===============================================================================
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, 2004 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:
65,699,796 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]
===============================================================================
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 19 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 or production 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 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.
i
TABLE OF CONTENTS
PART 1
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS................................ 1
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE.............................................. 1
ITEM 3. KEY INFORMATION...................................................................... 1
ITEM 4. INFORMATION ON THE COMPANY........................................................... 19
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS......................................... 35
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES........................................... 57
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS.................................... 65
ITEM 8. FINANCIAL INFORMATION................................................................ 67
ITEM 9. THE OFFER AND LISTING................................................................ 68
ITEM 10. ADDITIONAL INFORMATION............................................................... 69
ITEM. 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.......................... 77
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES............................... 80
PART II
ITEM 13. DEFAULTS, DIVIDENT AVERAGES AND DELINUENCIES......................................... 81
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS......... 81
ITEM 15. CONTROLS AND PROCEDURES.............................................................. 81
ITEM 16. [RESERVED]........................................................................... 81
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT..................................................... 81
ITEM 16B. CODE OF ETHICS....................................................................... 81
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES............................................... 82
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FROM AUDIT COMMITTEES ......................... 82
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PARTIES.................. 82
PART III
ITEM 17. FINANCIAL STATEMENTS................................................................. 82
ITEM 18. FINANCIAL STATEMENTS................................................................. 83
ITEM 19. EXHIBITS............................................................................. 83
ii
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 selected statement of operations data and other financial
data for the years ended December 31, 2004, 2003 and 2002, and selected balance
sheet data as of December 31, 2004 and 2003 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 registered public accounting firm.
We derived the selected statement of operations data and other financial data
for the years ended December 31, 2001 and 2000 and the selected balance sheet
data as of December 31, 2002, 2001 and 2000 from our audited financial
statements that are not included in this annual report, which were prepared in
accordance with Israeli GAAP. Statements of operations and other financial data
in accordance with US GAAP would not have materially differed from respective
data in accordance with Israeli GAAP. Other than as indicated below, balance
sheet data in accordance with US GAAP would not have materially differed from
the respective data in accordance with Israeli GAAP. Our management believes
that the financial statements contain all adjustments needed to present fairly
the information included therein.
1
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
2004 2003 2002 2001 2000
---------- --------- --------- --------- ---------
(in thousands, except share date and per share data)
STATEMENT OF OPERATIONS DATA:
Sales ...................................................... $ 126,055 $ 61,368 $ 51,801 $ 52,372 $ 104,775
Cost of sales .............................................. 228,410 122,395 67,022 76,733 88,787
--------- --------- --------- --------- ---------
Gross profit (loss) ........................................ (102,355) (61,027) (15,221) (24,361) 15,988
Research and development ................................... 17,053 20,709 17,031 9,556 8,965
Marketing, general and administrative ...................... 21,297 22,615 17,091 14,489 11,428
--------- --------- --------- --------- ---------
Operating loss ............................................. (140,705) (104,351) (49,343) (48,406) (4,405)
Financing income (expense), net ............................ (29,745) (9,826) (2,104) 1,465 1,394
Other income (expense), net ................................ 32,682 (84) 45 8,419 (478)
--------- --------- --------- --------- ---------
Loss before income tax expense ............................. (137,768) (114,261) (51,402) (38,522) (3,489)
Income tax expense ......................................... - - - - (500)
--------- --------- --------- --------- ---------
Loss for the year .......................................... $(137,768) $(114,261) $ (51,402) $ (38,522) $ (3,989)
========= ========= ========= ========= =========
Basic loss per ordinary share .............................. $ (2.13) $ (2.40) $ (1.63) $ (1.92) $ (0.26)
========= ========= ========= ========= =========
OTHER FINANCIAL DATA:
Depreciation and amortization .............................. $ 121,067 $ 54,611 $ 18,821 $ 21,721 $ 25,917
Capital expenditures (accrual basis) before
Investment Center grants .................................. 172,617 164,187 243,431 364,347 79,060
AS OF DECEMBER 31,
----------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- -------- --------- ---------
(in thousands, except share data)
SELECTED BALANCE SHEET DATA IN ACCORDANCE WITH ISRAELI
GAAP:
Cash and cash equivalents, including short-term
deposits and designated cash ............................... $ 81,457 $ 56,490 $ 69,695 $ 33,202 $ 18,707
Working capital ............................................. 63,591 50,492 21,927 (16,335) 28,635
Total assets ................................................ 847,508 788,335 716,261 472,054 179,298
Long-term debt from banks ................................... 497,000 431,000 253,000 115,000 12,064
Convertible debentures ...................................... 26,651 25,783 24,121 - -
Long-term liabilities in respect of customers' advances ..... 64,428 46,347 47,246 17,910 -
Shareholders' equity ........................................ 167,980 229,457 298,334 252,805 134,648
Weighted average number of ordinary shares outstanding (*) .. 64,717 47,608 31,523 20,020 13,676
Number of shares issued and outstanding (*) ................. 65,700 51,696 43,436 24,997 12,263
(*) Net of 1,300,000 Ordinary Shares held by our Company as of each date
presented.
2
AS OF DECEMBER 31,
-------------------------------------------------------------
2004 2003 2002 2001 2000
--------- --------- --------- --------- ---------
(in thousands)
RECONCILIATION TO US GAAP:
TOTAL ASSETS
According to Israel GAAP ...................................... $ 847,508 $ 788,335 $ 716,261 $ 472,054 $ 179,298
The effect of:
Presentation of long-term liabilities in respect of employees.. 16,350 14,607 12,368 10,334 7,952
Hedging activities ............................................ (4,619) (5,947) (5,727) (4,564) -
Sale of securities ............................................ (196) (196) (196) - -
Presentation of securities ........................... - - - - 12,563
--------- --------- --------- --------- ---------
According to US GAAP .......................................... $ 859,043 $ 796,799 $ 722,706 $ 477,824 $ 199,813
========= ========= ========= ========= =========
SHAREHOLDERS' EQUITY
According to Israel GAAP ...................................... $ 167,980 $ 229,457 $ 298,334 $ 252,805 $ 134,648
The effect of:
Hedging activities ................................... (7,025) (15,867) (17,807) (8,169) -
Proceeds on account of share capital ................. - (16,428) - - -
Sale of securities (*) ............................... 2,363 2,363 2,363 - -
Presentation of securities ........................... - - - - 12,563
--------- --------- --------- --------- ---------
According to US GAAP .......................................... $ 163,318 $ 199,525 $ 282,890 $ 244,636 $ 147,211
========= ========= ========= ========= =========
(*) The allocation of a portion of the total proceeds from the sale of
securities issued in January 2002.
3
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.
RISKS AFFECTING OUR BUSINESS
IF THE TERMS REFLECTED IN THE LETTER OF INTENT THAT WE SIGNED WITH OUR BANKS IN
MAY 2005 ARE NOT EFFECTUATED, OR IF DO WE NOT FIND ALTERNATIVE FINANCING, WE MAY
NOT BE ABLE TO MAINTAIN OUR OPERATIONS.
In May 2005, we signed a letter of intent with our banks which provides
for financing in the amount of up to $30 million, subject to, among other
things, a similar amount being raised by us from investors. To date, certain of
our equity investors and wafer partners have informed us of their willingness to
invest $23.5 million towards such funding by investors. The letter of intent is
subject to the execution of a definitive amendment to our credit facility
agreement, which we are currently negotiating. If a definitive amendment to our
credit facility agreement is not executed and consummated or if we are unable to
raise the funds from investors as stipulated in the letter of intent, or cannot
find alternative financing for said amounts, we do not expect to have adequate
liquidity for our short-term activities and liabilities during the second half
of 2005 and may have to cease our operations. If we raise the funds contemplated
by the letter of intent, we will still need to raise additional funds in order
to finance our activities and liabilities in 2006, at least until we achieve
positive cash flow from our operations.
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.
Fab 2 production capacity at the end of December 2004 was 14,600 200-mm
wafers per month and we currently expect to have production capacity of 15,400
wafers per month by the end of 2005. Depending on the process technology and
product mix, we estimate that Fab 2 will be able to achieve capacity levels of
up to 36,000 wafers per month. We have not completed the acquisition,
installation, equipping and financing necessary in order for production at our
Fab 2 facility to reach such levels. Our determination as to the timing to
increase Fab 2's production levels is dependent on prevailing and forecasted
market conditions and our ability to fund these increases. We need to complete
the qualification process of the 0.13-micron technology transferred from
Freescale Semiconductor, Inc. (formerly Motorola, Inc.) 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 have and may in the
future experience difficulties that are customary in the installation,
functionality and operation of equipment during manufacturing. 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.
4
IF WE DO NOT HAVE SUFFICIENT FUNDS TO COMPLETE FAB 2, OUR BUSINESS WILL BE
MATERIALLY ADVERSELY AFFECTED.
Fab 2's cost was estimated to be approximately $1.5 billion, including
costs of construction, equipment, installation, libraries, intellectual
property, technology transfers and other related ramp-up and pre-operation
costs. However, the actual total cost of Fab 2 may exceed our estimates. If we
cannot successfully raise sufficient funding to complete the ramp-up and to fund
other related costs, 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.
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, 2004, we had received
$150.6 million in grants from the Investment Center. To be eligible to receive
grants, we are required to invest minimum amounts on an annual basis. We
notified the Investment Center of our reduced rate of annual investments and in
July 2004, we received approval of our revised investment schedule from the
Investment Center. In addition, we are required to complete our Fab 2
investments by the end of 2005, which we do not currently expect to satisfy.
Israeli law limits the ability of the Investment Center to extend this time
limitation, unless approved through an expansion plan. We have been holding
discussions with the Investment Center to achieve satisfactory arrangements to
approve a new expansion program to commence on January 1, 2006. In April 2005,
at the Investment Center's request, we submitted a revised business plan to the
Investment Center for the period commencing on January 1, 2006. There can be no
assurance that we will obtain the Investment Center's approval for the new
expansion program. Any failure by us to meet the conditions of our grants 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 grants
already received, If this were to happen, we would be required to seek
alternative financing sources to refund the grants we received and complete the
ramp-up of Fab 2, which would have an adverse effect on our operations.
IF OUR FUTURE OPERATIONS DO NOT INCREASE OR IF WE FAIL TO RAISE ADDITIONAL
FUNDING, WE MAY BE UNABLE TO REPAY OUR DEBT ON A TIMELY BASIS.
We may from time to time lack liquidity to finance our ramp up of Fab 2.
Accordingly, there is no assurance that our future operations will increase or
that we will succeed in raising the additional funding required for the
completion of the ramp up of Fab 2. As a result, we may be unable to repay on
time or repay at all our short-term and long-term debt consisting mainly of
trade accounts payable, bank debt and convertible debentures. If we foresee that
we will be unable to secure additional financing, we may have to revise our
anticipated operations, or even cease our operations. We cannot assure you we
will be successful at negotiating price reductions and arrangements to slow down
or postpone payments to our suppliers and service providers when we have
liquidity problems and any postponement of payments may delay our ramp-up of Fab
2 and therefore harm our financial results.
5
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. The overcapacity
and downward price pressures characteristic of a prolonged downturn in the
semiconductor market may not allow us to operate at a profit, even at full
utilization, and could seriously harm our financial results and business.
WE HAVE A HISTORY OF OPERATING LOSSES AND EXPECT TO OPERATE AT A LOSS FOR THE
FORESEEABLE FUTURE; OUR FACILITIES MUST OPERATE AT HIGH UTILIZATION RATES FOR US
TO BE PROFITABLE.
We have operated at a loss for the last number of years and expect to
operate at a loss for the foreseeable future. Because fixed costs represent a
substantial portion of the operating costs of semiconductor manufacturing
operations, we must operate our facilities at high utilization rates for us to
be profitable. We began construction of Fab 2 in 2001 and Fab 2 operations began
in 2003. Our losses since 2003 are due primarily to significant depreciation and
amortization expenses related mainly to Fab 2, as well as financing and
operating expenses which have not yet been offset by a sufficient increase in
the level of our sales.
OUR OPERATING RESULTS FLUCTUATE FROM QUARTER TO QUARTER WHICH MAKES IT DIFFICULT
TO PREDICT OUR FUTURE PERFORMANCE.
Our revenues, expenses and operating results have varied significantly in
the past and may fluctuate significantly from quarter to quarter in the future
due to a number of factors, many of which are beyond our control. These factors
include, among others:
o The cyclical nature of both the semiconductor industry and the
markets served by our customers;
o Changes in the economic conditions of geographical regions where our
customers and their markets are located;
o Shifts by integrated device manufacturers (IDMs) and customers
between internal and outsourced production;
o Inventory and supply chain management of our customers;
o The loss of a key customer, postponement of an order from a key
customer, failure of a key customer to pay accounts receivables in a
timely manner or the financial condition of our customers;
o The occurrence of accounts receivables write-offs;
o The rescheduling or cancellation of large orders or planned capital
expenditures;
6
o Our ability to satisfy our customers' demand of quality and timely
production;
o The timing and volume of orders relative to our available production
capacity;
o Our ability to obtain raw materials and equipment on a timely and
cost-effective basis;
o Environmental events or industrial accidents such as fires or
explosions;
o Our susceptibility to intellectual property rights disputes;
o Our ability to continue with existing and to enter into new
partnerships and technology and supply alliances on mutually
beneficial terms;
o Actual capital expenditures exceeding planned capital expenditures;
o Currency and interest rate fluctuations that may not be adequately
hedged;
o Technological changes and short product life cycles; and
o Timing for designing and the qualification of new products.
Due to the factors noted above and other risks discussed in this section,
many of which are beyond our control, you should not rely on quarter to quarter
comparisons to predict our future performance. Unfavorable changes in any of the
above factors may seriously harm our company.
THE LACK OF A SIGNIFICANT BACKLOG RESULTING FROM OUR CUSTOMERS NOT PLACING
PURCHASE ORDERS FAR IN ADVANCE MAKES IT DIFFICULT FOR US TO FORECAST OUR
REVENUES IN FUTURE PERIODS.
Our customers generally do not place purchase orders far in advance,
partly due to the cyclical nature of the semiconductor industry. As a result, we
do not typically operate with any significant backlog. The lack of a significant
backlog makes it difficult for us to forecast our revenues in future periods.
Moreover, since our expense levels are based in part on our expectations of
future revenues, we may be unable to adjust costs in a timely manner to
compensate for revenue shortfalls. We expect that in the future our revenues in
any quarter will continue to be substantially dependent upon purchase orders
received in that quarter and in the immediately preceding quarter. We cannot
assure you that any of our customers will continue to place orders with us in
the future at the same levels as in prior periods.
OUR SALES CYCLES MAY BE LONG AND, AS A RESULT, ORDERS RECEIVED MAY NOT MEET OUR
EXPECTATIONS WHICH MAY ADVERSELY AFFECT OUR OPERATING RESULTS.
Our sales cycles, which measure the time between our first contact with a
customer and the first shipment of product orders to the customer, vary
substantially and may last as long as two years or more, particularly for new
technologies. In addition, even after we make initial shipments of prototype
products, it may take several more months to reach full production of the
product. As a result of these long sales cycles, we may be required to invest
substantial time and incur significant expenses in advance of the receipt of any
product order and related revenue. If orders ultimately received differ from our
expectations with respect to the product, volume, price or other items, our
operating results may be adversely affected.
7
DEMAND FOR OUR FOUNDRY SERVICES IS DEPENDANT ON THE DEMAND IN OUR CUSTOMERS' END
MARKETS.
We are ramping-up Fab 2 based on our expectations of customer demand and
our financial resources. 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 certain image sensor product
applications. 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 ATTRACT ADDITIONAL CUSTOMERS, OUR BUSINESS MAY BE ADVERSELY
AFFECTED.
For the year ended December 31, 2004, approximately 63% of our business
was generated by five significant customers which contributed between 6% to 24%
of our revenues. We expect to continue to receive a significant portion of our
revenue from a limited number of customers in 2005. Loss or cancellation of
business from, or decreases in, the sales volume or sales prices to these
customers, 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.
WE DEPEND ON A SMALL NUMBER OF PRODUCTS FOR A SIGNIFICANT PORTION OF OUR
REVENUES.
From time to time, a significant portion of our revenue is generated from
a small number of very high volume products that are shipped to volatile
consumer-oriented markets. The volume of orders of such products may adversely
change or demand for such products may be abruptly discontinued. We expect that
in the foreseeable future we will continue to be dependent upon a relatively
limited number of products for a significant portion of our revenue due to the
nature of our business. We cannot assure you that revenue generated from these
products, individually or in the aggregate, will reach or exceed historical
levels in any future period. A decrease in the price of, or demand for, any of
these products could negatively impact our financial results.
IF WE DO NOT RECEIVE ORDERS FROM OUR WAFER PARTNERS WE MAY HAVE EXCESS CAPACITY.
We have committed a portion of our Fab 2 capacity for future orders.
During the ramp-up of Fab 2, our capacity commitments to our wafer partners are
limited to approximately 50% of our Fab 2 capacity. Parties to whom we have
committed capacity are generally not obligated to utilize or pay for all or any
portion of their allocated capacity, and generally provide and confirm their
orders to us less than one month before the production start date. If these
parties do not place orders with us, and if we are unable to fill such
unutilized capacity, our financial results may be adversely affected.
8
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.
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. Our
ability to achieve and maintain profitable operations depends on the successful
development and introduction to production of these processes, which we may not
achieve.
IF WE DO NOT COMPETE EFFECTIVELY, WE WILL LOSE BUSINESS TO OUR COMPETITORS.
The semiconductor foundry industry is highly competitive. We compete with
more than ten independent dedicated foundries, the majority 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
integrated circuits, or ICs. Many of our competitors may 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;
o a better cost structure; and/or
o better operational performance in cycle time and yields.
9
WE HAVE A LARGE AMOUNT OF DEBT WHICH COULD HAVE SIGNIFICANT NEGATIVE
CONSEQUENCES.
We have a large amount of long-term debt, which could have significant
negative consequences. As of December 31, 2004, we had $497 million of bank debt
and $26.7 million of debt in connection with our issuance of convertible
debentures in January 2002. 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 a competitive disadvantage to less leveraged
competitors and competitors that have better access to capital
resources; and
o affecting our ability to make interest payments and other required
debt service on our indebtedness.
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 $497 million as of
December 31, 2004, requires that we comply with certain financial, capital
raising and production milestone covenants. Currently, we estimate that we may
not comply with certain of the financial ratios and covenants for the third
quarter of 2005 and thereafter. In connection with the negotiations for a
definitive amendment to our credit facility agreement with our banks following
the signing of a letter of intent in May 2005, we have submitted to our banks an
updated Fab 2 working-plan based on prevailing and forecasted market conditions
and requested our banks to amend the financial ratios and covenants in order to
align them with the updated Fab 2 working-plan. Should we fail to comply with
our covenants, and our banks do not waive our non-compliance, they may require
us to immediately repay all loans made by them to us, 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 an amendment to a directive published by the Israel Supervisor
of Banks, effective March 31, 2004, we may be deemed part of a group of
borrowers comprised of the Ofer Brothers Group, The Israel Corp., 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 for limits on amounts that banks may lend to
borrowers or groups of borrowers. Should our banks exceed these limitations,
they may limit our ability to borrow other money in the future and may require
us to return some or all of our outstanding borrowings (which were $497 million
as of December 31, 2004), which may have a material adverse effect on our
business, financial condition and results of operations.
10
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 MAY 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, and require large amounts of fresh water and electricity.
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. Shortages in supplies of manufacturing equipment and raw
materials 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.
OUR EXPOSURE TO CURRENCY EXCHANGE AND INTEREST RATE FLUCTUATIONS MAY INCREASE
OUR COST OF OPERATIONS.
Almost all of our cash generated from operations and from our financing
and investing activities is denominated in U.S. dollars and New Israeli Shekels,
or NIS. Our expenses and costs are denominated in NIS, U.S. 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 provide for interest based
on a floating LIBOR rate, thereby exposing us 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.
11
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 operating and financing activities.
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. 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. If any of our third party vendors go out of
business, liquidate, merge with, or are acquired by, another company that
discontinues the vendor's previous line of business, or if we fail to maintain
or acquire licenses to such intellectual property for any other reason, our
business may be adversely affected. 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 nor are we
currently plaintiff in any such action against other parties. However, we have
been subject to such claims in the past, all of which 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 if we are
unable to extend or renew it on similar terms, we may have to agree to less
favorable terms or consider other alternatives, including designing around
certain processes.
Because of the nature of the industry, we may continue to be a party to
infringement claims in the future. 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 use of 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;
12
o fighting the matter in court and paying substantial monetary damages
in the event we 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 May 31, 2005, we held 53 patents worldwide. We intend to continue to
file patent applications when appropriate. 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
courts will uphold our intellectual property rights, or enforce the contractual
arrangements that we have entered into to protect our proprietary technology,
which could reduce our opportunities to generate revenues.
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. 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 ARE 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 are therefore 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, or if our insurance proves to
be inadequate, it would reduce our manufacturing capacity and revenues.
13
POSSIBLE PRODUCT RETURNS COULD HARM OUR BUSINESS.
Products manufactured by us may be returned within specified periods if
they are defective or otherwise fail to meet customers' prior agreed upon
specifications. Product returns in excess of established provisions 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. Since our actual level of Fab 1 revenues and
employees for 2003 and 2004 were not in compliance with the above mentioned
levels, we may be required to repay the Investment Center up to approximately
$2.5 million.
WE ARE SUBJECT TO RISKS RELATED TO OUR INTERNATIONAL OPERATIONS.
In 2003 and 2004, 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 or
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.
14
IF OUR NEW EXECUTIVE OFFICERS ARE UNABLE TO FULLY TRANSITION INTO THEIR NEW
POSITIONS, OUR COMPANY MAY BE ADVERSELY AFFECTED.
We have made several changes to our senior management team in recent
months. If our new executive officers are unable to fully transition into their
new positions, or if such transition is significantly delayed, our company may
be adversely affected.
OUR BUSINESS COULD SUFFER IF WE ARE UNABLE TO RETAIN AND RECRUIT QUALIFIED
PERSONNEL.
We depend on the continued services of our executive officer, senior
managers and skilled technical and other personnel. Our business could suffer if
we lose the services of some of these personnel and we cannot and find and
adequately integrate replacement personnel into our operations in a timely
manner. We seek to recruit highly qualified personnel and there is intense
competition for the services of these personnel in the semiconductor industry.
Competition for personnel may increase significantly in the future as new
fabless semiconductor companies as well as new semiconductor manufacturing
facilities are established. We may need to review employee compensation
competitiveness with the purpose of retaining our existing officers and
employees and attracting and retaining additional personnel.
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.
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. These broad market and industry
fluctuations may adversely affect the market price of our ordinary shares,
regardless of our actual operating performance.
In addition, it is possible that in some future periods our operating
results may be below the expectations of public market analysts and investors.
In this event, the price of our securities may under perform or fall.
ISSUANCE OF ADDITIONAL SHARES PURSUANT TO OUR FAB 2 FINANCING ARRANGEMENTS AND
OPTIONS GRANTED TO OUR FAB 2 BUILDING CONTRACTOR, EMPLOYEES AND DIRECTORS MAY
DILUTE THE INTEREST OF OUR SHAREHOLDERS.
In connection with Fab 2, we have issued as of December 31, 2004,
53,405,787 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 8.5 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.
15
In addition, as of May 31, 2005, we had outstanding employee and directors
options to purchase up to 11.5 million shares at a weighted average exercise
price of $4.74 (excluding options to purchase up to 1,325,724 shares approved by
our board to be granted to our CEO but which are subject to approval of our
shareholders), of which 2.9 million options have an exercise price below $1.71.
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 into our
ordinary shares rather than use these credits to reduce their cash payments for
wafers manufactured in Fab 2, based on the average trading price of our ordinary
shares during the 15 consecutive trading days preceding the relevant quarter. As
of May 31, 2005, we have issued 703,554 of our ordinary shares to Sandisk upon
conversion of $1.5 million of wafer credits. See "Item 5 - Liquidity and Capital
Resources - "Fab 2 Agreements".
In May 2005, we signed a letter of intent with our banks which provides
for financing in the amount of up to $30 million, subject to, among other
things, a similar amount being raised by us from investors. To date, certain of
our equity investors and wafer partners have informed us of their willingness to
invest $23.5 million towards such funding by investors. In addition, we may seek
to raise additional funds from other sources. The investments to be made towards
the funding by investors required by our banks, or from other sources, may be
for shares or for securities convertible into shares, which would dilute the
holdings of our current shareholders.
MARKET SALES OF LARGE AMOUNTS OF OUR SHARES ELIGIBLE FOR FUTURE SALE MAY LOWER
THE PRICE OF OUR ORDINARY SHARES.
Of our 66,286,187 outstanding ordinary shares as of May 31, 2005,
24,589,143 are freely tradable and held by non-affiliates, and an additional
108,951 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. In addition, certain of our affiliates (Israel Corp.,
SanDisk, Alliance Semiconductor, and Macronix International) hold 41,588,093 of
our shares, of which 4,086,037 are registered for resale and are therefore
freely tradable and 6,810,462 are currently eligible for sale subject to the
time, volume and manner of sale limitations of Rule 144. An additional 691,594
shares held by SanDisk will become eligible for sale subject to the time, volume
and manner of sale limitations of Rule 144 during 2005 and 2006. Shares held by
these affiliates are 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. 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 THEIR INTEREST IN WAYS WHICH MAY BE ADVERSE TO YOUR INTERESTS.
Our wafer partners and Israel Corp. 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 Israel Corp. 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 shareholders meetings. If only two
large shareholders were to participate in one of our shareholders meetings,
these shareholders would determine the outcome of our shareholders meeting
without the benefit of the participation of our other shareholders. In addition,
even if our other shareholders were to participate in our shareholders meetings
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.
16
RISKS RELATED TO OUR OPERATIONS IN ISRAEL
INSTABILITY IN ISRAEL MAY HARM OUR BUSINESS.
All of our manufacturing facilities and our corporate and some of our
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, Israel has been subject to civil unrest and terrorist
activity, with varying levels of severity. 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. 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
increases in terrorist activity, there have been periods of significant call-ups
of military reservists, and it is possible that there will be additional
call-ups in the future. A large part of male Israeli citizens, including our
employees, are subject to compulsory military reserve 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.
17
OUR OPERATIONS MAY BE AFFECTED BY NEGATIVE ECONOMIC CONDITIONS IN ISRAEL.
In recent years, Israel has experienced periods 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 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. From time to time, the Israeli trade unions threaten strikes
or work-stoppages, which may, if carried out, have a material adverse effect on
the Israeli economy and our business.
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 expires on
December 31, 2005. 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. 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.
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, 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 in subsequent
years, subject to exceptions for U.S. Holders who made a timely QEF or
mark-to-market election.
18
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.
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 and strategically focused on embedded non-volatile memory,
complementary metal oxide semiconductor ("CMOS") image sensor, mixed signal and
radio frequency CMOS (RFCMOS) technologies. Typically, pure-play foundries do
not offer 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 offer
the manufacture of ICs with geometries ranging from 1.0 to 0.13-micron, while
0.13-micron is expected to be ready for production by the end of 2005. We also
provide complementary technical services and design support. ICs manufactured by
us are incorporated into a wide range of products in diverse markets, including
consumer electronics, personal computers, communications, automotive, industrial
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 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, mixed-signal and RFCMOS technologies. In addition, we have
commenced development of a new technology that targets the radio frequency
identification, or RFID, Tags market. 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, design support and services, competitive manufacturing indices, such
as cycle times and yields, and dedicated customer service.
19
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 wafers per
month. Since then, we have significantly modernized our Fab 1 facility and
equipment, which has improved our process geometries to range from 1.0-micron to
0.35-micron and enhanced our process technologies to include CMOS image sensors,
embedded flash and mixed-signal technologies. We have also expanded our capacity
in Fab 1 to approximately 16,000 wafers per month to meet additional customer
demand.
In May 2004, we signed a foundry agreement with Siliconix incorporated, a
subsidiary of Vishay Intertechnology, Inc., for the long-term production of
semiconductors. Pursuant to the terms of this agreement, 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. Siliconix has advanced to us $20 million to be used for the
purchase of additional equipment required to satisfy Siliconix's orders, with
this amount credited towards the purchase price of the wafers.
We have completed the construction of the building and infrastructure and
are in the course of ramping our second manufacturing facility, or Fab 2. Fab 2
is designed to operate in geometries of 0.18-micron and below, using advanced
materials and advanced CMOS technology licensed from Freescale and Toshiba and
other technologies that we might acquire or develop independently or with
development partners. Production capacity at the end of December 2004 was 14,600
wafers per month. We currently expect to have production capacity of 15,400
wafers per month by the end of 2005, of which approximately 800 wafers per month
are expected to be in 0.13-micron.
Our capital expenditures net of Investment Center grants for 2004, 2003
and 2002 of $142 million, $137 million and $206 million, respectively, were made
principally in connection with the construction of, and purchase of equipment
and technology for, Fab 2.
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 Ramat Gavriel 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 applications.
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.
20
Historically, the semiconductor industry was composed primarily of
companies that designed and manufactured 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 and cost
effectiveness 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. In addition to the
increased complexity of designs, there has also been a dramatic increase in the
number of applications for semiconductors. 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.
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.
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.
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 unique positions in large, high-growth specialized
markets for CMOS image sensors, embedded flash memory, mixed signal and RF CMOS
ICs. We serve as a sole source or alternative provider of foundry services.
21
We believe that we are a trusted, customer-oriented service provider that
has built a solid reputation in the foundry industry over the last twelve 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 (now Freescale).
We derived approximately 39% of our revenues for the year ended December
31, 2004 from our target specialized markets: CMOS image sensors, embedded flash
and mixed-signal ICs. 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, communications, medical, automotive and industrial 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 include applications such as industrial
machine vision, medical equipment and automotive sensors. While CMOS image
sensors for advanced optical applications are an emerging technology, we believe
that they are 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.
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. As the market for these products
becomes more main stream, we expect that more competition will enter this high
growth market and some of those products will become commodities.
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.
22
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 Semiconductors Ltd., pursuant to which we obtained approximately a
10% equity stake in Saifun. Together we brought to market a new non-volatile
memory technology based on 0.5-micron, microFlash(TM)/NROM(TM). NROM technology
enables the implementation of ultra high-density flash arrays using CMOS
processes, and is particularly suitable for embedding flash arrays with standard
CMOS logic, as well as for commodity memories. 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.
In December 2004, we sold our entire equity stake in Saifun for
approximately $39 million. This sale had no effect on our technology rights
under our agreement with Saifun.
MIXED SIGNAL AND RF CMOS
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 for our Fab 2.
Our customers can 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. For example, in February 2004, we launched production
of a Coder-Decoder (CODEC) IC for Smart Link, Ltd. utilizing 0.18-micron,
mixed-signal technology provided by Chipidea in our Fab 2 facility.
23
In recent years, more and more designers opt to develop high frequency
products based on RFCMOS technologies as opposed to exotic process technologies,
such as SiGe or GaAs. The superior cost structure of CMOS technologies enables
high volume, low cost production of such high frequency products. We use our
mixed signal expertise to leverage and develop processes and provide services
for customers utilizing CMOS technologies.
CONVERGENCE OF TECHNOLOGIES
In response to the growing demand for a single chip to offer a wide array
of functions, we are leveraging a combination of some of the abovementioned
technologies by developing a single chip with multiple functions. The successful
development of this chip will allow us to provide additional value to our
customers and obtain a unique market position by offering our customers a unique
technology platform. During 2004, we engaged in projects merging CMOS, NVM and
CIS for unique solutions to customers' needs, as well as in a project targeting
RFID Tags applications merging RFCMOS, Mixed Signal and NVM technologies onto a
single chip.
CUSTOMERS, MARKETING AND SALES
Our marketing and sales strategy seeks to aggressively expand our global
customer base. 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, sales
and engineering support personnel in the United States, Taiwan 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.
Our sales cycle is generally 12-24 months or longer for new customers and
can be as short as 9-12 months for existing customers. The typical stages in the
sales cycle 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 and third party manufacturing;
o silicon prototyping;
o assembly and test;
o validation and qualification; and
o production.
24
The primary customers of our foundry services are fabless semiconductor
companies and IDMs. A substantial 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, 2004, we had five significant customers who contributed 24%, 17%, 8%, 8% and
6% of our revenues, respectively. In 2003, we had three significant customers
who contributed 24%, 20% and 11% of our revenues, respectively. In 2002, we had
three significant customers who contributed 31%, 16% and 13% of our revenues,
respectively.
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
38%, 27% and 40% in the years ended December 31, 2002, 2003 and 2004,
respectively. We believe that a substantial portion of our sales will continue
to come from customers located outside the United States. The following table
sets forth the geographical distribution, by percentage, of our net sales for
the periods indicated:
Year ended December 31,
--------------------------------
2004 2003 2002
---- ---- ----
United States 60% 73% 62%
Israel 20 2 2
Pacific Rim (including Japan) 11(*) 10 25(*)
Europe 9 15 11
--- --- ---
Total 100% 100% 100%
=== === ===
(*) Including payments made to us in connection with our June 2002 joint
development agreement for 0.18-micron embedded MICROFLASH technology.
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., DongBuAnam, He Jien Technology, ASMC, Hynix, Powerchip Semiconductor, 1st
Silicon, Grace, HHNEC, and Silterra; other specialized foundries, such as AMI
Semiconductor, Jazz Semiconductor and X-Fab; and IDMs and end-product
manufacturers that produce ICs for their own use and/or allocate a portion of
their manufacturing capacity to foundry operations. Most of 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:
25
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.
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 services involving both design and manufacturing. We
believe we have a differentiated service offering and track record 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.
26
IC MANUFACTURING. Transistors and other circuit elements comprising an IC
are formed by repeating a series of processes in which 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 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 or cold. 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.
MANUFACTURING PROCESSES
We manufacture ICs on silicon wafers, generally using the customer's
proprietary circuit designs. In some cases, we use third-party or our own
proprietary design elements. The end product of our manufacturing process is a
silicon wafer containing multiple identical ICs. In most cases, our customer
assumes responsibility for dicing, assembly and testing. 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 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
processes have 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.
27
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, 0.35-micron and 0.18-micron CMOS image sensor processes are designed to
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.
EMBEDDED FLASH. Our microFLASH technology, based on Saifun NROM patented
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 offers 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. Our 0.18-micron
embedded flash technology was introduced during 2004, with multiple Flash
modules ranging in sizes from 2 megabit to 8 megabit and is currently expected
to be ready for production during 2005.
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 constantly expanding those features.
RFID. In 2004, we started a joint development program that targets the
RFID Tag market and utilizes a platform technology of Mixed Signal, RF and Non
Volatile memory function. We currently expect prototyping for this technology to
commence in 2005 and readiness for production is expected in 2006.
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, we
expect to continue to make purchases of semiconductor manufacturing equipment,
mainly for Fab 2.
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 also develop these technologies on our own, at our own
initiative, our customers' request or in cooperation with our customers.
28
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.
Such developments are very common in all of our value added process technologies
noted above. In 2004, in response to market demand, we introduced a 0.16-micron
optical shrink solution which represents a 10% linear shrink from our existing
0.18-micron offering while utilizing virtually the same 0.18-micron libraries
and IP. The shrink allows a 15 to 20 percent die size reduction and a
potentially higher wafer ASP and lower die cost. Applications include industry
standard CMOS logic and some mixed-signal technologies. This 0.16-micron
technology is expected to be ready for production by the end of 2005.
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, 2002, 2003
and 2004 were $17.0 million, $20.7 million and $17.1 million, net of government
participation of $1.2 million, $1.1 million and $1.5 million, respectively.
As of December 31, 2004, we employed 165 professionals in our research and
development department, 29 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 May 31, 2005, we held 53
patents. We have entered into various patent licenses and cross-licenses with
technology companies including Toshiba, Motorola (now Freescale), Synopsys, ARM,
Ceva, IMEC, Cadence Design Systems, Chipidea Microelectronics, Virage Logic,
Mentor Graphics Corporation and others. We may choose to renew our present
licenses or 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.
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 Freescale and Toshiba, and further develop specialized
processes through our internal design teams. The licensing of these technologies
has enormously reduced our internal development costs.
29
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 transferred to us
certain advanced CMOS technologies for use in Fab 2. In exchange for
certain license and technology transfer fees and royalties, Toshiba has
provided 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 (NOW FREESCALE). 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-developed 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. In August 2004, Motorola
assigned all of its rights and obligations under the aforementioned
agreement to Freescale.
DIGITAL CMOS AND 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.
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. Multiple customers use the Synopsys
libraries in producing their ICs at our company. In April 2004, we entered
into a comprehensive technology transfer and license agreement with
Synopsys that provides us with broad rights to use Synopsys' library
technology in multiple process technology generations including 0.18
micron and 0.13 micron. Under the agreement, we will develop, customize,
validate and characterize libraries, based on Synopsys' library
technology, which will be distributed and supported by Synopsys. This
agreement places us in a unique position of having in-house capability to
serve our customers' needs.
o ARTISAN COMPONENTS (NOW ARM PHYSICAL IP). 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 our company. In June 2004, we concluded an additional
agreement with Artisan Components whereby Artisan Components customizes
its libraries for our 0.13-micron process and licenses these libraries to
end-users free of charge. The Artisan Components libraries include
standard cells, general purpose and specialty input-output cells and
memory generators. In December 2004, Artisan Components was acquired by
ARM Physical IP and assigned thereto the aforementioned agreements.
30
o ARM PHYSICAL IP. 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, or system-on-chips, at our facilities.
o VIRAGE LOGIC. In March 2002, we entered into an agreement with
Virage Logic for the development of 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.
In June 2004, we entered into a license agreement with Virage Logic
Corporation under which Virage Logic will develop its platform of standard
and special libraries for our 0.13-micron process and license the
libraries to the end-users free of license charge. The Virage libraries
include standard cells and general purpose IO cells and a wide variety of
memory compilers.
In December 2004, we introduced Virage Logic's patented Nonvolatile
Electrically Alterable embedded memories for production on our 0.18-micron
CMOS logic process. NOVeA is the industry's first embedded reprogrammable
nonvolatile memory to be manufactured on a standard CMOS logic process
without any additional masks or process steps. We have selected and
qualified these memories for our process to help our customers meet their
application requirements for cost-effective embedded non-volatile memory
for security, encryption, unique device identification, analog trimming,
silicon repair and flexible program store.
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.
o CHIPIDEA MICROELECTRONICS. In January 2003, we entered into a
non-exclusive, perpetual, royalty-free license and design agreement with
Chipidea Microelectronics. Further to this agreement, several Chipidea
cores, including Chipidea's USB 2.0 (Universal Serial Bus 2.0) and OTG (On
The Go), are currently being utilized by our customers.
31
o CADENCE DESIGN SYSTEMS. Under our agreement with Cadence Design
Systems signed in 2001, Cadence Design Systems has developed a
mixed-signal Process Design Kit, or 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.
0.18 MICRON EMBEDDED MICROFLASH TECHNOLOGY
In June 2002, we entered into a joint development agreement for
0.18-micron embedded MICROFLASH technology with a Japanese semiconductor
manufacturer. We currently offer off-the-shelf memory blocks based on this
development. In April 2005, the Japanese semiconductor manufacturer elected, and
we agreed to terminate this agreement. According to the terms of the termination
agreement, the Japanese manufacturer paid us, net of deducted tax, $2.25
million. In addition, each party expressly released the other party from any
obligations or liabilities of any nature in connection with the joint
development agreement. The license rights granted to the parties continue
pursuant to the terms of the original agreement.
IMAGE SENSOR TECHNOLOGIES
We developed, both independently and together with our customers, basic
pixel intellectual property to be used by those customers in the manufacturing
of our CMOS image sensor products.
In May 2005, we entered into a technology development partnership
agreement with Atmel Corporation (Nasdaq:ATML) for the development of CMOS image
sensor-related processes, including technology modules specifically designed for
advanced photodiode structures. Under the agreement, both companies have rights
to use the jointly developed technology. Process development and fabrication
activities will be carried out at Fab 2.
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
nor are we currently plaintiff in any such action against other parties.
However, we have been subject to such claims in the past, all of which 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.
32
Because of the nature of the industry, we may continue to be a party to
such infringement claims in the future. 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 use of 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 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 1993, which
had operated the facility since 1986. We occupy the facility pursuant to a
long-term lease from the Israel Lands Authority that expires in 2032.
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 increased its manufacturing
capacity from 5,000 wafers per month, using 1.25-micron and 1.0-micron
processes, to approximately 16,000 wafers per month based on our current product
mix, using our 1.0 micron to 0.35-micron processes, including specialized
processes.
33
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. During 2004, we began the transfer of
Siliconix technology to Fab 1 and started wafer production for Siliconix in the
second quarter of 2005.
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 Freescale, and are in the process of completing its
qualification. 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. 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 2004, 2003 and 2002
were approximately $172 million, $164 million and $243 million, respectively,
before related Investment Center grants of $30 million, $27 million and $37
million, respectively.
ENVIRONMENTAL MATTERS
Our operations are subject to a variety of laws and governmental
regulations 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 believe that we are currently in compliance in all material respects
with applicable environmental laws and regulations.
In February 2004, we received ISO 14001 certification from The Standards
Institution of Israel. A series of international standards on environmental
management, ISO 14000 provides a framework for the development of an
environmental management system and the supporting audit program. ISO 14001 is
the cornerstone standard of the ISO 14000 series. It specifies a framework of
control for an environmental management system pursuant to which an organization
can be certified by a third party. The ISO 14001 certification applies to all of
our manufacturing facilities. Our authorized design center in Netanya, Israel
also received certification.
34
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. DIFFERENCES BETWEEN ISRAELI GAAP AND US GAAP AS THEY RELATE TO OUR
FINANCIAL STATEMENTS ARE DESCRIBED IN NOTE 19 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 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 offer the manufacture of ICs with geometries
ranging from 1.0 to 0.13-micron, while 0.13-micron is expected to be ready for
production by the end of 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, mixed-signal and RFID
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 IDMs.
A substantial 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. Our sales cycle is
generally 12-24 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, 2004, we had five significant customers
who contributed between 6% to 24% of our revenues. In 2003, we had five
significant customers who contributed between 6% to 24% of our revenues. In
2002, we had three significant customers who contributed 31%, 16% and 13% of our
revenues, respectively. In 2004, SanDisk was instrumental in ramping up our
business. While we currently expect that SanDisk will continue to be a
significant customer of Fab 2, additional customers are expected to commence or
increase their purchase orders following the qualification of their products in
Fab 2 during 2005. 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 40%, 27% and 38% in the years ended December 31, 2004, 2003 and 2002,
respectively. We believe that a substantial portion of our sales will continue
to come from customers located outside the United States.
35
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 wafers per
month. Since then, we have significantly modernized our Fab 1 facility, which
has improved its process geometries from 1.0-micron to 0.35-micron and enhanced
its process technologies to include CMOS image sensors, embedded flash and
mixed-signal technologies. We have also expanded our production capacity in Fab
1 to approximately 16,000 wafers per month to meet additional customer demand.
Fab 1 has been cash flow positive from operations since the second quarter of
2002. During 2004, we began the transfer of Siliconix technology to Fab 1 and
started wafer production for Siliconix in the second quarter of 2005.
During the third quarter of 2003, we completed the construction of the
building and infrastructure of our second manufacturing facility, or Fab 2 and
since then are in the process of ramping-up Fab 2. Fab 2 is designed to operate
in geometries of 0.18-micron and below, using advanced materials and advanced
CMOS technology licensed from Motorola (now Freescale) 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 2004 was 14,600 wafers per month, and we
expect to have production capacity of 15,400 wafers per month by the end of
2005, of which approximately 800 wafers per month are expected to be available
in 0.13-micron.
CRITICAL ACCOUNTING POLICIES
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.
36
DEPRECIATION AND AMORTIZATION OF FAB 2 ASSETS. Depreciation and
amortization expense in 2004 amounted to $121.1 million. 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 phases in commencing on the dates on which each of the
Fab 2 manufacturing lines is ready for its intended use. We expect that the
depreciation and amortization expenses relating to Fab 2 facilities will be
approximately $130 million in 2005 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 its
intended use, might affect our depreciation and amortization expenses. That
effect, if any, under Israel GAAP and US GAAP would be similar.
IMPAIRMENT OF ASSETS. Standard No. 15, "Impairment of Assets," of the
Israeli Accounting Standards Board 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 applying the
provisions of Standard No. 15 had no effect on our financial position and
results of operations, the use of different assumptions with respect to the
expected cash flows from our assets and with respect to 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.
STOCK-BASED COMPENSATION. For the purpose of our financial statements
under Israeli GAAP, we account 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, we account for share options granted to
our employees and directors based on the intrinsic value of the options on the
measurement date, and expense deferred compensation in respect of awards with
graded vesting terms over the relevant vesting periods.
We account for stock-based compensation of non-employees (our banks, the
construction company of Fab 2 and Israel Corp., our current major shareholder)
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.
Commencing in 2006, the initial reporting period in which we are to
implement the provisions of SFAS No. 123 (revised 2004) "Shared Based Payments",
including authoritative interpretations thereof, in our reconciliation note to
US GAAP, we are to account for options granted to our employees and directors
using the fair value method. In order to estimate the fair value of options and
warrants we have granted and may grant in the future, we use the Black-Scholes
option-pricing model. The overall compensation award expenses related to these
options and warrants may significantly differ from those recorded in our
financial statements as a result of applying different assumptions required for
utilizing this model. These assumptions relate mainly to risk-free interest
rates, expected life of options and warrants, expected annual volatility and
expected dividend yield.
37
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. 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. 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.
Direct internal costs which were capitalized to Fab 2 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 Fab 2, the classification and
accounting recognition of these costs may have been 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.
RECENT ACCOUNTING PRONOUNCEMENTS UNDER US GAAP AS THEY APPLY TO US
SFAS NO. 154. ACCOUNTING CHANGES AND ERROR CORRECTIONS. This Statement,
published in May 2005, replaces APB Opinion NO. 20, ACCOUNTING CHANGES, and FASB
Statement No. 3, REPORTING ACCOUNTING CHANGES IN INTERIM FINANCIAL STATEMENTS,
and changes the requirements for the accounting for and reporting of a change in
accounting principle. This Statement applies to all voluntary changes in
accounting principle, and to changes required by an accounting pronouncement in
the unusual instance that the pronouncement does not include specific transition
provisions.
Opinion 20 previously required that most voluntary changes in accounting
principle be recognized by including in net income of the period of the change
the cumulative effect of changing to the new accounting principle. This
Statement requires retrospective application to prior periods' financial
statements of changes in accounting principle, unless it is impracticable to
determine the specific effects or the cumulative effect of the change. The
Statement also provides guidance for cases in which it is impracticable to
determine the period-specific effects of an accounting change on one or more
individual prior periods presented, and/or for cases in which it is
impracticable to determine the cumulative effect of applying a change in
accounting principle to all prior periods.
This Statement defines retrospective application as the application of a
different accounting principle to prior accounting periods as if that principle
had always been used or as the adjustment of previously issued financial
statements to reflect a change in the reporting entity. This Statement also
redefines restatement as the revisiting of previously issued financial
statements to reflect the correction of an error.
38
This Statement also requires that a change in depreciation, amortization,
or depletion method for long-lived, non-financial assets be accounted for as a
change in accounting estimate effected by a change in accounting principle. This
Statement carries forward without change the guidance contained in Opinion 20
for reporting the correction of an error in previously issued financial
statements and a change in accounting estimate. This Statement also carries
forward the guidance in Opinion 20 requiring justification of a change in
accounting principle on the basis of preferability.
The provisions of this Statement are effective for accounting changes and
corrections of errors made during fiscal years beginning after December 15,
2005. The adoption of this Standard is not expected to have a material effect on
our financial position and results of operations.
SFAS NO. 151. Inventory Costs, an Amendment of ARB No. 43, Chapter 4 - In
November 2004 the FASB issued SFAS No. 151, "Inventory Costs, an Amendment of
ARB No. 43, Chapter 4". SFAS No. 151 amends the guidance in ARB 43, Chapter 4,
"Inventory Pricing", which provides guidance on the allocation of certain costs
to inventory. SFAS 151 clarifies that abnormal amounts of idle facility expense,
freight, handling costs, and wasted material (spoilage) should be recognized as
current-period charges. In addition, SFAS 151 requires that allocation of fixed
production overheads to the costs of conversion be based on the normal capacity
of the production facilities. The provisions of this statement are effective for
inventory costs incurred during fiscal years beginning after June 2005. The
provisions of this statement shall be applied prospectively. This Standard is
not expected to have a material effect on our financial position and results of
operations.
SFAS NO. 123 (REVISED 2004) "SHARE BASED PAYMENTS". In December 2004, the
FASB issued SFAS No. 123 (revised 2004) "Share Based Payments" ("SFAS 123(R)").
This Statement, including authoritative interpretation thereof, is a revision of
FASB Statement No. 123, "Accounting for Stock-Based Compensation", which
supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees" and
its authoritative interpretations. SFAS 123(R) will be implemented in the U.S.
GAAP reconciliation Note. According to Israeli GAAP, accounting for costs
associated with share-based payments is not required. SFAS 123(R) establishes
standards for the accounting for transactions in which an entity exchanges its
equity instruments for goods or services; focuses primarily on accounting for
transactions in which an entity obtains employee and directors services in
share-based payment transactions; and does not change the accounting guidance
for share-based payment transactions with parties other than employees.
SFAS 123(R) eliminates the alternative to use APB 25's intrinsic value
method of accounting that was provided in SFAS 123 as originally issued and
requires to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award. The
fair-value-based method in this Statement is similar to the fair-value-based
method in SFAS 123 in most respects. The costs associated with the awards will
be recognized over the period during which an employee is required to provide
service in exchange for the award - the requisite service period (usually the
vesting period). The grant-date fair value of employee share options and similar
instruments will be estimated using option-pricing models adjusted for the
unique characteristics of those instruments (unless observable market prices for
the same or similar instruments are available). If an equity award is modified
after the grant date, incremental compensation cost will be recognized in an
amount equal to the excess of the fair value of the modified award over the fair
value of the original award immediately before the modification.
39
On March 29, 2005, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 107 ("SAB 107"). This staff accounting bulletin
expresses views of the staff regarding the interaction between SFAS 123(R) and
certain SEC rules and regulations and provides the SEC staff's views regarding
the valuation of share-based payment arrangements for public companies.
On April 14, 2005, the SEC adopted a new rule amending the compliance
dates for SFAS 123(R). Under the SEC rule, the provisions of SFAS 123(R) apply
to all awards to be granted after January 1, 2006 and to awards modified,
repurchased, or cancelled after that date.
When initially applying the provisions of SFAS 123(R), in the first
quarter of 2006, we will be required to elect between using either the "modified
prospective method" or the "modified retrospective method". Under the modified
prospective method, we will be required to recognize compensation cost for all
awards granted after the adoption of SFAS 123(R) and for the unvested portion of
previously granted awards that are outstanding on that date. Under the modified
retrospective method, we are required to restate its previously issued financial
statements to recognize the amounts previously calculated and reported on a pro
forma basis, as if the original provisions of SFAS 123 had been adopted. Under
both methods, it is permitted to use either a straight line or an accelerated
method to amortize the cost as an expense for awards with graded vesting.
Recently we have commenced identifying the potential future impact of
applying the provisions of SFAS 123(R), including each of its proposed
transition methods, yet are currently unable to fully quantify the effect of
this Standard on the future financial position and results of operations in
accordance with U.S. GAAP. Nonetheless, it is expected that the adoption of SFAS
123(R) will increase the stock-based-award expenses we are to record in the
future in comparison to the expenses recorded under the guidance currently
applied by us.
SFAS 153, EXCHANGE OF NON-MONETARY ASSETS. In December 2004, the FASB
issued SFAS No. 153, "Exchanges of Nonmonetary Assets an amendment of APB No.
29". This Statement amends Opinion 29 to eliminate the exception for nonmonetary
exchanges of similar productive assets and replaces it with a general exception
for exchanges of nonmonetary assets that do not have commercial substance. The
Statement specifies that a nonmonetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result
of the exchange. This Statement is effective for nonmonetary asset exchanges
occurring in fiscal periods beginning after June 15, 2005. Earlier application
is permitted for nonmonetary asset exchanges occurring in fiscal periods
beginning after the date this Statement is issued. Retroactive application is
not permitted. The adoption of this Standard is not expected to have a material
effect on our financial position and results of operations.
40
RECENT ACCOUNTING PRONOUNCEMENTS UNDER ISRAELI GAAP AS THEY APPLY TO US
ACCOUNTING STANDARD NO. 19 "TAXES ON INCOME". In July 2004, the Israeli
Accounting Standard Board published Accounting Standard No. 19 "Taxes on Income"
(the "Standard"). The Standard established the guidelines for recognizing,
measuring, presenting and disclosing taxes on income in the financial
statements. The Standard is effective for financial statements relating to
reporting periods commencing on, or after, January 1, 2005. The initial adoption
of the Standard shall be accounted for by the cumulative effect of change in
accounting method, for the beginning of the period in which the Standard is
initially adopted. The adoption of the Standard is not expected to have a
material effect on the Company's financial position and results of operations.
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,
-----------------------------------
2004 2003 2002
------ ------ ------
STATEMENT OF OPERATIONS DATA:
Sales .......................................... 100.0% 100.0% 100.0%
Cost of sales .................................. 181.2 199.4 129.4
------ ------ ------
Gross loss ..................................... (81.2) (99.4) (29.4)
Research and development expenses, net ......... 13.5 33.7 32.8
Marketing, general and administrative expenses.. 16.9 36.9 33.0
------ ------ ------
Operating loss ................................. (111.6) (170.0) (95.2)
Financing expense, net ......................... (23.6) (16.1) (4.0)
Other income (expense), net .................... 25.9 (0.1) --
------ ------ ------
Loss ........................................... (109.3)% (186.2)% (99.2)%
====== ====== ======
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
SALES. Sales in the year ended December 31, 2004 increased by 105.4% to
$126.1 million from $61.4 million in 2003. This $64.7 million increase was
attributable to the ramp up of capacity of our Fab 2 wafer fabrication and the
increase in production levels.
COST OF SALES. Cost of sales in the year ended December 31, 2004 totaled
$228.4 million, compared with $122.4 million in 2003. This increase was due
mainly to Fab 2 operations, which in 2003 operated only for half a year while in
2004 operated for a full year, resulting in an increase of $61.6 million in
depreciation and amortization expenses and an increase of $23.9 million in
materials usage mainly related to Fab 2.
GROSS LOSS. Gross loss in the year ended December 31, 2004 was $102.4
million compared to a gross loss of $61.0 million in 2003. The increase in gross
loss was primarily attributable to the increased cost of sales, which was
partially offset by the increase in revenues.
41
RESEARCH AND DEVELOPMENT. Research and development expenses in the year
ended December 31, 2004 decreased to $17.1 million from $20.7 million in 2003.
The decrease was primarily due to decreased expenses related to the Fab 2
0.13-micron technology agreement signed with Freescale in 2002. Research and
development expenses are reflected net of participation grants received from the
Israeli government ($1.5 million and $1.1 million, in 2004 and 2003,
respectively).
MARKETING, GENERAL AND ADMINISTRATION. Marketing, general and
administrative expenses in the year ended December 31, 2004 decreased to $21.3
million from $22.6 million in 2003, primarily due to decreased use of
outsourcing services.
OPERATING LOSS. Operating loss in the year ended December 31, 2004 was
$140.7 million, compared to $104.4 million in 2003, attributable primarily to
the ramp-up of Fab 2. This increase in the operating loss reflects an increase
in gross loss of $41.4 million, a decrease in research and development expenses
of $3.6 million and a decrease in marketing and sales, general and
administrative expenses of $1.3 million.
FINANCING EXPENSES, NET. Financing expenses, net in the year ended
December 31, 2004 were $29.7 million compared to financing expenses, net of $9.8
million in 2003. This increase is mainly due to an increase of $19.5 million in
connection with our Fab 2 facility agreement attributable to (i) an increase
during 2004 in the total amount of long-term loans which financed the
construction and equipping of Fab 2, (ii) the discontinuation of capitalization
of financing costs that had been capitalized prior to the commencement of
operations of Fab 2 in the third quarter of 2003 and (iii) the increase in the
interest rate from LIBOR plus 1.5% in 2003 to LIBOR plus 2.5% commencing from
January 2004 pursuant to the November 2003 amendment to our credit facility
agreement with our banks.
OTHER INCOME (EXPENSE), NET. Other income, net in 2004 was $32.7 million
compared to other expense, net of $0.1 million in 2003 due to the sale in 2004
of our shareholdings in Saifun Semiconductors Ltd. for a net capital gain of
$32.4 million.
LOSS. Our loss in the year ended December 31, 2004 was $137.8 million,
compared to $114.3 million in 2003. This increase is primarily attributable to
the increased operating loss of $36.3 million and the increase in financing
expenses, net, of $19.9 million offset by increased other income, net of $32.8.
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 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.
42
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 Freescale 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.
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, net in the year ended
December 31, 2003 were $9.8 million compared to financing expenses, net 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.
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 2004, the dollar was devalued against the NIS by 1.6%, and the
Israeli Consumer Price Index, or CPI increased by 1.2%. During 2003, the dollar
was devalued against the NIS by 7.6%, while the CPI in Israel decreased by 1.9%.
We believe that the rate of inflation in Israel has had a non-material
effect on our business to date. However, our dollar costs 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.
43
Almost all of our cash generated from operations and from our financing
and investing activities is denominated in U.S. dollars and NIS. Our expenses
and costs are denominated in NIS, U.S. 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 exposed to interest rate fluctuations. From
time to time, we 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 currency exchange rate fluctuations, which may increase the
cost of our business activities, particularly our financing expenses.
Our convertible debentures are denominated in NIS linked to the Israeli
CPI and therefore we are exposed to fluctuation in the NIS/dollar exchange rate.
The dollar amount of our financing costs (interest and currency adjustments)
related to the convertible debentures will increase 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 increase as well.
The quantitative and qualitative disclosures about market risk are in Item
11 of this annual report.
B. LIQUIDITY AND CAPITAL RESOURCES
At December 31, 2004, we had an aggregate of $81.5 million in cash, cash
equivalents, and short-term interest-bearing deposits, of which $39.7 million
was contractually restricted for Fab 2 use only and $14.1 million was
contractually restricted for use in the Siliconix project only. This compares to
$56.5 million in cash, cash equivalents, and short-term and interest-bearing
deposits, of which $44.0 million was contractually restricted for Fab 2 use
only, as of December 31, 2003. In addition, as of December 31, 2004, we had $5.1
million (as of December 31, 2003, $4.8 million) in long-term interest-bearing
deposits, which were contractually serving as a security for our convertible
debentures.
During the year ended December 31, 2004, we generated cash from the
following sources: $66.0 million from bank loans; $75.9 million from the
issuance of shares, net; $38.7 million in proceeds from the sale of Saifun
shares; $20.0 million from Siliconix advances on account of future wafer
purchases; $32.6 million from Investment Center grants and $2.6 million in
proceeds from disposal of property. These liquidity resources financed our
operating activities (net amount of $54.3 million) and our investments made
during the year ended December 31, 2004, which aggregated $155.7 million mainly
in connection with the construction, and purchase and installation of equipment
and other assets, of Fab 2.
As of December 31, 2004, we had loans in the amount of $497.0 million in
connection with the loans we obtained during 2004, 2003 and 2002 for the
establishment of Fab 2.
44
We completed the construction of the building and infrastructure of Fab 2
during the third quarter of 2003 and since then are in the process of ramping-up
Fab 2, our new advanced wafer facility adjacent to Fab 1 in Migdal Haemek,
Israel. Production capacity of Fab 2 at the end of December 2004 was 14,600
wafers per month. We currently expect to have production capacity of 15,400
wafers per month by the end of 2005, of which approximately 800 wafers per month
are expected to be in 0.13-micron. As of December 31, 2004, we received a total
of $1,164 million for Fab 2, as set forth below in tabular form. The remainder
of the Fab 2 ramp up financing may be funded by additional grants available from
the Investment Center, sales of our securities, additional loans, including from
our banks, wafer prepayments from our customers and cash flow from operations or
from other sources.
In recent years, we have experienced significant recurring losses from
operations and recurring negative cash flows from operating activities and an
increasing accumulated deficit. In order to have adequate liquidity for our
activities in 2005, we have taken measures to reduce our short-term liabilities.
We have implemented cost reduction measures, including measures to reduce
expenses, cost structure and cash burn, and in March 2005, we completed a
workforce cutback, as part of an across-the-board savings plan focused on
operational efficiencies. In addition, in May 2005, we signed a letter of intent
with our banks which provides for financing in the amount of up to $30 million,
subject to, among other things, a similar amount being raised by us from
investors. To date, certain of our equity investors and wafer partners have
informed us of their willingness to invest $23.5 million towards such funding by
investors. The letter of intent is subject to the execution of a definitive
amendment to our credit facility agreement, which we are currently negotiating.
If the definitive amendment to our credit facility agreement is executed and
consummated and we raise from investors the funds stipulated in the letter of
intent, or if we find alternative financing for said amounts, we expect to have
adequate liquidity for our short-term activities and liabilities during the
second half of 2005. If we raise the funds contemplated by the letter of intent,
we will still need to raise additional funds in order to finance our activities
and liabilities in 2006, at least until we achieve positive cash flow from our
operations. During the years 2004, 2003 and 2002, the majority of our liquidity
and capital resources and expenditures were in connection with Fab 2, in which
we have spent as of December 31, 2004, $1,185 million, including net cash flows
for operating activities.
The following chart illustrates the various financial sources available to
us to fund the construction and ramp-up of Fab 2, the amounts received as of
December 31, 2004 and the amounts expected or required to be received from
various sources as of December 31, 2004. We cannot assure you that we will be
able to obtain funds from these sources as expected due to poor conditions in
capital markets, poor conditions in the semiconductor market, failure to benefit
from upswings in the semiconductor market or 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. The table does not reflect the letter of intent signed with our
banks in May 2005 which provides for financing in the amount of up to $30
million, subject to, among other things, a similar amount being raised by us
from investors (See "Risk Factors - If the terms reflected in the letter of
intent that we signed with our banks in May 2005 are not effectuated, or if do
we not find alternative financing, we may not be able to maintain our
operations.").
45
Financial Sources based on agreements and arrangements completed through
December 31, 2004
AMOUNTS
EXPECTED
OR REQUIRED
TO
RECEIVED AS BE RECEIVED
OF AFTER
DECEMBER DECEMBER TOTAL
31, 2004 31, 2004 (5)
(IN MILLIONS)
-------------
Wafer Partners and other equity investors...... $ 306 $ 0 $ 306
Israel Government Investment Center............ 151 99(1) 250
Credit facility................................ 497(2) 0(4) 497
Other financing sources........................ 210 28(3)(4) 238
(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). Currently, we do not expect to complete our investments
by December 2005 and failure to achieve a satisfactory arrangement with the
Investment Center by way of an expansion plan may result in the cancellation of
all or a portion of our grants and the Investment Center may require us to repay
all or a portion of grants already received. 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) Under the credit facility agreement, we are required to comply with
minimum production capacity milestones and maintain certain financial ratios and
additional conditions and covenants. For a description of these ratios and
covenants, see below "Fab 2 Agreements-Credit Facility".
(3) Under the November 11, 2003 amendment to our Fab 2 credit facility, we are
required to raise additional financing from specified sources by various
prescribed dates in an aggregate amount of $152.0 million by no later than the
end of 2005 (see "Material Agreements - Credit Facility"). As of December 31,
2004, we have raised an aggregate of $123.7 million and are required to raise
$28.3 by December 31, 2005. We expect to raise the remaining funding through:
(i) equity investments, including the sale of convertible securities and/or (ii)
wafer prepayments from customers.
(4) We have agreed with our banks and the Israel Corporation Ltd. to complete
a rights offering on pre-determined terms if we do not complete the required
fundraising of $152 described above. This arrangement may result in the
availability of up to $12 million additional loans under our credit facility and
up to $14 million from Israel Corp.
(5) We will be required to make capital investments and acquire and implement
advanced technologies in order to complete the ramp-up 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. (See "Risk Factors - If the terms reflected in the
letter of intent that we signed with our banks in May 2005 are not effectuated,
or if do we not find alternative financing, we may not be able to maintain our
operations.")
46
FAB 2 AGREEMENTS
In January 2001, we commenced construction of Fab 2, our new advanced
wafer fabrication facility adjacent to Fab 1 in Migdal Haemek. Fab 2 offers
integrated circuit manufacturing services utilizing advanced materials and using
a 0.18-micron process technology we licensed from Toshiba. We have also licensed
0.13-micron process technology from Motorola (now Freescale) and are in the
process of completing its qualification. 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 2004 was
14,600 wafers per month, and we currently expect to have production capacity of
15,400 wafers per month by the end of 2005, of which approximately 800 wafers
per month are expected to be in 0.13-micron.
WAFER PARTNER AGREEMENTS. During 2000, we entered into a series of
agreements with four wafer partners: SanDisk Corporation, Alliance
Semiconductor, Macronix International and QuickLogic Corporation. The wafer
partners agreed to invest $250 million in us; SanDisk, Alliance 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 Fab 2's capacity for our wafer partners for a
10-year period ending in January 2011, 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. These agreements (and the agreements with our
financial investors) were amended in April 2002, May 2003, and November 2003.
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 26,242,875
of our ordinary shares, and the remaining $47.2 million was established as wafer
credits. Our wafer partners are not obligated to invest any more money in us.
However, in connection with the letter of intent we signed with our banks in May
2005, certain of our equity investors and wafer partners have informed us of
their willingness to invest $23.5 million in our company.
INVESTMENT BY ISRAEL CORPORATION AND OTHER FINANCIAL INVESTORS. In
December 2000, Israel Corp., 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 Israel Corp.'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.
47
WAFER CREDITS. In connection with their investments in Fab 2, 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 agreed that they will not utilize any of
their credits, which amounted to $40.5 million as of December 31, 2004, for
purchase orders of our wafer products until December 31, 2006. From January 1,
2004 to December 31, 2006, each major wafer partner is entitled, every quarter,
to convert into our ordinary shares its 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 that have not been converted into shares will be repaid to
all our major wafer partners. 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 as of March 31,
2005, and they elect to convert all of these credits into ordinary shares, we
will issue them an aggregate of 27.6 million shares, assuming the average
trading price of our ordinary shares during the 15 consecutive trading days
preceding the last relevant quarter is $1.55. 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 the
right to purchase our shares at the same price per share.
All the ordinary shares issued to our wafer partners and Israel Corp. in
connection with their committed investments are subject to (i) restrictions on
transfer and (ii) registration rights. These transfer restrictions have been
extended by two years to January 2006 with respect to the ordinary shares that
represent 70% of the ordinary shares held by such investor which were acquired
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 pursuant to which Toshiba
has transferred to us certain advanced CMOS technologies for use in Fab 2. In
exchange for license and technology fees and royalties, Toshiba has provided us
with recipes, know-how and patent licenses and has trained a group of our
engineers and managers. We have internally developed an enhanced industry
compatible version of the CMOS process technology, as well as specialized
technologies such as CMOS image sensor and mixed signal. Subject to termination
for cause by Toshiba, our licenses under this agreement are perpetual. Our
agreement with Toshiba does not include any non-competition arrangements.
Toshiba has invested $10 million in our equity in exchange for 772,667 ordinary
shares pursuant to this agreement. We also agreed to reserve a portion of our
Fab 2 capacity for Toshiba for a period ending in December 2005.
48
TECHNOLOGY TRANSFER AND DEVELOPMENT AGREEMENT WITH MOTOROLA (NOW
FREESCALE). In September 2002, we entered into a technology transfer and
development agreement with Motorola, Inc. (which was later assigned to
Freescale) pursuant to which Freescale 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 termination for cause by Freescale, our licenses under this agreement
are perpetual. Our agreement with Freescale does not include any non-competition
arrangements.
JOINT DEVELOPMENT AGREEMENT. In June 2002, we entered into an agreement
for the joint development of 0.18-micron embedded microFLASH technology with a
Japanese manufacturer. The Japanese manufacturer granted to us the non-exclusive
right to utilize, on a royalty-free basis, our jointly developed technology,
which is based on its 0.18-micron process technology, for foundry services and
for the manufacture and sale of our own proprietary products. We granted the
Japanese manufacturer a 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.
In April 2005, the Japanese manufacturer elected, and we agreed, to cease
the joint development of certain technology and to terminate the agreement.
According to the terms of the termination agreement, the Japanese manufacturer
paid us, net of deducted tax, $2.25 million. In addition, each party expressly
released the other party from any obligations or liabilities of any nature in
connection with the joint development agreement. The license rights granted to
the parties continue pursuant to the terms of the original agreement.
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 in loans for Fab 2.
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, in
January 2002, we and our banks agreed to amend the credit facility such that the
total amount of loans committed by the banks was reduced to $500 million.
Pursuant to the comprehensive amendment to the credit facility signed on
November, 11, 2003, the loans were to 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
(amounting to $66.0 million), 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, 2004, we have drawn $497
million in loans. We paid the banks an annual commitment fee of 0.25% on any
unused portion of the facility. Under the terms of the amended facility
agreement, (i) Fab 2 must have full manufacturing capacity of 33,000 wafer
starts per month by December 31, 2007; (ii) there are limitations on changes of
ownership which generally requires that, through January 2006, (a) 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 (b) Israel Corp. 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
Israel Corp.; and (iii) additional conditions and covenants, including
restrictions on debt and a prohibition on the distribution of dividends prior to
2008.
49
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 December 31, 2004, due mainly to the recent and current slow-down
in the semiconductor industry, we did not comply with certain of the above
financial ratios and covenants. We prepared an updated Fab 2 working-plan for
2005 based on prevailing and forecasted market conditions. We requested our
banks to amend the financial ratios and covenants in order to align them with
the updated Fab 2 working-plan. In January 2005, we signed a waiver letter
agreement with our banks according to which the banks waived our non-compliance
with certain financial ratios and covenants for the fourth quarter of 2004. Said
agreement also amended certain of the financial ratios and covenants that we are
required to comply with during 2005. Currently, we estimate that we may not
comply with certain of the financial ratios and covenants for the third quarter
of 2005 and thereafter. In connection with the negotiations for a definitive
amendment to our credit facility agreement with our banks following the signing
of a letter of intent in May 2005, we have submitted to our banks an updated Fab
2 working-plan based on prevailing and forecasted market conditions and
requested our banks to amend the financial ratios and covenants in order to
align them with the updated Fab 2 working-plan. While the banks have waived our
past noncompliance, should we fail to comply with our covenants, and our banks
do not waive our non-compliance, the banks may require us to immediately repay
all loans made by them to us, 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.
Pursuant to our credit facility agreement, we have to raise an aggregate
amount of $152 million from specified financial sources by December 31, 2005. As
of the date of this annual report, we have raised $126 million out of the $152
million we have to raise. The amendment to the credit facility provides that,
should we fail to meet any of the fundraising obligation, 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 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;
50
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 compounded basis, which maturity shall not be
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 the 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 the 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.
If our banks exercise this option, Israel Corp., our current major
shareholder, has undertaken to our banks to exercise all of the rights Israel
Corp. receives in the rights offering. In addition, as part of Israel Corp.'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 Israel Corp.'s exercise of its own rights). As a result of our
satisfying certain of our fund raising obligations, the aggregate maximum amount
of Israel Corp.'s undertaking to our banks was effectively reduced to $14
million from $50 million. If certain of our shareholders participate in the
above investments, then their investments will be deemed to be investments made
by Israel Corp. towards its maximum commitment. In the event that the rights
offering cannot be completed, Israel Corp. has undertaken to purchase from us in
a private placement 50/93 of the amount we were to raise in the rights offering.
Israel Corp. may fulfill its investment commitments through IC Tech.
51
Israel Corp.'s commitment and our obligation to consummate a rights
offering expire 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 Israel Corp. has invested its maximum commitment as
described above ($14 million), or (iii) June 30, 2006. Under certain conditions,
the term of Israel Corp.'s commitment and our corresponding obligations may be
reduced.
Following the receipt of the above described investments from Israel
Corp., our banks will permit us to draw additional funds under the credit
facility at a ratio of $43 for every $50 invested by Israel Corp., up to $12
million in the aggregate, which will be repayable by December 31, 2007. Should
we draw down loans using this additional 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 Israel Corp.'s commitment to complete this
investment, we agreed to issue warrants to Israel Corp. comprised of a
commitment fee and a subscription fee: The commitment fee equals 1.0% of the
initial $50 million commitment less Israel Corp.'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 trading day average
closing price of our shares on Nasdaq prior to the date of the November 11, 2003
amendment with our banks). The subscription fee will equal 5% of the total
amount of money invested by Israel Corp. 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
trading day average closing price of our shares prior to the date of the rights
offering prospectus. All the warrants issued with respect to the commitment fee
and the subscription fee shall expire five years from their date of issuance.
We have agreed to indemnify Israel Corp. for any liabilities they incur
with respect to these arrangements, following the execution of Israel Corp.'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.
Our November 11, 2003 amendment to the credit facility further provides
that upon 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
Israel Corp. 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.
52
In May 2005, we signed a letter of intent with our banks which provides
for financing in the amount of up to $30 million, subject to, among other
things, a similar amount being raised by us from investors. To date, certain of
our equity investors and wafer partners have informed us of their willingness to
invest $23.5 million towards such funding by investors. The letter of intent is
subject to the execution of a definitive amendment to our credit facility
agreement, which we are currently negotiating.
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 result in the cancellation of all or a portion of our Fab 2 Investment
Center grants and tax benefits and in the Investment Center requiring us to
repay all or a portion of grants already received ($154.1 million as of March
31, 2005).
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 November 11, 2003 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.
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 and to Siliconix in respect of assets purchased under our
agreement with it) 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 equal to 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 with the consent of the
Investment Center). We have registered a lien on our assets for the benefit of
the Investment Center which ranks subordinate to that of 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, 2004, we had received $150.6 million in grants from the Investment Center,
and raised approximately $385 million as paid in capital towards the $400
million requirement described above. As long as we comply with the terms of our
approval certificate, we are not required to make royalty payments or any other
payments under the terms of our Investment Center grants.
53
To be eligible to receive grants, we are required to invest minimum
amounts on an annual basis. We notified the Investment Center of our reduced
rate of annual investments and in July 2004, we received approval of our revised
investment schedule from the Investment Center. In addition, we are required to
complete our Fab 2 investments by the end of 2005, which we do not currently
expect to satisfy. Israeli law limits the ability of the Investment Center to
extend this time limitation, unless approved through an expansion plan. We have
been holding discussions with the Investment Center to achieve satisfactory
arrangements to approve a new expansion program that shall commence on January
1, 2006. In April 2005, at the Investment Center's request, we submitted a
revised business plan to the Investment Center for the period commencing on
January 1, 2006. During 2005, we received letters from the Israeli Minister of
Industry, Trade and Employment and from the General Manager of the Investment
Center stating that they will act under Israeli law to support such expansion.
However, there can be no assurance that we will obtain the Investment Center's
approval for the new expansion program and we cannot estimate the outcome of our
efforts to obtain such approval.
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 principal 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, 2004 - NIS 41.20, $9.56), 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 exercised by
Israel Corp. 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 11.44 million of our
ordinary shares at a price to the public of $7.00 per share. The underwritten
public offering resulted in net proceeds of approximately $75.1 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, 2004, 2003
and 2002 were $17.1 million, $20.7 million and $17.0 million net of government
participation of $1.5 million, $1.1 million and $1.2 million, respectively. We
have also incurred costs in connection with the transfer of Toshiba and Motorola
(now Freescale) technology for use in Fab 2, some of which have been amortized
over the estimated economic 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."
54
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.
There is a trend within the semiconductor industry toward ever-smaller
features and ever-growing wafer sizes. State-of-the-art fabs are currently using
process geometries of 90-nanometer and below and wafer sizes of 300-mm. 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-micron and above on 150-mm wafers and Fab 2 currently
operates primarily at process geometries of 0.18-micron and produces 200-mm
wafers. We are in the process of completing the qualification of the 0.13-micron
technology transferred from Freescale.
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.
55
F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations and commercial
commitments as of December 31, 2004:
PAYMENT DUE
------------------------------------------------------------------------------------------------------
LESS
CONTRACTUAL THAN 1 AFTER
OBLIGATIONS TOTAL YEAR 2 YEARS 3 YEARS 4 YEARS 5 YEARS 5 YEARS
------------------------------------------------------------------------------------------------------
(IN THOUSANDS)
Short-term debt and
other current
liabilities (1) $ 73,012 $ 73,012 - - - - -
Long-term debt (2) 618,532 29,803 32,863 182,115 185,178 174,108 14,465
Convertible
Debentures (3) 31,577 1,274 8,054 7,735 7,416 7,098 -
Long -term liability
in respect to
customer advances 20,000 600 1,532 2,572 2,168 2,123 11,005
Operating leases 10,614 4,137 3,861 2,443 173 - -
Purchase obligations
in connection with
equipment
purchases(4) 40,410 38,579 1,831 - - - -
Other long-term
liabilities 9,945 - 2,894 2,463 - - 4,588
Other purchase
obligations 36,085 5,358 2,652 2,652 2,652 2,652 20,119
-------------------------------------------------------------------------------
TOTAL CONTRACTUAL
OBLIGATIONS $ 840,175 $ 152,763 $ 53,687 $ 199,980 $ 197,587 $ 185,981 $ 50,177
-------------------------------------------------------------------------------
(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 contractual obligations, we have committed
approximately $0.6 million in standby letters of credit and guarantees to
secure our Fab 2 construction and equipment obligations.
56
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 or the time table for such payments 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 to our wafer partner advances, which as of December 31, 2004, amounted
to $45.0 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 chosen by them to be converted into our fully paid ordinary
shares, as provided under the amendment with our wafer partners (see "Fab 2
Agreements").
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
Russell C. Ellwanger ........ 50 Chief Executive Officer
Oren Shirazi................. 35 Acting Chief Financial Officer
Doron Simon ................. 40 President, Tower Semiconductor USA, V.P. Marketing, Tower
Semiconductor Ltd.
Dr. Itzhak Edrei............. 45 Vice President of Research and Development
Rafi Nave.................... 55 Vice President of Customer Services
Erez Taoz.................... 50 Vice President, Fab 2 General Manager
Dalit Dahan.................. 37 Vice President of Human Resources
Hagay Dvir 41 Vice President of Sales, Europe and Asia
Nati Somekh Gilboa 30 Corporate Secretary and General Counsel
Rafi Mor..................... 41 Vice President, Fab 1 Manager
DIRECTORS
Ehud Hillman................. 52 Acting Chairman
Russell C. Ellwanger 50 Director
Yossi Rosen.................. 65 Director
Dr. Eli Harari............... 60 Director
Miin Wu...................... 56 Director
N.D. Reddy................... 66 Director
Hans Rohrer.................. 55 Independent Director
Tal Yaron-Eldar.............. 41 Independent Director
Russell C. Ellwanger has served as our Chief Executive Officer since May
2005. From 1998 to 2005, Mr. Ellwanger served in various executive positions for
Applied Materials Corporation, including Group Vice President, General Manager
of the Applied Global Services (AGS), from 2004 to 2005, Group Vice President,
General Manager of the CMP and Electroplating Business Group, from 2002 to 2004.
Mr. Ellwanger also served as Corporate Vice President, General Manager of the
Metrology and Inspection Business Group, from 2000 to 2002, during which he was
based in Israel. From 1998 to 2000, Mr. Ellwanger served as Vice President of
Applied Materials' 300-mm Program Office, USA. Mr. Ellwanger served as General
Manager of Applied Materials' Metal CVD Division from 1997 to 1998 and from 1996
to 1997, Mr. Ellwanger served as Managing Director of CVD Business Development,
during which he was based in Singapore. In addition, Mr. Ellwanger held various
managerial positions in Novellus System from 1992 to 1996 and in Philips
Semiconductors from 1980 to 1992.
57
Ehud Hillman has served as Acting Chairman of the Board since May 2005.
Mr. Hillman served as Acting Chief Executive Officer from February 2005 to April
2005. Mr. Hillman has served as a director 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 and resigned as Vice Chairman in March
2005. Mr. Hillman serves on the Tender Committee. Since March 2001, Mr. Hillman
has served as President and Chief Executive Officer of ICTech, a subsidiary of
Israel Corp., which is one of our current principal shareholders. Since February
2004, Mr. Hillman has served as a member of the Board of Directors of ZIM
Integrated Shipping Services. 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 Integrated Shipping Services and others. Prior thereto, Mr.
Hillman was Vice President and Controller of Clal Industries Ltd. and a director
of several companies in the Clal Group.
Yossi Rosen has served as a director and Chairman of the Stock Option and
Compensation Committee since February 2005. Since November 30, 1998, Mr. Rosen
has served as the President and CEO of The Israel Corporation. Mr. Rosen is also
Chairman of the Board of Directors of Israel Chemicals Ltd. and a director of
its subsidiaries, a member of the Board of Directors and Executive Committee of
ZIM Integrated Shipping Services, Chairman of the Board of Dead Sea Magnesium
Ltd. and a director of Oil Refineries Ltd. Mr. Rosen was previously President of
Mashav Initiating & Development Ltd. and Chairman of the Board of various
industrial companies, such as Nesher cement. Mr. Rosen holds a BA in Economics
from the Hebrew University of Jerusalem and an MA in Business Management from
the Hebrew University of Jerusalem.
Dr. Eli Harari has served as a director since 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, and served 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 has served as a director since January 2001. Mr. Wu serves as
President, Chief Executive Officer and an Executive Director 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.
58
N. Damodary Reddy has served as a director since 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 of the Board, 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.
Hans Rohrer has been a director and member of the Audit Committee since
April 2002. Since May 2002, Mr. Rohrer serves as President and Chief Executive
Officer of Acuid Corporation. From 1999 to 2002, Mr. Rohrer served as President
of Taiwan Semiconductor Manufacturing Company - Europe (TSMC - 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.
Tal Yaron-Eldar has been a director and member of the Audit Committee and
the Stock Option and Compensation Committee since January 2005. Since September
2004, Ms. Yaron-Eldar serves as Chief Executive Officer of Arazim Investment
Ltd. and she is a partner in Cohen, Cohen, Yaron-Eldar & Co. law offices. Ms.
Yaron-Eldar served as Israel's Income Tax and Real Property Tax Commissioner
from 2002 to 2004. Between 1998 and 2001, Ms. Yaron-Eldar served as the Chief
Legal Advisor to the Customs and V.A.T. Authority. During the preceding ten
years, Ms. Yaron-Eldar served in various positions with Israel's Income Tax and
Real Property Tax Commission, including Senior Head of its legislation
department and Deputy Chief Legal Advisor. Ms. Yaron-Eldar holds a master's
degree in business and a bachelor's degree in law from Tel-Aviv University and
is a member of the Israeli Bar Association.
Oren Shirazi was appointed as our acting Chief Financial Officer in
November 2004. Mr. Shirazi joined us in October 1998 and served as our
controller since July 2000, after serving as vice controller since October 1998.
Prior to joining us, Mr. Shirazi was employed as an Audit Manager in the
accounting firm of Ratzkovski-Fried & Co., which merged into Ernst & Young
(Israel). Mr. Shirazi is a Certified Public Accountant in Israel (CPA). He has
an MBA from the Graduate School of Business of Haifa University with honors and
a BA in economics and accounting from the Haifa University.
Doron Simon was appointed Vice President of Marketing in 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. Mr. Simon earned a B.Sc. in
Industrial Engineering from the Technion - Israel Institute of Technology and an
MBA from Herriot-Watt University Edinburgh, Scotland.
59
Hagay Dvir was appointed as Vice President of Sales, Europe and Asia, in
February 2005, having served as Director of Sales since March 2004. From 2001 to
2004, Mr. Dvir served as Customer Program Manager, Director of Customer programs
and Director of Applications. From 1998 to 2001, before joining our company, Mr.
Dvir was employed by Oren Semiconductor Ltd. as Director of Operations. From
1990 to 1998, Mr. Dvir was employed by National Semiconductor Ltd. as Product
Engineering Manager and Project Leader. Mr. Dvir earned a B.Sc. in Electrical
Engineering from Ben Gurion University and an MBA from the Technion - Israel
Institute of Technology.
Nati Somekh Gilboa was appointed as Corporate Secretary and General
Counsel in March 2005, as served as our Associate General Counsel since May
2004. From 2001 to 2004, Ms. Somekh Gilboa was employed by Goldsobel & Kirshen,
Adv. Ms. Somekh Gilboa holds an LL.M. and J.D. from Boston University and a B.A.
from Johns Hopkins University. She is a member of the Israeli Bar Association
and the New York bar.
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. Dr. Edrei earned his Ph.D. in physics from
Bar Ilan University and his post-doctorate from Rutgers University.
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 - Israel Institute of Technology.
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 Fab 1
Director of Manufacturing. Prior to that time, Mr. Taoz served as VP of
Operations at Cyclone Aviation Products. Mr. Taoz earned a B.Sc. in mechanical
engineering from the Technion.
Dalit Dahan was appointed Vice President of Human Resources in April 2004.
Ms. Dahan joined us in November 1993 and served as Personnel Manager since April
2000, after having served as Compensation & Benefits Manager and in various
other positions in the Human Resources Department. Prior to joining us, Ms.
Dahan served as Manager of the North Branch of O.R.S - Manpower Company for 3
years. Ms. Dahan holds a bachelor's degree in social science from Haifa
University and an MBA from the University of Derby.
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. Mr. Mor earned
master and bachelor degrees in chemical engineering from Ben Gurion University.
60
B. COMPENSATION
For the years ended December 31, 2004 and 2003, we paid to all our
directors and senior management, as a group, an aggregate of $1.2 million and
$0.9 million, respectively, in salaries, fees and bonuses, excluding management
fees paid to a subsidiary of Israel Corp. (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, 2004 to provide for severance,
retirement and similar benefits for such persons was $0.3 million. No directors
received cash compensation other than the annual and meeting fees described
below. During 2004, our former Chief Executive Officer and Chairman of our Board
of Directors, Mr. Carmel Vernia received annual compensation at a total cost to
us of approximately $210,000, including customary benefits provided to our
officers. As of December 31, 2004, our directors, excluding Mr. Vernia (see Item
7 "Major Shareholders and Related Party Transactions-Related Party
Transactions") were granted options to purchase an aggregate of 240,000 ordinary
shares at a weighted average exercise price of $8.41 per share. During February
2005, we granted our two new directors 80,000 options at an exercise price of
$1.87. These options will become exercisable according to various vesting
schedules over four years and generally remain exercisable for five years
following the vesting date.
In April 2005, our Board of Directors approved the grants of options to
purchase up to 1,325,724 Ordinary Shares to our new appointed Chief Executive
Officer, who was also appointed as a director. These options are exercisable at
an exercise price of $1.56, the opening market price of our shares on the date
of the board approval of the grants. Options granted under the plan vest over a
four-year period, 25% over each year of employment. The options granted are
exercisable for a period of ten years from the date of grant. If as a result of
future equity financings (excluding the exercise or conversion of currently
existing warrants, options or other rights to acquire the Company's securities),
the number of total options granted to our CEO through April 30, 2007 would
represent less than 1.2% of our total number of issued and outstanding shares as
of such date, additional options will be granted to the CEO to represent a 1.2%
holding of the total number of our issued and outstanding shares as of April 30,
2007. The grant of options is subject to the approval of our shareholders.
During the year ended December 31, 2004, we granted a total of 364,913
options to purchase ordinary shares to our senior managers as a group. These
options have a weighted average exercise price of $3.04 per share with vesting
periods over four years and expire in 2014.
Since October 2001, our directors have foregone their directors' fees,
except for fees required by law to be paid to our independent directors,
consisting of a NIS 26,000 (approximately $6,030) 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, 2004 was
approximately $14,000. The annual and meeting fees paid to our independent
directors are adjusted semiannually to reflect changes to the published
guidelines in Israel for independent directors.
In May 2005, our board of directors approved the grant of 2,900,000
options to our employees at an exercise price equal to the market price of our
shares as of the date of grant. The options will vest over a four-year period
from the date of grant and will expire ten years from such date.
61
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, except for
independent 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 are entitled to receive any severance or
similar benefits upon termination of service with the Board of Directors.
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.
The initial term of an independent director is three years and may be
extended for an additional three years.
Mr. Rohrer, who currently serves as an independent director, was appointed
for an initial three-year term expiring in April 2005 and was reappointed for a
subsequent three-year term expiring in April 2008. Ms. Yaron-Eldar, who
currently serves as an independent director, was appointed for an initial
three-year term expiring in December 2007.
62
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 Israeli 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 Companies Law, the
internal auditor may be an employee of the company but not an office holder, an
affiliate, or a relative of an office holder or affiliate, and he may not be the
company's independent accountant or its representative.
Mr. Rosen, Dr. Harari and Ms. Yaron-Eldar 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 employees. 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 future success
of our company by means of incentive schemes;
o the performance of the employee; and
o financial and operating results of our company.
63
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,
-------------------------------
2004 2003 2002
------ ------- --------
Process and Product Engineering, R&D, Design 360 405 407
Manufacturing, Operations (*) 780 670 102
Manufacturing Support 124 134 208
Administration, Marketing, Finance 100 117 130
Fab 2 Construction and Technology Transfer (*) 5 45 438
------ ------- -------
Total 1,369 1,371 1,285
====== ======= =======
(*) 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.
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.
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 own 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 13B to our consolidated financial statements is
incorporated herein by reference.
64
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
MAJOR SHAREHOLDERS
The following table and notes thereto set forth information, as of May 31,
2005, concerning the beneficial ownership (as defined in Rule 13d-3 under the
Securities Exchange Act of 1934) of ordinary shares by any person who is known
to own at least 5% of the ordinary shares of our company. On May 31, 2005,
66,286,187 ordinary shares were issued and outstanding. The table also sets
forth information as to the percentage of the ordinary shares owned by each such
person in accordance with Rule 13d-3 under the Securities Exchange Act of 1934
and on a fully diluted basis.
PERCENT OF CLASS
IDENTITY OF PERSON OR GROUP SHARES BENEFICIALLY OWNED PERCENT OF CLASS(1) (DILUTED)(2)
--------------------------- ------------------------- ------------------- ----------------
Israel Corporation Technologies
(ICTech) Ltd. ("ICTech")(3)(4) 15,143,064(4) 22.54% 17.29%
SanDisk Corporation(3) 10,006,115(5) 15.01% 11.42%
Alliance Semiconductor
Corporation(3) 9,266,137(6) 13.90% 10.58%
Macronix International Co.
Ltd.(3) 9,070,395(7) 13.62% 10.35%
Ontario Teachers' Pension Plan
Board ("OTPP") 4,350,000(8) 6.43% 4.97%
(1) Assumes the holder's beneficial ownership of all Ordinary Shares that
the holder has a right to purchase within 60 days from May 31, 2005.
(2) Assumes that all currently outstanding rights to purchase Ordinary
Shares have been exercised by all holders. As of May 31, 2005, a total
of 21,313,680 such rights were outstanding (excluding options to
purchase up to 1,325,724 shares approved by our board to be granted to
our CEO but which are subject to approval of our shareholders).
(3) Pursuant to a shareholders agreement among Israel Corp., Alliance
Semiconductor Corporation, SanDisk Corporation and Macronix Co. Ltd.,
each of Israel Corp., Alliance Semiconductor Corporation, SanDisk
Corporation and Macronix Co. Ltd. may be said to have shared voting and
dispositive control over 63.78% of our outstanding shares.
65
(4) Based on information provided by Israel Corp., represents 14,260,504
shares currently owned by Israel Corp. 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.
(5) Based on information provided by SanDisk, represents 9,645,803 shares
currently owned by SanDisk and 360,312 shares issuable upon the exercise
of currently exercisable warrants.
(6) 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.
(7) 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.
(8) 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.
The voting rights of our major shareholders do not differ from the voting
rights of other holders of our ordinary shares. However, certain of our major
shareholders are parties to a shareholders agreement which is described in the
following paragraph 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.
Pursuant to a shareholders agreement dated 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,
nominees recommended by the Board, the election of a designee of the Israel
Corp. to serve as Chairman of the Board, and against the election of any other
persons to the Board of Directors. In addition, subject to certain exceptions,
each shareholder agreed to restrictions on the transfer of its shares and to
maintain a minimum share ownership for five years. The shareholders agreement
also provides for certain rights of first refusal.
As of June 23, 2005, there were a total of 40 holders of record of our
ordinary shares, of which 27 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 our outstanding ordinary shares.
B. RELATED PARTY TRANSACTIONS
EXPENSE REIMBURSEMENT AGREEMENT WITH ISRAEL CORP. In March 2002, we
entered into an agreement with Israel Corp., pursuant to which Mr. Ehud Hillman,
a director of our company currently serving as Acting Chairman of our board of
directors, provides management services to our company in consideration of an
annual fee of $240,000 and $120,000 in 2003 and 2004, respectively. The term of
this agreement is for one year, with automatic renewal for successive one-year
periods thereafter, unless earlier terminated by one of the parties. Our Audit
Committee, Board of Directors and shareholders approved this agreement.
66
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.
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, 2004, 240,000 options to purchase ordinary shares, of which
200,000 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. In February 2005, we granted additional 80,000
options under this plan at an exercise price of $1.87. 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.
EXEMPTION AND INDEMNIFICATION AGREEMENTS WITH DIRECTORS. In December 2001,
we entered into exemption and indemnification agreements with the members of our
Board of Directors, pursuant to which, subject to the limitations set forth in
the Israeli 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.
C. INTERESTS OF EXPERTS AND COUNSEL
Not applicable.
ITEM 8. FINANCIAL INFORMATION
A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
Our consolidated financial statements are incorporated herein by reference
to pages following the signature page of this Annual Report.
LEGAL PROCEEDINGS
In August 2004, the United States District Court dismissed the class
action filed in July 2003 by certain of our shareholders in the United States
against us and certain of our directors, wafer partners and equity investors
(the "Defendants"). The plaintiffs had asserted claims arising under the
Securities Exchange Act of 1934, alleging misstatements and omissions made by
the Defendants in materials sent to our shareholders in April 2002 with respect
to the approval of an amendment to the investment agreements with our Fab 2
investors. In December 2004, one of the lead plaintiffs filed an appeal of the
decision dismissing the complaint. The Company believes that the complaint is
without merit and is vigorously contesting it.
67
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.
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 ($)
-------------------------------------------------------------------------
May 2005 1.81 1.56
-------------------------------------------------------------------------
April 2005 1.90 1.45
-------------------------------------------------------------------------
March 2005 1.86 1.36
-------------------------------------------------------------------------
February 2005 2.06 1.64
-------------------------------------------------------------------------
January 2005 2.38 1.78
-------------------------------------------------------------------------
December 2004 2.45 2.00
-------------------------------------------------------------------------
First Quarter 2005 2.38 1.36
-------------------------------------------------------------------------
Fourth quarter 2004 3.66 1.62
-------------------------------------------------------------------------
Third quarter 2004 5.96 2.95
-------------------------------------------------------------------------
Second quarter 2004 7.20 4.87
-------------------------------------------------------------------------
First quarter 2004 10.80 6.22
-------------------------------------------------------------------------
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
-------------------------------------------------------------------------
2004 10.80 1.62
-------------------------------------------------------------------------
2003 7.90 2.16
-------------------------------------------------------------------------
2002 8.50 3.11
-------------------------------------------------------------------------
2001 17.12 3.80
-------------------------------------------------------------------------
2000 43.50 10.38
-------------------------------------------------------------------------
68
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)
---------------------------------------------------------------------------
May 2005 7.40 6.85
---------------------------------------------------------------------------
April 2005 8.00 6.76
---------------------------------------------------------------------------
March 2005 8.30 6.36
---------------------------------------------------------------------------
February 2005 8.70 7.40
---------------------------------------------------------------------------
January 2005 10.30 8.25
---------------------------------------------------------------------------
December 2004 10.68 8.85
---------------------------------------------------------------------------
First Quarter 2005 10.30 6.36
---------------------------------------------------------------------------
Fourth quarter 2004 15.55 7.70
---------------------------------------------------------------------------
Third quarter 2004 26.95 13.03
---------------------------------------------------------------------------
Second quarter 2004 32.70 21.80
---------------------------------------------------------------------------
First quarter 2004 46.39 29.30
---------------------------------------------------------------------------
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
---------------------------------------------------------------------------
2004 46.36 7.70
---------------------------------------------------------------------------
2003 35.00 10.25
---------------------------------------------------------------------------
2002 37.99 15.30
---------------------------------------------------------------------------
2001 58.50 16.80
---------------------------------------------------------------------------
ITEM 10. ADDITIONAL INFORMATION
ARTICLES OF ASSOCIATION; ISRAELI COMPANIES LAW
ARTICLES OF ASSOCIATION
Our Articles of Association ("Articles") were adopted 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 liquidation of the
Company, in the distribution of assets after satisfaction of liabilities to
creditors. No preferred shares are currently authorized.
69
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 are
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 and termination of our independent 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 the 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 the 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.
THE COMPANIES LAW
We are subject to the provisions of the Israeli Companies Law. 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. With the exception of
compensation of outside directors in an amount specified in the regulations
adopted under the Companies Law, arrangements regarding the compensation of
directors also require audit committee and shareholder approval.
70
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 spouse of any of the foregoing, or 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.
The Companies Law requires that specific types of transactions, actions
and arrangements be approved as provided for in a company's articles of
association and in some circumstances by the company's audit committee, board of
directors and shareholders. 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
provide otherwise. If the transaction is an extraordinary transaction, then, in
addition to any approval required by the Articles it must be approved first by
the audit committee and then by the board of directors, and, in specific
circumstances, by a meeting of the shareholders. Subject to exceptions set forth
in the Companies Law, 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 such meeting or vote on such matter.
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 to approval by a company's board of directors, a private
placement in a public company requires approval by a company's shareholders in
the following cases:
o A private placement that meets all of the following conditions:
o 20 percent or more of the voting rights in the company prior
to such issuance are being offered.
o The private placement will increase the relative holdings of a
shareholder that holds five percent or more of the company's
outstanding share capital (assuming the exercise of all of the
securities convertible into shares held by that person), or
that will cause any person to become, as a result of the
issuance, a holder of five percent or more of the company's
outstanding share capital.
71
o All or part of the consideration for the offering is not cash
or registered securities, or the private placement is not
being offered at market terms.
o A private placement which results in anyone becoming a controlling
shareholder.
The above transactions must not be adverse to the company's interest.
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, vote in the general meeting of
shareholders on the following matters:
o any amendment to the Articles;
o an increase of the company's authorized share capital;
o a merger; or
o approval of interested party transactions that require shareholder
approval.
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 of an 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.
Tender Offer. A person wishing to acquire shares or any class of shares of
a publicly traded Israeli company and who would as a result hold over 90% of the
company's issued and outstanding share capital or of a class of shares which are
listed, is required by the Companies Law to make a tender offer to all of the
company's shareholders for the purchase of all of the issued and outstanding
shares of the company. If the shareholders who do not respond to the offer hold
less than 5% of the issued share capital of the company, all of the shares that
the acquirer offered to purchase will be transferred to the acquirer by
operation of law. The Companies Law provides for an exception regarding the
threshold requirement for a shareholder that prior to and following February
2000 holds over 90% of a company's issued and outstanding share capital.
However, the shareholders may petition the court to alter the consideration for
the acquisition. If the dissenting shareholders hold more than 5% of the issued
and outstanding share capital of the company, the acquirer may not acquire
additional shares of the company from shareholders who accepted the tender offer
if following such acquisition the acquirer would then own over 90% of the
company's issued and outstanding share capital.
The Companies Law provides that an acquisition of shares of a public
company must be made by means of a tender offer if as a result of the
acquisition the purchaser would become a 25% or greater shareholder of the
company. This rule does not apply if there is already another 25% shareholder of
the company. Similarly, the Companies Law provides that an acquisition of shares
in a public company must be made by means of a tender offer if as a result of
the acquisition the purchaser would become a 45% or greater shareholder of the
company, if there is no 45% or greater shareholder of the company.
72
Merger. The Companies Law permits merger transactions if approved by each
party's board of directors and the majority of each party's shares voted on the
proposed merger at a shareholders' meeting called on at least 21 days' prior
notice. Under the Companies Law, merger transactions may be approved by holders
of a simple majority of our shares present, in person or by proxy, at a general
meeting and voting on the transaction. In determining whether the required
majority has approved the merger, if shares of a company are held by the other
party to the merger, or by any person holding at least 25% of the outstanding
voting shares or 25% of the means of appointing directors of the other party to
the merger, then a vote against the merger by holders of the majority of the
shares present and voting, excluding shares held by the other party or by such
person, or anyone acting on behalf of either of them, is sufficient to reject
the merger transaction. If the transaction would have been approved but for the
exclusion of the votes of certain shareholders as provided above, a court may
still approve the merger upon the request of holders of at least 25% of the
voting rights of a company, if the court holds that the merger is fair and
reasonable, taking into account the value of the parties to the merger and the
consideration offered to the shareholders. Upon the request of a creditor of
either party to the proposed merger, the court may delay or prevent the merger
if it concludes that there exists a reasonable concern that, as a result of the
merger, the surviving company will be unable to satisfy the obligations of any
of the parties to the merger. In addition, a merger may not be executed unless
at least 30 days have passed from the receipt of the shareholders' approval and
50 days have passed from the time that a proposal for approval of the merger has
been filed with the Israeli Registrar of Companies.
NASDAQ MARKETPLACE RULES AND HOME COUNTRY PRACTICES
Nasdaq's Marketplace Rule 4350 was recently amended to permit foreign
private issuers to follow certain home country corporate governance practices
without the need to seek an individual exemption from Nasdaq. Instead, a foreign
private issuer must provide Nasdaq with a letter from outside counsel in its
home country certifying that the issuer's corporate governance practices are not
prohibited by home country law.
In May 2005, pursuant to this new exception, we provided a notice to
Nasdaq with a letter from our outside Israeli counsel certifying that our
practice of amending employee share option plans that do not permit the grant of
options to directors upon the approval of our board of directors, and without
seeking shareholder approval (which approval is required for Nasdaq-listed
companies under Marketplace Rule 4350(i)), is not prohibited by Israeli law. We
may in the future provide Nasdaq with an additional such letter or letters
notifying Nasdaq that we are following our own practices, consistent with the
Companies Law and practices in Israel in lieu of other requirements of
Marketplace Rule 4350.
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
12A to the consolidated financial statements included in this annual report.
73
EXCHANGE CONTROLS
Under Israeli law, non-residents of Israel who purchase ordinary shares
with certain non-Israeli currencies (including U.S. 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 Articles, both residents and
non-residents of Israel may freely hold, vote and trade our ordinary shares.
TAXATION
The below 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 below 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.
A. Israeli Capital Gains Tax
Until the end of the year 2002, and provided we maintained our status as
an industrial company, 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 part B of the
Israeli Income Tax Law (Inflationary Adjustments), 1985 or pursuant to the
Income Tax Regulations (Rules on Bookkeeping by Foreign Invested Companies and
Certain Partnership and Determination of their Chargeable Income), 1984
(hereinafter the "Dollar Regulations"), 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 Israeli tax reform legislation of January 2003, gains
from the sale of our securities derived from January 1, 2003 and on will, in
general, be subject 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; if the shareholder did not claim financial expenses related to the
purchase of the securities; and if the securities are not sold to a "relative"
as defined under section 105k to the Income Tax Ordinance. In those cases where
the 15% rate does not apply the real capital gain from the sale of the
securities will be subject to capital gains tax of 25%. 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. A
non-resident corporation will generally not enjoy this exemption if Israeli
residents are (1) its controlling shareholders, as defined for the purpose of
this section, or (2) directly or indirectly eligible to receive or are
beneficial owners of 25% or more of the income or the profits of the
corporation.
74
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 part B of the Israeli Income Tax Law (Inflationary
Adjustments), 1985 or pursuant to the "Dollar Regulations".
Pursuant to part B of the Israeli Income Tax Law (Inflationary
Adjustments), 1985 or the Dollars Regulations, capital gains derived from
selling our securities will be subject to the tax rate under section 126 to the
Ordinance (2005 - 34%, 2006 - 32%, and from 2007 and on - 30%) if the seller is
a corporation. Individuals will be subject to the tax rates under section 121 to
the Ordinance (up to 49%).
In any event, under the US-Israel Tax Treaty, a person who qualifies as a
resident of the United States within the meaning of the Tax Treaty and who is
entitled to claim benefits under the Treaty, may, in general, only be subject 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.
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 subject 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 expenses related to the purchase of
the debentures were deducted by the individual in the calculation of the
individual's Israeli taxable income. In such cases the regular rate of tax on
Interest and OID will apply - for corporations a rate of 35% in 2004, 34% in
2005, 32% in 2006 and from 2007 on - 30%, and for individuals a tax rate of up
to 49%. As a result of the provisions related to tax withholding, as explained
below, foreign resident individuals and corporations will be subject to tax of
25% or less, according to the relevant treaty relating to their domicile
country.
Under regulations promulgated as part of the tax reform discussed in
section A above, withholding tax at source from debenture interest and OID paid
to resident individuals will, in general, be at a rate of 15%, and corporations
will be subject to a rate of 35%. Withholding tax at source from debenture
interest and OID paid to non-resident individuals or corporations will be at a
rate of 25% or less, according to the relevant treaty relating to their domicile
country. 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 provisions 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.
75
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.
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
2004 or in any prior year. However, there can be no assurance that we will not
be a PFIC in 2005 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, rent 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 tax 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
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.
76
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 and copy 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. 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. 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.
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
and derivatives 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, 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, interest rate
collar agreements with a knock-out and knock-in features, and foreign currency
forward contracts and options (including zero-cost cylinders).
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.
77
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. We have entered into debt
obligations to support our capital expenditures and needs. From time to time we
enter into interest rate collar agreements with knock-out and knock-in features
to modify our exposure to interest rate movements and to reduce our borrowing
costs. These agreements limit our exposure to the risks 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. A knock-out LIBOR-based interest
rate collar is a combination of a purchased knock-out cap with a cap level,
floor level and a knock out level (and a knock in level for some of the
agreements).
We are subject to interest rate exposure in connection with $497 million
long-term debt outstanding as of December 31, 2004 under the Fab 2 facility
agreement, as such debt bears interest at a rate of LIBOR plus 2.5% per annum.
The interest rate as of December 31, 2004 on $205 million of the Fab 2 loans,
not subject to the results of our collar agreements, was 5.06%. Our remaining
loans of $292 million are covered by the collar agreements and bore annual
interest rate as of December 31, 2004, including the results of our hedging
activities described below, as follows: $172 million - 6.78%, $40 million -
5.30%, and $80 million - 5.06%. Loans in the amount of $431 million are
repayable in 12 equal consecutive quarterly installments commencing March 31,
2007, and loans in the amount of $66 million drawn down during 2004 are
repayable in 12 equal consecutive quarterly installments, commencing three years
from the end of the quarter of each draw down.
All our collar agreements, which gradually expire in 2006-2009, were
effective as of December 31, 2004. These agreements provide for combinations as
described below. Under the knock-out provision in these agreements, in the event
that the LIBOR rate exceeds the knock-out LIBOR rate level during a particular
quarter, the protection provided under the interest collar agreements will not
apply with respect to that entire quarter. If the LIBOR rate decreases
thereafter and remains below the knock-out LIBOR rate level in any successive
quarter for the duration of the entire quarter, the protection provided under
the interest rate collar will again be effective.
With respect to the $172 million of our Fab 2 credit facility debt, under
the terms of the 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 4.28% 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 5.56% 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, 2004, the LIBOR rate was 2.56%. Accordingly, as of
such date the interest rate on these long-term loans was 6.78% (the floor rate
of 4.28% plus 2.5%).
With respect to the $40 million of our Fab 2 credit facility debt, under
the terms of the collar agreements, if the LIBOR is below the floor rate of
2.80% we will pay total interest at the fixed rate of 5.30% (the 2.80% floor
rate plus 2.5%); if the LIBOR is between 2.80% and 5.50%, we will pay total
interest at actual LIBOR plus 2.5%; if the LIBOR is between 5.50% and 7.50% we
will pay total interest at a fixed rate of 8.00% (the 5.50% 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, 2004, the LIBOR rate was 2.56%. Accordingly, as of such
date, the interest rate on these long-term loans was 5.30% (the floor rate of
2.8% plus 2.5%).
78
With respect to the $80 million of our Fab 2 credit facility debt, under
the terms of the collar agreements, if the LIBOR is below the knock-in of 0.70%
we will pay total interest at the fixed rate of 5.25% (the 2.75% floor rate plus
2.5%); if the LIBOR is between 0.70% and 4.00%, we will pay total interest at
the actual LIBOR plus 2.5%; if the LIBOR is between 4.00% and 7.00% we will pay
total interest at a fixed rate of 6.50% (the 4.00% cap level plus 2.5%); and if
the LIBOR is higher than 7.00%, we will pay the actual LIBOR rate plus 2.5%. At
December 31, 2004, the LIBOR rate was 2.56%. Accordingly, as of such date, the
interest rate on these long-term loans was 5.06% (the actual LIBOR rate of 2.56%
plus 2.5%).
All our collar agreements resulted in a loss of $5.6 million in the year
ended December 31, 2004. The fair value of these agreements, as of December 31,
2004 was a $2.4 million loss
Assuming a 10% upward shift in the LIBOR rate at December 31, 2004 (from
2.56% to 2.82%), the effective fair value of $325 million debt would have
increased by approximately $2.5 million. The amount of $325 is comprised of $205
million debt not hedged by the collar agreements; $80 million debt hedged by a
collar agreement with a knock in level of 0.7% and as to which as of December
31, 2004 we are exposed to the risk of interest rate fluctuation; and $40
million debt hedged by a collar agreement with a floor rate of 2.80%. With
regard to the remaining $172 million debt hedged by the collar agreements, as of
December 31, 2004 such assumed increase in the LIBOR rate presents no change in
the interest rate exposure since as of such date the collar agreements would
still result in a fixed rate interest of the floor rate plus 2.5%.
Our cash equivalents and 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 our investments, their carrying value approximates their
fair value.
CONVERTIBLE DEBENTURES AND OPTIONS (SERIES 1)
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 Consumer Price Index
in Israel (CPI). As of December 31, 2004 the adjusted outstanding principal
amount of the convertible debentures was $27.1 million and the adjusted exercise
price of the options (Series 1) was $9.56. 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 31,
2004, the Israel consumer price index increased by 5.6% while the US dollar/NIS
exchange rate decreased by 6%.
79
The convertible debentures bear annual interest at a fixed rate of 4.7%.
The debentures are payable in four annual installments commencing in January
2006. Therefore, we are not subject to exposure to interest rate fluctuations
with respect to the debentures. However, in case the actual market interest
rates are lower than the interest rate provided on the convertible debentures,
our actual finance costs would be higher than in case our convertible debentures
bear floating interest rate.
FOREIGN EXCHANGE RISK
Our main foreign currency exposures give rise to market risk associated
with exchange rate movements of the US dollar, our functional and reporting
currency, against the Japanese Yen, the Euro and the NIS. To protect against
reductions in value and the volatility of future cash flows caused by changes in
foreign exchange rates, we utilize foreign currency forward contracts and
options (including zero-cost cylinder options) in order to minimize part of the
impact of foreign currency fluctuations on our financial position and results of
operations. A cylinder option is a combination of a purchased call option and a
written put option. The exercise prices of the options may not be identical and
this effectively creates a synthetic range forward. The maturity dates of the
options coincide with the scheduled payments to suppliers.
Accordingly, we enter, from time to time, into foreign currency agreements
to hedge exposure to equipment purchase commitments and other firm commitments.
Most of our agreements to hedge equipment purchase commitments are designated to
eliminate exposure changes in the Japanese Yen and the Euro vis-a-vis the US
dollar. During the year ended December 31, 2004, we had $19 million options
(including zero-cost cylinder options) transactions. The loss resulted from
these transactions in the year ended December 31, 2004 was immaterial. As of
December 31, 2004 we had no open transactions.
We enter from time to time into foreign exchange agreements to hedge
exposure relating to Value Added Tax (VAT), grants receivables and payroll
payments denominated in NIS. The effect of these agreements during the year
ended December 31, 2004 was immaterial. As of December 31, 2004, we had no open
transactions.
We are exposed to currency risk in the event of default by the other
parties of the exchange transaction. We estimate 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.
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
Not applicable.
80
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
acting 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 acting 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. Tal Yaron-Eldar, is an audit committee financial expert.
ITEM 16B. CODE OF ETHICS
We adopted a code of ethics which applies to all of our directors,
officers and employees, including our acting chief executive officer, acting
chief financial officer, principal accounting officer, and persons performing
similar functions. We amended our code of ethics to comply with the requirements
of the Sarbanes Oxley Act of 2002 as follows: (i) The section relating to
external requests for company information and contacts with outsiders now
specifies the person responsible for managing our company's relationships with
outsiders and the course of action to be taken when internal company data is
mistakenly disclosed; and (ii) The section regarding reporting illegal,
inappropriate or unethical behavior now requires employees to promptly report
any such behavior, including violations of the code of ethics or any law, and
allows for such report to be communicated anonymously.
81
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents fees for professional services rendered by
our independent registered public accounting firm for audit services,
audit-related services and for tax services:
2004 2003
(US DOLLARS) (US DOLLARS)
------------ ------------
Audit Fees(1) 362,000 309,000
Audit-Related Fees(2) 12,000 6,000
Tax Fees(3) 14,000 52,000
Other(4) - -
Total 388,000 367,000
(1) Audit fees consist of fees for professional services rendered for the
audit of our consolidated financial statements, services in connection
with statutory and regulatory filings and engagements (including review of
Forms 20-F, F-3 and S-8), and reviews of our unaudited interim
consolidated financial statements included in our quarterly reports.
(2) Audit related fees consist of accounting consultation and consultation on
financial accounting standards, not arising as part of the audit.
(3) Tax fees consist of fees for tax compliance services, tax planning and tax
advice.
Our audit committee's charter states that the audit committee is
responsible for receiving specific information on the independent auditor's
proposed services and for pre-approving all audit services annually and
separately approving any other permitted non-audit related services.
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FROM AUDIT COMMITTEES.
As a foreign private issuer we remain exempt, until July 31, 2005, from
Nasdaq's audit committee related listing standards that have come into effect
following December 13, 1999.
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PARTIES.
Not Applicable.
PART III
ITEM 17. FINANCIAL STATEMENTS
Not applicable.
82
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, 2000 (the "2000 Form 20-F"). (Pursuant to approvals by our
shareholders, our Articles of Association provide for an authorized share
capital of 250,000,000 divided into 250,000,000 shares).
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 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).
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 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 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 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 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 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).
83
4.5 Share Purchase Agreement, dated 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 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 December 12, 2000, between
Israel Corporation and the Registrant (incorporated by reference to the
correspondingly-numbered exhibit to the 2000 Form 20-F).
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 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 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).
4.12 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).
4.13 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")).
4.14 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).
4.15 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).
4.16 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).
84
4.17 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).
4.18 Letter Agreements among Alliance, Macronix, QuickLogic, Israel Corp. 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).
4.19 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).
4.20 First Amendment, dated January 29, 2001, to the Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2001
Form 20-F).
4.21 Second Amendment, dated January 10, 2002, to Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2001
Form 20-F).
4.22 Third Amendment, dated March 7, 2002, to the Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2001
Form 20-F).
4.23 Joint Development and Transfer and Cross License Agreement, dated May
2002, between the Registrant and a Japanese manufacturer (incorporated by
reference to exhibit 10.3 to the Registrant's Registration Statement on Form
F-2, No. 333-97043).
4.24 Technology License Agreement, dated 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).
4.25 Technology Transfer License Agreement, dated 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).
4.26 Fourth Amendment, dated April 29, 2002, to the Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2002
Form 20-F).
4.27 Fifth Amendment dated September 18, 2002 to the Facility Agreement
(incorporated by reference to the correspondingly-numbered exhibit to the 2002
Form 20-F).
4.28 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).
4.29 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).
85
4.30 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).
4.31 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).
4.32 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).
4.33 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).
4.34 Reserved.
4.35 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).
4.36 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).
4.37 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).
4.38 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).
4.39 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).
4.40 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).
4.41 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).
4.42 Foundry Agreement, dated May 12, 2004, between the Registrant and
Siliconix incorporated.#
86
4.43 Share Purchase Agreement, dated December 8, 2004, between the Registrant
and the Purchasers named therein.#
4.44 Agreement, dated December 31, 2004, by and among the Registrant and the
Purchasers named therein.#
4.45 Employee Share Option Plan 2004 (incorporated by reference to Exhibit 4.3
to the Registrant's Registration Statement on Form S-8 No. 333-117565 ("Form S-8
No. 333-117565").
4.46 Form of Grant Letter to Israeli Employees (incorporated by reference to
Exhibit 4.4 to Form S-8 No. 333-117565).
4.47 Form of Grant Letter to U.S. Employees (incorporated by reference to
Exhibit 4.5 to Form S-8 No. 333-117565).
11.1 Code of Ethics, as amended.
12.1 Certification by Acting Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
12.2 Certification by Acting Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
13.1 Certification by Acting Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
13.2 Certification by Acting Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
14.1 Consent of Brightman Almagor & Co.
# PORTIONS OF THIS EXHIBIT HAVE BEEN OMITTED PURSUANT TO A REQUEST FOR
CONFIDENTIAL TREATMENT.
87
================================================================================
TOWER SEMICONDUCTOR LTD.
AND SUBSIDIARY
CONSOLIDATED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 2004
================================================================================
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
-------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 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-50
[DELOITTE LOGO]
Brightman Almagor
1 Azrieli Center
Tel Aviv 67021
P.O.B. 16593, Tel Aviv 61164
Israel
Tel: +972 (3) 608 5555
Fax: +972 (3) 609 4022
[email protected]
www.deloitte.com
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS OF
TOWER SEMICONDUCTOR LTD.
We have audited the accompanying consolidated balance sheets of Tower
Semiconductor Ltd. and subsidiary ("the Company") as of December 31, 2004 and
2003, 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, 2004. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, 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 referred to above present
fairly, in all material respects, the consolidated financial position of the
Company and subsidiary as of December 31, 2004 and 2003, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004, 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 The
effect of the of America. 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 19.
Brightman Almagor & Co.
Certified Public Accountants
A Member Firm of Deloitte Touche Tohmatsu
Tel Aviv, Israel
February 3, 2005 (May 30, 2005 as for Note 20)
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 2004 2003
------- --------- ---------
A S S E T S
CURRENT ASSETS
CASH AND CASH EQUIVALENTS $ 27,664 $ 12,448
DESIGNATED CASH AND SHORT-TERM INTEREST-BEARING DEPOSITS 53,793 44,042
TRADE ACCOUNTS RECEIVABLE 14 19,286 11,631
OTHER RECEIVABLES 3 11,365 11,073
INVENTORIES 4 25,669 19,382
OTHER CURRENT ASSETS 1,818 1,729
--------- ---------
TOTAL CURRENT ASSETS 139,595 100,305
--------- ---------
LONG-TERM INVESTMENTS
LONG-TERM INTEREST-BEARING DEPOSITS
DESIGNATED FOR FAB 2 OPERATIONS 5,134 4,848
OTHER LONG-TERM INVESTMENT 5 - 6,000
--------- ---------
5,134 10,848
--------- ---------
PROPERTY AND EQUIPMENT, NET 6 609,296 568,412
--------- ---------
OTHER ASSETS, NET 7 93,483 108,770
========= =========
TOTAL ASSETS $ 847,508 $ 788,335
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
TRADE ACCOUNTS PAYABLE $ 65,326 $ 40,249
OTHER CURRENT LIABILITIES 8 10,678 9,564
--------- ---------
TOTAL CURRENT LIABILITIES 76,004 49,813
LONG-TERM DEBT 9 497,000 431,000
CONVERTIBLE DEBENTURES 10 26,651 25,783
LONG-TERM LIABILITY IN RESPECT
OF CUSTOMERS' ADVANCES 12A 64,428 46,347
OTHER LONG-TERM LIABILITIES 11 15,445 5,935
COMMITMENTS AND CONTINGENCIES 12
--------- ---------
TOTAL LIABILITIES 679,528 558,878
--------- ---------
SHAREHOLDERS' EQUITY
ORDINARY SHARES, NIS 1.00 PAR VALUE - AUTHORIZED
250,000,000 AND 150,000,000 SHARES, RESPECTIVELY;
ISSUED 66,999,796 AND 52,996,097 SHARES, RESPECTIVELY 12A, 13 16,274 13,150
ADDITIONAL PAID-IN CAPITAL 12A 517,476 427,881
PROCEEDS ON ACCOUNT OF SHARE CAPITAL 12A - 16,428
SHAREHOLDER RECEIVABLES (26) (26)
ACCUMULATED DEFICIT (356,672) (218,904)
--------- ---------
177,052 238,529
TREASURY STOCK, AT COST - 1,300,000 SHARES 13C (9,072) (9,072)
--------- ---------
TOTAL SHAREHOLDERS' EQUITY 167,980 229,457
========= =========
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 847,508 $ 788,335
========= =========
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 2004 2003 2002
------- --------- --------- ---------
SALES 12D, 14 $ 126,055 $ 61,368 $ 51,801
COST OF SALES 6A(4) 228,410 122,395 67,022
--------- --------- ---------
GROSS LOSS (102,355) (61,027) (15,221)
--------- --------- ---------
OPERATING COSTS AND EXPENSES
RESEARCH AND DEVELOPMENT 17,053 20,709 17,031
MARKETING, GENERAL AND ADMINISTRATIVE 21,297 22,615 17,091
--------- --------- ---------
38,350 43,324 34,122
========= ========= =========
OPERATING LOSS (140,705) (104,351) (49,343)
FINANCING EXPENSE, NET 15 (29,745) (9,826) (2,104)
OTHER INCOME (EXPENSE), NET 5 32,682 (84) 45
--------- --------- ---------
LOSS FOR THE YEAR $(137,768) $(114,261) $ (51,402)
========= ========= =========
BASIC LOSS PER ORDINARY SHARE
LOSS PER SHARE $ (2.13) $ (2.40) $ (1.63)
========= ========= =========
LOSS USED TO COMPUTE
BASIC LOSS PER SHARE $(137,768) $(114,114) $ (51,402)
========= ========= =========
WEIGHTED AVERAGE NUMBER OF
ORDINARY SHARES OUTSTANDING - IN THOUSANDS 64,717 47,608 31,523
========= ========= =========
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
ORDINARY SHARES ADDITIONAL ON
--------------------- PAID-IN ACCOUNT OF
SHARES AMOUNT CAPITAL SHARE CAPITAL
---------- -------- ---------- -------------
BALANCE - JANUARY 1, 2002 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 13B(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
ISSUANCE OF SHARES 2,463,949 553 16,414 (16,428)
ISSUANCE OF SHARES, NET OF RELATED COSTS -
PUBLIC OFFERING 11,444,500 2,550 72,536
EXERCISE OF SHARE OPTIONS 95,250 21 645
LOSS FOR THE YEAR
---------- -------- ---------- -------------
BALANCE - DECEMBER 31, 2004 66,999,796 $ 16,274 $ 517,476 $ -
========== ======== ========== =============
SHAREHOLDER
RECEIVABLES
AND
UNEARNED ACCUMULATED TREASURY
COMPENSATION DEFICIT STOCK TOTAL
------------ ----------- --------- ----------
BALANCE - JANUARY 1, 2002 $ (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 13B(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
ISSUANCE OF SHARES 539
ISSUANCE OF SHARES, NET OF RELATED COSTS -
PUBLIC OFFERING 75,086
EXERCISE OF SHARE OPTIONS 666
LOSS FOR THE YEAR (137,768) (137,768)
------------ ----------- --------- ----------
BALANCE - DECEMBER 31, 2004 $ (26) $ (356,672) $ (9,072) $ 167,980
============ =========== ========= ==========
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,
------------------------------------
2004 2003 2002
---------- ---------- ----------
CASH FLOWS - OPERATING ACTIVITIES
LOSS FOR THE YEAR $ (137,768) $ (114,261) $ (51,402)
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 121,067 54,611 18,821
EFFECT OF INDEXATION AND TRANSLATION ON
CONVERTIBLE DEBENTURES 676 (878) -
OTHER EXPENSE (INCOME), NET (32,682) 84 (45)
CHANGES IN ASSETS AND LIABILITIES:
INCREASE IN TRADE ACCOUNTS RECEIVABLE (7,655) (4,175) (4,135)
DECREASE (INCREASE) IN OTHER RECEIVABLES AND OTHER CURRENT ASSETS (413) 1,264 (1,305)
INCREASE IN INVENTORIES (6,287) (6,221) (609)
INCREASE IN TRADE ACCOUNTS PAYABLE 404 801 4,686
INCREASE (DECREASE) IN OTHER CURRENT LIABILITIES (970) 1,467 2,764
INCREASE IN OTHER LONG-TERM LIABILITIES 9,344 529 2,822
---------- ---------- ---------
(54,284) (66,779) (28,403)
INCREASE (DECREASE) IN LONG-TERM LIABILITY
IN RESPECT OF CUSTOMERS' ADVANCES, NET 19,384 (899) 29,336
---------- ---------- ---------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (34,900) (67,678) 933
---------- ---------- ---------
CASH FLOWS - INVESTING ACTIVITIES
DECREASE (INCREASE) IN DESIGNATED CASH, SHORT-TERM AND LONG-TERM
INTEREST-BEARING DEPOSITS, NET (10,037) 14,341 (59,683)
INVESTMENTS IN PROPERTY AND EQUIPMENT (154,975) (179,310) (205,099)
INVESTMENT GRANTS RECEIVED 32,636 33,811 40,481
PROCEEDS RELATED TO SALE AND DISPOSAL OF PROPERTY AND EQUIPMENT 2,626 222 70
INVESTMENTS IN OTHER ASSETS (702) (22,098) (34,290)
DECREASE (INCREASE) IN DEPOSITS, NET - 10,500 (456)
PROCEEDS FROM SALE OF LONG-TERM INVESTMENT 38,677 - -
---------- ---------- ---------
NET CASH USED IN INVESTING ACTIVITIES (91,775) (142,534) (258,977)
---------- ---------- ---------
CASH FLOWS - FINANCING ACTIVITIES
PROCEEDS FROM ISSUANCE OF SHARES, NET 75,225 24,375 96,751
PROCEEDS FROM LONG-TERM DEBT 66,000 - 142,000
PROCEEDS FROM EXERCISE OF SHARE OPTIONS 666 - -
PROCEEDS ON ACCOUNT OF SHARE CAPITAL - 16,428 -
DECREASE IN SHORT-TERM DEBT - - (10,000)
REPAYMENT OF LONG-TERM DEBT - (13,000) (4,000)
PROCEEDS FROM LONG-TERM DEBT, NET IN CONNECTION WITH
RE-BORROWING, NOTE 12A(6) - 187,000 -
PROCEEDS FROM SALE OF SECURITIES, NET - - 21,540
---------- ---------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 141,891 214,803 246,291
========== ========== ==========
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 15,216 4,591 (11,753)
CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 12,448 7,857 19,610
---------- ---------- ---------
CASH AND CASH EQUIVALENTS - END OF YEAR $ 27,664 $ 12,448 $ 7,857
========== ========== ==========
NON-CASH ACTIVITIES
INVESTMENTS IN PROPERTY AND EQUIPMENT $ 47,675 $ 17,160 $ 49,419
========== ========== ==========
STOCK-BASED COMPENSATION RELATED TO
THE FACILITY AGREEMENT WITH THE BANKS $ 4,205
==========
INVESTMENTS IN OTHER ASSETS $ 3,153 $ 4,304
========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
CASH PAID DURING THE YEAR FOR CAPITALIZED AND EXPENSED INTEREST $ 25,205 $ 15,674 $ 11,594
========== ========== ==========
CASH PAID DURING THE YEAR FOR INCOME TAXES $ 130 $ 239 $ 151
========== ========== ==========
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 in 0.18
microns and below at its 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 on the Tel-Aviv Stock Exchange.
B. ESTABLISHMENT AND OPERATIONS OF NEW FABRICATION FACILITY (FAB 2)
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 has completed
public and private financing deals, which, as of the approval
date of the financial statements, have provided an aggregate of
$1,267,000 of financing for Fab 2.
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, some of
which were amended several times, see Note 12A. For details
concerning non-compliance with certain of the financial ratios
and covenants under the Facility Agreement as of December 31,
2004; and a letter agreement signed between the Company and the
Banks prior to the approval date of the financial statements, in
connection with a waiver of certain of the financial ratios and
covenants for the fourth quarter of 2004 and revised financial
ratios and covenants for 2005, see Note 12A.
During the third quarter of 2003, in which Fab 2's construction
was substantially completed, 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, the Company began to depreciate and amortize Fab 2
assets, and to expense most of the ongoing 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.
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 19 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, net loss 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. Identifiable
incremental direct costs include 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 it ready for its 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
incremental 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 primary 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 incremental direct costs,
mainly payroll-related costs of employees designated for
integrating the technologies in the Company's facilities, and
incremental 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 its 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 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 19E 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 (under applicable law at the time the financial
statements are prepared) to be in effect 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 assets 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 issueable from probable
Exercise and from probable Conversion. Basic loss per ordinary
share is calculated based on loss for the period with the
inclusion of imputed interest income on the exercise price of
options and warrants exercised or whose Exercise is probable, and
of financing expenses in relation to converted debentures or on
probable Conversion, as required under Israeli GAAP. See Note 19J
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 19C 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 expenses, net in 2004, 2003 and
2002 include net foreign currency transaction losses of $760,
$232 and $1,509, 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 13B(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 a 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.
Q. RECENT ACCOUNTING PRONOUNCEMENTS BY THE FASB
(1) SFAS NO. 151 - INVENTORY COSTS, AN AMENDMENT OF ARB NO. 43,
CHAPTER 4 - In November 2004 the FASB issued SFAS No. 151,
"Inventory Costs, an Amendment of ARB No. 43, Chapter 4".
SFAS No. 151 amends the guidance in ARB 43, Chapter 4,
"Inventory Pricing", which provides guidance on the
allocation of certain costs to inventory. SFAS 151 clarifies
that abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage) should be
recognized as current-period charges. In addition, SFAS 151
requires that allocation of fixed production overheads to
the costs of conversion be based on the normal capacity of
the production facilities. The provisions of this statement
are effective for inventory costs incurred during fiscal
years beginning after June 2005. The provisions of this
statement shall be applied prospectively. The Company is
currently assessing the impact of the adoption of this
Standard on the Company's financial position and results of
operations under U.S. GAAP.
(2) SFAS NO. 123 (REVISED 2004) "SHARE BASED PAYMENTS" - In
December 2004, the FASB issued SFAS No. 123 (revised 2004)
"Share Based Payments" ("SFAS 123(R)"). This Statement is a
revision of FASB Statement No. 123, "Accounting for
Stock-Based Compensation", which supersedes APB Opinion No.
25, "Accounting for Stock Issued to Employees" and its
authoritative interpretations. SFAS 123(R) will be
implemented in the U.S. GAAP reconciliation Note. According
to Israeli GAAP, accounting for costs associated with
share-based payments is not required.
SFAS 123(R) establishes standards for the accounting for
transactions in which an entity exchanges its equity
instruments for goods or services; focuses primarily on
accounting for transactions in which an entity obtains
employee and directors services in share-based payment
transactions; and does not change the accounting guidance
for share-based payment transactions with parties other than
employees.
SFAS 123(R) eliminates the alternative to use APB 25's
intrinsic value method of accounting that was provided in
SFAS 123 as originally issued and requires to measure the
cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value of
the award. The fair-value-based method in this Statement is
similar to the fair-value-based method in SFAS 123 in most
respects. The costs associated with the awards will be
recognized over the period during which an employee is
required to provide service in exchange for the award - the
requisite service period (usually the vesting period).
F-11
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.)
Q. RECENT ACCOUNTING PRONOUNCEMENTS BY THE FASB (cont.)
(2) SFAS NO. 123 (REVISED 2004) "SHARE BASED PAYMENTS" (cont.)
The grant-date fair value of employee share options and
similar instruments will be estimated using option-pricing
models adjusted for the unique characteristics of those
instruments (unless observable market prices for the same or
similar instruments are available). If an equity award is
modified after the grant date, incremental compensation cost
will be recognized in an amount equal to the excess of the
fair value of the modified award over the fair value of the
original award immediately before the modification.
The provisions of SFAS 123(R) apply to all awards to be
granted by the Company after June 30, 2005 and to awards
modified, repurchased, or cancelled after that date. When
initially applying the provisions of SFAS 123(R), in the
third quarter of 2005, the Company will be required to elect
between using either the "modified prospective method" or
the "modified retrospective method". Under the modified
prospective method, the Company is required to recognize
compensation cost for all awards granted after the adoption
of SFAS 123(R) and for the unvested portion of previously
granted awards that are outstanding on that date. Under the
modified retrospective method, the Company is required to
restate its previously issued financial statements to
recognize the amounts previously calculated and reported on
a pro forma basis, as if the original provisions of SFAS 123
had been adopted. Under both methods, it is permitted to use
either a straight line or an accelerated method to amortize
the cost as an expense for awards with graded vesting.
Management has recently commenced identifying the potential
future impact of applying the provisions of SFAS 123(R),
including each of its proposed transition methods, yet is
currently unable to fully quantify the effect of this
Standard on the Company's future financial position and
results of operations in accordance with U.S. GAAP.
Nonetheless, it is expected that the adoption of SFAS 123(R)
will increase the stock-based-award expenses the Company is
to record in the future in comparison to the expenses
recorded under the guidance currently applied by the
Company.
(3) SFAS 153, EXCHANGE OF NON-MONETARY ASSETS - In December
2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets an amendment of APB No. 29". This
Statement amends Opinion 29 to eliminate the exception for
nonmonetary exchanges of similar productive assets and
replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance.
The Statement specifies that a nonmonetary exchange has
commercial substance if the future cash flows of the entity
are expected to change significantly as a result of the
exchange. This Statement is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June
15, 2005. Earlier application is permitted for nonmonetary
asset exchanges occurring in fiscal periods beginning after
the date this Statement is issued. Retroactive application
is not permitted. The Company is assessing the impact of the
adoption of this Standard, and currently estimates that its
adoption in not expected to have a material effect on the
Company's financial position and results of operations.
F-12
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.)
R. RECENT ACCOUNTING PRONOUNCEMENTS BY THE ISRAELI ACCOUNTING
STANDARDS BOARD
ACCOUNTING STANDARD NO. 19 "TAXES ON INCOME" - In July 2004, the
Israeli Accounting Standard Board published Accounting Standard
No. 19 "Taxes on Income" (the "Standard"). The Standard
established the guidelines for recognizing, measuring, presenting
and disclosing taxes on income in the financial statements. The
Standard is effective for financial statements relating to
reporting periods commencing on, or after, January 1, 2005. The
initial adoption of the Standard shall be accounted for by the
cumulative effect of change in accounting method, for the
beginning of the period in which the Standard is initially
adopted. The adoption of the Standard is not expected to have a
material effect on the Company's financial position and results
of operations.
NOTE 3 - OTHER RECEIVABLES
Other receivables consist of the following:
As of December 31,
-----------------------
2004 2003
---------- ----------
Government of Israel - investment grants receivable $ 8,400 $ 8,143
Other government agencies 2,382 2,655
Others 583 275
---------- ----------
$ 11,365 $ 11,073
========== ==========
NOTE 4 - INVENTORIES
Inventories consist of the following (*):
As of December 31,
-----------------------
2004 2003
---------- ----------
Raw materials $ 9,260 $ 5,736
Spare parts and supplies 3,950 3,341
Work in process 10,085 9,520
Finished goods 2,374 785
---------- ----------
$ 25,669 $ 19,382
========== ==========
(*) Net of aggregate write-downs to net realizable value of $2,665 and $1,228
as of December 31, 2004 and 2003, respectively.
NOTE 5 - OTHER LONG-TERM INVESTMENT
SAIFUN - Based on an agreement between the Company and Saifun
Semiconductors Ltd. ("Saifun"), an Israeli company which designs and
develops memory designs, the Company invested $6,000 in Saifun's share
capital. In December 2004, the Company entered into a definitive
agreement to sell all of its holdings in Saifun to a U.S. based
private equity investor in consideration for $38,677. In December
2004, shareholders of Saifun exercised their right of first refusal,
and accordingly purchased the shares from the Company for the said
amount. The agreement provides that the Company may receive additional
installments through August 2005, at an amount equal to 10% of the
difference by which the price to be determined at a future IPO, exit
or merger and acquisition transaction of Saifun, is greater than the
price per share under the agreement ($14.00 per share). The net gain
from the sale of Saifun's shares amounted to $32,377.
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
A. COMPOSITION
As of December 31,
----------------------
2004 2003
--------- ---------
COST:
Prepaid perpetual land lease and buildings $ 235,632 $ 225,218
Machinery and equipment 688,691 555,989
Transportation vehicles 2,989 3,683
--------- ---------
927,312 784,890
--------- ---------
ACCUMULATED DEPRECIATION AND AMORTIZATION:
Prepaid perpetual land lease and buildings 33,960 20,698
Machinery and equipment 282,092 193,682
Transportation vehicles 1,964 2,098
--------- ---------
318,016 216,478
========= =========
$ 609,296 $ 568,412
========= =========
SUPPLEMENTAL DISCLOSURE RELATING TO COST OF PROPERTY AND
EQUIPMENT:
(1) As of December 31, 2004 and 2003, the cost of property and
equipment included costs relating to Fab 2 in the amount of
$701,982 and $560,304, respectively. Said amounts are net of
investment grants of $158,830 and $126,226, 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, 2004, the cost of buildings, machinery
and equipment was reflected net of investment grants in the
aggregate of $262,320 (as of December 31, 2003 - $232,187).
(3) Cost of property and equipment as of December 31, 2004 and
2003 includes capitalized interest costs in the aggregate of
$18,480.
(4) Following the commencement of Fab 2 operations, 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 in the
cost of sales of $101,729 in 2004 and $37,302 in 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, 2004, the report has not yet received a final approval from
the Investment Center.
F-14
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 12A(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. See also Note 16A.
C. For liens see Note 12A(6).
NOTE 7 - OTHER ASSETS, NET
Other assets consist of the following:
As of December 31,
----------------------
2004 2003
--------- ---------
COST:
In relation to Fab 2:
Technologies - Note 12A(2) $ 90,747 $ 90,747
Deferred financing charges 20,915 20,864
Other 3,217 3,661
--------- ---------
114,879 115,272
--------- ---------
ACCUMULATED AMORTIZATION:
In relation to Fab 2 (*):
Technologies 13,797 2,793
Deferred financing charges 6,606 3,049
Other 993 660
--------- ---------
21,396 6,502
========= =========
$ 93,483 $ 108,770
========= =========
(*) For amortization policy, see Note 2G.
NOTE 8 - OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
As of December 31,
----------------------
2004 2003
--------- ---------
Accrued salaries $ 3,902 $ 3,579
Vacation accrual 3,509 3,474
Interest payable on convertible debentures 1,208 1,168
Other 2,059 1,343
--------- ---------
$ 10,678 $ 9,564
========= =========
F-15
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 9 - LONG-TERM DEBT
A. COMPOSITION:
As of December 31,
Effective interest rate as of ---------------------
December 31, 2004 2004 2003
----------------------------- --------- ---------
In U.S. Dollar 6.78% $ 172,000 $ 172,000
In U.S. Dollar 5.30% 40,000 40,000
In U.S. Dollar 5.06% 285,000 219,000
--------- ---------
$ 497,000 $ 431,000
========= =========
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 detail in Note
12A(6). Prior to the closing of this amendment in December 2003,
the loans bore interest based on the three-month USD Libor rate
plus 1.55%. The effective interest rate as of December 31, 2004
of loans, the amount of which as of such date was $292,000,
includes the terms of collar agreements with knock-out and
knock-in features described in Note 17A. 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 12A(6).
D. REPAYMENT SCHEDULE
The balance of the long-term debt as of December 31, 2004 is
repayable as follows:
2007 $ 151,667
2008 165,667
2009 and thereafter 179,666
---------
$ 497,000
=========
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 12A(6)). For
further details concerning non-compliance with certain of the
financial ratios and covenants under the Facility Agreement as of
December 31, 2004; and a letter agreement signed between the
Company and the Banks prior to the approval date of the financial
statements, in connection with a waiver of certain of the
financial ratios and covenants for the fourth quarter of 2004 and
revised financial ratios and covenants for 2005, see Note 12A(6).
F-16
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 10 - 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, 2004 - NIS 116,821,927, $27,117). 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, 2004 - NIS 43.31, $10.05). 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 13E, 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 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 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 19E for disclosure of the accounting treatment of the
convertible debentures under U.S. GAAP.
NOTE 11 - OTHER LONG-TERM LIABILITIES
A. COMPOSITION
As of December 31,
---------------------
2004 2003
--------- ---------
Net liability for employee
termination benefits (see B below):
Gross obligation $ 20,938 $ 19,042
Amounts funded through deposits to severance
pay funds and purchase of insurance policies (16,350) (14,607)
--------- ---------
4,588 4,435
Long-term advances (see Note 12B(3)) 5,500 1,500
Long-term liabilities in respect of license agreements 5,191 --
Other 166 --
--------- ---------
$ 15,445 $ 5,935
========= =========
F-17
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 11 - 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 separately 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 employee
termination benefits in accordance with U.S GAAP, see Note 19B.
Costs relating to employee termination benefits were
approximately $3,836, $2,828 and $2,070 for 2004, 2003 and 2002,
respectively.
NOTE 12 - 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 has
entered into several related agreements and other
arrangements, and has completed public and private financing
transactions, to provide an aggregate, as of the approval
date of the financial statements, of $1,267,000 of financing
for Fab 2. The agreements and arrangements include those
with technology partners, Wafer Partners, Equity Investors,
the Company's Banks, the Government of Israel through the
Investment Center and others. 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 process technologies
to produce wafers in Fab 2.
Through December 31, 2004, the Company has invested in the
Fab 2 project an aggregate of approximately $1,185,000.
Through such date, the Wafer Partners, Equity Investor 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 $497,000;
and the Investment Center granted the Company an aggregate
of $150,647. In addition, through December 31, 2004, the
Company has raised $209,858 from other financial sources.
F-18
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(1) OVERVIEW (cont.)
During the third quarter of 2003, in which Fab 2's
construction was substantially completed, 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, the majority of the
ongoing direct costs related to the construction and
equipping of Fab 2 and to the transfer of the Fab 2
technologies that previously had been capitalized, are no
longer capitalizable. Depreciation and amortization of Fab 2
assets in 2004 and 2003 amounted to $108,542 and $39,625,
respectively (see also Note 6A).
The construction and equipping of Fab 2 is a substantial
project, which requires extensive management involvement as
well as a timely 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 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 conditions and covenants under the
Facility Agreement; and completing the complex processes of
transferring from Freescale (formerly 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 details concerning
non-compliance with certain of the financial ratios and
covenants under the Facility Agreement as of December 31,
2004; and a letter agreement signed between the Company and
the Banks prior to the approval date of the financial
statements, in connection with a waiver of certain of the
financial ratios and covenants for the fourth quarter of
2004 and revised financial ratios and covenants for 2005,
see paragraph A(6) below.
(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. 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 ending in December 2005.
F-19
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(2) TECHNOLOGY TRANSFER AGREEMENTS (cont.)
FREESCALE (FORMERLY MOTOROLA) - In September 2002, the
Company entered into a non-exclusive technology transfer,
development and licensing agreement with Motorola, a U.S.
corporation, which was subsequently assigned to Freescale
("Freescale"). This agreement provides for the transfer by
Freescale 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 Freescale of related technology transfer assistance, 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
Freescale, 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. 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 ending January 2011.
Through December 31, 2004, the Wafer Partners invested in
the Company, based on the Wafer Partner 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
utilized as credit against purchases to be made by the Wafer
Partners, or converted into paid-in-capital. Through
December 31, 2004, the Wafer Partners were issued an
aggregate of 26,242,875 Ordinary Shares at an average price
per share of $7.63, which was determined based on the
average closing sale price of the Company's Ordinary Shares
for the 15-30 trading days prior to making any investment.
In December 2003, the primary Wafer Partners made their
final committed investment of $13,201. Said 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 19F.
For additional investments made by the Wafer Partners in
connection with a rights offering, see Note 13F.
F-20
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(4) EQUITY INVESTOR AGREEMENTS
Through December 31, 2004, The Israel Corporation ("TIC"),
the principal shareholder of the Company, and Challenge
Fund-Edgar II LP, a Delaware limited partnership
("Challenge") (all together, "Equity Investors") invested in
the Company, an aggregate of $55,000 for the purchase of an
aggregate of 7,419,835 Ordinary Shares of the Company at an
average price per share of $7.41, which was determined based
on the average closing sale price of the Company's Ordinary
Shares for the 15-30 trading days prior to making any
investment. Said amount includes $3,227 the Equity Investors
made in December 2003 as their final committed investment.
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 19F. The investments of TIC and
Challenge were made in accordance with share purchase
agreements the Company entered into with them in December
2000 and February 2001, respectively.
In 2002, Ontario Teachers' Pension Plan ("OTPP") invested in
the Company's equity $15,000 in consideration for 3,000,000
Ordinary Shares of the Company for $5.00 per share, and a
warrant to purchase an additional 1,350,000 Ordinary Shares
of the Company. The warrant is exercisable for a four-year
period ending in October 2006, at an exercise price of $7.50
per share (subject to customary adjustments).
(5) AMENDMENTS TO THE PRIMARY WAFER PARTNER AND EQUITY INVESTOR
AGREEMENTS
Pursuant to the primary Wafer Partner Agreements, as
amended, 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
number of shares to be issued shall be determined based on
the average closing sale price of the Company's Ordinary
Shares for the 15 trading days prior to December 31, 2005.
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.
F-21
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - 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.)
Pursuant to the primary Wafer Partner Agreements, as
amended, each of the primary Wafer Partners has an option to
convert, at the end of each calendar quarter in 2004-2006,
that portion of the long-term customers' advances which it
is entitled to utilize, based upon purchases made by such
primary Wafer Partner during that quarter, into fully-paid
Ordinary Shares of the Company. The number of shares is to
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. Accordingly, during 2004, one of
the primary Wafer Partners converted an aggregate of $539 of
long-term customer advances into 117,163 fully paid Ordinary
Shares of the Company, at an average share price of $4.59
per share. 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 the 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 that long-term customer's
advances could not be utilized before December 31, 2006.
Following December 31, 2006, the remaining long-term
customer advances may be utilized as credits against
purchases to be made.
(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"). Of that amount, as of
December 31, 2004, the Company withdrew an aggregate of
$497,000. 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, described below, the loans bore
interest at a rate of Libor plus 1.55% per annum). The loans
are subject to certain prepayment provisions. Unused amounts
under the Facility Agreement were subject to a quarterly
commitment fee of 0.25% per annum. In accordance with the
terms of the Facility Agreement, as of December 31, 2004 the
Company may no longer borrow thereunder.
Loans in the amount of $431,000 received by the Company
through December 31, 2003, were repaid on December 31, 2003
and, concurrently, an equivalent amount was 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 in the amount of $66,000 drawn down
during 2004 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. For further details
regarding loans drawn down under the Facility Agreement, see
Note 9.
F-22
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(6) FACILITY AGREEMENT (cont.)
Under the Facility Agreement and the terms of the Company's
long-term loans as of December 31, 2004, 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 amendment 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' equity to total assets,
quarterly and annual EBITDA, sales and production capacity
milestones.
As of December 31, 2004, due mainly to the recent and
current slow-down in the semiconductor markets, the Company
was not in compliance with certain of the financial ratios
and covenants stipulated in the Facility Agreement. The
Company has recently prepared an updated working-plan for
2005 for Fab 2, which is based on prevailing and the
Company's forecast of market conditions and requested its
Banks to agree to amend the financial ratios and covenants
in order to align them with the updated Fab 2 working-plan
for 2005. Prior to the approval date of the financial
statements, the Company and its Banks signed a waiver letter
agreement according to which the Banks waived the Company's
non-compliance with certain financial ratios and covenants
for the fourth quarter of 2004. The agreement signed also
amended certain of the financial ratios and covenants the
Company is to comply with during 2005.
According to the amended Facility Agreement with the Banks,
the Company is to raise from specified financial sources an
aggregate of $79,000 by December 2004, an aggregate of
$115,500 by June 2005 and an aggregate of $152,000 by
December 2005. As of December 31, 2004, the Company fully
satisfied the December 2004 and June 2005 fund raising
milestones. Accordingly, as of such date, the Company's
remaining obligation to raise financings from specified
financial sources is $28,300 to be raised by December 31,
2005.
The Facility Agreement provides that should the Company fail
to meet the above fundraising obligations towards the
remaining $28,300 by December 31, 2005, 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 Facility Agreement.
F-23
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(6) FACILITY AGREEMENT (cont.)
The Israel Corporation Ltd. ("TIC"), the current major
shareholder of the Company, has undertaken to the Banks to
exercise all of the rights it 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, less any amounts actually invested in the rights
offering by TIC in connection with the exercise of its own
rights. As a result of the Company satisfying certain of its
fund raising milestones, TIC's undertaking to the Banks as
of December 31, 2004 is limited to an aggregate of $15,215.
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 $15,215 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'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 $28,300 as described above; (ii) such
time as TIC has invested an aggregate amount of $15,215 as
described above; or (iii) June 30, 2006.
Following the receipt of the above described investments
from TIC, the Banks will permit the Company to draw
additional funds under the Facility Agreement at a ratio of
$43 for every $50 invested, up to $13,085 in the aggregate.
Any drawn loan will be repayable by December 2007. Should
the Company draw down loans from this additional amount, 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.
For further details regarding 1,296,596 warrants issued to
the Banks in connection with the Facility Agreement, see
Note 13B(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 13B(5)(b).
The Company has agreed to indemnify TIC for any liabilities
it incurs with respect to these arrangements, subject to
making any investment under its 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.
F-24
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(6) FACILITY AGREEMENT (cont.)
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 TIC 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. As of December 31,
2004, approximately $190,000 of that amount had already been
paid by the Company.
(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, or an aggregate of up to
$250,000, of which as of the balance sheet date, an
aggregate of $150,647 has been already received from the
Investment Center. The remaining grants are to be made in
accordance with a timetable set forth in the approval
certificate for the program and are subject to the described
below.
Under the terms of the Fab 2 approved enterprise program,
investments in respect of Fab 2 may 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, prevailing market conditions and
slower than planned ramp-up, as of December 31, 2004, the
Company completed approximately 70% of the investments under
the approved enterprise program. According to the original
terms of the program, had the Company completed as of
December 31, 2004 80% of the total investments under the
approved enterprise program, then the overall investment
period would have been automatically expanded through
December 31, 2005. Currently, the Company does not expect to
complete Fab 2 investments by the end of 2005. Accordingly,
and as a result of the Company's actual investments lagging
behind the original terms of the program, the Company
notified the Investment Center of its revised investment
schedule contemplated in an updated plan for the
construction and equipping Fab 2. Such plan includes, among
other matters, a reduced rate of annual investments and
lower than projected expectations for Fab 2 sales. In July
2004, the Company received from the Investment Center an
approval to the revised investment schedule. As of December
31, 2004, the Company was in compliance with the revised
investment schedule.
F-25
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
A. COMMITMENTS AND CONTINGENCIES RELATING TO FAB 2 (cont.)
(8) APPROVED ENTERPRISE STATUS (cont.)
While Israeli law currently limits the investment period to
five years (that is, through December 31, 2005), the
Company's management estimates, based on discussions held
with the Investment Center, that it is probable that
satisfactory arrangements will be made with the Investment
Center to allow for the extension of the investment period
beyond the five-year period (see also Note 16A).
(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 17C.
(11) OTHER AGREEMENTS
Through December 31, 2004 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 which were not supplied or rendered as of
such date, including the Fab 2 construction agreement
described in paragraph (7) above, amounted to $32,797.
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.
F-26
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
B. LICENSE AGREEMENTS (cont.)
(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
utilized against future purchases made by the Japanese
manufacturer through 2007. Sales for 2004 and 2002 included
$1,944 and $8,056 revenues in relation to this agreement,
respectively. See also Note 11A.
(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) With respect to a long-term lease agreement of land on which
Fab 2 was constructed, see paragraph A(9) above.
(3) The Company occupies certain other premises under various
operating leases. The obligations under such leases were not
material as of December 31, 2004.
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, 2004, a substantial
portion of the Company's production has been sold under such
agreements. For purchase agreements with related parties, see
paragraph A(3) above.
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-27
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
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 18B. The agreement terminates
in October 2007, unless terminated earlier for cause.
(3) SILICONIX - In May 2004, the Company and chip maker
Siliconix incorporated ("Siliconix"), an 80% owned
subsidiary of Vishay Intertechnology Inc., entered into a
definitive long-term foundry agreement for semiconductor
manufacturing. Pursuant to the agreement, Siliconix will
place with the Company orders valued at approximately
$200,000 for the purchase of wafers to be manufactured in
the Company's Fab 1 over a seven to ten year period.
Approximately $53,000 of that amount will be delivered over
an initial three-year period commencing after the completion
of the transfer of Siliconix's technology to Fab 1, which is
expected to be completed during the first half of 2005.
According to the agreement, in August 2004 Siliconix
advanced the Company $20,000 to be used primarily for the
purchase of additional equipment required to satisfy
Siliconix's orders. The advanced amount will be credited
towards the purchase price of wafers. The unused remaining
balance of the $20,000 ($14,068 as of December 31, 2004) is
included in designated cash and short-term interest-bearing
deposits in the balance sheet. The Company registered liens
in favor of Siliconix on equipment purchased in connection
with the transaction.
(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.
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 and licenses are
required for the operations of the Company's facilities and these
permits and licenses are subject to revocation, modification and
renewal. Government authorities have the power to enforce
compliance with these regulations, permits and licenses. The
Company's current business license requires that its
manufacturing facilities achieve a maximum fluoride level of 6
parts per million (PPM) in their wastewater. Under the terms of
the license, Fab 1 is permitted to achieve a maximum fluoride
level of 8 PPM, subject to the submission of certain documents to
the environmental authorities. The Company filed with the
authorities the required documents and accordingly Fab 1's
current fluoride level is in compliance with the terms of the
license.
F-28
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 12 - COMMITMENTS AND CONTINGENCIES (cont.)
H. CLASS ACTION
In August 2004, the United States District Court dismissed the
class action filed in July 2003 by certain of the Company's
shareholders in the United States against the Company and certain
of its directors, Wafer Partners and Equity Investors ("the
Defendants"). The plaintiffs had 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. In December 2004, one of the lead plaintiffs
filed an appeal of the decision dismissing the complaint. The
Company believes that the complaint is without merit and is
vigorously contesting it.
I. AMENDMENT TO ISRAELI BANKING REGULATIONS
Pursuant to a amendment to a directive published by the Israel
Supervisor of Banks, which became 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 latter
being currently the 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 that bank
amounts to 150% of such bank's capital (gradually reduced to 135%
between April 2005 and June 2006). The directive also provides
that a bank cannot extend debt financing to any single borrower
in amounts that exceed 15% of such bank's capital. If any of the
Company's Banks exceed these limitations, it may require that the
Company return some or all of the Company's outstanding
borrowings ($497,000 as of December 31, 2004) and may limit the
Company's ability to borrow additional funds in the future.
J. STAMP DUTY
In October 2004, the Company has been approached by Israeli Tax
Authorities with a request to provide certain information
relating the stamping of commercial documents in Israel. This
request was also sent to other Israeli public companies and other
entities, which oppose such request by arguing it contradicts the
common practice in Israel. Management estimates that the
Company's exposure, if any, in connection with this request is
not expected to have a material effect on the Company's financial
position and results of operations.
K. 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, 2004.
F-29
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - SHAREHOLDERS' EQUITY
A. DESCRIPTION OF ORDINARY SHARES
As of December 31, 2004 and 2003, the Company had 250,000,000 and
150,000,000 authorized par value NIS 1.00 Ordinary Shares,
respectively, of which 65,699,796 and 51,696,097, respectively,
were issued and outstanding (net of 1,300,000 Ordinary Shares
held by the Company as of such dates). As of December 31, 2004,
there were 9,858,236 Ordinary Shares of the Company contingently
issuable. This amount includes Ordinary Shares to be issued under
various agreements according to their provisions as of December
31, 2004 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. 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 12A(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-30
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - 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. As of
December 31, 2004 and 2003, 240,000 and 280,000 options
were outstanding under the plan, respectively, with
weighted average exercise price of $8.41 and $8.48,
respectively. 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, 2004, 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. As of December 31, 2004, there were 705,000
options exercisable by the former Co-Chief Executive
Officers.
(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 for the years 2004 and 2005 -
3.6%. Accordingly, as of December 31, 2004, an
aggregate of 2,365,193 options were added to the
Company's share option plans. An aggregate of 811,675
options had not yet been designated for identified
employees, and are accordingly available for grant
under the general terms described in paragraph (a)
above.
F-31
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - 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, 2004, 2003
and 2002, 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):
2004 2003 2002
--------------------- -------------------- --------------------
Weighted Weighted Weighted
Number average Number average Number average
of share exercise of share exercise of share exercise
options price options price options price
---------- -------- --------- -------- --------- --------
Outstanding as of beginning of year 6,842,442 $ 7.93 4,247,898 $ 10.79 3,717,770 $ 11.94
Granted 4,364,954 2.69 3,118,742 4.10 905,724 5.82
Exercised (95,250) 7.00 -- --
Terminated -- -- --
Forfeited (899,226) 7.89 (524,199) 8.25 (375,596) 10.27
---------- --------- ---------
Outstanding as of end of year 10,212,920 5.71 6,842,441 7.93 4,247,898 10.79
========== ========= =========
Options exercisable as of end of year 3,010,870 10.78 2,008,674 11.60 1,299,531 10.49
========== ========= =========
(3) SUMMARY OF INFORMATION ABOUT EMPLOYEE SHARE OPTIONS
OUTSTANDING
The following table summarizes information about employee
share options outstanding as of December 31, 2004:
Exercisable as of
Outstanding as of December 31, 2004 December 31, 2004
----------------------------------------------- ----------------------------
Weighted
Range of average Weighted Weighted
exercise Number remaining average Number average
prices outstanding contractual life exercise price exercisable exercise price
----------- ----------- ---------------- -------------- ----------- --------------
(in years)
2.05-3.96 5,234,304 9.20 2.67 9,497 3.51
4.42-4.92 1,290,237 8.38 4.43 349,856 4.43
5.00-5.96 148,700 8.06 5.27 47,808 5.37
6.00-6.99 853,856 7.48 6.13 271,613 6.08
7.00-7.99 621,000 2.12 7.04 615,541 7.03
8.06-8.99 465,918 3.39 8.56 413,250 8.52
9.06-9.81 48,013 0.54 9.21 48,013 9.21
10.00-10.89 725,887 6.01 10.42 505,291 10.42
11.81 200,000 6.41 11.81 133,332 11.81
12.13-13.00 52,125 4.24 12.56 43,789 12.63
14.25-17.19 30,750 5.29 15.79 30,750 15.79
18.75 76,500 4.12 18.75 76,500 18.75
20.00-25.00 465,630 4.99 24.39 465,630 24.39
---------- ---------
10,212,920 7.65 5.71 3,010,870 10.78
========== =========
F-32
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - 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 2004, 2003 and 2002 to employees and
directors amounted to $1.53, $2.18 and $2.83 per option,
respectively. The Company utilized the Black-Scholes
option-pricing model to estimate fair value, utilizing the
following assumptions for the years 2004, 2003 and 2002 (all
in weighted averages):
2004 2003 2002
---------- ---------- ----------
Risk-free interest rate 2.84%-3.88% 2.88%-3.22% 2.80%
Expected life of options 4.5 years 4.75 years 4.82 years
Expected annual volatility 65%-82% 55%-74% 56%
Expected dividend yield None None None
(5) NON-EMPLOYEE WARRANTS
(a) BANKS - As of December 31, 2004, 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, all of which
were outstanding as of such date:
WARRANTS ISSUED IN JANUARY 2001 - In January 2001, as part
of the Facility Agreement described in Note 12A(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, 2004, 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 12A(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
12A(6) was signed. As of December 31, 2004, 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-33
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - SHAREHOLDERS' EQUITY (cont.)
B. SHARE OPTION PLANS (cont.)
(5) NON-EMPLOYEE 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 12A(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
loans. As of December 31, 2004, no warrants were issued
under this commitment.
(b) WARRANTS GRANTED TO A RELATED PARTY - In consideration
for TIC's undertaking described in Note 12A(6), the
Company issued TIC 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
12A(6) was signed. As of December 31, 2004, all of the
warrants are fully vested and none of them was
exercised. The warrants are exercisable for a five-year
period ending December 2008.
The cost of the warrants award granted to TIC,
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 and is 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 12A(6), the Company undertook to
issue additional warrants to TIC 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) WARRANTS ISSUED TO OTPP - See Note 12A(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-34
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - 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, 2004 in accordance with
SFAS 123, as amended by SFAS 148, the Company's pro forma
loss per share would have been as follows:
2004 2003 2002
----------- ----------- -----------
PRO FORMA LOSS
Loss for the year, as reported $ (137,768) $ (114,261) $ (51,402)
Less - stock-based compensation
determined under APB 25 -- 27 142
Add - stock-based compensation
determined under SFAS 123 (3,980) (8,437) (7,476)
----------- ----------- -----------
Pro forma loss $ (141,748) $ (122,671) $ (58,736)
=========== =========== ===========
BASIC LOSS PER SHARE
As reported $ (2.13) $ (2.40) $ (1.63)
=========== =========== ===========
Pro forma $ (2.19) $ (2.57) $ (1.87)
=========== =========== ===========
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 of the Company 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 12A(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, mainly the
prior approval of the Banks.
F-35
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 13 - 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 10. 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,
2004 - NIS 41.20, $9.56). The total initial proceeds raised were
$23,200, and costs related to the issuance of the securities and
the prospectus were approximately $1,750. See Note 19E 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 1,844,070
warrants, all of which were outstanding as of December 31, 2004,
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
During the first quarter of 2004, the Company completed a public
offering of its Ordinary Shares at a price of $7.00 per share.
Following the offering, and including the partial exercise of an
over-allotment option the Company granted the underwriters, the
Company issued 11,444,500 of its Ordinary Shares, in
consideration for gross proceeds of $80,112 (net of related costs
- $75,086).
F-36
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 14 - INFORMATION ON GEOGRAPHIC AREAS AND MAJOR CUSTOMERS
A. SALES BY GEOGRAPHIC AREA (as percentage of total sales)
Year ended December 31,
-----------------------
2004 2003 2002
---- ---- ----
United States 60% 73% 62%
Israel 20 2 2
Asia Pacific - in 2004, primarily
Taiwan; in 2003, Taiwan; in
2002, primarily Japan 11 10 25
Europe 9 15 11
--- --- ---
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,
-----------------------
2004 2003 2002
---- ---- ----
Customer A 24% 20% --%
Customer B 17 1 --
Customer C 8 24 31
Customer D 6 11 13
Customer E 2 -- 16
Other customers (*) 22 20 21
(*) Represent sales to five different customers each of whom accounted for
between 1% and 8% of sales during 2004; to six customers (0%-9%) during
2003; and to five customers (2%-7%) during 2002.
As of December 31, 2004 and 2003, the above major customers
constituted the majority of the trade accounts receivable
reflected on the balance sheets.
NOTE 15 - FINANCING EXPENSE, NET
Financing income expense, net consist of the following:
Year ended December 31,
-----------------------------------
2004 2003 2002
--------- --------- ---------
Financial expenses (primarily bank loan interest) $ (29,709) $ (16,073) $ (11,669)
Interest expenses in relation
to convertible debentures (1,233) (1,198) (1,101)
Less capitalized interest - Note 6A(3) -- 6,892 10,260
--------- --------- ---------
(30,942) (10,379) (2,510)
Financing income (primarily bank deposit interest) 1,197 553 406
--------- --------- ---------
Financing expense, net $ (29,745) $ (9,826) $ (2,104)
========= ========= =========
F-37
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 16 - INCOME TAXES
A. APPROVED ENTERPRISE STATUS
Substantially all of the Company's existing facilities as of
December 31, 2004 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 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 35% in 2004 (regular "Company Tax"). The regular Company
Tax rate is to be gradually reduced to 30% until 2007 (34% in
2005, 32% in 2006 and 30% in 2007).
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 also
Notes 6B and 12A(8).
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,
----------------------
2004 2003
--------- ---------
DEFERRED TAX BENEFIT - CURRENT
Accrued vacation pay $ 702 $ 695
Other 68 62
--------- ---------
770 757
Valuation allowance (770) (757)
--------- ---------
Total current deferred tax benefit $ -- $ --
========= =========
NET DEFERRED TAX BENEFIT - LONG-TERM
Deferred tax assets -
Net operating loss carryforwards $ 112,147 $ 58,048
Research and development 3,213 3,748
Liability for employee rights upon severance 918 887
--------- ---------
116,278 62,683
Valuation allowance (75,613) (43,861)
--------- ---------
40,665 18,822
Deferred tax liability - depreciation and amortization (40,665) (18,822)
--------- ---------
Total net long-term deferred tax benefit $ -- $ --
========= =========
F-38
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 16 - 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,
-----------------------
2004 2003 2002
---- ----- ----
Israeli statutory rate (35)% (36)% (36)%
Reduced tax rate for approved enterprise 15 16 16
Tax benefits for which deferred taxes
were not recorded 23 23 10
Permanent differences and other, net (3) (3) 10
--- --- ---
--% --% --%
=== === ===
D. NET OPERATING LOSS CARRYFORWARD
As of December 31, 2004, the Company had net operating loss
carryforwards for tax purposes of approximately $560,000, 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 assessments for the
years 1999 and 2000 are deemed final.
NOTE 17 - 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 19C 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-39
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 17 - 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 9). 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, 2004 and 2003, there were no outstanding
foreign exchange agreements (options) to hedge exposure
related to the purchase of machinery and equipment.
The loss resulted from these agreements in 2004 was
immaterial.
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).
(2) As of December 31, 2004 and 2003, the Company had
outstanding agreements to hedge interest rate exposure on
loans to be withdrawn under the Facility Agreement, the
aggregate amount of which was $292,000 and $212,000
respectively all of which is attributable to Fab 2. These
agreements resulted in 2004 in a loss of $5,629, of which $0
was capitalized to property and equipment; in 2003 - $5,335
and $2,547, respectively; in 2002 - $3,707 and $3,593,
respectively.
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, 2004 and 2003. The
fair value of the interest rate hedging transactions as of
December 31, 2004 would have resulted in an unrealized
capitalizable loss of $2,406 (as of December 31, 2003 - $9,920).
F-40
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 18 - RELATED PARTIES BALANCES AND TRANSACTIONS
A. BALANCES
As of December 31,
--------------------
2004 2003
-------- --------
Trade accounts receivable $ 9,054 $ 5,286
======== ========
Current liabilities $ 12 $ 23
======== ========
Other Long-Term Liabilities $ 166 $ --
======== ========
B. TRANSACTIONS
Year ended December 31,
--------------------------------
2004 2003 2002
-------- -------- --------
Sales $ 37,521 $ 13,282 $ 3,836
======== ======== ========
Management fees $ 120 $ 240 $ 480
======== ======== ========
Expense reimbursements paid $ 60 $ 99 $ 101
======== ======== ========
Royalties received - Note 12F(2) $ 875 $ 225 $ --
======== ======== ========
Application of customer advances
towards purchases $ 445 $ 870 $ --
======== ======== ========
Equity conversion of customer advances -
Note 12A(5) $ 539 $ -- $ --
======== ======== ========
Purchases of raw materials $ -- $ -- $ 209
======== ======== ========
Development costs $ -- $ -- $ 102
======== ======== ========
Expense reimbursements received $ -- $ 282 $ 177
======== ======== ========
C. For commitments, contingencies and other transactions relating to
Fab 2 Wafer Partner and Equity Investor agreements - see Note
12A.
NOTE 19 - 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, 2004 and 2003 in accordance with U.S. GAAP.
A. PRESENTATION OF DESIGNATED CASH AND SHORT-TERM AND LONG-TERM
INTEREST-BEARING DEPOSITS
In accordance with U.S. GAAP, the Company's designated cash,
short-term and long-term interest-bearing deposits should be
excluded from current assets and long-term investments and
presented separately as a non-current asset. Accordingly, as of
December 31, 2004, $53,793 and $5,134 were reclassified,
respectively, from current assets and long-term investments to a
long-term asset (as of December 31, 2003 - $44,042 and $4,848,
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, as of December 31, 2004 an amount of
$16,350 was reclassified from other long-term liabilities to
long-term investments (as of December 31, 2003-$14,607).
F-41
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - 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).
(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, 2004 and 2003, there were
not any outstanding foreign exchange agreements.
The Company uses interest rate collars with a knock-out and
knock-in features to hedge its Libor-based variable
long-term debt cash flow exposure. The knock-out feature was
set above the cap level and the knock-in feature was set
below the floor 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 2M), as interest payment become due.
For outstanding contracts as of December 31, 2004 and 2003,
see Note 17C(2).
(3) 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-42
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - MATERIAL DIFFERENCES BETWEEN ISRAEL AND U.S. GAAP (cont.)
C. HEDGING ACTIVITIES IN ACCORDANCE WITH U.S. GAAP (SFAS 133)
(cont.)
(4) Complying with SFAS 133 and SFAS 138 and the related
interpretations thereon with respect to the Company's
hedging transactions as of December 31, 2004 would have
resulted in: an increase in other long-term liabilities in
the amount of $2,406; a decrease in other comprehensive loss
for the year ended December 31, 2004 in the net amount of
$8,842; an accumulated other comprehensive loss component of
equity balance as of such date in the amount of $7,055; and
in a decrease of $4,619 in property and equipment, net as of
December 31, 2004.
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, 2004 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 13B(4)):
Year ended December 31,
--------------------------------------
2004 2003 2002
---------- ---------- ----------
PRO FORMA LOSS
Loss for the year, as reported according
to U.S. GAAP (see H below) $ (137,768) $ (114,261) $ (51,402)
Less - stock-based compensation
determined under APB 25 -- 27 142
Add - stock-based compensation
determined under SFAS 123 (3,980) (8,437) (7,476)
---------- ---------- ----------
Pro forma loss $ (141,748) $ (122,671) $ (58,736)
========== ========== ==========
BASIC LOSS PER SHARE
As reported according to U.S.
GAAP (see J below) $ (2.13) $ (2.45) $ (1.63)
========== ========== ==========
Pro forma $ (2.19) $ (2.63) $ (1.87)
========== ========== ==========
F-43
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - 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 10
and 13E 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, 2004, 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 other
matters, a fixed monetary amount known at inception. Accordingly,
the $13,201 and $3,227 amounts which are described in detail in
Notes 12A(3) and (4), respectively, and which according to
Israeli GAAP are presented as of December 31, 2003 as "Proceeds
on account of share capital", were reclassified as of December
31, 2003 under SFAS 150 as "Liability in respect of variable
number of shares to be issued". Such presentation for U.S. GAAP
purposes was required since as of December 31, 2003, the amount
of shares the Company was to issue in consideration of the
aggregate of $16,428 was not determined as of such date, and was
actually based on mechanisms that embody a variable number of
shares. Following the issuance of shares, as described in Note
12A(3) and (4), the aggregate of $16,428 is presented for U.S.
GAAP purposes as well as paid in equity.
F-44
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - MATERIAL DIFFERENCES BETWEEN ISRAELI AND U.S. GAAP (cont.)
G. BALANCE SHEETS IN ACCORDANCE WITH U.S. GAAP
AS OF DECEMBER 31, 2004 AS OF DECEMBER 31, 2003
---------------------------------- ----------------------------------
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 $ 27,664 $ $ 27,664 $ 12,448 $ $ 12,448
DESIGNATED CASH AND SHORT-TERM INTEREST
-BEARING DEPOSITS A 53,793 (53,793) -- 44,042 (44,042) --
TRADE ACCOUNTS RECEIVABLE 19,286 19,286 11,631 11,631
OTHER RECEIVABLES 11,365 11,365 11,073 11,073
INVENTORIES 25,669 25,669 19,382 19,382
OTHER CURRENT ASSETS 1,818 1,818 1,729 1,729
---------- --------- ---------- ---------- --------- ----------
TOTAL CURRENT ASSETS 139,595 (53,793) 85,802 100,305 (44,042) 56,263
---------- --------- ---------- ---------- --------- ----------
LONG-TERM INVESTMENTS
LONG-TERM INTEREST-BEARING DEPOSITS
DESIGNATED FOR FAB 2 OPERATIONS A 5,134 (5,134) -- 4,848 (4,848) --
OTHER LONG-TERM INVESTMENT B -- 16,350 16,350 6,000 14,607 20,607
---------- --------- ---------- ---------- --------- ----------
5,134 11,216 16,350 10,848 9,759 20,607
---------- --------- ---------- ---------- --------- ----------
PROPERTY AND EQUIPMENT, NET C 609,296 (4,619) 604,677 568,412 (5,947) 562,465
---------- --------- ---------- ---------- --------- ----------
DESIGNATED CASH AND SHORT-TERM AND
LONG-TERM INTEREST-BEARING DEPOSITS A -- 58,927 58,927 -- 48,890 48,890
---------- --------- ---------- ---------- --------- ----------
OTHER ASSETS, NET E 93,483 (196) 93,287 108,770 (196) 108,574
========== ========= ========== ========== ========= ==========
TOTAL ASSETS $ 847,508 $ 11,535 $ 859,043 $ 788,335 $ 8,464 $ 796,799
========== ========= ========== ========== ========= ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
TRADE ACCOUNTS PAYABLE $ 65,326 $ $ 65,326 $ 40,249 $ $ 40,249
OTHER CURRENT LIABILITIES 10,678 10,678 9,564 9,564
---------- --------- ---------- ---------- --------- ----------
TOTAL CURRENT LIABILITIES 76,004 -- 76,004 49,813 -- 49,813
LONG-TERM DEBT 497,000 497,000 431,000 431,000
CONVERTIBLE DEBENTURES E 26,651 (2,559) 24,092 25,783 (2,559) 23,224
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 64,428 64,428 46,347 46,347
OTHER LONG-TERM LIABILITIES B, C 15,445 18,756 34,201 5,935 24,527 30,462
---------- --------- ---------- ---------- --------- ----------
TOTAL LIABILITIES 679,528 16,197 695,725 558,878 38,396 597,274
---------- --------- ---------- ---------- --------- ----------
SHAREHOLDERS' EQUITY
ORDINARY SHARES, NIS 1.00 PAR VALUE -
AUTHORIZED 250,000,000 AND 150,000,000
SHARES, RESPECTIVELY; ISSUED 66,999,796
AND 52,996,097 SHARES, RESPECTIVELY 16,274 16,274 13,150 13,150
ADDITIONAL PAID-IN CAPITAL E 517,476 2,363 519,839 427,881 2,363 430,244
PROCEEDS ON ACCOUNT OF SHARE CAPITAL F -- -- -- 16,428 (16,428) --
SHAREHOLDER RECEIVABLES (26) (26) (26) (26)
ACCUMULATED OTHER COMPREHENSIVE LOSS C -- (7,055) (7,055) -- (15,897) (15,897)
ACCUMULATED DEFICIT (356,672) 30 (356,642) (218,904) 30 (218,874)
---------- --------- ---------- ---------- --------- ----------
177,052 (4,662) 172,390 238,529 (29,932) 208,597
TREASURY STOCK, AT COST - 1,300,000 SHARES (9,072) (9,072) (9,072) (9,072)
---------- --------- ---------- ---------- --------- ----------
TOTAL SHAREHOLDERS' EQUITY 167,980 (4,662) 163,318 229,457 (29,932) 199,525
========== ========= ========== ========== ========= ==========
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 847,508 $ 11,535 $ 859,043 $ 788,335 $ 8,464 $ 796,799
========== ========= ========== ========== ========= ==========
F-45
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - 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 (C above) and APB 14 (E
above) would not have materially affected the results of
operations for the years ended December 31, 2004, 2003 and 2002.
I. COMPREHENSIVE INCOME (LOSS) 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,
----------------------------------------------
2004 2003 2002
--------- --------- --------
Loss for the year according to
U.S. GAAP $(137,768) $(114,261) $(51,402)
Other comprehensive loss:
Amortization of unrealized
losses on derivatives 1,328 664 --
Unrealized gains (losses) on
derivatives 7,514 1,276 (9,638)
--------- --------- --------
Net comprehensive loss for the
year $(128,926) $(112,321) $(61,040)
========= ========= ========
F-46
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - 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, and APB 14 as described
above), the basic and diluted loss per share would be:
Year ended December 31,
-----------------------------------------------
2004 2003 2002
--------- ---------- ----------
Basic loss per share $ (2.13) $ (2.45) $ (1.63)
========= ========== ==========
Diluted loss per share $ (2.13) $ (2.45) $ (1.63)
========= ========== ==========
The following tables provide a reconciliation of the numerators
and denominators of the basic and diluted per share computations
for 2004, 2003 and 2002 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. Israeli 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-47
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - 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 2004:
Year ended December 31, 2004
--------------------------------------------
Shares
Loss (in thousands) Per-share
(Numerator) (Denominator) amount
----------- -------------- ---------
BASIC LOSS PER SHARE
Loss available to ordinary
shareholders $(137,768) 64,633 $ (2.13)
========
EFFECT OF DILUTIVE SECURITIES
Convertible debentures -- --
Options and warrants -- --
========= ========
DILUTED LOSS PER SHARE
Loss available to ordinary
shareholders after assumed
conversions $(137,768) 64,633 $ (2.13)
========= ======== ========
Options and warrants to purchase 17,374,088 Ordinary Shares at an
average exercise price of $6.61 per share were outstanding as of
December 31, 2004 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, 2004 expire
between January 2005 and December 2014 (weighted average
remaining contractual life of 5.26 years), were still outstanding
as of such date. Convertible debentures, convertible into
2,697,068 Ordinary Shares, were outstanding as of December 31,
2004 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-48
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 19 - 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
(Numerator) (Denominator) amount
----------- -------------- ---------
BASIC LOSS PER SHARE
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.
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.
F-49
TOWER SEMICONDUCTOR LTD. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except share data and per share data)
NOTE 20 - SUBSEQUENT EVENTS
A. FINANCING OF THE COMPANY'S ONGOING OPERATIONS
In the recent years, the Company has experienced significant
recurring losses from operations and recurring negative cash
flows from operating activities and an increasing accumulated
deficit. According to the Company's recently approved short-term
working plan and based on the current prevailing semiconductor
market conditions, assuming no funds are raised based on the
Letter of Intent ("LOI") described below or otherwise, the
Company foresees to be in a cash shortage. In addition, and in
continuation to the disclosure in Note 12A(6) above, as of May
30, 2005, management's estimates that the Company may not comply
with certain of the financial ratios and covenants for the third
quarter of 2005 and thereafter, as contemplated in the letter
agreement signed between the Company and the Banks in January
2005, which is described in Note 12A(6) above.
In light of the above described, the Company has been taking
comprehensive measures to obtain the needed funds for its ongoing
operations in the near future, as well as measures to reduce its
short-term liabilities. The Company has also implemented cost
reduction measures, including measures to reduce expenses, cost
structure and cash burn, and in March 2005, the Company completed
a workforce cutback, as part of an across-the-board savings plan
focused on operational efficiencies. In this regard, the Company,
certain of its Equity Investors, Wafer Partners, and its Banks
are holding discussions for additional funding for the Company in
the amount of approximately $60,000. Accordingly, in May 2005, an
LOI was signed between the Company and its Banks which states
that financing in the amount of up to $30,000 will be provided by
the Banks to the Company, subject to a similar amount being
raised by the Company from investors. As of May 30, 2005, certain
of the Company's Equity Investors and Wafer Partners have
informed the Company of their willingness to invest $23,500
towards such funding by investors. The LOI is further subject to
reaching a definitive amendment to the Facility Agreement, which
management is currently negotiating. The execution of a
definitive amendment to the Facility Agreement is subject, among
other matters, to all required internal approvals by the Banks,
including the approval of their boards of directors. The
Company's management estimates based on the discussions held with
the banks and the potential investors that it is probable that
the LOI will materialize into a definitive amendment to the
Facility Agreement and that the Equity Investors and Wafer
Partners will invest the funds as described above.
B. APPROVED ENTERPRISE STATUS
In continuation to the disclosure in Note 12A(8) above, since the
approved investment period of five years ends on December 31,
2005, the Company has been holding discussions with the
Investment Center to approve a new expansion program that shall
commence on January 1, 2006. During 2005, the Company received
letters from the Israeli Minister of Industry, Trade and
Employment and from the General Manager of the Investment Center
stating that they will act under Israeli law to support such
expansion. In April 2005, at the Investment Center's request, the
Company submitted a revised business plan to the Investment
Center for the period commencing on January 1, 2006. As of May
30, 2005, the process of reviewing the revised business plan is
in its early stages, and the Company's management cannot estimate
the outcome of the Company's efforts to obtain approval for its
expansion program to its Fab 2 approved current enterprise
program.
F-50
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 29 day of June, 2005.
TOWER SEMICONDUCTOR LTD.
By: /s/ Russell C. Ellwanger
-----------------------------
Russell C. Ellwanger
Chief Executive Officer
88