Applied Micro Circuits (AMCC) 10-Q 2010 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2009

OR

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

For the transition period from                      to                     .

Commission File Number: 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.)
215 Moffett Park Drive, Sunnyvale, CA	94089
(Address of principal executive offices)	(Zip code)

Registrant’s telephone number, including area code: (408) 542-8600

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

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

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

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

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

As of September 30, 2009, 66,644,349 shares of the registrant’s common stock, $0.01 par value per share, were issued and outstanding.

APPLIED MICRO CIRCUITS CORPORATION

INDEX

		Page
Part I.	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Balance Sheets at September 30, 2009 and March 31, 2009	3
	Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2009 and 2008	4
	Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2009 and 2008	5
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	34
Part II.	OTHER INFORMATION
Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Submission of Matters to a Vote of Security Holders	50
Item 5.	Other Information	50
Item 6.	Exhibits	51
Signatures		52

2

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

	September 30, 2009			March 31, 2009
	(unaudited)			(note)
ASSETS
Current assets:
Cash and cash equivalents	$	111,818		$	99,337
Short-term investments available-for-sale		85,878			84,672
Accounts receivable, net		21,275			17,537
Inventories		19,421			26,598
Other current assets		8,356			8,871
Assets of discontinued operations		—			8,558
Total current assets		246,748			245,573
Property and equipment, net		26,237			25,749
Purchased intangibles, net		24,109			32,965
Other assets		20,303			20,323
Total assets	$	317,397		$	324,610
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	13,431		$	16,715
Accrued payroll and related expenses		5,376			5,875
Other accrued liabilities		9,624			15,466
Deferred revenue		861			2,584
Total current liabilities		29,292			40,640
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value:
Authorized shares — 2,000, none issued and outstanding		—			—
Common stock, $0.01 par value:
Authorized shares — 375,000 at September 30, 2009 and March 31, 2009
Issued and outstanding shares — 66,644 at September 30, 2009 and 65,874 at March 31, 2009		667			659
Additional paid-in capital		5,908,265			5,910,493
Accumulated other comprehensive income (loss)		2,774			(6,273	)
Accumulated deficit		(5,623,601	)		(5,620,909	)
Total stockholders’ equity		288,105			283,970
Total liabilities and stockholders’ equity	$	317,397		$	324,610

Note: Amounts have been derived from the March 31, 2009 audited consolidated financial statements.

See Accompanying Notes to Condensed Consolidated Financial Statements

3

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
Net revenues	$	49,232		$	64,290		$	94,284		$	125,489
Cost of revenues		23,796			28,576			45,971			57,002
Gross profit		25,436			35,714			48,313			68,487
Operating expenses:
Research and development		20,828			21,410			40,242			41,860
Selling, general and administrative		11,991			13,780			22,510			27,631
Amortization of purchased intangible assets		1,005			1,005			2,010			2,010
Restructuring charges (recoveries), net		(125	)		140			(279	)		(118	)
Litigation settlement, net		—			130			—			130
Option investigation, net		—			(184	)		—			163
Total operating expenses		33,699			36,281			64,483			71,676
Operating loss		(8,263	)		(567	)		(16,170	)		(3,189	)
Interest income (expense) and other-than-temporary impairments, net		(1,534	)		(814	)		(162	)		(2,216	)
Other income (expense), net		(1,891	)		264			(1,674	)		339
Loss from continuing operations before income taxes		(11,688	)		(1,117	)		(18,006	)		(5,066	)
Income tax expense (benefit)		(3,617	)		403			(7,136	)		905
Loss from continuing operations		(8,071	)		(1,520	)		(10,870	)		(5,971	)
Income (loss) from discontinued operations and gain on sale of Storage Business, net of taxes		1,347			(793	)		7,044			(1,516	)
Net loss	$	(6,724	)	$	(2,313	)	$	(3,826	)	$	(7,487	)
Basic and diluted income (loss) per share:
Loss per share from continuing operations	$	(0.12	)	$	(0.02	)	$	(0.16	)	$	(0.09	)
Income (loss) per share from discontinued operations		0.02			(0.02	)		0.10			(0.03	)
Net loss per share	$	(0.10	)	$	(0.04	)	$	(0.06	)	$	(0.12	)
Shares used in calculating basic and diluted income (loss) per share		66,469			65,150			66,270			65,007

See Accompanying Notes to Condensed Consolidated Financial Statements

4

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Six Months Ended September 30,
	2009			2008
Operating activities:
Net loss	$	(3,826	)	$	(7,487	)
Adjustments to reconcile net loss to net cash provided by (used for) operating activities:
Depreciation		3,173			3,449
Amortization of purchased intangibles		8,856			11,804
Stock-based compensation expense:
Stock options		2,090			3,703
Restricted stock units		4,292			2,502
Other-than-temporary impairment of marketable securities		3,454			6,837
Impairment of strategic investment		2,000			—
Tax benefit from other comprehensive income		(4,007	)		—
Net loss on disposals of property		24			29
Gain on sale of storage business unit		(11,366	)		—
Changes in operating assets and liabilities:
Accounts receivable		(3,738	)		(3,099	)
Inventories		6,720			3,485
Other assets		(503	)		1,050
Accounts payable		(4,398	)		(2,059	)
Accrued payroll and other accrued liabilities		(6,365	)		(244	)
Deferred tax liability		—			439
Deferred revenue		(1,723	)		111
Net cash provided by (used for) operating activities		(5,317	)		20,520
Investing activities:
Proceeds from sales and maturities of short-term investments		415,785			339,602
Purchases of short-term investments		(406,143	)		(335,619	)
Purchase of property, equipment and other assets		(3,664	)		(4,935	)
Purchase of strategic investment		(1,000	)		—
Proceeds from sale of storage business unit		21,527			—
Net cash provided by (used for) investing activities		26,505			(952	)
Financing activities:
Net proceeds from issuance of common stock		1,767			1,615
Funding of structured stock repurchase agreements		(21,797	)		—
Funds received from structured stock repurchase agreements		12,044			—
Other		(721	)		(63	)
Net cash used for financing activities		(8,707	)		1,552
Net increase in cash and cash equivalents		12,481			21,120
Cash and cash equivalents at the beginning of the period		99,337			42,689
Cash and cash equivalents at the end of the period	$	111,818		$	63,809
Supplementary cash flow disclosures:
Cash paid for:
Interest	$	—		$	3
Income taxes		220			555
Unrealized gains (losses) on available-for-sale securities		13,081			(4,025	)

See Accompanying Notes to Condensed Consolidated Financial Statements

5

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include all the accounts of Applied Micro Circuits Corporation (“AppliedMicro” or the “Company”) and its wholly-owned subsidiaries and entities which are variable interest entities (“VIE”) of which the Company is the primary beneficiary. A VIE is required to be consolidated by its primary beneficiary. The primary beneficiary is the party that absorbs a majority of the VIE’s anticipated losses and/or a majority of the expected returns. The Company has evaluated its strategic alliances for potential classification as variable interest entities by evaluating the sufficiency of each entity’s equity investment at risk to absorb losses and the Company’s share of respective expected losses. The Company determined that it is the primary beneficiary of one variable interest entity and has included the accounts of this entity in the consolidated financial statements (see Note 10). All significant intercompany balances and transactions have been eliminated in consolidation.

Certain amounts in the consolidated financial statements have been reclassified to conform to the current year presentation. As described in Note 13 of the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2009, the Company has classified the financial results of its 3ware storage adapter business as discontinued operations for all periods presented due to the sale of its 3ware storage adapter business to LSI Corporation on April 21, 2009. The assets sold to LSI Corporation were classified as assets of discontinued operations on the balance sheet at March 31, 2009. These notes to the Company’s condensed consolidated financial statements relate to continuing operations only, unless otherwise indicated.

In preparing the financial statements, we have evaluated subsequent events, which are events that occur after the balance sheet date but before financial statements are issued or are available to be issued, through October 30, 2009, which is the date that the financial statements were issued.

Use of Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. The Company regularly evaluates estimates and assumptions related to inventory valuation, warranty liabilities and revenue reserves, which affects its revenues, cost of sales and gross margin; allowance for doubtful accounts, which affects its operating expenses; the unrealized losses on its short-term marketable securities, which affects its interest income (expense), net; the valuation of purchased intangibles, which affects its amortization and impairments of purchased intangibles; the valuation of restructuring liabilities, which affects the amount and timing of restructuring charges; the potential costs of litigation, which affects its operating expenses; the valuation of deferred income taxes, which affects its income tax expense (benefit); and stock-based compensation, which affects its gross margin and operating expenses. The Company bases its estimates and assumptions on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from management’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

Recent Accounting Pronouncements

On September 30, 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-12,Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (“ASU 2009-12”). ASU 2009-12 amends FASB Accounting Standards Codification (“ASC”) No. 820 by providing additional guidance on measuring the fair value of certain alternative investments (“the amended guidance”). Under the amended guidance, entities are permitted, as a practical expedient, to estimate the fair value of investments within its scope using the net asset value (“NAV”) per share of the investment as of the reporting entities’ measurement dates.

The amended guidance applies only to investments in entities that calculate NAV (or its equivalent, such as member units or an ownership interest in partners’ capital) consistent with the measurement principles of ASC 946 (i.e., entities that measure investment assets at fair value on a recurring basis). In addition, use of the practical expedient is not permitted for investments that have a readily determinable fair value, or if it is probable as of the measurement date that the entity will sell the investment (or a portion of the investment) for an amount other than NAV.

The amended guidance also requires additional disclosures to better enable users of the financial statements to understand the nature and risks of the reporting entity’s alternative investments. The additional disclosures are required for all investments within the scope of ASU 2009-12 regardless of whether the practical expedient is applied.

6

The amended guidance is effective for the first reporting period, including interim periods, ending after December 15, 2009. Early adoption is permitted if financial statements for prior periods have not been issued. Entities that elect to early adopt may defer the additional disclosure requirements of the ASU until the effective date. The Company does not expect the adoption of ASU 2009-12 to have a material impact on the Company’s results of operations or financial position.

In June 2009, the FASB issued SFAS No. 167,Amendments to FASB Interpretation No. 46(R) (“SFAS 167”), which becomes effective the first annual reporting period after November 15, 2009 and will be effective for the Company in the fiscal year ended March 31, 2011. This Statement amends FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities — an interpretation of ARB No. 51,” to require revised evaluations of whether entities represent variable interest entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. The Company is evaluating the potential impact of the implementation of SFAS 167 on its consolidated financial statements.

2. CERTAIN FINANCIAL STATEMENT INFORMATION

Accounts receivable:

	September 30, 2009			March 31, 2009
	(In thousands)
Accounts receivable	$	22,261		$	18,688
Less: allowance for bad debts		(986	)		(1,151	)
	$	21,275		$	17,537

Inventories:

	September 30, 2009		March 31, 2009
	(In thousands)
Finished goods	$	15,695	$	20,170
Work in process		2,750		5,324
Raw materials		976		1,104
	$	19,421	$	26,598

Other current assets:

	September 30, 2009		March 31, 2009
	(In thousands)
Prepaid expenses	$	6,881	$	7,434
Deposits		726		634
Other		749		803
	$	8,356	$	8,871

Property and equipment:

	Useful Life	September 30, 2009			March 31, 2009
	(In years)	(In thousands)
Machinery and equipment	5-7	$	33,892		$	34,546
Leasehold improvements	1-15		9,606			9,375
Computers, office furniture and equipment	3-7		50,222			51,843
Buildings	31.5		2,756			2,756
Land	N/A		9,800			9,800
			106,276			108,320
Less: accumulated depreciation and amortization			(80,039	)		(82,571	)
		$	26,237		$	25,749

7

Purchased intangibles (in thousands):

	September 30, 2009							March 31, 2009
	Gross		Accumulated Amortization and Impairments			Net		Gross		Accumulated Amortization and Impairments			Net
Developed technology	$	425,000	$	(408,375	)	$	16,625	$	425,000	$	(401,528	)	$	23,472
Customer relationships		6,330		(5,101	)		1,229		6,330		(4,976	)		1,354
Patents/core technology rights/tradenames		62,305		(56,050	)		6,255		62,305		(54,166	)		8,139
	$	493,635	$	(469,526	)	$	24,109	$	493,635	$	(460,670	)	$	32,965

As of September 30, 2009, the estimated future amortization expense of purchased intangible assets to be charged to cost of sales and operating expenses was as follows (in thousands):

	Cost of Sales		Operating Expenses		Total
Fiscal years ending March 31,
2010 (remaining)	$	5,250	$	2,009	$	7,259
2011		10,500		4,018		14,518
2012		875		852		1,727
2013		—		250		250
2014		—		250		250
Thereafter		—		105		105
Total	$	16,625	$	7,484	$	24,109

Other assets:

	September 30, 2009		March 31, 2009
	(In thousands)
Non-current portion of prepaid expenses	$	10,074	$	10,860
Strategic investments		6,000		7,000
Other		4,229		2,463
	$	20,303	$	20,323

Strategic Investments

The Company has entered into certain equity investments in privately held businesses for the promotion of business and strategic objectives. The Company’s investments in equity securities of privately held businesses are accounted for under the cost method. Under the cost method, strategic investments in which the Company holds less than a 20% voting interest and on which the Company does not have the ability to exercise significant influence are carried at the lower of cost or cost reduced by other-than-temporary impairments, as appropriate. These investments are included in other assets on the Company’s condensed consolidated balance sheets. The Company periodically reviews these investments for other-than-temporary declines in fair value based on the specific identification method and writes down investments when an other-than-temporary decline has occurred. During the three months ended September 30, 2009, the Company determined one of its strategic investments was other-than-temporarily impaired. The strategic investment amount of $2.0 million was written down to zero and recognized under other income, net. The Company has reviewed its other strategic investments on a nonrecurring basis and concluded there was no material other-than-temporary impairment as of September 30, 2009.

8

Short-term investments:

The following is a summary of available-for-sale investments by type of instruments (in thousands):

	September 30, 2009								March 31, 2009
	Amortized Cost		Unrealized				Estimated Fair Value		Amortized Cost		Unrealized				Estimated Fair Value
			Gains		Losses						Gains		Losses
Cash	$	8,916	$	—	$	—	$	8,916	$	8,047	$	—	$	—	$	8,047
Cash equivalents		102,902		—		—		102,902		91,290		—		—		91,290
US Treasury securities and agency bonds		1,159		70		—		1,229		1,166		79		—		1,245
Corporate bonds		4,430		262		43		4,649		4,541		10		232		4,319
Mortgage backed and asset backed securities*		20,044		—		292		19,752		21,372		631		607		21,396
Closed-end bond funds		39,956		6,997		168		46,785		45,031		789		3,850		41,970
Preferred stock		13,455		8		—		13,463		18,809		28		3,095		15,742
	$	190,862	$	7,337	$	503	$	197,696	$	190,256	$	1,537	$	7,784	$	184,009
Reported as:
Cash and cash equivalents							$	111,818							$	99,337
Short-term investments available-for-sale								85,878								84,672
							$	197,696							$	184,009

The established guidelines for measuring fair value and expanded disclosures regarding fair value measurements are defined as a three-level valuation hierarchy for disclosure of fair value measurements as follows:

Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2 — Inputs (other than quoted market prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Valuation of instruments includes unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities.

The following is a summary of available-for-sale investments by type of instruments measured at fair value on a recurring basis (in thousands):

	September 30, 2009								March 31, 2009
	Level 1		Level 2		Level 3		Total		Level 1		Level 2		Level 3		Total
Cash	$	8,916	$	—	$	—	$	8,916	$	8,047	$	—	$	—	$	8,047
Cash equivalents		102,902		—		—		102,902		91,290		—		—		91,290
US Treasury securities and agency bonds		1,229		—		—		1,229		1,245		—		—		1,245
Corporate bonds		—		4,649		—		4,649		—		4,319		—		4,319
Mortgage backed and asset backed securities*		—		19,752		—		19,752		—		21,396		—		21,396
Closed-end bond funds		46,785		—		—		46,785		41,970		—		—		41,970
Preferred stock		—		13,463		—		13,463		—		15,742		—		15,742
	$	159,832	$	37,864	$	—	$	197,696	$	142,552	$	41,457	$	—	$	184,009
Reported as:
Cash and cash equivalents	$	111,818	$	—	$	—	$	111,818	$	99,337	$	—	$	—	$	99,337
Short-term investments available-for-sale		48,014		37,864		—		85,878		43,215		41,457		—		84,672
	$	159,832	$	37,864	$	—	$	197,696	$	142,552	$	41,457	$	—	$	184,009

* At September 30, 2009 and March 31, 2009 approximately $15.0 million and $16.6 million of the amounts presented were mortgage-backed securities, respectively.

The fair value of non-marketable strategic investments, on a non-recurring basis, based on Level 3 inputs, as of September 30, 2009 was zero and the impairment for the three and six months ended was approximately $2.0 million. The fair value of this investment was based on current cash position and recent operational performance.

9

At September 30, 2009, the cost and estimated fair values of available-for-sale securities with stated maturities are U.S. Treasury securities and agency bonds, corporate bonds, mortgage-backed, asset-backed securities and options, by contractual maturity are as follows (in thousands):

	Cost		Fair Value
Less than 1 year	$	4	$	4
Mature in 1–2 years		205		200
Mature in 3–5 years		9,347		9,422
Mature after 5 years		16,081		16,201
	$	25,637	$	25,827

The following is a summary of gross unrealized losses as of September 30, 2009 (in thousands):

	Less Than 12 Months of Unrealized Losses				12 Months or More of Unrealized Losses				Total
	Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses
Corporate bonds	$	541	$	43	$	—	$	—	$	541	$	43
Mortgage-backed and asset-backed securities		4,005		292		—		—		4,005		292
Closed-end bond funds		8,110		168		—		—		8,110		168
	$	12,660	$	503	$	—	$	—	$	12,660	$	503

Other-Than-Temporary Impairment

The Company assessed whether it intends to sell or it is more likely than not that it will be required to sell an available-for-sale debt instrument before recovery of its amortized cost basis less any current-period credit losses. For available-for-sale debt instruments that are considered other-than-temporarily impaired and that the Company does not intend to sell and will not be required to sell prior to recovery of the amortized cost basis, we separate the amount of the impairment into the amount that is credit related and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the debt instrument’s amortized cost basis and the present value of its expected future cash flows. The cumulative implementation adjustment was a $1.1 million reclassification of prior other-than-temporary impairment charges from retained earnings to other comprehensive income as the impairment losses were determined to be non-credit related. The remaining difference between the debt instrument’s fair value and the present value of future expected cash flows is due to factors that are not credit related and is recognized in other comprehensive income (loss).

Based on an evaluation of securities that have been in a loss position at September 30, 2009, the Company determined it holds certain securities that it intends to sell and based on other qualitative factors, like the ability and intent to hold the securities until a recovery of amortized cost, has therefore recognized an other-than-temporary impairment charge of approximately $3.3 million and $3.5 million, the extent of its unrealized losses, for the three and six months ended September 30, 2009, respectively, under interest income (expense) and other-than-temporary impairment, net. The other-than-temporary impairment charge for the three and six months ended September 30, 2008 was approximately $3.4 million and $6.8 million respectively. As of September 30, 2009, the Company also has $7.3 million in unrealized gains. The basis for computing realized gains or losses is by specific identification.

Other accrued liabilities:

	September 30, 2009		March 31, 2009
	(In thousands)
Executive deferred compensation	$	4,222	$	2,463
Employee related liabilities		1,771		1,896
Warranty		226		1,285
Restructuring liabilities		498		4,142
Professional services		896		644
Other taxes		325		220
Product development cost		—		2,000
Other		1,686		2,816
	$	9,624	$	15,466

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Warranty reserves:

The Company’s products typically carry a one year warranty. Reserves are established for estimated product warranty costs at the time revenue is recognized. Although the Company engages in extensive product quality programs and processes, its warranty obligation is affected by product failure rates, use of materials and service delivery costs incurred in correcting any product failure.

Should actual product failure rates, use of materials or service delivery costs differ from the Company’s estimates, additional warranty reserves could be required, which could reduce its gross margin. Additional changes to negotiated master purchase agreements could result in increased warranty reserves and unfavorably impact future gross margins.

The following table summarizes warranty reserve activity (in thousands):

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
Beginning balance	$	1,129		$	1,507		$	1,285		$	1,475
Charged to (reductions in) costs of revenues*		(777	)		(66	)		(659	)		46
Claims incurred		(26	)		(121	)		(137	)		(161	)
Adjustments to estimated liability		(100	)		—			(263	)		(40	)
Ending balance	$	226		$	1,320		$	226		$	1,320

* The amounts in 2009 include a $0.8 million reduction in warranty reserve related to the sale of our 3ware storage adapter business which was settled for $0.5 million.

Interest income (expense) and other-than-temporary impairment, net (in thousands):

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
Interest income	$	1,511		$	2,639		$	3,169		$	5,093
Net realized loss on short-term investments		234			(9	)		123			(469	)
Impairment of marketable securities		(3,279	)		(3,443	)		(3,454	)		(6,837	)
Interest expense		—			(1	)		—			(3	)
	$	(1,534	)	$	(814	)	$	(162	)	$	(2,216	)

Other income (expense), net (in thousands):

	Three Months Ended September 30,					Six Months Ended September 30,
	2009			2008		2009			2008
Impairment of strategic investment	$	(2,000	)	$	—	$	(2,000	)	$	—
Net gain (loss) on disposals of property		21			—		20		$	(29	)
Net foreign currency gain (loss)		11			—		8			(1	)
Other		77			264		298			369
	$	(1,891	)	$	264	$	(1,674	)	$	339

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Net loss per share:

Shares used in basic net income (loss) per share are computed using the weighted average number of common shares outstanding during each period. Shares used in diluted net income per share include the dilutive effect of common shares potentially issuable upon the exercise of stock options, vesting of RSUs and outstanding warrants. However, potentially issuable common shares are not used in computing net loss as their effect would be anti-dilutive due to the loss recorded during the period. The reconciliation of shares used to calculate basic and diluted net loss per share consists of the following (in thousands, except per share data):

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
Net income (loss):
From continuing operations	$	(8,071	)	$	(1,520	)	$	(10,870	)	$	(5,971	)
From discontinued operations, net of taxes		1,347			(793	)		7,044			(1,516	)
Net loss	$	(6,724	)	$	(2,313	)	$	(3,826	)	$	(7,487	)
Shares used in net income (loss) per share computation:
Weighted average common shares outstanding		66,469			65,150			66,270			65,007
Net effect of dilutive common share equivalents		—			—			—			—
Shares used in basic and diluted net income (loss) per share computation		66,469			65,150			66,270			65,007
Basic and diluted net income (loss) per share:
From continuing operations	$	(0.12	)	$	(0.02	)	$	(0.16	)	$	(0.09	)
From discontinued operations, net of taxes		0.02			(0.02	)		0.10			(0.03	)
Net loss per share	$	(0.10	)	$	(0.04	)	$	(0.06	)	$	(0.12	)

The effect of dilutive securities (comprised of options, restricted stock units and warrants) totaling 1.9 million and 1.3 million equivalent shares for the three and six months ended September 30, 2009, respectively, and dilutive securities (comprised of options and restricted stock units) totaling 0.2 million equivalent shares for both the three and six months ended September 30, 2008, respectively, have been excluded from the loss per share computation, as their impact would be anti-dilutive because the company has incurred losses in the periods presented.

3. RESTRUCTURING CHARGES

The Company recognizes restructuring costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. Over the last several years, the Company has undertaken significant restructuring activities under several plans in an effort to reduce operating costs. A combined summary of the restructuring programs initiated by the Company is as follows (in thousands):

	Workforce Reduction			Facilities Consolidation and Operating Lease Commitments			Property and Equipment Impairments and Contract Cancellations			Total
Liability, March 31, 2008	$	725		$	853		$	—		$	1,578
Charged to continuing operations		5,850			792			2,359			9,001
Charged to discontinued operations		126			—			—			126
Cash payments		(3,745	)		(451	)		—			(4,196	)
Non-cash charges		(1,130	)		—			(859	)		(1,989	)
Reductions to estimated liability		(258	)		(120	)		—			(378	)
Liability, March 31, 2009	$	1,568		$	1,074		$	1,500		$	4,142
Cash payments		(1,414	)		(451	)		(1,500	)		(3,365	)
Reductions to estimated liability		(154	)		(125	)		—			(279	)
Liability, September 30, 2009	$	—		$	498		$	—		$	498

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The following table provides detailed activity related to the restructuring programs as of September 30, 2009 (in thousands):

	Workforce Reduction			Facilities Consolidation and Operating Lease Commitments			Property and Equipment Impairments and Contract Cancellations			Total
Prior Fiscal Years’ Completed Restructuring Programs
Liability, March 31, 2008	$	377		$	—		$	—		$	377
Cash payments		(157	)		—			—			(157	)
Reductions to estimated liability		(220	)		—			—			(220	)
Liability, March 31, 2009	$	—		$	—		$	—		$	—
Prior Fiscal Years’ Active Restructuring Programs
Liability, March 31, 2008	$	348		$	853		$	—		$	1,201
Charged to continuing operations		1,163			—			—			1,163
Charged to discontinued operations		126			—			—			126
Cash payments		(1,448	)		(451	)		—			(1,899	)
Non-cash charge		(57	)		—			—			(57	)
Reductions to estimated liability		(38	)		(120	)		—			(158	)
Liability, March 31, 2009	$	94		$	282		$	—		$	376
Cash payments		—			(188	)		—			(188	)
Reductions to estimated liability		(94	)		—			—			(94	)
Liability, September 30, 2009	$	—		$	94		$	—		$	94
February 2009 Restructuring Program
Charged to continuing operations	$	4,687		$	792		$	2,359		$	7,838
Cash payments		(2,140	)		—			—			(2,140	)
Non-cash charge		(1,073	)		—			(859	)		(1,932	)
Liability, March 31, 2009	$	1,474		$	792		$	1,500		$	3,766
Cash payments		(1,414	)		(263	)		(1,500	)		(3,177	)
Reductions to estimated liability		(60	)		(125	)		—			(185	)
Liability, September 30, 2009	$	—		$	404		$	—		$	404

Prior Fiscal Years’ Completed Restructuring Programs

The July 2007 restructuring program consisted of the elimination of 29 positions. As a result of the July 2007 restructuring program, the Company recorded a net charge of $0.7 million, consisting of employee severances. During fiscal 2008, the Company paid down part of its remaining liabilities related to this restructuring program. During the three months ended June 30, 2008, the Company recorded a reversal of the remaining liabilities through restructuring expense.

The September 2007 restructuring program consisted of the elimination of 28 positions. As a result of the September 2007 restructuring program, the Company recorded a net charge of $0.7 million, consisting of employee severances. During fiscal 2008, the Company recorded an additional $0.1 million for employee severances and paid down part of its remaining liability. During the three months ended June 30, 2008, the Company reduced its estimated liability related to this restructuring program by $0.2 million through restructuring expense. During the three months ended September 30, 2008, the Company paid all remaining liabilities related to this restructuring program.

Prior Fiscal Years’ Active Restructuring Programs

The March 2008 restructuring program was implemented to reduce job redundancies and consisted of the elimination of 20 positions. As a result of the March 2008 restructuring program, the Company recorded a net charge of $1.6 million, consisting of $0.4 million for employee severances, $0.9 million for operating lease impairment and $0.3 million for an asset impairment. During fiscal 2009, the Company paid down part of its remaining liabilities related to this restructuring program and recorded a reversal for part of its liabilities which was no longer required to complete the restructuring activities. During the six months ended September 30, 2009, the Company paid down part of its remaining liabilities.

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The September 2008 restructuring program was implemented to realign and focus the Company’s resources on its core competencies and consisted of the elimination of 30 positions. As a result of the September 2008 restructuring program, the Company recorded a net charge of $1.2 million to continuing operations and $0.1 million to discontinued operations. During fiscal 2009, the Company paid down part of its remaining liabilities related to this restructuring program. During the three months ended June 30, 2009, the Company recorded a reversal of approximately $0.1 million for liabilities, which was no longer required to complete the restructuring activities.

Current Fiscal Year’s Restructuring Program

In February 2009, the Company implemented another restructuring program. The February 2009 restructuring program was implemented to reduce its expenses and excess capacity in response to the worsening economic conditions. The restructuring program consisted of the elimination of approximately 100 positions. As a result of the February 2009 restructuring program, the Company recorded a net charge of $7.8 million, consisting of $4.7 million for employee severances, $0.8 million for operating lease impairment, $1.5 million in contract cancellation charges for a cancelled project and $0.8 million for an asset impairment. During fiscal 2009, the Company paid down part of its remaining liabilities related to this restructuring program. During the six months ended September 30, 2009, the Company paid down part of its remaining liabilities related to this restructuring program and recorded a reversal of approximately $0.2 million for part of its liabilities, which was no longer required to complete the restructuring activities.

4. COMPREHENSIVE INCOME (LOSS)

The components of comprehensive income (loss), net of tax where applicable, are as follows (in thousands):

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
Net loss	$	(6,724	)	$	(2,313	)	$	(3,826	)	$	(7,487	)
Change in net unrealized gain (loss) on investments		3,837			(4,657	)		10,293			(4,025	)
Cumulative implementation reclassification for prior non-credit related other-than-temporary impairment charges		—			—			(1,134	)		—
Foreign currency translation adjustment gain (loss)		(16	)		7			(112	)		6
	$	(2,903	)	$	(6,963	)	$	5,221		$	(11,506	)

5. STOCKHOLDERS’ EQUITY

Preferred Stock

The Certificate of Incorporation allows for the issuance of up to two million shares of preferred stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences, and the number of shares constituting any series of the designation of such series, without further vote or action by the stockholders.

Common Stock

At September 30, 2009, the Company had 375.0 million shares authorized for issuance and approximately 66.6 million shares issued and outstanding. At March 31, 2009, there were approximately 65.9 million shares issued and outstanding.

Employee Stock Purchase Plan

The Company has in effect an employee stock purchase plan under which 4.8 million shares of common stock have been reserved for issuance. Under the terms of this plan, purchases are made semiannually and the purchase price of the common stock is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. During the three months ended September 30, 2009, 0.2 million shares were issued under this plan. During the fiscal year ended March 31, 2009, approximately 0.5 million shares were issued under this plan. At September 30, 2009, approximately 3.9 million shares had been issued under this plan and approximately 0.9 million shares were available for future issuance.

Stock Repurchase Program

In August 2004, the Board authorized a stock repurchase program for the repurchase of up to $200.0 million of the Company’s common stock. Under the program, the Company is authorized to make purchases in the open market or enter into structured

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agreements. In October 2008, the Board increased the stock repurchase program by $100.0 million. During the six months ended September 30, 2009 and the fiscal year ended March 31, 2009, no shares were repurchased on the open market. From the time the program was first implemented in August 2004, the Company has repurchased on the open market a total of 8.9 million shares at a weighted average price of $11.74 per share. All repurchased shares were retired upon delivery to the Company. The Board has reinstated the stock repurchase program and the Company will begin to repurchase shares under the approved repurchase plan.

The Company also utilizes structured stock repurchase agreements to buy back shares which are prepaid written put options on its common stock. The Company pays a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or stock depending on the closing market price of its common stock on the expiration date of the agreement. Upon expiration of each agreement, if the closing market price of its common stock is above the pre-determined price, the Company will have its cash investment returned with a premium. If the closing market price is at or below the pre-determined price, the Company will receive the number of shares specified at the agreement inception. The Company considers the guidance in ASC 480-10,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity and ASC 815-40,Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. Any cash received, including the premium, is treated as additional paid in capital on the balance sheet.

During the six months ended September 30, 2009, the Company entered into structured stock repurchase agreements totaling $21.8 million. For those agreements that had been settled during the six months ended September 30, 2009, the Company received approximately $12.0 million in cash. During the fiscal year ended March 31, 2009, the Company did not enter into any structured stock repurchase agreements. At September 30, 2009, the Company had two outstanding structured stock repurchase agreements for a total of $10.0 million, of which one settled for approximately $5.2 million in cash in October 2009. From the inception of the Company’s most recent stock repurchase program in August 2004, it entered into structured stock repurchase agreements totaling $237.5 million. Upon settlement of these agreements, the Company received $148.6 million in cash and 7.8 million shares of its common stock at an effective purchase price of $10.12 per share.

The table below is a plan-to-date summary of the Company’s repurchase program activity as of September 30, 2009 (in thousands, except per share data):

	Aggregate Price		Repurchased Shares	Average Price Per Share
Stock repurchase program
Authorized amount	$	300,000	—	$	—
Open market repurchases		103,966	8,856		11.74
Structured stock repurchase agreements*		90,517	7,797		11.61
Total repurchases	$	194,483	16,653	$	11.68
Available for repurchase	$	105,517

* The amounts above do not include gains of $11.6 million from structured stock repurchase agreements which settled in cash. The average price per share for structured stock repurchase agreements adjusted for gains from settlements in cash would have been $10.12 share and for total repurchases would have been $10.98 per share.

Stock Options

The Company has granted stock options to employees and non-employee directors under several plans. These option plans include two stockholder-approved plans (the 1992 Stock Option Plan and 1997 Directors’ Stock Option Plan) and four plans not approved by stockholders (the 2000 Equity Incentive Plan, Cimaron Communications Corporation’s 1998 Stock Incentive Plan assumed in the fiscal 1999 merger, and JNI Corporation’s 1997 and 1999 Stock Option Plans assumed in the fiscal 2004 merger). Certain other outstanding options were assumed through the Company’s various acquisitions.

In March 2007, the Company’s stockholders also approved the amendment and restatement of the 1992 Stock Option Plan (i) to expand the type of awards available under the plan, (ii) to rename the plan as the 1992 Equity Incentive Plan, (iii) to extend the plan’s expiration date until January 10, 2017, (iv) to increase the shares reserved under the plan by 2.3 million shares, (v) to serve as a successor plan to the 2000 Equity Incentive Plan, which has no longer been used for equity awards following completion of the Company’s prior stock option exchange, and (vi) to provide that any shares subject to stock awards under the 2000 Equity Incentive Plan that terminate or are forfeited or repurchased (other than options issued under the 2000 Equity Incentive Plan that were tendered in the stock option exchange) are added to the share reserve under the 1992 Equity Incentive Plan.

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The Board has delegated administration of the Company’s equity plans to the Compensation Committee, which generally determines eligibility, vesting schedules and other terms for awards granted under the plans. Options under the plans expire not more than ten years from the date of grant and are generally exercisable upon vesting. Vesting generally occurs over four years. New hire grants generally vest and become exercisable at the rate of 25% on the first anniversary of the date of grant and ratably on a monthly basis over a period of 36 months thereafter; subsequent option grants to existing employees generally vest and become exercisable ratably on a monthly basis over a period of 48 months measured from the date of grant.

In May 2009, Dr. Gopi, our CEO, was awarded 300,000 stock options for “Extraordinary Accomplishment.” These options will vest only if Company performance milestones are satisfied; otherwise they will expire unvested. The first milestone for 75,000 shares will vest only if we achieve an annual revenue target of $270 million or more for any fiscal year from fiscal 2010 through fiscal 2013. The next milestone for another 75,000 shares will vest only if we achieve an annual revenue target of $310 million or more for any fiscal year from fiscal 2010 through fiscal 2013 or an annual revenue target of $350 million or more for fiscal 2014. The last milestone for 150,000 shares will vest only if we achieve an annual operating margin of 13.5% of annual revenue by fiscal 2013. The Company evaluates the probability of achieving the milestones and adjusts any stock option expense accordingly under stock-based compensation expense.

At September 30, 2009 and March 31, 2009, there were no shares of common stock subject to repurchase. Options are granted at prices at least equal to fair value of the Company’s common stock on the date of grant.

Option activity under the Company’s stock incentive plans during the six months ended September 30, 2009 is set forth below:

	Number of Shares (in thousands)		Weighted Average Exercise Price Per Share
Outstanding at the beginning of the year	7,923		$	13.60
Granted	991			7.51
Exercised	(253	)		4.30
Forfeited	(1,697	)		13.31
Outstanding at the end of the period	6,964		$	13.14
Vested at the end of the period	4,269		$	16.96

At September 30, 2009, the weighted average remaining contractual term for options outstanding is 4.8 years and for options vested is 3.6 years.

The aggregate pretax intrinsic value of options exercised during the six months ended September 30, 2009 was $0.9 million. This intrinsic value represents the excess of the fair market value of the Company’s common stock on the date of exercise over the exercise price of such options.

The weighted average remaining contractual life and weighted average per share exercise price of options outstanding and of options exercisable as of September 30, 2009 were as follows (in thousands, except exercise prices and years):

	Options Outstanding				Options Exercisable
Range of Exercise Prices	Number of Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (in years)	Number of Shares	Weighted Average Exercise Price
$    0.52  -  $        7.12	1,824	$	5.89	6.59	207	$	4.88
7.13  -            8.56	1,435		7.95	6.91	501		7.88
8.57  -          12.84	1,596		12.26	2.92	1,485		12.23
12.85  -          19.80	1,414		14.64	4.04	1,381		14.65
19.81  -        300.13	695		41.81	1.93	695		41.81
$    0.52  -  $    300.13	6,964	$	13.14	4.83	4,269	$	16.96

As of September 30, 2009, the aggregate pre-tax intrinsic value of options outstanding and exercisable was $2.1 million and options outstanding was $10.4 million. The aggregate pretax intrinsic values were calculated based on the closing price of the Company’s common stock of $9.99 on September 30, 2009.

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Restricted Stock Units

The Company has granted restricted stock units pursuant to its 2000 Equity Incentive Plan as part of its regular annual employee equity compensation review program as well as to new hires. Restricted stock units are share awards that, upon vesting, will deliver to the holder shares of the Company’s common stock. Generally, restricted stock units vest ratably on a quarterly basis over four years from the date of grant. For employees hired after May 15, 2006, restricted stock units will vest on a quarterly basis over four years from the date of hire provided that no shares will vest during the first year, at the end of which the shares that would have vested during that year will vest and the remaining shares will vest over the remaining 12 quarters.

In May 2009, the Committee issued three-year RSU grants, or “EBITDA Grants”, for fiscal 2010. Vesting for the EBITDA Grants is subject to (i) the Company’s performance as measured by earnings before interest, taxes, depreciation and amortization (“EBITDA”), and (ii) individual performance as measured by the accomplishment of goals and objectives. For fiscal 2010, up to 36% of the three-year performance pool can vest. Approximately 18% can vest for “at plan” Company performance, 24% can vest for “stretch” Company performance and 36% can vest for “extraordinary” Company performance. The Company evaluates the probability of achieving the milestones and adjusts any RSU expense accordingly under stock-based compensation expense.

Restricted stock unit activity during the six months ended September 30, 2009 is set forth below:

	Restricted Stock Units Outstanding Number of Shares
	(in thousands)
Outstanding at the beginning of the year	1,467
Awarded	3,408
Vested	(417	)
Cancelled	(505	)
Outstanding at the end of the period	3,953

The weighted average grant-date fair value per share of restricted stock units granted during the six months ended September 30, 2009 was $6.60, and the weighted average remaining contractual term for the restricted stock units outstanding as of September 30, 2009 was 2.6 years.

Based on the closing price of the Company’s common stock of $9.99 on September 30, 2009, the total pretax intrinsic value of all outstanding restricted stock units on that date was $39.5 million.

Warrants

On May 17, 2009, the Company entered into agreements with Veloce Technologies, Inc. (“Veloce”) pursuant to which Veloce has agreed to perform development work for the Company on an exclusive basis for up to five years for cash and other consideration, including a warrant to purchase shares of the Company’s common stock, which would vest upon the achievement of certain performance and time-based milestones.

The warrant expires on July 15, 2014 and has an exercise price of $0.01. The first tranche is for 33% and will vest on the 12-month anniversary of the agreement date and the remaining 67% will vest 8% every three months beginning on the 15th month after the agreement date until the warrant is 100% vested provided that “certain milestones” are achieved by the 12-month anniversary of the agreement date. If at any time, Veloce achieves the “project milestone,” the warrant will vest 100% on the date the “project milestone” is achieved. Recognition of expense related to the warrant agreement is initially dependent upon whether the “certain milestones” are probable of being achieved. The Company assesses the probability of the “certain milestones” being achieved each reporting period. As of September 30, 2009, none of the warrants have vested.

6. STOCK-BASED COMPENSATION

The Company estimates the fair value of stock-based compensation on the date of grant using an option-pricing model. The Company uses the Black-Scholes model to value stock-based compensation. The Black-Scholes model determines the fair value of share-based payment awards based on the stock price on the date of grant and is affected by assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Although the fair value of stock options granted by the Company is estimated by the Black-Scholes model, the estimated fair value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

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The fair value of the options granted during the three months ended September 30, 2009 and 2008 is estimated as of the grant date using the Black-Scholes option-pricing model assuming the weighted-average assumptions listed in the following table:

	Three Months Ended September 30,
	Employee Stock Options						Employee Stock Purchase Plans
	2009			2008			2009			2008
Expected life (years)		3.9			3.9			0.5			0.5
Risk-free interest rate		2.2	%		3.0	%		0.3	%		1.9	%
Volatility		54	%		43	%		53	%		43	%
Dividend yield		—	%		—	%		—	%		—	%
Weighted average fair value	$	3.73		$	2.79		$	2.59		$	2.13

The weighted average fair value per share of the restricted stock units awarded was $7.52 and $6.60 during the three and six months ended September 30, 2009, respectively, compared to $8.57 and $8.95 during the three and six months ended September 30, 2008, respectively. The weighted average fair value per share was calculated based on the fair market value of the Company’s common stock on the respective grant dates.

Effective April 1, 2009, the Company revised its estimated forfeiture rate used in determining the amount of stock-based compensation from 5.2% to 5.8% as a result of an increasing rate of forfeitures in recent periods, which the Company believes is indicative of the rate it will experience during the remaining vesting period of currently outstanding unvested options.

The following table summarizes stock-based compensation expense related to stock options and restricted stock units under SFAS 123(R) (in thousands):

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
Stock-based compensation expense by type of awards
Stock options (including stock purchase program)	$	1,053		$	1,493		$	2,088		$	3,463
Restricted stock units		2,751			1,200			4,344			2,099
Total stock-based compensation		3,804			2,693			6,432			5,562
Stock-based compensation expensed from (capitalized to) inventory		(37	)		(64	)		(50	)		(64	)
Total stock-based compensation expense	$	3,767		$	2,629		$	6,382		$	5,498

The following table summarizes stock-based compensation expense as it relates to the Company’s statement of operations (in thousands):

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
Stock-based compensation expense by type of awards
Cost of revenues	$	180		$	146		$	304		$	320
Research and development		1,594			923			2,866			2,041
Selling, general and administrative		2,030			1,624			3,262			3,201
Total stock-based compensation	$	3,804		$	2,693		$	6,432		$	5,562
Stock-based compensation expensed from (capitalized to) inventory		(37	)		(64	)		(50	)		(64	)
Total stock-based compensation expense	$	3,767		$	2,629		$	6,382		$	5,498

The amount of unearned stock-based compensation currently estimated to be expensed from now through fiscal 2014 related to unvested share-based payment awards at September 30, 2009 is $31.9 million. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 3.0 years. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional equity awards or assumes unvested equity awards in connection with acquisitions.

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7. CONTINGENCIES

Legal Proceedings

The Company acquired JNI Corporation (“JNI”) in October 2003. In November 2001, a class action lawsuit was filed against JNI and the underwriters of its initial and secondary public offerings of common stock in the U.S. District Court for the Southern District of New York, case no. 01 Civ 10740 (SAS). The complaint alleges that defendants violated the Securities Exchange Act of 1934, as amended (the “Exchange Act”), in connection with JNI’s public offerings. This lawsuit is among more than 300 class action lawsuits pending in this District Court that have come to be known as the “IPO laddering cases.” In re Initial Public Offering Securities Litigation, No. 21 MC 92 (SAS). A settlement has been reached in all of the cases. On October 6, 2009, the Court issued an order granting final approval of the settlement and dismissing the case. The Court's order is subject to appeal. Any appeal must be filed within 30 days of the date on which the Court's order was entered. Should the order approving the settlement be overturned on appeal and the final approval vacated, the Company’s liability, if any, could not be reasonably estimated at this time.

8. INCOME TAXES

The Company adopted the provisions of ASC 740-10, as it relates to accounting for uncertainty in income taxes, on April 1, 2007. The adoption of these aspects ASC 740-10 was not material to the financial statements due to a full valuation allowance against deferred tax assets. The total amount of unrecognized tax benefits as of April 1, 2009, was $38.6 million, including interest and penalties. During the quarter ended September 30, 2009, additional unrecognized tax benefits of $21,000 were recorded. The Company does not foresee significant changes to its estimated amount of liability associated with its uncertain tax positions within the next twelve months.

The Company’s income tax expense consists of state taxes and foreign taxes. The federal statutory income tax rate was 35% for the three months ended September 30, 2009 and 2008. The Company’s income tax benefit for the three months ended September 30, 2009 was $3.6 million as compared to an income tax expense of $0.4 million during the three months ended September 30, 2008. The decrease in the income tax expense recorded for the three months ended September 30, 2009 compared to September 30, 2008, was primarily related to discontinued operations, other comprehensive income and an increase in refundable tax credits available to the Company. During the six months ended September 30, 2009, the Company recorded a tax charge of approximately $3.3 million to discontinued operations in connection with the sale of the Company’s 3ware storage adapter business and concurrently recorded the same amount as an income tax benefit to continuing operations. In applying the exception to the general principle of intra-period tax allocations under ASC 740-10, the Company considered income recognized both in discontinued operations and other comprehensive income. Accordingly, the allocation of the current year tax provision included recognizing $7.3 million tax benefit arising from the loss from continuing operations and the offsetting tax expense was allocated on a pro rata basis to discontinued operations and other comprehensive income of $3.3 million and $4.0 million, respectively, for the six-month period ended September 30, 2009.

The Company is subject to taxation in the U.S. and various state and foreign jurisdictions. The Company currently has no years under examination by the Internal Revenue Service or any state jurisdiction. Effectively, all of the Company’s historical tax years are subject to examination by the Internal Revenue Service and various state jurisdictions due to the generation of net operating loss and credit carryforwards. With few exceptions, the Company is no longer subject to foreign examinations by tax authorities for years before 2006.

9. SALE OF THE 3WARE STORAGE ADAPTER BUSINESS TO LSI CORPORATION

On April 5, 2009, the Company entered into a Purchase Agreement with LSI Corporation (“LSI”). Under the Purchase Agreement, the Company agreed to sell to LSI substantially all of the operating assets (other than patents) primarily used or held for use in its 3ware storage adapter business (the “Storage Business”) but retaining certain assets, including patents, cash, accounts receivable and accounts payable, even if related to the Storage Business (the “Transaction”). The assets sold included customer contracts, inventory, fixed assets, certain intellectual property and other assets, as well as rights to the name “3ware.”

The Company completed the Transaction on April 21, 2009. The purchase price for the Transaction was approximately $20.0 million, subject to adjustments based on the level of inventory and products in the channel at the closing of the Transaction. After adjustments for the level of inventory of $0.7 million and products in the channel of $0.8 million, the final adjusted price of the Transaction was approximately $21.5 million. During the three months ended September 30, 2009, the Company and LSI reached an agreement to end the warranty support portion of the Purchase Agreement. As a result of the Transaction, the Company decreased its number of full-time employees by approximately 56.

As part of the Transaction, the Company entered into an intellectual property agreement, a transition services agreement and a master procurement agreement with LSI. These agreements are not material to the Company’s financial condition and operating results and do not constitute a significant continuing involvement with the Storage Business.

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The Company has reclassified the financial results of the 3ware storage adapter business as discontinued operations for all periods presented.

During the six months ended September 30, 2009, the Company recognized a tax charge of approximately $3.3 million to discontinued operations in connection with the sale of the Company’s 3ware storage adapter business and concurrently recorded the same amount as an income tax benefit to continuing operations.

10. VELOCE

On May 17, 2009, the Company entered into agreements with Veloce pursuant to which Veloce has agreed to perform product development work for the Company on an exclusive basis for up to five years for cash and other consideration, including a warrant to purchase shares of the Company’s common stock, which will vest upon the achievement of both certain performance and time-based milestones.

The Company has determined that Veloce, a California corporation, is a VIE by evaluating the sufficiency of the entity’s equity investment at risk to absorb losses and the Company’s share of respective expected losses and determined that the Company is the primary beneficiary of the VIE. The Company has included the accounts of Veloce in the consolidated financial statements and all significant intercompany balances and transactions have been eliminated in consolidation.

Under the merger agreement between the Company and Veloce, which has been approved by Veloce’s Board of Directors and stockholders, the Company also agreed to acquire Veloce if certain performance milestones and delivery schedules set forth under the merger and other agreements are achieved. The Company also has the unilateral option to acquire Veloce in the event Veloce fails to meet the milestones and delivery schedules. Should the Company acquire Veloce pursuant to the merger agreement, the purchase price payable by the Company is estimated to be in the range of approximately $5 million up to approximately $100 million, subject to adjustments. The final price would be based upon the achievement and timing of achieving multiple performance milestones and currently is not determinable. The form of consideration used for the merger, cash or the Company’s stock, would be determined by the Company at the time of the merger. The merger agreement contains customary representations, warranties and covenants and may be terminated upon mutual agreement of the parties or unilaterally by the Company or Veloce if the other party fails to meet certain conditions set forth in the agreement. The agreements permit the Company to appoint one individual to serve on Veloce’s Board of Directors and Board committees.

In addition, the Company has provided Veloce a promissory note of $1.5 million to be forgiven over eight quarters starting on March 31, 2011. If Veloce commits a material breach of the merger agreement, the outstanding principal amount of the note and accrued interest is due to the Company. If the Company commits a material breach of the merger agreement, the outstanding principal amount of the note and accrued interest is to be forgiven by the Company. The $1.5 million promissory note has been eliminated in consolidation. The Company will pay Veloce $1.5 million per quarter for up to twelve consecutive quarters in order to assist Veloce in meeting its expenses to perform its obligations under the agreement and the Company will recognize the payments as research and development expenses when such operating costs have been incurred by Veloce.

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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 consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of our operations. The MD&A is organized as follows:

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

• Overview. This section provides an introductory overview and context for the discussion and analysis that follows in the MD&A.

• 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, 2009 and 2008. 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 and financial commitments.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

The MD&A should be read in conjunction with the consolidated financial statements and notes thereto included in this report. This discussion contains forward-looking statements. These forward-looking statements are made as of the date of this report. Any statement that refers to an expectation, projection or other characterization of future events or circumstances, including the underlying assumptions, is a forward-looking statement. We use certain words and their derivatives such as “anticipate”, “believe”, “plan”, “expect”, “estimate”, “predict”, “intend”, “may”, “will”, “should”, “could”, “future”, “potential”, and similar expressions in many of the forward-looking statements. The forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and other assumptions made by us. These statements and the expectations, estimates, projections, beliefs and other assumptions on which they are based are subject to many risks and uncertainties and are inherently subject to change. We describe many of the risks and uncertainties that we face in Part II, Item 1A, “Risk Factors” and elsewhere in this report. Our actual results and actual events could differ materially from those anticipated in any forward-looking statement. Readers should not place undue reliance on any forward-looking statement.

OVERVIEW

Applied Micro Circuits Corporation (“AppliedMicro” or the “Company”) is a leader in semiconductor solutions for the enterprise, telecom and consumer/small medium business (“SMB”) markets. We design, develop, market and support high-performance low power integrated circuits (“ICs”), which are essential for the processing, transporting and storing of information worldwide. In the telecom and enterprise markets, we utilize a combination of design expertise coupled with system-level knowledge and multiple technologies to offer IC products for wireline and wireless communications equipment such as wireless access points, wireless base stations, multi-function printers, edge switches, gateways, metro transport platforms, core switches and routers. In the consumer/SMB markets, we combine optimized software and system-level expertise with highly integrated semiconductors to deliver comprehensive reference designs and stand-alone semiconductor solutions for wireline and wireless communications equipment such as wireless access points. Our corporate headquarters are located in Sunnyvale, California. Sales and engineering offices are located throughout the world.

Our business had three reporting units, Process, Transport and Store. On April 21, 2009, we completed the sale of our 3ware storage adapter business, which was substantially all the business of our Store unit, to LSI Corporation to focus on our Process and Transport reporting units. AppliedMicro is a semiconductor company that possesses fundamental and differentiated intellectual property for high speed signal processing, packet based communications processors and telecommunications transport protocols. This intellectual property enables us to be a key player in the datacenter, enterprise and telecommunications applications. Our focus is on the original equipment manufacturers (“OEMs”) and telecommunications companies that build and connect to datacenters.

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Certain amounts have been reclassified to conform to the current year presentation. We classified the financial results of our 3ware storage adapter business as discontinued operations for all periods presented due to the sale of our 3ware storage adapter business to LSI Corporation on April 21, 2009.

The following tables present a summary of our results of operations for the three and six months ended September 30, 2009 and 2008 (dollars in thousands):

	Three Months Ended September 30,
	2009					2008
	Amount			% of Net Revenue		Amount			% of Net Revenue		Increase (Decrease)			% Change
Net revenues	$	49,232		100.0	%	$	64,290		100.0	%	$	(15,058	)	(23.4	)%
Cost of revenues		23,796		48.3			28,576		44.4			(4,780	)	(16.7	)
Gross profit		25,436		51.7			35,714		55.6			(10,278	)	(28.8	)
Total operating expenses		33,699		68.4			36,281		56.4			(2,582	)	(7.1	)
Operating loss		(8,263	)	(16.7	)		(567	)	(0.8	)		(7,696	)	(1,357.3	)
Interest and other income (expense), net		(3,425	)	(7.0	)		(550	)	(0.9	)		(2,875	)	(522.7	)
Loss from continuing operations before income taxes		(11,688	)	(23.7	)		(1,117	)	(1.7	)		(10,571	)	(946.4	)
Income tax expense (benefit)		(3,617	)	(7.3	)		403		0.6			(4,020	)	(997.5	)
Loss from continuing operations		(8,071	)	(16.4	)		(1,520	)	(2.3	)		(6,551	)	(431.0	)
Income (loss) from discontinued operations, net of taxes		1,347		2.7			(793	)	(1.3	)		2,140		269.9
Net loss	$	(6,724	)	13.7	%	$	(2,313	)	(3.6	)%	$	(4,411	)	(190.7	)%

	Six Months Ended September 30,
	2009					2008
	Amount			% of Net Revenue		Amount			% of Net Revenue		Increase (Decrease)			% Change
Net revenues	$	94,284		100.0	%	$	125,489		100.0	%	$	(31,205	)	(24.9	)%
Cost of revenues		45,971		48.8			57,002		45.4			(11,031	)	(19.4	)
Gross profit		48,313		51.2			68,487		54.6			(20,174	)	(29.5	)
Total operating expenses		64,483		68.4			71,676		57.1			(7,193	)	(10.0	)
Operating loss		(16,170	)	(17.2	)		(3,189	)	(2.5	)		(12,981	)	(407.1	)
Interest and other income (expense), net		(1,836	)	(1.9	)		(1,877	)	(1.5	)		41		2.2
Loss from continuing operations before income taxes		(18,006	)	(19.1	)		(5,066	)	(4.0	)		(12,940	)	(255.4	)
Income tax expense (benefit)		(7,136	)	(7.6	)		905		0.8			(8,041	)	(888.5	)
Loss from continuing operations		(10,870	)	(11.5	)		(5,971	)	(4.8	)		(4,899	)	(82.0	)
Income (loss) from discontinued operations, net of taxes		7,044		7.5			(1,516	)	(1.2	)		8,560		564.6
Net loss	$	(3,826	)	(4.0	)%	$	(7,487	)	(6.0	)%	$	3,661		48.9	%

Net Revenues. We generate revenues primarily through sales of our IC products, embedded processors and printed circuit board assemblies to OEMs, such as Alcatel-Lucent, Ciena, Cisco, Brocade, Fujitsu, Hitachi, Huawei, Juniper, Ericsson, NEC, Nortel, Nokia Siemens Networks, and Tellabs, who in turn supply their equipment principally to communications service providers.

In July 2008, we entered into a Patent Purchase Agreement (the “Agreement”) with QUALCOMM Incorporated (“Qualcomm”). Pursuant to the Agreement, we agreed to sell a series of our patents, patent applications and associated rights related to certain technologies which were no longer core to our long-term strategic direction and product road maps for an aggregate purchase price of $33.0 million. The purchase price is being paid over three years in equal quarterly payments of $3.0 million each beginning in the three months ended September 30, 2008. Due to the nature of the payment terms, related revenue is being recorded as the payments are received beginning in the quarter ended September 30, 2008. Under the Agreement, we and our affiliates have retained a worldwide and non-exclusive right to manufacture and sell existing AppliedMicro products that utilize technology covered by the patents. Prior to the due date of the final payment, Qualcomm is permitted to withhold a portion of the total purchase price in the event we breach the representations, warranties or covenants that we made under the Agreement.

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The demand for our products has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:

• the timing, rescheduling or cancellation of significant customer orders and our ability, as well as the ability of our customers, to manage inventory corrections;

• the qualification, availability and pricing of competing products and technologies and the resulting effects on sales and pricing of our products.

• our ability to specify, develop or acquire, complete, introduce, and market new products and technologies in a cost effective and timely manner;

• the rate at which our present and future customers and end-users adopt our products and technologies in our target markets;

• general economic and market conditions in the semiconductor industry and communications markets, including the current global economic recession;

• combinations of companies in our customer base, resulting in the combined company choosing our competitor’s IC standardization other than our supported product platforms; and

• the gain or loss of one or more key customers, or their key customers, or significant changes in the financial condition of one or more of our key customers or their key customers.

For these and other reasons, our net revenue and results of operations for the three and six months ended September 30, 2009 and prior periods may not necessarily be indicative of future net revenue and results of operations.

Based on direct shipments, net revenues to customers that was equal to or greater than 10% of total net revenues were as follows:

	Three Months Ended September 30,				Six Months Ended September 30,
	2009		2008		2009		2008
Avnet (distributor)	28	%	26	%	26	%	28	%
Flextronics (sub-contract manufacturer)	*		13	%	*		11	%
Hon Hai (sub-contract manufacturer)	14	%	*		13	%	*

* Less than 10% of total net revenues for period indicated.

We expect that our largest customers will continue to account for a substantial portion of our net revenue for the foreseeable future.

Net revenues by geographic region were as follows (in thousands):

	Three Months Ended September 30,								Six Months Ended September 30,
	2009				2008				2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Amount		% of Net Revenue		Amount		% of Net Revenue
United States of America	$	17,428	35.4	%	$	18,583	28.9	%	$	32,968	35.0	%	$	36,124	28.8	%
Other North America		1,734	3.5			7,389	11.5			4,344	4.6			12,691	10.1
Europe		9,267	18.8			8,970	14.0			16,234	17.2			18,157	14.5
Asia		20,650	41.9			29,078	45.2			40,340	42.8			58,021	46.2
Other		153	0.4			270	0.4			398	0.4			496	0.4
	$	49,232	100.0	%	$	64,290	100.0	%	$	94,284	100.0	%	$	125,489	100.0	%

All of our revenues have been denominated in U.S. dollars.

Sale of our 3ware storage adapter business. We completed the sale of our 3ware storage adapter business, a significant portion of our overall business, to LSI Corporation on April 21, 2009, after our 2009 fiscal year. As a result, we now expect to generate all of our sales from our remaining business, Process and Transport, which will require us to grow our remaining business in order to achieve profitability. Economic and other factors may prevent us from growing our remaining business. If we fail to grow our remaining business, it could have a material adverse impact on our business, financial condition and operating results. We may in the future dispose of additional assets or businesses that represent a significant portion of our business.

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Under the Asset Purchase Agreement with LSI Corporation (the “Purchase Agreement”), which we entered on April 5, 2009, we sold substantially all of the operating assets (other than patents) of our 3ware storage adapter business. The assets sold included customer contracts, inventory, fixed assets, certain intellectual property and other assets, as well as rights to the name “3ware.” The purchase price, adjusted for the level of inventory and products in the channel at the closing of the Transaction, was approximately $21.5 million.

The Purchase Agreement contained customary representations, warranties, covenants and indemnities, including, among others, entering into an intellectual property agreement, a transition services agreement and a master procurement agreement with LSI Corporation.

Net Loss. Our net loss has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:

• stock-based compensation expense;

• amortization of purchased intangibles;

• acquired in-process research and development;

• litigation settlement costs;

• restructuring charges;

• combinations of companies within our customer base;

• purchased intangible asset impairment charges;

• other-than-temporary impairment of short-term investments and marketable securities; and

• income tax expense (benefit).

Since the start of fiscal 2008, we have invested a total of $211.0 million in the research and development of new products, including higher-speed, lower-power and lower-cost products, products that combine the functions of multiple existing products into single highly integrated products, and other products to complete our portfolio of communications products. These products, and our customers’ products for which they are intended, are highly complex. Due to this complexity, it often takes several years to complete the development and qualification of these products before they enter into volume production. Accordingly, we have not yet generated significant revenues from some of the products developed during this time period. In addition, downturns in the telecommunications market can severely impact our customers’ business and usually results in significantly less demand for our products than was expected when the development work commenced. As a result of restructuring activities associated with these downturns, we have discontinued development of several products that were in process and slowed down development of others as we realized that demand for these products would not materialize as originally anticipated.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to: inventory valuation and warranty liabilities, which affect our cost of sales and gross margin; the valuation of purchased intangibles, which has in the past affected, and could in the future affect, our impairment charges to write down the carrying value of purchased intangibles and the amount of related periodic amortization expense recorded for definite-lived intangibles; the valuation of restructuring liabilities, which affects the amount and timing of restructuring charges; an evaluation of other than temporary impairment of our investments, which affects the amount and timing of write-down charges; and the valuation of deferred income taxes, which affects our income tax expense (benefit). We also have other key accounting policies, such as our policies for stock-based compensation and revenue recognition, including the deferral of a portion of revenues on sales to distributors. The methods, estimates and judgments we use in applying these critical accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from management’s estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

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We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements.

Inventory Valuation and Warranty Liabilities

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 future 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 would decrease gross margin and net operating results. For example, as of September 30, 2009, reducing our future demand estimate to six months could decrease our current inventory valuation by approximately $7.3 million or increasing our future demand forecast to 18 months could increase our current inventory valuation by approximately $0.1 million.

Our products typically carry a one year warranty. We establish reserves for estimated product warranty costs at the time revenue is recognized. Although we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, use of materials and service delivery costs incurred in correcting any product failure. Should actual product failure rates, use of materials or service delivery costs differ from our estimates, additional warranty reserves could be required, which could reduce our gross margin. Additional changes to negotiated master purchase agreements could result in increased warranty reserves and unfavorably impact future gross margins.

Intangible Asset Valuation

The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, including in process research and development (“IPR&D”). Intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. The amounts and useful lives assigned to other intangible assets impact future amortization. Determining the fair values and useful lives of intangible assets requires the use of estimates and the exercise of judgment. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets acquired, we primarily use the income (discounted cash flows) 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 use to value and amortize intangible assets are consistent with the plans and estimates that we use to manage our business and are based on available historical information and industry estimates and averages. These judgments can significantly affect our net operating results.

Intangible assets need to be tested for potential impairment at the reporting unit level on at least an annual basis and between annual tests in certain circumstances. Application of the intangible assets impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units and determining the fair value of each reporting unit. The intangible assets impairment test compares the fair value of the reporting unit with the carrying value of the reporting unit. The implied fair value of intangible assets is determined in the same manner as in a business combination. Determining the implied fair value of the intangible assets is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge. Estimates of fair value are primarily determined using discounted cash flows for each reporting unit and market comparisons from relevant industries for each reporting unit. These approaches use significant estimates and assumptions, including projection and timing of future cash flows, discount rates reflecting the risk inherent in future cash flows, perpetual growth rates, determination of appropriate market comparables, and determination of whether a premium or discount should be applied to comparables. It is possible that the plans and estimates used to value these assets may differ from actual outcomes.

Investments

We hold a variety of securities that have varied underlying investments. We review our investment portfolio periodically to assess for other-than-temporary impairment. We assess the existence of impairment of our investments in order to determine the classification of the impairment as “temporary” or “other-than-temporary”. The factors used to determine whether an impairment is temporary or other-than-temporary involve considerable judgment. The current rapidly changing economic climate and volatile financial markets have created an environment in which it is difficult to make accurate estimates and assumptions on which we base our judgments. The factors we consider in determining whether any individual impairment is temporary or other-than-temporary are primarily the length of the time and the extent to which the market value has been less than amortized cost, the nature of underlying assets (including the degree of collateralization), the financial condition, credit rating, market liquidity conditions and near-term prospects of the issuer. If the fair value of a debt security is less than its amortized cost basis at the balance sheet date, an assessment would have to be made as to whether the impairment is other-than-temporary. If we decided to sell the security, an other-than-

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temporary impairment shall be considered to have occurred. However, if we do not intend to sell the debt security, we shall consider available evidence to assess whether it more likely than not will be required to sell the security before the recovery of its amortized cost basis due to cash, working capital requirements, contractual or regulatory obligations indicate that the security will be required to be sold before a forecasted recovery occurs. If more likely than not, we are required to sell the security before recovery of its amortized cost basis, an other-than-temporary impairment is considered to have occurred. If we do not expect to recover the entire amortized cost basis of the security, we would not be able to assert that it will recover its amortized cost basis even if we do not intend to sell the security. Therefore, in those situations, an other-than-temporary impairment shall be considered to have occurred. Use of present value cash flow models to determine whether the entire amortized cost basis of the security will be recovered is expected. We will compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. An other-than-temporary impairment is said to have occurred if the present value of cash flows expected to be collected is less than the amortized cost basis of the security. In the three and six months ended September 30, 2009, we recorded other-than-temporary impairment charges of $3.3 million and $3.5 million to current earnings. For the three months ended September 30, 2009, we did not record an impairment charge in connection with other securities in a continuous loss position (fair value less than carrying value) with unrealized losses of $0.5 million as we believe that such unrealized losses are temporary. As of September 30, 2009, we also had $7.3 million in unrealized gains. For the year ended March 31, 2009 we recorded other-than-temporary impairment charges of $17.1 million to current earnings.

Fair Value of Financial Instruments

Beginning April 1, 2008, short term investments and long term marketable securities are recorded at fair value in our condensed consolidated balance sheet and are categorized based upon the level of judgment associated with inputs used to measure their fair value. In April 2009, the FASB provided additional guidance in determining fair value when the volume and level of activity for the asset or liability have significantly decreased and on identifying transactions that are not orderly for making fair value measurements more consistent and provided guidance in determining whether a market is active or inactive, and whether a transaction is distressed. The annual disclosure requirements are now also required in interim periods. ASC 820-10 defines a three-level valuation hierarchy for disclosure of fair value measurements as follows:

Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

Level 2 — Inputs (other than quoted market prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. Valuation of instruments includes unobservable inputs to the valuation methodology that are significant to the measurement of the fair value of assets or liabilities.

We classify inputs to derive fair values for short term investments and long-term marketable investments as Level 1 and 2. Instruments classified as Level 1 include highly liquid government and agency securities, money market funds and publicly traded equity securities in active markets. Instruments classified as Level 2 include corporate notes, asset-backed securities and commercial paper.

We have no instruments for which the valuation inputs are classified as Level 3.

Restructuring Charges

Over the last several years we have undertaken significant restructuring initiatives, which have required us to develop formalized plans for exiting certain business activities and reducing spending levels. We have had to record estimated expenses for employee severance, long-term asset write downs, lease cancellations, facilities consolidation costs, and other restructuring costs. Given the significance, and the timing of the execution, of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made. In calculating the charges for our excess facilities, we have to estimate the timing of exiting certain facilities. Our assumptions for exiting certain facilities may differ from actual outcomes, which could result in the need to record additional costs or reduce estimated amounts previously charged to restructuring expense. Our policies require us to periodically evaluate the adequacy of the remaining liabilities under our restructuring initiatives. In fiscal 2009, we recorded a net charge of $8.7 million for our restructuring activities, of which $0.1 million has been reclassified to discontinued operations. In the six months ended September 30, 2009, we recorded a reversal of restructuring charges of approximately $0.3 million associated with our restructuring actions. For a full description of our restructuring activities, refer to our discussion of restructuring charges in Note 3 to the condensed consolidated financial statements, included in Part I, Item 1 of this report.

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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, including reversals of deferred tax liabilities, in assessing the need for a valuation allowance. If we were to 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 income tax expense. Conversely, if we were to determine that we will realize a deferred tax asset, which currently has a valuation allowance, we would reverse the valuation allowance which would be reflected as an income tax benefit or as an adjustment to stockholders’ equity, for tax assets related to stock options, or goodwill, for tax assets related to acquired businesses. In determining taxable income for financial statement reporting purposes, we must make certain estimates and judgments. These estimates and judgments are applied in the calculation of certain tax liabilities and in the determination of the recoverability of deferred tax assets, which arise from temporary differences between the recognition of assets and liabilities for tax and financial statement reporting purposes. In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax rules and the potential for future adjustment of our uncertain tax positions by the Internal Revenue Service or other taxing jurisdiction. If our estimates of these taxes are greater or less than actual results, an additional tax benefit or charge will result.

Stock-Based Compensation Expense

All share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, are required to be recognized in our financial statements based on their respective grant date fair values. The fair value of each employee stock option and employee stock purchase right is estimated on the date of grant using an option pricing model that meets certain requirements. We currently use the Black-Scholes option pricing model to estimate the fair value of our share-based payments. The fair values generated by the Black-Scholes model may not be indicative of the actual fair values of our stock-based awards as it does not consider certain factors important to stock-based awards, such as continued employment, periodic vesting requirements and limited transferability. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We estimate the expected volatility of our stock options at grant date by equally weighting the historical volatility and the implied volatility of our stock over specific periods of time as the expected volatility assumption required in the Black-Scholes model. The expected life of the stock options is based on historical and other data including life of the option and vesting period. The risk-free interest rate assumption is the implied yield currently available on zero-coupon government issues with a remaining term equal to the expected term. The dividend yield assumption is based on our history and expectation of dividend payouts. The fair value of our restricted stock units is based on the fair market value of our common stock on the date of grant. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ significantly from those estimated. We evaluate the assumptions used to value stock-based awards on a quarterly basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. We currently estimate when and if performance-based options will be earned. If the awards are not considered probable of achievement, no amount of stock-based compensation is recognized. If we consider the award to be probable, expense is recorded over the estimated service period. To the extent that our assumptions are incorrect, the amount of stock-based compensation recorded will be increased or decreased. To the extent that we grant additional equity securities to employees or we assume unvested securities in connection with any acquisitions, our stock-based compensation expense will be increased by the additional unearned compensation resulting from those additional grants or acquisitions.

Revenue Recognition

We recognize revenue based on four basic criteria: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectability is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met. In addition, we do not recognize revenue until the applicable customer’s acceptance criteria have been met. The criteria are usually met at the time of product shipment, except for shipments to distributors with rights of return. The portion of revenue from shipments to distributors subject to rights of return is deferred until the agreed upon percentage of return or cancellation privileges lapse. Revenue from shipments to distributors without return rights is recognized upon shipment. In addition, we record reductions to revenue for estimated allowances such as returns not pursuant to contractual rights, competitive pricing programs and rebates. These estimates are based on our experience with product returns and the contractual terms of the competitive pricing and rebate programs. Shipping terms are generally FCA (Free Carrier) shipping point. If actual returns or pricing adjustments exceed our estimates, we would record additional reductions to revenue.

From time to time we generate revenue from the sale of our internally developed intellectual property (“IP”). We generally recognize revenue from the sale of IP when cash is received and all other basic criteria outlined above are met.

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Allowance for Bad Debts

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 collectability of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry and economy. 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

Comparison of the Three and Six Months Ended September 30, 2009 to the Three and Six Months Ended September 30, 2008

Net Revenues.Net revenues for the three and six months ended September 30, 2009 were $49.2 million and $94.3 million, representing an decrease of 23.4% and 24.9% from net revenues of $64.3 million and $125.5 million for the three and six months ended September 30, 2008, respectively. We classify our revenues into two categories based on the markets that the underlying products serve. The categories are Process and Transport. We use this information to analyze our performance and success in these markets. See the following tables (dollars in thousands):

	Three Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Decrease			% Change
Process	$	25,085	51.0	%	$	33,297	51.8	%	$	(8,212	)	(24.7	)%
Transport		24,147	49.0			30,993	48.2			(6,846	)	(22.1	)
	$	49,232	100.0	%	$	64,290	100.0	%	$	(15,058	)	(23.4	)%

	Six Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Decrease			% Change
Process	$	50,165	53.2	%	$	67,194	53.5	%	$	(17,029	)	(25.3	)%
Transport		44,119	46.8			58,295	46.5			(14,176	)	(24.3	)
	$	94,284	100.0	%	$	125,489	100.0	%	$	(31,205	)	(24.9	)%

During the three months ended September 30, 2009, revenues, as anticipated, partially recovered from the prior two quarter’s economic recession and overall softness in demand reflected in the lower volumes that resulted in lower revenues. In addition, during the three and six months ended September 30, 2009, we also recorded $3.0 million and $6.0 million in licensing revenues, respectively, under Transport from the sale of certain non-core patents and associated rights. Net revenues for the three months ended September 30, 2008 represented a recovery from the prior downward inventory corrections by our customers and product transitions as well as an overall softness in demand. We expect revenues from continuing operations to increase by 5% to 8% in the three months ending December 31, 2009, compared to the three months ended September 30, 2009.

Gross Profit. The following table presents net revenues, cost of revenues and gross profit for the three and six months ended September 30, 2009 and 2008 (dollars in thousands):

	Three Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Decrease			% Change
Net revenues	$	49,232	100.0	%	$	64,290	100.0	%	$	(15,058	)	(23.4	)%
Cost of revenues		23,796	48.3			28,576	44.4			(4,780	)	(16.7	)
Gross profit	$	25,436	51.7	%	$	35,714	55.6	%	$	(10,278	)	(28.8	)%

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	Six Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Decrease			% Change
Net revenues	$	94,284	100.0	%	$	125,489	100.0	%	$	(31,205	)	(24.9	)%
Cost of revenues		45,971	48.8			57,002	45.4			(11,031	)	(19.4	)
Gross profit	$	48,313	51.2	%	$	68,487	54.6	%	$	(20,174	)	(29.5	)%

The gross profit percentage for the three and six months ended September 30, 2009 decreased to 51.7% and 51.2%, compared to 55.6% and 54.6% for the three and six months ended September 30, 2008, respectively. The decrease in our gross profit percentage was primarily due to an unfavorable product mix, an overall decrease in net revenues and an unfavorable overhead adjustment, offset by $3.0 million and $6.0 million in revenue from the sale of our non-core patents and associated rights to Qualcomm and the sale of $0.3 million and $0.7 million of previously reserved inventory, during the three and six months ended September 30, 2009, respectively.

The amortization of purchased intangible assets included in cost of revenues during the three and six months ended September 30, 2009 was $3.3 million and $6.9 million compared to $3.9 million and $7.7 million for the three and six months ended September 30, 2008, respectively. Based on the amount of capitalized purchased intangibles on the balance sheet as of September 30, 2009, we expect amortization expense for purchased intangibles charged to cost of revenues to be $12.1 million in fiscal 2010, $10.5 million in fiscal 2011 and $0.9 million for fiscal 2012. Future acquisitions of businesses may result in substantial additional charges, which would impact the gross profit percentage in future periods.

Research and Development and Selling, General and Administrative Expenses. The following table presents research and development and selling, general and administrative expenses for the three and six months ended September 30, 2009 and 2008 (dollars in thousands):

	Three Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Decrease			% Change
Research and development	$	20,828	42.3	%	$	21,410	33.3	%	$	(582	)	(2.7	)%
Selling, general and administrative	$	11,991	24.4	%	$	13,780	21.4	%	$	(1,789	)	(13.0	)%

	Six Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Decrease			% Change
Research and development	$	40,242	42.7	%	$	41,860	33.4	%	$	(1,618	)	(3.9	)%
Selling, general and administrative	$	22,510	23.9	%	$	27,631	22.0	%	$	(5,121	)	(18.5	)%

Research and Development. Research and development (“R&D”) expenses consist primarily of salaries and related costs (including stock-based compensation) of employees engaged in research, design and development activities, costs related to engineering design tools, subcontracting costs and facilities expenses. The decrease in R&D expenses of 2.7% for the three months ended September 30, 2009 compared to the three months ended September 30, 2008 was primarily due to a decrease of $1.1 million in personnel costs related to our recent restructuring actions and $1.1 million in technology access fees, offset by an increase of $0.8 million in equipment and software costs, $0.7 million in printed circuit boards, $0.7 million in stock-based compensation charges and $0.6 million in customer funded non-recurring engineering payments. The decrease in R&D expenses of 3.9% for the six months ended September 30, 2009 compared to the six months ended September 30, 2008 was primarily due to a decrease of $3.1 million in personnel costs related to our recent restructuring actions, $1.5 million in technology access fees, offset by an increase of $1.7 million in equipment and software costs, $0.9 million in printed circuit boards, $0.8 million in stock-based compensation charges and $0.4 million in customer funded non-recurring engineering payments. We believe that a continued commitment to R&D is vital to our goal of maintaining a leadership position with innovative products. In addition to our internal R&D programs, our business strategy includes acquiring products, technologies or businesses from third parties. Future acquisitions of products, technologies or businesses may result in substantial additional on-going R&D costs.

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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. The decrease in SG&A expenses of 13.0% for the three months ended September 30, 2009 compared to the three months ended September 30, 2008 was primarily due to a decrease of $1.6 million in personnel costs related to our recent restructuring actions and $0.6 million in contractor costs, offset by an increase of $0.5 million in professional services expenses. The decrease in SG&A expenses of 18.5% for the six months ended September 30, 2009 compared to the six months ended September 30, 2008 was primarily due to a decrease of $2.9 million in personnel costs related to our recent restructuring actions, $1.3 million in contractor costs, $0.5 million in travel expenses and $0.4 million in marketing communications expenses. Future acquisitions of products, technologies or businesses may result in substantial additional on-going SG&A costs.

Stock-Based Compensation. The following table presents stock-based compensation expense for the three and six months ended September 30, 2009 and 2008, which was included in the tables above (dollars in thousands):

	Three Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Increase			% Change
Costs of revenues	$	143	0.3	%	$	82	0.1	%	$	61		74.4	%
Research and development		1,594	3.2			923	1.4			671		72.7
Selling, general and administrative		2,030	4.1			1,624	2.5			406		25.0
	$	3,767	7.7	%	$	2,629	4.0	%	$	1,138		43.3	%
	Six Months Ended September 30,
	2009				2008
	Amount		% of Net Revenue		Amount		% of Net Revenue		Increase (Decrease)			% Change
Costs of revenues	$	254	0.3	%	$	256	0.2	%	$	(2	)	(0.8	)%
Research and development		2,866	3.0			2,041	1.6			825		40.4
Selling, general and administrative		3,262	3.5			3,201	2.6			61		1.9
	$	6,382	6.8	%	$	5,498	4.4	%	$	884		16.1	%

The amount of unearned stock-based compensation currently estimated to be expensed from now through fiscal 2014 related to unvested share-based payment awards at September 30, 2009 is $31.9 million. This expense relates to equity instruments already issued and will not be affected by our future stock price. The increase is primarily due to the EBITDA Grants issued during the three months ended June 30, 2009. Vesting of the EBITDA Grants is subject to (i) the Company’s performance as measured by earnings before interest, taxes, depreciation and amortization (“EBITDA”), and (ii) individual performance as measured by the accomplishment of goals and objectives. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 3.0 years. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense will increase to the extent that we grant additional equity awards. We anticipate we will continue to grant additional employee stock options and RSUs in fiscal 2010 and thereafter. The value of these grants cannot be predicted at this time because it will depend on the number of share-based payments granted and the then current fair values.

Restructuring Charges. The reversal of restructuring charges recorded for the three and six months ended September 30, 2009 and 2008 was related to accruals made for the restructuring actions for which the liability is no longer required.

Option Investigation and Related Expenses. During the first quarter of fiscal 2007, we initiated a review of our historical stock option granting policies. We incurred professional and legal fees as a result of our self-initiated review. Although we concluded our investigation during the fourth quarter of fiscal 2007, we continued to incur expenses for the related ongoing legal and regulatory proceedings as a result of the option investigation. During fiscal 2009, we incurred additional expenses, offset by insurance proceeds for the related ongoing legal and regulatory proceedings which were concluded during fiscal 2009.

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Interest and Other Income (Expense) and Other-Than-Temporary Impairments, net. The following table presents interest and other income (expense) and other-than-temporary impairments, net for the three and six months ended September 30, 2009 and 2008 (dollars in thousands):

	Three Months Ended September 30,
	2009					2008
	Amount			% of Net Revenue		Amount			% of Net Revenue		Decrease			% Change
Interest income (expense) and other-than-temporary impairments, net	$	(1,534	)	(3.1	)%	$	(814	)	(1.3	)%	$	(720	)	(88.5	)%
Other income (expense), net	$	(1,891	)	(3.8	)%	$	264		0.4	%	$	(2,155	)	(816.3	)%
	Six Months Ended September 30,
	2009					2008
	Amount			% of Net Revenue		Amount			% of Net Revenue		Increase (Decrease)			% Change
Interest income (expense) and other-than-temporary impairments, net	$	(162	)	(0.2	)%	$	(2,216	)	(1.8	)%	$	2,054		92.7	%
Other income (expense), net	$	(1,674	)	(1.8	)%	$	339		0.3	%	$	(2,013	)	(593.8	)%

Interest and Other Income (Expense) and Other-Than-Temporary Impairment, net. Interest income (expense) and other-than-temporary impairment, net of management fees and other-than-temporary impairment, reflects interest earned on cash and cash equivalents, short-term investments and marketable securities as well as realized gains and losses from the sale of short-term investments and impairment charges on investments, less interest expense. The decrease in interest income (expense) and other-than-temporary impairment, net for the three months ended September 30, 2009, compared to the three months ended September 30, 2008 was primarily due to lower interest rates. The decrease in interest income (expense) and other-than-temporary impairment, net for the six months ended September 30, 2009, compared to the six months ended September 30, 2008 was primarily due to a $3.3 million decrease in other-than-temporary impairment charges offset by a decrease in interest income from lower interest rates. The decrease in other income (expense), net for the three and six months ended September 30, 2009, compared to the three and six months ended September 30, 2008 was primarily due to a $2.0 million impairment for a strategic investment which we determined was impaired at September 30, 2009.

Income Taxes.The federal statutory income tax rate was 35% for the three and six months ended September 30, 2009 and 2008. The decrease in the income tax expense recorded for the three and six months ended September 30, 2009 compared to the three and six months ended September 30, 2008, was primarily related to discontinued operations offset by an increase in refundable tax credits. The allocation of the current year tax provision included recognizing $7.3 million tax benefit arising from the loss from continuing operations and the offsetting tax expense was allocated on a pro rata basis to discontinued operations and other comprehensive income of $3.3 million and $4.0 million, respectively, for the six-month period ended September 30, 2009.

Discontinued Operations. We completed the sale of our 3ware storage adapter business (“Storage Business”) to LSI Corporation on April 21, 2009. Under the Asset Purchase Agreement, we substantially sold all of the operating assets (other than patents) of our Storage Business. The assets sold included customer contracts, inventory, fixed assets, certain intellectual property and other assets, as well as rights to the name “3ware.” The purchase price for the Transaction was approximately $20.0 million, subject to adjustments based on the level of inventory and products in the channel at the closing of the Transaction. After adjustments for the level of inventory of $0.7 million and products in the channel of $0.8 million, the final adjusted price of the Transaction was approximately $21.5 million. During the three months ended September 30, 2009, we reached an agreement with LSI to end the warranty support portion of the Purchase Agreement. We recorded a net gain of $11.4 million from the sale during the six months ended September 30, 2009. During the six months ended September 30, 2009, we recognized a tax charge of approximately $3.3 million to discontinued operations in connection with the sale of our 3ware storage adapter business and concurrently recorded the same amount as an income tax benefit to continuing operations.

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The following table presents the operating results of the discontinued operations of our 3ware storage adapter business for the three and six months ended September 30, 2009 and 2008:

3WARE STORAGE ADAPTER BUSINESS

CONSOLIDATED STATEMENTS OF OPERATIONS

	Three Months Ended September 30,						Six Months Ended September 30,
	2009			2008			2009			2008
	(in thousands)
Net revenues	$	703		$	12,641		$	1,219		$	25,502
Cost of revenues		51			7,405			784			14,829
Gross profit (loss)		652			5,236			435			10,673
Operating expenses:
Research and development		83			3,051			677			6,082
Selling, general and administrative		238			2,554			783			5,316
Amortization of purchased intangible assets		—			315			—			630
Total operating expenses		321			5,920			1,460			12,028
Operating loss		331			(684	)		(1,025	)		(1,355	)
Gain on sale of Storage Business		712			—			11,366			—
Income (loss) from discontinued operations before income taxes		1,043			(684	)		10,341			(1,355	)
Income tax expense		(304	)		109			3,297			161
Income (loss) from discontinued operations	$	1,347		$	(793	)	$	7,044		$	(1,516	)

FINANCIAL CONDITION AND LIQUIDITY

As of September 30, 2009, our principal source of liquidity consisted of $197.7 million in cash, cash equivalents and short-term investments. Working capital as of September 30, 2009 was $217.5 million. Total cash, cash equivalents, and short-term investments increased by $13.7 million during the six months ended September 30, 2009, primarily due to the proceeds from the sale of our Storage Business of approximately $21.5 million offset by open stock repurchase contracts of $10.0 million. At September 30, 2009, we had contractual obligations not included on our balance sheet totaling $40.1 million, primarily related to facility leases, engineering design software tool licenses and non-cancelable inventory purchase commitments.

For the six months ended September 30, 2009, we used $5.3 million of cash in our operations compared to generating $20.5 million for the six months ended September 30, 2008. Our net loss of $3.8 million for the six months ended September 30, 2009 included $20.0 million of non-cash charges consisting of $3.2 million of depreciation, $8.9 million of amortization of purchased intangibles, $6.4 million of stock-based compensation, $3.5 million for marketable securities impairment and $2.0 million impairment of a strategic investment, offset by $4.0 million in tax benefit from other comprehensive income. Our net loss of $7.5 million for the six months ended September 30, 2008 included $28.2 million of non-cash charges consisting of $3.4 million of depreciation, $11.8 million of amortization of purchased intangibles, $6.2 million of stock-based compensation and $6.8 million for marketable securities impairment. The remaining change in operating cash flows for the six months ended September 30, 2009 primarily reflected decreases in inventories, accounts payable, accrued payroll and other accrued liabilities and deferred revenue, primarily due to the sale of our 3ware storage adapter business to LSI, offset by increases in accounts receivable and other assets. Our overall days sales outstanding was 40 days and 35 days for the three months ended September 30, 2009 and March 31, 2009, respectively.

We generated $26.5 million in cash from our investing activities during the six months ended September 30, 2009, compared to using $1.0 million during the six months ended September 30, 2008. During the six months ended September 30, 2009, we generated net proceeds of $9.7 million from short-term investment activities and received proceeds of $21.5 million for the sale of our 3ware storage adapter business, offset by $3.7 million for the purchase of property, equipment and other assets and $1.0 million for a strategic investment. During the six months ended September 30, 2008, we used $4.9 million of cash for the purchase of property, equipment and other assets, offset by net proceeds of $3.9 million from short-term investment activities.

For the six months ended September 30, 2009, we used $8.7 million of cash in financing activities. The major financing use of cash for the six months ended September 30, 2009 was the funding of our structured stock repurchase agreements for $21.8 million, offset by proceeds of $12.0 million from the settlement of structured stock repurchase agreements and $1.8 million from the issuance of our common stock. For the six months ended September 30, 2008, we received $1.6 million of cash in financing activities from the sales of common stock through employee stock options and purchases.

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In August 2004, the Board authorized a stock repurchase program for the repurchase of up to $200.0 million of our common stock. Under the program, we are authorized to make purchases in the open market or enter into structured agreements. In October 2008, the Board increased the stock repurchase program by $100.0 million. During the six months ended September 30, 2009 and the fiscal year ended March 31, 2009, no shares were repurchased on the open market. All repurchased shares are retired upon delivery to us.

We also utilize structured stock repurchase agreements to buy back shares which are prepaid written put options on our common stock. We pay a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or stock depending on the closing market price of our common stock on the expiration date of the agreement. Upon expiration of each agreement, if the closing market price of our common stock is above the pre-determined price, we will have our cash investment returned with a premium. If the closing market price is at or below the pre-determined price, we will receive the number of shares specified at the agreement inception. Any cash received, including the premium, is treated as additional paid in capital on the balance sheet.

At September 30, 2009, we had approximately $105.5 million remaining available to repurchase shares under the stock repurchase program and two outstanding structured stock repurchase agreements for $10.0 million, of which one settled with the receipt of $5.2 million in cash in October 2009.

On May 17, 2009, we entered into agreements with Veloce pursuant to which Veloce has agreed to perform product development work for us on an exclusive basis for up to five years for cash and other consideration, including a warrant to purchase shares of our common stock, which will vest upon the achievement of both certain performance and time-based milestones.

Under the merger agreement between us and Veloce, we agreed to acquire Veloce if certain performance milestones and delivery schedules set forth under the merger and other agreements are achieved. We also have the unilateral option to acquire Veloce in the event Veloce fails to meet the milestones and delivery schedules. Should we acquire Veloce pursuant to the merger agreement, the purchase price is estimated to be in the range of approximately $5 million up to approximately $100 million, subject to adjustments. The final price would be based upon the achievement and timing of achieving multiple performance milestones and currently is not determinable. We will determine the form of consideration used for the merger, cash or our stock, at the time of the merger. The merger agreement contains customary representations, warranties and covenants and may be terminated upon mutual agreement of the parties or unilaterally by us or Veloce if the other party fails to meet certain conditions set forth in the agreement. The agreements permit us to appoint one individual to serve on Veloce’s Board of Directors and Board committees.

In addition, we provided Veloce a promissory note of $1.5 million to be forgiven over eight quarters starting on March 31, 2011. If Veloce commits a material breach of the merger agreement, the outstanding principal amount of the note and accrued interest is due to us. If we commit a material breach of the merger agreement, the outstanding principal amount of the note and accrued interest is to be forgiven by us. The promissory note has been eliminated in consolidation. We will pay Veloce $1.5 million per quarter for up to twelve consecutive quarters in order to assist Veloce in meeting its expenses to perform its obligations under the agreement and we will recognize the payments as research and development expenses when incurred.

The following table summarizes our contractual operating leases and other purchase commitments as of September 30, 2009 (in thousands):

	Operating Leases		Other Purchase Commitments		Total
Fiscal Years Ending March 31, 2010	$	7,031	$	20,997	$	28,028
2011		6,239		91		6,330
2012		4,038		—		4,038
2013		1,700		—		1,700
2014 and thereafter		—		—		—
Total minimum payments	$	19,008	$	21,088	$	40,096

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 debt or equity financing will be available on commercially reasonable terms or at all.

OFF-BALANCE SHEET ARRANGEMENTS

We did not have any off-balance sheet arrangements as of September 30, 2009 or March 31, 2009.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and a decline in the stock market. The current turbulence in the U.S. and global financial markets has caused a decline in stock values across all industries. We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are classified as available-for-sale and, consequently, are recorded on our consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income or loss. We have 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 interest rate trends. We invest our excess cash in debt instruments of the U.S. Treasury, corporate bonds, mortgage-backed and asset backed securities and closed-end bond funds, with credit ratings as specified in our investment policy. We also have invested in preferred stocks, which pay quarterly fixed rate dividends. We generally do not utilize derivatives to hedge against increases in interest rates which decrease market values, except for investments managed by one investment manager who utilizes U.S. Treasury bond futures options as a protection against the impact of increases in interest rates on the fair value of preferred stocks managed by that investment manager.

We are exposed to market risk as it relates to changes in the market value of our investments. At September 30, 2009, our investment portfolio included fixed-income securities classified as available-for-sale investments with an aggregate fair market value of $85.9 million and a cost basis of $79.0 million. These securities are subject to interest rate risk, as well as credit risk and liquidity risk, and will decline in value if interest rates increase or an issuer’s credit rating or financial condition is decreased.

The following table presents the hypothetical changes in fair value of our short-term investments held at September 30, 2009 (in thousands):

	Valuation of Securities Given an Interest Rate Decrease of X Basis Points (“BPS”)						Fair Value as of September 30, 2009		Valuation of Securities Given an Interest Rate Increase of X Basis Points (“BPS”)
	(150 BPS)		(100 BPS)		(50 BPS)				50 BPS		100 BPS		150 BPS
Available-for-sale investments	$	91,061	$	89,281	$	87,561	$	85,878	$	84,272	$	82,700	$	81,188

The modeling technique used measures the change in fair market 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, 100 basis points, and 150 basis points. While this modeling technique provides a measure of our exposure to market risk, the current economic turbulence could cause interest rates to shift by more than 150 basis points.

We also invest in equity instruments of private companies for business and strategic purposes. These investments 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. However, we have periodically entered into forward currency exchange contracts to hedge our overseas monthly operating expenses when deemed appropriate. Gains and losses on foreign currency forward contracts that are designated and effective as hedges of anticipated transactions, for which a firm commitment has been attained, are deferred and included in the basis of the transaction in the same period that the underlying transaction is settled. Gains and losses on any instruments not meeting the above criteria are recognized in income or expenses in the consolidated statements of operations in the current period. The effect of an immediate 10% change in foreign exchange rates would not have a material impact on our financial condition or results of operations.

ITEM 4. CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit with the SEC pursuant to the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In addition, the design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in

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achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

As required by SEC Rule 13a-15(b), we conducted an evaluation, under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2009. Based on the foregoing, our CEO and CFO concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control Over Financial Reporting

There was no change in our internal controls over financial reporting that occurred during the most recent quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The information set forth under Note 7 of Notes to Consolidated Financial Statements, included in Part I, Item 1 of this report, is incorporated herein by reference.

ITEM 1A. RISK FACTORS

Before deciding to invest in us 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. We update our descriptions of the risks and uncertainties facing us in our periodic reports filed with the SEC. The risks and uncertainties described below and in our other filings 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 occurs, 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. The risks and uncertainties set forth below with an asterisk (“*”) next to the title contain changes to the description of the risks and uncertainties associated with our business as previously disclosed in Item 1A to our Annual Report on Form 10-K for the fiscal year ended March 31, 2009 filed with the SEC on May 12, 2009.

*If we are unable to timely develop new products or new generations and versions of our existing products to replace our current products, our operating results and competitive position will be materially harmed.

Our industry is characterized by intense competition, rapidly evolving technology, and continually changing customer requirements. These factors could render our existing products obsolete. Accordingly, our ability to compete in the future will depend in large part on our ability to identify and develop new products or new generations and versions of our existing products that achieve market acceptance on a timely and cost-effective basis, and to respond to changing requirements. If we are unable to do so, our business, operating results and financial condition will be negatively affected.

The successful development and market acceptance of our products depend on a number of factors, including, but not limited to:

• our accurate prediction of changing customer requirements;

• timely development of new designs;

• timely qualification and certification of our products for use in electronic systems;

• commercial acceptance and production of the electronic systems into which our products are incorporated;

• availability, quality, price, performance, and size of our products relative to competing products and technologies;

• our customer service and support capabilities and responsiveness;

• successful development of relationships with existing and potential new customers;

• successful development of relationships with key developers of advanced digital semiconductors; and

• changes in technology, industry standards or consumer preferences.

Products we have recently developed and which we are currently developing may not achieve market acceptance. If these products fail to achieve market acceptance, or if we fail to timely develop new products that achieve market acceptance, our business, financial condition and operating results will be materially harmed.

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*The gross margins for our products could decrease rapidly or not increase as forecasted, which will negatively impact our operating results.

The gross margins for our solutions have historically declined over time. Factors that we expect to cause downward pressure on the gross margins for our products include competitive pricing pressures, the cost sensitivity of our customers, particularly in the higher-volume markets, new product introductions by us or our competitors, and other factors. From time to time, for strategic reasons, we may accept orders at less than optimal gross margins in order to facilitate the introduction of, or, market penetration of our new or existing products. To maintain acceptable operating results, we will need to offset any reduction in gross margins of our products by reducing costs, increasing sales volume, developing and introducing new products and developing new generations and versions of existing products on a timely basis. If the gross margins for our products decline or not increase as forecasted and we are unable to offset those reductions, our business, financial condition and operating results will be materially harmed.

*The current economic crisis and uncertain political conditions could harm our revenues, operating results and financial condition.

The economies of the United States and other developed countries are currently in a recession. We cannot predict either the depth or the duration of this economic downturn.

This recession has caused a decline in our near term revenues and it will take some time to return to our previous levels. The sale of our storage business could increase this time period. Our current operating plans are based on assumptions concerning levels of consumer and corporate spending. If global and domestic economic and market conditions persist or deteriorate further, we may experience further material impacts on our business, operating results and financial condition which could result in a decline in the price of our common stock. If economic conditions worsen, we may have to implement additional cost reduction measures or delay certain research and development spending.

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are generally classified as available-for-sale and, consequently, are recorded on our consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income. Our portfolio primarily includes fixed income securities, mutual funds and preferred stocks, the values of which are subject to market price volatility. The deterioration of these market prices has had an unfavorable impact on our portfolio and has caused us to record impairment charges to our earnings. During the six months ended September 30, 2009, we recorded an impairment charge of $3.5 million. During the fiscal year ended March 31, 2009, we recorded other-than-temporary impairment charge of $17.1 million. If the market prices continue to decline or securities continue to be in a loss position over time, we may recognize additional impairments in the fair value of our investments.

Adverse economic and market conditions could also harm our business by negatively affecting the parties with whom we do business, including our business partners, our customers and our suppliers. These conditions could impair the ability of our customers to pay for products they have purchased from us. As a result, allowances for doubtful accounts and write-offs of accounts receivable from our customers may increase. In addition, our suppliers may experience financial difficulties that could negatively affect their operations and their ability to supply us with the parts we need to manufacture our products.

We have invested in privately-held companies, many of which can still be considered in startup or developmental stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose all or substantially all of the value of our investments in these companies, and in some cases we have lost all or substantially all of the value of our investment in such entities.

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:

• communications, information technology and semiconductor industry conditions;

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

• the reduction, rescheduling or cancellation of orders by customers, including as a result of slowing demand for our products or our customers’ products or over-ordering of our products or our customers’ products;

• changes in the mix of products that our customers buy;

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

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

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

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• competitive pressures on selling prices;

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

• market acceptance of our products and our customers’ products;

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

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

• the availability of external foundry capacity, contract manufacturing services, purchased parts and raw materials including packaging substrates;

• problems or delays that we and our foundries may face in shifting the design and manufacture of our future generations of IC products to smaller geometry process technologies and in achieving higher levels of design and device integration;

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

• the amounts and timing of investments in research and development;

• the amounts and timing of the costs associated with payroll taxes related to stock option exercises or settlement of restricted stock units;

• costs associated with acquisitions and the integration of acquired companies, products and technologies;

• the impact of potential one-time charges related to purchased intangibles;

• our ability to successfully integrate acquired companies, products and technologies;

• the impact on interest income of a significant use of our cash for an acquisition, stock repurchase or other purpose;

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

• costs associated with compliance with applicable environmental, other governmental or industry regulations including costs to redesign products to comply with those regulations or lost revenue due to failure to comply in a timely manner;

• the effects of changes in accounting standards;

• costs associated with litigation, including without limitation, attorney fees, litigation judgments or settlements, relating to the use or ownership of intellectual property or other claims arising out of our operations;

• our ability to identify, hire and retain senior management and other key personnel;

• the effects of war, acts of terrorism or global threats, such as disruptions in general economic activity and changes in logistics and security arrangements; and

• global economic recession and industry 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:

• the reduction, rescheduling or cancellation of customer orders;

• declines in the average selling prices of our products;

• delays when our customers are transitioning from old products to new products;

• a decrease in demand for our products or our customers’ products;

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

• delays in the availability of our products or our customers’ products;

• the failure of our products to be qualified in our customers’ systems or certified by our customers;

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

• fabrication, test, product yield, or assembly constraints for our products that adversely affect our ability to meet our production obligations;

• the failure of one of our subcontract manufacturers to perform its obligations to us;

• our failure to successfully integrate acquired companies, products and technologies;

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• shortages of raw materials or production capacity constraints that lead our suppliers to allocate available supplies or capacity to other customers, which may disrupt our ability to meet our production obligations; and

• global economic recession and industry conditions.

Our business is characterized by short-term orders and shipment schedules. Customer orders typically can be cancelled or rescheduled without significant penalty to the customer. Because we do not have substantial non-cancellable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand, which is highly unpredictable and can fluctuate substantially. Customer orders for our products typically have non-standard lead times, which make it difficult for us to predict revenues and plan inventory levels and production schedules. If we are unable to plan inventory levels and production schedules 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 contract manufacturers, 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. If we are forced to hold excess inventory or we incur unanticipated inventory write-downs, our financial condition and operating results could be materially harmed.

Our expense levels are relatively fixed and are based on our expectations of future revenues. We have limited ability to reduce expenses quickly in response to any revenue shortfalls. Changes to production volumes and impact of overhead absorption may result in a decline in our financial condition or liquidity.

Our business substantially depends upon the continued growth of the technology sector and the Internet.

The technology equipment industry is cyclical and has in the past experienced significant and extended downturns. The current downturn is significant and we cannot predict how long it will last. A substantial portion of our business and revenue depends on the continued growth of the technology sector and the Internet. We sell our communications IC products primarily to communications equipment manufacturers that in turn sell their equipment to customers that depend on the growth of the Internet. The current downturn has already caused a reduction in capital spending on information technology. If this reduction continues or deepens, our business, operating results and financial condition may be materially harmed.

The loss of one or more key customers, the diminished demand for our products from a key customer, or the failure to obtain certifications from a key customer or its distribution channel 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 our key customers. One or more of our key customers may discontinue operations as a result of consolidation, liquidation or otherwise. Reductions, delays and cancellation of orders from our key customers or the loss of one or more key customers could significantly 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 significant new customers is subject to a variety of factors, including:

• customers may stop incorporating our products into their own products with limited notice to us and may suffer little or no penalty as a result of such action;

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

• design wins (as explained below) with customers or prospective customers may not result in sales to such customers;

• the introduction of new products by customers may occur later or be less successful in the market than planned;

• we may successfully design a product to customer specifications but the customer may not be successful in the market;

• sales of customer product lines incorporating our products may rapidly decline or such product lines may be phased out;

• our agreements with customers typically are non-exclusive and do not require them to purchase a minimum quantity of our products;

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

• some of our OEM customers may develop products internally that would replace our products;

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

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

• the impact of terminating certain sales representatives or sales personnel as a result of a Company workforce reduction or otherwise; and

• some of our customers and prospective customers may become less viable or fail.

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

There is no guarantee that design wins will become actual orders and sales.

A “design win” occurs when a customer or prospective customer notifies us that our product has been selected to be integrated with the customer’s product. There can be delays of several months or more between the design win and when a customer initiates actual orders of our product. Following a design win, we will commit significant resources to the integration of our product into the customer’s product before receiving the initial order. Receipt of an initial order from a customer following a design win, however, is dependent on a number of factors, including the success of the customer’s product, and cannot be guaranteed. The design win may never result in an actual order or sale.

Any significant order cancellations or order deferrals could cause unplanned inventory growth resulting in excess inventory which may adversely affect our operating results.

Our customers may increase orders during periods of product shortages or cancel orders if their inventories are too high. Major inventory corrections by our customers are not uncommon and can last for significant periods of time and affect demand for our products. Customers may also cancel or delay orders in anticipation of new products or for other reasons. Cancellations or deferrals could cause us to hold excess inventory, which could reduce our profit margins by reducing sales prices, incurring inventory write-downs or writing off additional obsolete products.

Inventory fluctuations could affect our results of operations and restrict our ability to fund our operations. Inventory management remains an area of focus as we balance the need to maintain strategic inventory levels to ensure competitive lead times against the risk of inventory obsolescence because of changing technology and customer requirements.

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.

Our customers’ products typically have lengthy design cycles. A customer may decide to cancel or change its product plans, which could cause us to lose anticipated sales.

After we have developed and delivered a product to a customer, the customer will usually test and evaluate our product prior to designing its own equipment to incorporate our product. Our customers may need more than six months to test, evaluate and adopt our product and an additional nine months or more to begin volume production of equipment that incorporates our product. Due to this lengthy design cycle, we may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring such expenditures. Even if a customer selects our product to incorporate into its equipment, we cannot guarantee that the customer will ultimately market and sell its equipment or that such efforts by our customer will be successful. The delays inherent in this lengthy design cycle increases the risk that a customer will decide to cancel or change its product plans. Such a cancellation or change in plans by a customer could cause us to lose sales that we had anticipated. While our customers’ design cycles are typically long, some of our product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, the resources devoted to product sales and marketing may not generate material revenue for us, and from time to time, we may need to write off excess and obsolete inventory. If we incur significant marketing expenses and investments in inventory in the future that we are not able to recover, and we are not able to mitigate those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions but still hold higher cost products in inventory, our operating results would be harmed.

An important part of our strategy is to focus on the markets for communications equipment. If we change strategy or are unable to further expand our share of these markets or react timely or properly to emerging trends, our revenues may not grow and could decline.

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,

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or if our products fail to be certified by OEMs, we would lose business from an existing or potential customer and may not have the opportunity to compete for new design wins or certification 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 certifying or 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.

We expect a significant portion of our revenues to continue to be derived from sales of products based on current, widely accepted 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.

The recent sale of our 3ware storage adaptor business to LSI Corporation marks a change in our strategy. This change, or any further changes we might make, could have a significant impact on our business, financial condition and results of operations while we are implementing our new strategy. Furthermore, there is no assurance that our new strategy will not fail.

If we do not identify and pursue the correct emerging trends and align ourselves with the correct market leaders, we may not be successful and our business, financial condition and results of operations could be materially and adversely affected.

Customers for our products generally have substantial technological capabilities and financial resources. Some customers have traditionally used 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 components. 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 or maintain strong relationships with them, our business, financial condition and results of operations would be materially and adversely affected.

*Our business strategy contemplates the acquisition of other companies, products and technologies. Merger and acquisition activities involve numerous risks and we may not be able to address these risks successfully without substantial expense, delay or other operational or financial problems.

Acquiring products, technologies or businesses from third parties is part of our business strategy. The risks involved with merger and acquisition activities include:

• potential dilution to our stockholders;

• use of a significant portion of our cash reserves;

• diversion of management’s attention;

• failure to retain or integrate key personnel;

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

• amortization of acquired intangible assets and deferred compensation;

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

• costs associated with acquisitions or mergers;

• difficulties associated with the integration of acquired companies, products or technologies;

• difficulties competing in markets that are unfamiliar to us;

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

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

Any of these risks could materially harm our business, financial condition and results of operations.

As with past 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. Our past purchase acquisitions required us to capitalize significant amounts of goodwill and purchased intangible assets. As a result of the slowdown in our industry and reduction of our market capitalization, we have been required to record significant impairment charges

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against these assets as noted in our financial statements. In the fiscal year ended March 31, 2009 we recorded a goodwill impairment charge of $223.0 million to continuing operations. The goodwill impaired was previously assigned to the Process and Transport reporting units in the amounts of $101.5 million, $121.5 million, respectively. In the fiscal years ended March 31, 2009 and 2008, we recorded goodwill impairment charges to discontinued operations of $41.1 million and $71.5 million, respectively, for the Store reporting unit. These market conditions continuously change and it is difficult to project how long this current economic downturn may last. These conditions have caused a decline in our near term revenues and it will take some time to ramp back up to our previous levels. Additionally, market values have deteriorated which has had an unfavorable impact on our valuations which are part of the goodwill and purchased intangible asset impairment tests. There can be no assurances that market conditions will not deteriorate further or that our market capitalization will not decline further. At September 30, 2009, we had $24.1 million of purchased intangible assets. We cannot assure you that we will not be required to take additional significant charges as a result of impairment to the carrying value of these assets, due to further adverse changes in market conditions.

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

There has been industry consolidation among communications IC companies, network equipment companies and telecommunications companies in the past. We expect this 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. The revenues we derive from international sales may be subject to certain risks, including:

• foreign currency exchange fluctuations;

• changes in regulatory requirements;

• tariffs, rising protectionism and other barriers;

• timing and availability of export licenses;

• political and economic instability;

• difficulties in accounts receivable collections;

• difficulties in staffing and managing foreign operations;

• difficulties in managing distributors;

• difficulties in obtaining governmental approvals for communications and other products;

• reduced or uncertain protection for intellectual property rights in some countries;

• longer payment cycles to collect accounts receivable in some countries;

• burdens of complying with a wide variety of complex foreign laws and treaties;

• potentially adverse tax consequences; and

• a worsening economic condition that may trail any improvements in the United States.

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 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 laws in the United States. As a result, our ability to enforce our rights under such agreements may be limited compared with our ability to enforce our rights under agreements governed by laws in the United States.

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

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are recorded on our 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. Our investment portfolio is exposed to market risks related to changes in interest rates and credit ratings of the issuers, as well as to the risks of default by the issuers and lack of overall market liquidity. Substantially all 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. Increases in interest rates or decreases in the credit worthiness of one or more of the issuers in our investment portfolio could have a material adverse impact on our financial condition or results of operations. For the six months ended September 30, 2009 we recorded an impairment charge associated with certain of these securities of $3.5 million to current earnings. During the fiscal year ended March 31, 2009, we recorded $17.1 million in write-downs in the carrying value of certain securities as we determined the decline in the fair value of these securities to be other than temporary. If the fair value of any of these securities does not recover to at least the amortized cost of such security or we are unable to hold these securities until they recover and there is a further deterioration in market conditions or there are additional losses incurred, we may be required to record a further decline in the carrying value of these securities resulting in further charges. At September 30, 2009, the unrealized losses on these securities, that were not written down as an other-than-temporary impairment charge, were approximately $0.5 million.

Our restructuring activities could result in management distractions, operational disruptions and other difficulties.

Over the past several years, we have initiated several restructuring activities in an effort to reduce operating costs, including new restructuring initiatives announced in October 2008 and February 2009. Employees whose positions were eliminated in connection with these restructuring activities may seek employment with our customers or competitors. Although each of our employees is required to sign a confidentiality agreement with us at the time of hire, we cannot guarantee that the confidential nature of our proprietary information will be maintained in the course of such future employment. Any additional restructuring efforts could divert the attention of our management away from our operations, harm our reputation and increase our expenses. We cannot guarantee that we will not undertake additional restructuring activities, that any of our restructuring efforts will be successful, or that we will be able to realize the cost savings and other anticipated benefits from our previous or future restructuring plans. In addition, if we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to new growth opportunities.

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:

• rapidly changing technologies;

• evolving and competing industry standards;

• changing customer needs;

• frequent introductions of new products and enhancements;

• increased integration with other functions;

• long design and sales cycles;

• short product life cycles; and

• intense competition.

To develop new products for the communications or other technology 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. 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 adopting such advances, we may be unable to timely bring to market new products and our revenues will suffer.

Many of our products 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 or requirements, we could miss opportunities to achieve crucial design wins which in turn could have a material adverse effect on our business, operating results and financial condition.

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The markets in which we compete are highly competitive, and we expect competition to increase in these markets in the future.

The markets in which we compete are highly competitive, and we expect that domestic and international competition will increase in these markets, due in part to deregulation, rapid technological advances, price erosion, changing customer preferences and evolving industry standards. Increased competition could result in significant price competition, reduced revenues, lower profit margins or loss of market share. Our ability to compete successfully in our markets depends on a number of factors, including:

• our ability to partner with OEM and channel partners who are successful in the market;

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

• product quality, interoperability, reliability, performance and certification;

• customer support;

• time-to-market;

• price;

• production efficiency;

• design wins;

• expansion of production of our products for particular systems manufacturers;

• end-user acceptance of the systems manufacturers’ products;

• market acceptance of competitors’ products; and

• general economic conditions.

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 enhancements or new products by our competitors could render our existing and future products obsolete or unmarketable. 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 transport communications IC markets, we compete primarily against companies such as LSI, Broadcom and Vitesse. In the embedded processor communications IC market, we compete with technology companies such as Freescale Semiconductor, Cavium and Intel. Many of these companies may have substantially greater financial, marketing and distribution resources than we have. Certain of our customers or potential customers have internal IC design or manufacturing capabilities with which we compete. We may also face competition from new entrants to our target markets, including larger technology companies that may develop or acquire differentiating technology and then apply their resources to our detriment. Any failure by us to compete successfully in these target markets would have a material adverse effect on our business, financial condition and results of operations.

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.

We depend upon third parties to manufacture, assemble, package or test certain of our products. As a result, we are subject to risks associated with these third parties, including:

• reduced control over delivery schedules and quality;

• inadequate manufacturing yields and excessive costs;

• difficulties selecting and integrating new subcontractors;

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

• limited warranties on products supplied to us;

• potential increases in prices;

• potential instability in countries where third-party manufacturers are located; and

• potential misappropriation of our intellectual property.

Our outside foundries generally manufacture our products on a purchase order basis, and we have few long-term supply arrangements with these suppliers. We have less control over delivery schedules, manufacturing yields and costs than competitors with their own fabrication facilities. A manufacturing disruption experienced by one or more of our outside foundries or a disruption

43

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.

Our IC products are generally 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 short notice. There is also the potential that they may discontinue manufacturing our products or go out of business. Because establishing relationships, designing or redesigning ICs, and ramping production with new outside foundries may take over a year, there is no readily available alternative source of supply for these products.

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 of our IC products. 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. The transition to the next generation of manufacturing technologies at one or more of our outside foundries could be unsuccessful or delayed.

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 of an older or lower-volume process that it uses to produce our parts. We cannot assure you that our external foundries will continue to devote resources to the production of parts for 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, lower our gross margin, cause us to hold more inventories or materially impact our ability to deliver our products on time. As our volumes decrease with any third-party foundry, the likelihood of unfavorable pricing increases.

Some companies that supply our customers are similarly dependent on a limited number of suppliers to produce their products. These other companies’ products may be designed into the same networking equipment into which our products are designed. Our order levels could be reduced materially if these companies are unable to access sufficient production capacity to produce in volumes demanded by our customers because our customers may be forced to slow down or halt production on the equipment into which our products are designed.

Our operating results depend on manufacturing output and yields of our ICs and printed circuit board assemblies, which may not meet expectations.

The yields on wafers we have manufactured 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 and final packaged parts 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 may have to 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.

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.

As smaller line width geometry processes become more prevalent, we expect to integrate greater levels of functionality into our IC products and to transition our IC products to increasingly smaller geometries. This transition will require us to redesign certain products and will require us and our foundries to migrate to new manufacturing processes for our products.

We may not be able to achieve higher levels of design integration or deliver new integrated products on a timely basis. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our

44

costs and increase performance, and we have designed IC products to be manufactured at as little as .09 micron geometry processes. We have experienced some difficulties in shifting to smaller geometry process technologies and 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 IC 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.

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

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

The complexity of our products may lead to errors, defects and bugs, which could negatively impact our reputation with customers and result in liability.

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 or result in a costly recall and 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 with device functionality, resulting in 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. We cannot assure you that problems will not be found in new products after commencement of commercial production, despite testing by us, our suppliers or our customers. Any problem could result in:

• additional development costs;

• loss of, or delays in, market acceptance;

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

• claims by our customers or others against us; and

• 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.

If our internal control over financial reporting is not considered effective, our business and stock price could be adversely affected.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of our internal control over financial reporting in our annual report on Form 10-K for that fiscal year. Section 404 also requires our independent registered public accounting firm to attest to and report on the effectiveness of our internal control over financial reporting.

Our management, including our chief executive officer and chief financial officer, does not expect that our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of control must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal control can provide absolute assurance that all control issues and instances of fraud involving a company have been, or will be, detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, our internal control over financial reporting may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Our management has concluded, and our independent registered public accounting firm has attested, that our internal control over financial reporting was effective as of March 31, 2009. We cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our internal control in the future. A material weakness in our internal control

45

over financial reporting would require management and our independent registered public accounting firm to report our internal control as ineffective. If our internal control over financial reporting is not considered effective, we may experience another restatement of our financial statements and/or a loss of public confidence, either of which could have an adverse effect on our business and on the market price of our common stock.

*Our leadership transition may not go smoothly and could adversely impact our future operations.

As previously announced, Kambiz Hooshmand has stepped down as our Chief Executive Officer and has been replaced by Dr. Paramesh Gopi, who was previously our Chief Operating Officer. A significant leadership change is inherently risky and we may be unable to manage this transition smoothly which could adversely impact our future strategy and ability to function or execute and could materially and adversely affect our business, financial condition and results of operations.

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

Our future success depends to a significant extent upon the continued service of our senior management personnel and successful succession planning. The loss of key senior executives could have a material adverse effect on our business. 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 retain 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. There may be significant costs associated with recruiting, hiring and retaining personnel. 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 development or other aspects of our business.

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

Our ability to supply 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 external foundries’ ability to manufacture our products could be impaired.

Several of our facilities, including our principal executive offices, are located in California. California has experienced prolonged energy alerts and blackouts caused by disruption in energy supplies. As a consequence, businesses and other energy consumers in California continue to experience substantially increased costs of electricity and natural gas. We are unsure whether energy alerts and blackouts will reoccur or how severe they may become in the future. Many of our customers and suppliers are also headquartered or have substantial operations in California. If we or any of our major customers or suppliers located in California experience a sustained disruption in energy supplies, our results of operations could be materially and adversely affected.

A portion of our test and assembly facilities are located in our San Diego, California location and a significant portion of our manufacturing operations are located in Asia. 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.

The effects of war, acts of terrorism or global threats, including, but not limited to, the outbreak of epidemic disease, could have a material adverse effect on our business, operating results and financial condition. 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 local and global 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

46

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 (“PRP”) 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 PRPs that has agreed to fund certain on-going remediation efforts at the Omega Chemical site. To date, our payment obligations with respect to these funding efforts have not been material, and although 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, we cannot guarantee this result. In 2003, we closed our wafer fabrication facility in San Diego and the property was returned to the landlord. In operating the facility at this site, we stored and used hazardous materials. Although we believe that we have been and currently are in material compliance with applicable environmental laws and regulations, we cannot guarantee 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 Chemical site, will not have a material adverse effect on our business.

Environmental laws and regulations could cause a disruption in our business and operations.

We are subject to various state, federal and international laws and regulations governing the environment, including those restricting the presence of certain substances in electronic products and making manufacturers of those products financially responsible for the collection, treatment, recycling and disposal of certain products. Such laws and regulations have been passed in several jurisdictions in which we operate, including various European Union (“EU”) member countries. For example, the EU has enacted the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) and the Waste Electrical and Electronic Equipment (“WEEE”) directives. RoHS prohibits the use of lead and other substances in semiconductors and other products put on the market after July 1, 2006. The WEEE directive obligates parties that place electrical and electronic equipment on the market in the EU to put a clearly identifiable mark on the equipment, register with and report to EU member countries regarding distribution of the equipment, and provide a mechanism to take back and properly dispose of the equipment. There can be no assurance that similar programs will not be implemented in other jurisdictions resulting in additional costs, possible delays in delivering products, and even the discontinuance of existing and planned future product replacements if the cost were to become prohibitive.

Any acquisitions we make could disrupt our business and harm our results of operations and financial condition.

We may make additional investments in or acquire other companies, products or technologies. These acquisitions may involve numerous risks, including:

• problems combining or integrating the purchased operations, technologies or products;

• unanticipated costs;

• diversion of management’s attention from our core business;

• adverse effects on existing business relationships with suppliers and customers;

• risks associated with entering markets in which we have limited or no prior experience; and

• potential loss of key employees, particularly those of the acquired organizations.

In addition, in the event of any such investments or acquisitions, we could

• issue stock that would dilute our current stockholders’ percentage ownership;

• incur debt;

• assume liabilities;

• incur amortization or impairment expenses related to goodwill and other intangible assets; or

• incur large and immediate write-offs.

We cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire.

Any dispositions we make could disrupt our business and harm our results of operations and financial condition.

We completed the sale of our 3ware storage adapter business, a significant portion of our business, to LSI Corporation on April 21, 2009. As a result, we now expect to generate all of our sales from our remaining business, which we would be required to grow in order to achieve profitability. Economic and other factors may prevent us from growing our remaining business. If we fail to grow our remaining business, it could have a material adverse impact on our business, financial condition and operating results. We

47

may in the future dispose of additional assets or businesses that represent a significant portion of our business. The sale of our 3ware storage adapter business and any possible future dispositions may involve numerous risks, including:

• problems carving out or disposing of assets, operations, technologies and products;

• the disposal of such assets or businesses could have an unanticipated adverse effect on the remaining business;

• unanticipated costs;

• diversion of management’s attention from core ongoing operations;

• potential adverse effects on existing business relationships with suppliers and customers; and

• if we do not structure the disposition properly and scale expenses according to the size of the remaining business, we could continue to incur expenses that could be unsustainable given the scope of the remaining 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 and processes, will provide us with competitive advantages or will not be challenged by third parties, or that if challenged, any such patent will be found to be valid or enforceable. 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 assure you 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 generally enter into confidentiality agreements with our employees, consultants and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. Also, former employees may seek employment with our business partners, customers or competitors and we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, former employees or third parties could attempt to penetrate our network to misappropriate our proprietary information or interrupt our business. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. As a result, our technologies and processes may be misappropriated, particularly in foreign countries where laws may not protect our proprietary rights as fully as in the United States.

We could be harmed by litigation involving patents, proprietary rights or other claims.

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 assure you 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 will not harm our business.

Any litigation relating to the intellectual property rights of third parties 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.

From time to time, we may be involved in litigation relating to other claims arising out of our operations in the normal course of business. We cannot assure you that the ultimate outcome of any such matters will not have a material, adverse effect on our business, financial condition or operating results.

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*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 by us or our competitors;

• anticipated or actual operating results of our customers, peers or competitors;

• technological innovations or setbacks by us or our competitors;

• conditions in the semiconductor, communications or information technology markets;

• the commencement or outcome of litigation or governmental investigations;

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

• announcements of merger or acquisition transactions;

• management changes;

• our inclusion in certain stock indices; and

• other events or factors.

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. In some instances, these fluctuations appear to have been unrelated or disproportionate to the operating performance of the affected companies. Any such fluctuation could harm the market price of our common stock. In addition, the current decline of the financial markets and related factors beyond our control, including the credit and mortgage crisis in both the U.S. and worldwide, may cause our stock price to decline rapidly and unexpectedly.

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 2.0 million 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 issuance of our common stock may result in immediate dilution of our stockholders.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

We held our annual meeting of stockholders on August 18, 2009. Of the 64.9 million shares of our common stock that could be voted at the annual meeting, 66.3 million shares, or 92%, were represented at the meeting in person or by proxy, which constituted a quorum. Voting results were as follows:

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

	For	Withheld
Cesar Cesaratto	51,462,114	9,419,119
Donald Colvin	59,150,791	1,730,442
Paramesh Gopi, Ph.D.	59,128,482	1,752,751
Paul R. Gray, Ph.D.	59,195,294	1,685,939
Fred Shlapak	51,495,794	9,385,439
Arthur B. Stabenow	57,197,647	3,683,586
Julie H. Sullivan	53,230,417	7,650,816

Ratification of the appointment of Ernst & Young LLP as our independent registered public accounting firm for the period ending March 31, 2010:

For	Against	Abstain
60,388,735	419,097	73,400

Stockholder proposal relating to a stockholder advisory vote on executive compensation:

For	Against	Abstain
23,681,830	17,331,757	9,801,889

Accordingly, the stockholder proposal was not approved by stockholders.

ITEM 5. OTHER INFORMATION

None.

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ITEM 6. EXHIBITS

2.1(1)+*	Agreement and Plan of Merger between the Company, Espresso Acquisition Corporation and Veloce Technologies, Inc., dated May 17, 2009.
3.1(2)	Amended and Restated Certificate of Incorporation of the Company.
3.2(3)	Amended and Restated Bylaws of the Company.
4.1(4)	Specimen Stock Certificate.
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 + Confidential treatment has been granted with respect to certain portions of this exhibit. Omitted portions have been filed separately with the SEC.

 * Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company has furnished supplementally to the SEC copies of the omitted schedules.

(1) Incorporated by reference to identically numbered exhibit filed with the Company’s Quarterly Report on Form 10-Q/A (No. 000-23193) for the quarter ended June 30, 2009.

(2) Incorporated by reference to Exhibit 3.2 filed with the Company’s Registration Statement on Form S-1 (No. 333-37609) filed October 10, 1997, and as amended by Exhibit 3.3 filed with the Company’s Registration Statement on Form S-4 (No. 333-45660) filed September 12, 2000 and Exhibit 3.1 filed with the Company’s Current Report on Form 8-K on December 11, 2007.

(3) Incorporated by reference to Exhibit 3.1 filed with the Company’s Current Report on Form 8-K filed on May 1, 2009.

(4) Incorporated by reference to identically numbered exhibit filed with the Company’s Registration Statement on Form S-1 (No. 333-37609) filed October 10, 1997, or with any amendments thereto.

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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.

Date: October 30, 2009

APPLIED MICRO CIRCUITS CORPORATION
By:	/s/    ROBERT G. GARGUS
	Robert G. Gargus
	Senior Vice President and Chief Financial Officer
	(Duly Authorized Signatory and Principal Financial and Accounting Officer)

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Exhibit Index

2.1(1)+*	Agreement and Plan of Merger between the Company, Espresso Acquisition Corporation and Veloce Technologies, Inc., dated May 17, 2009.
3.1(2)	Amended and Restated Certificate of Incorporation of the Company.
3.2(3)	Amended and Restated Bylaws of the Company.
4.1(4)	Specimen Stock Certificate.
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 + Confidential treatment has been granted with respect to certain portions of this exhibit. Omitted portions have been filed separately with the SEC.

 * Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. The Company has furnished supplementally to the SEC copies of the omitted schedules.

(1) Incorporated by reference to identically numbered exhibit filed with the Company’s Quarterly Report on Form 10-Q/A (No. 000-23193) for the quarter ended June 30, 2009.

(2) Incorporated by reference to Exhibit 3.2 filed with the Company’s Registration Statement on Form S-1(No. 333-37609) filed October 10, 1997, and as amended by Exhibit 3.3 filed with the Company’s Registration Statement on Form S-4 (No. 333-45660) filed September 12, 2000 and Exhibit 3.1 filed with the Company’s Current Report on Form 8-K on December 11, 2007.

(3) Incorporated by reference to Exhibit 3.1 filed with the Company’s Current Report on Form 8-K filed on May 1, 2009.

(4) Incorporated by reference to identically numbered exhibit filed with the Company’s Registration Statement on Form S-1 (No. 333-37609) filed October 10, 1997, or with any amendments thereto.

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