UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

 

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

 

For the quarterly period ended December 27, 2015

 

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  ☒     No  ☐

 

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

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 Exchange Act).    Yes  ☐    No  ☒

 

The number of shares outstanding of the Registrant’s Common Stock was 48,518,671 as of February 2, 2016.

 

 

 



 

 
1

 

 

EXAR CORPORATION AND SUBSIDIARIES

 

INDEX TO

 

QUARTERLY REPORT ON FORM 10-Q

 

FOR THE QUARTERLY PERIOD ENDED DECEMBER 27, 2015

 

   

Page

 

PART I – FINANCIAL INFORMATION

 
     

Item 1.

Financial Statements

3

     
 

Condensed Consolidated Balance Sheets (Unaudited)

3

     
 

Condensed Consolidated Statements of Operations (Unaudited)

4

     
 

Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

5

     
 

Condensed Consolidated Statements of Cash Flows (Unaudited)

6

     
 

Notes to Condensed Consolidated Financial Statements (Unaudited)

7

     

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

32

     

Item 4.

Controls and Procedures

33

     
 

PART II – OTHER INFORMATION

 
     

Item 1.

Legal Proceedings

34

     

Item 1A.

Risk Factors

34

     

Item 6.

Exhibits

49

     
 

Signatures

50

     
 

Index to Exhibits

51

 

 
2

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

 

EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts)

(Unaudited)

 

   

December 27,

2015

   

March 29,

2015

 

ASSETS

               
                 

Current assets:

               

Cash and cash equivalents

  $ 53,449     $ 55,233  

Accounts receivable (net of allowances of $1,010 and $1,334)

    27,079       27,459  

Accounts receivable, related party (net of allowances of $296 and $774)

    4,554       1,663  

Inventories

    28,659       30,767  

Other current assets

    2,018       3,090  

Total current assets

    115,759       118,212  
                 

Property, plant and equipment, net

    21,567       26,077  

Goodwill

    44,871       44,871  

Intangible assets, net

    74,119       86,102  

Other non-current assets

    778       7,838  

Total assets

  $ 257,094     $ 283,100  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               
                 

Current liabilities:

               

Accounts payable

  $ 13,234     $ 13,526  

Accrued compensation and related benefits

    4,207       5,649  

Deferred income and allowances on sales to distributors

    2,479       3,362  

Deferred income and allowances on sales to distributors, related party

    4,141       6,982  

Other current liabilities

    12,421       21,287  

Total current liabilities

    36,482       50,806  
                 

Long-term lease financing obligations

    1,714       5,069  

Other non-current obligations

    3,420       4,393  

Total liabilities

    41,616       60,268  
                 

Commitments and contingencies (Notes 14, 15 and 16)

               
                 

Stockholders' equity:

               

Common stock, $.0001 par value; 100,000,000 shares authorized; 48,481,338 and 47,745,618 shares outstanding

    5       5  

Additional paid-in capital

    527,980       521,490  

Accumulated other comprehensive loss

    (26 )     (26 )

Accumulated deficit

    (312,481 )     (298,637 )

Total stockholders' equity

    215,478       222,832  

Total liabilities and stockholders’ equity

  $ 257,094     $ 283,100  

 

 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

 
3

 

 

EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

      Three Months Ended       Nine Months Ended   
     

December 27, 

2015

     

December 28,

2014

     

December 27,  

2015

     

December 28,

2014

 

Sales:

                             

Net sales

  $ 29,013     $ 35,919     $ 84,095     $ 91,986  

Net sales, related party

    8,426       8,396       28,508       26,207  

Total net sales

    37,439       44,315       112,603       118,193  
                                 

Cost of sales:

                               

Cost of sales

    16,261       19,741       48,309       51,841  

Cost of sales, related party

    4,025       3,099       12,847       10,408  

Amortization of purchased intangible assets and inventory step-up costs

    2,461       2,533       7,422       9,215  

Restructuring charges and exit costs

          2,052       740       6,384  

Proceeds from legal settlement

                (1,500 )      

Impairment of intangibles

                      8,367  

Total cost of sales

    22,747       27,425       67,818       86,215  

Gross profit

    14,692       16,890       44,785       31,978  
                                 

Operating expenses:

                               

Research and development

    7,230       10,035       24,206       28,647  

Selling, general and administrative

    10,280       11,793       29,665       33,467  

Restructuring charges and exit costs

    2,228       1,418       3,550       4,052  

Impairment of intangibles

    1,807             1,807       3,917  

Merger and acquisition costs

          179             6,955  

Net change in fair value of contingent consideration

                      (4,343 )

Total operating expenses

    21,545       23,425       59,228       72,695  

Loss from operations

    (6,853 )     (6,535 )     (14,443 )     (40,717 )
                                 

Other income and expense, net:

                               

Interest income and other, net

    (7 )     53       (40 )     520  

Interest expense and other, net

    (69 )     (46 )     (170 )     (1,026 )

Total other income and expense, net

    (76 )     7       (210 )     (506 )
                                 

Loss before income taxes

    (6,929 )     (6,528 )     (14,653 )     (41,223 )

Provision for (benefit from) income taxes

    208       71       (809 )     870  

Net loss

    (7,137 )     (6,599 )     (13,844 )     (42,093 )

Less: Net loss attributable to non-controlling interests

                      (37 )

Net loss attributable to Exar Corporation

  $ (7,137 )   $ (6,599 )   $ (13,844 )   $ (42,056 )

Net loss per share:

                               

Basic

  $ (0.15 )   $ (0.14 )   $ (0.29 )   $ (0.89 )

Diluted

  $ (0.15 )   $ (0.14 )   $ (0.29 )   $ (0.89 )
                                 

Shares used in the computation of net loss per share:

                               

Basic

    48,386       47,119       48,146       47,165  

Diluted

    48,386       47,119       48,146       47,165  

 

 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

 
4

 

 

EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

(Unaudited)

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Net loss

  $ (7,137 )   $ (6,599 )   $ (13,844 )   $ (42,093 )

Changes in market value of investments:

                               

Changes in unrealized loss

                      199  

Reclassification adjustment for net realized gains

                      26  

Release of tax provision for unrealized gains

                      828  

Net change in market value of investments

                      1,053  

Comprehensive loss

  $ (7,137 )   $ (6,599 )   $ (13,844 )   $ (41,040 )

Less: comprehensive loss attributable to non-controlling interests

                      (37 )

Comprehensive loss attributable to Exar Corporation

  $ (7,137 )   $ (6,599 )   $ (13,844 )   $ (41,003 )

 

 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

 
5

 

  

EXAR CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

 

Cash flows from operating activities:

               

Net loss

  $ (13,844 )   $ (42,093 )

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

               

Depreciation and amortization

    14,595       13,325  

Stock-based compensation expense

    4,431       10,949  

Restructuring charges and exit costs

    905       6,732  

Impairment of intangibles

    1,807       12,284  

Release of deferred tax valuation allowance

          828  

Net change in fair value of contingent consideration

          (4,343 )

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

               

Accounts receivable and accounts receivable, related party

    (2,511 )     (1,125 )

Inventories

    1,684       (3,506 )

Other current and non-current assets

    8,132       (1,087 )

Accounts payable

    (909 )     (2,945 )

Accrued compensation and related benefits

    (1,442 )     (231 )

Other current and non-current liabilities

    (8,020 )     (5,380 )

Deferred income and allowance to distributors including related party

    (3,724 )     581  

Net cash provided by (used in) operating activities

    1,104       (16,011 )
                 

Cash flows from investing activities:

               

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

    (954 )     (2,447 )

Purchases of short-term marketable securities

          (9,296 )

Proceeds from maturities of short-term marketable securities

          3,997  

Proceeds from sales of short-term marketable securities

          158,412  

Acquisition of Integrated Memory Logic Limited, net of cash acquired

          (72,658 )

Net cash provided by (used in) investing activities

    (954 )     78,008  
                 

Cash flows from financing activities:

               

Proceeds from issuance of common stock

    2,351       4,530  

Purchase of stock for withholding taxes on vested restricted stock

    (1,562 )     (629 )

Payments of lease financing obligations

    (2,294 )     (1,006 )

Cash settlement of equity award

    (429 )      

Proceeds from issuance of debt

          91,000  

Repayment of debt

          (91,000 )

Capital contribution from Integrated Memory Logic Limited non-controlling interest

          (18,883 )

Repurchase of common stock

          (7,999 )

Net cash used in financing activities

    (1,934 )     (23,989 )
                 

Net increase (decrease) in cash and cash equivalents

    (1,784 )     38,008  

Cash and cash equivalents at the beginning of period

    55,233       14,614  

Cash and cash equivalents at the end of period

  $ 53,449     $ 52,622  
                 

Supplemental disclosure of cash flow and non-cash information1

               

Engineering design tools acquired under capital lease

          2,924  

Increase in equity associated with release of liability for Cadeka restricted stock units

    1,875        

 

 

See Accompanying Notes to Condensed Consolidated Financial Statements.

 

 
6

 

  

 EXAR CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1.

ORGANIZATION AND BASIS OF PRESENTATION

 

Description of Business— Exar Corporation (“Exar,” “us,” “our” or “we”) was incorporated in California in 1971 and reincorporated in Delaware in 1991. Exar designs, develops and markets high performance analog mixed-signal integrated circuits (“ICs”) for the Industrial, High-End Consumer and Infrastructure markets. Our comprehensive knowledge of end-user markets along with our experience in analog and mixed signal technology has enabled us to provide innovative solutions designed to meet the needs of the evolving connected world. Applying both analog and mixed signal technologies, our products are deployed in a wide array of applications such as industrial, instrumentation and medical equipment, networking and telecommunication systems, servers, flat panel displays, LED lighting solutions, and digital video recorders. We provide customers with a breadth of component products and sub-system solutions based on advanced silicon integration. Exar’s product portfolio includes Connectivity, Mixed-signal, Power Management, High Performance Analog, Processors, Flat Panel Display and LED lighting.

 

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 fiscal year ended March 29, 2015 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, that we believe are necessary for a fair statement of Exar’s financial position as of December 27, 2015 and our results of operations for the three and nine months ended December 27, 2015 and December 28, 2014, 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.

 

Our fiscal years consist of 52 or 53 weeks. In a 52-week year, each fiscal quarter consists of 13 weeks. Fiscal years 2016 and 2015 both consist of 52 weeks.

 

NOTE 2.

RECENT ACCOUNTING PRONOUNCEMENTS

 

In May 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The core principle of ASU 2014-09 is that revenue should be recognized in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 defines a five-step process in order to achieve this core principle which may require the use of judgment and estimates. The entity may adopt ASU 2014-09 either by using a full retrospective approach for all periods presented or a modified retrospective approach. This standard is effective for annual reporting periods beginning after December 15, 2017. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016. We have not yet selected a transition method and are currently evaluating the effect of adoption of this standard, if any, on our consolidated financial position, results of operations or cash flows.

 

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, to provide guidance about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures requirement. ASU 2014-15 (1) provides a definition of the term substantial doubt, (2) requires an evaluation every reporting period including interim periods, (3) provides principles for considering the mitigating effect of management’s plans, (4) requires certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) requires an express statement and other disclosures when substantial doubt is not alleviated, and (6) requires an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). ASU 2014-15 is effective for the annual reporting period ending after December 15, 2016, and for annual periods and interim periods thereafter. We do not expect the adoption of this guidance will have a material impact on our consolidated financial position, results of operations or cash flows.

 

 
7

 

 

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. ASU 2015-11 primarily provides that an entity using an inventory method other than last-in, first out ("LIFO") or the retail inventory method should measure inventory at the lower of cost and net realizable value. The new guidance clarifies that net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. This standard is effective for annual reporting periods beginning after December 15, 2016. We are currently evaluating the effect of adoption of this standard, if any, on our consolidated financial position, results of operations or cash flows.

 

In September 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments. This ASU 2015-16 simplifies the treatment of adjustments to provisional amounts recognized in the period for items in a business combination for which the accounting is incomplete at the end of the reporting period. The amendments in this ASU are effective for fiscal years beginning after December 15, 2015. As this applies to future business combinations, the adoption of this ASU has no impact on our current consolidated financial position, results of operations or cash flows.

 

In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 470): Balance Sheet Classification of Deferred Taxes. The amendments in ASU 2015-17 eliminate the requirement to bifurcate deferred taxes between current and non-current on the balance sheet and requires that deferred tax liabilities and assets be classified as noncurrent on the balance sheet. The amendments for ASU-2015-17 can be either applied prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented and early adoption is permitted. We early-adopted the ASU 2015-17 on a prospective basis as of December 27, 2015 and the statement of financial position as of this date reflects the revised classification of current deferred tax assets and liabilities as noncurrent. Adoption of the ASU resulted in an immaterial reclassification between current deferred tax assets and non-current deferred tax assets. There is no other impact on the financial statements of early-adopting the ASU.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and early adoption is not permitted. We are currently evaluating the effect of adoption of this standard, if any, on our consolidated financial position, results of operations or cash flows.

 

NOTE 3.    BUSINESS COMBINATIONS

 

We periodically evaluate potential strategic acquisitions to broaden our product offering and build upon our existing library of intellectual property, human capital and engineering talent, in order to expand our capabilities in the areas in which we operate or to acquire complementary businesses.

 

Acquisition of Integrated Memory Logic Limited

 

On June 3, 2014, we acquired approximately 92% of the outstanding shares of Integrated Memory Logic Limited (“iML”), a leading provider of analog mixed-signal solutions for the flat panel display market. On September 15, 2014, we completed the acquisition through a second-step merger to acquire all of the remaining outstanding shares of iML. iML’s results of operations and estimated fair value of assets acquired and liabilities assumed were included in our consolidated financial statements beginning June 4, 2014.

 

Consideration

 

In June 2014, we acquired approximately 92% of iML’s outstanding shares for $206.4 million in cash. In September 2014, we acquired the remaining 8% of iML’s outstanding shares and vested options exercised subsequent to June 3, 2014 for $18.9 million which was included as part of financing activities in the cash flow since we maintained control of the subsidiary when the payments were made. Additionally, as required under the terms of the merger agreement, we assumed and converted iML’s employees’ then outstanding options into options to purchase 1.5 million shares of Exar’s common stock. The fair value of pre-merger vested options of $3.8 million was recorded as purchase consideration.

 

In accordance with Accounting Standard Codification (“ASC”) 805, Business Combinations, the acquisition of iML’s outstanding shares was recorded as a purchase business acquisition since iML was considered a business. Under the purchase method of accounting, the fair value of the consideration was allocated to net assets acquired. The fair value of purchased identifiable intangible assets was determined using discounted cash flow models from operating projections prepared by management using an internal rate of return of 16.9%. The excess of the fair value of consideration paid over the fair values of net assets acquired and identifiable intangible assets resulted in recognition of goodwill of $14.5 million. Goodwill was primarily from expected synergies resulting from combining the operations of iML with that of Exar and is not deductible for tax purposes. The fair value of non-controlling interests was calculated using cash value per acquired share multiplied by the remaining 8% outstanding shares.

 

 
8

 

 

The summary of the purchase consideration was as follows (in thousands):

 

   

Amount

 

Cash

  $ 206,411  

Consideration for the acquisition of non-controlling interests

    17,872  

Fair value of assumed iML employee options

    3,835  

Total purchase price

  $ 228,118  

 

Purchase Price Allocation

 

The allocation of total purchase price to iML’s tangible and identifiable intangible assets and liabilities assumed was based on their estimated fair values at the date of acquisition.

 

The fair value allocated to each of the major classes of tangible and identifiable intangible assets acquired and liabilities assumed in the iML acquisition was as follows (in thousands):

 

   

Amount

 

Identifiable tangible assets (liabilities)

       

Cash

  $ 133,752  

Accounts receivable

    10,096  

Inventories

    3,950  

Other current assets

    962  

Property, plant and equipment

    480  

Other assets

    308  

Current liabilities

    (12,356 )

Long-term liabilities

    (3,595 )

Total identifiable tangible assets (liabilities), net

    133,597  

Identifiable intangible assets

    80,060  

Total identifiable assets, net

    213,657  

Goodwill

    14,461  

Fair value of total consideration transferred

  $ 228,118  

 

The following table sets forth the components of identifiable intangible assets acquired in connection with the iML acquisition (in thousands):

 

   

Amount

 

Developed technologies

  $ 55,780  

In-process research and development

    8,100  

Customer relationships

    15,060  

Trade names

    1,120  

Total identifiable intangible assets

  $ 80,060  

 

Acquisition Related Costs

 

Acquisition related costs relating to the acquisition of iML were included in the merger and acquisition costs and interest expense line on the consolidated statement of operations for fiscal year 2015 and were approximately $7.2 million.

 

NOTE 4.

BALANCE SHEET DETAILS

 

Our inventories consisted of the following as of the dates indicated (in thousands):

 

   

December 27,

2015

   

March 29,

2015

 

Work-in-process and raw materials

  $ 16,467     $ 16,789  

Finished goods

    12,192       13,978  

Total inventories

  $ 28,659     $ 30,767  

 

 
9

 

 

   

December 27,

2015

   

March 29,

2015

 

Land

  $ 6,660     $ 6,660  

Building

    17,415       17,431  

Machinery and equipment

    41,282       41,449  

Software and licenses

    22,217       22,044  

Property, plant and equipment, total

    87,574       87,584  

Accumulated depreciation and amortization

    (66,007

)

    (61,507

)

Total property, plant and equipment, net

  $ 21,567     $ 26,077  

 

In connection with our restructuring activities described in Note 11 – Restructuring Charges and Exit Costs, in fiscal year 2016 we wrote-off $0.4 million of mask set costs associated with our data compression product line and $0.5 million of design tools associated with processor product line.

 

Our other current liabilities consisted of the following as of the dates indicated (in thousands):

 

   

December 27,

2015

   

March 29,

2015

 

Short-term lease financing obligations

  $ 3,796     $ 3,834  

Accrued retention bonus

    1,226       2,951  

Accrued restructuring charges and exit costs

    754       982  

Purchase consideration holdback

    1,006       1,006  

Accrued legal and professional services

    1,915       982  

Accrued manufacturing expenses, royalties and licenses

    660       1,122  

Accrued sales and marketing expenses

    534       686  

Deferred tax liability

          7,021  

Other current liabilities

    2,530       2,703  

Total other current liabilities

  $ 12,421     $ 21,287  

 

Our other non-current obligations consisted of the following as of the dates indicated (in thousands):

 

   

December 27,

2015

   

March 29,

2015

 

Long-term taxes payable

  $ 3,266     $ 4,351  

Other

    154       42  

Total other non-current obligations

  $ 3,420     $ 4,393  

 

NOTE 5.

FAIR VALUE

 

Fair value is defined 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 must maximize the use of observable inputs and minimize the use of unobservable inputs. GAAP 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 as follows:

 

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.

 

Our cash and investment instruments are classified within Level 1 or Level 2 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency.

 

 
10

 

 

In the first quarter of fiscal year 2015, we received approximately 93,000 common shares of CounterPath Corporation (“CounterPath”) through the dissolution of Skypoint Telecom Fund II (US), LP. (“Skypoint Fund”) in which we were a limited partner since 2001. CounterPath was one of the investee companies of Skypoint Fund. We estimated the fair value using the market value of common shares as determined by trading on the Nasdaq Capital Market. These securities have been classified to Level 2 as of September 28, 2014 and recorded in the other non-current assets line item on the condensed consolidated balance sheet. We believe the fair value inputs of CounterPath do not meet all of the criteria for Level 1 classification primarily due to the low trading volume of the stock. See Note 7–Long-term Investments for the discussion on Skypoint Fund.

 

We had no assets or liabilities utilizing Level 3 inputs as of December 27, 2015 or March 29, 2015.

 

There were no transfers between Level 1 and Level 2 during the fiscal quarter ended December 27, 2015.

 

The following table summarizes our investment assets as of December 27, 2015 (in thousands):

 

   

December 27, 2015

 
   

Level 1

   

Level 2

   

Total

 

Assets:

                       

Money market funds

  $ 4     $     $ 4  

Common shares of CounterPath

          43       43  

Total investment assets

  $ 4     $ 43     $ 47  

 

The following table summarizes our investment assets as March 29, 2015 (in thousands):

 

   

March 29, 2015

 
   

Level 1

   

Level 2

   

Total

 

Assets:

                       

Money market funds

  $ 6     $     $ 6  

Common shares of CounterPath

          48       48  

Total investment assets

  $ 6     $ 48     $ 54  

 

Our cash and cash equivalents as of the dates indicated below were as follows (in thousands):

 

   

December 27,

2015

   

March 29,

2015

 

Cash and cash equivalents

               

Cash at financial institutions

  $ 53,445     $ 55,227  

Money market funds

    4       6  

Total cash and cash equivalents

  $ 53,449     $ 55,233  

 

Realized gains (losses) on the sale of marketable securities are determined by the specific identification method and are reflected in the interest income and other net, line item on the condensed consolidated statements of operations.

 

Our net realized gains (losses) on marketable securities for the periods indicated below were as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27, 2015

   

December 28, 2014

   

December 27, 2015

   

December 28, 2014

 

Gross realized gains

  $     $     $     $ 264  

Gross realized losses

                      (238 )

Net realized income (losses)

  $     $     $     $ 26  

 

 

NOTE 6.

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 evaluate goodwill for impairment on an annual basis or when 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. Estimations and assumptions regarding the number of reporting units, future performances, results of our operations and comparability of our market capitalization and net book value will be used. 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 single operating segment and one chief operating decision maker, our President and Chief Executive Officer (“CEO”), we utilize an entity-wide approach to assess goodwill for impairment. In the second and third quarters of fiscal year 2016, due to the significant decrease of our company’s stock value, we conducted impairment analysis by comparing the fair value of our single reporting unit with its carrying value. As of the test date and as of fiscal quarter-end, and before consideration of a control premium, the fair value, which was estimated as our market capitalization, exceeded the carrying value of our net assets. As a result, no goodwill impairment was recorded for the third quarter of fiscal year 2016.

 

 
11

 

 

The carrying amount of goodwill for the nine months ended December 27, 2015 remained the same as last fiscal year end.

 

Intangible Assets

 

Our purchased intangible assets as of the dates indicated below were as follows (in thousands):

 

    December 27, 2015     March 29, 2015  
   

Carrying

Amount

   

Accumulated Amortization

   

 

Impairment

Charge

   

Net Carrying

Amount

   

Carrying

Amount

   

Accumulated Amortization

   

Impairment

Charge

   

Net

Carrying

Amount

 

Amortized intangible assets:

                                                               

Existing technology

  $ 114,433     $ (55,230

)

  $     $ 59,203     $ 120,041     $ (47,259

)

  $ (9,134

)

  $ 63,648  

Customer relationships

    14,295       (5,877

)

          8,418       15,165       (4,520

)

    (870

)

    9,775  

Distributor relationships

    7,254       (2,616

)

          4,638       7,254       (1,973

)

          5,281  

Patents/core technology

    3,459       (3,459

)

                3,459       (3,446

)

          13  

Trade names

    1,330       (466

)

          864       1,330       (274

)

          1,056  

Total intangible assets subject to amortization

    140,771       (67,648

)

          73,123       147,249       (57,472

)

    (10,004

)

    79,773  

In-process research and development

    2,803             (1,807 )     996       9,148             (2,819

)

    6,329  

Total

  $ 143,574     $ (67,648

)

  $ (1,807 )   $ 74,119     $ 156,397     $ (57,472

)

  $ (12,823

)

  $ 86,102  

 

Long-lived assets are amortized on a straight-line basis over their respective estimated useful lives. Existing technology is amortized over four to nine years. Customer relationships are amortized over five to seven years. Distributor relationships are amortized over seven years. Patents/core technology is amortized over six years. Trade names are amortized over three to six years. In-process research & development (“IPR&D”) is reclassified as existing technology upon completion or written off upon abandonment. During the first and third quarters of fiscal year 2016, $2.9 million and $0.6 million, respectively, of IPR&D was reclassified as existing technology upon completion and started amortization. In the third quarter of fiscal year 2016, we conducted a review of our business environment, and as a result of a decline in forecasted gross margins related to three of the IPR&D projects, we abandoned those projects and recorded a $1.8 million charge in the impairment of intangibles line on the condensed consolidated statement of operations. During the third quarter of fiscal year 2015, $1.2 million of IPR&D was reclassified as existing technology upon completion and started amortization. As a result of a decline in forecasted revenue and not meeting critical specifications, we abandoned two IPR&D projects and recorded a $2.3 million charge in the impairment of intangibles line on the consolidated statement of operations in the first nine months of fiscal 2015. We expect the remaining IPR&D projects to be completed and to start amortization within the next six months. We evaluate the remaining useful life of our long-lived assets that are being amortized each reporting period to determine whether events and circumstances warrant a revision to the remaining period of amortization. If the estimate of an intangible asset’s remaining useful life is changed, the remaining carrying amount of the long-lived asset is amortized prospectively over the remaining useful life.

 

Long-lived assets are evaluated for impairment when events or changes in business circumstances indicate that the carrying amount of the assets (or asset group) may not be fully recoverable. When events or changes in circumstances suggest that the carrying amount of long-lived assets may not be recoverable, we estimate the future cash flows expected to be generated by the assets (or asset group) from its use or eventual disposition. If the sum of the expected future cash flows is less than the carrying amount of those assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. Significant management judgment is required in the grouping of long-lived assets and forecasts of future operating results that are used in the discounted cash flow method of valuation. If our actual results, or the plans and estimates used in future impairment analyses are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

 

As of December 27, 2015, except as noted above, there were no indicators or events that required us to perform an intangible assets impairment review.

 

 
12

 

 

The aggregate amortization expenses for our purchased intangible assets for the periods indicated below were as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Amortization expense

  $ 3,401     $ 3,248     $ 10,176     $ 9,429  

 

The total future amortization expenses for our purchased intangible assets excluding IPR&D are summarized below (in thousands):

 

Amortization Expense (by fiscal year)

 

2016 (3 months remaining)

  $ 3,406  

2017

    13,552  

2018

    13,516  

2019

    13,203  

2020

    12,412  

2021 and thereafter

    17,034  

Total future amortization

  $ 73,123  

 

NOTE 7.

LONG-TERM INVESTMENTS

 

In July 2001, Exar became a Limited Partner in the Skypoint Fund, a venture capital fund focused on investments in communications infrastructure companies. We accounted for this non-marketable equity investment under the cost method in the other non-current assets line item on the consolidated balance sheet. During the term of the fund, we made $4.8 million in capital contributions to Skypoint Fund since we became a limited partner in July 2001. The partnership was dissolved and the fund distributed stock of invested companies to us during the first quarter of fiscal year 2015.

 

We regularly review and determine whether each investment asset is other-than-temporarily impaired, in which case the investment is written down to its impaired value.

 

As of the date indicated below, our long-term investments balance, which is included in the Other non-current assets line item on the condensed consolidated balance sheets, consisted of the following (in thousands):

 

   

December 27,

2015

 

Beginning balance as of March 29, 2015

  $ 394  

Net distributions

     

Impairment charges

    (5 )

Ending balance

  $ 389  

 

Impairment

 

We evaluate each of our long-term investments for impairment on an annual basis or when events and changes in circumstances suggest that the carrying amount may not be recoverable. If the carrying amount exceeds its fair value, the long term-investment is considered impaired and a second step is performed to measure the amount of impairment loss.

 

During the first quarter of fiscal year 2015, we received approximately 93,000 common shares of CounterPath through the dissolution of Skypoint Fund in which we were a limited partner since 2001. CounterPath was one of the investee companies of Skypoint Fund. We estimated the fair value using the market value of CounterPath’s common shares on the Nasdaq Capital Market. We also received common shares from the other two private investee companies of Skypoint Fund through the dissolution. We regularly assess the fair value of the common shares received from these three companies and recorded $5,000 of impairment charges in the interest expense and other, net line on the condensed consolidated statements of operations during the nine months ended December 27, 2015. We recorded $35,000 of impairment charges during the nine months ended December 28, 2014.

 

NOTE 8.

RELATED PARTY TRANSACTIONS

 

Alonim Investments Inc. (“Alonim”) through its wholly-owned affiliate, Rodfre Holdings LLC, owns approximately 7.6 million shares, or approximately 16%, of our outstanding common stock as of December 27, 2015. As such, Alonim is our largest stockholder. Future Electronics Inc. (“Future”) is also an affiliate of Alonim and our largest distributor. One of our directors is an executive officer of Future. Our related party transactions primarily involved sales to Future.

 

 
13

 

 

Related party net sales as a percentage of our total net sales for the periods indicated below were as follows:

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Future and affiliates of Alonim

    23 %     19 %     25 %     22 %

 

Related party receivables as a percentage of our net accounts receivables were as follows as of the dates indicated below:

 

   

December 27,

2015

   

March 29,

2015

 

Future and affiliates of Alonim

    14 %     6 %

 

Related party expenses for marketing promotional materials reimbursed were not significant for the three and nine months ended December 27, 2015 and December 28, 2014, respectively.

 

NOTE 9.

SHORT-TERM DEBT

 

As part of the acquisition of iML in the first quarter of fiscal year 2015, we entered into short-term financing agreements with Stifel Financial Corporation (“Stifel”) and CTBC Bank Corporation (USA) (“CTBC”) to provide bridge financing for the acquisition.

 

CTBC

 

On June 9, 2014 we entered into a Business Loan Agreement with CTBC to provide a loan for $26.0 million. This loan bore an interest rate of 3.25% and had a maturity date of December 9, 2014. Interest payments were due monthly with the entire principal due not later than December 9, 2014.

 

All our obligations under the Business Loan Agreement were unconditionally guaranteed by iML through a $26.0 million short-term certificate deposit with the same institution. We repaid the CTBC business loan was paid off in the third quarter of fiscal year 2015.

 

Stifel

 

On May 27, 2014 (the “Initial Funding Date”), we entered into a bridge credit agreement (the “Credit Agreement”) with certain lender parties and Stifel Financial Corp., as Administrative Agent. The Credit Agreement provided us with a bridge term loan credit facility in an aggregate principal amount of up to $90.0 million (the “Bridge Facility”).

 

Interest on loans made under the Bridge Facility accrued, at our option, at a rate per annum equal to (1) the Base Rate (as defined below) plus (a) during the first 90 days following the Initial Funding Date, 7.5% and (b) thereafter, 8.5% or (2) 1-month LIBOR plus (a) during the first 90 days following the Initial Funding Date, 8.5% and (b) thereafter, 9.5%. The “Base Rate” was equal to, for any day, a rate per annum equal to the highest of (a) the prime rate in effect on such day, (b) the federal funds effective rate in effect on such day plus 0.50%, and (c) 1 month LIBOR plus 1.00%. The Base Rate was subject to a floor of 2.5%, and LIBOR was subject to a floor of 1.5%.

 

We had drawn $65.0 million in May 2014 to fund our acquisition of iML’s outstanding shares. We repaid $26.0 million of the debt in June 2014 through a loan from CTBC with a lower interest rate. We repaid the Credit Agreement in full in the second quarter of fiscal year 2015.

 

 
14

 

 

Interest

 

For the three and nine months ended December 27, 2015 and December 28, 2014, interest on our short-term debt, which is included in the “Interest expense” line item on the condensed consolidated statement of operations, consisted of the following (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

CTBC

  $     $ 9     $     $ 265  

Stifel

                      646  

Total interest on short-term debt

  $     $ 9     $     $ 911  

 

NOTE 10.

COMMON STOCK REPURCHASES

 

From time to time, we acquire outstanding common stock in the open market to partially offset dilution from our equity award programs, to increase our return on our invested capital and to bring our cash to a more appropriate level for Exar.

 

On August 28, 2007, we announced the approval of a share repurchase plan and authorized the repurchase of up to $100.0 million of our common stock.

 

On July 9, 2013, we announced the approval of a share repurchase program under which we were authorized to repurchase an additional $50.0 million of our common stock. The repurchase program does not have a termination date, and may be modified, extended or terminated at any time. We intend to retire all shares repurchased under the stock repurchase plan. The purchase price for the repurchased shares of Exar is reflected as a reduction of common stock and additional paid-in capital.

 

We did not repurchase any common stock during the three or nine months ended December 27, 2015. Stock repurchase activities during fiscal year 2015 were indicated below (in thousands, except per share amounts):

 

   

Total number of

Shares Purchased

   

Average Price Paid

Per Share

(or Unit)

   

Amount Paid for

Purchase

 

As of March 30, 2014

    10,319     $ 9.42     $ 97,189  

Repurchases – March 31 to April 27, 2014

    273       10.98       3,000  

Repurchases – July 28 to September 28, 2014

    393       9.83       3,864  

Repurchases – September 29 to December 28, 2014

    125       9.08       1,135  

As of March 29, 2015

    11,110     $ 9.47     $ 105,188  

—————

Note: The average price paid per share is based on the total price paid by Exar, which includes applicable broker fees.

 

NOTE 11.

RESTRUCTURING CHARGES AND EXIT COSTS

 

2016 Restructuring Charges and Exit Costs

 

During the second and third quarters of fiscal year 2016, we decided to restructure our business that mainly impacted our data compression and processor product lines. We believe this restructuring positions us to achieve operating efficiencies and to focus our resources on strategic priorities. During the three and nine months ended December 27, 2015, we incurred $2.2 million and $4.3 million of restructuring charges and exit costs, respectively. The charges consisted primarily of reduction of our workforce, the impairment of certain fixed assets and licensed technologies and the write-off of related inventory. Inventory write-offs are included in cost of sales and all other restructuring charges and exit costs are included in operating expenses

 

2015 Restructuring Charges and Exit Costs

 

We completed a significant strategic restructuring process that began in the quarter ended September 28, 2014 and ended in October 2014.  This restructuring was prompted by the recent acquisition of iML, and an associated significant reduction in force, including reductions at our Hangzhou, China; Loveland, Colorado; and Ipoh, Malaysia locations.  We completed this restructuring to enable us to achieve meaningful synergies and operating efficiencies and focus our resources on strategic priorities. During the three and nine months ended December 28, 2014, we incurred $3.5 million and $10.4 million restructuring charges and exit costs, respectively. The charges consisted primarily of reduction of our workforce, the impairment of certain fixed assets, licensed technologies and write-off of related inventory. Inventory write-offs are included in cost of sales and all other restructuring charges and exist costs are included in operating expenses

 

 
15

 

 

Our restructuring liabilities were included in the other current liabilities and other non-current obligations lines within our condensed consolidated balance sheets. Restructuring expenses of $22,000 are included in interest expense for the three and nine months ended December 27, 2015. The following table summarizes the activities affecting the liabilities as of the dates indicated below (in thousands):

 

   

March 29,

2015

   

Additions/

Adjustments

   

Non-cash

charges

   

Payments

   

December 27,

2015

 

Lease termination costs and others

  $ 330     $ 297     $ (165

)

  $ (293

)

  $ 169  

Impairment of fixed assets, licensed technologies and write down of inventory

          740       (740

)

           

Severance

    652       2,232             (2,299

)

    585  

Total

  $ 982     $ 3,269     $ (905

)

  $ (2,592

)

  $ 754  

 

NOTE 12.

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.

 

The following table summarizes our ESPP transactions during the fiscal periods presented (in thousands, except per share amounts):

 

   

As of

December 27, 2015

   

Nine Months Ended

December 27, 2015

 
   

Shares of Common

Stock

   

Shares of Common

Stock

   

Weighted Average

Price per Share

 

Authorized to issue

    4,500                  

Reserved for future issuance

    1,325                  

Issued

            21     $ 7.87  

 

Equity Incentive Plans

 

At the annual meeting of stockholders on September 18, 2014 (the “Annual Meeting”), our stockholders approved the Exar Corporation 2014 Equity Incentive Plan (“2014 Plan”). The 2014 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.

 

Prior to the Annual Meeting, we maintained the Exar Corporation 2006 Equity Incentive Plan (the “2006 Plan”) and the Sipex Corporation 2006 Equity Incentive Plan (the “Sipex 2006 Plan”). As of June 30, 2014, a total of 6,555,492 shares of our common stock were then subject to outstanding awards granted under the 2006 Plan and the Sipex 2006 Plan, and an additional 669,008 shares of our common stock were then available for new award grants under the 2006 Plan. As part of the stockholder approval of the 2014 Plan at the Annual Meeting, we agreed that no new awards will be granted under the 2006 Plan and the Sipex 2006 Plan, although awards made under these plans will remain subject to the terms of each such plan.

 

The maximum number of shares of our common stock that may be issued or transferred pursuant to awards under the 2014 Plan equals the sum of: (1) 5,170,000 shares, plus (2) the number of any shares subject to stock options granted under the 2006 Plan and the Sipex 2006 Plan and outstanding as of the date of the Annual Meeting which expire, or for any reason are cancelled or terminated, after the date of the Annual Meeting without being exercised, plus (3) the number of any shares subject to restricted stock and restricted stock unit awards granted under the 2006 Plan and the Sipex 2006 Plan that are outstanding and unvested as of the date of the Annual Meeting which are forfeited, terminated, cancelled, or otherwise reacquired after the date of the Annual Meeting without having become vested. Awards other than a stock option or stock appreciation right granted under the 2014 Plan are counted against authorized shares available for future issuance on a basis of two shares for each award issued. As of December 27, 2015, there were 3.9 million shares available for future grant under the 2014 Plan.

 

 
16

 

 

Stock Option Activities

 

Our stock option transactions during the nine months ended December 27, 2015 are summarized below:

 

   

Outstanding

   

Weighted
Average
Exercise
Price per
Share

   

Weighted
Average
Remaining
Contractual
Term

(in years)

   

Aggregate
Intrinsic

Value

(in thousands)

 

Balance at March 29, 2015

    7,609,622     $ 8.77       4.86     $ 14,377  

Granted

    1,845,120       6.03                  

Exercised

    (369,967 )     6.47                  

Cancelled

    (236,895 )     9.16                  

Forfeited

    (898,691 )     9.81                  

Balance at December 27, 2015

    7,949,189     $ 8.11       4.63     $ 1,420  
                                 

Vested and expected to vest, December 27, 2015

    7,284,444     $ 8.17       4.50     $ 1,186  

Vested and exercisable, December 27, 2015

    4,069,324     $ 8.30       3.55     $ 364  

 

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 $6.44 and $10.30 as of December 27, 2015 and March 29, 2015, respectively. These are the values which would have been received by option holders if all option holders exercised their options on that date.

 

In January 2012, we granted 480,000 performance-based stock options to our then CEO. The options were scheduled to vest in four equal annual installments at the end of fiscal years 2013 through 2016 if certain predetermined market based financial measures were met. If the financial measures are not met, each installment would be rolled over to the subsequent fiscal year. In January 2014, we granted 140,000 performance-based stock options to our then CEO. The options were scheduled to vest at the end of fiscal year 2017 if certain predetermined financial measures were met. We recorded $75,000 and $262,000 of compensation expense for these options in the three and nine months ended December 28, 2014, respectively. Due to the departure of our then CEO in October 2015, we recorded a reversal of $151,000 and $34,000 of compensation expense for these options in the three and nine months ended December 27, 2015, respectively as the requisite service period required for vesting was not completed.

 

Options exercised for the periods indicated below were as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Intrinsic value of options exercised

  $ 39     $ 668     $ 637     $ 1,524  

 

 

RSU Activities

 

Our RSU transactions during the nine months ended December 27, 2015 are summarized as follows:

 

   

Shares

   

Weighted
Average
Grant-

Date
Fair Value

   

Weighted
Average
Remaining
Contractual
Term

(in years)

   

Aggregate
Intrinsic

Value

(in thousands)

 

Unvested at March 29, 2015

    1,072,925     $ 10.26       1.50     $ 11,051  

Granted

    277,095       9.22                  

Issued and released

    (543,037 )     8.43                  

Cancelled

    (184,386 )     7.99                  

Unvested at December 27, 2015

    622,597     $ 12.07       1.52     $ 4,010  

 

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.

 

 
17

 

 

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. 

 

In March 2012, we granted 300,000 performance-based RSUs (“PRSUs”) to our then CEO. The PRSUs were scheduled to vest in three equal installments at the end of fiscal year 2013 through 2015 with three year vesting periods for each installment if certain predetermined financial measures were met. If the financial measures were not met, each installment would be forfeited at the end of its respective fiscal year. Due to the departure of our then CEO in October, 2015, we recorded a reversal of $169,000 and $41,000 of compensation expense for these PRSUs in the three and nine months ended December 27, 2015, respectively as the requisite service period required for vesting was not completed. We recorded $146,000 and $1,026,000 of compensation expense for these awards in the three and nine months ended December 28, 2014, respectively.

 

In July 2013, as part of the acquisition of Cadeka, in order to encourage retention of five former Cadeka employees, we agreed to recommend to our Board of Directors in July 2015 a bonus, which, if approved by the Board of Directors, would be settled in RSUs subject to fulfillment of the service period. The ultimate approval of these awards was subject to the discretion of the Board of Directors. We recorded $0 and $0.2 million of compensation expense for these awards in the three and nine months ended December 27, 2015, respectively. We recorded $0.5 million and $1.5 million of compensation expense for these awards in the three and nine months ended December 28, 2014, respectively. The expense is reported in the other current liabilities line on the condensed consolidated balance sheet as the total amount of bonus was to be settled in variable number of RSUs at the completion of the requisite service period. Such non-cash compensation expense was recorded as part of stock compensation expense in the condensed consolidated statements of operations. In July 2015, the Board of Directors ultimately determined not to approve the granting of these RSUs. During the three months ended December 27, 2015, we paid three of these five former Cadeka employees $75,000 in cash in exchange for a release of claims, including any claim such former employees may have to the RSUs described above. As a result of obtaining these releases, the proportional amount of liability net of cash payments was removed from our condensed consolidated balance sheet, with a corresponding increase in additional paid in capital. For the two remaining employees, an amount of $1.2 million is included other liabilities as of December 27, 2015, pending the earlier of a settlement with such former employees or the expiration of the relevant statue of limitations.

 

In October 2013, we granted 70,000 PRSUs to certain executives. The first 50% of the PRSUs are scheduled to start vesting in three equal installments at the end of fiscal year 2015 with a three-year vesting period if certain performance measures are met. The second 50% of the PRSUs are scheduled to start vesting in three equal installments at the end of fiscal year 2016 with a three-year vesting period if certain performance measures are met. We recorded $18,000 and $96,000 of compensation expense for these awards in the three and nine months ended December 27, 2015, respectively. We recorded a reversal of 78,000 and compensation expense of $208,000 associated with these awards in the three and nine months ended December 28, 2014, respectively, as a result of termination of one of our executives since the requisite service period required for vesting was not completed.

 

In December 2013, we granted 100,000 RSUs to our then CEO. The RSUs were scheduled to vest in two equal installments at the end of fiscal years 2016 and 2017. In October 2014, the second installment of 50,000 RSUs was modified to 50,000 PRSUs. These modified PRSUs were scheduled to vest at the end of fiscal year 2017 if certain predetermined financial measures are met. Due to the departure of our then CEO in October 2015, we recorded a reversal of $40,000 and $54,000 of compensation expense for these awards for the three and nine months ended December 27, 2015, respectively as the requisite service period for vesting was not completed. For the three and nine months ended December 28, 2014, we did not record compensation expense for these modified PRSUs as a result of a low probability of achieving performance goals measured by management.

 

In August 2014, we announced the Fiscal Year 2015 Management Incentive Program (“2015 Incentive Program”). Under this program, each participant’s award is denominated in shares of our common stock and is subject to attainment of Exar’s performance goals as established by the Compensation Committee of the Board of Directors for fiscal year 2015. We recorded a stock compensation expense of $2.0 million in fiscal year 2015 related to these awards. During the first quarter of fiscal year 2016, we settled 20% of these awards with cash and recorded $50,000 additional compensation cost due to the fair value change between grant day and settlement day.

 

In August and December 2014, we granted 88,448 PRSUs to certain former iML employees. The PRSUs are scheduled to start vesting in three equal annual installments upon achievement of certain performance measures. In the three and nine months ended December 27, 2015, we recorded $39,000 and $125,000 of stock compensation expense related to these PRSUs, respectively. In the three and nine months ended December 28, 2014, we did not record stock compensation expense related to these PRSUs.

 

In May 2015, we announced the Fiscal Year 2016 Management Incentive Program (“2016 Incentive Program”). Under this program, each participant’s award is subject to attainment of Exar’s performance goals as established by the Compensation Committee of the Board of Directors for fiscal year 2016 and the Committee reserves the right to settle awards either entirely with RSUs or with a combination of 20% settled in cash and 80% settled with RSUs We did not record any compensation expense for the three and nine months ended December 27, 2015 related to the 2016 Incentive Program as we do not expect to meet the performance goals established under the awards.

 

 
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Stock-Based Compensation Expense

 

The following table summarizes stock-based compensation expense related to stock options and RSUs during the fiscal periods presented (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Cost of sales

  $ 104     $ 496     $ 276     $ 983  

Research and development

    269       442       923       2,124  

Selling, general and administrative

    669       3,284       3,232       7,842  

Total Stock-based compensation expense

  $ 1,042     $ 4,222     $ 4,431     $ 10,949  

 

The amount of stock-based compensation cost capitalized in inventory was immaterial for all periods presented.

 

Unrecognized Stock-Based Compensation Expense

 

The following table summarizes unrecognized stock-based compensation expense related to stock options and RSUs, net of reversals, as of December 27, 2015:

 

   

December 27, 2015

 
   

Amount

(in thousands)

   

Weighted Average

Expected Remaining

Period (in years)

 

Options

  $ 7,094       2.62  

RSUs

    2,390       1.83  

PRSUs

    475       1.76  

Total Unrecognized Stock-based compensation expense

  $ 9,959          

 

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’s judgment, which includes the expected term of the stock-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.

 

Our Black-Scholes valuation model for valuing stock option grants uses the following assumptions and estimates:

 

Expected Volatility. The Company calculates expected volatility based on the historical price volatility of the Company's stock.

 

Expected Term. The Company utilizes a model, which uses historical exercise, cancellation and outstanding option data to calculate the expected term of stock option grants.

 

Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes valuation model on the implied yield available on a U.S. Treasury note with a term approximately equal to the expected term of the underlying grants.

 

Dividend Yield. The dividend yield was calculated by dividing the annual dividend by the average closing price of the Company's common stock on a quarterly basis.

 

 
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NOTE 13. NET LOSS PER SHARE

 

Basic net loss per share excludes dilution and is computed by dividing net loss attributable to Exar by the weighted average number of common shares outstanding for the applicable period. Diluted earnings per share reflects the potential dilution that would occur if outstanding stock options to purchase common stock were exercised for common stock, using the treasury stock method, and the common stock underlying outstanding RSUs was issued.

 

The following table summarizes our net loss per share for the periods indicated below (in thousands, except per share amounts):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Net loss attributable to Exar Corporation

  $ (7,137 )   $ (6,599 )   $ (13,844 )   $ (42,056 )
                                 

Shares used in computation of net loss per share:

                               

Basic

    48,386       47,119       48,146       47,165  

Effect of options and awards

 

   

   

   

 

Diluted

    48,386       47,119       48,146       47,165  

Net loss per share

                               

Basic

  $ (0.15 )   $ (0.14 )   $ (0.29 )   $ (0.89 )

Diluted

  $ (0.15 )   $ (0.14 )   $ (0.29 )   $ (0.89 )

 

Outstanding stock options and RSUs are potentially dilutive securities. For all periods presented, all outstanding stock options and RSUs were excluded from the computation of diluted net loss per share because they were determined to be anti-dilutive. 

 

NOTE 14.

LEASE FINANCING OBLIGATIONS

 

We have acquired engineering design tools (“Design Tools”) under capital leases. We acquired Design Tools of $6.9 million in January 2015 under a two-year license and two three-year licenses with prepayment of $1.0 million, $4.4 million in October 2014 under a three-year license with a prepayment of $1.5 million for the first year license and $0.9 million in July 2012 under a three-year license all of which were accounted for as capital leases and recorded in the property, plant and equipment, net line item in the consolidated balance sheets. The obligations related to the Design Tools were included in other current liabilities and long-term lease financing obligations in our condensed consolidated balance sheets as of December 27, 2015 and March 29, 2015, respectively. The effective interest rates for the Design Tools range from 2.0% to 7.25%.

 

Amortization expense related to the Design Tools, which was recorded using the straight-line method over the remaining useful life for the periods indicated below, was as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Amortization expense

  $ 941     $ 848     $ 2,979     $ 2,448  

 

Future minimum lease and sublease income payments for the lease financing obligations as of December 27, 2015 are as follows (in thousands):

 

Fiscal Years

 

Design Tools

 

2016 (3 months remaining)

  $ 465  

2017

    3,947  

2018

    1,355  

Total minimum lease payments

    5,767  

Less: amount representing interest

    257  

Present value of minimum lease payments

    5,510  

Less: short-term lease financing obligations

    3,796  

Long-term lease financing obligations

  $ 1,714  

 

 
20

 

 

Interest expense for the lease financing obligations for the periods indicated below was as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Interest expense

  $ 43     $ 37     $ 136     $ 115  

 

In the course of our business, we enter into arrangements accounted for as operating leases related to rental of office space. Rent expenses for all operating leases for the periods indicated below were as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Rent expense

  $ 257     $ 266     $ 748     $ 1,162  

 

Our future minimum lease payments for the lease operating obligations as of December 27, 2015 are as follows (in thousands):

 

 

Fiscal Years

 

Facilities

 

2016 (3 months remaining)

  $ 189  

2017

    351  

2018

    129  

2019

    3  

Total minimum lease payments

  $ 672  

 

NOTE 15.      COMMITMENTS AND CONTINGENCIES

 

In early 2012, we received correspondences from the California Department of Toxic Substance Control (“DTSC”) regarding its ongoing investigation of hazardous wastes and hazardous waste constituents at a former regulated treatment facility in San Jose, California. In 1985, MPSI made two separate permitted hazmat deliveries to a licensed and regulated site for treatment. DTSC has requested that former or current property owners and companies, that had hazardous waste treated at the site participate in further site assessment and limited remediation activities. We have entered into various agreements with other named generators, former property owners and DTSC limited to the investigation of the sites’ condition and evaluation, and selection of appropriate remedial measures. The designated environmental consulting firm has prepared and submitted to DTSC a site profile and is currently engaged in further study. Given that this matter is under investigation and discussions are ongoing with respect to various related considerations, we are unable to ascertain our exposure, if any, or estimate a reasonably possible range of loss. In the opinion of management, after consulting with legal counsel, and taking into account insurance coverage, any ultimate liability related to current outstanding claims and lawsuits, individually or in the aggregate, is not expected to have a material adverse effect on our financial statements, as a whole.

 

In a letter dated March 27, 2012, we were notified by the Alameda County Water District (“ACWD”) of the recent detection of volatile organic compounds at a site adjacent to a facility that was previously owned and occupied by Sipex. The letter was also addressed to prior and current property owners and tenants (collectively “Property Owners”). ACWD requested that the Property Owners carry out further site investigation activities to determine if the detected compounds are emanating from the site or simply flowing under it. In June 2012, the Property Owners filed with ACWD a report of its investigation/characterization activities and analytical data obtained. Accumulated data suggests that compounds of concern in groundwater appear to be from an offsite source. ACWD is investigating alternative upgradient sites. Given that this investigation is ongoing and hawse have not received any recent communications from ACWD, we are unable to ascertain our exposure, if any, or estimate a reasonably possible range of loss. In the opinion of management, after consulting with legal counsel, and taking into account insurance coverage, any ultimate liability related to current outstanding claims and lawsuits, individually or in the aggregate, is not expected to have a material adverse effect on our financial statements, as a whole.

 

We warrant all custom products and application specific products, including cards and boards, against defects in materials and workmanship for a period of 12 months, and occasionally we may provide an extended warranty from the delivery date. We warrant all of our standard products against defects in materials and workmanship for a period of 90 days from the date of delivery. Reserve requirements are recorded in the period of sale and are based on an assessment of the products sold with warranty, historical warranty costs incurred and customer/product specific circumstances. Our liability is generally limited, at our option, to replacing, repairing, or issuing a credit (if it has been paid for). Our 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.

 

 
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Warranty expense has historically been immaterial for our products. A warranty liability of $1.4 million was established during fiscal year 2014 for the return of certain older generation data compression products shipped in prior years. This liability has been fully fulfilled as of March 29, 2015. In February 2015, we received $0.5 million reimbursement from our insurance company and in July 2015, we received $1.5 million legal settlement from our vendor related to their defective products. Our warranty reserve balance as of December 27, 2015 and March 29, 2015 was $0.2 million and $0.3 million, respectively.

 

In the ordinary course of business, we may provide for indemnification of varying scope and terms to customers, vendors, lessors, business partners, purchasers of assets or subsidiaries, and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements or representations and warranties made by us, services to be provided by us, intellectual property infringement claims made by third parties or, matters related to our conduct of the business. In addition, we have entered into indemnification agreements with our directors and certain of our executive officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or executive officers. We maintain director and officer liability insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers, and former directors and officers of acquired companies, in certain circumstances.

 

It is not possible to determine the aggregate maximum potential loss under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement and claims. Such indemnification agreements might not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements and we have not accrued any liabilities related to such indemnification obligations in our condensed consolidated financial statements.

 

NOTE 16.

LEGAL PROCEEDINGS

 

From time to time, we are involved in various claims, legal actions and complaints arising in the normal course of business. We are not a named party to any ongoing lawsuit or formal proceeding that, in the opinion of our management, is likely to have a material adverse effect on our financial position, results of operations or cash flows.

 

In April 2015, Phenix, LLC (“Phenix”) filed a complaint against us and iML for patent infringement in the United States District Court for the Eastern District of Texas. Phenix alleged in its complaint that at least the iML 7990 and 7991 integrated circuit P-Gamma products and power management integrated circuit products that are combined with the functionality of the iML 7990 and 7991 integrated circuits infringe one of its patents. In October 2015, Phenix filed an amended complaint, adding a subsidiary of iML as a defendant, and in December 2015 Phenix filed a second amended complaint, adding additional iML P-Gamma integrated circuits as accused products. The court has set a trial date of September 6, 2016 for this matter, and discovery is ongoing. The parties have engaged in settlement discussions, but no settlement has been reached. During the three and nine months ended December 27, 2015, we recorded $1.0 million expense for a possible settlement of this matter. We do not expect an ultimate settlement in this case to be materially different from our accrual.

 

NOTE 17.

INCOME TAXES

 

During the three months ended December 27, 2015, we recorded an income tax expense of $208,000 due to income generated in foreign jurisdictions, and we recorded a benefit of $0.8 million during the nine months ended December 27, 2015 primarily due to the lapsing of the statute of limitations related to the U.S. federal tax reserves. During the three months and nine months ended December 28, 2014, we recorded an income tax expense of approximately $0.1 million and $0.9 million, respectively. The income tax expense was primarily related to the allocation of tax expense between continuing operations and other comprehensive income when applying the exception to ASC 740 intraperiod allocation rule upon liquidation of our available for sale security portfolio.

 

During the three months ended December 27, 2015, the unrecognized tax benefits increased by $0.3 million to $16.8 million primarily related to the increase of unrecognized tax benefit on R&D tax credits. If recognized, $13.8 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 consisted of the following as of the dates indicated (in thousands):

 

   

December 27,

2015

   

March 29,

2015

 

Accrued interest and penalties

  $ 1,295     $ 1,187  

 

Our major tax jurisdictions are the United States federal and various states, Canada, China, Hong Kong, Korea and certain other foreign jurisdictions. The fiscal years 2003 through 2015 remain open and subject to examinations by the appropriate governmental agencies in the United States and certain of our foreign jurisdictions.

 

 
22

 

 

NOTE 18.

SEGMENT AND GEOGRAPHIC INFORMATION

 

We operate in one reportable segment, which is comprised of one operating segment. We design, develop and market high performance analog mixed-signal integrated circuits and advanced sub-system solutions for the Industrial, High-End Consumer and Infrastructure markets.

 

Our net sales by end market were summarized as follows as of the dates indicated below (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014

 

Industrial

  $ 18,339     $ 20,506     $ 54,339     $ 59,029  

High-End Consumer

    13,207       16,202       39,906       35,825  

Infrastructure

    5,893       7,607       18,358       23,339  

Total net sales

  $ 37,439     $ 44,315     $ 112,603     $ 118,193  

 

Our foreign operations are conducted primarily through our wholly-owned subsidiaries in Canada, China, France, Germany, Japan, Malaysia, South Korea, Taiwan and the United Kingdom. Our principal markets include Asia Pacific region, North America, and Europe. Net sales by geographic areas represent direct sales principally to original equipment manufacturers (“OEM”), or their designated subcontract manufacturers, and to distributors (affiliated and unaffiliated) who buy our products and resell to their customers.

 

Our net sales by geographic area for the periods indicated below were as follows (in thousands):

 

   

Three Months Ended

   

Nine Months Ended

 
   

December 27,

2015

   

December 28,

2014

   

December 27,

2015

   

December 28,

2014