XNAS:BRCM Broadcom Corporation Quarterly Report 10-Q Filing - 6/30/2012
Effective Date 6/30/2012
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Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-Q
For the quarterly period ended June 30, 2012 or
For the transition period from to Commission file number: 000-23993
Broadcom Corporation (Exact Name of Registrant as Specified in Its Charter)
5300 California Avenue Irvine, California 92617-3038 (Address of Principal Executive Offices) (Zip Code) (949) 926-5000 (Registrant’s 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). Yes x 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):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x As of June 30, 2012 the registrant had 507 million shares of Class A common stock, $0.0001 par value, and 52 million shares of Class B common stock, $0.0001 par value, outstanding.
Table of ContentsQUARTERLY REPORT ON FORM 10-Q FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 TABLE OF CONTENTS
Broadcom® and the pulse logo are among the trademarks of Broadcom Corporation and/or its affiliates in the United States, certain other countries and/or the EU. Any other trademarks or trade names mentioned are the property of their respective owners. © 2012 Broadcom Corporation. All rights reserved.
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Table of ContentsBROADCOM CORPORATION UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying notes.
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Table of ContentsBROADCOM CORPORATION UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
The following table presents details of total stock-based compensation expense included in each functional line item in the unaudited condensed consolidated statements of income above:
See accompanying notes.
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Table of ContentsBROADCOM CORPORATION UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying notes.
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Table of ContentsBROADCOM CORPORATION UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
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Table of ContentsBROADCOM CORPORATION NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS June 30, 2012 1. Summary of Significant Accounting Policies Our Company Broadcom Corporation (including our subsidiaries, referred to collectively in this Report as “Broadcom,” “we,” “our” and “us”) is a global leader and innovator in semiconductor solutions for wired and wireless communications. Broadcom® products seamlessly deliver voice, video, data and multimedia connectivity in the home, office and mobile environments. We provide the industry’s broadest portfolio of state-of-the-art system-on-a-chip, or SoC, and software solutions. Basis of Presentation The interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and with the instructions to Securities and Exchange Commission, or SEC, Form 10-Q and Article 10 of SEC Regulation S-X. They do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended December 31, 2011, included in our Annual Report on Form 10-K filed with the SEC on February 1, 2012. In February 2012 we completed our acquisition of NetLogic Microsystems, Inc., or NetLogic and in April 2012 we completed our acquisition of BroadLight, Inc., or BroadLight. The unaudited condensed consolidated financial statements include the results of operations of NetLogic and BroadLight commencing as of the acquisition dates and are included in our Infrastructure & Networking and Broadband Communications reportable segments, respectively. See Note 3 for a further discussion. The interim unaudited condensed consolidated financial statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments that, in the opinion of management, are necessary to present fairly our consolidated financial position at June 30, 2012 and December 31, 2011, and our consolidated results of operations for the three and six months ended June 30, 2012 and cash flows for the six months ended June 30, 2012 and 2011. The results of operations for the three and six months ended June 30, 2012 are not necessarily indicative of the results to be expected for future quarters or the full year. Use of Estimates The preparation of financial statements in accordance with United States generally accepted accounting principles, or GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the dates of the financial statements and the reported amounts of total net revenue and expenses in the reporting periods. We regularly evaluate estimates and assumptions related to revenue recognition, rebates, allowances for doubtful accounts, sales returns and allowances, warranty obligations, inventory valuation, stock-based compensation expense, goodwill and purchased intangible asset valuations, strategic investments, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, self-insurance, restructuring costs or reversals, litigation and other loss contingencies. These estimates and assumptions are based on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results we experience may differ materially and adversely from our estimates. To the extent there are material differences between the estimates and actual results, our future results of operations will be affected. Revenue Recognition We derive revenue principally from sales of integrated circuit products, royalties and license fees for our intellectual property and software and related services. The timing of revenue recognition and the amount of revenue actually recognized for each arrangement depends upon a variety of factors, including the specific terms of each arrangement and the nature of our deliverables and obligations. Determination of the appropriate amount of revenue recognized involves judgments and estimates that we believe are reasonable, but actual results may differ from our estimates. We recognize product revenue when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the resulting receivable is reasonably assured. These criteria are usually met at the time of product shipment. However, we do not recognize revenue when any future performance obligations remain. We record reductions of revenue for estimated product returns and pricing adjustments, such as competitive pricing programs and rebates, in the same period that the related revenue is recorded. The amount of these reductions is based on historical sales returns, analysis of credit memo data, specific criteria included in rebate agreements, and other factors known at the time. We accrue 100% of potential rebates at the time of sale and do not apply a breakage factor. We reverse the accrual for unclaimed rebate amounts as specific rebate programs contractually end and when we believe unclaimed rebates are no longer subject to payment and will not be paid. See Note 2 for a summary of our rebate activity.
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Table of ContentsMultiple Element Arrangements Excluding Software We occasionally enter into revenue arrangements that contain multiple deliverables. Judgment is required to properly identify the accounting units of the multiple deliverable transactions and to determine the manner in which revenue should be allocated among the accounting units. Moreover, judgment is used in interpreting the commercial terms and determining when all criteria of revenue recognition have been met for each deliverable in order for revenue recognition to occur in the appropriate accounting period. While changes in the allocation of the arrangement consideration between the units of accounting will not affect the amount of total revenue recognized for a particular sales arrangement, any material changes in these allocations could impact the timing of revenue recognition, which could affect our results of operations. When we enter into an arrangement that includes multiple elements, the allocation of value to each element is derived based on management’s best estimate of selling price when vendor specific evidence or third party evidence is unavailable. Distributor Revenue A portion of our product sales is made through distributors under agreements allowing for pricing credits and/or rights of return. These pricing credits and/or right of return provisions prevent us from being able to reasonably estimate the final price of the inventory to be sold and the amount of inventory that could be returned pursuant to these agreements. As a result, the fixed and determinable revenue recognition criterion has not been met at the time we deliver products to our distributors. Accordingly, product revenue from sales made through these distributors is not recognized until the distributors ship the product to their customers. Software, Royalties and Cancellation Fee Revenue Revenue from software licenses is recognized when all of the software revenue recognition criteria are met and, if applicable, when vendor specific objective evidence, or VSOE, exists to allocate the total license fee to each element of multiple-element software arrangements, including post-contract customer support. Post-contract support is recognized ratably over the support period. When a contract contains multiple elements wherein the only undelivered element is post-contract customer support and VSOE of the fair value of post-contract customer support does not exist, revenue from the entire arrangement is recognized ratably over the support period. Software royalty revenue is recognized in arrears on a quarterly basis, based upon reports received from licensees during the period, unless collectability is not reasonably assured, in which case revenue is recognized when payment is received from the licensee. Revenue from cancellation fees is recognized when cash is received from the customer. Licensing Revenue We license or otherwise provide rights to use portions of our intellectual property, which includes certain patent rights essential to and/or utilized in the manufacture and sale of certain wireless products. Licensees typically pay a license fee in one or more installments and ongoing royalties based on their sales of products incorporating or using our licensed intellectual property. License fees are recognized over the estimated period of benefit to the licensee or the term specified. We recognize licensing revenue on the sale of patents when all of the following criteria are met: (i) persuasive evidence of an arrangement exist, (ii) delivery has occurred, (iii) the price to be paid by the purchaser is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured. These criteria are usually met at the time of patent transfer. We recognize royalty revenues based on royalties reported by licensees and when other revenue recognition criteria are met, which is generally a quarter in arrears from the period earned. Income from the Qualcomm Agreement On April 26, 2009 we entered into a four-year Settlement and Patent License and Non-Assert Agreement, or the Qualcomm Agreement, with Qualcomm Incorporated, or Qualcomm. The Qualcomm Agreement is a multiple element arrangement which includes: (i) an exchange of intellectual property rights, including in certain circumstances, by a series of covenants not to assert claims of patent infringement under future patents issued within one to four years of the execution date of the agreement, (ii) the assignment of certain existing patents by Broadcom to Qualcomm with Broadcom retaining a royalty-free license under these patents, and (iii) the settlement of all outstanding litigation and claims between us and Qualcomm. The proceeds of the Qualcomm Agreement were allocated amongst the principal elements of the transaction. A gain of $65 million from the settlement of litigation was immediately recognized as a reduction in settlement costs that approximates the value of awards determined by the United States District Court for the Central District of California. The remaining consideration was predominantly associated with the transfer of current and future intellectual property rights and is being recognized within net revenue over the performance period of four years as a single unit of accounting. However this income will be limited to the lesser of the cumulative straight-line amortization over the four year performance period or the cumulative cash proceeds received.
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Table of ContentsDeferred Revenue and Income We defer revenue and income when advance payments are received from customers before performance obligations have been completed and/or services have been performed. Deferred revenue does not include amounts from products delivered to distributors that the distributors have not yet sold through to their end customers. Fair Value of Financial Instruments Our financial instruments consist principally of cash and cash equivalents, short- and long-term marketable securities, accounts receivable, accounts payable and long-term debt. The fair value of a financial instrument is the amount that would be received in an asset sale or paid to transfer a liability in an orderly transaction between unaffiliated market participants. Assets and liabilities measured at fair value are categorized based on whether or not the inputs are observable in the market and the degree that the inputs are observable. The categorization of financial instruments within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The hierarchy is prioritized into three levels (with Level 3 being the lowest) defined as follows: Level 1: Inputs are based on quoted market prices for identical assets or liabilities in active markets at the measurement date. Level 2: Inputs include quoted prices for similar assets or liabilities in active markets and/or quoted prices for identical or similar assets or liabilities in markets that are not active near the measurement date. Level 3: Inputs include management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. The inputs are unobservable in the market and significant to the instrument’s valuation. The fair value of the majority of our cash equivalents and marketable securities was determined based on “Level 1” inputs. The fair value of certain marketable securities and our long-term debt were determined based on “Level 2” inputs. The valuation techniques used to measure the fair value of our “Level 2” instruments were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data. We do not have any marketable securities in the “Level 3” category. We believe that the recorded values of all our other financial instruments approximate their current fair values because of their nature and respective relatively short maturity dates or durations. Cash, Cash Equivalents and Marketable Securities We consider all highly liquid investments that are readily convertible into cash and have a maturity of three months or less at the time of purchase to be cash equivalents. The cost of these investments approximates their fair value. We maintain an investment portfolio of various security holdings, types and maturities. We define marketable securities as income yielding securities that can be readily converted into cash. Marketable securities’ short-term and long-term classifications are based on remaining maturities at each reporting period. Examples of marketable securities include U.S. Treasury and agency obligations, commercial paper, asset-back securities and corporate bonds. We place our cash investments in instruments that meet various parameters, including credit quality standards as specified in our investment policy. We do not use derivative financial instruments. We account for our investments in debt instruments as available-for-sale. Management determines the appropriate classification of such securities at the time of purchase and re-evaluates such classification as of each balance sheet date. Cash equivalents and marketable securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of shareholders’ equity, net of tax. We assess whether our investments with unrealized loss positions are other than temporarily impaired. Unrealized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in other income, net in the consolidated statements of income. Goodwill and Other Long-Lived Assets Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the acquired net tangible and intangible assets. Other long-lived assets primarily represent purchased intangible assets including developed technology, customer relationships and in-process research and development, or IPR&D. We currently amortize our intangible assets with definitive lives over periods ranging from one to fourteen years using a method that reflects the pattern in which the economic benefits of the intangible assets are consumed or otherwise used or, if that pattern cannot be reliably determined, using a straight-line amortization method. We capitalize IPR&D projects acquired as part of a business combination. On completion of each project, IPR&D assets are reclassified to developed technology and amortized over their estimated useful lives.
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Table of ContentsImpairment of Goodwill and Other Long-Lived Assets We evaluate goodwill on an annual basis in the fourth quarter or more frequently if we believe indicators of impairment exist. 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 amount. If we conclude that it is more likely than not that the fair value of a reporting units is less than its carrying amount, we conduct a two-step goodwill impairment test. The first step of the impairment test involves comparing the fair values of the applicable reporting units with their carrying values. We determine the fair values of our reporting units using the income valuation approach, as well as other generally accepted valuation methodologies. If the carrying amount of a reporting unit exceeds the reporting unit’s fair value, we perform the second step of the goodwill impairment test. The second step of the goodwill impairment test involves comparing the implied fair value of the affected reporting unit’s goodwill with the carrying value of that goodwill. The amount, by which the carrying value of the goodwill exceeds its implied fair value, if any, is recognized as an impairment loss. During development, IPR&D is not subject to amortization and is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value to its carrying amount. If the carrying value exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. Once an IPR&D project is complete, it becomes a definite lived intangible asset and is evaluated for impairment in accordance with our policy for long-lived assets. We test long-lived assets and purchased intangible assets (other than goodwill and IPR&D in development) for impairment if we believe indicators of impairment exist. We determine whether the carrying value of an asset or asset group is recoverable, based on comparisons to undiscounted expected future cash flows that the assets are expected to generate. If an asset is not recoverable, we record an impairment loss equal to the amount by which the carrying value of the asset exceeds its fair value. We primarily use the income valuation approach to determine the fair value of our long lived assets and purchased intangible assets. Guarantees and Indemnifications In some agreements to which we are a party, we have agreed to indemnify the other party for certain matters, including, but not limited to product liability. We include intellectual property indemnification provisions in our standard terms and conditions of sale for our products and have also included such provisions in certain agreements with third parties. We have and will continue to evaluate and provide reasonable assistance for these other parties. This may include certain levels of financial support to minimize the impact of the litigation in which the other parties are involved. To date, there have been no known events or circumstances that have resulted in any material costs related to these indemnification provisions and no liabilities therefor have been recorded in the accompanying consolidated financial statements. However, the maximum potential amount of the future payments we could be required to make under these indemnification obligations could be significant. We have obligations to indemnify certain of our present and former directors, officers and employees to the maximum extent not prohibited by law. Under these obligations, Broadcom is required (subject to certain exceptions) to indemnify each such director, officer and employee against expenses, including attorneys’ fees, judgments, fines and settlements, paid by such individual. The potential amount of the future payments we could be required to make under these indemnification obligations could be significant. We maintain directors’ and officers’ insurance policies that may generally limit our exposure and enable us to recover a portion of the amounts paid with respect to such obligations. Stock-Based Compensation Broadcom has in effect stock incentive plans under which incentive stock options have been granted to employees and restricted stock units and non-qualified stock options have been granted to employees and non-employee members of the Board of Directors. We also have an employee stock purchase plan for all eligible employees. We are required to estimate the fair value of share-based awards on the date of grant. The value of the award is principally recognized as an expense ratably over the requisite service periods. The fair value of our restricted stock units is based on the closing market price of our Class A common stock on the date of grant less our expected dividend yield. We have estimated the fair value of stock options and stock purchase rights as of the date of grant or assumption using the Black-Scholes option pricing model, which was developed for use in estimating the value of traded options that have no vesting restrictions and that are freely transferable. The Black-Scholes model considers, among other factors, the expected life of the award, the expected volatility of our stock price and the expected dividend yield. We evaluate the assumptions used to value stock options and stock purchase rights on a quarterly basis. The fair values generated by the Black-Scholes model may not be indicative of the actual fair values of our equity awards, as it does not consider other factors important to those awards to employees, such as continued employment, periodic vesting requirements and limited transferability.
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Table of ContentsLitigation and Settlement Costs Legal costs are expensed as incurred. We are involved in disputes, litigation and other legal actions in the ordinary course of business. We continually evaluate uncertainties associated with litigation and record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the loss or range of loss can be reasonably estimated. In the event of settlement discussions, this generally occurs when an agreement in principle has been reached by both parties that include substantive terms, conditions and amounts. If a settlement has more than one element, we account for the agreement as a multiple element arrangement and allocate the consideration to the identifiable elements based on relative fair value. Past multiple element settlement agreements have included the licensing of intellectual property for future use and payments related to alleged prior infringement. We use a relief-from-royalty method to value patented technology in settlement agreements related to alleged patent infringement, based on market royalties for similar fundamental technologies. The relief-from-royalty method estimates the cost savings that accrue to the owner of an intangible asset that would otherwise be payable as royalties or license fees on revenues earned through the use of the asset. The royalty rate used is based on an analysis of empirical, market-derived royalty rates for guideline intangible assets. Revenue is projected over the expected remaining useful life of the patented technology, or the license period if shorter. The market-derived royalty rate is then applied to estimate the royalty stream related to past revenue over the applicable alleged infringement period as well as projected revenue. We then allocate the consideration transferred to the identifiable elements based on relative fair value of the past and future royalties. The portion that is attributed to payments related to alleged prior infringement is recorded as a charge to our unaudited condensed consolidated statements of income. The remaining portion is attributed to the licensing of intellectual property for future use and is amortized to cost of revenue using a method that reflects the pattern in which the economic benefits of the intangible asset are consumed or otherwise used or, if that pattern cannot be reliably determined, using a straight-line amortization method. Recent Accounting Pronouncements In June 2011 the Financial Accounting Standards Board, or FASB, issued guidance regarding the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The updated guidance is effective on a retrospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. We adopted the provisions of this guidance effective January 1, 2012, as reflected in the unaudited condensed consolidated statements of comprehensive income herein. 2. Supplemental Financial Information Net Revenue The following table presents details of our product revenue:
Income from the Qualcomm Agreement is expected to be recognized as follows:
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Table of ContentsInventory The following table presents details of our inventory:
Property and Equipment The following table presents details of our property and equipment:
In the three months ended June 30, 2012 we recorded an impairment charge of $3 million related to certain computer software and equipment. Goodwill The following table summarizes the activity related to the carrying value of our goodwill:
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Table of ContentsPurchased Intangible Assets The following table presents details of our purchased intangible assets:
In the six months ended June 30, 2012 we reclassified $1 million of IPR&D costs related to previous acquisitions to developed technology and such costs will now be amortized to cost of product revenue. In June 2012 we recorded impairment charges for developed technology of $6 million, primarily related to our 2010 acquisition of Beceem Communications, Inc., or Beceem, included in our Mobile & Wireless reportable segment. The primary factor contributing to this impairment charge was the continued reduction in the forecasted cash flows derived from the acquired WiMAX products as wireless service providers have accelerated their adoption of Long Term Evolution, LTE, products. In March 2012 we recorded impairment charges for developed technology of $28 million, primarily related to our acquisitions of Dune Networks, Inc. and Percello Ltd. included in our Infrastructure & Networking and Broadband Communications reportable segments, respectively. The primary factor contributing to these impairment charges was the reduction in the revenue outlook for certain products and the resulting decrease to the estimated cash flows identified with the impaired assets. In June 2011 we recorded a purchased intangible impairment charge of $74 million related to our acquisition of Beceem. The primary factor contributing to this impairment charge was a reduction in the forecasted cash flows derived from the acquired WiMAX products as discussed above. In March 2011 we recorded an impairment charge of $9 million primarily related to a technology license that was acquired in 2008. The primary factor contributing to this impairment charge was the continued reduction in our revenue outlook for our Blu-ray business, and the related decrease to the estimated cash flows identified with the impaired assets. In determining the amount of the impairment charges we calculated fair values as of the impairment date for acquired developed technology. The fair value was determined using the multiple period excess earnings method, described in Note 3. The fair values were determined using significant unobservable inputs categorized as Level 3 inputs. The key unobservable inputs utilized in the model include discount rates ranging from 15% to 25%, a tax rate of 15%, and a probability adjusted level of future cash flows based on current product and market data.
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Table of ContentsThe following table presents details of the amortization of purchased intangible assets included in the cost of product revenue and other operating expense categories:
The following table presents details of the estimated future amortization of existing purchased intangible assets, including IPR&D:
Accrued Liabilities The following table presents details of our accrued liabilities:
Other Long-Term Liabilities The following table presents details of our other long-term liabilities:
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Table of ContentsAccrued Rebate Activity The following table summarizes the activity related to accrued rebates:
We recorded rebates to certain customers of $149 million and $163 million in the three months ended June 30, 2012 and 2011, respectively. Warranty Reserve Activity The following table summarizes activity related to the warranty reserve:
We recorded charges to costs and expenses of $2 million and $4 million in the three months ended June 30, 2012 and 2011, respectively. Restructuring Activity The following table summarizes activity related to our current and long-term restructuring liabilities during the six months ended June 30, 2012:
Settlement Costs (Gains) In the six months ended June 30, 2012 we recorded settlement costs of $88 million related to patent infringement claims. We recorded settlement gains of $50 million in the six months ended June 30, 2011 primarily related to the settlement of our shareholder derivative action. See Note 9.
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Table of ContentsCharitable Contribution In June 2011 we contributed $25 million to the Broadcom Foundation to support science, technology, engineering and mathematics programs, as well as a broad range of community services. This payment was recorded as an operating expense in our unaudited condensed consolidated statements of income in the three and six months ended June 30, 2011. Computation of Net Income Per Share The following table presents the computation of net income per share:
Net income per share (diluted) does not include the effect of anti-dilutive common share equivalents resulting from outstanding equity awards. There were 26 million and 24 million anti-dilutive common share equivalents in the three months ended June 30, 2012 and 2011, respectively, and 25 and 20 million anti-dilutive common share equivalents in the six months ended June 30, 2012 and 2011, respectively. Supplemental Cash Flow Information In the six months ended June 30, 2012 we accrued $10 million related to stock option exercises that had not settled by June 30, 2012. In the six months ended June 30, 2012, we paid $41 million for capital equipment that was accrued as of December 31, 2011 and had billings of $25 million for capital equipment that were accrued but not yet paid as of June 30, 2012. 3. Business Combinations On February 17, 2012 we completed our acquisition of NetLogic, a publicly traded company that is a provider of high performance intelligent semiconductor solutions for next generation networks. Our primary reasons for acquiring NetLogic were to enhance our ability to deliver a complete, end-to-end network infrastructure solution for customers and to reduce both time-to-market and development costs. The addition of NetLogic also extends Broadcom’s infrastructure portfolio with key technologies, including multi-core embedded processor and knowledge-based processor solutions, both critical enablers of the next generation infrastructure build-out. In April 2012 we completed our acquisition of BroadLight, a provider of networking and fiber access Passive Optical Network, or PON, processors. Our primary reason for acquiring BroadLight was to extend Broadcom’s broadband access product line, enabling Broadcom to offer a complete, end-to-end PON solution for customers — from the optical line terminal at the central office to the optical network unit at the home. BroadLight also extends Broadcom’s broadband access roadmap to support customer requirements for rolling out next-generation fiber networks worldwide. In addition, these acquisitions allowed us to enter into or expand our market share in the relevant wired and wireless communications market segments, reduce the time required to develop new technologies and products and bring them to market, incorporate enhanced functionality into and complement our existing product offerings, augment our engineering workforce, and enhance our technological capabilities.
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Table of ContentsThe following table presents details of the purchase consideration related to each acquisition:
The purchase price of the NetLogic acquisition was paid in cash, except for certain equity awards with a fair value of $349 million that were assumed. Approximately $137 million of the equity consideration was recorded as goodwill and $212 million will be recognized as stock-based compensation expense primarily over the next two to three years. A portion of the cash consideration in the BroadLight acquisition is currently held in escrow pursuant to the terms of the acquisition agreement and is reflected in goodwill as we believe the likelihood of the escrow fund being utilized by us is remote. In connection with these acquisitions, our results of operations in the three months ended June 30, 2012 included: (i) stock-based compensation of $25 million, (ii) the amortization of purchased intangibles of $66 million, and (iii) the amortization of acquired inventory valuation step-up of $43 million. In connection with these acquisitions, our results of operations in the six months ended June 30, 2012 included: (i) stock-based compensation of $52 million, of which $17 million related to the accelerated vesting of equity awards upon the termination of certain employees with change in control agreements, (ii) the amortization of purchased intangibles of $93 million, and (iii) the amortization of acquired inventory valuation step-up of $63 million. We also incurred certain severance and other benefit costs of $3 million in the six months ended June 30, 2012 that are classified as restructuring costs in our unaudited condensed consolidated statement of income. Lastly, we incurred $6 million in transaction costs related to legal, accounting and other related fees, of which $1 million was recorded in the six months ended June 30, 2012 in selling, general and administrative expense and the remaining was previously expensed in 2011.
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Table of ContentsWe have preliminarily estimated the fair value of the acquired assets and liabilities of BroadLight. We allocated the respective purchase prices to tangible assets, liabilities and identifiable intangible assets acquired based on their estimated respective fair values. The excess of the purchase price over the aggregate fair values was recorded as goodwill, of which $23 million is deductible for tax purpose. The principal factor that resulted in recognition of goodwill was that the purchase price for each acquisition was based on cash flow projections assuming the integration of any acquired technology and products with our products, which is of considerably greater value than utilizing each acquired company’s technology or product on a standalone basis. The fair value assigned to identifiable intangible assets acquired was based on estimates and assumptions made by management at the time of the acquisitions. We expect to finalize the allocation of the BroadLight acquisition by the end of the third quarter of 2012. Based upon those calculations, the purchase prices for the acquisitions were allocated as follows:
Purchased Intangible Assets Developed technology represents patented technology and completed technology. Patented technology is the fundamental technology that survives multiple product iterations, while completed technology is specific to certain products acquired. Both of these technologies have passed technological feasibility. We generally use a relief-from-royalty method to value patented technology, based on market royalties for similar fundamental technologies. The relief-from-royalty method estimates the cost savings that accrue to the owner of an intangible asset that would otherwise be payable as royalties or license fees on revenues earned through the use of the asset. The royalty rate used is based on an analysis of empirical, market-derived royalty rates for guideline intangible assets. Typically, revenue is projected over the expected remaining useful life of the patented technology. The market-derived royalty rate is then applied to estimate the royalty savings. To value completed technology, we generally use a multi-period excess earnings approach which calculates the value based on the risk-adjusted present value of the cash flows specific to the products, allowing for a reasonable return. The fair value of the IPR&D from our acquisitions was determined using the income approach. Under the income approach, the expected future cash flows from each project under development are estimated and discounted to their net present values at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return are the weighted average cost of capital, the return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. Each project was analyzed to determine the unique technological innovations, the existence and reliance on patented technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development. Future cash flows for each project were estimated based on forecasted revenue and costs, taking into account the expected product life cycles, market penetration and growth rates. We believe the amount recorded as IPR&D, as well as developed technology, represented the fair value and approximate the amount a market participant would pay for these projects as of the acquisition date.
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Table of ContentsThe following table summarizes the significant assumptions underlying the valuation of IPR&D at the date of acquisition:
There was no IPR&D related to our acquisition of BroadLight. At June 30, 2012 all development projects from the NetLogic acquisition were still in process. The assumptions consist primarily of expected completion dates for the IPR&D projects, estimated costs to complete the projects, and revenue and expense projections for the products once they have entered the market. Research and development costs to bring the products of the acquired companies to technological feasibility are not expected to have a material impact on our results of operations or financial condition. Actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisitions. Customer relationships represent the fair value of future projected revenue that will be derived from the sale of products to existing customers of the acquired companies. Contingent Earn-out Consideration In connection with our NetLogic acquisition, we assumed a liability of $53 million related to contingent consideration in connection with one of NetLogic’s prior acquisitions and subsequently paid this amount in the six months ended June 30, 2012. Additional cash consideration of up to $57 million may be paid to the former shareholders of this prior acquisition upon satisfaction of certain future performance goals. Additional contingent earn-out consideration of up to $10 million in cash may be paid to the former holders of BroadLight capital stock and other rights upon satisfaction of certain future performance goals. As of June 30, 2012 we do not have any liabilities recorded in connection with any remaining contingent earn-out consideration, as we believe that the achievement of the future performance goals is unlikely. Supplemental Pro Forma Data (Unaudited) The unaudited pro forma statement of income data below gives effect to our 2012 and 2011 acquisitions as if they had occurred at the beginning of the year prior to their respective acquisition dates. The following data includes the effects of amortization of purchased intangible assets and acquired inventory valuation step-up, stock-based compensation expense, foregone interest as a result of cash paid to acquire the companies, and other one-time transactions costs directly associated with the acquisitions such as legal, accounting and banking fees. This pro forma data is presented for informational purposes only and does not purport to be indicative of the results of future operations or of the results that would have occurred had the acquisitions taken place in the periods noted above.
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Table of Contents4. Fair Value Measurements Instruments Measured at Fair Value on a Recurring Basis. The following tables present our cash and marketable securities’ costs, gross unrealized gains, gross unrealized losses and fair value by major security type recorded as cash and cash equivalents or short-term or long-term marketable securities:
There were no transfers between Level 1, Level 2 or Level 3 securities in the six months ended June 30, 2012. All of our long-term marketable securities had maturities of between one and three years in duration at June 30, 2012. Our cash, cash equivalents and marketable securities at June 30, 2012 consisted of $1.15 billion held domestically, with the remaining balance of $1.03 billion held by foreign subsidiaries.
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Table of ContentsAt June 30, 2012 we had 85 investments with a fair value of $511 million that were in an unrealized loss position for less than 12 months. Our gross unrealized losses of less than $1 million for these investments at June 30, 2012 were due to changes in interest rates. We have determined that the gross unrealized losses on these investments at June 30, 2012 are temporary in nature. We evaluate securities for other-than-temporary impairment on a quarterly basis. Impairment is evaluated considering numerous factors, and their relative significance varies depending on the situation. Factors considered include the length of time and extent to which fair value has been less than the cost basis, the financial condition and near-term prospects of the issuer, and our intent and ability to hold the investment in order to allow for an anticipated recovery in fair value. Instruments Not Recorded at Fair Value on a Recurring Basis. We measure the fair value of our long-term debt carried at amortized cost quarterly for disclosure purposes. The estimated fair value of long-term debt is determined by Level 2 inputs and is based primarily on quoted market prices for the same or similar issues. Based on the market prices, the fair value of our long-term debt was $1.24 billion and $1.22 billion as of June 30, 2012 and December 31, 2011 respectively. The recorded values of all our accounts receivable and accounts payable approximate their current fair values because of their nature and respective relatively short maturity dates or durations. Assets and Liabilities Recorded at Fair Value on a Non-Recurring Basis. We measure the fair value of our cost method investments when they are deemed to be other-than-temporarily impaired, assets acquired and liabilities assumed in a business acquisition, and goodwill and other long lived assets when they are held for sale or determined to be impaired. See Notes 2 and 3 for discussion on fair value measurements of certain assets and liabilities recorded at fair value on a non-recurring basis. 5. Income Taxes We recorded tax benefits of $8 million and $53 million for the three and six months ended June 30, 2012, respectively, and a tax benefit of $4 million and a tax provision of $1 million for the three and six months ended June 30, 2011, respectively. Our effective tax rates were (5.3)% and (27.2)% for the three and six months ended June 30, 2012, respectively, and (2.3)% and 0.2% for the three and six months ended June 30, 2011, respectively. The difference between our effective tax rates and the 35% federal statutory rate resulted primarily from foreign earnings taxed at rates lower than the federal statutory rate in the three and six months ended June 30, 2012 and 2011, tax benefits resulting primarily from the expiration of statutes of limitations for the assessment of taxes in various foreign jurisdictions of $5 million and $7 million for the three and six months ended June 30, 2012, respectively, and $5 million and $6 million for the three and six months ended June 30, 2011, respectively, and tax benefits resulting from reductions in our U.S. valuation allowance on certain deferred tax assets due to recording net deferred tax liabilities for identifiable intangible assets under purchasing accounting of $4 million for our acquisition of BroadLight for the three months ended June 30, 2012, and $47 million for our acquisition of NetLogic for the six months ended June 30, 2012. During the three months ended March 31, 2012, we accessed $1.5 billion of cash from our foreign subsidiaries to facilitate the acquisition of NetLogic. This $1.5 billion was treated as includible in our U.S. taxable income for 2012. Nevertheless, this did not result in a tax liability for us because it was offset by our net operating loss and tax credit carryforwards. The $3.61 billion cash purchase price to acquire NetLogic greatly exceeded the purchase price of any prior cash acquisition we have made. The acquisition of NetLogic was unusual and nonrecurring. Our other cash acquisitions have been for significantly lower purchase prices, and we have never previously determined it prudent or necessary to access our prior years’ foreign earnings to facilitate an acquisition. We do not currently expect any future need to access our prior years’ foreign earnings, and therefore, aside from the $1.5 billion used to facilitate the NetLogic acquisition, we intend to continue to permanently reinvest our foreign earnings. We utilize the asset and liability method of accounting for income taxes. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. Forming a conclusion that a valuation allowance is not required is difficult when there is negative evidence such as cumulative losses in recent years. As a result of our recent cumulative tax losses in the U.S. and certain foreign jurisdictions, and the full utilization of our loss carryback opportunities, we have concluded that a full valuation allowance should be recorded in such jurisdictions. In certain other foreign jurisdictions where we do not have cumulative losses, we had net deferred tax liabilities of $59 million and $62 million at June 30, 2012 and December 31, 2011, respectively. We file federal, state and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2007 through 2011 tax years generally remain subject to examination by federal and most state tax authorities. In foreign jurisdictions, the 2004 through 2011 tax years generally remain subject to examination by tax authorities. Our income tax returns for the 2007, 2008 and 2009 tax years are currently under examination by the Internal Revenue Service.
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Table of ContentsOn June 30, 2011 we concluded the Internal Revenue Service (IRS) examination of our income tax returns for 2004 through 2006, executed a closing agreement covering the 2001 through 2006 tax years, and agreed to certain adjustments for the 2001 through 2006 tax years, primarily related to intercompany transfer pricing transactions. Those audit adjustments were offset by federal net operating losses and credits, and did not result in any income tax expense or cash tax liability for the Company. As a result of the IRS examination, taking into account effects on post-audit periods, we reduced our federal and state net operating losses by approximately $620 million and $430 million, respectively, and we reduced amounts relating to federal and state uncertain tax benefits by approximately $180 million and $100 million, respectively, as of June 30, 2011. This reduction in federal and state net operating loss carryforwards was fully offset with a reduction in our valuation allowance for deferred tax assets, and had no impact on our operating results or financial position. In December, 2010 the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 was enacted. A provision in this legislation provided for the extension of the research and development tax credit for qualifying expenditures paid or incurred from January 1, 2010 through the expiration date of December 31, 2011. As a result of this legislation, we generated federal research and development tax credits of $118 million for the year ended December 31, 2011. These tax credits, if unutilized, will carry forward to future periods. No tax benefit was recorded for these carryovers since we have a full valuation allowance on our U.S. net deferred tax assets. We operate under tax holidays in Singapore, which are effective through March 2014. The tax holidays are conditional upon our meeting certain employment and investment thresholds. We have begun discussions with the Singapore Economic Development Board with respect to tax incentives for periods after March 31, 2014. 6. Long-Term Debt and Credit Facility The following table presents details of our long-term debt liabilities:
We also have a credit facility with certain institutional lenders that provides for unsecured revolving facility loans, swing line loans and letters of credit in an aggregate amount of up to $500 million with a maturity date of November 19, 2016, at which time all outstanding revolving facility loans (if any) and accrued and unpaid interest must be repaid. No amounts were outstanding on our credit facility at June 30, 2012 and December 31, 2011. The long-term debt and credit facility contain customary representations, warranties and covenants. 7. Shareholders’ Equity Quarterly Dividend In January 2012 our Board of Directors adopted an amendment to the existing dividend policy pursuant to which we increased the quarterly cash dividend by 11.1% to $0.10 per share ($0.40 per share on an annual basis) payable to holders of our common stock. In the three and six months ended June 30, 2012 and 2011 we paid $56 million, $111 million, $48 million and $97 million, respectively, in dividends to holders of our Class A and Class B common stock. These dividends were paid from U.S. domestic sources other than our retained earnings and are accounted for as reductions of shareholders’ equity.
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Table of Contents8. Employee Benefit Plans Combined Incentive Plan Activity Activity under all stock option incentive plans is set forth below:
Restricted stock unit activity is set forth below:
The per share fair values of rights granted in connection with the employee stock purchase plan and stock options assumed from acquisitions in the six months ended June 30, 2012 have been estimated with the following weighted average assumptions:
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Table of ContentsStock-Based Compensation Expense The following table presents details of total stock-based compensation expense that is included in each functional line item in the unaudited condensed consolidated statements of income:
The following table presents details of unearned stock-based compensation currently estimated to be expensed in the remainder of 2012 through 2016 related to unvested share-based payment awards:
The weighted-average period over which the unearned stock-based compensation is expected to be recognized is 1.5 years. 9. Litigation We and certain of our subsidiaries are currently parties to various legal proceedings, including those noted in this section. Unless otherwise noted below, during the period presented we have not: recorded any accrual for loss contingencies associated with such legal proceedings; determined that an unfavorable outcome is probable or reasonably possible; or determined that the amount or range of any possible loss is reasonably estimable. We are engaged in numerous other legal actions not described below arising in the ordinary course of our business and, while there can be no assurance, we believe that the ultimate outcome of these actions will not have a material adverse effect on our operating results, liquidity or financial position. From time to time we may conclude it is in the best interests of our shareholders, employees, and customers to settle one or more litigation matters, and any such settlement could include substantial payments; however, other than as noted below, we have not reached this conclusion with respect to any particular matter at this time. There are a variety of factors that influence our decisions to settle and the amount we may choose to pay, including the strength of our case, developments in the litigation, the behavior of other interested parties, the demand on management time and the possible distraction of our employees associated with the case and/or the possibility that we may be subject to an injunction or other equitable remedy. It is difficult to predict whether a settlement is possible, the amount of an appropriate settlement or when is the opportune time to settle a matter in light of the numerous factors that go into the settlement decision. Intellectual Property Proceedings In September 2009 we filed a complaint in the United States District Court for the Central District of California against Emulex Corporation, or Emulex, alleging infringement of ten patents generally relating to networking technologies. In subsequent filings, we added two additional patents and withdrew six patents, bringing the total to six asserted patents: U.S. Patents Nos. 7,058,150; 7,471,691; 7,450,500; 6,424,194; 7,486,124, and 7,724,057 (referred to as the Asserted Patents). In its answers, Emulex denied liability and asserted counterclaims seeking a declaratory judgment that the Asserted Patents are invalid and not infringed. A trial occurred in September and October 2011, and the Court heard post-trial motions in December 2011. The Court found that the Asserted Patents are not invalid. The Court further found Emulex infringed the ‘150 and ‘691 patents. In March 2012, the Court granted Broadcom’s motion for an injunction on the ‘150 and ‘691 patents and in April 2012, the Court entered an injunction against Emulex. Emulex filed an appeal of the Court’s rulings on the ‘150 and ‘691 patents to the Federal Circuit. On the remaining Asserted Patents, the jury found the ‘500 patent was not infringed and failed to reach a verdict on infringement for the ‘194, ‘124, and ‘057 patents. The Court has scheduled a new trial regarding the ‘194, ‘124, and ‘057 patents for April 2013. On July 3, 2012, Broadcom and Emulex entered into a partial settlement and license agreement for the Asserted Patents. Under the terms of the agreement, the parties dismissed their respective claims on the ‘691 and ‘500 patents, Emulex received a license and release related to the Asserted Patents for certain products for certain fields of use and Emulex was required to make a payment of certain amounts to Broadcom. The litigation proceedings for the ‘150, ‘194, ‘124, and ‘057 patents will continue relating to Emulex’s unlicensed activity.
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Table of ContentsIn November 2009 we filed a complaint in the United States District Court for the Eastern District of Texas against the Commonwealth Scientific and Industrial Research Organisation, or CSIRO, seeking a declaratory judgment that a certain U.S. patent number is invalid, unenforceable and not infringed. CSIRO answered the complaint and counterclaimed for infringement against Broadcom wireless LAN products and sought damages, attorney’s fees, and an injunction. Following a court ordered mediation session in March 2012, Broadcom and CSIRO entered into a settlement agreement resolving the litigation and the Court dismissed the parties’ claims with prejudice. The terms of the settlement agreement included a full release from liability for all asserted claims, the grant of a perpetual license under the asserted patent and all related patents to Broadcom, and the payment of certain amounts by Broadcom. In August 2010, we filed a motion to intervene (i.e., to be added as a party) in U.S. Ethernet Innovations, LLC v. Acer, Inc., Case No. 10-cv-03724-JW (N.D. Cal.). In this case, U.S. Ethernet Innovations, LLC, or USEI, filed a patent infringement complaint alleging that numerous companies, including certain of our customers, infringe four patents relating generally to Ethernet technology. USEI seeks monetary damages, attorney’s fees, and an injunction. Defendants have filed answers denying the allegations in USEI’s complaint and asserting counterclaims for declaratory judgment that USEI’s patents are invalid, unenforceable, and not infringed. We contend that we have a license related to USEI’s patents and are seeking to assert this license as a defense. In December 2010, the Court granted our motion to intervene. No trial date has been set. We and our subsidiaries are also involved in other intellectual property proceedings, claims and litigation. We will disclose the nature of any such matter if we believe it to be material. Particularly in the early stages of such proceedings, an assessment of materiality may be complicated by limited information, including, without limitation, limited information about the patents-in-suit and Broadcom products against which the patents are being asserted. Accordingly, our assessment of materiality may change in the future based upon availability of discovery and further developments in the proceedings at issue. Some of these intellectual property proceedings may involve, for example, “non-practicing entities” asserting claims addressing certain of our products. The resolution of intellectual property litigation can include, among other things, payment of damages, royalties, or other amounts, which could adversely, impact our product gross margins in future periods, or could prevent us from manufacturing or selling some of our products or limit or restrict the type of work that employees may perform for us. In addition, from time to time we are approached by holders of intellectual property, including non-practicing entities, to engage in discussions about our obtaining licenses to their intellectual property. We will disclose the nature of any such discussion if we determine that (i) it is probable an intellectual property holder will assert a claim of infringement, (ii) there is a reasonable possibility the outcome (assuming assertion) will be unfavorable, and (iii) the resulting liability would be material to our financial condition. Other Proceedings In November 2009 Emulex filed a complaint in the Central District of California against us alleging violation of the antitrust laws, defamation, and unfair competition. The complaint seeks injunctive relief and monetary damages, including treble damages and attorneys’ fees. In January 2010, Emulex filed an amended complaint in which Emulex removed, among other things, the claim of unfair competition. In February 2010, we filed motions to dismiss the case and a motion to strike. In June 2010, the District Court granted in part and denied in part our motion to dismiss and denied our motion to strike. In April 2012, the Court granted a joint stipulation to dismiss Emulex’s antitrust, defamation, and unfair competition case against us without prejudice. Under the July 3, 2012 agreement (see above), Emulex released these claims against Broadcom. In April 2008 we delivered a Notice of Arbitration and Arbitration Claim to our former independent registered public accounting firm Ernst & Young LLP, or E&Y, and certain related parties. The arbitration relates to the issues that led to the restatement of our financial statements for the periods from 1998 through March 31, 2006 as disclosed in an amended Annual Report on Form 10-K/A for the year ended December 31, 2005 and an amended Quarterly Report on Form 10-Q/A for the three months ended March 31, 2006, each filed with the SEC January 23, 2007. In May 2008 E&Y delivered a Notice of Defense and Counterclaim. The arbitration hearing has been scheduled for October 2012. In September 2011, two lawsuits were filed by stockholders of NetLogic purporting to assert claims arising from our entry into a definitive merger agreement with NetLogic under which a subsidiary of Broadcom, I&N Acquisition Corp., was to be merged with and into NetLogic. On November 11, 2011, all parties to these actions, captioned New Jersey Carpenters’ Pension Fund v. Broyles et al., (Cal. Super. Ct. County of Santa Clara, Case No. 1-11-CV-209381) (referred to as the California Action), and Danielo v. NetLogic Microsystems, et al., (Del. Ct. of Chancery, Case No. 6881-VCG) (referred to as the Delaware Action), executed a Memorandum of Understanding, or MOU, respecting a proposed settlement of the claims in each of those actions. The terms of the proposed settlement required NetLogic to make certain supplemental disclosures regarding the merger in a Form 8-K filed with the SEC by NetLogic on November 14, 2011, and contemplate the payment by NetLogic of attorneys fees’ and costs to counsel representing the plaintiffs in the amount of $795,000, or such lower amount as the Court may order. The California court has entered a final order approving the settlement. The parties are awaiting dismissal by the Delaware court.
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Table of ContentsIn February 2012 we were notified by the SEC’s Division of Enforcement - Los Angeles Regional office that it is conducting a formal investigation of our accounting practices related to litigation reserves. The SEC has requested documents and information for the time period commencing June 1, 2010 to the present. We believe that the SEC’s investigation was prompted by allegations of a former employee relating to our processes and decisions regarding litigation reserves in the first quarter of 2011 in connection with asserted and unasserted intellectual property claims. Following our receipt of these allegations in April 2011, we, with oversight from the Audit Committee of the Board of Directors, conducted an internal review of these allegations with the assistance of independent outside counsel and did not identify any improprieties. This investigation was completed during the three months ended June 30, 2011. In addition, based on the internal review, the results of which were discussed with the our independent registered public accounting firm, we determined that no adjustments to our fiscal 2010 and March 31, 2011 consolidated financial statements were necessary relating to the subject matter of the review. We are cooperating with the SEC’s investigation. In July 2012, a former employee filed a lawsuit against us alleging wrongful termination in violation of the Dodd-Frank Wall Street Reform and Consumer Protection Act and fundamental public policy under state law. The former employee alleges that he was terminated in June 2011 because he raised concerns that Broadcom did not appropriately accrue for and report certain loss contingencies in the three months ended March 31, 2011. We believe the lawsuit is without merit. General We and our subsidiaries are also involved in other legal proceedings, claims and litigation arising in the ordinary course of business. We will disclose the nature of any such matter if we believe it to be material. The pending proceedings described above involve complex questions of fact and law and may require the expenditure of significant funds and the diversion of other resources to prosecute and defend. The results of legal proceedings are inherently uncertain, and material adverse outcomes are possible. From time to time we may enter into confidential discussions regarding the potential settlement of pending intellectual property or other litigation or other proceedings; however, there can be no assurance that any such discussions will occur or will result in a settlement. In the course of such settlement discussions, if we conclude that a settlement loss is probable and the settlement amount is estimable we may record settlement costs, notwithstanding not having reached a final settlement agreement. In the six months ended June 30, 2012 we recorded settlement costs of $88 million, related to the settlement of patent infringement claims referenced above. Also, upon the occurrence of certain events, we may be required to record additional settlement costs of up to $20 million related to a patent infringement case that settled in 2011. In July 2012 we received a payment of $58 million related to a partial settlement and license agreement. As this is a non-recognizable subsequent event for financial reporting purposes, we expect to record this transaction in the three months ending September 30, 2012 as a multiple element arrangement and will allocate the consideration between the licensing of intellectual property included in net revenue over the term of the license and to a lesser extent a gain on settlement of litigation. The settlement of any pending litigation or other proceedings could require us to incur substantial settlement payments and costs. Furthermore, the settlement of any intellectual property proceeding may require us to grant a license to certain of our intellectual property rights to the other party under a cross-license agreement. If any of those events were to occur, our business, financial condition and results of operations could be materially and adversely affected. See Note 1 for an additional discussion of our accounting policy under “Litigation and Settlement Costs”. 10. Business Enterprise Segments, Significant Customer and Geographical Information Business Enterprise Segments Broadcom has three reportable segments consistent with our target markets. Our three reportable segments are: Broadband Communications (Home), Mobile & Wireless (Hand) and Infrastructure & Networking (Infrastructure). Our Chief Executive Officer, who is our chief operating decision maker, or CODM, reviews financial information at the reportable segment level. Our net revenue is generated principally from sales of integrated circuit products, the income we receive from our agreement with Qualcomm and licensing revenue. While we derive some revenue from other sources, that revenue is not material as it represents approximately 1% of our total net revenue. Such revenue is classified under product revenue for reporting purposes. We group our net revenue consistent with our three target markets which comprise our reportable segments, as discussed above.
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Table of ContentsWith respect to the sales of integrated circuit products, we have approximately 600 products that are grouped into approximately 60 product lines. We have concluded that these products constitute a group of similar products within each reportable segment in each of the following respects:
We also report an “All Other” category that primarily includes licensing revenue and income from the Qualcomm Agreement since it is principally the result of corporate efforts. “All Other” also includes operating expenses that we do not allocate to our other operating segments as these expenses are not included in the segment operating performance measures evaluated by our CODM. Operating costs and expenses that are not allocated include stock-based compensation, amortization of purchased intangible assets, amortization of acquired inventory valuation step-up, impairment of goodwill and other long-lived assets, net settlement costs, net restructuring costs, charitable contributions, employer payroll tax on certain stock option exercises, and other miscellaneous expenses related to corporate allocations that were either over or under the original projections at the beginning of the year. We include stock-based compensation and acquisition-related items in the “All Other” category as decisions regarding equity compensation are made at the corporate level and our CODM reviews reportable segment performance exclusive of these charges. Our CODM does not review information regarding total assets, interest income or income taxes on an operating segment basis. The accounting policies for segment reporting are the same as for Broadcom as a whole. The following tables present details of our reportable segments and the “All Other” category:
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Table of ContentsIncluded in the “All Other” category:
Significant Customer and Geographical Information Sales to our significant customers, including sales to their manufacturing subcontractors, as a percentage of net revenue were as follows:
The geographical distribution of our shipments, as a percentage of product revenue was as follows:
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Table of ContentsItem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Cautionary Statement You should read the following discussion and analysis in conjunction with our Unaudited Condensed Consolidated Financial Statements and the related Notes thereto contained in Part I, Item 1 of this Report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the Securities and Exchange Commission, or SEC, including our Annual Report on Form 10-K for the year ended December 31, 2011 and subsequent reports on Forms 10-Q and 8-K, which discuss our business in greater detail. The section entitled “Risk Factors” contained in Part II, Item 1A of this Report, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, financial condition, results of operations and/or liquidity. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock. All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements or characterizations of historical fact, are forward-looking statements within the meaning of the federal securities laws, including the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to, statements concerning projected total net revenue, costs and expenses and product and total gross margin; our accounting estimates, assumptions and judgments; the demand for our products; our dependence on a few key customers and/or design wins for a substantial portion of our revenue; our ability to consummate acquisitions and integrate their operations successfully; estimates related to the amount and/or timing of the expensing of unearned stock-based compensation expense and stock-based compensation as a percentage of revenue; manufacturing, assembly and test capacity; the effect that economic conditions, seasonality and volume fluctuations in the demand for our customers’ consumer-oriented products will have on our quarterly operating results; our ability to adjust operations in response to changes in demand for existing products and services or the demand for new products requested by our customers; the competitive nature of and anticipated growth in our markets; our ability to migrate to smaller process geometries; our success in pending intellectual property litigation matters; our potential needs for additional capital; inventory and accounts receivable levels; our ability to obtain future tax holidays in Singapore; our ability to permanently reinvest our foreign earnings; the effect of potential changes in U.S. or foreign tax laws and regulations or the interpretation thereof; the level of accrued rebates; and income we expect to record in connection with the Qualcomm Agreement or similar arrangements in the future. These forward-looking statements are based on our current expectations, estimates and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions, and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section entitled “Risk Factors” in Part II, Item 1A of this Report. These forward-looking statements speak only as of the date of this Report. We undertake no obligation to revise or update publicly any forward-looking statement to reflect future events or circumstances. Overview Broadcom Corporation (including our subsidiaries, referred to collectively in this Report as “Broadcom,” “we,” “our” and “us”) is a global leader and innovator in semiconductor solutions for wired and wireless communications. Broadcom products seamlessly deliver voice, video, data and multimedia connectivity in the home, office and mobile environments. We provide the industry’s broadest portfolio of state-of-the-art system-on-a-chip, or SoC, and software solutions. We sell our products to leading wired and wireless communications manufacturers in each of our reportable segments: Broadband Communications (Home), Mobile & Wireless (Hand) and Infrastructure & Networking (Infrastructure). Because we leverage our technologies across different markets, certain of our integrated circuits may be incorporated into products used in multiple markets. We utilize independent foundries and third-party subcontractors to manufacture, assemble and test all of our semiconductor products. Our diverse product portfolio includes:
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Our product revenue consists principally of sales of semiconductor devices and, to a lesser extent, software licenses and royalties, development, support and maintenance agreements, data services and cancellation fees. The majority of our product sales occur through the efforts of our direct sales force. The remaining balance of our product sales occurs through distributors. Our licensing revenue and income is generated from the licensing of our intellectual property, of which the vast majority to date has been derived from agreements with two customers, Verizon Wireless and Qualcomm Incorporated. The licensing revenue from our agreement with Verizon Wireless ended in March 2009 and the income from the Qualcomm Agreement is non-recurring and will terminate in the three months ending June 30, 2013. There can be no assurances that we will be able to enter into similar arrangements of this magnitude in the future. At June 30, 2012 we had deferred income of $4 million related to the Qualcomm Agreement. A detailed discussion of our business may be found in Part I, Item 1, “Business,” of our 2011 Annual Report on Form 10-K for the year ended December 31, 2011. Operating Results for the Three and Six months ended June 30, 2012 In the three months ended June 30, 2012 our net income was $160 million as compared to net income of $175 million in the three months ended June 30, 2011. In the six months ended June 30, 2012 our net income was $248 million as compared to net income of $403 million in the six months ended June 30, 2011. The decrease in profitability was primarily related to lower gross margins due to the amortization of purchased intangible assets and inventory valuation step-up from our acquisition of NetLogic Microsystems, Inc., or NetLogic, in February 2012, and increase in research and development expenses associated with the NetLogic and BroadLight acquisitions and organic hiring. In addition, we recorded varying charges related to settlement costs, impairment of certain purchased intangible assets, charitable contributions and non-recurring income tax benefits. The unaudited condensed consolidated financial statements include the results of operations of NetLogic and BroadLight commencing as of the acquisition dates and are included in our Infrastructure & Networking and Broadband Communications reportable segments, respectively. In connection with the acquisition, our results of operations in the three months ended June 30, 2012 included: (i) stock-based compensation of $25 million, (ii) the amortization of purchased intangibles of $66 million, and (iii) the amortization of acquired inventory valuation step-up of $43 million. In connection with the acquisition, our results of operations in the six months ended June 30, 2012 included: (i) stock-based compensation of $52 million, of which $17 million related to the accelerated vesting of equity awards upon the termination of certain employees with change in control agreements, (ii) the amortization of purchased intangibles of $93 million, and (iii) the amortization of acquired inventory valuation step-up of $63 million. Other highlights during the six months ended June 30, 2012 include the following:
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Business Enterprise Segments. The following tables present details of our reportable segments and the “All Other” category:
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Table of ContentsIncluded in the “All Other” category:
For additional information about our business enterprise segments and “All Other” category, see further discussion in Note 10 of Notes to Unaudited Condensed Consolidated Financial Statements. Factors That May Impact Net Income Our net income has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:
Critical Accounting Policies and Estimates The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our
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Table of Contentsestimates and assumptions related to revenue recognition, rebates, allowances for doubtful accounts, sales returns and allowances, warranty reserves, inventory reserves, stock-based compensation expense, goodwill and purchased intangible asset valuations, strategic investments, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, self-insurance, restructuring costs, litigation and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. For a description of our critical accounting policies and estimates, please refer to the “Critical Accounting Policies and Estimates” section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2011. There have been no material changes in any of our critical accounting policies during the six months ended June 30, 2012.
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Table of ContentsResults of Operations The following table sets forth certain Unaudited Condensed Consolidated Statements of Income data expressed as a percentage of net revenue for the periods indicated:
The following table presents details of product and total gross margin as a percentage of product and total revenue, respectively:
The following table presents details of total stock-based compensation expense as a percentage of net revenue included in each functional line item in the unaudited condensed consolidated statements of income data above:
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Table of ContentsNet Revenue, Cost of Product Revenue, Product Gross Margin, and Total Gross Margin The following tables present net revenue, cost of product revenue, product gross margin and total gross margin:
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Table of ContentsNet Revenue. The following tables present net revenue from each of our reportable segments and its respective contribution to net revenue:
Broadband Communications. The increase in net revenue in the three months ended June 30, 2012 as compared to three months ended June 30, 2011 resulted primarily from an increase in demand for our broadband modems of $52 million, partially offset by a reduction in demand for our set-top boxes of $11 million and our digital television and Blu-ray Disc products of $11 million. The increase in net revenue in the six months ended June 30, 2012 as compared to the six months ended June 30, 2011 resulted primarily from an increase in demand for our broadband modems of $65 million, partially offset by a reduction in demand for our digital television and Blu-ray Disc products of $32 million. The increase in net revenue in the three months ended June 30, 2012 as compared to the three months ended March 31, 2012, resulted primarily from an increase in demand for our broadband modems of $49 million. Broadband modem and set-top box growth is generally driven by an increase in the number of global subscribers for broadband access and pay-TV services, as well as the adoption of faster modems and the roll out of more highly integrated set-top box platforms by global service providers. The decrease in our digital television and Blu-ray Disc products was the result of our decision to move away from those particular consumer electronic markets. Mobile & Wireless. The increase in net revenue in the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 resulted primarily from an increase in demand for our cellular baseband and wireless connectivity products of $101 million and other wireless technologies of $11 million, partially offset by a decrease in demand for our multimedia co-processors of $24 million. The increase in net revenue in the six months ended June 30, 2012 as
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Table of Contentscompared to the six months ended June 30, 2011 resulted primarily from an increase in demand for our cellular baseband and wireless connectivity products of $127 million and other wireless technologies of $20 million, partially offset by a decrease in demand for our multimedia co-processors of $38 million. The increase in net revenue in the three months ended June 30, 2012 as compared to the three months ended March 31, 2012 resulted primarily from an increase in demand for cellular baseband and wireless connectivity products of $17 million and other wireless technologies of $14 million, partially offset by a decrease in demand for our multimedia co-processors of $6 million. Growth in our baseband and wireless connectivity businesses has been driven by increased demand for our 3G baseband solutions and higher-end devices which require WiFi and Bluetooth connectivity, which more than offset the anticipated softness in demand for our 2G basebands. The multimedia co-processors business has declined due to the end of life of certain customer products. Infrastructure & Networking. The increase in net revenue for the three months ended June 30, 2012 as compared to the three months ended June 30, 2011 resulted primarily from an increase for our communication processors of $77 million, partially offset by softness in sales of Ethernet switches and PHYs of $18 million. The increase in net revenue for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011 resulted primarily from an increase in demand for our communication processors of $107 million, partially offset by softness in sales of Ethernet switches and PHYs of $56 million. The increase in communication processors for the three and six month ended June 30, 2012 was the result of our acquisition of NetLogic in February 2012. The decrease in Ethernet switches and PHYs was primarily due to softness in service provider spending as compared to the corresponding periods in 2011. The increase in net revenue for the three months ended June 30, 2012 as compared to the three months ended March 31, 2012 resulted primarily from an increase in revenue from communication processors of $47 million related to the full quarter impact in net revenue associated with our acquisition of NetLogic, as well as increased demand for our Ethernet switch and PHYs of $25 million driven primarily from growth in the service provider market. Rebates. We recorded rebates to certain customers of $149 million, or 7.6% of net revenue, $147 million, or 8.0% of net revenue, and $163 million, or 9.1% of net revenue, in the three months ended June 30, 2012, March 31, 2012, and June 30, 2011, respectively. We recorded rebates to certain customers of $296 million, or 7.8% of net revenue, and $314 million, or 8.7% of net revenue in the six months ended June 30, 2012 and 2011, respectively. We reverse the accrual of unclaimed rebate amounts as specific rebate programs contractually end or when we believe unclaimed rebates are no longer subject to payment and will not be paid. We reversed accrued rebates of $2 million, $3 million and $5 million in the three months ended June 30, 2012, March 31, 2012 and June 30, 2011, respectively. We reversed accrued rebates of $5 million and $7 million in the six months ended June 30, 2012 and 2011, respectively. We anticipate that accrued rebates will vary in future periods based upon the level of overall sales to customers that participate in our rebate programs. From time to time, our key customers place large orders causing our quarterly net revenue to fluctuate significantly. We expect that these fluctuations will continue and that they may be exaggerated by the seasonal variations in consumer products and changes in the overall economic environment. Additionally, since we own inventory that is physically located in a third party’s warehouse, our ability to effectively manage inventory levels may be impaired, causing our total inventory turns to decrease, which could increase expenses associated with excess and obsolete products and negatively impact our cash flow. For these and other reasons, our total net revenue and results of operations for the three and six months ended June 30, 2012 and prior periods may not necessarily be indicative of future net revenue and results of operations. Concentration of Net Revenue Income from the Qualcomm Agreement is expected to be recognized as follows:
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Table of ContentsThe following table presents details of our product net revenue:
Sales to our significant customers, including sales to their manufacturing subcontractors, as a percentage of net revenue were as follows:
We expect that our largest customers will continue to account for a substantial portion of our total net revenue for the remainder of 2012 and for the foreseeable future. The identities of our largest customers and their respective contributions to our total net revenue have varied and will likely continue to vary from period to period. The geographical distribution of our shipments, as a percentage of product revenue was as follows:
All of our revenue to date has been denominated in U.S. dollars. Factors That May Impact Net Revenue The demand for our products and the subsequent recognition of net revenue has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:
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Cost of Product Revenue and Product Gross Margin. Cost of product revenue comprises the cost of our semiconductor devices, which consists of the cost of purchasing finished silicon wafers manufactured by independent foundries, costs associated with our purchase of assembly, test and quality assurance services and packaging materials for semiconductor products, as well as royalties and license fees paid to vendors and non-practicing entities, or NPEs, for use of their technology. Also included in cost of product revenue is the amortization of purchased technology and inventory valuation step-up, and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support, product warranty costs, provisions for excess and obsolete inventories, and stock-based compensation expense for personnel engaged in manufacturing support. Product gross margin is product revenue less cost of product revenue divided by product revenue and does not include income from the Qualcomm Agreement or revenue from the licensing of intellectual property. Total gross margin is total net revenue less cost of product revenue divided by total net revenue. Product gross margin decreased to 46.7% in the three months ended June 30, 2012 as compared to 49.6% in the three months ended June 30, 2011 primarily because of increases in amortization of purchased intangibles, inventory valuation step-up and excess and obsolete inventory provisions of $42 million, $38 million and $8 million, respectively, offset in part by cancellation fees received of $9 million. The increase in the amortization of purchased intangibles and inventory valuation step-up were primarily the result of our acquisitions of NetLogic and BroadLight. Product gross margin also includes $8 million and $2 million of licensing costs related to NPEs in the three months ended June 30, 2012 and 2011, respectively. Product gross margin decreased to 47.4% in the six months ended June 30, 2012 as compared to 49.3% in the six months ended June 30, 2011 primarily because of increases in amortization of purchased intangibles and inventory valuation step-up of $64 million and $55 million respectively, offset in part by a decrease in excess and obsolete inventory provisions of $3 million and cancellation fees received of $9 million. The increase in the amortization of purchased intangibles and inventory valuation step-up were primarily the result of our acquisitions of NetLogic and BroadLight. Product gross margin also includes $11 million and $4 million of licensing costs related to NPEs in the six months ended June 30, 2012 and 2011, respectively. Product gross margin decreased to 46.7% in the three months ended June 30, 2012 as compared to 48.1% in the three months ended March 31, 2012 primarily because of an increase in amortization of purchased intangibles, inventory valuation step-up, and excess and obsolete inventory provisions of $19 million, $21 million and $13 million, respectively, offset in part by cancellation fees received of $9 million. The increase in the amortization of purchased intangibles and inventory step-up were primarily the result of the full quarter impact of our acquisition of NetLogic and the acquisition of BroadLight. Product gross margin also includes $8 million and $3 million of licensing costs related to NPEs in the three months ended June 30, 2012 and March 31, 2012, respectively. Factors That May Impact Product Gross Margin Our product gross margin has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:
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Our product and total gross margin may also be impacted by additional stock-based compensation expense and changes therein, as discussed below, and the amortization of purchased intangible assets related to future acquisitions. Research and Development Expense Research and development expense consists primarily of salaries and related costs of employees engaged in research, design and development activities, including stock-based compensation expense. Development and design costs consist primarily of costs related to engineering design tools, mask and prototyping costs, testing and subcontracting costs. In addition, we incur costs related to facilities and equipment expense, among other items. The following tables present details of research and development expense:
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