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Actel 10-K 2008
e10vk
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
 
     
(Mark One)    
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2006
OR
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
Commission file number 0-21970
 
 
 
 
ACTEL CORPORATION
 
     
California
  77-0097724
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
2061 Stierlin Court
Mountain View, California
(Address of principal executive offices)
  94043-4655
(Zip Code)
 
(650) 318-4200
 
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
None
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, $.001 par value
Preferred Stock Purchase Rights
 
 
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o      No  þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.
 
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 o     No þ
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Annual Report on Form 10-K or any amendment to this Annual Report on Form 10-K.  þ
 
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):
Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed fourth fiscal quarter: $337,300,407
 
Note. — If a determination as to whether a particular person or entity is an affiliate cannot be made without involving unreasonable effort and expense, the aggregate market value of the common stock held by non-affiliates may be calculated on the basis of assumptions reasonable under the circumstances, provided that the assumptions are set forth in this Form.
 
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: 26,496,497 shares of Common Stock outstanding as of January 16, 2008.
 
 
 
 
In this Annual Report on Form 10-K, Actel Corporation and its consolidated subsidiaries are referred to as “we,” “us,” “our,” or “Actel.” You should read the information in this Annual Report with the Risk Factors in Item 1A. Unless otherwise indicated, the information in this Annual Report is given as of January 21, 2008, and we undertake no obligation to update any of the information, including forward-looking statements. All forward-looking statements are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements containing words such as “anticipates,” “believes,” “estimates,” “expects,” “intends,” “plans,” “seeks,” and variations of such words and similar expressions are intended to identify the forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements due to the risks identified in the Risk Factors or for other reasons.
 


 
TABLE OF CONTENTS

PART I
ITEM 1. BUSINESS
ITEM 1B. UNRESOLVED STAFF COMMENTS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5. MARKET FOR THE REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURES
ITEM 9B. OTHER INFORMATION
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
EXHIBIT 10.12
EXHIBIT 21.1
EXHIBIT 23
EXHIBIT 24
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32


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This Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (“2006 Form 10-K”), includes restatements of the following previously-filed financial statements and data (and related disclosures): (i) our consolidated balance sheet as of January 1, 2006, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the fiscal years ended January 1, 2006 and January 2, 2005; (ii) our selected financial data as of and for the fiscal years ended January 1, 2006, January 2, 2005, January 4, 2004, and January 5, 2003, (iii) our management’s discussion and analysis of financial condition and results of operations as of and for the fiscal years ended January 1, 2006 and January 2, 2005, and (iv) our unaudited quarterly financial information for the first two quarters in the fiscal year ended December 31, 2006, and for all four quarters in the fiscal year ended January 1, 2006. We also recorded adjustments affecting previously-reported financial statements for fiscal years 1994 through 2003, the effects of which are summarized in cumulative adjustments to additional paid-in capital, deferred stock-based compensation, and retained earnings as of January 4, 2004. All restatements are a result of an independent stock option investigation conducted by a Special Committee of our Board of Directors and additional reviews conducted by our management. See below and Note 2, “Restatements of Consolidated Financial Statements,” to the Consolidated Financial Statements, and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a detailed discussion of the effect of the restatement.
 
Financial information included in our reports on Form 10-K, Form 10-Q, and Form 8-K filed with the Securities and Exchange Commission (“SEC”) before January 18, 2007, and the related opinions of our independent registered public accounting firm, and all of our earnings press releases and similar communications issued before January 18, 2007, should not be relied upon and are superseded in their entirety by this 2006 Form 10-K and our other reports on Form 10-Q and Form 8-K filed with the SEC on or after January 18, 2007.
 
Stock Option Reviews, Investigation, and Findings
 
In September 2006, our Board of Directors appointed a Special Committee of independent directors (“Special Committee”) to formally investigate our historical stock option grant practices and related accounting. The Special Committee retained an independent law firm and forensic team of professionals to assist the Committee in conducting a thorough investigation. The Special Committee investigated stock options granted during the eleven-year period from January 1, 1996, through December 31, 2006. On January 18, 2007, our management concluded (based on a preview of the Special Committee’s preliminary findings) that shareholders and other investors should no longer rely on the Company’s financial statements and the related reports or interim reviews of Actel’s independent registered public accounting firm and all earnings press releases and similar communications issued by the Company for fiscal periods commencing on or after January 1, 1996.
 
The Special Committee presented its preliminary findings to the Board of Directors on January 30, 2007, and its final report on March 9, 2007. The Special Committee concluded that there was inadequate documentation supporting the recorded measurement dates for each of our company-wide annual grants during the period 1996-2001; that there were a number of other grants during the 1996-2001 period for which there was inadequate documentation supporting the recorded measurement dates, including some executive grants and grants to new employees in connection with corporate acquisitions; and that, beginning in 2002, documentation relating to annual and other grants improved substantially, although some minor errors occurred thereafter in the form of corrections or adjustments to grant allocations after the recorded measurement dates.
 
Per the recommendation of the Special Committee, our management reviewed the information made available to it by the Special Committee and performed its own detailed review of historical stock option grants (including the examination of options granted during the period between our initial public offering on August 2, 1993, and January 1, 1996 ) as part of the effort to establish appropriate measurement dates. Management analyzed all available evidence related to each grant. Based on relevant facts and circumstances, management applied the applicable accounting standards to determine appropriate measurement dates for all grants. In addition to the grants found by the Special Committee to have lacked adequate documentation supporting the recorded measurement dates, our management concluded that there was inadequate documentation supporting the recorded measurement date for the four company-wide grants during the period 2002-2004, and for one company-wide grant in 1995. If the


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measurement date was other than the stated grant date, we made accounting adjustments as required, resulting in stock-based compensation expense and related tax effects. We have determined that we had unrecorded non-cash equity-based compensation charges associated with our equity incentive plans for the period 1995 through 2006. Since these charges were material to our financial statements for the years 1995 through 2005, we are restating our historical financial statements to record additional non-cash charges for stock-based compensation expense. At the direction of management, option exercises before December 31, 2000 (when employees could exercise shares directly with the Company, as opposed to through an independent, third-party broker), were also reviewed and tested, and no instance of exercise backdating was identified.
 
Restatement
 
As a result of the Special Committee’s investigation and findings, as well as our internal reviews, we have recorded additional stock-based compensation expense for stock option grants made from June 1995 through March 2004 for which the actual measurement date was different than the stated grant date. We determined that the stated grant dates for 28 granting actions (or 15% of the 190 granting actions between our initial public offering and the end of 2006) cannot be supported as the proper measurement dates. As a result, we corrected the measurement dates for options covering a total of 10.1 million shares (or 41% of the 24.7 million shares of Common Stock covered by options granted during the relevant period), resulting in a gross deferred stock-based compensation charge of $23.4 million. After accounting for forfeitures, cancellations, and other related adjustments, we recorded additional pre-tax stock-based compensation expense of $17.4 million as a result of the revised measurement dates for historical stock option grants.
 
In addition to the stock-based compensation expenses resulting from revised measurement dates for historical stock option grants, and the related payroll and withholding taxes and penalties, our internal review also identified certain other errors in accounting determinations and judgments relating to stock-based compensation that have been corrected in the restated consolidated financial statements. These errors include incorrect accounting for (i) modifications to equity awards in connection with, and subsequent to, certain employees’ terminations and (ii) equity awards granted to consultants. As a result of these errors, we recorded additional pre-tax stock-based compensation expense of $1.4 million.
 
Also included in this restatement are accounting adjustments for one item that is not related to stock options. These adjustments relate to errors associated with the recognition of deferred income at our European distributors. While we were aware of these errors outside of the course of the stock options investigation and reviews described above, these adjustments had not previously been recorded in the appropriate periods due to their immateriality. The restatement impact of recording these adjustments is a $1.0 million cumulative increase to pre-tax income from 2000 through 2005.


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For explanatory purposes and to assist in analysis of our consolidated financial statements, the impact of the stock option and other adjustments that were affected by the restatement are summarized below (in thousands):
 
                                                                 
    Adjustment to
                      Other
                   
    Stock-Based
                      Deferred
                   
    Compensation
                Subtotal
    Revenue
    Other
             
    Expense
    Other
    Adjustment to
    Stock-Based
    Adjustments
    Adjustments-
    Adjustment to
       
    Associated
    Adjustments
    Payroll
    Compensation
    Associated
    -Other
    Income
    Total
 
    with
    to Stock-Based
    Tax
    Expense and
    with
    Income and
    Tax
    Restatement
 
    Remeasured
    Compensation
    Expense
    Payroll
    European
    Expense
    Expense
    Expense
 
Fiscal Year
  Grants     Expense     (Benefit)     Taxes     Distributor     Charges(1)     (Benefit)     (Benefit)  
 
1994
  $     $ 60     $     $ 60     $     $     $ (24 )   $ 36  
1995
    205       27             232                   (73 )     159  
1996
    539       42       6       587                   (175 )     412  
1997
    823       32       23       878                   (262 )     616  
1998
    937       35       18       990                   (307 )     683  
1999
    814       12       105       931                   (242 )     689  
2000
    2,574       92       347       3,013       (1,528 )           (436 )     1,049  
2001
    5,455       485       88       6,028       (100 )     (17 )     (2,111 )     3,800  
2002
    2,810       (73 )     93       2,830       203       (31 )     (953 )     2,049  
2003
    2,155       1,687       181       4,023             20       (1,370 )     2,673  
                                                                 
Cumulative through January 4, 2004
    16,312       2,399       861       19,572       (1,425 )     (28 )     (5,953 )     12,166  
2004
    950       (604 )     (312 )     34       100       (463 )     (51 )     (380 )
2005
    186       (431 )     (91 )     (336 )     338       12       (14 )      
                                                                 
Total
  $ 17,448     $ 1,364     $ 458     $ 19,270     $ (987 )   $ (479 )   $ (6,018 )   $ 11,786  
                                                                 
 
 
(1) Reflects mark to market adjustments relating to $1.0 million of awards originally charged to stock-based compensation which were subsequently classified as liability awards following the termination of employment.


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PART I
 
ITEM 1.   BUSINESS
 
The leading supplier of nonvolatile field-programmable gate arrays (FPGAs), Actel Corporation designs, develops, and markets Flash- and antifuse-based FPGAs for a wide range of applications in the aerospace, automotive, avionics, communications, consumer, industrial, medical, and military markets. In support of our FPGAs, we also offer design and development software and tools, intellectual property (IP) cores, programming hardware, starter kits, and a variety of services. We sell our products globally through a worldwide, multi-tiered sales and distribution network.
 
The company was founded and incorporated in California in 1985. Actel’s common stock trades on the NASDAQ Global Market under the symbol ACTL. Our corporate headquarters are located at 2061 Stierlin Court, Mountain View, Calif., 94043, and our Website address is www.actel.com.
 
We provide access free of charge through a link on our Web site to our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as well as amendments to those reports, as soon as reasonably practicable after the reports are electronically filed with or furnished to the Securities and Exchange Commission (SEC). The Actel, Actel Fusion, Axcelerator, EPGA, FlashLock, FuseLock, Libero, ProASIC, ProASIC PLUS, and VariCore names and logos are registered trademarks of Actel. This Annual Report also includes unregistered trademarks of Actel as well as registered and unregistered trademarks of other companies.
 
 
Three principal types of integrated circuits (ICs) are used in nearly every electronic system: processors, which are used for control and computing tasks; memory devices, which are used to store program instructions and data; and logic devices, which are used to adapt these processing and storage capabilities to a specific application.
 
The logic market is highly fragmented and includes application-specific integrated circuits (ASICs). Programmable logic devices (PLDs) are one type of ASIC, and FPGAs are one type of PLD. While all of these devices are competitive, price, performance, reliability, power consumption, security, density, features, ease of use, and time to market determine the degree to which the devices compete for specific applications.
 
ASICs other than PLDs are customized for use in a specific application at the time they are manufactured. Because they are “hard wired,” they cannot be modified after they are manufactured, thereby subjecting them to the risk of inventory obsolescence if the system manufacturer changes the logic design. These devices generally have longer development times and greater development costs than their programmable alternatives. The advantages of hard-wired ASICs are high capacity, high density, high speed, and low cost in production volumes.
 
FPGAs and other PLDs, on the other hand, are manufactured as standard components and customized “in the field,” allowing the same device type to be used for many different applications. Using software tools, users can program their design directly into an FPGA, resulting in lower development costs and inventory risks, shorter design cycles, and faster time-to-market.
 
 
To a large extent, the characteristics of an FPGA are dictated by the technology used to make the device programmable. Devices based on nonvolatile Flash or antifuse programming elements, which are offered only by Actel, offer consistent single-chip, low-power, live-at-power-up, security, and neutron-immunity advantages over volatile devices based on static-random access memory (SRAM) technology.
 
 
Unlike volatile SRAM-based FPGAs, Actel’s nonvolatile FPGAs do not require additional system components, such as configuration serial nonvolatile memory (EEPROM) or a Flash-based microcontroller, to configure the device at every system power-up. By eliminating the support devices required by volatile SRAM-based FPGAs, Actel’s nonvolatile single-chip FPGAs reduce the direct costs of the bill of materials (BOM). In addition, the


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nonvolatile Flash- and antifuse-based FPGAs lower associated total system costs by reducing design complexity, increasing reliability, and simplifying materials management.
 
 
Among the primary FPGA technologies, only Flash and antifuse have power characteristics similar to hard-wired ASICs, making them an appropriate choice for battery-operated and other power-sensitive applications. All of our devices have low static and dynamic power consumption and our Flash devices also support sleep and standby modes of operation to maximize power savings. Unlike alternative FPGA technologies, our devices do not exhibit power-on current surges or no high-current transitions
 
 
Our nonvolatile devices are live at power-up (LAPU). As soon as system power is applied to the board and normal operating specifications are achieved, our devices are working. The LAPU feature greatly simplifies total system design and often allows for the removal of expensive power-sequencing, voltage-monitor, and brownout-detection devices from the board. Simplifying the system design reduces total system cost and design risk while increasing system reliability and improving system initialization time.
 
 
Secure systems and ultimately the underlying silicon technologies are becoming increasingly vital in preventing corruption, intrusion, and ultimately the theft of valuable IP. Once programmed, our nonvolatile single-chip FPGAs retain configuration indefinitely without requiring an external configuration device. With no bitstream susceptible to interception, our nonvolatile solutions eliminate the potential for in-system errors or data erasures that might occur during download. For our Flash-based devices, we offer the Actel FlashLock® feature, which provides a unique combination of reprogrammability and design security without external overhead. Our Flash-based devices with AES-based security allow for secure, remote field updates of both system design and Flash memory content. For our antifuse-based FPGAs, we offer the Actel FuseLock feature, which ensures that unauthorized users will not be able to read back the contents of our FPGA.
 
 
Independent radiation testing has confirmed that our Flash- and antifuse-based FPGAs are not subject to configuration upsets caused by high-energy neutrons naturally generated in the earth’s atmosphere. The testing also determined that SRAM-based FPGAs are vulnerable to neutron-induced configuration loss not only under high-altitude conditions, as traditionally believed, but also in ground-based applications. The energy of the collision can change the state of the SRAM FPGA’s configuration cell and thereby cause an unpredictable change in FPGA functionality. Impossible to prevent in SRAM FPGAs, these errors can result in failure-in-time (FIT) rates in the thousands and complete system failures.
 
 
Our strategy is to offer innovative solutions to markets in which our nonvolatile technologies have an inherent competitive advantage.
 
 
We expect that the value-based, sub-$10 market will be the fastest growing segment of the FPGA market. With low prices, high densities and performance, and an ASIC-like design flow, the Actel ProASIC3 and IGLOO families offer solutions for a broad range of cost-sensitive applications, including those traditionally served by hard-wired ASICs. These reprogrammable solutions combine the low-cost, low-power, nonvolatile single-chip advantages of hard-wired ASICs with the fast time-to-market and low development-cost advantages typically associated with FPGAs.


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Electronic system manufacturers are continuing to demand greater flexibility, reliability, and performance as well as lower power, board space, and total system cost. This has put increasing pressure on chip makers to integrate analog, processor, programmable logic, and nonvolatile memory circuits in a single programmable system chip (PSC). As a result, analog, processor, and hard-wired ASIC suppliers are moving to add configurability to their product lines, and PLD suppliers are moving to integrate analog, processor, and Flash memory into their products. In this race to develop PSC solutions, PLD suppliers have an advantage because programmable logic historically has been the most difficult of these technologies to master and the integration of analog and Flash memory has already been proven in processor and hard-wired ASIC technologies. We address this market with our Actel Fusion PSCs, which bring the benefits of true mixed-mode programmable logic to PSCs. By combining an advanced Flash FPGA core with Flash memory blocks and analog peripherals and using a fully functional on-chip soft Flash processor, the Actel Fusion devices allow designers to integrate a wide range of functionality into a single device, simplify system design, reduce total system cost, and upgrade during the production cycle or in the field. The Actel Fusion PSCs are the most comprehensive single-chip mixed-signal programmable logic solutions available today.
 
 
Our antifuse and Flash FPGAs are reliable, secure, nonvolatile, and immune to configuration corruption caused by radiation. A well-known supplier to the aerospace and military markets, Actel brings the same benefits to designers of automotive systems and system-critical avionics, industrial, and medical applications. In addition to high reliability and design security, nonvolatility, and firm-error immunity, these benefits include low power consumption and a small, single-chip footprint.
 
 
The key to our future success is the introduction of new products that address customer requirements and compete effectively with respect to price, features, and performance. Also critical are the intellectual property (IP) cores, development tools, technical support, and design services that enable our customers to implement their designs into our products.
 
We offer customers a range of single-chip, Flash-based solutions to address design challenges in the aerospace, automotive, avionics, communications, consumer, ,industrial, and medical markets. With densities ranging from 75,000 to 3,000,000 system gates, our reprogrammable product families highlight the inherent benefits of our nonvolatile Flash technology — low power, LAPU, security, and neutron immunity. Our Flash-based solutions include the Actel Fusion PSCs, M7 Fusion PSCs, M1 Fusion PSCs, IGLOO, ProASIC 3/E, M7 ProASIC 3/E, M1 ProASIC 3/E, ProASIC Plus, and ProASIC families.
 
We also offer a broad portfolio of nonvolatile antifuse-based FPGAs designed to meet the performance, power, security, and reliability requirements of the aerospace, automotive, avionics, communications, consumer, industrial, and military markets. Ranging in density from 3,000 to 4,000,000 system gates, our single-chip solutions include FPGAs qualified to commercial, industrial, military, and automotive specifications as well as radiation-tolerant and radiation-hardened devices. Spanning six process geometries, our antifuse-based solutions include the Axcelerator, eX, SX, SX-A, MX, and the legacy DX, XL, ACT 3, ACT 2, and ACT 1 families.
 
To meet the diverse requirements of our customers, we offer almost all our products in a variety of speed grades, package types, and/or ambient (environmental) temperature tolerances. We also offer “green,” lead-free, and RoHS-compliant packages, which provide the necessary mechanical and environmental protection while ensuring consistent reliability and performance.
 
A brief overview of our newer products follows. The families discussed below are currently being designed by customers into their next-generation applications. Although our more mature product families have been excluded from the discussion below, they continue to generate most of our revenues.


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• World’s first mixed-signal PSC, incorporating analog functions, embedded Flash, and FPGA fabric in a single chip
 
• Density: 90,000 to 1,500,000 system gates
 
• M7-enabled devices support Actel’s CoreMP7, the only soft 32-bit ARM7 microprocessor core for FPGAs
 
The Actel Fusion PSC has attracted interest from a broad spectrum of customers and applications. The Fusion PSC solutions have also won several prestigious product awards, including the 2005 EDN Innovation, the 2006 IEC DesignVision, the 2005 EDN “Hot 100 Products,”, the 2006 EDN China Leading Product, and the 2006 Electron D’Or Awards. Our Fusion design team was also a finalist in the 2005 ACE Awards Design Team of the Year category.
 
The Actel Fusion PSC’s system-management functionality, which includes power and thermal management, data logging, and system diagnostics, gives us the opportunity to win numerous designs in high-volume applications. The Actel Fusion PSC can integrate system-management functions and provide programmable flexibility in a single chip, resulting in potential cost and space savings of 50% or more relative to current implementations. To provide templates for the customization of system management functions and to speed development time, we also offer the System Management Development Kit, a complete prototyping and development kit. In addition, we have introduced several free Fusion-based reference designs addressing the Micro Telecom Computing Architecture (MicroTCA) standard, which is related to system management.
 
Sample Actel Fusion PSC applications:
 
     
Automotive
  Engine control units
GPS navigation systems
In-cab entertainment
Safety systems
Communications
  Handheld radios
Telecom and networking line-card management
Wireless base stations
Consumer
  Digital cameras
Home networking
Multimedia entertainment systems
Plasma displays
Set-top boxes
Smart handsets
Industrial
  Instrumentation and test equipment
Medical instrumentation systems
Point of sale
RFID infrastructure
Surveillance and automation systems
 
 
• The low-power, high-density reprogrammable ASIC alternative for portable applications
 
• Density: 30,000 to 3,000,000 system gates
 
Designers of portable and handheld applications are taking notice of the 5W Actel IGLOO family due to its unprecedented low power, large number of system gates, feature set, and ASIC-like design flow and methodology. The Actel IGLOO family consumes between 10 and 1,000 times less static power than the products of our competitors, setting a new standard for low power consumption. The only truly low-power FPGA solution to support 1.2V core operation, the Actel IGLOO family has several low-power modes to optimize power consumption — the Flash*Freezetm mode, a low-power active mode, and a sleep mode. The innovative IGLOO FPGA family was included on the 2006 EDN “Hot 100 Products” list.


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Sample IGLOO applications:
 
     
Automotive
  Personal occupancy detection systems (PODS)
Rear- and side-view cameras
Space- and power-constrained safety systems
Telematics
Communications
  Handheld radios
PC card-based wideband solutions (UMTS, 3G, EDO)
Wireless access points
Consumer
  Digital cameras
GPS devices
Multimedia entertainment systems
PDAs
Portable gaming
Smart phones
Industrial
  Portable medical instruments
Portable test equipment
 
 
• Third generation of single-chip, nonvolatile, reprogrammable, Flash-based FPGAs
 
• Density: 30,000 to 3,000,000 system gates
 
• M7-enabled devices support Actel’s CoreMP7, the only soft 32-bit ARM7 microprocessor core for FPGAs
 
Our successful ProASIC 3 devices are commercially qualified and shipping into high-volume applications to customers worldwide in the automotive, communications, consumer, industrial, and medical markets. ProASIC 3 offers designers a reprogrammable solution that combines the low-cost, low-power, nonvolatile single-chip advantages of a hard-wired ASIC with the fast time-to-market and low development-cost advantages typically associated with FPGAs.
 
 
     
Automotive
  Engine control units
GPS navigation systems
In-cab entertainment
Safety systems
Communications
  Handheld radios
Telecom and networking line-card management
Wireless base stations
Consumer
  Digital cameras
Gaming
Home networking
Multimedia entertainment systems
Plasma displays
Set-top boxes
Smart handsets
Industrial
  Instrumentation and test equipment
Medical instrumentation systems
Point of sale
RFID infrastructure
Surveillance and automation systems
 
 
• Space-grade radiation-tolerant devices with densities high enough to compete with hard-wired ASICs for space-flight sockets


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• Qualified to MIL-STD 883B and QML Class Q standards and DSCC certified
 
• Density: 250,000 to 4,000,000 system gates
 
Designers utilizing our RTAX-S FPGAs value their radiation tolerance, high reliability, firm-error immunity, and high densities. The 4,000,000 system gate RTAX4000S FPGA significantly expanded the number of space applications that can be supported by our RTAX-S family,
 
Sample RTAX-S applications:
 
     
Aerospace and Military
  Attitude and orbit control
Camera electronics
Command and data handling
Instrumentation
Management of spacecraft power and environmental controls
Propulsion system electronics
Radio communication
Sensor control
Sensor data processing
Telemetry
Medical
  Imaging equipment with high exposure to radiation
 
 
In support of our PSC and FPGA products, we offer design and development software and tools, IP cores, programming hardware, starter kits, and a variety of services that enable our customers to implement their designs into our products.
 
 
The Actel Libero integrated design environment (IDE) seamless integrates best-in-class design tools from Mentor Graphics, SynaptiCAD, and Synplicity with Actel-developed custom tools, such as the Actel Designer physical design solution, into a single FPGA development package. For customers who want to use their own design and verification tools, the Designer software is available as a standalone interactive design tool suite compatible with popular design entry and verification packages, including those from Cadence Design Systems, Inc., Mentor Graphics, Synopsys, Inc., and Synplicity. We also offer the CoreConsole IP Deployment Platform, which enables designers to quickly stitch IP blocks together into synthesizable register-transfer language (RTL), and Silicon Explorer, a design verification and debugging tool.
 
 
Designed, optimized, and verified to work with Actel’s FPGAs, we offer more than 130 proven IP cores for aerospace, automotive, , consumer, communications, industrial, military, and networking applications. DirectCore products, which are developed and supported by Actel, and CompanionCore IP cores from third-party participants, offer designers the ability to streamline design and offer the benefits of faster time to market and reduced design costs and risks. To support embedded systems designers using our FPGAs, we offer an extensive portfolio of optimized processor solutions, including a variety of industry-standard ARM®, 8051, and LEON cores, as well as a development environment, boards,and reference designs that enable customers to get system-level products to market quickly and reduce cost and risk.
 
 
We offer several programming options, including Silicon Sculptor 3 and the FlashPro series, for designers utilizing our nonvolatile FPGAs. Actel also has programming solutions for production design and offers volume programming services through distribution partners. Our Silicon Sculptor 3 is a high-speed, single-device programmer for all Actel devices. The compact Silicon Sculptor 3 programmer connects to a PC via USB 2.0. Up to 12 programmers can be connected to a single PC using nested USB hubs.


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FlashPro 3 and FlashPro Lite are compact and cost-effective programmers for our Flash-based devices. With their in-system programming (ISP) capability, these programmers limit incompatibility problems and expensive redesign costs and offer faster time to market. FlashPro 3 supports Fusion, IGLOO, ProASIC 3, and ProASIC 3E devices and is powered from the USB port. FlashPro Lite supports ProASIC Plus devices and is powered from the target board. In addition to programmers, we offer programming adapter modules, surface-mount sockets, prototyping adapter boards, and prototyping mechanical packages, and accessories.
 
 
We offer low-cost Fusion, ProASIC3/E, ProASIC Plus and Axcelerator starter kits. Starter kits are a quick and cost-effective way for potential customers to assess an FPGA technology without the expense and time needed to design a specialized evaluation board. Our kits contain a board with an FPGA, design software, and a programmer. Immediate prototyping for IGLOO devices is possible by using the ProASIC3/E Starter Kit.
 
 
To shorten design times for customers utilizing Actel’s nonvolatile FPGAs, we offer a variety of services and support, including design services, technical support, and training. Located in Mt. Arlington, New Jersey, our Protocol Design Services Group applies system-level design expertise to the government, military, and proprietary designs of our customers. The organization provides varying levels of design services, including FPGA, ASIC, and system design; software development and implementation; and development of prototypes, first articles, and production units. The Protocol Design Services team has participated in the development of a wide range of applications, including optical networks, routers, cellular phones, digital cameras, embedded DSP systems, automotive electronics, navigation systems, compilers, custom processors, and avionics systems. We also offer prototyping and high-volume programming services.
 
 
Today, FPGAs can be used in a broad range of applications across nearly all electronic system market segments. Our products serve a wide range of customers within the military and aerospace, industrial, communications, consumer and computer, and automotive markets.
 
 
With a focus on stringent quality and reliability requirements, military and aerospace designers have recognized the inherent advantages that nonvolatile FPGA technologies offer for applications that require high reliability, firm-error immunity, low power consumption, small footprint (single chip), and design security. Thousands of our radiation-tolerant and radiation-hardened FPGAs have performed mission- or flight-critical functions aboard manned space vehicles, earth observation satellites, and deep space probes. For example, our FPGAs continue to perform critical functions throughout several ongoing Mars missions, including the Mars Reconnaissance Orbiter (MRO), the Mars Express probe and the Mars Exploration Rovers — Spirit and Opportunity. Our FPGAs are also used to enable cameras and radio communications to transmit astounding images of the planet’s surface, including previously unexamined regions of the Mars surface, such as the Gusev Crater. We believe that we are the leading supplier of military and aerospace PLDs.
 
During 2006, we announced that Defense Supplier Center Columbus (DSCC) had released Standard Microcircuit Drawing (SMD) numbers for our radiation-tolerant RTAX2000S, RTAX1000S, and RTAX250S devices. Signaling compliance with the Department of Defense’s (DoD) MIL-PRF-38535 performance standard, designers can utilize SMD numbers to specify our RTAX-S FPGAs for their space-flight applications across all DoD programs In 2006, we also expanded our IP portfolio for military and aerospace applications with the Gaisler Research IP Library (GRLIB), a LEON 3 processor-based application solution optimized for our RTAX-S FPGAs; the Actel Core1553BRT-EBR, a complete, dual-redundant EBR remote terminal core that offers the reliability and data rates required for high-bandwidth applications, such as radar and laser targeting; and the free Actel CoreCORDIC RTL core, which enables designers to build highly configurable digital processing systems, such as digital receivers and cable modems.


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Recent advances in electronic component performance and integration at a lower price point have spurred the proliferation of electronic control units. Crossing many technologies and applications — from automated industrial manufacturing lines to instrumentation systems — the focus is on increasing design and power efficiency while reducing design, development, and total system costs. With technology improvements in semiconductor processes and integration, FPGAs have emerged as an important platform alternative for many industrial applications. Compared with ASICs, nonvolatile FPGAs are a cost-effective choice, eliminating ASIC-related development costs and speeding time to market. Using FPGAs also gives designers an efficient and reliable way to upgrade and customize features, whether during development or in the field.
 
For industrial motion-control applications, the Actel Fusion PSC can offer unprecedented integration in a single-chip implementation, replacing a host of discrete components at less than 50 percent of the cost and board space while maintaining system reliability. With the emergence of mixed-signal Actel Fusion PSC with integrated Flash memory, designers can also integrate a soft processor core, run directly from on-chip memory, and tightly couple control logic and processing needs.
 
Our ProASIC 3 and IGLOO FPGA families are also attractive to customers in the industrial market. These solutions offer designers a reprogrammable device that combines the low-cost, low-power, nonvolatile single-chip advantages of hard-wired ASICs with the fast time-to-market and low development-cost advatnages typically associated with FPGAs. For example, we announced in 2006 that our single-chip, Flash-based ProASIC3 FPGAs had been selected for use within the USBscope50, part of Elan Digital Systems’ portfolio of miniature USB-based test and measurement equipment. Our secure, low-power A3P250 solution will perform vital signal processing functions at the heart of current and future products that can turn a desktop or laptop PC into a professional-grade digital sampling oscilloscope.
 
 
Today’s system management implementations often require a large number of discrete components (sometimes numbering in the hundreds) that occupy large amounts of board space and are inflexible to change. In the communications market, increased costs and risks are driving the rapid adoption of standards for remotely managed systems, such as the Micro Telecom Computing Architecture (MicroTCA). Built on the AdvancedTCA (ATCA) specification, MicroTCA is an emerging global standard driven by the PCI Industrial Computer Manufacturers Group (PICMG) that offers adopters a powerful combination of lower cost, a smaller form factor, improved reliability and flexibility, and reduced time to market for remotely managed systems. As a smaller, lower cost option for the marketplace, many believe that MicroTCA has great potential to replace successful standards like CompactPCI and VME as the platform of choice. In the communications space, VoIP gateways, WiMax, wireless base stations and media servers are expected to be widespread adopters.
 
To meet this growing trend, we introduced a power module and an advanced mezzanine card (AMC) MicroTCA reference design in October 2006. Leveraging our single-chip mixed-signal Fusion PSC, these new reference designs include hardware, software, and IP for a complete solution to meet the cost, footprint, flexibility, security, and reliability requirements facing today’s system designers. We believe these free, tested reference designs will help drive MicroTCA adoption and provide templates for the customization of system management functions. As an early semiconductor entrant, we believe we are well-positioned to capture a significant share of this promising market. To support system management applications like MicroTCA, we also offers a portfolio of IP cores for processing, analog, and memory interface and communications.
 
 
The growth in battery-operated applications, such as digital cameras, wireless handhelds, smart phones, and multi-media players, has created a global demand for low-power semiconductors. For these applications, the ultimate goal is to achieve the lowest power possible and to accommodate long system idle times by allowing to the system to enter and exit low-power modes quickly. Other considerations include design security, path to prototyping, footprint, design reuse, and field upgradability. Traditionally, ASICs and CPLDs have addressed the needs of the consumer or portable marketplace. However, CPLDs are becoming less attractive in some low-


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power applications, mainly due to the increasing demand for high-end features. With longer time-to-market and a lack of flexibility to address changing standards and late-stage design modifications, hard-wired ASICs are riskier and often impractical for portable applications with short product-life cycles. As a result, PLDs are becoming the preferred solution as competition intensifies and time to market has an increasingly greater impact on product success. Of course, these PLDs must meet the other design requirements, including cost, features, performance, size, security, and (most importantly) power.
 
Today, reprogrammable, fully featured FPGAs, such as the Flash-based Actel IGLOO family, address the short product-life cycles and extreme competition in the portable application marketplace. These devices meet the design requirements of portable application, such as design security, small footprint, and LAPU, at ASIC-like unit costs, making them attractive alternatives to ASICs and CPLDs. With less than 5W static power, our reprogrammable, nonvolatile single-chip IGLOO FPGAs have set a new standard for low-power consumption, delivering much lower static power and much longer battery life in portable applications than other PLDs.
 
 
Electronic content in automotive applications is increasing in all areas, the most obvious being in-dash or in-cab infotainment and telematics, applications, such as GPS navigation and DVD players. However, improved technology, legislated emissions and safety regulations, and increased driver demand for safety and convenience have resulted in the steady increase in the proportion of electronics in the “core automotive systems” — engine control modules, powertrain, transmission, and diagnostic and monitoring systems; body electronics, such as power seats, windows, and locks; and safety systems, such as anti-lock brakes, adaptive cruise control and collision avoidance, emergency response consoles, smart airbags, back-up and side detect radar, tire pressure monitoring, and lane departure systems. For all automotive products, quality, reliability, and cost are of the greatest importance, particularly for the semiconductors used in the safety and system-critical subsystems. Automotive designers are also under great pressure to adapt the ever-changing technology standards, protocols, and legislation to the longevity and model development timescales of the automotive industry, all while meeting the stringent demands of low-cost, high-volume production. These factors, along with expanding component counts, greater time-to-market pressures, and increased performance demands, are causing many automotive designers to use nonvolatile FPGA technologies instead of the hard-wired ASICs they have traditionally relied on for these core automotive system application areas.
 
Compared with hard-wiredASICs, FPGAs offer designers a flexible platform that can more readily adapt to new protocols, standards, and (most importantly) market needs. With an FPGA, the design team can make late stage changes. Indeed, products can even be upgraded when they are already in service with minimal qualification and cost consequences. Product obsolescence is also an issue for automotive designers. FPGA lifecycles are typically longer than lower-volume hard-wired ASIC devices, with some FPGA suppliers only now issuing end-of-life notices for products introduced in the 1980s. Of perhaps greatest importance is the impact of FPGAs on the expensive and time-consuming automotive qualification and validation process. Unlike hard-wired ASICs, once the exhaustive automotive qualification process is complete, FPGAs can also be used in multiple programs/projects, thereby helping designers to minimize the time,resources, and risks associated with automotive qualification activities.
 
With its long-time focus on reliability, cost, and security, the automotive market has clearly begun to recognize the inherent advantages offered by nonvolatile FPGA technologies. Our broad offering of nonvolatile FPGAs are appropriate solutions for automotive applications that require high reliability, firm-error immunity, low power consumption, high junction temperature, small footprint, and design security.
 
 
We maintain a worldwide, multi-tiered selling organization that includes a direct sales force, independent sales representatives, electronics distributors, and value-added resellers. Our North American sales force consists of sales and administrative personnel and field application engineers (FAEs) operating from offices located in major metropolitan areas. Direct sales personnel call on target accounts and support direct original equipment manufacturers (OEMs). In addition to overseeing the activities of direct sales personnel, our sales managers also oversee


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the activities of sales representative firms operating from various office locations. The sales representatives concentrate on selling to major industrial companies in North America. To service smaller, geographically dispersed accounts in North America, we have a distribution agreement with Avnet, which has offices in North America and became our sole North American distributor during 2005. We generate a significant portion of our revenues from international sales. Sales to European customers accounted for 27% of net revenues in 2006, while sales to Pan Asian and Rest of the World (ROW) customers accounted for 22%. Our European and Pan Asian/ROW sales organization consists of employees operating from various sales offices and distributors and sales representatives.
 
Sales made through distributors accounted for 77% of our net revenues in 2006. As is common in the semiconductor industry, we generally grant price protection to distributors. Under this policy, distributors are granted a credit upon a price reduction for the difference between their original purchase price for products in inventory and the reduced price. From time to time, distributors are also granted credit on an individual basis for approved price reductions on specific transactions to meet competition. We also generally grant distributors limited rights to return products. Because of our price protection and return policies, we generally do not recognize revenue on products sold to distributors until the products are resold.
 
Our sales cycle for the initial sale of a design system is generally lengthy and often requires the ongoing participation of sales, engineering, and managerial personnel. After a sales representative or distributor evaluates a customer’s logic design requirements and determines if there is an application suitable for our FPGAs, the next step typically is a visit to the qualified customer by a regional sales manager or an FAE from Actel or one of our distributors or sales representatives. The sales manager or FAE may then determine if additional analysis is required by engineers based at our headquarters.
 
 
Our backlog was $57.2 million at December 31, 2006, compared with $42.6 million at January 1, 2006. We include in our backlog all OEM orders scheduled for delivery over the next nine months and all distributor orders scheduled for delivery over the next six months. We sell standard products that may be shipped from inventory within a short time after receipt of an order. Our business, and to a great extent that of the entire semiconductor industry, is characterized by short-term order and shipment schedules rather than volume purchase contracts. In accordance with industry practice, our backlog generally may be cancelled or rescheduled by the customer on short notice without significant penalty. As a result, our backlog may not be indicative of actual sales and therefore should not be used as a measure of future revenues.
 
 
We believe that premier customer service and technical support are essential for success in the FPGA market. Our customer service organization emphasizes dependable, prompt, accurate responses to questions about product delivery and order status. Many of our customers regularly measure the most significant areas of customer service and technical support. Our FAEs are strategically located around the world to provide technical support to our worldwide customer base. This network of experts is augmented by FAEs working for our sales representatives and distributors throughout the world. Customers in any stage of design may also obtain assistance from our technical support hotline or online interactive automated technical support system. In addition, we offer technical seminars on our products, comprehensive training classes on our software, and functional failure analysis services.
 
We generally warrant that our FPGAs will be free from defects in material and workmanship for one year, and that our software will conform to published specifications for 90 days. To date, we have not experienced significant warranty returns.
 
 
Our strategy is to utilize third-party manufacturers for our wafer requirements, which permits us to allocate our resources to product design, development, and marketing. Our FPGAs in production are manufactured by:
 
  •  Chartered in Singapore using 0.45- and 0.35-micron design rules;


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  •  Infineon in Germany using 0.25- and 0.13-micron design rules;
 
  •  Matsushita in Japan using 1.0-, 0.9and 0.8 micron design rules;
 
  •  UMC in Taiwan using 0.25/ 0.22- and 0.15-micron design rules; and
 
  •  Winbond in Taiwan using 0.8- and 0.45-micron design rules.
 
Wafers purchased from our suppliers are assembled, tested, marked, and inspected by Actel and/or our subcontractors before shipment to customers. We assemble most of our plastic commercial products in China, Hong Kong, South Korea, the Philippines and Singapore. Hermetic package assembly, which is often required for military applications, is performed at one or more subcontractor manufacturing facilities, some of which are in the United States.
 
We invest resources in the continual improvement of our products, processes, and systems. We strive to ensure that our quality and reliability systems conform to standards that have worldwide recognition for improving an organization’s capabilities. We recently were fully recertified for ISO 9001:2000 after a comprehensive audit by NSF International, a leader in quality management systems registrations. We are also STACK, QML, and PURE certified. STACK International consists of major electronic equipment manufacturers serving the worldwide high-reliability and communications markets. Our QML certification confirms that quality management procedures, processes, and controls comply with MIL-PRF-38535, the performance specification used by the U.S. Department of Defense for monolithic ICs. QML certification demonstrates our capability to produce quality products for all types of high reliability, military, and space applications. PURE, an abbreviation for “PEDs (plastic encapsulated devices) Used in Rugged Environments,” is an association of European equipment makers dedicated to quality and reliability. The PURE certification is for plastic quad flat pack packages. The ISO, STACK, QML, and PURE certifications demonstrate that our quality systems conform with internationally-valued standards and confirm our commitment to supply top-quality FPGAs to a diverse customer base.
 
 
We enjoy ongoing strategic relationships with customers, distributors, sales representatives, foundries, assembly houses, and other suppliers of goods and services. Some highlights from 2006 include the following:
 
 
In November 2006, Actel and Aldec announced to two highly integrated solutions designed specifically for our FPGAs in high-reliability avionics and aerospace applications. With the industry’s first hardware/software verification package to ease DO-254 certification, the two companies alleviate the verification bottleneck in the design assurance process. In addition, the companies unveiled a Flash-based prototyping solutions for our space-optimized RTAX-S FPGAs, allowing aerospace customers to tap the flexibility and reprogrammability of Flash-based prototypes for multiple aerospace applications.
 
 
In October 2006, Actel and ARM announced that Actel had licensed the ARM Cortex-M3 processor. The agreement further strengthened the partnership established in March 2005, which resulted in Actel’s CoreMP7, a soft ARM7 family processor core optimized for implementation in Actel’s FPGAs. As part of our ongoing relationship with ARM, we continue to explore current and next-generation technologies that will benefit our mutual customers, thereby increasing the choices available to designers.
 
 
In 2006, Actel and Gaisler expanded their long-standing relationship with the addition of Gaisler to our CompanionCore Partner Program. At the same time, we announced the availability of the Gaisler GRLIB, an RTAX-S-optimized LEON3 processor-based application solution.


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Because we offer our Fusion-based MicroTCA reference design boards for purchase as evaluation tools only, we formed a relationship with MicroBlade to deliver production-volume modules for MicroTCA applications. Customers who wish to purchase turn-key boards in production volumes can work with MicroBlade.
 
 
To provide a more complete Fusion-based MicroTCA solution for our customers, we also partnered with Signal Stream, a leader in MicroTCA design services, to offer design services, support, and customization for the hardware and software.
 
 
In May 2006, Actel and Synplicity announced that the companies had expanded their OEM agreement. Under terms of the multi-year agreement, we obtained the right to distribute the Synplify Pro®, Identify®, Synplify® DSP software solutions to our customers a part of its Libero IDE. The expanded agreement also provides our customers with future access to Synplicity’s innovative physical synthesis technology.
 
 
In October 2006, Actel and UMC announced that the two companies had partnered to produce the award-winning Actel IGLOO low-power FPGA family. UMC’s 0.13-micron low-power and e-Flash processes combined with Actel’s IGLOO power-mode options and Flash*Freeze technology enable power consumption as low as 5W, a new standard for the industry.
 
 
Our research and development expenditures are divided among circuit design, software development, and process technology activities, all of which are involved in the development of new products based on existing or emerging technologies. In the areas of circuit design and process technology, our research and development activities also involve continuing efforts to reduce the cost and improve the performance of current products, including “shrinks” of the design rules under which such products are manufactured. Our software research and development activities include enhancing the functionality, usability, and availability of high-level design and development tools and IP cores in a complete and automated desktop design environment.
 
In 2006, 2005, and 2004, our research and development expenses were $56.9 million, $48.2 million and $45.7 million, respectively. We believe technical leadership and innovation are essential to our future success and we are committed to continuing a significant level of research and development effort. However, there can be no assurance that any of these efforts will be successful, timely, or cost effective.
 
 
We believe that the increasing costs associated with the use of advanced chip manufacturing technology is driving the development and use of standard programmable digital integrated circuits. As with microprocessors and memory, programmable logic devices, such as FPGAs, provide the flexibility for the user to change and define circuits without incurring the cost, risk, and delays of the fabrication of hard-wired ASICs.
 
Competition in the PLD/FPGA market is intense and we expect that to increase as the market grows. We believe our products and technologies are superior than competitive products for many applications requiring low cost, nonvolatility, low power, high reliability and/or greater security. While a few hybrid or alternative approaches have been introduced, no other FPGA vendor has developed a true single-chip, Flash-based FPGA that delivers optimal architecture, technical features, low power, design security and ease of FPGA-to-ASIC migration. However, our primary competitors, Xilinx and Altera, are substantially larger than Actel, offering products to a more extensive customer base, and have substantially greater financial, technical, sales, and other resources. We also expect continued competition from the hard-wired ASIC suppliers and from new companies that may enter PLD or PSC markets.


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We believe that the important competitive factors in our market are price; performance; capacity (total number of usable gates); density (concentration of usable gates); ease of use and functionality of development tools; installed base of development tools; reprogrammability; strength of sales organization and channels; power consumption; reliability; security; adaptability of products to specific applications and IP; ease, speed, cost, and consistency of programming; length of research and development cycle (including migration to finer process geometries); number of I/Os; reliability; wafer fabrication and assembly capacity; availability of packages, adapters, sockets, programmers, and IP; technical service and support; and utilization of intellectual property laws. While we believe we compete favorably with respect to these factors, our failure to compete successfully in any of these areas could have a materially adverse effect on our business, financial condition, or results of operations.
 
 
We currently hold 346 United States patents and applications pending for an additional 114 United States patents. We also have 93 foreign patents and applications pending for 82 patents outside the United States. Our patents cover circuit architectures, antifuse and Flash structures, and programming methods among other things, and expire between 2007 and 2024. We expect to continue filing patent applications as appropriate to protect our proprietary technologies. We believe that patents, along with such factors as innovation, technological expertise, and experienced personnel, will become increasingly important.
 
In connection with the settlement of patent litigation in 1993, we entered into a Patent Cross License Agreement with Xilinx, under which Xilinx was granted a license under certain of our patents that permits Xilinx to make and sell antifuse-based PLDs, and we were granted a license under certain Xilinx patents to make and sell SRAM-based PLDs. Xilinx introduced antifuse-based FPGAs in 1995 and abandoned its antifuse FPGA business in 1996. We announced our intention to develop SRAM-based FPGA products in 1996 and abandoned the development in 1999.
 
In 1995, we entered into a License Agreement with BTR, Inc. (BTR) that was amended and restated in 2000, pursuant to which BTR licensed its proprietary technology to Actel for development and use in FPGAs and certain multichip modules. At the end of 2004, we elected under the License Agreement to convert to a non-exclusive license, as a consequence of which we ceased to pay BTR advance royalties after March 2006. In September 2005, Actel initiated an arbitration proceeding against BTR under the License Agreement to determine Actel’s rights under the License Agreement. This arbitration demand resulted from BTR’s assertion that Actel products were covered by BTR patents and therefore royalties were due under the License Agreement. BTR later added trade secret claims to the arbitration. In December 2006, the parties agreed in principle to settle the case through Actel’s acquisition of the patents and trade secrets at issue, as well as certain other intellectual property assets controlled by BTR and agreed on a purchase price for the acquisition. The parties executed the legal agreements closing the transaction, under which Actel purchased the intellectual property assets for $7.5 million, in March 2007.
 
In connection with the settlement of patent litigation in 1998, we entered into a Patent Cross License Agreement with QuickLogic that covers the products of both companies that were first offered for sale on or before September 4, 2000, or future generations of such products.
 
In December 2006, Zilog, Inc. filed suit against Actel, alleging that Actel products infringed a single patent owned by Zilog. In its answer to the complaint, Actel denied all allegations of infringement. The parties negotiated a settlement prior to any substantive litigation, under which Actel paid Zilog a settlement amount of $0.4 million in exchange for a complete release. The parties executed the settlement agreement in June 2007.
 
As is typical in the semiconductor industry, we have been and expect to be notified from time to time of claims that we may be infringing patents owned by others. When probable and reasonably estimable, we make provision for the estimated settlement costs of claims for alleged infringement. As we sometimes have in the past, we may obtain licenses under patents that we are alleged to infringe. While we believe that reasonable resolution will occur, there can be no assurance that these claims will be resolved or that the resolution of these claims will not have a materially adverse effect on our business, financial condition, or results of operations. Our failure to resolve a claim could result in litigation or arbitration, which can result in significant expense and divert the efforts of our technical and management personnel, whether or not determined in our favor. In addition, our evaluation of the impact of


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these pending disputes could change based upon new information. Subject to the foregoing, we do not believe that the resolution of any pending patent dispute is likely to have a materially adverse effect on our financial position at December 31, 2006, or results of operations or cash flows for the fiscal quarter or year then ended.
 
 
At the end of 2006, we had 574 full-time employees, including 145 in marketing, sales, and customer support; 231 in engineering and research and development; 160 in operations; and 38 in administration and finance. This compares with 565 full-time employees at the end of 2005, an increase of 2%. Net revenues were approximately $334,000 per employee in 2006 compared with approximately $317,000 per employee in 2005, representing an increase of 5%. We have no employees represented by a labor union, have not experienced any work stoppages, and believe that our employee relations are satisfactory.
 
ITEM 1A.   RISK FACTORS
 
Before deciding to purchase, hold, or sell our Common Stock, you should carefully consider the risks described below in addition to the other cautionary statements and risks described elsewhere, and the other information contained, in this Annual Report on Form 10-K and subsequent reports on Forms 10-Q and 8-K. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs with material adverse effects on us, our business, financial condition, and results of operations could be seriously harmed. In that event, the market price for our Common Stock will likely decline and you may lose all or part of your investment.
 
 
Since September 2006, we have been working to resolve issues associated with our stock option practices and accounting. A Special Committee of our Board of Directors (“Special Committee”), with the assistance of independent legal counsel, conducted an extensive review of our stock option practices covering the time from January 1996 through December 2006. The Special Committee concluded that there was inadequate documentation supporting the recorded measurement dates for each of our company-wide annual grants during the period 1996-2001; that there were a number of other grants during the 1996-2001 period for which there was inadequate documentation supporting the recorded measurement dates, including some executive grants and grants to new employees in connection with corporate acquisitions; and that, beginning in 2002, documentation relating to annual and other grants improved substantially, although some minor errors occurred thereafter in the form of corrections or adjustments to grant allocations after the recorded measurement dates. In addition to these awards, we subsequently concluded that there was inadequate documentation supporting the recorded measurement date for four of our company-wide grants during the period 2002-2004, and for one stock option grant in the period from our initial public offering in August 1993 through December 1995. As a result, we determined that we had unrecorded non-cash equity-based compensation charges associated with our equity incentive plans for the period 1994 through 2006. Since these charges were material to our financial statements for the years 1994 through 2005, we are restating our historical financial statements to record additional non-cash charges for stock-based compensation expense.
 
Our historical stock option granting practices and the restatement of our financial statements have exposed us to civil litigation claims and regulatory proceedings, and may expose us to future civil litigation claims, regulatory proceedings, government inquiries, and enforcement actions, that could burden Actel and have a materially adverse effect on our financial condition, business, results of operations, and/or cash flows.
 
Our past stock option granting practices and the restatement of our prior financial statements have exposed and may continue to expose us to greater risks associated with litigation. As described in Part I, Item 3, “Legal Proceedings,” a complaint and two amended complaints have been filed in the United States District Court for the Northern District of California derivatively on our behalf against certain of our current and former officers and


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Directors related to certain stock option grants that were allegedly backdated. We may become subject to additional private lawsuits related to our past stock option granting practices or the restatement of our prior financial statements. The expenses associated with the lawsuit(s) may be significant, the amount of time to resolve and the resolution of the lawsuit(s) is unpredictable, and defending the lawsuit(s) may divert management’s attention from the day-to-day operations of our business, any of which could have a materially adverse effect on our financial condition, business, results of operations, and/or cash flows.
 
In addition, our past stock option granting practices and the restatement of our prior financial statements have exposed and may continue to expose us to greater risks associated with regulatory proceedings and government inquiries and enforcement actions. As described in Part I, Item 3, “Legal Proceedings,” the SEC initiated an informal inquiry into our historical stock option granting practices and closed its file without recommending any enforcement action by the SEC. Any future government inquiries, investigations, or actions could require us to expend significant management time and incur significant legal and other expenses, and could result in civil and criminal actions seeking, among other things, injunctions against us and the payment of significant fines and penalties by us, any of which could have a materially adverse effect on our financial condition, business, results of operations, and/or cash flows.
 
We have not been in compliance with The Nasdaq Stock Market’s continued listing requirements and remain subject to the risk of our stock being delisted from The Nasdaq Global Select Market, which would have a materially adverse effect on us and our shareholders.
 
Due to the Special Committee investigation and resulting restatements, we failed to file a Quarterly Report on Form 10-Q for the third fiscal quarter of 2006, which ended on October 1; an Annual Report on Form 10-K for the 2006 fiscal year, which ended on December 31; a Quarterly Report on Form 10-Q for the first fiscal quarter of 2007, which ended on April 1; a Quarterly Report on Form 10-Q for the second fiscal quarter of 2007, which ended on July 1; and a Quarterly Report on Form 10-Q for the third fiscal quarter of 2007, which ended on September 30, 2007. As a result, and as described in Part I, Item 3, “Legal Proceedings,” we were not in compliance with the filing requirements for continued listing on The Nasdaq Global Select Market as set forth in Marketplace Rule 4310(c)(14) and were subject to delisting from The Nasdaq Global Select Market. With the filing of this Annual Report and our Quarterly Report on Form 10-Q for the third fiscal quarter of 2006, and following the filing of our Quarterly Report on Form 10-Q for the first, second, and third fiscal quarters of 2007, we believe we will have remedied our non-compliance with Marketplace Rule 4310(c)(14), subject to Nasdaq’s affirmative completion of its compliance protocols and its notification to us accordingly. If, however, we do not file our Quarterly Report on Form 10-Q for the first, second, and third fiscal quarters of 2007 or Nasdaq does not concur that we are in compliance with the applicable listing requirements, our Common Stock may be delisted from The Nasdaq Global Select Market and it would be uncertain when, if ever, our Common Stock would be relisted. If a delisting were to occur, the price of our Common Stock and the ability of our shareholders to trade in our Common Stock could be adversely affected and, depending on the duration of the delisting, some institutions whose charters disallow holding securities in unlisted companies might sell our shares, which could have a further adverse effect on the price of our Common Stock.
 
 
We believe our filings comply with all applicable requirements. Nevertheless, the issues surrounding our historical stock option grant practices are complex and the regulatory guidelines or requirements continue to evolve. There can be no assurance that further SEC or other requirements will not evolve or that we will not be required to further amend this or other filings. In addition to the cost and time to amend financial reports, such amendments may have a materially adverse effect on investors and the price of our Common Stock and could result in a delisting of our Common Stock from The Nasdaq Global Select Market.


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A number of our current and former executive officers and Directors have been named as parties to a derivative action lawsuit related to our historical stock option grant practices, and there is a possibility of additional civil litigation claims, regulatory proceedings, government inquiries, and enforcement actions, any of which could result in significant legal expenses.
 
Certain of our current and former officers and Board members are subject to a lawsuit purportedly filed on our behalf, they may become subject to additional private lawsuits. Although we are not aware of any current or former officer or Board member that is currently the subject of any government inquiry, investigation, or action, they could be the subject of future government inquiries, investigations, or other actions related to our historical stock option grant practices. Subject to certain limitations, we are obligated to indemnify our current and former Directors, officers, and employees in connection with the investigation of our historical stock option practices and the pending lawsuit, as well as any future civil litigation claims and government inquiries, investigations or actions. The expenses associated with such matters could have a materially adverse effect on our financial condition, business, results of operations and cash flows.
 
Risks Related to Our Failure to Meet Expectations
 
Our quarterly revenues and operating results are subject to fluctuations resulting from general economic conditions and a variety of risks specific to Actel or characteristic of the semiconductor industry, including booking and shipment uncertainties, supply problems, and price erosion. These and other factors make it difficult for us to accurately project quarterly revenues and operating results, which may fail to meet our expectations. When we fall short of our quarterly revenue expectations, our operating results will probably also be adversely affected because the majority of our expenses are fixed and therefore do not vary with revenues. Any failure to meet expectations could cause our stock price to decline significantly.
 
 
Our backlog (which generally may be cancelled or deferred by customers on short notice without significant penalty) at the beginning of a quarter typically accounts for about half of our revenues during the quarter. This means that we generate about half of our quarterly revenues from orders received during the quarter and “turned” for shipment within the quarter, and that any shortfall in “turns” orders will have an immediate and adverse impact on quarterly revenues. There are many factors that can cause a shortfall in turns orders, including declines in general economic conditions or the businesses of our customers, excess inventory in the channel, and conversion of our products to hard-wired ASICs or other competing products for price or other reasons. In addition, we sometimes book a disproportionately large percentage of turns orders during the final weeks of the quarter. Any failure or delay in receiving expected turns orders would have an immediate and adverse impact on quarterly revenues.
 
 
We sometimes ship a disproportionately large percentage of our quarterly revenues during the final weeks of the quarter, which makes it difficult to accurately project quarterly revenues. Any failure to effect scheduled shipments by the end of a quarter would have an immediate and adverse impact on quarterly revenues.
 
 
Orders from military and aerospace customers tend to be large monetarily and irregular, which contributes to fluctuations in our net revenues and gross margins. These sales are also subject to more extensive governmental regulations, including greater export restrictions. Historically, it has been difficult to predict if and when export licenses will be granted, if required. In addition, products for military and aerospace applications require processing and testing that is more lengthy and stringent than for commercial applications, which increases the complexity of scheduling and forecasting as well as the risk of failure. It is often impossible to determine before the end of processing and testing whether products intended for military or aerospace applications will fail and, if they do fail,


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it is generally not possible for replacements to be processed and tested in time for shipment during the same quarter. Any failure to effect scheduled shipments by the end of a quarter would have an immediate and adverse impact on quarterly revenues.
 
 
We generate the majority of our quarterly revenues from sales made through distributors. Since we generally do not recognize revenue on the sale of a product to a distributor until the distributor resells the product, our quarterly revenues are dependent on, and subject to fluctuations in, shipments by our distributors. We are therefore highly dependent on the accuracy of shipment forecasts from our distributors in setting our expectations. We are also highly dependent on the timeliness and accuracy of resale reports from our distributors. Late or inaccurate resale reports, particularly in the last month of a quarter, contribute to our difficulty in predicting and reporting our quarterly revenues and/or operating results.
 
 
In a typical semiconductor manufacturing process, silicon wafers produced by a foundry are sorted and cut into individual die, which are then assembled into individual packages and tested. The manufacture, assembly, and testing of semiconductor products is highly complex and subject to a wide variety of risks, including defects in photomasks, impurities in the materials used, contaminants in the environment, and performance failures by personnel and equipment. In addition, we may not discover defects or other errors in new products until after we have commenced volume production. Semiconductor products intended for military and aerospace applications and new products, such as our Flash-based Actel Fusion PSCs and ProASIC 3/E FPGAs and antifuse-based Axcelerator FPGAs, are often more complex and more difficult to produce, increasing the risk of manufacturing- and design-related defects. Our failure to effect scheduled shipments by the end of a quarter due to unexpected supply constraints or production difficulties would have an immediate and adverse impact on quarterly revenues.
 
 
As is also common in the semiconductor industry, our independent wafer suppliers from time to time experience lower than anticipated yields of usable die. Wafer yields can decline without warning and may take substantial time to analyze and correct, particularly for a company like Actel that utilizes independent facilities, almost all of which are offshore. Yield problems are most common at new foundries, particularly when new technologies are involved, or on new processes or new products, particularly new products on new processes. Our FPGAs are also manufactured using customized processing steps, which may increase the incidence of production yield problems as well as the amount of time needed to achieve satisfactory, sustainable wafer yields on new processes and new products. In addition, if we discover defects or other errors in a new product that require us to “re-spin” some or all of the product’s mask set, we must expense the photomasks that are replaced. This type of expense is becoming more significant as the cost and complexity of photomask sets continue to increase. Lower than expected yields of usable die or other unanticipated increases in the cost of our products could reduce our gross margin, which would adversely affect our quarterly operating results. In addition, in order to win designs, we generally must price new products on the assumption that manufacturing cost reductions will be achieved, which often do not occur as soon as expected. The failure to achieve expected manufacturing or other cost reductions during a quarter could reduce our gross margin, which would adversely affect our quarterly operating results.
 
 
The semiconductor industry is characterized by intense price competition. The average selling price of a product typically declines significantly between introduction and maturity. We sometimes are required by competitive pressures to reduce the prices of our new products more quickly than cost reductions can be achieved. We also sometimes approve price reductions on specific direct sales for strategic or other reasons, and provide price


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concessions to our distributors for a portion of their original purchase price in order for them to address individual negotiations involving high-volume or competitive situations. Typically, a customer purchasing a small quantity of product for prototyping or development from a distributor will pay list price. However, a customer using our products in volume production will often negotiate a substantial price discount from the distributor. Under such circumstances, the distributor will in turn often negotiate and receive a price concession from Actel. This is a standard practice in the semiconductor industry and we provide some level of price concession to every distributor. Unanticipated declines in the average selling prices of our products could cause our quarterly revenues and/or gross margin to fall short of expectations, which would adversely affect our quarterly financial results.
 
 
In preparing our financial statements in conformity with accounting principles generally accepted in the United States, we must make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and the related disclosure of contingent assets and liabilities. The most difficult estimates and subjective judgments that we make concern income taxes, inventories, legal matters and loss contingencies, revenues, and stock-based compensation expense. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates. If these estimates or their related assumptions change, our operating results for the periods in which we revise our estimates or assumptions could be adversely and perhaps materially affected.
 
 
The price we can charge for our products is constrained principally by our competition. While it has always been intense, we believe that price competition for new designs is increasing. This may be due in part to the transition toward high-level design methodologies. Designers can now wait until later in the design process before selecting a PLD or hard-wired ASIC and it is easier to convert between competing PLDs or between a PLD and a hard-wired ASIC. The increased price competition may also be due in part to the increasing penetration of PLDs into price-sensitive markets previously dominated by hard-wired ASICs. We have strategically targeted many of our products at the value-based market, which is defined primarily by low prices. If our strategy is successful, we will generate an increasingly greater percentage of our net revenues from low-price products, which may make it more difficult to maintain our gross margin at our historic levels. Any long-term decline in our gross margin may have an adverse effect on our operating results.
 
 
In order for us to sell an FPGA, our customer must incorporate our FPGA into the customer’s product in the design phase. We devote substantial resources, which we may not recover through product sales, to persuade potential customers to incorporate our FPGAs into new or updated products and to support their design efforts (including, among other things, providing design and development software). These efforts usually precede by many months (and often a year or more) the generation of FPGA sales, if any. In addition, the value of any design win depends in large part upon the ultimate success of our customer’s product in its market. Our failure to win sufficient designs, or the failure of the designs we win to generate sufficient revenues, could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Our products are complex and may contain errors, manufacturing defects, design defects, or otherwise fail to comply with our specifications, particularly when first introduced or as new versions are released. Our new products are being designed on ever more advanced processes, adding cost, complexity, and elements of experimentation to the development, particularly in the areas of mixed-voltage and mixed-signal design. We rely primarily on our in-


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house personnel to design test operations and procedures to detect any errors prior to delivery of our products to customers.
 
During 2003, several U.S. government contractors reported a small percentage of functional failures in our RTSX-S and SX-A antifuse devices manufactured on a 0.25 micron antifuse process at the original manufacturer of those FPGAs. During 2004, The Aerospace Corporation (Aerospace) proposed a series of experiments to test various hypotheses on the root cause of the failures and to generate reliability data that could be used by space industry participants in deciding whether or not to launch spacecraft with RTSX-S FPGAs that were already integrated. Also during 2004, we announced the availability of RTSX-SU devices from UMC; Aerospace and Actel each recommended that customers switch to UMC-manufactured RTSX-SU devices if their schedules permitted; and we offered to accept RTSX-S parts from the original manufacturer in exchange for RTSX-SU parts. By the fourth quarter of 2004, most customers had decided to switch to RTSX-SU devices. Utilizing all of the available data, Aerospace calculated a failure in time (FIT) rate for our RTSX-SU devices manufactured at UMC of 13 to 34 (depending on the definition of failure) for an average design, mission life, and amount of screening time. A FIT is one failure per billion device-hours, so if a group of devices has a FIT rate of 13 to 34, the customer should expect between 13 and 34 failures per billion device-hours. A billion hours is more than 114 centuries. On February 15, 2006, Aerospace brought to a close the regular meeting of space industry participants on this matter, although testing has continued.
 
 
If problems occur in the operation or performance of our products, we may experience delays in meeting key introduction dates or scheduled delivery dates to our customers, in part because our products are manufactured by third parties. These problems also could cause us to incur significant re-engineering costs, divert the attention of our engineering personnel from our product development efforts, and cause significant customer relations and business reputation problems. Any error or defect might require product replacement or recall or obligate us to accept product returns. Any of the foregoing could have a material adverse effect on our financial results and business in the short and/or long term.
 
 
Product liability claims may be asserted with respect to our products. Our products are typically sold at prices that are significantly lower than the cost of the end-products into which they are incorporated. A defect or failure in our product could cause failure in our customer’s end-product, so we could face claims for damages that are much higher than the revenues and profits we receive from the products involved. In addition, product liability risks are particularly significant with respect to aerospace, automotive, and medical applications because of the risk of serious harm to users of these products. Any product liability claim, whether or not determined in our favor, can result in significant expense, divert the efforts of our technical and management personnel, and harm our business. In the event of an adverse settlement of any product liability claim or an adverse ruling in any product liability litigation, we could incur significant monetary liabilities, which may not be covered by any insurance that we carry and might have a materially adverse effect on our financial condition and/or operating results.
 
 
The market for our products is characterized by rapid technological change, product obsolescence, and price erosion, making the timely introduction of new or improved products critical to our success. Our failure to design, develop, market, and sell new or improved products that satisfy customer needs, compete effectively, and generate acceptable margins may adversely affect our business, financial condition, and/or operating results. While most of our product development programs have achieved a level of success, some have not. For example:
 
  •  We announced our intention to develop SRAM-based FPGA products in 1996 and abandoned the development in 1999 principally because the product would no longer have been competitive.


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  •  We introduced our VariCore embeddable reprogrammable gate array (EPGA) logic core based on SRAM technology in 2001. Revenues from VariCore EPGAs did not materialize and the development of a more advanced VariCore EPGA was cancelled. In this case, a market that we believed would develop did not emerge.
 
  •  In 2001, we also launched our BridgeFPGA initiative to address the I/O problems created within the high-speed communications market by the proliferation of interface standards. We introduced the antifuse-based Axcelerator FPGA, which has dedicated I/O circuits that can support multiple interface standards, in 2002. However, the development of subsequent BridgeFPGA products was postponed in 2002 due principally to the prolonged downturn in the high-speed communications market. The development was cancelled in 2003 primarily because the subsequent BridgeFPGA products would no longer have been competitive.
 
Our experience generally suggests that the risk is greater when we attempt to develop products based in whole or in part on technologies with which we have limited experience. During 2005, we introduced our new Actel Fusion technology, which integrates analog capabilities, Flash memory, and FPGA fabric into a single PSC that may be used with soft processor cores, including the ARM7 processor core that we offer. We have limited experience with analog circuitry and soft processor cores and no prior experience with PSCs.
 
 
When entering a new market, the first-mover typically faces the greatest market and technological challenges. To be successful in the PSC market and realize the advantages of being the initial entrant, we need to understand the market, the competition, and the value proposition that we are bringing to potential customers; identify the early adopters and understand their buying process, decision criteria, and support requirements; and select the right sales channels and provide the right customer service, logistical, and technical support, including training. Any or all of these may be different for the PSC market than for the value-based or system-critical FPGA markets. Meeting these challenges is a top priority for Actel generally and for our sales and marketing organizations in particular. Our failure to meeting these challenges could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
To develop and introduce a product, we must successfully accomplish all of the following:
 
  •  anticipate future customer demand and the technology that will be available to meet the demand;
 
  •  define the product and its architecture, including the technology, silicon, programmer, IP, software, and packaging specifications;
 
  •  obtain access to advanced manufacturing process technologies;
 
  •  design and verify the silicon;
 
  •  develop and release evaluation software;
 
  •  layout the FPGA and other functional blocks along with the circuitry required for programming;
 
  •  integrate the FPGA block with the other functional blocks;
 
  •  simulate (i.e., test) the design of the product;
 
  •  tapeout the product (i.e., compile a database containing the design information about the product for use in the preparation of photomasks);
 
  •  generate photomasks for use in manufacturing the product and evaluate the software;
 
  •  manufacture the product at the foundry;
 
  •  verify the product; and
 
  •  qualify the process, characterize the product, and release production software.


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Each of these steps is difficult and subject to failure or delay, and the failure or delay of any step can cause the failure or delay of the entire development and introduction. In addition to failing to meet our development and introduction schedules for new products or the supporting software or hardware, our new products may not gain market acceptance, and we may not respond effectively to new technological changes or new product announcements by others. Any failure to successfully define, develop, market, manufacture, assemble, test, or program competitive new products could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Our future success is highly dependent upon the timely development and introduction of competitive new products at acceptable margins. However, there are greater design and operational risks associated with new products. The inability of our wafer suppliers to produce advanced products; delays in commencing or maintaining volume shipments of new products; the discovery of product, process, software, or programming defects or failures; and any related product returns could each have a materially adverse effect on our business, financial condition, and/or results of operation.
 
 
As is common in the semiconductor industry, we have experienced from time to time in the past, and expect to experience in the future, difficulties and delays in achieving satisfactory, sustainable yields on new products. The fabrication of antifuse and Flash wafers is a complex process that requires a high degree of technical skill, state-of-the-art equipment, and effective cooperation between Actel and the foundry to produce acceptable yields. Minute impurities, errors in any step of the fabrication process, defects in the photomasks used to print circuits on a wafer, and other factors can cause a substantial percentage of wafers to be rejected or numerous die on each wafer to be non-functional. Yield problems increase the cost of our new products as well as time it takes us to bring them to market, which can create inventory shortages and dissatisfied customers. Any prolonged inability to obtain adequate yields or deliveries of new products could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Our gross margin is the difference between the amount it costs Actel to make our products and the revenues we receive from the sale of those products. One of the most important variables affecting the cost of our products is manufacturing yields. With our customized antifuse and Flash manufacturing process requirements, we almost invariably experience difficulties and delays in achieving satisfactory, sustainable yields on new products. Until satisfactory yields are achieved, gross margins on new products are generally lower than on mature products. The lower gross margins typically associated with new products could have a materially adverse effect on our operating results.
 
 
The semiconductor industry is intensely competitive. Our competitors include suppliers of hard-wired ASICs, CPLDs, and FPGAs. Our biggest direct competitors are Xilinx, Altera, and Lattice, all of which are suppliers of CPLDs and SRAM-based FPGAs; and QuickLogic, a supplier of antifuse-based FPGAs. Altera and Lattice have announced the development of FPGAs manufactured on embedded Flash processes. In addition, we face competition from suppliers of logic products based on new or emerging technologies. While we seek to monitor developments in existing and emerging technologies, our technologies may not remain competitive. We also face competition from companies that specialize in converting our products into hard-wired ASICs.
 
 
We are much smaller than Xilinx and Altera, which have broader product lines, more extensive customer bases, and substantially greater financial and other resources. Additional competition is also possible from major domestic and international semiconductor suppliers, all of which are larger and have broader product lines, more


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extensive customer bases, and substantially greater financial and other resources than Actel, including the capability to manufacture their own wafers. We may not be able to overcome these competitive disadvantages.
 
 
All existing FPGAs not based on antifuse technology and certain CPLDs are reprogrammable. The one-time programmability of our antifuse FPGAs is necessary or desirable in some applications, but logic designers generally prefer to prototype with a reprogrammable logic device. This is because the designer can reuse the device if an error is made. The visibility associated with discarding a one-time programmable device often causes designers to select a reprogrammable device even when an alternative one-time programmable device offers significant advantages. This bias in favor of designing with reprogrammable logic devices appears to increase as the size of the design increases. Although we now offer reprogrammable Flash devices, we may not be able to overcome this competitive disadvantage.
 
 
Our antifuse-based FPGAs and (to a lesser extent) Flash-based PSCs and FPGAs are manufactured using customized steps that are added to otherwise standard manufacturing processes of independent wafer suppliers. There is considerably less operating history for the customized process steps than for the foundries’ standard manufacturing processes. Our dependence on customized processing steps means that, in contrast with competitors using standard manufacturing processes, we generally have more difficulty establishing relationships with independent wafer manufacturers; take longer to qualify a new wafer manufacturer; take longer to achieve satisfactory, sustainable wafer yields on new processes; may experience a higher incidence of production yield problems; must pay more for wafers; and may not obtain early access to the most advanced processes. For example, we expect that our next generation Flash product families will be manufactured on a 90-nanometer process and have found it challenging to identify and procure fabrication process arrangements for our technology development activities. Any of these factors could be a material disadvantage against competitors using standard manufacturing processes. As a result of these factors, our products typically have been fabricated using processes at least one generation behind the processes used by competing products. As a consequence, we generally have not fully realized the benefits of our technologies. Although we are attempting to obtain earlier access to advanced processes, we may not be able to overcome these competitive disadvantages.
 
 
Our performance is subject to events or conditions beyond our control, and the performance of each of our foundries, suppliers, subcontractors, distributors, agents, and customers is subject to events or conditions beyond their control. These events or conditions include labor disputes, acts of public enemies or terrorists, war or other military conflicts, blockades, insurrections, riots, epidemics, quarantine restrictions, landslides, lightning, earthquakes, fires, storms, floods, washouts, arrests, civil disturbances, restraints by or actions of governmental bodies acting in a sovereign capacity (including export or security restrictions on information, material, personnel, equipment, or otherwise), breakdowns of plant or machinery, and inability to obtain transport or supplies. These events or conditions could impair our operations, which may have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Our corporate offices are located in California, which was subject to power outages and shortages during 2001 and 2002. More extensive power shortages in the state could disrupt our operations and interrupt our research and development activities. Our foundry partners in Japan and Taiwan as well as our operations in California are located in areas that have been seismically active in the recent past. In addition, many of the countries outside of the United States in which our foundry partners and assembly and other subcontractors are located have unpredictable and potentially volatile economic, social, or political conditions, including the risks of conflict between Taiwan and China or between North Korea and South Korea. These countries may also be more susceptible to epidemics. For


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example, an outbreak of Severe Acute Respiratory Syndrome (SARS) occurred in Hong Kong, Singapore, and China in 2003. The occurrence of these or similar events or circumstances could disrupt our operations and may have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Our insurance policies provide coverage for only certain types of losses and may not be adequate to fully offset even covered losses. If we were to incur substantial liabilities not adequately covered by insurance, our business, financial condition, and/or operating results could be adversely and perhaps materially affected.
 
 
We rely heavily on, but generally have little control over, our independent foundries, suppliers, subcontractors, and distributors, whose interests may diverge from our interests
 
 
We do not manufacture any of the semiconductor wafers used in the production of our FPGAs. Our wafers are currently manufactured by Chartered in Singapore, Infineon in Germany, Matsushita in Japan, UMC in Taiwan, and Winbond in Taiwan. Our reliance on independent wafer manufacturers to fabricate our wafers involves significant risks, including lack of control over capacity allocation, delivery schedules, the resolution of technical difficulties limiting production or reducing yields, and the development of new processes. Although we have supply agreements with some of our wafer manufacturers, a shortage of raw materials or production capacity could lead any of our wafer suppliers to allocate available capacity to other customers, or to internal uses in the case of Infineon, which could impair our ability to meet our product delivery obligations and may have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
The semiconductor industry has from time to time experienced shortages of manufacturing capacity. When production capacity is tight, the relatively small number of wafers that we purchase from any foundry and the customized process steps that are necessary for our technologies put us at a disadvantage to foundry customers who purchase more wafers manufactured on standard processes. To secure an adequate supply of wafers, we may consider various transactions, including the use of substantial nonrefundable deposits, contractual purchase commitments, equity investments, or the formation of joint ventures. Any of these transactions could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
If our current independent wafer manufacturers were unable or unwilling to manufacture our products as required, we would have to identify and qualify additional foundries. No additional wafer foundries may be able or available to satisfy our requirements on a timely basis. Even if we are able to identify a new third party manufacturer, the costs associated with manufacturing our products may increase. In any event, the qualification process typically takes one year or longer, which could cause product shipment delays, and qualification may not be successful. Any of these developments could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
We rely primarily on foreign subcontractors for the assembly and packaging of our products and, to a lesser extent, for the testing of our finished products. Our reliance on independent subcontractors involves certain risks, including lack of control over capacity allocation and delivery schedules. We generally rely on one or two subcontractors to provide particular services for each product and from time to time have experienced difficulties


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with the timeliness and quality of product deliveries. We have no long-term contracts with our subcontractors and certain of those subcontractors sometimes operate at or near full capacity. Any significant disruption in supplies from, or degradation in the quality of components or services supplied by, our subcontractors could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
We are dependent on independent software and hardware developers for the design, development, supply, maintenance, and support of some of our analog capabilities, IP cores, design and development software, programming hardware, design diagnostics and debugging tool kits, and demonstration boards (or certain elements of those products). Our reliance on independent developers involves certain risks, including lack of control over delivery schedules and customer support. Any failure of or significant delay by our independent developers to complete software and/or hardware under development in a timely manner could disrupt the release of our software and/or the introduction of our new products, which might be detrimental to the capability of our new products to win designs. Any failure of or significant delay by our independent suppliers to provide updates or customer support could disrupt our ability to ship products or provide customer support services, which might result in the loss of revenues or customers. Any of these disruptions could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
In 2006, sales made through distributors accounted for 77% of our net revenues, compared with 64% for 2005. Our distributors offer products of several different companies, so they may reduce their efforts to win new designs or sell our products or give higher priority to other products. This is particularly a concern with respect to any distributor that also sells products of our direct competitors. A reduction in design win or sales effort, termination of relationship, failure to pay for products, or discontinuance of operations because of financial difficulties or for other reasons by one or more of our current distributors could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Although we have contracts with our distributors, the agreements are terminable by either party on short notice. We consolidated our distribution channel in 2001 by terminating our agreement with Arrow Electronics, Inc., which accounted for 13% of our net revenues in 2001. On March 1, 2003, we again consolidated our distribution channel by terminating our agreement with Pioneer-Standard Electronics, Inc., which accounted for 26% of our net revenues in 2002, after which Unique Technologies, Inc. (Unique), a sales division of Memec, was our sole distributor in North America. Unique accounted for 33% of our net revenues in 2004. During 2005, Avnet acquired Memec, after which Avnet became our sole distributor in North America. Avnet accounted for 40% of our net revenues in 2006. Even though Xilinx is Avnet’s biggest line, our transition from Unique to Avnet was generally satisfactory. The loss of Avnet as a distributor, or a significant reduction in the level of design wins or sales generated by Avnet, could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Our distributors occasionally build inventories in anticipation of significant growth in sales and, when such growth does not occur as rapidly as anticipated, substantially reduce the amount of product ordered from us in subsequent quarters. Such a slowdown in orders generally reduces our gross margin because we are unable to take advantage of any manufacturing cost reductions while the distributor depletes its inventory.


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Unlike our older RTSX-S and RTSX-SU space-grade FPGAs, our new RTAX-S space-grade FPGAs are subject to the International Traffic in Arms Regulations (ITAR), which is administered by the U.S. Department of State. ITAR controls not only the export of RTAX-S FPGAs, but also the export of related technical data and defense services as well as foreign production. While we believe that we have obtained and will continue to obtain all required licenses for RTAX-S FPGA exports, we have undertaken corrective actions with respect to the other ITAR controls and are implementing improvements in our internal compliance program. If the corrective actions and improvements were to fail or be ineffective for a prolonged period of time, it could have a materially adverse effect on our business, financial condition, and/or operating results. In addition, the fact that our new RTAX-S space-grade FPGAs are ITAR-controlled may make them less attractive to foreign customers, which could also have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
We purchase almost all of our wafers from foreign foundries and have almost all of our commercial products assembled, packaged, and tested by subcontractors located outside the United States. These activities are subject to the uncertainties associated with international business operations, including trade barriers and other restrictions, changes in trade policies, governmental regulations, currency exchange fluctuations, reduced protection for intellectual property, war and other military activities, terrorism, changes in social, political, or economic conditions, and other disruptions or delays in production or shipments, any of which could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Sales to customers outside North America accounted for 49% of net revenues in 2006 (compared with 44% in 2005), and we expect that international sales will continue to represent a significant portion of our total revenues. International sales are subject to the risks described above as well as generally longer payment cycles, greater difficulty collecting accounts receivable, and currency restrictions. We also maintain foreign sales offices to support our international customers, distributors, and sales representatives, which are subject to local regulation. In addition, international sales are subject to the export laws and regulations of the United States and other countries. Changes in United States export laws that require us to obtain additional export licenses sometimes cause significant shipment delays. Any future restrictions or charges imposed by the United States or any other country on our international sales or sales offices could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
We have experienced substantial period-to-period fluctuations in revenues and operating results due to conditions in the overall economy, in the general semiconductor industry, in our major markets, and at our major customers. We may again experience these fluctuations, which could be adverse and may be severe.
 
 
The semiconductor industry historically has been cyclical and periodically subject to significant economic downturns, which are characterized by diminished product demand, accelerated price erosion, and overcapacity. Beginning in the fourth quarter of 2000, we experienced (and the semiconductor industry in general experienced) reduced bookings and backlog cancellations due to excess inventories at communications, computer, and consumer equipment manufacturers and a general softening in the overall economy. During this downturn, which was severe and prolonged, we experienced lower revenues, which had a substantial negative effect on our operating results. Any future downturns in the semiconductor industry may have a similar adverse effect on our business, financial condition, and/or operating results.


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We estimate that sales of our products to customers in the military and aerospace industries, which carry higher overall gross margins than sales of products to other customers, accounted for 34% of our net revenues for 2006 compared with 41% for 2005, 36% for 2004 and 2003, and 26% for 2001. In general, we believe that the military and aerospace industries have accounted for a significantly greater percentage of our net revenues since the introduction of our Rad Hard FPGAs in 1996 and our Rad Tolerant FPGAs in 1998. Any further downturn in the military and aerospace market could have a materially adverse effect on our revenues and/or operating results.
 
 
In 1994, Secretary of Defense William Perry directed the Department of Defense to avoid government-unique requirements when making purchases and rely more on the commercial marketplace. We believe that this trend toward the use of “off-the-shelf” products generally has helped our business. However, if this trend continued to the point where defense contractors customarily purchased commercial-grade parts rather than military-grade parts, the revenues and gross margins that we derive from sales to customers in the military and aerospace industries would erode, which could have a materially adverse effect on our business, financial condition, and/or operating results. On the other hand, there are signs that this trend toward the use of off-the-shelf products may be reversing. If defense contractors were to use more customized hard-wired ASICs and fewer off-the-shelf products, the revenues and gross margins that we derive from sales to customers in the military and aerospace industries may erode, which could also have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
A relatively small number of customers are responsible for a significant portion our net revenues. We have experienced periods in which sales to one or more of our major customers declined significantly as a percentage of our net revenues. For example, Lockheed Martin accounted for 4% of our net revenues during 2004 compared with 11% during 2003. We believe that sales to a limited number of customers will continue to account for a substantial portion of net revenues in future periods. The loss of a major customer, or decreases or delays in shipments to major customers, could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
We have a mixed history of success in our acquisitions. For example:
 
  •  In 1999, we acquired AGL for consideration valued at $7.2 million. We acquired AGL for technology used in the unsuccessful development of an SRAM-based FPGA.
 
  •  In 2000, we acquired Prosys Technology, Inc. (Prosys) for consideration valued at $26.2 million. We acquired Prosys for technology used in our VariCore FPGA logic core, which was introduced in 2001 but for which no market emerged.
 
  •  Also in 2000, we completed our acquisition of GateField for consideration valued at $45.7 million. We acquired GateField for its Flash technology and ProASIC FPGA family. We introduced the second-generation ProASIC PLUS product family in 2002 and the third-generation ProASIC3/E families in 2005. We also introduced the Flash-based Actel Fusion PSC in 2005. Actel is currently the only company offering FPGAs with a nonvolatile, reprogrammable architecture.
 
In pursuing our business strategy, we may acquire other products, technologies, or businesses from third parties. Identifying and negotiating these acquisitions may divert substantial management time away from our operations. An acquisition could absorb substantial cash resources, require us to incur or assume debt obligations, and/or involve the issuance of additional Actel equity securities. The issuance of additional equity securities may dilute, and could represent an interest senior to, the rights of the holders of our Common Stock. An acquisition could involve significant write-offs (possibly resulting in a loss for the fiscal year(s) in which taken) and would require the


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amortization of any identifiable intangibles over a number of years, which would adversely affect earnings in those years. Any acquisition would require attention from our management to integrate the acquired entity into our operations, may require us to develop expertise outside our existing business, and could result in departures of management from either Actel or the acquired entity. An acquired entity could have unknown liabilities, and our business may not achieve the results anticipated at the time of the acquisition. The occurrence of any of these circumstances could disrupt our operations and may have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Pending or new accounting pronouncements, corporate governance or public disclosure requirements, or tax regulatory rulings could have an impact, possibly material and adverse, on our business, financial condition, and/or operating results. Any change in accounting pronouncements, corporate governance or public disclosure requirements, or taxation rules or practices, as well as any change in the interpretation of existing pronouncements, requirements, or rules or practices, may call into question our SEC or tax filings and could affect our reporting of transactions completed before the change.
 
 
In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment: An Amendment of FASB Statements No. 123 and 95.” SFAS No. 123(R) eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and instead requires companies to recognize compensation expense using a fair-value based method for costs related to share-based payments, including stock options and employee stock purchase plans. We implemented the standard in the fiscal year that began January 2, 2006, and the adoption of SFAS No. 123(R) had a material effect on our consolidated operating results and earnings per share.
 
In addition, we historically have used stock options as a key component of employee compensation in order to align employees’ interests with the interests of our shareholders, encourage employee retention, and provide competitive compensation packages. To the extent that SFAS No. 123(R) or other new regulations make it more difficult or expensive to grant options to employees, we may incur increased out-of-pocket compensation costs, change our equity compensation strategy, or find it difficult to attract, retain, and motivate employees. Any of these results could materially and adversely affect our business and/or operating results.
 
 
Changing laws, regulations, and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002 and new SEC regulations and Nasdaq National Market rules, have resulted in significant additional expense. We are committed to maintaining high standards of corporate governance and public disclosure, and therefore have invested the resources necessary to comply with the evolving laws, regulations, and standards. This investment has resulted in increased general and administrative expenses as well as a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations, and standards differ from the activities intended by regulatory or governing bodies, we might be subject to lawsuits or sanctions or investigation by regulatory authorities, such as the SEC or The Nasdaq National Market, and our reputation may be harmed.
 
We evaluated our internal controls systems in order to allow management to report on, and our independent public accountants to attest to, our internal controls, as required by Section 404 of the Sarbanes-Oxley Act. In performing the system and process evaluation and testing required to comply with the management certification and auditor attestation requirements of Section 404, we incurred significant additional expenses, which adversely affected our operating results and financial condition and diverted a significant amount of management’s time. While we believe that our internal control procedures are adequate, we may not be able to continue complying with the requirements relating to internal controls or other aspects of Section 404 in a timely fashion. If we were not able


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to comply with the requirements of Section 404 in a timely manner in the future, we may be subject to lawsuits or sanctions or investigation by regulatory authorities. Any such action could adversely affect our financial results and the market price of our Common Stock. In any event, we expect that we will continue to incur significant expenses and diversion of management’s time to comply with the management certification and auditor attestation requirements of Section 404.
 
 
As is typical in the semiconductor industry, we are notified from time to time of claims that we may be infringing patents owned by others. As we sometimes have in the past, we may obtain licenses under patents that we are alleged to infringe. Although patent holders commonly offer licenses to alleged infringers, we may not be offered a license for patents that we are alleged to infringe or we may not find the terms of any offered licenses acceptable. We may not be able to resolve any claim of infringement, and the resolution of any claim may have a materially adverse effect on our business, financial condition, and/or operating results.
 
Our failure to resolve any claim of infringement could result in litigation or arbitration. During 2006, we were involved with BTR in an arbitration, which settled on March 16, 2007, with Zilog in litigation, which settled on June 11, 2007 (see “BUSINESS — Patents and Licenses”). In addition, we have agreed to defend our customers from and indemnify them against claims that our products infringe the patent or other intellectual rights of third parties. All litigation and arbitration proceedings, whether or not determined in our favor, can result in significant expense and divert the efforts of our technical and management personnel. In the event of an adverse ruling in any litigation or arbitration involving intellectual property, we could suffer significant (and possibly treble) monetary damages, which could have a materially adverse effect on our business, financial condition, and/or operating results. We may also be required to discontinue the use of infringing processes; cease the manufacture, use, and sale or licensing of infringing products; expend significant resources to develop non-infringing technology; or obtain licenses under patents that we are infringing. In the event of a successful claim against us, our failure to develop or license a substitute technology on commercially reasonable terms could also have a materially adverse effect on our business, financial condition, and/or operating results.
 
We have devoted significant resources to research and development and believe that the intellectual property derived from such research and development is a valuable asset important to the success of our business. We rely primarily on patent, trademark, and copyright laws combined with nondisclosure agreements and other contractual provisions to protect our proprietary rights. The steps we have taken may not be adequate to protect our proprietary rights. In addition, the laws of certain territories in which our products are developed, manufactured, or sold, including Asia and Europe, may not protect our products and intellectual property rights to the same extent as the laws of the United States. Our failure to enforce our patents, trademarks, or copyrights or to protect our trade secrets could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
Our success is dependent in large part on our ability to attract and retain key managerial, engineering, marketing, sales, and support employees. Particularly important are highly skilled design, process, software, and test engineers involved in the manufacture of existing products and the development of new products and processes. The failure to recruit employees with the necessary technical or other skills or the loss of key employees could have a materially adverse effect on our business, financial condition, and/or operating results. From time to time we have experienced growth in the number of our employees and the scope of our operations, resulting in increased responsibilities for management personnel. To manage future growth effectively, we will need to attract, hire, train, motivate, manage, and retain a growing number of employees. During strong business cycles, we expect to experience difficulty in filling our needs for qualified engineers and other personnel. Any failure to attract and retain qualified employees, or to manage our growth effectively, could delay product development and introductions or otherwise have a materially adverse effect on our business, financial condition, and/or operating results.


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We have adopted an Employee Retention Plan that provides for payment of a benefit to our employees who hold unvested stock options or restricted stock units (RSUs) in the event of a change of control. Payment is contingent upon the employee remaining employed for six months after the change of control (unless the employee is terminated without cause during the six months). Each of our executive officers has also entered into a Management Continuity Agreement, which provides for the acceleration of stock options and RSUs unvested at the time of a change of control in the event the executive officer’s employment is actually or constructively terminated other than for cause following the change of control. While these arrangements are intended to make executive officers and other employees neutral towards a potential change of control, they could have the effect of biasing some or all executive officers or employees in favor of a change of control.
 
Our Articles of Incorporation authorize the issuance of up to 5,000,000 shares of “blank check” Preferred Stock with designations, rights, and preferences determined by our Board of Directors. Accordingly, our Board is empowered, without approval by holders of our Common Stock, to issue Preferred Stock with dividend, liquidation, redemption, conversion, voting, or other rights that could adversely affect the voting power or other rights of the holders of our Common Stock. Issuance of Preferred Stock could be used to discourage, delay, or prevent a change in control. In addition, issuance of Preferred Stock could adversely affect the market price of our Common Stock.
 
On October 17, 2003, our Board of Directors adopted a Shareholder Rights Plan. Under the Plan, we issued a dividend of one right for each share of Common Stock held by shareholders of record as of the close of business on November 10, 2003. The provisions of the Plan can be triggered only in certain limited circumstances following the tenth day after a person or group announces acquisitions of, or tender offers for, 15% or more of our Common Stock. The Shareholder Rights Plan is designed to guard against partial tender offers and other coercive tactics to gain control of Actel without offering a fair and adequate price and terms to all shareholders. Nevertheless, the Plan could make it more difficult for a third party to acquire Actel, even if our shareholders support the acquisition.
 
 
The stock markets broadly, technology companies generally, and our Common Stock in particular have experienced extreme price and volume volatility in recent years. Our Common Stock may continue to fluctuate substantially on the basis of many factors, including:
 
  •  quarterly fluctuations in our financial results or the financial results of our competitors or other semiconductor companies;
 
  •  changes in the expectations of analysts regarding our financial results or the financial results of our competitors or other semiconductor companies;
 
  •  announcements of new products or technical innovations by Actel or by our competitors; or
 
  •  general conditions in the semiconductor industry, financial markets, or economy.
 
 
We account for goodwill and other intangible assets under SFAS No. 142, “Goodwill and Other Intangible Assets.” Under this standard, goodwill is tested for impairment annually or more frequently if certain events or changes in circumstances indicate that the carrying amount of goodwill exceeds its implied fair value. The two-step impairment test identifies potential goodwill impairment and measures the amount of a goodwill impairment loss to be recognized (if any). The first step of the goodwill impairment test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. We are a single reporting unit under SFAS No. 142, so we use the enterprise approach to compare fair value with book value. Since the best evidence of fair value is quoted market prices in active markets, we use our market capitalization as the basis for the measurement. As long as our market capitalization is greater than our book value and we remain a single reporting unit, our goodwill will be considered not impaired, and the second step of the impairment test will be unnecessary. If


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our market capitalization were to fall below our book value, we would proceed to the second step of the goodwill impairment test, which measures the amount of impairment loss by comparing the implied fair value of our goodwill with the carrying amount of our goodwill. As long as we remain a single reporting entity, we believe that the difference between the implied fair value of our goodwill and the carrying amount of our goodwill would equal the difference between our market capitalization and our book value. Accordingly, if our market capitalization fell below our book value and we remained a single reporting unit, we expect that we would write down our goodwill, and recognize a goodwill impairment loss, equal to the difference between our market capitalization and our book value.
 
ITEM 1B.   UNRESOLVED STAFF COMMENTS
 
None.
 
ITEM 2.   PROPERTIES
 
Our principal facilities and executive offices are located in Mountain View, California, in two buildings that comprise approximately 158,000 square feet. These buildings are leased through June 2013. We have a renewal option for an additional ten-year term. In addition to our facility in Mountain View, we also lease sales offices in various countries around the world to support our worldwide customer base. We believe our facilities will be adequate for the foreseeable future.
 
ITEM 3.   LEGAL PROCEEDINGS
 
 
 
On August 30, 2006, a shareholder derivative action was filed in the United States District Court for the Northern District of California, entitled Frank Brozovich v. John C. East, et al., 06-cv-05352-JW, against certain of our former and current officers and directors alleging that the individual defendants violated Section 10(b)/Rule 10b-5 of the Securities Exchange Act of 1934 (the “Exchange Act”), breached their fiduciary duties, and were unjustly enriched in connection with the timing of stock option grants from 1996 to 2001. In addition, on November 2, 2006, a second nearly identical shareholder derivative complaint, entitled Samir Younan v. John C. East, et al., 5:06-cv-06832-JW, was filed in the same court. Younan alleged further causes of action in connection with the timing of stock option grants from 1994 to 2000, including violations of Sections 14(a) and 20(a) of the Exchange Act, and violation of California Corporation Code Section 25402. On January 10, 2007, these cases were consolidated as In re Actel Derivative Litigation, 5:06-cv-05352-JW and plaintiffs Younan and Brozovich were appointed lead plaintiffs. Plaintiffs filed a consolidated complaint on February 9, 2007. The consolidated complaint alleges causes of action in connection with the timing of stock option grants from 1996 to 2002, including violations of Sections 10(b), 14(a), and 20(a) of the Exchange Act, breach of fiduciary duty, accounting, unjust enrichment, and violation of California Corporation Code Section 25402. Actel is named solely as a nominal defendant against whom no recovery is sought. The Company and the individual defendants intend to defend these cases vigorously.
 
 
By a letter dated November 2, 2006, we were informed by the SEC’s Office of Enforcement that it was conducting an informal inquiry to determine whether there had been violations of the federal securities laws. The letter asked us to produce (i) spreadsheets identifying all stock options granted to any of our employees or members of the Board of Directors since January 1, 1997; (ii) documents constituting our policies, practices, and procedures for granting stock options during such period; and (iii) public disclosures of our policies, practices, and procedures and how we accounted for stock option grants during such period. We voluntarily produced the requested documents and the Special Committee and its independent counsel periodically apprised the SEC’s Office of Enforcement staff on the status of the independent investigation. By a letter dated May 23, 2007, we were informed by the SEC’s Office of Enforcement staff that it had closed its file and would not recommend any enforcement action by the SEC.


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On November 13, 2006, we received notice from The Nasdaq Stock Market (“Nasdaq”) of a staff determination that we were not in compliance with the requirement for continued listing set forth in Nasdaq Marketplace Rule 4310(c)(14). Under that Rule, listed companies must file with the SEC all required reports. Our noncompliance was a result of the ongoing stock option review and our related failure to file with the SEC a Quarterly Report on Form 10-Q for the fiscal quarter ended October 1, 2006. On January 3, 2007, we received an additional staff determination notice that we were not in compliance with the requirement for continued listing set forth in Nasdaq Marketplace Rules 4350(e) and 4350(g). Under those Rules, listed companies must hold an annual meeting of shareholders, solicit proxies, and provide proxy statements to Nasdaq. Our noncompliance was a result of the ongoing review and related failure to hold an annual shareholder meeting in 2006.
 
We appealed the Nasdaq staff’s determinations at a hearing held on January 11, 2007. On February 16, 2007, a Nasdaq Listing Qualifications Panel (the “Panel”) determined to continue our listing and grant our request for an extension until May 17, 2007, to file our delinquent filings and any required financial restatements and to hold our annual meeting, subject to us providing the Panel with either a copy of the Special Committee’s final investigatory report or a written submission regarding the Special Committee’s final investigatory results. On March 16, 2007, we provided the Panel with the required written submission. On March 20, 2007, we received an additional staff determination notice relating to our failure to file with the SEC an Annual Report on Form 10-K for the fiscal year ended December 31, 2006. On May 18, 2007, the Panel determined to delist our securities, but stayed the suspension pending further action by the Nasdaq Listing and Hearing Review Council (“Listing Council”).
 
On April 2, 2007, the Listing Council called the Panel’s decision for review and determined to stay the Panel’s decision pending further action by the Listing Council. The Nasdaq Listing Qualifications Department provided the Listing Council with an updated qualifications summary sheet on June 26, 2007, and we submitted additional information to the Listing Council on June 29, 2007. On May 15, 2007, we received an additional staff determination notice relating to our failure to file with the SEC a Quarterly Report on Form 10-Q for the fiscal quarter ended April 1, 2007. On August 13, 2007, we received an additional staff determination notice relating to our failure to timely file with the SEC a Quarterly Report on Form 10-Q for the fiscal quarter ended July 1, 2007. On August 23, 2007, the Listing Counsel granted us an extension until October 22, 2007, to demonstrate compliance with all continued listing requirements.
 
As we requested on October 9, 2007, the Nasdaq Board of Directors (the “Nasdaq Board”) on October 17, 2007, called for review the August 23, 2007, decision of the Listing Council, and stayed the suspension of our securities from trading, pending further consideration by the Nasdaq Board. On November 9, 2007, the Nasdaq Board granted us an extension until January 9, 2008, to file all delinquent periodic reports necessary to regain compliance with the filing requirement contained in Rule 4310(c)(14). On November 13, 2007, we received an additional staff determination notice relating to our failure to timely file with the SEC a Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2007. As we requested on January 4, 2008, the Nasdaq Board on January 8, 2008, granted us an extension until February 20, 2008, to file all delinquent periodic reports necessary to regain compliance with the filing requirement contained in Rule 4310(c)(14). We have filed this Annual Report on Form 10-K for the fiscal year ended December 31, 2006, with the SEC as part of our initial effort to resume our timely reporting and meet Nasdaq’s continued listing requirements.
 
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
None.
 
PART II
 
ITEM 5.   MARKET FOR THE REGISTRANT’S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Our Common Stock has been traded on the Nasdaq National Market under the symbol “ACTL” since our initial public offering on August 2, 1993. On January 11, 2008, there were 122 shareholders of record. The following table


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sets forth, for the fiscal quarters indicated, the high and low sale prices per share of our Common Stock as reported on the Nasdaq National Market.
 
                                 
    2006     2005  
    High     Low     High     Low  
 
First Quarter
  $ 15.95     $ 12.64     $ 18.64     $ 14.78  
Second Quarter
    17.53       13.20       15.54       13.65  
Third Quarter
    16.40       12.40       15.98       13.35  
Fourth Quarter
    19.36       15.00       15.25       12.52  
 
On January 16, 2008, the reported last sale of our Common Stock on the Nasdaq National Market was $12.07.
 
We have never declared or paid a cash dividend on our Common Stock and do not anticipate paying any cash dividends in the foreseeable future. Any future declaration of dividends is within the discretion of our Board of Directors and will be dependent on our earnings, financial condition, and capital requirements as well as any other factors deemed relevant by our Board of Directors.
 
ITEM 6.   SELECTED FINANCIAL DATA
 
The consolidated balance sheet as of January 1, 2006 and the consolidated statements of operations for the fiscal years ended January 1, 2006 and January 2, 2005 have been restated as set forth in this Form 10-K. The data for the consolidated balance sheets as of January 2, 2005, January 4, 2004, and January 5, 2003 and the consolidated statements of operations for the fiscal years ended January 4, 2004 and January 5, 2003, derived from our books and records, have been restated to include stock-based compensation and other adjustments. The information set forth below is not necessarily indicative of results of future operations, and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and related notes thereto included in Item 8 of this Form 10-K to fully understand factors that may affect the comparability of the information presented below. The information presented in the following tables has been adjusted to reflect the restatement of our financial results, which is more fully described in the “Explanatory Note” immediately preceding Part I, Item 1 and in Note 2, “Restatement of Consolidated Financial Statements,” in the Notes to Consolidated Financial Statements of this Form 10-K, and should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Actel has not amended its previously-filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the periods affected by this restatement. The financial information that has been previously filed or otherwise reported for these periods is superseded by the information in this Annual Report on Form 10-K, and the


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financial statements and related financial information contained in such previously-filed reports should no longer be relied upon.
 
ACTEL CORPORATION
SELECTED CONSOLIDATED FINANCIAL DATA
 
                                         
    Years Ended  
    Dec. 31, 2006     Jan. 1, 2006     Jan. 2, 2005     Jan. 4, 2004     Jan. 5, 2003  
          Restated(1)     Restated(1)     Restated(1)     Restated(1)  
    (In thousands, except per share data)  
 
Consolidated Statements of Operations Data:
                                       
Net revenues
  $ 191,499     $ 178,947     $ 165,402     $ 149,910     $ 134,096  
Costs and expenses:
                                       
Total cost of revenues(2)(4)
    75,618       73,282       70,404       59,867       53,011  
Research and development(4)
    56,926       48,242       45,701       41,720       40,798  
Selling, general, and administrative(4)(5)(6)
    67,959       49,649       47,975       46,422       44,269  
Amortization of acquisition-related intangibles(3)
    15       1,908       2,651       2,670       2,724  
                                         
Total costs and expenses
    200,518       173,081       166,731       150,679       140,802  
                                         
Income (loss) from operations
    (9,019 )     5,866       (1,329 )     (769 )     (6,706 )
Interest income and other, net of expense
    7,128       3,912       3,398       3,190       5,561  
Gain (loss) on sales and write-downs of equity investments
                      91       (3,707 )
                                         
Income (loss) before tax provision (benefit)
    (1,891 )     9,778       2,069       2,512       (4,852 )
Tax provision (benefit)
    264       2,742       (705 )     (1,043 )     (2,878 )
                                         
Net income (loss)
  $ (2,155 )   $ 7,036     $ 2,774     $ 3,555     $ (1,974 )
                                         
Net income (loss) per share:
                                       
Basic
  $ (0.08 )   $ 0.28     $ 0.11     $ 0.14     $ (0.08 )
                                         
Diluted
  $ (0.08 )   $ 0.28     $ 0.11     $ 0.14     $ (0.08 )
                                         
Shares used in computing net income (loss) per share:
                                       
Basic
    26,106       25,277       25,584       24,808       24,302  
                                         
Diluted
    26,106       25,545       26,381       26,190       24,302  
                                         
 
                                         
    As of  
    Dec. 31, 2006     Jan. 1, 2006     Jan. 2, 2005     Jan. 4, 2004     Jan. 5, 2003  
          Restated(1)     Restated(1)     Restated(1)     Restated(1)  
    (In thousands)  
 
Consolidated Balance Sheet Data:
                                       
Working capital
  $ 191,278     $ 177,491     $ 194,613     $ 190,545     $ 170,632  
Total assets
    368,922       343,196       318,171       319,637       295,101  
Total shareholders’ equity
    290,616       276,057       267,816       266,780       244,787  
 
 
(1) See the “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatement of Consolidated Financial Statements,” in the Notes to Consolidated Financial Statements of this Form 10-K, and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We recorded after-tax, stock-based compensation expense of ($0.2) million, ($0.5) million, $2.7 million, and $1.9 million in 2005, 2004, 2003 and 2002, respectively, as a result of improper measurement dates, equity awards to consultants,


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equity award modifications and related payroll and income tax impact. As part of the restatement, for the years ended January 1, 2006, January 2, 2005 and January 4, 2004 we recorded additional non-cash adjustments that were previously identified and considered not to be material to our consolidated financial statements, relating primarily to errors associated with the recognition of deferred income at our European distributors. These deferred income adjustments decreased net income by $0.2 million, $0.1 million and $0.1 million, respectively, in fiscal 2005, 2004 and 2002.
 
(2) During the fourth quarter of 2004 we incurred incremental charges included in cost of revenues of $3.2 million for expenses associated with the testing of the RTSX-S space qualified FPGAs and the write down of RTSX-S inventory from the original manufacturer. During the fourth quarter of fiscal 2006 we recorded charges of $2.2 million in connection with the write-down of certain excess inventory.
 
(3) Beginning in 2002, we ceased to amortize goodwill in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Instead, goodwill is subject to annual impairment tests and written down only when identified as impaired. Non-goodwill intangible assets with definite lives continue to be amortized under SFAS No. 141 and 142. See Notes 1 and 3 of Notes to Consolidated Financial Statements for further information.
 
(4) On January 2, 2006, we adopted SFAS No. 123R, “Share-Based Payment,” which requires us to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. As a result, we recorded pre-tax, stock based compensation expense of $11.0 million for fiscal 2006 under SFAS No. 123R.
 
(5) During fiscal 2006 we recorded charges of $10.0 million and $0.4 million in connection with the settlement of certain patent and license infringement claims. See Note 14 to Consolidated Financial Statements for further information.
 
(6) During fiscal 2006 we incurred $2.0 million of legal and accounting costs in connection with the Company’s stock options investigation that was initiated during the fourth quarter of fiscal 2006.


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The impact of the restatement and a comparison to the amounts originally reported are detailed in the tables below:
 
Consolidated Statements of Operations Data (in thousands, except per share data):
 
                                                 
    Year Ended January 1, 2006     Year Ended January 2, 2005  
    As Previously
                As Previously
             
    Reported     Adjustments     As Restated     Reported     Adjustments     As Restated  
 
Net revenues
  $ 179,397     $ (450 )   $ 178,947     $ 165,536     $ (134 )   $ 165,402  
Costs and expenses:
                                               
Cost of revenues
    73,392       (110 )     73,282       70,451       (47 )     70,404  
Research and development
    48,173       69       48,242       45,360       341       45,701  
Selling, general, and administrative
    50,056       (407 )     49,649       48,269       (294 )     47,975  
Amortization of acquisition-related intangibles
    1,908             1,908       2,651             2,651  
                                                 
Total costs and expenses
    173,529       (448 )     173,081       166,731             166,731  
                                                 
Income (loss) from operations
    5,868       (2 )     5,866       (1,195 )     (134 )     (1,329 )
Interest income and other, net of expense
    3,924       (12 )     3,912       2,935       463       3,398  
                                                 
Income before tax provision (benefit)
    9,792       (14 )     9,778       1,740       329       2,069  
Tax provision (benefit)
    2,756       (14 )     2,742       (654 )     (51 )     (705 )
                                                 
Net income
  $ 7,036     $     $ 7,036     $ 2,394     $ 380     $ 2,774  
                                                 
Net income per share:
                                               
Basic
  $ 0.28     $ 0.00     $ 0.28     $ 0.09     $ 0.01     $ 0.11  
                                                 
Diluted
  $ 0.28     $ 0.00     $ 0.28     $ 0.09     $ 0.01     $ 0.11  
                                                 
Shares used in computing net income per share:
                                               
Basic
    25,277             25,277       25,584             25,584  
                                                 
Diluted
    25,556       (11 )     25,545       26,421       (40 )     26,381  
                                                 
 


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    Year Ended January 4, 2004     Year Ended January 5, 2003  
    As Previously
                As Previously
             
    Reported     Adjustments     As Restated     Reported     Adjustments     As Restated  
 
Net revenues
  $ 149,910     $     $ 149,910     $ 134,368     $ (272 )   $ 134,096  
Costs and expenses:
                                               
Cost of revenues
    59,734       133       59,867       52,935       76       53,011  
Research and development
    39,602       2,118       41,720       39,349       1,449       40,798  
Selling, general, and administrative
    44,650       1,772       46,422       43,033       1,236       44,269  
Amortization of acquisition-related intangibles
    2,670             2,670       2,724             2,724  
                                                 
Total costs and expenses
    146,656       4,023       150,679       138,041       2,761       140,802  
                                                 
Income (loss) from operations
    3,254       (4,023 )     (769 )     (3,673 )     (3,033 )     (6,706 )
Interest income and other, net of expense
    3,210       (20 )     3,190       5,530       31       5,561  
Gain (loss) on sales and write-downs of equity investments
    91             91       (3,707 )           (3,707 )
                                                 
Income (loss) before tax provision (benefit)
    6,555       (4,043 )     2,512       (1,850 )     (3,002 )     (4,852 )
Tax provision (benefit)
    327       (1,370 )     (1,043 )     (1,925 )     (953 )     (2,878 )
                                                 
Net income (loss)
  $ 6,228     $ (2,673 )   $ 3,555     $ 75     $ (2,049 )   $ (1,974 )
                                                 
Net income (loss) per share:
                                               
Basic
  $ 0.25     $ (0.11 )   $ 0.14     $ 0.00     $ (0.08 )   $ (0.08 )
                                                 
Diluted
  $ 0.24     $ (0.10 )   $ 0.14     $ 0.00     $ (0.08 )   $ (0.08 )
                                                 
Shares used in computing net income (loss) per share:
                                               
Basic
    24,808             24,808       24,302             24,302  
                                                 
Diluted
    26,300       (110 )     26,190       25,252       (950 )     24,302  
                                                 
 
Consolidated Balance Sheet Data (in thousands):
 
                                                 
    Year Ended January 1, 2006     Year Ended January 2, 2005  
    As Previously
                As Previously
             
    Reported     Adjustments     As Restated     Reported     Adjustments     As Restated  
 
Working capital(1)
  $ 176,961     $ 530     $ 177,491     $ 194,472     $ 141     $ 194,613  
Total assets
    340,389       2,807       343,196       315,290       2,881       318,171  
Total shareholders’ equity
    272,721       3,336       276,057       264,793       3,023       267,816  
 
 
(1) Working capital balance As Previously Reported for the year ended January 1, 2006 includes a reclassification of $1.6 million of previously reported long-term investments to short-term to conform to current presentation.
 
                                                 
    Year Ended January 4, 2004     Year Ended January 5, 2003  
    As Previously
                As Previously
             
    Reported     Adjustments     As Restated     Reported     Adjustments     As Restated  
 
Working capital
  $ 191,078     $ (533 )   $ 190,545     $ 169,939     $ 693     $ 170,632  
Total assets
    316,757       2,880       319,637       293,321       1,780       295,101  
Total shareholders’ equity
    264,433       2,347       266,780       242,314       2,473       244,787  

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ITEM 7.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
You should read the following discussion of our financial condition and results of operations in conjunction with our Consolidated Financial Statements and the related “Notes to Consolidated Financial Statements”, and “Financial Statement Schedules” and “Supplementary Financial Data” included in this Annual Report on Form 10-K. This Annual Report on Form 10-K, including the “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, contains forward-looking statements regarding future events and the future results of our Company that are based on current expectations, estimates, forecasts, and projections about the industry in which we operate and the beliefs and assumptions of our management. Words such as ‘expects,’ ‘anticipates,’ ‘targets,’ ‘goals,’ ‘projects,’ ‘intends,’ ‘plans,’ ‘believes,’ ‘seeks,’ ‘estimates,’ variations of such words, and similar expressions are intended to identify such forward-looking statements. These forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in this Report under the section entitled “Risk Factors” in Item 1A of Part I and elsewhere, and in other reports we file with the Securities and Exchange Commission (“SEC”), specifically the most recent reports on Form 10-Q. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.
 
 
This Annual Report on Form 10-K for the fiscal year ended December 31, 2006 (“2006 Form 10-K”), includes restatements of the following previously-filed financial statements and data (and related disclosures): (i) our consolidated balance sheet as of January 1, 2006, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the fiscal years ended January 1, 2006 and January 2, 2005; (ii) our selected financial data as of and for the fiscal years ended January 1, 2006, January 2, 2005, January 4, 2004, and January 5, 2003, (iii) our management’s discussion and analysis of financial condition and results of operations as of and for the fiscal years ended January 1, 2006 and January 2, 2005, and (iv) our unaudited quarterly financial information for the first two quarters in the fiscal year ended December 31, 2006, and for all four quarters in the fiscal year ended January 1, 2006. We also recorded adjustments affecting previously-reported financial statements for fiscal years 1994 through 2003, the effects of which are summarized in cumulative adjustments to additional paid-in capital, deferred stock-based compensation, and retained earnings as of January 4, 2004. All restatements are a result of an independent stock option investigation conducted by a Special Committee of our Board of Directors and additional reviews conducted by our management.
 
Financial information included in our reports on Form 10-K, Form 10-Q, and Form 8-K filed with the Securities and Exchange Commission (“SEC”) before January 18, 2007, and the related opinions of our independent registered public accounting firm, and all of our earnings press releases and similar communications issued before January 18, 2007, should not be relied upon and are superseded in their entirety by this 2006 Form 10-K and our other reports on Form 10-Q and Form 8-K filed with the SEC on or after January 18, 2007.
 
Stock Option Reviews, Investigation, and Informal Inquiry
 
On August 30, 2006, a complaint was filed in the United States District Court for the Northern District of California derivatively on behalf of Actel against certain of our current and former officers and Directors. The derivative action relates to certain stock option grants that were allegedly backdated. On September 8, 2006, our Board of Directors directed management to conduct an informal review of our historical stock option grants. On September 21, 2006, our management found evidence indicating that the recipients of a stock option grant in 2000 were not determined with finality by the recorded measurement date. On September 22, 2006, our Board of Directors appointed a Special Committee of independent directors to formally investigate our historical stock option grant practices and related accounting. The Special Committee retained an independent law firm and forensic team of professionals (collectively, the “Investigation Team”), to assist the Committee in conducting a thorough investigation.


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We voluntarily notified the SEC about the independent investigation prior to announcing it publicly on October 2, 2006. By a letter dated November 2, 2006, we were informed by the SEC’s Office of Enforcement that it was conducting an informal inquiry to determine whether there had been violations of the federal securities laws. We voluntarily disclosed the requested information and otherwise cooperated with the Office of Enforcement, which notified us by a letter dated May 23, 2007, that it had closed its file and would not recommend any enforcement action by the SEC.
 
The Special Committee investigated stock options granted during the eleven-year period from January 1, 1996, through December 31, 2006 (the “Investigation Period”). Consistent with published guidance from the staff of the SEC, the Investigation Team organized option grants into categories based on the types of options granted and granting processes. During the Investigation Period, the Company had three processes by which stock options could be approved other than at a meeting of the Compensation Committee:
 
  •  A regular process of making “monthly grants” of new-hire, promotion, merit-adjustment, and patent-award options (and, in 2005 and 2006, annual replenishment awards to continuing employees known as “Evergreen” options) on the first Friday of each month. We have made a monthly grant of options on the first Friday of almost every month since September 1994. Primarily because our monthly grant process uses stock option grant dates that are fixed in advance, the Special Committee concluded that it is a reliable process with respect to the risk of stock option backdating (even though there is still a risk that the grants may not have been determined with finality on the stated grant date, requiring a measurement date for accounting purposes that is different than the stated grant date). Other factors that support our conclusion that the monthly grant process is reliable include the following:
 
  •  The parameters of the new-hire, promotion, merit-adjustment, and patent-award options included in monthly grants are pre-approved by the Compensation Committee as part of the annual stock option budget.
 
  •  The events giving rise to the new-hire, promotion, merit-adjustment, and patent-award options included in monthly grants are subject to separate formal approval processes that include the Vice President of Human Resources (who signs the grant list included in the monthly grants) and result in signed and dated Personnel Action Notices (or “PANs”) evidencing management approval of the stock option awards on or before the stated grant date. For this reason, the terms and recipients of each monthly grant are “known” on the stated grant date, making the compilation of the grant list for each monthly grant from the PANs merely an administrative task.
 
  •  As with the new-hire, promotion, merit-adjustment, and patent-award options included in other monthly grants, the budget for the Evergreen options granted in 2005 and 2006 was approved by the Compensation Committee at a meeting near the beginning of each fiscal year, and the grants to officers were pre-cleared by the Compensation Committee. By explicitly pre-clearing the grant of Evergreen options to officers in 2005 and 2006, the Compensation Committee implicitly authorized the grant of Evergreen options to all employees.
 
  •  The Company operated as if the terms of the awards included in the monthly grants were final prior to completion of the formal Compensation Committee approval procedure, indicating that formal approval of the monthly grants represented only an administrative delay rather than a period during which any of the terms of the awards remained under consideration or subject to change. For example, we frequently communicated the option terms to recipients and entered the option terms and recipients into Equity Edge, our stock administration database, prior to completion of the formal Compensation Committee approval procedure.
 
  •  The Special Committee recommended, and we agree, that the completion of the formal Compensation Committee approval procedure subsequent to the stated grant date does not in and of itself require a correction in the measurement date for a monthly grant.
 
  •  A process of making “non-monthly grants” on irregular dates primarily for (i) eleven annual replenishment options to continuing employees and one additional Evergreen grant in 2003, (ii) options to continuing employees in connection with two repricings (one in 1996 and one in 1998) and two exchanges (one in 2001


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  and one in 2006), and (iii) options to new employees retained in connection with four business combinations or acquisitions (one in 1998, one in 1999, and two in 2000). Any new-hire, promotion, merit-adjustment, and/or patent-award options that were pending on the date of these non-monthly grants were usually also awarded, and new-hire, promotion, merit-adjustment, and/or patent-award options were sometimes awarded by themselves in non-monthly grants. Primarily because our non-monthly grant process (which was abandoned in 2004) did not use stock option grant dates that were fixed in advance, the Special Committee concluded that it was not a reliable process with respect to the risk of stock option backdating to the extent that hindsight could have been used (and in one instance was found to have been used) to select the stated grant dates. Accordingly, the Special Committee recommended, and we agree, that the completion of the formal Compensation Committee approval procedure subsequent to the stated grant date does require a correction in the measurement date for a monthly grant.
 
  •  A process of making “automatic grants” of Director options. The automatic grant process uses stock option grant dates that are fixed in advance for replenishment options, so the Special Committee concluded that it is a reliable process with respect to the risk of stock option backdating (even though there can be uncertainty about when a new Director joins the Board). Almost all stock options granted during the Investigation Period were awarded under the monthly and non-monthly grant processes, which were approved by means of a Unaminous Written Consent (“UWC”) of the three-member Compensation Committee. In light of the risk of stock option backdating presented by each granting process, the Special Committee directed the Investigation Team to examine all non-monthly grants and all grants to Directors and executive officers (who are responsible for all of the stock option granting processes), but determined that testing of the monthly grants on a sample basis was sufficient in combination with appropriate analytical procedures. Approximately 85% of the options granted during the Investigation Period were examined by the Investigation Team. The additional analytical review procedures applied to the monthly grant population consisted of new-hire, rehire, and Equity Edge record-add date (i.e., the date option terms and recipients were entered into our stock administration database) analyses. The Special Committee concluded, and the Investigation Team agreed, that no additional procedures were required since all non-monthly grants and all grants to Directors and executive officers were tested directly and all monthly grants were either tested directly or analyzed using the additional review procedures to provide reasonable assurance that the untested population does not contain any material errors of the types found in the tested population.
 
The Special Committee presented its preliminary findings to the Board of Directors on January 30, 2007. The preliminary findings were described in our Form 8-K filed with the SEC on February 1, 2007, and include the following:
 
  •  There was inadequate documentation supporting the measurement dates for each of the Company’s company-wide annual grants during the period 1996-2001.
 
  •  There were a number of other grants during the 1996-2001 period for which there was inadequate documentation supporting the recorded measurement dates, including some executive grants and grants to new employees in connection with corporate acquisitions.
 
  •  In at least one instance during the 1996-2001 period, at a time when he was the Company’s Chief Financial Officer, Mr. Henry L. Perret participated in the selection of a favorable stated grant date with the benefit of hindsight and did not properly consider the accounting implications of that action.
 
  •  Beginning in 2002, documentation relating to annual and other grants improved substantially, although some minor errors occurred thereafter in the form of corrections or adjustments to grant allocations after the recorded measurement dates.
 
  •  The Special Committee did not conclude that any current officers or employees of the Company engaged in any knowing or intentional misconduct with regard to the Company’s option granting practices.
 
  •  The Special Committee has confidence in the integrity of John C. East, the Company’s Chief Executive Officer, and Jon A. Anderson, its Chief Financial Officer.


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Following the Special Committee’s presentation, the Board requested and accepted the resignation of Henry L. Perret as a member of the Board. The Special Committee presented its final report to the Board of Directors on March 9, 2007.
 
Per the recommendation of the Special Committee, our management reviewed the information made available to it by the Special Committee and performed its own detailed review of historical stock option grants (including the examination of approximately 73% of the options granted during the period between our initial public offering on August 2, 1993, and January 1, 1996 (the beginning of the Investigation Period)) as part of the effort to establish appropriate measurement dates. Management analyzed all available evidence related to each category of grants. Based on relevant facts and circumstances, management applied the applicable accounting standards to determine appropriate measurement dates for all grants. In addition to the grants found by the Special Committee to have lacked adequate documentation supporting the recorded measurement dates, our management concluded that there was inadequate documentation supporting the recorded measurement date for the four company-wide grants during the period 2002-2004, and for one company-wide grant in 1995. If the measurement date was other than the stated grant date, we made accounting adjustments as required, resulting in stock-based compensation expense and related tax effects. We have determined that we had unrecorded non-cash equity-based compensation charges associated with our equity incentive plans for the period 1994 through 2006. Since these charges were material to our financial statements for the years 1994 through 2005, we are restating our historical financial statements to record additional non-cash charges for stock-based compensation expense. At the direction of management, option exercises before December 31, 2000 (when employees could exercise shares directly with the Company, as opposed to through an independent, third-party broker), were also reviewed and tested, and no instance of exercise backdating was identified.
 
 
As a result of the Special Committee’s investigation and findings, as well as our internal reviews, we determined that the stated grant dates for 28 granting actions (or 15% of the 190 granting actions between our initial public offering and the end of 2006) cannot be supported as the proper measurement dates. As a result, we corrected the measurement dates for options covering a total of 10.1 million shares (or 41% of the 24.7 million shares of Common Stock covered by options granted during the relevant period) and we have recorded additional stock-based compensation expense for stock option grants made from June 1995 through March 2004 for which the actual measurement date was different than the stated grant date. The gross deferred stock-based compensation charge associated with these changes was $23.4 million. After accounting for forfeitures, cancellations and other related adjustments, we recorded additional pre-tax stock-based compensation expense of $17.4 million as a result of the revised measurement dates for historical stock option grants.
 
 
In calculating the amount of incremental stock-based compensation expense that we are required to record under generally accepted accounting principles, we made certain interpretations and assumptions and drew certain conclusions from the independent investigation and internal review findings. In addition, we made a number of accounting interpretations and applied those interpretations to our facts and circumstances. We considered, among other things, the guidance provided by the Office of the Chief Accountant of the SEC in a letter dated September 19, 2006 (“Chief Accountant’s Letter”), which states that:
 
The accounting guidance applicable to the grants in question was, in most cases, Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (Opinion 25). The accounting under Opinion 25 relies heavily on the determination of the measurement date, which is defined as “the first date on which are known both (1) the number of shares that an individual employee is entitled to receive and (2) the option or purchase price, if any.” Under Opinion 25, the final amount of compensation cost of an option is measured as the difference between the exercise price and the market price of the underlying stock at the measurement date. As such, for the purpose of determining compensation cost pursuant to Opinion 25, it is important to determine whether a company’s stock option granting practices resulted in the award of stock options with an exercise price that was lower than the market price of the underlying stock at the date on which the terms and recipients of those stock options were determined with finality.


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The Chief Accountant’s Letter also states that “a company must use all available relevant information to form a reasonable conclusion as to the most likely option granting actions that occurred and the dates on which such actions occurred in determining what to account for.” In light of the significant judgment used in the determination of measurement dates, alternate approaches to those used by us could have resulted in different compensation expense charges than those recorded in the restatements.
 
 
Management’s methodology was intended to determine appropriate measurement dates using clear and objective evidence, if possible, or to determine corrected measurement dates using objective evidence to the greatest extent possible and management’s judgment (applied in a consistent and rigorous manner) to the least extent possible. For many reasons, including the fact that the grant dates for monthly grants were fixed in advance, management concluded that the subsequent return of the UWC signature pages for the monthly grants represented only an administrative delay, as described in the Chief Accountant’s Letter, and therefore did not in and of itself necessitate corrections in the measurement dates for the monthly grants. For non-monthly grants, and for monthly grants that required measurement date corrections for other reasons, management selected the date of the last fax-dated UWC signature page as the appropriate measurement date for all awards requiring corrected measurement dates when there were three dated UWC signature pages because, in accordance with the Chief Accountant’s Letter, that was the date at which all required granting actions were complete. Greater management judgment was required when there were not three fax-dated UWC signature pages. After evaluating all available relevant information, management ranked the evidence used in determining corrected measurement dates, with fax transmittals of signed UWC signature pages being the most reliable evidence and Equity Edge (“EE”) data being the least reliable. The Equity Edge record-add date was used as the measurement date only if no other reliable objective evidence could be located supporting a specific date. We considered various alternative approaches, but believe that the approaches we used were the most appropriate.
 
Sensitivity Analysis
 
In applying its judgment, management considered the impact on compensation expense of selecting measurement dates based on different criteria. The sensitivity analysis included a review of the fair market value of Actel’s Common Stock (“FMV”) and potential compensation expense for each of the alternative dates considered in the selection of measurement dates that involved the application of significant management judgment. Set forth below is a sensitivity analysis table for awards with corrected measurement dates by type of grant:
 
                                                 
    Low Point of Range     Actel Actual     High Point of Range  
    Gross
    Expense
    Gross
    Expense
    Gross
    Expense
 
    Deferred
    (Net of
    Deferred
    (Net of
    Deferred
    (Net of
 
Grant Classification
  Compensation     Forfeitures)     Compensation     Forfeitures)     Compensation     Forfeitures)  
 
Evergreen Grants
  $ 4,659,783     $ 2,684,744     $ 10,132,794     $ 6,175,052     $ 19,001,910     $ 12,671,714  
Acquisition Grants
                50,916       50,916       50,916       50,916  
Non-Monthly Grants
    91,361       30,697       979,298       743,462       1,367,501       1,057,093  
Director Options
    26,213       26,213       97,508       97,508       97,508       97,508  
Monthly Grants
    462,215       385,936       505,015       421,673       624,842       521,726  
Non-Sensitivity
    11,607,096       9,959,521       11,607,095       9,959,521       11,607,095       9,959,521  
                                                 
Total
  $ 16,846,668     $ 13,087,111     $ 23,372,626     $ 17,448,132     $ 32,749,772     $ 24,358,478  
                                                 
 
In order to make these sensitivity calculations, management determined the earliest plausible measurement date and the latest plausible measurement date for each award requiring a corrected measurement date, and the highest FMV and lowest FMV between and including those dates because it is possible that the terms of the options were known with finality on any date within this range. For awards with corrected measurement dates that do not have three dated UWC signature pages, management believes the earliest and latest plausible measurement date is generally the earlier of (i) the date the last UWC signature page was received and (ii) the initial Equity Edge record-add date. The date the last UWC signature page was received and the initial Equity Edge record-add date are both considered by management to be evidence of when the terms and recipients of an award were finalized, although


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UWC signature pages are at the top of the evidence hierarchy and the Equity Edge record-add date is at the bottom of the hierarchy.
 
Sensitivity analysis was performed on all awards with corrected measurement dates that have one or more UWC signature pages missing or undated. Thus, it is possible that the last UWC signature page was actually received after the latest plausible measurement date used in the sensitivity analysis. However, based on an evaluation of awards with corrected measurement dates that have three dated UWC signature pages, we do not believe that any such occurrence would have a material effect on the range of potential compensation cost that we could have recorded. No sensitivity analysis was performed on awards with corrected measurement dates that have three dated UWC signature pages. To avoid skewing the sensitivity analysis table, these awards are included in the “Non-Sensitivity” line of the table, with the “High” and “Low” range numbers being equal to the “Actual” gross deferred compensation charge and net expense recorded by Actel.
 
Overall, the sensitivity table indicates that the total gross deferred compensation charge could range from a high of $32.7 million to a low of $16.8 million, while the Company recorded an actual gross deferred compensation charge of $23.4 million. Total net compensation expense could range from a high of $24.4 million to a low of $13.1 million, while the Company recorded actual net compensation expense of $17.4 million. The award that has the greatest impact on the sensitivity analysis is the Evergreen Options grant dated March 14, 2002, for which the measurement date was revised to April 5, 2002, when emails indicate that changes in the allocation of options were no longer under consideration. There was little volatility in our stock price between the earliest plausible measurement date of March 28, 2002 (the date the last UWC signature page was received), and the revised measurement date of April 5, 2002. However, for the latest plausible measurement date of May 14, 2002 (the initial EE record-add date), we experienced significant volatility in our stock price: it increased from the $20 share range in April to the $27 per share range in May and then declined back to the $20 per share range in June 2002. Due to the short-lived increase in the stock price during the month of May, coupled with the strength of the evidence used to establish the revised measurement date of April 5, 2002, we believe the March 14, 2002, grant sensitivity range potentially distorts the impact of management’s judgment. Eliminating the impact of this grant from the sensitivity analysis (by including it in the “Non-Sensitivity” line) would reduce the range of total net compensation expense from a high of $19.1 million and a low of $13.1 million, compared with the Company’s actual net compensation expense of $17.4 million. Thus, the grant dated March 14, 2002, accounts for $5.3 million, or almost half, of the $11.3 million range in total net compensation expense.
 
For fiscal years 2003 through 2005, the net compensation expense could range from a high of $7.8 million to a low of $3.0 million, compared with the Company’s actual net compensation expense of $3.3 million. For fiscal year 2006, the net compensation expense could be affected by no more than $0.2 million. We have concluded that the range of total net compensation expense is acceptable given the uncertainty of the corrected measurement dates and the resulting inability to precisely measure the resulting stock compensation expense. Accordingly, we believe the related compensation charges comply with U.S. Generally Accepted Accounting Principles in all material respects.
 
 
In addition to the stock-based compensation expenses resulting from revised measurement dates for historical stock option grants, and the related payroll and withholding taxes and penalties (which are described in more detail below), our internal review also identified certain other errors in accounting determinations and judgments relating to stock-based compensation that have been corrected in the restated consolidated financial statements. These errors include incorrect accounting for (i) modifications to equity awards in connection with and subsequent to, certain employees’ terminations, and (ii) equity awards granted to consultants. These errors in accounting for stock-based compensation expense are also described in more detail below.
 
 
Internal Revenue Code Section 421 prohibits the granting of Incentive Stock Options (“ISOs”) with an exercise price below the fair market value of the underlying shares on the date of grant. The Company issued both ISOs and Non Qualified Stock Options (“NQs”) during the period investigated. As described above, 28 of our stock option granting actions were subject to revised measurement dates (the last of which was in March 2004). For all but five of


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the granting actions, the fair market value of our Common Stock on the revised measurement date was higher than the fair market value of our Common Stock on the stated grant date.
 
Therefore, many of the stock options that were granted as ISOs should have been treated as NQs for purposes of payroll taxes and federal and state income tax withholding. ISOs receive special tax treatment by not being taxed or subject to FICA withholding at the time of exercise. The shares acquired upon the exercise of ISOs are taxable at the time of disposition and, if held for the required length of time, may receive the benefit of capital gains tax treatment. If not held for the required length of time, shares acquired upon the exercise of ISOs are taxed as ordinary income. The restated financial statements include expenses (arising from exercises of ISOs with corrected measurement dates) relating to the estimated payroll taxes, federal and state income taxes and penalties (including negligence penalties) arising from ISOs that should have been treated as NQ stock options (due to their below-market grant pricing). We calculated payroll taxes and the marginal income tax rate for each affected individual for each fiscal period on the stock option gains in the fiscal period the stock options were exercised, subject to the individual applicable employment tax ceilings for Social Security and Medicare for each fiscal period. Penalties were also factored into the restatement. The Company has calculated penalties in accordance with the applicable Internal Revenue Codes (10% of employer FICA) under IRC Sec. 6656 and a negligence (20%) penalty under IRC Sec. 6662. To the extent appropriate, the expense accrual for taxes and penalties was reversed in fiscal years in which the applicable statue of limitations was exceeded. The net accrual for payroll and withholding-related expense in the restatement is $0.5 million for 1996 through 2005.
 
 
The stock option reviews identified individuals who were terminated and rehired by us but whose options were not cancelled (and continued to vest between the termination and rehire dates). In accordance with Opinion 25 and its interpretations, modifications that renew or extend the life of fixed awards result in a new measurement date. Accordingly in the restated financial statements we have recorded the stock-based compensation expense (net of forfeitures) for these modified grants of less than $0.1 million.
 
The stock option reviews identified six consultants who received option awards, two of whom first received grants in 1994 and the other four of whom first received grants in 1995. We determined that three of these individuals did not have an “employee-like” relationship with us, and we measured their awards at the grant-date fair value and amortized the amount to compensation expense on a straight-line basis over their respective vesting periods. We determined that the other three of these individuals (who subsequently became employees) had an “employee-like” relationship with us from the beginning of the original grant period, so we measured the awards at the grant-date intrinsic value, which resulted in no compensation expense. However, the four individuals who first received grants in 1995 retained the right to exercise their vested options for a ten-year period from the date of grant, even after their relationship with the Company terminated. The relationship between the Company and one of these individuals was terminated in 2000, and the relationship between the Company and the other three of these individuals was terminated in 2003. Applying the accounting literature that was applicable at those points in time, we recorded a stock compensation charge equal to the fair value of those awards as of their termination date. These awards were then accounted for as liability awards from the date of termination (the options did not qualify as equity instruments because we could settle the options only by delivering registered shares, which is outside the control of the Company), and we subsequently marked the awards to market through the date the options were exercised or expired, with the related income or expense being recognized as “Other Income and Expense.” Net of forfeitures, the stock-based compensation expense for stock options grants to consultants reflected in the restated financial statements is $1.3 million on a pre-tax basis, which is offset in part by a related pre-tax financial statement benefit of $0.5 million in Other Income and Expense.
 
 
Also included in this restatement are accounting adjustments for one item that is not related to stock options. These adjustments relate to errors associated with the recognition of deferred income at our European distributors. While we were aware of these errors outside of the course of the stock options investigation and reviews described above, these adjustments had not previously been recorded in the appropriate periods due to their immateriality. The


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restatement impact of recording these adjustments is a $1.0 million increase to pre-tax income from 2000 through 2005.
 
We have incurred substantial expenses for legal, accounting, tax, and other professional services in connection with the Special Committee’s investigation, our internal reviews, the preparation of the restated consolidated financial statements, the SEC informal inquiry, and the derivative litigation. These expenses, which are included in selling, general, and administrative expenses, were approximately $2.0 million for the year ended December 31, 2006, and are expected to be approximately $5.5 million for the 2007 fiscal year.
 
Because almost all holders of options issued by us were not involved in or aware of the incorrect pricing, we have taken and intend to take actions to deal with certain adverse tax consequences that may be incurred by the holders of certain incorrectly priced options. Adverse tax consequences may arise as a result of the change in the status of employee awards from ISO to NQ stock options, and incorrectly priced stock options vesting after December 31, 2004, may subject the option holder to a penalty tax under IRC Section 409A (and, as applicable, similar penalty taxes under California and other state tax laws). The Company may incur future charges to resolve the adverse tax consequences of incorrectly priced options; however, based on current estimates the Company believes that such costs will be immaterial.
 
IRC Section 162(m) limits the deductibility of compensation in excess of $1.0 million that is not performance-based and that is paid to the Chief Executive Officer and the four other named executive officers in our annual proxy statement. In the year in which any such officers exercise options that have been revised as a result of our investigation, we have made appropriate adjustments to reduce our deferred income taxes for the compensation expense for which we are not able to take a corresponding tax deduction. Furthermore, since the Chief Executive Officer’s compensation has, on occasion, exceeded the 162 (m) limit, the company has recorded tax benefits associated with his options only when the options are exercised and the benefit is known. Accordingly, no deferred tax assets have been established for stock compensation associated with the Chief Executive Officer.
 
For explanatory purposes and to assist in analysis of our consolidated financial statements, the impact of the stock option and other adjustments that were affected by the restatement are summarized below (in thousands):
 
                                                                 
    Adjustment to
                      Other
                   
    Stock-Based
                      Deferred
                   
    Compensation
                      Revenue
    Other
             
    Expense
    Other
    Adjustment
    Subtotal
    Adjustments
    Adjustments-
             
    Associated
    Adjustments to
    to Payroll
    Stock-Based
    Associated
    -Other
    Adjustment
    Total
 
    with
    Stock-Based
    Tax
    Compensation
    with
    Income and
    to Income
    Restatement
 
    Remeasured
    Compensation
    Expense
    Expense and
    European
    Expense
    Tax Expense
    Expense
 
Fiscal Year
  Grants     Expense     (Benefit)     Payroll Taxes     Distributor     Charges(1)     (Benefit)     (Benefit)  
 
1994
  $     $ 60     $     $ 60     $     $     $ (24 )   $ 36  
1995
    205       27             232                   (73 )     159  
1996
    539       42       6       587                   (175 )     412  
1997
    823       32       23       878                   (262 )     616  
1998
    937       35       18       990                   (307 )     683  
1999
    814       12       105       931                   (242 )     689  
2000
    2,574       92       347       3,013       (1,528 )           (436 )     1,049  
2001
    5,455       485       88       6,028       (100 )     (17 )     (2,111 )     3,800  
2002
    2,810       (73 )     93       2,830       203       (31 )     (953 )     2,049  
2003
    2,155       1,687       181       4,023             20       (1,370 )     2,673  
                                                                 
Cumulative through January 4, 2004
    16,312       2,399       861       19,572       (1,425 )     (28 )     (5,953 )     12,166  
2004
    950       (604 )     (312 )     34       100       (463 )     (51 )     (380 )
2005
    186       (431 )     (91 )     (336 )     338       12       (14 )      
                                                                 
Total
  $ 17,448     $ 1,364     $ 458     $ 19,270     $ (987 )   $ (479 )   $ (6,018 )   $ 11,786  
                                                                 
 
 
(1) Reflects mark to market adjustments relating to $1.0 million of awards originally charged to stock-based compensation which were subsequently classified as liability awards following the termination of employment.


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Results of Operations
 
The following table sets forth certain financial data from the Consolidated Statements of Operations expressed as a percentage of net revenues:
 
                         
    Years Ended  
    Dec. 31, 2006     Jan. 1, 2006     Jan. 2, 2005  
          Restated     Restated  
 
Net revenues
    100.0 %     100.0 %     100.0 %
Cost of revenues
    39.5       41.0       42.6  
                         
Gross margin
    60.5       59.0       57.4  
Research and development
    29.7       27.0       27.6  
Selling, general, and administrative
    35.5       27.7       29.0  
Amortization of acquisition-related intangibles
    0.0       1.1       1.6  
                         
Income (loss) from operations
    (4.7 )     3.2       (0.8 )
Interest income and other, net of expense
    3.7       2.2       2.1  
                         
Income (loss) before tax provision (benefit)
    (1.0 )     5.4       1.3  
Tax provision (benefit)
    0.1       1.5       (0.4 )
                         
Net income (loss)
    (1.1 )%     3.9 %     1.7 %
                         
 
 
We derive our revenues primarily from the sale of FPGAs, which accounted for over 95% of net revenues in 2006, 2005 and 2004. Non-FPGA revenues are derived from our Protocol Design Services organization, royalties, and the licensing of software and sale of hardware used to design and program our FPGAs. We believe that we derived at least 53% of our revenues in 2006, 2005 and 2004 from sales of FPGAs to customers serving the military and aerospace and the communications markets. We have experienced, and may again in the future experience, substantial period-to-period fluctuations in operating results due to conditions in each of these markets as well as in the general economy.
 
Net revenues in 2006 were $191.5 million, an increase of 7% over 2005. This increase was due primarily to a 7% increase in the overall average selling price (ASP) and a slight increase in the total number of units shipped in the year. The overall ASP increased primarily due to increases in ASPs from most of the new and mature product families. Net revenues in 2006 increased $1.2 million as a result of a refinement in the Company’s estimate of distributor revenue as noted in Critical Accounting Policies and Estimates.
 
Net revenues in 2005 were $178.9 million, an 8% increase over 2004. This increase was due primarily to an 8% increase in the overall average selling price (ASP) and a 1% increase in the total number of units shipped in the year. The overall ASP increased principally because we derived a higher percentage of our revenues from our radiation hardened and radiation tolerant products which have higher ASPs than other product families.
 
We shipped approximately 77% of our net revenues through the distribution sales channel in 2006 compared with 64% in 2005 and 67% in 2004. Since 2003, Memec, Unique has been our sole distributor in North America. On April 26, 2005, Avnet, Inc. (Avnet) and Memec Group Holdings Ltd. (Memec) announced they had reached a definitive agreement for Avnet to acquire Memec in a stock and cash transaction. On July 5, 2005, Avnet announced the completion of its acquisition of Memec, Unique. We generally do not recognize revenue on product shipped to a distributor until the distributor resells the product to its customer.
 
Sales to customers outside the United States accounted for 49% of net revenues in 2006, 44% in 2005 and 45% in 2004 with European customers representing 27% of net revenues in each of these years.


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Gross margin was 60.5% of revenues in 2006 compared with 59.0% in 2005 and 57.4% in 2004. Gross margin in 2006 benefited from lower inventory write-downs as compared to fiscal 2005 coupled with a reduction in license costs as a result of consolidation of a number of our license agreements with third parties. Gross margin in 2006 was unfavorably impacted by a fourth quarter write-down of $2.2 million associated with excess radiation products. Gross margin in 2005 benefited from a product mix that contained a higher percentage of radiation products as a percentage of total, which typically generate higher gross margins. Gross margin in 2004 was unfavorably impacted by a $3.2 million write down we recorded in the fourth quarter. This charge included a write down of $2.1 million of RTSX-S inventory from the original manufacturer for which we determined there was no demand. In addition, $1.1 million of the charge was a write-off of certain boards and sockets, purchased solely to test the RTSX-S units, that have no future use to us in the production process. See the Risk Factors set forth at the end of Item I of this Annual Report on Form 10-K for more information about the investigations regarding the reliability of our RTSX-S space-qualified FPGAs. We also experienced some pressure on gross margin in 2004 due to a higher concentration of our newer products, as a percentage of total revenue, which tend to have lower gross margins than our more mature products.
 
Gross margin is affected by changes in excess and slow moving inventory write downs. Gross margin was positively impacted by the sell through of previously written down inventory of $0.9 million, or 1.0% in 2005 and $3.2 million, or 2.4% in 2004. The 2006 impact of such sales was not material.
 
We seek to reduce costs and improve gross margins by improving wafer yields, negotiating price reductions with suppliers, increasing the level and efficiency of our testing and packaging operations, achieving economies of scale by means of higher production levels, and increasing the number of die produced per wafer, principally by shrinking the die size of our products. No assurance can be given that these efforts will be successful. Our capability to shrink the die size of our FPGAs is dependent on the availability of more advanced manufacturing processes. Due to the custom steps involved in manufacturing antifuse and (to a lesser extent) Flash FPGAs, we typically obtain access to new manufacturing processes later than our competitors using standard manufacturing processes.
 
 
R&D expenditures were $56.9 million, or 30% of net revenues, in 2006 compared with $48.2 million, or 27% of net revenues, in 2005 and $45.7 million, or 28% of net revenues, in 2004. R&D spending in 2006 increased due to recognition of stock-based compensation expense under SFAS 123(R) of $5.6 million, along with higher costs associated with expanded R&D efforts and increased headcount. R&D expenditures increased $2.5 million in 2005 as compared to 2004 due to our expanded efforts and increased headcount needed to concurrently research and develop future commercial and radiation tolerant generations of both Flash and antifuse-based product families.
 
Our R&D consists of circuit design, software development, and process technology activities. We believe that continued substantial investment in R&D is critical to maintaining a strong technological position in the industry. Since our antifuse and (to a lesser extent) Flash FPGAs are manufactured using customized processes that require a substantial time to develop, our R&D expenditures will probably always be higher as a percentage of net revenues than that of our major competitors using standard manufacturing processes.
 
 
SG&A expenses in 2006 were $68.0 million, or 36% of net revenues, compared with $49.6 million, or 28% of net revenues, in 2005 and $48.0 million, or 29% of net revenues, in 2004. During fiscal 2006, we incurred costs of $10.0 million and $0.4 million in connection with the settlement of two patent infringement claims brought against us. See Note 14 of Notes to Consolidated Financial Statements for further information regarding these claims. SG&A expenses also increased $4.8 million in 2006 due to recognition of stock-based compensation expense under SFAS 123(R). SG&A expenses in 2006 included legal and accounting costs of approximately $2.0 million associated with the Company’s stock option investigation. SG&A spending in 2006 increased as a percentage of sales over 2005 levels primarily as a result of the items noted above.


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SG&A expenses in 2005 increased by $1.7 million from 2004 primarily as a result of higher selling expense associated with increased net revenues, higher legal costs associated with general business issues and employment matters and increased marketing expense related to new product offerings. SG&A spending in 2005 decreased slightly as a percentage of sales over 2004 levels. This was the result of 8% higher revenue levels in 2005, even though absolute spending in 2005 increased.
 
 
Amortization of other acquisition-related intangibles was $15,000 in 2006, $1.9 million in 2005 and $2.7 million in 2004. The decrease in 2006 was attributable to intangible assets, related to an acquisition completed in the year 2000, being fully amortized during the second quarter of 2006.
 
 
Interest income and other, net of expense, was $7.1 million, $3.9 million and $3.4 million in 2006, 2005 and 2004, respectively. For 2006, our average investment portfolio return on investment was 4.2% compared with 2.8% in 2005 and 1.9% in 2004, resulting in higher interest income during fiscal 2006 as compared to prior years. Our average investment portfolio balance was $157.0 million in 2006 compared with $144.9 million in 2005 and $154.0 million in 2004. We invest excess liquidity in investment portfolios consisting primarily of corporate bonds, floating rate notes, and federal and municipal obligations. In periods where market interest rates are falling, and for some time after rates stabilize, we typically experience declines in interest income and other as our older debt investments at higher interest rates mature and are replaced by new investments at the lower rates available in the market.
 
 
Significant components affecting the effective tax rate include pre-tax net income or loss, federal R&D tax credits, income from tax-exempt securities, the state composite tax rate, adjustments to income taxes as a result of tax audits and reviews and recognition of certain deferred tax assets subject to valuation allowances. Our tax provision for 2006 was $0.3 million despite a pre-tax loss of $1.9 million. This tax charge is primarily due to non-deductible stock-based compensation.
 
Our tax provision for 2005 was $2.7 million based upon a 28% annual effective tax rate. This rate was calculated based on a statutory tax rate benefited by R&D tax credits and state tax benefits. We recorded a tax benefit of $0.7 million in 2004 resulting from the combined effect of a small pre-tax income offset by R&D tax credits and state tax benefits.
 
Financial Condition, Liquidity, and Capital Resources
 
Our total assets were $368.9 million at the end of 2006 compared with $343.2 million at the end of 2005. The increase in total assets was attributable principally to increases in cash, cash equivalents, inventory and other assets. The following table sets forth certain financial data from the consolidated balance sheets expressed as the percentage change from January 1, 2006 to December 31, 2006.
 
                                 
    As of
    As of
             
    Dec. 31, 2006     Jan. 1, 2006     $ Change     % Change  
          Restated              
    In thousands  
 
Cash and cash equivalents, short and long term investments
  $ 191,955     $ 168,316     $ 23,639       14 %
Accounts receivable, net
  $ 22,017     $ 25,287     $ (3,270 )     (13 )%
Inventories
  $ 39,203     $ 37,372     $ 1,831       5 %
 


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    Year Ended  
    Dec. 31, 2006     Jan. 1, 2006  
          Restated  
    In thousands  
 
Net cash provided by operating activities
  $ 24,529     $ 22,585  
Net cash used in investing activities
  $ (22,066 )   $ (6,149 )
Net cash provided by financing activities
  $ 7,203     $ 1,192  
 
 
Our cash, cash equivalents, and short-term investments were $192.0 million at the end of 2006 compared with $168.3 million at the end of 2005. This increase of $23.6 million from the end of 2005 was due primarily to $24.5 million of net cash provided by operating activities, $7.2 million of cash provided by financing activities ($9.4 million provided from the issuance of Common Stock under employee stock plans partially offset by $2.2 million used to repurchase Actel Common Stock) partially offset by $13.5 million used to purchase available-for-sale securities and $8.7 million of cash used to purchase property and equipment.
 
The significant non-cash expenses used in the determination of cash flows from operating activities that provided cash for 2006 included non-cash charges of $9.8 million for depreciation and amortization, $11.0 million for non-cash stock compensation, decreases in accounts receivable of $3.3 million, and increases in accounts payable and other liabilities of $10.2 million. The significant components within operating activities that resulted in a reduction of cash from operations in 2006 included a net loss of $2.2 million, increases in inventories of $1.6 million, and increases in license agreements and other assets of $5.6 million.
 
Spending on property and equipment amounted to $8.7 million in 2006 compared with $10.2 million in 2005.
 
Cash from the issuance of Common Stock under employee stock plans amounted to $9.4 million in 2006, $11.0 million in 2005, and $8.2 million in 2004.
 
We meet all of our funding needs for ongoing operations with internally generated cash flows from operations and with existing cash and short-term investment balances. We believe that existing cash, cash equivalents, and short-term investments, together with cash generated from operations, will be sufficient to meet our cash requirements for the following twelve months. A portion of available cash may be used for investment in or acquisition of complementary businesses, products, or technologies. Wafer manufacturers have at times demanded financial support from customers in the form of equity investments and advance purchase price deposits, which in some cases have been substantial. Should we require additional capacity, we may be required to incur significant expenditures to secure such capacity.
 
The following represents contractual commitments not accrued on the balance sheet associated with operating leases as of December 31, 2006:
 
                                                         
    Payments Due by Period  
                                        2012
 
    Total     2007     2008     2009     2010     2011     and Later  
    (In thousands)  
 
Operating leases
  $ 21,628     $ 3,367     $ 3,080     $ 3,094     $ 2,933     $ 2,880     $ 6,274  
 
Purchase orders or contracts for the purchase of raw materials and other goods and services are not included in the table above. We are not able to determine the aggregate amount of such purchase orders that represent contractual obligations as purchase orders may represent authorizations to purchase rather than binding agreements. For the purposes of this table, contractual obligations for purchase of goods or services are defined as agreements that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Our purchase orders are based on our current manufacturing needs and fulfilled by our vendors within short time horizons. We do not have significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices that exceed our expected requirements for three months. We also enter

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into contracts for outsourced services; however, the obligations under these contracts were not significant and the contracts generally contain clauses allowing for cancellation without significant penalty.
 
We believe that the availability of adequate financial resources is a substantial competitive factor. To take advantage of opportunities as they arise, or to withstand adverse business conditions when they occur, it may become prudent or necessary for us to raise additional capital. No assurance can be given that additional capital would become available on acceptable terms if needed.
 
 
Our net accounts receivable was $22.0 million at the end of 2006 compared with $25.3 million at the end of 2005. This decrease was due primarily to the timing of shipments in the fourth quarter of each of these fiscal years. Approximately 46% of fourth quarter sales were shipped in the last month of fiscal 2005 compared to approximately 39% of fourth quarter sales shipped in the last month of fiscal 2006. This allowed us to collect a higher percentage of our quarterly sales prior to the end of fiscal 2006 as compared to fiscal 2005. Net accounts receivable represented 42 days of sales outstanding at the end of fiscal 2006 compared to 53 days at the end of fiscal 2005.
 
 
Our net inventories were $39.2 million at the end of 2006 compared with $37.4 million at the end of 2005. We continue to hold material from “last time buy” inventory purchases made in 2003 and 2005 from two wafer manufacturers for some of our mature product families. Last time buys occur when a wafer supplier is about to shut down the manufacturing line used to make a product and we believe that our then-current inventories are insufficient to meet foreseeable future demand. Inventory purchased in last time buy transactions is evaluated on an ongoing basis for indications of excess or obsolescence based on rates of actual sell through, expected future demand for those products, and any other qualitative factors that may indicate the existence of excess or obsolete inventory. Inventory at December 31, 2006 and January 1, 2006, included $1.9 million and $4.3 million, respectively, of inventory purchased in last time buys. Inventory days of supply decreased from 191 days at the end of 2005 to 174 days at the end of 2006.
 
Our FPGAs are manufactured using customized steps that are added to the standard manufacturing processes of our independent wafer suppliers, so our manufacturing cycle is generally longer and more difficult to adjust in response to changing demands or delivery schedules than our competitors using standard processes. Accordingly, our inventory levels will probably always be higher than that of our major competitors using standard processes.
 
 
Our net property and equipment was $22.8 million at the end of 2006 compared with $23.9 million at the end of 2005. We invested $8.7 million in property and equipment in 2006 compared with $10.2 million in 2005. Capital expenditures during the past two years have been primarily for engineering, manufacturing, and office equipment. Depreciation of property and equipment was $9.8 million in 2006 compared with $9.1 million in 2005.
 
 
Our net goodwill was $30.2 million at the end of 2006 compared to $32.1 million at the end of 2005. The decrease in goodwill is the result of the realization of certain net operating loss carryforwards associated with the Company’s fiscal 2000 acquisition of Gatefield. We had originally established a valuation allowance for a portion of the net operating loss carryforwards acquired in connection with the acquisition of Gatefield. To the extent such valuation allowance is subsequently reversed as a result of the realization of the deferred tax asset, FAS 109 requires that the offsetting credit is recognized first as a reduction of goodwill.
 
Goodwill is recorded when consideration paid in an acquisition exceeds the fair value of the net tangible and intangible assets acquired. At the beginning of 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition. Under SFAS No. 142, we do not amortize goodwill, but instead test for impairment annually or more frequently if certain events or changes in circumstances indicate that the carrying value may not be


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recoverable. We completed our annual goodwill impairments tests during the fourth quarter of 2006, and noted no indicators of impairment.
 
 
Our other assets, net were $19.8 million at the end of 2006 compared with $13.4 million at the end of 2005. The increase was due primarily to a $5.1 million increase in the capitalization of various technology license agreements and a $1.0 million increase in deferred compensation plan assets.
 
 
Our total current liabilities were $67.5 million at the end of 2006 compared with $58.4 million at the end of 2005. The increase was due primarily to the capitalization of certain long-term license agreements of $3.4 million and a $2.9 million increase in other accrued liabilities.
 
 
Shareholders’ equity was $290.6 million at the end of 2006 compared with $276.1 million at the end of 2005. The increase in 2006 included proceeds of $9.4 million from the sale of Common Stock under employee stock plans and $11.3 million of stock-based compensation partially offset by a net loss of $2.2 million, and stock repurchases of $2.2 million.
 
 
In February 2006, the FASB issued FASB Statement No. 155 (SFAS 155), “Accounting for Certain Hybrid Financial Instruments” an amendment of FASB Statements No. 133 and 140. SFAS 155 simplifies the accounting for certain hybrid financial instruments by permitting fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year. This Statement will be adopted by Actel in the first quarter of fiscal 2007. The adoption of SFAS 155 will not have a material impact on our consolidated results of operations and financial condition.
 
In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation is effective for fiscal years beginning after December 15, 2006 and will be adopted by Actel in the first quarter of fiscal 2007. The Company is evaluating the impact of this Interpretation, however, we currently do not expect that the adoption of FIN 48 will have a material effect on our results of operations and financial condition.
 
In June, 2006, the FASB ratified the consensus reached in EITF Issue No. 06-2, “Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences”. This consensus provides that sabbatical leave or other similar benefits provided to an employee should be considered to accumulate over the service period as described in FASB Statement No. 43. This EITF is effective for fiscal years beginning after December 15, 2006 and will be adopted by Actel in the first quarter of fiscal 2007. Actel will record a $2.5 million cumulative adjustment, net of tax, to decrease the January 1, 2007 balance of retained earnings. We expect the annual impact to earnings to be immaterial.
 
In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements of assets and liabilities. This Statement is effective for financial statements issued for fiscal years


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beginning after November 15, 2007, and interim periods within those fiscal years. This Statement will be adopted by Actel in the first quarter of fiscal 2008. Actel is currently evaluating the effect that the adoption of FASB No. 157 will have on its consolidated results of operations and financial condition.
 
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 provides interpretive guidance on how the effects of prior year errors should be considered in quantifying a current year misstatement. SAB 108 is effective for Actel for the fiscal year ended December 31, 2006. In connection with the adoption of SAB 108, the Company restated its financial statements for certain errors associated with the recognition of deferred income associated with its European distributors. See Note 2, “Restatements to Consolidated Financial Statements”.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157. The Company expects to adopt SFAS No. 159 in the first quarter of fiscal 2008. The Company is currently evaluating the impact that this pronouncement may have on its consolidated financial statements.
 
Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and the related disclosure of contingent assets and liabilities. The U.S. Securities and Exchange Commission has defined critical accounting policies as those that are most important to the portrayal of our financial condition and results and also require us to make the most difficult, complex and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Based upon this definition, our most critical policies include revenue recognition, inventories, legal matters and income taxes. During the first quarter of fiscal 2006, we implemented a new critical accounting policy, stock-based compensation expense, in conjunction with our adoption of SFAS 123(R). These policies, as well as the estimates and judgments involved, are discussed below. We also have other key accounting policies that either do not generally require us to make estimates and judgments that are as difficult or as subjective or they are less likely to have a material impact on our reported results of operations for a given period. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates. In addition, if these estimates or their related assumptions change in the future, it could result in material expenses being recognized on the income statement.
 
 
We sell our products to OEMs and to distributors who resell our products to OEMs or their contract manufacturers. We recognize revenue on products sold to our OEMs upon shipment. Because sales to our distributors are generally made under agreements allowing for price adjustments, credits, and right of return under certain circumstances, we generally defer recognition of revenue on products sold to distributors until the products are resold by the distributor and price adjustments are determined, at which time our final net sales price is fixed. Deferred revenue net of the corresponding deferred cost of sales are recorded in the caption “deferred income on shipments to distributors” in the liability section of the consolidated balance sheet. Deferred income effectively represents the gross margin on the sale to the distributor, however, the amount of gross margin we recognize in future periods will be less than the originally recorded deferred income as a result of negotiated price concessions.


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Distributors resell our products to end customers at various negotiated price points which vary by end customer, product, quantity, geography and competitive pricing environments. When a distributors’ resale is priced at a discount from list price, we credit back to the distributor a portion of their original purchase price after the resale transaction is complete. Thus, a portion of the deferred income on shipments to distributors balance will be credited back to the distributor in the future. Based upon historical trends and inventory levels on hand at each of our distributors as of December 31, 2006, we estimate that approximately $10.9 million of the deferred income on shipments to distributors on the Company’s balance sheet as of December 31, 2006, will be credited back to the distributors in the future. These amounts will not be recognized as revenue and gross margin in our Statement of Operations. Since we expect our distributors to “turn” their inventory balances five to six times a year, we expect that a majority of the inventory held by our distributors at the end of any quarter will be resold to end customers over the next two quarters.
 
Revenue recognition depends on notification from the distributor that product has been resold. This reported information includes product resale price, quantity, and end customer information as well as inventory balances on hand. Our revenue reporting is dependent on us receiving timely and accurate data from our distributors. In determining the appropriate amount of revenue to recognize, we use this data from our distributors and apply judgment in reconciling differences between their reported inventory and sell through activities. Because of the time involved in collecting, assimilating and analyzing the data provided by our distributors, we report actual sell through revenue one month in arrears. This practice requires us to make an estimate of one month’s distributor sell through activity at the end of each fiscal quarter. This estimate is adjusted the following month to reflect actual sell through activity reported by our distributors.
 
There is a level of uncertainty in the distributor revenue estimation process and, accordingly, Actel maintains a reserve for revenue estimates exceeding actual sell through activity. As a result of ongoing improvements in distributor reporting and reconciliation processes and an evaluation of recent trends in variances between estimated amounts and actual sell through activity, in the third quarter of 2006 Actel adjusted its estimate of the distributor revenue reserve. The net effect of this change in estimate was to increase 2006 revenue by $1.2 million, increase costs of sales by $0.5 million, and increase gross margin by $0.7 million.
 
 
We believe that a certain level of inventory must be carried to maintain an adequate supply of product for customers. This inventory level may vary based upon orders received from customers or internal forecasts of demand for these products. Other considerations in determining inventory levels include the stage of products in the product life cycle, design win activity, manufacturing lead times, customer demands, strategic relationships with foundries, and competitive situations in the marketplace. Should any of these factors develop other than anticipated, inventory levels may be materially and adversely affected.
 
We write down our inventory for estimated obsolescence 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. To address this difficult, subjective, and complex area of judgment, we apply a methodology that includes assumptions and estimates to arrive at the net realizable value. First, we identify any inventory that has been previously written down in prior periods. This inventory remains written down until sold, destroyed, or otherwise dispositioned. Second, we examine inventory line items that may have some form of non-conformance with electrical and mechanical standards. Third, we assess the inventory not otherwise identified to be written down against product history and forecasted demand (typically for the next six months). Finally, we analyze the result of this methodology in light of the product life cycle, design win activity, and competitive situation in the marketplace to derive an outlook for consumption of the inventory and the appropriateness of the resulting inventory levels. If actual future demand or market conditions are less favorable than those we have projected, additional inventory write-downs may be required.
 
Our inventory valuation policies also take into consideration “last time buy” inventory purchases. Last time buys occur when a wafer supplier is about to shut down the manufacturing line used to make a product and we believe that our then current inventories are insufficient to meet foreseeable future demand. We made last time buys of certain products from our wafer suppliers in 2003 and 2005. Since this inventory was not acquired to meet current


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demand, we apply a discrete write down policy for inventory purchased in last time buy transactions and the related inventory are excluded from the standard excess and obsolescence write down policy. Inventory purchased in last time buy transactions will be evaluated on an ongoing basis for indications of excess or obsolescence based on rates of actual sell through; expected future demand for those products over a longer time horizon; and any other qualitative factors that may indicate the existence of excess or obsolete inventory. Evaluations of last time buy inventory in 2006 and 2005 resulted in write-downs of $0.2 million and $0.3 million of material, respectively. These write-downs were taken because actual sell through results did not meet expectations or estimations of expected future demand.
 
 
From time to time we are notified of claims, including claims that we may be infringing patents owned by others, or otherwise become aware of conditions, situations, or circumstances involving uncertainty as to the existence of a liability or the amount of a loss. When probable and reasonably estimable, we make provisions for estimated liabilities. As we sometimes have in the past, we may settle disputes and/or obtain licenses under patents that we are alleged to infringe. We can offer no assurance that any pending or threatened claim or other loss contingency will be resolved or that the resolution of any such claim or contingency will not have a materially adverse effect on our business, financial condition, and/or results of operations. Our failure to resolve a claim could result in litigation or arbitration, which can result in significant expense and divert the efforts of our technical and management personnel, whether or not determined in our favor. Actel is a nominal defendant in a consolidated shareholder derivative action filed in the United States District Court for the Northern District of California against certain current and former officers and Directors. The Company and the individual defendants intend to defend these cases vigorously. In addition, our evaluation of the impact of these claims and contingencies could change based upon new information. Subject to the foregoing, we do not believe that the resolution of any pending or threatened legal claim or loss contingency is likely to have a materially adverse effect on our financial position as of December 31, 2006, or results of operations or cash flows for the fiscal year then ended.
 
 
We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be realized. We evaluate annually the realizability of our deferred tax assets by assessing our valuation allowance and, if necessary, we adjust the amount of such allowance. The factors used to assess the likelihood of realization include our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets. We assessed our deferred tax assets at the end of 2006 and determined that it was more likely than not that we would be able to realize approximately $33.4 million of net deferred tax assets based upon our forecast of future taxable income and other relevant factors.
 
 
Beginning January 2, 2006, we adopted the fair value recognition provisions of SFAS 123(R), using the modified prospective transition method, and therefore have not restated prior period’s results. Under the fair value recognition provisions of SFAS 123(R), we estimate the fair value of our employee stock awards at the date of grant using the Black-Scholes-Merton option pricing model, which requires the use of certain subjective assumptions. The most significant of these assumptions are our estimates of expected volatility of the market price of our stock and the expected term of the stock award. We have determined that historical volatility is the best predictor of expected volatility and the expected term of our awards was determined taking into consideration the vesting period of the award, the contractual term and our historical experience of employee stock option exercise behavior. As required under the accounting rules, we review our valuation assumptions at each grant date and, as a result, we could change our assumptions used to value employee stock-based awards granted in future periods. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those awards expected to vest. If our actual forfeiture rate were materially different from our estimate, the stock-based compensation expense would


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be different from what we have recorded in the current period. The fair value of restricted stock units was calculated based upon the fair value of our Common Stock at the date of grant. Further, SFAS 123(R) requires that employee stock-based compensation costs be recognized over the vesting period of the award and we have elected the straight-line method as the basis for recording our expense.
 
The Company recorded $11.0 million of stock-based compensation expense for the year ended December 31, 2006. As required by SFAS 123(R), management made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest. As of December 31, 2006, the total compensation cost related to options and nonvested stock granted to employees under the Company’s stock option plans but not yet recognized was approximately $11.5 million, net of estimated forfeitures of approximately $1 million. This cost will be amortized over a weighted-average period of 2.15 years and will be adjusted for subsequent changes in estimated forfeitures. As of December 31, 2006, the total compensation cost related to options to purchase shares of the Company’s common stock under the ESPP but not yet recognized was approximately $1.2 million. This cost will be amortized over a weighted-average period of 1.14 years.
 
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
As of December 31, 2006, our investment portfolio consisted primarily of asset backed obligations, corporate bonds, floating rate notes, and federal and municipal obligations. The principal objectives of our investment activities are to preserve principal, meet liquidity needs, and maximize yields. To meet these objectives, we invest excess liquidity only in high credit quality debt securities with average maturities of less than two years. We also limit the percentage of total investments that may be invested in any one issuer. Corporate investments as a group are also limited to a maximum percentage of our investment portfolio.
 
Our investments in debt securities, which totaled $158.6 million at December 31, 2006, are subject to interest rate risk. An increase in interest rates could subject us to a decline in the market value of our investments. These risks are mitigated by our ability to hold these investments for a period of time sufficient to recover the carrying value of the investment which may not be until maturity. A hypothetical 100 basis point increase in interest rates compared with interest rates at December 31, 2006, and January 1, 2006, would result in a reduction of approximately $2.4 million and $1.5 million in the fair value of our available-for-sale debt securities held at December 31, 2006, and January 1, 2006, respectively.
 
The potential changes noted above are based upon sensitivity analyses performed on our financial position and expected operating levels at December 31, 2006. Actual results may differ materially.


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ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
ACTEL CORPORATION
 
CONSOLIDATED BALANCE SHEETS
 
                 
    Dec. 31, 2006     Jan. 1, 2006  
          Restated(1)  
    (In thousands, except
 
    share and per share amounts)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 33,699     $ 24,033  
Short-term investments
    124,022       119,158  
Accounts receivable, net
    22,017       25,287  
Inventories
    39,203       37,372  
Deferred income taxes
    30,389       21,489  
Prepaid expenses and other current assets
    9,492       8,554  
                 
Total current assets
    258,822       235,893  
Long-term investments
    34,234       25,125  
Property and equipment, net
    22,770       23,859  
Goodwill
    30,209       32,142  
Deferred tax asset
    3,055       12,786  
Other assets, net
    19,832       13,391  
                 
    $ 368,922     $ 343,196  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 15,799     $ 14,503  
Accrued salaries and employee benefits
    5,984       5,452  
Accrued license
    9,098       5,714  
Other accrued liabilities
    7,366       4,482  
Deferred income on shipments to distributors
    29,297       28,251  
                 
Total current liabilities
    67,544       58,402  
Deferred compensation plan liability
    4,428       3,667  
Deferred rent liability
    1,367       1,242  
Long term accrued licenses, net
    4,967       3,828  
                 
Total liabilities
    78,306       67,139  
Commitments and contingencies
               
Shareholders’ equity:
               
Preferred stock, $.001 par value per share; 4,500,000 shares authorized; 1,000,000 issued and converted to common stock; and none outstanding
           
Series A Preferred stock, $.001 par value per share; 500,000 shares authorized; none issued or outstanding
           
Common Stock, $.001 par value; 55,000,000 shares authorized; 26,516,850 and 25,733,490 shares issued and outstanding at December 31, 2006 and January 1, 2006, respectively
    26       26  
Additional paid-in capital
    226,443       210,101  
Deferred stock compensation
          (63 )
Retained earnings
    64,578       66,733  
Accumulated other comprehensive loss
    (431 )     (740 )
                 
Total shareholders’ equity
    290,616       276,057  
                 
    $ 368,922     $ 343,196  
                 
 
 
(1) See “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatements of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.
 
See Notes to Consolidated Financial Statements


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ACTEL CORPORATION
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
                         
    Years Ended,  
    Dec. 31, 2006     Jan. 1, 2006     Jan. 2, 2005  
          Restated(1)        
                Restated(1)  
    (In thousands, except per share amounts)  
 
Net revenues
  $ 191,499     $ 178,947     $ 165,402  
Costs and expenses:
                       
Cost of revenues
    75,618       73,282       70,404  
Research and development
    56,926       48,242       45,701  
Selling, general, and administrative
    67,959       49,649       47,975  
Amortization of acquisition-related intangibles
    15       1,908       2,651  
                         
Total costs and expenses
    200,518       173,081       166,731  
                         
Income (loss) from operations
    (9,019 )     5,866       (1,329 )
Interest income and other, net of expense
    7,128       3,912       3,398  
                         
Income (loss) before tax provision (benefit)
    (1,891 )     9,778       2,069  
Tax provision (benefit)
    264       2,742       (705 )
                         
Net income (loss)
  $ (2,155 )   $ 7,036     $ 2,774  
                         
Net income (loss) per share:
                       
Basic
  $ (0.08 )   $ 0.28     $ 0.11  
                         
Diluted
  $ (0.08 )   $ 0.28     $ 0.11  
                         
Shares used in computing net income (loss) per share:
                       
Basic
    26,106       25,277       25,584  
                         
Diluted
    26,106       25,545       26,381  
                         
 
 
(1) See “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatements of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.
 
See Notes to Consolidated Financial Statements


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ACTEL CORPORATION
 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND ACCUMULATED OTHER
COMPREHENSIVE INCOME/(LOSS)
 
                                                 
                            Accumulated
       
                            Other
    Total
 
    Common
    Additional
    Deferred Stock
    Retained
    Comprehensive
    Shareholders’
 
    Stock     Paid-in Capital     Compensation     Earnings     Income (Loss)     Equity  
    (In thousands, except share amounts)  
 
Balance at January 1, 2004, as previously reported
  $ 25     $ 184,674     $ (44 )   $ 79,518     $ 260     $ 264,433  
Cumulative effect of restatements
          15,780       (1,267 )     (12,165 )           2,348  
                                                 
Balance at January 1, 2004 — Restated(1)
    25       200,454       (1,311 )     67,353       260       266,781  
                                                 
Net income
                      2,774             2,774  
Other comprehensive income (loss):
                                               
Change in unrealized loss on investments
                            (700 )     (700 )
                                                 
Total comprehensive income
                      2,774       (700 )     2,074  
Adjustment for stock-based compensation expense associated with remeasured grants
          950                         950  
Other adjustments for stock-based compensation expense
          (604 )                       (604 )
Adjustment to income tax benefit
          (51 )                       (51 )
Reversal of unearned stock-based compensation expense due to employee terminations, net
          (1,012 )     1,012                    
Issuance of stock option to consultant
          74                         74  
Issuance of 682,106 shares of Common Stock under employee stock plans
    1       8,174                         8,175  
Repurchase of 661,697 shares of Common Stock
    (1 )     (4,888 )           (4,738 )           (9,627 )
Cashless exercise of options to purchase 54,563 shares of Common Stock using 30,563 mature shares of Common Stock
          598             (598 )            
Amortization of unearned compensation cost
                44                   44  
                                                 
Balance at January 2, 2005 — Restated(1)
  $ 25     $ 203,695     $ (255 )   $ 64,791     $ (440 )   $ 267,816  
                                                 
 
 
(1) See “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatements of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.
 
See Notes to Consolidated Financial Statements


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ACTEL CORPORATION
 
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND ACCUMULATED OTHER
COMPREHENSIVE INCOME/(LOSS)
 
                                                 
                            Accumulated
       
                            Other
    Total
 
    Common
    Additional
    Deferred Stock
    Retained
    Comprehensive
    Shareholders’
 
    Stock     Paid-in Capital     Compensation     Earnings     Income (Loss)     Equity  
    (In thousands, except share amounts)  
 
Balance at January 2, 2005 — Restated(1)
  $ 25     $ 203,695     $ (255 )   $ 64,791     $ (440 )   $ 267,816  
                                                 
Net income
                        7,036             7,036  
Other comprehensive income (loss):
                                               
Change in unrealized loss on investments
                            (300 )     (300 )
                                                 
Total comprehensive income
                        7,036       (300 )     6,736  
Adjustment for stock-based compensation expense associated with remeasured grants
          186                         186  
Other adjustments for stock-based compensation expense
          (431 )                       (431 )
Reversal of unearned compensation expense due to expiration of options
          646                         646  
Tax impact of stock-based compensation
          (88 )                       (88 )
Reversal of unearned stock-based compensation expense due to employee terminations, net
          (192 )     192                    
Issuance of 951,835 shares of Common Stock under employee stock plans
    1       10,987                         10,988  
Repurchase of 627,500 shares of Common Stock
          (4,702 )           (5,094 )           (9,796 )
                                                 
Balance at January 1, 2006 — Restated(1)
    26       210,101       (63 )     66,733       (740 )     276,057  
                                                 
Net loss
                      (2,155 )           (2,155 )
Other comprehensive income (loss):
                                               
Change in unrealized loss on investments
                            309       309  
                                                 
Total comprehensive loss
                      (2,155 )     309       (1,846 )
Stock based compensation
          11,256                         11,256  
Reversal of deferred tax assets upon cancellation of options
          (2,054 )                       (2,054 )
Issuance of 906,380 shares of Common Stock under employee stock plans
          9,437                         9,437  
Repurchase of 123,020 shares of Common Stock
          (2,234 )                       (2,234 )
Reversal of unearned stock-based compensation upon adoption of SFAS No. 123R
          (63 )     63                    
                                                 
Balance at December 31, 2006
  $ 26     $ 226,443     $     $ 64,578     $ (431 )   $ 290,616  
                                                 
 
 
(1) See “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatements of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.
 
See Notes to Consolidated Financial Statements


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ACTEL CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                         
    Years Ended,  
    Dec. 31, 2006     Jan. 1, 2006     Jan. 2, 2005  
          Restated(1)     Restated(1)  
    (In thousands)  
 
Operating activities:
                       
Net income(loss)
  $ (2,155 )   $ 7,036     $ 2,774  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
                       
Depreciation and amortization
    9,782       11,033       10,496  
Stock compensation cost recognized
    10,990       (233 )     1  
Changes in operating assets and liabilities:
                       
Accounts receivable
    3,270       (8,854 )     2,946  
Inventories
    (1,564 )     3,846       (2,554 )
Deferred income taxes
    (434 )     2,187       (568 )
Prepaid expenses and other current assets
    (938 )     (2,446 )     (1,366 )
License agreements and other long-term assets
    (5,627 )     (7,894 )     1  
Accounts payable, accrued salaries and employee benefits, and other accrued liabilities
    10,159       11,992       (3,048 )
Deferred income on shipments to distributors
    1,046       5,918       1,213  
                         
Net cash provided by operating activities
    24,529       22,585       9,895  
Investing activities:
                       
Purchases of property and equipment
    (8,678 )     (10,180 )     (10,714 )
Purchases of available-for-sale securities
    (145,200 )     (72,252 )     (166,356 )
Sales and maturities of available-for-sale securities
    131,731       75,767       161,657  
Changes in other long term assets
    81       516       (273 )
                         
Net cash used in investing activities
    (22,066 )     (6,149 )     (15,686 )
Financing activities:
                       
Issuance of Common Stock under employee stock plans
    9,437       10,988       8,175  
Repurchase of Common Stock
    (2,234 )     (9,796 )     (9,627 )
                         
Net cash provided by (used in) financing activities
    7,203       1,192       (1,452 )
Net increase (decrease) in cash and cash equivalents
    9,666       17,628       (7,243 )
Cash and cash equivalents, beginning of year
    24,033       6,405       13,648  
                         
Cash and cash equivalents, end of year
  $ 33,699     $ 24,033     $ 6,405  
                         
Supplemental disclosures of cash flow information:
                       
Cash paid during the year for income taxes
  $ 510     $ 435     $ 431  
Supplemental schedule of non-cash activities:
                       
Accrual of long-term license agreements
  $ 9,557     $ 10,678     $  
 
 
(1) See “Explanatory Note” immediately preceding Part I, Item 1 and Note 2, “Restatements of Consolidated Financial Statements,” in Notes to Consolidated Financial Statements of this Form 10-K.
 
See Notes to Consolidated Financial Statements


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ACTEL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.   Organization and Summary of Significant Accounting Policies
 
The leading supplier of nonvolatile solutions, Actel Corporation, founded in California in 1985, designs, develops, and markets Flash- and antifuse-based field-programmable gate arrays (FPGAs) for a wide range of applications within the aerospace, automotive, avionics, communications, consumer, industrial, medical, and military markets. In support of its FPGA devices, the company also offers design and development software, intellectual property (IP) cores, programming hardware, debugging tool kits and demonstration boards, design services, field engineering and technical support. We sell our products globally through a worldwide, multi-tiered sales and distribution network.
 
 
Our policy is to expense advertising and promotion costs as they are incurred. Our advertising and promotion expenses were approximately $3.4 million in 2006, $3.4 million in 2005 and $3.2 million in 2004 and are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
 
 
The consolidated financial statements include the accounts of Actel Corporation and our wholly owned subsidiaries. We use the U.S. Dollar as the functional currency in our foreign operations. Assets and liabilities that are not denominated in the functional currency are remeasured into U.S. dollars, and the resulting gains or losses are included in interest income and other, net of expense. All significant intercompany accounts and transactions have been eliminated in consolidation.
 
Our fiscal year ends on the first Sunday after December 30th. Fiscal 2006 ended on December 31, 2006, fiscal 2005 ended on January 1, 2006, and fiscal 2004 ended on January 2, 2005.
 
 
For financial statement purposes, we consider all highly liquid debt instruments with insignificant interest rate risk and a maturity of three months or less when purchased to be cash equivalents. Cash equivalents consist primarily of cash deposits in money market funds that are available for withdrawal without restriction. Investments consist principally of corporate, federal, state, and local municipal obligations. See Note 4 for further information regarding short-term investments.
 
We account for our investments in accordance with the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” We determine the appropriate classification of debt securities at the time of purchase and re-evaluate such designation as of each balance sheet date. We may also make long term equity investments for the promotion of business and strategic objectives.
 
We monitor all of our equity investments for impairment on a periodic basis. In the event that the carrying value of the equity investment exceeds its fair value and the decline in value is determined to be other than temporary, the carrying value is reduced to its current fair market value. See Note 4 for further information regarding investments.
 
Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported as a component of comprehensive income in shareholders’ equity. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion is included in interest and other income, net of expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income and other.
 
In accordance with SFAS No. 115, if a decline in value below cost is determined to be other than temporary, the unrealized losses will be recorded as expense in the period when that determination is made. In the absence of other


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ACTEL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
overriding factors, we consider a decline in market value to be other than temporary when a publicly traded stock or a debt security has traded below book value for a consecutive six-month period. If an investment continues to trade below book value for more than six months, and mitigating factors such as general economic and industry specific trends including the creditworthiness of the issuer are not present this investment would be evaluated for impairment and written down to a balance equal to the estimated fair value at the time of impairment, with the amount of the write-down realized as expense on the income statement. If management concludes it has the intent and ability as necessary, to hold such securities for a period of time sufficient to allow for an anticipated recovery of fair value up to the cost of the investment, and the issuers of the securities are creditworthy, no other-than-temporary impairment is deemed to exist. No impairment charges were recorded for 2006, 2005 or 2004.
 
We maintain trading assets to generate returns that offset changes in liabilities related to our deferred compensation plan. The trading assets consist of insurance contracts, which are stated at fair value, and our Common Stock contributed to the plan by participants, which is stated at historical value. Recognized gains and losses are included in interest income and other, net of expense, and generally offset the change in the deferred compensation liability, which is also included in interest income and other, net of expense. Net losses on the trading asset portfolio were $0.2 million in 2006, and $0.1 million in 2005 and 2004. The deferred compensation assets were $4.1 million in 2006, $3.3 million in 2005 and $3.0 million in 2004 and the deferred compensation liabilities were $4.4 million, $3.7 million, and $3.3 million, respectively, in those years.
 
 
Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents, short-term investments, and trade receivables. We limit our exposure to credit risk by investing excess liquidity only in securities of A, A1, or P1 grade. We are exposed to credit risks in the event of default by the financial institutions or issuers of investments to the extent of amounts recorded on the balance sheet.
 
We sell our products to customers in diversified industries. We are exposed to credit risks in the event of non-payment by customers to the extent of amounts recorded on the balance sheet. We limit our exposure to credit risk by performing ongoing credit evaluations of our customers’ financial condition and generally require no collateral. We are exposed to credit risks in the event of insolvency by our customers and manage such exposure to accounting losses by limiting the amount of credit extended whenever deemed necessary. Our distributors accounted for approximately 77% of our revenues in 2006, 64% of our revenues in 2005 and 67% in 2004. During 2003, we consolidated our distribution channel by terminating our agreement with Pioneer, leaving Memec as our sole distributor in North America. On April 26, 2005, Avnet, Inc. (Avnet) and Memec Group Holdings Ltd. (Memec) announced they had reached a definitive agreement for Avnet to acquire Memec in a stock and cash transaction. On July 5, 2005, Avnet announced the completion of its acquisition of Memec. The loss of Avnet as a distributor could have a material adverse effect on our business, financial condition and results of operations. We had no single end customer accounting for greater than 10% of net revenues in 2006, 2005 or 2004.
 
As of December 31, 2006, we had accounts receivable totaling $22.0 million, net of an allowance for doubtful accounts of $0.6 million. If sales levels were to increase the level of receivables would likely also increase. In the event that customers were to delay their payments to us, the levels of accounts receivable would also increase. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The allowance for doubtful accounts is based on past payment history with the customer, analysis of the customer’s current financial condition, outstanding invoices older than 90 days, and other known factors. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required and our operating results would be negatively impacted.
 
We depend on a limited number of independent wafer manufacturers, subcontractors for the assembly and packaging of our products and software and hardware developers for the design, development and maintenance of our products. Our reliance on these independent suppliers of products and services involves certain risks, including lack of control over capacity allocation, delivery schedules and customer support. We have no long-term contracts


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ACTEL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
with our subcontractors and certain of those subcontractors sometimes operate at or near full capacity. Any significant disruption in supplies or services from, or degradation in the quality of components or services supplied by, our subcontractors could have a materially adverse effect on our business, financial condition, and/or operating results.
 
 
We use the following methods and assumptions in estimating our fair value disclosures for financial instruments:
 
 
The carrying amount reported in the balance sheets for accounts payable approximates fair value because of relatively short payment terms.
 
 
The carrying amounts reported in the balance sheets for cash and cash equivalents approximate fair value because of the relatively short time to maturity.
 
 
The fair value of our insurance contracts (entered into in connection with our deferred compensation plan) is based upon cash surrender value.
 
 
The fair values for marketable debt and equity securities are based on quoted market prices. Strategic equity investments in non-public companies with no readily available market value are carried on the balance sheet at cost as adjusted for impairment losses. If reductions in the market value of marketable equity securities to an amount that is below cost are deemed by us to be other than temporary, the reduction in market value will be realized, with the resulting loss in market value reflected on the income statement.
 
 
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition, we test goodwill for impairment annually or more frequently if certain events or changes in circumstances indicate that the carrying value may not be recoverable. We completed our annual goodwill impairment tests and noted no impairment. The initial test of goodwill impairment requires us to compare our fair value with our book value, including goodwill. Based on our total market capitalization, which we believe represents the best indicator of our fair value, we determined that our fair value was in excess of our book value. Since we found no indication of impairment, no further testing was necessary.
 
At January 1, 2006 and January 2, 2005 we had identified intangible assets arising from prior business acquisitions with a net book value of $15,000 and $1.9 million, respectively, which were being amortized on a straight line basis over their estimated lives. These non-goodwill intangible assets were fully amortized in 2006.
 
 
In February 2006, the FASB issued FASB Statement No. 155 (“SFAS 155”), “Accounting for Certain Hybrid Financial Instruments” an amendment of FASB Statements No. 133 and 140. SFAS 155 simplifies the accounting for certain hybrid financial instruments by permitting fair value remeasurement for any hybrid financial instrument


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ACTEL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
that contains an embedded derivative that otherwise would require bifurcation. SFAS 155 also clarifies and amends certain other provisions of SFAS 133 and SFAS 140. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including financial statements for any interim period for that fiscal year. This Statement will be adopted by Actel in the first quarter of fiscal 2007. The adoption of SFAS 155 will not have a material impact on our consolidated results of operations and financial condition.
 
In June 2006, the FASB issued FASB Interpretation No. (FIN) 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”. This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation is effective for fiscal years beginning after December 15, 2006 and will be adopted by Actel in the first quarter of fiscal 2007. The Company is evaluating the impact of this Interpretation, however, we currently do not expect that the adoption of FIN 48 will have a material effect on our results of operations and financial condition.
 
On June 28, 2006, the FASB ratified the consensus reached in EITF Issue No. 06-2, “Accounting for Sabbatical Leave and Other Similar Benefits Pursuant to FASB Statement No. 43, Accounting for Compensated Absences”. This consensus provides that sabbatical leave or other similar benefits provided to an employee should be considered to accumulate over the service period as described in FASB Statement No. 43. This EITF is effective for fiscal years beginning after December 15, 2006 and will be adopted by Actel in the first quarter of fiscal 2007. Actel will record a $2.5 million cumulative adjustment, net of tax, to decrease the January 1, 2007 balance of retained earnings. We expect the annual impact to earnings to be immaterial.
 
In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements of assets and liabilities. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. This Statement will be adopted by Actel in the first quarter of fiscal 2008. Actel is currently evaluating the effect that the adoption of FASB No. 157 will have on its consolidated results of operations and financial condition.
 
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 provides interpretive guidance on how the effects of prior year errors should be considered in quantifying a current year misstatement. SAB 108 is effective for Actel for the fiscal year ended December 31, 2006. In connection with the adoption of SAB 108, the Company restated its financial statements for certain errors associated with the recognition of deferred income associated with its European distributors. See Note 2, “Restatements to Consolidated Financial Statements”.
 
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.” This statement permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply the provisions of SFAS No. 157. The Company expects to adopt SFAS No. 159 in the first quarter of fiscal 2008. The Company is currently evaluating the impact that this pronouncement may have on its consolidated financial statements.


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ACTEL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. Under SFAS No. 109, the liability method is used in accounting for income taxes. Deferred tax assets and liabilities are determined based on the differences between financial reporting and the tax basis of assets and liabilities, and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. SFAS No. 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax asset will not be realized. We evaluate annually the realizability of our deferred tax assets by assessing our valuation allowance and by adjusting the amount of such allowance, if necessary. The factors used to assess the likelihood of realization include our forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets.
 
 
Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). We believe that a certain level of inventory must be carried to maintain an adequate supply of product for customers. This inventory level may vary based upon orders received from customers or internal forecasts of demand for these products. Other considerations in determining inventory levels include the stage of products in the product life cycle, design win activity, manufacturing lead times, customer demand, strategic relationships with foundries, and competitive situations in the marketplace. Should any of these factors develop other than anticipated, inventory levels may be materially and adversely affected.
 
We write down our inventory for estimated obsolescence or unmarketability equal to the difference between the cost of inventory and the estimated realizable value based upon assumptions about future demand and market conditions. To address this difficult, subjective, and complex area of judgment, we apply a methodology that includes assumptions and estimates to arrive at the net realizable value. First, we identify any inventory that has been previously written down in prior periods. This inventory remains written down until sold, destroyed, or otherwise dispositioned. Second, we examine inventory line items that may have some form of non-conformance with electrical and mechanical standards. Third, we assess the inventory not otherwise identified to be written down against product history and forecasted demand (typically for the next six months). Finally, we analyze the result of this methodology in light of the product life cycle, design win activity, and competitive situation in the marketplace to derive an outlook for consumption of the inventory and the appropriateness of the resulting inventory levels. If actual future demand or market conditions are less favorable than those we have projected, additional inventory write-downs may be required.
 
During the second quarter of 2004, we recommended that customers switch to RTSX-S parts manufactured by UMC if their schedules permitted, and we offered to accept RTSX-S parts from our original manufacturer in exchange for the UMC parts. By the fourth quarter of 2004, most customers had decided to switch to UMC devices, and we determined that the demand for parts from our original manufacturer no longer supported our inventory levels. As a result, we took a charge of $2.1 million in the fourth quarter of 2004 related to the unmarketability of RTSX-S parts from our original manufacturer.
 
We made “last time buys” of certain products from our wafer suppliers during 2003 and 2005. Our inventory valuation policy has been designed to take into consideration last time buy inventory purchases. Last time buys occur when a wafer supplier is about to shut down the manufacturing line used to make a product and current inventories are insufficient to meet foreseeable future demand. Since this inventory was not acquired to meet current demand, we did not believe the application of our existing inventory write down policy was appropriate, so a discrete write down policy was established for inventory purchased in last time buy transactions. As a consequence, these transactions and the related inventory are excluded from our standard excess and obsolescence write down policy. Inventory purchased in last time buy transactions is evaluated on an ongoing basis for indications of excess


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ACTEL CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
or obsolescence based on rates of actual sell through; expected future demand for those products over a longer time horizon; and any other qualitative factors that may indicate the existence of excess or obsolete inventory. In the event that actual sell through does not meet expectations and estimations of expected future demand decrease, last time buy inventory may be written down. Evaluations of last time buy inventory in 2005 resulted in a write down of $0.3 million of last time buy material