Silicon Laboratories Inc.
SILICON LABORATORIES INC (Form: 10-Q, Received: 10/28/2009 12:25:31)

Table of Contents

 

 

 

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 3, 2009

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   o  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 21, 2009, 45,670,190 shares of common stock of Silicon Laboratories Inc. were outstanding.

 

 

 



Table of Contents

 

 

 

Page
Number

 

 

 

Part I. Financial Information

 

 

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited):

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at October 3, 2009 and January 3, 2009

 

3

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income for the three and nine months ended October 3, 2009 and October 4, 2008

 

4

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended October 3, 2009 and October 4, 2008

 

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

 

32

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

32

 

 

 

 

 

Part II. Other Information

 

 

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

32

 

 

 

 

 

 

Item 1A.

Risk Factors

 

33

 

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

46

 

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

47

 

 

 

 

 

 

Item 4.

Submission of Matters to a Vote of Securities Holders

 

47

 

 

 

 

 

 

Item 5.

Other Information

 

47

 

 

 

 

 

 

Item 6.

Exhibits

 

47

 

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



Table of Contents

 

Part I.  Financial Information

Item 1.  Financial Statements

 

Silicon Laboratories Inc.

Condensed Consolidated Balance Sheets

(In thousands, except per share data)

(Unaudited)

 

 

 

October 3,
2009

 

January 3,
2009

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

149,072

 

$

172,272

 

Short-term investments

 

228,935

 

101,267

 

Accounts receivable, net of allowance for doubtful accounts of $645 at October 3, 2009 and $1,011 at January 3, 2009

 

61,487

 

36,144

 

Inventories

 

33,510

 

28,293

 

Deferred income taxes

 

7,437

 

6,439

 

Prepaid expenses and other current assets

 

17,869

 

18,297

 

Total current assets

 

498,310

 

362,712

 

Long-term investments

 

25,344

 

51,821

 

Property, equipment and software, net

 

28,698

 

30,496

 

Goodwill

 

105,109

 

105,515

 

Other intangible assets, net

 

43,804

 

49,728

 

Other assets, net

 

16,894

 

23,973

 

Total assets

 

$

718,159

 

$

624,245

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

26,840

 

$

22,274

 

Accrued expenses

 

30,176

 

29,119

 

Deferred income on shipments to distributors

 

31,966

 

21,599

 

Income taxes

 

 

4

 

Total current liabilities

 

88,982

 

72,996

 

Long-term obligations and other liabilities

 

50,513

 

48,789

 

Total liabilities

 

139,495

 

121,785

 

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; 45,577 and 44,613 shares issued and outstanding at October 3, 2009 and January 3, 2009, respectively

 

5

 

4

 

Additional paid-in capital

 

117,555

 

75,711

 

Retained earnings

 

465,633

 

432,793

 

Accumulated other comprehensive loss

 

(4,529

)

(6,048

)

Total stockholders’ equity

 

578,664

 

502,460

 

Total liabilities and stockholders’ equity

 

$

718,159

 

$

624,245

 

 

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

 

3



Table of Contents

 

Silicon Laboratories Inc.

Condensed Consolidated Statements of Income

(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

October 3,
2009

 

October 4,
2008

 

October 3,
2009

 

October 4,
2008

 

Revenues

 

$

125,913

 

$

113,483

 

$

313,830

 

$

316,282

 

Cost of revenues

 

44,878

 

44,174

 

117,336

 

120,593

 

Gross margin

 

81,035

 

69,309

 

196,494

 

195,689

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

25,904

 

25,785

 

77,841

 

73,836

 

Selling, general and administrative

 

28,592

 

25,940

 

78,221

 

75,035

 

In-process research and development

 

 

10,250

 

 

10,250

 

Operating expenses

 

54,496

 

61,975

 

156,062

 

159,121

 

Operating income

 

26,539

 

7,334

 

40,432

 

36,568

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

546

 

2,073

 

2,083

 

9,277

 

Interest expense

 

(51

)

(71

)

(154

)

(325

)

Other income (expense), net

 

8

 

(43

)

298

 

(540

)

Income before income taxes

 

27,042

 

9,293

 

42,659

 

44,980

 

Provision for income taxes

 

4,603

 

8,139

 

9,819

 

18,369

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

22,439

 

$

1,154

 

$

32,840

 

$

26,611

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.50

 

$

0.02

 

$

0.73

 

$

0.54

 

Diluted

 

$

0.47

 

$

0.02

 

$

0.71

 

$

0.53

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

45,170

 

47,331

 

44,814

 

49,036

 

Diluted

 

47,322

 

48,385

 

46,127

 

50,083

 

 

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

 

4



Table of Contents

 

Silicon Laboratories Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

October 3,
2009

 

October 4,
2008

 

Operating Activities

 

 

 

 

 

Net income

 

$

32,840

 

$

26,611

 

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

 

 

 

 

 

Depreciation and amortization of property, equipment and software

 

9,021

 

7,927

 

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

 

32

 

(15

)

Amortization of other intangible assets and other assets

 

5,924

 

5,118

 

Stock compensation expense

 

32,176

 

30,393

 

In-process research and development

 

 

10,250

 

Income tax benefit from employee stock-based awards

 

1,672

 

1,108

 

Excess income tax benefit from employee stock-based awards

 

(1,378

)

(810

)

Deferred income taxes

 

626

 

339

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(25,016

)

(5,838

)

Inventories

 

(5,256

)

(1,367

)

Prepaid expenses and other assets

 

3,444

 

8,930

 

Accounts payable

 

5,656

 

(1,258

)

Accrued expenses

 

3,801

 

(6,922

)

Deferred income on shipments to distributors

 

10,367

 

965

 

Income taxes

 

4,246

 

5,654

 

Net cash provided by operating activities

 

78,155

 

81,085

 

Investing Activities

 

 

 

 

 

Purchases of available-for-sale investments

 

(182,039

)

(151,470

)

Proceeds from sales and maturities of available-for-sale investments

 

80,312

 

271,824

 

Proceeds from sales of trading securities

 

2,600

 

 

Purchases of property, equipment and software

 

(6,991

)

(7,861

)

Proceeds from the sale of assets

 

 

14,265

 

Purchases of other assets

 

(2,763

)

(4,828

)

Acquisitions of businesses, net of cash acquired

 

(2,800

)

(74,560

)

Net cash provided by (used in) investing activities

 

(111,681

)

47,370

 

Financing Activities

 

 

 

 

 

Proceeds from issuance of common stock

 

26,322

 

7,649

 

Excess income tax benefit from employee stock-based awards

 

1,378

 

810

 

Repurchases of common stock

 

(12,325

)

(246,031

)

Repurchases of stock to satisfy employee tax withholding

 

(5,049

)

(3,980

)

Net cash provided by (used in) financing activities

 

10,326

 

(241,552

)

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

(23,200

)

(113,097

)

Cash and cash equivalents at beginning of period

 

172,272

 

264,408

 

Cash and cash equivalents at end of period

 

$

149,072

 

$

151,311

 

 

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

 

5



Table of Contents

 

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 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 3, 2009 and January 3, 2009, the condensed consolidated results of its operations for the three and nine months ended October 3, 2009 and October 4, 2008, and the Condensed Consolidated Statements of Cash Flows for the nine months ended October 3, 2009 and October 4, 2008. All intercompany balances and transactions have been eliminated. The condensed consolidated results of operations for the three and nine months ended October 3, 2009 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 January 3, 2009, included in the Company’s Form 10-K filed with the Securities and Exchange Commission (SEC) on February 11, 2009.

 

The Company prepares financial statements on a 52-53 week year that ends on the Saturday closest to December 31. Fiscal 2009 will have 52 weeks and fiscal 2008 had 53 weeks. In a 52-week year, each fiscal quarter consists of 13 weeks. The extra week in fiscal 2008 was added to the first quarter, making such quarter consist of 14 weeks.

 

Reclassifications

 

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

 

Revenue Recognition

 

Revenues are generated almost exclusively by sales of the Company’s ICs. The Company recognizes revenue 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, revenue from product sales to direct customers and contract manufacturers is recognized upon shipment.

 

A portion of the Company’s sales are made to distributors under agreements allowing certain rights of return and price protection related to the final selling price to the end customers. Accordingly, the Company defers revenue and cost of revenue on such sales until the distributors sell the product to the end customers. The net balance of deferred revenue less deferred cost of revenue associated with inventory shipped to a distributor but not yet sold to an end customer is recorded in the “deferred income on shipments to distributors” liability on the Consolidated Balance Sheet. Such net deferred income balance reflects the Company’s estimate of the impact of rights of return and price protection.

 

6



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Recent Accounting Pronouncements

 

In April 2009, the Financial Accounting Standards Board (FASB) issued the following:

 

·                   FASB Accounting Standards Codification (ASC) 820-10-65, formerly FASB Staff Position (FSP) FAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly , provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

 

·                   FASB ASC 320-10-65, formerly FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments , amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements.

 

·                   FASB ASC 825-10-65, formerly FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments , requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements.

 

These ASCs are effective for reporting periods ending after June 15, 2009 and were adopted by the Company on April 5, 2009. The adoption of the ASCs did not have a material impact on the Company’s financial statements.

 

In June 2008, the FASB issued FASB ASC 260-10-45, formerly FSP Emerging Issues Task Force (EITF) 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities . ASC 260-10-45 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in FASB ASC 260, Earnings per Share .  ASC 260-10-45 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years on a retrospective basis. The Company adopted ASC 260-10-45 at the beginning of fiscal 2009. The adoption did not have a material impact on the Company’s financial statements.

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

2. Earnings Per Share

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

October 3,
2009

 

October 4,
 2008

 

October 3,
2009

 

October 4,
 2008

 

Net income

 

$

22,439

 

$

1,154

 

$

32,840

 

$

26,611

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing basic earnings per share

 

45,170

 

47,331

 

44,814

 

49,036

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and awards

 

2,152

 

1,054

 

1,313

 

1,047

 

Shares used in computing diluted earnings per share

 

47,322

 

48,385

 

46,127

 

50,083

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.50

 

$

0.02

 

$

0.73

 

$

0.54

 

Diluted

 

$

0.47

 

$

0.02

 

$

0.71

 

$

0.53

 

 

Approximately 0.9 million, 3.9 million, 3.1 million and 3.7 million weighted-average dilutive potential shares of common stock have been excluded from the earnings per share calculation for the three months ended October 3, 2009 and October 4, 2008, and for the nine months ended October 3, 2009 and October 4, 2008, respectively, as they were anti-dilutive.

 

3. Financial Instruments

 

Investments

 

The Company’s short-term investments consist primarily of U.S. government agency bonds and discount notes, corporate bonds, municipal bonds, U.S. treasury bills, U.S. government bonds, commercial paper, international government bonds and auction-rate securities purchased through UBS (“UBS auction-rate securities”). The Company’s long-term investments consist of non-UBS auction-rate securities. Early in fiscal 2008, auctions for many of the Company’s auction-rate securities failed because sell orders exceeded buy orders. As of October 3, 2009, the Company held $51.6 million par value auction-rate securities, all of which experienced failed auctions. The underlying assets of the securities consisted of student loans and municipal bonds, of which $47.6 million were guaranteed by the U.S. government and the remaining $4.0 million were privately insured. As of October 3, 2009, $40.6 million of the auction-rate securities had credit ratings of AAA, $4.0 million had credit ratings of AA and $7.0 million had a credit rating of BBB. These securities had contractual maturity dates ranging from 2025 to 2046 and with current yields of 0.51% to 2.85% per year at October 3, 2009. The Company is receiving the underlying cash flows on all of its auction-rate securities. The principal amounts 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.

 

8



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

In November 2008, the Company entered into an agreement with UBS AG, which provides the Company certain rights to sell to UBS the auction-rate securities which were purchased through them. As of October 3, 2009, the Company held $24.2 million par value auction-rate securities purchased from UBS. The Company has the option to sell these securities to UBS at par value from June 30, 2010 through July 2, 2012. UBS, at its discretion, may purchase or sell these securities on the Company’s behalf at any time provided the Company receives par value for the securities sold. The issuers of the auction-rate securities continue to have the right to redeem the securities at their discretion. The agreement allows for the continuation of the accrual and payment of interest due on the securities. The agreement also provides the Company with access to loans of up to 75% of the market value of the unredeemed securities until June 30, 2010. These loans would carry interest rates which would be consistent with the interest income on the related auction-rate securities. As of October 3, 2009, the Company had no loans outstanding under this agreement.

 

The Company’s right to sell the auction-rate securities to UBS commencing June 30, 2010 represents a put option for a payment equal to the par value of the auction-rate securities. As the put option is non-transferable and cannot be attached to the auction-rate securities if they are sold to another entity other than UBS, it represents a freestanding instrument between the Company and UBS. The Company elected to record the put option at fair value. The Company has classified the UBS auction-rate securities as trading securities and, accordingly, recognizes changes in fair value in earnings. Adjustments to the fair values of the put option and the trading securities generally offset each other and are recorded in “other income (expense), net”. The Company intends to exercise its option to sell its UBS auction-rate securities to UBS on June 30, 2010 and has therefore classified both the UBS auction-rate securities and the related put option as short-term investments as of October 3, 2009.

 

The Company does not expect to need access to the capital represented by any of its auction-rate securities prior to their maturities. The Company does not intend to sell, and believes it is not more likely than not that it will be required to sell, its non-UBS auction-rate securities before their anticipated recovery in market value or final settlement at the underlying par value. 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 3, 2009.

 

The Company’s available-for-sale investments consist of the following (in thousands):

 

 

 

October 3, 2009

 

Debt Security

 

Cost

 

Gross
Unrealized
Losses

 

Gross
Unrealized
Gains

 

Fair Value

 

U.S. government agency

 

$

68,157

 

$

 

$

76

 

$

68,233

 

Corporate bonds

 

46,857

 

 

47

 

46,904

 

Municipal bonds

 

40,018

 

 

215

 

40,233

 

U.S. treasury bills

 

28,478

 

 

9

 

28,487

 

Auction rate securities

 

27,450

 

(2,106

)

 

25,344

 

Commercial paper

 

9,775

 

 

 

9,775

 

U.S. government bonds

 

9,108

 

 

21

 

9,129

 

International government bonds

 

8,011

 

 

8

 

8,019

 

 

 

$

237,854

 

$

(2,106

)

$

376

 

$

236,124

 

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

 

 

January 3, 2009

 

Debt Security

 

Cost

 

Gross
Unrealized
Losses

 

Gross
Unrealized
Gains

 

Fair Value

 

Municipal bonds

 

$

88,907

 

$

 

$

503

 

$

89,410

 

Auction-rate securities

 

30,000

 

(4,260

)

 

25,740

 

U.S. government agency

 

10,001

 

 

56

 

10,057

 

 

 

$

128,908

 

$

(4,260

)

$

559

 

$

125,207

 

 

All of the Company’s available-for-sale investments with gross unrealized losses had been in a continuous loss position for more than 12 months as of October 3, 2009 and had been in a continuous loss position for less than 12 months as of January 3, 2009. The gross unrealized losses as of October 3, 2009 and January 3, 2009 were due primarily to the illiquidity of the Company’s auction-rate securities.

 

The following summarizes the contractual underlying maturities of the Company’s available-for-sale investments at October 3, 2009 (in thousands):

 

 

 

Cost

 

Fair Value

 

Due in one year or less

 

$

129,808

 

$

130,075

 

Due after one year through three years

 

80,596

 

80,705

 

Due after ten years

 

27,450

 

25,344

 

 

 

$

237,854

 

$

236,124

 

 

In addition, the Company has made equity investments in non-publicly traded companies that it accounts for under the cost method. The Company periodically reviews these investments for other-than-temporary declines in fair value based on the specific identification method and writes down investments to their fair values when it determines that an other-than-temporary decline has occurred.

 

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 interest rates with losses and gains on the derivative contracts, thereby reducing volatility of earnings. The Company does not use derivative contracts for speculative purposes.

 

The interest rate swap agreements are designated and qualify as cash flow hedges. 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 and is subsequently recognized in earnings when the hedged exposure affects earnings. Cash flows from derivatives are classified as cash flows from operating activities in the Consolidated Statement of Cash Flows.

 

10



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The Company estimates the fair values of derivatives based on quoted prices and market observable data of similar instruments. 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 may be recognized in the Consolidated Statement of Income based on an assessment of the agreements at the time of termination. During the nine months ended October 3, 2009, the Company did not discontinue any cash flow hedges.

 

The Company measures the effectiveness of its cash flow hedges 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 3, 2009, no portions of the gains or losses from the hedging instruments were excluded from the assessment of effectiveness. There was no hedge ineffectiveness for any of the periods presented.

 

The Company’s derivative financial instruments consisted of the following (in thousands):

 

 

 

October 3, 2009

 

 

 

Balance Sheet
Location

 

Fair Value

 

Cash flow hedges:

 

 

 

 

 

Interest rate swaps

 

Long-term obligations and other liabilities

 

$

5,239

 

 

The before-tax effect of derivative instruments in cash flow hedging relationships was as follows (in thousands):

 

 

 

Gain (Loss)
Recognized in OCI
on Derivatives
(Effective Portion)
during the:

 

 

 

Gain (Loss) Reclassified
from Accumulated

OCI into Income
(Effective Portion)
during the:

 

 

 

Three Months Ended

 

Location of Gain

 

Three Months Ended

 

 

 

October 3,
2009

 

October 4,
2008

 

(Loss) Reclassified
into Income

 

October 3,
2009

 

October 4,
2008

 

Interest rate swaps

 

$

(1,111

)

$

(1,160

)

Rent expense

 

$

(775

)

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

Nine Months Ended

 

 

 

October 3,
2009

 

October 4,
2008

 

 

 

October 3,
2009

 

October 4,
2008

 

Interest rate swaps

 

$

(1,587

)

$

(1,160

)

Rent expense

 

$

(1,950

)

$

 

 

The Company expects to reclassify $3.1 million of its interest rate swap losses included in accumulated other comprehensive loss as of October 3, 2009 into earnings in the next 12 months, which is offset by lower rent payments.

 

11



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The Company’s interest rate swap agreements contain provisions that require it to maintain unencumbered cash and highly-rated short-term investments of at least $150 million.  If the Company’s unencumbered cash and highly-rated short-term investments are less than $150 million, it would be required to post collateral with the counterparty in the amount of the fair value of the interest rate swap agreements in net liability positions.  Both of the Company’s interest rate swaps were in a net liability position at October 3, 2009.  No collateral has been posted with the counterparties as of October 3, 2009.

 

4. Fair Value of Financial Instruments

 

The fair values of the Company’s financial instruments are recorded using a hierarchal disclosure framework based upon the level of subjectivity of the inputs used in measuring assets and liabilities.  The three levels are described below:

 

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.

 

The following summarizes the valuation of the Company’s financial instruments (in thousands).  The table does not include either cash on hand or assets and liabilities that are measured at historical cost or any basis other than fair value.

 

 

 

Fair Value Measurements
at October 3, 2009 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

 

$

134,863

 

$

 —

 

$

 —

 

$

134,863

 

Short-term investments (1)

 

204,812

 

 

24,123

 

228,935

 

Long-term investments (2)

 

 

 

25,344

 

25,344

 

 

 

$

339,675

 

$

 —

 

$

49,467

 

$

389,142

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Derivative instruments

 

$

 —

 

$

5,239

 

$

 —

 

$

 5,239

 

 

 

$

 —

 

$

5,239

 

$

 —

 

$

 5,239

 

 


(1)           Included in the Company’s short-term investments are $66.2 million of U.S. government agency debt securities, $52.8 million of corporate debt securities, $40.2 million of municipal debt securities, $37.6 million of U.S. government debt securities, $21.5 million of UBS auction-rate securities classified as trading together with a $2.6 million for a put option and $8.0 million of international government debt securities.

 

(2)           The Company’s long-term investments consist entirely of available-for-sale auction-rate securities.

 

12



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The Company’s cash equivalents and short-term investments (other than its UBS auction-rate securities and put option) are valued using quoted prices and other relevant information generated by market transactions involving identical assets.  The Company’s auction-rate securities and put option 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, a discount to reflect the Company’s inability to liquidate the securities and counterparty risk.  The Company’s derivative instruments are valued using quoted prices and market observable data of similar instruments.

 

The following summarizes the activity in Level 3 financial instruments for the three and nine months ended October 3, 2009 (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Auction
Rate
Securities

 

Put
Option

 

Total

 

Auction
Rate
Securities

 

Put
Option

 

Total

 

Beginning balance

 

$

43,540

 

$

4,881

 

$

48,421

 

$

46,859

 

$

4,962

 

$

51,821

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net purchases, sales, issuances and settlements

 

(1,325

)

 

(1,325

)

(4,299

)

(301

)

(4,600

)

Unrealized gains (losses)

 

2,331

 

 

2,331

 

2,154

 

 

2,154

 

Net recognized gains (losses)

 

2,362

 

(2,322

)

40

 

2,194

 

(2,102

)

92

 

Balance at October 3, 2009

 

$

46,908

 

$

2,559

 

$

49,467

 

$

46,908

 

$

2,559

 

$

49,467

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) for period included in earnings attributable to the Level 3 financial instruments still held at October 3, 2009 related to:

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading securities

 

$

2,362

 

$

 —

 

$

2,362

 

$

2,194

 

$

 —

 

$

2,194

 

Fair value of the put option

 

 

(2,322

)

(2,322

)

 

(2,102

)

(2,102

)

 

 

$

2,362

 

$

(2,322

)

$

 40

 

$

2,194

 

$

(2,102

)

$

 92

 

 

The Company’s other financial instruments, including cash, accounts receivable and accounts payable, are recorded at amounts that approximate their fair values due to their short maturities.

 

5. Balance Sheet Details

 

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

 

Inventories

 

 

 

October 3,
2009

 

January 3,
2009

 

Work in progress

 

$

26,159

 

$

23,474

 

Finished goods

 

7,351

 

4,819

 

 

 

$

33,510

 

$

28,293

 

 

13



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

6. Acquisition

 

Integration Associates

 

In July 2008, the Company completed its acquisition of Integration Associates, a privately held company that designed and developed silicon solutions for wireless, wireline and power system management applications.  The Company acquired Integration Associates for approximately $87.1 million, including $80.6 million in cash and approximately 202,000 shares of the Company’s common stock valued at $6.5 million on the closing date.  The shares vest over a two-year period and are not subject to future service requirements.  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 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 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

 

4,879

 

 

 

Inventories

 

5,925

 

 

 

Other current assets

 

3,604

 

 

 

Goodwill

 

32,013

 

 

 

Other non-current assets

 

4,688

 

 

 

Accounts payable

 

(2,833

)

 

 

Other current liabilities

 

(4,471

)

 

 

Deferred tax liabilities

 

(6,908

)

 

 

Total purchase price

 

$

87,141

 

 

 

 

14



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

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 were 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

 

Radio transmitters and transceivers

 

$

 7,740

 

Optoelectronic

 

2,020

 

Power

 

490

 

 

 

$

10,250

 

 

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.

 

7. Stockholders’ Equity and Stock-Based Compensation

 

Common Stock

 

The Company issued 1.4 million shares of common stock during the nine months ended October 3, 2009.  Approximately 147 thousand shares were withheld by the Company during the nine months ended October 3, 2009 to satisfy employee tax obligations for the vesting of certain stock grants made under the Company’s 2000 Stock Incentive Plan and 2009 Stock Incentive Plan.

 

Share Repurchase Program

 

In October 2008, the Company’s Board of Directors authorized a program to repurchase up to $100 million of the Company’s common stock over a 12-month period.  Such program will end on November 3, 2009.  In October 2009, the Board of Directors adopted a new share repurchase program to repurchase up to $150 million of the Company’s common stock through 2010 and which will become effective following termination of the prior program.  These programs allow 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 3, 2009, the Company repurchased 452 thousand shares of its common stock for $12.3 million under its repurchase program.  During the nine months ended October 4, 2008, the Company repurchased 7.6 million shares for $242 million under its previous share repurchase program that expired in November 2008.

 

15



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Comprehensive Income (Loss)

 

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

 

 

 

Three Months Ended

 

 

 

October 3,
2009

 

October 4,
 2008

 

Net income

 

$

22,439

 

$

1,154

 

Net unrealized gains (losses) on available-for-sale securities, net of tax provision of $(795) and $423, respectively

 

1,477

 

(786

)

Net unrealized losses on cash flow hedges, net of tax provision of $118 and $406, respectively

 

(218

)

(754

)

Comprehensive income (loss)

 

$

23,698

 

$

 (386

)

 

 

 

Nine Months Ended

 

 

 

October 3,
 2009

 

October 4,
 2008

 

Net income

 

$

32,840

 

$

26,611

 

Net unrealized gains (losses) on available-for-sale securities, net of tax provision of $(690) and $1,767, respectively

 

1,282

 

(3,282

)

Net unrealized gains (losses) on cash flow hedges, net of tax provision of $(127) and $406, respectively

 

236

 

(754

)

Comprehensive income

 

$

34,358

 

$

22,575

 

 

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

 

 

 

Unrealized
Losses on Cash
Flow Hedges

 

Net Unrealized
Losses on Available-
For-Sale Securities

 

Total

 

Balance at January 3, 2009

 

$

(3,642

)

$

(2,406

)

$

(6,048

)

Change associated with current period transactions, net of tax

 

(1,031

)

1,282

 

251

 

Amount reclassified into earnings, net of tax

 

1,268

 

 

1,268

 

Balance at October 3, 2009

 

$

(3,405

)

$

(1,124

)

$

(4,529

)

 

Stock-Based Compensation

 

In April 2009, the stockholders of the Company approved the 2009 Stock Incentive Plan (the “2009 Incentive Plan”) and the 2009 Employee Stock Purchase Plan (the “2009 Purchase Plan”).  The 2009 Incentive Plan is currently effective, and no further grants will be issued under the Company’s 2000 Stock Incentive Plan.  The 2009 Purchase Plan will take effect upon the termination of the existing Employee Stock Purchase Plan, on or before April 30, 2010.

 

16



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Stock-based compensation costs are generally based on the fair values on the date of grant for stock options and on the date of enrollment for the employee stock purchase plans, estimated by using the Black-Scholes option-pricing model.  The fair values of stock awards and restricted stock units (RSUs) generally equal their intrinsic value on the date of grant.  The fair values estimated from the Black-Scholes option-pricing model were calculated using the following assumptions:

 

 

 

Nine Months Ended

 

 

 

October 3,
2009

 

October 4,
2008

 

Stock Incentive Plan:

 

 

 

 

 

Expected volatility

 

n/a

 

43.7

%

Risk-free interest rate %

 

n/a

 

2.8

%

Expected term (in years)

 

n/a

 

5.0

 

Dividend yield

 

n/a

 

 

 

 

 

 

 

 

Employee Stock Purchase Plan:

 

 

 

 

 

Expected volatility

 

47.8

%

37.1

%

Risk-free interest rate %

 

0.4

%

1.8

%

Expected term (in months)

 

9.0

 

9.0

 

Dividend yield

 

 

 

 

There were no stock options granted during the nine months ended October 3, 2009.

 

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 3,
2009

 

October 4,
2008

 

October 3,
2009

 

October 4,
2008

 

Cost of revenues

 

$

375

 

$

100

 

$

1,142

 

$

850

 

Research and development

 

2,829

 

3,514

 

10,501

 

11,432

 

Selling, general and administrative

 

7,973

 

6,382

 

20,533

 

18,111

 

 

 

11,177

 

9,996

 

32,176

 

30,393

 

Provision for income taxes

 

1,693

 

1,350

 

4,657

 

4,062

 

 

 

$

9,484

 

$

8,646

 

$

27,519

 

$

26,331

 

 

The Company had approximately $58.7 million of total unrecognized compensation costs related to stock options, stock and RSUs at October 3, 2009 that are expected to be recognized over a weighted-average period of 1.9 years.

 

17



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

8.  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 of the coordinated cases, which are intended to serve as test, or “focus” cases.  The plaintiffs selected these six cases, which do not include the Company.  On April 6, 2007, the Second Circuit denied a petition for rehearing filed by the plaintiffs, but noted that the plaintiffs could ask the District Court to certify more narrow classes than those that were rejected.

 

The parties in the approximately 300 coordinated cases, including the Company, the underwriter defendants in the class action lawsuit, and the plaintiff class in the class action lawsuit, reached a settlement.  The insurers for the issuer defendants in the coordinated cases will make the settlement payment on behalf of the issuers, including the Company.  On October 5, 2009, the Court granted final approval of the settlement.  The thirty day deadline to appeal the final approval order will start to run when the judgment is filed.  The judgment has not yet been filed.  A group of three objectors has filed a petition to the Second Circuit seeking permission to appeal the District Court’s final approval order on the basis that the settlement class is broader than the class previously rejected by the Second Circuit in its December 5, 2006 order vacating the District Court’s order certifying classes in the focus cases.

 

As the litigation process is inherently uncertain, the Company is unable to predict the outcome of the above described matter if the approval of the settlement is appealed and the settlement does not survive the appeal.  While the Company does maintain liability insurance, it could incur losses that are not covered by its liability insurance or that exceed the limits of its liability insurance.  Such losses could have a material impact on the Company’s business and its results of operations or financial position.

 

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.

 

18



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Operating Leases

 

In March 2006, the Company entered into an operating lease agreement and a related participation agreement for a facility at 400 W. Cesar Chavez (“400 WCC”) in Austin, Texas for its corporate headquarters.  In March 2008, the Company entered into an operating lease agreement and a related participation agreement for a facility at 200 W. Cesar Chavez (“200 WCC”) in Austin, Texas for the expansion of its corporate headquarters.  During the terms of the leases, the Company has on-going options to purchase the buildings for purchase prices of approximately $44.3 million for 400 WCC and $50.1 million for 200 WCC.  Alternatively, the Company can cause each such property to be sold to third parties provided it is not in default under that property’s lease.  The Company is contingently liable on a first dollar loss basis for up to $35.3 million to the extent that the 400 WCC sale proceeds are less than the $44.3 million purchase option and up to $40.0 million to the extent that the 200 WCC sale proceeds are less than the $50.1 million purchase option.

 

Discontinued Operations Indemnification

 

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”).  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 3, 2009, the Company had no material liabilities recorded with respect to this indemnification obligation.

 

9. Income Taxes

 

Provision for income taxes includes both domestic and foreign income taxes at the applicable statutory rates adjusted for non-deductible expenses (including a portion of our stock compensation), research and development tax credits, interest income from tax-exempt investments and interest and penalties related to unrecognized tax benefits.  Income tax expense was $4.6 million and $8.1 million for the three months ended October 3, 2009 and October 4, 2008, respectively, resulting in effective tax rates of 17.0 % and 87.6%, respectively.  Income tax expense was $9.8 million and $18.4 million for the nine months ended October 3, 2009 and October 4, 2008, respectively, resulting in effective tax rates of 23.0% and 40.8%, respectively.  The effective tax rates for both the three months and nine months ended October 3, 2009 decreased from the prior periods, primarily due to the intercompany license of certain technology and the non-deductible write-off of in-process research and development costs during the three months ended October 4, 2008, both of which were related to the acquisition of Integration Associates.  Additionally, the effective tax rates for both the three months and nine months ended October 3, 2009 decreased due to an increase in the foreign tax rate benefit.  The impact of these items was partially offset by the decrease in the reduction of the liability for unrecognized tax benefits.

 

At October 3, 2009, the Company had gross unrecognized tax benefits of $34.5 million, $34.3 million of which would affect the effective tax rate if recognized. During the nine months ended October 3, 2009, the Company had gross increases of $3.0 million to its current year unrecognized tax benefits, primarily due to uncertainty related to intercompany transfer pricing, and gross decreases of $1.2 million to its unrecognized tax benefits related to the closure of an open tax year.  During the nine months ended October 4, 2008, the Company had gross increases of $7.3 million to its 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.

 

The Company believes it is reasonably possible that the gross unrecognized tax benefits will change in the next 12 months due to the Company’s participation in the Advance Pricing Agreement program with the U.S. Internal Revenue Service.  At this time, the Company is unable to estimate the range of the possible change to the unrecognized tax benefits.

 

19



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The Company recognizes interest and penalties related to unrecognized tax benefits in the provision for income taxes.  The Company recognized $0.6 million of interest, net of tax, in the provision for income taxes for the nine months ended October 3, 2009.  In addition, during the nine months ended October 3, 2009, the Company had decreases, net of tax, of $0.2 million related to the closure of an open tax year.  The Company recognized $0.7 million of interest, net of tax, in the provision 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.  As of October 3, 2009, the Company had accrued $2.3 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 has been notified by the U.S. Internal Revenue Service that its federal income tax returns for 2005 through 2008 will be examined.  Although the outcome of tax audits is always uncertain, the Company believes that the results of the examination will not materially affect its financial position or results of operations.

 

10.  Headquarter Relocation Costs

 

In fiscal 2006 and 2007, the Company relocated its Austin, Texas employees to a new corporate headquarters.  The following table summarizes the accrued relocation costs activity for the nine months ended October 3, 2009 (in thousands):

 

Balance at
January 3, 2009

 

Deductions

 

Balance at
October 3, 2009

 

$

986

 

$

865

 

$

121

 

 

Deductions represent lease payments.

 

11.  Subsequent Events

 

The Company evaluates events and transactions that occur after the balance sheet date as potential subsequent events.  This evaluation was performed through October 28, 2009, the date on which the Company’s financial statements were issued.

 

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 2009 will have 52 weeks and  fiscal 2008 had 53 weeks.  In a 52-week year, each fiscal quarter consists of 13 weeks. The extra week in fiscal 2008 was added to the first quarter, making such quarter consist of 14 weeks.  Our third quarter of fiscal 2009 ended October 3, 2009.  Our third quarter of fiscal 2008 ended October 4, 2008.

 

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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, Huawei, LG Electronics, Motorola, Panasonic, Philips, Samsung, Sony Ericsson, Thomson and Varian Medical Systems.

 

As a “fabless” semiconductor company, we rely on third-party semiconductor fabricators in Asia, and to a lesser extent the United States and Europe, 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 most cases, test these devices and ship these units to our customers.  Testing performed by such third parties 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 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 tuners and 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);

 

·                   Broad-based products, which include 8-bit microcontroller products, 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 the first nine months of 2009, we introduced the expansion of our Any-Rate Precision Clock family with a low jitter clock generator for broadcast video applications, a silicon hybrid TV tuner that supports both analog and digital broadcasts in a single device, a family of ProSLIC single channel telephony ICs for broadband networking equipment, the expansion of our small form factor microcontrollers in a tiny 2x2 mm footprint, a family of ISOpro high-performance, digital isolators, a family of high pin-count capacitive touch-sense microcontrollers for cost-sensitive embedded systems and the EZRadioPRO™ embedded wireless radio family.  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.

 

During the nine months ended October 3, 2009, one customer, Samsung, represented more than 10% of our revenues.  No other single end customer accounted for more than 10% of our revenues during the nine months ended October 3, 2009.  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.  Two of our distributors, Edom Technology and Avnet, represented 25% and 10% of our revenues during the nine months ended October 3, 2009, respectively.  There were no other distributors or contract manufacturers that accounted for more than 10% of our revenues during the nine months ended October 3, 2009.

 

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Table of Contents

 

The percentage of our revenues derived from customers located outside of the United States was 88% during the nine months ended October 3, 2009.  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.

 

Because many of our ICs are designed for use in consumer products such as televisions, personal video recorders, set-top boxes, portable navigation devices 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.

 

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, the mix of products we sell 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 and certain acquired intangible assets; an allocated portion of our occupancy costs; and allocable depreciation of testing equipment and leasehold improvements.

 

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Table of Contents

 

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, as well as an allocated portion of our occupancy costs for such operations.  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, 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.  For acquisitions occurring prior to fiscal 2009, these costs were expensed on the date of acquisition.  Beginning in fiscal 2009, IPR&D acquired in business combinations is recorded as an indefinite-lived intangible asset at fair value.  The asset is tested for impairment through its completion and then amortized over its useful life.

 

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

 

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Table of Contents

 

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 3,
2009

 

October 4,
2008

 

October 3,
2009

 

October 4,
2008

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of revenues

 

35.6

 

38.9

 

37.4

 

38.1

 

Gross margin

 

64.4

 

61.1

 

62.6

 

61.9

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

20.6

 

22.7

 

24.8

 

23.3

 

Selling, general and administrative

 

22.7

 

22.9

 

24.9

 

23.7

 

In-process research and development

 

 

9.0

 

 

3.2

 

Operating expenses

 

43.3

 

54.6

 

49.7

 

50.2

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

21.1

 

6.5

 

12.9

 

11.7

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

0.4

 

1.8

 

0.6

 

2.8

 

Interest expense

 

(0.0

)

(0.1

)

(0.0

)

(0.1

)

Other income (expense), net

 

0.0

 

(0.0

)

0.1

 

(0.2

)

Income before income taxes

 

21.5

 

8.2

 

13.6

 

14.2

 

Provision for income taxes

 

3.7

 

7.2

 

3.1

 

5.8

 

Net income

 

17.8

%

1.0

%

10.5

%

8.4

%

 

Revenues

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

Revenues

 

$

125.9

 

$

113.5

 

$

12.4

 

11.0

%

$

313.8

 

$

316.3

 

$

(2.5

)

(0.8

)%

 

The growth in the sales of our products in the recent three month period was driven primarily by increased revenues from our RF and broad-based product groups.  Unit volumes of our products increased compared to the three and nine months ended October 4, 2008 by 16.8% and 15.6%, respectively.  Average selling prices decreased during the same periods by 4.4% and 13.9%, respectively.  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 derivatives will offset these decreases to some degree.

 

Gross Margin

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

Gross margin

 

$

81.0

 

$

69.3

 

$

11.7

 

16.9

%

$

196.5

 

$

195.7

 

$

0.8

 

0.4

%

Percent of revenue

 

64.4

%

61.1

%

 

 

 

 

62.6

%

61.9

%

 

 

 

 

 

The increase in the dollar amount of gross margin in the recent three month period was primarily due to our increased sales.  The increase in gross margin as a percent of revenue in the recent three month period was primarily due to a charge of $1.4 million to record inventory acquired from Integration Associates at fair value during the three months ended October 4, 2008, improvements in our inventory management and manufacturing cost reductions.  We may continue to experience declines in the average selling prices of certain of our products.  This downward pressure on gross margin 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; 2) achieve lower production costs from our wafer suppliers and third-party assembly and test subcontractors; 3) achieve lower production costs per unit as a result of improved yields throughout the manufacturing process; or 4) reduce logistics costs.

 

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Table of Contents

 

Research and Development

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

Research and development

 

$

25.9

 

$

25.8

 

$

0.1

 

0.5

%

$

77.8

 

$

73.8

 

$

4.0

 

5.4

%

Percent of revenue

 

20.6

%

22.7

%

 

 

 

 

24.8

%

23.3

%

 

 

 

 

 

The increase in research and development expense in the recent nine month period was principally due to an increase of $4.1 million for personnel-related expenses, including personnel costs associated with the acquisition of Integration Associates.  We expect that research and development expense will remain relatively stable in absolute dollars, but may fluctuate somewhat due to the timing of certain items related to new product development initiatives, such as mask and wafer costs.  In addition, research and development expense will fluctuate as a percentage of revenues due to changes in sales.

 

Significant recent development projects include the expansion of our Any-Rate Precision Clock family with a low jitter clock generator for broadcast video applications, a silicon hybrid TV tuner that supports both analog and digital broadcasts in a single device, a family of ProSLIC single channel telephony ICs for broadband networking equipment, a family of ISOpro high-performance, digital isolators, a family of high pin-count capacitive touch-sense microcontrollers for cost-sensitive embedded systems, the EZRadioPRO embedded wireless radio family, the expansion of our Any-Rate Precision Clock family, a new family of clock generators and buffers, and an integrated automotive AM/FM radio receiver IC.  We also further expanded our microcontroller portfolio.

 

Selling, General and Administrative

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

October 3,
2009

 

October 4,
2008

 

Change

 

%
Change

 

Selling, general and administrative

 

$

28.6

 

$

25.9

 

$

2.7

 

10.2

%

$

78.2

 

$

75.0

 

$

3.2

 

4.2

%

Percent of revenue

 

22.7

%

22.9

%

 

 

 

 

24.9

%

23.7

%

 

 

 

 

 

The increase in selling, general and administrative expense in the recent three and nine month periods was principally due to increases of $2.5 million and $3.3 million for personnel-related expenses, including personnel costs associated with the acquisition of Integration Associates, respectively.  We expect that selling, general and administrative expense will remain relatively stable in absolute dollars in future periods and may fluctuate as a percentage of revenues due to changes in sales.

 

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.

 

There was no acquisition of IPR&D for the three and nine months ended October 3, 2009.

 

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Table of Contents

 

Interest Income

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 3,
2009

 

October 4,
2008

 

Change

 

October 3,
2009

 

October 4,
2008

 

Change

 

Interest income

 

$

0.5

 

$

2.1

 

$

(1.6

)

$

2.1

 

$

9.3

 

$

(7.2

)

 

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

 

Interest Expense

 

Interest expense was $0.1 million and $0.2 million for the three and nine months ended October 3, 2009, respectively, as compared to $0.1 million and $0.3 million for the three and nine months ended October 4, 2008, respectively.

 

Other Income (Expense), Net

 

Other income (expense), net was $8 thousand and $0.3 million for the three and nine months ended October 3, 2009, as compared $(43) thousand and $(0.5) million for the three and nine months ended October 4, 2008, respectively.

 

Provision for Income Taxes

 

 

 

Three Months Ended

 

Nine Months Ended

 

(in millions)

 

October 3,
2009

 

October 4,
2008

 

Change

 

October 3,
2009

 

October 4,
2008

 

Change

 

Provision for income taxes

 

$

4.6

 

$

8.1

 

$

(3.5

)

$

9.8

 

$

18.4

 

$

(8.6

)

Effective tax rate

 

17.0

%

87.6

%

 

 

23.0

%

40.8

%

 

 

 

The effective tax rates for both the three and nine months ended October 3, 2009 decreased from the prior periods, primarily due to the intercompany license of certain technology and the non-deductible write-off of in-process research and development costs during the three months ended October 4, 2008, both of which were related to the acquisition of Integration Associates.  Additionally, the effective tax rates for both the three and nine months ended October 3, 2009 decreased due to an increase in the foreign tax rate benefit.  The impact of these items was partially offset by the decrease in the reduction of the liability for unrecognized tax benefits.

 

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, the limited deductibility of stock compensation expense and other permanent items including changes to the liability for unrecognized tax benefits.

 

Business Outlook

 

We expect revenues in the fourth quarter of fiscal 2009 to be in the range of $124 to $129 million.  Furthermore, we expect our diluted earnings per share to be in the range of $0.40 to $0.43.

 

Liquidity and Capital Resources

 

Our principal sources of liquidity as of October 3, 2009 consisted of $378.0 million in cash, cash equivalents and short-term investments.  Our short-term investments consist primarily of U.S. government agency bonds and discount notes, corporate bonds, municipal bonds,  U.S. treasury bills, U.S. government bonds, commercial paper, international government bonds and auction-rate securities purchased through UBS (“UBS auction-rate securities”).

 

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Table of Contents

 

Our long-term investments consist of non-UBS 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 3, 2009, we held $51.6 million par value auction-rate securities, 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 inability to liquidate the securities.

 

The underlying assets of our auction-rate securities consisted of student loans and municipal bonds, of which $47.6 million were guaranteed by the U.S. government and the remaining $4.0 million were privately insured.  As of October 3, 2009, $40.6 million of the auction-rate securities had credit ratings of AAA, $4.0 million had credit ratings of AA and $7.0 million had a credit rating of BBB.  These securities had contractual maturity dates ranging from 2025 to 2046 and were yielding 0.51% to 2.85% per year at October 3, 2009.  We are receiving the underlying cash flows on all of our auction-rate securities.  The principal amounts 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.

 

In November 2008, we entered into an agreement with UBS AG, which provides us certain rights to sell to UBS the auction-rate securities which were purchased through them.  As of October 3, 2009, we held $24.2 million par value auction-rate securities purchased from UBS.  We have the option to sell these securities to UBS at par value from June 30, 2010 through July 2, 2012.  UBS, at its discretion, may purchase or sell these securities on our behalf at any time provided we receive par value for the securities sold.  The issuers of the auction-rate securities continue to have the right to redeem the securities at their discretion.  The agreement allows for the continuation of the accrual and payment of interest due on the securities.  The agreement also provides us with access to loans of up to 75% of the market value of the unredeemed securities until June 30, 2010.  These loans would carry interest rates which would be consistent with the interest income on the related auction-rate securities.  As of October 3, 2009, we had no loans outstanding under this agreement.

 

We do not expect to need access to the capital represented by any of our auction-rate securities prior to their maturities.  We do not intend to sell, and we believe that it is not more likely than not that we will be required to sell, our non-UBS investments before their anticipated recovery in market value or final settlement at the underlying par value.  See Note 3, Financial Instruments , to the Condensed Consolidated Financial Statements for additional information.

 

Net cash provided by operating activities was $78.2 million during the nine months ended October 3, 2009, compared to net cash provided of $81.1 million during the nine months ended October 4, 2008.  Operating cash flows during the nine months ended October 3, 2009 reflect our net income of $32.8 million, adjustments of $48.1 million for depreciation, amortization, deferred income taxes, stock compensation and in-process research and development, and a net cash outflow of $2.7 million due to changes in our operating assets and liabilities.

 

Accounts receivable increased to $61.5 million at October 3, 2009 from $36.1 million at January 3, 2009.  The increase in accounts receivable resulted primarily from an increase in revenues during the three months ended October 3, 2009 compared to the three months ended January 3, 2009.  Our average days sales outstanding (DSO) increased to 44 days at October 3, 2009 from 33 days at January 3, 2009.

 

Inventory increased to $33.5 million at October 3, 2009 from $28.3 million at January 3, 2009.  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 67 days at October 3, 2009 and 65 days at January 3, 2009.

 

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Table of Contents

 

Net cash used in investing activities was $111.7 million during the nine months ended October 3, 2009, compared to net cash provided of $47.4 million during the nine months ended October 4, 2008.  The decrease was principally due to an increase of $219.5 million in net outflows for purchases of investments and the receipt of $14.3 million previously held in escrow in connection with the sale of the Aero product lines during the nine months ended October 4, 2008, offset by a payment of $74.6 million for the acquisition of Integration Associates during the nine months ended October 4, 2008.

 

We anticipate capital expenditures of approximately $10 to $12 million for fiscal 2009.  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 provided by financing activities was $10.3 million during the nine months ended October 3, 2009, compared to net cash used of $241.6 million during the nine months ended October 4, 2008.  The increase was principally due to a decrease of $233.7 million for repurchases of our common stock and an increase of $18.7 million from proceeds from the issuance of common stock.  In July 2007 and October 2008, our Board of Directors authorized programs to repurchase up to $400 million and $100 million of our common stock, respectively.

 

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.

 

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 write-off 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.  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 7, Stockholders’ Equity and Stock-Based Compensation , to the Condensed Consolidated Financial Statements for a further discussion on stock-based compensation.

 

Investments in auction-rate securities —  We determine the fair value of our 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 inability to liquidate the securities.  For the available-for-sale auction-rate 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, our intent to sell or the likelihood that we would be required to sell the investment before its anticipated recovery in market value and the probability that the scheduled cash payments will continue to be made.  When we conclude that an other-than-temporary impairment has resulted due to credit losses, the difference between the fair value and the carrying value is recorded as an impairment charge in the Consolidated Statement of Income.  All other impairments 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.

 

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.

 

We recognize liabilities for uncertain tax positions based on a two-step process.  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 complex and requires subjective estimations of such amounts to determine the probability of various possible outcomes.  We re-evaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, expirations of statutes of limitation, 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. 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.

 

Recent Accounting Pronouncements

 

In April 2009, the Financial Accounting Standards Board (FASB) issued the following:

 

·                   FASB Accounting Standards Codification (ASC) 820-10-65, formerly FSP FAS No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly , provides additional guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased. This ASC also includes guidance on identifying circumstances that indicate a transaction is not orderly.

 

·                   FASB ASC 320-10-65, formerly FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments , amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements.

 

·                   FASB ASC 825-10-65, formerly FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments , requires disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements.

 

These ASCs are effective for reporting periods ending after June 15, 2009 and were adopted by us on April 5, 2009.  The adoption of the ASCs did not have a material impact on our financial statements.

 

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In June 2008, the FASB issued FASB ASC 260-10-45, formerly FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.   ASC 260-10-45 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in FASB ASC 260, Earnings per Share .  ASC 260-10-45 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years on a retrospective basis.  We adopted ASC 260-10-45 at the beginning of fiscal 2009.  The adoption did not have a material impact on our financial statements.

 

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 3, 2009, an immediate 100 basis point decline in the yield for such instruments would decrease our annual interest income by approximately $3.9 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.

 

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 3, 2009 was a $5.2 million obligation.

 

Investments in 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 3, 2009, we held $51.6 million par value auction-rate securities, all of which experienced failed auctions.  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 available-for-sale auction-rate securities has occurred, we may be required to adjust the carrying value of the investments through an impairment charge.  In November 2008, we entered into an agreement with UBS, which provides us certain rights to sell to UBS the auction-rate securities which were purchased through them.  As of October 3, 2009, we held $24.2 million par value auction-rate securities purchased from UBS.  We have the option to sell these securities to UBS at par value from June 30, 2010 through July 2, 2012.  See Note 3, Financial Instruments , to the Condensed Consolidated Financial Statements for additional information.

 

Available Information

 

Our 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 website and the information contained therein or connected thereto are not intended to be incorporated into this Quarterly Report on Form 10-Q.

 

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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 3, 2009 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.  Such disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed is accumulated and communicated to our management, including our CEO and CFO, to allow timely decisions regarding required disclosures.  There was no change in our internal controls during the fiscal quarter ended October 3, 2009 that materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

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 of the coordinated cases, which are intended to serve as test, or “focus” cases.  The plaintiffs selected these six cases, which do not include us.  On April 6, 2007, the Second Circuit denied a petition for rehearing filed by the plaintiffs, but noted that the plaintiffs could ask the District Court to certify more narrow classes than those that were rejected.

 

The parties in the approximately 300 coordinated cases, including us, the underwriter defendants in the class action lawsuit, and the plaintiff class in the class action lawsuit, reached a settlement.  The insurers for the issuer defendants in the coordinated cases will make the settlement payment on behalf of the issuers, including us.  On October 5, 2009, the Court granted final approval of the settlement.  The thirty day deadline to appeal the final approval order will start to run when the judgment is filed.  The judgment has not yet been filed.  A group of three objectors has filed a petition to the Second Circuit seeking permission to appeal the District Court’s final approval order on the basis that the settlement class is broader than the class previously rejected by the Second Circuit in its December 5, 2006 order vacating the District Court’s order certifying classes in the focus cases.

 

As the litigation process is inherently uncertain, we are unable to predict the outcome of the above described matter if the approval of the settlement is appealed and the settlement does not survive the appeal.  While we do maintain liability insurance, we could incur losses that are not covered by our liability insurance or that exceed the limits of our liability insurance.  Such losses could have a material impact on our business and 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:

 

·                   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;

 

·                   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.

 

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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.  The current economic situation could increase the likelihood of such defaults and bankruptcies.  Our ten largest customers or distributors represent a substantial majority of our accounts receivable.  If any such customer or distributor, or a material portion of our smaller customers or distributors, were to become insolvent or otherwise not satisfy their obligations to us, we could be materially harmed.

 

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 3, 2009 was $77.8 million, or 24.8% 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 3, 2009, our ten largest customers accounted for 44% 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.

 

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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.

 

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 88% during the nine months ended October 3, 2009.  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.

 

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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.

 

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.

 

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;

 

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·                   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 on third-party vendors to manufacture the ICs we design.  We also currently rely on Asian third-party assembly subcontractors 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.

 

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;

 

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·                   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 Taiwan Semiconductor Manufacturing Co. (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.

 

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.  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.

 

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We are subject to risks relating to product concentration

 

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;

 

·                  Competitive products;

 

·                  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.

 

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: