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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2003

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     .

 

Commission file number 000-31173

 


 

ChipPAC, Inc.

 

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

(State or Other Jurisdiction of

Incorporation or Organization)

 

77-0463048

(I.R.S. Employer

Identification No.)

 

47400 Kato Road, Fremont, California 94538

(Address of Principal Executive Offices, Zip Code)

 

Registrant’s telephone number, including area code (510) 979-8000

 


 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class


 

Name of Each Exchange on

Which Registered


None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Class A common stock, $.01 par value

 


 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b.2 of the Act). YES x  NO ¨

 

The aggregate market value of voting stock held by non-affiliates of the registrant (based upon the closing sales price of such shares on the Nasdaq National Market as of March 9, 2004) was $636,523,693.65.

 

At the close of market on March 9, 2004, there were 98,193,522 shares of the Registrant’s Class A common stock outstanding. No shares of the Registrant’s Class B common stock were outstanding on that date.

 



Table of Contents

TABLE OF CONTENTS

 

         Page

PART I        3

Item 1.

 

BUSINESS

   3

Item 2.

 

PROPERTIES

   13

Item 3.

 

LEGAL PROCEEDINGS

   14

Item 4.

 

SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   14
PART II        15

Item 5.

 

MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

   15

Item 6.

 

SELECTED FINANCIAL DATA

   16

Item 7.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   17

Item 7A.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

   28

Item 8.

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

   30

Item 9.

 

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

   69

Item 9A.

 

CONTROLS AND PROCEDURES

   69
PART III        69

Item 10.

 

DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

   69

Item 11.

 

EXECUTIVE COMPENSATION

   73

Item 12.

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

   78

Item 13.

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

   80

Item 14.

 

PRINCIPAL ACCOUNTANT FEES AND SERVICES

   81
PART IV        81

Item 15.

 

EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

   81
SIGNATURES        87

 

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PART I

 

ITEM 1.     BUSINESS

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

This annual report on Form 10-K contains forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “target,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These statements are only predictions and speak only as of their dates. These forward-looking statements are based largely on our current expectations and are subject to a number of risks and uncertainties, including those identified under Exhibit 99.1 of this annual report and other risks and uncertainties indicated from time to time in our filings with the SEC. Actual results could differ materially from these forward-looking statements. In addition, important factors to consider in evaluating these forward-looking statements include our proposed merger with ST Assembly Test, Ltd, possible international conflicts, changes in general economic and external market factors, changes in our business or growth strategy or an inability to execute our strategy due to changes in our industry or the economy generally, the emergence of new or growing competitors and various other competitive factors. In light of these risks and uncertainties, there can be no assurance that the matters referred to in the forward-looking statements contained in this annual report will in fact occur.

 

Industry

 

ChipPAC is one of the world’s largest independent providers of semiconductor packaging, test, and distribution services. We offer one of the broadest portfolios of packaging and test services for integrated circuits. We supply packaging solutions to some of the leading semiconductor companies servicing the computing, communications, consumer, automotive and industrial markets. We are a leader in providing high end packaging solutions, including ball grid array packages, or BGA packages, chip scale packages, flip-chip and stacked die packages. In addition to providing assembly and test services on a global basis, we are the largest independent semiconductor packaging and test service provider in mainland China. As consumers demand smaller electronic devices with more functionality, there is a greater requirement for power regulation and generation, which we expect to drive demand for our power packages. We are a leader in high-volume assembly, test and distribution of discrete and analog power packages. We are also one of the leading providers of advanced packaging products that address the needs of semiconductors used in wireless LAN and handset applications, including chip-scale, stacked die technologies.

 

Our online design and characterization process, referred to as SmartDESIGN, is a proprietary web-based design collaboration system that we believe provides a higher rate of product qualification, improved technical performance and shorter time-to-market service for our customers. This system enables us to link to our customers via the Internet to aid with the performance of package design, electrical, thermal and mechanical analysis and to model end system performance.

 

Outsourcing of packaging and test services to independent packagers like ChipPAC continues to expand due to several factors, including time-to-market pressures, cost reduction, resource allocation, equipment utilization, the increased technological complexity of packaging and test services and the growth of fabless semiconductor manufacturers. Historically, outsourced semiconductor manufacturing services have grown faster than the semiconductor market as a whole. Management believes that the reduced investments in assembly and test capacity by semiconductor manufacturers over the past two years will position outsource providers well to capture a greater percentage of future volume levels. The packaging and test industry is highly fragmented as we compete against a number of established independent packaging houses as well as the internal capabilities of some of our largest customers.

 

The semiconductor industry has historically experienced volatility with sharp periodic downturns and steep volume ramps. These downturns have been characterized by, among other things, diminished product demand,

 

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excess production capacity and accelerated erosion of selling prices. The semiconductor industry is presently recovering from a downturn, and we expect conditions to continue to improve in 2004.

 

Our headquarters are located in Fremont, California, and our manufacturing facilities are strategically located in China, Malaysia and South Korea, to address the global needs of our customers. We have design personnel located at customer sites, as well as design centers located in Arizona, China, Malaysia and South Korea to provide 24-hour design support to our customers.

 

We believe that we differentiate ourselves from our competitors by the following factors:

 

  High End Technology Expertise—We are one of the world’s largest providers of outsourced advanced packaging, which accounted for approximately 68.5% and 60.3% of our packaging revenue for the years ended December 31, 2003 and 2002, respectively. Our substrate based packages are used for most high-end applications such as computing, wireline and wireless communications devices, gaming, and stacked die packages for portable applications. Our advanced package portfolio also includes next generation flip-chip technology for system on a chip, or SOC, which is used in network servers and telecom switching devices, as well as single and multi-die CSP packaging for digital signal processors, or DSPs, and other chipsets for wireless handset, wireless LAN, and other portable handheld equipment such as PDAs. In addition, we have critical expertise for testing radio frequency, or RF, devices. We believe that our advanced technology expertise and our commitment to research and development will enable us to continue to drive the development of solutions for next generation semiconductor packages.

 

  Leader in Growing Power Discrete, Power Management and Analog Segment—We are a leader in high-volume semiconductor assembly and test services for discrete, analog, RF and mixed-signal technologies, for small signal and power applications. Power products manage the electricity requirements for multiple components, ensuring an accurate and efficient flow of voltage so electronic devices run longer and more efficiently. As electronics become increasingly more complex, portable and performance-driven, the demand for power regulation and management increases significantly. A broad and fast-growing range of end markets, including portable devices, household appliances, computers, automotive systems and telecommunications, will continue to drive power semiconductor usage and the demand for our power products.

 

  Strategic Geographic Diversification—We are strategically located to take advantage of industry outsourcing trends. Our Shanghai, China facility, which was established in 1994, is the largest packaging and test provider in China. We provide local content for products sold into the Chinese market, including cellular telephones, computers and portable devices. Our high-volume packaging site for advanced BGA packages is in Ichon, South Korea, which is significant for its proximity to large semiconductor customers and to an available pool of highly-skilled research and development and technical staff. Our Malaysian facility in Kuala Lumpur positions us to benefit from the growth in fabless manufacturing taking place in Southeast Asia. Our headquarters in Silicon Valley and state-of-the-art research development and design facilities in Arizona and South Korea are located near our customers and provide us with the ability to work on a 24-hour-basis with our customers in the design process and in supply chain management.

 

  New and Diversifying Customer Base—In 2003, we continued to diversify and broaden our customer base to over 90 customers worldwide. Our customers include some of the largest companies in the semiconductor industry. Our largest customer accounted for 15.9% of our total sales in 2003 versus 16.6% of total sales in 2002.

 

 

Among the Leaders in Growing Test Services—Through our long-term partnerships and existing customer base, we are well positioned to capitalize on the growth of outsourced testing by semiconductor producers. This growth in outsourced testing is driven by the increasing demand for RF, mixed-signal and high performance logic devices that require greater capital expenditures on testing equipment. We have made significant capital expenditures on testing equipment that provides us with the capability to test mixed-signal, analog, digital logic, memory, power and RF devices. By increasing

 

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our emphasis on our test business and adding capacity, we have increased our test revenue over the past several years, and we expect this growth to continue. Our test business revenue grew to $59.5 million in 2003 from $56.2 million in 2002.

 

Pending Merger

 

On February 10, 2004, we signed a definitive agreement for the merger of a wholly-owned subsidiary of ST Assembly Test Ltd, or STATS, with ChipPAC in a stock-for-stock transaction. If the merger is consummated, we will become a wholly owned subsidiary of STATS. Under the terms of the agreement, ChipPAC stockholders will receive 0.87 STATS American Depositary Shares, or ADSs, for each share of ChipPAC Class A common stock. Following the consummation of the merger, STATS and ChipPAC stockholders will own approximately 54% and 46% of the combined company, respectively, on a fully-converted basis. Charles Wofford, Chairman of STATS, will remain Chairman of the combined company, Dennis McKenna, Chairman and Chief Executive Officer of ChipPAC, will be the Vice-Chairman, and Tan Lay Koon, President and Chief Executive Officer of STATS, will be the President and Chief Executive Officer of the combined company. The Board of Directors of the combined company will have 11 members, and is expected to be comprised of 7 current STATS directors and each of Messrs. Conn, Norby, Park and McKenna, current members of the ChipPAC board, who will be nominated for election by STATS shareholders. The new company is proposed to be named STATS ChipPAC Ltd, and it will be headquartered in Singapore.

 

Consummation of the merger is subject to certain conditions, including approval by ChipPAC and STATS stockholders, expiration of waiting periods under the Hart-Scott-Rodino Act, receipt of a private letter ruling from the Internal Revenue Service or opinions of outside legal counsel relating to the tax treatment of the merger for ChipPAC stockholders and other customary conditions. A vote of the majority of our outstanding Class A common stock will be required to approve the merger. Our board of directors has voted to approve the transaction and recommend that our stockholders vote to approve the merger. The transaction is expected to close during the second calendar quarter of 2004. There can be no assurance that the conditions to the merger will be satisfied or that the merger will close in the expected time frame or at all. Additional information, including a discussion of the background and our reasons for the merger, will be provided in the proxy statement/prospectus to be mailed to our stockholders. The information in this report is qualified in its entirety by the impact of this proposed merger on us and our stockholders.

 

Our Services

 

We offer semiconductor packaging and test services to the semiconductor industry for applications in communications, computing, consumer, automotive and industrial end markets. Approximately 86.1%, 84.5% and 86.2% of our revenue were derived from packaging services during the years ended December 31, 2003, 2002 and 2001, respectively. Approximately 13.9%, 15.5% and 13.8% of our revenue were derived from test and other services during the years ended December 31, 2003, 2002 and 2001, respectively.

 

Since customers require their suppliers to pass a lengthy and rigorous qualification process that can be costly to the customers, we believe they generally do business with only a few suppliers. As our services are considered part of the customer’s manufacturing infrastructure, we must have dedicated resources and systems to provide flexible manufacturing, quick-turns and real-time information transfers.

 

Packaging

 

We have provided independent semiconductor packaging and test services since 1984, and offer a broad range of packaging formats for a wide variety of electronics applications. Our two types of packaging services,

 

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leadframe and advanced, contributed approximately 59.0% and 27.1%, respectively, of revenue for the year ended December 31, 2003.

 

Leaded Packaging

 

“Leaded” or “leadframe” packaging is the most widely used packaging type and is used in almost every electronic application, including automobiles, household appliances, desktop and notebook computers and telecommunications. Leaded packages have been in existence since semiconductors were first produced. A semiconductor die encapsulated in a plastic mold compound with metal leads surrounding the perimeter of the package characterizes leaded packages. With leaded packages, the die is attached to a leadframe (a flat lattice of leads) and very small gold wires are bonded (welded) to the chip and then welded to the leads to provide the interconnect. The chip is then encapsulated in plastic to form a package, with the ends of the leadframe leads protruding from the edges of the package to enable connection to a printed circuit board. This packaging type has evolved from packages design to be plugged into a printed circuit board by inserting the leads into holes on the printed circuit board to the more modern surface-mount design, in which the leads or pins are soldered to the surface of the printed circuit board. Specific packaging customization and improvements are continually being engineered to improve electrical and thermal performance, shrink package sizes and enable multi-chip capability.

 

We offer a wide range of lead counts and body sizes within this packaging group to satisfy customer die design variations. Our traditional leaded packages are at least two millimeters in thickness and include PDIP, PLCC, and SOIC. Our advanced leaded packages are thinner than our traditional leaded packages, approximately two millimeters in thickness or less, and generally have a finer pitch lead spacing, allowing for a higher pin count and greater functionality in a smaller package foot print. Our advanced leaded packages include MQFP, TQFP, iQUAD®, TSSOP and SSOP. Our acquisition of the Malaysian business in 2000 added power packages to our portfolio.

 

Power Packaging

 

Power semiconductors are used in a variety of end-markets, including telecommunications and networking systems, computers and computer peripherals, consumer electronics, electronic office equipment, automotive systems and industrial products. These end markets increasingly depend upon power regulation and control in the trend toward smaller devices and longer operating times. Packaging manufacturers are left to contend with shrinking chip geometries owing to continued emphasis upon greater mobility and portability. Power semiconductors typically involve higher current and voltage levels than memory, logic and microprocessor devices. The high current involved with switching on/off high voltages and the phase control of AC signals results in considerable power dissipated internally that produces heat. Thus our power packages are designed in such a way as to conduct the resultant heat away from the chip as power is dissipated, preventing the power device from being destroyed.

 

Power package assembly is somewhat different from non-power IC assembly as it often employs special solder alloys requiring different semiconductor bonding machines. Higher current levels of power semiconductors likewise require larger diameter aluminum and gold wire than non-power IC’s to carry the load. Our Malaysian facility maintains a vast array of these special machines needed for power semiconductor assembly and test. With a current capacity of over 12.5 million units per week, we believe we are the industry leader in power package assembly supporting a number of the world’s major power semiconductor manufacturers, whose products are designed and used in power supplies, battery chargers, ignition modules, voltage regulators, motor controllers, ignition controllers and power management devices.

 

Advanced Packaging

 

Advanced substrate based packaging represents one of the fastest growing areas in the packaging industry and is used primarily in computing platforms, networking, hand held consumer products, wireless

 

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communications devices, personal digital assistants, video cameras, home electronic devices such as DVDs and home video game machines.

 

Benefits of advanced packaging over leaded packaging include:

 

  smaller size;

 

  greater pin count, or number of connections to the printed circuit board;

 

  greater reliability;

 

  better electrical signal integrity; and higher power dissipation

 

  easier attachment to a printed circuit board.

 

BGA technology was first introduced as a solution to problems associated with the increasingly high lead counts required for advanced semiconductors. As the number of leads surrounding the integrated circuit increased, high lead count packages experienced significant electrical shorting problems. The BGA methodology solved this problem by effectively creating leads on the bottom surface of the package in the form of small bumps or solder balls. In a typical BGA package, the semiconductor die is placed on top of a plastic or tape laminate substrate rather than a lead frame. The die is connected to the circuitry in the substrate by a series of fine gold wires that are bonded to the top of the substrate near its edges. On the bottom of the substrate is a grid of metal balls that connect the packaged device to a printed circuit board.

 

We supply our customers with substantially the entire family of BGA packaging services offered in the marketplace today, including:

 

  Ball Grid Array (BGA).    Standard BGA packaging has a grid array of balls on the underside of the integrated circuit, and is used in high-performance applications, like personal computer chipsets, graphic controllers and DSPs. A BGA package generally has greater than 100 pins. BGA packages have better thermal and electrical performance than leaded packages. They also feature more advanced surface mount technology, allowing for easier handling in the packaging process.

 

  Chip-Scale.    Chip-scale BGA, LFCSP, and BCC packaging includes all packages where the package is less than 1.2 times the size of the silicon die. Chip-scale BGA is a substrate-based package that is designed for memory devices and other medium pin count semiconductors and requires dense ball arrays in very small package sizes, like wireless telephones and personal digital assistants, video cameras, digital cameras and pagers. We also include LFCSP and BCC packages in this category. While they use a metal lattice instead of a laminate substrate, they are a chip-scale package serving these markets.

 

  System-in-Package.    System-in-Package, or SiP, is a family of chip-scale-packages that contain several semiconductor die in one package, either stacked on top of each other or side by side. This technology allows greater functionality in the same package footprint and thickness without significant cost increase. These packages are used in wireless handsets, consumer products and mobile computing applications.

 

  Flip-Chip BGA.    Flip-chip BGA packaging in which the silicon die is directly attached to the substrate using gold bumps instead of solder balls provides the most dense interconnect at the lowest cost and highest performance. Flip-chip BGA technology is used in a wide array of applications ranging from consumer products to highly sophisticated application specific integrated circuits, referred to as ASIC, computer chipsets, graphics and memory packages. While we believe that flip-chip BGA represents the next generation of BGA packaging technology, we believe that standard BGA and chip-scale BGA packaging will experience long life cycles as have many of our leaded packaging solutions.

 

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The following chart summarizes the different types of packaging services we offer and revenue for the year ended December 31, 2003. The full names of each packaging type are provided in the Glossary accompanying our registration statement on Form S-1 (Registration Number 333-39428).

 

Year Ended

December 31, 2003


 

Year Ended

December 31, 2002


 

Year Ended

December 31, 2001


     

Package Types


 

Application


Revenue

  % of
Total
Assembly
Revenue


  Revenue

  % of
Total
Assembly
Revenue


  Revenue

  % of
Total
Assembly
Revenue


     
(in millions)       (in millions)       (in millions)                
Leadframe    
$  103.6   28.0%   $ 109.0   35.4%   $ 104.9   37.0%   Traditional:  

PDIP, PLCC, SOIC,

SSOP, TSOP, TSSOP,

SIP, DPAK, D2PAK,

and TO220

 

Telecommunications automobiles, household,

and appliances, and desktop and notebook computers

$    12.8   3.5%   $ 13.3   4.3%   $ 27.2   9.6%   Advanced:  

MQFP, TQFP, LQFP,

and iQUAD®

  Personal computers and telecommunications
Advanced    
$  132.6   35.9%   $ 112.3   36.6%   $ 110.9   39.2%   BGA:  

PBGA, M2BGA®

TBGA, EBGA, and

Flip PAC

  Personal computer chipsets, graphic controllers high-end network servers products, application specific integrated circuits, microprocessors and memory packages.
$  120.7   32.6%   $ 72.9   23.7%   $ 40.2   14.2%   Chip Scale
Packages:
 

EconoCSP, M2CSP®, Micro BGA, LFCSP,

BCC, and Flip Chip CSP

  Wireless telephones, personal digital assistants, video cameras, wireless pagers, and wireless LAN

 

Test Services

 

We also provide our customers with semiconductor test services for a number of device types, including mixed-signal, digital logic, memory, power and RF devices. Semiconductor testing measures and ensures the performance, functionality and reliability of a packaged device, and requires knowledge of the specific applications and functions of the devices being tested. In order to enable semiconductor companies to improve their time-to-market, streamline their operations and reduce costs, there has been an increasing trend toward outsourcing both packaging and test services. We have capitalized on this trend by enhancing our test service capabilities. Our test revenue increased 5.9% from 2002 to 2003. The acquisition of the Malaysian business expanded our mixed-signal tester base and provided us with critical expertise for testing RF devices, one of the fastest growth areas for test outsourcing. We have also noted an increased demand from our customers to provide both assembly and test services on a full turn-key basis.

 

In order to test the capability of a semiconductor device, a semiconductor company will provide us with its proprietary test program and specify the test equipment to run that program. Alternatively, our customers at times may consign their test equipment to us. The devices to be tested are placed into a socket-custom load board by an automated handling system, which is connected to the test equipment, which then tests the devices using software programs developed and supplied by our customers. The cost of any specific test and the time required to conduct it, ranging from a few milliseconds to several seconds, varies depending on the complexity of the semiconductor device and the customer’s test program.

 

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Other Services

 

We also provide a full range of other value-added services, including:

 

  Design and Characterization Services.    We offer design and characterization services at our Arizona, South Korea, Malaysia and China facilities. Our design engineers at these facilities select, design and develop the appropriate package, leadframe or substrate for that device by simulating the semiconductor’s performance and end-use environment.

 

  Dry Pack Services.    In order to prevent the failure of any semiconductors due to exposure to moisture during shipping, we “dry pack” many of our packaged integrated circuits in specially sealed, environmentally secure containers.

 

  Tape and Reel Services.    Many electronic assembly lines utilize “tape and reel” methods in which semiconductors are placed into a pocket tape to enable faster attachment to the printed circuit board. We offer a service in which we ship packaged and tested devices on a tape and reel mechanism rather than in a tray, to facilitate the assembly process.

 

  Warehousing and Drop Shipment.    In order to enable semiconductor companies to improve their time-to-market and reduce supply chain and handling costs, we offer warehousing and drop shipment services in which we ship packaged semiconductor devices directly to our customers’ customers.

 

  Wafer Probe.    We offer a wafer sort service where an electrical test is performed on the die while still in wafer form. This process identifies suitable die on each wafer which can be assembled into a final package.

 

Customers

 

In 2003, we continued to diversify and broaden our customer base to over 90 customers worldwide. Our customers are comprised of companies in the semiconductor industry located primarily in the United States of America. Our customers include some of the largest semiconductor companies in the world. There were four customers in 2003 and five customers in 2002 that each accounted for more than 10% of our total sales. These customers include Fairchild Semiconductor International, Inc., Intel Corporation, Intersil Corporation, LSI Logic Corporation and nVIDIA Corporation. Our largest single customer accounted for 15.9% and 16.6% of our total sales in 2003 and 2002, respectively. We anticipate that this customer concentration will decrease as our business grows with new customers with whom we have already become qualified and as we add new customers with whom we are currently undergoing qualification.

 

Our customers are located around the world, but principally in the United States of America. We report geographic distribution of revenue based on the location of our customers’ headquarters. The following table details the percentage of total revenue we received from the United States, Asia and Europe:

 

     Year Ended December 31,

 
     2003

    2002

    2001

 

United States of America

   86 %   89 %   92 %

Asia

   12     10     6  

Europe

   2     1     2  
    

 

 

Total

   100 %   100 %   100 %
    

 

 

 

In general, our customers rely on at least two sources for packaging. A packaging and test service company must pass a lengthy and rigorous qualification process that typically takes three to six months, and typically costs the customer approximately $250,000 to $300,000. Once a primary packager has been selected, that packager gains insight into its customer’s business operations and an understanding of its products as part of the overall working relationship. These factors, combined with the pressures of a semiconductor company to meet the time-

 

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to-market demands of its customers, result in high switching costs for semiconductor companies, making them adverse to changing or adding additional suppliers. We have been successful in attracting new customers because we are one of a few independent packaging and test companies that offers packaging, test and distribution services for a full portfolio of packages. Also, new customers are drawn to our advanced technologies.

 

Marketing, Sales and Customer Support

 

We provide sales support to our customers through an international network of offices coordinated from our British Virgin Islands company:

 

  United States of America:

 

  Chandler, Arizona

 

  Fremont, California

 

  Longmont, Colorado

 

  Palm Bay, Florida

 

  Northborough, Massachusetts

 

  Austin, Texas

 

  Dallas, Texas

 

  Shanghai, China,

 

  Tokyo, Japan,

 

  Kuala Lumpur, Malaysia,

 

  Kampen, Netherlands,

 

  Singapore

 

  Ichon, South Korea,

 

  Seoul, South Korea, and

 

  HsinChu City, Taiwan

 

Our account managers, applications engineers, customer service representatives and sales support personnel form teams that focus on a specific customer or geographic region.

 

Customers generally deliver rolling six month forecasts and release production die to us in daily or weekly increments for packaging, test and distribution. These near-term forecasts guide us as to anticipated volumes, but provide no meaningful backlog statistics. Substantially all of our materials inventory is purchased based on customer forecasts, we carry relatively small quantities of raw material inventory and we have relatively low levels of finished goods inventory.

 

Our marketing efforts focus on creating a brand awareness and familiarity with our advanced device packaging technologies and an understanding of our end-user market applications in wireless handset and PDA graphics, PC chipsets, wireless LAN, memory, storage and networking. We market our leadership in advanced packaging, test technology, and distribution and our ability to supply a broad line of packaging and test services to the semiconductor industry. We target engineers and executive level decision makers through a direct sales force, the delivery of “white papers” at industry conferences, mailings of technical brochures and newsletters, advertisements in trade journals and our website.

 

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Suppliers

 

Our packaging operations depend upon obtaining adequate supplies of materials on a timely basis. The principal materials used in our packaging process are lead frames, rigid and flexible substrates, gold wire, molding compound, epoxy, tubes and trays. We purchase materials based on the demand forecasts of our customers. Our customers are generally responsible for the costs of any unique materials that we purchase but do not use, particularly those lead frames and substrates that are ordered on the basis of customer-supplied forecasts. We work closely with our primary materials suppliers to insure the timely availability of materials supplies, and we are not dependent on any one supplier for a substantial portion of our materials requirements. We had no significant long-term agreements with materials suppliers in 2003. The materials we procure are normally available and we are able to meet our production requirements from multiple sources through periodic negotiation and placement of written purchase orders. We typically combine our global requirements into centrally negotiated blanket purchase orders to gain economies of scale in procurement and more significant volume discounts. Should material become scarce, we would look to enter into long-term supply agreements with key suppliers. In 2003, approximately 33% of our substrate costs were incurred from the purchase of materials from supplies located in South Korea, down from 79% in 2002. The balance of our substrate purchases was from suppliers in Japan and Taiwan.

 

Our packaging operations and expansion plans also depend on obtaining adequate quantities of equipment on a timely basis. To that end, we work closely with our major equipment suppliers to insure that equipment deliveries are on time and the equipment meets our stringent performance specifications. We expect that equipment lead times will lengthen in 2004 based on increased demand in the semiconductor equipment market.

 

Intellectual Property

 

Our ability to develop and provide advanced packaging technologies and designs for our customers depends in part on our proprietary know-how, trade secrets and other patented and non-patented, confidential technologies, which we either own or license from third parties. We have licenses to use numerous third party patents, patent applications and other technology rights, as well as trademark rights, in the operation of our business. We believe that these licenses are renewable under normal commercial terms once they expire.

 

Our primary registered trademark and trade name is “ChipPAC®.” We own or are licensed to use other secondary trademarks.

 

Research and Development

 

Our research and development efforts are focused on developing new packages, design, assembly and test technologies and on improving the efficiency and capabilities of our existing packaging and test services. Technology development is a basic competence of ChipPAC and a key competitive factor in the packaging industry. We have invested considerable resources and we are among the leaders in new product and technology development. Our web based proprietary design and performance characterization, SmartDESIGNTM capability, provides the shortest time-to-market with predictable performance.

 

During the past two years, we have introduced the following new package families:

 

   M2CSP®    Molded multi-die chip scale package family with the following chip-stack combinations in package profile thickness ranging from 1.0 to 1.4mm:
     ü                            Two-chip stack, same chip size
     ü        Three-chip stack, “pyramid stack”
     ü        Three-chip stack with the two chip same size
     ü        Three-chip stack with three chip same size
     ü        Four-chip stack, “pyramid stack”
     ü        Four-chip stack with two chips same size
     ü        Four-chip stack with three chips same size

 

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   LFCSP   Lead frame chip scale package

   BCC, BCC+, BCC++   Bumped Chip Carrier package family

   G4   “Gigabit-Green-Gold-to-Gold” flip chip interconnection package family of CSPs and BGAs

   TEBGA+   Thermally enhanced ball grid array family with integrated passive components

   TEBGA-II   Higher thermal performance TEBGA

   FC-MPM   Flip Chip Multi Package Module family module

   FC-CSP   Lead Free Flip Chip-Chip Scale Package

 

Materials engineering plays a critical role in advanced packaging and has enabled us to develop environmentally friendly, lead free, and halogen free packaging, which is required by several of our customers.

 

We have established four design centers where new packages are designed and fully characterized for performance and tested both for package and system level reliability to meet end customer needs.

 

During 2003, 2002 and 2001, we spent approximately $11.7 million, $10.1 million and $14.2 million, respectively, on research and development. The increase in spending in 2003 is due to the timing of projects and on increase in the number of package family introductions. Employee headcount in research and development went up by 16.8% in 2003, compared to 2002 and went up by 9.2% in 2002, compared to 2001.

 

Competition

 

The packaging and test industry is highly fragmented. Our primary competitors and their primary locations are as follows:

 

  Advanced Semiconductor Engineering, Inc.—Taiwan

 

  Amkor Technology, Inc.—South Korea, Japan, Taiwan and the Philippines

 

  ASE Test Limited—South Korea, Taiwan and Malaysia

 

  Siliconware Precision Industries Co., Ltd.—Taiwan

 

Each of these companies has significant packaging capacity, financial resources, research and development operations, marketing and other capabilities, and has some degree of operating experience. These companies also have established relationships with many large semiconductor companies, which are current or potential customers of ours. We also compete with the internal packaging and testing capabilities of many of our largest customers. We believe the principal elements of competition in the independent semiconductor packaging market include time-to-market, breadth of packaging services, technical competence, design services, quality, yield, customer service and price. We believe that we compete favorably in these areas.

 

In general, our customers principally rely on at least two independent packagers. A packaging company must pass a lengthy and rigorous qualification process that can take a minimum of three months for a typical leaded package and can take more than six months for a typical BGA package. Once a primary packager has been selected, that packager gains insight into its customer’s business operations and an understanding of its products as part of the overall working relationship. These factors, combined with the pressures of a semiconductor company to meet the time-to-market demands of its customers, result in high switching costs for semiconductor companies, making them adverse to changing or adding additional suppliers. We have been successful in attracting new customers because we are one of a few independent packaging and test companies that offers packaging, test and distribution services for a full portfolio of packages.

 

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Employees

 

As of December 31, 2003, we employed 6,319 full-time employees, of whom approximately 139 were employed in research and development, 5,850 in packaging and test services and 330 in marketing, sales, customer service and administration.

 

Approximately 1,200 of our employees at the Ichon, South Korea facility are represented by the ChipPAC Korea Labor Union and are covered by collective bargaining and wage agreements. The collective bargaining agreement, which covers basic union activities, working conditions and welfare programs, among other things is effective through May 1, 2005 and the wage agreement is effective to May 1, 2004. We believe that we have good relationships with our employees and the union.

 

SEC Reports

 

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to these reports filed with the U.S. Securities and Exchange Commission, are available for review free of charge on our website at www.chippac.com as soon as reasonably practicable after such material is electronically filed or furnished to the Commission.

 

ITEM 2.     PROPERTIES

 

Our corporate headquarters are located in Fremont, California, and we provide all packaging, test and distribution services through facilities in Ichon, South Korea, Shanghai, China and Kuala Lumpur, Malaysia. The Ichon facility was founded in 1985 and the Shanghai facility was founded in 1994. We acquired the Kuala Lumpur facility in 2000. Both the Ichon and Shanghai facilities are ISO-14001 certified and QS-9000 certified. The Kuala Lumpur facility is ISO-9002, QS-9000 and ISO-14001 certified.

 

The following chart summarizes the information about our main facilities:

 

Facility Location


  

Leased/Owned


   Sq. Ft.

  

Functions/Services


  

Principal Packaging
or Service Provided


Fremont, California

  

Leased

   56,320    Executive Offices, Research and Development, Sales, Marketing and Administration    Sales, Marketing, Administration and Design Review Services

Chandler, Arizona

  

Leased

   5,357    Research and Development, Sales and Marketing    Design and
Characterization Services

Shanghai, China

  

Owned(1)

   442,000    Packaging and Test Services, Research and Development, Warehousing Services Distribution Services    Leaded IC, Chip-Scale, BGA, Packaging and Test

Ichon, South Korea

  

Leased

   474,000    Packaging and Test Services, Research and Development, Warehousing Services Distribution Services    Advanced Leaded, BGA, Chip-Scale, Flip-Chip Packaging and Test

Kuala Lumpur, Malaysia

  

Owned(1)

   483,328    Packaging and Test Services, Research and Development, Warehousing Services    Discrete Power,
Chip-Scale, Test and Distribution Services

(1) Building and improvements are owned by ChipPAC but upon the termination of the existing long-term land lease revert to the lessor in the years 2044 and 2086 for our facilities in Shanghai, China and Kuala Lumpur, Malaysia, respectively.

 

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ITEM 3.     LEGAL PROCEEDINGS

 

On July 31, 2002, Seagate Technology L.L.C. filed suit against Atmel Corporation and Atmel SARL in Santa Clara County Superior Court. Seagate alleges that Atmel supplied defective semiconductor chips, and that Atmel had its chips outsourced and packaged by us, and Amkor Technology, Inc. On November 19, 2003, Atmel filed a First Amended Cross-Complaint against us, Amkor and Sumitomo Bakelite, Ltd., the Japanese manufacturer of the allegedly defective epoxy mold compound. We are currently being defended by insurance counsel, subject to the complete reservation of rights by the insurance company. In January 2004, we filed a cross-complaint against Amkor and Sumitomo. We believe the claims against us for indemnification are without merit and will vigorously defend the litigation. However, the litigation process is inherently uncertain and there can be no assurance that the outcome of these claims will be favorable for us.

 

We are not involved in any other legal proceedings, the outcome of which we believe would have a material adverse effect on our business, financial condition or results of operations. From time to time, however, we are involved in claims that arise in the ordinary course of business, and we maintain insurance that we believe to be adequate to cover these claims.

 

ITEM 4.     SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

No matters were submitted to a vote of our stockholders during the fourth quarter of 2003.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

Our Class A common stock is traded on the Nasdaq National Market under the symbol “CHPC.” The following table sets forth, for the periods indicated, the high and low sale price per share of our Class A common stock as quoted on the Nasdaq National Market.

 

     High

   Low

2003

             

Fourth Quarter

   $ 9.00    $ 5.41

Third Quarter

     9.50      5.00

Second Quarter

     7.60      3.29

First Quarter

     3.75      2.22

2002

             

Fourth Quarter

     5.02      0.99

Third Quarter

     6.75      1.89

Second Quarter

     12.55      4.66

First Quarter

     9.97      5.23

 

On March 9, 2004, the last reported sale price of our Class A common stock on the Nasdaq National Market was $7.93 per share. As of March 9, 2004, there were 98,193,522 shares outstanding and approximately 59 stockholders of record of our Class A common stock.

 

Shares Authorized for Issuance under Equity Compensation Plans

 

The following table sets forth the total shares of our Class A common stock that may be received by optionholders upon the exercise of currently outstanding options, the weighted average exercise price of those outstanding options and the number of shares of our Class A common stock that are still available for future issuance under our equity compensation plans after considering the stock options currently outstanding. All of the options described below have been or can be issued pursuant to our 1999 Stock Purchase and Option Plan, our 2000 Equity Incentive Plan and our 2000 Employee Stock Purchase Plan. All of these plans have been approved by our stockholders.

 

Plan Category


   Shares
to Be Issued
Upon Exercise
of Outstanding
Options


   Weighted Average
Exercise Price of
Outstanding
Options


   Number of Shares
Remaining Available
for Future Issuance
Under Equity
Compensation Plans1


Equity Compensation Plans Approved by Stockholders

   8,154,022    $ 3.92    13,067,547

Option Plans

   7,440,991    $ 3.81    6,721,239

Employee Stock Purchase Plan

   713,031    $ 5.11    6,346,308

Equity Compensation Plans Not Approved by Stockholders

   None           None

1 The number of shares available for issuance under our 2000 Equity Incentive Plan increases each year by one percent of the total shares of our outstanding common stock pursuant to the terms of the plan.

 

Dividend Policy

 

We have not in the past paid, and do not expect for the foreseeable future to pay dividends on our common stock. Instead, it is anticipated that all earnings, if any, in the foreseeable future will be used for working capital and other general corporate purposes. The payment of dividends by us to holders of our common stock is prohibited by our senior credit facilities and is restricted by the indenture relating to our senior subordinated

 

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notes. Any future determination to pay dividends will be at the discretion of the board of directors and will depend upon, among other factors, the results of operations, financial condition, capital requirements and contractual restrictions.

 

ITEM 6.     SELECTED FINANCIAL DATA

 

Our adoption of Statement of Financial Accounting Standards No. 145 in the first quarter of 2003 requires us to reclassify losses on extinguishment of debt that were previously classified as extraordinary items to non-operating income (expense) included in continuing operations. Set forth below is our last five years Selected Historical Financial Data reflecting the application of SFAS No. 145 to the periods presented. This reclassification had no impact on the reported net income (loss) of any period.

 

ChipPAC, Inc.

 

SELECTED HISTORICAL FINANCIAL DATA

(In thousands)

 

     For the Years Ended December 31,

 
     2003

    2002

    2001

    2000

    1999

 

Statement of Operations Data:

                                        

Revenue

   $ 429,189     $ 363,666     $ 328,701     $ 494,411     $ 375,530  

Gross profit

     63,890       55,601       31,113       109,144       58,042  

Operating income (loss)

     369       7,993       (55,229 )     62,330       12,619  

Net income (loss)

     (28,781 )     (28,855 )     (93,736 )     12,056       (7,308 )

Net income (loss) available to Common stockholders

     (28,781 )     (28,855 )     (93,736 )     2,869       (11,528 )

Net income (loss) per share available to Common stockholders:

                                        

Basic

   $ (0.30 )   $ (0.33 )   $ (1.36 )   $ 0.05     $ (0.30 )

Diluted

   $ (0.30 )   $ (0.33 )   $ (1.36 )   $ 0.05     $ (0.30 )

Shares use in per share calculation:

                                        

Basic

     95,554       87,430       68,878       57,067       38,935  

Diluted

     95,554       87,430       68,878       58,253       38,935  

Other Financial Data:

                                        

Depreciation and amortization

   $ 70,090     $ 58,949     $ 59,909     $ 45,049     $ 56,701  

Debt issuance cost amortization

     2,216       2,281       2,112       1,950       774  

Acquisition of property and equipment

     130,655       78,910       46,392       93,174       57,856  

Balance Sheet Data (at period end)

                                        

Cash and short-term investments

     59,708       44,173       41,872       18,850       32,117  

Accounts receivable, less allowance for doubtful accounts

     56,728       38,793       32,034       45,904       30,003  

Working capital

     52,932       34,395       (17,981 )     (16,296 )     10,224  

Total assets

     579,331       470,204       430,715       469,245       343,429  

Total long-term debt, including current portion

     365,000       267,887       333,627       290,200       300,000  

Mandatorily redeemable preferred stock

     —         —         —         —         82,970  

Total stockholders’ equity (deficit)

   $ 95,043     $ 115,544     $ (23,226 )   $ 65,697     $ (122,886 )

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations covers in part periods prior to our initial public offering in August 2000. As a result of the initial public offering, we significantly changed our capitalization. Accordingly, the results of operations for periods subsequent to the initial public offering are not necessarily comparable to prior periods. The following discussion should be read in conjunction with the consolidated financial statements contained in this annual report.

 

History

 

In 1997, we were incorporated as a distinct entity and established as the parent of a stand-alone worldwide business. Prior to this time, we operated as a separate division of Hyundai Electronics, now Hynix Semiconductor, one of the world’s largest semiconductor manufacturers and a member of the Hyundai Group, the South Korean conglomerate. In 1999, as part of a recapitalization, a group of equity investors along with management obtained control of ChipPAC. This transaction was accounted for as a recapitalization.

 

Pending Merger

 

On February 10, 2004, we signed a definitive agreement for the merger of a wholly-owned subsidiary of STATS with and into ChipPAC in a stock-for-stock transaction. If the merger is consummated, we will become a wholly owned subsidiary of STATS. Under the terms of the agreement, ChipPAC stockholders will receive 0.87 STATS ADSs, for each share of ChipPAC Class A common stock. Following consummation of the merger, STATS and ChipPAC stockholders will own approximately 54% and 46% of the combined company, respectively, on a fully-converted basis.

 

Consummation of the merger is subject to certain conditions, including approval by ChipPAC and STATS stockholders, expiration of waiting periods under the Hart-Scott-Rodino Act, receipt of a private letter ruling from the Internal Revenue Service or opinions of outside legal counsel relating to the tax treatment of the merger for ChipPAC stockholders and other customary conditions. A vote of the majority of our outstanding Class A common stock will be required to approve the merger. Our board of directors has voted to approve the transaction and recommend that our stockholders vote to approve the merger. The transaction is expected to close during the second calendar quarter of 2004. There can be no assurance that the conditions to the merger will be satisfied or that the merger will close in the expected time frame or at all. Additional information, including a discussion of the background and our reasons for the merger, will be provided in the proxy statement/prospectus to be mailed to our stockholders. The information in this report is qualified in its entirety by the impact of this proposed merger on us and our stockholders.

 

Overview

 

Our revenue consists of fees charged to our customers for packaging, testing, and distribution of their integrated circuits. From 1996 to 2003, revenue increased from $179.2 million to $429.2 million, a cumulative annual growth rate of 13.3%, primarily from the growth of substrate or BGA packaging, the growth of test revenue and the acquisition of our Malaysian business in 2000. The semiconductor industry is inherently volatile with sharp periodic downturns and slowdowns. These downturns have been characterized by, among other things, diminished product demand, excess production capacity and accelerated erosion of selling prices. The semiconductor industry is still recovering from the worst downturn in its history. Due to the severity of this downturn for the semiconductor industry and for our customers, we experienced the first decline in revenue on a year-over-year basis in our history in 2001. Subsequently, our revenue has increased year over year from 2001 to 2003.

 

Our revenue for the year ended December 31, 2003 increased to $429.2 million or 18.0% compared to the year ended December 31, 2002. Our continuing growth will depend upon factors influenced by current economic conditions such as replenishment of inventory in the electronics supply chain, gradual recovery in end markets

 

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and the ramp-up of new customers acquired in 2003. We have re-engineered our business model over the last two years to focus on products and customers in the fastest growth segments of the industry such as chips for use in wireless, broadband, consumer and automotive products. However, we are still solidly positioned in the computing and industrial markets, which will benefit from an overall economic recovery as it occurs.

 

The following table describes the composition of revenue by product group and test services, as a percentage of total revenue:

 

     Year Ended December 31,

 
     2003

    2002

    2001

 

Substrate

   59.0 %   50.9 %   46.0 %

Lead frame

   27.1     33.6     40.2  

Test and other services

   13.9     15.5     13.8  
    

 

 

Total

   100.0 %   100.0 %   100.0 %
    

 

 

 

Quarterly Results (Unaudited)

 

The following table describes our unaudited historical quarterly sales, gross profit, earnings per share and net income (loss):

 

     2003

    2002

 
     Q4

    Q3

    Q2

    Q1

    Q4

    Q3

    Q2

    Q1

 
     (in thousands, except per share amount)  

Revenue

   $ 128,357     $ 105,420     $ 106,844     $ 88,568     $ 92,708     $ 94,659     $ 97,086     $ 79,213  

Gross profit

     24,227       13,035       16,587       10,041       12,322       15,960       17,764       9,555  

Gross margin

     18.9 %     12.4 %     15.5 %     11.3 %     13.3 %     16.9 %     18.3 %     12.1 %

Writedown of impaired assets

     —         11,662       —         —           —       —         —         —    

Restructuring charge

     —         1,957       —         —         (661 )     —         —         —    

Net income (loss)

   $ 3,264     $ (17,919 )   $ (4,462 )   $ (9,664 )   $ (6,983 )   $ (3,179 )   $ (7,148 )   $ (11,545 )

Income (loss) per share

                                                                

Basic

   $ 0.03     $ (0.19 )   $ (0.05 )   $ (0.10 )   $ (0.07 )   $ (0.03 )   $ (0.05 )   $ (0.15 )

Diluted

     0.03       (0.19 )     (0.05 )     (0.10 )     (0.07 )     (0.03 )     (0.05 )     (0.15 )

 

Results of Operations

 

The following table describes our results of operations based on the percentage relationship of operating and other financial data to revenue during the periods shown:

 

     Year Ended December 31,

 
     2003

    2002

    2001

 

Historical Statement of Operations Data:

                  

Revenue

   100.0 %   100.0 %   100.0 %

Gross margin

   14.9     15.3     9.5  

Selling, general & administrative

   8.9     10.5     9.5  

Research & development

   2.7     2.8     4.3  

Restructuring/other expenses

   3.2     (0.2 )   12.4  
    

 

 

Operating income

   0.1 %   2.2 %   (16.8 )%
    

 

 

 

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Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

 

Revenue.    Revenue was $429.2 million in the year ended December 31, 2003, an increase of 18.0% from the year ended December 31, 2002. The increase in revenue was primarily due to growth in our advance substrate product lines, and particularly due to growth in revenue of stacked packages. We continued to gain and begin work for new customers in 2003 and benefited from the rebound of demand for semiconductors in 2003. Unit volumes in 2003 increased 18.6% versus 2002.

 

Gross Profit.    Gross profit during the year ended December 31, 2003 was $63.9 million, an increase of 14.9% from the year ended December 31, 2002. Gross margin as a percent of revenue was 14.9% for 2003 versus 15.3% for 2002. In order to produce favorable gross profit results, we installed cost reduction programs to reduce manufacturing overhead and renegotiate lower material prices with existing suppliers. The favorable results from these actions were more than offset by the effects of lower average selling prices, continuing higher gold prices, higher substrate prices, higher oil prices and the appreciation of the South Korean Won against the United States Dollar when compared to the year ended December 31, 2002.

 

Selling, General, and Administrative.    Selling, general, and administrative expenses remained flat at $38.2 million for both years ended December 31, 2003 and 2002. Salaries and employee related expenses increased in 2003 over 2002 due to additional personnel added to meet increased demand for our services, while expenses related to bonuses, amortization, and third party consulting were reduced in 2003. Other cost controls in 2003 included mandatory shut-down days, salary reductions, and travel restrictions.

 

Research and Development.    Research and development expenses for the year ended December 31, 2003 were $11.7 million, or 2.7% of revenue, compared to $10.1 million, or 2.8% of revenue, in the year ended December 31, 2002. Our research and development expenses in 2003 represent a 15.8% increase from similar expenses in 2002. We increased the number of research and development employees in 2003 compared to the year 2002. Employee headcount in research and development went up by 16.8% in 2003, compared to 2002. In 2003, we engaged in new projects due to the increase in the number of package families introduced.

 

Restructuring Charge and Write Down of Impaired Assets.    During the year ended December 31, 2003, restructuring plans were executed to realign our organization and reduce operating costs to better align our expenses with revenue. As of December 31, 2003, we had a total reduction of 252 personnel related to the restructuring. Restructuring and related charges of $2.0 million were expensed during the year ended December 31, 2003. In 2002, there was a restructuring action in our Malaysian plant in which we incurred $0.6 million to terminate 30 employees. Due to stronger than expected performance from our Korean subsidiary and the sale of our plating line in Korea which we had planned on shutting down, reserve releases in the amount of $1.3 million were credited to restructuring charges in our statement of operations for December 31, 2002. This resulted in a net credit of $0.7 million in 2002.

 

In addition, during the year ended December 31, 2003, we wrote down impaired assets by $11.7 million. We determined that the expected cash flows related to certain manufacturing equipment were not sufficient to recover the carrying value of the equipment. As the result of this, the carrying values of these assets were written down to the estimated fair market value and will continue to be depreciated over their remaining useful lives. There were no equivalent write-offs in the same period during 2002.

 

Interest Expense.    Total outstanding interest-bearing debt increased to $365.0 million at December 31, 2003 compared to $267.9 million at December 31, 2002. The increase in debt outstanding of $97.1 million from December 31, 2002 to December 31, 2003 is due to issuance of convertible subordinated notes in May and June 2003 of $150.0 million offset by $36.2 million pay down of our term loans and $16.7 million pay down of foreign loans. Interest expense was $30.9 million for the year ended December 31, 2003, a decrease of

 

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3.4% compared to the year ended December 31, 2002. The reduction in interest expense was primarily due to the refinancing of higher interest rate debt with new lower interest rate convertible subordinated notes.

 

Foreign Currency Losses.    We had a net foreign currency loss of $0.4 million in the year ended December 31, 2003 compared to a net foreign currency loss of $1.0 million in the year ended December 31, 2002. These non-cash losses are primarily due to the fluctuations between the exchange rate of the United States Dollar and the South Korean Won related to long-term pension benefits payable to our South Korean employees.

 

Write-Off of Debt Issuance Cost and Other Related Expenses.    In May and June 2003, we issued $150.0 million of 2.5% convertible subordinated notes in a private placement and used a portion of the proceeds to payoff term loans and foreign debt. As a result of the early extinguishment of this debt, associated capitalized debt issuance costs of $1.1 million along with $0.1 million of related debt expenses were written off. In May 2002, we used proceeds from our secondary public offering to pay off term loans. As the result of this early extinguishment of debt, associated capitalized debt issuance costs of $3.0 million and no other related debt expenses were written off.

 

Income Taxes.    Consolidated income tax provisions were $2.0 million for both of the years ended December 31, 2003 and 2002. We have a mix of tax rates across the various jurisdictions in which we do business. Our effective tax rates were approximately (7.5%) in 2003 and (7.4%) in 2002. Because the likelihood of future profitability does not meet the tests required under GAAP, this estimate does not take into account any future benefit from loss carryforwards.

 

Net Loss.    As a result of the items above, the net loss decreased to $28.8 million loss for the year ended December 31, 2003 from $28.9 million for the year ended December 31, 2002.

 

Subsequent Events.    On February 10, 2004, we announced in a joint press conference the signing of a definitive agreement with STATS for the companies to merge in a stock-for-stock transaction. We expect the merger to be completed after regulatory approvals and other closing conditions are satisfied, which we expect to occur during the second calendar quarter of 2004.

 

Under the terms of the agreement, ChipPAC shareholders will receive 0.87 STATS American Depositary Shares, or ADSs, for each share of ChipPAC common stock. Based on STATS ADS closing price of US$13.34 on February 9, 2004, the aggregate value of the transaction was approximately US$1.6 billion. Following consummation of the merger, STATS and ChipPAC shareholders will own approximately 54% and 46% of the combined company, respectively, on a fully converted basis.

 

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

 

Revenue.    Revenue was $363.7 million in the year ended December 31, 2002, an increase of 10.6% from the year ended December 31, 2001. The increase in revenue is primarily due to growth in our substrate and test product lines and the combination of higher end-market demand for our customers’ products and new customer and program wins in the year 2002 as compared to 2001. Unit volumes in 2002 also increased 10.2% versus the year 2001.

 

Gross Profit.    Gross profit during the year ended December 31, 2002 was $55.6 million, an increase of 78.8% from the year ended December 31, 2001. Gross margin as a percent of revenue was 15.3% for the year 2002 versus 9.5% for the year 2001. The actions taken by us, including reductions in work force and tight cost controls coupled with increased unit volume and higher equipment utilization contributed to the increased gross profit realized for the year ended December 31, 2002. These results were reduced by the effect of higher gold prices and the appreciation of the South Korean Won against the United States Dollar when compared to the year ended December 31, 2001.

 

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Selling, General, and Administrative.    Selling, general, and administrative expenses were $38.2 million in the year ended December 31, 2002, an increase of 22.4% from the year ended December 31, 2001. The increase in expenses was primarily due to implementation of strict cost reductions taken in 2001 to the decline in revenue. The cost controls in 2001 included mandatory shut-down days, salary reductions, travel restrictions, and deferment of expenditures where the timing could be delayed. In addition, we incurred additional expenses for our various employee incentive programs as a result of our improved results during the year ended December 31, 2002 as compared to the year ended December 31, 2001.

 

Research and Development.    Research and development expenses for the year ended December 31, 2002 were $10.1 million, or 2.8% of revenue, compared to $14.2 million, or 4.3% of revenue, in the year ended December 31, 2001. Our research and development expenses in 2002 represent a 28.9% decrease from similar expenses in 2001. Although we increased the number of research and development employees and internal resources in the year 2002 compared to the year 2001, we were engaged in a significant project that required external spending during 2001. A comparable level of external spending was not required during 2002.

 

Restructuring and Other Charges.    In the first and fourth quarter of 2001, we approved restructuring plans to realign our organization and reduce operating costs. These actions were designed to better align our existing workforce and to reduce operating expenses. These plans were a combination of reductions in work force and employee furloughs. Accordingly, our restructuring plans included reduction of associated employee positions by approximately 554 and 197 worldwide in connection with the first and fourth quarter plans, respectively. Restructuring and related charges of $3.0 million and $3.3 million were expensed during the first and fourth quarter of 2001, respectively. The entire first quarter charge of $3.0 million was related to employee separations and furloughs. The fourth quarter charge was comprised of $1.8 million related to employee separations and $1.5 million of other charges for the forgiveness of loans to executive officers. During the year ended December 31, 2002, we utilized $0.3 million of the restructuring accrual and completed another 92 of the planned 751 employee separations. We also utilized the $1.5 million of loan reserves. Cumulatively, we have completed 646 of the planned 751 employee separations. Due to stronger than expected performance from our Korean subsidiary and the sale of our plating line in Korea which we had planned on shutting down, reserve releases in the amount of $1.3 million were credited to restructuring charges in our statement of operations for December 31, 2002. We plan no further terminations or other restructuring activities related to our planned 2002 actions reserved in 2001. This credit was reduced by a restructuring action in our Malaysian plant in which $0.6 million was incurred to terminate 30 employees. This action was not included in the 2001 reserves.

 

In addition, we wrote down impaired assets by $34.7 million in the fourth quarter of 2001. There were no comparable write offs in the year ended December 31, 2002.

 

Interest Expense.    Total outstanding interest bearing debt decreased to $267.9 million at December 31, 2002 compared to $383.6 million at December 31, 2001. The decrease in debt outstanding of $115.7 million from December 31, 2001 to December 31, 2002 was due to the $82.4 million pay down of our term loans and the $50.0 million pay down of our revolving line of credit, offset by an increase in foreign loans of $16.7 million. The decrease in debt was funded by our January 2002 and May 2002 public offerings of our common stock. Related interest expense was $32.0 million for the year ended December 31, 2002, a decrease of 14.0% compared to the year ended December 31, 2001. The reduction in interest expense was primarily due to the combination of reduced interest rates along with the reduction in debt outstanding.

 

Foreign Currency Losses. We had net foreign currency losses of $1.0 million in the year ended December 31, 2002 compared to a net foreign currency gain of $0.2 million in the year ended December 31, 2001. These non-cash losses are primarily due to the fluctuations between the exchange rate of the United States Dollar and the South Korean Won related to long-term pension benefits payable to our South Korean employees.

 

Income Taxes.    Global income tax expense was $2.0 million and $2.6 million for the years ended December 31, 2002 and 2001, respectively, for effective tax rates of approximately (7.4%) in 2002 and (2.8%) in

 

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2001. In the fourth quarter of 2001, we recorded a valuation reserve that reversed previously recorded benefits in 2001 and previous years. We have a mix of tax rates across the various jurisdictions in which we do business. The tax provision for 2002 does not take into account any future benefit from loss carryforwards, which we may realize once we again achieve profitability.

 

Write-Off of Debt Issuance Cost.    A portion of the proceeds from our May 2002 public offering was used to extinguish term loan A and our capital expenditure loan and substantially pay down term loan B under our senior credit facilities. As a result, capitalized debt issuance costs of $3.0 million were written off and the charge was included in the results for the three and six month periods ended June 30, 2002 with no comparable results for the same periods in 2001. There is no tax benefit since the costs were written off in a tax jurisdiction that provides no benefit.

 

Net Loss.    As a result of the items above, the net loss decreased to $28.9 million loss for the year ended December 31, 2002, compared to a net loss of $93.7 million for the year ended December 31, 2001.

 

Critical Accounting Policies

 

We believe the following accounting policies are most important to the portrayal of our financial condition and results of operations and require our significant judgments.

 

We have made and expect to continue to make significant investments in fixed assets, intellectual property and related intangible assets. Management evaluates the valuation of these assets every quarter paying special attention to events or changes in circumstances that would indicate that their carrying amount might not be recoverable. We determine whether or not the assets are recoverable based on estimated undiscounted future cash flows to be generated by the assets and if not, we calculate the amount of the impairment charge based on estimated fair value. If different assumptions or conditions were to prevail rather than those used in estimating future cash flows, significantly different determination of recoverability or of fair value for these assets and results of operations could be reported. We recorded an asset impairment charge of $11.7 million for the year ended December 31, 2003 with no comparable amount in 2002.

 

Our management uses judgment when setting expected asset useful lives for long-lived assets. The asset useful lives used are based on historical experience and future expectations. However, business conditions or underlying technology may change in the future which could cause a change in asset lives. Any change in lives would cause a significant change in depreciation and amortization. There were no changes to useful lives for long-lived assets in 2003, 2002 or 2001.

 

We record estimated reductions to revenue for customer programs and incentive offerings including special pricing agreements, price protection, promotions and other volume-based incentives. If market conditions were to decline, we may take actions to increase customer incentive offerings possibly resulting in an incremental reduction of revenue at the time the incentive is offered. Furthermore, if anticipated volume levels turn out to be different, this would impact reductions to revenue and accrued customer rebates.

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

In the years ended December 31, 2003 and 2002, we have maintained the valuation allowance to reflect the likelihood of utilization of certain deferred tax assets. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize deferred tax assets in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

 

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Liquidity and Capital Resources

 

Our ongoing primary cash needs are for operations and equipment purchases. We spent $130.7 million on capital expenditures during the year ended December 31, 2003 compared to $78.9 million in capital expenditures during the year ended December 31, 2002. In addition during 2003, we invested $3.5 million to purchase Cirrus Logic Inc.’s back-end wafer probe and test assets. We anticipate spending $100.0 million in capital expenditures in 2004, however, we continually re-evaluate market conditions and the expectations for capital expenditures could and probably will change as the conditions merit.

 

Borrowings

 

We have a borrowing capacity of $50.0 million for working capital and general corporate purposes under the revolving credit line portion of our senior credit facilities. The revolving credit line under the senior credit facilities matures on July 31, 2005. During the year ended December 31, 2003, we borrowed and repaid $26.5 million against the revolving line of credit for general corporate purposes at an interest rate of 6.75% per annum. During the three month period ended December 31, 2003, we did not utilize any borrowings against this revolving line of credit and as of December 31, 2003, there was no outstanding balance on the revolving line of credit and the entire $50.0 million was available to us. Our pending merger with STATS will require us to obtain the approval of our lenders if we wish to maintain this line of credit.

 

We have also established two separate lines of credit with Korean Exchange Bank and Cho Hung Bank, with credit limits of $4.0 million and $8.0 million, respectively. During the three month period and year ended December 31, 2003, no borrowings were made against either of these lines of credit. Both agreements are subject to an annual review by Korean Exchange Bank and Cho Hung Bank for the continued use of the credit line facility. We also have a line of credit with a limit of $0.5 million per borrowing available with Southern Bank Bhd. for general corporate purposes at the interest rate of 6.9% per annum. During the year ended December 31, 2003, we utilized and repaid $0.5 million in the quarter ended March 31, 2003, $0.3 million in the quarter ended June 30, 2003 and $0.4 million during the quarter ended September 30, 2003. During the quarter ended December 31, 2003, we were not using this line of credit and there was no outstanding balance on this loan.

 

On May 28, 2003, we issued $125.0 million of 2.5% convertible subordinated notes due 2008 in a private placement and on June 5, 2003, the initial purchaser exercised the option to purchase an additional $25.0 million of 2.5% senior subordinated notes under the same terms. We received net proceeds of approximately $144.9 million after deducting debt issuance costs. The $150.0 million of 2.5% convertible subordinated notes are convertible into shares of the our Class A common stock at a conversion price of $8.062 per share, subject to adjustment, at any time prior to June 1, 2008, and bear an interest rate of 2.5% per annum. We used $63.9 million from the proceeds of these notes to pay down term loans of $36.2 million, a foreign loan of $16.7 million and revolving loans of $11.0 million. The remaining $81.0 million is being used for general corporate purposes. On November 24, 2003, a registration statement on Form S-3 for $143.8 million of these notes, along with the shares of common stock into which the notes are convertible, became effective with the Securities and Exchange Commission. We filed an additional registration statement for the other $6.2 million of the notes, along with the shares of common stock into which the notes are convertible, on January 22, 2004.

 

As of December 31, 2003, our total debt consisted of $365.0 million of borrowings, which was comprised of $165.0 million of 12.75% senior subordinated notes, $50.0 million of 8.0% convertible subordinated notes and $150.0 million of 2.5% convertible subordinated notes.

 

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Our total potential commitments on our loans, operating leases, contingent payments, royalty and license agreements as of December 31, 2003, were as follows: (in thousands)

 

     Total

  

Within
1

Year


   1 - 3
Years


   3 - 5 Years

   After 5 Years

On balance sheet commitments:

                                  

Senior subordinated notes

   $ 165,000    $ —      $ —      $ —      $ 165,000

Convertible subordinated notes

     200,000      —        —        150,000      50,000
    

  

  

  

  

Total on balance sheet commitments

     365,000      —        —        150,000      215,000
    

  

  

  

  

Off balance sheet commitments:

                                  

Operating leases

     56,721      7,360      13,474      12,634      23,253

Royalty/licensing agreements

     1,406      579      579      248      —  

Contingent payments to Cirrus Logic

     3,500      1,000      2,000      500      —  
    

  

  

  

  

Total off balance sheet commitments

     61,627      8,939      16,053      13,382      23,253
    

  

  

  

  

Total commitments

   $ 426,627    $ 8,939    $ 16,053    $ 163,382    $ 238,253
    

  

  

  

  

 

Our senior credit facilities, as amended, contain covenants restricting our operations and requiring that we meet specified financial tests. The financial covenants consist solely of a minimum interest coverage ratio and a maximum senior leverage ratio based on a rolling 12-months calculation. There were no violations of the covenants under the senior credit facilities, as amended, through December 31, 2003. The consummation of our proposed merger with STATS would constitute an event of default under our senior credit facilities if we do not terminate the senior credit facilities or obtain the consent of our lenders prior to the merger. We intend to terminate the senior credit facilities immediately prior to the consummation of the merger.

 

The consummation of the pending STATS merger will constitute a “change of control” for the purposes of the indenture governing our $165 million aggregate principal amount of 12 3/4% senior subordinated notes due 2009. Upon a change of control, these noteholders have the right to require our subsidiary ChipPAC International Company Limited to repurchase all or a part of the notes for a purchase price in cash of 101% of the principal amount plus any accrued and unpaid interest. While the 12 3/4% notes do not trade on a national securities exchange, we understand that recent trading of these notes have been at prices well in excess of 101% of principal amount plus accrued and unpaid interest. Accordingly, we have no current expectation that any holder of 12 3/4% notes will choose to exercise such repurchase or “put” right. We can give no assurance that the 12 3/4% notes will continue to trade at prices well in excess of 101% of principal amount plus accrued and unpaid interest. If trading prices were to fall below this amount, we would expect that some or all of the holders of the 12 3/4% notes would chose to exercise such repurchase or “put” right. In such case, the board and management of the combined STATS-ChipPAC entity would need to determine what additional financing or other arrangements would need to be made to finance such repurchase or “put”.

 

If our proposed merger with STATS is terminated under certain circumstances, we will be required to pay STATS a termination fee of $40 million.

 

During the quarter ended June 30, 2002, an assessment of approximately 16.0 billion Korean Won (approximately $13.4 million U.S. Dollars at December 31, 2003) was made by the Korean National Tax Service, or NTS, relating to withholding tax not collected on the loan between our subsidiaries in Korea and Hungary. The prevailing tax treaty does not require withholding on the transactions in question. We have appealed the assessment through the NTS’s Mutual Agreement Procedure, or MAP, and believe that the assessment should be overturned. On July 18, 2002, the Icheon tax office of the NTS approved a suspension of the proposed assessment until resolution of the disputed assessment. The NTS required a corporate guarantee amounting to the tax assessment in exchange for the suspension. We complied with the guarantee request on July 10, 2002. A further assessment of 2.7 billion Won (approximately $2.3 million U.S. Dollars at December 31, 2003) was made

 

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on January 1, 2004, for the subsequent interest. We have applied for the MAP and obtained an approval for a suspension of the proposed assessment by providing a corporate guarantee amounting to the additional taxes. As of December 31, 2003, no accrual has been made.

 

We believe that our existing cash balances, cash flows from operations and the available borrowings under our senior credit facilities of $50.0 million will provide sufficient cash resources to meet our projected operating and other cash requirements for the next twelve months. An event of default under any debt instrument, if not cured or waived, could have a material adverse effect on us. We may require capital sooner than currently expected. We cannot assure you that additional financing will be available when we need it or, if available, that it will be available on satisfactory terms. In addition, the terms of our senior credit facilities and senior subordinated notes significantly reduce our ability to incur additional debt. Failure to obtain any such required additional financing could have a material adverse effect on our company.

 

Other than the covenants on the debt as discussed above, we have no performance guarantees or unconsolidated entities. Our off-balance sheet commitments are limited to equipment operating leases, royalty/license agreements, leases on office and manufacturing space and additional contingent incentive payments to Cirrus Logic. Our total off-balance sheet obligations are approximately $61.6 million.

 

In 2003, 2002, and 2001 cash provided by (used in) operations was $50.8 million, $39.5 million, and ($3.9) million, respectively. Cash from operations mainly consisted of net income (loss) plus depreciation and amortization as well as the write-down of impaired assets in 2003 and 2001 less utilization for working capital.

 

In 2003, 2002, and 2001 cash used in investing activities was $160.4 million, $98.4 million, and $59.0 million, respectively. Cash used in investing activities related mainly to net short-term investments of $25.0 million and $10.0 million in 2003 and 2002, respectively. Investments in property and equipment were $130.7 million in 2003, $78.9 million in 2002 and $46.4 million in 2001.

 

In 2003, 2002, and 2001, cash provided by financing activities was $100.1 million, $51.2 million, and $85.9 million, respectively. Cash was mainly provided by or used in debt issuance, debt repayment, stock issuance, and stock redemption.

 

Recent Accounting Pronouncements

 

In May 2002, the Financial Accounting Standards Board issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections.” Among other things, SFAS No. 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” are met. SFAS No. 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. In the second quarter of 2003, we reclassified a loss on extinguishment of debt that was previously classified as an extraordinary item in prior periods but did not meet the criteria in APB Opinion No. 30 for classification as an extraordinary item and has included it within income from continuing operations.

 

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Exit or Disposal Activities.” SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” The scope of SFAS No. 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS No. 146 is

 

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effective for exit or disposal activities that are initiated after December 31, 2002 and early application is encouraged. We adopted SFAS No. 146 during the first quarter of fiscal year 2003. The effect on adoption of SFAS No. 146 changes on a prospective basis the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred

 

In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, or FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. We adopted FIN 45 in the first quarter of 2003 and have met the disclosure requirements of FIN 45. The adoption of FIN 45 has no material impact on our financial statements.

 

In November 2002, the Emerging Issues Task Force, or EITF, reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We adopted EITF Issue No. 00-21. The adoption of EITF Issue No. 00-21 has no material impact on our financial statements.

 

In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods beginning after December 15, 2002. We adopted SFAS No. 148 in the first quarter of 2003. The adoption of SFAS No. 148 has no material impact on our financial statements.

 

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, or FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. We believe that the adoption of this standard will have no material impact on our financial statements.

 

In April 2003, the Financial Accounting Standards Board issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting of derivative instruments and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 amends SFAS No. 133 for decisions made: (a) as part of the Derivatives Implementation Group process that require amendment to SFAS No. 133; (b) in connection with other FASB projects dealing with financial instruments; and (c) in connection with the implementation issues raised related to the application of the definition of a derivative. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for designated hedging relationships after June 30, 2003. We adopted SFAS No. 149 during 2003. The adoption of SFAS No. 149 will not have a material impact on our financial position and results of operations.

 

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In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We adopted SFAS No. 150 during 2003. The adoption of this standard will have no material impact on our financial statements.

 

Acquisition of Malaysian Business

 

Under the terms of the agreement relating to our acquisition of the Malaysian business, during the period from June 1, 2000 to June 30, 2003, Intersil is entitled to receive additional contingent incentive payments based upon the achievement of milestones relating to the transfer of business previously subcontracted by Intersil to a third party. As of December 31, 2003 Intersil achieved all the milestones, and we paid Intersil the sum of $17.9 million in the aggregate as additional purchase price. As of December 31, 2003, we have no further obligations under this arrangement. We also had recorded $2.4 million of other purchase price adjustments based on the difference between the final closing balance sheet and the estimated closing balance sheet of the Malaysian business, and we recorded deferred tax of $6.1 million on all of these adjustments, which resulted in a further increase of the effective purchase price and non-current assets.

 

There was no goodwill arising from the acquisition of the Malaysian business. The fair value of total assets and liabilities exceed the purchase price by $56.2 million as of July 1, 2000. This amount, reduced by the additional contingent incentive payments, other purchase price adjustments and related deferred taxes, as of December 31, 2003, has been allocated in full to non-current assets as summarized below.

 

Non-current assets


  

Estimated

Fair Value


  

Initial
Excess of Fair

Value of

Acquired Net
Assets Over Cost


   

Total

Additional
Purchase
Price


   Adjusted
Fair Value


     (in millions)

Land and buildings

   $ 27.9    $ (11.1 )   $ 5.0    $ 21.8

Plant and equipment

     93.9      (36.9 )     18.3      75.3

Intellectual property

     20.9      (8.2 )     3.1      15.8
    

  


 

  

     $ 142.7    $ (56.2 )   $ 26.4    $ 112.9
    

  


 

  

 

Initial and Secondary Public Offerings of Common Stock

 

In August 2000, the Securities and Exchange Commission declared effective the Registration Statement on Form S-1 (Registration No. 333-39428) relating to the initial public offering of our Class A common stock. In connection with the closing of the initial public offering, we issued a total of 13,693,000 shares of Class A Common Stock for gross proceeds of $163.0 million. The total proceeds from the offering and the concurrent private placement, net of issuance costs, were $151.8 million.

 

On January 30, 2002, we sold 10,000,000 shares of Class A common stock in an underwritten public offering for $6.00 per share. On February 14, 2002, we sold an additional 1,425,600 shares of Class A common stock in conjunction with the underwriters’ exercise of their over-allotment option for $6.00 per share. In connection with these sales, we received net proceeds of approximately $63.8 million, after deducting underwriting discounts, commissions and estimated offering expenses. Net proceeds of $62.4 million from this offering were used to pay down term loans and revolving loans. The remaining $1.3 million was used for general corporate purposes.

 

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On May 30, 2002, we sold 12,000,000 shares of Class A common stock in an underwritten public offering for $8.75 per share. In connection with these sales, we received net proceeds of approximately $99.2 million, after deducting underwriting discounts, commissions and estimated offering expenses. Net proceeds of $50.0 million from this offering were used to pay down term loans and revolving loans. The remaining $49.2 million was used for general corporate purposes.

 

Sources and Use of Funds From Issuances of Common Stock in 2002

 

     January
Offering


    May
Offering


    Totals

 

Source of funds:

                        

Gross proceeds from issuance of common stock

   $ 68,554     $ 105,000     $ 173,554  

Less: related issuance costs

     (4,768 )     (5,830 )     (10,598 )
    


 


 


Net proceeds from issuance of common stock

   $ 63,786     $ 99,170     $ 162,956  
    


 


 


Use of funds:

                        

Repayment of senior credit facilities

   $ 62,438     $ 50,000     $ 112,438  

General corporate purposes

     1,348       49,170       50,518  
    


 


 


     $ 63,786     $ 99,170     $ 162,956  
    


 


 


 

In June 2002, we utilized $50.0 million of the public offering proceeds to extinguish term loan A and the capital expenditure loan and substantially pay down term loan B under the senior credit facilities. As a result, capitalized debt issuance costs of $3.0 million were written off in the year ended December 31, 2002.

 

ITEM 7A.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. We have no derivative financial instruments. Historically, our long-term debt carried both fixed and variable interest rates. At December 31, 2003, all of our long-term debt carried only fixed interest rates and are not exposed to interest rate fluctuations. The exposure to foreign currency gains and losses has been significantly mitigated by the fact that we negotiated with the large majority of our material and equipment suppliers to denominate purchase transactions in U.S. Dollars.

 

For the years ended December 31, 2003, 2002 and 2001, we generated approximately 14.2%, 11.3%, and 8.1% of total revenue, respectively, from companies headquartered in international markets. Our facilities currently used to provide packaging services are located in China, Malaysia and South Korea. Moreover, many of our customers’ operations are located in countries outside of the United States of America. We cannot determine if our future operations and earnings will be affected by new laws, new regulations, a volatile political climate, armed conflicts, changes in or new interpretations of existing laws or regulations or other consequences of doing business outside the United States of America particularly in China, Malaysia and South Korea. If future operations are negatively affected by these changes, sales or profits may suffer.

 

Investment and Interest Risk

 

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio and short-term debt obligations. We do not use derivative financial instruments in our investment portfolio. We place our investments with high credit quality issuers and, by policy, limit the amount of credit exposure to any one issuer.

 

We mitigate default risk by investing in safe, high credit quality securities and by monitoring the credit rating of investment issuers. Our portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. We have no material cash flow exposure due to rate changes for cash equivalents and short-term investments.

 

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Our results are only affected by the interest rate changes to variable rate short-term borrowings. Due to the short-term nature of these borrowings, an immediate change to interest rates is not expected to have a material effect on our results. Our long-term bonds bear a fixed interest rate and the interest does not fluctuate with changes in short-term or long-term rates.

 

Foreign Currency Risk

 

Based on the our overall currency rate exposure at December 31, 2003, a near term 10% appreciation or depreciation in the value of the U.S. dollar would have an insignificant effect on our financial position, results of operations and cash flows over the next fiscal year. There can be no assurance, however, that there will not be a material impact further in the future.

 

A portion of our costs are denominated in foreign currencies, specifically, the Chinese Renminbi, the Malaysian Ringgit and the South Korean Won. As a result, changes in the exchange rates of these currencies or any other applicable currencies to the U.S. dollar will affect the cost of goods sold and operating margins and could result in exchange losses. We cannot fully predict the impact of future exchange rate fluctuations on our profitability. From time to time, we may have engaged in, and may continue to engage in, exchange rate hedging activities in an effort to mitigate the impact of exchange rate fluctuations. However, we cannot assure that any hedging technique we implement will be effective. If it is not effective, we may experience reduced operating margins.

 

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ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Report of Independent Auditors

   31

Consolidated Balance Sheets—December 31, 2003 and 2002

   32

Consolidated Statements of Operations for each of the three years in the period ended December 31, 2003

   33

Consolidated Statements of Stockholders’ Equity for each of the three years in the period ended December 31, 2003

   34

Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2003

   35

Notes to Consolidated Financial Statements

   37

Financial Statement Schedule:

    

 

Schedule II Valuation and Qualifying Accounts for each of the three years in the period ended December 31, 2003

 

30


Table of Contents

REPORT OF INDEPENDENT AUDITORS

 

To the Stockholders and Board of Directors of ChipPAC, Inc.:

 

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of stockholders’ equity and of cash flows, present fairly, in all material respects, the financial position of ChipPAC, Inc. and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. 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 of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note 2 to the financial statements, in 2003 the Company changed the manner in which it classifies gains and losses on the extinguishment of debt.

 

/s/    PRICEWATERHOUSECOOPERS LLP

 

San Jose, California

February 19, 2004

 

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Table of Contents

ChipPAC, Inc.

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amount)

 

    

December 31,

2003


   

December 31,

2002


 
ASSETS                 

Current assets:

                

Cash and cash equivalents

   $ 24,722     $ 34,173  

Short-term investments

     34,986       10,000  

Accounts receivable, less allowance for doubtful accounts of $574 and $391

     56,728       38,793  

Inventories (Note 6)

     26,060       15,299  

Prepaid expenses and other current assets

     7,411       5,285  
    


 


Total current assets

     149,907       103,550  

Property, plant and equipment, net (Note 6)

     397,267       336,397  

Intangible assets, net

     15,860       17,300  

Other assets

     16,297       12,957  
    


 


Total assets

   $ 579,331     $ 470,204  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY                 

Current liabilities:

                

Accounts payable

   $ 69,251     $ 39,755  

Accrued expenses and other current liabilities (Note 6)

     27,724       29,400  
    


 


Total current liabilities

     96,975       69,155  

Long-term debt

     165,000       217,887  

Convertible subordinated notes

     200,000       50,000  

Other long-term liabilities (Note 15)

     22,313       17,618  
    


 


Total liabilities

     484,288       354,660  
    


 


Commitments and contingencies (Notes 12 and 17)

                

Stockholders’ equity:

                

Preferred stock,—par value $0.01 per share; 10,000,000 shares authorized, no shares issued or outstanding at December 31, 2003 and 2002

     —         —    

Common stock, Class A—par value $0.01 per share; 250,000,000 shares authorized, 97,237,000 and 94,093,000 shares issued and outstanding at December 31, 2003 and 2002

     972       941  

Common stock, Class B—par value $0.01 per share; 250,000,000 shares authorized, no shares issued or outstanding at December 31, 2003 and 2002

     —         —    

Additional paid-in capital

     284,849       276,916  

Receivable from stockholders

     (164 )     (480 )

Accumulated other comprehensive income

     9,169       9,169  

Accumulated deficit

     (199,783 )     (171,002 )
    


 


Total stockholders’ equity

     95,043       115,544  
    


 


Total liabilities and stockholders’ equity

   $ 579,331     $ 470,204  
    


 


 

The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

ChipPAC, Inc.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amount)

 

    

For the Years Ended

December 31,


 
     2003

    2002

    2001

 

Revenue

   $ 429,189     $ 363,666     $ 328,701  

Cost of revenue

     365,299       308,065       297,588  
    


 


 


Gross profit

     63,890       55,601       31,113  
    


 


 


Operating expenses:

                        

Selling, general and administrative

     38,241       38,159       31,199  

Research and development

     11,661       10,110       14,223  

Restructuring, write-down of impaired assets and other charges

     13,619       (661 )     40,920  
    


 


 


Total operating expenses

     63,521       47,608       86,342  
    


 


 


Operating income (loss)

     369       7,993       (55,229 )
    


 


 


Non-operating (income) expenses:

                        

Interest expense

     30,887       31,986       37,214  

Interest income

     (828 )     (626 )     (688 )

Foreign currency (gain) loss

     35       1,029       (187 )

Loss from early debt extinguishment

     1,182       3,005       —    

Gain on sale of building (Note 19)

     (3,929 )     —         —    

Other income, net

     (197 )     (546 )     (410 )
    


 


 


Total non-operating expenses

     27,150       34,848       35,929  
    


 


 


Loss before income taxes

     (26,781 )     (26,855 )     (91,158 )

Provision for income taxes

     2,000       2,000       2,578  
    


 


 


Net loss

   $ (28,781 )   $ (28,855 )   $ (93,736 )
    


 


 


Net loss per share

                        

Basic

   $ (0.30 )   $ (0.33 )   $ (1.36 )

Diluted

   $ (0.30 )   $ (0.33 )   $ (1.36 )

Shares used in per share calculation:

                        

Basic

     95,554       87,430       68,878  

Diluted

     95,554       87,430       68,878  

 

The accompanying notes are an integral part of these financial statements.

 

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Table of Contents

ChipPAC, Inc.

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

 

    Common Stock

    Warrants
Class A
Common
Stock


    Additional
Paid in
Capital


    Receivable
from
Stockholders


    Accumulated
other
Comprehensive
Income


 

Accumulated

Deficit


    Total

 
    Number
of Shares


    Amount

             

Balance as of December 31, 2000

  68,438     $ 685     $ 1,250     $ 104,509     $ (1,505 )   $ 9,169   $ (48,411 )   $ 65,697  

Repayment of amount due from stockholders

  —         —         —         —         520       —       —         520  

Expiration of Intel Warrant

  —         —         (1,250 )     1,250       —         —       —         —    

Employee stock purchases

  922       9       —         4,117       —         —       —         4,126  

Common stock repurchased by Company during the year

  (63 )     (1 )     —         (18 )     —         —       —         (19 )

Exercise of stock options

  107       1       —         185       —         —       —         186  

Net loss

  —         —         —         —         —         —       (93,736 )     (93,736 )
   

 


 


 


 


 

 


 


Balance as of December 31, 2001

  69,404     $ 694     $ —       $ 110,043     $ (985 )   $ 9,169   $ (142,147 )   $ (23,226 )

Repayment of amount due from stockholders

  —         —         —         —         505       —       —         505  

Employee stock purchases

  1,092       11       —         3,324       —         —       —         3,335  

Common stock repurchased by Company during the year

  (71 )     (1 )     —         (23 )     —         —       —         (24 )

Exercise of stock options

  242       3       —         850       —         —       —         853  

Stock issued at public offerings, net of issuance cost of $10,598

  23,426       234       —         162,722       —         —       —         162,956  

Net loss

  —         —         —         —         —         —       (28,855 )     (28,855 )
   

 


 


 


 


 

 


 


Balance as of December 31, 2002

  94,093     $ 941     $ —       $ 276,916     $ (480 )   $ 9,169   $ (171,002 )   $ 115,544  

Repayment of amount due from stockholders

  —         —         —         —         316       —       —         316  

Employee stock purchases

  2,070       21       —         4,862       —         —       —         4,883  

Common stock repurchased by Company during the year

  (7 )     —         —         (2 )     —         —       —         (2 )

Exercise of stock options

  1,081       10       —         3,073       —         —       —         3,083  

Net loss

  —         —         —         —         —         —       (28,781 )     (28,781 )
   

 


 


 


 


 

 


 


Balance as of December 31, 2003

  97,237     $ 972     $ —       $ 284,849     $ (164 )   $ 9,169   $ (199,783 )   $ 95,043  
   

 


 


 


 


 

 


 


 

 

The accompanying notes are an integral part of these financial statements.

 

 

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ChipPAC, Inc.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     For the Years Ended December 31,

 
     2003

    2002

    2001

 

Cash flows from operating activities:

                        

Net loss

   $ (28,781 )   $ (28,855 )   $ (93,736 )

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

                        

Depreciation and amortization

     70,090       58,949       59,909  

Debt issuance cost amortization

     2,216       2,281       2,112  

Foreign currency (gain) loss

     35       1,029       (187 )

Deferred tax

     (1,195 )     (121 )     1,636  

Write-down of impaired assets

     11,662       —         34,688  

Loss from early debt extinguishment

     1,182       3,005       —    

Gain on sale of building

     (3,929 )     —         —    

Gain on sale of equipment

     (318 )     (50 )     (1 )

Changes in assets and liabilities:

                        

Accounts receivable

     (17,935 )     (6,759 )     13,870  

Inventories

     (10,761 )     (2,818 )     8,769  

Prepaid expenses and other current assets

     (2,209 )     (770 )     2,205  

Other assets

     (1,336 )     (415 )     2,866  

Accounts payable

     29,496       8,710       (23,618 )

Accrued expenses and other current liabilities

     (1,676 )     1,562       (11,919 )

Other long-term liabilities

     4,288       3,798       (510 )
    


 


 


Net cash provided by (used in) operating activities

     50,829       39,546       (3,916 )
    


 


 


Cash flows from investing activities:

                        

Purchase of short-term investments

     (204,116 )     (39,699 )     —    

Proceeds from sale of short-term investments

     179,130       29,699       —    

Acquisition of intangible assets

     (3,798 )     (3,362 )     (6,156 )

Acquisition of property and equipment

     (130,655 )     (78,910 )     (46,392 )

Proceeds from sale of building

     5,399       —         —    

Proceeds from sale of equipment

     786       488       965  

Acquisition of test assets

     (3,625 )     —         —    

Malaysian acquisition, net of cash and cash equivalents acquired

     (3,475 )     (6,643 )     (7,399 )
    


 


 


Net cash used in investing activities

     (160,354 )     (98,427 )     (58,982 )
    


 


 


Cash flows from financing activities:

                        

Proceeds from revolving loans

     27,704       105,596       84,633  

Repayment of revolving loans

     (27,704 )     (155,596 )     (49,234 )

Net proceeds from long-term debt

     144,861       16,700       79,085  

Repayment of long-term debt

     (52,887 )     (82,440 )     (28,857 )

Increase in debt issuance costs

     (180 )     (703 )     (4,520 )

Repayment of notes from stockholders

     316       505       520  

Proceeds from common stock issuances

     7,966       167,144       4,312  

Repurchase of common stock

     (2 )     (24 )     (19 )
    


 


 


Net cash provided by financing activities

     100,074       51,182       85,920  
    


 


 


Net increase (decrease) in cash and cash equivalents

     (9,451 )     (7,699 )     23,022  

Cash and cash equivalents at beginning of year

     34,173       41,872       18,850  
    


 


 


Cash and cash equivalents at end of year

   $ 24,722     $ 34,173     $ 41,872  
    


 


 


 

The accompanying notes are an integral part of these financial statements.

 

35


Table of Contents

ChipPAC, Inc.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)

 

     For the Years Ended December 31,

     2003

   2002

   2001

Supplemental disclosure of cash flow information

                    

Income taxes paid

   $ 563    $ 988    $ 666
    

  

  

Interest paid

   $ 28,817    $ 31,504    $ 33,659
    

  

  

 

The accompanying notes are an integral part of these financial statements.

 

36


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1:    Business, Recapitalization and Basis of Presentation

 

Business and Organization

 

ChipPAC, Inc. and its subsidiaries (the “Company” or “ChipPAC”) provide packaging and testing services to the semiconductor industry, with service offerings in communications, computing, consumer, automotive, industrial and multi-applications end markets. The Company packages and tests integrated circuits from wafers provided by its customers. The Company markets its services worldwide, with emphasis on the North American market, based on the headquarters of the Company’s customers. The Company’s packaging and testing operations are located in the Republic of Korea (“South Korea” or “Korea”), the People’s Republic of China (“China”) and Malaysia.

 

Recapitalization and Reincorporation

 

Prior to August 5, 1999, the Company represented the combination of four business units of Hyundai Electronics Industries Co., Ltd. (currently Hynix Semiconductor, Inc.) (“HEI”) which operated collectively as HEI’s worldwide packaging and testing operations.

 

On August 5, 1999, affiliates of Bain Capital, Inc. and SXI Group LLC, a portfolio concern of Citicorp Venture Capital, Ltd., which we refer to collectively as the “Equity Investors,” and management acquired a controlling interest in the Company from HEI through a series of transactions, including a merger into ChipPAC, Inc. of a special purpose corporation organized by the Equity Investors. The merger was structured to be accounted for as a recapitalization.

 

On June 13, 2000 the Company was reincorporated in Delaware (“ChipPAC Delaware”). In order to effect the reincorporation, ChipPAC, Inc., a California corporation (“ChipPAC California”), was merged with and into ChipPAC Delaware and as a result of which ChipPAC California ceased to exist. The Company operates its business as ChipPAC, Inc.

 

Basis of Presentation

 

The financial statements for the years ended December 31, 2003, 2002 and 2001, have been prepared on a consolidated basis. The consolidated financial statements include the accounts of ChipPAC, Inc. and its majority controlled and owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain prior period balances have been reclassified to conform to the current period presentation.

 

Recent Events—Proposed Merger

 

On February 10, 2004, the Company signed a definitive agreement for the merger of a wholly-owned subsidiary of ST Assembly Test Ltd, or STATS, with ChipPAC in a stock-for-stock transaction. If the merger is consummated, the Company will become a wholly owned subsidiary of STATS. Under the terms of the agreement, ChipPAC stockholders will receive 0.87 STATS American Depositary Shares, or ADSs, for each share of ChipPAC Class A common stock. Following consummation of the merger, STATS and ChipPAC stockholders will own approximately 54% and 46% of the combined company, respectively, on a fully-converted basis. The Board of Directors of the combined company will have 11 members, and is expected to be comprised of 7 current STATS directors and each of Messrs. Conn, Norby, Park and McKenna, current members of the ChipPAC board who will be nominated for election by STATS shareholders. The new company is proposed to be named STATS ChipPAC Ltd, and it will be headquartered in Singapore.

 

37


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Consummation of the merger is subject to certain conditions, including approval by ChipPAC and STATS stockholders, expiration of waiting periods under the Hart-Scott Rodino Act, receipt of a private letter ruling from the Internal Revenue Service or opinions of outside legal counsel relating to the tax treatment of the merger for ChipPAC stockholders and other customary conditions. A vote of the majority of the Company’s outstanding Class A common stock will be required to approve the merger. The Company’s board of directors has voted to approve the transaction and recommend that its stockholders vote to approve the merger. The transaction is expected to close during the second calendar quarter of 2004. There can be no assurance that the conditions to the merger will be satisfied or that the merger will close in the expected time frame or at all.

 

Note 2:    Summary of Significant Accounting Policies

 

Accounting Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenue and expenses in the financial statements and accompanying notes. Significant estimates made by management include: the useful lives of property, plant and equipment and intangible assets as well as future cash flows to be generated by those assets; revenue reductions relating to customer programs and incentive offerings; allowances for doubtful accounts, customer returns, and deferred tax assets; inventory realizability and contingent liabilities, among others. Actual results could differ from the estimates, and such differences may be material to the consolidated financial statements.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash and cash equivalents consisted of cash and money market funds at December 31, 2003 and 2002.

 

Short-term Investments

 

The Company invests excess cash in auction rate corporate notes which are high-quality and easily marketable instruments to ensure cash is readily available for use in current operations. These instruments have maturity terms of generally 30 days or less. Short-term investments are categorized as available for sale and recorded at market. Due to the short-term nature of these investments, cost approximates market value. The average interest rates on the cash and cash equivalents and short-term investments were 1.0% and 1.4%, respectively.

 

Financial Instruments

 

The amounts reported for cash and cash equivalents, short-term investments, accounts receivable, certain other assets, accounts payable, certain accrued and other liabilities, short-term and long-term debt approximate fair value due to their short maturities or market interest rates.

 

Comprehensive Income (Loss)

 

Statement of Financial Accounting Standard No. 130 “Reporting Comprehensive Income” establishes standards for reporting and displaying comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income (loss) includes all changes in equity during a period from transactions and events from non owner sources. In the years ended December 31, 2003, 2002 and 2001, comprehensive income (loss) equaled net income (loss).

 

38


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Inventories

 

Inventories are stated at the lower of cost (computed using the first-in, first-out method) or market value. The Company generally does not take ownership of its customer supplied semiconductors. The risk of loss associated with the customer supplied semiconductors remains with the customer. These customer supplied semiconductors are not included as part of the Company’s inventories.

 

Long-Lived Assets

 

Long-lived assets held by the Company are reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparison of carrying amounts to future net cash flows an asset is expected to generate. If an asset is considered to be impaired, the impairment to be recognized is measured by the amount which the carrying amount of the assets exceeds the fair value of the asset.

 

Property, Plant and Equipment

 

Property, plant and equipment are recorded at cost. The Company uses the straight-line method to depreciate machinery and equipment over their estimated useful lives from three to eight years. Building facilities and building improvements located in the Shanghai, China facilities are depreciated over 20 years. Building facilities and building improvements in the Kuala Lumpur, Malaysia facilities are depreciated over 25 and 17 years, respectively. Land use rights in Shanghai, China and Kuala Lumpur, Malaysia are amortized over 50 and 99 years, respectively. Leasehold improvements are amortized over the shorter of the asset life or the remaining lease term.

 

Intangibles

 

Intangibles are amortized over their useful lives on a straight-line basis over a period of three to 17 years. We classify our intangibles into three main groups: intellectual property with useful lives ranging from seven to 17 years, software and software development with useful lives of three years and licenses with useful lives of five years.

 

Concentration of Credit Risk and Major Customers

 

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of trade accounts receivable and cash and cash equivalents.

 

The Company’s customers are comprised of companies in the semiconductor industry located primarily in the United States of America. Credit risk with respect to the Company’s trade receivables is mitigated by selling to well established companies, performing ongoing credit evaluations and maintaining frequent contact with customers. The allowance for doubtful accounts is based upon the expected collectability of the Company’s accounts receivable.

 

At December 31, 2003, there was no single customer who accounted for more that 10% of the outstanding trade receivables. At December 31, 2002, three customers accounted for 16%, 15% and 11% of the outstanding trade receivables. Loss of or default by these customers could have an adverse effect upon the Company’s financial position, results of operations and cash flows.

 

39


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Cash and cash equivalents are deposited with banks in the United States of America, South Korea, China, Malaysia, Barbados, British Virgin Islands, Luxembourg, and Hungary. Deposits in these banks may exceed the amount of insurance provided on such deposits. The Company has not experienced any losses to date on its bank cash deposits.

 

Revenue Recognition

 

The Company recognizes revenue upon completion of services, generally at the time of shipment of packaged semiconductors to its customers. Additionally, we record estimated reductions to revenue for customer programs and incentive offerings including special pricing agreements, price protection, promotions and other volume-based incentives. The Company generally does not take ownership of customer supplied semiconductors as these materials are sent to the Company on a consignment basis. Accordingly, the value of the customer supplied materials are neither reflected in revenue nor in cost of revenue. The Company warrants its services; warranty claims historically have been insignificant.

 

Research and Development Costs

 

Research and development costs are charged to expense as incurred.

 

Accounting for Income Taxes

 

The Company accounts for deferred income taxes using the liability method whereby deferred tax assets and liabilities are recorded for temporary differences between amounts reported in the financial statements and amounts that are reported in the Company’s income tax returns. A valuation allowance is provided for deferred tax assets when management cannot conclude, based on the available evidence, that it is more likely than not that all or a portion of the deferred tax assets will be realized through future operations. The provision for income taxes represents taxes that are payable for the current period, plus the net change in deferred tax amounts.

 

Computation of Net Income per Share of Common Stock

 

Basic net income (loss) per share of common stock is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share of common stock is computed using the weighted-average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares result from dilutive stock options and the convertible subordinated notes.

 

Foreign Currency Translation

 

The functional currency of the Company’s foreign operations is the U.S. dollar. Therefore, gains and losses resulting from translation from local currencies to the U.S. dollar are included in determining net income or loss for the period.

 

Stock-Based Compensation

 

At December 31, 2003, the Company has three stock-based employee compensation plans, which are described more fully in Note 14. The Company accounts for those plans under the recognition and measurement principles of APB No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise

 

40


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to the stock-based employee compensation.

 

     Year Ended December 31,

 
     2003

    2002

    2001

 
     (In thousands, except per share
amounts)
 

Net loss as reported

   $ (28,781 )   $ (28,855 )   $ (93,736 )

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

     (4,097 )     (4,581 )     (6,130 )
    


 


 


Pro forma net loss

   $ (32,878 )   $ (33,436 )   $ (99,866 )
    


 


 


Loss per share as reported:

                        

Basic

   $ (0.30 )   $ (0.33 )   $ (1.36 )

Diluted

   $ (0.30 )   $ (0.33 )   $ (1.36 )

Pro forma loss per share:

                        

Basic

   $ (0.34 )   $ (0.38 )   $ (1.45 )

Diluted

   $ (0.34 )   $ (0.38 )   $ (1.45 )
    


 


 


 

Recent Accounting Pronouncements

 

In May 2002, the FASB issued SFAS No. 145, “Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections.” Among other things, SFAS No. 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting Principles Board Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” are met. SFAS No. 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. In 2003, the Company has reclassified a loss on extinguishment of debt that was previously classified as an extraordinary item in prior periods but did not meet the criteria in APB Opinion No. 30 for classification as an extraordinary item and has included it within income from continuing operations.

 

In June 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities.” SFAS No. 146 addresses significant issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring).” The scope of SFAS No. 146 also includes costs related to terminating a contract that is not a capital lease and termination benefits that employees who are involuntarily terminated receive under the terms of a one-time benefit arrangement that is not an ongoing benefit arrangement or an individual deferred-compensation contract. SFAS No. 146 was effective for exit or disposal activities that are initiated after December 31, 2002. The Company adopted SFAS No. 146 during the first quarter of fiscal year 2003. The effect on adoption of SFAS No. 146 changes on a prospective basis the timing of when restructuring charges are recorded from a commitment date approach to when the liability is incurred.

 

In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, or FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a liability be recorded in the guarantor’s balance sheet upon

 

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ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

issuance of a guarantee. In addition, FIN 45 requires disclosures about the guarantees that an entity has issued, including a reconciliation of changes in the entity’s product warranty liabilities. The initial recognition and initial measurement provisions of FIN 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor’s fiscal year-end. The Company adopted FIN 45 in the first quarter of 2003 and has met the disclosure requirements of FIN 45. The adoption of FIN 45 has no material impact on the Company’s financial statements.

 

In November 2002, the Emerging Issues Task Force, or EITF, reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company has adopted EITF Issue No. 00-21. The adoption of EITF Issue No. 00-21 has no material impact on the Company’s financial statements.

 

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based employee compensation be displayed more prominently and in a tabular format. Additionally, SFAS No. 148 requires disclosure of the pro forma effect in interim financial statements. The transition and annual disclosure requirements of SFAS No. 148 are effective for fiscal years ended after December 15, 2002. The interim disclosure requirements are effective for interim periods beginning after December 15, 2002. The Company adopted SFAS No. 148 in the first quarter of 2003. The adoption of SFAS No. 148 has no material impact on its financial statements.

 

In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, or FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after December 15, 2003. The Company believes that the adoption of this standard will have no material impact on its financial statements.

 

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting of derivative instruments and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 149 amends SFAS No. 133 for decisions made: (a) as part of the Derivatives Implementation Group process that require amendment to SFAS No. 133; (b) in connection with other FASB projects dealing with financial instruments; and (c) in connection with the implementation issues raised related to the application of the definition of a derivative. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for designated hedging relationships after June 30, 2003. The Company adopted SFAS No. 149 during 2003. The adoption of SFAS No. 149 will not have a material impact on its financial position and results of operations.

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” The Statement establishes standards for how an issuer classifies

 

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ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

and measures certain financial instruments with characteristics of both liabilities and equity and further requires that an issuer classify as a liability (or an asset in some circumstances) financial instruments that fall within its scope because that financial instrument embodies an obligation of the issuer. Many of these instruments were previously classified as equity. The statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted SFAS No. 150 during 2003. The adoption of this standard will not have a material impact on its financial position and results of operations.

 

Note 3:    Acquisition of Malaysian Business

 

Under the terms of the agreement relating to the Company’s June 2000 acquisition of the Malaysian business, during the period from June 1, 2000 to June 30, 2003, the seller, Intersil, was entitled to receive additional contingent incentive payments based upon the achievement of milestones relating to the transfer of business previously subcontracted by Intersil to a third party. As of December 31, 2003 Intersil achieved all the milestones, and the Company paid Intersil the sum of $17.9 million in the aggregate as additional purchase price. At December 31, 2003, the Company has no further obligations under this arrangement. Additionally, the Company had recorded $2.4 million of other purchase price adjustments based on the difference between the final closing balance sheet and the estimated closing balance sheet of the Malaysian business and recorded deferred tax of $6.1 million on all of these adjustments. All of these additional contingent incentive payments and other adjustments resulted in a further increase of the effective purchase price and non-current assets.

 

There was no goodwill arising from the acquisition of the Malaysian business. The fair value of total assets and liabilities exceeded the purchase price by $56.2 million as of July 1, 2000. This amount, reduced by the additional contingent incentive payments, other purchase price adjustments and related deferred taxes, as of December 31, 2003, has been allocated in full to non-current assets as summarized below:

 

Non-current asset


   Estimated
Fair
Value


   Excess of
Fair Value
of Acquired
Net Amounts
Over Cost


    Total
Additional
Purchase
Price


   Adjusted
Value


          (in millions)     

Land and buildings

   $ 27.9    $ (11.1 )   $ 5.0    $ 21.8

Plant and equipment

     93.9      (36.9 )     18.3      75.3

Intellectual property

     20.9      (8.2 )     3.1      15.8
    

  


 

  

     $ 142.7    $ (56.2 )   $ 26.4    $ 112.9
    

  


 

  

 

Note 4:    Lines of Credit and Other Bank Borrowings

 

Lines of Credit

 

The Company has a borrowing capacity of $50.0 million for working capital and general corporate purposes under the revolving credit line portion of its senior credit facilities. The revolving credit line under the senior credit facilities matures on July 31, 2005. During the year ended December 31, 2003, the Company borrowed and repaid $26.5 million against this revolving line of credit for general corporate purposes at an interest rate of 6.75% per annum. During the three month period ended December 31, 2003, the Company did not utilize any borrowings against this revolving line of credit and as of December 31, 2003, there was no outstanding balance on the revolving line of credit and the entire $50.0 million was available to the Company.

 

The Company has also established two separate lines of credit with Korean Exchange Bank and Cho Hung Bank, with credit limits of $4.0 million and $8.0 million, respectively. During the three month period and year

 

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ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

ended December 31, 2003, no borrowings were made against either of these lines of credit. Both agreements are subject to an annual review by Korean Exchange Bank and Cho Hung Bank for the continued use of the credit line facility. The Company also has a line of credit with a limit of $0.5 million per borrowing available with Southern Bank Bhd for general corporate purposes at an interest rate of 6.9% per annum. During the year ended December 31, 2003, the Company utilized and repaid $0.5 million in the quarter ended March 31, 2003, $0.3 million in the quarter ended June 30, 2003 and $0.4 million during the quarter ended September 30, 2003. During the quarter ended December 31, 2003, the Company did not use this line of credit, and there was no outstanding balance on this loan.

 

Other Borrowings

 

On May 28, 2003, the Company issued $125.0 million of 2.5% convertible subordinated notes due 2008 in a private placement and on June 5, 2003, the initial purchaser exercised the option to purchase an additional $25.0 million of 2.5% senior subordinated notes under the same terms. The Company received net proceeds of approximately $144.9 million after deducting debt issuance costs. The $150.0 million of 2.5% convertible subordinated notes are convertible into shares of the Company’s Class A common stock at a conversion price of $8.062 per share, subject to adjustment, at any time prior to June 1, 2008, and bear an interest rate of 2.5% per annum. The Company used $63.9 million from the proceeds of these notes to pay down term loans of $36.2 million, a foreign loan of $16.7 million and revolving loans of $11.0 million. The remaining $81.0 million is being used for general corporate purposes. On November 24, 2003, a registration statement on Form S-3 to register $143.8 million of these notes, along with the shares of common stock into which the notes are convertible, became effective with the Securities and Exchange Commission. The Company filed an additional registration statement for the other $6.2 million of the notes, along with the shares of common stock into which the notes are convertible, on January 22, 2004.

 

As of December 31, 2003, the Company’s total debt consisted of $365.0 million of borrowings, which was comprised of $165.0 million of 12.75% senior subordinated notes, $50.0 million of 8.0% convertible subordinated notes and $150.0 million of 2.5% convertible subordinated notes.

 

Note 5:    Risks and Uncertainties

 

Industry

 

The Company’s business involves certain risks and uncertainties. Factors that could affect the Company’s future operating results and cause actual results to vary materially from expectations include, but are not limited to, dependence on a cyclical industry that is characterized by rapid technological changes, fluctuations in end-user demands, evolving industry standards, competitive pricing and declines in average selling prices, risks associated with foreign currencies, and enforcement of intellectual property rights. Additionally, the market in which the Company operates is very competitive. As a result of these industry and market characteristics, key elements of competition in the independent semiconductor packaging market include breadth of packaging offerings, time-to-market, technical competence, design services, quality, production yields, reliability of customer service and price.

 

The Company reduced the concentration of its customers that make up more than 10.0% of sales from three customers in the year 2001 accounting for 51.3% of total revenue, and five customers in 2002 accounting for 66.3% of total revenue, to four customers in 2003 accounting for 50.0% of total revenue. Nonetheless, any decommitment from any major customer for products could have an adverse impact on the Company’s financial position, results of operations and cash flows.

 

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ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

In 2003, 2002 and 2001, the Company had four, five and three customers, which each accounted for more than 10.0% of sales, respectively. These customers include Fairchild Semiconductor International, Inc., Intel Corporation, Intersil Corporation, LSI Logic Corporation and nVIDIA Corporation.

 

Other

 

South Korean, Chinese, and Malaysian foreign currency exchange regulations may place restrictions on the flow of foreign funds into and out of those countries. The Company is required to comply with these regulations when entering into transactions in foreign currencies in South Korea, China and Malaysia. As of December 31, 2003 and 2002, there were no restrictions on foreign funds flow.

 

Note 6:    Selected Balance Sheet Accounts

 

The components of inventories were as follows (in thousands):

 

     December 31,

     2003

   2002

Raw materials

   $ 20,029    $ 11,198

Work in process

     4,761      3,293

Finished goods

     1,270      808
    

  

       26,060      15,299
    

  

 

Property, plant and equipment were comprised of the following (in thousands):

 

     December 31,

 
     2003

    2002

 

Land use rights

   $ 11,171     $ 12,368  

Buildings and improvements

     70,330       66,404  

Equipment

     621,327       529,710  
    


 


       702,828       608,482  

Less accumulated depreciation and amortization

     (305,561 )     (272,085 )
    


 


     $ 397,267     $ 336,397  
    


 


 

Land use rights represent payments made to secure, on a fully paid-up basis, the use of the property where the Company’s facilities are located in Shanghai, China and Kuala Lumpur, Malaysia for a period of 50 and 99 years, respectively. The land use rights expire in the year 2044 for Shanghai, China and in the year 2086 for Kuala Lumpur, Malaysia.

 

Other assets were comprised of the following (in thousands):

 

     December 31,

     2003

   2002

Deposits

   $ 925    $ 836

Long-term employee loans

     1,020      802

Debt issuance costs, net of amortization of $5,332 and $5,944

     12,134      10,132

Other

     2,218      1,187
    

  

     $ 16,297    $ 12,957
    

  

 

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ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Intangible assets balances are summarized as follows (in thousands):

 

     December 31, 2003

   December 31, 2002

     Gross
Assets


   Accumulated
Amortization


  

Net

Assets


   Gross
Assets


   Accumulated
Amortization


  

Net

Assets


Intellectual property

   $ 16,884    $ 7,310    $ 9,574    $ 15,734    $ 4,980    $ 10,754

Software and software development

     17,313      11,194      6,119      14,231      8,460      5,771

Licenses

     4,497      4,330      167      4,422      3,647      775
    

  

  

  

  

  

     $ 38,694    $ 22,834    $ 15,860    $ 34,387    $ 17,087    $ 17,300
    

  

  

  

  

  

 

Amortization expense for intangible assets is summarized as follows (in thousands):

 

    

Year Ended

December 31,


     2003

   2002

   2001

Intellectual property

   $ 2,330    $ 2,121    $ 1,955

Software and software development

     2,734      2,554      2,483

Licenses

     683      397      2,812
    

  

  

     $ 5,747    $ 5,072    $ 7,250
    

  

  

 

Intangible assets are being amortized over estimated useful lives of three to 17 years. Estimated future amortization expense is as follows (in thousands):

 

2004

   $ 5,322

2005

     4,606

2006

     3,459

2007

     1,428

2008

     153

Thereafter

     892
    

Total

   $ 15,860
    

 

Accrued expenses and other liabilities were comprised of the following (in thousands):

 

     December 31,

     2003

   2002

Payroll and related items

   $ 14,150    $ 14,778

Interest payable

     9,311      9,210

Other expenses

     4,263      5,412
    

  

     $ 27,724    $ 29,400
    

  

 

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Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Note 7:    Restructuring, write-down of impaired assets and other charges

 

Restructuring

 

2003

 

During the year ended December 31, 2003, restructuring plans were executed to realign the Company’s organization and reduce operating costs to better align the Company’s expenses with revenue. As of December 31, 2003, the Company had a total reduction of 252 personnel related to the restructuring. Restructuring and related charges of $2.0 million were expensed during the year ended December 31, 2003.

 

2002

 

In 2002, the Company utilized $0.3 million of the restructuring reserve for reductions in workforce in its South Korean operations and wrote off executive officer loans against the related $1.5 million loan loss reserve. In 2002, the Company completed another 92 of the planned 751 employee separations. Cumulatively the Company completed 646 of the planned 751 employee separations at December 31, 2002. Due to stronger than expected performance from the South Korean subsidiary and the sale of its plating line in Korea which had been planned to be shut down, reserve releases in the amount of $1.3 million were credited to restructuring charges in the statement of operations for the year ended December 31, 2002. There are no further terminations or other restructuring activities planned for which amounts were reserved in 2001. This credit of $1.3 million was reduced by a restructuring action in the Malaysian plant in which $0.6 million was incurred to terminate 30 employees. This action was not included in the 2001 reserves.

 

2001

 

In the first and fourth quarters of 2001, ChipPAC’s management approved restructuring plans to realign its organization and reduce operating costs. These actions were designed to better align ChipPAC’s workforce with the decrease in demand and to reduce selling, general, and administrative expenses. These plans were a combination of reductions in force and furloughs. Accordingly, ChipPAC planned to reduce associated employee positions by approximately 554 and 197 worldwide in connection with the first and fourth quarter plans, respectively. Restructuring and related charges of $3.0 million and $3.3 million were expensed during the first and fourth quarters of 2001, respectively. The entire first quarter charge was related to employee separations and furloughs. The fourth quarter charge was comprised of $1.8 million related to employee separations and a $1.5 million loan loss reserve for executive officer loans. Employee separation benefits under each plan were similar and included severance, medical and other benefits. As of December 31, 2001, ChipPAC completed 554 of the planned 751 employee separations and all of the furloughs planned for 2001.

 

Components of accrued restructuring costs and amounts charged for restructuring as of December 31, 2003 were as follows (in thousands):

 

   

Beginning

Accrual


  Expenditures

   

December 31,

2001


  Adjustments

    Expenditures

   

December 31,

2002


  Accrual

  Expenditures

   

December 31,

2003


Employee separations

  $ 4,732   $ (3,100 )   $ 1,632   $ (1,283 )   $ (349 )   $ —     $ 1,957   $ (1,458 )   $ 499

Loan loss reserve

    1,500     —         1,500     —         (1,500 )     —       —       —         —  
   

 


 

 


 


 

 

 


 

    $ 6,232   $ (3,100 )   $ 3,132   $ (1,283 )   $ (1,849 )   $ —     $ 1,957   $ (1,458 )   $ 499
   

 


 

 


 


 

 

 


 

 

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ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Write-down of impaired assets

 

The Company reviews property, plant and equipment and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company determines whether there has been an impairment by comparing the anticipated undiscounted future net cash flows to be generated by an asset to its carrying value. If an asset is considered impaired, the asset is written down to fair value which is either determined based on discounted cash flows or appraised or estimated values, depending on the nature of the asset. During the year ended December 31, 2003, the Company wrote down impaired assets by $11.7 million. The Company determined that the expected cash flow related to certain manufacturing equipment were not sufficient to recover the carrying value of the equipment. As the result of this analysis, the carrying values of these assets were written down to the estimated fair market value and will continue to be depreciated over the remaining useful lives. There were no equivalent write-offs in the same period during 2002. During the year ended December 31, 2001, the Company wrote down impaired assets by $34.7 million. The asset write-down related primarily to the Company’s manufacturing assets in the assembly and test facilities in South Korea and Malaysia. The Company determined that due to excess capacity, the future expected cash flows related to equipment for certain package types would not be sufficient to recover the carrying value of the manufacturing equipment in the facility for those package types. The carrying values of these assets were written down to the estimated fair value and continued to depreciate over their remaining useful lives.

 

Note 8:    Earnings per Share

 

Statement of Accounting Standards No. 128 requires a reconciliation of the numerators and denominators of the basic and diluted per share computations. Basic earnings per share (“EPS”) is computed by dividing net income available to stockholders (numerator) by the weighted average number of common shares outstanding (denominator) during the period. Diluted EPS is computed using the weighted average number of shares of common stock and all potentially dilutive shares of common stock outstanding during the period. In computing diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options and the if-converted method is used for determining the number of shares assumed issued from the conversion of the convertible subordinated notes.

 

As of December 31, 2003, there were options outstanding to purchase 7.4 million shares of Class A common stock with a weighted average exercise price of $3.81, which could potentially dilute basic earnings per share in the future, but which were not included in diluted earnings per share as their effect would have been antidilutive. The Company also has outstanding $200.0 million aggregate principal amount of convertible subordinated notes, which are convertible into approximately 23.6 million shares of Class A common stock but were not included in diluted earnings per share as their effect would also have been antidilutive. Had these options and the convertible subordinated notes been included in the diluted earnings per share counts, the total of weighted average shares of Class A common stock would have been 122,471,240 shares.

 

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Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Following is a reconciliation of the numerators and denominators of the basic and diluted EPS computations for the periods presented below.

 

     December 31, 2003

    December 31, 2002

    December 31, 2001

 
     Loss

    Shares

  

Per-Share

Amount


    Loss

    Shares

  

Per-Share

Amount


    Loss

    Shares

  

Per-Share

Amount


 
     (In thousands, except per share amounts)  

Basic EPS:

                                                               

Loss per share

   $ (28,781 )   95,554    $ (0.30 )   $ (25,850 )   87,430    $ (0.30 )   $ (93,736 )   68,878    $ (1.36 )

Effect of dilutive securities:

                                                               

Stock options and warrants

           —                      —                      —           

Diluted EPS:

                                                               

Loss per share

   $ (28,781 )   95,554    $ (0.30 )   $ (25,850 )   87,430    $ (0.30 )   $ (93,736 )   68,878    $ (1.36 )

 

Note 9:    Segments and Geographic Information

 

The Company is engaged in one industry segment, the packaging and testing of integrated circuits.

 

The following table describes the composition of revenue by product group and test services, as a percentage of total revenue:

 

     Year Ended December 31,

 
     2003

    2002

    2001

 

Substrate

   59.0 %   50.9 %   46.0 %

Lead frame

   27.1     33.6     40.2  

Test

   13.9     15.5     13.8  
    

 

 

Total

   100.0 %   100.0 %   100.0 %
    

 

 

 

Revenue from unaffiliated customers is based on the geographic location of each plant’s principal place of business. The Company’s sales by geographic location of the customer were as follows (in thousands):

 

     December 31,

Region


   2003

   2002

   2001

USA

   $ 369,102    $ 323,663    $ 302,405

Asia

     51,503      36,367      19,722

Europe

     8,584      3,636      6,574
    

  

  

Total

   $ 429,189    $ 363,666    $ 328,701
    

  

  

 

The following table presents long-lived identifiable assets based on the location of the asset (in thousands):

 

     December 31,

Region


   2003

   2002

United States

   $ 16,782    $ 9,079

British Virgin Islands

     14,886      18,928

South Korea

     169,745      142,630

China

     100,351      103,177

Malaysia

     127,660      92,840
    

  

Total

   $ 429,424    $ 366,654
    

  

 

49


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Note 10:    Senior Credit Facilities

 

Under the terms of the recapitalization and merger in 1999 all short and long-term debt, loans and leases and other credit facilities existing prior to the recapitalization were terminated at the recapitalization date.

 

To finance part of the recapitalization, the Company borrowed $300.0 million of new debt, comprising $150.0 million of term loans and $150.0 million of senior subordinated notes. The term loans bore interest based on the London Interbank Offered Rate (LIBOR, 1.43% at December 31, 2003) plus 4.3% and the senior subordinated notes bear interest at 12.75% per annum. In 2001, an additional $15.0 million of senior subordinated notes were issued in a private placement. As of December 31, 2003, the balances of the term loans were zero and the balance of the senior subordinated notes was $165.0 million. The senior subordinated notes mature on August 1, 2009. If a change of control occurs, the Company may be required to allow holders of the senior subordinated notes to sell the Company their notes at a purchase price of 101.0% of the principal amount of the notes, plus accrued and unpaid interest. The pending merger with ST Assembly Test Services, Ltd would constitute a change of control. Interest is payable semi-annually for the senior subordinated notes and quarterly for the term loans.

 

The Company has a borrowing capacity of $50.0 million under the senior credit facilities, for working capital and general corporate purposes under the revolving credit line portion of its senior credit facilities. The revolving credit line under the senior credit facilities matures on July 31, 2005. During the year ended December 31, 2003, the Company borrowed and repaid $26.5 million against the revolving line of credit for general corporate purposes at an interest rate of 6.75% per annum. During the three month period ended December 31, 2003, the Company did not utilize any borrowings against this revolving line of credit and as of December 31, 2003, there was no outstanding balance on the revolving line of credit and the entire $50.0 million was available to the Company.

 

The Company’s senior credit facilities, as amended, contain covenants restricting the Company’s operations and requiring that the Company meet specified financial tests. Beginning with the quarter ending December 31, 2002, the financial covenants consist solely of a minimum interest coverage ratio and a maximum senior leverage ratio based on a rolling 12 months calculation. There were no violations of the covenants under the senior credit facilities, as amended, through December 31, 2003.

 

In May and June 2003, the Company issued $150.0 million of 2.5% convertible subordinated notes in a private placement and used a portion of the proceeds to payoff term loans and foreign debt. As a result of the early extinguishment of this debt, associated capitalized debt issuance costs of $1.1 million along with $0.1 million of related debt expenses were written off. In May 2002, the Company used proceeds from the secondary public offering to pay off its remaining term loans. As the result of this early extinguishment of debt, associated capitalized debt issuance costs of $3.0 million and no other related debt expenses were written off.

 

50


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Future maturities of long-term debt at December 31, 2003 were as follows (in thousands):

 

Year Ended December 31,


    

2004

     —  

2005

     —  

2006

     —  

2007

     —  

2008

     150,000

2009

     165,000

2010

     —  

2011

     50,000
    

     $ 365,000

Less current portion

     —  
    

Non current portion

   $ 365,000
    

 

Substantially all assets of the ChipPAC consolidated group, with the exception of the Chinese non-guarantor entity, ChipPAC Shanghai, have been pledged as collateral under the term debt and revolving credit facilities agreement put in place on August 5, 1999. The indenture governing the 12.75% senior subordinated notes has been fully and unconditionally guaranteed, jointly and severally on a senior subordinated basis by the parent company and the guaranteeing subsidiaries. See Note 20—Supplemental Financial Statements of Guarantor/Non-Guarantor Entities.

 

Note 11:    Common Stock and Stockholders’ Equity

 

A portion of certain shares sold by the Company are subject to a right of repurchase by the Company subject to vesting, which is generally over a four year period from the earlier of grant date or employee hire date, as applicable until vesting is complete. At December 31, 2003, there were 8,573 shares subject to repurchase.

 

The Company currently has authorized Class A and B common stock. There are 250,000,000, $0.01 par value, shares authorized of each Class A and Class B common stock. At December 31, 2003 and 2002 there were 97,237,000 and 94,093,000 shares, respectively, of Class A common stock issued and outstanding. There were no shares of Class B common stock issued or outstanding at December 31, 2003 or 2002.

 

On June 13, 2000 the Company was reincorporated in Delaware. In order to effect the reincorporation, ChipPAC, Inc., a California corporation, was merged with and into ChipPAC Delaware and as a result of which ChipPAC California ceased to exist. The Company operates its business as ChipPAC, Inc. The merger occurred immediately prior to the effectiveness of the Company’s Registration Statement on Form S-1 for its initial public offering. In the merger, each outstanding share of ChipPAC California Class A common stock was converted into one share of ChipPAC Delaware Class A common stock. Each outstanding share of ChipPAC California Class B common stock was converted into one share of ChipPAC Delaware Class B common stock. Each outstanding share of ChipPAC California Class L common stock was converted into and became one share of ChipPAC Delaware Class A common stock plus an additional number of shares of ChipPAC Delaware Class A common stock which was determined by dividing a preferential distribution, based in part on the original cost of such share plus an amount which accrued daily at a rate of 12.0% per annum, compounded quarterly, by the per share price of the ChipPAC Delaware Class A common stock in the initial public offering. As a result, Class L common stockholders received 8,880,507 shares of Class A common stock.

 

51


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Initial and Secondary Public Offerings of Common Stock

 

In August 2000, the Securities and Exchange Commission declared effective the Registration Statement on Form S-1 (Registration No. 333-39428) relating to the initial public offering of our Class A common stock. In connection with the closing of the initial public offering, the Company issued a total of 13,693,000 shares of Class A Common Stock for gross proceeds of $163.0 million. The total proceeds from the offering and the concurrent private placement, net of issuance costs, were $151.8 million.

 

On January 30, 2002, the Company sold 10,000,000 shares of Class A common stock in an underwritten public offering for $6.00 per share. On February 14, 2002, the Company sold an additional 1,425,600 shares of Class A common stock in conjunction with the underwriter’s exercise of their over-allotment option for $6.00 per share. In connection with these sales, the Company received net proceeds of approximately $63.8 million, after deducting underwriting discounts, commissions and estimated offering expenses. Net proceeds of $62.4 million from this offering were used to pay down term loans and revolving loans. The remaining $1.3 million was used for general corporate purposes.

 

On May 30, 2002, the Company sold 12,000,000 shares of Class A common stock in an underwritten public offering for $8.75 per share. In connection with these sales, the Company received net proceeds of approximately $99.2 million, after deducting underwriting discounts, commissions and estimated offering expenses. Net proceeds of $50.0 million from this offering were used to pay down term loans and revolving loans. The remaining $49.2 million was used for general corporate purposes.

 

Sources and Use of Funds From Issuances of Common Stock in 2002

 

     January
Offering


    May
Offering


    Totals

 
     (in thousands)  

Source of funds:

        

Gross proceeds from issuance of common stock

   $ 68,554     $ 105,000     $ 173,554  

Less: related issuance costs

     (4,768 )     (5,830 )     (10,598 )
    


 


 


Net proceeds from issuance of common stock

   $ 63,786     $ 99,170     $ 162,956  
    


 


 


Use of funds:

                        

Repayment of senior credit facilities

   $ 62,438     $ 50,000     $ 112,438  

General corporate purposes

     1,348       49,170       50,518  
    


 


 


     $ 63,786     $ 99,170     $ 162,956  
    


 


 


 

In June 2002, the Company utilized $50.0 million of the public offering proceeds to extinguish term loan A and the capital expenditure loan and substantially pay down term loan B under its senior credit facilities. As a result, capitalized debt issuance costs of $3.0 million were written off and the expense is included in the results for the year ended December 31, 2002.

 

Based upon quoted market prices, the fair value of our Senior Subordinated Notes as of December 31, 2003 and 2002 was $181.5 million and $173.1 million, respectively. Based upon quoted market prices, the fair value of our 2.5% Convertible Subordinated Notes as of December 31, 2003 was $188.3 million.

 

52


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Note 12:    Commitments

 

The Company’s executive offices in the United States of America were leased from Hyundai Electronics America (“HEA”) until May 2001. Thereafter, the Company’s executive offices were moved to Fremont, California and are currently leased from an unrelated party. The Company’s facilities in Korea are leased from HEI under non-cancelable operating lease arrangements through 2004 with an option to extend to 2009. Rent expense in the years ended December 31, 2003, 2002, and 2001 was $4.9 million, $5.0 million, and $6.4 million respectively.

 

Future annual minimum lease payments under noncancellable operating leases that have initial or remaining noncancellable lease terms in excess of one year at December 31, 2003 were as follows (in thousands):

 

Years Ended December 31,


    

2004

   $ 7,360

2005

     7,014

2006

     6,460

2007

     6,387

2008

     6,247

Thereafter

     23,253
    

     $ 56,721
    

 

The Company is party to certain royalty and licensing agreements which have anticipated payments of $579 thousand, $331 thousand, $248 thousand and $248 thousand payable in 2004, 2005, 2006 and 2007, respectively.

 

In the ordinary course of business, the Company is subject to claims and litigation, including claims that it infringes third party patents, trademarks and other intellectual property rights. Although the Company believes that it is unlikely that any current claims or actions will have a material adverse impact on its operating results on our financial position, given the uncertainty of litigation, we can not be certain of this. Moreover, the defense of claims or actions against the Company, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

 

The Company is currently party to legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these matters is not presently determinable and cannot be predicted with certainty, management does not believe that the outcome of any of these matters or any of the above mentioned legal claims will have a material adverse effect on the Company’s financial position, results of operations or cash flow.

 

Note 13:    Related Party Transactions

 

     December 31,

     2002

   2001

     (In thousands)

Revenue from sale of packaging and testing services to HEI group

   $ 3,367    $ 4,623

Reimbursement for plating services provided to HEI group including margin of $25 and $2,020, respectively

     4,526      6,392

Accounts receivable at year end for sales and plating services to HEI Group

     6      417

Accounts payable to HEI group for common area use of facilities and utilities

     962      1,370

 

53


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The HEI group sold its entire equity investment of the Company in 2002 and was not considered a related party during the year ended December 31, 2003.

 

During the years ended December 31, 2001, HEA charged $0.3 million to the Company for rent and building related taxes, insurance, and maintenance. There were no similar expenses in the year 2002 or 2003.

 

At June 30, 1998, Hyundai Information Technology (“HIT”) entered into a three-year agreement with ChipPAC Korea to provide information technology services. This agreement terminated in June 2002. For the years ended December 31, 2002 and 2001, HIT charged ChipPAC Korea $0.5 million and $0.9 million, respectively.

 

Note 14:    2000 Equity Incentive Plan and 1999 Stock Purchase and Option Plan

 

The Company adopted the 1999 Stock Purchase and Option Plan, or the “1999 Stock Plan,” which authorized the granting of stock options and the sale of Class A common stock or Class L common stock to current or future employees, directors, consultants or advisors of the Company. Under the 1999 Stock Plan, a committee of the board of directors authorized to sell or otherwise issue Class A common stock or Class L common stock at any time prior to the termination of the 1999 Stock Plan in such quantity, at such price, on such terms and subject to such conditions as established by the committee up to an aggregate of 15,500,000 shares of Class A common stock and 500,000 shares of Class L common stock, including shares of common stock with respect to which options may be granted, subject to adjustment upon the occurrence of specified events to prevent any dilution or expansion of the rights of participants that might otherwise result from the occurrence of such events. No options or stock grants have been made under the 1999 Stock Plan since the initial public offering, when the 2000 Equity Incentive Plan or “2000 Plan” became effective.

 

The Company’s 2000 Plan was adopted by the board of directors and approved by the stockholders on June 14, 2000. Amendments to the 2000 Plan were adopted by the board of directors on January 30, 2001, and approved by the stockholders on March 16, 2001. The 2000 Plan provides for the grant of incentive stock options to employees (including officers and employee directors) and for the grant of nonstatutory stock options to employees, directors and consultants. A total of (1) 11,615,698 shares of common stock, (2) any shares returned to the Company’s 1999 Stock Plan as a result of termination of options and (3) annual increases to be added on the date of each annual meeting of stockholders of the Company commencing in 2001 equal to one percent of the outstanding shares of common stock, or a lesser amount as may be determined by the board of directors, have been reserved for issuance pursuant to the 2000 Plan.

 

In 2003, 92,982 shares were returned from the 1999 Stock Plan and pooled into the 2000 Stock Plan. In May 2003, an additional 950,927 shares were added to the 2000 Plan as the result of the annual increase of one percent of the outstanding shares of common stock as of the annual meeting of the stockholders.

 

Options are granted at the fair market value and expire up to ten years after the date of grant. Vesting occurs usually over a two to four-year period.

 

54


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following table summarizes stock option activity under the 1999 Stock Plan:

 

1999 Option Plan


   Options
Available
for Grant


    Options
Outstanding


    Weighted
Average
Exercise
Price


Balances at December 31, 2000

   —       1,688,240     $ 6.71

Options repurchased

   57,669     —         —  

Options cancelled

   201,362     (201,362 )     6.99

Vested options expired

   22,612     (22,612 )     7.48

Options exercised

   —       (106,772 )     1.74

Options transferred

   (281,643 )   —         —  
    

 

 

Balances at December 31, 2001

   —       1,357,494     $ 7.05

Options repurchased

   30,719     —         —  

Options cancelled

   111,670     (111,670 )     6.33

Vested options expired

   17,924     (17,924 )     10.59

Options exercised

   —       (104,395 )     4.20

Options transferred

   (160,313 )   —         —  
    

 

 

Balances at December 31, 2002

   —       1,123,505     $ 7.35

Options repurchased

   7,002     —         —  

Options cancelled

   25,686     (25,686 )     11.51

Vested options expired

   60,294     (60,294 )     11.90

Options exercised

   —       (204,109 )     4.25

Options transferred

   (92,982 )   —         —  
    

 

 

Balances at December 31, 2003

   —       833,416     $ 7.61
    

 

 

 

The following table summarizes stock option activity under the 2000 Plan:

 

2000 Option Plan


   Options
Available for
Grant


    Options
Outstanding


    Weighted
Average
Exercise
Price


Balances at December 31, 2000

   39,469     1,250,732     $ 4.93

Options reserved

   10,756,426     —         —  

1999 options transfer-in

   281,643     —         —  

Options granted

   (4,768,235 )   4,768,235       2.95

Options cancelled

   228,001     (228,001 )     4.81

Vested options expired

   200     (200 )     7.88
    

 

 

Balances at December 31, 2001

   6,537,504     5,790,766     $ 3.30

Options reserved

   811,081     —         —  

1999 options transfer-in

   160,313     —         —  

Options granted

   (334,600 )   334,600       6.02

Options cancelled

   668,865     (668,865 )     3.32

Vested options expired

   18,334     (18,334 )     8.03

Options exercised

   —       (137,540 )     2.97
    

 

 

Balances at December 31, 2002

   7,861,497     5,300,627     $ 3.46

Options reserved

   950,927     —         —  

1999 options transfer-in

   92,982     —         —  

Options granted

   (2,672,280 )   2,672,280       2.92

Options cancelled

   434,980     (434,980 )     3.48

Vested options expired

   53,133     (53,133 )     7.65

Options exercised

   —       (877,219 )     2.56
    

 

 

Balances at December 31, 2003

   6,721,239     6,607,575     $ 3.33
    

 

 

 

55


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The following table summarizes information with respect to options outstanding and exercisable at December 31, 2003:

 

   

Options Outstanding


 

Options Exercisable


Exercise Price


 

Number of

Shares


 

Weighted Avg.
Exercise Price


 

Weighted Avg.
Remaining
Contractual Life


 

Number of

Shares


 

Weighted Avg.
Exercise Price


$0.29 – 0.29

  74,672   $0.29   5.9        71,812   $0.29

  1.80 – 2.55

  3,636,823     2.29   8.6   1,424,268     1.88

  2.78 – 4.07

  2,154,396     3.48   7.2      898,706     3.34

  4.59 – 6.14

  863,393     5.69   7.3      496,665     5.56

  6.90 – 9.52

  320,243     8.43   8.0      126,926     8.59

12.60 – 12.75

  391,464   12.63   6.5      273,447   12.63
   
 
 
 
 

$0.29 – 12.75

  7,440,991   $3.81   7.9   3,291,824   $3.95
   
 
 
 
 

 

The estimated weighted average fair value of options granted in 2003, 2002 and 2001 were $2.92, $6.02 and $2.95, respectively, based on the Black-Scholes option pricing model using assumptions as described below.

 

Employee Stock Purchase Plan

 

In 2000, the Company adopted an employee stock purchase plan (“ESPP”) for the benefit of its employees. The ESPP qualified in the United States of America under section 423 of the Internal Revenue Code. Under the ESPP, substantially all employees may purchase the Company’s Class A common stock through payroll deductions at a price equal to 85.0% of the lower of the fair market value at the beginning or the end of each specified six-month offering period. Stock purchases are limited to 15.0% of an employee’s eligible compensation. During 2003, a total of 2,069,921 shares of Class A common stock at a weighted average price of $2.36 per share, were issued through the ESPP. For the year 2002, a total of 1,092,047 shares of Class A common stock at a weighted average price of $3.05 per share were issued. At December 31, 2003, 7,059,339 shares were reserved for future issuance under the ESPP.

 

The estimated weighted average fair value of shares purchased under the Employee Stock Purchase Plan in 2003 and 2002 was $0.79 and $1.90, respectively.

 

56


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Stock-Based Compensation

 

No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect of net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to the stock-based employee compensation.

 

     Year Ended December 31,

 
     2003

    2002

    2001

 
     (In thousands, except per share
amounts)
 

Net loss as reported

   $ (28,781 )   $ (28,855 )   $ (93,736 )

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

     (4,097 )     (4,581 )     (6,130 )
    


 


 


Pro forma net loss

     (32,878 )     (33,436 )     (99,866 )
    


 


 


Loss per share as reported:

                        

Basic

   $ (0.30 )   $ (0.33 )   $ (1.36 )

Diluted

   $ (0.30 )   $ (0.33 )   $ (1.36 )

Pro forma loss per share:

                        

Basic

   $ (0.34 )   $ (0.38 )   $ (1.45 )

Diluted

   $ (0.34 )   $ (0.38 )   $ (1.45 )

 

In calculating pro forma compensation, the fair value of each stock option and stock purchase right is estimated on the date of grant using the Black-Scholes option-pricing model and the following weighted average assumptions:

 

    

Employee Stock Options

December 31,


     2003

   2002

  2001

Dividend yield

   None    None   None

Volatility

   56%-71%    56%   57%

Risk-free interest rate

   1.91%-2.90%    3.00%-4.57%   3.63%-4.83%

Expected lives (in years)

   4    4   2-4

 

    

Employee Stock Purchase Plan

December 31,


     2003

   2002

   2001

Dividend yield

   None    None    None

Volatility

   56%    56%    57%

Risk-free interest rate

   1.18%-1.65%    1.96%-2.95%    4.96%-6.33%

Expected lives (in years)

   0.5    0.5    0.5

 

57


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Note 15:    Income Taxes

 

The components of the provision for income taxes are comprised of the following (in thousands):

 

     Year Ended December 31,

 
     2003

    2002

    2001

 

Current

                        

Federal

   $ —       $ —       $ —    

State

     5       6       1  

Foreign

     3,190       2,115       941  
    


 


 


Total Current

     3,195       2,121       942  
    


 


 


Deferred

                        

Federal

     —         —         3,327  

State

     —         —         385  

Foreign

     (1,195 )     (121 )     (2,076 )
    


 


 


Total Deferred

     (1,195 )     (121 )     1,636  
    


 


 


Provision for income taxes

   $ 2,000     $ 2,000     $ 2,578  
    


 


 


 

Loss before income taxes is comprised of the following (in thousands):

 

     Year Ended December 31,

 
     2003

    2002

    2001

 

Domestic

   $ (5,613 )   $ (2,117 )   $ (483 )

Foreign

     (21,168 )     (24,738 )     (90,675 )
    


 


 


     $ (26,781 )   $ (26,855 )   $ (91,158 )
    


 


 


 

A summary of the composition of net deferred income tax assets (liabilities) is as follows (in thousands):

 

     December 31,

 
     2003

    2002

 

Assets:

                

Loss due to impaired assets

   $ 842     $ 1,783  

Income recognized for tax but not for books

     3,843       15,099  

Tax credits

     15,230       10,691  

NOL Carryforward

     7,886       6,137  

Other

     2,327       2,331  
    


 


Total gross deferred tax assets

     30,128       36,041  

Less valuation allowance

     (18,575 )     (24,188 )
    


 


Net deferred tax assets

     11,553       11,853  

Liabilities:

                

Depreciation

     (18,427 )     (18,354 )
    


 


Gross deferred tax liabilities

     (18,427 )     (18,354 )
    


 


Total net deferred tax asset/(liability)

   $ (6,874 )   $ (6,501 )
    


 


 

58


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

As of December 31, 2003, the Company established a partial valuation allowance against its gross deferred tax assets to reduce the assets to the amount the Company deemed, more likely than not, to be recoverable prior to repatriation. The Company considered, among other factors, its historical profitability, excluding effect of one-time charges, projections of future taxable income and the ability of the Company’s foreign subsidiaries to utilize their deferred tax assets. The net change in total valuation allowance as of December 31, 2003 was an increase of approximately $1.1 million. A portion of the valuation allowance was attributable to the potential tax benefit of stock based compensation totaling approximately $0.3 million in 2003 and $0.2 million in 2002. These amounts, if realized, will be credited to additional paid-in capital.

 

Included in deferred tax liabilities relating to depreciation as of December 31, 2003 is an amount of $6.1 million relating to additional purchase price for the Malaysia business, which was included in non-current assets. The total net deferred tax liability is included in other long-term tax liabilities.

 

Reconciliation of the statutory federal income tax to the Company’s effective tax:

 

     December 31,

 
     2003

    2002

    2001

 

Tax at federal statutory rate

   35.0 %   35.0 %   35.0 %

State, net of federal benefit

   0.4     2.1     0.9  

Valuation allowance on net operating loss

   —       —       (6.8 )

Foreign operation net difference

   (41.4 )   (44.6 )   (31.4 )

Other

   (1.5 )   0.1     (0.5 )
    

 

 

Provision for income taxes

   (7.5 )%   (7.4 )%   (2.8 )%
    

 

 

 

At December 31, 2003, the Company had approximately $15.2 million of federal and $8.5 million of state net operating loss carryforwards available to offset future taxable income, which expire in varying amounts from 2006 to 2023. Under the Tax Reform Act of 1986, the amounts of the benefits from net operating loss carryforwards may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that the Company may utilize in any one year, include, but are not limited to, a cumulative ownership change of more than 50.0%, as defined over a three-year period.

 

Note 16:    Employee Benefit Plans

 

Retirement and Deferred Savings Plan—United States of America

 

The Company maintains a retirement and deferred savings plan for its employees (the “401(k) Plan”). The 401(k) Plan is intended to qualify as a tax qualified plan under the Internal Revenue Code. The 401(k) Plan provides that each participant may contribute up to 15.0% of tax gross compensation (up to a statutory limit). Under the 401(k) Plan, the Company is required to make contributions based on contributions made by employees. The Company’s contributions to the 401(k) Plan for the years ended December 31, 2003, 2002 and 2001 were approximately $0.2 million in each year. All amounts contributed by participants and related earnings are fully vested at all times.

 

Severance Benefits—Korea

 

Employees and directors with more than one year of service are entitled to receive a lump-sum payment upon termination of their employment with ChipPAC Korea, based on their length of service and rate of pay at the time of termination. Accrued severance benefits are adjusted annually for all eligible employees based on their employment as of the balance sheet date.

 

59


Table of Contents

ChipPAC, Inc.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

In accordance with the National Pension Act of South Korea, a certain portion of severance benefits has been deposited with the Korean National Pension Fund and deducted from accrued severance benefits. The amounts contributed will be refunded to employees from the National Pension Fund upon retirement. The expense for severance benefits for the years ended December 31, 2003, 2002, and 2001 amounted to approximately $3.6 million, $3.8 million, and $2.6 million, respectively.

 

Note 17:    Contingent Liabilities

 

During the quarter ended June 30, 2002, an assessment of approximately 16.0 billion Korean Won (approximately $13.4 million U.S. Dollars at December 31, 2003) was made by the Korean National Tax Service, or NTS, relating to withholding tax not collected on the loan between the Company’s subsidiaries in Korea and Hungary. The prevailing tax treaty does not require withholding on the transactions in question. The Company has appealed the assessment through the NTS’s Mutual Agreement Procedure (“MAP”) and believes that the assessment will be overturned. On July 18, 2002, the Icheon tax office of the NTS approved a suspension of the proposed assessment until resolution of the disputed assessment. The NTS required a corporate guarantee amounting to the tax assessment in exchange for the suspension. The Company complied with the guarantee request on July 10, 2002. A further assessment of 2.7 billion Won (approximately $2.3 million U.S. Dollars at December 31, 2003) was made on January 1, 2004, for the subsequent interest. The Company has applied for the MAP and obtained an approval for a suspension of the proposed assessment by providing a corporate guarantee amounting to the additional taxes. As of December 31, 2003, no accrual has been made.

 

Note 18:    Acquisition of Cirrus Logic Test Assets

 

On June 30, 2003, the Company acquired the semiconductor test assets of Cirrus Logic, Inc. Pursuant to the Asset Purchase Agreement by and between the Company and Cirrus Logic, the Company has paid Cirrus Logic $3.5 million in cash. The terms of the acquisition of the Cirrus Logic semiconductor test assets also requires the Company to pay until June 30, 2007 additional contingent incentive payments to Cirrus Logic of up to approximately $3.8 million based on the achievement of certain milestones.

 

Note 19:    Sale of Building

 

The Company sold a vacant building and land, located in its Malaysian facility to Texas Instruments Malaysia for total consideration of $5.4 million, net of expenses. The Company realized a gain of $3.9 million as a result of the sale.

 

Note 20:    Supplemental Financial Statements of Guarantor/Non-Guarantor Entities

 

In connection with the recapitalization, in August 1999, ChipPAC International Company Limited, (“CP Int’l”), issued senior subordinated debt securities which are fully and unconditionally guaranteed, jointly and severally, on a senior subordinated basis, by the parent company, ChipPAC, Inc. (“CPI”) and by ChipPAC (Barbados) Ltd., ChipPAC Limited, ChipPAC Korea Company Limited (“CPK”), ChipPAC Malaysia Sdn. Bhd. (“CPM”), ChipPAC Luxembourg S.a.R.L., and ChipPAC Liquidity Management Hungary Limited Liability Company (the “Guarantor Subsidiaries”). All Guarantor Subsidiaries are wholly owned direct or indirect subsidiaries of CPI. ChipPAC Shanghai Limited (“CPS”) did not provide guarantees (the “Non-Guarantor Subsidiary”). The following is consolidated financial information for CP Int’l, CPI, CPM, and CPK, CPS, ChipPAC (Barbados) Ltd., ChipPAC Limited, ChipPAC Luxembourg S.a.R.L., and ChipPAC Liquidity Management Hungary Limited Liability Company, segregated between the Guarantor and Non-Guarantor Subsidiaries.

 

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Table of Contents

ChipPAC, Inc.

 

SUPPLEMENTAL CONSOLIDATING CONDENSED BALANCE SHEETS

December 31, 2003

(In thousands)

 

    

Parent

Guarantor

CPI


   

Issuer

CP Int’l


   

Other

Guarantors


   

Non-

Guarantor

China


    Eliminations

    Consolidated

 

ASSETS

                                                

Current assets:

                                                

Cash and cash equivalents

   $ 899     $ 132     $ 20,614     $ 3,077     $ —       $ 24,722  

Short-term investments

     30,036       —         4,950       —         —         34,986  

Intercompany accounts receivable

     191,333       23,223       23,310       17,687       (255,553 )     —    

Accounts receivable, net

     —         —         56,659       69       —         56,728  

Inventories

     —         —         21,424       4,636       —         26,060  

Prepaid expenses and other current assets

     1,190       38       3,932       2,251       —         7,411  
    


 


 


 


 


 


Total current assets

     223,458       23,393       130,889       27,720       (255,553 )     149,907  

Property, plant and equipment, net

     5,022       13,855       278,555       99,835       —         397,267  

Intercompany loans receivable

     —         200,880       —         —         (200,880 )     —    

Investment in subsidiaries

     64,095       —         87,677       —         (151,772 )     —    

Intangible assets, net

     1,339       —         14,142       379       —         15,860  

Other assets

     7,230       5,019       3,911       137       —         16,297  
    


 


 


 


 


 


Total assets

   $ 301,144     $ 243,147     $ 515,174     $ 128,071     $ (608,205 )   $ 579,331  
    


 


 


 


 


 


Liabilities and stockholders’ equity

                                                

Current liabilities:

                                                

Intercompany accounts payable

   $ 171     $ 3,624     $ 227,228     $ 24,530     $ (255,553 )   $ —    

Accounts payable

     1,105       55       55,448       12,643       —         69,251  

Accrued expenses and other current liabilities

     4,825       8,970       8,955       4,974       —         27,724  
    


 


 


 


 


 


Total current liabilities

     6,101       12,649       291,631       42,147       (255,553 )     96,975  

Long-term debt

     —         165,000       —         —         —         165,000  

Convertible subordinated notes

     200,000       —         —         —         —         200,000  

Intercompany loans payable

     —         —         200,880       —         (200,880 )     —    

Other long-term liabilities

     —         —         22,313       —         —         22,313  
    


 


 


 


 


 


Total liabilities

     206,101       177,649       514,824       42,147       (456,433 )     484,288  
    


 


 


 


 


 


Stockholders’ equity:

                                                

Common stock

     972       —         —         —         —         972  

Additional paid in capital

     284,849       81,689       174,692       149,093       (405,474 )     284,849  

Receivable from stockholders

     (164 )     —         —         —         —         (164 )

Accumulated other comprehensive income

     9,169       —         8,705       464       (9,169 )     9,169  

Accumulated deficit

     (199,783 )     (16,191 )     (183,047 )     (63,633 )     262,871       (199,783 )
    


 


 


 


 


 


Total Stockholders’ equity

     95,043       65,498       350       85,924       (151,772 )     95,043  
    


 


 


 


 


 


Total liabilities and stockholders’ equity

   $ 301,144     $ 243,147     $ 515,174     $ 128,071     $ (608,205 )   $ 579,331  
    


 


 


 


 


 


 

61


Table of Contents

ChipPAC, Inc.

 

SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS

Year ended December 31, 2003

(In thousands)

 

     Parent
Guarantor
CPI


    Issuer CP
Int’l


    Other
Guarantors


   

Non-

Guarantor
China


    Eliminations

    Consolidated

 

Intercompany revenue

   $ 26,572     $ 2,141     $ —       $ 72,929     $ (101,642 )   $ —    

Customer revenue

     —         —         429,031       158       —         429,189  
    


 


 


 


 


 


Total revenue

     26,572       2,141       429,031       73,087       (101,642 )     429,189  

Cost of revenue

     567       1,323       397,073       67,978       (101,642 )     365,299  
    


 


 


 


 


 


Gross profit

     26,005