10-K 1 iphi20171231_10k.htm FORM 10-K iphi20171231_10k.htm
 

Table of Contents



 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 


 

Form 10-K

 

(Mark One)

 

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

For the fiscal year ended December 31, 2017

Or

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

 

 

Commission file number 001-34942

 

 

 

 

Inphi Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

 

Delaware

 

77-0557980

 
 

(State or Other Jurisdiction
of Incorporation or Organization)

 

(I.R.S. Employer
Identification No.)

 

 

2953 Bunker Hill Lane, Suite 300, Santa Clara, California 95054

(Address of Principal Executive Offices) (Zip Code)

 

Registrant’s telephone number, including area code: (408) 217-7300

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of Class

 

Name of Exchange on Which Registered

 
 

 

     
 

Common Stock, $0.001 par value

 

New York Stock Exchange

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  ☑     No  ☐

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ☐ No  ☑

 

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  ☑      No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  ☑      No  ☐

 

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ☑

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ☑

Accelerated filer ☐

Non-accelerated filer ☐

Smaller reporting company ☐

Emerging growth company ☐

  (Do not check if a smaller reporting company)  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

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

 

As of June 30, 2017, the aggregate market value of the Registrant’s common stock held by non-affiliates of the Registrant was approximately $1.41 billion, based on the closing price of $34.30 per share of common stock as reported on the New York Stock Exchange for that date.

 

The total number of shares outstanding of the Registrant’s common stock, $0.001 par value per share, as of February 23, 2018 was 43,142,260.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III incorporates by reference certain information from the registrant’s definitive proxy statement for the 2018 Annual Meeting of Stockholders to be filed no later than 120 days after the conclusion of the registrant’s fiscal year ended December 31, 2017.

 



 

 

INPHI CORPORATION

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2017

 

TABLE OF CONTENTS

 

 

 

Page

 

   

PART I

 

Item 1.

Business

4

Item 1A.

Risk Factors

11

Item 1B.

Unresolved Staff Comments

28

Item 2.

Properties

28

Item 3.

Legal Proceedings

28

Item 4.

Mine Safety Disclosures

29

 

 

PART II

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

30

Item 6.

Selected Consolidated Financial Data

32

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

34

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

49

Item 8.

Financial Statements and Supplementary Data

50

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

87

Item 9A.

Controls and Procedures

87

Item 9B.

Other Information

87

 

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance

87

Item 11.

Executive Compensation

88

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

88

Item 13.

Certain Relationships and Related Transactions, and Director Independence

88

Item 14.

Principal Accountant Fees and Services

88

 

 

PART IV

 

Item 15.

Exhibits and Financial Statement Schedules

88

Item 16.

Form 10-K Summary

92

 

 

PART I

 

Item 1.

Business

 

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, the terms “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” “plan,” “anticipate,” “seek,” “future,” “strategy,” “likely,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements include statements regarding our anticipated trends and challenges in our business and the markets in which we operate, including the market for 25G to 600G high-speed analog semiconductor solutions, demand for our current products, our plans for future products and anticipated features and benefits thereof, expansion of our product offerings and enhancements of existing products, anticipated benefits of our acquisition of ClariPhy and divestiture of our memory product business, critical accounting policies and estimates, our expectations regarding our expenses and revenue, sources of revenue, our tax benefits, the benefits of our products and services, our technological capabilities and expertise, timing of the development of our products, our liquidity position and sufficiency thereof, including our anticipated cash needs and uses of cash, our operating and capital expenditures and requirements and our needs for additional financing and potential consequences thereof, repatriation of cash balances from our foreign subsidiaries, our contractual obligations, our anticipated growth and growth strategies, our ability to retain and attract customers, particularly in light of our dependence on a limited number of customers for a substantial portion of our revenue, competition, interest rate sensitivity, adequacy of our disclosure controls, our legal proceedings and warranty claims. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these or any other forward-looking statements. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as factors affecting our results of operations, our ability to manage our growth, our ability to sustain or increase profitability, demand for our solutions, the effect of declines in average selling prices for our products, our ability to compete, our ability to rapidly develop new technology and introduce new products, our ability to safeguard our intellectual property, our ability to qualify for tax holidays and incentives, trends in the semiconductor industry and fluctuations in general economic conditions, and the risks set forth throughout this Report, including the risks set forth under Part I, “ Item 1A, Risk Factors”. Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management's opinions only as of the date hereof. These forward-looking statements speak only as of the date of this Report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any changes in events, conditions or circumstances on which any such statement is based.

 

All references to “Inphi,” “we,” “us” or “our” mean Inphi Corporation.

 

Inphi®, iKON™, InphiNityCore™, ColorZ®, ColorZ-Lite™, Polaris™, Vega™, and the Inphi logo are among the trademarks, registered trademarks, or service marks owned by Inphi.

 

Overview

 

Our Company

 

We are a fabless provider of high-speed analog and mixed signal semiconductor solutions for the communications and datacenter markets. Our analog and mixed signal semiconductor solutions provide high signal integrity at leading-edge data speeds while reducing system power consumption. Our semiconductor solutions are designed to address bandwidth bottlenecks in networks, maximize throughput and minimize latency in computing environments and enable the rollout of next generation communications and datacenter infrastructures. Our solutions provide a vital high-speed interface between analog signals and digital information in high-performance systems such as telecommunications transport systems, enterprise networking equipment and datacenters. We provide 25G to 600G high-speed analog semiconductor solutions for the communications market.

 

On August 4, 2016, we completed the sale of our memory product business to Rambus Inc. for $90 million in cash. The divestiture of the memory product business was part of a strategic plan to focus on and increase investments in the communication business. As a result of the sale, our financial statements and accompanying notes for current and prior periods have been retrospectively reclassified to present the results of operations of memory product business as discontinued operations. In addition, discussions in this Annual Report on Form 10-K focused only on continuing operations.

 

On December 12, 2016, we completed the acquisition of ClariPhy Communications, Inc. (ClariPhy) for $303.7 million in cash. We acquired ClariPhy to provide a more complete coherent platform to our customers in long haul, metro and datacenter interconnect applications.

 

 

We leverage our proprietary high-speed analog and mixed signal processing expertise and our deep understanding of system architectures to address data bottlenecks in current and emerging communications, enterprise network, computing and storage architectures. We develop these solutions as a result of our competitive strengths, including our system-level simulation capabilities, analog design expertise, strong relationships with industry leaders, extensive broad process technology experience and high-speed package modeling and design expertise. We use our core technology and strength in high-speed analog design to enable our customers to deploy next generation communications systems that operate with high performance at high-speed. We believe we are at the forefront of developing semiconductor solutions that deliver up to multi-Terabit speeds throughout the network infrastructure, including core, metro and the datacenter.

 

We have ongoing, informal collaborative discussions with industry and technology leaders such as Ciena Corporation (Ciena), Cisco Systems, Inc. (Cisco), Huawei Technologies Co., Ltd. (Huawei), Juniper Networks, Inc. (Juniper), Microsoft Corporation (Microsoft) and Nokia Corporation (Nokia), to design architectures and products that solve bandwidth bottlenecks in existing and next generation communications systems. Although we generally do not have any formal collaboration agreements with these entities, we often engage in informal discussions with these entities with respect to anticipated technological challenges, next generation customer requirements and industry conventions and standards. We help define industry conventions and standards within the markets we target by collaborating with technology leaders, original equipment manufacturers, or OEMs, systems manufacturers and standards bodies. Our products are designed into systems sold by OEMs, including Ciena, Cisco, Huawei, Juniper, Microsoft and Nokia. We believe we are one of a limited number of suppliers to these OEMs for the type of products we sell, and in some cases we may be the sole supplier for certain applications. We sell both directly to these OEMs and to other intermediary systems or module manufacturers that, in turn, sell to these OEMs.

 

Our Business

 

Our semiconductor solutions leverage our deep understanding of high-speed analog and mixed signal processing and our system architecture knowledge to address data bottlenecks in current and emerging network and datacenter architectures. We design and develop our products for the communications and computing markets, which typically have two to three year design cycles, and product life cycles of five or more years. We believe our leadership position in developing high-speed analog semiconductors is a result of the following core strengths:

 

 

System-Level Simulation Capabilities. We design our high-speed analog semiconductor solutions to be critical components in complex systems. In order to understand and solve system problems, we work closely with systems vendors to develop proprietary component, channel and system simulation models. We use these proprietary simulation and validation tools to accurately predict system performance prior to fabricating the semiconductor or alternatively, to identify and optimize critical semiconductor parameters to satisfy customer system requirements. We use these simulation and validation capabilities to reduce our customers’ time to market and engineering investments, thus enabling us to establish differentiated design relationships with our customers.

 

 

Analog Design Expertise. We believe that we are a leader in developing broadband analog semiconductors operating at high frequencies of up to 100 GHz. High-speed analog circuit design is extremely challenging because, as frequencies increase, semiconductors are increasingly sensitive to temperature, power supply noise, process variation and interaction with neighboring circuit elements. Development of components that work robustly at high frequencies requires an understanding of analog circuit design, including electromagnetic theory and practical experience in implementation and testing. Our analog design expertise has enabled us to design and commercially ship several first in the world technologies including the first 100G linear transimpedance amplifier, or TIA, and the first 400G linear modulator driver that is now being widely deployed in volume globally in long haul and metro networking infrastructures. We launched the world’s first 50/100/200/400G PAM4 interconnect ICs for cloud interconnects. The chipset solution included multiple variants of the PAM4 PHY IC based on a highly adaptable and scalable InphiNityCore™ digital signal processing (DSP) engine and the OmniConnect™ transmitter for copper and optics media along with a companion linear TIA for Nx50G PAM4 interfaces.

 

 

Strong Relationships with Industry Leaders. We develop many of our high-speed analog semiconductor solutions for applications and systems that are driven by industry leaders in the communications, datacenter and computing markets. Through our established relationships with industry leaders, we have repeatedly demonstrated the ability to address their technological challenges. As a result, we are designed into several of their current systems and believe we are well-positioned to develop high-speed analog semiconductor solutions for their emerging architectures. We have ongoing, informal collaborative discussions with communication, networking companies, and datacenter companies such as Cisco, Ciena, Huawei, Juniper, Nokia, and Microsoft, among others to address their next generation 100G and beyond 100G efforts. Specifically, we engage in informal discussions with these entities with respect to anticipated technological challenges, next generation customer requirements and industry conventions and standards. As a result of our development efforts with industry leaders, we help define industry conventions and standards within the markets we target by collaborating with technology leaders, OEMs and systems manufacturers, as well as standards bodies such as the Institute of Electrical and Electronic Engineers, or IEEE, and the Optical Internetworking Forum, or OIF, to establish industry standards.

 

 

 

Broad Process Technology. We employ process technology experts, device technologists and circuit designers who have extensive experience in many process technologies including CMOS, SiGe and III-V technologies such as gallium arsenide, or GaAs, or indium phosphide, or InP. We have developed specific internal models and design kits for each process to support a uniform design methodology across all of our semiconductor solutions. For example, our products using 16 nanometer CMOS technology require development of accurate models for sub-circuits such as integrated phase lock loop, or PLLs, varactors and inductors. In addition, for III-V materials-based processes, in-house model development is a necessity and we believe also provides a substantial competitive advantage because these processes have complex material and device interactions. Combined with our fabless manufacturing strategy, our design expertise, proprietary model libraries and uniform design methodology allow us to use the best possible materials and substrates to design and develop our semiconductor solutions. We believe that our ability to design high-speed analog semiconductors in a wide range of materials and process technologies allows us to provide superior performance, power, cost and reliability for a specific set of market requirements.

 

 

High-Speed Package Modeling and Design. We have developed deep expertise in high-speed package modeling and design, since introducing the first high-speed 50 GHz MUX and DEMUX product in 2001. At high frequencies, the interaction between an analog device, its package and the external environment can significantly affect product performance. Accurately modeling and developing advanced packaging allows semiconductor solutions to address this challenge. Due to the advanced nature of this work, there is a limited supply of engineers with experience in high-speed package modeling and design, and therefore, this required expertise can be difficult to acquire for companies that have not invested in developing such a skill set. We have developed an infrastructure to simulate electrical, mechanical and thermal properties of devices and packages that we integrate within our semiconductor design process and implement at our third-party packaging providers. Modeling is an inherently iterative process, and since our model libraries are used extensively by our circuit designers, the accuracy and value of these models increases over time. Our current packaging and modeling techniques enable us to deliver semiconductors that are energy efficient, offer high-speed processing and enable advanced signal integrity, all in a small footprint.

 

We believe that our system-level simulation capabilities, our analog design and broad process technology design capabilities as well as our strengths in packaging enable us to differentiate ourselves by delivering advanced high-speed analog signal processing solutions. For example, we believe we are the first vendor who has successfully commercialized DSP base 100G Ethernet PHYs running PAM4 standard CMOS process.

 

We believe the key benefits that our solutions provide to our customers are as follows:

 

 

High Performance. Our high-speed analog semiconductor solutions are designed to meet the specific technical requirements of our customers in their respective end markets. In many cases, our close design relationships and deep engineering expertise put us in a position where we are one of a limited group of semiconductor vendors that can provide the necessary solution. For instance, in the broadband communications market, we believe our products achieve the highest signal integrity and attain superior signal transmission distance at required error-free or low error rates.

 

 

Low Power and Small Footprint. In each of the end markets that we serve, the power budget of the overall system is a key consideration for systems designers. Power consumption greatly impacts system operation cost, footprint and cooling requirements, and is increasingly becoming a point of focus for our customers. We believe that our high-speed analog signal processing solutions enable our customers to implement system architectures that reduce overall system power consumption. We also believe that, at high frequencies, our high-speed analog semiconductor devices typically consume less power than competitors’ standard designs, which often incorporate power-consuming digital signal processing to perform data transfer functions, thereby further reducing overall system power consumption. In addition, in many of our applications, we are able to design and deliver semiconductors that have a smaller footprint and therefore reduce the overall system size.

 

 

Faster Time to Market. Our customers compete in markets that require high-speed, reliable semiconductors that can be integrated into their systems as soon as new market opportunities develop. To meet our customers’ time-to-market requirements, we work closely with them early in their design cycles and are actively involved in their development processes. Over the past ten years, we have developed methodologies and simulation environments that accurately predict the behavior of complex integrated circuits within various communications systems. In addition, we have developed an extensive internal library of proven building block circuits such as amplifiers, phase frequency detectors and transmitters that are reused to shorten design cycles and reduce risk.

 

 

Products

 

Our leading edge, high-speed, mixed signal semiconductor solutions equate to the planes, trains and trucks used by physical delivery services to quickly and reliably speed information from place to place.

 

Our long haul and metro solutions are our planes, working across distances of 100s to 1000s kilometers. Products include our coherent transimpedance amplifiers, drivers and DSPs which set the gold standard for leading edge performance, quality, and reliability. Our data center edge interconnect solutions are our trains, delivering a large amount of packages, across 80km distances. Our ColorZ® is the industry's first 100G DWDM solution in QSFP28 form factor, utilizing advanced silicon photonics and PAM4 modulation, to deliver up to 4Tb/s of bandwidth over a single fiber. Our inside data center interconnects are our trucks, working across hundreds of meters up to kilometers. Our PAM interconnects along with accompanying TIAs and drivers deliver low power, cost effective solutions for cloud and enterprise customers. 

 

 

 

As of December 31, 2017, we have a wide range of products in our portfolio, including products that have commercially shipped, products for which we have shipped engineering samples and products under development, that perform a wide range of functions such as amplifying, encoding, multiplexing, demultiplexing, and retiming signals at speeds up to 400 Gbps. These products are key enablers for servers, routers, switches, storage and other equipment that process, store and transport data traffic. We introduced 28 and 10 new products in 2017 and 2016, respectively. We design and develop our products for the communications and computing markets, which typically have two to three year design cycles, and product life cycles as long as five years or more.

 

We introduced ColorZ® in 2016 and began to ship in commercial volume in 2017. Sales of ColorZ® comprised 17% of our total revenue in 2017. In 2012, we introduced and began to ship in commercial volume a dual, differential input linear transimpedance/variable-gain amplifier that we identify as product number IN3250TA-SO2D. Sales of IN3250TA-SO2D product comprised 10%, 25% and 18% of our total revenue in 2017, 2016 and 2015, respectively. There were no other products that generated more than 10% of our total revenue in 2017, 2016 or 2015.

 

 

 

Customers

 

We sell our products directly to OEMs and indirectly to OEMs through module manufacturers, original design manufacturers or ODMs and sub-systems providers. We work closely with technology leaders to design architectures and products that help solve bandwidth bottlenecks in and between systems. These technology leaders often design our products into reference designs, which they provide to their customers and suppliers. In the networking market, we work closely with OEMs to deliver high performance communication links. These OEMs design our products into their systems and then require their ODM and electronics manufacturing services suppliers to purchase and use that specific product from us. We also work directly with optical module manufacturers to design our products into their modules, which they sell to OEMs.

 

We work closely with our customers throughout design cycles that often last two to three years and we are able to develop long-term relationships with them as our technology becomes embedded in their products. As a result, we believe we are well-positioned to not only be designed into their current systems, but also to continually develop next generation high-speed analog semiconductor solutions for their future products. During the year ended December 31, 2017, we sold our products to more than 100 customers.

 

Sales to customers in Asia accounted for 62%, 70%, and 62% of our total revenue in 2017, 2016 and 2015, respectively. Because many of our customers or their OEM manufacturers are located in Asia, we anticipate that a majority of our future revenue will continue to come from sales to that region. Although a large percentage of our sales are made to customers in Asia, we believe that a significant number of the systems designed by these customers and incorporating our semiconductor products are then sold to end-users outside Asia.

 

 

We currently rely, and expect to continue to rely, on a limited number of customers for a significant portion of our revenue. In the year ended December 31, 2017, we believe that sales to Microsoft, Huawei, and Cisco, directly and indirectly, through subcontractors, accounted for approximately 17%, 14%, and 11% of our total revenue, respectively, and that our 10 largest customers collectively accounted for 70% of our total revenue. In the year ended December 31, 2016, we believe that sales to Huawei and Cisco, directly and indirectly, through subcontractors, accounted for approximately 16% and 12% of our total revenue, respectively and that our 10 largest customers collectively accounted for 73% of our total revenue. In the year ended December 31, 2015, we believe that sales to Huawei and Cisco, directly and indirectly, through subcontractors, accounted for approximately 11% and 17% of our total revenue, respectively and that our 10 largest customers collectively accounted for 73% of our total revenue. No other single customer directly or indirectly accounted for more than 10% of our total revenue in 2017, 2016 or 2015.

 

Sales and Marketing

 

Our design cycle from initial engagement to volume shipment is typically two to three years, with product life cycles in the markets we serve ranging from five to 10 years or more. For many of our products, early engagement with our customers’ technical staff is necessary for success. To ensure an adequate level of early engagement, our application and development engineers work closely with our customers to identify and propose solutions to their systems challenges.

 

 

In addition to our direct customers, we work closely with technology leaders such as Ciena, Cisco, Huawei, Infinera Corporation, Juniper, Nokia and Microsoft for the datacenter, networking and communications market to anticipate and solve next generation challenges facing our customers. As part of the sales and product development process, we often design our products in close collaboration with these industry leaders and help define their architecture. We also participate actively in setting industry standards with organizations such as IEEE and OIF to have a voice in the definition of future market trends.

 

We sell our products worldwide through multiple channels, including our direct sales force and a network of sales representatives and distributors. For the year ended December 31, 2017, 82% of our revenue was generated by our direct sales team and third-party sales representatives. We operate marketing representative offices in China, Japan, Taiwan, Germany, and the United States and employ marketing personnel that meet with our customers locally and interact with our channel partners locally. We have twenty eight direct sales and marketing professionals including four in Japan, thirteen in Asia, eight in North America and three in Europe, the Middle East and Africa, or EMEA. We utilize nine distributors in Asia, one sales representative and two distributors in Europe, two distributors in Israel, two distributors in Japan and six sales representatives and three distributors in North America. Our channel network includes more than one hundred sales and support professionals to support our products and customers, including eight in Japan, thirty-eight in Asia (other than Japan), forty-five in North America and fifteen in EMEA. All of these sales a professionals are sales agents and are employed by our distributors and sales representatives. We believe these distributors and sales representatives have the requisite technical experience in our target markets and are able to leverage existing relationships and understanding of our customers’ products to effectively sell our products. Given the breadth of our target markets, customers and products, we provide our direct and indirect sales teams with regular training and share product information with our customers and sales team using web-based tools.

 

Manufacturing

 

We operate a fabless business model and use third-party foundries and assembly and test manufacturing contractors to manufacture, assemble and test our semiconductor products. We also inspect and test parts in our Irvine and Westlake Village, California facilities. This outsourced manufacturing approach allows us to focus our resources on the design, sale and marketing of our products. In addition, we believe outsourcing many of our manufacturing and assembly activities provides us the flexibility needed to respond to new market opportunities, simplifies our operations and significantly reduces our capital requirements.

 

We subject our third-party manufacturing contractors to qualification requirements in order to meet the high quality and reliability standards required of our products. We carefully qualify critical partners and processes before applying the technology to our products. Our engineers work closely with our foundries and other contractors to increase yield, lower manufacturing costs and improve product quality.

 

 

Wafer Fabrication. We currently utilize a wide range of semiconductor processes to develop and manufacture our products. Each of our foundries tends to specialize in a particular semiconductor wafer process technology. We choose the semiconductor process and foundry that we believe provides the best combination of performance attributes for any particular product. For most of our products, we utilize a single foundry for semiconductor wafer production. Our international headquarters in Singapore purchases all wafer material and owns the material until the manufacturing process is complete and the product is shipped to a customer either inside or outside North America or to physical inventory for the respective region. Our principal foundries are Taiwan Semiconductor Manufacturing Company Ltd., or TSMC, in Taiwan, Sumitomo Electric Device Innovations Inc., or SEDI, in Japan, WIN Semiconductors Corp. in Taiwan, TowerJazz Semiconductor Ltd. in North America and GlobalFoundries in North America.

 

 

 

Package and Assembly. Upon the completion of processing at the foundry, the finished wafers are shipped to our third-party assemblers for packaging and assembly. Currently, our principal packaging and assembly contractors are STATS ChipPAC Ltd. in Korea, Kyocera Corporation in North America and Japan, Tong Hsing Electronics Industries Ltd. in Taiwan, Amkor Technology in Korea, LuxNet Corporation in Taiwan and ASE Technology in Taiwan and Malaysia.

 

 

Test. At the last stage of integrated circuit production, our third-party test service providers test the packaged and assembled integrated circuits. Currently, Advanced Semiconductor Engineering, or ASE, in California, STATS ChipPAC in Korea, ISE Labs in North America, Giga Solution Tech in Taiwan, Amkor Technology in Korea, ASEM Technology in Malaysia and Presto Engineering in North America are our test partners. We also perform testing in our Irvine and Westlake Village, California facilities.

 

 

We are committed to maintaining the highest level of quality in our products. Our objective is that our products meet all of our customer requirements, are delivered on-time and function reliably throughout their useful lives. As part of our total quality assurance program, our quality management system has been certified to ISO 9001:2008 standards. Our manufacturing partners are also ISO 9001 certified.

 

Research and Development

 

We focus our research and development efforts on developing products that address bandwidth bottlenecks in networks and minimize latency in computing environments. We believe that our continued success depends on our ability to both introduce improved versions of our existing products and to develop new products for the markets that we serve. We devote a portion of our resources to expanding our core technology including efforts in system-level simulation, high-speed analog design, supporting a broad range of process technologies and high-speed package modeling and design.

 

We develop models that are used as an input to a combination of proprietary and commercially available simulation tools. We use these tools to predict overall system performance based on the performance of our product. After our product is manufactured, we perform system measurements and refine our model set to improve the model’s accuracy and predictive ability. As a result, our models and simulation tools have improved over time and we have been able to accurately predict overall system performance prior to fabricating a part.

 

We have assembled a core team of experienced engineers and systems designers in eight design centers located in the United States, Canada, Germany, Singapore, United Kingdom and Argentina. Our technical team typically has, on average, more than 20 years of industry experience with more than 45% having advanced degrees (master’s degree and above) and more than 15% having Ph.Ds. These engineers and designers are involved in advancing our core technologies, as well as applying these core technologies to our product development activities across a number of areas including telecommunications transport systems, enterprise networking equipment, datacenters and enterprise servers, storage platforms, test and measurement and military systems. In 2017, 2016 and 2015, our research and development expenses were $200.5 million, $108.0 million, and $87.8 million, respectively.

 

Competition

 

The global semiconductor market in general, and the communications market in particular, are highly competitive. We expect competition to increase and intensify as more and larger semiconductor companies enter our markets. Increased competition could result in price pressure, reduced profitability and loss of market share, any of which could materially and adversely affect our business, revenue and operating results.

 

Currently, our competitors range from large, international companies offering a wide range of semiconductor products to smaller companies specializing in narrow markets. Our primary competitors include Acacia Communications, Inc., Broadcom Ltd., Ciena Corporation, Integrated Device Technology, Inc., M/A-COM Technology Solutions Inc., MaxLinear, Inc., Microsemi Corporation, NTT Electronics Corporation, Qorvo, Inc. and Semtech Corp. as well as other smaller analog signal processing companies. We expect competition in our target markets to increase in the future as existing competitors improve or expand their product offerings.

 

Our ability to compete successfully depends on elements both within and outside of our control, including industry and general economic trends. During past periods of downturns in our industry, competition in the markets in which we operate intensified as our customers reduced their purchase orders. Many of our competitors are significantly larger, have greater financial, technical, marketing, distribution, customer support and other resources, are more established than we are, and have significantly better brand recognition and broader product offerings with which to withstand similar adverse economic or market conditions in the future. These developments may materially and adversely affect our current and future target markets and our ability to compete successfully in those markets.

 

 

We compete or plan to compete in different target markets to various degrees on the basis of a number of principal competitive factors, including:

 

 

product performance;

 

 

 

power budget;

 

 

features and functionality;

 

 

customer relationships;

 

 

size;

 

 

ease of system design;

 

 

product roadmap;

 

 

reputation and reliability;

 

 

customer support; and

 

 

price.

 

We believe we compete favorably with respect to each of these factors. We maintain our competitive position through our ability to successfully design, develop and market complex high-speed analog solutions for the customers that we serve.

 

Intellectual Property

 

We rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, and contractual protections, to protect our core technology and intellectual property. As of December 31, 2017, we had 669 issued and allowed patents and other patent applications pending in the United States. The 630 issued and allowed patents in the United States expire in the years beginning in 2018 through 2037. Many of our issued patents and pending patent applications relate to high-speed circuit and package designs.

 

We may not receive competitive advantages from any rights granted under our patents, and our patent applications may not result in the issuance of any patents. In addition, any future patent may be opposed, contested, circumvented, designed around by a third party or found to be unenforceable or invalidated. Others may develop technologies that are similar or superior to our proprietary technologies, duplicate our proprietary technologies or design around patents owned or licensed by us.

 

In addition to our own intellectual property, we also use third-party licensors for certain technologies embedded in our semiconductor solutions. These are typically non-exclusive contracts provided under paid-up licenses. These licenses are generally perpetual or automatically renewed for so long as we continue to pay any maintenance fees that may be due. To date, maintenance fees have not constituted a significant portion of our annual capital expenditures. We have entered into a number of licensing arrangements pursuant to which we license third-party technologies. We do not believe our business is dependent to any significant degree on any individual third-party license.

 

We generally control access to and use of our confidential information through the use of internal and external controls, including contractual protections with employees, contractors and customers. We rely in part on United States and international copyright laws to protect our mask work. All employees and consultants are required to execute confidentiality agreements in connection with their employment and consulting relationships with us. We also require them to agree to disclose and assign to us all inventions conceived or made in connection with the employment or consulting relationship.

 

Despite our efforts to protect our intellectual property, unauthorized parties may still copy or otherwise obtain and use our software, technology or other information that we regard as proprietary intellectual property. In addition, we intend to expand our international operations, and effective patent, copyright, trademark and trade secret protection may not be available or may be limited in foreign countries.

 

The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which has resulted in protracted and expensive litigation for many companies. We have in the past received and, particularly as a public company, we expect that in the future we may receive, communications from various industry participants alleging our infringement of their patents, trade secrets or other intellectual property rights. Any lawsuits could subject us to significant liability for damages, invalidate our proprietary rights and harm our business and our ability to compete. Any litigation, regardless of success or merit, could cause us to incur substantial expenses, reduce our sales and divert the efforts of our technical and management personnel. In the event we receive an adverse result in any litigation, we could be required to pay substantial damages, seek licenses from third parties, which may not be available on reasonable terms or at all, cease sale of products, expend significant resources to develop alternative technology or discontinue the use of processes requiring the relevant technology.

 

 

Cybersecurity

 

We have designed and implemented and continue to maintain a security program consisting of policies, procedures, and technology meant to maintain the privacy, security and integrity of our information, systems, and networks. Among other things, the program includes controls designed to limit and monitor access to authorized systems, networks, and data, prevent inappropriate access or modification, and monitor for threats or vulnerability.

 

Employees

 

At December 31, 2017, we employed 616 full-time equivalent employees, including 402 in research, product development and engineering, 64 in sales and marketing, 56 in general and administrative management and 94 in manufacturing engineering and operations. We consider relations with our employees to be good and have never experienced a work stoppage. None of our employees are either represented by a labor union or subject to a collective bargaining agreement, except for certain employees in Argentina.

 

Other

 

We were incorporated in Delaware in November 2000 as TCom Communications, Inc. and changed our name to Inphi Corporation in February 2001. Our principal executive offices are located at 2953 Bunker Hill Lane, Suite 300, Santa Clara, California 95054. Our telephone number at that location is (408) 217-7300. Our website address is www.inphi.com. Information on our website is not part of this report and should not be relied upon in determining whether to make an investment decision. The inclusion of our website address in this report does not include or incorporate by reference into this report any information on our website.

 

We electronically file our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, with the SEC. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.   You may obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports with the SEC on our website.

 

 

Item 1A.

Risk Factors

 

Risks Related to Our Business

 

Our revenue and operating results can fluctuate from period to period, which could cause our share price to fluctuate.

 

Our revenue and operating results have fluctuated in the past and may fluctuate from period to period in the future due to a variety of factors, many of which are beyond our control. Factors relating to our business that may contribute to these fluctuations include the following factors, as well as other factors described elsewhere herein:

 

 

the receipt, reduction or cancellation of orders by customers;

 

 

fluctuations in the levels of component inventories held by our customers;

 

 

the gain or loss of significant customers;

 

 

changes in orders or purchasing patterns from one or more of our major customers;

 

 

market acceptance of our products and our customers’ products;

 

 

our ability to develop, introduce and market new products and technologies on a timely basis;

 

 

the timing and extent of product development costs;

 

 

new product announcements and introductions by us or our competitors;

 

 

incurrence of research and development and related new product expenditures;

 

 

cyclical fluctuations in our markets;

 

 

fluctuations in our manufacturing yields;

 

 

significant warranty claims, including those not covered by our suppliers;

 

 

changes in our product mix or customer mix;

 

 

intellectual property disputes; and

 

 

 

loss of key personnel or the inability to attract qualified engineers.

 

As a result of these and other factors, the results of any prior quarterly or annual periods should not be relied upon as indications of our future revenue or operating performance. Fluctuations in our revenue and operating results could cause our share price to decline.

 

We incurred net losses in the past. We may incur net losses in the future.

 

As of December 31, 2017, we had an accumulated deficit of $74.1 million. We have incurred net losses in the past and may incur net losses in the future. We generated a net income (loss) from continuing operations of ($74.9) million, $26.5 million, and ($16.0) million for years ended December 31, 2017, 2016, and 2015, respectively.

 

We depend on a limited number of customers for a substantial portion of our revenue, and the loss of, or a significant reduction in orders from, one or more of our major customers could negatively impact our revenue and operating results. In addition, if we offer more favorable prices to attract or retain customers, our average selling prices and gross margins would decline.

 

In the year ended December 31, 2017, we believe that sales to Microsoft, Huawei, and Cisco, directly and indirectly, through subcontractors, accounted for approximately 17%, 14%, and 11% of our total revenue, respectively, and that our 10 largest customers collectively accounted for 70% of our total revenue. In the year ended December 31, 2016, we believe that sales to Huawei and Cisco, directly and indirectly, through subcontractors, accounted for approximately 16% and 12% of our total revenue, respectively and that our 10 largest customers collectively accounted for 73% of our total revenue. In the year ended December 31, 2015, we believe that sales to Huawei and Cisco, directly and indirectly, through subcontractors, accounted for approximately 11% and 17% of our total revenue, respectively and that our 10 largest customers collectively accounted for 73% of our total revenue. We believe our operating results for the foreseeable future will continue to depend on sales to a relatively small number of customers. In the future, these customers may decide not to purchase our products at all, may purchase fewer products than they did in the past or may alter their purchasing patterns. Further, the amount of revenue attributable to any single customer or our customer concentration generally, may fluctuate in any given period.

 

In addition, our relationships with some customers may deter other potential customers who compete with these customers from buying our products. To attract new customers or retain existing customers, we may offer these customers favorable prices on our products. In that event, our average selling prices and gross margins would decline. The loss of a key customer, a reduction in sales to any key customer or our inability to attract new significant customers could negatively impact our revenue and materially and adversely affect our results of operations.

 

We do not have long-term purchase commitments from our customers and if our customers cancel or change their purchase commitments, our revenue and operating results could suffer.

 

Substantially all of our sales to date have been made on a purchase order basis. We do not have any long-term commitments with any of our customers. As a result, our customers may cancel, change or delay product purchase commitments with little or no notice to us and without penalty. This in turn could cause our revenue to decline and materially and adversely affect our results of operations.

 

We may face claims of intellectual property infringement, which could be time-consuming, costly to defend or settle and result in the loss of significant rights and which could harm our relationships with our customers and distributors.

 

The semiconductor industry is characterized by companies that hold patents and other intellectual property rights and that vigorously pursue, protect and enforce intellectual property rights. From time to time, third parties may assert against us and our customers and distributors their patent and other intellectual property rights to technologies that are important to our business.

 

Claims that our products, processes or technology infringe third-party intellectual property rights, regardless of their merit or resolution, could be costly to defend or settle and could divert the efforts and attention of our management and technical personnel. For example, Netlist, Inc. filed suit against us in the United States District Court, Central District of California, in September 2009, alleging that our iMB™ and certain other memory module components infringe three of Netlist’s patents. This litigation is ongoing.

 

Infringement claims also could harm our relationships with our customers or distributors and might deter future customers from doing business with us. We do not know whether we will prevail in these proceedings given the complex technical issues and inherent uncertainties in intellectual property litigation. If any pending or future proceedings result in an adverse outcome, we could be required to:

 

 

cease the manufacture, use or sale of the infringing products, processes or technology;

 

 

pay substantial damages for infringement;

 

 

expend significant resources to develop non-infringing products, processes or technology, which may not be successful;

 

 

license technology from the third-party claiming infringement, which license may not be available on commercially reasonable terms, or at all;

 

 

 

cross-license our technology to a competitor to resolve an infringement claim, which could weaken our ability to compete with that competitor; or

 

 

pay substantial damages to our customers or end-users to discontinue their use of or to replace infringing technology sold to them with non-infringing technology, if available.

 

Any of the foregoing results could have a material adverse effect on our business, financial condition and results of operations.

 

Winning business is subject to lengthy competitive selection processes that require us to incur significant expenditures prior to generating any revenue or without any guarantee of any revenue related to this business. Even if we begin a product design, a customer may decide to cancel or change its product plans, which could cause us to generate no revenue from a product. If we fail to generate revenue after incurring substantial expenses to develop our products, our business and operating results would suffer.

 

We are focused on winning more competitive bid processes, known as “design wins,” that enable us to sell our high-speed analog semiconductor solutions for use in our customers’ products. These selection processes typically are lengthy and can require us to incur significant design and development expenditures and dedicate scarce engineering resources in pursuit of a single customer opportunity. We may not win the competitive selection process and may never generate any revenue despite incurring significant design and development expenditures. Failure to obtain a design win could prevent us from offering an entire generation of a product. This could cause us to lose revenue and require us to write-off obsolete inventory, and could weaken our position in future competitive selection processes. Even after securing a design win, we may experience delays in generating revenue from our products as a result of the lengthy development cycle typically required. Our customers generally take a considerable amount of time to evaluate our products. Our design cycle from initial engagement to volume shipment is typically two to three years.

 

The delays inherent in these lengthy sales cycles increase the risk that a customer will decide to cancel, curtail, reduce or delay its product plans or adopt a competing design from one of our competitors, causing us to lose anticipated revenue. In addition, any delay or cancellation of a customer’s plans could materially and adversely affect our financial results, as we may have incurred significant expense without generating any revenue. Finally, our customers’ failure to successfully market and sell their products could reduce demand for our products and materially and adversely affect our business, financial condition and results of operations. If we were unable to generate revenue after incurring substantial expenses to develop any of our products, our business would suffer.

 

Our customers require our products and our third-party contractors to undergo a lengthy and expensive qualification process which does not assure product sales. If we are unsuccessful or delayed in qualifying any of our products with a customer, our business and operating results would suffer.

 

Prior to purchasing our products, our customers require that both our products and our third-party contractors undergo extensive qualification processes, which involve testing of our products in the customers’ systems, as well as testing for reliability. This qualification process may continue for several months. However, qualification of a product by a customer does not assure any sales of the product to that customer. Even after successful qualification and sales of a product to a customer, a subsequent revision in our third party contractors’ manufacturing process or our selection of a new supplier may require a new qualification process with our customers, which may result in delays and in our holding excess or obsolete inventory. After our products are qualified, it can take several months or more before the customer commences volume production of components or systems that incorporate our products. Despite these uncertainties, we devote substantial resources, including design, engineering, sales, marketing and management efforts, to qualifying our products with customers in anticipation of sales. If we are unsuccessful or delayed in qualifying any of our products with a customer, sales of those products to the customer may be precluded or delayed, which may impede our growth and cause our business to suffer.

 

The complexity of our products could result in undetected defects and we may be subject to warranty claims and product liability, which could result in a decrease in customers and revenue, unexpected expenses and loss of market share. In addition, our product liability insurance may not adequately cover our costs arising from product defects or otherwise.

 

Our products are sold as components or as modules for use in larger electronic equipment sold by our customers. A product usually goes through an intense qualification and testing period performed by our customers before being used in production. We primarily outsource our product testing to third parties and also perform some testing in our Irvine and Westlake Village, California facilities. We inspect and test parts, or have them inspected and tested in order to screen out parts that may be weak or potentially suffer a defect incurred through the manufacturing process. From time to time, we are subject to warranty or product liability claims that may require us to make significant expenditures to defend these claims or pay damage awards.

 

Generally, our agreements seek to limit our liability to the replacement of the part or to the revenue received for the product, but these limitations on liability may not be effective or sufficient in scope in all cases. If a customer’s equipment fails in use, the customer may incur significant monetary damages including an equipment recall or associated replacement expenses, as well as lost revenue. The customer may claim that a defect in our product caused the equipment failure and assert a claim against us to recover monetary damages. The process of identifying a defective or potentially defective product in systems that have been widely distributed may be lengthy and require significant resources. We may test the affected product to determine the root cause of the problem and to determine appropriate solutions. We may find an appropriate solution or a temporary fix while a permanent solution is being determined. If we are unable to determine the root cause, find an appropriate solution or offer a temporary fix, we may delay shipment to customers. As a result, we may incur significant replacement costs and contract damage claims from our customers as well as harm to our reputation. In certain situations, circumstances might warrant that we consider incurring the costs or expense related to a recall of one of our products in order to avoid the potential claims that may be raised should the customer reasonably rely upon our product only to suffer a failure due to a design or manufacturing process defect. Defects in our products could harm our relationships with our customers and damage our reputation. Customers may be reluctant to buy our products, which could harm our ability to retain existing customers and attract new customers and our financial results. In addition, the cost of defending these claims and satisfying any arbitration award or judicial judgment with respect to these claims could harm our business prospects and financial condition. Although we carry product liability insurance, this insurance may not adequately cover our costs arising from defects in our products or otherwise.

 

 

We rely on our relationships with industry and technology leaders to enhance our product offerings and our inability to continue to develop or maintain such relationships in the future would harm our ability to remain competitive.

 

We develop many of our semiconductor products for applications in systems that are driven by industry and technology leaders in the communications market. We also work with OEMs, system manufacturers and standards bodies to define industry conventions and standards within our target markets. We believe these relationships enhance our ability to achieve market acceptance and widespread adoption of our products. If we are unable to continue to develop or maintain these relationships, our semiconductor solutions would become less desirable to our customers, our sales would suffer and our competitive position could be harmed.

 

If we fail to accurately anticipate and respond to market trends or fail to develop and introduce new or enhanced products to address these trends on a timely basis, our ability to attract and retain customers could be impaired and our competitive position could be harmed.

 

We operate in industries characterized by rapidly changing technologies and industry standards as well as technological obsolescence. We have developed products that may have long product life cycles of 10 years or more. We believe that our future success depends on our ability to develop and introduce new technologies and products that generate new sources of revenue to replace, or build upon, existing product revenue streams that may be dependent upon limited product life cycles. If we are not able to repeatedly introduce, in successive years, new products that ship in volume, our revenue will likely not grow and may decline significantly and rapidly. For example, we introduced ColorZ® in 2016 and began to ship in commercial volume in 2017. Sales of ColorZ® comprised 17% of our total revenue in 2017. In 2012, we introduced and began to ship in commercial volume a dual, differential input linear transimpedance/variable-gain amplifier that we identify as product number IN3250TA-SO2D. Sales of IN3250TA-SO2D product comprised 10%, 25% and 18% of our total revenue in 2017, 2016 and 2015, respectively. There were no other products that generated more than 10% of our total revenue in 2017, 2016 or 2015.

 

The IN3250TA-SO2D product matured in 2017 and as a result, sales of these products declined and were supplanted in part by newer parts which we developed. This underscores the importance of the need for us to continually develop and introduce new products to diversify our revenue base as well as generate new revenue to replace and build upon the success of previously introduced products which may be rapidly maturing.

 

To compete successfully, we must design, develop, market and sell new or enhanced products that provide increasingly higher levels of performance and reliability while meeting the cost expectations of our customers. The introduction of new products by our competitors, the delay or cancellation of a platform for which any of our semiconductor solutions are designed, the market acceptance of products based on new or alternative technologies or the emergence of new industry standards could render our existing or future products uncompetitive from a pricing standpoint, obsolete and otherwise unmarketable. Our failure to anticipate or timely develop new or enhanced products or technologies in response to technological shifts could result in decreased revenue and our competitors winning design wins. In particular, we may experience difficulties with product design, manufacturing, marketing or certification that could delay or prevent our development, introduction or marketing of new or enhanced products. Although we believe our products are fully compliant with applicable industry standards, proprietary enhancements may not in the future result in full conformance with existing industry standards under all circumstances. Due to the interdependence of various components in the systems within which our products and the products of our competitors operate, customers are unlikely to change to another design, once adopted, until the next generation of a technology. As a result, if we fail to introduce new or enhanced products that meet the needs of our customers or penetrate new markets in a timely fashion, and our designs do not gain acceptance, we will lose market share and our competitive position, very likely on an extended basis, and operating results will be adversely affected.

 

If sufficient market demand for 100G/200G/400G solutions does not develop or develops more slowly than expected, or if we fail to accurately predict market requirements or market demand for 100G/200G/400G solutions, our business, competitive position and operating results would suffer.

 

We are currently investing significant resources to develop semiconductor solutions supporting 100G/200G/400G data transmission rates in order to increase the number of such solutions in our product line. If we fail to accurately predict market requirements or market demand for 100G/200G/400G semiconductor solutions, or if our 100G/200G/400G semiconductor solutions are not successfully developed or competitive in the industry, our business will suffer. If 100G/200G/400G networks are deployed to a lesser extent or more slowly than we currently anticipate, we may not realize any benefits from our investment. As a result, our business, competitive position, market share and operating results would suffer.

 

 

Our target markets may not grow or develop as we currently expect and are subject to market risks, any of which could materially harm our business, revenue and operating results.

 

To date, a substantial portion of our revenue has been attributable to demand for our products in the communications and datacenter markets and the growth of these overall markets. These markets have fluctuated in size and growth in recent times. Our operating results are impacted by various trends in these markets. These trends include the deployment and broader market adoption of next generation technologies, such as 100G and 100Gbe CMOS CDR and Serdes, in datacenters, communications and enterprise networks, timing of next generation network upgrades, the introduction and broader market adoption of next generation server platforms and the timing of enterprise upgrades. We are unable to predict the timing or direction of the development of these markets with any accuracy. In addition, because some of our products are not limited in the systems or geographic areas in which they may be deployed, we cannot always determine with accuracy how, where or into which applications our products are being deployed. If our target markets do not grow or develop in ways that we currently expect, demand for our semiconductor products may decrease and our business, revenue, and operating results could suffer.

 

We recently received reports of a new 5-year plan update being issued by China's Ministry of Industry and Information Technology. The plan reportedly details objectives to further develop technology and an optical supply chain domestically. We are currently studying the potential impact, however efforts in this direction over time could become a competitive threat to us.

 

We rely on a limited number of third parties to manufacture, assemble and test our products, and the failure to manage our relationships with our third-party contractors successfully could adversely affect our ability to market and sell our products and our reputation. Our revenue and operating results would suffer if these third parties fail to deliver products or components in a timely manner and at reasonable cost or if manufacturing capacity is reduced or eliminated as we may be unable to obtain alternative manufacturing capacity.

 

We operate an outsourced manufacturing business model. As a result, we rely on third-party foundry wafer fabrication and assembly and test capacity. We also perform testing in our Irvine and Westlake Village, California facilities. We generally use a single foundry for the production of each of our various semiconductors. Currently, our principal foundries are SEDI, GlobalFoundries, TSMC, TowerJazz Semiconductor Ltd., and WIN Semiconductors. We also use third-party contract manufacturers for a significant majority of our assembly and test operations, including Kyocera, ASE, Presto, AIC, Tong Hsing, LuxNet and STATS ChipPAC.

 

Relying on third-party manufacturing, assembly and testing presents significant risks to us, including the following:

 

 

failure by us, our customers or their end customers to qualify a selected supplier;

 

 

capacity shortages during periods of high demand;

 

 

reduced control over delivery schedules and quality;

 

 

shortages of materials;

 

 

misappropriation of our intellectual property;

 

 

limited warranties on wafers or products supplied to us; and

 

 

potential increases in prices.

 

The ability and willingness of our third-party contractors to perform is largely outside our control. If one or more of our contract manufacturers or other outsourcers fails to perform its obligations in a timely manner or at satisfactory quality levels, our ability to bring products to market and our reputation could suffer. For example, if that manufacturing capacity is reduced or eliminated at one or more facilities, including as a response to the recent worldwide decline in the semiconductor industry, or any of those facilities are unable to keep pace with the growth of our business, we could have difficulties fulfilling our customer orders and our revenue could decline. In addition, if these third parties fail to deliver quality products and components on time and at reasonable prices, we could have difficulties fulfilling our customer orders, our revenue could decline and our business, financial condition and results of operations would be adversely affected.

 

Additionally, as many of our fabrication and assembly and test contractors are located in the Pacific Rim region, principally in Taiwan, our manufacturing capacity may be similarly reduced or eliminated due to natural disasters, including earthquakes, political unrest, war, labor strikes, work stoppages or public health crises. This could cause significant delays in shipments of our products until we are able to shift our manufacturing, assembly or test from the affected contractor to another third-party vendor. There can be no assurance that alternative manufacturing capacity could be obtained on favorable terms, if at all.

 

Our costs may increase substantially if the wafer foundries that supply our products do not achieve satisfactory product yields or quality.

 

The wafer fabrication process is an extremely complicated process where the slightest changes in the design, specifications or materials can result in material decreases in manufacturing yields or even the suspension of production. From time to time, our third-party wafer foundries have experienced, and are likely to experience, manufacturing defects and reduced manufacturing yields related to errors or problems in their manufacturing processes or the interrelationship of their processes with our designs. In some cases, our third-party wafer foundries may not be able to detect these defects early in the fabrication process or determine the cause of such defects in a timely manner. We may incur substantial research and development expense for prototype or development stage products as we qualify the products for production.

 

 

Generally, in pricing our semiconductors, we assume that manufacturing yields will continue to increase, even as the complexity of our semiconductors increases. Once our semiconductors are initially qualified with our third-party wafer foundries, minimum acceptable yields are established. We are responsible for the costs of the wafers if the actual yield is above the minimum. If actual yields are below the minimum we are not required to purchase the wafers. The minimum acceptable yields for our new products are generally lower at first and increase as we achieve full production. Unacceptably low product yields or other product manufacturing problems could substantially increase the overall production time and costs and adversely impact our operating results on sales of our products. Product yield losses will increase our costs and reduce our gross margin. In addition to significantly harming our operating results and cash flow, poor yields may delay shipment of our products and harm our relationships with existing and potential customers.

 

We do not have any long-term supply contracts with our contract manufacturers or suppliers, and any disruption in our supply of products or materials could have a material adverse effect on our business, revenue and operating results.

 

We currently do not have long-term supply contracts with any of our third-party contract manufacturers. We make substantially all of our purchases on a purchase order basis, and our contract manufacturers are not required to supply us products for any specific period or in any specific quantity. We expect that it would take approximately nine to 12 months to transition from our current foundry or assembly services to new providers. Such a transition would likely require a qualification process by our customers or their end customers. We generally place orders for products with some of our suppliers several months prior to the anticipated delivery date, with order volumes based on our forecasts of demand from our customers. Accordingly, if we inaccurately forecast demand for our products, we may be unable to obtain adequate and cost-effective foundry or assembly capacity from our third-party contractors to meet our customers’ delivery requirements, or we may accumulate excess inventories. On occasion, we have been unable to adequately respond to unexpected increases in customer purchase orders and therefore, were unable to benefit from this incremental demand. None of our third-party contract manufacturers have provided any assurance to us that adequate capacity will be available to us within the time required to meet additional demand for our products.

 

Our foundry vendors and assembly and test vendors may allocate capacity to the production of other companies’ products while reducing deliveries to us on short notice. In particular, other customers that are larger and better financed than us or that have long-term agreements with our foundry vendor or assembly and test vendors may cause our foundry vendor or assembly and test vendors to reallocate capacity to those customers, decreasing the capacity available to us. We do not have long-term supply contracts with our third-party contract manufacturers and if we enter into costly arrangements with suppliers that include nonrefundable deposits or loans in exchange for capacity commitments, commitments to purchase specified quantities over extended periods or investment in a foundry, our operating results could be harmed. We may not be able to make any such arrangement in a timely fashion or at all, and any arrangements may be costly, reduce our financial flexibility, and not be on terms favorable to us. Moreover, if we are able to secure foundry capacity, we may be obligated to use all of that capacity or incur penalties. These penalties may be expensive and could harm our financial results. To date, we have not entered into such arrangements with our suppliers. If we need another foundry or assembly and test subcontractor because of increased demand, or if we are unable to obtain timely and adequate deliveries from our providers, we might not be able to cost effectively and quickly retain other vendors to satisfy our requirements.

 

Many of our customers depend on us as the sole source for a number of our products. If we are unable to deliver these products as the sole supplier or as one of a limited number of suppliers, our relationships with these customers and our business would suffer.

 

A number of our customers do not have alternative sources for our semiconductor solutions and depend on us as the sole supplier or as one of a limited number of suppliers for these products. Since we outsource our manufacturing to third-party contractors, our ability to deliver our products is substantially dependent on the ability and willingness of our third-party contractors to perform, which is largely outside our control. A failure to deliver our products in sufficient quantities or at all to our customers that depend on us as a sole supplier or as one of a limited number of suppliers may be detrimental to their business and, as a result, our relationship with the customer would be negatively impacted. If we are unable to maintain our relationships with these customers after such failure, our business and financial results may be harmed.

 

If we are unable to attract, train and retain qualified personnel, particularly our design and technical personnel, we may not be able to execute our business strategy effectively.

 

Our future success depends on our ability to attract and retain qualified personnel, including our management, sales and marketing, and finance, and particularly our design and technical personnel. We do not know whether we will be able to retain all of these personnel as we continue to pursue our business strategy. Historically, we have encountered difficulties in hiring qualified engineers because there is a limited pool of engineers with the expertise required in our field. Competition for these personnel is intense in the semiconductor industry. As the source of our technological and product innovations, our design and technical personnel represent a significant asset. The loss of the services of one or more of our key employees, especially our key design and technical personnel, or our inability to attract and retain qualified design and technical personnel, could harm our business, financial condition and results of operations.

 

 

We may not be able to effectively manage our growth, and we may need to incur significant expenditures to address the additional operational and control requirements of our growth, either of which could harm our business and operating results.

 

To effectively manage our growth, we must continue to expand our operational, engineering and financial systems, procedures and controls and to improve our accounting and other internal management systems. This may require substantial managerial and financial resources, and our efforts in this regard may not be successful. Our current systems, procedures and controls may not be adequate to support our future operations. If we fail to adequately manage our growth, or to improve our operational, financial and management information systems, or fail to effectively motivate or manage our new and future employees, the quality of our products and the management of our operations could suffer, which could adversely affect our operating results.

 

We face intense competition and expect competition to increase in the future. If we fail to compete effectively, it could have an adverse effect on our revenue, revenue growth rate, if any, and market share.

 

The global semiconductor market in general, and the communications and computing markets in particular, are highly competitive. We compete or plan to compete in different target markets to various degrees on the basis of a number of principal competitive factors, including product performance, power budget, features and functionality, customer relationships, size, ease of system design, product roadmap, reputation and reliability, customer support and price. We expect competition to increase and intensify as more and larger semiconductor companies enter our markets. Increased competition could result in price pressure, reduced profitability and loss of market share, any of which could materially and adversely affect our business, revenue and operating results.

 

Currently, our competitors range from large, international companies offering a wide range of semiconductor products to smaller companies specializing in narrow markets. Our primary competitors include Acacia Communications, Inc., Broadcom Ltd., Ciena Corporation, Integrated Device Technology, Inc., M/A-COM Technology Solutions Inc., MaxLinear, Inc., Microsemi Corporation, NTT Electronics Corporation, Qorvo, Inc. and Semtech Corp.as well as other analog signal processing companies. We expect competition in the markets in which we participate to increase in the future as existing competitors improve or expand their product offerings.

 

Our ability to compete successfully depends on elements both within and outside of our control, including industry and general economic trends. During past periods of downturns in our industry, competition in the markets in which we operate intensified as our customers reduced their purchase orders. Many of our competitors have substantially greater financial and other resources with which to withstand similar adverse economic or market conditions in the future. These developments may materially and adversely affect our current and future target markets and our ability to compete successfully in those markets.

 

We use a significant amount of intellectual property in our business. Monitoring unauthorized use of our intellectual property can be difficult and costly and if we are unable to protect our intellectual property, our business could be adversely affected.

 

Our success depends in part upon our ability to protect our intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, copyrights, trademarks and trade secrets in the United States and in selected foreign countries where we believe filing for such protection is appropriate. Effective protection of our intellectual property rights may be unavailable, limited or not applied for in some countries. Some of our products and technologies are not covered by any patent or patent application, as we do not believe patent protection of these products and technologies is critical to our business strategy at this time. A failure to timely seek patent protection on products or technologies generally precludes us from seeking future patent protection on these products or technologies. We cannot guarantee that:

 

 

any of our present or future patents or patent claims will not lapse or be invalidated, circumvented, challenged or abandoned;

 

 

our intellectual property rights will provide competitive advantages to us;

 

 

our ability to assert our intellectual property rights against potential competitors or to settle current or future disputes will not be limited by our agreements with third parties;

 

 

any of our pending or future patent applications will be issued or have the coverage originally sought;

 

 

our intellectual property rights will be enforced in jurisdictions where competition may be intense or where legal protection may be weak;

 

 

any of the trademarks, copyrights, trade secrets or other intellectual property rights that we presently employ in our business will not lapse or be invalidated, circumvented, challenged or abandoned; or

 

 

we will not lose the ability to assert our intellectual property rights against or to license our technology to others and collect royalties or other payments.

 

 

In addition, our competitors or others may design around our protected patents or technologies. Effective intellectual property protection may be unavailable or more limited in one or more relevant jurisdictions relative to those protections available in the United States, or may not be applied for in one or more relevant jurisdictions. If we pursue litigation to assert our intellectual property rights, an adverse decision in any of these legal actions could limit our ability to assert our intellectual property rights, limit the value of our technology or otherwise negatively impact our business, financial condition and results of operations.

 

Monitoring unauthorized use of our intellectual property is difficult and costly. Unauthorized use of our intellectual property may have occurred or may occur in the future. Although we have taken steps to minimize the risk of this occurring, any such failure to identify unauthorized use and otherwise adequately protect our intellectual property would adversely affect our business. Moreover, if we are required to commence litigation, whether as a plaintiff or defendant, not only would this be time-consuming, but we would also be forced to incur significant costs and divert our attention and efforts of our employees, which could, in turn, result in lower revenue and higher expenses.

 

We also rely on contractual protections with our customers, suppliers, distributors, employees and consultants, and we implement security measures designed to protect our trade secrets. We cannot assure you that these contractual protections and security measures will not be breached, that we will have adequate remedies for any such breach or that our suppliers, employees or consultants will not assert rights to intellectual property arising out of such contracts.

 

In addition, we have a number of third-party patent and intellectual property license agreements. Some of these license agreements require us to make one-time payments or ongoing royalty payments. We cannot guarantee that the third-party patents and technology we license will not be licensed to our competitors or others in the semiconductor industry. In the future, we may need to obtain additional licenses, renew existing license agreements or otherwise replace existing technology. We are unable to predict whether these license agreements can be obtained or renewed or the technology can be replaced on acceptable terms, or at all.

 

Average selling prices of our products generally decrease over time, which could negatively impact our revenue and gross margins.

 

Our operating results may be impacted by a decline in the average selling prices of our semiconductors. If competition increases in our target markets, we may need to reduce the average unit price of our products in anticipation of competitive pricing pressures, new product introductions by us or our competitors and for other reasons. If we are unable to offset any reductions in our average selling prices by increasing our sales volumes or introducing new products with higher margins, our revenue and gross margins will suffer. To maintain our revenue and gross margins, we must develop and introduce new products and product enhancements on a timely basis and continually reduce our costs as well as our customers’ costs. Failure to do so would cause our revenue and gross margins to decline.

 

We are subject to order and shipment uncertainties, and differences between our estimates of customer demand and product mix and our actual results could negatively affect our inventory levels, sales and operating results.

 

Our revenue is generated on the basis of purchase orders with our customers rather than long-term purchase commitments. In addition, our customers can cancel purchase orders or defer the shipments of our products under certain circumstances. Our products are manufactured using semiconductor foundries according to our estimates of customer demand, which requires us to make separate demand forecast assumptions for every customer, each of which may introduce significant variability into our aggregate estimates. It is difficult for us to forecast the demand for our products, in part because of the complex supply chain between us and the end-user markets that incorporate our products. Due to our lengthy product development cycle, it is critical for us to anticipate changes in demand for our various product features and the applications they serve to allow sufficient time for product development and design. We have limited visibility into future customer demand and the product mix that our customers will require, which could adversely affect our revenue forecasts and operating margins. Moreover, because some of our target markets are relatively new, many of our customers have difficulty accurately forecasting their product requirements and estimating the timing of their new product introductions, which ultimately affects their demand for our products. Our failure to accurately forecast demand can lead to product shortages that can impede production by our customers and harm our customer relationships. Conversely, our failure to forecast declining demand or shifts in product mix can result in excess or obsolete inventory. For example, some of our customers may cancel purchase orders or delay the shipment of their products that incorporate our products as a result of component shortages they may experience due to earthquakes and tsunamis in Japan or Taiwan, or likewise with respect to flooding in Thailand, which may result in excess or obsolete inventory and impact our sales and operating results. In addition, the rapid pace of innovation in our industry could also render significant portions of our inventory obsolete. Excess or obsolete inventory levels could result in unexpected expenses or increases in our reserves that could adversely affect our business, operating results and financial condition. In contrast, if we were to underestimate customer demand or if sufficient manufacturing capacity were unavailable, we could forego revenue opportunities, potentially lose market share and damage our customer relationships. In addition, any significant future cancellations or deferrals of product orders or the return of previously sold products due to manufacturing defects could materially and adversely impact our profit margins, increase our write-offs due to product obsolescence and restrict our ability to fund our operations.

 

 

We rely on third-party sales representatives and distributors to assist in selling our products. If we fail to retain or find additional sales representatives and distributors, or if any of these parties fail to perform as expected, it could reduce our future sales.

 

For the year ended December 31, 2017, we derived 82% of our total revenue from sales by our direct sales team and third-party sales representatives and 18% of our sales were made through third-party distributors. For the year ended December 31, 2016, we derived 85% of our total revenue from sales by our direct sales team and third-party sales representatives and 15% of our sales were made through third-party distributors. For the year ended December 31, 2015, we derived 80% of our total revenue from sales by our direct sales team and third-party sales representatives and approximately 20% of our sales were made through third-party distributors. We are unable to predict the extent to which these third-party sales representatives and distributors will be successful in marketing and selling our products. Moreover, many of these third-party sales representatives and distributors also market and sell competing products, which may affect the extent to which they promote our products. Even where our relationships are formalized in contracts, our third-party sales representatives and distributors often have the right to terminate their relationships with us at any time. Our future performance will also depend, in part, on our ability to attract additional third-party sales representatives and distributors who will be able to market and support our products effectively, especially in markets in which we have not previously sold our products. If we cannot retain our current distributors or find additional or replacement third-party sales representatives and distributors, our business, financial condition and results of operations could be harmed. Additionally, if we terminate our relationship with a distributor, we may be obligated to repurchase unsold products. We record a reserve for estimated returns and price credits. If actual returns and credits exceed our estimates, our operating results could be harmed.

 

The facilities of our third-party contractors and distributors and a number of our facilities are located in regions that are subject to earthquakes and other natural disasters.

 

The facilities of our third-party contractors and distributors are subject to risk of catastrophic loss due to fire, flood or other natural or man-made disasters. A number of our facilities and those of our contract manufacturers are located in areas with above average seismic activity and also subject to typhoons and other Pacific storms. Several foundries that manufacture our wafers are located in Taiwan, Japan and California, and a majority of our third-party contractors who assemble and test our products are located in Asia. In addition, our headquarters are located in California. The risk of an earthquake in the Pacific Rim region or California is significant due to the proximity of major earthquake fault lines. Any catastrophic loss to any of these facilities would likely disrupt our operations, delay production, shipments and revenue and result in significant expenses to repair or replace the facility. In particular, any catastrophic loss at our California locations would materially and adversely affect our business.

 

We rely on third-party technologies for the development of our products and our inability to use such technologies in the future would harm our ability to remain competitive.

 

We rely on third parties for technologies that are integrated into our products, such as wafer fabrication and assembly and test technologies used by our contract manufacturers, as well as licensed architecture technologies. If we are unable to continue to use or license these technologies on reasonable terms, or if these technologies fail to operate properly, we may not be able to secure alternatives in a timely manner or at all, and our ability to remain competitive would be harmed. In addition, if we are unable to successfully license technology from third parties to develop future products, we may not be able to develop such products in a timely manner or at all.

 

Our business would be adversely affected by the departure of existing members of our senior management team and other key personnel.

 

Our success depends, in large part, on the continued contributions of our senior management team, in particular, the services of certain key personnel. Changes in our management team could negatively affect our operations and our relationships with our customers, employees and market leaders. In addition, we have not entered into non-compete agreements with members of our senior management team. The loss of any member of our senior management team or key personnel could harm our ability to implement our business strategy and respond to the rapidly changing market conditions in which we operate.

 

We may acquire businesses, enter into licensing arrangements or make investments in other companies or technologies that disrupt our business, are difficult to integrate, impair our operating results, dilute our stockholders’ ownership, increase our debt, divert management resources or cause us to incur significant expense.

 

As part of our business strategy, we have pursued and may continue to pursue in the future acquisitions of businesses and assets, as well as technology licensing arrangements that we believe will complement our business, semiconductor solutions or technologies. For example, we acquired ClariPhy in December 2016 to help expand our optical networking platform portfolio. We also may pursue strategic alliances that leverage our core technology and industry experience to expand our product offerings or distribution, or make investments in other companies. Any acquisition involves a number of risks, many of which could harm our business, including:

 

 

difficulty in integrating the operations, technologies, products, existing contracts, accounting and personnel of the acquired company or business;

 

 

realizing the anticipated benefits of any acquisition;

 

 

difficulty in transitioning and supporting customers, if any, of the acquired company;

 

 

difficulty in transitioning and collaborating with suppliers, if any, of the acquired company;

 

 

 

diversion of financial and management resources from existing operations;

 

 

the risk that the price we pay or other resources that we devote may exceed the value we realize, or the value we could have realized if we had allocated the purchase price or other resources to another opportunity;

 

 

potential loss of key employees, customers and strategic alliances from either our current business or the acquired company’s business;

 

 

inability to successfully bring newly acquired products to market or achieve design wins with such products;

 

 

fluctuations in industry trends that change the demand or purchasing volume of newly acquired products;

 

 

assumption of unanticipated problems or latent liabilities, such as problems with the quality of the acquired products;

 

 

inability to generate sufficient revenue to offset acquisition costs;

 

 

dilutive effect on our stock as a result of any equity-based acquisitions;

 

 

inability to successfully complete transactions with a suitable acquisition candidate; and

 

 

in the event of international acquisitions, risks associated with accounting and business practices that are different from applicable U.S. practices and requirements.

 

Acquisitions also frequently result in the recording of goodwill and other intangible assets that are subject to potential impairments, which could harm our financial results. For example, during the year ended December 31, 2017, we abandoned a project related to certain developed technology and in-process research and development from the ClariPhy acquisition and recorded an impairment charge of $47.0 million. The abandonment of the project was primarily related to change in product roadmap that occurred during the year ended December 31, 2017. Similarly, during the year ended December 31, 2015, we abandoned a project related to in-process research and development in connection with the Cortina acquisition and recorded an impairment charge of $1.8 million. If we fail to properly evaluate acquisitions or investments, it may impair our ability to achieve the anticipated benefits of any such acquisitions or investments, and we may incur costs in excess of what we anticipate. The failure to successfully evaluate and execute acquisitions or investments or otherwise adequately address these risks could materially harm our business and financial results.

 

To finance any acquisitions or investments, we may choose to issue shares of our common stock or convertible debt as consideration, which could dilute the ownership of our stockholders. If the price of our common stock is low or volatile, we may not be able to acquire other companies for stock. In addition, newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility, and would also require us to incur interest expense. Additional funds may not be available on terms that are favorable to us, or at all.

 

We may not realize the anticipated benefits of our acquisitions, which in turn could harm our business and operating results.

 

We may not achieve all of the anticipated benefits of any of our acquisitions in a timely manner or at all, including our acquisitions of Cortina and ClariPhy, due to a number of factors including: failure to successfully integrate the acquired business, unanticipated costs or liabilities associated with the acquisitions, incurrence of acquisition-related costs, harm to our relationships with existing customers as a result of the acquisitions, harm to our brands and reputation, the loss of key employees of the acquired companies, negative market reaction thereto, inability to successfully extend and expand product offerings, significant impairments of anticipated goodwill and other intangible assets and the use of resources that are needed in other parts of our business.

 

We may sell one or more of our product lines, from time to time, as a result of our evaluation of our products and markets, and any divestiture could adversely affect our continuing business and our expenses, revenues, results of operation, cash flows and financial position.

 

We periodically evaluate our various product lines and may, as a result, consider the divestiture of one or more of those product lines. For example, in August 2016, we sold our memory product business to Rambus Inc. for $90 million in cash. Any divestiture could adversely affect our continuing business and expenses, revenues, results of operations, cash flows and financial position.

 

Divestitures of product lines have inherent risks, including the expense of selling the product line, the possibility that any anticipated sale will not occur, delays in closing any sale, the risk of lower-than-expected proceeds from the sale of the divested business, unexpected costs associated with the separation of the business to be sold from the seller’s information technology and other operating systems, and potential post-closing claims for indemnification or breach of transition services obligations of the seller. Expected cost savings, which are offset by revenue losses from divested businesses, may also be difficult to achieve or maximize due to the seller’s fixed cost structure, and a seller may experience varying success in reducing fixed costs or transferring liabilities previously associated with the divested business.

 

 

Our business, particularly the high-speed interconnect and optical transport business, is dependent on capital expenditures by service providers, and any downturn that they experience could negatively impact our business.

 

Our business, particularly the high-speed interconnect and optical transport business, which we acquired in connection with our acquisition of Cortina, depends on continued capital expenditures by communication service providers and is subject to the cyclicality of such expenditures. Our communications semiconductor products are sold primarily to network equipment vendors that in turn sell their equipment to service providers. If the demand for our customers’ products declines or fails to increase, as a result of lower capital expenditures by service providers or any other factors, demand for our products will be similarly affected. The global economic downturn caused a significant reduction in capital spending on communications network equipment. While we are beginning to see improvement, there are no guarantees that this growth will continue, which could result in market volatility or another downturn. If there is another downturn, our business, operating results and financial condition may be materially harmed.

 

Our high-speed interconnect and optical transport business that we acquired in connection with our acquisition of Cortina has historically relied on a small number of key customers for a substantial portion of its revenue, and the loss of one or more of these key customers or the diminished demand for these products from one or more such key customers would significantly reduce our revenue and profits.

 

With respect to our high-speed interconnect and optical transport business that we acquired in connection with our acquisition of Cortina, a small number of customers have historically accounted for a substantial portion of the revenues in any particular period. We anticipate that our relationships with these key customers will continue to be important to this business, and we expect that this customer concentration will increase in the future. We have no long-term volume purchase commitments from our key customers. These customers may decide not to purchase our products at all, may purchase fewer products than they did in the past or may otherwise alter their purchasing patterns. Reductions, delays and cancellation of orders from our key customers or the loss of one or more key customers would significantly reduce our revenue and profits.

 

The failure of our distributors to perform as expected could materially reduce our future revenue or negatively impact our reported financial results.

 

Our high-speed interconnect and optical transport business that we acquired in connection with our acquisition of Cortina has historically relied on a number of distributors, in particular Arrow Electronics, Inc. and Paltek Corporation, to help generate customer demand, provide technical support and other value-added services to its customers, fill customer orders and stock its products. These distributors do not sell those products exclusively, and to the extent they choose to emphasize a competitor’s products over our products, our results of operations could be harmed. Our contracts with these distributors may be terminated by either party with notice. Our distributors are located all over the world, and are of various sizes and financial conditions. Lower sales, lower earnings, debt downgrades, the inability to access capital markets and higher interest rates could potentially affect our distributors’ operations. Further, our distributors have contractual rights to return unsold inventory to us, and, if this were to happen, we could incur significant cost in finding alternative sales channels for these products or through write-offs. Any adverse condition experienced by our distributors could negatively impact their level of support for our products or the rate at which they make payments to us and, consequently, could harm our results of operations. We rely on accurate and timely sales reports from our distributors in order for our financial results to represent the actual sales that our distributors make for us in any given period. Any inaccuracies or delays in these reports could negatively affect our ability to produce accurate and timely financial reports and to recognize revenue. We also rely on distributors for sales forecasts, and any inaccuracies in such forecasts could impair the accuracy of our projections and planned operations.

 

Our portfolio of marketable securities is significant and subject to market, interest and credit risk that may reduce its value.

 

We maintain a significant portfolio of marketable securities. Changes in the value of this portfolio could adversely affect our earnings. In particular, the value of our investments may decline due to increases in interest rates, downgrades of money market funds, U.S. Treasuries, municipal bonds, corporate bonds, certificates of deposit and asset-backed securities included in our portfolio, instability in the global financial markets that reduces the liquidity of securities included in our portfolio, declines in the value of collateral underlying the asset-backed securities included in our portfolio and other factors. Each of these events may cause us to record charges to reduce the carrying value of our investment portfolio or sell investments for less than our acquisition cost. Although we attempt to mitigate these risks by investing in high quality securities and continuously monitoring our portfolio’s overall risk profile, the value of our investments may nevertheless decline.

 

Tax benefits that we receive may be terminated or reduced in the future, which would increase our costs.

 

We continue to expand our international presence to take advantage of the opportunity to recruit additional engineering design talent, as well as to more closely align our operations geographically with our customers and suppliers in Asia. In certain international jurisdictions, we have also entered into agreements with local governments to provide us with, among other things, favorable local tax rates if certain minimum criteria are met. These agreements may require us to meet several requirements as to investment, headcount and activities to retain this status. We currently believe that we will be able to meet all the terms and conditions specified in these agreements. However, if adverse changes in the economy or changes in technology affect international demand for our products in an unforeseen manner or if we fail to otherwise meet the conditions of the local agreements, or if we fail to extend the favorable local tax rate, we may be subject to additional taxes, which in turn would increase our costs.

 

 

Changes in our effective tax rate may harm our results of operations. A number of factors may increase our future effective tax rates, including:

 

 

the jurisdictions in which profits are determined to be earned and taxed;

 

 

the resolution of issues arising from tax audits with various tax authorities;

 

 

changes in the measurement of our deferred tax assets and liabilities and in deferred tax valuation allowances;

 

 

changes in the value of assets or services transferred or provided from one jurisdiction to another;

 

 

adjustments to income taxes upon finalization of various tax returns;

 

 

increases in expenses not deductible for tax purposes, including write-offs of acquired in-process research and development and impairments of goodwill in connection with acquisitions;

 

 

changes in available tax credits;

 

 

changes in tax laws, such as Public Law 115-97, informally referred to as the Tax Cuts and Jobs Act (the “Tax Reform Act”), or the interpretation of such tax laws, and changes in U.S. generally accepted accounting principles; and

 

 

a decision to repatriate non-U.S. earnings for which we have not previously provided for U.S. taxes.

 

On December 22, 2017, the Tax Reform Act was signed into law. The Tax Reform Act contains significant changes to U.S. federal corporate income taxation, including a reduction of the corporate tax rate from 35% to 21% effective January 1, 2018, a one-time transition tax on deemed mandatory repatriation of accumulated earnings and profits of foreign subsidiaries in conjunction with the elimination of U.S. tax on dividend distributions from foreign subsidiaries, and a temporary 100% first-year depreciation deduction for certain capital investments. The effect of the tax law changes must be recognized in the period of enactment. As a result of the change in tax rate, our federal deferred tax assets and liabilities are required to be remeasured to reflect their value at a lower tax rate of 21%. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. We are in the process of completing the evaluation of the Tax Reform Act on our business and financial condition. We have made reasonable estimates of the effects of the tax law changes, including the remeasurement of our existing deferred tax balances and mandatory repatriation of deferred foreign earnings. The final impact of the Tax Reform Act may differ from the provisional estimate due to forthcoming guidance in interpretation of the law and accounting, or further refinement of our analysis. Any adjustment could adversely affect our earnings.

 

We are subject to regulatory compliance requirements, including Section 404 of the Sarbanes-Oxley Act of 2002, which are costly to comply with, and our failure to comply with these requirements could harm our business and operating results.

 

As a public company, we incur significant legal, accounting and other expenses related to compliance with laws such as Section 404 of the Sarbanes-Oxley Act of 2002. Compliance with Section 404 requires that our management report on, and our independent registered public accounting firm attest to, the effectiveness of our internal control over financial reporting in our annual reports on Form 10-K. Section 404 compliance has in the past diverted, and may continue to divert, internal resources, and require a significant amount of time and effort. If we fail to comply with Section 404, or if in the future our Chief Executive Officer, Chief Financial Officer or independent registered public accounting firm determines that our internal control over financial reporting is not effective, we could be subject to sanctions or investigations by The New York Stock Exchange, or NYSE, the Securities and Exchange Commission, or the SEC, or other regulatory authorities.

 

Furthermore, investor perceptions of our company may suffer, and this could cause a decline in the market price of our stock. Irrespective of compliance with Section 404, any failure of our internal controls could have a material adverse effect on our stated results of operations and harm our reputation.

 

The conditional conversion feature of our convertible senior notes, if triggered, may adversely affect our financial condition and operating results.

 

In the event the conditional conversion feature of our convertible senior notes is triggered, holders of notes will be entitled to convert the notes at any time during specified periods at their option. If one or more holders elect to convert their notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock, thereby incurring share dilution (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. In addition, even if holders do not elect to convert their notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.

 

 

The accounting method for convertible debt securities that may be settled in cash, such as the notes, could have a material effect on our reported financial results.

 

Under Accounting Standards Codification 470-20, Debt with Conversion and Other Options, which we refer to as ASC 470-20, an entity must separately account for the liability and equity components of the convertible debt instruments (such as the notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The effect of ASC 470-20 on the accounting for the notes is that the equity component is required to be included in the additional paid-in capital section of stockholders’ equity on our consolidated balance sheet, and the value of the equity component would be treated as debt discount for purposes of accounting for the debt component of the notes. As a result, we are required to record a greater amount of non-cash interest expense in current periods presented as a result of the amortization of the discounted carrying value of the notes to their face amount over the term of the notes. We will report lower net income in our financial results because ASC 470-20 will require interest to include both the current period’s amortization of the debt discount and the instrument’s non-convertible interest rate, which could adversely affect our reported or future financial results, the trading price of our common stock and the trading price of the notes.

 

In addition, under certain circumstances, convertible debt instruments (such as the notes) that may be settled entirely or partly in cash are currently accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of the notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of the notes exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, are issued. We cannot be sure that the accounting standards in the future will continue to permit the use of the treasury stock method. If we are unable to use the treasury stock method in accounting for the shares issuable upon conversion of the notes, then our diluted earnings per share would be adversely affected.

 

We are leveraged financially, which could adversely affect our ability to adjust our business to respond to competitive pressures and to obtain sufficient funds to satisfy our future growth, business needs and development plans.

 

We have substantial existing indebtedness. For example, in September 2016 and December 2015, we issued $287.5 million and $230.0 million, respectively in aggregate principal of convertible senior notes. The degree to which we are leveraged could have negative consequences, including, but not limited to, the following:

 

 

we may be more vulnerable to economic downturns, less able to withstand competitive pressures and less flexible in responding to changing business and economic conditions;

 

our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, general corporate or other purposes may be limited;

 

a substantial portion of our cash flows from operations in the future may be required for the payment of the principal amount of our existing indebtedness when it becomes due; and

 

we may elect to make cash payments upon any conversion of the convertible notes, which would reduce our cash on hand.

 

Our ability to meet our payment obligations under our convertible notes depends on our ability to generate significant cash flow in the future. This, to some extent, is subject to general economic, financial, competitive, legislative, and regulatory factors as well as other factors that are beyond our control. There can be no assurance that our business will generate cash flow from operations, or that additional capital will be available to us, in an amount sufficient to enable us to meet our debt payment obligations and to fund other liquidity needs. If we are unable to generate sufficient cash flow to service our debt obligations, we may need to refinance or restructure our debt, sell assets, reduce or delay capital investments, or seek to raise additional capital. If we were unable to implement one or more of these alternatives, we may be unable to meet our debt payment obligations, which could have a material adverse effect on our business, results of operations, or financial condition.

 

Our business could be negatively impacted by information technology security events and other disruptions.

 

We face various cybersecurity threats, including threats to our information technology infrastructure and attempts to gain access to our proprietary or classified information, denial-of-service attacks, requests for money transfers, ransomware, as well as threats to the physical security of our facilities and employees. In addition, we face cyber threats from entities that may seek to target us through our customers, vendors, subcontractors, employees, and other third parties with whom we do business. Accordingly, we maintain information security partners and staff, policies and procedures for managing risk to our information systems, and conduct employee training on cybersecurity to mitigate persistent and continuously evolving cyber security threats. We have experienced cybersecurity threats such as viruses and attacks by hackers targeting our information technology systems. Although such events have not had a material impact to date on our financial condition, results of operations or liquidity or reputation, future threats could, among other things, cause harm to our business and our reputation; disrupt our operations; expose us to potential liability, regulatory actions and the loss of business; as well as impact our results of operations materially. Due to the evolving nature of these security threats, we cannot predict the potential impact of any future incident.

 

 

Risks Related to Our Industry

 

We may be unable to make the substantial and productive research and development investments, which are required to remain competitive in our business.

 

The semiconductor industry requires substantial investment in research and development in order to develop and bring to market new and enhanced technologies and products. Many of our products originated with our research and development efforts and have provided us with a significant competitive advantage. Our research and development expenses were $200.5 million, $108.0 million, and $87.8 million in 2017, 2016, and 2015, respectively. We are committed to investing in new product development in order to remain competitive in our target markets. We do not know whether we will have sufficient resources to maintain the level of investment in research and development required to remain competitive. In addition, we cannot assure you that the technologies which are the focus of our research and development expenditures will become commercially successful.

 

Our business, financial condition and results of operations could be adversely affected by worldwide economic conditions, as well as political and economic conditions in the countries in which we conduct business.

 

Our business and operating results are impacted by worldwide economic conditions. Uncertainty about current global economic conditions may cause businesses to continue to postpone spending in response to tighter credit, unemployment or negative financial news. This in turn could have a material negative effect on the demand for our semiconductor products or the products into which our semiconductors are incorporated. Multiple factors relating to our international operations and to particular countries in which we operate could negatively impact our business, financial condition and results of operations. These factors include:

 

 

changes in political, regulatory, legal or economic conditions;

 

 

restrictive governmental actions, such as restrictions on the transfer or repatriation of funds and foreign investments and trade protection measures, including export duties and quotas and customs duties and tariffs;

 

 

disruptions of capital and trading markets;

 

 

changes in import or export requirements;

 

 

transportation delays;

 

 

civil disturbances or political instability;

 

 

geopolitical turmoil, including terrorism, war or political or military coups;

 

 

public health emergencies;

 

 

differing employment practices and labor standards;

 

 

limitations on our ability under local laws to protect our intellectual property;

 

 

local business and cultural factors that differ from our customary standards and practices;

 

 

nationalization and expropriation;

 

 

changes in tax or intellectual property laws;

 

 

currency fluctuations relating to our international operating activities; and

 

 

difficulty in obtaining distribution and support.

 

A significant portion of our products are manufactured, assembled and tested outside the United States. Any conflict or uncertainty in these countries, including due to natural disasters, public health concerns, political unrest or safety concerns, could harm our business, financial condition and results of operations. In addition, if the government of any country in which our products are manufactured or sold sets technical standards for products manufactured in or imported into their country that are not widely shared, it may lead some of our customers to suspend imports of their products into that country, require manufacturers in that country to manufacture products with different technical standards and disrupt cross-border manufacturing relationships which, in each case, could harm our business.

 

Changes in current or future laws or regulations or the imposition of new laws or regulations, including new or changed tax regulations, environmental laws and export control laws, or new interpretations thereof, by federal or state agencies or foreign governments could impair our ability to compete in international markets.

 

Changes in current laws or regulations applicable to us, the imposition of new laws and regulations in the United States or other jurisdictions in which we do business, such as Argentina, Canada, China, Germany, Japan, Malaysia, Singapore, Taiwan and United Kingdom, any changes or uncertainties with respect to such laws or regulations or with respect to trade relations between the United States and any such jurisdictions or any adverse outcome as a result of a review or examination by the applicable taxing authority, could materially and adversely affect our business, financial condition and results of operations. For example, we have entered into agreements with local governments to provide us with, among other things, favorable local tax rates if certain minimum criteria are met, as discussed in our risk factor entitled “Tax benefits that we received may be terminated or reduced in the future, which would increase our costs.” These agreements may require us to meet several requirements as to investment, headcount and activities to retain this status. If we fail to otherwise meet the conditions of the local agreements, we may be subject to additional taxes, which in turn would increase our costs. In addition, potential future U.S. tax legislation could impact the tax benefits we effectively realize under these agreements.

 

 

Due to environmental concerns, the use of lead and other hazardous substances in electronic components and systems is receiving increased attention. In response, the European Union passed the Restriction on Hazardous Substances, or RoHS, Directive, legislation that limits the use of lead and other hazardous substances in electrical equipment. The RoHS Directive became effective July 1, 2006. We believe that our current product designs and material supply chains are in compliance with the RoHS Directive. If our product designs or material supply chains are deemed not to be in compliance with the RoHS Directive, we and our third-party manufacturers may need to redesign products with components meeting the requirements of the RoHS Directive and we may incur additional expense as well as loss of market share and damage to our reputation.

 

We are also subject to export control laws, regulations and requirements that limit which products we sell and where and to whom we sell our products. In some cases, it is possible that export licenses would be required from U.S. government agencies for some of our products in accordance with the Export Administration Regulations and the International Traffic in Arms Regulations. We may not be successful in obtaining the necessary export licenses in all instances. Any limitation on our ability to export or sell our products imposed by these laws would adversely affect our business, financial condition and results of operations. In addition, changes in our products or changes in export and import laws and implementing regulations may create delays in the introduction of new products in international markets, prevent our customers from deploying our products internationally or, in some cases, prevent the export or import of our products to certain countries altogether. While we are not aware of any other current or proposed export or import regulations which would materially restrict our ability to sell our products in other countries, any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations, or change in the countries, persons or technologies targeted by these regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. In such event, our business and results of operations could be adversely affected. In addition, we are subject to economic and trade sanctions programs that are administered by the U.S. Treasury Department’s Office of Foreign Assets Control, or OFAC, that prohibit or restrict transactions to or from or dealings with specified countries, their governments, and in certain circumstances, with individuals and entities that are specially-designated nationals of those countries, narcotics traffickers and terrorists or terrorist organizations. Violations of these trade control laws and sanctions regulations are punishable by civil penalties, including fines, denial of export privileges, injunctions, asset seizures, debarment from government contracts, and revocations or restrictions of licenses, as well as criminal fines and imprisonment.

 

We are also subject to risks associated with compliance with applicable anti-corruption laws, including the Foreign Corrupt Practices Act, or FCPA, which generally prohibits companies and their employees and intermediaries from making payments to foreign officials for the purpose of obtaining or keeping business, securing an advantage, or directing business to another, and requires public companies to maintain accurate books and records and a system of internal accounting controls. Under the FCPA, companies may be held liable for actions taken by directors, officers, employees, agents, or other strategic or local partners or representatives. If we or our intermediaries fail to comply with the requirements of the FCPA or similar laws, governmental authorities in the United States and elsewhere could seek to impose civil and criminal fines and penalties which could have a material adverse effect on our business, results of operations and financial condition.

 

Our product or manufacturing standards could also be impacted by new or revised environmental rules and regulations or other social initiatives. For instance, the SEC adopted disclosure requirements in 2012 relating to the sourcing of certain minerals from the Democratic Republic of Congo and certain other adjoining countries. These rules, which required reporting starting in 2014, could adversely affect our costs, the availability of minerals used in our products and our relationships with customers and suppliers. Also, since our supply chain is complex, we may face reputational challenges with our customers, stockholders, and other stakeholders if we are unable to sufficiently verify the origins for any conflict minerals used in the products that we sell.

 

We are subject to the cyclical nature of the semiconductor industry, which has suffered and may suffer from future recessionary downturns.

 

The semiconductor industry is highly cyclical and is characterized by constant and rapid technological change, rapid product obsolescence and price erosion, evolving standards and wide fluctuations in product supply and demand. The industry experienced a significant downturn during the current global recession. These downturns have been characterized by diminished product demand, production overcapacity, high inventory levels and accelerated erosion of average selling prices. The most recent downturn and any future downturns could negatively impact our business and operating results. Furthermore, any upturn in the semiconductor industry could result in increased competition for access to third-party foundry and assembly capacity. We are dependent on the availability of this capacity to manufacture and assemble our integrated circuits. None of our third-party foundry or assembly contractors has provided assurances that adequate capacity will be available to us in the future.

 

 

Our products must conform to industry standards in order to be accepted by end-users in our markets.

 

Our products comprise only a part of larger electronic systems. All components of these systems must uniformly comply with industry standards in order to operate efficiently together. These industry standards are often developed and promoted by larger companies who are industry leaders and provide other components of the systems in which our products are incorporated. In driving industry standards, these larger companies are able to develop and foster product ecosystems within which our products can be used. We work with a number of these larger companies in helping develop industry standards with which our products are compatible. If larger companies do not support the same industry standards that we do, or if competing standards emerge, market acceptance of our products could be adversely affected, which would harm our business.

 

Some industry standards may not be widely adopted or implemented uniformly, and competing standards may still emerge that may be preferred by our customers. Products for communications and computing applications are based on industry standards that are continually evolving. Our ability to compete in the future will depend on our ability to identify and ensure compliance with these evolving industry standards. The emergence of new industry standards could render our products incompatible with products developed by other suppliers or make it difficult for our products to meet the requirements of certain OEMs. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our products to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards for a significant period of time, we could miss opportunities to achieve crucial design wins. We may not be successful in developing or using new technologies or in developing new products or product enhancements that achieve market acceptance. Our pursuit of necessary technological advances may require substantial time and expense.

 

Industry consolidation may lead to increased competition and may harm our operating results.

 

There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to improve the leverage of growing research and development costs, strengthen or hold their market positions in an evolving industry or are unable to continue operations. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in our operating results and could have a material adverse effect on our business, operating results and financial condition.

 

 

Risks Related to Our Common Stock

 

The trading price and volume of our common stock is subject to price volatility. This volatility may affect the price at which you could sell our common stock.

 

The trading price of our common stock has experienced wide fluctuations. For example, the closing sale prices for our common stock have ranged from $33.87 to $51.40 in the twelve-month period ended December 31, 2017.  The closing sale prices or our common stock have ranged from $24.44 to $38.98 between January 1, 2018 and February 23, 2018.  Volatility in the market price of our common stock may occur in the future in response to many risk factors discussed herein and others beyond our control, including but not limited to:

 

 

actual or anticipated fluctuations in our financial condition and operating results;

 

 

changes in the economic performance or market valuations of other companies that provide high-speed analog semiconductor solutions;

 

 

loss of a significant amount of existing business;

 

 

actual or anticipated changes in our growth rate relative to our competitors;

 

 

actual or anticipated fluctuations in our competitors’ operating results or changes in their growth rates;

 

 

issuance of new or updated research or reports by securities analysts;

 

 

our announcement of actual results for a fiscal period that are higher or lower than projected results or our announcement of revenue or earnings guidance that is higher or lower than expected;

 

 

regulatory developments in our target markets affecting us, our customers or our competitors;

 

 

fluctuations in the valuation of companies perceived by investors to be comparable to us;

 

 

share price and volume fluctuations attributable to inconsistent trading volume levels of our shares;

 

 

sales or expected sales of additional common stock or equity or equity-linked securities;

 

 

terrorist attacks or natural disasters or other such events impacting countries where we or our customers have operations; and

 

 

general economic and market conditions.

 

 

Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions such as recessions, interest rate changes or international currency fluctuations, may cause the market price of shares of our common stock to decline. In the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business. Each of these factors, among others, could harm the value of our common stock.

 

Due to the nature of our compensation program, our executive officers can sell shares of our common stock, often pursuant to trading plans established under Rule 10b5-1 of the Exchange Act, and certain of our executive officers currently have 10b5-1 trading plans in place. As a result, sales of common stock by our executive officers may not be indicative of their respective opinions of our performance at the time of sale or of our potential future performance. Nonetheless, the market price of our common stock may be affected by sales of shares by our executive officers.

 

If securities or industry analysts do not publish research or reports about our business, or if they change their recommendations regarding our stock adversely, our stock price and trading volume could decline.

 

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

We may not be able to obtain capital when desired on favorable terms, if at all, or without dilution to our stockholders and our failure to raise capital when needed could prevent us from executing our growth strategy.

 

We believe that our existing cash and cash equivalents, investments in marketable securities, and cash flows from our operating activities, will be sufficient to meet our anticipated cash needs for at least the next 12 to 18 months. We operate in an industry, however, that makes our financial prospects difficult to evaluate. It is possible that we may not generate sufficient cash flow from operations or otherwise have the capital resources to meet our future capital needs. If this occurs, we may need additional financing to execute on our current or future business strategies, including to:

 

 

invest in our research and development efforts by hiring additional technical and other personnel;

 

 

expand our operating infrastructure;

 

 

acquire complementary businesses, products, services or technologies; or

 

 

otherwise pursue our strategic plans and respond to competitive pressures.

 

If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operational flexibility, and would also require us to incur interest expense. There is no assurance that additional financing will be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, if and when needed, our ability to fund our operations, take advantage of unanticipated opportunities, develop or enhance our products, or otherwise respond to competitive pressures could be significantly limited.

 

Delaware law and our corporate charter and bylaws contain anti-takeover provisions that could delay or discourage takeover attempts that stockholders may consider favorable, which could also reduce the market price of our common stock.

 

Provisions in our restated certificate of incorporation and amended and restated bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

 

the right of our board of directors to elect a director to fill a vacancy created by the expansion of our board of directors;

 

 

the classification of our board of directors so that only a portion of our directors are elected each year, with each director serving a three-year term;

 

 

the requirement for advance notice for nominations for election to our board of directors or for proposing matters that can be acted upon at a stockholders’ meeting;

 

 

the ability of our board of directors to alter our bylaws without obtaining stockholder approval;

 

 

 

the ability of our board of directors to issue, without stockholder approval, up to 10,000,000 shares of preferred stock with rights set by our board of directors, which rights could be senior to those of common stock;

 

 

the required approval of holders of at least two-thirds of the shares entitled to vote at an election of directors to adopt, amend or repeal our bylaws or amend or repeal the provisions of our certificate of incorporation regarding the election and removal of directors and the ability of stockholders to take action by written consent;

 

 

the elimination of the right of stockholders to call a special meeting of stockholders and to take action by written consent; and

 

 

designating the state and federal courts located within the State of Delaware as the exclusive forums for derivative actions, claims of breach of fiduciary duty by any director, officer or other employee, claims arising pursuant to any provisions of the Delaware General Corporation Law and claims governed by the internal affairs doctrine.

 

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit or restrict large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our restated certificate of incorporation and amended and restated bylaws and under Delaware law could discourage potential takeover attempts and could reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price of our common stock being lower than they would without these provisions.

 

We do not currently intend to pay dividends on our common stock and, consequently, the ability to achieve a return on an investment in our stock will depend on appreciation in the price of our common stock.

 

We have never declared or paid any cash dividends on our common stock and do not currently intend to do so for the foreseeable future. We currently intend to invest our future earnings, if any, to fund our growth. The success of an investment in shares of our common stock will depend upon any future appreciation in their value. There is no guarantee that our common stock will appreciate in value.

 

 

Item 1b.

Unresolved Staff Comments

 

None.

 

 

Item 2.

Properties

 

We lease 57,914 square feet of office space in Santa Clara, California, which currently serves as our principal executive office that will expire on September 17, 2019, as well as 11,036 square feet of office space that expires on December 31, 2019. We also lease 42,197 square feet of office space in Westlake Village, California under a lease that will expire on December 31, 2024. We also lease 27,797 square feet of office in Irvine, California under a lease that will expire on July 31, 2019. Our Singapore subsidiary currently leases 6,378 square feet of office space in Singapore under a lease that will expire on April 30, 2020. Our United Kingdom subsidiary currently leases office space in Northamptonshire, England under a lease that will expire on April 2, 2026. We also occupy space in Folsom, California, consisting of 7,532 square feet of office space under a lease that will expire on November 30, 2020, and space in Durham, North Carolina, consisting of 1,572 square feet of office space under a lease that expires on May 31, 2020. Our Canada subsidiary currently leases 13,951 square feet of office space in Ottawa, Canada under a lease that will expire on October 31, 2021, as well as 1,546 square feet of office space in Vancouver, Canada under a lease that expires on June 30, 2020. Our Argentina subsidiary currently leases 6,100 square feet of office space in Cordoba, Argentina, as well as 1,700 square feet of office space that are both under a lease that will expire on February 28, 2018, and 12,300 square feet of office space that expires on September 30, 2022. We believe that our current facilities are sufficient to meet our needs for the foreseeable future. For additional information regarding our obligations under property leases, see Note 17 of Notes to Consolidated Financial Statements, included in Part II, “Item 8, Financial Statements and Supplementary Data.”

 

 

Item 3.

Legal Proceedings

 

We are currently a party to the following legal proceedings:

 

Netlist, Inc. v. Inphi Corporation, Case No. 09-cv-6900 (C.D. Cal.)

 

On September 22, 2009, Netlist filed suit in the United States District Court, Central District of California, or the Court, asserting that we infringe U.S. Patent No. 7,532,537. Netlist filed an amended complaint on December 22, 2009, further asserting that we infringe U.S. Patent Nos. 7,619,912 and 7,636,274, collectively with U.S. Patent No. 7,532,537, the patents-in-suit, and seeking both unspecified monetary damages to be determined and an injunction to prevent further infringement. These infringement claims allege that our iMB™ and certain other memory module components infringe the patents-in-suit. We answered the amended complaint on February 11, 2010 and asserted that we do not infringe the patents-in-suit and that the patents-in-suit are invalid. In 2010, we filed inter partes requests for reexamination with the United States Patent and Trademark Office (the “USPTO”), asserting that the patents-in-suit are invalid. As a result of the proceedings at the USPTO, the Court has stayed the litigation, with the parties advising the Court on status every 120 days.

 

 

As to the proceeding at the USPTO, reexamination has been ordered for all of the patents that were alleged to infringe, and at present, the USPTO has determined that none of the originally filed claims are valid, with certain amended claims being determined patentable. The Reexamination Certificate for U.S. Patent No. 7,532,537 was issued on August 2, 2016 based upon amended claims, and the parties continue to assert their respective positions with respect to the reexamination proceedings for U.S. Patent Nos. 7,619,912 and 7,636,274.

 

While we intend to defend the foregoing USPTO proceedings and lawsuit vigorously, the USPTO proceedings and litigation, whether or not determined in our favor or settled, could be costly and time-consuming and could divert management’s attention and resources, which could adversely affect our business.

 

Based on the nature of USPTO proceedings and litigation, we are currently unable to predict the final outcome of this lawsuit and therefore, cannot determine the likelihood of loss nor estimate a range of possible loss. However, because of the nature and inherent uncertainties of litigation, should the outcome of these actions be unfavorable, our business, financial condition, results of operations or cash flows could be materially and adversely affected.

 

Other Litigation Matters

 

There are possible claims by certain customers of ClariPhy associated with matters occurring prior to the acquisition date.  We are currently reviewing whether or not these claims are valid, and we are unable to reasonably estimate the amount of any potential liability at this time.  Amounts payable as a result of these claims may be recoverable from the escrow set up as part of the ClariPhy acquisition.

 

We are not currently a party to any other material litigation. The semiconductor industry is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. We may from time to time become involved in litigation relating to claims arising from our ordinary course of business. These claims, even if not meritorious, could result in the expenditure of significant financial and managerial resources.

 

 

Item 4.

MINE SAFETY DISCLOSURES

 

Not applicable.

 

 

PART II

 

Item 5.   

Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market for Registrant’s Common Equity

 

Our common stock is traded on the New York Stock Exchange under the symbol “IPHI”. The following table sets forth the range of high and low sales prices for our common stock in each quarter:

 

 

2017

 

Low

   

High

 

Fourth Quarter

  $ 35.18     $ 44.32  

Third Quarter

    33.60       40.99  

Second Quarter

    33.00       49.00  

First Quarter

    41.62       51.78  

 

2016

 

Low

   

High

 

Fourth Quarter

  $ 35.92     $ 48.46  

Third Quarter

    29.73       44.54  

Second Quarter

    25.89       34.87  

First Quarter

    22.07       34.61  

 

As of February 23, 2018, we had approximately 44 holders of record of our common stock. This number does not include the number of persons whose shares are in nominee or in “street name” accounts through brokers.

 

We have never declared or paid any cash dividends on shares of our capital stock. We expect to retain all of our earnings to finance the expansion and development of our business and we do not currently intend to pay any cash dividends on our capital stock in the foreseeable future. Our board of directors will determine future dividends, if any.

 

Directors and executive officers have currently and may from time to time in the future, establish pre-set trading plans in accordance with Rule 10b5-1 promulgated under the Securities Exchange Act of 1934.

 

 

Securities Authorized for Issuance under Equity Compensation Plans

 

Information regarding the securities authorized for issuance under our equity compensation plans can be found under Part III, “Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.

 

  

Share Performance Graph

 

  

The following information is not deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing.

 

 

Set forth below is a line graph showing the cumulative total stockholder return (change in stock price plus reinvested dividends) assuming the investment of $100 on December 31, 2012 in each of our common stock, the S&P 500 Index and PHLX Semiconductor Index for the period commencing on December 31, 2012 and ending on December 31, 2017. The comparisons in the table are required by the Securities and Exchange Commission and are not intended to forecast or be indicative of future performance of our common stock.

 

 

 

 

Item 6.

Selected Consolidated Financial Data

 

The following selected consolidated financial data should be read together with Part II, “Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this report. The selected balance sheet data as of December 31, 2017 and 2016, and the selected statements of operations data for each of the years ended December 31, 2017, 2016, and 2015 have been derived from our audited financial statements included elsewhere in this report. The selected balance sheet data as of December 31, 2015, 2014 and 2013 have been derived from our audited financial statements not included in this report. Our statements of operations have been retrospectively reclassified to present the results of operations of the memory product business as discontinued operations. Historical results are not necessarily indicative of the results to be expected in the future.

 

   

Year Ended December 31,

 
   

2017

   

2016

   

2015

   

2014

   

2013

 
   

(in thousands, except share and per share data)

 

Consolidated Statement of Operations Data:

                                       

Revenue(1)

  $ 348,201     $ 266,277     $ 192,710     $ 96,145     $ 42,951  

Cost of revenue(1) (2) (3)

    151,698       85,581       72,694       44,244       14,933  

Gross profit

    196,503       180,696       120,016       51,901       28,018  

Operating expenses:

                                       

Research and development(1) (2) (3)

    200,539       108,013       87,774       56,508       38,248  

Sales and marketing(1) (2)

    42,381       26,534       21,462       15,136       10,935  

General and administrative(1) (2)

    23,782       21,201       20,322       16,153       11,614  

Total operating expenses

    266,702       155,748       129,558       87,797       60,797  

Income (loss) from operations

    (70,199 )     24,948       (9,542 )     (35,896 )     (32,779 )

Interest expense(4)

    (29,842 )     (17,406 )     (783 )            

Other income

    3,961       3,914       221       495       876  

Income (loss) before income taxes from continuing operations

    (96,080 )     11,456       (10,104 )     (35,401 )     (31,903 )

Provision (benefit) for income taxes(5)

    (21,176 )     (15,057 )     5,857       1,131       1,221  

Net income (loss) from continuing operations

    (74,904 )     26,513       (15,961 )     (36,532 )     (33,124 )

Discontinued operations:

                                       

Gain from sale

          78,544                    

Income (loss) from discontinued operations

          (3,802 )     4,535       14,531       20,476  

Provision for income taxes

          (1,799 )     (2,125 )     (607 )     (530 )

Net income from discontinued operations

          72,943       2,410       13,924       19,946  

Net income (loss)

  $ (74,904 )   $ 99,456     $ (13,551 )   $ (22,608 )   $ (13,178 )

Earnings per share:

                                       

Basic

                                       

Net income (loss) from continuing operations

  $ (1.78 )   $ 0.65     $ (0.41 )   $ (1.12 )   $ (1.12 )

Net income from discontinued operations

          1.80     $ 0.06       0.43       0.67  

Basic earnings per share

  $ (1.78 )   $ 2.45     $ (0.35 )   $ (0.69 )   $ (0.45 )

Diluted

                                       

Net income (loss) from continuing operations

  $ (1.78 )   $ 0.60     $ (0.41 )   $ (1.12 )   $ (1.12 )

Net income from discontinued operations

          1.65     $ 0.06       0.43       0.67  

Diluted earnings per share

  $ (1.78 )   $ 2.25     $ (0.35 )   $ (0.69 )   $ (0.45 )

Weighted-average shares used in computing earnings per share:

                                       

Basic

    42,165,213       40,565,433       38,580,330       32,707,868       29,493,005  

Diluted

    42,165,213       44,124,881       38,580,330       32,707,868       29,493,005  

 


 

 

(1)

On October 3, 2014, we completed the acquisition of Cortina, including its high-speed interconnect and optical transport product lines, for approximately $52.5 million in cash and approximately 5.3 million shares of our common stock. On December 12, 2016, we completed the acquisition of ClariPhy for $303.7 million in cash. The results of operations of Cortina and ClariPhy and estimated fair value of assets acquired and liabilities assumed were included in our consolidated financial statements from the acquisition dates. The acquisitions resulted in a significant change in our statement of operations in 2017, 2016, 2015 and 2014 which includes:

 

(i)

Charge to cost of goods sold resulting from the step-up inventory acquired from Cortina and ClariPhy; and

 

(ii)

Charge to cost of goods sold and operating expenses from amortization of acquired intangibles.

 

 

Footnotes continued on the following page.

 

 

 

   

As of December 31,

 
   

2017

   

2016

   

2015

   

2014

   

2013

 
   

(in thousands)

 

Consolidated Balance Sheet Data:

                                       

Cash and cash equivalents

  $ 163,450     $ 144,867     $ 283,044     $ 30,366     $ 31,667  

Investments in marketable securities

    241,737       249,476       43,616       38,908       90,890  

Working capital

    457,062       433,250       344,897       108,623       129,013  

Total assets

    917,506       990,595       505,046       278,459       182,342  

Long-term convertible debt

    421,431       396,857       171,701              

Other liabilities

    84,674       131,214       42,675       39,285       22,949  

Total stockholders’ equity

    411,401       462,524       290,670       239,174       159,393  

 

 


Footnotes continued from the prior page.

 

(2)

Stock-based compensation expense is included in our results of operations as follows:

 

   

Year Ended December 31,

 
   

2017

   

2016

   

2015

   

2014

   

2013

 
    (in thousands)  

Operating expenses:

                                       

Cost of revenue

  $ 2,045     $ 1,796     $ 1,359     $ 1,154     $ 1,021  

Research and development

    28,846       17,390       13,268       9,670       6,177  

Sales and marketing

    8,340       4,405       3,213       2,998       2,080  

General and administrative

    5,602       4,407       5,473       4,701       4,102  

Discontinued operations

          2,194       4,980       3,937       3,598  

 

(3)

Cost of revenue and research and development expenses for the year ended December 31, 2017 included an impairment charge of $47.0 million as a result of abandonment of a project related to certain developed technology and in-process research and development from the ClariPhy acquisition.

 

(4)

The interest expense resulted from convertible debts issued in December 2015 and September 2016.

 

(5)

The benefit for income taxes for the year ended December 31, 2016 included the release of valuation allowance against deferred tax assets as a result of acquisition of ClariPhy. The benefit for income taxes for the year ended December 31, 2017 included revaluation of deferred tax liabilities to the new federal tax rate of 21% and tax benefit from intercompany transfer of intellectual property rights.

 

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and this report contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, the terms “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “estimate,” “predict,” “potential,” “plan,” “anticipate,” “seek,” “future,” “strategy,” “likely,” or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements include statements regarding our anticipated trends and challenges in our business and the markets in which we operate, including the market for 25G to 600G high-speed analog semiconductor solutions, demand for our current products, our plans for future products and anticipated features and benefits thereof, expansion of our product offerings and enhancements of existing products, anticipated benefits of our acquisition of ClariPhy and divestiture of our memory product business, critical accounting policies and estimates, our expectations regarding our expenses and revenue, sources of revenue, our tax benefits, the benefits of our products and services, our technological capabilities and expertise, timing of the development of our products, our liquidity position and sufficiency thereof, including our anticipated cash needs and uses of cash, our operating and capital expenditures and requirements and our needs for additional financing and potential consequences thereof, repatriation of cash balances from our foreign subsidiaries, our contractual obligations, our anticipated growth and growth strategies, our ability to retain and attract customers, particularly in light of our dependence on a limited number of customers for a substantial portion of our revenue, competition, interest rate sensitivity, adequacy of our disclosure controls, our legal proceedings and warranty claims. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these or any other forward-looking statements. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as factors affecting our results of operations, our ability to manage our growth, our ability to sustain or increase profitability, demand for our solutions, the effect of declines in average selling prices for our products, our ability to compete, our ability to rapidly develop new technology and introduce new products, our ability to safeguard our intellectual property, our ability to qualify for tax holidays and incentives, trends in the semiconductor industry and fluctuations in general economic conditions, and the risks set forth throughout this Report, including the risks set forth under Part I, “Item 1A, Risk Factors. Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management's opinions only as of the date hereof. These forward-looking statements speak only as of the date of this Report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any changes in events, conditions or circumstances on which any such statement is based.

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes that are included elsewhere in this Annual Report on Form 10-K.

 

Overview

 

We are a fabless provider of high-speed analog and mixed signal semiconductor solutions for the communications and datacenter markets. Our analog and mixed signal semiconductor solutions provide high signal integrity at leading-edge data speeds while reducing system power consumption. Our semiconductor solutions are designed to address bandwidth bottlenecks in networks, maximize throughput and minimize latency in computing environments and enable the rollout of next generation communications and datacenter infrastructures. Our solutions provide a vital high-speed interface between analog signals and digital information in high-performance systems such as telecommunications transport systems, enterprise networking equipment and datacenters. We provide 25G to 600G high-speed analog semiconductor solutions for the communications market. We have a wide range of products in our portfolio with many products sold in communication and datacenter markets as of December 31, 2017. We have ongoing, informal collaborative discussions with industry and technology leaders such as Ciena Corporation, Cisco Systems, Inc., Huawei Technologies Co., Ltd., Juniper Networks, Inc., Microsoft Corporation and Nokia Corporation, to design architectures and products that solve bandwidth bottlenecks in existing and next generation communications systems. Although we do not have any formal agreements with these entities, we engage in informal discussions with these entities with respect to anticipated technological challenges, next generation customer requirements and industry conventions and standards. We help define industry conventions and standards within the markets we target by collaborating with technology leaders, OEMs, systems manufacturers and standards bodies.

 

The recent history of our product development and sales and marketing efforts is as follows:

 

 

In 2009, we began development of our low power CMOS SerDes product for next generation 100G Ethernet in enterprise networks.

 

 

In 2010, we introduced and began to ship in commercial volume the industry’s first transimpedance ampliform for 100G reconfigurable colorless networks, which we identify as product number 2850TA-SO1D.

 

 

In 2011, we shipped engineering samples of our Optical PHY 100 Gb/sec CMOS CDR and SerDes Gearbox products.

 

 

 

In 2012, we started shipping samples of the IN3250TA, our second-generation transimpedance amplifier, or TIA, for 100G reconfigurable colorless networks. We also introduced the industry’s first quad linear driver designed for linear transmitters to enable next-generation 100G/400G coherent systems to address the need for higher speed and higher performance networking infrastructure. We also announced the availability of the world’s first production ready 100G CMOS PHY/SerDes Gearbox products for next-generation data center, enterprise and service provider line cards.

 

 

In 2013, we introduced the second generation 100G CMOS SerDes gearbox integrated circuit, or GB IC, for data center, enterprise and service provider line cards. The new GB IC with Tri-ratefoundation is designed to enable seamless support of 10G, 40G and 100G Ethernet and optical transport network on a single line card. We also began shipping the industry’s first quad linear driver designed for linear transmitters to enable next-generation 100G/400G coherent systems to address the need for higher speed, higher performance networking infrastructure.

 

 

In 2014, we completed the acquisition of Cortina Systems Inc. which expands our market share of the high-speed optical and networking interconnects. This added more than 130 products to our portfolio, including high-speed interconnect and optical transport products. We also started sampling the IN3252TA, the industry’s first 32 Gbps dual high gain linear/variable-gain amplifier. The IN3252TA is designed specifically to address the demanding requirements for 100G coherent transmission for the metro market. We also announced the availability of a new iKON™ family of 100G Clock and Data Recovery Retimer integrated circuits (IC) targeted at next-generation 2-Terabit line cards. The first product in this series, the IN112525-LC 100G CMOS CDR Retimer IC, is designed to accelerate deployment for higher density 100G in service center and data center networks. We also announced the availability of IN3216DZ, the first single chip quad channel linear Mach Zehnder driver in bare die form to address the network needs for 100G coherent systems in small form factors for the metro market. Specifically designed to be co-packaged with MZ modulators, the IN3216DZ will reduce size and cost of 100G coherent systems to enable higher density metro solutions. We also started sampling 45GBaud Linear Coherent Product Family, the industry’s first linear ICs enabling 400G coherent solutions for next-generation metro to long haul applications. The initial product offerings includes IN4514SZ, a high-performance octal linear differential to single-ended Mach-Zehnder Modulator Driver and IN4550TA, a quad linear TIA/VGA Amplifier.

 

 

In 2015, we started sampling a new product in our 45GBaud Linear Coherent Product Family, IN4518SZ. The IN4518SZ is a quad linear differential to single-ended Mach-Zehnder Modulator Driver, pin-compatible with the linear driver IN3214SZ, for 200G coherent Optical interconnect applications. The IN4518SZ extends the reach of 200G coherent for long haul applications and enables one set of hardware to serve multiple segments in the long haul and metro markets. We also announced the availability of the industry’s first, highly integrated, lowest power 4-level Pulse Amplitude Modulation (PAM4) chipset solutions for intra-data center and inter-data center cloud interconnects. The PAM4 chipset solution is a family of PAM4 PHY ICs for 40G (IN014020-XL), 50G (IN015050-SF), 100G (IN015025-CA), 400G (IN015025-CD) and a companion linear TIA (IN2860TA) to enable platform solutions for multi-rate PAM4 interconnects. We also started sampling IN3217SZ, a quad linear differential to single-ended Mach-Zehnder Modulator Driver in a Surface Mount Technology (SMT) package. The new SMT quad linear driver extends the product portfolio by utilizing cost effective packaging for higher volume 100G/200G coherent long haul and metro optical interconnect applications.

 

 

In 2016, we completed the acquisition of ClariPhy Communications, Inc. With this acquisition, we expect to provide a complete coherent platform to our customers in long haul, metro, and datacenter interconnect applications. We also introduced ColorZ® reference design, the industry’s first Silicon Photonics 100G PAM4 platform solution for 80km DWDM Data Center Interconnect in QSFP28 form factor. Utilizing advanced Pulse Amplitude Modulation signaling, ColorZ® delivers up to 4Tb/s of bandwidth over a single fiber and allows multiple data centers located up to 80 km of each other to be connected and act like a single data center. We further introduced a highly integrated Silicon Photonics (SiPho) technology platform for 100Gbit/s data center applications. The single-chip SiPho optics includes multi-channel modulators, photodetectors, multiplexers, demultiplexers, optical power monitors and fiber coupling structures all integrated onto a single integrated circuit. We also announced the availability of the industry’s lowest power Clock and Data Recovery Retimer for module applications, IN012525-CQ CMOS CDR and 45GBaud Linear Coherent Product Family, the industry’s first linear ICs enabling 400G coherent solutions for next-generation long haul, metro, and data center applications. We also announced the industry’s first 400GbE platform solution for next-generation 400G CFP8 modules. The platform solution includes our PAM4 digital signal processing (DSP) IC that supports IEEE P802.3bs 400G/s Ethernet standard alongside its companion market leading linear TIA and linear drivers for client based cloud interconnects. With the introduction of these new products, we are offering customers an end-to-end platform solution for moving data faster within and between data centers. We also announced the production availability of a new product in the 32GBaud Linear Coherent Product Family. The IN3217SZ, a quad linear Mach-Zehnder Modulator Driver in a SMT package, extends the product portfolio by utilizing cost effective packaging for the 100G/200G coherent long haul and metro optical interconnect applications. We also announced the sampling of IN6450TA, the world’s first 64GBaud dual channel linear TIA/VGA amplifier. The IN6450TA supports data rates of 400Gbps to 600Gbps on a single wavelength for long haul, metro, and data center interconnect networks using coherent technology.

 

 

 

In 2017, we started sampling IN6417SZ, the industry’s first 64GBaud quad linear differential to single-ended Mach-Zehnder Modulator Driver in 14x9 mm Surface Mount Technology (SMT) package. This new 64GBaud SMT quad linear driver extends our 64G product portfolio for next-generation 400G/600G coherent, long haul, and metro optical interconnect applications. We introduced Polaris™, the industry’s first 16nm CMOS 4-level Pulse Amplitude Modulation (PAM4) platform solution for next-generation cloud deployments. The Polaris platform includes our highly integrated, lowest power PAM4 digital signal processing IC alongside its companion market leading, low power linear driver and TIA for data center connectivity. We announced the commercial availability and production ramp of ColorZ®, the industry’s first Silicon Photonics 100G PAM4 platform solution for 80km DWDM Data Center Interconnect in QSFP28 form factor, and our IN6450TA, the world’s first 64GBaud dual channel linear TIA/VGA amplifier. We also announced the new Vega™ family of low power 50/100/200/400G PAM4 Gearbox and Retimer Digital Signal Processor (DSP)s for system line cards. Leveraging our DSP-based PAM4, the new Gearbox and Retimer DSPs expand bandwidth capacity of next generation networks, delivering accelerated connectivity for wired network infrastructure at cloud-scale data centers, enterprise, and service providers. We also started sampling our M200, an ultra-low power, and high-performance Coherent DSP, supporting 100G and 200G data rates for long haul, metro and data center interconnect applications. We announced the expansion of our ColorZ® portfolio with ColorZ-Lite™, 100G DWDM in QSFP28 form factor for campus and data center interconnects. The addition of ColorZ-Lite™ offers campus and data centers a cost optimized solution for shorter distances up to 20 km. We also expanded our 16nm Polaris™ PAM4 DSP portfolio for next generation 50G-400G cloud deployments. The new Polaris™ PAM4 DSP now includes products supporting an integrated driver to address the growing demands for lower power and reduced cost solutions over short reach data center optical connectivity.

 

Our products are designed into systems sold by OEMs, including Ciena, Cisco, Huawei, Juniper, Microsoft and Nokia. We believe we are one of a limited number of suppliers to these OEMs for the types of products we sell, and in some cases we may be the sole supplier for certain applications. We sell both directly to these OEMs and to module manufacturers, original design manufacturers, or ODMs, and subsystems providers that, in turn, sell to these OEMs. During the year ended December 31, 2017, we sold our products to more than 100 customers. A significant portion of our revenue has been generated by a limited number of customers. We believe that sales to Microsoft, Huawei, and Cisco, directly and indirectly, through subcontractors, accounted for approximately 17%, 14%, and 11% of our total revenue, respectively, in the year ended December 31, 2017. In the year ended December 31, 2016, we believe that sales to Huawei and Cisco, directly and indirectly, through subcontractors, accounted for approximately 16% and 12% of our total revenue, respectively. In the year ended December 31, 2015, we believe that sales to Huawei and Cisco, directly and indirectly, through subcontractors, accounted for approximately 11% and 17% of our total revenue, respectively. Substantially all of our sales to date, including our sales to Microsoft, Huawei and Cisco, are made on a purchase order basis. Since the beginning of 2006, we have shipped more than 50 million high-speed analog semiconductors. Our total revenue increased to $348.2 million, $266.3 million and $192.7 million for the years ended December 31, 2017, 2016, and 2015, respectively. The increase in our revenue was primarily a result of the increase in consumption of our ColorZ®, ClariPhy products and Cortina legacy components due to announced end of life programs.

 

Sales to customers in Asia accounted for 62%, 70% and 62% of our total revenue in 2017, 2016 and 2015, respectively. Because many of our customers or their OEM manufacturers are located in Asia, we anticipate that a majority of our future revenue will continue to come from sales to that region. Although a large percentage of our sales are made to customers in Asia, we believe that a significant number of the systems designed by these customers are then sold to end-users outside Asia.

 

In April 2010, we received approval from the government of Singapore to set up an international headquarters from which to conduct our international operations. Because of its geographic alignment with suppliers and customers, we established our operations in Singapore to become a new international headquarters office for receiving and fulfilling orders for product shipped to locations outside the United States. Singapore has a strong university system and an established group of technology-based companies from which to recruit new engineers. We intend to build a team of engineering capability in Singapore both for development as well as testing associated with manufacturing. International operations in Singapore commenced on May 1, 2010 and during 2010, we transitioned our international operations from the United States to our Singapore subsidiary.

 

Demand for new features changes rapidly. It is difficult for us to forecast the demand for our products, in part because of the complex supply chain between us and the end-user markets that incorporate our products. Due to our lengthy product development cycle, it is critical for us to anticipate changes in demand for our various product features and the applications they serve to allow sufficient time for product development and design. Our failure to accurately forecast demand can lead to product shortages that can impede production by our customers and harm our customer relationships. Conversely, our failure to forecast declining demand or shifts in product mix can result in excess or obsolete inventory.

 

 

Although revenue generated by each design win and the timing of the recognition of that revenue can vary significantly, we consider ongoing design wins to be a key factor in our future success. We consider a design win to occur when an OEM or contract manufacturer notifies us that it has selected our products to be incorporated into a product or system under development. The design win process is typically lengthy, and as a result, our sales cycles will vary based on the market served, whether the design win is with an existing or new customer and whether our product is under consideration for inclusion in a first or subsequent generation product. In addition, our customers’ products that incorporate our semiconductors can be complex and can require a substantial amount of time to define, design and produce in volume. As a result, we can incur significant design and development expenditures in circumstances where we do not ultimately recognize, or experience delays in recognizing revenue. Our customers generally order our products on a purchase order basis. We do not have any long-term purchase commitments (in excess of one year) from any of our customers. Once our product is incorporated into a customer’s design, however, we believe that our product is likely to continue to be purchased for that design throughout that product’s life cycle because of the time and expense associated with redesigning the product or substituting an alternative semiconductor. Our design cycle from initial engagement to volume shipment is typically two to three years. Product life cycles in the markets we serve typically range from five to 10 years or more and vary by application.

 

Summary of Consolidated Financial Results

 

As discussed in more detail below, for the year ended December 31, 2017, compared to the year ended December 31, 2016, we delivered the following financial performance. The financial results for the years ended December 31, 2017 and 2016, include the results of operations of ClariPhy from the acquisition date and the effect of purchase price accounting.

 

 

Total revenue increased by $81.9 million, or 31% to $348.2 million.

 

Gross profit as a percentage of revenue decreased from 68% to 56%.

 

Total operating expenses increased by $111.0 million, or 71% to $266.7 million.

 

Loss from operations increased by $95.1 million to $70.2 million.

 

Benefit for income taxes was $21.2 million in 2017, compared to $15.1 million in 2016.

 

Diluted earnings per share from continuing operations decreased by $2.38 to ($1.78).

 

During the year ended December 31, 2017, we abandoned a project related to certain developed technology and in-process research and development that resulted to an impairment charge of $47.0 million. The abandonment of the project was primarily related to change in product roadmap following the acquisition of ClariPhy.

 

During the year ended December 31, 2017, we recorded a tax benefit of $21.2 million which includes the revaluation of deferred tax liabilities to the new federal tax rate of 21% and the tax effect of intercompany transfer of intellectual property rights.

 

The increase in our revenue for the year ended December 31, 2017 was a result of increase in consumption of our ColorZ®, ClariPhy products and Cortina legacy components due to announced end of life programs.

 

The decrease in gross margin was mainly due to amortization of inventory fair value step-up of acquired inventories, amortization and impairment of acquired intangibles related to the ClariPhy acquisition and change in product mix for the year ended December 31, 2017.

 

Total operating expenses increased due primarily to an impairment of in-process research and development cost of $36.8 million, and increase in headcount and stock-based compensation expense primarily from increase in headcount. Our expenses mainly consist of personnel costs, which include compensation, benefits, payroll related taxes and stock-based compensation. From December 31, 2016 to December 31, 2017, our headcount increased by 49 new employees, mostly in the engineering department. In addition, the acquisition of ClariPhy added 144 employees. We expect expenses to continue to increase in absolute dollars as we continue to invest resources to develop more products, to support the growth of our business. Our diluted earnings per share from continuing operations decreased primarily due to increases in operating expenses and interest expense from convertible debt issued in September 2016, partially offset by an increase in revenue.

 

 

Critical Accounting Policies and Significant Management Estimates

 

Our consolidated financial statements are prepared in accordance with U.S. Generally Accepted Accounting Principles, or GAAP. In connection with the preparation of our consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

 

 

Our significant accounting policies are discussed in Note 1 of the Notes to our Consolidated Financial Statements. We believe that the following accounting estimates are the most critical to aid in fully understanding and evaluating our reported financial results, and they require our most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. We have reviewed these critical accounting estimates and related disclosures with our audit committee.

 

Revenue Recognition

 

Our products are fully functional at the time of shipment and do not require additional production, modification or customization. We recognize revenue from product sales when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collection is reasonably assured. Our fee is considered fixed or determinable at the execution of an agreement, based on specific products and quantities to be delivered at specified prices, which is evidenced by a customer purchase order or other persuasive evidence of an arrangement. Our agreements with non-distributor customers do not include rights of return or acceptance provisions. Product revenue is recognized upon shipment of product to customers, net of accruals for estimated sales returns and allowances, which to date, have not been significant.

 

Approximately 18% of our sales were made through third-party distributors in 2017. Sales to distributors are included in deferred revenue and we include the related costs in inventory until sales and delivery to the end customers occurs. Certain distributors may receive a credit for the price discounts associated with the distributors' customers that purchased those products. We estimate the extent of these distributor price discounts at each reporting period to reduce accounts receivable and deferred revenue, but we do not issue these discounts to the distributor until the inventory is sold to the distributors' customers. Revenue recognition on product sales through distributors is highly dependent on receiving pertinent and accurate data from our distributors in a timely fashion. Distributors provide us periodic data prior to the release of our consolidated financial statements regarding the product, price, quantity and end customer when products are resold, as well as the quantities of our products they still have in stock.

 

We recognize revenue from the sales and licensing of certain intellectual properties when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the sales price is fixed or determinable, and (iv) collection of resulting receivables is reasonably assured.

 

We monitor collectability of accounts receivable primarily through review of the accounts receivable aging. Our policy is to record an allowance for doubtful accounts based on specific collection issues we have identified, aging of underlying receivables and historical experience of uncollectible balances. As of both December 31, 2017 and 2016, our allowance for doubtful accounts was $155,000.

 

We have not made any material changes in the accounting methodology we use to record the allowance for doubtful accounts during the past three years. If actual results are not consistent with the assumptions and estimates used, for example, if the financial condition of the customer deteriorated, we may be required to record additional expense that could materially negatively impact our operating results. To date, however, substantially all of our receivables have been collected within the following quarter.

 

Inventory Valuation

 

We value our inventory, which includes materials, labor and overhead, at the lower of cost or market. Cost is computed using standard cost, which approximates actual cost, on a first-in, first-out basis. We periodically write-down our inventory to the lower of cost or market based on our estimates that consider historical usage and future demand. These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction. The calculation of our inventory valuation requires management to make assumptions and to apply judgment regarding forecasted customer demand and technological obsolescence that may turn out to be inaccurate. Inventory valuation reserves were $3,133,000 and $3,967,000 as of December 31, 2017 and 2016, respectively. Inventory valuation reserves, once established, are not reversed until the related inventory has been sold or scrapped.

 

We have not made any material changes in the accounting methodology we use to record inventory reserves during the past three years. We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions that we use to calculate our inventory reserve. However, if estimates regarding customer demand are inaccurate or changes in technology affect demand for certain products in an unforeseen manner, we may be exposed to losses or gains that could be material.

 

Product Warranty

 

Our products are under warranty against defects in material and workmanship generally for a period of one or two years. We accrue for estimated warranty cost at the time of sale based on anticipated warranty claims and actual historical warranty claims experience including knowledge of specific product failures that are outside of our typical experience. The warranty obligation is determined based on product failure rates, cost of replacement and failure analysis cost. We monitor product returns for warranty-related matters and monitor both a specific and general accrual for the related warranty expense based on specific circumstances and general historical experience. Our warranty obligation requires management to make assumptions regarding failure rates and failure analysis costs. If actual warranty costs differ significantly from these estimates, adjustments may be required in the future, which would adversely affect our gross margins and operating results. The warranty liability as of December 31, 2017 and 2016 was $110,000.

 

 

Business combinations

 

We use the acquisition method of accounting for business combinations and recognize assets acquired and liabilities assumed measured at their fair values on the date acquired. This requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed. While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we may adjust the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recognized in our consolidated statements of operations.

 

Accounting for business combinations requires our management to make significant estimates and assumptions, especially at the acquisition date, including our estimates for intangible assets, contractual obligations assumed and pre-acquisition contingencies, where applicable. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, they are based, in part, on historical experience and information obtained from the management of the acquired companies and are inherently uncertain. Critical estimates in valuing certain of the intangible assets we have acquired include, but are not limited to: future expected cash flows from product sales, customer contracts and acquired technologies, expected costs to develop in-process research and development into commercially viable products, estimated cash flows from the projects when completed, and discount rates. Unanticipated events and circumstances may occur that may affect the accuracy or validity of such assumptions, estimates or actual results.

 

Goodwill and Long-Lived Assets

 

Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the acquired net tangible and intangible assets. We evaluate goodwill on an annual basis in the fourth quarter or more frequently if we believe indicators of impairment exist. Significant management judgment is required in performing periodic impairment tests. To review for impairment, we first assess qualitative factors to determine whether events or circumstances lead to a determination that it is more likely than not that the fair value of any of our reporting unit is less than its carrying amount. Our qualitative assessment of the recoverability of goodwill, whether performed annually or based on specific events or circumstances, considers various macroeconomic, industry-specific and company-specific factors. Those factors include: (i) severe adverse industry or economic trends; (ii) significant company-specific actions, including exiting an activity in conjunction with restructuring of operations; (iii) current, historical or projected deterioration of our financial performance; or (iv) a sustained decrease in our market capitalization below our net book value. After assessing the totality of events and circumstances, if we determine that it is not more likely than not that the fair value of any of our reporting unit is less than its carrying amount, no further assessment is performed. If however, we determine that it is more likely than not that the fair value of any of our reporting unit is less than its carrying amount, we calculate the fair value of that reporting unit and compare the fair value to the reporting unit’s net book value. The estimate of implied fair value of goodwill may require valuations of certain internally generated and unrecognized intangible assets such as our technology, customer relationships, patents and trademarks. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

 

We assess the impairment of long-lived assets, which consist primarily of property and equipment and intangible assets, including purchased in-process research and development, whenever events or changes in circumstances indicate that such assets might be impaired and the carrying value may not be recoverable. Events or changes in circumstances that may indicate that an asset is impaired include significant decreases in the market value of an asset, significant underperformance relative to expected historical or projected future results of operations, a change in the extent or manner in which an asset is utilized, significant declines in the estimated fair value of the overall Company for a sustained period, shifts in technology, loss of key management or personnel, changes in the Company’s operating model or strategy and competitive forces. If events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable and the expected undiscounted future cash flows attributable to the asset are less than the carrying amount of the asset, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded. Fair value is determined based on the present value of estimated expected future cash flows using a discount rate commensurate with the risk involved, quoted market prices or appraised values, depending on the nature of the assets. Assumptions and estimates about future values and remaining useful lives are complex and often subjective.

 

The acquisition of ClariPhy on December 12, 2016 increased our goodwill and identifiable intangible assets by $96,637,000 and $235,898,000, respectively. During the year ended December 31, 2017, we abandoned a project related to certain developed technology and in-process research and development that resulted to an impairment charge of $47,014,000. The abandonment of the project was primarily related to change in product roadmap following the acquisition of ClariPhy. See Note 2 to the Notes to our Consolidated Financial Statements. There was no evidence of additional impairment based on the annual impairment testing for the year ended December 31, 2017.

 

 

Stock-Based Compensation

 

We account for stock-based compensation in accordance with authoritative guidance which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on the grant date fair values of the awards. The fair value of stock option awards is estimated using the Black-Scholes option pricing model. The fair value of restricted stock units is based on the fair market value of our common stock on the date of grant. The performance-based stock units are subject to the achievement of a pre-established revenue goal and earnings per share on a non-GAAP basis.  Once the goals are met, the performance-based stock units are subject to four years of vesting from the original grant date, contingent upon continuous service.  The fair value of the performance-based stock units is calculated using the same method as our standard restricted stock units described above once the performance goals are met. The value of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated statements of operations. We elected to treat share-based payment awards with graded vesting schedules and time-based service conditions as a single award and recognize stock-based compensation expense on a straight-line basis (net of estimated forfeitures) over the requisite service period. Stock-based compensation expenses are classified in the consolidated statement of operations based on the department to which the related employee reports.

 

We account for stock options issued to non-employees in accordance with the guidance for equity-based payments to non-employees. Stock option awards to non-employees are accounted for at fair value using the Black-Scholes option pricing model. Our management believes that the fair value of stock options is more reliably measured than the fair value of the services received. The fair value of the unvested portion of the options granted to non-employees is re-measured each period. The resulting increase in value, if any, is recognized as expense during the period the related services are rendered.

 

The Black-Scholes option pricing model requires management to make assumptions and to apply judgment in determining the fair value of our awards. The most significant assumptions and judgments include estimating the fair value of underlying stock, expected volatility and expected term. In addition, the recognition of stock-based compensation expense is impacted by estimated forfeiture rates.

 

Historically, we granted stock options to employees. We estimated the expected volatility from the historical volatilities of several unrelated public companies within the semiconductor industry because our common stock has limited trading history. When selecting the public companies used in the volatility calculation, we selected companies in the semiconductor industry with comparable characteristics to us, including stage of development, lines of business, market capitalization, revenue and financial leverage. The weighted average expected life of options was calculated using the simplified method. This decision was based on the lack of relevant historical data due to our limited experience and the lack of active market for our common stock. The risk-free interest rate is based on the U.S. Treasury yields in effect at the time of grant for periods corresponding to the expected term of the options. The expected dividend rate is zero based on the fact that we have not historically paid dividends and have no intention to pay cash dividends in the foreseeable future. The forfeiture rate is established based on the historical average period of time that options were outstanding and adjusted for expected changes in future exercise patterns.

 

We do not believe there is a reasonable likelihood that there will be material changes in the estimates and assumptions we use to determine stock-based compensation expense. In the future, if we determine that other valuation models are more reasonable, the stock-based compensation expense that we record in the future may differ significantly from what we have recorded using the Black-Scholes option pricing model.

 

Income Taxes

 

Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when and where the differences are expected to reverse. We recognize the deferred income tax effects of a change in tax rates in the period of enactment. We record a valuation allowance to reduce deferred tax assets to the amount that we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we consider all positive and negative evidence, including scheduled reversals of deferred tax liabilities, historical levels of income, projections of future income, expectations and risk associated with estimates of future taxable income and ongoing prudent and practical tax planning strategies. To the extent that we believe it is more likely than not that some portion of our deferred tax assets will not be realized, we would increase the valuation allowance against deferred tax assets. The determination of recording or releasing a tax valuation allowance is made, in part, pursuant to an assessment performed by management regarding the likelihood that we will generate sufficient future taxable income against which the benefits of our deferred tax assets may or may not be realized. This assessment requires management to exercise significant judgment and make estimates with respect to our ability to generate revenue, gross profits, operating income and taxable income in future periods. Among other factors, management must make assumptions regarding current and projected overall business and semiconductor industry conditions, operating efficiencies, our ability to timely develop, introduce and consistently manufacture new products to meet our customers’ needs and specifications, our ability to adapt to technological changes and the competitive environment, which may impact our ability to generate taxable income and, in turn, realize the value of our deferred tax assets. Although we believe that the judgment we used is reasonable, actual results can differ due to a change in market conditions, changes in tax laws and other factors.

 

 

We have valuation allowance against deferred tax assets for the years ended December 31, 2017, 2016 and 2015. The valuation allowance was established due to negative evidence that included our cumulative losses in the U.S. and various foreign subsidiaries, after considering permanent tax differences. During the year ended December 31, 2016, we released a portion of the federal valuation allowance against deferred tax assets as a result of the consolidation of our deferred tax assets with ClariPhy’s deferred tax liabilities. We also released the entire Singapore valuation allowance as a result of the full utilization of the Singapore deferred tax asset during the year primarily due to the gain from the sale of the memory product business, yielding a deferred tax liability as of December 31, 2016. During the year ended December 31, 2017, we released a portion of the federal and state valuation allowance against certain deferred tax assets that were deemed more likely than not to be realized. The valuation allowance release resulted in the recognition of an income tax benefit.

 

In accordance with FASB’s guidance on Accounting for Uncertainty in Income Taxes, we perform a comprehensive review of uncertain tax positions regularly. The guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken, or expected to be taken, in a tax return. We determine the tax liability for uncertain tax positions based on a two-step process. The first step is to determine whether it is more likely than not based on technical merits that each income tax position would be sustained upon examination. The second step is to measure the tax benefit as the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement with a tax authority that has full knowledge of all relevant information. The assessment of each tax position requires significant judgment and estimates. We believe our tax return positions are fully supported, but tax authorities could challenge certain positions, which may not be fully sustained. All tax positions are periodically analyzed and adjusted as a result of events, such as the resolution of tax audits, issuance of new regulations or new case law, negotiations with tax authorities, and expiration of statutes of limitations.

 

On December 22, 2017, the Tax Reform Act was signed into law. The Tax Reform Act contains significant changes to U.S. federal corporate income taxation, including a reduction of the corporate tax rate from 35% to 21% effective January 1, 2018, a one-time transition tax on deemed mandatory repatriation of accumulated earnings and profits of foreign subsidiaries in conjunction with the elimination of U.S. tax on dividend distributions from foreign subsidiaries, and a temporary 100% first-year depreciation deduction for certain capital investments. The effect of the tax law changes must be recognized in the period of enactment. As a result of the change in tax rate, our deferred tax assets and liabilities are required to be remeasured to reflect their value at a lower tax rate of 21%. In December 2017, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. We are in the process of completing the evaluation of the Tax Reform Act on our business and financial condition. We have made reasonable estimates of the effects of the tax law changes, including the remeasurement of our existing deferred tax balances and mandatory repatriation of deferred foreign earnings. The final impact of the Tax Reform Act may differ from the provisional estimate due to forthcoming guidance in interpretation of the law and accounting, or further refinement of our analysis.

 

 

Results of Operations and Key Operating Metrics

 

The following describes the line items in the statements of operations, which we consider to be our key operating metrics.

 

Revenue. We generate revenue from sales of our semiconductor products to end customers. A portion of our products is sold indirectly to customers through distributors.

 

We design and develop high-speed analog semiconductor solutions for the communications and datacenter markets. Our revenue is driven by various trends in these markets. These trends include the deployment and broader market adoption of next generation 400G technologies in communications and enterprise networks and the timing of next generation network.

 

Our revenue is also impacted by changes in the number and average selling prices of our semiconductor products. Our products are typically characterized by a life cycle that begins with higher average selling prices and lower volumes, followed by broader market adoption, higher volumes, and average selling prices that are lower than initial levels.

 

We operate in industries characterized by rapidly changing technologies and industry standards as well as technological obsolescence. Our revenue growth is dependent on our ability to continually develop and introduce new products to meet the changing technology and performance requirements of our customers, diversify our revenue base and generate new revenue to replace, or build upon, the success of previously introduced products which may be rapidly maturing. As a result, our revenue is impacted to a more significant extent by product life cycles for a variety of products and to a much lesser extent, if any, by any single product. We introduced ColorZ® in 2016 and began to ship in commercial volume in 2017. Sales of ColorZ® comprised 17% of our total revenue in 2017. In 2012, we introduced and began to ship in commercial volume a dual, differential input linear transimpedance/variable-gain amplifier that we identify as product number IN3250TA-SO2D. Sales of IN3250TA-SO2D product comprised 10%, 25% and 18% of our total revenue in 2017, 2016 and 2015, respectively.

 

 

 

The following table is based on the geographic location to which our product is initially shipped. In most cases this will differ from the ultimate location of the end-user of a product containing our technology. For sales to our distributors, their geographic location may be different from the geographic locations of the ultimate end customer. Sales by geography for the periods indicated were:

 

   

Year Ended December 31,

 
   

2017

   

2016

   

2015

 
   

(in thousands)

 

China

  $ 114,168     $ 103,071     $ 61,448  

United States

    92,620       29,976       34,605  

Japan

    29,061       36,308       24,410  

Thailand

    45,205       35,837       25,123  

Other

    67,147       61,085       47,124  
    $ 348,201     $ 266,277     $ 192,710  

 

Cost of revenue. Cost of revenue includes cost of materials such as wafers processed by third-party foundries, costs associated with packaging and assembly, testing and shipping, cost of personnel, including stock-based compensation, as well as equipment associated with manufacturing support, logistics and quality assurance, warranty costs, write-down of inventories, amortization of production mask costs, amortization and impairment of developed technology, amortization of step-up values of inventory, overhead and other indirect costs, such as allocated occupancy and information technology, or IT, costs.

 

As some semiconductor products mature and unit volumes increase, their average selling prices may decline. These declines are often paired with improvements in manufacturing yields and lower wafer, assembly and test costs, which offset some of the margin reduction that results from lower prices. However, our gross profit, period over period, may fluctuate as a result of changes in average selling prices due to new product introductions or existing product transitions into larger scale commercial volumes, manufacturing costs as well as our product and customer mix.

 

Research and development. Research and development expense includes personnel-related expenses, including salaries, stock-based compensation and employee benefits. It also includes pre-production engineering mask costs, software license expenses, prototype wafer, packaging and test costs, design and development costs, testing and evaluation costs, third-party fees paid to consultants, depreciation expense, impairment of in-process research and development, allocated facilities costs and other indirect costs. All research and development costs are expensed as incurred. We enter into development agreements with some of our customers. Recoveries from nonrecurring engineering services related to early stage technology are recorded as an offset to product development expense incurred in support of this effort and serve as a mechanism to partially recover development expenditures. These reimbursements are recognized upon completion and acceptance by the customer of contract deliverables or milestones. We expect research and development expense to increase in absolute dollars as we continue to invest resources to develop more products and enhance our existing product portfolio.

 

Sales and marketing. Sales and marketing expense consists primarily of salaries, stock-based compensation, employee benefits, travel, promotions, trade shows, marketing and customer support, commission payments to employees, depreciation expense and other indirect costs. We expect sales and marketing expense to increase in absolute dollars to support the growth of our business and promote our products to current and potential customers.

 

General and administrative. General and administrative expense consists primarily of salaries, stock-based compensation, employee benefits and expenses for executive management, legal, and finance. In addition, general and administrative expenses include fees for professional services and other indirect costs. We expect general and administrative expense to increase in absolute dollars due to the general growth of our business and the costs associated with continuing to be a public company for, among other things, SEC reporting and compliance, director fees, insurance, transfer agent fees and similar expenses.

 

Provision (benefit) for income taxes. For the year ended December 31, 2015, we recorded a provision for income taxes of $5.9 million, which reflects an effective tax rate of (58%). The effective tax rate of (58%) differs from the statutory rate of 34% primarily due to increase in valuation allowance, foreign income taxes provided at lower rates, geographic mix in profitability, unrecognized tax benefits, stock-based compensation adjustment, taxation of Subpart F income, and recognition of research and development credits. For the year ended December 31, 2016, we recorded an income tax benefit of $15.1 million, which reflects an effective tax rate of (131%). The effective tax rate of (131%) differs from the statutory rate of 34% primarily due to change in valuation allowance, foreign income taxes provided at lower rates, geographic mix in profitability, unrecognized tax benefits, stock-based compensation adjustments, transaction cost adjustments and recognition of research and development credits. The change in valuation allowance during the year ended December 31, 2016, included an income tax benefit of $17.8 million from the partial release of federal valuation allowance and full release of Singapore valuation allowance. The partial release of the federal valuation allowance against deferred tax assets resulted from the consolidation of the Company’s federal deferred tax assets with ClariPhy’s federal deferred tax liabilities. The full release of the Singapore valuation allowance against deferred tax assets resulted from the Company’s full utilization of its deferred tax asset during the year primarily due to the gain from the sale of the memory product business. For the year ended December 31, 2017, we recorded an income tax benefit of $21.2 million, which reflects an effective tax rate of 22%. The effective tax rate of 22% differs from the statutory rate of 34% primarily due to the effects of the Tax Reform Act that was enacted on December 22, 2017, change in valuation allowance, foreign income taxes provided at lower rates, geographic mix in profitability, unrecognized tax benefits, stock-based compensation adjustments, and recognition of research and development credits. The change in valuation allowance during the year ended December 31, 2017, included an income tax benefit of $1.1 million from the partial release of valuation allowance against certain federal and state deferred tax assets that were deemed more likely than not to be realized.

 

 

The following table sets forth a summary of our statement of operations for the periods indicated:

  

   

Year Ended December 31,

 
   

2017

   

2016

   

2015

 
   

(in thousands)

 

Revenue

  $ 348,201     $ 266,277     $ 192,710  

Cost of revenue

    151,698       85,581       72,694  

Gross profit

    196,503       180,696       120,016  

Operating expenses:

                       

Research and development

    200,539       108,013       87,774  

Sales and marketing

    42,381       26,534       21,462  

General and administrative

    23,782       21,201       20,322  

Total operating expenses

    266,702       155,748       129,558  

Income (loss) from operations

    (70,199 )     24,948       (9,542 )

Interest expense

    (29,842 )     (17,406 )     (783 )

Other income

    3,961       3,914       221  

Income (loss) before income taxes from continuing operations

    (96,080 )     11,456       (10,104 )

Provision (benefit) for income taxes

    (21,176 )     (15,057 )     5,857  

Net income (loss) from continuing operations

    (74,904 )     26,513       (15,961 )

Discontinued operations:

                       

Gain from sale

          78,544        

Income (loss) from discontinued operations

          (3,802 )     4,535  

Provision for income taxes

          (1,799 )     (2,125 )

Net income from discontinued operations

          72,943       2,410  

Net income (loss)

  $ (74,904 )   $ 99,456     $ (13,551 )

 

 

The following table sets forth a summary of our statement of operations as a percentage of each line item to the revenue:

 

   

Year Ended December 31,

 
   

2017

   

2016

   

2015

 

Revenue

    100 %     100 %     100 %

Cost of revenue

    44       32       38  

Gross profit

    56       68       62  

Operating expenses:

                       

Research and development

    57       40       45  

Sales and marketing

    12       10       11  

General and administrative

    7       8       11  

Total operating expenses

    76       58       67  

Income (loss) from operations

    (20 )     10       (5 )

Interest expense

    (9 )     (7 )      

Other income

    1       1        

Income (loss) before income taxes from continuing operations

    (28 )     4       (5 )

Provision (benefit) for income taxes

    (6 )     (6 )     3  

Net income (loss) from continuing operations

    (22 )     10       (8 )

Discontinued operations:

                       

Gain from sale

          29        

Income (loss) from discontinued operations

          (1 )     2  

Provision for income taxes

          (1 )     (1 )

Net income from discontinued operations

          27       1  

Net income (loss)

    (22 )%     37 %     (7 )%

 

 

 Comparison of the Years Ended December 31, 2017, 2016 and 2015

 

Revenue

 

   

 

   

Change

 
     Year Ended December 31,             

2017

   

2016

 
   

2017

   

2016

   

2015

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

Total revenue

  $ 348,201     $ 266,277     $ 192,710     $ 81,924       31 %   $ 73,567       38 %

 

Total revenue for the year ended December 31, 2017 increased by $81.9 million mainly due to increase in the number of units sold by 69%, partially offset by a decrease in average selling price (ASP) of 22%. The sales volumes were up in particular due to announced end of life programs on the legacy components. The ASP decreased by 22% primarily due to product mix. Legacy products contributed to the significant decline in ASP because of larger shipments to customers due to end of life programs we initiated in 2017. In addition, revenue from high-priced products such as quad linear driver and optical PHY products decreased. Excluding legacy and ClariPhy products, the ASP of other products generally increased due to product mix, mainly due to ColorZ®.

 

Total revenue for the year ended December 31, 2016 increased by $73.6 million due to a year over year increase in ASP of 12% and an increase in the number of units sold of 23%. The increases in ASP and number of units sold was due to product mix, mainly from the sale of dual linear TIA, quad linear driver products and Optical PHY products, including new product introductions.

 

 

Cost of Revenue and Gross Profit

 

                           

Change

 
    Year Ended December 31,    

2017

   

2016

 
   

2017

   

2016

   

2015

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

Cost of revenue

  $ 151,698     $ 85,581     $ 72,694     $ 66,117       77 %   $ 12,887       18 %

Gross profit

    196,503       180,696       120,016       15,807       9 %     60,680       51 %

Gross profit as a percentage of revenue

    56 %     68 %     62 %           (12% )           6 %

 

 

Cost of revenue and gross profit for the year ended December 31, 2017 increased by $66.1 million and $15.8 million, respectively, compared to the prior year primarily due to increase in revenue from sales of ColorZ®, ClariPhy products and Cortina legacy components. In addition, we recorded an impairment charge of $10.2 million of certain developed technology from the ClariPhy acquisition during 2017. Gross profit as a percentage of revenue decreased, due to impairment charge of $10.2 million of certain developed technology, increase in amortization of inventory fair value step-up related to acquired ClariPhy inventories sold in 2017 of $8.4 million, increase in amortization of acquired ClariPhy intangible assets of $16.3 million and product mix.

 

Cost of revenue and gross profit for the year ended December 31, 2016 increased by $12.9 million and $60.7 million, respectively, compared to the prior year primarily due to increased sales and mix of our higher margin products, including dual linear TIA, quad linear driver products and Optical PHY products. Gross profit as a percentage of revenue increased due to sale of high margin products and higher product cost in 2015 as a result of inventory fair value step-up related to the acquired Cortina inventories sold in 2015.

 

 

Research and Development

 

                           

Change

 
    Year Ended December 31,    

2017

   

2016

 
   

2017

   

2016

   

2015

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

Research and development

  $ 200,539     $ 108,013     $ 87,774     $ 92,526       86 %   $ 20,239       23 %

 

Research and development expense for the year ended December 31, 2017 increased by $92.5 million primarily due to an increase in research and development headcount, salaries and equity awards, which resulted in increase in personnel costs and stock-based compensation expense by $15.8 million and $11.5 million, respectively. During 2017, we abandoned a project related to in-process research and development costs, which resulted in an impairment charge of $36.8 million. CAD software tool license expense increased by $9.3 million due to an increase in headcount and engineering activities. Testing, laboratory supplies, packaging and pre-production engineering mask costs increased by $2.6 million. Depreciation, consulting and allocated expenses increased by $14.3 million due to an increase in equipment and research and development activities. The increase in research and development expense was primarily driven by the acquisition of ClariPhy and our strategy to continue to expand our product offerings and enhance our existing product offerings.

 

Research and development expense for the year ended December 31, 2016 increased by $20.2 million due to the increase in personnel costs and stock-based compensation expense of $5.5 million and $4.1 million, respectively, which in turn was also partially due to an increase in research and development headcount in 2016. In addition, CAD software tool license expense increased by $2.3 million, primarily due to an increase in headcount and engineering activities. Further, the reimbursement from customers related to research and development contracts was higher by $8.3 million in 2015 due to completion of development contracts entered with the customers. Depreciation and allocated expenses also increased by $3.5 million, primarily, due to an increase in equipment and research and development activities. The increases were partially offset by the absence of an impairment charge related to abandoned in-process research and development costs of $1.8 million in 2015. The increase in research and development expense was primarily driven by our strategy to continue to expand our product offerings and enhance our existing products.

 

 

Sales and Marketing

 

                           

Change

 
   

Year Ended December 31,

   

2017

   

2016

 
   

2017

   

2016

   

2015

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

Sales and marketing

  $ 42,381     $ 26,534     $ 21,462     $ 15,847       60 %   $ 5,072       24 %

 

Sales and marketing expense for the year ended December 31, 2017 increased by $15.8 million, primarily due to an increase in personnel costs, including stock-based compensation expense of $7.1 million due in part to the addition of ClariPhy employees and to support increasing sales activities from new products. In addition, amortization of intangible assets related to the ClariPhy acquisition increased by $8.5 million.

 

Sales and marketing expense for the year ended December 31, 2016 increased by $5.1 million, primarily due to an increase in personnel costs, including stock-based compensation expense of $2.9 million, to support increasing sales activities from new developed products. Commission expense increased by $0.6 million due to higher compensation and higher revenue. In addition, amortization of intangible asset related to the ClariPhy acquisition was $0.4 million. Product samples and trade shows expense increased by $0.5 million primarily associated with new products introduced into the market.

 

 

General and Administrative

 

                           

Change

 
    Year Ended December 31,    

2017

   

2016

 
   

2017

   

2016

   

2015

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

General and administrative

  $ 23,782     $ 21,201     $ 20,322     $ 2,581       12 %   $ 879       4 %

 

General and administrative expenses for the year ended December 31, 2017 increased by $2.6 million, primarily due to salaries and stock-based compensation of $1.3 million, which resulted from a mix of salary increases and new hires. Accounting and consulting fees increased by $0.8 million in relation to acquisition of ClariPhy. Allocated expenses increased by $1.1 million mainly due to increase in facility leases and information technology expenses. The increases were partially offset by a decrease in outside legal fees by $0.9 million due to expenses incurred in 2016 in connection with the ClariPhy acquisition.

 

General and administrative expenses for the year ended December 31, 2016 increased by $0.9 million, primarily due to increase in outside legal fees of $1.1 million in connection with the acquisition of ClariPhy and an increase in salaries of $0.9 million due to higher salaries and new hires. The increases were partially offset by a decrease in stock-based compensation by $1.1 million in connection with the completion of four year vesting of an initial grant to an officer in the first quarter 2016.

 

 

Provision (benefit) for Income Taxes

 

                           

Change

 
    Year Ended December 31,    

2017

   

2016

 
   

2017

   

2016

   

2015

   

Amount

   

%

   

Amount

   

%

 
   

(dollars in thousands)

 

Provision (benefit) for income taxes

  $ (21,176 )   $ (15,057 )   $ 5,857     $ (6,119 )     (41 %)   $ (20,914 )     (357 %)

 

For the year ended December 31, 2017, we recorded an income tax benefit of $21.2 million, which reflects an effective tax rate of 22%. The effective tax rate of 22% differs from the statutory rate of 34% primarily due to the effects of the Tax Reform Act that was enacted on December 22, 2017, change in valuation allowance, foreign income taxes provided at lower rates, geographic mix in profitability, unrecognized tax benefits, stock-based compensation adjustments, and recognition of research and development credits. The change in valuation allowance during the year ended December 31, 2017, included an income tax benefit of $1.1 million from the partial release of federal and state valuation allowance.

 

For the year ended December 31, 2016, we recorded an income tax benefit of $15.1 million, which reflects an effective tax rate of (131%). The effective tax rate of (131%) differs from the statutory rate of 34% primarily due to the change in valuation allowance, foreign income taxes provided at lower rates, geographic mix in profitability, unrecognized tax benefits, stock-based compensation adjustments, transaction cost adjustments, and recognition of research and development credits. The change in valuation allowance during the year ended December 31, 2016 included an income tax benefit of $17.8 million from the partial release of federal valuation allowance and full release of the Singapore valuation allowance. The partial release of the federal valuation allowance against deferred tax assets resulted from the consolidation of the Company’s federal deferred tax assets with ClariPhy’s federal deferred tax liabilities. The full release of the Singapore valuation allowance against deferred tax assets resulted from the Company’s full utilization of its deferred tax asset during the year primarily due to the gain from the sale of the memory product business.

 

For the year ended December 31, 2015, we recorded a provision for income taxes of $5.9 million, which reflects an effective tax rate of (58%). The effective tax rate of (58%) differs from the statutory rate of 34% primarily due to change in the valuation allowance, foreign income taxes provided at lower rates, geographic mix in profitability, unrecognized tax benefits, stock-based compensation adjustments, taxation of Subpart F income and recognition of research and development credits.

 

Our effective tax rate in the future will depend upon the proportion of our income before provision for income taxes earned in the United States and in jurisdictions with a tax rate lower than the U.S. statutory rate, as well as a number of other factors, including excess tax benefits from share-based compensation, changes to our provisional accounting for the effects of the Tax Reform Act during the measurement period, settlement of tax contingency items, and the impact of new legislation.

 

Liquidity and Capital Resources

 

As of December 31, 2017, we had cash and cash equivalents and investments in marketable securities of $405.2 million. Our primary uses of cash are to fund operating expenses, purchase inventory, acquire property and equipment and business acquisitions. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, as reflected in the changes in our outstanding accounts payable and accrued expenses. Our primary sources of cash are cash receipts on accounts receivable from our revenue. In 2016 and 2015, we issued convertible debt, which resulted in an increase in cash and cash equivalents. Aside from the growth in amounts billed to our customers, net cash collections of accounts receivable are impacted by the efficiency of our cash collections process, which can vary from period to period, depending on the timing of shipments and payment cycles of our major customers.

 

 

The following table summarizes our cash flows for the periods indicated:

 

   

Years Ended December 31,

 
   

2017

   

2016

   

2015

 
   

(in thousands)

 

Net cash provided by operating activities

  $ 77,308     $ 63,073     $ 72,543  

Net cash used in investing activities

    (38,341 )     (448,213 )     (23,871 )

Net cash provided by (used in) financing activities

    (20,384 )     246,963       204,006  

Net increase (decrease) in cash and cash equivalents

  $ 18,583     $ (138,177 )   $ 252,678  

 

Net Cash Provided by Operating Activities

 

Net cash provided by operating activities in 2017 primarily reflected depreciation and amortization of $77.9 million, stock-based compensation expense of $44.8 million, impairment of intangible assets of $47.0 million, accretion of convertible debt of $24.6 million, amortization of premiums on marketable securities of $1.0 million, decreases in prepaid expenses and other assets of $2.3 million, and increase in accounts payable of $1.7 million, partially offset by a net loss of $74.9 million, deferred income taxes of $22.4 million, a change in income tax payable/receivable of $0.6 million, increase in accounts receivable of $17.4 million, and decreases in deferred revenue of $3.2 million, accrued expenses of $0.6 million and other liabilities of $3.0 million. Our prepaid expenses and other assets decreased mainly due to receipt of funds for  a claim from escrow related to the ClariPhy acquisition. Our accounts payable increased due to increased production volume and timing of payments. Our accounts receivable increased due to higher product shipments to customers and longer payment terms of some customers. Our deferred revenue decreased due to lower inventory in the distributors.  Our accrued expenses and other liabilities decreased mainly due to the timing of payments.

 

Net cash provided by operating activities in 2016 primarily reflected net income of $99.5 million, depreciation and amortization of $31.2 million, stock-based compensation of $30.2 million, amortization of deferred tax charge of $0.9 million, amortization of premiums on marketable securities of $1.5 million, accretion of convertible debt and amortization of issuance expenses of $14.2 million, a change in income tax payable/receivable of $1.4 million, an increase in accounts payable of $3.5 million and other liabilities by $2.0 million, partially offset by a gain from sale of discontinued operations and cost method investment of $79.7 million, deferred income taxes of $15.5 million, increases in accounts receivable of $17.0 million, inventories of $6.4 million, prepaid expenses of $1.4 million and a decrease in deferred revenue of $1.3 million. Our accounts payable increased due to increased production volume. Our other liabilities increased due to amounts payable to Rambus. Our accounts receivable increased due to higher product shipments to customers and longer credit term. Our inventories increased as a result of growing production for expected delivery to customers in the first quarter of 2017. Our prepaid expenses and other assets increased due to additional subscriptions. Our deferred revenue decreased due to the sale of our memory product business.

 

Net cash provided by operating activities in 2015 primarily reflected depreciation and amortization of $26.9 million, stock-based compensation of $28.3 million, loss on disposal and abandonment of property and equipment of $1.9 million, impairment of in-process research and development of $1.8 million, amortization of deferred tax charge of $0.9 million, amortization of premiums on marketable securities of $0.5 million, accretion of convertible debt and amortization of issuance expenses of $0.6 million, decreases in accounts receivable by $6.5 million, inventories of $8.8 million, prepaid expenses and other assets of $2.2 million, change in income tax payable/receivable by $6.4 million and an increase in accrued expenses by $3.4 million, partially offset by a net loss of $13.6 million and a decrease in other liabilities of $1.4 million. Our accounts receivable decreased due to collections from customers. Our inventories decreased due to shipments to customers and amortization of fair value step-up on Cortina inventories. Our prepaid expenses and other current assets decreased due to settlement of a non-trade receivable. Our accrued expenses increased due to accrual of employee related expenses. Other liabilities decreased due to deposits received from customers used in 2015 and decrease in deferred rent on building leases.

 

Net Cash Used in Investing Activities

 

In 2017, net cash used in investing activities consisted of cash used to purchase investment in marketable securities of $261.2 million, payment of debt related to purchase of intangible assets of $16.1 million, purchases of property and equipment of $37.4 million, mainly for laboratory, production and computer equipment, and remittance of remaining balance due to shareholders of ClariPhy of $1.8 million, partially offset by sales and maturities of marketable securities of $267.5 million and proceeds from the sale of discontinued operations previously held in escrow of $10.7 million.

 

 

In 2016, net cash used in investing activities consisted of cash used to purchase investment in marketable securities of $330.6 million, the acquisition of ClariPhy for $294.4 million, net of cash acquired, purchases of property and equipment of $22.3 million, mainly for laboratory, production and computer equipment and leasehold improvements for our offices, and the purchase of minority interest in an early stage private companies for $8.0 million, partially offset by sales and maturities of marketable securities of $122.1 million, proceeds from the sale of discontinued operations of $78.8 million and cost method investment of $6.3 million.

 

In 2015, net cash used in investing activities consisted of cash used to purchase investment in marketable securities of $21.9 million, purchases of property and equipment of $16.6 million, mainly for laboratory, production and computer equipment and software and the purchase of a minority interest in an early stage private company for $2.0 million, partially offset by sales and maturities of marketable securities of $16.5 million.

 

Net Cash Provided by (Used in) Financing Activities

 

Net cash used by financing activities in 2017 consisted primarily of minimum tax withholding paid on behalf of employees for restricted stock units of $27.7 million and payment of capital lease obligations of $1.0 million; partially offset by proceeds from the exercise of stock options and employee stock purchase plan totaling $8.0 million and repayment of long-term loan provided to a supplier of $0.3 million.

 

Net cash provided by financing activities in 2016 consisted primarily of net proceeds from issuance of convertible debt of $279.5 million and proceeds from the exercise of stock options and employee stock purchase plan of $11.3 million. This was partially offset, by the purchase of capped call options related to convertible debt issued of $22.5 million, minimum tax withholding paid on behalf of employees for net share settlement of $20.4 million and a loan to a supplier of $0.7 million.

 

Net cash provided by financing activities in 2015 consisted primarily of the net proceeds from the issuance of convertible debt of $224 million and proceeds from the exercise of stock options and employee stock purchase plan of $10.7 million. This was offset, in part, by the purchase of capped call options related to convertible debt issued of $17.8 million and minimum tax withholding paid on behalf of employees for net share settlement of $12.9 million.

 

Operating and Capital Expenditure Requirements

 

Our principal sources of liquidity as of December 31, 2017 consisted of $405.2 million of cash, cash equivalents and investments in marketable securities. Based on our current operating plan, we believe that our existing cash and cash equivalents and investments in marketable securities from operations will be sufficient to finance our operational cash needs through at least the next 12 - 18 months. In the future, we expect our operating and capital expenditures to increase as we increase headcount, expand our business activities and grow our end customer base which will result in higher needs for working capital. Our ability to generate cash from operations is also subject to substantial risks described in Part I, “Item 1A., Risk Factors.” If any of these risks occur, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash and cash equivalents to support our working capital and other cash requirements. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through equity or debt financing or from other sources. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility, and would also require us to incur interest expense. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us.

 

Contractual Obligations, Commitments and Contingencies

 

The following table summarizes our outstanding contractual obligations as of December 31, 2017:

 

   

Payments due by period

 
   

Total

    Less
Than

1 Year
    1-3
Years
   

 

3-5

Years

   

More
Than
5 Years

 
   

(in thousands)

 

Convertible debt

  $ 517,500           $ 230,000     $ 287,500        

Interest payable on convertible debt

    16,388     $ 4,744       9,488       2,156        

Operating lease obligations

    21,332       5,815       8,484       3,712     $ 3,321  

Obligations related to intangibles

    33,986       17,983       16,003              

Obligations under capital lease

    1,623       662       868       93        

 

 

As of December 31, 2017, we recorded a liability for our uncertain tax position of $0.8 million. We are unable to reasonably estimate the timing of payments in individual years due to uncertainties in the timing of the effective settlement of tax positions.

 

We depend upon third-party subcontractors to manufacture our wafers. Our subcontractor relationships typically allow for the cancellation of outstanding purchase orders, but require payment of all expenses incurred through the date of cancellation. As of December 31, 2017, the total value of open purchase orders for wafers was approximately $7.3 million. As of December 31, 2017, we have a commitment to pay $2.2 million for equipment and software license starting in 2018 and mask of $0.6 million.

 

 

Off-Balance Sheet Arrangements

 

Since our inception, we have not engaged in any off-balance sheet arrangements, such as the use of structured finance, special purpose entities or variable interest entities.

 

Recent Authoritative Accounting Guidance

 

See Note 1 of the Notes to our Consolidated Financial Statements for information regarding recently issued accounting pronouncements.

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

Interest Rate Sensitivity

 

We had cash and cash equivalents and investments in marketable securities of $405.2 million and $394.3 million at December 31, 2017 and December 31, 2016, respectively, which was held for working capital purposes. Our exposure to market interest-rate risk relates primarily to our investment portfolio. We do not use derivative financial instruments to hedge the market risks of our investments. We manage our total portfolio to encompass a diversified pool of investment-grade securities to preserve principal and maintain liquidity. We place our investments with high-quality issuers, money market funds and debt securities. Our investment portfolio as of December 31, 2017 consisted of money market funds, municipal bonds, corporate bonds, variable rate demand notes, commercial paper and asset-backed securities. Investments in both fixed rate and floating rate instruments carry a degree of interest rate risk. Fixed rate securities may have their market value adversely impacted due to an increase in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or if the decline in fair value of our publicly traded debt investments is judged to be other-than-temporary. We may suffer losses in principal if we are forced to sell securities that have declined in market value due to changes in interest rates. However, because any debt securities we hold are classified as available-for-sale, no gains or losses are realized in the income statement due to changes in interest rates unless such securities are sold prior to maturity or unless declines in value are determined to be other-than-temporary. These securities are reported at fair value with the related unrealized gains and losses, net of applicable taxes, included in accumulated other comprehensive income (loss), reported in a separate component of stockholders' equity. Although we currently expect that our ability to access or liquidate these investments as needed to support our business activities will continue, we cannot ensure that this will not change. We believe that, if market interest rates were to change immediately and uniformly by 10% from levels at December 31, 2017, the impact on the fair value of these securities or our cash flows or income would not be material.

 

In a low interest rate environment, as short-term investments mature, reinvestment can occur at less favorable market rates. Given the short-term nature of certain investments, the current interest rate environment may negatively impact our investment income.

 

As of December 31, 2017, we had outstanding debt of $517.5 million in the form of Convertible Notes. The fair value of our Convertible Notes is subject to interest rate risk, market risk and other factors due to the convertible feature. The fair value of the Convertible Notes will generally increase as interest rates fall and decrease as interest rates rise. In addition, the fair value of the Convertible Notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines in value. The interest and market value changes affect the fair value of our Convertible Notes but do not impact our financial position, cash flows or results of operations due to the fixed nature of the debt obligation.

 

Our cash and cash equivalents and investment in marketable securities at December 31, 2017 consisted of $365.8 million held domestically, with the remaining balance of $39.4 million held by foreign subsidiaries. There may be adverse tax effects upon repatriation of these funds to the United States. We do not plan to repatriate cash balances from foreign subsidiaries to fund our operations in the United States.

 

Foreign Currency Risk

 

To date, our international customer and vendor agreements have been denominated almost exclusively in United States dollars. Accordingly, we have limited exposure to foreign currency exchange rates and currently enter into immaterial foreign currency hedging transactions.

 

 

Item 8.

Financial Statements and Supplementary Data

 

Index to Consolidated Financial Statements

 

   

Report of Independent Registered Public Accounting Firm

51

Consolidated Balance Sheets

53

Consolidated Statements of Income

54

Consolidated Statements of Comprehensive Income (Loss)

55

Consolidated Statements of Stockholders’ Equity

56

Consolidated Statements of Cash Flows

57

Notes to Consolidated Financial Statements

58

 

 

Report of Independent Registered Public Accounting Firm

 

 

To the Board of Directors and Stockholders of Inphi Corporation

 

Opinions on the Financial Statements and Internal Control over Financial Reporting

 

We have audited the accompanying consolidated balance sheets of Inphi Corporation and its subsidiaries as of December 31, 2017 and 2016 and the related consolidated statements of income (loss), comprehensive income (loss), stockholder’s equity and cash flows for each of the three years in the period ended December 31, 2017, including the related notes listed in the accompanying index (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.

 

Basis for Opinions

 

The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Annual Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

 

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

Definition and Limitations of Internal Control over Financial Reporting

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

 

 

/s/ PricewaterhouseCoopers LLP

San Jose, California

February 28, 2018

 

We have served as the Company’s auditor since 2002.

 

 

Inphi Corporation

Consolidated Balance Sheets

(in thousands, except share and per share amounts)

 

   

December 31,

 
   

2017

   

2016

 
                 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 163,450     $ 144,867  

Investments in marketable securities

    241,737       249,476  

Accounts receivable, net

    67,993       49,999  

Inventories

    31,721       32,039  

Prepaid expenses and other current assets

    12,208       23,139  

Total current assets

    517,109       499,520  

Property and equipment, net

    60,344       44,471  

Goodwill

    104,502       105,077  

Identifiable intangible assets, net

    222,933       327,063  

Deferred tax charge

          1,384  

Other assets, net

    12,618       13,080  

Total assets

  $ 917,506     $ 990,595  
                 

Liabilities and Stockholders’ Equity

               

Current liabilities:

               

Accounts payable

  $ 14,721     $ 14,039  

Deferred revenue

    435       3,630  

Accrued employee expenses

    15,214       16,588  

Other accrued expenses

    8,290       7,277  

Other current liabilities

    21,387       24,736  

Total current liabilities

    60,047       66,270  

Convertible debt

    421,431       396,857  

Other long-term liabilities

    24,627       64,944  

Total liabilities

    506,105       528,071  

Commitments and contingencies (Note 17)

               
                 

Stockholders’ equity:

               

Preferred stock, $0.001 par value; 10,000,000 shares authorized; no shares issued