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AMCC > SEC Filings for AMCC > Form 10-Q on 5-Nov-2013All Recent SEC Filings




Quarterly Report


This management's discussion and analysis of financial condition and results of operations ("MD&A") is provided as a supplement to the accompanying Condensed 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 quarterly 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 and six months ended September 30, 2013 and 2012. 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.

The MD&A should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and notes thereto included in this quarterly report. All statements included or incorporated by reference in this quarterly report, for the three and six months ended September 30, 2013, other than statements or characterizations of historical fact, are forward-looking statements. Any statement that refers to an expectation, projection or other characterization of future events or circumstances, including the underlying assumptions, is a forward-looking statement. We use certain words and their derivatives such as "anticipate", "believe", "plan", "expect", "estimate", "predict", "intend", "may", "will", "should", "could", "future", "potential", and similar expressions in many of the forward-looking statements.
These forward-looking statements include, but are not limited to, statements regarding: anticipated trends and challenges in our business and the markets in which we operate; expectations regarding the growth of next-generation cloud infrastructure and global data center traffic, energy consumption and total cost of ownership, anticipated market penetration for ARM-based cloud servers; the timing, anticipated features and benefits of, and our plans and strategy for, our X-Gene Server on a Chip products and development platform; our belief that our license for the ARM v8 will allow us to introduce new products into high growth markets where a combination of low power and high computational abilities are important; our strategy, including our focus on the development of products associated with our X-Gene architecture and our current connectivity investments in high growth 10G, 40G, 100G solutions while continuing to service the OTN and SONET/SDH market; the anticipated amount, form and timing of consideration to be paid in connection with our acquisition of Veloce, including our assessment of the timing and probability of achievement of milestones under the Veloce merger agreement, and related impact on our share dilution, research and development expense and operating results; our sales and marketing strategy; our expectations regarding adequacy of leased facilities; the impact of seasonal fluctuations and economic conditions on our business; our intellectual property; our expectations as to expenses, liquidity and capital resources, including without limitation our expected sources and uses of cash and substantial need for additional financing; our gross margin and how we may try to offset reductions in gross margin; factors affecting demand for our products; our ability to attract and retain qualified personnel; our restructuring program and related expense; and the impact of accounting pronouncements and our critical accounting policies, judgments, estimates and assumptions on our financial results.
The forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs, and other assumptions made by us. In addition, the forward-looking statements included below are based upon statements made by industry experts, analysts, and other third party sources. These statements and the expectations, estimates, projections, beliefs and other assumptions on which they are based are subject to many risks and uncertainties and are inherently subject to change. We describe many of the risks and uncertainties that we face in Part II, Item 1A, "Risk Factors" and elsewhere in this report. Our actual results and actual events could differ materially from those anticipated in any forward-looking statement. Readers should not place undue reliance on any forward-looking statement.


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. In July 2013, we announced the X-Weave family of products, designed to meet the needs of public cloud, private cloud and enterprise data centers. The X-Weave family of products spans 100Gbps to 240 Gbps of connectivity with unique multi protocol features and high density.
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 September 30, 2013, our business had two reporting units, Computing and Connectivity. Since the start of fiscal 2013, we have invested a total of $278.5 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.
Acquisition of Veloce
On June 20, 2012 (the "Closing Date"), we completed the acquisition of Veloce pursuant to the terms of the Agreement and Plan of Merger, (the "Merger Agreement"). Veloce has been developing specific technology for us. The terms of the Merger Agreement include the payment of the total consideration, 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 three and six months ended September 30, 2013, as part of the above arrangement, we paid approximately $19.2 million and $44.2 million, respectively, in cash and issued approximately 2.3 million shares and 3.7 million shares, respectively, valued at approximately $19.0 million and $29.0 million, respectively. During the three and six months ended September 30, 2012, as part of the above arrangement, we paid approximately $2.1 million and $14.8 million, respectively, in cash and issued approximately 0.2 million shares and 2.6 million shares, respectively, valued at approximately $1.1 million and $14.8 million, respectively.
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 $135.0 million to the contractual maximum of $178.5 million. The consideration that we will be obligated to pay, will be payable upon completion of the respective performance milestones and can be settled in cash or our common stock (or a combination of cash and stock), at our election.
We have treated the Veloce merger as a "reorganization" under Section 368 of the Internal Revenue Code in our and Veloce's tax returns. We believe that the requirements to qualify as a reorganization under the Code will be met. 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 September 30, 2013, 0.8 million Unallocated Veloce Units had not been allocated, and the maximum potential additional expense to be recognized associated with these Unallocated Veloce Units is approximately $9.4 million.

We periodically evaluate the progress of the development work that is being performed in connection with our contractual arrangement with Veloce. Based on such an evaluation as well as various other qualitative factors, we estimate the total value of the development work being performed and assess the timing and probability of attaining contractually defined performance milestones. We have completed the first and second performance milestones and assessed the third and final performance milestone relating to the Veloce project as probable of achievement as of September 30, 2013.
Cumulative R&D expenses recognized in connection with the achievement of the first, second and third and final performance milestone through September 30, 2013 is $166.3 million. Total R&D expenses recognized were approximately $30.4 million and $39.7 million during the three and six months ended September 30, 2013, respectively and approximately $2.3 million and $4.6 million during the three and six months ended September 30, 2012, respectively. The Veloce accrued liability included on the Condensed 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 September 30, 2013, is classified as long-term if payments of the consideration are expected to occur beyond a 12 month period.
As of September 30, 2013, $106.4 million has been paid and we expect that approximately an additional $51.9 million will be paid in cash and stock by March 31, 2014. The $106.4 million paid to date includes approximately $60.8 million in cash and the issuance of 6.7 million shares of common stock valued at approximately $45.6 million.
Summary Financials
The following tables present a summary of our results of operations for the three and six months ended September 30, 2013 and 2012 (dollars in thousands):

                                          Three Months Ended September 30,
                                           2013                       2012
                                                % of Net                   % of Net      Increase         %
                                   Amount       Revenue       Amount       Revenue      (Decrease)      Change
Net revenues                     $  55,387       100.0  %   $  46,324       100.0  %   $    9,063        19.6  %
Cost of revenues                    21,397        38.6         20,561        44.4             836         4.1
Gross profit                        33,990        61.4         25,763        55.6           8,227        31.9
Total operating expenses            66,757       120.5         48,515       104.7          18,242        37.6
Operating loss                     (32,767 )     (59.2 )      (22,752 )     (49.1 )       (10,015 )     (44.0 )
Interest and other income, net         576         1.0            835         1.8            (259 )     (31.0 )
Loss before income taxes           (32,191 )     (58.1 )      (21,917 )     (47.3 )       (10,274 )     (46.9 )
Income tax expense (benefit)           192         0.3           (360 )      (0.8 )           552      (153.3 )
Net loss                         $ (32,383 )     (58.5 )%   $ (21,557 )     (46.5 )%   $  (10,826 )     (50.2 )%

                                           Six Months Ended September 30,
                                           2013                       2012
                                                % of Net                   % of Net      Increase         %
                                   Amount       Revenue       Amount       Revenue      (Decrease)      Change
Net revenues                     $ 109,535       100.0  %   $  87,618       100.0  %   $   21,917        25.0  %
Cost of revenues                    43,739        39.9         38,916        44.4           4,823        12.4
Gross profit                        65,796        60.1         48,702        55.6          17,094        35.1
Total operating expenses            91,313        83.4         96,406       110.0          (5,093 )      (5.3 )
Operating loss                     (25,517 )     (23.3 )      (47,704 )     (54.4 )       (22,187 )     (46.5 )
Interest and other income, net       4,371         4.0          2,597         3.0           1,774        68.3
Loss before income taxes           (21,146 )     (19.3 )      (45,107 )     (51.5 )       (23,961 )     (53.1 )
Income tax expense (benefit)           380         0.3           (160 )      (0.2 )           540      (337.5 )
Net loss                         $ (21,526 )     (19.7 )%   $ (44,947 )     (51.3 )%   $  (23,421 )     (52.1 )%

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, excluding non-cancelable non-returnable inventory we had approximately 57 days of inventory in the distributor channel at September 30, 2013 as compared to 46 days at September 30, 2012. The increase in inventory days was primarily due to the timing of sell-through of distributor inventory.
The gross margins for our solutions have declined from time to time in the past. Factors that have caused downward pressure on 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 initial orders at less than optimal gross margins in order to facilitate the introduction and/or market penetration of our new or existing products. To maintain acceptable operating results, we seek to offset any reduction in gross margins of our products by reducing operating 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 high 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 is attributable to our SONET/SDH and Legacy Switch products was 80% and 20%, and 83% and 17% for the three and six months ended September 30, 2013, respectively and 77% and 23%, and 76% and 24% for the three and six months ended September 30, 2012, 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 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, performance, 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 products 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;

• the failure of a market ramp for our products to develop when and to the extent expected;

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

• natural disasters or other events affecting our supply chain or our customers' supply chain, thus affecting their requirements for our products.

For these and other reasons, our net revenue and results of operations for the three and six months ended September 30, 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 (in thousands):

                                            Three Months Ended        Six Months Ended
                                               September 30,            September 30,
                                             2013          2012       2013         2012
Avnet (distributor)                           21 %           28 %      29 %          28 %
Wintec (global logistics provider)            22 %           20 %      20 %          19 %
Arrow (distributor)                           10 %            *         *             *
Flextronics (sub-contract manufacturer)        *             12 %       *            11 %

* Less than 10% of total net revenues.

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, which are primarily denominated in U.S. dollars, were as follows (in thousands):

                                     Three Months Ended September 30,                             Six Months Ended
                                       2013                       2012                     2013                      2012
                                             % of Net                 % of Net                  % of Net                 % of Net
                                Amount        Revenue      Amount      Revenue      Amount       Revenue      Amount      Revenue
United States of America*   $   24,336          44.0 %   $ 17,283        37.3 %   $  53,497        48.9 %   $ 33,428        38.1 %
Taiwan                           3,012           5.4        4,965        10.7         6,086         5.6       10,066        11.5
Hong Kong                        5,466           9.9        6,189        13.4         9,679         8.8       11,918        13.6
China*                           1,696           3.1        1,056         2.3         2,441         2.2        1,589         1.8
Europe*                         11,363          20.5        9,832        21.2        18,956        17.3       16,790        19.2
Japan                            5,336           9.6        1,829         3.9         9,084         8.3        4,038         4.6
Malaysia                         1,649           3.0        1,401         3.0         2,893         2.6        2,345         2.7
Singapore                        2,397           4.3        2,659         5.7         5,438         5.0        5,062         5.8
Other Asia                         127           0.2        1,024         2.2         1,104         1.0        1,928         2.2
Other                                5             -           86         0.3           357         0.3          454         0.5
                            $   55,387         100.0 %   $ 46,324       100.0 %   $ 109,535       100.0 %   $ 87,618       100.0 %

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

Research and Development. Research and Development ("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 income
(loss) less interest income, income taxes, depreciation and amortization, stock-based compensation, amortization of intangibles and other one-time and/or non-cash items. The following table reconciles Adjusted EBITDA to the accompanying financial statements (in thousands):

                                                      Three Months Ended           Six Months Ended
                                                         September 30,               September 30,
                                                      2013          2012          2013          2012
Net loss                                           $ (32,383 )   $ (21,557 )   $ (21,526 )   $ (44,947 )
Adjustments to net loss:
Interest and other expense (income), net                 364          (661 )        (412 )      (1,334 )
Stock-based compensation expense                       3,834         7,634         7,548        15,323
Warrant expense                                            -             -             -         1,289
Amortization of purchased intangibles                     62         1,280           358         2,609
Restructuring charges, net                               999             -         1,092             -
Veloce accrued liability                              30,484         2,325        39,739         4,650
Impairment of marketable securities*                    (940 )        (174 )      (3,959 )      (1,263 )
Depreciation and amortization                          3,635         3,550         7,266         6,355
. . .
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