Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended October 29, 2016

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: 000-30877

Marvell Technology Group Ltd.

(Exact name of registrant as specified in its charter)

 

Bermuda   77-0481679

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Canon’s Court, 22 Victoria Street, Hamilton HM 12, Bermuda

(441) 296-6395

(Address of principal executive offices, Zip Code and registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of 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).    x  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   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

The number of common shares of the registrant outstanding as of November 28, 2016 was 507.9 million shares.


Table of Contents

TABLE OF CONTENTS

 

         Page  

PART I. FINANCIAL INFORMATION

  

Item 1.

  Financial Statements:   
  Unaudited Condensed Consolidated Balance Sheets as of October 29, 2016 and January 30, 2016      2   
  Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended October 29, 2016 and October 31, 2015      3   
  Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended October 29, 2016 and October 31, 2015      4   
  Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended October 29, 2016 and October 31, 2015      5   
  Notes to Unaudited Condensed Consolidated Financial Statements      6   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      26   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      34   

Item 4.

  Controls and Procedures      35   

PART II. OTHER INFORMATION

  

Item 1.

  Legal Proceedings      40   

Item 1A.

  Risk Factors      40   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      55   

Item 6.

 

Exhibits

     55   
  Signatures      57   

 

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PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

MARVELL TECHNOLOGY GROUP LTD.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value per share)

 

     October 29,
2016
     January 30,
2016
 

ASSETS

  

Current assets:

     

Cash and cash equivalents

   $ 751,588       $ 1,278,180   

Short-term investments

     898,784         1,004,569   

Accounts receivable, net

     362,195         323,300   

Inventories

     198,843         210,017   

Prepaid expenses and other current assets

     49,731         102,560   
  

 

 

    

 

 

 

Total current assets

     2,261,141         2,918,626   

Property and equipment, net

     265,984         299,540   

Long-term investments

     8,974         11,296   

Goodwill

     2,029,945         2,029,945   

Acquired intangible assets, net

     9,334         18,010   

Other non-current assets

     179,068         164,710   
  

 

 

    

 

 

 

Total assets

   $ 4,754,446       $ 5,442,127   
  

 

 

    

 

 

 
LIABILITIES AND SHAREHOLDERS’ EQUITY      

Current liabilities:

     

Accounts payable

   $ 183,252       $ 180,372   

Accrued liabilities

     124,289         132,060   

Carnegie Mellon University accrued litigation settlement

     —           736,000   

Accrued employee compensation

     132,050         121,631   

Deferred income

     63,656         55,722   
  

 

 

    

 

 

 

Total current liabilities

     503,247         1,225,785   

Non-current income taxes payable

     40,524         49,256   

Other non-current liabilities

     30,181         26,963   
  

 

 

    

 

 

 

Total liabilities

     573,952         1,302,004   

Commitments and contingencies (Note 10)

     

Shareholders’ equity:

     

Common shares, $0.002 par value

     1,017         1,015   

Additional paid-in capital

     3,057,535         3,028,921   

Accumulated other comprehensive income (loss)

     1,553         (795

Retained earnings

     1,120,389         1,110,982   
  

 

 

    

 

 

 

Total shareholders’ equity

     4,180,494         4,140,123   
  

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 4,754,446       $ 5,442,127   
  

 

 

    

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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MARVELL TECHNOLOGY GROUP LTD.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

 

     Three Months Ended     Nine Months Ended  
     October 29,
2016
     October 31,
2015
    October 29,
2016
     October 31,
2015
 

Net revenue

   $ 654,422       $ 674,890      $ 1,821,648       $ 2,109,670   

Operating costs and expenses:

          

Cost of goods sold

     286,063         379,254        832,881         1,192,126   

Research and development

     222,463         252,502        691,812         818,257   

Selling and marketing

     30,576         30,582        93,022         97,597   

General and administrative

     28,904         33,206        97,049         108,884   

Carnegie Mellon University litigation settlement

     —           —          —           654,667   

Restructuring and other related charges

     1,164         35,270        6,326         48,862   

Amortization and write-off of acquired intangible assets

     2,299         3,150        7,221         8,286   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total operating costs and expenses

     571,469         733,964        1,728,311         2,928,679   
  

 

 

    

 

 

   

 

 

    

 

 

 

Operating income (loss)

     82,953         (59,074     93,337         (819,009

Interest and other income, net

     5,470         4,644        13,242         16,601   
  

 

 

    

 

 

   

 

 

    

 

 

 

Income (loss) before income taxes

     88,423         (54,430     106,579         (802,408

Provision for income taxes

     15,807         3,320        5,337         13,192   
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ 72,616       $ (57,750   $ 101,242       $ (815,600
  

 

 

    

 

 

   

 

 

    

 

 

 

Net income (loss) per share:

          

Basic

   $ 0.14       $ (0.11   $ 0.20       $ (1.59
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted

   $ 0.14       $ (0.11   $ 0.20       $ (1.59
  

 

 

    

 

 

   

 

 

    

 

 

 

Weighted average shares:

          

Basic

     511,090         504,831        510,373         512,476   
  

 

 

    

 

 

   

 

 

    

 

 

 

Diluted

     522,091         504,831        516,476         512,476   
  

 

 

    

 

 

   

 

 

    

 

 

 

Cash dividends declared per share

   $ 0.06       $ 0.06      $ 0.18       $ 0.18   
  

 

 

    

 

 

   

 

 

    

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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MARVELL TECHNOLOGY GROUP LTD.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(In thousands)

 

     Three Months Ended     Nine Months Ended  
     October 29,     October 31,     October 29,     October 31,  
     2016     2015     2016     2015  

Net income (loss)

   $ 72,616      $ (57,750   $ 101,242      $ (815,600

Other comprehensive income (loss), net of tax:

        

Net change in unrealized gain (loss) on marketable securities

     (2,018     (491     2,391        (3,809

Net change in unrealized gain (loss) on auction rate securities

     —          59        —          (44

Net change in unrealized gain (loss) on cash flow hedges

     (444     (472     (43     1,363   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss), net of tax

     (2,462     (904     2,348        (2,490
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss), net of tax

   $ 70,154      $ (58,654   $ 103,590      $ (818,090
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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MARVELL TECHNOLOGY GROUP LTD.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Nine Months Ended  
     October 29,
2016
    October 31,
2015
 

Cash flows from operating activities:

    

Net income (loss)

   $ 101,242      $ (815,600

Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:

    

Depreciation and amortization

     81,168        77,376   

Share-based compensation

     89,912        101,360   

Amortization and write-off of acquired intangible assets

     8,676        9,741   

Non-cash restructuring and other related charges

     2,081        15,743   

Other non-cash expense, net

     1,020        5,926   

Excess tax benefits from share-based compensation

     (10     (27

Changes in assets and liabilities:

    

Accounts receivable

     (38,895     40,027   

Inventories

     10,944        21,042   

Prepaid expenses and other assets

     (2,578     18,132   

Accounts payable

     10,541        (43,735

Accrued liabilities and other non-current liabilities

     (23,735     12,016   

Carnegie Mellon University accrued litigation settlement

     (736,000     734,715   

Accrued employee compensation

     10,419        (14,636

Deferred income

     7,934        (10,034
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     (477,281     152,046   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of available-for-sale securities

     (343,810     (922,830

Sales of available-for-sale securities

     458,744        544,515   

Maturities of available-for-sale securities

     198,293        281,684   

Distribution from privately-held companies

     274        78   

Purchase of time deposits

     (200,000     —     

Maturities of time deposits

     50,000        —     

Purchases of technology licenses

     (8,439     (6,657

Purchases of property and equipment

     (37,724     (33,361

Purchase of equipment previously leased

     —          (10,240

Proceeds from sale of equipment held for sale

     —          10,007   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     117,338        (136,804
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Repurchase of common stock

     (56,531     (260,875

Proceeds from employee stock plans

     11,836        59,348   

Minimum tax withholding paid on behalf of employees for net share settlement

     (16,281     (23,876

Dividend payments to shareholders

     (91,835     (92,374

Payments on technology license obligations

     (13,848     (11,416

Excess tax benefits from share-based compensation

     10        27   
  

 

 

   

 

 

 

Net cash used in financing activities

     (166,649     (329,166
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (526,592     (313,924

Cash and cash equivalents at beginning of period

     1,278,180        1,210,977   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 751,588      $ 897,053   
  

 

 

   

 

 

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. The Company and Basis of Presentation

The Company

Marvell Technology Group Ltd., a Bermuda exempted company, and its subsidiaries (the “Company”), is a fabless semiconductor provider of high-performance application-specific standard products. The Company’s core strength is the development of complex System-on-a-Chip and System-in-a-Package devices, leveraging its extensive technology portfolio of intellectual property in the areas of analog, mixed-signal, digital signal processing, and embedded and standalone integrated circuits. The majority of the Company’s product portfolio leverages embedded central processing unit technology. The Company also develops platforms that it defines as integrated hardware along with software that incorporates digital computing technologies designed and configured to provide an optimized computing solution. The Company’s broad product portfolio includes devices for data storage, enterprise-class Ethernet data switching, Ethernet physical-layer transceivers, wireless connectivity, Internet-of-Things devices and multimedia solutions.

Basis of Presentation

The Company’s fiscal year is the 52- or 53-week period ending on the Saturday closest to January 31. Accordingly, every fifth or sixth fiscal year will have a 53-week period. The additional week in a 53-week year is added to the fourth quarter, making such quarter consist of 14 weeks. Fiscal 2017 and 2016 each have a 52-week period. The next 53-week year will be fiscal 2018.

The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. In the opinion of management, all adjustments consisting of normal and recurring entries considered necessary for a fair statement of the results for the interim periods have been included in the Company’s unaudited condensed consolidated balance sheet as of October 29, 2016, the results of its operations for the three and nine months ended October 29, 2016 and October 31, 2015, its comprehensive income (loss) for the three and nine months ended October 29, 2016 and October 31, 2015, and its cash flows for the nine months ended October 29, 2016 and October 31, 2015. The January 30, 2016 condensed consolidated balance sheet data was derived from the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 30, 2016, but does not include all disclosures required for annual periods.

These condensed consolidated financial statements and related notes are unaudited and should be read in conjunction with the Company’s audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 30, 2016 as filed on July 21, 2016 with the Securities and Exchange Commission (“SEC”). The results of operations for the three and nine months ended October 29, 2016 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to performance-based compensation, revenue recognition, provisions for sales returns and allowances, inventory excess and obsolescence, investment fair values, goodwill and other intangible assets, restructuring, income taxes, litigation and other contingencies. In addition, the Company uses assumptions when employing the Monte Carlo simulation and Black-Scholes valuation models to calculate the fair value of share-based awards that are granted. Actual results could differ from these estimates, and such differences could affect the results of operations reported in future periods.

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The functional currency of the Company and its subsidiaries is the U.S. dollar.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Note 2. Recent Accounting Pronouncements

Accounting Pronouncements Recently Adopted

In April 2015, the Financial Accounting Standards Board issued new guidance to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement, which the Company adopted beginning in the first quarter of fiscal 2017. The guidance provides a basis for evaluating whether a cloud computing arrangement includes a software license and whether the license arrangement should be accounted for as an intangible asset. This guidance also strikes from previous authoritative guidance, the use by analogy to the accounting for capital leases, which the Company previously applied in the accounting for certain of its technology license agreements. As such, the Company accounts for new agreements under the new guidance by determining if capitalization as an asset is appropriate or if the arrangement should be treated as a subscription with expense recognized in the period when service is received. Similarly, the Company will re-evaluate the accounting for any renewals to existing license agreements in accordance with the new guidance as they occur.

Accounting Pronouncements Not Yet Effective

In August 2016, the FASB issued an accounting standards update to add or clarify guidance on the classification of certain cash receipts and cash payments in the statement of cash flows. The amendments in the update provide guidance on eight specific cash flow issues, and is effective for annual and interim periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The amendments to the guidance should be applied using a retrospective transition method for each period presented and if it is impracticable to apply all of the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. The Company is evaluating the effect this new guidance will have on its consolidated statement of cash flows.

In October 2016, the FASB issued new guidance which simplifies the accounting for the income tax effects of intra-entity transfers and will require companies to recognize the income tax effects of intra-entity transfers of assets other than inventory when the transfer occurs. Previous guidance required companies to defer the income tax effects of intra-entity transfers of assets until the asset had been sold to an outside party or otherwise recognized. The guidance is effective for annual and interim periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The Company is evaluating the effect this new guidance will have on its consolidated financial statements.

In November 2016, the FASB issued new guidance which requires entities to include in their cash and cash-equivalent balances in the statement of cash flows those amounts that are deemed to be restricted cash and restricted cash equivalents. As a result, companies will no longer present transfers between cash and cash equivalents, and restricted cash and restricted cash equivalents in the statement of cash flows. The guidance is effective for annual and interim periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. The Company is evaluating the effect this new guidance will have on its consolidated financial statements.

Note 3. Investments

The following tables summarize the Company’s investments (in thousands):

 

     October 29, 2016  
            Gross      Gross         
     Amortized      Unrealized      Unrealized      Estimated  
     Cost      Gains      Losses      Fair Value  

Short-term investments:

           

Available-for-sale:

           

Corporate debt securities

   $ 487,067       $ 1,968       $ (289    $ 488,746   

U.S. government and agency debt

     165,538         86         (64      165,560   

Asset backed securities

     50,909         82         (16      50,975   

Foreign government and agency debt

     11,925         —           (17      11,908   

Municipal debt securities

     31,610         5         (20      31,595   

Held-to-maturity:

           

Time deposits

     150,000         —           —           150,000   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total short-term investments

     897,049         2,141         (406      898,784   

Long-term investments:

           

Available-for-sale:

           

Auction rate securities

     8,974         —           —           8,974   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term investments

     8,974         —           —           8,974   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 906,023       $ 2,141       $ (406    $ 907,758   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

     January 30, 2016  
            Gross      Gross         
     Amortized      Unrealized      Unrealized      Estimated  
     Cost      Gains      Losses      Fair Value  

Short-term investments:

           

Available-for-sale:

           

Corporate debt securities

   $ 558,337       $ 766       $ (1,282    $ 557,821   

U.S. government and agency debt

     317,595         64         (254      317,405   

Asset backed securities

     76,711         81         (56      76,736   

Foreign government and agency debt

     21,370         2         (14      21,358   

Municipal debt securities

     31,211         45         (7      31,249   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total short-term investments

     1,005,224         958         (1,613      1,004,569   

Long-term investments:

           

Available-for-sale:

           

Auction rate securities

     11,296         —           —           11,296   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total long-term investments

     11,296         —           —           11,296   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total investments

   $ 1,016,520       $ 958       $ (1,613    $ 1,015,865   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of October 29, 2016, the Company’s investment portfolio included auction rate securities with an aggregate par value of $10.0 million. Although these auction rate securities have continued to pay interest and the underlying collateral has not deteriorated, there is currently limited trading volume. The Company uses a discounted cash flow model to estimate the fair value of the auction rate securities based on its estimated timing and amount of future interest and principal payments. In developing the cash flow model, the Company considers the credit quality and liquidity of the underlying securities and related issuer, the collateralization of underlying security investments and other considerations.

The Company made a determination in January 2016 that it did not expect to recover the par value of these auction rate securities and considers any impairment of these securities to be other-than-temporary. There has been no change in circumstances since January 2016 based upon the current time horizon for holding these securities and the continuation of an illiquid market. Based on the Company’s assessment of fair value as of October 29, 2016, the Company determined there was no further impairment of these auction rate securities.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

In the nine months ended October 29, 2016, the Company sold auction rate securities with an aggregate par value of $2.5 million for total net proceeds of $2.4 million. The carrying value of these auction rate securities was $2.3 million and resulted in a net gain of $0.1 million recorded in interest and other income, net, in the nine months ended October 29, 2016.

Gross realized gains and gross realized losses on sales of available-for-sale securities are presented in the following tables (in thousands):

 

     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
     2016      2015      2016      2015  

Gross realized gains

   $ 298       $ 524       $ 966       $ 1,222   

Gross realized losses

     (46      (877      (289      (1,214
  

 

 

    

 

 

    

 

 

    

 

 

 

Total net realized gains (losses)

   $ 252       $ (353    $ 677       $ 8   
  

 

 

    

 

 

    

 

 

    

 

 

 

The contractual maturities of available-for-sale securities are presented in the following tables (in thousands):

 

     October 29, 2016      January 30, 2016  
     Amortized      Estimated      Amortized      Estimated  
   Cost      Fair Value      Cost      Fair Value  

Due in one year or less

   $ 390,731       $ 390,776       $ 304,117       $ 304,035   

Due between one and five years

     498,071         499,767         689,847         689,279   

Due over five years

     17,221         17,215         22,556         22,551   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 906,023       $ 907,758       $ 1,016,520       $ 1,015,865   
  

 

 

    

 

 

    

 

 

    

 

 

 

For individual securities that have been in a continuous unrealized loss position, the fair value and gross unrealized loss for these securities aggregated by investment category and length of time in an unrealized position are presented in the following tables (in thousands):

 

     October 29, 2016  
     Less than 12 months     12 months or more     Total  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  
     Value      Loss     Value      Loss     Value      Loss  

Corporate debt securities

   $ 116,138       $ (234   $ 21,515       $ (55   $ 137,653       $ (289

U.S. government and agency debt

     58,482         (60     6,995         (4     65,477         (64

Asset backed securities

     5,698         (8     5,994         (8     11,692         (16

Foreign government and agency debt

     8,509         (15     1,501         (2     10,010         (17

Municipal debt securities

     18,340         (18     998         (2     19,338         (20
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities

   $ 207,167       $ (335   $ 37,003       $ (71   $ 244,170       $ (406
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
     January 30, 2016  
     Less than 12 months     12 months or more     Total  
     Fair      Unrealized     Fair      Unrealized     Fair      Unrealized  
     Value      Loss     Value      Loss     Value      Loss  

Corporate debt securities

   $ 283,138       $ (1,237   $ 14,383       $ (45   $ 297,521       $ (1,282

U.S. government and agency debt

     263,325         (254     —           —          263,325         (254

Asset backed securities

     46,646         (56     —           —          46,646         (56

Foreign government and agency debt

     16,458         (14     —           —          16,458         (14

Municipal debt securities

     2,943         (5     1,571         (2     4,514         (7
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total securities

   $ 612,510       $ (1,566   $ 15,954       $ (47   $ 628,464       $ (1,613
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

9


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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Note 4. Supplemental Financial Information (in thousands)

Consolidated Balance Sheets

 

     October 29,      January 30,  
     2016      2016  

Inventories:

     

Work-in-process

   $ 117,624       $ 131,471   

Finished goods

     81,219         78,546   
  

 

 

    

 

 

 

Total inventories

   $ 198,843       $ 210,017   
  

 

 

    

 

 

 

Inventory held by third-party logistics providers is recorded as consigned inventory on the Company’s consolidated balance sheet. The amount of inventory held at third-party logistics providers was $23.5 million and $21.0 million at October 29, 2016 and January 30, 2016, respectively.

 

     October 29,      January 30,  
   2016      2016  

Property and equipment, net:

     

Machinery and equipment

   $ 598,781       $ 578,627   

Buildings

     144,320         144,320   

Computer software

     99,668         102,928   

Land

     53,373         53,373   

Building improvements

     49,970         49,927   

Leasehold improvements

     50,194         50,192   

Furniture and fixtures

     24,261         27,119   

Construction in progress

     4,580         1,353   
  

 

 

    

 

 

 
     1,025,147         1,007,839   

Less: Accumulated depreciation and amortization

     (759,163      (708,299
  

 

 

    

 

 

 

Total property and equipment, net

   $ 265,984       $ 299,540   
  

 

 

    

 

 

 
     October 29,      January 30,  
     2016      2016  

Other non-current assets:

     

Technology and other licenses

   $ 61,479       $ 48,770   

Deferred tax assets

     36,727         34,505   

Investments in privately-held companies

     5,530         5,804   

Prepaid land use rights

     12,888         13,123   

Deposits

     48,771         51,512   

Other

     13,673         10,996   
  

 

 

    

 

 

 

Total other non-current assets

   $ 179,068       $ 164,710   
  

 

 

    

 

 

 
     October 29,      January 30,  
     2016      2016  

Accrued liabilities:

     

Accrued rebates

   $ 30,091       $ 41,320   

Accrued royalties

     16,181         16,217   

Technology license obligations

     25,842         17,985   

Accrued legal expense

     7,401         9,761   

Accrued litigation

     2,750         3,830   

Other

     42,024         42,947   
  

 

 

    

 

 

 

Total accrued liabilities

   $ 124,289       $ 132,060   
  

 

 

    

 

 

 

 

10


Table of Contents

MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

     October 29,      January 30,  
     2016      2016  

Deferred income:

     

Deferred revenue

   $ 89,095       $ 77,935   

Deferred cost of goods sold

     (25,439      (22,213
  

 

 

    

 

 

 

Deferred income

   $ 63,656       $ 55,722   
  

 

 

    

 

 

 

 

     October 29,      January 30,  
     2016      2016  

Other non-current liabilities:

     

Technology license obligations

   $ 17,420       $ 12,461   

Long-term accrued employee compensation

     6,504         6,078   

Other

     6,257         8,424   
  

 

 

    

 

 

 

Other non-current liabilities

   $ 30,181       $ 26,963   
  

 

 

    

 

 

 

Accumulated other comprehensive income (loss)

The changes in accumulated other comprehensive income (loss) by components are presented in the following tables (in thousands):

 

     Unrealized Gain
(Loss) on
Marketable
Securities
     Unrealized Gain
(Loss) on
Auction Rate
Securities
     Unrealized Gain
(Loss) on Cash
Flow Hedges
     Total  

Balance at January 30, 2016

   $ (656    $ —         $ (139    $ (795

Other comprehensive income before reclassifications

     2,868         —           479         3,347   

Amounts reclassified from accumulated other comprehensive loss

     (477      —           (522      (999
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss), net of tax

     2,391         —           (43      2,348   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at October 29, 2016

   $ 1,735       $ —         $ (182    $ 1,553   
  

 

 

    

 

 

    

 

 

    

 

 

 
     Unrealized Gain
(Loss) on
Marketable
Securities
     Unrealized Gain
(Loss) on
Auction Rate
Securities
     Unrealized Gain
(Loss) on Cash
Flow Hedges
     Total  

Balance at January 31, 2015

   $ 3,768       $ (2,274    $ (1,186    $ 308   

Other comprehensive income (loss) before reclassifications

     (3,360      (44      1,296         (2,108

Amounts reclassified from accumulated other comprehensive income (loss)

     (449      —           67         (382
  

 

 

    

 

 

    

 

 

    

 

 

 

Other comprehensive income (loss), net of tax

     (3,809      (44      1,363         (2,490
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at October 31, 2015

   $ (41    $ (2,318    $ 177       $ (2,182
  

 

 

    

 

 

    

 

 

    

 

 

 

 

11


Table of Contents

MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

The amounts reclassified from accumulated other comprehensive income (loss) by components are presented in the following table (in thousands):

 

     Three Months Ended      Nine Months Ended  

Affected Line Item in the
Statement of Operations

   October 29,      October 31,      October 29,      October 31,  
   2016      2015      2016      2015  

Interest and other income, net:

           

Available-for-sale securities:

           

Marketable securities

   $ 415       $ (4    $ 477       $ 449   

Operating costs and expenses:

           

Cash flow hedges:

           

Research and development

     118         545         457         (68

Selling and marketing

     3         6         10         (57

General and administrative

     14         51         55         58   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 550       $ 598       $ 999       $ 382   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

Consolidated Statements of Operations

           
     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
     2016      2015      2016      2015  

Interest and other income, net:

           

Interest income

   $ 3,370       $ 3,932       $ 10,005       $ 11,980   

Net realized gain (loss) on investments

     252         (353      677         8   

Currency translation gain

     944         1,134         1,961         5,035   

Other income

     986         86         896         145   

Interest expense

     (82      (155      (297      (567
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 5,470       $ 4,644       $ 13,242       $ 16,601   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) per share

The Company reports both basic net income (loss) per share, which is based on the weighted average number of common shares outstanding during the period, and diluted net income (loss) per share, which is based on the weighted average number of common shares outstanding and potentially dilutive common shares outstanding during the period. The computations of basic and diluted net income (loss) per share are presented in the following table (in thousands, except per share amounts):

 

     Three Months Ended      Nine Months Ended  
     October 29,
2016
     October 31,
2015
     October 29,
2016
     October 31,
2015
 

Numerator:

           

Net income (loss)

   $ 72,616       $ (57,750    $ 101,242       $ (815,600
  

 

 

    

 

 

    

 

 

    

 

 

 

Denominator:

           

Weighted average shares — basic

     511,090         504,831         510,373         512,476   

Effect of dilutive securities:

           

Share-based awards

     11,001         —           6,103         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares — diluted

     522,091         504,831         516,476         512,476   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) per share:

           

Basic

   $ 0.14       $ (0.11    $ 0.20       $ (1.59

Diluted

   $ 0.14       $ (0.11    $ 0.20       $ (1.59

Potential dilutive securities include dilutive common shares from share-based awards attributable to the assumed exercise of stock options, restricted stock units and employee stock purchase plan shares using the treasury stock method. Under the treasury stock method, potential common shares outstanding are not included in the computation of diluted net income per share, if their effect is anti-dilutive.

 

12


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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Anti-dilutive potential shares are presented in the following table (in thousands):

 

     Three Months Ended      Nine Months Ended  
     October 29,
2016
     October 31,
2015
     October 29,
2016
     October 31,
2015
 

Weighted average shares outstanding:

           

Share-based awards

     20,211         68,613         37,309         62,825   
  

 

 

    

 

 

    

 

 

    

 

 

 

Anti-dilutive potential shares from share-based awards are excluded from the calculation of diluted earnings per share for all periods reported above because either their exercise price exceeded the average market price during the period or the share-based awards were determined to be anti-dilutive based on applying the treasury stock method. Anti-dilutive potential shares from share-based awards are also excluded from the calculation of diluted earnings per share for the three and nine months ended October 31, 2015 due to the net loss reported in those periods.

Note 5. Derivative Financial Instruments

The Company manages some of its foreign currency exchange rate risk through the purchase of foreign currency exchange contracts that hedge against the short-term effect of currency fluctuations. The Company’s policy is to enter into foreign currency forward contracts with maturities less than 12 months that mitigate the effect of rate fluctuations on certain local currency denominated operating expenses. All derivative instruments are recorded at fair value in either prepaid expenses and other current assets or accrued liabilities. The Company reports cash flows from derivative instruments in cash flows from operating activities. The Company uses quoted prices to value its derivative instruments.

The notional amounts of outstanding forward contracts were as follows (in thousands):

 

     Buy Contracts  
     October 29,      January 30,  
     2016      2016  

Israeli shekel

   $ 36,641       $ 19,082   
  

 

 

    

 

 

 

Cash Flow Hedges. The Company designates and documents its foreign currency forward exchange contracts as cash flow hedges for certain operating expenses. The Company evaluates and calculates the effectiveness of each hedge at least quarterly. The effective change is recorded in accumulated other comprehensive income and is subsequently reclassified to operating expense when the hedged expense is recognized. Ineffectiveness is recorded in interest and other income, net.

Other Foreign Currency Forward Contracts. The Company enters into foreign currency forward exchange contracts to hedge certain assets and liabilities denominated in various foreign currencies that it does not designate as hedges for accounting purposes. The maturities of these contracts are generally less than 12 months. Gains or losses arising from the remeasurement of these contracts to fair value each period are recorded in interest and other income, net.

The fair value of foreign currency exchange contracts was not significant as of any period presented.

The following table provides information about gains (losses) associated with the Company’s derivative financial instruments (in thousands):

 

          Amount of Gains (Losses) in Statement of Operations  
          Three Months Ended      Nine Months Ended  
     Location of Gains (Losses)    October 29,      October 31,      October 29,      October 31,  
    

in Statement of Operations

   2016      2015      2016      2015  

Derivatives designated as cash flow hedges:

              

Forward contracts:

  

Research and development

   $ 242       $ 116       $ 693       $ (460
  

Selling and marketing

     4         2         14         (6
  

General and administrative

     29         11         82         (34
     

 

 

    

 

 

    

 

 

    

 

 

 
      $ 275       $ 129       $ 789       $ (500
     

 

 

    

 

 

    

 

 

    

 

 

 

 

13


Table of Contents

MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

The portion of gains (losses) excluded from the assessment of hedge effectiveness are included in interest and other income, net, and these amounts were not material in the three and nine months ended October 29, 2016 and October 31, 2015. In addition, realized losses from forward contracts that are not designated as hedging instruments that are included in interest and other income, net, were not material in the three and nine months ended October 29, 2016 and October 31, 2015. The Company also reports hedge ineffectiveness from derivative financial instruments in current earnings which is not material in the three and nine months ended October 29, 2016 and October 31, 2015. No cash flow hedges were terminated as a result of forecasted transactions that did not occur.

Note 6. Fair Value Measurements

Fair value is an exit price representing the amount that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, the accounting guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1—Observable inputs that reflect quoted prices for identical assets or liabilities in active markets.

Level 2—Other inputs that are directly or indirectly observable in the marketplace.

Level 3—Unobservable inputs that are supported by little or no market activity.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company’s Level 1 assets include institutional money-market funds that are classified as cash equivalents and marketable investments in U.S. government and agency debt, which are valued primarily using quoted market prices. The Company’s Level 2 assets include its marketable investments in time deposits, corporate debt securities, foreign government and agency debt, municipal debt securities and asset backed securities as the market inputs used to value these instruments consist of market yields, reported trades and broker/dealer quotes, which are corroborated with observable market data. In addition, forward contracts, and the severance pay fund are classified as Level 2 assets as the valuation inputs are based on quoted prices and market observable data of similar instruments. The Company’s investments in auction rate securities are classified as Level 3 assets because there are currently no active markets for the auction rate securities and consequently the Company is unable to obtain independent valuations from market sources. Therefore, the auction rate securities are valued using a discounted cash flow model. Some of the inputs to the discounted cash flow model are unobservable in the market. The total amount of assets measured using Level 3 valuation methodologies represented 0.2% of total assets as of October 29, 2016. There were no transfers of assets between levels in either the nine months ended October 29, 2016 or October 31, 2015.

 

14


Table of Contents

MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

The tables below set forth, by level, the Company’s assets and liabilities that are measured at fair value on a recurring basis. The tables do not include assets and liabilities that are measured at historical cost or any basis other than fair value (in thousands):

 

     Fair Value Measurements at October 29, 2016  
     Level 1      Level 2      Level 3      Total  

Items measured at fair value on a recurring basis:

           

Assets

           

Cash equivalents:

           

Money market funds

   $ 63,191       $ —         $ —         $ 63,191   

Time deposits

     —           34,459         —           34,459   

Municipal debt securities

     —           8,740         —           8,740   

Corporate debt securities

     —           30,529         —           30,529   

Short-term investments:

           

U.S. government and agency debt

     165,560         —           —           165,560   

Corporate debt securities

     —           488,746         —           488,746   

Asset backed securities

     —           50,975         —           50,975   

Foreign government and agency debt

     —           11,908         —           11,908   

Municipal debt securities

     —           31,595         —           31,595   

Time deposits

     —           150,000         —           150,000   

Prepaid expenses and other current assets:

           

Foreign currency forward contracts

     —           11         —           11   

Long-term investments:

           

Auction rate securities

     —           —           8,974         8,974   

Other non-current assets:

           

Severance pay fund

     —           707         —           707   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 228,751       $ 807,670       $ 8,974       $ 1,045,395   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Accrued liabilities:

           

Foreign currency forward contracts

   $ —         $ 257       $ —         $ 257   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Fair Value Measurements at January 30, 2016  
     Level 1      Level 2      Level 3      Total  

Items measured at fair value on a recurring basis:

           

Assets

           

Cash equivalents:

           

Money market funds

   $ 160,400       $ —         $ —         $ 160,400   

Time deposits

     —           209,405         —           209,405   

U.S. government and agency debt

     184,374         —           —           184,374   

Corporate debt securities

     —           54,689         —           54,689   

Short-term investments:

           

U.S. government and agency debt

     317,405         —           —           317,405   

Corporate debt securities

     —           557,821         —           557,821   

Asset backed securities

     —           76,736         —           76,736   

Foreign government and agency debt

     —           21,358         —           21,358   

Municipal debt securities

     —           31,249         —           31,249   

Prepaid expenses and other current assets:

           

Foreign currency forward contracts

     —           30         —           30   

Long-term investments:

           

Auction rate securities

     —           —           11,296         11,296   

Other non-current assets:

           

Severance pay fund

     —           678         —           678   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 662,179       $ 951,966       $ 11,296       $ 1,625,441   
  

 

 

    

 

 

    

 

 

    

 

 

 

Liabilities

           

Accrued liabilities:

           

Foreign currency forward contracts

   $ —         $ 195       $ —         $ 195   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

15


Table of Contents

MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

The following table summarizes the change in fair value for Level 3 assets (in thousands):

 

     Nine Months Ended  
     October 29,      October 31,  
     2016      2015  

Beginning balance

   $ 11,296       $ 10,226   

Sales and redemptions

     (2,322      —     

Unrealized losses included in accumulated other comprehensive income

     —           (44
  

 

 

    

 

 

 

Ending balance

   $ 8,974       $ 10,182   
  

 

 

    

 

 

 

Note 7. Acquired Intangible Assets, Net

The carrying amounts of acquired intangible assets, net, are as follows (in thousands):

 

            October 29, 2016      January 30, 2016  
     Range of
Useful Lives
     Gross
Carrying
Amounts
     Accumulated
Amortization
and

Write-Offs
    Net
Carrying
Amounts
     Gross
Carrying
Amounts
     Accumulated
Amortization
and
Write-Offs
    Net
Carrying
Amounts
 

Purchased and core technology

     4 - 8 years       $ 35,498       $ (26,574   $ 8,924       $ 35,498       $ (21,910   $ 13,588   

Customer intangibles

     5 - 7 years         28,600         (28,190     410         28,600         (24,178     4,422   
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets, net

      $ 64,098       $ (54,764   $ 9,334       $ 64,098       $ (46,088   $ 18,010   
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Based on the identified intangible assets recorded at October 29, 2016, the future amortization expense for the next five fiscal years is as follows (in thousands):

 

Fiscal Year

      

Remainder of fiscal 2017

   $ 1,966   

2018

     5,508   

2019

     1,860   

2020 and thereafter

     —     
  

 

 

 
   $ 9,334   
  

 

 

 

Note 8. Restructuring and Other Related Charges

The following table provides a summary of restructuring and other related charges as presented in the unaudited condensed consolidated statements of operations (in thousands):

 

     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
     2016      2015      2016      2015  

Cost of goods sold

   $ —         $ 10,285       $ —         $ 10,285   

Restructuring and other related charges

     1,164         35,270         6,326         48,862   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,164       $ 45,555       $ 6,326       $ 59,147   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

16


Table of Contents

MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

The following table presents details of charges recorded by the Company related to the restructuring actions described below (in thousands):

 

     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
     2016      2015      2016      2015  

Severance and related costs

   $ —         $ 28,773       $ 15       $ 40,478   

Facilities and related costs

     108         657         4,585         882   

Other exit-related costs

     —           1,855         —           2,044   
  

 

 

    

 

 

    

 

 

    

 

 

 
     108         31,285         4,600         43,404   

Release of reserves:

           

Severance

     —           —           (86      —     

Other exit-related

     —           —           (269      —     

Impairment and write-off of assets:

           

Inventory

     —           8,046         —           8,046   

Technology license

     —           1,250         —           1,250   

Equipment and other

     1,056         4,974         2,081         6,447   
  

 

 

    

 

 

    

 

 

    

 

 

 

Restructuring and other related charges

   $ 1,164       $ 45,555       $ 6,326       $ 59,147   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company recorded $1.2 million and $6.3 million in the three and nine months ended October 29, 2016, respectively, in connection with restructuring and other related charges as described in the following paragraphs.

In connection with the Company’s decision to further reduce its research and development operations in Israel as announced in May 2015, the Company and the landlord of its facility located in Israel reached agreement for the Company to completely vacate and release certain floors back to the landlord for purposes of future sublease. As a result, the Company recorded charges of $4.3 million in the nine months ended October 29, 2016 primarily for the remaining lease obligation, net of sublease income, associated with the floors it vacated in the first half of fiscal 2017.

In connection with the restructuring of its mobile platform business announced in September 2015, the Company recorded a charge of $1.1 million in the three months ended October 29, 2016 to write off the remaining mobile-related equipment classified as held for sale that it was unable to sell. Total restructuring charges in the nine months ended October 29, 2016 were $1.9 million, primarily for the write off of all remaining mobile-related equipment that was previously classified as held for sale, which was offset by a recovery of $0.3 million from the release of reserve related to the loss on contract termination previously recognized in fiscal 2016. Of the remaining actions that were expected to be completed in the first half of fiscal 2017 related to restructuring of the mobile platform business, substantially all of the activities have been completed. Total cumulative charges recorded in fiscal 2016 through the nine months ended October 29, 2016 related to this restructuring action were $46.4 million, which included $28.1 million of severance benefits, a $1.3 million loss on early contract termination, $8.8 million for impairment of technology licenses and certain equipment, $0.2 million related to facility closures and an $8.0 million write down of inventory.

The following table sets forth a reconciliation of the beginning and ending restructuring liability balances by each major type of costs associated with the restructuring charges (in thousands):

 

     Severance      Facilities      Other         
     and Related      and Related      Exit-Related         
     Costs      Costs      Costs      Total  

Balance at January 30, 2016

   $ 1,155       $ 1,043       $ 1,644       $ 3,842   

Restructuring charges

     15         4,585         —           4,600   

Net cash payments

     (969      (4,606      (200      (5,775

Release of reserves

     (86      —           (269      (355

Exchange rate adjustment

     3         57         —           60   
  

 

 

    

 

 

    

 

 

    

 

 

 

Balance at October 29, 2016

   $ 118       $ 1,079       $ 1,175       $ 2,372   
  

 

 

    

 

 

    

 

 

    

 

 

 

The balance at October 29, 2016 for other exit-related costs includes contract termination costs that are expected to be paid upon execution of the settlement agreements, and for facilities and related costs includes remaining payments under lease obligations related to vacated space that are expected to be paid through fiscal 2018.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Note 9. Income Tax

The income tax expense for the three months ended October 29, 2016 was primarily due to a current income tax expense of $12.4 million, an expense of $0.6 million related to settlements of prior year tax in foreign jurisdictions, plus a net increase in unrecognized tax benefits of $2.8 million. The net increase in unrecognized tax benefits arose from the accrual of penalties and interest of $0.5 million on the outstanding unrecognized tax benefit balance, plus the accrual of an additional $2.3 million for changes in prior year tax positions. The income tax expense for the nine months ended October 29, 2016 was primarily due to a current income tax expense of $16.9 million, plus an expense of $0.6 million related to settlements of prior year tax in foreign jurisdictions, offset by a tax benefit of $9.7 million from a net reduction in unrecognized tax benefits and a deferred tax benefit of $2.5 million for the portion of a payment to the Company’s former Chief Executive Officer that became deductible after his departure from the Company in April 2016. The net reduction in unrecognized tax benefits arose from the release of $14.3 million due to expiration of the statute of limitations in certain non-U.S. jurisdictions, which was partially offset by penalties and interest of $2.0 million accrued on the outstanding unrecognized tax benefit balance, and the accrual of an additional $2.6 million for changes in prior year tax positions.

The income tax expense for the three months ended October 31, 2015 was primarily due to current income tax liability of $1.5 million, a $1.1 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and $0.7 million of interest on unrecognized tax benefits. The income tax expense for the nine months ended October 31, 2015 was primarily due to current income tax liability of $21.0 million, $7.8 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and an additional tax provision of $3.1 million related to a $15.4 million payment to the Company’s former Chief Executive Officer. These tax expenses for the nine months ended October 31, 2015 were partially offset by tax benefits of $14.0 million from a net reduction in unrecognized tax benefits, which primarily arose from the expiration of statutes of limitation and the settlement of tax audits in non-U.S. jurisdictions, and true-up adjustments of $4.8 million, primarily related to the filing of tax returns.

It is reasonably possible that the amount of unrecognized tax benefits could increase or decrease significantly due to changes in tax law in various jurisdictions, new tax audits and changes in the U.S. dollar as compared to foreign currencies within the next 12 months. Excluding these factors, uncertain tax positions may decrease by as much as $9.5 million from the lapse of statutes of limitation in various jurisdictions during the next 12 months. Government tax authorities from several non-U.S. jurisdictions are also examining the Company’s tax returns. The Company believes that it has adequately provided for any reasonably foreseeable outcomes related to its tax audits and that any settlement will not have a material effect on its results at this time.

The Company operates under tax incentives in certain countries that may be extended if certain additional requirements are satisfied. The tax incentives are conditional upon meeting certain employment and investment thresholds. The impact of these tax incentives decreased foreign taxes by $2.4 million and $4.6 million for the three and nine months ended October 29, 2016, respectively, and $1.8 million and $6.7 million for the three and nine months ended October 31, 2015, respectively. The benefit of the tax incentives on net income per share was $0.01 per share for the three and nine months ended October 29, 2016, compared to a benefit of less than $0.01 per share for the three months ended October 31, 2015 and $0.01 per share for the nine months ended October 31, 2015.

The Company’s principal source of liquidity as of October 29, 2016 consisted of approximately $1.7 billion of cash, cash equivalents and short-term investments, of which approximately $990 million was held by foreign subsidiaries (outside Bermuda). Approximately $680 million of this amount held by foreign subsidiaries is related to undistributed earnings, most of which have been indefinitely reinvested outside of Bermuda. These funds are primarily held in China, Israel, the United States and Switzerland. The Company plans to use such amounts to fund various activities outside of Bermuda including working capital requirements, capital expenditures for expansion, funding of future acquisitions or other financing activities. If such funds were needed by the parent company in Bermuda or if the amounts were otherwise no longer considered indefinitely reinvested, the Company would incur a tax expense of approximately $210 million.

Note 10. Commitments and Contingencies

Purchase Commitments

Under the Company’s manufacturing relationships with its foundry partners, cancellation of all outstanding purchase orders are allowed, but requires payment of all costs and expenses incurred through the date of cancellation. As of October 29, 2016, these foundries had incurred approximately $154.2 million of manufacturing costs and expenses relating to the Company’s outstanding purchase orders.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Intellectual Property Indemnification

The Company has agreed to indemnify certain customers for claims made against the Company’s products where such claims allege infringement of third party intellectual property rights, including, but not limited to, patents, registered trademarks and/or copyrights. Under the aforementioned indemnification clauses, the Company may be obligated to defend the customer and pay for the damages awarded against the customer as well as the attorneys’ fees and costs under an infringement claim. The Company’s indemnification obligations generally do not expire after termination or expiration of the agreement containing the indemnification obligation. Generally, there are limits on and exceptions to the Company’s potential liability for indemnification. Although historically the Company has not made significant payments under these indemnification obligations, the Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. The maximum potential amount of any future payments that the Company could be required to make under these indemnification obligations could be significant.

Contingencies and Legal Proceedings

The Company and certain of its subsidiaries are currently parties to various legal proceedings, including those noted in this section. The legal proceedings and claims described below could result in substantial costs and could divert the attention and resources of the Company’s management. The Company is also engaged in other legal proceedings and claims not described below, which arise in the ordinary course of its business. The Company is currently unable to predict the final outcome of these lawsuits and therefore cannot determine the likelihood of loss or estimate a range of possible loss, except with respect to amounts where it has determined a loss is both probable and estimatable and has made an accrual. As of October 29, 2016, the Company has an accrued litigation balance of $2.8 million related to certain legal proceedings. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling in litigation, particularly patent litigation, could require the Company to pay damages, one-time license fees or ongoing royalty payments, and could prevent the Company from manufacturing or selling some of its products or limit or restrict the type of work that employees involved in such litigation may perform for the Company, any of which could adversely affect financial results in future periods. There can be no assurance that these matters will be resolved in a manner that is not adverse to the Company’s business, financial condition, results of operations or cash flows.

Carnegie Mellon University Litigation. On March 6, 2009, CMU filed a complaint in the U.S. District Court for the Western District of Pennsylvania (“W.D. of Pennsylvania”). CMU has asserted U.S. Patent Nos. 6,201,839 and 6,438,180 (collectively, the “CMU patents in suit”), which relate to read-channel integrated circuit devices and the hard disk drive (“HDD”) incorporating such devices. A jury trial began on November 26, 2012. On December 26, 2012, a jury delivered a verdict that found the CMU patents in suit were literally and willfully infringed and valid, and awarded past damages in the amount of $1.17 billion. Based on post-trial motions and decisions, the W.D. of Pennsylvania calculated the damages including enhancement to total approximately $1.54 billion, and held that, under its decision, CMU is entitled to post judgment interest and an ongoing royalty. On May 7, 2014, the W.D. of Pennsylvania entered final judgment, from which the Company filed a notice of appeal on May 14, 2014. On August 4, 2015, the W.D. of Pennsylvania in a three-judge panel issued an opinion affirming in part, reversing in part, and vacating and remanding in part. On February 16, 2016, the Company and CMU entered into a Settlement Agreement and Patent License pursuant to which the Company has agreed to pay an aggregate of $750 million, without any ongoing royalty payments, to CMU and the parties have agreed to mutually acceptable release, license and covenant not to sue provisions. Please see “Note 13 – Carnegie Mellon University Settlement” for additional information on the effect of the settlement. In connection with the settlement, the primary supersedeas bond that the Company entered into in connection with this litigation was reduced to $439 million and the secondary bond was adjusted to $311 million. All of the Company’s obligations under both bonds were discharged pursuant to an order releasing supersedeas bonds on April 21, 2016. On October 18, 2016, the case was dismissed with prejudice.

Innovatio Litigation. On March 16, 2015, Innovatio IP Ventures, LLC filed suit against MSI in the U.S. District Court for the Northern District of Illinois, alleging infringement of U.S. Patent Nos. 6,697,415; 5,844,893; 5,740,366; 7,916,747; 6,665,536; 7,013,138; 7,107,052; 5,546,397; 7,710,907; 7,710,935; 6,714,559; 7,457,646; and 6,374,311, purportedly related to certain wireless technology. The complaint seeks unspecified damages. On October 11, 2016, the case was dismissed with prejudice.

Luna Litigation and Consolidated Cases. On September 11, 2015, Daniel Luna filed an action asserting putative class action claims on behalf of the Company’s shareholders in the United States District Court for the Southern District of New York (“S.D. of New York”). This action was consolidated with two additional, nearly identical complaints subsequently filed by Philip Limbacher and Jim Farno. The complaints asserted violations of federal securities laws based on allegations that the Company and certain of its officers and directors (Sehat Sutardja, Michael Rashkin, and Sukhi Nagesh) made, caused to be made, or failed to correct false and/or misleading statements in the Company’s press releases and public filings. The complaints request damages in unspecified amounts, costs and fees of bringing the action, and other unspecified relief.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

On November 18, 2015, the S.D. of New York granted the Company’s motion to transfer the consolidated cases to the N.D. of California. On December 21, 2015, the N.D. of California granted the Company’s motion to deem the consolidated cases related to the Saratoga litigation, discussed below. On February 8, 2016, the N.D. of California granted an unopposed motion to appoint Plumbers and Pipefitters National Pension Fund as Lead Plaintiff. On March 19, 2016, Lead Plaintiff filed a consolidated amended complaint. On April 29, 2016, Marvell and each of the individual defendants each filed motions to dismiss. The hearing on the motions to dismiss took place on July 29, 2016 and the court took the matter under submission. On October 12, 2016, the Court granted Defendants’ motions to dismiss with leave to amend and granted lead plaintiff 30 days to file an amended complaint. The parties agreed that the plaintiffs shall file and serve an amended complaint by November 28, 2016. Plaintiffs filed and served the amended complaint on November 28, 2016. Defendants have until January 16, 2017 to answer, move to dismiss, or otherwise respond to the complaint.

Saratoga Litigation. On October 16, 2015, Saratoga Advantage Trust Technology & Communications Portfolio (“Saratoga”) filed an action asserting shareholder derivative claims ostensibly on behalf of the Company in the Superior Court of the State of California, County of Santa Clara. The complaint names eight current or former officers and/or directors (Sehat Sutardja, Weili Dai, Juergen Gromer, Arturo Krueger, John Kassakian, Randhir Thakur, Michael Rashkin, and Sukhi Nagesh) as defendants and asserts various California state law causes of action based on allegations that the Company and the named officers and directors made, caused to be made, or failed to correct false and/or misleading statements in the Company’s press releases and public filings, leading to the filing of securities class actions that allegedly damaged the Company. The Company was named as a nominal defendant. The complaint requests damages and restitution in unspecified amounts, equitable and/or injunctive relief, costs and fees of bringing the action, and other unspecified relief.

On October 23, 2015, the Company removed the action to the N.D. of California. On December 21, 2015, the N.D. of California denied Saratoga’s motion to remand. On December 21, 2015, the N.D. of California granted the Company’s motion to deem the action related to the consolidated Luna actions, discussed above. On January 22, 2016, the Company filed a motion to dismiss the complaint; on March 25, 2016, the N.D. of California held a hearing on the motion and took the matter under submission. On August 16, 2016, the court granted the Company’s motion and gave plaintiff 30 days leave to amend the complaint, (until September 15, 2016). The parties agreed to a stipulated dismissal, and on September 15, 2016, the case was dismissed with prejudice.

Surety Bonds

On May 14, 2014, the Company filed a Notice of Appeal to appeal the final judgment issued by the W.D. of Pennsylvania in the CMU litigation. In order to stay the execution of the final judgment pending its appeal, the Company filed a supersedeas bond for $1.54 billion with the W.D. of Pennsylvania in the event the Company did not fully satisfy a final judgment as affirmed after the completion of all appellate proceedings. The bond was issued by a consortium of sureties authorized by the U.S. Treasury. In support of the bond, the Company entered into separate indemnity agreements with each of the sureties to indemnify the sureties from all costs and payments made under the bond. The indemnity agreements did not require collateral to be posted at the time of the issuance of the bond. However, the indemnity agreements provide that each of the sureties have the right to demand to be placed in funds or call for collateral under pre-defined events.

On November 14, 2014, the Company filed a second surety bond for $216 million and filed a commitment letter from the sureties to issue up to an additional $95 million in bonding under certain conditions. The second bond and commitment are secured by the Company’s campus located in Santa Clara, California, which has a carrying value of $128.3 million at October 29, 2016.

In connection with the settlement that was reached with CMU for a total $750 million in February 2016, the primary supersedeas bond that the Company entered into was reduced to $439 million and the secondary bond was adjusted to $311 million and both were discharged pursuant to an order releasing supersedeas bonds on April 21, 2016. For additional information, see CMU litigation under “Contingencies” above.

Indemnities, Commitments and Guarantees

During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities may include intellectual property indemnities to the Company’s customers in connection with the sales of its products, indemnities for liabilities associated with the infringement of other parties’ technology based upon the Company’s products, indemnities for general commercial obligations, indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease, and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of Bermuda. In addition, the Company has contractual commitments to various customers, which could require the Company to incur costs to repair an epidemic defect with respect to its products outside of the normal warranty period if such defect were to occur. The duration of these indemnities, commitments and guarantees varies and, in certain cases, is indefinite. Some of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments that the Company could be obligated to make. In general, the Company does not record any liability for these indemnities, commitments and guarantees in the accompanying consolidated balance sheets as the amounts cannot be reasonably estimated and are not considered probable. The Company does, however, accrue for losses for any known contingent liability, including those that may arise from indemnification provisions, when future payment is probable.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Note 11. Shareholders’ Equity

Stock Plans

Stock option activity under the Company’s stock option and stock incentive plans is included in the following table (in thousands, except per share amounts):

 

     Time-Based Options      Market-Based Options      Total  
     Number of
Shares
    Weighted
Average
Exercise Price
     Number of
Shares
    Weighted
Average

Exercise  Price
     Number of
Shares
    Weighted
Average
Exercise Price
 

Balance at January 30, 2016

     40,874      $ 13.59         2,156      $ 15.43         43,030      $ 13.68   

Granted

     2,105      $ 9.99         —        $ —           2,105      $ 9.99   

Exercised

     (1,202   $ 9.85         —        $ —           (1,202   $ 9.85   

Canceled/Forfeited

     (4,292   $ 19.44         (2,156   $ 15.43         (6,448   $ 18.09   
  

 

 

      

 

 

      

 

 

   

Balance at October 29, 2016

     37,485      $ 12.84         —             37,485      $ 12.84   
  

 

 

      

 

 

      

 

 

   

Vested or expected to vest at October 29, 2016

     36,155      $ 12.82             
  

 

 

             

Exercisable at October 29, 2016

     22,875      $ 12.71             
  

 

 

             

For time-based stock options vested and expected to vest at October 29, 2016, the aggregate intrinsic value was $54.0 million and the weighted average remaining contractual term was 5.5 years. For time-based stock options exercisable at October 29, 2016, the aggregate intrinsic value was $39.3 million and the weighted average remaining contractual term was 4.1 years. The aggregate intrinsic value of stock options exercised during the three months ended October 29, 2016 and October 31, 2015 was $2.9 million and $0.7 million, respectively. The aggregate intrinsic value of stock options exercised during the nine months ended October 29, 2016 and October 31, 2015 was $3.0 million and $9.5 million, respectively. The market-based stock options automatically expired in April 2016 since the market price conditions were not met within the required five years from date of grant. The Company’s closing stock price of $13.10 as reported on the NASDAQ Global Select Market for all in-the-money options as of October 28, 2016 (last trading day of the quarter) was used to calculate the aggregate intrinsic value.

As of October 29, 2016, the unamortized compensation expense was $22.0 million for time-based stock options. The unamortized compensation expense for time-based stock options will be amortized on a straight-line basis and is expected to be recognized over a weighted average period of 1.7 years.

Activity related to the non-vested portion of the restricted stock units is included in the following table (in thousands, except for share prices):

 

     Time-Based      Performance-Based      Market-Based      Total  
     Number of
Shares
    Weighted
Average

Grant  Date
Fair Value
     Number of
Shares
    Weighted
Average

Grant  Date
Fair Value
     Number of
Shares
    Weighted
Average

Grant  Date
Fair Value
     Number of
Shares
    Weighted
Average

Grant  Date
Fair Value
 

Balance at January 30, 2016

     8,343      $ 13.57         977      $ 14.43         353      $ 12.24         9,673      $ 13.61   

Granted

     8,751      $ 9.70         —        $ —           554   $ 11.71         9,305      $ 9.82   

Vested

     (5,367   $ 14.00         (155   $ 14.15         —        $ —           (5,522   $ 14.00   

Canceled/Forfeited

     (961   $ 11.13         (822   $ 14.50         (406   $ 12.39         (2,189   $ 12.63   
  

 

 

      

 

 

      

 

 

      

 

 

   

Balance at October 29, 2016

     10,766      $ 10.42         —        $ —           501      $ 11.53         11,267      $ 10.47   
  

 

 

      

 

 

      

 

 

      

 

 

   

 

* Amounts represent the target number of restricted stock units at grant date. For these awards granted to our executive officers, up to 150% of the target restricted stock units may vest if the maximum level for performance objectives is achieved.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

In August 2016, the Company granted performance-based equity awards to each of its executive officers who recently joined the Company. The Company also granted performance-based equity awards to its Chief Financial Officer in September 2016, when she joined the Company. These equity awards include RSU’s which vest based on the achievement of certain financial goals for which the financial metrics have not yet been approved by the Executive Compensation Committee of the Company’s Board of Directors (“ECC”) and as such, have no grant measurement date for accounting purposes. Therefore, the table presented above excludes the grant of 328,071 shares (based on 100% expected achievement) related to these performance-based RSUs. A portion of the equity awards shall vest based on total shareholder return (each a “Total Shareholder Return Award”). The Total Shareholder Return Awards will vest on the third anniversary of the commencement date based on the achievement of performance objectives relating to relative total shareholder return of the Company’s common shares as compared to that of comparable companies of the Philadelphia Semiconductor Sector Index over performance periods as defined in each award. These Total Shareholder Return Awards are reported in the table presented above as “Market-Based.” Share-based compensation for the Total Shareholder Return Award is measured using the Monte Carlo valuation method since the award is indexed to the price of the Company’s common stock as set forth under the terms of the award.

In connection with the performance-based equity awards granted in fiscal 2016 to each of the Company’s executive officers, a total of 33,616 shares vested on April 1, 2016 based on achieving certain individual strategic goals as evaluated by the ECC. No shares vested for the achievement of financial performance goals since the financial performance criteria were below the threshold level. The amount of canceled shares reported in the table above includes the unvested shares that were not earned.

The Company recognizes expense from performance-based equity awards when it becomes probable that the performance conditions will be met. Once it becomes probable that a performance-based award will vest, the Company recognizes share-based compensation expense equal to the number of shares expected to vest multiplied by the fair value of the award at the grant date, which is amortized using the accelerated method.

The aggregate intrinsic value of restricted stock units expected to vest as of October 29, 2016 was $122.0 million. The number of restricted stock units that are expected to vest is 10.4 million shares. As of October 29, 2016, unamortized compensation expense related to restricted stock units was $75.2 million. The unamortized compensation expense for restricted stock units will be amortized on a straight-line basis and is expected to be recognized over a weighted average period of 1.5 years.

Employee Stock Purchase Plan

During the three and nine months ended October 29, 2016, the Company issued no shares under the 2000 Employee Stock Purchase Plan, as amended and restated (the “ESPP”) because it was not eligible to issue shares of its common stock due to the delay in the timely filing of its periodic reports with the SEC for the first quarter of fiscal 2017, the year ended January 30, 2016, and the second and third quarters of fiscal 2016. The Company also canceled the June 2016 ESPP purchase and delayed the opening of the new offering period that would have started in June 2016. As a result, the Company refunded $27.2 million of contribution withholdings to its employees and it recorded an additional $6.8 million of share-based compensation expense representing the acceleration of the remaining unamortized compensation expense related to the June 2016 ESPP purchase period. In August 2016, the Company completed the filing of its periodic reports with the SEC and re-opened the ESPP plan. During the three and nine months ended October 31, 2015, a total of 3.2 million shares were issued at a weighted-average price of $11.88 per share under the ESPP. As of October 29, 2016, there was $21.8 million of unrecognized compensation cost related to the ESPP.

Share Repurchase Program

The Company repurchased 4.4 million of its common shares for $56.5 million during the three and nine months ended October 29, 2016. The Company repurchased 3.7 million of its common shares for $45.6 million in cash during the three months ended October 31, 2015 and 19.7 million of its common shares for $260.9 million during the nine months ended October 31, 2015. The repurchased shares were retired immediately after the repurchases were completed. The Company records all repurchases, as well as investment purchases and sales, based on trade date. As of October 29, 2016, a total of 246.0 million shares have been repurchased to date under the Company’s share repurchase program for a total $3.1 billion in cash and there was $126.1 million remaining available for future share repurchases.

Subsequent to the end of the quarter through November 25, 2016, the Company repurchased an additional 0.8 million of its common shares for $10.6 million at an average price per share of $12.86.

On November 17, 2016, the Company announced that its Board of Directors authorized a $1 billion share repurchase plan. The newly authorized stock repurchase program replaces in its entirety the prior $3.25 billion stock repurchase program, which had approximately $115 million of repurchase authority remaining as of November 27, 2016.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

Dividends

The Company paid the following cash dividends (in thousands, except per share amounts):

 

     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
     2016      2015      2016      2015  

Cash dividend per share

   $ 0.06       $ 0.06       $ 0.18       $ 0.18   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total payment to shareholders

   $ 30,699       $ 30,270       $ 91,835       $ 92,374   
  

 

 

    

 

 

    

 

 

    

 

 

 

On November 17, 2016, the Company announced that its Board of Directors had declared a cash dividend of $0.06 per share payable on December 28, 2016 to all shareholders of record on December 6, 2016.

Future payment of a regular quarterly cash dividend on the Company’s common shares will be subject to, among other things, the best interests of the Company and its shareholders, the Company’s results of operations, cash balances and future cash requirements, financial condition, developments in ongoing litigation, statutory requirements under Bermuda law and other factors that the Company’s board of directors may deem relevant. The Company’s dividend payments may change from time to time, and the Company cannot provide assurance that it will continue to declare dividends at all or in any particular amounts.

Note 12. Share-Based Compensation

The following table presents details of share-based compensation expenses by functional line item (in thousands):

 

     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
   2016      2015      2016      2015  

Cost of goods sold

   $ 2,225       $ 2,495       $ 6,859       $ 6,054   

Research and development

     19,998         22,573         72,975         75,162   

Selling and marketing

     2,958         2,608         9,215         7,892   

General and administrative

     3,082         3,789         863         12,252   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 28,263       $ 31,465       $ 89,912       $ 101,360   
  

 

 

    

 

 

    

 

 

    

 

 

 

Share-based compensation capitalized in inventory was $1.2 million at October 29, 2016 and $1.5 million at January 30, 2016.

Upon the termination of the employment of certain members of our executive management in April 2016, it was determined that the vesting in certain of their unvested stock awards was not probable. As a result, the Company recorded a $6.9 million reversal of the previously recognized related share-based compensation expense in the nine months ended October 29, 2016.

Valuation Assumptions

The following weighted average assumptions were used for each respective period to calculate the fair value of each time-based stock option award on the date of grant using the Black-Scholes valuation model:

 

     Three Months Ended     Nine Months Ended  
     October 29,     October 31,     October 29,     October 31,  
     2016     2015     2016     2015  

Time-based Stock Options:

        

Weighted average fair value

   $ 3.51      $ 2.82      $ 2.92      $ 3.94   

Expected volatility

     37     43     40     34

Expected term (in years)

     5.2        5.4        5.2        5.4   

Risk-free interest rate

     1.2     1.5     1.3     1.6

Expected dividend yield

     1.9     2.3     2.5     1.7

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

     Three Months Ended     Nine Months Ended  
     October 29,     October 31,     October 29,     October 31,  
   2016     2015     2016     2015  

Employee Stock Purchase Plan:

        

Estimated fair value

   $ 3.89      $ 3.78      $ 3.89      $ 3.78   

Volatility

     40     31     40     31

Expected term (in years)

     1.1        1.3        1.1        1.3   

Risk-free interest rate

     0.6     0.4     0.6     0.4

Dividend yield

     2.0     1.7     2.0     1.7

 

     Nine Months Ended  
     October 29,  
     2016  

Total Shareholder Return Awards:

  

Expected term (in years)

     2.9   

Expected volatility

     36

Average correlation coefficient of peer companies

     0.5

Risk-free interest rate

     0.8

Expected dividend yield

     2.1

The correlation coefficients are calculated based upon the price date used to calculate the historical volatilities and is used to model the way in which each entity tends to move in relation to its peers.

Note 13. Carnegie Mellon University Settlement

In February 2016, the Company and CMU settled their patent infringement lawsuit pursuant to a court-ordered mediation and entered into a Settlement Agreement and Patent License (the “Agreement”). The parties agreed to mutual release of claims, license and covenant not to sue provisions for which the Company paid an aggregate of $750 million to CMU in the nine months ended October 29, 2016. See CMU litigation under “Note 10 – Commitments and Contingencies” for further information about the lawsuit.

The Agreement was accounted for as a multiple-element arrangement and accordingly, a valuation was completed to determine the estimated fair value of each identifiable element. As a result, the Company allocated $654.7 million to the mutual release of claims and covenant not to sue provisions; $81.3 million to the licensing of intellectual property in fiscal 2016; and the remaining $14.0 million representing the future use of the license through April 2018.

The $654.7 million for the mutual release of claims and covenant not to sue was recorded in fiscal 2016 as a settlement charge in operating expenses since there is no future benefit. The $81.3 million license fee was recorded in fiscal 2016 as a charge in cost of goods sold for past use of the license. The $14.0 million representing the future use of the license, is to be recognized in cost of goods sold over the remaining term of the license from February 2016 through April 2018. Accordingly, the Company recorded $1.6 million and $4.7 million to cost of goods sold in the three and nine months ended October 29, 2016, respectively.

Note 14. Changes in the Company’s Organization

In April 2016, the employment of Dr. Sehat Sutardja as Chief Executive Officer and Ms. Weili Dai as President was terminated by the Company’s Board of Directors. The Board of Directors then formed an Interim Office of the Chief Executive and appointed Maya Strelar-Migotti, Executive Vice President of the Smart Networked Devices and Solutions Business Group, and Dr. Pantelis Alexopoulos, Executive Vice President of the Storage Business Group, as Interim Co-Chief Executive Officers.

Also in April 2016, the Company announced that it entered into an agreement with Starboard Value LP (“Starboard”), regarding the composition of its Board of Directors. Under the terms of the agreement, the Company elected Peter A. Feld, Richard S. Hill, Oleg Khaykin, Michael Strachan and Robert Switz to serve on its board. The agreement specifies that the Board would recommend and the Company would support and solicit proxies only for the election at the 2016 annual general meeting of Messrs. Feld, Hill, Khaykin, Murphy, Strachan and Switz and the four independent directors serving on the Board immediately prior to the execution of the agreement, Dr. Juergen Gromer, Dr. John G. Kassakian, Arturo Krueger and Dr. Randhir Thakur.

 

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MARVELL TECHNOLOGY GROUP LTD.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 

In May 2016, Mr. Hill replaced Dr. Sutardja as the Chairman of the Board. In June 2016, the Board of Directors appointed Matthew J. Murphy to serve as the Company’s President and Chief Executive Officer, effective July 11, 2016. Mr. Murphy also joined the Board of Directors on July 11, 2016.

Ms. Strelar-Migotti and Dr. Alexopoulos returned to their roles as Executive Vice Presidents of the Company effective upon Mr. Murphy’s commencement of employment.

Upon the commencement of Mr. Murphy’s employment, the Board subsequently appointed Richard S. Hill, the Chairman of the Board, as the Company’s Interim Principal Executive Officer, to serve in that capacity until the Company files its Quarterly Report on Form 10-Q for the second quarter of fiscal 2017 (“Q217 Form 10-Q”). Mr. Murphy assumed the role of the Company’s principal executive officer immediately following the filing of the Q217 Form 10-Q.

In August 2016, the Company announced the appointment of Jean Hu as Chief Financial Officer effective August 22, 2016. David P. Eichler, the Company’s Interim Chief Financial Officer and principal financial officer, ceased serving as the Company’s principal financial officer upon Ms. Hu’s appointment as Chief Financial Officer. In September 2016, Dr. Zining Wu, the Company’s Chief Technical Officer, left the Company. On October 3, 2016, the Company announced the appointment of David Caron as Chief Accounting Officer and Controller, effective immediately.

At the Company’s Annual General Meeting of Shareholders held on November 8, 2016 (the “Annual Meeting”), shareholders whose shares were present either in person or by proxy voted upon the election of directors to the Board of Directors. The shareholders elected the following directors to serve until the next annual general meeting of shareholders: Peter Feld; Richard Hill; Oleg Khaykin; Matthew Murphy; Michael Strachan; Robert Switz; and Randhir Thakur. Immediately following the Annual Meeting, the terms of directors Dr. Sehat Sutardja, Weili Dai, Dr. Juergen Groemer, Dr. John Kassakian and Arturo Krueger expired. On November 15, 2016, the Board of Directors appointed Dr. Thakur to serve on the Audit Committee of the Board of Directors, effective immediately.

Note 15. Subsequent Event

In November 2016, the Company announced a plan to restructure its operations to refocus its research and development, increase operational efficiency and improve profitability. The Company expects that the restructuring actions, which include discontinuing investment in specific research and development programs, streamlining engineering processes, and consolidating research and development sites, will eliminate approximately 900 positions worldwide. In addition, the Company plans to divest certain non-strategic businesses. These actions will begin immediately and are expected to be fully executed by the end of October 2017.

As a result of these actions, the Company expects to incur charges of $90 million to $110 million over the next four fiscal quarters, including cash charges of $35 million to $50 million. Restructuring and restructuring-related charges include an estimate of severance, asset impairment, lease termination fees and other costs.

 

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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results to differ materially from those implied by the forward-looking statements. Words such as “anticipates,” “expects,” “intends,” “plans,” “projects” “believes,” “seeks,” “estimates,” “may” “can,” “will” “would” and similar expressions identify such forward-looking statements.

Forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those indicated in the forward-looking statements. Factors that could cause actual results to differ materially from those predicted, include, but are not limited to:

 

   

our ability to successfully restructure our operations within our anticipated timeframe announced in November 2016 and with our anticipated amounts of costs and savings;

 

   

our dependence upon the hard disk drive and wireless markets, which are highly cyclical and intensely competitive;

 

   

the outcome of pending or future litigation and legal proceedings;

 

   

our dependence on a small number of customers;

 

   

our ability and the ability of our customers to successfully compete in the markets in which we serve;

 

   

our reliance on independent foundries and subcontractors for the manufacture, assembly and testing of our products;

 

   

our ability and our customers’ ability to develop new and enhanced products and the adoption of those products in the market;

 

   

decreases in our gross margin and results of operations in the future due to a number of factors;

 

   

our ability to estimate customer demand and future sales accurately;

 

   

our ability to scale our operations in response to changes in demand for existing or new products and services;

 

   

the impact of international conflict and continued economic volatility in either domestic or foreign markets;

 

   

the effects of transitioning to smaller geometry process technologies;

 

   

the risks associated with manufacturing and selling a majority of our products and our customers’ products outside of the United States;

 

   

the impact of any change in our application of the United States federal income tax laws and the loss of any beneficial tax treatment that we currently enjoy;

 

   

the effects of any potential acquisitions or investments;

 

   

our ability to protect our intellectual property;

 

   

the impact and costs associated with changes in international financial and regulatory conditions; and

 

   

our maintenance of an effective system of internal controls.

Additional factors which could cause actual results to differ materially include those set forth in the following discussion, as well as the risks discussed in Part II, Item 1A, “Risk Factors,” and other sections of this Quarterly Report on Form 10-Q. These forward-looking statements speak only as of the date hereof. Unless required by law, we undertake no obligation to update any forward-looking statements.

 

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Overview

We are a fabless semiconductor provider of high-performance application-specific standard products. Our core strength is the development of complex System-on-a-Chip (“SoC”) and System-in-a-Package devices, leveraging our extensive technology portfolio of intellectual property in the areas of analog, mixed-signal, digital signal processing, and embedded and standalone integrated circuits. The majority of our product portfolio leverages embedded central processing unit technology. We also develop platforms that we define as integrated hardware along with software that incorporates digital computing technologies designed and configured to provide an optimized computing solution. Our broad product portfolio includes devices for data storage, enterprise-class Ethernet data switching, Ethernet physical-layer transceivers (“PHY”), wireless connectivity, and multimedia solutions. Our products serve diverse applications used in carrier, metropolitan, enterprise and PC-client data communications and storage systems. Additionally, we serve the consumer electronics market for the convergence of voice, video and data applications. As a fabless integrated circuit Company, we rely on independent, third-party contractors to perform manufacturing, assembly and test functions. This approach allows us to focus on designing, developing and marketing our products, and significantly reduces the amount of capital we need to invest in manufacturing products.

Net revenue for the third quarter and first nine months of fiscal 2017 declined 3% and 14% compared to the third quarter and first nine months of fiscal 2016, respectively, which was mainly driven by a decline in the HDD market, and the anticipated decline in our mobile and wireless product sales as a result of the restructuring of our mobile handset platform business in fiscal 2016. These declines were partially offset by growth in networking and solid state drive (“SSD”) products.

We believe our financial position is strong and we remain committed to deliver shareholder value through our share repurchase and dividend programs. Our cash, cash equivalents and short-term investments were $1.7 billion at October 29, 2016. We used cash flow from operations of $477.3 million through the third quarter of fiscal 2017 primarily due to the $750 million settlement with CMU that was fully paid in April 2016. We also paid cash dividends of $0.06 per share for a total of $91.8 million through the third quarter of fiscal 2017. In November 2017, we announced that our board of directors had authorized a $1 billion share repurchase program, and our intention to repurchase approximately $500 million worth of shares over the next 12 months.

Historically, a relatively small number of customers have accounted for a significant portion of our net revenue. Net revenue attributable to significant customers whose revenues as a percentage of net revenue was 10% or greater of total net revenues is presented in the following table:

 

     Three Months Ended     Nine Months Ended  
     October 29,     October 31,     October 29,     October 31,  
     2016     2015     2016     2015  

End Customer:

        

Western Digital*

     21     14     19     18

Toshiba

     13     **     13     **

Seagate

     10     11     **     13

Samsung

     **     13     **     **

Distributor:

        

Wintech

     **     **     10     **

 

* The percentage of net revenues reported for Western Digital in the three and nine months ended October 29, 2016 includes net revenue of HGST and Sandisk, that became subsidiaries of Western Digital in late fiscal 2016.
** Less than 10% of net revenue

We continuously monitor the creditworthiness of our distributors and believe these distributors’ sales to diverse end customers and geographies further serve to mitigate our exposure to credit risk.

Most of our sales are made to customers located outside of the United States, primarily in Asia. Sales to customers with operations in Asia represented 94% of our net revenue for both the three and nine months ended October 29, 2016, compared to 96% of our net revenue for both the three and nine months ended October 31, 2015. Because many manufacturers and manufacturing subcontractors of our customers are located in Asia, we expect that most of our net revenue will continue to be represented by sales to our customers in that region.

A relatively large portion of our sales have historically been made on the basis of purchase orders rather than long-term agreements. In addition, the development process for our products is long, which may cause us to experience a delay between the time we incur expenses and the time revenue is generated from these expenditures. We anticipate that the rate of new orders may vary significantly from quarter to quarter. Consequently, if anticipated sales and shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter and future quarters may be adversely affected.

 

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Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results could differ from these estimates, and such differences could affect the results of operations reported in future periods. For a description of our critical accounting policies and estimates, please refer to the “Critical Accounting Policies and Estimates” section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended January 30, 2016 as filed with the SEC on July 21, 2016.

Results of Operations

The following table sets forth information derived from our unaudited condensed consolidated statements of operations expressed as a percentage of net revenue:

 

     Three Months Ended     Nine Months Ended  
     October 29,     October 31,     October 29,     October 31,  
     2016     2015     2016     2015  

Net revenue

     100.0     100.0     100.0     100.0

Operating costs and expenses:

        

Cost of goods sold

     43.7        56.2        45.7        56.5   

Research and development

     34.0        37.4        38.0        38.8   

Selling and marketing

     4.7        4.5        5.1        4.6   

General and administrative

     4.4        4.9        5.4        5.2   

Carnegie Mellon University litigation settlement

     —          —          —          31.0   

Restructuring and other related charges

     0.2        5.2        0.3        2.3   

Amortization and write-off of acquired intangible assets

     0.3        0.6        0.4        0.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating costs and expenses

     87.3        108.8        94.9        138.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     12.7        (8.8     5.1        (38.8

Interest and other income, net

     0.8        0.7        0.8        0.8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     13.5        (8.1     5.9        (38.0

Provision for income taxes

     2.4        0.5        0.3        0.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     11.1     (8.6 )%      5.6     (38.7 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Three and nine months ended October 29, 2016 and October 31, 2015

Net Revenue

 

     Three Months Ended            Nine Months Ended         
     October 29,      October 31,      %     October 29,      October 31,      %  
     2016      2015      Change     2016      2015      Change  
     (in thousands, except percentage)  

Net revenue

   $ 654,422       $ 674,890         (3.0 )%    $ 1,821,648       $ 2,109,670         (13.7 )% 

Net revenue for the three and nine months ended October 29, 2016 decreased by $20.5 million and $288.0 million compared to the three and nine months ended October 31, 2015, respectively. For the three months ended October 29, 2016, the decline was mainly driven by a decline in sales of products from our mobile and wireless end market customers as a result of the previously announced restructuring of our mobile handset platform business. These declines were partially offset by sales growth in all of our other end markets. For the nine months ended October 29, 2016 the decline was mainly driven by declines in sales of products from our mobile and wireless, and HDD end market customers, offset by increases in sales of products to our customers in the networking and SSD end markets. Unit shipments were 21% lower and weighted average selling prices increased 21% in the three months ended October 29, 2016, compared to the three months ended October 31, 2015, for an overall decline of 3%. Unit shipments were 23% lower and weighted average selling prices increased 12% in the nine months ended October 29, 2016, compared to the nine months ended October 31, 2015, for an overall decline of 14%.

From time to time prior to fiscal 2017, our customers agreed to take shipments in an earlier fiscal quarter than the fiscal quarter they originally requested delivery. When such agreement would not have occurred but for the request made by Marvell, we refer to such transactions internally as “pull-ins.” Beginning in fiscal 2017, our policy is not to engage in pull-in transactions and, as a result, there were no such transactions in the third quarter and first nine months of fiscal 2017. This compares to fiscal 2016, when we had net revenue related to pull-in sales for shipments taken early by our customers of less than 1% of net revenue in the third quarter of fiscal 2016, and 9% and 11% of net revenue in the first and second quarters of fiscal 2016, respectively.

 

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Cost of Goods Sold

 

     Three Months Ended           Nine Months Ended        
     October 29,     October 31,     %     October 29,     October 31,     %  
     2016     2015     Change     2016     2015     Change  
     (in thousands, except percentage)  

Cost of goods sold

   $ 286,063      $ 379,254        (24.6 )%    $ 832,881      $ 1,192,126        (30.1 )% 

% of net revenue

     43.7     56.2       45.7     56.5  

The cost of goods sold as a percentage of net revenue was lower for the three and nine months ended October 29, 2016, primarily due to a shift toward sales of higher margin storage products. Material and manufacturing costs for the three months ended October 29, 2016 were also lower compared to the three months ended October 31, 2015. In addition, cost of goods sold were higher by $1.1 million and $80.0 million in the three and nine months ended October 31, 2015, respectively, related to the litigation settlement reached with CMU and higher inventory write-downs due to lower than expected demand from our mobile related products. Our cost of goods sold as a percentage of net revenue may fluctuate in future periods due to, among other things: changes in the mix of products sold; the timing of production ramps of new products; increased pricing pressures from our customers and competitors; charges for obsolete or potentially excess inventory; changes in the costs charged by our foundry, assembly and test subcontractors; product warranty costs; changes in commodity prices such as gold; and the margin profiles of our new product introductions.

Share-Based Compensation Expense

 

     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
   2016      2015      2016      2015  
     (in thousands)  

Cost of goods sold

   $ 2,225       $ 2,495       $ 6,859       $ 6,054   

Research and development

     19,998         22,573         72,975         75,162   

Selling and marketing

     2,958         2,608         9,215         7,892   

General and administrative

     3,082         3,789         863         12,252   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 28,263       $ 31,465       $ 89,912       $ 101,360   
  

 

 

    

 

 

    

 

 

    

 

 

 

Share-based compensation expense decreased by $3.2 million and $11.4 million in the three and nine months ended October 29, 2016 compared to the three and nine months ended October 31, 2015. The decreases were mainly due to lower headcount from the restructuring of the mobile platform business in September 2015 and the $6.9 million reversal in the first quarter of fiscal 2017 of previously recognized expense associated with unvested stock awards for which vesting was determined as not probable upon the termination in April 2016 of certain members of our executive management. These decreases were partially offset by the effect from the acceleration of expense caused by the cancellation of the June 2016 ESPP purchase because the Company was not eligible to issue shares of its common stock due to the delay in the timely filing of its periodic reports with the SEC (see “Note 12 –Share-Based Compensation” in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q).

Restructuring and Other Related Charges

 

     Three Months Ended      Nine Months Ended  
     October 29,      October 31,      October 29,      October 31,  
     2016      2015      2016      2015  
     (in thousands)  

Cost of goods sold

   $ —         $ 10,285       $ —         $ 10,285   

Restructuring and other related charges

     1,164         35,270         6,326         48,862   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,164       $ 45,555       $ 6,326       $ 59,147   
  

 

 

    

 

 

    

 

 

    

 

 

 

We recorded total restructuring charges of $1.2 million and $6.3 million in the three and nine months ended October 29, 2016, respectively. The charges primarily included the remaining lease obligation associated with our facility located in Israel where we vacated and released certain floors back to the landlord as part of restructuring actions announced in May 2015. In addition, we wrote off certain mobile-related equipment classified as held for sale that we are no longer able to sell. See “Note 8 – Restructuring and Other Related Charges” in the Notes to Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion.

This compares to restructuring charges of $45.6 million and $59.1 million recorded in the three and nine months ended October 31, 2015, respectively. Those charges primarily related to the restructuring of our mobile platform business announced in September 2015 and included severance, other exit-related costs, the impairment of certain equipment and other assets, as well as the write down of inventory. In addition, we incurred additional charges in connection with our ongoing effort to streamline our business.

 

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In November 2016, we announced a plan to restructure our operations to refocus our research and development, increase operational efficiency and improve profitability. We expect to incur significant charges beginning in our fourth quarter of fiscal 2017 in connection with our restructuring actions. See “Note 16 – Subsequent Events” in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion.

Research and Development

 

     Three Months Ended           Nine Months Ended        
     October 29,     October 31,     %     October 29,     October 31,     %  
     2016     2015     Change     2016     2015     Change  
     (in thousands, except percentage)  

Research and development

   $ 222,463      $ 252,502        (11.9 )%    $ 691,812      $ 818,257        (15.5 )% 

% of net revenue

     34.0     37.4       38.0     38.8  

Research and development expense decreased by $30.0 million for the three months ended October 29, 2016 compared to the three months ended October 31, 2015. The decrease in the three months ended October 29, 2016 was attributable to $14.2 million of lower personnel-related costs due to headcount reduction, a large part of which was from the restructuring of our mobile platform business announced in September 2015 that now has been substantially completed. As a result, we anticipate total annual cost savings of approximately $130 million in lower research and development expenses for fiscal 2017. The decrease also reflects a decrease of $13.2 million for third-party vendor and non-recurring engineering services, and a reduction in depreciation and amortization expense of $1.8 million.

Research and development expense decreased by $126.4 million for the nine months ended October 29, 2016 compared to the nine months ended October 31, 2015. The decrease in the nine months ended October 29, 2016 was attributable to approximately $76.4 million of lower personnel-related costs due to the headcount reduction as described above, combined with a decrease of $30.9 million for third-party vendor and non-recurring engineering services, and a reduction in depreciation and amortization expense of $9.5 million.

Selling and Marketing

 

     Three Months Ended           Nine Months Ended        
     October 29,     October 31,     %     October 29,     October 31,     %  
     2016     2015     Change     2016     2015     Change  
     (in thousands, except percentage)  

Selling and marketing

   $ 30,576      $ 30,582        (0.0 )%    $ 93,022      $ 97,597        (4.7 )% 

% of net revenue

     4.7     4.5       5.1     4.6  

Selling and marketing expense remained flat at $30.6 million for the three months ended October 29, 2016 primarily due to an increase of $1.7 million of personnel-related costs that was offset by $1.7 million of lower costs for general marketing advertisement activities. Selling and marketing expense decreased by $4.6 million for the nine months ended October 29, 2016 primarily due to $6.1 million of lower spending for general marketing advertisement activities, including a special program offered in early fiscal 2016, offset by $1.7 million from higher personnel-related costs.

General and Administrative

 

     Three Months Ended           Nine Months Ended        
     October 29,     October 31,     %     October 29,     October 31,     %  
     2016     2015     Change     2016     2015     Change  
     (in thousands, except percentage)  

General and administrative

   $ 28,904      $ 33,206        (13.0 )%    $ 97,049      $ 108,884        (10.9 )% 

% of net revenue

     4.4     4.9       5.4     5.2  

General and administrative expense decreased by $4.3 million for the three months ended October 29, 2016 primarily due to decreases in legal expenses of $5.1 million associated with certain accounting and internal control matters that have been the subject of investigations by the Company, Securities and Exchange Commission and the U.S. Attorney and related civil litigation. Costs for the surety bonds related to the litigation with CMU were also lower by $2.9 million. These decreases were partially offset by $1.9 million of higher professional fees, primarily for audit-related services, combined with higher personnel-related costs of $1.5 million.

General and administrative expense decreased by $11.8 million for the nine months ended October 29, 2016 compared to the nine months ended October 31, 2015. The decrease reflects the effect of a $15.4 million charge for a cash payment to our former Chief Executive Officer approved by the Company’s Executive Compensation Committee and included in the nine months ended October 31, 2015 that is not included in the nine months ended October 29, 2016 combined with $7.7 million of lower charges for various litigation matters and $8.6 million of lower costs for the surety bonds related to the litigation with CMU. In addition, the decrease includes a $6.9 million reversal of previously recognized share-based compensation expense related to certain members of our executive management for which the vesting was determined not probable upon their termination in April 2016. These decreases were partially offset by increases in legal expenses of $12.9 million mainly associated with certain accounting and internal control matters that have been the subject of investigations by the Company, Securities and Exchange Commission and the U.S. Attorney and related civil litigation combined with $19.0 million of higher professional fees, primarily for audit-related services and $5.8 million of higher personnel-related costs.

 

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Carnegie Mellon University Litigation Settlement

 

     Three Months Ended           Nine Months Ended        
     October 29,     October 31,     %     October 29,     October 31,     %  
     2016     2015     Change     2016     2015     Change  
     (in thousands, except percentage)  

Litigation settlement with Carnegie Mellon University

   $ —        $ —          0.0   $ —        $ 654,667        (100.0 )% 

% of net revenue

     0.0     0.0       0.0     31.0  

In connection with the settlement agreement with CMU for $750 million (see “Note 10 – Commitments and Contingencies” and “Note 13 – Carnegie Mellon University Settlement” in the Notes to the Unaudited Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q), $654.7 million of the settlement allocated to the mutual release of claims and covenant not to sue was recorded in operating expenses in fiscal 2016. Of the remaining $95.3 million, $81.3 million was recorded in cost of goods sold in fiscal 2016. The remaining $14.0 million will be recognized in cost of goods sold over the remaining term of the license from February 2016 through April 2018.

Amortization and Write-Off of Acquired Intangible Assets

 

     Three Months Ended           Nine Months Ended        
     October 29,     October 31,     %     October 29,     October 31,     %  
     2016     2015     Change     2016     2015     Change  
     (in thousands, except percentage)  

Amortization and write-off of acquired intangible assets

   $ 2,299      $ 3,150        (27.0 )%    $ 7,221      $ 8,286        (12.9 )% 

% of net revenue

     0.3     0.6       0.4     0.4  

Amortization and write-off of acquired intangible assets decreased by $0.9 million and $1.1 million for the three and nine months ended October 29, 2016, respectively, compared to the three and nine months ended October 31, 2015. The decrease reflects lower amortization expense as certain intangible assets have become fully amortized. Amortization and write-off of acquired intangible assets in the nine months ended October 31, 2015 included a charge of $0.3 million to write off an existing trade name while there was no such charge in the nine months ended October 29, 2016.

Interest and Other Income, Net

 

     Three Months Ended           Nine Months Ended        
     October 29,     October 31,     %     October 29,     October 31,     %  
     2016     2015     Change     2016     2015     Change  
     (in thousands, except percentage)  

Interest and other income, net

   $ 5,470      $ 4,644        17.8   $ 13,242      $ 16,601        (20.2 )% 

% of net revenue

     0.8     0.7       0.8     0.8  

Interest and other income, net, increased by $0.8 million and decreased by $3.4 million for the three and nine months ended October 29, 2016 compared to the three and nine months ended October 31, 2015, respectively. The increase in the three months ended October 29, 2016 is mainly due to the sale of equipment and an intangible asset to a non-related third party, partially offset by a decline in interest income. The decrease in the nine months ended October 29, 2016 reflects lower foreign currency gains from the revaluation of our foreign currency denominated tax liabilities combined with a decrease in interest income. The decrease in interest income is mainly due to overall lower average cash balances offset by effects of higher interest rates.

 

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Provision for Income Taxes

 

     Three Months Ended            Nine Months Ended         
     October 29,      October 31,      %     October 29,      October 31,      %  
     2016      2015      Change     2016      2015      Change  
     (in thousands, except percentage)  

Provision for income taxes

   $ 15,807       $ 3,320         376.1   $ 5,337       $ 13,192         (59.5 )% 

We had an income tax provision in both the three and nine months ended October 29, 2016, and our effective tax rate was 17.9% and 5.0%, respectively. The income tax expense for the three months ended October 29, 2016 was primarily due to a current income tax expense of $12.4 million, an expense of $0.6 million related to settlements of prior year tax in foreign jurisdictions, plus a net increase in unrecognized tax benefits of $2.8 million. The net increase in unrecognized tax benefits arose from the accrual of penalties and interest of $0.5 million on the outstanding unrecognized tax benefit balance, plus the accrual of an additional $2.3 million for changes in prior year tax positions. The income tax expense for the nine months ended October 29, 2016 was primarily due to a current income tax expense of $16.9 million, plus an expense of $0.6 million related to settlements of prior year tax in foreign jurisdictions, offset by a tax benefit of $9.7 million from a net reduction in unrecognized tax benefits and a deferred tax benefit of $2.5 million for the portion of a payment to our former Chief Executive Officer that became deductible after his departure in April 2016. The net reduction in unrecognized tax benefits arose from the release of $14.3 million due to expiration of the statute of limitations in certain non-U.S. jurisdictions, which was partially offset by penalties and interest of $2.0 million accrued on the outstanding unrecognized tax benefit balance, and the accrual of an additional $2.6 million for changes in prior year tax positions.

We had an income tax provision in both the three and nine months ended October 31, 2015, and our effective tax rate was (6.1)% and (1.6)%, respectively. The income tax expense for the three months ended October 31, 2015 was primarily due to current income tax liability of $1.5 million, a $1.1 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and $0.7 million of interest on unrecognized tax benefits. The income tax expense for the nine months ended October 31, 2015 was primarily due to current income tax liability of $21.0 million, a $7.8 million provision to record a valuation allowance against certain deferred tax assets in a non-U.S. jurisdiction and an additional tax provision of $3.1 million related to a $15.4 million payment to our former Chief Executive Officer. These tax provisions were partially offset by tax benefits of $15.3 million from a net reduction in unrecognized tax benefits, which primarily arose from the expiration of statutes of limitation and the settlement of tax audits in non-U.S. jurisdictions, and true-up adjustments of $4.8 million, primarily related to the filing of tax returns.

It is reasonably possible that the amount of unrecognized tax benefits could increase or decrease significantly due to changes in tax law in various jurisdictions, new tax audits and changes in the U.S. dollar as compared to foreign currencies within the next 12 months. Excluding these factors, uncertain tax positions may decrease by as much as $9.5 million from the lapse of statutes of limitation in various jurisdictions during the next 12 months. Government tax authorities from several non-U.S. jurisdictions are also examining our tax returns. We believe that we have adequately provided for any reasonably foreseeable outcomes related to these tax audits and that any settlement will not have a material effect on our results at this time.

We operate under tax incentives in certain countries that may be extended if certain additional requirements are satisfied. The tax incentives are conditional upon meeting certain employment and investment thresholds. The impact of these tax incentives decreased foreign taxes by $2.4 million and $4.6 million for the three and nine months ended October 29, 2016, respectively, and $1.8 million and $6.7 million for the three and nine months ended October 31, 2015, respectively. The benefit of the tax incentives on net income per share was $0.01 per share for the three and nine months ended October 29, 2016, compared to a benefit of less than $0.01 per share for the three months ended October 31, 2015 and $0.01 per share for the nine months ended October 31, 2015.

Liquidity and Capital Resources

Our principal source of liquidity as of October 29, 2016 consisted of approximately $1.7 billion of cash, cash equivalents and short-term investments, of which approximately $990 million was held by foreign subsidiaries (outside Bermuda). Approximately $680 million of this amount held by foreign subsidiaries is related to undistributed earnings, most of which have been indefinitely reinvested outside of Bermuda. These funds are primarily held in China, Israel, the United States and Switzerland. We have plans to use such amounts to fund various activities outside of Bermuda, including working capital requirements, capital expenditures for expansion, funding of future acquisitions or other financing activities. If such funds were needed by the parent company in Bermuda or if the amounts were otherwise no longer considered indefinitely reinvested, we would incur a tax expense of approximately $210 million.

We believe that our existing cash, cash equivalents and short-term investments, together with cash generated from operations, exercise of employee stock options and purchases under our employee stock purchase plan, will be sufficient to cover our working capital needs, capital expenditures, investment requirements, and any declared dividends, repurchase of our common stock and commitments for at least the next 12 months. Our capital requirements will depend on many factors, including our rate of sales growth, market acceptance of our products, costs of securing access to adequate manufacturing capacity, the timing and extent of research and development projects and increases in operating expenses, which are all subject to uncertainty. In addition, we are named as defendants in several litigation actions and an unfavorable outcome in any current litigation could have a material adverse effect on our liquidity, cash flows and results of operations.

 

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To the extent that our existing cash, cash equivalents and short-term investments and cash generated by operations are insufficient to fund our future activities, we may need to raise additional funds through public or private debt or equity financing. We may also enter into additional acquisitions of businesses, purchase assets or enter into other strategic arrangements in the future, which could also require us to seek debt or equity financing. Additional equity financing or convertible debt financing may be dilutive to our current shareholders. If we elect to raise additional funds, we may not be able to obtain such funds on a timely basis or on acceptable terms, if at all. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing shareholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to our common shares.

Future payment of a regular quarterly cash dividend on our common shares and our planned repurchases of common stock will be subject to, among other things, the best interests of the Company and our shareholders, our results of operations, cash balances and future cash requirements, financial condition, developments in ongoing litigation, statutory requirements under Bermuda law, market conditions and other factors that our board of directors may deem relevant. Our dividend payments and repurchases of common stock may change from time to time, and we cannot provide assurance that we will continue to declare dividends at all or in any particular amounts.

Cash Flows from Operating Activities

Net cash used in operating activities was $477.3 million for the nine months ended October 29, 2016. The cash outflows from operations for the nine months ended October 29, 2016 were due to $101.2 million of net income adjusted for $182.9 million of non-cash items (primarily depreciation and amortization, and share-based compensation), offset by a net decrease in working capital of $761.4 million. The cash outflow from working capital for the nine months ended October 29, 2016 was primarily driven by the decrease in the CMU accrued litigation settlement that was fully paid in the first quarter of fiscal 2017.

Net cash provided by operating activities was $152.0 million for the nine months ended October 31, 2015. The cash inflows from operations for the nine months ended October 31, 2015 were primarily due to $815.6 million of net loss adjusted for $210.1 million of non-cash items (primarily depreciation and amortization, and share-based compensation), offset by a net increase in working capital of $757.5 million, mainly from the increase in the accrued litigation settlement with CMU.

Cash Flows from Investing Activities

Net cash provided by investing activities was $117.3 million for the nine months ended October 29, 2016 compared to net cash used in investing activities of $136.8 million for the nine months ended October 31, 2015. For the nine months ended October 29, 2016, net cash provided by investing activities was primarily from sales and maturities of available-for-sale securities of $657.0 million. This amount was partially offset by cash used in investing activities for the purchase of available-for-sale securities of $343.8 million and net purchases of $150 million for time deposits. We also paid $37.7 million for the purchase of property and equipment and $8.4 million for the purchase of technology licenses.

Net cash used in investing activities of $136.8 million for the nine months ended October 31, 2015 was primarily due to purchases of available-for-sale securities of $922.8 million partially offset by sales and maturities of available-for-sale securities of $826.2 million. We also paid $33.4 million for the purchase of property and equipment, $10.2 million for the purchase of equipment previously leased and $6.7 million for the purchase of technology licenses. These payments were partially offset by the receipt of $10.0 million from the sale of equipment held for sale.

Cash Flows from Financing Activities

Net cash used in financing activities was $166.6 million for the nine months ended October 29, 2016 compared to net cash of $329.2 million used in financing activities for the nine months ended October 31, 2015. For the nine months ended October 29, 2016, net cash used in financing activities was primarily attributable to payments of our quarterly dividends of $91.8 million, $56.5 million for repurchases of our common stock and $13.8 million for technology license obligations.

Net cash used in financing activities of $329.2 million for the nine months ended October 31, 2015 was primarily attributable to payments for the repurchase of our common stock of $260.9 million and payments of our quarterly dividends of $92.4 million. The cash outflow was partially offset by net proceeds of $35.5 million from the issuance of our common shares under our share-based plans less the payment for minimum tax withholding on behalf of employees for net share settlements.

 

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Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities of financial partnerships, such as entities often referred to as structured finance or special purpose entities (“SPEs”), that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of October 29, 2016, we were not involved in any unconsolidated SPE transactions.

Contractual Obligations

We presented our contractual obligations at January 30, 2016 in our Annual Report on Form 10-K for the fiscal year then ended. There have been no material changes outside the ordinary course of business in those obligations during the three months ended October 29, 2016, other than as noted under the section entitled “Off-Balance Sheet Arrangements” above.

Indemnification Obligations

See “Note 10 – Commitments and Contingencies” in the Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk. Our interest rate risk relates primarily to our fixed income short-term investment portfolio as we did not have any outstanding debt as of October 29, 2016. We maintain an investment policy that requires minimum credit ratings, diversification of credit risk and limits the long-term interest rate risk by requiring effective maturities of generally less than five years. We invest our excess cash primarily in highly liquid debt instruments of the U.S. government and its agencies, money market mutual funds, asset backed securities, corporate debt securities and municipal debt securities that are classified as available-for-sale and time deposits that are classified as held-to-maturity. These investments are recorded on our consolidated balance sheets at fair market value with their related unrealized gain or loss reflected as a component of accumulated other comprehensive income (loss) in the consolidated statement of shareholders’ equity. Investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall.

To provide an assessment of the interest rate risk associated with our investment portfolio, we performed a sensitivity analysis to determine the impact that an adverse change in interest rates would have on the value of the investment portfolio, excluding time deposits. Based on investment positions as of October 29, 2016, a hypothetical 100 basis point increase in interest rates across all maturities would result in a $9.5 million decline in the fair market value of the portfolio. Due to our positive cash flow from operations, the relatively short-term nature of our investment portfolio and our ability to hold investments to maturity, such change in fair market value would likely not have resulted in any significant cash flow impact.

As of October 29, 2016, our investment portfolio included $10.0 million in par value of auction rate securities classified as long-term investments. Although these securities have continued to pay interest, there is currently limited trading volume. To estimate the fair value of the auction rate securities, we use a discounted cash flow model based on estimated timing and amount of future interest and principal payments. In developing the cash flow model, we consider the credit quality and liquidity of the underlying securities and related issuer, the collateralization of underlying security investments and other considerations.

We made a determination in January 2016 that we did not expect to recover the par value of these auction rate securities and consider any impairment of these securities to be other-than-temporary. There has been no change in circumstances since January 2016 based upon the current time horizon for holding these securities and the continuation of an illiquid market. Based on our assessment of fair value as of October 29, 2016, we determined there was no further impairment of these auction rate securities.

In the nine months ended October 29, 2016, the Company sold auction rate securities with an aggregate par value of $2.5 million for total net proceeds of $2.4 million. The carrying value of these auction rate securities was $2.3 million and resulted in a net gain of $0.1 million recorded in interest and other income, net, in the nine months ended October 29, 2016.

Investment Risk. We invest in equity instruments of privately-held companies for strategic purposes. We account for these investments under the cost method when we do not have the ability to exercise significant influence or control over the operations of these companies and under the equity method when we have the ability to exercise significant influence but do not have control. Carrying value of these equity investments was $5.5 million at October 29, 2016, and was included in other non-current assets in our consolidated balance sheets. We monitor these investments for impairment and make appropriate reductions in carrying value when an impairment is deemed to be other-than-temporary.

 

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Foreign Currency Exchange Risk. All of our sales and the majority of our expenses are denominated in U.S. dollars. Since we operate in many countries, we pay certain payroll and other operating expenses in local currencies and these expenses may be higher or lower in U.S. dollar terms. Furthermore, our operations in Israel and China represent a large portion of our total foreign currency exposure. Additionally, we may hold certain assets and liabilities, including potential tax liabilities, in local currency on our consolidated balance sheet. These tax liabilities would be settled in local currency. Therefore, foreign exchange gains and losses from remeasuring the tax liabilities are recorded to interest and other income, net. The related effects of foreign exchange fluctuations on local currency expenses are recorded to operating expenses. There is also a risk that our customers may be negatively impacted in their ability to purchase our products priced in U.S. dollars when there has been significant volatility in foreign currency exchange rates.

We engage in hedging transactions to help mitigate some of the volatility to forecasted cash flows due to changes in foreign exchange rates and, in particular, hedge a portion of the forecasted expenses denominated in Israeli shekel and on occasion Chinese yuan. We enter into certain short-term forward exchange contracts, typically less than 12 months in duration, to hedge exposures for expenses denominated in foreign currencies when the currency exposure is significant and there is a high certainty of the underlying cash flow. We do not enter into derivative financial instruments for trading or speculative purposes. We may choose not to hedge certain foreign exchange exposures due to immateriality, offsetting exposures, prohibitive economic cost of hedging a particular currency, and limited availability of appropriate hedging instruments. To the extent our foreign currency hedges are effective, the results of the hedge activities offset the underlying expense within the operating expense. Financial instruments not designated as hedges or hedges deemed ineffective are recorded in interest and other income, net. We do not hedge our tax liabilities denominated in local currency on our consolidated balance sheet as the timing of these tax liabilities becoming cash flows is not deemed to be certain.

To provide an assessment of the foreign currency exchange risk associated with our foreign currency exposures within operating expense, we performed a sensitivity analysis to determine the impact that an adverse change in exchange rates would have on our financial statements. If the U.S. dollar weakened by 10%, our operating expense could increase by 3.9%. We expect our hedges of foreign currency exposures to be highly effective and offset a significant portion of the short-term impact of changes in exchange rates on the hedged portion of our exposures.

Item 4. Controls and Procedures

Audit Committee Investigation

As reported in the Current Report on Form 8-K filed by the Company with the SEC on March 1, 2016, and disclosed in our Quarterly Reports on Form 10-Q for the quarters ended August 1, 2015 and October 31, 2015, our Annual Report on Form 10-K for the fiscal year ended January 30, 2016 and our Quarterly Reports on Form 10-Q for the quarters ended April 30, 2016 and July 30, 2016, the Audit Committee (the “Audit Committee”) of the Company’s Board of Directors completed and made its findings with respect to an internal investigation (the “Audit Committee Investigation”). This investigation generally included a review of certain revenue recognized in the first and second quarters of fiscal 2016 and the fourth quarter of fiscal 2015, including transactions that would have, in the normal course of events and but for action by Marvell employees, been completed and recognized in a subsequent quarter (referred to internally as “pull-ins”), the accrual of a litigation reserve in the second quarter of fiscal 2016, and stated belief by Marvell’s former Chief Executive Officer and Chairman of ownership of certain patent rights related to the Final-Level Cache invention. The Audit Committee also reviewed disclosure concerning the foregoing matters and related circumstances, and whether senior management’s operating style during the relevant periods resulted in an open flow of information and communication to set an appropriate “tone at the top” for an effective control environment.

The Audit Committee identified no fraudulent activity in the course of this investigation. The Audit Committee’s key conclusions regarding this investigation included the following:

 

  (a) revenue related to pull-in transactions during the subject periods was for most such transactions properly recognized in accordance with Marvell’s revenue recognition policy and generally accepted accounting principles, though for certain transactions Marvell’s internal controls were not fully followed and revenue from certain pull-in and distributor transactions was recognized prematurely based on certain provisions of the revenue recognition policy in place at the time;

 

  (b) Marvell’s public disclosures for such periods related to revenue properly including pull-in transactions were not misleading;

 

  (c) while Marvell’s former Chief Executive Officer and Chairman stated his belief that he had a good faith claim to ownership of the Final-Level Cache invention, the invention was owned by Marvell during all periods in which company resources related to such invention were deployed and, as a result, there were no errors in accounting related to the Final-Level Cache invention, and the disclosures relating to such invention contained in Marvell’s Form 10-Q for the first quarter of fiscal 2016 were not misleading; and

 

  (d) while Marvell lacked a well-structured process to establish significant and judgmental reserves associated with litigation and royalties, there was no contemporaneous evidence that the increase in the reserve ultimately recorded in Marvell’s books and records for the second quarter of fiscal 2016 was not reasonable or appropriate.

 

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The Audit Committee investigation also found certain “tone at the top” issues, including significant pressure on sales and finance personnel to meet revenue targets and the failure by Marvell’s former Chief Executive Officer and Chairman and by legal counsel to raise to the appropriate level at the appropriate times the initial assertion of Marvell’s former Chief Executive Officer and Chairman that he owned the Final-Level Cache invention, the patent rights for which he later assigned to Marvell.

Management’s Evaluation of Disclosure Controls and Procedures

Management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of October 29, 2016. Disclosure controls and procedures are designed to ensure that information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were not effective as of October 29, 2016 to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures.

Notwithstanding the material weaknesses in our internal controls over financial reporting as of October 29, 2016, management has concluded that the consolidated financial statements included in this Form 10-Q present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.

Material Weaknesses

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. Management concluded that we did not maintain effective internal control over financial reporting as of October 29, 2016 because of certain material weaknesses in our internal control over financial reporting as of October 29, 2016 that were initially identified previously in fiscal 2016 as follows:

Entity Level Controls – The control environment, risk assessment, control activities, information and communication, and monitoring controls were not effective. These controls are the responsibility of senior management, who sets the tone of the organization, influences the control consciousness of employees, and is the foundation for internal control over financial reporting. As noted above, the Audit Committee investigation identified certain “tone at the top” issues that contributed to an ineffective control environment and to the deficiencies aggregating to the material weaknesses set forth below. The Company’s entity level controls related to assessing risk and communication of information, including the reporting of information to management and the Board of Directors, did not operate effectively as they relied upon information derived from processes where applicable controls were not fully followed.

Sufficiency of Accounting and Finance Department Resources – The Company had insufficient finance and accounting department resources with appropriate knowledge, expertise and training commensurate with the Company’s corporate structure and financial reporting requirements to effectively assess risk, and design, operate and oversee effective internal controls over financial reporting. The Company has experienced significant turnover at the senior financial management level. The lack of certain appropriate resources in the Company’s accounting and finance departments contributed to an ineffective control environment. This lack of resources resulted in inconsistent expectations around the preparation, review and maintenance of documentation critical to the design and consistent execution of internal controls. These factors contributed to deficiencies in the Company’s financial reporting process over (i) the establishment of significant and judgmental reserves, which included reserves for litigation and royalties, (ii) the Company’s process and controls over identification, communication and approval of related party transactions, and (iii) a lack of precision in the review controls over certain information and assumptions impacting various financial reporting areas, and monitoring of the Company’s terms and conditions for certain contractual arrangements to verify that all critical contract terms were communicated to accounting and finance for assessment.

Revenue Recognition – The Company’s internal controls to identify, accumulate and assess the accounting impact of certain concessions or side agreements on whether the Company’s revenue recognition criteria had been met were in certain instances not fully followed or were not effective. As noted above, the Audit Committee identified certain “tone at the top” issues, due to which the Company’s controls were not effective to ensure (i) consistent standards in the level of documentation of agreements required to support accurate recording of revenue transactions, and (ii) that such documentation is retained, complete, and independently reviewed to ensure certain terms impacting revenue recognition were accurately reflected in the Company’s books and records.

 

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Process to Identify Contingencies, Including Those Related to the Company’s Intellectual Property – The Company’s internal controls over contingencies were not effective as the Company lacked a well-structured process, including granting appropriate authority to senior legal management, to ensure the identification of actual and potential claims, and the assessment of probability of loss related to them. The Company also lacked a well-structured process to ensure the timely assignment to the Company of intellectual property.

Remediation Efforts to Address Material Weaknesses

Our management has worked, and continues to work, to strengthen our internal control over financial reporting. We are committed to ensuring that such controls are designed and operating effectively. Since identifying the material weaknesses in our internal control over financial reporting that are described in our Annual Report on Form 10-K for the fiscal year ended January 30, 2016, we are developing and implementing remediation plans to fully address these control failures. Our Board of Directors and management take internal controls over financial reporting and the integrity of the Company’s financial statements seriously and believe that the remediation steps described below, including with respect to personnel changes, were and are essential steps to maintaining strong and effective internal controls over financial reporting and a strong internal control environment.

The Company has taken significant steps to address the material weaknesses set forth above. The Company believes that making the following changes was a critical step toward addressing the “tone at the top” concerns that contributed to the material weaknesses it has identified.

The following steps are among the measures that have been implemented or will be implemented as soon as practicable after the date of this filing:

Entity Level Controls

 

   

By unanimous action of the Board of Directors in May 2016, we appointed five new independent directors to our Board of Directors. Two of the new members of the Board have significant finance and accounting experience, have been appointed to the Audit Committee, and have been determined by the Board of Directors to be “audit committee financial experts” as defined in rules promulgated by the SEC.

 

   

Concurrently with the appointment of our five new directors, we appointed a new Chairman of our Board of Directors.

 

   

In July 2016, we appointed a new Chief Executive Officer who is providing strong leadership to the Company and establishing open lines of communication with his internal business unit leaders and external partners.

 

   

In August 2016, we appointed a new, permanent Chief Financial Officer who has brought expertise and leadership to the Company and our finance team and is establishing open lines of communication with her internal business unit leaders and the finance and accounting team world-wide.

 

   

In October 2016, we appointed a new Controller and Chief Accounting Officer who has brought additional technical expertise to our finance and accounting function and is supporting the Company’s substantial efforts to design, operate and oversee effective internal controls over financial reporting.

 

   

In the second and third quarters of fiscal 2017, we conducted a training program for our executives, vice presidents and associate vice presidents, led by our executive management team, to enhance awareness and understanding of the Company’s Code of Conduct and Ethics Policy and the importance of financial reporting integrity, and developed and implemented a similar program for finance, operations and sales personnel and others involved in the sales process. Training is ongoing.

 

   

In accordance with the Audit Committee Charter, the Audit Committee approves future earnings guidance in accordance with the Company’s normal earnings cycle.

 

   

In accordance with the Executive Compensation Committee Charter, the Executive Compensation Committee reviews and approves the compensation arrangements of any employees with a title of Associate Vice President or higher reporting directly to the Chief Executive Officer, including, but not limited to, those designated as executive officers. We believe this provides more transparent monitoring of performance of, and incentives offered to, senior management that may influence “tone at the top.”

 

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Sufficiency of Accounting and Finance Department Resources

 

   

In August 2016, we appointed a new Chief Financial Officer who is providing strong leadership to the Company and, in particular, to our finance and accounting function, and is establishing open lines of communication with her staff and internal business partners.

 

   

In the first and second quarters of fiscal 2017, we hired a Senior Vice President of Finance and an Assistant Controller to increase the depth and breadth of knowledge and expertise commensurate with the Company’s corporate structure and financial reporting requirements. These new finance team members support the Company’s substantial efforts to design, operate and oversee effective internal controls over financial reporting.

 

   

In October 2016, we hired a new Chief Accounting Officer and Controller who has brought additional technical expertise to our finance and accounting function and is supporting the Company’s substantial efforts to design, operate and oversee effective internal controls over financial reporting.

 

   

We continue to enhance the Company’s finance and accounting department staff, in terms of both number and competency of personnel, particularly in the area of revenue recognition and technical accounting. Our new senior finance and accounting team members are contributing their substantial experience and abilities to raise the level of expertise across the finance and accounting functions.

 

   

In connection with its investigation, the Audit Committee directed our then Interim Chief Financial Officer, in coordination with our new Chief Legal Officer, to undertake a comprehensive review of the procedures to be followed by the Company for establishing significant and judgmental reserves, including reserves for litigation and royalties. As a result, a more comprehensive policy has been established and will be adhered to going forward. In addition, management will continue to report to the Audit Committee the methodologies used and basis of estimates for the establishment of significant and judgmental reserves.

 

   

We are in the process of developing a roles and responsibilities matrix for our key accounting and operations personnel to incorporate segregation of duties considerations. We expect our incoming senior finance personnel to contribute their significant expertise to this process.

Revenue Recognition

 

   

We have revised our revenue recognition policy to prohibit Company-initiated “pull-in” transactions. For fiscal 2017, “pull ins” will have no meaningful effect on our revenue.

 

   

As noted above, in the second and third quarters of fiscal 2017, we conducted a training program for our executive officers, vice presidents and associate vice presidents, led by our executive management team, to enhance awareness and understanding of the Company’s Code of Conduct and Ethics Policy and the importance of financial reporting integrity, and developed and implemented a similar program for finance, operations and sales personnel and others involved in the sales process. Training is ongoing.

Process to Identify Contingencies, Including Those Related to the Company’s Intellectual Property

 

   

The Audit Committee directed the Company to hire a Chief Legal Officer, such position having the authority of an executive officer (as defined in SEC rules) and to be deemed as such. In May 2016, the Company hired a new Executive Vice President and Chief Legal Officer to fill this role.

 

   

The Audit Committee directed the then Interim CFO, in coordination with the Chief Legal Officer, to undertake a comprehensive review of the procedures to be followed by the Company for establishing significant and judgmental reserves, including reserves for litigation and royalties. The Chief Legal Officer has assigned appropriate roles and responsibilities to Company personnel to improve the Company’s process for identifying litigation contingencies. As a result, a more comprehensive policy was established and has been adhered to. In addition, management will continue to report to the Audit Committee the methodologies used and basis of estimates for the establishment of significant and judgmental reserves.

 

   

We have adopted an updated patent disclosure and assignment policy that includes augmented procedures for review of claims of individual ownership and enhanced processes with respect to patent disclosure and assignment.

The Audit Committee directed management to develop a detailed plan and timetable for the completion of the implementation of the foregoing remedial measures and will monitor their implementation. In addition, under the direction of the Audit Committee, management continues to review and make necessary changes to the overall design of our internal control environment, as well as to our policies and procedures in order to improve the overall effectiveness of internal control over financial reporting.

 

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Aside from the above remediations, we reconstituted the memberships and chairmanships of the audit committee, the executive compensation committee and the nominating and governance committee in May 2016.

We are committed to maintaining a strong internal control environment and believe that these remediation actions represent significant improvements in our controls. Additional remediation measures continue to be considered and will be implemented as appropriate. We will continue to assess the effectiveness of our remediation efforts in connection with our evaluations of internal control over financial reporting.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the three months ended October 29, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting other than those previously described.

Inherent Limitations on Effectiveness of Controls

Our management, including our principal executive officer and our principal financial officer, does not expect that our disclosure controls or our internal control over financial reporting will prevent or detect all error 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. The design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

 

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The information under the caption “Contingencies” as set forth in “Note 10 – Commitments and Contingencies” of our Notes to Unaudited Condensed Consolidated Financial Statements, included in Part I, Item 1, is incorporated herein by reference. For additional discussion of certain risks associated with legal proceedings, see Part II, Item 1A, “Risk Factors,” immediately below.

Item 1A. Risk Factors

Investing in our common shares involves a high degree of risk. You should carefully consider the risks and uncertainties described below and all information contained in this report before you decide to purchase our common shares. Many of these risks and uncertainties are beyond our control, including business cycles and seasonal trends of the computing, semiconductor and related industries and end markets. If any of the possible adverse events described below actually occurs, we may be unable to conduct our business as currently planned and our financial condition and operating results could be harmed. In addition, the trading price of our common shares could decline due to the occurrence of any of these risks, and you could lose all or part of your investment

Factors That May Affect Future Results

Our financial condition and results of operations may vary from quarter to quarter, which may cause the price of our common shares to decline.

Our quarterly results of operations have fluctuated in the past and could do so in the future. Because our results of operations are difficult to predict, you should not rely on quarterly comparisons of our results of operations as an indication of our future performance.

Fluctuations in our results of operations may be due to a number of factors, including, but not limited to, those listed below and those identified throughout this “Risk Factors” section:

 

   

changes in general economic and political conditions and specific conditions in the end markets we address, including the continuing volatility in the technology sector and semiconductor industry;

 

   

the highly competitive nature of the end markets we serve, particularly within the semiconductor industry;

 

   

any current and future litigation that could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully maintain and grow our business;

 

   

our dependence on a few customers for a significant portion of our revenue;

 

   

our ability to maintain a competitive cost structure for our manufacturing and assembly and test processes and our reliance on third parties to produce our products;

 

   

our ability to successfully restructure our operations within our anticipated timeframe announced in November 2016 and with our anticipated savings;

 

   

cancellations, rescheduling or deferrals of significant customer orders or shipments, as well as the ability of our customers to manage inventory;

 

   

gain or loss of a design win or key customer;

 

   

seasonality in sales of consumer devices in which our products are incorporated;

 

   

failure to qualify our products or our suppliers’ manufacturing lines;

 

   

our ability to develop and introduce new and enhanced products in a timely and effective manner, as well as our ability to anticipate and adapt to changes in technology;

 

   

failure to protect our intellectual property;

 

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impact of a significant natural disaster, including earthquakes, floods and tsunamis, particularly in certain regions in which we operate or own buildings, such as Santa Clara, California and where our third party suppliers operate, such as Taiwan and elsewhere in the Pacific Rim; and

 

   

our ability to attract and retain a highly skilled workforce, especially managerial, engineering, sales and marketing personnel.

Due to fluctuations in our quarterly results of operations and other factors, the price at which our common shares will trade is likely to continue to be highly volatile. From January 31, 2015 through October 29, 2016, our common shares traded as low as $7.40 and as high as $16.78 per share. Accordingly, you may not be able to resell your common shares at or above the price you paid. In future periods, our stock price could decline if, amongst other factors, our revenues or operating results are below our estimates or the estimates or expectations of securities analysts and investors. As a result of stock price volatility, we may be subject to securities class action litigation. Any litigation could result in substantial costs and a diversion of management’s attention and resources that are needed to successfully maintain and grow our business.

If we fail to appropriately scale our operations in response to changes in demand for our existing products or to the demand for new products requested by our customers, including efforts such as our recently announced restructuring, our business and profitability could be materially and adversely affected.

To achieve our business objectives, it may be necessary from time to time for us to expand or contract our operations. For example, in November 2016, we announced a plan to restructure our operations to refocus our research and development, increase operational efficiency and improve profitability. We expect that the restructuring actions, which include discontinuing investment in specific research and development programs, streamlining engineering processes, and consolidating research and development sites, will eliminate approximately 900 positions worldwide. In addition, we plan to divest certain non-strategic businesses. These actions will begin immediately and are expected to be fully executed by the end of October 2017.

Our ability to scale our workforce and operations in a sufficiently timely manner to respond effectively to changes in demand for our existing products, or to the demand for new products requested by our customers, is critical to our future success. While we expect to realize efficiencies from these actions, these activities might not produce the full efficiency and cost reduction benefits we expect. Further, such benefits might be realized later than expected, and the ongoing costs of implementing these measures might be greater than anticipated. If these measures are not successful or sustainable, we might undertake additional realignment and cost reduction efforts, which could result in future charges. In the event that we are unable to execute on our restructuring plan to the extent currently anticipated, our ability to meet competitive challenges or exploit key market opportunities could be materially and adversely affected.

Any potential future acquisitions, strategic investments, divestitures, mergers or joint ventures may subject us to significant risks, any of which could harm our business.

Our long-term strategy may include identifying and acquiring, investing in or merging with suitable candidates on acceptable terms, or divesting of certain business lines or activities. In particular, over time, we may acquire, make investments in, or merge with providers of product offerings that complement our business or may terminate such activities. Mergers, acquisitions and divestitures include a number of risks and present financial, managerial and operational challenges, including but not limited to:

 

   

diversion of management attention from running our existing business;

 

   

possible material weaknesses in internal control over financial reporting;

 

   

increased expenses including legal, administrative and compensation expenses related to newly hired or terminated employees;

 

   

increased costs to integrate or, in the case of a divestiture, separate the technology, personnel, customer base and business practices of the acquired or divested business or assets;

 

   

potential exposure to material liabilities not discovered in the due diligence process;

 

   

potential adverse effects on reported operating results due to possible write-down of goodwill and other intangible assets associated with acquisitions;

 

   

potential damage to customer relationships or loss of synergies in the case of divestitures; and

 

   

unavailability of acquisition financing or unavailability of such financing on reasonable terms.

Any acquired business, technology, service or product could significantly under-perform relative to our expectations, and may not achieve the benefits we expect from possible acquisitions. For all these reasons, our pursuit of an acquisition, investment, divestiture, merger or joint venture could cause its actual results to differ materially from those anticipated.

 

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We operate in intensely competitive markets, and our failure to compete effectively would harm our results of operations.

The semiconductor industry and specifically the data storage, networking and wireless communications markets are extremely competitive, and we expect competition to intensify as current competitors expand their product offerings and new competitors enter the market. This has especially intensified as semiconductor companies have begun to offer more integrated platforms. We expect competition to continue to increase as industry standards continue to evolve and become better known, and others realize the market potential of this trend to platform integration. We currently compete with a number of large domestic and international companies in the business of designing integrated circuits and related applications, some of which have greater financial, technical and management resources than us. Our efforts to introduce new products into markets with entrenched competitors will expose us to additional competitive pressures. For example, we are facing and expect we will continue to face significant competition in the networking market. Additionally, customer expectations and requirements have been evolving rapidly. For example, customers now expect us to provide turnkey solutions and commit to future roadmaps that have technical risks. Some of our competitors may be better situated to meet changing customer needs and secure design wins. As competition in the markets in which we operate continues to increase, our revenues and gross margins may decline as a result. For example, competitors with greater financial resources may be able to offer lower prices than us, or they may offer additional products, services or other incentives that we may not be able to match. In addition, many of our competitors operate and maintain their own fabrication facilities and have longer operating histories, greater name recognition, larger customer bases, and greater sales, marketing and distribution resources than we do. Furthermore, our current and potential competitors in the data communication and wireless markets have established or may establish financial and strategic relationships among themselves or with existing or potential customers or other third parties to increase the ability of their products to address the needs of customers. Accordingly, new competitors or alliances among these competitors may acquire significant market share, which would harm our business. While we continue to pursue similar strategic relationships, and currently have significant financial and technical resources, we cannot assure you that we will be able to continue to compete successfully against existing or new competitors, which would harm our results of operations. As the technology inflections happen, our competitors may get ahead of us and impact our market share.

In addition, the semiconductor industry has experienced increased consolidation over the past several years. For example, Avago Technologies Limited (which has renamed itself as Broadcom Limited (“Broadcom”) acquired Broadcom Corporation in February 2016 and LSI Corporation in May 2014, Intel acquired Altera Corporation in December 2015 and NXP Semiconductors acquired Freescale Semiconductor, Ltd. These transactions and other pending transactions may further consolidate competition in our industry. Consolidation among our competitors could lead to a changing competitive landscape, capabilities and market share, which could harm our results of operations and put us at a competitive disadvantage.

A significant portion of our business is dependent on the HDD industry, which is highly cyclical, experiences rapid technological change, is subject to industry consolidation and is facing increased competition from alternative technologies.

The HDD industry is intensely competitive, and the technology inflections are happening rapidly. This industry has historically been cyclical, with periods of increased demand and rapid growth followed by periods of oversupply and subsequent contraction. These cycles may affect us because some of our largest customers are participants in this industry. For example, in fiscal 2016, our revenue was negatively affected by a meaningful decline in overall HDD unit demand.

HDD manufacturers tend to order more components than they may need during growth periods, and sharply reduce orders for components during periods of contraction. Rapid technological changes in the HDD industry often result in shifts in market share among the industry’s participants. If the HDD manufacturers using our products do not retain or increase their market share, our sales may decrease.

In addition, the HDD industry experienced consolidation in the past. For example, Western Digital completed the acquisition of Hitachi’s HDD unit in March 2012, Seagate Technology PLC (“Seagate”) completed the acquisition of Samsung’s HDD unit in December 2011 and Toshiba acquired the HDD operations of Fujitsu during fiscal 2010. Consolidation among our customers could lead to changing demand for our products, replacement of our products by the merged entity with those of our competitors and cancellation of orders, each of which could harm our results of operations. If we are unable to leverage our technology and customer relationships, we may not capitalize on the increased opportunities for our products within the combined company.

Furthermore, future changes in the nature of information storage products and personal computing devices could reduce demand for traditional HDDs. For example, products using alternative technologies, such as SSD and other storage technologies could become a source of competition to manufacturers of HDDs. Although we offer SSD controllers, leveraging our technology in hard drives, we cannot ensure we will be able to maintain significant market share if demand for traditional HDDs decreases. Additionally, we depend on a few customers for our SSD controllers and as such, the loss of any SSD controller customer or a significant reduction in sales we make to them (for example, as a result of a significant drop in market share) may harm our financial condition and results of operations. Unlike in the HDD industry, SSD customers may develop their own controllers, which could pose a challenge to our market share in the SSD space. The product mix change from HDD to SSD may impact our future market share.

 

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Our sales are concentrated in a few customers, and if we lose or experience a significant reduction in sales to any of these key customers, or if any of these key customers experience a significant decline in market share, our revenues may decrease substantially.

We receive a significant amount of our revenues from a limited number of customers. Net revenue from our two largest customers represented 32% and 31% of our net revenue for the nine months ended October 29, 2016 and October 31, 2015, respectively. Sales to our largest customers have fluctuated significantly from period to period and year to year primarily due to the timing and number of design wins with each customer, natural disasters that may divert a customer’s operations, as well as the continued diversification of our customer base as we expand into new markets, and will likely continue to fluctuate in the future. The loss of any of our large customers or a significant reduction in sales we make to them would likely harm our financial condition and results of operations. Our operating results in the foreseeable future will continue to depend on sales to a relatively small number of customers, as well as the ability of these customers to sell products that incorporate our products. In the future, these customers may decide not to purchase our products at all, purchase fewer products than they did in the past, or alter their purchasing patterns in some other way, particularly because:

 

   

a significant portion of our sales are made on a purchase order basis, which permits our customers to cancel, change or delay product purchase commitments with relatively short notice to us;

 

   

customers may purchase integrated circuits from our competitors;

 

   

customers may discontinue sales or lose market share in the markets for which they purchase our products (for example, a significant customer of our SSD products has recently seen a significant drop in its market share);

 

   

customers may develop their own solutions or acquire fully developed solutions from third-parties (for example, in September 2014, Seagate acquired the SSD business from Broadcom); or

 

   

customers may be subject to severe business disruptions.

In addition, if regulatory activity, such as enforcement of U.S. export control and sanctions laws, were to materially limit our ability to makes sales to any of our significant customers, it could harm our results of operations, reputation and financial condition.

We have been named as a party to several legal proceedings and may be named in additional ones in the future, including litigation involving our patents and other intellectual property, which could subject us to liability, require us to indemnify our customers, require us to obtain or renew licenses, or to stop selling our products or force us to redesign our products.

We have been named as a party to several lawsuits, government inquiries or investigations and other legal proceedings (referred to as “litigation”), and we may be named in additional ones in the future. Please see “Note 10 – Commitments and Contingencies” of our Notes to the Unaudited Condensed Consolidated Financial Statements set forth in Part I, Item 1 of this Quarterly Report on Form 10-Q (“Note 10”) for a more detailed description of a number of the litigation matters we are currently engaged in. In particular, litigation involving patents and other intellectual property is widespread in the high-technology industry and is particularly prevalent in the semiconductor industry, where a number of companies and other entities aggressively bring numerous infringement claims to assert their patent portfolios. The amount of damages alleged in intellectual property infringement claims can often be very significant. For example, the settlement of a lawsuit with Carnegie Mellon University resulted in a payment by us of $750 million as described further in Note 10.

From time to time our subsidiaries and customers receive, and may continue to receive in the future, standards-based infringement claims, as well as claims against us and our subsidiaries’ proprietary technologies. Our subsidiaries and customers could face claims of infringement for certain patent licenses that have not been renewed. These claims could result in litigation and/or claims for indemnification, which, in turn, could subject us to significant liability for damages, attorneys’ fees and costs. Any potential intellectual property litigation also could force us to do one or more of the following:

 

   

stop selling, offering for sale, making, having made or exporting products or using technology that contains the allegedly infringing intellectual property;

 

   

limit or restrict the type of work that employees involved in such litigation may perform for us;

 

   

pay substantial damages and/or license fees and/or royalties to the party claiming infringement or other license violations that could adversely impact our liquidity or operating results;

 

   

attempt to obtain or renew licenses to the relevant intellectual property, which licenses may not be available on reasonable terms or at all; and

 

   

attempt to redesign those products that contain the allegedly infringing intellectual property.

 

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Under certain circumstances, we have contractual and other legal obligations to indemnify and to incur legal expenses for current and former directors and officers. Additionally, from time to time, we have agreed to indemnify select customers for claims made against our products, where such claims allege infringement of third-party intellectual property rights, including, but not limited to, patents, registered trademarks and/or copyrights. If we are required to make a significant payment under any of our indemnification obligations, our results of operations may be harmed.

The ultimate outcome of litigation could have a material adverse effect on our business and the trading price for our securities. Litigation may be time consuming, expensive, and disruptive to normal business operations, and the outcome of litigation is difficult to predict. Litigation, regardless of the outcome, may result in significant expenditures, diversion of our management’s time and attention from the operation of our business, damage to our reputation or relationship with third parties, which could materially and adversely affect our business, financial condition, results of operations, cash flows and our stock price.

We identified material weaknesses in our internal controls over financial reporting, and we may be unable to develop, implement and maintain effective internal controls in future periods.

The Sarbanes-Oxley Act of 2002 and SEC rules require that management report annually on the effectiveness of our internal control over financial reporting and our disclosure controls and procedures. Among other things, management must conduct an assessment of our internal control over financial reporting to allow management to report on the effectiveness of our internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Based on management’s assessment, we concluded that our internal controls over financial reporting were not effective as of October 29, 2016. The specific material weaknesses are described in Item 4 of this Quarterly Report on Form 10-Q. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements would not be prevented or detected. As with any material weakness, if our remedial measures are insufficient to address the material weaknesses, or if additional material weaknesses or significant deficiencies in our internal control over financial reporting are discovered or occur in the future, our consolidated financial statements may contain material misstatements. Any material misstatements could result in a restatement of our consolidated financial statements, cause us to fail to meet our reporting obligations or cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

Even when we have remediated our material weaknesses, any 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. Because of its inherent limitations, internal control over financial reporting will not necessarily prevent all error and all fraud. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. In addition, we may modify the design and operating effectiveness of our internal controls, which could affect the overall effectiveness or evaluation of the control system in the future by us or our independent registered public accounting firm. We cannot ensure that any design will succeed in achieving its stated goals under all potential future conditions, as controls may become inadequate due to changes in conditions or deterioration in the degree of compliance. Any failure to maintain an effective system of internal control over financial reporting could limit our ability to provide reliable financial reports, or to detect and prevent fraud, which would harm our business.

Matters relating to or arising from our Audit Committee investigation, including regulatory proceedings, litigation matters and potential additional expenses, may adversely affect our business and results of operations.

As previously disclosed in our public filings, the Audit Committee of our Board of Directors completed an investigation that generally included a review of certain revenue recognized in the first and second quarters of fiscal 2016 and the fourth quarter of fiscal 2015, including transactions that would have, in the normal course of events and but for action by certain Marvell employees, been completed and recognized in a subsequent quarter (referred to internally as “pull-ins”), the accrual of a litigation reserve in the second quarter of fiscal 2016, and the stated belief by Marvell’s former Chairman and Chief Executive Officer of ownership of certain patent rights related to the Final-Level Cache invention and his later assignment of associated patent rights to Marvell. In addition, we are also the subject of investigations by the Securities and Exchange Commission and the U.S. Attorney related to these matters. We are fully cooperating with the SEC and the U.S. Attorney with respect to those investigations.

To date, we have incurred significant expenses related to legal, accounting, and other professional services in connection with the investigations and related matters, and may continue to incur significant additional expenses with regard to these matters and related remediation efforts. The expenses incurred, and expected to be incurred, on the investigations, the impact of our delay in meeting our periodic reports on the confidence of investors, employees and customers, and the diversion of the attention of the management team that has occurred, and is expected to continue, has adversely affected, and could continue to adversely affect, our business, financial condition and results of operations or cash flows. As a result of the delay in filing of our periodic reports, we are not eligible to use a registration statement on Form S-3, and will not be eligible to use that form until we have timely filed all periodic reports required by the SEC for one year, which may make it more difficult, costly or time consuming for us to raise capital if we should choose to do so.

 

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As a result of the matter reported above, we are exposed to greater risks associated with litigation, regulatory proceedings and government enforcement actions. In addition, securities class actions or other lawsuits have been filed against us, our directors and officers (see “We are subject to pending securities class action and shareholder derivative legal proceedings” below). Any future such investigations or additional lawsuits may adversely affect our business, financial condition, results of operations and cash flows.

We are subject to pending securities class action and shareholder derivative legal proceedings.

Several securities class action lawsu