APPLIED MICRO CIRCUITS CORP - 10-Q Quarterly Report

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, as amended (the “Exchange Act”), during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨

As of October 15, 2004, 308,142,903 shares of the registrant’s common stock were issued and outstanding.

The accompanying unaudited interim condensed consolidated financial statements of Applied Micro Circuits Corporation (“AMCC” or the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The accompanying financial statements reflect all adjustments (consisting of normal recurring accruals), which are, in the opinion of management, considered necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The Company has experienced significant quarterly fluctuations in net revenues and operating results, and expects that these fluctuations will continue.

The financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended March 31, 2004.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. The Company regularly evaluates estimates and assumptions related to allowances for bad debts, sales returns and allowances, warranty reserves, inventory reserves, goodwill and purchased intangible asset valuations and useful life, deferred income tax asset valuation allowances and restructuring liabilities. The Company bases its estimates and assumptions on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from management’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

The Company has in effect several stock option plans under which non-qualified and incentive stock options have been granted to employees and non-employee directors. The Company also has in effect an employee stock purchase plan. The Company accounts for stock-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and the related Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation—An Interpretation of APB Opinion No. 25”. The Company has adopted the disclosure-only alternative of SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), as amended by SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”).

In accordance with the requirements of the disclosure-only alternative of SFAS 123, set forth below are the assumptions used and a pro forma illustration of the effect on net loss and net loss per share if the Company had valued stock-based awards to employees using the Black-Scholes option pricing model instead of applying the guidelines provided by APB 25. In arriving at an option valuation, the Black-Scholes model considers, among other factors, the expected life of the option and the expected volatility of the Company’s stock price.

The Company’s pro forma information under SFAS 123 and SFAS 148 is as follows (in thousands, except per share amounts):

For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting periods. The per share fair value of options granted in connection with stock option plans and rights granted in connection with the employee stock purchase plan reported below has been estimated at the date of grant with the following weighted average assumptions:

The Company completed two acquisitions in the first quarter of fiscal 2005 using the purchase method of accounting. The accompanying consolidated financial statements include the results of operations of each business acquired from the date of acquisition. Details of the acquired businesses are as follows:

3ware, Inc. – On April 1, 2004, the Company completed the acquisition of 3ware, Inc. for approximately $145.0 million in cash and assumed options to purchase approximately 4.3 million shares of AMCC’s common stock. 3ware is a provider of high-performance, high-capacity Serial ATA (SATA) storage solutions for emerging storage applications such as disk-to-disk backup, near-line storage, network-attached storage (NAS), video, and high-performance computing.

Embedded Products Business – On May 5, 2004, the Company purchased intellectual property and a portfolio of assets associated with IBM’s 400 series of embedded PowerPC^® standard products, (the Embedded Products Business) for approximately $227.9 million in cash. The PowerPC 400 series product line is targeted at Internet, communication, data storage, consumer and imaging applications.

In connection with these transactions, the Company conducted valuations of the intangible assets acquired in order to allocate the purchase price in accordance with SFAS No. 141, “Business Combinations”, (SFAS 141). In accordance with SFAS 141, the Company has preliminarily allocated the excess purchase price over the fair value of net tangible assets acquired to the identifiable intangible assets. The purchase price in each transaction was allocated as follows (in thousands):

The total consideration issued in the acquisitions is as follows (in thousands):

The related purchased IPR&D for the above acquisitions represents the present value of the estimated after-tax cash flows expected to be generated by the purchased technology, which, at the acquisition dates, had not yet reached technological feasibility. The cash flow projections for revenues were based on estimates of relevant market sizes and growth factors, expected industry trends, the anticipated nature and timing of new product introductions by the Company and its competitors, individual product sales cycles and the estimated life of each product’s underlying technology. Estimated operating expenses and income taxes were deducted from estimated revenue projections to arrive at estimated after-tax cash flows. Estimated operating expenses included cost of goods sold, marketing and selling expenses, general and administrative expenses and research and development expenses, including estimated costs to maintain the products once they have been introduced into the market and are generating revenue.

The purchased inventory fair value adjustment represents the difference between the carrying value of work in process and finished goods inventory and the estimated selling price less costs to sell the related inventory at the date of acquisition.

As required by SFAS 141, the pro forma data set forth below gives effect to the purchase of JNI Corporation, which the Company acquired on October 28, 2003, and 3ware, Inc. as if they had occurred at the beginning of the periods presented and does not purport to be indicative of what would have occurred had the companies actually been combined nor does it reflect what may occur in the future. The results presented do not include the results of the PRS Business, which the Company acquired in September 2003 and January 2004 or the Embedded Products Business, acquired May 5, 2004, for periods prior to their acquisition dates because such interim information was not available. The results for the three and six months ended September 30, 2004 do not

include the $13.4 million IPR&D charge described above. The results for the three and six months ended September 30, 2003, give effect to the amortization of purchased intangible assets and deferred compensation from JNI and 3ware. Included in the results is a restructuring charge of $310,000 for the three and six months ended September 30, 2004, respectively, and a restructuring charge of $23.5 million for the six months ended September 30, 2003 (in thousands, except per share data):

Goodwill and other acquisition-related intangibles were as follows (in thousands):

The change in the carrying amount of goodwill for the six months ended September 30, 2004, was as follows (in thousands):

The estimated future amortization expense of purchased intangible assets as of September 30, 2004 was as follows (in thousands):

Shares used in basic net loss per share are computed using the weighted average number of common shares outstanding during each period. Shares used in diluted net loss per share include the dilutive effect of common shares potentially issuable upon the exercise of stock options. The reconciliation of shares used to calculate basic and diluted loss per share consists of the following (in thousands, except per share data):

Because the Company incurred losses for the three and six months ended September 30, 2004 and 2003, the effect of dilutive securities totaling 2.0 million and 4.4 million equivalent shares for the three and six months ended September 30, 2004, respectively, and 3.8 million and 3.4 million equivalent shares for the three and six months ended September 30, 2003, respectively, have been excluded from the net loss per share computations as their impact would be antidilutive.

In July 2001, the Company announced the first of its restructuring programs. The July 2001 restructuring plan was in response to the sharp downturn in business at the end of the Company’s fiscal 2001 and included reducing the Company’s overall cost structure and aligning manufacturing capacity with the then current demand. The July 2001 restructuring plan resulted in a total of $11.6 million of restructuring costs, which were recognized as operating expenses in the last three quarters of fiscal 2002. The July 2001 restructuring plan was comprised of the following components:

to operating expenses. As of September 30, 2004, the Company has completed the restructuring activities contemplated by the July 2001 restructuring plan and no further payments or expenses are anticipated under this program.

As a result of the prolonged downturn in the telecommunications industry and the uncertainty as to when the telecommunication equipment market would recover, in July 2002 the Company announced its second workforce reduction and restructuring program. The July 2002 workforce reduction and restructuring program was comprised of the following:

The Company’s wafer manufacturing facility was closed at the end of March 2003 and the facility was exited at the end of June 2003. During the third quarter of fiscal 2004, the Company completed the activities contemplated by the plan. As a result, the Company recorded an adjustment to the restructuring liability for the excess accrued severance and facilities restoration costs, and recognized a restructuring benefit of approximately $537,000. The Company does not expect any future charges or benefits related to the closure of the wafer manufacturing facility. As a result of the closure of the Company’s internal wafer manufacturing facility, the Company realized annual savings totaling approximately $14 million relating to fixed cost of sales overhead in fiscal 2004.

The Company has completed the activities contemplated by the global workforce reduction portion of the July 2002 plan, and no further payments or expenses are anticipated under this program. As a result of the global workforce reduction undertaken in July 2002, the Company realized approximately $16 million of annual savings relating to operating expenses in fiscal 2004.

As the downturn in the telecommunications industry continued, it became evident that further cost reductions were necessary. In April 2003, the Company announced its third workforce reduction and restructuring program. The April 2003 restructuring program consisted of a workforce reduction, further consolidation of excess facilities and additional fixed asset disposals. In June 2002, the FASB issued SFAS 146 requiring that costs associated with exit or disposal activities be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. Accordingly, restructuring costs of $23.5 million related to the restructuring plan were recognized in the first quarter of fiscal 2004 and approximately $281,000 was recognized in the fourth quarter of fiscal 2003 for severance packages communicated to employees in March 2003. The April 2003 workforce reduction and restructuring program was comprised of the following:

As a result of the Company’s April 2003 restructuring activities, the Company anticipated it would realize approximately $4 million of annual savings relating to fixed cost of sales overhead and approximately $36 million of annual savings relating to operating expenses in fiscal 2004. However, in November 2003 the Company elected to reoccupy a portion of the 58,000 square foot building in San Diego. This decision was based on the acquisition of JNI Corporation and the need to integrate the operations of the two companies in order to achieve the planned cost savings. As a result of this decision to reoccupy the San Diego building, the Company reversed a portion of the prior accrual for the excess lease commitment and reinstated the book value of the leasehold improvements, which were previously abandoned. The Company recorded a net restructuring benefit of approximately $2.4 million related to this activity. In addition, the Company recorded an adjustment to the amount of accrued severance of approximately $200,000 because it overestimated the amount of severance that would be paid.

In November 2003, the Company implemented a fourth workforce reduction and restructuring. The November 2003 workforce reduction was implemented as a means to achieve certain cost savings anticipated in connection with the fiscal 2004 acquisitions. The restructuring consisted of the elimination of approximately 50 employees and the abandonment of certain leased property. As a result of the November restructuring, the Company recorded a charge of approximately $2.8 million, consisting of $1.2 million for employee severance and $1.6 million for excess facilities costs. As of September 30, 2004, the Company has completed the restructuring activities contemplated by the November 2003 workforce reduction program and no further payments or expenses are anticipated under this program. The Company estimates that as a result of the November 2003 workforce reduction it will achieve annual operating expense savings of approximately $7 million in fiscal 2005.

The following tables provide detailed activity related to each of our continuing restructuring activities for the six months ended September 30, 2004 (in thousands):

The components of comprehensive income or loss, net of tax, are as follows (in thousands):

On August 12, 2004, the Company announced that the board of directors had authorized a stock repurchase program for the repurchase of up to $200.0 million of its common stock. During the second quarter of fiscal 2005, the Company repurchased and retired 5.4 million shares of its common stock for approximately $16.9 million. In addition, the Company entered into a series of agreements totaling $50.0 million that could result in the repurchase and retirement of additional shares of its common stock. On the expiration date of each agreement, depending on the closing price of the Company’s common stock, the Company will receive either a predetermined number of shares of its common stock, or a predetermined amount of cash. Collectively, under the agreements, the Company could receive up to $56.8 million of cash, or the delivery of up to 16.7 million shares of its common stock.

In April 2001, a series of similar federal complaints were filed against the Company and certain of its executive officers and directors. The complaints have been consolidated into a single proceeding in the U.S. District Court for the Southern District of California. In re Applied Micro Circuits Corp. Securities Litigation, lead case number 01-CV-0649-K(AB). In January 2002, the court appointed lead plaintiff filed a consolidated federal complaint. The consolidated federal complaint alleges violations of the Securities Exchange Act of 1934 and is brought as a shareholder class action under Sections 10(b), 20(a), 20A and Rule 10b-5 under the Act. Plaintiff seeks monetary damages on behalf of the shareholder class. Discovery in this lawsuit is continuing. Trial is currently scheduled for calendar year 2005.

The Company believes that the allegations in this lawsuit are without merit and intends to defend against the lawsuit vigorously. The Company cannot predict the likely outcome of this lawsuit, and an adverse result could have a material adverse effect on the Company. The Company has notified its insurance carriers of this lawsuit and submitted expenses incurred in defending the lawsuit as claims under the relevant insurance policies. Though insurers have paid defense costs to date, there can be no assurance that they will continue to pay such costs, judgments or other expenses associated with the lawsuit. To that end, one of the Company’s insurers,

Lumbermens Insurance Company (“Lumbermens”) issued to us a five million dollar policy providing defense and indemnity coverage for this lawsuit, Lumbermens is a subsidiary of Kemper Insurance Company (“Kemper”). Kemper has publicly indicated that its overall loss exposure may exceed its ability to pay future claims, and has obtained approval from the Illinois Department of Insurance to proceed with a three year run-off plan intended to resolve, to the maximum extent possible, valid policyholder claims. Though the Company currently believes that it is more likely than not that Lumbermens will pay amounts owed on the policy, it is possible that Lumbermens or one of the Company’s other insurers will become insolvent or will otherwise be unwilling or unable to pay some or all amounts owed on the policies.

In May 2001, a series of similar state derivative actions were filed against the Company’s directors and certain executive officers. The state complaints were coordinated and assigned to the Superior Court of California in the County of San Diego. Applied Micro Circuits Shareholders Cases, Case No. JCCP No. 4193. In July 2004, the court approved a settlement of the derivative actions, which became effective on August 27, 2004. As part of the settlement, the defendants expressly denied any wrongdoing or liability related to the allegations made in the derivative actions, and the settlement did not result in the payment of any monetary damages. Pursuant to the settlement, the Company agreed to pay the plaintiffs’ attorneys’ fees and costs and to implement certain corporate governance changes, including the election of two new directors and the separation of the positions of Chairman of the Board and Chief Executive Officer no later than the Company’s annual meeting of stockholders in 2005 and the appointment of a lead director if the Chairman of the Board is not independent. Costs of the settlement have been paid by the Company’s insurance carriers.

Since 1993, the Company has been named as a potentially responsible party, or PRP, along with a large number of other companies that used Omega Chemical Corporation in Whittier, California to handle and dispose of certain hazardous waste material. The Company is a member of a large group of PRPs that has agreed to fund certain remediation efforts at the Omega Chemical site, for which the Company has accrued approximately $100,000. In September 2000, the Company entered into a consent decree with the Environmental Protection Agency, pursuant to which the Company agreed to fund its proportionate share of the initial remediation efforts at the Omega Chemical site.

In September 2003, Silvaco Data Systems (“Silvaco”) filed a complaint against the Company in the Superior Court of the State of California in the County of Santa Clara. Silvaco Data Systems v. Applied Micro Circuits Corporation Case No. 103cv005696. In its complaint, Silvaco claims that the Company misappropriated trade secrets and engaged in unfair business practices by using software licensed to us by Circuit Symantics, Inc. The Company filed an answer denying Silvaco’s allegations and filed a motion seeking a stay of the lawsuit against us pending arbitration of terms of a settlement agreement between Circuit Symantics and Silvaco. The motion has been granted and the arbitration is taking place. The Company expects the arbitration to conclude in the third quarter of fiscal 2005.

Several litigation matters are discussed below involving JNI, which became a wholly-owned subsidiary of the Company in October 2003.

In April 2001, a series of similar federal complaints were filed against JNI and certain of its officers and directors. These complaints were consolidated into a single proceeding in U.S. District Court for the Southern District of California. Osher v. JNI, lead Case No. 01 cv 0557 J (NLS). The first consolidated and amended complaint alleged that between July 13, 2000 and March 28, 2001 JNI and the individual defendants made false statements about its business and operating results in violation of the Securities Exchange Act, and also included allegations that defendants made false statements in its secondary public offering of common stock in October 2000. In March, 2003, the Court dismissed the action, with prejudice. In April 2004, plaintiffs filed a notice of appeal. Plaintiffs have filed their appeal brief, and JNI’s response is currently due on November 8, 2004.

activities of management and that JNI allegedly made false statements about its business and results causing its stock to trade at artificially inflated levels. The court has sustained JNI’s demurrers to each of the plaintiff’s complaints and dismissed the plaintiff in June 2002. However, in May 2002, another plaintiff, Sik-Lin Huang, filed a motion to intervene in the case. In June 2002, the court granted Huang’s motion to intervene. Huang filed a complaint in intervention in July 2002. In September 2002, the board of directors of JNI appointed a special litigation committee to investigate the allegations. In February 2003, the special litigation committee issued a report of its investigation which concluded that it is not in the best interests of JNI to pursue the litigation. In February 2003, counsel for the special litigation committee filed a motion to dismiss the action. In November 2003, the court dismissed the matter with prejudice. In January 2004, plaintiffs filed a notice of appeal. A motion to dismiss the appeal has been filed by the defendants on the grounds that the plaintiffs have lost standing because they no longer own JNI shares. The Court has stated that it will rule on the motion to dismiss the appeal when it rules on the merits of the appeal. Plaintiff’s opening brief on the merits is due in October 2004.

In May 2002, following JNI’s announcement that it would restate its financial statements, a state derivative suit was filed against JNI and certain of its officers and directors in the San Diego County Superior Court, Case No. GIC 789481. The complaint repeated the allegations of the derivative lawsuit filed in October 2001, and added allegations that the defendants caused or allowed JNI to falsely report its results for the fourth quarter of fiscal 2001. The special litigation committee, appointed in September 2002, investigated the allegations in this case as well. In February 2003, the special litigation committee issued a report of its investigation which concluded that it was not in the best interests of JNI to pursue this action. In February 2003, counsel for the special litigation committee filed a motion to dismiss this action. In November 2003, the court dismissed the matter with prejudice. In January 2004, plaintiffs filed a notice of appeal. A motion to dismiss the appeal on the grounds that the plaintiffs have lost standing because they no longer own JNI shares was filed. Plaintiff voluntarily dismissed their appeal in the face of this motion, therefore concluding this matter.

In November 2001, a class action lawsuit was filed against JNI and the underwriters of its initial and secondary public offerings of common stock in the U.S. District Court for the Southern District of New York, Case No. 01 Civ 10740 (SAS). The complaint alleges that defendants violated the Securities Exchange Act in connection with JNI’s public offerings. This lawsuit is among over 300 class action lawsuits pending in this Court that have come to be known as the IPO laddering cases. In June 2003, a proposed partial global settlement, subsequently approved by JNI’s board of directors, was announced between the securities issuers defendants and the plaintiffs that would guarantee at least $1 billion to investors who are class members from the insurers of the issuers. The proposed settlement, if approved by the court and by the securities issuers, would be funded by insurers of the issuers, and would not result in any payment by JNI or the Company. Motions for preliminary approval of the settlement have been filed.

The Company is also party to various claims and legal actions arising in the normal course of business, including employee disputes and notification of possible infringement on the intellectual property rights of third parties.

Although the ultimate outcome of the pending matters is not presently determinable, the Company believes that the resolution of all such matters, net of amounts accrued, will not have a material adverse effect on its financial position or liquidity; however, there can be no assurance that the ultimate resolution of these matters and that costs and other expenses associated with these matters will not have a material impact on its results of operations in any period.

From time to time the Company charters an aircraft for business travel from an aircraft charter company, which manages an aircraft owned by a company that AMCC’s chief executive officer controls. The Company expensed a total of $200,000 and $400,000 for such charters during the three and six months ended September 30, 2004, respectively, and $200,000 and $400,000 during the three and six months ended September 30, 2003, respectively. These amounts were within the limits on such expenses approved by the board of directors.

Management’s discussion and analysis of financial condition and results of operations, or MD&A, is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of our operations. The MD&A is organized as follows:

This section should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended March 31, 2004. This report, and in particular the MD&A, contains forward-looking statements. These forward-looking statements are made as of the date of this report. Any statement that refers to an expectation, projection or other characterization of future events or circumstances, including the underlying assumptions, is a forward-looking statement. We use certain words and their derivatives such as “anticipate”, “believe”, “plan”, “expect”, “estimate”, “predict”, “intend”, “may”, “will”, “should”, “could”, “future”, “potential”, and similar expressions in many of the forward-looking statements. The forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and other assumptions made by us. These statements and the expectations, estimates, projections, beliefs and other assumptions on which they are based are subject to many risks and uncertainties and are inherently subject to change. We describe many of the risks and uncertainties that we face in the “Risk Factors” section of MD&A. We update our descriptions of the risks and uncertainties facing us in our periodic reports filed with the SEC in which we report our financial condition and results for the quarter and fiscal year-to-date. Our actual results and actual events could differ materially from those anticipated in any forward-looking statement. Readers should not place undue reliance on any forward-looking statement.

We design, develop and market technology products primarily for the communications and storage equipment markets. Our products are essential for the transport, processing, switching, routing and storage of information worldwide. We utilize a combination of design expertise coupled with system-level knowledge and multiple technologies to offer integrated circuits (ICs), as well as printed circuit board assemblies (PCBAs) for these markets. We generate revenues in the communications market primarily through sales of our IC products to communications equipment manufacturers, such as Alcatel, Ciena, Cisco, Fujitsu, Hitachi, Huawei, JDS Uniphase, Juniper, Lucent, Marconi, NEC, Nortel, Siemens, and Tellabs. In the storage market, we generate

revenues primarily through sales of our PCBAs, to original equipment manufacturers, or OEMs, such as EMC, Hitachi Data Systems, Network Appliance, StorageTek and Sun Microsystems.

In September 2003 and January 2004, we purchased assets and licensed intellectual property associated with IBM’s PowerPRS Switch Fabric product line (the PRS Business) for approximately $50 million in cash to complement our existing communications products portfolio. In October 2003, we completed the acquisition of all outstanding shares of JNI Corporation (JNI), a provider of Fibre Channel hardware and software products that are critical elements of storage networks, for approximately $196.4 million in cash. In April 2004, we completed the acquisition of 3ware, Inc., a provider of high-performance, high-capacity SATA storage solutions, for a purchase price of approximately $145 million in cash. In May 2004, we acquired intellectual property and a portfolio of assets associated with IBM’s 400 series of embedded PowerPC^® standard products, (the Embedded Products Business) for approximately $227.9 million in cash. The PowerPC 400 series product line is targeted at Internet, communication, data storage, consumer and imaging applications. We plan to continue evaluating strategic opportunities as they arise, including business combinations, strategic relationships, capital infusions and the purchase and sale of assets.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to inventory valuation and warranty liabilities, which affects our cost of sales and gross margin; the valuation of purchased intangibles and goodwill, which affects our amortization and impairments of goodwill and other intangibles; the valuation of restructuring liabilities, which affects the amount and timing of restructuring charges; and the valuation of deferred income taxes, which affects our income tax expense and benefit. We also have other key accounting policies, such as our policies for revenue recognition, including the deferral of a portion of revenues on sales to distributors, and allowance for bad debts. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess or obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future demand for our products within a specified time horizon, generally 12 months. The estimates we use for future demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. If our demand forecast is greater than our actual demand we may be required to take additional excess inventory charges, which would decrease gross margin and net operating results in the future. Our products typically carry a one to three year warranty. We establish reserves for estimated product warranty costs at the time revenue is recognized. Although we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, use of materials and service delivery costs incurred in correcting any product failure. Should actual product failure rates, use of materials or service delivery costs differ from our estimates, additional warranty reserves could be required, which could reduce our gross margins.

The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired,

including in-process research and development, or IPR&D. Goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. The amounts and useful lives assigned to other intangible assets impact future amortization, and the amount assigned to IPR&D is expensed immediately. Determining the fair values and useful lives of intangible assets especially requires the exercise of judgment. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets acquired, we primarily use the discounted cash flow method. This method requires significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required such as residual growth rates and discount factors. The estimates we use to value and amortize intangible assets are consistent with the plans and estimates that we use to manage our business and are based on available historical information and industry estimates and averages. These judgments can significantly affect our net operating results.

During fiscal 2001, we adopted SFAS 142. SFAS 142 requires that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques. If the carrying amount of a reporting unit exceeds its fair value, then a goodwill impairment test is performed to measure the amount of the impairment loss, if any. The goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as in a business combination. Determining the fair value of the implied goodwill is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions, including projection and timing of future cash flows, discount rates reflecting the risk inherent in future cash flows, perpetual growth rates, determination of appropriate market comparables, and determination of whether a premium or discount should be applied to comparables. It is reasonably possible that the plans and estimates used to value these assets may be incorrect. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

Over the last three years we have undertaken significant restructuring initiatives, which have required us to develop formalized plans for exiting certain business activities and reducing spending levels. We have had to record estimated expenses for employee severance, long-term asset write downs, lease cancellations, facilities consolidation costs, and other restructuring costs. Given the significance, and the timing of the execution, of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made. Prior to 2003, the liability for certain exit costs was recognized on the date that management committed to a plan. In 2003, new accounting guidance was issued requiring us to recognize costs associated with our exit and disposal activities at fair value when a liability is incurred. In calculating the charges for our excess facilities, we have to estimate the timing of exiting certain facilities and then estimate the future lease and operating costs to be paid until the lease is terminated and the amount of any sublease income. To form our estimates for these costs, we performed an assessment of the affected facilities and considered the current market conditions for each site. Our assumptions for the operating costs until termination or the offsetting sublease revenues may turn out to be incorrect, and our actual costs may be materially different from our estimates, which could result in the need to record additional costs or to reverse previously recorded liabilities. Our policies require us to periodically evaluate the adequacy of the remaining liabilities under our restructuring initiatives.

We record valuation allowances to reduce our deferred tax assets to an amount that we believe is more likely than not to be realized. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies, including reversals of deferred tax liabilities, in assessing the need for a valuation allowance.

If we were to determine that we would not realize all or part of our deferred tax assets in the future, we would make an adjustment to the carrying value of the deferred tax asset, which would be reflected as income tax expense. Conversely, if we were to determine that we would realize a deferred tax asset, which currently has a valuation allowance, we would reverse the valuation allowance, which would be reflected as an income tax benefit or as an adjustment to stockholders’ equity in our financial statements.

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements”, or SAB 101 as well as SAB 104, “Revenue Recognition”. These pronouncements require that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met. In addition, we do not recognize revenue until all customers’ acceptance criteria have been met. The criteria are usually met at the time of product shipment, except for shipments to distributors with rights of return. Revenue from shipments to distributors with rights of return is deferred until all return or cancellation privileges lapse. In addition, we record reductions to revenue for estimated allowances such as returns, competitive pricing programs and rebates. These estimates are based on our historical experience and the contractual terms of the competitive pricing and rebate programs. Shipping terms are generally FOB shipping point. If actual returns or pricing adjustments exceed our estimates, additional reductions to revenue would result.

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or our customers’ actual defaults exceed our historical experience, our estimates could change and impact our reported results.

Net Revenues. Net revenues for the three and six months ended September 30, 2004 were approximately $61.1 million and $128.5 million, respectively, representing an increase of 143.1% and 181.5% from net revenues of approximately $25.1 million and $45.6 million for the three and six months ended September 30, 2003, respectively. The increase in total net revenues was primarily attributable to the revenues generated from our fiscal 2004 and 2005 acquisitions, as well as increases in revenue from our existing communications product portfolio, offset by decreases in other revenue. See the following tables (dollars in thousands):

Communication revenue consists of our historical communications business and the PRS Business acquisition. Storage revenue is derived from of our JNI acquisition and our 3ware acquisition. The Embedded Products revenue consists of our Embedded Products Business acquisition and other revenue consists of our legacy non-communications products, such as computer, ATE and military products.

Based on direct shipments, net revenues to customers that exceeded 10% of total net revenues in the three and six months ended September 30, 2004 and 2003 were as follows:

Looking through product shipments to distributors and subcontractors to the end customers, net revenues to end customers that exceeded 10% of total net revenues in the three and six months ended September 30, 2004 and 2003 were as follows:

Revenues based on direct shipments outside the United States of America accounted for 52% and 51% of net revenues for the three and six months ended September 30, 2004 compared to 50% and 49% for the three and six months ended September 30, 2003.

Gross Profit. The following tables present net revenues, cost of revenues and gross profit for the three and six months ended September 30, 2004 and 2003 (dollars in thousands):

The increase in gross profit for the three and six months ended September 30, 2004 was primarily attributable to the increase in revenues, offset by an increase of $6.0 million and $11.1 million, respectively, of amortization of developed technology and purchased inventory fair value adjustment included in our cost of revenues.

The amortization of purchased intangible assets included in cost of revenues during the three and six months ended September 30, 2004 was $7.6 million and $14.3 million, respectively, compared to $1.6 million and $3.1 million, respectively, for the three and six months ended September 30, 2003. The increase is a result of our fiscal 2004 and fiscal 2005 acquisitions. Based on the amount of capitalized purchased intangibles on the balance sheet as of September 30, 2004, we expect amortization expense for purchased intangibles charged to cost of revenues to be $25.0 million, $22.8 million and $19.6 million for each of the fiscal years ending March 31, 2005, 2006 and 2007, respectively. Future acquisitions of businesses may result in substantial additional charges which would impact the gross margin in future periods.

Research and Development and Selling, General and Administrative Expenses. The following tables present research and development and selling, general and administrative expenses for the three and six months ended September 30, 2004 and 2003 (dollars in thousands):

Research and Development. Research and development, or R&D, expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities, costs related to engineering design tools, subcontracting costs and facilities expenses. The increase in R&D of 21.5% and 13.5% for the three and six months ended September 30, 2004, respectively, was primarily due to higher payroll, the related benefits expense, and facilities costs of approximately $9.6 million and $15.9 million, resulting from our fiscal 2004 and fiscal 2005 acquisitions, offset by lower software and equipment depreciation costs and design costs of approximately $4.0 million and $8.4 million, respectively, resulting from our restructuring initiatives. We believe that a continued commitment to R&D is vital to our goal of maintaining a leadership position with innovative communications, storage and embedded products. Currently, R&D expenses are focused on the development of products for the communications and storage equipment markets, and we expect to continue this focus. Future acquisitions of businesses may result in substantial additional on-going costs.

Since the start of fiscal 2002, we have invested a total of approximately $461.8 million in the research and development of new products, including higher-speed, lower-power and lower-cost products, products that

combine the functions of multiple existing products into single highly integrated products, and other products to complete our portfolio of communications and storage products. For most products developed by us, due to their complexity and the complexity of our OEM customers’ equipment, it often takes several years to complete development and qualification. We have not yet generated significant revenues from many of these new products for two additional reasons. First, the dramatic and extended downturn in the telecommunications market has severely impacted our customers and has resulted in significantly less demand for the quantity of these products than expected when some of the developments commenced. Second, we have discontinued development of several new products and slowed down development of other new products as we realized that demand for these products would not materialize as originally anticipated.

Selling, General and Administrative. Selling, general and administrative, or SG&A, expenses consist primarily of personnel-related expenses, professional and legal fees, corporate branding and facilities expenses. The increase in SG&A expenses for the three and six months ended September 30, 2004 was primarily due to the effect of higher payroll and related benefits expense of approximately $2.0 million and $3.3 million, respectively, as a result of our fiscal 2004 and fiscal 2005 acquisitions, as well as higher professional services, commissions and contracted services relating to the acquisition of the Embedded Products Business of approximately $2.3 million and $5.0 million, respectively. Future acquisitions of businesses may result in substantial additional on-going costs.

Stock-Based Compensation. The following tables present stock-based compensation expenses for employees engaged in research and development and selling, general and administrative activities expenses for the three and six months ended September 30, 2004 and 2003, all of which was excluded from those operating expenses (dollars in thousands):

Stock-based compensation expense represents the amortization of deferred compensation related to acquisitions. Deferred compensation is the difference between the fair value of our common stock at the date of each acquisition and the exercise price of the unvested stock options assumed in the acquisition. In fiscal 2005, we recorded approximately $19.0 million of deferred compensation in connection with stock options assumed in our acquisition of 3ware. Stock-based compensation charges, including amounts charged to cost of revenues, were $3.2 million and $5.8 million for the three and six months ended September 30, 2004, respectively, compared to $4.8 million and $17.5 million for the three and six months ended September 30, 2003, respectively. We currently expect to record amortization of deferred compensation with respect to these assumed options of approximately $3.6 million for the last two quarters of fiscal 2005 and $7.1 million in fiscal 2006. These charges could be reduced as a result of employee turnover. Acquisitions of businesses may result in substantial additional on-going costs. Such charges may cause fluctuations in our interim or annual operating results.

Acquired In-process Research and Development. For the six months ended September 30, 2004, we recorded $13.4 million of acquired in-process research and development, or IPR&D, resulting from the acquisition of 3ware and the Embedded Products Business. These amounts were expensed on the acquisition dates because the acquired technology had not yet reached technological feasibility and had no future alternative uses. The IPR&D charge related to the 3ware acquisition was made up of two projects that were 42% and 25% complete, respectively, at the date of acquisition. The estimated aggregate cost to complete these projects was $650,000 and $2.3 million, and the discount rate applied to calculate the IPR&D charge was 30% and 35%, respectively. The IPR&D charge related to the Embedded Products Business acquisition was made up of three projects, which were between 42% and 69% complete at the date of acquisition. The estimated aggregate cost to complete these projects was $9.1 million. The discount rate applied to calculate the IPR&D charge ranged from 25% to 30%.

For the six months ended September, 2003, we recorded $5.7 million of acquired in-process research and development resulting from the acquisition of assets and licenses associated with IBM’s PowerPRS Switch Fabric product line. This amount was expensed on the acquisition date because the acquired technology had not yet reached technological feasibility and had no future alternative uses. The total IPR&D charge related to five projects which were between 38% and 68% complete at the date of acquisition. The estimated aggregate cost to complete these projects was $5.3 million. The discount rate applied to calculate the IPR&D charge ranged from 20% to 30%. There can be no assurance that acquisitions of businesses, products or technologies by us in the future will not result in substantial charges for acquired in-process research and development that may cause fluctuations in our interim or annual operating results.

Restructuring Charges. The following tables present restructuring charges for the six months ended September 30, 2004 and 2003 (in thousands):

In July 2001, we announced the first of our restructuring programs. The July 2001 plan was in response to the sharp downturn in business at the end of our fiscal 2001 and included reducing our overall cost structure and aligning manufacturing capacity with the then current demand. The July 2001 restructuring plan resulted in a total of $11.6 million of restructuring costs, which were recognized as operating expenses in the last three quarters of fiscal 2002. The July 2001 restructuring plan was comprised of the following components:

As a result of the Company’s July 2001 restructuring activities, the Company realized approximately $4 million of annual savings relating to fixed cost of sales overhead and approximately $2 million of annual savings relating to operating expenses. As of September 30, 2004, the Company has completed the restructuring activities contemplated by the July 2001 restructuring plan and no further payments or expenses are anticipated under this program.

In July 2002, we announced our second workforce reduction and restructuring program. This came about as a result of the prolonged downturn in the telecommunications industry and the uncertainty as to when the telecommunications equipment market would recover. The July 2002 workforce reduction and restructuring program was comprised of the following:

Our wafer manufacturing facility was closed at the end of March 2003 and the facility was exited at the end of June 2003. During the third quarter of fiscal 2004, we completed the activities contemplated by the plan. As a result, we recorded an adjustment to the restructuring liability for the excess accrued severance and facilities restoration costs, and recognized a restructuring benefit of approximately $537,000. We do not expect any future charges or benefits related to the closure of the wafer manufacturing facility. As a result of the closure of our internal wafer manufacturing facility, we realized annual savings totaling approximately $14 million relating to fixed cost of sales overhead in fiscal 2004.

We have completed the activities contemplated by the global workforce reduction portion of the July 2002 plan, and no further payments or expenses are anticipated under this program. As a result of the global workforce reduction undertaken in July 2002, we realized approximately $16 million of annual savings relating to operating expenses in fiscal 2004.

As the downturn in the telecommunications industry continued it became evident that further cost reductions were necessary. In April of 2003, we announced our third workforce reduction and restructuring program. The April 2003 restructuring program consisted of a workforce reduction, further consolidation of excess facilities and additional fixed asset disposals. In June 2002, the FASB issued SFAS 146 requiring that costs associated with exit or disposal activities be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. Accordingly, restructuring costs of $23.5 million related to the restructuring plan were recognized in the first quarter of fiscal 2004 and approximately $281,000 was recognized in the fourth quarter of fiscal 2003 for severance packages communicated to employees in March 2003. The April 2003 workforce reduction and restructuring program was comprised of the following:

As a result of our April 2003 restructuring activities, we anticipated we would realize approximately $4 million of annual savings relating to fixed cost of sales overhead and approximately $36 million of annual savings relating to operating expenses in fiscal 2004. However, in November 2003 we elected to reoccupy a portion of the 58,000 square foot building in San Diego. This decision was based on the acquisition of JNI Corporation and the need to integrate the operations of the two companies in order to achieve the planned cost savings. As a result of this decision to reoccupy the San Diego building, we reversed a portion of the prior accrual for the excess lease commitment and reinstated the book value of the leasehold improvements, which were previously abandoned. We recorded a net restructuring benefit of approximately $2.4 million related to this activity. In addition, we recorded an adjustment to the amount of accrued severance of approximately $200,000 because we overestimated the amount of severance that would be paid.

In November 2003, we implemented a fourth workforce reduction and restructuring. The November 2003 workforce reduction was implemented as a means to achieve certain cost savings anticipated in connection with the fiscal 2004 acquisitions. The restructuring consisted of the elimination of approximately 50 employees and the abandonment of certain leased property. As a result of the November restructuring, the Company recorded a charge of approximately $2.8 million, consisting of $1.2 million for employee severance and $1.6 million for excess facilities costs. As of September 30, 2004, the Company has completed the restructuring activities contemplated by the November 2003 workforce reduction program and no further payments or expenses are anticipated under this program. We estimate that as a result of the November 2003 work force reductions we will achieve annual operating expense savings of approximately $7 million in fiscal 2005.

Interest and Other Income and Expenses, net. The following tables present interest and other income and expenses for the three and six months ended September 30, 2004 and September 30, 2003 (dollars in thousands):

Interest Income, net. Net interest income reflects interest earned on cash and cash equivalents and short-term investment balances, as well as realized gains and losses from the sale of short-term investments, less interest expense on our debt and capital lease obligations. The decrease for the three and six months ending September 30, 2004 is primarily due to lower interest income as a result of lower yields and lower cash balances as well as lower net realized gains on the portfolio.

Other Income (Expense), net. Other income (expense) for the three and six months ended September 30, 2003 consists of the disposal of fixed assets at a loss.

Income Taxes. Our income tax expense for the three and six months ended September 30, 2004 was $335,000. The expense primarily reflects estimated foreign taxes and domestic alternative minimum taxes to be paid for fiscal 2005.

As of September 30, 2004, our principal source of liquidity consisted of $410.6 million in cash, cash equivalents and short-term investments. Working capital as of September 30, 2004 was $403.5 million. Total cash and short-term investments decreased by $450.5 million during the six months ended September 30, 2004 primarily as a result of the use of $365.8 million of net cash to fund our fiscal 2005 acquisitions and the use of $66.9 million to fund our stock repurchase program. At the end of September 30, 2004, we had contractual obligations not included on our balance sheet totaling $75.2 million, primarily related to facilities leases, engineering design software tool licenses and inventory purchase commitments.

For the six months ended September 30, 2004, we used $5.8 million of cash from our operations compared to using $21.1 million for our operations in the six months ended September 30, 2003. Although we had a net loss of $40.1 million for the six months ended September 30, 2004, $44.3 million consisted of non-cash charges such as $9.5 million of depreciation, $15.6 million amortization of purchased intangibles, $13.4 million of acquired in-process research and development charges, and $5.8 million of stock-based compensation charges. The remaining change in operating cash flows for the six months ended September 30, 2004 primarily reflects an increase in accounts receivable from higher net revenues, an increase in inventories and accounts payables due to increased activity as a result of our fiscal year 2005 and 2004 acquisitions. These increases are offset by a decrease in accrued liabilities due to completing our restructuring initiatives. Net cash used for operations in the six months ended September 30, 2003 primarily reflects our operating results before non-cash charges, as well as increases in accounts receivables resulting from higher revenues and accrued liabilities primarily from our restructuring accruals and decreases in other assets and inventories.

We used $202.4 million of cash for investing activities during the six months ended September 30, 2004, compared to generating $98.5 million during the six months ended September 30, 2003. The use of cash for the six months ended September 30, 2004 primarily reflects the net cash paid for our fiscal 2005 acquisitions, and the purchases of capital equipment and property offset by the net proceeds from the sale of short-term investments.

We used $62.1 million of cash for the six months ended September 30, 2004 from financing activities compared to generating $4.7 million for the six months ended September 30, 2003. The major financing source of cash was from the sale of common stock through the exercise of employee stock options. The major financing uses of cash for the six months ended September 30, 2004 was related to the repurchase of company stock and a structured agreement to repurchase company stock.

On April 1, 2004, the Company completed the acquisition of 3ware, Inc., a provider of high-performance, high-capacity SATA storage solutions. Under the terms of the agreement, AMCC acquired all outstanding shares of 3ware, Inc. for approximately $145.0 million in cash and assumed options to purchase approximately 4.3 million shares of AMCC’s common stock.

On May 5, 2004, the Company completed the acquisition of the assets and intellectual property associated with IBM’s 400 series of embedded PowerPC^® standard products for approximately $227.9 million in cash. In connection with this acquisition we have exercised an option to purchase certain assets located in France for approximately $4.1 million, after certain local requirements are met.

We believe that our available cash, cash equivalents and short-term investments will be sufficient to meet our capital requirements and fund our operations for at least the next 12 months, although we could elect or could be required to raise additional capital during such period. There can be no assurance that such additional debt or equity financing will be available on commercially reasonable terms or at all.

The following table summarizes our contractual obligations not included on the balance sheet as of September 30, 2004 (in thousands):

Before deciding to invest in us or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC. We update our descriptions of the risks and uncertainties facing us in our periodic reports filed with the SEC in which we report our financial condition and results for the quarter and fiscal year-to-date. The risks and uncertainties described below and in our other filings are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose your investment.

Our operating results may fluctuate because of a number of factors, many of which are beyond our control.

If our operating results are below the expectations of public market analysts or investors, then the market price of our common stock could decline. Some of the factors that affect our quarterly and annual results, but which are difficult to control or predict are:

Our business, financial condition and operating results would be harmed if we do not achieve anticipated revenues.

Our business is characterized by short-term orders and shipment schedules. Customer orders typically can be cancelled or rescheduled without significant penalty to the customer. Because we do not have substantial noncancellable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. Customer orders for our products typically have non standard lead times, which makes it difficult for us to predict revenues and plan inventory levels and production schedules. If we are unable to plan inventory levels and production schedules effectively, our business, financial condition and operating results could be materially harmed.

From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside contract manufacturers, suppliers and foundries, we may order materials in advance of anticipated

customer demand. This advance ordering has in the past and may in the future result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize, or other factors render our products less marketable. Accordingly, our financial condition and operating results could be materially harmed.

Our expense levels are relatively fixed and are based on our expectations of future revenues. We have limited ability to reduce expenses quickly in response to any revenue shortfalls.

If the downturns in the communications equipment industry and in information technology spending continue, our revenues and profitability will continue to be adversely affected.

We derive a majority of our revenues from sales of IC products and subsystems to communications equipment manufacturers. The communications equipment industry has experienced a significant extended downturn and as a result, the financial condition of many telecommunications companies has significantly declined. This downturn has severely affected carrier capital equipment expenditures, which in turn has affected the demand for our communications IC products and our revenues and profitability. We cannot predict how long this downturn will last, but as long as it does, our revenues and profitability will continue to be impacted. Our need to continue investment in research and development during this downturn and to maintain extensive ongoing customer service and support constrains our ability to reduce expenses.

In addition to the downturn in the communications equipment industry, since late 2000 large enterprises throughout the global economy have significantly reduced their spending on information technology products such as our storage products. We cannot predict the depth or duration of this downturn in spending, and if it grows more severe or continues for a long period of time, our ability to derive or maintain revenues from our storage business may be impaired. Because we intend to continue to make significant investments in research and development in our storage business and to maintain its customer service and support capabilities, any resulting decline in its revenues will have a significant adverse impact on our operating results.

We expect revenues that are currently derived from non-communications ICs will decline in future periods.

We derived significant revenues from product sales to customers in the ATE, high-speed computing and military markets in the past. The majority of these products were manufactured at our internal wafer fabrication facility, which closed in March 2003. Throughout most of fiscal 2003, we were fulfilling last-time-buy orders for parts manufactured in this facility. As a result of the last-time-buy program in fiscal 2003, our revenues from sales of our non-communications IC products decreased.

Our business substantially depends upon the continued growth of the Internet.

A substantial portion of our business and revenue depends on the continued growth of the Internet. We sell our communications IC products primarily to communications equipment manufacturers that in turn sell their equipment to customers that depend on the growth of the Internet. OEMs and other customers that buy our storage products are similarly dependent on continued Internet growth and information technology spending. As a result of the economic slowdown, the significant decline in the financial condition of many telecommunications companies and the reduction in capital spending, spending on Internet infrastructure has declined. To the extent that the economic slowdown and reduction in capital spending continues to adversely affect spending on Internet infrastructure, our business, operating results, and financial condition will continue to be materially harmed.

Our customers are concentrated. The loss of one or more key customers, the diminished demand for our products from a key customer, or the failure to obtain certifications from a key customer or its distribution channel could significantly reduce our revenues and profits.

A relatively small number of customers have accounted for a significant portion of our revenues in any particular period. We have no long-term volume purchase commitments from any of our key customers. Many of

our key customers have announced dramatic declines in demand for their products into which our products are incorporated. As a result, new orders from these customers have been deferred, and customers may have overstocked our products. One or more of our key customers may discontinue operations as a result of consolidation, liquidation or otherwise. Continued reductions, delays and cancellation of orders from our key customers or the loss of one or more key customers could significantly further reduce our revenues and profits. We cannot assure you that our current customers will continue to place orders with us, that orders by existing customers will continue at current or historical levels or that we will be able to obtain orders from new customers.

Our ability to maintain or increase sales to key customers and attract new significant customers is subject to a variety of factors, including:

The occurrence of any one of the factors above could have a material adverse effect on our business, financial condition and results of operations.

In addition, before we can sell our storage products to an OEM, either directly or through the OEM’s associated distribution channel, that OEM must certify our products. The certification process can take up to 12 months. This process requires the commitment of OEM personnel and test equipment, and we compete with other suppliers for these resources. Any delays in obtaining these certifications or any failure to obtain these certifications would adversely affect our ability to sell our SAN products.

Any significant order cancellations or order deferrals could adversely affect our operating results.

We typically sell products pursuant to purchase orders that customers can generally cancel or defer on short notice without incurring a significant penalty. Any significant cancellations or deferrals in the future could materially and adversely affect our business, financial condition and results of operations. Cancellations or deferrals could cause us to hold excess inventory, which could reduce our profit margins, increase product obsolescence and restrict our ability to fund our operations. We generally recognize revenue upon shipment of products to a customer. If a customer refuses to accept shipped products or does not pay for these products, we could miss future revenue projections or incur significant charges against our income, which could materially and adversely affect our operating results.

Our products typically have lengthy sales cycles. A customer may decide to cancel or change its product plans, which could cause us to lose anticipated sales. In addition, our average product life cycles tend to be short and, as a result, we may hold excess or obsolete inventory that could adversely affect our operating results.

After we have developed and delivered a product to a customer, the customer will usually test and evaluate our product prior to designing its own equipment to incorporate our product. Our customers may need three to more than six months to test, evaluate and adopt our product and an additional three to more than nine months to begin volume production of equipment that incorporates our product. Due to this lengthy sales cycle, we may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring such expenditures. Even if a customer selects our product to incorporate into its equipment, we have no assurances that the customer will ultimately market and sell its equipment or that such efforts by our customer will be successful. The delays inherent in our lengthy sales cycle increase the risk that a customer will decide to cancel or change its product plans. Such a cancellation or change in plans by a customer could cause us to lose sales that we had anticipated. In addition, anticipated sales could be materially and adversely affected if a significant customer curtails, reduces or delays orders during our sales cycle or chooses not to release equipment that contains our products.

While our sales cycles are typically long, our average product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, the resources devoted to product sales and marketing may not generate material revenue for us, and from time to time, we may need to write off excess and obsolete inventory. If we incur significant marketing expenses and investments in inventory in the future that we are not able to recover, and we are not able to compensate for those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions but still hold higher cost products in inventory, our operating results would be harmed.

An important part of our strategy is to continue our focus on the markets for wireline communications and storage infrastructure. If we are unable to further expand our share of these markets, our revenues may not grow and could further decline.

Our markets frequently undergo transitions in which products rapidly incorporate new features and performance standards on an industry-wide basis. If our products are unable to support the new features or performance levels required by OEMs in these markets, or if our products fail to be certified by OEMs, we would be likely to lose business from an existing or potential customer and would not have the opportunity to compete for new design wins or certification until the next product transition occurs. If we fail to develop products with required features or performance standards, or if we experience a delay as short as a few months in certifying or bringing a new product to market, or if our customers fail to achieve market acceptance of their products, our revenues could be significantly reduced for a substantial period.

We expect a significant portion of our revenues to continue to be derived from sales of products based on current, widely accepted transmission standards. If the communications market evolves to new standards, we may not be able to successfully design and manufacture new products that address the needs of our customers or gain substantial market acceptance.

Customers for our products generally have substantial technological capabilities and financial resources. They traditionally use these resources to internally develop their own products. The future prospects for our products in these markets are dependent upon our customers’ acceptance of our products as an alternative to their internally developed products. Future prospects also are dependent upon acceptance of third-party sourcing for products as an alternative to in-house development. Network equipment vendors may in the future continue to use internally developed components. They also may decide to develop or acquire components, technologies or products that are similar to, or that may be substituted for, our products.

If our network equipment vendor customers fail to accept our products as an alternative, if they develop or acquire the technology to develop such components internally rather than purchase our products, or if we are otherwise unable to develop strong relationships with network equipment vendors, our business, financial condition and results of operations would be materially and adversely affected.

Because a significant portion of our storage products are designed to work with servers from Sun Microsystems, our storage business will be adversely affected if demand for Sun’s servers does not expand, or by our failure to market and sell our HBAs that interoperate with operating systems other than the Sun Solaris operating system.

A substantial amount of the historical revenues from our storage business are derived from sales of HBAs that include software designed to work with the Sun Microsystems Solaris operating system. These HBAs have achieved their greatest market acceptance in computing environments built with high-end servers from Sun Microsystems due to our products’ interoperability with the Solaris operating system. To increase our revenues and grow our storage business, we must increase our position in Solaris environments and build market share with our newer products that interoperate with other operating systems. These products have not obtained market penetration comparable to what we have achieved in the Solaris environment, and our ability to increase market share is subject to the risks inherent in the commercialization of new products. In particular, competition in the market for non-Solaris Fibre Channel HBAs is fierce, and it will be challenging to displace incumbent suppliers such as Emulex and Qlogic to expand our market share. To achieve increased market share, it may be necessary for us to reduce our product prices in these new markets. This strategy may not be successful in increasing our market share, and it could affect pricing in our existing markets. We may not be successful in marketing and selling our new products, and we cannot assure you that our intended customers will purchase our products instead of competing products. Our failure to obtain a significant share of the market for HBAs compatible with operating systems other than the Solaris operating system would impair our growth and harm our operating results. Also, in light of our dependence on interoperability with the Solaris operating system, our revenues and operating results also may suffer if the demand for Sun’s servers, and particularly its high-end servers, does not expand.

Because a significant portion of our HBAs are integrated with storage devices manufactured by a limited number of storage companies, the future revenue growth of our storage business depends on our ability to obtain OEM certifications for the new and existing products of these manufacturers and on the increased demand for such products.

We believe that the majority of our storage products are used to form connections to storage arrays manufactured by companies such as EMC, Hitachi Data Systems, Network Appliance, StorageTek or Sun Microsystems. To a material extent, the future revenue growth of our storage business depends upon the continued acceptance of and increased demand for the storage products offered by these vendors and other like vendors. To maintain and expand our position with these vendors, we must continue to provide high quality, early-to-market, high-performance HBAs at competitive prices. Even if we are able to meet the demands of these vendors, it is possible that they will develop or acquire products or technologies that make our storage products uncompetitive. These vendors may form alliances with other industry participants or competitive suppliers of HBAs that could adversely impact the demand for our storage products. If we are unable to timely obtain OEM certifications for new storage products offered by these vendors, they could make arrangements with competing HBA manufacturers that would make our products less competitive for both existing and new storage arrays. If we are unable to maintain or expand our relationships with vendors such as EMC, Hitachi Data Systems, Network Appliance, StorageTek or Sun Microsystems, our revenues may suffer.

Our industry and markets are subject to consolidation, which may result in stronger competitors, fewer customers and reduced demand.

There has been industry consolidation among communications IC companies, network equipment companies and telecommunications companies in the past. We expect this consolidation to continue as

companies attempt to strengthen or hold their positions in evolving markets. Consolidation may result in stronger competitors, fewer customers and reduced demand, which in turn could have a material adverse effect on our business, operating results, and financial condition.

Our operating results are subject to fluctuations because we rely heavily on international sales.

International sales account for a significant part of our revenues and may account for an increasing portion of our future revenues. As a result, an increasing portion of our revenues may be subject to certain risks, including:

We are subject to risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether quotas, duties, taxes or other charges or restrictions upon the importation or exportation of our products will be implemented by the United States or other countries. Because sales of our products have been denominated to date primarily in United States dollars, increases in the value of the United States dollar could increase the price of our products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country. Future international activity may result in increased foreign currency denominated sales. Gains and losses on the conversion to United States dollars of accounts receivable, accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in our results of operations. Some of our customer purchase orders and agreements are governed by foreign laws, which may differ significantly from United States laws. We may be limited in our ability to enforce our rights under such agreements.

Our cash and cash equivalents and portfolio of short-term investments are exposed to certain market risks.

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are recorded on the consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Our investment portfolio is exposed to market risks related to changes in interest rates, credit ratings of the issuers and foreign currency exchange rates, as well as the risk of default by the issuer. Substantially all of these securities are subject to interest rate and credit rating risk and will decline in value if interest rates increase or one of the issuer’s credit ratings is reduced. Increases in interest rates, decreases in the credit worthiness of one or more of the issuers in the portfolio or adverse changes in foreign currency exchange rates could have a material adverse impact on our financial condition or results of operations.

Our restructuring activities could result in management distractions, operational disruptions and other difficulties.

As a result of the economic slowdown and the related uncertainties in our industry, we implemented a restructuring plan in the first quarter of fiscal 2004. The plan focused on cost reductions and operating efficiencies, and included workforce reductions. Additionally, in the third quarter of fiscal 2004 we had a workforce reduction in connection with synergistic plans associated with the acquisition of the PRS business and JNI Corporation. Employees directly affected by the reductions may seek future employment with our customers or competitors. Although all employees are required to sign a confidentiality agreement with us at the time of hire, we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Our restructuring efforts could divert the attention of our management away from our operations, harm our reputation and increase our expenses. We cannot assure you that our restructuring efforts will be successful, or that we may not undertake additional restructuring activities. In addition, if we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to any renewed growth opportunities.

Our markets are subject to rapid technological change, so our success depends heavily on our ability to develop and introduce new products.

To develop new products for the communications IC and storage markets, we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to develop technical and design expertise. We must have our products designed into our customers’ future products and maintain close working relationships with key customers in order to develop new products that meet customers’ changing needs. We must respond to changing industry standards, trends towards increased integration and other technological changes on a timely and cost-effective basis. Our pursuit of technological advances may require substantial time and expense and may ultimately prove unsuccessful. If we are not successful in introducing such advances, we will be unable to timely bring to market new products and our revenues will suffer.

Products for communications applications are based on industry standards that are continually evolving. Our ability to compete in the future will depend on our ability to identify and ensure compliance with these evolving industry standards. The emergence of new industry standards could render our products incompatible with products developed by major systems manufacturers. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our products to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards, we could miss opportunities to achieve crucial design wins. If we fail to do so, we may not achieve design wins with key customers or may subsequently lose such design wins, and our business will significantly suffer because once a customer has designed a supplier’s product into its system, the customer typically is extremely reluctant to change its supply source due to significant costs associated with qualifying a new supplier.

The markets in which we compete are highly competitive and subject to rapid technological change, price erosion and heightened competition.

The markets in which we compete are highly competitive and we expect that domestic and international competition will increase in these markets, due in part to deregulation, rapid technological advances, price erosion, changing customer preferences and evolving industry standards. Increased competition could result in significant price competition, reduced revenues, lower profit margins or loss of market share. Our ability to compete successfully in our markets depends on a number of factors, including:

Our competitors may offer enhancements to existing products, or offer new products based on new technologies, industry standards or customer requirements, that are available to customers on a more timely basis than comparable products from us or that have the potential to replace or provide lower cost alternatives to our products. The introduction of such enhancements or new products by our competitors could render our existing and future products obsolete or unmarketable. Once a customer has designed a supplier’s product into its system, the customer is unlikely to change its supply source due to the significant costs associated with qualifying a new supplier. We expect that certain of our competitors and other semiconductor companies may seek to develop and introduce products that integrate the functions performed by our IC products on a single chip, thus eliminating the need for our products. Each of these factors could have a material adverse effect on our business, financial condition and results of operations.

In the communications IC markets, we compete primarily against companies such as Agere, Broadcom, Intel, Mindspeed, PMC-Sierra, and Vitesse. Certain of our customers or potential customers have internal IC design or manufacturing capability with which we compete. Any failure by us to compete successfully in these target markets, particularly in the communications markets, would have a material adverse effect on our business, financial condition and results of operations.

In the storage market, we primarily compete against companies such as Emulex, QLogic, Agilent Technologies, Adaptec and LSI Logic. As a result of our acquisition of IBM’s 400 series of embedded PowerPC^® standard products in May 2004, our list of competitors has been expanded to include large technology companies such as Motorola and IBM. Many of these companies have substantially greater financial, marketing and distribution resources than we have. Emulex and Qlogic have entered the Sun Solaris segment of the SAN market, which is the primary market for our SAN products. We may also face competition from new entrants to the SAN market, including larger technology companies that may develop or acquire differentiating technology and then apply their resources to our detriment. The storage market continues to mature and become commoditized. To the extent that commoditization leads to significant pricing declines, whether initiated by us or

by a competitor, we will be required to increase our product volumes and reduce our costs of goods sold to avoid resulting pressure on our profit margin for these products, and we cannot assure you that we will be successful in responding to these competitive pricing pressures.

Our HBA products may also compete at the end-user level with other current or future technology alternatives. Businesses that implement SANs may select fully-integrated SAN systems that are offered by large product solution companies. Because these systems typically do not interoperate with our products, customers that invest in these systems will be less likely to purchase our products. Unless we are able to develop products based on other emerging connectivity technologies, our SAN business could suffer if the market for Fibre Channel products grows more slowly than we anticipate as a result of competition from these technologies. To the extent that we develop products based on other standards, such as our InfiniBand products, we will face competition in the markets for these products that may come from larger technology companies such as Emulex, IBM, QLogic and Sun. We may not succeed, for competitive or other reasons, in achieving market penetration with our InfiniBand or other potential products directed at new markets.

The closing of our internal wafer fabrication facility could result in unanticipated liability and reduced revenues.

In the past we have derived a significant portion of our revenues from products manufactured in our internal wafer fabrication facility. This facility was closed during fiscal 2003 and we no longer have the ability to manufacture products in the facility, which subjects us to substantial risks, including:

A disruption in the manufacturing capabilities of our outside foundries would negatively impact the production of certain of our products.

In the past, we relied on outside foundries for the manufacture of the majority of our IC products. Now that we have closed our internal foundry, all of our IC products will be manufactured by outside foundries. These outside foundries generally manufacture our products on a purchase order basis, and we generally do not have long-term supply arrangements with these suppliers. We have less control over delivery schedules, manufacturing yields and costs than competitors with their own fabrication facilities. A manufacturing disruption experienced by one or more of our outside foundries or a disruption of our relationship with an outside foundry, including discontinuance of our products by that foundry, would negatively impact the production of certain of our products for a substantial period of time. The transition to the next generation of manufacturing technologies at one or more of our outside foundries could be unsuccessful or delayed.

Our IC products are generally only qualified for production at a single foundry. These suppliers can allocate, and in the past have allocated, capacity to the production of other companies’ products while reducing deliveries to us on short notice. Because establishing relationships, designing or redesigning ICs, and ramping production with new outside foundries may take over a year, there is no readily available alternative source of supply for these products.

Our dependence on third-party manufacturing and supply relationships increases the risk that we will not have an adequate supply of products to meet demand or that our cost of materials will be higher than expected.

The risks associated with our dependence upon third parties which manufacture, assemble or package certain of our products, include:

Difficulties associated with adapting our technology and product design to the proprietary process technology and design rules of outside foundries can lead to reduced yields of our IC products. The process technology of an outside foundry is typically proprietary to the manufacturer. Since low yields may result from either design or process technology failures, yield problems may not be effectively determined or resolved until an actual product exists that can be analyzed and tested to identify process sensitivities relating to the design rules that are used. As a result, yield problems may not be identified until well into the production process, and resolution of yield problems may require cooperation between us and our manufacturer. This risk could be compounded by the offshore location of certain of our manufacturers, increasing the effort and time required to identify, communicate and resolve manufacturing yield problems. Manufacturing defects that we do not discover during the manufacturing or testing process may lead to costly product recalls. These risks may lead to increased costs or delayed product delivery, which would harm our profitability and customer relationships.

If the foundries or subcontractors we use to manufacture our products discontinue the manufacturing processes needed to meet our demands, or fail to upgrade their technologies needed to manufacture our products, we may be unable to deliver products to our customers, which could materially adversely affect our operating results.

Our requirements typically represent a very small portion of the total production of the third-party foundries. As a result, we are subject to the risk that a producer will cease production of an older or lower-volume process that it uses to produce our parts. We cannot be certain our external foundries will continue to devote resources to the production of our products or continue to advance the process design technologies on which the manufacturing of our products are based. Each of these events could increase our costs and materially impact our ability to deliver our products on time.

Some companies that supply our customers are similarly dependent on a limited number of suppliers to produce their products. These other companies’ products may be designed into the same networking equipment into which our products are designed. Our order levels could be reduced materially if these companies are unable to access sufficient production capacity to produce in volumes demanded by our customers because our customers may be forced to slow down or halt production on the equipment into which our products are designed.

Our operating results depend on manufacturing output and yields of our ICs, which may not meet expectations.

The yields on wafers we have manufactured decline whenever a substantial percentage of wafers must be rejected or a significant number of die on each wafer are nonfunctional. Such declines can be caused by many factors, including minute levels of contaminants in the manufacturing environment, design issues, defects in

masks used to print circuits on a wafer, and difficulties in the fabrication process. Design iterations and process changes by our suppliers can cause a risk of defects. Many of these problems are difficult to diagnose, are time consuming and expensive to remedy, and can result in shipment delays.

We estimate yields per wafer in order to estimate the value of inventory. If yields are materially different than projected, work-in-process inventory may need to be revalued. We may have to take inventory write-downs as a result of decreases in manufacturing yields. We may suffer periodic yield problems in connection with new or existing products or in connection with the commencement of production at a new manufacturing facility.

We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration and that may result in reduced manufacturing yields, delays in product deliveries and increased expenses.

We expect to transition our IC products to increasingly smaller line width geometries. This transition will require us to migrate to new manufacturing processes for our products and redesign certain products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs and increase performance, and we have designed IC products to be manufactured at as little as .13 micron geometry processes. We have experienced some difficulties in shifting to smaller geometry process technologies and new manufacturing processes. These difficulties resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our IC products to smaller geometry processes. We are dependent on our relationships with our foundries to transition to smaller geometry processes successfully. We cannot assure you that our foundries will be able to effectively manage the transition or that we will be able to maintain our relationships with our foundries. If we or our foundries experience significant delays in this transition or fail to implement this transition, our business, financial condition and results of operations could be materially and adversely affected. As smaller geometry processes become more prevalent, we expect to continue to integrate greater levels of functionality into our IC products. We may not be able to achieve higher levels of design integration or deliver new integrated products on a timely basis.

We must develop or otherwise gain access to improved IC process technologies.

Our future success will depend upon our ability to improve existing IC process technologies or acquire new IC process technologies. In the future, we may be required to transition one or more of our IC products to process technologies with smaller geometries, other materials or higher speeds in order to reduce costs or improve product performance. We may not be able to improve our process technologies or otherwise gain access to new process technologies in a timely or affordable manner. Products based on these technologies may not achieve market acceptance.

The complexity of our products may lead to errors, defects and bugs when they are first introduced, which could negatively impact our reputation with customers and result in liability.

Products as complex as ours may contain errors, defects and bugs when first introduced or as new versions are released. Our products have in the past experienced such errors, defects and bugs. Delivery of products with production defects or reliability, quality or compatibility problems could significantly delay or hinder market acceptance of the products or result in a costly recall. This, in turn, could damage our reputation and adversely affect our ability to retain existing customers and to attract new customers. Errors, defects or bugs could cause problems with device functionality, resulting in interruptions, delays or cessation of sales to our customers.

We may also be required to make significant expenditures of capital and resources to resolve such problems. There can be no assurance that problems will not be found in new products after commencement of commercial production, despite testing by us, our suppliers or our customers. This could result in:

Any such event could have a material adverse effect on our business, financial condition and results of operations.

Changes in the accounting treatment of stock options could adversely affect our results of operations.

The Financial Accounting Standards Board has announced its decision to require companies to expense employee stock options in accordance with SFAS No. 123, Accounting for Stock-Based Compensation, or SFAS 123, for financial reporting purposes. Such stock option expensing would require us to value our employee stock option grants pursuant to an option valuation model, and then amortize that value against our reported earnings over the vesting period in effect for those options. We currently account for stock-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and have adopted the disclosure-only alternative of SFAS 123 and FAS 128. If we are required to expense employee stock options in the future, this change in accounting treatment would materially and adversely affect our reported results of operations as the stock-based compensation expense would be charged directly against our reported earnings. For an illustration of the effect of such a change on our recent results of operations, see Note 1 of Notes to Consolidated Financial Statements.

Our future success depends in part on the continued service of our senior management, design engineering, sales, marketing, and manufacturing personnel and our ability to identify, hire and retain additional, qualified personnel.

Our future success depends to a significant extent upon the continued service of our senior management personnel. The loss of a senior executive could have a material adverse effect on us. There is intense competition for qualified personnel in the semiconductor industry, in particular design, product and test engineers, and we may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business, or to replace engineers or other qualified personnel who may leave our employment in the future. Periods of contraction in our business may inhibit our ability to attract and retain our personnel. Loss of the services of, or failure to recruit, key design engineers or other technical and management personnel could be significantly detrimental to our product development.

To manage operations effectively, we will be required to continue to improve our operational, financial and management systems and to successfully hire, train, motivate, and manage our employees. The integration of past and future potential acquisitions will require significant additional management, technical and administrative resources. We cannot be certain that we would be able to manage our expanded operations effectively.

On July 28, 2004, our Chief Financial Officer announced his intention to retire. On September 9, 2004, the President, Chief Executive Officer and Chairman of our Board of Directors announced his intention to retire. A search is currently underway for their successors. However, there is no assurance that we will be able to attract, hire and retain qualified replacements, and there may be significant costs associated with the recruiting, hiring and retention of their successors.

Our ability to supply a sufficient number of products to meet demand could be severely hampered by a shortage of water, electricity or other supplies, or by natural disasters or other catastrophes.

The manufacture of our products requires significant amounts of water. Previous droughts have resulted in restrictions being placed on water use by manufacturers. In the event of a future drought, reductions in water use may be mandated generally and our external foundries’ ability to manufacture our products could be impaired.

Several of our facilities, including our principal executive offices, are located in California. In 2001, California experienced prolonged energy alerts and blackouts caused by disruption in energy supplies. As a consequence, California continues to experience substantially increased costs of electricity and natural gas. We are unsure whether these alerts and blackouts will reoccur or how severe they may become in the future. Many of our customers and suppliers are also headquartered or have substantial operations in California. If we, or any of our major customers or suppliers located in California, experience a sustained disruption in energy supplies, our results of operations could be materially and adversely affected.

Our test and assembly facilities are located in San Diego, California and our external manufacturing operations are mainly concentrated in Taiwan. These areas are subject to natural disasters such as earthquakes or floods. We do not have earthquake or business interruption insurance for these facilities, because adequate coverage is not offered at economically justifiable rates. A significant natural disaster or other catastrophic event could have a material adverse impact on our business, financial condition and operating results.

The effects of war, acts of terrorism or global threats, including, but not limited to, the outbreak of epidemic disease, could have a material adverse effect on our business, operating results and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

We could incur substantial fines or litigation costs associated with our storage, use and disposal of hazardous materials.

We are subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals that were used in our manufacturing process. Any failure to comply with present or future regulations could result in the imposition of fines, the suspension of production or a cessation of operations. These regulations could require us to acquire costly equipment or incur other significant expenses to comply with environmental regulations or clean up prior discharges. Since 1993, we have been named as a PRP, along with a large number of other companies that used Omega Chemical Corporation in Whittier, California to handle and dispose of certain hazardous waste material. We are a member of a large group of PRPs that has agreed to fund certain on-going remediation efforts at the Omega Chemical site. To date, our payment obligations with respect to these funding efforts have not been material, and we believe that our future obligations to fund these efforts will not have a material adverse effect on our business, financial condition or operating results. Although we believe that we are currently in material compliance with applicable environmental laws and regulations, we cannot assure you that we are or will be in material compliance with these laws or regulations or that our future obligations to fund any remediation efforts, including those at the Omega Chemical site, will not have a material adverse effect on our business.

Our business strategy contemplates the acquisition of other companies, products and technologies. Merger and acquisition activities involve numerous risks and we may not be able to address these risks successfully without substantial expense, delay or other operational or financial problems.

Acquiring products, technologies or businesses from third parties is part of our business strategy. The risks involved with merger and acquisition activities include:

Any of these risks could materially harm our business, financial condition and results of operations.

As with past acquisitions, future acquisitions could adversely affect operating results. In particular, acquisitions may materially and adversely affect our results of operations because they may require large one-time charges or could result in increased debt or contingent liabilities, adverse tax consequences, substantial additional depreciation or deferred compensation charges. Our past purchase acquisitions required us to capitalize significant amounts of goodwill and purchased intangible assets. As a result of the slowdown in our industry and reduction of our market capitalization, we have been required to record various significant impairment charges against these assets as noted in our financial statements. At September 30, 2004, we have $578.2 million of goodwill and purchased intangible assets. There can be no assurance that we will not be required to take additional significant charges as a result of an impairment to the carrying value of these assets, due to further declines in market conditions.

We have been named as a defendant in securities class action litigation that could result in substantial costs and divert management’s attention and resources.

Our chief executive officer, current and former chief financial officer and certain of our other executive officers and directors, have been sued for alleged violations of federal securities laws related to alleged misrepresentations regarding our financial prospects for the fourth quarter of fiscal 2001. In addition, JNI Corporation, which we acquired in October 2003, also has a number of pending lawsuits. We believe that the claims being brought against us, including the claims pending against JNI Corporation and our officers and directors, are without merit, and we intend to engage in a vigorous defense against such claims. If we are not successful in our defense against such claims, we could be forced to make significant payments to the plaintiffs and their lawyers, and such payments could have a material adverse effect on our business, financial condition and results of operations if not covered by our insurance carriers. Even if such claims are not successful, the litigation could result in substantial costs including, but not limited to, attorney and expert fees, and divert management’s attention and resources, which could have an adverse effect on our business. Though insurers have paid defense costs to date, there can be no assurance that they will continue to pay such costs, judgments or other expenses associated with the lawsuit. To that end, one of our insurers, Lumbermens Insurance Company (“Lumbermens”) issued to us a five million dollar policy providing defense and indemnity coverage for this lawsuit, Lumbermens is a subsidiary of Kemper Insurance Company (“Kemper”). Kemper has publicly indicated that its overall loss exposure may exceed its ability to pay future claims, and has obtained approval from the Illinois Department of Insurance to proceed with a three year run-off plan intended to resolve, to the maximum extent possible, valid policyholder claims. Though we currently believe that it is more likely than not that Lumbermens will pay amounts owed on the policy, it is possible that Lumbermens or our other insurers will become insolvent or will otherwise be unwilling or unable to pay some or all amounts owed on the policies.

We rely in part on patents to protect our intellectual property. We cannot assure you that our pending patent applications or any future applications will be approved, or that any issued patents will adequately protect the

intellectual property in our products, provide us with competitive advantages or will not be challenged by third parties, or that if challenged, will be found to be valid or enforceable. Others may independently develop similar products or processes, duplicate our products or processes or design around any patents that may be issued to us.

To protect our intellectual property, we also rely on the combination of mask work protection under the Federal Semiconductor Chip Protection Act of 1984, trademarks, copyrights, trade secret laws, employee and third-party nondisclosure agreements, and licensing arrangements. Despite these efforts, we cannot be certain that others will not independently develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property, or disclose such intellectual property or trade secrets, or that we can meaningfully protect our intellectual property. A failure by us to meaningfully protect our intellectual property could have a material adverse effect on our business, financial condition and operating results.

We generally enter into confidentiality agreements with our employees, consultants and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. Also, former employees may seek employment with our business partners, customers or competitors and we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, former employees or third parties could attempt to penetrate our network to misappropriate our proprietary information or interrupt our business. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. As a result, our technologies and processes may be misappropriated, particularly in foreign countries where laws may not protect our proprietary rights as fully as in the United States.

We could be harmed by litigation involving patents, proprietary rights or other claims.

Litigation may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or misappropriation. The semiconductor industry is characterized by substantial litigation regarding patent and other intellectual property rights. Such litigation could result in substantial costs and diversion of resources, including the attention of our management and technical personnel and could have a material adverse effect on our business, financial condition and results of operations. We may be accused of infringing on the intellectual property rights of third parties. We have certain indemnification obligations to customers with respect to the infringement of third-party intellectual property rights by our products. We cannot be certain that infringement claims by third parties or claims for indemnification by customers or end users resulting from infringement claims will not be asserted in the future, or that such assertions will not harm our business.

Any litigation relating to the intellectual property rights of third parties would at a minimum be costly and could divert the efforts and attention of our management and technical personnel. In the event of any adverse ruling in any such litigation, we could be required to pay substantial damages, cease the manufacturing, use and sale of infringing products, discontinue the use of certain processes or obtain a license under the intellectual property rights of the third party claiming infringement. A license might not be available on reasonable terms.

From time to time, we may be involved in litigation relating to other claims arising out of our operations in the normal course of business. We cannot assure you that the ultimate outcome of any such matters will not have a material, adverse effect on our business, financial condition or operating results.

The market price of our common stock has fluctuated significantly. In the future, the market price of our common stock could be subject to significant fluctuations due to general economic and market conditions and in response to quarter-to-quarter variations in:

The stock market in recent years has experienced extreme price and volume fluctuations that have affected the market prices of many high technology companies, particularly semiconductor companies, and that have often been unrelated or disproportionate to the operating performance of those companies. These fluctuations may harm the market price of our common stock.

The anti-takeover provisions of our certificate of incorporation and of the Delaware general corporation law may delay, defer or prevent a change of control.

Our board of directors has the authority to issue up to 2,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges and restrictions, including voting rights, of those shares without any further vote or action by our stockholders. The rights of the holders of common stock will be subject to, and may be harmed by, the rights of the holders of any shares of preferred stock that may be issued in the future. The issuance of preferred stock may delay, defer or prevent a change in control, as the terms of the preferred stock that might be issued could potentially prohibit our consummation of any merger, reorganization, sale of substantially all of our assets, liquidation or other extraordinary corporate transaction without the approval of the holders of the outstanding shares of preferred stock. The issuance of preferred stock could have a dilutive effect on our stockholders.

If we issue additional shares of stock in the future, it may have a dilutive effect on our stockholders.

We have a significant number of authorized and unissued shares of our common stock available. These shares will provide us with the flexibility to issue our common stock for proper corporate purposes, which may include making acquisitions through the use of stock, adopting additional equity incentive plans and raising equity capital. Any issuance of our common stock may result in immediate dilution of our then current stockholders.

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and a decline in the stock market. We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.

We maintain an investment portfolio of various holdings, types and maturities. These securities are classified as available-for-sale and, consequently, are recorded on the consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income. We have established guidelines relative to diversification and maturities that attempt to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of interest rate trends. We invest our excess cash in debt instruments of the U.S. Treasury, corporate bonds, mortgage-backed and asset

backed securities and closed-end bond funds, with credit ratings as specified in our investment policy. We also have invested in preferred stocks, which pay quarterly fixed rate dividends. We generally do not utilize derivatives to hedge against increases in interest rates which decrease market values, except for investment managers who utilize U.S. Treasury bond futures options (“futures options”) as a protection against the impact of increases in interest rates on the fair value of preferred stocks managed by that investment manager. The Company marks any outstanding futures options to market and market value changes are recognized in current earnings. The futures options generally have terms ranging from 90 to 180 days.

We are exposed to market risk as it relates to changes in the market value of our investments. At September 30, 2004, our investment portfolio included fixed-income securities classified as available-for-sale investments with a fair market value of $351.7 million and a cost basis of $352.3 million. These securities are subject to interest rate risk, as well as credit risk, and will decline in value if interest rates increase or an issuer’s credit rating or financial condition is decreased. The following table presents the hypothetical changes in fair value of our short-term investments held at September 30, 2004 (in thousands):

The modeling technique used measures the change in fair market value arising from selected potential changes in interest rates. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points, 100 basis points, and 150 basis points.

We invest in equity instruments of private companies for business and strategic purposes. These investments are valued based on our historical cost, less any recognized impairments. The estimated fair values are not necessarily representative of the amounts that we could realize in a current transaction.

We generally conduct business, including sales to foreign customers, in U.S. dollars, and as a result, we have limited foreign currency exchange rate risk. However, we have entered into forward currency exchange contracts to hedge our overseas monthly operating expenses when deemed appropriate. Gains and losses on foreign currency forward contracts that are designated and effective as hedges of anticipated transactions, for which a firm commitment has been attained, are deferred and included in the basis of the transaction in the same period that the underlying transaction is settled. Gains and losses on any instruments not meeting the above criteria are recognized in income or expenses in the consolidated statement of operations in the current period. The effect of an immediate 10 percent change in foreign exchange rates would not have a material impact on our financial condition or results of operations.

Our chief executive officer and chief financial officer performed an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) as of September 30, 2004 (the “Evaluation Date”). Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective and sufficient to ensure that the information required to be disclosed in the reports that we file under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

There was no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In April 2001, a series of similar federal complaints were filed against us and certain of our executive officers and directors. The complaints have been consolidated into a single proceeding in the U.S. District Court for the Southern District of California. In re Applied Micro Circuits Corp. Securities Litigation, lead case number 01-CV-0649-K(AB). In January 2002, the court appointed lead plaintiff filed a consolidated federal complaint. The consolidated federal complaint alleges violations of the Securities Exchange Act of 1934 and is brought as a shareholder class action under Sections 10(b), 20(a), 20A and Rule 10b-5 under the Act. Plaintiff seeks monetary damages on behalf of the shareholder class. Discovery in this lawsuit is continuing. Trial is currently scheduled for calendar year 2005.

We believe that the allegations in this lawsuit are without merit and intends to defend against the lawsuit vigorously. We cannot predict the likely outcome of this lawsuit, and an adverse result could have a material adverse effect on us. We have notified our insurance carriers of this lawsuit and submitted expenses incurred in defending the lawsuit as claims under the relevant insurance policies. Though insurers have paid defense costs to date, there can be no assurance that they will continue to pay such costs, judgments or other expenses associated with the lawsuit. To that end, one of our insurers, Lumbermens Insurance Company (“Lumbermens”) issued to us a five million dollar policy providing defense and indemnity coverage for this lawsuit, Lumbermens is a subsidiary of Kemper Insurance Company (“Kemper”). Kemper has publicly indicated that its overall loss exposure may exceed its ability to pay future claims, and has obtained approval from the Illinois Department of Insurance to proceed with a three year run-off plan intended to resolve, to the maximum extent possible, valid policyholder claims. Though we currently believe that it is more likely than not that Lumbermens will pay amounts owed on the policy, it is possible that Lumbermens or our other insurers will become insolvent or will otherwise be unwilling or unable to pay some or all amounts owed on the policies.

In May 2001, a series of similar state derivative actions were filed against our directors and certain executive officers. The state complaints were coordinated and assigned to the Superior Court of California in the County of San Diego. Applied Micro Circuits Shareholders Cases, Case No. JCCP No. 4193. In July 2004, the court approved a settlement of the derivative actions, which became effective on August 27, 2004. As part of the settlement, the defendants expressly denied any wrongdoing or liability related to the allegations made in the derivative actions, and the settlement did not result in the payment of any monetary damages. Pursuant to the settlement, we agreed to pay the plaintiffs’ attorneys’ fees and costs and to implement certain corporate governance changes, including the election of two new directors and the separation of the positions of Chairman of the Board and Chief Executive Officer no later than the Company’s annual meeting of stockholders in 2005 and the appointment of a lead director if the Chairman of the Board is not independent. Costs of the settlement have been paid by its insurance carriers.

Since 1993, we have been named as a potentially responsible party, or PRP, along with a large number of other companies that used Omega Chemical Corporation in Whittier, California to handle and dispose of certain hazardous waste material. We are a member of a large group of PRPs that has agreed to fund certain remediation efforts at the Omega Chemical site, for which we have accrued approximately $100,000. In September 2000, we entered into a consent decree with the Environmental Protection Agency, pursuant to which we agreed to fund its proportionate share of the initial remediation efforts at the Omega Chemical site.

In September 2003, Silvaco Data Systems (“Silvaco”) filed a complaint against us in the Superior Court of the State of California in the County of Santa Clara. Silvaco Data Systems v. Applied Micro Circuits Corporation Case No. 103cv005696. In its complaint, Silvaco claims that we misappropriated trade secrets and engaged in unfair business practices by using software licensed to us by Circuit Symantics, Inc. We filed an answer denying Silvaco’s allegations and filed a motion seeking a stay of the lawsuit against us pending arbitration of terms of a settlement agreement between Circuit Symantics and Silvaco. The motion has been granted and the arbitration is taking place. We expects the arbitration to conclude in the third quarter of fiscal 2005.

Several litigation matters are discussed below involving JNI, which became a wholly-owned subsidiary of us in October 2003.

In October 2001, a state derivative suit was filed against JNI and certain of its former officers and directors in the San Diego County Superior Court, Case No. GIC 775153. The complaint alleged that between October 16, 2000 and January 24, 2001, the defendants breached their fiduciary duty by failing to adequately oversee the activities of management and that JNI allegedly made false statements about its business and results causing its stock to trade at artificially inflated levels. The court has sustained JNI’s demurrers to each of the plaintiff’s complaints and dismissed the plaintiff in June 2002. However, in May 2002, another plaintiff, Sik-Lin Huang, filed a motion to intervene in the case. In June 2002, the court granted Huang’s motion to intervene. Huang filed a complaint in intervention in July 2002. In September 2002, the board of directors of JNI appointed a special litigation committee to investigate the allegations. In February 2003, the special litigation committee issued a report of its investigation which concluded that it is not in the best interests of JNI to pursue the litigation. In February 2003, counsel for the special litigation committee filed a motion to dismiss the action. In November 2003, the court dismissed the matter with prejudice. In January 2004, plaintiffs filed a notice of appeal. A motion to dismiss the appeal has been filed by the defendants on the grounds that the plaintiffs have lost standing because they no longer own JNI shares. The Court has stated that it will rule on the motion to dismiss the appeal when it rules on the merits of the appeal. Plaintiff’s opening brief on the merits is due in October 2004.

We are also party to various claims and legal actions arising in the normal course of business, including employee disputes and notification of possible infringement on the intellectual property rights of third parties.

Although the ultimate outcome of the pending matters is not presently determinable, we believe that the resolution of all such matters, net of amounts accrued, will not have a material adverse effect on its financial position or liquidity; however, there can be no assurance that the ultimate resolution of these matters and that costs and other expenses associated with these matters will not have a material impact on its results of operations in any period.

Below is a summary of stock repurchases for the quarter ended September 30, 2004 (in thousands, except average price per share). See Note 6 of our Notes to Condensed Consolidated Financial Statements for information regarding our stock repurchase plan.

We held our annual meeting of stockholders on September 1, 2004. Of the 311,901,311 shares of our common stock that could be voted at the annual meeting, 284,589,504 shares, or 91%, were represented at the annual meeting in person or by proxy, which constituted a quorum. Voting results were as follows:

(a) Election of the following persons to our Board of Directors to hold office until the next annual meeting of stockholders:

(b) Ratification of the appointment of Ernst & Young LLP as our independent auditors for the fiscal year ending March 31, 2005:

On September 9, 2004, David M. Rickey, Chairman of the Board, President and Chief Executive Officer of the registrant, provided to the registrant’s Board of Directors notice of his intention to resign all of his positions with the registrant effective August 25, 2005.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


APPLIED MICRO CIRCUITS CORPORATION

By:		/s/ STEPHEN M. SMITH
		Stephen M. Smith
		Senior Vice President and Chief Financial Officer (Duly Authorized Signatory and Principal Financial and Accounting Officer)


		Page
Part I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets at September 30, 2004 (unaudited) and March 31, 2004.	3

	Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended September 30, 2004 and 2003.	4

	Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended September 30, 2004 and 2003.	5

	Notes to Condensed Consolidated Financial Statements (unaudited).	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	17

Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	45

Item 4.	Controls and Procedures.	46

Part II.	OTHER INFORMATION

Item 1.	Legal Proceedings.	47

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	49

Item 4.	Submission of Matters to a Vote of Security Holders.	49

Item 5.	Other Information.	50

Item 6.	Exhibits.	50

Signatures		51


	September 30, 2004			March 31, 2004
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	58,899		$	329,162
Short-term investments-available-for-sale		351,677			531,879
Accounts receivable		27,872			23,284
Inventories		18,842			8,490
Other current assets		17,362			16,208

Total current assets		474,652			909,023
Property and equipment, net		39,762			37,271
Goodwill and purchased intangibles, net		578,206			240,193
Other assets		1,769			1,616

Total assets	$	1,094,389		$	1,188,103

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	26,163		$	18,164
Accrued payroll and related expenses		11,219			9,189
Other accrued liabilities		29,565			35,539
Deferred revenue		4,036			4,361
Current portion of long-term debt and capital lease obligations		171			303

Total current liabilities		71,154			67,556
Stockholders’ equity:
Preferred stock, $0.01 par value:
Authorized shares - 2,000, none issued and outstanding		—			—
Common stock, $0.01 par value:
Authorized shares - 630,000 at September 30, 2004
Issued and outstanding shares - 308,109 at September 30, 2004 and 310,985 at March 31, 2004		3,081			3,110
Additional paid-in capital		5,897,052			5,937,568
Deferred compensation, net		(14,228	)		(3,299	)
Accumulated other comprehensive income or loss		(343	)		5,352
Accumulated deficit		(4,862,327	)		(4,822,184	)

Total stockholders’ equity		1,023,235			1,120,547

Total liabilities and stockholders’ equity	$	1,094,389		$	1,188,103


	Three Months Ended September 30,						Six Months Ended September 30,
	2004			2003			2004			2003
Net revenues	$	61,069		$	25,119		$	128,471		$	45,634
Cost of revenues (1)		31,529			9,485			63,021			19,268

Gross profit		29,540			15,634			65,450			26,366
Operating expenses:
Research and development		31,702			26,102			62,692			55,228
Selling, general and administrative		15,298			11,037			29,676			21,399
Stock-based compensation:
Research and development		915			3,579			1,947			12,704
Selling, general and administrative		2,202			1,043			3,525			4,451
Acquired in-process research and development		—			5,700			13,400			5,700
Amortization of purchased intangibles		1,962			—			3,519			—
Restructuring charges		310			—			310			23,498

Total operating expenses		52,389			47,461			115,069			122,980

Operating loss		(22,849	)		(31,827	)		(49,619	)		(96,614	)
Interest income, net		4,530			8,929			9,811			20,324
Other income (expense), net		—			(10	)		—			(10	)

Loss before income taxes		(18,319	)		(22,908	)		(39,808	)		(76,300	)
Income tax expense (benefit)		—			—			335			—

Net loss	$	(18,319	)	$	(22,908	)	$	(40,143	)	$	(76,300	)

Basic and diluted net loss per share:
Net loss per share	$	(0.06	)	$	(0.08	)	$	(0.13	)	$	(0.25	)

Shares used in calculating basic and diluted net loss per share		310,128			305,195			310,824			304,498


(1) Cost of revenues includes the following (in thousands):
Stock-based compensation	$	129		$	171		$	284		$	389
Amortization of developed technology		6,474			1,572			12,075			3,143
Amortization of purchased inventory fair value adjustment		1,103			—			2,204			—

	$	7,706		$	1,743		$	14,563		$	3,532


	*Six months ended September 30,*
	2004			2003
Operating activities:
Net loss	$	(40,143	)	$	(76,300	)
Adjustments to reconcile net loss to net cash used for operating activities
Depreciation and amortization		9,519			10,623
Amortization of purchased intangibles		15,594			3,143
Acquired in-process research and development		13,400			5,700
Stock-based compensation expense		5,756			17,544
Non-cash restructuring charges		—			7,529
Loss on disposals of property		—			10
Changes in operating assets and liabilities:
Accounts receivable		(2,963	)		(5,652	)
Inventories		(5,402	)		2,136
Other assets		(842	)		7,736
Accounts payable		5,520			(682	)
Accrued payroll and other accrued liabilities		(5,377	)		5,625
Deferred revenue		(832	)		1,528

Net cash used for operating activities		(5,770	)		(21,060	)

Investing activities:
Proceeds from sales and maturities of short-term investments		2,142,809			2,939,209
Purchases of short-term investments		(1,968,400	)		(2,783,898	)
Repayments on notes receivable from employees		—			51
Purchase of property, equipment and other assets		(11,019	)		(9,054	)
Net cash paid for acquisitions		(365,755	)		(47,788	)

Net cash provided by (used for) investing activities		(202,365	)		98,520

Financing activities:
Proceeds from issuance of common stock		4,785			5,773
Repurchase of company stock		(16,879	)		—
Agreements to repurchase company stock		(50,000	)		—
Payments on capital lease obligations		(132	)		(763	)
Payments on long-term debt		—			(343	)
Other		98			39

Net cash provided by (used for) financing activities		(62,128	)		4,706

Net increase (decrease) in cash and cash equivalents		(270,263	)		82,166
Cash and cash equivalents at beginning of period		329,162			150,556

Cash and cash equivalents at end of period	$	58,899		$	232,722

Supplementary cash flow disclosure:
Cash paid for:
Interest	$	42		$	34

Income taxes	$	484		$	133


	Three Months Ended September 30,						Six Months Ended September 30,
	2004			2003			2004			2003
Net loss—as reported	$	(18,319	)	$	(22,908	)	$	(40,143	)	$	(76,300	)
Plus: Reported stock-based compensation		3,246			4,793			5,756			17,544
Less: Fair value stock-based compensation		(30,664	)		(78,265	)		(63,476	)		(206,865	)

Net loss—pro forma	$	(45,737	)	$	(96,380	)	$	(97,863	)	$	(265,621	)

Reported basic and diluted net loss per share	$	(0.06	)	$	(0.08	)	$	(0.13	)	$	(0.25	)

Pro forma basic and diluted net loss per share	$	(0.15	)	$	(0.32	)	$	(0.31	)	$	(0.87	)


	Employee Stock Options												Employee Stock Purchase Plan
	Three Months Ended September 30,						Six Months Ended September 30,						Three Months Ended September 30,						Six Months Ended September 30,
	2004			2003			2004			2003			2004			2003			2004			2003
Expected life (years)		4.0			4.0			4.0			4.0			1.4			1.3			1.4			1.3
Volatility		0.95			1.00			0.95			1.01			0.98			1.03			0.98	%		1.03
Risk-free interest rate		3.9	%		2.5	%		3.8	%		2.5	%		1.7	%		1.5	%		1.7	%		1.5	%
Dividend yield		0	%		0	%		0	%		0	%		0	%		0	%		0	%		0	%
Weighted average fair value per share	$	2.30		$	4.12		$	2.67		$	3.55		$	2.19		$	2.09		$	2.19		$	2.09


	3ware, Inc.		Embedded Products Business		Total
Net tangible assets	$	10,142	$	883	$	11,025
In-process research and development		8,000		5,400		13,400
Developed technology		14,500		73,500		88,000
Backlog/customer relationships		300		1,900		2,200
Patents/core technology rights/tradename		6,100		20,700		26,800
Purchased inventory fair value adjustment		1,465		739		2,204
Stock based compensation		19,024		—		19,024
Goodwill (Note 3)		110,189		126,161		236,350

Total consideration	$	169,720	$	229,283	$	399,003


	September 30, 2004		March 31, 2004
Finished goods	$	11,191	$	5,061
Work in process		4,248		2,376
Raw materials		3,403		1,053

	$	18,842	$	8,490


	Useful Life	September 30, 2004			March 31, 2004
	(in years)
Machinery and equipment	5-7	$	44,403		$	44,402
Leasehold improvements	1-10		11,099			9,969
Computers, office furniture and equipment	3-7		100,334			91,411
Building	31.5		3,333			—
Land	N/A		2,402			—

			161,571			145,782
Less accumulated depreciation and amortization			(121,809	)		(108,511	)

		$	39,762		$	37,271


	September 30, 2004							March 31, 2004
	Gross		Accumulated Amortization and Impairments			Net		Gross		Accumulated Amortization and Impairments			Net
Goodwill	$	4,403,337	$	(3,974,186	)	$	429,151	$	4,166,727	$	(3,974,186	)	$	192,541
Developed technology and patents		440,700		(301,884	)		138,816		333,900		(288,107	)		45,793
Customer relationships / backlog		3,600		(1,456	)		2,144		1,400		(489	)		911
Tradename/Trademark		32,000		(23,905	)		8,095		24,000		(23,052	)		948

	$	4,879,637	$	(4,301,431	)	$	578,206	$	4,526,027	$	(4,285,834	)	$	240,193


Balance as of March 31, 2004	$	192,541
Goodwill related to acquisitions (Note 2)		236,350
Acquired lease liability adjustment		260

Balance as of September 30, 2004	$	429,151


Six months ending March 31, 2005	$	16,836
Fiscal year 2006		28,669
Fiscal year 2007		25,213
Fiscal year 2008		25,000
Fiscal year 2009		22,316
Thereafter		31,021

Total	$	149,055


	September 30, 2004		March 31, 2004
Accrued warranty and excess purchase commitments	$	6,412	$	6,412
Current tax liabilities		451		600
Restructuring liabilities (Note 4)		3,179		7,118
Excess lease liability		9,917		11,159
Other		9,606		10,250

	$	29,565	$	35,539


	Workforce Reduction			Facilities Consolidation and Operating Lease Commitments			Property and Equipment Impairments		Total
July 2001 Restructuring Program
Liability, March 31, 2004	$	—		$	68		$	—	$	68
Cash payments		—			(26	)		—		(26	)
Adjustment		—			(42	)		—		(42	)

Liability, September 30, 2004	$	—		$	—		$	—	$	—

April 2003 Restructuring Program
Liability, March 31, 2004	$	51		$	5,639		$	—	$	5,690
Cash payments		—			(2,573	)		—		(2,573	)
Adjustments		(51	)		113			—		62

Liability, September 30, 2004	$	—		$	3,179		$	—	$	3,179

November 2003 Restructuring Program
Liability, March 31, 2004	$	15		$	1,345		$	—	$	1,360
Cash payments		(60	)		(1,590	)		—		(1,650	)
Adjustments		45			245			—		290

Liability, September 30, 2004	$	—		$	—		$	—	$	—


	Workforce Reduction			Facilities Consolidation and Operating Lease Commitments			Property and Equipment Impairments		Total
Liability, March 31, 2004	$	66		$	7,052		$	—	$	7,118
Cash payments		(60	)		(4,189	)		—		(4,249	)
Adjustments		(6	)		316			—		310

Liability, September 30, 2004	$	—		$	3,179		$	—	$	3,179


	Three Months Ended September 30,
	2004				2003
	Amount		% of Net Revenues		Amount		% of Net Revenues		Increase (Decrease)			Change
Communications	$	28,802	47.2	%	$	21,828	86.9	%	$	6,974		31.9	%
Storage		12,583	20.6	%		—	—			12,583		N/A
Embedded Products		16,692	27.3	%		—	—			16,692		N/A
Other		2,992	4.9	%		3,291	13.1	%		(299	)	-9.1	%

	$	61,069	100.0	%	$	25,119	100.0	%	$	35,950		143.1	%


	Six Months Ended September 30,
	2004				2003
	Amount		% of Net Revenues		Amount		% of Net Revenues		Increase (Decrease)			Change
Communications	$	65,178	50.7	%	$	37,891	83.0	%	$	27,287		72.0	%
Storage		25,805	20.1	%		—	—			25,805		N/A
Embedded Products		30,585	23.8	%		—	—			30,585		N/A
Other		6,903	5.4	%		7,743	17.0	%		(840	)	-10.8	%

	$	128,471	100.0	%	$	45,634	100.0	%	$	82,837		181.5	%


	Three Months Ended September 30,				Six Months Ended September 30,
	2004		2003		2004		2003
Insight Electronics, USA	13	%	*		16	%	*
Memec	*		10	%	*		12	%
Mitsui Comtek Corporation	*		10	%	*		10	%
Sanmina-SCI	*		13	%	*		11	%


	Three Months Ended September 30,			Six Months Ended September 30,
	2004	2003		2004	2003
Nortel Networks Corporation	*	16	%	*	16	%
Fujitsu	*	10	%	*	11	%


	Operating Leases		Other Purchase Commitments		Total
Six months ended 3/31/05	$	8,688	$	32,900	$	41,588
FY2006		7,861		—		7,861
FY2007		6,398		—		6,398
FY2008		5,109		—		5,109
FY2009		4,825		—		4,825
Thereafter		9,452		—		9,452

Total	$	42,333	$	32,900	$	75,233


	Valuation of Securities Given an Interest Rate Decrease of X Basis Points						Fair Value as of September 30, 2004		Valuation of Securities Given an Interest Rate Increase of X Basis Points
	(150 BPS)		(100 BPS)		(50 BPS)		Fair Value as of September 30, 2004		50 BPS		100 BPS		150 BPS
Available-for-sale investments	$	380,352	$	367,777	$	360,522	$	351,677	$	343,649	$	338,115	$	328,353


Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Amount that May Yet Be Purchased Under the Plans or Programs
July 1 – July 31, 2004	0		$	0.00	0	$	0
August 1 – August 31, 2004	5,380	(1)		3.14	5,380		183,121	(2)
September 1 – September 30, 2004	0			0.00	0		0

Total Shares Repurchased	5,380		$	3.14	5,380	$	183,121


	For	Withheld
David M. Rickey	277,804,816	6,784,688
Roger A. Smullen, Sr.	278,007,965	6,581,539
Cesar Cesaratto	270,640,800	13,948,704
Franklin P. Johnson, Jr.	275,834,168	8,755,336
L. Wayne Price	268,732,606	15,856,898
Arthur B. Stabenow	267,132,316	17,457,188
Harvey P. White	277,424,141	7,165,363


31.1		Certification of Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act, as amended.

31.2		Certification of Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act, as amended.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.