Peraso Inc. - Quarter Report: 2012 September (Form 10-Q)

Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

(Mark one)

 

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

 

For the quarterly period ended September 30, 2012

 

OR

 

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

 

For the transition period from           to           

 

Commission file number 000-32929

 

 

MOSYS, Inc.

(Exact name of registrant as specified in its charter)

 

 

3301 Olcott Street

Santa Clara, California, 95054

(Address of principal executive office and zip code)

 

(408) 415-4500

(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 filing requirements for the past 90 days. YES x NO o

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

As of November 1, 2012, 39,906,910 shares of the Registrant’s common stock, $0.01 par value, were outstanding.

 

 

 

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MOSYS, INC.

 

FORM 10-Q
September 30, 2012

 

TABLE OF CONTENTS

 

PART I —	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited):
	Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011	3
	Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2012 and 2011	4
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2011	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3.	Qualitative and Quantitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	20
PART II —	OTHER INFORMATION	21
Item 1	Legal Proceedings	21
Item 1A.	Risk Factors	21
Item 6.	Exhibits	21
	Signatures	22

 

 

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PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

MOSYS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except par value)

 

		September 30, 2012			December 31, 2011
ASSETS
Current assets
Cash and cash equivalents		$	5,967		$	40,025
Short-term investments		30,208			9,413
Accounts receivable, net		1			969
Prepaid expenses and other current assets		2,092			1,596
Total current assets		38,268			52,003
Long-term investments		9,089			8,537
Property and equipment, net		1,034			1,382
Goodwill		23,134			23,134
Intangible assets, net		2,904			4,400
Other assets		182			181
Total assets		$	74,611		$	89,637
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Accounts payable		$	847		$	336
Accrued expenses and other liabilities		1,923			2,779
Deferred revenue		663			920
Total current liabilities		3,433			4,035
Long-term liabilities		158			109
Commitments and contingencies (Note 4)
Stockholders’ equity
Preferred stock, $0.01 par value; 20,000 shares authorized; none issued and outstanding		—			—
Common stock, $0.01 par value; 120,000 shares authorized; 39,810 shares and 38,423 shares issued and outstanding at September 30, 2012 and December 31, 2011, respectively		398			384
Additional paid-in capital		155,836			150,507
Accumulated other comprehensive income		26			1
Accumulated deficit		(85,240		)	(65,399		)
Total stockholders’ equity		71,020			85,493
Total liabilities and stockholders’ equity		$	74,611		$	89,637

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MOSYS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)
(In thousands, except per share data)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
Net revenue
Licensing and other		$	248		$	756		$	1,113		$	3,319
Royalty		1,079			1,351			3,374			5,619
Total net revenue		1,327			2,107			4,487			8,938
Cost of net revenue
Licensing and other		53			356			289			1,515
Total cost of net revenue		53			356			289			1,515
Gross profit		1,274			1,751			4,198			7,423
Operating expenses
Research and development		7,026			6,648			21,220			19,369
Selling, general and administrative		1,738			1,952			6,092			6,583
Gain on sale of assets		(1,435		)	—			(3,291		)	—
Total operating expenses		7,329			8,600			24,021			25,952
Loss from operations		(6,055		)	(6,849		)	(19,823		)	(18,529		)
Other income and expense, net		61			10			121			44
Loss before income taxes		(5,994		)	(6,839		)	(19,702		)	(18,485		)
Income tax provision		79			24			139			59
Net loss		$	(6,073	)	$	(6,863	)	$	(19,841	)	$	(18,544	)
Other comprehensive loss, net of tax:
Net unrealized gains (losses) on available-for-sale securities		27			(23		)	25			(15		)
Comprehensive loss		$	(6,046	)	$	(6,886	)	$	(19,816	)	$	(18,559	)
Net loss per share
Basic and diluted		$	(0.15	)	$	(0.18	)	$	(0.51	)	$	(0.49	)
Shares used in computing net loss per share
Basic and diluted		39,299			38,090			38,919			37,700

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MOSYS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

		Nine Months Ended September 30,
		2012			2011
Cash flows from operating activities:
Net loss		$	(19,841	)	$	(18,544	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		730			839
Stock-based compensation		2,991			2,474
Amortization of intangible assets		1,496			1,964
Gain on sale of assets		(3,291		)	—
Provision for doubtful accounts		—			106
Other non-cash items		(27		)	18
Changes in assets and liabilities:
Accounts receivable		968			371
Prepaid expenses and other assets		161			1,126
Deferred revenue		(257		)	(589		)
Accounts payable		(211		)	(355		)
Accrued expenses and other liabilities		(203		)	(289		)
Net cash used in operating activities		(17,484		)	(12,879		)
Cash flows from investing activities:
Purchases of property and equipment		(257		)	(349		)
Net proceeds from sale of assets		3,437			—
Net cash paid for purchase of MagnaLynx, Inc.		—			(1,000		)
Proceeds from sales and maturities of marketable securities		29,175			30,314
Purchases of marketable securities		(50,497		)	(27,712		)
Net cash (used in) provided by investing activities		(18,142		)	1,253
Cash flows from financing activities:
Proceeds from issuance of common stock		3,146			3,207
Repurchase of common stock (Note 4)		(1,444		)	—
Payments on capital lease obligations		(134		)	(140		)
Net cash provided by financing activities		1,568			3,067
Net decrease in cash and cash equivalents		(34,058		)	(8,559		)
Cash and cash equivalents at beginning of period		40,025			14,340
Cash and cash equivalents at end of period		$	5,967		$	5,781

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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MOSYS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. The Company and Summary of Significant Accounting Policies

 

The Company

 

MoSys, Inc. (the “Company”) was incorporated in California in September 1991, and reincorporated in September 2000 in Delaware. The Company has been designing, developing, marketing and licensing high-performance semiconductor memory and high-speed parallel and serial interface intellectual property (IP) used by the semiconductor industry and communications, networking and storage equipment manufacturers. In February 2010, the Company announced the commencement of a new product initiative to develop a family of integrated circuit (IC) products under the “Bandwidth Engine” product name. Bandwidth Engine ICs combine the Company’s proprietary high-density embedded memory with its high-speed 10 Gigabits per second interface (I/O) technology and are initially being marketed to networking systems companies and designers of advanced systems-on-chip designs. The Company’s strategy and primary business objective is to become a fabless semiconductor company focused on development and sale of Bandwidth Engine ICs. During 2011, the Company began to dedicate more of its engineering resources and the engineering budget to IC efforts, and in 2012, most of the Company’s emphasis was on IC product sales as opposed to IP licensing transactions. The Company’s future success and ability to achieve and maintain profitability depends on its success in developing a market for the Bandwidth Engine ICs.

 

The accompanying condensed consolidated financial statements of the Company have been prepared without audit in accordance with the rules and regulations of the Securities and Exchange Commission (SEC).  The condensed consolidated balance sheet at December 31, 2011 has been derived from the audited consolidated financial statements at that date. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been condensed or omitted in accordance with these rules and regulations. The information in this report should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in its most recent annual report on Form 10-K filed with the SEC.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary to summarize fairly the Company’s financial position, results of operations and cash flows for the interim periods presented. The operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012 or for any other future period.

 

Basis of Presentation

 

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. The Company’s fiscal year is the calendar year.

 

Use of Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses recognized during the reported period. Actual results could differ from those estimates.

 

Cash Equivalents and Investments

 

The Company has invested its excess cash in money market accounts, certificates of deposit, commercial paper, corporate debt, government agency and municipal debt securities and considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. Investments with original maturities greater than three months and remaining maturities less than one year are classified as short-term investments. Investments with remaining maturities greater than one year are classified as long-term investments. Management generally determines the appropriate classification of securities at the time of purchase. All securities are classified as available-for-sale. The Company’s available-for-sale short-term and long-term investments are carried at fair value, with the unrealized holding gains and losses reported in accumulated other comprehensive income. Realized gains and losses and declines in the value judged to be other than temporary are included in the other income and expense, net line item in the condensed consolidated statements of operations and comprehensive loss. The cost of securities sold is based on the specific identification method.

 

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Fair Value Measurements

 

The Company measures the fair value of financial instruments using a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, as follows:

 

Level 1—Inputs used to measure fair value are unadjusted quoted prices that are available in active markets for the identical assets or liabilities as of the reporting date.

 

Level 2—Pricing is provided by third party sources of market information obtained through the Company’s investment advisors rather than models. The Company does not adjust for or apply any additional assumptions or estimates to the pricing information it receives from advisors. The Company’s Level 2 securities include cash equivalents and available-for-sale securities, which consisted primarily of certificates of deposit, commercial paper, corporate debt, and government agency and municipal debt securities from issuers with high quality credit ratings. The Company’s investment advisors obtain pricing data from independent sources, such as Standard & Poor’s, Bloomberg and Interactive Data Corporation, and rely on comparable pricing of other securities because the Level 2 securities are not actively traded and have fewer observable transactions. The Company considers this the most reliable information available for the valuation of the securities.

 

Level 3—Unobservable inputs that are supported by little or no market activity and reflect the use of significant management judgment are used to measure fair value. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions. The determination of fair value for Level 3 investments and other financial instruments involves the most management judgment and subjectivity.

 

Allowance for Doubtful Accounts

 

The Company establishes an allowance for doubtful accounts to ensure that its trade receivables balances are not overstated due to uncollectibility. The Company performs ongoing customer credit evaluations within the context of the industry in which it operates. A specific allowance of up to 100% of the invoice value is provided for any problematic customer balances. Delinquent account balances are written off after management has determined that the likelihood of collection is remote. The Company performs ongoing credit evaluations of its customers’ financial condition and generally does not require collateral from its customers. The Company grants credit only to customers deemed creditworthy in the judgment of management. The Company maintains an allowance for doubtful accounts receivable based upon the expected collectibility of all accounts receivable. There was no allowance for doubtful accounts receivable at September 30, 2012 or December 31, 2011.

 

Inventory

 

The Company values its inventories at the lower of cost, which approximates actual cost on a first-in, first-out basis, or market value.  The Company records inventory reserves for estimated obsolescence or unmarketable inventories based upon assumptions about future demand and market conditions.  Once a reserve is established, it is maintained until the product to which it relates is sold or otherwise disposed of. If actual market conditions are less favorable than those expected by management, additional adjustment to inventory valuation may be required.  As of September 30, 2012 and December 31, 2011, inventory was not significant and has been included in the prepaid expenses and other current assets line item of the condensed consolidated balance sheet.

 

Revenue Recognition

 

General

 

The Company generates revenue from the licensing of its IP and sales of IC products. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery or performance has occurred, the sales price is fixed or determinable, and collectibility is reasonably assured. Evidence of an arrangement generally consists of signed agreements or customer purchase orders.

 

Licensing

 

Licensing revenue consists of fees earned from license agreements, development services and support and maintenance. For stand-alone license agreements or license deliverables in multi-deliverable arrangements that do not require significant development, modification or customization, revenues are recognized when all revenue recognition criteria have been met. Delivery of the licensed technology is typically the final revenue recognition criterion met, at which time revenue is recognized. If any of the criteria are not met, revenue recognition is deferred until such time as all criteria have been met.

 

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When sales arrangements contain multiple deliverables (e.g., license and services), the Company reviews each deliverable to determine the separate units of accounting that exist within the agreement. If more than one unit of accounting exists, the consideration payable to the Company under the agreement is allocated to each unit of accounting using the relative fair value method. Revenue is recognized for each unit of accounting when the revenue recognition criteria have been met for that unit of accounting. The Company allocates revenue among the deliverables using the relative selling price method. Revenue allocated to each element is recognized when the basic revenue recognition criteria is met for each element. Under GAAP, the Company is required to apply a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence of fair value (VSOE), (ii) third-party evidence of selling price (TPE) and (iii) best estimate of the selling price (ESP). In general, the Company is unable to establish VSOE or TPE for license fees and development services.  Therefore revenue is allocated to these elements based on the Company’s ESP, which the Company determines after considering multiple factors such as management approved pricing guidelines, geographic differences, market conditions, competitor pricing strategies, internal costs and gross margin objectives. These factors may vary over time depending upon the unique facts and circumstances related to each deliverable. If the facts and circumstances underlying the factors considered change or should future facts and circumstances lead the Company to consider additional factors, the Company’s ESP for license fee and development services could change.

 

For license agreements involving deliverables that do require significant production, modification or customization, and where the Company has significant experience in meeting the design specifications in the contract and the direct labor hours related to services under the contract can be reasonably estimated, the Company recognizes revenue over the period in which the contract services are performed. For these arrangements, the Company recognizes revenue using the percentage of completion method. Under this method, revenue recognized in any period depends on the Company’s progress toward completion of projects in progress. Significant management judgment and discretion are used to estimate total direct labor hours. These judgmental elements include determining that the Company has the experience to meet the design specifications and estimate the total direct labor hours to perform the contract services, based on experience in developing prior licensees’ designs. The direct labor hours for the development of the licensee’s design are estimated at the beginning of the contract. As the direct labor hours are incurred, they are used as a measure of progress towards completion. During the contract performance period, the Company reviews estimates of direct labor hours to complete the contracts and will revise its estimates of revenue and gross profit under the contract if it revises the estimations of the direct labor hours to complete. The Company’s policy is to reflect any revision in the contract gross profit estimate in reported income or loss in the period in which the facts giving rise to the revision become known. Under the percentage of completion method, provisions for estimated losses on uncompleted contracts are recorded in the period in which such losses are determined to be likely. If the amount of revenue recognized under the percentage of completion accounting method exceeds the amount of billings to a customer, the excess amount is recorded as an unbilled contracts receivable. Unbilled contracts receivable as of September 30, 2012 and December 31, 2011 are not considered significant and have been included in the prepaid expenses and other current assets line item of the condensed consolidated balance sheets.

 

The Company provides support and maintenance under many of its license agreements. Under these arrangements, the Company provides unspecified upgrades, design rule changes and technical support. No other upgrades, products or other post-contract support are provided. Support and maintenance revenue is recognized at its fair value established by VSOE, ratably over the period during which the obligation exists, typically 12 months. These arrangements are generally renewable annually by the customer.

 

Under limited circumstances, the Company also recognizes prepaid pre-production royalties as license revenues. These are lump sum payments made when the Company enters into licensing agreements that cover future shipments of a product that is not commercially available from the licensee. The Company characterizes such payments as license revenues because they are paid as part of the initial license fee and not with respect to products being produced by the licensee. These payments are non-cancelable and non-refundable.

 

Royalty

 

The Company’s licensing contracts typically also provide for royalties based on licensees’ use of the Company’s memory technology in their currently shipping commercial products. The Company recognizes royalties in the quarter in which it receives the licensee’s report. Under limited circumstances, the Company may also recognize prepaid post-production royalties as revenue upon execution of the contract, which are paid in a lump sum after the licensee commences production of the royalty-bearing product and applied against future unit shipments regardless of the actual level of shipments by the licensee. The criteria for revenue recognition of prepaid royalties are that a formal agreement with the licensee is executed, no deliverables, development or support services related to prepaid royalties are required, the fees are non-refundable and not contingent upon future product shipments by the licensee, and the fees are payable by the licensee in a time period consistent with the Company’s normal billing terms. If any of these criteria are not met, the Company defers revenue recognition until such time as all criteria have been met.

 

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IC products

 

The Company sells products both directly to customers, as well as through distributors.  Revenue from sales directly to customers is generally recognized at the time of shipment. The Company records an estimated allowance, at the time of shipment, for future returns and other charges against revenue consistent with the terms of sale.  IC product revenue and costs relating to sales made through distributors with rights of return and stock rotation are deferred until the distributors sell the product to end customers due to the Company’s inability to estimate future returns and credits to be issued.  At the time of shipment to distributors, an accounts receivable for the selling price is recorded, as there is a legally enforceable right to receive payment, and inventory is relieved, as legal title to the inventory is transferred upon shipment.  Revenues are recognized upon receiving notification from the distributors that products have been sold to end customers. Distributors provide information regarding products and quantity, end customer shipments and remaining inventory on hand.  The associated deferred margin is included in the deferred revenues line item in the condensed consolidated balance sheet.  The Company recorded initial IC product revenue in 2012, and a significant reserve for returns has been recorded due to the product’s early stage of development and testing. IC product revenue was not significant for the three and nine months ended September 30, 2012, and has been included in the licensing and other revenue line item in the condensed consolidated statements of operations and comprehensive loss.

 

Cost of Revenue

 

Cost of licensing and other revenue consists primarily of engineering personnel and overhead allocation costs directly related to development services specified in licensing agreements and direct and indirect costs of IC product sales. Development services typically include customization of the Company’s technologies for the licensee’s particular IC design and may include engineering support to assist in the commencement of production of a licensee’s products.

 

Goodwill

 

The Company reviews goodwill for impairment on an annual basis or whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. The Company first assesses qualitative factors to determine whether it is more-likely-than-not that the fair value of the reporting unit is less than the carrying amount as a basis for determining whether it is necessary to perform the two-step impairment test. If the qualitative assessment warrants further analysis, the Company compares the fair value of the reporting unit to its carrying value. The fair value of the reporting unit is determined using the market approach. If the fair value of the reporting unit exceeds the carrying value of net assets of the reporting unit, goodwill is not impaired, and the Company is not required to perform further testing. If the carrying value of the net assets of the reporting unit exceeds the fair value of the reporting unit, then the Company must perform the second step in order to determine the implied fair value of the reporting unit’s goodwill and compare it to the carrying value of the reporting unit’s goodwill. If the carrying value of the reporting unit’s goodwill exceeds its implied fair value, then the Company must record an impairment charge equal to the difference. The Company has determined that it has a single reporting unit for purposes of performing its goodwill impairment test. The Company performed the annual impairment test in September 2012, and the test did not indicate impairment of goodwill, as the fair value exceeded the carrying value of the reporting unit by approximately 44%. As the Company used the market approach to assess impairment, the price of its common stock is an important component of the fair value calculation. If the Company’s stock price continues to experience significant price and volume fluctuations, this will impact the fair value of the reporting unit, which can lead to potential impairment in future periods. As of September 30, 2012, the Company had not identified any factors to indicate there was an impairment of our goodwill and determined that no additional impairment analysis was required.

 

Intangible Assets

 

Intangible assets acquired in business combinations, referred to as purchased intangible assets, are accounted for based on the fair value of assets purchased and are amortized over the period in which economic benefit is estimated to be received. Identifiable intangible assets relating to business combinations and the patent license were as follows (dollar amounts in thousands):

 

		September 30, 2012
		Life (years)		Gross Carrying Amount			Accumulated Amortization			Net Carrying Value
Developed technology		3-5		$	9,240		$	7,032		$	2,208
Customer relationships		3		390			390			—
Subtotal purchased intangible assets				9,630			7,422			2,208
Patent license		7		780			84			696
Total				$	10,410		$	7,506		$	2,904

 

		December 31, 2011
		Life (years)		Gross Carrying Amount			Accumulated Amortization			Net Carrying Value
Developed technology		3-5		$	9,240		$	5,676		$	3,564
Customer relationships		3		390			334			56
Contract backlog		1		750			750			—
Non-compete agreements		1.5		140			140			—
Subtotal purchased intangible assets				10,520			6,900			3,620
Patent license		7		780			—			780
Total				$	11,300		$	6,900		$	4,400

 

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The related amortization expense was $0.3 million and $0.7 million for the three months ended September 30, 2012 and 2011, respectively. The related amortization expense was $1.5 million and $2.0 million for the nine months ended September 30, 2012 and 2011, respectively. Amortization expense has been included in research and development expense in the condensed consolidated statements of operations and comprehensive loss.  The estimated aggregate amortization expense to be recognized in future years is approximately $0.3 million for the remainder of 2012, $1.0 million for 2013, $1.0 million for 2014, $0.3 million for 2015 and $0.1 million annually for 2016 through 2018.

 

Per Share Amounts

 

Basic net loss per share is computed by dividing net loss for the period by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share gives effect to all potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of incremental shares of common stock issuable upon the exercise of stock options, vesting of stock awards and purchases under the employee stock purchase plan. As of September 30, 2012 and 2011, stock awards to purchase approximately 10,990,000 and 10,129,000 shares, respectively, were excluded from the computation of diluted net loss per share as their inclusion would be anti-dilutive.

 

Note 2. Fair Value of Financial Instruments

 

The estimated fair values of financial instruments outstanding were as follows (in thousands):

 

		September 30, 2012
		Cost			Unrealized Gains			Unrealized Losses			Fair Value
Cash and cash equivalents		$	5,967		$	—		$	—		$	5,967
Short-term investments:
U.S. government debt securities		$	10,628		$	4		$	—		$	10,632
Corporate notes and commercial paper		14,403			15			(1		)	14,417
Certificates of deposit		5,156			3			—			5,159
Total short-term investments		$	30,187		$	22		$	(1	)	$	30,208
Long-term investments:
U.S. government debt securities		$	6,770		$	2		$	—		$	6,772
Corporate notes		2,074			2			—			2,076
Certificates of deposit		240			1			—			241
Total long-term investments		$	9,084		$	5		$	—		$	9,089

 

		December 31, 2011
		Cost			Unrealized Gains			Unrealized Losses			Fair Value
Cash and cash equivalents		$	40,025		$	—		$	—		$	40,025
Short-term investments:
U.S. government debt securities		$	4,834		$	2		$	—		$	4,836
Corporate notes		4,578			1			(2		)	4,577
Total short-term investments		$	9,412		$	3		$	(2	)	$	9,413
Long-term investments:
U.S. government debt securities		$	5,721		$	1		$	(1	)	$	5,721
Corporate notes		2,816			2			(2		)	2,816
Total long-term investments		$	8,537		$	3		$	(3	)	$	8,537

 

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As of September, 30, 2012 and December 31, 2011, all of the available-for-sale securities with unrealized losses had been in a loss position for less than 12 months. Total fair value of available-for-sale securities with unrealized losses was $7.6 million at September 30, 2012.

 

Cost and fair value of investments based on two maturity groups were as follows (in thousands):

 

		September 30, 2012
		Cost			Unrealized Gains			Unrealized Losses			Fair Value
Due within 1 year		$	30,187		$	22		$	(1	)	$	30,208
Due in 1-2 years		9,084			5			—			9,089
Total		$	39,271		$	27		$	(1	)	$	39,297

 

		December 31, 2011
		Cost			Unrealized Gains			Unrealized Losses			Fair Value
Due within 1 year		$	9,412		$	3		$	(2	)	$	9,413
Due in 1-2 years		8,537			3			(3		)	8,537
Total		$	17,949		$	6		$	(5	)	$	17,950

 

The following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and investments) as of September 30, 2012 and December 31, 2011 (in thousands):

 

		September 30, 2012
		Fair Value			Level 1			Level 2			Level 3
Money market funds		$	1,445		$	1,445		$	—		$	—
Certificates of deposit		5,400			—			5,400			—
Corporate notes and commercial paper		20,019			—			20,019			—
U.S. government debt securities		17,905			—			17,905			—
Total assets		$	44,769		$	1,445		$	43,324		$	—

 

		December 31, 2011
		Fair Value			Level 1			Level 2			Level 3
Money market funds		$	2,792		$	2,792		$	—		$	—
Corporate notes		7,393			—			7,393			—
U.S. government debt securities		10,557			—			10,557			—
Total assets		$	20,742		$	2,792		$	17,950		$	—

 

There were no transfers in or out of Level 1 and Level 2 securities during the three and nine months ended September 30, 2012 and 2011. There were no Level 3 financial assets as of September 30, 2012 or December 31, 2011.

 

Note 3:        Asset Purchase Agreement

 

In March 2012, the Company entered into an asset purchase agreement for an exclusive license of a portion of its intellectual property pertaining to its high-speed serial I/O technology for approximately $4.3 million.  As part of the agreement, the Company provided certain technology transfer support services, and 15 employees of the Company’s India subsidiary accepted employment with the purchaser.  The Company received approximately $2.2 million, net of transaction costs, in cash upon execution of the agreement.  The agreement provides for an additional $1.9 million (the “Holdback”) to be paid upon providing technology transfer support services and achievement of certain contractually agreed-upon development milestones.  A portion of the Holdback is reserved for any costs related to indemnification claims that may arise during the 12 month period following the agreement date. In July 2012, $1.3 million of the Holdback payment was received.

 

The Company recognized a $1.4 million and $3.3 million gain on this asset sale, net of transaction costs, during the three and nine months ended September 30, 2012, respectively.  The gain on asset sale has been recorded as a reduction of operating expenses in the condensed consolidated statements of operations and comprehensive loss.  Gains related to the remaining Holdback will be recorded when the indemnity period lapses, which is expected to be within 12 months of the agreement date.

 

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Note 4. Commitments and Contingencies

 

Indemnifications

 

In the ordinary course of business, the Company enters into contractual arrangements under which it may agree to indemnify the counterparties from any losses incurred relating to breach of representations and warranties, failure to perform certain covenants, or claims and losses arising from certain events as outlined within the particular contract, which may include, for example, losses arising from litigation or claims relating to past performance. Such indemnification clauses may not be subject to maximum loss clauses. The Company has entered into indemnification agreements with its officers and directors. No material amounts were reflected in the Company’s condensed consolidated financial statements for the three and nine months ended September 30, 2012 or 2011 related to these indemnifications.

 

The Company has not estimated the maximum potential amount of indemnification liability under these agreements due to the limited history of prior claims and the unique facts and circumstances applicable to each particular agreement. To date, the Company has not made any payments related to these indemnification agreements.

 

Legal Matters

 

The Company is not a party to any material legal proceeding that the Company believes is likely to have a material adverse effect on its consolidated financial position or results of operations. From time to time, the Company may be subject to legal proceedings and claims in the ordinary course of business. These claims, even if not meritorious, could result in the expenditure of significant financial resources and diversion of management efforts.

 

In September 2010, a claimant filed suit against the Company seeking a contractual payment of approximately 200,000 shares of the Company’s common stock, among other claims. In November 2010, the suit went to arbitration, and, in December 2010, the Company filed a counter claim against the claimant.  On April 3, 2012, the arbitrator ruled against the Company and awarded the claimant a cash award of approximately $1.4 million, which was paid in the second quarter of 2012 and has been recorded as a repurchase of common stock in the condensed consolidated statement of cash flows.  The Company repurchased the disputed shares in the second quarter of 2012, and the shares were retired.  In the first quarter of 2012, the value of the disputed shares, $0.8 million as of the arbitration settlement date, was recorded as a reduction to stockholders’ equity as a stock repurchase.  The remaining amount of $0.6 million was recorded as a selling, general and administrative expense in the Company’s condensed consolidated statements of operations and comprehensive loss.

 

Note 5. Business Segments and Significant Customers

 

The Company operates in one business segment and uses one measurement of profitability for its business. Revenue attributed to the United States and to all foreign countries is based on the geographical location of the customer.

 

The Company recognized revenue from customers in North America, Asia and Europe as follows (in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2012			2011			2012			2011
United States		$	600		$	638		$	2,217		$	3,072
Taiwan		473			785			1,244			2,422
Japan		247			511			940			2,721
Europe		7			173			86			715
Other Asia		—			—			—			8
Total		$	1,327		$	2,107		$	4,487		$	8,938

 

Customers who accounted for at least 10% of total revenues were as follows:

 

		Three Months Ended September 30,				Nine Months Ended September 30,
		2012		2011		2012		2011
Customer A		36	%	37	%	27	%	27	%
Customer B		34	%	17	%	32	%	14	%
Customer C		*		*		*		14	%
Customer D		*		13	%	*		*

*Represents percentages less than 10%.

 

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One customer accounted for 100% of net accounts receivable at September 30, 2012. Four customers accounted for 96% of net accounts receivable at December 31, 2011.

 

Note 6. Income Tax Provision

 

The Company determines deferred tax assets and liabilities based upon the differences between the financial statement and tax bases of the Company’s assets and liabilities using tax rates in effect for the year in which the Company expects the differences to affect taxable income. A valuation allowance is established for any deferred tax assets for which it is more likely than not that all or a portion of the deferred tax assets will not be realized.

 

The Company files U.S. federal and state and foreign income tax returns in jurisdictions with varying statutes of limitations.  The Company is currently under tax examination in India.  The 2003 through 2011 tax years generally remain subject to examination by federal, state and foreign tax authorities.  As of September 30, 2012, the Company has not recorded any liability for unrecognized tax benefits related to uncertain tax positions.

 

Note 7. Stock-Based Compensation

 

The Company recorded $0.9 million of stock-based compensation expense for both the three months ended September 30, 2012 and 2011. The Company recorded $3.0 million and $2.5 million of stock-based compensation expense for the nine months ended September 30, 2012 and 2011, respectively. The expense relating to stock-based awards is recognized on a straight-line basis over the requisite service period, usually the vesting period, based on the grant-date fair value. The unamortized compensation cost, net of expected forfeitures, as of September 30, 2012 was $5.7 million and is expected to be recognized as expense over a weighted average period of approximately 2.74 years.

 

The Company presents the tax benefits resulting from tax deductions in excess of the compensation cost recognized from the exercise of stock options as financing cash flows in the condensed consolidated statements of cash flows. For the three and nine months ended September 30, 2012 and 2011, there were no such tax benefits associated with the exercise of stock options due to the Company’s loss position.

 

Common Stock Options and Restricted Stock

 

A summary of the option and restricted stock unit activity under the Company’s Amended and Restated 2000 Stock Option and Equity Incentive Plan and 2010 Equity Incentive Plan (2010 Plan), referred to collectively as the “Plans,” is presented below (in thousands, except exercise price):

 

				Options Outstanding
		Available for Grant		Number of Shares		Weighted Average Exercise Prices
Balance at December 31, 2011		1,977		6,528		$	4.48
Additional shares authorized under the 2010 Plan		500		—		—
Options granted		(4	)	4		$	3.93
Options cancelled		111		(111	)	$	4.23
Options exercised		—		(34	)	$	2.85
Options expired		(55	)	—		—
Balance at March 31, 2012		2,529		6,387		$	4.50
Options granted		(430	)	430		$	3.23
Options cancelled		361		(361	)	$	6.70
Options exercised		—		(20	)	$	1.98
Options expired		(235	)	—		—
Balance at June 30, 2012		2,225		6,436		$	4.30
Options granted		(1,338	)	1,338		$	3.23
Options cancelled		356		(356	)	$	5.77
Options exercised		—		(78	)	$	2.29
Options expired		(209	)	—		—
Balance at September 30, 2012		1,034		7,340		$	4.04

 

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The Company also has awarded options to new employees outside of the Plans and may continue to do so outside of the 2010 Plan, as material inducements to the acceptance of employment with the Company, as permitted under the Listing Rules of the Nasdaq Stock Market. These grants must be approved by the compensation committee of the board of directors, a majority of the independent directors or, below a specified share level, by an authorized executive officer.

 

A summary of the inducement grant option activity is presented below (in thousands, except exercise price):

 

		Options Outstanding
		Number of Shares		Weighted Average Exercise Prices
Balance at December 31, 2011		4,815		$	3.29
Granted		350		$	3.92
Cancelled		(103	)	$	1.54
Exercised		(111	)	$	1.54
Balance at March 31, 2012		4,951		$	3.41
Cancelled		(199	)	$	1.55
Exercised		(438	)	$	1.55
Balance at June 30, 2012		4,314		$	3.69
Cancelled		(248	)	$	1.55
Exercised		(597	)	$	1.55
Balance at September 30, 2012		3,469		4.21

 

The following table summarizes significant ranges of outstanding and exercisable options, excluding restricted stock awards and restricted stock unit activity, as of September 30, 2012 (in thousands, except contractual life and exercise price):

 

		Options Outstanding										Options Exercisable
Range of Exercise Price		Number Outstanding		Weighted Average Remaining Contractual Life (in Years)		Weighted Average Exercise Price			Aggregate Intrinsic value			Number Exercisable		Weighted Average Remaining Contractual Life (in Years)		Weighted Average Exercise Price			Aggregate Intrinsic value
$1.50 - $3.09		2,995		3.79		$	2.30		$	5,224		1,408		2.72		$	1.85		$	3,087
$3.10 - $3.92		3,048		4.73		$	3.62		1,291			1,042		3.96		$	3.71		339
$3.93 - $5.61		3,216		3.48		$	4.96		—			2,756		3.43		$	5.03		—
$5.62 - $15.00		1,550		2.93		$	6.70		—			1,043		2.17		$	7.03		—
		10,809		3.84		$	4.09		$	6,515		6,249		3.15		$	4.43		$	3,426

 

As of September 30, 2012, the Company had 9.9 million shares subject to outstanding options fully vested and expected to vest, after estimated forfeitures, with a remaining contractual life of 3.72 years, weighted average exercise price of $4.13 and aggregate intrinsic value of $6.0 million.

 

The total fair value of shares subject to outstanding options vested calculated using the Black-Scholes valuation method was $1.7 million and $1.2 million for the nine months ended September 30, 2012 and 2011, respectively. The total intrinsic value of employee stock options exercised during the nine months ended September 30, 2012 and 2011 was $2.3 million and $2.2 million, respectively.

 

Options to purchase 6.2 million and 5.8 million shares with weighted average exercised prices of $4.43 and $4.36 per share were exercisable at September 30, 2012 and 2011, respectively.

 

Valuation Assumptions and Expense Information

 

The fair value of the Company’s share-based payment awards for the three and nine months ended September 30, 2012 and 2011 was estimated on the grant date using a Black-Scholes valuation method and an option-pricing model with the following assumptions:

 

		Three Months Ended September 30,				Nine Months Ended September 30,
		2012		2011		2012		2011
Employee stock options:
Risk-free interest rate		0.2% – 0.6%		0.2% – 0.7%		0.2% – 0.8%		0.2% – 1.7%
Volatility		65.2% – 73.1%		40.7% – 61.3%		65.2% – 73.1%		40.7% – 63.8%
Expected life (years)		4.0		4.0		4.0		4.0
Dividend yield		0%		0%		0%		0%

 

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The risk-free interest rate was derived from the Daily Treasury Yield Curve Rates as published by the U.S. Department of the Treasury as of the grant date for terms equal to the expected terms of the options. The expected volatility was based on the combination of: 1) four-year historical volatility and 2) implied volatility of the Company’s stock price. The expected term of options granted was derived from historical data based on employee exercises and post-vesting employment termination behavior. A dividend yield of zero is applied because the Company has never paid dividends and has no intention to pay dividends in the near future.

 

The stock-based compensation expense recorded is adjusted based on estimated forfeiture rates. An annualized forfeiture rate has been used as a best estimate of future forfeitures based on the Company’s historical forfeiture experience. The stock-based compensation expense will be adjusted in later periods if the actual forfeiture rate is different from the estimate.

 

Employee Stock Purchase Plan

 

In June 2010, the Company’s stockholders approved the 2010 Employee Stock Purchase Plan (ESPP). A total of 2,000,000 shares of common stock has been reserved for issuance under the ESPP. The ESPP, which is intended to qualify under Section 423 of the Internal Revenue Code, is administered by the board of directors or the compensation committee of the board of directors. The ESPP provides that eligible employees may purchase up to $25,000 worth of the Company’s common stock annually over the course of two six-month offering periods. The purchase price to be paid by participants is 85% of the price per share of the Company’s common stock either at the beginning or the end of each six-month offering period, whichever is less.  On February 29, 2012, approximately 178,000 shares of common stock were issued at an aggregate purchase price of $579,000 under the ESPP.  On August 30, 2012, approximately 173,000 shares of common stock were issued at an aggregate purchase price of $501,000 under the ESPP.  As of September 30, 2012, there were approximately 1,335,000 shares authorized and unissued under the ESPP.

 

Note 8. Related Party Transaction

 

In February 2012, the Company entered into a strategic development and marketing agreement with Credo Semiconductor (Hong Kong) Ltd. (Credo), a privately-funded fabless semiconductor company, to develop, market and sell integrated circuits.  Two of the Company’s executive officers are investors in Credo.  The agreement calls for the Company to pay approximately $1.4 million to Credo upon Credo achieving certain development and verification milestones towards the development of IC products and provides the Company with exclusive sales and marketing rights for such IC products.   In the first nine months of 2012, Credo achieved a number of the milestones set forth in the agreement and, in the third quarter of 2012, delivered the IC designs to its foundry for tape-out. As a result of the milestone achievements, the Company paid Credo $1.0 million, which the Company recorded as research and development expense.  As of September 30, 2012, $0.1 million is included as a current liability.  The first $1.2 million of gross profits generated by the sale of these integrated circuits will be retained by the Company.  Thereafter, the gross profits will be shared equally by the two companies.

 

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

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the accompanying condensed consolidated financial statements and notes included in this report. This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which include, without limitation, statements about the market for our technology, our strategy, competition, expected financial performance, all information disclosed under Item 3 of this Part I, and other aspects of our business identified in our most recent annual report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2012 and in other reports that we file from time to time with the Securities and Exchange Commission. Any statements about our business, financial results, financial condition and operations contained in this Form 10-Q that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” or similar expressions are intended to identify forward-looking statements. Our actual results could differ materially from those expressed or implied by these forward-looking statements as a result of various factors, including the risk factors described below in Risk Factors and elsewhere in this report and under Item 1A of our annual report on Form 10-K for the year ended December 31, 2011. We undertake no obligation to update publicly any forward-looking statements for any reason, except as required by law, even as new information becomes available or events occur in the future.

 

Overview

 

Our strategy and primary business objective is to become a fabless semiconductor company focused on the development and sale of integrated circuits (ICs) to networking equipment systems providers and their subsystem and component vendors. Our Bandwidth Engine family of ICs combines our 1T-SRAM high-density embedded memory and high-speed 10 Gigabits per second (Gbps) serial

 

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