10-Q 1 sndkq31210-q.htm FORM 10-Q Q3'12 SNDK Q3 '12 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, For the quarterly period ended September 30, 2012

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ________________

Commission file number:  000-26734

SANDISK CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
77-0191793
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
 
 
601 McCarthy Blvd.
Milpitas, California
95035
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code
(408) 801-1000

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes R
No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes R
No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer R
Accelerated filer ¨
Non accelerated filer ¨
Smaller reporting company ¨
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨
No R

Number of shares outstanding of the issuer’s common stock, $0.001 par value, as of September 30, 2012: 241,788,556.

 




SanDisk Corporation
Index

 
 
Page
No.
PART I. FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Financial Statements:
 
 
Condensed Consolidated Balance Sheets as of September 30, 2012 and January 1, 2012
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2012 and October 2, 2011
 
Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 and October 2, 2011
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and October 2, 2011
 
Notes to Condensed Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
PART II. OTHER INFORMATION
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
 
Signatures
 
Exhibit Index



PART I. FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Financial Statements

SANDISK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,
2012
 
January 1,
2012
 
(In thousands)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,110,485

 
$
1,167,496

Short-term marketable securities
1,485,584

 
1,681,492

Accounts receivable from product revenues, net
465,618

 
521,763

Inventory
852,725

 
678,382

Deferred taxes
100,328

 
100,409

Other current assets
303,888

 
206,419

Total current assets
4,318,628

 
4,355,961

Long-term marketable securities
2,818,969

 
2,766,263

Property and equipment, net
612,633

 
344,897

Notes receivable and investments in Flash Ventures
1,770,355

 
1,943,295

Deferred taxes
178,149

 
199,027

Goodwill
201,735

 
154,899

Intangible assets, net
265,876

 
287,691

Other non-current assets
155,166

 
122,615

Total assets
$
10,321,511

 
$
10,174,648

 
 
 
 
LIABILITIES
 
 
 

Current liabilities:
 
 
 

Accounts payable trade
$
318,347

 
$
258,583

Accounts payable to related parties
226,136

 
276,275

Convertible short-term debt
892,684

 

Other current accrued liabilities
199,183

 
337,517

Deferred income on shipments to distributors and retailers and deferred revenue
260,564

 
220,999

Total current liabilities
1,896,914

 
1,093,374

Convertible long-term debt
780,464

 
1,604,911

Non-current liabilities
436,122

 
415,524

Total liabilities
3,113,500

 
3,113,809

 
 
 
 
Commitments and contingencies (see Note 11)


 
 
 
 
 
 
EQUITY
 
 
 
Stockholders’ equity:
 
 
 
Preferred stock

 

Common stock
242

 
243

Capital in excess of par value
5,014,331

 
4,934,565

Retained earnings
1,882,265

 
1,796,849

Accumulated other comprehensive income
315,520

 
332,701

Total stockholders’ equity
7,212,358

 
7,064,358

Non-controlling interests
(4,347
)
 
(3,519
)
Total equity
7,208,011

 
7,060,839

Total liabilities and equity
$
10,321,511

 
$
10,174,648

The accompanying notes are an integral part of these condensed consolidated financial statements.

3


SANDISK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
 
(In thousands, except per share amounts)
Revenues:
 
 
 
 
 
 
 
Product
$
1,182,159

 
$
1,321,904

 
$
3,233,785

 
$
3,814,111

License and royalty
91,031

 
94,128

 
277,221

 
271,114

Total revenues
1,273,190

 
1,416,032

 
3,511,006

 
4,085,225

Cost of product revenues
880,469

 
790,465

 
2,398,086

 
2,281,264

Amortization of acquisition-related intangible assets
9,800

 
13,186

 
32,712

 
26,556

Total cost of product revenues
890,269

 
803,651

 
2,430,798

 
2,307,820

Gross profit
382,921

 
612,381

 
1,080,208

 
1,777,405

Operating expenses:
 

 
 

 
 
 
 
Research and development
150,336

 
135,271

 
443,690

 
400,145

Sales and marketing
57,938

 
48,538

 
159,234

 
144,195

General and administrative
40,205

 
40,567

 
110,488

 
116,020

Amortization of acquisition-related intangible assets
2,369

 
1,878

 
6,676

 
2,608

Total operating expenses
250,848

 
226,254

 
720,088

 
662,968

Operating income
132,073

 
386,127

 
360,120

 
1,114,437

Interest income
14,687

 
14,754

 
44,680

 
46,873

Interest (expense) and other income (expense), net
(28,382
)
 
(38,332
)
 
(100,888
)
 
(103,090
)
Total other income (expense), net
(13,695
)
 
(23,578
)
 
(56,208
)
 
(56,217
)
Income before income taxes
118,378

 
362,549

 
303,912

 
1,058,220

Provision for income taxes
41,871

 
129,296

 
100,051

 
352,453

Net income
$
76,507

 
$
233,253

 
$
203,861

 
$
705,767

 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.32

 
$
0.97

 
$
0.84

 
$
2.96

Diluted
$
0.31

 
$
0.96

 
$
0.83

 
$
2.90

Shares used in computing net income per share:
 
 
 
 
 
 
 
Basic
241,694

 
239,836

 
242,284

 
238,720

Diluted
244,221

 
243,680

 
245,502

 
243,782


The accompanying notes are an integral part of these condensed consolidated financial statements.


4


SANDISK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
 
(In thousands)
Net income
$
76,507

 
$
233,253

 
$
203,861

 
$
705,767

 
 
 
 
 
 
 
 
Other comprehensive income (loss), before tax:
 
 
 
 
 
 
 
Unrealized holding gain (loss) on marketable securities
6,233

 
(9,048
)
 
17,995

 
9,357

Reclassification adjustment for realized gain on marketable securities included in net income
(888
)
 
(604
)
 
(2,090
)
 
(6,073
)
 
5,345

 
(9,652
)
 
15,905

 
3,284

 
 
 
 
 
 
 
 
Foreign currency translation adjustments
39,088

 
80,427

 
(7,955
)
 
89,768

 
 
 
 
 
 
 
 
Unrealized holding gain (loss) on derivatives qualifying as cash flow hedges
11,239

 
26,863

 
(27,681
)
 
30,288

Reclassification adjustment for realized (gain) loss on derivatives qualifying as cash flow hedges included in net income
11,184

 
(7,386
)
 
6,399

 
(11,933
)
 
22,423

 
19,477

 
(21,282
)
 
18,355

 
 
 
 
 
 
 
 
Total other comprehensive income (loss), before tax
66,856

 
90,252

 
(13,332
)
 
111,407

Income tax expense related to items of other comprehensive income (loss)
6,857

 
9,342

 
3,849

 
20,798

Total other comprehensive income (loss), net of tax
59,999

 
80,910

 
(17,181
)
 
90,609

 
 
 
 
 
 
 
 
Comprehensive income
$
136,506

 
$
314,163

 
$
186,680

 
$
796,376


The accompanying notes are an integral part of these condensed consolidated financial statements.



5


SANDISK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
203,861

 
$
705,767

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Deferred taxes
9,554

 
(77,842
)
Depreciation
112,471

 
84,959

Amortization
128,825

 
118,035

Provision for doubtful accounts
70

 
(1,929
)
Share-based compensation expense
59,283

 
44,678

Excess tax benefit from share-based compensation
(14,116
)
 
(15,820
)
Impairment, restructuring and other
(11,172
)
 
(25,118
)
Other non-operating
67,066

 
63,771

Changes in operating assets and liabilities:
 
 
 

Accounts receivable from product revenues, net
56,081

 
(89,157
)
Inventory
(173,794
)
 
(164,798
)
Other assets
35,387

 
(69,443
)
Accounts payable trade
59,764

 
38,368

Accounts payable to related parties
(50,139
)
 
17,077

Other liabilities
(268,913
)
 
215,672

Total adjustments
10,367

 
138,453

Net cash provided by operating activities
214,228

 
844,220

 
 
 
 
Cash flows from investing activities:
 

 
 

Purchases of short and long-term marketable securities
(1,950,164
)
 
(2,500,913
)
Proceeds from sales of short and long-term marketable securities
1,583,503

 
2,276,356

Proceeds from maturities of short and long-term marketable securities
478,475

 
505,920

Acquisition of property and equipment, net
(382,632
)
 
(114,267
)
Investment in Flash Ventures
(50,439
)
 
(83,316
)
Notes receivable issuances to Flash Ventures
(142,316
)
 
(399,281
)
Notes receivable proceeds from Flash Ventures
357,876

 
248,516

Purchased technology and other assets
(245
)
 
(100,000
)
Acquisitions, net of cash acquired
(69,417
)
 
(317,649
)
Net cash used in investing activities
(175,359
)
 
(484,634
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Proceeds from sale (purchase) of convertible bond hedge

 
1,494

Proceeds from sale (purchase) of warrants

 
(1,158
)
Repayment of debt financing

 
(211,441
)
Proceeds from employee stock programs
77,770

 
81,791

Excess tax benefit from share-based compensation
14,116

 
15,820

Share repurchase program
(191,504
)
 

Net cash received for share repurchase contracts
2,675

 

Net cash used in financing activities
(96,943
)
 
(113,494
)
Effect of changes in foreign currency exchange rates on cash
1,063

 
(391
)
Net increase (decrease) in cash and cash equivalents
(57,011
)
 
245,701

Cash and cash equivalents at beginning of the period
1,167,496

 
829,149

Cash and cash equivalents at end of the period
$
1,110,485

 
$
1,074,850

The accompanying notes are an integral part of these condensed consolidated financial statements.

6


SANDISK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



1.
Organization and Summary of Significant Accounting Policies

Organization

These interim Condensed Consolidated Financial Statements are unaudited but reflect, in the opinion of management, all adjustments, consisting of normal recurring adjustments and accruals, necessary to present fairly the financial position of SanDisk Corporation and its subsidiaries (the “Company”) as of September 30, 2012, the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2012 and October 2, 2011, the Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 and October 2, 2011 and the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and October 2, 2011. Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) have been omitted in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). These Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and accompanying notes included in the Company’s most recent Annual Report on Form 10‑K filed with the SEC on February 23, 2012. The results of operations for the three and nine months ended September 30, 2012 are not necessarily indicative of the results to be expected for the entire fiscal year.

Basis of Presentation. The Company’s fiscal year ends on the Sunday closest to December 31, and its fiscal quarters consist of 13 weeks and generally end on the Sunday closest to March 31, June 30, and September 30. The third quarters of fiscal years 2012 and 2011 ended on September 30, 2012 and October 2, 2011, respectively. For accounting and disclosure purposes, the exchange rates of 77.76, 77.17 and 76.78 at September 30, 2012, January 1, 2012 and October 2, 2011, respectively, were used to convert Japanese yen to U.S. dollars. Certain prior period amounts have been reclassified in the footnotes to conform to the current period presentation, including line items within income tax expense (benefit) allocated to accumulated other comprehensive income in Note 4, “Balance Sheet Information.”

Organization and Nature of Operations. The Company was incorporated in Delaware on June 1, 1988. The Company designs, develops, markets and manufactures flash memory storage card products used in a wide variety of consumer electronics products. The Company operates in one segment, flash memory storage products.

Principles of Consolidation. The Condensed Consolidated Financial Statements include the accounts of the Company and its majority-owned subsidiaries. All intercompany balances and transactions have been eliminated. Non-controlling interests represent the minority shareholders’ proportionate share of the net assets and results of operations of the Company’s consolidated subsidiaries. The Condensed Consolidated Financial Statements also include the results of companies acquired by the Company from the date of each acquisition.

Use of Estimates. The preparation of Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Condensed Consolidated Financial Statements and accompanying notes. The estimates and judgments affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to customer programs and incentives, intellectual property claims, product returns, inventories and inventory reserves, valuation and impairments of marketable securities and investments, impairments of goodwill and long-lived assets, income taxes, warranty obligations, restructuring, contingencies, share-based compensation and litigation. The Company bases estimates on historical experience and on other assumptions that its management believes are reasonable under the circumstances. These estimates form the basis for making judgments about the carrying value of assets and liabilities when those values are not readily apparent from other sources. Actual results could materially differ from these estimates.


7


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Recent Accounting Pronouncements. In July 2012, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance related to the testing of indefinite-lived intangible assets for impairment. The guidance gives an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that an indefinite-lived asset is impaired. Under the amendments in this update, an entity has the option to bypass the qualitative assessment in any period and proceed directly to the quantitative impairment test. An entity may resume performing the qualitative assessment in any subsequent period. This guidance is effective for interim and annual impairment tests performed for fiscal years beginning after September 15, 2012 with early adoption permitted. The Company expects to early-adopt this guidance in the fourth quarter of fiscal year 2012 for its annual indefinite-lived intangible assets impairment test and does not believe the adoption of this guidance will have a material impact on its Consolidated Financial Statements.




8


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



2.
Investments and Fair Value Measurements

The Company’s total cash, cash equivalents and marketable securities were as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Cash and cash equivalents
$
1,110,485

 
$
1,167,496

Short-term marketable securities
1,485,584

 
1,681,492

Long-term marketable securities
2,818,969

 
2,766,263

Total cash, cash equivalents and marketable securities
$
5,415,038

 
$
5,615,251


For certain of the Company’s financial instruments, including cash held in banks, accounts receivable and accounts payable, the carrying amounts approximate fair value due to their short maturities, and are therefore excluded from the fair value tables below.

Financial assets and liabilities measured and recorded at fair value on a recurring basis consisted of the following types of instruments (in thousands):
 
September 30, 2012
                              
January 1, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Money market funds
$
606,845

 
$

 
$

 
$
606,845

 
$
901,500

 
$

 
$

 
$
901,500

Fixed income securities
22,988

 
4,451,060

 

 
4,474,048

 
214,431

 
4,312,929

 

 
4,527,360

Derivative assets

 
6,938

 

 
6,938

 

 
21,093

 

 
21,093

Other

 

 

 

 

 
4,501

 

 
4,501

Total financial assets
$
629,833

 
$
4,457,998

 
$

 
$
5,087,831

 
$
1,115,931

 
$
4,338,523

 
$

 
$
5,454,454

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
$

 
$
6,759

 
$

 
$
6,759

 
$

 
$
45,835

 
$

 
$
45,835

Total financial liabilities
$

 
$
6,759

 
$

 
$
6,759

 
$

 
$
45,835

 
$

 
$
45,835


Financial assets and liabilities measured and recorded at fair value on a recurring basis were presented on the Company’s Condensed Consolidated Balance Sheets as follows (in thousands):
 
September 30, 2012
                              
January 1, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Level 1
 
Level 2
 
Level 3
 
Total
Cash equivalents(1)
$
608,845

 
$
167,495

 
$

 
$
776,340

 
$
926,994

 
$
54,111

 
$

 
$
981,105

Short-term marketable securities
15,826

 
1,469,758

 

 
1,485,584

 
155,538

 
1,525,954

 

 
1,681,492

Long-term marketable securities
5,162

 
2,813,807

 

 
2,818,969

 
33,399

 
2,732,864

 

 
2,766,263

Other current assets and other non-current assets

 
6,938

 

 
6,938

 

 
25,594

 

 
25,594

Total financial assets
$
629,833

 
$
4,457,998

 
$

 
$
5,087,831

 
$
1,115,931

 
$
4,338,523

 
$

 
$
5,454,454

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other current accrued liabilities
$

 
$
4,272

 
$

 
$
4,272

 
$

 
$
40,045

 
$

 
$
40,045

Non-current liabilities

 
2,487

 

 
2,487

 

 
5,790

 

 
5,790

Total financial liabilities
$

 
$
6,759

 
$

 
$
6,759

 
$

 
$
45,835

 
$

 
$
45,835

————
(1) 
Cash equivalents exclude cash of $334.1 million and $186.4 million included in Cash and cash equivalents on the Condensed Consolidated Balance Sheets as of September 30, 2012 and January 1, 2012, respectively.


9


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



During the nine months ended September 30, 2012, the Company had no transfers of financial assets or liabilities between Level 1 and Level 2. As of September 30, 2012 and January 1, 2012, the Company had no financial assets or liabilities categorized as Level 3.

As of September 30, 2012 and January 1, 2012, the Company had not elected the fair value option for any financial assets and liabilities for which such an election would have been permitted.

Available-for-Sale Investments. Available-for-sale investments were as follows (in thousands):
 
September 30, 2012
                              
January 1, 2012
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
 
Amortized Cost
 
Gross Unrealized Gain
 
Gross Unrealized Loss
 
Fair Value
Fixed income securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and government agency securities
$
29,414

 
$
16

 
$
(1
)
 
$
29,429

 
$
219,366

 
$
69

 
$
(4
)
 
$
219,431

U.S. government-sponsored agency securities
87,948

 
56

 

 
88,004

 
97,087

 
10

 
(26
)
 
97,071

Corporate notes and bonds
808,426

 
4,524

 
(36
)
 
812,914

 
780,650

 
1,707

 
(3,889
)
 
778,468

Asset-backed securities
198,315

 
532

 
(5
)
 
198,842

 
180,828

 
61

 
(149
)
 
180,740

Mortgage-backed securities
3,764

 
25

 
(14
)
 
3,775

 
1,137

 
5

 

 
1,142

Municipal notes and bonds
3,313,224

 
28,018

 
(158
)
 
3,341,084

 
3,231,240

 
20,470

 
(1,202
)
 
3,250,508

Total available-for-sale investments
$
4,441,091

 
$
33,171

 
$
(214
)
 
$
4,474,048

 
$
4,510,308

 
$
22,322

 
$
(5,270
)
 
$
4,527,360


The fair value and gross unrealized losses on the available-for-sale securities that have been in an unrealized loss position, aggregated by type of investment instrument, and the length of time that individual securities have been in a continuous unrealized loss position as of September 30, 2012, are summarized in the following table (in thousands). Available-for-sale securities that were in an unrealized gain position have been excluded from the table.
 
Less than 12 months
 
Greater than 12 months
 
Fair Value
 
Gross Unrealized Loss
 
Fair Value
 
Gross Unrealized Loss
U.S. Treasury and government agency securities
$
3,420

 
$
(1
)
 
$

 
$

U.S. government-sponsored agency securities
28,995

 

 

 

Corporate notes and bonds
66,262

 
(16
)
 
7,727

 
(20
)
Asset-backed securities
6,804

 
(5
)
 

 

Mortgage-backed securities
1,863

 
(14
)
 

 

Municipal notes and bonds
101,058

 
(73
)
 
17,131

 
(85
)
Total
$
208,402

 
$
(109
)
 
$
24,858

 
$
(105
)

The gross unrealized loss related to U.S. Treasury and government agency securities, U.S. government-sponsored agency securities, corporate and municipal notes and bonds, and asset-backed and mortgage-backed securities was primarily due to changes in interest rates. The gross unrealized loss on all available-for-sale fixed income securities at September 30, 2012 was considered temporary in nature. Factors considered in determining whether a loss is temporary include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the investee, and the Company’s intent and ability to hold an investment for a period of time sufficient to allow for any anticipated recovery in market value. For debt security investments, the Company considered additional factors including the Company’s intent to sell the investments or whether it is “more likely than not” the Company will be required to sell the investments before the recovery of its amortized cost.


10


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



The following table shows the gross realized gains and losses on sales of available-for-sale securities (in thousands).
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Gross realized gains
$
940

 
$
1,276

 
$
2,964

 
$
6,890

Gross realized losses
(52
)
 
(672
)
 
(874
)
 
(882
)

Fixed income securities by contractual maturity as of September 30, 2012 are shown below (in thousands). Actual maturities may differ from contractual maturities because issuers of the securities may have the right to prepay obligations.
 
Amortized Cost
 
Fair Value
Due in one year or less
$
1,651,569

 
$
1,655,079

Due after one year through five years
2,789,522

 
2,818,969

Total
$
4,441,091

 
$
4,474,048

 

For those financial instruments where the carrying amounts differ from fair value, the following table represents the related carrying values and the fair values, which are based on quoted market prices (in thousands). These financial instruments were categorized as Level 1 as of September 30, 2012 and January 1, 2012.
 
September 30, 2012
 
January 1, 2012
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
1% Convertible Sr. Notes due 2013
$
892,684

 
$
919,987

 
$
852,146

 
$
914,140

1.5% Convertible Sr. Notes due 2017
780,464

 
1,135,140

 
752,765

 
1,177,500

Total
$
1,673,148

 
$
2,055,127

 
$
1,604,911

 
$
2,091,640





11


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



3.
Derivatives and Hedging Activities

The Company uses derivative instruments primarily to manage exposures to foreign currency. The Company’s primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in foreign currency. The program is not designated for trading or speculative purposes. The Company’s derivatives expose the Company to credit risk to the extent that the counterparties may be unable to meet the terms of the agreement. The Company seeks to mitigate such risk by limiting its counterparties to major financial institutions and by spreading the risk across several major financial institutions. In addition, the potential risk of loss with any one counterparty resulting from this type of credit risk is monitored by the Company on an ongoing basis.

The Company recognizes derivative instruments as either assets or liabilities on the balance sheet at fair value and provides qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. Changes in fair value (i.e., gains or losses) of the derivatives are recorded as cost of product revenues or other income (expense), or as accumulated other comprehensive income (“OCI”). The Company does not offset or net the fair value amounts of derivative instruments and separately discloses the fair value amounts of the derivative instruments as either assets or liabilities.

Cash Flow Hedges. The Company uses forward contracts designated as cash flow hedges to hedge a portion of future forecasted purchases in Japanese yen. The gain or loss on the effective portion of a cash flow hedge is initially reported as a component of accumulated OCI and subsequently reclassified into cost of product revenues in the same period or periods in which the cost of product revenues is recognized, or reclassified into other income (expense) if the hedged transaction becomes probable of not occurring. Any gain or loss after a hedge is no longer designated because it is no longer probable of occurring or it is related to an ineffective portion of a cash flow hedge, as well as any amount excluded from the Company’s hedge effectiveness, is recognized as other income (expense) immediately. As of September 30, 2012, the Company had forward contracts in place to hedge future purchases over the next twelve months of 26.3 billion Japanese yen, or approximately $338 million based upon the exchange rate as of September 30, 2012, and the net unrealized gain on the effective portion of these cash flow hedges was $2.9 million. As of September 30, 2012, the Company had no forward contracts in place to hedge future purchases beyond the next twelve months.

Other Derivatives. Other derivatives that are non-designated consist primarily of forward and cross currency swap contracts to minimize the risk associated with the foreign exchange effects of revaluing monetary assets and liabilities. Monetary assets and liabilities denominated in foreign currencies and the associated outstanding forward and cross currency swap contracts were marked-to-market at September 30, 2012 with realized and unrealized gains and losses included in other income (expense). As of September 30, 2012, the Company had foreign currency forward contracts hedging exposures in European euros, British pounds and Japanese yen. Foreign currency forward contracts were outstanding to buy and sell U.S. dollar equivalents of approximately $230 million and $143 million in foreign currencies, respectively, based upon the exchange rates at September 30, 2012.

The Company currently has cross currency swap contracts with various counterparties to exchange Japanese yen for U.S. dollars that require the Company to comply with certain covenants, the strictest of which is to maintain a minimum liquidity of $1.0 billion. Liquidity is defined as the sum of the Company’s cash and cash equivalents and short and long-term marketable securities. These cross currency swap contracts were outstanding to sell U.S. dollar equivalents of approximately $185 million based upon the exchange rates at September 30, 2012. Should the Company fail to comply with these covenants, the Company may be required to settle the unrealized gain or loss on the foreign exchange contracts prior to the original maturity date. The Company was in compliance with these covenants as of September 30, 2012.

The amounts in the tables below include fair value adjustments related to the Company’s own credit risk and counterparty credit risk.


12


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Fair Value of Derivative Contracts. Fair value of derivative contracts as of September 30, 2012 and January 1, 2012 were as follows (in thousands):
 
Derivative assets reported in
 
Other Current Assets
 
Other Non-current Assets
 
September 30,
2012
 
January 1,
2012
 
September 30,
2012
 
January 1,
2012
Designated cash flow hedges
 
 
 
 
 
 
 
Foreign exchange contracts
$
4,149

 
$
14,890

 
$

 
$

 
4,149

 
14,890

 

 

Foreign exchange contracts not designated
2,789

 
6,203

 

 

Total derivatives
$
6,938

 
$
21,093

 
$

 
$


 
Derivative liabilities reported in
 
Other Current Accrued Liabilities
 
Non-current Liabilities
 
September 30,
2012
 
January 1,
2012
 
September 30,
2012
 
January 1,
2012
Designated cash flow hedges
 
 
 
 
 
 
 
Foreign exchange contracts
$
1,243

 
$
3,265

 
$

 
$

 
1,243

 
3,265

 

 

Foreign exchange contracts not designated
3,029

 
36,780

 
2,487

 
5,790

Total derivatives
$
4,272

 
$
40,045

 
$
2,487

 
$
5,790


Foreign Exchange and Equity Market Risk Contracts Designated as Cash Flow Hedges. The impact of the effective portion of designated cash flow derivative contracts on the Company’s results of operations for the three and nine months ended September 30, 2012 and October 2, 2011 was as follows (in thousands):
 
Three months ended
                  
Nine months ended
 
Amount of gain recognized in OCI
 
Amount of gain (loss) reclassified from OCI to earnings
 
Amount of gain (loss) recognized in OCI
 
Amount of gain (loss) reclassified from OCI to earnings
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Foreign exchange contracts
$
11,239

 
$
21,617

 
$
(11,184
)
 
$
7,386

 
$
(27,681
)
 
$
21,338

 
$
(6,399
)
 
$
11,933

Equity market risk contract

 
5,246

 

 

 

 
8,950

 

 


Foreign exchange contracts designated as cash flow hedges relate primarily to wafer purchases in Japanese yen. Gains and losses associated with foreign exchange contracts designated as cash flow hedges are expected to be recorded in cost of product revenues when reclassified out of accumulated OCI. Losses from the equity market risk contract were recorded in other income (expense) when reclassified out of accumulated OCI. The Company expects to realize the majority of the accumulated OCI balance related to foreign exchange contracts within the next twelve months.


13


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



The following table includes the ineffective portion of designated cash flow derivative contracts and the forward points excluded for the purposes of cash flow hedging designation recognized in other income (expense) (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Foreign exchange contracts
$
(1,136
)
 
$
(584
)
 
$
(6,382
)
 
$
(3,025
)

Effect of Non-Designated Derivative Contracts on the Condensed Consolidated Statements of Operations. The effect of non-designated derivative contracts on the Company’s results of operations recognized in other income (expense) was as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Gain (loss) on foreign exchange contracts including forward point income
$
(652
)
 
$
(13,864
)
 
$
1,934

 
$
(15,900
)
Gain from revaluation of foreign currency exposures hedged by foreign exchange contracts
2,359

 
16,668

 
390

 
18,739




14


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



4.
Balance Sheet Information

Accounts Receivable from Product Revenues, net. Accounts receivable from product revenues, net, were as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Trade accounts receivable
$
604,112

 
$
692,702

Allowance for doubtful accounts
(5,544
)
 
(5,717
)
Price protection, promotions and other activities
(132,950
)
 
(165,222
)
Total accounts receivable from product revenues, net
$
465,618

 
$
521,763


Inventory. Inventory was as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Raw material
$
535,427

 
$
398,308

Work-in-process
106,564

 
89,332

Finished goods
210,734

 
190,742

Total inventory
$
852,725

 
$
678,382


Other Current Assets. Other current assets were as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Royalty and other receivables
$
41,773

 
$
53,443

Other non-trade receivable

 
26,875

Prepaid expenses
13,621

 
17,274

Tax-related receivables
220,979

 
67,157

Prepayment to Flash Forward Ltd.
20,577

 
20,577

Other current assets
6,938

 
21,093

Total other current assets
$
303,888

 
$
206,419


Notes Receivable and Investments in Flash Ventures. Notes receivable and investments in Flash Partners Ltd., Flash Alliance Ltd. and Flash Forward Ltd. (collectively referred to as “Flash Ventures”) were as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Notes receivable, Flash Partners Ltd.
$
199,331

 
$
291,564

Notes receivable, Flash Alliance Ltd.
688,014

 
973,176

Notes receivable, Flash Forward Ltd.
180,041

 
32,396

Investment in Flash Partners Ltd.
254,986

 
258,184

Investment in Flash Alliance Ltd.
375,518

 
368,459

Investment in Flash Forward Ltd.
72,465

 
19,516

Total notes receivable and investments in Flash Ventures
$
1,770,355

 
$
1,943,295


Equity-method investments and the Company’s maximum loss exposure related to Flash Ventures are discussed further in Note 11, “Commitments, Contingencies and Guarantees – Flash Partners, Flash Alliance and Flash Forward” and Note 12, “Related Parties and Strategic Investments.”


15


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



The Company assesses financing receivable credit quality through financial and operational reviews of the borrower and creditworthiness, including credit rating agency ratings, of significant investors of the borrower, where material or known. Impairments, when required, are recorded in other income (expense). The Company makes or will make long-term loans to Flash Ventures to fund new process technologies and additional wafer capacities. The Company aggregates its Flash Ventures notes receivable into one class of financing receivables due to the similar ownership interest and common structure in each Flash Ventures entity. For all reporting periods presented, no loans were past due and no loan impairments were recorded.

Other Non-Current Assets. Other non-current assets were as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Prepaid tax on intercompany transactions
$
43,211

 
$
46,489

Prepayment to Flash Forward Ltd.
10,289

 
29,396

Convertible note issuance costs
9,179

 
12,992

Long-term prepaid income tax
63,008

 
3,956

Other non-current assets
29,479

 
29,782

Total other non-current assets
$
155,166

 
$
122,615


Other Current Accrued Liabilities. Other current accrued liabilities were as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Accrued payroll and related expenses
$
79,473

 
$
132,182

Derivative contract payables
4,272

 
40,045

Taxes payable
8,181

 
61,144

Other accrued liabilities
107,257

 
104,146

Total other current accrued liabilities
$
199,183

 
$
337,517


Non-current liabilities. Non-current liabilities were as follows (in thousands):
 
September 30,
2012
 
January 1,
2012
Deferred tax liabilities
$
43,174

 
$
44,262

Income tax liabilities
210,114

 
218,994

Deferred credits on intercompany transactions
62,749

 
67,926

Other non-current liabilities
120,085

 
84,342

Total non-current liabilities
$
436,122

 
$
415,524

 

Warranties. The liability for warranty expense is included in Other current accrued liabilities and Non-current liabilities in the accompanying Condensed Consolidated Balance Sheets and the activity was as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Balance, beginning of period
$
31,640

 
$
23,156

 
$
26,957

 
$
24,702

Additions and adjustments to cost of product revenues
4,565

 
5,689

 
18,044

 
13,893

Usage
(4,339
)
 
(5,310
)
 
(13,135
)
 
(15,060
)
Balance, end of period
$
31,866

 
$
23,535

 
$
31,866

 
$
23,535



16


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



The majority of the Company’s products have a warranty of less than three years, with a small number of products having a warranty ranging up to ten years or more. For 100-year or lifetime warranties, the Company uses the estimated useful life of the product to calculate the warranty exposure. A provision for the estimated future cost related to warranty expense is recorded at the time of customer invoice. The Company’s warranty liability is affected by customer and consumer returns, product failures, number of units sold and repair or replacement costs incurred. Should actual product failure rates, or repair or replacement costs, differ from the Company’s estimates, increases or decreases to its warranty liability would be required.

Accumulated Other Comprehensive Income. Accumulated other comprehensive income presented in the accompanying Condensed Consolidated Balance Sheets consists of unrealized gains and losses on available-for-sale investments, foreign currency translation and hedging activities, net of tax, for all periods presented (in thousands):
 
September 30,
2012
 
January 1,
2012
Accumulated net unrealized gain (loss) on:
 
 
 
Available-for-sale investments
$
21,060

 
$
10,849

Foreign currency translation
294,679

 
300,788

Hedging activities
(219
)
 
21,064

Total accumulated other comprehensive income
$
315,520

 
$
332,701


The amount of income tax expense (benefit) allocated to available-for-sale investments, foreign currency translation and hedging activities was as follows (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Available-for-sale investments
$
1,860

 
$
(3,479
)
 
$
5,694

 
$
5,777

Foreign currency translation
4,997

 
10,906

 
(1,845
)
 
11,754

Hedging activities

 
1,915

 

 
3,267

 
$
6,857

 
$
9,342

 
$
3,849

 
$
20,798


 

17


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



5.
Goodwill and Intangible Assets

Goodwill. Goodwill balances are presented below (in thousands):
 
Carrying Amount
Balance as of January 1, 2012
$
154,899

Acquisitions
42,979

Acquisition earn-out provision
3,857

Balance as of September 30, 2012
$
201,735


Goodwill increased by $43.0 million due to the Company’s acquisition of 100% of the outstanding shares of FlashSoft Corporation (“FlashSoft”) on February 13, 2012 and Schooner Information Technology, Inc. (“Schooner”) on June 21, 2012. In addition, during the three months ended September 30, 2012, the Company recognized $3.9 million of goodwill under an achieved earn-out provision related to an acquisition consummated in fiscal year 2004.

FlashSoft is a provider of software caching solutions that enable flash-based products to be configured as high-performance cache. The acquisition of FlashSoft adds software caching solutions to the Company’s growing portfolio of enterprise storage solutions. The goodwill resulted from expected synergies from the transaction, including the Company’s resources and complementary products, and is not deductible for tax purposes. The preliminary estimates of fair value for the liabilities assumed from the acquisition are subject to change as the Company obtains additional information related to certain legal contingency matters during the measurement period (up to one year from the acquisition date).

Schooner is an enterprise software company that develops flash-optimized database and data store solutions.  Schooner’s products complement the Company’s growing portfolio of enterprise storage solutions and flash-optimized software offerings that enable customers to accelerate the performance of data-intensive applications and reduce overall cost of ownership. The goodwill resulted from expected synergies from the transaction, including the Company’s resources and complementary products, and is not deductible for tax purposes. The preliminary estimates of fair value for the liabilities assumed from the acquisition are subject to change as the Company obtains additional information related to certain legal contingency matters during the measurement period (up to one year from the acquisition date).

Intangible Assets. Intangible asset balances are presented below (in thousands):
 
September 30, 2012
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Developed product technology
$
200,010

 
$
(58,245
)
 
$
141,765

Core technology
80,500

 
(79,829
)
 
671

Customer relationships
13,050

 
(8,377
)
 
4,673

Trademarks
5,700

 
(1,554
)
 
4,146

Covenants not to compete
3,100

 
(1,230
)
 
1,870

Acquisition-related intangible assets
302,360

 
(149,235
)
 
153,125

Technology licenses and patents
133,340

 
(59,224
)
 
74,116

Total intangible assets subject to amortization
435,700

 
(208,459
)
 
227,241

Acquired in-process research and development
38,635

 

 
38,635

Total intangible assets
$
474,335

 
$
(208,459
)
 
$
265,876



18


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



 
January 1, 2012
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Developed product technology
$
172,800

 
$
(30,014
)
 
$
142,786

Core technology
79,800

 
(75,349
)
 
4,451

Customer relationships
12,200

 
(3,643
)
 
8,557

Trademarks
5,300

 
(633
)
 
4,667

Covenants not to compete
700

 
(209
)
 
491

Acquisition-related intangible assets
270,800

 
(109,848
)
 
160,952

Technology licenses and patents
131,340

 
(40,801
)
 
90,539

Total intangible assets subject to amortization
402,140

 
(150,649
)
 
251,491

Acquired in-process research and development
36,200

 

 
36,200

Total intangible assets
$
438,340

 
$
(150,649
)
 
$
287,691


Acquisition-related intangible assets increased in the nine months ended September 30, 2012 due to the acquisitions of FlashSoft and Schooner. During the three months ended September 30, 2012, the Company reclassified $0.7 million of acquired in-process research and development to core technology and commenced amortization.

The annual expected amortization expense of intangible assets as of September 30, 2012, excluding acquired in-process research and development, is presented below (in thousands):
 
Estimated Amortization Expense
 
Acquisition-related Intangible Assets
 
Technology Licenses and Patents
Fiscal year:
 
 
 
2012 (remaining three months)
$
12,184

 
$
6,159

2013
44,865

 
23,337

2014
40,482

 
21,231

2015
40,318

 
20,056

2016
15,276

 
3,333

Total intangible assets subject to amortization
$
153,125

 
$
74,116




19


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



6.
Financing Arrangements

The following table reflects the carrying value of the Company’s convertible debt (in thousands):
 
September 30,
2012
 
January 1,
2012
1% Notes due 2013
$
928,061

 
$
928,061

Less: Unamortized interest discount
(35,377
)
 
(75,915
)
Net carrying amount of 1% Notes due 2013
892,684

 
852,146

 
 
 
 
1.5% Notes due 2017
1,000,000

 
1,000,000

Less: Unamortized interest discount
(219,536
)
 
(247,235
)
Net carrying amount of 1.5% Notes due 2017
780,464

 
752,765

Total convertible debt
1,673,148

 
1,604,911

Less: Convertible short-term debt
(892,684
)
 

Convertible long-term debt
$
780,464

 
$
1,604,911


1% Convertible Senior Notes Due 2013. In May 2006, the Company issued and sold $1.15 billion in aggregate principal amount of 1% Convertible Senior Notes due May 15, 2013 (the “1% Notes due 2013”) at par and has subsequently repurchased $221.9 million of principal amount of these notes. The 1% Notes due 2013 may be converted, under certain circumstances, based on an initial conversion rate of 12.1426 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $82.36 per share). The net proceeds to the Company from the offering of the 1% Notes due 2013 were $1.13 billion. As of September 30, 2012, the Company had $928.1 million outstanding in aggregate principal amount at par.

The Company separately accounts for the liability and equity components of the 1% Notes due 2013. The principal amount of the liability component of $753.5 million as of the date of issuance was recognized at the present value of its cash flows using a discount rate of 7.4%, the Company’s borrowing rate at the date of the issuance for a similar debt instrument without the conversion feature. The carrying value of the equity component was $394.3 million as of September 30, 2012 and January 1, 2012.

The following table presents the amount of interest cost recognized relating to the contractual interest coupon, amortization of bond issuance costs and amortization of the discount on the liability component of the 1% Notes due 2013 (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Contractual interest coupon
$
2,319

 
$
2,504

 
$
6,959

 
$
8,254

Amortization of bond issuance costs
695

 
1,935

 
2,087

 
3,649

Amortization of bond discount
13,515

 
13,456

 
39,816

 
43,743

Total interest cost recognized
$
16,529

 
$
17,895

 
$
48,862

 
$
55,646


The effective interest rate on the liability component of the 1% Notes due 2013 was 7.4% for each of the three and nine months ended September 30, 2012 and October 2, 2011.  The remaining bond discount of $35.4 million as of September 30, 2012 will be amortized over the remaining life of the 1% Notes due 2013, which is approximately 0.6 years.

Concurrent with the issuance of the 1% Notes due 2013, the Company sold warrants to acquire shares of its common stock at an exercise price of $95.03 per share. Due to the repurchase of a portion of the outstanding 1% Notes due 2013 in fiscal year 2011, the Company unwound a pro-rata portion of the warrants. The counterparties may now purchase up to 11.3 million shares of the Company’s common stock at an exercise price of $95.03 per share. As of September 30, 2012, the warrants had an expected life of approximately 0.9 years and will expire on 20 different dates from August 23, 2013 through September 20, 2013. At expiration, the Company may, at its option, elect to settle the warrants on a net share basis. As of September 30, 2012, the remaining warrants had not been exercised and remain outstanding. In addition, at issuance, counterparties agreed to sell to the Company up to approximately 14.0 million shares of its common stock, which is the number of shares initially

20


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



issuable upon conversion of the 1% Notes due 2013 in full, at a conversion price of $82.36 per share. Due to the repurchase of a portion of the outstanding 1% Notes due 2013 in fiscal year 2011, the Company unwound a pro-rata portion of the convertible bond hedge. The Company may now purchase up to 11.3 million shares of its common stock at a conversion price of $82.36 per share. This convertible bond hedge transaction will be settled in net shares and will terminate upon the earlier of the maturity date of the 1% Notes due 2013 or the first day that none of the 1% Notes due 2013 remain outstanding due to conversion or otherwise. Settlement of the convertible bond hedge in net shares on the expiration date would result in the Company receiving net shares equivalent to the number of shares issuable by it upon conversion of the 1% Notes due 2013. As of September 30, 2012, the Company had not purchased any shares under the remaining convertible bond hedge agreement.

1.5% Convertible Senior Notes Due 2017. In August 2010, the Company issued and sold $1.0 billion in aggregate principal amount of 1.5% Convertible Senior Notes due August 15, 2017 (the “1.5% Notes due 2017”) at par. The 1.5% Notes due 2017 may be converted, under certain circumstances described below, based on an initial conversion rate of 19.0931 shares of common stock per $1,000 principal amount of notes (which represents an initial conversion price of approximately $52.37 per share). The net proceeds to the Company from the sale of the 1.5% Notes due 2017 were $981.0 million.

The Company separately accounts for the liability and equity components of the 1.5% Notes due 2017. The principal amount of the liability component of $706.0 million as of the date of issuance was recognized at the present value of its cash flows using a discount rate of 6.85%, the Company’s borrowing rate at the date of the issuance for a similar debt instrument without the conversion feature. The carrying value of the equity component was $294.0 million as of September 30, 2012, unchanged from the date of issuance.

The following table presents the amount of interest cost recognized relating to the contractual interest coupon, amortization of bond issuance costs and amortization of the discount on the liability component of the 1.5% Notes due 2017 (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Contractual interest coupon
$
3,750

 
$
3,750

 
$
11,250

 
$
11,250

Amortization of bond issuance costs
667

 
667

 
2,000

 
2,028

Amortization of bond discount
9,170

 
8,594

 
27,111

 
25,505

Total interest cost recognized
$
13,587

 
$
13,011

 
$
40,361

 
$
38,783


The effective interest rate on the liability component of the 1.5% Notes due 2017 was 6.85% for each of the three and nine months ended September 30, 2012 and October 2, 2011. The remaining unamortized interest discount of $219.5 million as of September 30, 2012 will be amortized over the remaining life of the 1.5% Notes due 2017, which is approximately 4.9 years.

Concurrent with the issuance of the 1.5% Notes due 2017, the Company sold warrants to acquire shares of its common stock at an exercise price of $73.33 per share. As of September 30, 2012, the warrants had an expected life of approximately 5.2 years and will expire on 40 different dates from November 13, 2017 through January 10, 2018. At each expiration date, the Company may, at its option, elect to settle the warrants on a net share basis. As of September 30, 2012, the warrants had not been exercised and remain outstanding. In addition, counterparties agreed to sell to the Company up to approximately 19.1 million shares of the Company’s common stock, which is the number of shares initially issuable upon conversion of the 1.5% Notes due 2017 in full, at a price of $52.37 per share. This convertible bond hedge transaction will be settled in net shares and will terminate upon the earlier of the maturity date of the 1.5% Notes due 2017 or the first day that none of the 1.5% Notes due 2017 remain outstanding due to conversion or otherwise. Settlement of the convertible bond hedge in net shares on the expiration date would result in the Company receiving net shares equivalent to the number of shares issuable by the Company upon conversion of the 1.5% Notes due 2017. As of September 30, 2012, the Company had not purchased any shares under this convertible bond hedge agreement.


21


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



7.
Share Repurchase Program

During the fourth quarter of fiscal year 2011, the Company’s Board of Directors authorized the repurchase of up to $500.0 million of the Company’s outstanding common stock over a period of up to five years. Under this program, shares repurchased are recorded as a reduction to capital in excess of par value and retained earnings in the Company’s Condensed Consolidated Balance Sheet. Since the inception of this stock repurchase program, the Company has repurchased 4.8 million shares for $195.5 million, of which 4.7 million shares for an aggregate purchase price of $191.5 million were repurchased during the nine months ended September 30, 2012. As part of its share repurchase program, the Company may from time-to-time enter into structured share repurchase arrangements with financial institutions. These arrangements generally require the Company to make an upfront cash payment in exchange for the right to receive shares of its common stock or cash at the expiration of the agreement, dependent upon the volume-weighted average price of the Company’s common stock at the expiration date. The initial cash principal payment, as well as the subsequent repayment of principal and return on principal, if settled in cash, are recorded as a component of capital in excess of par value in the Company’s Condensed Consolidated Balance Sheet. During the nine months ended September 30, 2012, the Company entered into structured share repurchase arrangements that required upfront cash payments of $40.0 million. These arrangements settled within the nine months ended September 30, 2012 and resulted in zero stock repurchases and the Company receiving its original upfront cash payment of $40.0 million and returns totaling $2.7 million. As of September 30, 2012, the Company had $304.5 million available for usage under this share repurchase program.


22


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



8.
Share-based Compensation

Share-based Plans. The Company has a share-based compensation program that provides its Board of Directors with broad discretion in creating equity incentives for employees, officers, non-employee board members and non-employee service providers. This program includes incentive and non-statutory stock option awards, stock appreciation right awards, restricted stock unit awards, performance-based cash bonus awards for Section 16 executive officers and an automatic grant program for non-employee board members pursuant to which such individuals will receive option grants or other stock awards at designated intervals over their period of board service. These awards are granted under various programs, all of which are stockholder approved. Stock option awards generally vest as follows: 25% of the shares vest on the first anniversary of the vesting commencement date and the remaining 75% vest proportionately each quarter over the next 12 quarters of continued service. Restricted stock unit awards generally vest in equal annual installments over a 4-year period. Initial grants to non-employee board members under the automatic grant program vest in equal annual installments over a 4-year period and subsequent grants to non-employee board members generally vest over a 1-year period in accordance with the specific vesting provisions set forth in that program. Additionally, the Company has an Employee Stock Purchase Plan (“ESPP”) that allows employees to purchase shares of common stock at 85% of the fair market value at the subscription date or the date of purchase, whichever is lower.

FlashSoft Corporation Amended and Restated 2011 Equity Plan. The FlashSoft Corporation Amended and Restated 2011 Equity Plan was assumed pursuant to the Company’s acquisition of FlashSoft on February 13, 2012. Unvested restricted stock unit awards that were outstanding under this plan on February 13, 2012 were assumed by the Company and are governed by the existing terms of the plan. Restricted stock unit awards granted under this plan generally vest in equal annual installments over a 4-year period.

Valuation Assumptions

Option Plan Shares. The fair value of the Company’s stock options granted to employees, officers and non-employee board members was estimated using the following weighted average assumptions:
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Dividend yield
None
 
None
 
None
 
None
Expected volatility
0.45
 
0.42
 
0.43
 
0.42
Risk-free interest rate
0.51%
 
0.80%
 
0.60%
 
1.52%
Expected term
4.3 years
 
4.3 years
 
4.3 years
 
4.2 years
Estimated annual forfeiture rate
8.59%
 
8.57%
 
8.59%
 
8.57%
Weighted average fair value at grant date
$15.39
 
$13.99
 
$16.63
 
$17.72

Employee Stock Purchase Plan Shares. The fair value of the Company’s ESPP shares issued to employees was estimated using the following weighted average assumptions:
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Dividend yield
None
 
None
 
None
 
None
Expected volatility
0.44
 
0.44
 
0.41
 
0.43
Risk-free interest rate
0.14%
 
0.08%
 
0.15%
 
0.13%
Expected term
½ year
 
½ year
 
½ year
 
½ year
Weighted average fair value at purchase date
$11.38
 
$10.44
 
$11.87
 
$12.30

23


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Share-based Compensation Plan Activities

Stock Options and SARs. A summary of stock option and stock appreciation rights (“SARs”) activity under all of the Company’s share-based compensation plans as of September 30, 2012 and changes during the nine months ended September 30, 2012 is presented below (in thousands, except for weighted average exercise price and remaining contractual term):
 
Shares
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Term (Years)
 
Aggregate Intrinsic Value
Options and SARs outstanding at January 1, 2012
17,559

 
$
36.55

 
3.4
 
$
257,251

Granted
2,171

 
46.82

 
 
 


Exercised
(2,853
)
 
22.42

 
 
 
66,663

Forfeited
(275
)
 
36.28

 
 
 
 

Expired
(235
)
 
52.82

 
 
 
 

Options and SARs outstanding at September 30, 2012
16,367

 
40.15

 
3.3
 
130,753

Options and SARs vested and expected to vest after September 30, 2012, net of forfeitures
15,797

 
40.00

 
3.2
 
129,132

Options and SARs exercisable at September 30, 2012
10,878

 
39.71

 
2.2
 
99,862


At September 30, 2012, the total compensation cost related to stock options granted to employees under the Company’s share-based compensation plans but not yet recognized was approximately $78.1 million, net of estimated forfeitures. This cost will be amortized on a straight-line basis over a weighted average period of approximately 2.5 years.

Restricted Stock Units. Restricted stock units (“RSUs”) are settled in shares of the Company’s common stock upon vesting on a one-for-one basis. Typically, vesting of RSUs is subject to the employee’s continuing service to the Company. The cost of these awards is determined using the fair value of the Company’s common stock on the date of grant, and compensation is recognized on a straight-line basis over the requisite vesting period.

A summary of the changes in RSUs outstanding under the Company’s share-based compensation plans during the nine months ended September 30, 2012 is presented below (in thousands, except for weighted average grant date fair value):
 
Shares
 
Weighted Average Grant Date Fair Value
 
Aggregate Intrinsic Value
Non-vested share units at January 1, 2012
2,051

 
$
40.22

 
$
100,913

Granted
1,697

 
45.25

 
 

Vested
(640
)
 
47.82

 
29,227

Forfeited
(144
)
 
42.54

 
 

Assumed through acquisition
59

 
46.63

 
 

Non-vested share units at September 30, 2012
3,023

 
42.74

 
131,307


As of September 30, 2012, the Company had approximately $92.9 million of unrecognized compensation expense, net of estimated forfeitures, related to RSUs, which will be recognized over a weighted average estimated remaining life of 2.9 years.

Employee Stock Purchase Plan. At September 30, 2012, there was approximately $2.4 million of total unrecognized compensation cost related to the Company’s ESPP that is expected to be recognized over a period of approximately 0.4 years.


24


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Share-based Compensation Expense. The following tables set forth the detailed allocation of the share-based compensation expense (in thousands):
 
Three months ended
 
Nine months ended
 
September 30,
2012
 
October 2,
2011
 
September 30,
2012
 
October 2,
2011
Share-based compensation expense by caption:
 
 
 
 
 
 
 
Cost of product revenues
$
1,929

 
$
1,283

 
$
5,389

 
$
3,316

Research and development
10,379

 
8,345

 
31,029

 
23,273

Sales and marketing
3,794

 
2,704

 
11,057

 
7,746

General and administrative
3,848

 
3,397

 
11,808

 
10,343

Total share-based compensation expense
19,950

 
15,729

 
59,283

 
44,678

Total tax benefit recognized
(5,464
)
 
(3,977
)
 
(15,309
)
 
(11,709
)
Decrease in net income
$
14,486

 
$
11,752

 
$
43,974

 
$
32,969