Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 28, 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 No. 0-14225

 

 

EXAR CORPORATION

(Exact Name of Registrant as specified in its charter)

 

 

 

Delaware   94-1741481

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

48720 Kato Road, Fremont, CA 94538

(Address of principal executive offices, Zip Code)

(510) 668-7000

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on it corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations 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  ¨

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.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The number of shares outstanding of the Registrant’s Common Stock was 43,548,422 as of July 31, 2009, net of 19,924,369 treasury shares.

 

 

 


Table of Contents

EXAR CORPORATION AND SUBSIDIARIES

INDEX TO

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 28, 2009

 

          Page
   PART I – FINANCIAL INFORMATION   
Item 1.    Financial Statements (Unaudited)    3
   Condensed Consolidated Balance Sheets    3
   Condensed Consolidated Statements of Operations    4
   Condensed Consolidated Statements of Cash Flows    5
   Notes to Condensed Consolidated Financial Statements    6
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    26
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    37
Item 5.    Other Information    51
Item 6.    Exhibits    51
   Signatures    52
   Index to Exhibits    53

 

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PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

 

     June 28,
2009
    March 29,
2009
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 41,915      $ 89,002   

Short-term marketable securities

     179,553        167,341   

Accounts receivable (net of allowances of $516 and $572)

     11,894        7,452   

Accounts receivable, related party (net of allowances of $356 and $736)

     2,456        1,796   

Inventories

     15,584        15,678   

Other current assets

     4,836        3,274   

Deferred income taxes, net

     361        62   
                

Total current assets

     256,599        284,605   

Property, plant and equipment, net

     43,342        42,549   

Goodwill

     2,621        —     

Intangible assets, net

     28,067        7,359   

Other non-current assets

     3,339        1,876   
                

Total assets

   $ 333,968      $ 336,389   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 5,233      $ 5,391   

Accrued compensation and related benefits

     5,425        4,773   

Deferred income and allowances on sales to distributors

     3,444        3,208   

Deferred income and allowances on sales to distributors, related party

     7,340        7,040   

Other accrued expenses

     11,675        7,014   
                

Total current liabilities

     33,117        27,426   

Long-term lease financing obligations

     15,217        15,633   

Other non-current obligations

     1,630        1,236   
                

Total liabilities

   $ 49,964      $ 44,295   
                

Commitments and contingencies (Notes 16 and 17)

    

Stockholders’ equity:

    

Preferred stock, $.0001 par value; 2,250,000 shares authorized; no shares outstanding

   $ —        $ —     

Common stock, $.0001 par value; 100,000,000 shares authorized; 43,515,088 and 43,036,271 shares outstanding at June 28, 2009 and March 29, 2009, respectively

     4        4   

Additional paid-in capital

     715,159        710,787   

Accumulated other comprehensive income

     1,215        802   

Treasury stock at cost, 19,924,369 shares at June 28, 2009 and March 29, 2009

     (248,983     (248,983

Accumulated deficit

     (183,391     (170,516
                

Total stockholders’ equity

     284,004        292,094   
                

Total liabilities and stockholders’ equity

   $ 333,968      $ 336,389   
                

See accompanying Notes to Condensed Consolidated Financial Statements

 

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EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended  
     June 28,
2009
    June 29,
2008
 

Sales:

    

Net sales

   $ 23,110      $ 20,171   

Net sales, related party

     7,752        12,040   
                

Total net sales

     30,862        32,211   
                

Cost of sales:

    

Cost of sales

     12,889        10,939   

Cost of sales, related party

     3,788        5,847   

Amortization of purchased intangible assets

     1,340        955   
                

Total cost of sales

     18,017        17,741   
                

Gross profit

     12,845        14,470   
                

Operating expenses:

    

Research and development

     12,294        8,092   

Selling, general and administrative

     15,112        11,301   
                

Total operating expenses

     27,406        19,393   

Loss from operations

     (14,561     (4,923

Other income and expense, net:

    

Interest income and other, net

     1,754        2,670   

Interest expense

     (324     (331

Impairment charges on investments

     (72     —     
                

Total other income and expense, net

     1,358        2,339   

Loss before income taxes

     (13,203     (2,584

Benefit from income taxes

     (328     (123
                

Net loss

   $ (12,875   $ (2,461
                

Loss per share:

    

Basic and diluted loss per share

   $ (0.30   $ (0.06
                

Shares used in the computation of loss per share:

    

Basic and diluted

     43,314        42,973   
                

See accompanying Notes to Condensed Consolidated Financial Statements

 

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EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

     Three Months Ended  
     June 28,
2009
    June 29,
2008
 

Cash flows from operating activities:

    

Net loss

   $ (12,875   $ (2,461

Reconciliation of net loss to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     5,553        3,479   

Deferred income taxes

     (29     —     

Stock-based compensation expense

     1,309        1,359   

Provision for sales returns and allowances

     2,212        1,711   

Other than temporary loss on long-term investment in non-marketable securities

     72        —     

Changes in operating assets and liabilities, net of effects of acquisitions:

    

Accounts receivable

     (4,212     (1,588

Inventories

     5,055        (239

Prepaid expenses and other assets

     897        (436

Accounts payable

     (879     773   

Other accrued expenses

     (182     499   

Deferred income and allowance on sales to distributors

     102        610   

Accrued compensation and related benefits

     (1,478     22   
                

Net cash provided by (used in) operating activities

     (4,455     3,729   
                

Cash flows from investing activities:

    

Purchases of property, plant and equipment and intellectual property, net

     (1,447     (990

Purchases of short-term marketable securities

     (86,775     (20,871

Proceeds from maturities of short-term marketable securities

     65,500        32,653   

Proceeds from sales of short-term marketable securities

     23,824        15,165   

Contributions to long-term investments

     (15     —     

Acquisition of Galazar, net of cash acquired

     (3,125     —     

Acquisition of Hifn, net of cash acquired

     (40,349     —     
                

Net cash provided by (used in) investing activities

     (42,387     25,957   
                

Cash flows from financing activities:

    

Repurchase of common stock

     —          (12,913

Proceeds from issuance of common stock

     153        1,487   

Repayment of lease financing obligations

     (398     (290
                

Net cash used in financing activities

     (245     (11,716
                

Net (decrease) increase in cash and cash equivalents

     (47,087     17,970   

Cash and cash equivalents at the beginning of period

     89,002        122,016   
                

Cash and cash equivalents at the end of period

   $ 41,915      $ 139,986   
                

Supplemental disclosure of non-cash investing and financial activities:

    

Issuance of common stock in connection with Hifn acquisition

   $ 2,705      $ —     

See accompanying Notes to Condensed Consolidated Financial Statements

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

Description of Business Exar Corporation was incorporated in California in 1971 and reincorporated in Delaware in 1991. Exar Corporation and its subsidiaries (“Exar” or “we”) is a fabless semiconductor company that designs, sub-contracts manufacturing of and sells highly differentiated silicon, software and subsystem solutions for industrial, datacom and storage applications.

On June 17, 2009, we completed the acquisition of Galazar Networks Inc. (“Galazar”). Galazar, based in Ottawa, Ontario, Canada, is a fabless semiconductor and software supplier focused on carrier grade transport over telecom networks. Galazar’s product portfolio addresses transport of a wide range of datacom and telecom services including Ethernet, SAN, TDM and video over SONET/SDH, PDH and OTN networks. On April 3, 2009, we completed the acquisition of hi/fn, inc. (“Hifn”). Hifn is a provider of network- and storage-security and data reduction products that simplify the way major network and storage original equipment manufacturers (“OEMs”), as well as small-and-medium enterprises (“SMEs”), efficiently and securely share, retain, access and protect critical data. See Note 3 “Business Combinations”.

Our fiscal year ends on the Sunday closest to March 31 and our fiscal quarters end on the Sunday closest to the end of the corresponding calendar quarter. The first quarter of fiscal 2010 and fiscal 2009 included 91 days from March 30, 2009 to June 28, 2009 and March 31, 2008 to June 29, 2008, respectively.

Basis of Presentation and Use of Management Estimates The accompanying condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with the Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended March 29, 2009 as filed with the SEC. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, which we believe are necessary for a fair statement of Exar’s financial position as of June 28, 2009 and our results of operations for the three months ended June 28, 2009 and June 29, 2008, respectively. These condensed consolidated financial statements are not necessarily indicative of the results to be expected for the entire year.

The financial statements include management’s estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of sales and expenses during the reporting periods. Actual results could differ from those estimates, and material effects on operating results and financial position may result.

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 166, Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140 (“SFAS 166”). SFAS 166 enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes and should be evaluated for consolidation by reporting entities. If the evaluation results in consolidation, the reporting entity should apply the transition guidance provided by SFAS 166. SFAS 166 is effective for the first annual reporting period that begins after November 15, 2009 and for interim and annual reporting periods thereafter. Early adoption is prohibited and SFAS 166 will apply to transfers occurring on or after March 29, 2010. The adoption of SFAS 166 is not expected to have a significant impact on our consolidated financial statements.

In June 2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162” (“SFAS 168”). The FASB Accounting Standards Codification (“Codification”) will be the single source of authoritative non-governmental U.S. generally accepted accounting principles. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative generally accepted accounting principles (“GAAP”) for SEC registrants. All existing accounting standards are superseded as described in SFAS 168 and all other accounting literature not included in the Codification is nonauthoritative. SFAS 168 is effective for interim and annual periods ending after September 15, 2009. The Company believes that the adoption of SFAS 168 will not have a significant impact on its financial statements.

 

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In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”). SFAS 165 establishes a general standard of accounting for the disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 sets forth (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS 165 is effective for interim or annual financial periods ending after June 15, 2009. SFAS 165 was adopted on March 30, 2009 with no significant impact on our financial statements. See Note 20 “Subsequent Events” for disclosure relating to SFAS 165.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairment” (“FSP FAS 115-2/FAS 124-2”). FSP FAS 115-2/FAS 124-2 amends the requirements for the recognition and measurement of other-than-temporary impairments for debt securities by modifying the pre-existing “intent and ability” indicator. Under FSP FAS 115-2/FAS124-2, an other-than-temporary impairment is triggered when there is an intent to sell the security, it is more likely than not that the security will be required to be sold before recovery, or the security is not expected to recover the entire amortized cost basis of the security. Additionally, FSP FAS 115-2/FAS 124-2 changes the presentation of an other-than-temporary impairment in the income statement for those impairments involving credit losses. The credit loss component will be recognized in earnings and the remainder of the impairment will be recorded in other comprehensive income. Early adoption was permitted and FSP FAS 115-2/FAS 124-2 was adopted on March 30, 2009 with no significant impact on our consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 107-1 and Accounting Principle Board (“APB”) Opinion 28-1, “Interim Disclosure about Fair Value of Financial Instruments” (“FSP FAS 107-1/APB 28-1”). FSP FAS 107-1/APB 28-1 requires interim disclosures regarding the fair values of financial instruments that are within the scope of FAS 107, “Disclosures about the Fair Value of Financial Instruments” (“FAS 107”). Additionally, FSP FAS 107-1/APB 28-1 requires disclosure of the methods and significant assumptions used to estimate the fair value of financial instruments on an interim basis as well as changes in the methods and significant assumptions from prior periods. The FSP will now require these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. FSP FAS 107-1/APB 28-1 is effective for periods ending after June 15, 2009. Early adoption was permitted and FSP FAS 107-1/APB 28-1 was adopted on March 30, 2009 with no significant impact on our consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 157-4, “Determining Fair Value When Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4 provides guidance on how to determine the fair value of assets and liabilities when the volume and level of activity for the asset/liability has significantly decreased. FSP FAS 157-4 also provides guidance on identifying circumstances that indicate a transaction is not orderly. In addition, FSP FAS 157-4 requires disclosure in interim and annual periods of the inputs and valuation techniques used to measure fair value and a discussion of changes in valuation techniques. FSP FAS 157-4 was effective for periods ending after June 15, 2009. Early adoption is permitted and FSP FAS 157-4 was adopted on March 30, 2009 with no significant impact on our consolidated financial statements.

In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whether participating share-based payment awards, that contain non-forfeitable rights to dividends or dividend equivalents (paid or unpaid) prior to vesting, should be included in the computation of earnings per share under the two-class method. FSP EITF 03-6-1 was adopted on March 30, 2009 with no significant impact on our financial position, cash flows or results of operations.

NOTE 3. BUSINESS COMBINATIONS

We periodically evaluate strategic acquisitions that build upon our existing library of intellectual property, human capital and engineering talent, and seek to increase our leadership position in the areas in which we operate.

In December 2007, FASB issued SFAS 141R and SFAS 160, an amendment of Accounting Research Bulletin No. 51. SFAS 141R changes how business acquisitions are accounted for and impacts financial statements both on the acquisition date and in subsequent periods. SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 141R and SFAS 160 were effective beginning in the first quarter of fiscal 2010. Early adoption was not permitted. SFAS 141R and SFAS 160 were adopted on March 30, 2009. Under SFAS 141R an entity shall account for each business combination by applying the acquisition method, which requires (i) identifying the acquirer; (ii) determining the acquisition date; (iii) recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest of the acquirer in the acquire at their acquisition date fair value; and (iv) recognizing and measuring goodwill or a gain from a bargain purchase.

 

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In April, 2009, the FASB issued FSP No. FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (“FSP FAS 141(R)-1”). FSP FAS 141(R)-1 amends and clarifies the initial recognition and measurement, subsequent measurement and accounting, and related disclosures arising from contingencies in a business combination under SFAS 141R. Under the new guidance, assets acquired and liabilities assumed in a business combination that arise from contingencies should be recognized at fair value on the acquisition date if fair value can be determined during the measurement period. If fair value cannot be determined, companies should typically account for the acquired contingencies using existing guidance of SFAS 5 and FIN 14. FSP FAS 141(R)-1 was effective beginning in our first quarter of fiscal 2010. Early adoption was not permitted and FSP FAS 141(R)-1 was adopted on March 30, 2009.

Goodwill is measured and recorded as the amount by which the consideration transferred, generally at the acquisition date fair value, exceeds the acquisition date fair value of identifiable assets acquired, the liabilities assumed, and any noncontrolling interest of the acquirer in the acquire. To the contrary, if the acquisition date fair value of identifiable assets acquired, the liabilities assumed, and any noncontrolling interest of the acquirer in the acquire exceeds the consideration transferred, it is considered a bargain purchase and the acquirer shall recognize the resulting gain in earnings on the acquisition date.

Acquisition related costs, including finder’s fees, advisory, legal, accounting, valuation and other professional or consulting fees are accounted for as expenses in the periods in which the costs are incurred and the services are received, with the exception that the costs to issue debt or equity securities shall be recognized in accordance with other applicable GAAP.

Acquisition of Galazar Networks Inc.

On June 17, 2009, we completed the acquisition of Galazar Networks Inc. (“Galazar”). Galazar, based in Ottawa, Ontario, Canada, is a fabless semiconductor and software supplier focused on carrier grade transport over telecom networks. Galazar’s product portfolio addresses transport of a wide range of datacom and telecom services including Ethernet, SAN, TDM and video over SONET/SDH, PDH and OTN networks.

The acquisition was accounted for in accordance with the acquisition method as defined under SFAS 141R. Accordingly, Galazar’s results of operations and estimated fair value of assets acquired and liabilities assumed were included in our condensed consolidated financial statements beginning June 18, 2009.

Consideration

We expect to pay $4.95 million in cash for Galazar, representing the fair value of total consideration transferred. This amount includes $1.0 million contingent consideration, that for purposes of valuation was assigned a 95% probability or a fair value of $0.95 million. The contingent consideration is expected to be paid within the next six months and is included in the “Other accrued expenses” line item in our condensed consolidated balance sheets.

Acquisition-related costs

Acquisition-related costs, which are included in the “Selling, general and administrative” line item on the condensed consolidated statement of operations for the three months ended June 28, 2009, were approximately $574,000.

Purchase Price Allocation

The allocation of the purchase price to Galazar’s tangible and identifiable intangible assets acquired and liabilities assumed was based on their estimated fair values at the date of acquisition. We will recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period shall not exceed one year from the acquisition date. Further, any associated restructuring activities will be expensed in future periods and not recorded through purchase accounting as previously done under SFAS 141. Subsequent to the acquisition, we recorded severance cost of $134,000 in the first quarter of fiscal 2010.

The excess of the purchase price over the tangible and identifiable intangible assets acquired and liabilities assumed has been allocated to goodwill. The $0.4 million in goodwill resulted primarily from our expected synergies from the integration of Galazar’s technology into our product offerings. Goodwill is not deductible for tax purposes. We have up to twelve months from the closing date of the acquisition to adjust pre-acquisition contingencies, if any.

 

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The fair value allocated to each of the major classes of tangible and identifiable intangible assets acquired and liabilities assumed of Galazar on June 17, 2009 are as follows (in thousands):

 

     As of
June 17,
2009
 

Identifiable tangible assets

  

Cash and cash equivalents

   $ 506   

Accounts receivable

     120   

Inventories

     692   

Other current assets

     97   

Property, plant and equipment

     223   

Other assets

     27   

Accounts payable and accruals

     (93

Accrued compensation and related benefits

     (230

Long-term obligations and other

     (224
        

Total identifiable tangible assets, net

     1,118   

Identifiable intangible assets

     3,460   
        

Total identifiable assets, net

     4,578   

Goodwill

     372   
        

Fair value of total consideration transferred

   $ 4,950   
        

Identifiable Intangible Assets

The following table sets forth the components of the identifiable intangible assets acquired in the Galazar acquisition, which are being amortized over their estimated useful lives, with a maximum amortization period of six years, on a straight-line basis with no residual value:

 

     Fair Value    Useful Life
     (in thousands)    (in years)

Existing technologies

   $ 2,100    6.0

Patents/Core technology

     400    6.0

In-process research and development

     300    6.0

Customer relationships

     500    6.0

Order backlog

     60    0.3

Tradenames/Trademarks

     100    3.0
         

Total acquired identifiable intangible assets

   $ 3,460   
         

Using SFAS 157 as the framework for measuring fair value, we allocated the purchase price using established valuation techniques.

Inventories – The value allocated to inventories reflects the estimated fair value of the acquired inventory based on the expected sales price of the inventory, less reasonable selling margin.

Property, plant and equipment – The basis used for our analysis is the fair value in continued use, which is considered to be the price expressed in terms of money which a willing and informed buyer would pay, contemplating continued use as part of a going concern of the assets in place for the purpose for which they were designed, engineered, installed, fabricated and erected. The fair value for specialty use assets was established through a cost approach methodology.

Intangible assets – The fair value of existing technology, patents/core technology, in-process research and development (“IPR&D”), customer relationships, order backlog and tradenames/trademarks were determined using the income approach, which discounted expected future cash flows to present value, taking into account multiple factors including, but not limited to, the stage of completion, estimated costs to complete, utilization of patents and core technology, the risks related to successful completion, and the markets served. The cash flows were discounted at rates ranging from 5% to 35%.

 

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Acquired In-Process Research and Development – The IPR&D project underway at Galazar at the acquisition date relates to the MXP2 product and to date has incurred approximately $1.3 million in costs. The total research and development expenditures expected to be incurred to complete the project is estimated at $3.1 million, based on project development timeline and resource requirements, and is scheduled for completion by April, 2011.

Acquisition of hi/fn, inc.

On April 3, 2009, we completed the acquisition of all of the outstanding shares of common stock of hi/fn, inc. (“Hifn”). Hifn is a provider of network- and storage-security and data reduction products that simplify the way major network and storage original equipment manufacturers (“OEMs”), as well as small-and-medium enterprises (“SMEs”), efficiently and securely share, retain, access and protect critical data.

The acquisition was accounted for in accordance with the acquisition method as defined under SFAS 141R. Accordingly, Hifn’s results of operations and estimated fair value of assets acquired and liabilities assumed were included in our condensed consolidated financial statements beginning April 4, 2009.

Consideration

The following table summarizes the consideration paid for Hifn, representing the fair value of total consideration transferred (in thousands):

 

     April 3,
2009

Cash

   $ 56,825

Equity instruments

     2,784
      

Total consideration paid

   $ 59,609
      

The $2.8 million estimated fair value for equity instruments represents approximately 429,600 shares of Exar’s common stock, valued at $6.48 per share, the closing price reported on the NASDAQ Global Market on April 3, 2009 (the acquisition date).

Acquisition-related costs

Acquisition-related costs, which are included in the “Selling, general and administrative” line item on the condensed consolidated statement of operations for the fiscal year ended March 29, 2009 and the three months ended June 28, 2009, are as follows (in thousands):

 

     Fiscal Year
Ending

March 29,
2009
   Three months
ending

June 28,
2009

Acquisition-related costs

   $ 778    $ 1,518
             

Purchase Price Allocation

The allocation of the purchase price to Hifn’s tangible and identifiable intangible assets acquired and liabilities assumed was based on their estimated fair values at the date of acquisition. We will recognize additional assets or liabilities if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period shall not exceed one year from the acquisition date. Further, any associated restructuring activities will be expensed in future periods and not recorded through purchase accounting as previously done under SFAS 141. Subsequent to the acquisition, we recorded $0.3 million in restructuring expenses for the period ended June 28, 2009, relating to severance and a building lease obligation in Los Gatos, California.

The excess of the purchase price over the tangible and identifiable intangible assets acquired and liabilities assumed has been allocated to goodwill. The $2.2 million in goodwill resulted primarily from our expected future product sales synergies from integrating Hifn’s technology with our product offerings. Goodwill is not deductible for tax purposes. We have up to twelve months from the closing date of the acquisition to adjust pre-acquisition contingencies, if any.

 

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The fair value allocated to each of the major classes of tangible and identifiable intangible assets acquired and liabilities assumed of Hifn on April 3, 2009 are as follows (in thousands):

 

     As of
April 3,
2009
 

Identifiable tangible assets

  

Cash, cash equivalents

   $ 16,468   

Short-term marketable securities

     14,133   

Accounts receivable

     2,982   

Inventories

     4,269   

Other current assets

     1,683   

Property, plant and equipment

     2,013   

Other assets

     1,721   

Accounts payable and accruals

     (586

Accrued compensation and related benefits

     (1,860

Other current liabilities

     (2,963
        

Total identifiable tangible assets, net

     37,860   

Identifiable intangible assets

     19,500   
        

Total identifiable assets, net

     57,360   

Goodwill

     2,249   
        

Fair value of total considerations transferred

   $ 59,609   
        

Identifiable Intangible Assets

The following table sets forth the components of the identifiable intangible assets acquired in the Hifn acquisition, which are being amortized over their estimated useful lives on a straight-line basis with no residual value:

 

     Fair Value    Useful Life
     (in thousands)    (in years)

Existing technologies

     9,000    5.0

Patents/Core technology

     1,500    5.0

In-process research and development

     1,600    5.0

Research and development reimbursement contract

     4,500    2.0

Customer relationships

     1,300    7.0

Order backlog

     900    0.5

Tradenames/Trademarks

     700    3.0
         

Total acquired identifiable intangible assets

   $ 19,500   
         

Using SFAS 157 as the framework for measuring fair value, we allocated the purchase price using established valuation techniques.

Inventories – Inventories acquired in connection with the Hifn acquisition were finished goods. The value allocated to inventories reflects the estimated fair value of the acquired inventory based on the expected sales price of the inventory, less reasonable selling margin.

Property, plant and equipment – The basis used for our analysis is the fair value in continued use, which is considered to be the price expressed in terms of money which a willing and informed buyer would pay, contemplating continued use as part of a going concern of the assets in place for the purpose for which they were designed, engineered, installed, fabricated and erected. The fair value for specialty use assets was established through a cost approach methodology.

Intangible assets – The fair value of existing technology, patents/core technology, in-process research and development, government research and development contracts, customer relationships, order backlog and tradenames/trademarks were determined using the income approach, which discounted expected future cash flows to present value, taking into account multiple factors including, but not limited to, the stage of completion, estimated costs to complete, utilization of patents and core technology, the risks related to successful completion, and the markets served. The cash flows were discounted at rates ranging from 5% to 30%.

 

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Acquired In-Process Research and Development – The IPR&D projects underway at Hifn at the acquisition date were in the security processors and flow through product families, each consisting of one project, and to date have incurred approximately $2.6 million and $1.1 million in costs, respectively. The percentage of completion for these projects ranged from 30% to 90% at the acquisition date. The total research and development expenditures expected to be incurred to complete the security processors and flow through projects are $2.1 million and $0.7 million, respectively, based on project development timeline and resource requirements. IPR&D projects for security processors and flow through are scheduled for completion ranging April, 2010 and September, 2009, respectively.

Pro Forma Financial Information for Hifn and Galazar

The following unaudited pro forma financial information is based on the respective historical financial statements of Exar, Hifn and Galazar. The unaudited pro forma financial information reflects the results of operations as if the acquisition of Hifn and Galazar occurred at the beginning of each period and included the amortization of the resulting identifiable acquired intangible assets and the effects of the estimated write-up of Hifn and Galazar inventory to fair value on cost of goods sold. These unaudited pro forma financial information adjustments reflect their related tax effects. The unaudited pro forma financial data is provided for illustrative purposes only and is not necessarily indicative of the results of operations for future periods or what actually would have been realized had Exar, Hifn and Galazar been a consolidated entity during the periods presented.

The amounts of Hifn’s and Galazar’s revenue and earnings included in Exar’s condensed consolidated statements of operations for the three months ended June 28, 2009, and the revenue and earnings of the combined entity had the acquisition date been March 31, 2008, are as follows (in thousands except for per share data):

 

     Revenue (1)    Net Loss (1)     Loss Per Shares
Basic and
Diluted
 

Actual included in this quarter

       

Hifn from 4/4/2009 through 6/28/2009

   $ 5,338    $ (6,765   $ (0.16

Galazar from 6/18/2009 through 6/28/2009

     427      (10     —     

Supplement pro forma from 3/30/2009 – 06/28/2009

     31,556      (16,876     (0.39

Supplement pro forma from 3/31/2008 – 06/29/2008

     43,498      (4,664     (0.11

 

(1) Supplement pro forma information includes Hifn’s and Galazar’s financial results for the periods April 1, 2009 through June 28, 2009 and April 1, 2008 through June 30, 2008, respectively.

NOTE 4. CASH, CASH EQUIVALENTS AND SHORT-TERM MARKETABLE SECURITIES

Fair Value of Financial Instruments

Fair value is defined under SFAS 157, “Fair Value Measurements” (“SFAS 157”), as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under SFAS 157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value which are the following:

 

Level 1     Quoted prices in active markets for identical assets or liabilities.
Level 2     Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3     Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

 

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Our investment assets, measured at fair value on a recurring basis, as of June 28, 2009 are as follows (in thousands):

 

     Quoted Prices
in Active

Markets for
Identical
Instruments
Level 1
   Significant
Other
Observable
Inputs
Level 2
   Significant
Unobservable
Inputs

Level 3
   Total

Assets:

           

Money market funds

   $ 29,326    $ —      $ —      $ 29,326

U.S. Treasury securities

     7,573      —        —        7,573

Asset-backed securities

     —        17,428      —        17,428

Mortgage-backed securities

     —        44,378      —        44,378

Other fixed income available-for-sale securities

     —        120,170      —        120,170
                           

Total financial instruments owned

   $ 36,899    $ 181,976    $ —      $ 218,875
                           

Our cash, cash equivalents and short-term marketable securities as of June 28, 2009 and March 29, 2009 are as follows (in thousands):

 

     June 28,
2009
   March 29,
2009

Cash and cash equivalents

     

Cash in financial institutions

   $ 2,593    $ 1,709
             

Cash equivalents

     

Money market funds

     29,326      26,332

U.S. government and agency securities

     9,996      60,961
             

Total cash equivalents

     39,322      87,293
             

Total cash and cash equivalents

   $ 41,915    $ 89,002
             

Available-for-sale securities

     

U.S. government and agency securities

   $ 69,218    $ 104,130

Corporate bonds and commercial paper

     48,529      28,188

Asset-backed securities

     17,428      8,559

Mortgage-backed securities

     44,378      26,464
             

Total short-term marketable securities

   $ 179,553    $ 167,341
             

Our marketable securities include municipal securities, commercial paper, asset and mortgage-backed securities, corporate bonds and government securities. We classify investments as available-for-sale at the time of purchase and re-evaluate such designation as of each consolidated balance sheet date. We amortize premiums and accrete discounts to interest income over the life of the investment. Our available-for-sale securities are classified as cash equivalents if the maturity from the date of purchase is ninety days or less and as short-term marketable securities for those with maturities, from the date of purchase, in excess of ninety days which we intend to sell as necessary to meet our liquidity requirements.

All marketable securities are reported at fair value based on the estimated or quoted market prices as of each consolidated balance sheet date, with unrealized gains or losses, net of tax effect, recorded in accumulated other comprehensive income within stockholders’ equity except those unrealized losses that are deemed to be other than temporary which are reflected in the other income and expense section in the condensed consolidated statement of operations.

Realized gains or losses on the sale of marketable securities are determined on the specific identification method and are reflected in “Interest income and other, net” line item on the condensed consolidated statements of operation. Net realized gains on marketable securities for three months ended June 28, 2009 and June 29, 2008 were $143,000 and $218,000, respectively.

 

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The following table summarizes our investments in marketable securities as of June 28, 2009 and March 29, 2009 (in thousands):

 

     June 28, 2009
     Amortized    Unrealized      
     Cost    Gross Gains    Gross Losses     Fair Value

Money market funds

   $ 29,326    $ —      $ —        $ 29,326

Corporate bonds and commercial paper

     48,142      449      (62     48,529

U.S. government and agency securities

     77,908      1,334      (28     79,214

Asset and mortgage-backed securities

     61,524      521      (239     61,806
                            

Total investment

   $ 216,900    $ 2,304    $ (329   $ 218,875
                            
     March 29, 2009
     Amortized    Unrealized      
     Cost    Gross Gains    Gross Losses     Fair Value

Money market funds

   $ 26,332    $ —      $ —        $ 26,332

Corporate bonds and commercial paper

     28,169      160      (141     28,188

U.S. government and agency securities

     163,750      1,379      (38     165,091

Asset and mortgage-backed securities

     35,070      317      (364     35,023
                            

Total investment

   $ 253,321    $ 1,856    $ (543   $ 254,634
                            

As of June 28, 2009, asset-backed and mortgage-backed securities, accounted for 8.0% and 20.3%, respectively, of our total investments in marketable securities of $218.9 million. The asset-back securities are comprised primarily of premium tranches of auto loans and credit card receivables, while our mortgage-backed securities are primarily from Federal agencies. We do not own auction rate securities nor do we own securities that are classified as sub-prime. As of June 28, 2009, the net unrealized gain of our asset-backed and mortgage-backed securities totaled approximately $282,000.

We account for our investments in debt and equity instruments under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). Management determines the appropriate classification of cash equivalents or short-term marketable securities at the time of purchase and reevaluates such classification as of each balance sheet date. The investments are adjusted for amortization of premiums and discounts to maturity and such amortization is included in the “Interest income and other, net” line item in the condensed consolidated statement of operations. Cash equivalents and short-term marketable securities are reported at fair value with the related unrealized gains and losses included in the “Accumulated other comprehensive income” line item in the condensed consolidated balance sheets. As of June 28, 2009, there was approximately $1.2 million of net unrealized gains including tax expense from our level 1 and level 2 investments.

We follow the guidance provided by FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1”) and FASB Staff Position No. 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairment”, to assess whether our investments with unrealized loss positions are other-than-temporarily impaired. We regularly review our investments in unrealized loss positions for other-than-temporary impairments. This evaluation includes, but is not limited to, significant quantitative and qualitative assessments and estimates regarding credit ratings, collateralized support, the length of time and significance of a security’s loss position and our intention to sell a security. Realized gains and losses and declines in value of our investments judged to be other-than-temporary are reported in the “Impairment charges on investments” line item in the condensed consolidated statements of operations. In September 2008, Lehman Brothers Holdings Inc. (“Lehman”) filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the U.S. Bankruptcy Court for the Southern District of New York. As a result of Lehman’s bankruptcy filing, we recorded an other-than-temporary impairment charge of $0.6 million during our fiscal year ended March 29, 2009.

The amortized cost and estimated fair value of cash equivalents and marketable securities classified as available-for-sale at June 28, 2009 and March 29, 2009 by expected maturity were as follows (in thousands):

 

     June 28, 2009    March 29, 2009
     Amortized
Cost
   Fair Value    Amortized
Cost
   Fair Value

Less than 1 year

   $ 101,139    $ 101,621    $ 183,724    $ 183,742

Due in 1 to 5 years

     115,761      117,254      69,597      70,892
                           

Total

   $ 216,900    $ 218,875    $ 253,321    $ 254,634
                           

 

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The following table summarizes the gross unrealized losses and fair values of our investments in an unrealized loss position as of June 28, 2009 and March 29, 2009, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands).

 

     June 28, 2009  
     Less than 12 months     12 months or greater     Total  
     Fair Value    Gross
Unrealized
Losses
    Fair Value    Gross
Unrealized
Losses
    Fair Value    Gross
Unrealized
Losses
 

Corporate bonds and commercial paper

   $ 10,152    $ (56   $ 352    $ (6   $ 10,504    $ (62

U.S. government and agency securities

     12,380      (28     —        —          12,380      (28

Asset and mortgage-backed securities

     15,674      (29     899      (210     16,573      (239
                                             

Total

   $ 38,206    $ (113   $ 1,251    $ (216   $ 39,457    $ (329
                                             
     March 29, 2009  
     Less than 12 months     12 months or greater     Total  
     Fair Value    Gross
Unrealized
Losses
    Fair Value    Gross
Unrealized
Losses
    Fair Value    Gross
Unrealized
Losses
 

Corporate bonds and commercial paper

   $ 10,144    $ (106   $ 3,614    $ (35   $ 13,758    $ (141

U.S. government and agency securities

     62,128      (38     —        —          62,128      (38

Asset and mortgage-backed securities

     8,913      (50     887      (314     9,800      (364
                                             

Total

   $ 81,185    $ (194   $ 4,501    $ (349   $ 85,686    $ (543
                                             

NOTE 5. GOODWILL AND INTANGIBLE ASSETS

Goodwill

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. We follow the provisions of SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), under which we evaluate goodwill for impairment on an annual basis or whenever events and changes in circumstances suggest that the carrying amount may not be recoverable. We conduct our annual impairment analysis in the fourth quarter of each fiscal year. Impairment of goodwill is tested at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. The fair values of the reporting units are estimated using a combination of the income approach that uses discounted cash flows and the market approach that utilizes comparable companies’ data. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second step is performed to measure the amount of impairment loss. Because we have one reporting unit under SFAS 142, we utilize an entity-wide approach to assess goodwill for impairment.

During the first quarter of fiscal 2010, no events or changes in circumstances suggest that the carrying amount for goodwill may not be recoverable and therefore we did not perform an interim goodwill impairment analysis. We recorded a goodwill impairment charge totaling $46.2 million and $128.5 million in fiscal years 2009 and 2008, respectively, which reduces the carrying amount to zero prior to the addition of Hifn and Galazar during the first quarter of fiscal 2010.

The changes in the carrying amount of goodwill for the first quarter of fiscal 2010 are as follows (in thousands):

 

     Amount

Balance as of March 29, 2009

   $ —  

Goodwill additions in connection with the Hifn acquisition

     2,249

Goodwill additions in connection with the Galazar acquisition

     372
      

Balance as of June 28, 2009

   $ 2,621
      

 

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Table of Contents

Intangible Assets

Our purchased intangible assets at June 28, 2009 and March 29, 2009 are as follows (in thousands):

 

     June 28, 2009    March 29, 2009
     Carrying
Amount
   Accumulated
Amortization
    Net Carrying
Amount
   Carrying
Amount
   Accumulated
Amortization
    Net Carrying
Amount

Existing technology

   $ 27,970    $ (11,870   $ 16,100    $ 16,870    $ (10,798   $ 6,072

Patents/Core technology

     3,592      (1,295     2,297      1,692      (1,189     503

In-process research and development

     1,900      —          1,900      —        —          —  

Research and development reimbursement

     4,500      (516     3,984      —        —          —  

Customer backlog

     1,300      (756     544      340      (340     —  

Distributor relationships

     1,264      (842     422      1,264      (817     447

Customer relationships

     2,570      (518     2,052      770      (460     310

Tradenames/Trademarks

     977      (209     768      177      (150     27
                                           

Total

   $ 44,073    $ (16,006   $ 28,067    $ 21,113    $ (13,754   $ 7,359
                                           

Our long-lived assets include land, buildings, equipment, furniture and fixtures and other intangible assets. Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We evaluate the recoverability of our long-lived assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”). We compare the carrying value of long-lived assets to our projection of future undiscounted cash flows attributable to such assets and, in the event that the carrying value exceeds the future undiscounted cash flows, we record an impairment charge equal to the excess of the carrying value over the asset’s fair value.

As of June 28, 2009 there were no indicators that required us to perform an intangible assets impairment review and therefore we did not record an impairment charge during the first quarter of fiscal 2010. We recorded a long-lived assets impairment charge totaling $13.5 million and $36.7 million in fiscal years 2009 and 2008, respectively.

The aggregate amortization expenses for our purchased intangible assets for periods presented below are as follows:

 

          Three Months Ended
     Weighted
Average Lives
   June 28,
2009
   June 29,
2008
     (in months)    (in thousands)

Existing technology

   67    $ 1,072    $ 1,300

Patents/Core technology

   60      106      135

Research and development reimbursement contracts

   24      516      —  

Customer backlog

   6      416      —  

Distributor relationships

   72      25      92

Customer relationships

   83      58      53

Tradenames/Trademarks

   36      59      17
                

Total

      $ 2,252    $ 1,597
                

The estimated future amortization expenses for our purchased intangible assets are summarized below (in thousands):

 

Amortization Expense (by fiscal year)

2010 (9 months ended)

   $ 6,725

2011

     7,854

2012

     4,437

2013

     4,008

2014

     3,497

2015 and thereafter

     1,546
      

Total estimated amortization

   $ 28,067
      

 

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NOTE 6. LONG-TERM INVESTMENTS

Our long-term investment consists of our investment in Skypoint Telecom Fund II (US), L.P. (“Skypoint Fund”). Skypoint Fund is a venture capital fund that invest primarily in private companies in the telecommunications and/or networking industry. We account for this non-marketable equity investment under the cost method. In accordance with FSP No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,” we periodically review and determine whether the investment is other-than-temporarily impaired, in which case the investment is written down to its impaired value.

Our investment in TechFarm Ventures L.P. (Q), L.P. (“TechFarm Fund”), to which we contributed $4.0 million in capital since we became a limited partner in May 2001, had a carrying amount of zero as of March 29, 2009, reflecting the net of the capital contribution and the accumulative impairment charges. We have never received any capital distribution from the fund.

As of June 28, 2009 and March 29, 2009, our long-term investments balance, which is included in “Other non-current assets” line item on the condensed consolidated balance sheet were as follows (in thousands):

 

Long-term investments

   June 28,
2009
   March 29,
2009

Skypoint Fund

   $ 1,604    $ 1,660
             

We have made approximately $4.5 million in capital contributions to Skypoint Fund since we became a limited partner in July 2001. Our total capital commitment is $5.0 million. We contributed $15,000 to the fund during the first quarter of fiscal 2010. As of June 28, 2009, we have a remaining obligation of approximately $0.5 million to the fund upon its request.

The approximate carrying amount of $1.6 million reflects the net of the capital contribution, accumulative impairment charges and capital distributions. We did not receive any distribution during the first quarter of either fiscal 2010 or fiscal 2009.

Impairment

In the first quarter of fiscal 2010, we analyzed the fair value of the underlying investments of Skypoint Fund and concluded a portion of the carrying value was other-than-temporarily impaired and recorded an impairment charge of $72,000.

NOTE 7. RELATED PARTY TRANSACTION

Affiliates of Future Electronics Inc. (“Future”), Alonim Investments Inc. and two of its affiliates (collectively “Alonim”), own approximately 7.7 million shares, or approximately 18%, of our outstanding common stock as of June 28, 2009. As such, Alonim is our largest stockholder.

Our sales to Future are made under an agreement that provides protection against price reduction for its inventory of our products and other sales allowances. We recognize revenue on sales to Future under the distribution agreement when Future sells the products to its end customers. Future has historically accounted for a significant portion of our net sales. It is our largest distributor worldwide and accounted for 25% and 37% of our total net sales for the three months ended June 28, 2009 and June 29, 2008, respectively.

We reimbursed Future for approximately $11,000 and $9,000 of expenses for marketing promotional materials for the three months ended June 28, 2009 and June 29, 2008, respectively.

NOTE 8. RESTRUCTURING

As part of the Hifn acquisition we assumed a lease obligation for the Hifn facility located in Los Gatos, California, which expires in September, 2009. As of June 28, 2009 the remaining lease obligation of approximately $202,000 was expensed in the first quarter of fiscal 2010. Severance expense incurred in the first quarter of fiscal 2010 was approximately $100,000. We expect to accrue an additional $67,000 in the second quarter of fiscal 2010 with all amounts being paid in such period.

 

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In connection with the Sipex acquisition in August 2007, our management approved and initiated plans to restructure the operations of the combined company to eliminate certain duplicative activities, reduce costs and better align product and operating expenses with current economic conditions. The Sipex restructuring costs were accounted for as liabilities assumed as part of the purchase business combination in accordance with the EITF Issue No. 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination” (“EITF 95-3”).

Our restructuring liabilities were included in the “Other accrued expenses” line item in our condensed consolidated balance sheets, and the activities affecting the liabilities for the first quarter of fiscal 2009 are summarized as follows (in thousands):

 

     Facility
Costs
    Severance
Costs
    Total
Restructuring
Liability
 

Balance at March 29, 2009

   $ 375      $ 8      $ 383   

Payments

     (33     (8     (41

Additional accruals

     202        —          202   
                        

Balance June 28, 2009

   $ 544      $ —        $ 544   
                        

Of the $544,000 remaining facility related balance, $202,000 is expected to be paid during the second quarter of fiscal 2010, while the remaining balance of approximately $342,000 is expected to be paid during the remaining term of the lease contract which extends through 2012. The severance related balance of approximately $8,000 was paid during the first quarter of fiscal 2010.

NOTE 9. INVENTORIES

As of June 28, 2009 and March 29, 2009, our inventories consisted of the following (in thousands):

 

     June 28,
2009
   March 29,
2009

Work-in-process

   $ 7,821    $ 9,175

Finished goods

     7,763      6,503
             

Total Inventories

   $ 15,584    $ 15,678
             

NOTE 10. PROPERTY, PLANT AND EQUIPMENT

As of June 28, 2009 and March 29, 2009, our property, plant and equipment consisted of the following (in thousands):

 

     June 28,
2009
    March 29,
2009
 

Land

   $ 11,960      $ 11,960   

Building and leasehold improvements

     23,449        22,641   

Machinery and equipment

     44,118        40,971   

Software and licenses

     30,600        28,704   
                

Property, plant and equipment, total

     110,127        104,276   

Accumulated depreciation and amortization

     (66,785     (61,727
                

Property, plant and equipment, net

   $ 43,342      $ 42,549   
                

NOTE 11. EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share excludes dilution and is computed by dividing net income (loss) by the weighted average number of common shares outstanding for the periods in accordance with SFAS No. 128, “Earnings Per Share” (“SFAS 128”). Diluted earnings per share (“EPS”) reflects the potential dilution that would occur if outstanding stock options or warrants to issue common stock were exercised for common stock, and the common stock underlying restricted stock units (“RSUs”) and restricted stock awards (“RSAs”) were issued by using the treasury stock method.

 

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A summary of our loss per share for the first quarter of fiscal 2010 and fiscal 2009 is as follows (in thousands, except per share amounts):

 

     Three Months Ended  
     June 28,
2009
    June 29,
2008
 

Net loss

   $ (12,875   $ (2,461
                

Shares used in computation:

    

Weighted average shares of common stock outstanding used in computation of basic loss per share

     43,314        42,973   

Dilutive effect of stock options and restricted stock units

     —          —     
                

Shares used in computation of diluted loss per share

   $ 43,314      $ 42,973   
                

Loss per share - basic and diluted

   $ (0.30   $ (0.06
                

For the first quarter of fiscal 2010, as we incurred a net loss, the weighted average number of common shares outstanding equals the weighted average number of common and common equivalent shares assuming dilution. Approximately 243,000 shares of the underlying options and RSUs were excluded from our loss per share calculation under the treasury method for the first quarter of fiscal 2010. Had we had income for the period, our diluted shares would have increased by the aforementioned amounts.

For the first quarter of fiscal 2010, options to purchase approximately 3.9 million shares of common stock, at exercise prices ranging from $5.44 to $86.10, were outstanding but were not included in the computation of diluted loss per share because they were anti-dilutive under the treasury stock method. Warrants to purchase approximately 280,000 shares of common stock with an exercise price of $9.63 were also excluded from the computation of diluted loss per share because they were anti-dilutive under the treasury stock method. Unvested RSUs corresponding to approximately 63,000 shares of our common stock with a grant date fair value of $6.45 were outstanding at June 28, 2009 and were not included in the computation of diluted net loss per share because they were anti-dilutive under the treasury stock method.

Our application of the treasury stock method includes assumed cash proceeds from option exercises, the average unamortized stock-based compensation expense for the period, and the estimated deferred tax benefit or detriment associated with stock-based compensation expense.

NOTE 12. COMMON STOCK REPURCHASES

From time to time, we acquire outstanding shares of our common stock in the open market to partially offset dilution from our stock awards program. We may continue to utilize our share repurchase program described below, which would reduce our cash, cash equivalents and/or short-term investments available to fund future operations and to meet other liquidity requirements.

On August 28, 2007, we established a share repurchase plan (“2007 SRP”) and authorized the repurchase of up to $100 million of our common stock.

During the first quarter of fiscal 2010, we did not repurchase any shares under the 2007 SRP. During the first quarter of fiscal 2009, we repurchased a total of 1.5 million shares of our common stock at an aggregate cost of $12.9 million under the 2007 SRP.

As of June 28, 2009, the remaining authorized amount for the stock repurchase under the 2007 SRP was $11.8 million. The 2007 SRP does not have a termination date.

NOTE 13. STOCK-BASED COMPENSATION

Employee Stock Participation Plan (“ESPP”)

Our ESPP permits employees to purchase common stock through payroll deductions at a purchase price that is equal to 95% of our common stock price on the last trading day of each three-calendar-month offering period. Our ESPP is non-compensatory under FAS 123R.

 

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We are authorized to issue 4.5 million shares of common stock under our ESPP. There were approximately 1,593,067 shares of common stock reserved for future issuance under our ESPP at June 28, 2009.

In the three months ended June 28, 2009, we issued approximately 14,630 shares of our common stock at a weighted average price of $5.87 to the participating employees under our ESPP.

Equity Incentive Plans

We currently have four equity incentive plans including the Exar Corporation 2006 Equity Incentive Plan (the “2006 Plan”) and three other equity plans assumed upon our acquisition of Sipex: the Sipex Corporation 2000 Non-Qualified Stock Option Plan, the Sipex Corporation Amended and Restated 2002 Non-Statutory Stock Option Plan and the Sipex Corporation 2006 Equity Incentive Plan (collectively, the “Sipex Plans”).

The 2006 Plan authorizes the issuance of stock options, stock appreciation rights, restricted stock, stock bonuses and other forms of awards granted or denominated in common stock or units of common stock, as well as cash bonus awards. RSUs granted under the 2006 Plan are counted against authorized shares available for future issuance on a basis of two shares for every RSU issued. The 2006 Plan allows for performance-based vesting and partial vesting based upon level of performance. Grants under the Sipex Plans are only available to former Sipex employees or employees of the combined company hired after that acquisition. At June 28, 2009, there were approximately 2.9 million shares available for future grant under all our equity incentive plans.

As of June 28, 2009 and March 29, 2009, there were options to purchase approximately 5.0 million and 3.4 million shares of our common stock outstanding under all stock option plans, respectively.

Stock Option Activities

Our stock option transactions during the first quarter of fiscal 2010 are summarized as follows:

 

     Outstanding     Weighted
Average
Exercise
Price per
Share
   Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic Value
                (in years)     

Balance at March 29, 2009

   3,406,091      $ 9.48    5.37    $ 128,514

Options granted

   1,732,400        6.51      

Options exercised

   (11,935     5.59      

Options cancelled

   (11,417     12.41      

Options forfeited

   (125,650     12.13      
              

Balance at June 28, 2009

   4,989,489      $ 8.38    5.67    $ 2,079,525
                        

Vested and expected to vest, June 28, 2009

   4,402,791      $ 8.51    5.58    $ 1,806,630
                        

Vested and exercisable, June 28, 2009

   1,297,852      $ 11.21    3.77    $ 274,809
                        

The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value, which is based on the closing price of our common stock of $7.36 and $6.17 as of June 28, 2009 and March 29, 2009, respectively. These are the values which would have been received by option holders if all option holders exercised their options on that date.

The total number of in-the-money options vested and exercisable was 0.2 million as of each of June 28, 2009 and March 29, 2009, respectively.

Total unrecognized stock-based compensation cost was $8.4 million at June 28, 2009, which is expected to be recognized over a weighted average period of 3.33 years.

 

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RSUs

Our RSU transactions during the three months ended June 28, 2009 are summarized as follows:

 

     Shares     Weighted
Average
Grand-Date Fair
Market Value
   Weighted
Average
Remaining
Contractual
Term
(in Years)
   Aggregate
Intrinsic Value

Unvested at March 29, 2009

   730,237      $ 8.36    1.14    $ 4,505,562

Granted

   78,884        6.33      

Issued and released

   (40,771     6.47      

Cancelled

   (24,841     11.99      
              

Unvested at June 28, 2009

   743,509      $ 8.02    1.04    $ 5,472,226
                        

Vested and expected to vest at June 28, 2009

   650,365      $ 7.79    1.01    $ 4,786,687
                        

The aggregate intrinsic value of RSUs represents the closing price per share of our stock at the end of the periods presented, multiplied by the number of unvested RSUs or the number of vested and expected to vest RSUs, as applicable, at the end of each period.

For RSUs, stock-based compensation expense was calculated based on our stock price on the date of grant, multiplied by the number of RSUs granted. The grant date fair value of RSUs, less estimated forfeitures, was recognized on a straight-line basis over the vesting period.

At June 28, 2009, there were RSUs corresponding to approximately 743,509 shares of our common stock outstanding with an unrecognized stock-based compensation cost of approximately $1.9 million to be recognized as compensation expense over a weighted average period of 1.04 years.

At June 29, 2008, there were approximately 197,000 RSUs outstanding with an unrecognized stock-based compensation cost of approximately $1.9 million to be recognized as compensation expense over a weighted average period of 1.81 years.

Stock-Based Compensation Expenses

The following table summarized stock-based compensation expense related to stock options, RSUs under FAS 123R for the first quarter of fiscal 2010 and fiscal 2009 (in thousands):

 

     Three Months Ended
     June 28,
2009
   June 29,
2008

Cost of sales

   $ 116    $ 192

Research and development

     486      358

Selling, general and administrative

     707      809
             

Total Stock-based compensation expense

   $ 1,309    $ 1,359
             

At June 28, 2009, there was an immaterial amount of total unamortized stock based compensation cost capitalized in inventory. There was no stock-based compensation cost capitalized in inventory at the end of the first quarter of fiscal 2008. Stock-based compensation expense for the three months ended June 28, 2009, includes approximately $148,000 of incremental stock-based compensation expense, associated with RSU awards covering an aggregate of 344,020 shares of our common stock issued in exchange for the options surrendered pursuant to the October 23, 2008 option exchange program.

Valuation Assumptions

We estimate the fair value of stock options on the date of grant using the Black-Scholes option-pricing model. The assumptions used in calculating the fair value of stock-based compensation represent our estimates, but these estimates involve inherent uncertainties and the application of management judgments which include the expected term of the share-based awards, stock price volatility and forfeiture rates. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

 

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We used the following weighted average assumptions to calculate the fair values of options granted during the fiscal periods presented:

 

     Three Months Ended  
     June 28,
2009
    June 29,
2008
 

Expected term of options (years)

     4.7 – 4.9        4.6 – 4.8   

Risk-free interest rate

     2.1 – 2.2     3.1 – 3.2

Expected volatility

     38     31 – 32

Expected dividend yield

     —          —     

Weighted average estimated fair value

   $ 2.31      $ 2.73   

NOTE 14. COMPREHENSIVE INCOME (LOSS)

Our comprehensive loss for the periods indicated below was as follows (in thousands):

 

     Three Months Ended  
     June 28,
2009
    June 29,
2008
 

Net loss

   $ (12,875   $ (2,461

Other comprehensive loss:

    

Change in unrealized income (loss), on marketable securities, net of tax

     413        (1,226
                

Total other comprehensive income (loss)

   $ 413      $ (1,226
                

Comprehensive loss

     (12,462     (3,687
                

NOTE 15. LEASE FINANCING OBLIGATION

In connection with the Sipex acquisition, we assumed a lease financing obligation related to our Hillview facility located in Milpitas, California (the “Hillview Facility”). The lease term expires in March 2011 with average lease payments of approximately $1.4 million per year.

The fair value of the Hillview Facility was estimated at $13.4 million at the time of the acquisition and was included in the “Property, plant and equipment, net” line item on the condensed consolidated balance sheet. In accordance with purchase accounting, we have accounted for this sale and leaseback transaction as a financing transaction which was included in the “Long-term lease financing obligations” line item on our condensed consolidated balance sheet. The effective interest rate is 8.2%. Depreciation for the Hillview Facility was recorded over the straight-line method for the remaining useful life and was $88,000 for the three months ended on each of June 28, 2009 and June 29, 2008, respectively.

At the end of the lease term, the estimated final lease obligation is approximately $12.2 million, which we will settle by returning the Hillview Facility to the lessor.

We sublet the Hillview Facility in April 2008. The sublease expires in March 2011 and we expect annual sublease income of approximately $1.4 million for the duration of the sublease term. The sublease income for the first quarter of each of fiscal 2010 and fiscal 2009 was $353,000 and $294,000, respectively, and was recorded in the “Interest income and other, net” line item in our condensed consolidated statements of operations.

We have also acquired engineering design tools (“design tools”) under capital leases. We acquired $5.2 million of design tools in December 2007 under a four-year license and $3.7 million of design tools in November 2008 under a three-year license, which were accounted for as capital leases and recorded in the “Property, plant and equipment, net” line item on the condensed consolidated balance sheets. The related design tool obligations were included in the “Long-term lease financing obligations” line item in our condensed consolidated balance sheets. The effective interest rates for the design tools are 7.25% for the four-year tools and 4.0% for the three-year tools based upon prevailing interest rates at the time of the respective acquisitions. Amortization on the design tools is recorded using the straight-line method over the remaining useful life and was $536,000 and $322,000 in the first quarter of each of fiscal 2010 and fiscal 2009, respectively.

 

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Future minimum lease payments for the lease financing obligations as of June 28, 2009 are as follows (in thousands):

 

Fiscal Years

   Hillview
Facility
    Design
Tools
    Total     Expected
Sublease
Income

2010 (9 months ended)

   $ 1,061      $ 2,308      $ 3,369      $ 1,059

2011

     13,624        2,670        16,294        1,412

2012

     —          1,087        1,087        —  
                              

Total minimum lease payments

     14,685        6,065        20,750        2,471

Less: amount representing interest

     (1,807     (630     (2,437  

Less: amount representing maintenance

     —          (618     (618  
                              

Present value of minimum lease payments

     12,878        4,817        17,695        2,471

Less: current portion of lease financing obligation

     (380     (2,098     (2,478     —  
                              

Long-term lease financing obligation

   $ 12,498      $ 2,719      $ 15,217      $ 2,471
                              

For the first quarter of fiscal 2010, interest expense totaled approximately $266,000 and $58,000 for the Hillview Facility lease financing obligation and design tools, respectively. For the first quarter of fiscal 2009, interest expense totaled approximately $272,000 and $44,000 for the Hillview Facility lease financing obligation and design tools, respectively.

NOTE 16. COMMITMENTS AND CONTINGENCIES

In 1986, Micro Power Systems Inc. (“MPSI”), a subsidiary that we acquired in June 1994, identified low-level groundwater contamination at its principal manufacturing site. Although the area and extent of the contamination appear to have been defined, the source of the contamination has not been identified. MPSI previously reached an agreement with a prior tenant to share in the cost of ongoing site investigations and the operation of remedial systems to remove subsurface chemicals. The frequency and number of wells monitored at the site was reduced with prior regulatory approval for a plume stability analysis as an initial step towards site closure. No significant rebound concentrations have been observed. The groundwater treatment system remains shut down during its two-year plume stability evaluation. In July 2008, we evaluated the effectiveness of the plume stability and decided to initiate a treatment program and pursue a no further action order for the site. As such, we accrued an additional $58,000, increasing our liability to $250,000. This accrual includes approximately $200,000 for various remediation options under consideration and $50,000 for future annual monitoring. As of June 28, 2009 the remaining liability was $204,000, net of payments of $46,000, during the first quarter of fiscal 2010.

Sipex, which we acquired in August 2007, had entered into a definitive Master Agreement with Hangzhou Silan Microelectronics Co. Ltd. and Hangzhou Silan Integrated Circuit Co. Ltd. (collectively “Silan”) in China. Silan is a China-based semiconductor foundry. This transaction was related to the closing of Sipex wafer fabrication operations located in Milpitas, California. Under this agreement, Sipex and Silan would work together to enable Silan to manufacture semiconductor wafers using Sipex process technology. The Master Agreement includes a Process Technology Transfer and License Agreement which contemplates the transfer of eight of our processes and related product manufacturing to Silan. Subject to our option to suspend in whole or in part, there is a purchase commitment under the Wafer Supply Agreement obligating us to purchase from Silan an average of at least one thousand equivalent wafers per week, calculated on a quarterly basis, for five years beginning February 2006. There were open purchase orders for approximately $1.0 million outstanding as of June 28, 2009.

Generally, we warrant all of our products against defects in materials and workmanship for a period ranging from ninety days to two years from the delivery date. Reserve requirements are recorded in the period of sale and are based on an assessment of the products sold with warranty and historical warranty costs incurred. Our liability is generally limited to replacing, repairing or issuing credit, at our option, for the product if it has been paid for. The warranty does not cover damage which results from accident, misuse, abuse, improper line voltage, fire, flood, lightning or other damage resulting from modifications, repairs or alterations performed other than by us, or resulting from failure to comply with our written operating and maintenance instructions. Warranty expense has historically been immaterial for our products. The warranty liabilities related to our products as of June 28, 2009 was immaterial.

Additionally, our sales agreements indemnify our customers for expenses or liability resulting from alleged or claimed infringement by our products of any U.S. letter patents of third parties. However, we are not liable for any collateral, incidental or consequential damages arising out of patent infringement. The terms of these indemnification agreements are perpetual, commencing after execution of the sales agreement or the date indicated on our order acknowledgement. The maximum amount of potential future indemnification is unlimited. However, to date, we have not paid any claims or been required to defend any lawsuits with respect to any such indemnity claim.

 

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NOTE 17. LEGAL PROCEEDINGS

From time to time, we are involved in various claims, legal actions and complaints arising in the normal course of business. Although the ultimate outcome of the matters discussed below and other matters is not presently determinable, management currently believes that the resolution of all such pending matters will not have a material adverse effect on our financial position, results of operations or liquidity.

Ericsson Wireless Communications, Inc. and Vicor Corporation

On November 16, 2004, Ericsson Wireless Communications, Inc. (now known as Ericsson Inc.) (“Ericsson”) initiated a lawsuit against us and our former customer, Vicor Corporation, in San Diego County Superior Court. Ericsson alleged that Vicor had sold it products that contained defects, including defects in the integrated circuits derived from the untested, semi-custom wafers we sold to Vicor. Ericsson sought monetary damages and unspecified injunctive relief. On April 5, 2005, Vicor Corporation (“Vicor”) filed a cross-complaint against us in San Diego County Superior Court asserting various contract, tort, and indemnity claims. Only the indemnity claims survived the pleading stage. In those claims, Vicor alleged, among other things, that we were responsible for the alleged defect in the products sold to Ericsson and that any damages awarded to Ericsson should be born solely by us. Ultimately, we settled the case with Ericsson and the claims against us were dismissed with prejudice. In addition, we obtained a finding from the trial court that the settlement with Ericsson was in good faith. The result of the good faith finding was that final judgment was entered in our favor on Vicor’s indemnity claims, a judgment which has been finally affirmed on appeal.

On March 4, 2005, we filed a complaint in Santa Clara County Superior Court against Vicor. In the complaint, we sought a declaration regarding the respective rights and obligations, including warranty and indemnity rights and obligations, under the written contracts between us and Vicor for the sale of untested, semi-custom wafers. In addition, we sought a declaration that we were not responsible for any damages that Vicor must pay to Ericsson or any other customer of Vicor arising from claims that Vicor sold allegedly defective products. On March 17, 2005, Vicor filed a cross-complaint against us (and the owners and operators of the foundry which supplied the untested, semi-custom wafers that we sold to Vicor). In the cross-complaint, Vicor asserted that it is entitled to indemnification from us for any damages that Vicor must pay to Ericsson or other Vicor customers resulting from Vicor’s sale of allegedly defective products. Following a motion to dismiss, Vicor filed an amended cross-complaint on August 1, 2005 asserting only a request for a declaration that we were obligated to indemnify Vicor for any damages resulting from claims brought against Vicor by its customers. We answered Vicor’s amended cross-complaint on September 2, 2005. The Santa Clara action was transferred to San Diego for coordination with the Ericsson San Diego County action on August 18, 2006. No trial date has been set.

DiPietro v. Sipex

In April 2003, plaintiff Frank DiPietro (former chief financial officer of Sipex) brought an action for breach of contract against Sipex in the Middlesex Superior Court in the state of Massachusetts. Mr. DiPietro was seeking approximately $800,000 in severance benefits. Sipex counterclaimed for approximately $150,000, which it was owed under a promissory note signed by Mr. DiPietro. In August 2004, Sipex filed two motions for summary judgment (one for Mr. DiPietro’s claims against it and one for its counterclaim against Mr. DiPietro). In June 2005, the Middlesex Superior Court granted both Sipex’s motions for summary judgment. Soon thereafter, Mr. DiPietro filed a notice of appeal. Sipex then filed motions for costs and pre-judgment interest. Sipex was successful in its motion for prejudgment interest and it was successful in requiring Mr. DiPietro to pay over $900 in deposition costs.

The Appeal briefing was completed during the summer of 2006. On December 12, 2006, the Massachusetts Appeals Court heard arguments in DiPietro v. Sipex and, on May 14, 2007, the Appeals Court issued its decision reversing the Middlesex Superior Court’s grant of summary judgment and remanding the case for further proceedings. Sipex filed a petition for rehearing and an application for further appellate review. After briefing by the parties, the Massachusetts Appeals Court amended its decision to clarify issues addressed in Sipex’s petition for rehearing.On October 31, 2007, Sipex’s application for further appellate review was denied.

The case was remanded to Middlesex Superior Court for further proceedings. Sipex serve its motion for leave to file renewed motions for summary judgment on August 11, 2008, and Mr. DiPietro served his opposition on August 21, 2008. On October 14, 2008, the Court heard arguments on Sipex’s motion for leave to file renewed motions for summary judgment. The Court denied Sipex’s motion on October 16, 2008. A pre-trial conference was held on February 3, 2009. At that time, opposing counsel requested a continuance due to a family emergency, and the trial was rescheduled for April 27, 2009. After a further continuance, the trial was scheduled for July 27, 2009. Before the trial commenced, the parties were able to negotiate a settlement agreement. The particular terms of the agreement have been negotiated and the parties are awaiting execution of the final settlement agreement. A joint stipulation of dismissal of this action will be filed on or after August 11, 2009.

 

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NOTE 18. INCOME TAX

During the first quarter of each of fiscal 2010 and fiscal 2009, we recorded an income tax benefit of approximately $0.3 million and $0.1 million, respectively. The increase in income tax benefit was primarily due to benefits recorded during the first quarter of fiscal 2010 for net operating losses and tax refunds.

Our unrecognized tax benefits increased by $3.3 million to $13.0 million during the first quarter of fiscal 2010 primarily as a result of the acquisition of Hifn during the quarter. If recognized, $9.4 million of these unrecognized tax benefits (net of federal benefit) would be recorded as a reduction of future income tax provision before consideration of changes in valuation allowance.

Estimated interest and penalties related to the income taxes are classified as a component of the provision for income taxes in the condensed consolidated statement of operations. Accrued interest and penalties were $0.3 million at the end of the first quarter of each of fiscal 2010 and fiscal 2009, respectively.

Our only major tax jurisdictions are the United States and various U.S. states. The fiscal years 1998 through 2009 remain open and subject to examinations by the appropriate governmental agencies in the U.S., with fiscal years 2001 through 2009 open to audits in certain of our state jurisdictions.

NOTE 19. SEGMENT AND GEOGRAPHIC INFORMATION

We operate in one reportable segment. We design, develop and market high-performance, analog and mixed-signal silicon solutions for a variety of markets including power management, interface and datacom. The nature of our products and production processes and the type of customers and distribution methods are consistent among all of our products.

Our net sales by product line are summarized as follows (in thousands):

 

     Three Months Ended
     June 28,
2009
   June 29,
2008

Datacom

   $ 12,983    $ 6,896

Interface

     13,022      18,526

Power management

     4,857      6,789
             

Total net sales

   $ 30,862    $ 32,211
             

Our foreign operations are conducted primarily through our wholly-owned subsidiaries in Canada, China, France, Germany, Italy, Japan, Malaysia, Singapore, South Korea, Taiwan and the United Kingdom. Our principal markets include North America, Europe and the Asia Pacific region. Net sales by geographic area represent sales to unaffiliated customers.

Our net sales by geographic area are summarized as follows (in thousands):

 

     Three Months Ended
     June 28,
2009
   June 29,
2008

United States

   $ 7,184    $ 7,241

China

     11,264      8,288

Singapore

     3,030      3,885

Japan

     1,969      3,078

Italy

     1,073      1,223

Europe (excludes Italy)

     3,811      5,904

Rest of world

     2,531      2,592
             

Total net sales

   $ 30,862    $ 32,211
             

Substantially all of our long-lived assets at each of June 28, 2009 and March 29, 2009 were located in the United States.

 

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NOTE 20. SUBSEQUENT EVENTS

Management evaluated all subsequent events and some nonrecognized subsequent events through August 7, 2009, the date the financial statements were issued, and concluded that no subsequent event or nonrecognized subsequent event required disclosure pursuant to SFAS 165.

 

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

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained in “Part II, Item 1A. Risk Factors” below and elsewhere in this Quarterly Report on Form 10-Q, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are generally written in the future tense and/or may generally be identified by words such as “will,” “may,” “should,” “could,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan,” or other similar words. Forward-looking statements contained in this Quarterly Report include, among others, statements regarding (1) our revenue growth, (2) our future gross profits, (3) our future research and development efforts and related expenses, (4) our future selling, general and administrative expenses, (5) our cash and cash equivalents, short-term marketable securities and cash flows from operations being sufficient to satisfy working capital requirements and capital equipment needs for at least the next 12 months, (6) our ability to continue to finance operations with cash flows from operations, existing cash and investment balances, and some combination of long-term debt and/or lease financing and sales of equity securities, (7) the possibility of future acquisitions and investments, (8) our ability to accurately estimate our assumptions used in valuing stock-based compensation, (9) our ability to estimate and reconcile distributors’ reported inventories to their activities, (10) our ability to estimate future cash flows associated with long-lived assets, (11) the weak global economic and financial market conditions, and (12) anticipated results in connection with the acquisition of hi/fn, inc. (“Hifn”) and Galazar Networks Inc. (“Galazar”). Actual results may differ materially from those projected in the forward-looking statements as a result of various factors. Factors that could cause actual results to differ materially from those stated herein include, but are not limited to: the information contained under the captions “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II, Item 1A. Risk Factors.” We disclaim any obligation to update information in any forward-looking statement.

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the condensed consolidated financial statements and notes thereto, included in this Quarterly Report on Form 10-Q, and our audited consolidated financial statements for the fiscal year ended March 29, 2009 included in our Annual Report on Form 10-K, as filed with the Securities and Exchange Commission (“SEC”). Our results of operations for the three months ended June 28, 2009 are not necessarily indicative of results to be expected for any future period.

BUSINESS OVERVIEW

Exar Corporation and its subsidiaries (“Exar” or “we”) is a fabless semiconductor company that designs, sub-contracts manufacturing of and sells highly differentiated silicon, software and subsystem solutions for industrial, datacom and storage applications. We use our extensive knowledge of end-user markets along with our underlying analog, mixed signal and digital technology to provide customers with innovative solutions designed to meet the needs of the evolving connected world. Our product portfolio includes power management and interface components, datacom products, storage optimization solutions, network security and applied service processors. Applying both analog and digital technologies, our products are deployed in a wide array of applications such as portable electronic devices, set top boxes, digital video recorders, telecommunication systems, servers, enterprise storage systems and industrial automation equipment. We provide customers with a breadth of component products and subsystem solutions based on advanced mixed signal silicon integration.

We market our products worldwide with sales offices and personnel located throughout the Americas, Europe, and Asia. Our products are sold in the United States through a number of manufacturers’ representatives and distributors. Internationally, our products are sold through various regional and country specific distributors with locations in thirty-three countries around the globe. In addition to our sales offices, we also employ a worldwide team of field application engineers to work directly with our customers.

Our international sales consist of sales that are denominated in U.S. dollars. Our international related operations expenses expose us to fluctuations in currency exchange rates because our foreign operating expenses are denominated in foreign currency while our sales are denominated in U.S. dollars. Although foreign sales within certain countries or foreign sales comprised of certain products may subject us to tariffs, our gross profit margin on international sales, adjusted for differences in product mix, is not significantly different from that realized on our sales to domestic customers. Our operating results are subject to quarterly and annual fluctuations as a result of several factors that could materially and adversely affect our future profitability as described in “Part II, Item 1A. Risk Factors—Our Financial Results May Fluctuate Significantly Because Of A Number Of Factors, Many Of Which Are Beyond Our Control.”

 

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Our fiscal year ends on the Sunday closest to March 31 and our fiscal quarters end on the Sunday closest to the end of the corresponding calendar quarter. The first quarter of each of fiscal 2010 and fiscal 2009 included 91 days from March 30, 2009 to June 28, 2009 and March 31, 2008 to June 29, 2008, respectively.

Business Outlook

As we enter our fiscal year 2010, the economy is still in a recession and our visibility to a recovery in our industry, to end customer demand, and to our business is limited. Net sales for the first quarter of fiscal 2010 increased $7.0 million or 29% when compared to the immediate preceding quarter. Included in the first quarter of 2010 net sales is $5.8 million of sales from our newly acquired companies, hi/fn, inc. (“Hifn”) and Galazar Networks Inc. (“Galazar”). Excluding net sales from these acquired companies, net sales would have increased $1.2 million or 5% from the immediate preceding quarter.

Business Combinations

On June 17, 2009, we completed the acquisition of Galazar for $4.95 million in cash. Galazar, based in Ottawa, Canada, is a fabless semiconductor and software supplier focused on carrier grade transport over telecom networks. Galazar’s product portfolio addresses transport of a wide range of datacom and telecom services including Ethernet, SAN, TDM and video over SONET/SDH, PDH and OTN networks.

On April 3, 2009, we completed the acquisition of Hifn, a fabless semiconductor company that was founded in 1996, spun off from Stac, Inc. in 1999 and traded on the NASDAQ under the symbol “HIFN” since 1999, for a total consideration of $59.6 million, which consist of approximately 429,600 shares of Exar’s common stock with an estimated fair value of $2.8 million and $56.8 million in cash. The acquisition of Hifn expands and complements our product offerings in the enterprise storage, networking and telecom markets where we have had a significant base of business for more than 10 years. The Hifn technology adds world class compression and data deduplication products used in storage applications to optimize data and speed up data backup and retrieval. Hifn has also been a leading provider in security acceleration technology by providing encryption and compression products to the leading networking and telecom system manufacturers. The Hifn products complement the existing Exar connectivity solutions and provide us with a more significant product offering to our customers.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of our financial statements and accompanying disclosures in conformity with GAAP requires estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the condensed consolidated financial statements and the accompanying notes. The SEC has defined a company’s critical accounting policies as policies that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified our most critical accounting policies and estimates to be as follows: (1) revenue recognition; (2) valuation of inventories; (3) income taxes; (4) stock-based compensation; (5) goodwill; (6) long-lived assets; and (7) valuation of business combinations. Although we believe that of our estimates, assumptions and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates if the assumptions, judgments and conditions upon which they are based turn out to be inaccurate. With the exception of our goodwill and long-lived asset policies discussed below, a further discussion of our critical accounting policies can be found in “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended March 29, 2009.

 

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RESULTS OF OPERATIONS

We acquired Hifn on April 3, 2009 and Galazar on June 17, 2009 and consequently, our results of operations in the first quarter of fiscal 2010 include the results of those entities for 12 weeks and 10 days, respectively.

Net Sales by Product Line

Our net sales by product line in dollars and as a percentage of net sales were as follows for the periods presented (in thousands):

 

     Three Months Ended        
     June 28,
2009
    June 29,
2008
    Change  

Net Sales:

            

Datacom

   $ 12,983    42   $ 6,896    21   88

Interface

     13,022    42     18,526    58   (30 )% 

Power management

     4,857    16     6,789    21   (28 )% 
                            

Total

   $ 30,862    100   $ 32,211    100  
                            

Datacom

Datacom products include network access, transmission and storage products, as well as encryption, data reduction and packet processing products from the Hifn acquisition and network transport products from the Galazar acquisition.

Net sales of datacom products for the first quarter of fiscal 2010 increased $6.1 million as compared to the same period a year ago and included $5.8 million of additional sales from Hifn and Galazar products. Net of this effect, net sales of network access, transmission and storage products for the first quarter of fiscal 2010 increased $0.3 million, primarily due to increased volume of our SONET products and price erosion on a SONET product.

Interface

Interface products include Universal Asynchronous Receiver/Transmitter (“UART”) and serial transceiver products.

Net sales of interface products for the first quarter of fiscal 2010 decreased $5.5 million as compared to the same period a year ago, primarily due to decreased volume of UARTs and serial transceiver sales and price erosion on a limited number of both UART and serial transceiver products.

Power Management

Power management products include DC-DC regulators and LED drivers.

Net sales of power management products for the first quarter of fiscal 2010 decreased $1.9 million as compared to the same period a year ago primarily due to decreased volumes and price erosion on a limited number of power management products.

Net Sales by Channel

Our net sales by channel in dollars and as a percentage of net sales were as follows for the periods presented (in thousands):

 

     Three Months Ended        
     June 28,
2009
    June 29,
2008
    Change  

Net Sales:

            

Sell-through distributors

   $ 15,297    50   $ 19,348    60   (21 )% 

Direct and others

     15,565    50     12,863    40   21
                            

Total

   $ 30,862    100   $ 32,211    100  
                            

Net sales to our distributors for which we recognize revenue on the sell-through method, for the first quarter of fiscal 2010, included $0.3 million in sales of Hifn and Galazar products. Net sales to direct customers and other distributors for the first quarter of fiscal 2010 included $5.5 million in sales of Hifn and Galazar products.

 

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Net Sales by Geography

Our net sales by geography in dollars and as a percentage of net sales were as follows for the periods presented (in thousands):

 

     Three Months Ended        
     June 28,
2009
    June 29,
2008
    Change  

Net Sales:

            

Americas

   $ 7,316    24   $ 7,792    24   (6 )% 

Asia

     18,662    60     17,292    54   8

Europe

     4,884    16     7,127    22   (31 )% 
                            

Total

   $ 30,862    100   $ 32,211    100  
                            

Net sales in the Americas, Asia and Europe, for the first quarter of fiscal 2010, included $2.2 million, $3.0 million and $0.6 million, respectively, of sales of Hifn and Galazar products.

Gross Profit

Our gross profit in dollars and as a percentage of net sales was as follows for the periods indicated (in thousands):

 

     Three Months Ended        
     June 28,
2009
    June 29,
2008
    Change  

Net sales

   $ 30,862      $ 32,211     

Cost of sales:

            

Cost of sales

     14,890    48     16,786    52   (11 )% 

Fair value adjustment of acquired inventories

     1,787    6     —      —     100

Amortization of acquired intangible assets

     1,340    4     955    3   40
                            

Gross profit

   $ 12,845    42   $ 14,470    45   (11 )% 
                            

Gross profit represents net sales less cost of sales. Cost of sales includes:

 

 

the cost of purchasing finished silicon wafers manufactured by independent foundries;

 

 

the costs associated with assembly, packaging, test, quality assurance and product yields;

 

 

the cost of personnel and equipment associated with manufacturing support and manufacturing engineering;

 

 

the cost of stock-based compensation associated with manufacturing engineering and support personnel;

 

 

the amortization of purchased intangible assets; and

 

 

the provision for excess and obsolete inventory.

The decrease in gross profit, as a percentage of net sales, for the first quarter of fiscal 2010, was primarily due to the amortization of the fair value of inventories acquired from Hifn and Galazar, increased amortization of intangible assets established with the purchase of Hifn and Galazar, and manufacturing inefficiencies associated with shipping lower product volume as compared to the prior year, partially offset by higher margins on Hifn and Galazar products, improved margins on serial transceiver and power management products and a lower provision for excess and obsolete inventory.

 

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Other Costs and Expenses

 

     Three Months Ended     Change  
     June 28,
2009
    June 29,
2008
   

Net Sales

   $ 30,862      $ 32,211     

Research and development expense:

            

Research and development – base

     10,663    35     7,471    23   43

Stock-based compensation

     486    2        358    1      36   

Amortization expense – acquired intangibles

     588    2        263    1      124   

Acquisition related costs

     557    2        —      —        100   
                    

Total research and development expense

   $ 12,294    40   $ 8,092    25   52
                    

Selling, general and administrative expense:

            

Selling, general and administrative – base

     10,337    33     9,788    30   6

Stock-based compensation

     707    2        809    3      (13

Amortization expense – acquired intangibles

     142    —          162    1      (12

Acquisition related costs

     3,926    13        542    2      624   
                    

Total selling, general and administrative expense

   $ 15,112    49     11,301    35   34
                    

Research and Development (“R&D”)

Our R&D costs consist primarily of:

 

   

the salaries, stock-based compensation, and related expenses of employees engaged in product research, design and development activities;

 

   

costs related to engineering design tools, mask tooling costs, test hardware, engineering supplies and services, and use of in-house test equipment;

 

   

amortization of purchased intangible assets; and

 

   

facilities expenses.

The $3.2 million increase in base R&D expenses for the first quarter of fiscal 2010 as compared to the same period a year ago was primarily a result of incremental labor-related expenses, EDA software amortization and equipment depreciation due to the growth of our company as a result of the acquisition of Hifn and, to a lesser extent, Galazar.

Stock-based compensation expense recorded in R&D expenses was $0.5 million for the first quarter of fiscal 2010 as compared to $0.4 million for the same period a year ago. We expect stock-based compensation expense to increase primarily as a result of new stock option and restricted stock unit (“RSU”) grants made in connection with the Hifn and Galazar acquisitions.

The growth in amortization expense – acquired intangibles relates to the amortization of a R&D reimbursement contract associated with the Hifn acquisition. Acquisition related costs in the first quarter of fiscal 2010 are primarily associated with the accelerated depreciation relating to shortened remaining lives of equipment of $0.5 million acquired from Hifn and employee severance costs.

Selling, General and Administrative (“SG&A”)

SG&A expenses consist primarily of:

 

   

salaries, stock-based compensation and related expenses;

 

   

sales commissions;

 

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professional and legal fees;

 

   

amortization of acquired intangible assets; and

 

   

facilities expenses.

The $0.5 million increase in base SG&A expenses for the first quarter of fiscal 2010 as compared to the same period a year ago, was primarily a result of incremental labor-related expenses and equipment depreciation due to the growth of our company as a result of the acquisition of Hifn, and to a lesser extent, Galazar. These increases were partially offset by decreased property taxes, consulting and insurance premiums.

Stock-based compensation expense recorded in SG&A expenses was $0.7 million for the first quarter of fiscal 2010 as compared to $0.8 million for the same period a year ago. We expect stock-based compensation expense to increase primarily as a result of new stock option and RSU grants made in connection with the Hifn and Galazar acquisitions.

Acquisition related costs in the first quarter of fiscal 2010 are primarily associated with $2.1 million in investment banker, printing, legal and other professional fees that are now recorded as expenses under SFAS141(R) and the accelerated depreciation relating to shortened remaining lives of equipment of $0.7 million acquired from Hifn and employee severance of $0.6 million, and building exit and moving costs of $0.3 million related to the Hifn Los Gatos facility.

Other Income and Expenses

 

     Three Months Ended     Change  
     June 28,
2009
    June 29,
2008
   

Net Sales

   $ 30,862        $ 32,211       

Interest income and other, net

     1,754      6     2,670      8   (34 )% 

Interest expense

     (324   (1 )%      (331   (1 )%    (2 )% 

Impairment charges on investments

     (72   —       —        —     100

Interest Income and Other, Net

Interest income and other, net primarily consists of:

 

   

interest income;

 

   

sublease income;

 

   

foreign exchange gains or losses; and

 

   

gains or losses on the sale or disposal of equipment.

The decrease in interest income and other, net during the first quarter of fiscal 2010 as compared to the same period a year ago was primarily attributable to a decrease in interest income as a result of lower invested cash balances (we repurchased 1.6 million shares of our common stock for $13.4 million during fiscal 2009), lower yield of the investments and increased investment management fees as we transitioned the internally managed portion of our portfolio to our professional money managers. Cash and short-term investments balances decreased $34.9 million during the first quarter of fiscal 2010 primarily due to the cash consideration paid to acquire Hifn and Galazar, partially offset by cash acquired from Hifn and Galazar.

Our Hillview Facility, which we originally leased from Mission West Properties, L.P., was sublet to a subtenant in April 2008. The sublease expires on March 31, 2011 with average annual rent of approximately $1.4 million. The sublease also requires the subtenant to pay certain operating costs associated with subleasing the facility. The sublease income for the first quarter of fiscal 2010 was approximately $353,000. (See “Part I, Item 1, Notes to Condensed Consolidated Financial Statements, Note 15 – Lease Financing Obligation.”)

 

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Interest Expense

In fiscal year 2008, in connection with the acquisition of Sipex, we assumed a lease financing obligation related to the Hillview Facility. We have accounted for this sale and leaseback transaction as a financing transaction which is included in the “Long-term lease financing obligation” line item on our condensed consolidated balance sheet. The effective interest rate is 8.2%.

We have acquired engineering design tools (“design tools”) under capital leases. We acquired $5.2 million of design tools in December 2007 under a four-year license and $3.7 million of design tools in November 2008 under a three-year license, which were accounted for as capital leases and recorded in the “Property, plant and equipment, net” line item on the condensed consolidated balance sheets. The related design tool obligations were included in the “Long-term lease financing obligations” line on our condensed consolidated balance sheets. The effective interest rates for the design tools are 7.25% for the four-year tools and 4.0% for the three-year tools.

Interest expense for the Hillview Facility lease financing and the design tools lease obligations was $324,000 and $316,000 for the first quarter of fiscal 2010 and fiscal 2009, respectively.

Impairment Charges on Investments

We follow the guidance provided by FASB Staff Position No. 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1”) and FASB Staff Position No. 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairment”, to assess whether our investments with unrealized loss positions are other-than-temporarily impaired. We regularly review our investments in unrealized loss positions for other-than-temporary impairments. This evaluation includes, but is not limited to, significant quantitative and qualitative assessments and estimates regarding credit ratings, collateralized support, the length of time and significance of a security’s loss position and our intention to sell a security. Realized gains and losses and declines in value of our investments, both marketable and non-marketable, judged to be other-than-temporary are reported in the “Impairment charges on investments, net of realized gain” line item in the condensed consolidated statements of operations.

Our long-term investments consist of the investments in TechFarm Ventures L.P. (Q), L.P. (“TechFarm Fund”) and Skypoint Telecom Fund II (US), L.P. (“Skypoint Fund”). Both TechFarm Fund and Skypoint Fund are venture capital funds which invest primarily in private companies in the telecommunications and/or networking industry. We account for these non-marketable equity securities under the cost method. In accordance with EITF 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments, we periodically review and determine whether the investments are other-than-temporarily impaired, in which case the investments are written down to their impaired value.

Skypoint Fund

In the first quarter of fiscal 2010, we analyzed the fair value of the underlying investments of Skypoint Fund and concluded a portion of the carrying value was other-than-temporarily impaired and recorded an impairment charge of $72,000.

Provision (Benefit) for Income Taxes

During the first quarter of each of fiscal 2010 and fiscal 2009, we recorded an income tax benefit of approximately $0.3 million and $0.1 million, respectively. The increase in income tax benefit was primarily due to benefits recorded during the first quarter of fiscal 2010 for net operating losses and tax refunds.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

     Three Months Ended  
     June 28,
2009
    June 29,
2008
 
     (dollars in thousands)  

Cash and cash equivalents

   $ 41,915      $ 139,986   

Short-term investments

     179,553        118,565   
                

Total cash, cash equivalents, and short-term investments

   $ 221,468      $ 258,551   
                

Percentage of total assets

     66     63

Net cash (used in) provided by operating activities

   $ (4,455   $ 3,729   

Net cash (used in) provided by investing activities

     (42,387     25,957   

Net cash used in financing activities

     (245     (11,716
                

Net decrease in cash and cash equivalents

   $ (47,087   $ (17,970
                

Our net loss was approximately $12.9 million for the first quarter of fiscal 2010. After adjustments for non-cash items and changes in working capital, we used $4.5 million of cash through operating activities.

Significant non-cash charges included:

 

   

Depreciation and amortization expenses of $5.6 million;

 

   

Stock-based compensation expense of $1.3 million;

 

   

Provision for sales returns and allowances of $2.2 million; and

 

   

Fair value adjustments of acquired inventories included in cost of sales of $1.8 million.

Working capital changes included:

 

   

a $4.2 million increase in accounts receivable primarily due to higher level of shipments towards the end of the quarter;

 

   

a $5.1 million decrease in inventory primarily as a result of increased shipments and a reduction in material and assembly purchases; and

 

   

a $1.5 million decrease in accrued compensation and related benefits primarily due to the decrease in the number of days accrued for payroll and benefits.

In the first quarter of fiscal 2010, net cash provided by investing activities reflects net sales and maturities of short-term marketable securities of $2.5 million partially offset by $1.5 million in purchases of property, plant and equipment and intellectual property.

As previously discussed, Exar acquired Hifn and Galazar on April 3, 2009 and June 17, 2009, respectively. Cash used in these acquisitions, net of cash acquired, was $40.3 million and $3.1 million, respectively.

We acquire outstanding common stock in the open market from time to time to partially offset dilution from our stock awards program, to increase our return on our invested capital and to bring our cash to a more appropriate level for our company. We may continue to utilize our stock purchase program described below, which would reduce our cash, cash equivalents and/or short-term investments available to fund future operations and to meet other liquidity requirements.

On August 28, 2007, we established a share repurchase plan (“2007 SRP”) and authorized the repurchase of up to $100 million of our common stock. During the first quarter of fiscal 2010, we did not repurchase any of our common stock under the 2007 SRP. As of June 28, 2009, the remaining authorized amount for the stock repurchase under the 2007 SRP was $11.8 million with no termination date.

 

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To date, inflation has not had a significant impact on our operating results.

We anticipate that we will continue to finance our operations with cash flows from operations, existing cash and investment balances, and some combination of long-term debt and/or lease financing and additional sales of equity securities. The combination and sources of capital will be determined by management based on our needs and prevailing market conditions.

The following table summarizes our investments in marketable securities (in thousands):

 

     June 28, 2009
     Amortized
Cost
   Unrealized     Fair Value
        Gross Gains    Gross Losses    

Money market funds

   $ 29,326    $ —      $ —        $ 29,326

Corporate bonds and commercial paper

     48,142      449      (62     48,529

U.S. government and agency securities

     77,908      1,334      (28     79,214

Asset and mortgage-backed securities

     61,524      521      (239     61,806
                            

Total investment

   $ 216,900    $ 2,304    $ (329   $ 218,875
                            
     March 29, 2009
     Amortized
Cost
   Unrealized     Fair Value
        Gross Gains    Gross Losses    

Money market funds

   $ 26,332    $ —      $ —        $ 26,332

Corporate bonds and commercial paper

     28,169      160      (141     28,188

U.S. government and agency securities

     163,750      1,379      (38     165,091

Asset and mortgage-backed securities

     35,070      317      (364     35,023
                            

Total investment

   $ 253,321    $ 1,856    $ (543   $ 254,634
                            

As of June 28, 2009, our fixed income investment securities included asset-backed and mortgage-backed securities, accounted for 8% and 20%, respectively, of our total investments. The asset-backed securities are comprised primarily of premium tranches of auto loans and credit card receivables, while our mortgage-backed securities are primarily from the Federal agencies. We do not own auction rate securities nor do we own securities that are classified as sub-prime. As of the date of this Report, we have sufficient liquidity and do not intend to sell these securities nor realize any significant losses in the short term. As of June 28, 2009, the net unrealized gain of our asset-backed and mortgage-backed securities totaled $282,000.

We believe that our cash and cash equivalents, short-term marketable securities and cash flows from operations will be sufficient to satisfy working capital requirements and capital equipment needs for at least the next 12 months. However, should the demand for our products decrease in the future, the availability of cash flows from operations may be limited, thus having a material adverse effect on our financial condition or results of operations. From time to time, we evaluate potential acquisitions, strategic arrangements and equity investments complementary to our design expertise and market strategy, which may include investments in wafer fabrication foundries. To the extent that we pursue or position ourselves to pursue these transactions, we could consume a significant portion of our capital resources or choose to seek additional equity or debt financing. There can be no assurance that additional financing could be obtained on terms acceptable to us or at all. The sale of additional equity or convertible debt could result in dilution to our stockholders.

RECENT ACCOUNTING PRONOUNCEMENTS

Please refer to “Part I, Item 1. Financial Statements” and “Notes to Condensed Consolidated Financial Statements, Note 2 – Recent Accounting Pronouncements.”

OFF-BALANCE SHEET ARRANGEMENTS

As of June 28, 2009, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of the SEC’s Regulation S-K.

SUBSEQUENT EVENTS

Please refer to “Part I, Item 1. Financial Statements” and “Notes to Condensed Consolidated Financial Statements, Note 20 – Subsequent Events.”

 

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CONTRACTUAL OBLIGATIONS AND COMMITMENTS

Our contractual obligations and commitments at June 28, 2009 were as follows (in thousands):

 

     Payments due by period

Contractual Obligations

   Total    Less than
1 year
   1-3
years
   3-5
years
   More than
5 years

Purchase commitment (1)

   $ 7,012    $ 7,012    $ —      $ —      $ —  

Long-term lease financing obligation (2)

     8,581      4,095      4,486      —        —  

Lease obligations (3)

     2,389      1,554      835      —        —  

Long-term investment commitments (Skypoint Fund) (4)

     495      495      —        —        —  

Remediation commitment (5)

     204      154      10      40      —  
                                  

Total

   $ 18,681    $ 13,310    $ 5,331    $ 40    $ —  
                                  

 

        
  Note: The table above excludes the liability for unrecognized income tax benefit of approximately $1.1 million at June 30, 2009 since we cannot predict with reasonable reliability the timing of cash settlements with the respective taxing authorities.

 

  (1) We place purchase orders with wafer foundries and other vendors as part of our normal course of business. We expect to receive and pay for wafers, capital equipment and various service contracts over the next 12 to 18 months from our existing cash balances.
  (2) Lease payments (excluding $12.2 million estimated final obligation settlement with the lessor by returning the Hillview facility at the end of the lease term due on our Hillview facility in Milpitas, California under a 5-year Standard Form Lease agreement that we signed with Mission West Properties L.P. on March 9, 2006, as amended on August 25, 2007). It also includes a $6.1 million licensing agreement related to engineering design software.
  (3) Includes lease payments related to worldwide offices and buildings.
  (4) The commitment related to the Skypoint Fund does not have a set payment schedule and thus will become payable upon the request from the Fund’s General Partner.
  (5) The commitment relates to the environmental remediation activities of Micro Power Systems, Inc.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Fluctuations. We are exposed to foreign currency fluctuations primarily through our foreign operations. This exposure is the result of foreign operating expenses being denominated in foreign currency. Operational currency requirements are typically forecasted for a one-month period. If there is a need to hedge this risk, we may enter into transactions to purchase currency in the open market or enter into forward currency exchange contracts.

If our foreign operations forecasts are overstated or understated during periods of currency volatility, we could experience unanticipated currency gains or losses. At June 28, 2009, we did not have significant foreign currency denominated net assets or net liabilities positions, and had no foreign currency contracts outstanding.

Investment Risk and Interest Rate Sensitivity. We maintain investment portfolio holdings of various issuers, types, and maturity dates with various banks and investment banking institutions. The market value of these investments on any given day during the investment term may vary as a result of market interest rate fluctuations. Our investment portfolio consisted of cash equivalents, money market funds and fixed income securities of $218.9 million as of June 28, 2009 and $254.6 million as of March 29, 2009. These securities, like all fixed income instruments, are subject to interest rate risk and will vary in value as market interest rates fluctuate. If market interest rates were to increase or decline immediately and uniformly by less than 10% from levels as of June 28, 2009, the increase or decline in the fair value of the portfolio would not be material. At June 28, 2009, the difference between the fair market value and the underlying cost of the investments portfolio was a net unrealized gain of $2.0 million.

Our short-term investments are classified as “available-for-sale” securities and the cost of securities sold is based on the specific identification method. At June 28, 2009, short-term investments consisted of asset and mortgage-backed securities, corporate bonds and government agency securities of $179.6 million.

 

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ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures (“Disclosure Controls”)

We evaluated the effectiveness of the design and operation of our Disclosure Controls, as defined by the rules and regulations of the SEC (the “Evaluation”), as of the end of the period covered by this Quarterly Report on Form 10-Q. This Evaluation was performed under the supervision and with the participation of management, including our Chief Executive Officer (the “CEO”), as principal executive officer, and Chief Financial Officer (the “CFO”), as principal financial officer.

Attached as Exhibits 31.1 and 31.2 of this Quarterly Report on Form 10-Q are the certifications of the CEO and the CFO, respectively, in compliance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Certifications”). This section of the Quarterly Report on Form 10-Q provides information concerning the Evaluation referred to in the Certifications and should be read in conjunction with the Certifications.

Disclosure Controls are controls and procedures designed to ensure that information required to be disclosed in the reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods as specified in the SEC’s rules and forms. In addition, Disclosure Controls are designed to ensure the accumulation and communications of information required to be disclosed in reports filed or submitted under the Securities Exchange Act of 1934, as amended, to our management, including the CEO and CFO, to allow timely decisions regarding required disclosure.

Based on the Evaluation, our CEO and CFO have concluded that our Disclosure Controls are effective as of June 28, 2009.

Inherent Limitations on the Effectiveness of Disclosure Controls

Our management, including the CEO and CFO, does not expect that our Disclosure Controls will prevent all errors and all fraud. Disclosure Controls, no matter how well conceived, managed, utilized and monitored, can provide only reasonable assurance that the objectives of such controls are met. Therefore, because of the inherent limitation of Disclosure Controls, no evaluation of such controls can provide absolute assurance that all control issues and instances of fraud, if any, within us have been detected.

Changes in Internal Control over Financial Reporting

We have recently completed our acquisitions of hi/fn, inc. (“Hifn”) on April 3, 2009 and Galazar Networks Inc. (“Galazar”) on June 17, 2009. We are currently in the process of integrating Exar’s, Hifn’s and Galazar’s internal controls and procedures, and therefore, have excluded those controls and procedures in Hifn and Galazar from our assessment of internal controls as of June 28, 2009. At this time, we anticipate that the fiscal year 2010 management report, under Section 404 of the Sarbanes-Oxley act 2002, will include Hifn and Galazar.

Other than described above, there has been no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

The disclosure in “Notes to Condensed Consolidated Financial Statements, Note 17 – Legal Proceedings” contained in “Part I, Item 1. Financial Statements” is hereby incorporated by reference.

 

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ITEM 1A. RISK FACTORS

Global capital and credit market conditions, and resulting declines in consumer confidence and spending, could have a material adverse effect on our business, operating results, and financial condition.

Volatility and disruption in the global capital and credit markets in 2008 and 2009 have led to a tightening of business credit and liquidity, a contraction of consumer credit, business failures, higher unemployment, and declines in consumer confidence and spending in the United States and internationally. If global economic and financial market conditions deteriorate or remain weak for an extended period of time, many related factors could have a material adverse effect on our business, operating results, and financial condition, including the following:

 

   

slower spending may result in reduced demand for our products, reduced orders for our products, order cancellations, lower revenues, increased inventories, and lower gross margins;

 

   

we may be unable to find suitable investments that are safe, liquid, and provide a reasonable return resulting in lower interest income or longer investment horizons, and disruptions to capital markets or the banking system may also impair the value of investments or bank deposits we currently consider safe or liquid;

 

   

the failure of financial institution counterparties to honor their obligations to us under credit instruments could jeopardize our ability to rely on and benefit from those instruments, and our ability to replace those instruments on the same or similar terms may be limited under poor market conditions;

 

   

continued volatility in the markets and prices for commodities and raw materials we use in our products and in our supply chain could have a material adverse effect on our costs, gross margins, and profitability;

 

   

if distributors of our products experience declining revenues, or experience difficulty obtaining financing in the capital and credit markets to purchase our products, it could result in reduced orders for our products, order cancellations, inability to timely meet payment obligations to us, extended payment terms, higher accounts receivable, reduced cash flows, greater expense associated with collection efforts, and increased bad debt expense;

 

   

if distributors of our products experience severe financial difficulty, some may become insolvent and cease business operations, which could reduce the availability of our products to customers;

 

   

if contract manufacturers or foundries of our products or other participants in our supply chain experience difficulty obtaining financing in the capital and credit markets to purchase raw materials or to finance general working capital needs, it may result in delays or non-delivery of shipments of our products;

 

   

potential shutdowns by our third-party foundry, assembly and test subcontractors due to slow business conditions could result in longer lead-times, higher buffer inventory levels and degraded on-time delivery performance; and

 

   

the current macroeconomic environment also limits our visibility into future purchases by our customers and renewals of existing agreements, which may necessitate changes to our business model.

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

Our financial results may fluctuate significantly as a result of a number of factors, many of which are difficult or impossible to control or predict, which include:

 

   

the cyclical nature of the semiconductor industry;

 

   

difficulty in predicting revenues and ordering the correct mix of products from suppliers due to limited visibility provided by customers and channel partners;

 

   

fluctuations of our revenue and gross profits due to the mix of product sales as our margins vary by product;

 

   

the effect of the timing of sales by our resellers on our reported results as a result of our sell-through revenue recognition policies; and

 

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the reduction, rescheduling, cancellation or timing of orders by our customers, distributors and channel partners due to, among others, the following factors:

 

   

management of customer, subcontractor and/or channel inventory;

 

   

delays in shipments from our subcontractors causing supply shortages;

 

   

inability of our subcontractors to provide quality products in a timely manner;

 

   

dependency on a single product with a single customer and/or distributor;

 

   

volatility of demand for equipment sold by our large customers, which in turn, introduces demand volatility for our products;

 

   

disruption in customer demand as customers change or modify their complex subcontract manufacturing supply chain;

 

   

disruption in customer demand due to technical or quality issues with our devices or components in their system;

 

   

the inability of our customers to obtain components from their other suppliers;

 

   

disruption in sales or distribution channels;

 

   

our ability to maintain and expand distributor relationships;

 

   

changes in sales and implementation cycles for our products;

 

   

the ability of our suppliers and customers to remain solvent, obtain financing or fund capital expenditures as a result of the current global recession;

 

   

risks associated with entering new markets;

 

   

the announcement or introduction of products by our existing competitors or new competitors;

 

   

loss of market share by our customers;

 

   

competitive pressures on selling prices or product availability;

 

   

pressures on selling prices overseas due to foreign currency exchange fluctuations;

 

   

erosion of average selling prices coupled with the inability to sell newer products with higher average selling prices, resulting in lower overall revenue and margins;

 

   

delays in product design releases;

 

   

market and/or customer acceptance of our products;

 

   

consolidation among our competitors, our customers and/or our customers’ customers;

 

   

changes in our customers’ end user concentration or requirements;

 

   

loss of one or more major customers;

 

   

significant changes in ordering pattern by major customers;

 

   

our or our channel partners’ ability to maintain and manage appropriate inventory levels;

 

   

the availability and cost of materials and services, including foundry, assembly and test capacity, needed by us from our foundries and other manufacturing suppliers;

 

   

disruptions in our or our customers’ supply chain due to natural disasters, fire, outbreak of communicable diseases, labor disputes, civil unrest or other reasons;

 

   

delays in successful transfer of manufacturing processes to our subcontractors;

 

   

fluctuations in the manufacturing output, yields, and capacity of our suppliers;

 

   

fluctuation in suppliers’ capacity due to reorganization, relocation or shift in business focus or other reasons;

 

   

problems, costs, or delays that we may face in shifting our products to smaller geometry process technologies and in achieving higher levels of design and device integration;

 

   

our ability to successfully introduce and transfer into production new products and/or integrate new technologies;

 

   

increased manufacturing costs;

 

   

higher mask tooling costs associated with advanced technologies;

 

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the amount and timing of our investment in research and development;

 

   

costs and business disruptions associated with stockholder or regulatory issues;

 

   

the timing and amount of employer payroll tax to be paid on our employees’ gains on stock options exercised;

 

   

inability to generate profits to utilize net operating losses;

 

   

increased costs and time associated with compliance with new accounting rules or new regulatory requirements;

 

   

changes in accounting or other regulatory rules, such as the requirement to record assets and liabilities at fair value;

 

   

fluctuations in interest rates and/or market values of our marketable securities;

 

   

litigation costs associated with the defense of suits brought or complaints made against us; and

 

   

change in or continuation of certain tax provisions.

Our expense levels are based, in part, on expectations of future revenues and are, to a large extent, fixed in the short-term. Our revenues are difficult to predict and at times we have failed to achieve revenue expectations. We may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. If revenue levels are below expectations for any reason, operating results are likely to be materially adversely affected.

Our stock price is volatile.

The market price of our common stock has fluctuated significantly to date. In the future, the market price of our common stock could be subject to significant fluctuations due to, among other reasons:

 

   

loss of or changes to key executives;

 

   

our anticipated or actual operating results;

 

   

announcements or introductions of new products by us or our competitors;

 

   

technological innovations by us or our competitors;

 

   

product delays or setbacks by us, our customers or our competitors;

 

   

potential supply disruptions;

 

   

sales channel interruptions;

 

   

concentration of sales among a small number of customers;

 

   

conditions in our customers’ markets and the semiconductor markets;

 

   

the commencement and/or results of litigation;

 

   

changes in estimates of our performance by securities analysts;

 

   

decreases in the value of our investments or long-lived assets, thereby requiring an asset impairment charge against earnings;

 

   

repurchasing shares of our common stock;

 

   

announcements of merger or acquisition transactions; and/or

 

   

general global economic and capital market conditions.

In the past, securities and class action litigation has been brought against companies following periods of volatility in the market prices of their securities. We may be the target of one or more of these class action suits, which could result in significant costs and divert management’s attention, thereby harming our business, results of operations and financial condition.

 

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In addition, at times the stock market has experienced and is currently experiencing extreme price, volume and value fluctuations that affect the market prices of many high technology companies, including semiconductor companies, and that are unrelated or disproportionate to the operating performance of those companies. Any such fluctuations may harm the market price of our common stock.

The general state of the U.S. and global economies, as well as our markets, may materially and adversely impact our business, financial condition and results of operations.

Periodic declines or fluctuations in the U.S. dollar, corporate profits, interest rates, capital markets, and inflation, lower spending, the impact of conflicts throughout the world, terrorist acts, natural disasters, volatile energy costs, the outbreak of communicable diseases and other geopolitical factors, have had, and may continue to have, a negative impact on the U.S. and global economies. Our revenue and profitability have generally followed market fluctuations in our industry, which fluctuations have affected the demand for our own and our customers’ products, thus affecting our revenues and profitability. Our customers continue to experience consolidation in their industries which may result in project delays or cancellations. We are unable to predict the strength or duration of current market conditions or the effects of consolidation. Uncertainties in anticipated spending levels or further consolidation may adversely affect our business, financial condition and results of operations.

We derive a substantial portion of our revenues from distributors, especially from our two primary distributors, Future Electronics Inc. (“Future”), a related party, and Nu Horizons Electronics Corp. (“Nu Horizons”). Our revenues would likely decline significantly if our primary distributors elected not to promote or sell our products or if they elected to cancel, reduce or defer purchases of our products.

Our distributors rely heavily on the availability of short-term capital at reasonable rates to fund their ongoing operations. If this capital is not available, or is only available on onerous term, certain distributors may not be able to pay for inventory received or we may experience a reduction in orders from these distributors, which would likely cause our revenue to decline and materially and adversely impact our business, financial condition and results of operations.

Future and Nu Horizons have historically accounted for a significant portion of our revenues, and they are our two primary distributors worldwide. We anticipate that sales of our products to these distributors will continue to account for a significant portion of our revenues. The loss of either Future or Nu Horizons as a distributor, or a significant reduction in orders from either of them would materially and adversely affect our operating results, business and financial condition.

Sales to Future and Nu Horizons are made under agreements that provide protection against price reduction for their inventory of our products. As such, we could be exposed to significant liability if the inventory value of the products held by Future and Nu Horizons declined dramatically. Our distributor agreements with Future and Nu Horizons do not contain minimum purchase commitments. As a result, Future and Nu Horizons could cease purchasing our products with short notice or cease distributing these products. In addition, they may defer or cancel orders without penalty, which would likely cause our revenues to decline and materially and adversely impact our business, financial condition and results of operations.

Any error in our sell-through revenue recognition judgment or estimates could lead to inaccurate reporting of our net sales, gross profit, deferred income and allowances on sales to distributors and net income.

Sell-through revenue recognition is highly dependent on receiving pertinent and accurate data from our distributors in a timely fashion. Distributors provide us periodic data regarding the product, price, quantity, and end customer when products are resold as well as the quantities of our products they still have in stock. We must use estimates and apply judgment to reconcile distributors’ reported inventories to their activities. Any error in our judgment could lead to inaccurate reporting of our net sales, gross profit, deferred income and allowances on sales to distributors and net income.

The complexity of our products may lead to errors, defects and bugs, which could subject us to significant costs or damages and adversely affect market acceptance of our products.

Although we, our customers and our suppliers rigorously test our products, they may contain undetected errors, weaknesses, defects or bugs when first introduced or as new versions are released. If any of our products contain production defects, reliability, quality or compatibility problems that are significant to our customers, our reputation may be damaged and customers may be reluctant to continue to buy our products, which could adversely affect our ability to retain and attract new customers. In addition, these defects or bugs could interrupt or delay sales of affected products, which could adversely affect our results of operations.

If defects or bugs are discovered after commencement of commercial production, we may be required to make significant expenditures of capital and other resources to resolve the problems. This could result in significant additional development costs and the diversion of technical and other resources from our other development efforts. We could also incur significant costs to repair or replace defective products or may agree to be liable for certain damages incurred. These costs or damages could have a material adverse effect on our financial condition and results of operations.

 

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If we fail to develop, introduce or enhance products that meet evolving market needs or which are necessitated by technological advances, or we are unable to grow revenues, then our business, financial condition and results of operations could be materially and adversely impacted.

The markets for our products are characterized by a number of factors, some of which are listed below:

 

   

changing technologies;

 

   

evolving and competing industry standards;

 

   

changing customer requirements;

 

   

increasing price pressure;

 

   

increasing product development costs;

 

   

long design-to-production cycles;

 

   

competitive solutions;

 

   

fluctuations in capital equipment spending levels and/or deployment;

 

   

rapid adjustments in customer demand and inventory;

 

   

increasing functional integration;

 

   

moderate to slow growth;

 

   

frequent product introductions and enhancements;

 

   

changing competitive landscape (consolidation, financial viability);

 

   

finite market windows for product introductions; and

 

   

short end market product life cycles.

Our growth depends in part on our successful development and acceptance of new products for our core markets. We must: (i) anticipate customer and market requirements and changes in technology and industry standards; (ii) properly define and develop new products on a timely basis; (iii) gain access to and use technologies in a cost-effective manner; (iv) have suppliers produce quality products; (v) continue to expand our technical and design expertise; (vi) introduce and cost-effectively manufacture new products on a timely basis; (vii) differentiate our products from our competitors’ offerings; and (viii) gain customer acceptance of our products. In addition, we must continue to have our products designed into our customers’ future products and maintain close working relationships with key customers to define and develop new products that meet their evolving needs. Moreover, we must respond in a rapid and cost-effective manner to shifts in market demands, the trend towards increasing functional integration and other changes. Migration from older products to newer products may result in volatility of earnings as revenues from older products decline and revenues from newer products begin to be achieved.

Products for our customers’ applications are based on continually evolving industry standards and new technologies. Our ability to compete will depend in part on our ability to identify and ensure compliance with these industry standards. The emergence of new standards could render our products incompatible. We could be required to invest significant time, effort and expenses to develop and qualify new products to ensure compliance with industry standards.

The process of developing and supporting new products is complex, expensive and uncertain, and if we fail to accurately predict and understand our customers’ changing needs and emerging technological trends, our business may be harmed. In addition, we may make significant investments to modify new products according to input from our customers who may choose a competitor’s or an

 

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internal solution, or cancel their projects. We may not be able to identify new product opportunities successfully, develop and bring to market new products, achieve design wins, ensure when and which design wins actually get released to production, or respond effectively to technological changes or product announcements by our competitors. In addition, we may not be successful in developing or using new technologies or may incorrectly anticipate market demand and develop products that achieve little or no market acceptance. Our pursuit of technological advances may require substantial time and expense and may ultimately prove unsuccessful. Failure in any of these areas may materially and adversely harm our business, financial condition and results of operations.

If we are unable to convert a significant portion of our design wins into revenue, our business, financial condition and results of operations could be materially and adversely impacted.

We have secured a significant number of design wins for new and existing products. Such design wins are necessary for revenue growth. However, many of our design wins may never generate revenues if their end-customer projects are unsuccessful in the market place or the end-customer terminates the project, which may occur for a variety of reasons. Mergers and consolidations among our customers may lead to termination of certain projects before the associated design win generates revenue. If design wins do generate revenue, the time lag between the design win and meaningful revenue is typically between six months to greater than eighteen months. If we fail to convert a significant portion of our design wins into substantial revenue, our business, financial condition and results of operations could be materially and adversely impacted. Under current deteriorating global economic conditions, our design wins could be delayed even longer than the typical lag period and our eventual revenue could be less than anticipated from products that were introduced within the last eighteen to thirty-six months, which would likely materially and adversely affect our business, financial condition and results of operations.

We may be exposed to additional credit risk as a result of the addition of significant direct customers through recent acquisitions.

From time to time one of our customers has contributed more than 10% of our annual net sales. The acquisition of Hifn might result in additional customers, individually, contributing 10% or more of our annual net sales. Substantially all of Hifn’s customers are OEMs, or the manufacturing subcontractors of OEMs, which might result in an increase in concentrated credit risk with respect to our trade receivables.

We have made and in the future may make acquisitions and significant strategic equity investments, which may involve a number of risks. If we are unable to address these risks successfully, such acquisitions and investments could have a materially adverse effect on our business, financial condition and results of operations.

We have undertaken a number of strategic acquisitions and investments in the past and may do so from time to time in the future. The risks involved with these acquisitions and investments include:

 

   

the possibility that we may not receive a favorable return on our investment or incur losses from our investment or the original investment may become impaired;

 

   

failure to satisfy or set effective strategic objectives;

 

   

our assumption of known or unknown liabilities or other unanticipated events or circumstances; and

 

   

the diversion of management’s attention from day-to-day operations of the business and the resulting potential disruptions to the ongoing business.

Additional risks involved with acquisitions include:

 

   

difficulties in integrating and managing various operations such as sales, engineering, marketing, and operations;

 

   

difficulties in incorporating acquired technologies and intellectual property rights into new products;

 

   

difficulties or delays in the transfer of manufacturing flows and supply chains of products of acquired businesses;

 

   

failure to retain and integrate key personnel;

 

   

failure to retain and maintain relationships with existing customers, distributors, channel partners and other parties;

 

   

failure to manage and operate multiple geographic locations both effectively and efficiently;

 

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failure to coordinate research and development activities to enhance and develop new products and services in a timely manner that optimize the assets and resources of the combined company;

 

   

difficulties in creating uniform standards, controls (including internal control over financial reporting), procedures, policies and information systems;

 

   

unexpected capital equipment outlays and continuing expenses related to technical and operational integration;

 

   

difficulties in entering markets or retaining current markets in which we have limited or no direct prior experience and where competitors in such markets may have stronger market positions;

 

   

insufficient revenues to offset increased expenses associated with acquisitions;

 

   

under-performance problems with an acquired company;

 

   

issuance of common stock that would dilute our current stockholders’ percentage ownership;

 

   

reduction in liquidity and interest income on lower cash balances;

 

   

recording of goodwill and intangible assets that will be subject to periodic impairment testing and potential impairment charges against our future earnings;

 

   

incurring amortization expenses related to certain intangible assets;

 

   

the opportunity cost associated with committing capital in such investments;

 

   

incurring large and immediate write-offs; and

 

   

being subject to litigation.

Additional risks involved with strategic equity investments include:

 

   

the possibility of litigation resulting from these types of investments;

 

   

the possibility that we may not receive a financial return on our investments or incur losses from these investments;

 

   

a changed or poorly executed strategic plan; and

 

   

the opportunity cost associated with committing capital in such investments.

We may not address these risks successfully without substantial expense, delay or other operational or financial problems, or at all. Any delays or other such operations or financial problems could adversely impact our business, financial condition and results of operations.

Because a significant portion of our total assets were, and may again be with future potential acquisitions, represented by goodwill and other intangible assets which are subject to mandatory annual impairment evaluations, we could be required to write off some or all of our goodwill and other intangible assets, which may adversely impact our financial condition and results of operations.

A significant portion of the purchase price for any business combination may be allocated to identifiable tangible and intangible assets and assumed liabilities based on estimated fair values at the date of consummation. The excess purchase price, if any, over the fair value of these assets less liabilities would be allocated as required by GAAP utilized by Exar and would typically be allocated to goodwill. In accordance with the SFAS 142, Goodwill and Other Intangible Assets, goodwill is not amortized but is reviewed for impairment annually or more frequently if impairment indicators arise. We typically conduct our annual analysis of our goodwill in the fourth quarter of our fiscal year. Intangible assets that are subject to amortization are reviewed for impairment in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

The assessment of goodwill and other intangible assets impairment is a subjective process. Estimations and assumptions regarding future performance, results of our operations and comparability of our market capitalization and its net book value will be used. Changes in estimates and assumptions could have an adverse impact on our financial conditions and results of operations.

 

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Occasionally, we enter into agreements that expose us to potential damages that exceed the value of the agreement.

We have given certain customers increased indemnification for product deficiencies that is in excess of our standard limited warranty indemnification and could possibly result in greater costs, in excess of the original contract value. In an attempt to limit this liability, we have purchased an errors and omissions insurance policy to partially offset these potential additional costs; however, our insurance coverage could be insufficient to prevent us from suffering material losses if the indemnification amounts are large enough.

If we are unable to accurately forecast demand for our products, we may be unable to efficiently manage our inventory.

Due to the absence of substantial non-cancelable backlog, we typically plan our production and inventory levels based on customer forecasts, internal evaluation of customer demand and current backlog, which can fluctuate substantially. As a consequence of inaccuracies inherent in forecasting, inventory imbalances periodically occur that result in surplus amounts of some of our products and shortages of others. Such shortages can adversely impact customer relations and surpluses can result in larger-than-desired inventory levels, which can adversely impact our financial position. Due to deteriorating global economic conditions and increased difficulty in forecasting demand for our products, we are currently experiencing and will likely continue to experience an increase in inventory levels.

Our business may be adversely impacted if we fail to effectively utilize and incorporate acquired technology.

We have acquired and may in the future acquire intellectual property in order to accelerate our time to market for new products. Acquisitions of intellectual property may involve risks such as successful technical integration into new products, market acceptance of new products and achievement of planned return on investment. Successful technical integration in particular requires a variety of factors which we may not currently have, such as available technical staff with sufficient time to devote to integration, the requisite skill sets to understand the acquired technology and the necessary support tools to effectively utilize the technology. The timely and efficient integration of acquired technology may be adversely impacted by inherent design deficiencies or application requirements. The potential failure of or delay in product introduction utilizing acquired intellectual property could lead to an impairment of capitalized intellectual property acquisition costs.

If we are unable to compete effectively with existing or new competitors, we will experience fewer customer orders, reduced revenues, reduced gross margins and lost market share.

We compete in markets that are intensely competitive, and which are subject to both rapid technological change and continued price erosion. Our competitors include many large domestic and foreign companies that have substantially greater financial, technical and management resources, name recognition and leverage than we have. As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to promote the sale of their products.

We have experienced increased competition at the design stage, where customers evaluate alternative solutions based on a number of factors, including price, performance, product features, technologies, and availability of long-term product supply and/or roadmap guarantee. Additionally, we experience, in some cases, severe pressure on pricing from some of our competitors or on-going cost reduction expectations from customers. Such circumstances may make some of our products unattractive due to price or performance measures and result in losing our design opportunities or causing a decrease in our revenue and margins. Also, competition from new companies in emerging economy countries with significantly lower costs could affect our selling price and gross margins. In addition, if competitors in Asia reduce prices on commodity products, it would adversely affect our ability to compete effectively in that region. Specifically, we have licensed rights to Hangzhou Silan Microelectronics Co. Ltd. and Hangzhou Silan Integrated Circuit Co. Ltd. (collectively “Silan”) in China to market our commodity interface products that could reduce our sales in the future should they become a meaningful competitor. Loss of competitive position could result in price reductions, fewer customer orders, reduced revenues, reduced gross margins and loss of market share, any of which would affect our operating results and financial condition. To the extent that our competitors offer distributors or sales representatives more favorable terms, these distributors and sales representatives may decline to carry, or discontinue carrying, our products. Our business, financial condition and results of operations could be harmed by any failure to maintain and expand our distribution network. Furthermore, many of our existing and potential customers internally develop solutions which attempt to perform all or a portion of the functions performed by our products. To remain competitive, we continue to evaluate our manufacturing operations for opportunities for additional cost savings and technological improvements. If we are unable to successfully implement new process technologies and to achieve volume production of new products at acceptable yields, our operating results and financial condition may be materially and adversely affected. Our future competitive performance depends on a number of factors, including our ability to:

 

   

increase device performance and improve manufacturing yields;

 

   

accurately identify emerging technological trends and demand for product features and performance characteristics;

 

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develop and maintain competitive and reliable products;

 

   

enhance our products by adding innovative features that differentiate our products from those of our competitors;

 

   

bring products to market on a timely basis at competitive prices;

 

   

respond effectively to new technological changes or new product announcements by others;

 

   

adapt products and processes to technological changes;

 

   

adopt or set emerging industry standards;

 

   

meet changing customer requirements; and

 

   

provide adequate technical service and support.

Our design, development and introduction schedules for new products or enhancements to our existing and future products may not be met. In addition, these products or enhancements may not achieve market acceptance, or we may not be able to sell these products at prices that are favorable.

If our distributors or sales representatives stop selling or fail to successfully promote our products, our business, financial condition and results of operations could be adversely impacted.

We sell many of our products through sales representatives and distributors, many of which sell directly to OEMs, contract manufacturers and end customers. Our non-exclusive distributors and sales representatives may carry our competitors’ products, which could adversely impact or limit sales of our products. Additionally, they could reduce or discontinue sales of our products or may not devote the resources necessary to sell our products in the volumes and within the time frames that we expect. Our agreements with distributors contain limited provisions for return of our products, including stock rotations whereby distributors may return a percentage of their purchases from us based upon a percentage of their most recent three months of shipments. In addition, in certain circumstances upon termination of the distributor relationship, distributors may return some portion of their prior purchases. The loss of business from any of our significant distributors or the delay of significant orders from any of them, even if only temporary, could materially and adversely harm our business, financial conditions and results of operations.

Moreover, we depend on the continued viability and financial resources of these distributors and sales representatives, some of which are small organizations with limited working capital. In turn, these distributors and sales representatives are subject to general economic and semiconductor industry conditions. We believe that our success will continue to depend on these distributors and sales representatives. If some or all of our distributors and sales representatives experience financial difficulties, or otherwise become unable or unwilling to promote and sell our products, our business, financial condition and results of operations could be adversely impacted.

Affiliates of Future, Alonim Investments Inc. and two of its affiliates (collectively “Alonim”), own approximately 18% of our common stock, and as such, Alonim is our largest stockholder. This ownership position will allow Future to significantly influence matters requiring stockholders’ approval. Future’s ownership may continue to increase as a percentage of our outstanding shares if we continue to repurchase our common stock. In addition, an executive officer of Future is on our board of directors, which could lead to actual or perceived influence from Future.

An affiliate of Future, our largest distributor, owns a significant percentage of our outstanding shares and Pierre Guilbault, the chief financial officer of Future, is a member of our board of directors. Due to its affiliate’s ownership of a significant percentage of our common stock, Future may be able to exert strong influence over actions requiring the approval of our stockholders, including the election of directors, many types of change of control transactions and amendments to our charter documents, although Future is bound by a Lock-Up and Standstill Agreement until August 25, 2009, prohibiting Future from either soliciting proxies or seeking to advise anyone with respect to voting our stock. The significant ownership percentage of Future could have the effect of delaying or preventing a change of control or otherwise discouraging a potential acquirer from obtaining control of us. Conversely, by virtue of Future’s percentage ownership of our stock, Future could facilitate a takeover transaction that our board of directors did not approve.

This relationship could also result in actual or perceived attempts to influence management to take actions beneficial to Future which may or may not be beneficial to us or in our best interests. Future could attempt to obtain terms and conditions more favorable than those we would typically provide our distributors because of its relationship with us. Any such actual or perceived preferential treatment could materially and adversely affect our business, financial condition and results of operations.

 

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We depend on third-party subcontractors to manufacture our products. We utilize wafer foundries for processing our wafers and assembly and test subcontractors for manufacturing and testing our packaged products. Any disruption in or loss of subcontractors’ capacity to manufacture our products subjects us to a number of risks, including the potential for an inadequate supply of products and higher materials costs. These risks may lead to delayed product delivery or increased costs, which could materially and adversely impact our business, financial condition and results of operations.

We do not own or operate a semiconductor fabrication facility or a foundry. We utilize various foundries for different processes. Our products are based on Complementary Metal Oxide Semiconductor (“CMOS”) processes, bipolar processes and bipolar-CMOS (“BiCMOS”) processes. Chartered Semiconductor Manufacturing Ltd. (“Chartered”), located in Singapore, manufactures the majority of the CMOS wafers from which our communications and UART products are produced. Episil Technologies, Inc. (“Episil”), located in Taiwan, and Silan, located in China, manufacture the majority of the CMOS and bipolar wafers from which our power and serial products are produced. High Voltage BiCMOS power products are supplied by Polar Semiconductor (MN, USA) and Jazz Semiconductor (CA, USA). All of these foundries produce semiconductors for many other companies (many of which have greater requirements than us), and therefore, we may not have access on a timely basis to sufficient capacity or certain process technologies. In addition, we rely on our foundries’ continued financial health and ability to continue to invest in smaller geometry manufacturing processes and additional wafer processing capacity.

Many of our new products are designed to take advantage of smaller geometry manufacturing processes. Due to the complexity and increased cost of migrating to smaller geometries as well as process changes, we could experience interruptions in production or significantly reduced yields causing product introduction or delivery delays. If such delays occur, our products may have delayed market acceptance or customers may select our competitors’ products during the design process.

New process technologies or new products can be subject to especially wide variations in manufacturing yields and efficiency. There can be no assurance that our foundries or the foundries of our suppliers will not experience unfavorable yield variances or other manufacturing problems that result in delayed product introduction or delivery delays.

We do not have long-term wafer supply agreements with Chartered that would guarantee wafer quantities, prices, and delivery or lead times, but we do provide minimum purchase commitments to Silan and Episil in accordance with our supply agreements. Subject to any such minimum purchase commitments, these foundries manufacture our products on a purchase order basis. We provide our foundries with rolling forecasts of our production requirements. However, the ability of our foundries to provide wafers is limited by the foundries’ available capacity. There can be no assurance that our third-party foundries will allocate sufficient capacity to satisfy our requirements.

Furthermore, any sudden reduction or elimination of any primary source or sources of fully processed wafers could result in a material delay in the shipment of our products. Any delays or shortages will materially and adversely impact our business, financial condition and operating results.

In addition, we may not continue to do business with our foundries on terms as favorable as our current terms. Significant risks associated with our reliance on third-party foundries include:

 

   

the lack of assured process technology and wafer supply;

 

   

limited control over quality assurance, manufacturing yields and production costs;

 

   

financial and operating stability of the foundries;

 

   

limited control over delivery schedules;

 

   

limited manufacturing capacity of the foundries; and

 

   

potential misappropriation of our intellectual property.

Our reliance on our wafer foundries and assembly and test subcontractors involves the following risks:

 

   

a manufacturing disruption or sudden reduction or elimination of any existing source or sources of semiconductor manufacturing materials or processes, which might include the potential closure, change of ownership, change in business conditions or relationships, change of management or consolidation by one of our foundries;

 

   

disruption of manufacturing or assembly or test services due to relocation or limited capacity of the foundries or subcontractors;

 

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inability to obtain or develop technologies needed to manufacture our products;

 

   

extended time required to identify, qualify and transfer to alternative manufacturing sources for existing or new products or the possible inability to obtain an adequate alternative;

 

   

failure of our foundries or subcontractors to obtain raw materials and equipment;

 

   

increasing cost of raw materials and energy resulting in higher wafer or package costs;

 

   

long-term financial and operating stability of the foundries, or their suppliers or subcontractors and their ability to invest in new capabilities and expand capacity to meet increasing demand, to remain solvent, or to obtain financing in tight credit markets;

 

   

continuing measures taken by our suppliers such as reductions in force, pay reductions, forced time off or shut down their production for extended periods of time to reduce and/or control operating expenses in response to weakened and weakening customer demand;

 

   

subcontractors’ inability to transition to smaller package types or new package compositions;

 

   

a sudden, sharp increase in demand for semiconductor devices, which could strain the foundries’ or subcontractors’ manufacturing resources and cause delays in manufacturing and shipment of our products;

 

   

manufacturing quality control or process control issues, including reduced control over manufacturing yields, production schedules and product quality;

 

   

disruption of transportation to and from Asia where most of our foundries and subcontractors are located;

 

   

embargoes or other regulatory limitations affecting the availability of raw materials, equipment or changes in tax laws, tariffs, services and freight rates; and

 

   

compliance with local or international regulatory requirements.

Other additional risks associated with subcontractors include:

 

   

subcontractors imposing higher minimum order quantities for substrates;

 

   

potential increase in assembly and test costs;

 

   

our board level product volume may not be attractive to preferred manufacturing partners, which could result in higher pricing or having to qualify an alternative vendor;

 

   

difficulties in selecting, qualifying and integrating new subcontractors;

 

   

entry into “take-or-pay” agreements; and

 

   

limited warranties from our subcontractors for products assembled and tested for us.

To secure foundry capacity, we may be required to enter into financial and other arrangements with foundries, which could result in the dilution of our earnings or otherwise harm our operating results.

Allocation of a foundry’s manufacturing capacity may be influenced by a foundry customer’s size, the existence of a long-term agreement with the foundry or other commitments. To address foundry capacity constraints, we and other semiconductor companies that rely on third-party foundries have utilized various arrangements, including equity investments in or loans to foundries in exchange for guaranteed production capacity, joint ventures to own and operate foundries or “take or pay” contracts that commit a company to purchase specified quantities of wafers over extended periods. These arrangements may not be available to us on acceptable terms, if at all. Any of these arrangements could require us to commit substantial capital and, accordingly, could require us to reduce our cash holdings, incur additional debt or secure equity financing. This could result in the dilution of our earnings or the ownership of our stockholders or otherwise harm our operating results. Furthermore, we may not be able to obtain sufficient foundry capacity in the future pursuant to such arrangements.

 

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We depend in part on the continued service of our key engineering and management personnel and our ability to identify, hire, incentivize and retain qualified personnel. If we lose key employees or fail to identify, hire, incentivize and retain these individuals, our business, financial condition and results of operations could be materially and adversely impacted.

Our future success depends, in part, on the continued service of our key design engineering, technical, sales, marketing and executive personnel and our ability to identify, hire, motivate and retain other qualified personnel.

Under certain circumstances, including a company acquisition or business downturn, current and prospective employees may experience uncertainty about their future roles with us. Volatility or lack of positive performance in our stock price and the ability to offer equity compensation to as many key employees or in amounts consistent with past practices, as a result of regulations regarding the expensing of equity awards, may also adversely affect our ability to retain key employees, all of whom have been granted equity awards. In addition, competitors may recruit employees, as is common in the high tech sector. If we are unable to retain personnel that are critical to our future operations, we could face disruptions in operations, loss of existing customers, loss of key information, expertise or know-how, and unanticipated additional recruitment and training costs.

Competition for skilled employees having specialized technical capabilities and industry-specific expertise is intense and continues to be a considerable risk inherent in the markets in which we compete. At times competition for such employees has been particularly notable in California and the People’s Republic of China (“PRC”). Further, the PRC historically has been deficient in Western style management and financial reporting concepts and practices, as well as in modern banking, computer and other control systems, making the successful identification and employment of qualified personnel particularly important, and hiring and retaining a sufficient number of such qualified employees may be difficult. As a result of these factors, we may experience difficulty in establishing management, legal and financial controls, collecting financial data, books of account and records and instituting business practices that meet Western standards, which could negatively affect our business and results of operations.

Our employees are employed at-will, which means that they can terminate their employment at any time. The failure to recruit and retain, as necessary, key design engineers, technical, sales, marketing and executive personnel could harm our business, financial condition and results of operations.

Our results of operations could vary as a result of the methods, estimations and judgments we use in applying our accounting policies.

The methods, estimates and judgments we use in applying our accounting policies have a significant impact on our results of operations. Such methods, estimates and judgments are, by their nature, subject to substantial risks, uncertainties, assumptions and changes in rulemaking by the regulatory bodies; and factors may arise over time that lead us to change our methods, estimates, and judgments. Changes in those methods, estimates and judgments could significantly impact our results of operations. Our revenue reporting is highly dependent on receiving pertinent and accurate data from our distributors in a timely fashion. Distributors provide us periodic data regarding the product, price, quantity and end customer when products are resold as well as the quantities of our products they still have in stock. We must use estimates and apply judgment to reconcile distributors’ reported inventories to their activities. Any error in our judgment could lead to inaccurate reporting of our revenues, deferred income and allowances on sales to distributors and net income.

The final determination of our income tax liability may be materially different from our income tax provision, which could have an adverse effect on our results of operations.

Our future effective tax rates may be adversely affected by a number of factors including:

 

   

the jurisdictions in which profits are determined to be earned and taxed;

 

   

the resolution of issues arising from tax audits with various tax authorities;

 

   

changes in the valuation of our deferred tax assets and liabilities;

 

   

adjustments to estimated taxes upon finalization of various tax returns;

 

   

increases in expenses not deductible for tax purposes, including write-offs of acquired in-process research and development and impairment of goodwill in connection with acquisitions;

 

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changes in available tax credits;

 

   

changes in share-based compensation expense;

 

   

changes in tax laws or the interpretation of such tax laws and changes in generally accepted accounting principles; and/or

 

   

the repatriation of non-U.S. earnings for which we have not previously provided for U.S. taxes.

Any significant increase in our future effective tax rates could adversely impact net income for future periods. In addition, the U.S. Internal Revenue Service (“IRS”) and other tax authorities regularly examine our income tax returns. Our results of operations could be adversely impacted if these assessments or any other assessments resulting from the examination of our income tax returns by the IRS or other taxing authorities are not resolved in our favor.

We have acquired significant Net Operating Loss (“NOL”) carryforwards as a result of our acquisitions. The utilization of acquired NOL carryforwards is subject to the IRS’s complex limitation rules that carry significant burdens of proof. Our eventual ability to utilize our estimated NOL carryforwards is subject to IRS scrutiny and our future results may not benefit as a result of potential unfavorable IRS rulings.

On September 30, 2008, California enacted Assembly Bill 1452 which among other provisions, suspends net operating loss deductions for our fiscal years 2009 and 2010 and extends the carryforward period of any net operating losses not utilized due to such suspension; adopts the federal 20-year net operating loss carryforward period; phases-in the federal two-year net operating loss carryback periods beginning in fiscal year 2012 and limits the utilization of tax credits to 50 percent of a taxpayer’s taxable income. We do not expect any impact to our effective tax rate or tax provision during fiscal year 2010 as the result of this law change.

Our engagement with foreign customers could cause fluctuations in our operating results, which could materially and adversely impact our business, financial condition and results of operations.

International sales have accounted for, and will likely continue to account for a significant portion of our revenues, which subjects us to the following risks, among others:

 

   

changes in regulatory requirements;

 

   

tariffs and other barriers;

 

   

timing and availability of export or import licenses;

 

   

disruption of services due to political, civil, labor, and economic instability;

 

   

disruption of services due to natural disasters outside the United States;

 

   

disruptions to customer operations outside the United States due to the outbreak of communicable diseases;

 

   

difficulties in accounts receivable collections;

 

   

difficulties in staffing and managing foreign subsidiary and branch operations;

 

   

difficulties in managing sales channel partners;

 

   

difficulties in obtaining governmental approvals for communications and other products;

 

   

limited intellectual property protection;

 

   

foreign currency exchange fluctuations;

 

   

the burden of complying with foreign laws and treaties; and

 

   

potentially adverse tax consequences.

 

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In addition, because sales of our products have been denominated primarily in U.S. dollars, increases in the value of the U.S. dollar as compared with local currencies could make our products more expensive to customers in the local currency of a particular country resulting in pricing pressures on our products. Increased international activity in the future may result in foreign currency denominated sales. Furthermore, because some of our customers’ purchase orders and agreements are governed by foreign laws, we may be limited in our ability, or it may be too costly for us, to enforce our rights under these agreements and to collect damages, if awarded.

Because some of our integrated circuit products have lengthy sales cycles, we may experience substantial delays between incurring expenses related to product development and the revenue derived from these products.

A portion of our revenue is derived from selling integrated circuits to communications equipment vendors. Due to their product development cycle, we have typically experienced at least an eighteen-month time lapse between our initial contact with a customer and realizing volume shipments. We first work with customers to achieve a design win, which may take nine months or longer. Our customers then complete their design, test and evaluation process and begin to ramp-up production, a period which typically lasts an additional nine months. The customers of communications equipment manufacturers may also require a period of time for testing and evaluation, which may cause further delays. As a result, a significant period of time may elapse between our research and development efforts and our realization of revenue, if any, from volume purchasing of our communications products by our customers. Due to the length of the communications equipment vendors’ product development cycle, the risks of project cancellation by our customers, price erosion or volume reduction are present for an extended period of time.

Our backlog may not result in revenue.

Due to the possibility of customer changes in delivery schedules and quantities actually purchased, cancellation of orders, distributor returns or price reductions, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. The current economic downturn increases the risk of purchase order cancellations or delays, product returns and price reductions. We may not be able to meet our expected revenue levels or results of operations if there is a reduction in our order backlog for any particular period and we are unable to replace those sales during the same period.

Fixed operating expenses and our practice of ordering materials in anticipation of projected customer demand could make it difficult for us to respond effectively to sudden swings in demand and result in higher than expected costs and excess inventory. Such sudden swings in demand could therefore have a material adverse impact on our business, financial condition and results of operations.

Our operating expenses are relatively fixed in the short to medium term, and therefore, we have limited ability to reduce expenses quickly and sufficiently in response to any revenue shortfall. In addition, we typically plan our production and inventory levels based on forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside suppliers and foundries, we may order materials in advance of anticipated customer demand. This advance ordering may result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize. This incremental cost could have a materially adverse impact on our business, financial condition and results of operations.

We may be unable to protect our intellectual property rights, which could harm our competitive position.

Our ability to compete is affected by our ability to protect our intellectual property rights. We rely on a combination of patents, trademarks, copyrights, mask work registrations, trade secrets, confidentiality procedures and non-disclosure and licensing arrangements to protect our intellectual property rights. Despite these efforts, we may be unable to protect our proprietary information. Such intellectual property rights may not be recognized or if recognized, may not be commercially feasible to enforce. Moreover, our competitors may independently develop technology that is substantially similar or superior to our technology.

More specifically, our pending patent applications or any future applications may not be approved, and any issued patents may not provide us with competitive advantages or may be challenged by third parties. If challenged, our patents may be found to be invalid or unenforceable, and the patents of others may have an adverse effect on our ability to do business. Furthermore, others may independently develop similar products or processes, duplicate our products or processes or design around any patents that may be issued to us.

We could be required to pay substantial damages or could be subject to various equitable remedies if it were proven that we infringed the intellectual property rights of others.

As a general matter, the semiconductor industry is characterized by substantial litigation regarding patents and other intellectual property rights. If a third party were to prove that our technology infringed its intellectual property rights, we could be required to pay substantial damages for past infringement and could be required to pay license fees or royalties on future sales of our products. If we

 

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were required to pay such license fees whenever we sold our products, such fees could exceed our revenue. In addition, if it was proven that we willfully infringed a third party’s proprietary rights, we could be held liable for three times the amount of the damages that we would otherwise have to pay. Such intellectual property litigation could also require us to:

 

   

stop selling, incorporating or using our products that use the infringed intellectual property;

 

   

obtain a license to make, sell or use the relevant technology from the owner of the infringed intellectual property, which license may not be available on commercially reasonable terms, if at all; and/or

 

   

redesign our products so as not to use the infringed intellectual property, which may not be technically or commercially feasible.

The defense of infringement claims and lawsuits, regardless of their outcome, would likely be expensive and could require a significant portion of management’s time. In addition, rather than litigating an infringement matter, we may determine that it is in our best interests to settle the matter. Terms of a settlement may include the payment of damages and our agreement to license technology in exchange for a license fee and ongoing royalties. These fees could be substantial. If we were required to pay damages or otherwise became subject to such equitable remedies, our business, financial condition and results of operations would suffer. Similarly, if we were required to pay license fees to third parties based on a successful infringement claim brought against us, such fees could exceed our revenue.

Earthquakes and other natural disasters may damage our facilities or those of our suppliers and customers.

Our corporate headquarters in Fremont, California is located near major earthquake faults that have experienced seismic activity. In addition, some of our customers and suppliers are in locations which may be subject to similar natural disasters. In the event of a major earthquake or other natural disaster near our headquarters, our operations could be disrupted. Similarly, a major earthquake or other natural disaster affecting one or more of our major customers or suppliers could adversely impact the operations of those affected, which could disrupt the supply of our products and harm our business.

 

ITEM 5. OTHER INFORMATION

Exar filed a Current Report on Form 8-K on April 8, 2009 in which we reported the closing of our acquisition of Hifn. The Exar undertook to file all financial information required by Item 9.01 of Form 8-K in connection with the acquisition by amendment to the Form 8-K within 71 days of the date of the Form 8-K. Following review of the financial statements of the acquired business, Exar has determined that no historical financial statements of the acquired business or pro forma financial information relating to the acquisition is required to be filed under Item 9.01 and therefore did not file an amendment to the form 8-K as described above.

 

ITEM 6. EXHIBITS

(a) Exhibits required by Item 601 of Regulation S-K

See the Exhibit Index, which follows the signature page to this Quarterly Report on Form 10-Q.

 

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SIGNATURES

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

 

     

EXAR CORPORATION

(Registrant)

August 7, 2009     By  

/s/    Pedro (Pete) P. Rodriguez

       

Pedro (Pete) P. Rodriguez

Chief Executive Officer, President and Director

(On the Registrant’s Behalf and as Principal Executive Officer)

 

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INDEX TO EXHIBITS

 

Exhibit

Number

  

Exhibit

  

Incorporated by Reference

    
     

Form

  

File No.

  

Exhibit

  

Filing Date

  

Filed
Herewith

2.1    Agreement and Plan of Merger, dated as of February 23, 2009, among Exar Corporation, Hybrid Acquisition Corp. and hi/fn, inc.    8-K    0-14225    2.1    02/27/2009   
3.1    Amended and Restated Certificate of Incorporation    10-K    0-14225    3.1    6/12/2007   
3.2    Amended and Restated Bylaws    8-K    0-14225    3.1    12/10/2007   
10.1    Separation Agreement between Exar Corporation and J. Scott Kamsler, dated as of June 23, 2009    8-K    0-14225    10.1    06/29/2009   
10.2    VP Worldwide Sales – FY10 Sales Incentive Plan                X
10.3    Letter Agreement between Exar Corporation and Bentley Long                X
10.4    Fiscal Year 2010 Executive Incentive Program                X
31.1    Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a)                X
31.2    Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a)                X
32.1    Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                X
32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                X

 

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