[May 17, 2012] APPLIED MICRO CIRCUITS CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations. Tweet (Edgar Glimpses Via Acquire Media NewsEdge) This management's discussion and analysis of financial condition and results of operations ("MD&A") is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of our operations. The MD&A is organized as follows: • Caution concerning forward-looking statements. This section discusses how forward-looking statements made by us in the MD&A and elsewhere in this Annual Report are based on management's present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances. • Overview. This section provides an introductory overview and context for the discussion and analysis that follows in the MD&A. • Critical accounting policies. This section discusses those accounting policies that are both considered important to our financial condition and operating results and require significant judgment and estimates on the part of management in their application. • Results of operations. This section provides an analysis of our results of operations for the three fiscal years ended March 31, 2012. A brief description is provided of transactions and events that impact the comparability of the results being analyzed. • Financial condition and liquidity. This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements and financial commitments. CAUTION CONCERNING FORWARD-LOOKING STATEMENTS The MD&A should be read in conjunction with the consolidated financial statements and notes thereto included in this report. This discussion contains forward-looking statements. These forward-looking statements are made as of the date of this report. Any statement that refers to an expectation, projection or other characterization of future events or circumstances, including the underlying assumptions, is a forward-looking statement. We use certain words and their derivatives such as "anticipate", "believe", "plan", "expect", "estimate", "predict", "intend", "may", "will", "should", "could", "future", "potential", and similar expressions in many of the forward-looking statements. The forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs, and other assumptions made by us. These statements and the expectations, estimates, projections, beliefs and other assumptions on which they are based are subject to many risks and uncertainties and are inherently subject to change. We describe many of the risks and uncertainties that we face in Part II, Item 1A, "Risk Factors" and elsewhere in this report. Our actual results and actual events could differ materially from those anticipated in any forward-looking statement. Readers should not place undue reliance on any forward-looking statement. OVERVIEW The Company Applied Micro Circuits Corporation ("AppliedMicro", "APM", "AMCC", the "Company", "we" or "our") is a leader in semiconductor solutions for the data center, enterprise, telecom and consumer/small medium business ("SMB") markets. We design, develop, market, sell and support high-performance low power ICs, which are essential for the processing, transporting and storing of information worldwide. In the telecom and enterprise markets, we utilize a combination of design expertise coupled with system-level knowledge and multiple technologies to offer IC products for wireline and wireless communications equipment such as wireless access points, wireless base stations, multi-function printers, enterprise and edge switches, blade servers, storage systems, gateways, core switches, routers, metro, long-haul, and ultra-long-haul transport platforms. In the consumer/SMB markets, we combine optimized software and system-level expertise with highly integrated 42-------------------------------------------------------------------------------- Table of Contents semiconductors to deliver comprehensive reference designs and stand-alone semiconductor solutions for wireline and wireless communications equipment such as wireless access points, network attached storage, and residential and smart energy gateways. Our corporate headquarters are located in Sunnyvale, California. Sales and engineering offices are located throughout the world. We are a semiconductor company that possesses fundamental and differentiated intellectual property for high speed signal processing, packet based communications processors and telecommunications transport protocols. This intellectual property enables us to be a key player in the data center, enterprise and telecommunications applications. Our customer focus is on the OEMs and telecommunications companies that build and connect to data centers. As of March 31, 2012, our business had two reporting units, Computing and Connectivity (formerly referred to as "Process" and "Transport", respectively). Since the start of fiscal 2010, we have invested a total of $372.5 million in the R&D of new products, including higher-speed, lower-power and lower-cost products, products that combine the functions of multiple existing products into single highly-integrated solutions, and other products to expand and complete our portfolio of communications solutions. These products, and our customers' products for which they are intended, are highly complex. Due to this complexity, it often takes several years to complete the development and qualification of a product before it enters into volume production. Accordingly, we have not yet generated significant revenues from some of the products developed during this time period. In addition, downturns in the telecommunications market can severely impact our customers' business and often result in significantly less demand for our products than was expected when the development work commenced. Acquisition of Veloce The Company proposes to acquire Veloce in accordance with the terms and conditions of the Agreement and Plan of Merger, entered into as of May 17, 2009, by and among the Company, Veloce, a wholly owned subsidiary of the Company ("Merger Sub"), and the Stockholders' Representative named therein (the "Initial Agreement"). The Initial Agreement was amended by Amendment No. 1 entered into on November 8, 2010 (the "First Amendment") and Amendment No. 2 entered into on April 5, 2012 (the "Second Amendment" and, together with the Initial Agreement and the First Amendment, the "Merger Agreement"). The Second Amendment, which added a second wholly owned subsidiary of the Company ("Merger Sub II") as a party, amended, restated and replaced the First Amendment in its entirety. Pursuant to the Merger Agreement, upon achievement of a specified FPGA product development milestone by Veloce (the "FPGA II Milestone"), and the satisfaction or waiver of certain closing conditions, a two-step merger will occur, in each case in accordance with the merger certificate filing and other statutory requirements of the Delaware General Corporation Law. First, Merger Sub will merge with and into Veloce, with Veloce as the surviving entity. Second, directly thereafter Veloce will merge with and into Merger Sub II, with Merger Sub II surviving as a wholly owned subsidiary of the Company (the "Surviving Entity"). In and as a result of the Merger, and without any further action by any party to the Merger Agreement or any security holder of Veloce, each authorized share of Veloce capital stock or its equivalent will be converted at the effective time of the Merger into and represent the right to receive a portion of the total consideration payable by the Company in the Merger (the "Merger Consideration"), subject to the satisfaction of any remaining vesting requirements, if applicable. The Merger Consideration will consist of the following aggregate amounts: • $60.4 million payable upon the closing of the Merger (the "Closing"); and • Additional amounts ranging from $0 to $75 million, as adjusted based upon actual technical performance results, in the event that certain post-Closing performance-based product development milestones relating to the products on which Veloce has worked are achieved by the Surviving Entity and the Company. The additional consideration would be payable in partial amounts calculated pursuant to the Merger Agreement upon the achievement of each such milestone. 43 -------------------------------------------------------------------------------- Table of Contents The Merger Consideration is payable, at the Company's election, in cash, shares of the Company's common stock, or a combination of the two. Pursuant to the Merger Agreement, each share of Company common stock issued as Merger Consideration will be valued, with respect to any given payment, based upon the average closing price of the Company's common stock as quoted on The Nasdaq Global Select Market for the ten trading days immediately preceding the date such payment is paid or becomes payable. The Company currently intends to treat the Merger as a "reorganization" under Section 368 of the Internal Revenue Code (a "Reorganization") in the tax returns of the Company, Veloce and the Surviving Entity. One of the requirements of a Reorganization is that the "continuity of interest" test be satisfied, which requires that shares of Company common stock form a substantial part of the consideration received by Veloce's shareholders in exchange for their Veloce stock. One of the intended purposes of the two-step merger procedure described above is to reduce the total amount of Company common stock required to be issued to satisfy the continuity of interest test. The Company currently intends to issue sufficient shares of its common stock to cause the continuity of interest test to be satisfied. Under the Nasdaq Rules, the Company would be required to obtain Company shareholder approval if the Merger transaction involved the issuance or potential issuance of shares of Company common stock equal to 20% or more of the Company's common stock outstanding before the issuance. The Company does not currently anticipate that the amount of Company common stock to be issued as Merger Consideration will trigger the Company shareholder approval requirement described above. The Company has filed an application for the purpose of qualifying the sale of the Company's common stock to be issued in the Merger in accordance with the California Corporations Code (the "CCC"), and for the purpose of requesting and conducting a hearing (the "Fairness Hearing") pursuant to the CCC, in order to exempt such common stock from the registration requirements of the Securities Act of 1933, as amended (the "Securities Act"), by virtue of the exemption provided by Section 3(a)(10) thereof. Under applicable corporate law, upon the Closing, all of the property, rights, privileges, powers and franchises of Veloce will vest in the Surviving Entity and all debts, liabilities and duties of Veloce will become the debts, liabilities and duties of the Surviving Entity. It is currently anticipated that the Closing will occur in June 2012, subject to the achievement of the FPGA II Milestone by Veloce and the satisfaction of all closing conditions, including the completion of the Fairness Hearing. In the event of a June 2012 Closing, the Company anticipates that approximately $25 million to $30 million of the $60.4 million initial Merger Consideration will be paid out at the Closing and the remaining portion of the $60.4 million will be payable over the next three years upon completion of the remaining vesting requirements of the Veloce shares or share equivalents. For accounting purposes, all Merger Consideration, regardless of form, will be recognized as R&D expense. The Merger Agreement contains customary representations, warranties and covenants and may be terminated upon mutual agreement of the parties or unilaterally by the Company or Veloce if the other party fails to meet certain conditions and comply with certain obligations set forth in the agreement. Under the Second Amendment, the Company and Veloce agreed to have the Company, subject to the terms and conditions of the Merger Agreement, offset claims for future potential indemnifiable losses, if any, against the amount of any unpaid Merger Consideration as of the time such claim is made. The Company's right to offset claims for future potential indemnifiable losses against unpaid Merger Consideration is in lieu of any requirement that a portion of the Merger Consideration be deposited in an escrow account to secure any future claims by the Company for such losses. In connection with the Second Amendment, the Company and Veloce also modified the warrant to purchase shares of the Company's common stock, previously granted to Veloce in May 2009 and amended in November 2010, by accelerating the vesting schedule so as to be fully vested on April 5, 2012. 44-------------------------------------------------------------------------------- Table of Contents On May 17, 2009, the Company and Veloce also entered into a product development agreement (as amended on November 8, 2010 and July 18, 2011, the "Development Agreement") pursuant to which Veloce performs product development work relating to an ARM v8 processor for the Company on an exclusive basis for cash and other consideration, including a warrant to purchase Company common stock. Veloce's product development work for the Company comprises substantially all of Veloce's business and operations. The Company does not hold any equity interest in Veloce. In March 2009, we entered into a master technology license agreement ("TLA") with ARM, a leading semiconductor IP supplier, enabling us thereafter to license specific ARM technology. Subsequent thereto, we licensed under the TLA a new 64-bit version of ARM's core specification (ARM v8). Summary Financials The following tables present a summary of our results of operations for the fiscal years ended March 31, 2012 and 2011 (dollars in thousands): Fiscal Year Ended March 31, 2012 2011 % of Net % of Net Increase % Amount Revenue Amount Revenue (Decrease) Change Net revenues $ 230,887 100.0 % $ 247,710 100.0 % $ (16,823 ) (6.8 )% Cost of revenues 98,804 42.8 95,282 38.5 3,522 3.7 Gross profit 132,083 57.2 152,428 61.5 (20,345 ) (13.3 ) Total operating expenses 225,527 97.7 163,722 66.1 61,805 37.7 Operating loss (93,444 ) (40.5 ) (11,294 ) (4.6 ) (82,150 ) 727.4 Interest and other income (expense), net 11,684 5.0 10,687 4.3 997 9.3 Loss before income taxes (81,760 ) (35.5 ) (607 ) (0.3 ) (81,153 ) 13,370.0 Income tax expense 928 0.3 399 0.1 529 132.6 Net loss $ (82,688 ) (35.8 )% $ (1,006 ) (0.4 )% $ (81,682 ) 8,119.5 % The following tables present a summary of our results of operations for the fiscal years ended March 31, 2011 and 2010 (dollars in thousands): Fiscal Year Ended March 31, 2011 2010 % of Net % of Net Increase % Amount Revenue Amount Revenue (Decrease) Change Net revenues $ 247,710 100.0 % $ 205,598 100.0 % $ 42,112 20.5 % Cost of revenues 95,282 38.5 92,931 45.2 2,351 2.5 Gross profit 152,428 61.5 112,667 54.8 39,761 35.3 Total operating expenses 163,722 66.1 138,763 67.5 24,959 18.0 Operating loss (11,294 ) (4.6 ) (26,096 ) (12.7 ) 14,802 56.7 Interest and other income (expense), net 10,687 4.3 1,889 0.9 8,798 465.7 Loss from continuing operations before income taxes (607 ) (0.3 ) (24,207 ) (11.8 ) 23,600 97.5 Income tax benefit (expense) 399 0.1 (10,610 ) (5.2 ) 11,009 103.8 Loss from continuing operations (1,006 ) (0.4 ) (13,597 ) (6.6 ) 12,591 92.6 Gain from discontinued operations, net of taxes - - 6,112 3.0 (6,112 ) (100.0 ) Net loss $ (1,006 ) (0.4 )% $ (7,485 ) (3.6 )% $ 6,479 86.6 % 45 -------------------------------------------------------------------------------- Table of Contents Net Revenues. We generate revenues primarily through sales of our IC products, embedded processors and printed circuit board assemblies to OEMs, such as Alcatel-Lucent, Ciena, Cisco, Brocade, Fujitsu, Hitachi, Huawei, Juniper, Ericsson, NEC, Nortel, Nokia Siemens Networks, and Tellabs, who in turn supply their equipment principally to communications service providers. In November 2009, we entered into a Patent Purchase Agreement ("PPA") with Acacia Patent Acquisition LLC whereby we agreed to sell a series of our patents, patent applications and associated rights related to certain technologies for an aggregate purchase price of $2.5 million payable over two years and a 25% share of royalty payments for assignment of rights under the sale and/or use of the patents. Due to the nature of the payment terms, related revenue is being recorded as the payments are received. In July 2008, we also entered into a PPA with QUALCOMM Incorporated whereby we agreed to sell a series of our patents, patent applications and associated rights related to certain technologies for an aggregate purchase price of $33.0 million payable over three years in equal quarterly payments of $3.0 million each beginning in the three months ended December 31, 2008 through March 31, 2011. Due to the nature of the payment terms, related revenue was recorded as the payments were received. On a sell-through basis, we had approximately 83 days of inventory in the distributor channel at March 31, 2012 as compared to 78 days at March 31, 2011. The increase in inventory days during fiscal 2012 related in part due to the effect of increased revenues from end-of-life product sales that are usually sold on a non-cancellable, non-returnable basis and may take several quarters for the product to be sold-through and decremented from the channel. The gross margins for our solutions have historically declined over time. Some factors that we expect to cause downward pressure on the gross margins for our products include competitive pricing pressures, unfavorable product mix, the cost sensitivity of our customers particularly in the higher-volume markets, new product introductions by us or our competitors, and capacity constraints in our supply chain. From time to time, for strategic reasons, we may accept orders at less than optimal gross margins in order to facilitate the introduction of, or, market penetration of our new or existing products. To maintain acceptable operating results, we will need to offset any reduction in gross margins of our products by reducing costs, increasing sales volume, developing and introducing new products and developing new generations and versions of existing products on a timely basis. We classify our revenues into two categories based on the markets that the underlying products serve. The categories are Computing and Connectivity. We use this information to analyze our performance and success in these markets. We are continuing to focus our current connectivity investments on high growth 10G and faster Ethernet solutions, data center, Optical Transport Network ("OTN") and enterprise market opportunities while continuing to service the Telecom (SONET/SDH) market. Over time, we believe customers will transition from the SONET/SDH standard to higher speed, lower power products that utilize the OTN standard in order to support the increasing demand for transmission of data over networks. However, the timing and extent of this transition is uncertain due to the significant investment that is needed to convert networks to the OTN standard. As such, the rate of conversion to the OTN standard is, in part, greatly influenced by global economic market conditions. Recessionary type market conditions will result in a slower transition of networks to the OTN standard. Additionally, there can be no assurance that our revenues will increase as the OTN standard is adopted. The demand for our products has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following: • the timing, rescheduling or cancellation of significant customer orders and our ability, as well as the ability of our customers, to manage inventory corrections; 46 -------------------------------------------------------------------------------- Table of Contents • the qualification, availability and pricing of competing products and technologies and the resulting effects on the sales, pricing and gross margins of our products. • our ability to specify, develop or acquire, complete, introduce, and market new products and technologies in a cost effective and timely manner; • the rate at which our present and future customers and end-users adopt our products and technologies in our target markets; • general economic and market conditions in the semiconductor industry and communications markets; • combinations of companies in our customer base, resulting in the combined company choosing our competitor's IC standardization rather than our supported product platforms; • the gain or loss of one or more key customers, or their key customers, or significant changes in the financial condition of one or more of our key customers or their key customers; • our expectation of a market ramp for our products could be incorrect and such ramp could get pushed out or not happen at all; • our ability to meet customer demand due to capacity constraints at our suppliers; and • natural disasters that could affect our supply chain or our customer's supply chain which would affect their requirements of our products. For these and other reasons, our net revenue and results of operations for the three fiscal years ended March 31, 2012 may not necessarily be indicative of future net revenue and results of operations. Based on direct shipments, net revenues to customers that was equal to or greater than 10% of total net revenues in any of the three years ended March 31, 2012 were as follows: 2012 2011 2010 Avnet (distributor) 20 % 29 % 30 % Wintec (global logistics provider) 20 % - - Flextronics (sub-contract manufacturer) 11 % - - Hon Hai (sub-contract manufacturer) * 14 % 13 % * Less than 10% of total net revenues for period indicated. We expect that our largest customers will continue to account for a substantial portion of our net revenue for the foreseeable future. Net revenues by geographic region were as follows (in thousands): Fiscal Years Ended March 31, 2012 2011 2010 United States of America $ 99,214 $ 81,113 $ 68,817 Taiwan* 20,950 45,489 33,118 Hong Kong 21,458 24,747 16,171 China 4,503 9,030 15,427 Europe 41,691 45,714 35,372 Japan 13,596 9,305 5,580 Malaysia 8,276 8,258 3,843 Singapore 14,011 11,808 16,123 Other Asia 5,790 9,394 2,597 Other 1,398 2,852 8,550 $ 230,887 $ 247,710 $ 205,598 * The change is primarily due to a major end customer changing its logistics management program. 47 -------------------------------------------------------------------------------- Table of Contents All of our revenues are primarily denominated in U.S. dollars, other than revenues that account for less than 10% of our total revenues, which are denominated primarily in Danish Kroner. Key non-GAAP measurements. We use certain non-GAAP metrics such as Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") to measure our performance. We define Adjusted EBITDA as net income (loss), less interest income, income taxes, depreciation and amortization, stock-based compensation, amortization of intangibles and other one-time and/or non-cash items. The following table reconciles Adjusted EBITDA to the accompanying financial statements (in thousands): Fiscal Years Ended March 31, 2012 2011 2010 Net loss $ (82,688 ) $ (1,006 ) $ (7,485 ) Adjustment to net loss: Interest and other income, net (3,794 ) (5,403 ) (6,816 ) Stock-based compensation expense 18,374 16,684 13,682 Amortization of purchased intangibles 6,754 17,162 16,117 Restructuring charges 875 532 746 Veloce accrued liability 60,400 - - Impairment of marketable securities* (743 ) (5,284 ) 2,927 Depreciation 10,009 8,834 8,301 (Gain) impairment on strategic investments, net (7,147 ) - 2,000 Acquisition related adjustment (2,532 ) 859 - Other and income tax adjustment 938 403 (10,610 ) Gain from discontinued operations - - (6,112 ) Adjusted EBITDA $ 446 $ 32,781 $ 12,750 * For non-GAAP purposes, any gain or loss relating to marketable securities is not recognized until the underlying securities are sold and the actual gain or loss is realized. We believe that Adjusted EBITDA is a useful supplemental measure of our operation's performance because it helps investors evaluate and compare the results of operations from period to period by removing the accounting impact of the Company's financing strategies, tax provisions, depreciation and amortization, restructuring charges, stock based compensation expense, discontinued operations and certain other operating items. We adjust for these excluded items because we believe that, in general, these items possess one or more of the following characteristics: their magnitude and timing is largely outside of the Company's control; they are unrelated to the ongoing operations of the business in the ordinary course; they are unusual or infrequent and the Company does not expect them to occur in the ordinary course of business; or they are non-cash expenses. Adjusted EBITDA is not a measure determined in accordance with generally accepted accounting principles in the United States, or GAAP, and should not be considered a substitute for operating income, net income or any other measure determined in accordance with GAAP. Adjusted EBITDA should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. Adjusted EBITDA is used by our management as a measure of operating efficiency and overall financial performance for benchmarking against our peers and competitors and is used as a metric to determine the performance vesting of our three-year Restricted Stock Unit grants issued in May 2009 (the "EBITDA Grants") and May 2011 (the "EBITDA2 Grants"). Management believes Adjusted EBITDA provides meaningful supplemental information regarding the underlying operating performance of our business. Management also believes that Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties to evaluate the Company. The book-to-bill ratio is another metric commonly used by investors to compare and evaluate technology and semiconductor companies. The book-to-bill ratio is a demand-to-supply ratio that compares the total amount 48-------------------------------------------------------------------------------- Table of Contents of orders received to the total amount of orders filled. This ratio tells whether the Company has more orders than it delivered (if greater than 1), has the same amount of orders that it delivered (equals 1), or has less orders than it delivered (under 1). Though the ratio provides an indicator of whether orders are rising or falling, it does not consider the timing of or if the order will result in future revenues. Our book-to-bill ratio at March 31, 2012, 2011 and 2010 was 0.8, 1.0 and 1.3, respectively. CRITICAL ACCOUNTING POLICIES The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires 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 net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to: inventory valuation and capitalized mask set costs, which affect our cost of sales and gross profit; the valuation of goodwill and purchased intangibles, which has in the past affected, and could in the future affect, our impairment charges to write down the carrying value of purchased intangibles and the amount of related periodic amortization expense recorded for definite-lived intangibles; the valuation of the Veloce consideration which affects operating expenses; and an evaluation of other-than-temporary impairment of our investments, which affects the amount and timing of write-down charges. We also have other key accounting policies, such as our policies for stock-based compensation and revenue recognition. The methods, estimates and judgments we use in applying these critical accounting policies have a significant impact on the results we report in our financial statements. 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 values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from management's estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements. Investments We hold a variety of securities that have varied underlying investments. We review our investment portfolio periodically to assess for other-than-temporary impairment. We assess the existence of impairment of our investments in order to determine the classification of the impairment as "temporary" or "other-than-temporary". The factors used to determine whether an impairment is temporary or other-than-temporary involves considerable judgment. The factors we consider in determining whether any individual impairment is temporary or other-than-temporary are primarily the length of the time and the extent to which the market value has been less than amortized cost, the nature of underlying assets (including the degree of collateralization), the financial condition, credit rating, market liquidity conditions and near-term prospects of the issuer. If the fair value of a debt security is less than its amortized cost basis at the balance sheet date, an assessment would have to be made as to whether the impairment is other-than-temporary. If we decided to sell the security, an other-than-temporary impairment shall be considered to have occurred. However, if we do not intend to sell the debt security, we shall consider available evidence to assess whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost basis due to cash, working capital requirements, contractual or regulatory obligations indicate that the security will be required to be sold before a forecasted recovery occurs. If it is more likely than not that we are required to sell the security before recovery of its amortized cost basis, an other-than-temporary impairment is considered to have occurred. If we do not expect to recover the entire amortized cost basis of the security, we would not be able to assert that we will recover its amortized cost basis even if we do not intend to sell the security. Therefore, in those situations, an other-than-temporary impairment shall be considered to have occurred. We use present value cash flow models to determine whether the entire amortized cost basis of the security will be recovered. We will compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. An other-than-temporary impairment is said to have occurred if the present value of cash flows expected to be collected is less 49-------------------------------------------------------------------------------- Table of Contents than the amortized cost basis of the security. In the fiscal year ended March 31, 2012, we did not record any other-than-temporary impairment charges. As of March 31, 2012, we did not record an impairment charge in connection with other securities in a continuous loss position (fair value less than carrying value) with unrealized losses of $1.7 million as we believe that such unrealized losses are temporary. In addition, we also had $7.5 million in unrealized gains. For the fiscal years ended March 31, 2011 and 2010, we recorded other-than-temporary impairment charges of zero and $4.1 million, respectively. Veloce Consideration We periodically evaluate the progress of the development work that is performed by our VIE, Veloce, in connection with our contractual arrangement with Veloce. Based on such an evaluation as well as considering various other qualitative factors, we assess the estimated timing and probability of attaining certain performance milestones. Upon assessing a milestone as probable of achievement, the expense that is recognized considers the stage of product development and estimating the performance metrics that will be achieved. The consideration that we will pay for each performance milestone is based upon the timing and the performance metrics that will ultimately be achieved. Significant judgment is required to assess estimated timing and the probability of achieving the performance milestones and determining the amount of expense to be recognized. Based on our assessment as of March 31, 2012, we concluded that one of the milestones was probable of being attained and accordingly we recognized $60.4 million of research and development expense. Our probability determination included both an evaluation of the current stage of product development and the remaining risks associated with attaining completion of the milestone. The amount of expense recognized included consideration of our revised contractual arrangement with Veloce which was executed on April 5, 2012 and for which we have committed to pay $60.4 million upon the occurrence of certain events which are expected to occur during the first quarter of fiscal 2013. The additional performance milestones included in our contractual arrangement that was in effect as of March 31, 2012 are not considered probable of being achieved. No expense was recognized in connection with these milestones during any of the periods presented. Inventory Valuation Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess or obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future demand for our products within a specified time horizon, generally 12 months. The estimates we use for future demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. If our demand forecast is greater than our actual demand we may be required to take additional excess inventory charges, which would decrease gross margin and net operating results. Any impairment charges taken establishes a new cost basis for the underlying inventory and the cost basis for such inventory is not marked-up on changes in circumstances until a gain is realized upon its eventual sale. This accounting is consistent with the guidance provided by SAB Topic 5-BB. To illustrate the sensitivity of inventory valuations to future estimates, as of March 31, 2012, reducing our future demand estimate to six months would decrease our current inventory valuation by approximately $2.4 million or increasing our future demand forecast to 18 months would not have any significant effect on our current inventory valuation. Purchased Definite-Lived Intangible Assets and Other Long-Lived Assets We evaluate our long-lived assets such as property, plant and equipment and purchased intangible assets with finite lives, for impairment whenever events or changes in circumstances indicate the carrying value of an asset or asset group may not be recoverable. The carrying value of an asset or asset group is not recoverable if the 50 -------------------------------------------------------------------------------- Table of Contents amount of undiscounted future cash flows the assets are expected to generate (including any net proceeds expected from the disposal of the asset) are less than its carrying value. When we identify an impairment has occurred, we reduce the carrying value of the assets to its comparable market value (if available and appropriate) or to its estimated fair value based on a discounted cash flow approach. Revenue Recognition We recognize revenue based on four basic criteria: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met. In addition, we do not recognize revenue until the applicable customer's acceptance criteria have been met. The criteria are usually met at the time of product shipment. Our standard terms and conditions of sale do not allow for product returns and we generally do not allow product returns other than under warranty or stock rotation agreements. Revenue from shipments to distributors is recognized upon shipment. In addition, we record reductions to revenue for estimated allowances such as returns not pursuant to contractual rights, competitive pricing programs and rebates. These estimates are based on our experience with stock rotations and the contractual terms of the competitive pricing and rebate programs. Royalty revenues are recognized when cash is received, only when royalty amounts cannot be reasonably estimated. Royalty revenues are based upon sales of our customer's products that include our technology. Shipping terms are generally FCA (Free Carrier) shipping point. If actual returns or pricing adjustments exceed our estimates, we would record additional reductions to revenue. From time to time we generate revenue from the sale of our internally developed IP. We generally recognize revenue from the sale of IP when all basic criteria outlined above are met, which is generally when the payments are received. Mask Costs We incur significant costs for the fabrication of masks used by our contract manufacturers to manufacture our products. If we determine, at the time the cost for the fabrication of masks are incurred, that technological feasibility of the product has been achieved, we consider the nature of these costs to be pre-production costs. Accordingly, such costs are capitalized as property and equipment under machinery and equipment and are amortized as cost of sales over approximately three years, representing the estimated production period of the product. If we determine, at the time fabrication mask costs are incurred, that either technological feasibility of the product has not occurred or that the mask is not reasonably expected to be used in production manufacturing or that the commercial feasibility of the product is uncertain, the related mask costs are expensed to R&D in the period in which the costs are incurred. We will also periodically assess capitalized mask costs for impairment. During the fiscal years ended March 31, 2012 and 2011, total mask costs capitalized was $4.8 million and $4.7 million, respectively. Stock-Based Compensation Expense All share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, are required to be recognized in our financial statements based on their respective grant date fair values. The fair value of each employee stock option and employee stock purchase right is estimated on the date of grant using an option pricing model that meets certain requirements. We currently use the Black-Scholes option pricing model to estimate the fair value of our share-based payments, excluding RSUs, which we use the fair market value of our common stock. The fair values generated by the Black-Scholes model may not be indicative of the actual fair values of our stock-based awards as it does not consider certain factors important to stock-based awards, such as continued employment, periodic vesting requirements and limited transferability. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected 51-------------------------------------------------------------------------------- Table of Contents by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We estimate the expected volatility of our stock options at grant date by equally weighting the historical volatility and the implied volatility of our stock over specific periods of time as the expected volatility assumption required in the Black-Scholes model. The expected life of the stock options is based on historical and other data including life of the option and vesting period. The risk-free interest rate assumption is the implied yield currently available on zero-coupon government issues with a remaining term equal to the expected term. The dividend yield assumption is based on our history and expectation of dividend payouts. The fair value of our restricted stock units is based on the fair market value of our common stock on the date of grant. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ significantly from those estimated. We evaluate the assumptions used to value stock-based awards on a quarterly basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. We currently estimate when and if performance-based grants will be earned. If the awards are not considered probable of achievement, no amount of stock-based compensation is recognized. If we consider the award to be probable, expense is recorded over the estimated service period. To the extent that our assumptions are incorrect, the amount of stock-based compensation recorded will be increased or decreased. To the extent that we grant additional equity securities to employees or we assume unvested securities in connection with any acquisitions, our stock-based compensation expense will be increased by the additional unearned compensation resulting from those additional grants or acquisitions. RESULTS OF OPERATIONS Comparison of the Fiscal Year Ended March 31, 2012 to the Fiscal Year Ended March 31, 2011 Net Revenues. Net revenues for the fiscal year ended March 31, 2012 were $230.9 million, representing a decrease of 6.8% from the net revenues of $247.7 million for the fiscal year ended March 31, 2011. We classify our revenues into two categories based on the markets that the underlying products serve. The categories are Computing and Connectivity (previously called Process and Transport). We use this information to analyze our performance and success in these markets. See the following tables (dollars in thousands): Fiscal Years Ended March 31, 2012 2011 % of Net % of Net Increase/ % Amount Revenue Amount Revenue (Decrease) Change Computing $ 120,608 52.2 % $ 123,897 50.0 % $ (3,289 ) (2.7%) Connectivity 110,279 47.8 % 123,813 50.0 % (13,534 ) (10.9%) $ 230,887 100.0 % $ 247,710 100.0 % $ (16,823 ) (6.8%) During the fiscal year ended March 31, 2012, our Computing revenues declined by 2.7% while our Connectivity revenues declined by 10.9%. The overall revenue decline was spread across both the Computing and Connectivity product families and was as a result of lower demand for our products due to overall softness in the macro conditions. In addition, the revenues for our Connectivity products were lower due to the delay in the overall OTN infrastructure build-out and the impact of the end of licensing revenues related to the sale of IP to Qualcomm. 52 -------------------------------------------------------------------------------- Table of Contents Gross Profit. The following table presents net revenues, cost of revenues and gross profit for the fiscal years ended March 31, 2012 and 2011 (dollars in thousands): Fiscal Years Ended March 31, 2012 2011 % of Net % of Net Increase/ % Amount Revenue Amount Revenue (Decrease) Change Net revenues $ 230,887 100.0 % $ 247,710 100.0 % $ (16,823 ) (6.8% ) Cost of revenues 98,804 42.8 % 95,282 38.5 % 3,522 3.7% Gross profit $ 132,083 57.2 % $ 152,428 61.5 % $ (20,345 ) (13.3% ) The gross profit percentage for the fiscal year ended March 31, 2012 decreased to 57.2%, compared to 61.5% for the fiscal year ended March 31, 2011. The decrease in our gross profit percentage, excluding the impact of amortization of purchased intangibles, was 58.8% and 66.3% for the fiscal years ended March 31, 2012 and 2011, respectively. The decrease in our gross profit percentage was primarily due to an overall decline in both Computing and Connectivity product margins arising out of lower licensing revenues, unfavorable product mix and declining average selling prices. The amortization of purchased intangible assets included in cost of revenues during the fiscal year ended March 31, 2012 was $3.6 million, compared to $11.9 million for the fiscal year ended March 31, 2011. The decrease was primarily due to certain purchased intangible assets being fully amortized during the fiscal year ended March 31, 2011 resulting in a lower amortization charge in the current fiscal year ended March 31, 2012. Future acquisitions of businesses may result in substantial additional charges, which may impact the gross profit percentage in future periods. Research and Development and Selling, General and Administrative Expenses. The following table presents research and development and selling, general and administrative ("SG&A") expenses for the fiscal years ended March 31, 2012 and 2011 (dollars in thousands): Fiscal Years Ended March 31, 2012 2011 % of Net % of Net % Amount Revenue Amount Revenue Increase Change Research and development $ 175,656 76.1% $108,732 43.9% $ 66,924 61.5% Selling, general and administrative $ 45,794 19.8% $ 49,173 19.9% $ (3,379 ) (6.9% ) Research and Development. Increases in research and development ("R&D") expenses are primarily driven by the effect of the merger and consolidation of Veloce, our VIE, our internal costs related to the ARM 64-bit silicon server development effort, and the costs relating to TPack, an entity we acquired in September 2010, offset by a decrease in other R&D expenses. Total consolidated R&D expenses consist primarily of salaries and related costs (including stock-based compensation) of employees engaged in research, design and development activities, costs related to engineering design tools, subcontracting costs and facilities expenses. We recorded an initial consideration of $60.4 million as of March 31, 2012 relating to the Veloce merger as the consummation of this merger was considered probable as of this date. For accounting purposes, the initial consideration of $60.4 million is considered a compensatory R&D expenditure (as the merger consideration is primarily to acquire the R&D employees of Veloce) which will be paid out in cash or equity, or a combination thereof, at the discretion of the Company. Assuming that the acquisition of Veloce occurs in June 2012, approximately $25 million to $30 million of the $60.4 million will be payable upon the closing of the acquisition, and the remaining portion of the $60.4 million will be payable upon the completion of certain post-closing development milestones and the continued vesting of time-based Veloce common stock and other equity awards. Additional purchase consideration will be recorded and amortized in future periods, if and when the additional development milestones are achieved. Refer to note 4 for further details relating to Veloce. 53-------------------------------------------------------------------------------- Table of Contents The increase in R&D expenses of 61.5% for the fiscal year ended March 31, 2012 compared to the fiscal year ended March 31, 2011, was primarily due to $60.4 million for the Veloce accrued liability and increases of $3.3 million in personnel cost, $1.5 million in stock-based compensation charges, $1.8 million in consumable equipment and software cost, $0.6 million in technology access fees, $1.2 million in corporate allocation expense offset by a decrease of $1.3 million in third party foundry cost, $0.4 million decrease in development cost related to new products and $0.3 million in printed circuit board costs. We believe that a continued commitment to R&D is vital to our goal of maintaining a leadership position with innovative products. In addition to our internal R&D programs, our business strategy includes acquiring products, technologies or businesses from third parties. Future acquisitions of products, technologies or businesses may result in substantial additional on-going R&D costs. Selling, General and Administrative. Selling, general and administrative ("SG&A") expenses consist primarily of personnel related expenses (including stock-based compensation), professional and legal fees, corporate branding and facilities expenses. The decrease in SG&A expenses of 6.9% for the fiscal year ended March 31, 2012 compared to the fiscal year ended March 31, 2011, was primarily due to a $2.5 million reversal of certain acquisition related contingencies and reductions relating to $0.9 million of acquisition related expenses, $0.8 million in contractor costs, $0.4 million in travel and entertainment, $0.3 million in marketing costs offset by an increase of $0.8 million corporate allocation expense, $0.4 million in stock compensation expense and $0.4 million in professional service fees. Future acquisitions of products, technologies or businesses may result in substantial additional on-going SG&A costs. Stock-Based Compensation. The following table presents stock-based compensation expense for the fiscal years ended March 31, 2012 and 2011, which was included in the tables above (dollars in thousands): Fiscal Years Ended March 31, 2012 2011 % of Net % of Net Increase/ % Amount Revenue Amount Revenue (Decrease) Change Costs of revenues $ 432 0.2 % $ 651 0.3 % $ (219 ) (33.6 %) Research and development 10,496 4.5 9,000 3.6 1,496 16.6 Selling, general and administrative 7,446 3.2 7,033 2.8 413 5.9 $ 18,374 7.9 % $ 16,684 6.7 % $ 1,690 10.1 % The increase in stock-based compensation of 10.1% during the fiscal year ended March 31, 2012 compared to the fiscal year ended March 31, 2011 was primarily due to the vesting of performance based awards, additional equity awards from increased headcount and higher ESPP employee participation during the year. Vesting of the EBITDA and EBITDA2 Grants is subject to (i) the Company's performance as measured by earnings before interest, taxes, depreciation and amortization ("EBITDA"), and (ii) individual performance as measured by the accomplishment of goals and objectives. Vesting of our Performance Retention Grants are subject to (i) the accomplishment of goals and objectives of the individual's business unit and (ii) individual performance as measured by the accomplishment of individual goals and objectives. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is 18 months. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense will increase to the extent that we grant additional equity awards. The value of these grants cannot be predicted at this time because it will depend on the number of share-based payments granted and the then current fair values. The amount of unearned stock-based compensation currently estimated to be expensed from now through fiscal 2016 related to unvested share-based payment awards at March 31, 2012 is $29.8 million, which includes stock-based compensation from Veloce, our VIE. This expense relates to equity instruments already issued and will not be affected by our future stock price. 54-------------------------------------------------------------------------------- Table of Contents Restructuring Charges, net. The restructuring charges recorded during the fiscal year ended March 31, 2012 was primarily for employee severances. During the year ended March 31, 2012, we implemented a restructuring plan as part of our ongoing cost reduction efforts and to better align our global operations to achieve greater efficiencies. We moved more of our functions offshore, which allow us to be closer and more connected to our and our customer's third party subcontract manufacturers. The April 2011 restructuring plan included eliminating or relocating 25 positions. As a result of the April 2011 restructuring program, we recorded a charge of $0.9 million for employee severances. We anticipate this restructuring plan will reduce our ongoing net operating expenses by $1.5 million to $2.0 million annually. As part of our ongoing cost reduction efforts, we could implement additional restructuring programs and may incur significant additional restructuring charges. For additional information on our restructuring activities, see Note 7 of the Notes to the Consolidated Financial Statements. We have completed all the restructuring activities as described above. Interest and Other Income, net. The following table presents interest income (expense) and other income, net for the fiscal years ended March 31, 2012 and 2011 (dollars in thousands): Fiscal Years Ended March 31, 2012 2011 % of Net % of Net Increase/ % Amount Revenue Amount Revenue Decrease Change Interest income, net $ 4,247 1.8 % $ 9,890 4.0 % $ (5,643 ) (57.1 %) Other income, net $ 7,437 3.2 % $ 797 0.3 % $ 6,640 833.1 % Interest Income, net. Interest income, net of management fees, reflects interest earned on cash and cash equivalents, short-term investments and marketable securities. The decrease in interest income, net for the year ended March 31, 2012, compared to fiscal year ended March 31, 2011 was primarily due to our lower cash, cash equivalents and short-term investments available-for-sale balances. Other Income, net. The increase in other income for the fiscal year ended March 31, 2012, compared to the fiscal year ended March 31, 2011 was primarily due to a $8.1 million gain relating to the disposal of a strategic investment and which was partially offset by a $1.0 million impairment for another strategic investment. Income Taxes. The federal statutory income tax rate was 35% for the fiscal year ended March 31, 2012 and 2011. Income tax expense recorded for the fiscal year ended March 31, 2012 was $0.9 million compared to $0.4 million for the year ended March 31, 2011. The increase in tax expense in fiscal 2012 versus fiscal 2011 is primarily related to an increase in foreign taxes due to expiration of various tax holidays. Comparison of the Fiscal Year Ended March 31, 2011 to the Fiscal Year Ended March 31, 2010 Net Revenues. Net revenues for the fiscal year ended March 31, 2011 were $247.7 million, representing an increase of 20.5% from the net revenues of $205.6 million for the fiscal year ended March 31, 2010. We classify our revenues into two categories based on the markets that the underlying products serve. The categories are Computing and Connectivity (formerly referred to as "Process" and "Transport", respectively). We use this information to analyze our performance and success in these markets. See the following tables (dollars in thousands): Fiscal Years Ended March 31, 2011 2010 % of Net % of Net % Amount Revenue Amount Revenue Increase Change Computing $ 123,897 50.0 % $ 106,374 51.7 % $ 17,523 16.5 % Connectivity 123,813 50.0 99,224 48.3 24,589 24.8 $ 247,710 100.0 % $ 205,598 100.0 % $ 42,112 20.5 % 55 -------------------------------------------------------------------------------- Table of Contents During the fiscal year ended March 31, 2011, revenues recovered strongly as the overall market for semiconductor products continued to show improved growth trends. The year over year increase represents the recovery from the recessionary economic conditions and overall softness in demand that was observed during the prior years and the current pace of infrastructure build out. Though revenues increased year over year, revenues decreased in the fourth fiscal quarter compared to the preceding three month period primarily due to inventory corrections in the industry. We expect that additional channel inventories will be consumed over the next several quarters. We expect revenues for the three months ending June 30, 2011 to be approximately $60.5 million, plus or minus $2.0 million. This represents an increase of approximately 3%, compared to the revenues for the three months ended March 31, 2011. Our future revenues could be impacted by various factors, including the duration and the severity of inventory corrections and other factors. Gross Profit. The following table presents net revenues, cost of revenues and gross profit for the fiscal years ended March 31, 2011 and 2010 (dollars in thousands): Fiscal Years Ended March 31, 2011 2010 % of Net % of Net % Amount Revenue Amount Revenue Increase Change Net revenues $ 247,710 100.0 % $ 205,598 100.0 % $ 42,112 20.5 % Cost of revenues 95,282 38.5 92,931 45.2 2,351 2.5 Gross profit $ 152,428 61.5 % $ 112,667 54.8 % $ 39,761 35.3 % The gross profit percentage for the fiscal year ended March 31, 2011 increased to 61.5%, compared to 54.8% for the fiscal year ended March 31, 2010. The increase in our gross profit percentage was primarily due to favorable product mix, higher licensing revenues, improved manufacturing yields and efficiencies and the overall impact of increased revenues. The amortization of purchased intangible assets included in cost of revenues during the fiscal year ended March 31, 2011 was $11.9 million, compared to $12.1 million for the fiscal year ended March 31, 2010. The acquisition of TPack has increased our expected amortization of purchased intangible assets included in cost of revenues by approximately $0.6 million per quarter. The increased expected amortization does not include $1.0 million of in-process R&D. Future acquisitions of businesses may result in substantial additional charges, which may impact the gross profit percentage in future periods. Research and Development and Selling, General and Administrative Expenses. The following table presents research and development and selling, general and administrative ("SG&A") expenses for the fiscal years ended March 31, 2011 and 2010 (dollars in thousands): Fiscal Years Ended March 31, 2011 2010 % of Net % of Net % Amount Revenue Amount Revenue Increase Change Research and development $ 108,732 43.9 % $ 88,096 42.8 % $ 20,636 23.4 % Selling, general and administrative $ 49,173 19.9 % $ 45,901 22.3 % $ 3,272 7.1 % Research and Development. R&D expenses consist primarily of salaries and related costs (including stock-based compensation) of employees engaged in research, design and development activities, costs related to engineering design tools, subcontracting costs and facilities expenses. The increase in R&D expenses of 23.4% for the fiscal year ended March 31, 2011 compared to the fiscal year ended March 31, 2010, was primarily due to an increase of $11.3 million in personnel cost, $2.7 million in stock-based compensation charges, $2.5 million in third party foundry cost, $2.0 million in printed circuit board costs, $1.5 million in contractor costs, $1.2 million in corporate allocation expense, $0.7 million in other miscellaneous expenses, $0.5 million in consumable equipment and software cost, $0.4 million in technology access fees offset by a decrease of $1.5 million in 56 -------------------------------------------------------------------------------- Table of Contents customer funded non-recurring engineering payments and $0.7 million decrease in development cost of a new processor core. The overall increase in R&D expense is primarily driven by the effect of the consolidation of Veloce, our VIE, and the cost relating to TPack, an entity that we acquired in September 2010. We believe that a continued commitment to R&D is vital to our goal of maintaining a leadership position with innovative products. In addition to our internal R&D programs, our business strategy includes acquiring products, technologies or businesses from third parties. Future acquisitions of products, technologies or businesses may result in substantial additional on-going R&D costs. Selling, General and Administrative. SG&A expenses consist primarily of personnel-related expenses, professional and legal fees, corporate branding and facilities expenses. The increase in SG&A expenses of 7.1% for the fiscal year ended March 31, 2011 compared to the fiscal year ended March 31, 2010, was primarily due to an increase of $2.0 million in contractor costs, $1.0 million in personnel cost, $0.9 million in TPack acquisition costs, $0.8 million in indirect materials and services, $0.5 million in travel expenses offset by a decrease of $1.1 million in professional service fees and $0.9 million in taxes and licensing fees. Future acquisitions of products, technologies or businesses may result in substantial additional on-going SG&A costs. Stock-Based Compensation. The following table presents stock-based compensation expense for the fiscal years ended March 31, 2011 and 2010, which was included in the tables above (dollars in thousands): Fiscal Years Ended March 31, 2011 2010 % of Net % of Net % Amount Revenue Amount Revenue Increase Change Costs of revenues $ 651 0.3 % $ 587 0.3 % $ 64 10.9 % Research and development 9,000 3.6 6,268 3.0 2,732 43.6 Selling, general and administrative 7,033 2.8 6,827 3.3 206 3.0 $ 16,684 6.7 % $ 13,682 6.6 % $ 3,002 21.9 % The amount of unearned stock-based compensation currently estimated to be expensed from now through fiscal 2015 related to unvested share-based payment awards at March 31, 2011 is $26.7 million, which includes stock-based compensation from Veloce, our VIE. This expense relates to equity instruments already issued and will not be affected by our future stock price. Vesting of the EBITDA Grants is subject to (i) the Company's performance as measured by earnings before interest, taxes, depreciation and amortization ("EBITDA"), and (ii) individual performance as measured by the accomplishment of goals and objectives. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 2.1 years. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense will increase to the extent that we grant additional equity awards. The value of these grants cannot be predicted at this time because it will depend on the number of share-based payments granted and the then current fair values. Restructuring Charges, net. The restructuring charges recorded during the fiscal year ended March 31, 2011 was primarily for employee severances. Interest and Other Income, net. The following table presents interest income (expense) and other income, net for the fiscal years ended March 31, 2011 and 2010 (dollars in thousands): Fiscal Years Ended March 31, 2011 2010 % of Net % of Net % Amount Revenue Amount Revenue Increase Change Interest income (expense), net and other-than-temporary impairment $ 9,890 4.0 % $ 3,440 1.7 % $ 6,450 187.5 % Other income (expense), net $ 797 0.3 % $ (1,551 ) (0.8 )% $ 2,348 151.4 % 57 -------------------------------------------------------------------------------- Table of Contents Interest Income (Expense) and Other-Than-Temporary Impairment, net. Interest income and other-than-temporary impairment, net of management fees and other-than-temporary impairment, reflects interest earned on cash and cash equivalents, short-term investments and marketable securities. The increase in interest income and other-than-temporary impairment, net for the fiscal year ended March 31, 2011, compared to the fiscal year ended March 31, 2010 was primarily due to gains that were realized from the sale of securities in our investment portfolio in the current fiscal year and an other-than-temporary impairment charge of $4.1 million in the prior fiscal year. Other Income, net. The increase in other income for the fiscal year ended March 31, 2011, compared to the fiscal year ended March 31, 2010 was primarily due to $2.0 million impairment for a strategic investment in the prior fiscal year. Income Taxes. The federal statutory income tax rate was 35% for the fiscal year ended March 31, 2011 and 2010. The benefit recorded during the fiscal year ended March 31, 2010, related primarily to the gains from discontinued operations, other comprehensive income and an increase in refundable tax credits. For the fiscal year ended March 31, 2011, the Company had no gains or losses relating to discontinued operations. Tax expense during the fiscal year ended March 31, 2011 primarily consisted of state and foreign taxes. Discontinued Operations. We completed the sale of our 3ware storage adapter business ("Storage Business") to LSI Corporation on April 21, 2009. Under the Purchase Agreement, we substantially sold all of the operating assets (other than patents) of our Storage Business. The assets sold included customer contracts, inventory, fixed assets, certain intellectual property and other assets, as well as rights to the name "3ware." The purchase price for the Transaction was approximately $20.0 million, subject to adjustments based on the level of inventory and products in the channel at the closing of the Transaction. After adjustments for the level of inventory of $0.7 million and products in the channel of $0.8 million, the final adjusted price of the Transaction was approximately $21.5 million. During the fiscal year ended March 31, 2010, we reached an agreement with LSI Corporation to end the warranty support portion of the Purchase Agreement. We recorded a net gain of $11.4 million from the sale during the fiscal year ended March 31, 2010. During the fiscal year ended March 31, 2010, we recognized a tax charge of approximately $4.2 million to discontinued operations in connection with the sale of our 3ware storage adapter business and concurrently recorded the same amount as an income tax benefit to continuing operations. FINANCIAL CONDITION AND LIQUIDITY Overview As of March 31, 2012, our principal source of liquidity consisted of $113.8 million in cash, cash equivalents and short-term investments, which is approximately $1.84 per share of outstanding common stock as compared to $2.64 per share at March 31, 2011. Working capital as of March 31, 2012 was $118.6 million. Total cash, cash equivalents, and short-term investments decreased by $54.2 million during the year ended March 31, 2012, primarily due to the repurchases of our common stock for $30.8 million, purchase of property and equipment of $13.3 million, cash used for operations of $9.3 million, purchases of strategic investments of $4.8 million and the funding of restricted stock units withheld for taxes of $2.9 million offset by proceeds from stock issuance of $6.7 million. At March 31, 2012, we had contractual obligations not included on our balance sheet totaling $93.3 million, primarily related to facility leases, IP licenses, engineering design software tool licenses, non-cancelable inventory purchase commitments and liability for uncertain tax positions. For the fiscal year ended March 31, 2012, we used $9.3 million of cash in our operations compared to generating $31.0 million for the fiscal year ended March 31, 2011. Our net loss of $82.7 million for fiscal the year ended March 31, 2012 included $84.3 million of non-cash charges consisting of $60.4 million of Veloce purchase price consideration expense, $8.4 million of depreciation, $6.8 million of amortization of purchased intangibles and $18.4 million of stock-based compensation, offset by a $2.5 million reduction to the estimated 58 -------------------------------------------------------------------------------- Table of Contents fair value of acquisition related adjustment (relating to our Tpack acquisition in fiscal 2011) and a net $7.1 million gain on strategic equity investments. The remaining change in operating cash flows for the fiscal year ended March 31, 2012 primarily reflected increases in accounts receivable and other assets, and decreases in inventories, accounts payable, accrued payroll and other accrued liabilities and deferred revenue. Our net loss of $1.0 million for the fiscal year ended March 31, 2011 included $39.9 million of non-cash charges consisting of $7.2 million of depreciation, $17.2 million of amortization of purchased intangibles, $16.7 million of stock-based compensation and a credit of $1.2 million related to the capitalization of prior years mask set costs. The remaining change in operating cash flows for the fiscal year ended March 31, 2011 primarily reflected decreases in accounts receivable and other assets and increases in inventories, accounts payable, accrued payroll and other accrued liabilities, and deferred revenue. Our overall quarterly days sales outstanding were 42 days and 31 days for the fourth fiscal quarter ended March 31, 2012 and March 31, 2011, respectively. Increase in the revenues generated during the last month of the quarter ended March 31, 2012 compared to the same period for the quarter ended March 31, 2011 was the primary reason for the increase in our days' sales outstanding. We used $19.8 million in cash from our investing activities during the fiscal year ended March 31, 2012, compared to using $39.3 million during the fiscal year ended March 31, 2011. During the fiscal year ended March 31, 2012, we used $1.8 million for net short-term investment activities, $13.3 million for the purchase of property and equipment and $4.8 million for purchases of strategic investments. We used net cash of $27.2 million for our financing activities during the fiscal year ended March 31, 2012, compared to $29.8 million during the fiscal year ended March 31, 2011. The major financing use of cash for the fiscal year ended March 31, 2012 was the funding of our structured stock repurchase agreements for $10.0 million, $20.9 million for the open market repurchases of common stock, restricted stock units withheld for taxes of $2.9 million offset by proceeds of $6.7 million from the issuances of our common stock. Veloce Merger The Company proposes to acquire Veloce in accordance with the terms and conditions of the Agreement and Plan of Merger, entered into as of May 17, 2009, as amended by Amendment No. 1 to Agreement and Plan of Merger dated as of November 8, 2010 and Amendment No. 2 to Agreement and Plan of Merger dated as of April 5, 2012 (the "Merger Agreement"). Pursuant to the Merger Agreement, achievement of a specified FPGA product development milestone by Veloce will trigger the merger, subject to the satisfaction or waiver of certain closing conditions (the "Merger"). In and as a result of the Merger a portion of the total consideration in the Merger, consisting of the following aggregate amounts, will become payable, at the Company's election, in cash, shares of the Company's common stock, or a combination of the two: • $60.4 million upon the closing of the Merger (the "Closing"); and • An additional amount that is expected to range from $0 to up to $75 million, in the event that certain post-Closing performance-based product development milestones are achieved. The Company anticipates that approximately $25 million to $30 million of the $60.4 million will be paid out at Closing. The payment we will make at Closing could consist of both cash and shares of the Company's stock. The number of shares of the Company's stock we issue could vary but we currently expect to keep dilution of our common stock to less than ten percent. Although we currently believe we have adequate liquidity to operate normally, our cash balances could decrement significantly if we decide to pay for the Veloce acquisition using a greater proportion of cash or if our normal operations require us to expend more cash. If our cash balances decline significantly, we may be faced with liquidity issues and may be forced to raise capital from other sources, which may or may not be possible to do so on reasonable terms. 59 -------------------------------------------------------------------------------- Table of Contents Stock Repurchase Program In August 2004, our Board of Directors authorized a stock repurchase program for the repurchase of up to $200.0 million of our common stock. Under the program, we are authorized to make purchases in the open market or enter into structured agreements. In October 2008, our Board of Directors increased the stock repurchase program by $100.0 million. During the fiscal year ended March 31, 2012, 3.5 million shares were repurchased on the open market at a weighted average price of $5.98 per share. During the fiscal year ended March 31, 2011, 3.7 million shares were repurchased on the open market at a weighted average price of $10.70 per share. All repurchased shares were retired upon delivery to us. As of March 31, 2012, we had $16.5 million available in our stock repurchase program. In February 2011, we entered into a Rule 10b5-1 plan to repurchase up to 3.0 million shares of its common stock at various price parameters. We cancelled this Rule 10b5-1 plan in May 2011. Included in the open market repurchases during the three months ended June 30, 2011 is 0.3 million shares that were repurchased under this Rule 10b5-1 plan at a weighted average price of $9.98 per share. At the time this Rule 10b5-1 plan was cancelled, we repurchased 1.0 million shares at a weighted average price of $10.00 per share under this Rule 10b5-1 plan. We also utilize structured stock repurchase agreements to buy back shares which are prepaid written put options on our common stock. We pay a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or stock depending on the closing market price of our common stock on the expiration date of the agreement. Upon expiration of each agreement, if the closing market price of our common stock is above the pre-determined price, we will have our cash investment returned with a premium. If the closing market price is at or below the pre-determined price, we will receive the number of shares specified at the agreement inception. Any cash received, including the premium, is treated as additional paid in capital on the balance sheet. During the fiscal year ended March 31, 2012 and 2011, we entered into structured stock repurchase agreements totaling $10.0 million during each period. For those agreements that settled during the fiscal year ended March 31, 2012, we received 1.0 million in shares of our common stock at an effective purchase price of $9.74 per share. For those agreements that settled during fiscal year ended March 31, 2011, we received $15.5 million in cash and 0.5 million in shares of our common stock at an effective purchase price of $10.01 per share. At March 31, 2012, we had no outstanding structured stock repurchase agreements. TPack Acquisition On September 17, 2010, we acquired TPack A/S, a Corporation organized under the laws of Denmark, in accordance with the terms and conditions of the stock purchase agreement dated August 17, 2010. The total consideration paid at the closing of the transaction was approximately $32 million. The former TPack shareholders may also earn up to approximately $5 million in additional consideration, subject to the achievement of certain revenue and performance milestones by TPack within 18 months after the acquisition. As of March 31, 2012, we have accrued a contingent consideration liability of approximately $0.6 million. Approximately $5 million was placed in escrow to secure the indemnification obligations of TPack which is included in the purchase price allocation and which was released in April 2012. See Note 12 of the Notes to the Consolidated Financial Statements for further discussion Other Our aggregate fixed commitments payable over the next five years for licensing fees relating to our R&D efforts, including our licensed IP, technology, product design, test and verification tools, are approximately $23.9 million. These amounts are also included in the table below. 60-------------------------------------------------------------------------------- Table of Contents The following table summarizes our contractual operating leases and other purchase commitments as of March 31, 2012 (in thousands): Other Operating Purchase Leases Commitments Total Fiscal Years Ending March 31, 2013 $ 2,337 $ 75,201 * $ 77,538 2014 2,062 8,253 10,315 2015 950 4,132 5,082 2016 155 244 399 Total minimum payments $ 5,504 $ 87,830 $ 93,334 * Includes liability for uncertain tax positions of $43.2 million including interest and penalties. Due to the high degree of uncertainty regarding the timing of potential future cash flows associated with these liabilities, we are unable to make a reasonably reliable estimate of the amount and period in which these liabilities might be paid. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as at March 31, 2012. We believe that our available cash, cash equivalents and short-term investments will be sufficient to meet our capital requirements and fund our operations for at least the next 12 months, although we could elect or could be required to raise additional capital during such period. There can be no assurance that such additional debt or equity financing will be available on commercially reasonable terms or at all. Although we currently believe we have adequate liquidity to operate normally, our cash balances could decrement significantly if we decide to pay for the Veloce acquisition using a greater proportion of cash or our normal operations requires us to expend more cash. If our cash balances decline significantly, we may be faced with liquidity issues and may be forced to raise capital from other sources, which may or may not be possible to do so on reasonable terms. [ Back To TMCnet.com's Homepage ]