Applied Micro Circuits 10Q 2003 Q2 Quarterly report

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 fiscal quarter ended September 30, 2002

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: 000-23193

APPLIED MICRO CIRCUITS CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware		94-2586591
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

6290 Sequence Drive, San Diego, CA 92121

(Address of principal executive offices)

Registrant’s telephone number, including area code: (858) 450-9333

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

As of November 1, 2002, 302,114,334 shares of the Registrant’s Common Stock were issued and outstanding.

APPLIED MICRO CIRCUITS CORPORATION

INDEX

		Page
Part I	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets at September 30, 2002 (unaudited) and March 31, 2002	3

	Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended September 30, 2002 and 2001	4

	Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended September 30, 2002 and 2001	5

	Notes to Condensed Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13

Item 3	Quantitative and Qualitative Disclosures About Market Risk	32

Item 4.	Controls and Procedures	32

Part II.	OTHER INFORMATION

Item 1.	Legal Proceedings	33

Item 4.	Submission of Matters to a Vote of Security Holders	34

Item 5.	Other Information	34

Item 6.	Exhibits and Reports on Form 8-K	34

	Signatures	35

	Certifications	36

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

	September 30, 2002			March 31, 2002
	(unaudited)
ASSETS
Current assets :
Cash and cash equivalents	$	129,072		$	335,592
Short-term investments-available-for-sale		915,152			723,117
Accounts receivable, net of allowance for doubtful accounts—$5,226 and $5,357 at September 30, 2002 (unaudited) and March 31, 2002, respectively		10,933			14,191
Inventories		12,423			16,608
Other current assets		22,912			27,653

Total current assets		1,090,492			1,117,161
Property and equipment, net		91,291			106,412
Goodwill and purchased intangibles, net		280,953			590,610
Strategic equity investments		2,850			14,523
Other assets		397			487

Total assets	$	1,465,983		$	1,829,193

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	14,871		$	18,378
Accrued payroll and related expenses		8,308			9,812
Other accrued liabilities		32,951			25,246
Deferred revenue		1,792			2,223
Current portion of long-term debt and capital lease obligations		1,079			1,138

Total current liabilities		59,001			56,797
Long-term debt and capital lease obligations, less current portion		625			1,145
Stockholders’ equity:
Preferred stock, $0.01 par value:
Authorized shares—2,000, none issued and outstanding		—			—
Common stock, $0.01 par value:
Authorized shares—630,000 at September 30, 2002
Issued and outstanding shares—301,901 at September 30, 2002 (unaudited) and 300,468 at March 31, 2002		3,019			3,005
Additional paid-in capital		5,905,121			5,907,754
Deferred compensation, net		(59,102	)		(170,538	)
Accumulated other comprehensive income		6,425			2,843
Accumulated deficit		(4,449,106	)		(3,971,766	)
Note receivable from stockholder		—			(47	)

Total stockholders’ equity		1,406,357			1,771,251

Total liabilities and stockholders’ equity	$	1,465,983		$	1,829,193

See accompanying Notes to Condensed Consolidated Financial Statements.

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)

	Three Months Ended September 30,						Six Months Ended September 30,
	2002			2001			2002			2001
Net revenues	$	30,219		$	41,302		$	60,374		$	82,508
Cost of revenues (1)(2)		16,084			31,990			32,286			81,425

Gross profit		14,135			9,312			28,088			1,083
Operating expenses:
Research and development (1)		33,441			39,770			68,938			78,823
Selling, general and administrative (1)		14,989			19,355			31,315			39,792
Stock-based compensation (1)		35,936			36,793			104,680			73,586
Amortization of goodwill and purchased intangibles		—			23,339			—			192,887
Other purchased intangible asset impairment charges		—			—			204,284			—
Goodwill impairment charge		—			—			—			3,101,817
Restructuring costs		3,000			11,177			5,500			11,177

Total operating expenses		87,366			130,434			414,717			3,498,082

Operating loss		(73,231	)		(121,122	)		(386,629	)		(3,496,999	)
Other income (expense), net		(12,811	)		(4,995	)		(12,941	)		(13,737	)
Interest income, net		13,606			13,162			24,459			26,787

Net loss before income taxes and cumulative effect of accounting change		(72,436	)		(112,955	)		(375,111	)		(3,483,949	)
Income tax expense (benefit)		—			(17,012	)		—			(49,826	)

Net loss before cumulative effect of accounting change		(72,436	)		(95,943	)		(375,111	)		(3,434,123	)
Cumulative effect of accounting change		—			—			(102,229	)		—

Net loss	$	(72,436	)	$	(95,943	)	$	(477,340	)	$	(3,434,123	)

Net loss per share:
Basic and diluted net loss per share before cumulative effect of accounting change	$	(0.24	)	$	(0.32	)	$	(1.25	)	$	(11.49	)
Cumulative effect of accounting change		—			—			(0.34	)		—

Basic and diluted net loss per share	$	(0.24	)	$	(0.32	)	$	(1.59	)	$	(11.49	)

Shares used in calculating basic and diluted loss per share		300,701			299,235			300,256			298,892


(1) Stock-based compensation expense related to acquired companies isexcluded from the following (in thousands):
Cost of revenues	$	419		$	1,227		$	1,856		$	2,454
Research and development		11,413			18,368			52,090			36,735
Selling, general and administrative		24,104			17,198			50,734			34,397

	$	35,936		$	36,793		$	104,680		$	73,586


(2) Cost ofrevenues includes the following acquisition-related and other special charges (in thousands):
Amortization of developed core technology	$	1,571		$	14,586		$	3,143		$	29,170
Special excess inventory charge		—			—			—			15,859

	$	1,571		$	14,586		$	3,143		$	45,029

See accompanying Notes to Condensed Consolidated Financial Statements.

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

	Six Months Ended September 30,
	2002			2001
Operating Activities:
Net loss	$	(477,340	)	$	(3,434,123	)
Adjustments to reconcile net loss to net cash provided by (used for) operating activities:
Cumulative effect of accounting change		102,229			—
Depreciation and amortization		16,424			14,661
Amortization of purchased intangibles		3,143			222,057
Goodwill and other intangible asset impairment charges		204,284			3,101,817
Amortization of deferred compensation		104,682			73,586
Tax benefit of disqualifying dispositions		—			5,545
Noncash restructuring costs		45			8,727
Net loss on strategic equity investments		11,650			13,775
Loss on disposals of property and equipment		1,270			119
Changes in assets and liabilities:
Accounts receivable		3,258			62,795
Inventories		4,185			11,741
Other assets		5,951			(6,554	)
Accounts payable		(3,507	)		(12,173	)
Accrued payroll and other accrued liabilities		6,156			7,342
Deferred income taxes		—			(56,674	)
Deferred revenue		(431	)		3,895

Net cash provided by (used for) operating activities		(18,001	)		16,536
Investing Activities:
Proceeds from sales and maturities of investments		1,553,988			1,825,370
Purchases of investments		(1,742,544	)		(1,697,456	)
Proceeds from sales of strategic equity investments		—			2,902
Notes receivable from employees		(19	)		98
Purchase of property and equipment		(3,651	)		(18,996	)

Net cash provided by (used for) investing activities		(192,226	)		111,918
Financing Activities:
Proceeds from issuance of common stock, net		4,135			9,597
Repurchase of common stock		—			(29,397	)
Payment on note receivable from stockholder		47			—
Payments on capital lease obligations		(228	)		(274	)
Payments on long-term debt		(351	)		(329	)
Other		104			30

Net cash provided by (used for) financing activities		3,707			(20,373	)

Net increase (decrease) in cash and cash equivalents		(206,520	)		108,081
Cash and cash equivalents at beginning of period		335,592			58,197

Cash and cash equivalents at end of period	$	129,072		$	166,278

Supplemental disclosure of cash flow information:
Cash paid for:
Interest	$	84		$	116

Income taxes	$	223		$	698

See accompanying Notes to Condensed Consolidated Financial Statements.

APPLIED MICRO CIRCUITS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

The financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended March 31, 2002.

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 amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. These estimates include among others, assessing the collectibility of accounts receivable, inventory valuation, costs of future product returns under warranty, the valuation of deferred income taxes, the fair value and useful lives of intangible assets and the valuation of strategic equity investments. Actual results could differ from those estimates.

Reclassification

Certain prior period amounts have been reclassified to conform to the current period presentation.

Accounting Change

Effective April 1, 2002, the Company completed the adoption of Statement of Financial Accounting Standards (SFAS) 142, “Goodwill and Other Intangible Assets”. SFAS 142 requires that the Company discontinue amortizing the remaining balances of goodwill. All remaining and future acquired goodwill will be subject to impairment tests annually, or earlier if indicators of potential impairment exist, using a fair-value-based approach. All other intangible assets will continue to be amortized over their estimated useful lives and assessed for impairment under SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” As a result of the implementation of SFAS 142, the Company recorded a non-cash charge of approximately $102.2 million to reduce the carrying value of its goodwill as of April 1, 2002. Such charge is reflected as the cumulative effect of an accounting change in the accompanying condensed consolidated statements of operations. See Note 4.

The following table presents the impact of SFAS 142 on the net loss and the net loss per share as if SFAS 142 had been in effect for all periods presented in the interim condensed consolidated statements of operations (in thousands except per share data):

	Three Months Ended September 30,						Six Months Ended September 30,
	2002			2001			2002			2001
Net loss—as reported	$	(72,436	)	$	(95,943	)	$	(477,340	)	$	(3,434,123	)
Adjustments:
Cumulative effect of accounting change		—			—			102,229			—
Amortization of goodwill		—			21,012			—			188,232
Amortization of assembled workforce previously classified as purchased intangible assets		—			1,048			—			2,097
Income tax effect		—			424			—			849

Total adjustments		—			22,484			102,229			191,178

Net loss—as adjusted	$	(72,436	)	$	(73,459	)	$	(375,111	)	$	(3,242,945	)

Basic and diluted net loss per share—as reported	$	(0.24	)	$	(0.32	)	$	(1.59	)	$	(11.49	)

Basic and diluted net loss per share—as adjusted	$	(0.24	)	$	(0.25	)	$	(1.25	)	$	(10.85	)

2. NET LOSS PER SHARE

The reconciliation of the net loss used to calculate basic and diluted loss per share consists of the following (in thousands except per share data):

	Three Months Ended September 30,						Six Months Ended September 30,
	2002			2001			2002			2001
Net loss (numerator):
Net loss before cumulative effect of accounting change	$	(72,436	)	$	(95,943	)	$	(375,111	)	$	(3,434,123	)
Cumulative effect of accounting change		—			—			(102,229	)		—

Net loss	$	(72,436	)	$	(95,943	)	$	(477,340	)	$	(3,434,123	)


Shares used in basic and diluted net loss per share computation (denominator):
Weighted average common shares outstanding		301,528			301,103			301,124			300,812
Less: Unvested common shares outstanding		827			1,868			868			1,920

Shares used in basic and diluted net loss per share computation		300,701			299,235			300,256			298,892

Basic and diluted net loss per share:
Basic and diluted net loss per share before cumulative effect of accounting change	$	(0.24	)	$	(0.32	)	$	(1.25	)	$	(11.49	)
Cumulative effect of accounting change		—			—			(0.34	)		—

Basic and diluted net loss per share	$	(0.24	)	$	(0.32	)	$	(1.59	)	$	(11.49	)

Because the Company incurred net losses for the three and six months ended September 30, 2002 and 2001, the effect of dilutive securities has been excluded from the net loss per share computation as its impact would be antidilutive. The dilutive securities (in thousands) totaled 2,929 and 3,556 equivalent shares for the three and six months ended September 30, 2002, respectively, and 10,196 and 11,605 equivalent shares for the three and six months ended September 30, 2001, respectively.

3. CERTAIN FINANCIAL STATEMENT INFORMATION

	September 30, 2002		March 31, 2002
Inventories (in thousands):
Finished goods	$	5,605	$	3,356
Work in process		5,961		12,485
Raw materials		857		767

	$	12,423	$	16,608

	September 30, 2002			March 31, 2002
Property and equipment (in thousands):
Machinery and equipment	$	78,837		$	81,084
Leasehold improvements		16,820			16,873
Computers, office furniture and equipment		72,106			82,382
Land		22,160			22,160

		189,923			202,499
Less accumulated depreciation and amortization		(98,632	)		(96,087	)

	$	91,291		$	106,412

	Three Months Ended September 30,						Six Months Ended September 30,
	2002			2001			2002			2001
Other income (expense), net includes the following (in thousands):
Gain on strategic equity investments	$	—		$	—		$	—		$	1,225
Recognized impairments on strategic equity investments		(11,650	)		(5,000	)		(11,650	)		(15,000	)
Gains (losses) on disposals of property and equipment, net		(1,144	)		(47	)		(1,270	)		(119	)
Other		(17	)		52			(21	)		157

	$	(12,811	)	$	(4,995	)	$	(12,941	)	$	(13,737	)

	Three Months Ended September 30,						Six Months Ended September 30,
	2002			2001			2002			2001
Interest income, net includes the following (in thousands):
Interest income	$	10,405		$	12,496		$	19,945		$	26,172
Net realized gains (losses) from short-term investments		3,241			721			4,598			732
Interest expense		(40	)		(55	)		(84	)		(117	)

	$	13,606		$	13,162		$	24,459		$	26,787

4. GOODWILL AND OTHER PURCHASED INTANGIBLE ASSETS

As discussed in Note 1, effective April 1, 2002, the Company adopted SFAS 142, which requires the Company to discontinue amortizing goodwill and certain intangible assets with indefinite useful lives. Instead, all remaining balances of goodwill will be reviewed annually for impairment. Upon adoption on April 1, 2002, the Company completed its first impairment test, which resulted in the recording of a non-cash charge of $102.2 million to reduce the carrying value of its goodwill. In calculating the impairment charge, the fair value of the impaired reporting unit was estimated using both the

discounted cash flow methodology as well as a market comparable approach. This charge is reflected as the cumulative effect of an accounting change in the accompanying condensed consolidated statements of operations.

In performing the fair value analysis as required under SFAS 142, it became evident, as a result of lower revenue forecasts, that certain other purchased intangible assets were also impaired. As a result of these indicators of impairment to the carrying value of the Company’s other purchased intangible assets, the Company performed an analysis of these assets as required under SFAS 144 and recorded an additional non-cash charge of $187.9 million for the impairment of developed core technology. In addition, the Company recorded a non-cash charge of $16.3 million as a result of the abandonment of the MMC Networks trademark in the first quarter of fiscal 2003. These charges are reflected as operating expenses in the condensed consolidated statement of operations for the six months ended September 30, 2002.

Net goodwill and other acquisition-related intangibles were as follows (dollar amounts in thousands):

	Life in Years	September 30, 2002		March 31, 2002
Goodwill	N/A	$	262,089	$	358,014
Developed core technology	5		18,864		209,956
Assembled workforce	N/A		—		6,304
Trademark	5		—		16,336

		$	280,953	$	590,610

As required by SFAS 142, assembled workforce was reclassified to goodwill effective April 1, 2002. The total balances presented above are net of accumulated amortization and impairments of $4.0 billion and $3.7 billion at September 30, 2002 and March 31, 2002, respectively.

Amortization of other purchased intangibles was $1.6 million and $3.1 million for the three and six months ended September 30, 2002 and $15.9 million and $31.7 million for the three and six months ended September 30, 2001.

In June 2001, as a result of the then current industry conditions, lower market valuations and reduced estimates of carrier capital equipment spending, the Company determined that there were indicators of impairment to the carrying value of goodwill. Based on a review of the value of the intangible assets in accordance with SFAS 121, “Accounting for the Impairment of Long-Lived Assets and for Long-lived Assets to Be Disposed Of”, the Company recorded a charge of $3.1 billion to write down the value of intangible assets associated with its purchase acquisitions. This charge is reflected as operating expense in the condensed consolidated statement of operations for the six months ended September 30, 2001.

5. RESTRUCTURING COSTS

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

•

Closure of wafer manufacturing facility—In June 2002, the Company completed its plan to discontinue manufacturing non-communication ICs and close its internal wafer manufacturing facility. As a result, the Company recorded a charge of $2.5 million in the first quarter of fiscal 2003. The charge is comprised of severance packages for the manufacturing workforce, which had been notified of the reduction prior to June 30, 2002, and estimated facility restoration costs. The cash payments for severance and facilities restoration costs are estimated to be made by the end of the first quarter of fiscal 2004.

•

Global workforce reduction—In an effort to reduce the Company’s expenses and lower its breakeven point, in July 2002, the Company began implementation of a workforce reduction plan. This global workforce reduction plan resulted in a $3.0 million restructuring charge in the second quarter of fiscal 2003. Of this amount, $2.8 million is related to employee severance and approximately $200,000 is related to closing a design center and disposing of the assets. The payments for amounts related to employee severance were substantially paid as of September 30, 2002, and the remainder will be paid by the end of fiscal 2003. The amounts for the consolidation of facilities will be paid through the end of the related lease term.

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

•

Workforce reduction—Approximately 5% of the workforce was eliminated, which resulted in severance payments of approximately $900,000 for fiscal 2002.

•

Consolidation of excess facilities—As a result of the Company’s acquisitions and significant internal growth in fiscal 2001, the Company expanded its number of locations throughout the world. In an effort to improve the efficiency of the workforce and reduce the cost structure, the Company implemented a plan to consolidate its workforce into certain designated facilities. As a result, a charge of approximately $2.0 million was recognized in the second quarter of fiscal 2002, primarily relating to non-cancelable lease commitments.

•

Property and equipment impairments—During fiscal 2000 and 2001, the Company aggressively expanded its manufacturing capacity in order to meet demand. As a result of the sharp decrease in demand in fiscal 2002, the Company recorded a charge of approximately $5.6 million in the second quarter of fiscal 2002, for the elimination of certain excess manufacturing equipment related to older process technologies. In addition, the Company recorded a charge of approximately $3.1 million relating to the abandonment of certain leasehold improvements and software licenses in connection with the restructuring plan.

Payments in conjunction with the workforce reduction in the July 2001 plan were substantially paid by the end of fiscal 2002. Amounts related to the consolidation of facilities will be paid over the respective lease terms through fiscal 2005. The estimated costs to exit these facilities are based on available commercial rates and an estimate of the time required to sublet the facilities. The actual loss incurred in exiting these facilities may differ from our estimates.

A summary of the July 2002 and July 2001 restructuring costs is as follows (in thousands):

	Total Costs		Noncash Charges			Cash Payments			Liability, September 30, 2002
July 2002 restructuring program:
Closure of wafer manufacturing facility:
Workforce reduction	$	1,500	$	—		$	—		$	1,500
Facilities restoration costs		1,000		—			—			1,000

		2,500		—			—			2,500
Global workforce reduction:
Employee severance		2,760		—			(2,527	)		233
Consolidation of excess facilities		195		—			(41	)		154
Property and equipment impairments		45		(45	)		—			—

		3,000		(45	)		(2,568	)		387

July 2002 restructuring costs		5,500		(45	)		(2,568	)		2,887
July 2001 restructuring program:
Workforce reduction		900		—			(900	)		—
Consolidation of excess facilities		1,950		—			(1,216	)		734
Property and equipment impairments		8,727		(8,727	)		—			—

July 2001 restructuring costs		11,577		(8,727	)		(2,116	)		734

Total restructuring costs	$	17,077	$	(8,772	)	$	(4,684	)	$	3,621

6. STRATEGIC EQUITY INVESTMENTS

During the three months ended September 30, 2002, the Company recorded an impairment charge of $11.7 million to reduce the carrying value of its strategic equity investments. This charge reflects an other-than-temporary decline in the value of these private equity securities as a result of lower market valuations and declining private capital markets. Of the total $11.7 million impairment charge, $9.0 million is related to an investment made in Raza Foundries, Inc. in which S. Atiq Raza, an AMCC director, is the Chief Executive Officer and Chairman of the Board of Directors. During the six months ended September 30, 2001, the Company also recorded an impairment charge of $15.0 million, which was partially offset by a recognized gain of $1.2 million. These amounts are included in other income (expense), net in the Company’s unaudited condensed consolidated statements of operations for the periods indicated.

7. COMPREHENSIVE INCOME (LOSS)

The components of comprehensive income (loss) are as follows (in thousands):

	Three Months Ended September 30,						Six Months Ended September 30,
	2002			2001			2002			2001
Net loss	$	(72,436	)	$	(95,943	)	$	(477,340	)	$	(3,434,123	)
Change in net unrealized gain on available-for-sale investments, net of tax		1,290			3,828			3,479			4,983
Foreign currency translation adjustment		7			65			103			14

Comprehensive income (loss)	$	(71,139	)	$	(92,050	)	$	(473,758	)	$	(3,429,126	)

8. CONTINGENCIES

In April 2001, a series of similar federal complaints were filed against the Company and certain executive officers and directors of the Company. The complaints have been consolidated into a single proceeding in the U.S. District Court for the Southern District of California.In re Applied Micro Circuits Corp. Securities Litigation, lead case number 01-CV-0649-K(AB). In November 2001, the court appointed the lead plaintiff and lead plaintiff’s counsel in the consolidated proceeding, and plaintiff filed a consolidated federal complaint in January 2002. The consolidated federal complaint alleged violations of the Securities Exchange Act of 1934 (the “1934 Act”) and was brought as a purported shareholder class action under Sections 10(b), 20(a) and 20A of the 1934 Act and Rule 10b-5 under the 1934 Act. Plaintiff sought monetary damages on behalf of the shareholder class. Defendants brought a motion to dismiss the consolidated federal complaint in March 2002. On May 9, 2002, the court granted the motion, dismissing the complaint, but giving plaintiff 45 days to file an amended complaint. On June 23, 2002, plaintiff filed an amended consolidated complaint. In general, the consolidated amended federal complaint alleges that the Company and the individual defendants misrepresented the Company’s financial prospects for the quarters ended December 31, 2000 and March 30, 2001, in order to inflate the value of the Company’s stock. Defendants brought a motion to dismiss the consolidated amended complaint, which motion was denied in October 2002. The Company expects that discovery in this matter will commence during the third quarter of fiscal 2003.

In May 2001, a series of similar state derivative actions were filed against the directors and certain executive officers of the Company. The state complaints have been coordinated and assigned to the Superior Court of California in the County of San Diego.Applied Micro Circuits Shareholders Cases, No. JCCP No. 4193. In November 2001, the court appointed liaison plaintiffs’ counsel in the coordinated proceeding, and plaintiffs filed a consolidated state complaint in December 2001. The consolidated state complaint alleges overstatement of the financial prospects of the Company, mismanagement, inflation of stock value and sale of stock at inflated prices for personal gain during the period from November 2000 through February 2001. Defendants demurred to the consolidated state complaint, which demurrer was partially granted and partially overruled in February 2002. In February 2002, the Company’s Board of Directors formed a special litigation committee to evaluate the claims in the consolidated state complaint. The special litigation committee retained independent legal counsel and submitted a report to the court in July 2002. Defendants intend to file motions seeking dismissal of the actions, which motions are expected to be heard by the court in early 2003. Limited discovery against the individual defendants in this lawsuit and third parties has commenced. The court has ordered limited discovery to take place regarding the special litigation committee’s report. The Company expects that such discovery will take place during the third quarter and conclude in the fourth quarter of fiscal 2003.

The Company believes that the allegations in these lawsuits are without merit and intends to defend the lawsuits vigorously. The Company cannot predict the likely outcome of these lawsuits, and an adverse result in either lawsuit could have a material adverse effect on the Company. The lawsuits have been tendered to the Company’s insurance carriers.

The Company is party to various claims and legal actions arising in the normal course of business, including notification of possible infringement on the intellectual property rights of third parties. Since 1993, the Company has been named as a potentially responsible party (“PRP”) along with a large number of other companies that used Omega Chemical Corporation (“Omega”) in Whittier, California to handle and dispose of certain hazardous waste material. The Company is a member of a large group of PRPs that has agreed to fund certain remediation efforts at the Omega site for which the Company has accrued approximately $100,000. On September 14, 2000, the Company entered into a consent decree with the Environmental Protection Agency, pursuant to which the Company agreed to fund its proportionate share of the initial remediation efforts at the Whittier site. Although the ultimate outcome of these matters is not presently determinable, management believes that the resolution of all such pending matters, net of amounts accrued, will not have a material adverse effect on the Company’s financial position or liquidity; however, there can be no assurance that the ultimate resolution of these matters will not have a material impact on the Company’s results of operations in any period.

9. RELATED PARTY TRANSACTIONS

From time to time the Company charters an aircraft for business travel from an aircraft charter company, which manages an aircraft owned by a company that AMCC’s Chairman of the Board, Chief Executive Officer and President controls. The Board of Directors unanimously approved a resolution to limit such charters to Company-related business matters at rates not to exceed market prices, up to a maximum of $800,000 in fiscal 2003. In the six months ended September 30, 2002, the Company expensed a total of $400,000 for such charters.

10. SUBSEQUENT EVENTS

On October 16, 2002, the Company’s Board of Directors approved a stock repurchase program. Under this program, the Company is authorized to purchase up to $200 million in shares of its common stock.

11. RECENT ACCOUNTING PRONOUNCEMENTS

In June 2002, the Financial Accounting Standards Board (FASB) issued SFAS 146,“Accounting for Costs Associated with Exit or Disposal Activities”, which addresses issues regarding the recognition, measurement and reporting of costs associated with exit and disposal activities, including restructuring activities. This statement requires that costs associated with exit or disposal activities be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. SFAS 146 is effective for all exit or disposal activities initiated after December 31, 2002. The Company has not yet determined the effect, if any, of the adoption of this statement on its results of operations and financial condition.

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

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

•

Caution concerning forward-looking statements. This section discusses how certain forward-looking statements made by us throughout the MD&A are based on management’s present expectations about future events and are inherently susceptible to uncertainty and changes in circumstances.

•

Overview. This section provides a general description of our business.

•

Critical accounting policies. This section discusses those accounting policies that are both considered important to our financial condition and operating results and require significant judgment and estimates on the part of management in their application.

•

Results of operations. This section provides an analysis of our results of operations for the three and six months ended September 30, 2002 and 2001. In addition, a brief description is provided of transactions and events that impact the comparability of the results being analyzed.

•

Financial condition and liquidity. This section provides an analysis of our cash position and cash flows, as well as a discussion of our financing arrangements.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

This MD&A should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended March 31, 2002. This Quarterly Report on Form 10-Q, and in particular the MD&A, contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those described in the section entitled “Risk Factors”. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our present expectations and analysis and are inherently susceptible to uncertainty and changes in circumstances. We assume no obligation to update these forward-looking statements to reflect changes in factors or assumptions affecting such forward-looking statements.

OVERVIEW

We design, develop, manufacture, and market high-performance, high-bandwidth silicon solutions empowering intelligent wide area networks. We utilize a combination of digital, mixed-signal and high-frequency analog design expertise coupled with system-level knowledge and multiple silicon process technologies to offer integrated circuit products that enable the transport of voice and data over wide area networks. Our system solution portfolio includes switch fabric, traffic management, network processor, framer/mapper, physical layer, and physical media dependent devices that address the high-performance needs of the evolving intelligent wide area network. In addition, we supply silicon ICs for the automated test equipment, or ATE, high-speed computing and military markets.

CRITICAL ACCOUNTING POLICIES

The U.S. Securities and Exchange Commission (“SEC”) recently issued Financial Reporting Release No. 60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies” (“FRR 60”), suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the SEC defined the most critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include: inventory valuation, which affects our cost of sales and gross margin; the valuation of purchased intangibles and goodwill, which affects our amortization and write-offs of goodwill and other intangibles; the valuation of strategic equity investments, which affects our other income and expense; and valuation of deferred income taxes, which affects our income tax expense and benefit. We also have other key accounting policies, such as our policies for revenue recognition, including the deferral of a portion of revenues on sales to distributors, and allowance for bad debt. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our financial statements.

Inventory Valuation

Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess or obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future demand for our products within a specified time horizon, generally 12 months. The estimates we use for demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. If our demand forecast is greater than our actual demand we may be required to take additional excess inventory charges, which will decrease gross margin and net operating results in the future. In addition, as a result of the downturn in demand for our products, we have excess capacity in our manufacturing facilities. Currently, we are not capitalizing any inventory costs related to this excess capacity as the recoverability of such costs is not certain. The application of this policy adversely affects our gross margin.

Goodwill and Intangible Asset Valuation

The determination of the fair value of certain acquired assets and liabilities is subjective in nature and often involves the use of significant estimates and assumptions. Determining the fair values and useful lives of intangible assets especially requires the exercise of judgment. To assist us in this process we used an independent valuation firm. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets acquired, we primarily use the discounted cash flow method. This method requires significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required such as residual growth rates and discount factors. The estimates we have used are consistent with the plans and estimates that we use to manage our business, based on available historical information and industry averages. The judgments made in determining the estimated useful lives assigned to each class of assets acquired can also significantly affect our net operating results.

In the first quarter of fiscal 2003, we adopted the new rules for measuring the impairment of goodwill and certain intangible assets under SFAS 142 and SFAS 144. Under the new accounting guidance, the estimates and assumptions described above, as well as the determination as to how goodwill is allocated to our operating segments, had an effect on the amount of the impairment charge we recorded in the first quarter of fiscal 2003.

In addition, the value of our intangible assets, including goodwill, is exposed to future impairments if we experience further declines in operating results or additional negative industry or economic trends or if our future performance is below our projections and estimates.

Valuation of Strategic Equity Investments

We enter into certain equity investments for the promotion of business and strategic objectives. Based on our level of ownership interest, our policy is to value these investments at our historical cost. In addition, our policy requires us to periodically review these investments for impairment. For these investments, an impairment analysis requires significant judgment, including an assessment of the investees’ financial condition, the existence and valuation of any subsequent rounds of financing and the impact of any contractual preferences, as well as the investees’ historical results, projected results, prospects for additional financing, and prevailing market conditions. If the actual outcomes for the investees are significantly different from our estimates, our recorded impairments may be understated, and we may incur additional charges in future periods.

Valuation of Deferred Income Taxes

We record valuation allowances to reduce our deferred tax assets to an amount that we believe is more likely than not to be realized. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If we determine that we will not realize all or part of our deferred tax assets in the future, we would make an adjustment to the carrying value of the deferred tax asset, which would be reflected as an income tax expense. Conversely, if we determine that we will realize a deferred tax asset, which currently has a valuation allowance, we would be required to reverse the valuation allowance which would be reflected as an income tax benefit.

Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101 “Revenue Recognition in Financial Statements” (“SAB 101”). SAB 101 requires that four basic criteria be met before revenue can be recognized: 1) evidence an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met. The criteria are usually met at the

time of product shipment, except for shipments to distributors with rights of return. Revenue from shipments to distributors with rights of return are deferred until all return or cancellation privileges lapse. In addition, we record reductions to revenue for estimated allowances such as returns and competitive pricing programs. If actual returns or pricing adjustments exceed our estimates, additional reductions to revenue would result.

Allowance for Bad Debt

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

RESULTS OF OPERATIONS

Net Revenues. Net revenues for the three and six months ended September 30, 2002 were $30.2 million and $60.4 million, respectively, a decrease of 27% from net revenues of $41.3 million and $82.5 million for the three and six months ended September 30, 2001, respectively.

The decline in revenues for the three and six months ended September 30, 2002 when compared to the three and six months ended September 30, 2001 is primarily due to a decrease in the volume of shipments of our communications ICs. This volume decrease was driven by reduced demand for our communications products as our customers for these products faced slower demand for their products. This decrease in the volume of shipments of our communication ICs was partially offset by increases in the shipments of our non-communications ICs. Revenues from sales of our non-communications products increased to 40% of net revenues for both the three and six months ended September 30, 2002 from 13% of net revenues for both the three and six months ended September 30, 2001. The increase in the non-communications IC revenue was driven by the fulfillment of certain last-time-buy orders generated as a result of the planned closure of the manufacturing facility in which our non-communications ICs are made. We expect that revenues from our non-communications products will decline materially over the next few quarters as we complete the last-time-buy orders. We anticipate that we will be substantially done fulfilling the last-time-buy orders by the fourth quarter of fiscal 2003. Due to the prolonged downturn in the communications portion of our business and lack of backlog visibility, we are not able to assess the near-term trend for our total net revenues, although we currently believe that net revenues for the three months ended December 31, 2002 will be less than the net revenues for the three months ended September 30, 2002.

Based on direct shipments, the percentage of net revenues to customers exceeding 10% of net revenues were as follows:

	Three Months Ended September 30,				Six Months Ended September 30,
	2002		2001		2002		2001
Harris Corporation	27	%	1	%	27	%	1	%
Insight Electronics	7	%	14	%	7	%	7	%
Solectron Corporation	5	%	10	%	4	%	12	%

Looking through product shipments to distributors and subcontractors, the percentage of net revenues on an end-customer basis exceeding 10% of net revenues were as follows:

	Three Months Ended September 30,				Six Months Ended September 30,
	2002		2001		2002		2001
Harris Corporation	27	%	2	%	27	%	1	%
Nortel Networks Corporation	18	%	12	%	14	%	13	%
Cisco Systems, Inc.	6	%	15	%	6	%	10	%

Sales outside of North America accounted for 29% and 30% of net revenues for the three and six months ended September 30, 2002, respectively, compared to 30% and 40% for the three and six months ended September 30, 2001, respectively.

Gross Margin. Gross margin was 47% for both the three and six months ended September 30, 2002, respectively, compared to 23% and 1% for the three and six months ended September 30, 2001, respectively. The increase in gross margin was primarily attributable to decreases in non-cash acquisition-related charges and a special prior year charge for excess inventory of $15.9 million.

In the three and six months ended September 30, 2002, cost of revenues included approximately $1.6 million and $3.1 million of non-cash purchased intangible amortization, respectively, compared to $14.6 million and $29.2 million in the three and six months ended September 30, 2001, respectively. Excluding the effect of these non-cash amortization charges and the special inventory charge in the three months ended June 30, 2001, gross margin was 52% for both the three and six months ended September 30, 2002, compared to 58% and 56% in the three and six months ended September 30, 2001, respectively. This decrease in gross margin, exclusive of non-cash purchase accounting charges and the special inventory charge, reflects the under utilization of our manufacturing facilities and a decrease in the volume of our product shipments, as well as accelerated depreciation as a result of the decision to close the internal wafer manufacturing facility. Due to the current market conditions and uncertainty with respect to expected shipment volumes, we anticipate that gross margin will continue to be affected by fluctuations in the volume of our product sales, fluctuations in wafer costs, ongoing non-cash amortization of purchased intangibles and the under utilization of our manufacturing facilities. However, when the closure of our wafer manufacturing facility is complete, currently estimated to be the end of our fiscal year, we expect to reduce the manufacturing facility under utilization included in cost of revenues by approximately $3.0 million per quarter. At September 30, 2002, the balance of purchased intangible assets expected to be charged to cost of revenues was $18.9 million. See “Amortization of Goodwill and Purchased Intangibles.”

Research and Development. Research and development (“R&D”) expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities, costs related to engineering design tools, subcontracting costs and facilities expenses. R&D expenses decreased 16% to approximately $33.4 million and 13% to approximately $68.9 million for the three and six months ended September 30, 2002, respectively, from approximately $39.8 million and $78.8 million for the three and six months ended September 30, 2001, respectively. The decrease in R&D spending is a result of streamlining and prioritizing our product development efforts, reducing subcontracting costs and the effect of the global workforce reduction. We believe that a continued commitment to R&D is vital to maintain a leadership position with innovative communications products. Currently, R&D expenses are focused on the development of products and processes for the communications markets, and we expect to continue this focus. We expect R&D in absolute dollars to decrease modestly on a quarterly basis throughout fiscal 2003 as we continue to streamline our cost structure and implement our workforce reduction program. See “Restructuring Costs” below.

Selling, General and Administrative. Selling, general and administrative (“SG&A”) expenses consist primarily of personnel-related expenses, professional and legal fees, corporate branding and facilities expenses. SG&A expenses were approximately $15.0 million, or 50% of net revenues, and $31.3 million, or 52% of net revenues, for the three and six months ended September 30, 2002, respectively, as compared to approximately $19.4 million, or 47% of net revenues, and $39.8 million, or 48% of net revenues, for the three and six months ended September 30, 2001, respectively. The decrease in SG&A expenses in absolute dollars was primarily attributable to the decrease in payroll and related benefits as a result of reduced headcount, decreases in commissions as a result of lower net revenues and lower travel and marketing expenses as we reduced discretionary spending. We expect SG&A in absolute dollars to decrease modestly on a quarterly basis throughout fiscal 2003, as we continue cost reduction programs, reduce discretionary spending and implement our workforce reduction program. See “Restructuring Costs” below.

Stock-based Compensation. Stock-based compensation expense represents the amortization of deferred compensation as well as any expense related to options subject to variable accounting. Deferred compensation is the difference between the fair value of our common stock at the date of an acquisition and the exercise price of the unvested stock options assumed in the acquisition. In fiscal 2001, we recorded approximately $438.8 million of deferred compensation, in connection with stock options assumed in our purchase acquisitions. Stock-based compensation charges were $35.9 million and $104.7 million for the three and six months ended September 30, 2002, respectively, compared to $36.8 million and $73.6 million for the three and six months ended September 30, 2001, respectively. The increase for the six months ended September 30, 2002 is related to an acceleration of the deferred compensation charge in the first quarter of fiscal 2003 resulting from the voluntary cancellation of certain employees’ stock options in connection with our stock option exchange program. We currently expect to record amortization of deferred compensation with respect to these assumed options of approximately $132.7 million, $30.7 million, and $398,000 during the fiscal years ending March 31, 2003, 2004, and 2005, respectively. These charges could be reduced based on the level

of employee turnover. Future acquisitions of businesses may result in substantial additional charges. Such charges may cause fluctuations in our interim or annual operating results.

Amortization of Goodwill and Purchased Intangibles. Goodwill is recorded as the amount by which the aggregate consideration paid for an acquisition exceeds the fair value of the net tangible and intangible assets acquired. Purchased intangible assets include developed technology, trademarks and assembled workforce. As required by SFAS 142, adopted in April 2002, we ceased amortizing goodwill as of the beginning of April 2002 and reclassified $6.3 million of assembled workforce to goodwill. Including the amortization of developed core technology, which is included in cost of revenues, amortization of goodwill and purchased intangible assets was $1.6 million and $3.1 million for the three and six months ended September 30, 2002, respectively, and $37.9 million and $222.1 million for the three and six months ended September 30, 2001, respectively. The decrease is primarily related to discontinuing the periodic amortization of goodwill and the impairment of other purchased intangible assets recorded as of the beginning of April 2002. See “Other Intangible Asset Impairment Charges” below.

We expect amortization expense for other purchased intangibles, including amounts which will be charged to cost of revenues, to be $3.1 million throughout the remainder of fiscal 2003, $6.3 million annually through fiscal 2005 and $3.1 million for fiscal 2006.

Other Purchased Intangible Asset Impairment Charges. In performing the fair value analysis as required under SFAS 142, it became evident, as a result of lower revenue forecasts, that certain other purchased intangible assets were also impaired. As a result of these indicators of impairment to the carrying value of our other purchased intangible assets, we performed an additional analysis of these assets as required under SFAS 144, and recorded an additional non-cash charge of $187.9 for the impairment of developed core technology in the first quarter of fiscal 2003. We also recorded a non-cash charge of $16.3 million as a result of the abandonment of the MMC Networks trademark in the first quarter of fiscal 2003.

Goodwill Impairment Charge. In the first quarter of fiscal 2002, as a result of the then current industry conditions, lower market valuations and reduced estimates of carrier capital equipment spending, we determined that there were indicators of impairment to the carrying value of our goodwill. Based on our review of the value of our intangible assets in accordance with SFAS 121, we recorded a charge of $3.1 billion to write down the value of intangible assets associated with our purchase acquisitions.

Restructuring Costs. As a result of the prolonged downturn in the telecommunications industry and the uncertainty as to when the telecommunication equipment market will recover, in July 2002 the Company announced its second workforce reduction and restructuring program in the last two years. The July 2002 workforce reduction and restructuring program is comprised of the following components:

•

Workforce reduction—Approximately 5% of the workforce was eliminated, which resulted in severance payments of approximately $900,000 for fiscal 2002. These payments were substantially paid by the end of fiscal 2002.

•

Consolidation of excess facilities—As a result of the Company’s acquisitions and significant internal growth in fiscal

2001, the Company expanded its number of locations throughout the world. In an effort to improve the efficiency of the workforce and reduce the cost structure, the Company implemented a plan to consolidate its workforce into certain designated facilities. As a result, a charge of approximately $2.0 million was recognized in the second quarter of fiscal 2002, primarily relating to non-cancelable lease commitments. Amounts related to the consolidation of facilities will be paid over the respective lease terms through fiscal 2005. The estimated costs to exit these facilities are based on available commercial rates and an estimate of the time required to sublet the facilities. The actual loss incurred in exiting these facilities may differ from our estimates.

•

Other Expenses, Net. Other expenses, net, primarily includes recorded gains and losses on strategic equity investments as well as gains and losses from dispositions of property and equipment. Other expenses for the three and six months ended September 30, 2002 primarily consist of a recognized impairment charge of $11.7 million for certain strategic equity investments and losses on certain fixed asset disposals. In the six months ended September 30, 2001, we realized a gain on our strategic equity investments of $1.2 million, offset by an impairment charge of $15.0 million and certain losses on fixed asset disposals.

Interest Income, Net. Net interest income reflects interest earned on average cash and cash equivalents and short-term investment balances, as well as realized gains and losses from the sale of short-term investments, less interest accrued on our debt and capital lease obligations. Net interest income was $13.6 million and $24.5 million for the three and six months ended September 30, 2002, respectively, which is consistent with the $13.2 million and $26.8 million for the three and six months ended September 30, 2001, respectively, due to the realization of gains on sales of short-term investments offset by lower interest income due to lower yields and cash balances in fiscal 2003.

Income Taxes. We recorded no income taxes for the three and six months ended September 30, 2002, compared to income tax benefits of $17.0 million and $49.8 million for the three and six months ended September 30, 2001. The difference between our effective tax rates and the federal statutory rate for the three and six months ended September 30, 2002 primarily resulted from the fact that we are establishing valuation allowances for our deferred tax assets being generated in the current year, as it is more likely than not that our net operating loss and other credit carryforwards will expire unused. The differences between our effective tax rate and our federal statutory rate for the three and six months ended September 30, 2001 resulted from the non-deductibility of certain acquisition-related expenses from our purchase transactions completed during fiscal 2001.

Accounting Change. As a result of the initial impairment review performed as of April 1, 2002 as required by the adoption of SFAS 142, we recorded a non-cash charge of $102.2 million as the cumulative effect of an accounting change. The following table presents the impact of SFAS 142 on the net loss and the net loss per share as if SFAS 142 had been in effect for all periods presented in the interim condensed consolidated statements of operations (in thousands except per share amounts):

	Three Months Ended September 30,						Six Months Ended September 30,
	2002			2001			2002			2001
Net loss—as reported	$	(72,436	)	$	(95,943	)	$	(477,340	)	$	(3,434,123	)
Adjustments:
Cumulative effect of accounting change		—			—			102,229			—
Amortization of goodwill		—			21,012			—			188,232
Amortization of assembled workforce previously classified as purchased intangible assets		—			1,048			—			2,097
Income tax effect		—			424			—			849

Total adjustments		—			22,484			102,229			191,178

Net loss—as adjusted	$	(72,436	)	$	(73,459	)	$	(375,111	)	$	(3,242,945	)

Basic and diluted net loss per share—as reported	$	(0.24	)	$	(0.32	)	$	(1.59	)	$	(11.49	)

Basic and diluted net loss per share—as adjusted	$	(0.24	)	$	(0.25	)	$	(1.25	)	$	(10.85	)

FINANCIAL CONDITION AND LIQUIDITY

As of September 30, 2002, our principal source of liquidity consisted of $1.0 billion in cash, cash equivalents and short-term investments. Working capital as of September 30, 2002 was $1.0 billion, and total long-term debt was only $1.7 million. At the end of September 30, 2002, we had future operating lease obligations not included on our balance sheet totaling $46.4 million, primarily related to facilities and engineering design software tools.

For the six months ended September 30, 2002, we used $18.0 million of cash to fund our operations compared to generating $16.5 million from our operations in the six months ended September 30, 2001. Although we had a net loss of $477.3 million for the six months ended September 30, 2002, $414.3 million, or 87%, was non-cash and related to amortization or impairments of amounts recorded in connection with our purchase acquisitions. The remaining change in operating cash flows for the six months ended September 30, 2002, primarily reflects decreases in receivables, inventories, other assets and accounts payable, plus increases in other accrued liabilities. Net cash provided by operations for the six months ended September 30, 2001 primarily reflects our operating results before non-cash charges, plus decreases in accounts receivable and inventories, offset by deferred taxes.

We used $192.2 million of cash from investing activities during the six months ended September 30, 2002, compared to generating $111.9 million during the six months ended September 30, 2001. The outflow of cash for the six months ended September 30, 2002 primarily represents the net purchases of available-for-sale investments, as we looked to increase our investment return by shifting our cash to investments with longer initial maturities.

Capital expenditures totaled $3.7 million and $19.0 million for the six months ended September 30, 2002 and 2001, respectively. These capital expenditures primarily consisted of the purchases of engineering hardware and design software.

We generated $3.7 million of cash in the six months ended September 30, 2002 from financing activities compared to using $20.4 million for the six months ended September 30, 2001. The major financing source of cash in the six months ended September 30, 2002 was from the sale of our common stock through the exercise of employee stock options and purchases through the employee stock purchase plan. The major use of cash from financing activities was for the repayment of debt and capital lease obligations.

On October 16, 2002, our Board of Directors approved a stock repurchase program whereby we were authorized to expend up to $200 million to purchase our common stock. Depending on market conditions and other factors, repurchases will be made from time to time in the open market and in negotiated transactions, including block transactions, at times and prices considered appropriate by the Company. Such program may be discontinued at any time. Under a similar program which expired in September 2002, the Company repurchased 3.6 million shares of common stock for $29.4 million in the six months ended September 30, 2001.

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

The following table summarizes our contractual obligations as of September 30, 2002 (in thousands):

	Notes Payable		Operating Leases		Capital Leases		Total
Six months ended March 31, 2003	$	386	$	6,655	$	208	$	7,249
Fiscal 2004		516		14,803		679		15,998
Fiscal 2005		—		12,022		—		12,022
Fiscal 2006		—		4,162		—		4,162
Fiscal 2007		—		2,199		—		2,199
Thereafter		—		4,780		—		4,780

Total	$	902	$	44,621	$	887	$	46,410

RISK FACTORS

Before deciding to invest in the Company or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC, including our other reports on Forms 10-K, 10-Q and 8-K. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occur, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose all or part of your investment.

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

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

•

the reduction, rescheduling or cancellation of orders by customers, whether as a result of slowing demand for our customers’ products or their customers’ products, stockpiling of our products or otherwise;

•

fluctuations in the timing and amount of customer requests for product shipments;

•

general communications equipment industry and semiconductor industry conditions, including the effects of the current significant slowdown;

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the availability of external foundry capacity, purchased parts and raw materials;

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the effects of the pending closure of our internal wafer fabrication facility or July 2002 workforce reduction to take place over the remainder of fiscal 2003;

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increases in the costs of products or discontinuance of products by suppliers;

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fluctuations in manufacturing output, yields or other potential problems or delays in the fabrication, assembly, testing or delivery of our products;

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changes in the mix of products that our customers buy;

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the gain or loss of a key customer or significant changes in the financial condition of one or more of our key customers or their key customers;

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our ability to introduce and deliver new products and technologies on a timely basis;

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the announcement or introduction of products and technologies by our competitors;

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competitive pressures on selling prices;

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market acceptance of our products and our customers’ products;

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the amounts and timing of costs associated with warranties and product returns;

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the amounts and timing of investments in research and development;

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

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the amounts and timing of the costs associated with payroll taxes related to stock option exercises;

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costs associated with acquisitions and the integration of acquired companies;

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costs associated with compliance with applicable environmental regulations or remediation;

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the effects of changes in interest rates or the credit worthiness on the value and yield of our short-term investment portfolio;

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costs associated with litigation, including without limitation, litigation judgments or settlements relating to the use or ownership of intellectual property or the pending litigation against us and certain of our executive officers and directors alleging violations of federal securities laws and various state claims;

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

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the effects of war or acts of terrorism, such as disruptions in general economic activity, changes in logistics and security arrangements, and reduced customer demand for our products and services; and

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general economic conditions.

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

We can have revenue shortfalls for a variety of reasons, including:

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a decrease in demand for our customers’ products;

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a decline in the financial condition or liquidity of our customers or their customers;

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delays in the availability of our products;

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a stockpiling of our products by our customers resulting in a reduction in their order patterns as they work through the excess inventory of our products;

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fabrication, test or assembly constraints for devices, which adversely affects our ability to meet our production obligations;

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the reduction, rescheduling or cancellation of customer orders;

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declines in the average selling prices of our products;

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the pending closure of our internal wafer fabrication facility; and

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shortages of raw materials or production capacity constraints that lead our suppliers to allocate available supplies or capacity to customers with resources greater than us and, in turn, interrupt our ability to meet our production obligations.

Our business is characterized by short-term orders and shipment schedules. Customer orders typically can be canceled or rescheduled without significant penalty to the customer. Because we do not have substantial noncancelable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. Our revenues are increasingly derived from sales of ASSPs, or application-specific standard products, as compared to ASICs or application-specific integrated circuits. Customer orders for ASSPs typically have shorter lead times than orders for ASICs, which makes it more difficult for us to predict revenues and inventory levels and adjust production appropriately. If we are unable to plan inventory and production levels effectively, our business, financial condition and operating results could be materially harmed.

From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside suppliers and foundries, we may order materials in advance of anticipated customer demand. This advance ordering has in the past and may in the future result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize, or other factors render our products less marketable.

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

If the downturn in the communications equipment industry continues, our revenues and profitability will continue to be adversely affected.

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

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

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

Our customers are concentrated. The loss of one or more key customers or the diminished demand for our products from a key customer could significantly reduce our revenues and profits.

A relatively small number of customers have accounted for a significant portion of our revenues in any particular period. We have no long-term volume purchase commitments from any of our key customers. Many of our key customers have announced dramatic declines in demand for their products into which our products are incorporated. As a result, new orders from these customers have been deferred, and customers may have overstocked our products. In addition, one or more of our key customers may discontinue operations as a result of consolidation, liquidation or otherwise. Continued reductions, delays and cancellation of orders from our key customers or the loss of one or more key customers could significantly further reduce our revenues and profits. We cannot assure you that our current customers will continue to place orders with us, that orders by existing customers will continue at current or historical levels or that we will be able to obtain orders from new customers.

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

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customers may stop incorporating our products into their own products with limited notice to us and may suffer little or no penalty;

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customers or prospective customers may not incorporate our products in their future product designs;

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design wins with customers may not result in sales to such customers;

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the introduction of a customer’s new products may be late or less successful in the market than planned;

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a customer’s product line using our products may rapidly decline or be phased out;

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our agreements with customers typically do not require them to purchase a minimum amount of our products;

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many of our customers have pre-existing relationships with current or potential competitors that may cause them to switch from our products to competing products;

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we may not be able to successfully develop relationships with additional network equipment vendors;

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our relationship with some of our larger customers may deter other potential customers (who compete with these customers) from buying our products; and

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the continued viability of these customers.

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

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

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

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

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

A significant portion of our revenues in recent periods has been, and is expected to continue to be, derived from sales of products based on SONET, SDH, DWDM, and ATM transmission standards. If the communications market evolves to new standards, we may not be able to successfully design and manufacture new products that address the needs of our customers or gain substantial market acceptance. Although we have developed products for the Gigabit Ethernet and Fibre Channel

communications standards, sales volumes of these products are modest, and we may not be successful in addressing the market opportunities for products based on these standards.

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

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

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

There has been a trend toward industry consolidation among communications IC companies, network equipment companies and telecom companies for several years. We expect this trend toward industry consolidation to continue as companies attempt to strengthen or hold their positions in evolving markets. Consolidation may result in stronger competitors, fewer customers and reduced demand, which in turn could have a material adverse effect on our business, operating results, and financial condition.

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

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

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foreign currency exchange fluctuations;

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changes in regulatory requirements;

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tariffs and other barriers;

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timing and availability of export licenses;

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political and economic instability;

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difficulties in accounts receivable collections;

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difficulties in staffing and managing foreign subsidiary operations;

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difficulties in managing distributors;

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difficulties in obtaining governmental approvals for communications and other products;

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the burden of complying with a wide variety of complex foreign laws and treaties; and

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potentially adverse tax consequences.

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

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

of these securities are subject to interest rate and credit rating risk and will decline in value if interest rates increase or one of the issuers’ credit ratings is reduced. We do not use derivative financial instruments to manage any of these risks or for any other purpose. Although we make investment decisions in accordance with our investment policy guidelines in order to maintain safety and liquidity, increases in interest rates, decreases in the creditworthiness of one or more of the issuers in the portfolio or adverse changes in foreign currency exchange rates could have a material adverse impact on our financial condition or results of operations.

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

The markets for our products are characterized by:

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rapidly changing technologies;

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evolving and competing industry standards;

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short product life cycles;

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changing customer needs;

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emerging competition;

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frequent new product introductions and enhancements;

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increased integration with other functions; and

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rapid product obsolescence.

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

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

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

The communications IC markets are highly competitive and we expect that competition will increase in these markets, due in part to deregulation and heightened international competition. Our ability to compete successfully in our markets depends on a number of factors, including:

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success in designing and subcontracting the manufacture of new products that implement new technologies;

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product quality, reliability and performance;

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customer support;

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time-to-market;

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price;

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production efficiency;

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design wins;

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expansion of production of our products for particular systems manufacturers;

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end-user acceptance of the systems manufacturers’ products;

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market acceptance of competitors’ products; and

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general economic conditions.

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

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

Revenues that are currently derived from non-communications markets have generally been declining and we expect them to continue to decline in future periods.

We have derived significant revenues from product sales to customers in the ATE, high-speed computing and military markets and currently anticipate that we will continue to derive revenues from sales to customers in these markets in the near term. We are not currently developing products for these markets, and have initiated a plan to exit these markets entirely. The plan includes closing the facility where a majority of these products are manufactured, as well as coordinating a last time buy program with our customers in these markets. As a result of the last-time-buy program, our revenues from sales of our non-communications products increased to 40% of net revenues for the three and six months ended September 30, 2002 from 13% of net revenues for the three and six months ended September 30, 2001. We expect that our revenues from our non-communications products will decline materially over the next few quarters as we complete the last-time-buy orders. We anticipate that we will be substantially done fulfilling the last-time-buy orders by the end of fiscal 2003.

The closing of our internal foundry could result in liability and reduced revenues.

A significant portion of our recent revenues has been derived from products developed for and manufactured in our internal foundry. We have announced plans to close our internal foundry by the end of fiscal 2003. Our plans for closing this facility include notifying customers of the closing, giving them an opportunity to place last-time-buy orders and building a supply of certain products. Once the facility is closed, we will not have the ability to manufacture the products designed for manufacture in the facility, which subjects us to substantial risks, including:

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we may be unable to repair or replace defective products;

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we may be unable to fulfill customer orders for products which are not in our inventory;

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if we do not build or effectively store products which we have committed to customers, we may incur liability to these customers;

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if we are unable to successfully design and sell products manufactured in external foundries, our revenues will decline; and,

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costs and liabilities associated with closing the foundry may exceed our estimates.

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

There is intense competition for qualified personnel in the semiconductor industry, in particular design, product and test engineers, and we may not be able to continue to attract and train engineers or other qualified personnel necessary for the development of our business, or to replace engineers or other qualified personnel who may leave our employment in the future. Periods of contraction in our business may inhibit our ability to attract and retain our personnel. Loss of the services of, or failure to recruit, key design engineers or other technical and management personnel could be significantly detrimental to our product and process development programs.

To manage operations effectively, we will be required to continue to improve our operational, financial and management systems and to successfully hire, train, motivate, and manage our employees. The integration of past and future potential

acquisitions will require significant additional management, technical and administrative resources. We cannot be certain that we will be able to manage our expanded operations effectively.

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

We currently rely on outside foundries for the manufacture of the majority of our products. Once we close our internal foundry, all of our products will be manufactured by outside foundries. These outside foundries generally manufacture our products on a purchase order basis and we generally do not have long-term supply arrangements or contracts with these suppliers. A manufacturing disruption experienced by one or more of our outside foundries or a disruption of our relationship with an outside foundry, including discontinuance of our products by that foundry, would negatively impact the production of certain of our products for a substantial period of time. In addition, the transition to the next generation of manufacturing technologies at one or more of our outside foundries could be unsuccessful or delayed.

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

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

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

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reduced control over delivery schedules and quality;

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risks of inadequate manufacturing yields and excessive costs;

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difficulties selecting and integrating new subcontractors;

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the potential lack of adequate capacity during periods of excess demand;

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limited warranties on products supplied to us;

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potential increases in prices; and

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potential misappropriation of our intellectual property.

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

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

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

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

Our yields decline whenever a substantial percentage of wafers must be rejected or a significant number of die on each wafer are nonfunctional. Such declines can be caused by many factors, including minute levels of contaminants in the manufacturing environment, design issues, defects in masks used to print circuits on a wafer and difficulties in the fabrication process. Design iterations and process changes by our suppliers can cause a risk of defects. Many of these problems are difficult to diagnose, are time consuming and expensive to remedy, and can result in shipment delays.

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

Though we intend to close our wafer manufacturing facility by the end of fiscal 2003, we still manufacture a portion of our ICs at that facility. Because the majority of our costs of manufacturing are relatively fixed, downturns in the volumes manufactured by our internal process such as wafer fabrication and test and assembly will result in substantially higher unit costs and may result in reduced gross profit and net income.

Manufacturing ICs requires manufacturing tools which are unique to each product being produced. If one of these unique manufacturing tools was damaged or destroyed, then our ability to manufacture the related product and fulfill any last-time-buy orders would be impaired and our business would suffer until the tools were repaired or replaced.

Due to an industry transition to six-inch, eight-inch and twelve-inch wafer fabrication facilities, there is a limited number of suppliers of the four-inch wafers that we use to build products in our existing manufacturing facility, and we rely on a single supplier for these wafers. We believe that we will have sufficient access to four-inch wafers to support production in our existing fabrication facility until it is closed. However, if we are unable to attain sufficient numbers of these four-inch wafers, it may prevent us from fulfilling our last-time-buy orders with certain customers of our legacy products.

In addition, our manufacturing output or yields may decline as a result of power outages, supply shortages, accidents, natural disasters or other disruptions to the manufacturing process.

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

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

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

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

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

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additional development costs;

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loss of, or delays in, market acceptance;

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diversion of technical and other resources from our other development efforts;

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claims by our customers or others against us; and

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loss of credibility with our current and prospective customers.

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

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

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

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

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

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

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

In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition. The terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce throughout the world and intensified the uncertainty of the U.S. economy and other economies around the world. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

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

We are subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our manufacturing process. Any failure to comply with present or future regulations could result in the imposition of fines, the suspension of production or a cessation of operations. These regulations could require us to acquire costly equipment or incur other significant expenses to comply with environmental regulations or clean up prior discharges. Since 1993, we have been named as a potentially responsible party, along with a large number of other companies that used Omega Chemical Corporation in Whittier, California to handle and dispose of certain

hazardous waste material. We are a member of a large group of potentially responsible parties that has agreed to fund certain remediation efforts at the Omega site, which efforts are ongoing. To date, our payment obligations with respect to these funding efforts have not been material, and we believe that our future obligations to fund these efforts will not have a material adverse effect on our business, financial condition or operating results. Although we believe that we are currently in material compliance with applicable environmental laws and regulations, we cannot assure you that we are or will be in material compliance with these laws or regulations or that our future obligations to fund any remediation efforts, including those at the Omega site, will not have a material adverse effect on our business.

We have in the past and may in the future make acquisitions that will involve numerous risks. We may not be able to address these risks successfully without substantial expense, delay or other operational or financial problems.

The risks involved with acquisitions include:

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diversion of management’s attention;

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failure to retain key personnel;

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difficulty in completing an acquired company’s in-process research or development projects;

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amortization of acquired intangible assets and deferred compensation;

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customer dissatisfaction or performance problems with an acquired company’s products or services;

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the cost associated with acquisitions and the integration of acquired operations;

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ability of the acquired companies to meet their financial projections; and

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assumption of unknown liabilities, or other unanticipated events or circumstances.

As with past purchase acquisitions, future acquisitions could adversely affect operating results. In particular, acquisitions may materially and adversely affect our results of operations because they may require large one-time charges or could result in increased debt or contingent liabilities, adverse tax consequences, substantial additional depreciation or deferred compensation charges. In connection with our six purchase acquisitions in fiscal 2001, we recorded goodwill in the aggregate amount of approximately $4.0 billion. In accordance with SFAS 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of”, we recorded a goodwill impairment charge of $3.1 billion in the three months ended June 30, 2001 to write down the value of goodwill associated with certain of our purchase transactions. In connection with the adoption of SFAS 141, “Business Combinations” and SFAS 142, “Goodwill and Other Intangible Assets” in the first quarter of fiscal 2003, we recorded a $102.2 million charge for the impairment of the carrying value of goodwill and an additional $204.3 million for the estimated impairment of the carrying value of other purchased intangibles. There can be no assurance that we will not be required to take additional significant charges as a result of an impairment to the carrying value of goodwill or other intangible assets. Any of these risks could materially harm our business, financial condition and results of operations. Any business that we acquire may not achieve anticipated revenues or operating results.

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

We are aware of several lawsuits in which we, our chief executive officer, chief financial officer and certain of our other executive officers and directors, have been sued for alleged violations of federal securities laws related to alleged misrepresentations regarding our financial prospects for the fourth quarter of fiscal 2001. We believe that the claims being brought against us, our officers and directors are without merit, and we intend to engage in a vigorous defense of such claims. If we are not successful in our defense of such claims, we could be forced to make significant payments to our stockholders and their lawyers, and such payments could have a material adverse effect on our business, financial condition and results of operations if not covered by our insurance carriers. Even if such claims are not successful, the litigation could result in substantial costs and divert management’s attention and resources, which could have an adverse effect on our business.

We may not be able to protect our intellectual property adequately.

We rely in part on patents to protect our intellectual property. We cannot assure you that our pending patent applications or any future applications will be approved, or that any issued patents will adequately protect the intellectual property in our products, provide us with competitive advantages or will not be challenged by third parties, or that if challenged, will be found to be valid or enforceable. Furthermore, others may independently develop similar products or processes, duplicate our products or processes or design around any patents that may be issued to us.

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

We could be harmed by litigation involving patents and proprietary rights.

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

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

Our stock price is volatile.

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

•

our anticipated or actual operating results;

•

announcements or introductions of new products;

•

technological innovations or setbacks by us or our competitors;

•

conditions in the semiconductor, telecommunications, data communications or high-speed computing markets;

•

the commencement or outcome of litigation;

•

changes in ratings and estimates of our performance by securities analysts;

•

announcements of merger or acquisition transactions;

•

our inclusion in certain stock indices; and

•

other events or factors.

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

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

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

approval of the holders of the outstanding shares of preferred stock. The issuance of preferred stock could have a dilutive effect on our stockholders.

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

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We maintain an investment portfolio of various holdings, types and maturities. These securities are classified as available-for-sale and, consequently, are recorded on the consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. We invest our excess cash in debt instruments of the U.S. Treasury, governmental agencies and corporations with strong credit ratings as specified in our investment policy. We have also established guidelines relative to diversification and maturities that attempt to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of trends in yields and interest rates. We do not use derivative financial instruments.

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange, interest rates and a decline in the stock market. We do not hold or enter into derivatives or other financial instruments for trading or speculative purposes. We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.

We are exposed to market risk as it relates to changes in the market value of our investments. At September 30, 2002, our investment portfolio includes fixed-income securities classified as available-for-sale investments with a fair market value of $915.2 million and a cost basis of $905.3 million. These securities are subject to interest rate risk, as well as credit risk, and will decline in value if interest rates increase or an issuer’s credit rating is decreased. The following table presents the hypothetical changes in fair value of our short-term investments held at September 30, 2002 (in thousands):

	Valuation of Securities Given an Interest Rate Decrease of X Basis Points						Fair Value as of September 30, 2002		Valuation of Securities Given an Interest Rate Increase of X Basis Points
Issuer	(150 BPS)		(100 BPS)		(50 BPS)		Fair Value as of September 30, 2002		(50 BPS)		(100 BPS)		(150 BPS)
U.S. government and government agency notes and bonds	$	457,131	$	450,380	$	444,350	$	437,362	$	431,209	$	425,271	$	419,656
Corporate notes and bonds and other		493,552		488,143		482,887		477,790		472,832		468,011		463,309

Total	$	950,683	$	938,523	$	927,237	$	915,152	$	904,041	$	893,282	$	882,965

These instruments are not leveraged and are held for purposes other than trading. The modeling technique used measures the change in fair value arising from selected potential changes in interest rates. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points (“BPS”), 100 BPS, and 150 BPS, which are representative of the historical movements in the Federal Funds Rate.

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

We generally conduct business, including sales to foreign customers, in U.S. dollars, and as a result, we have limited foreign currency exchange rate risk. The effect of an immediate 10 percent change in foreign exchange rates would not have a material impact on our financial condition or results of operations.

ITEM 4. CONTROLS AND PROCEDURES

On November 4, 2002, the Company’s chief executive officer and chief financial officer performed an evaluation of the Company’s disclosure controls and procedures. Based on that evaluation, the chief executive officer and chief financial officer concluded that the Company’s disclosure controls and procedures were effective and sufficient to ensure that information required to be disclosed by the Company in the reports that it files under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

There have been no significant changes in the Company’s internal controls since November 4, 2002. The Company is not aware of any significant change in any other factors that could significantly affect its internal controls subsequent to November 4, 2002.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

We held our annual meeting of stockholders on August 28, 2002. Of the 300,876,538 shares of our common stock that could be voted at the annual meeting, 260,769,290 shares, or 87%, were represented at the annual meeting in person or by proxy, which constituted a quorum. Voting results were as follows:

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

	For	Withheld
Cesar Cesaratto	257,926,771	2,842,519
Franklin P. Johnson, Jr.	256,679,229	4,090,061
Kevin N. Kalkhoven	258,026,492	2,742,798
L. Wayne Price	256,723,445	4,045,845
S. Atiq Raza	257,991,067	2,778,223
David M. Rickey	256,772,569	3,996,721
Roger A. Smullen, Sr.	257,838,954	2,930,336
Douglas C. Spreng	257,931,290	2,838,000
Arthur B. Stabenow	257,879,913	2,889,377
Harvey P. White	257,997,385	2,771,905

(b) Ratification of the appointment of Ernst & Young LLP as our independent auditors for the fiscal year ending March 31, 2003:

For		Against		Abstain
251,182,268		8,426,436		1,159,486

ITEM 5. OTHER INFORMATION

This report when filed with the SEC was accompanied by written statements by David Rickey, our chief executive officer, and William Bendush, our chief financial officer, as required by Section 906 of the Sarbanes-Oxley Act of 2002.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

10.39 Separation Agreement by and between the Company and Douglas C. Spreng.

(b) Reports on Form 8-K

The Company did not file any current reports on Form 8-K with the SEC during the quarter ended September 30, 2002.

SIGNATURES

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

APPLIED MICRO CIRCUITS CORPORATION

By:		/s/ WILLIAM BENDUSH
		William Bendush Senior Vice President and Chief Financial Officer (Duly Authorized Signatory and Principal Financial Officer)

Date: November 5, 2002

CERTIFICATIONS

I, David Rickey, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Applied Micro Circuits Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent function):

a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


		/s/ DAVID RICKEY
		David Rickey, Chief Executive Officer

Dated: November 5, 2002

I, William Bendush, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Applied Micro Circuits Corporation;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and


		/s/ WILLIAM BENDUSH
		William Bendush, Chief Financial Officer

Dated: November 5, 2002

EXHIBIT INDEX

Exhibit Number		Description

10.39		Separation Agreement by and between the Company and Douglas C. Spreng

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Good

Applied Micro Circuits (AMCC) Inactive 10-Q2003 Q2 Quarterly report

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