XNAS:SIGM Sigma Designs Inc Quarterly Report 10-Q Filing - 7/28/2012

Effective Date 7/28/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(MARK ONE)
x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 28, 2012
or

o       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 001-32207

Sigma Designs, Inc.
(Exact name of registrant as specified in its charter)
 
   
California
94-2848099
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)


1778 McCarthy Boulevard,
Milpitas, California 95035
(Address of principal executive offices including Zip Code)
(408) 262-9003
(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 R  No o

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 R No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer o
 
Accelerated filer  R
 
Non-accelerated filer  o
 
Smaller reporting company o
   
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No R

As of August 30, 2012, the Company had 33,346,871 shares of Common Stock outstanding.

 
1

 
 
SIGMA DESIGNS, INC.
TABLE OF CONTENTS
 
   
Page No.
PART I.
FINANCIAL INFORMATION
 
     
Item 1.
Unaudited Condensed Consolidated Financial Statements:
 
     
 
Unaudited Condensed Consolidated Balance Sheets as of July 28, 2012 and January 28, 2012
3
     
 
Unaudited Condensed Consolidated Statements of Operations for the three and six months ended July 28, 2012 and July 30, 2011
4
     
 
Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended July 28, 2012 and July 30, 2011
4
     
 
Unaudited Condensed Consolidated Statements of Cash Flows for the six months ended July 28, 2012 and July 30, 2011
5
     
 
Notes to Unaudited Condensed Consolidated Financial Statements
6
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
36
     
Item 4.
Controls and Procedures
37
     
PART II.
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
38
     
Item 1A.
Risk Factors
38
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
49
     
Item 3.
Defaults Upon Senior Securities
49
     
Item 4.
Mine Safety Disclosures
50
     
Item 5.
Other Information
50
     
Item 6.
Exhibits
51
     
Signatures
52
   
Exhibit index
53
 
 
2

 
 
PART I.                      FINANCIAL INFORMATION

ITEM 1.                      UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


SIGMA DESIGNS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
 
   
July 28, 2012
   
January 28, 2012
 
Assets
           
Current assets:
           
Cash and cash equivalents
 
$
58,071
   
$
44,283
 
Short-term marketable securities
   
10,770
     
42,134
 
Restricted cash
   
1,766
     
1,769
 
Accounts receivable, net
   
43,053
     
21,180
 
Inventories
   
33,182
     
22,037
 
Deferred tax assets
   
4,777
     
4,832
 
Prepaid expenses and other current assets
   
19,232
     
7,234
 
Total current assets
   
170,851
     
143,469
 
                 
Long-term marketable securities
   
35,796
     
62,022
 
Software, equipment and leasehold improvements, net
   
20,602
     
19,609
 
Intangible assets, net
   
43,272
     
45,656
 
Deferred tax assets, net of current portion
   
16,549
     
16,595
 
Notes receivable, net of current portion
   
2,500
     
3,000
 
Long-term investments
   
6,444
     
6,443
 
Other non-current assets
   
3,491
     
430
 
Total assets
 
$
299,505
   
$
297,224
 
                 
Liabilities and Shareholders' Equity
               
Current liabilities:
               
Accounts payable
 
$
19,388
   
$
8,438
 
Accrued liabilities
   
35,317
     
24,081
 
Total current liabilities
   
54,705
     
32,519
 
                 
Other long-term liabilities
   
14,766
     
15,168
 
Long-term deferred tax liabilities
   
1,038
     
1,062
 
Total liabilities
   
70,509
     
48,749
 
                 
Commitments and contingencies (Note 11)
               
                 
Shareholders' equity:
               
Preferred stock
   
     
 
Common stock and additional paid-in capital
   
468,055
     
460,246
 
Treasury stock
   
(85,941)
     
(85,941)
 
Accumulated other comprehensive income
   
435
     
603
 
Accumulated deficit
   
(153,553
)
   
(126,433)
 
Total shareholders’ equity
   
228,996
     
248,475
 
Total liabilities and shareholders' equity
 
$
299,505
   
$
297,224
 

See the accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 
3

 
 
SIGMA DESIGNS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)


   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
 
Net revenue
 
$
68,251
   
$
46,694
   
$
108,509
   
$
107,326
 
Cost of revenue
   
37,671
     
33,700
     
56,834
     
64,540
 
Gross profit
   
30,580
     
12,994
     
51,675
     
42,786
 
                                 
Operating expenses:
                               
Research and development
   
27,975
     
21,805
     
49,764
     
43,401
 
Sales and marketing
   
7,795
     
8,429
     
14,683
     
16,930
 
General and administrative
   
9,489
     
5,197
     
15,868
     
10,632
 
Gain on acquisition
   
(1,417
)
   
     
(1,417
)
   
 
Total operating expenses
   
43,842
     
35,431
     
78,898
     
70,963
 
Loss from operations
   
(13,262
)
   
(22,437)
     
(27,223
)
   
(28,177)
 
 
                               
Interest and other income, net
   
242
     
734
     
733
     
1,553
 
Loss before income taxes
   
(13,020
)
   
(21,703)
     
(26,490
)
   
(26,624)
 
Provision for income taxes
   
398
     
259
     
630
     
1,008
 
Net loss
 
$
(13,418
)
 
$
(21,962)
   
$
(27,120
)
 
$
(27,632)
 
                                 
Net loss per share:
                               
Basic
 
$
(0.41
)
 
$
(0.69)
   
$
(0.83)
   
$
(0.87)
 
Diluted
 
$
(0.41
)
 
$
(0.69)
   
$
(0.83)
   
$
(0.87)
 
                                 
Shares used in computing net loss per share:
                 
Basic
   
33,052
     
31,913
     
32,857
     
31,822
 
Diluted
   
33,052
     
31,913
     
32,857
     
31,822
 


 
SIGMA DESIGNS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)

 
   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
 
Net loss
 
$
(13,418
)
 
$
(21,962
)  
$
(27,120
)
 
$
(27,632
)
                                 
Other comprehensive income (loss):
                               
Accumulated translation adjustment
   
(567
)
   
(235
)    
(496
)
   
405
 
Unrealized gain (loss) on marketable securities
   
61
     
(137
)    
328
     
29
 
Other comprehensive income (loss)
   
(506
)    
(372
)    
(168
)
   
434
 
                                 
Comprehensive loss
 
$
(13,924
)  
$
(22,334
)  
$
(27,288
)  
$
(27,198
)
 
See the accompanying Notes to Unaudited Condensed Consolidated Financial Statements

 
4

 
 
SIGMA DESIGNS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
 
Cash flows from operating activities:
           
Net loss
 
$
(27,120
 
$
(27,632)
 
Adjustments to reconcile net loss to net cash used in operating activities:
               
Depreciation and amortization
   
10,693
     
15,415
 
Stock-based compensation
   
5,576
     
6,327
 
Provision for excess and obsolete inventory
   
1,700
     
7,969
 
Provision for sales discounts and (recovery) of doubtful account
   
62
     
(44
)
Deferred income taxes
   
(204
)
   
(4
)
Loss on disposal of equipment
   
87
     
77
 
Accretion of contributed leasehold improvements
   
(139
)
   
(122
)
Gain on acquisition
   
(1,417
)
   
 
Changes in operating assets and liabilities:
               
Accounts receivable
   
(8,525
)
   
1,032
 
Inventories
   
1,572
     
6,583
 
Prepaid expenses and other current assets
   
(3,190
)
   
(876
)
Other non-current assets
   
(2,567
)
   
41
 
Accounts payable
   
9,113
     
(4,776
)
Accrued liabilities
   
12,118
     
(6,928
)
Other long-term liabilities
   
(957
)
   
578
 
Net cash used in operating activities
   
(3,198
)
   
(2,360
)
                 
Cash flows from investing activities:
               
Restricted cash
   
3
     
(156
)
Purchases of marketable securities
   
(14,593
)
   
(44,814
)
Sales and maturities of marketable securities
   
72,511
     
43,795
 
Purchases of software, equipment and leasehold improvements
   
(3,312
)
   
(6,977
)
Cash paid in connection with acquisition
   
(39,740
)
   
(5,000
)
Purchases of long-term investments
   
     
(2,000
)
Net cash provided by (used in) investing activities
   
14,869
     
(15,152
)
                 
Cash flows from financing activities:
               
Net proceeds from exercises of employee stock options and stock purchase rights
   
2,233
     
3,129
 
Net cash provided by financing activities
   
2,233
     
3,129
 
                 
Effect of foreign exchange rate changes on cash and cash equivalents
   
(116
)
   
163
 
Increase (decrease) in cash and cash equivalents
   
13,788
     
(14,220)
 
                 
Cash and cash equivalents at beginning of period
   
44,283
     
72,732
 
Cash and cash equivalents at end of period
 
$
58,071
   
$
58,512
 
                 
Supplemental disclosure of cash flow information:
               
                 
Cash paid for income taxes
 
$
1,282
   
$
514
 
 
See the accompanying Notes to Unaudited Condensed Consolidated Financial Statements
 
 
5

 
 
SIGMA DESIGNS, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. 
Organization and summary of significant accounting policies

Organization and nature of operations:  Sigma Designs, Inc. (referred to collectively in these consolidated financial statements as “Sigma,” “we,” “our” and “us”) is a leader in connected media platforms.  We specialize in digital television, or DTV, media processors and chipset solutions that serve as the foundation for some of the world’s leading internet protocol television, or IPTV, set-top-boxes, connected media players, residential gateways and home control systems.  We sell our products to manufacturers, designers and, to a lesser extent, to distributors who, in turn, sell to manufacturers.

Basis of presentation:  The consolidated financial statements include Sigma Designs, Inc. and its wholly-owned subsidiaries.  All intercompany balances and transactions are eliminated upon consolidation.

The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or US GAAP, for interim financial information and the rules and regulations of the Securities and Exchange Commission, or SEC.  They do not include all disclosures required by US GAAP for complete financial statements.  However, we believe that the disclosures are adequate and fairly present the information.  The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended January 28, 2012 included in our Annual Report on Form 10-K.

The condensed consolidated financial statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments that, in our opinion, are necessary to present fairly our consolidated financial position at July 28, 2012 and January 28, 2012, the consolidated results of our operations for the three and six months ended July 28, 2012 and July 30, 2011, and the consolidated cash flows for the six months ended July 28, 2012 and July 30, 2011.  The results of operations for the three and six months ended July 28, 2012 are not necessarily indicative of the results to be expected for future quarters or the year.

Accounting period:  Each of our fiscal quarters presented herein includes 13 weeks and ends on the last Saturday of the period.  The second quarter of fiscal 2013 ended on July 28, 2012.  The second quarter of fiscal 2012 ended on July 30, 2011.
 
Reclassifications:  Certain prior fiscal year balances have been reclassified to conform to the current fiscal year presentation.  In the first quarter of fiscal 2013, we concluded that it was appropriate to reclassify our purchased intellectual property, or IP, that is incorporated into our products, from software, equipment and leasehold improvements to intangible assets.  The reclassification has no effect on previously reported Condensed Consolidated Statements of Operations for any period and does not affect previously reported cash flows from operations or from financing activities in the Condensed Consolidated Statements of Cash Flows.  For comparability purposes, the corresponding gross assets and accumulated amortization of $22.2 million and $5.9 million, respectively, have been reclassified as of January 28, 2012.  Such reclassifications had no effect on previously reported results of operations or retained earnings.
 
Software, equipment and leasehold improvements:  Software, equipment and leasehold improvements are stated at cost.  Depreciation and amortization for software, equipment and leasehold improvements is computed using the straight-line method based on the useful lives of the assets (one to five years) or the remaining lease term if shorter.  Any allowance for leasehold improvements received from the landlord for improvements to our facilities is amortized using the straight-line method over the lesser of the remaining lease term or the useful life of the leasehold improvements.  Repairs and maintenance costs are expensed as incurred.

Long-lived assets:   The amounts and useful lives assigned to finite lived intangible assets acquired, other than goodwill, impact the amount and timing of future amortization.  Long-lived assets include intellectual property that we purchase for incorporation into our product designs.  We begin amortizing such intellectual property at the time that we begin shipment of the associated products into which it is incorporated.  We amortize the intellectual property over the estimated useful life of the associated products, which is generally two to three years.  We assess the carrying value of long-lived assets, including purchased intangible assets, whenever events or changes in circumstances, such as a change in technology, indicate that the carrying value of these assets may not be recoverable.  An impairment loss would be recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposal is less than its carrying amount.

Use of estimates:  The preparation of the consolidated financial statements in conformity with US GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances.  Actual results could differ from those estimates, and such differences may be material to the consolidated financial statements.
 
 
6

 
 
Revenue recognition: We derive our revenue primarily from product sales.  Our products, which we refer to as chipsets, consist of highly integrated semiconductors and embedded software that enables real-time processing of digital video and audio content, which we refer to as real-time software.  We do not deliver software as a separate product in connection with product sales.  We recognize revenue for product sales when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured.

Inventories:  Inventories are stated at the lower of standard cost, which approximates actual cost on a first-in, first-out basis, or market value.  We evaluate our ending inventories for excess quantities and obsolescence on a quarterly basis.  This evaluation includes analysis of historical and estimated future unit sales by product as well as product purchase commitments that are not cancelable.  We develop our demand forecasts based, in part, on discussions with our customers about their forecasted supply needs.  However, our customers usually only provide us with firm purchase commitments for the current period and not our entire forecasted period.  Additionally, our sales and marketing personnel provide estimates of future sales to prospective customers based on actual and expected design wins.  A provision is recorded for inventories in excess of estimated future demand.  In addition, we write off inventories that are obsolete.  Obsolescence is determined from several factors, including competitiveness of product offerings, market conditions and product life cycles.  Provisions for excess and obsolete inventory are charged to cost of revenue.  At the time of the loss recognition, a new, lower-cost basis for that inventory is established and subsequent changes in facts and circumstances do not result in the restoration or increase in that newly established cost basis.  If this lower-cost inventory is subsequently sold, we will realize higher gross margins for those products.
 
Inventory write-downs inherently involve assumptions and judgments as to amount of future sales and selling prices.  Although we believe that the assumptions we use in estimating inventory write-downs are reasonable, significant future changes in these assumptions could produce a significantly different result.  There can be no assurances that future events and changing market conditions will not result in significant inventory write-downs.

Income taxes:  Income taxes are accounted for under an asset and liability approach.  Deferred income taxes reflect the net tax effects of any temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts reported for income tax purposes, and any operating losses and tax credit carry forwards.  Deferred tax liabilities are recognized for future taxable amounts and deferred tax assets are recognized for future deductions, net of any valuation allowance, to reduce deferred tax assets to amounts that are considered more likely than not to be realized.  

The impact of an uncertain income tax position on an income tax return must be recognized as the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.  An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. 

Recent accounting pronouncements:  There have been no significant changes in accounting pronouncements as compared to the recent accounting pronouncements described in our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended January 28, 2012.

 
7

 

2.
Cash, cash equivalents and marketable securities

Cash, cash equivalents and marketable securities consist of the following (in thousands):

   
July 28, 2012
   
January 28, 2012
 
   
Book
Value
   
Net Unrealized
Gain (Loss)
   
Fair
Value
   
Book
Value
   
Net Unrealized
Gain (Loss)
   
Fair
Value
 
Corporate bonds
 
$
42,372
   
$
528
   
$
42,900
   
$
91,829
   
$
192
   
$
92,021
 
Money market funds
   
17,728
     
     
17,728
     
20,876
     
     
20,876
 
Corporate commercial paper
   
     
     
     
1,946
     
     
1,946
 
US agency discount notes
   
2,003
     
(2)
     
2,001
     
8,506
     
(4)
     
8,502
 
Municipal bonds and notes
   
1,641
     
23
     
1,664
     
1,668
     
19
     
1,687
 
Total cash equivalents and marketable securities
 
$
63,744
   
$
549
     
64,293
   
$
124,825
   
$
207
     
125,032
 
                                                 
Cash on hand held in the United States
                   
5,783
                     
1,030
 
Cash on hand held overseas
                   
34,561
                     
22,377
 
Total cash on hand
                   
40,344
                     
23,407
 
Total cash, cash equivalents and marketable securities
                 
$
104,637
                   
$
148,439
 
                                                 
Reported as:
                                               
Cash and cash equivalents
                 
$
58,071
                   
$
44,283
 
Short-term marketable securities
                   
10,770
                     
42,134
 
Long-term marketable securities
                   
35,796
                     
62,022
 
                   
$
104,637
                   
$
148,439
 
 
The amortized cost and estimated fair value of cash equivalents and marketable securities, by contractual maturity, are as follows (in thousands):  
 
   
July 28, 2012
   
January 28, 2012
 
   
Book
Value
   
Fair
Value
   
Book
Value
   
Fair
Value
 
Due in 1 year or less
 
$
28,455
    $
28,497
   
$
62,970
   
$
63,010
 
Due in greater than 1 year
   
35,289
     
35,796
     
61,855
     
62,022
 
Total
 
$
63,744
     
64,293
   
$
124,825
   
$
125,032
 
 

3.
Fair values of assets and liabilities

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  The accounting standards establish a consistent framework for measuring fair value and disclosure requirements about fair value measurements and among other things, requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Fair value hierarchy

The accounting standards discuss valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost).  The standards utilize a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels.  The following is a brief description of those three levels:

 
Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets.

 
Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.

 
Level 3 - Valuation is generated from model-based techniques that use significant assumptions not observable in the market.  These unobservable assumptions reflect our estimate of assumptions that market participants would use in pricing the asset or liability.  Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
 
 
8

 

Determination of Fair Value

Our cash equivalents and marketable securities are classified within Level 1 because they are valued using quoted market prices, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency.  The types of marketable securities valued based on quoted market prices in active markets include most U.S. government and agency securities, sovereign government obligations, money market securities and certain corporate obligations with high credit ratings and an ongoing trading market.

Our foreign currency derivative instruments are classified as Level 2 because they are valued using quoted prices and other observable data of similar instruments in active markets.

The table below presents the balances of our assets and liabilities measured at fair value on a recurring basis as of July 28, 2012 and January 28, 2012 (in thousands):
   
As of July 28, 2012
 
   
Fair Value
   
Quoted Prices In Active Markets for Identical Assets
(Level 1)
   
Significant Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Corporate bonds
 
$
42,900
   
$
42,900
   
$
   
$
 
Money market funds
   
17,728
     
17,728
     
     
 
US agency discount notes
   
2,001
     
2,001
     
     
 
Municipal bonds and notes
   
1,664
     
1,664
     
     
 
Total cash equivalents and marketable securities
   
64,293
     
64,293
     
     
 
Restricted cash
   
1,766
     
1,766
     
     
 
Derivative instruments
   
(458)
     
     
(458)
     
 
Total assets/liabilities measured at fair value
 
$
65,601
   
$
66,059
   
$
(458)
   
$
 
 

   
As of January 28, 2012
 
   
Fair Value
   
Quoted Prices In Active Markets for Identical Assets
(Level 1)
   
Significant Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Corporate bonds
 
$
92,021
   
$
92,021
   
$
   
$
 
Money market funds
   
20,876
     
20,876
     
     
 
Corporate commercial paper
   
1,946
     
1,946
     
     
 
US agency discount notes
   
8,502
     
8,502
     
     
 
Municipal bonds and notes
   
1,687
     
1,687
     
     
 
Total cash equivalents and marketable securities
   
125,032
     
125,032
     
     
 
Restricted cash
   
1,769
     
1,769
     
     
 
Derivative instruments
   
(121)
     
     
(121)
     
 
Total assets/liabilities measured at fair value
 
$
126,680
   
$
126,801
   
$
(121)
   
$
 
 
Assets measured and recorded at fair value on a non-recurring basis

Our non-marketable convertible promissory note and preferred stock investments in privately-held venture capital funded technology companies are recorded at fair value only if an impairment charge is recognized.

As of July 28, 2012, we held equity investments in six, and promissory notes receivable in two, privately held venture capital funded technology companies with face values equal to cost of $6.4 million and $3.5 million, respectively.  Each of these investments constituted less than a 20% ownership position.  Furthermore, we do not believe that we have the ability to exert significant influence over any of these companies.

 
9

 

4.
Derivative financial instruments

Foreign exchange contracts are recognized either as assets or liabilities on the balance sheet at fair value at the end of each reporting period.  Changes in fair value of the derivatives are recorded as operating expenses or other income (expense), or as accumulated other comprehensive income, or OCI. 

We currently use and expect to continue to use foreign currency derivatives such as forward and option contracts as hedges against certain anticipated transactions denominated in Israeli shekels, or NIS.  For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of OCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings.  Gains and losses on derivatives representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
 
We currently do not assess our derivate contracts that are used in managing NIS denominated transactions for hedge effectiveness and thus such contracts do not qualify for hedge accounting.  As of July 28, 2012, we had foreign exchange contracts to sell up to approximately $12.6 million for a total amount of approximately NIS 47.7 million, that mature on or before June 26, 2013.  As of January 28, 2012, we had foreign exchange contracts to sell up to approximately $10.2 million for a total amount of approximately NIS 37.0 million, that mature on or before December 27, 2012.  For the three and six months ended July 28, 2012, we recognized losses of approximately $0.5 million and $0.4 million, respectively, as a result of foreign exchange contracts.  For the three and six months ended July 30, 2011, we recognized gains of approximately $0.2 million and $0.7 million, respectively, as a result of foreign exchange contracts.

The following table presents the fair value of our outstanding derivative instruments as of July 28, 2012 and January 28, 2012 (in thousands):
 
Derivative Assets
 
Balance Sheet Location
 
July 28, 2012
   
January 28, 2012
 
Foreign exchange contracts not designated as cash flow hedges
 
Current  liabilities
  $ (458 )   $ (121 )
Total fair value of derivative instruments
      $ (458 )   $ (121 )

The effects of derivative instruments on income and accumulated other comprehensive income for the three months and six months ended July 28, 2012 and July 30, 2011 are summarized below (in thousands):

 
 
Gains (Losses) Recognized
in Accumulated Other Comprehensive Income on
Derivatives
(Effective Portion)
   
Gains Reclassified from
Accumulated Other Comprehensive Income into Earnings
 
Gains (Losses) Recognized
in Earnings on Derivatives
(Including Ineffective Portion)
Derivatives instruments
 
Amount
   
Amount
 
Location
 
Amount
 
Location
                   
 
       
Three months ended July 28, 2012 foreign exchange contracts
 
$
   
$
 
Operating expenses and cost of revenue
 
$
(513)  
Interest and other
income, net
                             
Six months ended July 28, 2012 foreign exchange contracts
 
$
   
$
 
Operating expenses and cost of revenue
 
$
(431)  
Interest and other
income, net
                             
Three months ended July 30, 2011 foreign exchange contracts
 
$
   
$
29  
Operating expenses and cost of revenue
 
$
150  
Interest and other
income, net
                             
Six months ended July 30, 2011 foreign exchange contracts
 
$
   
$
103  
Operating expenses and cost of revenue
 
$
600  
Interest and other
income, net
 
 
10

 
 
5.
Restricted cash

As of July 28, 2012 and January 28, 2012, we had $1.8 million of restricted cash related to deposits pledged to a financial institution in connection with our foreign exchange forward hedging transactions and an office operating lease.


6.
Investments in and notes receivable from privately held companies
 
Issuer A, B, C, D, E and F

During fiscal 2009, we purchased shares of preferred stock in a privately held venture capital funded technology company (“Issuer A”) at a total investment cost of $1.0 million.  In the fourth quarter of fiscal 2010, we purchased additional shares of preferred stock in Issuer A at a cost of $1.0 million. 

In the third quarter of fiscal 2011, we purchased shares of preferred stock in another privately held technology company (“Issuer B”) at a total investment cost of $1.0 million. 

 In the fourth quarter of fiscal 2011, we purchased shares of preferred stock in another privately held technology company (“Issuer C”) at a total investment cost of $1.0 million.  

In the fourth quarter of fiscal 2011, we also purchased a convertible note from another privately held technology company (“Issuer D”) with a face value equal to the cost of $0.3 million.  This amount of $0.3 million will convert to a quantity of equity upon any closing of financing prior to December 31, 2012.  

In the second quarter of fiscal 2012, we purchased shares of preferred stock in another privately held technology company (“Issuer E”) at a total investment cost of $2.0 million.

In the third quarter of fiscal 2012, we made an equity investment of $0.2 million in a privately held joint venture (“Issuer F”).

As of July 28, 2012 and January 28, 2012, our equity investments in privately held companies were valued at $6.4 million, representing their cost.

Notes receivable from privately held companies

In November 2010, we loaned $1.0 million to Issuer A and received a secured promissory note.  This promissory note is secured by the assets of Issuer A, bearing interest at a rate of 5% per annum, and is scheduled to be fully repaid by June 2013.  In January 2012, we loaned $2.5 million to a privately held venture capital funded technology company (“Issuer G”), pursuant to a strategic agreement dated January 25, 2012.  We made this loan in exchange for a secured promissory note, bearing interest at a rate of 3% per annum.  The note plus the accrued interest is due 36 months from the agreement date.  The note is secured by the assets of Issuer G.  Additionally, pursuant to this agreement we have the right, subject to certain conditions, for one year from the agreement date, to acquire all the outstanding securities of Issuer G for $11.2 million.  As of July 28, 2012, these conditions had not been met and we had not determined whether we intend to exercise this right.  This right will expire in January 2013.  We have a variable interest in Issuer G and it is a variable interest entity, however, we have concluded that we are not the primary beneficiary of Issuer G because we do not have the power to direct the activities that most significantly impact Issuer G’s financial performance.  As of July 28, 2012, our maximum exposure to loss as a result of our involvement with Issuer G was limited to our $2.5 million note receivable.

As of July 28, 2012 and January 28, 2012, our notes receivable from privately held companies were valued at $3.5 million, representing their cost.  We made each of the above-described investments because we viewed the issuer as either having strategic technology or a business that would complement our technological capabilities or help create an opportunity for us to sell our chipset solutions.  In each case, we entered into a commercial or strategic agreement in connection with our investment.  None of our officers or directors held any interest in each of the issuers described above.
 
 
11

 
 
The following table sets forth the value of investments in and notes receivable from privately held companies as of July 28, 2012 and January 28, 2012 (in thousands):

Equity investments
 
July 28, 2012
   
January 28, 2012
 
Issuer A
  $ 2,000     $ 2,000  
Issuer B
    1,000       1,000  
Issuer C
    1,000       1,000  
Issuer D
    300       300  
Issuer E
    2,000       2,000  
Issuer F
    144       143  
Total equity investments
    6,444       6,443  

Notes receivable
           
Issuer A
    1,000       1,000  
Issuer G
    2,500       2,500  
Total notes receivable
    3,500       3,500  
                 
Total investments and notes   $ 9,944     $ 9,943  
 
7.
Inventories

Inventories consist of the following (in thousands):
 
 
 
July 28, 2012
   
January 28, 2012
 
Wafers and other purchased materials
 
$
15,416
   
$
11,006
 
Work-in-process
   
5,351
     
191
 
Finished goods
   
12,415
     
10,840
 
Total
 
$
33,182
   
$
22,037
 


8.
Acquisitions

On May 4, 2012, we completed our acquisition of certain assets from Trident Microsystems, Inc. and certain of its subsidiaries (collectively referred to as “Trident”) used in or related to Trident’s digital television and PC television businesses (the “DTV Business”) for a purchase price of $21.0 million plus additional cash consideration of $18.7 million as a result of adjustments based on the closing asset balance of the DTV Business, plus the assumption of certain employee related liabilities pursuant to an Asset Purchase Agreement dated March 23, 2012 (the “Purchase Agreement”).  The addition of Trident's industry-leading DTV media processor System-on-a-Chip, or SoC, products for next-generation Internet-enabled digital televisions is expected to significantly expand our served available market.  DTV products complement our existing IPTV set-top-box and connected media player SoC solutions and will augment our ability to develop innovative solutions for the anticipated convergence of IP-video delivery across any device within the home.
 
Pursuant to the Purchase Agreement, we acquired all of Trident’s DTV business products, certain licensed intellectual property rights, specified tangible assets and other assets specified in the Purchase Agreement.  We also acquired the right to use certain facilities of Trident under short-term facilities use agreements for facilities located in Shanghai and Beijing, China, The Netherlands, Taiwan and California.  We hired approximately 320 employees whose services are used in the DTV Business.  We also entered into a transition services agreement with Trident under which Trident agreed to provide certain services to us following the closing.  The purchaser of Trident's set-top box business also agreed to provide transition support services to us.
 
In connection with this acquisition, we obtained a valuation of the assets acquired in order to allocate the purchase price.  The total purchase price was allocated to the net tangible and identified intangible assets based upon fair values as of May 4, 2012.  The fair value of the tangible assets and identifiable intangible assets acquired, net of liabilities assumed, exceeded the purchase price by $1.4 million, which was recognized in the condensed statements of operations as a gain on acquisition.  The purchase price in the transaction was allocated as follows (in thousands, except years):
 
   
Amount
   
           
Purchase consideration:
         
Cash
 
$
39,740
   
           
Tangible assets acquired and liabilities assumed
 
$
40,019
   
           
         
Estimated
Useful Life
(in years)
Identifiable intangible assets:
         
Developed technology
   
1,138
 
3
Gain on acquisition
   
(1,417
)
 
Total consideration
 
$
39,740
   
 
 
12

 
 
Beginning in the second quarter of fiscal 2013, the results of operations of the DTV business are included in the condensed consolidated results of operations.  For the three and six months ended July 28, 2012, net sales of approximately $26.6 million and operating loss of approximately $2.1 million attributable to the DTV business were included in the condensed consolidated results of operations.

The following unaudited pro forma consolidated results of operations give effect to the acquisition of the DTV business as if it had occurred at January 30, 2011.  The unaudited pro forma consolidated results of operations are provided for informational purposes only and do not purport to represent actual consolidated results of operations had the acquisition occurred on the date assumed, nor are these financial statements necessarily indicative of future consolidated results of operations.  We expect to incur costs and realize benefits associated with integrating the operations of the DTV business.  The unaudited pro forma consolidated results of operations do not reflect the cost of any integration activities or any benefits that may result from operating efficiencies or revenue synergies.  The pro forma consolidated results of operations for the three and six months ended July 28, 2012 and July 30, 2011 include non-recurring adjustments of $3.5 million and $4.0 million of direct acquisition costs for the three and six months ended July 28, 2012, respectively (in thousands, except per share data).

   
Three Months Ended
   
Six Months Ended
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
Net revenue
 
$
68,251
   
$
85,877
   
$
131,453
   
$
202,778
Net loss
   
(13,418)
     
(32,442)
     
(45,665)
     
(45,709)
Basic and diluted net loss per share
   
(0.41)
     
(1.02)
     
(1.39)
     
(1.44)

On March 21, 2011, we executed a definitive agreement to acquire certain assets, including intangible assets and products, from a business division of a large computer manufacturer for $5.0 million in cash, which we paid on May 3, 2011.

The assets we acquired include a low-power High Definition, or HD, video encoder processor aimed at capturing HD video for visual telephony between set-top boxes, connected media players, Voice over Internet Protocol, or VoIP, devices, video phones, video conferencing TV’s and video surveillance devices.

In connection with this acquisition, we obtained a valuation of the assets acquired in order to allocate the purchase price.  The total purchase price was allocated to the net tangible and identified intangible assets based upon fair values as of March 21, 2011.  The excess purchase price over the value of the net tangible and identifiable intangible assets was recorded as goodwill.  The purchase price in the transaction was allocated as follows (in thousands, except years):
   
Amount
   
           
           
Purchase consideration:
         
Cash
 
$
5,000
   
           
Net tangible assets
 
$
752
   
           
         
Estimated
Useful Life
Identifiable intangible assets:
         
Developed technology:
         
Technology
   
1,250
 
5 years
Technology leveraged
   
1,680
 
8 years
Customer relationships
   
750
 
5 years
In-process research and development
   
370
 
Goodwill
   
198
 
Total consideration
 
$
5,000
   

 
9.
Intangible assets
 
In the first quarter of fiscal 2013, we concluded that it was appropriate to reclassify our purchased intellectual property, or IP, that is incorporated into our products, from software, equipment and leasehold improvements to intangible assets.  For comparability purposes, corresponding gross assets and accumulated amortization of $22.2 million and $5.9 million, respectively, have been reclassified as of January 28, 2012.  The reclassification has no effect on previously reported Condensed Consolidated Statements of Operations for any period and does not materially affect previously reported cash flows from operations or from financing activities in the Condensed Consolidated Statements of Cash Flows.
 
 
13

 
 
We amortize purchased IP over the estimated useful life of the associated products, which is generally two to three years, and begin amortization at the time that we begin shipment of the associated products into which it is incorporated.
 
The table below presents the balances of our intangible assets as of July 28, 2012 and January 28, 2012 (in thousands):
 
   
July 28,
2012
   
January 28,
2012
 
Acquired intangible assets
 
$
76,285
   
$
75,978
 
Purchased IP
   
22,457
     
22,204
 
Total
 
$
98,742
   
$
98,182
 
Accumulated amortization
   
(55,470)
     
(52,526)
 
Intangible assets, net
 
$
43,272
   
$
45,656
 

We assess the carrying value of long-lived assets whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable.  As of October 29, 2011, we performed a review of the carrying value of our acquired intangible assets due to continued reductions in our profitability and sales forecasts, and negative cash flows from operations.  In performing this review, we developed a forecast of the total undiscounted cash flow expected to be generated by each acquired intangible asset group and compared the result to the carrying value.  The results of this review indicated that two of these intangible asset groups, consisting primarily of certain developed technology and customer relationship intangibles related to our CopperGate acquisition, were not fully recoverable.  Therefore, we performed the second step of the analysis by developing a discounted cash flow analysis for each of the individual identifiable assets in these two groups to determine the amount of impairment.  Our analysis resulted in an intangible asset impairment charge of $55.1 million during the third quarter of fiscal 2012.  In addition, as a result of our review of indefinite-lived intangible assets during the third quarter of fiscal 2012, we recorded an impairment charge for our in-process research and development intangible assets of $11.1 million and a goodwill impairment charge of $45.1 million, which reduced the carrying value of goodwill to zero.

 
14

 

Acquired intangible assets, subject to amortization, were as follows as of July 28, 2012 and January 28, 2012 (in thousands, except for years): 
   
July 28, 2012
 
   
Gross Value
   
Impairment
   
Accumulated Amortization and Effect of Currency Translation
   
Net Value
   
Weighted Average Remaining Amortization Period (Years)
 
Developed technology
 
$
76,603
   
$
(24,614
)
  $
(31,245
)
 
$
20,744
   
4.2
 
Customer relationships
   
50,706
     
(30,486
)
   
(15,130
)
   
5,090
   
4.3
 
Purchased IP - amortizing
   
7,398
     
     
(5,803
)
   
1,595
   
1.7
 
Trademarks
   
2,676
     
     
(1,892
)
   
784
   
6.3
 
Non-compete agreements
   
1,400
     
     
(1,400
)
   
   
 
     
138,783
     
(55,100
)
   
(55,470
)
   
28,213
   
4.1
 
Purchased IP – not yet deployed
   
15,059
     
     
     
15,059
       
In-process research and development
   
11,070
     
(11,070
)
   
     
       
   
$
164,912
   
$
(66,170
)
 
$
(55,470
)
 
$
43,272
       


   
January 28, 2012
 
   
Gross Value
   
Impairment
   
Accumulated Amortization and Effect of Currency Translation
   
Net Value
   
Weighted Average Remaining Amortization Period
(Years)
 
Developed technology
 
$
75,827
   
$
(24,614
)
 
$
(28,455
)
 
$
22,758
   
4.7
 
Customer relationships
   
51,174
     
(30,486
)
   
(14,966
)
   
5,722
   
4.8
 
Purchased IP - amortizing
   
8,395
     
     
(5,900)
     
2,495
   
1.9
 
Trademarks
   
2,677
     
     
(1,805
)
   
872
   
6.6
 
Non-compete agreements
   
1,400
     
     
(1,400
)
   
   
 
     
139,473
     
(55,100
)
   
(52,526
)
   
31,847
   
4.8
 
Purchased IP – not yet deployed
   
13,809
     
     
     
13,809
       
In-process research and development
   
11,070
     
(11,070
)
   
     
       
   
$
164,352
   
$
(66,170
)
 
$
(52,526
)
 
$
45,656
       

Amortization expense related to acquired intangible assets and purchased IP was $2.5 million and $4.9 million for the three and six months ended July 28, 2012, respectively, and $5.3 million and $10.5 million for the three and six months ended July 30, 2011, respectively.  As of July 28, 2012, we had $15.1 million of purchased IP which we have not yet begun to amortize.  As of July 28, 2012, we expect the amortization expense in future periods to be as follows (in thousands):

Fiscal year
  Purchased IP-Amortizing    
Developed
Technology
   
Customer
Relationships
   
Trademarks
   
Total
 
Remainder of 2013
  $ 510     $ 3,247     $ 633     $ 89     $ 4,479  
2014
    835       5,757       1,265       120       7,977  
2015
    215       4,272       1,265       118       5,870  
2016
    35       3,955       1,109       118       5,217  
2017
          3,019       818       118       3,955  
Thereafter
          494             221       715  
    $ 1,595     $ 20,744     $ 5,090     $ 784     $ 28,213  
 
 
10.
Product warranty

In general, we sell products with a one-year limited warranty that our products will be free from defects in materials and workmanship.  Warranty cost is estimated at the time revenue is recognized based on historical activity, and additionally, for any specific known product warranty issues.  Accrued warranty cost includes hardware repair and/or replacement and software support costs and is included in accrued liabilities on the consolidated balance sheets.

 
15

 
 
Details of the change in accrued warranty as of July 28, 2012 and July 30, 2011 are as follows (in thousands):
 
Three Months Ended
 
Balance
Beginning
of Period
   
Additions
   
Deductions
   
Balance
End of
Period
 
July 28, 2012
 
$
1,125
   
$
232
   
$
(200)
    $
1,157
 
July 30, 2011
   
1,300
     
324
     
(297)
     
1,327
 
 
Six Months Ended
 
Balance
Beginning
of Period
   
Additions
   
Deductions
   
Balance
End of
Period
 
July 28, 2012
 
$
1,326
    $
356
    $
(525)
    $
1,157
 
July 30, 2011
   
1,300
     
530
     
(503)
     
1,327
 


11.           Commitments and contingencies

Commitments

Leases

Our primary facility in Milpitas, California is leased under a non-cancelable operating lease which expires in September 2012.  We also lease facilities in Canada, China, Denmark, France, Hong Kong, Israel, Japan, Singapore, Taiwan and Vietnam, and vehicles in Israel under non-cancelable operating leases.  Future minimum annual payments under operating leases are as follows (in thousands):

Fiscal years
 
Operating
Leases
 
Remainder of 2013
 
$
1,613
 
2014
   
1,965
 
2015
   
1,268
 
2016
   
821
 
2017
   
725
 
Thereafter
   
613
 
Total minimum lease payments
 
$
7,005
 

Purchase commitments

We place non-cancelable orders to purchase semiconductor products from our suppliers on an eight to twelve week lead-time basis.  As of July 28, 2012, the total amount of outstanding non-cancelable purchase orders was approximately $29.2 million.

Indemnifications

In certain limited circumstances, we have agreed and may agree in the future to indemnify certain customers against patent infringement claims from third parties related to our intellectual property.  In these limited circumstances, the terms and conditions of sale generally limit the scope of the available remedies to a variety of industry-standard methods including, but not limited to, a right to control the defense or settlement of any claim, procure the right for continued usage, and a right to replace or modify the infringing products to make them non-infringing.  To date, we have not incurred or accrued any significant costs related to any claims under such indemnification provisions.

Royalties

We pay royalties for the right to sell certain products under various license agreements.  During the three and six months ended July 28, 2012, we recorded royalty expense of $0.4 million and $0.8 million, respectively, and $0.5 million and $1.1 million for the three and six months ended July 30, 2011, respectively, which was recorded to cost of revenue.

Our wholly-owned subsidiary, Sigma Designs Israel SDI Ltd. (formerly, CopperGate Communication Ltd.), participated in programs sponsored by the Office of the Chief Scientist of Israel's Ministry of Industry, Trade and Labor, or the OCS, for the support of research and development activities that we conducted in Israel.  Through July 28, 2012, we had obtained grants from the OCS aggregating to $4.8 million for certain of our research and development projects in Israel.  We completed the most recent of these projects in 2007.  We are obligated to pay royalties to the OCS, amounting to 3% of the sales of certain products up to an amount equal to the amount of the grants received, plus LIBOR-based interest.  As of July 28, 2012, our remaining obligation under these programs was $0.7 million.
 
 
16

 
 
Contingencies

Litigation

On August 6, 2011, Powerline Innovations, LLC, or Powerline, filed suit against us, certain of our subsidiaries and many other named defendants, including Qualcomm Incorporated, Qualcomm Atheros, Inc., Broadcom Corporation and ST Microelectronics N.V. in the United States District Court for the Eastern District of Texas asserting infringement of U.S. Patent No. 5,471,190.  The Powerline complaint seeks unspecified monetary damages and injunctive relief.  At this time, we are unable to predict the outcome of this matter and, accordingly, cannot estimate the potential financial impact this action could have on our business, operating results, cash flows or financial position.
 
From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business.  We expect that the number and significance of these matters will increase as our business expands.  In particular, we could face an increasing number of patent and other intellectual property claims as the number of products and competitors in our industry grows.  Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources or cause us to enter into royalty or licensing agreements which, if required, may not be available on terms favorable to us or at all.  If an unfavorable outcome were to occur against us, there exists the possibility of a material adverse impact on our financial position and results of operations for the period in which the unfavorable outcome occurs and, potentially, in future periods.

Third-party licensed technology
 
 We license technologies from various third parties and incorporate that technology into our products.  From time to time, we are audited by licensors of these technologies for compliance with the terms of these licenses.  In the first quarter of fiscal 2013, we settled one such audit for $1.4 million.  As of July 28, 2012, we were under two such audits.  We have accrued estimated fees and penalties of $0.6 million in connection with these audits.  If we cannot resolve these audits in a cooperative manner with our license partners, we could be subject to revocation of the applicable license or other penalties, including additional cash penalties.


12.
Net loss per share

Basic and diluted net loss per share for the periods presented is computed by dividing net loss by the weighted average number of common shares outstanding.  

The following table sets forth the excluded anti-dilutive and excluded potentially dilutive securities for the three and six months ended July 28, 2012 and July 30, 2011 (in thousands):

   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
 
Stock options excluded because the effect of including would be anti-dilutive
   
168
     
329
     
161
     
470
 
Stock options excluded because exercise price is in excess of average stock price
   
5,454
     
5,421
     
5,500
     
4,429
 
Restricted stock awards and units excluded because the effect of including would be anti-dilutive
   
94
     
     
57
     
 
Restricted stock awards and units excluded because potential buyback shares exceed weighted average restricted stock units and awards outstanding
   
69
     
     
401
     
 

 
17

 

13.
Equity incentive plans and employee benefits

Stock incentive plans

We have adopted equity incentive plans that provide for the grant of stock option awards to employees, directors and consultants which are designed to encourage and reward their long-term contributions to us and provide an incentive for them to remain with us.  These plans also align our employees’ interest with the creation of long-term shareholder value.  As of July 28, 2012, we have four stock option plans: the 2003 Director Stock Option Plan (the “2003 Director Plan”), the 2001 Stock Plan (the “2001 Plan”), the Amended and Restated 2009 Stock Incentive Plan (the “2009 Incentive Plan”) and the CopperGate Share Option Plan (the “CopperGate Plan”).  The 2009 Incentive Plan was approved by our shareholders in July 2009 along with the approval of a one-time stock option exchange program.  The CopperGate Plan was assumed by us in connection with the acquisition of CopperGate in November 2009.

Our 2009 Incentive Plan provides for the grant of stock options, restricted stock, restricted stock units, other stock-related and performance awards that may be settled in cash, stock or other property.  In July 2009, 2,900,000 shares of common stock were reserved for issuance and in July 2011 an additional 2,000,000 shares were reserved for issuance under the 2009 Incentive Plan.  In addition, up to 1,000,000 shares of common stock subject to stock awards outstanding under the 2001 Plan but terminated prior to exercise and would otherwise be returned to the share reserves under our 2001 Plan may become available for issuance under the 2009 Incentive Plan. 
 
As of July 28, 2012, 2,044,611 shares were available for future grants under our stock incentive plans.  Additionally, up to 648,106 shares of common stock subject to stock awards outstanding under the 2001 Plan may become available for issuance under the 2009 Incentive Plan.  As of September 23, 2009, the 2001 Plan and the 2003 Director Plan were closed for future grants, however, these plans will continue to govern all outstanding options that we originally granted from each plan.

Stock Options

The total stock option activities and balances of our stock option plans are summarized as follows:
 
   
Number of
Shares
Outstanding
   
Weighted Average
Exercise Price
Per Share
   
Weighted Average
Remaining
Contractual Term
(Years)
   
Aggregate
Intrinsic
Value
 
Balance, January 28, 2012
   
5,846,027
   
$
12.47
     
6.16
   
$
885,840
 
Granted
   
     
                 
Cancelled
   
(152,654
)
   
11.33
                 
Exercised
   
(25,801
)
   
2.18
                 
Balance, April 28, 2012
   
5,667,572
     
12.54
     
6.03
     
710,739
 
Granted
   
100,000
     
5.56
                 
Cancelled
   
(84,414
)
   
12.34
                 
Exercised
   
(5,201
)
   
3.23
                 
Balance, July 28, 2012
   
5,677,957
     
12.43
     
5.72
     
1,163,897
 
                                 
Ending Vested and Expected to Vest
   
5,598,252
     
12.47
     
5.68
     
1,127,291
 
Ending Exercisable
   
3,946,445
     
13.12
     
4.96
     
861,903
 

The aggregate intrinsic value as of July 28, 2012 in the table above represents the total pretax intrinsic value, based on our closing stock price of $6.74 on that date, which would have been received by the option holders had all options holders exercised their options as of that date.  The aggregate exercise date intrinsic value of options that were exercised under our stock option plans, determined as of the dates of option exercises, was zero and $0.1 million for the three and six months ended July 28, 2012, respectively, and $0.2 million and $0.8 million for the three and six months ended July 30, 2011, respectively.  The total fair value of options which vested, determined as of the dates such options vested, was $2.0 million and $3.5 million during the three and six months ended July 28, 2012, respectively, and $2.9 million and $6.1 million during the three and six months ended July 30, 2011, respectively.

As of July 28, 2012, the unrecorded stock-based compensation balance related to stock options outstanding excluding estimated forfeitures was $14.9 million and will be recognized over an estimated weighted average amortization period of 2.7 years.  The amortization period is based on the expected remaining vesting term of the options.
 
 
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Restricted Stock Awards

We value restricted stock awards, or RSAs, using the quoted market price of the underlying stock on the date of grant.  RSAs are granted under our 2009 Incentive Plan and reduce shares available to grant under the plan by 1.3 shares for every one share of restricted stock granted and consist of time-based restricted shares, which shares are subject to forfeiture until vested if length of service requirements are not met.  The majority of RSAs vest over five years according to the terms specified in the individual grants.  As of July 28, 2012, the unrecorded stock-based compensation balance related to RSAs outstanding excluding estimated forfeitures was $1.5 million and will be recognized over an estimated weighted average amortization period of 3.4 years.  The following table sets forth the shares of restricted stock awards outstanding as of July 28, 2012:
 
   
Restricted Stock Awards
   
Weighted Average
Grant Date
Fair Value Per Award
   
Aggregate
Value
 
Balance as of January 28, 2012
   
231,179
   
$
8.82
     
 
 
Granted
   
                 
Released
   
                 
Balance as of April 28, 2012
   
231,179
     
8.82
         
Granted
   
                 
Released
   
(28,070
)
   
8.63
         
Balance as of July 28, 2012
   
203,109
     
8.84
   
$
1,795,484
 
 

Restricted Stock Units

We value restricted stock units, or RSUs, using the quoted market price of the underlying stock on the date of grant.  RSUs are granted under our 2009 Incentive Plan and reduce shares available to grant under the plan by 1.3 shares for every one restricted stock unit granted and consist of time-based restricted stock units.  The RSUs granted under this plan primarily vest over a period of four years according to the terms specified in the individual grants.  As of July 28, 2012, the unrecorded stock-based compensation balance related to RSUs outstanding excluding estimated forfeitures was $3.4 million and will be recognized over an estimated weighted average amortization period of 3.4 years.  The following table sets forth the shares of RSUs outstanding as of July 28, 2012:

   
Restricted Stock Units
   
Weighted Average
Grant Date
Fair Value Per Unit
   
Aggregate
Value
 
Balance as of January 28, 2012
   
547,500
   
$
5.92
     
 
 
Granted
   
23,075
     
6.03
         
Cancelled
   
(7,600
)
   
6.44
         
Balance as of April 28, 2012
   
562,975
     
5.62
         
Granted
   
84,625
     
5.56
         
Released
   
(234
)
   
5.95
         
Cancelled
   
(21,975
)
   
6.36
         
Balance as of July 28, 2012
   
625,391
     
6.74
   
$
4,215,135
 


Employee stock purchase plan
 
As of July 28, 2012, we had reserved a total of 2,500,000 shares of common stock for issuance under the 2010 Purchase Plan, of which 1,106,269 shares had been issued.

Valuation of stock-based compensation

The fair value of RSA and RSU awards is based on the quoted market price of the underlying stock at the date of grant.  The fair value of stock option and employee stock purchase plan right awards is estimated at the grant date using the Black-Scholes option valuation model.  The determination of fair value of stock option and employee stock purchase plan right awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables.  These variables include, but are not limited to, our expected stock price volatility over the term of the awards and actual employee stock option exercise behavior.

 
19

 

The fair value of each option and employee stock purchase plan right was estimated on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions:
 
   
Three Months Ended
 
   
July 28, 2012
   
July 30, 2011
 
   
Stock Option Plan
   
Employee Stock Purchase Plan
   
Stock Option Plan
   
Employee Stock Purchase Plan
 
Expected volatility
    52.07 %     41.54 %     52.02 %     49.49 %
Risk-free interest rate
    0.82 %     0.16 %     1.70 %     0.10 %
Expected term (in years)
    5.88       0.50       5.94       0.50  
Dividend yield
 
None
   
None
   
None
   
None
 
Weighted average fair value at grant date
  $ 2.70     $ 1.70     $ 5.92     $ 2.27  
 
 
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
 
   
Stock Option Plan
   
Employee Stock Purchase Plan
   
Stock Option Plan
   
Employee Stock Purchase Plan
 
Expected volatility
    52.07 %     41.54 %     51.78 %     49.49 %
Risk-free interest rate
    0.82 %     0.16 %     1.90 %     0.10 %
Expected term (in years)
    5.88       0.50       5.93       0.50  
Dividend yield
 
None
   
None
   
None
   
None
 
Weighted average fair value at grant date
  $ 2.70     $ 1.70     $ 6.25     $ 2.27  

The computation of the expected volatility assumptions used in the Black-Scholes calculations for new stock option and employee stock purchase plan right awards is based on the historical volatility of our stock price, measured over a period equal to the expected term of the grants or purchase rights.  The risk-free interest rate is based on the yield available on U.S. Treasury Strips with an equivalent remaining term.  The expected term of stock options represents the weighted-average period that the stock options are expected to remain outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based payment awards and vesting schedules.  The expected term of employee stock purchase rights is the period of time remaining in the current offering period.  The dividend yield assumption is based on our history of not paying dividends and assumption that we will not pay dividends in the future.

The following table sets forth the total stock-based compensation expense that is included in each functional line item in the Condensed Consolidated Statements of Operations (in thousands):

   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
 
Cost of revenue
  $ 133     $ 129     $ 250     $ 229  
Research and development expenses
    1,508       1,684       2,971       3,216  
Sales and marketing expenses
    483       565       955       1,159  
General and administrative expenses
    627       758       1,400       1,723  
Total share-based compensation
  $ 2,751     $ 3,136     $ 5,576     $ 6,327  

401(k) tax deferred savings plan

We maintain a 401(k) tax deferred savings plan for the benefit of qualified employees who are U.S. based.  Under the 401(k) tax deferred savings plan, U.S. based employees may elect to reduce their current annual taxable compensation up to the statutorily prescribed limit.  We have a matching contribution program whereby we match employee contributions made by each employee at a rate of $0.25 per $1.00 contributed.  The matching contributions to the 401(k) tax deferred savings plan totaled $0.2 million and $0.5 million for the three and six months ended July 28, 2012, respectively, and $0.2 million and $0.5 million for the three and six months ended July 30, 2011, respectively.  

Group registered retirement savings plan

We maintain a Group Registered Retirement Savings Plan, or GRRSP, for the benefit of qualified employees who are based in Canada.  Under the GRRSP, Canadian based employees may elect to reduce their annual taxable compensation up to the statutorily prescribed limit, which is $22,970 Canadian in calendar year 2012.  We have a matching contribution program under the GRRSP whereby we match employee contributions made by each employee up to 2.5% of their annual salary.  The matching contributions to the GRRSP for the three and six months ended July 28, 2012 and July 30, 2011 were not significant.  
 
 
20

 
 
Endowment insurance pension plan
 
Related to our acquisition of our DTV business in the second quarter of fiscal 2013, we added operations in Shanghai, China.  It is required by the “Procedures of Shanghai Municipality on Endowment Insurance for Town Employees” to provide pension insurance for Shanghai employees.  The plan is managed by the local authority and it is a mandatory plan.  Under the current plan, the employee will contribute 8.0% of the annual base to the plan and the employer will match 22% of the annual base.  For calendar year 2012, the annual base is capped at RMB 12,993.  The matching contributions to the Pension Insurance totaled $0.2 million for the three and six months ended July 28, 2012.

Retirement pension plan

We maintain a Retirement Pension Plan for the benefit of qualified employees who are based in Denmark.  Under the Retirement Pension Plan, Denmark-based employees may elect to reduce their annual taxable compensation up to their annual salary.  We have a matching contribution program whereby we will contribute 3.0% of our employee’s annual salary and may elect to terminate future contributions at our option at any time.  The matching contributions to the Retirement Pension Plan for the three and six months ended July 28, 2012 and July 30, 2011 were not significant.  

Severance plan

We maintain a severance plan for several Israeli employees pursuant to Israel's Severance Pay Law based on the most recent salary of the employees multiplied by the number of years of employment.  Upon termination of employment, employees are entitled to one month salary for each year of employment or a portion thereof.  As of July 28, 2012, we have an accrued severance liability of $1.2 million partially offset by $1.1 million of severance employee funds.


 14.
Segment and geographical information

Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance.  We are organized as, and operate in, one reportable segment.  Our operating segment consists of our geographically based entities in the United States, Hong Kong, Israel and Singapore.  Our chief operating decision-maker reviews consolidated financial information, accompanied by information about revenue by product group, target market and geographic region.  We do not assess the performance of our geographic regions on other measures of income or expense or net income.

The following table sets forth net revenue for each geographic region based on the ship-to location of customers (in thousands):
   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
 
Asia
 
$
44,314
   
$
42,575
   
$
80,918
   
$
100,189
 
North America
   
5,325
     
2,785
     
7,191
     
4,900
 
Europe
   
15,924
     
1,087
     
16,513
     
1,929
 
Other regions
   
2,688
     
247
     
3,887
     
308
 
Net revenue
 
$
68,251
   
$
46,694
   
$
108,509
   
$
107,326
 


 The following table sets forth net revenue to each significant country based on the ship-to location of customers (in thousands):
   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
 
China, including Hong Kong
 
$
32,465
   
$
35,974
   
$
62,543
   
$
87,097
 
Hungary
   
12,159
     
     
12,159
     
 
Rest of the world
   
23,627
     
10,720
     
33,807
     
20,229
 
Net revenue
 
$
68,251
   
$
46,694
   
$
108,509
   
$
107,326
 


The following table sets forth the major customers that accounted for 10% or more of our net revenue:

   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
July 30, 2011
   
July 28, 2012
   
July 30, 2011
 
TP Vision
    18%       *       11%       *  
Flextronics
    *       *       12%       *  
Motorola
    *       17%       12%       19%  
Gemtek
    *       28%       *       29%  

* This customer provided less than 10% of our net revenue in this period.
 
One international customer accounted for 23% of total accounts receivable as of July 28, 2012.  Four international customers accounted for 17%, 17%, 15% and 13% of total accounts receivable as of January 28, 2012.
 
 
21

 
 
ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion in conjunction with our unaudited condensed consolidated financial statements and related notes in this Form 10-Q and our Form 10-K previously filed with the Securities and Exchange Commission.  Except for historical information, the following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  In some cases, you can identify forward-looking statements by terms such as "may," "might," "will," "objective," "intend," "should," "could," "can," "would," "expect," "believe," "estimate," "predict," "potential," "plan," or the negative of these terms, and similar expressions intended to identify forward-looking statements.  These forward-looking statements, include, but are not limited to, statements about our capital resources and needs, including the adequacy of our current cash reserves, revenue, anticipated seasonality associated with our DIV business and our expectations that our gross margin will vary from period to period.  These forward-looking statements involve risks and uncertainties.  Our actual results may differ significantly from those projected in the forward-looking statements.  Factors that might cause future results to differ materially from those discussed in the forward-looking statements include, but are not limited to, those discussed under Part II, Item 1A “Risk Factors” in this Form 10-Q as well as other information found in the documents we file from time to time with the Securities and Exchange Commission.  Also, these forward-looking statements represent our estimates and assumptions only as of the date of this Form 10-Q.  Unless required by U.S. federal securities laws, we do not intend to update any of these forward-looking statements to reflect circumstances or events that occur after the statement is made.

 Overview

Our goal is to be a leader in connected media platforms for use in home entertainment and control.  We focus on integrated chipset solutions that serve as the foundation for some of the world’s leading internet protocol television, or IPTV, set-top boxes, digital televisions, connected media players, residential gateways and home control systems.  We have four chipset product lines: media processor products, home networking products, video image processor and encoder products, and home control and energy management automation products.  We sell our products into six primary markets: digital television, or DTV, Home networking, IPTV media processor, home control and energy management, connected media player and prosumer and industrial audio/video markets.  We also sell a small amount of our chipsets into other markets, such as the digital signage, projection TV and PC-based add-in markets, which we refer to as our other market.  We believe our software suite is a key differentiator within each of our target markets.  Our software suite provides a foundation for our customers to develop their products that incorporate our chipsets.

Our chipset products and target markets

Products

Our products are delineated into four primary lines of chipset products.  Our chipsets are targeted toward manufacturers and large volume original equipment manufacturers, or OEMs, and original design manufacturers, or ODMs, building products for the DTV, home networking, IPTV media processor, home control and energy management, connected media player and prosumer and industrial audio/video consumer electronic markets.  We derive nearly all of our net revenue from sales of our chipset products.  We derive a minor portion of our revenue from other products and services, including technology licenses, software development kits, engineering support services for hardware and software, engineering development for customization of chipsets and other accessories.  The revenue derived from other products and services is not a significant portion of our total net revenue.

Home Networking

Our home networking product line consists of wired home networking controller chipsets that are designed to provide connectivity solutions between various home entertainment products and incoming video streams.  We believe these connectivity solutions provide consumers additional connection choices with greater flexibility and allow system integrators and service providers an opportunity to reduce their time and cost of home networking installations.  Our home networking solutions are based on the HomePNA, or HPNA, HomePlug AV, or HPAV, and G.hn standards.  HPNA and HPAV are two of the current leading technology standards used for transferring internet protocol, or IP, content across coaxial cables, phone lines and power lines.  G.hn is the next generation ITU standard ratified in 2010 to create a unified global standard across coaxial cables, phone lines and power lines.  Products based on these technologies enable service providers such as telecommunication carriers, cable operators and satellite providers to deliver IPTV solutions and other media-rich applications such as HDTV, Voice over Internet Protocol, or VoIP, and fast internet throughout the home.
 
 
22

 
 
Media Processors

Our media processor product line consists of two distinct, but functionally similar, platforms that include highly integrated chipsets and reference system designs.  One platform, secure media processors, provides processing prior to the TV and the other, DTV processors, within the TV.  Both are based around multiple elements of media processing that typically include functionalities such as combined video and audio decoding, graphics processing, display processing, security management, memory control, peripheral interfaces, frame rate conversion, motion estimation and compensation, and one or more application processors, or CPUs.  Our embedded software suite provides an operating environment and coordinates the real-time processing of digital video and audio content, is readily customizable by our customers and is interoperable with multiple standard operating systems. Our reference system designs provide a hardware implementation of the circuit board, access to our embedded software suite, and sometimes provide a prototypical end-use product example for customer evaluation and use.

We believe our two media processor chipset lines deliver industry-leading performance in video and audio decoding and picture quality, respectively, which allows our customers to offer consumers a high-quality viewing experience.  Outside the TV, we surround the media processing functionality with a security management system, one of more in-chip CPUs, a high-speed memory interface and complementary system peripherals.  Within the TV, media processing includes the use of enhanced algorithms for functionalities such as motion estimation and compensation, picture conversion, noise reduction, and de-interlacing.  As a result, we believe our media processor solutions enable our customers to efficiently bring competitive consumer multimedia devices to market.  We believe IPTV set-top box, connected media player, and DTV designers and other devices manufacturers select our media processor solutions because of their high performance and ease of integration.

Home Control and Energy Management Automation

Our home control and energy management automation product line consists of our wireless Z-Wave chipsets.  These chipsets enable consumers to enjoy advanced home control and energy management automation functionality, such as home security, environmental and energy control and monitoring, within both new and existing homes.  These devices consist of wireless transceiver devices along with a mesh networking protocol.  Our Z-Wave chipsets utilize a low-bitrate, low-power, low-cost RF communication technology that provides an interoperable connected home security, monitoring and automation solution.
 
Video Image Processors and Encoders

Our video image processor and encoder products consist of our VXP brand video image processor chipsets and our video encoder chipsets.  Our VXP chipsets are standalone high performance semiconductors that provide studio-quality video output or input for professional, prosumer and consumer applications and address applications including audio/video receivers, broadcast studios, digital cinema, digital signage, front-projection home theatre televisions, HDTV, medical imaging and video conferencing systems.  Our video encoder chipsets are designed to capture video for visual telephony between set-top boxes, connected media players, VoIP devices, video conferencing TVs and video surveillance devices.

Target Markets

DTV Market

Our DTV media processor products are primarily for the next generation Internet-enabled digital televisions.  DTV products complement our IPTV set-top box and connected media player solutions, which we believe will enable us to develop highly innovative solutions for the anticipated convergence of Internet video delivery across any device within the home.

Home Networking Market

The home networking market consists of communication devices that use a standard protocol to connect equipment inside the home and stream IP-based video and audio, VoIP or data through wired connectivity.  Our home networking products are currently used in IPTV set-top boxes as well as residential gateways, optical network terminals, multiple-dwelling unit, or MDU, masters and network adapters by leading OEMs, such as Actiontec, Cisco Systems, Pace and Motorola.  Set-top boxes containing our home networking products are deployed globally, primarily in North America, by telecommunications carriers, such as AT&T, Bell Aliant, Bell Canada, Century Link and Telus.  To date, we have not generated significant revenue from our products based on HPAV or G.hn technologies.

IPTV Media Processor Market

The IPTV media processor market consists primarily of telecommunication carriers that deploy IPTV set-top boxes for delivering video services over a DSL network.  We serve this market primarily with our media processor products.  We are a leading provider of high definition digital media processors for set-top boxes in the IPTV media processor market in terms of units shipped.  Our media processor products are used by leading IPTV set-top box providers, such as Cisco Systems, Motorola, Netgem and Samsung.  IPTV set-top boxes incorporating our media processors are deployed by telecommunications carriers globally including carriers in Asia, Europe and North America, such as AT&T, Deutsche Telekom, NTT and SFR.  We work with these carriers and set-top box providers as well as with systems software providers, such as Microsoft and various Android and Linux providers, to design solutions that address carriers' specific requirements regarding features and performance.  In connection with our efforts to expand our IPTV media processor market, we have development projects underway to address the hybrid set-top box opportunities that result from combining IPTV with cable and terrestrial broadcast reception.
 
 
23

 
 
Home Control and Energy Management Market

The home control and energy management market consists of communication devices that use a standard protocol to connect equipment inside the home through wireless connectivity.  Our wireless Z-Wave home control and energy management automation products are used in a wide variety of consumer products such as thermostats, light switches and door locks.  These consumer products are designed by leading industry participants such as Danfoss, Ingersoll-Rand (Schlage and Trane), Leviton and Cooper Wiring.

Prosumer and Industrial Audio/Video Market

The prosumer and industrial audio/video market consists of studio quality audio/video receivers and monitors, video conferencing, digital projectors and medical video monitors.  We target this market with our video image processor and video encoder product lines.  Our VXP video image processor products are one of the leading solutions for studio-quality video image processing and are used by leading industry participants, such as Harris, Panasonic, Polycom and Sony.  Our video encoder products are used in security and video conferencing systems.

Connected Media Player Market

The connected media player market consists primarily of digital media adapters, or DMAs, portable media devices and wireless streaming PC to TV devices that perform playback of digital media.  We target this market with our media processor products.  Our media processors are used by consumer electronics providers, such as Iomega, Netgear and Western Digital in applications such as DMAs and other connected media player devices.

Other Markets

We also sell products into other markets, such as the digital signage, projection TV and PC-based add-in markets, which we refer to as our other market.  We derive minor revenue from sales of our products into these other markets.

Characteristics of Our Business
 
We do not enter into long-term commitment contracts with our customers and generate substantially all of our net revenue based on customer purchase orders.  We forecast demand for our products based not only on our assessment of the requirements of our direct customers, but also on the anticipated requirements of the telecommunications carriers that our direct customers serve.  We work with both our direct customers and these carriers to address the market demands and the necessary specifications for our technologies.  However, our failure to accurately forecast demand can lead to product shortages that can impede production by our customers and harm our relationship with these customers or lead to excess inventory, which could negatively impact our gross margins in a particular period.  During the year ended January 28, 2012, we recorded provisions for excess inventory of $9.0 million primarily due to a large end customer’s transition to a next generation product sold by one of our competitors.

Our business is substantially dependent upon being designed into set-top boxes of large telecommunications carriers.  If we are not designed into a particular generation of set-top boxes for our large target end customers, our operating results can be materially and adversely affected.  We must spend a considerable amount of resources to compete for these design wins and the failure to obtain a design win for a particular generation of set-top boxes, and in particular for our large target end customers, means we likely would not recover a substantial portion of our expenses in competing for these design wins.  However, if we do obtain these design wins, it is often the case that our end customer and direct customer will continue to incorporate our chipset solutions for that generation of set-top boxes.  The set-top box industry is cyclical due to product transitions from generation to generation.  Each generation typically incorporates emerging technologies, and so we must expend a considerable amount of research and development resources in order to compete in each of these cycles.  Our failure to obtain a design win in a particular generation does not mean we necessarily will be unable to obtain a design win in the next generation.  For example, our sales in the IPTV media processor market decreased in the past four fiscal quarters as a result of our inability to obtain certain design wins for our last generation of chipset solutions.  However, we are in the process of competing for the next generation of set-top boxes, and we believe our chipset solutions contain features and prices that compete favorably with competitive offerings.
 
 
24

 
 
Many of our target markets are characterized by intense price competition.  The semiconductor industry is highly competitive and, as a result, we expect our average selling prices to decline over time.  On occasion, we have reduced our prices for individual customer volume orders as part of our strategy to obtain a competitive position in our target markets.  The willingness of customers to design our chipsets into their products depends to a significant extent upon our ability to sell our products at competitive prices.  If we are unable to reduce our costs sufficiently to offset any declines in product selling prices or are unable to introduce more advanced products with higher gross margins in a timely manner, we could see declines in our market share or gross margins.  We expect our gross margins will vary from period to period due to changes in our average selling prices and average costs, volume order discounts, mix of product sales, amount of development revenue and provisions for inventory excess and obsolescence.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations are based on our unaudited condensed consolidated financial statements which have been prepared in accordance with United States generally accepted accounting principles.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts and disclosures of the assets and liabilities at the date of the unaudited condensed consolidated financial statements and also revenue and expenses during the period reported.  By their nature, these estimates and judgments are subject to an inherent degree of uncertainty.  Management bases its estimates and judgments on historical experience, market trends and other factors that are believed to be reasonable under the circumstances.  These estimates form the basis for judgments about the carrying value of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from what we anticipate and different assumptions or estimates about the future could change our reported results.  Management believes the critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended January 28, 2012 reflect the more significant judgments and estimates used in preparation of our annual and interim financial statements except for the updated policies below.
 
Reclassifications:  Certain prior fiscal year balances have been reclassified to conform to the current fiscal year presentation.  In the first quarter of fiscal 2013, we concluded that it was appropriate to reclassify our purchased intellectual property, or IP, that is incorporated into our products, from software, equipment and leasehold improvements to intangible assets.  The reclassification has no effect on previously reported Condensed Consolidated Statements of Operations for any period and does not affect previously reported cash flows from operations or from financing activities in the Condensed Consolidated Statements of Cash Flows.  For comparability purposes, the corresponding gross assets and accumulated amortization of $22.0 million and $5.9 million, respectively, have been reclassified as of January 28, 2012.  Such reclassifications had no effect on previously reported results of operations or retained earnings.
 
Software, equipment and leasehold improvements:  Software, equipment and leasehold improvements are stated at cost.  Depreciation and amortization for software, equipment and leasehold improvements are computed using the straight-line method based on the useful lives of the assets (one to five years) or the remaining lease term if shorter.  Any allowance for leasehold improvements received from the landlord for improvements to our facilities is amortized using the straight-line method over the lesser of the remaining lease term or the useful life of the leasehold improvements.  Repairs and maintenance costs are expensed as incurred.

Long-lived assets:   The amounts and useful lives assigned to finite-lived intangible assets acquired, other than goodwill, impact the amount and timing of future amortization.  Long-lived assets include intellectual property that we purchase for incorporation into our product designs.  We begin amortizing such intellectual property at the time that we begin shipment of the associated products into which it is incorporated.  We amortize the intellectual property over the estimated useful life of the associated products, which is generally two to three years.  We assess the carrying value of long-lived assets, including purchased intangible assets, whenever events or changes in circumstances, such as a change in technology, indicate that the carrying value of these assets may not be recoverable.  An impairment loss would be recognized when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposal is less than its carrying amount.

 
25

 

Results of Operations

The following table is derived from our unaudited condensed consolidated financial statements and sets forth our historical operating results as a percentage of net revenue for each of the periods indicated (in thousands, except percentages):
 
   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
% of Net Revenue
   
July 30, 2011
   
% of Net Revenue
   
July 28, 2012
   
% of Net Revenue
   
July 30, 2011
   
% of Net Revenue
 
Net revenue
 
$
68,251
     
100%
   
$
46,694
     
100%
   
$
108,509
     
100%
   
$
107,326
     
100%
 
Cost of revenue
   
37,671
     
55%
     
33,700
     
72%
     
56,834
     
52%
     
64,540
     
60%
 
Gross profit
   
30,580
     
45%
     
12,994
     
28%
     
51,675
     
48%
     
42,786
     
40%
 
Operating expenses:
                                                               
Research and development
   
27,975
     
41%
     
21,805
     
47%
     
49,764
     
46%
     
43,401
     
40%
 
Sales and marketing
   
7,795
     
11%
     
8,429
     
18%
     
14,683
     
13%
     
16,930
     
16%
 
General and administrative
   
9,489
     
14%
     
5,197
     
11%
     
15,868
     
15%
     
10,632
     
10%
 
Gain on acquisition
   
(1,417)
     
(2%)
     
             
(1,417)
     
(1%)
     
         
Total operating expenses
   
43,842
     
64%
     
35,431
     
76%
     
78,898
     
73%
     
70,963
     
66%
 
Loss from operations
   
(13,262)
     
(19%)
     
(22,437)
     
(48%)
     
(27,223)
     
(25%)
     
(28,177)
     
(26%)
 
Interest income and other income, net
   
242
     
*
     
734
     
1%
     
733
     
1%
     
1,553
     
1%
 
Loss before income taxes
   
(13,020)
     
(19%)
     
(21,703)
     
(47%)
     
(26,490)
     
(24%)
     
(26,624)
     
(25%)
 
Provision for income taxes
   
398
     
1%
     
259
     
*
     
630
     
1%
     
1,008
     
*
 
Net loss
 
$
(13,418)
     
(20%)
   
$
(21,962)
     
(47%)
   
$
(27,120)
     
(25%)
   
$
(27,632)
     
(25%)
 
 
* The percentage of net revenue is less than one percent.

Net revenue

Our net revenue for the three months ended July 28, 2012 increased $21.6 million, or 46%, compared to the corresponding period in the prior fiscal year.  Net revenue benefited $26.6 million from the addition of the DTV product line, resulting from our acquisition of certain assets from Trident Microsystems in the second quarter of fiscal 2013.  Excluding DTV, our net revenue for the three months ended July 28, 2012 decreased $5.0 million, or 11%, compared to the corresponding period in the prior fiscal year.  The net revenue decrease was primarily attributable to decreases in sales in the IPTV media processor and connected media player markets of $8.2 million and $3.8 million, respectively, partially offset by increases in the home networking market and license revenue from our home control and energy management technology of $6.7 million and $1.4 million, respectively.

Our net revenue for the six months ended July 28, 2012 increased $1.2 million, or 1%, compared to the corresponding period in the prior fiscal year.  Net revenue benefited $26.6 million from the addition of the DTV product line, resulting from our acquisition of certain assets from Trident Microsystems in the second quarter of fiscal 2013.  Excluding DTV, our net revenue for the six months ended July 28, 2012 decreased $25.4 million, or 24%, compared to the corresponding period in the prior fiscal year.  The net revenue decrease was primarily attributable to decreases in sales in the IPTV media processor, connected media player and prosumer and digital audio/video markets of $20.1 million, $8.5 million, and $0.9 million respectively, partially offset by an increase in sales to the home networking market and license revenue from our home control and energy management technology of $2.5 million and $1.4 million, respectively.

Net revenue by target market

We sell our products into six primary target markets, which are the DTV market, home networking market, IPTV media processor market, home control and energy management market, prosumer and industrial audio/video market and connected media player market.  We also sell a small amount of our chipsets into other markets, such as the digital signage, projection TV and PC-based add-in markets, which we refer to as our other market.

 
26

 

The following table sets forth our net revenue by target market and the percentage of net revenue represented by our product sales to each target market (in thousands, except percentages):
 
   
Three Months Ended
   
Six Months Ended
 
   
July 28, 2012
   
% of Net Revenue
   
July 30, 2011
   
% of Net Revenue
   
July 28, 2012
   
% of Net Revenue
   
July 30, 2011
   
% of Net Revenue
 
DTV
 
$
26,576
     
39%
   
$
            $
26,576
     
24%
   
$
         
Home networking
   
22,418
     
33%
     
15,734
     
34%
   
 
43,256
     
40%
     
40,718
     
38%
 
IPTV media processor
   
10,150
     
15%
     
18,349
     
39%
     
20,540
     
19%
     
40,657
     
38%
 
Home control and energy management
   
4,510
     
6%
     
3,702
     
8%
     
7,694
     
7%
     
6,128
     
6%
 
Prosumer and industrial audio/video
   
2,691
     
4%
     
3,270
     
7%
     
5,262
     
5%
     
6,153
     
6%
 
Connected media player
   
1,825
     
3%
     
5,623
     
12%
     
4,977
     
5%
     
13,478
     
12%
 
Other
   
81
     
*
     
16
     
*
     
204
     
*
     
192
     
*
 
Net revenue
 
$
68,251
     
100%
   
$
46,694
     
100%
   
$
108,509
     
100%
   
$
107,326
     
100%
 
 
* This market provided less than 1% of our net revenue in this period.

DTV market:  Our acquisition of the DTV assets of Trident Microsystems in the second quarter of fiscal 2013 allowed us to expand our participation in the DTV market, which previously had not been significant and had been included in the other markets category. We believe DTV products complement our existing IPTV media processor and connected media player products, which will provide substantial research and development leverage and improved operating scale to augment our ability to develop innovative solutions for the anticipated convergence of IP-video delivery across any device within the connected home.  Net revenue from sales of our products into the DTV market was $26.6 million for the three and six months ended July 28, 2012, or 39% and 24%, respectively, of total net revenue.  We expect that our DTV business may experience some seasonality common to consumer electronics markets as Trident Microsystems typically experienced slower DTV sales in the first quarter of the calendar year and strongest DTV sales in the third calendar quarter.  We expect our revenue from the DTV market to continue to be a significant percentage of net revenues but will fluctuate in future periods as we develop and introduce new products for this market.

Home networking market:   For the three and six months ended July 28, 2012, net revenue from sales of our products into the home networking market increased $6.7 million, or 42%, and $2.5 million, or 6%, respectively, compared to the corresponding periods in the prior fiscal year.  The increase was primarily the result of a higher volume of units shipped, partially offset by a decrease in ASP.  Excluding DTV net revenues, our revenue from the home networking market as a percentage of total net revenue for the three and six months ended July 28, 2012 was 54% and 53%, respectively, increases of 20 and 15 percentage points, respectively, compared to the corresponding periods in the prior fiscal year.  The increase in home networking market revenues as a percentage of net revenues, excluding DTV, was primarily the result of the increase in demand in the home networking market as well as the decline in demand in the connected media player and IPTV media processor markets.  We expect our revenue from the home networking market to fluctuate in future periods based on changes in inventory levels at contract manufacturers who manufacture equipment incorporating our products for deployment by telecommunication providers.

IPTV media processor market:  For the three and six months ended July 28, 2012, net revenue from sales of our products into the IPTV media processor market decreased $8.2 million, or 45%, and $20.1 million, or 49%, respectively, compared to the corresponding periods in the prior fiscal year.  This decline was attributable to a decline in units shipped as a result of reduced demand for our chipsets in the IPTV media processor market as a result of competitive factors in connection with product transitions at telecommunications service providers to the next generation IPTV media processor solutions.  Excluding DTV net revenues, our revenue from the IPTV media processor market as a percentage of our total net revenue for the three and six months ended July 28, 2012 was 24% and 25%, respectively, decreases of 15 and 13 percentage points, respectively, compared to the corresponding periods in the prior fiscal year.  We expect our revenue from the IPTV media processor market to fluctuate in future periods as this revenue is dependent on IPTV service deployments by telecommunication service providers, adoption of our newer and future generations of our technology, changes in inventory levels at the contract manufacturers that supply them and competitive market pressures.

Home control and energy management market:   For the three and six months ended July 28, 2012, net revenue from sales of our products into the home control and energy management market increased $0.8 million, or 22%, and $1.6 million, or 26%, respectively, compared to the corresponding periods in the prior fiscal year.  The increase was primarily the result of $1.4 million of technology license revenue for the second quarter of fiscal 2013, partially offset by a decrease in demand in the home control and energy management market in the three months ended July 28, 2012.  Excluding DTV net revenues, our revenue from the home control and energy management market as a percentage of our total net revenue for the three and six months ended July 28, 2012 was 11% and 9%, respectively, increases of three percentage points compared to the corresponding periods in the prior fiscal year.  The percentage point increase is primarily the result of the increase in demand and technology license revenue in the home control and energy management market as well as the decline in demand in the connected media player and IPTV media processor markets.  We expect our revenue from the home control and energy management market to continue to increase in fiscal 2013.
 
 
27

 
 
Prosumer and industrial audio/video market:  For the three and six months ended July 28, 2012, net revenue from sales of our products into the prosumer and industrial audio/video market decreased $0.6 million, or 18%, and $0.9 million, or 14%, respectively, compared to the corresponding periods in the prior fiscal year.  The decrease was primarily attributable to a decrease in demand for our products.  Excluding DTV net revenues, our revenue from sales into the prosumer and industrial audio/video market as a percentage of total net revenue for the three and six months ended July 28, 2012 was 6%, a decrease of one percentage point and no change, respectively, compared to the corresponding periods in the prior fiscal year.  We expect our revenue from the prosumer and industrial audio/video market to fluctuate based on our ability to obtain design wins in our customers' newer generation products, broad economic trends affecting business spending on video conferencing and high-end audio/video products and also discretionary consumer spending.

Connected media player market:  For the three and six months ended July 28, 2012, net revenue from sales of our products into the connected media player market decreased $3.8 million, or 68%, and $8.5 million, or 63%, respectively, compared to the corresponding period in the prior fiscal year.  The decrease in revenue was the result of a decrease of approximately 60% in units shipped, which was primarily due to competitive factors.  Excluding DTV net revenues, our revenue from the connected media player market as a percentage of our total net revenue for the three and six months ended July 28, 2012 was 4% and 6%, respectively, decreases of eight and six percentage points, respectively, compared to the corresponding periods in the prior fiscal year.  We expect our revenue from the connected media player market to fluctuate in future periods primarily due to the timing and nature of new product introductions by consumer electronics companies that incorporate our products and their transition to our newer-generation products.  Additionally, due to decreases in the ASPs of our newer generation products relative to our older generation products, we must increase unit shipments of our products substantially in order to increase our revenue.

Other markets:  Our other markets consist of PC add-in boards, development contracts, services and other ancillary markets.  The revenue derived from our other markets was not a significant portion of our total net revenue.

Net revenue by product group

Our primary product group consists of our chipsets.  Our chipsets are targeted toward manufacturers and large volume designer and manufacturer customers building products for the DTV, home networking, IPTV, home control and energy management, prosumer and industrial audio/video consumer electronic and connected media player markets.  For the three and six months ended July 28, 2012, sales of our chipsets accounted for approximately 98% of our net revenue compared to approximately 100% and 99%, respectively, in the corresponding periods in the prior fiscal year.

We derive a minor portion of our revenue from other products and services, including technology licenses, software development kits, engineering support services for hardware and software, engineering development for customization of chipsets and other accessories.  The revenue derived from other products and services was not a significant portion of our total net revenue.

Net revenue by geographic region

The following table sets forth net revenue for each geographic region based on the ship-to location of customers (in thousands, except percentages):
 

    Three Months Ended     Six Months Ended  
   
July 28, 2012
   
% of Net Revenue
   
July 30, 2011
   
% of Net Revenue
   
July 28, 2012
   
% of Net Revenue
   
July 30, 2011
   
% of Net Revenue
 
Asia
 
$
44,314
     
65%
   
$
42,575
     
91%
   
$
80,918
     
75%
   
$
100,189
     
93%
 
North America
   
5,325
     
8%
     
2,785
     
6%
     
7,191
     
7%
     
4,900
     
5%
 
Europe
   
15,924