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LSI > SEC Filings for LSI > Form 10-K on 26-Feb-2014All Recent SEC Filings

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Form 10-K for LSI CORP


26-Feb-2014

Annual Report


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

This management's discussion and analysis should be read in conjunction with the other sections of this Form 10-K, including Part 1, Item 1- "Business"; Part I, Item 1A- "Risk Factors"; Part II, Item 6- "Selected Financial Data"; and

Part II, Item 8- "Financial Statements and Supplementary Data."

Where more than one significant factor contributed to changes in results from year to year, we have quantified these factors throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where practicable and material to understanding the discussion.

OVERVIEW

We design, develop and market complex, high-performance storage and networking semiconductors. We offer a broad portfolio of capabilities including custom and standard product integrated circuits that are used in hard disk drives, solid state drives, high-speed communications systems, computer servers, storage systems and personal computers. We deliver our products to our customers as stand-alone integrated circuits as well as incorporated onto circuit boards that offer additional functionality. We also license our intellectual property to other entities.

On December 15, 2013, we entered into a definitive agreement with Avago Technologies Limited, or Avago, and certain of its subsidiaries under which Avago will acquire LSI for $11.15 per share in an all-cash transaction valued at approximately $6.6 billion. The merger is expected to close in the first half of 2014, subject to regulatory approvals in various jurisdictions and satisfaction of customary closing conditions, as well as the approval of our stockholders.

Sixteen purported class action complaints have been filed by alleged stockholders of LSI against us, our individual directors, and, in fifteen of the cases, against Avago. These actions generally allege that the members of our board of directors breached their fiduciary duties in connection with the merger because the merger was not in the best interest of the company, the merger consideration is unfair, and certain other terms of the merger agreement are unfair. Among other remedies, the lawsuits seek to enjoin the merger, or in the event that an injunction is not entered and the merger closes, to rescind the merger or obtain unspecified money damages, costs and attorneys' fees. We and our board of directors believe these claims are entirely without merit, and intend to vigorously defend these actions.

Our results of operations for 2013, 2012 and 2011 were as follows:

                                          Year Ended December 31,                     Year Ended December 31,
                                     2013           2012          Change         2012           2011          Change
                                                    (Dollars in millions, except per share amounts)
Revenues                           $ 2,370.2      $ 2,506.1      $ (135.9 )    $ 2,506.1      $ 2,044.0      $  462.1
Gross profit margin as a
percentage of revenues                  51.1 %         49.2 %         1.9 %         49.2 %         47.1 %         2.1 %
Net income                         $   124.7      $   196.2      $  (71.5 )    $   196.2      $   331.5      $ (135.3 )
Net income per diluted share       $    0.22      $    0.34      $  (0.12 )    $    0.34      $    0.55      $  (0.21 )

On January 3, 2012, we acquired SandForce, Inc., a provider of flash storage processors for enterprise and client flash solutions and solid state drives, for total consideration of approximately $346.4 million, net of cash acquired.

On May 6, 2011, we sold our external storage systems business to NetApp, Inc. for $480.0 million in cash. That business sold external storage systems, primarily to original equipment manufacturers, or OEMs, who resold these products to end customers under their own brand name. We have reported the results of that business as discontinued operations in our statements of operations. Our net income in 2011 included a gain from that sale of $260.1 million or $0.43 per diluted share.

We derive the majority of our revenues from sales of products for the hard disk and solid state drive, server and networking equipment end markets, and our revenues depend on market demand for these types of products. We believe that these markets offer us attractive opportunities because of the growing demand to create, store, manage and move digital content efficiently. Our products are sold primarily to OEMs in the storage, server and networking industries. We also sell some of our products through a network of resellers and distributors. The


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markets in which we operate are highly competitive and our revenues depend on our ability to compete successfully. We face competition not only from makers of products similar to ours, but also from competing technologies.

Our board of directors authorized a stock repurchase program of up to $500.0 million on August 1, 2012. During 2013, we repurchased 22.8 million shares for $163.5 million under this program. As of December 31, 2013, $315.1 million remained available for stock repurchases. During 2013, we declared and paid cash dividends of $0.06 per common share, or $32.8 million in total, on our outstanding common stock. In connection with the merger agreement entered into with Avago, we have discontinued share repurchases and our quarterly dividend.

We ended 2013 with cash and cash equivalents, together with short-term investments, of $809.8 million, compared to $676.0 million at the end of 2012.

In early 2012, our sales of semiconductors for hard disk drives benefited as the hard disk drive industry recovered from the impact of flooding that occurred in Thailand in late 2011. Sales of desktop and notebook computers declined in 2013 compared to 2012, and we expect the year over year decline in personal computer sales to continue in the near term, affecting sales of hard disk and solid state drives and our revenues from semiconductors for hard disk and solid state drives. We also believe that global economic conditions remain uncertain resulting in reduced spending on information technology products in general, which is also affecting our revenues.

We are working to manage our operating expenses while at the same time continuing work on products under development. We are focusing our research and development operations on products that we believe provide favorable growth opportunities for our business. We are also working to expand our sales of products in newer areas such as flash memory-based server adapter cards, where we are working directly with large, Internet-based datacenter operators, in addition to our more traditional customer base of OEMs and distributors.

RESULTS OF OPERATIONS

Revenues

Year Ended Year Ended December 31, $ % December 31, $ % 2013 2012 Change Change 2012 2011 Change Change

(Dollars in millions)

Revenues $ 2,370.2 $ 2,506.1 $ (135.9 ) (5.4 )% $ 2,506.1 $ 2,044.0 $ 462.1 22.6 %

The decrease in revenues in 2013 as compared to 2012 reflected lower unit sales of semiconductors used in hard disk drives and our older networking products in 2013. Revenues in 2012 reflected temporarily higher unit sales of semiconductors used in hard disk drives as a result of the recovery from the Thailand flooding. These decreases were partially offset by increased unit sales from the ramping of flash memory-based storage products and a $19.7 million increase in intellectual property licensing revenues in 2013.

The increase in revenues in 2012 as compared to 2011 was driven by higher unit sales of semiconductors used in storage applications and the ramping of new products to existing customers. Sales of semiconductors used in hard disk drives benefited in 2012 as a result of the recovery from the Thailand flooding. The increase also reflects $159.7 million of revenues from flash storage processors as a result of the acquisition of SandForce. These increases were offset in part by a decrease in unit sales of legacy networking products.

Significant Customers:

The following table provides information about sales to Seagate Technology, which was our only customer that accounted for 10% or more of our revenues in each of 2013, 2012 and 2011:

Year Ended December 31, 2013 2012 2011 Percentage of revenues 25 % 31 % 25 %


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Revenues by Geography:

The following table summarizes our revenues by geography based on the ordering
location of the customer. Because we sell our products primarily to other
sellers of technology products and not to end users, the information in the
table below may not accurately reflect geographic end-user demand for our
products.



                                     Year Ended                                              Year Ended
                                    December 31,              $             %               December 31,              $            %
                                 2013          2012         Change       Change          2012          2011        Change       Change
                                                                        (Dollars in millions)
North America*                 $   622.0     $   635.9     $  (13.9 )       (2.2 )%    $   635.9     $   520.2     $ 115.7         22.2 %
Asia:
China (including Hong Kong)        643.8         788.1                                     788.1         569.7
Singapore                          265.0         306.0                                     306.0         256.8
Taiwan                             287.6         290.3                                     290.3         272.1
Other                              346.0         300.7                                     300.7         224.9

Total Asia                       1,542.4       1,685.1       (142.7 )       (8.5 )%      1,685.1       1,323.5       361.6         27.3 %
Europe and the Middle East         205.8         185.1         20.7         11.2 %         185.1         200.3       (15.2 )       (7.6 )%

Total                          $ 2,370.2     $ 2,506.1     $ (135.9 )       (5.4 )%    $ 2,506.1     $ 2,044.0     $ 462.1         22.6 %

* Primarily the United States.

The decrease in revenues in North America in 2013 as compared to 2012 primarily resulted from lower unit sales of semiconductors used in storage products in 2013. The decrease was partially offset by an increase in intellectual property licensing revenues in 2013. The decrease in revenues in Asia in 2013 as compared to 2012 was primarily attributable to lower unit sales of semiconductors used in hard disk drives in 2013 as compared to 2012, when sales of those products temporarily benefited from the recovery from the flooding in Thailand. The increase in revenues in Europe and the Middle East in 2013 as compared to 2012 was primarily due to an increase in networking product sales as a result of the ramping of new networking products with existing customers.

The increases in revenues in both Asia and North America in 2012 as compared to 2011 were primarily attributable to higher unit sales of semiconductors used in storage applications and the ramping of new products to existing customers. Sales of semiconductors used in hard disk drives benefited in 2012 as a result of the recovery from the flooding in Thailand. The increases were also due to higher unit sales of flash storage processors as a result of the acquisition of SandForce. The increases were offset in part by a decrease in unit sales of legacy networking products. The decrease in revenues in Europe and the Middle East in 2012 as compared to 2011 was primarily attributable to a decrease in unit sales of legacy networking products.

Revenues by Product Groups:

The following table presents our revenues by product groups:



                                    Year Ended                                              Year Ended
                                   December 31,              $             %               December 31,              $            %
                                2013          2012         Change       Change          2012          2011        Change       Change
                                                                       (Dollars in millions)
Storage products              $ 1,846.7     $ 1,994.4     $ (147.7 )       (7.4 )%    $ 1,994.4     $ 1,487.1     $ 507.3         34.1 %
Networking products               398.4         407.2         (8.8 )       (2.2 )%        407.2         453.7       (46.5 )      (10.2 )%
Other                             125.1         104.5         20.6         19.7 %         104.5         103.2         1.3          1.3 %

Total                         $ 2,370.2     $ 2,506.1     $ (135.9 )       (5.4 )%    $ 2,506.1     $ 2,044.0     $ 462.1         22.6 %

The decrease in revenues from storage products in 2013 as compared to 2012 was attributable to lower unit sales of semiconductors used in hard disk drives in 2013 as compared to 2012, when sales of those products


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temporarily benefited from the recovery from the flooding in Thailand. The decrease was partially offset by increased unit sales from the ramping of flash memory-based storage products in 2013. The increase in revenues from storage products in 2012 as compared to 2011 was primarily attributable to higher unit sales of semiconductors used in hard disk drives, as a result of the recovery from the Thailand flooding, and an increase in sales of new products to existing customers. The increase was also the result of higher unit sales of flash storage processors due to the acquisition of SandForce.

The decrease in revenues from networking products in 2013 as compared to 2012 was primarily the result of lower unit sales of semiconductors used in our older networking products, offset in part by increased sales from the ramping of new products with existing customers. The decrease in revenues from networking products in 2012 as compared to 2011 was primarily the result of lower unit sales of semiconductors used in older networking products.

Other revenues consist primarily of fees from the licensing of our intellectual property. The increase in other revenues in 2013 as compared to 2012 primarily resulted from higher intellectual property licensing revenues in 2013.

Gross Profit Margin

Year Ended December 31,
Dollar Amount Percentage of Revenues
2013 2012 2011 2013 2012 2011
(Dollar in millions)

Gross profit margin $ 1,212.3 $ 1,231.9 $ 962.5 51.1 % 49.2 % 47.1 %

Various factors affect and may continue to affect our product gross margin. These factors include, but are not limited to, changes in our production mix and volume of product sales, the timing of production ramps and the margin structures of new products, the positions of our products in their life cycles, the effects of competition, the price of commodities used in our products, provisions for excess and obsolete inventories, changes in the costs charged by foundry, assembly and test subcontractors, and amortization of acquired intangible assets.

Gross profit margin as a percentage of revenues increased by 1.9% in 2013 as compared to 2012. The increase was primarily attributable to continued improvement in operational efficiencies. The increase was offset in part by decreased revenues with a similar level of fixed costs.

Gross profit margin as a percentage of revenues increased by 2.1% in 2012 as compared to 2011. The increase was primarily attributable to increased revenues from higher margin products and higher revenues enabling better absorption of fixed costs. The increases were offset in part by a 0.6% adverse effect on gross profit margin resulting from fair valuing inventories acquired from SandForce.

Research and Development



                                   Year Ended                                           Year Ended
                                  December 31,             $            %              December 31,             $           %
                               2013         2012         Change       Change        2012         2011        Change      Change
                                                                    (Dollars in millions)
Research and development      $ 692.4      $ 690.3      $    2.1          0.3 %    $ 690.3      $ 576.0      $ 114.3        19.8 %
Percentage of revenues           29.2 %       27.5 %                                  27.5 %       28.2 %

R&D expense consists primarily of employee salaries, contractor expenses and materials used in product development, costs related to third-party design tools and materials used in the design of custom silicon and standard products, as well as depreciation of capital equipment and facilities-related expenditures. In addition to the significant resources we devote to hardware development, we also devote resources to the development of software for our products.

The increase in R&D expense in 2013 as compared to 2012 was primarily attributable to higher compensation-related expenses resulting from headcount additions to support product development efforts, offset in part by lower costs for shared development engineering projects due to higher funding from customers.


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The increase in R&D expense in 2012 as compared to 2011 was primarily attributable to higher compensation-related expense resulting from headcount additions associated with the acquisition of SandForce and headcount additions to support our ongoing product development efforts, higher performance-based compensation expense as a result of improved financial performance and increased spending to support new design wins.

Selling, General and Administrative



                                    Year Ended                                           Year Ended
                                   December 31,             $            %              December 31,             $           %
                                2013         2012        Change       Change         2012         2011        Change      Change
                                                                     (Dollars in millions)
Selling, general and
administrative                 $ 343.4      $ 354.9      $ (11.5 )       (3.2 )%    $ 354.9      $ 295.4      $  59.5        20.1 %
Percentage of revenues            14.5 %       14.2 %                                  14.2 %       14.5 %

SG&A expense consists primarily of compensation related expenditures for sales, marketing and administrative employees, costs related to third party services, depreciation and facilities-related expenditures.

The decrease in SG&A expense in 2013 as compared to 2012 was primarily attributable to lower compensation-related expenses and decreases in general and administrative expenses as a result of our continuing focus on control of expenses.

The increase in SG&A expense in 2012 as compared to 2011 was primarily attributable to higher compensation-related expense resulting from headcount additions associated with the acquisition of SandForce and headcount additions to support revenue growth, along with higher performance-based compensation expense as a result of improved financial performance.

Restructuring of Operations and Other Items, net

Restructuring:

In 2013, 2012 and 2011, we initiated restructuring plans designed to focus our business on targeted end markets and to improve operational efficiency and financial results. These plans primarily involved the termination of employees and consolidation of facilities. The restructuring charges recorded in conjunction with these plans primarily represented severance and costs related to the continuation of certain employee benefits, exit costs for facility consolidations and closures, research and development program cancellations, and asset impairment charges.

The following table summarizes items included in restructuring expenses:

                                                Year Ended December 31,
                                            2013          2012          2011
                                                     (In millions)
         Leases                            $  3.6 (a)    $ 10.3 (a)    $  6.2 (a)
         Employee severance and benefits     19.4           8.2          11.3
         Other exit costs                       -           4.5 (b)      (1.0 )(c)

         Total                             $ 23.0        $ 23.0        $ 16.5

(a) Includes lease obligation costs and related changes in estimates, changes in time value and other ongoing expenditures. The 2012 amount includes $6.2 million related to our former headquarters.

(b) Consists of a $2.7 million loss on the sale of property in the U.S. and $1.8 million of other asset impairment and exit costs.

(c) Includes a $6.4 million gain on the sale of property in the U.S., substantially offset by a $5.5 million write-off of intellectual property in connection with the restructuring actions.


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Other Items:

We recorded net charges of $29.4 million and $26.1 million for other items during 2013 and 2012, respectively, primarily for litigation settlements and acquisition-related costs. We recorded a net charge of $7.2 million for other items during 2011, primarily for transition service agreement costs associated with the sale of the external storage systems business, offset by a reversal of a sales and use tax related liability.

Interest Income and Other, net

The following table summarizes components of interest income and other, net:



                             Year Ended                                         Year Ended
                            December 31,            $            %             December 31,            $            %
                          2013        2012       Change       Change         2012        2011       Change       Change
                                                              (Dollars in millions)
Interest income          $  3.8      $  6.6      $  (2.8 )      (42.4 )%    $  6.6      $ 11.1      $  (4.5 )      (40.5 )%
Other income, net           9.9        31.1        (21.2 )      (68.2 )%      31.1        15.4         15.7        101.9 %

Total                    $ 13.7      $ 37.7      $ (24.0 )      (63.7 )%    $ 37.7      $ 26.5      $  11.2         42.3 %

The decrease in interest income in 2013 as compared to 2012 primarily resulted from lower returns on investments in 2013 as compared to 2012. The decrease in interest income in 2012 as compared to 2011 primarily resulted from the absence of interest income in 2012 on a note we received in connection with the sale of a business in 2007 and lower interest rates in 2012 than in 2011.

Other income, net, in 2013 primarily included $6.1 million of insurance proceeds we received for covered losses related to the 2011 Thailand flooding. We do not expect any further insurance recoveries related to the Thailand flooding. Other income, net in 2012 primarily included $10.8 million of insurance proceeds we received for covered losses from the 2011 Thailand flooding, $6.4 million of income for services provided under the transition service agreements associated with the sale of the external storage systems business, a $5.8 million gain as a result of re-measuring our pre-acquisition equity interest in SandForce to estimated fair value, and a $2.6 million gain on sale of non-marketable securities. Other income, net in 2011 primarily included $13.6 million of income for services provided under the transition service agreements associated with the sale of the external storage systems business.

Income Taxes

During 2013, we recorded an income tax provision of $13.1 million, which represents an effective tax rate of approximately 9.5% on our income before income taxes of $137.8 million. This rate differs from the U.S. statutory rate primarily because we have a full valuation allowance recorded against the U.S. deferred tax assets and lower tax rates in foreign jurisdictions. The income tax provision in 2013 also included a reversal of $23.3 million of liabilities for uncertain tax positions, which included previously unrecognized tax benefits of $13.5 million and interest and penalties of $9.8 million, as a result of the expiration of statutes of limitations in multiple jurisdictions.

In December 2013, we entered into an Advance Pricing Agreement, or APA, with the Internal Revenue Service, or IRS, in connection with the valuation of intellectual property in conjunction with a cost sharing arrangement. This APA has resulted in an intercompany recognition of prepaid U.S. income in the current year. We have utilized our available net operating losses to offset this income. The use of net operating losses has resulted in a reduction of deferred tax assets and a corresponding reduction in the valuation allowance of $252.4 million and had no impact on the effective tax rate.

Management continues to monitor the realizability of our deferred tax assets. Historically, we have sustained losses from our U.S. operations and, as a result, have maintained a full valuation allowance against U.S. net deferred tax assets. We do not believe there is sufficient positive evidence to reach a conclusion that it is


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more likely than not that we will generate sufficient future taxable income in the U.S. to realize the benefits of our deferred tax assets. Depending on future results and projected trends, it is reasonably possible that we may determine in the foreseeable future that it is more likely than not that a significant portion of our U.S. deferred tax assets will be realized, resulting in a release of a significant portion of the valuation allowance.

The American Taxpayers Relief Act of 2012 was signed into law on January 2, 2013. The act retroactively extended research credits for a two year period from January 1, 2012 through December 31, 2013. The provisions of the act did not have a material impact on our effective tax rate.

On September 13, 2013, the IRS and Treasury Department released final regulations related to the timing of deductibility of expenditures related to tangible property. These regulations apply to tax years beginning on or after January 1, 2014. We are currently assessing the impact of these regulations and do not expect that the application of these rules will have a material impact on our results of operations.

During 2012, we recorded an income tax benefit of $21.0 million, which represents an effective tax rate of approximately (12.0)% on our income before income taxes of $175.3 million. This rate differs from the U.S. statutory rate . . .

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