UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

(Mark One)

 

x

 

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

 

 

For the quarterly period ended April 29, 2006

 

or

 

o

 

Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                to               

Commission file number: 0-30877

Marvell Technology Group Ltd.
(Exact name of registrant as specified in its charter)

Bermuda

 

77-0481679

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

Canon’s Court, 22 Victoria Street, Hamilton HM 12, Bermuda

(441) 296-6395

(Address, including Zip Code, of Principal Executive Offices and
Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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. o Yes x No

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

Large accelerated filer  x

 

Accelerated filer  o

 

Non-accelerated filer  o

 

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

The number of shares of the registrant’s common stock outstanding as of May 31, 2007 was 587,591,437 shares.

 




TABLE OF CONTENTS

 

 

 

Page

 

 

 

PART I.  FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

 

Financial Statements:

 

 

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets at April 29, 2006 and January 28, 2006 (restated)

 

4

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Income for the three months ended April 29, 2006 and April 30, 2005 (restated)

 

5

 

 

 

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended April 29, 2006 and April 30, 2005 (restated)

 

6

 

 

 

 

 

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

 

7

 

 

 

 

 

Item 2.

 

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

 

37

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

61

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

61

 

 

 

 

 

PART II.  OTHER INFORMATION

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

64

 

 

 

 

 

Item 1A.

 

Risk Factors

 

67

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

83

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

84

 

 

 

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

84

 

 

 

 

 

Item 5.

 

Other Information

 

84

 

 

 

 

 

Item 6.

 

Exhibits

 

84

 

 

 

 

 

Signatures

 

 

 

85

 

 

 

 

 

Exhibit Index

 

 

 

86

 

2




Explanatory Note

In this Form 10-Q/A, we are restating our consolidated financial statements and related disclosures as of January 28, 2006 and for the three months ended April 29, 2006 and April 30, 2005.  This Form 10-Q/A also reflects the restatement of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 for the first quarters of fiscal 2007 and 2006, “Controls and Procedures” in Item 4 and new management certifications.

For more information regarding our internal review of historical stock option practices and related accounting matters and the restatement of stock-based compensation and other items, please refer to Note 1, “Restatement of Consolidated Financial Statements” to Item 1, “Financial Statements” and Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”.  For more information regarding the deficiencies noted in the internal review relating to stock option practices and our remedial measures, refer in Part I to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 and “Controls and Procedures” in Item 4.

We have not amended any of our other previously filed annual reports on Form 10-K or quarterly reports on Form 10-Q for the periods affected by the restatement except for this Form 10-Q/A.  Consequently, the consolidated financial statements and related financial information contained in such previously filed reports should no longer be relied upon.  Our Form 10-K for fiscal year ended January 27, 2007 includes the restatement of all periods through the first quarter of fiscal 2007.

3




PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

MARVELL TECHNOLOGY GROUP LTD.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)

 

 

April 29,
2006

 

January 28,
2006

 

 

 

(restated) (1)

 

(restated) (1)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

529,389

 

$

348,431

 

Short-term investments

 

392,021

 

572,591

 

Accounts receivable, net of allowances of $3,054 and $3,028

 

293,536

 

245,164

 

Inventories

 

205,554

 

211,374

 

Prepaid expenses and other current assets

 

116,854

 

104,307

 

Deferred income taxes

 

3,945

 

3,945

 

Total current assets

 

1,541,299

 

1,485,812

 

Property and equipment, net

 

279,398

 

260,921

 

Goodwill

 

1,558,209

 

1,558,209

 

Acquired intangible assets

 

125,379

 

111,973

 

Other noncurrent assets

 

99,823

 

87,591

 

Total assets

 

$

3,604,108

 

$

3,504,506

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

150,738

 

$

196,606

 

Accrued liabilities

 

44,482

 

34,905

 

Accrued employee compensation

 

50,956

 

59,177

 

Income taxes payable

 

27,847

 

24,394

 

Deferred income

 

28,640

 

29,773

 

Current portion of capital lease obligations

 

17,032

 

16,563

 

Total current liabilities

 

319,695

 

361,418

 

Capital lease obligations, net of current portion

 

22,561

 

24,447

 

Non-current income taxes payable

 

98,191

 

86,545

 

Other long-term liabilities

 

26,835

 

24,871

 

Total liabilities

 

467,282

 

497,281

 

Commitments and contingencies (Notes 7 and 10)

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Common stock, $0.002 par value; 492,000 shares authorized; 292,381 and 291,388 shares issued and outstanding

 

585

 

583

 

Additional paid-in capital

 

3,624,464

 

3,634,821

 

Deferred stock-based compensation

 

 

(61,987

)

Accumulated other comprehensive loss

 

(1,353

)

(1,759

)

Accumulated deficit

 

(486,870

)

(564,433

)

Total shareholders’ equity

 

3,136,826

 

3,007,225

 

Total liabilities and shareholders’ equity

 

$

3,604,108

 

$

3,504,506

 


(1) See Note 1 – Restatement of Consolidated Financial Statements

See accompanying notes to unaudited condensed consolidated financial statements.

4




MARVELL TECHNOLOGY GROUP LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)

 

 

Three Months Ended

 

 

 

April 29,
2006

 

April 30,
2005

 

 

 

(restated) (1)

 

(restated) (1)

 

Net revenue

 

$

521,196

 

$

364,770

 

Operating costs and expenses:

 

 

 

 

 

Cost of goods sold

 

240,233

 

175,785

 

Research and development and other

 

129,228

 

77,950

 

Selling and marketing

 

38,862

 

22,022

 

General and administrative

 

18,558

 

9,568

 

Amortization of acquired intangible assets

 

17,351

 

19,759

 

Total operating costs and expenses

 

444,232

 

305,084

 

Operating income

 

76,964

 

59,686

 

Interest and other income, net

 

7,616

 

3,612

 

Income before income taxes

 

84,580

 

63,298

 

Provision for income taxes

 

15,863

 

9,351

 

Income before change in accounting principle

 

68,717

 

53,947

 

Cumulative effect of change in accounting principle, net of tax effect

 

8,846

 

 

Net income

 

$

77,563

 

$

53,947

 

Basic income per share:

 

 

 

 

 

Income before change in accounting principle

 

$

0.24

 

$

0.19

 

Cumulative effect of change in accounting principle, net of tax effect

 

0.03

 

 

Basic net income per share

 

$

0.27

 

$

0.19

 

Shares used in basic per share computation

 

291,851

 

278,793

 

Diluted income per share:

 

 

 

 

 

Income before change in accounting principle

 

$

0.21

 

$

0.17

 

Cumulative effect of change in accounting principle, net of tax effect

 

0.03

 

 

Diluted net income per share

 

$

0.24

 

$

0.17

 

Shares used in diluted per share computation

 

319,758

 

310,695

 


(1) See Note 1 – Restatement of Consolidated Financial Statements

See accompanying notes to unaudited condensed consolidated financial statements.

5




MARVELL TECHNOLOGY GROUP LTD.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

 

 

Three Months Ended

 

 

 

April 29,
2006

 

April 30,
2005

 

 

 

(restated) (1)

 

(restated) (1)

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

77,563

 

$

53,947

 

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

 

 

 

 

 

Cumulative effect of change in accounting principle, net

 

(8,846

)

 

Depreciation and amortization

 

15,615

 

13,431

 

Stock-based compensation

 

48,762

 

9,590

 

Amortization of acquired intangible assets

 

17,351

 

19,759

 

Excess tax benefits from stock-based compensation

 

(697

)

 

Changes in assets and liabilities, net of acquisition:

 

 

 

 

 

Accounts receivable

 

(48,372

)

(4,189

)

Inventories

 

8,729

 

15,664

 

Prepaid expenses and other assets

 

(25,799

)

(43,800

)

Accounts payable

 

(45,868

)

(7,428

)

Accrued liabilities and other

 

2,500

 

763

 

Accrued employee compensation

 

(8,222

)

506

 

Income taxes payable

 

15,100

 

8,086

 

Deferred income

 

(1,133

)

2,575

 

Net cash provided by operating activities

 

46,683

 

68,904

 

Cash flows from investing activities:

 

 

 

 

 

Cash paid for acquisition

 

(24,008

)

 

Purchases of short-term investments

 

(57,405

)

(99,018

)

Sales and maturities of short-term investments

 

238,124

 

48,051

 

Acquisition costs

 

(461

)

 

Purchases of property and equipment

 

(28,948

)

(18,395

)

Net cash provided by (used in) investing activities

 

127,302

 

(69,362

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from the issuance of common stock

 

10,904

 

20,119

 

Principal payments on capital lease obligations

 

(4,628

)

(3,156

)

Excess tax benefits from stock-based compensation

 

697

 

 

Net cash provided by financing activities

 

6,973

 

16,963

 

Net increase in cash and cash equivalents

 

180,958

 

16,505

 

Cash and cash equivalents at beginning of period

 

348,431

 

166,471

 

Cash and cash equivalents at end of period

 

$

529,389

 

$

182,976

 

Supplemental cash flows information:

 

 

 

 

 

Acquisition of property and equipment under capital lease obligations

 

$

3,212

 

$

3,862

 

Elimination of deferred stock-based compensation due to FAS 123R adoption

 

$

61,987

 

$

 


(1) See Note 1 – Restatement of Consolidated Financial Statements

See accompanying notes to unaudited condensed consolidated financial statements.

6




MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1.  Restatement of Consolidated Financial Statements

Background

On about May 23, 2006, the Company’s Chief Executive Officer initiated a review of the Company’s past stock option granting practices.  Then on May 25, 2006, the Board appointed a committee, chaired by and consisting solely of an independent and disinterested member of the Audit Committee who had no prior involvement in the stock option process, to conduct the internal review of the Company’s historical stock option practices and related accounting matters.   This committee retained outside legal counsel at the time to assist with this internal review.  In June and July 2006, this committee identified various stock option grants as having been potentially selected with the benefit of hindsight.  During this time the Company was also named as a nominal defendant, and a number of the Company’s current and former directors and officers were named as defendants, in purported shareholder derivative actions.

During this time, the Company was informed that its outside legal counsel at the time could not represent both the independent committee and the Company, particularly if that independent committee was going to evaluate and address matters raised by the derivative actions. The Company’s Board met on July 19, 2006 and appointed a successor special committee, titled the Special Committee Regarding Derivative Litigation, to assume responsibility for the stock option review and to evaluate and address matters raised by the derivative action (the “Special Committee”).  The same independent director continued as the sole member of the Special Committee and, after consideration of a number of firms, selected new, independent counsel to represent the Special Committee.  The Special Committee subsequently retained a second independent law firm (collectively “Independent Counsel”).  Independent Counsel retained forensic accounting experts to assist in the internal review.

The Special Committee reported its preliminary findings on quantitative issues to the Audit Committee and the Board on September 28, 2006.  Based on the report of the Special Committee, and upon the recommendation of management and the Audit Committee, the Board concluded on October 2, 2006, that the Company would need to restate historical financial statements to record additional non-cash charges for stock-based compensation expense related to past option grants and that the historical financial statements and all earnings press releases and similar communications issued by the Company relating to periods beginning on or after its initial public offering in June 2000 should no longer be relied upon.  The Company reported these conclusions in a current report on Form 8-K filed on the same day.

On February 7, 2007, the former General Counsel of the U.S. subsidiary, Marvell Semiconductor, Inc. (“MSI”), who was a subject of the internal review, raised allegations regarding the independence of the sole member of the Special Committee.  The Audit Committee thereafter formed a subcommittee consisting of the Chairman of the Audit Committee to investigate the matter.  The subcommittee appointed a former federal judge to serve as independent reviewer for the subcommittee who in turn retained independent counsel.  Although the independent reviewer made no findings as to the truth of the allegations themselves and expressed substantial doubt regarding the credibility of the allegations, he nevertheless concluded that the independent director should step down from the Special Committee to ensure compliance with the stringent independence standards developed by courts reviewing the independence of special litigation committees formed to assess the merits of shareholder derivative litigation.  The subcommittee also found that the General Counsel violated the Company’s Code of Ethics and Business Conduct for not reporting the allegations timely.  The subcommittee accepted the findings of the independent reviewer.  The Company has since terminated the General Counsel for the violation.  On March 30, 2007, the independent director resigned from the Special Committee and the Board appointed two independent non-director members to the Special Committee to continue the review of the Company’s historical stock option practices and related accounting matters, which action is permitted under the Company’s bye-laws.  As a result, the Special Committee thereafter consisted of two non-directors.

On April 27, 2007, the Special Committee reported its findings to the Board of Directors and to the Implementation Committee, which consists of three independent members of the Board.  The Implementation Committee was formed by the Board on April 26, 2007 to make such decisions and take such action as the committee determines to be appropriate in light of the Special Committee’s findings and recommendations.  On May 8, 2007, the Company disclosed on Form 8-K the completion of the independent review.

7




Findings of the Special Committee

From the Company’s initial public offering through June 9, 2006 (the “Relevant Period”), option grants awarded to employees who were not then executive officers, as defined in Section 16 of the Securities Exchange Act of 1934, as amended (“Section 16 Officers”), were awarded either by the Board of Directors or the Stock Option Committee of the Board. The Stock Option Committee was formed by the Board of Directors in December 2000 and consisted of the Chief Executive Officer and the former Executive Vice President and Chief Operating Officer.  Pursuant to authority delegated by the Board of Directors under Marvell’s 1995 Stock Option Plan, the Stock Option Committee was empowered to act jointly.  The Stock Option Committee awarded all grants to non-executives employees after its formation until June 9, 2006.

The Special Committee concluded that only one member of the Stock Option Committee was actively involved in the grant approval process.  Of the 59 minutes of meetings of the Stock Option Committee, all of which were prepared by or under the direction of the former General Counsel of MSI, only the first set of minutes were separately prepared for each member’s signature and signed by each of them; subsequently the minutes were only prepared for one member to sign and only one member signed those minutes.  Additionally, the Special Committee determined that the Stock Option Committee conducted no meetings with respect to option grants and that minutes reflecting such meetings were false.

The Special Committee determined that in a substantial number of instances grant dates were chosen by management with the benefit of hindsight, so as to provide exercise prices lower than the fair market value on the actual measurement date.

In addition to the foregoing, the review determined that false employee-related paperwork was employed to reflect start dates that preceded the actual first day of employment, and to reflect secondary grant authorizations as if they occurred on dates prior to the original grant date, which facilitated giving the employees favorable prices.

From the Company’s initial public offering in June 2000 through February 28, 2002, grants to its former Chief Financial Officer were awarded only by the Stock Option Committee.  The Stock Option Committee was not advised that it lacked the authority to make such awards.  Furthermore, the first award made to its former Chief Financial Officer by the Executive Compensation Committee dated October 16, 2002 was backdated and the Special Committee found that the former General Counsel misled the Executive Compensation Committee with respect to the facts and circumstances surrounding the grant, including the grant date.

During the Relevant Period, option grants to Section 16 Officers and members of the Board of Directors were approved by the Board of Directors or the Executive Compensation Committee or made pursuant to the Automatic Director Grant Program under the 1997 Director’s Stock Option Plan.  In the absence of a meeting, grant approvals by the Executive Compensation Committee were documented via written consents, which were dated “as of” a specified date but signed at a later time.  The Executive Compensation Committee comprised three to four independent members of the Board over the Relevant Period.  The Special Committee found that current board members who had served or are serving on the Executive Compensation Committee had not engaged in impropriety or intentional backdating with the benefit of hindsight.

The Special Committee found evidence of recommendations made by representatives of Human Resources and Finance and our external auditors between 2000 and 2004 to grant options on fixed grant dates   In August 2004, the Company implemented revisions to the Company’s stock option grant processes and procedures for new hire and secondary grants that generally followed a fixed grant date schedule.

For the period from the Company’s initial public offering in June 2000 through June 2006, the Special Committee found a systemic failure in controls over the stock option process, and that corporate documents, including the Company’s SEC filings on Form 10-K and Form 10-Q and proxy statements, were false in relation to the accounting and related disclosure covering stock option matters.

The Special Committee found that certain individuals had varying degrees of responsibility for the lack of controls and the inappropriate grant practices. As to the following individuals, the Special Committee concluded among other things:

Matthew Gloss, MSI’s corporate counsel from April 2000 until February 2001 and thereafter its Vice President and subsequently, General Counsel until his termination in March 2007, failed to properly advise upper management, including Dr. Sutardja and Ms. Dai, about their responsibilities and duties regarding stock options and other financial filings. The minutes of the Stock Option Committee were prepared by or at the direction of Matthew Gloss.  Mr. Gloss was also found to have misled the Executive Compensation Committee by creating false minutes and unanimous written consents, including in one instance adding or directing the addition of a grant date to a unanimous written consent after that unanimous written consent was executed, or by creating minutes that were incomplete, inaccurate or misleading.  He also failed to establish proper controls over the stock option process despite being on notice of various control problems.

8




George A. Hervey, the Company’s Vice President and Chief Financial Officer throughout the Relevant Period until his resignation in May 2007, failed to properly advise upper management, including Dr. Sutardja and Ms. Dai, about their responsibilities and duties regarding stock options and other financial filings.  Mr. Hervey also was found to have been aware of awarding options to two employees prior to their start date.  He also failed to establish a system of proper controls despite being on notice of repeated concerns raised by others regarding the stock option process. He signed inaccurate external documents, including the Company’s SEC filings and financial statements.

Weili Dai, the Company’s former Board member, who served as Executive Vice President and General Manager of the Communications Business Group from 1999 to April 2006 and thereafter also as Chief Operating Officer until she resigned from such positions in May 2007, played a central role in all Stock Option Committee grants. Ms. Dai participated in the selection of grant dates with the benefit of hindsight and signed false minutes and other employee related corporate documents.  The Special Committee also found that she failed to establish proper internal controls and failed to exercise proper review and inquiry as an officer. Certain individuals involved in the process said that they did not feel able to provide her with frank advice. She signed inaccurate external documents, including 10-K’s and proxy statements.  She did not personally benefit from any of the grants she approved.

Dr. Sehat Sutardja, the Company’s Chairman of the Board, President and Chief Executive Officer, was found to have had a limited role in the stock option process and to have participated in only a few instances in awards with incorrect measurement dates with respect to which he had received no or inadequate advice.  He signed inaccurate external documents, including the Company’s SEC filings, financial statements, and proxy statements.  The Special Committee found that he failed to establish proper internal controls and that certain individuals involved in the process to some extent did not feel able to provide him with frank advice.  He did not personally benefit from any of the grants he approved.

Remediation

With respect to the following employees, the Special Committee made recommendations, and Marvell’s Implementation Committee has implemented or is in the process of implementing the following remedial steps:

The Company accepted the resignation of George A. Hervey on May 2, 2007.  All unvested stock options previously awarded to him were cancelled.

The Implementation Committee of our Board of Directors determined, contrary to the recommendation of the Special Committee, that Ms. Dai has no continuing role with the Company, that retaining the services of Ms. Dai in a substantially reduced capacity as Director of Strategic Marketing and Business Development, an individual contributor in a non-managerial role, and under the auspices of the Implementation Committee better serves the interests of all shareholders. Ms. Dai will have no authority to undertake any decisions affecting internal controls or financial matters of the Company. The Implementation Committee will provide periodic compliance updates to the Board of Directors on Ms. Dai’s activities. Additionally, all of Ms. Dai’s outstanding options that were unvested as of May 6, 2007 have been cancelled and the exercisability of already vested options have been limited, notwithstanding her continued employment.

Dr. Sehat Sutardja will remain as President and Chief Executive Officer and as a member of the Board, but will step down as Chairman of the Board in favor of a non-executive Chairman. Dr. Sutardja agreed to reduce the number of shares received in his December 26, 2003 option grant by 500,000 pre-split shares (2,000,000 post-split shares), which is the amount of underlying shares mistakenly awarded by the Executive Compensation Committee in excess of that authorized under the applicable stock option plan.

In April 2007, the Stock Option Committee was formally dissolved; however, it ceased to function during June 2006 and has granted no options since that time.  Currently, the Executive Compensation Committee, comprising two independent Board members, holds periodic meetings to approve equity award grants.  The process requires that any proposed equity awards be reviewed in advance by the Human Resources, Legal, Finance and Internal Audit Departments, and requires communication of the details of proposed equity awards to committee members prior to each monthly meeting, as well as awarding recipients promptly after the meeting. Equity awards are priced and valued based upon the closing price of the Company’s common stock on the date of the meeting. Decisions of the committee meeting are documented by minutes.  Additionally, the Executive Compensation Committee adopted a policy regarding

9




the granting of equity-based compensation awards.  Following the Special Committee’s recommendations, the Company is conducting a search for a new Chief Operating Officer, Chief Financial Officer, General Counsel and Vice President of Compliance.  Additionally, the Board’s Governance Committee is conducting a search for three new independent directors to fill existing vacancies.  One of these independent directors will succeed Dr. Sutardja as Chairman of the Board.

Pre-tax Financial Impact of the Equity Award Review

Approximately 74% of shares granted during the Relevant Period were backdated or resulted in additional accounting charges.  Of these re-measured grants, the stock prices on the original grant date were lower than the prices on the appropriate measurement dates for 97% of such shares.  Substantially all options granted (99% of shares granted during the Relevant Period) have been evaluated for appropriate re-measurement dates under Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB25”).

The types of grant discrepancies uncovered by the internal review (by both the Special Committee and management) and the additional pre-tax stock-compensation expense arising from these adjustments, quantified under APB 25 for periods through fiscal 2006, are summarized as follows (in thousands):

 

Cumulative
through
January 28,
2006

 

Year Ended
January 28,
2006

 

Year Ended
January 29,
2005

 

Year Ended
January 31,
2004

 

Year Ended
February 1,
2003

 

Year Ended
February 2,
2002

 

Year Ended
January 27,
2001 and
prior

 

Board of Director Grants (a)

 

$

1

 

$

1

 

$

 

$

 

$

 

$

 

$

 

Officer Grants (b)

 

19,577

 

6,317

 

12,023

 

836

 

270

 

127

 

4

 

Re-priced Officer Grants (c)

 

39,658

 

24,827

 

9,888

 

4,943

 

 

 

 

New Hire Grants – effective hire dates (d)

 

19,879

 

249

 

1,530

 

2,729

 

4,754

 

7,278

 

3,339

 

Other New Hire (e)

 

49,876

 

5,313

 

13,235

 

13,437

 

10,322

 

7,061

 

508

 

Secondary Grants (e)

 

18,165

 

2,360

 

3,713

 

3,016

 

4,432

 

3,975

 

669

 

Re-priced New Hire Grants (f)

 

100,575

 

49,798

 

23,727

 

25,254

 

(1,885

)

3,681

 

 

Evergreen Grants (g)

 

60,838

 

9,870

 

11,082

 

12,634

 

17,911

 

9,312

 

29

 

Non-employee Grants * (h)

 

8,800

 

121

 

486

 

1,166

 

(264

)

1,884

 

5,407

 

Termination related charges (i)

 

10,006

 

 

 

 

 

 

10,006

 

 

 

$

327,375

 

$

98,856

 

$

75,684

 

$

64,015

 

$

35,540

 

$

33,318

 

$

19,962

 

 


*The restated financial statements include charges for non-employee grants of $1,062,000 for fiscal 2000, $139,000 for fiscal 1999, $41,000 for fiscal 1998, $12,000 for fiscal 1997 and $1,000 for fiscal 1996.

(a)       Board of Director Grants:  Non-employee directors receive initial and annual grants in their capacity as directors.  A grant of 24,000 shares to a non-employee director, issued on an annual general meeting date in accordance with the terms of his appointment letter, was outside the 1997 Directors’ Stock Option Plan and therefore required approval from the Board.  The Board approval was obtained at a later date.   For accounting purposes, the grant was re-measured based on the Company’s stock price at the date of the Board’s ratification.

In December 2006, the terms of this option were reformed to reflect the revised stock option exercise price.

(b)       Officer Grants:  During the Relevant Period, the Company granted options on 13 different dates (including the Re-Priced Officer Grants) to the then-Section 16 Officers — Dr. Sehat Sutardja, Weili Dai, Dr. Pantas Sutardja and George Hervey.  The Company recorded additional compensation costs for

10




one grant on December 26, 2003 (which represented 75% of options granted) for three of the officers who were also founders of the Company (“Founder Officers”) and six grants (which represented 96% of options granted) for George Hervey.  For accounting purposes, the grant of 12,640,000 shares to the Founder Officers was re-measured based on the stock price at the date the Executive Compensation Committee meeting occurred to approve the grants.  Grants to George Hervey totaling 1,279,892 shares of options originally priced at the “as of” dates of the written consents have been re-measured to the last documented date of approval received from members of the Executive Compensation Committee.

In December 2006, the terms of the options deemed to have been issued at a discount were reformed to reflect the revised stock option exercise prices for all affected Section 16 Officer grants.  Of these 5.4 million reformed options, the Company received from the Officers the incremental exercise prices for the portion of these options which had previously been exercised totaling $9.6 million. The reformation of these options did not result in incremental compensation cost in the fourth quarter of fiscal 2007.

The amounts above do not include $7.5 million in unrecognized stock-based compensation that will be recorded in the second quarter of fiscal 2008 in connection with the cancellation of certain officer grants to Dr. Sehat Sutardja and Weili Dai.

(c)        Re-priced Officer Grants:  The minutes of the May 22, 2002 Executive Compensation Committee meeting reflect the Executive Compensation Committee’s approval of a grant to the Founder Officers totaling 1.6 million shares, to be effective on the execution of a unanimous written consent. In June 2002, the Executive Compensation Committee members executed a unanimous written consent dated June 6, 2002 and effective as of May 22, 2002. The Special Committee found that on September 10, 2002 after the former General Counsel had a discussion with two of the Founder Officers who indicated that the setting of the price as of May 22, 2002 was inaccurate, the grant was repriced to the fair market value on June 6, 2002.  The Special Committee further found that the former General Counsel had misled the Executive Compensation Committee as to the reasons for the change.  The Special Committe further found that the amendment was falsely characterized as a documentation error rather than a grant modification.  While the affected options were not considered to be issued at a discount on the date of the modification, these shares were subject to variable accounting until the Company’s adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”) at the beginning of fiscal 2007.

(d)       New Hire Grants – effective hire dates:  The internal review identified 4,669,200 options to 30 new hire recipients which required revision to reflect a later date.  In all cases, the stock price on the original grant date was lower than the price on the appropriate measurement date.  For accounting purposes, the new hire start dates had to be reconstructed through payroll records and evaluated to determine appropriate re-measurement dates. 

(e)        Other New Hire and Secondary Grants: In addition to grants issued to new hires at the commencement of their employment, the Company occasionally issues secondary grants to employees for outstanding performance, retention or other discretionary reasons outside of the annual performance review cycle.  During the Relevant Period, the Company granted new hire and secondary options on 86 different dates, excluding assumption of acquisition-related options.  These dates included grants made from August 2004 onwards when a fixed grant date schedule was set on the first Friday of each month. As a result of the internal review, the Company recorded additional compensation costs for grants relating to 37 different grant dates, impacting approximately two-thirds of the new hire and secondary grants (totaling 48,708,478 options).  The original grant date with respect to such grants preceded the appropriate measurement date and in substantially all instances, the stock price on the former date was lower than the price on the appropriate measurement date.  Generally, the terms of new hire grants, except for their exercise prices, are stated in employee offer letters which are acknowledged by employees.  For new hire grants, re-measurement dates were determined based on the first instance when the Stock Option Committee grant date was picked.  For secondary grants, as there was no other reliable documentation available to support the measurement date, the Company applied the date the grant was submitted to stock administration for processing, which typically indicated the conclusion of the grant process.  The last date of submission was used unless the submitted change was proven to be purely administrative in nature and unrelated to the terms of the grant.  Absent such submission documentation, the Company used the date the grant entry was created in the option database, as this was the most objectively verifiable date when the terms of the grant were known, in accordance with the SEC Chief Accountant’s letter issued on September 19, 2006, outlining the SEC staff’s interpretation of specific accounting guidance for registrants under APB 25.

(f)           Re-priced New Hire Grants: Of the new hire grants in the Relevant Period, grant prices were re-set for a segment of grants on three grant dates.  Consequently, affected awards totaling 6,224,200 options were subject to variable accounting until the Company’s adoption of SFAS 123R.  The re-pricing resulted from the Stock Option Committee’s originally designated grant date being modified to a later grant date.

11




(g)       Evergreen Grants:  During the Relevant Period, there were eight Evergreen grant dates.  Substantially all employees are entitled to these grants for retention purposes.  There were two Evergreen grant dates in both fiscal 2003 and 2004.  There was evidence of amendments to the recipients and/or the number of options subsequent to the original grant date.  In all cases, the definitive lists of award recipients could not be reasonably determined until after the original grant date, impacting 54,702,828 options.  Consequently, all Evergreen grants were re-measured on subsequent dates when the granting process was considered to be finalized.  For purposes of the restatement, the Company used the date the grant was submitted to stock administration for processing, which typically indicated the conclusion of the grant process.  The last date of submission was used unless the submitted change was proven to be purely administrative in nature and unrelated to the terms of the grant.  Absent this supporting documentation, the date the grant entry was created in the option database was used.  In substantially all instances, the stock price on the former date was lower than the price on the appropriate measurement date.  The last Evergreen grant (totaling 7,215,056 options) occurred during fiscal 2007 and the effects on the restatement were included in the restated fair value of the affected grants under SFAS 123R, increasing the grant date fair value of affected options by $0.31 per share.

(h)       Non-employee Grants:  Since the inception of the Company, 3,819,000 options were granted to 13 recipients who were not employees or directors of the Company.  These grants were erroneously accounted for under APB 25 as if they had been made to employees. Of these, four recipients that were granted a total of 1,483,000 options subsequently became employees or directors of the Company.  As a result, the affected awards were accounted for as non-employee grants under EITF 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, which resulted in the application of variable accounting on these options until exercised or cancelled.  Options held by consultants who became employees or directors of the Company have been accounted for under FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, which addresses a change in grantee status.

(i)          Termination-related charges:  With respect to option grants to an employee, the post-service exercise period for 605,332 vested stock options was effectively extended by an unpaid leave of absence arrangement which appears to have lacked substance.   The Company applied APB 25 as if the leave of absence arrangement was a constructive modification extending the exercise period of vested awards. The Company recorded $10.0 million in additional deferred compensation charges in fiscal 2001.

Notwithstanding the foregoing, the lack of conclusive evidence in the case of certain grants required management to apply significant judgment in establishing revised measurement dates.  The Company determined that the total cumulative, pre-tax, non-cash, stock-based compensation expense resulting from revised measurement dates under APB 25 was $327.4 million for periods through fiscal 2006.  There was no impact on revenue.  The Company adopted SFAS 123R at the beginning of fiscal 2007.  As a result of the above adjustments, and after revisions to the SFAS 123R fair value assumptions, the pre-tax, non-cash, stock-based compensation expense in the first quarter of fiscal 2007 increased by $4.2 million to $48.8 million.

Tax Impact of the Equity Award Review and other

The majority of the additional $327.4 million stock option compensation is expensed on the financial statements of the entities located in tax jurisdictions having a lower tax rate than that of the U.S. The tax benefits associated with all but $12.0 million of the $327.4 million total expense is recorded in Bermuda at zero percent tax rate. The $12.0 million of compensation expense and associated tax benefits have resulted in a cumulative deferred tax asset of $2.5 million as of January 28, 2006 and a deferred provision benefit of $4.8 million. The tax impact of the adjustments arising from the equity award review is summarized as follows (in thousands):

12




 

 

Cumulative
through
January 28,
2006

 

Year Ended
January 28,
2006

 

Year Ended
January 29,
2005

 

Year Ended
January 31,
2004

 

Year Ended
February 1,
2003

 

Year Ended
February 2,
2002

 

Year Ended
January 27,
2001

 

Operating costs and expenses - Payroll tax* (a)

 

$

7,628

 

$

4,384

 

$

2,306

 

$

921

 

$

17

 

$

 

$

 

Provision for income tax – Deferred Income Tax Benefit (b)

 

(4,806

)

(1,822

)

(1,150

)

(1,170

)

(405

)

(259

)

 

Provision for income tax – Section 162(m) and utilization of deferred tax assets** (c)

 

27,206

 

27,206

 

 

 

 

 

 

Tax impact of the equity award review

 

$

30,028

 

$

29,768

 

$

1,156

 

$

(249

)

$

(388

)

$

(259

)

$

 

Reduction to deferred tax asset for exemption benefit (d)

 

$

5,275

 

$

3,249

 

$

2,026

 

 

 

 

 

 


*              $3.0 million of additional employer and employee withholding taxes relating to exercises of affected opinions, including penalty and interest, and $24.2 million of Section 409A expenses of employees, including penalties and interest was also recorded in fiscal 2007.

**         $4.9 million of penalty and interest associated with Section 162(m) liability was also recorded in fiscal 2007.

(a)      Payroll Tax -  The revised measurement dates for certain stock options as discussed in this filing may result in adverse federal and state tax consequences to holders of those options under IRC Section 409A which was enacted in 2004 to impose certain restrictions on deferred compensation arrangements.  The adverse tax consequences are that Section 409A may subject the option holder of the re-measured retroactively priced stock options to a penalty tax and interest on the exercise of the options vesting after December 31, 2004.  In addition to similar penalty taxes and interest under California and other state income tax laws upon the exercise of the option grant will apply.

·                  Exercised options.  The option grants had been originally issued as incentive stock options.  Due to the re-measurement caused by the re-pricing, they have become non-statutory stock options.  The Company has accrued employment taxes for the exercise in each of the years due to the conversion of the options from incentive to non-statutory.   Included in the restated results through fiscal 2006 are additional employer and employee withholding taxes relating to exercises of affected options totaling $7.6 million, including penalties and interest.  The amounts represent additional compensation expense and have been classified in their respective functional categories.   On a calendar year basis the amounts total:  calendar 2003 of $0.8 million, calendar 2004 of $1.9 million, calendar 2005 of $3.7 million, and calendar 2006 of $4.2 million.   The above table reflects the amounts on a fiscal year basis.   The full amount of compensation, taxes, interest and penalties has been accrued as reflected above as well as in fiscal 2007.  The total amount accrued through fiscal 2007 is $10.6 million.

·                  Section 409A

The Company has informed employees who exercised options in 2006 that any additional tax costs accruing to such employees from Section 409A, ISO disqualification, and employment taxes will be reimbursed by the company and grossed up.  For the Section 409A affected options exercised during calendar year 2006, the IRS issued guidelines that would allow employers to enter into a global settlement of Section 409A issues on behalf of their employees.  California and other states have offered a similar program.  This liability does not appear in the above table, but has been accrued in fiscal year 2007 as explained in the remainder of this section.

Because all holders of re-measured stock options generally were not involved in or aware of the retroactive pricing, the Board of Directors approved our plan to deal with the adverse tax consequences that may be incurred by the holders of the re-measured options in the fourth quarter of fiscal

13




2007.  Therefore, the Company recorded in the last quarter of fiscal 2007 Section 409A expenses for the adverse tax consequences of the re-measured options exercised during calendar year 2006 of approximately $24.2 million, including estimated penalties and interest.  The amount represents additional compensation expense and has been classified in the respective functional categories.  The Company has sent timely notices to the IRS and the California Franchise Tax Board that it has elected to participate in these programs.

·                  Unexercised options. The IRS has provided taxpayers with the following two ways of correcting unexercised discounted stock options: 1) setting a fixed exercise date; or 2) increasing the exercise price of the option up to the fair market price on the date of grant. The Company is actively evaluating these options.  The discount associated with unexercised stock options outstanding as of January 27, 2007 amounted to $51.7 million.  The company has not determined the tax consequences associated with these potential future remedies.

(b)       Deferred Tax Asset for Stock Based Compensation:  The Company recorded adjustments for the creation of additional deferred tax asset for stock based compensation that is deductible at later periods for U.S. income tax purposes on its balance sheets for year end dates of each of fiscal 2002 through fiscal 2006.  As a result, additional benefits for income tax arising from stock based compensation were recognized in fiscal 2006 of $1.8 million, fiscal 2005 of $1.1 million, fiscal 2004 of $1.2 million, fiscal 2003 of $0.4 million and fiscal 2002 of $0.3 million.  The total gross stock based compensation cost that results in a deferred tax benefit is $12.0 million of the total expense of $327.4 million.

In addition, the Company evaluated the impact of the restatement on its global tax provision.  The Company and its subsidiaries file tax returns in multiple tax jurisdictions around the world.  In the U.S. jurisdiction one of the company’s subsidiaries claims a tax deduction relative to stock options with regard to the U.S. distributor business.   In accordance with FAS 123R for this jurisdiction where the deduction is claimed during fiscal 2007, the Company has recorded a deferred tax asset totaling $3.5 million at January 27, 2007, to reflect future tax deductions to the extent the company believes such asset is recoverable.

(c)        Income Tax - Section 162(m) and utilization of deferred tax assets:  The Company has accrued for the current and deferred tax impact of $104.5 million of non-deductible officer compensation related to Internal Revenue Code Section 162(m) (“Section 162(m)”)in fiscal 2006. Section 162(m) limits the deductibility of compensation in excess of one million dollars, but exempts stock option compensation where the option was issued at fair market value on the date of grant. The Company has determined that $104.5 million of executive compensation in fiscal 2006 does not meet the exclusion criteria under Section 162(m), under existing IRS interpretations, and have therefore accrued $21.8 million of current tax expense and $5.4 million of deferred tax expense associated with the utilization of net operating losses. The Company has accrued the penalty and interest totaling $4.9 million associated with this liability in fiscal 2007.

(d)       Other:  The Company recorded adjustments to correct an overstatement of deferred tax asset related to the Singapore entity.  The original deferred tax asset had not reflected the benefit of the Pioneer status of this entity.

Accumulated Deficit Impact of Equity Award Review and Other Tax Adjustments

The table below reflects the breakdown by year of the cumulative adjustment to retained earnings.  The consolidated financial statements for periods through fiscal 2006 included in previously filed periodic reports with the SEC for such periods have not been amended.  The consolidated financial statements, included in this Form 10-Q, have been restated as follows (in thousands):

14




 

 

Stock-based
compensation
expense

 

Estimated
additional
payroll tax
expense

 

Additional
deferred
income tax
benefit

 

Additional
deferred
income tax
provision

 

Section
162(m) and
utilization
of deferred
tax assets

 

Cumulative
effect of
change in
accounting
principle,
net of tax
effect

 

Total
Adjustments,
net of tax

 

Fiscal 2000 and
prior*

 

$

1,255

 

$

 

$

 

$

 

$

 

$

 

$

1,255

 

Fiscal 2001

 

18,707

 

 

 

 

 

 

18,707

 

Fiscal 2002

 

33,318

 

 

(259

)

 

 

 

33,059

 

Fiscal 2003

 

35,540

 

17

 

(405

)

 

 

 

35,152

 

Fiscal 2004

 

64,015

 

921

 

(1,170

)

 

 

 

63,766

 

Cumulative effect
at January 31,
2004

 

152,835

 

938

 

(1,834

)

 

 

 

151,939

 

 

 

Net income
as reported

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income
as restated

 

Fiscal 2005

 

$

141,661

 

75,684

 

2,306

 

(1,150

)

2,026

 

 

 

78,866

 

$

62,795

 

Fiscal 2006:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended April 30, 2005

 

 

 

8,719

 

866

 

 

 

 

 

9,585

 

 

 

Three months ended July 30, 2005

 

 

 

29,120

 

1,083

 

 

 

 

 

30,203

 

 

 

Three months ended October 29, 2005

 

 

 

9,102

 

589

 

 

 

 

 

9,691

 

 

 

Three months ended January 28, 2006

 

 

 

51,915

 

1,846

 

(1,822

)

3,249

 

27,206

 

 

82,394

 

 

 

Total for Fiscal 2006

 

331,363

 

98,856

 

4,384

 

(1,822

)

3,249

 

27,206

 

 

131,873

 

199,490

 

Cumulative effect at January 28, 2006

 

 

 

327,375

 

7,628

 

(4,806

)

5,275

 

27,206

 

 

362,678

 

 

 

Three months ended April 29, 2006

 

75,297

 

4,225

 

2,170

 

(3,325

)

 

3,510

 

(8,846

)

(2,266

)

77,563

 

Cumulative effect at April 29, 2006

 

 

 

$

331,600

 

$

9,798

 

$

(8,131

)

$

5,275

 

$

30,716

 

$

(8,846

)

$

360,412

 

 

 

 


*                Comprised $1,062,000 for fiscal 2000, $139,000 for fiscal 1999, $41,000 for fiscal 1998, $12,000 for fiscal 1997 and $1,000 for fiscal 1996.

The restatement adjustments increased previously reported basic net income per share by $0.48 and $0.28 for fiscal 2006 and 2005, respectively and diluted net income per share by $0.40 and $0.26 for fiscal 2006 and fiscal 2005, respectively.

Cashflows Impact of Equity Award Review

The additional payable for payroll taxes associated with these stock option grants of approximately $10.6 million, additional Section 409A expenses for the adverse tax consequences of the re-measured options exercised during calendar year 2006 of approximately $24.2 million, and Section 162(m) liabilities of $26.5 million for cumulative period from fiscal 2001 through 2007, represents future cash outflow totaling $61.3 million.

15




The following tables present the impact of the financial statement adjustments on the previously reported Consolidated Statement of Operations for the first quarter of fiscal 2007 and 2006:

 

Quarter Ended April 29, 2006

 

Quarter Ended April 30, 2005

 

 

 

As
Previously
Reported

 

Adjustments

 

As
Restated

 

As
Previously
Reported

 

Adjustments

 

As
Restated

 

 

 

(In thousands, except per share amounts)

 

Net revenue

 

$

521,196

 

$

 

$

521,196

 

$

364,770

 

$

 

$

364,770

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of goods sold

 

240,664

 

(431

)A

240,233

 

175,251

 

534

C

175,785

 

Research and development

 

124,831

 

4,397

A

129,228

 

72,409

 

5,541

C

77,950

 

Selling and marketing

 

38,133

 

729

A

38,862

 

21,203

 

819

C

22,022

 

General and administrative

 

16,858

 

1,700

A

18,558

 

6,877

 

2,691

C

9,568

 

Amortization and write-off of goodwill and acquired intangible assets and other

 

17,351

 

 

17,351

 

19,759

 

 

19,759

 

Total operating costs and expenses

 

437,837

 

6,395

 

444,232

 

295,499

 

9,585

 

305,084

 

Operating income (loss)

 

83,359

 

(6,395

)

76,964

 

69,271

 

(9,585

)

59,686

 

Interest and other income, net

 

7,616

 

 

7,616

 

3,612

 

 

3,612

 

Income (loss) before income taxes

 

90,975

 

(6,395

)

84,580

 

72,883

 

(9,585

)

63,298

 

Provision (benefit) for income taxes

 

15,678

 

185

B

15,863

 

9,351

 

 

9,351

 

Income (loss) before change in accounting principle

 

75,297

 

(6,580

)

68,717

 

63,532

 

(9,585

)

53,947

 

Cumulative effect of change in accounting principle, net of tax effect

 

 

8,846

D

8,846

 

 

 

 

Net income (loss)

 

$

75,297

 

$

2,266

 

$

77,563

 

$

63,532

 

$

(9,585

)

$

53,947

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before change in accounting principle

 

$

0.26

 

$

0.02

 

$

0.24

 

$

0.23

 

$

(0.04

)

$

0.19

 

Cumulative effect of change in accounting principle

 

 

0.03

 

0.03

 

 

 

 

Basic net income per share

 

$

0.26

 

 

 

$

0.27

 

$

0.23

 

 

 

$

0.19

 

Shares used in basic per share computation

 

291,851

 

 

 

291,851

 

278,793

 

 

 

278,793

 

Diluted income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before change in accounting principle

 

$

0.23

 

$

(0.02

)

$

0.21

 

$

0.20

 

$

(0.03

)

$

0.17

 

Cumulative effect of change in accounting principle

 

 

0.03

 

0.03

 

 

 

 

Diluted net income per share

 

$

0.23

 

 

 

$

0.24

 

$

0.20

 

 

 

$

0.17

 

Shares used in diluted per share computation

 

320,415

 

 

 

319,758

 

310,736

 

 

 

310,695

 

 


A.          Adjustments for stock-based compensation expense under SFAS 123R for the impact of remeasured grants and the effect of revisions to fair value assumptions, and additional payroll tax expenses.

B.            Accural of penalty and interest associated with Section 162(m), net of adjustments to provision for income taxes arising from stock option exercises.

C.            Adjustments for additional stock-based compensation expense pursuant to APB 25 and reclassification of previously reported stock-based compensation expenses to the respective functional cost and expense line items.

D.           Adjustments for the cumulative effect of change in accounting principle related to estimating forfeitures in the adoption of  SFAS 123R.

16




The following tables present the impact of the financial statement adjustments on the previously reported Consolidated Balance Sheets as of April 29, 2006 and January 28, 2006:

 

 

April 29, 2006

 

January 28, 2006

 

 

 

As

 

 

 

 

 

As

 

 

 

 

 

 

 

Previously

 

 

 

As

 

Previously

 

 

 

As

 

 

 

Reported

 

Adjustments

 

Restated

 

Reported

 

Adjustments

 

Restated

 

 

 

(In thousands, except per share amounts)

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

529,389

 

$

 

$

529,389

 

$

348,431

 

$

 

$

348,431

 

Short-term investments

 

392,021

 

 

392,021

 

572,591

 

 

572,591

 

Accounts receivable, net of allowance

 

293,536

 

 

293,536

 

245,164

 

 

245,164

 

Inventories

 

204,839

 

715

D

205,554

 

211,374

 

 

211,374

 

Prepaid expenses and other current assets

 

116,854

 

 

116,854

 

104,307

 

 

104,307

 

Deferred income taxes

 

18,007

 

(14,062

)B

3,945

 

18,007

 

(14,062

)B

3,945

 

Total current assets

 

1,554,646

 

(13,347

)

1,541,299

 

1,499,874

 

(14,062

)

1,485,812

 

Property and equipment, net

 

279,398

 

 

279,398

 

260,921

 

 

260,921

 

Goodwill

 

1,558,209

 

 

1,558,209

 

1,558,209

 

 

1,558,209

 

Acquired intangible assets, net

 

125,379

 

 

125,379

 

111,973

 

 

111,973

 

Other non-current assets

 

94,544

 

5,279

B

99,823

 

82,312

 

5,279

B

87,591

 

Total assets

 

$

3,612,176

 

$

(8,068

)

$

3,604,108

 

$

3,513,289

 

$

(8,783

)

$

3,504,506

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

150,738

 

$

 

$

150,738

 

$

196,606

 

$

 

$

196,606

 

Accrued liabilities

 

44,482

 

 

44,482

 

34,905

 

 

34,905

 

Accrued employee compensation

 

41,158

 

9,798

C

50,956

 

51,549

 

7,628

C

59,177

 

Income taxes payable

 

3,296

 

24,551

B

27,847

 

3,352

 

21,042

B

24,394

 

Deferred income

 

28,640

 

 

28,640

 

29,773

 

 

29,773

 

Current portion of capital lease obligations

 

17,032

 

 

17,032

 

16,563

 

 

16,563

 

Total current liabilities

 

285,346

 

34,349

 

319,695

 

332,748

 

28,670

 

361,418

 

Capital lease obligations, net of current portion

 

22,561

 

 

22,561

 

24,447

 

 

24,447

 

Non-current income taxes payable

 

100,097

 

(1,906

)B

98,191

 

85,126

 

1,419

B

86,545

 

Other long-term liabilities

 

26,835

 

 

26,835

 

24,871

 

 

24,871

 

Total liabilities

 

434,839

 

32,443

 

467,282

 

467,192

 

30,089

 

497,281

 

Shareholders’ equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock, $0.002 par value; 8,000 shares authorized; no shares issued and outstanding

 

 

 

 

 

 

 

Common stock, $0.002 par value; 492,000 shares authorized; 292,381 shares issued and outstanding

 

585

 

 

585

 

583

 

 

583

 

Additional paid-in capital

 

3,304,563

 

319,901

A

3,624,464

 

3,250,169

 

384,652

A

3,634,821

 

Deferred stock-based compensation

 

 

 

 

(1,141

)

(60,846

)A

(61,987

)

Accumulated other comprehensive loss

 

(1,353

)

 

(1,353

)

(1,759

)

 

(1,759

)

Accumulated deficit

 

(126,458

)

(360,412

)E

(486,870

)

(201,755

)

(362,678

)E

(564,433

)

Total shareholders’ equity

 

3,177,337

 

(40,511

)

3,136,826

 

3,046,097

 

(38,872

)

3,007,225

 

Total liabilities and shareholders’ equity

 

$

3,612,176

 

$

(8,068

)

$

3,604,108

 

$

3,513,289

 

$

(8,783

)

$

3,504,506

 

 


A.            Adjustments for additional stock-based compensation expense pursuant to APB 25, net of tax benefit from employee stock transactions and cumulative effect of change in accounting principle related to estimating preferrences in the adoption of SFAS 125R.

B.              Adjustments to deferred tax assets arising from the stock-based compensation charge and annual of penalty and other assisted Section 162(m).

C.              Adjustments for additional payroll taxes.

D.             Adjustments to inventory arising from amount of stock-based compensation capitalized to inventory.

E.               Adjustments for additional stock-based compensation expense, payroll tax, deferred income tax benefit and cumulative effect of change in accounting principle.

17




The following tables present the impact of the financial statement adjustments on the previously reported Statements of Cash Flows for first quarter of fiscal 2007 and fiscal 2006:

 

Three Months Ended April 29, 2006

 

Three Months Ended April 30, 2005

 

 

 

As

 

 

 

 

 

As 

 

 

 

 

 

 

 

Previously

 

 

 

As

 

Previously 

 

 

 

As

 

 

 

Reported

 

Adjustments

 

Restated

 

Reported

 

Adjustments

 

Restated

 

 

 

(In thousands)

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

75,297

 

$

2,266

 

$

77,563

 

$

63,532

 

$

(9,585

)

$

53,947

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative effect of change in accounting principle

 

 

(8,846

)

(8,846

)

 

 

 

Depreciation and amortization

 

15,615

 

 

15,615

 

13,431

 

 

13,431

 

Stock-based compensation

 

44,536

 

4,225

A

48,761

 

871

 

8,719

A

9,590

 

Amortization of acquired intangible assets

 

17,351

 

 

17,351

 

19,759

 

 

19,759

 

Excess tax benefits from stock-based compensation

 

(697

)

 

(697

)

 

 

 

Changes in assets and liabilities, net of acquisition:

 

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

(48,372

)

 

(48,372

)

(4,189

)

 

(4,189

)

Inventories

 

8,729

 

 

8,729

 

15,664

 

 

15,664

 

Prepaid expenses and other assets

 

(25,799

)

 

(25,799

)

(43,800

)

 

(43,800

)

Accounts payable

 

(45,868

)

 

(45,868

)

(7,428

)

 

(7,428

)

Accrued liabilities and other

 

2,500

 

 

2,500

 

763

 

 

763

 

Accrued employee compensation

 

(10,391

)

2,170

B

(8,221

)

(360

)

866

B

506

 

Income taxes payable

 

14,915

 

185

C

15,100

 

8,086

 

 

8,086

 

Deferred income

 

(1,133

)

 

(1,133

)

2,575

 

 

2,575

 

Net cash provided by operating activities

 

46,683

 

 

46,683

 

68,904

 

 

68,904

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash paid for acquisition

 

(24,008

)

 

(24,008

)

 

 

 

Purchases of short-term investments

 

(57,405

)

 

(57,405

)

(99,018

)

 

(99,018

)

Sales and maturities of short-term investments

 

238,124

 

 

238,124

 

48,051

 

 

48,051

 

Acquisition costs

 

(461

)

 

(461

)

 

 

 

Purchases of property and equipment

 

(28,948

)

 

(28,948

)

(18,395

)

 

(18,395

)

Net cash provided by (used in) investing activities

 

127,302

 

 

127,302

 

(69,362

)

 

(69,362

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Proceeds from the issuance of common stock

 

10,904

 

 

10,904

 

20,119

 

 

20,119

 

Principal payments on capital lease obligations

 

(4,628

)

 

(4,628

)

(3,156

)

 

(3,156

)

Excess tax benefits from stock-based compensation

 

697

 

 

697

 

 

 

 

Net cash provided by financing activities

 

6,973

 

 

6,973

 

16,963

 

 

16,963

 

Net increase (decrease) in cash and cash equivalents

 

180,958

 

 

180,958

 

16,505

 

 

16,505

 

Cash and cash equivalents at beginning of period

 

348,431

 

 

348,431

 

166,471

 

 

166,471

 

Cash and cash equivalents at end of period

 

$

529,389

 

$

 

$

529,389

 

$

182,976

 

$

 

$

182,976

 

 


A.            Adjustments for additional stock-based compensation expense pursuant to APB 25.

B.              Adjustments for additional payroll tax.

C.              Adjustments for income taxes payable.

18




Note 2. The Company and its Significant Accounting Policies

The Company

 Marvell Technology Group Ltd. (the “Company”), a Bermuda company, was incorporated on January 11, 1995. The Company is a leading global semiconductor provider of high-performance analog, mixed-signal, digital signal processing and embedded microprocessor integrated circuits. The Company’s diverse product portfolio includes switching, transceivers, wireless, PC connectivity, gateways, communications controllers, storage and power management solutions that serve diverse applications used in business enterprises, consumer electronics and emerging markets.

Basis of presentation

The Company’s fiscal year is the 52- or 53-week period ending on the Saturday closest to January 31. In a 52-week year, each fiscal quarter consists of 13 weeks. The additional week in a 53-week year is added to the fourth quarter, making such quarter consist of 14 weeks. Fiscal years 2007 and 2006 comprised 52-weeks.

On February 21, 2006, the Board of Directors approved a 2 for 1 stock split of the Company’s common stock, to be effected pursuant to the issuance of additional shares as a stock dividend. The stock split was subject to shareholder approval of an increase in the Company’s authorized share capital at the Company’s 2006 Annual General Meeting.  On June 9, 2006, shareholders at the Company’s 2006 Annual General Meeting approved an increase in the authorized share capital by 500 million shares of common stock.  Stock certificates representing one additional share for each share held were delivered on July 24, 2006 (payment date) to all shareholders of record at the close of business on July 10, 2006 (record date).

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments except for the effects of the restatement as discussed in Note 1, necessary to fairly state the Company’s financial position as of April 29, 2006, the results of its operations for the three months ended April 29, 2006 and April 30, 2005, respectively and its cash flows for the three months ended April 29, 2006 and April 30, 2005, respectively. These condensed consolidated financial statements and related notes are unaudited and should be read in conjunction with the Company’s audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended January 27, 2007, filed concurrently with this Form 10-Q. The results of operations for the three months ended April 29, 2006 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year.

Use of estimates

The preparation of unaudited interim condensed consolidated financial statements in conformity with generally accepted accounting principles in the United States (“GAAP”) requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities.  On an on-going basis, the Company evaluates its estimates, including those related to uncollectible receivables, the useful lives of long-lived assets including property and equipment, investment fair values, goodwill and other intangible assets, income taxes, and contingencies.  In addition, the Company uses assumptions when employing the Black-Scholes option valuation model to calculate the fair value of stock-based awards granted.  The Company bases its estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, when these carrying values are not readily available from other sources.  Actual results may differ from these estimates.

Principles of consolidation

The unaudited interim condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The functional currency of the Company and its significant subsidiaries is the United States dollar.

Revenue recognition

The Company accounts for its revenues under the provisions of Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition in Financial Statements.” Under this provision, the Company recognizes revenues when there is persuasive evidence of an arrangement, delivery has occurred, the fee is fixed or determinable, and collection is reasonably assured.

Product revenue is generally recognized upon shipment of product to customers, net of accruals for estimated sales returns and allowances. However, some of the Company’s sales are made through distributors under agreements allowing for price protection and rights of return on product unsold by the distributors. Product revenue on sales made through distributors with rights of return and price protection is deferred until the distributors sell the product to end customers.  The Company’s sales to direct customers are made primarily pursuant to standard purchase orders for delivery of products.  The Company generally allows customers to cancel or change purchase orders with limited notice prior to the scheduled shipment dates and from time to time it also may request a customer to accept a shipment of product before the original requested delivery date, in which case revenue is not recognized until there is written confirmation from the customer accepting early shipment, delivery has occurred, the fee is fixed or determinable, and collection is

19




reasonably assured.  Additionally, collection is not deemed to be “reasonably assured” if customers receive extended payment terms. As a result, revenue on sales to customers with payment terms substantially greater than the Company’s normal payment terms is deferred and is recognized as revenue as the payments become due. Deferred revenue less the related cost of the inventories is reported as deferred income.

The provision for estimated sales returns and allowances on product sales is recorded in the same period the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. Actual returns could differ from these estimates.

The Company also enters into development agreements with some of its customers. Under these development agreements product revenue is recognized under the proportionate performance method.  Revenue is recognized as related costs to complete the contract are incurred. These costs are included in research and development expense.

The provisions of EITF Issue No. 00-21 apply to sales arrangements with multiple arrangements that include a combination of hardware, software and /or services. For multiple element arrangements, revenue is allocated to the separate elements based on fair value. If an arrangement includes undelivered elements that are not essential to the functionality of the delivered elements, the Company defers the fair value of the undelivered elements and the residual revenue is allocated to the delivered elements. If the undelivered elements are essential to the functionality of the delivered elements, no revenue is recognized. Undelivered elements typically are software warranty and maintenance services.

In arrangements that include a combination of hardware and software products that are also sold separately, where software is more than incidental and essential to the functionality of the product being sold, the Company follows the guidance in EITF Issue No. 03-05, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software,” accounts for the entire arrangement as a sale of software and software-related items and follows the revenue recognition criteria in SOP No. 97-2, “Software Revenue Recognition,” and related interpretations.

Revenue from licensed software is recognized when persuasive evidence of an arrangement exists and delivery has occurred, provided that the fee is fixed and determinable and collectibility is probable. Revenue from post-contract customer support and any other future deliverables is deferred and earned over the support period or as contract elements are delivered.

Research and development and other

Research and development and other costs consist primarily of $126.9 million and $76.8 million of research and development costs for the three month periods ended April 29, 2006 and April 30, 2005, respectively, excluding costs related to patent investigation and filings for the three month periods ended April 29, 2006 and April 30, 2005 which were $2.3 million  and $1.1 million  respectively. Research and development and other costs are expensed as incurred.

Inventories

Inventories are stated at the lower of cost or market, cost being determined under the first-in, first-out method. Appropriate consideration is given to obsolescence, excessive levels, deterioration and other factors in evaluating net realizable value.

Warranty accrual

The Company’s products are generally subject to warranty, which provides for the estimated future costs of repair, replacement or customer accommodation upon shipment of the product in the accompanying statements of operations. The Company’s products typically carry a standard 90-day warranty with certain exceptions in which the warranty period can range from one to five years. The warranty accrual is estimated based on historical claims compared to historical revenues and assumes that the Company will have to replace products subject to a claim. For new products, the Company uses a historical percentage for the appropriate class of product.

Stock-based compensation

Effective from January 29, 2006, the Company adopted FASB Statement of Financial Accounting Standards No. 123 (revised 2004), “Share Based Payment” (“SFAS 123R”).  SFAS 123R requires the measurement and recognition of compensation expense for all share-based awards to employees and directors, including employee stock options, restricted stock units and employee stock purchase rights based on estimated fair values.  SFAS 123R supersedes previous accounting guidance under Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations and amends SFAS No.95, “Statement of Cash Flows.”  Under SFAS 123R, the benefits of tax deductions in excess of recognized compensation cost has to be reported as a financing cash flow, rather than as an operating cash flow.  This may reduce future net cash flows from operations and increase future net financing cash flows.  In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”), which provides guidance regarding the interaction of SFAS 123R and certain SEC rules and regulations.  The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R.

20




Prior to January 29, 2006, the Company accounted for its stock based compensation plans using the intrinsic value method under the provisions of APB 25 and related guidance, under the accelerated method of amortization.

The Company adopted SFAS 123R using the modified prospective method.  Under the modified prospective method, results of operations include compensation costs of unvested options granted prior to January 29, 2006, and options granted subsequent to that date.  For grants prior to January 29, 2006, the Company amortizes stock-based compensation expense under the accelerated method.  For grants from January 29, 2006, the Company amortizes stock-based compensation expense ratably over the vest term.

Cumulative Effect of Change in Accounting Principle

The adoption of SFAS 123R resulted in a cumulative benefit from change in auditing principle of $8.8 million net of tax as of the year ended January 27, 2007, as restated, reflecting the net cumulative impact of estimated forfeitures that were previously not included in the determination of historic stock-based compensation expense in periods prior to January 28, 2006.

As a result of the adoption of SFAS 123R, stock-based compensation increased from $9.6 million in the first quarter of fiscal 2006 to $48.8 million in the first quarter of fiscal 2007.  Stock-based compensation of $0.7 million was capitalized in inventory as of April 29, 2006.  There was no stock-based compensation cost included in inventory as of January 28, 2006.  In accordance with the modified prospective method, the consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R.  Prior to the adoption of SFAS 123R, the Company presented deferred compensation as a separate component of shareholders’ equity.  In accordance with the provisions of SFAS 123R, on January 29, 2006, unamortized deferred compensation totaling $62.0 million on that date was eliminated with a corresponding reduction in additional paid-in capital.

In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards” (FSP 123R-3). We have elected to adopt the alternative transition method provided in the FSP 123R-3 for calculating the tax effects of stock-based compensation pursuant to SFAS 123R. The alternative transition method includes simplified methods to establish the beginning balance of the APIC pool related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool and Consolidated Statements of Cash Flows of the tax effects of employee stock-based compensation awards that are outstanding upon adoption of SFAS 123R.

Note 3. Supplemental Financial Information

Available-for-sale investments (in thousands)

 

April 29, 2006

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

Corporate debt securities

 

$

28,375

 

$

 

$

(494

)

$

27,881

 

Auction rate securities

 

263,086

 

 

 

263,086

 

U.S. Federal, State, county and municipal debt securities

 

102,555

 

 

(1,501

)

101,054

 

Short-term investments

 

$

394,016

 

$

 

$

(1,995

)

$

392,021

 

 

 

January 28, 2006

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Estimated
Fair Value

 

Corporate debt securities

 

$

33,662

 

$

 

$

(551

)

$

33,111

 

Auction rate securities

 

438,615

 

 

 

438,615

 

U.S. Federal, State, county and municipal debt securities

 

107,414

 

 

(1,592

)

105,822

 

 

 

579,691

 

 

(2,143

)

577,548

 

Less amounts classified as cash equivalents

 

(4,957

)

 

 

(4,957

)

Short-term investments

 

$

574,734

 

$

 

$

(2,143

)

$

572,591

 

 

Auction rate securities are securities that are structured with short-term reset dates of generally less than 90 days but with legally stated maturities in excess of 90 days. At the end of the reset period, investors can sell or continue to hold the securities at par. These securities are classified in the table below based on their legal stated maturity dates.

The contractual maturities of available-for-sale debt securities classified as short-term investments at April 29, 2006 are presented in the following table (in thousands):

 

Amortized
Cost

 

Estimated
Fair Value

 

Due in one year or less

 

$

68,014

 

$

67,493

 

Due between one and five years

 

62,916

 

61,442

 

Due over five years

 

263,086

 

263,086

 

 

 

$

394,016

 

$

392,021

 

 

Included in the Company’s available-for-sale investments are fixed income securities. As market yields increase, those securities with a lower yield-at-cost show a mark-to-market unrealized loss. All unrealized losses are primarily due to changes in interest rates

21




and bond yields. Investments are reviewed periodically to identify possible other-than-temporary impairment.  When evaluating the investments, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis and the Company’s ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value.  The Company has the intent and ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investment.  The Company expects to realize the full value of all of these investments upon maturity or sale. The following table shows the investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):

 

 

April 29, 2006

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

 

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

Corporate debt securities

 

$

 

$

 

$

27,881

 

$

(494

)

$

27,881

 

$

(494

)

U.S. Federal, State, county and municipal debt securities

 

 

 

101,054

 

(1,501

)

101,054

 

(1,501

)

Total temporarily impaired securities

 

$

 

$

 

$

128,935

 

$

(1,995

)

$

128,935

 

$

(1,995

)

 

 

 

January 28, 2006

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

 

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

Fair
Value

 

Unrealized
Losses

 

Corporate debt securities

 

$

 

$

 

$

28,154

 

$

(551

)

$

28,154

 

$

(551

)

U.S. Federal, State, county and municipal debt securities

 

4,998

 

(24

)

100,824

 

(1,568

)

105,822

 

(1,592

)

Total temporarily impaired securities

 

$

4,998

 

$

(24

)

$

128,978

 

$

(2,119

)

$

133,976

 

$

(2,143

)

 

Inventories (in thousands)

 

April 29,
2006

 

January 28,
2006

 

Work-in-process

 

$

102,641

 

$

96,110

 

Finished goods

 

102,913

 

115,264

 

 

 

$

205,554

 

$

211,374

 

 

Prepaid expenses and other current assets (in thousands)

 

April 29,
2006

 

January 28,
2006

 

Prepayments for foundry capacity

 

$

56,900

 

$

62,120

 

Receivable from foundry

 

26,339

 

19,512

 

Other

 

33,615

 

22,675

 

 

 

$

116,854

 

$

104,307

 

 

Property and equipment (in thousands)

 

April 29,

 

January 28,

 

 

 

2006

 

2006

 

Property and equipment:

 

 

 

 

 

Machinery and equipment

 

$

155,722

 

$

142,320

 

Computer software

 

112,785

 

108,032

 

Furniture and fixtures

 

11,526

 

10,588

 

Leasehold improvements

 

9,535

 

9,292

 

Buildings

 

8,727

 

8,727

 

Building improvements

 

25,768

 

24,747

 

Land

 

51,500

 

51,500

 

Construction in progress

 

68,106

 

56,311

 

 

 

443,669

 

411,517

 

Less: Accumulated depreciation and amortization

 

(164,271

)

(150,596

)

 

 

$

279,398

 

$

260,921

 

 

22




Intangible assets (in thousands)

 

As of April 29, 2006

 

As of January 28, 2006

 

 

 

Gross
Carrying
Amount

 


Accumulated
Amortization