UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

 

 

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 October 28, 2006 and January 28, 2006 (restated)				4
		Unaudited Condensed Consolidated Statements of Income for the three and nine months ended October 28, 2006 and October 29, 2005 (restated)				5
		Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended October 28, 2006 and October 29, 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				38
Item 3.		Quantitative and Qualitative Disclosures About Market Risk				64
Item 4.		Controls and Procedures				64
		PART II.   OTHER INFORMATION
Item 1.		Legal Proceedings				67
Item 1A.		Risk Factors				70
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds				87
Item 3.		Defaults Upon Senior Securities				87
Item 4.		Submission of Matters to a Vote of Security Holders				87
Item 5.		Other Information				87
Item 6.		Exhibits				87
Signatures						88
Exhibit Index						89

 

2

Explanatory Note

In this Form 10-Q, we are restating our consolidated financial statements and related disclosures as of January 28, 2006 and for the three and nine months ended October 29, 2005.  This Form 10-Q also reflects the restatement of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2 for the third quarter of fiscal 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 Operation” 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 the Form 10-Q/A concurrently filed with this Form 10-Q for the first quarter of fiscal 2007.  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.

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PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

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

		October 28,   2006			January 28,   2006
					(restated) (1)
ASSETS
Current assets:
Cash and cash equivalents		$	839,441		$	348,431
Short-term investments		36,231			572,591
Accounts receivable, net of allowances of $3,549 and $3,028		294,216			245,164
Inventories		227,872			211,374
Prepaid expenses and other current assets		103,479			104,307
Deferred income taxes		3,945			3,945
Total current assets		1,505,184			1,485,812
Property and equipment, net		366,731			260,921
Goodwill		1,654,376			1,558,209
Acquired intangible assets		224,342			111,973
Other noncurrent assets		151,809			87,591
Total assets		$	3,902,442		$	3,504,506
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	199,677		$	196,606
Accrued liabilities		78,186			34,905
Accrued employee compensation		62,408			59,177
Income taxes payable		28,006			24,394
Deferred income		31,672			29,773
Current portion of capital lease obligations		19,443			16,563
Total current liabilities		419,392			361,418
Capital lease obligations, net of current portion		23,748			24,447
Non-current income taxes payable		110,845			86,545
Other long-term liabilities		35,701			24,871
Total liabilities		589,686			497,281
Commitments and contingencies (Note 7)
Shareholders’ equity:
Common stock, $0.002 par value; 992,000 shares authorized; 587,423 and 582,776 shares issued and outstanding		1,175			1,165
Additional paid-in capital		3,747,626			3,634,239
Deferred stock-based compensation		—			(61,987		)
Accumulated other comprehensive loss		(102		)	(1,759		)
Accumulated deficit		(435,943		)	(564,433		)
Total shareholders’ equity		3,312,756			3,007,225
Total liabilities and shareholders’ equity		$	3,902,442		$	3,504,506

 

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

See accompanying notes to unaudited condensed consolidated financial statements.

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

		Three Months Ended						Nine Months Ended
		October 28, 2006			October 29, 2005			October 28, 2006			October 29, 2005
					(restated) (1)						(restated) (1)
Net revenue		$	520,398		$	426,026		$	1,615,579		$	1,181,250
Operating costs and expenses:
Cost of goods sold		256,090			197,580			775,398			558,816
Research and development and other		152,939			83,043			434,812			249,098
Selling and marketing		37,875			23,129			116,004			71,290
General and administrative		40,427			11,833			78,674			38,851
Amortization of acquired intangible assets		27,405			19,746			72,161			59,258
Total operating costs and expenses		514,736			335,331			1,477,049			977,313
Operating income		5,662			90,695			138,530			203,937
Interest and other income, net		6,845			5,244			15,552			13,240
Income before income taxes		12,507			95,939			154,082			217,177
Provision for income taxes		6,461			12,584			34,438			32,776
Income before change in accounting principle		6,046			83,355			119,644			184,401
Cumulative effect of change in accounting principle, net of tax effect		—			—			8,846			—
Net income		$	6,046		$	83,355		$	128,490		$	184,401
Basic income per share:
Income before change in accounting principle		$	0.01		$	0.15		$	0.20		$	0.33
Cumulative effect of change in accounting principle, net of tax effect		—			—			0.02			—
Basic net income per share		$	0.01		$	0.15		$	0.22		$	0.33
Shares used in basic per share computation		587,348			567,310			585,728			562,243
Diluted income per share:
Income before change in accounting principle		$	0.01		$	0.13		$	0.19		$	0.29
Cumulative effect of change in accounting principle, net of tax effect		—			—			0.01			—
Diluted net income per share		$	0.01		$	0.13		$	0.20		$	0.29
Shares used in diluted per share computation		628,104			632,424			633,718			626,673

 

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

See accompanying notes to unaudited condensed consolidated financial statements.

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

		Nine Months Ended
		October 28, 2006			October 29, 2005
					(restated) (1)
Cash flows from operating activities:
Net income		$	128,490		$	184,401
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		52,519			41,840
Stock-based compensation		146,494			48,794
Amortization of acquired intangible assets		72,161			59,258
Excess tax benefits from stock-based compensation		(889		)	—
Changes in assets and liabilities, net of acquisitions:
Accounts receivable		(49,052		)	(52,383		)
Inventories		10,306			(21,040		)
Prepaid expenses and other assets		(51,790		)	(105,044		)
Accounts payable		3,072			60,441
Accrued liabilities and other		13,772			3,358
Accrued employee compensation		(767		)	4,901
Income taxes payable		29,092			29,562
Deferred income		1,899			9,854
Net cash provided by operating activities		346,461			263,942
Cash flows from investing activities:
Cash paid in acquisitions		(282,978		)	—
Purchases of short-term investments		(266,938		)	(490,811		)
Sales and maturities of short-term investments		804,902			533,876
Acquisition costs		(4,233		)	—
Purchases of property and equipment		(121,412		)	(62,309		)
Purchases of technology licenses		(8,029		)	—
Net cash provided by (used in) investing activities		121,312			(19,244		)
Cash flows from financing activities:
Proceeds from the issuance of common stock		36,035			65,732
Principal payments on capital lease obligations		(13,687		)	(12,042		)
Excess tax benefits from stock-based compensation		889			—
Net cash provided by financing activities		23,237			53,690
Net increase in cash and cash equivalents		491,010			298,388
Cash and cash equivalents at beginning of period		348,431			166,471
Cash and cash equivalents at end of period		$	839,441		$	464,859
Supplemental cash flows information:
Acquisition of property and equipment under capital lease obligations		$	15,868		$	19,797
Long-term leased assets under construction		$	7,000		$	14,750
Elimination of deferred stock-based compensation due to adoption of FAS 123R		$	61,986		$	—

 

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

See accompanying notes to unaudited condensed consolidated financial statements.

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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.

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

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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-executive 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 the 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 the 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 the Company’s 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 the Company’s 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.

George A. Hervey, MSI’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

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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 the Board of Directors determined, contrary to the recommendation of the Special Committee, that Ms. Dai have 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 our 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 the granting of equity-based compensation awards. Following the Special Committee’s recommendations, we are 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.

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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” (“APB 25”).

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 one grant on December 26, 2003 (which represents 75% of options granted) for three of the officers who were also founders of the Company (“Founder Officers”) and six grants (which represents 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

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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 found that the former General Counsel had misled the Executive Compensation Committee as to the reasons for the change.  The Special Committee 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 that 4,669,200 of 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 constructively 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.

(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

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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.

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):

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		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 options, 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 us 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 2007.  Therefore, the Company recorded in the last quarter of fiscal

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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 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; and 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 was 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):

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				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.

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The restatement adjustments reduced previously reported basic net income per share by $0.24 and $0.14 for fiscal 2006 and 2005, respectively and diluted net income per share by $0.20 and $0.13 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 outflows totaling $61.3 million.

The following tables present the impact of the financial statement adjustments on the previously reported Consolidated Statement of Operations for the three and nine months ended October 29, 2005:

		Three Months Ended October 29, 2005									Nine Months Ended October 29, 2005
		As Previously Reported			Adjustments			As Restated			As Previously Reported			Adjustments			As Restated
		(In thousands, except per share amounts)
Net revenue		$	426,026		$	—		$	426,026		$	1,181,250		$	—		$	1,181,250
Operating costs and expenses:
Cost of goods sold		197,077			503		(A)	197,580			555,967			2,849		(A)	558,816
Research and development		77,689			5,354		(A)	83,043			222,751			26,347		(A)	249,098
Selling and marketing		21,634			1,495		(A)	23,129			63,898			7,392		(A)	71,290
General and administrative		9,029			2,804		(A)	11,833			24,107			14,744		(A)	38,851
Amortization of stock-based compensation		465			(465		)(A)	—			1,853			(1,853		)(A)	—
Amortization and write-off of goodwill and acquired intangible assets and other		19,746			—			19,746			59,258			—			59,258
Total operating costs and expenses		325,640			9,691			335,331			927,834			49,479			977,313
Operating income (loss)		100,386			(9,691		)	90,695			253,416			(49,479		)	203,937
Interest and other income, net		5,244			—			5,244			13,240			—			13,240
Income (loss) before income taxes		105,630			(9,691		)	95,939			266,656			(49,479		)	217,177
Provision for income taxes		12,584			—			12,584			32,776			—			32,776
Net income (loss)		$	93,046		$	(9,691	)	$	83,355		$	233,880		$	(49,479	)	$	184,401
Basic net income (loss) per share		$	0.16		$	(0.01	)	$	0.15		$	0.42		$	(0.09	)	$	0.33
Diluted net income (loss) per share		$	0.15		$	(0.02	)	$	0.13		$	0.37		$	(0.08	)	$	0.29
Weighted average shares — basic		567,310						567,310			562,243						562,243
Weighted average shares — diluted		632,424						632,424			626,673						626,673

 

(A).    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.

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

		January 28, 2006
		As Previously Reported			Adjustments			As Restated
		(In thousands, except per share amounts)
ASSETS
Current assets:
Cash and cash equivalents		$	348,431		$	—		$	348,431
Short-term investments		572,591			—			572,591
Accounts receivable, net of allowance of $3,028		245,164			—			245,164
Inventories		211,374			—			211,374
Prepaid expenses and other current assets		104,307			—			104,307
Deferred income taxes		18,007			(14,062		)(B)	3,945
Total current assets		1,499,874			(14,062		)	1,485,812
Property and equipment, net		260,921			—			260,921
Goodwill		1,558,209			—			1,558,209
Acquired intangible assets, net		111,973			—			111,973
Other non-current assets		82,312			5,279		(B)	87,591
Total assets		$	3,513,289		$	(8,783	)	$	3,504,506
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	196,606		$	—		$	196,606
Accrued liabilities		34,905			—			34,905
Accrued employee compensation		51,549			7,628		(C)	59,177
Income taxes payable		3,352			21,042		(B)	24,394
Deferred income		29,773			—			29,773
Current portion of capital lease obligations		16,563			—			16,563
Total current liabilities		332,748			28,670			361,418
Capital lease obligations, net of current portion		24,447			—			24,447
Non-current income taxes payable		85,126			1,419		(B)	86,545
Other long-term liabilities		24,871			—			24,871
Total liabilities		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; 992,000 shares authorized; 582,776 shares issued and outstanding		1,165			—			1,165
Additional paid-in capital		3,249,587			384,652		(A)	3,634,239
Deferred stock-based compensation		(1,141		)	(60,846		)(A)	(61,987		)
Accumulated other comprehensive loss		(1,759		)	—			(1,759		)
Accumulated deficit		(201,755		)	(362,678		)	(564,433		)
Total shareholders’ equity		3,046,097			(38,872		)	3,007,225
Total liabilities and shareholders’ equity		$	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.

(B).     Adjustments to deferred tax assets arising from the stock-based compensation charge.

(C).     Adjustments for additional payroll taxes.

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The following tables present the impact of the financial statement adjustments on the previously reported Statements of Cash Flows for three and nine months ended October 29, 2005:

		Nine Months Ended October 29, 2005
		As Previously Reported			Adjustments			As Restated
		(In thousands)
Cash flows from operating activities:
Net income		$	233,880		$	(49,479	)	$	184,401
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		41,840			—			41,840
Stock-based compensation		1,853			46,941		(A)	48,794
Amortization of acquired intangible assets		59,258			—			59,258
Changes in assets and liabilities, net of acquisition:
Accounts receivable		(52,383		)	—			(52,383		)
Inventories		(21,040		)	—			(21,040		)
Prepaid expenses and other assets		(105,044		)	—			(105,044		)
Accounts payable		60,441			—			60,441
Accrued liabilities and other		3,358			—			3,358
Accrued employee compensation		2,363			2,538		(B)	4,901
Income taxes payable		29,562			—			29,562
Deferred income		9,854			—			9,854
Net cash provided by operating activities		263,942			—			263,942
Cash flows from investing activities:
Purchases of short-term investments		(490,811		)	—			(490,811		)
Sales and maturities of short-term investments		533,876			—			533,876
Purchases of property and equipment		(62,309		)	—			(62,309		)
Net cash provided by (used in) investing activities		(19,244		)	—			(19,244		)
Cash flows from financing activities:
Proceeds from the issuance of common stock		65,732			—			65,732
Principal payments on capital lease obligations		(12,042		)	—			(12,042		)
Net cash provided by financing activities		53,690			—			53,690
Net increase (decrease) in cash and cash equivalents		298,388			—			298,388
Cash and cash equivalents at beginning of period		166,471			—			166,471
Cash and cash equivalents at end of period		$	464,859		$	—		$	464,859

 

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

(B).     Adjustments for additional payroll tax.

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