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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2011

OR

 

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

For the transition period from              to             .

Commission File Number: 000-23193

 

 

APPLIED MICRO CIRCUITS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-2586591

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

215 Moffett Park Drive, Sunnyvale, CA   94089
(Address of principal executive offices)   (Zip code)

Registrant’s telephone number, including area code: (408) 542-8600

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of June 30, 2011, 64,373,474 shares of the registrant’s common stock, $0.01 par value per share, were issued and outstanding.

 

 

 


Table of Contents

APPLIED MICRO CIRCUITS CORPORATION

INDEX

 

          Page  
Part I.    FINANCIAL INFORMATION   
Item 1.    Condensed Consolidated Balance Sheets at June 30, 2011 and March 31, 2011      3   
   Condensed Consolidated Statements of Operations for the three months ended June 30, 2011 and 2010      4   
   Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2011 and 2010      5   
   Notes to Condensed Consolidated Financial Statements (unaudited)      6   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      22   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk      33   
Item 4.    Controls and Procedures      33   
Part II.    OTHER INFORMATION   
Item 1.    Legal Proceedings      34   
Item 1A.    Risk Factors      34   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      49   
Item 3.    Defaults Upon Senior Securities      50   
Item 4.    (Removed and Reserved)      50   
Item 5.    Other Information      50   
Item 6.    Exhibits      51   
Signatures      52   

 

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Table of Contents

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

 

     June 30,
2011
    March 31,
2011
 
     (unaudited)     (note)  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 41,394      $ 84,402   

Short-term investments-available-for-sale

     100,456        83,649   

Accounts receivable, net

     24,157        19,997   

Inventories

     26,746        26,561   

Other current assets

     20,534        16,784   
                

Total current assets

     213,287        231,393   

Property and equipment, net

     33,803        32,023   

Goodwill

     13,183        13,183   

Purchased intangibles

     20,774        23,388   

Other assets

     11,775        8,670   
                

Total assets

   $ 292,822      $ 308,657   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 24,232      $ 24,431   

Accrued payroll and related expenses

     8,940        7,261   

Other accrued liabilities

     13,309        12,748   

Deferred revenue

     1,959        2,407   
                

Total current liabilities

     48,440        46,847   

Commitments and contingencies (Note 7)

    

Stockholders’ equity:

    

Preferred stock, $0.01 par value:

    

Authorized shares — 2,000, none issued and outstanding

     —          —     

Common stock, $0.01 par value:

    

Authorized shares — 375,000 at June 30, 2011 and March 31, 2011

    

Issued and outstanding shares — 64,373 at June 30, 2011 and 63,666 at March 31, 2011

     644        637   

Additional paid-in capital

     5,880,117        5,891,036   

Accumulated other comprehensive loss

     (1,236     (1,597

Accumulated deficit

     (5,635,143     (5,628,266
                

Total stockholders’ equity

     244,382        261,810   
                

Total liabilities and stockholders’ equity

   $ 292,822      $ 308,657   
                

Note: Amounts have been derived from the March 31, 2011 audited consolidated financial statements.

See Accompanying Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

     Three Months Ended
June 30,
 
     2011     2010  

Net revenues

   $ 60,844      $ 60,810   

Cost of revenues

     26,331        22,485   
                

Gross profit

     34,513        38,325   

Operating expenses:

    

Research and development

     28,368        25,777   

Selling, general and administrative

     12,556        11,624   

Amortization of purchased intangible assets

     1,099        1,005   

Restructuring charges, net

     913        369   
                

Total operating expenses

     42,936        38,775   
                

Operating loss

     (8,423     (450

Interest income (expense), net

     1,281        1,915   

Other income (expense), net

     75        166   
                

(Loss) income before income taxes

     (7,067     1,631   

Income tax (benefit) expense

     (190     240   
                

Net (loss) income

   $ (6,877   $ 1,391   
                

Basic (loss) income per share

   $ (0.11   $ 0.02   
                

Shares used in calculating basic net (loss) income per share

     63,878        66,005   
                

Diluted (loss) income per share

   $ (0.11   $ 0.02   
                

Shares used in calculating diluted net (loss) income per share

     63,878        68,735   
                

See Accompanying Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Three Months Ended
June 30,
 
     2011     2010  

Operating activities:

    

Net (loss) income

   $ (6,877   $ 1,391   

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

    

Depreciation

     1,822        1,885   

Amortization of purchased intangibles

     2,614        3,630   

Stock-based compensation expense:

    

Stock options

     1,573        987   

Restricted stock units

     2,605        2,859   

Tax benefit from other comprehensive income

     (367     —     

Capitalization of mask set cost

     —          (1,177

Net gain (loss) on disposals of property

     10        (8

Changes in operating assets and liabilities:

    

Accounts receivable

     (4,160     2,686   

Inventories

     (185     (2,010

Other assets

     (3,230     225   

Accounts payable

     624        (1,183

Accrued payroll and other accrued liabilities

     1,825        1,718   

Deferred revenue

     (448     230   
                

Net cash (used for) provided operating activities

     (4,194     11,233   
                

Investing activities:

    

Purchases of short-term investments

     (57,879     (76,014

Proceeds from sales and maturities of short-term investments

     41,891        5,121   

Purchase of property and equipment

     (4,533     (1,527

Proceeds from sale of property and equipment

     —          20   

Purchases of strategic equity investment

     (2,500     —     

Proceeds from the sale of strategic equity investment

     —          4,991   

Funding of note receivable

     (1,000     —     
                

Net cash used for investing activities

     (24,021     (67,409
                

Financing activities:

    

Proceeds from issuance of common stock

     587        1,531   

Funding of restricted stock units withheld for taxes

     (2,172     (2,132

Repurchase of common stock

     (3,097     —     

Funding of structured stock repurchase agreements

     (10,000     (10,000

Funds received from structured stock repurchase agreements, including gains

     —          10,273   

Other

     (111     (10
                

Net cash used for financing activities

     (14,793     (338
                

Net decrease in cash and cash equivalents

     (43,008     (56,514

Cash and cash equivalents at beginning of year

     84,402        122,526   
                

Cash and cash equivalents at end of year

   $ 41,394      $ 66,012   
                

Supplementary cash flow disclosures:

    

Income taxes

   $ 457      $ 714   
                

See Accompanying Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include all the accounts of Applied Micro Circuits Corporation (“AMCC”, “APM”, “AppliedMicro” or the “Company”), its wholly-owned subsidiaries and Veloce, the Company’s variable interest entity (“VIE”) of which the Company is the primary beneficiary. A VIE is required to be consolidated by its primary beneficiary. The primary beneficiary is the party that absorbs a majority of the VIE’s anticipated losses and/or a majority of the expected returns. The Company has evaluated its strategic alliances for potential classification as variable interest entities by evaluating the sufficiency of each entity’s equity investment at risk to absorb losses and the Company’s share of the respective expected losses. The Company determined that it is the primary beneficiary of one variable interest entity and has included the accounts of this entity in the consolidated financial statements (see Note 9). All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management 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. The Company regularly evaluates estimates and assumptions related to its capitalized mask sets, which affects cost of goods sold and property and equipment or R&D expenses, if not capitalized; inventory valuation, warranty liabilities, and revenue reserves, which affects revenues, cost of sales and gross margin; allowance for doubtful accounts, which affects operating expenses; the unrealized losses or other-than-temporary impairments of short-term investments available for sale, which affects interest income (expense), net; the valuation of purchased intangibles and goodwill, which affects amortization and impairments of purchased intangibles and impairments of goodwill; the contingent consideration, which affects operating expenses; the valuation of restructuring liabilities, which affects the amount and timing of restructuring charges; the potential costs of litigation, which affects operating expenses; the valuation of deferred income taxes, which affects income tax expense (benefit); and stock-based compensation, which affects gross margin and operating expenses. The Company bases its estimates and assumptions on historical experience and on various other factors that it believes 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 the Company may differ materially and adversely from management’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

Recent Accounting Pronouncements

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. ASU 2011-05 increases the prominence of other comprehensive income in financial statements. Under ASU 2011-05, companies will have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. ASU 2011-05 eliminates the option to present other comprehensive income in the statement of changes in equity and is applied retrospectively. For public companies, ASU 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.The Company does not expect this to have a material impact on its financial statements.

In May 2011, the FASB issued additional guidance on fair value measurements that clarifies the application of existing guidance on disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The Company does not expect this to have a material impact on its financial statements.

2. CERTAIN FINANCIAL STATEMENT INFORMATION

Accounts receivable:

 

     June 30,
2011
    March 31,
2011
 
     (In thousands)  

Accounts receivable

   $ 25,483      $ 21,321   

Less: allowance for bad debts

     (1,326     (1,324
  

 

 

   

 

 

 
   $ 24,157      $ 19,997   
  

 

 

   

 

 

 

 

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Table of Contents

Inventories:

 

     June 30,
2011
     March 31,
2011
 
     (In thousands)  

Finished goods

   $ 20,760       $ 21,255   

Work in process

     4,049         4,334   

Raw materials

     1,937         972   
                 
   $ 26,746       $ 26,561   
                 

Other current assets:

 

     June 30,
2011
     March 31,
2011
 
     (In thousands)  

Prepaid expenses

   $ 16,695       $ 12,972   

Executive deferred compensation assets

     2,012         2,003   

Deposits

     873         749   

Other

     954         1,060   
                 
   $ 20,534       $ 16,784   
                 

Property and equipment:

 

     Useful
Life
     June 30,
2011
    March 31,
2011
 
     (In years)      (In thousands)  

Machinery and equipment

     3-7       $ 29,202      $ 29,837   

Leasehold improvements

     1-15         12,825        12,783   

Computers, office furniture and equipment

     3-7         41,851        37,664   

Buildings

     31.5         2,756        2,756   

Land

     N/A         9,800        9,800   
                   
        96,434        92,840   

Less: accumulated depreciation and amortization

        (62,631     (60,817
                   
      $ 33,803      $ 32,023   
                   

Goodwill and purchased intangibles:

Goodwill is as follows:

 

     (In thousands)  

Gross

   $ 4,441,026   

Accumulated amortization and impairments

     (4,441,026

Net, as of March 31, 2010

     —     

Goodwill related to TPack acquisition (see Note 10)

     13,183   
        

Net, as of March 31, 2011 and June 30, 2011

   $ 13,183   
        

 

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Table of Contents

Purchase-related intangibles were as follows:

 

    June 30, 2011     March 31, 2011  
    Gross     Accumulated
Amortization
and
Impairments
    Net     Weighted
average
remaining
useful life
    Gross     Accumulated
Amortization
and
Impairments
    Net     Weighted
average
remaining
useful life
 
    (In thousands)     (In years)     (In thousands)     (In years)  

Developed technology/in-process research and development

  $ 441,300      $ (427,017   $ 14,283        5.3      $ 441,300      $ (425,502   $ 15,798        5.2   

Customer relationships

    12,830        (7,156     5,674        3.3        12,830        (6,581     6,249        3.5   

Patents/core technology rights/tradename

    63,206        (62,389     817        1.9        63,206        (61,865     1,341        1.5   
                                                   
  $ 517,336      $ (496,562   $ 20,774        $ 517,336      $ (493,948   $ 23,388     
                                                   

As of June 30, 2011, the estimated future amortization expense of purchased intangible assets to be charged to cost of sales and operating expenses was as follows (in thousands):

 

     Cost of
Sales*
     Operating
Expenses
     Total  

Fiscal Years Ending March 31,

        

2012 (remaining)

   $ 1,919         2,103         4,022   

2013

     2,558         1,926         4,484   

2014

     2,558         1,189         3,747   

2015

     2,558         904         3,462   

2016

     2,558         369         2,927   

2017 and thereafter

     1,182         —           1,182   
                          

Total

   $ 13,333       $ 6,491       $ 19,824   
                          

 

* The amounts do not include approximately $1.0 million in in-process research and development.

Other assets:

 

     June 30,
2011
     March 31,
2011
 
     (In thousands)  

Non-current portion of prepaid expenses

   $ 6,939       $ 7,340   

Strategic investments

     3,836         1,330   

Notes receivable

     1,000         —     
                 
   $ 11,775       $ 8,670   
                 

Strategic Investments

The Company has entered into certain equity investments in privately held businesses for the promotion of business and strategic objectives. The Company’s investments in equity securities of privately held businesses are accounted for under the cost method. Under the cost method, strategic investments in which the Company holds less than a 20% voting interest and on which the Company does not have the ability to exercise significant influence are carried at the lower of cost or cost reduced by other-than-temporary impairments, as appropriate. These investments are included in other assets on the Company’s condensed consolidated balance sheets. The Company periodically reviews these investments for other-than-temporary declines in fair value based on the specific identification method and writes down investments when an other-than-temporary decline has occurred.

 

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Table of Contents

Short-term investments:

The following is a summary of cash, cash equivalents and available-for-sale investments by type of instruments (in thousands):

 

    June 30, 2011     March 31, 2011  
    Amortized
Cost
    Gross Unrealized     Estimated
Fair Value
    Amortized
Cost
    Gross Unrealized     Estimated
Fair Value
 
      Gains     Losses         Gains     Losses    

Cash

  $ 11,065      $ —        $ —        $ 11,065      $ 8,766      $ —        $ —        $ 8,766   

Cash equivalents

    30,329        —          —          30,329        75,636        —          —          75,636   

U.S. Treasury securities and agency bonds

    11,426        61        —          11,487        9,685        4        58        9,631   

Corporate bonds

    5,425        44        3        5,466        6,428        32        48        6,412   

Mortgage-backed and asset-backed securities*

    8,973        342        78        9,237        9,281        271        45        9,507   

Mutual funds

    33,069        —          —          33,069        17,611        —          —          17,611   

Closed-end bond funds

    29,255        5,980        1,000        34,235        29,255        5,561        1,186        33,630   

Preferred stock

    6,209        753        —          6,962        6,209        649        —          6,858   
                                                               
  $ 135,751      $ 7,180      $ 1,081      $ 141,850      $ 162,871      $ 6,517      $ 1,337      $ 168,051   
                                                               

Reported as:

               

Cash and cash equivalents

        $ 41,394            $ 84,402   

Short-term investments available-for-sale

          100,456              83,649   
                           
        $ 141,850            $ 168,051   
                           

 

* At June 30, 2011 and March 31, 2011, approximately $5.9 million and $6.5 million of the estimated fair value presented were mortgage-backed securities, respectively.

The established guidelines for measuring fair value and expanded disclosures regarding fair value measurements are defined as a three-level valuation hierarchy for disclosure of fair value measurements as follows:

 

Level 1 —   Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2 —   Inputs (other than quoted market prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
Level 3 —   Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Valuation of instruments includes unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities.

The following is a summary of cash, cash equivalents and available-for-sale investments by type of instruments measured at fair value on a recurring basis (in thousands):

 

    June 30, 2011     March 31, 2011  
    Level 1     Level 2     Level 3     Total     Level 1     Level 2     Level 3     Total  

Cash

  $ 11,065      $ —        $ —        $ 11,065      $ 8,766      $ —        $ —        $ 8,766   

Cash equivalents

    30,329        —          —          30,329        75,636        —          —          75,636   

U.S. Treasury securities and agency bonds

    11,487        —          —          11,487        9,631        —          —          9,631   

Corporate bonds

    —          5,466        —          5,466        —          6,412        —          6,412   

Mortgage-backed and asset-backed securities

    —          9,237        —          9,237        —          9,507        —          9,507   

Mutual funds

    33,069        —          —          33,069        17,611        —          —          17,611   

Closed-end bond funds

    34,235        —          —          34,235        33,630        —          —          33,630   

Preferred stock

    —          6,962        —          6,962        —          6,858        —          6,858   
                                                               
  $ 120,185      $ 21,665      $ —        $ 141,850      $ 145,274      $ 22,777      $ —        $ 168,051   
                                                               

 

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There were no significant transfers in and out of Level 1 and Level 2 fair value measurements during the three months ended June 30, 2011.

The Company periodically reviews its strategic investments for other-than-temporary declines in fair value based on the specific identification method and writes down investments when an other-than-temporary decline has occurred. During the three months ended June 30, 2011, the Company invested $2.5 million in a non-marketable equity investment and this amount was carried at cost.

The following is a summary of the cost and estimated fair values of available-for-sale securities with stated maturities, which include U.S. Treasury securities and agency bonds, corporate bonds and mortgage-backed and asset-backed securities, by contractual maturity (in thousands):

 

     June 30, 2011      March 31, 2011  
     Cost      Fair Value      Cost      Fair Value  

Less than 1 year

   $ —         $ —         $ —         $ —     

Mature in 1 – 2 years

     7,664         7,685         2,075         2,065   

Mature in 3 – 5 years

     11,064         11,090         13,991         13,902   

Mature after 5 years

     7,096         7,415         9,328         9,583   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 25,824       $ 26,190       $ 25,394       $ 25,550   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following is a summary of gross unrealized losses (in thousands):

 

    Less Than 12 Months of
Unrealized Losses
    12 Months or More of
Unrealized Losses
    Total  
As of June 30, 2011   Estimated
Fair
Value
    Gross
Unrealized
Losses
    Estimated
Fair
Value
    Gross
Unrealized
Losses
    Estimated
Fair
Value
    Gross
Unrealized
Losses
 

U.S. Treasury securities and agency bonds

  $ 1,602      $ —        $ —        $ —        $ 1,602      $ —     

Corporate bonds

    829        3        —          —          829        3   

Mortgage-backed and asset-backed securities

    3,132        78        —          —          3,132        78   

Closed-end bond funds

    8,138        1,000        —          —          8,138        1,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 13,701      $ 1,081      $ —        $ —        $ 13,701      $ 1,081   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
    Less Than 12 Months of
Unrealized Losses
    12 Months or More of
Unrealized Losses
    Total  
As of March 31, 2011   Estimated
Fair
Value
    Gross
Unrealized
Losses
    Estimated
Fair
Value
    Gross
Unrealized
Losses
    Estimated
Fair
Value
    Gross
Unrealized
Losses
 

U.S. Treasury securities and agency bonds

  $ 6,227      $ 58      $ —        $ —        $ 6,227      $ 58   

Corporate bonds

    3,672        48        —          —          3,672        48   

Mortgage-backed and asset-backed securities

    2,105        45        —          —          2,105        45   

Closed-end bond funds

    7,951        1,186        —          —          7,951        1,186   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
  $ 19,955      $ 1,337      $ —        $ —        $ 19,955      $ 1,337   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other-Than-Temporary Impairment

Based on an evaluation of securities that have been in a loss position, the Company did not recognize any other-than-temporary impairment charges, for the three months ended June 30, 2011 and the fiscal year ended March 31, 2011. The Company considered various factors which included its intent and ability to hold the underlying securities until its estimated recovery of amortized cost. As of June 30, 2011 and March 31, 2011, the Company also had $7.2 million and $6.5 million in gross unrealized gains, respectively. The basis for computing realized gains or losses is by specific identification.

 

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Other accrued liabilities:

 

     June 30,
2011
     March 31,
2011
 
     (In thousands)  

Contingent consideration

   $ 3,150       $ 3,150   

Customer deposits

     2,224         953   

Employee related liabilities

     2,139         2,306   

Executive deferred compensation

     2,012         2,003   

Income taxes

     877         1,157   

Professional fees

     564         735   

Other

     2,343         2,444   
  

 

 

    

 

 

 
   $ 13,309       $ 12,748   
  

 

 

    

 

 

 

Warranty reserves:

The Company’s products typically carry a one year warranty. The Company establishes reserves for estimated product warranty costs at the time revenue is recognized. Although the Company engages in extensive product quality programs and processes, its warranty obligation is affected by product failure rates, use of materials and service delivery costs incurred in correcting any product failure. Should actual product failure rates, use of materials or service delivery costs differ from the Company’s estimates, additional warranty reserves could be required, which could reduce its gross margin.

The following table summarizes warranty reserve activity (in thousands):

 

     Three Months Ended
June 30,
 
     2011     2010  

Beginning balance

   $ 176      $ 169   

Charged to costs of revenues

     206        16   

Charges incurred

     (185     (16
  

 

 

   

 

 

 

Ending balance

   $ 197      $ 169   
  

 

 

   

 

 

 

Interest income (expense), net (in thousands):

 

     Three Months Ended
June 30,
 
     2011      2010  

Interest income

   $ 961       $ 1,521   

Net realized gain on short-term investments

     320         394   
  

 

 

    

 

 

 
   $ 1,281       $ 1,915   
  

 

 

    

 

 

 

Other income, net (in thousands):

 

     Three Months Ended
June 30,
 
     2011     2010  

Net (loss) gain on disposals of property

   $ (10   $ 8   

Other, net

     85        158   
  

 

 

   

 

 

 
   $ 75      $ 166   
  

 

 

   

 

 

 

Net (loss) income per share:

Shares used in basic net (loss) income per share are computed using the weighted average number of common shares outstanding during each period. Shares used in diluted net income per share include the dilutive effect of common shares potentially issuable upon the exercise of stock options, vesting of restricted stock units (“RSUs”) and outstanding warrants. However, potentially issuable common shares are not used in computing diluted net loss per share as their effect would be anti-dilutive due to the loss

 

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recorded during the periods presented. The reconciliation of shares used to calculate basic and diluted net (loss) income per share consists of the following (in thousands, except per share data):

 

    Three Months Ended
June 30,
 
    2011     2010  

Net (loss) income

  $ (6,877   $ 1,391   
 

 

 

   

 

 

 

Shares used in net (loss) income per share computation:

   

Weighted average common shares outstanding, basic

    63,878        66,005   

Net effect of dilutive common share equivalents

    —          2,730   
 

 

 

   

 

 

 

Weighted average common shares outstanding, diluted

    63,878        68,735   
 

 

 

   

 

 

 

Basic net (loss) income per share

  $ (0.11   $ 0.02   
 

 

 

   

 

 

 

Diluted net (loss) income per share

  $ (0.11   $ 0.02   
 

 

 

   

 

 

 

The effect of anti-dilutive securities (comprised of options and restricted stock units) totaling 5.6 million and 3.8 million equivalent shares for the three months ended June 30, 2011 and 2010, respectively, have been excluded from the net income (loss) per share computation.

The effect of dilutive securities (comprised of options and restricted stock units) totaling 1.1 million equivalent shares for the three months ended June 30, 2011 have been excluded from the net loss per share computation, as their impact would be anti-dilutive because the company has incurred losses in the period.

3. RESTRUCTURING CHARGES

The Company recognizes restructuring costs associated with exit or disposal activities. Cost relating to facilities closure or lease commitments are recognized when the facility has been exited. Termination costs are recognized when the cost are deemed both probable and estimable. A combined summary of the recent activity of the restructuring programs initiated by the Company is as follows (in thousands):

 

     Workforce
Reduction
    Facilities
Consolidation
and
Operating
Lease
Commitments
    Total  

Liability, March 31, 2010

   $ 393      $ 190      $ 583   
  

 

 

   

 

 

   

 

 

 

Restructuring charges

     486        112        598   

Cash payments

     (831     (284     (1,115

Reductions to estimated liability

     (48     (18     (66
  

 

 

   

 

 

   

 

 

 

Liability, March 31, 2011

   $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

 

Restructuring charges

     913        —          913   

Cash payments

     (638     —          (638
  

 

 

   

 

 

   

 

 

 

Liability, June 30, 2011

   $ 275      $ —        $ 275   
  

 

 

   

 

 

   

 

 

 

The following table provides detailed activity related to the restructuring programs as of June 30, 2011 (in thousands):

 

     Workforce
Reduction
    Facilities
Consolidation
and
Operating
Lease
Commitments
    Total  

Prior Fiscal Years’ Completed Restructuring Programs:

      

Liability, March 31, 2010

   $ 393      $ 190      $ 583   
  

 

 

   

 

 

   

 

 

 

Restructuring charges

     486        112        598   

Cash payments

     (831     (284     (1,115

Reductions to estimated liability

     (48     (18     (66
  

 

 

   

 

 

   

 

 

 

Liability, March 31, 2011

   $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

 

 

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     Workforce
Reduction
    Facilities
Consolidation
and
Operating
Lease
Commitments
    Total  

April 2011 Restructuring Program

                     

Restructuring charges

     913        —          913   

Cash payments

     (638     —          (638
  

 

 

   

 

 

   

 

 

 

Liability, June 30, 2011

   $ 275      $ —        $ 275   
  

 

 

   

 

 

   

 

 

 

Prior Fiscal Years’ Completed Restructuring Programs

The February 2009 restructuring program was implemented to reduce its expenses and excess capacity in response to the worsening economic conditions. The restructuring program consisted of the elimination of approximately 100 positions. As a result of the February 2009 restructuring program, the Company recorded a net charge of $7.8 million, consisting of $4.7 million for employee severances, $0.8 million for operating lease impairments, $1.5 million in contract cancellation charges for a cancelled project and $0.8 million for an asset impairment. During the fiscal year ended March 31, 2011, the Company paid all its remaining liabilities related to this restructuring program.

The January 2010 restructuring program was implemented as part of the Company’s ongoing cost reduction efforts and to better align its global operations to achieve greater efficiencies. The Company moved some of its functions offshore, which will allow it to be much closer to its third party subcontract manufacturers, thus reducing costs by taking advantage of its global cost structure and improving efficiencies by eliminating the delays inherent in working in different time zones. The January 2010 restructuring plan includes eliminating or relocating 63 positions. As a result of the January 2010 restructuring program, the Company recorded a charge of $1.0 million, consisting of $0.6 million for employee severances and $0.4 million for an asset impairment in the fiscal year ended March 31, 2010. During the fiscal year ended March 31, 2011, the Company recorded an additional charge of $0.5 million for employee severances.

April 2011 Restructuring Program

The April 2011 restructuring program was implemented as part of the Company’s ongoing cost reduction efforts and to better align its global operations to achieve greater efficiencies. The Company moved more of its functions offshore, which will allow it to be closer and more connected to its and its customer’s third party subcontract manufacturers. The April 2011 restructuring plan includes eliminating or relocating 25 positions. As a result of the April 2011 restructuring program, the Company recorded a charge of $0.9 million for employee severances. The Company expects to record additional charges of approximately $0.1 million for employee severances during the remainder of the fiscal year relating to this restructuring action.

4. COMPREHENSIVE (LOSS) INCOME

The components of comprehensive (loss) income, net of tax where applicable, are as follows (in thousands):

 

     Three Months Ended
June 30,
 
     2011     2010  

Net (loss) income

   $ (6,877   $ 1,391   

Change in unrealized gain on investments

     452        1,431   

Release upon disposition of investment with cumulative implementation reclassification for prior non-credit related other-than-temporary impairment charges

     —          68   

Loss on foreign currency translation

     (91     (43
  

 

 

   

 

 

 
   $ (6,516   $ 2,847   
  

 

 

   

 

 

 

5. STOCKHOLDERS’ EQUITY

Preferred Stock

The Certificate of Incorporation allows for the issuance of up to two million shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences, and the number of shares constituting any series of the designation of such series, without further vote or action by the stockholders.

 

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Common Stock

At June 30, 2011, the Company had 375.0 million shares authorized for issuance and approximately 64.4 million shares issued and outstanding. At March 31, 2011, there were approximately 63.7 million shares issued and outstanding.

Employee Stock Purchase Plan

The Company has in effect an employee stock purchase plan under which 4.8 million shares of common stock was reserved for issuance. In August 2010, the Company’s stockholders approved the proposal to increase the number of shares reserved for issuance to 6.3 million shares. Under the terms of this plan, purchases are made semiannually and the purchase price of the common stock is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. During the three months ended June 30, 2011 and 2010, no shares were issued under this plan. At June 30, 2011, 5.3 million shares had been issued under this plan and 1.0 million shares were available for future issuance.

Stock Repurchase Program

In August 2004, the Board authorized a stock repurchase program for the repurchase of up to $200.0 million of the Company’s common stock. Under the program, the Company is authorized to make purchases in the open market or enter into structured stock repurchase agreements. In October 2008, the Board increased the stock repurchase program by $100.0 million. During the three months ended June 30, 2011, approximately 0.3 million shares were repurchased on the open market at a weighted average price of $9.98 per share. During the three months ended June 30, 2010, no shares were repurchased on the open market. From the time the program was first implemented in August 2004, the Company has repurchased on the open market a total of 14.0 million shares at a weighted average price of $11.10 per share. All repurchased shares were retired upon delivery to the Company.

In February 2011, the Company entered into a Rule 10b5-1 plan to repurchase up to 3.0 million shares of its common stock at various price parameters. The Company 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, the Company repurchased 1.0 million shares at a weighted average price of $10.00 per share under this Rule 10b5-1 plan.

The Company also utilizes structured stock repurchase agreements to buy back shares which are prepaid written put options on its common stock. The Company pays 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 its common stock on the expiration date of the agreement. Upon expiration of each agreement, if the closing market price of its common stock is above the pre-determined price, the Company will have its cash investment returned with a premium. If the closing market price is at or below the pre-determined price, the Company will receive the number of shares specified at the agreement inception. The Company considered the guidance in ASC Topic 480-10, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and ASC Topic 815-40, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. Any cash received, including the premium, is treated as additional paid-in capital on the balance sheet.

During the three month ended June 30, 2011 and 2010, the Company entered into structured stock repurchase agreements totaling $10.0 million during each period. No structured stock repurchase agreements settled during the three months ended June 30, 2011. For those structured stock repurchase agreements that settled during the three months ended June 30, 2010, the Company received $10.3 million in cash. At June 30, 2011, the Company had one outstanding structured stock repurchase agreement, which subsequently settled in July 2011 for 1.0 million in shares of its common stock at an effective purchase price of $9.74 per share. From the inception of the Company’s most recent stock repurchase program in August 2004, it entered into structured stock repurchase agreements totaling $277.5 million. Upon settlement of these agreements, as of June 30, 2011, the Company received $179.8 million in cash and 9.0 million shares of its common stock at an effective purchase price of $9.79 per share.

The table below is a plan-to-date summary of the Company’s repurchase program activity as of June 30, 2011 (in thousands, except per share data):

 

     Aggregate
Price
     Repurchased
Shares
     Average Price
Per Share
 

Stock repurchase program

        

Authorized amount

   $ 300,000         —         $ —     

Open market repurchases

     155,203         13,981         11.10   

Structured stock repurchase agreements*

     100,517         8,962         11.22   
                          

Total repurchases

   $ 255,720         22,943       $ 11.15   
                          

Available for repurchase

   $ 44,280         
              

 

 

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* The amounts above do not include gains recorded to additional paid-in-capital of $12.8 million from structured stock repurchase agreements which settled in cash. The average price per share for structured stock repurchase agreements adjusted for gains from settlements in cash would have been $9.79 per share and for total repurchases would have been $10.59 per share.

Stock Options

The Company has granted stock options to employees and non-employee directors under several plans. These option plans include two stockholder-approved plans (the 1992 Stock Option Plan and 1997 Directors’ Stock Option Plan) and four plans not approved by stockholders (the 2000 Equity Incentive Plan, Cimaron Communications Corporation’s 1998 Stock Incentive Plan assumed in the fiscal 1999 merger, and JNI Corporation’s 1997 and 1999 Stock Option Plans assumed in the fiscal 2004 merger). Certain other outstanding options were assumed through the Company’s various acquisitions.

In April 2011, the Compensation Committee and the Board of Directors approved, subject to approval by the stockholders of the Company, adoption of Applied Micro Circuits Corporation 2011 Equity Incentive Plan (“2011 Plan”). If approved by the Company’s stockholders during its August 16, 2011 annual meeting, the 2011 Plan will serve as a successor to the 1992 Plan and no additional equity awards will be, granted under the 1992 Plan. The total number of shares of common stock reserved for issuance under the 2011 Plan will consist of 4,200,000 shares plus the number of shares subject to any stock awards under the 1992 Plan or the 2000 Plan that terminate or are forfeited or repurchased and would otherwise be returned to the share reserve under the 1992 Plan or the 2000 Plan, respectively.

The Board has delegated administration of the Company’s equity plans to the Compensation Committee, which generally determines eligibility, vesting schedules and other terms for awards granted under the plans. Options under the plans expire not more than ten years from the date of grant and are generally exercisable upon vesting. Vesting generally occurs over four years. New hire grants generally vest and become exercisable at the rate of 25% on the first anniversary of the date of grant and ratably on a monthly basis over a period of 36 months thereafter; subsequent option grants to existing employees generally vest and become exercisable ratably on a monthly basis over a period of 48 months measured from the date of grant.

In May 2009, Dr. Gopi, our CEO, was awarded 300,000 stock options for “Extraordinary Accomplishment.” The Black-Scholes value of these stock options is $1.1 million. These options will vest only if Company performance milestones are satisfied; otherwise they will expire unvested. The first milestone for 75,000 shares will vest only if we achieve an annual revenue target of $270 million or more for any fiscal year from fiscal 2010 through fiscal 2013. The next milestone for another 75,000 shares will vest only if we achieve an annual revenue target of $310 million or more for any fiscal year from fiscal 2010 through fiscal 2013 or an annual revenue target of $350 million or more for fiscal 2014. The last milestone for 150,000 shares will vest only if we achieve an annual operating margin of 13.5% of annual revenue or higher in fiscal 2013 or 15% or higher for any fiscal year from fiscal 2010 through fiscal 2012. The Company evaluates the probability of achieving the milestones and adjusts any stock option expense accordingly.

At June 30, 2011 and March 31, 2011, there were no shares of common stock subject to repurchase. Options are granted at prices at least equal to fair value of the Company’s common stock on the date of grant.

Option activity under the Company’s stock incentive plans during the three months ended June 30, 2011 is set forth below (in thousands, except per share data):

 

     Number of Shares     Weighted Average
Exercise Price
Per Share
 

Outstanding at the beginning of the year

     5,390      $ 11.90   

Granted

     250        10.10   

Exercised

     (38     4.77   

Forfeited

     (1,102     16.25   
  

 

 

   

 

 

 

Outstanding at the end of the period

     4,500      $ 10.80   
  

 

 

   

Vested and expected to vest during the remaining recognition period

     4,392      $ 10.84   
  

 

 

   

Vested at the end of the period

     2,888      $ 12.02   
  

 

 

   

At June 30, 2011, the weighted average remaining contractual term for options outstanding is 4.8 years and for options vested is 4.4 years.

The aggregate pretax intrinsic value of options exercised during the three months ended June 30, 2011 was $0.2 million. This intrinsic value represents the excess of the fair market value of the Company’s common stock on the date of exercise over the exercise price of such options.

 

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The weighted average remaining contractual life and weighted average per share exercise price of options outstanding and of options exercisable as of June 30, 2011 were as follows (in thousands, except exercise prices and years):

 

     Options Outstanding      Options Exercisable  

Range of Exercise Prices

   Number of
Shares
     Weighted
Average
Remaining
Contractual
Life
     Weighted
Average
Exercise Price
     Number of
Shares
     Weighted
Average
Exercise Price
 

$ 0.52 - $  7.12

     1,075         4.52       $ 6.24         427       $ 5.90   

   7.13 -     8.08

     941         5.25         7.74         665         7.73   

   8.09 -   11.86

     947         6.36         10.55         404         10.46   

 11.87 -   14.40

     912         4.50         12.95         767         13.08   

 14.41 -   56.72

     625         2.62         20.48         625         20.48   
                                            

$ 0.52 - $56.72

     4,500         4.79       $ 10.80         2,888       $ 12.02   
                                            

As of June 30, 2011, the aggregate pre-tax intrinsic value of options outstanding and exercisable was $2.1 million and options outstanding were $4.0 million. The aggregate pretax intrinsic values were calculated based on the closing price of the Company’s common stock of $8.86 on June 30, 2011.

Restricted Stock Units

The Company has granted restricted stock units pursuant to its 2000 Equity Incentive Plan as part of its regular annual employee equity compensation review program as well as to new hires. Restricted stock units are share awards that, upon vesting, will deliver to the holder shares of the Company’s common stock. Generally, restricted stock units will vest on a quarterly basis over four years from the date of hire provided that no shares will vest during the first year, at the end of which the shares that would have vested during that year will vest and the remaining shares will vest over the remaining 12 quarters.

In May 2009, the Company issued three-year RSU grants, or “EBITDA Grants.” Vesting for 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. For the fiscal year ended March 31, 2011 and 2010, approximately 36% and 34% of the three-year performance pool has vested because the Company’s performance exceeded its “stretch” EBITDA target. For the fiscal year ending March 31, 2012, up to 30% of the remaining three-year performance pool can vest, after adjusting for individual performance factors. The Company evaluates the probability of achieving the milestones and adjusts any RSU expense which is included in stock-based compensation expense.

In April 2011, the Committee authorized additional EBITDA based performance RSUs, or “EBITDA2”. EBITDA2 is similar to the EBITDA program introduced in 2009 with one major exception. For Vice Presidents, the Company EBITDA attainment scale must be 50% or more for stock vesting to occur in that year. As with the previous EBITDA program, unearned amounts based on company performance will roll over to the subsequent year, offering a “make-up” opportunity based on future company performance and unvested shares remaining at the end of the three-year program period will expire unvested. The Company evaluates the probability of achieving the milestones and adjusts any RSU expense which is included in stock-based compensation expense.

Restricted stock unit activity during the three months ended June 30, 2011 is set forth below (in thousands):

 

     Restricted Stock Units
Outstanding
Number of Shares
 

Outstanding at the beginning of the year

     3,074   

Awarded

     4,707   

Vested

     (1,126

Cancelled

     (290
        

Outstanding at the end of the period

     6,365   
        

The weighted average remaining contractual term for the restricted stock units outstanding as of June 30, 2011 was 2.6 years.

As of June 30, 2011, the aggregate pre-tax intrinsic value of restricted stock units outstanding was $56.4 million. The aggregate pretax intrinsic values were calculated based on the closing price of the Company’s common stock of $8.86 on June 30, 2011.

 

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The aggregate pretax intrinsic value of RSUs released during the three months ended June 30, 2011 was $11.4 million. This intrinsic value represents the fair market value of the Company’s common stock on the date of release.

Warrants

On May 17, 2009, the Company entered into a merger and other agreements with Veloce Technologies, Inc. (“Veloce”) pursuant to which Veloce has agreed, among other things, to perform development work for the Company on an exclusive basis for up to five years for cash and other consideration, including a warrant to purchase shares of the Company’s common stock. The warrant vesting schedule was amended in conjunction with the amended merger agreement on November 8, 2010.

The warrant expires on July 15, 2014 and has an exercise price of $0.01 per share. The warrant was 38% vested as of June 30, 2011. The remaining shares will vest quarterly through December 2012. A portion of the vested shares have been committed to be distributed to the employees of Veloce and will be settled in cash instead of common stock. Veloce will sell the committed shares and distribute the proceeds to its employees. Therefore, the Company has recognized stock-based compensation expense which is included in R&D expense and recorded a corresponding liability for the amount to be distributed as of June 30, 2011. No stock-based compensation expense has been recognized for the portion of the warrants that have been retained by Veloce.

6. STOCK-BASED COMPENSATION

The Company estimates the fair value of stock-based compensation on the date of grant using an option-pricing model. The Company uses the Black-Scholes model to value stock-based compensation, excluding RSUs, which we use the fair market value of our common stock. The Black-Scholes option-pricing model determines the fair value of share-based payment awards based on the stock price on the date of grant and is affected by assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s stock price, volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Although the fair value of stock options granted by the Company is estimated by the Black-Scholes model, the estimated fair value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

The fair value of the options granted is estimated as of the grant date using the Black-Scholes option-pricing model assuming the weighted-average assumptions listed in the following table:

 

     Three Months Ended June 30,  
     Employee Stock
Options
    Employee Stock
Purchase Plans
 
     2011     2010     2011     2010  

Expected life (years)

     3.8        3.8        0.5        0.5   

Risk-free interest rate

     1.4     1.9     0.2     0.2

Volatility

     48     52     42     48

Dividend yield

     —       —       —       —  

Weighted average fair value

   $ 3.83      $ 4.71      $ 2.63      $ 2.09   

The weighted average fair value per share of the restricted stock units awarded was $10.16 and $10.60 during the three months ended June 30, 2011 and 2010, respectively. The weighted average fair value per share was calculated based on the fair market value of the Company’s common stock on the respective grant dates.

Effective April 1, 2011, the Company revised its estimated forfeiture rate used in determining the amount of stock-based compensation from 6.6% to 6.8% as a result of an increasing rate of forfeitures in recent periods, which the Company believes is indicative of the rate it will experience during the remaining vesting period of currently outstanding unvested grants.

The following table summarizes stock-based compensation expense related to stock options and restricted stock units (in thousands):

 

     Three Months Ended
June 30,
 
     2011      2010  

Stock-based compensation expense by type of award

     

Stock options (including employee stock purchase program)

   $ 1,569       $ 996   

Restricted stock units

     2,606         2,883   
  

 

 

    

 

 

 

Total stock-based compensation

     4,175         3,879   

Stock-based compensation expensed from (capitalized to) inventory

     3         (33
  

 

 

    

 

 

 

Total stock-based compensation expense

   $ 4,178       $ 3,846   
  

 

 

    

 

 

 

 

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The following table summarizes stock-based compensation expense as it relates to the Company’s statement of operations (in thousands):

 

     Three Months Ended
June 30,
 
     2011      2010  

Stock-based compensation expense by cost centers

     

Cost of revenues

   $ 108       $ 186   

Research and development

     2,388         1,971   

Selling, general and administrative

     1,679         1,722   
  

 

 

    

 

 

 

Total stock-based compensation

   $ 4,175       $ 3,879   

Stock-based compensation expensed from (capitalized to) inventory

     3         (33
  

 

 

    

 

 

 

Total stock-based compensation expense

   $ 4,178       $ 3,846   
  

 

 

    

 

 

 

Stock-based compensation expense will continue to have a significant adverse impact on the Company’s reported results of operations, although it will have no impact on its overall financial position. 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 June 30, 2011 is $21.2 million, which includes stock-based compensation for Veloce, the Company’s VIE. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 2.6 years. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional equity awards or assumes unvested equity awards in connection with acquisitions.

7. CONTINGENCIES

Legal Proceedings

The Company acquired JNI Corporation (“JNI”) in October 2003. In November 2001, a class action lawsuit was filed against JNI and the underwriters of its initial and secondary public offerings of common stock in the U.S. District Court for the Southern District of New York, case no. 01 Civ 10740 (SAS). The complaint alleged that defendants violated the Securities Exchange Act of 1934, as amended (the “Exchange Act”), in connection with JNI’s public offerings. This lawsuit was among more than 300 class action lawsuits pending in this District Court that have come to be known as the “IPO laddering cases.” Pursuant to In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS), in mid-2009 a settlement was reached in all of the cases. In October 2009, the Court issued an order granting final approval of the settlement and dismissing the case. The settlement did not have a material impact on the Company. The Court subsequently issued a final judgment. Several appeals of the settlement and judgment were filed between October 29 and November 4, 2009. Should the settlement be overturned on appeal and the final judgment vacated, the Company’s liability, if any, could not be reasonably estimated at this time.

In 1993, the Company was named as a Potentially Responsible Party (“PRP”) along with more than 100 other companies that used an Omega Chemical Corporation waste treatment facility in Whittier, California (the “Omega Site”). The U.S. Environmental Protection Agency (“EPA”) has alleged that Omega failed to properly treat and dispose of certain hazardous waste materials at the Omega Site. The Company is a member of a large group of PRPs, known as the Omega Chemical Site PRP Organized Group (“OPOG”), that has agreed to fund certain on-going remediation efforts at the Omega Site. In February 2001, the U.S. District Court for the Central District of California approved a consent decree between the EPA and the OPOG to study contamination and evaluate cleanup options at the Omega Site. In January 2009, the District Court ordered that two amendments be entered and made part of the consent decree, the first expanding the scope of work to mitigate volatile organic compounds affecting indoor air quality near the Omega Site and the second adding settling parties to the consent decree. Efforts to remove waste materials from the Omega Site are completed. Efforts to remediate the soil and groundwater at the Omega Site are underway and are expected to be ongoing for several years. In addition, OPOG and the EPA are investigating a regional groundwater contamination plume allegedly originating at the Omega Site and it is anticipated they will in the future enter into a remediation consent decree with the Court regarding such plume. In November 2007, Angeles Chemical Company filed a lawsuit in the U.S. District Court for the Central District of California against OPOG and the PRPs for cost recovery and indemnification for future response costs allegedly resulting from the regional groundwater contamination plume described above. In March 2008, the Court granted OPOG’s motion to stay the action pending EPA’s determination of how to investigate and remediate the regional groundwater. In 2010, certain PRPs challenged the criteria previously used to allocate liability among the PRPs and, in early 2011, the OPOG established an allocation committee that has proposed a re-allocation structure which, if approved, could increase the Company’s overall share of liability within the PRP group. In February 2011, a toxic tort litigation was commenced against Omega and OPOG in Los Angeles Superior Court by a group of employees of the Tri-Cities Regional Occupational Program located near the Omega Site. The plaintiffs claim, among other things, negligence, unlawful discharge of pollutants and public nuisance, and seek monetary damages for a variety of alleged injuries. In July 2011, OPOG agreed to secure a financial assurance of up to $12 million in connection with potential liability relating to the litigation. Given

 

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that the litigation is in its early phases, there is no estimate of total potential liability. Liability, if any, stemming from this litigation could flow through to the PRPs, most likely pursuant to the same allocation formulae used for the remediation costs. Although the Company considers a loss relating to the Omega Site probable, its share of any obligation for the remediation of the Omega Site is not currently believed to be material to the Company’s financial statements, based on the Company’s approximately 0.5% contribution to the total waste tonnage sent to the site and current estimates of the potential remediation costs. Based on currently available information, the Company has a loss accrual that is not material and believes that the actual amount of its costs will not be materially different from the amount accrued. However, proceedings are ongoing and the eventual outcome of the clean-up efforts and the pending litigation matters is uncertain at this time. Based on currently available information, the Company does not believe that any eventual outcome will have a material adverse effect on its operations.

AppliedMicro TPack A/S, the Company’s wholly-owned subsidiary acquired in September 2010 (“TPack”), is involved in a contractual dispute with Xtera Communications Inc. and its subsidiary Meriton Networks Canada Inc. (collectively, “Xtera”), regarding a software development and licensing agreement the parties entered into in September 2006. In August 2009, Xtera filed an action against TPack in the United States District Court for the Eastern Division of Texas. In October 2010, the action was dismissed for lack of jurisdiction. In September 2009, TPack filed an action against Xtera in the Ontario Superior Court of Justice in Canada, which action was resumed in March 2011 following dismissal of the Texas action. In the Canadian action, TPack seeks contract damages from Xtera of approximately $1.0 million plus pre-judgment interest and expenses. In April 2011, Xtera filed a statement of defense and counter claim with the Ontario court, in which Xtera denies liability to TPack and seeks reimbursement of approximately $1.7 million in development fees and royalties previously paid to TPack, plus pre-judgment interest and expenses. The Company does not currently anticipate that the TPack/Xtera legal proceedings will have a material adverse effect on TPack, the Company or their respective operations.

8. INCOME TAXES

The total amount of unrecognized tax benefits as of April 1, 2011, was $40.8 million, including interest and penalties. During the quarter ended June 30, 2011, additional unrecognized tax benefits of $38,000 were recorded. The Company does not foresee significant changes to its estimated amount of liability associated with its uncertain tax positions within the next twelve months.

The Company’s income tax expense consists of state taxes and foreign taxes. The federal statutory income tax rate was 35% for the three months ended June 30, 2011 and 2010. The Company’s income tax benefit for the three months ended June 30, 2011 was $0.2 million as compared to an income tax expense of $0.2 million during the three months ended June 30, 2010. The decrease in the income tax expense recorded for the three months ended June 30, 2011 compared to June 30, 2010, was primarily related to other comprehensive income. In applying the exception to the general principle of intra-period tax allocations under ASC 740-10, the Company considered income recognized in other comprehensive income. Accordingly, the allocation of the current year tax provision included recognizing 0.4 million tax benefit arising from the loss from continuing operations and the offsetting tax expense was allocated to other comprehensive income.

9. VELOCE

In November 2010, the Company and Veloce Technologies, Inc., a California corporation (“Veloce”), amended certain agreements, initially entered into in May 2009, pursuant to which Veloce has agreed to perform product development work for the Company on an exclusive basis for up to five years for cash and other consideration, including a warrant to purchase shares of the Company’s common stock, which will vest in quarterly increments through December 2012. A portion of the vested shares have been committed to be distributed to the employees of Veloce and will be settled in cash instead of common stock. Therefore, the Company has recognized stock-based compensation expense in R&D expense and recorded a corresponding liability for this distribution in the Company’s consolidated financial statements. The warrant was 38% vested as of June 30, 2011. In addition, Veloce has granted options to purchase shares of Veloce common stock pursuant to its own stock incentive plan. Stock-based compensation expense recognized in connection with this plan was not material and is included in R&D expense.

Under the amended merger agreement between the Company and Veloce, which has been approved by Veloce’s Board of Directors and stockholders, the Company agreed to acquire Veloce if certain performance milestones and delivery schedules set forth under the merger and other agreements are achieved. The Company also has the unilateral option to acquire Veloce in the event Veloce fails to meet the milestones and delivery schedules. Should the Company acquire Veloce pursuant to the merger agreement, the purchase price payable by the Company is estimated to be in the range of approximately $7 million up to approximately $135 million, subject to additional adjustments. The final price would be based upon the achievement and timing of multiple development and performance milestones. At this time the eventual outcome is not determinable and as such the Company is unable to provide a narrower range for the estimated merger consideration. The Company will update the range in the future when additional relevant information is available. The form of consideration used for the merger, cash or the Company’s stock, would be determined by the Company at the time of the merger. 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 set forth in the agreement. The amended agreements permit the Company to appoint two individuals to serve on Veloce’s Board of Directors and Board committees. The Company’s chief executive officer and another member of the Company’s Board of

 

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Directors have been appointed to Veloce’s Board of Directors. As of June 30, 2011, the performance milestones and delivery schedules set forth under the merger and other agreements are not considered probable of being achieved.

In addition, the Company has provided Veloce with a $1.5 million loan, to be forgiven over eight quarters beginning on March 31, 2011. If Veloce commits a material breach of the merger agreement, the outstanding principal amount of the promissory note evidencing the loan plus accrued interest is due to the Company. If the Company commits a material breach of the merger agreement, the outstanding principal amount of the note and accrued interest is to be forgiven by the Company. The $1.5 million promissory note is eliminated in consolidation. The Company’s previously agreed to loan of $5.0 million to Veloce was not issued and has been cancelled. Pursuant to the product development agreement, as amended, the Company will pay Veloce $2.3 million per quarter for up to twelve consecutive quarters in order to assist Veloce in meeting its expenses to perform its obligations under the agreement. In July 2011, the Company agreed to pay Veloce an additional $2.0 million over the next four quarters to cover certain increased expenses under the development agreement. These additional payments started in July 2011 and will end in the quarter ending June 30, 2012. The Company will recognize the payments as R&D expenses when such operating costs have been incurred by Veloce. During the three months ended June 30, 2011 and 2010, the Company recognized $3.3 million and $2.1 million, respectively, as R&D expense relating to Veloce. The Company also paid, and will likely do so again, certain product development and manufacturing expenses incurred by Veloce.

10. ACQUISITION OF TPACK A/S

In September 2010, the Company acquired all of the shares of TPack A/S, (“TPack”) a corporation organized under the laws of Denmark. The Company believes the acquisition of TPack (subsequently renamed AppliedMicro TPack A/S), a provider of silicon intellectual property for mapping and switching functions to leading telecom and networking equipment suppliers, will enable AppliedMicro to expand its presence and customer relationships in the rapidly growing OTN and Carrier Ethernet markets.

The total consideration paid at the closing of the transaction (the “Closing”) was approximately $32 million, exclusive of $0.5 million cash acquired. Approximately $5 million was withheld in escrow for indemnity agreements. 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 during the 18 month period following the Closing. The Company calculated and recorded the initial fair value of the contingent consideration liability based on a weighted probability assessment. The liability will continue to be measured at fair value at the end of each reporting period.

The Company has calculated the fair value of the tangible and intangible assets acquired to allocate the purchase price as of the acquisition date. The excess of purchase price over the aggregate fair values was recognized as goodwill. Based upon these calculations, the preliminary purchase price of the transaction was allocated as follows, and also includes the estimated amortization period of the acquired intangibles:

 

     Estimated
Useful Life
(In years)
     Purchase
price

(In  thousands)
 

Purchased intangible assets

     

Developed Technology

     6       $ 15,350   

Existing customer contracts

     5         4,000   

Partner relationship

     2         2,500   

Trademarks and tradenames

     3         650   

Covenants not-to-compete

     3         250   

In-process R&D

     —           950   

Goodwill (non tax deductible)

        13,183   

Contingent consideration (payable)

        (3,150

Net liabilities

      $ (1,699
           

Cash consideration

        32,034   

Contingent consideration

        3,150   
           

The total consideration issued in the acquisition

      $ 35,184   
           

The fair values of the TPack intangible assets were determined using the income approach with significant inputs that are not observable in the market. Key assumptions included expected future cash flows and discount rates consistent with the assessment of risk. Purchased intangible assets, including IPR&D, are amortized using a method that reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used, or if that pattern cannot be reliably determined, using a straight-line amortization method.

 

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The financial information in the table below summarizes the combined results of operations of the Company and TPack, on a proforma basis, as though the companies have been combined as of the beginning of the fiscal years of the periods presented. The proforma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place on April 1, 2010 or of results that may occur in the future.

 

     Three Months Ended
June 30,
 
     2011     2010  

Net revenues

   $ 60,844      $ 62,275   

Net loss

     (6,877     776   

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management’s discussion and analysis of financial condition and results of operations (“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 months ended June 30, 2011 and 2010. 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 condensed 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

Applied Micro Circuits Corporation (“AppliedMicro”, “APM”, “AMCC”, the “Company”, “we” or “our”) is a leader in semiconductor solutions for the 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 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 datacenter, enterprise and telecommunications applications. Our customer focus is on the OEMs and telecommunications companies that build and connect to datacenters. As of June 30, 2011, our business had two reporting units, Process and Transport.

Since the start of fiscal 2010, we have invested a total of $225.2 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 products, and other products to complete our portfolio of communications products. 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 these products before they enter into volume production. Accordingly, we have not yet generated significant revenues

 

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from some of the products developed during this time period. In addition, downturns in the telecommunications market can severely impact our customers’ business and usually results in significantly less demand for our products than was expected when the development work commenced.

The following tables present a summary of our results of operations for the three months ended June 30, 2011 and 2010 (dollars in thousands):

 

     Three Months Ended June 30,              
     2011     2010              
     Amount     % of Net
Revenue
    Amount     % of Net
Revenue
    Increase
(Decrease)
    %
Change
 

Net revenues

   $ 60,844        100.0   $ 60,810        100.0   $ 34        0.1

Cost of revenues

     26,331        43.3        22,485        37.0        3,846        17.1   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Gross profit

     34,513        56.7        38,325        63.0        (3,812     (9.9

Total operating expenses

     42,936        70.6        38,775        63.8        4,161        10.7   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Operating loss

     (8,423     (13.9     (450     (0.8     (7,973     (1,771.8

Interest and other income (expense), net

     1,356        2.3        2,081        3.5        (725     (34.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

(Loss) income before income taxes

     (7,067     (11.6     1,631        2.7        (8,698     (533.3

Income tax (benefit) expense

     (190     (0.3     240        0.4        (430     (179.2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Net (loss) income

   $ (6,877     (11.3 )%    $ 1,391        2.3   $ (8,268     (594.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

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 July 2008, we entered into a Patent Purchase Agreement (the “Agreement”) with QUALCOMM Incorporated (“Qualcomm”). Pursuant to the Agreement, 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. The purchase price was paid 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.

In November 2009, we also entered into another Patent Purchase Agreement with Acacia Patent Acquisition LLC (“APAC”). Pursuant to this Agreement, 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.

The occurrence of natural disasters in certain regions, such as the recent earthquake and tsunami in Japan, could negatively impact our manufacturing and supply chain, our ability to deliver products, on a timely basis or at all, to our customers, the cost of our products, and the demand for our products. The occurrence of natural disasters could also cause delays in our customers supply chain, causing them to delay their requirements for our products until they resolve shortages from their other suppliers. Any such occurrences of natural disasters could have a material adverse effect on our business, our results of operations and our financial condition.

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.

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;

 

   

the qualification, availability and pricing of competing products and technologies and the resulting effects on the sales, pricing and gross margins of our products.

 

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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 other 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 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 months ended June 30, 2011 and 2010 may not necessarily be indicative of future net revenue and results of operations.

Based on direct shipments, net revenues to customers that were equal to or greater than 10% of total net revenues were as follows (in thousands):

 

     Three Months Ended
June 30,
 
     2011     2010  

Wintec (global logistics provider) (1)

     21     *   

Avnet (distributor)

     14     33

Hon Hai (sub-contract manufacturer) (1)

     *        14

Flextronics (sub-contract manufacturer)

     19     *   

 

* 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):

 

     Three Months Ended June 30,  
     2011     2010  
     Amount      % of Net
Revenue
    Amount      % of Net
Revenue
 

United States of America (1)

   $ 26,065         42.8   $ 18,471         30.4

Taiwan (1)

     4,595         7.5        10,271         16.9   

Hong Kong (2)

     4,174         6.9        8,778         14.4   

China

     1,360         2.2        1,957         3.2   

Europe

     13,974         23.0        9,964         16.4   

Other Asia

     10,629         17.5        10,830         17.8   

Other

     47         0.1        539         0.9   
                                  
   $ 60,844         100.0   $ 60,810         100.0
                                  

 

(1) The change is primarily due to a major end customer changing its logistics management program.
(2) The higher revenues during the three months ended June 30, 2010 was due to the timing of inventory consumption by our end customers.

All of our revenues have been denominated in U.S. dollars.

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 (loss) income less interest income, income taxes, depreciation and amortization, stock-based compensation, amortization of intangibles and other

 

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one-time and/or non-cash items. The following table reconciles Adjusted EBITDA to the accompanying financial statements (in thousands):

 

     Three Months Ended
June 30,
 
     2011     2010  

Net (loss) income

   $ (6,877   $ 1,391   

Adjustment to net (loss) income:

    

Stock-based compensation expense

     4,178        3,846   

Amortization of purchased intangibles

     2,614        3,630   

Restructuring charges

     913        369   

Depreciation and amortization

     2,231        2,278   

Interest and other income, net

     (1,344     (1,173

Impairment of marketable securities*

     (12     (908

Other and income tax adjustment

     (190     240   
  

 

 

   

 

 

 

Adjusted EBITDA

   $ 1,513      $ 9,673   
  

 

 

   

 

 

 

 

* 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 RSU 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 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 and the effect of changing lead times on bookings. Our book-to-bill ratio at June 30, 2011 and 2010 was 0.8 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 restructuring liabilities, which affects the amount and timing of restructuring charges; 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

 

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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. Use of present value cash flow models to determine whether the entire amortized cost basis of the security will be recovered is expected. 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 than the amortized cost basis of the security. During the three months ended June 30, 2011 and fiscal year ended March 31, 2011, we did not record any other-than-temporary impairment charges. As of June 30, 2011, we did not record an impairment charge in connection with securities in a loss position (fair value less than carrying value) with unrealized losses of $1.1 million as we believe that such unrealized losses are temporary. In addition, we also had $7.2 million in unrealized gains.

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 June 30, 2011, reducing our future demand estimate to six months would decrease our current inventory valuation by approximately $1.6 million and increasing our future demand forecast to 18 months would not have any effect on our current inventory valuation.

Goodwill, Purchased Intangible Assets and Other Long-Lived Assets

The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, such as purchased technology. Goodwill and purchased intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. The values and useful lives assigned to other purchased intangible assets impact future amortization. Determining the fair values and useful lives of intangible assets requires the use of estimates and the exercise of judgment on factors such as expectations for the success and life cycle of products and technology acquired. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets acquired, we primarily use the discounted cash flow method and the market comparison approach. These methods require significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required such as residual growth rates and discount factors. The estimates we use to value and amortize intangible assets are consistent with the plans and estimates that we use to manage our business and are based on available historical information and industry estimates and averages. These judgments can significantly affect our net operating results.

 

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In accordance with ASC Topic 350-10 (“ASC 350-10”) as it relates to Goodwill and Other Intangible Assets, we perform our annual impairment review at the reporting unit level each fiscal year or more frequently if we believe indicators of impairment are present. We recently finalized the purchase price allocation for the TPack acquisition. ASC 350-10 requires that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques. Specifically, goodwill impairment is determined using a two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. Goodwill is allocated to reporting units based upon the type of products under development by the acquired company, which initially generated the goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. The fair value is determined using a combination of the discounted cash flow analysis and/or market comparisons. The determination of fair value requires significant judgment and estimates. We evaluate the useful lives of our intangible assets each reporting period to determine whether events and circumstances require revising the remaining period of amortization.

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 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 software.

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 three months ended June 30, 2011 and 2010, total mask costs of $1.3 million and $1.5 million were incurred and expensed as R&D expense because technological feasibility had not been achieved, respectively.

During the three months ended June 30, 2010, we made a correction resulting in the recognition of an asset totaling $1.2 million for unamortized mask costs incurred in prior periods as it was determined that these costs represented pre-production costs instead of

 

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R&D expenses. The unamortized costs will be amortized as cost of sales over a period of approximately three years. As part of this correction we recognized a reduction to R&D expenses of approximately $1.2 million. Amortization of these capitalized mask set costs that have been recognized as cost of sales during the three months ended June 30, 2011 and 2010 were approximately $0.1 million and $0.2 million, respectively. The net adjustments to make the correction to capitalize mask costs were not material to any periods affected.

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, for 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 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.

Restructuring Charges

Over the last several years we have undertaken significant restructuring initiatives, which have required us to develop formalized plans for exiting certain business activities and reducing spending levels. We have had to record estimated expenses for employee severance, long-term asset write downs, lease cancellations, facilities consolidation costs, and other restructuring costs. Given the significance, and the timing of the execution, of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made. Our assumptions for exiting certain facilities, such as estimating sublease incomes, may differ from actual outcomes, which could result in the need to record additional costs or reduce estimated amounts previously charged to restructuring expense. Our policies require us to periodically evaluate the adequacy of the remaining liabilities under our restructuring initiatives. During the three months ended June 30, 2011 and 2010, we recorded net restructuring charges of approximately $0.9 million and $0.4 million associated with our restructuring actions, respectively. As part of our ongoing cost reduction efforts, we could implement additional restructuring programs and may incur significant additional restructuring charges.

RESULTS OF OPERATIONS

Comparison of the Three Months Ended June 30, 2011 to the Three Months Ended June 30, 2010

Net Revenues. Net revenues for the three months ended June 30, 2011 was $60.8 million, representing an increase of 0.1% from net revenues of $60.8 million for the three months ended June 30, 2010. We classify our revenues into two categories based on the markets that the underlying products serve. The categories are Process and Transport. We use this information to analyze our performance and success in these markets. See the following tables (dollars in thousands):

 

     Three Months Ended June 30,     Increase
(Decrease)
    %
Change
 
     2011     2010      
     Amount      % of Net
Revenue
    Amount      % of Net
Revenue
     

Process

   $ 31,594         51.9   $ 29,483         48.5   $ 2,111        7.2

Transport

     29,250         48.1        31,327         51.5        (2,077     (6.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

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     Three Months Ended June 30,     Increase
(Decrease)
    %
Change
 
     2011     2010      
     Amount      % of Net
Revenue
    Amount      % of Net
Revenue
     
   $ 60,844         100.0   $ 60,810         100.0   $ 34        0.1
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

During the three months ended June 30, 2011, total revenues remained flat compared to the same period last year. Overall, our processor revenues grew by approximately 7.2% while our transport products declined by 6.6%. The increase in the processor revenues were new design wins while the decline in the transport revenues was due primarily to a decline in our licensing revenues as well as a drop off of our legacy transport products. We expect revenues for the three months ending September 30, 2011 to be approximately $64.5 million, plus or minus $2.0 million. This represents an increase of approximately 6%, compared to the revenues for the three months ended June 30, 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 three months ended June 30, 2010 and 2009 (dollars in thousands):

 

 

     Three Months Ended June 30,     Increase
(Decrease)
    %
Change
 
     2011     2010      
     Amount      % of Net
Revenue
    Amount      % of Net
Revenue
     

Net revenues

   $ 60,844         100.0   $ 60,810         100.0   $ 34        0.1

Cost of revenues

     26,331         43.3        22,485         37.0        3,846        17.1   
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   
   $ 34,513         56.7   $ 38,325         63.0   $ (3,812     (9.9 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

The gross margin for the three months ended June 30, 2011 was to 57.0%, compared to 63.0% for the three months ended June 30, 2010. The decrease in our gross margin for the three months ended June 30, 2011 was primarily due to an unfavorable product mix of increased Process revenues which has lower gross margins and lower licensing revenues.

The amortization of purchased intangible assets included in cost of revenues during the three months ended June 30, 2011 was $1.5 million, compared to $2.6 million for the three months ended June 30, 2010. The acquisition of TPack has increased our amortization of purchased intangible assets included in cost of revenues by approximately $0.6 million per quarter. The increased 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 expenses for the three months ended June 30, 2011 and 2010 (dollars in thousands):

 

     Three Months Ended June 30,     Increase      %
Change
 
     2011     2010       
     Amount      % of Net
Revenue
    Amount      % of Net
Revenue
      

Research and development

   $ 28,368         46.6   $ 25,777         42.4   $ 2,591         10.1

Selling, general and administrative

   $ 12,556         20.6   $ 11,624         19.1   $ 932         8.0

Research and Development. 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 10.1% for the three months ended June 30, 2011, compared to the three months ended June 30, 2010 was primarily due to an increase of $1.3 million in personnel costs primarily related to TPack and Veloce, our variable interest entity, $0.6 million in contractor costs, $0.5 consumable equipment and software cost and $0.2 million in stock-based compensation charges. 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. 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

 

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increase in SG&A expenses of 8.0% for the three months ended June 30, 2011 compared to the three months ended June 30, 2010 was primarily due to an increase of $0.4 million in professional service fees, $0.2 million in personnel cost, $0.2 million in travel expense and $0.2 million in indirect materials and services. 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 three months ended June 30, 2011 and 2010, which was included in the tables above (dollars in thousands):

 

     Three Months Ended June 30,     Increase
(Decrease)
    %
Change
 
     2011     2010      
     Amount      % of Net
Revenue
    Amount      % of Net
Revenue
     

Costs of revenues

   $ 111         0.2   $ 153         0.3   $ (42     (27.5 )% 

Research and development

     2,388         3.9        1,971         3.2        417        21.2   

Selling, general and administrative

     1,679         2.8        1,722         2.8        (43     (2.5
                                            
   $ 4,178         6.9   $ 3,846         6.3   $ 332        8.6
                                            

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 June 30, 2011 is $21.2 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 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. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 2.6 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. The restructuring charges recorded during the three months ended June 30, 2011 and 2010 was primarily for employee severances. During the three months ended June 30, 2011, 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 includes 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 expect to record additional charges of approximately $0.1 million for employee severances during the remainder of the fiscal year related to the April 2011 restructuring program. 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 3 of the Notes to Consolidated Financial Statements.

Interest and Other Income (Expense), net. The following table presents interest and other income (expense), net for the three months ended June 30, 2011 and 2010 (dollars in thousands):

 

     Three Months Ended June 30,     Decrease     %
Change
 
     2011     2010      
     Amount      % of Net
Revenue
    Amount      % of Net
Revenue
     

Interest income (expense), net

   $ 1,281         3.1   $ 1,915         3.1   $ (634     (33.1 )% 

Other income (expense), net

   $ 75         0.1   $ 166         0.3   $ (91     (54.8 )% 

Interest Income (Expense), 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 three months ended June 30, 2011, compared to the three months ended June 30, 2010 was primarily due to our lower cash, cash equivalents and short-term investments available-for-sale balances.

 

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Income Taxes. The federal statutory income tax rate was 35% for the fiscal three months ended June 30, 2011 and 2010. The decrease in the income tax expense recorded for the three months ended June 30, 2011 compared to June 30, 2010, was primarily related to other comprehensive income. The allocation of the current year tax provision included recognizing 0.4 million tax benefit arising from the loss from continuing operations and the offsetting tax expense was allocated to other comprehensive income.

FINANCIAL CONDITION AND LIQUIDITY

As of June 30, 2011, our principal source of liquidity consisted of $141.9 million in cash, cash equivalents and short-term investments. Working capital as of June 30, 2011 was $164.8 million. Total cash, cash equivalents, and short-term investments decreased by $26.2 million during the three months ended June 30, 2011, primarily due to funding of our structured stock repurchase agreements for $10.0 million, purchase of property and equipment of $4.5 million, cash used for operations of $4.2 million, the repurchases of our common stock for $3.1 million, a strategic investment of $2.5 million, the funding of restricted stock units withheld for taxes of $2.2 million and the funding of a note receivable for $1.0 million. At June 30, 2011, we had contractual obligations not included on our balance sheet totaling $43.6 million, primarily related to facility leases, engineering design software tool licenses and non-cancelable inventory purchase commitments.

For the three months ended June 30, 2011, we used $4.2 million of cash in our operations compared to generating $11.2 million for the three months ended June 30, 2010. Our net loss of $6.9 million for the three months ended June 30, 2011 included $8.2 million of non-cash charges consisting of $1.8 million of depreciation, $2.6 million of amortization of purchased intangibles and $4.2 million of stock-based compensation, offset by $0.4 million in tax expense primarily attributable to unrealized gains included in other comprehensive income. Our net income of $1.4 million for the three months ended June 30, 2010 included $8.2 million of non-cash charges consisting of $1.9 million of depreciation, $3.6 million of amortization of purchased intangibles, $3.9 million of stock-based compensation and a credit of $1.2 million related to the capitalization of mask set costs. The remaining change in operating cash flows for the three months ended June 30, 2011 primarily reflected increases in accounts receivable, inventories, other current assets, accrued payroll and related expenses, and other accrued liabilities and decreases in accounts payable and deferred revenue. Our overall days sales outstanding was 37 days and 32 days for the three months ended June 30, 2011 and March 31, 2011, respectively.

We used $24.0 million in cash from our investing activities during the three months ended June 30, 2011, compared to using $67.4 million during the three months ended June 30, 2010. During the three months ended June 30, 2011, we used $16.0 million for short-term investment activities, $4.5 million for the purchase of property and equipment, $2.5 million for purchase of strategic investment and $1.0 million in funding of a note receivable. During the three months ended June 30, 2010, we used $70.9 million for

short-term investment activities and $1.5 million for the purchase of property and equipment offset by proceeds of $5.0 million from the sale of a strategic equity investment.

We used $14.8 million in cash for our financing activities during the three months ended June 30, 2011, compared to using $0.3 million during the three months ended June 30, 2010. The major financing use of cash for the three months ended June 30, 2011 was the funding of our structured stock repurchase agreements for $10.0 million, $3.1 million for the repurchase of common stock and restricted stock units withheld for taxes of $2.2 million, offset by proceeds from the issuance of common stock of $0.6 million. The major financing use of cash for the three months ended June 30, 2010 was the funding of our structured stock repurchase agreements for $10.0 million, restricted stock units withheld for taxes of $2.1 million, offset by proceeds of $10.3 million from the settlement of structured stock repurchase agreements and the proceeds from issuance of common stock of $1.5 million.

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 three months ended June 30, 2011, 0.3 million shares were repurchased on the open market at a weighted average price of $9.98 per share. During the three months ended June 30, 2010, no shares were repurchased on the open market. All repurchased shares were retired upon delivery to us.

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.

 

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During the three month ended June 30, 2011 and 2010, we entered into structured stock repurchase agreements totaling $10.0 million during each period. No structured stock repurchase agreements settled during the three months ended June 30, 2011. For those structured stock repurchase agreements that settled during the three months ended June 30, 2010, we received $10.3 million in cash. At June 30, 2011, we had one outstanding structured stock repurchase agreement, which subsequently settled in July 2011 for 1.0 million in shares of our common stock at an effective purchase price of $9.74 per share.

On November 8, 2010, we amended the merger and certain other agreements with Veloce, initially entered into on May 17, 2009, pursuant to which Veloce has agreed to perform product development work for us on an exclusive basis for up to five years for cash and other consideration, including a warrant to purchase shares of our common stock, which will vest quarterly through December 2012.

Under the merger agreement between us and Veloce, we agreed to acquire Veloce if certain performance milestones and delivery schedules set forth under the merger and other agreements are achieved. We also have the unilateral option to acquire Veloce in the event Veloce fails to meet the milestones and delivery schedules. Should we acquire Veloce pursuant to the merger agreement, the purchase price is estimated to be in the range of approximately $7 million up to approximately $135 million, subject to adjustments. At this time the eventual outcome is not determinable and as such we are unable to provide a narrower range for the estimated merger consideration. We will update the range in the future when additional relevant information is available. We will determine the form of consideration used for the merger, cash or our stock, at the time of the merger. The merger agreement contains customary representations, warranties and covenants and may be terminated upon mutual agreement of the parties or unilaterally by us or Veloce if the other party fails to meet certain conditions set forth in the agreement.

In addition, we provided Veloce a promissory note of $1.5 million to be forgiven over eight quarters starting on March 31, 2011. If Veloce commits a material breach of the merger agreement, the outstanding principal amount of the note and accrued interest is due to us. If we commit a material breach of the merger agreement, the outstanding principal amount of the note and accrued interest is to be forgiven by us. The promissory note is eliminated in consolidation. The previously agreed to loan of $5.0 million to Veloce was not issued and has been cancelled. Pursuant to the product development agreement, as amended, we will pay Veloce $2.3 million per quarter for up to twelve consecutive quarters in order to assist Veloce in meeting its expenses to perform its obligations under the agreement. In July 2011, we agreed to pay Veloce an additional $2.0 million over the next four quarters to cover certain increased expenses under the development agreement. These additional payments started in July 2011 and will end in the quarter ending June 30, 2012.We will recognize the payments as R&D expenses when incurred. We have no direct equity interest in Veloce. We also paid, and will likely do so again, certain product development and manufacturing expenses incurred by Veloce.

On September 17, 2010, we acquired TPack, a Danish 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. Approximately $5 million was placed in escrow to secure the indemnification obligation of TPack. In addition, we recorded acquisition related transaction costs of $0.9 million, which were included in SG&A expense.

In July 2010, we entered into an agreement for a multi-year license with a leading semiconductor IP supplier, where the components of the licensed technology are expected to be delivered over multiple years. We do not regard the license as significant to our current business. We intend to use the license to develop new products. The aggregate licensing fees are approximately $18.1 million and are payable over five years.

The following table summarizes our contractual operating leases and other purchase commitments as of June 30, 2011 (in thousands):

 

     Operating
Leases
     Other
Purchase
Commitments
     Total  

Fiscal Years Ending March 31, 2012

   $ 11,939       $ 30,942       $ 42,881   

2013

     650         —           650   

2014

     95         —           95   

2015 and thereafter

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total minimum payments

   $ 12,684       $ 30,942       $ 43,626   
  

 

 

    

 

 

    

 

 

 

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements as at June 30, 2011.

 

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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.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and a decline in the stock market. We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are classified as available-for-sale and, consequently, are recorded on our consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income or loss. We have established guidelines relative to diversification and maturities that attempt to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of interest rate trends. We invest our excess cash in debt instruments of the U.S. Treasury, corporate bonds, mortgage-backed and asset backed securities, mutual funds and closed-end bond funds, with credit ratings as specified in our investment policy. We also have invested in preferred stocks, which pay quarterly fixed rate dividends. We generally do not utilize derivatives to hedge against increases in interest rates which decrease market values.

We are exposed to market risk as it relates to changes in the market value of our investments. At June 30, 2011, our investment portfolio included short-term securities classified as available-for-sale investments with an aggregate fair market value of $100.5 million and a cost basis of $94.3 million. These securities are subject to interest rate risk, as well as credit risk and liquidity risk, and will decline in value if interest rates increase or an issuer’s credit rating or financial condition is decreased.

The following table presents the hypothetical changes in fair value of our short-term investments held at June 30, 2011 (in thousands):

 

     Valuation of Securities Given an
Interest Rate Decrease of X Basis
Points (“BPS”)
     Fair Value
as of
June 30, 2011
     Valuation of Securities Given an
Interest Rate Increase of X Basis
Points (“BPS”)
 
     (150 BPS)      (100 BPS)      (50 BPS)         50 BPS      100 BPS      150 BPS  

Available-for-sale investments

   $ 104,221       $ 102,980       $ 101,765       $ 100,456       $ 99,149       $ 97,947       $ 96,808   
                                                              

The modeling technique used measures the change in fair market value arising from selected potential changes in interest rates. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points, 100 basis points, and 150 basis points. While this modeling technique provides a measure of our exposure to market risk, the current economic turbulence could cause interest rates to shift by more than 150 basis points.

We also invest in equity instruments of private companies for business and strategic purposes. These investments are valued based on our historical cost, less any recognized impairments. The estimated fair values are not necessarily representative of the amounts that we could realize in a current transaction.

We generally conduct business, including sales to foreign customers, in U.S. dollars, and as a result, we have limited foreign currency exchange rate risk. We did not enter into any forward currency exchange contract during the three months year ended June 30, 2011. Gains and losses on foreign currency forward contracts that are designated and effective as hedges of anticipated transactions, for which a firm commitment has been attained, are deferred and included in the basis of the transaction in the same period that the underlying transaction is settled. Gains and losses on any instruments not meeting the above criteria are recognized in income or expenses in the consolidated statements of operations in the current period.

 

ITEM 4. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit with the SEC pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In addition, the design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future

 

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conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

As required by Exchange Act Rule 13a-15(b), we conducted an evaluation, under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2011. Based on the foregoing, our CEO and CFO concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The information set forth under Note 7 of Notes to Consolidated Financial Statements, included in Part I, Item 1 of this report, is incorporated herein by reference.

 

ITEM 1A. RISK FACTORS

Before deciding to invest in us or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC. We update our descriptions of the risks and uncertainties facing us in our periodic reports filed with the SEC. The risks and uncertainties described below and in our other filings are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment. The risks and uncertainties set forth below with an asterisk (“*”) next to the title contain changes to the description of the risks and uncertainties associated with our business as previously disclosed in Item 1A to our Annual Report on Form 10-K for the fiscal year ended March 31, 2011 filed with the SEC on May 10, 2011.

*If we are unable to timely develop new products or new generations and versions of our existing products to replace our current products, our operating results and competitive position will be materially harmed.

Our industry is characterized by intense competition, rapidly evolving technology and continually changing customer requirements. These factors could render our existing products obsolete. Accordingly, our ability to compete in the future will depend in large part on our ability to identify and develop new products or new generations and versions of our existing products that achieve market acceptance on a timely and cost-effective basis, and to respond to changing requirements. If we are unable to do so, our business, operating results and financial condition will be negatively affected.

The successful development and market acceptance of our products depend on a number of factors, including, but not limited to:

 

   

our accurate prediction of changing customer requirements;

 

   

timely development of new designs;

 

   

timely qualification and certification of our products for use in electronic systems;

 

   

commercial acceptance and production of the electronic systems into which our products are incorporated;

 

   

availability, quality, price, performance, and size of our products relative to competing products and technologies;

 

   

our customer service and support capabilities and responsiveness;

 

   

successful development of relationships with existing and potential new customers;

 

   

successful development of relationships with key developers of advanced digital semiconductors;

 

   

changes in technology and industry standards; and

 

   

rapidly changing consumer preferences.

In addition, in November 2010, we amended certain agreements with Veloce, initially entered into in May 2009, pursuant to which Veloce agreed to perform product development work for us on an exclusive basis for up to five years for cash and other consideration, including a warrant to purchase shares of our common stock, which will vest quarterly through December 2012. A portion of the vested shares have been committed to be distributed to the employees of Veloce and will be settled in cash instead of

 

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common stock. Therefore, we have recognized stock-based compensation expense in R&D expense and recorded a corresponding liability for this distribution in our consolidated financial statements. Under the merger agreement with Veloce, as amended, we agreed to acquire Veloce if certain performance milestones and delivery schedules set forth under the merger and other agreements are achieved. We also have the unilateral option to acquire Veloce in the event Veloce fails to meet the milestones and delivery schedules. Should we acquire Veloce pursuant to the merger agreement, the purchase price is estimated to be in the range of approximately $7 million up to approximately $135 million, subject to adjustments. At this time the eventual outcome is not determinable and as such we are unable to provide a narrower range for the estimated merger consideration. We will update the range in the future when additional relevant information is available. We also provided Veloce a $1.5 million loan to be forgiven in equal installments over eight quarters starting on March 31, 2011. The previously agreed to loan of $5.0 million to Veloce was not issued and has been cancelled. We will also pay Veloce $2.3 million per quarter for up to twelve consecutive quarters in order to assist Veloce in meeting its expenses to perform its obligations under the agreement. In July 2011, we agreed to pay Veloce an additional $2.0 million over the next four quarters to cover certain increased expenses under the development agreement. These additional payments started in July 2011 and will end in the quarter ending June 30, 2012. These amounts have increased in the past and may change again in the future. We also paid, and will likely do so again, certain product development and manufacturing expenses incurred by Veloce.

Our arrangement with Veloce may not result in the development of any new technologies or products. Moreover, products we have recently developed and which we are currently developing may not achieve market acceptance. If these products fail to achieve market acceptance, or if we fail to timely develop new products that achieve market acceptance, our business, financial condition and operating results will be materially and adversely affected.

*We face intense competition and price pressure.

The semiconductor industry is intensely competitive. We expect competition to continue to increase as our industry and our competitors evolves and develop.

Many of our competitors have longer operating histories and presences in key markets, greater name recognition, larger customer bases, and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do, and in some cases operate their own fabrication facilities. These competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources to the promotion and sale of their products. We also face competition from newly established competitors, suppliers of products, and customers who choose to develop their own semiconductor solutions.

Existing or new competitors may develop technologies that more effectively address our markets with products that offer enhanced features and functionality, lower power requirements, greater levels of integration or lower cost. Increased competition also has resulted in and is likely to continue to result in increased expenditures on research and development, declining average selling prices, reduced gross margins and loss of market share in certain markets. These factors in turn create increased pressure to consolidate. We cannot assure you that we will be able to continue to compete successfully against current or new competitors. If we do not compete successfully, we may lose market share in our existing markets and our revenues may fail to increase or may decline.

We and our customers face intense price pressure from competition from companies in lower cost countries like China. This could cause our customers and us to not be competitive and lose significant revenues. Furthermore, our discrete legacy products are being and could continue to be integrated into ASIC’s that could cause our revenues to decline at faster rate.

*Our dependence on third-party manufacturing and supply relationships increases the risk that we will not have an adequate supply of products to meet demand or that our cost of materials will be higher than expected.

We depend upon third parties to manufacture, assemble, package or test certain of our products. As a result, we are subject to risks associated with these third parties, including:

 

   

reduced control over delivery schedules and quality;

 

   

inadequate manufacturing yields and excessive costs;

 

   

ability to attract and retain key personnel and to maintain knowledge base;

 

   

difficulties selecting and integrating new subcontractors;

 

   

potential lack of adequate capacity at the foundry during periods of excess demand, resulting in significant increases in lead-time requirements and production delays;

 

   

increased risk of excess and obsolete inventory charges due to the higher level of inventories in response to the increased lead-times;

 

   

limited warranties on products supplied to us;

 

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potential increases in prices;

 

   

potential instability and business disruption in countries where third-party manufacturers are located; and

 

   

potential misappropriation of our intellectual property.

Our outside foundries generally manufacture our products on a purchase order basis, and we have few long-term supply arrangements with these suppliers. We have less control over delivery schedules, manufacturing yields and costs than competitors with their own fabrication facilities. A manufacturing disruption or capacity constraint experienced by one or more of our outside foundries or a disruption of our relationship with an outside foundry, including discontinuance of our products by that foundry, would negatively impact the production of certain of our products for a substantial period of time.

As our third-party manufacturing suppliers extend their lead time requirements, we will likely need to also extend our lead time requirements to our customers. This could cause our customers to lower their competitive assessment of us as a supplier and, as a result, we may not be considered for future design awards.

Our IC products are generally only qualified for production at a single foundry. These suppliers can allocate, and in the past have allocated, capacity to the production of other companies’ products while reducing deliveries to us on short notice. There is also the potential that they may discontinue manufacturing our products or go out of business. Because establishing relationships, designing or redesigning ICs, and ramping production with new outside foundries may take over a year, there is no readily available alternative source of supply for these products.

Difficulties associated with adapting our technology and product design to the proprietary process technology and design rules of outside foundries can lead to reduced yields of our IC products. The process technology of an outside foundry is typically proprietary to the manufacturer. Since low yields may result from either design or process technology failures, yield problems may not be effectively determined or resolved until an actual product exists that can be analyzed and tested to identify process sensitivities relating to the design rules that are used. As a result, yield problems may not be identified until well into the production process, and resolution of yield problems may require cooperation between us and our manufacturer. This risk could be compounded by the offshore location of certain of our manufacturers, increasing the effort and time required to identify, communicate and resolve manufacturing yield problems. Manufacturing defects that we do not discover during the manufacturing or testing process may lead to costly product recalls. These risks may lead to increased costs or delayed product delivery, which would harm our profitability and customer relationships.

If the foundries or subcontractors we use to manufacture our products discontinue the manufacturing processes needed to meet our demands, or fail to upgrade their technologies needed to manufacture our products, we may be unable to deliver products to our customers, which could materially adversely affect our operating results and harm our reputation. The transition to the next generation of manufacturing technologies at one or more of our outside foundries could be unsuccessful or delayed.

Our requirements typically represent a very small portion of the total production of the third-party foundries. As a result, we are subject to the risk that a producer will cease production of an older or lower-volume process that it uses to produce our parts. We cannot assure you that our external foundries will continue to devote resources to the production of parts for our products or continue to advance the process design technologies on which the manufacturing of our products are based. Each of these events could increase our costs, lower our gross margin, cause us to hold more inventories or materially impact our ability to deliver our products on time. As our volumes decrease with any third-party foundry, the likelihood of unfavorable pricing increases.

Some companies that supply our customers are similarly dependent on a limited number of suppliers to produce their products. These other companies’ products may be designed into the same networking equipment into which our products are designed. Our order levels could be reduced materially if these companies are unable to access sufficient production capacity to produce in volumes demanded by our customers because our customers may be forced to slow down or halt production on the equipment into which our products are designed.

Natural disasters in certain regions, such as Japan, could adversely affect our manufacturing and supply chain which, in turn, could have a material adverse effect on our business, our results of operations and our financial condition.

The occurrence of natural disasters in certain regions, such as the recent earthquake and tsunami in Japan, could negatively impact our manufacturing and supply chain, our ability to deliver products, on a timely basis or at all, to our customers, the cost of our products, and the demand for our products. The occurrence of natural disasters could also cause delays in our customers supply chain, causing them to delay their requirements for our products until they resolve shortages from their other suppliers. Any such occurrences of natural disasters could have a material adverse effect on our business, our results of operations and our financial condition.

 

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We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration and, as a result, may experience reduced manufacturing yields, delays in product deliveries and increased expenses.

As smaller line width geometry processes become more prevalent, we expect to integrate greater levels of functionality into our IC products and to transition our IC products to increasingly smaller geometries. This transition will require us to redesign certain products and will require us and our foundries to migrate to new manufacturing processes for our products.

We may not be able to achieve higher levels of design integration or deliver new integrated products on a timely basis. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs and increase performance, and we have designed IC products to be manufactured at as little as .04 micron geometry processes. We have experienced some difficulties in shifting to smaller geometry process technologies and new manufacturing processes. These difficulties resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. The transition to smaller geometries is inherently more expensive and as we manufacture more products using smaller geometries, the incremental costs could have an adverse impact on our earnings. We may face similar difficulties, delays and expenses as we continue to transition our IC products to smaller geometry processes. We are dependent on our relationships with our foundries to transition to smaller geometry processes successfully. We cannot assure you that our foundries will be able to effectively manage the transition or that we will be able to maintain our relationships with our foundries. If we or our foundries experience significant delays in this transition or fail to implement this transition, our business, financial condition and results of operations could be materially and adversely affected.

The gross margins for our products could decrease rapidly or not increase as forecasted, which will negatively impact our business, financial conditions and results of operations.

The gross margins for our solutions have historically declined over time. Factors that we expect to cause downward pressure on the gross margins for our products include competitive pricing pressures, the cost sensitivity of our customers, particularly in the higher-volume markets, new product introductions by us or our competitors, and other factors. 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. If the gross margins for our products decline or not increase as anticipated and we are unable to offset those reductions, our business, financial condition and results of operations will be materially and adversely affected.

*The current economic circumstances and uncertain political conditions could harm our revenues, operating results and financial condition.

The economies of the United States and other developed or developing countries appear to be currently coming out of a recession. We cannot predict either if this economic recovery will continue or reverse course.

The recent recession has caused a decline in our near term revenues and it will take some time for our near-term revenues to return to our previous levels. Our current operating plans are based on assumptions concerning levels of consumer and corporate spending. If weak global and domestic economic and market conditions persist or deteriorate, we may experience further material impacts on our business, operating results and financial condition which could result in a decline in the price of our common stock. If economic conditions worsen, we may have to implement additional cost reduction measures or delay certain R&D spending, which may adversely impact our ability to introduce new products and technologies.

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are generally classified as available-for-sale and, consequently, are recorded on our consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss). Our portfolio primarily includes fixed income securities, mutual funds and preferred stock, the values of which are subject to market price volatility. The deterioration of these market prices has had an unfavorable impact on our portfolio and has caused us to record impairment charges to our earnings. During the fiscal year ended March 31, 2010 we recorded other-than-temporary impairment charges of $4.1 million. If market prices continue to decline or securities continue to be in a loss position over time, we may recognize additional impairments in the fair value of our investments.

Adverse economic and market conditions could also harm our business by negatively affecting the parties with whom we do business, including our business partners, our customers and our suppliers. These conditions could impair the ability of our customers to pay for products they have purchased from us. As a result, allowances for doubtful accounts and write-offs of accounts receivable from our customers may increase. In addition, our suppliers may experience financial difficulties that could negatively affect their operations and their ability to supply us with the parts we need to manufacture our products.

We have invested in privately-held companies, many of which can still be considered in startup or developmental stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early

 

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stages and may never materialize. We could lose all or substantially all of the value of our investments in these companies and, in some cases, we have lost all or substantially all of the value of our investment in such entities.

Our operating results may fluctuate because of a number of factors, many of which are beyond our control.

If our operating results are below the expectations of research analysts or investors, then the market price of our common stock could decline. Some of the factors that affect our quarterly and annual results, but which are difficult to control or predict, are:

 

   

communications, information technology and semiconductor industry conditions;

 

   

fluctuations in the timing and amount of customer requests for product shipments;

 

   

the reduction, rescheduling or cancellation of orders by customers, including as a result of slowing demand for our products or our customers’ products or over-ordering or double booking of our products or our customers’ products;

 

   

changes in the mix of products that our customers buy;

 

   

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 ability to introduce, certify and deliver new products and technologies on a timely basis;

 

   

the announcement or introduction of new products and technologies by our competitors;

 

   

competitive pressures on selling prices;

 

   

the ability of our customers to obtain components from their other suppliers;

 

   

market acceptance of our products and our customers’ products;

 

   

fluctuations in manufacturing output, yields or other problems or delays in the fabrication, assembly, testing or delivery of our products or our customers’ products;

 

   

disasters that could effect our supply chain or our customers supply chain;

 

   

increases in the costs of products or discontinuance of products by our suppliers;

 

   

the availability of external foundry capacity, contract manufacturing services, purchased parts and raw materials including packaging substrates;

 

   

the availability of package and test vendor capacity;

 

   

problems or delays that we and our foundries may face in shifting the design and manufacture of our future generations of IC products to smaller geometry process technologies and in achieving higher levels of design and device integration;

 

   

the timing of meeting the specifications and expense recovery on non-recurring engineering projects;

 

   

the amounts and timing of costs associated with warranties and product returns;

 

   

the amounts and timing of investments in R&D;

 

   

the product lifecycle and recoverability of capitalized architectural licenses, technology access fees and mask sets;

 

   

the amounts and timing of the costs associated with payroll taxes related to stock option exercises or settlement of restricted stock units;

 

   

costs associated with acquisitions and the integration of acquired companies, products and technologies;

 

   

the impact of potential one-time charges related to purchased intangibles;

 

   

our ability to successfully integrate acquired companies, products and technologies;

 

   

the impact on interest income of a significant use of our cash for an acquisition, stock repurchase or other purpose;

 

   

the effects of changes in interest rates or credit worthiness on the value and yield of our short-term investment portfolio;

 

   

costs associated with compliance with applicable environmental, other governmental or industry regulations including costs to redesign products to comply with those regulations or lost revenue due to failure to comply in a timely manner;

 

   

the effects of changes in accounting standards;

 

   

costs associated with litigation, including without limitation, attorney fees, litigation judgments or settlements, relating to the use or ownership of intellectual property or other claims arising out of our operations;

 

   

our ability to identify, hire and retain senior management and other key personnel;

 

   

the effects of war, acts of terrorism or global threats, such as disruptions in general economic activity and changes in logistics and security arrangements; and

 

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global economic and industry conditions.

Our business, financial condition and operating results would be harmed if we do not achieve anticipated revenues.

We can have revenue shortfalls for a variety of reasons, including:

 

   

shortages of raw materials or production capacity constraints that lead our suppliers to allocate available supplies or capacity to their other customers, which may disrupt our ability to meet our production obligations;

 

   

our customers may experience shortages from their suppliers that may cause them to delay orders or deliveries of our products;

 

   

delays in the availability of our products or our customers’ products;

 

   

the reduction, rescheduling or cancellation of customer orders;

 

   

declines in the average selling prices of our products;

 

   

delays when our customers are transitioning from old products to new products;

 

   

a decrease in demand for our products or our customers’ products;

 

   

a decline in the financial condition or liquidity of our customers or their customers;

 

   

the failure of our products to be qualified in our customers’ systems or certified by our customers;

 

   

excess inventory of our products held by our customers, resulting in a reduction in their order patterns as they work through the excess inventory of our products;

 

   

fabrication, test, product yield, or assembly constraints for our products that adversely affect our ability to meet our production obligations;

 

   

the failure of one or more of our subcontract manufacturers to perform its obligations to us;

 

   

our failure to successfully integrate acquired companies, products and technologies; and

 

   

global economic and industry conditions.

Our business is characterized by short-term orders and shipment schedules. Customer orders typically can be cancelled or rescheduled without significant penalty to the customer. Because we do not have substantial non-cancellable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. Customer orders for our products typically have non-standard lead times, which make it difficult for us to predict revenues and plan inventory levels and production schedules. If we are unable to plan inventory levels and production schedules effectively, our business, financial condition and operating results could be materially and adversely affected.

From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside contract manufacturers, suppliers and foundries, we may order materials in advance of anticipated customer demand. This advance ordering has in the past and may in the future result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize, or other factors render our products less marketable. If we are forced to hold excess inventory or we incur unanticipated inventory write-downs, our financial condition and operating results could be materially and adversely affected.

Our expense levels are relatively fixed in the short-term and are based on our expectations of future revenues. We have limited ability to reduce expenses quickly in response to any revenue shortfalls. Changes to production volumes and impact of overhead absorption may result in a decline in our financial condition or liquidity.

Our business substantially depends upon the continued growth of the technology sector and the Internet.

The technology equipment industry is cyclical and has in the past experienced significant and extended downturns. The recent downturn was significant and we cannot predict if the current improvement is sustainable in the near future. A substantial portion of our business and revenue depends on the continued growth of the technology sector and the Internet. We sell our communications IC products primarily to communications equipment manufacturers that in turn sell their equipment to customers that depend on the growth of the Internet. The past downturn has caused a reduction in capital spending on information technology. While we are beginning to see indications of improvement, there are no guarantees that this growth will sustain, resulting in potential volatility. If there is another downturn, our business, operating results and financial condition may be materially and adversely affected.

The loss of one or more key customers, the diminished demand for our products from a key customer, or the failure to obtain certifications from a key customer or its distribution channel could significantly reduce our revenues and profits.

A relatively small number of customers have accounted for a significant portion of our revenues in any particular period. We have no long-term volume purchase commitments from our key customers. One or more of our key customers may discontinue

 

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operations as a result of consolidation, bankruptcy or otherwise. Reductions, delays and cancellation of orders from our key customers or the loss of one or more key customers could significantly reduce our revenues and profits. We cannot assure you that our current customers will continue to place orders with us, that orders by existing customers will continue at current or historical levels or that we will be able to obtain orders from new customers.

Our ability to maintain or increase sales to key customers and attract significant new customers is subject to a variety of factors, including:

 

   

supply constraints and manufacturing delays by our outside foundries may result in significantly reduced volumes and delayed deliveries of our products;

 

   

customers may stop incorporating our products into their own products with limited notice to us and may suffer little or no penalty as a result of such action;

 

   

customers or prospective customers may not incorporate our products into their future product designs;

 

   

design wins (as explained below) with customers or prospective customers may not result in sales to such customers;

 

   

the introduction of new products by customers may occur later or be less successful in the market than planned;

 

   

we may successfully design a product to customer specifications but the customer may not be successful in the market;

 

   

sales of customer product lines incorporating our products may rapidly decline or such product lines may be phased out;

 

   

our agreements with customers typically are non-exclusive and do not require them to purchase a minimum quantity of our products;

 

   

many of our customers have pre-existing relationships with our current or potential competitors that may cause our customers to switch from using our products to using competing products;

 

   

some of our OEM customers may develop products internally that would replace our products;

 

   

we may not be able to successfully develop relationships with additional network equipment vendors;

 

   

our relationships with some of our larger customers may deter other potential customers (who compete with these customers) from buying our products;

 

   

the impact of terminating certain sales representatives or sales personnel as a result of a Company workforce reduction or otherwise; and

 

   

some of our customers and prospective customers may become less viable or fail.

The occurrence of any one of the factors above could have a material adverse effect on our business, financial condition and results of operations.

There is no guarantee that design wins will become actual orders and sales.

A “design win” occurs when a customer or prospective customer notifies us that our product has been selected to be integrated with the customer’s product. There can be delays of several months or more between the design win and when a customer initiates actual orders of our product. Following a design win, we will commit significant resources to the integration of our product into the customer’s product before receiving the initial order. Receipt of an initial order from a customer following a design win, however, is dependent on a number of factors, including the success of the customer’s product, and cannot be guaranteed. The design win may never result in an actual order or sale.

*Any significant order cancellations or order deferrals could cause unplanned inventory growth resulting in excess inventory, which may adversely affect our operating results.

Our customers may increase orders during periods of product shortages or cancel orders if their inventories are too high. Major inventory corrections by our customers are not uncommon and can last for significant periods of time and affect demand for our products. Customers may also cancel or delay orders in anticipation of new products or for other reasons. Cancellations or deferrals could cause us to hold excess inventory, which could reduce our profit margins by reducing sales prices, incurring inventory write-downs or writing off additional obsolete products.

The book-to-bill ratio is 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 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 and the effect of changing lead times on bookings. As lead times increase, customers will place orders sooner, therefore increasing our bookings and book-to-bill ratio.

 

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The increasing lead times from our suppliers cause us to make commitments for inventory purchases earlier in our production cycle which in turn increases our risk of having excess inventory. In addition, some of our suppliers are delivering based on allocations which in turn causes us to increase our inventory levels. We must balance our inventory levels between the risk of losing a significant customer to a competitor because we cannot meet our customer’s requirements and the risk of having excess inventory if a significant order is cancelled.

Inventory fluctuations could affect our results of operations and restrict our ability to fund our operations. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times, meet customer expectations and guard against the risk of inventory obsolescence because of changing technology and customer requirements.

We generally recognize revenue upon shipment of products to a customer. If a customer refuses to accept shipped products or does not pay for these products, we could miss future revenue projections or incur significant charges against our income, which could materially and adversely affect our operating results.

Our customers’ products typically have lengthy design cycles. A customer may decide to cancel or change its product plans, which could cause us to lose anticipated sales.

After we have developed and delivered a product to a customer, the customer will usually test and evaluate our product prior to designing its own equipment to incorporate our product. Our customers may need more than six months to test, evaluate and adopt our product and an additional nine months or more to begin volume production of equipment that incorporates our product. Due to this lengthy design cycle, we may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring such expenditures. Even if a customer selects our product to incorporate into its equipment, we cannot guarantee that the customer will ultimately market and sell its equipment or that such efforts by our customer will be successful. The delays inherent in this lengthy design cycle increases the risk that a customer will decide to cancel or change its product plans. Such a cancellation or change in plans by a customer could cause us to lose sales that we had anticipated. While our customers’ design cycles are typically long, some of our product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, the resources devoted to product sales and marketing may not generate material revenue for us, and from time to time, we may need to write off excess and obsolete inventory. If we incur significant marketing expenses and investments in inventory in the future that we are not able to recover, and we are not able to mitigate those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions but still hold higher cost products in inventory, our operating results would be harmed.

*An important part of our strategy is to focus on the markets for communications equipment. If we change strategy or are unable to further expand our share of these markets or react timely or properly to emerging trends, our revenues may not grow and could decline.

Our markets frequently undergo transitions in which products rapidly incorporate new features and performance standards on an industry-wide basis. If our products are unable to support the new features or performance levels required by OEMs in these markets, or if our products fail to be certified by OEMs, we will lose business from an existing or potential customer and may not have the opportunity to compete for new design wins or certification until the next product transition occurs. If we fail to develop products with required features or performance standards, or if we experience a delay as short as a few months in certifying or bringing a new product to market, or if our customers fail to achieve market acceptance of their products, our revenues could be significantly reduced for a substantial period.

We expect a significant portion of our revenues to continue to be derived from sales of products based on current, widely accepted transmission standards. If the communications market evolves to new standards, we may not be able to successfully design and manufacture new products that address the needs of our customers or gain substantial market acceptance.

If we do not identify and pursue the correct emerging trends and align ourselves with the correct market leaders, we may not be successful and our business, financial condition and results of operations could be materially and adversely affected.

Customers for our products generally have substantial technological capabilities and financial resources. Some customers have traditionally used these resources to internally develop their own products. The future prospects for our products in these markets are dependent upon our customers’ acceptance of our products as an alternative to their internally developed products. Future prospects also are dependent upon acceptance of third-party sourcing for products as an alternative to in-house development. Network

 

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equipment vendors may in the future continue to use internally developed components. They also may decide to develop or acquire components, technologies or products that are similar to, or that may be substituted for, our products.

If our network equipment vendor customers fail to accept our products as an alternative, if they develop or acquire the technology to develop such components internally rather than purchase our products, or if we are otherwise unable to develop or maintain strong relationships with them, our business, financial condition and results of operations would be materially and adversely affected.

*Our business strategy contemplates the acquisition of other companies, products and technologies. Merger and acquisition activities involve numerous risks and we may not be able to address these risks successfully without substantial expense, delay or other operational or financial problems that could disrupt our business and harm our results of operations and financial condition.

Acquiring products, technologies or businesses from third parties or making additional investments in companies we already have an interest in is part of our long-term business strategy. The risks involved with merger and acquisition activities include:

 

   

potential dilution to our stockholders;

 

   

use of a significant portion of our cash reserves;

 

   

diversion of management’s attention from our core business;

 

   

failure to integrate or potential loss of key employees, particularly those of the acquired companies.

 

   

difficulty in completing an acquired company’s in-process research or development projects;

 

   

amortization of acquired intangible assets and deferred compensation;

 

   

customer dissatisfaction or performance problems with an acquired company’s products or services;

 

   

adverse effects on existing business relationships with suppliers and customers;

 

   

costs associated with acquisitions or mergers;

 

   

difficulties associated with combining or integrating acquired companies and purchased operations, products or technologies;

 

   

difficulties and risks associated with entering and competing in markets that are unfamiliar to us;

 

   

ability of the acquired companies to meet their financial projections; and

 

   

assumption of unknown liabilities, or other unanticipated costs, events or circumstances.

In addition, in the event of any such investments or acquisitions, we could;

 

   

issue stock that would dilute our current stockholders’ percentage ownership;

 

   

incur debt;

 

   

assume liabilities;

 

   

incur amortization or impairment expenses related to goodwill and other intangible assets; and

 

   

incur large and immediate write-offs.

Any of these risks could materially harm our business, financial condition and results of operations.

As with past acquisitions, future acquisitions could adversely affect operating results. In particular, acquisitions may materially and adversely affect our results of operations because they may require large one-time charges or could result in increased debt or contingent liabilities, adverse tax consequences, substantial additional depreciation or deferred compensation charges. Our past purchase acquisitions required us to capitalize significant amounts of goodwill and purchased intangible assets. As a result of the slowdown in our industry and reduction of our market capitalization, we have been required to record significant impairment charges against these assets as noted in our previous financial statements. These market conditions continuously change and it is difficult to project how long these current uncertain economic conditions may last. These conditions have caused a decline in our near term revenues and it will take some time to ramp back up to our previous levels. Additionally, market values had deteriorated, which had an unfavorable impact on our valuations which are part of the goodwill and purchased intangible asset impairment tests. There can be no assurances that market conditions will not deteriorate further or that our market capitalization will not decline further. At June 30, 2011, we had $34.0 million of goodwill and purchased intangible assets. We cannot assure you that we will not be required to take significant charges as a result of impairment to the carrying value of the purchased intangible assets, due to further adverse changes in market conditions.

 

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On September 17, 2010, we completed the acquisition of TPack for $32 million in cash, exclusive of $0.5 million cash acquired, and potentially up to an additional $5 million if certain performance milestones are achieved during an 18 month period following the closing of the acquisition. In conjunction with the acquisition, we recorded $23.7 million in amortizable intangible assets and $13.2 million in goodwill.

In January 2011, TPack’s primary supplier of FPGAs announced it had acquired a competitor of TPack. This supplier will continue to provide FPGAs for TPack’s current products and products currently under development, but not for any future products. While we were negotiating with another supplier of FPGAs, they too acquired a competitor of TPack in March 2011. The increased competition from these synergistic acquisitions could adversely affect the future revenue streams as we implement a library strategy where customers can choose either FPGA supplier. We recently finalized the purchase price allocation for the TPack acquisition. The financial forecasts and other assumptions used to evaluate the acquisition that is included as part of the overall reporting unit may not materialize as expected.

We cannot assure you that we will be able to successfully integrate TPack’s business, products, technologies or personnel or any additional businesses, products, technologies or personnel that we might acquire.

Our industry and markets are subject to consolidation, which may result in stronger competitors, fewer customers and reduced demand.

There has been industry consolidation among communications IC companies, network equipment companies and telecommunications companies in the past. We expect this consolidation to continue as companies attempt to strengthen or hold their positions in evolving markets. Consolidation may result in stronger competitors, fewer customers and reduced demand, which in turn could have a material adverse effect on our business, operating results, and financial condition.

Our operating results are subject to fluctuations because we rely heavily on international sales.

International sales account for a significant part of our revenues and may account for an increasing portion of our future revenues. The revenues we derive from international sales may be subject to certain risks, including:

 

   

foreign currency exchange fluctuations;

 

   

changes in regulatory requirements;

 

   

tariffs, rising protectionism and other barriers;

 

   

timing and availability of export licenses;

 

   

political and economic instability;

 

   

natural disasters;

 

   

difficulties in staffing and managing foreign operations;

 

   

difficulties in managing distributors;

 

   

difficulties in obtaining governmental and export approvals for communications, processors and other products;

 

   

reduced or uncertain protection for intellectual property rights in some countries;

 

   

longer payment cycles and difficulties in collecting accounts receivable in some countries;

 

   

burdens of complying with a wide variety of complex foreign laws and treaties;

 

   

potentially adverse tax consequences; and

 

   

an uncertain economic condition that may trail any improvements in the United States.

We are subject to risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether quotas, duties, taxes or other charges or restrictions upon the importation or exportation of our products will be implemented by the United States or other countries. Because sales of our products have been denominated to date primarily in United States dollars, increases in the value of the United States dollar could increase the price of our products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country. Future international activity may result in increased foreign currency denominated sales. Gains and losses on the conversion to United States dollars of accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in our results of operations.

Some of our customer purchase orders and agreements are governed by foreign laws, which may differ significantly from laws in the United States. As a result, our ability to enforce our rights under such agreements may be limited compared with our ability to enforce our rights under agreements governed by laws in the United States.

 

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*Our portfolio of short-term investments are exposed to certain market risks.

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are recorded on our consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Our investment portfolio is exposed to market risks related to changes in interest rates and credit ratings of the issuers, as well as to the risks of default by the issuers and lack of overall market liquidity. Substantially all of these securities are subject to interest rate and credit rating risk and will decline in value if interest rates increase or one of the issuers’ credit ratings is reduced. Increases in interest rates or decreases in the credit worthiness of one or more of the issuers in our investment portfolio could have a material adverse impact on our financial condition or results of operations. During the fiscal year ended March 31, 2010, we recorded $4.1 million in write-downs in the carrying value of certain securities as we determined the decline in the fair value of these securities to be other-than-temporary. If there is a further deterioration in market conditions or there are additional losses incurred, we may be required to record a further decline in the carrying value of these securities resulting in further charges. At June 30, 2011, the unrealized losses on these securities that were not written down as an other-than-temporary impairment charge were approximately $1.1 million. If the fair value of any of these securities does not recover to at least the amortized cost of such security or we are unable to hold these securities until they recover, we may be required to record a decline in the carrying value of these securities.

*Our restructuring activities could result in management distractions, operational disruptions and other difficulties.

Over the past several years, we have initiated several restructuring activities in an effort to reduce operating costs, including recent restructuring initiatives announced in January 2010 and April 2011. Employees whose positions were eliminated in connection with these restructuring activities may seek employment with our customers or competitors. Although each of our employees is required to sign a confidentiality agreement with us at the time of hire, we cannot guarantee that the confidential nature of our proprietary information will be maintained in the course of such future employment. Any additional restructuring efforts could divert the attention of our management away from our operations, harm our reputation, increase our expenses and cause our remaining employees to lose confidence in the future performance of the Company and decide to leave. We cannot guarantee that we will not undertake additional restructuring activities, that any of our restructuring efforts will be successful, or that we will be able to realize the cost savings and other anticipated benefits from our previous or future restructuring plans. In addition, if we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to new growth opportunities.

Our markets are subject to rapid technological change, so our success depends heavily on our ability to develop and introduce new products.

The markets for our products are characterized by:

 

   

rapidly changing technologies;

 

   

evolving and competing industry standards;

 

   

changing customer needs;

 

   

frequent introductions of new products and enhancements;

 

   

increased integration with other functions;

 

   

long design and sales cycles;

 

   

short product life cycles; and

 

   

intense competition.

To develop new products for the communications or other technology markets, we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to develop technical and design expertise. We must have our products designed into our customers’ future products and maintain close working relationships with key customers in order to develop new products that meet customers’ changing needs. We must respond to changing industry standards, trends towards increased integration and other technological changes on a timely and cost-effective basis. Our pursuit of technological advances may require substantial time and expense and may ultimately prove unsuccessful. If we are not successful in adopting such advances, we may be unable to timely bring to market new products and our revenues will suffer.

Many of our products are based on industry standards that are continually evolving. Our ability to compete in the future will depend on our ability to identify and ensure compliance with these evolving industry standards. The emergence of new industry standards could render our products incompatible with products developed by major systems manufacturers. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our products to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards or requirements, we could miss opportunities to achieve crucial design wins which in turn could have a material adverse effect on our business, operating results and financial condition.

 

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The markets in which we compete are highly competitive, and we expect competition to increase in these markets in the future.

The markets in which we compete are highly competitive, and we expect that domestic and international competition will increase in these markets, due in part to deregulation, rapid technological advances, price erosion, changing customer preferences and evolving industry standards. Increased competition could result in significant price competition, reduced revenues, lower profit margins or loss of market share. Our ability to compete successfully in our markets depends on a number of factors, including:

 

   

our ability to partner with OEM and channel partners who are successful in the market;

 

   

success in designing and subcontracting the manufacture of new products that implement new technologies;

 

   

product quality, interoperability, reliability, performance and certification;

 

   

customer support;

 

   

time-to-market;

 

   

price;

 

   

production efficiency;

 

   

design wins;

 

   

expansion of production of our products for particular systems manufacturers;

 

   

end-user acceptance of the systems manufacturers’ products;

 

   

market acceptance of competitors’ products; and

 

   

general economic conditions.

Our competitors may offer enhancements to existing products, or offer new products based on new technologies, industry standards or customer requirements that are available to customers on a more timely basis than comparable products from us or that have the potential to replace or provide lower cost alternatives to our products. The introduction of enhancements or new products by our competitors could render our existing and future products obsolete or unmarketable. We expect that certain of our competitors and other semiconductor companies may seek to develop and introduce products that integrate the functions performed by our IC products on a single chip, thus eliminating the need for our products. Each of these factors could have a material adverse effect on our business, financial condition and results of operations.

In the transport communications IC markets, we compete primarily against companies such as Broadcom, Cortina, Netlogic, PMC-Sierra and Vitesse. In the embedded processor communications IC market, we compete with technology companies such as Freescale Semiconductor, Cavium and Intel. Many of these companies may have substantially greater financial, marketing and distribution resources than we have. Certain of our customers or potential customers have internal IC design or manufacturing capabilities with which we compete. We may also face competition from new entrants to our target markets, including larger technology companies that may develop or acquire differentiating technology and then apply their resources to our detriment. Any failure by us to compete successfully in these target markets would have a material adverse effect on our business, financial condition and results of operations.

Our operating results depend on manufacturing output and yields of our ICs and printed circuit board assemblies, which may not meet expectations.

The yields on wafers we have manufactured decline whenever a substantial percentage of wafers must be rejected or a significant number of die on each wafer are nonfunctional. Such declines can be caused by many factors, including minute levels of contaminants in the manufacturing environment, design issues, defects in masks used to print circuits on a wafer and difficulties in the fabrication process. Design iterations and process changes by our suppliers can cause a risk of defects. Many of these problems are difficult to diagnose, are time consuming and expensive to remedy and can result in shipment delays.

We estimate yields per wafer and final packaged parts in order to estimate the value of inventory. If yields are materially different than projected, work-in-process inventory may need to be re-valued. We may have to take inventory write-downs as a result of decreases in manufacturing yields. We may suffer periodic yield problems in connection with new or existing products or in connection with the commencement of production at a new manufacturing facility.

We must develop or otherwise gain access to improved IC process technologies.

Our future success will depend upon our ability to access new IC process technologies. In the future, we may be required to transition one or more of our IC products to process technologies with smaller geometries, other materials or higher speeds in order to reduce costs or improve product performance. We may not be able to gain access to new process technologies in a timely or affordable manner or products based on these new technologies may not achieve market acceptance.

 

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The complexity of our products may lead to errors, defects and bugs, which could negatively impact our reputation with customers and result in liability.

Products as complex as ours may contain errors, defects and bugs when first introduced or as new versions are released. Our products have in the past experienced such errors, defects and bugs. Delivery of products with production defects or reliability, quality or compatibility problems could significantly delay or hinder market acceptance of the products or result in a costly recall and could damage our reputation and adversely affect our ability to retain existing customers and to attract new customers. Errors, defects or bugs could cause problems with device functionality, resulting in interruptions, delays or cessation of sales to our customers.

We may also be required to make significant expenditures of capital and resources to resolve such problems. We cannot assure you that problems will not be found in new products after commencement of commercial production, despite testing by us, our suppliers or our customers. Any problem could result in:

 

   

additional development costs;

 

   

loss of, or delays in, market acceptance;

 

   

diversion of technical and other resources from our other development efforts;

 

   

claims by our customers or others against us; and

 

   

loss of credibility with our current and prospective customers.

Any such event could have a material adverse effect on our business, financial condition and results of operations.

If our internal control over financial reporting is not considered effective, our business and stock price could be adversely affected.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of our internal control over financial reporting in our annual report on Form 10-K for that fiscal year. Section 404 also requires our independent registered public accounting firm to attest to and report on the effectiveness of our internal control over financial reporting.

Our management, including our chief executive officer and chief financial officer, does not expect that our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of control must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal control can provide absolute assurance that all control issues and instances of fraud involving a company have been, or will be, detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our internal control over financial reporting may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Our management has concluded, and our independent registered public accounting firm has attested, that our internal control over financial reporting was effective as of March 31, 2011. We cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our internal control over financial reporting in the future. A material weakness in our internal control over financial reporting would require management and our independent registered public accounting firm to report our internal control over financial reporting as ineffective. If our internal control over financial reporting is not considered effective, we may experience a restatement like we have in the past of our financial statements and/or a loss of public confidence, either of which could have an adverse effect on our business and on the market price of our common stock.

*Our future success depends in part on the continued service of our key senior management, design engineering, sales, marketing, and manufacturing personnel, our ability to identify, hire and retain additional, qualified personnel and successful succession planning.

Our future success depends to a significant extent upon the continued service of our senior management personnel and successful succession planning. The loss of key senior executives could have a material adverse effect on our business. There is intense competition for qualified personnel in the semiconductor industry, in particular design, product and test engineers. We may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business, or to replace engineers or other qualified personnel who may leave our employment in the future. We face the risks associated with our former employees assisting their new employers to recruit our key talent, in violation of their non-solicitations covenants to us, as well as allegations by other companies that we have unlawfully solicited their employees to join us. There may be significant costs associated with recruiting, hiring and retaining personnel. Periods of contraction in our business may inhibit our ability to attract and retain our personnel. As we respond to declining revenues and/or implement additional cost improvement measures such as reductions

 

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in force, our remaining key employees may lose confidence in the future performance of the Company and decide to leave. Loss of the services of, or failure to recruit, key design engineers or other technical and management personnel could be significantly detrimental to our product development or other aspects of our business.

To manage operations effectively, we will be required to continue to improve our operational, financial and management systems and to successfully hire, train, motivate, and manage our employees. The integration of future acquisitions would require significant additional management, technical and administrative resources. We cannot guarantee that we would be able to manage our expanded operations effectively.

Our ability to supply a sufficient number of products to meet demand could be severely hampered by a shortage of water, electricity or other supplies or by natural disasters or other catastrophes or by the effects of war, acts of terrorism or global threats.

The manufacture of our products requires significant amounts of water. Previous droughts have resulted in restrictions being placed on water use by manufacturers. In the event of a future drought, reductions in water use may be mandated generally and our external foundries’ ability to manufacture our products could be impaired.

Several of our facilities, including our principal executive offices, are located in California. California has experienced prolonged energy alerts and blackouts caused by disruption in energy supplies. As a consequence, businesses and other energy consumers in California continue to experience substantially increased costs of electricity and natural gas. We are unsure whether energy alerts and blackouts will reoccur or how severe they may become in the future. Many of our customers and suppliers are also headquartered or have substantial operations in California. If we or any of our major customers or suppliers located in California experience a sustained disruption in energy supplies, our results of operations could be materially and adversely affected.

A significant portion of our manufacturing operations are located in Asia. These areas are subject to natural disasters such as earthquakes or floods, like Japan. We do not have earthquake insurance for these facilities, because adequate coverage is not offered at economically justifiable rates. A significant natural disaster or other catastrophic event could have a material adverse impact on our business, financial condition and operating results.

The effects of war, acts of terrorism or global threats, including, but not limited to, the outbreak of epidemic disease, could have a material adverse effect on our business, operating results and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to local and global economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

We could incur substantial fines or litigation costs associated with our storage, use and disposal of hazardous materials.

We are subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our manufacturing process. Any failure to comply with present or future regulations could result in the imposition of fines, the suspension of production or a cessation of operations. These regulations could require us to acquire costly equipment or incur other significant expenses to comply with environmental regulations or clean up prior discharges. Since 1993, we have been named as a PRP along with more than 100 other companies that used Omega Chemical Corporation waste treatment facility in Whittier, California. The U.S. Environmental Protection Agency (“EPA”) has alleged that Omega failed to properly treat and dispose of certain hazardous waste material. We are a member of a large group of PRPs that has agreed to fund certain on-going remediation efforts at the Omega Chemical Corporation site. Based on currently available information, we have a loss accrual that is not material and we believe that the actual amount of costs will not be materially different from the amount accrued. However, proceedings are ongoing and the eventual outcome of the clean-up efforts and the pending litigation matters is uncertain at this time. Based on currently available information, we do not believe that any eventual outcome will have a material adverse effect on its operations but we cannot guarantee this result. In 2007, the PRPs were sued by a downstream chemical company; that action has been stayed since March 2008 to allow for further delineation of the regional groundwater. In 2009, the U.S. Supreme Court decided U.S. v. Burlington Northern & Santa Fe Railway Co., 129 S.Ct. 1870, which determined that hazardous substance cleanup liability need not be joint and several in all cases. As a result of this decision, the liability is potentially divisible among the PRP at an earlier stage in superfund cases such as Omega. At this time we do not know and cannot predict the full impact of this decision on our liability; however, to protect against an unfavorable impact, we have joined the recently formed Omega Allocation Committee in order to limit such exposure. Although we believe that we have been and currently are in material compliance with applicable environmental laws and regulations, we cannot guarantee that we are or will be in material compliance with these laws or regulations or that our future obligations to fund any remediation efforts, including those at the Omega Chemical Corporation site, will not have a material adverse effect on our business and financial condition.

 

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Environmental laws and regulations could cause a disruption in our business and operations.

We are subject to various state, federal and international laws and regulations governing the environment, including those restricting the presence of certain substances in electronic products and making manufacturers of those products financially responsible for the collection, treatment, recycling and disposal of certain products. Such laws and regulations have been passed in several jurisdictions in which we operate, including various European Union (“EU”) member countries. For example, the EU has enacted the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) and the Waste Electrical and Electronic Equipment (“WEEE”) directives. RoHS prohibits the use of lead and other substances in semiconductors and other products put on the market after July 1, 2006. The WEEE directive obligates parties that place electrical and electronic equipment on the market in the EU to put a clearly identifiable mark on the equipment, register with and report to EU member countries regarding distribution of the equipment, and provide a mechanism to take back and properly dispose of the equipment. There can be no assurance that similar programs will not be implemented in other jurisdictions resulting in additional costs, possible delays in delivering products, and even the discontinuance of existing and planned future product replacements if the cost were to become prohibitive.

We may not be able to protect our intellectual property adequately.

We rely in part on patents to protect our intellectual property. We cannot assure you that our pending patent applications or any future applications will be approved, or that any issued patents will adequately protect the intellectual property in our products and processes, will provide us with competitive advantages or will not be challenged by third parties, or that if challenged, any such patent will be found to be valid or enforceable. Others may independently develop similar products or processes, duplicate our products or processes or design around any patents that may be issued to us.

To protect our intellectual property, we also rely on the combination of mask work protection under the Federal Semiconductor Chip Protection Act of 1984, trademarks, copyrights, trade secret laws, employee and third-party nondisclosure agreements, and licensing arrangements. Despite these efforts, we cannot assure you that others will not independently develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property, or disclose such intellectual property or trade secrets, or that we can meaningfully protect our intellectual property. A failure by us to meaningfully protect our intellectual property could have a material adverse effect on our business, financial condition and operating results.

We generally enter into confidentiality agreements with our employees, consultants and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. Also, former employees may seek employment with our business partners, customers or competitors and we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, former employees or third parties could attempt to penetrate our network to misappropriate our proprietary information or interrupt our business. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. As a result, our technologies and processes may be misappropriated, particularly in foreign countries where laws may not protect our proprietary rights as fully as in the United States.

*We could be harmed by litigation involving patents, proprietary rights or other claims.

Litigation may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or misappropriation. The semiconductor industry is characterized by substantial litigation regarding patent and other intellectual property rights. As the Company’s products and IP become instantiated in more and more customer products and applications, and as patent infringement litigation brought by Company competitors, non-practicing entities (also known as “patent trolls”) and patent-licensing companies is on the rise, AppliedMicro is at an increased risk of being named as a defendant in such lawsuits or of having its IP records subpoenaed in patent litigation between third and parties. Such litigation could result in substantial costs and diversion of resources, including the attention of our management and technical personnel, and could have a material adverse effect on our business, financial condition and results of operations. We may be accused of infringing on the intellectual property rights of third parties. We have certain indemnification obligations to our customers, or our customers may improperly assert we have certain duties to indemnify them, with respect to the infringement of third-party intellectual property rights by our products. We cannot assure you that infringement claims by third parties or claims for indemnification by customers or end users resulting from infringement claims will not be asserted in the future, or that such assertions will not harm our business.

Any litigation relating to the intellectual property rights of third parties would at a minimum be costly and could divert the efforts and attention of our management and technical personnel. In the event of any adverse ruling in any such litigation, we could be required to pay substantial damages, cease the manufacturing, use and sale of infringing products, discontinue the use of certain processes or obtain a license under the intellectual property rights of the third party claiming infringement. A license might not be available on reasonable terms or at all.

 

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From time to time, we may be involved in litigation relating to other claims arising out of our operations in the normal course of business. The ultimate outcome of any such litigation matters could have a material, adverse effect on our business, financial condition or operating results.

Our stock price is volatile.

The market price of our common stock has fluctuated significantly. In the future, the market price of our common stock could be subject to significant fluctuations due to general economic and market conditions and in response to quarter-to-quarter variations in:

 

   

our anticipated or actual operating results;

 

   

announcements or introductions of new products by us or our competitors;

 

   

anticipated or actual operating results of our customers, peers or competitors;

 

   

technological innovations or setbacks by us or our competitors;

 

   

conditions in the semiconductor, communications or information technology markets;

 

   

the commencement or outcome of litigation or governmental investigations;

 

   

changes in ratings and estimates of our performance by securities analysts;

 

   

announcements of merger or acquisition transactions;

 

   

management changes;

 

   

our inclusion in certain stock indices; and

 

   

other events or factors.

The stock market in recent years has experienced extreme price and volume fluctuations that have affected the market prices of many high technology companies, particularly semiconductor companies. In some instances, these fluctuations appear to have been unrelated or disproportionate to the operating performance of the affected companies. Whether or not our stock is part of one or more Index funds could have a significant impact on our stock. We cannot assure you that our stock will be part of any Index fund. In addition, the current decline of the financial markets and related factors beyond our control, including the credit and mortgage crisis in both the U.S. and worldwide, may cause our stock price to decline rapidly and unexpectedly.

The anti-takeover provisions of our certificate of incorporation and of the Delaware General Corporation Law may delay, defer or prevent a change of control.

Our board of directors has the authority to issue up to 2.0 million shares of preferred stock and to determine the price, rights, preferences and privileges and restrictions, including voting rights, of those shares without any further vote or action by our stockholders. The rights of the holders of common stock will be subject to, and may be harmed by, the rights of the holders of any shares of preferred stock that may be issued in the future. The issuance of preferred stock may delay, defer or prevent a change in control, as the terms of the preferred stock that might be issued could potentially prohibit our consummation of any merger, reorganization, sale of substantially all of our assets, liquidation or other extraordinary corporate transaction without the approval of the holders of the outstanding shares of preferred stock. The issuance of preferred stock could have a dilutive effect on our stockholders.

If we issue additional shares of stock in the future, it may have a dilutive effect on our stockholders.

We have a significant number of authorized and unissued shares of our common stock available. These shares will provide us with the flexibility to issue our common stock for proper corporate purposes, which may include making acquisitions through the use of stock, adopting additional equity incentive plans and raising equity capital. Any issuance of our common stock may result in immediate dilution of our stockholders.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Period

   Total Number of
Shares Purchased
     Average Price
Paid
per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced  Plans or
Programs
     Maximum Amount
that May Yet Be
Purchased Under the
Plans or Programs
 

April 1 — April 30, 2011

     310       $ 9.98         310       $ 44,280   

May 1 — May 31, 2011

     —           —           —           44,280   

June 1 — June 30, 2011

     —           —           —           44,280   
                             

 

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Period

   Total Number of
Shares Purchased
     Average Price
Paid
per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced  Plans or
Programs
     Maximum Amount
that May Yet Be
Purchased Under the
Plans or Programs
 

Total shares repurchased

     310       $ 9.98         310      

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. (REMOVED AND RESERVED)

None.

 

ITEM 5. OTHER INFORMATION

None.

 

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ITEM 6. EXHIBITS

 

    2.4(1)^   Amendment No. 1 to Agreement and Plan of Merger between the Company, Espresso Acquisition Corporation and Veloce Technologies, Inc., dated November 8, 2010.
    3.1(2)   Amended and Restated Certificate of Incorporation of the Company.
    3.2(3)   Amended and Restated Bylaws of the Company.
    3.3(4)   Certificate of Amendment of Amended and Restated Certificate of Incorporation of the Company.
    4.1(5)   Specimen Stock Certificate.
  31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
  31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
  32.1   Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2   Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

^ The Company has requested confidential treatment for certain portions of the agreement and certain terms and conditions have been redacted from the exhibits. Omitted portions have been filed separately with the SEC.
(1) Incorporated by reference to identically numbered exhibit filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2010.
(2) Incorporated by reference to Exhibit 3.2 filed with the Company’s Registration Statement (No. 333-37609) filed October 10, 1997, and as amended by Exhibit 3.3 filed with the Company’s Registration Statement (No. 333-45660) filed September 12, 2000 and Exhibit 3.1 filed with the Company’s Current Report on Form 8-K filed on December 11, 2007.
(3) Incorporated by reference to identically numbered exhibit filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010.
(4) Incorporated by reference to Exhibit 3.1 filed with the Company’s Current Report on Form 8-K filed on December 11, 2007.
(5) Incorporated by reference to identically numbered exhibit filed with the Company’s Registration Statement (No. 333-37609) filed October 10, 1997, or with any amendments thereto, which registration statement became effective November 24, 1997.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: August 1, 2011

 

APPLIED MICRO CIRCUITS CORPORATION

By:

 

/S/    ROBERT G. GARGUS        

  Robert G. Gargus
  Senior Vice President and Chief Financial Officer
 

(Duly Authorized Signatory and Principal Financial and

Accounting Officer)

 

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Exhibit Index

 

    2.4(1)^   Amendment No. 1 to Agreement and Plan of Merger between the Company, Espresso Acquisition Corporation and Veloce Technologies, Inc., dated November 8, 2010.
    3.1(2)   Amended and Restated Certificate of Incorporation of the Company.
    3.2(3)   Amended and Restated Bylaws of the Company.
    3.3(4)   Certificate of Amendment of Amended and Restated Certificate of Incorporation of the Company.
  4.1(5)   Specimen Stock Certificate.
  31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
  31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
  32.1   Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  32.2   Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

^ The Company has requested confidential treatment for certain portions of the agreement and certain terms and conditions have been redacted from the exhibits. Omitted portions have been filed separately with the SEC.
(1) Incorporated by reference to identically numbered exhibit filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended December 31, 2010.
(2) Incorporated by reference to Exhibit 3.2 filed with the Company’s Registration Statement (No. 333-37609) filed October 10, 1997, and as amended by Exhibit 3.3 filed with the Company’s Registration Statement (No. 333-45660) filed September 12, 2000 and Exhibit 3.1 filed with the Company’s Current Report on Form 8-K filed on December 11, 2007.
(3) Incorporated by reference to identically numbered exhibit filed with the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2010.
(4) Incorporated by reference to Exhibit 3.1 filed with the Company’s Current Report on Form 8-K filed on December 11, 2007.
(5) Incorporated by reference to identically numbered exhibit filed with the Company’s Registration Statement (No. 333-37609) filed October 10, 1997, or with any amendments thereto, which registration statement became effective November 24, 1997.

 

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