Silicon Laboratories Inc.
SILICON LABORATORIES INC (Form: 10-Q, Received: 10/29/2008 12:54:04)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x

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

 

For the quarterly period ended October 4, 2008

 

Or

 

o

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

 

For the transition period from                                                                                 to                                                                            

 

Commission file number:  000-29823

 

SILICON LABORATORIES INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

74-2793174

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

400 West Cesar Chavez, Austin, Texas

 

78701

(Address of principal executive offices)

 

(Zip Code)

 

(512) 416-8500

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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.

x  Yes o  No

 

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

 

Large accelerated filer    x            Accelerated filer    o            Non-accelerated filer    o            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). o Yes x No

 

As of October 22, 2008, 46,259,339 shares of common stock of Silicon Laboratories Inc. were outstanding.

 

 

 



 

 

 

Page
Number

Part I.   Financial Information

 

 

 

 

 

 

 

Item 1.

 

Financial Statements (Unaudited):

 

 

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at October 4, 2008 and December 29, 2007

 

3

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income for the three and nine months ended October 4, 2008 and September 29, 2007

 

4

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended October 4, 2008 and September 29, 2007

 

5

 

 

 

 

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

6

 

 

 

 

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

20

 

 

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

34

 

 

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

34

 

 

 

 

 

 

 

Part II.   Other Information

 

 

 

 

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

35

 

 

 

 

 

 

 

 

 

Item 1A.

 

Risk Factors

 

36

 

 

 

 

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

51

 

 

 

 

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

51

 

 

 

 

 

 

 

 

 

Item 4.

 

Submission of Matters to a Vote of Securities Holders

 

51

 

 

 

 

 

 

 

 

 

Item 5.

 

Other Information

 

51

 

 

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

51

 

Cautionary Statement

 

Except for the historical financial information contained herein, the matters discussed in this report on Form 10-Q (as well as documents incorporated herein by reference) may be considered “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.  Such forward-looking statements include declarations regarding the intent, belief or current expectations of Silicon Laboratories Inc. and its management and may be signified by the words “expects,” “anticipates,” “intends,” “believes” or similar language.  You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties.  Actual results could differ materially from those indicated by such forward-looking statements.  Factors that could cause or contribute to such differences include those discussed under “Risk Factors” and elsewhere in this report.  Silicon Laboratories disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

2



 

Part I.  Financial Information

Item 1.  Financial Statements

 

Silicon Laboratories Inc.

Condensed Consolidated Balance Sheets

(In thousands, except per share data)

 

 

 

October 4,
2008

 

December 29,
2007

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

151,311

 

$

264,408

 

Short-term investments

 

131,496

 

308,566

 

Accounts receivable, net of allowance for doubtful accounts of $1,004 at October 4, 2008 and $517 at December 29, 2007

 

61,601

 

51,211

 

Inventories

 

34,360

 

28,587

 

Deferred income taxes

 

6,003

 

6,025

 

Prepaid expenses and other current assets

 

11,451

 

33,895

 

Total current assets

 

396,222

 

692,692

 

Long-term investments

 

53,367

 

 

Property, equipment and software, net

 

29,372

 

28,157

 

Goodwill

 

107,494

 

73,199

 

Other intangible assets, net

 

51,707

 

18,077

 

Other assets, net

 

22,194

 

28,121

 

Total assets

 

$

660,356

 

$

840,246

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

32,407

 

$

33,321

 

Accrued expenses

 

23,137

 

26,397

 

Deferred income on shipments to distributors

 

29,413

 

28,448

 

Income taxes

 

4,688

 

5,226

 

Total current liabilities

 

89,645

 

93,392

 

Long-term obligations and other liabilities

 

45,537

 

43,309

 

Total liabilities

 

135,182

 

136,701

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock–$0.0001 par value; 10,000 shares authorized; no shares issued and outstanding

 

 

 

Common stock–$0.0001 par value; 250,000 shares authorized; 46,251 and 52,810 shares issued and outstanding at October 4, 2008 and December 29, 2007, respectively

 

5

 

5

 

Additional paid-in capital

 

102,736

 

303,682

 

Retained earnings

 

426,469

 

399,858

 

Accumulated other comprehensive loss

 

(4,036

)

 

Total stockholders’ equity

 

525,174

 

703,545

 

Total liabilities and stockholders’ equity

 

$

660,356

 

$

840,246

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

3



 

Silicon Laboratories Inc.

Condensed Consolidated Statements of Income

(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

October 4,
2008

 

September 29,
2007

 

October 4,
2008

 

September 29,
2007

 

Revenues

 

$

113,483

 

$

87,938

 

$

316,282

 

$

237,349

 

Cost of revenues

 

44,174

 

34,986

 

120,593

 

93,658

 

Gross profit

 

69,309

 

52,952

 

195,689

 

143,691

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

25,785

 

20,844

 

73,836

 

67,796

 

Selling, general and administrative

 

25,940

 

21,693

 

75,035

 

67,267

 

In-process research and development

 

10,250

 

 

10,250

 

 

Operating expenses

 

61,975

 

42,537

 

159,121

 

135,063

 

Operating income

 

7,334

 

10,415

 

36,568

 

8,628

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

2,073

 

7,136

 

9,277

 

18,003

 

Interest expense

 

(71

)

(129

)

(325

)

(527

)

Other income (expense), net

 

(43

)

(214

)

(540

)

(384

)

Income from continuing operations before income taxes

 

9,293

 

17,208

 

44,980

 

25,720

 

Provision (benefit) for income taxes

 

8,139

 

(416

)

18,369

 

1,950

 

Income from continuing operations

 

1,154

 

17,624

 

26,611

 

23,770

 

Income from discontinued operations, net of income taxes

 

 

2,810

 

 

159,750

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

1,154

 

$

20,434

 

$

26,611

 

$

183,520

 

Basic earnings per share:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.02

 

$

0.32

 

$

0.54

 

$

0.43

 

Net income

 

$

0.02

 

$

0.37

 

$

0.54

 

$

3.34

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per share:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

0.02

 

$

0.31

 

$

0.53

 

$

0.42

 

Net income

 

$

0.02

 

$

0.36

 

$

0.53

 

$

3.25

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

47,331

 

55,215

 

49,036

 

54,996

 

Diluted

 

48,385

 

56,767

 

50,083

 

56,481

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

4



 

Silicon Laboratories Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

October 4,
2008

 

September 29,
2007

 

Operating Activities

 

 

 

 

 

Net income

 

$

26,611

 

$

183,520

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Income from discontinued operations

 

 

(159,750

)

Depreciation and amortization of property, equipment and software

 

7,927

 

8,429

 

Loss (gain) on disposal of property, equipment and software

 

(15

)

248

 

Amortization of other intangible assets and other assets

 

5,118

 

3,640

 

Stock compensation expense

 

30,393

 

28,928

 

In-process research and development

 

10,250

 

 

Additional income tax benefit from employee stock-based awards

 

1,108

 

2,068

 

Excess income tax benefit from employee stock-based awards

 

(810

)

(1,499

)

Deferred income taxes

 

339

 

1,131

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(5,838

)

(20,036

)

Inventories

 

(1,367

)

(2,116

)

Prepaid expenses and other assets

 

8,930

 

5,952

 

Accounts payable

 

(1,258

)

2,431

 

Accrued expenses

 

(6,922

)

(7,035

)

Deferred income on shipments to distributors

 

965

 

3,720

 

Income taxes

 

5,654

 

(44,118

)

Net cash provided by operating activities of continuing operations

 

81,085

 

5,513

 

Investing Activities

 

 

 

 

 

Purchases of available-for-sale investments

 

(151,470

)

(444,638

)

Sales and maturities of available-for-sale investments

 

271,824

 

276,719

 

Purchases of property, equipment and software

 

(7,861

)

(3,409

)

Proceeds from the sale of assets

 

14,265

 

270,750

 

Purchases of other assets

 

(4,828

)

(6,691

)

Acquisition of businesses, net of cash acquired

 

(74,560

)

 

Net cash provided by investing activities of continuing operations

 

47,370

 

92,731

 

Financing Activities

 

 

 

 

 

Proceeds from exercises of stock options

 

6,080

 

13,361

 

Proceeds from Employee Stock Purchase Plan

 

1,569

 

1,399

 

Excess income tax benefit from employee stock-based awards

 

810

 

1,499

 

Repurchases of common stock

 

(246,031

)

(46,599

)

Repurchases of stock to satisfy employee tax withholding

 

(3,980

)

(5,053

)

Net cash used in financing activities of continuing operations

 

(241,552

)

(35,393

)

Discontinued Operations

 

 

 

 

 

Operating activities

 

 

3,800

 

Investing activities

 

 

(1,654

)

Financing activities

 

 

18,369

 

Net cash provided by discontinued operations

 

 

20,515

 

Increase (decrease) in cash and cash equivalents

 

(113,097

)

83,366

 

Cash and cash equivalents at beginning of period

 

264,408

 

68,188

 

Cash and cash equivalents at end of period

 

$

151,311

 

$

151,554

 

Supplemental Disclosure of Non-Cash Activity:

 

 

 

 

 

Stock issued for acquisition of business

 

$

6,521

 

$

 

Proceeds from the sale of assets held in escrow

 

$

 

$

14,250

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

5



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.  Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The Condensed Consolidated Financial Statements, other than the Condensed Consolidated Balance Sheet as of December 29, 2007, included herein are unaudited; however, they contain all normal recurring accruals and adjustments which, in the opinion of management, are necessary to present fairly the condensed consolidated financial position of Silicon Laboratories Inc. and its subsidiaries (collectively, the “Company”) at October 4, 2008 and December 29, 2007, the condensed consolidated results of its operations for the three and nine months ended October 4, 2008 and September 29, 2007, and the Condensed Consolidated Statements of Cash Flows for the nine months ended October 4, 2008 and September 29, 2007.  All intercompany balances and transactions have been eliminated.  The condensed consolidated results of operations for the three and nine months ended October 4, 2008 are not necessarily indicative of the results to be expected for the full year.

 

The accompanying unaudited Condensed Consolidated Financial Statements do not include certain footnotes and financial presentations normally required under U.S. generally accepted accounting principles.  Therefore, these Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto for the year ended December 29, 2007, included in the Company’s Form 10-K filed with the Securities and Exchange Commission (SEC) on February 7, 2008.

 

The Company prepares financial statements on a 52-53 week year that ends on the Saturday closest to December 31. Fiscal 2008 will have 53 weeks with the extra week occurring in the first quarter of the year.  Fiscal 2007 had 52 weeks.

 

Reclassifications

 

Certain reclassifications have been made to prior year financial statements to conform with current year presentation.

 

Recent Accounting Pronouncements

 

In May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 162, The Hierarchy of Generally Accepted Accounting Principles .  SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States (the GAAP hierarchy).  SFAS 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles .  Based on its current operations, the Company does not expect that the adoption of SFAS 162 will have a material impact on its financial position or results of operations.

 

6



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, Determination of the Useful Life of Intangible Assets.    FSP FAS 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 FASB Statement No. 142, Goodwill and Other Intangible Assets .  FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.  Early adoption is prohibited.  Based on its current operations, the Company does not expect that the adoption of FSP FAS 142-3 will have a material impact on its financial position or results of operations.

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 .  SFAS 161 amends and expands the disclosure requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities .  SFAS 161 requires entities to provide greater transparency about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows.  SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008.  Based on its current operations, the Company does not expect that the adoption of SFAS 161 will have a material impact on its financial position or results of operations.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations , (SFAS 141R).  SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree.  The Statement also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The impact of adopting SFAS 141R will be dependent on the future business combinations that the Company may pursue after its effective date.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements .  SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements.  In February 2008, the FASB amended SFAS 157 by issuing FSP FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, a nd FAS 157-2, Effective Date of FASB Statement No. 157 .  In October 2008, the FASB amended SFAS 157 by issuing FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.  FSP FAS 157-1 amends SFAS 157 to exclude SFAS 13, Accounting for Leases, and certain other lease-related accounting pronouncements.  FSP FAS 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008.  FSP FAS 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.  The Company adopted certain provisions of SFAS 157 effective December 30, 2007 (see Note 5, Fair Value of Financial Instruments , to the Condensed Consolidated Financial Statements for additional information).  The Company is currently evaluating the effect that the adoption of the provisions deferred by FSP FAS 157-2 will have on its financial position and results of operations.  FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. The adoption of FSP FAS 157-3 did not have a material impact on the Company’s financial position or results of operations.

 

7



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

2. Discontinued Operation

 

In March 2007, the Company sold its Aero® transceiver, AeroFONE™ single-chip phone and power amplifier product lines (the “Aero product lines”) to NXP B.V. and NXP Semiconductors France SAS (collectively “NXP”) for $285 million in cash, (including $14.3 million held in escrow recorded in the “prepaid expenses and other current assets” line of the Consolidated Balance Sheet at December 29, 2007), plus additional earn-out potential of up to an aggregate of $65 million over the next three years.  In March 2008, the full amount previously held in escrow was distributed to the Company.

 

The financial results of the sold product lines have been presented as discontinued operations in the Condensed Consolidated Financial Statements.  The following summarizes results from the discontinued operations (in thousands, except per share data):

 

 

 

September 29, 2007

 

 

 

Three Months
Ended

 

Nine Months
Ended

 

Revenues

 

$

118

 

$

43,284

 

Costs of revenues and operating expenses

 

(68

)

41,107

 

 

 

186

 

2,177

 

Gain on sale of discontinued operations

 

92

 

222,515

 

Income from discontinued operations before income taxes

 

278

 

224,692

 

Provision (benefit) for income taxes

 

(2,532

)

64,942

 

Income from discontinued operations, net of income taxes

 

$

2,810

 

$

159,750

 

 

 

 

 

 

 

Income from discontinued operations per common share:

 

 

 

 

 

Basic

 

$

0.05

 

$

2.91

 

Diluted

 

$

0.05

 

$

2.83

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

Basic

 

55,215

 

54,996

 

Diluted

 

56,767

 

56,481

 

 

In connection with the closing of the sale, the Company entered into certain ancillary agreements with NXP, including a Transition Services Agreement (“TSA”).  Through the TSA, the Company subleased certain premises to NXP and provided various temporary support services, such as IT support services. Such services were provided for approximately six months from the closing date and are no longer being provided. The fees for these services were generally equivalent to the Company’s cost. The TSA fees were $1.9 million and $3.9 million for the three and nine months ended September 29, 2007, respectively.

 

In the three months ended September 29, 2007, the Company recognized $2.5 million in tax benefits related to its discontinued operations due primarily to the closure of open tax years.  During the nine months ended September 29, 2007, the Company made a $40.0 million estimated tax payment due to the gain on the sale of its Aero products and received $18.3 million for the exercise of stock options from employees who were hired by NXP associated with the sale of the Aero products.

 

8



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

3. Earnings Per Share

 

The following table sets forth the computation of basic and diluted earnings per share from continuing operations (in thousands, except per share data):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

October 4,
2008

 

September 29,
2007

 

October 4,
2008

 

September 29,
2007

 

Income from continuing operations

 

$

1,154

 

$

17,624

 

$

26,611

 

$

23,770

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing basic earnings per share

 

47,331

 

55,215

 

49,036

 

54,996

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and awards

 

1,054

 

1,552

 

1,047

 

1,485

 

Shares used in computing diluted earnings per share

 

48,385

 

56,767

 

50,083

 

56,481

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

 

 

 

 

 

 

 

 

Basic earnings per share

 

$

0.02

 

$

0.32

 

$

0.54

 

$

0.43

 

Diluted earnings per share

 

$

0.02

 

$

0.31

 

$

0.53

 

$

0.42

 

 

Approximately 3.9 million, 3.6 million, 3.7 million and 4.2 million weighted-average dilutive potential shares of common stock have been excluded from the earnings per share calculation for the three months ended October 4, 2008 and September 29, 2007, and for the nine months ended October 4, 2008 and September 29, 2007, respectively, as they are anti-dilutive.

 

4. Financial Instruments

 

Investments

 

The Company’s short-term investments consist primarily of municipal bonds and U.S. government agency notes.  These securities typically have original maturities greater than ninety days as of the date of purchase and are classified as available-for-sale.  Investments in which the Company has the ability and intent, if necessary, to liquidate in order to support its current operations (including those with contractual maturities greater than one year from the date of purchase) are classified as short-term.

 

9



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The Company’s long-term investments consist of auction-rate securities.  Prior to fiscal 2008, the Company classified all auction-rate securities as short-term investments.  Early in fiscal 2008, auctions for many of the Company’s auction-rate securities failed because sell orders exceeded buy orders.  As of October 4, 2008, the Company held $57.9 million of auction-rate securities at cost, all of which experienced failed auctions during the first nine months of the year.  The underlying assets of the securities consisted of student loans and municipal bonds, of which $52.7 million were guaranteed by the U.S. government and the remaining $5.2 million were insured.  $54.7 million of the auction-rate securities had credit ratings of AAA and $3.2 million had credit ratings of AA.  These securities had contractual maturity dates ranging from 2025 to 2047 and with current yields of 2.1% to 11.9% per year at October 4, 2008.  The Company is receiving the underlying cash flows on all of its auction-rate securities.  The principal associated with failed auctions are not expected to be accessible until a successful auction occurs, the issuer redeems the securities, a buyer is found outside of the auction process or the underlying securities mature.  The Company is unable to predict if these funds will become available before their maturity dates.  As such, the Company’s auction-rate securities have been classified as long-term investments as of October 4, 2008.

 

The Company reviews its investments as of the end of each reporting period for other-than-temporary declines in fair value based on the specific identification method.  The Company considers various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, changes in underlying credit ratings, forecasted recovery and its ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value. When the Company concludes that an other-than-temporary impairment has resulted, the difference between the fair value and the carrying value is written off and recorded as an impairment charge in the Consolidated Statement of Income.  The Company does not expect to need access to the capital represented by any of its auction-rate securities prior to their maturities and it has the ability and intent to hold the investments for a period of time sufficient to allow for any anticipated recovery in market value.  In addition, the Company believes that the credit ratings and credit support of the security issuers indicate that they have the ability to settle the securities at par value.  As such, the Company has determined that no other-than-temporary impairment losses existed as of October 4, 2008.

 

The carrying value of the Company’s investments as of October 4, 2008 consist of the following (in thousands):

 

 

 

Cost

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

Short-term investments

 

$

132,011

 

$

(515

)

$

131,496

 

Long-term investments

 

57,901

 

(4,534

)

53,367

 

 

 

$

189,912

 

$

(5,049

)

$

184,863

 

 

Derivative Financial Instruments

 

The Company is exposed to interest rate fluctuations in the normal course of its business, including through its corporate headquarters leases.  The base rents for these leases are calculated using a variable interest rate based on the three-month LIBOR.  The Company has entered into interest rate swap agreements with notional values of $44.3 million and $50.1 million and, effectively, fixed the rent payment amounts on these leases through March 2011 and March 2013, respectively.  The Company’s objective is to offset gains and losses resulting from changes in the three-month LIBOR with losses and gains on the derivative contracts, thereby reducing volatility of earnings.  The Company does not use derivative contracts for speculative purposes.

 

10



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The interest rate swap agreements are designated and qualify as cash flow hedges under SFAS 133, Accounting for Derivative Instruments and Hedging Activities .  The Company recognizes derivatives in the Consolidated Balance Sheet at fair value and reports them in other assets, net or long-term obligations and other liabilities.  The fair value of the interest rate swap agreements at October 4, 2008 was a $1.2 million obligation.  The effective portion of the gain or loss on interest rate swaps is recorded in accumulated other comprehensive loss as a separate component of stockholders’ equity.  Cash flows from derivatives are classified as cash flows from operating activities in the Consolidated Statement of Cash Flows.

 

The Company estimates the fair values of derivatives based on quoted prices and market observable data of similar instruments.  The effective portion of the interest rate swaps recorded in accumulated other comprehensive loss was $0.8 million, net of tax at October 4, 2008.  None of this amount is expected to be reclassified to earnings in the next 12 months.  However, if the lease agreements or the interest rate swap agreements are terminated prior to maturity, the fair value of the interest rate swaps recorded in accumulated other comprehensive loss will be recognized in the Consolidated Statement of Income.  During the nine months ended October 4, 2008, the Company did not discontinue any cash flow hedges.

 

Hedge Effectiveness

 

For interest rate swaps designated as cash flow hedges, the Company measures effectiveness by comparing the change in fair value of the hedged item with the change in fair value of the interest rate swap.  The Company recognizes ineffective portions of the hedge, as well as amounts not included in the assessment of effectiveness, in the Consolidated Statement of Income.  As of October 4, 2008, no portion of hedging instruments’ gains or losses were excluded from the assessment of effectiveness.  Hedge ineffectiveness was not material for any of the periods presented.

 

5. Fair Value of Financial Instruments

 

The Company’s financial instruments are recorded at amounts that reflect the Company’s estimate of their fair values.  SFAS 157, Fair Value Measurement, provides a hierarchal disclosure framework associated with the level of subjectivity used in measuring assets and liabilities at fair value.  The three levels defined by the SFAS 157 hierarchy are as follows:

 

Level 1 - Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

Level 2 - Inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

 

Level 3 - Inputs are unobservable for the asset or liability and are developed based on the best information available in the circumstances, which might include the Company’s own data.

 

11



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The following summarizes the valuation of the Company’s financial instruments measured under the SFAS 157 hierarchy (in thousands):

 

 

 

Fair Value Measurements
at October 4, 2008 Using

 

 

 

Description

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

Cash equivalents

 

$

124,203

 

$

 

$

 

$

124,203

 

Short-term investments

 

131,496

 

 

 

131,496

 

Long-term investments

 

 

 

53,367

 

53,367

 

 

 

$

255,699

 

$

 

$

53,367

 

$

309,066

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Derivative instruments

 

$

 

$

1,160

 

$

 

$

1,160

 

 

 

$

 

$

1,160

 

$

 

$

1,160

 

 

The Company’s cash equivalents and short-term investments are valued using quoted prices and other relevant information generated by market transactions involving identical assets.  The Company’s derivative instruments are valued using quoted prices and market observable data of similar instruments.  The Company’s long-term investments are valued using a discounted cash flow model.  The assumptions used in preparing the discounted cash flow model include estimates for interest rates, amount of cash flows, expected holding periods of the securities and a discount to reflect the Company’s ability to liquidate the securities.

 

The following summarizes the activity in Level 3 financial instruments for the three and nine months ended October 4, 2008 (in thousands):

 

 

 

Three Months
Ended

 

Nine Months
Ended

 

Beginning balance

 

$

57,960

 

$

 

Net transfers into Level 3 (1)

 

 

68,800

 

Net purchases, sales, issuances and settlements

 

(3,899

)

(10,899

)

Unrealized losses

 

(694

)

(4,534

)

Balance at October 4, 2008

 

$

53,367

 

$

53,367

 

 


(1) Early in fiscal 2008, quoted prices for the Company’s long-term investments were no longer observable.  As such, the Company changed its fair value measurement methodology from quoted prices in active markets to a cash flow model. Accordingly, these securities were reclassified from Level 1 to Level 3.

 

12



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

6. Balance Sheet Details

 

Balance sheet details consist of the following (in thousands):

 

Inventories

 

 

 

October 4,
2008

 

December 29,
2007

 

Work in progress

 

$

27,745

 

$

25,605

 

Finished goods

 

6,615

 

2,982

 

 

 

$

34,360

 

$

28,587

 

 

7. Acquisition

 

On July 29, 2008, the Company completed its acquisition of Integration Associates Incorporated (“Integration Associates”), a privately held company that designs and develops silicon solutions for wireless, wireline and power system management applications for a wide range of systems.  The Company acquired Integration Associates for approximately $87.1 million, including $80.6 million in cash and approximately 202,000 shares of Silicon Laboratories’ common stock valued at $6.5 million on the closing date.  The shares vest over a two-year period.  Of such consideration, $9.0 million in cash was deposited in escrow as security for breaches of representations and warranties and certain other expressly enumerated matters.  The acquisition price includes $1.0 million for amounts currently in dispute in the calculation of the surplus consideration.

 

The acquisition was recorded using the purchase method of accounting and accordingly, the results of Integration Associates’ operations are included in the Company’s consolidated results of operations beginning with the date of the acquisition.  Pro forma financial information has not been presented since the effect of the acquisition was not material.  The Company believes that the acquisition enables the Company to address new product vectors, accelerates its entry into certain markets and further scales the Company’s engineering team.  These factors contributed to a purchase price that was in excess of the fair value of the net assets acquired and, as a result, the Company recorded goodwill.  The goodwill is not expected to be deductible for tax purposes.  The purchase price was allocated as follows (in thousands):

 

 

 

Amount

 

Weighted-Average
Amortization Period
(Years)

 

Intangible assets:

 

 

 

 

 

Core and developed technology

 

$

36,270

 

9.7

 

Customer relationships

 

1,080

 

10.0

 

In-process research and development

 

10,250

 

 

 

 

 

47,600

 

 

 

Cash and cash equivalents

 

2,644

 

 

 

Accounts receivable

 

4,552

 

 

 

Inventories

 

5,925

 

 

 

Other current assets

 

3,502

 

 

 

Goodwill

 

34,398

 

 

 

Other non-current assets

 

3,005

 

 

 

Accounts payable

 

(3,039

)

 

 

Other current liabilities

 

(4,538

)

 

 

Deferred tax liabilities

 

(6,908

)

 

 

Total purchase price

 

$

87,141

 

 

 

 

13



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The purchase price allocation for this acquisition is preliminary and subject to revision as more detailed analysis is completed and additional information about the fair value of assets and liabilities becomes available.  Adjustments in the fair value of the net assets acquired may affect the calculation of goodwill.

 

In-process research and development (IPR&D) represents acquired technology that had not achieved technological feasibility as of the acquisition closing date and that had no alternative future use.  These costs are expensed on the date of acquisition.  The fair value of each project was determined using the income approach. The discount rate applicable to the cash flows was 20%.  This rate reflects the weighted-average cost of capital and the risks inherent in the development process.  The IPR&D recorded in connection with the acquisition consisted of the following (in thousands):

 

Projects

 

Fair Value

 

Costs to
Complete

 

Radio transmitters and transceivers

 

$

7,740

 

$

2,839

 

Optoelectronic

 

2,020

 

578

 

Power

 

490

 

436

 

 

 

$

10,250

 

$

3,853

 

 

The radio transmitters and transceivers projects enable the delivery of data over proprietary, short range wireless links.  The optoelectronic projects are used for infrared data communications and proximity sensing.  The power projects enable ac/dc conversion in power supply systems.  The Company does not expect the products in design derived from these technologies to begin to contribute to revenues prior to fiscal 2009.

 

8. Stockholders’ Equity and Stock-Based Compensation

 

Common Stock

 

The Company issued 1.1 million shares of common stock during the nine months ended October 4, 2008.  Approximately 124 thousand shares were withheld by the Company during the nine months ended October 4, 2008 to satisfy employee tax obligations for the vesting of certain stock grants made under the Company’s 2000 Stock Incentive Plan.

 

Share Repurchase Program

 

In July 2007, the Company’s Board of Directors authorized a program to repurchase up to $400 million of the Company’s common stock from time to time over a 24-month period.  The program allows for repurchases to be made in the open market or in private transactions, including structured or accelerated transactions, subject to applicable legal requirements and market conditions.  During the nine months ended October 4, 2008, the Company repurchased 7.6 million shares of its common stock for $242 million under its current repurchase program.  During the nine months ended September 29, 2007, the Company repurchased 1.5 million shares for $51 million under its current repurchase program and its previous share repurchase program that expired in July 2007.

 

14



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Comprehensive Income (Loss)

 

The changes in the components of other comprehensive income (loss), net of taxes, were as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

October 4,
2008

 

September 29,
2007

 

October 4,
2008

 

September 29,
2007

 

Net income

 

$

1,154

 

$

20,434

 

$

26,611

 

$

183,520

 

Change in net unrealized losses on available-for-sale securities

 

(786

)

 

(3,282

)

 

Change in net unrealized losses on cash flow hedges

 

(754

)

 

(754

)

 

Comprehensive income (loss)

 

$

(386

)

$

20,434

 

$

22,575

 

$

183,520

 

 

The components of accumulated other comprehensive loss, net of taxes, were as follows (in thousands):

 

 

 

October 4,
2008

 

December 29,
2007

 

Net unrealized losses on available-for-sale securities

 

$

(3,282

)

$

 

Net unrealized losses on cash flow hedges

 

(754

)

 

Accumulated other comprehensive loss

 

$

(4,036

)

$

 

 

Stock-Based Compensation

 

The Company has two stock-based compensation plans, the 2000 Stock Incentive Plan and the Employee Stock Purchase Plan (the “Purchase Plan”).  At the beginning of fiscal 2006, the Company adopted FASB SFAS No. 123 (revised 2004), Share-Based Payment , (SFAS 123R) using the modified-prospective-transition method.

 

Accounting for Stock Compensation

 

Stock-based compensation costs are generally based on the fair value calculated from the Black-Scholes option-pricing model on the date of grant for stock options and on the date of enrollment for the Purchase Plan.  The fair values of stock awards and restricted stock units (RSUs) generally equal their intrinsic value on the date of grant.  The weighted-average fair value of share-based payments was estimated using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Nine Months Ended

 

 

 

October 4,
2008

 

September 29,
2007

 

2000 Stock Incentive Plan:

 

 

 

 

 

Expected volatility

 

43.7

%

48.1

%

Risk-free interest rate %

 

2.8

%

4.7

%

Expected term (in years)

 

5.0

 

4.9

 

Dividend yield

 

 

 

 

 

 

 

 

 

Employee Stock Purchase Plan:

 

 

 

 

 

Expected volatility

 

37.1

%

36.7

%

Risk-free interest rate %

 

1.8

%

4.9

%

Expected term (in months)

 

9.0

 

14.5

 

Dividend yield

 

 

 

 

15



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The following are the stock-based compensation costs recognized in the Company’s Condensed Consolidated Statements of Income (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

October 4,
2008

 

September 29,
2007

 

October 4,
2008

 

September 29,
2007

 

Cost of revenues

 

$

100

 

$

414

 

$

850

 

$

1,099

 

Research and development

 

3,514

 

3,472

 

11,432

 

12,921

 

Selling, general and administrative

 

6,382

 

4,651

 

18,111

 

14,908

 

 

 

9,996

 

8,537

 

30,393

 

28,928

 

Provision for income taxes

 

1,350

 

1,524

 

4,062

 

4,729

 

 

 

$

8,646

 

$

7,013

 

$

26,331

 

$

24,199

 

 

During the nine months ended September 29, 2007, the Company recorded $3.3 million of stock compensation expense in continuing operations for a one-time equity award to employees retained by the Company after the sale of the Aero product lines.

 

The Company had approximately $91.2 million of total unrecognized compensation costs related to stock options, stock and RSUs at October 4, 2008 that are expected to be recognized over a weighted-average period of 2 years.

 

9.  Commitments and Contingencies

 

Securities Litigation

 

On December 6, 2001, a class action complaint for violations of U.S. federal securities laws was filed in the United States District Court for the Southern District of New York against the Company, four officers individually and the three investment banking firms who served as representatives of the underwriters in connection with the Company’s initial public offering of common stock.  The Consolidated Amended Complaint alleges that the registration statement and prospectus for the Company’s initial public offering did not disclose that (1) the underwriters solicited and received additional, excessive and undisclosed commissions from certain investors, and (2) the underwriters had agreed to allocate shares of the offering in exchange for a commitment from the customers to purchase additional shares in the aftermarket at pre-determined higher prices.  The Complaint alleges violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.  The action seeks damages in an unspecified amount and is being coordinated with approximately 300 other nearly identical actions filed against other companies.  A court order dated October 9, 2002 dismissed without prejudice the four officers of the Company who had been named individually.  On December 5, 2006, the Second Circuit vacated a decision by the District Court granting class certification in six “focus” cases, which are intended to serve as test cases.  The plaintiffs selected these six cases, which do not include the Company.  The Court has indicated that its decisions in the six focus cases are intended to provide strong guidance for the parties in the remaining cases.  On April 6, 2007, the Second Circuit denied a petition for rehearing filed by plaintiffs, but noted that plaintiffs could ask the District Court to certify more narrow classes than those that were rejected.

 

16



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

On August 14, 2007, the plaintiffs filed amended complaints in the six focus cases.  On September 27, 2007, the plaintiffs moved to certify a class in the six focus cases.  On November 14, 2007, the issuers and the underwriters named as defendants in the six focus cases filed motions to dismiss the amended complaints against them.  On March 26, 2008, the District Court dismissed the Securities Act claims of those members of the putative classes in the focus cases who sold their securities for a price in excess of the initial offering price and those who purchased outside the previously certified class period.  With respect to all other claims, the motions to dismiss were denied.  On October 10, 2008, at the request of plaintiffs, plaintiffs’ motion for class certification was withdrawn, without prejudice.

 

The Company is unable to estimate or predict the potential damages that might be awarded as a result of this litigation, whether such damages would be greater than the Company’s insurance coverage, or whether the outcome would have a material impact on the Company’s results of operations or financial position.

 

Patent and Copyright Infringement Litigation

 

On December 14, 2006, Analog Devices, Inc. (Analog Devices), a Massachusetts corporation, filed a lawsuit against the Company, in the United States District Court in the District of Massachusetts, alleging infringement of United States Patents Nos. 7,075,329, 6,262,600, 6,525,566, 6,903,578 and 6,873,065, and copyright infringement of certain Analog Devices datasheets.  On September 17, 2007, the Company filed a lawsuit against Analog Devices in the United States District Court for the Eastern District of Texas, Marshall Division, alleging infringement of United States Patent No. 7,171,542.  On March 7, 2008, the Company settled both lawsuits with Analog Devices.  In connection with the settlement, each company agreed to dismiss the lawsuits.

 

Other

 

The Company is involved in various other legal proceedings that have arisen in the normal course of business.  While the ultimate results of these matters cannot be predicted with certainty, the Company does not expect them to have a material adverse effect on its consolidated financial position or results of operations.

 

Operating Leases

 

400 W. Cesar Chavez Building

 

In March 2006, the Company entered into an operating lease agreement and a related participation agreement for a facility in Austin, Texas for its corporate headquarters.  During the term of the lease, the Company has an on-going option to purchase the building for a total purchase price of approximately $44.3 million. Alternatively, the Company can cause the property to be sold to third parties provided it is not in default under the lease. The Company is contingently liable on a first dollar loss basis for the guaranteed residual value associated with this property in the event that the net sale proceeds are less than the original financed cost of the facility up to approximately $35.3 million.

 

17



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

200 W. Cesar Chavez Building

 

In March 2008, the Company entered into an operating lease agreement and a related participation agreement for a facility in Austin, Texas for the expansion of its corporate headquarters.  The lease has a term of five years.  The base rent for the term of the lease is an amount equal to the interest accruing on $50.1 million at 155 basis points over the three-month LIBOR (which would be approximately $13.3 million over the remaining term assuming LIBOR averages 4.33% during such term).

 

The Company has granted certain rights and remedies to the lessor in the event of certain defaults, including the right to terminate the lease, to bring suit to collect damages, and to compel the Company to purchase the facility.  The lease contains other customary representations, warranties, obligations, conditions, indemnification provisions and termination provisions, including covenants that the Company shall maintain unencumbered cash and highly-rated short-term investments of at least $75 million.  If the Company’s unencumbered cash and highly-rated short-term investments are less than $150 million, it must also maintain a ratio of funded debt to earnings before interest expense, income taxes, depreciation, amortization, lease expense and other non-cash charges (EBITDAR) over the four prior fiscal quarters of no greater than 2 to 1.  As of October 4, 2008, the Company believes it was in compliance with all covenants of the lease.

 

During the term of the lease, the Company has an on-going option to purchase the building for a total purchase price of approximately $50.1 million.  Alternatively, the Company can cause the property to be sold to third parties provided it is not in default under the lease.  The Company is contingently liable on a first dollar basis for up to $40.0 million to the extent that the sale proceeds are less than the $50.1 million purchase option.  To the extent that the net proceeds generated from the sale of the facility to a third party exceed the purchase option, the Company would have the right to receive substantially all of such excess proceeds if the sale occurs prior to the end of the term of the lease. If the property is sold after the term of the lease, the Company would have the right to recover its $40.0 million guarantee, to the extent such sale proceeds exceed $10.1 million.

 

In accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others , the Company determined that the fair value associated with the guaranteed residual value was $1.2 million.  This amount was recorded in “Other assets, net” and “Long-term obligations and other liabilities” in the Condensed Consolidated Balance Sheets and is being amortized over the term of the lease.

 

The Company is required to periodically evaluate the expected fair value of the facility at the end of the lease term.  If the Company determines that it is estimable and probable that the expected fair value will be less than $50.1 million, it will ratably accrue the loss up to a maximum of approximately $40.0 million over the remaining lease term.  As of October 4, 2008, the Company has determined that a loss contingency accrual is not required.

 

18



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Interest Rate Swap Agreements

 

In connection with its headquarters leases, the Company has entered into interest rate swap agreements as a hedge against the variable rent under the leases.  Under the terms of the swap agreements, the Company has effectively converted the variable rents to fixed rents through March 2011 for its 400 W. Cesar Chavez building and March 2013 for its 200 W. Cesar Chavez building.  See Note 4, Financial Instruments , to the Condensed Consolidated Financial Statements for additional information.

 

Discontinued Operations Indemnification

 

In connection with the sale of the Aero product lines, the Company agreed to indemnify NXP with respect to liabilities for certain tax matters.  There is no contractual limit on exposure with respect to such matters.  As of October 4, 2008, the Company had no material liabilities recorded with respect to this indemnification obligation.

 

10. Income Taxes

 

Income tax expense was $8.1 million and a benefit of $0.4 million for the three months ended October 4, 2008 and September 29, 2007, respectively, resulting in effective tax rates of 87.6% and (2.4)%, respectively. Income tax expense was $18.4 million and $2.0 million for the nine months ended October 4, 2008 and September 29, 2007, respectively, resulting in effective tax rates of 40.8% and 7.6%, respectively.

 

The increase in the effective rate for the current three month and nine month periods was primarily attributable to a current period tax charge of $11.8 million related to the intercompany license of certain technology obtained in the acquisition of Integration Associates and an increase in the liability for unrecognized tax benefits.  Additionally, the effective tax rate for these periods increased due to the non-deductible write-off of in-process research and development cost related to the acquisition.

 

For both the current three and nine month periods, these increases were partially offset by the reduction of the liability for unrecognized tax benefits further described below.  Additionally, for the current three month period, the increases were offset by the renewal of the federal research and development credit.

 

At October 4, 2008, the Company had gross unrecognized tax benefits of $28.0 million which would affect the effective tax rate if recognized.  During the nine months ended October 4, 2008, the Company had gross increases of $7.3 million to its current year unrecognized tax benefits, primarily due to uncertainty related to intercompany transfer pricing, and gross decreases of $6.6 million to its unrecognized tax benefits related to the closure of an open tax year.  During the nine months ended September 29, 2007, the Company had gross increases of $18.2 million to its unrecognized tax benefits, primarily due to tax consequences associated with discontinued operations, and gross decreases of $6.4 million to its unrecognized tax benefits related to the closure of an income tax audit and the closure of open tax years.

 

The Company believes it is reasonably possible that the gross unrecognized tax benefits will change in the next twelve months due to the Company’s participation in the Advance Pricing Agreement program with the U.S. Internal Revenue Service.  The Company is unable to estimate the range of the possible change to the unrecognized tax benefits at this time.

 

The Company recognizes interest and penalties related to unrecognized tax benefits in the provision (benefit) for income taxes.  The Company recognized $ 0.7 million of interest, net of tax, in the provision (benefit) for income taxes for the nine months ended October 4, 2008.  In addition, during the nine months ended October 4, 2008, the Company had decreases, net of tax, of $1.2 million related to the closure of an open tax year.  The Company also recognized $ 0.7 million of interest, net of tax, in the provision (benefit) for income taxes for the nine months ended September 29, 2007.  In addition, during the nine months ended September 29, 2007 the Company had decreases, net of tax, of $1.1 million related to the closure of an income tax audit and the closure of open tax years.  As of October 4, 2008, the Company had accrued $1.4 million for the payment of interest related to unrecognized tax positions.

 

The tax years 2004 through 2008 remain open to examination by the major taxing jurisdictions to which the Company is subject.  The Company is not currently under audit in any major taxing jurisdiction.

 

19



 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

11.  Headquarter Relocation Costs

 

In fiscal 2006, the Company relocated most of its Austin, Texas employees to a new corporate headquarters.  In fiscal 2007, the Company relocated the remainder of its Austin employees to its headquarters.  The following table summarizes the accrued relocation costs activity for the nine months ended October 4, 2008 (in thousands):

 

Balance at
December 29, 2007

 

Deductions

 

Balance at
October 4, 2008

 

$

2,618

 

$

 1,347

 

$

1,271

 

 

Deductions represent lease payments.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Condensed Consolidated Financial Statements and related notes thereto included elsewhere in this report.  This discussion contains forward-looking statements.  Please see the “Cautionary Statement” above and “Risk Factors” below for discussions of the uncertainties, risks and assumptions associated with these statements.  Our fiscal year-end financial reporting periods are a 52- or 53- week year ending on the Saturday closest to December 31st. Fiscal 2008 will have 53 weeks with the extra week occurring in the first quarter of the year.  Fiscal 2007 had 52 weeks. Our third quarter of fiscal 2008 ended October 4, 2008.  Our third quarter of fiscal 2007 ended September 29, 2007.  Except as noted, financial results are for continuing operations.  Our former Aero product lines are reported as discontinued operations.  The sale of these product lines closed in March 2007.

 

Overview

 

We design and develop proprietary, analog-intensive, mixed-signal integrated circuits (ICs) for a broad range of applications.  Mixed-signal ICs are electronic components that convert real-world analog signals, such as sound and radio waves, into digital signals that electronic products can process.  Therefore, mixed-signal ICs are critical components in a broad range of applications in a variety of markets, including communications, consumer, industrial, automotive, medical and power management.  Our major customers include 2Wire, Garmin, Huawei, LG Electronics, Motorola, Panasonic, Philips, Sagem, Samsung and Thomson.

 

As a “fabless” semiconductor company, we rely on third-party semiconductor fabricators in Asia, and to a lesser extent the United States, to manufacture the silicon wafers that reflect our IC designs.  Each wafer contains numerous die, which are cut from the wafer to create a chip for an IC.  We rely on third-parties in Asia to assemble, package, and, in the substantial majority of cases, test these devices and ship these units to our customers.  We have increased the portion of testing performed by such third parties, which facilitates faster delivery of products to our customers (particularly those located in Asia), shorter production cycle times, lower inventory requirements, lower costs and increased flexibility of test capacity.

 

Our product set addresses a variety of broad-based mixed-signal applications.  Our expertise in analog-intensive, high-performance, mixed-signal ICs enables us to develop highly differentiated solutions that address multiple markets.  We group our products into the following categories:

 

·                   RF products, which include our broadcast radio receivers and transmitters, short-range wireless transceivers, video demodulators, satellite set-top box receivers and satellite radio tuners;

 

·                   Access products, which include our ISOmodem® embedded modems and Voice over IP (VoIP) products, such as our ProSLIC® subscriber line interface circuits and voice direct access arrangement (DAA);

 

20



 

·                   Broad-based products, which include microcontrollers, timing products (including clocks, precision clock & data recovery ICs and oscillators) and power products (including our isolators, current sensors, ac/dc converters and Power over Ethernet devices); and

 

·                   Mature products, which include our silicon DAA for PC modems, DSL analog front end ICs, optical physical layer transceivers and RF Synthesizers.

 

Through acquisitions and internal development efforts, we have continued to diversify our product portfolio and introduce next generation ICs with added functionality and further integration.  In July 2008, we completed our acquisition of Integration Associates, a privately-held company that designs and develops silicon solutions for wireless, wireline and power system management applications for a wide range of systems.  Products acquired include ac/dc converters and the EZRadio® family of short range wireless ICs designed for point to point data transmission for consumer and industrial monitoring and control, such as remote keyless entry, security monitoring and other near range wireless applications.

 

In the first nine months of 2008, we introduced a 100% CMOS oscillator, a highly integrated automotive communications controller, a family of integrated isolated gate drivers, four new FM receivers with embedded antenna support, a single-chip digital video demodulator, a single input, single output jitter-attenuating clock multiplier IC, two high-performance radio data system (RDS) receivers for portable and in-car navigation devices, a family of fully-integrated AM/FM radio receivers with weather band coverage and expanded our microcontroller portfolio with the addition of low voltage microcontrollers capable of operating down to 0.9 volts and new small form factor microcontrollers with EPROM.  We plan to continue to introduce products that increase the content we provide for existing applications, thereby enabling us to serve markets we do not currently address and expanding our total available market opportunity.

 

We had no customers that accounted for more than 10% of our revenues during the nine months ended October 4, 2008.  In addition to direct sales to customers, some of our end customers purchase products indirectly from us through distributors and contract manufacturers.  An end customer purchasing through a contract manufacturer typically instructs such contract manufacturer to obtain our products and incorporate such products with other components for sale by such contract manufacturer to the end customer.  Although we actually sell the products to, and are paid by, the distributors and contract manufacturers, we refer to such end customer as our customer.  One of our distributors, Edom Technology, represented 31% of our revenues during the nine months ended October 4, 2008.  There were no other distributors or contract manufacturers that accounted for more than 10% of our revenues during the nine months ended October 4, 2008.

 

The percentage of our revenues derived from customers located outside of the United States was 87% during the nine months ended October 4, 2008, which reflects our product and customer diversification and market penetration for our products, as many of our customers manufacture and design their products in Asia.  All of our revenues to date have been denominated in U.S. dollars.  We believe that a majority of our revenues will continue to be derived from customers outside of the United States.

 

The sales cycle for our ICs can be as long as 12 months or more.  An additional three to six months or more are usually required before a customer ships a significant volume of devices that incorporate our ICs.  Due to this lengthy sales cycle, we typically experience a significant delay between incurring research and development and selling, general and administrative expenses, and the corresponding sales.  Consequently, if sales in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter and, potentially, future quarters would be adversely affected.  Moreover, the amount of time between initial research and development and commercialization of a product, if ever, can be substantially longer than the sales cycle for the product.  Accordingly, if we incur substantial research and development costs without developing a commercially successful product, our operating results, as well as our growth prospects, could be adversely affected.

 

21



 

Because many of our ICs are designed for use in consumer products such as personal computers, personal video recorders, set-top boxes and mobile handsets, we expect that the demand for our products will be typically subject to some degree of seasonal demand.  However, rapid changes in our markets and across our product areas make it difficult for us to accurately estimate the impact of seasonal factors on our business.

 

Discontinued Operation

 

In March 2007, we sold our Aero transceiver, AeroFONE single-chip phone and power amplifier product lines to NXP for $285 million in cash, plus additional earn-out potential of up to an aggregate of $65 million over the following three years.  The results of operations of the sold product lines have been presented as discontinued operations.

 

Results of Operations

 

The following describes the line items set forth in our Condensed Consolidated Statements of Income:

 

Revenues.   Revenues are generated almost exclusively by sales of our ICs.  We recognize revenue on sales when all of the following criteria are met: 1) there is persuasive evidence that an arrangement exists, 2) delivery of goods has occurred, 3) the sales price is fixed or determinable, and 4) collectibility is reasonably assured.  Generally, we recognize revenue from product sales to direct customers and contract manufacturers upon shipment. Certain of our sales are made to distributors under agreements allowing certain rights of return and price protection on products unsold by distributors. Accordingly, we defer the revenue and cost of revenue on such sales until the distributors sell the product to the end customer.  Our products typically carry a one-year replacement warranty.  Replacements have been insignificant to date.  Our revenues are subject to variation from period to period due to the volume of shipments made within a period and the prices we charge for our products.  The vast majority of our revenues were negotiated at prices that reflect a discount from the list prices for our products.  These discounts are made for a variety of reasons, including: 1) to establish a relationship with a new customer, 2) as an incentive for customers to purchase products in larger volumes, 3) to provide profit margin to our distributors who resell our products or 4) in response to competition.  In addition, as a product matures, we expect that the average selling price for such product will decline due to the greater availability of competing products.  Our ability to increase revenues in the future is dependent on increased demand for our established products and our ability to ship larger volumes of those products in response to such demand, as well as our ability to develop or acquire new products and subsequently achieve customer acceptance of newly introduced products.

 

Cost of Revenues.   Cost of revenues includes the cost of purchasing finished silicon wafers processed by independent foundries; costs associated with assembly, test and shipping of those products; costs of personnel and equipment associated with manufacturing support, logistics and quality assurance; costs of software royalties and amortization of purchased software, other intellectual property license costs, certain acquired intangible assets and adjustments to record inventory acquired from Integration Associates at fair value; an allocated portion of our occupancy costs; and allocable depreciation of testing equipment and leasehold improvements.  Generally, we depreciate equipment over four years on a straight-line basis and leasehold improvements over the shorter of the estimated useful life or the applicable lease term.  Recently introduced products tend to have higher cost of revenues per unit due to initially low production volumes required by our customers and higher costs associated with new package variations.  As production volumes for a product increase, unit production costs tend to decrease as our yields improve and our semiconductor fabricators, assemblers and test suppliers achieve greater economies of scale for that product.  Additionally, the cost of wafer procurement and assembly and test services, which are significant components of cost of goods sold, vary cyclically with overall demand for semiconductors and our suppliers’ available capacity of such products and services.

 

22



 

Research and Development.   Research and development expense consists primarily of personnel-related expenses, including stock compensation, new product mask, wafer, packaging and test costs, external consulting and services costs, amortization of purchased software, equipment tooling, equipment depreciation, amortization of acquired intangible assets, acquired research and development resulting from acquisitions, as well as an allocated portion of our occupancy costs for such operations.  We generally depreciate our research and development equipment over four years and amortize our purchased software from computer-aided design tool vendors over the shorter of the estimated useful life or the license term.  Research and development activities include the design of new products and software, refinement of existing products and design of test methodologies to ensure compliance with required specifications.

 

Selling, General and Administrative.   Selling, general and administrative expense consists primarily of personnel-related expenses, including stock compensation, related allocable portion of our occupancy costs, sales commissions to independent sales representatives, applications engineering support, professional fees, directors’ and officers’ liability insurance, patent litigation legal fees, costs related to relocating our headquarters and promotional and marketing expenses.

 

In-Process Research and Development.   In-process research and development (IPR&D) represents acquired technology resulting from business combinations that had not achieved technological feasibility as of the acquisition closing date and had no alternative future use. These costs are expensed on the date of acquisition.

 

Interest Income.   Interest income reflects interest earned on our cash, cash equivalents and investment balances.

 

Interest Expense.   Interest expense consists of interest on our short and long-term obligations.

 

Other Income (Expense), Net.   Other income (expense), net reflects foreign currency remeasurement adjustments and gains on the disposal of fixed assets.

 

Provision (Benefit) for Income Taxes.   We accrue a provision (benefit) for domestic and foreign income tax at the applicable statutory rates adjusted for non-deductible expenses (including a portion of our stock compensation), research and development tax credits and interest income from tax-exempt investments.  We recognize interest and penalties related to unrecognized tax benefits in the provision (benefit) for income taxes.

 

23



 

The following table sets forth our Condensed Consolidated Statements of Income data as a percentage of revenues for the periods indicated:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

October 4, 
2008

 

September 29, 
2007

 

October 4,
 2008

 

September 29,
 2007

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of revenues

 

38.9

 

39.8

 

38.1

 

39.5

 

Gross profit

 

61.1

 

60.2

 

61.9

 

60.5

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

22.7

 

23.7

 

23.3

 

28.6

 

Selling, general and administrative

 

22.9

 

24.7

 

23.7

 

28.3

 

In-process research and development

 

9.0

 

 

3.2

 

 

Operating expenses

 

54.6

 

48.4

 

50.2

 

56.9

 

Operating income

 

6.5

 

11.8

 

11.7

 

3.6

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

1.8

 

8.1

 

2.8

 

7.6

 

Interest expense

 

(0.1

)

(0.2

)

(0.1

)

(0.2

)

Other income (expense), net

 

(0.0

)

(0.2

)

(0.2

)

(0.2

)

Income from continuing operations before income taxes

 

8.2

 

19.5

 

14.2

 

10.8

 

Provision (benefit) for income taxes

 

7.2

 

(0.5

)

5.8

 

0.8

 

Income from continuing operations

 

1.0

 

20.0

 

8.4

 

10.0

 

Income from discontinued operations, net of income taxes

 

 

3.2

 

 

67.3

 

Net income

 

1.0

%

23.2

%

8.4

%

77.3

%

 

Revenues

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 4,
 2008

 

September 29,
 2007

 

Change

 


Change

 

October 4, 
2008

 

September 29,
 2007

 

Change

 


Change

 

Revenues

 

$

113.5

 

$

87.9

 

$

25.6

 

29.0

%

$

316.3

 

$

237.3

 

$

79.0

 

33.3

%

 

The growth in the sales of our products for the recent three and nine month periods was primarily driven by (a) increased revenues from substantially all of our product groups and (b) product revenues from the acquisition of Integration Associates in July 2008.  Unit volumes of our products increased compared to the three and nine months ended September 29, 2007 by 70.9% and 57.6%, respectively.  Average selling prices decreased during the same periods by 25.5% and 16.5%, respectively.  Unit volumes and average selling prices were substantially affected by the addition of certain high volume, low average selling price products through the Integration Associates acquisition.  Excluding the Integration Associates products, during the same periods, unit volumes increased by 28.0% and 41.0% and average selling prices decreased by only 5.7% and 8.4%.  In general, as our products become more mature, we expect to experience decreases in average selling prices.  We anticipate that newly announced higher priced, next generation products and product extensions will offset these decreases to some degree.

 

24



 

Gross Profit

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 4, 
2008

 

September 29,
 2007

 

Change

 


Change

 

October 4, 
2008

 

September 29,
 2007

 

Change

 


Change

 

Gross profit

 

$

69.3

 

$

53.0

 

$

16.3

 

30.9

%

$

195.7

 

$

143.7

 

$

52.0

 

36.2

%

Percent of revenue

 

61.1

%

60.2

%

 

 

 

 

61.9

%

60.5

%

 

 

 

 

 

The increase in gross profit as a percent of revenue for the recent three and nine month periods was primarily due to changes in product mix, improvements in our inventory management and product cost reductions.  Gross profit for the recent three and nine month periods includes a charge of $1.4 million to record inventory acquired from Integration Associates at fair value.

 

We may experience declines in the average selling prices of certain of our products.  This downward pressure on gross profit as a percentage of revenues may be offset to the extent we are able to: 1) introduce higher margin new products and gain market share with our ICs; or 2) achieve lower production costs from our wafer suppliers and third-party assembly and test subcontractors.

 

Research and Development

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 4,
 2008

 

September 29,
 2007

 

Change

 


Change

 

October 4, 
2008

 

September 29,
 2007

 

Change

 


Change

 

Research and development

 

$

25.8

 

$

20.8

 

$

5.0

 

23.7

%

$

73.8

 

$

67.8

 

$

6.0

 

8.9

%

Percent of revenue

 

22.7

%

23.7

%

 

 

 

 

23.3

%

28.6

%

 

 

 

 

 

The increase in research and development expense for the recent three and nine month periods was principally due to increases of $4.4 million and $4.5 million for personnel-related expenses, respectively, and to $1.3 million and $2.7 million of reduced occupancy and IT support costs during the three and nine months ended September 29, 2007, respectively, which were billed to NXP in connection with our transition services agreement (which has now expired).  This impact was partially offset by decreased product introduction costs of $0.8 million for the recent three month period and increased research credits of $0.9 million for the recent nine month period.  The decrease in research and development expense as a percent of revenues is due to our increased sales.

 

Significant recent development projects include a 100% CMOS oscillator, a highly integrated automotive communications controller, a family of integrated isolated gate drivers, four new FM receivers with embedded antenna support, a single-chip digital video demodulator, a single input, single output jitter-attenuating clock multiplier IC, two high-performance radio data system (RDS) receivers for portable and in-car navigation devices, a family of fully-integrated AM/FM radio receivers with weather band coverage, a dual-function, single-port Power over Ethernet (PoE) controller with an integrated dc-dc controller for power sourcing equipment, fully-integrated AM/FM radio receivers with short-wave and long-wave band coverage and we further expanded our microcontroller portfolio.  We expect that research and development expense will increase with revenue in absolute dollars due to increases in hiring and may fluctuate as a percentage of revenue due to changes in sales and the timing of certain expensive items related to new product development initiatives, such as engineering mask and wafer costs.

 

25



 

Selling, General and Administrative

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 4,
 2008

 

September 29,
 2007

 

Change

 


Change

 

October 4,
 2008

 

September 29,
 2007

 

Change

 


Change

 

Selling, general and administrative

 

$

25.9

 

$

21.7

 

$

4.2

 

19.6

%

$

75.0

 

$

67.3

 

$

7.7

 

11.5

%

Percent of revenue

 

22.9

%

24.7

%

 

 

 

 

23.7

%

28.3

%

 

 

 

 

 

The increase in selling, general and administrative expense for the recent three and nine month periods was principally due to increases of $3.4 million and $6.7 million for personnel-related expenses, respectively, and to $0.5 million and $1.0 million of reduced occupancy costs during the three and nine months ended September 29, 2007, respectively, which were billed to NXP in connection with our TSA.  Selling, general and administrative expense for the recent nine month period also reflects an increase of $0.8 million for sales commissions and a decrease of $1.6 million in legal fees, primarily related to litigation.  The decrease in selling, general and administrative expense as a percent of revenues is due to our increased sales.  We expect that selling, general and administrative expense will increase slightly in absolute dollars in future periods.

 

In-Process Research and Development

 

In-process research and development (IPR&D) recorded in connection with the acquisition of Integration Associates was $10.3 million for the three and nine months ended October 4, 2008.  The IPR&D projects included optoelectronic, power, and radio transmitter and transceiver technologies.  The optoelectronic projects are used for infrared data communications and proximity sensing.  The power projects enable ac/dc conversion in power supply systems.  The radio transmitters and transceivers projects enable the delivery of data over proprietary, short range wireless links.  The fair value of each project was determined using the income approach.  The discount rate applicable to the cash flows was 20%.  This rate reflects the weighted-average cost of capital and the risks inherent in the development process.

 

We estimate that these projects ranged from 30% to 84% complete at the date of acquisition.  The remaining research and development efforts include additional design, integration and testing.  We project the costs to complete the projects will be $3.9 million.  The significant risks associated with the successful completion of these projects include our potential inability to finish the product designs, produce working models and gain customer acceptance.  Failure to complete these projects in a timely manner could result in lost revenues.  We do not expect the products in design derived from these technologies to begin to contribute to revenues prior to fiscal 2009.

 

There was no IPR&D for the three and nine months ended September 29, 2007.

 

Interest Income

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 4, 
2008

 

September 29,
 2007

 

Change

 

October 4, 
2008

 

September 29,
 2007

 

Change

 

Interest income

 

$

2.1

 

$

7.1

 

$

(5.0

)

$

9.3

 

$

18.0

 

$

(8.7

)

 

The decrease in interest income for the recent three and nine month periods was due to lower average cash and investment balances and lower interest rates of the underlying instruments.

 

Interest Expense

 

Interest expense was $0.1 million and $0.3 million for the three and nine months ended October 4, 2008, respectively, as compared to $0.1 million and $0.5 million for the three and nine months ended September 29, 2007, respectively.

 

26



 

Other Income (Expense), Net

 

Other income (expense), net was $(43) thousand and $(0.5) million for the three and nine months ended October 4, 2008, respectively, as compared to $(0.2) million and $(0.4) million for the three and nine months ended September 29, 2007, respectively.

 

Provision (Benefit) for Income Taxes

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 4, 
2008

 

September 29,
 2007

 

Change

 

October 4, 
2008

 

September 29,
 2007

 

Change

 

Provision (benefit) for income taxes

 

$

8.1

 

$

(0.4

)

$

8.6

 

$

18.4

 

$

2.0

 

$

16.4

 

Effective tax rate

 

87.6

%

(2.4

)%

 

 

40.8

%

7.6

%

 

 

 

The effective tax rate for the three months ended October 4, 2008 was higher than the three months ended September 29, 2007 primarily due to a one-time tax cost associated with the current quarter intercompany licensing of certain intellectual property, the non-deductible write-off of in-process research and development costs, a decrease in the ratio of tax deductible stock compensation expense as a percentage of income before income taxes, and the unfavorable impact of a reduction in tax exempt interest income.  The impact was partially offset by the current quarter reduction of the liability for unrecognized tax benefits due to the closure of an open tax year and the renewal of the federal research and development credit.

 

The effective tax rate for the nine months ended October 4, 2008 was higher than the nine months ended September 29, 2007 primarily due to a one-time tax cost associated with the current quarter intercompany licensing of certain intellectual property, the non-deductible write-off of in-process research and development costs, and the unfavorable impact of a reduction in tax exempt interest income.

 

In the third quarter of 2008, we aligned, through an intercompany license, the non-U.S. intellectual property rights associated with the acquisition of Integration Associates with existing non-U.S. rights currently owned by one of our non-U.S. manufacturing subsidiaries. This transfer resulted in a one-time increase in the 2008 effective tax rate.

 

The effective tax rates for each of the periods presented differ from the federal statutory rate of 35% due to the amount of income earned in foreign jurisdictions where the tax rate may be lower than the federal statutory rate, tax exempt interest income, the limited deductibility of stock compensation expense and other permanent items including non-deductible in-process research and development.

 

Income from Discontinued Operations, Net of Income Taxes

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 4, 
2008

 

September 29,
 2007

 

Change

 

October 4, 
2008

 

September 29,
 2007

 

Change

 

Income from discontinued operations, net of income taxes

 

$

 

$

2.8

 

$

(2.8

)

$

 

$

159.8

 

$

(159.8

)

 

Revenues from our discontinued operations for the three and nine months ended October 4, 2008 were zero, as compared to $0.1 million and $43.3 million for the three and nine months ended September 29, 2007, respectively.  Income from our discontinued operations for the nine months ended September 29, 2007 included a gain on the sale of our Aero product lines of $224.7 million and a provision for income taxes of $64.9 million.  We do not expect to recognize any additional revenue from our discontinued operations.  See Note 2, Discontinued Operation , to the Condensed Consolidated Financial Statements for additional information.

 

27



 

Business Outlook

 

We expect revenues in the fourth quarter of fiscal 2008 to be flat to down five percent sequentially.  Furthermore, we expect our diluted net income per share to be in the range of $0.21 to $0.26.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity as of October 4, 2008 consisted of $282.8 million in cash, cash equivalents and short-term investments.  Our short-term investments consist primarily of municipal bonds and U.S government agency notes.

 

Our long-term investments consist of auction-rate securities.  Early in fiscal 2008, auctions for many of our auction-rate securities failed because sell orders exceeded buy orders.  As of October 4, 2008, we held $57.9 million of auction-rate securities at cost, all of which experienced failed auctions.  The securities had previously been valued using quoted prices in active markets.  When the auctions began to fail, quoted prices for the securities were no longer observable.  As such, we changed our fair value measurement methodology for all auction-rate securities from quoted prices in active markets to a cash flow model. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, amount of cash flows, expected holding periods of the securities and a discount to reflect our ability to liquidate the securities.

 

The underlying assets of our auction-rate securities consisted of student loans and municipal bonds, of which $52.7 million were guaranteed by the U.S. government and the remaining $5.2 million were insured.  $54.7 million of the auction-rate securities had credit ratings of AAA and $3.2 million had credit ratings of AA.  These securities had contractual maturity dates ranging from 2025 to 2047 and were yielding 2.1% to 11.9% per year at October 4, 2008.  We are receiving the underlying cash flows on all of our auction-rate securities.  The principal associated with failed auctions are not expected to be accessible until a successful auction occurs, the issuer redeems the security, a buyer is found outside of the auction process or the underlying securities mature.  We are unable to predict if these funds will become available before their maturity dates.  As such, our auction-rate securities have been classified as long-term investments as of October 4, 2008.  We do not expect to need access to the capital represented by any of these auction-rate securities prior to their maturities and we have the ability and intent to hold the investments for a period of time sufficient to allow for any anticipated recovery in market value.  See Note 4, Financial Instruments , to the Condensed Consolidated Financial Statements for additional information.

 

Net cash provided by operating activities was $81.1 million during the nine months ended October 4, 2008, compared to net cash provided of $5.5 million during the nine months ended September 29, 2007.  Operating cash flows during the nine months ended October 4, 2008 reflect our net income of $26.6 million, adjustments of $54.3 million for depreciation, amortization, deferred income taxes, stock compensation and in-process research and development, and a net cash inflow of $0.2 million due to changes in our operating assets and liabilities.

 

Accounts receivable increased to $61.6 million at October 4, 2008 from $51.2 million at December 29, 2007.  The increase in accounts receivable resulted primarily due to (a) an increase in revenues during the three months ended October 4, 2008 compared to the three months ended December 29, 2007 and (b) the accounts receivable acquired in the purchase of Integration Associates.  Our average days sales outstanding (DSO) increased to 49 days at October 4, 2008 from 46 days at December 29, 2007.

 

Inventory increased to $34.4 million at October 4, 2008 from $28.6 million at December 29, 2007.  Our inventory level is primarily impacted by our need to make purchase commitments to support forecasted demand and variations between forecasted and actual demand.  Our average days of inventory (DOI) was 70 days at October 4, 2008 and December 29, 2007.

 

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Net cash provided by investing activities was $47.4 million during the nine months ended October 4, 2008, compared to net cash provided of $92.7 million during the nine months ended September 29, 2007.  The decrease was principally due to a decrease in cash proceeds of $256.5 million from the sale of our Aero product lines and an increase of $74.6 million used for the acquisition of Integration Associates (net of $2.6 million of cash acquired), offset by an increase of $288.3 million in net maturities of available-for-sale investments.  We expect to pay up to an additional $3.6 million in surplus consideration to the former shareholders of Integration Associates.   Net cash provided by investing activities during the nine months ended October 4, 2008 includes receipt of the $14.3 million previously held in escrow in connection with the sale of the Aero product lines.

 

We anticipate capital expenditures of approximately $10 to $15 million for fiscal 2008.  Additionally, as part of our growth strategy, we expect to evaluate opportunities to invest in or acquire other businesses, intellectual property or technologies that would complement or expand our current offerings, expand the breadth of our markets or enhance our technical capabilities.

 

Net cash used in financing activities was $241.6 million during the nine months ended October 4, 2008, compared to net cash used of $35.4 million during the nine months ended September 29, 2007.  The increase was principally due to an increase of $199.4 million for repurchases of our common stock.  In July 2007, our Board of Directors authorized a program to repurchase up to $400 million of our common stock over a 24-month period, of which $386.7 million had been purchased through October 4, 2008.

 

Net cash provided by discontinued operations was zero during the nine months ended October 4, 2008.  Net cash provided by discontinued operations during the nine months ended September 29, 2007 was $20.5 million , which included adjustments of $7.4 million for stock compensation and $18.3 million for proceeds from the exercise of stock options from employees who were hired by NXP in connection with the sale of the Aero product lines.

 

Our future capital requirements will depend on many factors, including the rate of sales growth, market acceptance of our products, the timing and extent of research and development projects, potential acquisitions of companies or technologies and the expansion of our sales and marketing activities.  We believe our existing cash and investment balances are sufficient to meet our capital requirements through at least the next 12 months, although we could be required, or could elect, to seek additional funding prior to that time.  We may enter into acquisitions or strategic arrangements in the future which also could require us to seek additional equity or debt financing.

 

Off-Balance Sheet Arrangements

 

In March 2008, we entered into an operating lease agreement and a related participation agreement (collectively, the “lease”) for a facility in Austin, Texas for the expansion of our corporate headquarters.  The lease has a term of five years.  The base rent for the term of the lease is an amount equal to the interest accruing on $50.1 million at 155 basis points over the three-month LIBOR (which would be approximately $13.3 million over the remaining term assuming LIBOR averages 4.33% during such term).  We entered into a lease for a similar building in Austin in March 2006.

 

We have granted certain rights and remedies to the lessor in the event of certain defaults, including the right to terminate the lease, to bring suit to collect damages, and to compel us to purchase the facility.  The lease contains other customary representations, warranties, obligations, conditions, indemnification provisions and termination provisions, including covenants that we shall maintain unencumbered cash and highly-rated short-term investments of at least $75 million.  If our unencumbered cash and highly-rated short-term investments are less than $150 million, we must also maintain a ratio of funded debt to earnings before interest expense, income taxes, depreciation, amortization, lease expense and other non-cash charges (EBITDAR) over the four prior fiscal quarters of no greater than 2 to 1.  As of October 4, 2008, we believe we were in compliance with all covenants of the lease.

 

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During the term of the lease, we have an on-going option to purchase the building for a total purchase price of approximately $50.1 million.  Alternatively,  we can cause the property to be sold to third parties provided we are not in default under the lease.  We are contingently liable on a first dollar loss basis for up to $40.0 million to the extent that the sale proceeds are less than the $50.1 million purchase option.  To the extent that the net proceeds generated from the sale of the facility to a third party exceed the purchase option, we would have the right to receive substantially all of such excess proceeds if the sale occurs prior to the end of the term of the lease. If the property is sold after the term of the lease, we would have the right to recover our $40.0 million guarantee, to the extent such sale proceeds exceed $10.1 million.

 

In accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others , we determined that the fair value associated with the guaranteed residual value was $1.2 million.  This amount was recorded in “Other assets, net” and “Long-term obligations and other liabilities” in the Condensed Consolidated Balance Sheets and is being amortized over the term of the lease.

 

We are required to periodically evaluate the expected fair value of the facility at the end of the lease term.  If we determine that it is estimable and probable that the expected fair value will be less than $50.1 million, we will ratably accrue the loss up to a maximum of approximately $40.0 million over the remaining lease term.  As of October 4, 2008, we have determined that a loss contingency accrual is not required.

 

Interest Rate Swap Agreements

 

In connection with our headquarters leases, we have entered into interest rate swap agreements as a hedge against the variable rent under the leases.  Under the terms of the swap agreements, we have effectively converted the variable rents to fixed rents through March 2011 for our 400 W. Cesar Chavez building and March 2013 for our 200 W. Cesar Chavez building.  See Note 4, Financial Instruments , to the Condensed Consolidated Financial Statements for additional information.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles requires that we make estimates and assumptions that affect the amounts reported.  Changes in facts and circumstances could have a significant impact on the resulting estimated amounts included in the financial statements.  We believe the following critical accounting policies affect our more complex judgments and estimates.  We also have other policies that we consider to be key accounting policies, such as our policies for revenue recognition, including the deferral of revenues and cost of revenues on sales to distributors; however, these policies do not meet the definition of critical accounting estimates because they do not generally require us to make estimates or judgments that are difficult or subjective.

 

Inventory valuation – We assess the recoverability of inventories through the application of a set of methods, assumptions and estimates.  In determining net realizable value, we write down inventory that may be slow moving or have some form of obsolescence, including inventory that has aged more than 12 months.  We also adjust the valuation of inventory when its standard cost exceeds the estimated market value.  We assess the potential for any unusual customer returns based on known quality or business issues and establish reserves based on the estimated inventory losses for scrap or non-saleable material.  Inventory not otherwise identified to be written down is compared to an assessment of our 12-month forecasted demand.  The result of this methodology is compared against the product life cycle and competitive situations in the marketplace to determine the appropriateness of the resulting inventory levels.  Demand for our products may fluctuate significantly over time, and actual demand and market conditions may be more or less favorable than those that we project.  In the event that actual demand is lower or market conditions are worse than originally projected, additional inventory write-downs may be required.

 

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Stock compensation – We recognize the fair-value of stock-based compensation transactions in the Consolidated Statement of Income in accordance with SFAS 123R.  We adopted the provisions of SFAS 123R using the modified-prospective-transition method at the beginning of fiscal 2006. The fair value of our stock-based awards is estimated at the date of grant using the Black-Scholes option pricing model.  The Black-Scholes valuation calculation requires us to estimate key assumptions such as future stock price volatility, expected terms, risk-free rates and dividend yield.  Expected stock price volatility is based on implied volatility from traded options on our stock in the marketplace and historical volatility of our stock.  The expected term of options granted is derived from an analysis of historical exercises and remaining contractual life of stock options, and represents the period of time that options granted are expected to be outstanding.  The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant.  We have never paid cash dividends, and do not currently intend to pay cash dividends, and thus have assumed a 0% dividend yield.  In addition, we are required to estimate the expected forfeiture rate of our stock grants and only recognize the expense for those shares expected to vest.  If our actual experience differs significantly from the assumptions used to compute our stock-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little stock-based compensation cost.  See Note 8, Stockholders’ Equity and Stock-Based Compensation , to the Condensed Consolidated Financial Statements for a further discussion on stock-based compensation.

 

Long-term investments – Our long-term investments consist of auction-rate securities.  We determine the fair value of our long-term auction-rate securities using a discounted cash flow model.  The assumptions used in preparing the discounted cash flow model include estimates for interest rates, amount of cash flows, expected holding periods of the securities and a discount to reflect our ability to liquidate the securities.  If the calculated value is below the carrying amount of the securities, we then determine if the decline in value is other-than-temporary.  We consider various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, changes in underlying credit ratings, forecasted recovery and our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.  When we conclude that an other-than-temporary impairment has resulted, the difference between the fair value and the carrying value is recorded as an impairment charge in the Consolidated Statement of Income.  Impairments that we conclude are temporary are recorded in accumulated other comprehensive loss.

 

Impairment of goodwill and other long-lived assets – We review long-lived assets which are held and used, including fixed assets and purchased intangible assets, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable.  Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors which are inherently difficult to forecast.  If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique.  Occasionally, we may hold certain assets for sale.  In those cases, the assets are reclassified on our balance sheet from long-term to current, and the carrying value of such assets are reviewed and adjusted each period thereafter to the fair value less expected cost to sell.

 

We test our goodwill for impairment annually as of the first day of our fourth fiscal quarter and in interim periods if certain events occur indicating that the carrying value of goodwill may be impaired.  The goodwill impairment test is a two-step process. The first step of the impairment analysis compares our fair value to our net book value. In determining fair value, the accounting guidance allows for the use of several valuation methodologies, although it states quoted market prices are the best evidence of fair value. If the fair value is less than the net book value, the second step of the analysis compares the implied fair value of our goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, we recognize an impairment loss equal to that excess amount.

 

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Income taxes – We are required to estimate income taxes in each of the jurisdictions in which we operate.  This process involves estimating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes.  These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheet.  We then assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance against the deferred tax asset.  Further, we operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions.  These audits can involve complex issues which may require an extended period of time to resolve and could result in additional assessments of income tax.  We believe adequate provisions for income taxes have been made for all periods.

 

We adopted FASB Financial Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxes , at the beginning of fiscal 2007.  As a result of the adoption of FIN 48, we recognize liabilities for uncertain tax positions based on the two-step process prescribed by the interpretation.  The first step requires us to determine if the weight of available evidence indicates that the tax position has met the threshold for recognition; therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes.  The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized upon ultimate settlement.  This measurement step is inherently difficult and requires subjective estimations of such amounts to determine the probability of various possible outcomes.  We reevaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity.  Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

 

Although we believe the measurement of our liabilities for uncertain tax positions is reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals.  If additional taxes are assessed as a result of an audit or litigation, it could have a material effect on our income tax provision and net income in the period or periods for which that determination is made.

 

Recent Accounting Pronouncements

 

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles .  SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States (the GAAP hierarchy).  SFAS 162 will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles .  Based on our current operations, we do not expect that the adoption of SFAS 162 will have a material impact on our financial position or results of operations.

 

In April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful Life of Intangible Assets.    FSP FAS 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 FASB Statement No. 142, Goodwill and Other Intangible Assets .  FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years.  Early adoption is prohibited.  Based on our current operations, we do not expect that the adoption of FSP FAS 142-3 will have a material impact on our financial position or results of operations.

 

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In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 .  SFAS 161 amends and expands the disclosure requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities .  SFAS 161 requires entities to provide greater transparency about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows.  SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008.  Based on our current operations, we do not expect that the adoption of SFAS 161 will have a material impact on our financial position or results of operations.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations , (SFAS 141R).  SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, including goodwill, the liabilities assumed and any non-controlling interest in the acquiree.  The Statement also establishes disclosure requirements to enable users of the financial statements to evaluate the nature and financial effects of the business combination.  SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The impact of adopting SFAS 141R will be dependent on the future business combinations that we may pursue after its effective date.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements .  SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements.  In February 2008, the FASB amended SFAS 157 by issuing FSP FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, a nd FAS 157-2, Effective Date of FASB Statement No. 157 .  In October 2008, the FASB amended SFAS 157 by issuing FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.  FSP FAS 157-1 amends SFAS 157 to exclude SFAS 13, Accounting for Leases, and certain other lease-related accounting pronouncements.  FSP FAS 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008.  FSP FAS 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active.  We adopted certain provisions of SFAS 157 effective December 30, 2007 (see Note 5, Fair Value of Financial Instruments , to the Condensed Consolidated Financial Statements for additional information).  We are currently evaluating the effect that the adoption of the provisions deferred by FSP FAS 157-2 will have on our financial position and results of operations.  FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued. The adoption of FSP FAS 157-3 did not have a material impact on our financial position or results of operations.

 

Qualitative and Quantitative Disclosures about Market Risk

 

Interest Income

 

Our investment portfolio includes cash, cash equivalents, short-term investments and long-term investments.  Our main investment objectives are the preservation of investment capital and the maximization of after-tax returns on our investment portfolio.  Our interest income is sensitive to changes in the general level of U.S. interest rates.  Based on our investment portfolio holdings as of October 4, 2008, an immediate 100 basis point decline in the yield for such instruments would decrease our annual interest income by approximately $3.4 million.  We believe that our investment policy is conservative, both in the duration of our investments and the credit quality of the investments we hold.

 

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Headquarters Lease Rent

 

We are exposed to interest rate fluctuations in the normal course of our business, including through our corporate headquarters leases.  The base rents for these leases are calculated using a variable interest rate based on the three-month LIBOR.  We have entered into interest rate swap agreements with notional values of $44.3 million and $50.1 million and, effectively, fixed the rent payment amounts on these leases through March 2011 and March 2013, respectively.  The fair value of the interest rate swap agreements at October 4, 2008 was a $1.2 million obligation.

 

Long-term Investments

 

Our long-term investments consist of auction-rate securities.  Beginning in fiscal 2008, auctions for many of our auction-rate securities failed because sell orders exceeded buy orders.  As of October 4, 2008, we held $57.9 million of auction-rate securities at cost, all of which experienced failed auctions during the first nine months of the year.  The principal associated with failed auctions are not expected to be accessible until a successful auction occurs, the issuer redeems the securities, a buyer is found outside of the auction process or the underlying securities mature. We are unable to predict if these funds will become available before their maturity dates.  Additionally, if we determine that an other-than-temporary decline in the fair value of any of our auction-rate securities has occurred, we may be required to adjust the carrying value of the investments through an impairment charge.  See Note 4, Financial Instruments , to the Condensed Consolidated Financial Statements for additional information.

 

Available Information

 

Our internet website address is www.silabs.com.  Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available through the investor relations page of our internet website free of charge as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC).  Our internet website and the information contained therein or connected thereto are not intended to be incorporated into this Quarterly Report on
Form 10-Q.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

 

Information related to quantitative and qualitative disclosures regarding market risk is set forth in Management’s Discussion and Analysis of Financial Condition and Results of Operations under Item 2 above.  Such information is incorporated by reference herein.

 

Item 4.  Controls and Procedures

 

We have performed an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), of the effectiveness of our disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act).  Based on that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures were effective as of October 4, 2008 to provide reasonable assurance that information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.  There was no change in our internal controls during the fiscal quarter ended October 4, 2008 that materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

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Part II.  Other Information

 

Item 1.  Legal Proceedings

 

Securities Litigation

 

On December 6, 2001, a class action complaint for violations of U.S. federal securities laws was filed in the United States District Court for the Southern District of New York against us, four of our officers individually and the three investment banking firms who served as representatives of the underwriters in connection with our initial public offering of common stock.  The Consolidated Amended Complaint alleges that the registration statement and prospectus for our initial public offering did not disclose that (1) the underwriters solicited and received additional, excessive and undisclosed commissions from certain investors, and (2) the underwriters had agreed to allocate shares of the offering in exchange for a commitment from the customers to purchase additional shares in the aftermarket at pre-determined higher prices.  The Complaint alleges violations of the Securities Act of 1933 and the Securities Exchange Act of 1934.  The action seeks damages in an unspecified amount and is being coordinated with approximately 300 other nearly identical actions filed against other companies.  A court order dated October 9, 2002 dismissed without prejudice our four officers who had been named individually.  On December 5, 2006, the Second Circuit vacated a decision by the District Court granting class certification in six “focus” cases, which are intended to serve as test cases.  The plaintiffs selected these six cases, which do not include us.  The Court has indicated that its decisions in the six focus cases are intended to provide strong guidance for the parties in the remaining cases.  On April 6, 2007, the Second Circuit denied a petition for rehearing filed by plaintiffs, but noted that plaintiffs could ask the District Court to certify more narrow classes than those that were rejected.

 

On August 14, 2007, the plaintiffs filed amended complaints in the six focus cases.  On September 27, 2007, the plaintiffs moved to certify a class in the six focus cases.  On November 14, 2007, the issuers and the underwriters named as defendants in the six focus cases filed motions to dismiss the amended complaints against them.  On March 26, 2008, the District Court dismissed the Securities Act claims of those members of the putative classes in the focus cases who sold their securities for a price in excess of the initial offering price and those who purchased outside the previously certified class period.  With respect to all other claims, the motions to dismiss were denied.  On October 10, 2008, at the request of plaintiffs, plaintiffs’ motion for class certification was withdrawn, without prejudice.

 

We are unable to estimate or predict the potential damages that might be awarded as a result of this litigation, whether such damages would be greater than our insurance coverage, or whether the outcome would have a material impact on our results of operations or financial position.

 

Other

 

We are involved in various other legal proceedings that have arisen in the normal course of business.  While the ultimate results of these matters cannot be predicted with certainty, we do not expect them to have a material adverse effect on the consolidated financial position or results of operations.

 

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Item 1A.  Risk Factors

 

Risks Related to our Business

 

We may not be able to maintain our historical growth and may experience significant period-to-period fluctuations in our revenues and operating results, which may result in volatility in our stock price

 

Although we have generally experienced revenue growth in our history, we may not be able to sustain this growth.  We may also experience significant period-to-period fluctuations in our revenues and operating results in the future due to a number of factors, and any such variations may cause our stock price to fluctuate.  In some future period our revenues or operating results may be below the expectations of public market analysts or investors.  If this occurs, our stock price may drop, perhaps significantly.

 

A number of factors, in addition to those cited in other risk factors applicable to our business, may contribute to fluctuations in our revenues and operating results, including:

 

·

 

The timing and volume of orders received from our customers;

 

 

 

·

 

The timeliness of our new product introductions and the rate at which our new products may cannibalize our older products;

 

 

 

·

 

The rate of acceptance of our products by our customers, including the acceptance of new products we may develop for integration in the products manufactured by such customers, which we refer to as “design wins”;

 

 

 

·

 

The time lag and realization rate between “design wins” and production orders;

 

 

 

·

 

The demand for, and life cycles of, the products incorporating our ICs;

 

 

 

·

 

The rate of adoption of mixed-signal ICs in the markets we target;

 

 

 

·

 

Deferrals or reductions of customer orders in anticipation of new products or product enhancements from us or our competitors or other providers of ICs;

 

 

 

·

 

Changes in product mix;

 

 

 

·

 

The average selling prices for our products could drop suddenly due to competitive offerings or competitive predatory pricing, especially with respect to our mobile handset and modem products;

 

 

 

·

 

The average selling prices for our products generally decline over time;

 

 

 

·

 

Changes in market standards;

 

 

 

·

 

Impairment charges related to inventory, equipment or other long-lived assets;

 

 

 

·

 

The software used in our products, including software provided by third-parties, may not meet the needs of our customers;

 

 

 

·

 

Significant legal costs to defend our intellectual property rights or respond to claims against us; and

 

 

 

·

 

The rate at which new markets emerge for products we are currently developing or for which our design expertise can be utilized to develop products for these new markets.

 

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The markets for mobile handsets, consumer electronics, satellite set-top boxes and VoIP applications are characterized by rapid fluctuations in demand and seasonality that result in corresponding fluctuations in the demand for our products that are incorporated in such devices.  Additionally, the rate of technology acceptance by our customers results in fluctuating demand for our products as customers are reluctant to incorporate a new IC into their products until the new IC has achieved market acceptance.  Once a new IC achieves market acceptance, demand for the new IC can quickly accelerate to a point and then level off such that rapid historical growth in sales of a product should not be viewed as indicative of continued future growth.  In addition, demand can quickly decline for a product when a new IC product is introduced and receives market acceptance.  Due to the various factors mentioned above, the results of any prior quarterly or annual periods should not be relied upon as an indication of our future operating performance.

 

If we are unable to develop or acquire new and enhanced products that achieve market acceptance in a timely manner, our operating results and competitive position could be harmed

 

Our future success will depend on our ability to reduce our dependence on a few products by developing or acquiring new ICs and product enhancements that achieve market acceptance in a timely and cost-effective manner.  The development of mixed-signal ICs is highly complex, and we have at times experienced delays in completing the development and introduction of new products and product enhancements.  Successful product development and market acceptance of our products depend on a number of factors, including:

 

·

 

Changing requirements of customers;

 

 

 

·

 

Accurate prediction of market and technical requirements;

 

 

 

·

 

Timely completion and introduction of new designs;

 

 

 

·

 

Timely qualification and certification of our ICs for use in our customers’ products;

 

 

 

·

 

Commercial acceptance and volume production of the products into which our ICs will be incorporated;

 

 

 

·

 

Availability of foundry, assembly and test capacity;

 

 

 

·

 

Achievement of high manufacturing yields;

 

 

 

·

 

Quality, price, performance, power use and size of our products;

 

 

 

·

 

Availability, quality, price and performance of competing products and technologies;

 

 

 

·

 

Our customer service, application support capabilities and responsiveness;

 

 

 

·

 

Successful development of our relationships with existing and potential customers;

 

 

 

·

 

Changes in technology, industry standards or end-user preferences; and

 

 

 

·

 

Cooperation of third-party software providers and our semiconductor vendors to support our chips within a system.

 

We cannot provide any assurance that products which we recently have developed or may develop in the future will achieve market acceptance.  We have introduced to market or are in development of many ICs.  If our ICs fail to achieve market acceptance, or if we fail to develop new products on a timely basis that achieve market acceptance, our growth prospects, operating results and competitive position could be adversely affected.

 

37



 

Our research and development efforts are focused on a limited number of new technologies and products, and any delay in the development, or abandonment, of these technologies or products by industry participants, or their failure to achieve market acceptance, could compromise our competitive position

 

Our ICs are used as components in electronic devices in various markets.  As a result, we have devoted and expect to continue to devote a large amount of resources to develop products based on new and emerging technologies and standards that will be commercially introduced in the future.  Research and development expense during the nine months ended October 4, 2008 was $73.8 million, or 23.3% of revenues.  A number of large companies are actively involved in the development of these new technologies and standards.  Should any of these companies delay or abandon their efforts to develop commercially available products based on new technologies and standards, our research and development efforts with respect to these technologies and standards likely would have no appreciable value.  In addition, if we do not correctly anticipate new technologies and standards, or if the products that we develop based on these new technologies and standards fail to achieve market acceptance, our competitors may be better able to address market demand than we would.  Furthermore, if markets for these new technologies and standards develop later than we anticipate, or do not develop at all, demand for our products that are currently in development would suffer, resulting in lower sales of these products than we currently anticipate.

 

We depend on a limited number of customers for a substantial portion of our revenues, and the loss of, or a significant reduction in orders from, any key customer could significantly reduce our revenues

 

The loss of any of our key customers, or a significant reduction in sales to any one of them, would significantly reduce our revenues and adversely affect our business.  During the nine months ended October 4, 2008, our ten largest customers accounted for 39% of our revenues.  Some of the markets for our products are dominated by a small number of potential customers.  Therefore, our operating results in the foreseeable future will continue to depend on our ability to sell to these dominant customers, as well as the ability of these customers to sell products that incorporate our IC products.  In the future, these customers may decide not to purchase our ICs at all, purchase fewer ICs than they did in the past or alter their purchasing patterns, particularly because:

 

·

 

We do not have material long-term purchase contracts with our customers;

 

 

 

·

 

Substantially all of our sales to date have been made on a purchase order basis, which permits our customers to cancel, change or delay product purchase commitments with little or no notice to us and without penalty;

 

 

 

·

 

Some of our customers may have efforts underway to actively diversify their vendor base which could reduce purchases of our ICs; and

 

 

 

·

 

Some of our customers have developed or acquired products that compete directly with products these customers purchase from us, which could affect our customers’ purchasing decisions in the future.

 

While we have been a significant supplier of ICs used in many of our customers’ products, our customers regularly evaluate alternative sources of supply in order to diversify their supplier base, which increases their negotiating leverage with us and protects their ability to secure these components.  We believe that any expansion of our customers’ supplier bases could have an adverse effect on the prices we are able to charge and volume of product that we are able to sell to our customers, which would negatively affect our revenues and operating results.

 

38



 

We have increased our international activities significantly and plan to continue such efforts, which subjects us to additional business risks including increased logistical and financial complexity, political instability and currency fluctuations

 

We have established additional international subsidiaries and have opened additional offices in international markets to expand our international activities in Europe and Asia.  This has included the establishment of a headquarters in Singapore for non-U.S. operations.  The percentage of our revenues derived from customers located outside of the United States was 87% during the nine months ended October 4, 2008.  We may not be able to maintain or increase international market demand for our products.  Our international operations are subject to a number of risks, including:

 

·

 

Increased complexity and costs of managing international operations and related tax obligations, including our headquarters for non-U.S. operations in Singapore;

 

 

 

·

 

Protectionist laws and business practices that favor local competition in some countries;

 

 

 

·

 

Difficulties related to the protection of our intellectual property rights in some countries;

 

 

 

·

 

Multiple, conflicting and changing tax and other laws and regulations that may impact both our international and domestic tax and other liabilities and result in increased complexity and costs;

 

 

 

·

 

Longer sales cycles;

 

 

 

·

 

Greater difficulty in accounts receivable collection and longer collection periods;

 

 

 

·

 

High levels of distributor inventory subject to price protection and rights of return to us;

 

 

 

·

 

Political and economic instability;

 

 

 

·

 

Greater difficulty in hiring and retaining qualified technical sales and applications engineers and administrative personnel; and

 

 

 

·

 

The need to have business and operations systems that can meet the needs of our international business and operating structure.

 

To date, all of our sales to international customers and purchases of components from international suppliers have been denominated in U.S. dollars.  As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive for our international customers to purchase, thus rendering our products less competitive.

 

Failure to manage our distribution channel relationships could impede our future growth

 

The future growth of our business will depend in large part on our ability to manage our relationships with current and future distributors and sales representatives, develop additional channels for the distribution and sale of our products and manage these relationships.  As we execute our indirect sales strategy, we must manage the potential conflicts that may arise with our direct sales efforts.  For example, conflicts with a distributor may arise when a customer begins purchasing directly from us rather than through the distributor.  The inability to successfully execute or manage a multi-channel sales strategy could impede our future growth.  In addition, relationships with our distributors often involve the use of price protection and inventory return rights.  This often requires a significant amount of sales management’s time and system resources to manage properly.

 

39



 

We are subject to increased inventory risks and costs because we build our products based on forecasts provided by customers before receiving purchase orders for the products

 

In order to ensure availability of our products for some of our largest customers, we start the manufacturing of our products in advance of receiving purchase orders based on forecasts provided by these customers.  However, these forecasts do not represent binding purchase commitments and we do not recognize sales for these products until they are shipped to the customer.  As a result, we incur inventory and manufacturing costs in advance of anticipated sales.  Because demand for our products may not materialize, manufacturing based on forecasts subjects us to increased risks of high inventory carrying costs, increased obsolescence and increased operating costs.  These inventory risks are exacerbated when our customers purchase indirectly through contract manufacturers or hold component inventory levels greater than their consumption rate because this causes us to have less visibility regarding the accumulated levels of inventory for such customers.  A resulting write-off of unusable or excess inventories would adversely affect our operating results.

 

We are subject to credit risks related to our accounts receivable

 

We do not generally obtain letters of credit or other security for payment from customers, distributors or contract manufacturers.  Accordingly, we are not protected against accounts receivable default or bankruptcy by these entities.  Our ten largest customers or distributors represent a substantial majority of our accounts receivable.  If any such customer or distributor were to become insolvent or otherwise not satisfy their obligations to us, we could be materially harmed.

 

Our products are complex and may contain errors which could lead to product liability, an increase in our costs and/or a reduction in our revenues

 

Our products are complex and may contain errors, particularly when first introduced or as new versions are released.  Our new products are increasingly being designed in more complex processes which further increases the risk of errors.  We rely primarily on our in-house testing personnel to design test operations and procedures to detect any errors prior to delivery of our products to our customers.  Because our products are manufactured by third parties, should problems occur in the operation or performance of our ICs, we may experience delays in meeting key introduction dates or scheduled delivery dates to our customers.  These errors also could cause us to incur significant re-engineering costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations and business reputation problems.  Any defects could require product replacement or recall or we could be obligated to accept product returns.  Any of the foregoing could impose substantial costs and harm our business.

 

Product liability claims may be asserted with respect to our products.  Our products are typically sold at prices that are significantly lower than the cost of the end-products into which they are incorporated.  A defect or failure in our product could cause failure in our customer’s end-product, so we could face claims for damages that are disproportionately higher than the revenues and profits we receive from the products involved.  Furthermore, product liability risks are particularly significant with respect to medical and automotive applications because of the risk of serious harm to users of these products.  There can be no assurance that any insurance we maintain will sufficiently protect us from any such claims.

 

40



 

Significant litigation over intellectual property in our industry may cause us to become involved in costly and lengthy litigation which could seriously harm our business

 

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights.  From time to time, we receive letters from various industry participants alleging infringement of patents, trademarks or misappropriation of trade secrets or from customers requesting indemnification for claims brought against them by third parties.  The exploratory nature of these inquiries has become relatively common in the semiconductor industry.  We respond when we deem appropriate and as advised by legal counsel.  We have been involved in litigation to protect our intellectual property rights in the past and may become involved in such litigation again in the future.  In the future, we may become involved in additional litigation to defend allegations of infringement asserted by others, both directly and indirectly as a result of certain industry-standard indemnities we may offer to our customers.  Legal proceedings could subject us to significant liability for damages or invalidate our proprietary rights.  Legal proceedings initiated by us to protect our intellectual property rights could also result in counterclaims or countersuits against us.  Any litigation, regardless of its outcome, would likely be time-consuming and expensive to resolve and would divert our management’s time and attention.  Most intellectual property litigation also could force us to take specific actions, including:

 

·

 

Cease selling products that use the challenged intellectual property;

 

 

 

·

 

Obtain from the owner of the infringed intellectual property a right to a license to sell or use the relevant technology, which license may not be available on reasonable terms, or at all;

 

 

 

·

 

Redesign those products that use infringing intellectual property; or

 

 

 

·

 

Pursue legal remedies with third parties to enforce our indemnification rights, which may not adequately protect our interests.

 

Our customers require our products to undergo a lengthy and expensive qualification process without any assurance of product sales

 

Prior to purchasing our products, our customers require that our products undergo an extensive qualification process, which involves testing of the products in the customer’s system as well as rigorous reliability testing.  This qualification process may continue for six months or longer.  However, qualification of a product by a customer does not ensure any sales of the product to that customer.  Even after successful qualification and sales of a product to a customer, a subsequent revision to the IC or software, changes in the IC’s manufacturing process or the selection of a new supplier by us may require a new qualification process, which may result in delays and in us holding excess or obsolete inventory.  After our products are qualified, it can take an additional six months or more before the customer commences volume production of components or devices that incorporate our products.  Despite these uncertainties, we devote substantial resources, including design, engineering, sales, marketing and management efforts, toward qualifying our products with customers in anticipation of sales.  If we are unsuccessful or delayed in qualifying any of our products with a customer, such failure or delay would preclude or delay sales of such product to the customer, which may impede our growth and cause our business to suffer.

 

We rely on third parties to manufacture, assemble and test our products and the failure to successfully manage our relationships with our manufacturers and subcontractors would negatively impact our ability to sell our products

 

We do not have our own wafer fab manufacturing facilities.  Therefore, we rely principally on one third-party vendor, Taiwan Semiconductor Manufacturing Co. (TSMC), to manufacture the ICs we design.  We also currently rely on Asian third-party assembly subcontractors, principally Advanced Semiconductor Engineering (ASE), to assemble and package the silicon chips provided by the wafers for use in final products.  Additionally, we rely on these offshore subcontractors for a substantial portion of the testing requirements of our products prior to shipping.  We expect utilization of third-party subcontractors to continue in the future.

 

41



 

The cyclical nature of the semiconductor industry drives wide fluctuations in available capacity at third-party vendors.  On occasion, we have been unable to adequately respond to unexpected increases in customer demand due to capacity constraints and, therefore, were unable to benefit from this incremental demand.  We may be unable to obtain adequate foundry, assembly or test capacity from our third-party subcontractors to meet our customers’ delivery requirements even if we adequately forecast customer demand.

 

There are significant risks associated with relying on these third-party foundries and subcontractors, including:

 

·

 

Failure by us, our customers or their end customers to qualify a selected supplier;

 

 

 

·

 

Potential insolvency of the third-party subcontractors;

 

 

 

·

 

Reduced control over delivery schedules and quality;

 

 

 

·

 

Limited warranties on wafers or products supplied to us;

 

 

 

·

 

Potential increases in prices or payments in advance for capacity;

 

 

 

·

 

Increased need for international-based supply, logistics and financial management;

 

 

 

·

 

Their inability to supply or support new or changing packaging technologies; and

 

 

 

·

 

Low test yields.

 

We typically do not have long-term supply contracts with our third-party vendors which obligate the vendor to perform services and supply products to us for a specific period, in specific quantities, and at specific prices.  Our third-party foundry, assembly and test subcontractors typically do not guarantee that adequate capacity will be available to us within the time required to meet demand for our products.  In the event that these vendors fail to meet our demand for whatever reason, we expect that it would take up to 12 months to transition performance of these services to new providers.  Such a transition may also require qualification of the new providers by our customers or their end customers.

 

Since our inception, most of the silicon wafers for the products that we have shipped were manufactured either by TSMC or its affiliates.  Our customers typically complete their own qualification process.  If we fail to properly balance customer demand across the existing semiconductor fabrication facilities that we utilize or are required by our foundry partners to increase, or otherwise change the number of fab lines that we utilize for our production, we might not be able to fulfill demand for our products and may need to divert our engineering resources away from new product development initiatives to support the fab line transition, which would adversely affect our operating results.

 

Our products incorporate technology licensed from third parties

 

We incorporate technology (including software) licensed from third parties in our products.  We could be subjected to claims of infringement regardless of our lack of involvement in the development of the licensed technology.  Although a third party licensor is typically obligated to indemnify us if the licensed technology infringes on another party’s intellectual property rights, such indemnification is typically limited in amount and may be worthless if the licensor becomes insolvent. See “Significant litigation over intellectual property in our industry may cause us to become involved in costly and lengthy litigation which could seriously harm our business.”  Furthermore, any failure of third party technology to perform properly would adversely affect sales of our products incorporating such technology.

 

42



 

Our inability to manage growth could materially and adversely affect our business

 

Our past growth has placed, and any future growth of our operations will continue to place, a significant strain on our management personnel, systems and resources.  We anticipate that we will need to implement a variety of new and upgraded sales, operational and financial enterprise-wide systems, information technology infrastructure, procedures and controls, including the improvement of our accounting and other internal management systems to manage this growth and maintain compliance with regulatory guidelines, including Sarbanes-Oxley Act requirements.  In April 2007, we implemented a global enterprise resource planning (ERP) system to help us improve our planning and management processes.  We have experienced, and may continue to experience, challenges in implementing the new ERP system and other related systems that could adversely affect our business by disrupting our ability to timely and accurately process and report key components of our financial position, affecting our ability to complete the evaluation of our internal control over financial reporting and attestation activities pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 or disrupting our ability to process certain transactions necessary for our operations.  To the extent our business grows, our internal management systems and processes will need to improve to ensure that we remain in compliance.  We also expect that we will need to continue to expand, train, manage and motivate our workforce.  All of these endeavors will require substantial management effort, and we anticipate that we will require additional management personnel and internal processes to manage these efforts and to plan for the succession from time to time of certain persons who have been key management and technical personnel.  If we are unable to effectively manage our expanding global operations, including our international headquarters in Singapore, our business could be materially and adversely affected.

 

We are subject to risks relating to product concentration and lack of revenue diversification

 

We derive a substantial portion of our revenues from a limited number of products, and we expect these products to continue to account for a large percentage of our revenues in the near term.  Continued market acceptance of these products, is therefore, critical to our future success.  In addition, substantially all of our products that we have sold include technology related to one or more of our issued U.S. patents.  If these patents are found to be invalid or unenforceable, our competitors could introduce competitive products that could reduce both the volume and price per unit of our products.  Our business, operating results, financial condition and cash flows could therefore be adversely affected by:

 

·

 

A decline in demand for any of our more significant products, including our modem products, FM tuners or ProSLIC;

 

 

 

·

 

Failure of our products to achieve continued market acceptance;

 

 

 

·

 

An improved version of our products being offered by a competitor;

 

 

 

·

 

New technological standards or changes to existing standards that we are unable to address with our products;

 

 

 

·

 

A failure to release new products or enhanced versions of our existing products on a timely basis; and

 

 

 

·

 

The failure of our new products to achieve market acceptance.

 

43



 

We depend on our key personnel to manage our business effectively in a rapidly changing market, and if we are unable to retain our current personnel and hire additional personnel, our ability to develop and successfully market our products could be harmed

 

We believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing personnel.  We believe that our future success will be dependent on retaining the services of our key personnel, developing their successors and certain internal processes to reduce our reliance on specific individuals, and on properly managing the transition of key roles when they occur.  There is currently a shortage of qualified personnel with significant experience in the design, development, manufacturing, marketing and sales of analog and mixed-signal ICs.  In particular, there is a shortage of engineers who are familiar with the intricacies of the design and manufacturability of analog elements, and competition for such personnel is intense.  Our key technical personnel represent a significant asset and serve as the primary source for our technological and product innovations.  We may not be successful in attracting and retaining sufficient numbers of technical personnel to support our anticipated growth.  The loss of any of our key employees or the inability to attract or retain qualified personnel both in the United States and internationally, including engineers, sales, applications and marketing personnel, could delay the development and introduction of, and negatively impact our ability to sell, our products.

 

Any acquisitions we make could disrupt our business and harm our financial condition

 

As part of our growth and product diversification strategy, we continue to evaluate opportunities to acquire other businesses, intellectual property or technologies that would complement our current offerings, expand the breadth of our markets or enhance our technical capabilities.  The acquisitions that we have made and may make in the future, including our acquisition of Integration Associates, entail a number of risks that could materially and adversely affect our business and operating results, including:

 

·

 

Problems integrating the acquired operations, technologies or products with our existing business and products;

 

 

 

·

 

Diversion of management’s time and attention from our core business;

 

 

 

·

 

Need for financial resources above our planned investment levels;

 

 

 

·

 

Difficulties in retaining business relationships with suppliers and customers of the acquired company;

 

 

 

·

 

Risks associated with entering markets in which we lack prior experience;

 

 

 

·

 

Risks associated with the transfer of licenses of intellectual property;

 

 

 

·

 

Tax issues associated with acquisitions;

 

 

 

·

 

Acquisition-related disputes, including disputes over earn-outs and escrows;

 

 

 

·

 

Potential loss of key employees of the acquired company; and

 

 

 

·

 

Potential impairment of related goodwill and intangible assets.

 

Future acquisitions also could cause us to incur debt or contingent liabilities or cause us to issue equity securities that could negatively impact the ownership percentages of existing shareholders.

 

44



 

Any dispositions we make could harm our financial condition

 

In connection with our sale of the Aero product lines, we incurred various risks.  This disposition and any disposition that we may make in the future entail a number of risks that could materially and adversely affect our business and operating results, including:

 

·

 

Diversion of management’s time and attention from our core business;

 

 

 

·

 

Difficulties separating the divested business;

 

 

 

·