Advanced processors such as those designed and sold by the Company impact the functionality, performance, reliability and cost of today's personal computers. The demand for increased performance from microprocessor-based personal computers and the proliferation of sophisticated, advanced software applications are forcing manufacturers of personal computers to bring increasingly complex, faster and smaller products to market rapidly. Their ability to do so is largely dependent upon the designers, developers and manufacturers of microprocessors (such as Cyrix) and other complex integrated circuits.
The Cyrix design system involves integration of industry standard and Cyrix proprietary hardware and software components. The proprietary components are used throughout the design process primarily for simulation and testing for IBM compatibility. The use of these proprietary tools throughout the process and the refinement of specifications based on their output have enabled the Company to design and develop IBM compatible products. Although the Company seeks through such testing to ensure the IBM compatibility of its products, there can be no assurance that the Company will be able to continue to introduce IBM compatible products or that any particular design will be flawless.
Prior to the third quarter of 1992, substantially all of the Company's revenue had been derived from the sale of math coprocessors, integrated circuits designed to operate in tandem with a microprocessor to accelerate the performance of math-intensive software applications such as computer automated design, scientific programming and presentation graphics. Since the commencement of volume shipments of microprocessors in the third quarter of 1992, microprocessors have represented the majority of the Company's revenue and accounted for approximately 96% and 99% of its product revenue in the fiscal years ended January 1, 1995 ("fiscal 1994") and December 31, 1995 ("fiscal 1995"), respectively.
Since all of the Company's products are used in personal computers, the Company's business is closely tied to the performance of the personal computer industry. Further, the outlook for the Company's microprocessor products is highly dependent on the timing of new product introductions by the Company and its competitors and other microprocessor market conditions. Intel currently has a dominant microprocessor market share, dictates the performance standards required to compete in the microprocessor market and influences product life cycles through frequent product introductions, product enhancements and price competition. In addition to its dominant microprocessor market share, Intel is also beginning to dominate the entire personal computer platform. For example, Intel has obtained a dominant market share in sales of 64-bit or Pentium-class core logic chip sets and has emerged as the world's largest motherboard manufacturer. In fiscal 1995, Intel purchased an equity interest in Phoenix Technologies Ltd., a company which has approximately 30% of the market for BIOS (basic input/output system) software, which translates signals from the personal computer's operating system software to interface with the computer's hardware devices. Further, Intel manufactures personal computers, incorporating Intel microprocessors, chip sets, motherboards and other Intel-designed components, for resale by third-party original equipment manufacturers ("OEM") under such OEMs' names.
To compete with Intel at higher levels of integration as required by many personal computer OEMs and dealers, Cyrix is dependent upon the infrastructure of third-party designers and manufacturers of core logic chip sets, motherboards, BIOS software, and other components of personal computers. As Intel has become the dominant competitor in these segments of the personal computer industry, third-party designers and manufacturers of core logic chip sets, motherboards, BIOS software and other components to support non-Intel microprocessors have lost market share to Intel, which owns the microprocessor designs and enjoys significantly greater financial, technical, manufacturing and marketing resources than such parties. Further, as Intel expanded its role in designing and setting standards for personal computer systems, many personal computer OEMs reduced their system development expenditures and now require processor technologies to be provided at various levels of integration. Therefore, to compete with Intel and deliver the higher levels of integration required by many OEMs and dealers in 1996 and beyond, the Company intends to form closer relationships with third-party designers and manufacturers of core logic chip sets, motherboards, BIOS software and other components, expand its chip set and system design capabilities, and sell a portion of the Company's processors at higher levels of integration incorporated into modules, boards and systems. There can be no assurance that the infrastructure which supports non-Intel personal computer platforms will be competitive with Intel or continue to support the Company's products.
Microprocessor manufacturing cost per unit is primarily a function of die size (since the potential number of good die per wafer increases with reduced die size), number of mask layers, and the yield of acceptable die produced on each wafer. Other contributing factors include number of fabrication steps, costs and sophistication of the manufacturing equipment, package type, process complexity, and cleanliness. The manufacture of the Company's microprocessor products is a complex process and involves a number of precise steps, including wafer fabrication, assembly, burn-in, and final test.
The wafers fabricated by semiconductor manufacturers and purchased by the Company are sent to assembly subcontractors in the United States, Canada, Japan, Korea, Hong Kong and other locations where each silicon wafer is separated into individual die. Functional die are then connected to external leads by extremely fine wire and are assembled into plastic or ceramic packages. High temperature burn-in and circuit testing are performed by the Company to verify that outgoing production meets Cyrix quality standards and specifications.
Relationship with SGS-Thomson Microelectronics, Inc. ("SGS"). Since 1990, SGS has manufactured and sold to the Company a portion of the Company's products. On January 11, 1994 Cyrix and SGS entered into an agreement whereby SGS committed its best efforts to manufacture wafers of Cyrix-designed products for sale to Cyrix through December 1997 up to specified maximum quantities of wafers per year at agreed upon prices.
Also pursuant to the January 11, 1994 agreement, as amended, Cyrix granted SGS a license to manufacture and sell under its own name specified maximum quantities per year of certain current and future Cyrix-designed microprocessors. Further, Cyrix granted SGS the right to use certain Cyrix-designed chips as part of the SGS libraries to design application specific integrated circuits in which such Cyrix-designed chips would represent only a portion of the functionality of such products ("ASIC products"). SGS is able to manufacture and sell such ASIC products under its own name in unlimited quantities, with Cyrix receiving a royalty based on SGS's quarterly net revenue derived from the sale of such ASIC products, if any. The agreement also provides the terms under which ASIC product rights based on other Cyrix-designed products may be granted to SGS by Cyrix in the future. Further, the agreement gives Cyrix the right to sell SGS-designed ASIC products, if any, under its own name. To date, SGS has not manufactured and sold any ASIC products in which a Cyrix-designed chip is a portion of the functionality of such product.
Relationship with International Business Machines Corporation ("IBM"). On April 8, 1994, the Company and IBM signed an agreement whereby IBM's Microelectronics division agreed to manufacture specified quantities of wafers of Cyrix-designed products for sale to Cyrix through December 1999 at defined prices. Cyrix is responsible for the total production costs (including equipment costs) of such specified quantities of products irrespective of the number of products actually ordered by the Company. Cyrix made a capital equipment investment of approximately $88 million in an IBM manufacturing facility pursuant to the agreement. The depreciation expense associated with such capital equipment, which Cyrix owns, is reimbursed to the Company by IBM on a monthly basis. In the event of expiration or termination of this agreement by either party, IBM has the option to purchase this capital equipment from Cyrix at its then net book value, if any. Also, Cyrix made prepayments for product purchases of approximately $30 million during fiscal 1994, $30 million during fiscal 1995 and $10 million on January 1, 1996. Two additional product prepayments of $10 million each are due on January 1, 1997 and January 1, 1998. Such prepayments will be credited to Cyrix as it purchases wafers from IBM at defined prices during the period from July 1, 1995 through December 31, 1999. In addition to supplying microprocessors to Cyrix, IBM has the right to manufacture an equivalent amount of Cyrix-designed products for use internally or to sell on an OEM basis.
Process Technology. The Company's products are manufactured using CMOS process technology. CMOS technology is generally reliable, cost-effective and capable of producing high volumes of processors and has the additional advantage of providing high performance products which operate at low power. The Company currently uses 0.65 micron, five-level metal processes for its 6x86 products. In the second half of fiscal 1996, the Company will seek to employ 0.5 micron, five-level metal processes for certain of its products to improve die size and product performance. The Company believes that its primary competitors, Intel and Advanced Micro Devices, Inc. ("AMD"), will use advanced 0.35 micron process technologies to manufacture microprocessors in 1996. Thus, Intel and AMD may employ more advanced manufacturing processes than are available to the Company from IBM and SGS in 1996, potentially resulting in improved product performance and decreased manufacturing costs as compared to the Company.
The Company's reliance on third-party manufacturers involves several material risks, including the possible unavailability of or delays in obtaining access to certain process technologies, the absence of controllable product delivery schedules, manufacturing yields and production costs and the possible breakdown in the relationship with the third-party manufacturers. Any significant delay or production cost problem would have a material adverse effect on the Company's operating results. The Company experienced manufacturing yield problems with SGS-produced microprocessors in the second half of fiscal 1993 and experienced problems in obtaining 486DX2 products which yielded to 40/80 MHz in the fourth quarter of fiscal 1994. Further, the Company's 5x86 and 6x86 microprocessors require more advanced manufacturing processes than those required for the Company's previous products. SGS does not currently have the appropriate combination of sophisticated manufacturing equipment and advanced process technologies to manufacture the Company's 5x86 and 6x86 products with acceptable performance and cost. Until SGS becomes capable of manufacturing the Company's 6x86 processors with acceptable performance and cost, the Company will obtain most, if not all, of its microprocessors from IBM. There can be no assurance that third-party manufacturers will consistently produce acceptable yields of products in fiscal 1996 and beyond. Further, the Company has licensed some of its intellectual property to SGS and IBM to obtain specified levels of manufacturing capacity. To obtain additional manufacturing capacity, the Company could be required to license more of its intellectual property and product rights and proprietary technology, thereby increasing competition in the IBM compatible microprocessor market.
In fiscal years 1995, 1994 and 1993, the Company's research and development expenses were $29.1 million, $24.8 million and $15.7 million, respectively. The Company's research and development expenses are charged to operations as incurred. Cyrix believes that technological leadership is essential to its success and expects that it will continue to expend substantial resources on research and development. However, there can be no assurance that such research and development efforts will result in the design and development of competitive products in a timely manner.
As described above, the Company has supply agreements with SGS and IBM, pursuant to which both SGS and IBM have the right to manufacture and sell certain current and future Cyrix-designed products, including the Company's 6x86 microprocessors. In return, SGS and IBM have agreed to manufacture and sell wafers of Cyrix-designed products to the Company at defined prices and in certain quantities. To obtain additional manufacturing capacity, the Company could be required to license more of its intellectual property, product rights and proprietary technology. In addition, Cyrix licensed Texas Instruments Incorporated ("TI") to manufacture and sell certain Cyrix-designed products under the TI name pursuant to an agreement effective February 21, 1991 ("the TI Agreement"). From December 1993 to November 1994, TI and Cyrix were in litigation regarding certain disputes that had arisen under the TI Agreement, including a dispute as to which Cyrix products were licensed under the TI Agreement. Such disputes were settled in November 1994, and TI was granted licenses to certain Cyrix-designed 486 products and the option to take licenses under certain future Cyrix patents. However, TI does not have product rights or licenses to manufacture the Company's 5x86, 6x86 or future generation microprocessors.
From time to time, Cyrix has been notified that it may infringe intellectual property rights of others. If any such claims are asserted against the Company, the Company may seek to obtain a license under the third-party's intellectual property rights. The Company could decide, however, to resort to litigation to challenge such claims. Such challenges could be extremely expensive and time consuming and could materially adversely affect the Company's business, financial condition and results of operations. No assurance can be given that all necessary licenses can be obtained on reasonable terms or that litigation can be avoided. The Company is currently involved in litigation involving intellectual property rights with Intel. See "Legal Proceedings."
The Company's relationships with its distributors are non-exclusive. These distributors typically maintain an inventory of Cyrix products. The Company, pursuant to its agreements with certain distributors, provides protection to the distributors for their inventory of Cyrix products against price reductions as well as products that are slow-moving or have been discontinued by the Company. Certain of these agreements, which may be canceled by either party upon notice, provide for the return of Cyrix products to the Company if the agreement is terminated. With respect to these contracts, the Company records revenue from the sale of products to distributors when shipments are made and invoiced to the distributor, and the Company maintains reserves for estimated product returns and price allowances (see Note 1 to the Consolidated Financial Statements contained in Part II, Item 8 of this Form 10-K).
Sales Organization. In addition to the Company's domestic sales staff, the Company maintains an international sales staff in the United Kingdom, Taiwan, Hong Kong and Japan to support the Company's international marketing and sales efforts. In fiscal 1995, 1994 and 1993, the Company's sales to international customers were 66%, 52% and 48% respectively, of its net product sales. The Company's international sales operations subject the Company to political and economic risks including expropriation, currency controls, exchange fluctuations, and changes in rates and exemptions for taxes and tariffs. To date, the Company has not experienced any material adverse effects associated with such risks.
Warranty Policy. Depending upon the customer, the Company offers warranties for all of its products, the terms of which the Company believes are standard for the industry. Under such warranties, the Company may be obligated to replace defective products or products that do not perform to applicable industry standards or refund the purchase price of any such products. The Company could be obligated to recall a product that does not perform to applicable industry standards, and such a recall would likely have a material adverse effect on the Company's results of operations and future prospects. To date, warranty claims have been immaterial; however, there can be no assurance that future warranty claims will not have a material adverse effect on the Company's business and results of operations.
Other competitors in the IBM compatible microprocessor market include AMD, IBM, SGS and TI. Under a technology exchange agreement and patent cross-license agreement between AMD and Intel, AMD has historically competed in the microprocessor market with products which use intellectual property developed by Intel. AMD recently acquired Nexgen, Inc., which has designed microprocessors which they claim are competitive with the leading performance processors in the market. In recent years, IBM, SGS and TI have entered the market using Cyrix's microprocessor designs. In addition, each of these companies is in the process of designing IBM compatible microprocessors. The Company may also face competition from manufacturers of processors that are not currently IBM compatible, such as manufacturers of IBM's, Motorola's and Apple's Power PC system processors. The Company believes that other semiconductor manufacturers may enter the market resulting in even greater competition. Further, the rapid pace of technological change in the industry means that companies other than Cyrix could develop a design or process that radically advances microprocessor standards using a proprietary or patent-protected design or process.
The Company's ability to compete in the advanced processor market is dependent on its timely introduction of products that are competitive in performance, features and pricing, and there can be no assurance that the Company will introduce such products on a timely basis. During fiscal 1995, the Company was not able to introduce and ramp production of products with performance competitive with the leading performance processors designed and manufactured by Intel. Therefore, the Company's revenues and profits declined compared to prior periods. The Company believes that, in 1996, its 6x86 microprocessors will offer performance competitive with Intel's Pentium products at competitive prices for the desktop personal computer market. However, there can be no assurances that the Company can successfully supply 6x86 products with competitive performance and cost in adequate commercial volumes or that manufacturers of personal computers will design the 6x86 products into desktop computers or purchase the 6x86 products in sufficient volumes to maintain or increase Cyrix's quarterly revenues. Further, in the recent past Intel and other competitors have increased the frequency of product introductions and enhancements and have used price decreases to protect or improve their market share. The Company expects that Intel, AMD and other competitors will continue to improve the performance of their microprocessor products and use price decreases to protect or improve their market share. There can be no assurance that the Company will be able to successfully improve the performance of its microprocessors at the rate required to remain competitive with the leading performance processors in the market or compete against price decreases, since Intel and several of the Company's other competitors have substantially greater financial, technical, manufacturing and marketing resources than the Company. Further, the processor industry is characterized by litigation involving patent and infringement claims which could impact the Company's ability to compete.
OEMs generally select processors for inclusion in their personal computer products based on the processors' price/performance characteristics and feature mix with respect to the market segments targeted by such OEMs. In addition, OEMs consider the ability of processor vendors to supply adequate volumes of processors which meet their performance requirements in a timely and reliable manner. Even after a Cyrix product has been designed into an OEM's personal computer, a "design win," the Company still faces competition to keep its products in the OEM's design. Generally, an OEM can qualify a second source for any of the Company's products because SGS, IBM and TI each have licenses to manufacture certain Cyrix-designed products. As the Company does not have exclusive rights to the products it designs, revenue and gross margin for such products could be reduced.
To date, the Company has been unable to sell significant quantities of its microprocessors to most large OEMs such as Compaq, Packard Bell, Gateway and Dell. During 1995, AST Research Inc. accounted for approximately 11% of Cyrix's sales. As the Company is currently transitioning its product offerings from entry level 486 and 5x86 microprocessors to higher performance 6x86 processors, the Company must obtain design wins for its 6x86 processors with current or new OEM customers. There can be no assurance that the Company will retain its current OEM customers during this product transition or thereafter. The loss of such customers, if not replaced by other OEM customers with similar sales volumes, could have a material adverse effect on the Company's results of operations.
To compete with Intel at higher levels of integration as required by many personal computer OEMs and dealers, Cyrix is dependent upon the infrastructure of third-party designers and manufacturers of core logic chip sets, motherboards, BIOS software, and other components of personal computers. As Intel has become the dominant competitor in these segments of the personal computer industry, third-party designers and manufacturers of core logic chip sets, motherboards, BIOS software and other components to support non-Intel microprocessors have lost market share and many personal computer OEMs have reduced their system development expenditures by requiring processor technologies to be provided at various levels of integration. Therefore, the Company intends to form closer relationships with third-party designers and manufacturers of core logic chip sets, motherboards, BIOS software and other components, expand its chip set and system design capabilities, and sell a portion of the Company's processors at higher levels of integration incorporated into modules, boards and systems. There can be no assurance that the infrastructure which supports non-Intel personal computer platforms will be competitive with Intel or continue to support the Company's products.
The Company believes that attracting and retaining competent employees and motivating them to meet corporate objectives are essential elements of its success. Since its inception in 1988, the Company has implemented policies designed to create a favorable working environment for its employees. For example, the Company has a stock option plan, a stock purchase plan, a profit sharing program and a 401(k) plan matching program, all with broad based eligibility and participation, and the Company funds competitive health insurance policies. As competent employees are in high demand in the semiconductor industry, at times the Company has difficulty hiring experienced personnel at a pace consistent with the Company's objectives. While the Company intends to use whatever forms of compensation, benefits and other incentives that are necessary and cost effective to attract and retain qualified personnel, there can be no assurance that the Company will be able to do so.
None of the Company's employees are represented by a labor union. Cyrix has not experienced any work stoppages and considers relations with its employees to be good.
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In addition, there are many patents held by companies other than Intel which relate to the design and manufacture of semiconductor components, including microprocessors, and computer systems. Potential claims of infringement could be asserted by other holders of patents relating to semiconductor components or computer systems. Currently, the Company is a licensee of a limited number of specified patents under an agreement with Intel and is not a licensee under any patent license agreement with any other party. If the Company is alleged to infringe one or more patents, it may seek a license to the patent. However, there can be no assurance that a license will be available or available on reasonable terms. In such event, the Company may be forced to litigate the matter. If litigation were to commence, a license is not available on reasonable terms or if any other third party is found to have a valid claim against the Company, it could have a material adverse effect on the Company.
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