Item 1. Business
Introduction
QLogic Corporation was organized as a Delaware corporation in 1992. Our principal executive offices are located at 26650 Aliso Viejo Parkway, Aliso Viejo, California 92656, and our telephone number at that location is (949) 389-6000. Our Internet address is www.qlogic.com. The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendment to these reports, that we file with the Securities and Exchange Commission (SEC) are available free of charge on our website as soon as reasonably practicable after those reports are electronically filed with the SEC. On April 3, 2006, we completed the acquisition of PathScale, Inc. (PathScale); on November 1, 2006, we completed the acquisition of SilverStorm Technologies, Inc. (SilverStorm); and on April 27, 2009, we completed the acquisition of NetXen, Inc. (NetXen).
Unless the context indicates otherwise, “we,” “our,” “us,” “QLogic” and the “Company” each refer to QLogic Corporation and its subsidiaries.
All references to years refer to our fiscal years ended March 29, 2009, March 30, 2008 and April 1, 2007, as applicable, unless calendar years are specified.
Overview
We are a designer and supplier of high performance storage networking, server networking, data networking and converged networking infrastructure solutions. Our solutions are sold worldwide, primarily to original equipment manufacturers, or OEMs, and distributors. We sell Fibre Channel and Internet Small Computer Systems Interface, or iSCSI, host bus adapters; InfiniBand® host channel adapters; and Fibre Channel over Ethernet, or FCoE, converged network adapters, which we collectively refer to as Host Products. We sell Fibre Channel switches, including stackable edge, blade and virtualized pass through switches; InfiniBand switches, including high-end multi-protocol directors, edge and blade switches; and storage routers for bridging Fibre Channel and iSCSI networks, which we collectively refer to as Network Products. We also sell Fibre Channel controllers, iSCSI controllers and converged network controllers, all for select embedded and target applications, which we collectively refer to as Silicon Products. In addition, we also design and supply Ethernet adapters and controllers as a result of our acquisition of NetXen in April 2009.
Customers, Markets and Applications
Our customers rely on our various networking infrastructure technologies to deliver solutions to information technology professionals in virtually every business sector.
Our products are found primarily in server, workstation and storage subsystem solutions that are used by small, medium and large enterprises with critical business data requirements. The business applications that drive requirements for our high performance networking infrastructure include:
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General business information technology requirements;
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Data warehousing, data mining and online transaction processing;
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Media-rich environments such as film/video, broadcast, medical imaging, computer-aided design, or CAD, and computer-aided manufacturing, or CAM;
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Server clustering, high-speed backup and data replication; and
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Research and scientific applications.
Our products are incorporated in solutions from a number of OEM customers, including Cisco Systems, Inc., Dell Inc., EMC Corporation, Hewlett-Packard Company, International Business Machines Corporation, NetApp, Inc., Sun Microsystems, Inc. and many others. For information regarding our major customers, see Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Part II, Item 7 of this report.
Some of our OEM customers experience seasonality and uneven sales patterns in their businesses. The seasonality is primarily due to the closing of a disproportionate percentage of sales transactions in the last month, weeks and days of each quarter and spikes in sales during the fourth quarter of each calendar year. Although we do not consider our business to be highly seasonal, we believe that seasonality has and may impact our business. To the extent that we experience seasonality in our business, it would most likely have a negative impact on the sequential growth rate of our net revenues during the fourth quarter of our fiscal year.
International revenues accounted for 52% of our net revenues for fiscal 2009. For additional information on our international sales and operations and related risks, see Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Part II, Item 7 of this report.
Our Networking Solutions
Our ability to address the market stems from our broad product line based on a variety of technologies, including Fibre Channel, iSCSI, Ethernet, FCoE and InfiniBand. Fibre Channel is currently the dominant technology for enterprise storage networking, while iSCSI is a lower cost alternative primarily used by small and medium sized businesses. FCoE is a converged networking technology that provides a unified storage and data network over enhanced Ethernet, while preserving the investment in existing Fibre Channel infrastructure and storage. Although we recently began shipping FCoE products, as with most emerging technologies it is expected that the market for FCoE will take a number of years to develop and mature.
We provide host Fibre Channel, iSCSI and Ethernet adapters. We also provide FCoE converged network adapters that leverage our core technology and expertise. Connecting servers to storage, we provide the network infrastructure with a broad line of Fibre Channel switches, including stackable edge, blade and virtualized pass through switches. In addition, we provide storage routers for bridging Fibre Channel and iSCSI networks and certain silicon controller products.
Our server networking solutions are based on InfiniBand technology. InfiniBand is a high performance, low-latency, server area fabric interconnect. Our ability to successfully address the requirements of server vendors targeting high performance computing environments is enhanced by our experience and success addressing the server to storage connectivity demands of these same customers. Our InfiniBand products include adapters and multi-protocol directors, edge and blade switches. These products provide high performance interconnect fabric solutions for cluster and grid computing networks.
We have focused on providing our customers with solutions that are qualified and easy to install and, as a result, are designed to significantly reduce the critical implementation and time-to-market effort for OEMs.
Sales and Marketing
Our products are marketed and sold primarily to OEMs by our internal sales team supported by field sales and systems engineering personnel. In addition, we sell our products through a network of regional and international distributors.
In domestic and in certain international markets, we maintain both a sales force to serve our large OEM customers and distributors that are focused on medium-sized and emerging accounts. We maintain a focused business development and outbound marketing organization to assist, train and equip the sales organizations of our major OEM customers and their respective reseller organizations and partners. We maintain sales offices in the United States and various international locations. For information regarding revenue by geographic area, see Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Part II, Item 7 of this report.
We work with our large storage system and computer system OEM customers during their design cycles. We support these customers with pre-sales system design support and services, as well as training classes and seminars conducted both in the field and from our worldwide offices.
Our sales efforts are focused on establishing and developing long-term relationships with our OEM customers. The sales cycle typically begins with the identification of an OEM’s requirement that could be potentially fulfilled with an existing QLogic product or a product based on a new technology. The cycle continues with technical and sales collaboration with the OEM and if successful, leads to one of our product designs being selected as a component in a potential customer’s computer system or data storage peripheral. We then work closely with the customer to integrate our products with the customer’s current and next generation products or platforms. This cycle, from opportunity identification to initial production shipment, typically ranges from six to twenty-four months.
In addition to sales and marketing efforts, we actively participate with industry organizations relating to the development and acceptance of industry standards. We collaborate with peer companies through open standards bodies, cooperative testing and certifications. To ensure and promote multi-vendor interoperation, we maintain interoperability certification programs and testing laboratories.
Engineering and Development
Our industry is subject to rapid and regular technological change. Our ability to compete depends upon our ability to continually design, develop and introduce new products that take advantage of market opportunities and address emerging standards. Our strategy is to leverage our substantial base of architectural and systems expertise to address a broad range of input/output storage and server networking solutions.
We are engaged in the design and development of application-specific integrated circuits, or ASICs, adapters and switches based on one or more of Fibre Channel, iSCSI, FCoE and Ethernet technologies. We also design and develop ASICs, adapters and switches based on InfiniBand technology for server fabric environments; and storage routers for bridging Fibre Channel and iSCSI networks.
We continue to invest in engineering and development to expand our capabilities to address the emerging technologies in the rapid evolution of storage and server networks. During fiscal 2009, 2008 and 2007, we incurred engineering and development expenses of $133.3 million, $134.7 million, and $135.3 million, respectively.
Backlog
A substantial portion of our sales with OEM customers are transacted through hub arrangements whereby our products are purchased on a just-in-time basis and fulfilled from warehouse facilities, or hubs, in proximity to the facilities of our customers or their contract manufacturers. Our sales are made primarily pursuant to purchase orders, including blanket purchase orders for hub arrangements. Because of the hub arrangements with our customers and industry practice that allows customers to cancel or change orders with limited advance notice, we believe that backlog at any particular date is not a reliable indicator of our future revenue levels and is not material to understanding our business.
Competition
The markets for networking infrastructure components are highly competitive and characterized by short product life cycles, price erosion, rapidly changing technology, frequent product performance improvements and evolving industry standards. We believe the principal competitive factors in our industry include:
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time-to-market;
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features and functionality;
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product quality, reliability and performance;
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price;
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new product innovation;
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customer relationships;
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design capabilities;
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customer service and technical support; and
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interoperability of components in the storage and server networking infrastructure.
While we expect competition to continue to increase and evolve, we believe that we compete effectively with respect to each of these factors.
Due to the broad array of components required in the storage and server networking infrastructure, we compete with several companies. In the traditional Fibre Channel adapter market, our primary competitor is Emulex Corporation, followed by Brocade Communications Systems, Inc. In the iSCSI adapter market, our primary competitor is Broadcom Corporation and we also compete with companies offering software initiator solutions. In the FCoE adapter market, we compete with traditional Fibre Channel players like Emulex Corporation and Brocade Communications Systems, Inc. as well as established Ethernet adapter suppliers such as Broadcom Corporation and Intel Corporation. In the Fibre Channel switch and storage router markets, we compete primarily with Brocade Communications Systems, Inc. and Cisco Systems, Inc. In the InfiniBand adapter and switch markets, we compete primarily with Voltaire Ltd. and Mellanox Technologies, Ltd.
Manufacturing
We use outside suppliers and foundries to manufacture our products. This approach allows us to avoid the high costs of owning, operating, maintaining and upgrading wafer fabrication and assembly facilities. As a result, we focus our resources on product design and development, quality assurance, sales and marketing, and supply chain management. Prior to the sale of our products, final tests are performed to ensure quality. Product test, customer-specific configuration and product localization are completed by third-party service providers or by us. We also provide fabrication process reliability tests and conduct failure analysis to confirm the integrity of our quality assurance procedures.
Our semiconductors are currently manufactured by a number of foundries. Our major semiconductor suppliers are LSI Corporation and International Business Machines Corporation. Most of the ASICs used in our products are manufactured using 180, 130, 90 or 65 nanometer process technology. In addition, we continually evaluate smaller geometries. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes.
We depend on foundries to allocate a portion of their capacity sufficient to meet our needs and to produce products of acceptable quality and with satisfactory manufacturing yields in a timely manner. These foundries fabricate products for other companies and, in certain cases, manufacture products of their own design. We do not have long-term supply agreements with any of these foundries; we purchase both wafers and finished chips on a purchase order basis. Therefore, the foundries generally are not obligated to supply products to us for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order. We work with our existing foundries, and intend to qualify new foundries, as needed, to obtain additional manufacturing capacity. However, there can be no assurance that we will be able to maintain our current foundry relationships or obtain additional capacity.
We currently purchase our semiconductor products from foundries either in finished or wafer form. We use subcontractors to assemble our semiconductor products purchased in wafer form, and to assemble our adapter, switch and other products. In the assembly process for our semiconductor products, the silicon wafers are separated into individual die, which are then assembled into packages and tested. For our adapter, switch and other products, we use third-party suppliers for material procurement, assembly, test and inspection in a turnkey model, prior to shipment to our customers.
Many of the component parts used in our adapter, switch and other products are standard off-the-shelf items, which are, or can be, obtained from more than one source. We select suppliers on the basis of technology, manufacturing capacity, financial viability, quality and cost. Our reliance on third-party manufacturers involves risks, including possible limitations on availability of products due to market abnormalities, geopolitical instability, unavailability of or delays in obtaining access to certain product technologies, and the absence of complete control over delivery schedules, manufacturing yields and total production costs. In addition, the current global economic downturn and tightening of credit markets could adversely affect our supplier base and increase the potential for one or more of our suppliers to experience financial distress or bankruptcy. The inability of our suppliers to deliver products of acceptable quality and in a timely manner or our inability to procure adequate supplies of our products could have a material adverse effect on our business, financial condition or results of operations.
Intellectual Property
While we have a number of patents issued and additional patent applications pending in the United States, Canada, Europe and Asia, we rely primarily on our trade secrets, trademarks, copyrights and contractual provisions to protect our intellectual property. We attempt to protect our proprietary information through confidentiality agreements and contractual provisions with our customers, suppliers, employees and consultants, and through other security measures. However, the laws of certain countries in which our
products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all.
Our ability to compete may be affected by our ability to protect our intellectual property. Although we intend to protect our rights vigorously, there can be no assurance that these measures will be successful.
We have received notices of claimed infringement of intellectual property rights in the past. There can be no assurance that third parties will not assert additional claims of infringement of intellectual property rights against us, or against customers who we are contractually obligated to indemnify, with respect to existing and future products. In the event of a patent or other intellectual property dispute, we may be required to expend significant resources to defend such claims, develop non-infringing technology or to obtain licenses to the technology which is the subject of the claim. There can be no assurance that we would be successful in such development or that any such license would be available on commercially reasonable terms, if at all. In the event of litigation to determine the validity of any third party’s claims, such litigation could result in significant expense to us, and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor.
Environment
Our operations are subject to regulation under various federal, state, local and foreign laws concerning the environment, including laws addressing the discharge of pollutants into the environment, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated sites. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, and third-party damage or personal injury claims, if we were to violate or become liable under environmental laws.
Most of our products are also subject to various laws governing chemical substances in products, including those regulating the manufacture and distribution of chemical substances and those restricting the presence of certain substances in electronic products. We could incur substantial costs, or our products could be restricted from entering certain countries, if our products become non-compliant with environmental laws. We also face increasing complexity in our product design and procurement operations as we adjust to new and future requirements relating to the materials composition of our products. For example, the European Union adopted the Waste Electrical and Electronic Equipment, or WEEE, Directive, which requires European Union countries to enact legislation to make producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. These and similar laws adopted in other countries could impose a significant cost of doing business in those countries.
Environmental costs are presently not material to our results of operations or financial position, and we do not currently anticipate material capital expenditures for environmental control facilities.
Working Capital
Cash provided by operating activities was $221.3 million for fiscal 2009. For additional information on our working capital, see Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources, included in Part II, Item 7 of this report.
Employees
We had 1,031 employees as of May 14, 2009, including approximately 90 employees related to our acquisition of NetXen in April 2009. We believe our future prospects will depend, in part, on our ability to continue to attract, train, motivate, retain and manage skilled engineering, sales, marketing and executive personnel. Our employees are not represented by a labor union. We believe that our relations with our employees are good.
Item 1A.
Item 1A. Risk Factors
Set forth below and elsewhere in this report and in other documents we file with the Securities and Exchange Commission are risks and uncertainties that could cause our actual results of operations to differ materially from the results contemplated by the forward-looking statements contained in this report or otherwise publicly disclosed by the Company.
The current economic downturn has resulted in a decrease in IT spending levels and could result in further deterioration of our revenues and operating results.
The United States and other countries around the world have been experiencing deteriorating economic conditions. There has been an erosion of global consumer confidence amidst concerns over declining asset values, inflation, energy costs, geopolitical issues, the availability and cost of credit, rising unemployment, and the stability and solvency of financial institutions, financial markets, businesses and sovereign nations. We are unable to predict the likely duration and severity of the current disruption in financial markets and adverse economic conditions in the U.S. and other countries. The economic decline has resulted in a global downturn in information technology, or IT, spending rates, which has negatively impacted our revenue and operating results. Further reductions in IT spending rates could result in longer sales cycles, increased inventory provisions, increased production costs, lower prices for our products and reduced sales volumes. Even if IT spending rates were to increase, we cannot be certain that the market for storage and server networking infrastructure solutions would be positively impacted. If economic conditions worsen, there are future reductions in either domestic or international IT spending rates, or IT spending rates do not increase, our revenues, operating results and financial condition could deteriorate further.
As a result of the worldwide economic slowdown, it is extremely difficult for us and our customers to forecast future revenue levels based on historical information and trends. Portions of our expenses are fixed and other expenses are tied to expected levels of revenue. To the extent that we do not achieve our anticipated level of revenue, our operating results could be adversely affected until such expenses are reduced to an appropriate level. In addition, we have implemented various cost cutting measures in order to better align our revenues and cost structure. We may not be able to identify and implement appropriate further cost savings in a timely manner. Additionally, we may determine that the costs of implementing reductions outweigh the commensurate benefits. Should we implement certain cost reductions, there could be adverse consequences on our business which could have a material adverse effect on our results of operations or financial condition.
We are also subject to various counterparty risks as a result of the economic slowdown, including the potential insolvency of key suppliers resulting in product delays, inability of customers to obtain credit to finance purchases of our products and/or potential customer insolvencies, increased risk that customers may delay payments or fail to pay, and counterparty failures, particularly financial institutions, negatively impacting our treasury operations, any of which could have a material adverse effect on our results of operations or financial condition.
Our operating results may fluctuate in future periods, which could cause our stock price to decline.
We have experienced, and expect to experience in future periods, fluctuations in sales and operating results from quarter to quarter. In addition, there can be no assurance that we will maintain our current gross margins or profitability in the future. A significant portion of our net revenues in each fiscal quarter results from orders booked in that quarter. Orders placed by major customers are typically based on their forecasted sales and inventory levels for our products.
Fluctuations in our quarterly operating results may also be the result of:
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the timing, size and mix of orders from customers;
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gain or loss of significant customers;
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customer policies pertaining to desired inventory levels of our products;
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negotiated rebates and extended payment terms;
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changes in our ability to anticipate in advance the mix of customer orders;
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levels of inventory our customers require us to maintain in our inventory hub locations;
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the availability and sale of new products;
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shifts or changes in technology;
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changes in the mix or average selling prices of our products;
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variations in manufacturing capacities, efficiencies and costs;
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the availability and cost of components, including silicon chips;
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variations in product development costs, especially related to advanced technologies;
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variations in operating expenses;
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changes in effective income tax rates, including those resulting from changes in tax laws;
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our ability to timely produce products that comply with new environmental restrictions or related requirements of our OEM customers;
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actual events, circumstances, outcomes and amounts differing from judgments, assumptions and estimates used in determining the value of certain assets (including the amounts of related valuation allowances), liabilities and other items reflected in our consolidated financial statements;
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the timing of revenue recognition and revenue deferrals;
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gains or losses related to our investment securities;
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changes in accounting rules;
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changes in our accounting policies;
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general economic and other conditions affecting the timing of customer orders and capital spending; or
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changes in the global economy that impact IT spending.
In addition, our quarterly results of operations are influenced by competitive factors, including the pricing and availability of our products and our competitors’ products. Furthermore, communications regarding new products and technologies could cause our customers to defer or cancel purchases of our products. Order deferrals by our customers, delays in our introduction of new products, and longer than anticipated design-in cycles for our products have in the past adversely affected our quarterly results of operations. Due to these factors, as well as other unanticipated factors, it is likely that in some future quarter or quarters our operating results will be below the expectations of public market analysts or investors, and as a result, the price of our common stock could significantly decrease.
We expect gross margin to vary over time, and our recent level of gross margin may not be sustainable.
Our recent level of gross margin may not be sustainable and may be adversely affected by numerous factors, including:
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changes in product mix;
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increased price competition;
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introduction of new products by us or our competitors, including products with advantages in price, performance or features;
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our inability to reduce manufacturing-related or component costs;
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entry into new markets or the acquisition of new businesses;
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amortization and impairments of purchased intangible assets;
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sales discounts;
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increases in material, labor or overhead costs;
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excess inventory and inventory holding charges;
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changes in distribution channels;
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increased warranty costs; and
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how well we execute our business strategy and operating plans.
Our stock price may be volatile.
The market price of our common stock has fluctuated substantially, and there can be no assurance that such volatility will not continue. Several factors could impact our stock price including, but not limited to:
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differences between our actual revenues and operating results and the published expectations of analysts;
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quarterly fluctuations in our revenues and operating results;
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introduction of new products or changes in product pricing policies by our competitors or us;
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conditions in the markets in which we operate;
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changes in market projections by industry forecasters;
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changes in estimates of our earnings by industry analysts;
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operating results or forecasts of our major customers or competitors;
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overall market conditions for high technology equities;
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rumors or dissemination of false information; and
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general economic and geopolitical conditions.
In addition, stock markets have experienced extreme price and volume volatility in recent years and stock prices of technology companies have been especially volatile. This volatility has had a substantial effect on the market prices of securities of many public companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations could adversely affect the market price of our common stock.
Our business is dependent, in large part, on the continued growth of the networking markets that we serve and if these markets do not continue to develop, our business will suffer.
A significant number of our products are used in storage area networks, or SANs, and server networks. Therefore, our business is dependent on the SAN and server infrastructure markets. Our success in generating revenue in these markets will depend on, among other things, our ability to:
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educate potential OEM customers, distributors, resellers, system integrators, storage system providers and end-user organizations about the benefits of our products;
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maintain and enhance our relationships with OEM customers, distributors, resellers, system integrators and storage system providers;
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predict and base our products on standards which ultimately become industry standards; and
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achieve interoperability between our products and other components from diverse vendors.
Our business could be adversely affected by the broad adoption of server virtualization technology.
Server virtualization technologies, which allow a single server to handle the function that was previously performed by many individual servers, are gaining momentum in the industry. The broad implementation of server virtualization could result in a decrease in the demand for servers, which could result in a lower demand for our products. This could have a material adverse effect on our business or results of operations.
Our business could be adversely affected by a significant increase in the market acceptance of blade servers.
Blade server products have gained acceptance in the market over the past few years. Blade servers use custom SAN infrastructure products, including blade switches and mezzanine cards, which have lower average selling prices than the SAN infrastructure products used in a non-blade server environment. If blade servers gain an increased percentage of the overall server market, our business could be adversely affected by the transition to blade server products. This could have a material adverse effect on our business or results of operations.
Our financial condition will be materially harmed if we do not maintain and gain market acceptance of our products.
The markets in which we compete involve rapidly changing technology, evolving industry standards and continuing improvements in products and services. Our future success depends, in part, on our ability to:
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enhance our current products and develop and introduce in a timely manner new products that keep pace with technological developments and industry standards;
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compete effectively on the basis of price and performance; and
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adequately address OEM and end-user customer requirements and achieve market acceptance.
We believe that to remain competitive, we will need to continue to develop new products, which will require a significant investment in new product development. Our competitors may be developing alternative technologies, which may adversely affect the market acceptance of our products. Although we continue to explore and develop products based on new technologies, a substantial portion of our revenues is generated today from Fibre Channel technology. If alternative technologies are adopted by the industry, we may not be able to develop products for new technologies in a timely manner. Further, even if alternative technologies do augment Fibre Channel revenues, our products may not be fully developed in time to be accepted by our customers. Even if our new products are developed on time, we may not be able to manufacture them at competitive prices or in sufficient volumes.
We recently began shipping products based on the Fibre Channel over Ethernet, or FCoE, protocol. FCoE is a developing converged networking technology that provides a unified storage and data network over enhanced Ethernet, while preserving the investment in existing Fibre Channel infrastructure and storage. As with most emerging technologies, it is expected that the market for FCoE will take a number of years to develop and mature. We expect products based on the FCoE protocol to supplement, and perhaps replace, certain products based on the Fibre Channel protocol. As a result, an inability to maintain our market share in the Fibre Channel market and build upon our market share in the FCoE market could have a material adverse effect on our business or results of operations.
We depend on a small number of customers, and any decrease in revenues or cash flows from any one of our major customers could adversely affect our results of operations and cause our stock price to decline.
A small number of customers account for a substantial portion of our net revenues, and we expect that a small number of customers will continue to represent a substantial portion of our net revenues in the foreseeable future. Our top ten customers accounted for 84%, 85% and 80% of net revenues for fiscal years 2009, 2008 and 2007, respectively. We are also subject to credit risk associated with the concentration of our accounts receivable. In addition, the worldwide economic slowdown and tightening of credit in financial markets may impact the businesses of our customers, which could have a material adverse effect on our business, financial condition or results of operations.
Our customers generally order products through written purchase orders as opposed to long-term supply contracts and, therefore, are generally not obligated to purchase products from us for any extended period. Major customers also have significant leverage over us and may attempt to change the terms, including pricing and payment terms, which could have a material adverse effect on our business, financial condition or results of operations. This risk is increased due to the potential for some of these customers to merge
with or acquire one or more of our other customers. As our OEM customers are pressured to reduce prices as a result of competitive factors, we may be required to contractually commit to price reductions for our products before we know how, or if, cost reductions can be obtained. If we are unable to achieve such cost reductions, our gross margins could decline and such decline could have a material adverse effect on our business, financial condition or results of operations.
Our business may be subject to seasonal fluctuations and uneven sales patterns in the future.
A large percentage of our products are sold to customers who experience seasonality and uneven sales patterns in their businesses. As a result, we may experience similar seasonality and uneven sales patterns. We believe this uneven sales pattern is a result of many factors including:
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the tendency of our customers to close a disproportionate percentage of their sales transactions in the last month, weeks and days of each quarter;
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spikes in sales during the fourth quarter of each calendar year that some of our customers experience; and
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differences between our quarterly fiscal periods and the fiscal periods of our customers.
In addition, as our customers increasingly require us to maintain products at hub locations near their facilities, it becomes increasingly difficult for us to predict sales trends. Our uneven sales pattern also makes it extremely difficult to predict the demand of our customers and adjust manufacturing capacity accordingly. If we predict demand that is substantially greater than actual customer orders, we will have excess inventory. Alternatively, if customer orders substantially exceed predicted demand, the ability to assemble, test and ship orders received in the last weeks and days of each quarter may be limited, or at an increased cost, which could have a material adverse effect on quarterly revenues and earnings.
Competition within the markets for our products is intense and includes various established competitors.
The markets for our products are highly competitive and are characterized by short product life cycles, price erosion, rapidly changing technology, frequent product improvements and evolving industry standards. In the traditional Fibre Channel adapter market, we compete primarily with Emulex Corporation, followed by Brocade Communications Systems, Inc. In the iSCSI adapter market, we compete primarily with Broadcom Corporation and we also compete with companies offering software initiator solutions. In the FCoE adapter market, we compete with traditional Fibre Channel players like Emulex Corporation and Brocade Communications Systems, Inc. as well as established Ethernet adapter suppliers such as Broadcom Corporation and Intel Corporation. In the Fibre Channel switch and storage router markets, we compete primarily with Brocade Communications Systems, Inc. and Cisco Systems, Inc. Our competition in the Fibre Channel switch market includes well-established participants who have significantly more sales and marketing resources to develop and penetrate this market. In the InfiniBand adapter and switch markets, we compete primarily with Voltaire Ltd. and Mellanox Technologies, Ltd. We may also compete with some of our server and storage systems customers, some of which have the capability to develop products comparable to those we offer.
We need to continue to develop products appropriate to our markets to remain competitive as our competitors continue to introduce products with improved features. While we continue to devote significant resources to engineering and development, these efforts may not be successful or competitive products may not be developed and introduced in a timely manner. In addition, while relatively few competitors offer a full range of storage and server networking infrastructure products, additional domestic and foreign manufacturers may increase their presence in these markets. We may not be able to compete successfully against these or other competitors. If we are unable to design, develop or introduce competitive new products on a timely basis, our future operating results may be materially and adversely affected.
We expect the pricing of our products to continue to decline, which could reduce our revenues, gross margins and profitability.
We expect the average unit prices of our products (on a like-for-like product comparison basis) to decline in the future as a result of competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors, or other factors. In addition, there is a general market trend of customers migrating away from the distribution channel for product purchases to OEMs, where products have a lower average unit price. If we are unable to offset these factors by increasing sales volumes, or reducing product manufacturing costs, our total revenues and gross margins may decline. In addition, we must develop and introduce new products and product enhancements. Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenues. As a result, we may not be able to decrease our spending to offset any unexpected shortfall in revenues. If
this occurs, our operating results and gross margins may be below our expectations and the expectations of investors and public market analysts, and our stock price could be negatively affected.
Our distributors may not adequately stock and sell our products and their reseller customers may purchase products from our competitors, which could negatively affect our results of operations.
Our distributors generally offer a diverse array of products from several different manufacturers and suppliers. Accordingly, we are at risk that these distributors may give higher priority to stocking and selling products from other suppliers, thus reducing their efforts and ability to sell our products. A reduction in sales efforts by our current distributors could materially and adversely impact our business or results of operations. In addition, if we decrease our distributor-incentive programs (i.e., competitive pricing and rebates), our distributors may decrease the amount of product purchased from us. This could result in a change of business behavior, and distributors may decide to decrease the amount of product held and reduce their inventory levels, which could impact availability of our products to their customers.
As a result of these factors regarding our distributors or other unrelated factors, the reseller customers of our distributors could decide to purchase products developed and manufactured by our competitors. Any loss of demand for our products by value-added resellers and system integrators could have a material adverse effect on our business or results of operations.
We are dependent on sole source and limited source suppliers for certain key components.
We purchase certain key components used in the manufacture of our products from single or limited sources. We purchase application-specific integrated circuits, or ASICs, from single sources and we purchase microprocessors, certain connectors, logic chips, power supplies and programmable logic devices from limited sources. If one of these suppliers experiences an interruption in its ability to supply our needs, or chooses to sever their relationship with us, we may be unable to produce certain of our products, which could result in the loss of customers and have a material adverse effect on our results of operations. The worldwide economic slowdown and tightening of credit in financial markets may adversely impact our suppliers by limiting their ability to finance their business operations and as a result limit their ability to supply products to us.
We are dependent on worldwide third-party subcontractors and contract manufacturers.
Third-party subcontractors located outside the United States assemble and test certain products for us. To the extent that we rely upon third-party subcontractors to perform these functions, we will not be able to directly control product delivery schedules and quality assurance. This lack of control may result in product shortages or quality assurance problems that could delay shipments of products or increase manufacturing, assembly, testing or other costs. If any of these subcontractors experience capacity constraints or financial difficulties, suffer damage to their facilities, experience power outages or any other disruption of assembly or testing capacity, we may not be able to obtain alternative assembly and testing services in a timely manner.
In addition, the loss of any of our major third-party contract manufacturers could significantly impact our ability to produce products for an indefinite period of time. Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process. Some customers will not purchase any products, other than a limited number of evaluation units, until they qualify the manufacturing line for the product, and we may not always be able to satisfy the qualification requirements of these customers. If we are required to change a contract manufacturer or if a contract manufacturer experiences delays, disruptions, capacity constraints, component parts shortages or quality control problems in its manufacturing operations, shipment of our products to our customers could be delayed, resulting in loss or postponement of revenues and potential harm to our competitive position and relationship with customers. In addition, the current global economic downturn and tightening of credit markets could adversely affect our third-party subcontractors or contract manufacturers and increase the potential for one or more of them to experience financial distress or bankruptcy.
Our investment securities portfolio could experience a decline in market value which could materially and adversely affect our financial results.
As of March 29, 2009, we held short-term and long-term investment securities aggregating $174.5 million. We invest primarily in debt securities, the majority of which are high investment grade, and we limit the exposure to credit risk through diversification and investment in highly-rated securities. However, investing in highly-rated securities does not entirely mitigate the risk of potential declines in market value. During fiscal 2009, we recorded impairment charges related to investment securities, including securities issued by companies in the financial services sector that had previously been rated AA or higher. A further deterioration in the economy, including further tightening of credit markets or significant volatility in interest rates, could cause additional declines in
value of our investment securities or could impact the liquidity of the portfolio. If market conditions deteriorate significantly, our results of operations or financial condition could be materially and adversely affected.
Our investment securities include $25.7 million of investments in auction rate debt and preferred securities (ARS), the majority of which are rated AA or higher. During late fiscal 2008, the market auctions of many ARS began to fail, including auctions for our ARS. The underlying assets for auction rate debt securities in our portfolio are student loans, substantially all of which are backed by the federal government under the Federal Family Education Loan Program. The underlying assets of our auction rate preferred securities are the respective funds’ investment portfolios.
In November 2008, we entered into an agreement with the broker for substantially all of the ARS we currently hold, which provides us with certain rights (ARS Rights), in exchange for the release of potential claims and damages against the broker. The ARS Rights entitle us to sell the related ARS back to the broker for a price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, if any, which price is referred to as “par.” The ARS Rights may be exercised by us at any time between June 30, 2010 and July 2, 2012, if the securities are not earlier redeemed or sold. Under the ARS Rights, the broker may, at its discretion, purchase the ARS at any time through July 2, 2012 without prior notice to us and must pay us par value for the ARS within one day of the sale transaction settlement. While we expect to ultimately recover our investments in the ARS at par, we may be unable to liquidate some or all of our ARS should we need or desire to access the funds invested in those securities prior to redemption by the issuer or the exercise of the ARS Rights. There is also a risk that our broker will default on its obligation to purchase the ARS in the event that we exercise the ARS Rights.
Our products are complex and may contain undetected software or hardware errors that could lead to an increase in our costs, reduce our net revenues or damage our reputation.
Our products are complex and may contain undetected software or hardware errors when first introduced or as newer versions are released. We are also exposed to risks associated with latent defects in existing products. From time to time, we have found errors in existing, new or enhanced products. In addition, our products are frequently combined with other products, including software, from other vendors, and these products often need to interface with existing networks, each of which have different specifications and utilize multiple protocol standards and products from other vendors. As a result, when problems occur, it may be difficult to identify the source of the problem. The occurrence of hardware or software errors could adversely affect the sales of our products, cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems.
The migration of our customers toward new products could adversely affect our results of operations.
As new or enhanced products are introduced, we must successfully manage the transition from older products in order to minimize the effects of product inventories that may become excess and obsolete, as well as ensure that sufficient supplies of new products can be delivered to meet customer demand. Our failure to manage the transition to newer products in the future or to develop and successfully introduce new products and product enhancements could adversely affect our business or results of operations. When we introduce new products and product enhancements, we face risks relating to product transitions, including risks relating to forecasting demand. Any such adverse event could have a material adverse effect on our business, financial condition or results of operations.
Historically, the technology industry has developed higher performance ASICs, which create chip-level solutions that replace selected board-level or box-level solutions at a significantly lower average selling price. We have previously offered ASICs to customers for certain applications that have effectively resulted in a lower-priced solution when compared to an adapter solution. This transition to ASICs may also occur with respect to other current and future products. The result of this transition may have an adverse effect on our business, financial condition or results of operations. In the future, a similar adverse effect to our business could occur if there were rapid shifts in customer purchases from our midrange server and storage solutions to products for the small and medium-sized business market or if our customers shifted to lower-cost products that could replace our adapter solutions.
Unanticipated changes in our tax provisions or adverse outcomes resulting from examination of our income tax returns could adversely affect our results of operations.
We are subject to income taxes in the United States and various foreign jurisdictions. Our effective income tax rates have recently been and could in the future be adversely affected by changes in tax laws or interpretations of those tax laws, by changes in the mix of earnings in countries with differing statutory tax rates, by discovery of new information in the course of our tax return preparation process, or by changes in the valuation of our deferred tax assets and liabilities. Our effective income tax rates are also affected by intercompany transactions for licenses, services, funding and other items. Given the increased global scope of our operations, and the
complexity of global tax and transfer pricing rules and regulations, it has become increasingly difficult to estimate earnings within each tax jurisdiction. If actual earnings within a tax jurisdiction differ materially from our estimates, we may not achieve our expected effective tax rate. Additionally, our effective tax rate may be impacted by the tax effects of acquisitions, newly enacted tax legislation, stock-based compensation and uncertain tax positions. Finally, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities which may result in the assessment of additional income taxes. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. However, unanticipated outcomes from these continuous examinations could have a material adverse effect on our financial condition or results of operations.
Environmental compliance costs could adversely affect our results of operations.
We are subject to various federal, state, local and foreign laws concerning environmental protection, including laws addressing the discharge of pollutants into the environment, the management and disposal of hazardous substances and wastes, the cleanup of contaminated sites, the content of our products and the recycling, treatment and disposal of our products. In particular, we face increasing complexity in our product design and procurement operations as we adjust to new and future requirements relating to the chemical and material composition of our products, their safe use, the energy consumption associated with those products and product take-back legislation (i.e., legislation that makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products). We could incur substantial costs, our products could be restricted from entering certain jurisdictions, and we could face other sanctions, if we were to violate or become liable under environmental laws or if our products become non-compliant with environmental laws. Our potential exposure includes fines and civil or criminal sanctions, third-party property damage or personal injury claims, and clean up costs. Further, liability under some environmental laws relating to contaminated sites can be imposed retroactively, on a joint and several basis, and without any finding of noncompliance or fault. The amount and timing of costs under environmental laws are difficult to predict.
Because we have operations in foreign countries and depend on foreign customers and suppliers, we are subject to international economic, currency, regulatory, political and other risks that could harm our business, financial condition and results of operations.
International revenues accounted for 52%, 49% and 46% of our net revenues for fiscal year 2009, 2008 and 2007, respectively. We expect that international revenues will continue to account for a significant percentage of our net revenues for the foreseeable future. In addition, we maintain operations in foreign countries and a significant portion of our inventory purchases are from suppliers that are located outside the United States. As a result, we are subject to several risks, which include:
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a greater difficulty of administering and managing our business globally;
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compliance with multiple and potentially conflicting regulatory requirements, such as import or export requirements, tariffs and other barriers;
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less effective intellectual property protections;
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potentially longer accounts receivable collection cycles;
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currency fluctuations;
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overlapping or differing tax structures;
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potential restrictions on transferring funds between countries and difficulties associated with repatriating cash generated or held outside of the U.S. in a tax-efficient manner;
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political and economic instability, including terrorism and war; and
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general trade restrictions.
Our international sales are invoiced in U.S. dollars and, accordingly, if the relative value of the U.S. dollar in comparison to the currency of our foreign customers should increase, the resulting effective price increase of our products to such foreign customers could result in decreased sales. Any of the foregoing factors could have a material adverse effect on our business, financial condition or results of operations.
In addition, we and our customers are subject to various import and export regulations of the United States government and other countries. Certain government export regulations apply to the encryption or other features contained in some of our products. Changes in or violations of any such import or export regulations could materially and adversely affect our business, financial condition or results of operations.
Moreover, in many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by regulations applicable to us, such as the Foreign Corrupt Practices Act. Although we implement policies and procedures designed to ensure compliance with these laws, our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, may take actions in violation of our policies. Any such violation, even if prohibited by our policies, could have a material adverse effect on our business, financial condition or results of operations.
We may engage in mergers, acquisitions and strategic investments and these activities may adversely affect our results of operations and stock price.
Our future growth may depend in part on our ability to identify and acquire complementary businesses, technologies or product lines that are compatible with our existing business. Mergers and acquisitions involve numerous risks, including:
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the failure of markets for the products of acquired companies to develop as expected;
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uncertainties in identifying and pursuing target companies;
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difficulties in the assimilation of the operations, technologies and products of the acquired companies;
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the existence of unknown defects in acquired companies’ products or assets that may not be identified due to the inherent limitations involved in the due diligence process of an acquisition;
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the diversion of management’s attention from other business concerns;
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risks associated with entering markets or conducting operations with which we have no or limited direct prior experience;
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risks associated with assuming the legal obligations of acquired companies;
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risks related to the effect that acquired companies’ internal control processes might have on our financial reporting and management’s report on our internal control over financial reporting;
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the potential loss of, or impairment of our relationships with, current customers or failure to retain the acquired companies’ customers;
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the potential loss of key employees of acquired companies; and
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the incurrence of significant exit charges if products or technologies acquired in business combinations are unsuccessful.
Further, we may never realize the perceived benefits of a business combination. Acquisitions by us could negatively impact gross margins or dilute stockholders’ investment and cause us to incur debt, contingent liabilities and amortization/impairment charges related to intangible assets, all of which could materially and adversely affect our financial position or results of operations. In addition, our effective tax rate for future periods could be negatively impacted by mergers and acquisitions.
We have made, and could make in the future, investments in technology companies, including privately-held companies in a development stage. Many of these private equity investments are inherently risky because the companies’ businesses may never develop, and we may incur losses related to these investments. In addition, we may be required to write down the carrying value of these investments to reflect other-than-temporary declines in their value, which could have a material adverse effect on our financial position and results of operations.
If we are unable to attract and retain key personnel, we may not be able to sustain or grow our business.
Our future success largely depends on our key engineering, sales, marketing and executive personnel, including highly skilled semiconductor design personnel and software developers, and in particular, our Chief Executive Officer, H.K. Desai. If we lose the services of Mr. Desai or other key personnel or fail to hire personnel for key positions, our business could be adversely affected. We believe that the market for key personnel in the industries in which we compete is highly competitive. In particular, periodically we have experienced difficulty in attracting and retaining qualified engineers and other technical personnel and anticipate that competition for such personnel will increase in the future. Our recent implementation of various cost saving measures, as well as past reductions in force, could negatively impact employee morale and potentially make attracting and retaining qualified employees more difficult in the future. As a result, we may not be able to attract and retain key personnel with the skills and expertise necessary to develop new products in the future or to manage our business, both in the United States and abroad.
We have historically used stock options and other forms of stock-based compensation as key components of our total employee compensation program in order to align employees’ interests with the interests of our stockholders, encourage retention of key personnel, and provide competitive compensation packages. In recent periods, many of our employee stock options were granted with exercise prices which exceed our current stock price, which reduces their value to employees and could affect our ability to retain employees. Moreover, applicable stock exchange listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant stock-based awards to employees in the future, which may result in changes in our stock-based compensation strategy. These and other developments relating to the provision of stock-based compensation to employees could make it more difficult to attract, retain and motivate key personnel.
We may experience difficulties in transitioning to smaller geometry process technologies.
We expect to continue to transition our semiconductor products to increasingly smaller line width geometries. This transition requires us to modify the manufacturing processes for our products and to redesign some products as well as standard cells and other integrated circuit designs that we may use in multiple products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies. Currently, most of our products include ASICs which are manufactured in 180, 130, 90 and 65 nanometer geometry processes. In addition, we continually evaluate smaller geometries. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes.
Our proprietary rights may be inadequately protected and difficult to enforce.
In some jurisdictions, we have patent protection on certain aspects of our technology. However, we rely primarily on trade secrets, trademarks, copyrights and contractual provisions to protect our proprietary rights. There can be no assurance that these protections will be adequate to protect our proprietary rights, that others will not independently develop or otherwise acquire equivalent or superior technology, or that we can maintain such technology as trade secrets. There also can be no assurance that any patents we possess will not be invalidated, circumvented or challenged. We have taken steps in several jurisdictions to enforce our trademarks against third parties. No assurances can be given that we will ultimately be successful in protecting our trademarks. The laws of certain countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all. If we fail to protect our intellectual property rights, our business could be negatively impacted.
Disputes relating to claimed infringement of intellectual property rights may adversely affect our business.
We have received notices of claimed infringement of intellectual property rights in the past and have been involved in intellectual property litigation in the past. There can be no assurance that third parties will not assert future claims of infringement of intellectual property rights against us, or against customers who we are contractually obligated to indemnify, with respect to existing and future products. In addition, individuals and groups are purchasing intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies such as ours. Although patent and intellectual property disputes may be settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and the necessary licenses or similar arrangements may not be available to us on satisfactory terms, or at all. As a result, we could be prevented from manufacturing and selling some of our products. In addition, if we litigate these kinds of claims, the litigation could be expensive, time consuming and could divert management’s attention from other matters and there is no guarantee we would prevail. Our business could suffer regardless of the outcome of the litigation. Our supply of silicon chips and other components can also be interrupted by intellectual property infringement claims against our suppliers.
Dependence on third-party technology could adversely affect our business.
Some of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that necessary licenses will be available on acceptable terms, if at all. In addition, we may have little or no ability to correct errors in the technology provided by such third parties, or to continue to develop new generations of such technology. Accordingly, we may be dependent on their ability and willingness to do so. In the event of a problem with such technology, or in the event that our rights to use such technology become impaired, we may be unable to ship our products containing such technology, and may be unable to replace the technology with a suitable alternative within the time frame needed by our customers. The inability to find suitable alternatives to third-party technology, obtain certain licenses or obtain such licenses on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse impact on our business, results of operations and financial condition.
If we fail to carefully manage the use of “open source” software in our products, we may be required to license key portions of our products on a royalty-free basis or expose key parts of source code.
Certain of our software may be derived from “open source” software that is generally made available to the public by its authors and/or other third parties. Such open source software is often made available to us under licenses, such as the GNU General Public License (GPL) which impose certain obligations on us in the event we were to distribute derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public, and/or license such derivative works under a particular type of license, rather than the forms of licenses customarily used to protect our intellectual property. In the event the copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public and/or stop distribution of that work.
Our business could be materially adversely affected by changes in regulations or standards regarding energy use of our products.
We continually seek ways to increase the energy efficiency of our products. Recent analyses have estimated the amount of global carbon emissions that are due to information technology products. As a result, governmental and non-governmental organizations have turned their attention to development of regulations and standards to drive technological improvements and reduce such amount of carbon emissions. There is a risk that the rush to development of these standards will not fully address the complexity of the technology developed by the IT industry or will favor certain technological approaches. Depending on the regulations or standards that are ultimately adopted, compliance could adversely affect our business, results of operations or financial condition.
Computer viruses and other forms of tampering with our computer systems or servers may disrupt our operations and adversely affect our results of operations.
Despite our implementation of network security measures and anti-virus defenses, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, results of operations or financial condition.
Our facilities and the facilities of our suppliers and customers are located in regions that are subject to natural disasters.
Our California facilities, including our principal executive offices, our principal design facilities and our critical business operations, are located near major earthquake faults. We are not specifically insured for earthquakes or other natural disasters. Any personal injury or damage to the facilities as a result of such occurrences could have a material adverse effect on our business, results of operations or financial condition. Additionally, we have operations, suppliers and customers in regions which have historically experienced natural disasters. Any earthquake or other natural disaster, including a hurricane, tsunami or fire, affecting any of these regions could adversely affect our business, results of operations and financial condition.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our principal product development, operations, sales and corporate offices are located in three buildings comprising approximately 165,000 square feet in Aliso Viejo, California. We own each of these buildings. We also lease one building comprising approximately 100,000 square feet in Shakopee, Minnesota, that houses product development and operations teams for many of our Network Products. We lease an operations, sales and fulfillment facility located near Dublin, Ireland. In addition, we lease facilities in Mountain View and Roseville, California; King of Prussia, Pennsylvania; and Pune, India. We also maintain sales offices at various locations in the United States, Europe and Asia. We believe that our existing properties, including both owned and leased sites, are in good condition and suitable for the conduct of our business.
Item 3.
Item 3. Legal Proceedings
Various lawsuits, claims and proceedings have been or may be instituted against us. The outcome of litigation cannot be predicted with certainty and some lawsuits, claims and proceedings may be disposed of unfavorably to us. Many intellectual property disputes have a risk of injunctive relief and there can be no assurance that a license will be granted. Injunctive relief could have a material adverse effect on our financial condition or results of operations. Based on an evaluation of matters which are pending or asserted, we believe the disposition of such matters will not have a material adverse effect on our financial condition or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matter was submitted to a vote of security holders during the fourth quarter of fiscal 2009.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Principal Market and Prices
Shares of our common stock are traded and quoted on The NASDAQ Stock Market under the symbol QLGC. The following table sets forth the range of high and low sales prices per share of our common stock for each quarterly period of the two most recent fiscal years as reported on The NASDAQ Stock Market.
Number of Common Stockholders
The number of record holders of our common stock was 522 as of May 14, 2009.
Dividends
We have never paid cash dividends on our common stock. We currently anticipate that we will retain all of our future earnings for use in the development and expansion of our business and for general corporate purposes, including repurchases of our common stock. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon our operating results, financial condition and other factors as the board of directors deems relevant.
Recent Sales of Unregistered Securities
We did not issue any unregistered securities during fiscal 2009.
Issuer Purchases of Equity Securities
In November 2007, our Board of Directors approved a program to repurchase up to $200 million of our common stock over a two-year period. During the three months ended March 29, 2009, we purchased 0.7 million shares of our common stock under this program for an aggregate purchase price of $8.9 million, which completed this program. In November 2008, our Board of Directors approved a new program to repurchase up to an additional $300 million of our common stock over a two-year period. Set forth below is information regarding our stock repurchases made during the fourth quarter of fiscal 2009 under these programs.
We previously purchased 14.1 million shares under the November 2007 program for an aggregate purchase price of $191.1 million.
Stockholder Return Performance
The performance graph below shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act), or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that we specifically incorporate this information by reference, and will not otherwise be deemed filed under the Acts.
The following graph compares, for the five-year period ended March 29, 2009, the cumulative total stockholder return for the Company’s common stock, the Standard & Poor’s 500 Index (S&P 500 Index) and the NASDAQ Computer Index. Measurement points are the last trading day of each of the Company’s fiscal years ended March 28, 2004, April 3, 2005, April 2, 2006, April 1, 2007, March 30, 2008 and March 29, 2009. The graph assumes that $100 was invested on March 28, 2004 in the common stock of the Company, the S&P 500 Index and the NASDAQ Computer Index and assumes reinvestment of dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURNS*
AMONG QLOGIC CORPORATION, THE STANDARD & POOR’S 500 INDEX
AND THE NASDAQ COMPUTER INDEX
Item 6.
Item 6. Selected Financial Data
The following selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto appearing elsewhere in this report.
(1)
The statement of operations data for all periods presented reflects the operating results of the hard disk drive controller and tape drive controller business as discontinued operations.
(2)
The per share amounts for all periods presented reflect the effects of the two-for-one split of our common stock in March 2006.
(3)
In fiscal 2007, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment.” In addition, the Company completed the acquisitions of PathScale, Inc. and SilverStorm Technologies, Inc. during fiscal 2007.
(4)
In fiscal 2006, the Company completed the acquisition of Troika Networks, Inc.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our audited consolidated financial statements and related notes. In this discussion and elsewhere in this report, we make forward-looking statements. These forward-looking statements are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, without limitation, descriptions of our expectations regarding future trends affecting our business and other statements regarding future events or our objectives, goals, strategies, beliefs and underlying assumptions that are other than statements of historical fact. When used in this report, the words “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” “will” and similar expressions, or the negative of such expressions, are intended to identify these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of several factors, including, but not limited to those factors set forth and discussed in Part I, Item 1A “Risk Factors” and elsewhere in this report. In light of the significant uncertainties inherent in the forward-looking information included in this report, the inclusion of this information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. We undertake no obligation to update or revise these forward-looking statements, whether as a result of new information, future events or otherwise.
Overview
We are a designer and supplier of high performance storage networking, server networking, data networking and converged networking infrastructure solutions. Our solutions are sold worldwide, primarily to original equipment manufacturers, or OEMs, and distributors. We sell Fibre Channel and Internet Small Computer Systems Interface, or iSCSI, host bus adapters; InfiniBand® host channel adapters; and Fibre Channel over Ethernet, or FCoE, converged network adapters, which we collectively refer to as Host Products. We sell Fibre Channel switches, including stackable edge, blade and virtualized pass through switches; InfiniBand switches, including high-end multi-protocol directors, edge and blade switches; and storage routers for bridging Fibre Channel and iSCSI networks, which we collectively refer to as Network Products. We also sell Fibre Channel controllers, iSCSI controllers and converged network controllers, all for select embedded and target applications, which we collectively refer to as Silicon Products.
Our products are incorporated in solutions from a number of OEM customers, including Cisco Systems, Inc., Dell Inc., EMC Corporation, Hewlett-Packard Company, International Business Machines Corporation, NetApp, Inc., Sun Microsystems, Inc. and many others.
We use a fifty-two/fifty-three week fiscal year ending on the Sunday nearest March 31. Fiscal years 2009, 2008 and 2007 each comprised fifty-two weeks and ended on March 29, 2009, March 30, 2008 and April 1, 2007, respectively.
Fiscal Year and Fourth Quarter Financial Highlights and Other Information
During fiscal 2009, our net revenues increased 6% to $633.9 million from $597.9 million in fiscal 2008 and included increases in each of our Host Products, Network Products and Silicon Products. Net income for fiscal 2009 increased 13% to $108.8 million, or $0.85 per diluted share, from $96.2 million, or $0.67 per diluted share, in fiscal 2008. In addition, the Company generated $221.3 million in cash from operations during fiscal 2009.
A summary of the key factors and significant events which impacted our financial performance during the fourth quarter of fiscal 2009 are as follows:
As a result of the worldwide economic slowdown, it is extremely difficult for us and our customers to forecast future sales levels based on historical information and trends. Portions of our expenses are fixed and other expenses are tied to expected levels of sales activities. To the extent that we do not achieve our anticipated level of sales, our gross profit and net income could be adversely affected until such expenses are reduced to an appropriate level.
Results of Operations
Net Revenues
A summary of the components of our net revenues is as follows:
Historically, the global marketplace for network infrastructure solutions has expanded in response to the information storage requirements of enterprise business environments, as well as the market for solutions in high performance computing environments. These markets have been characterized by rapid advances in technology and related product performance, which has generally resulted in declining average selling prices over time. In general, our revenues have been favorably affected by increases in units sold as a result of market expansion and the release of new products. The favorable effect on our revenues as a result of increases in volume has been partially offset by the impact of declining average selling prices.
The United States and other countries around the world have been experiencing deteriorating economic conditions. This economic decline has resulted in a global downturn in information technology spending rates, which has negatively impacted our revenue and operating results. In addition, we believe there may be potential for a broader slowdown in global information technology spending rates. Accordingly, it is extremely difficult for us to forecast future sales levels and historical information may not be indicative of future trends.
Our net revenues are derived primarily from the sale of Host Products, Network Products and Silicon Products. Net revenues increased 6% to $633.9 million for fiscal 2009 from $597.9 million for fiscal 2008. This increase was primarily the result of a $3.0 million, or 1%, increase in revenue from Host Products; a $15.8 million, or 16%, increase in revenue from Network Products; and a $17.1 million, or 39%, increase in revenue from Silicon Products. The increase in revenue from Host Products was primarily due to an 8% increase in the quantity of host bus adapters sold partially offset by a 7% decrease in average selling prices of these products. The increase in revenue from Network Products was primarily due to a 40% increase in the number of Fibre Channel switches sold, partially offset by a 21% decrease in the average selling prices of these products, and a 32% increase in the number of InfiniBand switches sold, partially offset by an 11% decrease in the average selling prices of these products. The increase in revenue from Silicon Products from the prior year was due primarily to a 32% increase in the number of Fibre Channel and iSCSI controllers sold. Net revenues for fiscal 2009 included $14.0 million of royalty and service revenue compared with $13.9 million of royalty and service
revenue for fiscal 2008. Royalty and service revenues are unpredictable and we do not expect them to be significant to our overall revenues.
Net revenues were $597.9 million for fiscal 2008 compared to $586.7 million for fiscal 2007. This increase was primarily the result of a $27.3 million, or 7%, increase in revenue from Host Products and a $13.5 million, or 15%, increase in revenue from Network Products, partially offset by a $32.4 million, or 42%, decrease in revenue from Silicon Products. The increase in revenue from Host Products was primarily due to a 21% increase in the quantity of host bus adapters sold partially offset by a 12% decrease in average selling prices of these products. This host bus adapter volume increase was primarily driven by approximately a 150% increase in the quantity of Fibre Channel mezzanine cards sold which are used in blade servers and have a lower average selling price than standard host bus adapter products. The increase in revenue from Network Products was primarily due to the addition of InfiniBand switches to our product portfolio as a result of our acquisition of SilverStorm Technologies, Inc. (SilverStorm), partially offset by a 4% decrease in revenue from Fibre Channel switch products. The decrease in Fibre Channel switch revenue was primarily due to a decline in revenue from our legacy and end-of-life products, which was not offset by revenue from our more recent product offerings until late fiscal 2008. The decrease in revenue from Silicon Products from the same period in the prior year was due primarily to an expected decrease in units sold. Net revenues for fiscal 2008 included $13.9 million of royalty and service revenue compared with $11.1 million of royalty and service revenue for fiscal 2007.
A small number of our customers account for a substantial portion of our net revenues, and we expect that a small number of customers will continue to represent a substantial portion of our net revenues for the foreseeable future. Our top ten customers accounted for 84%, 85% and 80% of net revenues during fiscal 2009, 2008 and 2007, respectively.
A summary of our customers, including their manufacturing subcontractors, that represent 10% or more of our net revenues for any of the fiscal years presented is as follows:
We believe that our major customers continually evaluate whether or not to purchase products from alternative or additional sources. Additionally, customers’ economic and market conditions frequently change. Accordingly, there can be no assurance that a major customer will not reduce, delay or eliminate its purchases from us. Any such reduction, delay or loss of purchases could have a material adverse effect on our business, financial condition or results of operations.
Net revenues by geographic area are as follows:
Revenues by geographic area are presented based upon the country of destination, which is not necessarily indicative of the location of the ultimate end-user of our products. No individual country other than the United States represented 10% or more of net revenues for any of the fiscal years presented.
Gross Profit
Gross profit represents net revenues less cost of revenues. Cost of revenues consists primarily of the cost of purchased products, assembly and test services; costs associated with product procurement, inventory management and product quality; and the amortization and impairment of purchased intangible assets. A summary of our gross profit and related percentage of net revenues is as follows:
Gross profit for fiscal 2009 increased $31.9 million, or 8%, from gross profit for fiscal 2008. The gross profit percentage for fiscal 2009 was 66.9% and increased from 65.6% for the prior year. The increase in gross profit percentage was primarily the result of manufacturing related efficiencies and a decline of $3.5 million in amortization and impairment of purchased intangible assets in fiscal 2009.
Gross profit for fiscal 2008 decreased $2.8 million from gross profit for fiscal 2007. The gross profit percentage for fiscal 2008 was 65.6% and decreased from 67.3% for the prior year. The decline in gross profit percentage was primarily impacted by a shift in product mix, including the addition of InfiniBand products as a result of our acquisition of SilverStorm, and an increase of $4.1 million in amortization and impairment of purchased intangible assets.
Our ability to maintain our current gross profit percentage can be significantly affected by factors such as the results of our investment in engineering and development activities, supply costs, the worldwide semiconductor foundry capacity, the mix of products shipped, the transition to new products, competitive price pressures, the timeliness of volume shipments of new products, the level of royalties received, our ability to achieve manufacturing cost reductions, and amortization and impairments of purchased intangible assets. We anticipate that it will be increasingly difficult to reduce manufacturing costs. As a result of these and other factors, it may be difficult to maintain our gross profit percentage consistent with historical periods and it may decline in the future.
Operating Expenses
Our operating expenses are summarized in the following table:
Engineering and Development. Engineering and development expenses consist primarily of compensation and related benefit costs, service and material costs, occupancy costs and related computer support costs. During fiscal 2009, engineering and development expenses decreased to $133.2 million from $134.7 million in fiscal 2008. The decrease was primarily due to a $1.0 million decrease in acquisition-related stock-based compensation that resulted from headcount reductions in the fourth quarter of fiscal 2009, a $0.9 million decrease in cash compensation and benefit costs and a $0.7 million decrease in occupancy and related computer support costs that both resulted from a net reduction in headcount, including a reduction in headcount related to the consolidation and elimination of certain engineering activities during fiscal 2008. These decreases were partially offset by a $1.2 million increase in depreciation and equipment costs.
During fiscal 2008, engineering and development expenses decreased to $134.7 million from $135.3 million in fiscal 2007. The decrease in engineering and development expenses was due primarily to a decrease in acquisition-related stock-based compensation of $6.4 million, a $1.6 million decrease in new product development costs and a $1.5 million decrease in cash compensation and related benefit costs. These decreases resulted primarily from the consolidation and elimination of certain engineering activities. See further discussion under “Special Charges.” These decreases were partially offset by a $3.3 million increase in stock-based compensation, excluding acquisition-related charges, a $3.2 million increase in occupancy costs and related computer support costs, and a $2.5 million increase in depreciation and equipment costs.
We believe continued investments in engineering and development activities are critical to achieving future design wins, expansion of our customer base and revenue growth opportunities.
Sales and Marketing. Sales and marketing expenses consist primarily of compensation and related benefit costs, sales commissions, promotional activities and travel for sales and marketing personnel. Sales and marketing expenses increased to $87.0 million for fiscal 2009 from $84.2 million for fiscal 2008. The increase in sales and marketing expenses was due primarily to a $2.4 million increase in salaries due to increased average headcount during fiscal 2009, a $1.7 million increase in occupancy costs and related computer support costs and a $1.4 million increase in commissions. These increases were partially offset by a $2.2 million decrease in promotional costs, including our costs for certain sales and marketing programs, and a $0.6 million decrease in travel costs, both related to our cost cutting measures in the second half of fiscal 2009.
Sales and marketing expenses decreased to $84.2 million for fiscal 2008 from $86.8 million for fiscal 2007. The decrease in sales and marketing expenses was due primarily to a $4.0 million decrease in promotional costs, including the costs for certain sales and marketing programs, and a decrease in stock-based compensation of $3.3 million, including stock-based compensation related to acquisitions, partially offset by a $2.0 million increase in amortization of purchased intangible assets related to the acquisition of SilverStorm, an increase in depreciation and equipment costs of $1.0 million, a $0.9 million increase in cash compensation and related benefit costs and a $0.9 million increase in travel related expenses.
We believe continued investments in our sales and marketing organizational infrastructure and related marketing programs are critical to the success of our strategy of expanding our customer base and enhancing relationships with our existing customers.
General and Administrative. General and administrative expenses consist primarily of compensation and related benefit costs for executive, finance, accounting, human resources, legal and information technology personnel. Non-compensation components of general and administrative expenses include accounting, legal and other professional fees, facilities expenses and other corporate expenses. General and administrative expenses decreased to $32.6 million for fiscal 2009 from $34.0 million for fiscal 2008. The decrease in general and administrative expenses was due primarily to a $2.8 million decrease in stock-based compensation, partially offset by a $1.6 million increase in cash compensation and related benefit costs due to increased headcount.
General and administrative expenses increased to $34.0 million for fiscal 2008 from $31.0 million for fiscal 2007. The increase in general and administrative expenses was due primarily to a $0.7 million increase in cash compensation and related benefit costs, a $0.6 million increase in accounting and legal fees, and a $0.4 million increase in bad debt expense.
Special Charges. During fiscal 2009, we implemented a workforce reduction initiative, primarily in response to the macroeconomic environment, and recorded special charges totaling $4.1 million. The special charges consisted primarily of $3.9 million of exit costs associated with severance benefits for the affected employees and costs related to a facility under a non-cancelable lease that we vacated during fiscal 2009.
During fiscal 2008, we recorded special charges totaling $5.3 million related to workforce reductions and the consolidation and elimination of certain activities, principally related to certain engineering functions. The special charges consisted of $5.0 million for exit costs and $0.3 million for asset impairments. The exit costs include the costs associated with workforce reductions, the cancellation of a contract and the consolidation of certain facilities.
The unpaid exit costs as of March 29, 2009, which aggregate $2.0 million, are expected to be paid over the terms of the related agreements, principally during fiscal 2010.
Purchased In-Process Research and Development. In connection with our acquisitions, we recorded $3.7 million of purchased in-process research and development (IPR&D) charges during fiscal 2007. The amounts allocated to IPR&D were determined through established valuation techniques used in the high technology industry and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed.
The fair value of the IPR&D for each of the acquisitions was determined using the income approach. Under the income approach, the expected future cash flows from each project under development are estimated and discounted to their net present values at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return are the weighted-average cost of capital and return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. Each project was analyzed to determine the unique technological innovations, the existence and reliance on core technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development. Future cash flows for each project were estimated based on forecasted revenue and costs, taking into account product life cycles, and market penetration and growth rates.
As of March 30, 2008, all IPR&D projects were complete.
Interest and Other Income, Net
Components of our interest and other income, net, are as follows:
Interest income decreased to $11.3 million in fiscal 2009 from $20.6 million in fiscal 2008 primarily due to a decrease in the balance of our investment securities and a decline in interest rates.
The impairment charges on investment securities of $16.4 million, includes $11.3 million related to declines in value of our available-for-sale securities that were deemed to be other-than-temporary and $5.1 million related to our investments in a money market fund and an enhanced cash fund sponsored by The Reserve (an asset management company).
During fiscal 2009, we sold all of our remaining holdings in common stock that we held in a publicly-traded company and recorded a net gain of $2.1 million. We had received the common stock in connection with the sale of our hard disk drive controller and tape drive controller business in fiscal 2006. We had previously recorded impairment charges related to these shares totaling $15.9 million since fiscal 2007, including $4.3 million during fiscal 2009.
The gain related to put options includes $8.1 million recognized as a result of an agreement that we entered into with the broker for substantially all of our auction rate securities (ARS) that entitles us to sell the related ARS back to the broker for a price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, if any, at any time between June 30, 2010 and July 2, 2012, if the securities are not earlier redeemed or sold. In addition, we recorded a $1.2 million gain related to subsequent increases in the fair value of these put options during fiscal 2009.
The loss on trading securities was due to the realization of $3.4 million of previously unrealized losses on certain ARS that were transferred from accumulated other comprehensive loss as a result of the reclassification of the ARS from available-for-sale to trading securities and $2.4 million related to changes in the fair value of these trading securities subsequent to the reclassification.
Interest and other income, net, for fiscal 2008 of $14.0 million was comprised principally of interest income of $20.6 million related to our portfolio of investment securities and $0.6 million of net realized gains on sales of available-for-sale securities, partially offset by a $6.9 million impairment charge on available-for-sale securities. Interest income decreased primarily due to a decrease in the balance of our investment securities and a decline in interest rates.
We reviewed various factors in determining whether to recognize an impairment charge related to our unrealized losses in available-for-sale securities, including the current financial and credit market environment, the financial condition and near term prospects of the issuer of the investment security, the magnitude of the unrealized loss compared to the cost of the investment, the length of time the investment has been in a loss position and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of market value. Based on this analysis, we determined that a portion of the unrealized losses were other-than-temporary and recorded impairment charges of $11.3 million, $6.9 million and $8.1 million related to our portfolio of available-for-sale securities during fiscal 2009, 2008 and 2007, respectively.
Income Taxes
Our effective income tax rate was 36% in fiscal 2009, 35% in fiscal 2008 and 32% in fiscal 2007. In fiscal 2009, our effective income tax rate was adversely impacted by additional payments in connection with an intercompany technology license related to our intellectual property, which resulted in additional income taxed at U.S. rates, and a valuation allowance against deferred tax assets related to impairment charges on certain investment securities. The impact of these items was partially offset by the resolution of routine tax examinations and higher income generated from our foreign operations, which are taxed at more favorable rates. Given the
increased global scope of our operations, and the complexity of global tax and transfer pricing rules and regulations, it has become increasingly difficult to estimate earnings within each tax jurisdiction. If actual earnings within each tax jurisdiction differ materially from our estimates, we may not achieve our expected effective tax rate. Additionally, our effective tax rate may be impacted by other items including the tax effects of acquisitions, newly enacted tax legislation, stock-based compensation and uncertain tax positions.
As of April 2, 2007, we adopted Financial Accounting Standards Board Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109,” which prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. The adoption of FIN 48 did not have a material impact on our financial position or results of operations.
Liquidity and Capital Resources
Our combined balances of cash, cash equivalents and investment securities increased to $378.3 million at March 29, 2009, from $376.4 million at March 30, 2008. We believe that existing cash, cash equivalents, investment securities and expected cash flow from operations will provide sufficient funds to finance our operations for at least the next twelve months. However, it is possible that we may need to supplement our existing sources of liquidity to finance our activities beyond the next twelve months or for the future acquisition of businesses, products or technologies and there can be no assurance that sources of liquidity will be available to us at that time.
Cash provided by operating activities was $221.3 million for fiscal 2009 and $211.6 million for fiscal 2008. Operating cash flow for fiscal 2009 reflects our net income of $108.8 million, net non-cash charges of $104.6 million and a net decrease in the non-cash components of working capital of $7.9 million. The decrease in the non-cash components of working capital was primarily due to a $12.8 million decrease in accounts receivable and a $7.2 million increase in accrued taxes, partially offset by $12.8 million increase in inventories. The decrease in accounts receivable was primarily due to the decline in revenue during the fiscal fourth quarter compared to the corresponding period in fiscal 2008 and the increase in accrued taxes was mainly due to the timing of payment obligations. The increase in inventories was primarily due to an increase as a result of a planned contract manufacturer transition.
Cash provided by investing activities was $4.4 million for fiscal 2009 and consisted of distributions totaling $48.9 million related to our investments in a money market fund and enhanced cash fund sponsored by The Reserve (an asset management company) and net sales and maturities of investment securities of $43.4 million, partially offset by a $57.2 million reclassification of certain cash equivalents to investment securities related to our investments in the funds sponsored by The Reserve and purchases of property and equipment of $30.7 million. Cash provided by investing activities for fiscal 2008 was $209.4 million and consisted primarily of net sales and maturities of investment securities of $239.3 million, partially offset by purchases of property and equipment of $30.0 million.
As our business grows, we expect capital expenditures to increase in the future as we continue to invest in machinery and equipment, more costly engineering and production tools for new technologies, and enhancements to our corporate information technology infrastructure.
Cash used in financing activities of $181.9 million for fiscal 2009 consisted primarily of our purchase of $205.7 million of common stock under our stock repurchase programs, partially offset by $23.8 million of proceeds from the issuance of common stock under our stock plans and the related tax benefit. Cash used in financing activities for fiscal 2008 of $337.8 million resulted from our purchase of $352.8 million of common stock under our stock repurchase programs, partially offset by $15.0 million of proceeds from the issuance of common stock under our stock plans and the related tax benefit.
Our investment securities include $25.7 million of investments in ARS, the majority of which are rated AA or higher. During late fiscal 2008, the market auctions of many ARS began to fail, including auctions for our ARS. The underlying assets for auction rate debt securities in our portfolio are student loans, substantially all of which are backed by the federal government under the Federal Family Education Loan Program. The underlying assets of our auction rate preferred securities are the respective funds’ investment portfolios.
In November 2008, we entered into an agreement with the broker for substantially all of the ARS we currently hold, which provides us with certain rights (ARS Rights), in exchange for the release of potential claims and damages against the broker. The ARS Rights entitle us to sell the related ARS back to the broker for a price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, if any, which price is referred to as “par.” The ARS Rights may be exercised by us at any time between
June 30, 2010 and July 2, 2012, if the securities are not earlier redeemed or sold. Under the ARS Rights, the broker may, at its discretion, purchase the ARS at any time through July 2, 2012 without prior notice to us and must pay us par value for the ARS within one day of the sale transaction settlement. While we expect to ultimately recover our investments in the ARS at par, we may be unable to liquidate some or all of our ARS should we need or desire to access the funds invested in those securities prior to redemption by the issuer or the exercise of the ARS Rights. There is also a risk that our broker will default on its obligation to purchase the ARS in the event that we exercise the ARS Rights.
Except for our ARS and the related put options, our investment securities are valued based on quoted market prices or other observable market inputs. As of March 29, 2009, the entire $25.7 million portfolio of ARS and the related put options valued at $9.3 million (collectively 20% of our investment securities portfolio) were measured at fair value based on an income approach using an estimate of future cash flows. The assumptions used in preparing the discounted cash flow model included estimates for the amount and timing of future interest and principal payments, the collateralization of underlying security investments, the creditworthiness of the issuer and the rate of return required by investors to own these securities in the current environment, including call and liquidity premiums.
Since fiscal 2003, we have had various stock repurchase programs that authorized the purchase of up to $1.55 billion of our outstanding common stock, including a program approved in November 2008 authorizing the repurchase of up to $300 million of our outstanding common stock. During fiscal 2009, we purchased 15.8 million shares of our common stock for an aggregate purchase price of $205.5 million, of which $1.5 million was pending settlement at March 29, 2009 and is included in other current liabilities in the 2009 consolidated balance sheet. During fiscal 2008, we purchased 24.1 million shares of our common stock for an aggregate purchase price of $351.5 million, of which $1.7 million was pending settlement and is included in other current liabilities in the 2008 consolidated balance sheet. Pursuant to the existing stock repurchase programs, we are authorized to repurchase shares with an aggregate cost of up to $269.9 million as of March 29, 2009.
On April 27, 2009, we acquired NetXen, Inc. (NetXen) in a merger transaction. NetXen develops, markets and sells Ethernet adapter and controller products targeted at the enterprise server market. The acquisition provides us with complementary networking products and intellectual property. The acquisition further expands our expertise in strategic areas of technology and enables us to better address a wider range of emerging customer requirements for converged networks. Consideration paid for this acquisition was approximately $21 million in cash, subject to certain closing adjustments.
We have certain contractual obligations and commitments to make future payments in the form of non-cancelable purchase orders to our suppliers and commitments under operating lease arrangements. A summary of our contractual obligations as of March 29, 2009, and their impact on our cash flows in future fiscal years, is as follows:
The amount of unrecognized tax benefits under FIN 48, including related accrued interest and penalties, at March 29, 2009 was $47.1 million. We are not able to provide a reasonable estimate of the timing of future tax payments related to these obligations.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. We base our estimates on historical experience and on various other factors, including the current economic environment, which we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We believe the accounting policies described below to be our most critical accounting policies. These accounting policies are affected significantly by judgments, assumptions and estimates used in the preparation of the financial statements and actual results could differ materially from the amounts reported based on these policies.
Revenue Recognition
We recognize revenue from product sales when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.
For all sales, we use a binding purchase order or a signed agreement as evidence of an arrangement. Delivery occurs when goods are shipped and title and risk of loss transfer to the customer, in accordance with the terms specified in the arrangement with the customer. The customer’s obligation to pay and the payment terms are set at the time of delivery and are not dependent on the subsequent resale of our product. However, certain of our sales are made to distributors under agreements which contain a limited right to return unsold product and price protection provisions. We recognize revenue from these distributors based on the sell-through method using inventory information provided by the distributor. At times, we provide standard incentive programs to our customers and account for such programs in accordance with Emerging Issues Task Force (EITF) Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” Accordingly, we account for our competitive pricing incentives, which generally reflect front-end price adjustments, as a reduction of revenue at the time of sale, and rebates as a reduction of revenue in the period the related revenue is recorded based on the specific program criteria and historical experience. In addition, we record provisions against revenue and cost of revenue for estimated product returns in the same period that revenue is recognized. These provisions are based on historical experience as well as specifically identified product returns. Royalty and service revenue is recognized when earned and receipt is reasonably assured.
For those sales that include multiple deliverables, we allocate revenue based on the relative fair values of the individual components as determined in accordance with EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” When more than one element, such as hardware and services, are contained in a single arrangement, we allocate revenue between the elements based on each element’s relative fair value, provided that each element meets the criteria for treatment as a separate unit of accounting. An item is considered a separate unit of accounting if it has value to the customer on a standalone basis and there is objective and reliable evidence of the fair value of the undelivered items. Fair value is generally determined based upon the price charged when the element is sold separately. In the absence of fair value for a delivered element, we allocate revenue first to the fair value of the undelivered elements and allocate the residual revenue to the delivered elements. In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a deferral of revenue recognition for the delivered elements. Such deferred revenue is recognized over the service period or when all elements have been delivered.
We sell certain software products and related post-contract customer support (PCS), and account for these transactions in accordance with the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended. We recognize revenue from software products when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is probable. Revenue is allocated to undelivered elements based upon vendor-specific objective evidence (VSOE) of the fair value of the element. VSOE of the fair value is based upon the price charged when the element is sold separately. Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element. If we are unable to determine VSOE of fair value for an undelivered element, the entire amount of revenue from the arrangement is deferred and recognized over the service period or when all elements have been delivered.
An allowance for doubtful accounts is maintained for estimated losses resulting from the inability of our customers to make required payments. This reserve is determined by analyzing specific customer accounts, applying estimated loss rates to the aging of remaining accounts receivable balances, and considering the impact of the current economic environment where appropriate. If the financial condition of our customers were to deteriorate, resulting in their inability to pay their accounts when due, additional reserves might be required.
Stock-Based Compensation
Statement of Financial Accounting Standards (SFAS) No. 123 (revised), “Share-Based Payment,” requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and non-employee directors including stock options, restricted stock units and stock purchases under our Employee Stock Purchase Plan (the ESPP) based on estimated fair values on the date of grant. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period in our consolidated financial statements. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We recognize stock-based compensation expense on a straight-line basis over the requisite service period, which is the vesting period for stock options and restricted stock units, and the offering period for the ESPP. The determination of fair value of stock-based awards on the date of grant
using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. In estimating expected stock price volatility, we use a combination of both historical volatility, calculated based on the daily closing prices of our common stock over a period equal to the expected term of the option, and implied volatility, utilizing market data of actively traded options on our common stock. We believe that the historical volatility of the price of our common stock over the expected term of the option is a strong indicator of the expected future volatility. We also believe that implied volatility takes into consideration market expectations of how future volatility will differ from historical volatility. Accordingly, we believe a combination of both historical and implied volatility provides the best estimate of the future volatility of the market price of our common stock. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. However, our employee stock options have certain characteristics that are significantly different from traded options. Changes in the subjective assumptions can materially affect the estimate of their fair value.
Income Taxes
We utilize the asset and liability method of accounting for income taxes. FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. Under FIN 48, income tax positions should be recognized in the first reporting period that the tax position meets the recognition threshold. Previously recognized income tax positions that fail to meet the recognition threshold in a subsequent period should be derecognized in that period. As a multinational corporation, we are subject to complex tax laws and regulations in various jurisdictions. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional liabilities or potentially to reverse previously recorded tax liabilities. Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known. We recognize potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.
Deferred income taxes are recognized for the future tax consequences of temporary differences using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Temporary differences include the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carryforwards. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.
A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. An adjustment to income would occur if we determine that we are able to realize a different amount of our deferred tax assets than currently expected.
Investment Securities
Our investment securities include available-for-sale securities, trading securities and other investment securities and are classified in the consolidated balance sheets based on the nature of the security and the availability for use in current operations.
Our available-for-sale securities are recorded at fair value, based on quoted market prices or other observable inputs. Unrealized gains and losses, net of related income taxes, on our portfolio of available-for-sale securities are excluded from earnings and reported as a separate component of accumulated other comprehensive income until realized.
Our trading securities are recorded at fair value with unrealized holding gains and losses included in earnings and reported in interest and other income, net. In the absence of quoted market prices for trading securities, we value these securities based on an income approach using an estimate of future cash flows.
Our other investment securities are primarily accounted for under the cost method and recorded at the lower of fair value or cost.
We recognize an impairment charge when the decline in the fair value of an investment below its cost basis is judged to be other-than-temporary. Significant judgment is required in determining the fair value of investment securities in inactive markets as well as determining when declines in fair value constitute an other-than-temporary impairment. We consider various factors in determining whether to recognize an impairment charge, including the current financial and credit market environment, the financial condition and near term prospects of the issuer of the security, the magnitude of the loss compared to the cost of the investment, the length of time
the investment has been in a loss position and our intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of market value.
Realized gains or losses and other-than-temporary declines in the fair value of investment securities are determined on a specific identification basis and reported in interest and other income, net, as incurred.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market. We write down the carrying value of our inventory to estimated net realizable value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. These assumptions are based on economic conditions and trends (both current and projected), anticipated customer demand and acceptance of our current products, expected future products and other assumptions. If actual market conditions are less favorable than those projected by management, additional write-downs may be required. Once we write down the carrying value of inventory, a new cost basis is established. Subsequent changes in facts and circumstances do not result in an increase in the newly established cost basis.
Goodwill and Other Intangible Assets
We account for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. The amounts and useful lives assigned to intangible assets acquired, other than goodwill, impact the amount and timing of future amortization, and the amount assigned to in-process research and development is expensed immediately.
SFAS No. 142 requires that goodwill not be amortized but instead be tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that the assets might be impaired, by comparing the carrying value to the fair value of the reporting unit to which the goodwill is assigned. A two-step test is used to identify the potential impairment and to measure the amount of impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit with the carrying amount of goodwill. We perform the annual test for impairment as of the first day of our fiscal fourth quarter and utilize the two-step process.
The initial recording and subsequent evaluation for impairment of goodwill and purchased intangible assets requires the use of significant management judgment regarding the forecasts of future operating results. It is possible that our business plans may change and our estimates used may prove to be inaccurate. If our actual results, or the plans and estimates used in future impairment analyses, are lower than current estimates used, we could incur impairment charges.
Long-Lived Assets
Long-lived assets, including property and equipment and purchased intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Significant judgment is required in determining whether a potential indicator of impairment of our long-lived assets exists and in estimating future cash flows for any necessary impairment tests. Recoverability of assets to be held and used is measured by the comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such an asset is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Estimating future net cash flows and determining proper asset groupings for the purpose of this impairment test requires the use of significant management judgment. If our actual results, or estimates used in future impairment analyses, are lower than our current estimates, we could incur impairment charges.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is generally effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which provides a one-year deferral of the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, effective March 31, 2008, we adopted the provisions of SFAS No. 157 with respect to only financial assets, which are comprised primarily of investment securities. The adoption of SFAS No. 157 did not have a material impact on our consolidated results of operations or financial position.
In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” that clarifies the application of SFAS No. 157 in valuing assets in inactive markets. FSP No. 157-3 was effective upon issuance and its adoption did not have a material impact on our consolidated financial statements.
In April 2009, the FASB issued FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” This FSP provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP No. FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and would apply to us beginning in fiscal 2010. We are currently assessing the impact of this FSP on our consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115.” SFAS No. 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. Under SFAS No. 159, a company may elect to use fair value to measure certain financial assets and liabilities. The fair value election is irrevocable and generally made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to measure based on fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the adoption of SFAS No. 159, changes in fair value are recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We adopted SFAS No. 159 effective March 31, 2008, and have elected the fair value election for put options related to our investments in certain ARS.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations,” which replaces SFAS No. 141, “Business Combinations.” SFAS No. 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. SFAS No. 141R also requires acquisition-related costs and restructuring costs that the acquirer expected, but was not obligated to incur at the acquisition date, to be recognized separately from the business combination. In addition, SFAS No. 141R amends SFAS No. 109, “Accounting for Income Taxes,” to require the acquirer to recognize changes in the amount of its deferred tax benefits that are recognizable because of a business combination either in income in the period of the combination or directly in contributed capital. SFAS No. 141R applies prospectively to business combinations in fiscal years beginning on or after December 15, 2008 and would apply to us beginning in fiscal 2010.
In April 2009, the FASB issued FSP FAS No. 141(R)-1 “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP FAS No. 141(R)-1 amends the provisions in SFAS No. 141R for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. In addition, FSP FAS No. 141(R)-1 eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria in SFAS No. 141R and instead carries forward most of the provisions in SFAS 141 for acquired contingencies. FSP FAS No.141(R)-1 is effective for contingent assets and contingent liabilities acquired in business combinations in fiscal years beginning on or after December 15, 2008 and would apply to us beginning in fiscal 2010.
In November 2008, the FASB issued EITF Issue No. 08-7, “Accounting for Defensive Intangible Assets.” EITF No. 08-7 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does not intend to actively use but intends to hold to prevent others from obtaining access to them. As these assets are separately identifiable, EITF No. 08-7 requires an acquiring entity to account for defensive intangible assets as a separate unit of accounting, which should be amortized to expense over the period the asset will diminish in value. Defensive intangible assets must be recognized at fair value in accordance with SFAS No. 141R and
SFAS No. 157. EITF No. 08-7 is effective for intangible assets acquired in fiscal years beginning after December 15, 2008 and would apply to us beginning in fiscal 2010.
In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” This FSP provides guidance in determining whether impairments in debt securities are other-than-temporary, and modifies the presentation and disclosures surrounding such instruments. FSP Nos. FAS 115-2 and FAS 124-2 are effective for interim and annual periods ending after June 15, 2009 and would apply to us beginning in fiscal 2010. We are currently assessing the impact of this FSP on our consolidated financial statements.
Item 7a.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. As of March 29, 2009, the carrying value of our cash and cash equivalents approximates fair value.
We maintain a portfolio of investment securities consisting primarily of debt securities, including government and agency securities, corporate debt obligations, asset and mortgage-backed securities, and municipal bonds, which principally have remaining terms of three years or less. We are exposed to fluctuations in interest rates as movements in interest rates can result in changes in the market value of our investments in debt securities. However, due to the short-term nature of our investment portfolio we do not believe that we are subject to material interest rate risk.
In accordance with our investment guidelines, we only invest in instruments with high credit quality standards and we limit our exposure to any one issuer or type of investment. Our portfolio includes $136.0 million of investment securities that are classified as available for sale. Our asset and mortgage-backed securities totaled $21.0 million as of March 29, 2009 and consisted primarily of high quality investments insured by the federal government under various programs.
As of March 29, 2009, we had gross unrealized losses associated with our available-for-sale securities of $0.3 million that were determined by management to be temporary in nature. If the credit market continues to deteriorate, we may conclude that the decline in value is other-than-temporary and incur realized losses, which could adversely affect our financial condition or results of operations.
Our portfolio of investment securities as of March 29, 2009 also includes $25.7 million of investments in auction rate debt and preferred securities (ARS), the majority of which are rated AA or higher, and related put options valued at $9.3 million. Substantially all of these investment securities are accounted for as trading securities. There is currently significant turmoil in the credit market, including the impact to the value and liquidity of ARS. As of March 29, 2009, our investment portfolio includes $20.7 million of auction rate debt securities and $5.0 million of auction rate preferred securities. During late fiscal 2008, the market auctions of many ARS began to fail, including auctions for our ARS. The underlying assets for auction rate debt securities in our portfolio are student loans, substantially all of which are backed by the federal government under the Federal Family Education Loan Program. The underlying assets of our auction rate preferred securities are the respective funds’ investment portfolios.
In November 2008, we entered into an agreement with the broker for substantially all of the ARS we currently hold, which provides us with certain rights (ARS Rights), in exchange for the release of potential claims and damages against the broker. The ARS Rights entitle us to sell the related ARS back to the broker for a price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, if any, which price is referred to as “par.” The ARS Rights may be exercised by us at any time between June 30, 2010 and July 2, 2012, if the securities are not earlier redeemed or sold. Under the ARS Rights, the broker may, at its discretion, purchase the ARS at any time through July 2, 2012 without prior notice to us and must pay us par value for the ARS within one day of the sale transaction settlement. While we expect to ultimately recover our investments in the ARS at par, we may be unable to liquidate some or all of our ARS should we need or desire to access the funds invested in those securities prior to redemption by the issuer or the exercise of the ARS Rights. There is also a risk that our broker will default on its obligation to purchase the ARS in the event that we exercise the ARS Rights.
In addition, our investment securities as of March 29, 2009, include an aggregate of $3.6 million in a money market fund and enhanced cash fund sponsored by The Reserve (an asset management company) that suspended trading and redemptions in September 2008. These funds are in the process of being liquidated and we expect the liquidation to occur in stages with proceeds distributed as the underlying securities mature or are sold. In February 2009, The Reserve announced a plan for liquidation and distribution of assets of the money market fund that includes the establishment of a special reserve which will be used to satisfy pending or threatened claims against the fund, its officers and trustees, and anticipated costs and expenses, including legal and accounting fees. The Reserve plans to continue to make periodic distributions, up to the amount of the special reserve, on a pro-rata basis. During fiscal 2009, we recorded other-than-temporary impairment charges aggregating $5.1 million related to our investments in the funds sponsored by The Reserve.
Based on our existing cash, cash equivalents and other investment securities, as well as our expected cash flows from operating activities, we do not anticipate that the potential lack of liquidity of these investments in the near term will affect our ability to execute our current business plan.
We do not use derivative financial instruments.
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
QLogic Corporation:
We have audited the accompanying consolidated balance sheets of QLogic Corporation and subsidiaries as of March 29, 2009 and March 30, 2008, 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 March 29, 2009. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule of valuation and qualifying accounts as listed in the index under Item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of QLogic Corporation and subsidiaries as of March 29, 2009 and March 30, 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended March 29, 2009, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for uncertainty in income taxes in fiscal 2008 due to the adoption of a new accounting pronouncement.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), QLogic Corporation’s internal control over financial reporting as of March 29, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated May 21, 2009, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Irvine, California
May 21, 2009
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
QLogic Corporation:
We have audited QLogic Corporation’s internal control over financial reporting as of March 29, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). QLogic Corporation’s management is responsible 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 the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit 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 audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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, QLogic Corporation maintained, in all material respects, effective internal control over financial reporting as of March 29, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of QLogic Corporation and subsidiaries as of March 29, 2009 and March 30, 2008, 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 March 29, 2009, and our report dated May 21, 2009, expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Irvine, California
May 21, 2009
QLOGIC CORPORATION
CONSOLIDATED BALANCE SHEETS
March 29, 2009 and March 30, 2008
See accompanying notes to consolidated financial statements.
QLOGIC CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Years Ended March 29, 2009, March 30, 2008 and April 1, 2007
See accompanying notes to consolidated financial statements.
QLOGIC CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
Years Ended March 29, 2009, March 30, 2008 and April 1, 2007
See accompanying notes to consolidated financial statements.
QLOGIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended March 29, 2009, March 30, 2008 and April 1, 2007
See accompanying notes to consolidated financial statements.
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description of Business and Summary of Significant Accounting Policies
General Business Information
QLogic Corporation (QLogic or the Company) is a designer and supplier of high performance storage networking, server networking, data networking and converged networking infrastructure solutions. The Company’s solutions are sold worldwide, primarily to original equipment manufacturers (OEMs) and distributors. The Company produces Fibre Channel and Internet Small Computer Systems Interface (iSCSI) host bus adapters; InfiniBand® host channel adapters; and Fibre Channel over Ethernet (FCoE) converged network adapters. The Company is also a supplier of Fibre Channel switches, including stackable edge, blade and virtualized pass through switches; InfiniBand switches, including high-end multi-protocol directors, edge and blade switches; and storage routers for bridging Fibre Channel and iSCSI networks. In addition, the Company supplies Fibre Channel, iSCSI and converged network controller products.
Principles of Consolidation
The consolidated financial statements include the financial statements of QLogic Corporation and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Financial Reporting Period
The Company uses a fifty-two/fifty-three week fiscal year ending on the Sunday nearest March 31. Fiscal years 2009, 2008 and 2007 each comprised fifty-two weeks and ended on March 29, 2009, March 30, 2008 and April 1, 2007, respectively.
Use of Estimates
The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates that affect the amounts reported in the Company’s consolidated financial statements and accompanying notes. Among the significant estimates affecting the consolidated financial statements are those related to revenue recognition, stock-based compensation expense, income taxes, investment securities, inventories, goodwill and long-lived assets.
The Company evaluates its estimates on an ongoing basis using historical experience and other factors, including the current economic environment. The current volatility in the capital markets and the economy has increased the uncertainty in our estimates, including our estimates impacting investment securities and long-lived assets. Significant judgment is required in determining the fair value of investment securities in inactive markets, as well as determining when declines in fair value constitute an other-than-temporary impairment. In addition, significant judgment is required in determining whether a potential indicator of impairment of our long-lived assets exists and in estimating future cash flows for any necessary impairment tests. As future events unfold and their effects cannot be determined with precision, actual results could differ significantly from management’s estimates.
Revenue Recognition
The Company recognizes revenue from product sales when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
For all sales, the Company uses a binding purchase order or a signed agreement as evidence of an arrangement. Delivery occurs when goods are shipped and title and risk of loss transfer to the customer, in accordance with the terms specified in the arrangement with the customer. The customer’s obligation to pay and the payment terms are set at the time of delivery and are not dependent on the subsequent resale of the product. However, certain of the Company’s sales are made to distributors under agreements which contain a limited right to return unsold product and price protection provisions. The Company recognizes revenue from these distributors based on the sell-through method using inventory information provided by the distributor. At times, the Company provides standard incentive programs to its customers and accounts for such programs in accordance with Emerging Issues Task Force (EITF) Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” Accordingly, the Company accounts for its competitive pricing incentives, which generally reflect front-end price adjustments, as a reduction of revenue at the time of sale, and rebates as a reduction of revenue in the period the related revenue is recorded based on the specific program criteria and historical experience. In addition, the Company records provisions against revenue and cost of revenue for estimated product returns in the same period that revenue is recognized. These provisions are based on historical experience as well as specifically identified product returns. Royalty and service revenue is recognized when earned and receipt is reasonably assured.
For those sales that include multiple deliverables, the Company allocates revenue based on the relative fair values of the individual components as determined in accordance with EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” When more than one element, such as hardware and services, are contained in a single arrangement, the Company allocates revenue between the elements based on each element’s relative fair value, provided that each element meets the criteria for treatment as a separate unit of accounting. An item is considered a separate unit of accounting if it has value to the customer on a standalone basis and there is objective and reliable evidence of the fair value of the undelivered items. Fair value is generally determined based upon the price charged when the element is sold separately. In the absence of fair value for a delivered element, the Company allocates revenue first to the fair value of the undelivered elements and allocates the residual revenue to the delivered elements. In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a deferral of revenue recognition for the delivered elements. Such deferred revenue is recognized over the service period or when all elements have been delivered.
The Company sells certain software products and related post-contract customer support (PCS), and accounts for these transactions in accordance with the American Institute of Certified Public Accountants Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended. The Company recognizes revenue from software products when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is probable. Revenue is allocated to undelivered elements based upon vendor-specific objective evidence (VSOE) of the fair value of the element. VSOE of the fair value is based upon the price charged when the element is sold separately. Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element. If the Company is unable to determine VSOE of fair value for an undelivered element, the entire amount of revenue from the arrangement is deferred and recognized over the service period or when all elements have been delivered.
Research and Development
Research and development costs, including costs related to the development of new products and process technology, are expensed as incurred.
Advertising Costs
The Company expenses all advertising costs as incurred, and the amounts were not material to the accompanying consolidated statements of income for all periods presented.
Income Taxes
The Company utilizes the asset and liability method of accounting for income taxes. As of April 2, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109,” which prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. Under FIN 48, income tax positions should be recognized in the first reporting period that the tax position meets the recognition threshold. Previously recognized income tax positions that fail to meet the recognition threshold in a subsequent period should be derecognized in that period. Differences
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
between actual results and the Company’s assumptions, or changes in its assumptions in future periods, are recorded in the period they become known. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.
Deferred income taxes are recognized for the future tax consequences of temporary differences using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Temporary differences include the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carryforwards. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.
Net Income per Share
The Company computes basic net income per share based on the weighted-average number of common shares outstanding during the periods presented. Diluted net income per share is computed based on the weighted-average number of common and dilutive potential common shares outstanding, using the treasury stock method, during the periods presented. The Company has granted stock options, restricted stock units and other stock-based awards, which have been treated as dilutive potential common shares in computing diluted net income per share.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents, investment securities and trade accounts receivable. Cash and cash equivalents are maintained with several financial institutions. Deposits held with banks may exceed the amount of insurance provided on such deposits.
The Company invests primarily in debt securities, all of which are high investment grade. The Company, by policy, limits the exposure to credit risk through diversification and investment in highly-rated securities. A portion of the Company’s portfolio of investment securities includes certain auction rate debt and preferred securities (ARS), the majority of which are rated AA or higher. During late fiscal 2008, the market auctions of many ARS began to fail, including auctions for the Company’s ARS. Accordingly, the Company may be unable to liquidate some or all of its investments in these securities should it need or desire to access the funds. There is also a risk that the broker will default on its obligation to purchase the ARS in the event that the Company exercises the ARS Rights (see Note 4).
The Company also has investments in a money market fund and an enhanced cash fund sponsored by The Reserve (an asset management company) that have suspended trading and redemptions. These funds are in the process of being liquidated and the Company expects the liquidation to occur in stages with proceeds distributed as the underlying securities mature or are sold.
The Company sells its products to OEMs and distributors throughout the world. As of March 29, 2009 and March 30, 2008, the Company had four customers which individually accounted for 10% or more of the Company’s accounts receivable. These customers, all of which were OEMs of servers and workstations, accounted for an aggregate of 74% and 77% of the Company’s accounts receivable at March 29, 2009 and March 30, 2008, respectively. The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral from its customers. Sales to customers are denominated in U.S. dollars. As a result, the Company believes its foreign currency risk is minimal.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with original maturities of three months or less on their acquisition date to be cash equivalents. The carrying amounts of cash and cash equivalents approximate their fair values.
Investment Securities
The Company’s investment securities include available-for-sale securities, trading securities and other investment securities and are classified in the accompanying consolidated balance sheets based on the nature of the security and the availability for use in current operations.
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company’s available-for-sale securities are recorded at fair value, based on quoted market prices or other observable inputs. Unrealized gains and losses, net of related income taxes, on the Company’s portfolio of available-for-sale securities are excluded from earnings and reported as a separate component of accumulated other comprehensive income (loss) until realized.
The Company’s trading securities are recorded at fair value with unrealized holding gains and losses included in earnings and reported in interest and other income, net. In the absence of quoted market prices for trading securities, the Company values these securities based on an income approach using an estimate of future cash flows.
The Company’s other investment securities are accounted for under the cost method and recorded at the lower of fair value or cost.
The Company recognizes an impairment charge when the decline in the fair value of an investment below its cost basis is judged to be other-than-temporary. Significant judgment is required in determining the fair value of investment securities in inactive markets as well as determining when declines in fair value constitute an other-than-temporary impairment. The Company considers various factors in determining whether to recognize an impairment charge, including the current financial and credit market environment, the financial condition and near term prospects of the issuer of the security, the magnitude of the loss compared to the cost of the investment, the length of time the investment has been in a loss position and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of market value.
Realized gains or losses and other-than-temporary declines in the fair value of investment securities are determined on a specific identification basis and reported in interest and other income, net, as incurred.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are recorded at the invoiced amount and do not bear interest. An allowance for doubtful accounts is maintained for estimated losses resulting from the inability of the Company’s customers to make required payments. This reserve is determined by analyzing specific customer accounts, applying estimated loss rates to the aging of remaining accounts receivable balances, and considering the impact of the current economic environment where appropriate.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or market. The Company writes down the carrying value of inventory to estimated net realizable value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. Once the Company writes down the carrying value of inventory, a new cost basis is established. Subsequent changes in facts and circumstances do not result in an increase in the newly established cost basis.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over estimated useful lives of 39.5 years for buildings, five to fifteen years for building and land improvements, and two to five years for other property and equipment. Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the related asset.
Goodwill and Other Intangible Assets
The Company accounts for goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets.” Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. The amounts and useful lives assigned to intangible assets acquired, other than goodwill, impact the amount and timing of future amortization, and the amount assigned to in-process research and development is expensed immediately.
SFAS No. 142 requires that goodwill not be amortized but instead be tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that the assets might be impaired, by comparing the carrying value to the fair value of the reporting unit to which the goodwill is assigned. A two-step test is used to identify the potential impairment and to measure the amount of impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill
QLOGIC CORPORATION
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is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit with the carrying amount of goodwill. Management considers the Company as a whole to be its reporting unit for purposes of testing for impairment. The Company performs the annual test for impairment as of the first day of its fiscal fourth quarter and utilizes the two-step process. During the annual goodwill impairment test in fiscal 2009, the Company completed step one and determined that there was no impairment of goodwill since the fair value (based on quoted market price) of the reporting unit exceeded its carrying value.
Long-Lived Assets
Long-lived assets, including property and equipment and purchased intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Significant judgment is required in determining whether a potential indicator of impairment of long-lived assets exists and in estimating future cash flows for any necessary impairment tests. Recoverability of assets to be held and used is measured by the comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such an asset is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Purchased intangible assets consist primarily of technology and customer relationships acquired in business acquisitions. Purchased intangible assets that have definite lives are amortized on a straight-line basis over the estimated useful lives of the related assets, generally ranging from one to six years.
Warranty
The Company’s products typically carry a warranty for periods of up to five years. The Company records a liability for product warranty obligations in the period the related revenue is recorded based on historical warranty experience. Warranty expense and the corresponding liability were not material to the accompanying consolidated financial statements for all periods presented.
Comprehensive Income
Comprehensive income includes all changes in equity other than transactions with stockholders. The Company’s accumulated other comprehensive income (loss) consists primarily of unrealized gains (losses) on available-for-sale securities, net of income taxes.
Foreign Currency Translation
Assets and liabilities of foreign subsidiaries that operate where the functional currency is the local currency are translated to U.S. dollars at exchange rates in effect at the balance sheet date, and income and expense accounts are translated at average exchange rates during the period. The resulting translation adjustments are recorded as a component of accumulated other comprehensive income (loss). Accumulated other comprehensive income (loss) related to translation adjustments was not material to the accompanying consolidated financial statements for all periods presented. Gains and losses resulting from transactions denominated in currencies other than the functional currency are included in interest and other income, net, in the accompanying consolidated statements of income and were not material for all periods presented.
Stock-Based Compensation
SFAS No. 123 (revised 2004), “Share-Based Payment,” requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and non-employee directors including stock options, restricted stock units and stock purchases under the Company’s Employee Stock Purchase Plan (the ESPP) based on estimated fair values on the date of grant. Stock-based compensation expense is recognized for the portion of the award that is ultimately expected to vest. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company recognizes stock-based compensation expense on a straight-line basis over the requisite service period, which is the vesting period for stock options and restricted stock units, and the offering period for the ESPP. The determination of fair value of stock-based awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. In
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estimating expected stock price volatility, the Company uses a combination of both historical volatility, calculated based on the daily closing prices of the Company’s common stock over a period equal to the expected term of the option, and implied volatility, utilizing market data of actively traded options on the Company’s common stock.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is generally effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-2, “Effective Date of FASB Statement No. 157,” which provides a one-year deferral of the effective date of SFAS No. 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. Therefore, effective March 31, 2008, the Company adopted the provisions of SFAS No. 157 with respect to only financial assets that are comprised primarily of investment securities. The adoption of SFAS No. 157 did not have a material impact on the Company’s consolidated results of operations or financial position.
In October 2008, the FASB issued FSP No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” that clarifies the application of SFAS No. 157 in valuing assets in inactive markets. FSP No. 157-3 was effective upon issuance and its adoption did not have a material impact on the Company’s consolidated financial statements.
In April 2009, the FASB issued FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” This FSP provides additional guidance for estimating fair value in accordance with SFAS No. 157 when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP No. FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and would apply to the Company beginning in fiscal 2010. The Company is currently assessing the impact of this FSP on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115.” SFAS No. 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. Under SFAS No. 159, a company may elect to use fair value to measure certain financial assets and liabilities. The fair value election is irrevocable and generally made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to measure based on fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings. Subsequent to the adoption of SFAS No. 159, changes in fair value are recognized in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 effective March 31, 2008, and has elected the fair value election for put options related to the Company’s investment in certain ARS (see Note 4).
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations,” which replaces SFAS No. 141, “Business Combinations.” SFAS No. 141R requires an acquirer to recognize the assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. SFAS No. 141R also requires acquisition-related costs and restructuring costs that the acquirer expected, but was not obligated to incur at the acquisition date, to be recognized separately from the business combination. In addition, SFAS No. 141R amends SFAS No. 109, “Accounting for Income Taxes,” to require the acquirer to recognize changes in the amount of its deferred tax benefits that are recognizable because of a business combination either in income in the period of the combination or directly in contributed capital. SFAS No. 141R applies prospectively to business combinations in fiscal years beginning on or after December 15, 2008 and would apply to the Company beginning in fiscal 2010.
In April 2009, the FASB issued FSP No. FAS 141(R)-1 “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP No. FAS 141(R)-1 amends the provisions in SFAS No. 141R for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. In addition, FSP No. FAS 141(R)-1 eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria in SFAS No. 141(R) and instead carries forward most of the provisions in SFAS No. 141 for acquired contingencies. FSP No. FAS 141(R)-1 is effective for contingent assets and contingent liabilities acquired in business combinations in fiscal years beginning on or after December 15, 2008 and would apply to the Company beginning in fiscal 2010.
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In November 2008, the FASB issued EITF Issue No. 08-7, “Accounting for Defensive Intangible Assets.” EITF No. 08-7 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does not intend to actively use but intends to hold to prevent others from obtaining access to them. As these assets are separately identifiable, EITF No. 08-7 requires an acquiring entity to account for defensive intangible assets as a separate unit of accounting, which should be amortized to expense over the period the asset will diminish in value. Defensive intangible assets must be recognized at fair value in accordance with SFAS No. 141R and SFAS No. 157. EITF No. 08-7 is effective for intangible assets acquired in fiscal years beginning after December 15, 2008 and would apply to Company beginning in fiscal 2010.
In April 2009, the FASB issued FSP Nos. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” This FSP provides guidance in determining whether impairments in debt securities are other-than-temporary, and modifies the presentation and disclosures surrounding such instruments. FSP Nos. FAS 115-2 and FAS 124-2 are effective for interim and annual periods ending after June 15, 2009, and would apply to the Company beginning in fiscal 2010. The Company is currently assessing the impact of this FSP on its consolidated financial statements.
Note 2. Business Combinations
SilverStorm Technologies
In November 2006, the Company acquired SilverStorm Technologies, Inc. (SilverStorm) in a merger transaction. The results of operations for SilverStorm have been included in the consolidated financial statements from the date of acquisition. Cash consideration was $59.6 million, including $59.1 million for all outstanding SilverStorm common stock, vested stock options and stock warrants and $0.5 million for direct acquisition costs. SilverStorm provided end-to-end, high-performance interconnect fabric solutions for cluster and grid computing networks. The acquisition of SilverStorm expanded the Company’s portfolio of InfiniBand solutions to include edge fabric switches and multi-protocol fabric directors. The acquisition agreement required that $9.0 million of the consideration paid be placed into escrow for 15 months in connection with certain standard representations and warranties. As of the acquisition date, the Company accounted for the escrowed amount as contingent consideration and, as such, did not record it as a component of the initial purchase price as the outcome of the related contingencies was not determinable beyond a reasonable doubt. The escrow expired in February 2008 and the Company recorded $8.7 million of the contingent consideration as additional purchase price and allocated it to goodwill. During fiscal 2009, the Company finalized its determination of the net operating loss carryforwards and other tax benefits available from the acquisition, resulting in an increase in deferred tax assets of $8.6 million and a corresponding decrease in goodwill.
PathScale
In April 2006, the Company acquired PathScale, Inc. (PathScale) in a merger transaction. PathScale designed and developed system area network fabric interconnects targeted at high-performance clustered system environments. The acquisition of PathScale expanded the Company’s portfolio to include InfiniBand solutions. Consideration for this acquisition was $110.5 million, including $0.3 million related to PathScale unvested stock options assumed by QLogic. Cash consideration was $110.2 million, including $109.7 million for all outstanding PathScale common stock and vested stock options and $0.5 million for direct acquisition costs. The acquisition agreement required that $15.0 million of the consideration paid be placed into escrow for 18 months in connection with certain standard representations and warranties. As of the acquisition date, the Company accounted for the escrowed amount as contingent consideration and, as such, did not record it as a component of the initial purchase price as the outcome of the related contingencies was not determinable beyond a reasonable doubt. The escrow expired in October 2007 and the Company recorded the entire $15.0 million of the contingent consideration as additional purchase price and allocated it to goodwill. Also during fiscal 2008, the Company finalized its determination of the net operating loss carryforwards and other tax benefits available from the acquisition resulting in a decrease in deferred tax assets of $0.9 million and a corresponding increase in goodwill.
The Company also converted unvested PathScale stock options for continuing employees into options to purchase 308,000 shares of QLogic common stock with a weighted-average exercise price of $3.00 per share. The total fair value of the options at the date of conversion was $5.2 million, calculated using the Black-Scholes option pricing model. The Company has accounted for $0.3 million of the value of the converted stock options as consideration for the acquisition to reflect the related employee services rendered through the date of the acquisition and the balance will be expensed over the remaining service period.
The Company also entered into performance plans with certain former PathScale employees who became employees of QLogic as of the acquisition date. The performance plans provide for the issuance of QLogic common stock based on the achievement of certain
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performance milestones and continued employment with QLogic. In connection with the performance plans, the Company recognized $0.2 million, $2.0 million and $7.5 million of compensation expense during fiscal 2009, 2008 and 2007, respectively, and could recognize up to $0.2 million of additional compensation expense through April 2010. During fiscal 2009 and 2008, the Company issued 111,000 shares of common stock valued at $1.7 million and 154,000 shares of common stock valued at $2.6 million, respectively, under this performance plan.
Troika Networks
In November 2005, the Company completed the purchase of substantially all of the assets of Troika Networks, Inc. (Troika) for $36.5 million in cash and the assumption of certain liabilities. The acquisition has been accounted for as a purchase business combination. The assets acquired included intellectual property (including patents and trademarks), inventory and property and equipment. Troika developed, marketed and sold a storage services platform that hosted third-party software solutions. The acquisition of Troika expanded the Company’s product line and, through the acquired intellectual property, enhanced certain of the Company’s existing products.
In August 2007, the Company reevaluated the use of the intellectual property acquired from Troika. As a result, the Company suspended internal development of the underlying acquired technology and entered into a nonexclusive license of the technology with a third party. In addition, the Company sold all of the related inventory and equipment to the licensee.
Revenue generated by the nonexclusive license did not meet the Company’s expectations during the fourth quarter of fiscal 2008. As a result, the Company re-evaluated the carrying amount of intangible assets previously acquired from Troika and, based on revised forecasts, determined that the carrying amount exceeded the estimated future undiscounted cash flows expected to be generated by these assets. Accordingly, the Company recorded a non-cash impairment charge of $2.3 million to write down the carrying value of the core technology to its estimated fair value. This impairment charge is included in cost of revenues in the accompanying 2008 consolidated statement of income.
Purchased In-Process Research and Development
The Company recorded IPR&D charges of $3.7 million during fiscal 2007, consisting of $1.8 million for SilverStorm, $1.6 million for PathScale and $0.3 million for Troika. The amounts allocated to IPR&D were determined through established valuation techniques used in the high technology industry and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed. As of March 30, 2008, all IPR&D projects were complete.
The fair value of the IPR&D for each of the acquisitions was determined using the income approach. Under the income approach, the expected future cash flows from each project under development are estimated and discounted to their net present values at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return are the weighted-average cost of capital and return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. Each project was analyzed to determine the unique technological innovations, the existence and reliance on core technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development. Future cash flows for each project were estimated based on forecasted revenue and costs, taking into account product life cycles, and market penetration and growth rates.
The IPR&D charges include only the fair value of IPR&D performed as of the respective acquisition dates. The fair value of core/developed technology is included in identifiable purchased intangible assets. The Company believes the amounts recorded as IPR&D, as well as core/developed technology, represent the fair values and approximate the amounts an independent party would pay for these projects at the time of the respective acquisition dates.
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Note 3. Net Income per Share
The following table sets forth the computation of basic and diluted net income per share:
Stock-based awards, including stock options and restricted stock units, representing 25,374,000, 24,490,000 and 19,118,000 shares of common stock have been excluded from the diluted net income per share calculations for fiscal 2009, 2008 and 2007, respectively, because their effect would have been antidilutive.
Note 4. Investment Securities
Components of investment securities are as follows:
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Available-For-Sale Securities
The Company’s portfolio of available-for-sale securities consists of the following:
The amortized cost and estimated fair value of debt securities as of March 29, 2009, by contractual maturity, are presented below. Expected maturities will differ from contractual maturities because the issuers of securities may have the right to repay obligations without prepayment penalties. Certain debt instruments, although possessing a contractual maturity greater than one year, are classified as short-term investment securities based on their ability to be traded on active markets and availability for current operations.
As of March 29, 2009, and March 30, 2008, the fair value of certain of the Company’s available-for-sale securities was less than their cost basis. Management reviewed various factors in determining whether to recognize an impairment charge related to these unrealized losses, including the current financial and credit market environment, the financial condition and near term prospects of the issuer of the investment security, the magnitude of the unrealized loss compared to the cost of the investment, the length of time the investment has been in a loss position and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of market value. Based on this analysis, the Company determined that a portion of the unrealized losses associated with the Company’s portfolio of available-for-sale securities were other-than-temporary and recorded impairment charges for these securities of $11.3 million and $6.9 million during fiscal 2009 and 2008, respectively, which are included in interest and other income, net, in the accompanying consolidated statements of income. The Company determined that the remaining unrealized losses are temporary in nature and recorded them as a component of accumulated other comprehensive income (loss).
During fiscal 2009, the Company sold all of its remaining holdings in common stock that it held in a publicly-traded company for $7.9 million and recorded a net gain of $2.1 million. The Company had received the common stock in connection with the sale of its
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hard disk drive controller and tape drive controller business in fiscal 2006. The Company had previously recorded impairment charges related to these shares totaling $15.9 million since fiscal 2007, including $4.3 million during fiscal 2009.
The following table presents the Company’s investments with unrealized losses by investment category and length of time that individual securities have been in a continuous unrealized loss position at March 29, 2009 and March 30, 2008.
Trading Securities
The Company’s portfolio of trading securities consists of the following:
The Company’s trading securities include investments in auction rate securities, the majority of which are rated AA or higher. During late fiscal 2008, the market auctions of many ARS began to fail, including auctions for the Company’s ARS. The underlying assets for the auction rate debt securities in the Company’s portfolio are student loans, substantially all of which are backed by the federal government under the Federal Family Education Loan Program. The underlying assets of the Company’s auction rate preferred securities are the respective funds’ investment portfolios.
In November 2008, the Company entered into an agreement with the broker for substantially all of the ARS currently held by the Company, which provides the Company with certain rights (ARS Rights), in exchange for the release of potential claims and damages against the broker. The ARS Rights entitle the Company to sell the related ARS back to the broker for a price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, if any, which price is referred to as “par.” The ARS Rights may be exercised by the Company at any time between June 30, 2010 and July 2, 2012, if the securities are not earlier redeemed or sold. Under the ARS Rights, the broker may, at its discretion, purchase the ARS at any time through July 2, 2012 without prior notice to the Company and must pay the Company par value for the ARS within one day of the sale transaction settlement.
The ARS Rights agreement, a legally enforceable contract, results in put options that are recognized as free standing assets separate from the ARS, in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The Company elected to measure the put options at fair value in accordance with SFAS No. 159. In connection with the election to measure the put options at fair value, the Company has classified these financial instruments as trading securities and recorded the initial fair value of $8.1 million in investment securities. In addition, the Company also recorded a $1.2 million gain related to subsequent increases in the fair value of these put options during fiscal 2009. These gains are included in interest and other income,
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net, in the accompanying consolidated statement of income for fiscal 2009. The ARS associated with the ARS Rights, previously classified as available-for-sale securities, were reclassified to trading securities during fiscal 2009. As a result, the Company recognized a loss of $3.4 million, which had previously been recorded in accumulated other comprehensive income (loss) and $2.4 million related to changes in the fair value of the trading securities subsequent to the reclassification. The loss related to the ARS is included in interest and other income, net, in the accompanying consolidated statement of income for fiscal 2009. Subsequent changes in fair value of the put options and the ARS will be recorded in earnings in the related period.
The Company may be unable to liquidate some or all of its ARS in the near term and, accordingly, has classified its auction rate debt and preferred securities, as well as the related put options, as long-term investment securities as of March 29, 2009.
Other Investment Securities
As of March 29, 2009, the Company’s other investment securities include a money market fund and an enhanced cash fund sponsored by The Reserve (an asset management company) that suspended trading and redemptions in September 2008. These funds are in the process of being liquidated and the Company expects the liquidation to occur in stages with proceeds distributed as the underlying securities mature or are sold. As a result, during fiscal 2009, the Company reclassified $57.2 million of such investments from cash equivalents to short-term investment securities and accounts for these investments under the cost method. Subsequent to the reclassification to investment securities, the Company has received distributions from The Reserve totaling $48.9 million during fiscal 2009.
In February 2009, The Reserve announced a plan for liquidation and distribution of assets of the money market fund that includes the establishment of a special reserve which will be used to satisfy pending or threatened claims against the fund, its officers and trustees, and anticipated costs and expenses, including legal and accounting fees. The Reserve plans to continue to make periodic distributions, up to the amount of the special reserve, on a pro-rata basis. During fiscal 2009, the Company recorded other-than-temporary impairment charges aggregating $5.1 million related to its investments in the funds sponsored by The Reserve.
Fair Value Measurements
SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is defined under SFAS No. 157 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS No. 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:
•
Level 1 - Quoted prices in active markets for identical assets or liabilities.
•
Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
•
Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
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Assets measured at fair value on a recurring basis as of March 29, 2009 are as follows:
The Company’s investments in auction rate securities and the related put options are classified within Level 3 because there are currently no active markets for these securities and the Company is unable to obtain independent valuations from market sources. Therefore, the auction rate securities and the related put options were primarily valued based on an income approach using estimates of future cash flows. The assumptions used in preparing these discounted cash flow models included estimates for the amount and timing of future interest and principal payments, the collateralization of underlying security investments, the creditworthiness of the issuer and the rate of return required by investors to own these securities in the current environment, including call and liquidity premiums. The total amount of assets measured using Level 3 valuation methodologies represented less than 5% of total assets as of March 29, 2009.
A summary of the changes in Level 3 assets measured at fair value on a recurring basis for fiscal 2009 is as follows:
Note 5. Inventories
Components of inventories are as follows:
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Note 6. Property and Equipment
Components of property and equipment are as follows:
Note 7. Goodwill and Purchased Intangible Assets
Goodwill
A rollforward of the activity in goodwill is as follows:
Purchased Intangible Assets
Purchased intangible assets consist of the following:
A summary of the amortization expense, by classification, included in the accompanying consolidated statements of income is as follows:
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The following table presents the estimated future amortization expense of purchased intangible assets as of March 29, 2009:
Note 8. Stockholders’ Equity
Capital Stock
The Company’s authorized capital consists of 1 million shares of preferred stock, par value $0.001 per share, and 500 million shares of common stock, par value $0.001 per share. As of March 29, 2009 and March 30, 2008, the Company had 202.0 million and 199.7 million shares of common stock issued, respectively. At March 29, 2009, 37.6 million shares of common stock were reserved for the exercise of issued and unissued stock-based awards, including restricted stock units and an acquisition-related performance milestone plan, and 2.7 million shares were reserved for issuance in connection with the Company’s Employee Stock Purchase Plan.
Treasury Stock
Since fiscal 2003, the Company has had various stock repurchase programs that authorized the purchase of up to $1.55 billion of the Company’s outstanding common stock, including a program approved in November 2008 authorizing the repurchase of up to $300 million of the Company’s outstanding common stock. During fiscal 2009, the Company purchased 15.8 million shares of its common stock for an aggregate purchase price of $205.5 million, of which $1.5 million was pending settlement at March 29, 2009 and is included in other current liabilities in the accompanying 2009 consolidated balance sheet. During fiscal 2008, the Company purchased 24.1 million shares of its common stock for an aggregate purchase price of $351.5 million, of which $1.7 million was pending settlement and is included in other current liabilities in the accompanying 2008 consolidated balance sheet. As of March 29, 2009, the Company had purchased a total of 82.5 million shares of common stock under these repurchase programs for an aggregate purchase price of $1.28 billion.
Repurchased shares have been recorded as treasury shares and will be held until the Company’s Board of Directors designates that these shares be retired or used for other purposes.
Note 9. Stock-Based Compensation
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan (the ESPP) that operates in accordance with Section 423 of the Internal Revenue Code. The ESPP is administered by the Compensation Committee of the Board of Directors. Under the ESPP, employees of the Company who elect to participate are granted options to purchase common stock at a 15% discount from the lower of the market value of the common stock at the beginning or end of each three-month offering period. The ESPP permits an enrolled employee to make contributions to purchase shares of common stock by having withheld from their salary an amount between 1% and 10% of compensation. As of March 29, 2009 and March 30, 2008, ESPP participant contributions of $1.1 million and $1.0 million, respectively, were included in other current liabilities in the accompanying consolidated balance sheets. The total number of shares issued under the ESPP was 528,000, 501,000 and 405,000 during fiscal 2009, 2008 and 2007, respectively.
Stock Incentive Compensation Plans
The Company may grant stock-based awards to employees and directors under the QLogic 2005 Performance Incentive Plan (the 2005 Plan). Prior to the adoption of the 2005 Plan in August 2005, the Company granted options to purchase shares of the Company’s common stock to employees and directors under certain predecessor stock plans. Additionally, the Company has assumed stock options as part of acquisitions.
The 2005 Plan provides for the issuance of incentive and non-qualified stock options, restricted stock units and other stock-based incentive awards for employees. The 2005 Plan permits the Compensation Committee of the Board of Directors to select eligible
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employees to receive awards and to determine the terms and conditions of awards. In general, stock options granted to employees have ten-year terms and vest over four years from the date of grant. Restricted stock units represent a right to receive a share of stock at a future vesting date with no cash payment from the holder. In general, restricted stock units vest over four years from the date of grant for employees.
Under the terms of the 2005 Plan, as amended, non-employee directors receive grants of stock-based awards upon initial election or appointment to the Board of Directors and upon annual reelection to the Board. The target fair value of such grants are determined by reference to the equity compensation for non-employee directors of the Company’s peer group of companies. The target value is then allocated 100% to a non-qualified stock option grant in the case of the initial grant and allocated 35% to a restricted stock unit award and 65% to a non-qualified stock option grant in the case of the annual grant. All stock options and restricted stock units granted to non-employee directors have ten-year terms and vest over three years from the date of grant.
In connection with the acquisition of PathScale in fiscal 2007, the Company assumed options subject to the terms of the original PathScale equity plan. These options have ten-year terms from the original grant date and generally vest over four years from the date of grant.
The Company also entered into stock-based performance plans in connection with the acquisitions of PathScale and Troika (see Note 2).
As of March 29, 2009, options to purchase 25.9 million shares of common stock and 1.7 million restricted stock units were held by employees and directors. Shares available for future grant were 9.7 million under the 2005 Plan as of March 29, 2009. No further awards can be granted under any other plans.
A summary of stock option activity is as follows:
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A summary of restricted stock unit activity is as follows:
Stock-Based Compensation Expense
A summary of stock-based compensation expense, excluding stock-based compensation related to acquisitions, recorded under SFAS No. 123R by functional line item in the accompanying consolidated statements of income is as follows:
Stock-based compensation expense related to acquisitions of $0.2 million, $1.2 million and $9.1 million for fiscal 2009, 2008 and 2007, respectively, is excluded from the above table.
SFAS No. 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The fair value of stock options granted and shares to be purchased under the ESPP have been estimated at the date of grant using a Black-Scholes option-pricing model. The weighted-average fair values and underlying assumptions are as follows:
Restricted stock units granted were valued based on the closing market price on the date of grant.
Stock-based compensation expense for stock options, restricted stock units and employee stock purchases recognized under the provisions of SFAS No. 123R for fiscal 2009, 2008 and 2007 was $28.6 million ($24.0 million after income taxes), $31.8 million
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
($26.4 million after income taxes) and $30.3 million ($24.7 million after income taxes), respectively. Stock-based compensation costs capitalized as part of the cost of assets for fiscal 2009, 2008 and 2007 were not material.
As of March 29, 2009, there was $58.5 million of total unrecognized compensation costs related to outstanding stock-based awards. These costs are expected to be recognized over a weighted average period of 2.6 years.
During fiscal 2009, 2008 and 2007, the grant date fair value of options vested totaled $20.5 million, $26.2 million and $22.9 million, respectively. The intrinsic value of options exercised during fiscal 2009, 2008 and 2007 totaled $6.9 million, $5.7 million and $17.9 million, respectively. Intrinsic value of options exercised is calculated as the difference between the market price on the date of exercise and the exercise price multiplied by the number of options exercised.
The fair value of restricted stock units vested during fiscal 2009 and 2008 totaled $5.5 million and $3.4 million, respectively. No restricted stock units vested during fiscal 2007.
The Company currently issues new shares to deliver common stock under its stock-based award plans.
Note 10. Employee Retirement Savings Plan
The Company has established a pretax savings and profit sharing plan under Section 401(k) of the Internal Revenue Code for substantially all domestic employees. Under the plan, eligible employees are able to contribute up to 50% of their compensation, subject to limits specified in the Internal Revenue Code. Company contributions match up to 3% of a participant’s compensation. The Company’s direct contributions on behalf of its employees were $2.7 million, $2.8 million and $2.7 million in fiscal 2009, 2008 and 2007, respectively. The Company also maintains retirement plans in certain non-US locations. The total expense and total obligation of the Company for these plans were not material to the accompanying consolidated financial statements for all periods presented.
Note 11. Special Charges
During the fiscal 2009, the Company implemented a workforce reduction initiative, primarily in response to the macroeconomic environment, and recorded special charges totaling $4.1 million. The special charges consisted primarily of $3.9 million of exit costs associated with severance benefits for the affected employees and costs related to a facility under a non-cancelable lease that the Company vacated during fiscal 2009 (collectively, the Fiscal 2009 Initiative).
During fiscal 2008, the Company recorded special charges totaling $5.3 million related to workforce reductions and the consolidation and elimination of certain activities, principally related to certain engineering functions. The special charges consisted of $5.0 million for exit costs and $0.3 million for asset impairments. The exit costs include the costs associated with workforce reductions, the cancellation of a contract and the consolidation of certain facilities (collectively, the Fiscal 2008 Initiative).
Activity and liability balances for the exit costs related to the Fiscal 2009 Initiative are as follows:
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Activity and liability balances for the exit costs related to the Fiscal 2008 Initiative are as follows:
The unpaid exit costs are expected to be paid over the terms of the related agreements, principally during fiscal 2010.
Note 12. Interest and Other Income, net
Components of interest and other income, net, are as follows:
Note 13. Commitments and Contingencies
Leases
The Company leases certain facilities, software and equipment under operating lease agreements. A summary of the future minimum lease commitments under non-cancelable operating leases as of March 29, 2009 is as follows:
Rent expense for fiscal 2009, 2008 and 2007 was $9.0 million, $9.7 million and $8.2 million, respectively.
Litigation
Various lawsuits, claims and proceedings have been or may be instituted against the Company. The outcome of litigation cannot be predicted with certainty and some lawsuits, claims and proceedings may be disposed of unfavorably to the Company. Many intellectual property disputes have a risk of injunctive relief and there can be no assurance that a license will be granted. Injunctive relief could have a material adverse effect on the Company’s financial condition or results of operations. Based on an evaluation of matters which are pending or asserted, the Company believes the disposition of such matters will not have a material adverse effect on the Company’s financial condition or results of operations.
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Indemnifications
The Company indemnifies certain of its customers against claims that products purchased from the Company infringe upon a patent, copyright, trademark or trade secret of a third party. In the event of such a claim, the Company agrees to pay all litigation costs, including attorney fees, and any settlement payments or damages awarded directly related to the infringement. The indemnification provisions generally do not expire. The Company is not currently defending any intellectual property infringement claims. On occasion, the Company has been made aware of potential infringement claims. However, based on an evaluation of these potential claims, the Company believes the disposition of such matters will not have a material adverse effect on the Company’s financial condition or results of operations. Accordingly, the Company has not recorded a liability related to such indemnifications.
Note 14. Income Taxes
Income before income taxes consists of the following components:
The components of income taxes are as follows:
The tax benefits associated with dispositions from employee stock compensation plans of $0.3 million, $0.3 million and $5.8 million in fiscal 2009, 2008 and 2007, respectively, were recorded directly to additional paid-in capital. In addition, the tax expense (benefit) associated with the change in unrealized gains and losses on the Company’s marketable securities of $2.2 million, $(1.8) million and $1.3 million in fiscal 2009, 2008 and 2007, respectively, were recorded in other comprehensive income (loss).
A reconciliation of the income tax provision with the amount computed by applying the federal statutory tax rate to income before income taxes is as follows:
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The components of the deferred tax assets and liabilities are as follows:
A summary of the breakdown between current and noncurrent net deferred tax assets included in the accompanying consolidated balance sheets is as follows:
During fiscal 2009, the Company recorded a $3.5 million valuation allowance against deferred tax assets related to impairments on certain investment securities. Due to the recent turmoil in the financial and credit markets, and limitations on the deductibility of capital losses, management is currently unable to assert that it is more likely than not that the Company will realize the benefit of the related deferred tax assets.
Based upon the Company’s current and historical pre-tax earnings, except for the valuation allowance related to impairments on certain investment securities, management believes it is more likely than not that the Company will realize the benefit of the existing net deferred tax assets as of March 29, 2009. Management believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income or that there would be sufficient tax carrybacks available; however, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years.
As of March 29, 2009, the Company has federal net operating loss carryforwards of $7.3 million, which will expire between 2018 and 2026, if not utilized, and state net operating loss carryforwards of $37.7 million, which will expire between 2015 and 2028, if not utilized. The net operating loss carryforwards relate to acquired companies and are subject to limitations on utilization.
As of March 29, 2009, the Company has federal general business credit carryforwards of $2.1 million, which will expire between 2022 and 2026, if not utilized, and state tax credit carryforwards of $1.6 million, of which the majority have no expiration date. The tax credit carryforwards relate to an acquired company and are subject to limitations on their utilization.
As of March 29, 2009, the Company has federal capital loss carryovers of $18.9 million which the Company plans to carryback to offset capital gains reported on the 2006 federal return. The Company also has state capital loss carryovers of $19.0 million. In general, the state carryovers will expire in 2014, if not utilized. Management believes it is more likely than not that sufficient capital gains will be available to realize the benefits of the existing net deferred tax assets associated with capital loss carryovers.
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company has made no provision for U.S. income taxes or foreign withholding taxes on the earnings of its foreign subsidiaries, as these amounts are intended to be indefinitely reinvested in operations outside the United States. As of March 29, 2009, the cumulative amount of undistributed earnings of our foreign subsidiaries was $115.3 million. Because of the availability of U.S. foreign tax credits, it is not practicable to determine the U.S. federal income tax liability that would be payable if such earnings were not reinvested indefinitely.
During fiscal 2009, the audits of the Company’s federal consolidated income tax returns for fiscal years 2005 and 2006 and California combined income tax returns for fiscal years 2004 through 2006 were completed. The Company is no longer subject to federal or California examinations prior to fiscal 2007. The Company’s California combined income tax returns for fiscal year 2007 through 2008 are presently under examination by the Franchise Tax Board. With limited exceptions, the Company is no longer subject to other state and foreign income tax examinations by taxing authorities for the years through fiscal 2004. Management does not believe that the results of these examinations will have a material impact on the Company’s financial condition or results of operations.
As of April 2, 2007, the Company adopted FIN 48, which prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more likely than not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. The adoption of FIN 48 did not have a material impact on the Company’s financial position or results of operations. Upon adoption, the Company had $32.9 million of total gross unrecognized tax benefits.
A rollforward of the activity in the gross unrecognized tax benefits is as follows:
If the unrecognized tax benefits as of March 29, 2009 were recognized, $29.9 million, net of tax benefits from foreign tax credits, state income taxes and timing adjustments, would favorably affect the Company’s effective income tax rate. It is reasonably possible that the Company’s liability for uncertain tax positions may be reduced by as much as $5.3 million as a result of either the settlement of tax positions with various tax authorities or by virtue of the statute of limitations expiring through the end of fiscal 2010.
In addition to the unrecognized tax benefits at March 29, 2009 noted above, the Company had accrued $3.5 million and $4.7 million of interest expense, net of the related tax benefit, and penalties as of March 29, 2009 and March 30, 2008, respectively. The Company recognized interest expense, net of the related tax benefit, and penalties aggregating ($1.2) million and $0.8 million during fiscal 2009 and 2008, respectively.
Note 15. Product Revenues, Geographic Revenues and Significant Customers
Operating segments, as defined by SFAS No. 131 “Disclosures about Segments of an Enterprise and Related Information,” are components of an enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. SFAS No. 131 also requires disclosures about products and services, geographic areas and significant customers. The Company operates in one operating segment for purposes of SFAS No. 131.
Product Revenues
The Company classifies its products into four categories. Host Products consist primarily of Fibre Channel and iSCSI host bus adapters and InfiniBand host channel adapters. Network Products consist primarily of Fibre Channel switches, InfiniBand switches,
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
and storage routers. Silicon Products consist primarily of Fibre Channel and iSCSI controllers. Royalty and Service consist primarily of royalties and service fees. A summary of the components of the Company’s net revenues is as follows:
Geographic Revenues
Revenues by geographic area are presented based upon the country of destination. No individual country other than the United States represented 10% or more of net revenues for any of the years presented. Net revenues by geographic area are as follows:
Significant Customers
A summary of the Company’s customers, including their manufacturing subcontractors, that represent 10% or more of the Company’s net revenues for any of the years presented is as follows:
Note 16. Subsequent Event
On April 27, 2009, the Company acquired NetXen, Inc. (NetXen) in a merger transaction. NetXen develops, markets and sells Ethernet adapter and controller products targeted at the enterprise server market. The acquisition provides the Company with complementary networking products and intellectual property. The acquisition further expands the Company’s expertise in strategic areas of technology and enables it to better address a wider range of emerging customer requirements for converged networks. Consideration paid for this acquisition was approximately $21 million in cash, subject to certain closing adjustments.
The Company is in the process of evaluating the net assets acquired and expects to finalize the purchase price allocation during fiscal 2010. The consideration paid in excess of the fair value of tangible assets acquired is expected to be allocated to intangible assets and goodwill. The historical results of operations of NetXen are not material in relation to the consolidated financial statements of the Company.
QLOGIC CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Note 17. Condensed Quarterly Results (Unaudited)
The following table summarizes certain unaudited quarterly financial information for fiscal 2009 and 2008:
(1)
During the three months ended September 28, 2008, the Company recorded impairment charges related to investment securities of $5.0 million.
(2)
During the three months ended December 28, 2008, the Company recorded impairment charges of $4.3 million related to investment securities, a $4.5 million loss upon the transfer of auction rate securities from the available-for-sale classification to trading securities and an $8.1 million gain for the initial recognition of the put options related to auction rate securities owned by the Company (see Note 4).
(3)
During the three months ended March 29, 2009, the Company recorded impairment charges related to investment securities of $4.4 million, recorded a gain of $2.1 million related to the sale of all of its remaining holdings in common stock of a publicly-traded company and recorded special charges of $2.7 million associated with a workforce reduction initiative. During the three months ended March 30, 2008, the Company recorded impairment charges related to investment securities of $6.9 million.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and (ii) is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure. Our management evaluated, with the participation of our chief executive officer and chief financial officer, the effectiveness of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act. Based on this evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures were effective as of March 29, 2009.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act. Internal control over financial reporting is 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. 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.
Our management evaluated the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on its evaluation as of March 29, 2009, management believes that the Company’s internal control over financial reporting is effective in achieving the objectives described above.
The independent registered public accounting firm that audited the consolidated financial statements included in this annual report has issued an audit report on the effectiveness of the Company’s internal control over financial reporting. See page 37 herein.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act, that occurred during the fourth quarter of fiscal 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Reference is made to the Company’s Definitive Proxy Statement for its 2009 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2009, for information required under this Item 10. Such information is incorporated herein by reference.
The Company has adopted and implemented a Business Ethics Policy (the “Code of Ethics”) that applies to the Company’s officers, employees and directors. The Code of Ethics is available on our website at www.qlogic.com.
Item 11.
Item 11. Executive Compensation
Reference is made to the Company’s Definitive Proxy Statement for its 2009 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2009, for information required under this Item 11. Such information is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Reference is made to the Company’s Definitive Proxy Statement for its 2009 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2009, for information required under this Item 12. Such information is incorporated herein by reference.
There are no arrangements, known to the Company, which might at a subsequent date result in a change in control of the Company.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Reference is made to the Company’s Definitive Proxy Statement for its 2009 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2009, for information required under this Item 13. Such information is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
Reference is made to the Company’s Definitive Proxy Statement for its 2009 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2009, for information required under this Item 14. Such information is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a) (1) Consolidated Financial Statements
The following consolidated financial statements of the Company for the years ended March 29, 2009, March 30, 2008 and April 1, 2007 are filed as part of this report:
FINANCIAL STATEMENT INDEX
(a) (2) Financial Statement Schedule
The following consolidated financial statement schedule of the Company for the years ended March 29, 2009, March 30, 2008 and April 1, 2007 is filed as part of this report and is incorporated herein by reference:
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because the required information is presented in the financial statements or notes thereto, the amounts involved are not significant or the schedules are not applicable.
(a) (3) Exhibits
An exhibit index has been filed as part of this report and is incorporated herein by reference.
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.
Date: May 21, 2009
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes H.K. Desai and/or Simon Biddiscombe, as attorney-in-fact, to sign on his or her behalf and in each capacity stated below, and to file all amendments and/or supplements to this Annual Report on Form 10-K.
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.
SCHEDULE II
QLOGIC CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
EXHIBIT INDEX
*
Compensation plan, contract or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.