UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

 

 

 

 

Commission file number: 000-23993

 

 

Broadcom Corporation

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

5300 California Avenue
Irvine, California 92617-3038
(Address of Principal Executive Offices) (Zip Code)

 

 

(949) 926-5000

(Registrant’s telephone number, including area code)

 

 

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

 

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

 

 

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

 

As of September 30, 2007 the registrant had 470.6 million shares of Class A common stock, $0.0001 par value, and 70.2 million shares of Class B common stock, $0.0001 par value, outstanding.

 

 

BROADCOM CORPORATION

 

QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007

 

TABLE OF CONTENTS

 

 

 

Broadcom ^® , the pulse logo and SystemI/O ^tm are among the trademarks of Broadcom Corporation and/or its affiliates in the United States, certain other countries and/or the EU. Any other trademarks or trade names mentioned are the property of their respective owners.

 

 

^© 2007 Broadcom Corporation. All rights reserved.

 

PART I. FINANCIAL INFORMATION

 

 

The following table presents details of total stock-based compensation expense included in each functional line item in the unaudited condensed consolidated statements of income above:

 

 

See accompanying notes.

 

See accompanying notes.

BROADCOM CORPORATION

 

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Revenue Recognition

 

The Company’s net revenue is generated principally by sales of its semiconductor products. The Company derives the remaining balance of its net revenue predominantly from software licenses, development agreements, support and maintenance agreements, data services and cancellation fees. The majority of the Company’s sales occur through the efforts of its direct sales force. The remaining balance of its sales occurs through distributors.

 

The following table presents details of the Company’s revenue:

 

 

 

In accordance with SEC Staff Accounting Bulletin (“SAB”) No. 101, Revenue Recognition in Financial Statements (“SAB 101”), and SAB No. 104, Revenue Recognition (“SAB 104”), the Company recognizes product revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable, and (iv) collection of the resulting receivable is reasonably assured. These criteria are usually met at the time of product shipment. However, the Company does not recognize revenue until all customer acceptance requirements have been met and no significant obligations remain, when applicable. A portion of the Company’s sales are made through distributors under agreements allowing for pricing credits and/or rights of return. Product revenue on sales made through these distributors is not recognized until the distributors ship the product to their customers. The Company records reductions to revenue for estimated product returns and pricing adjustments, such as competitive pricing programs and rebates, in the same period that the related revenue is recorded. The amount of these reductions is based on historical sales returns, analysis of credit memo data, specific criteria included in rebate agreements, and other factors known at the time. The Company also maintains inventory (hubbing) arrangements with certain of its customers. Pursuant to these arrangements the Company delivers products to a customer or a designated third party warehouse based upon the customer’s projected needs, but does not recognize product revenue unless and until the customer reports that it has removed the Company’s product from the warehouse to incorporate into its end products.

 

For a limited number of arrangements that include multiple deliverables, such as sales of semiconductor products and related services, the Company allocates revenue based on the relative fair values of the individual components as determined in accordance with Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). If there is no established fair value for an undelivered element, the entire arrangement is accounted for as a single unit of accounting, resulting in a deferral of revenue and costs for the delivered element until the undelivered element has been fulfilled. In the case that the undelivered element is a service, the revenue and costs applicable to both the delivered and undelivered elements are recorded ratably over the respective service period. If the undelivered element is essential to the functionality of the delivered element, no revenue or costs are recognized until the undelivered element is delivered.

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

In arrangements that include a combination of hardware and software products that are also sold separately, where software is more than incidental and essential to the functionality of the product being sold, the Company follows the guidance in EITF Issue No. 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software , and accounts for the entire arrangement as a sale of software and software-related items, and follows the revenue recognition criteria in accordance with the American Institute of Certified Public Accountants Statement of Position (“SOP”) 97-2, Software Revenue Recognition (“SOP 97-2”), and related interpretations.

 

Revenue under development agreements is recognized when applicable contractual milestones have been met, including deliverables, and in any case, does not exceed the amount that would be recognized using the percentage-of-completion method in accordance with SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. The costs associated with development agreements are included in cost of revenue. Revenue from software licenses and maintenance agreements is recognized in accordance with the provisions of SOP 97-2 and related interpretations. Royalty revenue is recognized based upon reports received from licensees during the period, unless collectibility is not reasonably assured, in which case revenue is recognized when payment is received from the licensee. Revenue from cancellation fees is recognized when cash is received from the customer.

 

Inventory

 

Inventory consists of work in process and finished goods and is stated at the lower of cost (first-in, first-out) or market. The Company establishes inventory reserves for estimated obsolete or unmarketable inventory equal to the difference between the cost of inventory and the estimated realizable value based upon assumptions about future demand and market conditions. Shipping and handling costs are classified as a component of cost of revenue in the consolidated statements of income.

 

Rebates

 

The Company accounts for rebates in accordance with EITF Issue No. 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products) , and, accordingly, records reductions to revenue for rebates in the same period that the related revenue is recorded. The amount of these reductions is based upon the terms included in the Company’s various rebate agreements.

 

Warranty

 

The Company’s products typically carry a one to three year warranty. The Company establishes reserves for estimated product warranty costs at the time revenue is recognized based upon its historical warranty experience, and additionally for any known product warranty issues.

 

Guarantees and Indemnifications

 

In some agreements to which the Company is a party, it has agreed to indemnify the other party for certain matters such as product liability. The Company includes intellectual property indemnification provisions in its standard terms and conditions of sale for its products and has also included such provisions in certain agreements with third parties. To date, there have been no known events or circumstances that have resulted in any material costs related to these indemnification provisions, and as a result, no liabilities have been recorded in the accompanying condensed financial statements. However, the maximum potential amount of the future payments the Company could be required to make under these indemnification obligations could be significant.

 

The Company also has obligations to indemnify certain of its present and former employees, officers and directors to the maximum extent permitted by law. The maximum potential amount of the future payments the Company could be required to make under these indemnification obligations could be significant; however, the

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Company maintains directors’ and officers’ insurance policies that should limit the Company’s exposure and enable it to recover a portion of amounts paid with respect to such obligations.

 

Stock-Based Compensation

 

The Company has in effect stock incentive plans under which incentive stock options have been granted to employees and restricted stock units and non-qualified stock options have been granted to employees and non-employee members of the Board of Directors. The Company also has an employee stock purchase plan for all eligible employees. Effective January 1, 2006 the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), which requires all share-based payments to employees, including grants of employee stock options, restricted stock units and employee stock purchase rights, to be recognized in the financial statements based upon their respective grant date fair values, and does not allow the previously permitted pro forma disclosure-only method as an alternative to financial statement recognition. SFAS 123R supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R also requires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under previous literature. In March 2005 the SEC issued SAB No. 107, Share-Based Payment (“SAB 107”), which provides guidance regarding the interaction of SFAS 123R and certain SEC rules and regulations. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R.

 

SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service periods. The Company has estimated the fair value of stock options and stock purchase rights as of the date of grant or assumption using the Black-Scholes option pricing model, which was developed for use in estimating the value of traded options that have no vesting restrictions and that are freely transferable. The Black-Scholes model considers, among other factors, the expected life of the award and the expected volatility of the Company’s stock price. Although the Black-Scholes model meets the requirements of SFAS 123R and SAB 107, the fair values generated by the model may not be indicative of the actual fair values of the Company’s equity awards, as it does not consider other factors important to those awards to employees, such as continued employment, periodic vesting requirements and limited transferability.

 

In November 2005 the FASB issued Staff Position No. SFAS 123R-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (“SFAS 123R-3”). The Company has elected to adopt the alternative transition method provided in SFAS 123R-3 for calculating the tax effects of stock-based compensation pursuant to SFAS 123R. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC Pool”) related to the tax effects of employee stock-based compensation expense, and to determine the subsequent impact on the APIC Pool and unaudited condensed consolidated statements of cash flows of the tax effects of employee stock-based compensation awards that were outstanding at the Company’s adoption of SFAS 123R. In addition, in accordance with SFAS 123R, SFAS No. 109, Accounting for Income Taxes (“SFAS 109”), and EITF Topic D-32, Intraperiod Tax Allocation of the Tax Effect of Pretax Income from Continuing Operations , the Company has elected to recognize excess income tax benefits from stock option exercises in additional paid-in capital only if an incremental income tax benefit would be realized after considering all other tax attributes presently available to the Company.

 

Income Taxes

 

In July 2006 the FASB issued Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 provides detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with SFAS 109. Income tax positions must meet a more-likely-than-not recognition threshold at the effective

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

date to be recognized upon the adoption of FIN 48 and in subsequent periods. The Company adopted FIN 48 effective January 1, 2007, and the provisions of FIN 48 have been applied to all income tax positions commencing from that date. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits within operations as income tax expense. The cumulative effect of applying the provisions of FIN 48 has been reported as an adjustment to the opening balance of retained earnings as of January 1, 2007.

 

Net Income Per Share

 

Net income per share (basic) is calculated by dividing net income by the weighted average number of common shares outstanding during the period. Net income per share (diluted) is calculated by adjusting outstanding shares, assuming any dilutive effects of options, employee stock purchase rights and restricted stock units calculated using the treasury stock method. Under the treasury stock method, the exercise of employee stock options, employee stock purchases and the vesting of restricted stock units result in a greater dilutive effect on net income per share. Additionally, an increase in the fair market value of the Company’s Class A common stock results in a greater dilutive effect from outstanding options, employee stock purchase rights and unvested restricted stock units.

 

Business Enterprise Segments

 

The Company operates in one reportable operating segment, wired and wireless broadband communications. SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS 131”), establishes standards for the way public business enterprises report information about operating segments in annual consolidated financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. Although the Company had four operating segments at September 30, 2007, under the aggregation criteria set forth in SFAS 131 the Company operates in only one reportable operating segment, wired and wireless broadband communications.

 

Under SFAS 131, two or more operating segments may be aggregated into a single operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles of SFAS 131, if the segments have similar economic characteristics, and if the segments are similar in each of the following areas:

 

 

The Company meets each of the aggregation criteria for the following reasons:

 

 

All of the Company’s operating segments share similar economic characteristics as they have a similar long term business model, operate at gross margins similar to the Company’s consolidated gross margin, and have similar research and development expenses and similar selling, general and administrative expenses. The causes for

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

variation among each of the operating segments are the same and include factors such as (i) life cycle and price and cost fluctuations, (ii) number of competitors, (iii) product differentiation and (iv) size of market opportunity. Additionally, each operating segment is subject to the overall cyclical nature of the semiconductor industry. The number and composition of employees and the amounts and types of tools and materials required are similar for each operating segment. Finally, even though the Company periodically reorganizes its operating segments based upon changes in customers, end markets or products, acquisitions, long-term growth strategies, and the experience and bandwidth of the senior executives in charge, the common financial goals for each operating segment remain constant.

 

Because the Company meets each of the criteria set forth in SFAS 131 and its four operating segments as of September 30, 2007 share similar economic characteristics, the Company has aggregated its results of operations into one reportable operating segment.

 

 

 

 

In addition to the business combinations discussed in Note 3, the Company acquired purchased intangible assets that did not meet the definition of a business as defined in SFAS No. 141, Business Combinations (“SFAS 141”), for $3.9 million during the three months ended September 30, 2007.

 

 

The following table presents details of the Company’s future amortization of purchased intangible assets. Should the Company acquire additional purchased intangible assets in the future, its cost of revenue or operating expenses will increase by the amortization of those assets.

 

 

 

 

 

 

 

 

 

 

At September 30, 2007 common share equivalents were calculated based on (i) stock options to purchase 130.5 million shares of Class A or Class B common stock outstanding with a weighted average exercise price of $24.64 per share and (ii) 18.0 million restricted stock units that entitle the holder to receive a like number of freely transferable shares of Class A common stock as the awards vest.

 

Patent License Agreement

 

In July 2007 the Company entered into a patent license agreement with a wireless network operator. Under the agreement, royalty payments will be made to the Company at a rate of $6.00 per unit for each applicable unit sold by the operator on or after the date of the agreement, subject to certain conditions, including without limitation a maximum payment of $40 million per calendar quarter and a lifetime maximum of $200 million. No royalty revenue under this agreement has been recognized for the periods ended September 30, 2007, as no report on the manufacture and/or sale of licensed products was due or received from the licensee during that time.

 

Supplemental Cash Flow Information

 

The Company repurchased $6.5 million of its Class A common stock in one or more transactions that had not been settled by September 30, 2007. In addition, billings of $3.8 million for capital equipment were accrued but not yet paid as of September 30, 2007. There were no comparable amounts in 2006. These amounts have been excluded from the unaudited condensed consolidated statements of cash flows.

 

 

From January 1, 2007 through September 30, 2007 the Company completed three business acquisitions. The unaudited condensed consolidated financial statements for the nine months ended September 30, 2007 include the results of operations of these acquired companies commencing as of their respective acquisition dates.

 

 

In addition, the Company issued 93,750 restricted shares of Class A common stock in connection with the acquisition of Global Locate. Certain of the cash consideration in the above acquisitions is currently held in escrow pursuant to the terms of the acquisition agreements.

 

Additional cash consideration of up to $80.0 million will be paid to the former holders of Global Locate capital stock and other rights upon satisfaction of certain future performance goals. In accordance with SFAS 141, contingent consideration is recorded when a contingency is satisfied and additional consideration is issued or becomes issuable. In accordance with EITF Issue No. 95-8, Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business Combination , the additional consideration issuable to holders of unrestricted common stock and fully vested options as of the acquisition date is recorded as additional purchase price, as the consideration is unrelated to any employment requirement with the Company. If additional consideration is recorded, such amount will be allocated to goodwill.

 

The Company’s primary reasons for the above acquisitions were to enter into or expand its market share in the relevant wired and wireless communications markets, reduce the time required to develop new technologies and products and bring them to market, incorporate enhanced functionality into and complement the Company’s existing product offerings, augment its engineering workforce, and enhance its technological capabilities. The significant factors that resulted in recognition of goodwill were: (a) the purchase price was based on cash flow projections assuming integration with the Company’s products; and (b) there were very few tangible and identifiable intangible assets that qualified for recognition.

 

 

In addition, the Company recorded $3.0 million of unearned stock-based compensation relating to restricted shares issued in connection with the acquisition of Global Locate. This amount will be recognized as expense ratably over the service period of three years.

 

 

In connection with these acquisitions, the Company incurred acquisition costs of $2.6 million in 2007.

 

 

During the three months ended March 31, 2007 the Company received $14.0 million in connection with an escrow settlement from its prior acquisition of Siliquent Technologies Inc., which resulted in a corresponding reduction of goodwill.

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

In-Process Research and Development

 

In-process research and development (“IPR&D”) totaled $5.0 million and $15.5 million in the three and nine months ended September 30, 2007, respectively. The amounts allocated to IPR&D were determined through established valuation techniques used in the high technology industry and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed. In accordance with SFAS No. 2, Accounting for Research and Development Costs , as clarified by FIN No. 4, Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method, an Interpretation of FASB Statement No. 2 , amounts assigned to IPR&D meeting the above-stated criteria were charged to expense as part of the allocation of the purchase price.

 

The fair value of the IPR&D for each of the acquisitions was determined using the income approach. Under the income approach, the expected future cash flows from each project under development are estimated and discounted to their net present values at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return are the weighted average cost of capital and return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. Each project was analyzed to determine the unique technological innovations, the existence and reliance on core technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development. Future cash flows for each project were estimated based on forecasted revenue and costs, taking into account product life cycles, and market penetration and growth rates.

 

The IPR&D charge includes only the fair value of IPR&D performed as of the respective acquisition dates. The fair value of developed technology is included in identifiable purchased intangible assets. The Company believes the amounts recorded as IPR&D, as well as developed technology, represent the fair values and approximate the amounts an independent party would pay for these projects as of the respective acquisition dates.

 

The following table summarizes the significant assumptions underlying the valuations of IPR&D at the acquisition dates for the acquisitions completed in 2007:

 

 

As of the respective acquisition dates of these companies, certain ongoing development projects were in process. Research and development costs to bring the products of the acquired companies to technological feasibility are not expected to have a material impact on the Company’s results of operations or financial condition.

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Supplemental Pro Forma Data (Unaudited)

 

The pro forma data of the Company set forth below gives effect to acquisitions completed in 2006 and 2007 as if they had occurred at the beginning of 2006 and includes amortization of purchased intangible assets, but excludes the charge for acquired IPR&D. This pro forma data is presented for informational purposes only and does not purport to be indicative of the results of future operations of the Company or of the results that would have actually been attained had the acquisitions taken place at the beginning of 2006.

 

 

 

The Company recorded tax provisions of $3.5 million and $4.9 million for the three and nine months ended September 30, 2007, respectively, and tax benefits of $23.8 million and $15.7 million for the three and nine months ended September 30, 2006, respectively. The effective tax rates for the Company were 11.3% and 3.8% for the three and nine months ended September 30, 2007, respectively, and (27.6)% and (4.9)% for the three and nine months ended September 30, 2006, respectively. The difference between the Company’s effective tax rates and the 35% federal statutory rate resulted primarily from domestic losses recorded without income tax benefit and foreign earnings taxed at rates lower than the federal statutory rate for the three and nine months ended September 30, 2007 and September 30, 2006. Included in the foregoing amounts and percentages, the Company recorded $4.6 million of tax benefits for the nine months ended September 30, 2007 resulting primarily from the expiration of the statutes of limitations for the assessment of taxes in various foreign jurisdictions. For the three and nine months ended September 30, 2006, the Company recorded income tax benefits of $27.9 million and $29.6 million, respectively, resulting primarily from the expiration of the statutes of limitations for the assessment of taxes for certain foreign subsidiaries.

 

The Company utilizes the liability method of accounting for income taxes as set forth in SFAS 109. The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. In making such determination, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. SFAS 109 further states that forming a conclusion that a valuation allowance is not required is difficult when there is negative evidence such as cumulative losses in recent years. As a result of the Company’s recent cumulative losses in the U.S. and certain foreign jurisdictions, and the full utilization of its loss carryback opportunities, the Company has concluded that a full valuation allowance should be recorded in such jurisdictions. In certain other foreign jurisdictions where the Company does not have cumulative losses, the Company had net deferred tax assets of $2.9 million and $1.8 million, at September 30, 2007 and December 31, 2006, respectively, in accordance with SFAS 109.

 

As a result of applying the provisions of FIN 48, the Company recognized a decrease of $3.9 million in the liability for unrecognized tax benefits, and a $4.7 million increase in retained earnings, as of January 1, 2007. The Company’s unrecognized tax benefits totaled $36.5 million at January 1, 2007 and related to various foreign jurisdictions. This amount included $14.5 million of potential penalties and $1.1 million of interest. Included in the balance at January 1, 2007 was $34.3 million of tax benefits that, if recognized, would reduce the Company’s

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

annual effective income tax rate. The Company does not expect its unrecognized tax benefits to change significantly over the next 12 months.

 

The Company files U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2003 through 2007 tax years generally remain subject to examination by federal and most state tax authorities. In significant foreign jurisdictions, the 2001 through 2007 tax years generally remain subject to examination by tax authorities.

 

 

Share Repurchase Program

 

In February 2007 the Company’s Board of Directors authorized a program to repurchase shares of the Company’s Class A common stock. The Board approved the repurchase of shares having an aggregate market value of up to $1.0 billion, depending on market conditions and other factors. Repurchases under the program may be made at any time and from time to time during the 18 month period that commenced February 12, 2007. From the time the new program was implemented through September 30, 2007, the Company repurchased a total of 24.7 million shares at a weighted average price of $33.12 per share, of which $811.8 million was settled in cash during the nine months ended September 30, 2007 and the remaining $6.5 million was included in accrued liabilities. At September 30, 2007, $181.6 million remained available to repurchase shares under the authorized program.

 

 

Accumulated other comprehensive income (loss) reflected on the unaudited condensed consolidated balance sheets at September 30, 2007 and December 31, 2006 represents accumulated translation adjustments.

 

 

Equity Awards

 

The Company granted options to purchase 20.3 million shares of its Class A common stock and awarded 11.3 million restricted stock units during the nine months ended September 30, 2007. As a result of employee terminations, the Company cancelled options to purchase 2.8 million shares of its Class A common stock and 0.9 million restricted stock units during the nine months ended September 30, 2007.

 

Stock-Based Compensation Expense

 

The amount of unearned stock-based compensation currently estimated to be expensed from 2007 through 2011 related to unvested share-based payment awards at September 30, 2007 is $1.037 billion. Of this amount, $128.1 million, $405.2 million, $293.5 million, $165.5 million and $45.1 million are currently estimated to be recorded in the remainder of 2007, and in 2008, 2009, 2010 and 2011, respectively. The weighted-average period

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

over which the unearned stock-based compensation is expected to be recognized is approximately 1.5 years. Approximately 96% of the total unearned stock-based compensation at September 30, 2007 will be expensed by the end of 2010. If there are any modifications or cancellations of the underlying unvested awards, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional equity awards or assumes unvested equity awards in connection with acquisitions.

 

Charges Related to the Voluntary Review of the Company’s Equity Award Practices

 

In connection with the Company’s equity award review, the results of which were reported in January 2007, the Company determined that the accounting measurement dates for most of its options granted between June 1998 and May 2003, covering options to purchase 232.9 million shares of its Class A or Class B common stock, differed from the measurement dates previously used for such awards. As a result, there are potential adverse tax consequences that may apply to holders of affected options. By amending or replacing these options, the potential adverse tax consequences could be eliminated.

 

In March 2007 the Company offered to amend or replace affected options by adjusting the exercise price for each such option to the lower of (i) the fair market value per share of its Class A common stock on the revised measurement date applied to that option as a result of its equity award review or (ii) the closing selling price per share of its Class A common stock on the date on which the option would be amended. If the adjusted exercise price for an affected option was lower than the original exercise price, that option was not amended but instead was replaced with a new option that had the same exercise price, vesting schedule and expiration date as the affected option, but a new grant date. The offer expired April 20, 2007. Participants whose affected options were amended pursuant to the offer are entitled to a special cash payment with respect to those options. The amount payable will be determined by multiplying (i) the amount of the increase in exercise price by (ii) the number of shares for which a participant’s options were amended. As a result, the Company will make payments of $29.6 million in January 2008 to reimburse affected employees for the increases in their exercise prices. A liability has been recorded for these payments and is included in the liability for wages and related benefits as of September 30, 2007.

 

In accordance with SFAS 123R, the Company recorded total estimated charges of $3.4 million in the nine months ended September 30, 2007 and a reduction of additional paid-in capital in the amount of $26.2 million in connection with the offer. Charges of $0.1 million, $1.5 million and $1.8 million are included in cost of revenue, research and development expense and selling, general and administrative expense, respectively, as wages and related benefits for the nine months ended September 30, 2007.

 

 

Intellectual Property Proceedings.   In May 2005 the Company filed a complaint with the U.S. International Trade Commission (“ITC”) asserting that Qualcomm Incorporated (“Qualcomm”) engaged in unfair trade practices by importing integrated circuits and other products that infringe, both directly and indirectly, five of the Company’s patents relating generally to wired and wireless communications. The complaint sought an exclusion order to bar importation of those Qualcomm products into the United States and a cease and desist order to bar further sales of infringing Qualcomm products that have already been imported. In June 2005 the ITC instituted an investigation of Qualcomm based upon the allegations made in the Company’s complaint. The investigation was later limited to asserted infringement of three Broadcom patents. At Qualcomm’s request, the U.S. Patent and Trademark Office (“USPTO”) is reexamining one of the patents. In December 2006 the full Commission upheld the ITC administrative law judge’s October 2006 Initial Determination finding all three patents valid and one infringed. In June 2007 the Commission issued an exclusion order banning the importation into the United States of infringing Qualcomm chips and certain cellular phone models incorporating those chips. The Commission also issued a cease and desist order prohibiting Qualcomm from engaging in certain activities related to the infringing

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

chips. The ITC’s orders were subject to a 60-day Presidential review period, which involved extensive review by the United States Trade Representative, who the President designated to decide whether to let the ITC orders stand or to overturn them through a statutory disapproval. In August 2007 the United States Trade Representative declined to disapprove the orders. In September 2007 the United States Court of Appeals for the Federal Circuit stayed the orders as to certain third parties pending appeal, but not as to Qualcomm. A hearing date on the appeal has not been set.

 

In May 2005 the Company filed two complaints against Qualcomm in the United States District Court for the Central District of California. The first complaint asserts that Qualcomm has infringed, both directly and indirectly, the same five patents asserted by Broadcom in the ITC complaint. The District Court complaint seeks preliminary and permanent injunctions against Qualcomm and the recovery of monetary damages, including treble damages for willful infringement, and attorneys’ fees. In July 2005 Qualcomm answered the complaint and asserted counterclaims seeking a declaratory judgment that the Company’s patents are invalid and not infringed. In December 2005 the court transferred the causes of action relating to two of the patents to the United States District Court for the Southern District of California. Pursuant to statute, the court has stayed the remainder of this action pending the outcome of the ITC action.

 

A second District Court complaint asserts that Qualcomm has infringed, both directly and indirectly, five other Broadcom patents relating generally to wired and wireless communications and multimedia processing technologies. The complaint seeks preliminary and permanent injunctions against Qualcomm and the recovery of monetary damages, including treble damages for willful infringement, and attorneys’ fees. In July 2005 Qualcomm answered the second complaint and asserted counterclaims seeking a declaratory judgment that the Company’s patents are invalid and not infringed. In November 2006 Broadcom withdrew one of the patents from the case. In December 2006 the court granted a motion to stay proceedings on a second patent pending the outcome of a USPTO reexamination of that patent initiated at Qualcomm’s request. In May 2007 a jury returned a verdict that Qualcomm willfully infringed the three remaining patents and awarded the Company $19.6 million in compensatory damages. In August 2007 the court also awarded Broadcom enhanced damages and its attorneys’ fees in the case. Qualcomm has filed a motion challenging that ruling and the jury’s verdict in light of subsequent changes in law by the United States Court of Appeals for the Federal Circuit in an unrelated case. The foregoing amounts have not been recognized in the Company’s unaudited condensed consolidated income statement. The Company has petitioned the court to have Qualcomm enjoined from future infringement.

 

In July 2005 Qualcomm filed a complaint against the Company in the United States District Court for the Southern District of California alleging that certain Broadcom products infringed, both directly and indirectly, seven Qualcomm patents relating generally to the transmission, reception and processing of communication signals, including radio signals and/or signals for wireless telephony. The Company filed an answer in September 2005 denying the allegations in Qualcomm’s complaint and asserting counterclaims. The counterclaims sought a declaratory judgment that the seven Qualcomm patents were invalid and not infringed, and asserted that Qualcomm had infringed, both directly and indirectly, six Broadcom patents relating generally to wired and wireless communications. In March 2007 the court granted the parties’ joint motion to dismiss this case.

 

In August 2005 Qualcomm filed a second complaint against the Company in the United States District Court for the Southern District of California alleging that Broadcom breached a contract relating to Bluetooth development and seeking a declaration that two of the Company’s patents relating to Bluetooth ^® technology were invalid and not infringed. The Company filed an answer in April 2006 denying the allegations in the complaint and asserting counterclaims. The counterclaims asserted that Qualcomm had infringed, both directly and indirectly, the same two Broadcom patents, and also alleged breach of the Bluetooth contract by Qualcomm. In February 2007 the court granted the parties’ joint motion to dismiss this case.

 

In October 2005 Qualcomm filed a third complaint against the Company in the United States District Court for the Southern District of California alleging that certain Broadcom products infringe, both directly and indirectly, two Qualcomm patents relating generally to the processing of digital video signals. The complaint seeks

 

BROADCOM CORPORATION

 

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preliminary and permanent injunctions against the Company as well as the recovery of monetary damages and attorneys’ fees. The Company filed an answer in December 2005 denying the allegations in Qualcomm’s complaint and asserting counterclaims seeking a declaratory judgment that the two Qualcomm patents are invalid and not infringed. In January 2007 a jury returned a verdict that the Company did not infringe either patent, and rendered advisory verdicts that Qualcomm committed inequitable conduct before the U.S. Patent and Trademark Office and waived its patent rights in connection with its conduct before an industry standards body. In March 2007 the court adopted the jury’s finding that Qualcomm waived its patent rights. In August 2007 the court held that Qualcomm’s asserted patents were unenforceable due to Qualcomm’s conduct, declared the case exceptional, and awarded the Company its attorneys’ fees and costs. The Company has also moved for sanctions against Qualcomm for litigation misconduct. Qualcomm has appealed the case.

 

In March 2006 Qualcomm filed a fourth complaint against the Company in the United States District Court for the Southern District of California alleging that the Company had misappropriated certain Qualcomm trade secrets and that certain Broadcom products infringed, both directly and indirectly, a patent related generally to orthogonal frequency division multiplexing technology. The Company filed an answer in May 2006 denying the allegations in Qualcomm’s complaint and asserting counterclaims. The counterclaims sought a declaratory judgment that the Qualcomm patent was invalid and not infringed, and asserted that Qualcomm had infringed, both directly and indirectly, two Broadcom patents relating generally to video technology. The Company amended its answer to add a counterclaim asserting that Qualcomm had misappropriated certain Broadcom trade secrets, and Qualcomm amended its complaint to add three individual Broadcom employees as defendants and include additional allegations of trade secret misappropriation. In March 2007 the court granted the parties’ joint motion to dismiss this case.

 

In December 2006 SiRF Technology, Inc. (“SiRF”) filed a complaint in the United States District Court for the Central District of California against Global Locate, Inc., a wholly-owned subsidiary of the Company acquired in July 2007 (see Note 3), alleging that certain Global Locate products infringe four SiRF patents relating generally to GPS technology. In January 2007 Global Locate filed an answer denying the allegations in SiRF’s complaint and asserting counterclaims. The counterclaims seek a declaratory judgment that the four SiRF patents are invalid and not infringed, assert that SiRF has infringed four Global Locate patents relating generally to GPS technology, and assert unfair competition and antitrust violations related to the filing of sham litigation. In May 2007 the court granted Global Locate’s motion to stay the case until the ITC actions between Global Locate and SiRF, discussed below, become final.

 

In February 2007 SiRF filed a complaint in the ITC asserting that Global Locate engaged in unfair trade practices by importing integrated circuits and other products that infringe, both directly and indirectly, four of SiRF’s patents relating generally to GPS technology. The complaint seeks an exclusion order to bar importation of those Global Locate products into the United States and a cease and desist order to bar further sales of infringing Global Locate products that have already been imported. In March 2007 the ITC instituted an investigation of Global Locate based upon the allegations made in the SiRF complaint. The ITC has set a target date for completion of the investigation in October 2008.

 

In April 2007 Global Locate filed a complaint in the ITC against SiRF and four of its customers, e-TEN Corporation, Pharos Science & Applications, Inc., MiTAC International Corporation and Mio Technology Limited (collectively, the “SiRF Defendants”), asserting that the SiRF Defendants engaged in unfair trade practices by importing GPS devices, including integrated circuits and embedded software, and products containing such products, such as personal navigation devices and GPS-enabled cellular telephones, that infringe, both directly and indirectly, six of Global Locate’s patents relating generally to GPS technology. The complaint seeks an exclusion order to bar importation of the SiRF Defendants’ products into the United States and a cease and desist order to bar further sales of infringing products that have already been imported. In May 2007 the ITC instituted an investigation of the SiRF Defendants based upon the allegations made in the Global Locate’s complaint. The ITC has set a target date for completion of the investigation in December 2008.

 

BROADCOM CORPORATION

 

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Antitrust and Unfair Competition Proceedings.   In July 2005 the Company filed a complaint against Qualcomm in the United States District Court for the District of New Jersey asserting that Qualcomm’s licensing and other practices related to cellular technology and products violate federal and state antitrust laws. The complaint also asserts causes of action based on breach of contract, promissory estoppel, fraud, and tortious interference with prospective economic advantage. In September 2005 the Company filed an amended complaint in the action also challenging Qualcomm’s proposed acquisition of Flarion Technologies, Inc. under the antitrust laws and asserting violations of various state unfair competition and unfair business practices laws. In August 2006 the court granted Qualcomm’s motion to dismiss the complaint. In September 2007 the United States Court of Appeals for the Third Circuit reversed the dismissal in part and returned the case to the district for further proceedings. A trial date in district court has not yet been set.

 

In October 2005 the Company and five other leading mobile wireless technology companies filed complaints with the European Commission requesting that the Commission investigate Qualcomm’s anticompetitive conduct related to the licensing of its patents and the sale of its chipsets for mobile wireless devices and systems. In October 2007 the Commission announced that it has instituted a formal investigation, of Qualcomm.

 

In June 2006 the Company and another leading mobile wireless technology company filed complaints with the Korean Fair Trade Commission requesting that the Commission investigate Qualcomm’s anticompetitive conduct related to the licensing of its patents and the sale of its chipsets for mobile wireless devices and systems. The Commission has instituted a formal investigation of Qualcomm.

 

In April 2007 the Company filed a complaint in the Superior Court for Orange County, California alleging that Qualcomm’s conduct before various industry standards organizations constitutes unfair competition, fraud and breach of contract. The complaint seeks an injunction against Qualcomm as well as the recovery of monetary damages. In October 2007 the court stayed the case pending final resolution of the Company’s case against Qualcomm in the United States District Court for the District of New Jersey.

 

Securities Litigation.   From March through August 2006 a number of purported Broadcom shareholders filed putative shareholder derivative actions (the “Options Derivative Actions”) against the Company, each of the members of its Board of Directors, certain current or former officers, and Henry T. Nicholas III, its co-founder, alleging, among other things, that the defendants improperly dated certain Broadcom employee stock option grants. Four of those cases, Murphy v. McGregor, et al. (Case No. CV06-3252 R (CWx)), Shei v. McGregor, et al. (Case No. SACV06-663 R (CWx)), Ronconi v. Dull, et al. (Case No. SACV 06-771 R (CWx)) and Jin v. Broadcom Corporation, et al. (Case No. 06CV00573) have been consolidated in the United States District Court for the Central District of California. The plaintiffs filed a consolidated amended complaint in November 2006. In addition, two putative shareholder derivative actions, Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust v. Samueli, et al. (Case No. 06CC0124) and Servais v. Samueli, et al. (Case No. 06CC0142), were filed in the California Superior Court for the County of Orange. The Superior Court consolidated the state court derivative actions in August 2006, and the plaintiffs filed a consolidated amended complaint in September 2006. The plaintiffs in the Options Derivative Actions contend, among other things, that the defendants’ conduct violated United States and California securities laws, breached defendants’ fiduciary duties, wasted corporate assets, unjustly enriched the defendants, and caused errors in the Company’s financial statements. The plaintiffs seek, among other things, unspecified damages and disgorgement of profits from the alleged conduct, to be paid to Broadcom.

 

In January 2007 the Superior Court granted defendants’ motion to stay the state derivative action pending resolution of the prior-filed federal derivative action. In March 2007 the court in the federal derivative action denied the Company’s motion to dismiss, which motion was based on the ground that the shareholder plaintiffs lack standing to assert claims on behalf of Broadcom. Motions to dismiss filed by the individual defendants were heard, and mostly denied, in May 2007. Additionally, in May 2007 the Board of Directors established a special litigation committee (the “SLC”) to decide what course of action the Company should pursue in respect of the claims asserted in the Options Derivative Actions. The SLC is currently engaged in its review. Awaiting the

 

BROADCOM CORPORATION

 

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outcome of the SLC’s review, the Company intends to continue to vigorously oppose each of the Options Derivative Actions.

 

From August through October 2006 several plaintiffs filed purported shareholder class actions in the United States District Court for the Central District of California against the Company and certain of its current or former officers and directors, entitled Bakshi v. Samueli, et al. (Case No. 06-5036 R (CWx)), Mills v. Samueli, et al. (Case No. SACV 06-9674 DOC R(CWx)), and Minnesota Bakers Union Pension Fund, et al. v. Broadcom Corp., et al. (Case No. SACV 06-970 CJC R (CWx)) (the “Options Class Actions”). The essence of the plaintiffs’ allegations is that Broadcom improperly backdated stock options, resulting in false or misleading disclosures concerning, among other things, Broadcom’s business and financial condition. Plaintiffs also allege that Broadcom failed to account for and pay taxes on stock options properly, that the individual defendants sold Broadcom common stock while in possession of material nonpublic information, and that the defendants’ conduct caused artificial inflation in Broadcom’s stock price and damages to the putative plaintiff class. The plaintiffs assert claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. In November 2006 the Court consolidated the Options Class Actions and appointed the New Mexico State Investment Council as lead class plaintiff. In October 2007 the federal appeals court resolved a dispute regarding the appointment of lead class counsel. The lead plaintiff’s consolidated class action complaint will be due 45 days after the district judge enters a revised order appointing lead class counsel. The Company intends to defend the consolidated action vigorously.

 

The Company has entered into indemnification agreements with each of its present and former directors and officers. Under these agreements, Broadcom is required to indemnify each such director or officer against expenses, including attorney’s fees, judgments, fines and settlements, paid by such individual in connection with the Options Derivative Actions, the Options Class Actions and the pending SEC and U.S. Attorney’s Office investigations described below (other than indemnified liabilities arising from willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest).

 

SEC Formal Order of Investigation and United States Attorney’s Office Investigation.   In June 2006 the Company received an informal request for information from the staff of the Los Angeles regional office of the SEC regarding its historical option granting practices. In December 2006 the SEC issued a formal order of investigation and a subpoena for the production of documents. The SEC continues to depose present and former Company employees, officers and directors as part of its investigation. In July 2007 the Company received a “Wells Notice” from the SEC in connection with this investigation. The Chairman of the Board of Directors and Chief Technical Officer of the Company, Dr. Henry Samueli, also received a Wells Notice at that time. In August 2007 the Senior Vice President, Business Affairs and General Counsel of the Company, David A. Dull, also received a Wells Notice. The Wells Notices provide notification that the staff of the SEC intends to recommend to the Commission that it bring a civil action against the recipients for possible violations of the securities laws. Based on discussions with the SEC staff, the Company believes that the issues the staff intends to pursue relate to the Company’s historical option granting processes and the accounting relating to those option grants. Under the process established by the SEC, recipients have the opportunity to respond in writing to a Wells Notice before the SEC staff makes any formal recommendation to the Commission regarding what action, if any, should be brought by the SEC. In response to its Wells Notice, the Company has communicated with the SEC staff in an effort to explore possible resolution, and is awaiting further communication. The Company is continuing to cooperate with the SEC, but does not know when the investigation will be resolved or what, if any, actions the SEC may require it, Dr. Samueli and/or Mr. Dull to take as part of that resolution.

 

In August 2006 the Company was informally contacted by the U.S. Attorney’s Office for the Central District of California and asked to produce documents. In 2006 the Company voluntarily provided documents and data to the U.S Attorney’s Office. In 2007 the Company has continued to provide substantial amounts of documents and information to the U.S. Attorney’s Office on a voluntary basis. In addition, the Company has produced documents pursuant to grand jury subpoenas. The U.S. Attorney’s Office continues to interview present and former Company

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

employees, officers and directors as part of its investigation. The Company is continuing to cooperate with the U.S. Attorney’s Office in its investigation. Any action by the SEC, the U.S. Attorney’s Office or other governmental agency could result in civil or criminal sanctions and/or fines against the Company and/or certain of its current or former officers, directors and/or employees.

 

United States Attorney’s Office Investigation and Prosecution.   In June 2005 the United States Attorney’s Office for the Northern District of California commenced an investigation into the possible misuse of proprietary competitor information by certain Broadcom employees. In December 2005 one former employee was indicted for fraud and related activity in connection with computers and trade secret misappropriation. The former employee had been immediately suspended in June 2005, after just two months’ employment, when the Company learned about the government investigation. Following an internal investigation, his employment was terminated, nearly two months prior to the indictment. The indictment does not allege any wrongdoing by Broadcom, which is cooperating fully with the ongoing investigation and the prosecution.

 

General.   The foregoing discussion includes material developments that occurred during the three and nine months ended September 30, 2007 or thereafter in material legal proceedings in which the Company and/or its subsidiaries are involved. For additional information regarding certain of these legal proceedings, see Note 11 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

The Company and its subsidiaries are also involved in other legal proceedings, claims and litigation arising in the ordinary course of business.

 

The pending proceedings involve complex questions of fact and law and will require the expenditure of significant funds and the diversion of other resources to prosecute and defend. The results of legal proceedings are inherently uncertain, and material adverse outcomes are possible. The resolution of intellectual property litigation may require the Company to pay damages for past infringement or to obtain a license under the other party’s intellectual property rights that could require one-time license fees or running royalties, which could adversely impact gross profit and gross margins in future periods, or could prevent Broadcom 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 Broadcom. From time to time the Company may enter into confidential discussions regarding the potential settlement of pending litigation or other proceedings; however, there can be no assurance that any such discussions will occur or will result in a settlement. The settlement of any pending litigation or other proceeding could require Broadcom to incur substantial settlement payments and costs. In addition, the settlement of any intellectual property proceeding may require the Company to grant a license to certain of the Company’s intellectual property rights to the other party under a cross-license agreement. If any of those events were to occur, Broadcom’s business, financial condition and results of operations could be materially and adversely affected.

 

 

Cautionary Statement

 

You should read the following discussion and analysis in conjunction with our Unaudited Condensed Consolidated Financial Statements and the related Notes thereto contained in Part I, Item 1 of this Report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Report and in our other reports filed with the Securities and Exchange Commission, or SEC, including our Annual Report on Form 10-K for the year ended December 31, 2006 and subsequent reports on Forms 10-Q and 8-K, which discuss our business in greater detail.

 

As a reminder, you should not rely on financial information included in the reports on Form 10-K, Form 10-Q and Form 8-K previously filed by Broadcom, the related opinions of our independent registered public accounting firm, or earnings press releases and similar communications issued by us, for periods ended on or before March 31, 2006, all of which have been superseded in their entirety by the information contained in our amended Annual Report on Form 10-K/A for the year ended December 31, 2005 and our amended Quarterly Report on Form 10-Q/A for the three months ended March 31, 2006, each filed January 23, 2007.

 

The section entitled “Risk Factors” contained in Part II, Item 1A of this Report, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, financial condition, results of operations and/or liquidity. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock.

 

All statements included or incorporated by reference in this Report, other than statements or characterizations of historical fact, are forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements concerning projected net revenue, costs and expenses and gross margin; our accounting estimates, assumptions and judgments; the impact of the January 2007 restatement of our financial statements for prior periods; estimates related to the amount and/or timing of the expensing of unearned stock-based compensation expense; our success in pending litigation; the demand for our products; the effect that seasonality and volume fluctuations in the demand for our customers’ consumer-oriented products will have on our quarterly operating results; our dependence on a few key customers for a substantial portion of our revenue; our ability to scale operations in response to changes in demand for existing products and services or the demand for new products requested by our customers; the competitive nature of and anticipated growth in our markets; our ability to migrate to smaller process geometries; manufacturing, assembly and test capacity; our ability to consummate acquisitions and integrate their operations successfully; our potential needs for additional capital; inventory and accounts receivable levels; and the level of accrued rebates. These forward-looking statements are based on our current expectations, estimates and projections about our industry and business, management’s beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “may,” “will,” “should,” “would,” “could,” “potential,” “continue,” “ongoing,” similar expressions, and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section “Risk Factors” contained in Part II, Item 1A of this Report. These forward-looking statements speak only as of the date of this Report. We undertake no obligation to revise or update publicly any forward-looking statement for any reason, except as otherwise required by law.

 

Overview

 

Broadcom Corporation is a major technology innovator and global leader in semiconductors for wired and wireless communications. Our products enable the delivery of voice, video, data and multimedia to and throughout the home, the office and the mobile environment. Broadcom provides the industry’s broadest portfolio of state-of-the-art system-on-a-chip and software solutions to manufacturers of computing and networking equipment, digital entertainment and broadband access products, and mobile devices. Our diverse product portfolio includes solutions for digital cable, satellite and Internet Protocol (IP) set-top boxes and media servers; high definition television (HDTV); high definition DVD players and personal video recording (PVR) devices;

cable and DSL modems and residential gateways; high-speed transmission and switching for local, metropolitan, wide area and storage networking; SystemI/O server solutions; broadband network and security processors; wireless and personal area networking; cellular communications; global positioning system (GPS) applications; mobile multimedia and applications processors; mobile power management; and Voice over Internet Protocol (VoIP) gateway and telephony systems.

 

Net Revenue.   We sell our products to leading manufacturers of wired and wireless communications equipment in each of our target markets. Because we leverage our technologies across different markets, certain of our integrated circuits may be incorporated into equipment used in multiple markets. We utilize independent foundries and third-party subcontractors to manufacture, assemble and test all of our semiconductor products.

 

Our net revenue is generated principally by sales of our semiconductor products. We derive the remainder of our net revenue predominantly from software licenses, development agreements, support and maintenance agreements, data services and cancellation fees. The majority of our sales occur through the efforts of our direct sales force. The remaining balance of our sales occurs through distributors.

 

The following table presents details of our net revenue:

 

 

 

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

 

 

For these and other reasons, our net revenue and results of operations for the three months ended September 30, 2007 and prior periods may not necessarily be indicative of future net revenue and results of operations.

From time to time, our key customers place large orders causing our quarterly net revenue to fluctuate significantly. We expect that these fluctuations will continue and that they may be exaggerated by the increasing volume of our products that are incorporated into consumer products, sales of which are typically subject to greater seasonality and greater volume fluctuations than non-consumer OEM products. We also maintain inventory, or hubbing, arrangements with certain of our customers. Pursuant to these arrangements we deliver products to a customer or a designated third party warehouse based upon the customer’s projected needs, but do not recognize product revenue unless and until the customer reports that it has removed our product from the warehouse to incorporate into its end products. Historically we have had good visibility into customer requirements and shipments within a quarter. However, if a customer does not take our products under a hubbing arrangement in accordance with the schedule it originally provided to us, our predicted future revenue stream could vary substantially from our forecasts and our results of operations could be materially and adversely affected. Additionally, since we own inventory that is physically located in a third party’s warehouse, our ability to effectively manage inventory levels may be impaired, causing our total inventory turns to decrease, which could increase expenses associated with excess and obsolete product and negatively impact our cash flow.

 

Sales to our five largest customers, including sales to their manufacturing subcontractors, as a percentage of net revenue were as follows:

 

 

Net revenue derived from all independent customers located outside the United States, excluding foreign subsidiaries or manufacturing subcontractors of customers that are headquartered in the United States, as a percentage of total net revenue was as follows:

 

 

Net revenue derived from shipments to international destinations, as a percentage of total net revenue was as follows:

 

 

We have recently entered into arrangements that include multiple deliverables, such as the sale of semiconductor products and related data services. Under these arrangements, the services may be provided without having a separate “fair value” under Emerging Issues Task Force Issue No. 00-21, Revenue Arrangements with Multiple Deliverables , or EITF 00-21. In that event, we will only recognize a portion of the total revenue we receive from the customer during a quarter, and will recognize the remaining revenue on a ratable basis over the expected life of the service being provided. As we enter into future multiple element arrangements, where we do

not have fair value of each deliverable, the portion of revenue we recognize on a deferred basis may vary significantly in any given quarter, which could cause even greater fluctuations in our quarterly operating results.

 

All of our revenue to date has been denominated in U.S. dollars.

 

Gross Margin.   Our gross margin, or gross profit as a percentage of net revenue, has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:

 

 

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

 

 

In the three months ended September 30, 2007 our net income was $27.8 million as compared to $110.2 million in the three months ended September 30, 2006, a difference of $82.4 million. This decrease in profitability was the direct result of an $84.3 million increase in operating expenses due principally to an increase in the number of employees engaged in research and development activities, resulting from both direct hiring and acquisitions since September 30, 2006, as well as a charge for IPR&D in the amount of $5.0 million. This was partially offset by additional gross profit as a result of the $47.4 million increase in net revenue in the three months ended September 30, 2007 as compared to the three months ended September 30, 2006.

 

In the nine months ended September 30, 2007 our net income was $123.0 million as compared to $334.0 million in the nine months ended September 30, 2006, a difference of $211.0 million. This decrease in profitability was the direct result of a $204.8 million increase in operating expenses due principally to an increase in the number of employees engaged in research and development activities, resulting from both direct hiring and

acquisitions since September 30, 2006, as well as an increase in charges for IPR&D in the amount of $10.3 million.

 

Product Cycles.   The cycle for test, evaluation and adoption of our products by customers can range from three to more than nine months, with an additional three to more than twelve months before a customer commences volume production of equipment incorporating our products. Due to this lengthy sales cycle, we may experience significant delays from the time we incur expenses for research and development, selling, general and administrative efforts, and investments in inventory, to the time we generate corresponding revenue, if any. The rate of new orders may vary significantly from month to month and quarter to quarter. If anticipated sales or shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our results of operations for that quarter, and potentially for future quarters, would be materially and adversely affected.

 

Acquisition Strategy.   An element of our business strategy involves the acquisition of businesses, assets, products or technologies that allow us to reduce the time required to develop new technologies and products and bring them to market, incorporate enhanced functionality into and complement our existing product offerings, augment our engineering workforce, and enhance our technological capabilities. We plan to continue to evaluate strategic opportunities as they arise, including acquisitions and other business combination transactions, strategic relationships, capital infusions and the purchase or sale of assets. See Note 3 of Notes to Unaudited Condensed Consolidated Financial Statements for information related to the acquisitions made during the three and nine months ended September 30, 2007.

 

Business Enterprise Segments.   We operate in one reportable operating segment, wired and wireless broadband communications. Statement of Financial Accounting Standards, or SFAS, No. 131, Disclosures about Segments of an Enterprise and Related Information , or SFAS 131, establishes standards for the way public business enterprises report information about operating segments in annual consolidated financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. Although we had four operating segments at September 30, 2007, under the aggregation criteria set forth in SFAS 131 we operate in only one reportable operating segment, wired and wireless broadband communications.

 

Under SFAS 131, two or more operating segments may be aggregated into a single operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles of SFAS 131, if the segments have similar economic characteristics, and if the segments are similar in each of the following areas:

 

 

We meet each of the aggregation criteria for the following reasons:

 

 

All of our operating segments share similar economic characteristics as they have a similar long term business model, operate at gross margins similar to our consolidated gross margin, and have similar research and development expenses and similar selling, general and administrative expenses. The causes for variation among each of our operating segments are the same and include factors such as (i) life cycle and price and cost fluctuations,

(ii) number of competitors, (iii) product differentiation and (iv) size of market opportunity. Additionally, each operating segment is subject to the overall cyclical nature of the semiconductor industry. The number and composition of employees and the amounts and types of tools and materials required are similar for each operating segment. Finally, even though we periodically reorganize our operating segments based upon changes in customers, end markets or products, acquisitions, long- term growth strategies, and the experience and bandwidth of the senior executives in charge, the common financial goals for each operating segment remain constant.

 

Because we meet each of the criteria set forth in SFAS 131 and our four operating segments as of September 30, 2007 share similar economic characteristics, we have aggregated our results of operations into one reportable operating segment.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to allowances for doubtful accounts, sales returns and allowances, warranty reserves, inventory reserves, stock-based compensation expense, goodwill and purchased intangible asset valuations, strategic investments, deferred income tax asset valuation allowances and uncertain tax positions, restructuring costs, litigation and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

 

We believe the following either are (i) critical accounting policies that require us to make significant judgments and estimates in the preparation of our consolidated financial statements or (ii) other key accounting policies, such as revenue recognition, that generally do not require us to make estimates or judgments that are difficult or subjective:

 

 

 

 

change as a result of changes in fiscal policy, changes in legislation, the evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially to reverse previously recorded tax liabilities.