The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements. Please see the "Cautionary Statement" and "Risk Factors" above for discussions of the uncertainties, risks and assumptions associated with these statements. Our fiscal year-end financial reporting periods are a 52- or 53-week fiscal year that ends on the Saturday closest toDecember 31 . Fiscal 2019, 2018 and 2017 were 52-week years and ended onDecember 28, 2019 ,December 29, 2018 andDecember 30, 2017 , respectively. Fiscal 2020 will have 53 weeks with the extra week occurring in the first quarter of the year.
Overview
We are a leading provider of silicon, software and solutions for a smarter, more connected world. Our award-winning technologies are shaping the future of the Internet of Things (IoT), Internet infrastructure, industrial automation, consumer and automotive markets. Our world-class engineering team creates products focused on performance, energy savings, connectivity and simplicity. Our primary semiconductor products are mixed-signal integrated circuits (ICs), which are electronic components that convert real-world analog signals, such as sound and radio waves, into digital signals that electronic products can process. As a fabless semiconductor company, we rely on third-party semiconductor fabricators inAsia , and to a lesser extentthe United States andEurope , to manufacture the silicon wafers that reflect our IC designs. Each wafer contains numerous die, which are cut from the wafer to create a chip for an IC. We rely on third parties inAsia to assemble, package, and, in most cases, test these devices and ship these units to our customers. Testing performed by such third parties facilitates faster delivery of products to our customers (particularly those located inAsia ), shorter production cycle times, lower inventory requirements, lower costs and increased flexibility of test capacity.
Our expertise in analog-intensive, high-performance, mixed-signal ICs and software enables us to develop highly differentiated solutions that address multiple markets. We group our products into the following categories:
? Internet of Things products, which include wireless, microcontroller (MCU) and
sensor products;
? Broadcast products, which include broadcast consumer and automotive products;
? Infrastructure products, which include timing products (clocks and
oscillators), and isolation devices; and
? Access products, which include Voice over IP (VoIP) products, embedded modems
and Power over Ethernet (PoE) devices.
The sales cycle for our ICs can be as long as 12 months or more. An additional three to six months or more are usually required before a customer ships a significant volume of devices that incorporate our ICs. Due to this lengthy sales cycle, we typically experience a significant delay between incurring research and development and selling, general and administrative expenses, and the corresponding sales. Consequently, if sales in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter and, potentially, future quarters would be adversely affected. Moreover, the amount of time between initial research and development and commercialization of a product, if ever, can be substantially longer than the sales cycle for the product. Accordingly, if we incur substantial research and development costs without developing a commercially successful product, our operating results, as well as our growth prospects, could be adversely affected. Because some of our ICs are designed for use in consumer products such as televisions, set-top boxes and radios, we expect that the demand for our products will be typically subject to some degree of seasonal demand. However, rapid changes in our markets and across our product areas make it difficult for us to accurately estimate the impact of seasonal factors on our business.
Current Period Highlights
Revenues decreased$30.7 million in fiscal 2019 compared to fiscal 2018, due to decreased revenues from our Infrastructure, Broadcast and Access products offset by increased revenues from our IoT products. Gross profit decreased$11.1 million during the same period due primarily to decreased product sales. Gross margin increased to 60.9% in fiscal 2019 compared to 60.1% in fiscal 2018 primarily due to the fair value write-up associated with acquired inventory in fiscal 2018, offset in part by a decrease resulting from variations in product mix. Operating expenses increased$17.4 million in fiscal 2019 compared to fiscal 2018 due primarily to increased personnel-related expenses, occupancy costs and amortization of intangible assets, offset in part by decreased acquisition-related costs and sales commissions. Operating income in fiscal 2019 was$56.7 million compared to$85.2 million in fiscal 2018. 28
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We ended fiscal 2019 with$726.0 million in cash, cash equivalents and short-term investments. Net cash provided by operating activities was$166.5 million during fiscal 2019. Accounts receivable was$75.6 million atDecember 28, 2019 , representing 31 days sales outstanding (DSO). Inventory was$73.1 million atDecember 28, 2019 , representing 76 days of inventory (DOI). In fiscal 2019, we repurchased 0.3 million shares of our common stock for$26.7 million . Through acquisitions and internal development efforts, we have continued to diversify our product portfolio and introduce new products and solutions with added functionality and further integration. InOctober 2019 , we acquired IEEE 1588 precision time protocol (PTP) software and module assets from Qulsar. This complementary portfolio simplifies adoption of IEEE 1588 synchronization in 5G wireless, transport and access networks. In fiscal 2019, we introduced new highly integrated Wireless Gecko modules that streamline secure IoT product design; a portfolio of automotive grade timing solutions designed to meet the demanding clocking needs of in-vehicle systems; robust isolated smart switches designed to drive loads in harsh industrial environments; hybrid software-defined radio (SDR) tuners supporting global digital radio standards with a common platform; 5G-ready jitter attenuators with new device options featuring a fully integrated crystal; the next generation of our Wireless Gecko platform, Series 2, designed to make IoT products more powerful, efficient and reliable; a portfolio of timing solutions that provide superior jitter performance and meet the latest generation PCI Express® (PCIe®) 5.0 specification; isolation products designed to provide precise current and voltage measurement with very low temperature drift; new Bluetooth software for our Wireless Gecko portfolio that increases location services accuracy; and Wi-Fi modules and transceivers that cut power consumption for IoT applications. We plan to continue to introduce products that increase the content we provide for existing applications, thereby enabling us to serve markets we do not currently address and expand our total available market opportunity. During fiscal 2019, 2018 and 2017, we had no customer that represented more than 10% of our revenues. In addition to direct sales to customers, some of our end customers purchase products indirectly from us through distributors and contract manufacturers. An end customer purchasing through a contract manufacturer typically instructs such contract manufacturer to obtain our products and incorporate such products with other components for sale by such contract manufacturer to the end customer. Although we actually sell the products to, and are paid by, the distributors and contract manufacturers, we refer to such end customer as our customer. Two of our distributors who sell to our customers, Arrow Electronics and Edom Technology, each represented 26% and 20% of our revenues during fiscal 2019, and 21% and 17% of our revenues during fiscal 2018, respectively. Edom, Avnet and Arrow, each represented 19%, 14% and 12% of our revenues during fiscal 2017, respectively. The percentage of our revenues derived from outside ofthe United States was 87% in fiscal 2019, 83% in fiscal 2018 and 85% in fiscal 2017. All of our revenues to date have been denominated inU.S. dollars. We believe that a majority of our revenues will continue to be derived from customers outside ofthe United States .
Results of Operations
The following describes the line items set forth in our Consolidated Statements of Income:
Revenues. Revenues are generated predominately by sales of our products. Our revenues are subject to variation from period to period due to the volume of shipments made within a period, the mix of products we sell and the prices we charge for our products. Cost of Revenues. Cost of revenues includes the cost of purchasing finished silicon wafers processed by independent foundries; costs associated with assembly, test and shipping of those products; costs of personnel and equipment associated with manufacturing support, logistics and quality assurance; costs of software royalties, other intellectual property license costs and certain acquired intangible assets; and an allocated portion of our occupancy costs. Our gross margin fluctuates depending on product mix, manufacturing yields, inventory valuation adjustments, average selling prices and other factors. Research and Development. Research and development expense consists primarily of personnel-related expenses, including stock-based compensation, as well as new product masks, external consulting and services costs, equipment tooling, equipment depreciation, amortization of intangible assets and an allocated portion of our occupancy costs. Research and development activities include the design of new products, refinement of existing products and design of test methodologies to ensure compliance with required specifications. 29 Table of Contents Selling, General and Administrative. Selling, general and administrative expense consists primarily of personnel-related expenses, including stock-based compensation, as well as an allocated portion of our occupancy costs, sales commissions to independent sales representatives, amortization of intangible assets, professional fees, legal fees, and promotional and marketing expenses. Interest Income and Other, Net. Interest income and other, net reflects interest earned on our cash, cash equivalents and investment balances, foreign currency remeasurement adjustments and other non-operating income and expenses. Interest Expense. Interest expense consists of interest on our short and long-term obligations, including our convertible senior notes and credit facility. Interest expense on our convertible senior notes includes contractual interest, amortization of the debt discount and amortization of debt issuance costs.
Provision (Benefit) for Income Taxes. Provision (benefit) for income taxes includes both domestic and foreign income taxes at the applicable tax rates adjusted for non-deductible expenses, research and development tax credits and other permanent differences.
The following table sets forth our Consolidated Statements of Income data as a percentage of revenues for the periods indicated:
Fiscal Year 2019 2018 2017 Revenues 100.0 % 100.0 % 100.0 % Cost of revenues 39.1 39.9 40.9 Gross margin 60.9 60.1 59.1 Operating expenses: Research and development 30.7 27.5 27.2
Selling, general and administrative 23.4 22.8 20.8 Operating expenses
54.1 50.3 48.0 Operating income 6.8 9.8 11.1 Other income (expense): Interest income and other, net 1.5 0.8 0.8 Interest expense (2.4) (2.3) (1.9) Income before income taxes 5.9 8.3 10.0
Provision (benefit) for income taxes 3.6 (1.3) 3.9 Net income
2.3 % 9.6 % 6.1 %
Comparison of Fiscal 2019 to Fiscal 2018
Revenues Fiscal Year % (in millions) 2019 2018 Change Change Internet of Things$ 488.2 $ 463.8 $ 24.4 5.2 % Infrastructure 183.2 199.5 (16.3) (8.2) % Broadcast 114.9 141.4 (26.5) (18.7) % Access 51.3 63.6 (12.3) (19.2) % Total$ 837.6 $ 868.3 $ (30.7) (3.5) %
The change in revenues in fiscal 2019 was due primarily to:
Increased revenues of
? addition of revenues from an acquisition and increased demand for our wireless
products offset by decreased demand for our MCU products.
? Decreased revenues of
primarily to decreased demand for our timing and isolation products.
Decreased revenues of
? decreased demand for our consumer broadcast products and decreased demand for
our automotive broadcast products.
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? Decreased revenues of
decreased demand for our products and a decreasing market for such products.
Unit volumes of our products decreased by 3.8% and average selling prices increased by 0.2% compared to fiscal 2018. The average selling prices of our products may fluctuate significantly from period to period due to changes in product mix and other factors. In general, as our products become more mature, we expect to experience decreases in average selling prices. We anticipate that newly announced, higher priced, next generation products and product derivatives will offset some of these decreases. Gross Profit Fiscal Year (in millions) 2019 2018 Change Gross profit$ 510.3 $ 521.4 $ (11.1) Gross margin 60.9 % 60.1 % 0.8 % Gross profit decreased in fiscal 2019 due primarily to decreased product sales. The change in gross profit in fiscal 2019 was due to decreases in gross profit of$20.8 million for our Infrastructure products,$13.2 million for our Broadcast products and$8.0 million for our Access products, offset by an increase in gross profit of$30.9 million for our Internet of Things products. Gross profit in fiscal 2018 included$6.1 million in acquisition-related charges for the fair value write-up associated with acquired inventory. Gross margin increased in fiscal 2019 primarily due to the impact of the fair value write-up associated with acquired inventory in fiscal 2018. The increase in gross margin in fiscal 2019 was offset in part by a decrease in gross margin resulting from variations in product mix. We may experience declines in the average selling prices of certain of our products. This creates downward pressure on gross margin and may be offset to the extent we are able to introduce higher margin new products and gain market share with our products; reduce costs of existing products through improved design; achieve lower production costs from our wafer suppliers and third-party assembly and test subcontractors; achieve lower production costs per unit as a result of improved yields throughout the manufacturing process; or reduce logistics costs. Research and Development Fiscal Year % (in millions) 2019 2018 Change Change Research and development$ 257.2 $ 238.3 $ 18.9 7.9 % Percent of revenue 30.7 % 27.5 % The increase in research and development expense in fiscal 2019 was primarily due to increases of$13.7 million for personnel-related expenses, including costs associated with increased headcount and an acquisition,$2.8 million for occupancy costs and$2.2 million for the amortization of intangible assets. We expect that research and development expense will increase in absolute dollars in the first quarter of 2020 compared to the fourth quarter of 2019.
Selling, General and Administrative
Fiscal Year % (in millions) 2019 2018 Change
Change
Selling, general and administrative
23.4 % 22.8 % The decrease in selling, general and administrative expense in fiscal 2019 was primarily due to decreases of$2.0 million for acquisition-related costs and$1.0 million for sales commissions. The decrease in selling, general and administrative expense was offset in part by an increase of$1.8 million for personnel-related expenses, including costs associated with increased headcount and an acquisition. We expect that selling, general and administrative expense will increase in absolute dollars in the first quarter of 2020 compared to
the fourth quarter of 2019. 31 Table of Contents
Interest Income and Other, Net
Interest income and other, net in fiscal 2019 was$13.2 million compared to$6.6 million in fiscal 2018. The increase in interest income and other, net in fiscal 2019 was primarily due to increased interest income earned as a result of higher market interest rates and higher investment balances.
Interest Expense
Interest expense in fiscal 2019 was relatively flat at
Provision (Benefit) for Income Taxes
Fiscal Year (in millions) 2019 2018 Change
Provision (benefit) for income taxes
61.2 % (15.8) % The effective tax rate for fiscal 2019 increased from fiscal 2018 primarily due to a change in our financial statement position related to the treatment of stock-based compensation within our intercompany cost-sharing arrangement. Due to the Ninth Circuit's reversal of theAltera Corp v. Commissioner Tax Court decision, we are no longer reflecting a net tax benefit within our financial statements related to the removal of stock-based compensation from our intercompany cost-sharing arrangement. As such, we recognized incremental, discrete income tax expense of$27.2 million in fiscal 2019 related to this change. The effective tax rates for each of the periods presented differ from theU.S. federal statutory tax rates of 21% due to the aforementioned impact of the Altera decision, the amount of income earned in foreign jurisdictions where the tax rate may be higher or lower than the federal statutory tax rate, and other permanent items including research and development tax credits and GILTI, or global intangible low-tax income.
Comparison of Fiscal 2018 to Fiscal 2017
Revenues Fiscal Year % (in millions) 2018 2017 Change Change Internet of Things$ 463.8 $ 395.0 $ 68.8 17.4 % Infrastructure 199.5 152.2 47.3 31.1 % Broadcast 141.4 153.0 (11.6) (7.6) % Access 63.6 68.7 (5.1) (7.5) % Total$ 868.3 $ 768.9 $ 99.4 12.9 %
The change in revenues in fiscal 2018 was due primarily to:
Increased revenues of
? increased demand for our wireless products and the addition of revenues from an
acquisition.
? Increased revenues of
primarily to increased demand for our isolation and timing products.
? Decreased revenues of
decreases in the market for our consumer products.
Decreased revenues of
? decreased demand for our VoIP products and decreases in the market for such
products.
Unit volumes of our products increased by 11.5% and average selling prices increased by 1.1% compared to fiscal 2017.
32 Table of Contents Gross Profit Fiscal Year (in millions) 2018 2017 Change Gross profit$ 521.4 $ 454.2 $ 67.2 Gross margin 60.1 % 59.1 % 1.0 % Gross profit increased in fiscal 2018 due primarily to increased product sales. The increased dollar amount of gross profit in fiscal 2018 was due to increases in gross profit of$42.8 million for our Internet of Things products and$34.6 million for our Infrastructure products, offset by decreases in gross profit of$8.5 million for our Broadcast products and$1.7 million for our Access products. Gross profit in fiscal 2018 included$6.1 million in acquisition-related charges for the fair value write-up associated with acquired inventory. Gross margin increased in fiscal 2018 primarily due to a higher mix of Infrastructure products sold.
Research and Development
Fiscal Year % (in millions) 2018 2017 Change Change
Research and development
27.5 % 27.2 % The increase in research and development expense in fiscal 2018 was primarily due to increases of$16.5 million for personnel-related expenses, including costs associated with increased headcount and an acquisition, and$7.2 million for the amortization of intangible assets.
Selling, General and Administrative
Fiscal Year % (in millions) 2018 2017 Change
Change
Selling, general and administrative
22.8 % 20.8 % The increase in selling, general and administrative expense in fiscal 2018 was primarily due to increases of$23.6 million for personnel-related expenses, including costs associated with increased headcount and an acquisition,$3.6 million for the amortization of intangible assets and$3.4 million for acquisition-related costs.
Interest Income and Other, Net
Interest income and other, net in fiscal 2018 was$6.6 million compared to$6.1 million in fiscal 2017. The increase in interest income and other, net in fiscal 2018 was primarily due to increased interest income earned as a result of higher market interest rates and higher investment balances, offset by a net loss of$1.8 million recorded in connection with fair value adjustments to an equity investment. Interest Expense
Interest expense in fiscal 2018 was$19.7 million compared to$14.1 million in fiscal 2017. The increase in interest expense in fiscal 2018 was primarily due to increased interest expense of$3.8 million on our convertible debt, including amortization of the debt discount and debt issuance costs, as a result of recording a full year of interest expense in fiscal 2018 versus a partial year in fiscal 2017. In addition, interest expense in fiscal 2017 was lower than fiscal 2018 due to a$2.0 million gain recorded in fiscal 2017 in connection with the termination of our interest rate swap agreement.
Provision (Benefit) for Income Taxes
Fiscal Year (in millions) 2018 2017 Change Provision (benefit) for income taxes$ (11.4) $ 29.8 $ (41.2) Effective tax rate (15.8) % 38.8 % 33 Table of Contents
The effective tax rate for fiscal 2018 decreased from fiscal 2017 primarily due to a reduction in theU.S. federal statutory rate as well as the inclusion of one-time tax impacts recorded in 2017 from the enactment of the Tax Cuts and Jobs Act. This overall decrease in the effective tax rate was offset by a decrease in the Company's foreign tax rate benefit.
Business Outlook
The following represents our business outlook for the first quarter of fiscal 2020. Income Statement Item Estimate Revenues$209 million to$219 million Gross margin 59.5% Operating expenses$127 million Effective tax rate 0.0% Diluted earnings (loss) per share$(0.03) to$0.07
Liquidity and Capital Resources
Our principal sources of liquidity as ofDecember 28, 2019 consisted of$726.0 million in cash, cash equivalents and short-term investments, of which approximately$583.8 million was held by ourU.S. entities. The remaining balance was held by our foreign subsidiaries. Our cash equivalents and short-term investments consisted of government debt securities, which include agency bonds, municipal bonds,U.S. government securities and variable-rate demand notes; corporate debt securities, which include asset-backed securities, corporate bonds and commercial paper; and money market funds. Our long-term investments consisted of auction-rate securities.
Operating Activities
Net cash provided by operating activities was$166.5 million during fiscal 2019, compared to net cash provided of$173.5 million during fiscal 2018. Operating cash flows during fiscal 2019 reflect our net income of$19.3 million , adjustments of$147.8 million for depreciation, amortization, stock-based compensation and deferred income taxes, and a net cash outflow of$0.6 million due to changes in our operating assets and liabilities. Net cash provided by operating activities was$173.5 million during fiscal 2018, compared to net cash provided of$189.5 million during fiscal 2017. Operating cash flows during fiscal 2018 reflect our net income of$83.6 million , adjustments of$114.7 million for depreciation, amortization, stock-based compensation and deferred income taxes, and a net cash outflow of$24.8 million due to changes in our operating assets and liabilities. Accounts receivable increased to$75.6 million atDecember 28, 2019 from$73.2 million atDecember 29, 2018 . The increase in accounts receivable resulted primarily from normal variations in the timing of collections and billings. Our average DSO was 31 days atDecember 28, 2019 andDecember 29, 2018 . Inventory decreased to$73.1 million atDecember 28, 2019 from$75.0 million atDecember 29, 2018 . Our inventory level is primarily impacted by our need to make purchase commitments to support forecasted demand and variations between forecasted and actual demand. Our DOI was 76 days atDecember 28, 2019 and
79 days atDecember 29, 2018 . Investing Activities Net cash used in investing activities was$106.8 million during fiscal 2019, compared to net cash used of$197.0 million during fiscal 2018. The decrease in cash outflows was principally due to a decrease of$237.2 million in net payments for the acquisition of businesses, offset by a decrease of$157.8 million in net purchases and sales of marketable securities in the current period. Net cash used in investing activities was$197.0 million during fiscal 2018, compared to net cash used of$374.3 million during fiscal 2017. The decrease in cash outflows was principally due to an increase of$420.1 million in net purchases and sales of marketable securities, offset by an increase of$224.6 million in net payments for the acquisition of businesses. 34
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We anticipate capital expenditures of approximately$23 to$27 million for fiscal 2020. Additionally, as part of our growth strategy, we expect to evaluate opportunities to invest in or acquire other businesses, intellectual property or technologies that would complement or expand our current offerings, expand the breadth of our markets or enhance our technical capabilities.
Financing Activities
Net cash used in financing activities was$29.6 million during fiscal 2019, compared to cash used of$48.8 million during fiscal 2018. The decrease in cash outflows was principally due to a decrease of$12.6 million for repurchases of our common stock during fiscal 2019. Our existing share repurchase program has an authorization amount of$200 million and a termination date ofDecember 2020 . Net cash used in financing activities was$48.8 million during fiscal 2018, compared to net cash provided of$313.0 million during fiscal 2017. The decrease in cash inflows was principally due to$389.5 million in net proceeds from the issuance of long-term debt during fiscal 2017 and an increase of$39.3 million for repurchases of our common stock during fiscal 2018, offset by a decrease of$72.5 million in payments on debt. Our debt facilities include$400 million principal amount convertible senior notes (the "Notes") and a$400 million revolving credit facility. The Notes bear interest semi-annually at a rate of 1.375% per year and will mature onMarch 1, 2022 , unless repurchased, redeemed or converted at an earlier date. We have an option to increase the size of the borrowing capacity of the revolving credit facility by up to the greater of an aggregate of$250 million and 100% of EBITDA, plus an amount that would not cause a secured leverage ratio to exceed 3.25 to 1.00, subject to certain conditions. See Note 10, Debt, to the Consolidated Financial Statements for additional information. Our future capital requirements will depend on many factors, including the rate of sales growth, market acceptance of our products, the timing and extent of research and development projects, potential acquisitions of companies or technologies and the expansion of our sales and marketing activities. We believe our existing cash, cash equivalents, investments and credit under our Credit Facility are sufficient to meet our capital requirements through at least the next 12 months, although we could be required, or could elect, to seek additional funding prior to that time. We may enter into acquisitions or strategic arrangements in the future which also could require us to seek additional equity or debt financing.
Contractual Obligations
The following table summarizes our contractual obligations as ofDecember 28, 2019 (in thousands): Payments due by period Total 2020 2021 2022 2023 2024 Thereafter
Longterm debt obligations (1)$ 400,000 $ - $ -$ 400,000 $ - $ - $ - Interest on longterm debt obligations (2)$ 17,417 $ 6,300 $ 6,300 $ 3,550 $ 800 $ 467 $ - Operating lease obligations (3)$ 20,584 $ 5,604 $ 4,410 $ 3,713 $ 3,061 $ 2,524 $ 1,272 Purchase obligations (4)$ 38,780 $ 38,780 $ - $ - $ - $ - $ - Other longterm obligations (5)$ 21,902 $ - $ - $
2,820
Long-term debt obligations represent the principal portion of our convertible
(1) senior notes (the "Notes"). The Notes mature on
repurchased, redeemed or converted at an earlier date.
Interest on our long-term debt obligations primarily represents contractual (2) interest on the Notes, which bear interest semi-annually at a rate of 1.375%
per year. Interest excludes non-cash amortization of the debt discount and
debt issuance costs.
(3) Operating lease obligations include amounts for leased facilities.
Purchase obligations include contractual arrangements in the form of purchase (4) orders with suppliers where there is a fixed non-cancelable payment schedule
or minimum payments due with a reduced delivery schedule.
(5) Other long-term obligations primarily represent non-current income taxes.
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We are unable to make a reasonably reliable estimate as to when or if cash settlement with taxing authorities will occur for our unrecognized tax benefits. Therefore, our liability of$2.4 million for unrecognized tax benefits is not included in the table above. See Note 17, Income Taxes, to the Consolidated Financial Statements for additional information.
Off-Balance Sheet Arrangements
As of
Critical Accounting Policies and Estimates
The preparation of financial statements and accompanying notes in conformity withU.S. generally accepted accounting principles requires that we make estimates and assumptions that affect the amounts reported. Changes in facts and circumstances could have a significant impact on the resulting estimated amounts included in the financial statements. We believe the following critical accounting policies affect our more complex judgments and estimates. Inventory valuation - We assess the recoverability of inventories through the application of a set of methods, assumptions and estimates. In determining net realizable value, we write down inventory that may be slow moving or have some form of obsolescence, including inventory that has aged more than 12 months. We also adjust the valuation of inventory when its manufacturing cost exceeds the estimated selling price less costs of completion, disposal and transportation. We assess the potential for any unusual customer returns based on known quality or business issues and write-off inventory losses for scrap or non-saleable material. Inventory not otherwise identified to be written down is compared to an assessment of our 12-month forecasted demand. The result of this methodology is compared against the product life cycle and competitive situations in the marketplace to determine the appropriateness of the resulting inventory levels. Demand for our products may fluctuate significantly over time, and actual demand and market conditions may be more or less favorable than those that we project. In the event that actual demand is lower or market conditions are worse than originally projected, additional inventory write-downs may be required. Impairment of goodwill and other long-lived assets - We review long-lived assets which are held and used, including fixed assets and purchased intangible assets, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors which are inherently difficult to forecast. If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique. We test our goodwill for impairment annually as of the first day of our fourth fiscal quarter and in interim periods if certain events occur indicating that the carrying value of goodwill may be impaired. The goodwill impairment test is a two-step process. The first step of the impairment analysis compares our fair value to our net book value. In determining fair value, the accounting guidance allows for the use of several valuation methodologies, although it states quoted market prices are the best evidence of fair value. If the fair value is less than the net book value, the second step of the analysis compares the implied fair value of our goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, we recognize an impairment loss equal to that excess amount. Acquired intangible assets - When we acquire a business, a portion of the purchase price is typically allocated to identifiable intangible assets, such as acquired technology and customer relationships. Fair value of these assets is determined primarily using the income approach, which requires us to project future cash flows and apply an appropriate discount rate. We amortize intangible assets with finite lives over their expected useful lives. Our estimates are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Incorrect estimates could result in future impairment charges, and those charges could be material to
our results of operations. 36 Table of Contents Revenue recognition - We recognize revenue when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. In order to achieve this core principle, we apply a five-step process. As part of this process, we analyze the performance obligations in a customer contract and estimate the consideration we expect to receive. The evaluation of performance obligations requires that we identify the promised goods and services in the contract. For contracts that contain more than one promised good and service, we then must determine whether the promises are capable of being distinct and if they are separately identifiable from other promises in the contract. Additionally, for our sales to distributors, we must estimate the impact that price adjustments and rights of return will have on consideration. We make these estimates based on available information, including recent sales activity and pricing data. If our evaluation of performance obligations is incorrect, we may recognize revenue sooner or later than is appropriate. If our estimates of consideration are inaccurate, we may recognize too much or too little revenue in a period. Stock-based compensation - We recognize the fair-value of stock-based compensation transactions in the Consolidated Statements of Income. The fair value of our full-value stock awards (with the exception of market-based performance awards) equals the fair market value of our stock on the date of grant. The fair value of our market-based performance awards is estimated at the date of grant using a Monte-Carlo simulation. The fair value of our stock option and employee stock purchase plan grants is estimated at the date of grant using the Black-Scholes option pricing model. In addition, we are required to estimate the expected forfeiture rate of our stock grants and only recognize the expense for those shares expected to vest. If our actual experience differs significantly from the assumptions used to compute our stock-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little stock-based compensation cost. See Note 15, Stock-Based Compensation, to the Consolidated Financial Statements for additional information. Income taxes - We are required to calculate income taxes in each of the jurisdictions in which we operate. This process involves calculating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheet. We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, we are required to estimate the amount of expected future taxable income. Judgment is inherent in this process and differences between the estimated and actual taxable income could result in a material impact on our Consolidated Financial Statements. We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine whether the weight of available evidence indicates that the tax position has met the threshold for recognition. Therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized upon ultimate settlement. This measurement step is inherently complex and requires subjective estimations of such amounts to determine the probability of various possible outcomes. We re-evaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, expirations of statutes of limitation, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period. Although we believe the measurement of our liabilities for uncertain tax positions is reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals. If additional taxes are assessed as a result of an audit or litigation, they could have a material effect on our income tax provision and net income in the period or periods for which that determination is made. We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues which may require an extended period of time to resolve and could result in additional assessments of income tax. We believe adequate provisions for income taxes have been made for all periods.
Recent Accounting Pronouncements
Information regarding recent accounting pronouncements is provided in Note 2, Significant Accounting Policies, to the Consolidated Financial Statements. Such information is incorporated by reference herein. 37
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