ITEM 1B.
UNRESOLVED STAFF COMMENTS
Not applicable.
Our principal executive offices as well as our principal research, development, sales, marketing, and administrative functions are located in our 70,000 square foot facility in Santa Clara, California and an adjacent 64,000 square foot facility. In New York, we lease approximately 15,000 square feet used for research and development. Our Asia/Pacific headquarters are located in Hong Kong where we lease approximately 23,000 square feet of space. We also maintain approximately 22,000 square feet of office space in Taiwan, approximately 14,000 square feet of office space in China, approximately 6,000 square feet of office space in Japan, approximately 10,000 square feet of office space in Korea, and less than 1,000 square feet of office space in Switzerland. We have satellite sales support offices in Finland, Singapore, Thailand, and Texas.
None.
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information on Common Stock
Our common stock has been listed on the Nasdaq Global Select Market (formerly on the Nasdaq National Market) under the symbol “SYNA” since January 29, 2002. Prior to that time, there was no public market for our common stock. The following table sets forth for the periods indicated the high and low sales prices of our common stock as quoted on the Nasdaq Global Select Market.
Stockholders
As of August 10, 2011, there were approximately 200 holders of record of our common stock.
Dividends
We have never declared or paid cash dividends on our common stock. We currently plan to retain any earnings to finance the growth of our business, or purchase shares under our common stock purchase program rather than to pay cash dividends. Payments of any cash dividends in the future will depend on our financial condition, results of operations, and capital requirements as well as other factors deemed relevant by our board of directors.
Our revolving line of credit also places restrictions on the payment of any dividends.
Issuer Purchases of Equity Securities
From April 2005 through April 2010, our Board of Directors has cumulatively authorized $420.0 million for our common stock repurchase program, which expires in April 2012. The remaining amount authorized for the repurchase of our common stock is $67.9 million. Repurchases under the stock repurchase program during the three-month period ended June 25, 2011 were as follows:
Performance Graph
The following line graph compares cumulative total stockholder returns for the five years ended fiscal 2011 for (i) our common stock, (ii) the Nasdaq Composite Index, and (iii) the Nasdaq Computer Index. The graph assumes an investment of $100 on June 25, 2006. The calculations of cumulative stockholder return on the Nasdaq Composite Index and the Nasdaq Computer Index include reinvestment of dividends. The calculation of cumulative stockholder return on our common stock does not include reinvestment of dividends because we did not pay any dividends during the measurement period. The historical performance shown is not necessarily indicative of future performance.
The performance graph above shall not be deemed “filed” for purposes of Section 18 of the Securities Act or the Exchange Act, or otherwise subject to the liability of that section. The performance graph above will not be deemed incorporated by reference into any filing of our company under the Exchange Act or the Securities Act.
The following presents selected financial data for each fiscal year in the five-year period ended fiscal 2011. Our fiscal year is the 52- or 53-week period ending on the last Saturday in June. Fiscal 2007 was a 53-week period and the other fiscal years presented were 52-week periods. As our past operating results are not necessarily indicative of our future operating results, you should read the selected financial data below in conjunction with Item 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements and Factors That May Affect Results
You should read the following discussion and analysis in conjunction with our financial statements and related notes contained elsewhere in this report. This discussion contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under Item 1A. Risk Factors.
Overview
We are a leading worldwide developer and supplier of custom-designed human interface solutions that enable people to interact more easily and intuitively with a wide variety of mobile computing, communications, entertainment, and other electronic devices. We believe our results to date reflect the combination of our customer focus, the strength of our intellectual property, and our engineering know-how, which allow us to develop or engineer products that meet the demanding design specifications of OEMs.
We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred or title has transferred, the price is fixed or determinable, and collection is reasonably assured. Our net revenue increased from $266.8 million for fiscal 2007 to $598.5 million for fiscal 2011, representing a compound annual growth rate of approximately 22%. For fiscal 2007, we derived 85% of our net revenue from the personal computer market and 15% of our net revenue from the digital lifestyle product markets. For fiscal 2011, revenue from the personal computer market accounted for 48% of our net revenue and revenue from the digital lifestyle product markets accounted for 52% of our net revenue.
Many of our customers have migrated their manufacturing operations from Taiwan to China, and many of our OEM customers have established design centers in that region. With our expanded global presence, including offices in China, Finland, Hong Kong, Japan, Korea, Switzerland, Taiwan, and the United States, we are well positioned to provide local sales, operational, and engineering support services to our existing customers, as well as potential new customers, on a global basis.
Our manufacturing operations are based on a variable cost model in which we outsource all of our production requirements and generally drop ship our products directly to our customers from our contract manufacturers’ facilities, eliminating the need for significant capital expenditures and allowing us to minimize our investment in inventories. This approach requires us to work closely with our contract manufacturers to ensure adequate production capacity to meet our forecasted volume requirements. We provide our contract manufacturers with six-month rolling forecasts and issue purchase orders based on our anticipated requirements for the next 90 days. However, we do not have any long-term supply contracts with any of our contract manufacturers. We use three third-party wafer manufacturers to supply wafers and two third-party packaging manufacturers to package our proprietary ASICs. In certain cases, we rely on a single source or a limited number of suppliers to provide other key components of our products. Our cost of revenue includes all costs associated with the production of our products, including materials, logistics, manufacturing, assembly, and test costs paid to third-party manufacturers and related overhead costs associated with our indirect manufacturing operations personnel. Additionally, we charge all warranty costs, yield losses, and any inventory provisions or write-downs to cost of revenue.
Our gross margin generally reflects the combination of the added value we bring to our OEM customers’ products in meeting their custom design requirements and the impact of our ongoing cost-improvement programs. These cost-improvement programs include reducing materials and component costs and implementing design and process improvements. Our newly introduced products may have lower margins than our more mature products, which have realized greater benefits associated with our ongoing cost-improvement programs. As a result, new product introductions may initially negatively impact our gross margin.
Our research and development expenses include costs for supplies and materials related to product development, as well as the engineering costs incurred to design human interface solutions for OEM customers prior to and after their commitment to incorporate those solutions into their products. These expenses have generally increased, reflecting our continuing commitment to the technological and design innovation required to maintain our position in our existing markets and to adapt our existing technologies or develop new technologies for new markets.
Selling, general, and administrative expenses include expenses related to sales, marketing, and administrative personnel; internal sales and outside sales representatives’ commissions; market and usability research; outside legal, accounting, and consulting costs; and other marketing and sales activities. These expenses have generally increased, primarily reflecting incremental staffing and related support costs associated with our increased business levels, growth in our existing markets, and penetration into new markets.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements in conformity with GAAP requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, cost of revenue, inventories, product warranty, share-based compensation costs, provision for income taxes, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, goodwill, intangible assets, investments, and contingencies. We base our estimates on historical experience, applicable laws, and regulations, and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The methods, estimates, interpretations, and judgments we use in applying our most critical accounting policies can have a significant impact on the results that we report in our consolidated financial statements. The SEC considers an entity’s most critical accounting policies to be those policies that are both most important to the portrayal of the entity’s financial condition and results of operations and those that require the entity’s most difficult, subjective, or complex judgments, often as a result of the need to make assumptions and estimates about matters that are inherently uncertain. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred or title has transferred, the price is fixed or determinable, and collection is reasonably assured, which is generally upon shipment. We accrue for estimated sales returns and other allowances, based on historical experience, at the time we recognize revenue.
Investments
Accounting standards require us to record available-for-sale securities at fair value, with unrealized gains and losses being reported as a component of other comprehensive income. We follow the accounting standards to assess whether our investments with loss positions are other-than-temporarily impaired. We follow the hierarchal approach established under the accounting standards to determine fair value of our investments.
The accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Our fair value estimates consider, among other factors, the collateral underlying the security investments, creditworthiness of the counterparty, timing of expected future cash flows, and, in the case of ARS investments, the probability of a successful auction in a future period. We follow the guidance provided to estimate fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability, and to determine circumstances that may indicate that a transaction is not orderly.
Further, we use judgment in evaluating whether a decline in fair value is temporary or other-than-temporary and consider the following indicators: changes in credit ratings or asset quality; changes in the economic environment; length of time and extent to which fair value has been below cost basis; changes in market conditions; and changes in expected cash flows. We do not intend to sell the investments and it is more likely than not that we will not be required to sell the investments before recovery of their amortized cost basis. Temporary declines in fair value are recorded as charges to accumulated other comprehensive income in the equity section of our balance sheet, while other-than-temporary declines in fair value are bifurcated between credit losses, which are charged to earnings, and noncredit losses, which depending on facts and circumstances may be charged to other comprehensive income or earnings.
Inventory
We state our inventories at the lower of cost or market. We base our assessment of the ultimate realization of inventories on our projections of future demand and market conditions. Sudden declines in demand, rapid product improvements, or technological changes, or any combination of these factors can cause us to have excess or obsolete inventories. On an ongoing basis, we review for estimated obsolete or unmarketable inventories and write down our inventories to their net realizable value based upon our forecasts of future demand and market conditions. If actual market conditions are less favorable than our forecasts, additional inventory write-downs may be required. The following factors influence our estimates: changes to or cancellations of customer orders, unexpected decline in demand, rapid product improvements and technological advances, and termination or changes by our OEM customers of any product offerings incorporating our product solutions.
Periodically, we purchase inventory from our contract manufacturers when a customer delays its delivery schedule or cancels its order. In those circumstances in which our customer has cancelled its order and we purchase inventory from our contract manufacturers, we consider a write-down to reduce the carrying value of the inventory purchased to its net realizable value. We charge write-downs to reduce the carrying value of obsolete, slow moving, and non-usable inventory to net realizable value to cost of revenue. The effect of these write-downs is to establish a new cost basis in the related inventory, which we do not subsequently write up.
Share-Based Compensation Costs
We account for employee share-based compensation costs in accordance with relevant accounting standards. We utilize the Black-Scholes option pricing model to estimate the grant date fair value of employee share-based compensatory awards, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical and implied volatilities were used in estimating the fair value of our share-based awards. The expected life for our options was previously estimated based on historical trends since our initial public offering. In fiscal 2011, we began to grant options with a contractual life of seven years rather than ten years and now use the simplified method of establishing the expected life as we do not have any history of options with seven-year lives. Estimated forfeitures for share-based awards that are not expected to vest are estimated based on historical trends since our initial public offering. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. We charge the estimated fair value less estimated forfeitures to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years for our stock options and DSUs and up to two years for our employee stock purchase plan.
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. As our stock option and our employee stock purchase plan awards have characteristics that differ significantly from traded options, and as changes in the subjective assumptions can materially affect the estimated value, our estimate of fair value may not accurately represent the value assigned by a third party in an arms-length transaction. There currently is no market-based mechanism to verify the reliability and accuracy of the estimates derived from the Black-Scholes option pricing model or other allowable valuation models, nor is there a means to compare and adjust the estimates to actual values. While our estimate of fair value and the associated charge to earnings materially affects our results of operations, it has no impact on our cash position.
There are significant variations among allowable valuation models, and there is a possibility that we may adopt a different valuation model or refine the inputs and assumptions under our current valuation model in the future, resulting in a lack of consistency in future periods. Our current or future valuation model and the inputs and assumptions we make may also lack comparability to other companies that use different models, inputs, or assumptions, and the resulting differences in comparability could be material.
Income Taxes
We recognize federal, foreign, and state current tax liabilities or assets based on our estimate of taxes payable or refundable in the then current fiscal year for each tax jurisdiction. We also recognize federal, foreign, and state deferred tax liabilities or assets for our estimate of future tax effects attributable to temporary differences and carryforwards and record a valuation allowance to reduce any deferred tax assets by the amount of any tax benefits that, based on available evidence and our judgment, are not expected to be realized. If our assumptions, and consequently our estimates, change in the future, the valuation allowance we have established for our deferred tax assets may be changed, which could impact income tax expense.
We use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement with a taxing authority. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of highly complex tax laws. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our consolidated financial position, result of operations, or cash flows. We believe we have adequately provided for reasonably foreseeable outcomes in connection with the resolution of income tax uncertainties. However, our results have in the past, and could in the future, include favorable and unfavorable adjustments to our estimated tax liabilities in the period a determination of such estimated tax liability is made or resolved, upon the filing of an amended return, upon a change in facts, circumstances, or interpretation, or upon the expiration of a statute of limitation. Accordingly, our effective tax rate could fluctuate materially from period to period.
We consider the operating earnings of our foreign subsidiaries to be indefinitely invested outside the United States. Accordingly, no provision has been made for the U.S. federal, state, or foreign taxes that may result from future remittances of undistributed earnings of our foreign subsidiaries.
We recognize tax benefit upon expensing certain share-based awards associated with our share-based compensation plans, including nonqualified stock options and DSUs, but we cannot recognize tax benefit concurrent with the recognition of share-based compensation expenses associated with qualified stock options (incentive stock options and employee stock purchase plan shares). For qualified stock options that vested after we began to expense share-based compensation, we recognize tax benefit only in the period when disqualifying dispositions of the underlying stock occur, which historically has been up to several years after vesting and in a period when our stock price substantially increases. For qualified stock options that vested prior to when we began to expense share-based compensation, we record the tax benefit directly to additional paid-in capital. Accordingly, because we cannot recognize the tax benefit for share-based compensation expense associated with qualified stock options until the occurrence of future disqualifying dispositions of the underlying stock and such disqualified dispositions may happen in periods when our stock price substantially increases, and because a portion of that tax benefit may be directly recorded to additional paid-in capital, our future quarterly and annual effective tax rates will be subject to greater volatility and, consequently, our ability to estimate reasonably our future quarterly and annual effective tax rates is greatly diminished.
Results of Operations
The following sets forth certain of our consolidated statements of income data for fiscal 2011, 2010, and 2009, along with comparative information regarding the absolute and percentage changes in these amounts (in thousands, except percentages):
The following sets forth certain of our consolidated statements of income data as a percentage of revenues for fiscal 2011, 2010, and 2009:
Fiscal 2011 compared with fiscal 2010
Net Revenue.
Net revenue was $598.5 million for fiscal 2011 compared with $514.9 million for fiscal 2010, an increase of $83.6 million, or 16.2%. Of our fiscal 2011 net revenue, $289.4 million, or 48.3%, of net revenue was from the personal computing market and $309.1 million, or 51.7%, of net revenue was from the digital lifestyle product markets, including $304.5 million from mobile smartphones and feature phones. The increase in net revenue for fiscal 2011 was attributable to a $100.0 million, or 47.8%, increase in net revenue from digital lifestyle product applications, partially offset by a decline of $16.4 million, or 5.4%, in net revenue from PC applications due to the weakness in the consumer notebook computer market. The overall increase in net revenue was primarily attributable to a 68.4% increase in unit shipments of digital lifestyle products reflecting higher market penetration of our products in these markets, partially offset by an 8.2% decline in unit shipments in the personal computing market as well as lower priced product mix in the digital lifestyle product markets, general competitive pricing pressure, and a $27.1 million decline in portable digital entertainment device revenue.
Based on industry estimates of unit shipments, the notebook computer market is anticipated to increase approximately 7% and the mobile smartphone market is anticipated to increase approximately 55% from calendar 2010 to 2011.
Gross Margin.
Gross margin as a percentage of net revenue was 41.1%, or $246.1 million, for fiscal 2011 compared with 40.5%, or $208.7 million, for fiscal 2010. As each custom-designed module we sell utilizes our capacitive sensing technology in a design that is generally unique or specific to an OEM customer’s application, gross margin varies on a product-by-product basis, making our cumulative gross margin a blend of our product specific designs and independent of the vertical markets that our products serve. As a virtual manufacturer, our gross margin percentage is generally not impacted materially by our shipment volume. We charge write-downs to reduce the carrying value of obsolete, slow moving, and non-usable inventory to net realizable value, including warranty costs, to cost of revenue.
Operating Expenses.
Research and Development Expenses. Research and development expenses increased as a percentage of net revenue to 17.5% from 16.8%, and the cost of research and development activities increased $18.5 million, or 21.3%, to $105.0 million in fiscal 2011 compared with $86.6 million in fiscal 2010. The increase in research and development expenses primarily reflected a $9.3 million increase in employee compensation and employment related costs, resulting from a 19.8% increase in research and development staffing, annual compensation adjustments, a $4.1 million increase in infrastructure and support costs for the additional staffing, a $3.7 million increase in temporary services, and a $1.1 million increase in project specific costs.
Selling, General, and Administrative Expenses. Selling, general, and administrative expenses decreased slightly as a percentage of net revenue to 11.5% from 11.7%, and the cost of selling, general, and administrative activities increased $8.5 million, or 14.2%, to $68.5 million in fiscal 2011 compared with $60.0 million in fiscal 2010. The increase in selling, general, and administrative expenses primarily reflected a $3.5 million increase in employee compensation and employment related costs resulting from a 10.9% increase in selling, general, and administrative staffing and annual compensation adjustments; $2.7 million of non-recurring executive officer resignation costs; a $1.1 million increase in travel and entertainment costs; and a $728,000 increase in professional fees.
Operating Income.
We generated operating income of $72.5 million, or 12.1% of net revenue, for fiscal 2011, an increase of $10.4 million compared with $62.1 million, or 12.1% of net revenue, for fiscal 2010. As discussed in the preceding paragraphs, the increase in operating income was primarily attributable to an increase in net revenue and gross profit, partially offset by a $27.0 million increase in our operating expenses.
Non-Operating Income/(Loss).
Interest Income. Interest income was $911,000 for fiscal 2011 compared with $977,000 for fiscal 2010. The decrease in interest income resulted from lower average interest rates, partially offset by higher average invested cash balances.
Interest Expense. Interest expense was $17,000 and $2.4 million for fiscal 2011 and 2010, respectively. The reduction in interest expense resulted from the settlement of all but $2.3 million of our convertible notes in December 2009.
Impairment of Investments. In fiscal 2010, a portion of our ARS investments were converted to auction rate preferred stock. Accordingly, we wrote down the remaining value based on our fair value analysis and taking into account the period of time the fair value has been less than our cost. For fiscal 2011, we recognized a gain of $59,000 on the redemption of $3.2 million of our ARS investments and for fiscal 2010 we reduced the carrying value of our ARS investments by $443,000 through an other-than-temporary impairment charge to income.
Provision for Income Taxes.
The provision for income taxes was $9.7 million and $7.3 million for fiscal 2011 and 2010, respectively. The income tax provision represented estimated federal, state, and foreign taxes for fiscal 2011 and 2010. The effective tax rate for fiscal 2011 was approximately 13.2% and diverged from the combined federal and state statutory rate, primarily as a result of an increase in profits in lower tax rate jurisdictions, the release of unrecognized tax benefits, and benefit of research tax credits, partially offset by the foreign withholding taxes and net unrecognized tax benefits associated with qualified stock options. The effective tax rate for fiscal 2010 was approximately 12.1% and diverged from the combined federal and state statutory rate, primarily as a result of an increase in profits in lower tax rate jurisdictions, the recognition of tax benefit on the carryback of a prior year net operating loss of $1.8 million, the release of unrecognized tax benefits, and the benefit of research tax credits, partially offset by foreign withholding taxes, a write-down of state deferred tax assets, and net unrecognized tax benefits associated with qualified stock options.
Tax benefit associated with total share-based compensation was approximately $9.7 million and $9.6 million for fiscal 2011 and 2010, respectively. Excluding the impact of share-based compensation and the related tax benefit, the effective tax rate for fiscal 2011 and 2010 would have been 18.1% and 17.7%, respectively.
In May 2011, we were notified by the IRS that our fiscal 2003 through 2006 and fiscal 2008 through 2010 will be subject to an audit. The early periods are being audited in connection with the mandatory Joint Committee Review for a refund in excess of $2.0 million when we carried back our fiscal 2008 net operating loss. The audit is ongoing, and no tax assessment has been proposed.
Fiscal 2010 compared with fiscal 2009
Net Revenue.
Net revenue was $514.9 million for fiscal 2010 compared with $473.3 million for fiscal 2009, an increase of $41.6 million, or 8.8%. Of our fiscal 2010 net revenue, $305.7 million, or 59.4%, of net revenue was from the personal computing market and $209.2 million, or 40.6%, of net revenue was from the digital lifestyle product markets, including $177.4 million from mobile smartphones and feature phones. The increase in net revenue for fiscal 2010 was attributable to a $36.2 million, or 13.4%, increase in net revenue from PC applications, and a $5.4 million, or 2.7%, increase in net revenue from digital lifestyle product applications. The overall increase in net revenue was primarily attributable to a 26.1% increase in unit shipments reflecting higher market penetration of our products in the personal computing and digital lifestyle markets, partially offset by lower priced product mix, general competitive pricing pressure, a decline in portable digital entertainment device revenue, and a reduced attach rate of our multimedia control solutions in notebook computers.
Gross Margin.
Gross margin as a percentage of net revenue was 40.5%, or $208.7 million, for fiscal 2010 compared with 40.5%, or $191.5 million, for fiscal 2009. As each custom-designed module we sell utilizes our capacitive sensing technology in a design that is generally unique or specific to an OEM customer’s application, gross margin varies on a product-by-product basis, making our cumulative gross margin a blend of our product specific designs and independent of the vertical markets that our products serve. As a virtual manufacturer, our gross margin percentage is generally not impacted materially by our shipment volume. We charge write-downs to reduce the carrying value of obsolete, slow moving, and non-usable inventory to net realizable value, including warranty costs, to cost of revenue.
Operating Expenses.
Research and Development Expenses. Research and development expenses increased as a percentage of net revenue to 16.8% from 14.4%, and the cost of research and development activities increased $18.5 million, or 27.2%, to $86.6 million in fiscal 2010 compared with $68.0 million in fiscal 2009. The increase in research and development expenses primarily reflected a $9.1 million increase in employee compensation and employment related costs, resulting from a 16.1% increase in research and development staffing, increased base compensation related to our annual performance review process, a $5.4 million increase in share-based compensation costs due to a $1.5 million cumulative correction to share-based compensation expense in research and development (see note 8 in the notes to consolidated financial statements) as well as grants made during the year, and a $2.1 million increase in facility related costs to support the increased headcount.
Selling, General, and Administrative Expenses. Selling, general, and administrative expenses increased as a percentage of net revenue to 11.7% from 11.4%, and the cost of selling, general, and administrative activities increased $6.0 million, or 11.1%, to $60.0 million in fiscal 2010 compared with $54.0 million in fiscal 2009. The increase in selling, general, and administrative expenses primarily reflected a $4.9 million increase in share-based compensation costs due to a $2.7 million cumulative correction to share-based compensation expense in selling, general, and administrative expenses as well as grants made during the year, and a $2.4 million increase in employee compensation and employment related costs resulting from a 14.1% increase in selling, general, and administrative staffing and increased base compensation related to our annual performance review process, partially offset by a $1.5 million decrease in legal fees related to patent litigation settled in fiscal 2009.
Operating Income.
We generated operating income of $62.1 million, or 12.1% of net revenue, for fiscal 2010, a decrease of $7.4 million compared with $69.5 million, or 14.7% of net revenue, for fiscal 2009. As discussed in the preceding paragraphs, the decrease in operating income was primarily attributable to a $24.5 million increase in our operating expenses, partially offset by an increase operating leverage resulting from the 8.8% increase in net revenue.
Non-Operating Income/(Loss).
Interest Income. Interest income was $1.0 million for fiscal 2010 compared with $3.2 million for fiscal 2009. The $2.2 million decrease in interest income resulted from lower average interest rates, partially offset by higher average invested cash balances.
Interest Expense. Interest expense was $2.4 million and $7.1 million for fiscal 2010 and 2009, respectively, and consisted primarily of interest expense, and amortization of debt discount and debt issuance costs related to our convertible senior subordinated notes issued in December 2004. The decline in interest expense primarily reflected the retirement of $63.0 million in principal amount of our convertible notes in December 2009.
Impairment of Investments. A portion of our ARS investments were converted to auction rate preferred stock, and we have seen a decline in the credit ratings for certain of our ARS investments. Accordingly, based on our fair value analysis and taking into account the period of time the fair value has been less than our cost, we reduced the carrying value of our ARS investments by $443,000 and $9.2 million for fiscal 2010 and 2009, respectively, through an other-than-temporary impairment charge to income.
Provision for Income Taxes.
The provision for income taxes for each of fiscal 2010 and 2009 was approximately $7.3 million. The income tax provision represented estimated federal, state, and foreign taxes for fiscal 2010 and 2009. The effective tax rate for fiscal 2010 was approximately 12.1% and diverged from the combined federal and state statutory rate, primarily as a result of an increase in profits in lower tax rate jurisdictions, the recognition of tax benefit on the carryback of a prior year net operating loss of $1.8 million, the release of unrecognized tax benefits, and the benefit of research tax credits, partially offset by foreign withholding taxes, a write-down of state deferred tax assets, and net unrecognized tax benefits associated with qualified stock options. The effective tax rate for fiscal 2009 was approximately 13.1% and diverged from the combined federal and state statutory rate primarily as a result of an increase in profits in lower tax rate jurisdictions, the incremental research credits associated with stock option activity, the extension of the federal research credit, and tax-exempt interest income, partially offset by the impact of accounting for share-based compensation and foreign withholding taxes.
Tax benefit associated with total share-based compensation was approximately $9.6 million and $8.0 million for fiscal 2010 and 2009, respectively. Excluding the impact of share-based compensation and the related tax benefit, the effective tax rate for fiscal 2010 and 2009 would have been 17.7% and 19.1%, respectively.
Quarterly Results of Operations
The following table sets forth our unaudited quarterly results of operations for the eight quarters in the two-year period ended fiscal 2011. You should read the following table in conjunction with the financial statements and related notes contained elsewhere in this report. We have prepared this unaudited information on the same basis as our audited financial statements. This table includes all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our financial position and operating results for the quarters presented. Past operating results are not necessarily indicative of future operating performance; accordingly, you should not draw any conclusions about our future results from the results of operations for any quarter presented.
Liquidity and Capital Resources
Our cash and cash equivalents, which exclude ARS investments, were $247.2 million as of the end of fiscal 2011 compared with $209.9 million as of the end of fiscal 2010, an increase of $37.3 million. This increase primarily reflected $89.7 million provided from operating cash flows, $26.4 million from the issuance of common stock under our share-based compensation plans, partially offset by $70.2 million used to repurchase shares of our common stock and $11.6 million used for purchase of capital assets. We consider earnings of our foreign subsidiaries indefinitely invested overseas and have made no provision for income or withholding taxes that may result from a future repatriation of those earnings. As of June 2011, $215.7 million of cash and cash equivalents was held by our foreign subsidiaries. If these funds are needed for our operations in the United States, we would be required to accrue and pay U.S. taxes to repatriate these funds.
Cash Flows from Operating Activities. For fiscal 2011, the net cash provided by operating activities of $89.7 million was primarily attributable to net income of $63.8 million plus adjustments for non-cash charges, including share-based compensation costs of $33.9 million, depreciation and deferred taxes aggregating $7.5 million, and a net decrease in operating assets and liabilities of $14.3 million. The net decrease in operating assets and liabilities related primarily to a decrease in accounts payable of $20.7 million and an increase in inventory of $10.2 million. Our days sales outstanding decreased slightly from 63 to 59 days from fiscal 2010 to fiscal 2011 and our inventory turns decreased from 19 to 11 days for the same period. For fiscal 2010, the net cash provided by operating activities of $114.0 million was primarily attributable to net income of $53.0 million plus adjustments for non-cash charges, including share-based compensation costs of $35.4 million and depreciation, deferred taxes, amortization of debt issuance costs and debt discount, and impairment of investments, aggregating $4.7 million, and a net increase in operating assets and liabilities of $20.9 million. The net increase in operating assets and liabilities related primarily to an increase in accounts payable of $33.4 million, partially offset by an increase in accounts receivable, net of $16.8 million. Our days sales outstanding decreased slightly from 66 to 63 days from fiscal 2009 to fiscal 2010 and our inventory turns increased from 18 to 19 days for the same period. For fiscal 2009, the net cash provided by operating activities of $81.6 million was primarily attributable to net income of $48.1 million plus adjustments for non-cash charges, including share-based compensation costs of $24.4 million and impairment of investments, depreciation, amortization of debt issuance costs and debt discount, deferred taxes and early retirement of debt aggregating $9.1 million. Our days sales outstanding increased slightly from 64 to 66 days from fiscal 2008 to fiscal 2009 and our inventory turns increased from 11 to 18 days for the same period.
Cash Flows from Investing Activities. Our investing activities typically relate to purchases of government-backed securities and investment-grade fixed income instruments and purchases of capital assets. Investing activities used net cash of $8.4 million for fiscal 2011, generated net cash of $15.6 million for fiscal 2010, and generated net cash of $22.9 million for fiscal 2009. Net cash used in investing activities for fiscal 2011 consisted of $3.2 million in redemptions of ARS investments, partially offset by $11.6 million used for the purchase of capital assets. Net cash provided by investing activities for fiscal 2010 consisted of proceeds from sales and maturities of $28.9 million for short-term investments and $1.8 million in redemptions of ARS investments, partially offset by $9.1 million used for the purchase of capital assets and $6.0 million used for the purchase of short-term investments. Net cash provided by investing activities for fiscal 2009 consisted of proceeds from sales and maturities of $52.3 million for short-term investments and $4.9 million in redemptions of ARS investments, partially offset by $25.0 million used for the purchase of short-term investments and $9.3 million used for the purchase of capital assets.
Cash Flows from Financing Activities. Net cash used in financing activities for fiscal 2011, 2010, and 2009 was $44.0 million, $88.8 million, and $31.7 million, respectively. Our net cash used in financing activities for fiscal 2011 was primarily attributable to $70.2 million to repurchase shares of our common stock in the open market and $3.1 million used for the payment of payroll taxes for DSUs, partially offset by $26.4 million of proceeds from common stock issued under share-based compensation plans and $2.9 million excess tax benefit from share-based compensation. Our net cash used in financing activities for fiscal 2010 was primarily attributable to $63.0 million for the retirement of debt and $44.5 million for the purchase of our common stock in the open market and $2.4 million used for the payment of payroll taxes for DSUs, partially offset by $14.0 million of proceeds from common stock issued under share-based compensation plans and $7.1 million from excess tax benefit from share-based compensation. Our net cash used in financing activities for fiscal 2009 was primarily attributable to $55.7 million for the early retirement of debt and $1.8 million used for the payment of payroll taxes for DSUs, partially offset by $16.4 million in proceeds from common stock issued under our share-based compensation plans and $9.4 million of excess tax benefit from share-based compensation.
Common Stock Purchase Program. In April 2010, our Board of Directors approved an additional $100.0 million for the stock repurchase program, expiring in April 2012, bringing the cumulative authorization to $420.0 million. The program authorizes us to purchase our common stock in the open market or in privately negotiated transactions, depending upon market conditions and other factors. The number of shares purchased and the timing of purchases is based on the level of our cash balances, general business and market conditions, and other factors, including alternative investment opportunities. Common stock purchased under this program is held as treasury stock. From April 2005 through the end of fiscal 2011, we purchased 13,366,476 shares of our common stock in the open market for an aggregate cost of $352.1 million. Treasury shares purchased prior to August 28, 2008 were not subject to the stock split on that date, if adjusted for the stock split the average cost would be $19.66. As of the end of fiscal 2011, we had $67.9 million remaining under our common stock purchase program.
Bank Credit Facility. We currently maintain a $50.0 million working capital line of credit with Wells Fargo Bank. The Wells Fargo Bank revolving line of credit, which expires on September 1, 2012, provides for an interest rate equal to the prime lending rate or 250 basis points above LIBOR, depending on whether we choose a variable or fixed rate, respectively. We did not borrow any amounts under the line of credit during and subsequent to the fiscal year.
$250 Million Shelf Registration. We have registered an aggregate of $250.0 million of securities for issuance to raise funds for general corporate purposes, which may include the repayment of indebtedness outstanding from time to time, working capital, capital expenditures, acquisitions, and repurchases of our common stock or other securities. Securities issued under the shelf registration generally will be freely tradeable after their issuance unless held by an affiliate of our company, in which case such shares will be subject to the volume and manner of sale restrictions of Rule 144.
$100 Million Shelf Registration. We have registered an aggregate of $100.0 million of common stock and preferred stock for issuance in connection with acquisitions, which shares generally will be freely tradeable after their issuance under Rule 145 of the Securities Act unless held by an affiliate of the acquired company, in which case such shares will be subject to the volume and manner of sale restrictions of Rule 144.
Liquidity and Capital Resources. We believe our existing cash and cash equivalents and anticipated cash flows from operating activities will be sufficient to meet our working capital and other cash requirements over the course of at least the next 12 months. Our future capital requirements will depend on many factors, including our revenue, the timing and extent of spending to support product development efforts, costs related to protecting our intellectual property, the expansion of sales and marketing activities, the timing of introductions of new products and enhancements to existing products, the costs to ensure access to adequate manufacturing capacity, our common stock purchase program, and the amount and timing of our investments in, or acquisitions of, other technologies or companies. Further equity or debt financing may not be available to us on acceptable terms or at all. If sufficient funds are not available or are not available on acceptable terms, our ability to take advantage of unexpected business opportunities or to respond to competitive pressures could be limited or severely constrained.
Our non-current investments consist of ARS investments, which have failed to settle in auctions. These failures generally resulted in the interest rates resetting from LIBOR plus 50 basis points to LIBOR plus 150 basis points on the regularly scheduled auction dates. These investments are not liquid, and in the event we need to access these funds, we will not be able to do so without a loss of principal, unless a future auction on these investments is successful.
Based on our ability to access our cash and cash equivalents, our expected operating cash flows, and our other sources of cash, we do not anticipate the lack of liquidity on these investments will affect our ability to operate our business as usual.
Contractual Obligations and Commercial Commitments
The following table sets forth a summary of our material contractual obligations and commercial commitments as of the end of fiscal 2011 (in millions):
(1)
Represents both principal and interest payable through the maturity date of the underlying contractual obligation.
(2)
Purchase obligations and other commitments include payments due under a long-term services agreement and inventory purchase obligations with contract manufacturers.
The amounts in the table above exclude unrecognized tax benefits of $20.2 million. As of the end of fiscal 2011, we were unable to make a reasonably reliable estimate of when cash settlement with a taxing authority may occur in connection with our gross unrecognized tax benefits.
Off-Balance Sheet Arrangements
We do not have any transactions, arrangements, or other relationships with unconsolidated entities that are reasonably likely to materially affect our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, or capital resources. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity, or market or credit risk support; engage in leasing, hedging, or research and development services; or have other relationships that expose us to liability that is not reflected in the financial statements.
Recently Issued Accounting Pronouncements
In June 2011, the Financial Accounting Standards Board, or FASB, issued new guidance on the presentation of comprehensive income. This new guidance requires the components of net income and other comprehensive income to be either presented in one continuous statement, referred to as the statement of comprehensive income, or in two separate but consecutive statements. This new guidance eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. This new guidance is effective for our fiscal 2013. As this guidance only amends the presentation of the components of comprehensive income, the adoption will not have an impact on our consolidated financial position, results of operations, or cash flows.
In April 2011, the FASB issued new guidance to achieve common fair value measurement and disclosure requirements between U.S. GAAP and International Financial Reporting Standards. This new guidance, which is effective for our fiscal 2013, amends current U.S. GAAP fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. We do not expect that the adoption will have a material impact on our consolidated financial position, results of operations, or cash flows.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest rate risk
Our exposure to market risk for changes in interest rates relates primarily to our cash and cash equivalents, and ARS investments. We do not use our investment portfolio for trading or other speculative purposes.
The table below presents principal amounts and related weighted average interest rates by year of maturity for our cash equivalents, investments, and debt obligations as of the end of fiscal 2011 (in thousands, except average interest rates):
Our Convertible Senior Subordinated Notes bear a fixed coupon interest rate of 0.75% and mature in December 2024. The noteholders could require us to repurchase their notes on December 1, 2014, December 1, 2019, or in the event of a fundamental change as described in the indenture governing the notes. The early repayment of the notes is not reflected in the preceding schedule.
Our non-current investments, which consist of ARS investments, have a par value of $37.5 million and have failed to settle in auctions beginning in 2007. These investments are not liquid, and in the event we need to access these funds, we will not be able to do so without a loss of principal, unless redeemed by the issuers or a future auction on these investments is successful. During fiscal 2011, $3.2 million of our ARS investments were redeemed at par and we recognized a gain of $59,000 on the redemption of these investments, which is included in impairment of investments, net on the accompanying consolidated statements of income.
As there are currently no active markets for our various failed ARS investments, we have estimated the fair value of these investments as of the end of fiscal 2011 using a trinomial discounted cash flow analysis. The analysis considered, among other factors:
•
the collateral underlying the security investments;
•
creditworthiness of the counterparty;
•
timing of expected future cash flows;
•
the probability of a successful auction in a future period;
•
the underlying structure of each investment;
•
the present value of future principal and interest payments discounted at rates considered to reflect current market conditions;
•
consideration of the probabilities of default, passing a future auction, or redemption at par for each period; and
•
estimates of the recovery rates in the event of default for each investment.
When possible, our failed ARS investments were compared to other observable market data or securities with similar characteristics. Our estimate of the fair value of our ARS investments could fluctuate materially from period to period depending on future market conditions.
Contractual maturities for our ARS investments are generally greater than five years, with fair value of $9.9 million maturing from fiscal 2016 to fiscal 2018, $8.7 million maturing from fiscal 2034 to fiscal 2045, and $7.3 million maturing thereafter or having no stated maturity. Of our ARS investments $19.0 million par value are investment grade; and the remaining $18.5 million par value is below investment grade.
Based on our ability to access our cash and cash equivalents, our expected operating cash flows, and our other sources of cash, we do not anticipate the lack of liquidity on these investments will affect our ability to operate our business as usual.
There have been no significant changes in the maturity dates and average interest rates for our cash equivalents and debt obligations subsequent to fiscal 2011.
Foreign currency exchange risk
All of our revenue and approximately 93% of our consolidated costs are denominated in U.S. dollars. As a result, we have relatively little exposure to foreign currency exchange risks and foreign exchange losses have been immaterial to date. We do not currently enter into forward-exchange contracts to hedge exposure denominated in foreign currencies or any other derivative financial instruments for trading or speculative purposes. In the future, if our operations change and we determine that our foreign exchange exposure has increased, we may consider entering into hedging transactions to mitigate such risk.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report of our independent registered public accounting firm, and the notes thereto commencing at page of this report, which financial statements, report, and notes are incorporated herein by reference. Reference is also made to the quarterly results of operations on page 46 of this report, which quarterly results of operations are incorporated herein by reference.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Conclusions Regarding Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our interim Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our interim Chief Executive Officer and Chief Financial Officer, as of June 25, 2011, concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are effective to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our interim Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
We are responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our interim Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control-Integrated Framework, our management concluded that our internal control over financial reporting was effective as of June 25, 2011. The effectiveness of our internal control over financial reporting as of June 25, 2011 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in its report included herein on page.
Changes in Internal Control Over Financial Reporting
There was no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
Our management, including our interim Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, misstatements, errors, and instances of fraud, if any, within our company have been or will be prevented or detected. Further, internal controls may become inadequate as a result of changes in conditions, or through the deterioration of the degree of compliance with policies or procedures.
There were no items requiring reporting on Form 8-K that were not reported on Form 8-K during the fourth quarter of the year covered by this Form 10-K.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item relating to directors of our company and corporate governance is incorporated herein by reference to the definitive Proxy Statement to be filed pursuant to Regulation 14A of the Exchange Act for our 2011 Annual Meeting of Stockholders. The information required by this Item relating to our executive officers is included in Item 1, “Business - Executive Officers.”
We have adopted a code of ethics that applies to our principal executive officer, principal financial officer, and other senior accounting personnel. The “Code of Ethics for the CEO and Senior Financial Officers” is located on our website at www.synaptics.com in the Investor Relations section under Corporate Governance.
We intend to satisfy the disclosure requirement under Item 10 of Form 8-K regarding any amendment to, or waiver from, a provision of this code of ethics by posting such information on our website, at the address and location specified above.
The information required by this Item is incorporated herein by reference to the definitive Proxy Statement (particularly under the caption “Executive Compensation”) to be filed pursuant to Regulation 14A of the Exchange Act for our 2011 Annual Meeting of Stockholders.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is incorporated herein by reference to the definitive Proxy Statement (particularly under the caption “Security Ownership of Principal Stockholders, Directors, and Officers”) to be filed pursuant to Regulation 14A of the Exchange Act for our 2011 Annual Meeting of Stockholders.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated herein by reference to the definitive Proxy Statement (particularly under the caption “Certain Relationships and Related Transactions”) to be filed pursuant to Regulation 14A of the Exchange Act for our 2011 Annual Meeting of Stockholders.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated herein by reference to the definitive Proxy Statement (particularly under the caption “Ratification of Appointment of Independent Auditor”) to be filed pursuant to Regulation 14A of the Exchange Act for our 2011 Annual Meeting of Stockholders.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Financial Statement Schedules
(1)
Financial Statements are listed in the Index to Consolidated Financial Statements on page of this report.
(b) Exhibits
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
SYNAPTICS INCORPORATED AND SUBSIDIARIES
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Synaptics Incorporated:
We have audited the accompanying consolidated balance sheets of Synaptics Incorporated and subsidiaries (the Company) as of June 25, 2011 and June 26, 2010, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended June 25, 2011. We also have audited the Company’s internal control over financial reporting as of June 25, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Synaptics Incorporated and subsidiaries as of June 25, 2011 and June 26, 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended June 25, 2011, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 25, 2011, based on criteria established in Internal Control - Integrated Framework issued by the COSO.
/s/ KPMG LLP
Mountain View, California
August 22, 2011
SYNAPTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value and share amounts)
See notes to consolidated financial statements.
SYNAPTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
See notes to consolidated financial statements.
SYNAPTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
(in thousands, except share amounts)
See notes to consolidated financial statements.
SYNAPTICS INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See notes to consolidated financial statements.
SYNAPTICS INCORPORATED AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Organization and Basis of Presentation
We are a leading worldwide developer and supplier of custom-designed user interface solutions that enable people to interact more easily and intuitively with a wide variety of mobile computing, communications, entertainment, and other electronic devices. We currently target the personal computer, or PC, market, primarily notebook computers, the markets for digital lifestyle products, including mobile smartphones and feature phones, the tablet market, and other select electronic device markets with our customized human interface solutions. Our original equipment manufacturer, or OEM, customers include most of the tier one PC OEMs and many of the world’s largest OEMs for mobile smartphones and feature phones.
The consolidated financial statements include our financial statements and those of our wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated upon consolidation.
Our fiscal year is the 52- or 53-week period ending on the last Saturday in June. The fiscal years presented in this report were 52-week periods ended June 25, 2011, June 26, 2010, and June 27, 2009.
Stock Split
On July 31, 2008, we announced a 3-for-2 stock split to be effected as a stock dividend. The stock dividend was effective for stockholders of record on August 15, 2008 and was paid on August 29, 2008. All share and per share amounts contained herein for each period presented prior to the stock dividend date have been retroactively adjusted to reflect the stock split, except for treasury shares.
Use of Estimates
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles, or U.S. GAAP, requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, cost of revenue, inventories, product warranty, share-based compensation costs, provision for income taxes, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, goodwill, intangible assets, investments, and contingencies. We base our estimates on historical experience, applicable laws, and regulations, and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Cash Equivalents and Investments
Cash equivalents consist of highly liquid investments with original maturities of three months or less. Our non-current investments are reported at fair value, with unrealized gains and losses excluded from earnings and shown separately as a component of accumulated other comprehensive income within stockholders’ equity. We charge other-than-temporary declines in the fair value of a debt security to earnings if the decline is due to a credit loss or if we intend to or need to sell at a loss. We charge other-than-temporary declines in the fair value of a debt security to other comprehensive income if the decline is due to a noncredit loss, resulting in the establishment of a new cost basis for the debt security. We charge other-than-temporary declines in the fair value of equity securities to earnings. We include interest earned on securities in interest income. We determine realized gains and losses on the sale of securities using the specific identification method.
Investments in available-for-sale securities and cash equivalents as of the end of fiscal 2011 and 2010 were as follows (in thousands):
Weighted average interest rates, amortized costs, and estimated fair values of our money market investments as of the end of fiscal 2011 and 2010 were as follows (in thousands):
Fair Values of Cash Equivalents and Investments
We measure financial assets at fair value. When we measure fair value on either a recurring or nonrecurring basis, inputs used in valuation techniques are assigned a hierarchical level as follows:
•
Level 1 inputs are observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
•
Level 2 inputs reflect quoted prices for identical assets or liabilities in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs other than quoted prices that are observable for the assets or liabilities; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
•
Level 3 inputs are unobservable inputs reflecting our assumptions, which are incorporated into valuation techniques and models used to determine fair value. The assumptions are consistent with market participant assumptions that are reasonably available. Our Level 3 assets consist of non-current auction rate securities, or ARS, investments. We estimated the fair value of our ARS investments based on, among other factors, the following: (i) the collateral underlying the security investments; (ii) creditworthiness of the counterparty; (iii) timing of expected future cash flows; (iv) the probability of a successful auction in a future period; (v) the underlying structure of each investment; (vi) the present value of future principal and interest payments discounted at rates considered to reflect current market conditions; (vii) consideration of the probabilities of default, passing a future auction, or repurchase at par for each period; and (viii) estimates of the recovery rates in the event of default for each investment. See Note 3 - Auction Rate Securities.
Financial assets measured at fair value on a recurring basis, by level within the fair value hierarchy, as of the end of fiscal 2011 and 2010 were as follows (in thousands):
Money market balances are included in cash and cash equivalents as of the end of fiscal 2011 and 2010. ARS investments are included in non-current investments as of the end of fiscal 2011 and 2010. There were no Level 2 financial assets as of the end of fiscal 2011 or 2010.
Changes in fair value of our Level 3 financial assets for fiscal 2011 and 2010 were as follows (in thousands):
There were no transfers in or out of our Level 1, 2, or 3 assets during fiscal 2011 or 2010.
The fair values of our cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximate their carrying values because of the short-term nature of those instruments. We base the fair value of our ARS investments on a discounted cash flow model.
Concentration of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents, investments, and trade accounts receivable. Our investment policy, which is predicated on capital preservation and liquidity, limits investments to U.S. government treasuries and agency issues, taxable securities, and municipal issued securities with a minimum rating of A1 (Moody’s) or P1 (Standard and Poor’s) or equivalent. Included within our investment portfolio are investments in ARS investments, which met our investment guidelines at the time of our investment. Our ARS investments are currently not liquid as a result of continued auction failures. If the issuers are not able to meet their payment obligations or if we sell our ARS investments before they recover, we may lose some or all of our principal invested or may be required to further reduce the carrying value. We do not intend to sell our ARS investments for less than par value.
We sell our products primarily to contract manufacturers that provide manufacturing services for OEMs. We extend credit based on an evaluation of a customer’s financial condition, and we generally do not require collateral. To date, credit losses on our accounts receivable have been insignificant, and we believe that an adequate allowance for doubtful accounts has been provided.
The following customers accounted for more than 10% of our accounts receivable balance as the end of fiscal 2011 and 2010:
Other Concentrations
Our products include certain components that are currently single sourced. We believe other vendors would be able to provide similar components; however, the qualification of such vendors may require start-up time. In order to mitigate any adverse impacts from a disruption of supply, we attempt to maintain an adequate supply of critical single-sourced components.
Revenue Recognition
We recognize revenue from product sales when there is persuasive evidence that an arrangement exists, delivery has occurred and title has transferred, the price is fixed or determinable, and collection is reasonably assured, which is generally upon shipment. We accrue for estimated sales returns and other allowances, based on historical experience, at the time we recognize revenue.
Allowance for Doubtful Accounts
We maintain allowances for doubtful accounts for estimated losses resulting from the inability of customers to meet their financial obligations. On an ongoing basis, we evaluate the collectability of accounts receivable based on a combination of factors. In circumstances in which we are aware of a specific customer’s potential inability to meet its financial obligation, we record a specific reserve of the bad debt against amounts due. In addition, we make judgments and estimates on the collectability of accounts receivable based on our historical bad debt experience, customers’ creditworthiness, current economic trends, recent changes in customers’ payment trends, and deterioration in customers’ operating results or financial position. If circumstances change adversely, additional bad debt allowances may be required.
Cost of Revenue
Our cost of revenue includes the cost of products shipped to our customers, which primarily includes the cost of products built to our specifications by our contract manufacturers, the cost of silicon wafers supplied by independent wafer foundries, and the related assembly, package, and test costs of our die and packaged ASICs. Also included in our cost of revenue are personnel and related costs, including share-based compensation, for quality assurance, and manufacturing support; logistics costs; depreciation of equipment supporting manufacturing; license amortization; provisions for excess and obsolete inventories;and warranty costs.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or market (estimated net realizable value) as of the end of fiscal 2011 and 2010 and consisted of the following (in thousands):
Periodically, we purchase inventory from our contract manufacturers when a customer delays its delivery schedule or cancels its order. In those circumstances in which our customer has cancelled its order and we purchase inventory from our contract manufacturers, we consider a write-down to reduce the carrying value of the inventory purchased to its net realizable value. We charge write-downs to reduce the carrying value of obsolete, slow moving, and non-usable inventory to net realizable value to cost of revenue. The effect of these write-downs is to establish a new cost basis in the related inventory, which we do not subsequently write up.
Property and Equipment
We state property and equipment at cost less accumulated depreciation and amortization. We compute depreciation using the straight-line method over the estimated useful lives of the assets. We apply estimated useful lives of three to seven years to our computer equipment and software; estimated useful lives ranging from one to five years to our manufacturing equipment; estimated useful lives of three to five years to our furniture and fixtures; and an estimated useful life of 35 years to our building. We amortize leasehold improvements over the shorter of the lease term or the useful life of the asset. For fiscal 2011 and 2010, we retired fully depreciated equipment and furniture with an original cost of $1.9 million and zero, respectively.
Foreign Currency Translation
The U.S. dollar is our functional and reporting currency. We remeasure our monetary assets and liabilities not denominated in the functional currency into U.S. dollar equivalents at the rate of exchange in effect on the balance sheet date. We measure and record non-monetary balance sheet accounts at the historical rate in effect at the date of translation. All of our revenue and approximately 93% of our consolidated costs are denominated in U.S. dollars. We translate certain expenses at the weighted average exchange rate in the month that the transaction occurred. Remeasurement of monetary assets and liabilities that are not denominated in the functional currency are included currently in operating results. Translation losses included in operating results for fiscal 2011, 2010, and 2009 were not material. To date, we have not undertaken hedging transactions related to foreign currency exposure.
Goodwill
We review the carrying value of goodwill at least annually for impairment as of the fiscal year-end balance sheet date. The frequency of our review is dictated by events or changes in circumstances indicating that the carrying value may be impaired. Based on our latest review, we determined there was no impairment of the carrying value of goodwill.
Impairment of Long-Lived Assets
We evaluate long-lived assets, such as property and equipment and intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We measure recoverability of assets to be held and used by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of the asset exceeds its estimated undiscounted future cash flows, we recognize an impairment charge in an amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the consolidated balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and would no longer be depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheet. There were no events during the fiscal year that would trigger an impairment of our long-lived assets.
Segment Information
We operate in one segment: the development, marketing, and sale of intuitive user interface solutions for electronic devices and products.
Share-Based Compensation Costs
We utilize the Black-Scholes option pricing model to estimate the grant date fair value of employee share-based compensatory awards, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical and implied volatilities were used in estimating the fair value of our share-based awards. The expected life for our options was previously estimated based on historical trends since our initial public offering. In fiscal 2011, we began to grant options with a contractual life of seven years rather than 10 years and now use the simplified method of establishing the expected life as we do not have any history of options with seven-year lives. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation. Further, we estimate forfeitures for share-based awards that are not expected to vest. We charge estimated fair value less estimated forfeitures to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years for our stock option and deferred stock unit, or DSU, awards and up to two years for our employee stock purchase plan.
Product Warranties
We generally warrant our products for a period of 12 months or more from the date of sale and estimate probable product warranty costs at the time we recognize revenue. Factors that affect our warranty liability include historical and anticipated rates of warranty claims, materials usage, rework, and delivery costs. However, we assess the adequacy of our warranty obligations periodically and adjust the accrued warranty liability on the basis of our estimates.
Changes in our warranty liability (included in other accrued liabilities)for fiscal 2011 and 2010 were as follows (in thousands):
Comprehensive Income
Our comprehensive income generally consists of net income plus the effect of unrealized gains and losses on our investments primarily due to changes in market value of certain of our ARS investments. In addition, we recognize the noncredit portion of other-than-temporary impairment on debt securities in comprehensive income.
Income Taxes
We account for income taxes under the asset and liability method. We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. We measure deferred tax assets and liabilities using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period that includes the enactment date. We establish valuation allowances when necessary to reduce deferred tax assets to the amounts expected to be realized. We consider the operating earnings of our foreign subsidiaries to be indefinitely invested outside the United States. Accordingly, no provision has been made for the U.S. federal, state, or foreign taxes that may result from future remittances of undistributed earnings of our foreign subsidiaries.
We use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement with a taxing authority. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of highly complex tax laws. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our consolidated financial position, results of operations, and cash flows. We believe we have adequately provided for reasonably foreseeable outcomes in connection with the resolution of income tax uncertainties. However, our results have in the past, and could in the future, include favorable and unfavorable adjustments to our estimated tax liabilities in the period a determination of such estimated tax liability is made or resolved, upon the filing of an amended return, upon a change in facts, circumstances, or interpretation, or upon the expiration of a statute of limitation. Accordingly, our effective tax rate could fluctuate materially from period to period.
Research and Development
We expense costs to develop our products, which include the costs incurred to design interface solutions for customers prior to the customers incorporating those solutions into their products.
Net Income Per Share
Basic net income per share amounts for each period presented have been computed using the weighted average number of shares of common stock outstanding.
Diluted net income per share amounts for each period presented have been computed (1) using the weighted average number of potentially dilutive shares issuable in connection with our share-based compensation plans under the treasury stock method, and (2) using the weighted average number of potentially dilutive shares issuable in connection with our convertible debt under the treasury stock method, when dilutive.
2. Net Income Per Share
The computation of basic and diluted net income per share for fiscal 2011, 2010, and 2009 was as follows (in thousands, except per share amounts):
Diluted net income per share does not include the effect of share-based awards for fiscal 2011, 2010, and 2009 as follows (in thousands):
These share-based awards were not included in the computation of diluted net income per share because the proceeds received, if any, from such share-based awards combined with the average unamortized compensation costs adjusted for the hypothetical tax benefit or deficiency creditable or chargeable, respectively, to additional paid-in capital, were greater than the average market price of our common stock, and therefore, their effect would have been antidilutive.
Our basic net income per share amounts for each period presented have been computed using the weighted average number of shares of common stock outstanding. Our diluted net income per share amounts for each period presented include the weighted average effect of potentially dilutive shares. We used the “treasury stock” method to determine the dilutive effect of our stock options, DSUs, and convertible notes. Under the treasury stock method, shares associated with our convertible notes are included in the calculation of diluted net income per share only if the weighted average price of our common stock exceeds $33.69 during the reporting period.
3. Auction Rate Securities
Our ARS investments, which are included in non-current investments, have failed to settle in auctions beginning in 2007. These investments are not liquid, and in the event we need to access these funds, we will not be able to do so without a loss of principal, unless redeemed by the issuers or a future auction on these investments is successful. During fiscal 2011, 2010, and 2009, $3.2 million,$1.8 million, and $4.9 million, respectively, of our ARS investments were redeemed at par, and we recognized a gain of $59,000, $6,000, and $160,000, respectively, on the redemption of these investments, which is included in impairment of investments, net on the accompanying consolidated statements of income.
As there are currently no active markets for our various failed ARS investments, we have estimated the fair value of these investments as of the end of fiscal 2011 using a trinomial discounted cash flow analysis. The analysis considered, among others, the following factors:
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the collateral underlying the security investments;
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creditworthiness of the counterparty;
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timing of expected future cash flows;
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the probability of a successful auction in a future period;
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the underlying structure of each investment;
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the present value of future principal and interest payments discounted at rates considered to reflect current market conditions;
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consideration of the probabilities of default, passing a future auction, or redemption at par for each period; and
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estimates of the recovery rates in the event of default for each investment.
When possible, our failed ARS investments were compared to other observable market data or securities with similar characteristics. Our estimate of the fair value of our ARS investments could fluctuate materially from period to period depending on future market conditions.
Contractual maturities for our ARS investments are generally greater than five years, with fair value of $9.9 million maturing from 2016 to 2018, $8.7 million maturing from 2034 to 2045, and $7.3 million maturing thereafter or having no stated maturity. Of our ARS investments, $19.0 million are investment grade and the remaining $18.5 million par value is below investment grade. In fiscal 2011, 2010, and 2009, we recorded $59,000, ($443,000), and ($9.2) million, respectively, related to other-than-temporary impairment (loss)/recovery on investments, net.
Upon our adoption of the recognition and presentation of other-than-temporary impairments accounting standard in fiscal 2009, we reclassified $2.4 million from retained earnings to accumulated other comprehensive income to reflect the cumulative effect adjustment as of the beginning of the period of adoption to reclassify the noncredit component of a previously recognized other-than-temporary impairment.
The various types of failed ARS investments we held as of the end of fiscal 2011, including the original cost basis, other-than-temporary impairment included in other comprehensive income, other-than-temporary impairment included in retained earnings, new cost basis, unrealized gain, and fair value consisted of the following (in thousands):
The various types of failed ARS investments we held as of the end of fiscal 2010, including the original cost basis, other-than-temporary impairment included in other comprehensive income, other-than-temporary impairment included in retained earnings, new cost basis, unrealized gain, and fair value consisted of the following (in thousands):
We have accounted for all of our ARS investments as non-current as we are not able to reasonably determine when the ARS markets will recover or be restructured. Based on our ability to access our cash and cash equivalents, our expected operating cash flows, and our other sources of cash, we have the intent and ability to hold these investments until the value recovers or the investments mature. We will continue to monitor our ARS investments and evaluate our accounting for these investments quarterly. Subsequent to recording other-than-temporary impairment charges, certain of our ARS investments have increased in value above their new cost bases, and this increase is included as unrealized gain above and in accumulated other comprehensive income in the accompanying consolidated balance sheet.
4. Property and Equipment
Property and equipment as of the end of fiscal 2011 and 2010 consisted of the following (in thousands):
5. Leases, Other Commitments, and Contingencies
Leases
We maintain office facilities in various locations under operating leases with expiration dates from fiscal 2012 to fiscal 2015, some of which have renewal options of two to three years. Our leased office facilities are located in China, Finland, Hong Kong, Japan, Korea, Switzerland, Taiwan, and the United States. We recognized rent expense on a straight-line basis of $4.0 million, $3.4 million, and $2.4 million for fiscal 2011, 2010, and 2009, respectively.
The aggregate future minimum rental commitments as of the end of fiscal 2011 for noncancelable operating leases with initial or remaining terms in excess of one year were as follows (in thousands):
Contingencies
We may receive notices from third parties that claim our products infringe their rights. From time to time, we receive notice from third parties alleging infringement of their intellectual property rights. We cannot be certain that our technologies and products do not and will not infringe issued patents or other proprietary rights of third parties.
Any infringement claims, with or without merit, could result in significant litigation costs and diversion of management and financial resources, including the payment of damages, which could have a material adverse effect on our business, financial condition, and results of operations.
Indemnifications
In connection with certain third-party agreements we have executed in the past, we are obligated to indemnify the third party in connection with any technology infringement by us. We have also entered into indemnification agreements with our officers and directors. Maximum potential future payments cannot be estimated because these agreements do not have a maximum stated liability. However, historical costs related to these indemnification provisions have not been significant. We have not recorded any liability in our consolidated financial statements for such indemnification obligations.
Line of Credit
We have an unsecured $50.0 million working capital line of credit with Wells Fargo Bank. The Wells Fargo Bank revolving line of credit, which expires on September 1, 2012, has an interest rate equal to the prime lending rate or 250 basis points above LIBOR, depending on whether we choose a variable or fixed rate, respectively. We did not borrow any amounts under the line of credit during fiscal 2011.
6. Convertible Senior Subordinated Notes
In December 2004, we issued an aggregate of $125.0 million of convertible notes in a private offering pursuant to Rule 144A under the Securities Act of 1933, as amended. In connection with issuing the convertible notes, we incurred issuance costs of $4.3 million, consisting primarily of the initial purchasers’ discount and costs related to legal, accounting, and printing. We used the net proceeds for working capital and general corporate purposes.
In fiscal 2009, we repurchased and retired $59.7 million of our outstanding notes at a discount of approximately 7%, which resulted in a $1.1 million net loss on retirement of debt after deducting the associated unamortized discount and issuance costs. In fiscal 2010, we repurchased and retired $63.0 million par value of our notes when investors exercised their rights to require us to repurchase their notes. As of the end of fiscal 2011, $2.3 million par value of our notes remained outstanding and have been classified as long-term as the next date noteholders can require us to repurchase all or a portion of their notes is in December 2014.
During the first quarter of fiscal 2010, we adopted the accounting standard on convertible debt that can be settled in cash. The adoption of this accounting standard, which must be applied on a retrospective basis, results in a non-cash interest charge for all periods presented in our financial statements during which the notes were outstanding. This standard requires issuers of convertible notes that can be settled in cash to separately account for the liability and equity components of such convertible notes in a manner that reflects the entity’s nonconvertible debt borrowing rate. Prior to the application of the standard, the liability of the notes was carried at their par value, and only the contractual interest and amortization of debt issuance costs were recognized in our condensed consolidated statements of income.
Upon adoption of the new standard, and effective as of the issuance date of the notes, we recorded $39.4 million of the principal amount to equity, representing the debt discount for the difference between our estimated nonconvertible debt borrowing rate of 8.5% at the time of issuance and the 0.75% coupon rate of the notes using a five-year life, which coincides with the initial put rights of the noteholders. In addition, we allocated the $4.3 million of issuance costs pro-rata to the equity and debt components of the notes, or $1.4 million and $2.9 million, respectively. The discount and the issuance costs allocated to the debt component were amortized as interest expense using the effective interest method over five years and were fully amortized as of December 31, 2009.
The liability and equity components of the notes as of the end of fiscal 2011 and 2010 consisted of $2.3 million and $727,000, respectively.
The contractual interest expense and amortization of issuance costs and discount for the notes for fiscal 2011, 2010, and 2009 were as follows (in thousands):
7. Stockholders’ Equity
We have a Stockholders’ Rights Plan that may have the effect of deterring, delaying, or preventing a change in control that might otherwise be in the best interests of our stockholders. In general, stock purchase rights issued under the plan become exercisable when a person or group acquires 15% or more of our common stock or when a tender offer or exchange offer for 15% or more of our common stock is announced or commenced. After any such event, our other stockholders may purchase additional shares of our common stock at 50% of the then-current market price. The rights will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our board of directors. The rights should not interfere with any merger or other business combination approved by our board of directors. The rights expire in August 2012.
Preferred Stock
We are authorized, subject to limitations imposed by Delaware law, to issue up to a total of 10,000,000 shares of preferred stock in one or more series without stockholder approval. Our board of directors has the power to establish from time to time the number of shares to be included in each series and to fix the rights, preferences, and privileges of the shares of each wholly unissued series and any of its qualifications, limitations, or restrictions. Our board of directors can also increase or decrease the number of shares of a series, but not below the number of shares of that series then outstanding, without any further vote or action by the stockholders.
Our board of directors may authorize the issuance of preferred stock with voting or conversion rights that could harm the voting power or other rights of the holders of our common stock. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could, among other things, have the effect of delaying, deferring, or preventing a change in control of our company and might harm the market price of our common stock and the voting power and other rights of the holders of common stock. As of the end of fiscal 2011, there were no shares of preferred stock outstanding and we have no current plans to issue any shares of preferred stock.
Shares Reserved for Future Issuance
Shares of common stock reserved for future issuance as of the end of fiscal 2011 were as follows:
Treasury Stock
In April 2010, our board of directors approved an additional $100.0 million for the stock repurchase program, expiring in April 2012, bringing the cumulative authorization to $420.0 million. The program authorizes us to repurchase our common stock in the open market or in privately negotiated transactions depending upon market conditions and other factors. The number of shares repurchased and the timing of repurchases is based on the level of our cash balances, general business and market conditions, and other factors, including alternative investment opportunities. Common stock repurchased under this program is held as treasury stock. As of the end of fiscal 2011, we had $67.9 million remaining under our common stock repurchase program.
8. Share-Based Compensation
The purpose of our various share-based compensation plans is to attract, motivate, retain, and reward high-quality employees, directors, and consultants by enabling such persons to acquire or increase their proprietary interest in our common stock in order to strengthen the mutuality of interests between such persons and our stockholders and to provide such persons with annual and long-term performance incentives to focus their best efforts in the creation of stockholder value. Consequently, we determine share-based compensatory awards issued subsequent to the initial award to our employees and consultants primarily on individual performance. Our share-based compensation plans with outstanding awards consist of our 1996 Stock Option Plan, or our 1996 Plan, our 2001 Incentive Compensation Plan, as amended, or our 2001 Plan, our 2010 Incentive Compensation Plan, or our 2010 Plan, and our 2010 Employee Stock Purchase Plan, or our 2010 ESPP.
Share-based compensation awards available for grant or issuance for each plan as of the beginning of the fiscal year, including changes in the balance of awards available for grant for fiscal 2011, were as follows:
Our 1996 Plan expired in December 2006. Accordingly, no new grants can be issued under our 1996 Plan. Option awards that are currently outstanding under our 1996 Plan will remain outstanding until exercised, forfeited, or cancelled under the terms of the option grant agreements. Our 2001 Plan, which expired in March 2011, was replaced by our 2010 Plan. Option awards and DSUs that are currently outstanding under our 2001 Plan will remain outstanding until exercised, delivered, forfeited, or cancelled under the terms of the grant agreements. Our 2001 ESPP expired in December 2010, and was replaced by our 2010 ESPP.
Share-based compensation and the related tax benefit recognized in our consolidated statement of income for fiscal 2011,2010, and 2009 were as follows (in thousands):
We utilize the Black-Scholes option pricing model to estimate the grant date fair value of certain employee share-based compensatory awards, which requires the input of highly subjective assumptions, including expected volatility and expected life. Historical and implied volatilities were used in estimating the fair value of our share-based awards. The expected life for our options was previously estimated based on historical trends since our initial public offering. In fiscal 2011, we began to grant options with a contractual life of seven years rather than 10 years and now use the simplified method of establishing the expected life as we do not have any history of options with seven-year lives. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based awards. Further, as required under accounting standards, we estimate forfeitures for share-based awards that are not expected to vest. We charge the estimated fair value less estimated forfeitures to earnings on a straight-line basis over the vesting period of the underlying awards, which is generally four years for our stock option and DSU awards and up to two years for our employee stock purchase plan. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options having no vesting restrictions and being fully transferable. As our stock option and employee stock purchase plan awards have characteristics that differ significantly from traded options and, as changes in the subjective assumptions can materially affect the estimated value, our estimate of fair value may not accurately represent the value assigned by a third party in an arms’-length transaction. While our estimate of fair value and the associated charge to earnings materially affects our results of operations, it has no impact on our cash position.
We recognize tax benefit upon expensing certain share-based awards associated with our share-based compensation plans, including nonqualified stock options and DSU awards, but under current accounting standards we cannot recognize tax benefit concurrent with the recognition of share-based compensation expenses associated with incentive stock options and employee stock purchase plan shares (qualified stock options). For qualified stock options that vested after our adoption of the accounting standards, we recognize tax benefit only in the period when disqualifying dispositions of the underlying stock occur, which historically has been up to several years after vesting and in a period when our stock price substantially increases. For qualified stock options that vested prior to our adoption of the accounting standards, the tax benefit is recorded directly to additional paid-in capital.
We determine excess tax benefit using the long-haul method in which we compare the actual tax benefit associated with the tax deduction from share-based award activity to the hypothetical tax benefit on the grant date fair values of the corresponding share-based awards. Tax benefit associated with excess tax deduction creditable to additional paid-in capital is not recognized until the deduction reduces taxes payable. During fiscal 2011, 2010, and 2009, we recognized $1.7 million, $7.1 million, and $9.4 million, respectively, of net excess tax benefit as additional paid-in capital.
Historically, we have issued new shares in connection with our share-based compensation plans; however, treasury shares were also available for issuance as of the end of fiscal 2011. Any additional shares repurchased under our common stock repurchase program would be available for issuance under our share-based compensation plans.
Stock Options
Our share-based compensation plans with outstanding stock option awards include our 1996 Plan, our 2001 Plan, and our 2010 Plan. Under our 2010 Plan, we may grant employees, consultants, and directors incentive stock options or nonqualified stock options to purchase shares of our common stock at not less than 100% of the fair market value, or FMV, on the date of grant. Stock options granted to our employees generally are incentive stock options, or qualified options, under the Internal Revenue Code, subject to calendar year vesting limitations with any balance being nonqualified stock options.
Options granted under the 2010 Plan generally vest over four years from the vesting commencement date and expire seven years after the date of grant if not exercised.
Certain stock option activity for fiscal 2011 and balances as of the end of fiscal 2011 were as follows:
The aggregate intrinsic value was determined using the closing price of our common stock on the last trading day of fiscal 2011, or June 24, 2011, of $25.02 and excludes the impact of options that were not in-the-money.
At the end of fiscal 2011, we estimated fully vested options and options expected to vest to be 7.6 million with an aggregate intrinsic value of $21.8 million, having a weighted average exercise price of $24.67 and a weighted average remaining contractual term of seven years. The weighted average remaining contractual term for the options exercisable is approximately six years.
Cash received and the aggregate intrinsic value of stock options exercised for fiscal 2011, 2010, and 2009 were as follows (in thousands):
The fair value of each award granted from our plans for fiscal 2011, 2010, and 2009 was estimated at the date of grant using the Black-Scholes option pricing model, assuming no expected dividends and the following range of assumptions:
The unrecognized share-based compensation costs for stock options granted under our various plans were approximately $39.7 million as of the end of fiscal 2011 to be recognized over a weighted average period of approximately 2.3 years.
During fiscal 2011, we modified the vesting provisions of our former Chief Executive Officer’s share-based awards and recorded an additional $1.4 million of share-based compensation expense in connection with the modification of the awards.
Deferred Stock Units
Our 2001 Plan, which expired in March 2011, provided for the grant of DSU awards to our employees, consultants, and directors. Currently, our 2010 Plan provides for the grant of DSU awards to our employees, consultants, and directors. A DSU is a promise to deliver shares of our common stock at a future date in accordance with the terms of the DSU grant agreement. We began granting DSUs in January 2006.
DSUs granted under our 2010 Plan generally vest 25% over four years from the vesting commencement date. Delivery of shares under the plan takes place on the quarterly vesting dates. At the delivery date, we withhold shares to cover statutory minimum tax withholding by delivering a net quantity of shares. Until delivery of shares, the grantee has no rights as a stockholder.
An election to defer delivery of the underlying shares for unvested DSUs can be made by the grantee provided the deferral election is made at least one year before vesting and the deferral period is at least five years from the scheduled delivery date.
DSU activity, including DSUs granted, delivered, and forfeited in fiscal 2011, and the balance and aggregate intrinsic value of DSUs as of the end of fiscal 2011 were as follows:
Of the shares delivered, 108,807 shares valued at $3.2 million were withheld to meet statutory minimum tax withholding requirements. The aggregate intrinsic value was determined using the closing price of our common stock on the last trading day of fiscal 2011, or June 24, 2011, of $25.02.
The unrecognized share-based compensation cost for DSUs granted under the 2001 Plan and the 2010 Plan was approximately $24.6 million as of the end of fiscal 2011, which will be recognized over a weighted average period of approximately 2.6 years. The aggregate market value of DSUs delivered in fiscal 2011, 2010, and 2009 was $11.1 million, $7.7 million, and $6.1 million, respectively.
Employee Stock Purchase Plan
Our 2001 Employee Stock Purchase Plan, or our 2001 ESPP, became effective on January 29, 2002, the effective date of the registration statement for our initial public offering. Our 2010 ESPP became effective on January 1, 2011 and replaced our 2001 ESPP, which expired in December 2010. The 2010 ESPP allows employees to designate up to 15% of their base compensation, subject to legal restrictions and limitations, to purchase shares of common stock at 85% of the lesser of the FMV at the beginning of the offering period or the exercise date. The offering period extends for up to two years and includes four exercise dates occurring at six-month intervals. Under the terms of our 2010 ESPP, if the FMV at an exercise date is less than the FMV at the beginning of the offering period, the current offering period will terminate and a new two-year offering period will commence.
Shares purchased, weighted average purchase price, cash received, and the aggregate intrinsic value for employee stock purchase plan purchases in fiscal 2011, 2010, and 2009 were as follows (in thousands, except shares purchased and weighted average purchase price):
In accordance with accounting standards related to the accounting for employee stock purchase plans with a look-back option, the early termination of an offering period followed by the commencement of a new offering period represents a modification to the terms of the related awards. Under the terms of our 2010 ESPP, the offering period that commenced on January 3, 2011 was terminated on May 13, 2011 and a new offering period commenced on May 16, 2011. The May 16, 2011 modification affected approximately 437 employees and resulted in incremental compensation costs, which are not material and which will be recognized on a straight-line basis over the two-year period ending May 15, 2013.
Under the terms of our 2001 ESPP, the offering period that commenced on July 1, 2007 was terminated on December 31, 2008 and a new offering period commenced on January 1, 2009. The December 31, 2008 modification affected approximately 275 employees and resulted in incremental compensation costs, which are not material and which were recognized on a straight-line basis over the two-year period ended December 31, 2010.
The fair value of each award granted under our 2001 ESPP and 2010 ESPP for fiscal 2011, 2010, and 2009 was estimated using the Black-Scholes option pricing model, assuming no expected dividends and the following range of assumptions:
The expected volatility is based on either implied volatility or a weighting of implied and historical volatility; the expected life is based on each period that begins with the enrollment date until each purchase date remaining in the offering period at the date of enrollment in the plan; and the risk free interest rate is based on U.S. Treasury yields or yield curve in effect for each expected life.
Unrecognized share-based compensation costs for awards granted under our 2010 ESPP at the end of fiscal 2011 were approximately $4.8 million to be amortized over the next 22 months.
9. Employee Benefit Plans
401(k) Plan
We have a 401(k) Retirement Savings Plan for full-time employees. Under the plan, eligible employees may contribute a maximum of 30% of their net compensation or the annual limit of $16,500. The annual limit for employees who are 50 years or older is $22,000. In fiscal 2011, we provided matching funds of 25% of the employee’s contribution up to a maximum of $4,125 per employee. We made matching contributions of $1.0 million, $943,000, and $783,000 in fiscal 2011, 2010, and 2009, respectively.
10. Income Taxes
Income (loss) before provision for income taxes for fiscal 2011, 2010, and 2009 consisted of the following (in thousands):
The provision for income taxes for fiscal 2011, 2010, and 2009 consisted of the following (in thousands):
The provision for income taxes differs from the federal statutory rate for fiscal 2011, 2010, and 2009 as follows (in thousands):
Net deferred tax assets as of the end of fiscal 2011 and 2010 consisted of the following (in thousands):
Current deferred tax assets and non-current deferred tax assets are included in prepaid expenses and other current assets, and other assets, respectively, in the accompanying consolidated balance sheets.
Significant components of our deferred tax assets (liabilities) as of the end of fiscal 2011 and 2010 consisted of the following (in thousands):
Realization of deferred tax assets depends on our generating sufficient U.S. and certain foreign taxable income in future years to obtain benefit from the reversal of deferred tax assets. Accordingly, the amount of deferred tax assets considered realizable may increase or decrease when we reevaluate the underlying basis for our estimates of future U.S. and foreign taxable income. As of the end of fiscal 2011, a valuation allowance of $15.1 million had been established to reduce deferred tax assets to levels that we believe are more than likely than not to be realized through future taxable income.
Undistributed operating earnings of our foreign subsidiaries were approximately $280.2 million as of the end of fiscal 2011 and are all considered to be indefinitely reinvested overseas, and no U.S. income taxes have been provided for on these earnings. The potential deferred tax liability associated with undistributed operating earnings of our foreign subsidiaries was approximately $70.7 million.
As of the end of fiscal 2011, we had state net operating loss carryforwards of approximately $31.6 million. The state net operating loss carryforwards were attributable to share-based award deductions. The benefit of these net operating losses will be recorded directly to additional paid-in capital when realized. In addition, we had $7.7 million and $6.7 million of federal and state research tax credit carryforwards, respectively. The federal research tax credit carryforward begins to expire in 2027 and the state research tax credit can be carried forward indefinitely. We also had $1.7 million of federal alternative minimum tax credit carryforward available to offset future federal tax liabilities with no expiration.
Under the current tax law, net operating loss and tax credit carryforwards available to offset future income or income taxes may be limited by statute or upon the occurrence of certain events, including significant changes in ownership. The state net operating loss will begin to expire in fiscal 2017, if not utilized. The federal and state capital losses begin to expire in fiscal 2013.
The total liability for gross unrecognized tax benefits, included in other liabilities in our consolidated balance sheet, increased $1.2 million to $20.2 million in fiscal 2011 from $19.0 million in fiscal 2010. All of this amount would affect the effective tax rate on income from continuing operations, if recognized. A reconciliation of the beginning and ending balance of gross unrecognized tax benefits consisted of the following (in millions):
Accrued interest and penalties increased by $438,000 to $1.6 million at the end of fiscal 2011 from $1.2 million at the end of fiscal 2010. Our policy to classify interest and penalties, if any, as components of income tax expense did not change.
In May 2011, we were notified by the Internal Revenue Service that our fiscal 2003 through 2006 and fiscal 2008 through 2010 will be subject to an audit. The early periods are being audited in connection with the mandatory Joint Committee Review for a refund in excess of $2.0 million when we carried back our fiscal 2008 net operating loss. The audit is ongoing, and no tax assessment has been proposed.
It is reasonably possible that the amount of the liability for unrecognized tax benefits may change within the next 12 months and an estimate of the range of possible changes cannot be made at this time due to the high uncertainty of the resolution of our tax positions with the tax authorities in various jurisdictions in which we operate.
Our major tax jurisdictions are the United States, California, and Hong Kong SAR and fiscal 2003 onward remain subject to examination by one or more of these jurisdictions.
On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, or the Act. The Act in part retroactively reinstated the research credit to January 1, 2010. Accordingly, our current quarterly and year-to-date effective tax rates for fiscal 2011 include the benefit of the retroactive reinstatement.
11. Segment, Customers, and Geographic Information
We operate in one segment: the development, marketing, and sale of interactive user interface solutions for electronic devices and products. We generate our revenue from two broad product categories: the PC market and digital lifestyle product markets. The PC market accounted for 48%, 59%, and 57%of our net revenue for fiscal 2011, 2010, and 2009, respectively.
Net revenue within geographic areas based on our customers’ locations for fiscal 2011, 2010, and 2009 consisted of the following (in thousands):
Long-lived assets within geographic areas as of the end of fiscal 2011 and 2010 consisted of the following (in thousands):
Our goodwill of $1.9 million represents a corporate asset arising primarily from an acquisition of an Asian subsidiary in a prior year.
Major customers as a percentage of net revenue for fiscal 2011, 2010, and 2009 were as follows: