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MIPS TECHNOLOGIES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis together with our consolidated financial statements and notes to those statements included elsewhere in this report. Except for the historical information contained in this Annual Report on Form 10-K, this discussion contains forward-looking statements that involve risks and uncertainties including statements regarding our expectation for specific aspects of our results of operations in fiscal 2011. Our actual results could differ materially from those indicated in these forward-looking statements as a result of certain factors, as more fully described under "Risk Factors," and other risks included from time to time in our other Securities and Exchange Commission reports, copies of which are available from us upon request. The forward-looking statements within this Annual Report on Form 10-K are identified by words such as "believes," "anticipates," "expects," "intends," "may" and other similar expressions. However, these words are not the exclusive means of identifying such statements. We undertake no obligation to update any forward-looking statements included in this discussion. Introduction MIPS Technologies, Inc. is a leading provider of industry-standard processor architectures and cores for digital home, networking and mobile applications. Our offerings include flexible and widely-applicable single- and multi-threaded core processors that can be used in a wide variety of markets. Our technology is broadly used in products such as digital televisions, set-top boxes, Blu-ray players, broadband customer premises equipment, WiFi access points and routers, networking infrastructure and portable/mobile communications and entertainment products. Our customers are global semiconductor companies and system original equipment manufacturers (system OEMs). We offer our customers high-performance, easy-to-use functionality at a fraction of the cost and time to market that internal development would require. Our customers pay us license fees for architectural and product rights, as well as royalties based on processor unit shipments. Overview In fiscal 2011 we increased our investments in research and development and marketing with a specific focus on the mobile market, as our activities and opportunities in that market are growing. Our increased investment activities included adding headcount, utilizing third party IP suppliers, contracting with software developers and partnering with third parties to accelerate our development efforts. To date, our investments have enabled us to secure numerous mobile-related licenses including those for the MIPS architecture, as well as the MIPS32 4KE, M4K, M14K, 24K, 34K, 74K, 1004K and 1074K cores. In addition, we received the first royalties related to mobile handset applications processing in the third quarter of fiscal 2011. 27 -------------------------------------------------------------------------------- Our fiscal 2011 revenue increased by $11.1 million over the prior year. Total fiscal 2011 revenue of $82 million increased 16% from the $71 million reported in the prior fiscal year. Royalty revenue in fiscal 2011 was $53.7 million, an increase of 18% from the $45.7 million reported during fiscal 2010. Total royalty units reported in fiscal year 2011 were 656 million or 29 percent higher than the 510 million units reported in fiscal 2010. As our royalty revenue is reported one quarter in arrears, shipments and revenue reported in our fourth quarter represented our customer shipments from the quarter ended March 31, 2011. License and contract revenue in fiscal 2011 was $28.4 million, an increase of 12% from the $25.3 million in the prior fiscal year. The increase in license and contract revenue in the fiscal 2011 as compared to prior year was due to the higher average selling prices of our licenses in fiscal 2011 as compared to the prior year. In fiscal 2011, we completed 26 new license agreements compared to 37 in the prior year. Our operating income in fiscal 2011 increased to $20.5 million, as compared to our operating income of $15.7 million in fiscal 2010. The increase in operating performance for our fiscal year 2011 compared to the same period of fiscal 2010 was mainly due to the increase in royalty and license revenue offset by increased operating expenses as we continued to invest in research and development and marketing. We recorded a tax provision of $3.8 million in fiscal 2011 consisting mainly of U.S. state, foreign tax, and withholding tax expenses. Our cash, cash equivalents and short term investments at June 30, 2011 were $109.4 million compared to $52.4 million at June 30, 2010. The increase in cash, cash equivalents and short term investments was primarily a result of cash provided from operations and stock option exercises. We issued approximately 6.2 million shares from option exercises for the year ended June 30, 2011. These exercises were the primary reason that our total diluted shares outstanding increased from 46.4 million for the year ended June 30, 2010 to 53.3 million for the year ended June 30, 2011. As a result of these option exercises, our total outstanding options decreased from 11.5 million at June 30, 2010 to 6.1 million at June 30, 2011. Approximately 38% of the options exercised for the year ended June 30, 2011 were from two recently departed executives. Discontinued Operations On May 7, 2009, we entered into a simultaneous sale and close agreement with Synopsys, Inc. (Synopsys) to sell our Analog Business Group (ABG) for $22 million in cash. As a result of the sale, the assets and liabilities related to ABG are presented as assets and liabilities of discontinued operations, respectively, and the results of ABG's operations are classified as discontinued operations on our statements of operations for all periods presented. In connection with the sale of our ABG to Synopsys, we agreed to retain responsibility for certain actual or contingent liabilities and agreed to indemnify Synopsys against certain breaches of representations and warranties and other liabilities. Our potential liability to Synopsys is subject to certain limitations, including limitations on the time period during which claims may be asserted and the amounts for which we are liable. To date, we have not incurred any losses in respect of claims asserted by Synopsys in connection with this transaction. However, there can be no assurance that we will not incur future liabilities to Synopsys in connection with this transaction, or that the amount of such liabilities will not be material. In May 2010, Synopsys delivered a letter to MIPS asserting breaches of certain representations and warranties and requesting compensation in an aggregate amount of approximately $3.7 million. We responded to Synopsys in June 2010 and denied all claims set forth in the May 2010 letter. In July 2010, Synopsys responded to our letter. General discussions between the parties have commenced and additional documents have been exchanged. However, there can be no assurance that the current dispute can be resolved on terms that are acceptable to us. 28 -------------------------------------------------------------------------------- The results from discontinued operations of ABG (exclusive of the gain on disposition) are as follows for the years ended June 30, 2011, 2010 and 2009 (in thousands): 2011 2010 2009 Revenue $ - $ - $ 19,729 Expenses 212 214 (40,534 ) Restructuring expense - - (6,813 ) Gain (loss) from discontinued operations, before tax 212 214 (27,618 ) Tax benefit of discontinued operations - - (5,559 ) Gain (loss) from discontinued operations, net of tax $ 212 $ 214 $ (22,059 ) The summarized balance sheet of discontinued operations of ABG consisted of the following (in thousands): June 30, 2011 June 30, 2010 Assets: Total assets of discontinued liabilities $ - $ - Liabilities: Accounts payable and other current liabilities $ - $ 26 Total liabilities of discontinued operations $ - $ 26 In fiscal 2011, we recorded a gain from discontinued operations of $0.2 million as a result of receiving a withholding tax refund from discontinued operations. In fiscal 2010, we recorded a gain from discontinued operations of $0.2 million, primarily as a result of receiving a withholding tax refund of approximately $0.3 million from discontinued operations. This gain was partially offset by administrative costs for closure of foreign subsidiaries, and our remaining liability at June 30, 2010 consisted of remaining administrative costs relating to the closure of certain foreign operations. The payments and receipts relating to discontinued operations have been reflected as cash activities from discontinued operations in our consolidated statement of cash flows for all periods presented. Critical Accounting Policies and Estimates We prepare our financial statements in conformity with U.S. generally accepted accounting principles, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. We regularly evaluate our accounting estimates and assumptions. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results inevitably will differ from the estimates, and such differences may require material adjustments to our financial statements. We believe the following critical accounting policies affect the significant judgments and estimates we use in the preparation of our consolidated financial statements. 29-------------------------------------------------------------------------------- Revenue Recognition. Royalty Revenue. We classify all revenue that involves the sale of a licensee's products as royalty revenue. Royalty revenue is recognized in the quarter in which we receive a report from a licensee detailing the shipments of products incorporating our IP components, which is generally in the quarter following the licensee's sale of the product to its customer. Royalties are calculated either as a percentage of the revenue received by the seller on sales of such products or on a per unit basis, as specified in our agreement with the licensee. We periodically engage a third party to perform royalty audits of our licensees, and if these audits indicate any over- or under-reported royalties, we account for the results when they are resolved. License and Contract Revenue. We generally derive revenue from license fees for the transfer of proven and reusable IP components on currently available technology. We enter into licensing agreements that provide licensees the right to incorporate our IP components in their products with terms and conditions that have historically varied by licensee. These agreements include a nonexclusive license for the underlying IP. Fees for contracts for currently available technology include: license fees relating to our IP, including processor designs; maintenance and support, typically for one year; and royalties payable following the sale by our licensees of products incorporating the licensed technology. Generally, our customers pay us a single upfront fee that covers the license and first year maintenance and support. Our deliverables in these arrangements include (a) processor designs and related IP and (b) maintenance and support. In October 2009, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2009-13, "Revenue Arrangements with Multiple Deliverables" ("ASU 2009-13"). The standard changes the requirements for establishing separate units of accounting in a multiple element arrangement and requires the allocation of arrangement consideration to each deliverable based on the relative selling price. The selling price for each deliverable is based on vendor-specific objective evidence ("VSOE") if available, third-party evidence ("TPE") if VSOE is not available, or best estimate of selling price ("BESP") if neither VSOE nor TPE is available. We adopted the provisions of ASU 2009-13 as of the beginning of fiscal 2011 for licenses that originate or are materially modified customer arrangements originating after July 1, 2010. The amount of license and contract revenue we recognize in a given period is affected by our judgment as to whether an arrangement includes multiple deliverables and, if so, our determinations surrounding whether VSOE exists. In circumstances when VSOE does not exist, we then apply judgment with respect to whether we can obtain TPE. Generally, we are not able to determine TPE because our go-to-market strategy typically differs from that of our peers. When we are unable to establish selling price using VSOE or TPE, we use BESP in our allocation of arrangement consideration. We determine VSOE based on our normal pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, we require that a substantial majority of the selling prices for a product or service fall within a reasonably narrow pricing range. In determining BESP, we apply significant judgment as we weigh a variety of factors, based on the facts and circumstances of the arrangement. We typically arrive at BESP for license and contract revenue by considering historical and current evidence of pricing including bundled pricing practices, selling region, license term and number of uses allowed. The adoption of ASU 2009-13 had no material effect to our financial results. License and contract revenue from currently available technology is recorded as revenue upon the execution of the license agreement when there is persuasive evidence of an arrangement, fees are fixed or determinable, delivery has occurred and collectability is reasonably assured. We assess the credit worthiness of each customer when a transaction under the agreement occurs. If collectability is not considered reasonably assured, revenue is recognized when the fee is collected. Other than maintenance and support, there is no continuing obligation under these arrangements after delivery of the IP. 30 -------------------------------------------------------------------------------- Contracts relating to technology under development also can involve delivery of a license to intellectual property, including processor designs. However, in these arrangements we undertake to provide best-efforts engineering services intended to further develop technology that has yet to be developed into a final processor design. Rather than paying an upfront fee to license completed technology, customers in these arrangements pay us milestone fees as we perform the engineering services. If the development work results in completed technology in the form of a processor design and related intellectual property, the customer is granted a license to such completed technology at no additional fee. These contracts typically include the purchase of first year maintenance and support commencing upon the completion of a processor design and related intellectual property for an additional fee, which fee is equal to the renewal rate specified in the arrangement. The licensee is also obligated to pay us royalties following sale of products incorporating the licensed technology. We continue to own the intellectual property that we develop and we retain the fees for engineering services regardless of whether the work performed results in a completed processor design. Fees for engineering services in contracts for technology under development are recognized as revenue as the services are performed; however, we limit the amount of revenue recognized to the aggregate amount received or currently due pursuant to the milestone terms. As engineering activities are best-efforts and at-risk and because the customer must pay an additional fee for the first year of maintenance and support if the activities are successful, the maintenance and support is a contingent deliverable that is not accounted for upfront under contracts relating to technology under development. When we provide engineering services involving design and development of customized specifications, we recognize revenue on a percentage of completion basis from the signing of the agreement through the completion of all outstanding development obligations. The amount of revenue recognized is based on the total license fees under the license agreement and the percentage of completion is measured by the actual costs incurred to date on the project compared to the total estimated project cost. Revenue is recognized only when collectability is probable. The estimates of project costs are based on the IP specifications and prior experience with the same or similar IP development and are reviewed and updated regularly. Under the percentage of completion method, provisions for estimated losses on uncompleted contracts are recognized in the period in which the likelihood of such losses is determined. Licensing of existing IP that does not require any configuration is recognized upon delivery of the IP and when all other revenue recognition criteria have been met. Direct costs incurred in the design and development of the IP under these arrangements is included in cost of sales. Maintenance and Support. Certain arrangements include maintenance and support obligations. Under such arrangements, we provide unspecified upgrades, bug fixes and technical support. No other upgrades, products or other post-contract support are provided. These arrangements are generally renewable annually by the customer. Maintenance and support revenue is recognized at its selling price based on VSOE ratably over the period during which the obligation exists, typically 12 months. The fair value of any maintenance and support obligation is established based on the specified renewal rate for such maintenance and support. Maintenance and support revenue is included in license and contract revenue in the statement of operations and was $2.5 million, $2.7 million and $3.2 million in fiscal 2011, 2010 and 2009, respectively. Income Taxes. Significant judgment is required in determining our worldwide income tax provision. In the ordinary course, there are many transactions and calculations for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of revenue sharing and cost reimbursement arrangements among related entities and segregation of foreign and domestic income and expense to avoid double taxation. Although we believe that our estimates are reasonable, no assurance can be given that the final tax outcome of these matters will not be different from that which is reflected in our historical income tax provisions and accruals. Such differences could have a material effect on our income tax provision and net income in the period in which such determination is made. 31-------------------------------------------------------------------------------- We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. In order for us to realize our deferred tax assets, we must be able to generate sufficient taxable income in those jurisdictions where the deferred tax assets are located. We have provided a full valuation allowance against our net deferred tax assets due to our history of net losses, difficulty in forecasting future results and belief that we cannot rely on projections of future taxable income to realize deferred tax assets. Significant management judgment is required in determining our deferred tax assets and liabilities and valuation allowances for purposes of assessing our ability to realize any future benefit from our net deferred tax assets. We intend to maintain this valuation allowance until sufficient positive evidence exists to support the reversal of the valuation allowance. Future income tax expense will be reduced to the extent that we have sufficient positive evidence to support a reversal of, or decrease in, our valuation allowance. We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed during the subsequent year. Adjustments based on filed returns are generally recorded in the period when the tax returns are filed and the tax implications are known. The amount of income taxes we pay is subject to ongoing audits by federal, state and foreign tax authorities, which often result in proposed assessments. Our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. As a result, our effective tax rate may fluctuate significantly on a quarterly basis. We account for uncertain tax positions using a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon tax authority examination, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement. At June 30, 2011 and June 30, 2010, we had gross unrecognized tax benefits of $4.6 million and $4.3 million, respectively. The Company's policy is to include interest and penalties related to unrecognized tax benefits, if any, within the provision for taxes in the consolidated statements of operations. Goodwill. Goodwill represents the excess of the purchase price over the fair value of net tangible and identifiable intangible assets acquired. Goodwill amounts are not amortized, but rather are tested for impairment at least annually or more frequently if there are indicators of impairment present. The Company performs its annual goodwill impairment analysis in the fourth quarter of each fiscal year. The Company evaluates whether goodwill has been impaired at the reporting unit level by first determining whether the estimated fair value of the reporting unit is less than its carrying value and, if so, by determining whether the implied fair value of goodwill within the reporting unit is less than the carrying value. As a result of the divestiture of the ABG, we now operate in one reportable segment and our reporting unit is consistent with the reportable segments identified. As such the estimated fair values of our single reporting unit was determined by using the Company's market capitalization. Impairment of Long-Lived Assets including Acquisition Related Intangible Assets. For long-lived assets other than goodwill, the Company evaluates whether impairment losses have occurred when events and circumstances indicate that these assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. If less, the impairment losses are based on the excess of the carrying amounts of these assets over their respective fair values. Their fair values would then become the new cost basis. Fair value is determined by discounted future cash flows, appraisals or other methods. Short-term Investments. Investments with original maturities of greater than 90 days at the time of acquisition but less than one year from the balance sheet date are classified as short-term investments. 32 -------------------------------------------------------------------------------- We classify investments in marketable debt and equity securities as available-for-sale securities. Available-for-sale securities are carried at fair value, based on quoted market prices, with the unrealized gains or losses reported net of tax, in stockholders' equity as part of accumulated other comprehensive income (loss). We determine the fair values for short-term investments (that principally consist of marketable debt and equity securities) using industry standard pricing services, data providers and other third-party sources and by internally performing valuation analyses (see Note 4 to our Notes to Consolidated Financial Statements). The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, both of which are included in interest and other income, net. Realized gains and losses, if any, are recorded on the specific identification method and are included in interest and other income, net. We review our investments in marketable securities for possible other-than-temporary impairments on a regular basis. In determining if and when a decline in value below the adjusted cost of marketable debt and equity securities is other-than-temporary, we evaluate on an ongoing basis the market conditions, trends of earnings, financial condition, credit ratings, any underlying collateral and other key measures for our investments. In addition, we consider: 1) our intent to sell the security, 2) if we intend to hold the security, whether it is more likely than not that we will be required to sell the security before recovery of the security's amortized cost basis and 3) if we intend to hold the security, whether or not we expect the security to recover the entire amortized cost basis. If any loss on investment is believed to be other-than-temporary, a charge will be recognized. Due to the high credit quality and short term nature of our investments, there have been no other-than-temporary impairments recorded to date. Stock-Based Compensation. We recognize stock compensation expense for all share-based payments to employees, including grants of employee stock options in our financial statements based on the fair value of the grants. For awards of restricted stock and restricted stock units, we measure compensation expense at grant date based on the estimated fair value of the award, reduced by expected forfeitures, and generally recognize the expense on a straight line basis over the expected requisite service period. For options granted, the fair value is estimated at the date of grant using a Black-Scholes option pricing model with weighted average assumptions for the activity under our stock plans. Option pricing model assumptions such as expected term, expected volatility, and risk-free interest rate, impact the fair value estimate. Further, the forfeiture rate impacts the amount of aggregate compensation. These assumptions are subjective and generally require significant analysis and judgment to develop. When estimating fair value, some of the assumptions will be based on or determined from external data and other assumptions may be derived from our historical experience with share-based payment arrangements. The appropriate weight to place on historical experience is a matter of judgment, based on relevant facts and circumstances. As a result of the adjustment to our term and vesting schedule in July 2005 for stock options awarded under our 1998 and 2002 Plans, we do not believe that we are able to rely on our historical exercise and post-vested termination activity to provide relevant data for estimating our expected term for use in determining the fair value of these options. Therefore, we have opted to use the simplified method for estimating our expected term equal to the midpoint between the vesting period and the contractual term. We currently estimate volatility by considering our historical stock volatility. The risk-free interest rate is the implied yield currently available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term used as the input to the Black-Scholes model. We estimate forfeitures using a weighted average historical forfeiture rate. Our estimates of forfeitures will be adjusted over the requisite service period based on the extent to which actual forfeitures differ, or are expected to differ, from their estimate. 33 --------------------------------------------------------------------------------Results of Operations-Years Ended June 30, 2011, 2010 and 2009 Our results of continuing operations are discussed below. See above in Item 7 Management's Discussion and Analysis of Financial Condition and Note 6 of the Notes to Consolidated Financial Statements for additional details on our discontinued operations. Revenue. Total revenue primarily consists of royalties, license and contract revenue. Royalties are based upon sales by licensees of products incorporating our technology. License and contract revenue consists of technology license fees generated from new and existing license agreements for developed technology, associated maintenance agreements and engineering service fees generated from contracts for technology under development. Technology license fees vary based on, among other things, whether a particular technology is licensed for a single application or for multiple or unlimited applications, and whether the license granted covers a particular design or a broader architecture. Our revenues in fiscal 2011, 2010 and 2009 were as follows (in millions, except percentages): Fiscal Year Fiscal Year Change in Change in Percent Percent 2011 2010 2010-2011 2009 2009-2010 Revenue Royalties $ 53.7 $ 45.7 18 % $ 42.5 7 % Percentage of Total Revenue 65 % 64 % 61 % License and Contract Revenue $ 28.3 $ 25.3 12 % 27.7 -9 % Percentage of Total Revenue 35 % 36 % 39 % Total Revenue $ 82.0 $ 71.0 16 % $ 70.2 1 % Royalties. Fiscal 2011 compared to fiscal 2010. The 18% increase in royalty revenue resulted from an increase in units reported to 656 million in fiscal 2011 compared to 510 million in fiscal 2010. The 29% growth in unit volume was partially offset by a decrease in per unit royalty rates. Our customers in general were under pricing pressures in the markets we serve. Since a significant portion of our royalty revenue is calculated based on a percentage of our customers' revenue, the decrease in our customers' selling prices resulted in lower royalty revenue to us. In addition, certain customers met time or volume based discount levels in their contracts, resulting in lower per unit royalties paid to us. Fiscal 2010 compared to fiscal 2009. The 7% increase in royalties resulted from an increase in units reported to 510 million in fiscal 2010 compared to 427 million in fiscal 2009. The 19% growth in unit volume was partially offset by a decrease in average selling price as certain customers met time or volume based discount levels in their contracts. 34 --------------------------------------------------------------------------------License and Contract Revenue. We license our embedded processor intellectual property in the form of both architectures and specific processor cores. Our license agreements include both limited and unlimited uses of our products; however, all licenses contain a limitation in the number of years that license is valid and only cover those products specifically licensed and available at the time of the license. Under unlimited use license agreements, customers typically pay a larger fixed, up-front fee for the unlimited use of (i) one or more of our MIPS-developed cores or (ii) our architecture to develop their own MIPS-compatible cores during the term of the agreement. Architecture license agreements are not as common as core license agreements. The company currently has 14 active architecture customers. We generally recognize all license revenues under limited and unlimited use license agreements upon execution of the agreement, provided all revenue recognition criteria have been met. Fiscal 2011 compared to fiscal 2010. The 12% increase in contract revenue was due to the higher average selling prices of our licenses in fiscal 2011 as compared to the prior year. There were 26 new agreements in fiscal 2011 compared to 37 in fiscal 2010. Fiscal 2010 compared to fiscal 2009. The 9% decrease in contract revenue was primarily due to the global economic slowdown during the year, but our license and contract revenue showed significant growth in the fourth quarter of fiscal 2010, increasing to $10.9 million as compared to $4.9 million in the same period of the prior year. There were 37 new agreements in fiscal 2010 compared to 31 in fiscal 2009. Unlimited use licenses accounted for $17.4 million of our license and contract revenue in fiscal 2011. The range of terms of unlimited license agreements we completed in fiscal 2011 was 1 to 16 years with an average term of approximately 4 years. License revenue from unlimited use license agreements was $13.0 million in fiscal 2010. International revenue accounted for approximately 54% of our total revenue in fiscal 2011, 59% of our total revenue in fiscal 2010 and 54% of our total revenue in fiscal 2009. The majority of this revenue has been denominated in U.S. dollars. We expect that revenue derived from international licensees will continue to represent a significant portion of our total revenue. In 2011, we had two customers that accounted for approximately 16% and 11% (Customer A and Customer B, respectively) in 2010 and 2009 we had one customer (Customer A) that accounted for approximately, 16%, and 19% of our revenue, respectively. Costs and Expenses. Our costs and expenses in fiscal 2011, 2010, and 2009 were as follows (in millions, except percentages): Fiscal Year Fiscal Year Change in Change in Percent Percent 2011 2010 2010-2011 2009 2009-2010 Cost and Expenses Cost of Sales $ 1.3 $ 0.9 48 % $ 0.7 34 % Research and Development $ 27.7 $ 24.3 14 % $ 21.5 13 % Sales and Marketing $ 19.1 $ 15.8 21 % $ 11.0 43 % General and Administrative $ 13.5 $ 13.6 -1 % $ 15.5 -13 % Restructuring $ - $ 0.7 -100 % $ 0.7 6 % Cost of Sales. Cost of sales primarily includes labor and overhead related costs for contracts with engineering service requirements, material costs and costs associated with acquired third party software used in our products. Fiscal 2011 compared to fiscal 2010. The increase in cost of sales is primarily due to additional engineering labor and overhead costs associated with larger customized customer projects and an increase in purchased technology amortization cost in fiscal 2011 compared to fiscal 2010. 35 -------------------------------------------------------------------------------- Fiscal 2010 compared to fiscal 2009. The increase in cost of sales is primarily due to additional engineering labor and overhead costs associated with larger customized customer projects in fiscal 2010 compared to fiscal 2009. Research and Development. Research and development expenses include salaries and contractor and consultant fees, as well as costs related to workstations, software, and computer aided design tools utilized in the development of new technologies. The costs we incur with respect to internally developed technology and engineering services are included in research and development expenses as they are incurred and are generally not directly related to any particular licensee, license agreement or license fee. Fiscal 2011 compared to fiscal 2010. Research and development expenses in fiscal 2011 increased by $3.3 million compared to fiscal 2010. Our 2011 research and development costs increased by $2.1 million due to increased outside services spending for additional software and tool development costs for Android and mobile related end applications. In addition, our salary and employee related expense increased by $1.4 million due to the hiring of additional headcount in our engineering team and increased payroll taxes resulting from the additional headcount as well as from stock option exercises in fiscal 2011. Our stock compensation expense also increased by $0.1 million due to higher average grant date fair value of options as compared to prior years. These increases were partially offset by a $0.3 million reduction in depreciation expense with more equipment being fully depreciated. Fiscal 2010 compared to fiscal 2009. Research and development expenses in fiscal 2010 increased by $2.8 million compared to fiscal 2009. Our 2010 research and development costs increased by $1.5 million due to higher bonus expense as the company exceeded certain financial targets for the year. In addition, we increased outside services spending by $1.2 million for additional software and tool development costs for Android and mobile related end applications. Our salary expense also increased by $0.7 million due to the mix and timing of hiring of our engineering team. These increases were partially offset by a $0.5 million reduction in depreciation and facilities expenses primarily resulting from lower rent in connection with our headquarter relocation in May 2009 and $0.1 million reduction in stock compensation expenses due to lower average grant date fair value of options as compared to prior years. Our research and development staff totaled 95 employees at June 30, 2011 compared to 81 employees at June 30, 2010 and at June 30, 2009. Sales and Marketing. Sales and marketing expenses include salaries, commissions and costs associated with third party independent software development tools, direct marketing and other marketing efforts. Our sales and marketing efforts are directed at establishing and supporting our licensing relationships. Fiscal 2011 compared to fiscal 2010. Our sales and marketing expense increased by $3.3 million in fiscal 2011 compared to fiscal 2010. Salary and employee related expenses increased by $1.3 million due to hiring of additional marketing personnel and increased payroll taxes resulting from the additional headcount as well as from stock option exercises in fiscal 2011. In addition, outside services and consulting expenses increased by $1.0 million resulting from additional sales and marketing efforts primarily focused on Android and mobile related end applications. There was also an increase in travel expense of $0.4 million with increased staffing levels and international travel. Lastly, there was an increase in stock compensation expenses of $0.6 million due to increased staffing levels and higher average grant date fair value of options as compared to prior years. Fiscal 2010 compared to fiscal 2009. Our sales and marketing expense increased by $4.8 million in fiscal 2010 compared to fiscal 2009. As a result of our sales teams' focus on selling our processor products with the divestiture of ABG the costs increased by $3.4 million. The increase in sales cost was due to commissions and bonus expense increasing by $1.0 million as the company exceeded certain sales and financial targets and to an increase of $1.3 million in outside services and consulting expenses resulting from additional sales and marketing efforts with significant focus on Android and mobile related end applications. These increases were partially offset by a decrease in stock compensation expenses of $0.5 million due to decreased staffing levels and lower average grant date fair value of options as compared to prior years, decrease in facilities and depreciation expenses of $0.2 million primarily resulting from lower rent in connection with our headquarter relocation in May 2009 and decrease in travel expenses of $0.2 million. 36 --------------------------------------------------------------------------------Our sales and marketing staff increased to 41 employees at June 30, 2011 compared to 36 employees at June 30, 2010 and compared to 37 employees at June 30, 2009. General and Administrative. General and administrative expenses comprise salaries, legal fees including those associated with the establishment and protection of our patent, trademark and other intellectual property rights which are integral to our business, and expenses related to compliance with the reporting and other requirements of a publicly traded company including directors and officers liability insurance and financial audit fees. Fiscal 2011 compared to fiscal 2010. The decrease in general and administrative expense of $0.1 million in fiscal 2011 compared to fiscal 2010 was primarily due to $0.5 million of severance expense in connection with the departure of our former Chief Executive Officer and recruiter expenses of $0.2 million associated with hiring a new CEO in fiscal 2010. There was also a decrease of $0.3 million in facilities and depreciation expenses primarily resulting from more equipment being fully depreciated. Salary expenses also decreased by $0.2 million due to the mix and timing of personnel being hired. These decreases were partially offset by an increase of $0.8 million in stock compensation expense primarily resulting from higher average grant date fair value of options as compared to prior years and an increase of $0.3 million with increase in payroll taxes due to an increase of stock option exercises in fiscal 2011. Fiscal 2010 compared to fiscal 2009. The decrease in general and administrative expense of $1.9 million in fiscal 2010 compared to fiscal 2009 was primarily due to a $2.2 million decrease in outside services resulting from the lower legal, tax and audit fees in fiscal 2010. There was also a decrease of $0.6 million in facilities and depreciation expenses primarily resulting from lower rent in connection with our headquarter relocation in May 2009, a decrease of $0.5 million in salary related costs due to lower staffing levels, and a decrease of $0.3 million in stock compensation expense due to decreased staffing levels and lower average grant date fair value of options as compared to prior years. These decreases were partially offset by a higher bonus expense of $1.3 million as we exceeded certain financial targets for the year and higher recruiting expenses of $0.3 million associated with hiring a new CEO. Our general and administrative staff was 26 employees at June 30, 2011 compared to 24 employees at June 30, 2010 and compared to 28 employees at June 30, 2009. Restructuring. We had no restructuring expense in fiscal 2011. The fiscal 2010 restructuring expense of $0.7 million related to terminations of headcount in the US and was primarily designed to reduce spending in general and administrative functions and to reallocate spending to other functions. The fiscal 2009 restructuring expense of $0.7 million from continuing operations was primarily driven by two executive terminations and reductions in our sales force. Other Income, Net. Other income, net in fiscal 2011, 2010 and 2009 was comprised of the following (in thousands): Years Ended June 30, 2011 2010 2009 Interest income $ 482 $ 143 $ 194 Interest expense - (349 ) (662 ) Impairment - other-than-temporary - - (1,728 ) Gain on investment 646 669 - Loan amortization fees (7 ) (127 ) (130 ) Other (253 ) (126 ) (55 ) Total interest and other income, net $ 868 $ 210 $ (2,381 ) 37-------------------------------------------------------------------------------- Other Income, net increased by $0.7 million for fiscal 2011 compared to fiscal 2010 primarily due to a $0.3 million decrease in interest expense and a decrease of $0.1 million in loan amortization fees as our outstanding debt balances was fully paid off in April 2010. In addition, there was an increase in interest income by $0.3 million due to increase in our cash and investment balance in fiscal 2011. The other income, net increased by $2.6 million for fiscal 2010 compared to fiscal 2009 primarily due to a $0.7 million gain on the investment in a privately held company that was acquired by a public entity and a $0.3 million decrease in interest expense as our outstanding debt balances decreased from fiscal 2009. In addition, in fiscal 2009 the other-than-temporary impairment due to a write down in the value of equity held in a privately held company was $1.7 million, and there was no other-than-temporary impairment expense in fiscal 2010. These changes were partially offset by an increase in foreign exchange loss in fiscal 2010 as compared to fiscal 2009. Income Taxes. In fiscal 2011, we recorded an income tax provision of $3.8 million. The tax provision was primarily comprised of U.S. state, foreign, and withholding taxes. U.S. federal tax has been offset by foreign tax credits from withholding taxes, and tax benefits from employee stock option exercises. Included in the fiscal 2011 income tax expense is $0.9 million withholding tax related to the repatriation of undistributed earnings from one of our foreign subsidiaries, for which a U.S. foreign tax credit is available. However, our U.S. foreign tax credit is subject to a valuation allowance consistent with the other U.S. deferred tax assets. The tax provision is lower than the applicable combined federal and state statutory rate primarily due to utilization of foreign tax credits and tax benefits from employee stock option exercises. In fiscal 2010, we recorded an income tax provision of $3.3 million. The tax provision was primarily comprised of U.S. state, foreign, and withholding taxes, partially offset by tax refunds from tax incentives in certain jurisdictions, and benefits from previously unrecognized tax benefits. U.S. federal income tax has been offset by foreign tax credits. During the quarter ended June 30, 2010, we filed a tax refund claim for U.S. net operating loss carry-back and realized a tax benefit of approximately $0.5 million. Included in the income tax provision is $1.0 million withholding tax related to the pending repatriation of undistributed earnings from one of our foreign subsidiaries, for which a U.S. foreign tax credit is available. However, this deferred tax asset is subject to a valuation allowance. In fiscal 2009, we recorded an income tax provision of approximately $7.5 million from continuing operations and an income tax benefit of $8.3 million from discontinued operations for a total consolidated income tax benefit of $0.8 million. The tax provision from continuing operations is primarily comprised of foreign withholding taxes on royalties and license fees and income taxes in jurisdictions where there is taxable income. The tax benefit for discontinued operations reflects a benefit associated with using the discontinued operations losses to offset U.S. taxable income from continuing operations and a tax benefit associated with foreign losses, partially offset by foreign withholding tax on royalties and license fees. Segment In the first quarter of fiscal 2008 following the acquisition of Chipidea, we organized into two business groups, the Processor Business Group and the ABG. As a result of the divestiture of the ABG, effective May 7, 2009, we operated in one reportable segment. Impact of Currency Certain of our international licensees pay royalties based on revenues that are reported in a local currency and translated into U.S. dollars at the exchange rate in effect when such revenues are reported by the licensee. To date, the majority of our revenue from international customers has been denominated in U.S. dollars. However, to the extent that sales by our manufacturing licensees are denominated in foreign currencies, royalties we receive on such sales could be subject to fluctuations in currency exchange rates. 38 --------------------------------------------------------------------------------Liquidity and Capital Resources At June 30, 2011, we had cash, cash equivalents and short term investments of $109.4 million, an increase of approximately $57.0 million from June 30, 2010. Our cash and cash equivalents increased by $37.6 million, primarily as a result of cash provided from operations and stock option exercises, offset by net purchases of marketable securities. We allowed our revolving credit facility to expire during the first quarter of fiscal 2011 without being renewed. We ended our fiscal 2010 with cash and cash equivalents and short term investments of $52.4 million, up approximately $7.9 million from June 30, 2009. In fiscal 2010, we primarily generated cash from operations while we used cash in investing and financing activities. We used cash in investing activities to diversify our portfolio. In addition, we used cash in financing activities to repay all our debt, including repaying the outstanding balance of $1.2 million on our revolving credit line in July 2009 and repaying the outstanding balance of $8.8 million of our term loan in April 2010. Since we paid off both the revolving credit line and the term loan in our fiscal 2010, we have no debt obligations as of June 30, 2010. In fiscal 2009, we divested our ABG and therefore it is no longer part of our ongoing operations. As a result of the divestiture, we have separately classified the cash flows of the discontinued operations from operating activities in our Statements of Cash Flows for all impacted periods that have been presented. For cash flows from investing and financing activities, we have combined our disclosure of cash flows from continuing and discontinued operations. We ended our fiscal 2009 with cash and cash equivalents of $44.5 million, up approximately $24.5 million from the prior quarter and up approximately $31.8 million from June 30, 2008 cash from continuing operations. The increase was largely due to our divesture of ABG. Our aggregate loan balance outstanding as of June 30, 2009 was $12.8 million which represented our credit facility in the United States through Silicon Valley Bank. For complete statements of cash flows for fiscal 2011, 2010 and 2009, see Item 8 "Financial Statements and Supplementary Data." Operating Activities For fiscal 2011, our operating activities provided net cash of $22.3 million. The cash generated from operating activities included $22.1 million from continuing operations and cash provided from discontinued operations of $0.2 million. The cash generated from operations was primarily a result of our positive net income net of non-cash expenses. Our net income from continuing operations included the effects of non-cash charges of $5.1 million from stock compensation expense and $1.2 million in depreciation and amortization of intangible assets. In addition, cash generated from operating activities of continuing operations increased primarily as a result of $1.2 million decrease in prepaid expenses and other current and long term assets, primarily reflecting the timing of engineering design software license payments as compared to their amortization and a $4.9 million decrease in accounts receivable, reflecting timing of customer billings and payments received. These increases in cash were offset by cash used as a result of (i) a $0.6 million decrease in long term liabilities, primarily reflecting timing of engineering design software license payments, (ii) a $5.6 million decrease in accounts payable and accrued liabilities, primarily reflecting timing of engineering design software license payments as well as timing of income tax payments and (iii) a $1.7 million decrease in deferred revenue, reflecting timing of customer payments compared to timing of revenue recognition. 39 -------------------------------------------------------------------------------- For fiscal 2010, our operating activities provided net cash of $18.7 million. The cash generated from operating activities included $19.9 million from continuing operations, partially offset by cash used by discontinued operations of $1.2 million. The cash generation from continuing operations was primarily a result of our positive net income, net of non-cash expenses. Our net income from continuing operations included the effects of non-cash charges of $3.6 million from stock compensation expense and $1.6 million in depreciation and amortization of intangible assets and a $0.7 million gain on exchange and sale of investments. In addition, cash generated from operating activities of continuing operations increased primarily as a result of (i) a $4.9 million decrease in prepaid expenses and other current and long term assets reflecting increased utilization of operating assets, and (ii) a $5.6 million increase in accrued liabilities, primarily due to the increased commission and bonus costs relating to higher revenue. These increases in cash were partially offset by cash used as a result of (i) a $3.5 million decrease in long term liabilities, primarily reflecting timing of engineering design software license payments, (ii) a $0.5 million decrease in accounts payable due to the timing of payments and (iii) a $5.1 million increase in accounts receivable, reflecting timing of customer billings and payments received. The negative cash flow from operating activities of discontinued operations was primarily driven by the payment of $1.2 million of cash for restructuring and administrative expenses. For fiscal 2009, our operating activities provided net cash of $13.1 million. The cash generated from operating activities included $21.0 million from continuing operations, partially offset by cash used by discontinued operations of $7.9 million. The cash generation from continuing operations was primarily a result of our positive net income, net of non-cash expenses. Our net income from continuing operations included the effects of non-cash charges of (i) $4.2 million from stock compensation expense, (ii) $2.2 million in depreciation and amortization, (iii) $1.7 million impairment of a private company investment and (iv) $0.1 million of other non-cash charges, including non-cash activities relating to our disposition of Chipidea. The majority of remaining increase in cash was due to timing of customer receipts and timing of paying liabilities as our accounts receivable and accounts payable accounted for an additional increase in cash of $3.2 million in the aggregate in fiscal 2009. The negative cash flow from operating activities of discontinued operations was primarily driven by the $22.1 million loss from discontinued operations, net of tax, being partially offset by $5.7 million of cash being provided from customer accounts receivables. In addition, $4.9 million of the discontinued operations loss resulted from non-cash charges from depreciation and amortization expenses. Investing Activities Net cash used in investing activities was $20.5 million in fiscal 2011 as a result of usage of $19.6 million from the net purchases of available-for-sale securities and $0.9 million used to purchase property, furniture and equipment. Net cash used in investing activities was $21.7 million in fiscal 2010, primarily as a result of usage of $20.2 million from the net purchases of available-for-sale securities and $1.5 million used to purchase property, furniture and equipment. Net cash provided by investing activities was $20.4 million in 2009, primarily as a result of the receipt of net proceeds of $21.8 million from our disposition of the ABG which includes $1.0 million of cash from the settlement of indemnification claims made by us against the prior Chipidea shareholders in connection with our acquisition of Chipidea in August 2007. These sources of cash were partially offset by $1.3 million of cash used for capital expenditures. Financing Activities Net cash provided by financing activities was $35.7 million in fiscal 2011. This cash generated from financing activities resulted from stock option exercises and purchases under our employee stock purchase plan. Net cash used in financing activities was $9.8 million in fiscal 2010. Net cash used of $12.8 million related to the full repayment of our debt. This use of cash was partially offset by $3.0 million that we received from stock option exercises and purchases under our employee stock purchase plan. 40 -------------------------------------------------------------------------------- Net cash used in financing activities was $3.9 million in fiscal 2009. Net cash provided by debt financing of $16.2 million was the primary driver of cash provided by financing activities. This inflow was more than offset by payments of debt of $21.3 million. In addition, we received $1.7 million from the issuance of common stock from stock option exercises and purchases under our employee stock purchase plans. We also used $0.5 million to repay capital lease obligations. Liquidity Our future liquidity and capital requirements could vary significantly from quarter to quarter, depending on numerous factors, including, among others: • general economic and political conditions and specific conditions in the markets we address, including the continuing volatility in the technology sector and semiconductor industry, the recent global economic recession, and trends in the semiconductor markets in various geographic regions, including seasonality in sales of consumer products into which our products are incorporated; • our ability to continue to generate cash flow from operations; • litigation expenses, settlements and judgments; • required levels of research and development and other operating costs; • changes in our compensation policies; • the issuance of restricted stock units and the related cash payments we make for withholding taxes due from employees in future years; • the level of exercises of stock options and stock purchases under our employee stock purchase plan; • the timing and payment of taxes in connection with changing the legal structure of our foreign operations; • significant payments to suppliers including Computer Aided Design (CAD) system vendors required under long term purchase agreements as these payments vary and can be up to $1.0 million per quarter; • the costs associated with capital expenditures. Our investment policy requires all investments with original maturities at the time of investment of up to 6 months to be rated at least A-1/P-1 by Standard & Poor's/Moody's, and specifies higher minimum ratings for investments with longer maturities. We continually monitor the credit risk in our portfolio and seek to mitigate our credit and interest rate exposures. We intend to continue to closely monitor future developments in the credit markets and make appropriate changes to our investment policy as deemed necessary. Based on our ability to liquidate our investment portfolio and our expected operating cash flows, we do not anticipate any liquidity constraints as a result of either the current credit environment or potential investment fair value fluctuations. 41 -------------------------------------------------------------------------------- We believe that we have sufficient cash to meet our projected operating and capital requirements for the foreseeable future and at least the next twelve months. Our future capital requirements will depend on many factors including our rate of revenue growth, the timing and extent of spending to support development efforts, any expansion of sales and marketing activities and potential future acquisitions. Contractual Obligations Our contractual obligations as of June 30, 2011, were as follows: Payments due by period (in thousands) Less than 1 More than 5 Total year 1-3 years 3-5 years years Contractual Obligations Operating lease obligations (1) $ 4,889 $ 1,174 $ 1,955 $ 1,696 $ 64 Purchase obligations (2) 8,843 6,049 1,744 950 100 Other long-term liabilities and obligations (3) 1,461 - 1,461 - - Total $ 15,193 $ 7,223 $ 5,160 $ 2,646 $ 164 (1) We lease office facilities and equipment under non-cancelable operating leases including the lease for our headquarter facility in Sunnyvale, California. (2) Our purchase obligations of $8.8 million at June 30, 2011 increased from our purchase obligations as of June 30, 2010 by $3.3 million primarily as a result of the company entering into purchase agreements in connection with our focus on Android and mobile related end applications. At June 30, 2011, $0.6 million of our purchase obligations relate to engineering design software license contracts that are reflected in our accrued liabilities and other long term liabilities. The remaining $8.2 million of purchase obligations includes $6.0 million of obligations which will be completed within one year with the balance to be completed within five years. (3) Other long-term liabilities and obligations consist of amounts due to employees under a deferred compensation plan, under which distributions are elected by the employees. The table above excludes an aggregate liability of $1.2 million for uncertainty in income taxes as we are unable to reasonably estimate the ultimate amount or timing of settlement. Off-Balance-Sheet Arrangements As of June 30, 2011, we did not have any off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. 42 --------------------------------------------------------------------------------New Accounting Pronouncements In June 2011, the FASB amended its guidance on the presentation of comprehensive income in financial statements. The amended guidance eliminates the option to present components of other comprehensive income ("OCI") as part of the statement of changes in equity. Instead, entities can elect to present items of net income and OCI in one continuous statement (a "statement of comprehensive income"), or can elect to present these items in two separate but consecutive statements. The guidance, which is effective beginning the Company's fiscal year 2013, will not have an impact on the Company's consolidated financial statements as the guidance only relates to changes in financial statement presentation. In April 2011, the FASB issued new guidance to achieve common fair value measurement and disclosure requirements between U.S. generally accepted accounting principles ("U.S. GAAP") and International Financial Reporting Standards ("IFRS"). This new guidance, which is effective beginning the Company's fiscal year 2012, amends current U.S. GAAP fair value measurement and disclosure requirements to include increased transparency around valuation inputs and investment categorization. The adoption of this new guidance is not expected to have a material impact on the Company's consolidated financial statements. |