10-Q 1 a2038035z10-q.txt 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For quarterly period ended December 31, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______TO _______ Commission File No. 0-14225 EXAR CORPORATION (Exact Name of Registrant as specified in its charter) Delaware 94-1741481 -------------------------------------------------------------------------------- (State or other jurisdiction of ( I.R.S. Employer incorporation or organization) Identification No.) 48720 Kato Road, Fremont, California 94538 -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (510) 668-7000 -------------------------------------------------------------------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at January 31, 2001 -------------------------------------------------------------------------------- Common Stock, .0001 par value 38,856,176 shares net of treasury shares TABLE OF CONTENTS
Page ---- PART I FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements..................................... 3-5 Notes to Condensed Consolidated Financial Statements............................ 6-9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................................... 10-23 Item 3. Quantitative and Qualitative Disclosures About Market Risk...................... 23 PART II OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K................................................ 24 Signatures...................................................................... 24 EXHIBITS
2 PART I - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS EXAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts)
DECEMBER 31, MARCH 31, 2000 2000 (UNAUDITED) -------------- -------------- ASSETS CURRENT ASSETS: Cash and equivalents $ 362,903 $ 377,158 Short-term investments 37,896 3,000 Accounts receivable, net 16,911 11,550 Inventories 8,832 8,299 Prepaid expenses and other 4,032 3,012 Deferred income taxes 4,831 3,369 -------------- -------------- Total current assets 435,405 406,388 PROPERTY AND EQUIPMENT, Net 27,711 26,653 OTHER ASSETS 3,331 5,392 LONG-TERM INVESTMENTS 21,224 - -------------- -------------- TOTAL ASSETS $ 487,671 $ 438,433 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 5,117 $ 3,497 Accrued compensation and related benefits 7,685 7,060 Accrued sales commissions 1,611 1,096 Other accrued expenses 1,857 1,165 Income taxes payable 12,150 - -------------- -------------- Total current liabilities 28,420 12,818 -------------- -------------- LONG-TERM LIABILITIES 498 574 -------------- -------------- STOCKHOLDERS' EQUITY: Preferred stock; $.0001 par value; 2,250,000 shares authorized; no shares outstanding - - Common stock; $.0001 par value; 100,000,000 and 25,000,000 shares authorized; 38,672,870 and 37,158,363 shares outstanding 362,871 352,614 Accumulated other comprehensive income 255 188 Retained earnings 95,627 72,239 -------------- -------------- Total stockholders' equity 458,753 425,041 -------------- -------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 487,671 $ 438,433 ============== ==============
See notes to condensed consolidated financial statements 3 EXAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ------------- ------------- -------------- ------------- NET SALES $ 32,515 $ 20,708 $ 91,356 $ 55,509 COSTS AND EXPENSES: Cost of sales 12,993 8,947 37,385 24,409 Research and development 5,739 4,151 17,293 13,041 Selling, general and administrative 6,804 5,408 19,538 16,605 Goodwill amortization - 126 - 378 ------------- ------------- -------------- ------------- Total costs and expenses 25,536 18,632 74,216 54,433 ------------- ------------- -------------- ------------- OPERATING INCOME 6,979 2,076 17,140 1,076 OTHER INCOME (EXPENSE): Interest income, net 7,025 1,485 19,753 3,766 Gain on sale of investment - - - 7,003 Other, net 248 (62) 233 (6) ------------- ------------- -------------- ------------- Total other income, net 7,273 1,423 19,986 10,763 ------------- ------------- -------------- ------------- INCOME BEFORE INCOME TAXES 14,252 3,499 37,126 11,839 INCOME TAXES 5,273 1,124 13,737 3,788 ------------- ------------- -------------- ------------- NET INCOME $ 8,979 $ 2,375 $ 23,389 $ 8,051 ============= ============= ============== ============= NET INCOME PER SHARE: BASIC $ 0.23 $ 0.08 $ 0.62 $ 0.29 ============= ============= ============== ============= DILUTED $ 0.21 $ 0.07 $ 0.54 $ 0.26 ============= ============= ============== ============= SHARES USED IN COMPUTATION OF NET INCOME PER SHARE: BASIC 38,503 28,615 37,859 28,248 ============= ============= ============== ============= DILUTED 43,138 32,819 43,039 31,112 ============= ============= ============== =============
See notes to condensed consolidated financial statements. 4 EXAR CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
NINE MONTHS ENDED DECEMBER 31, 2000 1999 ------------ ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 23,389 $ 8,051 Reconciliation of net income to net cash provided by operating activities: Depreciation and amortization 2,904 2,999 Deferred income taxes 1,459 (294) Gain on sale of equipment - (474) Gain on sale of investment - (7,003) Changes in operating assets and liabilities: Accounts receivable (5,361) 482 Inventories (533) (1,841) Prepaid expenses and other (1,819) (172) Accounts payable 1,620 17 Accrued compensation and related benefits 625 2,804 Other accrued expenses 1,207 (331) Income taxes payable 12,150 2,144 ------------ ----------- Net cash provided by operating activities 35,641 6,382 ------------ ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of equipment and leasehold improvements (3,971) (1,905) Proceeds from sale of equipment and leasehold improvements 9 548 Purchases of short-term investments (56,038) (21,340) Proceeds from maturities of short-term investments 21,142 3,710 Purchases of long-term investments (28,557) - Proceeds from maturities of long-term investments 7,450 - Proceeds from sale of investments - 13,080 Other assets (61) (344) ------------ ----------- Net cash used in investing activities (60,026) (6,251) ------------ ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Long-term liabilities (77) (104) Proceeds from issuance of common stock 10,257 8,442 Acquisition of common stock - (3,392) ------------ ----------- Net cash provided by financing activities 10,180 4,946 ------------ ----------- EFFECT OF EXCHANGE RATE CHANGES ON CASH (50) (33) NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS (14,255) 5,044 CASH AND EQUIVALENTS AT BEGINNING OF PERIOD 377,158 79,154 ------------ ----------- CASH AND EQUIVALENTS AT END OF PERIOD $ 362,903 $84,198 ============ =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for income taxes $ 218 $ 920 ============ =========== Cash paid for interest $ - $ 725 ============ ===========
See notes to condensed consolidated financial statements. 5 EXAR CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) THREE MONTHS AND NINE MONTHS ENDED DECEMBER 31, 2000 AND 1999 NOTE 1. BASIS OF PRESENTATION The accompanying condensed consolidated financial statements include the accounts of Exar Corporation and its wholly owned subsidiaries (collectively "Exar" or the "Company"). Such financial statements have been prepared in conformity with generally accepted accounting principles consistent with those reflected in the Company's 2000 annual report on Form 10-K, and include all adjustments (consisting only of normal, recurring adjustments) necessary for a fair presentation of financial position, results of operations and cash flows. The results of operations for the three months and nine months ended December 31, 2000 are not necessarily indicative of the results of operations to be expected for the full year. The financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these accompanying financial statements should be read in conjunction with the audited financial statements and the related notes thereto contained in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended March 31, 2000. Certain prior period amounts have been reclassified to conform to the current period presentation. Exar designs, develops and markets high-performance, high-bandwidth analog and mixed-signal silicon solutions for the worldwide communications infrastructure. The Company utilizes its high-speed, analog and mixed-signal design expertise, system-level knowledge and standard CMOS process technologies to offer integrated circuits, or ICs, for the communications markets that address transmission standards, such as T/E carrier, ATM and SONET/SDH. Additionally, Exar provides solutions for the serial communications markets as well as the video and imaging markets. For the nine months ended December 3, 2000, Exar's largest customers' included Alcatel, Cisco, Hewlett-Packard, Lucent, Nokia and Tellabs. NOTE 2. INVENTORIES Inventories consist of the following (in thousands):
DECEMBER 31, MARCH 31, 2000 2000 ------------- ------------- Work-in-process $ 4,911 $ 5,064 Finished goods 3,921 3,235 ------------- ------------- $ 8,832 $ 8,299 ============= =============
NOTE 3. GAIN ON SALE OF INVESTMENT The gain on investment of $7.0 million in the first quarter of fiscal 2000 was related to the Company's minority equity investment in IC Works, Inc. ("IC Works"), which had a net book value of $6.1 million. In April 1999, the Company received in excess of 1.1 million shares of common stock in Cypress Semiconductor, Inc. ("Cypress") in exchange for the Company's investment in IC Works due to the merger of Cypress and IC Works. The Company sold this stock at a fair market value of $13.1 million during the 6 first quarter of fiscal 2000 resulting in a pre-tax gain of $7.0 million in other income and a related employee benefits expense of $3.0 million in Costs and Expenses. NOTE 4. NET INCOME PER SHARE Statement of Financial Accounting Standards ("SFAS") No. 128 requires a dual presentation of basic and diluted earnings per share ("EPS"). Basic EPS excludes dilution and is computed by dividing net income by the weighted average of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. All common share amounts for each period reported have been adjusted for the tow-for-one stock split effected October 19, 2000. A summary of the Company's EPS is as follows (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ------------ ------------ ------------ ------------- NET INCOME $ 8,979 $ 2,375 $ 23,389 $ 8,051 ============ ============ ============ ============= SHARES USED IN COMPUTATION: Weighted average common shares outstanding used in computation of basic net income per share 38,503 28,615 37,859 28,248 Dilutive effect of stock options 4,635 4,204 5,180 2,864 ------------ ------------ ------------ ------------- Shares used in computation of diluted net income per share 43,138 32,819 43,039 31,112 ============ ============ ============ ============= BASIC NET INCOME PER SHARE $ 0.23 $ 0.08 $ 0.62 $ 0.29 ============ ============ ============ ============= DILUTED NET INCOME PER SHARE $ 0.21 $ 0.07 $ 0.54 $ 0.26 ============ ============ ============ =============
Options to purchase 1,762,561 and 40,500 shares of common stock at prices ranging from $41.55 to $60.75 and $16.21 were outstanding as of December 31, 2000 and 1999, respectively, but not included in the computation of diluted net income per share because the options' exercise prices were greater than the average market price of the common shares as of such dates and, therefore, would be anti-dilutive under the treasury stock method. 7 NOTE 5. COMPREHENSIVE INCOME SFAS No. 130, "Reporting Comprehensive Income," requires an enterprise to report, by major components and as a single total, the change in net assets during the period from non-owner sources. For the three months and nine months ended December 31, 2000 and 1999, comprehensive income, which was comprised of the Company's net income for the periods, unrealized gain or loss on long-term investments and changes in cumulative translation adjustments is as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ----------- ----------- ---------- ---------- NET INCOME $ 8,979 $ 2,375 $23,389 $ 8,051 ACCUMULATED OTHER COMPREHENSIVE INCOME: Cumulative translation adjustments (34) 25 (50) (33) Unrealized gain or loss on long-term investments 95 - 117 ----------- ----------- ---------- ---------- Total Other Comprehensive Income (Loss) 61 25 67 (33) COMPREHENSIVE INCOME $ 9,040 $ 2,400 $23,456 $ 8,018 =========== =========== ========== ==========
Accumulated other comprehensive income presented in the accompanying condensed consolidated balance sheets consists of the accumulated net unrealized gain (loss) on available-for-sale investments and foreign currency translation adjustments. NOTE 6. INDUSTRY AND SEGMENT INFORMATION In fiscal 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for reporting information about operating segments in annual financial statements and requires that certain selected information about operating segments be reported in interim financial reports. It also establishes standards for related disclosures about products and services and geographic areas. Operating segments are defined as components of an enterprise about which separate financial information is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. Under SFAS No. 131, the Company operates in one reportable segment and is engaged in the design, development and marketing of a variety of analog and mixed-signal application-specific integrated circuits for use in communications and in video and imaging products. The nature of the Company's products and production processes as well as type of customers and distribution methods are consistent among all of the Company's devices. The Company's foreign operations are conducted primarily through its wholly owned subsidiaries in Japan, the United Kingdom, France and Taiwan. The Company's principal markets include North America, Asia, and Europe. The following table sets forth net income by product line revenue:
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ------------ ------------ ----------- ------------ Communications $ 24,636 $ 15,328 $ 68,900 $ 41,424 Video and Imaging 6,324 3,578 18,033 9,858 Other 1,555 1,802 4,423 4,227 ------------ ------------ ----------- ------------ $ 32,515 $ 20,708 $ 91,356 $ 55,509 ============ ============ =========== ============
8 Identifiable assets represent assets used in the Company's operations in each geographic area. Geographic financial information is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ----------------------- ----------------- ----------------------- ------------------ Net sales: United States $ 22,273 $ 14,480 $ 62,900 $ 37,650 Export sales to Japan and Asia 5,801 2,986 14,952 8,989 Export sales to Western Europe 3,931 2,910 12,363 7,661 Export sales to rest of world 510 146 1,141 615 Japan - 186 - 594 ----------------------- ----------------- ----------------------- ------------------ $ 32,515 $ 20,708 $ 91,356 $ 55,509 ======================= ================== ======================= ==================
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ----------------------- ----------------- ----------------------- ------------------ Income (Loss) from operations: United States $ 7,391 $ 2,444 $ 18,386 $ 2,338 Japan (137) (133) (433) (395) Western Europe (275) (235) (813) (867) ----------------------- ----------------- ----------------------- ------------------ $ 6,979 $ 2,076 $ 17,140 $ 1,076 ======================= ================== ======================= ==================
AT DECEMBER 31, AT MARCH 31, 2000 2000 ----------------------- ----------------- Long-lived assets: United States $ 27,294 $ 26,621 Japan 270 526 Western Europe 456 402 ----------------------- ----------------- $ 28,020 $ 27,549 ======================= ==================
NOTE 7. RECENTLY ISSUED ACCOUNTING STANDARDS In June 1999, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which defines derivatives, requires that all derivatives be carried at fair value, and provides for hedging accounting when certain conditions are met. This statement is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. We do not believe the adoption of this statement has will have a material impact on our financial position or results of operations. In December 1999, the Securities and Exchange Commission (SEC) released Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements." This bulletin summarizes certain interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant of the SEC in administering the disclosure requirements of the Federal securities laws in applying generally accepted accounting principles to revenue recognition in financial statements. As amended by SAB 101, applications of the accounting and disclosures desired in the bulletin is required by the fourth quarter of fiscal 2001. Management does not believe that the adoption of SAB No. 101 will have a significant impact on our consolidated financial position, results of operations or cash flows. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO AND WITH MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THAT ARE INCLUDED IN THE ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED MARCH 31, 2000 FOR EXAR CORPORATION. THIS QUARTERLY REPORT ON FORM 10-Q, AND IN PARTICULAR THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTAINS FORWARD-LOOKING STATEMENTS REGARDING FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY THAT INVOLVE CERTAIN RISKS AND UNCERTAINTIES INCLUDING, BUT NOT LIMITED TO, THOSE SET FORTH IN THE "RISK FACTORS" DISCUSSED BELOW. ACTUAL EVENTS OR THE ACTUAL FUTURE RESULTS OF THE COMPANY MAY DIFFER MATERIALLY FROM ANY FORWARD-LOOKING STATEMENTS DUE TO SUCH RISKS AND UNCERTAINTIES. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH REFLECT MANAGEMENT'S ANALYSIS ONLY AS OF THE DATE HEREOF. THE COMPANY ASSUMES NO OBLIGATION TO UPDATE THESE FORWARD-LOOKING STATEMENTS TO REFLECT ACTUAL RESULTS OR CHANGES IN FACTORS OR ASSUMPTIONS AFFECTING SUCH FORWARD-LOOKING ASSUMPTIONS. OVERVIEW We design, develop and market analog and mixed-signal ICs for the communications markets that address Wide Area Network ("WAN") transmission standards, such as T/E carrier, ATM and SONET/SDH. Additionally, we provide solutions for the serial communications markets as well as the video and imaging markets. Our primary customers are large communications OEMs. In 1997 we chose to refocus our business strategy and developmental efforts on the communications markets. At that time, our communications products represented 43.2% of our net sales. For the three months and nine months ended December 31, 2000, our communications product sales increased to 75.8% and 75.4%, respectively, of our net sales. Our international sales represented 31.5% and 31.2%, respectively, of our net sales for the three months and nine months ended December 31, 2000, compared to 30.1% and 32.2%, respectively, of net sales for the same period in fiscal 2000. Our international sales consist of export sales from the United States denominated in United States dollars. Such international operations give rise to exposures from changes in currency exchange rates due to the result of our foreign operating expenses being denominated in foreign currency. We have adopted a set of practices to minimize our foreign currency risk, which include the occasional use of foreign currency exchange contracts to hedge operating results from our foreign subsidiaries. Although foreign sales may be subject to tariffs in certain countries or with regard to certain products, our profit margin on international sales of ICs, adjusted for differences in product mix, is not significantly different from that realized on our sales to domestic customers. We recognize revenue from the sale of products when shipped to customers and distributors. Our distributor agreements generally permit the return of up to 10% of their purchases annually for purposes of stock-rotation and also provide for credits to distributors in the event that we reduce the price of any product. We record an allowance at the time revenue is recognized based on authorized and historical patterns of returns, price protection and other concessions. Our gross margins vary depending on product mix, competition, the volume of products manufactured and sold, our suppliers' ability to achieve certain manufacturing efficiencies and the cost of materials procured from our suppliers. Our newer analog and mixed-signal products, especially our communications products, generally have higher gross margins than our more mature products, and margins of any particular product may erode over time. 10 RESULTS OF OPERATIONS The following table sets forth for the periods indicated the percentage relationship to net sales of certain cost, expense and income items. The table and subsequent discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto.
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ------------- ---------- ------------- ---------- Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 40.0 43.2 40.9 44.0 ------------- ---------- ------------- ---------- Gross profit 60.0 56.8 59.1 56.0 Research and development 17.7 20.0 18.9 23.5 Selling, general and administrative 20.9 26.1 21.4 29.9 Goodwill amortization - 0.6 - 0.7 ------------- ---------- ------------- ---------- Operating income (loss) 21.4 10.1 18.8 1.9 Other income, net 22.4 6.9 21.9 19.4 ------------- ---------- ------------- ---------- Income before income taxes 43.8 17.0 40.7 21.3 Income taxes 16.2 5.4 15.0 6.8 ------------- ---------- ------------- ---------- Net income 27.6 % 11.6 % 25.7 % 14.5 % ============= ========== ============= ==========
PRODUCT LINE SALES AS A PERCENTAGE OF NET SALES The following table sets forth product line revenue information as a percentage of net sales. The table and subsequent discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto.
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 --------- --------- --------- --------- Communications 75.8% 74.0% 75.4% 74.6% Video and Imaging 19.4% 17.3% 19.8% 17.8% Other 4.8% 8.7% 4.8% 7.6% --------- --------- --------- --------- 100.0% 100.0% 100.0% 100.0%
THREE MONTHS AND NINE MONTHS ENDED DECEMBER 31, 2000 COMPARED TO THREE MONTHS AND NINE MONTHS ENDED DECEMBER 31, 1999 NET SALES. Net sales for the three months ended December 31, 2000 were $32.5 million compared to $20.7 million for the three months ended December 31, 1999, an increase of 57.0%. This increase was primarily due to an increase in the revenue composition of communications products, which increased 60.7% or $9.3 million when compared to the corresponding period in fiscal 2000. Net sales for the nine months ended December 31, 2000 were $91.4 million compared to $55.5 million for the nine months ended December 31, 1999. Fueling this increase was the continued growth in sales of our communications products, which increased 66.3% or $27.5 million when compared to the corresponding period in fiscal 2000. Communications products represented 75.8% and 75.4%, respectively, of our net sales for the three months 11 and nine months ended December 31, 2000. This continued growth in communications product sales resulted primarily from market acceptance and previous design wins going into production of our transmission products. Design wins in the reference period would not have significant revenue contribution. For the three months ended December 31, 2000, sales to domestic customers increased by 53.8% to $22.3 million and international sales increased by 64.5% to $10.2 million. For the nine months ended December 31, 2000, sales to domestic customers increased by 67.1% to $62.9 million and international sales increased by 59.3% to $28.5 million. For the three months ended December 31, 2000 we have experienced a slow-down in on quarter-on-quarter revenue growth due to what we believe are inventory channel adjustments. Additionally, the Company experienced bookings for future revenue at a lower rate than current shipments. COST OF SALES. Cost of sales as a percentage of net sales for the three months ended December 31, 2000 decreased to 40.0% compared to 43.2% for the corresponding period in fiscal 2000. For the nine months ended December 31, 2000, cost of sales as a percentage of net sales decreased to 40.9% compared to 44.0% for the corresponding period in fiscal 2000. The resulting increase in gross margins is related to the shift in product to higher margin products resulting from the growth in communications revenue, primarily from transmission product sales. Gross margins from sales of ICs vary depending on product mix, price competition, the volume of products manufactured and sold, the ability of our suppliers to achieve certain manufacturing efficiencies and the cost of materials procured from our suppliers. Margins on any particular product may erode over time. RESEARCH AND DEVELOPMENT. Research and development expenses for the three months ended December 31, 2000 represented 17.7% of net sales compared to 20.0% of net sales for the corresponding period in fiscal 2000, an increase of 38.3%. Research and development expenses for the nine months ended December 31, 2000 represented 18.9% of net sales compared to 23.5% of net sales for the corresponding period in fiscal 2000, resulting in a 32.6% spending increase generated by our continued investment in the development of our communications products. Our increased spending in research and development included the addition of staff in the communications product line area coupled with increases in expenditures for supplies, services and equipment used in the development activities of communications products. A decrease in benefits expenses related to a pre-tax gain recognized in Other Income in the first quarter of fiscal 2000 (see Other Income below) partially offset these increases in the first quarter of fiscal 2001. In the future, we expect to continue to increase spending on research and development activities, particularly for communications products. We expect research and development expenses to continue to fluctuate as a percentage of net sales as a result of the timing of expenditures and changes in the level of net sales. However, we intend to spend approximately 20% of net sales on research and development activities to support our growth. We do not intend to increase funding of development efforts relating to our video and imaging products, and as a result, we expect that revenues from these products will decline in future periods as a percentage of net sales. SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative expenses for the three months ended December 31, 2000 represented 20.9% of net sales compared to 26.1% of net sales for the corresponding period in fiscal 2000, an increase of 25.8%. Selling, general and administrative expenses for the nine months ended December 31, 2000 represented 21.4% of net sales compared 29.9% of net sales in the corresponding period in fiscal 2000, an increase of 9.0%. This spending increase was due to growth in our communications product sales and increases in employee compensation. A decrease in benefits expenses related to a pre-tax gain recognized in Other Income in the first quarter of fiscal 2000 (see Other Income below) partially offset these increases in the first quarter of fiscal 2001. In the short-term, many of the selling, general, and administrative expenses are fixed, causing a decline as a percentage of net sales in 12 periods of rapidly rising sales and an increase as a percentage of net sales when sales growth is slower or declining. OTHER INCOME. Other income for the three months and nine months ended December 31, 2000 includes interest income of $7.0 million and $19.8 million, respectively, compared to $1.5 million and $3.8 million for the three months and nine months ended December 31, 1999, respectively. The increase in other income was the result of increased cash and equivalents, short-term investment and long-term investment balances resulting from $260.8 million in net proceeds received from the public sale of 6,900,000 common shares in March 2000. Other income for the nine months ended December 31, 1999 includes a pre-tax $7.0 million gain on the sale of our minority equity investment in IC Works. In April 1999, we received approximately 1.1 million shares of common stock in Cypress Semiconductor, Inc. in exchange for our investment in IC Works due to the merger of Cypress Semiconductor and IC Works. We sold the majority of this stock during the three months ended June 30, 1999, resulting in a pre-tax gain of $7.0 million in other income and related employee compensation and benefits expense of $3.0 million. PROVISION FOR INCOME TAXES. The effective tax rate for the three months and nine months ended December 31, 2000 was approximately 37% compared with the federal statutory rate of 35%. The difference is due to non-deductible expenses, state income taxes and foreign income, which is taxed at rates different from U.S. income, partially offset by utilization of capital loss carry-forwards and tax savings generated from our foreign sales corporation. NET INCOME PER BASIC AND DILUTED SHARE. The increase in basic and diluted net income per share for the three months and nine months ended December 31, 2000 compared to the corresponding periods in fiscal 2000 is due to the increased net income for the period partially offset by the increase in the weighted average common shares outstanding primarily resulting from the public sale of 6,900,000 common shares in March 2000. To date, inflation has not had a significant impact on our operating results. LIQUIDITY AND CAPITAL RESOURCES During the three months and nine months ended December 31, 2000, our operations were financed primarily with cash flows from operations in conjunction with existing cash. At December 31, 2000, total cash, equivalents and both short-term and long-term investments, was approximately $422.0 million, comprised of $362.9 million of cash and equivalents, $37.9 million of short-term investments and $21.2 million of long-term investments. We have a credit facility agreement with a domestic bank under which we may execute up to $15.0 million in foreign currency transactions. At December 31, 2000, we had no foreign currency contracts outstanding. For the nine months ended December 31, 2000, we generated $35.6 million of cash from our operating activities, the result of net income of $23.4 million, a net increase in working capital of $7.9 million and non-cash items of $4.4 million. Net capital and other asset expenditures for the nine months ended December 31, 2000 totaled $4.0 million, including purchases of computer equipment and software used for product development. Other investing activities for the nine months ended December 31, 2000 included purchases of $56.0 million of short-term investments and $28.6 million of long-term investments offset by proceeds of $21.1 from maturities of short-term investments and $7.5 from maturities of long-term investments. During the nine months ended December 31, 2000, we received $10.3 million from the issuance of 1,514,507 common shares upon the exercise of stock options under our stock option plans. 13 We have no material firm capital commitments. We anticipate that we will continue to finance our operations with cash flows from operations, existing cash and investment balances, and some combination of long-term debt and/or lease financing and additional sales of equity securities. The combination and sources of capital will be determined by management based on needs and prevailing market conditions. We believe that our cash and cash equivalents, short-term investments, long-term investments and cash flows from operations will be sufficient to satisfy working capital requirements and capital equipment needs for at least the next 12 months. From time to time, we evaluate potential acquisitions and equity investments complementary to our design expertise and market strategy, including investments in wafer fabrication foundries. To the extent that we pursue or position ourselves to pursue these transactions, we could choose to seek additional equity or debt financing. There can be no assurance that additional financing could be obtained on terms acceptable to us. The sale of additional equity or convertible debt could result in dilution to our stockholders. RISK FACTORS THIS 10-Q CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES, INCLUDING STATEMENTS ABOUT FUTURE PLANS, OBJECTIVES, INTENTIONS AND EXPECTATIONS. MANY FACTORS, INCLUDING THOSE DESCRIBED BELOW, COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE DISCUSSED IN ANY FORWARD-LOOKING STATEMENT. OUR OPERATING RESULTS MAY FLUCTUATE BECAUSE OF A NUMBER OF FACTORS, MANY OF WHICH ARE BEYOND OUR CONTROL. Our operating results may fluctuate significantly. Some of the factors that affect our quarterly and annual results, many of which are difficult to control or predict, are: - the reduction, rescheduling or cancellation of orders by customers; - fluctuations in the timing and amount of customer requests for product shipments; - fluctuations in the manufacturing output, yields and inventory levels of our suppliers; - changes in the mix of products that our customers purchase; - our ability to introduce new products on a timely basis; - the announcement or introduction of products by our competitors; - the availability of external foundry capacity and raw materials; - competitive pressures on selling prices; - the amounts and timing of costs associated with warranties and product returns; - the amounts and timing of investments in research and development; - market acceptance of our products; - costs associated with acquisitions and the integration of acquired operations; 14 - the ability of our customers to obtain components from their other suppliers and customers; - general conditions in the communications and semiconductor industries; - fluctuations in interest rates; - inventory build-up in channel; and - general economic conditions. OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND OUR SUCCESS, THEREFORE, DEPENDS ON OUR ABILITY TO DEVELOP AND INTRODUCE NEW PRODUCTS. The markets for our products are characterized by: - rapidly changing technologies; - evolving and competing industry standards; - changing customer needs; - frequent new product introductions and enhancements; - increased integration with other functions; and - rapid product obsolescence. To develop new products for our target markets we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to expand our technical and design expertise. In addition, we must have our products designed into our customers' future products and maintain close working relationships with key customers in order to develop new products that meet our customers changing needs. In addition, products for communications 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. 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. We may not be able to identify new product opportunities successfully, develop and bring to market new products, achieve design wins or respond effectively to new technological changes or product announcements by our competitors. In addition, 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. Failure in any of these areas could harm our operating results. WE MAY FAIL TO ATTRACT OR RETAIN KEY PERSONNEL. Our future success depends, in part, on the continued service of our key design engineering, sales, marketing and executive personnel and our ability to identify, hire and retain additional personnel. 15 We may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business or to replace engineers or other qualified personnel who may leave our Company. There is intense competition, particularly in Silicon Valley, where our headquarters are located, for qualified personnel in the semiconductor industry, in particular the highly skilled design, process, software application support, and test engineers involved in the development of new communications ICs. Our anticipated growth is expected to place increased demands on our resources and will likely require the addition of new management personnel and the development of additional expertise by existing management personnel. Loss of the services of, or failure to recruit key design engineers or other technical and management personnel, could harm our business. WE DEPEND ON THIRD-PARTY FOUNDRIES TO MANUFACTURE OUR ICS. We do not own or operate a semiconductor fabrication facility. A single foundry manufactures the majority of our products. Two foundries manufacture our products based on CMOS processes, and one foundry manufactures all of our BiCMOS products. Most of our products are based on CMOS processes. We do not have long-term wafer supply agreements with our CMOS foundries that guarantee wafer or product quantities, prices, or delivery lead times, and our CMOS foundries manufacture our products on a purchase order basis. We may not be able to maintain strong relationships with our foundries. In addition, we cannot be certain that we will continue to do business with our foundries on terms as favorable as our current terms. Other significant risks associated with our reliance on outside foundries include: - the lack of assured semiconductor wafer supply and control over delivery schedules; - the unavailability of, or delays in obtaining access to, key process technologies; - limited control over quality assurance, manufacturing yields and production costs; and - potential misappropriation of our intellectual property. We do not have a guaranteed level of production capacity at either of our CMOS foundries. We provide these foundries with rolling forecasts of our production requirements; however, the ability of each foundry to provide wafers to us is limited by the foundry's available capacity. Therefore, our CMOS foundries could choose to prioritize capacity for other customers or reduce or eliminate deliveries to us on short notice. Accordingly, these foundries may not allocate sufficient capacity to satisfy our requirements. WE COULD EXPERIENCE A SUBSTANTIAL DELAY OR INTERRUPTION IN THE SHIPMENT OF OUR PRODUCTS OR AN INCREASE IN OUR COSTS DUE TO THE FOLLOWING: - a sudden demand for an increased amount of semiconductor devices; - a manufacturing disruption, due to a natural disaster or other factors, experienced by one or more of our foundries or sudden reduction or elimination of any existing source or sources of semiconductor devices; - the need to find or qualify alternative manufacturing sources for an existing or new product; or - failure of our suppliers to obtain the raw materials and equipment used in the production of our ICs. 16 TO SECURE FOUNDRY CAPACITY, WE MAY BE REQUIRED TO ENTER INTO FINANCIAL AND OTHER ARRANGEMENTS WITH FOUNDRIES, AND SUCH AGREEMENTS MAY RESULT IN THE DILUTION OF OUR EARNINGS OR OF THE OWNERSHIP OF OUR STOCKHOLDERS. A customer's size or the existence of a long-term agreement with the foundry may influence allocation of a foundry's manufacturing capacity. To address foundry capacity constraints, we and other semiconductor companies that rely on third-party foundries have utilized various arrangements, including equity investments in or loans to foundries, in exchange for guaranteed production capacity, joint ventures to own and operate foundries, or "take or pay" contracts that commit a company to purchase specified quantities of components over extended periods. While we are not currently a party to any of these arrangements, we may decide to enter into such arrangements in the future. We cannot be sure, however, that these arrangements will be available on acceptable terms or at all. Any of these arrangements could require that we commit substantial capital. The need to commit substantial capital could require that we obtain additional debt or equity financing, which could result in the dilution of our earnings or the ownership of our stockholders, or otherwise harm our operating results. IF OUR FOUNDRIES DISCONTINUE THE MANUFACTURING PROCESSES NEEDED TO MEET OUR DEMANDS, OR FAIL TO UPGRADE THE TECHNOLOGIES NEEDED TO MANUFACTURE OUR PRODUCTS, WE MAY FACE PRODUCTION DELAYS. Our wafer and product requirements typically represent a small portion of the total production of the foundries that manufacture our products. As a result, we are subject to the risk that a foundry will cease production on an older or lower-volume process that it uses to produce our devices. Additionally our foundries may not continue to devote resources to the production of our products or continue to advance the process design technologies on which the manufacturing of our products is based. Each of these events could increase our costs and negatively impact our ability to deliver products on time. THE MARKETS IN WHICH WE PARTICIPATE ARE INTENSELY COMPETITIVE. Our target markets are intensely competitive. Our ability to compete successfully in these target markets depends on the following factors: - designing new products that implement new technologies; - sub-contracting the manufacture of new products and delivering them in a timely manner; - product quality and reliability; - customer support; - time-to-market; - product performance; - price; - end-user acceptance of our customers' products; and - market acceptance of competitors' products. In addition, our competitors or customers may offer new products based on new technologies, industry standards or end-user or customer requirements, including products that have the potential to replace or 17 provide lower-cost or higher-performance alternatives to our products. The introduction of new products by our competitors or customers could render our existing and future products obsolete or unmarketable. In addition, our competitors and customers may introduce products that integrate the functions performed by our ICs on a single IC, thus eliminating the need for our products. Because the IC markets are highly fragmented, we generally encounter different competitors in our various market areas. Competitors with respect to our communications products include Conexant Systems, PMC-Sierra, Inc. and TranSwitch Corporation. In addition, the expansion of our communications product portfolio may, in the future, bring us into competition with other established communications IC companies, such as Applied MicroCircuits Corporation and Vitesse Semiconductor Corporation. Competitors in our other markets include Analog Devices, Philips Semiconductor and Texas Instruments. Many of our competitors have greater financial, technical and management resources than we have. Some of these competitors may be able to sell their products at prices that are below those at which it would be financially feasible to sell our products. IF WE FAIL TO FURTHER PENETRATE THE MARKETS FOR COMMUNICATIONS ICS OR IF THESE MARKETS FAIL TO GROW AS EXPECTED, OUR REVENUES COULD STOP GROWING AND MAY DECLINE. A significant portion of our revenues in recent periods has been, and is expected to continue to be, derived from sales of communications ICs, particularly products based on the T1/E1, T3/E3 and ATM transmission standards. To be successful, we must continue to penetrate these markets. Furthermore, if these markets fail to grow as expected our revenues could stop growing and may decline. WE EXPECT THAT REVENUES CURRENTLY DERIVED FROM NON-COMMUNICATIONS PRODUCTS WILL DECLINE IN FUTURE PERIODS, AND OUR BUSINESS WILL BE HARMED IF OUR COMMUNICATIONS PRODUCTS FAIL TO MAKE UP FOR THIS DECLINE. We do not intend to increase funding of development efforts relating to our serial communications and video and imaging products, and as a result, we expect that revenues from these products will decline in future periods. In addition, the markets for these products are subject to extreme price competition and we may not be able to reduce our costs in response to declining average selling prices. Even if we reduce costs, our customers in these markets may not purchase these products. Moreover, these markets may decrease in size in the future. If our communications products fail to make up for any revenue shortfall, our business may be harmed. OUR DEPENDENCE ON THIRD-PARTY SUB-CONTRACTORS TO ASSEMBLE AND TEST OUR PRODUCTS INCREASES THE RISK THAT WE WILL NOT HAVE AN ADEQUATE SUPPLY OF PRODUCTS TO MEET DEMAND OR THAT OUR COST OF MATERIALS WILL BE HIGHER THAN EXPECTED. We depend on independent sub-contractors for the assembly and testing of our products. Such reliance on these sub-contractors involves the following significant risks: - reduced control over delivery schedules and quality; - the potential lack of adequate capacity during periods of increasing demand; - difficulties selecting, qualifying and integrating new sub-contractors; - limited warranties on products supplied to us; - potential increases in prices due to capacity shortages and other factors; and 18 - potential misappropriation of our intellectual property. These risks may lead to increased costs or delayed product delivery, which would harm our profitability and customer relationships. OUR RELIANCE UPON FOREIGN SUPPLIERS EXPOSES US TO RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. We use semiconductor assembly and test sub-contractors throughout Asia for most of our products, and we intend to continue utilizing testing and shipping operations of offshore subcontractors. Our dependence on these subcontractors involves the following substantial risks: - political and economic instability; - disruption of transportation to/from Asia; - embargo affecting the availability of raw materials, equipment or services; - changes in tax laws, tariffs and freight rates; and - compliance with local or foreign regulatory requirements. These risks may lead to increased costs or delayed product delivery, which would harm our profitability and customer relationships. OUR RELIANCE ON FOREIGN CUSTOMERS COULD CAUSE FLUCTUATIONS IN OPERATING RESULTS. International sales accounted for 31.5% and 31.2% of our net sales for the three months and nine months ended December 31, 2000, respectively, compared to 30.1% and 32.2% of net sales for the three months and nine months ended December 31, 1999, respectively. Our reliance on foreign customers could cause our operating results to fluctuate due to the following factors: - changes in regulatory requirements; - tariffs and other barriers; - timing and availability of export licenses; - political and economic instability; - difficulties in accounts receivable collections; - difficulties in staffing and managing foreign subsidiary and branch operations; - difficulties in managing distributors; - difficulties in obtaining governmental approvals for communications and other products; - limited intellectual property protection; - foreign currency exchange fluctuations; 19 - the burden of complying with and the risk of violating a wide variety of complex foreign laws and treaties; and - potentially adverse tax consequences. In addition, because sales of our products have been denominated, to date, primarily in United States dollars, increases in the value of the United States Dollar could increase the relative price of our products so that they become more expensive to customers in the local currency of a particular country. Future international activity may result in increased foreign currency denominated sales which could have a negative impact on margins. Furthermore, because some of our customer purchase orders and agreements that are governed by foreign laws, we may be limited in our ability to enforce our rights under these agreements and to collect damages, if awarded. WE RELY ON OUR DISTRIBUTORS AND SALES REPRESENTATIVES TO SELL MANY OF OUR PRODUCTS. We sell many of our products through distributors and sales representatives. Such distributors and sales representatives could reduce or discontinue sales of our products. Distributors and sales representatives may not devote the resources necessary to sell our products in the volumes and within the time frames that we expect. In addition, we depend upon the continued viability and financial resources of these distributors and sales representatives, some of which are small organizations with limited working capital. These distributors and sales representatives, in turn, depend substantially on general economic conditions and conditions within the semiconductor industry. We believe that our success will continue to depend upon these distributors and sales representatives. If some or all of these distributors and sales representatives experience financial difficulties, or otherwise become unable or unwilling to promote and sell our products, our business could be harmed. BECAUSE OUR COMMUNICATIONS ICS TYPICALLY HAVE LENGTHY SALES CYCLES, WE MAY EXPERIENCE SUBSTANTIAL DELAYS BETWEEN INCURRING EXPENSES RELATED TO RESEARCH AND DEVELOPMENT AND THE GENERATION OF SALES REVENUE. Due to the communications IC product cycle, it usually takes more than 12 months for us to realize volume shipments of our communications ICs after we first contact a customer. We commence by working with our customers to achieve a design win, which may take nine months or longer. Our customers then complete the design, testing and evaluation process and begin to ramp up production, a period which typically lasts an additional three months or longer. As a result, a significant period of time may elapse between our research and development and sales efforts and the realization of revenue, if any, from volume purchasing of our communications products by our customers. OUR BACKLOG MAY NOT RESULT IN FUTURE REVENUE. Due to possible customer-driven changes in delivery schedules and cancellations of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. A reduction of backlog during any particular period or the failure of our backlog to result in future revenue could harm our business. OUR OPERATING EXPENSES ARE RELATIVELY FIXED, AND MATERIALS MAY BE ORDERED IN ADVANCE OF ANTICIPATED CUSTOMER DEMAND. THEREFORE, WE MAY HAVE LIMITED ABILITY TO REDUCE EXPENSES QUICKLY IN RESPONSE TO ANY REVENUE SHORTFALLS. We may experience revenue shortfalls due to the following reasons: 20 - significant pricing pressures that occur because of declines in average selling prices over the life of a product; - sudden shortages of raw materials or fabrication, test or assembly capacity constraints that lead our suppliers to allocate available supplies or capacity to other customers and, in turn, harm our ability to meet sales obligations; and - the reduction, rescheduling or cancellation of customer orders. In addition, we typically plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside suppliers and foundries, we may order materials in advance of anticipated customer demand. This advance ordering may result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize. PERIODS OF RAPID GROWTH AND EXPANSION COULD CONTINUE TO PLACE A SIGNIFICANT STRAIN ON OUR LIMITED PERSONNEL AND OTHER RESOURCES. To manage our possible future growth effectively, we will be required to continue to improve our operational, financial, and management systems and to successfully hire, train, motivate and manage our employees. In addition, the integration of past and future potential acquisitions and the evolution of our business plan will require significant additional management, technical and administrative resources. We cannot be certain that we will be able to manage the growth and evolution of our current business effectively. WE HAVE, IN THE PAST AND MAY IN THE FUTURE, MAKE ACQUISITIONS, WHICH WILL INVOLVE NUMEROUS RISKS. WE CANNOT ASSURE YOU THAT WE WILL BE ABLE TO ADDRESS THESE RISKS SUCCESSFULLY WITHOUT SUBSTANTIAL EXPENSE, DELAY OR OTHER OPERATIONAL OR FINANCIAL PROBLEMS. The risks involved with acquisitions include: - diversion of management's attention; - failure to retain key personnel; - amortization of acquired intangible assets; - customer dissatisfaction or performance problems with an acquired company; - the cost associated with acquisitions and the integration of acquired operations; and - assumption of unknown liabilities, or other unanticipated events or circumstances. We may not be able to address these risks successfully without substantial expense, delay, or other operational or financial problems. WE MAY NOT BE ABLE TO PROTECT OUR INTELLECTUAL PROPERTY ADEQUATELY. Our ability to compete is affected by our ability to protect our proprietary information. We rely on a combination of patents, trademarks, copyrights, mask work registrations, trade secret laws, confidentiality 21 procedures and non-disclosure and licensing arrangements to protect our intellectual property. Despite these efforts, we cannot be certain that the steps taken to protect our proprietary information will be adequate to prevent misappropriation of our technology, or that our competitors will not independently develop technology that is substantially similar or superior to our technology. More specifically, we cannot assure you that our pending patent applications or any future applications will be approved, or that any issued patents will provide us a competitive advantage or will not be challenged by third parties, or that if challenged, will be found to be valid or enforceable, or that the patents of others will not have an adverse effect on our ability to do business. Furthermore, others may independently develop similar products or processes, duplicate our products or processes or design around any patents that may be issued to us. WE COULD BE HARMED BY LITIGATION INVOLVING PATENTS AND PROPRIETARY RIGHTS. As a general matter, the semiconductor industry is characterized by substantial litigation regarding patent and other intellectual property rights. We may be accused of infringing the intellectual property rights of third parties. Furthermore, we have certain indemnification obligations to customers with respect to the infringement of third-party intellectual property rights by our products. We cannot be certain that infringement claims by third parties or claims for indemnification by customers or end users of our products resulting from infringement claims will not be asserted in the future or that such assertions, if proven to be true, will not harm our business. Any litigation relating to the intellectual property rights of third parties, whether or not determined in our favor or which we settle, would, at a minimum, be costly and could divert the efforts and attention of our management and technical personnel. In the event of any adverse ruling in any such litigation, we could be required to pay substantial damages, cease the manufacturing, use and sale of infringing products, discontinue the use of certain processes or obtain a license under the intellectual property rights of the third party claiming infringement. A license might not be available on reasonable terms, or at all. EARTHQUAKES AND OTHER NATURAL DISASTERS MAY DAMAGE OUR FACILITY OR THOSE OF OUR SUPPLIERS. Our corporate headquarters in Fremont, California are located near major earthquake faults, which have experienced earthquakes in the past. In addition, some of our suppliers are located near areas with seismic activity. In the event of a major earthquake or other natural disaster near our headquarters, our operations could be harmed. Similarly, a major earthquake or other natural disaster near one or more of our major suppliers, like the one that occurred in Taiwan in September 1999, could disrupt the operations of those suppliers, which could limit the supply of our products and harm our business. OUR STOCK PRICE IS VOLATILE. The market price of our common stock has fluctuated significantly to date. In the future, the market price of our common stock could be subject to significant fluctuations due to general market conditions and in response to quarter-to-quarter variations in: - our anticipated or actual operating results; - announcements or introductions of new products; - technological innovations or setbacks by us or our competitors; - conditions in the communication and semiconductor markets; 22 - the commencement of litigation; - changes in estimates of our performance by securities analysts; - announcements of merger or acquisition transactions; and - general economic and market conditions. In addition, the stock market in recent years has experienced extreme price and volume fluctuations that have affected the market prices of many high technology companies, including semiconductor companies, and that have often been unrelated or disproportionate to the operating performance of companies. These fluctuations, as well as general economic and market conditions may harm the price of our common stock. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK FOREIGN CURRENCY FLUCTUATIONS. We are exposed to foreign currency fluctuations primarily through our foreign operations. This exposure is the result of the foreign operating expenses being denominated in foreign currency. Operational currency requirements are typically forecasted for a three-month period. If there is a need to hedge this risk, we will enter into transactions to purchase currency in the open market; or enter into forward currency exchange contracts which are currently available under our bank lines of credit. While it is expected that this method of hedging foreign currency risk will be utilized in the future, the hedging methodology and/or usage may be changed to manage exposure to foreign currency fluctuations. If our foreign operations forecasts are overstated or understated during periods of currency volatility, we could experience unanticipated currency gains or losses. For the three months and nine months ended December 31, 2000, we did not have significant foreign currency denominated net assets or net liabilities positions, and had no foreign currency contracts outstanding. INTEREST RATE SENSITIVITY. We maintain investment portfolio holdings of various issuers, types, and maturity dates with various banks and investment banking institutions. The market value of these investments on any given day during the investment term may vary as a result of market interest rate fluctuations. This exposure is not hedged because a hypothetical 10% movement in interest rates during the investment term would not likely have a material impact on investment income. The actual impact on investment income in the future may differ materially from this analysis, depending on actual balances and changes in the timing and the amount of interest rate movements. Both short-term and long-term investments are classified as "available-for-sale" securities and the cost of securities sold is based on the specific identification method. At December 31, 2000, short-term investments consisted of auction rate securities, government and corporate securities of $37.9 million and long-term investments consisted of government and corporate securities of $22.2 million. At December 31, 2000, the difference between the fair market value and the underlying cost of such investments was attributable to the unrealized gain of $117,000. 23 PART II - OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits:
Exhibit Number Description of Document -------------- ----------------------- 10.1 Executive Employment Agreement between Exar Corporation and Donald L. Ciffone, Jr. 10.2 Letter Agreement Regarding Change of Control for each of the following: Frank P. Carrubba, Raimon L. Conlisk, James E. Dykes, Richard Previte, Donald L. Ciffone, Jr., Michael J. Class, Roubik Gregorian, Ronald W. Guire, Susan J. Hardman, Thomas W. Jones, Thomas R. Melendrez, Stephen W. Michael, John Sramek.
(b) During the quarter for which this report is filed, the Registrant filed no reports on Form 8-K. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. EXAR CORPORATION By /s/ DONALD L. CIFFONE, JR. Date: February 12, 2001 ------------------------------------------ Donald L. Ciffone, Jr. President Chief Executive Officer By /s/ RONALD W. GUIRE Date: February 12, 2001 ------------------------------------------ Ronald W. Guire Executive Vice President, Chief Financial Officer, Secretary 24 EXHIBIT INDEX
Exhibit ------- 10.1 Executive Employment Agreement between Exar Corporation and Donald L. Ciffone, Jr. 10.2 Letter Agreement Regarding Change of Control for each of the following: Frank P. Carrubba, Raimon L. Conlisk, James E. Dykes, Richard Previte, Donald L. Ciffone, Jr., Michael J. Class, Roubik Gregorian, Ronald W. Guire, Susan J. Hardman, Thomas W. Jones, Thomas R. Melendrez, Stephen W. Michael, John Sramek.
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