Broadcom (BRCM)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended March 31, 2006
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from           to

California		33-0480482
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

						Page
PART I. FINANCIAL INFORMATION
	Item 1.			Financial Statements			2
				Unaudited Condensed Consolidated Balance Sheets at March 31, 2006 and December 31, 2005			2
				Unaudited Condensed Consolidated Statements of Income for the Three Months Ended March 31, 2006 and 2005			3
				Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005			4
				Notes to Unaudited Condensed Consolidated Financial Statements			5
	Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations			22
	Item 3.			Quantitative and Qualitative Disclosures about Market Risk			38
	Item 4.			Controls and Procedures			39
PART II. OTHER INFORMATION
	Item 1.			Legal Proceedings			39
	Item 1A.			Risk Factors			39
	Item 2.			Unregistered Sales of Equity Securities and Use of Proceeds			58
	Item 3.			Defaults upon Senior Securities			58
	Item 4.			Submission of Matters to a Vote of Security Holders			58
	Item 5.			Other Information			58
	Item 6.			Exhibits			60
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 10.4
EXHIBIT 10.5
EXHIBIT 31
EXHIBIT 32

1

 

 

Item 1.	Financial Statements

 

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

		March 31,				December 31,
		2006				2005
		(In thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	1,868,162			$	1,437,276
Short-term marketable securities			272,402				295,402
Accounts receivable, net			351,599				307,356
Inventory			226,301				194,571
Prepaid expenses and other current assets			87,355				101,271
Total current assets			2,805,819				2,335,876
Property and equipment, net			100,556				96,438
Long-term marketable securities			172,889				142,843
Goodwill			1,188,694				1,149,602
Purchased intangible assets, net			37,368				7,332
Other assets			18,156				20,108
Total assets		$	4,323,482			$	3,752,199
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	323,930			$	289,069
Wages and related benefits			79,203				69,837
Deferred revenue			2,121				2,053
Accrued liabilities			241,031				233,663
Total current liabilities			646,285				594,622
Commitments and contingencies
Long-term liabilities			9,027				12,138
Shareholders’ equity:
Common stock			55				52
Additional paid-in capital			9,450,216				9,243,045
Notes receivable from employees			(2,544	)			(4,743	)
Deferred compensation			—				(178,217	)
Accumulated deficit			(5,780,920	)			(5,915,806	)
Accumulated other comprehensive income			1,363				1,108
Total shareholders’ equity			3,668,170				3,145,439
Total liabilities and shareholders’ equity		$	4,323,482			$	3,752,199

2

 

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

		Three Months Ended
		March 31,
		2006				2005
		(In thousands, except
		per share data)
Net revenue		$	900,647			$	550,345
Cost of revenue			432,776				266,116
Gross profit			467,871				284,229
Operating expense:
Research and development			240,131				145,870
Selling, general and administrative			108,707				58,397
Amortization of purchased intangible assets			1,083				912
In-process research and development			5,200				6,652
Income from operations			112,750				72,398
Interest income, net			23,738				7,958
Other income, net			1,771				98
Income before income taxes			138,259				80,454
Provision for income taxes			3,373				11,272
Net income		$	134,886			$	69,182
Net income per share (basic)		$	.25			$	.14
Net income per share (diluted)		$	.22			$	.13
Weighted average shares (basic)			538,968				497,206
Weighted average shares (diluted)			602,776				537,138

3

 

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		Three Months Ended
		March 31,
		2006				2005
		(In thousands)
Operating activities
Net income		$	134,886			$	69,182
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			11,188				14,513
Stock-based compensation expense:
Stock options and other awards			79,528				6,136
Restricted stock units issued by the Company			14,163				5,158
Additional acquisition-related items:
Amortization of purchased intangible assets			4,064				3,202
In-process research and development			5,200				6,652
Gain on strategic investments			(700	)			—
Change in operating assets and liabilities:
Accounts receivable			(44,199	)			(2,153	)
Inventory			(31,105	)			20,386
Prepaid expenses and other assets			16,395				2,890
Accounts payable			30,225				20,008
Accrued settlement liabilities			(2,000	)			(10,053	)
Other accrued liabilities			13,754				15,178
Net cash provided by operating activities			231,399				151,099
Investing activities
Net purchases of property and equipment			(14,957	)			(8,054	)
Net cash paid for acquisitions			(67,921	)			(24,028	)
Net proceeds from sales (purchases) of strategic investments			137				(119	)
Purchases of marketable securities			(174,927	)			(133,323	)
Proceeds from maturities of marketable securities			167,881				104,951
Net cash used in investing activities			(89,787	)			(60,573	)
Financing activities
Net proceeds from issuance of common stock			385,161				28,226
Repurchases of Class A common stock			(93,799	)			—
Repayment of notes receivable by employees			2,199				53
Excess tax benefits from stock-based compensation			338				—
Payments on assumed debt and other obligations			(4,625	)			(2,482	)
Net cash provided by financing activities			289,274				25,797
Increase in cash and cash equivalents			430,886				116,323
Cash and cash equivalents at beginning of period			1,437,276				858,592
Cash and cash equivalents at end of period		$	1,868,162			$	974,915

4

1.	Summary of Significant Accounting Policies

5

6

7

	•	the nature of products and services;
	•	the nature of the production processes;

8

	•	the type or class of customer for their products and services; and
	•	the methods used to distribute their products or provide their services.

	•	the sale of integrated circuits is the only material source of revenue for each of its five operating segments;
	•	the integrated circuits sold by each of its operating segments use the same standard CMOS manufacturing processes;
	•	the integrated circuits marketed by each of its operating segments are sold to one type of customer: manufacturers of wired and wireless communications equipment, which incorporate the Company’s integrated circuits into their electronic products; and
	•	all of its integrated circuits are sold through a centralized sales force and common wholesale distributors.

2.	Supplemental Financial Information

		March 31,				December 31,
		2006				2005
		(In thousands)
Work in process		$	98,641			$	86,445
Finished goods			127,660				108,126
		$	226,301			$	194,571

9

		March 31, 2006												December 31, 2005
						Accumulated												Accumulated
		Gross				Amortization				Net				Gross				Amortization				Net
		(In thousands)
Completed technology		$	186,799			$	(153,657	)		$	33,142			$	156,099			$	(150,676	)		$	5,423
Customer relationships			49,266				(46,066	)			3,200				46,266				(45,228	)			1,038
Customer backlog			3,316				(3,316	)			—				3,316				(3,316	)			—
Other			7,614				(6,588	)			1,026				7,214				(6,343	)			871
		$	246,995			$	(209,627	)		$	37,368			$	212,895			$	(205,563	)		$	7,332

		Three Months Ended
		March 31,
		2006				2005
		(In thousands)
Cost of revenue		$	2,981			$	2,290
Operating expense			1,083				912
		$	4,064			$	3,202

		March 31,				December 31,
		2006				2005
		(In thousands)
Accrued rebates		$	97,666			$	99,645
Accrued taxes			69,915				68,318
Warranty reserve			15,630				14,131
Restructuring liabilities			7,574				8,083
Accrued settlement liabilities			2,047				2,047
Other			48,199				41,439
		$	241,031			$	233,663

10

		March 31,				December 31,
		2006				2005
		(In thousands)
Restructuring liabilities		$	7,027			$	8,138
Accrued settlement liabilities			2,000				4,000
		$	9,027			$	12,138

		Three Months Ended
		March 31,
		2006				2005
		(In thousands)
Beginning balance		$	99,645			$	93,222
Charged as a reduction to revenue			54,330				52,063
Payments and reversals			(56,309	)			(57,970	)
Ending balance		$	97,666			$	87,315

		Three Months Ended
		March 31,
		2006				2005
		(In thousands)
Beginning balance		$	14,131			$	19,185
Charged to costs and expenses			2,267				—
Acquired through acquisition			877				55
Payments			(1,645	)			(1,120	)
Ending balance		$	15,630			$	18,120

11

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

 

Restructuring Activity

 

The following table summarizes the activity related to the Company’s current and long-term restructuring liabilities during the three months ended March 31, 2006:

 

 

 

 

Computation of Net Income Per Share

 

The following table presents the computation of net income per share:

 

 

At March 31, 2006 common share equivalents were calculated based on (i) stock options to purchase 121.8 million shares of Class A or Class B common stock outstanding with a weighted average exercise price of $19.85 per share and (ii) 7.3 million restricted stock units that entitle the holder to receive a like number of freely transferable shares of Class A common stock as the awards vest.

 

 

In March 2006 the Company completed the acquisition of Sandburst Corporation, a fabless semiconductor company specializing in the design and development of packet switching and routing systems-on-a-chip (“SoCs”) that are deployed in enterprise core and metropolitan Ethernet networks. In connection with this acquisition, the Company paid $72.0 million in cash. In addition, the Company assumed 0.1 million unvested stock options that had a fair value of $4.4 million in accordance with SFAS 123R. The Company recorded a one-time charge of $5.2 million for purchased in-process research and development (“IPR&D”) expense. The amount allocated to IPR&D in the three months ended March 31, 2006 was determined through established

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

valuation techniques used in the high technology industry and was expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed. The Company also assumed $7.6 million in net liabilities and recorded $40.2 million in goodwill, $30.7 million of completed technology and $3.4 million in other purchased intangible assets in connection with this acquisition.

 

The Company’s primary reasons for the Sandburst acquisition were to enter into the design and development of packet switching and routing SoCs that are deployed in enterprise core and metropolitan Ethernet networks, reduce the time required to develop new technologies and products and bring them to market, incorporate enhanced functionality into and complement the Company’s existing network switch product offerings, augment its engineering workforce, and enhance its technological capabilities. Certain of the cash consideration in the above acquisition is currently held in escrow pursuant to the terms of the acquisition agreement.

 

The unaudited consolidated financial statements include the results of operations of Sandburst commencing as of the acquisition date. No supplemental pro forma information is presented for the acquisition due to the immaterial effect of the acquisition on the Company’s results of operations.

 

 

The Company recorded a tax provision of $3.4 million for the three months ended March 31, 2006 as compared to $11.3 million for the three months ended March 31, 2005, representing effective tax rates of 2.4% and 14.0%, respectively. The difference between the Company’s effective tax rates and the 35% federal statutory rate resulted primarily from domestic losses recorded without income tax benefit for the three months ended March 31, 2006 and foreign earnings taxed at rates lower than the federal statutory rate for the three months ended March 31, 2006 and March 31, 2005. In addition, during the three months ended March 31, 2006 the Company realized income tax benefits of $1.7 million resulting from the reversal of certain prior period tax accruals for certain foreign subsidiaries, due to the conclusion of certain foreign tax audits and the expiration of the statute of limitations for assessment of taxes related to prior periods.

 

The Company utilizes the liability method of accounting for income taxes as set forth in SFAS 109. The Company records net deferred tax assets to the extent it believes these assets will more likely than not be realized. In making such determination, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies and recent financial performance. SFAS 109 further states that forming a conclusion that a valuation allowance is not required is difficult when there is negative evidence such as cumulative losses in recent years. As a result of the Company’s recent cumulative losses in the U.S. and certain foreign jurisdictions, and the full utilization of its loss carryback opportunities, the Company has concluded that a full valuation allowance should be recorded in such jurisdictions. In certain other foreign jurisdictions where the Company does not have cumulative losses, the Company recorded net deferred tax assets of $1.4 million at March 31, 2006 and December 31, 2005 in accordance with SFAS 109.

 

 

Share Repurchase Program

 

In February 2005 the Company’s Board of Directors authorized a program to repurchase shares of the Company’s Class A common stock. The Board approved the repurchase of shares having an aggregate value of up to $250 million from time to time over a period of one year, depending on market conditions. In January 2006 the Board approved an amendment to the share repurchase program extending the program through January 26, 2007 and authorizing the repurchase of additional shares of the Company’s Class A common stock

		Three Months Ended
		March 31,
		2006				2005
		(In thousands)
Net income		$	134,886			$	69,182
Other comprehensive income (loss):
Translation adjustments			255				(37	)
Total comprehensive income		$	135,141			$	69,145

6.	Employee Benefit Plans

14

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

the options granted thereunder will accelerate in whole or in part upon the occurrence of certain specified events.

 

In addition, the Company grants restricted stock units as part of its regular annual employee equity compensation review program as well as to new hires and non-employee members of the Board of Directors. Restricted stock units are share awards that entitle the holder to receive freely tradable shares of the Company’s Class A common stock upon vesting. Generally, restricted stock units vest ratably on a quarterly basis over 16 quarters from the date of grant.

 

Combined Incentive Plan Information

 

Option activity under the Company’s stock incentive plans in the three months ended March 31, 2006 is set forth below:

 

 

The total pretax intrinsic value of options exercised during the three months ended March 31, 2006 was $609.6 million. This intrinsic value represents the difference between the fair market value of the Company’s Class A common stock on the date of exercise and the exercise price of each option.

 

The aggregate pretax intrinsic value, weighted average remaining contractual life, and weighted average per share exercise price of options outstanding and of options exercisable as of March 31, 2006 were as follows:

 

 

The aggregate pretax intrinsic values in the preceding table were calculated based on the closing price of the Company’s Class A common stock of $43.16 on March 31, 2006. At March 31, 2006 the weighted average remaining contractual life of the exercisable options was 6.4 years.

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

 

Restricted stock unit activity under the 1998 Plan in the three months ended March 31, 2006 is set forth below:

 

 

The total pretax intrinsic value of restricted stock units vested during the three months ended March 31, 2006 was $24.1 million. Based on the closing price of the Company’s Class A common stock of $43.16 on March 31, 2006, the total pretax intrinsic value of all outstanding restricted stock units was $314.5 million.

 

Employee Stock Purchase Plan

 

The Company has an employee stock purchase plan for all eligible employees. Under the plan, employees may purchase shares of the Company’s Class A common stock at six-month intervals at 85% of fair market value (calculated in the manner provided in the plan). Employees purchase such stock using payroll deductions, which may not exceed 15% of their total cash compensation. The plan imposes certain limitations upon an employee’s right to acquire Class A common stock, including the following: (i) no employee may purchase more than 6,000 shares of Class A common stock on any one purchase date and (ii) no employee may be granted rights to purchase more than $25,000 worth of Class A common stock for each calendar year in which such rights are at any time outstanding. At March 31, 2006, 9.0 million shares were available for future issuance under this plan. The Company did not issue any shares under this plan in the three months ended March 31, 2006.

 

Stock-Based Compensation Expense

 

The following table presents details of stock-based compensation expense by functional line item:

 

 

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

 

The weighted average fair values per share of stock options granted in connection with the Company’s stock incentive plans have been estimated utilizing the following assumptions:

 

 

The weighted average fair values per share of the restricted stock units awarded in the three months ended March 31, 2006 and 2005 were $43.02 and $21.46, respectively, calculated based on the fair market value of the Company’s Class A common stock on the respective grant dates.

 

The adoption of SFAS 123R will continue to have a significant adverse impact on the Company’s reported results of operations, although it will have no impact on its overall financial position. The amount of unearned stock-based compensation currently estimated to be expensed in the period 2006 through 2010 related to unvested share-based payment awards at March 31, 2006 is $687.9 million. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 1.4 years. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional equity awards to employees or assumes unvested equity awards in connection with acquisitions.

 

On April 24, 2006, as part of the Company’s regular annual employee compensation review program, the Company awarded 6.2 million restricted stock units, resulting in unearned stock-based compensation of $258.4 million calculated based on the $41.57 closing price of the Company’s Class A common stock on that date. One-sixteenth of the restricted stock units will vest May 5, 2006 and the remainder will vest ratably over the next 15 quarters. These restricted stock units, the respective unearned stock-based compensation, and their fair values are not included above. The Company also plans to grant additional employee stock options in the second quarter of 2006 in connection with the annual employee compensation review. The unearned stock-based compensation resulting from those stock option grants is also not included above, as the impact of the grants will depend on the number of stock options granted and their then current fair values.

 

In accordance with the requirements of the disclosure-only alternative of SFAS 123, set forth below is a pro forma illustration of the effect on net income (loss) and net income (loss) per share computed as if the Company had valued stock-based awards to employees using the Black-Scholes option pricing model instead of applying the guidelines provided by APB 25 in the three months ended March 31, 2005:

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

 

 

Intellectual Property Proceedings.  In May 2005 the Company filed a complaint in the U.S. International Trade Commission (“ITC”) asserting that Qualcomm Incorporated (“Qualcomm”) has engaged in unfair trade practices by importing integrated circuits and other products that infringe, both directly and indirectly, five of the Company’s patents relating generally to wired and wireless communications. The complaint seeks an exclusion order to bar importation of those Qualcomm products into the United States and a cease and desist order to bar further sales of infringing Qualcomm products that have already been imported. In June 2005 the ITC instituted an investigation of Qualcomm based upon the allegations made in the Company’s complaint. The hearing on the liability portion of the case concluded in March 2006. In February 2006 the administrative law judge granted the motions of various third parties to intervene to contest the application of any exclusion order to downstream products. That hearing is set to begin in July 2006.

 

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

 

The second District Court complaint asserts that Qualcomm has infringed, both directly and indirectly, five other Broadcom patents relating generally to wired and wireless communications and multimedia processing technologies. The complaint seeks preliminary and permanent injunctions against Qualcomm and the recovery of monetary damages, including treble damages for willful infringement, and attorneys’ fees. In July 2005 Qualcomm answered the second complaint and asserted counterclaims seeking a declaratory judgment that the Company’s patents are invalid and not infringed. The court denied Qualcomm’s motion to stay the second action pending the outcome of the ITC action, and discovery is now proceeding. A claims construction hearing is scheduled for July 2006 and trial has been set for February 2007.

 

In July 2005 Qualcomm filed a complaint against the Company in the United States District Court for the Southern District of California asserting that certain of the Company’s products infringe, both directly and

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

indirectly, seven Qualcomm patents relating generally to the transmission, reception and processing of communication signals, including radio signals and/or signals for wireless telephony. The complaint seeks a preliminary and permanent injunction against the Company as well as the recovery of monetary damages and attorneys’ fees. The Company filed an answer in September 2005 denying the allegations in Qualcomm’s complaint and asserting counterclaims. The counterclaims seek a declaratory judgment that the seven Qualcomm patents are invalid and not infringed, and assert that Qualcomm has infringed, both directly and indirectly, six of the Company’s patents relating generally to wired and wireless communications. The counterclaims seek preliminary and permanent injunctions against Qualcomm and the recovery of monetary damages, including treble damages for willful infringement, and attorneys’ fees. In January 2006 Qualcomm amended its complaint to seek treble damages for willful infringement. Discovery is ongoing, but no trial date has been set. The court has scheduled claims construction hearings in May 2006.

 

In August 2005 Qualcomm filed a second complaint against the Company in the United States District Court for the Southern District of California asserting that the Company breached a contract relating to Bluetooth development and seeking a declaration that two of the Company’s patents are invalid and not infringed. In March 2006 Qualcomm filed an amended complaint providing further details concerning the same causes of action. The Company filed an answer in April 2006 denying the allegations in the complaint and asserting counterclaims. The counterclaims assert that Qualcomm has infringed, both directly and indirectly, the same two Company patents, and also allege breach of the Bluetooth contract by Qualcomm. The Company is seeking preliminary and permanent injunctions against Qualcomm and the recovery of monetary damages, including treble damages for willful infringement, and attorneys’ fees. Discovery in the action has not commenced, and no trial date has been set.

 

In October 2005 Qualcomm filed a third complaint against the Company in the United States District Court for the Southern District of California asserting that certain of the Company’s products infringe, both directly and indirectly, two Qualcomm patents relating generally to the processing of digital video signals. The complaint seeks preliminary and permanent injunctions against the Company as well as the recovery of monetary damages and attorneys’ fees. The Company filed an answer in December 2005 denying the allegations in Qualcomm’s complaint and asserting counterclaims seeking a declaratory judgment that the two Qualcomm patents are invalid and not infringed. A claims construction hearing was held in March 2006. Discovery in the action is ongoing, and trial has been set for January 2007.

 

In March 2006 Qualcomm filed a fourth complaint against the Company in the United States District Court for the Southern District of California asserting that the Company had misappropriated certain Qualcomm trade secrets and that certain of the Company’s products infringe, both directly and indirectly, a patent related generally to orthogonal frequency division multiplexing. The complaint seeks preliminary and permanent injunctions against the Company as well as the recovery of monetary damages, including double damages, and attorneys’ fees. Qualcomm also filed a motion for expedited discovery. The court has not yet ruled on the motion. The Company has not yet filed an answer in the action.

 

Antitrust Proceedings.  In July 2005 the Company filed a complaint against Qualcomm in the United States District Court for the District of New Jersey asserting that Qualcomm’s licensing and other practices related to cellular technology and products violate federal and state antitrust laws. The complaint also asserts causes of action based on breach of contract, promissory estoppel, fraud, and tortious interference with prospective economic advantage. In September 2005 the Company filed an amended complaint in the action also challenging Qualcomm’s proposed acquisition of Flarion Technologies, Inc. under the antitrust laws and asserting violations of various state unfair competition and unfair business practices laws. In December 2005 Qualcomm filed a motion to dismiss the complaint. The court has not yet ruled on the motion. Discovery has commenced, but a trial date has not been set.

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

 

In October 2005 the Company and five other leading mobile wireless technology companies filed complaints with the European Commission requesting that the Commission investigate Qualcomm’s anticompetitive conduct related to the licensing of its patents and the sale of its chipsets for mobile wireless devices and systems. The Commission has commenced a preliminary investigation, and is determining whether to institute a formal investigation, of Qualcomm.

 

Securities Litigation.  In March 2006 a purported class action lawsuit was filed in the Superior Court of California, County of Orange, by a plaintiff who claims to be a shareholder of Broadcom. The lawsuit, entitled Jin v. Broadcom Corporation, et al. (Case No. 06 CC00057), names as defendants the Company, each of the members of its Board of Directors, and Henry T. Nicholas III, the Company’s co-founder. The principal claims asserted in the lawsuit are that (a) disclosures in the company’s March 27, 2006 proxy statement concerning proposed Second Amended and Restated Articles of Incorporation (the “Second Amended Articles”), which would, among other things, increase the number of authorized shares of its Class A common stock, are incorrect and/or misleading; and (b) Broadcom’s recent stock split, the recent amendment to its share repurchase program, and recent and proposed changes in the compensation of its non-employee directors constitute breaches of the defendants’ fiduciary duties. Plaintiff contends, among other things, that the proposed increase in the number of authorized Class A shares is part of an alleged scheme to allow company insiders to sell Class B stock and nevertheless retain voting control over the Company’s affairs. The complaint seeks, among other things, a declaration that the Second Amended Articles are invalid, an injunction against the continuation and expansion of a plan to repurchase shares of the Company’s Class A common stock, rescission of certain changes to non-employee director compensation, and unspecified damages.

 

The plaintiff filed a motion for a temporary restraining order enjoining the Company from holding a vote on the approval of the Second Amended Articles at the Company’s 2006 annual meeting of shareholders and from filing the Second Amended Articles with the California Secretary of State. The court denied that motion in April 2006.

 

The Company believes that the claims asserted in the lawsuit are entirely without merit and intends to defend them vigorously.

 

The Company has entered into indemnification agreements with each of its present and former directors and officers. Under these agreements, the Company is required to indemnify each such director or officer against expenses, including attorney’s fees, judgments, fines and settlements (collectively “Liabilities”), paid by such individual in connection with the Jin lawsuit (other than Liabilities arising from willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest).

 

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

 

General.  The foregoing discussion includes material developments that occurred during the three months ended March 31, 2006 or thereafter in material legal proceedings in which the Company and/or its subsidiaries are involved. For additional information regarding certain of these legal proceedings, see Note 12 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

 

BROADCOM CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS — (Continued)

 

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

 

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

 

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

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	•	general economic and market conditions in the semiconductor industry and wired and wireless communications markets;
	•	our ability to specify, develop or acquire, complete, introduce, market and transition to volume production new products and technologies in a cost effective and timely manner;
	•	the timing, rescheduling or cancellation of significant customer orders and our ability, as well as the ability of our customers, to manage inventory;
	•	seasonality in the demand for consumer wired and wireless communication products into which our solutions are incorporated;
	•	the rate at which our present and future customers and end-users adopt our products and technologies in our target markets; and
	•	the qualification, availability and pricing of competing products and technologies and the resulting effects on sales and pricing of our products.

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	•	our product mix and volume of product sales;
	•	stock-based compensation expense;
	•	the position of our products in their respective life cycles;
	•	the effects of competition;
	•	the effects of competitive pricing programs;
	•	manufacturing cost efficiencies and inefficiencies;
	•	fluctuations in direct product costs such as wafer pricing and assembly, packaging and testing costs, and overhead costs;
	•	provisions for excess or obsolete inventories;
	•	product warranty costs;
	•	amortization of purchased intangible assets; and
	•	licensing and royalty arrangements.

	•	stock-based compensation expense;
	•	settlement costs;
	•	amortization of purchased intangible assets;
	•	in-process research and development, or IPR&D;
	•	impairment of goodwill and other intangible assets;
	•	income tax benefits from adjustments to tax reserves of foreign subsidiaries;
	•	gain (loss) on strategic investments; and
	•	restructuring costs or reversals thereof.

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	•	the nature of products and services;
	•	the nature of the production processes;
	•	the type or class of customer for their products and services; and
	•	the methods used to distribute their products or provide their services.

	•	the sale of integrated circuits is the only material source of revenue for each of our five operating segments;
	•	the integrated circuits sold by each of our operating segments use the same standard CMOS manufacturing processes;
	•	the integrated circuits marketed by each of our operating segments are sold to one type of customer: manufacturers of wired and wireless communications equipment, which incorporate our integrated circuits into their electronic products; and
	•	all of our integrated circuits are sold through a centralized sales force and common wholesale distributors.

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	•	Net Revenue.  We recognize product revenue when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) our price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured. These criteria are usually met at the time of product shipment. However, we do not recognize revenue until all customer acceptance requirements have been met, when applicable. A portion of our sales are made through distributors under agreements allowing for pricing credits and/or rights of return. Product revenue on sales made through these distributors is not recognized until the distributors ship the product to their customers, at which time the terms of the sale become fixed and determinable. Customer purchase orders and/or contracts are generally used to determine the existence of an arrangement. Shipping documents and the completion of any customer acceptance requirements, when applicable, are used to verify product delivery or that services have been rendered. We assess whether a price is fixed or determinable based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess the collectibility of our accounts receivable based primarily upon the creditworthiness of the customer as determined by credit checks and analysis, as well as the customer’s payment history.
	•	Sales Returns and Allowance for Doubtful Accounts.  We record reductions to revenue for estimated product returns and pricing adjustments, such as competitive pricing programs and rebates, in the same period that the related revenue is recorded. The amount of these reductions is based on historical sales returns, analysis of credit memo data, specific criteria included in rebate agreements, and other factors known at the time. Additional reductions to revenue would result if actual product returns or pricing adjustments exceed our estimates. We also maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. If the financial condition of any of our customers were to deteriorate, resulting in an impairment of its ability to make payments, additional allowances could be required.
	•	Inventory and Warranty Reserves.  We establish inventory reserves for estimated obsolescence or unmarketable inventory in an amount equal to the difference between the cost of inventory and its estimated realizable value based upon assumptions about future demand and market conditions. If actual demand and market conditions are less favorable than those projected by management, additional inventory reserves could be required. Our products typically carry a one to three year warranty. We establish reserves for estimated product warranty costs at the time revenue is recognized. Although we

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		engage in extensive product quality programs and processes, our warranty obligation has been and may in the future be affected by product failure rates, product recalls, repair or field replacement costs and additional development costs incurred in correcting any product failure, as well as possible claims for consequential costs. Should actual product failure rates, use of materials or service delivery costs differ from our estimates, additional warranty reserves could be required. In that event, our gross profit and gross margins would be reduced.

	•	Stock-Based Compensation Expense for 2006 and Thereafter.  Effective January 1, 2006 we adopted SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS 123R. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, restricted stock units and employee stock purchase rights, to be recognized in our financial statements based on their respective grant date fair values. Under this standard, the fair value of each share-based payment award is estimated on the date of grant using an option pricing model that meets certain requirements. We currently use the Black-Scholes option pricing model to estimate the fair value of our share-based payment awards. The Black-Scholes model meets the requirements of SFAS 123R; however, the fair values generated by the model may not be indicative of the actual fair values of our awards as it does not consider certain factors important to our awards, such as continued employment, periodic vesting requirements and limited transferability. The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We use the implied volatility for traded options on our stock as the expected volatility assumption required in the Black-Scholes model. Our selection of the implied volatility approach is based on the availability of data regarding actively traded options on our stock as we believe that implied volatility is more representative than historical volatility. The expected life of the awards is based on historical and other economic data trended into the future. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our awards. The dividend yield assumption is based on our history and expectation of dividend payouts. The fair value of our restricted stock units is based on the fair market value of our Class A common stock on the date of grant. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense recognized in our financial statements in 2006 and thereafter is based on awards that are ultimately expected to vest. We evaluate the assumptions used to value our awards on a quarterly basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional equity awards to employees or we assume unvested equity awards in connection with acquisitions. Had we adopted SFAS 123R in prior periods, the magnitude of the impact of that standard on our results of operations would have approximated the impact of SFAS 123 assuming the application of the Black-Scholes option pricing model as described in the disclosure of pro forma net income (loss) and pro forma net income (loss) per share in Notes 1 and 6 of our Notes to Unaudited Condensed Consolidated Financial Statements.
	•	Goodwill and Purchased Intangible Assets.  Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. The amounts and useful lives assigned to intangible assets acquired, other than goodwill, impact the amount and timing of future amortization, and the amount assigned to in-process research and development is expensed immediately. The value of our intangible assets, including goodwill, could be impacted by future adverse changes such as: (i) any future declines in our operating results, (ii) a decline in the valuation of technology company stocks, including the valuation of our common stock, (iii) another significant slowdown in the worldwide economy or the semiconductor industry or (iv) any failure to meet the performance projections included in our forecasts of future operating results. We evaluate these assets, including purchased intangible assets deemed to have indefinite lives, on an annual basis in the fourth quarter or more frequently if we believe indicators of

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		impairment exist. In the process of our annual impairment review, we primarily use the income approach methodology of valuation that includes the discounted cash flow method as well as other generally accepted valuation methodologies to determine the fair value of our intangible assets. Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation. The estimates we have used are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the plans and estimates used may be incorrect. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

	•	Deferred Taxes and Tax Contingencies.  We utilize the liability method of accounting for income taxes. We record a valuation allowance to reduce our deferred tax assets to the amount that we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we consider all positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance. Forming a conclusion that a valuation allowance is not required is difficult when there is negative evidence such as cumulative losses in recent years. As a result of our cumulative losses in the U.S. and certain foreign jurisdictions and the full utilization of our loss carryback opportunities, we have concluded that a full valuation allowance against our net deferred tax assets is appropriate in such jurisdictions. In certain other foreign jurisdictions where we do not have cumulative losses, we record valuation allowances to reduce our net deferred tax assets to the amount we believe is more likely than not to be realized. In the future, if we realize a deferred tax asset that currently carries a valuation allowance, we may record a reduction to income tax expense in the period of such realization. We record estimated income tax liabilities to the extent they are probable and can be reasonably estimated. As a multinational corporation, we are subject to taxation in many jurisdictions, and the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various taxing jurisdictions. If we ultimately determine that the payment of these liabilities will be unnecessary, we reverse the liability and recognize a tax benefit during the period in which we determine the liability no longer applies. Conversely, we record additional tax charges in a period in which we determine that a recorded tax liability is less than we expect the ultimate assessment to be. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional tax liabilities or potentially to reverse previously recorded tax liabilities.
	•	Litigation and Settlement Costs.  From time to time, we are involved in disputes, litigation and other legal proceedings. We prosecute and defend these matters aggressively. However, there are many uncertainties associated with any litigation, and we cannot assure you that these actions or other third party claims against us will be resolved without costly litigation and/or substantial settlement charges. In addition the resolution of any future intellectual property litigation may require us to pay damages for past infringement or one-time license fees or ongoing royalties, which could adversely impact gross profit and gross margins in future periods or could prevent us from manufacturing or selling some of our products or limit or restrict the type of work that employees involved in such litigation may perform for Broadcom. If any of those events were to occur, our business, financial condition and results of operations could be materially and adversely affected. We record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. However the actual liability in any such litigation may be materially different from our estimates, which could result in the need to record additional costs.

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		Three Months
		Ended
		March 31,
		2006				2005
Net revenue			100.0	%			100.0	%
Cost of revenue(1)			48.1				48.4
Gross profit			51.9				51.6
Operating expense:
Research and development(1)			26.6				26.5
Selling, general and administrative(1)			12.1				10.6
Amortization of purchased intangible assets			0.1				0.1
In-process research and development			0.6				1.2
Income from operations			12.5				13.2
Interest income, net			2.7				1.4
Other income, net			0.2				0.0
Income before income taxes			15.4				14.6
Provision for income taxes			0.4				2.0
Net income			15.0	%			12.6	%

(1)		The percentages included in the three months ended March 31, 2006 reflect the adoption of SFAS 123R. In accordance with the modified prospective transition method, the Company’s unaudited condensed consolidated statements of income for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. See Notes 1 and 6 of Notes to Unaudited Consolidated Financial Statements.

		Three Months Ended								Three Months Ended
		March 31, 2006								March 31, 2005
						% of Net								% of Net								%
		Amount				Revenue				Amount				Revenue				Increase				Change
		(In thousands, except percentages)
Net revenue		$	900,647				100.0	%		$	550,345				100.0	%		$	350,302				63.7	%
Cost of revenue(1)			432,776				48.1				266,116				48.4				166,660				62.6
Gross profit		$	467,871				51.9	%		$	284,229				51.6	%		$	183,642				64.6

(1)		The amounts included in the three months ended March 31, 2006 reflect the adoption of SFAS 123R. In accordance with the modified prospective transition method, the Company’s unaudited condensed consolidated statements of income for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. See Notes 1 and 6 of Notes to Unaudited Consolidated Financial Statements.

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		Three Months Ended								Three Months Ended
		March 31, 2006								March 31, 2005
						% of Net								% of Net								%
		Amount				Revenue				Amount				Revenue				Increase				Change
		(In thousands, except percentages)
Enterprise networking		$	305,590				33.9	%		$	233,953				42.5	%		$	71,637				30.6	%
Broadband communications			331,152				36.8				207,208				37.7				123,944				59.8
Mobile and wireless			263,905				29.3				109,184				19.8				154,721				141.7
Net revenue		$	900,647				100.0	%		$	550,345				100.0	%		$	350,302				63.7

		Three Months Ended								Three Months Ended
		March 31, 2006								December 31, 2005
						% of Net								% of Net				Increase				%
		Amount				Revenue				Amount				Revenue				(Decrease)				Change
		(In thousands, except percentages)
Enterprise networking		$	305,590				33.9	%		$	303,892				37.1	%		$	1,698				0.6	%
Broadband communications			331,152				36.8				249,683				30.4				81,469				32.6
Mobile and wireless			263,905				29.3				267,030				32.5				(3,125	)			(1.2	)
Net revenue		$	900,647				100.0	%		$	820,605				100.0	%		$	80,042				9.8

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		Three Months Ended								Three Months Ended
		March 31, 2006								March 31, 2005
						% of Net								% of Net								%
		Amount				Revenue				Amount				Revenue				Increase				Change
		(In thousands, except percentages)
Research and development(1)		$	240,131				26.6	%		$	145,870				26.5	%		$	94,261				64.6	%
Selling, general and administrative(1)			108,707				12.1				58,397				10.6				50,310				86.2

(1)		The amounts included in the three months ended March 31, 2006 reflect the adoption of SFAS 123R. In accordance with the modified prospective transition method, the Company’s unaudited condensed consolidated statements of income for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. See Notes 1 and 6 of Notes to Unaudited Consolidated Financial Statements.

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