UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended October 31, 2015
or
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 000-30877
Marvell Technology Group Ltd.
(Exact name of registrant as specified in its charter)
Bermuda | 77-0481679 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
Canons Court, 22 Victoria Street, Hamilton HM 12, Bermuda
(441) 296-6395
(Address of principal executive offices, Zip Code and registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ¨ Yes x No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | x | Accelerated filer | ¨ | |||
Non-accelerated filer | ¨ (Do not check if a smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
The number of common shares of the registrant outstanding as of July 11, 2016 was 511.2 million shares.
EXPLANATORY NOTE
As previously reported, we were unable to timely file our Quarterly Report on Form 10-Q for the second and third quarters of fiscal 2016 and our Annual Report on Form 10-K for fiscal 2016. Except as specifically set forth herein, this Form 10-Q speaks only as of October 31, 2015 and the period then ended, and these financial results do not reflect events or results of operations that may have occurred subsequent to October 31, 2015. The Company was obligated to adjust its financial results for the third quarter of fiscal 2016 through the date of filing of this report to account for certain activities subsequent to October 31, 2015 (Type 1 subsequent events). As a result, certain results, including net loss and net loss per share, reported in this report may differ from the preliminary results for the third quarter of fiscal 2016 released on December 7, 2015. Please see also our Annual Report on Form 10-K for the fiscal year ended January 30, 2016, which is being filed on the date hereof.
1
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value per share)
October 31, 2015 |
January 31, 2015 |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
$ | 897,053 | $ | 1,210,977 | ||||
Short-term investments |
1,406,699 | 1,318,578 | ||||||
Accounts receivable, net |
380,928 | 420,955 | ||||||
Inventories |
279,359 | 308,162 | ||||||
Prepaid expenses and other current assets |
54,123 | 68,140 | ||||||
Deferred income taxes |
17,327 | 17,228 | ||||||
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Total current assets |
3,035,489 | 3,344,040 | ||||||
Property and equipment, net |
309,647 | 340,639 | ||||||
Long-term investments |
10,182 | 10,226 | ||||||
Goodwill |
2,029,945 | 2,029,945 | ||||||
Acquired intangible assets, net |
20,957 | 30,698 | ||||||
Other non-current assets |
100,304 | 128,839 | ||||||
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Total assets |
$ | 5,506,524 | $ | 5,884,387 | ||||
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LIABILITIES AND SHAREHOLDERS EQUITY |
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Current liabilities: |
||||||||
Accounts payable |
$ | 236,675 | $ | 282,899 | ||||
Accrued liabilities |
145,139 | 131,388 | ||||||
Carnegie Mellon University accrued litigation settlement |
734,715 | | ||||||
Accrued employee compensation |
140,333 | 154,969 | ||||||
Deferred income |
58,086 | 68,120 | ||||||
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Total current liabilities |
1,314,948 | 637,376 | ||||||
Non-current income taxes payable |
55,147 | 68,729 | ||||||
Other non-current liabilities |
24,946 | 32,193 | ||||||
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Total liabilities |
1,395,041 | 738,298 | ||||||
Commitments and contingencies (Note 10) |
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Shareholders equity: |
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Common shares, $0.002 par value |
1,010 | 1,030 | ||||||
Additional paid-in capital |
2,975,426 | 3,099,548 | ||||||
Accumulated other comprehensive income (loss) |
(2,182 | ) | 308 | |||||
Retained earnings |
1,137,229 | 2,045,203 | ||||||
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Total shareholders equity |
4,111,483 | 5,146,089 | ||||||
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Total liabilities and shareholders equity |
$ | 5,506,524 | $ | 5,884,387 | ||||
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
2
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Net revenue |
$ | 674,890 | $ | 930,136 | $ | 2,109,670 | $ | 2,849,511 | ||||||||
Operating costs and expenses: |
||||||||||||||||
Cost of goods sold |
379,254 | 454,974 | 1,192,126 | 1,426,575 | ||||||||||||
Research and development |
252,502 | 288,348 | 818,257 | 873,381 | ||||||||||||
Selling and marketing |
30,582 | 34,410 | 97,597 | 106,717 | ||||||||||||
General and administrative |
33,206 | 32,358 | 108,884 | 93,535 | ||||||||||||
Carnegie Mellon University litigation settlement |
| | 654,667 | | ||||||||||||
Restructuring and other related charges |
35,270 | 1,202 | 48,862 | 7,025 | ||||||||||||
Amortization and write-off of acquired intangible assets |
3,150 | 3,304 | 8,286 | 13,297 | ||||||||||||
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Total operating costs and expenses |
733,964 | 814,596 | 2,928,679 | 2,520,530 | ||||||||||||
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Operating income (loss) |
(59,074 | ) | 115,540 | (819,009 | ) | 328,981 | ||||||||||
Interest and other income, net |
4,644 | 4,764 | 16,601 | 18,952 | ||||||||||||
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Income (loss) before income taxes |
(54,430 | ) | 120,304 | (802,408 | ) | 347,933 | ||||||||||
Provision (benefit) for income taxes |
3,320 | 5,000 | 13,192 | (5,720 | ) | |||||||||||
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Net income (loss) |
$ | (57,750 | ) | $ | 115,304 | $ | (815,600 | ) | $ | 353,653 | ||||||
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Net income (loss) per share: |
||||||||||||||||
Basic |
$ | (0.11 | ) | $ | 0.22 | $ | (1.59 | ) | $ | 0.69 | ||||||
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Diluted |
$ | (0.11 | ) | $ | 0.22 | $ | (1.59 | ) | $ | 0.68 | ||||||
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Weighted average shares: |
||||||||||||||||
Basic |
504,831 | 513,859 | 512,476 | 510,261 | ||||||||||||
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Diluted |
504,831 | 519,907 | 512,476 | 520,309 | ||||||||||||
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Cash dividend declared per share |
$ | 0.06 | $ | 0.06 | $ | 0.18 | $ | 0.18 | ||||||||
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
3
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Net income (loss) |
$ | (57,750 | ) | $ | 115,304 | $ | (815,600 | ) | $ | 353,653 | ||||||
Other comprehensive income (loss), net of tax: |
||||||||||||||||
Net change in unrealized gain (loss) on marketable securities |
(491 | ) | (1,209 | ) | (3,809 | ) | (1,052 | ) | ||||||||
Net change in unrealized gain (loss) on auction rate securities |
59 | 305 | (44 | ) | 448 | |||||||||||
Net change in unrealized gain (loss) on cash flow hedges |
(472 | ) | (2,687 | ) | 1,363 | (2,957 | ) | |||||||||
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Other comprehensive loss, net of tax |
(904 | ) | (3,591 | ) | (2,490 | ) | (3,561 | ) | ||||||||
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Comprehensive income (loss), net of tax |
$ | (58,654 | ) | $ | 111,713 | $ | (818,090 | ) | $ | 350,092 | ||||||
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
4
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended | ||||||||
October 31, 2015 |
November 1, 2014 |
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Cash flows from operating activities: |
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Net income (loss) |
$ | (815,600 | ) | $ | 353,653 | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
77,376 | 79,784 | ||||||
Share-based compensation |
101,360 | 99,283 | ||||||
Amortization and write-off of acquired intangible assets |
9,741 | 14,752 | ||||||
Non-cash restructuring and other related charges |
15,743 | | ||||||
Other non-cash expense (income), net |
5,926 | (12,160 | ) | |||||
Excess tax benefits from share-based compensation |
(27 | ) | (78 | ) | ||||
Changes in assets and liabilities: |
||||||||
Accounts receivable |
40,027 | 10,055 | ||||||
Inventories |
21,042 | (8,793 | ) | |||||
Prepaid expenses and other assets |
18,132 | (8,621 | ) | |||||
Accounts payable |
(43,735 | ) | 16,937 | |||||
Accrued liabilities and other non-current liabilities |
12,016 | (22,035 | ) | |||||
Carnegie Mellon University accrued litigation settlement |
734,715 | | ||||||
Accrued employee compensation |
(14,636 | ) | 41,651 | |||||
Deferred income |
(10,034 | ) | 9,087 | |||||
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Net cash provided by operating activities |
152,046 | 573,515 | ||||||
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Cash flows from investing activities: |
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Purchases of available-for-sale securities |
(922,830 | ) | (784,296 | ) | ||||
Sales and maturities of available-for-sale securities |
826,199 | 578,095 | ||||||
Distribution from (investments in) privately-held companies |
78 | (701 | ) | |||||
Proceeds from sale of an investment in a privately-held company |
| 13,220 | ||||||
Purchases of technology licenses |
(6,657 | ) | (14,514 | ) | ||||
Purchases of property and equipment |
(33,361 | ) | (48,615 | ) | ||||
Purchase of equipment previously leased |
(10,240 | ) | | |||||
Proceeds from sale of equipment held for sale |
10,007 | | ||||||
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Net cash used in investing activities |
(136,804 | ) | (256,811 | ) | ||||
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Cash flows from financing activities: |
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Repurchase of common stock |
(260,875 | ) | (43,774 | ) | ||||
Proceeds from employee stock plans |
59,348 | 71,308 | ||||||
Minimum tax withholding paid on behalf of employees for net share settlement |
(23,876 | ) | (25,586 | ) | ||||
Dividend payments to shareholders |
(92,374 | ) | (91,859 | ) | ||||
Payments on technology license obligations |
(11,416 | ) | (8,628 | ) | ||||
Excess tax benefits from share-based compensation |
27 | 78 | ||||||
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Net cash used in financing activities |
(329,166 | ) | (98,461 | ) | ||||
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Net increase (decrease) in cash and cash equivalents |
(313,924 | ) | 218,243 | |||||
Cash and cash equivalents at beginning of period |
1,210,977 | 965,750 | ||||||
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Cash and cash equivalents at end of period |
$ | 897,053 | $ | 1,183,993 | ||||
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See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.
5
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1. The Company and Basis of Presentation
The Company
Marvell Technology Group Ltd., a Bermuda company, and its subsidiaries (the Company), is a fabless semiconductor provider of high-performance application-specific standard products. The Companys core strength of expertise is the development of complex System-on-a-Chip and System-in-a-Package devices, leveraging its extensive technology portfolio of intellectual property in the areas of analog, mixed-signal, digital signal processing, and embedded and stand alone integrated circuits. The majority of the Companys product portfolio leverages embedded central processing unit technology. The Company also develops platforms that it defines as integrated hardware along with software that incorporates digital computing technologies designed and configured to provide an optimized computing solution. The Companys broad product portfolio includes devices for data storage, enterprise-class Ethernet data switching, Ethernet physical-layer transceivers, wireless connectivity, Internet-of-Things devices and multimedia solutions.
Basis of Presentation
The Companys fiscal year is the 52- or 53-week period ending on the Saturday closest to January 31. In a 52-week year, each fiscal quarter consists of 13 weeks. The additional week in a 53-week year is added to the fourth quarter, making such quarter consist of 14 weeks. Fiscal 2016 and 2015 each have a 52-week period.
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. In the opinion of management, all adjustments consisting of normal and recurring entries considered necessary for a fair statement of the results for the interim periods have been included in the Companys unaudited condensed consolidated balance sheet as of October 31, 2015, the results of its operations for the three and nine months ended October 31, 2015 and November 1, 2014, its comprehensive income for the three and nine months ended October 31, 2015 and November 1, 2014, and its cash flows for the nine months ended October 31, 2015 and November 1, 2014. The January 31, 2015 condensed consolidated balance sheet data was derived from the audited consolidated financial statements included in the Companys Annual Report on Form 10-K for the fiscal year ended January 31, 2015, but does not include all disclosures required for annual periods.
These condensed consolidated financial statements and related notes are unaudited and should be read in conjunction with the Companys audited financial statements and related notes included in the Companys Annual Report on Form 10-K for the fiscal year ended January 31, 2015 as filed on March 26, 2015 with the Securities and Exchange Commission. The results of operations for the three and nine months ended October 31, 2015 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to performance-based compensation, revenue recognition, provisions for sales returns and allowances, inventory excess and obsolescence, investment fair values, goodwill and other intangible assets, restructuring, income taxes, litigation and other contingencies. In addition, the Company uses assumptions when employing the Monte Carlo simulation and Black-Scholes valuation models to calculate the fair value of share-based awards that are granted. Actual results could differ from these estimates, and such differences could affect the results of operations reported in future periods.
Principles of Consolidation
The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The functional currency of the Company and its subsidiaries is the U.S. dollar.
6
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 2. Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
In April 2014, the Financial Accounting Standards Board (FASB) issued an amendment to its guidance regarding the reporting requirements of discontinued operations, which was effective for the Company beginning in the first quarter of fiscal 2016. Under the amended guidance, a discontinued operation is defined as a disposal of a component or group of components that is disposed of or is classified as held for sale and represents a strategic shift that has (or will have) a major effect on an entitys operations and financial results. As a result, the Company has adopted and will apply the new guidance for any future dispositions that meet the criteria of a discontinued operation under the amendment.
In November 2015, the FASB issued a new standard to simplify the presentation of deferred income taxes. Currently, deferred income tax assets and liabilities are separately presented as current and non-current amounts on the consolidated balance sheet. The new standard will require that deferred tax assets and liabilities be classified and presented on the balance sheet as non-current. The guidance is effective for annual and interim reporting periods beginning after December 15, 2016, although early adoption is permitted. The Company will adopt the new guidance at the beginning of its fourth quarter of fiscal 2016 on a prospective basis, and will not retrospectively adjust any prior periods. Adoption will have no impact on the Companys consolidated results of operations and it had no material impact on working capital.
Accounting Pronouncements Not Yet Effective
In May 2014, the FASB issued a new standard on the recognition of revenue from contracts with customers, which will supersede nearly all existing revenue recognition guidance under GAAP. Under the new standard, recognition of revenue occurs when a customer obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Additional disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, and assets recognized from costs incurred to obtain or fulfill a contract will also be required. The FASB subsequently issued an update to this standard in August 2015, which provides deferral of the effective date by one year. The standard is now effective for the Companys first quarter of fiscal 2019 and allows for either full retrospective or modified retrospective adoption. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016 and including interim reporting periods within such reporting period.
The FASB has since issued additional updates of its new standard on revenue recognition issued in May 2014. In March 2016, an amendment was issued to clarify the implementation guidance on principal versus agent consideration. The guidance requires entities to determine whether the nature of its promise to provide goods or services to a customer is performed in a principal or agent capacity and to recognize revenue in a gross or net manner based on its principal/agent designation. In April 2016, amendments were issued to clarify the identification of performance obligations and the licensing implementation guidance in the initial standard. Amendments were issued in May 2016 related to its guidance on assessing collectability, presentation of sales tax, noncash consideration, and completed contracts and contract modification at transition, which reduce the potential for diversity in practice, and the cost and complexity of application at transition and on an ongoing basis. The Company has been evaluating the effects of the new guidance and has not yet selected a transition method nor has it determined the potential effects of adoption on its consolidated financial statements.
In April 2015, the FASB issued new guidance to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. The guidance provides a basis for evaluating whether a cloud computing arrangement includes a software license or whether the arrangement should be accounted for as a service contract. The guidance is effective for annual and interim reporting periods beginning after December 15, 2015. The newly issued guidance also strikes from previous authoritative guidance, the use by analogy to the accounting for capital leases, which the Company applied in the accounting for certain of its technology license agreements. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
In July 2015, the FASB issued an amendment to its guidance regarding the subsequent measurement of inventory. Currently, inventory is measured at the lower of cost or market. Market could be replacement cost, net realizable value or net realizable value less an approximately normal profit margin. Under this amended guidance, inventory is to be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. This amendment applies to inventories for which cost is determined by methods other than last-in first-out and the retail inventory method. This standard is effective for annual and interim reporting periods beginning after December 15, 2016. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
In January 2016, the FASB issued new guidance which requires entities to measure all investments in equity securities at fair value with changes recognized through net income. This requirement does not apply to investments that qualify for the equity method of accounting, investments that result in consolidation of the investee, or investments for which the entity meets a practicability exception to fair value measurement. The new guidance also changes certain disclosure requirements for financial instruments. This standard is effective for annual and interim reporting periods beginning after December 15, 2017. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
7
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In March 2016, the FASB issued an amendment to its guidance on the effects of derivative contract novations on existing hedge accounting relationships. The new guidance clarifies that a change in the counterparty to a designated hedging instrument, in and of itself, does not require the de-designation of that hedging relationship, provided that all other hedge accounting criteria continue to be met. The guidance is effective for annual and interim reporting periods beginning after December 15, 2016. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
In March 2016, the FASB issued a new standard on the accounting for leases, which requires a lessee to record a right-of-use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than twelve months. The standard also expands the required quantitative and qualitative disclosures surrounding lease arrangements. The standard is effective for annual and interim reporting periods beginning after December 15, 2018. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
In March 2016, the FASB issued an amendment to its guidance for investments that eliminates the requirement to retrospectively apply the equity method in previous periods when an investor initially obtains significant influence over an investee. Under the amended guidance, the investor should apply the equity method prospectively from the date the investment qualifies for the equity method. The guidance is effective for annual and interim reporting periods beginning after December 15, 2016. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
In March 2016, the FASB issued new guidance which simplifies several aspects of the accounting for share-based payment award transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance is effective for annual and interim reporting periods beginning after December 15, 2016. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
In June 2016, the FASB issued a new standard requiring financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The standard eliminates the probable initial recognition in current GAAP and reflects an entitys current estimate of all expected credit losses. The measurement of expected credit losses is based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets. The standard is effective for annual and interim reporting periods beginning after December 15, 2019. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements.
Note 3. Investments
The following tables summarize the Companys investments (in thousands):
October 31, 2015 | ||||||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value |
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Short-term investments: |
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Available-for-sale: |
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Corporate debt securities |
$ | 880,204 | $ | 1,174 | $ | (1,305 | ) | $ | 880,073 | |||||||
U.S. government and agency debt |
378,687 | 152 | (143 | ) | 378,696 | |||||||||||
Asset backed securities |
89,638 | 85 | (51 | ) | 89,672 | |||||||||||
Foreign government and agency debt |
21,907 | 7 | (12 | ) | 21,902 | |||||||||||
Municipal debt securities |
36,303 | 63 | (10 | ) | 36,356 | |||||||||||
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Total short-term investments |
1,406,739 | 1,481 | (1,521 | ) | 1,406,699 | |||||||||||
Long-term investments: |
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Available-for-sale: |
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Auction rate securities |
12,500 | | (2,318 | ) | 10,182 | |||||||||||
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Total long-term investments |
12,500 | | (2,318 | ) | 10,182 | |||||||||||
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Total investments |
$ | 1,419,239 | $ | 1,481 | $ | (3,839 | ) | $ | 1,416,881 | |||||||
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8
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
January 31, 2015 | ||||||||||||||||
Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Estimated Fair Value |
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Short-term investments: |
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Available-for-sale: |
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Corporate debt securities |
$ | 983,008 | $ | 3,872 | $ | (563 | ) | $ | 986,317 | |||||||
U.S. government and agency debt |
178,898 | 265 | (7 | ) | 179,156 | |||||||||||
Asset backed securities |
91,432 | 108 | (9 | ) | 91,531 | |||||||||||
Foreign government and agency debt |
28,051 | 61 | (2 | ) | 28,110 | |||||||||||
Municipal debt securities |
33,421 | 47 | (4 | ) | 33,464 | |||||||||||
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|||||||||
Total short-term investments |
1,314,810 | 4,353 | (585 | ) | 1,318,578 | |||||||||||
Long-term investments: |
||||||||||||||||
Available-for-sale: |
||||||||||||||||
Auction rate securities |
12,500 | | (2,274 | ) | 10,226 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total long-term investments |
12,500 | | (2,274 | ) | 10,226 | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total investments |
$ | 1,327,310 | $ | 4,353 | $ | (2,859 | ) | $ | 1,328,804 | |||||||
|
|
|
|
|
|
|
|
As of October 31, 2015, the Companys investment portfolio included auction rate securities with an aggregate par value of $12.5 million classified as long-term investments. Although these securities have continued to pay interest, there is currently limited trading volume in the securities. The Company uses a discounted cash flow model to estimate the fair value of the auction rate securities based on estimated timing and amount of future interest and principal payments. In developing the discounted cash flow model, the Company considers the credit quality and liquidity of the underlying securities and related issuer, the collateralization of underlying security investments and other considerations. The fair value of these auction rate securities as of October 31, 2015 was $2.3 million less than their par value. Based on the Companys balance of approximately $2.3 billion in cash, cash equivalents and short-term investments, and the fact that the Company continues to generate positive cash flow from operations on a quarterly basis, the Company does not anticipate having to sell these securities below par value and does not have the intent to sell these auction rate securities until recovery. Since the Company considers the impairment to be temporary, the Company recorded the unrealized loss to accumulated other comprehensive loss, a component of shareholders equity.
Gross realized gains and gross realized losses on sales of available-for-sale securities are presented in the following tables (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Gross realized gains |
$ | 524 | $ | 415 | $ | 1,222 | $ | 1,367 | ||||||||
Gross realized losses |
(877 | ) | (25 | ) | (1,214 | ) | (50 | ) | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Total net realized gains |
$ | (353 | ) | $ | 390 | $ | 8 | $ | 1,317 | |||||||
|
|
|
|
|
|
|
|
The contractual maturities of available-for-sale securities are presented in the following tables (in thousands):
October 31, 2015 | January 31, 2015 | |||||||||||||||
Amortized Cost |
Estimated Fair Value |
Amortized Cost |
Estimated Fair Value |
|||||||||||||
Due in one year or less |
$ | 426,398 | $ | 426,440 | $ | 361,108 | $ | 361,396 | ||||||||
Due between one and five years |
969,328 | 969,271 | 950,702 | 954,151 | ||||||||||||
Due over five years |
23,513 | 21,170 | 15,500 | 13,257 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 1,419,239 | $ | 1,416,881 | $ | 1,327,310 | $ | 1,328,804 | |||||||||
|
|
|
|
|
|
|
|
9
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
For individual securities that have been in a continuous unrealized loss position, the fair value and gross unrealized loss for these securities aggregated by investment category and length of time in an unrealized position are presented in the following tables (in thousands):
October 31, 2015 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
|||||||||||||||||||
Corporate debt securities |
$ | 454,216 | $ | (1,265 | ) | $ | 17,591 | $ | (40 | ) | $ | 471,807 | $ | (1,305 | ) | |||||||||
U.S. government and agency debt |
214,176 | (143 | ) | | | 214,176 | (143 | ) | ||||||||||||||||
Asset backed securities |
38,276 | (51 | ) | | | 38,276 | (51 | ) | ||||||||||||||||
Foreign government and agency debt |
14,801 | (12 | ) | | | 14,801 | (12 | ) | ||||||||||||||||
Municipal debt securities |
2,242 | (9 | ) | 1,082 | (1 | ) | 3,324 | (10 | ) | |||||||||||||||
Auction rate securities |
| | 10,182 | (2,318 | ) | 10,182 | (2,318 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total securities |
$ | 723,711 | $ | (1,480 | ) | $ | 28,855 | $ | (2,359 | ) | $ | 752,566 | $ | (3,839 | ) | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
January 31, 2015 | ||||||||||||||||||||||||
Less than 12 months | 12 months or more | Total | ||||||||||||||||||||||
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
Fair Value |
Unrealized Loss |
|||||||||||||||||||
Corporate debt securities |
$ | 243,699 | $ | (558 | ) | $ | 2,005 | $ | (5 | ) | $ | 245,704 | $ | (563 | ) | |||||||||
U.S. government and agency debt |
32,165 | (7 | ) | | | 32,165 | (7 | ) | ||||||||||||||||
Asset backed securities |
25,053 | (9 | ) | | | 25,053 | (9 | ) | ||||||||||||||||
Foreign government and agency debt |
2,999 | (2 | ) | | | 2,999 | (2 | ) | ||||||||||||||||
Municipal debt securities |
2,845 | (4 | ) | | | 2,845 | (4 | ) | ||||||||||||||||
Auction rate securities |
| | 10,226 | (2,274 | ) | 10,226 | (2,274 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Total securities |
$ | 306,761 | $ | (580 | ) | $ | 12,231 | $ | (2,279 | ) | $ | 318,992 | $ | (2,859 | ) | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
Note 4. Supplemental Financial Information (in thousands)
Consolidated Balance Sheets
October 31, 2015 |
January 31, 2015 |
|||||||
Inventories: |
||||||||
Work-in-process |
$ | 144,192 | $ | 183,869 | ||||
Finished goods |
135,167 | 124,293 | ||||||
|
|
|
|
|||||
Total inventories |
$ | 279,359 | $ | 308,162 | ||||
|
|
|
|
October 31, 2015 |
January 31, 2015 |
|||||||
Property and equipment, net: |
||||||||
Machinery and equipment |
$ | 630,243 | $ | 601,961 | ||||
Buildings |
144,320 | 144,320 | ||||||
Computer software |
104,073 | 99,312 | ||||||
Land |
53,373 | 53,373 | ||||||
Building improvements |
49,902 | 49,753 | ||||||
Leasehold improvements |
50,659 | 51,434 | ||||||
Furniture and fixtures |
27,542 | 27,883 | ||||||
Construction in progress |
1,504 | 6,167 | ||||||
|
|
|
|
|||||
1,061,616 | 1,034,203 | |||||||
Less: Accumulated depreciation and amortization |
(751,969 | ) | (693,564 | ) | ||||
|
|
|
|
|||||
Total property and equipment, net |
$ | 309,647 | $ | 340,639 | ||||
|
|
|
|
10
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
October 31, 2015 |
January 31, 2015 |
|||||||
Other non-current assets: |
||||||||
Technology and other licenses |
$ | 41,070 | $ | 61,217 | ||||
Deferred tax assets |
19,244 | 22,273 | ||||||
Investments in privately-held companies |
8,685 | 9,267 | ||||||
Prepaid land use rights |
13,200 | 13,432 | ||||||
Deposits |
6,949 | 7,903 | ||||||
Other |
11,156 | 14,747 | ||||||
|
|
|
|
|||||
Total other non-current assets |
$ | 100,304 | $ | 128,839 | ||||
|
|
|
|
October 31, 2015 |
January 31, 2015 |
|||||||
Accrued liabilities: |
||||||||
Accrued rebates |
$ | 31,797 | $ | 39,105 | ||||
Accrued royalties |
17,732 | 24,680 | ||||||
Technology license obligations |
9,718 | 14,428 | ||||||
Accrued legal expense |
9,830 | 8,327 | ||||||
Accrued litigation |
4,000 | 1,700 | ||||||
Other |
72,062 | 43,148 | ||||||
|
|
|
|
|||||
Total accrued liabilities |
$ | 145,139 | $ | 131,388 | ||||
|
|
|
|
October 31, 2015 |
January 31, 2015 |
|||||||
Other non-current liabilities: |
||||||||
Technology license obligations |
$ | 10,896 | $ | 16,468 | ||||
Long-term accrued employee compensation |
6,551 | 4,610 | ||||||
Other |
7,499 | 11,115 | ||||||
|
|
|
|
|||||
Other non-current liabilities |
$ | 24,946 | $ | 32,193 | ||||
|
|
|
|
Accumulated other comprehensive income (loss)
The changes in accumulated other comprehensive income (loss) by components are presented in the following tables (in thousands):
Unrealized Gain (Loss) on Marketable Securities |
Unrealized Gain (Loss) on Auction Rate Securities |
Unrealized Gain (Loss) on Cash Flow Hedges |
Total | |||||||||||||
Balance at January 31, 2015 |
$ | 3,768 | $ | (2,274 | ) | $ | (1,186 | ) | $ | 308 | ||||||
Other comprehensive income (loss) before reclassifications |
(3,360 | ) | (44 | ) | 1,296 | (2,108 | ) | |||||||||
Amounts reclassified from accumulated other comprehensive income (loss) |
(449 | ) | | 67 | (382 | ) | ||||||||||
|
|
|
|
|
|
|
|
|||||||||
Other comprehensive income (loss), net of tax |
(3,809 | ) | (44 | ) | 1,363 | (2,490 | ) | |||||||||
|
|
|
|
|
|
|
|
|||||||||
Balance at October 31, 2015 |
$ | (41 | ) | $ | (2,318 | ) | $ | 177 | $ | (2,182 | ) | |||||
|
|
|
|
|
|
|
|
11
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Unrealized Gain (Loss) on Marketable Securities |
Unrealized Gain (Loss) on Auction Rate Securities |
Unrealized Gain (Loss) on Cash Flow Hedges |
Total | |||||||||||||
Balance at February 1, 2014 |
$ | 2,534 | $ | (2,871 | ) | $ | 934 | $ | 597 | |||||||
Other comprehensive income (loss) before reclassifications |
67 | 448 | (1,603 | ) | (1,088 | ) | ||||||||||
Amounts reclassified from accumulated other comprehensive income (loss) |
(1,119 | ) | | (1,354 | ) | (2,473 | ) | |||||||||
|
|
|
|
|
|
|
|
|||||||||
Other comprehensive income (loss), net of tax |
(1,052 | ) | 448 | (2,957 | ) | (3,561 | ) | |||||||||
|
|
|
|
|
|
|
|
|||||||||
Balance at November 1, 2014 |
$ | 1,482 | $ | (2,423 | ) | $ | (2,023 | ) | $ | (2,964 | ) | |||||
|
|
|
|
|
|
|
|
The amounts reclassified from accumulated other comprehensive income (loss) by components are presented in the following table (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
Affected Line Item in the |
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
||||||||||||
Interest and other income, net: |
||||||||||||||||
Available-for-sale securities: |
||||||||||||||||
Marketable securities |
$ | (4 | ) | $ | 264 | $ | 449 | $ | 1,119 | |||||||
Operating costs and expenses: |
||||||||||||||||
Cash flow hedges: |
||||||||||||||||
Research and development |
545 | 320 | (68 | ) | 1,241 | |||||||||||
Selling and marketing |
6 | 29 | (57 | ) | 110 | |||||||||||
General and administrative |
51 | 1 | 58 | 3 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total |
$ | 598 | $ | 614 | $ | 382 | $ | 2,473 | ||||||||
|
|
|
|
|
|
|
|
Consolidated Statements of Operations
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Interest and other income, net: |
||||||||||||||||
Interest income |
$ | 3,932 | $ | 2,914 | $ | 11,980 | $ | 7,838 | ||||||||
Net realized gain (loss) on investments |
(353 | ) | 390 | 8 | 1,317 | |||||||||||
Currency translation gain |
1,134 | 1,667 | 5,035 | 981 | ||||||||||||
Other income |
86 | 108 | 145 | 9,765 | ||||||||||||
Interest expense |
(155 | ) | (315 | ) | (567 | ) | (949 | ) | ||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 4,644 | $ | 4,764 | $ | 16,601 | $ | 18,952 | |||||||||
|
|
|
|
|
|
|
|
12
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Net income (loss) per share
The Company reports both basic net income (loss) per share, which is based on the weighted average number of common shares outstanding during the period, and diluted net income (loss) per share, which is based on the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the period. The computations of basic and diluted net income (loss) per share are presented in the following table (in thousands, except per share amounts):
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Numerator: |
||||||||||||||||
Net income (loss) |
$ | (57,750 | ) | $ | 115,304 | $ | (815,600 | ) | $ | 353,653 | ||||||
|
|
|
|
|
|
|
|
|||||||||
Denominator: |
||||||||||||||||
Weighted average shares basic |
504,831 | 513,859 | 512,476 | 510,261 | ||||||||||||
Effect of dilutive securities: |
||||||||||||||||
Share-based awards |
| 6,048 | | 10,048 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Weighted average shares diluted |
504,831 | 519,907 | 512,476 | 520,309 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Net income (loss) per share: |
||||||||||||||||
Basic |
$ | (0.11 | ) | $ | 0.22 | $ | (1.59 | ) | $ | 0.69 | ||||||
Diluted |
$ | (0.11 | ) | $ | 0.22 | $ | (1.59 | ) | $ | 0.68 |
Potential dilutive securities include dilutive common shares from share-based awards attributable to the assumed exercise of stock options, restricted stock units and employee stock purchase plan shares using the treasury stock method. Under the treasury stock method, potential common shares outstanding are not included in the computation of diluted net income per share, if their effect is anti-dilutive.
Anti-dilutive potential shares are presented in the following table (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Weighted average shares outstanding: |
||||||||||||||||
Share-based awards |
68,613 | 29,237 | 62,825 | 26,070 | ||||||||||||
|
|
|
|
|
|
|
|
Anti-dilutive potential shares from share-based awards are excluded from the calculation of diluted earnings per share for the three and nine months ended October 31, 2015 due to the net loss reported in those periods. Anti-dilutive potential shares from share-based awards are excluded from the calculation of diluted earnings per share for all other periods reported above because either their exercise price exceeded the average market price during the period or the share-based awards were determined to be anti-dilutive based on applying the treasury stock method.
Note 5. Derivative Financial Instruments
The Company manages some of its foreign currency exchange rate risk through the purchase of foreign currency exchange contracts that hedge against the short-term effect of currency fluctuations. The Companys policy is to enter into foreign currency forward contracts with maturities less than 12 months that mitigate the effect of rate fluctuations on certain local currency denominated operating expenses. All derivative instruments are recorded at fair value in either prepaid expenses and other current assets or accrued liabilities. The Company reports cash flows from derivative instruments in cash flows from operating activities. The Company uses quoted prices to value its derivative instruments.
The notional amounts of outstanding forward contracts were as follows (in thousands):
Buy Contracts | ||||||||
October 31, 2015 |
January 31, 2015 |
|||||||
Israeli shekel |
$ | 22,027 | $ | 51,326 | ||||
|
|
|
|
Cash Flow Hedges. The Company designates and documents its foreign currency forward exchange contracts as cash flow hedges for certain operating expenses. The Company evaluates and calculates the effectiveness of each hedge at least quarterly. The effective change is recorded in accumulated other comprehensive income and is subsequently reclassified to operating expense when the hedged expense is recognized. Ineffectiveness is recorded in interest and other income, net.
13
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Other Foreign Currency Forward Contracts. The Company enters into foreign currency forward exchange contracts to hedge certain assets and liabilities denominated in various foreign currencies that it does not designate as hedges for accounting purposes. The maturities of these contracts are generally less than 12 months. Gains or losses arising from the remeasurement of these contracts to fair value each period are recorded in interest and other income, net.
The fair value of foreign currency exchange contracts was not significant as of any period presented.
The following table provides information about gains (losses) associated with the Companys derivative financial instruments (in thousands):
Amount of Gains (Losses) in Statement of Operations | ||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||
Location of Gains (Losses) in Statement of Operations |
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
||||||||||||||
Derivatives designated as cash flow hedges: |
||||||||||||||||||
Forward contracts: |
Research and development |
$ | 116 | $ | (625 | ) | $ | (460 | ) | $ | 284 | |||||||
Selling and marketing |
2 | (57 | ) | (6 | ) | 25 | ||||||||||||
General and administrative |
11 | (1 | ) | (34 | ) | (2 | ) | |||||||||||
|
|
|
|
|
|
|
|
|||||||||||
$ | 129 | $ | (683 | ) | $ | (500 | ) | $ | 307 | |||||||||
|
|
|
|
|
|
|
|
The portion of gains (losses) excluded from the assessment of hedge effectiveness are included in interest and other income, net, and these amounts were not material in the three and nine months ended October 31, 2015 and November 1, 2014. In addition, realized losses from forward contracts that are not designated as hedging instruments that are included in interest and other income, net, were not material in the three and nine months ended October 31, 2015 and November 1, 2014. The Company also reports hedge ineffectiveness from derivative financial instruments in current earnings, which was not material in the three and nine months ended October 31, 2015 and November 1, 2014. No cash flow hedges were terminated as a result of forecasted transactions that did not occur.
Note 6. Fair Value Measurements
Fair value is an exit price representing the amount that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, the accounting guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.
Level 2Other inputs that are directly or indirectly observable in the marketplace.
Level 3Unobservable inputs that are supported by little or no market activity.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The Companys Level 1 assets include institutional money-market funds that are classified as cash equivalents and marketable investments in U.S. government and agency debt, which are valued primarily using quoted market prices. The Companys Level 2 assets include its marketable investments in time deposits, corporate debt securities, foreign government and agency debt, municipal debt securities and asset backed securities as the market inputs used to value these instruments consist of market yields, reported trades and broker/dealer quotes, which are corroborated with observable market data. In addition, forward contracts, and the severance pay fund are classified as Level 2 assets as the valuation inputs are based on quoted prices and market observable data of similar instruments. The Companys investments in auction rate securities are classified as Level 3 assets because there are currently no active markets for the auction rate securities and consequently the Company is unable to obtain independent valuations from market sources. Therefore, the auction rate securities are valued using a discounted cash flow model. Some of the inputs to the discounted cash flow model are unobservable in the market. The total amount of assets measured using Level 3 valuation methodologies represented 0.2% of total assets as of October 31, 2015.
14
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The tables below set forth, by level, the Companys assets and liabilities that are measured at fair value on a recurring basis. The tables do not include assets and liabilities that are measured at historical cost or any basis other than fair value (in thousands):
October 31, 2015 | ||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets |
||||||||||||||||
Cash equivalents: |
||||||||||||||||
U.S. government and agency debt |
$ | 4,998 | $ | | $ | | $ | 4,998 | ||||||||
Money market funds |
33,263 | | | 33,263 | ||||||||||||
Time deposits |
| 207,219 | | 207,219 | ||||||||||||
Corporate debt securities |
| 49,245 | | 49,245 | ||||||||||||
Short-term investments: |
||||||||||||||||
U.S. government and agency debt |
378,696 | | | 378,696 | ||||||||||||
Corporate debt securities |
| 880,073 | | 880,073 | ||||||||||||
Asset backed securities |
| 89,672 | | 89,672 | ||||||||||||
Foreign government and agency debt |
| 21,902 | | 21,902 | ||||||||||||
Municipal debt securities |
| 36,356 | | 36,356 | ||||||||||||
Prepaid expenses and other current assets: |
||||||||||||||||
Foreign currency forward contracts |
| 173 | | 173 | ||||||||||||
Long-term investments: |
||||||||||||||||
Auction rate securities |
| | 10,182 | 10,182 | ||||||||||||
Other non-current assets: |
||||||||||||||||
Severance pay fund |
| 1,081 | | 1,081 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total assets |
$ | 416,957 | $ | 1,285,721 | $ | 10,182 | $ | 1,712,860 | ||||||||
|
|
|
|
|
|
|
|
|||||||||
Liabilities |
||||||||||||||||
Accrued liabilities: |
||||||||||||||||
Foreign currency forward contracts |
$ | | $ | 37 | $ | | $ | 37 | ||||||||
|
|
|
|
|
|
|
|
15
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
January 31, 2015 | ||||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Assets |
||||||||||||||||
Cash equivalents: |
||||||||||||||||
Money market funds |
$ | 111,286 | $ | | $ | | $ | 111,286 | ||||||||
Time deposits |
| 213,012 | | 213,012 | ||||||||||||
Corporate debt securities |
| 21,999 | | 21,999 | ||||||||||||
Short-term investments: |
||||||||||||||||
U.S. government and agency debt |
179,156 | | | 179,156 | ||||||||||||
Corporate debt securities |
| 986,317 | | 986,317 | ||||||||||||
Asset backed securities |
| 91,531 | | 91,531 | ||||||||||||
Foreign government and agency debt |
| 28,110 | | 28,110 | ||||||||||||
Municipal debt securities |
| 33,464 | | 33,464 | ||||||||||||
Prepaid expenses and other current assets: |
||||||||||||||||
Foreign currency forward contracts |
| 124 | | 124 | ||||||||||||
Long-term investments: |
||||||||||||||||
Auction rate securities |
| | 10,226 | 10,226 | ||||||||||||
Other non-current assets: |
||||||||||||||||
Severance pay fund |
| 1,758 | | 1,758 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Total assets |
$ | 290,442 | $ | 1,376,315 | $ | 10,226 | $ | 1,676,983 | ||||||||
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|
|
|
|
|
|
|
|||||||||
Liabilities |
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Accrued liabilities: |
||||||||||||||||
Foreign currency forward contracts |
$ | | $ | 1,379 | $ | | $ | 1,379 | ||||||||
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|
|
The following table summarizes the change in fair value for Level 3 assets (in thousands):
Nine Months Ended | ||||||||
October 31, | November 1, | |||||||
2015 | 2014 | |||||||
Beginning balance |
$ | 10,226 | $ | 16,279 | ||||
Sales and redemptions |
| (3,650 | ) | |||||
Transfer Out |
| (3,000 | ) | |||||
Unrealized losses included in accumulated other comprehensive income |
(44 | ) | 448 | |||||
|
|
|
|
|||||
Ending balance |
$ | 10,182 | $ | 10,077 | ||||
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|
|
|
In November 2014, the Company received notification by the issuer of a mandatory full call of an auction rate security to be redeemed at par value and as a result, the security was classified within Level 2 based on the issuers quoted price. Subsequently, the auction rate security was fully redeemed before the end of fiscal 2015.
Note 7. Goodwill and Acquired Intangible Assets, Net
Goodwill
The Company has identified that its business operates as a single operating segment with two components (Storage, and Smart Networked Devices and Solutions) that it has concluded can be aggregated into a single reporting unit for which it obtained an independent valuation to complete a step one assessment for goodwill impairment. In October 2015, the Company performed an impairment assessment for testing goodwill due to certain events and circumstances management considered could be indicators of potential impairment, which included the U.S. Court of Appeals for the Federal Circuit (Federal Circuit) panels decision in August 2015 related to the CMU litigation (see Note 10 Commitments and Contingencies), the Companys decision to significantly restructure its mobile platform business announced in September 2015 (see Note 8 Restructuring and Other Related Charges) and a significant decline in the Companys stock price during fiscal 2016. Based on the assessment, the Company concluded there was no impairment of its goodwill as of October 31, 2015.
16
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Acquired Intangible Assets, Net
The carrying amounts of acquired intangible assets, net, are as follows (in thousands):
October 31, 2015 | January 31, 2015 | |||||||||||||||||||||||||
Range of Useful Lives |
Gross Carrying Amounts |
Accumulated Amortization and Write-Offs |
Net Carrying Amounts |
Gross Carrying Amounts |
Accumulated Amortization and Write-Offs |
Net Carrying Amounts |
||||||||||||||||||||
Purchased and core technology |
4 - 8 years | $ | 36,348 | $ | (21,203 | ) | $ | 15,145 | $ | 36,348 | $ | (16,107 | ) | $ | 20,241 | |||||||||||
Trade names |
5 years | 1,300 | (1,300 | ) | | 1,300 | (828 | ) | 472 | |||||||||||||||||
Customer intangibles |
5 - 7 years | 28,600 | (22,788 | ) | 5,812 | 28,600 | (18,615 | ) | 9,985 | |||||||||||||||||
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|
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|
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Total intangible assets, net |
$ | 66,248 | $ | (45,291 | ) | $ | 20,957 | $ | 66,248 | $ | (35,550 | ) | $ | 30,698 | ||||||||||||
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|
In the three months ended October 31, 2015, the Company recorded charges of $0.3 million to write-off core technology due to its decision to discontinue the related development project and $0.3 million to write-off a trade name it no longer intends to market.
Based on the identified intangible assets recorded at October 31, 2015, the future amortization expense for the next five fiscal years is as follows (in thousands):
Fiscal Year |
||||
Remainder of fiscal 2016 |
$ | 2,947 | ||
2017 |
10,642 | |||
2018 |
5,508 | |||
2019 |
1,860 | |||
2020 and thereafter |
| |||
|
|
|||
$ | 20,957 | |||
|
|
Note 8. Restructuring and Other Related Charges
The following table provides a summary of restructuring and other related charges as presented in the unaudited condensed consolidated statements of operations (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Cost of goods sold |
$ | 10,285 | $ | | $ | 10,285 | $ | | ||||||||
Restructuring and other related charges |
35,270 | 1,202 | 48,862 | 7,025 | ||||||||||||
Write-off of acquired intangible assets |
| | | 3,386 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 45,555 | $ | 1,202 | $ | 59,147 | $ | 10,411 | |||||||||
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|
|
|
|
|
|
|
17
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents details of charges recorded by the Company related to the restructuring actions described below (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Severance and related costs |
$ | 28,773 | $ | 72 | $ | 40,478 | $ | 5,107 | ||||||||
Facilities and related costs |
657 | 1,117 | 882 | 1,815 | ||||||||||||
Other exit-related costs |
1,855 | 13 | 2,044 | 86 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
31,285 | 1,202 | 43,404 | 7,008 | |||||||||||||
Impairment and write-off of assets: |
||||||||||||||||
Inventory |
8,046 | | 8,046 | | ||||||||||||
Technology license |
1,250 | | 1,250 | | ||||||||||||
Equipment and other |
4,974 | | 6,447 | 17 | ||||||||||||
Acquired intangible asset |
| | | 3,386 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
$ | 45,555 | $ | 1,202 | $ | 59,147 | $ | 10,411 | |||||||||
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|
|
The Company recorded $45.6 million and $59.1 million in the three and nine months ended October 31, 2015, respectively, in connection with restructuring and other related charges as described in the following paragraphs:
In September 2015, the Company announced a significant restructuring of its mobile platform business in order to focus the mobile product line on more profitable opportunities and align its expenses with corporate targets. The Company began implementing actions to significantly downsize the mobile platform organization to refocus its technology to other emerging opportunities, but it will continue its commitment to wireless connectivity such as WiFi and other wireless standards. As a result of these actions, the Company recorded a $41.5 million charge in the three months ended October 31, 2015, that included severance benefits for 778 employees who were notified of their termination, a loss on early contract termination, the impairment of technology licenses and certain equipment, and the write down of inventory. The majority of the affected employees departed by October 31, 2015 and the remaining departed before the end of fiscal 2016. Total charges for the nine months ended October 31, 2015 related to this restructuring were $55.4 million.
The Company expects to complete remaining actions, including the finalization of certain additional related activities, within the first half of fiscal 2017 and will incur additional charges of approximately $5 million. As a result, total restructuring and other related charges will be lower than the original estimate of $100 million to $130 million primarily due to the Companys decision to retain approximately 140 more mobile employees to support the remaining mobile business than it originally anticipated and certain equipment planned for disposal was subsequently determined to have alternative use. The Company also decided to offer retention bonuses to another 128 mobile employees to remain through the ramp down of certain operations. Their benefit packages will be recognized ratably over the employees remaining service periods through the first half of fiscal 2017.
In May 2015, the Company decided to further reduce its research and development operations in Israel and close certain other design centers, primarily located in Europe and the U.S. in connection with its ongoing effort to streamline its business. As a result, the Company recorded a $3.8 million charge primarily for severance related to the termination of an additional 44 employees who were notified of their termination in the three months ended October 31, 2015. Cumulative charges for the nine months ended October 31, 2015 were $15.7 million for severance and a lease obligation related to a facility that was vacated in July 2015. Although the majority of the affected employees departed immediately, certain employees remained through the end of calendar 2015 to facilitate the transfer of ongoing operations to other major sites and remaining charges were not material. Before the end of fiscal 2016, substantially all of the activities associated with these actions were completed and all affected employees had departed.
In March 2015, the Company exercised the early buyout option under an operating lease for corporate equipment that it had planned to sell as part of a cost reduction action. The Company actively sought a buyer and classified the equipment as held for sale included in prepaid and current assets on the unaudited condensed consolidated balance sheet. It also ceased depreciation on the asset and measured its carrying value at the lower of net book value or fair value (less cost to sell). In October 2015, the Company sold the corporate equipment for net proceeds of $9.3 million, which approximated the carrying value and resulted in no gain or loss recognized in the three months ended October 31, 2015 upon the sale of the asset.
During the three and nine months ended October 31, 2015, the Company also continued to make payments and incur ongoing operating expenses related to vacated facilities under previous restructure actions.
18
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table sets forth a reconciliation of the beginning and ending restructuring liability balances by each major type of costs associated with the restructuring charges (in thousands):
Severance and Related Costs |
Facilities and Related Costs |
Other Exit-Related Costs |
Total | |||||||||||||
Balance at January 31, 2015 |
$ | | $ | 1,339 | $ | 3,230 | $ | 4,569 | ||||||||
Restructuring charges |
40,478 | 882 | 2,140 | 43,500 | ||||||||||||
Net cash payments |
(15,558 | ) | (902 | ) | (3,726 | ) | (20,186 | ) | ||||||||
Exchange rate adjustment |
(16 | ) | (80 | ) | | (96 | ) | |||||||||
|
|
|
|
|
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|
|
|||||||||
Balance at October 31, 2015 |
$ | 24,904 | $ | 1,239 | $ | 1,644 | $ | 27,787 | ||||||||
|
|
|
|
|
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|
|
During the nine months ended October 31, 2015, the Company paid severance and related costs to a total 1088 employees who departed in the third quarter of fiscal 2016 as part of the restructuring actions described above. The remaining severance balance at October 31, 2015 is expected to be paid within the first half of fiscal 2017. The balance at October 31, 2015 for facility and related costs includes remaining payments under lease obligations related to vacated space that are expected to be paid through fiscal 2018.
Note 9. Income Tax
The income tax expense for the three months ended October 31, 2015 was primarily due to current income tax liability of $1.5 million, a $1.1 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and $0.7 million of interest on unrecognized tax benefits. The income tax expense for the nine months ended October 31, 2015 was primarily due to current income tax liability of $21.0 million, $7.8 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and an additional tax provision of $3.1 million related to a $15.4 million payment to the Companys former Chief Executive Officer (see Note 13 Related Party Transaction). These tax expenses for the nine months ended October 31, 2015 were partially offset by tax benefits of $14.0 million from a net reduction in unrecognized tax benefits, which primarily arose from the expiration of statutes of limitation and the settlement of tax audits in non-U.S. jurisdictions, and true-up adjustments of $4.8 million, primarily related to the filing of tax returns.
The income tax provision for the three months ended November 1, 2014 included the current income tax liability of $4.5 million and a $0.9 million increase in unrecognized tax benefits from interest on non-U.S. jurisdictions, which was partially offset by a $0.4 million tax benefit due to a return-to-provision adjustment upon the filing of a tax return in a non-U.S. jurisdiction. The income tax benefit for the nine months ended November 1, 2014 included the current income tax liability of $15.1 million, which was offset by tax benefits of $8.9 million from a net reduction in unrecognized tax benefits, $11.5 million from an increase in the net deferred tax assets because of the tax rate change in Singapore and $0.4 million from a return-to-provision adjustment upon the filing of a tax return in a non-U.S. jurisdiction. The net reduction in unrecognized tax benefits arose from the release of $13.2 million due to the expiration of statutes of limitation, which was reduced by a $4.3 million increase in current unrecognized tax benefit estimates in various non-U.S. jurisdictions.
It is reasonably possible that the amount of unrecognized tax benefits could increase or decrease significantly due to changes in tax law in various jurisdictions, new tax audits and changes in the U.S. dollar as compared to foreign currencies within the next 12 months. Excluding these factors, uncertain tax positions may decrease by as much as $18.5 million from the lapse of statutes of limitation in various jurisdictions during the next 12 months. Government tax authorities from several non-U.S. jurisdictions are also examining returns. The Company believes that it has adequately provided for any reasonably foreseeable outcomes related to its tax audits and that any settlement will not have a material effect on its results at this time.
The Company operates under tax incentives in certain countries, which may be extended if certain additional requirements are satisfied. The tax incentives are conditional upon meeting certain employment and investment thresholds. The impact of these tax incentives decreased foreign taxes by $1.8 million and $6.7 million for the three and nine months ended October 31, 2015, respectively, and $1.8 million and $12.3 million for the three and nine months ended November 1, 2014, respectively. The benefit of the tax incentives on net loss per share was less than $0.01 per share for the three months ended October 31, 2015 and $0.01 per share for the nine months ended October 31, 2015, compared to a benefit on net income of less than $0.01 per share for the three months ended November 1, 2014 and $0.02 per share for the nine months ended November 1, 2014.
The Companys principal source of liquidity as of October 31, 2015 consisted of approximately $2.3 billion of cash, cash equivalents and short-term investments, of which approximately $750 million was held by foreign subsidiaries (outside Bermuda). Approximately $650 million of this amount held by foreign subsidiaries is related to undistributed earnings, most of which have been indefinitely reinvested outside of Bermuda. These funds are primarily held in China, Israel, the United States and Switzerland. The Company plans to use such amounts to fund various activities outside of Bermuda including working capital requirements, capital
19
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
expenditures for expansion, funding of future acquisitions or other financing activities. If such funds were needed by the parent company in Bermuda or if the amounts were otherwise no longer considered indefinitely reinvested, the Company would incur a tax expense of approximately $190 million.
Note 10. Commitments and Contingencies
Purchase Commitments
Under the Companys manufacturing relationships with its foundry partners, cancellation of all outstanding purchase orders are allowed, but requires payment of all costs and expenses incurred through the date of cancellation. As of October 31, 2015, these foundries had incurred approximately $125.8 million of manufacturing costs and expenses relating to the Companys outstanding purchase orders.
Intellectual Property Indemnification
The Company has agreed to indemnify certain customers for claims made against the Companys products, where such claims allege infringement of third party intellectual property rights, including, but not limited to, patents, registered trademarks, and/or copyrights. Under the aforementioned indemnification clauses, the Company may be obligated to defend the customer and pay for the damages awarded against the customer under an infringement claim as well as the attorneys fees and costs. The Companys indemnification obligations generally do not expire after termination or expiration of the agreement containing the indemnification obligation. Generally, there are limits on and exceptions to the Companys potential liability for indemnification. Although historically the Company has not made significant payments under these indemnification obligations, the Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. The maximum potential amount of any future payments that the Company could be required to make under these indemnification obligations could be significant.
Contingencies
The Company and certain of its subsidiaries are currently parties to various legal proceedings, including those noted in this section. The legal proceedings and claims described below could result in substantial costs and could divert the attention and resources of the Companys management. The Company is also engaged in other legal proceedings and claims not described below, which arise in the ordinary course of its business. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling in litigation could require the Company to pay damages, one-time license fees or ongoing royalty payments, and could prevent the Company from manufacturing or selling some of its products or limit or restrict the type of work that employees involved in such litigation may perform for the Company, any of which could adversely affect financial results in future periods. The Company believes that its products do not infringe valid and enforceable claims and it will continue to vigorously defend against the allegations in these matters. However, there can be no assurance that these matters will be resolved in a manner that is not adverse to the Companys business, financial condition, results of operations or cash flows.
As of October 31, 2015, the Company has an accrued litigation balance of $738.7 million related to certain legal proceedings described below. Unless otherwise stated, the Company is currently unable to predict the final outcome of these lawsuits and therefore cannot determine the likelihood of loss or estimate a range of possible loss.
Carnegie Mellon University Litigation. On March 6, 2009, CMU filed a complaint in the U.S. District Court for the Western District of Pennsylvania (W.D. of Pennsylvania). CMU has asserted U.S. Patent Nos. 6,201,839 and 6,438,180 (collectively, the CMU patents in suit), which relate to read-channel integrated circuit devices and the hard disk drive (HDD) incorporating such devices. A jury trial began on November 26, 2012. On December 26, 2012, a jury delivered a verdict that found the CMU patents in suit were literally and willfully infringed and valid, and awarded past damages in the amount of $1.17 billion. Based on post-trial motions and decisions, the W.D. of Pennsylvania calculated the damages including enhancement to total approximately $1.54 billion, and held that, under its decision, CMU is entitled to post judgment interest and an ongoing royalty. On May 7, 2014, the W.D. of Pennsylvania entered final judgment, from which the Company filed a notice of appeal on May 14, 2014. On August 4, 2015, the W.D. of Pennsylvania in a three-judge panel issued an opinion affirming in part, reversing in part, and vacating and remanding in part. On February 16, 2016, the Company and CMU entered into a Settlement Agreement and Patent License pursuant to which the Company has agreed to pay an aggregate of $750 million, without any ongoing royalty payments, to CMU and the parties have agreed to mutually acceptable release, license and covenant not to sue provisions. Please see Note 15 Subsequent Events for additional information on the effect of the settlement in the Companys unaudited condensed consolidated financial statements for fiscal 2016. The Company expects the action to be finally dismissed in the third quarter of fiscal 2017, approximately 6 months after payment of the full amount of the settlement payment. In connection with the settlement, the primary supersedeas bond that the Company entered into in connection with this litigation was reduced to $439 million and the secondary bond, which is secured, was adjusted to $311 million. All of the Companys obligations under both bonds were discharged pursuant to an order releasing supersedeas bonds on April 21, 2016. Any bond specific indemnity agreement will be terminated and released upon final dismissal of the action.
20
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
USEI Litigation. On October 9, 2009, U.S. Ethernet Innovations, LLC (USEI) filed a complaint in the U.S. District Court for the Eastern District of Texas (E.D. of Texas), in which USEI accused a number of system manufacturers, including the Companys customers, of patent infringement (the USEI litigation). Specifically, USEI asserted that these customers infringe U.S. Patent Nos. 5,307,459, 5,434,872, 5,732,094 and 5,299,313, which relate to Ethernet technologies. The complaint seeks unspecified damages and an injunction.
On May 4, 2010, MSI filed a motion to intervene in the USEI litigation, which was granted on May 19, 2010. On July 13, 2010, the E.D. of Texas issued an order granting the defendants motion to transfer the action to the U.S. District Court for the Northern District of California (N.D. of California); the case was formally transferred on August 23, 2010. On September 14, 2011, USEI withdrew its allegations against MSI for the 459 patent. The N.D. of California issued a first claim construction ruling on January 31, 2012 and a supplemental claim construction ruling on August 29, 2012. On August 16, 2013, the N.D. of California granted defendants summary judgment motion to preclude the plaintiff from recovering certain pre-suit damages. On November 7, 2014, on summary judgment, the N.D. of California found that all the patents-in-suit were either invalid or not infringed. On December 1, 2014, the N.D. of California entered a judgment in favor of defendants and awarded defendants costs. On December 29, 2014, USEI filed a motion to alter or amend the N.D. of Californias summary judgment order, which the N.D. of California denied on March 31, 2015. On April 24, 2015, USEI filed its notice of appeal. On April 25, 2016, the Federal Circuit affirmed the N.D. of Californias judgment in favor of MSI. On June 29, 2016, the Federal Circuit denied USEIs petition for rehearing.
Azure Networks Litigation. On March 22, 2011, Azure Networks, LLC (Azure) and Tri-County Excelsior Foundation filed suit in the E.D. of Texas against MSI and eight other companies. The Complaint asserts U.S. Patent No. 7,756,129 against MSIs Bluetooth products. MSI filed its answer and counterclaims on July 20, 2011. On November 2, 2012, MSI and the other defendants filed a motion for summary judgment of invalidity, which was denied. A claim construction hearing was held on December 20, 2012. On January 15, 2013, the magistrate judge issued a claim construction ruling. On May 20, 2013, the E.D. of Texas issued an order denying plaintiffs motion for reconsideration and adopted the magistrate judges claim construction ruling. On May 30, 2013, the E.D. of Texas entered a judgment of non-infringement. On June 24, 2013, Azure appealed. On November 6, 2014, the Federal Circuit issued an order vacating the judgment of non-infringement and remanding for further proceedings. MSI filed a petition for writ of certiorari to the United States Supreme Court on February 4, 2015. On February 10, 2015, the E.D. of Texas stayed all proceedings pending the Supreme Courts ruling on the Companys petition. On April 20, 2015, the United States Supreme Court granted MSIs petition, vacating the Federal Circuits judgment and remanding the case for further consideration. The case was dismissed with prejudice on October 14, 2015 with no significant impact on the Companys unaudited condensed consolidated financial statements.
On January 13, 2015, Azure filed a second suit against MSI in the E.D. of Texas, alleging infringement of U.S. Patent Nos. 8,582,570; 8,582,571; 8,588,196; 8,588,231; 8,589,599; 8,675,590; 8,683,092; 8,700,815; 8,732,347; and 8,732,361, purportedly related to certain Wi-Fi and near field communication (NFC) technologies. The complaint seeks unspecified damages. On April 6, 2015, MSI filed an amended answer and counterclaims. The case was dismissed with prejudice on January 4, 2016 with no significant impact on the Companys unaudited condensed consolidated financial statements.
France Telecom Litigation. On June 26, 2012, France Telecom S.A. filed a complaint against MSI in the U.S. District Court for the Southern District of New York. The complaint asserts U.S. Patent No. 5,446,747 against MSIs communications processors and thin modems. The complaint sought unspecified damages as well as injunctive relief. MSI answered the complaint on July 18, 2012 and August 1, 2012. On July 30, 2012, MSI filed a motion to transfer the lawsuit to the N.D. of California. On September 17, 2012, the Court granted MSIs motion and transferred the case to the N.D. of California. A claim construction hearing was held on December 13, 2013. On April 14, 2014, the Court denied MSIs motion for summary judgment of invalidity, and granted MSIs summary judgment motion concerning certain damages preclusion. A jury trial began on September 17, 2014. On September 30, 2014, a jury delivered a verdict that found the patent in suit was literally, but not willfully, infringed and valid, and awarded damages. The award did not have a significant impact on the Companys unaudited condensed consolidated financial statements. A hearing for post-trial motions and non-jury issues took place on January 14, 2015. On March 2, 2015, the N.D. of California issued an order on post-trial briefs finding no direct infringement by Marvell as a matter of law and entered judgment in favor of Marvell. On March 30, 2015, France Telecom filed a notice of appeal. On April 10, 2015, MSI filed a notice of cross appeal. On July 15, 2015, the Federal Circuit granted the parties joint stipulation to dismiss both parties appeals.
Vantage Point Technology Patent Litigation. On November 21, 2013, Vantage Point Technology, Inc. (VPT) filed suit against a third-party defendant in the E.D. of Texas for patent infringement relating to processor technology. On February 3, 2014, VPT filed an amended complaint against the third party and added MSI as an additional defendant. The complaint sought unspecified damages. On December 8, 2014, the case was transferred to the N.D. of California. The case was dismissed with prejudice in March, 2015 with no significant impact on the Companys unaudited condensed consolidated financial statements.
21
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Bandspeed Litigation. On May 9, 2014, Bandspeed, Inc. filed suit against MSI in the U.S. District Court for the Western District of Texas, alleging infringement of U.S. Patent Nos. 7,027,418; 7,570,614; 7,477,624; 7,903,608; and 8,542,643, purportedly related to certain Bluetooth technology. The complaint sought unspecified damages. On February 13, 2015, Bandspeed amended its complaint and added allegations of infringement of U.S. Patent No. 8,873,500. On April 29, 2015, the parties filed a joint motion to dismiss the case with prejudice. The case was dismissed with prejudice on May 7, 2015 with no significant impact on the Companys unaudited condensed consolidated financial statements.
NXP Litigation. On January 22, 2015, NXP Semiconductors N.V. filed suit against MSI in the N.D. of California, alleging infringement of U.S. Patent Nos. 5,939,791; 7,039,133; 8,185,050; and 8,203,432, purportedly related to certain NFC technology. The complaint sought unspecified damages. MSI filed its response and counterclaims on February 26, 2015. Marvell International Limited (MIL) also filed counterclaims against NXP Semiconductors U.S.A. (NXP USA), alleging infringement of U.S. Patent Nos. 7,047,393; 7,555,065; and 7,302,600. On February 2, 2015, MIL filed suit against NXP USA in the U.S. District Court for the Central District of California, alleging patent infringement of U.S. Patent Nos. 8,171,309; 7,957,777; 7,454,634; and 6,903,448, related to certain NFC and automotive technologies. On April 15, 2015, the parties filed stipulations to dismiss without prejudice their claims and counterclaims in both cases.
Paone Litigation. On February 6, 2015, Luciano F. Paone filed suit against MSI in the U.S. District Court for the Eastern District of New York, alleging infringement of U.S. Patent No. 6,259,789, purportedly related to certain encryption technology. The complaint seeks unspecified damages. MSI filed its response on May 22, 2015. The case was dismissed with prejudice on December 31, 2015 with no significant impact on the Companys unaudited condensed consolidated financial statements.
Innovatio Litigation. On March 16, 2015, Innovatio IP Ventures, LLC filed suit against MSI in the U.S. District Court for the Northern District of Illinois, alleging infringement of U.S. Patent Nos. 6,697,415; 5,844,893; 5,740,366; 7,916,747; 6,665,536; 7,013,138; 7,107,052; 5,546,397; 7,710,907; 7,710,935; 6,714,559; 7,457,646; and 6,374,311, purportedly related to certain wireless technology. The complaint seeks unspecified damages.
Visual Memory Litigation. On May 8, 2015, Visual Memory LLC (Visual Memory) filed suit against MSI in the District of Delaware, alleging infringement of U.S. Patent Nos. 5,654,932 and 6,026,027, purportedly related to certain memory technology. The complaint seeks unspecified damages. The case was dismissed with prejudice on September 4, 2015 with no significant impact on the Companys unaudited condensed consolidated financial statements.
Luna Litigation and Consolidated Cases. On September 11, 2015, Daniel Luna filed an action asserting putative class action claims on behalf of the Companys shareholders in the United States District Court for the Southern District of New York (S.D. of New York). This action was consolidated with two additional, nearly identical complaints subsequently filed by Philip Limbacher and Jim Farno. The complaints asserted violations of federal securities laws based on allegations that the Company and certain of its officers and directors (Sehat Sutardja, Michael Rashkin, and Sukhi Nagesh) made, caused to be made, or failed to correct false and/or misleading statements in the Companys press releases and public filings. The complaints request damages in unspecified amounts, costs and fees of bringing the action, and other unspecified relief.
On November 18, 2015, the S.D. of New York granted the Companys motion to transfer the consolidated cases to the N.D. of California. On December 21, 2015, the N.D. of California granted the Companys motion to deem the consolidated cases related to the Saratoga litigation, discussed below. On February 8, 2016, the N.D. of California granted an unopposed motion to appoint Plumbers and Pipefitters National Pension Fund as Lead Plaintiff. On March 19, 2016, Lead Plaintiff filed a consolidated amended complaint. On April 29, 2016, Marvell and each of the individual defendants each filed motions to dismiss; Lead Plaintiffs oppositions were filed on June 10, 2016; and defendants replies are due by July 15, 2016. The hearing on the motions to dismiss is set for July 29, 2016.
22
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Saratoga Litigation. On October 16, 2015, Saratoga Advantage Trust Technology & Communications Portfolio (Saratoga) filed an action asserting shareholder derivative claims ostensibly on behalf of the Company in the Superior Court of the State of California, County of Santa Clara. The complaint names eight current or former officers and/or directors (Sehat Sutardja, Weili Dai, Juergen Gromer, Arturo Krueger, John Kassakian, Randhir Thakur, Michael Rashkin, and Sukhi Nagesh) as defendants and asserts various California state law causes of action based on allegations that the Company and the named officers and directors made, caused to be made, or failed to correct false and/or misleading statements in the Companys press releases and public filings, leading to the filing of securities class actions that allegedly damaged the Company. The Company was named as a nominal defendant. The complaint requests damages and restitution in unspecified amounts, equitable and/or injunctive relief, costs and fees of bringing the action, and other unspecified relief.
On October 23, 2015, the Company removed the action to the N.D. of California. On December 21, 2015, the N.D. of California denied Saratogas motion to remand. On December 21, 2015, the N.D. of California granted the Companys motion to deem the action related to the consolidated Luna actions, discussed above. On January 22, 2016, the Company filed a motion to dismiss the complaint; on February 19, 2016, Saratoga filed an opposition; and on March 4, 2016, the Company filed a reply. On March 25, 2016, the N.D. of California held a hearing on the motion and took the matter under submission. To the Companys knowledge, none of the individual defendants has yet been served.
Surety Bonds
On May 14, 2014, the Company filed a Notice of Appeal to appeal the final judgment issued by the W.D. of Pennsylvania in the CMU litigation. In order to stay the execution of the final judgment pending its appeal, the Company filed a supersedeas bond for $1.54 billion with the W.D. of Pennsylvania in the event the Company did not fully satisfy a final judgment as affirmed after the completion of all appellate proceedings. The bond was issued by a consortium of sureties authorized by the U.S. Treasury. In support of the bond, the Company entered into separate indemnity agreements with each of the sureties to indemnify the sureties from all costs and payments made under the bond. The indemnity agreements did not require collateral to be posted at the time of the issuance of the bond. Therefore no cash is considered restricted as of the date of this filing. However, the indemnity agreements provide that each of the sureties have the right to demand to be placed in funds or call for collateral under pre-defined events.
On November 14, 2014, the Company filed a second surety bond for $216 million and filed a commitment letter from the sureties to issue up to an additional $95 million in bonding under certain conditions. The second bond and commitment are secured by the Companys campus located in Santa Clara, California, which has a carrying value of $134.6 million at October 31, 2015.
In connection with the settlement that was reached with CMU for a total $750 million in February 2016, the primary supersedeas bond that the Company entered into was reduced to $439 million and the secondary bond was adjusted to $311 million and both were discharged pursuant to an order releasing supersedeas bonds on April 21, 2016. The underlying indemnity agreements will terminate upon the final dismissal of the case in the third quarter of fiscal 2017. For additional information, see CMU litigation under Contingencies above.
Indemnities, Commitments and Guarantees
During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities may include intellectual property indemnities to the Companys customers in connection with the sales of its products, indemnities for liabilities associated with the infringement of other parties technology based upon the Companys products, indemnities for general commercial obligations, indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease, and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of Bermuda. In addition, the Company has contractual commitments to various customers, which could require the Company to incur costs to repair an epidemic defect with respect to its products outside of the normal warranty period if such defect were to occur. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. Some of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that the Company could be obligated to make. In general, the Company does not record any liability for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets as the amounts cannot be reasonably estimated and are not considered probable. The Company does, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable.
23
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Note 11. Shareholders Equity
Stock Plans
Stock option activity under the Companys stock option and stock incentive plans is included in the following table (in thousands, except per share amounts):
Time-Based Options | Market-Based Options | Total | ||||||||||||||||||||||
Number of Shares |
Weighted Average Exercise Price |
Number of Shares |
Weighted Average Exercise Price |
Number of Shares |
Weighted Average Exercise Price |
|||||||||||||||||||
Balance at January 31, 2015 |
47,140 | $ | 13.79 | 2,232 | $ | 15.43 | 49,372 | $ | 13.88 | |||||||||||||||
Granted |
6,099 | $ | 14.20 | | $ | | 6,099 | $ | 14.20 | |||||||||||||||
Exercised |
(2,098 | ) | $ | 9.96 | | $ | | (2,098 | ) | $ | 9.96 | |||||||||||||
Canceled/Forfeited |
(7,301 | ) | $ | 15.98 | (39 | ) | $ | 15.43 | (7,340 | ) | $ | 15.98 | ||||||||||||
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|
|
|
|
|
|||||||||||||||||||
Balance at October 31, 2015 |
43,840 | $ | 13.67 | 2,193 | $ | 15.43 | 46,033 | $ | 13.75 | |||||||||||||||
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|
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Vested or expected to vest at October 31, 2015 |
41,230 | $ | 13.67 | |||||||||||||||||||||
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|
|||||||||||||||||||||||
Exercisable at October 31, 2015 |
22,814 | $ | 14.26 | |||||||||||||||||||||
|
|
For time-based stock options vested and expected to vest at October 31, 2015, the aggregate intrinsic value was $4.7 million and the weighted average remaining contractual term was 5.9 years. For time-based stock options exercisable at October 31, 2015, the aggregate intrinsic value was $4.7 million and the weighted average remaining contractual term was 4.0 years. The aggregate intrinsic value of stock options exercised during the three months ended October 31, 2015 and November 1, 2014 was $0.7 million and $1.5 million, respectively. The aggregate intrinsic value of stock options exercised during the nine months ended October 31, 2015 and November 1, 2014 was $9.5 million and $15.1 million, respectively. There was no aggregate intrinsic value for market-based stock options at October 31, 2015 and the weighted average remaining contractual term of market-based stock options expected to reach the end of the vesting period at October 31, 2015 was 5.5 years. The Companys closing stock price of $8.21 as reported on the NASDAQ Global Select Market for all in-the-money options as of October 30, 2015 was used to calculate the aggregate intrinsic value.
As of October 31, 2015, the unamortized compensation expense for time-based stock options was $47.0 million and market-based stock options were fully amortized in fiscal 2015. The unamortized compensation expense for time-based stock options will be amortized on a straight-line basis and is expected to be recognized over a weighted average period of 2.2 years.
Activity related to the non-vested portion of the restricted stock units is included in the following table (in thousands, except for share prices):
Time-Based | Performance-Based | Market-Based | Total | |||||||||||||||||||||||||||||
Number of Shares |
Weighted Average Grant Date Fair Value |
Number of Shares |
Weighted Average Grant Date Fair Value |
Number of Shares |
Weighted Average Grant Date Fair Value |
Number of Shares |
Weighted Average Grant Date Fair Value |
|||||||||||||||||||||||||
Balance at January 31, 2015 |
9,748 | $ | 14.84 | 1,254 | $ | 14.99 | 11,002 | $ | 14.85 | |||||||||||||||||||||||
Granted |
5,012 | $ | 13.56 | 669 | $ | 14.08 | 407 | $ | 12.24 | 6,088 | $ | 13.53 | ||||||||||||||||||||
Vested |
(4,910 | ) | $ | 15.13 | (659 | ) | $ | 15.15 | | $ | | (5,569 | ) | $ | 15.13 | |||||||||||||||||
Canceled/Forfeited |
(1,369 | ) | $ | 13.98 | (252 | ) | $ | 14.41 | (54 | ) | $ | 12.24 | (1,675 | ) | $ | 13.99 | ||||||||||||||||
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|
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Balance at October 31, 2015 |
8,481 | $ | 14.05 | 1,012 | $ | 14.43 | 353 | $ | 12.24 | 9,846 | $ | 14.02 | ||||||||||||||||||||
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In April 2015, the Company granted performance-based equity awards to each of its executive officers, which are based on their achievement of certain performance goals for a new performance period beginning in fiscal 2016. These equity awards include restricted stock units which vest based on the achievement of certain financial goals (each a Financial Performance RSU), and performance awards for which a portion shall vest based on the achievement of individual strategic objectives (each a Strategic Objective Award) and a portion shall vest based on total shareholder return (each a Total Shareholder Return Award). These awards are reported in the above table as Performance-Based, except for the Total Shareholder Return Award which is reported as Market-Based. The Financial Performance RSUs will be earned based on the achievement of revenue and modified non-GAAP operating income that have been established at threshold, target and maximum levels and will vest on the first anniversary of the commencement date. The Strategic Objective Awards will vest on the first anniversary of the vest commencement date at the target level based on the achievement of individual strategic goals and, with respect to a portion of each Strategic Objective Award, the further achievement of either the revenue or modified non-GAAP operating income objective established for the Financial Performance RSU. The Total Shareholder Return Awards will vest on the second anniversary of the commencement date based on the Companys stock price performance in comparison to the Philadelphia Semiconductor Sector Index. Share-based compensation for the Total Shareholder Return Award is measured using the Monte Carlo valuation method since the award is indexed to the price of the Companys common stock as set forth under the terms of the award.
24
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
In connection with the performance-based equity awards granted in fiscal 2016 to each of the Companys executive officers, a total of 33,616 shares vested on April 1, 2016 based on achieving certain individual strategic goals as evaluated by the Executive Compensation Committee of the Companys Board of Directors. No shares vested for the achievement of financial performance goals since the financial performance criteria were below the threshold level. The amount of canceled shares reported in the table above includes the unvested shares that were not earned.
In connection with the performance-based equity awards granted in fiscal 2015 to each of the Companys executive officers, a total of 478,001 shares vested on April 1, 2015 in connection with the first performance period completed at the end of fiscal 2015. Of this amount, an additional 107,954 shares are included as granted in the table above for the nine months ended October 31, 2015 since each executive officer achieved greater than their target shares for one of the financial performance goals. The amount of canceled shares reported in the table above includes the portion of unvested shares that were not earned since performance objectives for each executive officers other financial and strategic performance goals were not fully achieved. During the first quarter of fiscal 2016, the Company determined the performance goals established for the second performance period to be completed at the end of fiscal 2016 would not be achieved and adjusted the related share-based compensation expense accordingly. As of October 31, 2015, the Company determined it was still not probable these performance goals would be achieved.
In connection with the performance-based restricted stock units granted in fiscal 2015 to certain members of senior management, final evaluation for each individuals achievement of their performance was measured in the first quarter of fiscal 2016. As a result, a total of 360,723 shares vested on April 1, 2015 and are included in the above table. There was no material adjustment to share-based compensation expense related to these performance-based restricted stock units in fiscal 2016. The amount of canceled shares reported in the table above includes the portion of unvested shares that were not earned since certain performance achievements were not fully achieved.
The Company recognizes expense from performance-based equity awards when it becomes probable that the performance conditions will be met. Once it becomes probable that a performance-based award will vest, the Company recognizes share-based compensation expense equal to the number of shares expected to vest multiplied by the fair value of the award at the grant date, which is amortized using the accelerated method.
The aggregate intrinsic value of restricted stock units expected to vest as of October 31, 2015 was $75.8 million. The number of restricted stock units that are expected to vest is 9.2 million shares. As of October 31, 2015, unamortized compensation expense related to restricted stock units was $74.4 million. The unamortized compensation expense for restricted stock units will be amortized on a straight-line basis and is expected to be recognized over a weighted average period of 1.2 years.
Employee Stock Purchase Plan
During the three months ended October 31, 2015 and November 1, 2014, the Company issued no shares under the 2000 Employee Stock Purchase Plan, as amended and restated (the ESPP). A total of 3.2 million shares were issued at a weighted average price of $11.88 per share in the nine months ended October 31, 2015 and a total of 5.2 million shares were issued at a weighted average price of $7.58 per share in the nine months ended November 1, 2014 under the ESPP. As of October 31, 2015, there was $33.4 million of unrecognized compensation expense related to the ESPP.
Share Repurchase Program
The Company repurchased 3.7 million of its common shares for $45.6 million in cash during the three months ended October 31, 2015 and 19.7 million of its common shares for $260.9 million during the nine months ended October 31, 2015. During the three and nine months ended November 1, 2014, the Company repurchased 3.7 million of its common shares for $45.0 million. The repurchased shares are retired immediately after the repurchases are completed. The Company records all repurchases, as well as investment purchases and sales, based on their trade date. As of October 31, 2015, a total of 241.6 million cumulative shares have been repurchased under the Companys share repurchase program for a total $3.1 billion in cash and there was $182.6 million remaining available for future share repurchases. The Company has made no subsequent share repurchases since August 24, 2015.
25
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Dividends
The Company paid the following cash dividends (in thousands, except per share amounts):
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Cash dividend per share |
$ | 0.06 | $ | 0.06 | $ | 0.18 | $ | 0.18 | ||||||||
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Total payment to shareholders |
$ | 30,270 | $ | 30,867 | $ | 92,374 | $ | 91,859 | ||||||||
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On December 7, 2015, the Company announced that its board of directors declared a cash dividend of $0.06 per share that was paid on December 29, 2015 to shareholders of record as of December 16, 2015. The Company subsequently announced that its board of directors declared a quarterly cash dividend of $0.06 per share that was paid in April 2016 and on May 18, 2016, it announced that its board of directors declared a cash dividend of $0.06 per share to be paid on July 12, 2016 to shareholders of record as of June 14, 2016.
Note 12. Share-Based Compensation
The following table presents details of share-based compensation expenses by functional line item (in thousands):
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, | November 1, | October 31, | November 1, | |||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Cost of goods sold |
$ | 2,495 | $ | 1,934 | $ | 6,054 | $ | 5,966 | ||||||||
Research and development |
22,573 | 24,198 | 75,162 | 68,842 | ||||||||||||
Selling and marketing |
2,608 | 2,855 | 7,892 | 8,400 | ||||||||||||
General and administrative |
3,789 | 5,307 | 12,252 | 16,075 | ||||||||||||
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$ | 31,465 | $ | 34,294 | $ | 101,360 | $ | 99,283 | |||||||||
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Share-based compensation capitalized in inventory was $1.3 million at October 31, 2015 and $1.5 million at January 31, 2015.
Upon the termination of certain members of our executive management in April 2016, it was determined that the vesting in certain of their unvested stock awards was not probable. As a result, the Company recorded a reversal of the previously recognized related share-based compensation expense in the first quarter of fiscal 2017.
Valuation Assumptions
The following weighted average assumptions were used for each respective period to calculate the fair value of each time-based stock option award on the date of grant using the Black-Scholes valuation model and of each market-based equity award using a Monte Carlo simulation model:
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, | November 1, | October 31, | November 1, | |||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Time-based Stock Options: |
||||||||||||||||
Weighted average fair value |
$ | 2.82 | $ | 3.43 | $ | 3.94 | $ | 4.35 | ||||||||
Expected volatility |
43 | % | 34 | % | 34 | % | 35 | % | ||||||||
Expected term (in years) |
5.4 | 5.0 | 5.4 | 5.0 | ||||||||||||
Risk-free interest rate |
1.5 | % | 1.7 | % | 1.6 | % | 1.6 | % | ||||||||
Expected dividend yield |
2.3 | % | 1.8 | % | 1.7 | % | 1.6 | % |
26
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Nine Months Ended | ||||||||
October 31, | November 1, | |||||||
2015 | 2014 | |||||||
Employee Stock Purchase Plan: |
||||||||
Estimated fair value |
$ | 3.78 | $ | 4.13 | ||||
Volatility |
31 | % | 32 | % | ||||
Expected term (in years) |
1.3 | 1.3 | ||||||
Risk-free interest rate |
0.4 | % | 0.2 | % | ||||
Dividend yield |
1.7 | % | 1.6 | % |
Nine Months Ended | ||||
October 31, | ||||
2015 | ||||
Total Shareholder Return Awards: |
||||
Expected term (in years) |
2.0 | |||
Expected volatility |
27 | % | ||
Average correlation coefficient of peer companies |
0.4 | % | ||
Risk-free interest rate |
0.5 | % | ||
Expected dividend yield |
1.7 | % |
The correlation coefficients are calculated based upon the price date used to calculate the historical volatilities and is used to model the way in which each entity tends to move in relation to its peers.
Note 13. Related Party Transaction
On February 25, 2015, the Executive Compensation Committee (Committee) of the Companys Board of Directors approved a cash payment of approximately $15.4 million to Dr. Sehat Sutardja, the Companys former Chief Executive Officer, which was recorded in the first quarter of fiscal 2016 and is included in general and administrative expense for the nine months ended October 31, 2015. The U.S. Court of Federal Claims ruled against Dr. Sutardja in his legal challenge with the Internal Revenue Service and the California Franchise Tax Board related to the tax treatment of several stock options granted in fiscal 2004. After discussing and evaluating the alternatives to a continuing legal challenge of the courts determination, the likelihood of success of further appeal by Dr. Sutardja and the potential negative impact on the Company of a continuation of the case regardless of the outcome, on February 25, 2015, the Committee determined to provide Dr. Sutardja with relief from the financial effects of the penalty taxes. Accordingly, the Committee approved the cash payment to Dr. Sutardja equal to the amount of his penalty taxes owed under the Tax Codes, plus accrued interest owed with respect to such liabilities, all grossed-up for income taxes that will be owed by Dr. Sutardja on receipt of such cash payment. The Company paid $8.4 million to Dr. Sutardja in the nine months ended October 31, 2015 representing reimbursement for the U.S. federal tax portion. As of October 31, 2015, the Company had a remaining $7.0 million liability to Dr. Sutardja.
Note 14. Subsequent Events
In April 2016, the employment of Dr. Sehat Sutardja as Chief Executive Officer and Weili Dai as President was terminated by the Companys Board of Directors. Dr. Sutardja and Ms. Dai remain on the Board of Directors at this time. The Board of Directors then formed an Interim Office of the Chief Executive and has appointed Maya Strelar-Migotti, Executive Vice President of the Smart Networked Devices and Solutions Business Group, and Dr. Pantelis Alexopoulos, Executive Vice President of the Storage Business Group, as Interim Co-Chief Executive Officers, each having the authority to exercise all powers of the Chief Executive Officer. In June 2016, the Board of Directors appointed Matthew J. Murphy to serve as the Companys President and Chief Executive Officer, effective July 11, 2016. Upon the commencement of Mr. Murphys employment, Ms. Strelar-Migotti and Dr. Alexopoulos returned to their roles as Executive Vice Presidents of the Company. The Board subsequently appointed Richard S. Hill, the Chairman of the Board, as the Companys Interim Principal Executive Officer, to serve in that capacity until the Company files its Quarterly Report on Form 10-Q for the second quarter of fiscal 2017 (Q217 Form 10-Q). Mr. Murphy will assume the role of the Companys principal executive officer immediately following the filing of the Q217 Form 10-Q. Mr. Murphy also joined the Board of Directors on July 11, 2016.
27
MARVELL TECHNOLOGY GROUP LTD.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Also in April 2016, the Company announced that it entered into an agreement with Starboard Value LP (Starboard), regarding the composition of its Board of Directors. Under the terms of the agreement, the Company elected Peter A. Feld, Richard S. Hill, Oleg Khaykin, Michael Strachan and Robert Switz to serve on its board. Mr. Hill replaced Dr. Sutardja as the Chairman of the Board in May 2016. The agreement specifies that the Board will recommend and the Company will support and solicit proxies only for the election at the 2016 annual general meeting of Messrs. Feld, Hill, Khaykin, Murphy, Strachan and Switz and the four independent directors serving on the Board immediately prior to the execution of the agreement, Dr. Gromer, Dr. Kassakian, Mr. Krueger and Dr. Thakur.
In February 2016, the Company and CMU settled their patent infringement lawsuit pursuant to a court-ordered mediation and entered into a Settlement Agreement and Patent License (the Agreement). The parties agreed to mutual release of claims, license and covenant not to sue provisions for which the Company will pay an aggregate of $750 million to CMU. See CMU litigation under Note 10 Commitments and Contingencies for further information about the lawsuit.
The Agreement was accounted for as a multiple-element arrangement and accordingly, a valuation was completed to determine the estimated fair value of each identifiable element. As a result, the Company allocated $654.7 million to the mutual release of claims and covenant not to sue provisions; $81.3 million to the licensing of intellectual property in fiscal 2016; and the remaining $14.0 million representing the future use of the license through April 2018.
The $654.7 million for the mutual release of claims and covenant not to sue provisions is included in the nine months ended October 31, 2015 as a settlement charge in operating expenses since there is no future benefit. Of the $81.3 million license fee, $1.1 million and $80.0 million was recorded in the three and nine months ended October 31, 2015, respectively, as a charge in cost of goods sold for past use of the license with the remaining $1.3 million to be charged to cost of goods sold the remainder of fiscal 2016. Due to the contingent status of the litigation at August 31, 2015 and October 31, 2015, these charges were recorded in the fiscal 2016 second and third quarters since those unaudited condensed consolidated financial statements had not been filed with the Securities and Exchange Commission at the time the settlement was reached.
The Company considers its existing cash, cash equivalents and short-term investments to be sufficient to cover payment of the $750 million settlement, and in April 2016, the Company completed full payment of the $750 million to CMU.
28
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act), which are subject to the safe harbor created by those sections. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements. Words such as anticipates, expects, intends, plans, believes, seeks, estimates, can, will and similar expressions identify such forward-looking statements.
Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements. Factors that could cause actual results to differ materially from those predicted, include, but are not limited to:
| our dependence upon the hard disk drive and wireless markets, which are highly cyclical and intensely competitive; |
| the outcome of pending or future litigation and legal proceedings; |
| our dependence on a small number of customers; |
| our ability and the ability of our customers to successfully compete in the markets in which we serve; |
| our reliance on independent foundries and subcontractors for the manufacture, assembly and testing of our products; |
| our ability and our customers ability to develop new and enhanced products and the adoption of those products in the market; |
| decreases in our gross margin and results of operations in the future due to a number of factors; |
| our ability to estimate customer demand and future sales accurately; |
| our ability to scale our operations in response to changes in demand for existing or new products and services; |
| the impact of international conflict and continued economic volatility in either domestic or foreign markets; |
| the effects of transitioning to smaller geometry process technologies; |
| the risks associated with manufacturing and selling a majority of our products and our customers products outside of the United States; |
| the impact of any change in our application of the United States federal income tax laws and the loss of any beneficial tax treatment that we currently enjoy; |
| the effects of any potential acquisitions or investments; |
| our ability to protect our intellectual property; |
| the impact and costs associated with changes in international financial and regulatory conditions; and |
| our maintenance of an effective system of internal controls. |
Additional factors which could cause actual results to differ materially include those set forth in the following discussion, as well as the risks discussed in Part II, Item 1A, Risk Factors, and other sections of this Quarterly Report on Form 10-Q. These forward-looking statements speak only as of the date hereof. Unless required by law, we undertake no obligation to update any forward-looking statements.
Overview
We are a fabless semiconductor provider of high-performance application-specific standard products. Our core strength of expertise is the development of complex System-on-a-Chip (SoC) and System-in-a-Package devices, leveraging our extensive technology portfolio of intellectual property in the areas of analog, mixed-signal, digital signal processing, and embedded and standalone integrated circuits. The majority of our product portfolio leverages embedded central processing unit technology. We also develop platforms that we define as integrated hardware along with software that incorporates digital computing technologies designed and configured to provide an optimized
29
computing solution. Our broad product portfolio includes devices for data storage, enterprise-class Ethernet data switching, Ethernet physical-layer transceivers, wireless connectivity, Internet-of-Things (IoT) devices and multimedia solutions. We were incorporated in Bermuda in January 1995.
We continued to experience declining revenues through the first nine months of fiscal 2016, as we saw weaker demand from our HDD customers in the storage end market who have faced continued challenges due to the declining growth in PC unit shipments. The storage market softness was compounded by an increasingly competitive environment in smartphones. As a result, net revenue in the nine months ended October 31, 2015 of $2.1 billion was down 26% compared to net revenue of $2.8 billion in the nine months ended November 1, 2014. Revenue from products for the storage end market declined 30% in the nine months ended October 31, 2015 compared to the nine months ended November 1, 2014. In addition, we saw lower revenue from products for the mobile and wireless end markets, which declined 27% in the nine months ended October 31, 2015 compared to the nine months ended November 1, 2014.
In the first nine months of fiscal 2016, we reported a net loss of $811.8 million, primarily due to a $734.7 million charge in connection with the settlement that was reached in the CMU patent litigation in February 2016 (see Note 10 Commitments and Contingencies and Note 14 Subsequent Events in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q). In connection with the settlement, we expect to incur additional charges in cost of goods sold over the remaining term of the license through April 2018 for the remaining portion of the settlement allocated to the licensing of intellectual property.
| In the storage market, we continued to see weak order trends from our HDD customers due to the decline in demand in the PC and notebook market. Our results for our previous fiscal second quarter were affected by pull-in activity as described below under the discussion of net revenue for the three and nine months ended October 31, 2015 and November 1, 2014, which had the effect of shifting orders and the associated revenue from our fiscal third quarter to our fiscal second quarter. In our solid state drive (SSD) business, we saw stronger-than-anticipated demand as one of our major SSD customers regained momentum, but we saw overall weakness due to slower demand for new products than we anticipated. |
| In the mobile market, we announced plans to significantly downsize the mobile platform organization. In the wireless connectivity market, revenue was in-line with expectations as increased demand in smartphones connectivity and video streaming were offset by lower notebook and gaming console sales. Our wireless microcontroller products continue to be designed into a wide variety of applications. |
| In the networking business, revenue came in weaker than expected and declined sequentially, mainly due to continued soft demand from enterprise customers. We continue to focus on our core networking technologies for switches, PHYs and embedded networking processors. We have secured multiple new design wins at tier 1 enterprise and cloud/datacenter customers. |
Our cost of goods sold was lower in the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015, due to overall lower revenues primarily for our storage, mobile and wireless, and networking products, partially offset by a charge related to the CMU litigation settlement and higher inventory write downs as described below.
Our cost of goods sold as a percentage of revenue was higher in the first nine months of fiscal 2016 compared to the first nine months of fiscal 2015, primarily due to a shift in the mix of our revenue toward products with higher average cost of goods sold, a $80.0 million charge related to the litigation settlement reached with CMU in February 2016 (see Note 14- Subsequent Events in the Notes to the Unaudited Condensed Consolidated Financial Statements) and higher inventory write downs related to the mobile platform business (see Note 8 Restructuring and Other Related Charges in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q).
As a result of our restructuring of the mobile platform business, we expect continued decline in revenues from our mobile and wireless products and a corresponding reduction in cost of goods sold as a percentage of revenue as the mobile and wireless end markets generally have lower average gross margins than the rest of our business. Changes in the revenue mix between end markets will affect cost of goods sold as a percentage of net revenue.
We believe our financial position is strong and we remain committed to deliver shareholder value through our share repurchase and dividend programs.
| Our cash, cash equivalents and short-term investments were $2.3 billion at October 31, 2015. |
| We generated cash flow from operations of $152.0 million through the third quarter of fiscal 2016. |
| We paid cash dividends of $0.06 per share for a total of $30.3 million during the third quarter of fiscal 2016. |
| We repurchased 3.7 million of our common shares for $45.6 million in the third quarter of fiscal 2016. |
30
A significant number of our products are being incorporated into consumer electronics products, including gaming devices and personal computers, which are subject to significant seasonality and fluctuations in demand. Holiday and back to school buying trends may at times negatively impact our results in the first and fourth quarter, and positively impact our results in the second and third quarter of our fiscal years. In addition, consumer electronics sales are heavily dependent on new product launch timelines and product refreshes. For example, our sales of wireless connectivity products may increase significantly during a period when one of our customers launches a new gaming console, and these sales may taper significantly after the initial launch period.
Historically, a relatively small number of customers have accounted for a significant portion of our net revenue. Net revenue from one customer was 14% and 18% for the three and nine months ended October 31, 2015, respectively, compared to 20% and 19% for the same customer in the three and nine months ended November 1, 2014. Net revenue from a second customer was 11% and 13% of total net revenue for the three and nine months ended October 31, 2105 compared to 14% and 12% for the same customer in the three and nine months ended November 1, 2014. In addition, a third customer accounted for 13% of net revenue in the three months ended October 31, 2015. Although no revenue from a single distributor represented 10% or more of total net revenue for the three and nine months ended October 31, 2015 or the three months ended November 1, 2014, we had revenue from one distributor representing 11% of total net revenue for the nine months ended November 1, 2014. We continuously monitor the creditworthiness of our distributors and believe these distributors sales to diverse end customers and geographies further serve to mitigate our exposure to credit risk.
Most of our sales are made to customers located outside of the United States, primarily in Asia. Sales to customers located in Asia represented 96% of our net revenue for both the three and nine months ended October 31, 2015, compared to 97% and 96% of our net revenue for the three and nine months ended November 1, 2014, respectively. Because many manufacturers and manufacturing subcontractors of our customers are located in Asia, we expect that most of our net revenue will continue to be represented by sales to our customers in that region.
A relatively large portion of our sales have historically been made on the basis of purchase orders rather than long-term agreements. In addition, the development process for our products is long, which may cause us to experience a delay between the time we incur expenses and the time revenue is generated from these expenditures. We anticipate that the rate of new orders may vary significantly from quarter to quarter. Consequently, if anticipated sales and shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter and future quarters may be adversely affected.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results could differ from these estimates, and such differences could affect the results of operations reported in future periods. For a description of our critical accounting policies and estimates, please see below and refer to the Critical Accounting Policies and Estimates section of our Managements Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended January 31, 2015.
Goodwill. We record goodwill when the consideration paid for a business acquisition exceeds the fair value of net tangible and intangible assets acquired. We review goodwill for impairment annually on the last business day of our fiscal fourth quarter and whenever events or changes in circumstances indicate the carrying amount of goodwill may not be recoverable. We have identified that our business operates as a single operating segment which can further be divided into two components; Storage, and Smart Networked Devices and Solutions. Management concluded that goodwill is recoverable from these two components working jointly due to a fact pattern demonstrating significant sharing of assets, corporate resources, and benefits from common research and development. The two components also exhibit similar economic characteristics. Accordingly, management concluded that these two components should be aggregated into a single reporting unit for purposes of testing goodwill impairment.
When testing goodwill for impairment, we first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. Factors we consider important which could trigger a goodwill impairment review include;
| significant underperformance relative to historical or projected future operating results; |
| significant changes in the manner of our use of the acquired assets or the strategy for our overall business; |
| significant negative industry or economic trends; |
31
| a significant decline in our stock price for a sustained period; and |
| a significant change in our market capitalization relative to our net book value. |
If we conclude that it is more likely than not that the fair value of a reporting unit is less than its carrying amount or if we note multiple qualitative factors indicating potential impairment, then a two-step quantitative impairment test is performed. The first step requires comparing the fair value of the reporting unit to its net book value, including goodwill. A potential impairment exists if the fair value of the reporting unit is lower than its net book value. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. Our goodwill impairment test uses a weighting of the income method and the market method to estimate a reporting units fair value. The income method is based on a discounted future cash flow approach that uses the following assumptions and inputs: revenue based on assumed market segment growth rates and our assumed market segment share, estimated costs, and appropriate discount rates based on our weighted average cost of capital as determined by considering the observable weighted average cost of capital of comparable companies. The market method is based on quoted prices of our shares as well as an implied control premium (the excess of the reporting units fair value over Marvells market capitalization). We evaluate the control premium by comparing it to observable control premiums from recent comparable market acquisition transactions.
The second step of the process is only performed if a potential impairment exists, and it involves determining the implied fair value of the reporting units goodwill and comparing it to the carrying value of goodwill. If the carrying value of goodwill were to exceed its implied fair value, then the Company will record a charge for the amount of impairment in the fiscal quarter in which the determination is made.
On the last day of the third quarter of fiscal 2016, the Company performed an impairment assessment for testing goodwill due to certain events and circumstances management considered could be factors that could trigger a goodwill impairment. These factors included the Federal Circuit panels decision in August 2015 related to the CMU litigation (see Note 10 Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q), the Companys decision to significantly restructure its mobile platform business announced in September 2015 (see Note 8 Restructuring and Other Related Charges) and a significant decline in the Companys stock price during fiscal 2016. Our goodwill impairment analysis did not result in any impairment charges. The excess of fair value over carrying amount for our reporting unit approximated 36% of its carrying amount. Our annual goodwill impairment analysis, which we performed as of the last day of the fourth quarter of fiscal 2016, also did not result in any impairment charges since the excess of fair value over carrying amount for our reporting unit approximated 41% of its carrying amount.
Results of Operations
The following table sets forth information derived from our unaudited condensed consolidated statements of operations expressed as a percentage of net revenue:
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
Net revenue |
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Operating costs and expenses: |
||||||||||||||||
Cost of goods sold |
56.2 | 48.9 | 56.5 | 50.1 | ||||||||||||
Research and development |
37.4 | 31.0 | 38.8 | 30.7 | ||||||||||||
Selling and marketing |
4.5 | 3.7 | 4.6 | 3.7 | ||||||||||||
General and administrative |
4.9 | 3.5 | 5.2 | 3.3 | ||||||||||||
Carnegie Mellon University litigation settlement |
| | 31.0 | | ||||||||||||
Restructuring and other related charges |
5.2 | 0.1 | 2.3 | 0.2 | ||||||||||||
Amortization and write-off of acquired intangible assets |
0.6 | 0.4 | 0.4 | 0.5 | ||||||||||||
|
|
|
|
|
|
|
|
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Total operating costs and expenses |
108.8 | 87.6 | 138.8 | 88.5 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Operating income (loss) |
(8.8 | ) | 12.4 | (38.8 | ) | 11.5 | ||||||||||
Interest and other income, net |
0.7 | 0.5 | 0.8 | 0.7 | ||||||||||||
|
|
|
|
|
|
|
|
|||||||||
Income (loss) before income taxes |
(8.1 | ) | 12.9 | (38.0 | ) | 12.2 | ||||||||||
Provision (benefit) for income taxes |
0.5 | 0.5 | 0.7 | (0.2 | ) | |||||||||||
|
|
|
|
|
|
|
|
|||||||||
Net income (loss) |
(8.6 | )% | 12.4 | % | (38.7 | )% | 12.4 | % | ||||||||
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|
|
|
|
|
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Three and nine months ended October 31, 2015 and November 1, 2014
Net Revenue
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, 2015 |
November 1, 2014 |
% Change |
October 31, 2015 |
November 1, 2014 |
% Change |
|||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
Net revenue |
$ | 674,890 | $ | 930,136 | (27.4 | )% | $ | 2,109,670 | $ | 2,849,511 | (26.0 | )% |
Net revenue for the three and nine months ended October 31, 2015 decreased by $255.2 million and $739.8 million, respectively, compared to the three and nine months ended November 1, 2014 due to overall lower sales primarily for our storage, mobile and wireless, and networking products. The decrease in net revenue was particularly affected by lower sales of products for the storage market due to lower demand for our HDD products as a result of the overall market decline in the PC and notebook markets, combined with slower than anticipated demand for sale of our SSD products. Our networking revenue also declined in the three and nine months ended October 31, 2015 compared to the three and nine months ended November 1, 2014 from lower demand for enterprise switches and routers.
From time to time during fiscal 2016, our customers agreed to take shipments in an earlier fiscal quarter than the fiscal quarter they originally requested delivery. When such agreement would not have occurred but for the request made by Marvell, we refer to such transactions internally as pull-ins. Pull-in sales increased compared to historical levels beginning in the fourth quarter of fiscal 2015 and returned to historical levels in the third quarter of fiscal 2016. Net revenue in fiscal 2016 related to pull-in sales for shipments taken early by our customers were approximately 9% and 11% of net revenue in the first and second quarters of fiscal 2016, respectively, and declined to less than 1% of net revenue in the third quarter of fiscal 2016. This compares to net revenue in fiscal 2015 related to pull-in sales for shipments taken early by our customers, which were less than 1% in each of the first and second quarters and 1% in the third quarter of fiscal 2015. Customer concessions related to these pull-in transactions, if any, were recorded in the same period in which the revenue was recognized. Beginning in fiscal 2017, our policy is not to engage in pull-in transactions and we therefore do not expect them to have any meaningful impact on our net revenue in future periods.
Cost of Goods Sold
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, 2015 |
November 1, 2014 |
% Change |
October 31, 2015 |
November 1, 2014 |
% Change |
|||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
Cost of goods sold |
$ | 379,254 | $ | 454,974 | (16.6 | )% | $ | 1,192,126 | $ | 1,426,575 | (16.4 | )% | ||||||||||||
% of net revenue |
56.2 | % | 48.9 | % | 56.5 | % | 50.1 | % |
Cost of goods sold for the three and nine months ended October 31, 2015 was lower in the three and nine months ended October 31, 2015 compared to the three and nine months ended November 1, 2014, due to overall lower revenues primarily from our storage, mobile and wireless, and networking products. Our cost of goods sold as a percentage of revenue was higher in the three and nine months ended October 31, 2015 compared to the three and nine months ended November 1, 2014, primarily due to a shift in the mix of our revenue toward products with higher average cost of goods sold. Cost of goods sold also includes charges of $1.1 million and $80.0 million in the three and nine months ended October 31, 2015, respectively, related to the litigation settlement reached with CMU in February 2016 (see Note 14- Subsequent Events in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q), as well as higher inventory write downs due to lower than expected demand for our mobile related product. Our cost of goods sold as a percentage of net revenue may fluctuate in future periods due to, among other things, changes in the mix of products sold; the timing of production ramps of new products; increased pricing pressures from our customers and competitors, particularly in the consumer product markets that we are targeting; charges for obsolete or potentially excess inventory; changes in the costs charged by our foundry, assembly and test subcontractors; product warranty costs; changes in commodity prices such as gold; and the margin profiles of our new product introductions.
33
Share-Based Compensation Expense
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
(in thousands) | ||||||||||||||||
Cost of goods sold |
$ | 2,495 | $ | 1,934 | $ | 6,054 | $ | 5,966 | ||||||||
Research and development |
22,573 | 24,198 | 75,162 | 68,842 | ||||||||||||
Selling and marketing |
2,608 | 2,855 | 7,892 | 8,400 | ||||||||||||
General and administrative |
3,789 | 5,307 | 12,252 | 16,075 | ||||||||||||
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|
|
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$ | 31,465 | $ | 34,294 | $ | 101,360 | $ | 99,283 | |||||||||
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|
|
Share-based compensation expense in the three months ended October 31, 2015 decreased by $2.8 million compared to the three months ended November 1, 2014 while share-based compensation expense in the nine months ended October 31, 2015 increased by $2.1 million compared to the nine months ended November 1, 2014. The increase in share-based compensation expense in the nine months ended October 31, 2015 was attributable to more restricted stock awards included in fiscal 2016 than in fiscal 2015 combined with the effect of lower share-based compensation expense in fiscal 2015 from the reversal of previously recognized expense associated with unvested equity awards that were cancelled as a result of the resignation in February 2014 of our former Chief Technology Officer. No such credit was reflected in the share-based compensation expense for the nine months ended October 31, 2015. Despite the increase in share-based compensation expense in the nine months ended October 31, 2015, share-based compensation expense in both the three and nine months ended October 31, 2015 reflects decreases due to the reversal of previously recognized expense associated with unvested equity awards that were cancelled as a result of the termination of employees affected by the restructuring of our mobile platform business. In addition, the financial goals related to performance-based equity awards granted in fiscal 2016 to our executive officers are not expected to be achieved and the related share-based compensation expense was adjusted accordingly.
Restructuring and Other Related Charges
Three Months Ended | Nine Months Ended | |||||||||||||||
October 31, 2015 |
November 1, 2014 |
October 31, 2015 |
November 1, 2014 |
|||||||||||||
(in thousands) | ||||||||||||||||
Cost of goods sold |
$ | 10,285 | $ | | $ | 10,285 | $ | | ||||||||
Restructuring and other related charges |
35,270 | 1,202 | 48,862 | 7,025 | ||||||||||||
Write-off of acquired intangible assets |
| | | 3,386 | ||||||||||||
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|
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|
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$ | 45,555 | $ | 1,202 | $ | 59,147 | $ | 10,411 | |||||||||
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|
We recorded a total $45.6 million and $59.1 million in the three and nine months ended October 31, 2015, respectively in connection with restructuring and other related charges. The charges primarily related to the restructuring of our mobile platform business announced in September 2015 and include severance, other exit-related costs, the impairment of certain equipment and other assets, as well as the write down of inventory. In addition, we incurred additional charges in connection with our ongoing effort to streamline our business. See Note 8 Restructuring and Other Related Charges in the Notes to Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion.
Research and Development
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, 2015 |
November 1, 2014 |
% Change |
October 31, 2015 |
November 1, 2014 |
% Change |
|||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
Research and development |
$ | 252,502 | $ | 288,348 | (12.4 | )% | $ | 818,257 | $ | 873,381 | (6.3 | )% | ||||||||||||
% of net revenue |
37.4 | % | 31.0 | % | 38.8 | % | 30.7 | % |
Research and development expense decreased by $35.8 million for the three months ended October 31, 2015 compared to the three months ended November 1, 2014. The decrease was attributable to $18.3 million of lower personnel-related costs due to headcount reductions that occurred in Israel and certain other locations in connection with our efforts to streamline our operations in fiscal 2015 and the first half of fiscal 2016, combined with lower costs of $8.6 million for third-party vendor and non-recurring engineering services, and lower costs for professional service of $2.7 million. The decrease also reflects a reduction in depreciation and amortization expense of $5.2 million as certain equipment has become fully amortized.
Research and development expense decreased by $55.1 million for the nine months ended October 31, 2015 compared to the nine months ended November 1, 2014. The decrease was attributable to approximately $29.5 million of lower personnel-related costs due to headcount reductions in Israel and certain other locations in connection with our efforts to streamline our operations in the fiscal 2015 and in the first half of fiscal 2016, combined with a reduction in depreciation expense of $12.3 million, lower costs for third-party vendor and non-recurring services of $11.3 million, and lower costs for professional services of $5.0 million.
34
Selling and Marketing
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, 2015 |
November 1, 2014 |
% Change |
October 31, 2015 |
November 1, 2014 |
% Change |
|||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
Selling and marketing |
$ | 30,582 | $ | 34,410 | (11.1 | )% | $ | 97,597 | $ | 106,717 | (8.5 | )% | ||||||||||||
% of net revenue |
4.5 | % | 3.7 | % | 4.6 | % | 3.7 | % |
Selling and marketing expense decreased by $3.8 million and $9.1 million for the three and nine months ended October 31, 2015, respectively, compared to the three and nine months ended November 1, 2014. The decreases were attributable to approximately $1.7 million and $7.0 million of lower personnel-related costs due to lower headcount for the three and nine months ended October 31, 2015, respectively. The decrease also reflected decreases of $0.8 million and $1.0 million from lower sales commissions due to lower sales for the three and nine months ended October 31, 2015, respectively. These decreases were partially offset by increases in marketing communications expenses of $0.4 million and $2.5 million in the three and nine months ended October 31, 2015, respectively.
General and Administrative
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, 2015 |
November 1, 2014 |
% Change |
October 31, 2015 |
November 1, 2014 |
% Change |
|||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
General and administrative |
$ | 33,206 | $ | 32,358 | 2.6 | % | $ | 108,884 | $ | 93,535 | 16.4 | % | ||||||||||||
% of net revenue |
4.9 | % | 3.5 | % | 5.2 | % | 3.3 | % |
General and administrative expense increased by $0.8 million and $15.4 million for the three and nine months ended October 31, 2015, respectively, compared to the three and nine months ended November 1, 2014. The increase in the three months ended October 31, 2015 was attributable to $1.7 million of higher legal expenses primarily due to the independent investigation undertaken by the Companys Audit Committee of certain accounting and internal control matters that began in the second quarter of fiscal 2016, $0.5 million of higher costs for the surety bond related to CMU. These increases were partially offset by $1.8 million of lower personnel-related costs due to lower headcount in the three months ended October 31, 2015.
The increase in general and administrative expense for the nine months ended October 31, 2015 includes a $15.4 million payment due to our former Chief Executive Officer (see Note 13 Related Party Transactions in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q) and $7.1 million related to resolution of litigation matters. The increases were partially offset by $6.3 million of lower personnel-related costs due to lower headcount in the nine months ended October 31, 2015.
Carnegie Mellon University Litigation Settlement
Nine Months Ended | ||||||||||||
October 31, 2015 |
November 1, 2014 |
% Change |
||||||||||
(in thousands, except percentage) | ||||||||||||
Litigation settlement with Carnegie Mellon University |
$ | 654,667 | $ | | 100.0 | % | ||||||
% of net revenue |
31.0 | % | | % |
In connection with the settlement agreement with CMU for $750 million (see Note 10 Commitments and Contingencies: and Note 14 Subsequent Events in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q), $654.7 million of the settlement allocated to the mutual release of claims and covenant not to sue was recorded in operating expenses. Of the remaining $95.3 million, $80.0 million was recorded in cost of goods sold in the nine months ended October 31, 2015. The remaining $15.3 million will be recognized in cost of goods sold over the remaining term of the license through April 2018.
35
Amortization and Write-Off of Acquired Intangible Assets
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, | November 1, | % | October 31, | November 1, | % | |||||||||||||||||||
2015 | 2014 | Change | 2015 | 2014 | Change | |||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
Amortization and write-off of acquired intangible assets |
$ | 3,150 | $ | 3,304 | (4.7 | )% | $ | 8,286 | $ | 13,297 | (37.7 | )% | ||||||||||||
% of net revenue |
0.6 | % | 0.4 | % | 0.4 | % | 0.5 | % |
Amortization and write-off of acquired intangible assets decreased by $0.2 million and $5.0 million for the three and nine months ended October 31, 2015, respectively, compared to the three and nine months ended November 1, 2014. The decrease reflects lower amortization expense as certain intangible assets have become fully amortized. Amortization and write-off of acquired intangible assets in the nine months ended October 31, 2015 includes a charge of $0.3 million to write off an existing trade name compared to the nine months ended November 1, 2014, which included a charge of $3.4 million to write off in-process research and development.
Interest and Other Income, Net
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, | November 1, | % | October 31, | November 1, | % | |||||||||||||||||||
2015 | 2014 | Change | 2015 | 2014 | Change | |||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
Interest and other income, net |
$ | 4,644 | $ | 4,764 | (2.5 | )% | $ | 16,601 | $ | 18,952 | (12.4 | )% | ||||||||||||
% of net revenue |
0.7 | % | 0.5 | % | 0.8 | % | 0.7 | % |
Interest and other income, net, decreased by $0.1 million and $2.4 million for the three and nine months ended October 31, 2015 compared to the three and nine months ended November 1, 2014, respectively. The decrease for the three months ended October 31, 2015 was attributable to net realized losses on investments combined with lower foreign currency gains from the revaluation of our foreign currency denominated tax liabilities at October 31, 2015 compared to November 1, 2014. These decreases were partially offset by higher interest income due to overall higher interest rates despite lower average cash and short-term investment balances in the third quarter of fiscal 2016.
The decrease in the nine months ended October 31, 2015 is due to lower realized gains on investments combined with the effect that a $8.8 million gain from the sale of an investment was included in the nine months ended November 1, 2014, which is not included in the nine months ended October 31, 2015. Despite the overall decrease, interest and other income, net, for the nine months ended October 31, 2015 includes the recognition of higher foreign currency gains from the revaluation of our foreign currency denominated tax liabilities as the U.S. dollar strengthened during the nine months ended October 31, 2015 compared to nine months ended November 1, 2014. In addition, we had higher interest income due to higher interest rates and higher average cash and short-term investment balances in the first nine months of fiscal 2016.
Provision (Benefit) for Income Taxes
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
October 31, | November 1, | % | October 31, | November 1, | % | |||||||||||||||||||
2015 | 2014 | Change | 2015 | 2014 | Change | |||||||||||||||||||
(in thousands, except percentage) | ||||||||||||||||||||||||
Provision (benefit) for income taxes |
$ | 3,320 | $ | 5,000 | (33.6 | )% | $ | 13,192 | $ | (5,720 | ) | (330.6 | )% | |||||||||||
% of net revenue |
0.5 | % | 0.5 | % | 0.7 | % | (0.2 | )% |
We had an income tax provision in both the three and nine months ended October 31, 2015, and our effective tax rate was (6.1)% and (1.6)%, respectively. The income tax expense for the three months ended October 31, 2015 was primarily due to current income tax liability of $1.5 million, a $1.1 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and $0.7 million of interest on unrecognized tax benefits. The income tax expense for the nine months ended October 31, 2015 was primarily due to current income tax liability of $21.0 million, a $7.8 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and an additional tax provision of $3.1 million related to a $15.4 million payment to the Companys former Chief Executive Officer (see Note 13 Related Party Transaction in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q). These tax provisions were partially offset by tax benefits of $15.3 million from a net reduction in unrecognized tax benefits, which primarily arose from the expiration of statutes of limitation and the settlement of tax audits in non-U.S. jurisdictions, and true-up adjustments of $4.8 million, primarily related to the filing of tax returns.
We had an effective tax rate of 4.2% in the three months ended November 1, 2014, whereas we had an effective tax rate of 1.6% in the nine months ended November 1, 2014. Our income tax provision for the three months ended November 1, 2014 included the current income tax liability of $4.5 million and a $0.9 million increase in unrecognized tax benefits from interest on unrecognized tax benefits in non-U.S. jurisdictions, which was partially offset by a $0.4 million tax benefit due to a return-to-provision adjustment upon the filing of a tax return in
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a non-U.S. jurisdiction. The income tax benefit for the nine months ended November 1, 2014 included the current income tax liability of $15.1 million which was offset by tax benefits of $8.9 million from a net reduction in unrecognized tax benefits, $11.5 million from an increase in the net deferred tax assets because of the tax rate change in Singapore and $0.4 million from a return-to-provision adjustment upon the filing of a tax return in a non-U.S. jurisdiction. The net reduction in unrecognized tax benefits arose from the release of $13.2 million due to the expiration of statutes of limitation, which was reduced by a $4.3 million increase in current unrecognized tax benefit estimates in various non-U.S. jurisdictions.
It is reasonably possible that the amount of unrecognized tax benefits could increase or decrease significantly due to changes in tax law in various jurisdictions, new tax audits and changes in the U.S. dollar as compared to foreign currencies within the next 12 months. Excluding these factors, uncertain tax positions may decrease by as much as $18.5 million from the lapse of statutes of limitation in various jurisdictions during the next 12 months. Government tax authorities from several non-U.S. jurisdictions are also examining returns. We believe that we have adequately provided for any reasonably foreseeable outcomes related to our tax audits and that any settlement will not have a material effect on our results at this time.
We operate under tax incentives in certain countries, which may be extended if certain additional requirements are satisfied. The tax incentives are conditional upon meeting certain employment and investment thresholds. The impact of these tax incentives decreased foreign taxes by $1.8 million and $6.7 million for the three and nine months ended October 31, 2015, respectively, and $1.8 million and $12.3 million for the three and nine months ended November 1, 2014, respectively. The benefit of the tax incentives on net loss per share was less than $0.01 per share for the three months ended October 31, 2015 and $0.01 per share for the nine months ended October 31, 2015, compared to a benefit on net income of less than $0.01 per share for the three months ended November 1, 2014 and $0.02 per share for the nine months ended November 1, 2014.
Liquidity and Capital Resources
Our principal source of liquidity as of October 31, 2015 consisted of approximately $2.3 billion of cash, cash equivalents and short-term investments, of which approximately $750 million was held by foreign subsidiaries (outside Bermuda). Approximately $650 million of this amount held by foreign subsidiaries is related to undistributed earnings, most of which have been indefinitely reinvested outside of Bermuda. These funds are primarily held in China, Israel, the United States and Switzerland. We have plans to use such amounts to fund various activities outside of Bermuda, including working capital requirements, capital expenditures for expansion, funding of future acquisitions or other financing activities. If such funds were needed by the parent company in Bermuda or if the amounts were otherwise no longer considered indefinitely reinvested, we would incur a tax expense of approximately $190 million. We believe that our existing cash, cash equivalents and short-term investments, together with cash generated from operations, exercise of employee stock options and purchases under our employee stock purchase plan will be sufficient to cover our working capital needs, capital expenditures, investment requirements, any declared dividends and commitments for at least the next 12 months, as well as payment of $750 million related to our settlement of the patent litigation with CMU. Our capital requirements will depend on many factors, including our rate of sales growth, market acceptance of our products, costs of securing access to adequate manufacturing capacity, the timing and extent of research and development projects and increases in operating expenses, which are all subject to uncertainty. In addition, we are named as defendants to several litigation actions and an unfavorable outcome in any current litigation could have a material adverse effect on our liquidity, cash flows and results of operations.
To the extent that our existing cash, cash equivalents and short-term investments and cash generated by operations are insufficient to fund our future activities, we may need to raise additional funds through public or private debt or equity financing. We may also enter into additional acquisitions of businesses, purchase assets or enter into other strategic arrangements in the future, which could also require us to seek debt or equity financing. Additional equity financing or convertible debt financing may be dilutive to our current shareholders. If we elect to raise additional funds, we may not be able to obtain such funds on a timely basis or on acceptable terms, if at all. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing shareholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to our common shares.
On December 7, 2015, we announced that our board of directors declared a cash dividend of $0.06 per share to be paid on December 29, 2015 to shareholders of record as of December 16, 2015. We subsequently announced that our board of directors declared an additional quarterly cash dividend of $0.06 per share that was paid in April 2016 and on May 18, 2016, we announced that our board of directors declared a cash dividend of $0.06 per share to be paid on July 12, 2016 to shareholders of record as of June 14, 2016.
Future payment of a regular quarterly cash dividend on our common shares will be subject to, among other things, the best interests of the Company and our shareholders, our results of operations, cash balances and future cash requirements, financial condition, statutory requirements under Bermuda law and other factors that our board of directors may deem relevant. Our dividend payments may change from time to time, and we cannot provide assurance that we will continue to declare dividends at all or in any particular amounts. In addition, developments in ongoing litigation could affect the our ability to make a dividend payment on a declared payment date until such time as we can meet statutory requirements under Bermuda law.
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Net Cash Provided by Operating Activities
Net cash provided by operating activities was $152.0 million for the nine months ended October 31, 2015. The cash inflows from operations for the nine months ended October 31, 2015 were due to $815.6 million of net loss adjusted for $210.1 million of non-cash items and changes in working capital of $757.5 million. The cash inflow from working capital for the nine months ended October 31, 2015 was driven by an increase in accrued liabilities and the accrued litigation settlement with CMU, which was partially offset by a decrease in accrued employee compensation, primarily from the payment of the annual incentive compensation.
Net cash provided by operating activities was $573.5 million for the nine months ended November 1, 2014. The cash inflows from operations for the nine months ended November 1, 2014 were primarily due to $353.7 million of net income adjusted for $181.5 million of non-cash items and changes in working capital of $38.3 million.
Net Cash Used in Investing Activities
Net cash used in investing activities was $136.8 million for the nine months ended October 31, 2015 compared to net cash used in investing activities of $256.8 million for the nine months ended November 1, 2014. For the nine months ended October 31, 2015, net cash used in investing activities was primarily due to purchases of available-for-sale securities of $922.8 million partially offset by sales and maturities of available-for-sale securities of $826.2 million. We also paid $33.4 million for the purchase of property and equipment, $10.2 million for the purchase of equipment previously leased and $6.7 million for the purchase of technology licenses. These payments were partially offset by the receipt of $10.0 million from the sale of equipment held for sale.
Net cash used in investing activities of $256.8 million for the nine months ended November 1, 2014 was primarily due to payment of $48.6 million for the purchase of property and equipment, and $14.5 million for the purchase of technology licenses. These payments were partially offset by the receipt of $13.2 million from the sale of an investment in a privately-held company. In addition to these payments, net cash used in investing activities for the nine months ended November 1, 2014 included net cash outflows from purchases of available-for-sales securities of $784.3 million less the sales and maturities of available-for-sale securities of $578.1 million.
Net Cash Used in Financing Activities
Net cash used in financing activities was $329.2 million for the nine months ended October 31, 2015 compared to net cash used in financing activities of $98.5 million for the nine months ended November 1, 2014. For the nine months ended October 31, 2015, net cash used in financing activities was primarily attributable to payments for the repurchase of our common stock of $260.9 million and payments of our quarterly dividends of $92.4 million. The cash outflow was partially offset by net proceeds of $35.5 million from the issuance of our common shares under our share-based plans less the payment for minimum tax withholding on behalf of employees for net share settlements.
Net cash used in financing activities of $98.5 million for the nine months ended November 1, 2014 was primarily attributable payments of our quarterly dividends of $91.9 million and cash payments of $43.8 million to repurchase our common stock. The cash outflow was partially offset by net proceeds of $45.7 million from the issuance of our common shares under our share-based plans less the payment for minimum tax withholding on behalf of employees for net share settlements.
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or special purpose entities (SPEs), which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of October 31, 2015, we were not involved in any unconsolidated SPE transactions.
In the CMU litigation, in order to stay the execution of the final judgment pending its appeal, we filed a supersedeas bond for $1.54 billion with the District Court. The bond was issued by a consortium of sureties authorized by the U.S. Treasury. In support of the bond, we entered into separate indemnity agreements with each of the sureties to indemnify the sureties from all costs and payments made under the bond. The indemnity agreements did not require collateral to be posted at the time of the issuance of the bond. Therefore no cash is considered restricted as of the date of this filing. However, the indemnity agreements provide that each of the sureties have the right to demand to be placed in funds or call for collateral under pre-defined events. See also Note 10 Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for a further discussion of this matter.
On November 14, 2014, we filed a second surety bond for $216 million and filed a commitment letter from the sureties to issue up to an additional $95 million in bonding under certain conditions. The second bond and commitment are secured by our campus located in Santa Clara, California, which has a carrying value of $134.6 million at October 31, 2015.
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In connection with the settlement that was reached with CMU for a total $750 million in February 2016, the primary supersedeas bond that the Company entered into has been reduced to $439 million and the secondary bond has been adjusted to $311 million. For additional information, see CMU litigation in Note 10 Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Contractual Obligations
We presented our contractual obligations at January 31, 2015 in our Annual Report on Form 10-K for the fiscal year then ended. There have been no material changes outside the ordinary course of business in those obligations during the three months ended October 31, 2015, other than as noted under the section entitled Off-Balance Sheet Arrangements above.
Indemnification Obligations
See Note 10 Commitments and Contingencies in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. Our interest rate risk relates primarily to our fixed income short-term investment portfolio as we did not have any outstanding debt as of October 31, 2015. We maintain an investment policy that requires minimum credit ratings, diversification of credit risk and limits the long-term interest rate risk by requiring maturities of generally less than five years. We invest our excess cash primarily in highly liquid debt instruments of the U.S. government and its agencies, time deposits, money market mutual funds, asset backed securities, corporate debt securities and municipal debt securities. These investments are classified as available-for-sale and, consequently, are recorded on our consolidated balance sheets at fair market value with their related unrealized gain or loss reflected as a component of accumulated other comprehensive income in the consolidated statements of shareholders equity. Investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall.
To provide an assessment of the interest rate risk associated with our investment portfolio, we performed a sensitivity analysis to determine the impact that an adverse change in interest rates would have on the value of the investment portfolio. Based on investment positions as of October 31, 2015, a hypothetical 100 basis point increase in interest rates across all maturities would result in a $17.0 million decline in the fair market value of the portfolio. Due to our positive cash flow from operations, the relatively short-term nature of our investment portfolio and our ability to hold investments to maturity, such change in fair market value would likely not have resulted in any significant cash flow impact.
As of October 31, 2015, our investment portfolio included $12.5 million in par value of auction rate securities classified as long-term investments. Although these securities have continued to pay interest, there is currently limited trading volume. To estimate the fair value of the auction rate securities, we use a discounted cash flow model based on estimated timing and amount of future interest and principal payments. In developing the discounted cash flow model, we consider the credit quality and liquidity of the underlying securities and related issuer, the collateralization of underlying security investments and other considerations. The fair value of these auction rate securities as of October 31, 2015, was $2.3 million less than par value.
Based on our balance of approximately $2.3 billion in cash, cash equivalents and short-term investments, and the fact that we continue to generate positive cash flow on a quarterly basis, we do not anticipate having to sell these securities below par value and do not have the intent to sell these auction rate securities until recovery. Since we consider the impairment to be temporary, we recorded the unrealized loss to accumulated other comprehensive income, a component of shareholders equity.
Investment Risk. We invest in equity instruments of privately held companies for strategic purposes. We account for these investments under the cost method when we do not have the ability to exercise significant influence or control over the operations of these companies and under the equity method when we have the ability to exercise significant influence, but do not have control. Carrying value of these equity investments was $8.7 million at October 31, 2015, and was included in other non-current assets in our consolidated balance sheets. We monitor these investments for impairment and make appropriate reductions in carrying value when an impairment is deemed to be other-than-temporary.
Foreign Currency Exchange Risk. All of our sales and the majority of our expenses are denominated in U.S. dollars. Since we operate in many countries, we pay certain payroll and other operating expenses in local currencies and these expenses may be higher or lower in U.S. dollar terms. Furthermore, our operations in Israel and China represent a large portion of our total foreign currency exposure. Additionally, we may hold certain assets and liabilities, including potential tax liabilities, in local currency on our consolidated balance sheet. These tax
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liabilities would be settled in local currency. Therefore, foreign exchange gains and losses from remeasuring the tax liabilities are recorded to interest and other income, net. The related effects of foreign exchange fluctuations on local currency expenses are recorded to operating expenses. There is also a risk that our customers may be negatively impacted in their ability to purchase our products priced in U.S. dollars when there has been significant volatility in foreign currency exchange rates.
We engage in hedging transactions to help mitigate some of the volatility to forecasted cash flows due to changes in foreign exchange rates, and in particular hedge a portion of the forecasted expenses denominated in Israeli shekel and on occasion Chinese yuan. We enter into certain short-term forward exchange contracts, typically less than 12 months in duration, to hedge exposures for expenses denominated in foreign currencies when the currency exposure is significant and there is a high certainty of the underlying cash flow. We do not enter into derivative financial instruments for trading or speculative purposes. We may choose not to hedge certain foreign exchange exposures due to immateriality, offsetting exposures, prohibitive economic cost of hedging a particular currency, and limited availability of appropriate hedging instruments. To the extent our foreign currency hedges are effective, the results of the hedge activities offset the underlying expense within the operating expense. Financial instruments not designated as hedges or hedges deemed ineffective are recorded in interest and other income, net. We do not hedge our tax liabilities denominated in local currency on our consolidated balance sheet as the timing of these tax liabilities becoming cash flows is not deemed to be certain.
To provide an assessment of the foreign currency exchange risk associated with our foreign currency exposures within operating expense, we performed a sensitivity analysis to determine the impact that an adverse change in exchange rates would have on our financial statements. If the U.S. dollar weakened by 10%, our operating expense could increase by 4.6%. We expect our hedges of foreign currency exposures to be highly effective and offset a significant portion of the short-term impact of changes in exchange rates on the hedged portion of our exposures.
Item 4. Controls and Procedures
Audit Committee Investigation
As reported in the Current Report on Form 8-K filed by the Company with the SEC on March 1, 2016, the Audit Committee (the Audit Committee) of the Companys Board of Directors completed and made its findings with respect to an internal investigation (the Audit Committee Investigation). This investigation generally included a review of certain revenue recognized in the first and second quarters of fiscal 2016 and the fourth quarter of fiscal 2015, including transactions that would have, in the normal course of events and but for action by Marvell employees, been completed and recognized in a subsequent quarter (referred to internally as pull-ins), the accrual of a litigation reserve in the second quarter of fiscal 2016, and stated belief by Marvells former Chief Executive Officer and Chairman of ownership of certain patent rights related to the Final-Level Cache invention. The Audit Committee also reviewed disclosure concerning the foregoing matters and related circumstances, and whether senior managements operating style during the relevant periods resulted in an open flow of information and communication to set an appropriate tone at the top for an effective control environment.
The Audit Committee identified no fraudulent activity in the course of this investigation. The Audit Committees key conclusions regarding this investigation included the following:
(a) | revenue related to pull-in transactions during the subject periods was for most such transactions properly recognized in accordance with Marvells revenue recognition policy and generally accepted accounting principles, though for certain transactions Marvells internal controls were not fully followed and revenue from certain pull-in and distributor transactions was recognized prematurely based on certain provisions of the revenue recognition policy in place at the time; |
(b) | Marvells public disclosures for such periods related to revenue properly including pull-in transactions were not misleading; |
(c) | while Marvells former Chief Executive Officer and Chairman stated his belief that he had a good faith claim to ownership of the Final-Level Cache invention, the invention was owned by Marvell during all periods in which company resources related to such invention were deployed and, as a result, there were no errors in accounting related to the Final-Level Cache invention, and the disclosures relating to such invention contained in Marvells Form 10-Q for the first quarter of fiscal 2016 were not misleading; and |
(d) | while Marvell lacked a well-structured process to establish significant and judgmental reserves associated with litigation and royalties, there was no contemporaneous evidence that the increase in the reserve ultimately recorded in Marvells books and records for the second quarter of fiscal 2016 was not reasonable or appropriate. |
The Audit Committee investigation also found certain tone at the top issues, including significant pressure on sales and finance personnel to meet revenue targets and the failure by Marvells former Chief Executive Officer and Chairman and by legal counsel to raise to the appropriate level at the appropriate times the initial assertion of Marvells former Chief Executive Officer and Chairman that he owned the Final-Level Cache invention, the patent applications for which he later assigned to Marvell.
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Managements Evaluation of Disclosure Controls and Procedures
Management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of October 31, 2015. Disclosure controls and procedures are designed to ensure that information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of October 31, 2015 to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.
Notwithstanding the material weaknesses in our internal controls over financial reporting as of October 31, 2015 management has concluded that the consolidated financial statements included in this Form 10-Q present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.
Material Weaknesses
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the companys annual or interim financial statements will not be prevented or detected on a timely basis. Management concluded that we did not maintain effective internal control over financial reporting as of October 31, 2015 because of certain material weaknesses in our internal control over financial reporting as of October 31, 2015 as follows:
Entity Level Controls The control environment, risk assessment, control activities, information and communication, and monitoring controls were not effective. These controls are the responsibility of senior management, who sets the tone of the organization, influences the control consciousness of employees, and is the foundation for internal control over financial reporting. As noted above, the Audit Committee investigation identified certain tone at the top issues that contributed to an ineffective control environment and to the deficiencies aggregating to the material weaknesses set forth below. The Companys entity level controls related to assessing risk and communication of information, including the reporting of information to management and the Board of Directors, did not operate effectively as they relied upon information derived from processes where applicable controls were not fully followed.
Sufficiency of Accounting and Finance Department Resources The Company had insufficient finance and accounting department resources with appropriate knowledge, expertise and training commensurate with the Companys corporate structure and financial reporting requirements to effectively assess risk, and design, operate and oversee effective internal controls over financial reporting. The Company has experienced significant turnover at the senior financial management level. The lack of certain appropriate resources in the Companys accounting and finance departments contributed to an ineffective control environment. This lack of resources resulted in inconsistent expectations around the preparation, review and maintenance of documentation critical to the design and consistent execution of internal controls. These factors contributed to deficiencies in the Companys financial reporting process over (i) the establishment of significant and judgmental reserves, which included reserves for litigation and royalties, (ii) the Companys process and controls over identification, communication and approval of related party transactions, and (iii) a lack of precision in the review controls over certain information and assumptions impacting various financial reporting areas, and monitoring of the Companys terms and conditions for certain contractual arrangements to verify that all critical contract terms were communicated to accounting and finance for assessment.
Revenue Recognition The Companys internal controls to identify, accumulate and assess the accounting impact of certain concessions or side agreements on whether the Companys revenue recognition criteria had been met were in certain instances not fully followed or were not effective. As noted above, the Audit Committee identified certain tone at the top issues, due to which the Companys controls were not effective to ensure (i) consistent standards in the level of documentation of agreements required to support accurate recording of revenue transactions, and (ii) that such documentation is retained, complete, and independently reviewed to ensure certain terms impacting revenue recognition were accurately reflected in the Companys books and records.
Process to Identify Contingencies, Including Those Related to the Companys Intellectual Property The Companys internal controls over contingencies were not effective as the Company lacked a well-structured process, including granting appropriate authority to senior legal management, to ensure the identification of actual and potential claims, and the assessment of probability of loss related to them. The Company also lacked a well-structured process to ensure the timely assignment to the Company of intellectual property.
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Remediation Efforts to Address Material Weaknesses
Our management has worked, and continues to work, to strengthen our internal control over financial reporting. We are committed to ensuring that such controls are designed and operating effectively. Since identifying the material weaknesses in our internal control over financial reporting, we have developed and implemented remediation plans to fully address these control failures. Our Board of Directors and management take internal controls over financial reporting and the integrity of the Companys financial statements seriously and believe that the remediation steps described below, including with respect to personnel changes, were and are essential steps to maintaining strong and effective internal controls over financial reporting and a strong internal control environment.
The Company has taken significant steps to address the material weaknesses set forth above. The Company believes that making the following changes was a critical step toward addressing the tone at the top concerns that contributed to the material weaknesses it has identified.
The following steps are among the measures that have been implemented or will be implemented as soon as practicable after the date of this filing:
Entity Level Controls
| By unanimous action of the Board of Directors, we appointed five new independent directors to our Board of Directors. Two of the new members of the Board have significant finance and accounting experience, have been appointed to the Audit Committee, and have been determined by the Board of Directors to be audit committee financial experts as defined in rules promulgated by the SEC. |
| We appointed a new Chairman of our Board of Directors. |
| We recently appointed a new Chief Executive Officer who we expect will provide strong leadership to the Company and establish open lines of communication with his internal business unit leaders and external partners. |
| We are actively engaged in a search for a new, permanent Chief Financial Officer who we expect will bring expertise and leadership to the Company and our finance team and establish open lines of communication with his or her internal business unit leaders and the finance and accounting team world-wide. |
| We conducted a training program for our executives, vice presidents and associate vice presidents, led by our executive management team, to enhance awareness and understanding of the Companys Code of Conduct and Ethics Policy and the importance of financial reporting integrity. We are developing and planning to implement a similar program for finance, operations and sales personnel and others involved in the sales process. |
| In accordance with changes to the Audit Committee Charter approved by the Board on September 23, 2015, the Audit Committee now approves future earnings guidance in accordance with the Companys normal earnings cycle. |
| In accordance with changes to the Executive Compensation Committee Charter approved by the Board on September 23, 2015, the Executive Compensation Committee now reviews and approves the compensation arrangements of any employees with a title of Associate Vice President or higher reporting directly to the Chief Executive Officer, including, but not limited to, those designated as executive officers. We believe this provides more transparent monitoring of performance of, and incentives offered to, senior management that may influence tone at the top. |
Sufficiency of Accounting and Finance Department Resources
| We are actively engaged in a search for a new Chief Financial Officer who we expect will provide strong leadership to the Company and, in particular, to our finance and accounting function, and establish open lines of communication with his or her staff and internal business partners. |
| We have hired a new Senior Vice President of Finance and a new Assistant Controller to increase the depth and breadth of knowledge and expertise commensurate with the Companys corporate structure and financial reporting requirements. These new finance team members will support the Companys substantial efforts to design, operate and oversee effective internal controls over financial reporting. |
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| We are actively engaged in a search for a new Chief Accounting Officer and Controller who we expect will bring additional technical expertise to our finance and accounting function and will support the Companys substantial efforts to design, operate and oversee effective internal controls over financial reporting. |
| We continue to enhance the Companys finance and accounting department staff, in terms of both number and competency of personnel, particularly in the area of revenue recognition and technical accounting. We expect our new senior finance team to contribute their substantial experience and abilities to raise the level of expertise across the finance and accounting teams. |
| The Audit Committee directed our Interim Chief Financial Officer, in coordination with our new Chief Legal Officer, to undertake a comprehensive review of the procedures to be followed by the Company for establishing significant and judgmental reserves, including reserves for litigation and royalties. As a result, a more comprehensive policy has been established and will be adhered to going forward. In addition, management will continue to report to the Audit Committee the methodologies used and basis of estimates for the establishment of significant and judgmental reserves. |
| We are in the process of developing a roles and responsibilities matrix for our key accounting and operations personnel to incorporate segregation of duties considerations. We expect our incoming senior finance personnel to contribute their significant expertise to this process. |
Revenue Recognition
| We have revised our revenue recognition policy to prohibit Company-initiated pull-in transactions. For fiscal 2017, pull ins will have no meaningful effect on our revenue. |
| As noted above, we conducted a training program for our executive officers, vice presidents and associate vice presidents, led by our executive management team, to enhance awareness and understanding of the Companys Code of Conduct and Ethics Policy and the importance of financial reporting integrity. We are developing and planning to implement a similar program for finance, operations and sales personnel and others involved in the sales process. |
Process to Identify Contingencies, Including Those Related to the Companys Intellectual Property.
| The Audit Committee directed the Company to hire a Chief Legal Officer, such position having the authority of an executive officer (as defined in SEC rules) and to be deemed as such. The Company has hired a new Executive Vice President and Chief Legal Officer to fill this role. |
| The Audit Committee directed the Interim CFO, in coordination with the Chief Legal Officer, to undertake a comprehensive review of the procedures to be followed by the Company for establishing significant and judgmental reserves, including reserves for litigation and royalties. As a result, a more comprehensive policy has been established and will be adhered to going forward. In addition, management will continue to report to the Audit Committee the methodologies used and basis of estimates for the establishment of significant and judgmental reserves. |
| We are in the process of adopting an updated patent disclosure and assignment policy that includes augmented procedures for review of claims of individual ownership and enhanced processes with respect to patent disclosure and assignment. We expect our new Chief Legal Officer to contribute his significant experience to this process. |
The Audit Committee has directed management to develop a detailed plan and timetable for the completion of the implementation of the foregoing remedial measures and will monitor their implementation. In addition, under the direction of the Audit Committee, management will continue to review and make necessary changes to the overall design of our internal control environment, as well as to our policies and procedures in order to improve the overall effectiveness of internal control over financial reporting.
Aside from the above remediations, we reconstituted the memberships and chairmanships of the audit committee, the executive compensation committee and the nominating and governance committee.
We are committed to maintaining a strong internal control environment, and believe that these remediation actions represent significant improvements in our controls. Additional remediation measures continue to be considered and will be implemented as appropriate. We will continue to assess the effectiveness of our remediation efforts in connection with our evaluations of internal control over financial reporting.
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Changes in Internal Control Over Financial Reporting
During the quarter ended October 31, 2015 (and including events during the quarter ended August 1, 2015), changes in our internal control over financial reporting that materially affected or are reasonably likely to materially affect our internal control over financial reporting were as follows:
Our Chief Financial Officer retired in May 2015 prior to our earnings release for the first quarter of fiscal 2016 and the filing of our Form 10-Q for the first quarter of fiscal 2016. On May 22, 2015, we appointed our Vice President, Financial Planning and Analysis, as interim Chief Financial Officer and he transitioned from that position to SVP, Corporate Development and Strategy, FP&A and Investor Relations on October 7, 2015. On October 16, 2015, we appointed David Eichler as our Interim Chief Financial Officer.
Our Vice President and Corporate Controller resigned prior to our earnings release for the second quarter of fiscal 2016 and the filing of our Form 10-Q for the second quarter of fiscal 2016. Our Forms 10-Q for the second and third quarters of fiscal 2016 were not filed when due and the Audit Committee commenced an independent investigation as described above. The Companys independent public accounting firm, PricewaterhouseCoopers, then resigned from our account in October 2015.
In the interim period between August 2015 and December 2015, the controllership role was shared by several senior managers in the finance and accounting departments, including our Vice President/Treasurer, our Vice President/Corporate Tax and our Director/Internal Audit. Our previous Finance Director of Marvells Israel business then assumed the role of acting Controller/Assistant Controller until such time as we hired a new Controller in December 2015.
Inherent Limitations on Effectiveness of Controls
Our management, including our principal executive officer and our principal financial officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems objectives will be met. The design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
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The information under the caption Contingencies as set forth in Note 10 Commitments and Contingencies of our Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1, is incorporated herein by reference. For additional discussion of certain risks associated with legal proceedings, see Part II, Item 1A, Risk Factors, immediately below.
Investing in our common shares involves a high degree of risk. You should carefully consider the risks and uncertainties described below and all information contained in this report before you decide to purchase our common shares. Many of these risks and uncertainties are beyond our control, including business cycles and seasonal trends of the computing, semiconductor and related industries and end markets. If any of the possible adverse events described below actually occurs, we may be unable to conduct our business as currently planned and our financial condition and operating results could be harmed. In addition, the trading price of our common shares could decline due to the occurrence of any of these risks, and you could lose all or part of your investment.
Factors That May Affect Future Results
Our financial condition and results of operations may vary from quarter to quarter, which may cause the price of our common shares to decline.
Our quarterly results of operations have fluctuated in the past and could do so in the future. Because our results of operations are difficult to predict, you should not rely on quarterly comparisons of our results of operations as an indication of our future performance.
Fluctuations in our results of operations may be due to a number of factors, including, but not limited to, those listed below and those identified throughout this Risk Factors section:
| changes in general economic and political conditions and specific conditions in the end markets we address, including the continuing volatility in the technology sector and semiconductor industry; |
| the highly competitive nature of the end markets we serve, particularly within the semiconductor industry; |
| any current and future litigation that could result in substantial costs and a diversion of managements attention and resources that are needed to successfully maintain and grow our business; |
| our dependence on a few customers for a significant portion of our revenue; |
| our ability to maintain a competitive cost structure for our manufacturing and assembly and test processes and our reliance on third parties to produce our products; |
| cancellations, rescheduling or deferrals of significant customer orders or shipments, as well as the ability of our customers to manage inventory; |
| gain or loss of a design win or key customer; |
| seasonality in sales of consumer devices in which our products are incorporated; |
| failure to qualify our products or our suppliers manufacturing lines; |
| our ability to develop and introduce new and enhanced products in a timely and effective manner, as well as our ability to anticipate and adapt to changes in technology; |
| failure to protect our intellectual property; |
| impact of a significant natural disaster, including earthquakes, floods and tsunamis, particularly in certain regions in which we operate or own buildings, such as Santa Clara, California and where our third party suppliers operate, such as Taiwan and elsewhere in the Pacific Rim; and |
| our ability to attract and retain highly skilled managerial, engineering, sales and marketing personnel. |
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Due to fluctuations in our quarterly results of operations and other factors, the price at which our common shares will trade is likely to continue to be highly volatile. From February 2, 2014 through October 31, 2015, our common shares traded as low as $7.55 and as high as $16.78 per share. Accordingly, you may not be able to resell your common shares at or above the price you paid. In future periods, our stock price could decline if, amongst other factors, our revenues or operating results are below our estimates or the estimates or expectations of securities analysts and investors. As a result of stock price volatility, we may be subject to securities class action litigation. Any litigation could result in substantial costs and a diversion of managements attention and resources that are needed to successfully maintain and grow our business.
We operate in intensely competitive markets, and our failure to compete effectively would harm our results of operations.
The semiconductor industry and specifically the data storage, networking and wireless communications markets are extremely competitive, and we expect competition to intensify as current competitors expand their product offerings and new competitors enter the market. This has especially intensified as semiconductor companies have begun to offer more integrated platforms. We expect competition to continue to increase as industry standards continue to evolve and become better known, and others realize the market potential of this trend to platform integration. We currently compete with a number of large domestic and international companies in the business of designing integrated circuits and related applications, some of which have greater financial, technical and management resources than us. Our efforts to introduce new products into markets with entrenched competitors will expose us to additional competitive pressures. For example, we are facing and expect we will continue to face significant competition in the networking market. Additionally, customer expectations and requirements have been evolving rapidly. For example, customers now expect us to provide turnkey solutions. Some of our competitors may be better situated to meet changing customer needs. As competition in the markets in which we operate continues to increase, our revenues and gross margins may decline. For example, competitors with greater financial resources may be able to offer lower prices than us, or they may offer additional products, services or other incentives that we may not be able to match. In addition, many of our competitors operate and maintain their own fabrication facilities and have longer operating histories, greater name recognition, larger customer bases, and greater sales, marketing and distribution resources than we do. Furthermore, our current and potential competitors in the data communication and wireless markets have established or may establish financial and strategic relationships among themselves or with existing or potential customers or other third parties to increase the ability of their products to address the needs of customers. Accordingly, new competitors or alliances among these competitors may acquire significant market share, which would harm our business. While we continue to pursue similar strategic relationships, and currently have significant financial and technical resources, we cannot assure you that we will be able to continue to compete successfully against existing or new competitors, which would harm our results of operations.
In addition, semiconductor providers have experienced consolidation over the past several years. For example, Avago Technologies Limited (which has renamed itself as Broadcom Limited (Broadcom) acquired Broadcom Corporation in February 2016 and LSI Corporation in May 2014, Intel acquired Altera Corporation in December 2015 and NXP Semiconductors acquired Freescale Semiconductor, Ltd. These transactions and other pending transactions may further consolidate competition in our industry. Consolidation among our competitors could lead to a changing competitive landscape, capabilities and market share, which could harm our results of operations.
A significant portion of our business is dependent on the HDD industry, which is highly cyclical, experiences rapid technological change, is subject to industry consolidation and is facing increased competition from alternative technologies.
The HDD industry is intensely competitive, and the technology changes rapidly. This industry has historically been cyclical, with periods of increased demand and rapid growth followed by periods of oversupply and subsequent contraction. These cycles may affect us because some of our largest customers are participants in this industry.
HDD manufacturers tend to order more components than they may need during growth periods, and sharply reduce orders for components during periods of contraction. Rapid technological changes in the HDD industry often result in shifts in market share among the industrys participants. If the HDD manufacturers using our products do not retain or increase their market share, our sales may decrease.
In addition, the HDD industry experienced consolidation in the past. For example, Western Digital completed the acquisition of Hitachis HDD unit in March 2012, Seagate Technology PLC (Seagate) completed the acquisition of Samsungs HDD unit in December 2011 and Toshiba acquired the HDD operations of Fujitsu during fiscal 2010. Consolidation among our customers could lead to changing demand for our products, replacement of our products by the merged entity with those of our competitors and cancellation of orders, each of which could harm our results of operations. If we are unable to leverage our technology and customer relationships, we may not capitalize on the increased opportunities for our products within the combined company.
Furthermore, future changes in the nature of information storage products and personal computing devices could reduce demand for traditional HDDs. For example, products using alternative technologies, such as SSD and other storage technologies could become a source
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of competition to manufacturers of HDDs. Although we offer SSD controllers, leveraging our technology in hard drives, we cannot ensure we will be able to maintain significant market share if demand for traditional HDDs decreases. Additionally, we depend on a few customers for our SSD controllers and as such, the loss of any SSD controller customer or a significant reduction in sales we make to them (for example, as a result of a significant drop in market share) may harm our financial condition and results of operations.
Our sales are concentrated in a few customers, and if we lose or experience a significant reduction in sales to any of these key customers, or if any of these key customers experience a significant decline in market share, our revenues may decrease substantially.
We receive a significant amount of our revenues from a limited number of customers. Net revenue from our two largest customers represented 31% of our net revenue for both of the nine months ended October 31, 2015 and November 1, 2014, respectively. Sales to our largest customers have fluctuated significantly from period to period and year to year primarily due to the timing and number of design wins with each customer, natural disasters that may divert a customers operations, as well as the continued diversification of our customer base as we expand into new markets, and will likely continue to fluctuate in the future. The loss of any of our large customers or a significant reduction in sales we make to them would likely harm our financial condition and results of operations. Our operating results in the foreseeable future will continue to depend on sales to a relatively small number of customers, as well as the ability of these customers to sell products that incorporate our products. In the future, these customers may decide not to purchase our products at all, purchase fewer products than they did in the past, or alter their purchasing patterns in some other way, particularly because:
| a significant portion of our sales are made on a purchase order basis, which permits our customers to cancel, change or delay product purchase commitments with relatively short notice to us; |
| customers may purchase integrated circuits from our competitors; |
| customers may discontinue sales or lose market share in the markets for which they purchase our products (for example, a significant customer of our SSD products has recently seen a significant drop in its market share); |
| customers may develop their own solutions or acquire fully developed solutions from third-parties (for example, in September 2014, Seagate acquired the SSD business from Broadcom); or |
| customers may be subject to severe business disruptions. |
We have been named as a party to several legal proceedings and may be named in additional ones in the future, including litigation involving our patents and other intellectual property, which could subject us to liability, require us to indemnify our customers, require us to obtain or renew licenses, or to stop selling our products or force us to redesign our products.
We have been named as a party to several lawsuits, government inquiries or investigations and other legal proceedings (referred to as litigation), and we may be named in additional ones in the future. Please see Note 10 Commitments and Contingencies of our Notes to the Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q (Note 10) for a more detailed description of a number of the litigation matters we are currently engaged in. In particular, litigation involving patents and other intellectual property is widespread in the high-technology industry and is particularly prevalent in the semiconductor industry, where a number of companies and other entities aggressively bring numerous infringement claims to assert their patent portfolios. The amount of damages alleged in intellectual property infringement claims can often be very significant. For example, the settlement of a lawsuit with Carnegie Mellon University resulted in a payment by us of $750 million as described further in Note 10.
From time to time our subsidiaries and customers receive, and may continue to receive in the future, standards-based infringement claims, as well as claims against us and our subsidiaries proprietary technologies, particularly those related to storage technology, microprocessors and other circuit components. Our subsidiaries and customers could face claims of infringement for certain patent licenses that have not been renewed. These claims could result in litigation and/or claims for indemnification, which, in turn, could subject us to significant liability for damages, attorneys fees and costs. Any potential intellectual property litigation also could force us to do one or more of the following:
| stop selling, offering for sale, making, having made or exporting products or using technology that contains the allegedly infringing intellectual property; |
| limit or restrict the type of work that employees involved in such litigation may perform for us; |
| pay substantial damages and/or license fees and/or royalties to the party claiming infringement or other license violations that could adversely impact our liquidity or operating results; |
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| attempt to obtain or renew licenses to the relevant intellectual property, which licenses may not be available on reasonable terms or at all; and |
| attempt to redesign those products that contain the allegedly infringing intellectual property. |
Under certain circumstances, we have contractual and other legal obligations to indemnify and to incur legal expenses for current and former directors and officers. Additionally, from time to time, we have agreed to indemnify select customers for claims made against our products, where such claims allege infringement of third-party intellectual property rights, including, but not limited to, patents, registered trademarks and/or copyrights. If we are required to make a significant payment under any of our indemnification obligations, our results of operations may be harmed.
The ultimate outcome of litigation could have a material adverse effect on our business and the trading price for our securities. Litigation may be time consuming, expensive, and disruptive to normal business operations, and the outcome of litigation is difficult to predict. Litigation, regardless of the outcome, may result in significant expenditures, diversion of our managements time and attention from the operation of our business, damage to our reputation or relationship with third parties, which could materially and adversely affect our business, financial condition, results of operations, cash flows and our stock price.
We identified material weaknesses in our internal controls over financial reporting, and we may be unable to develop, implement and maintain effective internal controls in future periods.
The Sarbanes-Oxley Act of 2002 and SEC rules require that management report annually on the effectiveness of our internal control over financial reporting and our disclosure controls and procedures. Among other things, management must conduct an assessment of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Based on managements assessment, we concluded that our internal controls over financial reporting were not effective as of January 30, 2016. The specific material weaknesses are described in Part II Item 9A. Controls and Procedures of our Form 10-K in Managements Report on Internal Control over Financial Reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements would not be prevented or detected on a timely basis. As with any material weakness, if our remedial measures are insufficient to address the material weaknesses, or if additional material weaknesses or significant deficiencies in our internal control over financial reporting are discovered or occur in the future, our consolidated financial statements may contain material misstatements. Any material misstatements could result in a restatement of our consolidated financial statements, cause us to fail to meet our reporting obligations or cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.
Even when we have remediated our material weaknesses, any control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control systems objectives will be met. Because of its inherent limitations, internal control over financial reporting will not necessarily prevent all error and all fraud. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. In addition, we may modify the design and operating effectiveness of our internal controls, which could affect the overall effectiveness or evaluation of the control system in the future by us or our independent registered public accounting firm. We cannot ensure that any design will succeed in achieving its stated goals under all potential future conditions, as controls may become inadequate due to changes in conditions or deterioration in the degree of compliance. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to provide reliable financial reports, or to detect and prevent fraud, which would harm our business.
Matters relating to or arising from our Audit Committee investigation, including regulatory proceedings, litigation matters and potential additional expenses, may adversely affect our business and results of operations.
As previously disclosed in our public filings, the Audit Committee of our Board of Directors of the Company has recently completed an investigation that generally included a review of certain revenue recognized in the first and second quarters of fiscal 2016 and the fourth quarter of fiscal 2015, including transactions that would have, in the normal course of events and but for action by certain Marvell employees, been completed and recognized in a subsequent quarter (referred to internally as pull-ins), the accrual of a litigation reserve in the second quarter of fiscal 2016, and the stated belief by Marvells former Chairman and Chief Executive Officer of ownership of certain patent rights related to the Final-Level Cache invention and his later assignment of associated patent applications to Marvell. In addition, we are also the subject of investigations by the Securities and Exchange Commission and the U.S. Attorney related to these matters. We are fully cooperating with the SEC and the US Attorney with respect to those investigations.
To date, we have incurred significant expenses related to legal, accounting, and other professional services in connection with the investigations and related matters, and may continue to incur significant additional expenses with regard to these matters and related remediation efforts. The expenses incurred, and expected to be incurred, on the investigations, the impact of our delay in meeting our periodic
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reports on the confidence of investors, employees and customers, and the diversion of the attention of the management team that has occurred, and is expected to continue, has adversely affected, and could continue to adversely affect, our business, financial condition and results of operations or cash flows. As a result of the delay in filing of our periodic reports, we are not eligible to use a registration statement on Form S-3, and will not be eligible to use that form until we have timely filed all periodic reports required by the SEC for one year, which may make it more difficult, costly or time consuming for us to raise capital if we should choose to do so.
As a result of the matter reported above, we are exposed to greater risks associated with litigation, regulatory proceedings and government enforcement actions. In addition, securities class actions or other lawsuits have been filed against us, our directors and officers (see also, We are subject to pending securities class action and shareholder derivative legal proceedings below). Any future such investigations or additional lawsuits may adversely affect our business, financial condition, results of operations and cash flows.
We are subject to pending securities class action and shareholder derivative legal proceedings
Several securities class action lawsuits were filed against us following our September 11, 2015 announcement of an independent audit committee investigation of certain accounting and internal control matters in the second quarter of fiscal 2016 and our subsequent delinquency in filing our periodic financial reports. We also have been named as a nominal defendant in a shareholder derivative lawsuit filed in fiscal 2016 concerning our announcement of the audit committee investigation. No specific amounts of damages have been alleged in the class action lawsuits and, by the nature of the lawsuits, no damages will be alleged against Marvell in the derivative lawsuit.
We will continue to incur legal fees in connection with these pending cases, including expenses for the reimbursement of legal fees of present and former officers and directors under indemnification obligations. The expense of continuing to defend such litigation may be significant. We intend to defend these lawsuits vigorously, however there can be no assurance that we will be successful in any defense. If any of the lawsuits related to our audit committee investigation are adversely decided, we may be liable for significant damages directly or under our indemnification obligations, which could adversely affect our business, results of operations and cash flows. Further, the amount of time that will be required to resolve these lawsuits is unpredictable and these actions may divert managements attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows.
Our indemnification obligations and limitations of our director and officer liability insurance may have a material adverse effect on our financial condition, results of operations and cash flows.
Under Bermuda law, our articles of association and bye-laws and certain indemnification agreements to which we are a party, we have an obligation to indemnify, or we have otherwise agreed to indemnify, certain of our current and former directors and officers with respect to current and future investigations and litigation, including the matters discussed in Part II Item 1, Legal Proceedings. In connection with some of these pending matters, we are required to, or we have otherwise agreed to, advance, and have advanced, legal fees and related expenses to certain of our current and former directors and officers and expect to continue to do so while these matters are pending. Certain of these obligations may not be covered matters under our directors and officers liability insurance, or there may be insufficient coverage available. Further, in the event the directors and officers are ultimately determined to not be entitled to indemnification, we may not be able to recover the amounts we previously advanced to them.
In addition, we have incurred significant expenses in connection with the Audit Committees independent investigation, the pending government investigations, and the shareholder litigation. We cannot provide any assurances that pending claims, or claims yet to arise, including the cost of fees, penalties or other expenses will not exceed the limits of our insurance policies, that such claims are covered by the terms of our insurance policies or that our insurance carrier will be able to cover our claims. Additionally, to the extent there is coverage of these claims, the insurers also may seek to deny or limit coverage in some or all of these matters. Furthermore, the insurers could become insolvent and unable to fulfill their obligation to defend, pay or reimburse us for insured claims. Accordingly, we cannot be sure that claims will not arise that are in excess of the limits of our insurance or that are not covered by the terms of our insurance policy. Due to these coverage limitations, we may incur significant unreimbursed costs to satisfy our indemnification obligations, which may have a material adverse effect on our business, financial condition, results of operations or cash flows.
We rely on independent foundries and subcontractors for the manufacture, assembly and testing of our integrated circuit products, and the failure of any of these third-party vendors to deliver products or otherwise perform as requested could damage our relationships with our customers, decrease our sales and limit our ability to grow our business.
We do not have our own manufacturing or assembly facilities and have very limited in-house testing facilities. Therefore, we currently rely on several third-party foundries to produce our integrated circuit products. We also currently rely on several third-party assembly and test subcontractors to assemble, package and test our products. This exposes us to a variety of risks, including the following:
Regional Concentration
Substantially all of our products are manufactured by third-party foundries located in Taiwan, and other sources are located in China and Singapore. In addition, substantially all of our third-party assembly and testing facilities are located in China, Singapore and Taiwan. Because of the geographic concentration of these third-party foundries, as well as our assembly and test subcontractors, we are exposed to the risk that their operations may be disrupted by regional disasters including, for example, earthquakes (particularly in Taiwan and elsewhere in the Pacific Rim close to fault lines), tsunamis or typhoons, or by political, social or economic instability. In the case of such an event, our revenues, cost of goods sold and results of operations would be negatively impacted. In addition, there are limited numbers of alternative foundries and identifying and implementing alternative manufacturing facilities would be time consuming. As a result, if we needed to implement alternate manufacturing facilities, we could experience significant expenses and delays in product shipments, which could harm our results of operations.
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No Guarantee of Capacity or Supply
The ability of each foundry to provide us with semiconductor devices is limited by its available capacity and existing obligations. When demand is strong, availability of foundry capacity may be constrained or not available, and with limited exceptions, our vendors are not obligated to perform services or supply products to us for any specific period, in any specific quantities, or at any specific price, except as may be provided in a particular purchase order. We place our orders on the basis of our customers purchase orders or our forecast of customer demand, and the foundries can allocate capacity to the production of other companies products and reduce deliveries to us on short notice. It is possible that foundry customers that are larger and better financed than we are or that have long-term agreements with our main foundries may induce our foundries to reallocate capacity to those customers. This reallocation could impair our ability to secure the supply of components that we need. In particular, as we and others in our industry transition to smaller geometries, our manufacturing partners may be supply constrained or may charge premiums for these advanced technologies, which may harm our business or results of operations. See also, We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration, which may result in reduced manufacturing yields, delays in product deliveries and increased expenses. Moreover, if any of our third-party foundry suppliers are unable to secure necessary raw materials from their suppliers, lose benefits under material agreements, experience power outages, lack sufficient capacity to manufacture our products, encounter financial difficulties or suffer any other disruption or reduction in efficiency, we may encounter supply delays or disruptions, which could harm our business or results of operations.
Despite our strategy to move to multiple sources, most of our products are not manufactured at more than one foundry at any given time, and our products typically are designed to be manufactured in a specific process at only one of these foundries. Accordingly, if one of our foundries is unable to provide us with components as needed, it would be difficult for us to transition the manufacture of our products to other foundries, and we could experience significant delays in securing sufficient supplies of those components. This could result in a material decline in our revenues, net income and cash flow.
In order to secure sufficient foundry capacity when demand is high and to mitigate the risks described in the foregoing paragraph, we may enter into various arrangements with suppliers that could be costly and harm our results of operations, such as non-refundable deposits with or loans to foundries in exchange for capacity commitments, or contracts that commit us to purchase specified quantities of integrated circuits over extended periods. We may not be able to make any such arrangement in a timely fashion or at all, and any arrangements may be costly, reduce our financial flexibility, and not be on terms favorable to us. Moreover, if we are able to secure foundry capacity, we may be obligated to use all of that capacity or incur penalties. These penalties may be expensive and could harm our financial results.
Uncertain Yields and Quality
The fabrication of integrated circuits is a complex and technically demanding process. Our foundries have from time to time experienced manufacturing defects and reduced manufacturing yields, which are difficult to detect at an early stage of the manufacturing process and may be time consuming and expensive to correct. Changes in manufacturing processes or the inadvertent use of defective or contaminated materials by our foundries could result in lower than anticipated manufacturing yields or unacceptable performance. In addition, we may face lower manufacturing yields and reduced quality in the process of ramping up and diversifying our manufacturing partners. Poor yields from our foundries, or defects, integration issues or other performance problems with our products could cause us significant customer relations and business reputation problems, harm our financial performance and result in financial or other damages to our customers. Our customers could also seek damages in connection with product liability claims, which would likely be time consuming and costly to defend. In addition, defects could result in significant costs. See also, Costs related to defective products could have a material adverse effect on us.
To the extent that we rely on outside suppliers to manufacture or assemble and test our products, we may have a reduced ability to directly control product delivery schedules and quality assurance, which could result in product shortages or quality assurance problems that could delay shipments or increase costs.
Commodity Prices
We are also subject to risk from fluctuating market prices of certain commodity raw materials that are incorporated into our end products or used by our suppliers to manufacture our end products. Supplies for such commodities may from time to time become restricted, or general market factors and conditions may affect pricing of such commodities.
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If we are unable to develop and introduce new and enhanced products that achieve market acceptance in a timely and cost-effective manner, our results of operations and competitive position will be harmed.
Our future success will depend on our ability, in a timely and cost-effective manner, to develop and introduce new products and enhancements to our existing products. We sell products in markets that are characterized by rapid technological change, evolving industry standards, frequent new product introductions, short product life cycles and increasing demand for higher levels of integration and smaller process geometries. In addition, the development of new silicon devices is highly complex, and due to supply chain cross-dependencies and other issues, we may experience delays in completing the development, production and introduction of our new products. For example, we believe the success of Final-Level Cache (FLCTM) technology may be an important factor in the future growth of the company. If FLCTM technology fails to function in actual product development at the level required for market acceptance, or if our customers do not readily embrace the technology as quickly as we would anticipate, our future results may be impacted. No revenue was derived from FLC related products in fiscal 2016 and we anticipate no revenue in fiscal 2017 as these products are still in development. See also, We may be unable to protect our intellectual property, which would negatively affect our ability to compete.
Our ability to adapt to changes and to anticipate future standards, and the rate of adoption and acceptance of those standards, will be a significant factor in maintaining or improving our competitive position and prospects for growth. We may also have to incur substantial unanticipated costs to comply with these new standards. Our success will also depend on the ability of our customers to develop new products and enhance existing products for the markets they serve and to introduce and promote those products successfully in a timely manner. Even if we and our customers introduce new and enhanced products to the market, those products may not achieve market acceptance.
Our gross margin and results of operations may be adversely affected in the future by a number of factors, including decreases in average selling prices of products over time and shifts in our product mix.
The products we develop and sell are primarily used for high-volume applications. As a result, the prices of those products have historically decreased rapidly. In addition, our more recently introduced products tend to have higher associated costs because of initial overall development and production expenses. Therefore, over time, we may not be able to maintain or improve our gross margins. Our financial results could suffer if we are unable to offset any reductions in our average selling prices by other cost reductions through efficiencies, introduction of higher margin products and other means.
To attract new customers or retain existing customers, we may offer certain price concessions to certain customers, which could cause our average selling prices and gross margins to decline. In the past, we have reduced the average selling prices of our products in anticipation of future competitive pricing pressures, new product introductions by us or by our competitors and other factors. We expect that we will continue to have to reduce prices of existing products in the future. Moreover, because of the wide price differences across the markets we serve, the mix and types of performance capabilities of our products sold may affect the average selling prices of our products and have a substantial impact on our revenue and gross margin. We may enter new markets in which a significant amount of competition exists, and this may require us to sell our products with lower gross margins than our established businesses. If we are successful in growing revenue in these markets, our overall gross margin may decline. Fluctuations in the mix and types of our products may also affect the extent to which we are able to recover the fixed costs and investments associated with a particular product, and as a result may harm our financial results.
Additionally, because we do not operate our own manufacturing, assembly or testing facilities, we may not be able to reduce our costs as rapidly as companies that operate their own facilities, and our costs may even increase, which could also reduce our gross margins.
We are subject to order and shipment uncertainties, and if we are unable to accurately predict customer demand, we may hold excess or obsolete inventory, which would reduce our gross margin; conversely, we may have insufficient inventory, which would result in lost revenue opportunities and potentially in loss of market share and damaged customer relationships.
We typically sell products pursuant to purchase orders rather than long-term purchase commitments. Customers can generally cancel or defer purchase orders on short notice without incurring a significant penalty. Due to their inability to predict demand or other reasons, some of our customers may accumulate excess inventories and, as a consequence, defer purchase of our products. We cannot accurately predict what or how many products our customers will need in the future. Anticipating demand is difficult because our customers face unpredictable demand for their own products and are increasingly focused more on cash preservation and tighter inventory management. In addition, as an increasing number of our chips are being incorporated into consumer products, we anticipate greater fluctuations in demand for our products, which makes it more difficult to forecast cus