10-Q 1 a67259e10-q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED SEPT.30, 2000 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------------- FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 2000 ----------------------- 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: 000-23993 BROADCOM CORPORATION (Exact name of registrant as specified in its charter) CALIFORNIA 33-0480482 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 16215 ALTON PARKWAY IRVINE, CALIFORNIA 92618-3616 (Address of principal executive offices and zip code) (949) 450-8700 (Registrant's telephone number, including area code) 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 X No --- --- The number of shares of the registrant's common stock, $0.0001 par value, outstanding as of October 31, 2000: 152,861,711 shares of Class A common stock and 82,341,239 shares of Class B common stock. 2 BROADCOM CORPORATION QUARTERLY REPORT ON FORM 10-Q NINE MONTHS ENDED SEPTEMBER 30, 2000 INDEX Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets at September 30, 2000 (Unaudited) and December 31, 1999 1 Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2000 and 1999 2 Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2000 and 1999 3 Notes to Unaudited Condensed Consolidated Financial Statements 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Item 3. Quantitative and Qualitative Disclosures about Market Risk 38 PART II. OTHER INFORMATION Item 1. Legal Proceedings 39 Item 2. Change in Securities and Use of Proceeds 40 Item 3. Defaults Upon Senior Securities 42 Item 4. Submission of Matters to a Vote of Security Holders 42 Item 5. Other Information 42 Item 6. Exhibits and Reports on Form 8-K 42 Signatures 43 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS BROADCOM CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
September 30, December 31, 2000 1999(1) (Unaudited) ------------- ------------ ASSETS Current assets: Cash and cash equivalents $ 377,813 $ 180,816 Short-term investments 104,570 90,059 Accounts receivable, net 152,484 92,124 Inventory 44,471 19,177 Deferred taxes 8,980 8,380 Other current assets 25,807 12,950 ----------- --------- Total current assets 714,125 403,506 Property and equipment, net 85,961 51,151 Long-term investments -- 9,351 Deferred taxes 293,766 137,779 Goodwill and other intangible assets, net 1,354,419 -- Other assets 24,963 7,966 ----------- --------- Total assets $ 2,473,234 $ 609,753 =========== ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Trade accounts payable $ 92,818 $ 46,458 Wages and related benefits 14,279 15,430 Income taxes payable 29,068 6,179 Accrued liabilities 25,058 19,952 Current portion of long-term debt 1,152 1,787 ----------- --------- Total current liabilities 162,375 89,806 Long-term debt, less current portion 702 3,075 Shareholders' equity: Common stock 2,629,682 451,294 Notes receivable from employees (13,561) (1,821) Deferred compensation (461,157) (12,632) Retained earnings 155,193 80,031 ----------- --------- Total shareholders' equity 2,310,157 516,872 ----------- --------- Total liabilities and shareholders' equity $ 2,473,234 $ 609,753 =========== =========
--------------- (1) The consolidated balance sheet as of December 31, 1999 has been restated to give retroactive effect to subsequent acquisitions accounted for using the pooling-of-interests method. See accompanying notes. 1 4 BROADCOM CORPORATION UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Nine Months Ended September 30, September 30, ------------------------ ---------------------- 2000 1999(1) 2000 1999(1) --------- -------- -------- -------- Revenue $ 319,155 $139,561 $755,923 $359,227 Cost of revenue (2) 135,908 56,308 317,430 145,316 --------- -------- -------- -------- Gross profit 183,247 83,253 438,493 213,911 Operating expense: Research and development (2) 67,945 30,635 163,350 84,295 Selling, general and administrative (2) 30,148 14,869 72,097 43,211 Stock-based compensation 27,615 959 30,655 2,816 Amortization of goodwill and purchased intangible assets 24,936 -- 24,936 -- In-process research and development 45,660 -- 45,660 -- Merger-related costs -- 4,088 4,745 15,210 Litigation settlement costs -- -- -- 17,036 --------- -------- -------- -------- Income (loss) from operations (13,057) 32,702 97,050 51,343 Interest and other income, net 4,934 2,156 12,984 5,869 --------- -------- -------- -------- Income (loss) before income taxes (8,123) 34,858 110,034 57,212 Provision for income taxes 11,241 10,264 34,872 17,730 --------- -------- -------- -------- Net income (loss) $ (19,364) $ 24,594 $ 75,162 $ 39,482 ========= ======== ======== ======== Basic earnings (loss) per share $ (.09) $ .12 $ .35 $ .20 ========= ======== ======== ======== Diluted earnings (loss) per share $ (.09) $ .10 $ .29 $ .17 ========= ======== ======== ======== Weighted average shares (basic) 220,510 203,756 215,444 199,660 ========= ======== ======== ======== Weighted average shares (diluted) 220,510 238,333 257,111 232,469 ========= ======== ======== ======== (2) Excludes stock-based compensation as follows: Cost of revenue $ 615 $ 37 $ 690 $ 112 Research and development 20,636 659 22,789 1,879 Selling, general and administrative 6,364 263 7,176 825 --------- -------- -------- -------- Total $ 27,615 $ 959 $ 30,655 $ 2,816 ========= ======== ======== ========
-------------- (1) The consolidated statements of operations for the three and nine months ended September 30, 1999 have been restated to give retroactive effect to subsequent acquisitions accounted for using the pooling-of-interests method. See accompanying notes. 2 5 BROADCOM CORPORATION UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Nine Months Ended September 30, ------------------------- 2000 1999(1) --------- --------- OPERATING ACTIVITIES Net income $ 75,162 $ 39,482 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 15,752 11,710 Amortization of stock-based compensation 31,289 3,820 Amortization of goodwill and purchased intangibles 24,936 -- Purchased in-process research and development 45,660 -- Tax benefit from exercise of stock options and stock purchase plan 77,544 23,848 Deferred taxes (69,492) (10,160) Change in operating assets and liabilities: Accounts receivable (59,520) (22,087) Inventory (23,072) (4,932) Other assets (37,243) (8,567) Accounts payable 40,162 33,525 Income taxes 22,149 6,265 Other accrued liabilities (1,922) 20,911 --------- --------- Net cash provided by operating activities 141,405 93,815 INVESTING ACTIVITIES Purchases of property and equipment (47,085) (22,496) Net cash received from purchase acquisitions 10,658 -- Purchases of held-to-maturity investments (13,668) (23,020) Proceeds from sale of held-to-maturity investments 8,508 1,770 --------- --------- Net cash used in investing activities (41,587) (43,746) FINANCING ACTIVITIES Proceeds from long-term obligations 250 458 Payments on long-term obligations (1,592) (7,254) Payments on capital lease obligations (3,034) (430) Net proceeds from issuance of common stock 100,726 40,813 Proceeds from repayment of notes receivable from employees 829 918 --------- --------- Net cash provided by financing activities 97,179 34,505 --------- --------- Increase in cash and cash equivalents 196,997 84,574 Cash and cash equivalents at beginning of period 180,816 77,555 --------- --------- Cash and cash equivalents at end of period $ 377,813 $ 162,129 ========= ========= Supplemental disclosure of non-cash activities: Notes receivable from employees in connection with exercise of stock options $ -- $ 394 ========= ========= Purchase of equipment through capital leases $ 168 $ 1,792 ========= =========
--------- (1) The consolidated statement of cash flows for the nine months ended September 30, 1999 has been restated to give retroactive effect to subsequent acquisitions accounted for using the pooling-of-interests method. See accompanying notes. 3 6 BROADCOM CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2000 1. Basis of Presentation The condensed consolidated financial statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments which, in the opinion of management, are necessary to present fairly the consolidated financial position of Broadcom Corporation and its subsidiaries (collectively, the "Company") at September 30, 2000 and the consolidated results of the Company's operations and cash flows for the three and nine months ended September 30, 2000 and 1999. These condensed consolidated financial statements have been restated to include the pooled operations of each of the Company's prior acquisitions. All intercompany accounts and transactions have been eliminated. It should be understood that accounting measurements at interim dates inherently involve greater reliance on estimates than at yearend. The results of operations for the three and nine months ended September 30, 2000 are not necessarily indicative of the results to be expected for the full year. The accompanying unaudited condensed consolidated financial statements do not include footnotes and certain financial presentations normally required under generally accepted accounting principles. Therefore, these financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 1999, included in the Company's Current Report on Form 8-K/A filed with the Securities and Exchange Commission ("SEC") on July 10, 2000. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("Statement 133"). Statement 133, as amended, establishes accounting and reporting standards for derivative instruments and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. The Company is required to and will adopt Statement 133 in the fourth quarter of fiscal 2000. Management does not expect the initial adoption of Statement 133 will have a significant effect on the Company's consolidated results of operations or financial position. In December 1999 the SEC issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"). SAB 101 summarizes certain areas of the Staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company believes that its current revenue recognition policies comply with SAB 101. In March 2000 the Financial Accounting Standards Board issued Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25 ("FIN 44"). FIN 44 clarifies the definition of an employee for purposes of applying Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25"), the criteria for determining whether a plan qualifies as a 4 7 noncompensatory plan, the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and the accounting for an exchange of stock compensation awards in a business combination. FIN 44 was effective July 1, 2000 but certain conclusions in this Interpretation cover specific events that occur after either December 15, 1998 or January 12, 2000. The provisions of FIN 44 change the accounting for an exchange of unvested employee stock options and restricted stock awards in a purchase business combination. The new rules require the intrinsic value of the unvested awards be allocated to deferred compensation and recognized as non-cash compensation expense over the remaining future vesting period. The Company adopted these new rules in its third fiscal quarter (beginning July 1, 2000) for acquisitions accounted for as purchase business combinations. 2. Business Combinations Purchase Transactions In July 2000 the Company completed the acquisition of Innovent Systems, Inc. ("Innovent"), a developer of radio frequency integrated circuits for wireless data communications. In connection with the acquisition, the Company issued an aggregate of 2,339,149 shares of its Class A common stock in exchange for all outstanding shares of Innovent preferred and common stock and reserved 605,961 additional shares of its Class A common stock for issuance upon exercise of outstanding employee stock options and other rights of Innovent. The share issuances were exempt from registration pursuant to section 3(a)(10) of the Securities Act of 1933, as amended. Portions of the shares issued will be held in escrow pursuant to the terms of the acquisition agreement as well as various employee share repurchase agreements. In August 2000 the Company completed the acquisition of Puyallup Integrated Circuit Company, Inc., ("Puyallup"), a provider of integrated circuit design services including full chip designs and embedded macro blocks for microprocessors, system-on-a-chip and ASIC designs. In connection with the acquisition, the Company issued an aggregate of 148,539 shares of its Class A common stock in exchange for all outstanding shares of Puyallup common stock and reserved 139,993 additional shares of its Class A common stock for issuance upon exercise of outstanding employee stock options and other rights of Puyallup. The share issuances were exempt from registration pursuant to section 3(a)(10) of the Securities Act of 1933, as amended. Portions of the shares issued will be held in escrow pursuant to the terms of the acquisition agreement as well as various employee share repurchase agreements. In September 2000 the Company completed the acquisition of Altima Communications, Inc. ("Altima"), a supplier of networking integrated circuits for the small-to-medium sized business networking market. In connection with the acquisition, the Company issued an aggregate of 1,661,784 shares of its Class A common stock in exchange for all outstanding shares of Altima preferred and common stock and reserved 875,111 additional shares of its Class A common stock for issuance upon exercise of outstanding employee stock options and other rights of Altima. The share issuances were exempt from registration pursuant to section 3(a)(10) of the Securities Act of 1933, as amended. Portions of the shares issued will be held in escrow pursuant to the terms of the acquisition agreement as well as various employee share repurchase agreements. In addition to the purchase consideration, the Company has reserved 2,889,667 additional shares of its Class A common stock for future issuance to customers upon exercise of outstanding performance-based warrants of Altima that become exercisable upon satisfaction of certain customer purchase requirements. These acquisitions have been accounted for under the purchase method of accounting. The Company is in the process of obtaining an independent appraisal of the fair value of the tangible and intangible assets acquired in order to allocate the purchase price in accordance with Accounting Principles Board Opinion No. 16. The Company does not expect that the final allocation of purchase price will produce materially different results from those reflected herein. The preliminary purchase price was allocated as follows based upon management's best estimate of the tangible and intangible assets and in-process research and development: 5 8
Innovent Altima Puyallup Total -------- ---------- ------------ ---------- (in thousands) Net tangible assets (liabilities) $ 6,875 $ 930 $ (621) $ 7,184 Acquisition costs 423 1,025 160 1,608 In-process research & development 41,690 3,970 -- 45,660 Goodwill and other intangibles 265,647 1,075,726 37,982 1,379,355 Deferred tax liabilities (71,354) (21,267) (8,767) (101,388) Deferred compensation 281,982 159,490 35,934 477,406 -------- ---------- ------- ---------- Total consideration $525,263 $1,219,874 $64,688 $1,809,825 ======== ========== ======= ==========
The total consideration for the three purchase transactions consists in aggregate of approximately 8,660,204 shares of common stock, including (a) approximately 3,064,471 shares of common stock valued at $575.3 million based upon the Company's stock price for a short period just before and after the companies reached agreement and the proposed transactions were announced, (b) approximately 2,889,667 shares for performance-based warrants issued to customers valued at $689.4 million based upon the Company's stock price on the day the acquisitions closed, and (c) approximately 2,706,066 shares of restricted common stock and employee stock options valued at $545.1 million in accordance with FIN 44. In-process research and development ("IPR&D") totaled in aggregate $45.7 million. The amounts allocated to IPR&D were determined through established valuation techniques in the high-technology industry and were expensed upon acquisition as it was determined that the 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 value 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 upon 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 upon forecasted revenues and costs, taking into account product life cycles, and market penetration and growth rates. The IPR&D charge includes only the fair value of IPR&D completed. The fair value of developed technology is included in identifiable intangible assets, and the fair values of IPR&D to-be-completed and future research and development are included in goodwill. The Company believes the amounts recorded as IPR&D, as well as developed technology, represent fair value and approximate the amounts an independent party would pay for these projects. As of the acquisition dates of Innovent, Puyallup and Altima, development projects were in process. Research and development costs to bring the products from the acquired companies to technological feasibility are not expected to have a material impact on the Company's future results of operations or financial condition. 6 9 Goodwill, which represents the excess of the purchase price of an investment in an acquired business over the fair value of the underlying net identifiable assets, is being amortized on a straight-line basis over its estimated remaining useful life of five years. Reviews are regularly performed to determine whether the carrying value of the asset is impaired. Impairment is based on the excess of the carrying amount over the fair value of those assets. No impairment has been indicated to date. Deferred stock-based compensation, which is included in the purchase price of the acquisitions, has been valued in accordance with FIN 44. This amount is being amortized over the remaining vesting period (generally three to four years) of the underlying restricted common stock and stock options assumed. The results of operations of the three acquired companies are included in the consolidated financial statements from their respective dates of acquisition. The pro forma statements of operations data below gives effect to the three acquisitions as if they had occurred at the beginning of fiscal 1999. The following unaudited pro forma statements of operations data includes amortization of goodwill, identified intangibles and stock-based compensation but excludes the charge for acquired IPR&D. This pro forma data is presented for informational purposes only and does not purport to be indicative of the results of future operations nor of the results that would have occurred had the acquisitions taken place at the beginning of fiscal 1999. Nine Months Ended September 30, ----------------------------- 2000 1999 ------------ ----------- (In thousands, except per share data) Net revenue $ 775,750 $ 362,345 Net loss $(149,593) $(275,462) Net loss per share $ (.68) $ (1.36) 7 10 3. Earnings (Loss) Per Share The following table sets forth the computation of earnings (loss) per share:
Three Months Ended Nine Months Ended September 30, September 30, ------------------------- ------------------------- 2000 1999 2000 1999 --------- --------- --------- --------- (In thousands, except per share data) Numerator: Net income (loss) $ (19,364) $ 24,594 $ 75,162 $ 39,482 ========= ========= ========= ========= Denominator: Weighted-average shares outstanding 223,078 209,449 218,470 206,204 Less: nonvested common shares outstanding (2,568) (5,693) (3,026) (6,544) --------- --------- --------- --------- Denominator for basic earnings per common share 220,510 203,756 215,444 199,660 Effect of dilutive securities: Nonvested common shares -- 5,000 3,007 4,905 Stock options -- 29,577 38,660 27,893 Warrants -- -- -- 11 --------- --------- --------- --------- Denominator for diluted earnings per common share 220,510 238,333 257,111 232,469 ========= ========= ========= ========= Basic earnings (loss) per share $ (.09) $ .12 $ .35 $ .20 ========= ========= ========= ========= Diluted earnings (loss) per share $ (.09) $ .10 $ .29 $ .17 ========= ========= ========= =========
4. Inventory Inventory is stated at the lower of cost (first-in, first-out) or market, and consists of the following: September 30, December 31, 2000 1999 ------------ ---------- (In thousands) Work in process $24,312 $11,878 Finished goods 20,159 7,299 ------- ------- $44,471 $19,177 ======= ======= 5. Long-Term Debt The following is a summary of the Company's long-term debt and other loans, including debt and loans assumed in connection with acquisitions:
September 30, December 31, 2000 1999 -------------- ------------ (In thousands) Notes payable at rates from 3.0% to 8.58% secured by certain of the Company's assets $ -- $ 531 Line of credit at a 12.0% rate secured by certain of the Company's assets -- 770 Capitalized lease obligations payable in varying monthly installments at rates from 7.8% to 14.7% 1,854 3,561 ------- ------- 1,854 4,862 Less current portion of long-term debt (1,152) (1,787) ------- ------- $ 702 $ 3,075 ======= =======
8 11 6. Shareholders' Equity On February 11, 2000 the Company effected a two-for-one stock split of its Class A common stock and Class B common stock in the form of a 100% stock dividend. All share numbers and per share amounts contained in these notes and in the accompanying consolidated financial statements have been retroactively restated to reflect this change in the Company's capital structure. 7. Litigation In July 1997 the Company commenced an action against Sarnoff Corporation and Sarnoff Digital Communications, Inc., now known as NxtWave Communications, Inc. (collectively, "Sarnoff"), in the California Superior Court alleging breach of contract, fraud, misappropriation of trade secrets, false advertising, trade libel, intentional interference with prospective economic advantage and unfair competition. The claims center on Sarnoff's violation of a non-disclosure agreement entered into with the Company with respect to limited use of certain of the Company's technology and on inaccurate comparisons that the Company believes Sarnoff has made in its product advertising and in statements to potential customers and others. This action was removed to the United States District Court for the Central District of California, and was stayed pending resolution of an action Sarnoff had brought against the Company in April 1997 in New Jersey Superior Court. Following the decision in the New Jersey action in the Company's favor in early 1999, Sarnoff filed a motion for summary judgment in the California case on the basis that the issues therein had been or should have been previously litigated in the New Jersey action under the New Jersey "entire controversy" doctrine. Following oral argument in August 1999, the District Court granted Sarnoff's motion and dismissed the Company's claims on the grounds that they should have been brought as part of the New Jersey action. The Company believes that the California action involves facts, circumstances and claims unrelated to those at issue in the New Jersey action, and has filed an appeal of the District Court's ruling. Briefing of the appeal in the Ninth Circuit Court of Appeals is now complete and the parties await a date for oral argument in the case. In March 2000 Intel Corporation ("Intel")and its subsidiary Level One Communications, Inc. ("Level One") filed a complaint in California Superior Court asserting claims against the Company for misappropriation of trade secrets, unfair competition, and tortious interference with existing contractual relations by the Company in connection with its recent hiring of three former Intel employees. The complaint sought injunctive relief, an accounting, damages, exemplary damages and attorneys' fees. Intel/Level One filed a first amended complaint on April 28, 2000 seeking additional relief and containing certain additional allegations, but asserting the same causes of action as the original complaint. On May 25, 2000 the Court concluded a preliminary injunction hearing in the matter. The Court denied Intel/Level One's request for injunctive relief restricting the positions in which the three employees could work for the Company, but issued an order granting certain other preliminary relief. The Company has denied any wrongdoing or liability and has instructed its attorneys to vigorously defend the action. On June 30, 2000 the Company filed a cross-complaint against Intel/Level One, and on September 18, 2000, amended that cross-complaint. The Company's amended cross-complaint includes causes of action against Intel/Level One for unfair competition, trade secret misappropriation, and tortious interference with contractual relations. On September 25, 2000 the Company filed a motion for preliminary injunction, which asks the Court to enjoin Intel/Level One from further unfair competition and seeks other relief, including enjoining the marketing, sampling, distribution, shipment or sale of certain products. The motion was heard on November 8, 2000, and a decision from the Court is pending. The litigation is currently in the discovery stage and is scheduled for trial in March 2001. In August 2000 Intel filed a complaint in the United States District Court for the District of Delaware against the Company asserting that (i) the Company infringes five Intel patents relating to video compression, high-speed networking and semiconductor packaging, (ii) the Company induces the infringement of such patents, and (iii) the Company contributorily infringes such patents. The complaint sought a preliminary and permanent injunction against the Company as well as the recovery of monetary damages, including treble damages for willful infringement. Intel has not yet identified which products allegedly infringe its patents. The Company has not yet answered the complaint, but on October 10, 2000 the Company filed a motion to dismiss, or in the alternative, to transfer venue; this motion is currently pending before the court. The Company believes that it has strong defenses to Intel's claims. The parties are currently in the initial stages of discovery in the action. The Court has tentatively scheduled a hearing on patent claims construction to commence in September 2001 and a trial to begin in October 2001. On October 6, 2000 the Company filed a complaint for declaratory judgment in the United States District Court for the Northern District of California against Intel asserting that the patents asserted by Intel in the Delaware action are not infringed. Although the Company believes that it has strong defenses and is defending the Delaware action vigorously, a finding of infringement by the Company as to one or more of the patents in this action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful), the issuance of an injunction requiring that the Company withdraw various products from the market, and indemnification claims by the Company's customers or strategic partners, each of which events could have a material adverse effect on the Company's, business, results of operations and financial condition. In September 1998 Motorola, Inc. ("Motorola") filed a complaint in the United States District Court for the District of Massachusetts against AltoCom, Inc. ("AltoCom")(and co-defendant, PC-Tel, Inc.) asserting that (i) AltoCom's V.34 and V.90 compliant software modem technology infringes several patents owned by Motorola, (ii) AltoCom induces its V.34 and V.90 licensees to infringe such patents, and (iii) AltoCom contributorily infringes such patents. The complaint sought a preliminary and permanent injunction against AltoCom as well as the recovery of monetary damages, including treble damages for willful infringement. In October 1998 Motorola affirmatively dismissed its case in the District of Massachusetts and filed a substantially similar complaint in the United States District Court for the District of Delaware. AltoCom has filed an answer and affirmative defenses to the District of Delaware complaint. AltoCom has also asserted a counterclaim requesting declaratory relief that AltoCom has not infringed the Motorola patents and that such patents are invalid and/or unenforceable as well as a counterclaim requesting declaratory and injunctive relief based on a breach of 9 12 contract theory. AltoCom believes that it has strong defenses to Motorola's claims on invalidity, noninfringement and inequitable conduct grounds. In May 2000 Motorola filed an amended complaint alleging that AltoCom's technology infringes an additional Motorola patent. The parties are currently engaged in discovery in the action. AltoCom became a subsidiary of the Company on August 31, 1999. In September 1999 PC-Tel, Inc., the co-defendant in the case, reached a settlement with Motorola. Although AltoCom believes that it has strong defenses and is defending the action vigorously, a finding of infringement by AltoCom as to at least one of the patents in this action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful), the issuance of an injunction requiring that AltoCom withdraw various products from the market, and indemnification claims by AltoCom's customers or strategic partners, each of which events could have a material adverse effect on AltoCom's, and possibly the Company's, business, results of operations and financial condition. In December 1999 Level One filed a complaint in the United States District Court for the Eastern District of California against Altima Communications, Inc., asserting that Altima's AC108R repeater products infringe a U.S. patent owned by Level One. The complaint sought an injunction against Altima as well as the recovery of monetary damages, including treble damages for willful infringement. Altima filed an answer and affirmative defenses to the complaint in the Eastern District of California. In March 2000 Level One filed a related complaint in the U.S. International Trade Commission ("ITC"), seeking an exclusion order and cease and desist order based on alleged infringement of the same patent. Monetary damages are not available in the ITC. The ITC instituted an investigation in April 2000. Altima filed an answer and affirmative defenses to the complaint in the ITC. In July 2000 Intel and Level One filed a second complaint in the ITC, asserting that certain of Altima's repeater, switch, and transceiver products infringe three additional U.S. patents owned by Level One or Intel. The ITC instituted a second investigation in August 2000, and the Administrative Law Judge assigned to hear the cases issued an order in August 2000 granting a motion to consolidate the two investigations. In September 2000, Altima filed declaratory judgment actions against Intel and Level One, respectively, in the United States District Court for the Northern District of California asserting that Altima has not infringed the three additional Intel and Level One patents and that such patents are invalid or unenforceable. Pursuant to statute, Altima is entitled to a stay of all proceedings in the three District Court actions while the ITC investigation is pending. The Level One action in the Eastern District of California has already been stayed and Altima has formally requested a stay of both of the Northern District of California actions. Altima believes it has strong defenses to the claims of Level One and Intel on noninfringement, invalidity, and inequitable conduct grounds. The parties are currently engaged in discovery in the consolidated ITC action, and a hearing on the merits before the ITC Administrative Law Judge is scheduled to begin in April 2001. Altima became a subsidiary of the Company on September 7, 2000. Although Altima believes that it has strong defenses and is defending the action vigorously, a finding of infringement by Altima as to the patent in the Eastern District of California action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful) and the issuance of an injunction requiring that Altima withdraw various products from the market. A finding against Altima in the consolidated ITC action could result in the exclusion of certain Altima products from entering the United States. Any finding adverse to Altima in these actions could also result in indemnification claims by Altima's customers or strategic partners. Any of the foregoing events could have a material adverse effect on Altima's, and possibly the Company's, business, results of operations and financial condition. The Company and its subsidiaries are also involved in other legal proceedings, claims and litigation arising in the ordinary course of business. The pending lawsuits involve complex questions of fact and law and could require the expenditure of significant costs and diversion of resources to defend. Although management currently believes the outcome of outstanding legal proceedings, claims and litigation will not have a material adverse effect on the Company's business, results of operations or financial condition, the results of litigation are inherently uncertain, and an adverse outcome is at least reasonably possible. The Company is unable to estimate the range of possible loss from outstanding litigation, and no amounts have been provided for such matters in the accompanying consolidated financial statements. 8. Subsequent Events Completed Business Combinations On October 3, 2000 the Company completed the acquisition of NewPort Communications, Inc. ("NewPort"), a supplier of mixed-signal integrated circuits for the high-speed communications infrastructure market. In connection with the acquisition, the Company issued an aggregate of 5,211,050 shares of its Class A common stock in exchange for all outstanding shares of NewPort preferred and common stock and reserved 411,088 additional shares of Class A common stock for issuance upon exercise of outstanding employee stock 10 13 options and other rights of NewPort. The share issuances were exempt from registration pursuant to section 3(a)(10) of the Securities Act of 1933, as amended. Portions of the shares issued will be held in escrow pursuant to the terms of the acquisition agreement as well as various employee share repurchase agreements. In connection with the acquisition, the Company will record a one-time charge for purchased in-process research and development expenses related to the acquisition in its fourth fiscal quarter ending December 31, 2000. On October 6, 2000 the Company completed the acquisition of Silicon Spice Inc. ("Silicon Spice"), a developer of communications processors and other technology for high-density voice, fax and data packet transmission over wide area networks. In connection with the acquisition, the Company issued an aggregate of 3,864,161 shares of its Class A common stock in exchange for all outstanding shares of Silicon Spice preferred and common stock and reserved 1,126,885 additional shares of Class A common stock for issuance upon exercise of outstanding employee stock options, warrants and other rights of Silicon Spice. The share issuances were exempt from registration pursuant to section 3(a)(10) of the Securities Act of 1933, as amended. Portions of the shares issued will be held in escrow pursuant to the terms of the acquisition agreement as well as various employee share repurchase agreements. In connection with the acquisition, the Company will record a one-time charge for purchased in-process research and development expenses related to the acquisition in its fourth fiscal quarter ending December 31, 2000. Pending Business Combinations On October 4, 2000 the Company announced that it had signed a definitive agreement to acquire Element 14, Inc. ("Element 14"), a developer of high-port density, low-power digital subscriber line chipsets, software and communications processor technology. In connection with the acquisition, the Company will issue in aggregate approximately 2,650,000 shares of its Class A common stock in exchange for all outstanding shares of Element 14 preferred and common stock and upon exercise of outstanding employee stock options, warrants and other rights of Element 14. The merger transaction is expected to close within 60 days and will be accounted for under the purchase method of accounting. The boards of directors of both companies have approved the merger, which awaits approval by Element 14's shareholders and the satisfaction of regulatory requirements and other customary closing conditions. The Company expects to record a one-time charge for purchased in-process research and development expenses related to the acquisition in its fourth fiscal quarter ending December 31, 2000. On October 17, 2000 the Company announced that it had signed a definitive agreement to acquire Allayer Communications ("Allayer"), a developer of high-performance enterprise and optical networking communications chips. In connection with the acquisition, the Company will issue in aggregate about 1,230,000 shares of its Class A common stock in exchange for all outstanding shares of Allayer's preferred and common stock and upon exercise of outstanding employee stock options and other rights of Allayer. If certain performance goals are satisfied, the Company will issue up to an additional 300,000 shares of its Class A common stock to the shareholders and option holders of Allayer. The merger transaction is expected to close within 60 days and will be accounted for under the purchase method of accounting. The boards of directors of both companies have approved the merger, which awaits approval by Allayer's shareholders and the satisfaction of regulatory requirements and other customary closing conditions. The Company expects to record a one-time charge for purchased in-process research and development expenses related to the acquisition in its fourth fiscal quarter ending December 31, 2000. In addition to the purchase consideration, the Company will reserve an aggregate of approximately 790,000 shares of its Class A common stock for future issuance to customers upon exercise of outstanding performance-based warrants of Allayer that become exercisable upon satisfaction of certain customer purchase requirements. 11 14 On November 6, 2000 the Company announced that it had signed a definitive agreement to acquire SiByte, Inc. ("SiByte"), a developer of high-performance microprocessor solutions for broadband networking. In connection with the acquisition, the Company will issue in aggregate up to 9,300,000 shares of its Class A common stock in exchange for all outstanding shares of SiByte's preferred and common stock and upon exercise of outstanding employee stock options and other rights of SiByte. About 5,600,000 of the Company's shares will be issuable at closing of the acquisition; approximately 3,700,000 additional shares will be reserved for future issuance to the shareholders and option holders of SiByte upon satisfaction of certain performance goals. The merger transaction is expected to close within 60 days and will be accounted for under the purchase method of accounting. The boards of directors of both companies have approved the merger, which awaits approval by SiByte's shareholders and the satisfaction of regulatory requirements and other customary closing conditions. The Company expects to record a one-time charge for purchased in-process research and development expenses related to the acquisition in its fourth fiscal quarter ending December 31, 2000. In addition to the purchase consideration, the Company will reserve approximately 1,800,000 million shares of its Class A common stock for future issuance to customers upon the exercise of outstanding performance-based warrants of SiByte that become exercisable upon satisfaction of certain customer purchase requirements. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CAUTIONARY STATEMENT You should read the following discussion and analysis in conjunction with the Consolidated Financial Statements and related Notes thereto contained elsewhere in this Report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 1999 and our subsequent reports on Forms 10-Q, 8-K and 8-K/A, that discuss our business in greater detail. The section entitled "Risk Factors" set forth below, and similar discussions in our other SEC filings, discuss some of the important risk factors that may affect our business, results of operations and financial condition. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to invest in our company or to maintain or increase your investment. This Report contains forward-looking statements which include, but are not limited to, statements concerning projected revenues, expenses, gross profit and income, the need for additional capital, Year 2000 compliance, market acceptance of our products, our ability to consummate acquisitions and integrate their operations successfully, the competitive nature of our markets, our ability to achieve further product integration, the status of evolving 12 15 technologies and their growth potential, our production capacity, our ability to migrate to smaller process geometries, and the success of pending litigation. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs, and certain assumptions made by us. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," "may," "will" and variations of these words or similar expressions are intended to identify forward-looking statements. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. All share numbers and per share amounts in this Report have been retroactively adjusted to reflect our 2-for-1 stock splits, each in the form of a 100% stock dividend, effective February 17, 1999 and February 11, 2000, respectively. OVERVIEW We are the leading provider of highly integrated silicon solutions that enable broadband digital transmission of voice, video and data. These integrated circuits permit the cost effective delivery of high-speed, high-bandwidth networking using existing communications infrastructures that were not originally designed for the transmission of broadband digital content. Using proprietary technologies and advanced design methodologies, we design, develop and supply integrated circuits for a number of the most significant broadband communications markets, including the markets for cable set-top boxes, cable modems, high-speed local, metropolitan and wide area networks, home networking, Voice over Internet Protocol ("VoIP"), carrier access, residential broadband gateways, direct broadcast satellite and terrestrial digital broadcast, optical networking, digital subscriber lines ("xDSL") and wireless communications. From our inception in 1991 through 1994, we were primarily engaged in product development and the establishment of strategic customer and foundry relationships. During that period, we generated the majority of our revenue from development work performed for key customers. We began shipping our products in 1994, and subsequently our revenue has grown predominately through sales of our semiconductor products. We intend to continue to enter into development contracts with key customers, but expect that development revenue will constitute a decreasing percentage of our total revenue. We also generate a small percentage of our product revenue from sales of software and software support and sales of system-level reference designs. We recognize product revenue at the time of shipment. Provision is concurrently made for estimated product returns, which historically have been immaterial. Our products typically carry a one-year warranty. We recognize development revenue when earned. Revenue from licensed software is recognized at the time of shipment, provided that we have vendor-specific objective evidence of the fair value of each element of the software offering. Revenue from post-contract customer support and any other future deliverables is deferred and earned over the support period or as contract elements are delivered. 13 16 From time to time, our key customers have placed large orders causing our quarterly revenue to fluctuate significantly. We expect these fluctuations will continue in the future. Sales to our five largest customers, including sales to their respective manufacturing subcontractors, decreased to approximately 63.9% of our revenue in the nine months ended September 30, 2000 as compared to 71.8% in the nine months ended September 30, 1999. We expect that our key customers will continue to account for a significant portion of our revenue for 2000 and in the future. Our gross margin has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following: o our product mix; o the position of our products in their respective life cycles; o competitive pricing strategies; o the mix of product revenue and development revenue; and o manufacturing cost efficiencies and inefficiencies. For example, newly-introduced products generally have higher average selling prices and gross margins, both of which typically decline over product life cycles due to competitive pressures and volume pricing agreements. Our gross margin and operating results in the future may continue to fluctuate as a result of these and other factors. The sales cycle for the test and evaluation of our products can range from three to six months or more, with an additional three to six months or more before a customer commences volume production of equipment incorporating our products. Due to these lengthy sales cycles, we may experience a significant delay between increasing expenses for research and development and selling, general and administrative efforts, and the generation of corresponding revenue, if any. Furthermore, during 2000 and thereafter, we intend to continue to increase our investment in research and development, selling, general and administrative functions and inventory as we expand our operations through indigenous growth and acquisitions. We anticipate that the rate of new orders may vary significantly from month to month. Consequently, if anticipated sales and shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter, and potentially future quarters, would be materially and adversely affected. 14 17 RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999 The following table sets forth certain statement of operations data expressed as a percentage of revenue:
Three Months Ended Nine Months Ended September 30, September 30, ------------------- ------------------ 2000 1999(1) 2000 1999(1) ----- ------- ----- ------- Revenue 100.0% 100.0% 100.0% 100.0% Cost of revenue 42.6 40.3 42.0 40.5 ----- ----- ----- ----- Gross profit 57.4 59.7 58.0 59.5 Operating expense: Research and development 21.3 22.0 21.7 23.5 Selling, general and administrative 9.4 10.7 9.5 12.0 Stock-based compensation 8.7 0.7 4.1 0.8 Amortization of goodwill and purchased intangible assets 7.8 -- 3.3 -- In-process research and development 14.3 -- 6.0 -- Merger-related costs -- 2.9 0.6 4.2 Litigation settlement costs -- -- -- 4.7 ----- ----- ----- ----- Income (loss) from operations (4.1) 23.4 12.8 14.3 Interest and other income, net 1.5 1.6 1.8 1.6 ----- ----- ----- ----- Income (loss) before income taxes (2.6) 25.0 14.6 15.9 Provision for income taxes 3.5 7.4 4.7 4.9 ----- ----- ----- ----- Net income (loss) (6.1)% 17.6% 9.9% 11.0% ===== ===== ===== =====
------------- (1) Restated to give retroactive effect to acquisitions accounted for using the pooling-of-interests method. Business Combinations. During the three months ended September 30, 2000 we completed the acquisitions of Innovent, Puyallup and Altima. These acquisitions were accounted for as purchase transactions. Accordingly, the accompanying financial statements include the results of operations of the acquired companies as of their respective acquisition dates. See Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements. The restated condensed consolidated financial statements also include the pooled operations of each of our prior acquisitions, which were accounted for using the pooling-of-interests method. Revenue. Revenue consists of product revenue generated principally by sales of our semiconductor products, and to a lesser extent, from sales of software and software support and development revenue generated under development contracts with our customers. Revenue for the three months ended September 30, 2000 was $319.2 million, an increase of $179.6 million or 128.7% from revenue of $139.6 million in the three months ended September 30, 1999. Revenue for the nine months ended September 30, 2000 was $755.9 million, an increase of $396.7 million or 110.4% from revenue of $359.2 million in the nine months ended September 30, 1999. This growth in revenue resulted mainly from increases in volume shipments of our semiconductor products for the high-speed networking market, cable set-top boxes and cable modems. 15 18 Gross Profit. Gross profit represents revenue less the cost of revenue. Cost of revenue includes the cost of purchasing the finished silicon wafers processed by independent foundries, and costs associated with assembly, test and quality assurance for those products, as well as costs of personnel and equipment associated with manufacturing support and contracted development work. Gross profit for the three months ended September 30, 2000 was $183.2 million or 57.4% of revenue, an increase of $100.0 million as compared with gross profit of $83.3 million or 59.7% of revenue in the three months ended September 30, 1999. Gross profit for the nine months ended September 30, 2000 was $438.5 million or 58.0% of revenue, an increase of $224.6 million as compared with gross profit of $213.9 million or 59.5% of revenue in the nine months ended September 30, 1999. The increase in gross profit was mainly attributable to the significant increase in the volume of semiconductor product shipments. The decrease in gross profit as a percentage of revenue was largely driven by volume-pricing agreements and competitive pricing strategies on certain high volume products. We expect that gross profit as a percentage of revenue will continue to decline in future periods due to higher anticipated silicon wafer costs and as volume-pricing agreements and competitive pricing strategies continue to take effect. In addition, our gross profit may be affected by the future introduction of certain lower margin products. Research and Development Expense. Research and development expense consists primarily of salaries and related costs of employees engaged in research, design and development activities, costs related to engineering design tools, and subcontracting costs. Research and development expense for the three months ended September 30, 2000 was $67.9 million or 21.3% of revenue, an increase of $37.3 million as compared with research and development expense of $30.6 million or 22.0% of revenue for the three months ended September 30, 1999. Research and development expense for the nine months ended September 30, 2000 was $163.3 million or 21.7% of revenue, an increase of $79.1 million as compared with research and development expense of $84.3 million or 23.5% of revenue for the nine months ended September 30, 1999. The increase in research and development expense in absolute dollars was primarily due to the addition of personnel and the investment in design tools for the development of new products and the enhancement of existing products. The decrease in research and development expense as a percentage of revenue reflected the significant increase in revenue in the three and nine months ended September 30, 2000 as compared to the respective prior year period. We expect that research and development expense in absolute dollars will continue to increase for the foreseeable future as a result of indigenous growth and acquisitions. Selling, General and Administrative Expense. Selling, general and administrative expense consists primarily of personnel-related expenses, professional fees and facilities expenses. Selling, general and administrative expense for the three months ended September 30, 2000 was $30.1 million or 9.4% of revenue, an increase of $15.3 million as compared with selling, general and administrative expense of $14.9 million or 10.7% of revenue for the three months ended September 30, 1999. Selling, general and administrative expense for the nine months ended September 30, 2000 was $72.1 million or 9.5% of revenue, an increase of $28.9 million as compared with selling, general and administrative expense of $43.2 million or 12.0% of revenue for the nine months ended September 30, 1999. The increase in absolute dollars reflected higher personnel related costs resulting from the hiring of additional sales and marketing personnel, senior management and administrative 16 19 \ personnel, increased facilities expenses and legal and other professional fees. The decrease in selling, general and administrative expense as a percentage of revenue reflected the significant increase in revenue during the three and nine months ended September 30, 2000 as compared with the respective prior year period. We expect that selling, general and administrative expense in absolute dollars will continue to increase for the foreseeable future to support the planned continued expansion of our operations through indigenous growth and acquisitions and as a result of periodic changes and additions to our infrastructure to support increased headcount, acquisition and integration activities, and international operations. Stock-Based Compensation. Stock-based compensation represents the difference between the fair value of the common stock for accounting purposes and the exercise price of such options at the date of underlying employee stock options grant in accordance with FIN 44. Stock-based compensation for the three months ended September 30, 2000 was $27.6 million or 8.7% of revenue, an increase of $26.7 million as compared with stock-based compensation of $1.0 million or 0.7% of revenue for the three months ended September 30, 1999. Stock-based compensation for the nine months ended September 30, 2000 was $30.7 million or 4.1% of revenue, an increase of $27.8 million as compared with stock-based compensation of $2.8 million or 0.8% of revenue for the nine months ended September 30, 1999. The increase in stock-based compensation in the three and nine months ended September 30, 2000 relates primarily to stock options granted to certain employees of acquired companies that we assumed in the various purchase transactions completed during the third quarter of fiscal 2000. We have presented these amounts as a reduction of shareholders' equity and are amortizing these amounts ratably over the respective vesting periods of the applicable options. See Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements. We expect to incur additional stock-based compensation expenses in future periods as a result of these purchase transactions and the additional purchase transactions expected to close during the fourth quarter of fiscal 2000. Amortization of Goodwill and Purchased Intangible Assets. Amortization of goodwill and purchased intangible assets includes the amortization of goodwill and other purchased intangible assets relating to various purchase transactions completed during the third quarter of fiscal 2000. The amortization of goodwill and purchased intangible assets for the three and nine months ended September 30, 2000 was $24.9 million or 7.8% and 3.3% of revenue, respectively. No amortization of goodwill and purchased intangible assets were incurred in the three and nine months ended September 30, 1999. See Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements. We expect to incur additional amortization of goodwill and purchased intangible assets in future periods as a result of these purchase transactions and the additional purchase transactions expected to close during the fourth quarter of fiscal 2000. In-Process Research and Development. In-process research and development relates to various purchase transactions completed during the third quarter of fiscal 2000. The in-process research and development cost for the three and nine months ended September 30, 2000 was $45.7 million or 14.3% and 6.0% of revenue, respectively. No in-process research and development costs were incurred in the three and nine months ended September 30, 1999. See Note 2 of Notes to Unaudited Condensed Consolidated Financial Statements. We expect to incur additional in-process research and development costs in future periods as a result of these purchase transactions and the additional purchase transactions expected to close during the fourth quarter of fiscal 2000. 17 20 Merger-Related Costs. Merger-related costs are costs incurred in connection with acquisitions accounted for using the pooling-of-interests method and consist primarily of transaction costs, such as fees for investment bankers, attorneys, accountants, and other related fees and expenses, certain restructuring costs related to the disposal of assets and the write-down of unutilized assets, and adjustments to conform the accounting policies of the acquired companies to those of our Company. No merger-related costs were incurred for the three months ended September 30, 2000 as compared with merger-related costs of $4.1 million for the three months ended September 30, 1999. The decrease in merger-related costs resulted primarily from the fact that we did not enter into any pooling-of-interests acquisitions during the three months ended September 30, 2000. Merger-related costs for the nine months ended September 30, 2000 were $4.7 million as compared with merger-related costs of $15.2 million for the nine months ended September 30, 1999. This decrease in merger-related costs resulted primarily from the fact that an investment banking fee was incurred in connection with a fiscal 1999 transaction while no such investment banking fees were incurred during the nine months ended September 30, 2000. Litigation Settlement Costs. Litigation settlement costs consist primarily of settlement fees and associated attorneys' fees, expenses and court costs. No litigation settlement costs were incurred in the three and nine months ended September 30, 2000 and the three months ended September 30, 1999. Litigation settlement costs of approximately $17.0 million were incurred in the nine months ended September 30, 1999. Interest and Other Income, Net. Interest and other income, net reflects interest earned on average cash, cash equivalents and investment balances, less interest on our long-term debt and capital lease obligations. Interest and other income, net for the three months ended September 30, 2000 was $4.9 million, an increase of $2.7 million as compared with $2.2 million in the three months ended September 30, 1999. Interest and other income, net for the nine months ended September 30, 2000 was $13.0 million, an increase of $7.1 million as compared with $5.9 million in the nine months ended September 30, 1999. The increase was principally due to higher cash balances available to invest resulting from cash generated by operations and the exercise of employee stock options. Provision for Income Taxes. We utilize the liability method of accounting for income taxes as set forth in Financial Accounting Standards Board Statement 109 ("Statement 109"), Accounting for Income Taxes. Our effective tax rates for the three and nine months ended September 30, 2000 were (138%) and 32%, respectively. Our effective tax rates for the three and nine months ended September 30, 1999 were 29% and 30%, respectively. The federal statutory income tax rate was 35% for each period. Our effective tax rates for the three and nine months ended September 30, 2000 were affected by intangible expenses resulting from acquisitions accounted for under the purchase method of accounting, and benefits from research and development credits. For the three and nine months ended September 30, 1999, our effective tax rate was reduced by research and development credits. 18 21 LIQUIDITY AND CAPITAL RESOURCES Since our inception, we have financed our operations through a combination of sales of equity securities and cash generated by operations. At September 30, 2000 we had $551.8 million in working capital, and $482.4 million in cash, cash equivalents and short-term investments. At December 31, 1999 we had $313.7 million in working capital, $270.9 million in cash, cash equivalents and short-term investments, and $9.4 million in long-term investments. Operating activities provided cash in the amount of $141.4 million for the nine months ended September 30, 2000. This was primarily the result of net income, the non-cash impact of depreciation and amortization including the amortization of stock-based compensation, goodwill and purchased intangibles, purchased in-process research and development, tax benefit from the exercise of stock options, increases in accounts payable and an increase in income taxes partially offset by increases in accounts receivable, inventory, deferred tax assets and prepaid expenses and other assets. Operating activities provided cash in the amount of $93.8 million for the nine months ended September 30, 1999. This was primarily the result of net income, the non-cash impact of depreciation and amortization including amortization of stock-based compensation, tax benefit from the exercise of stock options, increases in accounts payable, income taxes and other accrued liabilities, partially offset by increases in accounts receivable, deferred tax assets, inventory and prepaid expenses and other assets. In the nine months ended September 30, 2000 our investing activities used $47.1 million in cash for the purchase of capital equipment to support our expanding operations, provided $10.7 million in cash as a result of cash received from purchase acquisitions, and used a net $5.2 million in cash for the purchase of held-to-maturity securities. In the nine months ended September 30, 1999 our investing activities used $22.5 million in cash for the purchase of capital equipment and a net $21.3 million in cash for the purchase of held-to-maturity investments. Cash provided by financing activities was $97.2 million in the nine months ended September 30, 2000, primarily from $100.7 million in proceeds from the issuance of common stock, partially offset by $4.6 million in payments on long-term obligations and capital leases of acquired companies. Financing activities provided cash of $34.5 million in the nine months ended September 30, 1999, primarily from $40.8 million in proceeds from the issuance of common stock, partially offset by $7.7 million in payments on long-term obligations and capital leases of acquired companies. We believe that our existing cash, cash equivalents and investments on hand, together with cash that we expect to generate from our operations, will be sufficient to meet our capital needs for at least the next twelve months. However, it is possible that we may need or choose to raise additional funds to fund our activities beyond the next year or to consummate acquisitions of other businesses, products or technologies. We could raise such funds by selling more stock to the public or to selected investors, or by borrowing money. In addition, even though we may not need additional funds, we may still elect to sell additional equity securities or obtain credit facilities for other reasons. We may not be able to obtain additional funds on favorable terms, or at all. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing shareholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock. 19 22 We had commitments totaling approximately $17.2 million as of September 30, 2000 primarily for the purchase of engineering design tools, computer hardware and information systems infrastructure. During 1999 we spent approximately $48.4 million on capital equipment to support our expanding operations. We expect that we will spend more than that amount during 2000 to purchase additional engineering design tools, computer hardware, test equipment, information systems and leasehold improvements, as our operations continue to expand and as we integrate and upgrade the capital equipment and facilities of acquired companies. We may finance these purchases from our cash and cash equivalents and investments on hand, cash generated from our operations, borrowings, equity offerings, or a combination thereof. Although we believe we have sufficient capital to fund our activities for at least the next twelve months, our future capital requirements may vary materially from those now planned. The amount of capital that we will need in the future will depend on many factors, including: o the market acceptance of our products; o the levels of promotion and advertising that will be required to launch our new products and achieve and maintain a competitive position in the marketplace; o volume price discounts; o our business, product, capital expenditure and research and development plans and product and technology roadmaps; o the levels of inventory and accounts receivable that we maintain; o capital improvements to new and existing facilities; o technological advances; o our competitors' response to our products; and o our relationships with suppliers and customers. In addition, we may require additional capital to accommodate planned growth, hiring, infrastructure and facility needs or to consummate acquisitions of other businesses, products or technologies. YEAR 2000 COMPLIANCE To date we have not experienced any known material Year 2000 problems in our products, our internal systems or facilities, or the products, systems and services of third parties. We will continue to monitor our mission critical computer applications and those of our suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. We did not incur material costs to identify and address specific Year 2000 compliance issues. We could, however, incur additional costs in addressing any residual Year 2000 issues, which could have a material and adverse effect on our business. 20 23 RISK FACTORS BEFORE DECIDING TO INVEST IN OUR COMPANY OR TO MAINTAIN OR INCREASE YOUR INVESTMENT, YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS REPORT AND IN OUR OTHER FILINGS WITH THE SEC, INCLUDING OUR ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 AS WELL AS OUR SUBSEQUENT REPORTS ON FORMS 10-Q, 8-K AND 8-K/A. THE RISKS AND UNCERTAINTIES DESCRIBED BELOW ARE NOT THE ONLY ONES FACING OUR COMPANY. ADDITIONAL RISKS AND UNCERTAINTIES NOT PRESENTLY KNOWN TO US OR THAT WE CURRENTLY DEEM IMMATERIAL MAY ALSO AFFECT OUR BUSINESS OPERATIONS. IF ANY OF THESE RISKS ACTUALLY OCCUR, OUR BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE SERIOUSLY HARMED. IN THAT EVENT, THE MARKET PRICE FOR OUR CLASS A COMMON STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY. AS A RESULT, WE MAY FAIL TO MEET OR EXCEED THE EXPECTATIONS OF SECURITIES ANALYSTS AND INVESTORS, WHICH COULD CAUSE OUR STOCK PRICE TO DECLINE. Our quarterly revenues and operating results have fluctuated significantly in the past and may continue to vary from quarter to quarter due to a number of factors, many of which are not within our control. If our operating results do not meet the expectations of securities analysts or investors, our stock price may decline. Fluctuations in our operating results may be due to a number of factors, including the following: o the volume of our product sales and pricing concessions on volume sales; o the timing, rescheduling or cancellation of significant customer orders; o the gain or loss of a key customer; o the qualification, availability and pricing of competing products and technologies and the resulting effect on sales and pricing of our products; o silicon wafer pricing and the availability of foundry and assembly capacity and raw materials; o the risks inherent in our acquisitions of technologies and businesses, including the timing and successful completion of technology and product development through volume production, integration issues, costs and unanticipated expenditures, changing relationships with customers, suppliers and strategic partners, potential contractual, intellectual property or employment issues, accounting treatment and charges, and the risks that the acquisition cannot be completed successfully or that anticipated benefits are not realized; o our ability to specify, develop or acquire, complete, introduce, market and transition to volume production new products and technologies in a timely manner; o the timing of customer-industry qualification and certification of our products and the risks of non-qualification or non-certification; o the rate at which our present and future customers and end users adopt Broadcom technologies in our target markets; o the rate of adoption and acceptance of new industry standards in our target markets; o the effects of new and emerging technologies; 21 24 o intellectual property disputes and customer indemnification claims; o the effectiveness of our product cost reduction efforts; o fluctuations in the manufacturing yields of our third party semiconductor foundries and other problems or delays in the fabrication, assembly, testing or delivery of our products; o the risks of producing products with new suppliers and at new fabrication and assembly facilities; o the risks and uncertainties associated with our international operations; o problems or delays that we may face in shifting our products to smaller geometry process technologies and in achieving higher levels of design integration; o our ability to retain and hire key executives, technical personnel and other employees in the numbers, with the capabilities, and at the compensation levels that we need to implement our business and product plans; o changes in our product or customer mix; o the quality of our products and any remediation costs; o the effects of natural disasters and other events beyond our control; o the level of orders received that we can ship in a fiscal quarter; o potential business disruptions, claims, expenses and other difficulties resulting from residual "Year 2000" problems in computer-based systems used by us, our suppliers or our customers; o economic and market conditions in the semiconductor industry and the broadband communications markets; and o general economic and market conditions. We intend to continue to increase our operating expenses in 2000 and in the future. A large portion of our operating expenses, including rent, salaries and capital lease expenditures, is fixed and difficult to reduce or change. Accordingly, if our total revenue does not meet our expectations, we probably would not be able to adjust our expenses quickly enough to compensate for the shortfall in revenue. In that event, our business, financial condition and results of operations would be materially and adversely affected. Due to all of the foregoing factors, and the other risks discussed in this report, you should not rely on quarter-to-quarter comparisons of our operating results as an indication of future performance. BECAUSE WE DEPEND ON A FEW SIGNIFICANT CUSTOMERS FOR A SUBSTANTIAL PORTION OF OUR REVENUES, THE LOSS OF A KEY CUSTOMER COULD SERIOUSLY HARM OUR BUSINESS. IN ADDITION, IF WE ARE UNABLE TO CONTINUE TO SELL EXISTING AND NEW PRODUCTS TO OUR KEY CUSTOMERS IN SIGNIFICANT QUANTITIES OR TO ATTRACT NEW SIGNIFICANT CUSTOMERS, OUR FUTURE OPERATING RESULTS COULD BE ADVERSELY AFFECTED. We have derived a substantial portion of our revenues in the past from sales to a relatively small number of customers. As a result, the loss of any significant customer could materially and adversely affect our financial condition and results of operations. Sales to Motorola, Cisco and 3Com, including 22 25 sales to their respective manufacturing subcontractors, accounted for approximately 23.9%, 14.8% and 14.6%, respectively, of our revenue in the nine months ended September 30, 2000. In the nine months ended September 30, 2000 sales to our five largest customers, including sales to their respective manufacturing subcontractors, decreased to 63.9% of our total revenues compared to 66.6% in the year ended December 31, 1999. We expect that our key customers will continue to account for a substantial portion of our revenues for 2000 and in the future. Accordingly, our future operating results will continue to depend on the success of our largest customers and on our ability to sell existing and new products to these customers in significant quantities. We may not be able to maintain or increase sales to certain of our key customers for a variety of reasons, including the following: o Most of our customers can stop incorporating our products into their own products with limited notice to us and suffer little or no penalty. o Our agreements with our customers typically do not require them to purchase a minimum amount of our products. o Many of our customers have pre-existing relationships with our current or potential competitors that may affect their decision to purchase our products. o Our customers face intense competition from other manufacturers that do not use our products. o Some of our customers offer or may offer products that compete with our products. o Our longstanding relationships with some of our larger customers may also deter other potential customers who compete with these customers from buying our products. In addition, in order to attract new customers or retain existing customers, we may offer certain customers favorable prices on our products. If these prices are lower than the prices paid by our existing customers, we would have to offer the same lower prices to certain of our customers who have contractual "most favored nation" pricing arrangements. In that event, our average selling prices and gross margins would decline. The loss of a key customer, a reduction in our sales to any key customer or our inability to attract new significant customers could materially and adversely affect our business, financial condition or results of operations. WE FACE INTENSE COMPETITION IN THE BROADBAND COMMUNICATIONS MARKETS AND SEMICONDUCTOR INDUSTRY, WHICH COULD REDUCE OUR MARKET SHARE IN EXISTING MARKETS AND AFFECT OUR ENTRY INTO NEW MARKETS. The broadband communications markets and semiconductor industry are intensely competitive. We expect competition to continue to increase in the future as industry standards become well known and as other competitors enter our target markets. We currently compete with a number of major domestic and international suppliers of integrated circuits in the markets for cable set-top boxes, cable modems, high-speed local, metropolitan and wide area networks, home networking, Voice over Internet Protocol ("VoIP"), carrier 23 26 access, residential broadband gateways, direct broadcast satellite and terrestrial digital satellite, optical networking, digital subscriber lines ("xDSL") and wireless communications, including without limitation the markets for products such as network interface cards and LAN-on-motherboard solutions. We also compete with suppliers of system- and motherboard-level solutions incorporating integrated circuits that are proprietary or sourced from manufacturers other than Broadcom. This competition has resulted and may continue to result in declining average selling prices for our products. In all of our target markets, we also may face competition from newly established competitors and suppliers of products based on new or emerging technologies. We also expect to encounter further consolidation in the markets in which we compete. Many of our competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than we do. As a result, these competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources to the promotion and sale of their products. In addition, current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. Existing or new competitors may also develop technologies in the future that more effectively address the transmission of digital information through existing analog infrastructures or through new digital infrastructures at lower costs than our technologies. Increased competition has in the past and is likely to continue to result in price reductions, reduced gross margins and loss of market share. We cannot assure you that we will be able to continue to compete successfully or that competitive pressures will not materially and adversely affect our business, financial condition and results of operations. OUR ACQUISITION STRATEGY MAY REQUIRE US TO UNDERTAKE SIGNIFICANT CAPITAL INFUSIONS, BE DILUTIVE TO OUR EXISTING SHAREHOLDERS, RESULT IN UNANTICIPATED CHANGES OR OTHERWISE ADVERSELY AFFECT OUR RESULTS OF OPERATIONS, AND RESULT IN DIFFICULTIES IN ASSIMILATING AND INTEGRATING THE OPERATIONS, PERSONNEL, TECHNOLOGIES, PRODUCTS AND INFORMATION SYSTEMS OF ACQUIRED COMPANIES. A key element of our business strategy involves expansion through the acquisition of businesses, products or technologies that allow us to complement our existing product offerings, expand our market coverage, increase our engineering workforce or enhance our technological capabilities. Between January 1, 1999 and September 30, 2000, we acquired Maverick Networks, Epigram, Inc., Armedia, Inc., HotHaus Technologies Inc., AltoCom, Inc., Digital Furnace Corporation, BlueSteel Networks, Inc., Stellar Semiconductor, Inc., Pivotal Technologies Corp., Innovent Systems, Inc., Puyallup Integrated Circuit Company, Inc. and Altima Communications, Inc. In October 2000 we completed the acquisitions of Silicon Spice Inc. and NewPort Communications, Inc. We have also entered into definitive agreements to acquire Element 14, Inc. Allayer Communications and SiByte, Inc. We plan to continue to pursue acquisition opportunities in 2000 and in the future. Acquisitions may require significant capital infusions, typically entail many risks and could result in difficulties in assimilating and integrating the operations, personnel, 24 27 technologies, products and information systems of the acquired company. We may also encounter delays in the timing and successful completion of the acquired company's technology and product development through volume production, costs and unanticipated expenditures, changing relationships with customers, suppliers and strategic partners, or contractual, intellectual property or employment issues. In addition, the key personnel of the acquired company may decide not to work for us. The acquisition of another company or its products and technologies may also require us to enter into a geographic or business market in which we have little or no prior experience. These challenges could disrupt our ongoing business, distract our management and employees and increase our expenses. In addition, acquisitions may materially and adversely affect our results of operations because they may require large one-time charges, increased debt or contingent liabilities, adverse tax consequences, substantial depreciation or deferred compensation charges, or the amortization of amounts related to deferred compensation, goodwill and other intangible assets. We may seek to account for acquisitions under the pooling-of-interests accounting method, but that method may not be available. Any of these events could cause the price of our Class A common stock to decline. Acquisitions made entirely or partially for cash may reduce our cash reserves. Furthermore, if we issue equity or convertible debt securities in connection with an acquisition, as in the case of our recent acquisitions, the issuance may be dilutive to our existing shareholders. In addition, the equity or debt securities that we may issue could have rights, preferences or privileges senior to those of the holders of our common stock. Thus, for example, as a consequence of the pooling-of-interest rules, the securities issued in nine of the fourteen completed acquisitions described above were Class B common stock, which has voting rights superior to our publicly-traded Class A common stock. We cannot assure you that we will be able to consummate any pending or future acquisitions or that we will realize the benefits anticipated from these acquisitions. In the future, we may not be able to find other suitable acquisition opportunities that are available at attractive valuations, if at all. Even if we do find suitable acquisition opportunities, we may not be able to consummate the acquisitions on commercially acceptable terms. Moreover, it may be difficult for us to successfully integrate any acquired businesses, products, technologies or personnel, which could materially and adversely affect our business, financial condition and results of operations. WE MUST KEEP PACE WITH RAPID TECHNOLOGICAL CHANGES IN THE SEMICONDUCTOR INDUSTRY AND BROADBAND COMMUNICATIONS MARKETS IN ORDER TO REMAIN COMPETITIVE. Our future success will depend on our ability to anticipate and adapt to changes in technology and industry standards. We will also need to continue to develop and introduce new and enhanced products to meet our customers' changing demands. Substantially all of our product revenue in recent fiscal quarters has been derived from sales of products for the high-speed office network, cable set-top box and cable modem markets. These markets are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and short product life cycles. In addition, these markets continue to undergo rapid growth and consolidation. A significant slowdown in any of these markets or other broadband communications markets could materially and adversely affect our business, financial condition and results of operations. Our success will also depend on the ability of our customers to develop new products and enhance existing products for the broadband communications markets and to introduce and promote those products successfully. The 25 28 broadband communications markets may not continue to develop to the extent or in the timeframes that we anticipate. If new markets do not develop as we anticipate, or if our products do not gain widespread acceptance in these markets, our business, financial condition and results of operations could be materially and adversely affected. IF WE DO NOT ANTICIPATE AND ADAPT TO EVOLVING INDUSTRY STANDARDS IN THE SEMICONDUCTOR INDUSTRY AND BROADBAND COMMUNICATIONS MARKETS, OUR PRODUCTS COULD BECOME OBSOLETE AND WE COULD LOSE MARKET SHARE. Products for broadband communications applications generally are based on industry standards that are continually evolving. If new industry standards emerge, our products or our customers' products could become unmarketable or obsolete. We may also have to incur substantial unanticipated costs to comply with these new standards. Our past sales and profitability have resulted, to a large extent, from our ability to anticipate changes in technology and industry standards and to develop and introduce new and enhanced products incorporating the new standards. Our ability to adapt to these changes and to anticipate future standards, and the rate of adoption and acceptance of those standards, will be a significant factor in maintaining or improving our competitive position and prospects for growth. We have in the past invested substantial resources in emerging technologies that did not achieve the market acceptance that we had expected. Our inability to anticipate the evolving standards in the semiconductor industry and, in particular the broadband communications markets, or to develop and introduce new products successfully into these markets could materially and adversely affect our business, financial condition and results of operations. IF WE ARE UNABLE TO DEVELOP AND INTRODUCE NEW PRODUCTS SUCCESSFULLY AND IN A COST-EFFECTIVE AND TIMELY MANNER OR TO ACHIEVE MARKET ACCEPTANCE OF OUR NEW PRODUCTS, OUR OPERATING RESULTS WOULD BE ADVERSELY AFFECTED. Our future success will depend on our ability to develop new silicon solutions for existing and new markets, introduce these products in a cost-effective and timely manner and convince leading equipment manufacturers to select these products for design into their own new products. Our quarterly results in the past have been, and are expected in the future to continue to be, dependent on the introduction of a relatively small number of new products and the timely completion and delivery of those products to customers. The development of new silicon devices is highly complex, and from time to time we have experienced delays in completing the development and introduction of new products. Our ability to develop and deliver new products successfully will depend on various factors, including our ability to: o accurately predict market requirements and evolving industry standards; o accurately define new products; o timely complete and introduce new product designs; o timely qualify and obtain industry interoperability certification of our products and our customers' products into which our products will be incorporated; o obtain sufficient foundry capacity; o achieve high manufacturing yields; and o gain market acceptance of our products and our customers' products. 26 29 If we are not able to develop and introduce new products successfully and in a cost-effective and timely manner, our business, financial condition and results of operations would be materially and adversely affected. Our new products generally are incorporated into our customers' products at the design stage. We have often incurred significant expenditures on the development of a new product without any assurance that an equipment manufacturer will select our product for design into its own product. The value of our products largely depends on the commercial success of our customers' products and on the extent to which those products accommodate components manufactured by our competitors. We cannot assure you that we will continue to achieve design wins. In addition, the equipment that incorporates our products may never become commercially successful. WE DEPEND ON TWO INDEPENDENT FOUNDRIES TO MANUFACTURE SUBSTANTIALLY ALL OF OUR CURRENT PRODUCTS, AND ANY FAILURE TO OBTAIN SUFFICIENT FOUNDRY CAPACITY COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS. We do not own or operate a fabrication facility. Two outside foundries, Taiwan Semiconductor Manufacturing Corporation, or TSMC, in Taiwan and Chartered Semiconductor Manufacturing, or Chartered, in Singapore, currently manufacture substantially all of our semiconductor devices in current production. In September 1999 TSMC's principal facility was affected by a significant earthquake in Taiwan. As a consequence of this earthquake, TSMC suffered power outages and equipment damage that impaired TSMC's wafer deliveries and, together with strong demand, could result in wafer shortages and higher wafer pricing industrywide. In addition, if either TSMC or Chartered experiences financial difficulties, if either foundry suffers any damage to its facilities or in the event of any other disruption of foundry capacity, we may not be able to qualify an alternative foundry in a timely manner. Even our current foundries would need to have new manufacturing processes qualified if there is a disruption in an existing process. If we choose to use a new foundry or process, it would typically take us several months to qualify the new foundry or process before we can begin shipping products from it. If we cannot accomplish this qualification in a timely manner, we may still experience a significant interruption in supply of the affected products. Because we rely on outside foundries with limited capacity, we face several significant risks, including: o a lack of ensured wafer supply and potential wafer shortages and higher wafer prices; o limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs; and o the unavailability of or potential delays in obtaining access to key process technologies. In addition, the manufacture of integrated circuits is a highly complex and technologically demanding process. Although we work closely with our foundries to minimize the likelihood of reduced manufacturing yields, our foundries have from time to time experienced lower than anticipated manufacturing yields. This often occurs during the production of new products or the installation and start-up of new process technologies. The ability of each foundry to provide us with semiconductor devices is limited by its available capacity. Although we have entered into contractual commitments to supply specified levels of products to certain of our customers, we do not have a long-term volume purchase agreement or a guaranteed level of production capacity with either TSMC or Chartered. Foundry capacity may not be available when we need it or at reasonable prices. Availability of foundry capacity has recently been reduced due to strong demand. We place 27 30 our orders on the basis of our customers' purchase orders, and TSMC and Chartered can allocate capacity to the production of other companies' products and reduce deliveries to us on short notice. It is possible that foundry customers that are larger and better financed than we are, or that have long-term agreements with TSMC or Chartered, may induce our foundries to reallocate capacity to them. Such a reallocation could impair our ability to secure the supply of components that we need. Although we primarily use two independent foundries, most of our components are not manufactured at both foundries at any given time and some of our products may be designed to be manufactured at only one. Accordingly, if one of our foundries is unable to provide us with components as needed, we could experience significant delays in securing sufficient supplies of those components. Any of these delays would likely materially and adversely affect our business, financial condition and results of operations. We cannot assure you that any of our existing or new foundries would be able to produce integrated circuits with acceptable manufacturing yields. Furthermore, our foundries may not be able to deliver enough semiconductor devices to us on a timely basis, or at reasonable prices. Certain of our acquired companies have established relationships with foundries other than TSMC and Chartered, and we are using these other foundries to produce the initial products of these acquired companies. We may utilize such foundries for other products in the future. In using these new foundries, we will be subject to all of the same risks described in the foregoing paragraphs with respect to TSMC and Chartered. WE MAY BE UNABLE TO RETAIN KEY TECHNICAL AND SENIOR MANAGEMENT PERSONNEL AND ATTRACT ADDITIONAL KEY EMPLOYEES, WHICH COULD SERIOUSLY HARM OUR BUSINESS. Our future success depends to a significant extent upon the continued service of our key technical and senior management personnel, in particular, our co-founder, President and Chief Executive Officer, Dr. Henry T. Nicholas III, and our co-founder, Vice President of Research & Development and Chief Technical Officer, Dr. Henry Samueli. We do not have employment agreements with these executives or any other key employees that govern the length of their service. The loss of the services of Dr. Nicholas or Dr. Samueli, or certain other key employees, would likely materially and adversely affect our business, financial condition and results of operations. Our future success also depends on our ability to continue to attract, retain and motivate qualified personnel, particularly digital circuit designers, mixed-signal circuit designers and systems applications engineers. Competition for these employees is intense. Our inability to attract and retain additional key employees could have an adverse effect on our business, financial condition and results of operations. 28 31 OUR INABILITY TO MANAGE OUR SIGNIFICANT RECENT AND ANTICIPATED FUTURE GROWTH COULD STRAIN OUR MANAGERIAL, OPERATIONAL AND FINANCIAL RESOURCES, AND COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS. During the past year, we have continued to significantly increase the scope of our operations and expand our workforce, growing from 436 employees as of December 31, 1998 to 1,785 employees as of September 30, 2000, including contract and temporary employees and employees who joined us as the result of acquisitions. This growth has placed, and our anticipated future growth of operations is expected to continue to place, a significant strain on our management personnel, systems and resources. We anticipate that we will need to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the ongoing improvement of our accounting and other internal management systems. We also will need to continue to expand, train, manage and motivate our workforce. All of these endeavors will require substantial management effort. In the future, we will likely need to expand our facilities or relocate some or all of our employees or operations from time to time to support our growth. These relocations could result in temporary disruptions of our operations or a diversion of management's attention and resources. If we are unable to effectively manage expanding operations, our business, financial condition and results of operations could be materially and adversely affected. THE LOSS OF ANY OF THE THREE THIRD-PARTY SUBCONTRACTORS THAT ASSEMBLE AND TEST SUBSTANTIALLY ALL OF OUR CURRENT PRODUCTS COULD DISRUPT OUR SHIPMENTS, HARM OUR CUSTOMER RELATIONSHIPS AND ADVERSELY AFFECT OUR NET SALES. Three third-party subcontractors, ASAT Ltd. in Hong Kong, ST Assembly Test Services, STATS, in Singapore, and Amkor Technology in the Philippines and South Korea, assemble and test almost all of our current products. Because we rely on third-party subcontractors to assemble and test our products, we cannot directly control our product delivery schedules and quality assurance and control. This lack of control has in the past, and could in the future, result in product shortages or quality assurance problems that could increase our manufacturing, assembly or testing costs. We do not have long-term agreements with ASAT, STATS or Amkor. We typically procure services from these suppliers on a per order basis. If either ASAT, STATS or Amkor experiences capacity constraints or financial difficulties, if any subcontractor suffers any damage to its facilities or in the event of any other disruption of assembly and testing capacity, we may not be able to obtain alternative assembly and testing services in a timely manner. Due to the amount of time that it usually takes us to qualify assemblers and testers, we could experience significant delays in product shipments if we are required to find alternative assemblers or testers for our components. Any problems that we may encounter with the delivery, quality or cost of our products could materially and adversely affect our business, financial condition or results of operations. We are continuing to develop relationships with additional third-party subcontractors to assemble and test our products. In using these new subcontractors, we will be subject to all of the same risks described in the foregoing paragraph with respect to ASAT, STATS and Amkor. 29 32 AS OUR INTERNATIONAL BUSINESS EXPANDS, OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS COULD BE ADVERSELY AFFECTED AS A RESULT OF LEGAL, BUSINESS AND ECONOMIC RISKS SPECIFIC TO INTERNATIONAL OPERATIONS. We currently obtain substantially all of our manufacturing, assembly and testing services from suppliers located outside of the United States. In addition, approximately 13.7% of our revenue in the nine months ended September 30, 2000 was derived from sales to independent customers outside the United States. We also frequently ship products to our domestic customers' international manufacturing divisions and subcontractors. In 1999 we established an international distribution center in Singapore and a design center in The Netherlands. As a result of our acquisition of HotHaus in August 1999, we now undertake software design, development and marketing activities in Canada. Furthermore, as a result of our acquisition of Armedia in May 1999 and Altima in September 2000, we also undertake design and development activities in India and Taiwan. In the future, we intend to continue to expand these international business activities and also to open other design and operational centers abroad. International operations are subject to many inherent risks, including: o political, social and economic instability; o trade restrictions; o the imposition of governmental controls; o exposure to different legal standards, particularly with respect to intellectual property; o burdens of complying with a variety of foreign laws; o import and export license requirements and restrictions of the United States and each other country in which we operate; o unexpected changes in regulatory requirements; o foreign technical standards; o changes in tariffs; o difficulties in staffing and managing international operations; o fluctuations in currency exchange rates; o difficulties in collecting receivables from foreign entities; and o potentially adverse tax consequences. VARIOUS EXPORT LICENSING REQUIREMENTS, THE SEASONALITY OF INTERNATIONAL SALES OR AN INCREASE IN THE VALUE OF THE U.S. DOLLAR RELATIVE TO FOREIGN CURRENCIES COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS OR REQUIRE US TO MODIFY OUR CURRENT BUSINESS PRACTICES SIGNIFICANTLY. Various government export regulations apply to the encryption or other features contained in some of our products. We have applied for and received several export licenses under these regulations, but we cannot assure you that we will obtain any licenses for which we have currently applied or any licenses that we may apply for in the future. If we do not receive the required licenses, we may be unable to manufacture the affected products at our foreign foundries or to ship these products to certain customers located outside the United States. Moreover, the seasonality of international sales and economic conditions in our primary overseas markets may negatively impact the demand for our products abroad. All of 30 33 our international sales to date have been denominated in U.S. dollars. Accordingly, an increase in the value of the U.S. dollar relative to foreign currencies could make our products less competitive in international markets. Any one or more of the foregoing factors could materially and adversely affect our business, financial condition or results of operations or require us to modify our current business practices significantly. We anticipate that these factors will impact our business to a greater degree as we further expand our international business activities. OUR FUTURE SUCCESS DEPENDS IN SIGNIFICANT PART ON STRATEGIC RELATIONSHIPS WITH CERTAIN OF OUR CUSTOMERS. IF WE CANNOT MAINTAIN THESE RELATIONSHIPS OR IF THESE CUSTOMERS DEVELOP THEIR OWN SOLUTIONS OR ADOPT A COMPETITOR'S SOLUTIONS INSTEAD OF BUYING OUR PRODUCTS, OUR OPERATING RESULTS WOULD BE ADVERSELY AFFECTED. In the past, we have relied on our strategic relationships with certain customers who are technology leaders in our target markets. We intend to pursue and continue to form these strategic relationships in the future but we cannot assure you that we will be able to do so. These relationships often require us to develop new products that typically involve significant technological challenges. Our partners frequently place considerable pressure on us to meet their tight development schedules. Accordingly, we may have to devote a substantial amount of our limited resources to our strategic relationships, which could detract from or delay our completion of other important development projects. Delays in development could impair our relationships with our strategic partners and negatively impact sales of the products under development. Moreover, it is possible that our customers may develop their own solutions or adopt a competitor's solution for products that they currently buy from us. If that happens, our business, financial condition and results of operations could be materially and adversely affected. WE MAY EXPERIENCE DIFFICULTIES IN TRANSITIONING TO SMALLER GEOMETRY PROCESS TECHNOLOGIES OR IN ACHIEVING HIGHER LEVELS OF DESIGN INTEGRATION AND THAT MAY RESULT IN REDUCED MANUFACTURING YIELDS, DELAYS IN PRODUCT DELIVERIES AND INCREASED EXPENSES. In order to remain competitive, we expect to continue to transition our products to increasingly smaller geometries. This transition will require us to redesign certain products and modify the manufacturing processes for our products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies in order to reduce our costs, and we have begun shifting certain products from .50 micron to .35 micron, .22 micron and smaller geometry processes. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes. These difficulties 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 are dependent on our relationships with our foundries to transition to smaller geometry processes successfully. We cannot assure you that our foundries will be able to effectively manage the transition or that we will be able to maintain our relationships with our foundries. If our foundries or we experience significant delays in this transition or fail to efficiently implement this transition, our business, financial condition and results of operations could be materially and adversely affected. As smaller geometry processes become more prevalent, we expect to integrate greater levels of functionality, as well as customer and third party intellectual property, into our products. However, we may not be able to achieve higher levels of design integration or deliver new integrated products on a timely basis, or at all. 31 34 WE MAY NOT BE ABLE TO ADEQUATELY PROTECT OR ENFORCE OUR INTELLECTUAL PROPERTY RIGHTS, WHICH COULD HARM OUR COMPETITIVE POSITION. Our success and future revenue growth will depend, in part, on our ability to protect our intellectual property. We primarily rely on patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods, to protect our proprietary technologies and processes. Despite our efforts to protect our proprietary technologies and processes, it is possible that certain of our competitors or other parties may obtain, use or disclose our technologies and processes. We currently hold 17 issued United States patents and have filed over 400 United States patent applications. We cannot assure you that any additional patents will be issued. Even if a new patent is issued, the claims allowed may not be sufficiently broad to protect our technology. In addition, any of our existing or future patents may be challenged, invalidated or circumvented. Moreover, any rights granted under these patents may not provide us with meaningful protection. If our patents do not adequately protect our technology, then our competitors may be able to offer products similar to ours. Our competitors may also be able to develop similar technology independently or design around our patents. Moreover, because we have participated in developing various industry standards, we may be required to license some of our technology and patents to others, including competitors, who develop products based on the adopted standards. We generally enter into confidentiality agreements with our employees and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. As a result, our technologies and processes may be misappropriated, particularly in foreign countries where laws may not protect our proprietary rights as fully as in the United States. In addition, some of our customers have entered into agreements with us that grant them the right to use our proprietary technology if we ever fail to fulfill our obligations under those agreements, including product supply obligations, and do not correct this failure within a specified time period. Moreover, we often incorporate the intellectual property of our strategic customers into our own designs, and have certain obligations not to use or disclose their intellectual property without their authorization. We cannot assure you that our efforts to prevent the misappropriation or infringement of our intellectual property or the intellectual property of our customers will succeed. In the future, we may have to engage in litigation to enforce our intellectual property rights, protect our trade secrets or determine the validity and scope of the proprietary rights of others, including our customers. This litigation may be very expensive and time consuming, divert management's attention and materially and adversely affect our business, financial condition and results of operations. INFRINGEMENT OR OTHER CLAIMS AGAINST US COULD ADVERSELY AFFECT OUR ABILITY TO MARKET OUR PRODUCTS, REQUIRE US TO REDESIGN OUR PRODUCTS OR SEEK LICENSES FROM THIRD PARTIES AND SERIOUSLY HARM OUR OPERATING RESULTS. 32 35 Companies in the semiconductor industry often aggressively protect and pursue their intellectual property rights. From time to time, we have received, and may continue to receive in the future, notices that claim we have infringed upon, misappropriated or misused other parties' proprietary rights. In March 2000 Intel Corporation and its subsidiary Level One Communications, Inc. filed a lawsuit against us alleging misappropriation of trade secrets, unfair competition and tortious interference with existing contractual relations related to our recent hiring of three former Intel employees. In August 2000 Intel filed a lawsuit against us alleging infringement of five Intel patents. In 1999 we settled litigation with Stanford Telecommunications, Inc. that related to the alleged infringement of one of Stanford's patents by several of our cable modem products. In 1999 we prevailed in litigation with Sarnoff Corporation and NxtWave Communications, Inc., formerly Sarnoff Digital Communications, Inc., which alleged that we misappropriated and misused certain of their trade secrets in connection with our hiring of five former Sarnoff employees. Our subsidiary, AltoCom, is the defendant in patent litigation brought by Motorola, Inc. relating to software modem technology. Our new subsidiary, Altima, is the defendant in patent litigation and International Trade Commission proceedings brought by Intel and Level One. Although we are defending the pending litigation vigorously, it is possible that we will not prevail in pending or future lawsuits. In addition, we may be sued in the future by other parties who claim that we have infringed their patents or misappropriated or misused their trade secrets, or who may seek to invalidate one of our patents. Any of these claims may materially and adversely affect our business, financial condition and results of operations. For example, in a patent or trade secret action, a court could issue an injunction against us that would require us to withdraw or recall certain products from the market or redesign certain products offered for sale or under development. In addition, we may be liable for damages for past infringement and royalties for future use of the technology. We may also have to indemnify certain customers and strategic partners under our agreements with such parties if a third party alleges or if a court finds that we have infringed upon, misappropriated or misused another party's proprietary rights. Even if claims against us are not valid or successfully asserted, these claims could result in significant costs and a diversion of management and personnel resources to defend. In that event, our business, financial condition and results of operations would likely be materially and adversely affected. If any claims or actions are asserted against us, we may seek to obtain a license under a third party's intellectual property rights. However, we may not be able to obtain a license on commercially reasonable terms, if at all. OUR PRODUCTS TYPICALLY HAVE LENGTHY SALES CYCLES. A CUSTOMER MAY DECIDE TO CANCEL OR CHANGE ITS PRODUCT PLANS, WHICH COULD CAUSE US TO LOSE ANTICIPATED SALES. IN ADDITION, OUR AVERAGE PRODUCT CYCLES TEND TO BE SHORT AND, AS A RESULT, WE MAY HOLD EXCESS OR OBSOLETE INVENTORY WHICH COULD ADVERSELY AFFECT OUR OPERATING RESULTS. After we have developed and delivered a product to a customer, our customer will often test and evaluate our product prior to designing its own equipment to incorporate our product. Our customer may need three to six months or longer to test and evaluate our product and an additional three to six months or more to begin volume production of equipment that incorporates our product. Due to this lengthy sales cycle, we may experience delays from the time we increase our operating expenses and our investments in inventory until the time that we generate revenues for these products. It is possible that we may never generate any revenues from these products after incurring such expenditures. Even if a customer selects our product to incorporate into its equipment, we have no assurances that such customer will ultimately market and sell their equipment or that such efforts by our customer will be successful. The delays inherent in our lengthy sales cycle increase the risk 33 36 that a customer will decide to cancel or change its product plans. Such a cancellation or change in plans by a customer could cause us to lose sales that we had anticipated. In addition, our business, financial condition and results of operations could be materially and adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle or chooses not to release equipment that contains our products. While our sales cycles are typically long, our average product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, the resources devoted to product sales and marketing may not generate material revenues for us, and from time to time, we may need to write off excess and obsolete inventory. If we incur significant marketing and inventory expenses in the future that we are not able to recover, and we are not able to compensate for those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions, and we still have higher cost products in inventory, our operating results would be harmed. BECAUSE WE ARE SUBJECT TO ORDER AND SHIPMENT UNCERTAINTIES, ANY SIGNIFICANT CANCELLATIONS OR DEFERRALS COULD ADVERSELY AFFECT OUR OPERATING RESULTS. We typically sell products pursuant to purchase orders that customers can generally cancel or defer on short notice without incurring a significant penalty. Any significant cancellations or deferrals could materially and adversely affect our business, financial condition and results of operations. In addition, cancellations or deferrals could cause us to hold excess inventory, which could reduce our profit margins and restrict our ability to fund our operations. We recognize revenue upon shipment of products to a customer. If a customer refuses to accept shipped products or does not timely pay for these products, we could incur significant charges against our income. These charges could materially and adversely affect our operating results. THE COMPLEXITY OF OUR PRODUCTS COULD RESULT IN UNFORESEEN DELAYS OR EXPENSES AND IN UNDETECTED DEFECTS OR BUGS, WHICH COULD ADVERSELY AFFECT THE MARKET ACCEPTANCE OF NEW PRODUCTS AND DAMAGE OUR REPUTATION WITH CURRENT OR PROSPECTIVE CUSTOMERS. Highly complex products such as the products that we offer frequently contain defects and bugs when they are first introduced or as new versions are released. We have in the past experienced, and may in the future experience, these defects and bugs. If any of our products contain defects or bugs, or have reliability, quality or compatibility problems, our reputation may be damaged and customers may be reluctant to buy our products, which could materially and adversely affect our ability to retain existing customers or attract new customers. In addition, these defects or bugs could interrupt or delay sales to our customers. In order to alleviate these problems, we may have to invest significant capital and other resources. Although our products are tested by our suppliers, our customers and ourselves, it is possible that our new products will contain defects or bugs. If any of these problems are not found until after we have commenced commercial production of a new product, we may be required to incur additional development costs and product recall, repair or replacement costs. These problems may also result in claims against us by our customers or others. In addition, these problems may divert our technical and other resources from other development efforts. Moreover, we would likely lose, or experience a delay in, market acceptance of the affected product or products, and we could lose credibility with our current and prospective customers. 34 37 OUR OPERATING RESULTS MAY VARY SIGNIFICANTLY DUE TO THE CYCLICALITY OF THE SEMICONDUCTOR INDUSTRY. ANY SUCH VARIATIONS COULD ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK. We operate in the semiconductor industry, which is cyclical and subject to rapid technological change. From time to time, the semiconductor industry has experienced significant economic downturns, characterized by diminished product demand, accelerated erosion of prices and excess production capacity. This industry also periodically experiences increased demand and production capacity constraints. Accordingly, our quarterly results may vary significantly as a result of the general conditions in the semiconductor industry. OUR CALIFORNIA FACILITIES AND THE FACILITIES OF ONE OF THE TWO INDEPENDENT FOUNDRIES UPON WHICH WE RELY TO MANUFACTURE SUBSTANTIALLY ALL OF OUR CURRENT PRODUCTS ARE LOCATED IN REGIONS THAT ARE SUBJECT TO EARTHQUAKES AND OTHER NATURAL DISASTERS. Our California facilities, including our principal executive offices, are located near major earthquake fault lines. If there is a major earthquake or any other natural disaster in a region where one of our facilities is located, our business could be materially and adversely affected. In addition, TSMC, one of the two outside foundries upon which we rely to manufacture substantially all of our semiconductor devices, is located in Taiwan, a country that is also subject to earthquakes. Any earthquake or other natural disaster in Taiwan could materially disrupt TSMC's production capabilities and could result in our experiencing a significant delay in delivery, or substantial shortage, of wafers and possibly in higher wafer prices. CHANGES IN CURRENT OR FUTURE LAWS OR REGULATIONS OR THE IMPOSITION OF NEW LAWS OR REGULATIONS BY THE FCC, OTHER FEDERAL OR STATE AGENCIES OR FOREIGN GOVERNMENTS COULD IMPEDE THE SALE OF OUR PRODUCTS OR OTHERWISE HARM OUR BUSINESS. The Federal Communications Commission has broad jurisdiction over each of our target markets. Although current FCC regulations and the laws and regulations of other federal or state agencies are not directly applicable to our products, they do apply to much of the equipment into which our products are incorporated. As a result, the effects of regulation on our customers or the industries in which they operate may, in turn, materially and adversely impact our business, financial condition and results of operations. FCC regulatory policies that affect the ability of cable operators or telephone companies to offer certain services or other aspects of their business may impede the sale of our products. For example, in the past we have experienced delays when products incorporating our chips failed to comply with FCC emissions specifications. We and our customers may also be subject to regulation by countries other than the United States. Foreign governments may impose tariffs, duties and other import restrictions on components that we obtain from non-domestic suppliers and may impose export restrictions on products that we sell internationally. These tariffs, duties or restrictions could materially and adversely affect our business, financial condition and results of operations. Changes in current laws or regulations or the imposition of new laws and regulations in the United States or elsewhere could also materially and adversely affect our business. 35 38 CERTAIN OF OUR DIRECTORS, EXECUTIVE OFFICERS AND THEIR AFFILIATES CAN CONTROL THE OUTCOME OF MATTERS THAT REQUIRE THE APPROVAL OF OUR SHAREHOLDERS, AND ACCORDINGLY WE WILL NOT BE ABLE TO ENGAGE IN CERTAIN TRANSACTIONS WITHOUT THEIR APPROVAL. As of September 30, 2000 our directors and executive officers beneficially owned approximately 31.4% of our outstanding common stock and 70.3% of the total voting control held by our shareholders. In particular, as of September 30, 2000 our two founders, Dr. Henry T. Nicholas III and Dr. Henry Samueli, beneficially owned a total of approximately 30.2% of our outstanding common stock and 67.9% of the total voting control held by our shareholders. Accordingly, these shareholders currently have enough voting power to control the outcome of matters that require the approval of our shareholders. These matters include the election of a majority of our Board of Directors, the issuance of additional shares of Class B common stock, and the approval of most significant corporate transactions, including a merger, consolidation or sale of substantially all of our assets. In addition, these insiders currently also control the management of our business. Because of their significant stock ownership, we will not be able to engage in certain transactions without the approval of these shareholders. These transactions include proxy contests, mergers, tender offers, open market purchase programs or other purchases of our Class A common stock that could give our shareholders the opportunity to receive a higher price for their shares than the prevailing market price at the time of such purchases. OUR STOCK PRICE IS HIGHLY VOLATILE. ACCORDINGLY, YOU MAY NOT BE ABLE TO RESELL YOUR SHARES OF COMMON STOCK AT OR ABOVE THE PRICE YOU PAID FOR THEM. The market price of our Class A common stock has fluctuated substantially in the past and is likely to continue to be highly volatile and subject to wide fluctuations. Since our initial public offering in April 1998, our Class A common stock has traded at prices as low as $11.75 and as high as $274.75 per share. These fluctuations have occurred and may continue to occur in response to various factors, many of which we cannot control, including: o quarter-to-quarter variations in our operating results; o announcements of technological innovations or new products by our competitors, customers or us; o general conditions in the semiconductor industry and telecommunications and data communications equipment markets; o changes in earnings estimates or investment recommendations by analysts; o changes in investor perceptions; or o changes in expectations relating to our products, plans and strategic position or those of our competitors or customers. In addition, the market prices of securities of Internet-related and other high technology companies have been especially volatile. This volatility has significantly affected the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. Accordingly, you may not be able to resell your shares of common stock at or above the price you paid. In the past, companies that have experienced volatility in the market price of their securities have been the subject of 36 39 securities class action litigation. If we were the object of a securities class action litigation, it could result in substantial losses and divert management's attention and resources from other matters. OUR PRODUCTS AND INTERNAL INFORMATION SYSTEMS AND THE PRODUCTS AND SYSTEMS OF OUR CUSTOMERS AND THE THIRD PARTY SUPPLIERS WHO FABRICATE, TEST AND ASSEMBLE OUR PRODUCTS MAY BE NEGATIVELY IMPACTED BY YEAR 2000 COMPLIANCE PROBLEMS. Many existing computer systems, software applications and embedded computer chips, software and firmware in control devices use only two digits to identify a year in the date field. These systems, applications and control devices need to accept four digit entries to distinguish 21st Century dates from 20th Century dates. In addition, they may not correctly process "leap year" dates or may fail to recognize February 29, 2000 as a leap year date as a result of an exception to the calculation of leap years that will occur in the Year 2000 and otherwise occurs only once every 400 years. As a result, these systems and applications had to be upgraded to comply with the Year 2000 requirements or risk system failure, miscalculations or other disruptions to normal business activities. To date we have not experienced any known material Year 2000 problems in our products, our internal systems or facilities, or the products, systems and services of third parties. We will continue to monitor our mission critical computer applications and those of our suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. We did not incur material costs to identify and address specific Year 2000 compliance issues. We could however incur additional costs in addressing any residual Year 2000 issues, which could have a material and adverse effect on our business. WE MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE THROUGH THE ISSUANCE OF ADDITIONAL EQUITY OR CONVERTIBLE DEBT SECURITIES OR BY BORROWING MONEY, AND ADDITIONAL FUNDS MAY NOT BE AVAILABLE ON TERMS ACCEPTABLE TO US. We believe that our existing cash, cash equivalents and investments on hand, together with the cash that we expect to generate from our operations, will be sufficient to meet our capital needs for at least the next twelve months. However, it is possible that we may need to raise additional funds to fund our activities beyond the next year or to consummate acquisitions of other businesses, products, or technologies. We could raise these funds by selling more stock to the public or to selected investors, or by borrowing money. In addition, even though we may not need additional funds, we may still elect to sell additional equity securities or obtain credit facilities for other reasons. We may not be able to obtain additional funds on favorable terms, or at all. If adequate funds are not available, we may be required to curtail our operations significantly or to obtain funds through arrangements with strategic partners or others that may require us to relinquish rights to certain technologies or potential markets. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing shareholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to those of the holders of our common stock. 37 40 It is possible that our future capital requirements may vary materially from those now planned. The amount of capital that we will need in the future will depend on many factors, including: o the market acceptance of our products; o the levels of promotion and advertising that will be required to launch our new products and achieve and maintain a competitive position in the marketplace; o volume price discounts; o our business, product, capital expenditure and research and development plans and product and technology roadmaps; o the levels of inventory and accounts receivable that we maintain; o capital improvements to new and existing facilities; o technological advances; o our competitors' response to our products; and o our relationships with suppliers and customers. In addition, we may require additional capital to accommodate planned growth, hiring, infrastructure and facility needs or to consummate acquisitions of other businesses, products or technologies. OUR ARTICLES OF INCORPORATION AND BYLAWS CONTAIN ANTI-TAKEOVER PROVISIONS THAT COULD ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK. Our articles of incorporation and bylaws contain provisions that may prevent or discourage a third party from acquiring us, even if the acquisition would be beneficial to our shareholders. In addition, we have in the past issued and will in the future issue shares of Class B common stock in connection with certain acquisitions, upon exercise of certain stock options, and for other purposes. Class B shares have superior voting rights entitling the holder to ten votes for each share held on matters that we submit to a shareholder vote (as compared with one vote per share in the case of our publicly-held Class A common stock). Our Board of Directors also has the authority to fix the rights and preferences of shares of our preferred stock and to issue such shares without a shareholder vote. It is possible that the provisions in our charter documents, the existence of supervoting rights by holders of our Class B common stock, our officers' ownership of a majority of the Class B common stock and the ability of our Board of Directors to issue preferred stock may prevent parties from acquiring us. In addition, these factors may discourage third parties from bidding for our Class A common stock at a premium over the market price for this stock. Finally, these factors may also materially and adversely affect the market price of our Class A common stock, and the voting and other rights of the holders of our common stock. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Reference is made to the section titled Quantitative and Qualitative Disclosures about Market Risk, in the Company's Current Report on Form 8-K/A filed with the SEC on July 10, 2000. 38 41 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In July 1997 the Company commenced an action against Sarnoff Corporation and Sarnoff Digital Communications, Inc., now known as NxtWave Communications, Inc. (collectively, "Sarnoff"), in the California Superior Court alleging breach of contract, fraud, misappropriation of trade secrets, false advertising, trade libel, intentional interference with prospective economic advantage and unfair competition. The claims center on Sarnoff's violation of a non-disclosure agreement entered into with the Company with respect to limited use of certain of the Company's technology and on inaccurate comparisons that the Company believes Sarnoff has made in its product advertising and in statements to potential customers and others. This action was removed to the United States District Court for the Central District of California, and was stayed pending resolution of an action Sarnoff had brought against the Company in April 1997 in New Jersey Superior Court. Following the decision in the New Jersey action in the Company's favor in early 1999, Sarnoff filed a motion for summary judgment in the California case on the basis that the issues therein had been or should have been previously litigated in the New Jersey action under the New Jersey "entire controversy" doctrine. Following oral argument in August 1999, the District Court granted Sarnoff's motion and dismissed the Company's claims on the grounds that they should have been brought as part of the New Jersey action. The Company believes that the California action involves facts, circumstances and claims unrelated to those at issue in the New Jersey action, and has filed an appeal of the District Court's ruling. Briefing of the appeal in the Ninth Circuit Court of Appeals is now complete and the parties await a date for oral argument in the case. In March 2000 Intel Corporation ("Intel") and its subsidiary Level One Communications, Inc. ("Level One") filed a complaint in California Superior Court asserting claims against the Company for misappropriation of trade secrets, unfair competition, and tortious interference with existing contractual relations by the Company in connection with its recent hiring of three former Intel employees. The complaint sought injunctive relief, an accounting, damages, exemplary damages and attorneys' fees. Intel/Level One filed a first amended complaint on April 28, 2000 seeking additional relief and containing certain additional allegations, but asserting the same causes of action as the original complaint. On May 25, 2000 the Court concluded a preliminary injunction hearing in the matter. The Court denied Intel/Level One's request for injunctive relief restricting the positions in which the three employees could work for the Company, but issued an order granting certain other preliminary relief. The Company has denied any wrongdoing or liability and has instructed its attorneys to vigorously defend the action. On June 30, 2000 the Company filed a cross-complaint against Intel/Level One, and on September 18, 2000, amended that cross-complaint. The Company's amended cross-complaint includes causes of action against Intel/Level One for unfair competition, trade secret misappropriation, and tortious interference with contractual relations. On September 25, 2000 the Company filed a motion for preliminary injunction, which asks the Court to enjoin Intel/Level One from further unfair competition and seeks other relief, including enjoining the marketing, sampling, distribution, shipment or sale of certain products. The motion was heard on November 8, 2000, and a decision from the Court is pending. The litigation is currently in the discovery stage and is scheduled for trial in March 2001. In August 2000 Intel filed a complaint in the United States District Court for the District of Delaware against the Company asserting that (i) the Company infringes five Intel patents relating to video compression, high-speed networking and semiconductor packaging, (ii) the Company induces the infringement of such patents, and (iii) the Company contributorily infringes such patents. The complaint sought a preliminary and permanent injunction against the Company as well as the recovery of monetary damages, including treble damages for willful infringement. Intel has not yet identified which products allegedly infringe its patents. The Company has not yet answered the complaint, but on October 10, 2000 the Company filed a motion to dismiss, or in the alternative, to transfer venue; this motion is currently pending before the court. The Company believes that it has strong defenses to Intel's claims. The parties are currently in the initial stages of discovery in the action. The Court has tentatively scheduled a hearing on patent claims construction to commence in September 2001 and a trial to begin in October 2001. On October 6, 2000 the Company filed a complaint for declaratory judgment in the United States District Court for the Northern District of California against Intel asserting that the patents asserted by Intel in the Delaware action are not infringed. Although the Company believes that it has strong defenses and is defending the Delaware action vigorously, a finding of infringement by the Company as to one or more of the patents in this action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful), the issuance of an injunction requiring that the Company withdraw various products from the market, and indemnification claims by the Company's customers or strategic partners, each of which events could have a material adverse effect on the Company's, business, results of operations and financial condition. In September 1998 Motorola, Inc. ("Motorola") filed a complaint in the United States District Court for the District of Massachusetts against AltoCom, Inc. ("AltoCom")(and co-defendant, PC-Tel, Inc.) asserting that (i) AltoCom's V.34 and V.90 compliant software modem technology infringes several patents owned by Motorola, (ii) AltoCom induces its V.34 and V.90 licensees to infringe such patents, and (iii) AltoCom contributorily infringes such patents. The complaint sought a preliminary and permanent injunction against AltoCom as well as the recovery of monetary damages, including treble damages for willful infringement. In October 1998 Motorola affirmatively dismissed its case in the District of Massachusetts and filed a substantially similar complaint in the United States District Court for the District of Delaware. AltoCom has filed an answer and affirmative defenses to the District of Delaware complaint. AltoCom has also asserted a counterclaim requesting declaratory relief that AltoCom has not infringed the Motorola patents and that such patents are invalid and/or unenforceable as well as a counterclaim requesting declaratory and injunctive relief based on a breach of 39 42 contract theory. AltoCom believes that it has strong defenses to Motorola's claims on invalidity, noninfringement and inequitable conduct grounds. In May 2000 Motorola filed an amended complaint alleging that AltoCom's technology infringes an additional Motorola patent. The parties are currently engaged in discovery in the action. AltoCom became a subsidiary of the Company on August 31, 1999. In September 1999 PC-Tel, Inc., the co-defendant in the case, reached a settlement with Motorola. Although AltoCom believes that it has strong defenses and is defending the action vigorously, a finding of infringement by AltoCom as to at least one of the patents in this action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful), the issuance of an injunction requiring that AltoCom withdraw various products from the market, and indemnification claims by AltoCom's customers or strategic partners, each of which events could have a material adverse effect on AltoCom's, and possibly the Company's, business, results of operations and financial condition. In December 1999 Level One filed a complaint in the United States District Court for the Eastern District of California against Altima Communications, Inc., asserting that Altima's AC108R repeater products infringe a U.S. patent owned by Level One. The complaint sought an injunction against Altima as well as the recovery of monetary damages, including treble damages for willful infringement. Altima filed an answer and affirmative defenses to the complaint in the Eastern District of California. In March 2000 Level One filed a related complaint in the U.S. International Trade Commission ("ITC"), seeking an exclusion order and cease and desist order based on alleged infringement of the same patent. Monetary damages are not available in the ITC. The ITC instituted an investigation in April 2000. Altima filed an answer and affirmative defenses to the complaint in the ITC. In July 2000 Intel and Level One filed a second complaint in the ITC, asserting that certain of Altima's repeater, switch, and transceiver products infringe three additional U.S. patents owned by Level One or Intel. The ITC instituted a second investigation in August 2000, and the Administrative Law Judge assigned to hear the cases issued an order in August 2000 granting a motion to consolidate the two investigations. In September 2000, Altima filed declaratory judgment actions against Intel and Level One, respectively, in the United States District Court for the Northern District of California asserting that Altima has not infringed the three additional Intel and Level One patents and that such patents are invalid or unenforceable. Pursuant to statute, Altima is entitled to a stay of all proceedings in the three District Court actions while the ITC investigation is pending. The Level One action in the Eastern District of California has already been stayed and Altima has formally requested a stay of both of the Northern District of California actions. Altima believes it has strong defenses to the claims of Level One and Intel on noninfringement, invalidity, and inequitable conduct grounds. The parties are currently engaged in discovery in the consolidated ITC action, and a hearing on the merits before the ITC Administrative Law Judge is scheduled to begin in April 2001. Altima became a subsidiary of the Company on September 7, 2000. Although Altima believes that it has strong defenses and is defending the action vigorously, a finding of infringement by Altima as to the patent in the Eastern District of California action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful) and the issuance of an injunction requiring that Altima withdraw various products from the market. A finding against Altima in the consolidated ITC action could result in the exclusion of certain Altima products from entering the United States. Any finding adverse to Altima in these actions could also result in indemnification claims by Altima's customers or strategic partners. Any of the foregoing events could have a material adverse effect on Altima's, and possibly the Company's, business, results of operations and financial condition. The Company and its subsidiaries are also involved in other legal proceedings, claims and litigation arising in the ordinary course of business. The pending lawsuits involve complex questions of fact and law and could require the expenditure of significant costs and diversion of resources to defend. Although management currently believes the outcome of outstanding legal proceedings, claims and litigation will not have a material adverse effect on the Company's business, results of operations or financial condition, the results of litigation are inherently uncertain, and an adverse outcome is at least reasonably possible. The Company is unable to estimate the range of possible loss from outstanding litigation, and no amounts have been provided for such matters in the accompanying consolidated financial statements. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On February 29, 2000 in connection with our acquisition of Digital Furnace Corporation, we issued an aggregate of 664,734 shares of our Class B common stock in exchange for all shares of Digital Furnace's preferred and common stock and reserved 85,266 additional shares of our Class B common stock for issuance upon exercise of outstanding Digital Furnace employee stock options and other rights of Digital Furnace. On March 1, 2000 in connection with our acquisition of BlueSteel Networks, Inc., we issued an aggregate of 678,227 shares of our Class B common stock in exchange for all shares of BlueSteel's preferred and common stock and reserved 132,151 additional shares of our Class B common stock for issuance upon exercise of outstanding BlueSteel employee stock options and other rights of BlueSteel. On March 1, 2000 in connection with our acquisition of Stellar Semiconductor Inc., we issued an aggregate of 672,346 shares of our Class B common stock in exchange for all shares of Stellar's preferred and common stock and reserved 112,877 additional shares of our Class B common stock for issuance upon exercise of outstanding Stellar employee stock options and other rights of Stellar. On May 31, 2000 in connection with our acquisition of Pivotal Technologies Corp., we issued an aggregate of 1,895,823 shares of our Class B common stock in exchange for all shares of Pivotal's preferred and common stock and reserved 43,419 additional shares of our Class B common stock for issuance upon exercise of outstanding employee stock options and other rights of Pivotal. 40 43 On July 19, 2000 in connection with our acquisition of Innovent Systems, Inc., we issued an aggregate of 2,339,149 shares of our Class A common stock in exchange for all shares of Innovent's preferred and common stock and reserved 605,961 additional shares of our Class A common stock for issuance upon exercise of outstanding employee stock options and other rights of Innovent. On August 31, 2000 in connection with our acquisition Puyallup Integrated Circuit Company, Inc., we issued an aggregate of 148,539 shares of our Class A common stock in exchange for all outstanding shares of Puyallup common stock and reserved 139,993 additional shares of our Class A common stock for issuance upon exercise of outstanding employee stock options and other rights of Puyallup. On September 7, 2000 in connection with our acquisition of Altima Communications, Inc., we issued an aggregate of 1,661,784 shares of our Class A common in exchange for all outstanding shares of Altima preferred and common stock and reserved 875,111 additional shares of our Class A common stock for issuance upon exercise of outstanding employee stock options and other rights of Altima. In addition to the purchase consideration, we reserved 2,889,667 shares of our Class A common stock for future issuance to customers upon exercise of outstanding performance-based warrants of Altima that become exercisable upon satisfaction of certain customer purchase requirements. The offer and sale of the securities described above were effected without registration in reliance on the exemption afforded by section 3(a)(10) of the Securities Act of 1933, as amended. The foregoing issuances were approved, after a hearing upon the fairness of the terms and conditions of the transaction, by the California Department of Corporations under authority to grant such approval as expressly authorized by the laws of the State of California. 41 44 ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 27.1 -- Financial Data Schedule (b) Reports on Form 8-K On July 10, 2000 the Company filed a report on Form 8-K/A to provide restated historical consolidated financial statements as of December 31, 1999 and 1998 and for each of the three years in the period ended December 31, 1999 to reflect the pooled operations of Digital Furnace Corporation, BlueSteel Networks, Inc., Stellar Semiconductor, Inc. and Pivotal Technologies Corp. On July 21, 2000 the Company filed a report on Form 8-K relating to its second quarter earnings press release and to disclose the completion of the Company's acquisition of Innovent Systems, Inc. on July 19, 2000. On August 2, 2000 the Company filed a report on Form 8-K to disclose the completion of the Company's acquisition of Innovent Systems, Inc on July 19, 2000. On August 4, 2000 the Company filed a report on Form 8-K relating to its agreement to acquire Altima Communications, Inc. On August 9, 2000 the Company filed a report on Form 8-K relating to its agreement to acquire Silicon Spice Inc. On August 16, 2000 the Company filed a report on Form 8-K relating to its agreement to acquire NewPort Communications, Inc. On September 22, 2000 the Company filed a report on Form 8-K to disclose the completion of the Company's acquisition of Altima Communications, Inc. 42 45 SIGNATURES Pursuant to the requirements 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. BROADCOM CORPORATION, A CALIFORNIA CORPORATION (Registrant) November 14, 2000 /s/ WILLIAM J. RUEHLE ------------------------------------- William J. Ruehle Vice President and Chief Financial Officer (Principal Financial Officer) /s/ SCOTT J. POTERACKI ------------------------------------- Scott J. Poteracki Corporate Controller and Senior Director of Finance (Principal Accounting Officer) 43 46 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION ------- ----------- 27.1 Financial Data Schedule