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AMCC > SEC Filings for AMCC > Form 10-Q on 31-Jul-2014All Recent SEC Filings

Show all filings for APPLIED MICRO CIRCUITS CORP

Form 10-Q for APPLIED MICRO CIRCUITS CORP


31-Jul-2014

Quarterly Report


ITEM 2. 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 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 months ended June 30, 2014 and 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 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 months ended June 30, 2014, 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 by ARM®-based cloud servers and other market and technological trends; our plans and predictions regarding the development, production, performance and market acceptance of our X-Gene™ Server on a Chip™ product family and development platform, our X-Weave™ product family, and other new products; the timing and scope of customer testing and adoption of such products and their total addressable market and total cost of ownership; product development cycles and schedules; design-win pipeline; our strategy, including our focus on the development of our X-Gene and X-Weave product families and our current connectivity investments in highgrowth 10, 40 and 100Gbps (gigabit per second) solutions; the timing and extent of customers' transition away from older connectivity solutions and toward higher performance solutions; our assumptions and forecasts regarding competitors' product offerings, pricing and strategies, and our products' ability to compete; the anticipated amount, form and timing of consideration to be paid in connection with our acquisition of Veloce, 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; our gross margin and efforts to offset reductions in gross margin; our estimates regarding eventual actual costs compared to amounts accrued in our financial statements; factors affecting demand for our products; our ability to attract and retain qualified personnel; our restructuring activities 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 and our business, 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. All forward-looking statements in this report speak only as of the filing date of this report, and except as required by law, we undertake no obligation to update or revise any forward-looking statements to reflect events or circumstances after such date.

OVERVIEW
The Company
Applied Micro Circuits Corporation (the "Company", "we" or "our") is a global leader in silicon solutions for next-generation cloud infrastructure and data centers, as well as connectivity products for edge, metro and long haul communications equipment. Our products include the X-Gene™ ARM® 64-bit Server on a Chip™ solution, or X-Gene. The X-Gene product is targeted to serve existing and emerging hyperscale cloud, high performance computing and enterprise applications. X-Gene began sampling in silicon to current and prospective customers as well as ecosystem partners in March 2013 and we expect to ship production units during the summer of 2014. We expect X-Gene to begin generating meaningful production sales revenue during the second half of our fiscal year 2015.

We believe that X-Gene is the first ARM 64-bit server solution to have sampled and to have production units being manufactured. 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 power and lower total cost of ownership ("TCO").

As part of our current base business, we offer a line of embedded computing products based on Power Architecture. Our future embedded processor products will be based on the ARM Instruction Set Architecture ("ISA"). Our embedded processor products are currently deployed in applications 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.

The connectivity portion of our base business includes a broad array of physical layer ("PHY"), framer and mapper solutions that are high-speed, high-bandwidth, high-reliability communications products. Our highly integrated framer-PHY silicon solutions transmit and receive signals and are used in high-speed optical network infrastructure equipment. For Optical Transport Network ("OTN") applications, our framer products incorporate our industry-leading forward error correction ('FEC") technology to significantly improve reach. 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 includes products spanning 100Gbps to 240Gbps of connectivity with unique multi-protocol features and high density.

Our corporate headquarters are located in Sunnyvale, California. Sales and engineering offices are located throughout the world. As of June 30, 2014, our business had two reporting units, Computing and Connectivity.
Since the start of fiscal 2014, we have invested a total of $179.8 million in the Research and Development ("R&D") of new products, including high-speed, high-bandwidth and low-power products that often combine the functions of multiple existing products into single highly-integrated solutions. A considerable portion of this investment is directed to our ARM 64-bit based server product development. Our products and our customers' products 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, some major products in development during the last few years have not yet started to generate significant revenues. In addition, demand for our products can be impacted by economic downturns, cyclicality in the telecommunications market, competitive and technological developments, and other factors described elsewhere in this report. Acquisition of Veloce
On June 20, 2012, we completed the acquisition of Veloce. Veloce has been developing specific technology for us.

The total estimated consideration to be paid is approximately $178.5 million based on the benchmarks achieved during simulations. The consideration that we are obligated to pay upon completion of the respective performance milestones can be settled in cash or our common stock (or a combination of cash and stock), at our election. During the three months ended June 30, 2014 and 2013, as part of the above arrangement, we paid approximately $6.4 million and $25.0 million, respectively, in cash and issued approximately 38,000 shares and 1.4 million shares, respectively, valued at approximately $0.3 million and $10.0 million, respectively.
For accounting purposes, the costs to be incurred in connection with the development milestones relating to Veloce are considered compensatory and are recognized as R&D expense. Recognition of these costs as expense occurred when certain


development and performance milestones became probable of achievement and were deemed earned. However, the value allocated to Veloce stock equivalents that had not yet been allocated to individuals ("Unallocated Veloce Units") will not be recognized as R&D expense until distribution of the underlying units occurs. As of June 30, 2014, 0.1 million Unallocated Veloce Units remain to be allocated, and the maximum potential additional expense to be recognized associated with these Unallocated Veloce Units is approximately $2.1 million.

Veloce completed all three performance milestones relating to the project as of March 31, 2014. Cumulative R&D expenses recognized in connection with the achievement of the three performance milestones through June 30, 2014 were $176.4 million. Total R&D expenses recognized were approximately $7.1 million and $9.3 million during the three months ended June 30, 2014 and 2013, respectively. Veloce consideration that has been accrued as of June 30, 2014, is classified as long-term if payments of the consideration are expected to occur beyond a 12 month period.
As of June 30, 2014, we had paid $160.8 million of the total Veloce acquisition consideration, and we expect that approximately an additional $1.4 million will be paid in cash and stock by September 30, 2014. The $160.8 million paid to date includes approximately $86.6 million in cash and the issuance of 9.7 million shares of common stock valued at approximately $74.2 million. Summary Financials
The following tables present a summary of our results of operations for the three months ended June 30, 2014 and 2013 (dollars in thousands):

                                         Three Months Ended June 30,
                                        2014                      2013
                                             % of Net                 % of Net      Increase          %
                                Amount       Revenue       Amount      Revenue     (Decrease)       Change
Net revenues                  $  50,272       100.0  %   $ 54,148       100.0 %   $    (3,876 )      (7.2 )%
Cost of revenues                 20,257        40.3        22,342        41.3          (2,085 )      (9.3 )
Gross profit                     30,015        59.7        31,806        58.7          (1,791 )      (5.6 )
Total operating expenses         43,536        86.6        24,556        45.3          18,980        77.3
Operating (loss) income         (13,521 )     (26.9 )       7,250        13.4          20,771      (286.5 )
Interest and other income,
net                                 315         0.6         3,795         7.0          (3,480 )     (91.7 )
(Loss) income before income
taxes                           (13,206 )     (26.3 )      11,045        20.4          24,251      (219.6 )
Income tax expense                 (141 )      (0.3 )         188         0.3            (329 )    (175.0 )
Net (loss) income             $ (13,065 )     (26.0 )%   $ 10,857        20.1 %   $    23,922      (220.3 )%

Net Revenues. We generate revenues primarily through sales of our IC products, embedded processors and printed circuit board assemblies to OEMs, such as Cisco, Huawei, Alcatel-Lucent, Ciena, Fujitsu, Juniper, NEC, Coriant and ZTE, 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 80 days of inventory in the distributor channel at June 30, 2014 as compared to 66 days at June 30, 2013. 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. We may also accept orders for older products at less than optimal gross margins to encourage customers to order sooner or in larger quantities than previously anticipated. 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 Connectivity and Computing. We use the information about these categories to analyze our performance and success in these markets, including our strategy to focus on the transition to the high-growth data center market.


For the three months ended June 30, 2014 and 2013, our OTN and 10Gbps or faster Ethernet products represented 90% and 86%, respectively, of our Connectivity revenues, and our SONET/SDH and legacy switch products represented 10% and 14%, respectively, of our Connectivity revenues. We expect our SONET/SDH and legacy switch products to continue to decline, as Connectivity customers continue to transition to higher speed, lower power products.
Based on direct shipments, net revenues to customers that were equal to or greater than 10% of total net revenues were as follows:

                                         Three Months Ended
                                              June 30,
                                          2014          2013
Avnet (distributor)                        32 %           38 %
Wintec (global logistics provider)**       23 %           18 %
Paltek (distributor)                       16 %            *

* Less than 10% of total net revenues for period indicated. ** Wintec provides vendor managed inventory support primarily for Cisco Systems, Inc. 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 June 30,
                                   2014                    2013
                                       % of Net                % of Net
                            Amount      Revenue     Amount      Revenue
United States of America   $ 19,006       37.8 %   $ 29,161       53.9 %
Taiwan                        1,694        3.3        3,074        5.7
Hong Kong                    10,553       21.0        4,213        7.8
China                           139        0.3          745        1.4
Europe                        5,157       10.3        7,593       14.0
Japan                        10,666       21.2        3,748        6.9
Malaysia                      1,276        2.6        1,244        2.3
Singapore                     1,712        3.4        3,041        5.6
Other Asia                       69        0.1          977        1.8
Other                             -          -          352        0.6
                           $ 50,272      100.0 %   $ 54,148      100.0 %

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.
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 also assess the performance of our business on a non-GAAP basis. Non-GAAP net income (loss) is derived by excluding certain items required by GAAP, such as stock-based compensation charges, amortization of purchased intangibles, Veloce accrued liability, restructuring charges, impairment of marketable securities, income tax effect related to reconciling items, and other one-time and/or non-cash items.


The following table reconciles GAAP net (loss) income to the Non-GAAP net income (in thousands except for per share data):

                                                                Three Months Ended
                                                                     June 30,
                                                                2014          2013
GAAP net (loss) income                                       $ (13,065 )   $ 10,857
Adjustments:
Stock-based compensation expense                                 5,216        3,714
Amortization of purchased intangibles                               62          296
Restructuring charges, net                                       1,211           93
Veloce acquisition consideration                                 7,140        9,255
Impairment of marketable securities                                (18 )     (3,019 )
Gain on sale of TPack                                                -      (19,699 )
Other and income tax adjustment                                   (391 )        (62 )
Total GAAP to Non-GAAP adjustments                              13,220       (9,422 )
Non-GAAP net income                                          $     155     $  1,435

Diluted non-GAAP income per share                            $    0.00     $   0.02

Shares used in calculating diluted non-GAAP income per share    79,082       70,234

The book-to-bill ratio is another metric commonly used by investors to compare and evaluate technology and semiconductor companies. The book-to-bill ratio is a demand-to-supply ratio that compares the total amount of orders received to the total amount of orders filled. This ratio tells whether the company has more orders than it delivered (if greater than 1), has the same amount of orders that it delivered (equals 1), or has less orders than it delivered (under 1). Though the ratio provides an indicator of whether orders are rising or falling, it does not consider the timing of orders or if the orders will result in future revenues and the effect of changing lead times on bookings. In addition, orders within any given period can fluctuate for a variety of reasons such as product phase-out decisions, which can cause customers to place final, non-recurring "last time buy" orders for the "end of life" product, or other agreements with customers to accelerate, delay, increase or decrease orders in a given period. Our quarterly book-to-bill ratio at June 30, 2014, March 31, 2014 and June 30, 2013 was 0.9, 1.0 and 1.1 respectively.

CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in accordance with GAAP in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. See Note 1, Summary of Significant Accounting Policies, to the Condensed Consolidated Financial Statements for details. The methods, estimates and judgments we use in applying these critical accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, The actual results experienced by us may differ materially and adversely from management's estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our Condensed Consolidated Financial Statements.
Investments
We hold a variety of securities that have varied underlying investments. We review our investment portfolio periodically to assess for other-than-temporary impairment. We assess the existence of impairment of our investments in order to determine the classification of the impairment as "temporary" or "other-than-temporary". The factors used to determine whether an impairment is temporary or other-than-temporary involve considerable judgment. The factors considered in determining whether any individual impairment is temporary or other-than-temporary are primarily the length of the time and the extent to


which the market value has been less than amortized cost, the nature of underlying assets (including the degree of collateralization) and the financial condition, credit rating, market liquidity conditions and near-term prospects of the issuer. If the fair value of a security is less than its amortized cost basis at the balance sheet date, an assessment would have to be made as to whether the impairment is other-than-temporary. If we do not intend to sell the security, we shall consider available evidence to assess whether it is more likely than not, we will be required to sell the security before the recovery of the amortized cost basis due to cash, working capital requirements, contractual or regulatory obligations indicate that the security will be required to be sold before a forecasted recovery occurs. If it is more likely than not that we are required to sell the security before recovery of the amortized cost basis, an other-than-temporary impairment is considered to have occurred. We use present value cash flow models to determine whether the entire amortized cost basis of the security will be recovered. We will compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. An other-than-temporary impairment is said to have occurred if the present value of cash flows expected to be collected is less than the amortized cost basis of the security. During the three months ended June 30, 2014 and 2013, we did not record any other-than-temporary impairment charges. During the three months ended June 30, 2014, we did not record an impairment charge in connection with other securities in a continuous loss position (fair value less than carrying value) with unrealized losses of $0.1 million as we believe that such unrealized losses are temporary. In addition, we had $3.8 million in unrealized gains during the three months ended June 30, 2014. Veloce Consideration
We periodically evaluated the progress of the development work that was being performed in connection with our contractual arrangement with Veloce. Based on such an evaluation as well as various other qualitative factors, we estimated the total value of the development work being performed and assessed the timing and probability of attaining contractually defined performance milestones.

Upon assessing a performance milestone as probable of achievement, R&D expense was recognized based upon the estimated stage of development of that milestone and the estimated value associated with each performance milestone. The amount of R&D costs recognized in connection with the Veloce consideration excludes any value relating to the Unallocated Veloce Units. As of June 30, 2014, the maximum potential additional expense to be recognized associated with the Unallocated Veloce Units was approximately $2.1 million. Payment of the Veloce consideration occurs based upon when a performance milestone is completed and upon satisfaction of vesting requirements, if applicable. As of March 31, 2014, Veloce completed all three performance milestones.

The total estimated consideration based on the benchmarks achieved during simulations is approximately $178.5 million of which approximately $176.4 million has been recognized through June 30, 2014. Total R&D expenses recognized were approximately $7.1 million and $9.3 million during the three months ended June 30, 2014 and 2013, respectively. See Note 4, "Veloce", to the Condensed Consolidated Financial Statements.
Inventory Valuation
Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess or obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future demand for its products within a specified time horizon, generally 12 months. The estimates used for future demand are also used for near-term . . .

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