ITEM 1. BUSINESS
VLSI Technology, Inc., a Delaware corporation ("VLSI" or the "Company"), was incorporated in May 1987 as a successor to the business of VLSI Technology, Inc., a California corporation ("VLSI-California"). The merger of VLSI-California with and into the Company was consummated on December 31, 1987. All references herein to "VLSI" or the "Company" include its predecessor VLSI-California unless specified or unless the context otherwise requires.
This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of the risk factors set forth below and elsewhere in this Form 10-K.
OVERVIEW
VLSI designs, manufactures and sells complex application-specific integrated circuits ("ASICs"), which are custom designed chips for an individual customer, and application-specific standard products ("ASSPs"), which are semi-custom chips designed for a particular market application that may be used by several different customers. Through its majority-owned subsidiary, COMPASS Design Automation, Inc. ("COMPASS"), VLSI offers an integrated suite of electronic design automation ("EDA") software tools, foundry-flexible libraries and support services for use by systems and circuit designers at other semiconductor and systems design companies in addition to VLSI (see "COMPASS DESIGN AUTOMATION" below).
VLSI applies its value-added technology to deliver products targeted at specific segments of the electronics marketplace. These products address a range of applications in the computing, communications and consumer digital entertainment markets. VLSI targets a limited number of key Original Equipment Manufacturer ("OEM") customers who are leaders in their respective industries. See "MARKETING AND CUSTOMERS" below.
The Company has developed significant design expertise in its targeted markets by establishing a library of proprietary cells and highly integrated building blocks and uses that expertise to assist customers in rapidly designing products and bringing them to market.
The Company's objective is to design and manufacture highly-integrated, complex semiconductor devices that allow its customers to develop and bring to market higher value-added systems and products. Key elements in its strategy to achieve this objective include:
Target selected growth markets. VLSI has targeted a limited number of growth markets in which it has built significant expertise. In these markets, the Company can utilize its library of proprietary cells and high-level building blocks to assist customers in designing and bringing the customers' products to market rapidly. VLSI believes that this allows the Company to offer more value to the customer at potentially higher gross margins for the Company. VLSI's target markets include computing (high-end computing and desktop and portable personal computers) applications, wireless and networking communications applications and consumer digital entertainment systems.
Develop differentiated products. VLSI seeks to develop differentiated products that allow a customer both to distinguish the customer's products from those offered by its competitors and to reduce the customer's product cost. The Company creates highly complex products that reduce the number of integrated circuit devices required for a given application and contain advantageous combinations of features and functionality. VLSI emphasizes high performance applications where its products are critical elements of complex electronic systems.
Focus on large, industry-leading OEM customers. VLSI focuses its manufacturing and research and development resources on products for a limited number of OEM customers who are leaders in their respective industries. The Company believes that such large OEM customers provide the Company with
significant potential. During the year ended December 29, 1995, approximately two-thirds of the Company's net revenues were derived from sales to its top 20 customers.
Use FSB(TM) libraries to reduce customers' time to market. VLSI's Functional System Block(TM) ("FSB") libraries, an expanding collection of pre-designed cells and high-level building blocks, provides easy design-in of frequently used integrated circuit functions. The FSB library elements allow VLSI and its customers to more rapidly design and integrate products, thereby reducing VLSI's customers' time to market. VLSI's library of FSBs includes Graphics Controllers (LCD and CRT), a DES Encryption FSB, a PCI FSB, Floppy Disk Controllers, SCSI Controllers, T1 Controllers and a suite of analog functions for communications FSBs. VLSI continues to expand its FSB libraries through internal development and through the acquisition or licensing of technology from other companies. Technology acquired and/or licensed from other companies include an ARM RISC-based microprocessor (low power, high performance embedded control applications), DSP, Ethernet, Fibre Channel, MPEGII and SSA.
Focus on customer support. The Company seeks to differentiate itself from its competitors not only through the quality of its products, but also through the level of its technological support and service. VLSI operates a network of geographically dispersed Technology Centers where experienced engineers with a specific technical focus work directly with customers to develop designs for new products and to provide continuing after-sale customer support.
SILICON OPERATIONS -- VLSI PRODUCTS
PRODUCTS AND SERVICES
VLSI has organized its business around targeted market segments, establishing groups to address specific silicon markets. Each of the Company's silicon groups maintains independent marketing and applications research and development capabilities.
The Company's market-focused structure permits VLSI to dedicate certain of its engineers to develop systems expertise in, and experience with issues peculiar to, applications in a particular market. VLSI believes that this increased systems expertise allows it to offer more value to the customer through the development of FSBs to address those specific issues. VLSI's customers in silicon market segments have a choice of using proprietary solutions, standard solutions that are shared among multiple customers, or a combination of both.
The Computing Products group designs, manufactures and markets devices for the computer market, including personal computer ("PC") applications and high-end computing applications such as graphics workstations and high-end storage. The Communications Products group designs, manufactures and markets devices for networking and wireless communications. The Consumer Digital Entertainment Products group designs, manufactures and markets devices for secure communications and home entertainment applications (such as interactive television and video game systems).
The key to the success of these business units is providing customers with timely silicon solutions optimized for their applications. This approach enables rapid market introduction of customer products coupled with the ability to customize for specific customer requirements.
FSB library elements consist of system-level blocks that provide a higher level of integration than in a traditional design library. These blocks are designed to be combined with other FSB blocks, random logic and compiled elements to provide the optimum silicon circuit with minimum customer design time. FSB cells are intended to speed the development of integrated circuits ("ICs"), resulting in faster time to market for customers.
Competition comes from a wide variety of large, established IC providers, including, but not limited to, AT&T, Intel, IBM, LSI Logic, Motorola, NEC, Texas Instruments ("TI") and Toshiba.
COMPUTING PRODUCTS
This group produces PC devices for Apple, its subcontractors and licensees as well as Apple-compatible peripheral suppliers worldwide and system-logic chip sets and peripheral components for personal computers based on X86 and competing personal computing architectures. The group also serves workstations (from entry-level through high-end graphic), servers, parallel processors, mass storage devices and peripherals. Apple and its licensees are provided with high-performance gate array and cell-based products, which are used in second-generation Power Macintosh(TM) systems, Apple's Powerbook(TM) computer line based on the Macintosh(R) platform and in a host of printer products. While the Company did not have significant silicon content in Apple's first generation Power Macintosh(TM) machines in 1994, VLSI has returned to historic levels of silicon content in second-generation Power Mac systems in 1995. See "MARKETING AND CUSTOMERS" below. See also "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results" in Item 7 of Part II herein.
The PC chip set product line consists of highly-integrated core logic and peripheral input/output devices for X86 systems. The group primarily targets a selected set of high-volume market leaders worldwide. VLSI's chip sets currently support Intel, Advanced Micro Devices and other competing microprocessors.
During 1995, the dynamics of the X86 core logic chip set market changed dramatically with Intel, the dominant microprocessor supplier, gaining significant market share in core logic chip sets that work with its microprocessors, as well as motherboards that use the microprocessor and core logic chip sets. By the second half of 1995, Intel dominated the core logic chip set business and VLSI's design wins in this area dropped significantly. This drop is expected to result in a sharp decline in the Company's core logic chip set business in 1996. The Computing Products group is therefore shifting its focus away from standard core logic chip sets and redirecting its expertise to develop and produce custom products for X86 applications.
See "COMPETITION" herein and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results" in Item 7 of Part II hereof for recent 1996 developments that will likely reduce VLSI's current market share of the PC chip set market.
Significant high-end computing customers include AT&T, DEC, Silicon Graphics and Storage Technology.
COMMUNICATIONS PRODUCTS
This group serves wireless and network customers. Wireless solutions are provided for communications voice and data through the use of baseband signal processing technology developed to support various voice and data standards, the majority of which in 1995 were GSM solutions, and in 1996 are expected to include GSM, PHS, DECT and CDPD solutions. Standard products include GTI2000 (a GSM reference solution), Geode (a CDPD reference solution), RubyII (a communication processor) and Vocoder and Kernal (GSM basebands). The group supports major wireless telephone manufacturers, including Ericsson, Acer and Motorola. Additionally, solutions have been developed for other markets and standards. Wireless revenues are primarily generated in non-U.S. markets; sales to a single OEM, Ericsson, accounted for over 50% of 1995 and 1994 worldwide wireless revenues.
Network solutions are provided for customers such as Alcatel, Cisco Systems, DSC Communications, NEC and Tellabs in several applications, including digital cross-connect, transmission, networking/internetworking, switching and multiplexing. Certain communications-specific FSB cells have been employed as high-level building blocks and designed to consolidate voice, data, image and video onto single networks and comply with the relevant industry standards that include high complexity analog, digital and memory functions. Specific solutions for major customers include FSB cells for various networking standards, including ATM, T1, E1 and Sonet/SDH.
CONSUMER DIGITAL ENTERTAINMENT PRODUCTS
This group primarily targets high-volume entertainment-related markets including satellite and cable set-top box, digital video disk, cable modem, and electronic games as well as other miscellaneous industrial
applications including manufacturing and robotics. The customer base for the group includes the Allen Bradley Division of Rockwell International, General Instruments, Pioneer, Sagem SAT, Sony and Thomson Consumer Electronic.
As these products become more sophisticated and interactive, security becomes a critical element of the product. In response to this critical need, VLSI has teamed its secure information technology with these consumer products. Secure information technologies in the form of data encryption strategies are another key area of focus for this group. VLSI also provides commercial applications of technologies developed for military applications, including Geo-Positioning Satellite systems and entertainment applications of graphics technology.
MARKETING AND CUSTOMERS
The Company primarily uses a direct sales force and commissioned representatives to sell its silicon products and services. VLSI's silicon operations have 27 sales offices (19 in the United States, four in Europe, two in Japan and two in the Asia-Pacific region) as well as 19 Technology Centers (12 in the United States, four in Europe, two in Japan and one in the Asia-Pacific region). The direct sales force is assisted by VLSI engineers located in its Technology Centers.
The Company's Technology Centers support VLSI's customers by offering a range of design services. These services include system definition, complete logic and circuit design and test program generation. The Technology Centers are staffed by system and integrated circuit designers.
During each of the years 1995, 1994 and 1993, VLSI's top 20 customers represented approximately two-thirds of the Company's net revenues. Shipments to a single customer in the personal computer business, Apple, accounted for 11% of net revenues in 1995 and 19% in 1993, as compared to less than 10% in 1994. Shipments to Compaq accounted for 22% of net revenues in 1994, as compared to less than 10% in both 1995 and 1993. Due to the expected decline in the Company's X86 chip set business, the Company anticipates a shift in its top 20 customers in 1996 away from the high concentration of personal computer industry companies that was seen in 1995 and in prior years. See also Item 7 of Part II herein, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results."
RESEARCH AND DEVELOPMENT
The Company's research and development ("R&D") is focused on continued development and improvement of its systems applications expertise, process and packaging technologies, design libraries and its expertise with cell-based and gate array ICs. The Company's R&D expenditures for the years 1995, 1994 and 1993 have shown sequential increases with total expenses of $89.7 million, $78.9 million and $66.4 million, respectively.
The Company's future success depends on its ability to develop and introduce new products that compete effectively on the basis of price and performance and that satisfy customer requirements. New product development often requires long-term forecasting of market trends, development and implementation of new processes and technologies and substantial capital commitments. For example, the Company invested significant resources in 1993 and 1994 toward developing products for the handheld computer market, which failed to develop as estimated, thereby postponing, if not permanently deferring, the Company's recovery of the cost of these development expenditures. If the Company is unable to design, develop, manufacture and market new products successfully and in a timely manner, its operating results could be adversely affected. No assurance can be given that the Company's product and process development efforts will be successful.
The Company regards purchased technology as a key component of product development. A few examples include ARM, DSP, Ethernet, Fibre Channel, MPEGII, SSA, power management, communications (including standards such as DECT, CT2, GSM and PHS), signal converters, forward error correction and digital signal processing, which represent key licensed technology. Research and development efforts are
ongoing to create products from those technologies and establish them as FSB's for use in ASIC products or for incorporation in ASSPs.
The Company's process technology development activities in 1995 concentrated on the successful development of a 0.35-micron CMOS process and on the development of software for the EDA market. R&D activities in the packaging area continue to focus on high performance, high pincount advanced packaging solutions and assembly techniques.
Research and development activities are sometimes augmented through alliances with other companies. Wafer process technology development efforts in 1995 in conjunction with the Company's strategic agreement with Hitachi include integration of 0.35-micron CMOS process and manufacturing methodologies.
See also "EMPLOYEES" below and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results" in Item 7 of Part II herein.
MANUFACTURING
The fabrication of ICs is an extremely complex and precise process consisting of hundreds of separate steps and requiring production in a highly controlled, clean environment. Minute impurities, errors in any step of the fabrication process, defects in the masks used to print circuits on a wafer or a number of other factors can cause a substantial percentage of wafers to be rejected or numerous die on each wafer to be nonfunctional.
Semiconductor manufacturing is also highly capital intensive, and capital costs have tended to significantly increase as geometries have decreased in size. The marketplace has placed an ongoing emphasis on ever-smaller geometries, evidenced by increasing demand for deep sub-micron devices (those geometries under 0.6-micron), requiring the Company to increase its capital investment needs.
The Company's success is partially dependent upon its ability to develop and implement new manufacturing process technologies. Semiconductor design and process methodologies are subject to rapid technological change, requiring large expenditures for research and development. The Company believes that the transition to smaller geometry process technologies will be important to remaining competitive. There can be no assurance that the Company will be able to profitably manufacture devices in geometries smaller than 0.6-micron.
In addition to large R&D expenditures required to develop processes for deep sub-micron devices, capital expenditure requirements to manufacture at such small geometries increase rapidly. Decreases in geometries call for sophisticated design efforts, advanced manufacturing equipment and cleaner fabrication environments. The Company made significant investments during 1995 into sub-micron manufacturing and expects to continue a high level of investment in this area in the future.
The majority of the Company's 1995 wafer production utilized a 0.8-micron CMOS process; however, the production of wafers utilizing a 0.6-micron CMOS process increased to approximately 30% of total monthly wafer production by the end of the year.
The Company has three manufacturing locations. Its San Jose, California plant performs wafer fabrication, probe and final test activities. The Tempe, Arizona site contains design, probe and final test facilities. The San Antonio facility is primarily dedicated to wafer fabrication and includes four modules. Modules A, B and C have been fully facilitized, while VLSI currently anticipates facilitizing Module D during 1996. During 1995, the Company began the process of converting its San Antonio wafer fabrication facility from a predominantly 0.8-micron process to predominantly 0.6-micron and smaller processes. The conversion is expected to be completed in the first half of 1996. This will enable the Company to significantly increase its production capacity at the San Antonio facility in the fourth quarter of 1996 over the fourth quarter of 1995. These conversions, if successfully completed, will increase device volume production and lead to lower overall device costs.
The building housing the Company's San Jose wafer fabrication facility, which in 1995 accounted for approximately 45% of its total internal wafer production, was purchased by the Company during the first quarter of 1994. In late 1995, the conversion of the Class 10 San Jose facility from a 5-inch wafer process to a
6-inch process was completed. This conversion is expected to increase device production capacity at this facility. The San Jose wafer fabrication facility is located near major earthquake faults and in an area that has in the recent past experienced an extended drought. Additionally, as a 12-year-old fabrication facility, it faces certain technological limitations. Due to the age of the Class 10 San Jose facility and other factors, including ground motion, it is uncertain whether geometries smaller than the 0.8-micron level can ever be profitably manufactured there. To the extent customers and markets served by the Company require advanced process technologies, there are no assurances that the Company will have sufficient demand to fully utilize the San Jose fabrication facility or have ultimate use for its capacity.
In addition to manufacturing in its own facilities, VLSI has wafer manufacturing arrangements with several foreign companies specializing in subcontract wafer foundry services. These wafer subcontractors are themselves subject to all of the manufacturing risks that are applicable to VLSI's own wafer manufacturing operations. In addition, the Company's foreign subcontract manufacturing arrangements are subject to risks such as changes in government policies, transportation delays, increased tariffs, fluctuations in foreign exchange rates, and export and tax controls. Lengthy or recurring disruptions of operations at either the Company's production facilities or those of its subcontractors for any reason, such as fire or earthquake, could cause significant delays in shipments until the Company could shift the products from an affected facility or subcontractor to another facility.
The Company subcontracts substantially all of its integrated circuit packaging and approximately 50% of its final testing to third parties. The final tested circuits are then shipped to VLSI's customers or returned to the Company for shipment to customers. Subcontractors include Anam Semiconductor Technology Co. Ltd. in Korea and the Philippines (see Item 13 in Part III hereof). Although the Company has no long-term contractual commitments from these suppliers, the Company believes that these sources of packaging and testing services are relatively reliable given their level of interdependence with the Company and the overall level of availability of worldwide subcontract packaging and testing capacity. Any problems experienced in obtaining acceptable subcontract manufacturing services could delay shipments of the Company's products and affect the Company's results of operations.
The principal raw materials used by the Company in the manufacture of its products are silicon wafers, processing chemicals and gases and certain precious metals. Subcontractors use ceramic and plastic packages to enclose the devices produced for the Company. Certain raw materials used for the manufacture of ICs are available from a limited number of worldwide suppliers. The Company does not generally depend on long-term fixed-price supply contracts. Shortages could occur in various essential materials due to interruption of supply or increased demand in the industry. If VLSI was unable to procure certain of such materials from any source, it would be required to reduce its manufacturing operations. To date, the Company has experienced no significant difficulty in obtaining the necessary raw materials. The Company's operations also depend upon a continuing adequate supply of electricity, natural and specialty gases and water.
See also "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results" in Item 7 of Part II herein.
COMPETITION
The semiconductor industry in general and the markets in which the Company competes in particular are intensely competitive, exhibiting both rapid technological change and ongoing price erosion as technologies mature. Competition in the X86 core logic chip set market, the Company's largest individual market segment, is especially intense and is subject to significant shifts in demand and severe pricing pressures. During the latter portion of 1995 and continuing into 1996, VLSI has experienced significant changes in customer behavior as Intel has become the predominant supplier of PC chip sets. As a result of this competition, VLSI expects significantly reduced market share and, to the extent VLSI elects to continue to compete in the X86 core logic market, expects to do so at reduced sales prices and gross margins.
The Company competes with large domestic and foreign companies that have substantially greater financial, technical, marketing and management resources than the Company, such as AT&T, Intel, IBM,
LSI Logic, Motorola, NEC, TI and Toshiba. There is no assurance that the Company will be able to compete successfully in the future.
Competition is primarily based on design capabilities (including both the design tool features and the skills of the design team), quality, delivery time and price. The Company believes that its overall competitive strengths include: a growing expertise in systems applications in specific market segments, its high quality wafer processing technology and fabrication facilities, its experienced engineering staff, test capabilities, cost effectiveness, technical design services offered through its network of Technology Centers and design tools and services, including its proprietary FSB libraries.
See also "EMPLOYEES" below and "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors Affecting Future Results" in Item 7 of Part II herein.
COMPASS DESIGN AUTOMATION, INC.
The Company's COMPASS subsidiary designs, develops, markets and services software-based products used by systems or circuit designers to design complex integrated circuits using either schematic capture, high level design languages, data path descriptions or state diagrams. These design tools integrate many steps of the design process, from design specification (beginning with synthesis and test) through physical layout and verification.
COMPASS product offerings are organized into four main product lines: logic design and analysis tools, physical design and verification tools, library development tools and physical libraries. These products are intended to reduce overall time to market and decrease engineering and production costs for advanced integrated circuit design.
COMPASS produces a complete set of tools for all levels of design from VHDL and Verilog down to basic silicon structures. In the top-down design market segment, COMPASS focuses on VHDL and Verilog-based synthesis and test-generation tools, along with services to import custom libraries from various semiconductor vendors to work on the COMPASS toolset. In the physical design software area, COMPASS develops tools for floorplanning, automatic place-and-route, a range of symbolic and polygon-based custom layout tools, and a complete set of physical layout verification tools. In library technology, COMPASS develops a wide range of libraries, memory and datapath compilers. It also develops high-productivity tools to automate the process of library generation.
COMPASS' R&D efforts are focused on making its array of software technology capable of supporting a wider variety of semiconductor vendor design tools and semiconductor foundry formats. Product development efforts are focused on the design environment requirements imposed by deep sub-micron designs. COMPASS uses a number of different vendors' software tools to develop its own software tools and physical libraries. Vendor changes in those underlying tools in terms of features and functionality, interoperability, licensing and support can influence the focus of certain R&D projects and COMPASS' development strategies. The focus of COMPASS product development is on deep sub-micron physical libraries, the associated physical design software tools, and related EDA tools required by large, complex design projects.
COMPASS competes with other software vendors in the EDA market for integrated circuit design automation. Competition in the EDA market has come primarily from a few established vendors, such as Cadence Design Systems, Mentor Graphics, Viewlogic Systems and Synopsys. COMPASS pursues cooperative relationships with certain of these EDA companies to provide complementary solutions to the vendors' offerings. Competition is based on such factors as design capabilities (including both the design tool features and the skills of the design team), quality, delivery time and price. The Company believes that a principal competitive strength of COMPASS is its expertise and products for deep sub-micron libraries and physical design. The Company's ability to compete in the EDA market will depend upon the expansion of vendor libraries available for the logic design system and the foundries that can fabricate designs using COMPASS libraries. Such vendor libraries are available from COMPASS as well as other semiconductor vendors, which include Fujitsu, General Electric Corporation Ltd.'s Plessey Division, LG Semicon, Hitachi, Mitsubishi, NEC and Toshiba. Additionally, COMPASS libraries are supported by VLSI, Taiwan Semiconductor Manufactur-
ing Company Ltd., Chartered Semiconductor Manufacturing Pte Ltd., European Silicon Structures BV, and other foundries.
COMPASS uses direct sales, commissioned representatives and distributors to sell its software products. COMPASS' 20 sales offices (14 in the United States, four in Europe, one in Japan and one in the Asia-Pacific region) include its three worldwide development centers. Direct sales represent COMPASS' primary domestic and European distribution channels.
COMPASS generally licenses its design tools under nontransferable, non-exclusive license agreements and provides postcontract customer and software revision support. In addition, COMPASS offers training and consulting services to its customers. COMPASS retains ownership rights to all software that it develops. COMPASS uses various security schemes to protect its software products from unauthorized use or copying.
BACKLOG
The Company's sales are made primarily pursuant to standard purchase orders for delivery of products, with such purchase orders officially acknowledged by VLSI according to its own terms and conditions. Due to industry practice with respect to cancellation of orders, VLSI believes that backlog is a potentially misleading indicator of future revenue levels.
EMPLOYEES
As of December 29, 1995, the Company and its subsidiaries had approximately 3,000 employees worldwide. Management believes that the future success of VLSI will depend in part on its ability to attract and retain qualified employees, including technical and design personnel. In particular, the Company currently has numerous open positions, specifically in the engineering arena. Any lengthy delays in filling these positions will lead to delays in the introduction of various products currently being developed, as well as the research and development associated with potential new products.
PATENTS AND LICENSES
The Company has filed a number of patent applications and currently holds various patents expiring from 2003 to 2012 covering inventions in areas including computer-aided engineering, semiconductor manufacturing and electronic circuitry. The Company expects to file additional patent applications from time to time, as appropriate. VLSI does not consider the success of its business to be materially dependent on any single patent or group of patents.
The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which have on occasion resulted in protracted and expensive litigation. The Company is currently one of three remaining defendants in a major patent infringement suit brought by TI and currently under appeal by TI (see "Legal Proceedings" in Item 3 of Part I herein).
Periodically, the Company is made aware that technology used by the Company in the manufacture of some or all of its products may infringe on product or process technology rights held by others. Resolution of whether the Company's manufacture of products has infringed on valid rights held by others may have a material adverse effect on the Company's financial position or results of operations, and may require material changes in production processes and products. IBM, Motorola and others have individually contacted the Company concerning its alleged use of intellectual property belonging to them. In addition, VLSI has also entered into licensing agreements and technology exchange agreements with various strategic partners and other third parties in order to allow VLSI limited access to third party technology, or to allow third parties limited access to VLSI's technology. Certain of these agreements will require renewal in calendar 1996. The Company is unable to predict whether license agreements can be obtained or renewed on terms acceptable to the Company. Failure to obtain or renew such licenses could result in litigation and the attendant cost and diversion of resources associated therewith. An adverse decision on any such litigation or such material changes could have a material effect on the Company's financial position or results of operations.
WORKING CAPITAL
Information regarding the Company's working capital practices is incorporated herein by reference from Item 7 of Part II hereof under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources".
FINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC DATA
This information is included in Note 9 of Notes to Consolidated Financial Statements, which information is incorporated herein by reference to Item 8 of Part II hereof.
ENVIRONMENTAL ISSUES
The Company is subject to a variety of federal, state and local governmental regulations related to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufacturing process. Increasing public attention has been focused on the environmental impact of semiconductor manufacturing operations. The Company's San Jose and San Antonio facilities are located near residential areas, which could increase the incidence of environmental complaints or investigations. There can be no assurance that changes in environmental regulations will not impose the need for additional capital equipment or other requirements. Any failure by the Company to control the use of, or adequately to restrict the discharge of, hazardous substances under present or future regulations could subject VLSI to substantial liability or could cause its manufacturing operations to be suspended, which could have a material adverse effect on the Company's operating results.
ITEM 2.

ITEM 2. PROPERTIES
The Company owns the buildings housing its three manufacturing facilities located in San Jose, California, Tempe, Arizona and San Antonio, Texas and recently acquired ownership of its previously leased headquarters buildings in San Jose. In addition, VLSI (including its subsidiary, COMPASS) has 47 sales offices (33 in the U. S., eight in Europe, three in Japan and three in the Asia-Pacific region) and 19 Technology Centers (12 in the U. S., four in Europe, two in Japan and one in the Asia-Pacific region). The Company's other properties, including some comprising its San Jose campus, are occupied under operating leases that expire on various dates through October 2023 with options to renew in most instances. The Tempe facility is located on land held under a long-term ground lease, which expires in December 2037, while the Company owns the land beneath those San Jose and San Antonio facilities that it owns.
The Company's San Jose facility, which includes manufacturing, COMPASS, corporate support services such as its computer center, technology development, primary shipping location and major design center, is located near major earthquake faults. Should an earthquake cause an interruption in operations, operating results would be materially adversely affected.
The San Antonio facility began qualified production in 1989 and is primarily dedicated to wafer fabrication. Module A of four planned modules of class 1 clean room was completed in 1990. Module B was partially facilitized, equipped and used to augment capacity beginning in 1991 with the balance of facilitization completed in 1993. During 1995, Module B was fully equipped and Module C was fully facilitized and minimally equipped, while Module D was partially facilitized.
The Tempe site contains the research and development resources supporting the PC chip set products for the Computing Products group, test facilities, marketing, sales and Technology Center functions.
VLSI expanded into new leased facilities adjacent to its San Jose headquarters in each of the last three years ending in 1995. The Company anticipates that the lease of the additional space, along with an option obtained for additional space adjacent to its leased facilities in San Jose, will satisfy the Company's growth needs in the near term.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
Texas Instruments Litigation
The Company along with LSI Logic and Cypress Semiconductor (the Company and such other defendants are collectively referred to as the "TI Defendants") are named defendants in a lawsuit filed by TI in 1990 that claims alleged patent infringement.
TI filed this patent infringement action against the TI Defendants in the United States District Court for the Northern District of Texas seeking damages for alleged past infringement of now expired U.S. Patent Nos. 4,043,027 and 3,716,764. A trial in April 1995 resulted in a May 1995 jury verdict against the Company in the amount of $19.4 million. While in the process of contesting the jury verdict, the Company recorded a charge to earnings of $19.4 million in the second quarter of 1995. In August 1995, the trial judge issued an order overturning and setting aside the jury verdict and conditionally granting a new trial on the matter in the event that his order is reversed on appeal. TI is pursuing an appeal of the trial judge's order in the United States Court of Appeals for the Federal Circuit and seeks a reversal of that order as well as enhanced damages, pre-judgment interest and attorneys' fees. The Company has not made any adjustments to the $19.4 million charge taken during the second quarter of 1995, pending resolution of this and related intellectual property matters. In the event that TI's appeal is successful and enhanced damages (which by statute may be as high as treble damages), pre-judgment interest and/or attorney's fees are awarded, such a judgment could result in a material reduction in liquidity, as well as an additional adverse impact on the Company's reported results of operations.
Other Patent Matters
Periodically, the Company is made aware that technology used by the Company in the manufacture of some or all of its products may infringe on product and process technology rights held by others. An adverse decision on infringement of patents may have a material adverse effect on the Company's financial position or results of operations and may require material changes in production processes or products. Where deemed advisable, the Company may seek or extend licenses or negotiate settlements. See "Patents and Licenses" in Item I of Part I herein.
Other Litigation
The Company is currently a party to various other legal actions arising out of the normal course of business, none of which are expected to have a material effect on the Company's financial position or results of operations.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders of the Company during the fourth quarter of fiscal 1995, which ended December 29, 1995.
EXECUTIVE OFFICERS OF THE COMPANY
Information concerning executive officers of the Company who are not also directors is set forth below:
Mr. John C. Batty, age 41, was elected Vice President and Treasurer in December 1992. Mr. Batty joined the Company in June 1986 as Financial Manager. From April 1989 to April 1991, Mr. Batty was the Tempe, Arizona Site Controller. From April 1991 to December 1992, Mr. Batty was Director, Corporate Financial Planning.
Mr. Bernd U. Braune, age 40, was named Senior Vice President of Worldwide Sales and Marketing in November 1995. Mr. Braune joined the Company in June 1993 as General Manager and Vice President of European Operations. Prior to joining the Company, Mr. Braune was Managing Director for European operations of NCR Microelectronics, a computing company, from 1987 until 1991 and then Director
of Marketing for NCR Central Europe as part of the Global Information Systems Group of AT&T, a computing company, until joining VLSI.
Mr. Donald L. Ciffone, Jr., age 40, was named Senior Vice President of VLSI Products in November 1995. Mr. Ciffone was elected Vice President and General Manager of the VLSI Product Divisions in August 1992. Mr. Ciffone joined the Company in November 1991 as Vice President, Primary and Emerging Markets Division. From March 1991 until joining the Company, Mr. Ciffone was Director of Marketing for Oasic Technology, an ASIC company. Mr. Ciffone was employed by National Semiconductor Corporation, a semiconductor manufacturer, in various capacities from 1978 until 1991, including as Director of Marketing, ASIC Division immediately prior to his departure.
Mr. Larry Grant, age 50, joined the Company in January 1996 as Vice President, General Counsel and Secretary. From 1985 until joining VLSI, Mr. Grant was Vice President and General Counsel to Micron Technology, Inc., a semiconductor manufacturer.
Mr. Gregory K. Hinckley, age 49, was named Senior Vice President in November 1995. Mr. Hinckley was elected Vice President, Finance and Chief Financial Officer of the Company in August 1992 upon joining the Company. From December 1991 until August 1992, he was an independent consultant. From January 1989 until December 1991, Mr. Hinckley was Senior Vice President and Chief Financial Officer of Crowley Maritime Corporation, a U.S. shipping company. Mr. Hinckley is a director of Advanced Molecular Systems and OEC Medical Systems, Inc.
Mr. Balakrishnan S. Iyer, age 39, joined the Company in April 1993 as Vice President and Controller. From July 1992 until joining VLSI, Mr. Iyer was Corporate Controller for Cypress Semiconductor Corporation, a semiconductor manufacturer. From August 1988 until July 1992, Mr. Iyer was Group Controller at Advanced Micro Devices, Inc., a semiconductor manufacturer.
Mr. L. Don Maulsby, age 44, was named Group Vice President of the Computing Products Division in November 1995. Prior to that time, he was Vice President and General Manager of the Personal Computer Division from June 1994, and Vice President, Worldwide Sales and Technology Center Operations, from November 1992 until June 1994. Mr. Maulsby joined the Company in 1988 as a Regional Sales Manager. Mr. Maulsby was Area Sales Manager from January 1989 to September 1990. From September 1990 to August 1991, Mr. Maulsby was Vice President, Central U.S. Business Unit; and from August 1991 to November 1992, Vice President, North American Sales and Technology Center Operations.
Mr. Dieter J. Mezger, age 52, has been President of the Company's subsidiary, COMPASS Design Automation, Inc., since its formation in February 1991. Since July 1990, Mr. Mezger has also been Senior Vice President of the Company. He joined the Company in 1984 as Director and General Manager of the Company's European operations. From December 1988 until March 1991, he was President of VLSI Technology Europe.
There are no family relationships among the Company's executive officers and directors.
PART II
ITEM 5.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
FINANCIAL INFORMATION BY QUARTER (UNAUDITED) (THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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(1) The Company's Common Stock is traded on the Nasdaq National Market under the symbol VLSI. The prices per common share represent the highest and lowest closing prices for VLSI's Common Stock in the Nasdaq National Market during each quarter. On February 23, 1996, there were approximately 2,020 stockholders of record. The Company has not paid cash dividends and is currently prohibited from doing so. See Note 2 of Notes to Consolidated Financial Statements.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA(1)
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(1) Certain prior year amounts previously reported have been reclassified to conform to the 1995 presentation.
(2) Included in operations for the fourth quarter of 1992 is a special charge of $22.5 million related to the deemphasis of older technologies, costs of streamlining sales distribution channels, costs of relocating certain offices, writedowns of non-performing assets and costs associated with intellectual property matters.
The Company has never paid any cash dividends and is currently prohibited from doing so under the terms of its committed Credit Agreement. See Note 2 of Notes to Consolidated Financial Statements, which information is incorporated herein by reference to Item 8 of Part II hereof.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MDA") should be read in conjunction with the 1995 Consolidated Financial Statements and Notes thereto in Item 8

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The chart entitled "Financial Information by Quarter (Unaudited)" contained in Item 5 of Part II hereof is hereby incorporated by reference into this Item 8 of Part II of this Form 10-K.
VLSI TECHNOLOGY, INC.
ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 29, 1995
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Consolidated Financial Statements Included in Item 8:
Schedules other than those listed above have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the notes thereto.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders of VLSI Technology, Inc.
We have audited the accompanying consolidated balance sheets of VLSI Technology, Inc. as of December 29, 1995 and December 30, 1994 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three fiscal years in the period ended December 29, 1995. Our audits also included the financial statement schedule listed in the index at Item 14(a)(2). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of VLSI Technology, Inc. at December 29, 1995 and December 30, 1994, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended December 29, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
-------------------------------------- ERNST & YOUNG LLP
San Jose, California January 16, 1996
VLSI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
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(1) See Note 8 for related party disclosures.
See accompanying Notes to Consolidated Financial Statements.
VLSI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS AND SHARES IN THOUSANDS)
See accompanying Notes to Consolidated Financial Statements.
VLSI TECHNOLOGY, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS AND SHARES IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- ---------------
(1) See Note 8 for related party disclosures.
See accompanying Notes to Consolidated Financial Statements.
VLSI TECHNOLOGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
See accompanying Notes to Consolidated Financial Statements.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THREE YEARS ENDED DECEMBER 29, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION. The consolidated financial statements include the accounts of VLSI Technology, Inc. ("VLSI" or the "Company") and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
FISCAL YEAR. In 1994, the Company changed its fiscal year to end on the last Friday in December, in years prior to 1994, the Company's fiscal year ended on the last Saturday in December. Fiscal years 1995, 1994 and 1993 ended December 29, 30 and 25, respectively. Fiscal year 1994 consisted of 53 weeks, while all other years presented herein consisted of 52 weeks.
CASH EQUIVALENTS AND LIQUID INVESTMENTS. Cash equivalents reflect highly liquid short-term investments with maturities at date of purchase of three months or less. These investments are readily convertible to known amounts of cash, while investments with maturities of between three and twelve months are considered liquid investments.
CONCENTRATIONS OF CREDIT RISK. Financial instruments that potentially subject VLSI to concentration of credit risk consist principally of cash equivalents, liquid investments and trade receivables. VLSI invests cash through high-credit-quality financial institutions. A majority of VLSI's trade receivables are derived from sales to manufacturers of computer systems, with the remainder spread across various other industries. Management believes that any risk of accounting loss is reduced due to the diversity of its products, end customers and geographic sales areas. VLSI performs ongoing credit evaluations of its customers' financial condition and requires collateral, such as letters of credit and bank guarantees, whenever deemed necessary.
INVENTORIES. Inventories are stated at the lower of cost or market. Cost is computed on a semi-annual adjusted standard basis (which approximates average cost on a FIFO basis); market is based upon estimated net realizable value. The valuation of inventory at the lower of cost or market requires the use of estimates as to the amounts of current inventory that will be sold. These estimates are dependent on the Company's assessment of current and expected orders from its customers, given that orders, particularly of core logic and cellular handset chip sets, are subject to cancellation with limited advance notice prior to shipment. In most instances, inventory is reserved if the units in inventory exceed six months of estimated demand for that product. As a considerable portion of the Company's sales are to the personal computer and cellular handset markets, it is reasonably possible that the recoverability of VLSI's investment in inventory associated with these markets will change in the near term. No estimate can be made of a range of amounts of customer cancellations that would materially affect the consolidated financial statements.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are stated at cost. Depreciation and amortization are provided on the straight-line method for financial reporting purposes and on accelerated methods for tax purposes. Assets leased under capitalized leases are recorded at the present value of the lease obligations and amortized on a straight-line basis over the lease term. The valuation of property, plant and equipment at depreciated cost requires use of estimates as to the estimated useful lives and salvage value of these assets. As the Company competes in an industry that relies on rapidly changing technology and manufacturing developments, the actual useful lives and salvage values may eventually prove to be lower than those estimated. No estimate can be made of a range of amounts of loss that are reasonably possible should actuals prove lower than estimated.
REVENUES. Revenues from silicon product sales to customers are recognized upon shipment.
Revenues associated with software system sales and software licenses are generally recognized at the time of shipment. Postcontract customer support revenues are recognized ratably over the term of the related agreements. Training and consulting revenues are recognized as the related services are performed.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
Revenues relating to the licensing of technology are generally recognized when the significant contractual obligations have been fulfilled and the fees are billable.
TRANSLATION OF FOREIGN CURRENCIES. During 1995, the Company changed the functional currency of the majority of its larger foreign subsidiaries from the local subsidiary currency to U.S. dollar-based currency. Results from foreign operations are subject to exchange rate fluctuations and foreign currency transaction costs. Net foreign currency transaction losses included in interest income and other expenses, net, were not material in 1995, 1994 and 1993. Foreign translation gains and losses and the effect of foreign currency exchange rate fluctuations on cash flows in all years have not been material.
FOREIGN EXCHANGE CONTRACTS. The Company's policy is to hedge all material monetary assets, liabilities and commitments denominated in currencies other than the functional currency of the Company's subsidiaries. This activity is primarily performed using forward contracts. This policy of hedging is intended to minimize the effect of fluctuating foreign currencies on reported income on a going-forward basis. No high correlation hedging activities are performed, as all currency risks are hedged with instruments using the same currency. The forward contracts qualify as hedges for financial reporting purposes and, accordingly, are reported at market value with gains and losses on such hedges included in other current assets or accrued liabilities and offset against foreign exchange gains or losses on the exposures hedged. The forward contracts position at December 29, 1995 relates to hedging foreign currency net asset and liability positions as well as purchase orders and consists of foreign exchange forward contracts to sell $25.8 million in foreign currency and buy $23.0 million in foreign currency. These contracts, which matured through January 1996, were with major international financial institutions resulting in a net gain of $0.8 million on the forward contracts hedging foreign currency net asset and liability positions and a $0.6 million deferred loss on the forward contracts hedging purchase orders. The deferred loss is to be included in the cost of the items to be acquired. The realized gain on the contracts substantially equaled the offsetting loss of the underlying exposure.
FAIR VALUE DISCLOSURES. The following estimated fair values have been determined by the Company using available market information and appropriate valuation methodologies:
Cash, cash equivalents and liquid investments -- The carrying amounts of these items are their fair values.
Debt (See Note 2) -- Quoted market prices of the Company's convertible debt are currently available. Interest rates that are currently available to the Company for issuance of debt similar to existing secured equipment loans are used to estimate the fair value of remaining maturities of existing secured equipment loans.
Foreign currency contracts -- The estimated fair value of foreign currency contracts is based on quoted market prices obtained from dealers.
The carrying amount and fair value of the Company's financial instruments at December 29, 1995 and December 30, 1994 are as follows:
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
The fair value estimates presented are based on pertinent information available to management as of December 29, 1995 and December 30, 1994, respectively. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since such dates, and current estimates of fair value may differ significantly from the amounts presented.
The Company classifies liquid investments as available-for-sale or held-to-maturity at the time of purchase and reevaluates such designation as of each balance sheet date in accordance with the nature of the securities and the intent and investment goals of the Company. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost with corresponding premiums or discounts amortized over the life of the investment to interest income. Marketable equity securities, and debt securities not classified as held-to-maturity, are classified as available-for-sale and reported at fair value. Unrealized gains or losses on available-for-sale securities are included, net of tax, in equity until their disposition. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific identification method.
All liquid investments at December 29, 1995 are classified as available-for-sale securities. Such investments, which mature through June 1996, are categorized in the following table.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
All investments at December 30, 1994 were classified as available-for-sale securities. Such investments, which matured through April 1995, are categorized in the following table.
There were no gains or losses realized on sales of available-for-sale securities during 1995. Unrealized holding losses on available-for-sale securities included in stockholders' equity in 1995 and 1994 were immaterial.
CAPITALIZED INTEREST. Of total interest expenditures in 1995 and 1994 of $12.3 million and $8.7 million, respectively, the Company capitalized $4.3 million and $0.4 million. Amounts subject to capitalization in prior years were not material.
STOCK-BASED COMPENSATION. The Company grants stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees" and, accordingly, recognizes no compensation expense for the stock option grants.
NET INCOME PER SHARE. Net income per share is computed using the weighted average number of shares of outstanding Common Stock and dilutive common equivalent shares -- shares issuable under the stock option plans and through late August 1995 a warrant held by Intel Corporation ("Intel"). Fully diluted earnings per share have not been presented, because the amounts are not materially different.
USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
RECLASSIFICATIONS. Certain prior year amounts previously reported have been reclassified to conform to the 1995 presentation.
NEW ACCOUNTING PRONOUNCEMENTS. The Company must adopt Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("FAS 121") and Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("FAS 123") with the commencement of fiscal 1996. Initial adoption of FAS 121 will not have a material effect on the Company's consolidated financial statements. The Company has elected to adopt the disclosure requirements of FAS 123 rather than the accounting requirements of FAS 123.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
2. LONG-TERM DEBT
Total debt at December 29, 1995 and December 30, 1994 consists of the following:
The Company has a two-year committed Credit Agreement (the "Credit Agreement") with a syndicate of banks providing for borrowings of up to $52.5 million at various rates of interest that expires June 7, 1996. The Credit Agreement has various covenants that preclude the Company from, among other things, paying cash dividends and also places certain other limits on the Company. The Company is required to maintain certain financial ratios as defined in the Credit Agreement. The Credit Agreement also calls for a variable limit on the Company's dollar amount of capital spending. Annual commitment fees, which the Company believes are immaterial, are charged on the unused portion of the committed credit amount. There are no compensating balance requirements. Borrowings outstanding under the Credit Agreement are unsecured. At December 29, 1995 and December 30, 1994, the Company had no outstanding borrowings on the Credit Agreement.
Interest on short-term borrowing facilities was based on market rates. Interest on long-term borrowing facilities is generally payable quarterly at contractual rates based on U.S. Treasury securities. Certain secured equipment loans require adherence to certain financial covenants, one of which prohibits payment of cash dividends.
In July 1995, the Company called for redemption of the 7% Convertible Subordinated Debentures due 2012 ("Debentures"). Of the $57,500,000 in principal amount of Debentures, $57,364,000 were converted into 2,607,359 shares of the Company's Common Stock. The Debentures not converted, which amounted to $136,000, were redeemed by the Company at a price of $1,032.86 for each $1,000 in principal amount of Debentures redeemed. This resulted in the issuance of 6,181 shares of the Company's Common Stock under an underwritten call agreement that the Company had entered into with Bear, Stearns & Co. Inc. and Hambrecht & Quist LLC.
In September 1995, the Company completed the public offering of an aggregate of $172.5 million of 8.25% Convertible Subordinated Notes ("Notes") due 2005, for net proceeds of approximately $168 million. Interest on the Notes is payable on April 1 and October 1 of each year commencing April 1, 1996. The Notes are convertible into shares of VLSI Common Stock at any time on or before the close of business on the last trading day prior to maturity, unless previously redeemed, at a conversion price of $54.80 per share, subject to adjustment in certain events. The Notes are redeemable, in whole or in part, at the option of the Company, upon at least 15 days' notice, at any time on or after October 3, 1997, at redemption prices starting at 103.3% and at diminishing prices thereafter, plus accrued interest, except that the Notes may not be redeemed prior to October 3, 1999 unless the closing price of the Common Stock is at least 125% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the fifth trading day prior to the notice of redemption. The Notes are unsecured and subordinated in right of payment in full to all existing and future Senior Debt of the Company (as defined). The Company expects from time to time to incur
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
indebtedness constituting Senior Debt. Additionally, the terms of the Company's existing Credit Agreement prohibit the Company from repaying any Notes prior to maturity.
Maturities of debt are as follows: 1996 -- $7.6 million, 1997 -- $7.8 million, 1998 -- $7.9 million, 1999 -- $8.4 million, 2000 -- $9.0 million and thereafter (starting in 2001) -- $182.3 million.
3. LEASES AND OTHER COMMITMENTS
Obligations under capital leases represent the present value of future minimum rental payments under various agreements to lease manufacturing equipment. The Company has options to purchase leased assets at the end of the lease terms for their fair market values or at stipulated values up to 30% of original cost. Accumulated amortization of these leased assets was $50.2 million and $54.6 million at December 29, 1995 and December 30, 1994, respectively.
The Company rents certain equipment and manufacturing and office facilities under operating lease agreements that expire through 2037 and contain renewal options and provisions adjusting the lease payments, based upon changes in the Consumer Price Index or in fixed increments. VLSI is generally responsible for taxes, insurance and utilities under these leases.
Future minimum lease payments under capital leases, together with the present value of those payments and the aggregate annual rental commitments under noncancelable operating leases as of December 29, 1995, are shown as follows:
Rental expense was approximately $10.2 million in 1995 ($9.0 million in 1994 and $11.3 million in 1993).
OTHER COMMITMENTS. The Company has commitments for the purchase of equipment totaling approximately $157.2 million at December 29, 1995, as well as various other long-term committed contracts.
4. LITIGATION AND CONTINGENCIES
In 1990, patent infringement claims were filed by Texas Instruments ("TI") against the Company and four other defendants with the International Trade Commission ("ITC") and the U.S. District Court for the Northern District of Texas, Dallas Division ("District Court"), seeking to preclude importation into the U.S. of, and an injunction against the sale and/or manufacture of, parts using the allegedly protected process and seeking unspecified damages, respectively. During 1991, the Company developed an alternate process and discontinued use of the allegedly protected process. In February 1992, the ITC determined that the Company infringed the original patented process, but found the alternate process to be non-infringing. The Court of
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
Appeals, for the Federal Circuit, affirmed the ITC decision in 1993. The U.S. District Court proceedings resulted in a May 1995 jury verdict against the Company for damages of $19.4 million. Although the Company was in the process of contesting the verdict at the trial court level, the Company recorded a charge to earnings of $19.4 million in the second quarter of 1995. In August 1995, the trial judge issued an order overturning and setting aside the jury verdict and conditionally granting a new trial on the matter in the event that his order is reversed on appeal. TI has filed a notice of appeal and will seek a reversal of the trial judge's order as well as enhanced damages (which by statute may be as high as treble damages), pre-judgment interest and attorneys' fees. The Company intends to continue to vigorously defend itself against the TI claims throughout the appeals process. The Company has retained the $19.4 million charge taken during the second quarter of 1995, pending resolution of this and related intellectual property matters. The litigation charge is shown as a separate liability on the balance sheet, net of TI litigation expenditures incurred during 1995.
While the final outcome of this matter is currently not determinable, management believes that the ultimate resolution of this matter will not have a material adverse effect on the Company's consolidated financial position or results of operations. However, should the ultimate outcome of this matter be unfavorable, VLSI may be required to pay damages and other expenses.
In addition, in the normal course of business, the Company receives and makes inquiries with regard to other possible patent infringement. Where deemed advisable, the Company may seek or extend licenses or negotiate settlements.
5. STOCKHOLDERS' EQUITY
The Company's amended certificate of incorporation authorizes 102,000,000 shares of Capital Stock for issuance, 100,000,000 shares of which are designated Common Shares and 2,000,000 shares of which are designated Preferred Shares. The Common Shares are authorized to be issued in series, with the first series designated Common Stock and consisting of 99,000,000 shares. All other series of Common Shares (other than Common Stock) are designated, as a group, Junior Common Stock and consist of 1,000,000 shares. The Board of Directors ("Board") has the authority to issue the Preferred Shares and the Common Shares (other than Common Stock) in series, the rights, preferences and privileges of which can be determined by the Board without stockholder approval.
In June 1995, the Company completed the public offering of an aggregate of 3,450,000 shares of its Common Stock at a price to the public of $28.625 per share, for net proceeds to the Company of approximately $94 million.
In January 1996, the Board authorized the Company to repurchase shares of the Company's Common Stock on the open market or in privately negotiated transactions. The Board authorized the Company to re-issue those shares at a later date through certain of its employee stock plans and/or to fund stock or asset acquisitions authorized by the Board. By the end of January 1996, the Company had repurchased 1.8 million shares at an average per share price of $15.10, and had not yet re-issued any of these shares.
INTEL AGREEMENTS. In the third quarter of 1992, VLSI and Intel entered into two related agreements. On July 8, 1992, VLSI and Intel entered into a Technology and Manufacturing Agreement ("Technology Agreement"), and on August 25, 1992, pursuant to the Intel/VLSI Stock and Warrant Purchase Agreement ("Equity Agreement") also entered into on July 8, 1992, Intel invested $50 million in VLSI to acquire 5,355,207 shares of the Company's Common Stock ("Intel Shares") plus a warrant ("Warrant") to purchase an additional 2,677,604 shares of the Company's Common Stock ("Warrant Shares") at $11.69 per share. In addition, pursuant to the Technology Agreement, the two companies were working together to manufacture -- with VLSI responsible for designing, marketing and selling -- chips that would enable manufacturers to build handheld computers on the standardized system platform to be developed by the companies. The development
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
efforts were completed in 1994; however, the market for handheld computers developed more slowly than originally anticipated. As a result, in November 1994, the Company and Intel terminated the Technology Agreement, and in January and February 1995, Intel sold all of the Intel Shares. In August 1995, Intel exercised its Warrant, resulting in net proceeds to the Company of approximately $31 million.
The Equity Agreement currently provides Intel with demand registration rights with respect to the Warrant Shares. The Equity Agreement also imposes certain restrictions on Intel, including a limitation on Intel's ability to acquire additional shares of VLSI voting stock (referred to as a standstill) and a requirement that Intel vote its VLSI stock in the same proportion as other stockholders on matters submitted to the VLSI stockholders for approval (unless it would be materially adverse to Intel's interest). All other significant rights of, and restrictions on, Intel under the Equity Agreement have terminated.
STOCKHOLDERS' RIGHTS PLAN. In August 1992, the Board approved the adoption of the First Amended and Restated Rights Agreement ("Restated Rights Agreement"), which replaces the Common Shares Rights Agreement dated as of November 7, 1989 ("Prior Rights Agreement") and amends the outstanding rights issued pursuant to the Prior Rights Agreement ("Rights"). Among other things, the Restated Rights Agreement provides that each Right will now relate to a fraction of a share of Series A Participating Preferred Stock of the Company (a "Unit"), which is economically equivalent to one share of Common Stock. On August 24, 1992, the Board further amended the Restated Rights Agreement for the purpose of excepting certain transactions contemplated by the Equity Agreement between the Company and Intel from operation of the Restated Rights Agreement. The Rights can be transferred or exercised (initially at a price of $45 per Unit) only upon the occurrence of certain events involving substantial transfers of ownership of Common Shares. The Rights are redeemable, in whole but not in part, at VLSI's option at $.01 per Right, at any time prior to becoming exercisable and in certain other circumstances. The Rights expire no later than November 7, 1999.
DIRECTORS' STOCK OPTION PLAN. Under the Directors' Stock Option Plan, which expires in 2001, options having ten-year terms are automatically granted annually to non-employee directors. At December 29, 1995, non-employee directors held options to purchase 115,000 shares of Common Stock at exercise prices ranging from $6.75 to $14.25 per share, of which 65,000 were exercisable. In addition, 160,000 shares were available for future grant under this Plan.
EMPLOYEE STOCK PURCHASE PLAN. Under VLSI's Employee Stock Purchase Plan, qualified employees are entitled to purchase shares of Common Stock at 85% of the fair market value at certain specified dates. Of the 9,000,000 shares authorized to be issued under this Plan, 6,816,094 shares have been issued through December 29, 1995.
STOCK OPTION PLANS. Employees and consultants may be granted options to purchase shares of VLSI's Common Stock, as well as certain other awards, under the Company's 1992 Stock Plan. Additionally, employees and consultants may exercise options to purchase shares of VLSI Common Stock previously granted under the 1982 Incentive Stock Option Plan. No new options may be granted under the 1982 Incentive Stock Option Plan. Options granted under these Plans may either be "incentive stock options" or "nonstatutory" options. All outstanding options have exercise prices equal to the fair market value on the date of grant. Generally, outstanding options expire ten years from date of grant and become exercisable at a rate of 25% per year from date of grant. At December 29, 1995, 1,087,626 shares were available for grant under the 1992 Stock Plan. This Plan expires in 2002. The Board has authorized an increase of 5,000,000 shares under this Plan, subject to stockholder approval. The Board has also amended this Plan to limit the total number of shares that may be granted under the Plan to any one individual to 500,000 shares per annum for both new and existing employees.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
Additional information relative to the Plans is as follows:
During 1995, VLSI recorded a tax benefit related to options exercised under the Plans, resulting in a $10,250,000 increase in stockholders' equity ($1,200,000 in 1994 and $1,680,000 in 1993).
6. EMPLOYEE BENEFIT PLANS
The Company accrued approximately $7.6 million, $5.0 million and $3.8 million in 1995, 1994 and 1993, respectively, for its Employee Profit Sharing Plan, Executive Performance Incentive Plan and Performance Recognition Plan. The Company's contribution expenses associated with its 401(k) plan were approximately $1.4 million, $0.6 million and $0.5 million in 1995, 1994 and 1993, respectively.
7. INCOME TAXES
The provision for taxes on income is as follows:
Pre-tax income from foreign operations was $9.6 million, $4.5 million and $1.2 million in 1995, 1994 and 1993, respectively.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
The provision for taxes reconciles with the amount computed by applying the U.S. statutory rate to income before provision for taxes as follows:
Deferred income taxes reflect tax credits and loss carryforwards and the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
Significant components of the Company's deferred tax liabilities and assets are as follows:
In accordance with Financial Accounting Standards No. 109, the Company has recorded net deferred tax assets totaling $30.0 million as of December 29, 1995 reflecting the benefit of credit and loss carryforwards, and other temporary differences. The credit and loss carryforwards expire in various years between 1998 and 2010. Realization of the benefits is dependent on generating sufficient U.S. taxable income prior to expiration of the carryforwards. Although realization is not assured, management believes it is more likely than not that all net deferred tax assets will be realized. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
For U.S. tax purposes, at December 29, 1995, VLSI had general business and alternative minimum tax credit carryforwards of approximately $9.9 million. Foreign subsidiaries have tax loss carryforwards of approximately $8.7 million. Such credit and loss carryforwards expire in various years beginning in 1998. The Company's federal income tax returns have been examined by the Internal Revenue Service ("IRS") for all years through 1990. All issues have been resolved with no material effect, and the IRS has closed those years. Certain foreign subsidiaries have accumulated earnings of $15.2 million, on which no U.S. deferred taxes have been provided. There is no intention to distribute these earnings. If distributed, there would be minimal incremental income taxes.
8. RELATED PARTIES
As of December 30, 1994, VLSI had received advances of $5.5 million from Intel in accordance with the Technology Agreement, of which $3.3 million and $2.2 million was amortized to income in 1994 and 1993, respectively, in accordance with the terms of the Technology Agreement.
VLSI purchased $42.6 million, $27.6 million and $38.1 million in 1995, 1994 and 1993, respectively, of production, assembly and test services from a company with whom a director of the Company is affiliated. Outstanding amounts payable to that company were $4.3 million and $1.9 million in 1995 and 1994, respectively. Such company, which provides production, assembly and test services, is one of three primary suppliers that provide substantially all of the Company's assembly and test needs. Although the above company is not the only provider of these services and, as a related party, is not believed likely by management to precipitate a change in suppliers, a change in suppliers could cause manufacturing delays and a possible loss of sales, which would adversely affect operating results.
9. INDUSTRY SEGMENT AND GEOGRAPHIC INFORMATION
VLSI operates in a single industry segment and designs, manufactures and markets primarily custom and semicustom integrated circuits of high complexity, along with associated integrated circuit computer-aided engineering and design software and systems. The Company focuses its products for the computing, communications and consumer digital entertainment industries and distributes its products through worldwide direct sales, commissioned representatives and distributors.
In 1995 and 1993, Apple Computer, Inc. ("Apple") accounted for 11% and 19%, respectively, of net revenues. In 1994, Apple represented less than 10% of net revenues. In 1994, Compaq Computer Corporation accounted for 22% of net revenues.
Major operations outside the United States include sales offices and technology centers in Western Europe, Japan and Asia-Pacific. Foreign operations are subject to risks of political instability and foreign currency exchange rate fluctuations.
Transfers between geographic areas are accounted for at amounts that are generally above cost and consistent with the rules and regulations of governing tax authorities. Such transfers are eliminated in the consolidated financial statements. Identifiable assets are those assets that can be directly associated with a particular geographic area and thus do not include assets used for general corporate purposes, such as cash, cash equivalents and liquid investments.
VLSI TECHNOLOGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) THREE YEARS ENDED DECEMBER 29, 1995
The following is a summary of operations located within the indicated geographic areas for the three years ended December 29, 1995:
U.S. export revenues, primarily to the Asia-Pacific region, were approximately $153.8 million, $162.1 million and $126.7 million in 1995, 1994 and 1993, respectively.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding directors appearing under the caption "Election of Directors -- Nominees for Director" in the Proxy Statement is hereby incorporated herein by reference.
Information regarding executive officers who are not also directors is incorporated herein by reference from Part I hereof under the heading "Executive Officers of the Company" immediately following Item 4 in Part I hereof.
Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, is hereby incorporated herein by reference from the section entitled "Information Concerning Solicitation and Voting -- Compliance with Section 16(a) Filing Requirements" in the Proxy Statement.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference from the Proxy Statement under the captions "Election of Directors -- Nominees for Director", "Election of Directors -- Director Compensation", "Election of Directors -- Compensation Committee Interlocks and Insider Participation" and "Executive Officer Compensation" .
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference from the Proxy Statement under the caption "Information Concerning Solicitation and Voting -- Security Ownership".
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference from the Proxy Statement under the captions "Election of Directors -- Compensation Committee Interlocks and Insider Participation", "Election of Directors -- Certain Transactions" and "Executive Officer Compensation".
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The financial statements (including the notes thereto) listed in the index to financial statements and financial statement schedule (set forth in Item 8 of Part II of this Form 10-K) are filed within this Annual Report on Form 10-K.
2. Financial Statement Schedule
The financial statement schedule listed in the Index to Consolidated Financial Statements and Financial Statement Schedule (set forth in Item 8 of Part II of this Form 10-K) are filed as part of this Annual Report on Form 10-K.
3. Exhibits
The exhibits listed under Item 14(c) hereof are filed as part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
There were no Reports on Form 8-K filed by the Company during the fourth quarter ended December 29, 1995.
(c) Exhibits
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* Denotes a compensation plan in which an executive officer participates.
** Denotes a document for which confidential treatment has been granted for selected portions.
(d) Financial Statement Schedules
See Item 14(a)(2) above.
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements (Forms S-8 Nos. 2-86600, 2-90890, 33-4797, 33-12909, 33-21116, 33-27872, 33-39653, 33-52908, 33-62068, 33-57433 and 33-57991) pertaining to the Employee Stock Purchase Plan, 1992 Stock Plan, 1982 Incentive Stock Option Plan and 1986 Directors' Stock Option Plan of VLSI Technology, Inc. and in the related Prospectuses, of our report dated January 16, 1996, with respect to the consolidated financial statements and schedule of VLSI Technology, Inc. included in this Annual Report (Form 10-K) for the year ended December 29, 1995.
/s/ ERNST & YOUNG LLP -------------------------------------- ERNST & YOUNG LLP
San Jose, California March 22, 1996
VLSI TECHNOLOGY, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
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(1) Deductions represent amounts written off against the allowance for doubtful accounts and customer returns.
(2) Deductions represent amounts written off against the reserves.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
VLSI TECHNOLOGY, INC. (Registrant)
By: /s/ ALFRED J. STEIN ---------------------------------- Alfred J. Stein, Chairman of the Board, Chief Executive Officer and President
Date: March 12, 1996
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Alfred J. Stein and Gregory K. Hinckley, and each of them his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
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* Denotes a compensation plan in which an executive officer participates.
** Denotes a document for which confidential treatment has been granted selected portions.