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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 

 
(MARK ONE)
x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended October 31, 2009
or

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

For the transition period from              to             

Commission file number 001-32207

Sigma Designs, Inc.
(Exact name of registrant as specified in its charter)
 

 
   
California
94-2848099
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)


1778 McCarthy Boulevard,
Milpitas, California 95035
(Address of principal executive offices including Zip Code)
(408) 262-9003
(Registrant’s telephone number, including area code)
 

 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes R  No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes £ No R

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

As of December 2, 2009, the Company had 30,734,258 shares of Common Stock outstanding.

1

 
SIGMA DESIGNS, INC.
TABLE OF CONTENTS
 
 
 
Page No.
PART I.
FINANCIAL INFORMATION
 
     
Item 1.
Unaudited Condensed Consolidated Financial Statements:
 
     
 
Unaudited Condensed Consolidated Balance Sheets as of October 31, 2009 and January 31, 2009
3
     
 
Unaudited Condensed Consolidated Statements of Operations for the three months and nine months ended October 31, 2009 and November 1, 2008
4
     
 
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended October 31, 2009 and November 1, 2008
5
     
 
Notes to Unaudited Condensed Consolidated Financial Statements
6
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
19
   
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
35
     
Item 4.
Controls and Procedures
36
     
PART II.
OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
36
     
Item 1A.
Risk Factors
36
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
49
     
Item 3.
Defaults Upon Senior Securities
49
     
Item 4.
Submission of Matters to a Vote of Security Holders
49
     
Item 5.
Other Information
49
     
Item 6.
Exhibits
50
     
Signatures
51
   
 
Exhibit index
52
 
2

PART I.                      FINANCIAL INFORMATION

ITEM 1.                      UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SIGMA DESIGNS, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
 
   
October 31, 2009
   
January 31, 2009
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 142,707     $ 90,845  
Short-term marketable securities
    60,355       28,862  
Accounts receivable, net
    17,902       30,719  
Inventories
    23,142       36,058  
Deferred tax assets
    1,478       1,417  
Prepaid expenses and other current assets
    8,488       5,909  
Total current assets
    254,072       193,810  
                 
Long-term marketable securities
    32,201       72,523  
Software, equipment and leasehold improvements, net
    21,448       21,124  
Goodwill
    9,913       9,928  
Intangible assets, net
    15,435       17,520  
Deferred tax assets, net of current portion
    10,791       12,824  
Long-term investments
    3,550       3,000  
Other non-current assets
    338       218  
Total assets
  $ 347,748     $ 330,947  
                 
Liabilities and Shareholders' Equity
               
Current liabilities:
               
Accounts payable
  $ 10,420     $ 5,655  
Accrued liabilities
    11,747       12,826  
Total current liabilities
    22,167       18,481  
                 
Other long-term liabilities
    5,031       5,801  
Long-term deferred tax liabilities
    1,669       1,415  
Total liabilities
    28,867       25,697  
                 
Commitments and contingencies (Note 7)
               
                 
Shareholders' equity:
               
Preferred stock
           
Common stock and additional paid-in capital
    367,868       360,908  
Treasury stock
    (85,941 )     (85,941 )
Accumulated other comprehensive income
    1,699       273  
Retained earnings
    35,255       30,010  
Total shareholders' equity
    318,881       305,250  
                 
Total liabilities and shareholders' equity
  $ 347,748     $ 330,947  

See accompanying notes to the unaudited condensed consolidated financial statements
3

SIGMA DESIGNS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
 
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 31, 2009
   
November 1, 2008
   
October 31, 2009
   
November 1, 2008
 
Net revenue
  $ 35,464     $ 46,760     $ 137,990     $ 161,854  
Cost of revenue
    19,396       25,101       74,285       82,654  
Gross profit
    16,068       21,659       63,705       79,200  
                                 
Operating expenses:
                               
Research and development
    11,727       11,131       34,961       32,364  
Sales and marketing
    3,488       3,102       10,181       8,526  
General and administrative
    5,467       3,837       12,220       13,939  
Acquired in-process research and development
                      1,571  
Total operating expenses
    20,682       18,070       57,362       56,400  
Income (loss) from operations
    (4,614 )     3,589       6,343       22,800  
                                 
Interest and other income, net
    564       1,150       1,610       4,382  
Income (loss) before income taxes
    (4,050 )     4,739       7,953       27,182  
Provision for (benefit from) income taxes
    (1,752 )     1,068       2,708       7,338  
Net income (loss)
  $ (2,298 )   $ 3,671     $ 5,245     $ 19,844  
                                 
Net income (loss) per share:
                               
Basic
  $ (0.09 )   $ 0.14     $ 0.20     $ 0.73  
Diluted
  $ (0.09 )   $ 0.14     $ 0.19     $ 0.71  
                                 
Shares used in computing net income (loss) per share:
                 
Basic
    26,782       26,351       26,681       27,045  
Diluted
    26,782       27,084       27,354       27,971  
 

See accompanying notes to the unaudited condensed consolidated financial statements

4

SIGMA DESIGNS, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
   
Nine Months Ended
 
   
October 31, 2009
   
November 1, 2008
 
Cash flows from operating activities:
           
Net income
  $ 5,245     $ 19,844  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    6,816       5,631  
Acquired in-process research and development
          1,571  
Share-based compensation
    5,552       9,935  
Provision for excess and obsolete inventory
    137       1,844  
Provision for sales returns, discounts and doubtful accounts
    486       2,425  
Deferred income taxes
    2,268       1,546  
Loss on disposal of software, equipment and leasehold improvements
    114       1  
Tax benefit from employee stock option plan
    (346 )     4,459  
Excess tax benefit from share-based compensation
    (179 )     (4,459 )
Accretion of contributed leasehold improvements
    (128 )     (93 )
Goodwill adjustment
    15        
Changes in operating assets and liabilities:
               
Accounts receivable
    12,426       13,502  
Inventories
    12,982       (17,562 )
Prepaid expenses and other current assets
    669       (886 )
Other non-current assets
    (120 )     (108 )
Accounts payable
    4,733       (5,612 )
Accrued liabilities
    (1,232 )     (4,616 )
Other long-term liabilities
    (691 )     2,265  
Net cash provided by operating activities
    48,747       29,687  
                 
Cash flows from investing activities:
               
Purchase of marketable securities
    (52,889 )     (85,135 )
Sales and maturities of marketable securities
    61,894       79,736  
Purchases of software, equipment and leasehold improvements
    (4,883 )     (10,520 )
Net cash paid in connection with acquisitions
          (18,576 )
Purchases of long-term investments
    (524 )      
Other
           
Net cash provided by (used in) investing activities
    598       (34,495 )
                 
Cash flows from financing activities:
               
Repayment of bank borrowings
               
Net proceeds from exercises of employee stock options and stock purchase rights
    1,754       3,260  
Proceeds from issuance of common stock, net of offering costs
               
Net cash provided by (used in) financing activities
    1,933       (78,222 )
                 
Effect of foreign exchange rate changes on cash and cash equivalents
    584       (277 )
Increase (decrease) in cash and cash equivalents
    51,862       (83,307 )
                 
Cash and cash equivalents at beginning of period
    90,845       174,089  
Cash and cash equivalents at end of period
  $ 142,707     $ 90,782  
                 
Supplemental disclosure of cash flow information:
               
                 
Cash paid for interest
  $ 75     $  
Cash paid for income taxes
  $ 609     $ 104  

See accompanying notes to the unaudited condensed consolidated financial statements
5

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

1. 
Organization and Summary of significant accounting policies

Organization and nature of operations:  Sigma Designs, Inc. (referred to collectively in these unaudited condensed consolidated financial statements as “Sigma,” “we,” “our” and “us”) specializes in integrated system-on-chip solutions (“SoC”) for the IPTV, connected media player, prosumer and industrial audio/video, connected home technologies and other markets.  We sell our products to manufacturers, designers and to a lesser extent, to distributors who, in turn, sell to manufacturers.

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

The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”).  They do not include all disclosures required by US GAAP for complete financial statements.  However, we believe that the disclosures are adequate and fairly present the information.  The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our audited consolidated financial statements and notes thereto for the year ended January 31, 2009 included in our Annual Report on Form 10-K and 10-K/A.

During the third quarter of fiscal year 2010, we adopted the Accounting Standards Codification, or ASC, issued by the Financial Accounting Standards Board ("FASB").  This standard established only two levels of Generally Accepted Accounting Principles, or GAAP, authoritative and nonauthoritative.  The ASC became the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants.  All other non-grandfathered, non-SEC accounting literature not included in the ASC became nonauthoritative.  This standard was effective for financial statements for interim or annual reporting periods ending after September 15, 2009.  We began to use the new guidelines and numbering system prescribed by the ASC when referring to GAAP in the third quarter of fiscal year 2010.  As the Codification was not intended to change or alter existing GAAP, it did not have any impact on our consolidated financial statements.

The condensed consolidated financial statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments that, in our opinion, are necessary to present fairly our consolidated financial position at October 31, 2009 and January 31, 2009, the consolidated results of our operations for the three months and nine months ended October 31, 2009 and November 1, 2008, and the consolidated cash flows for the nine months ended October 31, 2009 and November 1, 2008.  The results of operations for the three months and nine months ended October 31, 2009 are not necessarily indicative of the results to be expected for future quarters or the year.

Accounting period:  Each of our fiscal quarters presented herein includes 13 weeks and ends on the last Saturday of the period.  The third quarter of fiscal 2010 ended on October 31, 2009.  The third quarter of fiscal 2009 ended on November 1, 2008.

We have performed an evaluation of subsequent events through December 10, 2009, which is the date the financial statements were issued.

Income taxes:  Deferred income taxes reflect the net tax effects of any temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts reported for income tax purposes, and any operating losses and tax credit carryforwards.  Income taxes are accounted for under an asset and liability approach in accordance with ASC 740, Accounting for Income Taxes, (formerly, Statement of Financial Accounting Standard,  “SFAS” No. 109).  Deferred tax liabilities are recognized for future taxable amounts and deferred tax assets are recognized for future deductions, net of any valuation allowance, to reduce deferred tax assets to amounts that are considered more likely than not to be realized.

Under ASC 740, Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109 (formerly, the FASB issued Interpretation No. 48, “FIN 48”), the impact of an uncertain income tax position on the income tax return must be recognized as the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.  An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.  Additionally, ASC 740 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  For the three months ended October 31, 2009, there was an increase of $0.4 million in unrecognized tax benefits.  For the nine months ended October 31, 2009, we recorded a net increase of $1.4 million in unrecognized tax benefits.

6

 
On February 20, 2009, the California Budget Act of 2008 was signed into law which revised certain provisions of the California State Tax Code, including the option to elect an alternative method to attribute taxable income to California for tax years beginning on or after January 1, 2011.  We now expect that in years 2011 and beyond, our income subject to tax in California will be lower than under prior tax law and that our California deferred tax assets are therefore less likely to be realized.  As a result, we recorded a $3.6 million charge in the three months ended May 2, 2009 to reduce our previously recognized California deferred tax assets.

The income tax benefit for the three months ended October 31, 2009 was $1.8 million and the income tax provision for the nine months ended October 31, 2009 was $2.7 million.  The income tax provision for the three months and nine months ended November 1, 2008 was $1.1 million and $7.3 million, respectively.

Recent accounting pronouncements:

Recent Accounting Pronouncements Not Yet Adopted

In August 2009, the FASB issued Accounting Standard Update (“ASU”) No. 2009-05, Fair Value Measurements and Disclosures (Topic 820) -- Measuring Liabilities at Fair Value ("ASU 2009-05").  ASU 2009-05 amends ASC 820, Fair Value Measurements and Disclosures, to provide further guidance on how to measure the fair value of a liability.  It primarily does three things: 1) sets forth the types of valuation techniques to be used to value a liability when a quoted price in an active market for the identical liability is not available, 2) clarifies that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability and 3) clarifies that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. This standard is effective beginning in our fiscal fourth quarter of 2010.  We do not expect the adoption of this standard update to have a material impact on our consolidated financial statements.

In September 2009, the FASB reached a consensus on ASU No. 2009-13, Revenue Recognition (Topic 605) – Multiple-Deliverable Revenue Arrangements ("ASU 2009-13") and ASU No. 2009-14, Software (Topic 985) – Certain Revenue Arrangements That Include Software Elements ("ASU 2009-14").  ASU 2009-13 modifies the requirements that must be met for an entity to recognize revenue from the sale of a delivered item that is part of a multiple-element arrangement when other items have not yet been delivered.  ASU 2009-13 eliminates the requirement that all undelivered elements must have either: i) vendor-specific objective evidence, or VSOE or ii) third-party evidence, or TPE, before an entity can recognize the portion of an overall arrangement consideration that is attributable to items that already have been delivered.  In the absence of VSOE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements.  Overall arrangement consideration will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price.  The residual method of allocating arrangement consideration has been eliminated.  ASU 2009-14 modifies the software revenue recognition guidance to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality.  These new updates are effective for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010.  Early adoption is permitted.  We are currently evaluating the impact that the adoption of these ASUs will have on our consolidated financial statements.

 
2.
Cash, cash equivalents and marketable securities

Cash, cash equivalents and marketable securities consist of the following (in thousands):
 
7

 
   
October 31, 2009
   
January 31, 2009
 
   
Book
   
Net unrealized
   
Fair
   
Book
   
Net unrealized
   
Fair
 
   
Value
   
Gain
   
Value
   
Value
   
Gain
   
Value
 
Money market funds
  $ 115,456     $     $ 115,456     $ 59,213     $     $ 59,213  
Auction rate securities
    42,625             42,625       43,000             43,000  
Corporate bonds
    35,578       245       35,823       26,529       52       26,581  
US agency discount notes
    12,563       37       12,600       16,015       28       16,043  
Municipal bonds and notes
    1,500       7       1,507       15,728       33       15,761  
Total cash equivalents and marketable securities
  $ 207,722     $ 289     $ 208,011     $ 160,485     $ 113     $ 160,598  
                                                 
Cash on hand held in the United States
                    11,006                       1,709  
Cash on hand held overseas
                    16,246                       29,923  
Total cash on hand
                    27,252                       31,632  
Total cash, cash equivalents and marketable securities
            $ 235,263                     $ 192,230  
                                                 
Reported as:
                                               
     Cash and cash equivalents
                  $ 142,707                     $ 90,845  
     Short-term marketable securities
                    60,355                       28,862  
     Long-term marketable securities
                    32,201                       72,523  
                    $ 235,263                     $ 192,230  
 
The amortized cost and estimated fair value of cash equivalents and marketable securities, by contractual maturity as measured on the date of purchase, are as follows (in thousands).  Actual maturities may differ from contractual maturities.
 
   
October 31, 2009
   
January 31, 2009
 
   
Book
   
Fair
   
Book
   
Fair
 
   
Value
   
Value
   
Value
   
Value
 
Due in 1 year or less
  $ 175,708     $ 175,810     $ 88,046     $ 88,075  
Due in greater than 1 year
    32,014       32,201       72,439       72,523  
Total
  $ 207,722     $ 208,011     $ 160,485     $ 160,598  
 
Our marketable securities include primarily auction rate securities (“ARS”), corporate commercial paper and bonds and US agency notes.  We classify our marketable securities as available-for-sale and report them at fair market value with the related unrealized gains and losses included in accumulated other comprehensive income.  We monitor all of our marketable securities for impairment and, if these securities are reported to have had a decline in fair value, we use significant judgment to identify events or circumstances that would likely have a significant adverse effect on the future value of each investment including: (i) the nature of the investment; (ii) the cause and duration of any impairment; (iii) the financial condition and near term prospects of the issuer; (iv) our ability to hold the security for a period of time sufficient to allow for any anticipated recovery of fair value; (v) the extent to which fair value may differ from cost; and (vi) a comparison of the income generated by the securities compared to alternative investments.  We would recognize an impairment charge if a decline in the fair value of our marketable securities is judged to be other-than-temporary.

Included in our marketable securities portfolio at October 31, 2009 were nine ARS that we purchased at par value of $43.0 million and during our second and third quarter of fiscal 2010, the issuer of the one of these ARS redeemed a limited portion in the amount of $0.1 million and $0.3 million, respectively, from us.  As a result, as of October 31, 2009 we held nine auction rate securities with a par value of $42.6 million.  Auction rate securities are bought and sold in the marketplace through a bidding process sometimes referred to as a “Dutch auction.”  Historically, the fair value of our ARS has been determined by the frequent auction periods, generally every 28 days, which provided liquidity at par value for these investments.  However, subsequent to February 2008, all auctions involving such securities that we hold failed.  The result of a failed auction is that these ARS continue to pay interest in accordance with their terms as adjusted at each respective auction date.  However, liquidity of the securities will continue to be limited until there is a successful auction, the issuer redeems the securities, the securities mature or until such time as other markets for these ARS develop.  We cannot be certain regarding the amount of time it will take for an auction market or other markets to develop for these securities.  In October 2008, we accepted an offer from our cash investment advisor, UBS, for a comprehensive settlement agreement in which all the ARS currently in our portfolio could be redeemed at par value.  The offer to redeem will be at our option during a two year period beginning in June 2010.  The offer also gives UBS the discretion to buy any or all of these securities from us at par value at any time through June 2012.  Additionally, the solution by UBS to the lack of liquidity of our ARS includes a commitment effective October 2008 through June 2010 to loan an amount up to 75% of the par value of the ARS.  The interest charged on such loan would be equal to the proportional amount of interest being paid by the issuers of the ARS borrowed against.  At October 31, 2009, UBS provided an estimated value for the nine ARS of approximately $37.3 million, which reflects an unrealized loss of $5.3 million from our carrying value.  We have not adopted UBS’ estimated value of our ARS for the reasons described below.  As a result of our review and in accordance with the various accounting pronouncements in this area, we reached the conclusion that the $42.6 million carrying value of our nine ARS has not been impaired and that we have no expectation of any material adverse impact on our future results of operations, liquidity or capital resources associated with holding these securities.

8

 
We have reviewed the prospectuses for each of the nine ARS in our investment portfolio as of October 31, 2009 and determined that the unprecedented disruption in the auction process and resulting pattern of interest payments has been in accordance with their established rules of operation under these circumstances.  The default mechanism called for in the operating rules of these instruments is designed to adjust their interest payments to a limit based on the income generated by their underlying student loans.  The most significant consequences of this mechanism are the preservation of their AAA credit rating while adjusting to a continuing stream of interest payments to the security holders at a rate correlating to contemporary credit market rates.

As a result of this review, we reached the conclusion that the securities do have a strong underlying principle value and that any potential adjustment in their carrying value would be based upon our ability to endure their lack of liquidity, the degree of certainty of continuing interest payments and the rate of return on these securities.  Given that we expect considerable liquidity from our other assets, foresee continuing positive cash flow from operations and have accepted our investment advisor’s offer to purchase all of our ARS at par value in June 2010, we do not consider the remaining liquidity risk and UBS’ default risk to be significant enough to justify a reduction in the carrying value.  The remaining valuation factor that we considered was the rate of return evidenced by the interest received.  We used a discounted cash flow calculation that reached a valuation that was similar to other of our recent investments with comparably high credit ratings.

3.
Fair values of assets and liabilities

ASC 820, Fair Value Measurements (formerly, SFAS 157), define fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price)” and also, establishes a framework for measuring fair value and expands fair value measurement disclosure.

Fair value hierarchy

ASC 820 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow), and the cost approach (cost to replace the service capacity of an asset or replacement cost).  The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels.  The following is a brief description of those three levels:

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

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

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

Determination of fair value

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

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Our ARS holdings are classified within Level 3.  We have valued the ARS through a discounted cash flow model which requires making a significant assumption as to the expectation of UBS’s offer to redeem all of the ARS at par value in June 2010 and future interest income from those securities which is not observable in the market.  During the nine months ended October 31, 2009, we recorded no impairment loss relating to the value of ARS and recorded no realized gains or losses for these ARS.  In August 2009, we purchased a convertible note receivable from a privately-held venture capital funded technology company with a face value which is equal to its cost of $3.0 million, is convertible into the issuer’s preferred stock under certain circumstances and bears interest at a rate of 9% per annum with a maturity date of November 30, 2009.  At October 31, 2009 the convertible note receivable was valued at $3.1 equaling its cost plus accrued interest.  We also purchased shares of preferred stock in this issuer at a cost of $2.0 million during the fourth quarter of fiscal 2009.  Three of our directors hold equity interests in the issuer of the convertible note receivable and one of these directors is also a director of the issuer of the convertible note.  In the aggregate, these equity interests do not rise to the level of a material or a controlling interest in the issuer.  Our board of directors appointed one of our independent directors who has no interest in the issuer to evaluate each investment in this issuer and recommend appropriate action to our board of directors.  All investment transactions with this issuer were approved and recommended by this independent director and made as a result of a negotiation process.  This convertible note receivable and all of our investments in privately-held companies are classified within Level 3.  We have valued our convertible note receivable and investments in privately-held companies at cost, plus accrued interest in the case of the convertible note receivable, as the inputs are unobservable and significant to the fair value measurements.

The table below presents the balances of our financial instruments measured at fair value on a recurring basis (in thousands):
 
   
Fair Value Measurement at Reporting Date
 
         
Quoted Prices In Active Markets for Identical Assets
   
Significant Observable Inputs
   
Significant Unobservable Inputs
 
   
Fair Value
   
(Level 1 )
   
(Level 2)
   
(Level 3)
 
Money market funds
  $ 115,456     $ 115,456     $     $  
Auction rate securities
    42,625                   42,625  
Corporate bonds
    35,823       35,823              
US agency discount notes
    12,600       12,600              
Municipal bonds and notes
    1,507       1,507              
Total cash equivalent and marketable securities
  $ 208,011     $ 165,386     $     $ 42,625  
Convertible note receivable
    3,068                   3,068  
Equity investments in privately-held companies
    3,550                   3,550  
Total financial instruments measured and recorded at fair value
  $ 214,629     $ 165,386     $     $ 49,243  
 
The table below presents the balances of our assets measured at fair value on a recurring basis on our consolidated condensed balance sheets (in thousands):
 
   
Fair Value Measurement at Reporting Date
 
Assets
 
Fair Value
   
(Level 1 )
   
(Level 2)
   
(Level 3)
 
Cash eqivalents
  $ 115,456     $ 115,456     $     $  
Short-term marketable securities
    60,354       17,729             42,625  
Long-term marketable securities
    32,201       32,201              
Prepaid expenses and other current assets
    3,068                   3,068  
Long-term investments
    3,550                   3,550  
Total assets measured and recorded at fair value
  $ 214,629     $ 165,386     $     $ 49,243  
 
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The table below presents a summary of the changes in Level 3 assets measured at fair value on a recurring basis (in thousands):
 
 
 
Fair Value Measurements
 
 
 
Using Significant
 
 
 
Unobservable Inputs (Level 3)
 
Beginning Balance at February 1, 2009
  $ 46,501  
Total realized gains or losses included in net income
     
Total unrealized gain and translation adjustments included in other comprehensive income
    49  
Purchases, sales and settlements, net
    2,693  
Ending balance at October 31, 2009
  $ 49,243  
         
The total amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at the reporting date
  $  

 
4.
Inventories

Inventories consist of the following (in thousands):
 
   
October 31, 2009
   
January 31, 2009
 
Wafers and other purchased materials
  $ 13,021     $ 22,325  
Work-in-process
    2,871       2,869  
Finished goods
    7,250       10,864  
Total
  $ 23,142     $ 36,058  
 
 
5.
Intangible assets

The change in the gross amount of the acquired intangible assets from January 31, 2009 to October 31, 2009 was as follows (in thousands):
 
   
January 31, 2009
   
Cumulative Translation Adjustments
   
October 31, 2009
 
Developed technology
  $ 18,914     $ 310     $ 19,224  
Trademarks
    1,478       76       1,554  
Noncompete agreements
    1,400             1,400  
Customer relationships
    1,123             1,123  
    $ 22,915     $ 386     $ 23,301  
 
Acquired intangible assets, subject to amortization, were as follows as of October 31, 2009 (in thousands, except for estimated useful life):
 
   
Gross Value
   
Accumulated Amortization
   
Net Value
 
Estimated Useful Life
Developed technology
  $ 19,224     $ 5,975     $ 13,249  
2 to 9 years
Trademarks
    1,554       214       1,340  
5 to 10 years
Noncompete agreements
    1,400       1,400        
3 years
Customer relationships
    1,123       277       846  
7 years
    $ 23,301     $ 7,866     $ 15,435    
 
Amortization expense related to acquired intangible assets was $0.8 million and $2.5 million for the three and nine months ended October 31, 2009, respectively, and $0.7 million and $2.2 million for the three and nine months ended November 1, 2008, respectively.  As of October 31, 2009, we expect the amortization expense in future periods to be as follows (in thousands):

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Developed
         
Customer
       
Fiscal year
 
Technology
   
Trademarks
   
Relationships
   
Total
 
Reminder of 2010
  $ 712     $ 44     $ 40     $ 796  
2011
    2,693       178       160       3,031  
2012
    2,689       178       160       3,027  
2013
    2,689       178       160       3,027  
2014
    1,964       119       161       2,244  
Thereafter
    2,502       643       165       3,310  
    $ 13,249     $ 1,340     $ 846     $ 15,435  
 
 
6.
Product warranty

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

Details of the change in accrued warranty as of October 31, 2009 and November 1, 2008 are as follows (in thousands):
 
   
Balance
               
Balance
 
   
Beginning
               
End of
 
Three Months Ended
 
of Period
   
Additions
   
Deductions
   
Period
 
October 31, 2009
  $ 1,250     $ 123     $ (198 )   $ 1,175  
November 1, 2008
    1,590       641       (581 )     1,650  
                                 
Nine Months Ended
                               
October 31, 2009
  $ 1,330     $ 365     $ (520 )   $ 1,175  
November 1, 2008
    1,564       1,175       (1,089 )     1,650  
 
 
7.
Commitments and contingencies

Commitments

Leases

Our primary facility in Milpitas, California is leased under a non-cancelable lease which expires in September 2012.  As of October 31, 2009, we also lease facilities in Canada, Denmark, France, Hong Kong, Singapore and Japan under non-cancelable leases.  Future minimum annual payments under operating leases are as follows (in thousands):
 
   
Operating
 
Fiscal years
 
Leases
 
Remainder of fiscal 2010
  $ 523  
2011
    1,938  
2012
    1,825  
2013
    1,419  
2014
    749  
Thereafter
    2,851  
Total minimum lease payments
  $ 9,305  

Purchase commitments

We place non-cancelable orders to purchase semiconductor products from our suppliers on an eight to twelve week lead-time basis.  As of October 31, 2009, the total amount of outstanding non-cancelable purchase orders was approximately $9.8 million.

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Indemnifications

Our standard terms and conditions of sale include a patent infringement indemnification provision for claims from third parties related to our intellectual property.  The terms and conditions of sale generally limit the scope of the available remedies to a variety of industry-standard methods including, but not limited to, a right to control the defense or settlement of any claim, procure the right for continued usage and a right to replace or modify the infringing products to make them non-infringing.  Such indemnification provisions are accounted for in accordance with ASC 30, Accounting for Contingencies (formerly, SFAS 5).  To date, we have incurred minimal costs related to claims under such indemnification provisions.

Royalties

We pay royalties for the right to sell certain products under various license agreements.  During the three and nine months ended October 31, 2009, we recorded royalty expense of $0.4 million and $1.6 million, respectively, and $0.6 million and $1.6 million for the three and nine months ended November 1, 2008, respectively, which was recorded to cost of revenue.

Contingencies

Litigation

We are not currently a party to any material legal proceedings.  From time to time, we are involved in claims and legal proceedings that arise in the ordinary course of business.  We expect that the number and significance of these matters will increase as our business expands.  In particular, we could face an increasing number of patent and other intellectual property claims as the number of products and competitors in our industry grows.  Any claims or proceedings against us, whether meritorious or not, could be time consuming, result in costly litigation, require significant amounts of management time, result in the diversion of significant operational resources, or cause us to enter into royalty or licensing agreements which, if required, may not be available on terms favorable to us or at all.  If an unfavorable outcome were to occur against us, there exists the possibility of a material adverse impact on our financial position and results of operations for the period in which the unfavorable outcome occurs and, potentially, in future periods.

 
8.
Net income (loss) per share

Basic net income (loss)  per share for the periods presented is computed by dividing net income by the weighted average number of common shares outstanding.  Diluted net income (loss) per share is computed by including shares subject to repurchase as well as dilutive options.

The following table sets forth the basic and diluted net income (loss) per share computed for the three and nine months ended October 31, 2009 and November 1, 2008 (in thousands, except per share amounts):
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 31, 2009
   
November 1, 2008
   
October 31, 2009
   
November 1, 2008
 
Numerator:
                       
Net income (loss), as reported
  $ (2,298 )   $ 3,671     $ 5,245     $ 19,844  
Denominator:
                               
Weighted average common shares outstanding - basic
    26,782       26,351       26,681       27,045  
Effect of dilutive securities:
                               
Stock options
    -       733       673       926  
Shares used in computation - diluted
    26,782       27,084       27,354       27,971  
Net income (loss) per share:
                               
Basic
  $ (0.09 )   $ 0.14     $ 0.20     $ 0.73  
Diluted
  $ (0.09 )   $ 0.14     $ 0.19     $ 0.71  
 

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A summary of the excluded potentially dilutive securities for the three and nine months ended October 31, 2009 and November 1, 2008 is as follows (in thousands):
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 31, 2009
   
November 1, 2008
   
October 31, 2009
   
November 1, 2008
 
Stock options excluded because of the effect of including would be anti-dilutive
    690                    
Stock options excluded because exercise price is in excess of average stock price
    2,638       1,987       2,753       1,617  
 
 
9.
Equity incentive plans and employee benefits

Stock option plans

We have adopted equity incentive plans that provide for the grant of stock option awards to employees, directors and consultants which are designed to encourage and reward their long-term contributions to us and provide an incentive for them to remain with us.  These plans also align our employees’ interest with the creation of long-term shareholder value.  As of October 31, 2009, we have three stock option plans: the 2003 Director Stock Option Plan (the “2003 Director Plan”), the 2001 Stock Plan (the “2001 Plan”) and the 2009 Stock Incentive Plan (the “2009 Incentive Plan”).  The 2009 Incentive Plan was approved by our shareholders in July 2009 along with the approval of a one-time stock option exchange program.

The exchange program began on August 24, 2009 and concluded on September 22, 2009.  Under the exchange program, eligible employees were permitted to exchange outstanding stock options granted under our 2001 Option Plan prior to June 2008 with exercise prices equal to or greater than $20.25 per share for a lesser number of stock options that were granted following the expiration of the exchange program at a ratio of 1 share in the replacement option for every 1.5 shares exchanged from eligible options.  Our directors and executive officers were not eligible to participate in the option exchange program.  As a result, on September 22, 2009, pursuant to the terms of the exchange program, we accepted for exchange and cancelled options to purchase an aggregate of 663,737 shares of our common stock under the 2001 Option Plan.  On September 23, 2009, we issued replacement options to purchase an aggregate of 442,550 shares of our common stock in exchange for the options tendered under our 2001 Option Plan.  These replacement options have a strike price of $15.25 with a 5 year vesting schedule and 8-year term, each commencing on September 23, 3009.
 
Our 2009 Incentive Plan provides for the grant of stock options, restricted stock, restricted stock units, other stock-related awards and performance awards that may be settled in cash, stock or other property.  There are 2,900,000 shares of common stock reserved for issuance under the 2009 Incentive Plan.  In addition, up to 1,000,000 shares of common stock that were subject to stock awards outstanding under the 2001 Plan but terminate prior to exercise and would otherwise be returned to the share reserves under our 2001Option Plan will become available for issuance under the 2009 Incentive Plan. 
 
As of October 31, 2009, 2,820,000 shares were available for future grants under the 2009 Incentive Plan.  As of September 23, 2009, the 2001 Option Plan and the 2003 Director Plan were closed for future grants, however, these plans will continue to govern all outstanding options that we originally granted from each plan.

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    The total stock option activities and balances of our stock option plans are summarized as follows:
 
               
Weighted Average
   
Aggregate
 
   
Number of
   
Weighted Average
   
Remaining
   
Intrinsic
 
   
Shares
   
Exercise Price
   
Contractual Term
   
Value
 
   
Outstanding
   
Per Share
   
(Years)
   
(in thousands)
 
Balance, January 31, 2009
    4,457,757     $ 17.50              
Granted
    264,500       11.09              
Cancelled
    (150,578 )     36.42              
Exercised
    (41,341 )     7.63              
                             
Balance, May 2, 2009
    4,530,338     $ 16.59              
Granted
    143,500       14.60              
Cancelled
    (41,511 )     37.24              
Exercised
    (60,637 )     6.45              
                             
Balance, August 1, 2009
    4,571,690     $ 16.50              
Granted
    522,550       15.47              
Cancelled
    (676,194 )     39.90              
Exercised
    (37,192 )     5.69              
                             
                             
Balance, October 31, 2009
    4,380,854     $ 12.85       6.99     $ 8,785,363  
                                 
Ending Vested and Expected to Vest
    4,079,107     $ 12.81       6.89     $ 8,548,199  
Ending Exercisable
    1,962,721     $ 11.75       5.34     $ 6,979,495  
 
The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on our closing stock price of $12.01 as of October 31, 2009, which would have been received by the option holders had all options holders exercised their options as of that date.  The aggregate exercise date intrinsic value of options that were exercised under our stock option plans was $0.3 million and $0.9 million for the three months ended October 31, 2009 and November 1, 2008, respectively, determined as of the date of option exercise.  The aggregate exercise date intrinsic value of options that were exercised under our stock option plans was $1.0 million and $12.2 million for the nine months ended October 31, 2009 and November 1, 2008, respectively, determined as of the date of option exercise.  The total fair value of options which vested during the three months ended October 31, 2009 and November 1, 2008 was $1.3 million and $2.4 million, respectively.  The total fair value of options which vested during the nine months ended October 31, 2009 and November 1, 2008 was $3.9 million and $8.2 million, respectively.

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The options outstanding and currently exercisable at October 31, 2009 were in the following exercise price ranges:
 
Options Outstanding
   
Options Exercisable
 
Range of Exercise Prices Per Share
   
Number of Shares Outstanding at October 31, 2009
   
Weighted Average Remaining Life (Years)
   
Weighted Average Exercise Price
Per Share
   
Number of Shares Exercisable at
October 31, 2009
   
Weighted Average Exercise Price
Per Share
 
$ 0.95     $ 3.50       453,698       2.53     $ 2.56       451,851     $ 2.56  
$ 4.25     $ 8.89       447,608       4.75     $ 7.26       435,496     $ 7.23  
$ 9.35     $ 9.89       225,931       7.17     $ 9.66       69,023     $ 9.78  
$ 10.87     $ 10.87       790,500       9.01     $ 10.87       8316       11  
$ 11.06     $ 11.06       531,232       6.82     $ 11.06       325,609     $ 11.06  
$ 11.09     $ 11.40       578,606       7.45     $ 11.26       246,884     $ 11.40  
$ 11.69     $ 13.88       136,250       7.47     $ 13.25       57,792     $ 12.75  
$ 15.25     $ 15.25       442,550       7.90     $ 15.25       0     $ -  
$ 15.32     $ 28.63       563,913       7.97     $ 20.65       219,720     $ 21.92  
$ 31.57     $ 45.83       210,566       7.98     $ 40.49       148,030     $ 40.76  
$ 0.95     $ 45.83       4,380,854       6.99     $ 12.85       1,962,721     $ 11.75  

As of October 31, 2009, the unrecorded share-based compensation balance related to stock options outstanding excluding estimated forfeitures was $42.6 million and will be recognized over an estimated weighted average amortization period of 3.65 years.  The amortization period is based on the expected remaining vesting term of the options.

Employee stock purchase plan
 
        Under our 2001 Employee Stock Purchase Plan (the “2001 Purchase Plan”), employees are granted the right to purchase shares of common stock at a price per share that is 85% of the fair market value at the beginning or end of each six-month offering period, whichever is lower.  As of October 31, 2009, 303,440 shares under the 2001 Purchase Plan remain available for future purchase.

Valuation and expense of share-based compensation

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

The fair value of each option and employee stock purchase right was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
 
 
Three Months Ended
 
October 31, 2009
 
November 1, 2008
 
Stock Options
 
Stock Purchase Plan
 
Stock Options
 
Stock Purchase Plan
Expected volatility
58.08%
 
62.60%
 
67.86%
 
95.06%
Risk-free interest rate
2.61%
 
0.33%
 
3.03%
 
2.17%
Expected term (in years)
  5.91
 
  0.50
 
  5.94
 
  0.50
Dividend yield
None
 
None
 
None
 
None
Weighted avg. fair value at grant date
$9.29
 
$5.35
 
$13.70
 
$5.92
               
 
Nine Months Ended
       
 
October 31, 2009
 
November 1, 2008
 
Stock Options
 
Stock Purchase Plan
 
Stock Options
 
Stock Purchase Plan
Expected volatility
63.08%
 
62.60%
 
70.07%
 
95.06%
Risk-free interest rate
2.50%
 
0.33%
 
3.31%
 
2.17%
Expected term (in years)
  5.91
 
  0.50
 
  5.74
 
  0.50
Dividend yield
None
 
None
 
None
 
None
Weighted avg. fair value at grant date
$7.51
 
$5.35
 
$17.02
 
$5.92
 
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The computation of the expected volatility assumptions used in the Black-Scholes calculations for new grants and purchase rights is based on the historical volatility of our stock price, measured over a period equal to the expected term of the grants or purchase rights.  The risk-free interest rate is based on the yield available on U.S. Treasury STRIPS with an equivalent remaining term.  The expected term life of employee stock options represents the weighted-average period that the stock options are expected to remain outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the share-based awards and vesting schedules.  The expected term life of purchase rights is the period of time remaining in the then current offering period.  The dividend yield assumption is based on our history of not paying dividends and assumption of not paying dividends in the future.

The following table set forth the share-based compensation expense for the three and nine months ended October 31, 2009 and November 1, 2008 (in thousands):
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 31, 2009
   
November 1, 2008
   
October 31, 2009
   
November 1, 2008
 
Cost of revenue
  $ 89     $ 87     $ 254     $ 261  
Research and development expenses
    1,178       1,239       3,633       3,892  
Sales and marketing expenses
    384       796       1,102       1,536  
General and administrative expenses
    560       655       563       4,246  
Total share-based compensation
  $ 2,211     $ 2,777     $ 5,552     $ 9,935  
 
401(k) tax deferred savings plan

We maintain a 401(k) tax deferred savings plan ("401(k) Plan") for the benefit of qualified employees who are U.S. based.  Under the 401(k) Plan, U.S. based employees may elect to reduce their current annual taxable compensation up to the statutorily prescribed limit, which is $16,500 in calendar year 2009.  Employees age 50 or over may elect to contribute an additional $5,500.  We have a matching contribution program whereby we match employee contributions made by each employee at a rate of $0.25 per $1.00 contributed.  The matching contributions to the 401(k) Plan totaled $0.1 million and $0.5 million for the three and nine months ended October 31, 2009, respectively.  The matching contributions to the 401(k) Plan totaled $0.1 million and $0.4 million for the three and nine months ended November 1, 2008, respectively.

Group registered retirement savings plan

We maintain a Group Registered Retirement Savings Plan (“GRRSP”) for the benefit of qualified employees who are based in Canada.  Under the Registered Retirement Savings Plan (“RRSP”), Canadian based employees may elect to reduce their annual taxable compensation up to the statutorily prescribed limit which is $20,000 Canadian in calendar year 2009.  We have a matching contribution program under the GRRSP whereby we match employee contributions made by each employee up to 2.5% of their annual salary.  The matching contributions to the GRRSP totaled $24,000 and $65,000 for the three and nine months ended October 31, 2009, respectively.  The matching contributions to the GRRSP totaled $25,000 and $51,000 for the three and nine months ended November 1, 2008, respectively.

Retirement pension plan

We maintain a Retirement Pension Plan for the benefit of qualified employees who are based in Denmark.  Under the Retirement Pension Plan, Denmark based employees may elect to reduce their annual taxable compensation up to their annual salary.  In December 2008, we implemented a contribution program whereby we will contribute 3.0% of our employee’s annual salary and may elect to terminate future contributions at our option at any time.  The matching contribution to the Retirement Pension Plan totaled $31,000 and $80,000 for the three and nine months ended October 31, 2009, respectively.

17

 
 
10.
Significant customers

The following table sets forth the major customers that accounted for 10% or more of our net revenue:
 
   
Three Months Ended
   
Nine Months Ended
 
Customer
 
October 31, 2009
   
November 1, 2008
   
October 31, 2009
   
November 1, 2008
 
Unihan Corporation
    15%       *       10%       *  
MTC Singapore
    11%       17%       20%       21%  
Cowin Worldwide Corporation
    11%       *       10%       *  
Gemtek Electronics Compontents, LTD
    *       *       11%       *  
Cisco Systems, Inc. **
    *       12%       *       20%  
Netgem
    *       11%       *       *  
 
 
*
Net revenue from customer was less than 10% of our total net revenue in these periods.
 
**
Starting in the third quarter of fiscal 2009, Cisco Systems, Inc. began processing its orders with us through multiple third-party contract manufacturers.

Five international customers accounted for 17%, 17%, 16%, 16% and 10%, each of total accounts receivable at October 31, 2009.  Four international customers accounted for 20%, 13%, 10% and 10%, each of total accounts receivable at January 31, 2009.

 
11.
Segment and geographical information

ASC 280, Disclosures about Segments of an Enterprise and Related Information (formerly, SFAS No. 131), provides annual and interim reporting standards for an enterprise’s business segments and related disclosures about its products, services, geographical areas and major customers.

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

The following table sets forth net revenue for each geographic region based on the invoiced location of customers (in thousands):
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 31, 2009
   
November 1, 2008
   
October 31, 2009
   
November 1, 2008
 
Asia
  $ 27,510     $ 26,287     $ 103,601     $ 86,927  
Europe
    5,430       16,881       28,884       64,634  
North America
    2,515       3,584       5,478       10,248  
Other regions
    9       8       27       45  
Net revenue
  $ 35,464     $ 46,760     $ 137,990     $ 161,854  
 
18

The following table sets forth net revenue for each significant country based on the invoiced location of customers (in thousands):
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 31, 2009
   
November 1, 2008
   
October 31, 2009
   
November 1, 2008
 
Taiwan
  $ 12,592     $ 7,487     $ 35,031     $ 12,870  
China
    6,535       6,178       29,269       16,470  
France
    5,156       7,586       21,775       21,410  
Singapore
    3,970       7,949       27,140       33,484  
Korea
    2,511       1,901       7,292       8,909  
Japan
    357       1,212       1,356       10,646  
Belgium
    27       2,649       57       8,230  
Netherlands
    9       3,067       2       24,813  
Hungary
    -       2,661       5,340       7,437  
Rest of the world
    4,307       6,070       10,728       17,585  
Net revenue
  $ 35,464     $ 46,760     $ 137,990     $ 161,854  
 
12.
Subsequent event

On November 10, 2009, we purchased all of the issued and outstanding share capital, including vested stock options, of CopperGate Communications Ltd.  ("CopperGate") pursuant to an Acquisition Agreement dated October 12, 2009, as amended by the First Amendment to Acquisition Agreement dated November 10, 2009.  Under the terms of the Agreement, we paid approximately $116.0 million in cash, which includes approximately $25.0 million of cash and cash equivalents of CopperGate at the closing and of which approximately $11.6 million will be held in escrow for a period of 18 months and issued an aggregate of 3,931,352 shares of our common stock, of which 393,138 shares will be held in escrow for a period of 18 months.  At the closing, we also assumed all unvested CopperGate options and, as a result, will issue unvested options to purchase an aggregate of 574,881 shares of our common stock, which options will vest over time following the closing.  Under the terms of the Agreement, we also agreed to pay up to an aggregate of $5.0 million in cash to specified CopperGate employees provided that certain milestones are achieved over a specified period of time.
 
CopperGate is a provider of silicon-based modem solutions enabling distribution of media-rich digital content over all three types of wires in the home: coax, phone and power.  CopperGate solutions are deployed by service providers enabling the delivery of HDTV, VoIP and fast Internet services.  CopperGate is headquartered in Tel Aviv, Israel with offices in the U.S. and Taiwan.
 
The results of CopperGate will be consolidated in our financial results as of November 10, 2009.
 

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

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

19

 
Overview

We are a leading fabless provider of highly integrated system-on-chip, or SoC, solutions that are used to deliver multimedia entertainment throughout the home.  We currently offer four separate product lines: media processors, home entertainment networking solutions, video image processors and home automation solutions.  Each of these product lines also contributes to our fully integrated SoC offerings.


Our media processor product line represents a family of SoC solutions that combine our semiconductors and software and are a critical component of multiple consumer applications that process digital video and audio content including IPTV, connected media players and portable media players.  Our media processors provide high definition digital video decoding for multiple compression standards, graphics acceleration, audio decoding and display control.  Our software provides control of media processing and system security management.  Together, our media processor semiconductors and software form a complete SoC solution that we believe provides our customers with a foundation to quickly develop feature-rich consumer entertainment products.

Our home entertainment networking product line consists of our CopperGate silicon based modem and Ultra-wideband, or UWB, products.  Our CopperGate products enable IP communication across phone lines, coax cables and power lines in order to enable service providers such as telecommunication carriers, cable operators and satellite providers to deliver IPTV solutions and other media-rich applications such as HDTV, VoIP and fast Internet throughout the home.  Our UWB product line provides a high bandwidth radio frequency, or RF, communication solution based on the WiMedia standard to enable home networking and connectivity of high definition video signals using wireless and coax mediums.

Our home automation product line consists of our Z-Wave products.  Our Z-Wave products utilizes a low-bitrate, low-power, low-cost RF communication technology that provides an interoperable or connected home security, monitoring and automation solution, or SMA.

We target the connected home technologies market with our CopperGate, Z-Wave and UWB products.  The financial results of CopperGate will be included in our consolidated financial statements beginning in our fourth quarter of fiscal 2010.  To date, we have not generated revenue from our UWB products.

Our video image processor product line consists of our VXP products.  Our VXP products provide a high performance silicon solution that enables studio-quality video output for professional and prosumer applications such as audio video receivers, broadcast studios, digital cinema, digital signage, front-projection home theatre televisions, HDTV, medical imaging and video conferencing systems.  We target the prosumer and industrial audio/video markets with our image processor products.

We believe we are the leading provider of digital media processor SoCs for set-top boxes in the IPTV market in terms of units shipped.  Our digital media processor SoC solutions are used by leading IPTV set-top box providers, such as Cisco Systems/Scientific-Atlanta, Motorola, Netgem and UTStarcom.  IPTV set-top boxes incorporating our SoC solutions are deployed by telecommunications carriers globally including carriers in Asia, Europe and North America such as AT&T, Deutsche Telekom and Freebox.  We work with these carriers and set-top box providers as well as with systems software providers, such as Microsoft, to design solutions that address the carriers' specific requirements regarding features and performance.  Our media processor products are also used by consumer electronics providers, such as Netgear, Sharp, Sony and Western Digital, in applications such as digital media adaptors (DMAs), Blu-ray DVD players, HDTVs and other connected media player devices.  Our CopperGate products primarily consist of home entertainment networking communications SoCs which are used by leading IPTV set-top box and residential gateway providers, such as 2Wire, Cisco Systems/Scientific-Atlanta and Motorola.  These solutions are deployed by telecommunications carriers globally, but primarily in North America, such as AT&T, Telus and Bell Aliant.  Our VXP video image processor products are one of the leading solutions for studio-quality video image processing and are used by leading industry participants such as Polycom, Sony and Panasonic.  Our Z-Wave home automation products are used by leading industry participants such as Danfoss, Leviton, Schlage and Trane.

20

 
Our primary target markets are IPTV, connected home technologies, connected media player and, prosumer and industrial audio/video.  The IPTV set-top box market consists of consumer and commercial products that distribute and receive streaming video using internet protocol, or IP.  The connected home technologies market is served by our home entertainment networking and home automation product lines.  Our home entertainment networking products are used in IPTV set-top boxes as well as residential gateways, optical network terminals, multi-dwelling unit masters and network adapters.  Our home automation products are used in a wide variety of home control products such as thermostats, light switches and door locks.  Our UWB products target wireless high definition audio/video, or HDAV, speaker solutions and wireless home entertainment networking solutions over coax applications.  The connected media player market consists primarily of digital media adapters, portable media devices and Blu-ray DVD players that perform playback of digital media stored on optical or hard disk formats.  The prosumer and industrial audio/video market consists of studio quality audio/video receivers and monitors, digital projectors and medical video monitors.  We also sell products into other markets such as the HDTV, PC-based add-in and connectivity markets.  We derive minor net revenue from sales of our products into these other markets.

For each of the nine months ended October 31, 2009 and November 1, 2008, we derived 99% of our net revenue from our SoC solutions.  Our SoC solutions primarily consist of highly integrated semiconductors and software that process digital video and audio content.  Our net revenue from sales of our SoC solutions decreased $24.1 million, or 15%, in the nine months ended October 31, 2009 compared to the corresponding period in the prior fiscal year.  The decrease was primarily due to an approximate 10% decline in the average selling prices of our SoCs and approximately 5% decline in units sold.  The decline in average selling prices was primarily the result of certain customers achieving cumulative volume pricing discounts on purchases of our SoC products.

We do not enter into long-term commitment contracts with our customers and receive substantially all of our net revenue based on purchase orders.  We forecast demand for our products based not only on our assessment of the requirements of our direct customers but also on the anticipated requirements of the telecommunications carriers that our customers serve.  We work with both our direct customers and these carriers to address the market demands and the necessary specifications for our technologies.  However, our failure to accurately forecast demand can lead to product shortages that can impede production by our customers and harm our relationship with these customers or lead to excess inventory which could negatively impact our future revenues and gross margins in a particular period.

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

In July 2009, our shareholders approved our 2009 Incentive Plan and a one-time stock option exchange program.  The exchange program began on August 24, 2009 and concluded on September 22, 2009.  Under the exchange program, eligible employees were permitted to exchange outstanding stock options granted under our 2001 Option Plan prior to June 2008 and with exercise prices equal to or greater than $20.25 per share for a lesser number of stock options that were granted following the expiration of the exchange program at a ratio of 1 share in the replacement option for every 1.5 shares exchanged from eligible options.  Our directors and executive officers were not eligible to participate in the option exchange program.  As a result, on September 22, 2009, pursuant to the terms of the exchange program, we accepted for exchange and cancelled options to purchase an aggregate of 663,737 shares of our common stock under the 2001 Option Plan. The incremental impact to our share-based compensation is approximately $0.4 million, which will be expensed over the remaining expected term.  On September 23, 2009, we issued replacement options to purchase an aggregate of 442,550 shares of our common stock in exchange for the options tendered under our 2001 Option Plan.  These replacement options have a strike price of $15.25 with a 5-year vesting schedule and 8-year term, each commencing on September 23, 2009.

On November 10, 2009, we purchased all of the issued and outstanding share capital, including vested stock options, of CopperGate Communications Ltd. pursuant to an Acquisition Agreement dated October 12, 2009, as amended by the First Amendment to Acquisition Agreement dated November 10, 2009.  Under the terms of the Agreement, we paid approximately $116.0 million in cash, which includes approximately $25.0 million of cash and cash equivalents of CopperGate at the closing and of which approximately $11.6 million will be held in escrow for a period of 18 months and issued an aggregate of 3,931,352 shares of our common stock, of which 393,138 shares will be held in escrow for a period of 18 months.  At the closing, we also assumed all unvested CopperGate options and, as a result, will issue unvested options to purchase an aggregate of approximately 574,881 shares of our common stock, which options will vest over time following the closing.  Under the terms of the Agreement, we also agreed to pay up to an aggregate of $5.0 million in cash to specified CopperGate employees provided that certain milestones are achieved over a specified period of time.  Our ability to integrate CopperGate successfully into our business and operations could be costly and time-consuming.  The integration process may disrupt our business and, if implemented ineffectively, preclude us from realizing the anticipated benefits of the acquisition.  CopperGate is headquartered in Tel Aviv, Israel with&