e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2008
OR
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o |
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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: 001-33435
CAVIUM NETWORKS, INC.
(Exact name of Registrant as specified in its charter)
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DELAWARE
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77-0558625 |
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(State or other jurisdiction
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(I.R.S. Employer Identification No.) |
of incorporation or organization) |
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805 E. Middlefield Road |
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Mountain View, California
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94043 |
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(Address of principal executive offices)
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(Zip Code) |
Registrants telephone number, including area code: (650) 623-7000
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 þ No o
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):
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Large accelerated filer o |
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Accelerated filer
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Non-accelerated filer
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(Do not check if a smaller reporting company) |
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Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o No þ
The number of shares of the Registrants Common Stock, $.001 par value, outstanding at November 7,
2008 was: 40,831,252
CAVIUM NETWORKS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008
TABLE OF CONTENTS
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
CAVIUM NETWORKS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
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September 30, |
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December 31, |
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2008 |
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2007 |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
91,918 |
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$ |
98,462 |
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Accounts receivable, net of allowance of $200 and $177, respectively |
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13,483 |
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9,768 |
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Inventories |
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15,301 |
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9,573 |
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Prepaid expenses and other current assets |
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1,276 |
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946 |
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Total current assets |
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121,978 |
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118,749 |
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Property and equipment, net |
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10,836 |
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11,608 |
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Intangible assets, net |
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8,212 |
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4,096 |
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Goodwill |
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4,186 |
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Other assets |
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385 |
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157 |
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Total assets |
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$ |
145,597 |
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$ |
134,610 |
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Liabilities and Stockholders Equity |
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Current liabilities: |
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Accounts payable |
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$ |
7,116 |
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$ |
5,311 |
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Accrued expenses and other current liabilities |
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3,447 |
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2,253 |
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Deferred revenue |
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1,685 |
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1,666 |
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Capital lease and technology license obligations, current portion |
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2,666 |
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4,471 |
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Total current liabilities |
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14,914 |
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13,701 |
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Capital lease and technology license obligations, net of current portion |
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2,255 |
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4,059 |
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Other non-current liabilities |
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616 |
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Total liabilities |
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17,785 |
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17,760 |
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Commitments and contingencies (Note 13) |
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Stockholders equity |
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Preferred stock, par value $0.001: |
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10,000,000 shares authorized, no shares issued and outstanding as of September
30, 2008 and December 31, 2007 |
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Common stock, par value $0.001: |
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200,000,000 shares authorized; 40,810,284 and 40,307,361 shares issued and
outstanding as of September 30, 2008 and December 31, 2007, respectively |
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41 |
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40 |
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Additional paid-in capital |
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180,637 |
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175,540 |
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Accumulated deficit |
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(52,866 |
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(58,730 |
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Total stockholders equity |
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127,812 |
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116,850 |
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Total liabilities and stockholders equity |
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$ |
145,597 |
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$ |
134,610 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
3
CAVIUM NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
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Three Months Ended |
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Nine Months Ended |
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September 30, |
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September 30, |
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2008 |
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2007 |
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2008 |
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2007 |
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Net revenue |
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$ |
24,525 |
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$ |
14,165 |
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$ |
64,429 |
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$ |
37,972 |
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Cost of revenue |
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10,099 |
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5,207 |
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24,494 |
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14,087 |
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Gross profit |
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14,426 |
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8,958 |
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39,935 |
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23,885 |
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Operating expenses: |
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Research and development |
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6,593 |
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4,796 |
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18,874 |
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13,843 |
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Sales, general and administrative |
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5,944 |
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3,976 |
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15,953 |
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10,667 |
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Total operating expenses |
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12,537 |
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8,772 |
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34,827 |
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24,510 |
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Income (loss) from operations |
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1,889 |
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186 |
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5,108 |
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(625 |
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Other income, net: |
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Interest expense |
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(115 |
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(73 |
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(403 |
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(572 |
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Warrant revaluation expense |
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(574 |
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Interest income and other |
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499 |
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1,307 |
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2,100 |
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2,193 |
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Total other income, net |
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384 |
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1,234 |
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1,697 |
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1,047 |
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Income before income tax expense |
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2,273 |
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1,420 |
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6,805 |
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422 |
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Income tax expense |
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454 |
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110 |
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941 |
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201 |
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Net income |
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$ |
1,819 |
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$ |
1,310 |
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$ |
5,864 |
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$ |
221 |
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Net income, per common share, basic |
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$ |
0.04 |
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$ |
0.03 |
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$ |
0.15 |
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$ |
0.01 |
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Shares used in computing basic net income per
common share |
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40,578 |
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39,046 |
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40,283 |
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25,498 |
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Net income, per common share, diluted |
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$ |
0.04 |
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$ |
0.03 |
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$ |
0.14 |
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$ |
0.01 |
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Shares used in computing diluted net income per
common share |
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42,628 |
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42,737 |
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42,617 |
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28,786 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
4
CAVIUM NETWORKS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
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Nine Months Ended |
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September 30, |
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2008 |
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2007 |
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Cash flows from operating activities |
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Net income |
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$ |
5,864 |
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$ |
221 |
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Adjustments to reconcile net income to net cash provided by operating activities |
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Stock-based compensation expense |
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4,115 |
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1,302 |
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Amortization of warrant costs to interest expense |
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149 |
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Revaluation of warrants to fair value |
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574 |
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Depreciation and amortization |
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7,873 |
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4,285 |
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Changes in operating
assets and liabilities, net of effects of acquisitions: |
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Accounts receivable, net |
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(3,338 |
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(513 |
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Inventories |
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(4,923 |
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(1,790 |
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Prepaid expenses and other current assets |
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(325 |
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(170 |
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Other assets |
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(227 |
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(176 |
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Accounts payable |
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2,723 |
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935 |
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Accrued expenses and other current and non-current liabilities |
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689 |
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(520 |
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Deferred revenue |
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19 |
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1,957 |
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Net cash provided by operating activities |
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12,470 |
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6,254 |
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Cash flows used in investing activities |
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Purchases of property and equipment |
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(6,398 |
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(2,713 |
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Purchases of IP licenses and intangible assets |
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(369 |
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Purchase of Parallogic and Star |
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(9,811 |
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Net cash
(used in) investing activities |
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(16,209 |
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(3,082 |
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Cash flows (used in) provided by financing activities |
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Repayment for term loan financing |
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(4,000 |
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Proceeds from initial public offering, net of costs |
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97,458 |
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Payments of initial public offering costs |
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(2,740 |
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Proceeds from issuance of common stock upon exercise of options |
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808 |
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177 |
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Principal payment of capital lease and technology license obligations |
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(3,609 |
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(2,707 |
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Repurchases of shares of unvested common stock |
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(4 |
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(10 |
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Net cash (used in) provided by financing activities |
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(2,805 |
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88,178 |
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Net (decrease) increase in cash and cash equivalents |
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(6,544 |
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91,350 |
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Cash and cash equivalents, beginning of period |
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98,462 |
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10,154 |
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Cash and cash equivalents, end of period |
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$ |
91,918 |
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$ |
101,504 |
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Supplemental disclosure of cash flow information |
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Cash paid for interest |
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$ |
403 |
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$ |
422 |
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Supplemental disclosure of non-cash activities |
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Capital lease and technology license obligations |
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$ |
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$ |
3,342 |
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Vesting of early exercised options |
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$ |
58 |
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$ |
88 |
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Additions to property and equipment included in accounts payable and accrued expenses |
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$ |
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$ |
389 |
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Accrual for Parallogic and Star acquisition |
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$ |
1,095 |
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$ |
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Net exercise of common stock warrant |
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$ |
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$ |
249 |
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Conversion of mandatorily redeemable convertible preferred stock to common stock |
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$ |
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$ |
72,437 |
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The accompanying notes are an integral part of these condensed consolidated financial statements.
5
CAVIUM NETWORKS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Organization and Significant Accounting Policies
Organization
Cavium Networks, Inc., or the Company, was incorporated in the State of California on
November 21, 2000 and was reincorporated in the State of Delaware on February 6, 2007. The Company
designs, develops and markets semiconductor processors for intelligent and secure networks.
Initial Public Offering
In May 2007, the Company completed its initial public offering, or IPO, of common stock
in which it sold and issued 7,762,500 shares of common stock, including 1,012,500 shares of
underwriters over-allotment, at an issue price of $13.50 per share. A total of $104.8 million in
gross proceeds was raised from the IPO, or approximately $94.7 million in net proceeds after
deducting underwriting discounts and commissions of $7.3 million and other offering costs of $2.8
million. Upon the closing of the IPO, all shares of convertible preferred stock outstanding
automatically converted into 22,364,378 shares of common stock, and 102,619 warrants to purchase
mandatorily redeemable convertible preferred stock were converted into warrants to purchase common
stock.
Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Cavium Networks, Inc. and
its wholly owned foreign subsidiaries. All significant intercompany transactions and balances have
been eliminated in consolidation.
The unaudited condensed consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America, or GAAP, and with
the instructions to Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC
Regulation S-X. Accordingly, they do not include all of the information and footnotes required by
GAAP for complete financial statements. For further information, these financial statements should
be read in conjunction with the Companys Annual Report on Form 10-K (File No. 001-33435) on file
with the SEC for the year ended December 31, 2007.
The unaudited condensed consolidated financial statements contain all normal recurring
accruals and adjustments that, in the opinion of management, are necessary to present fairly the
Companys condensed consolidated financial position at September 30, 2008, and the condensed
consolidated results of its operations for the three months and nine months ended September 30,
2008 and 2007, and the condensed consolidated cash flows for the nine months ended September 30,
2008 and 2007. The results of operations for the three months and nine months ended September 30,
2008 are not necessarily indicative of the results to be expected for the full year.
The condensed consolidated balance sheet at December 31, 2007 has been derived from the
audited consolidated financial statements at that date but does not include all of the information
and footnotes required by GAAP.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to
make estimates and assumptions that affect the amounts reported in its consolidated financial
statements and accompanying notes. Management bases its estimates on historical experience and on
various other assumptions it believes to be reasonable under the circumstances, the results of
which form the basis of making judgments about the carrying values of assets and liabilities.
Actual results could differ from those estimates.
Cash & Cash Equivalents
The Company considers all highly liquid investments with an original or remaining
maturity of 90 days or less at the date of purchase to be cash equivalents. Cash equivalents
consist primarily of an investment in a money market fund.
Historically, we have not experienced any losses due to such concentration of credit risk.
Allowance for Doubtful Accounts
The Company reviews its allowance for doubtful accounts quarterly by assessing individual
accounts receivable over a specific age and amount. The Companys allowance for doubtful accounts
was $35,000 and $38,000 as of September 30, 2008 and December 31,
2007, respectively.
6
Inventories
Inventories consist of work-in-process and finished goods. Inventories are stated at the
lower of cost (determined using the first-in, first-out method), or market value (estimated net
realizable value). The Company writes down inventory by establishing inventory reserves based on
aging and forecasted demand. These factors are impacted by market and economic conditions,
technology changes new product introductions and changes in strategic direction and require
estimates that may include uncertain elements. Actual demand may differ from forecasted demand and
such differences may have a material effect on recorded inventory values. Inventory reserves, once
established, are not released until the related inventories have been sold or scrapped.
Property and Equipment
Property and equipment are stated at cost and depreciated over their estimated useful
lives using the straight-line method. Leasehold improvements are amortized over the shorter of
estimated useful lives or unexpired lease term. Additions and improvements that increase the value
or extend the life of an asset are capitalized. Upon retirement or sale, the cost of assets
disposed of and the related accumulated depreciation are removed from the accounts and any
resulting gain or loss is credited or charged to income. Repairs and maintenance costs are expensed
as incurred.
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Estimated |
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Useful Lives |
Software, computer and other equipment |
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1 to 5 years |
Mask costs and test equipment |
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1 to 3 years |
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Furniture, office equipment and leasehold improvements |
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1 to 5 years |
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The Company capitalizes the cost of fabrication masks that are reasonably expected to be used
during production manufacturing. Such amounts are included within property and equipment and
depreciated to cost of revenue generally over a period of twelve months. If the Company does not
reasonably expect to use the fabrication mask during production manufacturing, the related mask
costs are expensed to research and development in the period in which the costs are incurred. The
Company has capitalized mask costs of $1.0 million and $0.1 million for the three months ended
September 30, 2008 and 2007, respectively, and $3.3 million and $1.8 million for the nine months
ended September 30, 2008 and 2007, respectively.
Impairment of Long-Lived Assets
The Company reviews long-lived assets, including property and equipment, for impairment
whenever events or changes in business circumstances indicate that the carrying value of the assets
may not be fully recoverable. According to the Companys accounting policy, when such indicators
are present, and the undiscounted cash flows expected to be generated from operations from those
long-lived assets are less than the carrying value of those long-lived assets, the Company compares
the fair value of the assets (estimated using discounted future net cash flows to be generated from
the lowest common level of operations utilizing the assets) to the carrying value of the long-lived
assets to determine any impairment charges. The Company reduces the carrying value of the
long-lived assets if the carrying value of the long-lived assets is greater than their fair value.
Fair Value of Financial Instruments
The carrying amounts of certain of the Companys financial instruments, including cash
and cash equivalents, accounts receivable, other assets, accounts payable, accrued expenses and
liabilities, approximate their fair values due to their short-term nature.
Concentration of Risk
A majority of the Companys products are currently manufactured, assembled and tested by
third-party contractors in Asia. There are no long-term agreements with any of these contractors. A
significant disruption in the operations of one or more of these contractors would impact the
production of the Companys products for a substantial period of time, which could have a material
adverse effect on the Companys business, financial condition and results of operations.
Financial instruments that potentially subject the Company to a concentration of credit
risk consist of cash, cash equivalents and accounts receivable. The Company deposits cash and cash
equivalents with credit worthy financial institutions. The Company has not experienced any losses
on its deposits of cash and cash equivalents. Management believes that the cash and cash
equivalents are in quality money market funds, and, accordingly, minimal credit risk exists.
7
A majority of the Companys accounts receivable are derived from revenue earned from
customers primarily headquartered in the United States. The Company performs ongoing credit evaluations of its customers financial
condition and, generally, requires no collateral from its customers. The Company provides an
allowance for doubtful accounts receivable based upon the expected collectibility of accounts
receivable. Summarized below are individual customers whose accounts receivable balances or
revenues were 10% or higher of respective total consolidated amounts.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
Nine months ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Percentage
of total net revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer A |
|
|
24 |
% |
|
|
24 |
% |
|
|
29 |
% |
|
|
24 |
% |
|
Customer B |
|
|
12 |
% |
|
|
18 |
% |
|
|
10 |
% |
|
|
19 |
% |
|
Customer C |
|
|
13 |
% |
|
|
* |
|
|
|
11 |
% |
|
|
* |
|
|
|
|
* |
|
Represents less than 10% of the consolidated net revenue for the respective period end. |
|
|
|
|
|
|
|
|
|
|
|
As of September 30, |
|
As of December 31, |
|
|
2008 |
|
2007 |
Percentage of gross accounts receivable |
|
|
|
|
|
|
|
|
|
Customer D |
|
|
18 |
% |
|
|
23 |
% |
|
Customer E |
|
|
* |
|
|
|
13 |
% |
|
Customer F |
|
|
12 |
% |
|
|
* |
|
|
|
|
* |
|
Represents less than 10% of the consolidated accounts receivable for the respective period end.
|
Intangible Assets
Prepaid technology licenses and acquired technologies, which includes technologies
acquired from other companies either as a result of acquisitions or licensing, are capitalized and
amortized on the straight-line method over the estimated useful life of the technologies, which
generally does not exceed five years. Technology license obligations payable in installments are
capitalized using the present value of the payments.
Revenue Recognition
The Company derives its revenue primarily from sales of semiconductor products. The
Company applies the provisions of Staff Accounting Bulletin No. 104 Revenue Recognition, (SAB
104) for product revenue derived by the sale of semiconductor products. Under SAB 104, the Company
recognizes revenue when all of the following criteria have been met: (i) persuasive evidence of a
binding arrangement exists, (ii) delivery has occurred, (iii) the price is deemed fixed or
determinable and free of contingencies and significant uncertainties, and (iv) collection is
probable. The price is considered fixed or determinable at the execution of an agreement, based on
specific products and quantities to be delivered at specified prices, which is often memorialized
with a customer purchase order. Agreements with non-distributor customers do not include rights of
return or acceptance provisions. The Company assesses the ability to collect from the Companys
customers based on a number of factors, including credit worthiness and any past transaction
history of the customer. If the customer is not deemed credit worthy, or the price is not
considered fixed or determinable, the Company defers all revenue from the arrangement until payment
is received and all other revenue recognition criteria are met.
Shipping charges billed to customers are included in product revenue and the related
shipping costs are included in cost of revenue. The Company generally recognizes revenue at the
time of shipment to the Companys customers. Revenue consists primarily of sales of the Companys
products to networking original equipment manufacturers, or OEMs, their contract manufacturers or
its distributors.
8
Initial sales of the Companys products for a new design are usually made
directly to networking OEMs as they design and develop their product. Once their design enters
production, they often outsource their manufacturing to contract manufacturers that purchase
the Companys products directly from the Company or from the Companys distributors.
Revenue is recognized upon shipment for sales to distributors with limited rights of
returns and price protection if the Company concludes it can reasonably estimate the credits for
returns and price adjustments issuable. The Company records an estimated allowance, at the time of
shipment, based on the Companys historical patterns of returns and pricing credits of sales
recognized upon shipment. The credits issued to distributors or other customers were not material
in the three and nine months ended September 30, 2008 and 2007.
Revenue and costs relating to sales to distributors are deferred if the Company grants
more than limited rights of returns and price credits or if it cannot reasonably estimate the level
of returns and credits issuable. During the quarter ended June 30, 2007, the Company signed a
distribution agreement with Avnet, Inc. to distribute the Companys products primarily in the
United States. Given the terms of the distribution agreement, for sales to Avnet revenue and costs
are being deferred until products are sold by Avnet to its end customers. For the three months and
nine months ended September 30, 2008, 3.7% and 3.6% of the Companys net revenues were from
products sold by Avnet. For the three and nine months ended September 30, 2007, less than 1% of the
Companys net revenues were from products sold by Avnet. Revenue recognition depends on
notification from the distributor that product has been sold to Avnets end customers. Avnet
reports to the Company, on at least a monthly basis, the product resale price, quantity and end
customer shipment information, as well as inventory on hand. Reported distributor inventory on hand
is reconciled monthly to the Companys deferred revenue and cost balances. Deferred income on
shipments to Avnet is included in deferred revenue. Accounts receivable from Avnet is recognized
and inventory is relieved when title to inventories transfers, which typically takes place at the
time of shipment, which is the point in time at which the Company has a legal enforceable right to
collection under normal payment terms.
The Company also derives revenue in the form of license and maintenance fees through
licensing its software products. Revenue from such arrangements is recorded by applying the
provisions of Statement of Position, or SOP No. 97-2, Software Revenue Recognition, as amended by
SOP No. 98-9, Modification of SOP No. 97-2, Software Revenue Recognition with Respect to Certain
Transactions. Revenue from such arrangements totaled $1.2 million and $0.2 million for the three
months ended September 30, 2008 and 2007, respectively, and $1.7 million and $0.8 million for the
nine months ended September 30, 2008 and 2007, respectively. The value of any support services is
recognized as services revenue on a straight-line basis over the term of the related support
period, which is typically one year.
The Company also enters into development agreements with some of its customers.
Development revenue is recognized under the proportional performance method, with the associated
costs included in cost of revenue. The Company estimates the proportional performance of the
development contracts based on an analysis of progress toward completion. The Company periodically
evaluates the actual status of each project to ensure that the estimates to complete each contract
remain accurate. If the amount billed exceeds the amount of revenue recognized, the excess amount
is recorded as deferred revenue. Revenue recognized in any period is dependent on progress toward
completion of projects in progress. To the extent the Company is unable to estimate the
proportional performance then the revenue is recognized on a completed performance basis. Revenue
from such arrangements totaled $0.7 million and $1.0 million for the three months ended
September 30, 2008 and 2007, respectively, and $1.7 million and $2.2 million for the nine months
ended September 30, 2008 and 2007, respectively.
Total deferred revenue was $1.7 million as of September 30, 2008 and December 31, 2007,
which includes deferred revenue associated with license and maintenance fees, development revenue
and deferred income on shipments to Avnet.
Warranty Accrual
The Companys products are subject to a one-year warranty period. The Company provides
for the estimated future costs of replacement upon shipment of the product as cost of revenue. The
warranty accrual is estimated based on historical claims compared to historical revenue. The
following table presents a reconciliation of the Companys product warranty liability, which is
included within accrued expenses and other current liabilities in the consolidated balance sheets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands) |
|
Beginning balance |
|
$ |
260 |
|
|
$ |
183 |
|
|
$ |
261 |
|
|
$ |
161 |
|
Accruals for warranties issued |
|
|
35 |
|
|
|
113 |
|
|
|
159 |
|
|
|
211 |
|
Settlements made |
|
|
(35 |
) |
|
|
(32 |
) |
|
|
(160 |
) |
|
|
(108 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending balance |
|
$ |
260 |
|
|
$ |
264 |
|
|
$ |
260 |
|
|
$ |
264 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
9
Indemnities
In the ordinary course of business the Company enters into agreements with customers that
include indemnity provisions. Based on historical experience and other available information the
Company believes its exposure related to the indemnity provisions was immaterial for each of the
periods presented.
Research and Development
Research and development costs are expensed as incurred and primarily include personnel
costs, prototype expenses, which include the cost of fabrication mask costs not reasonably expected
to be used in production manufacturing, and allocated facilities costs as well as depreciation of
equipment used in research and development.
Advertising
The Company expenses advertising costs as incurred. Advertising costs were $34,000 and
$53,000 for the three months ended September 30, 2008 and 2007, respectively, and $0.3 million for
each of the nine months ended September 30, 2008 and 2007.
Operating Leases
The Company recognizes rent expense on a straight-line basis over the term of the lease.
The difference between rent expense and rent paid is recorded as accrued rent in accrued expenses
and other current and non-current liabilities components of the consolidated balance sheets.
Income Taxes
The Company provides for deferred income taxes under the asset and liability method.
Under this method, deferred tax assets, including those related to tax loss carryforwards and
credits, and liabilities are determined based on the differences between the financial statement
and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. A valuation allowance is recorded to reduce deferred tax
assets when it is more likely than not that the net deferred tax asset will not be recovered. The
Company monitors the status of the deferred tax assets on a regular basis. Once sustained
profitability has been achieved in certain tax jurisdictions, the Company will release the
valuation allowance per Statement of Financial Accounting Standards No. 109.
Accounting for Stock-Based Compensation
The Company recognizes stock-based compensation for options granted to employees in
accordance with FAS 123(R). The Company estimates the grant date fair value of stock option awards
under the provisions of SFAS 123(R) using the Black-Scholes option valuation model. The Company
recorded stock-based compensation expense of $1.8 million and $0.5 million for the three months
ended September 30, 2008 and 2007, respectively, and $4.1 million and $1.3 million for the nine
months ended September 30, 2008 and 2007, respectively. In future periods, stock-based compensation
expense may increase as the Company issues additional stock-based awards to continue to attract and
retain key employees. SFAS 123(R) also requires that the Company recognize stock-based compensation
expense only for the portion of stock options that are expected to vest, based on the Companys
estimated forfeiture rate. If the actual number of future forfeitures differs from that estimated
by management, the Company will be required to record adjustments to stock-based compensation
expense in future periods.
The Company accounts for stock-based compensation arrangements with non-employees in
accordance with SFAS 123(R) and Emerging Issues Task Force, or EITF No. 96-18, Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, using a fair value approach. The fair value of the stock options
granted to non-employees was estimated using the Black-Scholes option valuation model. This model
utilizes the value of the Companys common stock on the date of grant, the contractual term of the
option, the expected volatility of the price of the Companys common stock, risk-free interest
rates and the expected dividend yields of the Companys common stock. Stock-based compensation
expense related to non-employees was $20,000 and $19,000 for the three months ended September 30,
2008 and 2007, respectively, and $20,000 and $0.1 million for the nine months ended September 30,
2008 and 2007, respectively.
10
The following table presents the detail of stock-based compensation expense amounts
included in the consolidated statement of operations for each of the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Nine Months Ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
(in thousands) |
|
Cost of revenue |
|
$ |
20 |
|
|
$ |
16 |
|
|
$ |
103 |
|
|
$ |
36 |
|
Research and development |
|
|
805 |
|
|
|
222 |
|
|
|
1,792 |
|
|
|
537 |
|
Sales, general and administrative |
|
|
1,012 |
|
|
|
287 |
|
|
|
2,220 |
|
|
|
729 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,837 |
|
|
$ |
525 |
|
|
$ |
4,115 |
|
|
$ |
1,302 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The total stock-based compensation cost capitalized as part of inventory as of
September 30, 2008 and 2007 was $0.2 million and $19,000, respectively.
Other Comprehensive Income (Loss)
Comprehensive income (loss) includes all changes in equity that are not the result of
transactions with stockholders. For the three and nine months ended September 30, 2008 and 2007,
there are no components of comprehensive income (loss) which are excluded from the net income
(loss) and, therefore, no separate statement of comprehensive income (loss) has been presented.
Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations,
or SFAS No. 141R, which replaces SFAS No 141. The statement retains the purchase method of
accounting for acquisitions, but requires a number of changes, including changes in the way assets
and liabilities are recognized in the purchase accounting. It also changes the recognition of
assets acquired and liabilities assumed arising from contingencies, requires the capitalization of
in-process research and development at fair value, and requires the expensing of
acquisition-related costs as incurred. SFAS No. 141R is effective for financial statements issued
for fiscal years beginning after December 15, 2008 and will apply prospectively to business
combinations completed on or after that date. The Company will assess the impact of SFAS 141R if
and when a future acquisition occurs.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements, or SFAS No. 160. SFAS No. 160 clarifies that a noncontrolling or minority
interest in a subsidiary is considered an ownership interest and, accordingly, requires all
entities to report such interests in subsidiaries as equity in the consolidated financial
statements. SFAS No. 160 is effective for fiscal years beginning after December 15, 2008. The
Company will assess the impact of SFAS 160 if and when a future event occurs.
In April 2008, the FASB issued FSP 142-3, Determination of the Useful Life of Intangible
Assets, or FSP 142-3. FSP 142-3 amends the factors that should be considered in developing renewal
or extension assumptions used to determine the useful life of a recognized intangible asset under
SFAS No. 142, Goodwill and Other Intangible Asset. FSP 142-3 is intended to improve the
consistency between the useful life of a recognized intangible asset under FAS 142 and the period
of expected cash flows used to measure the fair value of the asset under FAS 141(R), Business
Combinations, and other guidance under U.S. GAAP. FSP 142-3 is effective for fiscal years beginning
after December 15, 2008. The Company is currently evaluating the impact, if any, of the adoption of
FSP 142-3 on its consolidated financial statements.
In October 2008, the FASB issued FASB Staff Position FAS 157-3, Determining the Fair Value of
a Financial Asset When the Market for That Asset Is Not Active (FSP 157-3). FSP 157-3 clarified
the application of SFAS 157. FSP 157-3 demonstrated how the fair value of a financial asset is
determined when the market for that financial asset is inactive. FSP 157-3 was effective upon
issuance, including prior periods for which financial statements had not been issued. The
implementation of this standard did not have an impact on our condensed consolidated financial
statements.
2. Net Income Per Common Share
The Company calculates net income per share in accordance with SFAS No. 128, Earnings per
Share, or SFAS 128. Under SFAS 128, basic net income per common share is computed by dividing net
income by the weighted average number of common shares outstanding during the period (excluding
shares subject to repurchase). Diluted net income per common share is computed by dividing net
income by the weighted-average number of common and potentially dilutive common equivalent shares
outstanding during the period. Potentially dilutive securities, composed of incremental common
shares issuable upon the exercise of stock options, restricted stock units, and common stock
subject to repurchase, are included in diluted net income per share for the three months and nine
months ended September 30, 2008 and 2007, respectively.
11
The
following table sets forth the computation of net income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30 |
|
|
Nine Months Ended September 30 |
|
(in thousands, except per share data) |
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
Net income |
|
$ |
1,819 |
|
|
$ |
1,310 |
|
|
$ |
5,864 |
|
|
$ |
221 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding basic |
|
|
40,578 |
|
|
|
39,046 |
|
|
|
40,283 |
|
|
|
25,498 |
|
Dilutive effect of employee stock plans |
|
|
2,050 |
|
|
|
3,691 |
|
|
|
2,334 |
|
|
|
3,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding diluted |
|
|
42,628 |
|
|
|
42,737 |
|
|
|
42,617 |
|
|
|
28,786 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income per share |
|
$ |
0.04 |
|
|
$ |
0.03 |
|
|
$ |
0.15 |
|
|
$ |
0.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted net income per share |
|
$ |
0.04 |
|
|
$ |
0.03 |
|
|
$ |
0.14 |
|
|
$ |
0.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3. Fair Value
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, or SFAS
No. 157. SFAS No. 157 defines fair value, establishes a framework and provides guidance regarding
the methods used for measuring fair value, and expands disclosures about fair value measurements.
SFAS No. 157 was effective for the Company as of January 1, 2008. In February 2008, the FASB issued
FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157, which provides a one
year deferral of the effective date of SFAS 157 for non-financial assets and non-financial
liabilities, except those that are recognized or disclosed in the financial statements at fair
value at least annually. Therefore, the Company has adopted the provisions of SFAS 157 with respect
to its financial assets and liabilities only.
Fair value is defined under SFAS 157 as the exchange price that would be received for an
asset or paid to transfer a liability (an exit price) in the principal or most advantageous market
for the asset or liability in an orderly transaction between market participants on the measurement
date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of
observable inputs and minimize the use of unobservable inputs. The standard describes a fair value
hierarchy based on three levels of inputs, of which the first two are considered observable and the
last unobservable, that may be used to measure fair value which are the following:
|
|
Level 1 Quoted prices in active markets for identical assets or liabilities. |
|
|
|
Level 2 Inputs other than Level 1 that are observable, either directly or
indirectly, such as quoted prices for similar assets or liabilities; quoted
prices in markets that are not active; or other inputs that are observable or
can be corroborated by observable market data for substantially the full term
of the assets or liabilities. |
|
|
|
Level 3 Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets or
liabilities. |
The adoption of this statement did not have a material impact on the Companys consolidated
results of operations and financial condition.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets
and Financial Liabilities, or SFAS No. 159, which permits entities to choose to measure eligible
financial instruments and certain other items at fair value that are not currently required to be
measured at fair value. Unrealized gains and losses on items for which the fair value option has
been elected are reported in earnings at each subsequent reporting date. SFAS No. 159 is effective
for fiscal years beginning after November 15, 2007. Effective January 1, 2008, the Company adopted
SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159).
SFAS 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent
measurement for specified financial assets and liabilities on a contract-by-contract basis. The
Company did not elect to adopt the fair value option for assets or liabilities under this
Statement.
At September 30, 2008, the Companys investment was classified as cash
equivalents and was comprised of an investment in a money market fund. In accordance with SFAS
157, the Company determined the fair value hierarchy of its financial assets (cash equivalents) in
the money market fund as Level 1, which approximated $87.1 million as of September 30, 2008.
12
4. Inventories
Inventories are stated at the lower of cost (determined using the first-in, first-out
method), or market value (estimated net realizable value) and are comprised of the following:
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
As of |
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Work-in-process |
|
$ |
12,859 |
|
|
$ |
8,092 |
|
Finished goods |
|
|
2,442 |
|
|
|
1,481 |
|
|
|
|
|
|
|
|
|
|
$ |
15,301 |
|
|
$ |
9,573 |
|
|
|
|
|
|
|
|
5. Property and Equipment, net
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
As of |
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Mask costs and test equipment |
|
$ |
9,778 |
|
|
$ |
5,587 |
|
Software, computer and other equipment |
|
|
13,955 |
|
|
|
12,738 |
|
Furniture, office equipment and leasehold improvements |
|
|
120 |
|
|
|
57 |
|
|
|
|
|
|
|
|
|
|
|
23,853 |
|
|
|
18,382 |
|
Less: accumulated depreciation and amortization |
|
|
(13,017 |
) |
|
|
(6,774 |
) |
|
|
|
|
|
|
|
|
|
$ |
10,836 |
|
|
$ |
11,608 |
|
|
|
|
|
|
|
|
Depreciation and amortization expense was $2.2 million and $1.3 million for the three months
ended September 30, 2008 and 2007, respectively, and $6.2 million and $3.1 million for the nine
months ended September 30, 2008 and 2007, respectively.
Assets under capital leases included in property and equipment were $8.1 million at September
30, 2008 and $7.9 million at December 31, 2007. Amortization expense related to assets recorded
under capital lease was $0.7 million and $0.4 million for the three months ended September 30, 2008
and 2007, respectively, and $2.0 million and $1.0 million for the nine months ended September 30,
2008 and 2007, respectively.
6. Acquisition
Star Semiconductor Corporation
On August 1, 2008, the Company and two of its subsidiaries (the Purchasers) acquired
substantially all of the intangible assets and inventory and certain other tangible assets of Star
Semiconductor Corporation (Star), a Taiwan-based design house in Hsinchu that builds highly
integrated ARM-based SOC processors for the broadband, connected home and SOHO market segments. The
Purchasers paid approximately $9.6 million in cash, including acquisition related expenses of
approximately $0.8 million. Included in the purchase price was $1.0 million that was placed in
escrow for 60 days after the close in order to indemnify the Company for certain matters, including
breaches of representations and warranties and covenants made by Star. The acquisition will provide
the Company with a highly experienced stand-alone SOC processor team based in Taiwan. The results
of operations from Star have been included in the Companys consolidated statements of operations
only since the date of acquisition.
The acquisition was accounted for using the purchase method of accounting in accordance with
SFAS No. 141, Business Combinations. Under the purchase method of accounting, the total
estimated purchase price was allocated to the tangible and identifiable intangible assets and
liabilities assumed based on their relative fair values. The excess of the purchase price over the
net tangible and identifiable intangible assets was recorded as goodwill. In accordance with SFAS
No. 142, goodwill will not be amortized, but instead will be tested for impairment at least
annually and more frequently if certain indicators are present. All of the $3.4 million allocated
to goodwill is expected to be deductible for state income tax purposes but not for federal
purposes. The final purchase price allocation may differ based upon the final purchase price. While
the Company has accrued all acquisition costs that it is aware of, any adjustments to these costs
will be adjusted to goodwill. The purchase price allocation will be
finalized in the year ending December 31, 2009. The total
purchase price was as follows:
|
|
|
|
|
|
|
Amount |
|
Total purchase price of the acquisition of Star is as follows: |
|
(in thousands) |
|
Cash consideration |
|
$ |
8,790 |
|
Acquisition related expenses (1) |
|
|
849 |
|
|
|
|
|
Total purchase price |
|
$ |
9,639 |
|
|
|
|
|
|
|
|
(1) |
|
Acquisition related expenses include legal and accounting fees and other external costs directly related to the
acquisition. |
13
The purchase price allocation was as follows (in thousands):
|
|
|
|
|
Net tangible assets |
|
$ |
973 |
|
Identifiable intangible assets: |
|
|
|
|
Existing and core technology |
|
|
4,823 |
|
Customer contracts and relationships |
|
|
307 |
|
Trade name |
|
|
82 |
|
Order backlog |
|
|
83 |
|
Goodwill |
|
|
3,371 |
|
|
|
|
|
Total purchase price |
|
$ |
9,639 |
|
|
|
|
|
The following table represents details of the purchased intangible assets as part of the
acquisition:
|
|
|
|
|
|
|
|
|
|
|
Estimated useful |
|
|
|
|
Intangible Assets |
|
life (in years) |
|
|
Amount |
|
|
|
|
Existing technology product |
|
|
4.0 |
|
|
$ |
3,849 |
|
Core technology product |
|
|
4.0 |
|
|
|
467 |
|
Existing technology licensed |
|
|
0.2 |
|
|
|
507 |
|
Customer contracts and relationships |
|
|
7.0 |
|
|
|
307 |
|
Trade name |
|
|
2.0 |
|
|
|
82 |
|
Order backlog |
|
|
0.2 |
|
|
|
83 |
|
|
|
|
|
|
|
|
|
Total |
|
|
|
|
|
$ |
5,295 |
|
|
|
|
|
|
|
|
|
The fair value of the existing technology- product, existing technology-licensed and the
customer contracts and relationships was determined based on an income approach using the
discounted cash flow method. The discount rate of 18.0% used to value the existing technology -
product and discount rate of 20.0% used to value the customer contracts and relationships was
estimated using a discount rate based on implied rate of return of the transaction, adjusted for
the specific risk profile of each asset. The discount rate of 4.5% used to value the existing
technology-licensed was based on a short-term risk free interest rate. The remaining useful life
was estimated based on historical product development cycles, the projected rate of technology
attrition, and the patterns of project economic benefit of the assets.
The fair value of core technology and trade name was determined using a variation of income
approach known as the profit allocation method. The estimated savings in profit were determined
using a 3.0% profit allocation rate and a discount rate of 18.0%. The estimated useful life was
determined based on the future economic benefit expected to be received from the asset.
The fair value of order backlog was determined using cost approach where the fair value was
based on estimated sales and marketing expenses expected to be incurred to regenerate the order
backlog. The estimated useful life was determined based on the future economic benefit expected to
be received from the asset.
Pro forma financial information
The unaudited financial information in the table below summarizes the combined results of
operations of the Company and Star, on a pro forma basis, as though the companies had been combined
as of the beginning of each of the periods presented. The pro forma 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 at the beginning of each of the periods
presented. The pro forma financial information
for all periods presented includes the purchase accounting adjustments on historical Star
inventory, amortization charges
from acquired intangible assets and related tax effects.
The unaudited pro forma financial information for the three months ended September 30, 2008
combines the results for the Company for the three months ended September 30, 2008, which include
the results of Star subsequent to August 1, 2008 (the acquisition date), and the historical results
for Star for the one month ended July 31, 2008. The unaudited pro forma financial information for
the nine months ended September 30, 2008 combines the results of the Company for the nine months
ended September 30, 2008, which include the results of Star subsequent to August 1, 2008, and the
historical results of Star for the seven months ended July 31, 2008. The unaudited pro forma
financial information for the three and nine months ended September 30, 2007
14
combines the
historical results of the Company and Star for the three and nine months ended September 30, 2007.
The following table summarizes the pro forma financial information (in thousands, except per share
amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Net revenue |
|
$ |
24,596 |
|
|
$ |
14,593 |
|
|
$ |
65,784 |
|
|
$ |
39,247 |
|
|
Net income (loss) |
|
$ |
1,171 |
|
|
$ |
(114 |
) |
|
$ |
3,576 |
|
|
$ |
(2,664 |
) |
|
Net income (loss) per common share, basic |
|
$ |
0.03 |
|
|
$ |
(0.00 |
) |
|
$ |
0.09 |
|
|
$ |
(0.10 |
) |
|
Net income (loss) per common share, diluted |
|
$ |
0.03 |
|
|
$ |
(0.00 |
) |
|
$ |
0.08 |
|
|
$ |
(0.10 |
) |
Parallogic Corporation
On
May 20, 2008, the Company acquired Parallogic Corporation
(Parallogic), a privately held company. The aggregate purchase price consisted of cash
consideration of $1.3 million, including direct acquisition costs of approximately $61,000. To date
the Company has paid $0.8 million in cash associated with the acquisition. The remaining two
subsequent payments of $0.2 million each are due at the completion of certain milestones or 18
th and 36 th month anniversaries of the acquisition date, whichever comes first.
Identifiable intangible assets of approximately $0.5 million consist of intellectual property
related to the developed technology as well as incremental value associated with existing customer
relationships. The developed technology acquired from Parallogic is the multi-core software focused
on gigabit packet processing and security applications.
The total purchase price was allocated to tangible and identifiable intangible assets based on
their estimated fair value as of May 20, 2008. The excess of the purchase price over the tangible
and identifiable intangible assets were recorded as goodwill. The purchase price allocation was as
follows (in thousands):
|
|
|
|
|
Net tangible assets |
|
$ |
|
|
Identifiable intangible assets: |
|
|
|
|
Customer relationships |
|
|
76 |
|
Developed technology |
|
|
374 |
|
Goodwill |
|
|
816 |
|
|
|
|
|
Total purchase price |
|
$ |
1,266 |
|
|
|
|
|
The fair value assigned to developed technology and customer relationships were based upon
future discounted cash flows related to the assets projected income streams using a discount rate
of 20% and 15% respectively. Factors considered in estimating the discounted cash flows to be
derived from developed technology and customer relationships include risk related to the
characteristics and applications of the technology, existing and future markets and an assessment
of the age of the technology within its life span. The Company is amortizing the purchased
intangible assets to cost of revenue on a straight-line basis over its estimated useful life of 1
to 5 years.
Beginning on the acquisition date, May 20, 2008, the results of operations of Parallogic are
included in our condensed consolidated
statements of operations. Pro forma results of operations for the acquisition have not been
presented as the effect has not been significant.
Of the total purchase price, approximately $0.8 million was allocated to goodwill, which
represents the excess of the purchase price over the estimated fair value of the underlying net
tangible and identifiable intangible assets acquired. The goodwill was attributed to the premium
paid for the opportunity to expand and better serve the addressable market and achieve greater
long-term growth opportunities. All of the $0.8 million allocated to the goodwill is expected to be
deductible for tax purposes. Management believes with the acquisition the Company will be better
positioned to deliver professional services for customers to help reduce the time-to-market for
design wins and provide high-performance tuning. In accordance with SFAS No. 142, goodwill will not
be amortized, but instead will be tested for impairment at least annually and more frequently if
certain indicators are present.
15
7. Intangible Assets, net
Intangible assets consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
As of |
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Developed technology |
|
$ |
8,540 |
|
|
$ |
3,343 |
|
Customer contracts and relationships |
|
|
383 |
|
|
|
|
|
Technology license |
|
|
9,205 |
|
|
|
9,205 |
|
Trade name |
|
|
82 |
|
|
|
|
|
Order backlog |
|
|
83 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,293 |
|
|
|
12,548 |
|
Less: accumulated amortization |
|
|
|
|
|
|
|
|
Developed technology |
|
|
(4,055 |
) |
|
|
(3,235 |
) |
Customer contracts and relationships |
|
|
(32 |
) |
|
|
|
|
Technology license |
|
|
(5,904 |
) |
|
|
(5,217 |
) |
Trade name |
|
|
(7 |
) |
|
|
|
|
Order backlog |
|
|
(83 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
8,212 |
|
|
$ |
4,096 |
|
|
|
|
|
|
|
|
Amortization expense was $1.0 million and $0.4 million for the three months ended
September 30, 2008 and 2007, respectively, and $1.6 million and $1.2 million for the nine months
ended September 30, 2008 and 2007, respectively. The weighted-average remaining estimated lives for
intangible assets are approximately 3.2 years for developed technology and 1.7 years for technology
license. The weighted average remaining estimated life of intangible assets in total is
approximately 2.4 years. Future amortization expenses are estimated to be $0.5 million for 2008,
$2.8 million for 2009, $2.5 million for 2010, $1.4 million for 2011, $0.9 million for 2012 and
$0.1 million thereafter.
8. Accrued Expenses and Other Current Liabilities
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
As of |
|
|
|
September 30, 2008 |
|
|
December 31, 2007 |
|
|
|
(in thousands) |
|
Accrued compensation and related benefit |
|
$ |
911 |
|
|
$ |
1,010 |
|
Accrued warranty |
|
|
260 |
|
|
|
261 |
|
Refundable deposits related to unvested employee stock option exercises |
|
|
12 |
|
|
|
70 |
|
Professional fees |
|
|
1,005 |
|
|
|
285 |
|
Income tax payable |
|
|
870 |
|
|
|
231 |
|
Other |
|
|
389 |
|
|
|
396 |
|
|
|
|
|
|
|
|
|
|
$ |
3,447 |
|
|
$ |
2,253 |
|
|
|
|
|
|
|
|
9. Common Stock
Stock Options and Unvested Common Stock
Upon completion of its IPO in May 2007, the Company adopted the 2007 Stock Incentive
Plan, or the 2007 Plan, which reserved 5,000,000 shares of the Companys common stock. The number
of shares of the common stock reserved for issuance increased in January 2008 by 2,015,368 shares,
pursuant to the automatic provision of the 2007 Plan. The 2007 Plan provides for the grant of
incentive stock options, nonstatutory stock options, restricted stock awards, restricted stock unit
awards, stock appreciation rights, performance stock awards, and other forms of equity
compensation, or collectively, the stock awards, and performance cash awards, all of which may be
granted to employees (including officers), directors, and consultants or affiliates. Awards granted
under the 2007 Plan vest at the rate specified by the plan administrator, typically with 1/8th of
the shares vesting six months after the date of grant and 1/48th of the shares vesting monthly
thereafter over the next three and one half years. The term of awards expires seven to ten years
from the date of grant. As of September 30, 2008, 2,518,495 shares have been granted under the 2007
Plan.
Prior to the IPO, the Company issued stock options pursuant to the 2001 Stock Incentive
Plan, or the 2001 Plan. As of September 30, 2008, 409,243 shares of the Companys common stock were
reserved for issuance to employees, officers, directors, consultants and advisors of the Company
pursuant to outstanding options. Options granted under the 2001 Plan were either incentive stock
options or non-statutory stock options as determined by the Companys board of directors. Options
granted under the 2001 Plan
16
vest at the rate specified by the plan administrator, typically with
1/8th of the shares vesting six months after the date of grant and 1/48th of the shares vesting
monthly thereafter over the next three and one half years to four and one half years. The term of
option expires ten years from the date of grant. No options to purchase shares have been granted
under the 2001 Plan in the three months and nine months ended September 30, 2008.
Under the Companys 2001 Plan, certain employees have the right to early-exercise
unvested stock options, subject to rights held
by the Company to repurchase unvested shares in the event of voluntary or involuntary termination.
For options granted prior to March 2005, the Company has the right to repurchase any such shares at
the shares original purchase price. For options granted after March 2005, the Company has the
right to repurchase such shares at the lower of market value or the original purchase price.
For those options granted prior to March 2005, in accordance with EITF 00-23, Working
Group Work Plan Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25,
Accounting for Stock Issued to Employees, and FASB Interpretation No. 44 Accounting for Certain
Transactions involving Stock Compensation, the Company accounts for cash received in consideration
for the early-exercise of unvested stock options as a current liability, included as a component of
accrued liabilities in the Companys consolidated balance sheets. For those shares issued in
connection with options granted prior to March 2005, there were 16,201 and 123,895 unvested shares
outstanding as of September 30, 2008 and December 31, 2007, respectively, and $13,000 and $70,000
related liabilities, respectively.
Detail related to activity of early-exercise unvested shares of common stock is as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
Number of |
|
|
Average |
|
|
|
Unvested |
|
|
Exercise/ |
|
|
|
Shares |
|
|
Purchase |
|
|
|
Outstanding |
|
|
Price |
|
Balance as of December 31, 2007 |
|
|
436,662 |
|
|
$ |
2.45 |
|
Issued |
|
|
|
|
|
|
|
|
Vested |
|
|
(87,125 |
) |
|
|
1.89 |
|
Cancelled and forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2008 |
|
|
349,537 |
|
|
$ |
2.59 |
|
|
|
|
|
|
|
|
|
Issued |
|
|
|
|
|
|
|
|
Vested |
|
|
(85,654 |
) |
|
|
1.98 |
|
Cancelled and forfeited |
|
|
(4,480 |
) |
|
|
0.88 |
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2008 |
|
|
259,403 |
|
|
$ |
2.82 |
|
|
|
|
|
|
|
|
|
Issued |
|
|
|
|
|
|
|
|
Vested |
|
|
(61,089 |
) |
|
|
1.85 |
|
Cancelled and forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of September 30, 2008 |
|
|
198,314 |
|
|
$ |
3.12 |
|
|
|
|
|
|
|
|
|
17
Detail related to stock option activity is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
Average |
|
|
|
Number of |
|
|
Exercise |
|
|
|
Shares |
|
|
Price |
|
|
|
Outstanding |
|
|
per Share |
|
Balance at December 31, 2007 |
|
|
3,920,001 |
|
|
$ |
3.86 |
|
Options granted |
|
|
1,476,975 |
|
|
|
15.24 |
|
Options exercised |
|
|
(81,395 |
) |
|
|
1.61 |
|
Options cancelled and forfeited |
|
|
(20,754 |
) |
|
|
7.34 |
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2008 |
|
|
5,294,827 |
|
|
$ |
7.06 |
|
|
|
|
|
|
|
|
|
Options granted |
|
|
404,800 |
|
|
|
20.53 |
|
Options exercised |
|
|
(402,901 |
) |
|
|
1.47 |
|
Options cancelled and forfeited |
|
|
(22,068 |
) |
|
|
7.00 |
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2008 |
|
|
5,274,658 |
|
|
$ |
8.52 |
|
|
|
|
|
|
|
|
|
Options granted |
|
|
144,200 |
|
|
|
16.74 |
|
Options exercised |
|
|
(17,232 |
) |
|
|
2.58 |
|
Options cancelled and forfeited |
|
|
(75,227 |
) |
|
|
13.88 |
|
|
|
|
|
|
|
|
|
Balance as of September 30, 2008 |
|
|
5,326,399 |
|
|
$ |
8.68 |
|
|
|
|
|
|
|
|
|
The total intrinsic value for options exercised amounted to $0.3 million and $3,000 for the
three months ended September 30, 2008 and 2007, respectively, and $9.1 million and $1.2 million for
the nine months ended September 30, 2008 and 2007, respectively, representing the difference
between the closing price of the Companys common stock at the date of exercise and the exercise
price.
The following table summarizes information about stock options outstanding as of
September 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding Options |
|
|
Exercisable Options |
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number |
|
|
Average |
|
|
Weighted |
|
|
Number |
|
|
Weighted |
|
|
Aggregate |
|
|
|
Outstanding |
|
|
Remaining |
|
|
Average |
|
|
Exercisasble |
|
|
Average |
|
|
Intrinsic |
|
Exercise Prices |
|
As of 9/30/08 |
|
|
Contractual Term |
|
|
Exercise Price |
|
|
As of 9/30/08 |
|
|
Exercise Price |
|
|
Value |
|
$0.20 - 0.80 |
|
|
281,556 |
|
|
|
5.69 |
|
|
$ |
0.31 |
|
|
|
280,253 |
|
|
$ |
0.30 |
|
|
|
|
|
1.02 - 1.50 |
|
|
966,086 |
|
|
|
6.86 |
|
|
|
1.05 |
|
|
|
743,745 |
|
|
|
1.03 |
|
|
|
|
|
3.04 - 3.04 |
|
|
1,440,926 |
|
|
|
7.47 |
|
|
|
3.04 |
|
|
|
710,091 |
|
|
|
3.04 |
|
|
|
|
|
3.74 - 8.52 |
|
|
489,140 |
|
|
|
8.20 |
|
|
|
6.96 |
|
|
|
166,063 |
|
|
|
6.59 |
|
|
|
|
|
14.80 - 14.80 |
|
|
1,316,075 |
|
|
|
6.46 |
|
|
|
14.80 |
|
|
|
160,826 |
|
|
|
14.80 |
|
|
|
|
|
16.32 - 20.98 |
|
|
615,916 |
|
|
|
6.56 |
|
|
|
19.17 |
|
|
|
48,583 |
|
|
|
19.89 |
|
|
|
|
|
23.92 - 31.54 |
|
|
216,700 |
|
|
|
8.53 |
|
|
|
28.09 |
|
|
|
53,046 |
|
|
|
28.40 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.20 - 31.54 |
|
|
5,326,399 |
|
|
|
7.02 |
|
|
$ |
8.68 |
|
|
|
2,162,607 |
|
|
$ |
4.14 |
|
|
$ |
35,861,728 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable |
|
|
2,162,607 |
|
|
|
|
|
|
$ |
4.14 |
|
|
|
|
|
|
|
|
|
|
$ |
22,646,137 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest |
|
|
4,921,995 |
|
|
|
|
|
|
$ |
8.53 |
|
|
|
|
|
|
|
|
|
|
$ |
33,773,257 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of each employee option grant for the three months and nine months ended
September 30, 2008 and 2007 under SFAS 123(R) was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Risk-free interest rate |
|
2.70% |
|
4.13% |
|
2.33% to 3.32% |
|
4.13%-4.72% |
Expected life |
|
4.53 - 4.75 years |
|
4 years |
|
4.53 - 4.75 years |
|
4.0 to 5.0 years |
Dividend yield |
|
None |
|
None |
|
None |
|
None |
Volatility |
|
58.50% |
|
45.00% |
|
55.40% to 58.50% |
|
45-55% |
The Company determined that it was not practical to calculate the historical volatility of
its share price since the Company has limited information on its past volatility as its securities
were not publicly traded prior to May 2007, before which there was no readily
18
determinable market
value for its stock. Further, the Company is a high-growth technology company whose future
operating results are not comparable to its prior operating results. Therefore, the Company
estimated its expected volatility based on reported market value data for a group of publicly
traded companies, which it selected from certain market indices, that the Company believed was
relatively comparable after consideration of their size, stage of life cycle, profitability,
growth, and risk and return on investment. The expected term represents the period that stock-based
awards are expected to be outstanding, giving consideration to the contractual terms of the
stock-based awards, vesting schedules and expectations of future employee behavior as influenced by
changes to the terms of our stock-based awards. For the nine months ended September 30, 2008, the
Company used the simplified method of determining the expected term as permitted by the provisions
of Staff Accounting Bulletin No. 110, Year-End Help for Expensing Employee Stock Options.
The estimated weighted-average grant date fair value of options granted were $8.36 and $11.04
for the three months ended September 30, 2008 and 2007, respectively, and $7.89 and $7.16 for the
nine months ended September 30, 2008 and 2007, respectively.
As of September 30, 2008, there was $17.7 million of unrecognized compensation costs related
to stock options granted under the companys 2001 Plan and 2007 Plan. The unrecognized compensation
cost is expected to be recognized over a weighted average period of 2.81 years.
Restricted Stock Unit Awards
The company began issuing restricted stock units, or RSUs, in the fourth quarter of 2007.
Shares are issued on the date the restricted stock units vest, and the fair value of the underlying
stock on the dates of grant is recognized as stock-based compensation over the vesting periods.
Below is the information as of September 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
Average |
|
|
Average |
|
|
|
|
|
|
|
|
|
|
Grant |
|
|
Remaining |
|
|
Aggregate |
|
|
|
Number of |
|
|
Date Fair |
|
|
Contractual |
|
|
Intrinsic |
|
|
|
Shares |
|
|
Value Per |
|
|
Term (years) |
|
|
Value (1) |
|
Balance as of December 31, 2007 |
|
|
12,000 |
|
|
$ |
31.54 |
|
|
|
|
|
|
|
|
|
Granted |
|
|
18,400 |
|
|
|
14.80 |
|
|
|
|
|
|
|
|
|
Issued and released |
|
|
(2,375 |
) |
|
|
31.54 |
|
|
|
|
|
|
|
|
|
Cancelled and forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of March 31, 2008 |
|
|
28,025 |
|
|
$ |
20.55 |
|
|
|
1.06 |
|
|
$ |
459,610 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and expected to vest as of March 31, 2008 |
|
|
26,312 |
|
|
|
20.55 |
|
|
|
1.05 |
|
|
$ |
431,519 |
|
Granted |
|
|
28,000 |
|
|
|
19.65 |
|
|
|
|
|
|
|
|
|
Issued and released |
|
|
(875 |
) |
|
|
31.54 |
|
|
|
|
|
|
|
|
|
Cancelled and forfeited |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of June 30, 2008 |
|
|
55,150 |
|
|
$ |
19.92 |
|
|
|
1.41 |
|
|
$ |
1,158,150 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected to vest as of June 30, 2008 |
|
|
50,597 |
|
|
|
19.92 |
|
|
|
1.36 |
|
|
$ |
1,062,539 |
|
Granted |
|
|
248,420 |
|
|
|
16.70 |
|
|
|
|
|
|
|
|
|
Issued and released |
|
|
(2,625 |
) |
|
|
16.14 |
|
|
|
|
|
|
|
|
|
Cancelled and forfeited |
|
|
(500 |
) |
|
|
14.80 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of September 30, 2008 |
|
|
300,445 |
|
|
$ |
17.30 |
|
|
|
1.82 |
|
|
$ |
4,230,266 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected to vest as of September 30, 2008 |
|
|
271,638 |
|
|
$ |
17.30 |
|
|
|
1.75 |
|
|
$ |
3,824,658 |
|
|
|
|
(1) |
|
Aggregate intrinsic value for RSUs represents the closing price per
share of the Companys stock on September 30, 2008, multiplied by the
number of unvested RSUs expected to vest as of September 30, 2008. |
For RSUs, stock-based compensation expense is calculated based on the market price of the
Companys common stock on the date of grant, multiplied by the number of RSUs granted. The grant
date fair value of RSUs, less estimated forfeitures, is recorded on a straight-line basis, over the
vesting period.
During the three months ended September 30, 2008, the Company issued 248,420 restricted
stock units which will vest over four years. As of September 30, 2008, there was $4.4 million of
unrecognized compensation costs related to restricted stock units granted under the Companys 2007
Equity Incentive Plan. The unrecognized compensation cost is expected to be recognized over a
weighted average period of 1.82 years.
19
10. Current and Deferred Income Taxes
For the three months ended September 30, 2008 and 2007, the provision for income taxes
was based on the estimated annual effective tax rate in compliance with SFAS 109 and other related
guidance. The Company updates its estimate of its annual effective tax rate at the end of each
quarterly period. The estimate takes into account estimations of annual pre-tax income, the
geographic mix of pre-tax income and interpretations of tax laws and the possible outcomes of
current and future audits.
The following table presents the provision and benefit for income taxes and the effective
tax rates for the three months and nine months ended September 30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
|
(in thousands) |
Income before income taxes |
|
$ |
2,273 |
|
|
$ |
1,420 |
|
|
$ |
6,805 |
|
|
$ |
422 |
|
Income tax provision |
|
$ |
454 |
|
|
$ |
110 |
|
|
$ |
941 |
|
|
$ |
201 |
|
Effective tax rate |
|
|
20.0 |
% |
|
|
7.7 |
% |
|
|
13.8 |
% |
|
|
47.6 |
% |
The provision for income taxes was $0.5 million and $0.1 million for the three months
ended September 30, 2008 and 2007, respectively, and $0.9 million and $0.2 million for the nine
months ended September 30, 2008 and 2007, respectively. The income tax expense was primarily
related to the federal alternative minimum tax on profits in the United States adjusted by certain
non-deductible items, international taxes and state income taxes.
A valuation allowance is recorded to reduce any deferred tax asset that is more likely
than not to be not realized. The Company performed assessments of the realization of the deferred
tax assets considering all available evidence, both positive and negative. These assessments
require that management makes significant judgments about many factors, including the amount and
likelihood of future taxable income. As a result of this assessment, the Company concluded that it
was more likely than not that the deferred tax assets would not be realized and recorded a full
valuation allowance against its deferred tax assets. The Company will continue to evaluate the need
for a valuation allowance. The Company may determine that some, or all, of its deferred tax assets
will be realized, in which case it will reduce the valuation allowance in the quarter in which such
determination is made. If a determination is made to reduce the valuation allowance the impact to
the net income could be material. If the valuation allowance is reduced, the Company may recognize
a benefit from income taxes on its income statement in that period. If such a benefit is
recognized, then subsequent periods are likely to have significantly higher tax provision expenses.
The difference between the provision for income that would be derived by applying the
statutory rate to income before tax for the three months and nine months ended September 30, 2008
and the provision actually recorded was due to the impact of non-deductible SFAS 123R stock option
compensation expenses offset by the benefit from net operating loss carryforwards and utilization
of research credits carryforwards.
As a result of the implementation of FIN 48, the Company did not recognize any adjustment
to the liability for uncertain tax positions and therefore did not record any adjustment to the
beginning balance of retained earnings. As of December 31, 2007 the Company had $3.6 million of
unrecognized tax benefits, which is netted against deferred tax assets and is fully offset by a
valuation allowance. There were no significant changes to the unrecognized tax benefit during the
nine months ended September 30, 2008.
The Companys major tax jurisdictions are the United States federal government and the
State of California. The Company files income tax returns in the United States federal
jurisdiction, the State of California and various state and foreign tax jurisdictions in which it
has a subsidiary or branch operation. The United States federal corporation income tax returns
beginning with the 2000 tax year remain subject to examination by the Internal Revenue Service, or
IRS. The California corporation income tax returns beginning with the 2000 tax year remain subject
to examination by the California Franchise Tax Board. There are no on-going income tax audits
in the major tax jurisdictions.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (Act) was enacted. The
Act retroactively extended the federal research credits that expired on January 1, 2008. The
Company is currently evaluating the impact of this Act for the year-end December 31, 2008 tax
provision.
11. Retirement Plan
The Company has established a defined contribution savings plan under Section 401(k) of
the Internal Revenue Code. This plan covers substantially all employees who meet minimum age and
service requirements and allows participants to defer a portion of their annual compensation on a
pre-tax basis. Company contributions to the plan may be made at the discretion of the board of
directors. For the year ending December 31, 2008 the Company matches 50% of the employees
contribution up to $2,000 per year per employee.
20
12. Segment Information
SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information,
establishes standards for reporting information about operating segments. Operating segments are
defined as components of an enterprise for which separate financial information is available and
evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding
how to allocate resources and in assessing performance. The Company is organized as, and operates
in, one reportable segment: the development and sale of semiconductor processor solutions for
next-generation intelligent networking equipment. The chief operating decision-maker is the Chief
Executive Officer. The Companys Chief Executive Officer reviews financial information presented on
a consolidated basis, accompanied by information about revenue by customer and geographic region,
for purposes of evaluating financial performance and allocating resources. The Company and its
Chief Executive Officer evaluate performance based primarily on revenue to the customers and in the
geographic locations in which the Company operates. Revenue is attributed by geographic location
based on the ship-to location of customers. The Companys assets are primarily located in the
United States of America and not allocated to any specific region. Therefore, geographic
information is presented only for total revenue. Substantially all of the Companys long-lived
assets are located in the United States of America.
The following table is based on the geographic location of the OEMs or the distributors
who purchased the Companys products. For sales to the distributors, their geographic location may
be different from the geographic locations of the ultimate end users. Sales by geography for the
periods indicated were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Nine months ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
United States |
|
$ |
12,252 |
|
|
$ |
8,435 |
|
|
$ |
32,803 |
|
|
$ |
23,163 |
|
Taiwan |
|
|
3,786 |
|
|
|
2,567 |
|
|
|
9,419 |
|
|
|
7,162 |
|
Japan |
|
|
3,675 |
|
|
|
516 |
|
|
|
8,515 |
|
|
|
2,030 |
|
China |
|
|
1,732 |
|
|
|
1,128 |
|
|
|
4,686 |
|
|
|
2,296 |
|
Other countries |
|
|
3,080 |
|
|
|
1,519 |
|
|
|
9,006 |
|
|
|
3,321 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
24,525 |
|
|
$ |
14,165 |
|
|
$ |
64,429 |
|
|
$ |
37,972 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13. Commitments and Contingencies
The Company is not currently a party to any legal proceedings that management believes
would have a material adverse effect on the consolidated financial position, results of operations
or cash flows of the Company.
The Company leases its facilities under non-cancelable operating leases, which contain
renewal options and escalation clauses, and
expires in May 2012. The Company also acquires certain assets under capital leases.
21
Minimum commitments under non-cancelable capital and operating lease agreements as of
September 30, 2008 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital lease |
|
|
|
|
|
|
|
|
|
and technology |
|
|
|
|
|
|
|
|
|
license |
|
|
Operating |
|
|
|
|
|
|
obligations |
|
|
leases |
|
|
Total |
|
|
|
(in thousands) |
|
Remainder of 2008 |
|
$ |
957 |
|
|
$ |
402 |
|
|
$ |
1,359 |
|
2009 |
|
|
2,595 |
|
|
|
1,103 |
|
|
|
3,698 |
|
2010 |
|
|
1,774 |
|
|
|
1,113 |
|
|
|
2,887 |
|
2011 |
|
|
|
|
|
|
844 |
|
|
|
844 |
|
2012 |
|
|
|
|
|
|
199 |
|
|
|
199 |
|
thereafter |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
5,326 |
|
|
$ |
3,661 |
|
|
$ |
8,987 |
|
Less: Interest component |
|
|
(405 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Present value of minimum lease payment |
|
|
4,921 |
|
|
|
|
|
|
|
|
|
Less: current portion |
|
|
(2,666 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term portion of obligations |
|
$ |
2,255 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rent expense incurred under operating leases was $0.5 million and $0.3 million for the three
months ended September 30, 2008 and 2007, and $1.2 million and $0.7 million for the nine months
ended September 30, 2008 and 2007, respectively.
The Company also has a purchase agreement with Synopsys Inc., or Synopsys, to purchase
certain intellectual property which is to be used for the Companys future products. The Company
has an agreement to pay $1.15 million over the two-year period for various intellectual properties.
The agreement will expire in October 2008. As of September 30, 2008, $1.0 million has been paid to
purchase certain intellectual property.
The technology license obligations include future cash payments payable primarily for
license agreements with outside vendors. One of the license agreements is with Cadence Design
Systems for its electronic design automation software which is used in the design of the Companys
products. The term of the license is two years and will expire in June 2009. The second license
agreement is with MIPS Technologies, Inc. which includes a non-exclusive, non-transferable right to
develop multiple licensed MIPS cores that implement the MIPS architecture. This second license
agreement required the Company to pay $1.9 million after the completion of its IPO for an automatic
two-year extension of the license. The term of the license after the two-year extension is seven
years and will expire in December 2010. As of September 30, 2008, $1.7 million was paid, and the
balance is accrued within capital lease and technology license obligations on the consolidated
balance sheets.
In October 2007, the Company signed a license agreement with Synopsys for certain design
tools totaling $7.0 million, with 12 installment payments. The term of the license is three years
and will expire in October 2010. The present value of the installment payments has been capitalized
and is amortized over three years, and included within capital lease and technology license
obligations on the consolidated balance sheets. As of September 30, 2008, $2.3 million was paid.
22
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended, which are subject to the safe harbor created by those sections.
Forward-looking statements are based on our managements beliefs and assumptions and on information
currently available to our management. In some cases, you can identify forward-looking statements
by terms such as may, will, should, could, would, expect, plan, anticipate,
believe, estimate, project, predict, potential and similar expressions intended to
identify forward-looking statements. These statements involve known and unknown risks,
uncertainties and other factors, which may cause our actual results, performance, time frames or
achievements to be materially different from any future results, performance, time frames or
achievements expressed or implied by the forward-looking statements. We discuss many of these
risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail
under the heading Risk Factors. Given these risks, uncertainties and other factors, you should
not place undue reliance on these forward-looking statements. Also, these forward-looking
statements represent our estimates and assumptions only as of the date of this filing. You should
read this Quarterly Report on Form 10-Q completely and with the understanding that our actual
future results may be materially different from what we expect. We hereby qualify our
forward-looking statements by these cautionary statements. Except as required by law, we assume no
obligation to update these forward-looking statements publicly, or to update the reasons actual
results could differ materially from those anticipated in these forward-looking statements, even if
new information becomes available in the future.
Overview
We are a provider of highly integrated semiconductor products that enable intelligent
processing for networking, communications, storage, wireless and security applications. We market
and sell our products to providers of networking equipment that sell their products into the
enterprise network, data center, broadband and consumer, and access and service provider markets.
Our products are used in a broad array of networking equipment, including routers, switches,
content-aware switches, unified threat management, or UTM and other security appliances,
application-aware gateways, voice/video/data, or triple-play, gateways, wireless local area
network, or WLAN and third-generation, or 3G access and aggregation devices, storage networking
equipment, servers and intelligent network interface cards. We focus our resources on the design,
sales and marketing of our products, and outsource the manufacturing of our products.
From our incorporation in 2000 through 2003, we were primarily engaged in the design and
development of our first processor family, NITROX, which we began shipping commercially in 2003. In
2004, we introduced and commenced commercial shipments of NITROX Soho. In 2006, we commenced our
first commercial shipments of our OCTEON family of multi-core MIPS64 processors. We introduced a
number of new products within all three of these product families in 2006. In 2007 we introduced
our new line of OCTEON based storage services processors designed to address the specific needs in
the storage market, as well as other new products in the OCTEON and NITROX families. In 2008, we
expanded our OCTEON and NITROX product families with new products including wireless services
processors to address the needs for wireless infrastructure equipment. Through the acquisition of
substantially all of the assets of Star Semiconductor in the third quarter of 2008 for a purchase
price of $9.6 million, we also added the Star ARM-based processors to our portfolio to address
connected home and office applications. Since inception, we have invested heavily in new product
development and achieved our first quarter of profitability during the quarter ended September 30,
2007. Our net revenue has grown from $19.4 million in 2005 to $34.2 million in 2006, $54.2 million
in 2007, and $64.4 million for the nine months ended September 30, 2008, driven primarily by demand
in the enterprise network and data center markets, and more recently by increased demand in the
broadband and consumer markets. We expect sales of our products for use in the enterprise network
and data center markets to continue to represent a substantial portion of our revenue in the
foreseeable future. However, we expect sales into those markets to decline as a percentage of
overall sales as sales in the broadband and consumer and the access and service provider markets
are expected to increase at a faster rate than the expected increase in sales into the enterprise
network and data center markets.
We primarily sell our products to OEMs, either directly or through their contract
manufacturers. Contract manufacturers purchase our products only when an OEM incorporates our
product into the OEMs product, not as commercial off-the-shelf products. Our customers products
are complex and require significant time to define, design and ramp to volume production.
Accordingly, our sales cycle is long. This cycle begins with our technical marketing, sales and
field application engineers engaging with our customers system designers and management, which is
typically a multi-month process. If we are successful, a customer will decide to incorporate our
product in its product, which we refer to as a design win. Because the sales cycles for our
products are long, we incur expenses to develop and sell our products, regardless of whether we
achieve the design win and well in advance of generating revenue, if any, from those expenditures.
We do not have long-term purchase commitments from any of our customers, as sales of our products
are generally made under individual purchase orders. However, once one of our products is
incorporated into a customers design, it is likely to remain designed in for the life cycle of its
product. We believe this to be the case because a redesign would generally be time consuming and
expensive. We have experienced revenue growth due to an increase in the number of our products, an
expansion of our customer base, an increase in the number of average design wins within any one
customer and an increase in the average revenue per design win.
23
Key Business Metrics
Design Wins. We closely monitor design wins by customer and end market on a periodic
basis. We consider design wins to be a key ingredient in our future success, although the revenue
generated by each design can vary significantly. Our long-term sales expectations are based on
internal forecasts from specific customer design wins based upon the expected time to market for
end customer products deploying our products and associated revenue potential.
Pricing and Margins. Pricing and margins depend on the features of the products we
provide to our customers. In general, products
with more complex configurations and higher performance tend to be priced higher and have higher
gross margins. These configurations tend to be used in high performance applications that are
focused on the enterprise network, data center, and access and service provider markets. We tend to
experience price decreases over the life cycle of our products, which can vary by market and
application. In general, we experience less pricing volatility with customers that sell to the
enterprise and data center markets.
Sales Volume. A typical design win can generate a wide range of sales volumes for our
products, depending on the end market demand for our customers products. This can depend on
several factors, including the reputation, market penetration, the size of the end market that the
product addresses, and the marketing and sales effectiveness of our customers. In general, our
customers with greater market penetration and better branding tend to develop products that
generate larger volumes over the product life cycle. In addition, some markets generate large
volumes if the end market product is adopted by the mass market.
Customer Product Life Cycle. We typically commence commercial shipments from nine months
to three years following the design win. Once our product is in production, revenue from a
particular customer may continue for several years. We estimate our customers product life cycles
based on the customer, type of product and end market. In general, products that go into the
enterprise network and data center take longer to reach volume production but tend to have longer
lives. Products for other markets, such as broadband and consumer, tend to ramp relatively quickly,
but generally have shorter life cycles. We estimate these life cycles based on our managements
experience with providers of networking equipment and the semiconductor market as a whole.
Results of Operations
Three and Nine months ended September 30, 2008 and 2007
Net Revenue. Our net revenue consists primarily of sales of our semiconductor products to
providers of networking equipment and their contract manufacturers and distributors. Initial sales
of our products for a new design are usually made directly to providers of networking equipment as
they design and develop their product. Once their design enters production, they often outsource
their manufacturing to contract manufacturers that purchase our products directly from us or from
our distributors. We price our products based on market and competitive conditions and periodically
reduce the price of our products, as market and competitive conditions change, and as manufacturing
costs are reduced. We do not experience different margins on direct sales to providers of
networking equipment and indirect sales through contract manufacturers because in all cases we
negotiate product pricing directly with the providers of networking equipment. To date, all of our
revenue has been denominated in U.S. dollars.
We also derive revenue in the form of license and maintenance fees through licensing our
software products which help our customers build products around our systems-on-a-chip, or SoCs in
a more time and cost efficient manner. Revenue from such arrangements totaled $1.2 million and $0.2
million for the three months ended September 30, 2008 and 2007, respectively, and $1.7 million and
$0.8 million for the nine months ended September 30, 2008 and 2007, respectively.
Our customers representing greater than 10% of net revenue for each of the periods were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months |
|
For the nine months |
|
|
ended September 30, |
|
ended September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
Percentage of total net revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cisco |
|
|
24 |
% |
|
|
24 |
% |
|
|
29 |
% |
|
|
24 |
% |
F5 Networks |
|
|
12 |
% |
|
|
18 |
% |
|
|
10 |
% |
|
|
19 |
% |
Sumitomo |
|
|
13 |
% |
|
|
* |
|
|
|
11 |
% |
|
|
* |
|
|
|
|
* |
|
Represents less than 10% of the net revenue for the respective period end. |
Our distributors are used primarily to support international sale logistics in Asia,
including importation and credit management. Total net revenue through distributors was
$9.5 million and $2.9 million for the three months ended September 30, 2008 and 2007, or
24
38.9% and
20.6% of net revenue, respectively, and $22.8 million and $8.6 million for the nine months ended
September 30, 2008 and 2007, or 35.4% and 22.7% of net revenue, respectively. While we have
purchase agreements with our distributors, the distributors do not have long-term contracts with
any of the equipment providers. Our distributor agreements limit the distributors ability to
return product up to a portion of purchases in the preceding quarter. Given our experience, along
with our distributors limited contractual return rights, we believe we can reasonably estimate
expected returns from our distributors. Accordingly, we recognize sales through distributors at the
time of shipment, reduced by our estimate of expected returns.
Net revenue and costs relating to sales to distributors are deferred if we grant more than
limited rights of returns and price credits or if we cannot reasonably estimate the level of
returns and credits issuable. During the quarter ended June 30, 2007, we signed a distribution
agreement with Avnet, Inc. to distribute our products primarily in the United States. Given the
terms of the distribution agreement, for sales to Avnet, revenue and costs are being deferred until
products are sold by Avnet to their end customers. For the three months and nine months ended
September 30, 2008, 3.7% and 3.6%, respectively, of our net revenues were from products sold by
Avnet. For the three and nine months ended September 30, 2007, less than 1% of our net revenues
were from products sold by Avnet. Revenue recognition depends on notification from Avnet that
product has been sold to Avnets end customers.
The following table is based on the geographic location of the original equipment
manufacturers or the distributors who purchased our products. For sales to our distributors, their
geographic location may be different from the geographic locations of the ultimate end customers.
Revenues by geography for the periods indicated were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended |
|
|
Nine months ended |
|
|
|
September 30, |
|
|
September 30, |
|
|
|
2008 |
|
|
2007 |
|
|
2008 |
|
|
2007 |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
United States |
|
$ |
12,252 |
|
|
$ |
8,435 |
|
|
$ |
32,803 |
|
|
$ |
23,163 |
|
Taiwan |
|
|
3,786 |
|
|
|
2,567 |
|
|
|
9,419 |
|
|
|
7,162 |
|
Japan |
|
|
3,675 |
|
|
|
516 |
|
|
|
8,515 |
|
|
|
2,030 |
|
China |
|
|
1,732 |
|
|
|
1,128 |
|
|
|
4,686 |
|
|
|
2,296 |
|
Other countries |
|
|
3,080 |
|
|
|
1,519 |
|
|
|
9,006 |
|
|
|
3,321 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
24,525 |
|
|
$ |
14,165 |
|
|
$ |
64,429 |
|
|
$ |
37,972 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of Revenue and Gross Margin. We outsource wafer fabrication, assembly and test
functions of our products. A significant portion of our cost of revenue consists of payments for
the purchase of wafers and for assembly and test services. To a lesser extent, cost of revenue
includes expenses relating to our internal operations that manage our contractors, stock-based
compensation, the cost of shipping and logistics, royalties, inventory valuation expenses for
excess and obsolete inventories, warranty costs and changes in product cost due to changes in sort,
assembly and test yields. In general, our cost of revenue associated with a particular product
declines over time as a result of yield improvements, primarily associated with design and test
enhancements.
We use third-party foundries and assembly and test contractors, which are primarily
located in Asia, to manufacture, assemble and test our semiconductor products. We purchase
processed wafers on a per wafer basis from our fabrication suppliers, which are currently TSMC and
UMC. We also outsource the sort, assembly, final testing and other processing of our product to
third-party contractors, primarily ASE and ISE. We negotiate wafer fabrication on a purchase order
basis and do not have long-term agreements with any of our third-party contractors. A significant
disruption in the operations of one or more of these contractors would impact the production of our
products which could have a material adverse effect on our business, financial condition and
results of operations.
Cost of revenue also includes amortized costs related to certain acquired technology
assets in 2004 and 2005, and our most recent acquisitions of Parallogic in May 2008 and
substantially all of the assets of Star Semiconductor Corporation (Star) in August 2008. In
August 2004, we acquired certain assets of Brecis Communications Corporation, which included the
purchase of its secure communication processor product line. We capitalized a total of $2.3 million
of developed technology and amortized that amount on a straight-line basis over the expected useful
life of three years. In April 2005, we acquired Menlo Logic, LLC, which included the purchase of
technology used for secure communication. We capitalized a total of $1.1 million of developed
technology and amortized that amount on a straight-line basis over the expected useful life of
three years. In May 2008, we acquired Parallogic. The purchase included identifiable intangible
assets of approximately $0.5 million, which consisted of intellectual property related to the
developed technology as well as incremental value associated with existing customer relationships.
We capitalized identifiable intangibles and are amortizing the amount on a straight-line basis over
the expected useful life of one to five years. In August 2008, we acquired certain assets of Star,
which included the purchase of identifiable intangible assets of $5.3 million. We capitalized the
intangible assets and are amortizing the amount of $5.3 million on a straight-line basis over the
expected useful lives of less than a year to seven
years. The total intangible assets amortization expense included in cost of revenue was $0.8
million and $0.2 million for the three months September 30, 2008 and 2007, respectively, and
$0.9 million and $0.8 million for the nine months September 30, 2008 and
25
2007, respectively. In
addition, in the three and nine months ended September 30, 2008, we incurred a $0.2 million expense
related to the fair value adjustment of Star inventory.
In addition, we incur costs for the fabrication of masks used by our contract
manufacturers to manufacture wafers that incorporate our products. The cost of fabrication mask
sets has increased as we began transitioning from a 130-nanometer to a 90-nanometer process in our
next-generation products in 2007. During the three months ended September 30, 2008 and 2007, we
capitalized $1.0 million and $0.1 million, respectively, and during the nine months ended
September 30, 2008 and 2007, we capitalized $3.3 million and $1.8 million of mask costs,
respectively. As our product processes continue to mature and as we develop more history and
experience, we expect that, in the future, a large percentage of mask costs will be used directly
for production manufacturing and will be capitalized. We amortize the cost of fabrication masks
that we reasonably expect to use for production manufacturing over a 12-month period and include
them in cost of revenue. Total amortized expenses for the masks included in the cost of revenue was
$1.0 million and $0.6 million for the three months ended September 30, 2008 and 2007, respectively,
and $2.3 million and $1.2 million for the nine months ended September 30, 2008 and 2007,
respectively. The unamortized balance of capitalized mask costs at September 30, 2008 and
December 31, 2007 was $2.4 million and $2.2 million, respectively. We anticipate that a large
percentage of our total mask costs will be capitalized and amortized to cost of revenue.
Our net revenue, cost of revenue, gross profit and gross margin for the three months and
nine months ended September 30, 2008 and 2007 were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
|
|
|
2008 |
|
|
2007 |
|
|
$ change |
|
|
% change |
|
|
2008 |
|
|
2007 |
|
|
$ change |
|
|
% change |
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
Net revenue |
|
$ |
24,525 |
|
|
$ |
14,165 |
|
|
$ |
10,360 |
|
|
|
73.1 |
% |
|
$ |
64,429 |
|
|
$ |
37,972 |
|
|
$ |
26,457 |
|
|
|
69.7 |
% |
Cost of revenue |
|
|
10,099 |
|
|
|
5,207 |
|
|
|
4,892 |
|
|
|
94.0 |
% |
|
|
24,494 |
|
|
|
14,087 |
|
|
|
10,407 |
|
|
|
73.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Profit |
|
$ |
14,426 |
|
|
$ |
8,958 |
|
|
$ |
5,468 |
|
|
|
61.0 |
% |
|
$ |
39,935 |
|
|
$ |
23,885 |
|
|
$ |
16,050 |
|
|
|
67.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Margin |
|
|
58.8 |
% |
|
|
63.2 |
% |
|
|
-4.4 |
% |
|
|
-7.0 |
% |
|
|
62.0 |
% |
|
|
62.9 |
% |
|
|
-0.9 |
% |
|
|
-1.5 |
% |
Our gross margin has been and will continue to be affected by a variety of factors,
including average sales prices of our products, the product mix, the cost of fabrication masks that
are capitalized and amortized, the timing of cost reductions for fabricated wafers and assembly and
test service costs, inventory valuation charges and the timing and changes in sort, assembly and
test yields. Overall product margin is impacted by the mix between higher performance, higher
margin products and lower performance, lower margin products. In addition, we typically experience
lower yields and higher associated costs on new products, which improve as production volumes
increase.
Three Months and Nine months ended September 30, 2008 Compared to the Three Months and
Nine months ended September 30, 2007: Net Revenue. Our net revenue was $24.5 and $64.4 million in
the three months and nine months ended September 30, 2008, as compared to $14.2 million and
$38.0 million in the three months and nine months ended September 30, 2007, an increase of 73.1%
and 69.7%, respectively. The majority of the increase is related to an increase in sales of
$18.1 million and $49.3 million in the three months and nine months ended September 30, 2008, to
existing customers, which was primarily a result of design wins reaching commercial production. In
the three months and nine months ended September 30, 2008 and 2007, a substantial majority of our
sales were to customers that sell into the enterprise network and data center markets as well as
broadband and consumer markets. In the three months and nine months ended September 30, 2008 we
derived 38.9% and 35.4% of our net revenue from distributors compared to 20.6% and 22.7% in the
three months and nine months ended September 30, 2007, due to increased sales to top five customers
through distributors.
Three Months and Nine months ended September 30, 2008 Compared to the Three Months and
Nine months ended September 30, 2007: Gross Margin. Gross margin declined by 4.4 percentage points
and 0.9 percentage points to 58.8 % and 62.0% in the three months and nine months ended
September 30, 2008 from 63.2% and 62.9% in the three months and nine months ended September 30,
2007. The decline in gross margin in the three months and nine months ended September 30, 2008
compared to the three months and nine months ended September 30, 2007 was primarily due to higher
amortization costs related to acquired intangible assets and amortization of fair value of Stars
acquired inventory. In addition, to a lesser extent, the gross margin decline in the three months
and nine months ended September 30, 2008 was due to a sales mix shift towards increased sales of
lower performance, lower margin products.
Research and Development Expenses
Research and development expenses primarily include personnel costs, engineering design
development software and hardware tools, allocated facilities expenses and depreciation of
equipment used in research and development, and stock-based
compensation under SFAS 123(R).
26
We expect research and development expenses to continue to increase in total dollars although
we expect these expenses to generally decrease as a percentage of revenue. Additionally, as a
percentage of revenue, these costs fluctuate from one period to another. Total research and
development expenses for the three months and nine months ended September 30, 2008 and 2007 were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2008 |
|
2007 |
|
$ change |
|
% change |
|
2008 |
|
2007 |
|
$ change |
|
% change |
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Research and development
expenses |
|
$ |
6,593 |
|
|
$ |
4,796 |
|
|
$ |
1,797 |
|
|
|
37.5 |
% |
|
$ |
18,874 |
|
|
$ |
13,843 |
|
|
$ |
5,031 |
|
|
|
36.3 |
% |
Percent of total net revenue |
|
|
26.9 |
% |
|
|
33.9 |
% |
|
|
-7.0 |
% |
|
|
-20.6 |
% |
|
|
29.3 |
% |
|
|
36.5 |
% |
|
|
-7.2 |
% |
|
|
-19.6 |
% |
Three Months and Nine months ended September 30, 2008 Compared to the Three Months and Nine months
ended September 30, 2007: Research and development expenses increased by $1.8 million and
$5.0 million, or 37.5% and 36.3% to $6.6 million and $18.9 million in the three months and nine
months ended September 30, 2008 from $4.8 million and $13.8 million in the three months and nine
months ended September 30, 2007. Of the $1.8 million and $5.0 million increase, salaries, benefits
and commissions accounted for $0.9 million and $2.2 million, and stock-based compensation expense
accounted for $0.6 million and $1.5 million, for the three months and nine months ended
September 30, 2008. Design tools accounted for $0.1 million and $0.6 million of the increase in the
three months and nine months ended September 30, 2008 and professional services and other
miscellaneous expenses accounted for $0.2 million and $0.7 million of the increase, for the three
months and nine months ended September 30, 2008. Research and development headcount increased to
191 at the end of September 2008 from 122 at the end of September 2007.
Sales, General and Administrative Expenses
Sales, general and administrative expenses primarily include personnel costs, accounting
and legal fees, information systems, sales commissions, trade shows, marketing programs,
depreciation, allocated facilities expenses and stock-based compensation under SFAS 123(R). We plan
to continue to increase hiring of our sales and marketing organization to enable us to expand into
existing and new markets. We also plan to continue to invest in expanding our domestic and
international sales and marketing activities and building brand awareness. We incurred significant
additional, accounting and legal compliance costs as well as additional insurance, and investor
relations and other costs associated with being a public company. We expect sales, general and
administrative expenses to increase significantly in absolute dollars and to generally decrease as
a percentage of revenue in the future due to our expected growth and economies of scale. Total
sales, general and administrative costs for the three months and nine months ended September 30,
2008 and 2007 were:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2008 |
|
2007 |
|
$ change |
|
% change |
|
2008 |
|
2007 |
|
$ change |
|
% change |
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Sales , general and
administrative |
|
$ |
5,944 |
|
|
$ |
3,976 |
|
|
$ |
1,968 |
|
|
|
49.5 |
% |
|
$ |
15,953 |
|
|
$ |
10,667 |
|
|
$ |
5,286 |
|
|
|
49.6 |
% |
Percent of total net revenue |
|
|
24.2 |
% |
|
|
28.1 |
% |
|
|
-3.8 |
% |
|
|
-13.7 |
% |
|
|
24.8 |
% |
|
|
28.1 |
% |
|
|
-3.3 |
% |
|
|
-11.9 |
% |
Three Months and Nine months ended September 30, 2008 Compared to the Three Months and
Nine months ended September 30, 2007: Sales, general and administrative expenses increased
$2.0 million and $5.3 million, or 49.5% and 49.6% to $6.0 million and $16.0 million in the three
months and nine months ended September 30, 2008 from $4.0 million and $10.7 million in the three
months and nine months ended September 30, 2007. Of the $2.0 million and $5.3 million increase,
salaries, benefits and commissions accounted for $0.7 million and $1.6 million, and stock-based
compensation expense accounted for $0.7 million and $1.7 million, for the three months and nine
months ended September 30, 2008. Marketing programs, accounting, legal fees and other services
accounted for $0.3 million and $1.1 of the increase in the three months and nine months ended
September 30, 2008 due to the implementation of internal systems and other costs associated with
being a public company. Other miscellaneous expenses accounted for $0.3 million and $0.9 million of
the increase, for the three months and nine months ended September 30, 2008. Sales, general and
administrative headcount increased to 84 at the end of September 2008 from 57 at the end of
September 2007.
Other Income, Net. Other income, net, primarily includes interest income on cash and cash
equivalents and interest expense on capitalized licenses. For 2007, it also includes adjustments we
made to record our preferred stock warrants at fair value in accordance with FSP 150-5. These
warrants have converted into warrants to purchase shares of our common stock in May 2007. As a
result, there were no warrant revaluation expenses in the three months and nine months ended
September 30, 2008.
27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the three months ended |
|
|
|
|
|
|
|
|
|
For the nine months ended |
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
|
|
|
September 30, |
|
|
|
|
|
|
2008 |
|
2007 |
|
$ change |
|
% change |
|
2008 |
|
2007 |
|
$ change |
|
% change |
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
|
|
Interest income and other |
|
$ |
499 |
|
|
$ |
1,307 |
|
|
$ |
(808 |
) |
|
|
-61.8 |
% |
|
$ |
2,100 |
|
|
$ |
2,193 |
|
|
$ |
(93 |
) |
|
|
-4.2 |
% |
Interest expense |
|
|
(115 |
) |
|
|
(73 |
) |
|
|
(42 |
) |
|
|
57.5 |
% |
|
|
(403 |
) |
|
|
(572 |
) |
|
|
169 |
|
|
|
-29.5 |
% |
Warrant revaluation expense |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
0.0 |
% |
|
|
|
|
|
|
(574 |
) |
|
|
574 |
|
|
|
-100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total other income, net |
|
$ |
384 |
|
|
$ |
1,234 |
|
|
$ |
(850 |
) |
|
|
-68.9 |
% |
|
$ |
1,697 |
|
|
$ |
1,047 |
|
|
$ |
650 |
|
|
|
62.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months and Nine months ended September 30, 2008 Compared to the Three Months and
Nine months ended September 30, 2007: Other income, net decreased in the three months ended
September 30, 2008 due primarily the result of lower short-term U.S. interest rates, which
decreased the interest income from our cash balances. Other income, net increased in the nine
months ended September 30, 2008 due primarily the result of warrant revaluation expenses and, to a
lesser extent, from the lower interest expense associated with the capital leases.
Income Tax Expense. For the three months ended September 30, 2008 and 2007, the provision for
income taxes was based on our estimated annual effective tax rate in compliance with SFAS 109 and
other related guidance. We update our estimate of our annual effective tax rate at the end of each
quarterly period. Our estimate takes into account estimations of annual pre-tax income, the
geographic mix of pre-tax income and our interpretations of tax laws and the possible outcomes of
current and future audits.
The following table presents the provision and benefit for income taxes and the effective tax
rates for the three months and nine months ended September 30, 2008 and 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Nine Months Ended |
|
|
September 30, |
|
September 30, |
|
|
2008 |
|
2007 |
|
2008 |
|
2007 |
|
|
|
|
|
|
(in thousands) |
|
|
|
|
Income before income taxes |
|
$ |
2,273 |
|
|
$ |
1,420 |
|
|
$ |
6,805 |
|
|
$ |
422 |
|
Income tax provision |
|
$ |
454 |
|
|
$ |
110 |
|
|
$ |
941 |
|
|
$ |
201 |
|
Effective tax rate |
|
|
20.0 |
% |
|
|
7.7 |
% |
|
|
13.8 |
% |
|
|
47.6 |
% |
The provision for income taxes of $0.5 million and $0.9 million for the three months and
nine months ended September 30, 2008 related to alternative minimum tax on the Companys United
States profits adjusted by certain non-deductible items, international taxes and state income
taxes. The difference between the provision for income that would be derived by applying the
statutory rate to income before tax for the three months and nine months ended September 30, 2008
and the provision actually recorded was due to the impact of non-deductible SFAS 123(R) stock-based
compensation expenses offset by the benefit from net operating loss carryforwards and utilization
of research credits carryforwards.
A valuation allowance is recorded to reduce any deferred tax asset that is more likely
than not to be not realized. We perform assessments of the realization of our deferred tax assets
considering all available evidence, both positive and negative. These assessments require that
management make significant judgments about many factors, including the amount and likelihood of
future taxable income. As a result of this assessment, we have concluded that it was more likely
than not that our deferred tax assets would not be realized and have recorded a full valuation
allowance against our deferred tax assets. We will continue to evaluate the need for
a valuation allowance. We may determine that some, or all, of our deferred tax assets will be
realized, in which case we will reduce our valuation allowance in the quarter in which such
determination is made. If a determination is made to reduce the valuation allowance the impact to
the net income could be material. If the valuation allowance is reduced, we may recognize a benefit
from income taxes on our income statement in that period. If such a benefit is recognized, then
subsequent periods are likely to have significantly higher tax provision expenses.
As a result of the implementation of FIN 48, we did not recognize any adjustment to the
liability for uncertain tax positions and therefore did not record any adjustment to the beginning
balance of retained earnings. As of December 31, 2007 we had $3.6 million of unrecognized tax
benefits, which is netted against deferred tax assets and is fully offset by a valuation allowance.
There were no significant changes to the unrecognized tax benefit during the three months and nine
months ended September 30, 2008.
Our major tax jurisdictions are the United States federal government and the State of
California. We file income tax returns in the United States federal jurisdiction, the State of
California and various state and foreign tax jurisdictions in which
we have a subsidiary
28
or branch
operation. The United States federal corporation income tax returns beginning with the 2000 tax
year remain subject to examination by the Internal Revenue Service, or IRS. The California
corporation income tax returns beginning with the 2000 tax year remain subject to examination by
the California Franchise Tax Board. There are no on-going income tax audits in the major tax
jurisdictions.
On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (Act) was enacted. The
Act retroactively extended the federal research credits that expired on January 1, 2008. The
Company is currently evaluating the impact of this Act for the year-end December 31, 2008 tax
provision.
Liquidity and Capital Resources
In May 2007, we received net proceeds of approximately $94.7 million (after deducting
underwriting discounts and commissions of $7.3 million and other offering related costs of
approximately $2.8 million). Our other primary sources of cash historically have been proceeds from
issuances of convertible preferred stock, cash collections from customers, a working capital line
of credit and term loan and cash received from the exercise of employee stock options. As of
September 30, 2008, we had cash and cash equivalents of $91.9 million and net accounts receivable
of $13.5 million.
Following is a summary of our working capital and cash and cash equivalents as of
September 30, 2008 and December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
As of |
|
|
September 30, |
|
December 31, |
|
|
2008 |
|
2007 |
|
|
(in thousands) |
Working capital |
|
$ |
107,064 |
|
|
$ |
105,048 |
|
Cash and cash equivalents |
|
|
91,918 |
|
|
|
98,462 |
|
Cash Flows from Operating Activities
Net cash provided by operating activities was $12.5 million for the nine months ended
September 30, 2008. Net cash provided by operating activities primarily consisted of $5.9 million
of net income and $12.0 million in non-cash operating expenses, offset in part by $5.4 million in
changes in working capital. Non-cash items in the nine months ended September 30, 2008 included
depreciation and amortization expense of $7.9 million and stock-based compensation of $4.1 million.
Net cash provided by operating activities was $6.3 million for the nine months ended September 30,
2007. This primarily consisted of our net income of $0.2 million, $6.3 million in non-cash
operating expenses and offset by $0.3 million in changes in operating assets and liabilities.
Non-cash items in the nine months ended September 30, 2007 included depreciation and amortization
expense of $4.3 million, stock-based compensation of $1.3 million, warrant revaluation and
amortization of $0.7 million. Changes in operating activities in the nine months of 2008 in
comparison to 2007 were primarily driven by increases of $3.1 million in inventory and $2.8 million
in accounts receivable, offset by increase in payables and accrued expenses of $0.9 million.
Cash Flows used in Investing Activities
Net cash used in investing activities was $16.2 million and $3.1 million for the nine
months ended September 30, 2008 and 2007, respectively. In the nine months ended September 30, 2008
net cash of $9.8 million was used to purchase certain assets of Star in August 2008 and Parallogic
in May 2008. In addition, in the nine months ended September 30, 2008, $3.3 million and $3.1
million of
net cash were used for mask costs and capital expenditures, respectively, compared to $1.8 million
and $1.3 million, respectively in the nine months ended September 30, 2007.
Cash Flows (used in) provided by Financing Activities
Net cash used in financing activities was $2.8 million for the nine months ended
September 30, 2008, which was primarily due to principal payments of capital lease and technology
license obligations of $3.6 million, offset by proceeds from stock option exercises. Net cash
provided by financing activities was $88.2 million in the nine months ended September 30, 2007,
which was primarily due to net proceeds of $94.7 million initial public offering, offset by
$2.7 million in principal payments of capital lease and technology license obligations and
$4.0 million in repayment of the term loan.
We believe that our $91.9 million of cash and cash equivalents at September 30, 2008 and
expected cash flow from operations will be sufficient to fund our projected operating requirements
for at least the next twelve months. However, we may need to raise additional capital or incur
additional indebtedness to continue to fund our operations in the future. Our future capital
requirements will depend on many factors, including our rate of revenue growth, the expansion of
our engineering, sales and marketing activities, the timing and extent of our expansion into new
territories, the timing of introductions of new products and enhancements to existing
29
products and
the continuing market acceptance of our products. In addition, we may also enter into other types
of arrangements in the future, which could require us to seek additional equity or debt financing.
Additional funds may not be available on terms favorable to us or at all.
Indemnities
In the ordinary course of business, we have entered into agreements with customers that
include indemnity provisions. Based on historical experience and information known as of
September 30, 2008, we believe our exposure related to the indemnities at September 30, 2008 is not
material. We also enter into indemnification agreements with our officers and directors and our
certificate of incorporation and bylaws include similar indemnification obligations to our officers
and directors. It is not possible to determine the amount of our liability related to these
indemnification agreements and obligations to our officers and directors due to the limited history
of prior indemnification claims and the unique facts and circumstances involved in each particular
agreement.
Off-Balance Sheet Arrangements
During the periods presented, we did not have, nor do we currently have, any
relationships with unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have been established
for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or
limited purposes.
Contractual Obligations
The following table describes our commitments to settle contractual obligations in cash
as of September 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due By Period |
|
|
|
Less Than 1 |
|
|
|
|
|
|
|
|
|
|
More Than 5 |
|
|
|
|
|
|
Year |
|
|
1 to 2 Years |
|
|
3 to 5 Years |
|
|
Years |
|
|
Total |
|
|
|
(in thousands) |
|
Operating lease obligations |
|
$ |
402 |
|
|
$ |
2,216 |
|
|
$ |
1,043 |
|
|
$ |
|
|
|
$ |
3,661 |
|
Capital lease obligations |
|
|
957 |
|
|
|
4,369 |
|
|
|
|
|
|
|
|
|
|
|
5,326 |
|
Purchase obligations |
|
|
185 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
185 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,544 |
|
|
$ |
6,585 |
|
|
$ |
1,043 |
|
|
$ |
|
|
|
$ |
9,172 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We adopted FIN 48 on January 1, 2007. As of September 30, 2008, we had $3.6 million of
total gross unrecognized tax benefits and related interest. The timing of any payments which could
result from these unrecognized tax benefits will depend upon a number of factors. Accordingly, the
timing of payment cannot be estimated. We do not expect a significant tax payment related to these
obligations to occur within the next 12 months.
Critical Accounting Policies and Estimates
The preparation of our financial statements and accompanying disclosures in conformity
with GAAP requires estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in
the consolidated financial statements and the accompanying notes. The SEC has defined a companys
critical
accounting policies as policies that are most important to the portrayal of a companys financial
condition and results of operations, and which require a company to make its most difficult and
subjective judgments, often as a result of the need to make estimates of matters that are
inherently uncertain. Based on this definition, we have identified our most critical accounting
policies and estimates to be as follows: (1) revenue recognition; (2) product warranty accrual; (3)
stock-based compensation; (4) inventory valuation; (5) accounting for income tax; (6) mask costs
and (7) business combinations. Although we believe that our estimates, assumptions and judgments
are reasonable, they are based upon information not presently available. Actual results may differ
significantly from these estimates if the assumptions, judgments and conditions upon which they are
based turn out to be inaccurate. During the three months ended September 30, 2008, we have
identified business combinations as critical accounting policy and estimate. Except for the
business combination critical accounting policy as described in detail below, management believes
that there have been no significant changes during the nine months ended September 30, 2008 to the
items that we disclosed as our critical accounting policies and estimates in Managements
Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on
Form 10-K for the year ended December 31, 2007 filed on March 10, 2008.
30
Business Combinations
We account for business combinations in accordance with SFAS No. 141, Business Combinations
(SFAS 141), which requires the purchase method of accounting for business combinations. In
accordance with SFAS 141, we determine the recognition of intangible assets based on the following
criteria: (i) the intangible asset arises from contractual or other rights; or (ii) the intangible
is separable or divisible from the acquired entity and capable of being sold, transferred,
licensed, returned or exchanged. In accordance with SFAS 141, we allocate the purchase price of
business combinations to the tangible assets, liabilities and intangible assets acquired, including
in-process research and development (IPR&D), based on their estimated fair values. The excess
purchase price over those fair values is recorded as goodwill. Management makes valuation
assumptions that require significant estimates, especially with respect to intangible assets.
Critical estimates in valuing certain intangible assets include, but are not limited to future
expected cash flows from customer contracts, customer lists, distribution agreements and acquired
developed technologies, expected costs to develop IPR&D into commercially viable products,
estimated cash flows from projects when completed and discount rates. We estimate fair value based
upon assumptions we believe to be reasonable, but which are inherently uncertain and unpredictable
and, as a result, actual results may differ from estimates. Other estimates associated with the
accounting for acquisitions may change as additional information becomes available regarding the
assets acquired and liabilities assumed.
Recent Accounting Pronouncements
Please refer to the recent accounting pronouncements listed in the footnote 1 of the
financial statements.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
During the three months ended September 30, 2008, there were no material changes to our
quantitative and qualitative disclosures about market risk related to our investment activities as
disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007 as filed with the
SEC on March 10, 2008.
Item 4T. Controls and Procedures
Disclosure Controls and Procedures
Our Chief Executive Officer and our Chief Financial Officer evaluated with the
participation of our management, the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of
September 30, 2008. Based on this evaluation, our Chief Executive Officer and our Chief Financial
Officer have concluded that our disclosure controls and procedures are effective to ensure that
information we are required to disclose in reports that we file or submit under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms, and that such information is accumulated and communicated
to management as appropriately to allow for timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during the third quarter
of 2008 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
From time to time, we may become involved in legal proceedings arising in the ordinary
course of our business. We are not presently a party to any legal proceedings the outcome of which,
if determined adversely against us, would individually or in the aggregate have a material adverse
effect on our business, operating results, financial condition or cash flows.
Item 1A. Risk Factors
The following risks and uncertainties may have a material adverse effect on our business,
financial condition or results of operations. Investors should carefully consider the risks
described below before making an investment decision. The risks described below are not the only
ones we face. Additional risks not presently known to us or that we currently believe are
immaterial may also significantly impair our business operations. Our business could be harmed by
any of these risks. The trading price of our common stock could decline due to any of these risks,
and investors may lose all or part of their investment.
31
We have marked with an asterisk(*) those risks described below that reflect substantive
changes from the risks described under Item 1A. Risk Factors included in our Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March 10, 2008.
Risks Related to Our Business and Industry
We have a history of losses, and we may not achieve or sustain profitability in the
future, on a quarterly or annual basis.*
We were established in 2000 and were not profitable in any fiscal period until the
quarter ended September 30, 2007. We experienced net income of $1.8 million and $1.3 million for
the three months ended September 30, 2008 and 2007, respectively, and $5.9 million and $0.2 million
for the nine months ended September 30, 2008 and 2007, respectively. As of September 30, 2008, our
accumulated deficit was $52.9 million. We expect to make significant expenditures related to the
development of our products and expansion of our business, including research and development and
sales and administrative expenses. As a public company, we also incur significant legal, accounting
and other expenses that we did not incur as a private company. Additionally, we may encounter
unforeseen difficulties, complications, product delays and other unknown factors that require
additional expenditures. As a result of these increased expenditures, we may have to generate and
sustain substantially increased revenue to achieve profitability. Our revenue growth trends in
prior periods may not be sustainable. Accordingly, we may not be able to achieve or maintain
profitability and we may continue to incur significant losses in the future.
We face intense competition and expect competition to increase in the future, which could
reduce our revenue and customer base.
The market for our products is highly competitive and we expect competition to intensify in
the future. This competition could make it more difficult for us to sell our products, and result
in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and
failure to increase, or the loss of, market share or expected market share, any of which would
likely seriously harm our business, operating results and financial condition. For instance,
semiconductor products have a history of declining prices as the cost of production is reduced.
However, if market prices decrease faster than product costs, gross and operating margins can be
adversely affected. Currently, we face competition from a number of established companies,
including Broadcom Corporation, Freescale Semiconductor, Inc., Intel Corporation, Marvell
Technology Group Ltd., PMC-Sierra, Inc., Hifn, Inc., and others. We also face competition from a
number of private companies, including Raza Microelectronics, Inc. and others. A few of our current
competitors operate their own fabrication facilities and have, and some of our potential
competitors could have, longer operating histories, greater name recognition, larger customer bases
and significantly greater financial, technical, sales, marketing and other resources than we have.
Potential customers may prefer to purchase from their existing suppliers rather than a new supplier
regardless of product performance or features.
We expect increased competition from other established and emerging companies both
domestically and internationally. Our current and potential competitors may also establish
cooperative relationships among themselves or with third parties. If so, new competitors or
alliances that include our competitors may emerge that could acquire significant market share. We
expect these trends to continue as companies attempt to strengthen or maintain their market
positions in an evolving industry. In the future, further development by our competitors could
cause our products to become obsolete. We expect continued competition from incumbents as well as
from new entrants into the markets we serve. Our ability to compete depends on a number of factors,
including:
|
|
our success in identifying new and emerging markets, applications and technologies; |
|
|
|
our products performance and cost effectiveness relative to that of our competitors products; |
|
|
|
our ability to deliver products in large volume on a timely basis at a competitive price; |
|
|
|
our success in utilizing new and proprietary technologies to offer products and features
previously not available in the marketplace; |
|
|
|
our ability to recruit design and application engineers and sales and marketing personnel; and |
|
|
|
our ability to protect our intellectual property. |
In addition, we cannot assure you that existing customers or potential customers will not
develop their own products, purchase competitive products or acquire companies that use alternative
methods to enable networking, communication or security applications to facilitate network-aware
processing in their systems. Any of these competitive threats, alone or in combination with others,
could seriously harm our business, operating results and financial condition.
32
Our customers may cancel their orders, change production quantities or delay production,
and if we fail to forecast demand for our products accurately, we may incur product shortages,
delays in product shipments or excess or insufficient product inventory.
We generally do not obtain firm, long-term purchase commitments from our customers.
Because production lead times often exceed the amount of time required to fulfill orders, we often
must build in advance of orders, relying on an imperfect demand forecast to project volumes and
product mix. Our demand forecast accuracy can be adversely affected by a number of factors,
including inaccurate forecasting by our customers, changes in market conditions, adverse changes in
our product order mix and demand for our customers products. Even after an order is received, our
customers may cancel these orders or request a decrease in production quantities. Any such
cancellation or decrease subjects us to a number of risks, most notably that our projected sales
will not materialize on schedule or at all, leading to unanticipated revenue shortfalls and excess
or obsolete inventory which we may be unable to sell to other customers. Alternatively, if we are
unable to project customer requirements accurately, we may not build enough products, which could
lead to delays in product shipments and lost sales opportunities in the near term, as well as force
our customers to identify alternative sources, which could affect our ongoing relationships with
these customers. We have in the past had customers dramatically increase their requested production
quantities with little or no advance notice. If we do not timely fulfill customer demands, our
customers may cancel their orders and we may be subject to customer claims for cost of replacement.
Either underestimating or overestimating demand would lead to insufficient, excess or obsolete
inventory, which could harm our operating results, cash flow and financial condition, as well as
our relationships with our customers.
Adverse changes in general economic or political conditions in any of the major countries in
which we do business could adversely affect our operating results.*
As our business has grown to both customers located in the United States as well as customers
located outside of the United States, we have become increasingly subject to the risks arising from
adverse changes in both the domestic and global economic and political conditions. For example, the
direction and relative strength of the U.S. and International economies has recently been
increasingly uncertain due to softness in the housing markets, difficulties in the financial
services sector and credit markets and continuing geopolitical uncertainties. If economic growth in
the United States and other countries economies is slowed, the demand for our customers products
could decline which would then decrease demand for our products. Furthermore, if economic
conditions in the countries into which our customers sell their products continue to deteriorate,
some of our customers may decide to postpone or delay certain development programs which would
then delay their need to purchase our products. This could result in a reduction in sales of our
products or in a reduction in the growth of our product sales. Any of these events would likely
harm investors view of our business, our results of operations and financial condition.
We receive a substantial portion of our revenues from a limited number of customers, and
the loss of, or a significant reduction in, orders from one or a few of our major customers would
adversely affect our operations and financial condition.*
We receive a substantial portion of our revenues from a limited number of customers. We
received an aggregate of approximately 57.3% and 61.0% of our revenues from our top five customers
for the three months ended September 30, 2008 and 2007, respectively. We anticipate that we will
continue to be dependent on a limited number of customers for a significant portion of our revenues
in the immediate future and in some cases the portion of our revenues attributable to certain
customers may increase in the future. However, we may not be able to maintain or increase sales to
certain of our top customers for a variety of reasons, including the following:
|
|
our agreements with our customers do not require them to purchase a minimum quantity of our products; |
|
|
|
some of our customers can stop incorporating our products into their own products with limited
notice to us and suffer little or no penalty; and |
|
|
|
many of our customers have pre-existing or concurrent relationships with our current or potential
competitors that may affect the customers decisions to purchase our products. |
In the past, we have relied in significant part on our strategic relationships with
customers that are technology leaders in our target markets. We intend to pursue the expansion of
such relationships and the formation of new strategic relationships but we cannot
assure you that we will be able to do so. These relationships often require us to develop new
products that may involve significant technological challenges. Our customers frequently place
considerable pressure on us to meet their tight development schedules. Accordingly, we may have to
devote a substantial amount of our resources to our strategic relationships, which could detract
from or delay our completion of other important development projects. Delays in development could
impair our relationships with our strategic customers and negatively impact sales of the products
under development. Moreover, it is possible that our customers may develop their own product or
adopt a competitors solution for products that they currently buy from us. If that happens, our
sales would decline and our business, financial condition and results of operations could be
materially and adversely affected.
In addition, our relationships with some customers may also deter other potential customers who
compete with these customers from buying our products. To attract new customers or retain existing
customers, we may offer certain customers favorable prices on our products. In that event, our
average selling prices and gross margins would decline. The loss of a key customer, a reduction in
sales to any key customer or our inability to attract new significant customers could seriously
impact our revenue and materially and adversely affect our results of operations.
33
We expect our operating results to fluctuate.
We expect our revenues and expense levels to vary in the future, making it difficult to
predict our future operating results. In particular, we experience variability in demand for our
products as our customers manage their product introduction dates and their inventories.
Additional factors that could cause our results to fluctuate include, among other things:
|
|
fluctuations in demand, sales cycles, product mix and prices for our products; |
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the timing of our product introductions, and the variability in lead time between the time when a customer begins to
design in one of our products and the time when the customers end system goes into production and they begin
purchasing our products; |
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the forecasting, scheduling, rescheduling or cancellation of orders by our customers; |
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our ability to successfully define, design and release new products in a timely manner that meet our customers needs; |
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changes in manufacturing costs, including wafer, test and assembly costs, mask costs, manufacturing yields and
product quality and reliability; |
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the timing and availability of adequate manufacturing capacity from our manufacturing suppliers; |
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the timing of announcements by our competitors or us; |
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future accounting pronouncements and changes in accounting policies; |
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volatility in our stock price, which may lead to higher stock compensation expenses; |
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general economic and political conditions in the countries where we operate or our products are sold or used; costs
associated with litigation, especially related to intellectual property; and |
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productivity and growth of our sales and marketing force. |
Unfavorable changes in any of the above factors, most of which are beyond our control, could
significantly harm our business and results of operations.
We may not sustain our growth rate, and we may not be able to manage any future growth
effectively.*
We have experienced significant growth in a short period of time. Our revenues increased
from approximately $7.4 million in 2004 to approximately $34.2 million in 2006, $54.2 million in
2007 and $64.4 million in the first nine months of 2008. We may not achieve similar growth rates in
future periods. You should not rely on our operating results for any prior quarterly or annual
periods as an indication of our future operating performance. If we are unable to maintain adequate
revenue growth, our financial results could suffer and our stock price could decline.
To manage our growth successfully and handle the responsibilities of being a public
company, we believe we must effectively, among other things:
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recruit, hire, train and manage additional qualified engineers for our research and development
activities, especially in the positions of design engineering, product and test engineering, and
applications engineering; |
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add additional sales personnel and expand sales offices; |
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implement and improve our administrative, financial and operational systems, procedures and controls; and |
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enhance our information technology support for enterprise resource planning and design engineering by
adapting and expanding our systems and tool capabilities, and properly training new hires as to their
use. |
If we are unable to manage our growth effectively, we may not be able to take advantage of
market opportunities or develop new products and we may fail to satisfy customer requirements,
maintain product quality, execute our business plan or respond to competitive pressures.
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The average selling prices of products in our markets have historically decreased over
time and will likely do so in the future, which could harm our revenues and gross profits.
Average selling prices of semiconductor products in the markets we serve have
historically decreased over time. Our gross profits and financial results will suffer if we are
unable to offset any reductions in our average selling prices by reducing our costs, developing new
or enhanced products on a timely basis with higher selling prices or gross profits, or increasing
our sales volumes. Additionally, because we do not operate our own manufacturing, assembly or
testing facilities, we may not be able to reduce our costs as rapidly as companies that operate
their own facilities, and our costs may even increase, which could also reduce our margins. We have
reduced the prices of our products in anticipation of future competitive pricing pressures, new
product introductions by us or our competitors and other factors. We expect that we will have to do
so again in the future.
We may be unsuccessful in developing and selling new products or in penetrating new
markets.
We operate in a dynamic environment characterized by rapidly changing technologies and
industry standards and technological obsolescence. Our competitiveness and future success depend on
our ability to design, develop, manufacture, assemble, test, market and support new products and
enhancements on a timely and cost effective basis. A fundamental shift in technologies in any of
our product markets could harm our competitive position within these markets. Our failure to
anticipate these shifts, to develop new technologies or to react to changes in existing
technologies could materially delay our development of new products, which could result in product
obsolescence, decreased revenues and a loss of design wins to our competitors. The success of a new
product depends on accurate forecasts of long-term market demand and future technological
developments, as well as on a variety of specific implementation factors, including:
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timely and efficient completion of process design and transfer to manufacturing, assembly and test processes; |
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the quality, performance and reliability of the product; and |
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effective marketing, sales and service. |
If we fail to introduce new products that meet the demand of our customers or penetrate new
markets that we target our resources on, our revenues will likely decrease over time and our
financial condition could suffer.
Fluctuations in the mix of products sold may adversely affect our financial results.
Because of the wide price differences among our processors, the mix and types of
performance capabilities of processors sold affect the average selling price of our products and
have a substantial impact on our revenue. Generally, sales of higher performance products have
higher gross margins than sales of lower performance products. We currently offer both higher and
lower performance products within each of our NITROX and OCTEON product families. To the extent our
sales mix shifts toward increased sales of lower performance products, our overall gross margins
will be negatively affected. Fluctuations in the mix and types of our products may also affect the
extent to which we are able to recover our fixed costs and investments that are associated with a
particular product, and as a result can negatively impact our financial results.
Our products must meet exact specifications, and defects and failures may occur, which
may cause customers to return or stop buying our products.
Our customers generally establish demanding specifications for quality, performance and
reliability that our products must meet. However, our products are highly complex and may contain
defects and failures when they are first introduced or as new versions are released. If defects and
failures occur in our products during the design phase or after, we could experience lost revenues,
increased costs, including warranty expense and costs associated with customer support, delays in
or cancellations or rescheduling of orders or shipments, product returns or discounts, diversion of
management resources or damage to our reputation and brand equity, and in
some cases consequential damages, any of which would harm our operating results. In addition,
delays in our ability to fill product orders as a result of quality control issues may negatively
impact our relationship with our customers. We cannot assure you that we will have sufficient
resources, including any available insurance, to satisfy any asserted claims.
We may have difficulty selling our products if our customers do not design our products
into their systems, and the nature of the design process requires us to incur expenses prior to
recognizing revenues associated with those expenses which may adversely affect our financial
results.
One of our primary focuses is on winning competitive bid selection processes, known as
design wins, to develop products for use in our customers products. We devote significant time
and resources in working with our customers system designers to understand their future needs and
to provide products that we believe will meet those needs and these bid selection processes can be
lengthy. If a customers system designer initially chooses a competitors product, it becomes
significantly more difficult for us to sell our products for use in that system because changing
suppliers can involve significant cost, time, effort and risk for our customers. Thus, our failure
35
to win a competitive bid can result in our foregoing revenues from a given customers product line
for the life of that product. In addition, design opportunities may be infrequent or may be
delayed. Our ability to compete in the future will depend, in large part, on our ability to design
products to ensure compliance with our customers and potential customers specifications. We
expect to invest significant time and resources and to incur significant expenses to design our
products to ensure compliance with relevant specifications.
We often incur significant expenditures in the development of a new product without any
assurance that our customers system designers will select our product for use in their
applications. We often are required to anticipate which product designs will generate demand in
advance of our customers expressly indicating a need for that particular design. Even if our
customers system designers select our products, a substantial period of time will elapse before we
generate revenues related to the significant expenses we have incurred.
The reasons for this delay generally include the following elements of our product sales
and development cycle timeline and related influences:
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our customers usually require a comprehensive technical evaluation of
our products before they incorporate them into their designs; |
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it can take from nine months to three years from the time our products
are selected to commence commercial shipments; and our customers may
experience changed market conditions or product development issues.
The resources devoted to product development and 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 have
produced product in anticipation of expected demand. We may spend
resources on the development of products that our customers may not
adopt. If we incur significant expenses and investments in inventory
in the future that we are not able to recover, and we are not able to
compensate for 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. |
Additionally, even if system designers use our products in their systems, we cannot assure you that
these systems will be commercially successful or that we will receive significant revenue from the
sales of processors for those systems. As a result, we may be unable to accurately forecast the
volume and timing of our orders and revenues associated with any new product introductions.
If customers do not believe our products solve a critical need, our revenues will decline.
Our products are used in networking and security equipment including routers, switches,
UTM appliances, intelligent switches, application-aware gateways, triple-play gateways, WLAN and 3G
access and aggregation devices, storage networking equipment, servers, and intelligent network
interface cards.
In order to meet our growth and strategic objectives, providers of networking equipment
must continue to incorporate our products into their systems and the demands for their systems must
grow as well. Our future depends in large part on factors outside our control, and the sale of
next-generation networks may not meet our revenue growth and strategic objectives.
In the event we terminate one of our distributor arrangements, it could lead to a loss of
revenues and possible product returns.
A portion of our sales are made through third-party distribution agreements. Termination of a
distributor relationship, either by us or by the distributor, could result in a temporary or
permanent loss of revenues, until a replacement distributor can be established to service the
affected end-user customers. We may not be successful in finding suitable alternative distributors
on satisfactory terms or at all and this could adversely affect our ability to sell in certain
locations or to certain end-user customers. Additionally, if we terminate our relationship with a
distributor, we may be obligated to repurchase unsold products. We record a reserve for estimated
returns and price credits. If actual returns and credits exceed our estimates, our operating
results could be harmed. Our arrangements
with our distributors typically also include price protection provisions if we reduce our list
prices.
We rely on our ecosystem partners to enhance our product offerings and our inability to
continue to develop or maintain such relationships in the future would harm our ability to remain
competitive.
We have developed relationships with third parties, which we refer to as ecosystem
partners, which provide operating systems, tool support, reference designs and other services
designed for specific uses with our SoCs. We believe that these relationships enhance our
customers ability to get their products to market quickly. If we are unable to continue to develop
or maintain these relationships, we might not be able to enhance our customers ability to
commercialize their products in a timely fashion and our ability to remain competitive would be
harmed.
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The loss of any of our key personnel could seriously harm our business, and our failure
to attract or retain specialized technical, management or sales and marketing talent could impair
our ability to grow our business.
We believe our future success will depend in large part upon our ability to attract,
retain and motivate highly skilled managerial, engineering, sales and marketing personnel. The loss
of any key employees or the inability to attract, retain or motivate qualified personnel, including
engineers and sales and marketing personnel, could delay the development and introduction of and
harm our
ability to sell our products. We believe that our future success is highly dependent on the
contributions of Syed Ali, our co- founder, President and Chief Executive Officer, and others. None
of our employees have fixed-term employment contracts; they are all at-will employees. The loss of
the services of Mr. Ali, other executive officers or certain other key personnel could materially
and adversely affect our business, financial condition and results of operations. For instance, if
any of these individuals were to leave our company unexpectedly, we could face substantial
difficulty in hiring qualified successors and could experience a loss in productivity during the
search for and while any such successor is integrated into our business and operations.
There is currently a shortage of qualified technical personnel with significant
experience in the design, development, manufacturing, marketing and sales of integrated circuits.
In particular, there is a shortage of engineers who are familiar with the intricacies of the design
and manufacture of networking processors, and competition for these engineers is intense. Our key
technical personnel represent a significant asset and serve as the source of our technological and
product innovations. We may not be successful in attracting, retaining and motivating sufficient
numbers of technical personnel to support our anticipated growth.
To date, we have relied primarily on our direct marketing and sales force to drive new
customer design wins and to sell our products. Because we are looking to expand our customer base
and grow our sales to existing customers, we will need to hire additional qualified sales personnel
in the near term and beyond if we are to achieve revenue growth. The competition for qualified
marketing and sales personnel in our industry, and particularly in Silicon Valley, is very intense.
If we are unable to hire, train, deploy and manage qualified sales personnel in a timely manner,
our ability to grow our business will be impaired. In addition, if we are unable to retain our
existing sales personnel, our ability to maintain or grow our current level of revenues will be
adversely affected.
Stock options generally comprise a significant portion of our compensation packages for all
employees. The FASB requirement to expense the fair value of stock options awarded to employees
beginning in the first quarter of our fiscal 2006 has increased our operating expenses and may
cause us to reevaluate our compensation structure for our employees. Our inability to attract,
retain and motivate additional key employees could have an adverse effect on our business,
financial condition and results of operations.
We have a limited operating history, and we may have difficulty accurately predicting our
future revenues for the purpose of appropriately budgeting and adjusting our expenses.*
We were established in 2000. We have not been profitable in any fiscal period until the
quarter ended September 30, 2007. We experienced net income of $1.8 million and $5.9 million for
the three months and nine months ended September 30, 2008. Since we have only five quarters of
operating profitability, we do not have an extended history from which to predict and manage
profitability. Our limited operating experience, a dynamic and rapidly evolving market in which we
sell our products, our dependence on a limited number of customers, as well as numerous other
factors beyond our control, impede our ability to forecast quarterly and annual revenues
accurately. As a result, we could experience budgeting and cash flow management problems,
unexpected fluctuations in our results of operations and other difficulties, any of which could
make it difficult for us to gain and maintain profitability and could increase the volatility of
the market price of our common stock.
Some of our operations and a significant portion of our customers and contract
manufacturers are located outside of the United States, which subjects us to additional risks,
including increased complexity and costs of managing international operations and geopolitical
instability.
We have sales offices and research and development facilities and we conduct, and expect
to continue to conduct, a significant amount of our business with companies that are located
outside the United States, particularly in Asia and Europe. Even customers of ours that are based
in the U.S. often use contract manufacturers based in Asia to manufacture their systems, and it is
the contract
manufacturers that purchase products directly from us. As a result of our international focus, we
face numerous challenges, including:
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increased complexity and costs of managing international operations; |
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longer and more difficult collection of receivables; |
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difficulties in enforcing contracts generally; |
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geopolitical and economic instability and military conflicts; |
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limited protection of our intellectual property and other assets; |
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compliance with local laws and regulations and unanticipated changes
in local laws and regulations, including tax laws and regulations; |
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trade and foreign exchange restrictions and higher tariffs; |
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travel restrictions; |
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timing and availability of import and export licenses and other
governmental approvals, permits and licenses, including export
classification requirements; |
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foreign currency exchange fluctuations relating to our international operating activities; |
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transportation delays and limited local infrastructure and disruptions, such as large
scale outages or interruptions of service from utilities or telecommunications providers; |
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difficulties in staffing international operations; |
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heightened risk of terrorism; |
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local business and cultural factors that differ from our normal standards and practices; |
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differing employment practices and labor issues; |
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regional health issues (e.g., SARS) and natural disasters; and |
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work stoppages. |
We outsource our wafer fabrication, assembly, testing, warehousing and shipping operations to third
parties, and rely on these parties to produce and deliver our products according to requested
demands in specification, quantity, cost and time.
We rely on third parties for substantially all of our manufacturing operations, including
wafer fabrication, assembly, testing, warehousing and shipping. We depend on these parties to
supply us with material of a requested quantity in a timely manner that meets our standards for
yield, cost and manufacturing quality. We do not have any long-term supply agreements with our
manufacturing suppliers. Any problems with our manufacturing supply chain could adversely impact
our ability to ship our products to our customers on time and in the quantity required, which in
turn could cause an unanticipated decline in our sales and possibly damage our customer
relationships.
The fabrication of integrated circuits is a complex and technically demanding process.
Our foundries could, from time to time, experience manufacturing defects and reduced manufacturing
yields. Changes in manufacturing processes or the inadvertent use of defective or contaminated
materials by our foundries could result in lower than anticipated manufacturing yields or
unacceptable performance. Many of these problems are difficult to detect at an early stage of the
manufacturing process and may be time consuming and expensive to correct. Poor yields from our
foundries, or defects, integration issues or other performance problems in our products could cause
us significant customer relations and business reputation problems, harm our financial results and
result in financial or other damages to our customers. Our customers could also seek damages from
us for their losses. A product liability claim brought against us, even if unsuccessful, would
likely be time consuming and costly to defend.
Our products are manufactured at a limited number of locations. If we experience
manufacturing problems at a particular location, we would be required to transfer manufacturing to
a backup location or supplier. Converting or transferring manufacturing from a primary location or
supplier to a backup fabrication facility could be expensive and could take one to two quarters.
During such a transition, we would be required to meet customer demand from our then-existing
inventory, as well as any partially finished goods that can be modified to the required product
specifications. We do not seek to maintain sufficient inventory to address a lengthy transition
period because we believe it is uneconomical to keep more than minimal inventory on hand. As a
result, we may not be able
to meet customer needs during such a transition, which could delay shipments, cause a production
delay or stoppage for our customers, result in a decline in our sales and damage our customer
relationships. In addition, we have no long-term supply contracts with the foundries that we work
with. Availability of foundry capacity has in the recent past been reduced due to strong demand.
The ability of each foundry to provide us with semiconductor devices is limited by its available
capacity and existing obligations. Foundry capacity may not be available when we need it or at
reasonable prices.
In addition, a significant portion of our sales is to customers that practice
just-in-time order management from their suppliers, which gives us a very limited amount of time in
which to process and complete these orders. As a result, delays in our production or shipping by
the parties to whom we outsource these functions could reduce our sales, damage our customer
relationships and damage our reputation in the marketplace, any of which could harm our business,
results of operations and financial condition.
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Any increase in the manufacturing cost of our products could reduce our gross margins and
operating profit.
The semiconductor business exhibits ongoing competitive pricing pressure from customers
and competitors. Accordingly, any increase in the cost of our products, whether by adverse purchase
price variances or adverse manufacturing cost variances, will reduce our gross margins and
operating profit. We do not have any long-term supply agreements with our manufacturing suppliers
and we typically negotiate pricing on a purchase order by purchase order basis. Consequently, we
may not be able to obtain price reductions or anticipate or prevent future price increases from our
suppliers.
Some of our competitors may be better financed than we are, may have long-term agreements
with our main foundries and may induce our foundries to reallocate capacity to those customers.
This reallocation could impair our ability to secure the supply of components that we need.
Although we use several independent foundries to manufacture substantially all of our semiconductor
products, most of our components are not manufactured at more than one foundry at any given time,
and our products typically are designed to be manufactured in a specific process at only one of
these foundries. Accordingly, if one of our foundries is unable to provide us with components as
needed, we could experience significant delays in securing sufficient supplies of those components.
We cannot assure you that any of our existing or new foundries will be able to produce integrated
circuits with acceptable manufacturing yields, or that our foundries will be able to deliver enough
semiconductor devices to us on a timely basis, or at reasonable prices. These and other related
factors could impair our ability to meet our customers needs and have a material and adverse
effect on our operating results.
In order to secure sufficient foundry capacity when demand is high and mitigate the risks
described in the foregoing paragraph, we may enter into various arrangements with suppliers that
could be costly and harm our operating results, such as nonrefundable deposits with or loans to
foundries in exchange for capacity commitments and contracts that commit us to purchase specified
quantities of integrated circuits over extended periods. We may not be able to make any such
arrangement in a timely fashion or at all, and any arrangements may be costly, reduce our financial
flexibility, and not be on terms favorable to us. Moreover, if we are able to secure foundry
capacity, we may be obligated to use all of that capacity or incur penalties. These penalties may
be expensive and could harm our financial results.
If we fail to maintain an effective system of internal controls, we may not be able to
accurately report our financial results or prevent fraud.
Effective internal controls are necessary for us to provide reliable financial reports
and effectively prevent fraud. Any inability to provide reliable financial reports or prevent fraud
could harm our business. The Sarbanes-Oxley Act of 2002 requires management and our auditors to
evaluate and assess the effectiveness of our internal control over financial reporting. We will be
required to adhere to these requirements by the end of 2008. These Sarbanes-Oxley Act requirements
may be modified, supplemented or amended from time to time. Implementing these changes may take a
significant amount of time and may require specific compliance training of our personnel. In the
future, we may discover areas of our internal controls that need improvement. If our auditors or we
discover a material weakness, the disclosure of that fact, even if quickly remedied, could reduce
the markets confidence in our financial statements and harm our stock price. We may not be able to
effectively and timely implement necessary control changes and employee training to ensure
continued compliance with the Sarbanes-Oxley Act and other regulatory and reporting requirements.
Our rapid growth in recent periods, and our possible future expansion through acquisitions, present
challenges to maintain the internal control and disclosure control standards applicable to public
companies. If we fail to maintain effective internal controls, we could be subject to regulatory
scrutiny and sanctions and investors could lose confidence in the accuracy and completeness of our
financial reports. We cannot assure you that we will be able to fully comply with the requirements
of the Sarbanes-Oxley Act or that management or our auditors will conclude that our internal
controls are effective in future periods.
We rely on third-party technologies for the development of our products and our inability
to use such technologies in the future would harm our ability to remain competitive.
We rely on third parties for technologies that are integrated into our products, such as
wafer fabrication and assembly and test technologies used by our contract manufacturers, as well as
licensed MIPS architecture technologies. If we are unable to continue to
use or license these technologies on reasonable terms, or if these technologies fail to operate
properly, we may not be able to secure alternatives in a timely manner and our ability to remain
competitive would be harmed. In addition, if we are unable to successfully license technology from
third parties to develop future products, we may not be able to develop such products in a timely
manner or at all.
Our failure to protect our intellectual property rights adequately could impair our
ability to compete effectively or to defend ourselves from litigation, which could harm our
business, financial condition and results of operations.*
We rely primarily on patent, copyright, trademark and trade secret laws, as well as
confidentiality and nondisclosure agreements and other methods, to protect our proprietary
technologies and know-how. We have been issued 14 patents in the United States and two patents in
foreign countries and have an additional 27 patent applications pending in the United States and 26
patent applications pending in foreign countries. Even if the pending patent applications are
granted, the rights granted to us may not be meaningful or provide us with any commercial
advantage. For example, these patents could be opposed, contested, circumvented or designed around
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by our competitors or be declared invalid or unenforceable in judicial or administrative
proceedings. The failure of our patents to adequately protect our technology might make it easier
for our competitors to offer similar products or technologies. Our foreign patent protection is
generally not as comprehensive as our U.S. patent protection and may not protect our intellectual
property in some countries where our products are sold or may be sold in the future. Many
U.S.-based companies have encountered substantial intellectual property infringement in foreign
countries, including countries where we sell products. Even if foreign patents are granted,
effective enforcement in foreign countries may not be available.
Monitoring unauthorized use of our intellectual property is difficult and costly.
Although we are not aware of any unauthorized use of our intellectual property in the past, it is
possible that unauthorized use of our intellectual property may have occurred or may occur without
our knowledge. We cannot assure you that the steps we have taken will prevent unauthorized use of
our intellectual property.
Our failure to effectively protect our intellectual property could reduce the value of
our technology in licensing arrangements or in cross-licensing negotiations, and could harm our
business, results of operations and financial condition. We may in the future need to initiate
infringement claims or litigation. Litigation, whether we are a plaintiff or a defendant, can be
expensive, time consuming and may divert the efforts of our technical staff and managerial
personnel, which could harm our business, whether or not such litigation results in a determination
favorable to us.
Some of the software used with our products, as well as that of some of our customers,
may be derived from so called open source software that is generally made available to the public
by its authors and/or other third parties. Such open source software is often made available to us
under licenses, such as the GNU General Public License, which impose certain obligations on us in
the event we were to make available derivative works of the open source software. These obligations
may require us to make source code for the derivative works available to the public, and/or license
such derivative works under a particular type of license, rather than the forms of license
customarily used to protect our intellectual property. In addition, there is little or no legal
precedent for interpreting the terms of certain of these open source licenses, including the
determination of which works are subject to the terms of such licenses. While we believe we have
complied with our obligations under the various applicable licenses for open source software, in
the event the copyright holder of any open source software were to successfully establish in court
that we had not complied with the terms of a license for a particular work, we could be required to
release the source code of that work to the public and/or stop distribution of that work.
Assertions by third parties of infringement by us of their intellectual property rights
could result in significant costs and cause our operating results to suffer.
The semiconductor industry is characterized by vigorous protection and pursuit of
intellectual property rights and positions, which has resulted in protracted and expensive
litigation for many companies. We expect that in the future we may receive, particularly as a
public company, communications from various industry participants alleging our infringement of
their patents, trade secrets or other intellectual property rights. Any lawsuits resulting from
such allegations could subject us to significant liability for damages and invalidate our
proprietary rights. Any potential intellectual property litigation also could force us to do one or
more of the following:
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stop selling products or using technology that contain the allegedly infringing intellectual property; |
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lose the opportunity to license our technology to others or to collect royalty payments based upon
successful protection and assertion of our intellectual property against others; incur significant legal
expenses; |
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pay substantial damages to the party whose intellectual property rights we may be found to be infringing; |
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redesign those products that contain the allegedly infringing intellectual property; or |
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attempt to obtain a license to the relevant intellectual property from third parties, which may not be
available on reasonable terms or at all. |
Any significant impairment of our intellectual property rights from any litigation we face could
harm our business and our ability to compete.
Our customers could also become the target of litigation relating to the patent and other
intellectual property rights of others. This could trigger technical support and indemnification
obligations in some of our licenses or customer agreements. These obligations could result in
substantial expenses, including the payment by us of costs and damages relating to claims of
intellectual property infringement. In addition to the time and expense required for us to provide
support or indemnification to our customers, any such litigation could disrupt the businesses of
our customers, which in turn could hurt our relationships with our customers and cause the sale of
our products to decrease. We cannot assure you that claims for indemnification will not be made or
that if made, such claims would not have a material adverse effect on our business, operating
results or financial conditions.
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Our third-party contractors are concentrated primarily in Taiwan, an area subject to
earthquake and other risks. Any disruption to the operations of these contractors could cause
significant delays in the production or shipment of our products.
Substantially all of our products are manufactured by third-party contractors located in
Taiwan. The risk of an earthquake in Taiwan and elsewhere in the Pacific Rim region is significant
due to the proximity of major earthquake fault lines to the facilities of our foundries and
assembly and test subcontractors. For example, several major earthquakes have occurred in Taiwan
since our incorporation in 2000. Although our third-party contractors did not suffer any
significant damage as a result of these most recent earthquakes, the occurrence of additional
earthquakes or other natural disasters could result in the disruption of our foundry or assembly
and test capacity. Any disruption resulting from such events could cause significant delays in the
production or shipment of our products until we are able to shift our manufacturing, assembling or
testing from the affected contractor to another third-party vendor. We may not be able to obtain
alternate capacity on favorable terms, if at all.
The semiconductor and communications industries have historically experienced significant
fluctuations with prolonged downturns, which could impact our operating results, financial
condition and cash flows.
The semiconductor industry has historically exhibited cyclical behavior, which at various
times has included significant downturns in customer demand. Though we have not yet experienced any
of these industry downturns, we may in the future. Because a significant portion of our expenses is
fixed in the near term or is incurred in advance of anticipated sales, we may not be able to
decrease our expenses rapidly enough to offset any unanticipated shortfall in revenues. If this
situation were to occur, it could adversely affect our operating results, cash flow and financial
condition. Furthermore, the semiconductor industry has periodically experienced periods of
increased demand and production constraints. If this happens in the future, we may not be able to
produce sufficient quantities of our products to meet the increased demand. We may also have
difficulty in obtaining sufficient wafer, assembly and test resources from our subcontract
manufacturers. Any factor adversely affecting the semiconductor industry in general, or the
particular segments of the industry that our products target, may adversely affect our ability to
generate revenue and could negatively impact our operating results.
The communications industry has, in the past, experienced pronounced downturns, and these
cycles may continue in the future. To respond to a downturn, many networking equipment providers
may slow their research and development activities, cancel or delay new product development, reduce
their inventories and take a cautious approach to acquiring our products, which would have a
significant negative impact on our business. If this situation were to occur, it could adversely
affect our operating results, cash flow and financial condition. In the future, any of these trends
may also cause our operating results to fluctuate significantly from year to year, which may
increase the volatility of the price of our stock.
We may experience difficulties in transitioning to new wafer fabrication process
technologies or in achieving higher levels of design integration, which may result in reduced
manufacturing yields, delays in product deliveries and increased expenses.
In order to remain competitive, we expect to continue to transition our semiconductor
products to increasingly smaller line width geometries. This transition requires us to modify our
designs to work with the manufacturing processes of our foundries. We periodically evaluate the
benefits, on a product-by-product basis, of migrating to new process technologies to reduce cost
and improve performance. We may face difficulties, delays and expenses as we continue to transition
our products to new processes. We are dependent on our relationships with our foundry contractors
to transition to new processes successfully. We cannot assure you that the foundries that we use
will be able to effectively manage the transition or that we will be able to maintain our existing
foundry relationships or develop new ones. If any of our foundry contractors or we experience
significant delays in this transition or fail to efficiently implement this transition, we could
experience reduced manufacturing yields, delays in product deliveries and increased expenses, all
of which could harm our relationships with our customers and our results of operations. As new
processes become more prevalent, we expect to continue to integrate greater levels of
functionality, as well as customer and third-party intellectual property, into our products.
However, we may not be able to achieve higher levels of design integration or deliver new
integrated products on a timely basis.
Any acquisitions we make could disrupt our business and harm our financial condition.*
In May 2008 we acquired certain assets of Parallogic Corporation, in August 2008 we
acquired substantially all of the assets of Star Semiconductor Corporation and we may in the future
acquire companies or assets that we believe to be complementary to our business, including for the
purpose of expanding our new product design capacity, introducing new design, market or application
skills or enhancing and expanding our existing product lines. In connection with any such future
acquisitions, we may need to use a significant portion of our available cash, issue additional
equity securities that would dilute current stockholders percentage ownership and incur
substantial debt or contingent liabilities. Such actions could adversely impact our operating
results and the market price of our common stock. In addition, difficulties in assimilating any
acquired workforce, merging operations or avoiding unplanned attrition in connection with such
acquisitions could disrupt or harm our business. Furthermore, the purchase price of any acquired
businesses may exceed the current fair values of the net tangible assets of such acquired
businesses. As a result, we would be required to record material amounts of goodwill, and acquired
in-process research and development charges and other intangible assets, which could result in
significant impairment and acquired in-process research and development charges and amortization
expense in future
41
periods. These charges, in addition to the results of operations of such acquired
businesses, could have a material adverse effect on our business, financial condition and results
of operations. We cannot forecast the number, timing or size of future acquisitions, or the effect
that any such acquisitions might have on our operating or financial results.
Our investment portfolio may become impaired by further deterioration of the capital markets.*
Our cash equivalents as of September 30, 2008 consisted primarily of money market instruments,
which are invested primarily in US treasury securities, bonds of government agencies, and corporate
bonds. We follow an established investment policy and set of guidelines to monitor, manage and
limit our exposure to interest rate and credit risk. The policy sets forth credit quality standards
and limits our exposure to any one issuer, as well as our maximum exposure to various asset
classes.
As a result of current adverse financial market conditions, investments in some financial
instruments, such as structured investment vehicles, sub-prime mortgage-backed securities and
collateralized debt obligations, may pose risks arising from liquidity and credit concerns. As of
September 30, 2008, we had no direct holdings in these categories of investments and our indirect
exposure to these financial instruments through our holdings in money market instruments was
immaterial. As of September 30, 2008, we had no impairment charge associated with our cash
equivalents relating to such adverse financial market conditions. Although we believe our current
investment portfolio has very little risk of impairment, we cannot predict future market conditions
or market liquidity and can provide no assurance that our investment portfolio will remain
unimpaired.
We may need to raise additional capital, which might not be available or which, if available,
may be on terms that are not favorable to use.
We believe our existing cash balances and cash expected to be generated from our
operations will be sufficient to meet our working capital, capital expenditures and other needs for
at least the next twelve months. In the future, we may need to raise additional funds, and we
cannot be certain that we will be able to obtain additional financing on favorable terms, if at
all. If we issue equity securities to raise additional funds, the ownership percentage of our
stockholders would be reduced, and the new equity securities may have rights, preferences or
privileges senior to those of existing holders of our common stock. If we borrow money, we may
incur significant interest charges, which could harm our profitability. Holders of debt would also
have rights, preferences or privileges senior to those of existing holders of our common stock. If
we cannot raise needed funds on acceptable terms, we may not be able to develop or enhance our
products, take advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, which could harm our business, operating results and financial
condition.
Our future effective tax rates could be affected by the allocation of our income among
different geographic regions, which could affect our future operating results, financial condition
and cash flows.
We are in the process of expanding our international operations and staff to better
support our expansion into international markets. This expansion includes the implementation of an
international structure that includes, among other things, a research and development cost-sharing
arrangement, certain licenses and other contractual arrangements between us and our wholly-owned
domestic and foreign subsidiaries. As a result of these changes, we anticipate that our
consolidated pre-tax income will be subject to foreign tax at relatively lower tax rates when
compared to the U.S. federal statutory tax rate and, as a consequence, our effective income tax
rate is expected to be lower than the U.S. federal statutory rate. Our future effective income tax
rates could be adversely affected if tax authorities challenge our international tax structure or
if the relative mix of U.S. and international income changes for any reason. Accordingly, there can
be no assurance that our income tax rate will be less than the U.S. federal statutory rate.
Risks Related to our Common Stock
The market price of our common stock may be volatile, which could cause the value of your
investment to decline.*
The trading prices of the securities of technology companies have been highly volatile.
Further, our common stock has a limited trading history. Since our initial public offering in May
2007 through September 30, 2008, our stock price has fluctuated from a low of $12.33 to a high of
$34.29. We cannot predict the extent to which the trading market will continue to develop or how
liquid the market may become. The trading price of our common stock is therefore likely to be
highly volatile and could be subject to wide fluctuations in price in response to various factors,
some of which are beyond our control. These factors include:
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quarterly variations in our results of operations or those of our competitors; |
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general economic conditions and slow or negative growth of related markets; |
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announcements by us or our competitors of design wins, acquisitions, new products, significant contracts, commercial
relationships or capital commitments; |
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our ability to develop and market new and enhanced products on a timely basis; |
42
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commencement of, or our involvement in, litigation; |
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disruption to our operations; |
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the emergence of new sales channels in which we are unable to compete effectively; |
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any major change in our board of directors or management; |
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changes in financial estimates including our ability to meet our future revenue and operating profit or loss projections; |
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changes in governmental regulations; and |
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changes in earnings estimates or recommendations by securities analysts. |
Furthermore, the stock market in general, and the market for semiconductor and other technology
companies in particular, have experienced price and volume fluctuations that have often been
unrelated or disproportionate to the operating performance of those companies. These broad market
and industry factors may seriously harm the market price of our common stock, regardless of our
actual operating performance. These trading price fluctuations may also make it more difficult for
us to use our common stock as a means to make acquisitions or to use options to purchase our common
stock to attract and retain employees. In addition, in the past, following periods of volatility in
the overall market and the market price of a companys securities, securities class action
litigation has often been instituted against these companies. This litigation, if instituted
against us, could result in substantial costs and a diversion of our managements attention and
resources.
A limited number of stockholders may have the ability to influence the outcome of
director elections and other matters requiring stockholder approval.*
Our directors, executive officers and principal stockholders and their affiliates
beneficially own approximately 40% of our outstanding common stock as of September 30, 2008. These
stockholders, if they acted together, could exert substantial influence over matters requiring
approval by our stockholders, including electing directors, adopting new compensation plans and
approving mergers, acquisitions or other business combination transactions. This concentration of
ownership may discourage, delay or prevent a change of control of our company, which could deprive
our stockholders of an opportunity to receive a premium for their stock as part of a sale of our
company and might reduce our stock price. These actions may be taken even if they are opposed by
our other stockholders.
Delaware law and our amended and restated certificate of incorporation and bylaws contain
provisions that could delay or discourage takeover attempts that stockholders may consider
favorable.
Provisions in our amended and restated certificate of incorporation and bylaws may have
the effect of delaying or preventing a change of control or changes in our management. These
provisions include the following:
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the division of our board of directors into three classes; |
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the right of the board of directors to elect a director to fill a vacancy created by the
expansion of the board of directors or due to the resignation or departure of an existing board
member; |
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the prohibition of cumulative voting in the election of directors, which would otherwise allow
less than a majority of stockholders to elect director candidates; |
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the requirement for the advance notice of nominations for election to the board of directors or
for proposing matters that can be acted upon at a stockholders meeting; |
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the ability of our board of directors to alter our bylaws without obtaining stockholder approval; |
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the ability of the board of directors to issue, without stockholder approval, up to 10,000,000
shares of preferred stock with terms set by the board of directors, which rights could be senior
to those of our common stock; |
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the elimination of the rights of stockholders to call a special meeting of stockholders and to
take action by written consent in lieu of a meeting; |
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the required approval of at least 66 2/3% of the shares entitled to vote at an election of
directors to adopt, amend or repeal our bylaws or repeal the provisions of our amended and
restated certificate of incorporation regarding the election and removal of directors and the
inability of stockholders to take action by written consent in lieu of a meeting; and |
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the required approval of at least a majority of the shares entitled to vote at an election of
directors to remove directors without cause. |
43
In addition, because we are incorporated in Delaware, we are governed by the provisions of
Section 203 of the Delaware General Corporation Law. These provisions may prohibit large
stockholders, particularly those owning 15% or more of our outstanding voting stock, from merging
or combining with us. These provisions in our amended and restated certificate of incorporation and
bylaws and under Delaware law could discourage potential takeover attempts, could reduce the price
that investors are willing to pay for shares of our common stock in the future and could
potentially result in the market price being lower than they would without these provisions.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sale of Equity Securities
None.
Use of Proceeds from Sale of Registered Securities
Our initial public offering of common stock was effected through a Registration Statement
on Form S-1 (File No. 333-140660), that was declared effective by the SEC on May 1, 2007. We
registered 7,762,500 shares of our common stock with a proposed maximum aggregate offering price of
$104.8 million, all of which we sold. The offering was completed after the sale of all 7,762,500
shares. Morgan Stanley & Co. Incorporated and Lehman Brothers Inc. were the joint book-running
managing underwriters of our initial public offering and Thomas Weisel Partners LLC, Needham &
Company, LLC and JMP Securities LLC acted as co-managers. As of September 30, 2008, $78.6 million
of the approximately $94.7 million in net proceeds received by us in the offering, after deducting
approximately $7.3 million in underwriting discounts, commissions, and $2.8 million in other
offering costs, were invested in various interest-bearing instruments, and $16.1 million of the net
proceeds had been used for acquisitions, general corporate purposes, including the repayment of the
outstanding balances under the term loan with Silicon Valley Bank, general and administrative and
manufacturing expenses. None of the expenses were paid, directly or indirectly, to directors,
officers or persons owning 10% or more of our common stock, or to our affiliates other than
payments in the ordinary course of business to officers for salaries and to non-employee directors
as compensation for board or board committee service.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
On August 1, 2008, we and two of our subsidiaries, (the Purchasers) completed the
acquisition of substantially all of the intangible assets, inventory and certain other tangible
assets of Star Semiconductor Corporation (Star) pursuant to an asset purchase agreement dated
July 15, 2008 (the Acquisition). The Purchasers paid approximately $9.6 million in cash,
including acquisition related expenses of approximately $0.8 million. Included in the purchase
price was $1.0 million that was placed in escrow for 60 days after the close in order to indemnify
the Purchasers for certain matters, including breaches of representations and warranties and
covenants made by Star in the Asset Purchase Agreement.
Item 6. Exhibits
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Exhibit |
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Number |
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Description |
2.1
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Asset Purchase Agreement by and between Cavium Networks, Inc., Cavium
International, Cavium (Taiwan) Ltd., and Star Semiconductor
Corporation, dated July 15, 2008 (1) |
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3.1
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Amended and Restated Certificate of Incorporation of the Registrant (2) |
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3.2
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Amended and Restated Bylaws (3) |
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4.1
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Reference is made to Exhibits 3.1 and 3.2 |
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Exhibit |
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Number |
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Description |
4.2
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Specimen of Common Stock Certificate (4) |
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31.1
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 of Syed B. Ali,
President and Chief Executive Officer |
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31.2
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 of Arthur D.
Chadwick, Chief Financial Officer |
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32.1*
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 of Syed B. Ali,
President and Chief Executive Officer and Arthur D. Chadwick, Chief
Financial Officer |
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(1)
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Filed as Exhibit 10.1 to the Registrants report on Form 8-K (No.
001-33435), filed with the SEC on July 16, 2008, and incorporated
herein by reference. |
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(2)
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Filed as Exhibit 3.3 to the Registrants registration statement on
Form S-1 (No. 333-140660), filed with the SEC on February 13, 2007, as
amended, and incorporated herein by reference. |
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(3)
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Filed as Exhibit 3.5 to the Registrants registration statement on
Form S-1 (No. 333-140660), filed with the SEC on February 13, 2007, as
amended, and incorporated herein by reference. |
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(4)
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Filed as Exhibit 4.2 to the Registrants registration statement on
Form S-1 (No. 333-140660), filed with the SEC on February 13, 2007, as
amended, and incorporated herein by reference. |
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* |
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This certification accompanies the Form 10-Q to which it relates, is
not deemed filed with the Securities and Exchange Commission and is
not to be incorporated by reference into any filing of the Registrant
under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended (whether made before or after the
date of the Form 10-Q), irrespective of any general incorporation
language contained in such filing. |
45
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.
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CAVIUM NETWORKS, INC.
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Date: November 12, 2008 |
By: |
/s/ ARTHUR D. CHADWICK
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Arthur D. Chadwick |
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Chief Financial Officer |
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46
EXHIBIT INDEX
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Exhibit |
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Number |
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Description |
2.1
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Asset Purchase Agreement by and between Cavium Networks, Inc., Cavium
International, Cavium (Taiwan) Ltd., and Star Semiconductor
Corporation, dated July 15, 2008 (1) |
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3.1
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Amended and Restated Certificate of Incorporation of the Registrant (2) |
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3.2
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Amended and Restated Bylaws (3) |
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4.1
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Reference is made to Exhibits 3.1 and 3.2 |
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4.2
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Specimen of Common Stock Certificate (4) |
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31.1
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 of Syed B. Ali,
President and Chief Executive Officer |
|
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31.2
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 of Arthur D.
Chadwick, Chief Financial Officer |
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32.1*
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Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002 of Syed B. Ali,
President and Chief Executive Officer and Arthur D. Chadwick, Chief
Financial Officer |
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(1)
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Filed as Exhibit 10.1 to the Registrants report on Form 8-K (No.
001-33435), filed with the SEC on July 16, 2008, and incorporated
herein by reference. |
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(2)
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Filed as Exhibit 3.3 to the Registrants registration statement on
Form S-1 (No. 333-140660), filed with the SEC on February 13, 2007, as
amended, and incorporated herein by reference. |
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(3)
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Filed as Exhibit 3.5 to the Registrants registration statement on
Form S-1 (No. 333-140660), filed with the SEC on February 13, 2007, as
amended, and incorporated herein by reference. |
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(4)
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Filed as Exhibit 4.2 to the Registrants registration statement on
Form S-1 (No. 333-140660), filed with the SEC on February 13, 2007, as
amended, and incorporated herein by reference. |
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* |
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This certification accompanies the Form 10-Q to which it relates, is
not deemed filed with the Securities and Exchange Commission and is
not to be incorporated by reference into any filing of the Registrant
under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended (whether made before or after the
date of the Form 10-Q), irrespective of any general incorporation
language contained in such filing. |