the
National Semiconductor Design Center at Hertzliya.
Rafi Mor was appointed Vice President and Fab 1 Manager in August 2003,
having served as Senior Director and Fab 1 Manager since March 2003. From
November 2000 to March 2003, Mr. Mor served as Senior Director of Process Device
& Yield of Fab 1. From 1998 to 2000, Mr. Mor served as Director of Equipment
Reliability & Support of Fab 1. Previously, Mr. Mor was employed by National
Semiconductor in various engineering and management capacities.
B. COMPENSATION
For the years ended December 31, 2003 and 2002, we paid to all our
directors and senior management, as a group, an aggregate of $0.9 million and
$1.4 million, respectively, in salaries, fees and bonuses, excluding management
fees paid to a subsidiary of TIC (see Item 7 "Major Shareholders and Related
Party Transactions--Related Party Transactions"). The total amount set aside or
accrued in the year ended December 31, 2003 to provide for severance, retirement
and similar benefits for such persons was $0.2 million. No directors received
cash compensation other than the annual and meeting fees described below. Mr.
Vernia receives annual compensation at a total cost to us of approximately
$220,000, including customary benefits provided to our officers. As of December
31, 2003, our directors were granted options to purchase an aggregate of 280,000
ordinary shares at a weighted average exercise price of $8.48. These options
will become exercisable according to various vesting schedules over four years
and generally remain exercisable for five years following the vesting date.
69
During the year ended December 31, 2003, we granted a total of 462,000
options to purchase ordinary shares to our senior managers as a group. These
options have a weighted average exercise price of $5.31 per share with vesting
periods over four years and expire in 2013. For options granted to the Chairman
of our Board of Directors and Chief Executive Officer, see "Certain Transactions
-- Grant of Options to Chairman and Chief Executive Officer."
Since October 2001, the directors have foregone their directors' fees,
except for fees required by law to be paid to our independent directors,
consisting of NIS 26,000 (approximately $5,940) annual fee plus NIS 915
(approximately $210) per meeting. The aggregate amount payable to our
independent directors with respect to the year ended December 31, 2003 was
approximately $15,200. The annual and per meeting fees paid to our independent
directors are adjusted semiannually to reflect changes to the published
guidelines in Israel for independent directors.
C. BOARD PRACTICES
Our Articles of Association provide that the Board of Directors shall
consist of at least five and no more than 11 members. All directors hold office
until their successors are elected at the next annual general meeting of
shareholders. Pursuant to a shareholders agreement described in ``Certain
Transactions,'' Israel Corp., SanDisk, Alliance Semiconductor and Macronix have
agreed to vote all their respective shares for nominees designated by each
shareholder and for the election of a nominee of Israel Corp. as Chairman of the
Board. Our officers are appointed by the Board of Directors and (subject, in
certain cases, to employment agreement provisions that require 270 days notice
of termination) continue to serve at the discretion of the Board of Directors.
Our Articles of Association provide that any director may, by written
notice to us, appoint another person to serve as an alternate director, and may
cancel such appointment. Any person who is not already a director may act as an
alternate, and the same person may not act as the alternate for more than one
director at a time. The term of appointment of an alternate director may be for
one meeting of the Board of Directors or for a specified period or until notice
is given of the cancellation of the appointment.
None of the members of the Board is entitled to receive any severance or
similar benefits upon termination of his service with the Board of Directors,
other than Mr. Vernia, who is entitled to severance as an employee under Israeli
law.
Pursuant to Israeli law, we are required to appoint two independent
directors. These directors must be unaffiliated with us and our principals. Any
committee of the Board of Directors which is authorized to exercise any function
of the board must include at least one independent director.
Independent directors are to be elected by a majority vote at a
shareholders' meeting, provided that such majority includes at least one-third
of the shares held by non-controlling shareholders voted at the meeting or the
total number of shares held by non-controlling shareholders voted against the
election of the director does not exceed one percent of the aggregate voting
rights in the company.
70
The initial term of an independent director is three years and may be
extended for an additional three years. Independent directors may be removed
only by the same percentage of shareholders as is required for their election,
or by a court, and then only if the independent directors cease to meet the
statutory qualifications for their appointment or if they violate their duty of
loyalty to the company.
An independent director is entitled to compensation, as provided in
regulations adopted under the new Companies Law, and is otherwise prohibited
from receiving any other compensation, directly or indirectly, in connection
with service provided as an independent director.
The Companies Law requires public companies to appoint an audit committee.
The responsibilities of the audit committee include reviewing the company's
financial statements, monitoring the company's independent auditors, identifying
irregularities in the management of the company's business and approving related
party transactions as required by law. An audit committee must consist of at
least three directors, including the independent directors of the company. The
chairman of the board of directors, any director employed by or otherwise
providing services to the company, and a controlling shareholder or any relative
of a controlling shareholder, may not be a member of the audit committee. An
employee, executive officer or director of a controlling shareholder of an
Israeli company may serve as a member of an audit committee under Israeli law,
unless such individual controls more than 50% of the controlling shareholder.
Each of our independent directors and Mr. Dan Reddy (who according to public
filings is the Chairman, President, Chief Executive Officer and a 21%
shareholder of Alliance Semiconductor) are members of our audit committee.
Under the Companies Law, the board of directors must appoint an internal
auditor, who is recommended by the audit committee. The role of the internal
auditor is to examine, among other matters, whether the company's actions comply
with the law and orderly business procedure. Under the new Companies Law, the
internal auditor may be an employee of the company but not an office holder, or
an affiliate, or a relative of an office holder or affiliate, and he may not be
the company's independent accountant or its representative.
Ms. Simon, who currently serves as an independent director, was appointed
under a predecessor law to a fixed five-year term, which expires in September
2004. Mr. Rohrer, who currently serves as an independent director, was appointed
under the current Companies Law, with an initial three-year term expiring in
April 2005. Both Ms. Simon and Mr. Rohrer serve on our Audit Committee, and Ms.
Simon is deemed to be a financial expert as required under the Sarbanes-Oxley
Act.
71
Mr. Ofer, Dr. Harari and Ms. Simon serve on the Stock Option and
Compensation Committee. The committee meets at least once a year. The primary
function of our Stock Option and Compensation Committee is to approve our
employee compensation policy and determine remuneration and other terms of
employment for our officers and senior employee. In setting our remuneration
policy, the committee considers a number of factors including:
o the overall employment market environment;
o the basic salaries and benefits available to comparable officers at
comparable companies;
o the need to attract and retain officers of an appropriate caliber;
o the need to ensure such executives' commitment to the continued
success of our company by means of incentive schemes;
o the performance of the employee; and
o financial and operating results of our company.
D. EMPLOYEES
The following table sets forth for the last three fiscal years, the number
of our employees engaged in the specified activities.
AS OF
DECEMBER 31,
---------------------------
2003 2002 2001
----- ----- -----
Process and Product Engineering, R&D, Design 375 375 299
Manufacturing, Operations (*) 650 94 78
Manufacturing Support 114 189 154
Administration, Marketing, Finance 81 99 108
Fab 2 Construction and Technology Transfer (*) 45 438 409
----- ----- -----
Total 1,265 1,195 1,048
===== ===== =====
(*) Following the commencement of operations of Fab 2 during the third quarter
of 2003, most of the employees that prior to that date were classified under Fab
2 construction and technology transfer activities are classified under
manufacturing operations activities.
We also use temporary employees as necessary. During 2003, we used on
average 96 temporary employees.
Except for an arrangement regarding pension contributions, we have no
collective bargaining agreements with any of our employees. However, by
administrative order, certain provisions of the collective bargaining agreements
between the Histadrut (General Federation of Labor in Israel) and the
Coordination Bureau of Economic Organizations, relating primarily to the length
of the work day, minimum wages, pension contributions, insurance for
work-related accidents, procedures for dismissing employees, determination of
severance pay and other conditions of employment are applicable to our
employees. In accordance with these provisions, the salaries of our employees
are partially indexed to the Consumer Price Index in Israel.
72
We generally provide our employees with benefits and working conditions
beyond the minimum requirements. We consider our relationship with our employees
to be good, and we have never experienced a labor dispute, strike or work
stoppage.
E. SHARE OWNERSHIP
All of the persons listed above under the caption "Directors and Senior
Management" own ordinary shares and/or options to purchase ordinary shares. None
of such persons owns shares and/or options amounting to 1% or more of the
outstanding ordinary shares. Information regarding our share option plans and
warrants presented in Note 14B to our consolidated financial statements is
incorporated herein by reference.
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
MAJOR SHAREHOLDERS
The following table and notes thereto set forth information, as of February
29, 2004, concerning the beneficial ownership (as defined in Rule 13d-3 under
the Securities Exchange Act of 1934) and on a diluted basis of ordinary shares
by any person who is known to own at least 5% of the ordinary shares of our
company. On such date 65,582,383 ordinary shares were issued and outstanding.
The voting rights of our major shareholder do not differ from the voting rights
of other holders of our ordinary shares. However, certain of our major
shareholders are party to a shareholders agreement as a result of which they may
be able to exercise control over matters requiring shareholder approval,
including the election of directors and approval of significant corporate
transactions.
73
IDENTITY OF PERSON OR SHARES BENEFICIALLY PERCENT OF CLASS
GROUP OWNED PERCENT OF CLASS(1) (DILUTED)(2)
----- ------------------- ------------------- ----------------
Israel Corporation Technologies 15,143,066(5) 22.78% 18.42%
(ICTech) Ltd. ("ICTech")(3) (4)
SanDisk Corporation(4) 9,302,561(6) 14.11% 11.32%
Alliance Semiconductor 9,266,137(7) 14.05% 11.27%
Corporation(4)
Macronix International Co. Ltd.(4) 9,070,395(8) 13.77% 11.04%
Ontario Teachers' Pension Plan 4,350,000(9) 6.50% 5.29%
Board ("OTPP")
(1) Assumes the holder's beneficial ownership of all Ordinary Shares that
the holder has a right to purchase within 60 days from February 29,
2004.
(2) Assumes that all currently outstanding rights to purchase Ordinary
Shares have been exercised by all holders.
(3) On January 31, 2001, Israel Corp. transferred all its beneficial
ownership of shares of Tower to ICTech.
(4) Pursuant to a shareholders agreement among Israel Corp., Alliance
Semiconductor Corporation, SanDisk Corporation and Macronix Co. Ltd.,
each of ICTech, Alliance Semiconductor Corporation, SanDisk
Corporation and Macronix Co. Ltd. may be said to have shared voting
and dispositive control over 63.40% of our outstanding shares.
(5) Based on information provided by ICTech, represents 14,260,504 shares
currently owned by ICTech and 823,656 shares issuable upon the
exercise of currently exercisable warrants and 58,906 shares issuable
upon exercise of warrants granted on December 2003 at an exercise
price of $6.17.
(6) Based on information provided by SanDisk, represents 8,942,249 shares
currently owned by SanDisk and 360,312 shares issuable upon the
exercise of currently exercisable warrants.
(7) Based upon information provided by Alliance, represents 8,908,390
shares currently owned by Alliance, and 357,747 shares issuable upon
the exercise of currently exercisable warrants.
74
(8) Based on information provided by Macronix, represents 8,773,395 shares
currently owned by Macronix, and 297,000 shares issuable upon the
exercise of currently exercisable warrants.
(9) Based on information provided by OTPP, represents 3,000,000 shares
currently owned by OTPP and 1,350,000 shares issuable upon the
exercise of currently exercisable warrants issued pursuant to a Share
Purchase Agreement dated July 23, 2002.
Pursuant to a shareholders agreement dated as of January 18, 2001, among
Israel Corp., Alliance Semiconductor, SanDisk and Macronix, such parties have
agreed, among other things, to vote or cause to be voted all their respective
shares for the election to the Board of Directors of nominees designated by each
party, for nominees recommended by the Board, and for the election of a designee
of the Israel Corp. to serve as Chairman of the Board, as well as to vote
against the election of any other persons to the Board of Directors. In
addition, subject to certain exceptions, each shareholder has agreed to
restrictions on transfer of its shares for three years and to maintain a minimum
share ownership for five years. The shareholders agreement also provides for
certain rights of first refusal.
As of February 19, 2004, there were a total of 33 holders of record of our
ordinary shares, of which 24 were registered with addresses in the United
States. Such United States holders were, as of such date, the holders of record
of approximately 29% of the outstanding ordinary shares.
B. RELATED PARTY TRANSACTIONS
EXPENSE REIMBURSEMENT AGREEMENT WITH ISRAEL CORP. In March 2002, we entered
into an agreement with Israel Corp., the parent company of Israel Corporation
Technologies (ICTech), pursuant to which, Mr. Ehud Hillman, a director of our
company, provides management services in consideration of an annual fee of
$240,000. The term of this agreement is for one year, with automatic renewal for
successive one-year periods thereafter, unless prior terminated by one of the
parties. Our Audit Committee, Board of Directors and shareholders approved this
agreement.
GRANT OF OPTIONS TO EHUD HILLMAN. In November 2000 and September 2001, we
granted to Mr. Hillman, options to purchase up to 50,000 and 21,500 ordinary
shares, respectively, at an exercise price of $20.00 and $10.75 per share,
respectively, which have all vested. All options granted will remain exercisable
for a period of three years from the date of vesting.
75
GRANT OF OPTIONS TO CHAIRMAN AND CHIEF EXECUTIVE OFFICER. In May 2003, our
shareholders approved the grant of options to Mr. Carmel Vernia, the Chairman of
our Board of Directors and Chief Executive Officer to purchase up to 1,043,000
ordinary shares of the Company at an exercise price of $2.983. The options vest
over five years, with 417,200 options (40%) vesting on May 31, 2005 and an
additional 208,600 options (20%) vesting on May 31st of each of 2006, 2007 and
2008. The vesting of the options is subject to Mr. Vernia's serving as the
Chairman of our Board of Directors, Chief Executive Officer or President on the
relevant vesting date. Other than as set forth below, the options will be
exercisable for a period of 5 years from the date on which the options vest.
GRANT OF OPTIONS TO DIRECTORS. During 2001, the Audit Committee, Board of
Directors and shareholders approved a stock option plan pursuant to which our
Board members will be granted options to purchase up to 400,000 ordinary shares.
As of December 31, 2003, 280,000 options to purchase ordinary shares, of which
240,000 options were exercisable at an exercise price of $8.88 per share, and
40,000 options were exercisable at an exercise price of $6.08 per share, were
outstanding under the plan. These options vest over a four-year period,
according to various vesting schedules and are generally not exercisable
following the fifth anniversary of their vesting date.
INDEMNIFICATION AGREEMENTS WITH DIRECTORS. In December 2001, we entered
into indemnification agreements with the members of our Board of Directors,
pursuant to which, subject to the limitations set forth in the Israel Companies
Law and our Articles of Association, they will be exempt from liability for
breaches of the duty of care owed by them to the Company or indemnified for
certain costs, expenses and liabilities with respect to events specified in the
exemption and indemnification agreements. Such indemnification will be limited
to up to 25% of the then current fully paid-in-equity of the Company (in
addition to any amounts paid under insurance), with respect to specified events,
in each case of indemnification (including all matters connected therewith). The
agreements were approved by our shareholders at the general meeting of the
shareholders in November 2001 after approval of our Audit Committee and our
Board of Directors. In May 2003, our shareholders approved the execution of an
exemption and indemnification agreement with Mr. Vernia, under the same terms as
the above agreements.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
76
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Our consolidated financial statements are incorporated herein by reference to
pages F-1 through F-35.
LEGAL PROCEEDINGS
In July 2003, we and several of our directors and shareholders were named
as defendants in a securities class action complaint filed in the United States
District Court for the Southern District of New York. The plaintiffs have
asserted claims arising under the Securities Exchange Act of 1934, alleging
misstatements and omissions made by the defendants in materials sent to our
shareholders with respect to the approval of an amendment to the investment
agreements with our Fab 2 investors. The plaintiffs seek damages in unspecified
amounts, which could be substantial, and unspecified rescissory relief. We
believe the complaint is without merit and intend to defend ourselves
vigorously. In January 2004, the defendants filed a motion to dismiss the
plaintiffs' complaint on both substantive and procedural grounds; as of the date
of this annual report, the presiding court has not rendered a decision to this
motion to dismiss the plaintiffs' complaint. Any liability we incur in
connection with this complaint could materially harm our business and financial
position and, even if we defend ourselves successfully, there is a risk that
management distraction in dealing with this complaint could harm our results.
From time to time we are a party to various litigation matters incidental
to the conduct of our business. There is no pending or threatened legal
proceeding to which we are a party, that, in the opinion of management, is
likely to have a material adverse effect on our future financial results or
financial condition.
B. SIGNIFICANT CHANGES
NOT APPLICABLE.
77
ITEM 9. THE OFFER AND LISTING
MARKETS AND SHARE PRICE HISTORY
The primary trading market for our ordinary shares is the Nasdaq National
Market, where our shares are listed and traded on the under the symbol "TSEM."
The following table sets forth, for the periods indicated, the high and low
reported sales prices of the ordinary shares on the Nasdaq National Market:
PERIOD HIGH ($) LOW ($)
------ -------- -------
February 2004 7.95 6.60
January 2004 10.80 6.53
December 2003 7.90 6.18
November 2003 7.61 5.88
October 2003 6.15 4.00
September 2003 5.00 4.02
Fourth Quarter 2003 7.90 4.00
Third Quarter 2003 5.30 4.02
Second Quarter 2003 6.46 2.78
First Quarter 2003 3.56 2.16
Fourth Quarter 2002 5.51 3.11
Third Quarter 2002 5.85 3.26
Second Quarter 2002 6.93 5.23
First Quarter 2002 8.50 5.11
2003 7.90 2.16
2002 8.50 3.11
2001 17.12 3.80
2000 43.50 10.38
1999 13.75 6.13
78
In January 2001, our shares commenced trading on the Tel Aviv Stock
Exchange (TASE) in Israel under the symbol "Tower." The following table sets
forth, for the periods indicated, the high and low reported sales prices, in
NIS, of the ordinary shares on the Tel Aviv Stock Exchange:
PERIOD HIGH (NIS) LOW (NIS)
------ ---------- ---------
February 2004 34.88 29.37
January 2004 46.39 30.50
December 2003 34.67 24.61
November 2003 35.00 22.30
October 2003 27.75 18.30
September 2003 22.19 21.80
Fourth Quarter 2003 35.00 18.30
Third Quarter 2003 22.90 18.20
Second Quarter 2003 28.60 12.90
First Quarter 2003 16.46 10.25
Fourth Quarter 2002 25.11 15.30
Third Quarter 2002 27.46 18.70
Second Quarter 2002 33.98 25.04
First 2003 37.99 24.49
2003 35.00 10.25
2002 37.99 15.30
2001 58.50 16.80
79
ITEM 10. ADDITIONAL INFORMATION
ARTICLES OF ASSOCIATION; ISRAEL COMPANIES LAW
ARTICLES OF ASSOCIATION
Our shareholders approved the amendment of our Articles of Association
("Articles") in November 2000. The objective stated in the Articles is to engage
in any lawful activity.
We have currently outstanding only one class of equity securities, our
ordinary shares, par value NIS 1.00 per share. Holders of ordinary shares have
one vote per share, and are entitled to participate equally in the payment of
dividends and share distributions and, in the event of a liquidation of the
Company, in the distribution of assets after satisfaction of liabilities to
creditors. No preferred shares are currently authorized.
Our Articles require that we hold our annual general meeting of
shareholders each year no later than 15 months from the last annual meeting, at
a time and place determined by the Board of Directors, upon at least 21 days'
prior notice to our shareholders. No business may be commenced until a quorum of
two or more shareholders holding at least 33% of the voting rights is present in
person or by proxy. Shareholders may vote in person or by proxy, and will be
required to prove title to their shares as required by the Israeli Companies Law
(the "Companies Law") pursuant to procedures established by the Board of
Directors. Resolutions regarding the following matters must be passed by an
ordinary majority of those voting at the general meeting:
o amendments to our Articles;
o appointment or termination of our auditors;
o appointment and dismissal of directors;
o approval of acts and transactions requiring general meeting approval
under the Companies Law;
o increase or reduction of authorized share capital or the rights of
shareholders or a class of shareholders;
o any merger as provided in section 320 of the Companies Law; and
o the exercise of the Board of Directors' powers by general meeting, if
the Board of Directors is unable to exercise its powers and the
exercise of any of its powers is essential for Tower's proper
management, as provided in section 52(a) of the Companies Law.
A special meeting may be convened by request of two directors or by written
request of one or more shareholders holding at least 5% of our issued share
capital and 1% of the voting rights or one or more shareholders holding at least
5% of the voting rights. Shareholders requesting a special meeting must submit
their proposed resolution with their request. Within 21 days of receipt of the
request, the Board must convene a special meeting and send out notices setting
forth the date, time and place of the meeting. Such notice must be given at
least 21 days but not more than 35 days prior to the special meeting.
80
THE COMPANIES LAW
We are subject to the provisions of new Israeli Companies Law, which became
effective on February 1, 2000. The Companies Law codifies the fiduciary duties
that "office holders," including directors and executive officers, owe to a
company. An office holder, as defined in the Companies Law, is a director,
general manager, chief business manager, deputy general manager, vice general
manager, executive vice president, vice president, another manager directly
subordinate to the managing director or any other person assuming the
responsibilities of any of the forgoing positions without regard to such
person's title. Each person listed in the table in "Item 6. Directors, Senior
Management and Employees" above is an office holder. Under the Companies Law,
all arrangements as to compensation of office holders who are not directors
require approval of the board of directors or a committee thereof. With the
exception of compensation to outside directors in an amount specified in the
regulations discussed above, arrangements regarding the compensation of
directors also require audit committee and shareholder approval.
The Companies Law requires an office holder to promptly disclose any
personal interest that he or she may have and all related material information
known to him or her, in connection with any existing or proposed transaction by
the company. In addition, if the transaction is an extraordinary transaction,
the office holder must also disclose any personal interest held by the office
holder's spouse, siblings, parents, grandparents, descendants, spouse's
descendants and the spouses of any of the foregoing, or by any corporation in
which the office holder is a 5% or greater shareholder, holder of 5% or more of
the voting power, director or general manager or in which he or she has the
right to appoint at least one director or the general manager. An extraordinary
transaction is defined as a transaction not in the ordinary course of business,
not on market terms, or that is likely to have a material impact on the
company's profitability, assets or liabilities.
In the case of a transaction that is not an extraordinary transaction,
after the office holder complies with the above disclosure requirements, only
board approval is required unless the articles of association of the company
provide otherwise. The transaction must not be adverse to the company's
interest. If the transaction is an extraordinary transaction, then, in addition
to any approval required by the Articles of Association, it also must be
approved first by the audit committee and then by the board of directors, and,
in specified circumstances, by a meeting of the shareholders. An office holder
who has a personal interest in a matter that is considered at a meeting of the
board of directors or the audit committee may not be present at this meeting or
vote on this matter.
81
The Companies Law applies the same disclosure requirements to a controlling
shareholder of a public company, which is defined as a shareholder who has the
ability to direct the activities of a company, other than if this power derives
solely from the shareholder's position on the board of directors or any other
position with the company and includes a shareholder that holds 25% or more of
the voting rights if no other shareholder owns more than 50% of the voting
rights in the company. Extraordinary transactions with a controlling shareholder
or in which a controlling shareholder has a personal interest, and agreements
relating to employment and compensation terms of controlling shareholders
require the approval of the audit committee, the board of directors and the
shareholders of the company. The shareholder approval must either include at
least one-third of the shares held by disinterested shareholders who are
present, in person or by proxy, at the meeting, or, alternatively, the total
shareholdings of the disinterested shareholders who vote against the transaction
must not represent more than one percent of the voting rights in the company.
In addition, a private placement of securities that will increase the
relative holdings of a shareholder that holds five percent or more of the
company's outstanding share capital, assuming the exercise by such person of all
of the convertible securities into shares held by that person, or that will
cause any person to become, a holder of more than five percent of the company's
outstanding share capital, requires approval by the board of directors and the
shareholders of the company. However, subject to certain exceptions, shareholder
approval will not be required if the aggregate number of shares issued pursuant
to such private placement, assuming the exercise of all of the convertible
securities into shares being sold in such a private placement, comprises less
than twenty percent of the voting rights in a company prior to the consummation
of the private placement.
Under the Companies Law, a shareholder has a duty to act in good faith
towards the company and other shareholders and refrain from abusing his power in
the company, including, among other things, voting in the general meeting of
shareholders on the following matters:
o any amendment to the Articles of Association;
o an increase of the company's authorized share capital;
o a merger; or
o approval of interested party transactions that require shareholder
approval.
82
In addition, any controlling shareholder, any shareholder who knows that it
possesses power to determine the outcome of a shareholder vote and any
shareholder who has the power to appoint or prevent the appointment office
holder in the company is under a duty to act with fairness towards the company.
The Companies Law does not describe the substance of this duty. The Companies
Law requires that specified types of transactions, actions and arrangements be
approved as provided for in a company's articles of association and in some
circumstances by the audit committee, by the board of directors and by the
shareholders. In general, the vote required by the audit committee and the board
of directors for approval of these matters, in each case, is a majority of the
disinterested directors participating in a duly convened meeting.
MATERIAL CONTRACTS
FAB 2 AGREEMENTS. During 2000 and through 2002, we entered into several
important Fab 2 agreements and arrangements with a key technology partner, wafer
and equity financing partners, the Israeli Investment Center and two leading
Israeli banks. Discussions of these agreements are incorporated herein by
reference to the discussion under the caption "Fab 2 Agreements" in "Item 5.
Operating and Financial Review and Prospects" of this annual report and to Note
13A to the consolidated financial statements included in this annual report.
83
EXCHANGE CONTROLS
Under Israeli law, non-residents of Israel who purchase ordinary shares
with certain non-Israeli currencies (including dollars) may freely repatriate in
such non-Israeli currencies all amounts received in Israeli currency in respect
of the ordinary shares, whether as a dividend, as a liquidating distribution, or
as proceeds from any sale in Israel of the ordinary shares, provided in each
case that any applicable Israeli income tax is paid or withheld on such amounts.
The conversion into the non-Israeli currency must be made at the rate of
exchange prevailing at the time of conversion.
Under Israeli law and our company's Memorandum and Articles of Association
both residents and non-residents of Israel may freely hold, vote and trade our
ordinary shares.
TAXATION
A. Israeli Capital Gains Tax
Until the end of the year 2002 and provided we maintained our status as an
industrial corporation, capital gains from the sale of our securities were
generally exempt from Israeli Capital Gains Tax. This exemption did not apply to
a shareholder whose taxable income is determined pursuant to the Israeli Income
Tax Law (Inflationary Adjustments), 1985, or to a person whose gains from
selling or otherwise disposing of our securities are deemed to be business
income.
As a result of the recent tax reform legislation in Israel, gains from the
sale of our securities derived from January 1, 2003 and on will, in general, be
liable to capital gains tax of 15%. This will be the case so long as our
securities remain listed for trading on the Tel Aviv Stock Exchange or NASDAQ.
However, according to the tax reform legislation, non-residents of Israel will
be exempt from any capital gains tax from the sale of our securities so long as
the gains are not derived through a permanent establishment that the
non-resident maintains in Israel, and so long as our securities remain listed
for trading as described above. These provisions dealing with capital gains are
not applicable to an Israeli resident whose gains from selling or otherwise
disposing of our securities are deemed to be business income or whose taxable
income is determined pursuant to the Israeli Income Tax Law (Inflationary
Adjustments), 1985; the latter law would not normally be applicable to
non-resident shareholders who have no business activity in Israel.
In any event, under the US-Israel Tax Treaty, a US treaty resident may, in
general, only be liable to Israeli capital gains tax on the sale of our ordinary
shares (subject to the provisions of Israeli domestic law as described above) if
that US treaty resident holds 10% or more of the voting power in our company.
84
B. Israeli Tax on Interest Income and on Original Issuance Discount
Interest and Original Issuance Discount (OID) on our convertible
debentures, issued in January 2002, accruing from January 1, 2003 and on will in
general be liable to Israeli tax of up to 15% if received by an individual. This
reduced rate of tax will not apply if the interest and OID are business income
in the hands of the recipient, if the recipient is a controlling shareholder of
our company, or if financing costs for the purchase of the debentures were
deducted by the individual in the calculation of the individual's Israeli
taxable income in which cases regular rate of tax will apply. Interest and OID
received by a corporation are generally taxable at a rate of 36%.
Under new regulations, promulgated as part of the recent tax reform,
withholding tax at source from debenture interest and OID paid to non-resident
individuals will in general be at a rate of 15% and from debenture interest and
OID paid to non-resident corporations at a rate of 25%. In any event, under the
US-Israel tax treaty, the maximum Israeli tax withheld on interest and OID paid
on our convertible debentures to a US treaty resident (other than a US bank,
savings institution or company) is 17.5%.
C. Israeli Tax on Dividend Income
Israeli tax at a rate of 25% is generally withheld at source from dividends
paid to Israeli individuals and non-residents; in general, no withholding tax is
imposed on dividends paid to Israeli companies (subject to the provision of the
Israeli Income Tax Ordinance). The applicable rate for dividends paid out of the
profits of an Approved Enterprise is 15%. These rates are subject to the
provisions of any applicable tax treaty.
Under the US-Israel Tax Treaty, Israeli withholding tax on dividends paid
to a US treaty resident may not in general exceed 25%, or 15% in the case of
dividends paid out of the profits of an Approved Enterprise. Where the recipient
is a US corporation owning 10% or more of the voting stock of the paying
corporation and the dividend is not paid from the profits of an Approved
Enterprise, the Israeli tax withheld may not exceed 12.5% subject to certain
conditions.
85
D. PFIC Rules
A non-U.S. corporation will be classified as a passive foreign investment
company, or a PFIC, for U.S. federal income tax purposes if either (i) 75% or
more of its gross income for the taxable year is passive income, or (ii) on a
quarterly average for the taxable year by value (or, if it is not a publicly
traded corporation and so elects, by adjusted basis), 50% or more of its gross
assets produce or are held for the production of passive income.
We do not believe that we satisfied either of the tests for PFIC status in
2003 or in any prior year. However, there can be no assurance that we will not
be a PFIC in 2004 or a later year. If, for example, the "passive income" earned
by us exceeds 75% or more of our "gross income", we will be a PFIC under the
"income test". Passive income for PFIC purposes includes, among other things,
gross interest, dividends, royalties, rents and annuities. For manufacturing
businesses, gross income for PFIC purposes should be determined by reducing
total sales by the cost of goods sold. Although not free from doubt, if our cost
of goods sold exceeds our total sales by an amount greater than our passive
income, such that we are treated as if we had no gross income for PFIC purposes,
we believe that we would not be a PFIC as a result of the income test. However,
the tests for determining PFIC status are applied annually and it is difficult
to make accurate predictions of future income and assets, which are relevant to
the determination of PFIC status.
If we were to be a PFIC at any time during a U.S. holder's holding period,
such U.S. holder would be required to either: (i) pay an interest charge
together with tax calculated at maximum ordinary income rates on "excess
distributions," which is defined to include gain on a sale or other disposition
of ordinary shares, or (ii) so long as the ordinary shares are "regularly
traded" on a qualifying exchange, elect to recognize as ordinary income each
such year the excess in the fair market value, if any, of its ordinary shares at
the end of the taxable year over such holder's adjusted basis in such ordinary
shares and, to the extent of prior inclusions of ordinary income, recognize
ordinary loss for the decrease in value of such ordinary shares (the "mark to
market" election). For this purpose, the Nasdaq National Market is a qualifying
exchange. U.S. holders are strongly urged to consult their own tax advisers
regarding the possible application and consequences of the PFIC rules.
The above discussion does not purport to be an official interpretation of
the tax law provisions mentioned therein or to be a comprehensive description of
all tax law provisions which might apply to our securities or to reflect the
views of the relevant tax authorities, and it is not meant to replace
professional advice in these matters. The above discussion is based on current,
applicable tax law, which may be changed by future legislation or reforms.
Non-residents should obtain professional tax advice with respect to the tax
consequences under the laws of their countries of residence of holding or
selling our securities.
86
DOCUMENTS ON DISPLAY
We are required to file reports and other information with the SEC under
the Securities Exchange Act of 1934 and the regulations thereunder applicable to
foreign private issuers. Reports and other information filed by us with the SEC
may be inspected and copied at the SEC's public reference facilities described
below. Although as a foreign private issuer we are not required to file periodic
information as frequently or as promptly as United States companies, we
generally do publicly announce our quarterly and year-end results promptly and
file periodic information with the SEC under cover of Form 6-K. As a foreign
private issuer, we are also exempt from the rules under the Exchange Act
prescribing the furnishing and content of proxy statements and our officers,
directors and principal shareholders are exempt from the reporting and other
provisions in Section 16 of the Exchange Act.
You may review a copy of our filings with the SEC, including any exhibits
and schedules, at the SEC's public reference facilities in Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional
offices of the SEC located at the Northwestern Atrium Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. You may also obtain copies of such
materials from the Public Reference Section of the SEC, Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. You
may call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms. In addition, such information concerning our company can be
inspected and copied at the offices of the National Association of Securities
Dealers, Inc., 9513 Key West Avenue, Rockville, Maryland 20850 and at the
offices of the Israel Securities Authority at 22 Kanfei Nesharim St., Jerusalem,
Israel. As a foreign private issuer, all documents which were filed after
November 4, 2002 on the SEC's EDGAR system will be available for retrieval on
the SEC's website at www.sec.gov. You may read and copy any reports, statements
or other information that we file with the SEC at the SEC facilities listed
above. These SEC filings are also available to the public on the Israel
Securities Authority's website at www.isa.gov.il and from commercial document
retrieval services. We also generally make available on our own Web site
(www.towersemi.com) all our quarterly and year-end financial statements as well
as other information.
Any statement in this annual report about any of our contracts or other
documents is not necessarily complete. If the contract or document is filed as
an exhibit to the registration statement, the contract or document is deemed to
modify the description contained in this annual report. We urge you to review
the exhibits themselves for a complete description of the contract or document.
87
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss related to changes in market prices,
including interest rates and foreign exchange rates, of financial instruments
that may adversely impact our consolidated financial position, results of
operations or cash flows.
Our primary market risk exposures relate to interest rate movements on
borrowings and fluctuations of the exchange rate of the US dollar, which is the
primary currency in which we conduct our operations, against the NIS, the
Japanese Yen and the Euro. To manage those risks and mitigate our exposure to
them, we from time to time use financial instruments, primarily collar
agreements with a knock-out feature, cylinder options (call & put) and forward
transactions.
All financial instruments are managed and controlled under a program of
risk management in accordance with established policies. These policies are
reviewed and approved by our board of directors. Our treasury operations are
subject to an internal audit on a regular basis. We do not hold derivative
financial instruments for speculative purposes, and we do not issue any
derivative financial instruments for trading or speculative purposes.
RISK OF INTEREST RATE FLUCTUATION
We have market risk exposure to changes in interest rates on our long-term
debt obligations with floating interest rates. As of December 31, 2003 we had
$431 million outstanding long term debts which bear interest of three-month USD
LIBOR plus 2.5%. We primarily enter into debt obligations to support capital
expenditures needs. From time to time, we enter into interest rate collar
agreements to modify our exposure to interest rate movements. These agreements
limit our exposure to the risk of fluctuating interest rates by allowing us to
convert a portion of the interest on our borrowings from a variable rate to a
limited variable rate. We entered into various interest rate collar agreements
with respect to a total amount of $212 million of which $172 million was
effective as of December 31, 2003; some of these agreement gradually expire in
2006, with the remainder expiring in 2007,. With respect to $172 million of our
Fab 2 credit facility debt, under the terms of these collar agreements, if the
LIBOR is below the floor rate of 4.28%, we will pay total interest at the fixed
rate of 6.78% (the floor rate plus 2.5%); if the LIBOR is between 4.28% and
5.56%, we will pay total interest at the actual LIBOR plus 2.5%; if the LIBOR is
between 5.56% and 7.50%, we will pay total interest at a fixed rate of 8.06%
(the cap rate plus 2.5%); and if the LIBOR is higher than 7.50%, we will pay the
actual LIBOR rate plus 2.5%. At December 31, 2003, the LIBOR rate was 1.19%.
Accordingly, as of December 31, 2003, the interest rate on the $172 million of
long-term loans covered by the collar agreements was 6.78%, and the interest
rate on the $259 million of long-term loans not subject to the collar agreements
was 3.69%. These collar agreements resulted in a loss of $5.3 million in the
year ended December 31, 2003, of which $2.5 million was capitalized to property
and equipment. The fair value of the interest rate collar, as of December 31,
2003, was a $9.9 million loss. Assuming a 10% upward shift in the LIBOR rate at
December 31, 2003, (from 1.19% to 1.30%), the effective fair value of the $259
million debt that is not hedged by the collar agreements, and as to which we are
exposed to the risk of interest rate fluctuation, would have increased by $1.3
million. The $172 million debt hedged by the collar agreements would not have
changed assuming such interest rate increases by 10%.
88
Under the terms of the $40 million collar agreements to be effective as of
July 2004 and the credit facility, if the LIBOR is below 2.8%, we will pay total
interest at the fixed rate of 5.3%; if the LIBOR is between 2.8% and 5.5%, we
will pay interest at the LIBOR plus 2.5%; if the LIBOR is between 5.5% and
7.50%, we will pay total interest at a fixed rate of 8.0%; and if the LIBOR is
higher than 7.50%, we will pay the LIBOR rate plus 2.5%.
Our cash equivalents and short-term interest-bearing deposits are exposed
to market risk due to fluctuation in interest rates, which may affect our
interest income and the fair market value of our investments. We manage this
exposure by performing ongoing evaluations of our investments in those deposits.
Due to the short maturities of these investments, their carrying value
approximates the fair value.
FOREIGN EXCHANGE RISK
Our main foreign currency exposures give rise to market risk associated
with exchange rate fluctuations of the US dollar, our functional and reporting
currency, against the Japanese Yen, the Euro and the NIS. To protect the
reductions in value and the volatility of future cash flows caused by changes in
foreign exchange rates, we utilize from time to time forward transactions and
currency cylinder options in order to minimize part of the impact of foreign
currency fluctuations on our financial position and results of operations. Most
of those agreements are designated to eliminate exposure changes in the Japanese
Yen and the Euro vis-a-vis the US dollar. A cylinder option is a combination of
a purchased call option and a written put option. The combination of these
options limit our exposure to changes in the exchange rate of the US dollar
against foreign currencies by placing a maximum and minimum effective exchange
rate, and accordingly, the dollar amount to be paid for equipment purchases. The
forward transactions limit our foreign exchange risk exposure by placing a
predetermined effective exchange rate. During the year ended December 31, 2003,
we had options in an aggregate amount of $45 million, which resulted in this
period in a $2.3 million gain (mostly capitalized to property and equipment). As
of December 31, 2003, we had no open transactions.
89
We are exposed to the risk of fluctuation in the NIS/dollar exchange rate
with respect to our convertible debentures and the exercise price of our Options
(Series 1), which are both denominated in NIS linked to the Israeli Consumer
Price Index, or CPI. As of December 31, 2003, the adjusted outstanding principal
amount of the convertible debentures was NIS 115.8 million (equivalent to $26.4
million), and the exercise price of the Options (Series 1) was NIS 40.83
(equivalent to $9.32). The dollar amount of our finance costs (interest and
currency adjustments) related to the convertible debentures will be increased if
the rate of inflation in Israel is not offset (or is offset on a lagging basis)
by the devaluation of the NIS in relation to the dollar. In addition, the dollar
amount of any repayment on account of the principal of the convertible
debentures will be increased as well. On the other hand, if the devaluation of
the NIS against the dollar is greater than the rate of inflation in Israel, the
dollar amounts we shall raise on the date of exercising our Options (Series 1)
will be decreased. From the date of the issuance of the convertible debentures
and Options (Series 1) in January 2002 until December 2003, the CPI increased by
4.7% while the US dollar/NIS exchange rate decreased by 4.5%.
As of December 31, 2003 approximately half of the convertible debentures
amount is covered by a deposit denominated in NIS and linked to the CPI.
Therefore, we are exposed to the risk of fluctuations in the NIS/dollar exchange
rate only for the remaining balance of the convertible debentures.
The convertible debentures bear annual interest at a fixed rate of 4.7%.
The debentures are payable in four annual installments commencing January 2006.
Therefore, we are not subject to exposure to interest rate fluctuations with
respect to the debentures.
We enter, from time to time, into foreign exchange agreements to hedge
exposure relating to Value Added Tax, grants receivables and payroll expenses
denominated in NIS. The effect of these agreements during the year ended
December 31, 2003 was immaterial. As of December 31, 2003, we had no open
transactions.
We are exposed to currency risk in the event of default by the other
parties of the exchange transaction. The likelihood of such default to occur is
remote, as the other parties are widely recognized and reputable Israeli banks.
IMPACT OF INFLATION
We believe that the rate of inflation in Israel has had a minor effect on
our business to date. However, our dollar costs in Israel will increase if
inflation in Israel exceeds the devaluation of the NIS against the dollar or if
the timing of such devaluation lags behind inflation in Israel.
90
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
PART II
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
None.
ITEM 15. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the
participation of our management, including our chief executive officer and
chief financial officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities
Exchange Act of 1934, as amended). Based on that evaluation, which was completed
within 90 days of the filing date of this annual report, our chief executive
officer and chief financial officer concluded that our disclosure controls and
procedures were effective though we are constantly engaged in the process of
improving these controls and procedures. There have been no significant changes
in our disclosure controls or in other factors that could significantly affect
disclosure controls subsequent to the date of the evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
ITEM 16. [RESERVED]
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
Our Board of Directors has determined that a member of our Audit Committee,
Ms. Zehava Simon, is an audit committee financial expert.
ITEM 16B. CODE OF ETHICS
We have revised our code of ethics, inter alia, to impose certain policies
relating to ethical conduct on all of our directors and employees, including our
chief executive officer, chief financial officer, principal accounting officer,
and persons performing similar functions.
91
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents fees for professional audit services rendered
by our auditors for the audit of our consolidated annual financial statements
for the years ended December 31, 2003 and 2002, and fees billed for other
services rendered by our auditors including our public offerings of securities
and tax services.
2003 2002
-------- --------
Audit Fees(1) $367,000 $342,800
----------
(1) Audit fees consist of fees for professional services rendered for the audit
of our consolidated financial statements and review of unaudited interim
financial statements included in our quarterly reports and services
provided by the independent auditor in connection with statutory and
regulatory filings or engagements as well as tax services.
PART III
ITEM 17. FINANCIAL STATEMENTS
Not applicable.
ITEM 18. FINANCIAL STATEMENTS
See Index to Financial Statements following the signature page.
ITEM 19. EXHIBITS
1.1 Articles of Association of the Registrant, approved by shareholders on
November 14, 2000 (incorporated by reference to the correspondingly-numbered
exhibit to the Registrant's Annual Report on Form 20-F for the year ended
December 31, 2001 (the "2000 Form 20-F")).
1.2 Memorandum of Association of the Registrant (incorporated by reference
to the correspondingly-numbered exhibit to the Registrant's Registration
Statement on Form S-1, No. 33-83126).
2.1 Bank Warrants dated January 18, 2001 between the Registrant and Bank
Hapoalim B.M. and Bank Leumi Le-Israel B.M. (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
2.2 Registration Rights Agreement, dated as of January 18, 2001, by and
between SanDisk Corporation, Israel Corporation, Alliance Semiconductor Ltd. and
Macronix International Co., Ltd. (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
92
2.3 Terms of the Registrant's Convertible Debentures issued under an
Indenture dated January 22, 2002 (incorporated by reference to the summary of
terms included under the caption "Description of the Debentures" in Exhibit C to
the Registrant's Report on Form 6-K for January 2002 (No. 2), filed January 16,
2002 ("January 2002 Form 6-K")).
2.4 Terms of the Registrant's Options (Series 1) (incorporated by reference
to the summary of terms included under the caption "Description of the Options"
in Exhibit C to the January 2002 Form 6-K).
3.1 Consolidated Shareholders Agreement, dated as of January 18, 2001, by
and between SanDisk Corporation, Israel Corporation, Alliance Semiconductor Ltd.
and Macronix International Co., Ltd. (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
4.1 Share Purchase Agreement, dated as of July 4, 2000, by and between
SanDisk Corporation and the Registrant (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
4.2 Additional Purchase Obligation Agreement, dated as of July 4, 2000, by
and between SanDisk Corporation ("SanDisk") and the Registrant (incorporated by
reference to the correspondingly-numbered exhibit to the 2000 Form 20-F).
4.3 Share Purchase Agreement, dated as of August 29, 2000, by and between
Alliance Semiconductor Corporation ("Alliance") and the Registrant (incorporated
by reference to the correspondingly-numbered exhibit to the 2000 Form 20-F).
4.4 Share Purchase Agreement, dated as of December 11, 2000, by and between
QuickLogic Corporation ("QuickLogic") and the Registrant (incorporated by
reference to the correspondingly-numbered exhibit to the 2000 Form 20-F).
4.5 Share Purchase Agreement, dated as of December 12, 2000, by and between
Macronix International Co., Ltd. ("Macronix") and the Registrant (incorporated
by reference to the correspondingly-numbered exhibit to the 2000 Form 20-F).
4.6 Share Purchase Agreement, dated as of December 12, 2000, between Israel
Corporation and the Registrant (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
4.7 Additional Purchase Obligation Agreement, dated as of December 12,
2000, between Israel Corporation and the Registrant (incorporated by reference
to the correspondingly-numbered exhibit to the 2000 Form 20-F).
93
4.8 Share Purchase Agreement, dated February 11, 2001, between The
Challenge Fund - Etgar II and the Registrant (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
4.9 Facility Agreement dated January 18, 2001 among the Registrant, Bank
Hapoalim B.M. and Bank Leumi Le-Israel B.M. (the "Facility Agreement")
(incorporated by reference to the correspondingly-numbered exhibit to the 2000
Form 20-F).
4.10 Design and Construction/Turn-Key Contract dated as of August 20, 2000
among the Registrant, M+W Zander Holding GmbH, Meissner-Baran Ltd. and Baran
Group Ltd. (incorporated by reference to the correspondingly-numbered exhibit to
the 2000 Form 20-F).
4.11 Option Grant to Ehud Hillman dated September 24, 2000 (Hebrew language
document; a summary of the terms is included in the 2000 Form 20-F under the
caption "Related Party Transactions" in "Item 7. Major Shareholders and Related
Party Transactions") (incorporated by reference to the correspondingly-numbered
exhibit to the 2000 Form 20-F).
4.12 Approval dated December 31, 2000 of the Israeli Investment Center
(Hebrew language document; a summary of the terms is included in the 2000 Form
20-F under the caption "Fab 2 Agreements" in "Item 5. Operating and Financial
Review and Prospects") (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
4.13 Agreement between the Registrant and Saifun dated October 9, 1997
(incorporated by reference to exhibit 1.1 to the Registrant's Annual Report on
Form 20-F for the year ended December 31, 1997).
4.14 Registrant's Non-Employee Director Share Option Plan 2000/3
(incorporated by reference to exhibit 4.5 to the Registrant's Registration
Statement on Form S-8 No. 333-83204 ("Form S-8 No. 333-83204")).
4.15 Form of Grant Letter for Non-Employee Directors Share Option Plan
2001/4 (incorporated by reference to exhibit 4.9 to the Form S-8 No. 333-83204).
4.16 Form of Grant Letter for Non-Employee Directors Share Option Plan
2001/5 (incorporated by reference to exhibit 4.10 to the Form S-8 No.
333-83204).
4.17 Wafer Partner Conversion Agreements dated September 2001 between the
Registrant and each of SanDisk, Alliance and Macronix (incorporated by reference
to the correspondingly-numbered exhibit to the 2001 Form 20-F).
94
4.18 Letter Agreement dated November 29, 2001 among SanDisk, Alliance,
Macronix, QuickLogic and the Registrant regarding the Utilization of Prepayments
(incorporated by reference to the correspondingly-numbered exhibit to the 2001
Form 20-F).
4.19 Letter Agreements among Alliance, Macronix, QuickLogic, ICTech and the
Registrant and between SanDisk and the Registrant regarding Additional Wafer
Partner Financing Date (incorporated by reference to the
correspondingly-numbered exhibit to the 2001 Form 20-F).
4.20 Letter Agreement dated November 15, 2001 among SanDisk, Alliance,
Macronix, QuickLogic, ICTech and the Registrant regarding Amendment to Financing
Plan (incorporated by reference to the correspondingly-numbered exhibit to the
2001 Form 20-F).
4.21 First Amendment dated January 29, 2001 to the Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2001
Form 20-F).
4.22 Second Amendment dated January 10, 2002 to Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2001
Form 20-F).
4.23 Third Amendment dated March 7, 2002 to the Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2001
Form 20-F).
4.24 Joint Development and Transfer and Cross License Agreement dated as of
May 2002 between the Registrant and Matsushita Industrial Electronic Co., Inc.
(incorporated by reference to exhibit 10.3 to the Registrant's Registration
Statement on Form F-2, No. 333-97043).
4.25 Technology License Agreement dated as of April 7, 2000 between the
Registrant and Toshiba Corporation (incorporated by reference to exhibit 10.4 to
the Registrant's Registration Statement on Form F-2, No. 333-97043).
4.26 Technology Transfer License Agreement, dated as of September 2002
between Registrant and Motorola, Inc. (incorporated by reference to exhibit 10.5
to the Registrant's Registration Statement on Form F-2, No. 333-97043).
4.27 Fourth Amendment dated April 29, 2002 to the Facility
Agreement (incorporated by reference to the correspondingly-numbered exhibit to
the 2002 Form 20-F).
4.28 Fifth Amendment dated September 18, 2002 to the Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2002
Form 20-F).
4.29 Amendment to Fifth Amendment to the Facility Agreement dated October
22, 2002 to the Facility Agreement (incorporated by reference to the
correspondingly-numbered exhibit to the 2002 Form 20-F).
95
4.30 Letter Agreement dated March 2002 among SanDisk, Alliance, Macronix,
ICTech and Challenge Fund to advance Third and Fourth Milestone Payments
(incorporated by reference to the correspondingly-numbered exhibit to the 2002
Form 20-F).
4.31 Letter Agreement dated July, 2002 among SanDisk, Alliance, Macronix,
and ICTech to exercise rights distributed in rights offering (incorporated by
reference to the correspondingly-numbered exhibit to the 2002 Form 20-F).
4.32 Letter Agreement dated March 2003 among SanDisk, Alliance, Macronix,
ICTech, and the Registrant (incorporated by reference to the
correspondingly-numbered exhibit to the 2002 Form 20-F).
4.33 Form of Rights Agent Agreement between the Registrant and American
Stock Transfer & Trust Company (including form of Rights Certificate)
(incorporated by reference to exhibit 4.1 to the Registrant's Registration
Statement on Form F-2, No. 333-97043).
4.34 Form of Warrant Agreement between the Registrant and American Stock
Transfer & Trust Company (including form of Warrant Certificate) (incorporated
by reference to exhibit 4.2 to the Registrant's Registration Statement on Form
F-2, No. 333-97043).
4.35 Form of Commitment Letter from the Registrant's Shareholders, dated
July 23, 2002, regarding participation in the Registrant's Rights Offering
(incorporated by reference to exhibit 10.1 to the Registrant's Registration
Statement on Form F-2, No. 333-97043).
4.36 Investment Center Agreement related to Fab 1, dated November 13, 2001
(English translation of Hebrew original) (incorporated by reference to exhibit
10.2 to the Registrant's Registration Statement on Form F-2, No. 333-97043).
4.37 Development and License Agreement dated March 31, 2002 between Virage
Logic Corporation and the Registrant (incorporated by reference to the
correspondingly-numbered exhibit to the 2002 Form 20-F).
4.38 Master Services and License Agreement dated June 2002 between Artisan
Components, Inc. and the Registrant (incorporated by reference to the
correspondingly-numbered exhibit to the 2002 Form 20-F).
4.39 Seventh Amendment to the Facility Agreement dated November 11, 2003
(incorporated by reference to Exhibit 99.1 of the Registrant's Report on Form
6-K filed on December 17, 2003).
4.40 Undertaking of The Israel Corporation Ltd. dated November 11, 2003
(incorporated by reference to Exhibit 99.2 of the Registrant's Report on Form
6-K filed on December 17, 2003).
4.41 Undertaking of the Registrant dated November 11, 2003 (incorporated by
reference to Exhibit 99.3 of the Registrant's Report on Form 6-K filed on
December 17, 2003).
4.42 Letter Agreement dated November 11, 2003 by and among the Registrant,
Israel Corporation Technologies, SanDisk Corporation, Alliance Semiconductor
Corporation and Macronix International Co., Ltd. (incorporated by reference to
Exhibit 99.4 of the Registrant's Report on Form 6-K filed on December 17, 2003).
96
11.1 Code of Ethics.
12.1 Certification by Chief Executive Officer pursuant to section 302 of
the Sarbanes-Oxley Act of 2002.
12.2 Certification by Chief Financial Officer pursuant to section 302 of
the Sarbanes-Oxley Act of 2002.
13.1 Certification by Chief Executive Officer pursuant to section 906 of
the Sarbanes-Oxley Act of 2002.
13.2 Certification by Chief Financial Officer pursuant to section 906 of
the Sarbanes-Oxley Act of 2002.
97
TOWER SEMICONDUCTOR LTD.
AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2003
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
INDEPENDENT AUDITORS' REPORT F-1
BALANCE SHEETS F-2
STATEMENTS OF OPERATIONS F-3
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY F-4
STATEMENTS OF CASH FLOWS F-5
NOTES TO FINANCIAL STATEMENTS F-6-F-48
INDEPENDENT AUDITORS' REPORT
TO THE SHAREHOLDERS OF
TOWER SEMICONDUCTOR LTD.
We have audited the accompanying consolidated balance sheets of Tower
Semiconductor Ltd. (the "Company") and subsidiary as of December 31, 2003 and
2002, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2003. These financial statements are the responsibility of
the Company's Board of Directors and management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by the Board of Directors and management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly, in all
material respects, the consolidated financial position of the Company and
subsidiary as of December 31, 2003 and 2002, and the consolidated results of
their operations, changes in shareholders' equity and cash flows for each of the
three years in the period ended December 31, 2003, in accordance with accounting
principles generally accepted in Israel.
Accounting principles generally accepted in Israel vary in certain significant
respects from accounting principles generally accepted in the United States of
America. The effect of the application of the latter on the financial position
and results of operations as of the dates and for the years presented is
summarized in Note 20.
Brightman Almagor & Co.
Certified Public Accountants
A member firm of Deloitte Touche Tohmatsu
Tel Aviv, Israel
February 2, 2004
- F-1 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA AND PER SHARE DATA)
AS OF DECEMBER 31,
----------------------------------
NOTE 2003 2002
--------- --------------- ---------------
A S S E T S
CURRENT ASSETS
CASH AND CASH EQUIVALENTS $ 12,448 $ 7,857
SHORT-TERM INTEREST-BEARING DEPOSITS -- 10,500
CASH AND SHORT-TERM INTEREST-BEARING DEPOSITS
DESIGNATED FOR INVESTMENTS RELATING TO FAB 2 44,042 51,338
TRADE ACCOUNTS RECEIVABLE (NET OF ALLOWANCE FOR
DOUBTFUL ACCOUNTS OF $0 AND $155, RESPECTIVELY) 15 11,631 7,456
OTHER RECEIVABLES 3 11,073 21,322
INVENTORIES 4 19,382 10,201
OTHER CURRENT ASSETS 1,729 1,407
---------- -----------
TOTAL CURRENT ASSETS 100,305 110,081
---------- -----------
LONG-TERM INVESTMENTS
LONG-TERM INTEREST-BEARING DEPOSITS
DESIGNATED FOR INVESTMENTS RELATING TO FAB 2 4,848 11,893
OTHER LONG-TERM INVESTMENT 5 6,000 6,000
----------- -----------
10,848 17,893
---------- -----------
PROPERTY AND EQUIPMENT, NET 6 568,412 493,074
---------- -----------
OTHER ASSETS, NET 7 108,770 95,213
=========== ===========
TOTAL ASSETS $ 788,335 $ 716,261
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
SHORT-TERM DEBT 8 $ -- $ 4,000
TRADE ACCOUNTS PAYABLE 40,249 76,083
OTHER CURRENT LIABILITIES 9 9,564 8,071
----------- -----------
TOTAL CURRENT LIABILITIES 49,813 88,154
LONG-TERM DEBT 10 431,000 253,000
CONVERTIBLE DEBENTURES 11 25,783 24,121
OTHER LONG-TERM LIABILITIES 12 5,935 5,406
LONG-TERM LIABILITY IN RESPECT
OF CUSTOMERS' ADVANCES 13A 46,347 47,246
----------- -----------
TOTAL LIABILITIES 558,878 417,927
---------- -----------
SHAREHOLDERS' EQUITY
ORDINARY SHARES, NIS 1.00 PAR VALUE - AUTHORIZED
150,000,000 AND 70,000,000 SHARES, RESPECTIVELY;
ISSUED 52,996,097 AND 44,735,532 SHARES, RESPECTIVELY 13A, 14 13,150 11,294
ADDITIONAL PAID-IN CAPITAL 13A 427,881 400,808
PROCEEDS ON ACCOUNT OF SHARE CAPITAL 13A 16,428 --
SHAREHOLDER RECEIVABLES AND UNEARNED COMPENSATION (26) (53)
ACCUMULATED DEFICIT (218,904) (104,643)
----------- -----------
238,529 307,406
TREASURY STOCK, AT COST - 1,300,000 SHARES 14C (9,072) (9,072)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY 229,457 298,334
=========== ===========
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 788,335 $ 716,261
=========== ===========
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- F-2 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA AND PER SHARE DATA)
Year ended December 31,
-----------------------
Note 2003 2002 2001
---- ---- ---- ----
SALES 13D, 15 $ 61,368 $ 51,801 $ 52,372
COST OF SALES 6A(4) 122,395 67,022 76,733
------------- ----------- ------------
GROSS LOSS (61,027) (15,221) (24,361)
------------- ----------- ------------
OPERATING COSTS AND EXPENSES
RESEARCH AND DEVELOPMENT 20,709 17,031 9,556
MARKETING, GENERAL AND ADMINISTRATIVE 22,615 17,091 14,489
------------- ----------- ------------
43,324 34,122 24,045
============= =========== ============
OPERATING LOSS (104,351) (49,343) (48,406)
FINANCING INCOME (EXPENSE), NET 16 (9,826) (2,104) 1,465
OTHER INCOME (EXPENSE), NET 5B, 5D (84) 45 8,419
------------- ----------- ------------
LOSS FOR THE YEAR $ (114,261) $ (51,402) $ (38,522)
============= =========== ============
BASIC LOSS PER ORDINARY SHARE
LOSS PER SHARE $ (2.40) $ (1.63) $ (1.92)
============= =========== ============
LOSS USED TO COMPUTE
BASIC LOSS PER SHARE $ (114,114) $ (51,402) $ (38,459)
============= =========== ============
WEIGHTED AVERAGE NUMBER OF ORDINARY
SHARES OUTSTANDING - IN THOUSANDS 47,608 31,523 20,020
============= =========== ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- F-3 -
TOWER SEMICONDUCTOR LTD.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA AND PER SHARE DATA)
PROCEEDS PROCEEDS
ADDITIONAL ON ON ACCOUNT
ORDINARY SHARES PAID-IN ACCOUNT OF OF SHARE
SHARES AMOUNT CAPITAL A WARRANT CAPITAL
---------- --------- ------------ -------- ---------
BALANCE - JANUARY 1, 2001 13,562,606 $ 4,404 $ 144,538 $ 9,990 $ --
ISSUANCE OF SHARES,
NET OF RELATED COSTS 11,930,675 2,850 147,798
EXERCISE OF A WARRANT 772,667 187 9,813 (9,990)
EXERCISE OF SHARE OPTIONS 31,154 7 265
CANCELLATION OF UNEARNED COMPENSATION
IN RESPECT OF NON-VESTED OPTIONS, NET (15)
STOCK-BASED COMPENSATION RELATED TO THE
FACILITY AGREEMENT WITH THE BANKS, NOTE 14B(5) 5,466
AMORTIZATION OF UNEARNED COMPENSATION
LOSS FOR THE YEAR
---------- --------- ------------ -------- ---------
BALANCE - DECEMBER 31, 2001 26,297,102 $ 7,448 $ 307,865 $ -- $ --
ISSUANCE OF SHARES,
NET OF RELATED COSTS 18,438,430 3,846 92,943
AMORTIZATION OF UNEARNED COMPENSATION
LOSS FOR THE YEAR
---------- --------- ------------ -------- ---------
BALANCE - DECEMBER 31, 2002 44,735,532 $ 11,294 $ 400,808 $ -- $ --
STOCK-BASED COMPENSATION RELATED TO
THE FAB 2 CONSTRUCTOR 145
STOCK-BASED COMPENSATION RELATED TO THE
FACILITY AGREEMENT WITH THE BANKS, NOTE 14B(5) 4,205
ISSUANCE OF SHARES,
NET OF RELATED COSTS 8,260,565 1,856 22,723
PROCEEDS ON ACCOUNT OF SHARE CAPITAL 16,428
AMORTIZATION OF UNEARNED COMPENSATION
LOSS FOR THE YEAR
---------- --------- ------------ -------- ---------
BALANCE - DECEMBER 31, 2003 52,996,097 $ 13,150 $ 427,881 $ -- $ 16,428
========== ========= ============ ======== =========
SHAREHOLDER
RECEIVABLES
AND
UNEARNED ACCUMULATED TREASURY
COMPENSATION DEFICIT STOCK TOTAL
------ ----------- -------- ------------
BALANCE - JANUARY 1, 2001 $ (493) $ (14,719) $ (9,072) $ 134,648
ISSUANCE OF SHARES,
NET OF RELATED COSTS 150,648
EXERCISE OF A WARRANT 10
EXERCISE OF SHARE OPTIONS 272
CANCELLATION OF UNEARNED COMPENSATION
IN RESPECT OF NON-VESTED OPTIONS, NET 15 --
STOCK-BASED COMPENSATION RELATED TO THE
FACILITY AGREEMENT WITH THE BANKS, NOTE 14B(5) 5,466
AMORTIZATION OF UNEARNED COMPENSATION 283 283
LOSS FOR THE YEAR (38,522) (38,522)
------ ----------- -------- ------------
BALANCE - DECEMBER 31, 2001 $ (195) $ (53,241) $ (9,072) $ 252,805
ISSUANCE OF SHARES,
NET OF RELATED COSTS 96,789
AMORTIZATION OF UNEARNED COMPENSATION 142 142
LOSS FOR THE YEAR (51,402) (51,402)
------ ----------- -------- ------------
BALANCE - DECEMBER 31, 2002 $ (53) $ (104,643) $ (9,072) $ 298,334
STOCK-BASED COMPENSATION RELATED TO
THE FAB 2 CONSTRUCTOR 145
STOCK-BASED COMPENSATION RELATED TO THE
FACILITY AGREEMENT WITH THE BANKS, NOTE 14B(5) 4,205
ISSUANCE OF SHARES,
NET OF RELATED COSTS 24,579
PROCEEDS ON ACCOUNT OF SHARE CAPITAL 16,428
AMORTIZATION OF UNEARNED COMPENSATION 27 27
LOSS FOR THE YEAR (114,261) (114,261)
------ ----------- -------- ------------
BALANCE - DECEMBER 31, 2003 $ (26) $ (218,904) $ (9,072) $ 229,457
====== =========== ======== ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- F-4 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands, except share data and per share data)
Year ended December 31,
-----------------------
2003 2002 2001
----------- ----------- ------------
CASH FLOWS - OPERATING ACTIVITIES
LOSS FOR THE YEAR $ (114,261) $ (51,402) $ (38,522)
ADJUSTMENTS TO RECONCILE LOSS FOR THE YEAR
TO NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES:
INCOME AND EXPENSE ITEMS NOT INVOLVING CASH FLOWS:
DEPRECIATION AND AMORTIZATION 54,611 18,821 21,721
DEVALUATION OF CONVERTIBLE DEBENTURES (878) -- --
OTHER EXPENSE (INCOME), NET 84 (45) (8,419)
CHANGES IN ASSETS AND LIABILITIES:
DECREASE (INCREASE) IN TRADE ACCOUNTS RECEIVABLE (4,175) (4,135) 8,602
DECREASE (INCREASE) IN OTHER RECEIVABLES AND OTHER CURRENT ASSETS 1,264 (1,305) 649
DECREASE (INCREASE) IN INVENTORIES (6,221) (609) 8,402
INCREASE (DECREASE) IN TRADE ACCOUNTS PAYABLE 801 4,686 (5,190)
INCREASE (DECREASE) IN OTHER CURRENT LIABILITIES 1,467 2,764 (999)
INCREASE IN OTHER LONG-TERM LIABILITIES 529 2,822 105
----------- ----------- ------------
(66,779) (28,403) (13,651)
INCREASE (DECREASE) IN LONG-TERM LIABILITY
IN RESPECT OF CUSTOMERS' ADVANCES (899) 29,336 17,910
----------- ----------- ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (67,678) 933 4,259
----------- ----------- ------------
CASH FLOWS - INVESTING ACTIVITIES
DECREASE (INCREASE) IN CASH, SHORT-TERM AND LONG-TERM INTEREST-BEARING
DEPOSITS DESIGNATED FOR INVESTMENTS RELATING TO FAB 2 14,341 (59,683) (3,548)
INVESTMENTS IN PROPERTY AND EQUIPMENT (179,310) (205,099) (295,203)
INVESTMENT GRANTS RECEIVED 33,811 40,481 56,454
PROCEEDS FROM SALE OF EQUIPMENT 222 70 229
INVESTMENTS IN OTHER ASSETS (22,098) (34,290) (32,098)
DECREASE (INCREASE) IN DEPOSITS, NET 10,500 (456) (1,599)
PROCEEDS FROM SALE OF LONG-TERM INVESTMENTS -- -- 11,050
----------- ----------- ------------
NET CASH USED IN INVESTING ACTIVITIES (142,534) (258,977) (264,715)
----------- ----------- ------------
CASH FLOWS - FINANCING ACTIVITIES
PROCEEDS FROM ISSUANCE OF SHARES, NET 24,375 96,751 152,586
PROCEEDS FROM EXERCISE OF SHARE OPTIONS -- -- 272
PROCEEDS ON ACCOUNT OF SHARE CAPITAL 16,428 -- --
PROCEEDS ON ACCOUNT OF AN EXERCISE OF A WARRANT -- -- 10
INCREASE (DECREASE) IN SHORT-TERM DEBT -- (10,000) 10,000
REPAYMENT OF LONG-TERM DEBT (13,000) (4,000) (15,064)
PROCEEDS FROM LONG-TERM DEBT, NET IN CONNECTION WITH
RE-BORROWING, NOTE 13A(6) 187,000 -- --
PROCEEDS FROM LONG-TERM DEBT -- 142,000 122,000
PROCEEDS FROM SALE OF SECURITIES, NET -- 21,540 --
----------- ----------- ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 214,803 246,291 269,804
=========== =========== ============
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 4,591 (11,753) 9,348
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 7,857 19,610 10,262
----------- ----------- ------------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 12,448 $ 7,857 $ 19,610
=========== =========== ============
NON-CASH ACTIVITIES
INVESTMENTS IN PROPERTY AND EQUIPMENT $ 17,160 $ 49,419 $ 41,610
=========== =========== ============
EXERCISE OF A WARRANT $ 9,990
============
STOCK-BASED COMPENSATION RELATED TO
THE FACILITY AGREEMENT WITH THE BANKS $ 4,205 $ 5,466
=========== ============
INVESTMENTS IN OTHER ASSETS $ 3,153 $ 4,304 $ 4,357
=========== =========== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
CASH PAID DURING THE YEAR FOR CAPITALIZED AND EXPENSED INTEREST $ 15,674 $ 11,594 $ 3,143
=========== =========== ============
CASH PAID DURING THE YEAR FOR INCOME TAXES $ 239 $ 151 $ 1,819
=========== =========== ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- F-5 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 1 - DESCRIPTION OF BUSINESS AND GENERAL
A. DESCRIPTION OF BUSINESS
Tower Semiconductor Ltd. (the "Company"), incorporated in Israel,
commenced operations in March 1993. The Company is an independent
wafer foundry dedicated to the manufacture of semiconductor integrated
circuits on silicon wafers. The Company manufactures integrated
circuits in geometries from 1.0 to 0.35 microns at its 150-millimeter
fabrication facility ("Fab 1"), and 0.18 micron at its
recently-constructed 200-millimeter fabrication facility ("Fab 2"). As
a foundry, the Company manufactures wafers using its advanced
technological capabilities and the proprietary integrated circuit
designs of its customers.
The industry in which the Company operates is characterized by wide
fluctuations in supply and demand. Such industry is also characterized
by the complexity and sensitivity of the manufacturing process, by
high levels of fixed costs, and by the need for constant improvements
in production technology.
The Company's Ordinary Shares are traded on the Nasdaq National Market
and in the Tel-Aviv Stock Exchange.
B. ESTABLISHMENT OF NEW FABRICATION FACILITY
In January 2001, the Company's Board of Directors approved the
establishment of a new wafer fabrication facility in Israel ("Fab 2"),
at an expected cost of approximately $1,500,000. Fab 2 is designed to
manufacture semiconductor integrated circuits on silicon wafers in
geometries of 0.18 micron and below on 200-millimeter wafers. The
Company has entered into several related agreements and other
arrangements and completed public and rights offerings all in
connection with Fab 2 to provide, as of the approval date of the
financial statements, an aggregate of $1,220,000 of financing for Fab
2. For further details concerning the related agreements, which were
amended several times, see Note 13A.
During the third quarter of 2003, in which Fab 2 was substantially
completed, the Company begun commercial production and shipment of
wafers to its customers utilizing the 0.18 micron process technology.
With the commencement of Fab 2 operations, the Company begun to
depreciate and amortize Fab 2 assets, as well as to expense most of
the direct costs related to the construction and equipping of Fab 2
and to the transfer of the Fab 2 technology that had been previously
capitalized. For further details concerning the depreciation and
amortization of Fab 2 assets, see Note 6A.
The Fab 2 project is a complex undertaking which entails substantial
risks and uncertainties. For further details concerning the Fab 2
project and related agreements, risks and uncertainties, see Note 13A.
C. USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities as of
the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
- F-6 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company's consolidated financial statements are presented in accordance
with generally accepted accounting principles ("GAAP") in Israel. See Note
20 for the reconciliation of material differences between GAAP in Israel
and in the United States of America.
A. PRINCIPLES OF CONSOLIDATION
The Company's financial statements include the financial statements of
the Company and its wholly-owned marketing subsidiary in the United
States, after elimination of material inter-company transactions and
balances. The effect of the subsidiary's operations on the Company's
revenues and total assets was immaterial for the dates and periods
presented.
B. CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of deposits in banks and short-term
investments (primarily time deposits and certificates of deposit) with
original maturities of three months or less.
C. ALLOWANCE FOR DOUBTFUL ACCOUNTS
The allowance for doubtful accounts is computed on the specific
identification basis for accounts whose collectibility, in
management's estimation, is uncertain.
D. INVENTORIES
Inventories are stated at the lower of cost or market. Cost is
determined for raw materials, spare parts and supplies on the basis of
weighted moving average cost per unit. Cost is determined for work in
process and finished goods on the basis of actual production costs.
E. LONG-TERM INVESTMENTS
Long-term investments in other entities, over whose operating and
financial policies the Company does not have the ability to exercise
significant influence, are presented at cost.
F. PROPERTY AND EQUIPMENT
(1) Property and equipment are presented at cost, including interest
and other capitalizable costs. Capitalizable costs include only
incremental direct costs that are identifiable with and related
to the property and equipment and are incurred prior to its
initial operation. Directly identifiable costs include
incremental direct costs associated with acquiring, constructing,
establishing and installing property and equipment (whether
performed by others or by the Company); and costs directly
related to preproduction test runs of property and equipment that
are necessary to get them ready for their intended use. Those
costs include payroll and payroll-related costs of employees who
devote time and are dedicated solely to the acquiring,
constructing, establishing and installing property and equipment.
Allocation, when appropriate, of capitalizable direct costs is
based on management's estimates and methodologies including time
sheet inputs.
- F-7 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)
F. PROPERTY AND EQUIPMENT (cont.)
(1) (cont.)
Cost is presented net of investment grants received or
receivable, and less accumulated depreciation and amortization.
The accrual for grants receivable is determined based on
qualified investments made during the reporting period, provided
that the primarily criteria for entitlement have been met.
Depreciation is calculated based on the straight-line method over
the estimated economic lives of the assets or terms of the
related leases, as follows:
Prepaid perpetual land lease and buildings 14-25 years
Machinery and equipment 5 years
Transportation vehicles 7 years
(2) Impairment examinations and recognition are performed and
determined based on the accounting policy outlined in P below.
G. OTHER ASSETS
The cost of Fab 2 technologies presented in other assets includes the
technology process cost, internal costs, mainly payroll-related costs
of employees designated for integrating the technologies in the
Company's facilities, and direct costs associated with implementing
the technologies until the technologies are ready for their intended
use. The costs in relation to Fab 2 technologies are amortized over
the expected estimated economic life of the technologies. Amortization
phases in commencing on the dates on which each of the Fab 2
manufacturing lines is ready for their intended use, and is based on
the straight-line method over a four-year period.
Deferred financing charges included in other assets in relation to
funding the establishment of Fab 2, are being amortized over the lives
of the borrowings based on the repayment schedule of such funding (in
general, 6 to 8 years). During the establishment period of Fab 2,
amortized deferred financing charges were capitalized to property and
equipment. Commencing the third quarter of 2003, in which the building
and infrastructures of Fab 2 were substantially completed and became
ready for their intended use, and in which the initial ramp-up
commenced, the deferred financing charges are being amortized to the
financing expenses, net.
Impairment examinations and recognition are performed and determined
based on the accounting policy outlined in P below.
H. CONVERTIBLE DEBENTURES
Convertible debentures, the conversion of which is not anticipated as
of the balance-sheet date, are presented as long-term liabilities
based on their terms as of such date, net of discount. See Note 20E
for disclosure of convertible debentures in accordance with U.S. GAAP.
- F-8 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)
I. INCOME TAXES
The Company records deferred income taxes to reflect the net tax
effects of temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and for tax
purposes. Deferred taxes are computed based on the tax rates
anticipated to be in effect (under applicable law at the time the
financial statements are prepared) when the deferred taxes are
expected to be paid or realized.
Deferred tax liabilities and assets are classified as current or
noncurrent based on the classification of the related asset or
liability for financial reporting, or according to the expected
reversal dates of the specific temporary differences, if not related
to an asset or liability for financial reporting. Deferred tax
liabilities are recognized for temporary differences that will result
in taxable amounts in future years. Deferred tax assets are recognized
for temporary differences which will result in deductible amounts in
future years and for carryforwards. A valuation allowance against such
deferred tax asset is recognized if it is more likely than not that
some portion or all of the deferred tax asset will not be realized.
J. REVENUE RECOGNITION
Revenues are recognized upon shipment or as services are rendered when
title has been transferred, collectibility is reasonably assured and
acceptance provisions criteria are satisfied, based on performing
electronic, functional and quality tests on the products prior to
shipment and customer on-site testing. Such testing reliably
demonstrates that the products meet all of the specified criteria
prior to formal customer acceptance, and that product performance upon
customer on-site testing can reasonably be expected to conform to the
specified acceptance provisions. An accrual for estimated returns,
computed primarily on the basis of historical experience, is recorded
at the time when revenues are recognized.
K. RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred.
Amounts received or receivable from the government of Israel and
others, as participation in research and development programs, are
offset against research and development costs. The accrual for grants
receivable is determined based on the terms of the programs, provided
that the criteria for entitlement have been met.
L. LOSS PER ORDINARY SHARE
Basic loss per ordinary share is calculated based on the weighted
average number of ordinary shares outstanding during each year
presented. The calculation includes retroactive effect from the
beginning of each year of shares issued upon exercise of options and
warrants ("Exercise") and upon conversion of convertible debentures
("Conversion"), outstanding at the beginning of each year and giving
effect to shares issuable from probable Exercise and from probable
Conversion. Basic loss per ordinary share is calculated based on loss
for the year with the inclusion of imputed interest income on the
exercise price of options and warrants exercised or of probable
Exercise, and of financing expenses in relation to converted
debentures or on probable Conversion, as required under Israeli GAAP.
See Note 20J for disclosure of loss per share data in accordance with
U.S. GAAP.
- F-9 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)
M. DERIVATIVE FINANCIAL INSTRUMENTS
The Company, from time to time, enters into foreign exchange
agreements (primarily forward contracts and options) as a hedge
against non-dollar equipment purchase and other firm commitments.
Gains and losses on such agreements through the date that the
equipment is received or the commitment is realized are deferred and
capitalized to the cost of equipment or the commitment, while gains
and losses subsequent thereto, through the date of agreement
expiration, are included in financing income (expense), net.
In addition, the Company, from time to time, enters into agreements to
hedge interest rate exposure on long-term loans. Gains and losses on
such agreements are recognized on a current basis in accordance with
the terms of these agreements, and expensed or capitalized in the same
manner as the corresponding interest costs.
See Note 20C for disclosure of the derivative financial instruments in
accordance with U.S. GAAP.
N. FUNCTIONAL CURRENCY AND TRANSACTION GAINS AND LOSSES
The currency of the primary economic environment in which the Company
conducts its operations is the U.S. dollar ("dollar"). Accordingly,
the Company uses the dollar as its functional and reporting currency.
Financing income (expenses), net in 2003, 2002 and 2001 include net
foreign currency transaction loss of $232, $1,509 and $263,
respectively.
O. STOCK-BASED COMPENSATION
The Company accounts for employee and director stock-based
compensation in accordance with Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and
authoritative interpretations thereof. Accordingly, the Company
accounts for share options granted to employees and directors based on
the intrinsic value of the options on the measurement date. The
compensation cost of options without a fixed measurement date is
remeasured at each balance sheet date. Deferred compensation in
respect of awards with graded vesting terms is amortized to
compensation expense over the relevant vesting periods. In a manner
consistent with FIN 28, the vesting period over which compensation is
expensed is determined, based on the straight-line method, separately
for each portion of the award as if the grant were a series of awards.
See Note 14B(6) for pro forma disclosures required by SFAS 123 and
SFAS 148.
The Company accounts for stock-based compensation of non-employees
using the fair value method in accordance with Financial Accounting
Standards Board Statement No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123") and EITF 96-18: Accounting for Equity
Instruments That are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services. The award cost of
warrants granted in connection with bank financing is amortized as
deferred financing charges over the terms of the loans, in a manner
described in paragraph G above. The award cost of warrants granted in
connection with the construction of Fab 2, is recorded as depreciation
expense over the life of the prepaid perpetual land lease and
buildings. The award cost of warrants granted to consultants and
related party in connection with equity transactions is offset against
paid-in-capital.
- F-10 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont.)
P. IMPAIRMENT OF LONG-LIVED ASSETS
Management reviews long-lived assets on a periodic basis, as well as
when such a review is required based upon relevant circumstances, to
determine whether events or changes in circumstances indicate that the
carrying amount of such assets may not be recoverable. According to
the Israeli Accounting Standards Board No.15, "Impairment of Assets",
an asset's recoverable value is the higher of the asset's net selling
price and the asset's value in use, the latter being equal to the
asset's discounted expected cash flows. Prior to issuing Standard No.
15 in January 2003, the Company tested the recoverability of its
assets based on undiscounted expected cash flows, as applicable by
U.S. GAAP, a method that under Standard No. 15 is no longer
acceptable. As of December 31, 2003 no impairment was recognized.
Q. RECENT ACCOUNTING PRONOUNCEMENTS BY THE FASB
(1) SFAS NO. 149 - AMENDMENT OF SFAS 133 - In May 2003, the FASB
issued SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments including certain
derivative instruments embedded in other contracts and hedging
activities under SFAS No. 133. It is effective for contracts
entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of
this Standard had no impact on the Company's financial position
or results of operations under U.S. GAAP.
(2) ACCOUNTING FOR CERTAIN FINANCIAL INSTRUMENTS WITH CHARACTERISTICS
OF BOTH LIABILITIES AND EQUITY - In May 2003, the FASB issued
SFAS No. 150, "Accounting For Certain Financial Instruments with
Characteristics of Both Liabilities and Equity" which establishes
standards for how an issuer of financial instruments classifies
and measures certain financial instruments with characteristics
of both liabilities and equity. SFAS 150 requires that an issuer
classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances) if, at inception,
the monetary value of the obligation (as defined in that
guidance) is based solely or predominantly on a fixed monetary
amount known at inception, variations in something other than the
fair value of the issuer's equity shares or variations inversely
related to changes in the fair value of the issuer's equity
shares. This Statement is effective in connections with
activities for financial instruments entered into at the
beginning of the third quarter of 2003. See Note 20F for
disclosure of proceeds on account of share capital in accordance
with U.S. GAAP under SFAS 150.
(3) SAB-104 - REVENUE RECOGNITION - In December 2003, the Securities
and Exchange Commission ("SEC") issued Staff Accounting Bulletin
104 ("SAB-104") - Revenue Recognition. This SAB revises or
rescinds portions of the interpretative guidance included in
Topic 13 of the codification of staff accounting bulletins in
order to make this interpretive guidance consistent with current
authoritative accounting guidance. The principal revisions relate
to the rescission of material no longer necessary because of
developments outside of the SEC in U.S. generally accepted
accounting principles, and the incorporation of certain sections
of the SEC's "Revenue Recognition in Financial Statements -
Frequently Asked Questions and Answers" document into Topic 13.
The adoption of SAB-104 had no impact on the Company's financial
position and results of operations.
- F-11 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 3 - OTHER RECEIVABLES
Other receivables consist of the following:
As of December 31,
------------------
2003 2002
---- ----
Government of Israel - investment grants receivable $ 8,143 $14,200
Other government agencies 2,655 5,025
Others 275 2,097
------- -------
$11,073 $21,322
======= =======
NOTE 4 - INVENTORIES
Inventories consist of the following (*):
As of December 31,
------------------
2003 2002
---- ----
Raw materials $ 5,736 $ 3,815
Spare parts and supplies 3,341 3,509
Work in process 9,520 2,860
Finished goods 785 17
------- -------
$19,382 $10,201
======= =======
(*) Net of write-downs to net realizable value of $1,228 and $307 as of
December 31, 2003 and 2002, respectively.
NOTE 5 - OTHER LONG-TERM INVESTMENTS
A. SAIFUN - The investment in Saifun Semiconductor Ltd. ("Saifun"), an
Israeli company which designs and develops memory designs, is based on
an agreement between the Company and Saifun signed in October 1997.
The Company's investments in Saifun as of December 31, 2003 and 2002
amounted to $6,000, representing 11.8% of Saifun's share capital as of
such dates (on a fully-diluted basis - 10.3% and 10.5%, respectively).
B. AZALEA - In September 2000, the Board of Directors of the Company
approved the investment of $1,100 in Azalea Microelectronics
Corporation ("Azalea"), a California corporation that, inter-alia,
develops and designs microelectronics modules. This investment
represents 14.9% of Azalea's share capital as of December 31, 2003. In
addition, the Company and Azalea signed a development agreement for
the development by Azalea of certain modules based on the Company's
technologies. Due to management's estimate, based on certain
circumstances indicating that the carrying amount of the Company's
investment in Azalea may not be recoverable, the Company wrote off,
during the third quarter of 2001, its entire investment in Azalea.
C. Under certain provisions stipulated in the amended Facility Agreement
entered into by the Company in connection with Fab 2 (see Note
13A(6)), the Company might be obliged to dispose of some or all its
long-term investments, in order to comply with that agreement's
financing requirements. For liens, see Note 13A(6).
D. VIRAGE LOGIC CORP. - During the year ended December 31, 2001, the
Company sold all of its shareholdings in Virage Logic Corp. for an
aggregate of $11,050 and for a gain of $9,550. Virage Logic Corp. is a
Delaware corporation, which provides semiconductor companies with
memory designs for systems contained on silicon chips.
- F-12 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 6 - PROPERTY AND EQUIPMENT, NET
A. COMPOSITION
As of December 31,
------------------
COST: 2003 2002
---- ----
Prepaid perpetual land lease and buildings $225,218 $215,240
Machinery and equipment 555,989 440,048
Transportation vehicles 3,683 4,198
-------- --------
784,890 659,486
-------- --------
ACCUMULATED DEPRECIATION AND AMORTIZATION:
Prepaid perpetual land lease and buildings 20,698 13,215
Machinery and equipment 193,682 151,191
Transportation vehicles 2,098 2,006
-------- --------
216,478 166,412
======== ========
$568,412 $493,074
======== ========
SUPPLEMENTAL DISCLOSURE RELATING TO COST OF PROPERTY AND EQUIPMENT:
(1) As of December 31, 2003 and 2002, the cost of property and
equipment included costs relating to Fab 2 in the amount of
$560,304 and $434,421, respectively. Said amounts are net of
investment grants of $126,226 and $99,365, respectively.
Depreciation of Fab 2 assets commenced in the third quarter of
2003, in which the building and infrastructures of Fab 2 were
substantially completed and became ready for their intended use.
(2) As of December 31, 2003, the cost of buildings, machinery and
equipment was reflected net of investment grants of $232,187 (as
of December 31, 2002 - $205,390).
(3) Cost of property and equipment as of December 31, 2003 includes
capitalized interest costs of $18,480 (as of December 31, 2002 -
$11,588).
(4) Following the commencement of operations of Fab 2, in the third
quarter of 2003, the Company began to depreciate and amortize Fab
2 property and equipment and other assets, resulting in
depreciation and amortization expenses of $37,302 which were
included in cost of sales of 2003.
B. INVESTMENT GRANTS
In connection with the formation of the Company, the Investment Center
of the Ministry of Industry and Trade of the State of Israel
("Investment Center"), under its "approved enterprise" program,
approved an investment program for expenditures on buildings and
equipment in Fab 1 in the aggregate amount (as amended) of
approximately $96,850. The Company completed its investments under
this program, and received final approval from the Investment Center
in November 1997.
In January 1996, an investment program ("1996 program") for expansion
of Fab 1 in the aggregate amount (as amended in December 1999 and
2001) of $228,680 was approved by the Investment Center. The approval
certificate provides for a benefit track entitling the Company to
investment grants at a rate of 34% of the investments included in such
certificate made through December 31, 2001. The Company completed its
investments under the 1996 program in December 2001 and invested
through such date approximately $207,000. In May 2002, the Company
submitted the final report in relation to the 1996 program. As of
December 31, 2003, the report has not yet received a final approval
from the Investment Center.
- F-13 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 6 - PROPERTY AND EQUIPMENT, NET (cont.)
B. INVESTMENT GRANTS (cont.)
See Note 13A(8) with respect to the Fab 2 program approved by the
Investment Center in December 2000.
Entitlement to the above grants and other tax benefits is subject to
various conditions stipulated by the Investments Law and the
regulations promulgated thereunder, as well as the criteria set forth
in the certificates of approval. In the event the Company fails to
comply with such conditions, the Company may be required to repay all
or a portion of the grants received plus interest and certain
inflation adjustments. In order to secure fulfillment of the
conditions related to the receipt of investment grants, floating liens
were registered in favor of the State of Israel on substantially all
assets of the Company.
C. For liens see Note 13A(6).
NOTE 7 - OTHER ASSETS
Other assets consist of the following:
As of December 31,
------------------
2003 2002
---- ----
COST:
In relation to Fab 2:
Technologies - Note 13A(2) $ 90,747 $ 78,572
Deferred financing charges 20,864 14,322
Other 3,001 3,052
Other -- 29
-------- --------
114,612 95,975
-------- --------
ACCUMULATED AMORTIZATION:
In relation to Fab 2 (*):
Technologies 2,793 --
Deferred financing charges 3,049 762
Other -- --
Other -- --
-------- --------
5,842 762
======== ========
$108,770 $ 95,213
======== ========
(*) For amortization policy, see Note 2G.
NOTE 8 - SHORT-TERM DEBT
The short-term debt as of December 31, 2002 consisted of current
maturities of long-term debt (see Note 10A).
NOTE 9 - OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
As of December 31,
------------------
2003 2002
---- ----
Accrued salaries $3,579 $2,858
Vacation accrual 3,474 2,910
Interest payable on convertible debentures 1,168 1,101
Other 1,343 1,202
------ ------
$9,564 $8,071
====== ======
- F-14 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 10 - LONG-TERM DEBT
A. COMPOSITION:
Effective interest rate as of As of December 31,
------------------
December 31, 2003 2003 2002
----------------- ---- ----
In U.S. Dollar 6.78% $ 172,000 $ 172,000
In U.S. Dollar 3.69% 259,000 85,000
--------- -----------
Total long-term debt 431,000 257,000
Less - current maturities -- 4,000
--------- -----------
$ 431,000 $ 253,000
========= ===========
B. Loans received under the Facility Agreement bear interest based on the
three-month USD Libor rate plus 2.5%, as revised under the amendment
to the Facility Agreement described in more detail in Note 13A(6).
Prior to the closing of this amendment on December 2003, the loans
bore interest based on the three-month USD Libor rate plus 1.55%. The
effective annual interest rate of loans, the amount of which as of
December 31, 2003 was $172,000, includes the terms of collar
agreements with a knock-out feature described in Note 18A. Interest is
payable at the end of each quarter.
C. For additional information regarding the Facility Agreement, as
amended, between the Company and the Banks for financing the
construction and equipping of Fab 2 including re-borrowing terms, see
Note 13A(6).
Of the total amount of the long-term debt as of December 31, 2002,
$13,000 was designated for the Company's activities related to Fab 1,
and was fully repaid during 2003, resulting in the termination of the
Fab 1 facility agreement.
D. REPAYMENT SCHEDULE
The balance of the long-term debt as of December 31, 2003 is repayable
according to the November 2003 amendment to the Facility Agreement as
follows:
2007 $ 143,667
2008 and thereafter 287,333
---------
$ 431,000
=========
E. The agreement with the Company's Banks restricts the Company's ability
to place liens on its assets (other than to the State of Israel in
respect of investment grants) without the prior consent of the Banks.
Furthermore, the agreements contain certain restrictive financial
covenants (see also Note 13A(6)). As of December 31, 2003, in
management's opinion the Company was in full compliance with such
covenants.
- F-15 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 11 - CONVERTIBLE DEBENTURES
In January 2002, the Company issued on the Tel-Aviv Stock Exchange, NIS
110,579,800 principal amount of convertible debentures, linked to the
Israeli Consumer Price Index ("CPI") (adjusted to the CPI as of December
31, 2003 - NIS 115,775,760, $26,439). The debentures were issued at 96% of
their par value, and bear annual interest at the rate of 4.7%, payable in
January of each year commencing in January 2003. The principal amount is
payable in four installments in January of each year between 2006 and 2009.
The debentures may be converted until December 31, 2008 into Ordinary
Shares, at a conversion rate of one Ordinary Share per each NIS 41.00
principal amount of the debentures, linked to the CPI (subject to customary
adjustments) (adjusted to the CPI as of December 31, 2003 - NIS 42.93,
$9.80). The effective rate of interest on the convertible debentures,
taking into account the initial proceeds, net of the discount and the
related costs of issuance, is 7.26%. For U.S. GAAP purposes, which require
taking into account, in addition to the discount and the related issuance
costs, amounts attributed to the options described in Note 14E, the
effective rate of interest on the convertible debentures is 9.88%.
Subject to certain conditions, the Company may, commencing in July 2005,
announce the early redemption of the debentures or part thereof, provided
that the sum of the last payment on account of the principal shall be no
less than approximately $700.
If on a payment date of the principal or interest on the debentures there
exists an infringement of certain covenants and conditions under the
Facility Agreement, the dates for payment of interest and principal on the
debentures may be postponed, depending on various scenarios under the
Facility Agreement until such covenant or condition is settled.
Pursuant to a covenant in the amended Facility Agreement, the Company is to
deposit at least 20% of the principal amount (net of discounts) of the
unconverted debentures in favor of the Banks as security for payment of the
amounts the Company owes the Banks. The deposited amounts may be released
only as provided in the amended Facility Agreement, including for payment
of interest on the convertible debentures.
The debentures are unsecured and rank behind the Company's existing and
future secured indebtedness to the Banks under the Facility Agreement, as
well as to the government of Israel in connection with grants the Company
receives under the Fab 2 approved enterprise program.
See Note 20E for disclosure of the accounting treatment of the convertible
debentures under U.S. GAAP.
NOTE 12 - OTHER LONG-TERM LIABILITIES
A. COMPOSITION
As of December 31,
------------------
2003 2002
---- ----
Net liability for employee
termination benefits (see B below):
Gross obligation $ 19,042 $ 16,274
Amounts funded through deposits to severance
pay funds and purchase of insurance policies (14,607) (12,368)
-------- --------
4,435 3,906
Other 1,500 1,500
-------- --------
$ 5,935 $ 5,406
======== ========
- F-16 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - OTHER LONG-TERM LIABILITIES (cont.)
B. EMPLOYEE TERMINATION BENEFITS
Israeli law and labor agreements determine the obligations of the
Company to make severance payments to dismissed employees and to
employees leaving employment under certain other circumstances. The
liability for severance pay benefits, as determined by Israeli Law, is
based upon length of service and the employee's most recent monthly
salary. This liability is primarily covered by regular deposits made
by the Company into recognized severance and pension funds and by
insurance policies purchased by the Company. The amounts so funded are
not reflected on the balance sheets, since they are controlled by the
fund trustees and insurance companies and are not under the control
and management of the Company. For presentation of employees'
termination benefits in accordance with U.S GAAP, see Note 20B.
Costs relating to employee termination benefits were approximately
$2,828, $2,070 and $4,379 for 2003, 2002 and 2001, respectively.
NOTE 13 - COMMITMENTS AND CONTINGENCIES
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2
(1) OVERVIEW
In January 2001, the Company's Board of Directors approved the
establishment of a new wafer fabrication facility in Israel ("Fab
2"), at an expected cost of approximately $1,500,000. Fab 2 is
designed to manufacture semiconductor integrated circuits on
silicon wafers in geometries of 0.18 micron and below on
200-millimeter wafers. The Company entered into several related
agreements and other arrangements, and completed public and
rights offerings, in connection with Fab 2, including agreements
and arrangements with technology partners, Wafer Partners, Equity
Investors, the Company's Banks, the Government of Israel through
the Investment Center and others, to provide an aggregate, as of
the approval date of the financial statements, of $1,220,000 of
financing for Fab 2. The agreements with the Banks and the
Investment Center are subject to certain conditions, including
the achievement of performance and financing milestones, and the
securing of additional required financing. The Company has also
entered into agreements for the design and construction of Fab 2,
for equipping Fab 2 and for the transfer to the Company of the
process technologies to be utilized to produce wafers in Fab 2.
Through December 31, 2003 the Company has invested in the Fab 2
project an aggregate of approximately $900,000. Through such
date, the Wafer Partners, Equity Investors and technology
partners had invested in the Company through committed agreements
an aggregate of $306,823 ($47,246 of which was established as
long-term customers' advances); the Banks had made long-term
loans in the aggregate of $431,000; and the Investment Center
granted the Company an aggregate of $118,011. In addition,
through December 31, 2003, the Company has raised approximately
$86,600 from other financial sources, and in January 2004, the
Company raised additional $77,000 in connection with the public
offering described in Note 14G.
- F-17 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(1) OVERVIEW (cont.)
During the third quarter of 2003, the Company began commercial
production and shipment of wafers to its customers utilizing the
0.18 micron process technology. With the commencement of Fab 2
operations, most of the direct costs related to the construction
and equipping of Fab 2 and to the transfer of the Fab 2
technology that previously had been capitalized, are no longer
capitalizable. For the depreciation and amortization amounts in
2003 of Fab 2 assets, see Note 6A.
The construction and equipping of Fab 2 is a substantial project,
which requires extensive management involvement as well as the
timely participation by and coordination of the activities of
many participants. In addition, this project is a complex
undertaking which entails substantial risks and uncertainties,
including but not limited to those associated with the following:
obtaining additional commitments to finance the construction and
equipping of Fab 2; achieving certain operational milestones and
complying with various conditions and covenants under the current
financing agreements in order to receive the additional funds
committed by the Investment Center, as well as those provided by
the Facility Agreement with the Banks, which establishes
significant additional conditions and covenants for borrowing
loans under the Facility Agreement; and completing the complex
processes of transferring from Motorola the manufacturing
technologies to be used at Fab 2 and development of new
technologies. According to the Facility Agreement with the Banks,
raising certain required additional funding by the dates
specified, achieving the milestones as scheduled, as well as
complying with all the conditions and covenants stipulated in
that agreement and in the Approval Certificate from the
Investment Center, are material provisions for providing the
Company with the required financing for completing and equipping
Fab 2. As of December 31, 2003 the construction and equipping of
Fab 2 is currently in process and, progressing according to the
revised agreed upon schedule.
(2) TECHNOLOGY TRANSFER AGREEMENTS
TOSHIBA - In April 2000, the Company entered into a technology
transfer agreement with Toshiba Corporation ("Toshiba"), a
Japanese corporation. This agreement provides for the transfer by
Toshiba to the Company of advanced semiconductor manufacturing
process technologies installed in Fab 2 including related
technology transfer assistance in exchange for certain fees for
patent licenses, technology transfer and technical assistance and
ongoing royalties based on sales of products manufactured in Fab
2 with the transferred technology. The transfer of the technology
was substantially completed during the first half of 2003. Under
the Toshiba agreement, the Company agreed, subject to certain
conditions, to reserve for Toshiba a certain portion of Fab 2
wafer manufacturing capacity for a period of 10 years.
- F-18 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(2) TECHNOLOGY TRANSFER AGREEMENTS (cont.)
MOTOROLA - In September 2002, the Company entered into a
non-exclusive technology transfer, development and licensing
agreement with Motorola Inc. ("Motorola"), a U.S. corporation.
This agreement provides for the transfer by Motorola to the
Company of existing and newly developed versions of advanced
semiconductor manufacturing process technologies to be installed
in Fab 2, and for the provision by Motorola of related technology
transfer assistance, all in exchange for certain fees for patent
and other intellectual property licenses, technology transfer and
development, technical assistance and ongoing royalties based on
sales of products to be manufactured in Fab 2 with the
transferred technology. Subject to prior termination for cause by
Motorola, the licenses under the agreement are perpetual.
(3) WAFER PARTNER AGREEMENTS
During 2000, the Company entered into various share purchase
agreements ("Wafer Partner Agreements") with SanDisk Corporation,
Alliance Semiconductor Corporation, Macronix International Co.,
Ltd. and QuickLogic Corporation (collectively, the "Wafer
Partners"; excluding QuickLogic, the "primary Wafer Partners") to
partially finance the construction and equipping of Fab 2.
Pursuant to the Wafer Partner Agreements, the Wafer Partners
agreed to invest an aggregate of $250,000 to purchase Ordinary
Shares of the Company, over a period of time, subject to the
achievement of certain milestones relating to the construction
and operation of Fab 2. According to the Wafer Partner
Agreements, the Company agreed, subject to certain conditions, to
reserve for each Wafer Partner a certain portion, and
collectively approximately 50%, of Fab 2 wafer manufacturing
capacity for a period of 10 years.
Through December 31, 2003, the Wafer Partners invested in the
Company, based on the Wafer Partners Agreements, an aggregate of
$246,823, of which $199,577 was credited as paid in capital and
$47,246 was established as long-term customers' advances which
may be, subject to the terms and conditions stipulated in the
Wafer Partner Agreements, as amended, utilized as credit against
purchases to be made by the Wafer Partners, or converted into
paid-in-capital. Through December 31, 2003, the Wafer Partners
were issued an aggregate of 24,239,879 Ordinary Shares in
consideration for their aggregate committed investment of
$233,622. In January 2004, the primary Wafer Partners were issued
additional 1,885,833 Ordinary Shares in consideration for their
final $13,201 committed investment made in December 2003, at a
per share price equal to the offering price of the public
offering described in Note 14G. The $13,201 amount is presented
on the face of the balance sheet as of December 31, 2003 as
proceeds on account of share capital. For the classification of
that amount under U.S. GAAP, see Note 20F.
For additional investments made by the Wafer Partners in
connection with a rights offering, see Note 14F.
In addition to the Wafer Partner Agreements, in January 2002, the
Company entered into a share purchase agreement with another
wafer partner, pursuant to which that wafer partner invested
$2,000 in Fab 2 for the purchase of 332,945 Ordinary Shares of
the Company. The shares were issued in January 2002.
- F-19 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(4) EQUITY INVESTOR AGREEMENTS
Through December 31, 2003, Israel Corporation Technologies
(IC-Tech) Ltd., a wholly owned subsidiary of Israel Corporation
Ltd. and the principal shareholder of the Company ("IC-Tech") and
Challenge Fund-Edgar II LP, a Delaware limited partnership
("Challenge") (all together, "Equity Investors") invested in the
Company, pursuant to agreements described below, an aggregate of
$51,773, for the purchase of an aggregate of 6,958,882 Ordinary
Shares of the Company. In January 2004, IC-Tech and Challenge
were issued additional 460,953 Ordinary Shares of the Company in
consideration for their final investments according to their
agreements in the amount of $3,227 made in December 2003. The
shares were issued at a per share price equal to the price at the
public offering described in Note 14G. The $3,227 amount is
presented on the face of the balance sheet as of December 31,
2003 as proceeds on account of share capital. For the
classification of that amount under U.S. GAAP, see Note 20F.
In December 2000, the Company entered into a share purchase
agreements pursuant to which IC-Tech agreed to invest $50,000 to
purchase Ordinary Shares of the Company over a period of time in
several mandatory closings contemporaneous with the closings
under the Wafer Partner Agreements and subject to the achievement
of the same milestones. For additional investments made by
IC-Tech in connection with a rights offering, see Note 14F. For
additional investments which IC-Tech or the Israel Corporation
Ltd. may be required to make in the Company, see A(6) below.
In February 2001, the Company entered into a share purchase
agreement with Challenge pursuant to which Challenge agreed to
invest $5,000 in Fab 2 for the purchase of Ordinary Shares of the
Company under terms substantially similar to those under the
Company's share purchase agreements with IC-Tech.
In July 2002, the Company entered into a definitive agreement
with Ontario Teachers' Pension Plan Board for an investment,
which was fully paid in October 2002, of $15,000 in the Company's
equity in consideration for 3,000,000 Ordinary Shares of the
Company for $5.00 per share (the same as the subscription price
per right in the rights offering described in Note 14F), and a
warrant, exercisable for a four-year period ending in October
2006, to purchase an additional 1,350,000 Ordinary Shares of the
Company, at an exercise price of $7.50 per share (subject to
customary adjustments).
(5) AMENDMENTS TO THE PRIMARY WAFER PARTNER AND EQUITY INVESTOR
AGREEMENTS
The agreements between the Company and its primary Wafer Partners
and Equity Investors have been amended several times since they
were originally signed. The major terms of the amendments,
including those recently made in the fourth quarter of 2003,
relate to: advancing the milestone installments regardless of
their achievements; updating the price per share of each advanced
installment to be based on the average closing sale price of the
Company's Ordinary Shares for the 15-30 trading days prior to
making any installment; and granting the Company with a waiver in
connection with the requirement to raise a cumulative of $50,000
from new wafer partners. The Company's shareholders approved all
these amendments.
- F-20 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(5) AMENDMENTS TO THE PRIMARY WAFER PARTNER AND EQUITY INVESTOR
AGREEMENTS (cont.)
Following the approval of the fourth quarter of 2003 amendment by
the Company's shareholders, and obtaining in November 2003 an
agreement with the Banks for amending the Facility Agreement as
outlined in paragraph A(6) below, the primary Wafer Partners and
Equity Investors completed their committed investments.
Pursuant to an amendment to the primary Wafer Partner Agreements
entered into in the first quarter of 2003 and approved by the
Company's shareholders in May 2003, the primary Wafer Partners
are entitled to convert an aggregate of up to $13,201 of the
unutilized long-term customers' advances, which they may have as
of December 31, 2005, into fully-paid Ordinary Shares of the
Company, the amount of which shall be determined based on the
average closing sale price of the Company's Ordinary Shares for
the 15 trading days prior to such date. The option is exercisable
during January 2006. In case such conversion occurs and the
amount of shares issued is equivalent to or greater than 5% of
the Company's outstanding share capital as of the conversion
date, the Company has undertaken to offer to all of its other
shareholders rights to purchase shares of the Company at the same
price per share.
Pursuant to the fourth quarter of 2003 amendment, the Company
granted each one of the primary Wafer Partners an option to
convert, at the end of each quarter of the years 2004-2006, any
amount that may be utilized against the long-term customers'
advances, as derived from purchases made by each primary Wafer
Partner during that quarter, into fully-paid Ordinary Shares of
the Company. The amount of shares shall be determined based on
the average closing sale price of the Company's Ordinary Shares
for the 15 trading days preceding the end of each quarter. Any
quarterly amount, which the primary Wafer Partners have elected
not to so convert, will not be utilizable against purchases made
subsequent to that quarter, and shall bear interest, payable at
the end of each quarter, at an annual rate equal to three-month
LIBOR plus 2.5% through December 31, 2007. The aggregate
principal of the unconverted long-term customers' advances, which
could have been utilized against purchases and which the primary
Wafer Partners elected not to convert into fully-paid Ordinary
Shares of the Company, shall be fully repaid on December 31,
2007. Other than as described above in this paragraph and the
preceding paragraph, each of the primary Wafer Partners agreed,
on a going forward basis to only utilize long-term customer's
advances after December 31, 2006.
(6) FACILITY AGREEMENT
In January 2001, the Company entered into a credit facility
agreement with two leading Israeli banks ("Banks") entitling the
Company to borrow an aggregate, as amended in January 2002, of
$500,000 to finance the construction and equipping of Fab 2
("Facility Agreement"). Following the amendment entered into
between the Company and the Banks in November 2003, which is
described in more detail below, the loans bear interest at a rate
of Libor plus 2.5% per annum payable at the end of each quarter.
Prior to the November 2003 amendment, the loans bore interest at
a rate of Libor plus 1.55% per annum payable at the end of each
quarter. The loans are available for withdrawal through December
31, 2004, and are subject to certain prepayment provisions.
Unused amounts under the Facility Agreement, in the amount of
$69,000 as of December 31, 2003, are subject to a quarterly
commitment fee of 0.25% per annum.
- F-21 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(6) FACILITY AGREEMENT (cont.)
Loans in the amount of $431,000 received by the Company through
December 31, 2003 ($244,000 through December 31, 2002), were
repaid on December 31, 2003 and, concurrently, were drawn down on
such date at an equivalent amount to be repaid in 12 equal
consecutive quarterly installments commencing on March 31, 2007
(the net amount of long-term loans the Company received in 2003
in connection with the abovementioned re-borrowing was $187,000).
Loans drawn down after December 31, 2003, are repayable in 12
equal consecutive quarterly installments, commencing three years
from the draw down date of each loan, which in no case shall be
after the maturity date of the Facility Agreement. With regard to
further details regarding loans drawn down under the $500,000
credit facility, see Note 10.
Under the Facility Agreement and the terms of the Company's
long-term loans as of December 31, 2003, the Company agreed to
register liens in favor of the Banks on substantially all its
present and future assets. If, as a result of any default under
the Facility Agreement, the Banks were to accelerate the
Company's obligations, the Company would be obligated to
immediately repay all loans made by the Banks, plus penalties,
and the Banks would be entitled to exercise the remedies
available to them under the Facility Agreement, including
enforcement of the liens against the Company's assets.
In November 2003, the Company and its Banks entered into an
amendment to the Facility Agreement. The amendment was based,
among other things, on an updated plan for the construction and
equipping Fab 2 submitted to the Banks, and was approved by the
Company's shareholders' meeting held in December 2003. Pursuant
to the amendment, the Banks waived all noncompliance or breach of
covenants by the Company prior to the date of amendment. The
amendments further revised and updated the covenants under the
Facility Agreement according to which the Company is obligated to
comply with certain operational and financial ratios, primarily
total shareholders to total assets and production and capacity
milestones.
- F-22 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(6) FACILITY AGREEMENT (cont.)
As of December 31, 2003, the revised remaining aggregate amount
the Company is required to raise from specified financial sources
is $152,000. This amount is to be raised through the following
dates: by mid-March 2004, an aggregate of $28,000; by the end of
June 2004, an aggregate of $53,500; by the end of December 2004,
an aggregate of $79,000; by the end of June 2005, an aggregate of
$115,500; and by the end of December 2005, an aggregate of
$152,000. Out of the Company's aggregate fundraising to be made
by the end of December 2004, $77,000 was achieved by the proceeds
from the public offering described in Note 14G.
As of December 31, 2003, the Company was in full compliance with
the revised financial ratios and covenants under the amended
Facility Agreement.
The amended Facility Agreement provides that should the Company
fail to meet any of the above fundraising obligations towards the
$152,000 at the dates described above, the Banks will have the
option to demand that the Company consummate within three months
from the failing raising date a rights offering of convertible
debentures and warrants to purchase the Company's Ordinary Shares
to raise the missing amount towards the required funding, all in
accordance with the terms prescribed in the amended Facility
Agreement.
The Israel Corporation Ltd. ("TIC"), the parent company of the
Company's current major shareholder ("IC-Tech") has undertaken to
the Banks to exercise all of the rights IC-Tech receives in the
rights offering. In addition, as part of TIC's undertaking, it
agreed to purchase from the Company additional securities in a
private placement on the same terms as the rights offering, in an
amount equal to 50/93 of the difference between the amount the
Company was to raise in the rights offering and the amount raised
from shareholders other than TIC and/or IC-Tech, less any amounts
actually invested in the rights offering by TIC and/or IC-Tech in
connection with the exercise of their own rights. TIC's
undertaking to the Banks is limited to an aggregate of $50,000.
If certain of the Company's shareholders participate in the above
investment, then their investment will be deemed to be
investments made by TIC towards the $50,000 commitment. In the
event that the rights offering cannot be completed, TIC has
undertaken to purchase from the Company in a private placement
50/93 of the amount the Company was to raise in the rights
offering. TIC may fulfill its investment commitments through
IC-Tech.
TIC's undertaking and the Company's obligation to consummate a
rights offering expires on the earlier of: (i) such time that the
Company will fulfill the fundraising obligation to raise an
aggregate of $152,000 under the Facility Agreement as described
above; (ii) such time as TIC has invested an aggregate amount of
$50,000 as described above; or (iii) June 30, 2006.
Following the receipt of the above described investments from
TIC, the Banks will increase the total amount which the Company
may draw under the Facility Agreement at a ratio of $43 for every
$50 invested, up to $43,000 in the aggregate. Any drawn loan will
be repayable by the earlier of (i) December 2007 and (ii) three
years from the date the loan is drawn. Should the Company draw
down loans using this increased amount of facility, the Banks
will be issued 30% warrant coverage of the amount drawn down,
based on the average closing price of the Company's Ordinary
Shares during the 15 consecutive trading days prior to the time
the Company draws down such loans.
- F-23 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(6) FACILITY AGREEMENT (cont.)
For further details regarding 896,596 warrants issued to the
Banks in connection with this amendment, and warrants granted to
the Banks in January 2001, see Note 14B(5)(a).
For further details regarding 58,906 warrants issued to TIC in
connection with its undertaking described above, and additional
warrants issuable to TIC in the event the undertaking is
realized, see Note 14B(5)(b).
The Company has agreed to indemnify IC-Tech and TIC for any
liabilities they incur with respect to these arrangements,
subject to them making any investment under their undertaking, up
to a maximum of $100,000 as follows: up to $25,000 in cash and
any amount exceeding such $25,000 limit will earn interest at
LIBOR plus 2.5% and will be paid on the same terms that the
Company repays its loans to the Banks.
Following certain bankruptcy related events, the Banks will be
able to bring a firm offer made by a potential investor to
purchase the Company's ordinary shares (the "Offer") at a price
provided in the Offer. In such case, the Company shall be
required thereafter to procure a rights offering to invest up to
60% of the amount of the Offer on the same terms. If the offeror
intends to purchase a majority of the Company's outstanding share
capital, the rights offering will be limited to allow for this,
unless IC-Tech and the primary Wafer Partners agree to exercise
in a rights offering rights applicable to their shareholdings and
agree to purchase in a private placement enough shares to ensure
that the full amount of the Offer is invested.
(7) FAB 2 CONSTRUCTION AGREEMENT
In August 2000, the Company entered into a fixed price turn-key
agreement with a contractor for the design and construction of
Fab 2 in consideration of approximately $200,000, to be paid
according to certain performance milestones stipulated in the
agreement, over approximately two years. As of December 31, 2003,
approximately $180,000 of that amount had already been paid by
the Company.
- F-24 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(8) APPROVED ENTERPRISE STATUS
In December 2000, the Investment Center approved an investment
program in connection with Fab 2 for expansion of the Company's
plant. The approval certificate for the program provides for a
benefit track entitling the Company to investment grants at a
rate of 20% of qualified investments of up to $1,250,000. The
grants are to be made in accordance with a timetable set forth in
the approval certificate for the program.
Under the terms of the approval certificate, investments in
respect of the Fab 2 approved enterprise program are to be
completed by December 31, 2005, five years from the date the
approval certificate was obtained. Due to the later than planned
commencement of construction of Fab 2 and prevailing market
conditions, the Company does not currently expect to complete Fab
2 investments defined in the approval certificate by the end of
2005. The Company has notified the Investment Center of its
revised investment schedule contemplated in an updated plan for
the construction and equipping Fab 2, and has also informed the
Investment Center of the reduced rate of annual investments and
lower than projected expectations for Fab 2 sales.
As of December 31, 2003, the Company's revised investments plan
is currently being evaluated by the Investment Center. While
Israeli law currently limits the ability of the Investment Center
to extend the investment period beyond five years, the Company's
management estimates, based on discussions held with the
Investment Center, that it is probable that satisfactory
arrangements will be made to allow for the extension of the
reinvestment period.
(9) AGREEMENT WITH THE ILA
In November 2000, the Company entered into a development
agreement with the Israel Land Administration ("ILA") with
respect to a parcel of land on which Fab 2 was constructed.
Following the completion of the construction of Fab 2 on the
land, in June 2003 the Company entered into a long-term lease
agreement with the ILA for a period ending in 2049. The lease
payments through 2049 relating to this lease have been paid in
advance.
(10) HEDGING ACTIVITIES
For hedging transactions and agreements the Company has entered
into, see Note 18C.
(11) OTHER AGREEMENTS
Through December 31, 2003 the Company had entered into several
additional agreements related mainly to the construction,
equipping and transfer of technology for Fab 2. The Company's
aggregate commitment in connection with these agreements as of
such date, including the Fab 2 construction agreement described
in paragraph (7) above, amounted to $99,035.
- F-25 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
B. LICENSE AGREEMENTS
(1) In June 2000, the Company entered into a cross license agreement
with a major technology company. According to the agreement, each
party acquired a non-exclusive license under the other's patents.
The Company agreed to pay an annual royalty through July 2005.
The licenses terminate on December 31, 2005.
(2) In December 2001, the Company and DSP Group Ltd. ("DSPG") entered
into a license agreement, pursuant to which DSPG granted the
Company a personal, non-exclusive, nontransferable license to use
certain technology in the Company's products, in exchange for
license fee and ongoing royalties to be paid by either the
Company or its customers based on sales of products manufactured
in Fab 2 based on the technology. In addition, the agreement
provides for technical support by DSPG in connection with using
the technology. The license terminates on December 31, 2007.
(3) In May 2002, the Company entered into a joint development and
royalty-free, non-exclusive cross-license agreement with a
Japanese semiconductor manufacturer corporation, for the joint
development of certain technology to be used by the Company in
its Fab 2 and by the Japanese manufacturer in its facilities. The
agreement calls for certain amounts to be paid by the Japanese
manufacturer to the Company following the signing of the
agreement and subject to achievement of certain milestones,
through a period ending 2005. Pursuant to the agreement, the
Japanese manufacturer may allocate, subject to certain conditions
stipulated in the agreement, part or all of the second half of
the total amounts paid by it to the Company as long-term customer
advances to be applied against future purchases made by the
Japanese manufacturer through 2007. Sales for 2002 included a
$8,056 revenue in relation to this agreement.
(4) The Company from time to time enters into intellectual property
and licensing agreements with third parties, the effect of each
of them on the Company's total assets and results of operations
is immaterial. Certain of these agreements call for royalties to
be paid by the Company to these third parties. See also paragraph
F(2) below.
C. LEASES
(1) The Company's offices and engineering and manufacturing
operations are located in a building complex situated in an
industrial park in Migdal Ha'emek, in the northern part of
Israel. These premises are currently occupied under a long-term
lease from the Israel Lands Authority, which expires in 2032. The
Company has no obligation for lease payments related to this
lease through the year 2032.
(2) The Company occupies certain other premises under various
operating leases. The obligations under such leases were not
material as of December 31, 2003.
(3) With respect to a long-term lease agreement of land on which Fab
2 was constructed, see paragraph A(9) above.
- F-26 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
D. PURCHASE AGREEMENTS
The Company from time to time enters into long-term purchase
agreements with customers. Pursuant to such agreements, the Company is
committed to sell, and the customer is committed to purchase (subject
to reductions in certain circumstances), a specific monthly output
derived from the start of processing of silicon wafers at prices which
are stipulated in the agreements and are subject to periodic
re-negotiations. From commencement of the Company's operations through
December 31, 2003, a substantial portion of the Company's production
has been sold under such agreements.
E. PROFIT SHARING PLAN
The Company maintains an employee profit sharing plan. No amounts were
provided for under this plan for periods presented in these financial
statements, since the Company did not record profits for these
periods.
F. OTHER PRINCIPAL AGREEMENTS
(1) MACRONIX - In December 2000, the Company and Macronix entered
into an agreement according to which the Company waived in favor
of Macronix certain exclusive semiconductor manufacturing rights
it received from Saifun.
(2) SAIFUN - Pursuant to an agreement between the Company and Saifun
signed in October 1997, the Company has certain exclusive
semiconductor manufacturing rights for certain licensed
technology. The agreement also sets certain limitations on Saifun
regarding future licensing of such technology (see (1) above).
Pursuant to certain provisions of the agreement, the Company and
Saifun are obligated, under certain circumstances, to pay each
other royalties. For royalty amounts received and payable by the
Company under the agreement, see Note 19B.
(3) SILICONIX - In December 2003, the Company and chip maker
Siliconix incorporated, an 80% owned subsidiary of Vishay
Intertechnology Inc., entered into a memorandum of understanding
("MOU") for a long-term manufacturing and supply arrangement.
Pursuant to the MOU, Siliconix will place with the Company orders
valued at approximately $200,000 for the purchase of wafers to be
manufactured at the Company's Fab 1 over a seven to ten year
period, of which approximately $53,000 is guaranteed and will be
delivered over a three year period starting at the first
anniversary of the definitive agreement. Siliconix will advance
the Company with $20,000 to be used primarily for the purchase of
additional equipment required to satisfy Siliconix orders, which
will be credited towards the purchase price of the wafers. The
transaction is subject to the approval of both companies' board
of directors, the Company's Banks, the Investment Center and to
the negotiation of definitive documentation. A definitive
agreement is expected to be signed during the first quarter of
2004.
(4) OTHER - The Company, from time to time in the normal course of
business, enters into long-term agreements with various entities
for the joint development of products and processes utilizing
technologies owned by both the other entities and the Company.
- F-27 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - COMMITMENTS AND CONTINGENCIES (cont.)
G. ENVIRONMENTAL AFFAIRS
The Company's operations are subject to a variety of laws and
governmental regulations in Israel relating to the use, discharge and
disposal of toxic or otherwise hazardous materials used in the
production processes. Operating permits are required for the
operations of the Company's facilities and these permits are subject
to revocation, modification and renewal. Government authorities have
the power to enforce compliance with these regulations and permits. As
of December 31, 2003 the Company operated under a conditional permit
from the Ministry of Environmental Affairs concerning the
concentration of fluoride in the Company's wastewater. In management's
opinion, the Company is in compliance with the terms of this permit,
with one exception: the Company is monitoring the levels of fluoride
in accordance with an oral understanding with the Israeli Ministry of
Environmental Affairs, which is less frequent than required by the
written terms of the permit. In addition, management is of the opinion
that the Company is currently in compliance in all other material
respects with applicable laws and regulations.
H. CLASS ACTION
In July 2003, certain shareholders of the Company filed a
shareholders' class action complaint in the United States against the
Company and certain of its directors, Wafer Partners and Equity
Investors (the "Defendants"). The plaintiffs have asserted claims
arising under the Securities Exchange Act of 1934, alleging
misstatements and omissions made by the Defendants in materials sent
to the Company's shareholders in April 2002 with respect to the
approval of an amendment to the Company's investment agreements with
its Fab 2 investors. The plaintiffs seek damages in unspecified
amounts and unspecified rescissory relief. The Company believes that
the complaint is without merit and intends to vigorously contest it.
In January 2004, the Company filed with the court a motion to dismiss
the action.
I. AMENDMENT TO ISRAELI BANKING REGULATIONS
Pursuant to a recent amendment to a directive published by the Israel
Supervisor of Banks, which becomes effective on March 31, 2004, the
Company may be deemed part of a group of borrowers comprised of the
Ofer Brothers Group, The Israel Corporation (the later being currently
the indirect major shareholder of the Company), and other companies
which are also included in such group of borrowers pursuant to the
directive, including companies under the control or deemed control of
these entities. The directive provides that an entity will be subject
to limitations on the amount of bank financing available to it if such
entity is included within a group of borrowers, to which the amount of
debt financing that has been extended from such bank amounts to 30% of
such bank's capital, or is a member of one of the bank's six largest
borrowers or groups of borrowers to which, collectively, the amount of
debt financing that has been extended from a bank amounts to 150% of
such bank's capital (gradually reduced to 135% between April 2005 and
June 2006). If the Company's Banks exceed these limitations, they may
limit the Company's ability to draw down the remaining Fab 2 credits
of $69,000 and may require that the Company return some or all of the
Company's outstanding borrowings ($431,000 as of December 31, 2003).
J. OTHER COMMITMENTS
Receipt of certain research and development grants from the government
of Israel is subject to various conditions. In the event the Company
fails to comply with such conditions, the Company may be required to
repay all or a portion of the grants received. In management's
opinion, the Company has been in full compliance with the conditions
through December 31, 2003.
- F-28 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - SHAREHOLDERS' EQUITY
A. DESCRIPTION OF ORDINARY SHARES
As of December 31, 2003 and 2002, the Company had 150,000,000 and
70,000,000 authorized par value NIS 1.00 Ordinary Shares,
respectively, of which 51,696,097 and 43,435,532, respectively, were
issued and outstanding (net of 1,300,000 Ordinary Shares held by the
Company as of such dates). As of the approval date of the financial
statements, the Company had 65,137,883 issued and outstanding Ordinary
Shares (net of 1,300,000 Ordinary Shares held by the Company as of
such date). For shares issued in January 2004 following a public
offering, see Note 14G. As of December 31, 2003, the Company was
engaged in agreements and arrangements to issue 12,205,034 additional
Ordinary Shares of the Company. This amount includes Ordinary Shares
to be issued under various agreements according to their provisions as
of December 31, 2003 related to Fab 2 Wafer Partners and Equity
Investors warrants, the exercise of all options granted and issued to
non-employees and the conversion of all the convertible debentures.
Holders of Ordinary Shares are entitled to participate equally in the
payment of cash dividends and bonus share (stock dividend)
distributions and, in the event of the liquidation of the Company, in
the distribution of assets after satisfaction of liabilities to
creditors. Each ordinary share is entitled to one vote on all matters
to be voted on by shareholders.
B. SHARE OPTION PLANS
(1) EMPLOYEE AND DIRECTOR SHARE OPTIONS
(A) GENERAL - The Company has granted to its employees options
to purchase its Ordinary Shares under several option plans
adopted by the Company since 1994 through 2003. The
particular provisions of each plan and grant vary as to
vesting period, exercise price, exercise period and other
terms. Generally, the options are granted at an exercise
price which equals to not less than 85% of the market value
of the Ordinary Shares at the date of grant (in mostly all
cases, at an exercise price equal to the market value of the
underlying shares at the date of grant); vest over a three
to four-year period according to various vesting schedules;
and are not exercisable beyond ten years from the grant date
under each plan.
(B) OPTIONS TO THE COMPANY'S CHAIRMAN OF THE BOARD OF DIRECTORS
- In March 2003, the Board of Directors of the Company
approved a share option plan, which was approved by the
Company's shareholders in May 2003, pursuant to which the
Company's Chairman of the Board of Directors ("Chairman") is
entitled to receive the right to purchase up to 1,043,000
Ordinary Shares of the Company at an exercise price of
$2.983, an exercise price which is higher than the Company's
share price at the date of the approval by the Board of
Directors, and is equivalent to the average closing trading
price for the Company's Ordinary Shares during the 30
consecutive trading days preceding the date of board
approval of the amendment to the Fab 2 investment agreements
described in Note 13A(5) above. Options granted under the
plan vest over a five-year period according to various
vesting schedules. The vesting of the options is subject to
the Chairman's serving as the Chairman or as the Company's
Chief Executive Officer or President on the relevant vesting
dates. The options granted are exercisable for a period of
five years from the date on which the options vest.
- F-29 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - SHAREHOLDERS' EQUITY (cont.)
B. SHARE OPTION PLANS (cont.)
(1) EMPLOYEE AND DIRECTOR SHARE OPTIONS (cont.)
(C) OPTIONS GRANTED TO DIRECTORS - During 2001, the Audit
Committee, the Board of Directors of the Company and the
general meeting of the Company's shareholders approved a
stock option plan pursuant to which the Company's directors
will be granted options to purchase up to 400,000 Ordinary
Shares of the Company (40,000 to each eligible director
appointed to the Board of Directors) at an exercise price
equal to the market price of the Company's shares on the
grant dates (weighted average exercise price of
approximately $8.48). As of December 31, 2003 and 2002,
280,000 options were outstanding under the plan. Options
granted under the plan vest over a four-year period
according to various vesting schedules, and generally may
not be exercised beyond five years from the date they first
become exercisable.
In addition, during 2000 and 2001, the Audit Committee, the
Board of Directors of the Company and the general meeting of
the Company's shareholders approved the grant to a director
of the Company options to purchase up to 50,000 and 21,500
Ordinary Shares, respectively, of the Company at an exercise
price of $20.00 and $10.75, respectively, per share, the
market price of the Company's shares on the dates of grant.
The options may be exercised for a period of three years
from the date on which they have become vested. As of
December 31, 2003, all the options are vested.
(D) OPTIONS GRANTED TO FORMER CO-CEOS IN OCTOBER 1998 AND MAY
2001 - In October 1998 and May 2001, the Board of Directors
of the Company approved share option plans pursuant to which
each of the Company's two former Co-Chief Executive Officers
was granted the right to purchase up to 300,000 and 100,000,
respectively, Ordinary Shares of the Company at an exercise
price of $7.00 and $11.81, respectively, the market price of
the Company's shares on the dates of grant. In the framework
of the retirement of the former Co-Chief Executive Officers
in May 2003, based on their retirement provisions as
stipulated in the agreements, the 300,000 options are
available for exercise through April 2007.
(E) OPTIONS AVAILABLE FOR GRANT - Under a provision approved in
September 2000, as amended in December 2003, by the
Company's Board of Directors, on January 1 of each year
commencing 2001 and ending 2003 and on each year commencing
November 1, 2003 and November 1, 2004, the total number of
options available for grant under all the Company's employee
share option plans is to be increased by an amount equal to
certain percentage of the outstanding Ordinary Shares of the
Company on each such dates, provided that the maximum number
of options available for grant at any time shall not exceed
12% of the outstanding Ordinary Shares of the Company, and
that additional options may not be granted if the total
number of unvested options outstanding under all the
Company's share option plans exceeds 12% of the outstanding
Ordinary Shares of the Company. The percentage of the
outstanding Ordinary Shares of the Company added for the
years 2001, 2002 and 2003 was 4% and the percentage for the
years 2004 and 2005 will be 3.6%. Accordingly, as of
December 31, 2003, an aggregate of 5,583,353 options were
added to the Company's share option plans, of which
2,120,916 had not yet been designated for identified
employees, and are accordingly available for grant under the
general terms described in paragraph (a) above.
- F-30 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - SHAREHOLDERS' EQUITY (cont.)
B. SHARE OPTION PLANS (cont.)
(2) SUMMARY OF THE STATUS OF ALL THE COMPANY'S EMPLOYEE AND DIRECTOR
SHARE OPTIONS
A summary of the status of all the Company's employee and
director share option plans as of December 31, 2003, 2002 and
2001, as well as changes during each of the years then ended, is
presented below (for options granted to the Banks, a related
party and a consultant, see paragraph B(5) below):
2003 2002 2001
Weighted Weighted Weighted
Number of average Number average Number average
share exercise of share exercise of share exercise
options price options price options price
------- ----- ------- ----- ------- -----
Outstanding as of
beginning of year 4,247,898 $ 10.79 3,717,770 $ 11.94 2,376,543 $ 13.34
Granted 3,118,742 4.10 905,724 5.82 1,583,722 10.20
Exercised -- -- (31,154) 8.76
Terminated -- -- --
Forfeited (524,199) 8.25 (375,596) 10.27 (211,341) 15.30
--------- --------- ---------
Outstanding as of
end of year 6,842,441 7.93 4,247,898 10.79 3,717,770 11.94
========= ========= =========
Options exercisable
as of end of year 2,008,674 11.60 1,299,531 10.49 1,080,867 7.79
========= ========= =========
(3) SUMMARY OF INFORMATION ABOUT EMPLOYEE SHARE OPTIONS OUTSTANDING
The following table summarizes information about employee share
options outstanding as of December 31, 2003:
Exercisable as of
Outstanding as of December 31, 2003 December 31, 2003
----------------------------------- -----------------
Weighted average Weighted
Range of exercise Number remaining AVERAGE Number Weighted average
prices outstanding contractual life exercise price exercisable exercise price
------ ----------- ---------------- -------------- ----------- --------------
(in years)
2.98 - 3.96 1,078,000 7.66 3.00 -- --
4.42 - 4.92 1,505,400 9.63 4.43 -- --
5.00 - 5.96 168,200 8.90 5.25 10,334 5.89
6.00 - 6.99 974,575 8.57 6.10 10,416 6.10
7.00 - 7.99 720,350 3.61 7.03 715,500 7.03
8.06 - 8.99 565,335 4.37 8.55 364,801 8.52
9.06 - 9.81 64,038 2.89 9.23 57,370 9.22
10.00 - 10.89 857,088 7.19 10.42 318,535 10.43
11.81 - 11.81 200,000 7.41 11.81 66,666 11.81
12.13 - 13.00 71,910 5.01 12.49 47,577 12.59
14.25 - 17.19 30,750 6.67 15.79 20,499 15.79
18.75 - 18.75 76,500 6.26 18.75 25,497 18.75
20.00 - 25.00 530,295 6.22 24.43 371,479 24.24
--------- ---------
Total 6,842,441 7.28 7.93 2,008,674 11.60
========= =========
- F-31 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - SHAREHOLDERS' EQUITY (cont.)
B. SHARE OPTION PLANS (cont.)
(4) WEIGHTED AVERAGE GRANT-DATE FAIR VALUE OF OPTIONS GRANTED TO
EMPLOYEES
The weighted average grant-date fair value of the options granted
during 2003, 2002 and 2001 to employees and directors amounted to
$2.18, $2.83 and $6.95 per option, respectively. The Company
utilized the Black-Scholes option pricing model to estimate fair
value, utilizing the following assumptions for the years 2003,
2002 and 2001 (all in weighted averages):
2003 2002 2001
---- ---- ----
Risk-free interest rate 2.88%-3.22% 2.80% 4.25%
Expected life of options 4.75 years 4.82 years 4.80 years
Expected annual volatility 55%-74% 56% 87%
Expected dividend yield None None None
(5) Non-Employee Warrants
(A) BANKS - As of December 31, 2003, the Company granted the
Banks an aggregate of 1,296,596 warrants to purchase
Ordinary Shares of the Company, at an average exercise price
of $6.18 per share, at terms described below:
WARRANTS ISSUED IN JANUARY 2001 - In January 2001, as part
of the Facility Agreement described in Note 13A(6), the
Banks received an aggregate of 400,000 warrants to purchase
Ordinary Shares of the Company (200,000 each) at an exercise
price, as amended in December 2001, of $6.20 per share. As
of December 31, 2003, all of these warrants were fully
vested. The warrants are exercisable for a five-year period
ending January 2006.
In lieu of paying the exercise price in cash as described
below, the Banks are entitled to exercise the warrants on a
"cashless" basis, i.e. by forfeiting all or part of the
warrants in exchange for ordinary shares equal to the
aggregate fair market value of the shares underlying the
warrants forfeited less the aggregate exercise price.
The cost of the warrants issued to the Banks, determined
based on the fair value at the grant and amendment dates in
accordance with SFAS 123, amounted to a total of $5,466.
Such amount is amortized as deferred financing charges over
the terms of the loans under the Facility Agreement.
WARRANTS GRANTED IN DECEMBER 2003 - In December 2003, as
part of the amendment to the Facility Agreement described in
Note 13A(6), the Banks received an aggregate of 896,596
warrants to purchase Ordinary Shares of the Company (448,298
each) at an exercise price of $6.17 per share, the 15 day
average closing price of the Company's Ordinary Shares prior
to the date the amendment with the Banks described in Note
13A(6) was signed. As of December 31, 2003, all of the
warrants are fully vested. The warrants are exercisable for
a five-year period ending December 2008.
The cost of the warrants issued to the Banks, determined
based on the fair value at the grant and amendment dates in
accordance with SFAS 123, amounted to a total of $3,946.
Such amount is amortized as deferred financing charges over
the terms of the loans under the Facility Agreement.
- F-32 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - SHAREHOLDERS' EQUITY (cont.)
B. SHARE OPTION PLANS (cont.)
(5) NON-EMPLOYEE SHARE WARRANTS (cont.)
(A) BANKS (cont.)
WARRANTS TO BE GRANTED TO THE BANKS - In the event the Banks
increase the loans available to be drawn down by the Company
under the Facility Agreement, as described in Note 13A(6),
the Company will issue the Banks additional five-year
warrants equivalent to 30% of the amount drawn down based on
the average closing price of the Company's Ordinary Shares
during the 15 trading days prior to the time the Company
draws down such loan. As of December 31, 2003, no warrants
were issued under this commitment.
(B) WARRANTS GRANTED TO A RELATED PARTY - In consideration for
TIC's undertaking described in Note 13A(6), the Company
issued IC-Tech warrants for the purchase of 58,906 of the
Company's Ordinary Shares. The exercise price for the
warrants is $6.17 per share, the 15-day average closing
price of the Company's Ordinary Shares prior to the date the
amendment with the Banks described in Note 13A(6) was
signed. As of December 31, 2003, all of the warrants are
fully vested. The warrants are exercisable for a five-year
period ending December 2008.
The cost of the warrants award granted to IC-Tech,
determined based on the fair value at the grant date in
accordance with SFAS 123, amounted to a total of $259. Such
amount was allocated to other assets as deferred financing
charges to be amortized as financing expense over the terms
of the loans under the Facility Agreement with the Banks.
In addition, in the framework of TIC's undertaking described
in Note 13A(6), the Company undertook to issue additional
warrants to IC-Tech as a subscription fee which will be 5%
of the total amount of money invested by TIC in case the
TIC's undertaking is realized in consideration for all of
the unsubscribed rights that it actually purchases. The
exercise price of these warrants shall be the 15-day average
closing price of the Company's Ordinary Shares prior to the
date of the rights offering prospectus, and they shall
expire five years from their date of issuance.
(C) OPTIONS GRANTED TO CONSULTANT - In return for services
provided to the Company by a consultant in connection with
obtaining certain agreements relating to Fab 2, the Company
awarded the consultant with options, which were fully
expired in August 2001. The cost of the options award
granted to the consultant, determined based on the fair
value at the relevant measurement dates in accordance with
SFAS 123, amounted to $1,576. Of that amount, $524 was
attributed to the technology transfer agreement with Toshiba
and is being amortized in accordance with the other
technology transfer costs. The remaining $1,052 was
attributed to issuance of Ordinary Shares to certain Wafer
Partners and was included in paid-in capital.
(D) WARRANTS ISSUED TO OTPP - See Note 13A(4).
The Company utilized the Black-Scholes option pricing model to
estimate fair values of options and warrants granted to
non-employees, utilizing the assumptions similar to those
presented in paragraph B(4) above.
- F-33 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - SHAREHOLDERS' EQUITY (cont.)
B. SHARE OPTION PLANS (cont.)
(6) PRO FORMA LOSS PER SHARE ACCORDING TO SFAS 123 AND SFAS 148
Had compensation cost for the Company's share option plans been
determined based on fair value at the grant dates for all awards
made through December 31, 2003 in accordance with SFAS 123, as
amended by SFAS 148, the Company's pro forma loss per share would
have been as follows:
2003 2002 2001
---- ---- ----
PRO FORMA LOSS
Loss for the year, as reported $(114,261) $ (51,402) $ (38,522)
Less - stock-based compensation
determined under APB-25 27 142 283
Add - stock-based compensation determined
under SFAS 123 (8,437) (7,476) (6,209)
--------- --------- ---------
Pro forma loss $(122,671) $ (58,736) $ (44,448)
========= ========= =========
PRO FORMA BASIC LOSS PER SHARE
As reported $ (2.40) $ (1.63) $ (1.92)
========= ========= =========
Pro forma $ (2.57) $ (1.87) $ (2.27)
========= ========= =========
C. TREASURY STOCK
During 1998, the Board of Directors of the Company authorized, subject
to certain conditions, the purchase of up to 1,400,000 Ordinary Shares
to facilitate the exercise of employee stock options under the
Company's share option plans. During 1999 and 1998, the Company funded
the purchase by a trustee of 142,500 and 1,157,500, respectively, of
the Company's Ordinary Shares.
D. DIVIDEND DISTRIBUTIONS
According to the Facility Agreement, as amended, (Note 13A(6)), the
Company undertook not to distribute any dividends prior to January 1,
2008. Any dividend distributions after that date shall be subject to
provisions stipulated in such agreement.
- F-34 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - SHAREHOLDERS' EQUITY (cont.)
E. SALE OF SECURITIES
In January 2002, the Company issued on the Tel Aviv Stock Exchange,
Israel NIS 110,579,800 principal amount of convertible debentures,
under terms described in Note 11. Together with the convertible
debentures the Company issued for no consideration an aggregate of
552,899 options (all of which expired without being exercised) and
2,211,596 Options (Series 1) exercisable into one Ordinary Share of
the Company until January 20, 2006 at an exercise price of NIS 39.00
(subject to customary adjustments), linked to the Israeli Consumer
Price Index (as of December 31, 2003 - NIS 40.83, $9.32). The total
initial proceeds raised were $23,200, and costs related to the
issuance of the securities and the prospectus in Israel were
approximately $1,750. See Note 20E for the disclosure of the
accounting treatment of the sale of these securities under U.S. GAAP.
F. RIGHTS OFFERING
In October 2002, the Company issued in connection with a rights
offering done on the Nasdaq and on the Tel-Aviv Stock Exchange in
Israel 4,097,964 Ordinary Shares of the Company and 1,844,082 warrants
to purchase Ordinary Shares of the Company, in consideration for an
aggregate of gross proceeds of $20,490. Of these amounts, 4,086,037
Ordinary Shares and 1,838,715 warrants were issued to Wafer Partners
and Equity Investors in consideration for an aggregate of $20,430.
Each warrant may be exercised for the purchase of one Ordinary Share
at an exercise price of $7.50 for a period ending on October 31, 2006.
Costs in relation to the prospectus and the issuance of the securities
were approximately $800.
G. PUBLIC OFFERING IN JANUARY 2004
In January 2004, the Company completed a public offering of 11,000,000
of its Ordinary Shares. Gross proceeds received in January 2004 were
$77,000, and costs in relation to the prospectus and the issuance of
the securities were approximately $4,700. In addition, the Company
granted the underwriters a 30-day option to purchase up to an
additional 1,650,000 ordinary shares at the public offering price to
cover over-allotments.
- F-35 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 15 - INFORMATION ON GEOGRAPHIC AREAS AND MAJOR CUSTOMERS
A. SALES BY GEOGRAPHIC AREA (as percentage of total sales)
Year ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
United States 73% 62% 69%
Asia Pacific - in 2003, Taiwan; in 2002,
primarily Japan; in 2001, primarily
Taiwan 10 25 18
Europe 15 11 10
Israel 2 2 3
--- --- ---
Total 100% 100% 100%
=== === ===
B. LONG-LIVED ASSETS BY GEOGRAPHIC AREA - Substantially all of the
Company's long-lived assets are located in Israel.
C. MAJOR CUSTOMERS (as percentage of total sales)
Year ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Customer A 24% 31% 30%
Customer B 20 -- --
Customer C 11 13 17
Customer D -- 16 --
Other customers (*) 20 21 28
(*) Represent sales to six different customers each of whom accounted
for between 0% and 9% of sales during 2003; to five customers
(2%-7%) during 2002; and to five customers (2%-8%) during 2001.
As of December 31, 2003 and 2002, the above major customers
constituted the majority of the trade accounts receivable reflected on
the balance sheets.
NOTE 16 - FINANCING INCOME (EXPENSE), NET
Financing income (expense), net consist of the following:
Year ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Financial expenses (primarily bank loan interest) $(16,073) $(11,669) $ (3,365)
Financial expenses in relation
to convertible debentures (1,198) (1,101) --
Less capitalized interest - Note 6A(3) 6,892 10,260 1,328
-------- -------- --------
(10,379) (2,510) (2,037)
Financing income (primarily bank deposit interest) 553 406 3,502
-------- -------- --------
Financing income (expense), net $ (9,826) $ (2,104) $ 1,465
======== ======== ========
- F-36 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 17 - INCOME TAXES
A. APPROVED ENTERPRISE STATUS
Substantially all of the Company's existing facilities as of December
31, 2003 have been granted approved enterprise status, as provided by
the Israeli Law for the Encouragement of Capital Investments - 1959
("Investments Law") (see Note 6B).
The tax benefits derived from approved enterprise status relate only
to taxable income attributable to each approved enterprise investments
programs. Pursuant to the Investments Law and the approval
certificates, the Company's income attributable to its various
approved enterprise investments is taxed at a rate of up to 25%
through periods ending between 2003 and 2012. Taxable income
attributable to Fab 2 approved program shall be tax-exempt for the
first two years it arises. The portion of the Company's taxable income
that is not attributable to approved enterprise investments is taxed
at a rate of 36% (regular "Company Tax").
The tax benefits are also conditioned upon fulfillment of the
requirements stipulated by the Investments Law and the regulations
promulgated there under, as well as the criteria set forth in the
certificates of approval. In the event of a failure by the Company to
comply with these conditions, the tax benefits could be canceled, in
whole or in part, and the Company would be required to refund the
amount of the canceled benefits, plus interest and certain inflation
adjustments. In management's opinion, the Company has been in
compliance with the conditions through the approval date of the
financial statements (see Note 6B).
B. COMPONENTS OF DEFERRED TAX ASSET/LIABILITY
The following is a summary of the components of the deferred tax
benefit and liability reflected on the balance sheets as of the
respective dates:
As of December 31,
------------------
2003 2002
---- ----
DEFERRED TAX BENEFIT - CURRENT
Accrued vacation pay $ 695 $ 582
Other 62 82
-------- --------
757 664
Valuation allowance (757) (664)
-------- --------
Total current deferred tax benefit $ -- $ --
======== ========
NET DEFERRED TAX BENEFIT - LONG-TERM
Deferred tax asset -
Net operating loss carryforward $ 58,048 $ 19,094
Research and development 3,748 2,759
Liability for employee rights upon severance 887 781
-------- --------
62,683 22,634
Valuation allowance (43,861) (17,229)
-------- --------
18,822 5,405
Deferred tax liability - depreciation and amortization (18,822) (5,405)
-------- --------
Total net long-term deferred tax benefit $ -- $ --
======== ========
- F-37 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 17 - INCOME TAXES (cont.)
C. EFFECTIVE INCOME TAX RATES
The reconciliation of the statutory tax rate to the Company's
effective tax rate is as follows:
Year ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Israeli statutory rate (36)% (36)% (36)%
Reduced tax rate for approved enterprise 16 16 16
Tax benefits for which deferred taxes
were not recorded 23 10 22
Permanent differences and other, net (3) 10 (2)
--- --- ---
--% --% --%
=== === ===
D. NET OPERATING LOSS CARRYFORWARD
As of December 31, 2003, the Company had net operating loss
carryforwards for tax purposes of approximately $300,000, which may be
carried forward for an unlimited period of time.
E. FINAL TAX ASSESSMENTS
The Company possesses final tax assessments under agreement through
the year 1998. In addition, the tax assessment for 1999 is deemed
final.
NOTE 18 - FINANCIAL INSTRUMENTS
A financial instrument is defined as cash, evidence of an ownership
interest in an entity, or a contract that imposes on one entity a
contractual obligation either to deliver or receive cash or another
financial instrument to or from a second entity. Examples of financial
instruments include cash and cash equivalents, trade accounts receivable,
loans, investments, trade accounts payable, accrued expenses, options and
forward contracts.
The Company makes certain disclosures with regard to financial instruments,
including derivatives. These disclosures include, among other matters, the
nature and terms of derivative transactions, information about significant
concentrations of credit risk, and the fair value of financial assets and
liabilities.
See Note 20C for disclosure related to the Company's derivatives financial
instruments in accordance with U.S. GAAP.
A. HEDGING ACTIVITIES
The Company, from time to time, enters into foreign currency
derivatives to hedge its foreign currency exposure to equipment
purchase commitments and other firm commitments denominated in foreign
currency (primarily Japanese Yen and Euro). In that regard, the
Company generally uses foreign currency forward contracts and options
(zero-cost cylinder) as hedging instruments for foreign currency
exposure. Accordingly, if the hedge is determined to be effective all
changes in value attributed to spot rate fluctuations as well as the
premium of forward contracts and the time value of options at
inception are deferred until the hedged item is recognized (i.e.,
receipt of the equipment). The time value of options at inception is
amortized on a straight-line basis.
- F-38 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 18 - FINANCIAL INSTRUMENTS (cont.)
A. HEDGING ACTIVITIES (cont.)
In addition, the Company, from time to time, enters into agreements to
hedge variable interest rate exposure on long-term loans (see Note
10). In order to hedge the cash flow related to this exposure, the
Company uses various types of derivative contracts, consisting
primarily of interest rate caps, floors and collars. If the hedge is
determined to be effective, the changes in the intrinsic value of the
derivative contracts are deferred and recognized in results of
operations as interest payments become due. The time value of options
at inception is recognized in earnings on a straight-line basis. When
the related debt is issued in connection with the acquisition of
assets not yet placed into operations, interest costs and gains and
losses on the derivative contracts are capitalized to the related
asset.
The Company does not hold or issue derivative financial instruments
for non-hedging purposes.
B. CREDIT RISK OF FINANCIAL INSTRUMENTS, INCLUDING DERIVATIVES
The face or contract amounts of derivatives do not represent amounts
exchanged by the parties and, accordingly, are not a measure of the
exposure of the Company through its use of derivatives.
The Company is exposed to credit-related losses in respect of
derivative financial instruments in a manner similar to the credit
risk involved in the realization or collection of other types of
assets. In management's estimation, due to the fact that derivative
financial instrument transactions are entered into solely with
financial institution counterparties, it is not expected that such
counterparties will fail to meet their obligations. Substantially all
remaining financial instruments held by the Company are due from
governmental entities and, accordingly, the Company's credit risk in
respect thereof is negligible.
C. PRESENTATION OF HEDGING ACTIVITIES IN THE FINANCIAL STATEMENTS
(1) As of December 31, 2002, the Company had an outstanding foreign
exchange agreements (options) to hedge exposure related to the
purchase of machinery and equipment in an aggregate of $44,032
(as of December 31, 2003 - $0). The agreements resulted in 2003
in a gain of $2,357 of which $1,663 was capitalized to fixed
assets; in 2002 -$3,062 and $2,770, respectively; in 2001 - in a
loss of $4,462 from forward transactions of which $4,564 was
capitalized to fixed assets.
(2) As of December 31, 2003 and 2002, the Company had an outstanding
agreements to hedge interest rate exposure on loans to be
withdrawn under the Facility Agreement, the aggregate amount of
which was $212,000, all of which is attributable to Fab 2. These
agreements resulted in 2003 in a loss of $5,335 of which $2,547
was capitalized to property and equipment; in 2002 - a loss of
$3,707 of which $3,593 was capitalized to property and equipment;
in 2001 - a loss of $463 of which $344 was capitalized to
property and equipment.
D. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments,
excluding the Company's agreements to hedge interest rate exposure on
long-term loans, did not materially differ from their respective
carrying amounts as of December 31, 2003 and 2002. The fair value of
the interest rate hedging transactions as of December 31, 2003 would
have resulted in an unrealized capitalizable loss of $9,920 (as of
December 31, 2002 - $11,952).
- F-39 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - RELATED PARTIES BALANCES AND TRANSACTIONS
A. BALANCES
As of December 31,
------------------
2003 2002
---- ----
Trade accounts receivable $5,286 $ 583
====== ======
Current liabilities $ 23 $ 6
====== ======
B. Transactions
Year ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Sales $13,282 $ 3,836 $ 4,339
======= ======= =======
Management fees $ 240 $ 480
======= =======
Purchases of raw materials $ -- $ 209 $ 2,460
======= ======= =======
Development costs - Note 5B $ -- $ 102 $ 225
======= ======= =======
Expense reimbursements paid $ 99 $ 101 $ 290
======= ======= =======
Expense reimbursements received $ 282 $ 177
======= =======
Royalties received - Note 13F(2) $ 225 $ 500
======= =======
Royalties paid/payable - Note 13F(2) $ 12 $ 300
======= =======
C. For commitments, contingencies and other transactions relating to Fab
2 Wafer Partner and Equity Investor agreements - see Note 13A.
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP
With regard to the Company's financial statements, the material differences
between GAAP in Israel and in the U.S. relate to the following. See G below
for the presentation of the Company's balance sheets as of December 31,
2003 and 2002 in accordance with U.S. GAAP.
A. PRESENTATION OF CASH AND SHORT-TERM AND LONG-TERM INTEREST-BEARING
DEPOSITS DESIGNATED FOR INVESTMENTS RELATING TO FAB 2
In accordance with U.S. GAAP, cash, short-term and long-term
interest-bearing deposits designated for investments relating to Fab 2
should be excluded from current assets and long-term investments and
presented separately as a non-current asset. Accordingly, as of
December 31, 2003, $44,042 and $4,848 were reclassified, respectively,
from current assets and long-term investments to a long-term asset (as
of December 31, 2002 - $51,338 and $11,893, respectively).
B. PRESENTATION OF NET LONG-TERM LIABILITIES IN RESPECT OF EMPLOYEES
Under U.S. GAAP, assets and liabilities relating to severance
arrangements are to be presented separately and are not to be offset,
while according to Israeli GAAP such an offset is required.
Accordingly, an amount of $14,607 and $12,368 as of December 31, 2003
and 2002, respectively, was reclassified from other long-term
liabilities to long-term investments.
- F-40 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
C. HEDGING ACTIVITIES IN ACCORDANCE WITH U.S. GAAP (SFAS 133)
(1) In 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities" and the related
statements and interpretations thereon (collectively, "SFAS
133"). A derivative is typically defined as an instrument whose
value is derived from an underlying instrument, index or rate,
has a notional amount, requires no or little initial investment
and can be net settled.
SFAS 133 requires that all derivatives be recorded in the
financial statements at their fair value at the date of the
financial statements. The changes in the fair value of the
derivatives are charged to the statement of operations or to
other comprehensive income, as appropriate in the circumstances.
The Company's derivatives consist mainly of foreign currency
forward transactions and options and interest rate instruments
(collars).
Prior to the adoption of SFAS 133, the Company accounted for
hedging activities for U.S. GAAP purposes according to the policy
described in Notes 2M and 18A. Based on the hedging activities
the Company had prior to January 1, 2001, the financial
statements of the Company were not materially affected by the
initial adoption of SFAS 133.
(2) The Company uses foreign exchange agreements (forward contracts
and options) to hedge its foreign currency exposure in
anticipated equipment purchases denominated in foreign currency.
All foreign exchange agreements are with underlying terms that
match or approximate the hedged transactions and thus are highly
effective. The Company measures the effectiveness of the forward
contracts hedges based on forward rates. The Company assesses and
measures the effectiveness of the options hedge, at inception and
throughout the hedge, based on total changes in cash flows. All
changes in fair value are reported in other comprehensive income.
The amounts accumulated in other comprehensive income are
expensed to results of operations concurrent with the recognition
of depreciation expenses on the equipment. As of December 31,
2003, there were not any outstanding foreign exchange agreements.
For outstanding foreign exchange agreements as of December 31,
2002, see Note 18C(1).
The Company uses interest rate collars with a knock-out feature
to hedge its Libor-based variable long-term debt cash flow
exposure. The knock-out feature was set above the cap level. The
Company determined that the probability that the cap will be
knocked-out is remote and thus expected that the hedge will be
highly effective. The Company assessed and measured the
effectiveness of the hedge, at inception and throughout the
hedge, based on total changes in cash flows of the collar, and
reported all changes in fair value in other comprehensive income.
Amounts presented in other comprehensive income are reclassified
to operations or capitalized to property and equipment, as
applicable (see Note 2G), as interest payment become due. For
outstanding contracts as of December 31, 2003 and 2002, see Note
18C(2).
Following the commencement of operations of Fab 2 during the third
quarter of 2003, $6,641 of the aggregate comprehensive loss as of June
30, 2003, which is attributable to property and equipment, is
amortized on a straight-line method over five years, in corresponding
to the economic useful lives of the machinery and equipment.
- F-41 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
C. HEDGING ACTIVITIES IN ACCORDANCE WITH U.S. GAAP (SFAS 133) (cont.)
(3) Complying with SFAS 133 and SFAS 138 and the related
interpretations thereon with respect to the Company's hedging
transactions as of December 31, 2003 would have resulted in: an
increase in other long-term liabilities in the amount of $9,920;
a decrease in other comprehensive loss for the year ended
December 31, 2003 of $1,940 and in the accumulated other
comprehensive loss component of equity as of such date in the
amount of $15,897; and in a decrease of $5,947 in property and
equipment, net as of December 31, 2003.
D. IMPLEMENTATION OF SFAS 123 AND SFAS 148
Had compensation cost for the Company's share option plans been
determined based on fair value at the grant dates for awards made
through December 31, 2003 in accordance with SFAS 123, as amended by
SFAS 148, the Company's pro forma loss and loss per share would have
been as follows (for further information with regard to the Company's
share option plans and the assumptions for utilizing the Black-Scholes
pricing model, see Note 14B(4)):
Year ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
PRO FORMA LOSS
Loss for the year, as reported according to
U.S. GAAP (see H below) $(114,261) $ (51,402) $ (38,522)
Less - stock-based compensation determined
under APB-25 27 142 283
Add - stock-based compensation
determined under SFAS 123 (8,437) (7,476) (6,209)
--------- --------- ---------
Pro forma loss $(122,671) $ (58,736) $ (44,448)
========= ========= =========
BASIC LOSS PER SHARE
As reported according to U.S.
GAAP (see J below) $ (2.45) $ (1.63) $ (1.92)
========= ========= =========
Pro forma $ (2.63) $ (1.87) $ (2.27)
========= ========= =========
- F-42 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
E. SALE OF SECURITIES
Under Accounting Principles Board Opinion No. 14 ("APB 14"), the
proceeds from the sale of the securities described in Notes 11 and 14E
are to be allocated to each of the securities issued based on their
relative fair value, while according to Israeli GAAP such treatment is
not required. Complying with APB 14, based on the average market value
of each of the securities issued in the first three days following
their issuance, would have resulted in an increase in shareholders'
equity in the amount of $2,363 (net of $196 related issuance
expenses), and a decrease in convertible debentures in the amount of
$2,559. The effect of amortization of the discount on the convertible
debentures under U.S. GAAP for each of the years ended December 31,
2003 and 2002 would have been immaterial.
F. PRESENTATION OF PROCEEDS ON ACCOUNT OF SHARES IN ACCORDANCE WITH U.S.
GAAP (SFAS 150)
According to SFAS No. 150, "Accounting For Certain Financial
Instruments with Characteristics of Both Liabilities and Equity", a
financial instrument that embodies an unconditional obligation (as
defined in that guidance), that the issuer must or may settle by
issuing a variable number of its equity shares, shall be classified as
a liability if, at inception, the monetary value of the obligation is
based solely or predominantly on, among others, a fixed monetary
amount known at inception. Accordingly, the $13,201 and $3,227 amounts
which are described in detail in Notes 13A(3) and (4), respectively,
and which according to Israeli GAAP are presented as "Proceeds on
account of share capital", are reclassified under SFAS 150 as
"Liability in respect of variable number of shares to be issued". Such
presentation for the U.S. GAAP purposes is required since as of
December 31, 2003, the amount of shares the Company is to issue in
consideration of the aggregate of $16,428 is not determined as of such
date, and is actually based on mechanisms that embodies variable
number of shares.
- F-43 -
TOWER SEMICONDUCTOR LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA AND PER SHARE DATA)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAELI AND U.S. GAAP (CONT.)
G. BALANCE SHEETS IN ACCORDANCE WITH U.S. GAAP
AS OF DECEMBER 31, 2003 AS OF DECEMBER 31, 2002
----------------------- -----------------------
U.S. AS PER AS PER AS PER AS PER
GAAP ISRAELI ADJUST- U.S. ISRAELI ADJUST- U.S.
REMARK GAAP MENTS GAAP GAAP MENTS GAAP
-------- --------- -------- --------- --------- --------- -----------
A S S E T S
CURRENT ASSETS
CASH AND CASH EQUIVALENTS $ 12,448 $ $ 12,448 $ 7,857 $ $ 7,857
SHORT-TERM INTEREST-BEARING DEPOSITS -- -- 10,500 10,500
CASH AND SHORT-TERM INTEREST-BEARING DEPOSITS
DESIGNATED FOR INVESTMENTS RELATING TO FAB 2 A 44,042 (44,042) -- 51,338 (51,338) --
TRADE ACCOUNTS RECEIVABLE (NET OF ALLOWANCE FOR
DOUBTFUL ACCOUNTS OF $0 AND $155, RESPECTIVELY 11,631 11,631 7,456 7,456
OTHER RECEIVABLES 11,073 11,073 21,322 21,322
INVENTORIES 19,382 19,382 10,201 10,201
OTHER CURRENT ASSETS 1,729 1,729 1,407 1,407
--------- -------- --------- --------- --------- -----------
TOTAL CURRENT ASSETS 100,305 (44,042) 56,263 110,081 (51,338) 58,743
--------- -------- --------- --------- --------- -----------
LONG-TERM INVESTMENTS
LONG-TERM INTEREST-BEARING DEPOSITS
DESIGNATED FOR INVESTMENTS RELATING TO FAB 2 A 4,848 (4,848) -- 11,893 (11,893) --
OTHER LONG-TERM INVESTMENTS B 6,000 14,607 20,607 6,000 12,368 18,368
--------- -------- --------- --------- --------- -----------
10,848 9,759 20,607 17,893 475 18,368
--------- -------- --------- --------- --------- -----------
PROPERTY AND EQUIPMENT, NET C 568,412 (5,947) 562,465 493,074 (5,727) 487,347
--------- -------- --------- --------- --------- -----------
CASH AND SHORT-TERM AND LONG-TERM
INTEREST-BEARING DEPOSITS DESIGNATED
FOR INVESTMENTS RELATING TO FAB 2 A -- 48,890 48,890 -- 63,231 63,231
--------- -------- --------- --------- --------- -----------
OTHER ASSETS E 108,770 (196) 108,574 95,213 (196) 95,017
========= ======== ========= ========= ========= ===========
TOTAL ASSETS $ 788,335 $ 8,464 $ 796,799 $ 716,261 $ 6,445 $ 722,706
========= ======== ========= ========= ========= ===========
LIABILITIES AND
SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
SHORT-TERM DEBT $ -- $ $ -- $ 4,000 $ $ 4,000
TRADE ACCOUNTS PAYABLE 40,249 40,249 76,083 76,083
OTHER CURRENT LIABILITIES C 9,564 9,564 8,071 128 8,199
--------- -------- --------- --------- --------- -----------
TOTAL CURRENT LIABILITIES 49,813 49,813 88,154 128 88,282
LONG-TERM DEBT 431,000 431,000 253,000 253,000
CONVERTIBLE DEBENTURES E 25,783 (2,559) 23,224 24,121 (2,559) 21,562
OTHER LONG-TERM LIABILITIES B, C 5,935 24,527 30,462 5,406 24,320 29,726
LIABILITY IN RESPECT OF A VARIABLE NUMBER
OF SHARES TO BE ISSUED F -- 16,428 16,428 -- --
LONG-TERM LIABILITY IN RESPECT
OF CUSTOMERS' ADVANCES 46,347 46,347 47,246 47,246
--------- -------- --------- --------- --------- -----------
TOTAL LIABILITIES 558,878 38,396 597,274 417,927 21,889 439,816
--------- -------- --------- --------- --------- -----------
SHAREHOLDERS' EQUITY
ORDINARY SHARES, NIS 1 PAR VALUE - AUTHORIZED
150,000,000 SHARES; ISSUED 52,996,097 AND
44,735,532 SHARES, RESPECTIVELY 13,150 13,150 11,294 11,294
ADDITIONAL PAID-IN CAPITAL E 427,881 2,363 430,244 400,808 2,363 403,171
SHAREHOLDER RECEIVABLES AND UNEARNED COMPENSATION (26) (26) (53) (53)
PROCEEDS ON ACCOUNT OF SHARE CAPITAL F 16,428 (16,428) -- -- --
ACCUMULATED OTHER COMPREHENSIVE LOSS C -- (15,897) (15,897) -- (17,837) (17,837)
ACCUMULATED DEFICIT H (218,904) 30 (218,874) (104,643) 30 (104,613)
--------- -------- --------- --------- --------- -----------
238,529 (29,932) 208,597 307,406 (15,444) 291,962
TREASURY STOCK, AT COST - 1,300,000 SHARES (9,072) (9,072) (9,072) (9,072)
--------- -------- --------- --------- --------- -----------
TOTAL SHAREHOLDERS' EQUITY 229,457 (29,932) 199,525 298,334 (15,444) 282,890
========= ======== ========= ========= ========= ===========
TOTAL LIABILITIES AND SHAREHOLDERS' EQUIT $ 788,335 $ 8,464 $ 796,799 $ 716,261 $ 6,445 $ 722,706
========= ======== ========= ========= ========= ===========
- F-44 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
H. STATEMENTS OF OPERATIONS IN ACCORDANCE WITH U.S. GAAP
Complying with SFAS 133 and SFAS 138 would not have affected the
results of operations for the years ended December 31, 2003 and 2002.
The effect on the results of operations for the year ended December
31, 2001 as a result of complying with SFAS 133 and SFAS 138 would be
additional financing income (and a reduction of the loss) in the
amount of $30. Accordingly, the Company's loss for the year ended
December 31, 2001 would have been $38,492.
I. COMPREHENSIVE INCOME IN ACCORDANCE WITH U.S. GAAP (SFAS 130)
Comprehensive income (loss) represents the change in shareholder's
equity during a reporting period from transactions and other events
and circumstances from non-owner sources. It includes all changes in
equity during a reporting period except those resulting from
investments by owners and distributions to owners. Other comprehensive
income (loss) represents gains and losses that under U.S. GAAP are
included in comprehensive income but excluded from net income.
Following are statements of comprehensive loss in accordance with U.S.
GAAP:
Year Ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Loss for the year according to U.S. GAAP $(114,261) $ (51,402) $ (38,492)
Other comprehensive loss:
Realized gain on securities
arising during the year -- -- (9,550)
Adjustment of unrealized gain
on securities arising during previous year -- -- (3,013)
Amortization of unrealized
losses on derivatives 664 -- --
Unrealized gains (losses) on derivatives 1,276 (9,638) (8,199)
--------- --------- ---------
Net comprehensive loss for the year $(112,321) $ (61,040) $ (59,254)
========= ========= =========
- F-45 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
J. LOSS PER SHARE DATA IN ACCORDANCE WITH U.S. GAAP (SFAS 128)
In accordance with U.S. GAAP (SFAS 128, including the implementation
of SFAS 133 and SFAS 138 as described above), the basic and diluted
loss per share would be:
Year Ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
Basic loss per share $ (2.45) $ (1.63) $ (1.95)
========= ========= =========
Diluted loss per share $ (2.45) $ (1.63) $ (1.95)
========= ========= =========
The following tables provide a reconciliation of the numerators and
denominators of the basic and diluted per share computations for 2003,
2002 and 2001 in accordance with U.S. GAAP. The loss per share for
each year presented according to U.S. GAAP may differ from the
corresponding amount under Israeli GAAP due to different methods for
determining the weighted average number of ordinary shares outstanding
and the loss used to compute loss per share. According to Israeli
GAAP, the weighted average number of ordinary shares outstanding for
each year presented include retroactive effect from the beginning of
each year of shares issued upon exercise of share options and warrants
("Exercise") and upon conversion of convertible debentures
("Conversion"), outstanding at the beginning of each year and giving
effect to shares issuable from probable Exercise and from probable
Conversion. IL GAAP further provide that loss per ordinary share is to
be calculated based on loss for the year with the inclusion of imputed
interest income on the exercise price of options and warrants
exercised or of probable Exercise, and of financial expenses in
relation to converted debentures or on probable Conversion. According
to U.S. GAAP, the amount of shares underlying the options, warrants
and convertible debentures is accounted for according to the treasury
method, regardless of the probability of the exercise of the options
and warrants or the conversion into shares of the convertible
debentures. According to Israeli GAAP, the loss to compute loss per
share may include imputed interest income on the exercise price of
options and warrants exercised during the year and of probable
Exercise and probable Conversion, an inclusion which is not required
by U.S. GAAP.
- F-46 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
J. LOSS PER SHARE DATA IN ACCORDANCE WITH U.S. GAAP (SFAS 128) (cont.)
RECONCILIATION FOR 2003:
Year ended December 31, 2003
----------------------------
Shares
Loss (in thousands) Per-share
Basic Loss Per Share (Numerator) (Denominator) Amount
-------------------- ----------- ------------- ------
Loss available to ordinary shareholders $(114,261) 46,710 $ (2.45)
========
EFFECT OF DILUTIVE SECURITIES
Convertible debentures -- --
Options and warrants -- --
--------- ------
DILUTED LOSS PER SHARE
Loss available to ordinary
shareholders after assumed conversions $(114,261) 46,710 $ (2.45)
========= ====== ========
Options and warrants to purchase 14,003,621 Ordinary Shares at an
average exercise price of $7.87 per share were outstanding as of
December 31, 2003 but were not included in the computation of diluted
loss per share because their effect was anti-dilutive. The options and
warrants, which as of December 31, 2003 expire between April 2005 and
December 2013 (weighted average remaining contractual life of 5.02
years), were still outstanding as of such date. Convertible
debentures, convertible into 2,697,068 Ordinary Shares, were
outstanding as of December 31, 2003 but were not included in the
computation of diluted loss per share since their effect is
anti-dilutive. The convertible debentures may be converted until
December 31, 2008 into Ordinary Shares.
- F-47 -
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
J. LOSS PER SHARE DATA IN ACCORDANCE WITH U.S. GAAP (SFAS 128) (cont.)
RECONCILIATION FOR 2002:
Year ended December 31, 2002
----------------------------
Shares
Loss (in thousands) Per-share
(Numerator) (Denominator) Amount
----------- ------------- ------
BASIC LOSS PER SHARE
Loss available to ordinary shareholders $(51,402) 31,523 $ (1.63)
========
EFFECT OF DILUTIVE SECURITIES
Convertible debentures -- --
Options and warrants -- --
-------- ------
DILUTED LOSS PER SHARE
Loss available to ordinary
shareholders after assumed conversions $(51,402) 31,523 $ (1.63)
======== ====== ========
Options and warrants to purchase 10,053,578 Ordinary Shares at an
average exercise price of $9.12 per share were outstanding as of
December 31, 2002 but were not included in the computation of diluted
loss per share because their effect was anti-dilutive. The options and
warrants, which as of December 31, 2002 expire between April 2005 and
December 2012 (weighted average remaining contractual life of 4.9
years), were still outstanding as of such date. Convertible
debentures, convertible into 2,697,068 Ordinary Shares, were
outstanding as of December 31, 2002 but were not included in the
computation of diluted loss per share since their effect is
anti-dilutive. The convertible debentures may be converted until
December 31, 2008 into Ordinary Shares.
RECONCILIATION FOR 2001:
Year ended December 31, 2001
----------------------------
Shares
Loss (in thousands) Per-share
(Numerator) (Denominator) Amount
----------- ------------- ------
BASIC LOSS PER SHARE
Loss available to ordinary shareholders $(38,492) 19,724 $ (1.95)
========
EFFECT OF DILUTIVE SECURITIES
Options and warrants -- --
-------- ------
DILUTED LOSS PER SHARE
Loss available to ordinary
Shareholders after assumed conversions $(38,492) 19,724 $ (1.95)
======== ====== ========
Options and warrants to purchase 4,117,770 Ordinary Shares at an
average exercise price of $11.39 per share were outstanding as of
December 31, 2001 but were not included in the computation of diluted
loss per share because their effect was anti-dilutive. The options and
warrants, which as of December 31, 2001 expire between April 2005 and
December 2011 (weighted average remaining contractual life of 6.84
years), were still outstanding as of such date.
- F-48 -
SIGNATURES
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant certifies that it meets all the requirements for filing
on Form 20-F and has duly caused this Annual Report to be signed on its behalf
by the undersigned, thereunto duly authorized on this 1st day of March, 2004.
TOWER SEMICONDUCTOR LTD.
By: /s/ Carmel Vernia
---------------------
Carmel Vernia
Chairman and Chief Executive Officer
98