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AMCC > SEC Filings for AMCC > Form 10-K on 11-Jun-2013All Recent SEC Filings

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Form 10-K for APPLIED MICRO CIRCUITS CORP


11-Jun-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

This management's discussion and analysis of financial condition and results of operations ("MD&A") is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of our operations. The MD&A is organized as follows:
• Caution concerning forward-looking statements. This section discusses how forward-looking statements made by us in the MD&A and elsewhere in this Annual Report are based on management's present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances.

• Overview. This section provides an introductory overview and context for the discussion and analysis that follows in the MD&A.

• Critical accounting policies. This section discusses those accounting policies that are both considered important to our financial condition and operating results and require significant judgment and estimates on the part of management in their application.

• Results of operations. This section provides an analysis of our results of operations for the three fiscal years ended March 31, 2013. A brief description is provided of transactions and events that impact the comparability of the results being analyzed.

• Liquidity and capital resources. This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements and financial commitments.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS
The MD&A should be read in conjunction with the consolidated financial statements and notes thereto included in this report. This discussion contains forward-looking statements. Refer to the Cautionary Statement about Forward-Looking Statements on page 1 for further details.
OVERVIEW
The Company
Applied Micro Circuits Corporation ("AppliedMicro", "APM", "AMCC", the "Company", "we" or "our") is a global leader in computing and connectivity solutions that span embedded computing, Telco, and solutions for next-generation cloud infrastructure and data centers. Our products include the X-GeneTM ARM® 64-bit Server on a ChipTM solution, or X-Gene, designed for cloud data center and enterprise applications. X-Gene began sampling in silicon to several current and prospective customers and ecosystem partners in March 2013. We currently expect X-Gene to be in production by the end of calendar year 2013 and to begin generating sales revenue during calendar year 2014. We believe that X-Gene is the first, and currently the only, ARM 64-bit server solution sampling today. In addition to having a time-to-market advantage, we believe X-Gene will lead the next generation cloud data center silicon market by addressing the need for high performance, lower total cost of ownership silicon and system solutions. X-Gene builds upon our solid base business of providing energy efficient, sustainable computing and connectivity solutions. Our embedded computing products are deployed in applications in markets such as control- and data-plane functionality, wireless access points, residential gateways, wireless base-stations, storage controllers, network attached storage, network switches and routing products, and multi-function printers. Our connectivity products address high growth segments including 10, 40, and 100Gbps solutions serving data center and service provider market opportunities. Our connectivity products include framer/mapper devices for Optical Transport Network ("OTN") equipment and physical layer devices that transmit and receive signals in a very high-speed serial format.
Our corporate headquarters are located in Sunnyvale, California. Sales and engineering offices are located throughout the world. As of March 31, 2013, our business had two reporting units, Computing and Connectivity.
Since the start of fiscal 2011, we have invested a total of $471.8 million in the Research and Development ("R&D") of new products, including higher-speed, lower-power and lower-cost products, products that combine the functions of multiple existing products into single highly-integrated solutions, and other products to expand and complete our portfolio of communications solutions including our ARM 64-bit based server product development. These products, and our customers' products for which they are intended, are highly complex. Due to this complexity, it often takes several years to complete the development and qualification of a product before it enters into volume production. Accordingly, we have not yet generated significant revenues from some of the products developed during this time period. In addition, downturns in the telecommunications market can severely impact our customers' business and often result in significantly less demand for our products than was expected when the development work commenced.


We implemented a restructuring program during December 2012 to reorganize our operations and reduce our workforce and related operating expenses. The plan includes eliminating job redundancies and reducing our current workforce by approximately 70 employees. As a result, we recorded a charge of $1.7 million for employee severance expenses and $4.7 million for an asset impairment during the twelve months ended March 31, 2013. The asset impairment related to the impairment of the unamortized value of a software intellectual property license, which the Company no longer intends to use to develop new products. We incurred cash expenditures of approximately $1.2 million during the twelve months ended March 31, 2013 for employee severance expenses and anticipate that the restructuring plan will reduce ongoing headcount expenses by approximately $8.0 million to $9.0 million annually and other additional operational expenses by $4.0 million to $5.0 million annually commencing fiscal 2013. Acquisition of Veloce
On June 20, 2012 (the "Closing Date"), the Company completed its acquisition of Veloce pursuant to the terms of the Agreement and Plan of Merger, entered into as of May 17, 2009 (the "Initial Agreement"), as amended by Amendment No. 1 to Agreement and Plan of Merger, entered into as of November 8, 2010 (the "First Amendment"), and Amendment No. 2 to Agreement and Plan of Merger, entered into as of April 5, 2012 (the "Second Amendment" and, collectively with the Initial Agreement and the First Amendment, the "Merger Agreement"). The First Amendment was amended, restated and replaced in its entirety by the Second Amendment. The terms of the Merger Agreement included an initial consideration amount of $60.4 million, payable to holders of Veloce common stock options that were vested on the Closing Date and holders of Veloce common stock and stock equivalents (collectively, "Veloce Equity Holders"), and to Veloce stock equivalents that had not yet been allocated to individuals ("Unallocated Veloce Units"). During the twelve months ended March 31, 2013, as part of the above arrangement, we issued approximately 3.0 million shares valued at approximately $16.6 million and paid approximately $16.6 million in cash. The Merger Agreement further provides for payments of additional merger consideration contingent upon the achievement of certain post-closing product development milestones. The total estimated consideration to be paid is based upon the benchmarks achieved during simulations that were performed during the third quarter of fiscal 2013 and correlating the results of the simulations to the contractual terms included in the Merger Agreement. As a result of higher than expected benchmarks achieved during simulations, the total estimated consideration to be paid was updated during fiscal 2013 from a previous estimated maximum of approximately $135 million to the contractual maximum of $178.5 million. The consideration that we will be obligated to pay, incremental to the $60.4 initial consideration, will be payable upon completion of the respective performance milestones and can be settled in cash or the Company's common stock (or a combination of cash and stock), at the election of the Company.
The Company has treated the Veloce merger as a "reorganization" under Section 368 of the Internal Revenue Code in its and Veloce's tax returns. We believe that the requirements to qualify as a reorganization under the Code will be met. Accordingly, the Company intends to issue at least an additional approximately $20 million of the Company's common stock as Veloce merger consideration, assuming that the maximum consideration amount of $178.5 million is paid. For accounting purposes, the costs to be incurred in connection with the development milestones relating to Veloce is considered compensatory and is recognized as R&D expense. Recognition of these costs as expense will generally occur when certain development and performance milestones become probable of achievement and are deemed earned. However, the value allocated to the Unallocated Veloce Units will not be recognized as R&D expense until distribution of the underlying units occurs.
As of March 31, 2013, the Company has completed the first performance milestone and assessed the second performance milestone relating to the Veloce project as probable of achievement. The third and final performance milestone is currently not yet believed to be probable of attainment as of March 31, 2013. Total R&D expenses expected to be recognized in connection with the first and second performance milestones is approximately $142.8 million (including the initial consideration of $60.4 million), which includes the costs associated with Unallocated Veloce Units that have not been expensed as these units have not been distributed as of March 31, 2013. Cumulative R&D expenses recognized in connection with the achievement of the first and second milestone through March 31, 2013 is $126.6 million. See Note 4 and Note 13 to the Notes to Consolidated Financial Statements. During fiscal year 2013, expenses recognized in connection with the achievement of the first and second performance milestones was $66.2 million. The Veloce accrued liability included on the Consolidated Balance Sheets is based upon the amount of R&D expense recognized in connection with the development of the Veloce performance milestones less amounts paid either in cash or our common stock. Veloce consideration that has been accrued as of March 31, 2013, is classified as long-term if payments of the consideration is expected to occur beyond a 12 month period.
Approximately $142.8 million of Veloce consideration is expected to be payable upon the attainment of the first two Veloce development and performance milestones and is expected to be paid over multiple quarters. As of March 31, 2013, $33.2 million


has been paid and we expect that an additional $74.0 million will be paid in cash and stock by September 30, 2013. Additional consideration may become payable if the third and final performance milestone is completed. Summary Financials
The following tables present a summary of our results of operations for the fiscal years ended March 31, 2013 and 2012 (dollars in thousands):

                             Fiscal Year Ended March 31,
                         2013                          2012
                               % of Net                      % of Net       Increase           %
                 Amount        Revenue         Amount        Revenue       (Decrease)        Change
Net revenues  $  195,642         100.0  %   $  230,887         100.0  %   $   (35,245 )       (15.3 )%
Cost of
revenues          83,048          42.4          98,804          42.8          (15,756 )       (15.9 )
Gross profit     112,594          57.6         132,083          57.2          (19,489 )       (14.8 )
Total
operating
expenses         247,464         126.5         225,527          97.7           21,937           9.7
Operating
loss            (134,870 )       (68.9 )       (93,444 )       (40.5 )         41,426          44.3
Interest and
other income
(expense),
net                  201           0.1          11,684           5.0          (11,483 )       (98.3 )
Loss before
income taxes    (134,669 )       (68.8 )       (81,760 )       (35.4 )         52,909          64.7
Income tax
(benefit)
expense             (554 )        (0.3 )           928           0.4           (1,482 )      (159.7 )
Net loss      $ (134,115 )       (68.5 )%   $  (82,688 )       (35.8 )%   $    51,427          62.2  %

The following tables present a summary of our results of operations for the fiscal years ended March 31, 2012 and 2011 (dollars in thousands):

                             Fiscal Year Ended March 31,
                         2012                          2011
                               % of Net                      % of Net       Increase           %
                 Amount        Revenue         Amount        Revenue       (Decrease)        Change
Net revenues  $  230,887         100.0  %   $  247,710         100.0  %   $   (16,823 )        (6.8 )%
Cost of
revenues          98,804          42.8          95,282          38.5            3,522           3.7
Gross profit     132,083          57.2         152,428          61.5          (20,345 )       (13.3 )
Total
operating
expenses         225,527          97.7         163,722          66.1           61,805          37.7
Operating
loss             (93,444 )       (40.5 )       (11,294 )        (4.6 )         82,150         727.4
Interest and
other income
(expense),
net               11,684           5.0          10,687           4.3              997           9.3
Loss before
income taxes     (81,760 )       (35.4 )          (607 )        (0.3 )         81,153      13,370.0
Income tax
expense              928           0.4             399           0.1              529         132.6
Net loss      $  (82,688 )       (35.8 )%   $   (1,006 )        (0.4 )%   $    81,682       8,119.5  %

Net Revenues. We generate revenues primarily through sales of our IC products, embedded processors and printed circuit board assemblies to OEMs, such as Alcatel-Lucent, Ciena, Cisco, Brocade, Fujitsu, Hitachi, Huawei, Juniper, Ericsson, NEC, Nokia Siemens Networks, and Tellabs, who in turn supply their equipment principally to communications service providers.
On a sell-through basis, we had approximately 78 days of inventory in the distributor channel at March 31, 2013 as compared to 83 days at March 31, 2012. The decrease in inventory days was due to higher distributor sell-through revenues in the fourth quarter of fiscal year 2013 offset by higher overall net inventory in the distributor channel.


The gross margins for our solutions have from time to time, in the past declined. Some factors that has caused downward pressure on the gross margins for our products include competitive pricing pressures, unfavorable product mix, the cost sensitivity of our customers particularly in the higher-volume markets, new product introductions by us or our competitors, and capacity constraints in our supply chain. From time to time, for strategic reasons, we may accept orders at less than optimal gross margins in order to facilitate the introduction of, or, market penetration of our new or existing products. To maintain acceptable operating results, we will need to offset any reduction in gross margins of our products by reducing costs, increasing sales volume, developing and introducing new products and developing new generations and versions of existing products on a timely basis.
We classify our revenues into two categories based on the markets that the underlying products serve. The categories are Computing and Connectivity. We use this information to analyze our performance and success in these markets, including our strategy to focus on the transition to the large growth data center market.
We are continuing to focus our current connectivity investments on high growth 10G, 40G and faster Ethernet solutions, data center, OTN and enterprise market opportunities while continuing to service the Telecom (SONET/SDH) market. Over time, we believe customers will transition from the SONET/SDH standard to higher speed, lower power products that utilize the OTN standard in order to support the increasing demand for transmission of data over networks. However, the timing and extent of this transition is uncertain due to the significant investment that is needed to convert networks to the OTN standard. As such, the rate of conversion to the OTN standard is, in part, greatly influenced by global economic market conditions. Recessionary type market conditions will result in a slower transition of networks to the OTN standard. Additionally, there can be no assurance that our revenues will increase as the OTN standard is adopted. The portion of our business represented by connectivity revenues attributable to our OTN and 10 gigabit or faster Ethernet products and that attributable to our SONET/SDH and Legacy Switch products for the fiscal years ended March 31, 2013, 2012 and 2011 was 74% and 26%, 59% and 41%, and 60% and 40%, respectively. The demand for our products has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:
• the timing, rescheduling or cancellation of significant customer orders and our ability, as well as the ability of our customers, to manage inventory corrections;

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

• our ability to specify, develop or acquire, complete, introduce, and market new products and technologies in a cost effective and timely manner;

• the rate at which our present and future customers and end-users adopt our products and technologies in our target markets;

• general economic and market conditions in the semiconductor industry and communications markets;

• combinations of companies in our customer base, resulting in the combined company choosing our competitor's IC standardization rather than our supported product platforms;

• the gain or loss of one or more key customers, or their key customers, or significant changes in the financial condition of one or more of our key customers or their key customers;

• our expectation of a market ramp for our products could be incorrect and such ramp could get pushed out or not happen at all;

• our ability to meet customer demand due to capacity constraints at our suppliers; and

• natural disasters that could affect our supply chain or our customer's supply chain which would affect their requirements of our products.

For these and other reasons, our net revenue and results of operations for the three fiscal years ended March 31, 2013 may not necessarily be indicative of future net revenue and results of operations.
Based on direct shipments, net revenues to customers that were equal to or greater than 10% of total net revenues were as follows:

                                        2013    2012    2011
Wintec (global logistics provider)       19 %    20 %     - %
Avnet (distributor)                      27 %    20 %    29 %
Flextronics (sub-contract manufacturer)   *      11 %     -
Hon Hai (sub-contract manufacturer)       *       *      14 %


____________________


* Less than 10% of total net revenues for period indicated.

We expect that our largest customers will continue to account for a substantial portion of our net revenue for the foreseeable future. Net revenues by geographic region were as follows (in thousands):

                               Fiscal Years Ended March 31,
                              2013          2012         2011
United States of America* $    79,930    $  99,214    $  81,113
Taiwan                         22,684       20,950       45,489
Hong Kong                      22,044       21,458       24,747
China*                          2,053        4,503        9,030
Europe*                        35,216       41,691       45,714
Japan                          13,237       13,596        9,305
Malaysia*                       4,733        8,276        8,258
Singapore*                     10,399       14,011       11,808
Other Asia                      4,621        5,790        9,394
Other                             725        1,398        2,852
                          $   195,642    $ 230,887    $ 247,710


 ____________________


* Change in revenues was primarily due to shift in customer demand and continuing geographic changes to macro-economic conditions.

Our revenues are primarily denominated in U.S. dollars, other than revenues that account for less than 10% of our total revenues, which are denominated primarily in the Danish Kroner. In April 2013, we completed the sale of our wholly owned Danish subsidiary, TPack A/S - refer to Note 12 to the Notes to the Consolidated Financial Statements for further details.
Research and Development. Total consolidated R&D expenses consist primarily of salaries and related costs (including stock-based compensation) of employees engaged in research, design and development activities including amounts relating to Veloce, costs related to engineering licenses and design tools, subcontracting costs and facilities expenses. We believe that a continued commitment to R&D is vital to our goal of maintaining a leadership position with innovative products. In addition to our internal R&D programs, our business strategy includes acquiring products, technologies or businesses from third parties. We currently expect that future acquisitions of products, technologies or businesses may result in substantial additional on-going R&D costs. Selling, General and Administrative. Selling, general and administrative ("SG&A") expenses consist primarily of personnel related expenses (including stock-based compensation), professional and legal fees, corporate branding and facilities expenses. We currently expect that future acquisitions of products, technologies or businesses may result in substantial additional on-going SG&A costs.
Key non-GAAP measurements. We use certain non-GAAP metrics such as Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") to measure our performance. We define Adjusted EBITDA as net (loss) income, less interest income, income taxes, depreciation and amortization, stock-based compensation, amortization of intangibles and other non-recurring and/or non-cash items.
The following table reconciles Adjusted EBITDA to the accompanying financial statements (in thousands):


                                                     Fiscal Years Ended March 31,
                                                    2013          2012          2011
Net loss                                        $ (134,115 )   $ (82,688 )   $ (1,006 )
Adjustment to net loss:
Interest and other income, net                      (2,540 )      (3,794 )     (5,403 )
Stock-based compensation expense                    24,236        18,374       16,684
Warrant expense                                      1,289             -            -
Amortization of purchased intangibles                4,643         6,754       17,162
Restructuring charges, net                           6,435           875          532
Veloce accrued liability                            66,188        60,400            -
Impairment of marketable securities*                  (412 )        (743 )     (5,284 )
Acquisition related (recoveries)/charges              (133 )      (2,532 )        859
Depreciation and amortization**                     13,542        10,009        8,834
Gain on sale of assets                              (1,299 )           -            -
Impairment (gain) on strategic investments, net      2,250        (7,147 )          -
Impairment of notes receivable and other assets      1,800             -            -
Other and income tax adjustment                       (554 )         938          403
Adjusted EBITDA                                 $  (18,670 )   $     446     $ 32,781


 ____________________


* For non-GAAP purposes, any gain or loss relating to marketable securities is not recognized until the underlying securities are sold and the actual gain or loss is realized.

** For non-GAAP purposes, amortization adjustment is related to certain prepaid software intellectual property licenses.

We believe that Adjusted EBITDA is a useful supplemental measure of our operation's performance because it helps investors evaluate and compare the results of operations from period to period by removing the accounting impact of the company's financing strategies, tax provisions, depreciation and amortization, restructuring charges, stock based compensation expense, Veloce accrued liability and certain other operating items. We adjust for these excluded items because we believe that, in general, these items possess one or more of the following characteristics: their magnitude and timing is largely outside of the company's control; they are unrelated to the ongoing operations of the business in the ordinary course; they are unusual or infrequent and the company does not expect them to occur in the ordinary course of business; or they are non-cash expenses.
Adjusted EBITDA is not a measure determined in accordance with generally accepted accounting principles in the United States, or GAAP, and should not be considered a substitute for operating income, net income or any other measure determined in accordance with GAAP. Adjusted EBITDA should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. Adjusted EBITDA is used by our management as a measure of operating efficiency and overall financial performance for benchmarking against our peers and competitors and is used as a metric to determine the performance vesting of our three-year RSU grants issued in May 2009 (the "EBITDA Grants") and May 2011 (the "EBITDA2 Grants" which are expected to expire unvested when the program concludes in May 2014). Management believes Adjusted EBITDA provides meaningful supplemental information regarding the underlying operating performance of our business. Management also believes that Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors and other interested parties to evaluate the company.
We also assess the performance of our business on a non-GAAP basis, excluding the impact of expenditures relating to our X-Gene product development costs. Non-GAAP net (loss) income is derived by excluding certain items required by GAAP, such as stock-based compensation charges, amortization of purchased intangibles, Veloce acquisition consideration, restructuring charges, impairment of strategic investments, impairment of notes receivable and other assets, other-than-temporary impairment on investments, income taxes, and other one-time and/or non-cash items. In addition, when X-Gene product development related expenditures are excluded from the above, we derive the adjusted Non-GAAP income from our base business ("NGIBB").


The following table reconciles GAAP net loss to the NGIBB (in thousands except for per share data): . . .

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