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| EXAR > SEC Filings for EXAR > Form 10-K on 12-Jun-2009 | All Recent SEC Filings |
12-Jun-2009
Annual Report
The following Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained in "Risk Factors" above and elsewhere in this Annual Report on Form 10-K contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties. Please see "Forward Looking Statements" in Part I above. Actual results may differ materially from those projected in the forward-looking statements as a result of various factors, including, among others, those identified above under Part I, Item 1A-"Risk Factors."
COMPANY OVERVIEW
Exar Corporation and its subsidiaries ("Exar" or "we") is a fabless semiconductor company that designs, sub-contracts manufacturing and sells highly differentiated silicon, software and subsystem solutions for industrial, datacom and storage applications. Our comprehensive knowledge of end-user markets along with our underlying analog, mixed signal and digital technology has enabled innovative solutions that meet the needs of the evolving connected world. Our product portfolio includes power management and interface components, datacom products, storage optimization solutions, network security and applied service processors. Applying both analog and digital technologies, our products are deployed in a wide array of applications such as portable electronic devices, set top boxes, digital video recorders, telecommunication systems, servers, enterprise storage systems and industrial automation equipment. We have the unique ability to provide customers with a breadth of component products and subsystem solutions based on advanced mixed signal silicon integration.
We market our products worldwide with sales offices and personnel located throughout the Americas, Europe and Asia. Our products are sold in the United States through a number of manufacturers' representatives and distributors. Internationally, our products are sold through various global and regional distributors with locations in thirty-three countries around the globe. In addition to our sales offices, we also employ a worldwide team of field application engineers to work directly with our customers.
Our international sales are generally denominated in U.S. dollars. Our international related operations expenses expose us to fluctuations in currency exchange rates because our foreign operating expenses are denominated in foreign currency while our sales are denominated in U.S. dollars. Although foreign sales within certain countries or foreign sales comprised of certain products may subject us to tariffs, our gross profit margin on international sales, adjusted for differences in product mix, is not significantly different from that realized on our sales to domestic customers. Our operating results are subject to quarterly and annual fluctuations as a result of several factors that could materially and adversely affect our future profitability as described in "Part II, Item 1A. Risk Factors-Our Financial Results May Fluctuate Significantly Because Of A Number Of Factors, Many Of Which Are Beyond Our Control."
On April 3, 2009, we completed the acquisition of Hifn, a leading provider of network- and storage-security and data reduction products that simplify the way major network and storage original equipment manufacturers, as well as small-and-medium enterprises, efficiently and securely share, retain, access and protect critical data. We believe the acquisition has enabled us to expand both our market presence and revenue without compromising our financial condition.
In December 2007, we changed our fiscal year end from a fiscal year ending March 31 to a 52-53 week fiscal year ending on the Sunday closest to March 31. As part of this change, each fiscal quarter will also end on the Sunday closest to the end of the corresponding calendar quarter. As a result of the change in our fiscal year end, our fiscal year ended March 29, 2009 contains 364 days and our fiscal years ended March 30, 2008 and March 31, 2007 each contained 365 days. Fiscal years ended March 29, 2009, March 30, 2008 and March 31, 2007 are also referred to herein as "2009," "2008" and "2007" unless otherwise indicated.
In August 2007, we completed the acquisition of Sipex Corporation ("Sipex"), a company that designed, manufactured and marketed high performance, analog Integrated Circuits ("ICs") used by OEMs in the computing, consumer electronics, datacom and networking infrastructure markets. As a result of the acquisition, we have combined product offerings, increased technical expertise, distribution channels, customer base and geographic reach as well as reduced expenses due to significant cost synergies.
EXECUTIVE SUMMARY
During fiscal year 2009, we continued to execute on our strategy of growing the company through new product introductions and through acquisitions.
We acquired Sipex in August 2007, and fiscal year 2009 represents our first full year of combined operations. We have completed the integration of the organization and information systems, and the rationalization of our sales channels, development projects, business processes, compensation plans and internal controls. We also achieved annualized cost savings in the first quarter of fiscal 2009, which exceeded the targeted savings for that quarter when we announced the proposed acquisition of Sipex in May 2007.
We commenced a tender offer for the shares of Hifn in the fourth quarter of fiscal 2009 and subsequently closed the transaction on April 3, 2009. We expect to benefit by combining the encryption and data deduplication technologies of Hifn together with our network and storage technology into new products.
Our net sales for fiscal year 2009 were $115.1 million, an increase of $25.4 million or 28% as compared to net sales for fiscal year 2008. The increase was primarily due to growth in net sales of $31.8 million associated with Sipex products acquired in August 2007. The transition of the recognition of revenue through our two primary distributors from the sell-in to the sell-through basis reduced net sales in fiscal year 2008 by an estimated $6.9 million. As this fiscal year progressed, our net sales were severely impacted by the economic recession and resulting decline in end customer demand. Our net sales in the second fiscal quarter grew 2% over the first fiscal quarter, then declined 20% and 9% on a sequential basis in the third and fourth fiscal quarters.
For fiscal year 2009, sales of our datacom products represented 24% of our net sales, as compared to 31% in fiscal year 2008 and 42% in fiscal year 2007. For fiscal year 2009, sales of our interface products represented 55% of our net sales, as compared to 56% in fiscal year 2008 and 58% in fiscal year 2007. For fiscal years 2009 and 2008, sales of our power management products, a new line of products that we acquired from Sipex, represented 21% and 13% of our net sales, respectively.
The gross margin percentage in fiscal year 2009 was 44% as compared to 45% for fiscal year 2008 and 68% for fiscal year 2007. The reduction in gross margin in fiscal year 2008 compared to fiscal year 2007 resulted primarily from lower gross margins on acquired Sipex products and to the amortization of intangible assets associated with the Sipex acquisition. In addition, in fiscal year 2008, the gross margin was also reduced by the amortization of the fair value adjustment for inventories acquired in connection with the Sipex acquisition.
Our operating expenses for fiscal year 2009 were $130.5 million, or $112.1 million lower than fiscal year 2008, and included a non-cash charge of $59.7 million for the impairment of goodwill and other intangible assets as compared to a similar charge of $165.2 million in fiscal year 2008.
For fiscal year 2009, our loss from operations was $80.2 million. Interest income and other, net was $9.7 million and interest expense was $1.3 million. We also recorded an impairment charge of $1.8 million associated with our marketable and non-marketable securities during the period. The net loss for fiscal year 2009 was $73.0 million, or $1.70 loss per share.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements and accompanying disclosures in conformity with GAAP, the accounting principles generally accepted in the United States, requires estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosures of contingent assets and liabilities in the consolidated financial
statements and the accompanying notes. The U.S. Securities and Exchange
Commission ("SEC") has defined a company's critical accounting policies as
policies that are most important to the portrayal of a company's financial
condition and results of operations, and which require a company to make its
most difficult and subjective judgments, often as a result of the need to make
estimates of matters that are inherently uncertain. Based on this definition, we
have identified our most critical accounting policies and estimates to be as
follows: (1) revenue recognition; (2) inventories; (3) income taxes;
(4) stock-based compensation; (5) goodwill and long-lived assets; each of which
is addressed below. We also have other key accounting policies that involve the
use of estimates, judgments and assumptions that are significant to
understanding our results. For additional information, see Part II,
Item 8-"Financial Statements and Supplementary Data" and "Notes to Consolidated
Financial Statements, Note 2-Accounting Policies." Although we believe that our
estimates, assumptions and judgments are reasonable, they are based upon
information presently available. Actual results may differ significantly from
these estimates if the assumptions, judgments and conditions upon which they are
based turn out to be inaccurate.
Revenue Recognition
We recognize revenue in accordance with SEC Staff Accounting Bulletin 104, "Revenue Recognition" ("SAB 104"). SAB 104 requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured.
We derive revenue principally from the sale of our products to distributors and to OEMs or their contract manufacturers. Our delivery terms are primarily FOB shipping point, at which time title and all risks of ownership are transferred to the customer. For fiscal years ended March 29, 2009, March 30, 2008 and March 31, 2007, approximately 44%, 35% and 38%, respectively, of our net sales were derived from product sales to our two primary distributors, Future Electronics Inc. ("Future") and Nu Horizons Electronics Corp. ("Nu Horizons"); and approximately 56%, 65% and 62%, respectively, of our net sales were derived from sales to other distributors, OEM customers and other non-distributors.
Non-distributors
For non-distributors, revenue is recognized when title to the product is transferred to the customer, which occurs upon shipment or delivery, depending upon the terms of the customer order, provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, collection of the resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations. Provisions for returns and allowances for non-distributor customers are provided at the time product sales are recognized. An allowance for sales returns and allowances for non-distributor customers are recorded based on historical experience or specific identification of an event necessitating an allowance.
Distributors
Our two primary distributors' agreements permit the return of 3% to 5% of their purchases during the preceding quarter for purposes of stock rotation. For one of these distributors, a scrap allowance of 2% of the preceding quarter's purchases is permitted. We also provide discounts to certain distributors based on volume of product they sell for a specific product with a specific volume range for a given customer over a period not to exceed one year.
We recognize revenue from each of our distributors using either of the following basis. Once adopted, the basis for revenue recognition for a distributor is maintained unless there is a change in circumstances indicating the basis for revenue recognition for that distributor is no longer appropriate.
• Sell-in Basis-Revenue is recognized upon shipment if we conclude we meet the same criteria as for non-distributors discussed above and we can reasonably estimate the credits for returns, pricing
• Sell-through Basis-Revenue and the related costs of sales are deferred until the resale to the end customer if we grant more than limited rights of return, pricing allowances and/or other concessions or if we cannot reasonably estimate the level of returns and credits issuable (i.e., "sell-through" basis). Under the sell-through basis, accounts receivable are recognized and inventory is relieved upon shipment to the distributor as title to the inventory is transferred upon shipment, at which point we have a legally enforceable right to collection under normal terms. The associated sales and cost of sales are deferred and are included in deferred income and allowance on sales to distributors in the consolidated balance sheet. When the related product is sold by our distributors to their end customers, at which time the ultimate price we receive is known, we recognize previously deferred income as sales and cost of sales.
Sell-through revenue recognition is highly dependent on receiving pertinent and accurate data from our distributors in a timely fashion. Distributors provide us periodic data regarding the product, price, quantity, and end customer when products are resold as well as the quantities of our products they still have in stock. We must use estimates and apply judgments to reconcile distributors' reported inventories to their activities. Any error in our judgment could lead to inaccurate reporting of our net sales, gross profit, deferred income and allowances on sales to distributors and net income.
Our historical patterns of returns, pricing allowances and other concessions with distributors had been fairly consistent, which enabled us to reasonably estimate such allowances at the time of shipment. Therefore, we historically recognized revenue on sales to all distributors on the sell-in basis and recorded an estimated allowance, at the time of shipment, based on authorized and historical patterns of returns and other concessions. Concurrent with the acquisition of Sipex, we reassessed our expected ability to continue to reasonably estimate such allowances for each of our distributors as well as for Sipex's distributors. Prior to the acquisition, Sipex recognized revenue on sales to all distributors on the sell-through basis. Consistent with Sipex's past practice, we concluded that we were not able to reasonably estimate such allowances at the time of shipment of products to Sipex's distributors. Therefore, we determined that consistent with Sipex's past practice, we will continue to recognize sales to Sipex's distributors on the sell-through basis. In addition, as a result of the acquisition, our relationships, marketing and sales practices with our two primary distributors had changed. Further, as disclosed in "Part II, Item 8-Financial Statements and Supplementary Data" and "Notes to Consolidated Financial Statements, Note 5- Related Party Transaction," Future is a related party of Exar. As a result of these changes, we have concluded that we can no longer reasonably estimate returns, pricing allowances and other concessions at the time of shipment of products to these distributors. Accordingly, concurrent with our consummation of the Sipex acquisition on August 25, 2007, we determined it was appropriate that revenue on all sales to our two primary distributors, Future and Nu Horizons, be recognized on the sell-through basis.
Inventories
Our policy is to establish a provision for excess inventories, based on the nature of the specific product that is greater than six or twelve months of forecasted demand unless there are other factors indicating that the inventories will be sold at a profit after such periods. Among other factors, management considers known backlog of orders, projected sales and marketing forecasts, shipment activity, inventory-on-hand at our primary distributors, past and current market conditions, anticipated demand for our products, changing lead times in the manufacturing process and other business conditions when determining if a provision for excess inventory is required. Our net inventories at March 29, 2009 were $15.7 million, compared with $14.2 million at March 30, 2008. The increase was primarily due to the rapid decline in demand caused by the recession, versus the cycle time required for us to reduce orders from our wafer subcontractors. Should the assumptions used by management in estimating the provision for excess inventory differ from actual future demand or should market conditions become less favorable than those projected by management, additional inventory write-downs may be required, which would have a negative impact on our gross margins. See Part I, Item 1A. "Risk Factors-'Our Financial Results May Fluctuate Significantly Because Of A Number Of Factors, Many Of Which Are Beyond Our Control'."
Income Taxes
We account for income taxes under the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("FAS 109"). Under this method, we determine our deferred tax assets and liabilities based upon the difference between the financial statement and tax bases of our assets and liabilities. We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain deferred tax assets and liabilities, which arise from timing differences in the recognition of revenue and expense for tax and financial statement purposes. Such deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax base, operating losses and tax credit carryforwards. Changes in tax rates affect the deferred income tax assets and liabilities and are recognized in the period in which the tax rates or benefits are enacted. See Part II, Item 8-"Financial Statements and Supplementary Data" and "Notes to Consolidated Financial Statements, Note 17-Income Taxes" for more details about our deferred tax assets and liabilities.
We must determine the probability that we will be able to utilize our deferred tax assets. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. As of March 29, 2009 and March 30, 2008, we maintained a full valuation allowance and our net deferred tax assets recorded on our consolidated balance sheets is zero.
Uncertain Income Tax Provisions
Effective April 1, 2007, we adopted Financial Accounting Standards Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of uncertain tax positions taken or expected to be taken in our income tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The unrecognized tax benefits increased by $0.5 million during the fiscal year ended March 29, 2009 to $9.9 million. If recognized, $8.2 million of these unrecognized tax benefits (net of federal benefit) would be recorded as a reduction of future income tax provision before consideration of changes in valuation allowance.
Stock-Based Compensation
We compute the fair value of stock options utilizing the Black-Scholes model. Calculating stock-based compensation expense requires the input of highly subjective assumptions. The assumptions used in calculating the fair value of stock-based compensation represent our estimates, which involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. Additionally, a change in the estimated forfeiture rate will have a significant effect on reported stock-based compensation expense, as the effect of adjusting the rate for all unamortized expense after April 1, 2006 is recognized in the period the forfeiture estimate is changed. See Part II, Item 8-"Financial Statements and Supplementary Data" and "Notes to the Consolidated Financial Statements, Note 12-Stock-Based Compensation" for more details about our assumptions used in calculating the stock-based compensation expenses and activities of our stock-based compensation.
In fiscal year 2007, our stockholders ratified the Exar Corporation 2006 Equity Incentive Plan (the "2006 Plan"). Within the terms of the 2006 Plan, we now grant stock options and Restricted Stock Units ("RSUs"). At March 29, 2009, unrecognized stock-based compensation was $6.0 million and $2.0 million for stock-options and RSUs, respectively, with remaining weighted average recognition periods of 3.03 years and 1.14 years, respectively.
Option Exchange Program
On October 23, 2008, we commenced a tender offer (the "Offer") and filed a Schedule TO with the SEC pursuant to which holders of options with exercise prices equal to or greater than $11.00 per share and an expiration date after March 31, 2009 could tender their options in exchange for RSU awards. The exchange ratio of shares subject to such eligible options to shares subject to new awards issued was 4-to-1, 5-to-1 or 6-to-1, depending on the exercise price of the option being exchanged. New awards received in exchange for eligible options are subject to a two-year vesting schedule with 50% vesting at each anniversary of the grant date.
Pursuant to the Offer, 242 eligible participants tendered, and we accepted for exchange, options to purchase an aggregate of 1,650,231 shares of our common stock, representing approximately 94% of the 1,755,691 shares subject to options that were eligible to be exchanged in the Offer as of the commencement of the Offer on October 23, 2008. On November 24, 2008, upon the terms and subject to the conditions set forth in the Offer to Exchange Certain Outstanding Options for Restricted Stock Units, filed as an exhibit to the Schedule TO, we issued RSUs covering an aggregate of 344,020 shares of our common stock in exchange for the options surrendered pursuant to the Offer.
The new awards were granted with a price of $6.51, the closing price of our common stock on November 24, 2008 as reported on the NASDAQ Global Select Market. The fair value of the options exchanged was measured as the total of the unrecognized compensation cost of the original options tendered and the incremental compensation cost of the RSUs awarded on November 24, 2008, the date of exchange. The incremental compensation cost of $1.2 million was measured as the excess of the fair value of the RSUs over the fair value of the options immediately before cancellation based on the share price and other pertinent factors at that date. The amount will be amortized over the two years service period. During fiscal year 2009, we recorded approximately $208,000 of such incremental stock-based compensation expense.
Goodwill and Long-Lived Assets
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. We follow the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("FAS 142"), under which we evaluate goodwill for impairment on an annual basis or whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. We conduct our annual impairment analysis in the fourth quarter of each fiscal year. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit's carrying amount, including goodwill, to the fair value of the reporting unit. The fair values of the reporting units are estimated using a combination of the income approach that uses discounted cash flows and the market approach that utilizes comparable companies' data. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss, if any. Because we have one reporting unit under FAS 142, we utilize an entity-wide approach to assess goodwill for impairment. See Part II, Item 8-"Financial Statements and Supplementary Data" and "Notes to the Consolidated Financial Statements, Note 3-Business Combinations" and "Note 8-Goodwill and Intangible Assets" for more details about our assumptions used in calculating the stock-based compensation expenses and activities of our stock-based compensation.
Our long-lived assets include land, buildings, equipment, furniture and fixtures and other intangible assets. Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We evaluate the recoverability of our long-lived assets in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("FAS 144"). We compare the carrying value of long-lived assets to our projection of future undiscounted cash flows attributable to such assets and, in the event that the carrying value exceeds the future undiscounted cash flows, we record an impairment charge equal to the excess of the carrying value over the asset's fair value.
Fiscal Year 2009
The rapid and severe deterioration of worldwide economic conditions has affected our industry and led customers to scale down their levels of production. As a result of third quarter fiscal year 2009 impairment indicators, we considered the potential impairment of goodwill and other long-lived assets including intangible assets. Indicators that required us to perform an interim impairment . . .
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