Marvell Technology Group 10-Q 2008
x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended November 1, 2008
o Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission file number: 0-30877
Marvell Technology Group Ltd.
Court, 22 Victoria Street, Hamilton HM 12, Bermuda
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes x No
The number of common shares of the registrant outstanding as of November 30, 2008 was 613,308,520 shares.
MARVELL TECHNOLOGY GROUP LTD.
See accompanying notes to unaudited condensed consolidated financial statements.
MARVELL TECHNOLOGY GROUP LTD.
See accompanying notes to unaudited condensed consolidated financial statements.
MARVELL TECHNOLOGY GROUP LTD.
See accompanying notes to unaudited condensed consolidated financial statements.
Note 1. The Company and its Significant Accounting Policies
Marvell Technology Group Ltd., a Bermuda company (the Company), is a leading global semiconductor provider of high-performance analog, mixed-signal, digital signal processing and embedded microprocessor integrated circuits. The Companys diverse product portfolio includes switching, transceivers, wireless, PC connectivity, gateways, communications controllers, storage and power management solutions that serve diverse applications used in business enterprise, consumer electronics and emerging markets.
Basis of presentation
The Companys fiscal year is the 52- or 53-week period ending on the Saturday closest to January 31. In a 52-week year, each fiscal quarter consists of 13 weeks. The additional week in a 53-week year is added to the fourth quarter, making such quarter consist of 14 weeks. Fiscal 2009 is comprised of a 52-week period and fiscal 2008 was comprised of a 53-week period.
The unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. In the opinion of management, all adjustments consisting of normal and recurring entries considered necessary for a fair statement of the results for the interim periods have been included in the Companys financial position as of November 1, 2008, the results of its operations for the three and nine months ended November 1, 2008 and October 27, 2007, and its cash flows for the nine months ended November 1, 2008 and October 27, 2007. The February 2, 2008 condensed consolidated balance sheet data was derived from audited consolidated financial statements included in the Companys 2008 Annual Report on Form 10-K but does not include all disclosures required by GAAP. Certain reclassifications have been made to the prior period balances in the Statements of Operations and Statements of Cash Flows in order to conform to the current periods presentation.
These condensed consolidated financial statements and related notes are unaudited and should be read in conjunction with the Companys audited financial statements and related notes for the year ended February 2, 2008 included in the Companys Annual Report on Form 10-K as filed on March 28, 2008 with the Securities and Exchange Commission (SEC). The results of operations for the three and nine months ended November 1, 2008 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year.
Use of estimates
The preparation of consolidated financial statements in conformity with GAAP in the United States requires management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to performance based compensation, uncollectible receivables, inventory excess and obsolescence, the useful lives of long-lived assets including property and equipment, investment fair values, goodwill and other intangible assets, income taxes and contingencies. In addition, the Company uses assumptions when employing the Black-Scholes option valuation model to calculate the fair value of stock-based awards granted. The Company bases its estimates of the carrying value of certain assets and liabilities on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, when these carrying values are not readily available from other sources. Actual results could differ from these estimates, and such differences could affect the results of operations reported in future periods.
Principles of consolidation
The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The functional currency of the Company and its subsidiaries is the United States dollar.
Cash and cash equivalents
The Company considers all highly liquid investments with a maturity of three months or less from the date of purchase to be cash equivalents. Cash and cash equivalents consist of cash on deposit with banks and money market funds.
The Companys marketable investments are classified as available-for-sale securities and are reported at fair value. Unrealized gains and losses are reported, net of tax, if any, in accumulated other comprehensive income (loss), a component of shareholders equity. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in interest and other income, net.
The Company also has equity investments in privately-held companies. These investments are recorded at cost and are included in other non-current assets. The Company accounts for these investments under the cost method because its ownership is less than 20% and it does not have the ability to exercise significant influence over the operations of these companies. The Company monitors these investments for impairment and makes appropriate reductions in carrying value when impairment is deemed to be other than temporary.
Concentration of credit risk
Financial instruments that potentially subject the Company to significant concentration of credit risk consist principally of cash equivalents, short-term investments and accounts receivable. The Company places its cash primarily in checking and money market accounts. Cash equivalents and short-term investment balances are maintained with high quality financial institutions, the composition and maturities of which are regularly monitored by management. The Company believes that the concentration of credit risk in its trade receivables with respect to its served markets, as well as the limited customer base located primarily in the Asia Pacific Region, are substantially mitigated by the Companys credit evaluation process, relatively short collection terms and the high level of credit worthiness of its customers. The Company performs ongoing credit evaluation of its customers financial condition and limits the amount of credit extended when deemed necessary based upon payment history and the customers current credit worthiness, but generally requires no collateral. The Company regularly reviews the allowance for bad debt and doubtful accounts by considering factors such as historical experience, credit quality, age of the account receivable balances and current economic conditions that may affect a customers ability to pay.
Inventories are stated at the lower of cost or market, determined under the first-in, first-out method. We establish inventory excess and obsolescence provisions for estimated obsolete or unmarketable inventory equal to the difference between the cost of inventory and estimated net realizable value based upon assumptions about future demand and market conditions. Shipping and handling costs are classified as a component of cost of goods sold in the unaudited condensed consolidated statements of operations.
Property and equipment, net
Property and equipment, including capital leases and leasehold improvements, are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which ranges from three to five years. Buildings are depreciated over an estimated useful life of 30 years and building improvements are depreciated over estimated useful lives of 15 years. Land is not depreciated. Assets held under capital leases and leasehold improvements are amortized over the shorter of term of lease or their estimated useful lives.
Goodwill and acquired intangible assets, net
Goodwill is recorded when the consideration paid for a business acquisition exceeds the fair value of net tangible and intangible assets acquired. Acquisition-related identified intangible assets are amortized on a straight-line basis over their estimated economic lives of one to seven years for purchased technology, one to eight years for core technology and four to seven years for customer contracts.
Goodwill is measured and tested for impairment on an annual basis during the fourth fiscal quarter or more frequently if the Company believes indicators of impairment exist. The performance of the test involves a two-step process. The first step requires comparing the fair value of the reporting unit to its net book value, including goodwill. As the Company has only one reporting unit, the fair value of the reporting unit is determined by taking the market capitalization of the reporting unit as determined through quoted market prices and adjusted for control premiums and other relevant factors. A potential impairment exists if the fair value of the reporting unit is lower than its net book value. The second step of the process is only performed if a potential impairment exists, and it involves determining the difference between the fair value of the reporting units net assets other than goodwill and the fair value of the reporting unit. If the difference is less than the net book value of goodwill, impairment exists and is recorded. In the event that the Company determines that the value of goodwill has become impaired, the Company will record an accounting charge for the amount of impairment during the fiscal quarter in which the determination is made. The Company has not been required to perform this second step of the process since its implementation of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, because the fair value of the reporting unit has exceeded its net book value at every measurement date.
Impairment of long-lived assets
Long-lived assets include equipment, furniture and fixtures, privately held equity investments and intangible assets. Whenever events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable, the Company estimates the future cash flows, undiscounted and without interest charges, expected to result from the use of those assets and their eventual cash position. If the sum of the expected future cash flows is less than the carrying amount of those assets, the Company recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets.
The Company accounts for its revenues under the provisions of Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements. Under these provisions, the Company recognizes revenues when there is persuasive evidence of an arrangement, delivery has occurred, the fee is fixed or determinable, and collection is reasonably assured.
Product revenue is generally recognized upon shipment of product to customers, net of accruals for estimated sales returns and allowances. However, some of the Companys sales are made through distributors under agreements allowing for price protection, shipped from stock pricing adjustment rights and limited rights of return on product unsold by the distributors. Although title passes to the distributor upon shipment terms and payment by the Companys distributors is not contingent on resale of the product, product revenue on sales made through distributors with price protection, ship from stock pricing adjustment and stock rotation rights is deferred until the distributors sell the product to end customers because the Companys selling price is not fixed and determinable and the Company is not able to estimate future returns. Deferred revenue less the related cost of the inventories is reported as deferred income. The Company does not believe that there is any significant exposure related to impairment of deferred cost of sales, as its historical returns have been minimal and inventory turnover for its distributors generally ranges from 60 to 90 days. The Companys sales to direct customers are made primarily pursuant to standard purchase orders for delivery of products. The Company generally allows customers to cancel or change purchase orders with limited notice prior to the scheduled shipment dates and from time to time it also may request a customer to accept a shipment of product before its original requested delivery date, in which case, revenue is not recognized until there is written confirmation from the customer accepting early shipment, delivery has occurred, the fee is fixed or determinable, and collection is reasonably assured. Additionally, collection is not deemed to be reasonably assured, fixed or determinable if customers receive extended payment terms. As a result, revenue on sales to customers with payment terms substantially greater than the Companys normal payment terms is deferred and is recognized as revenue as the payments become due. Revenue related to the sale of consignment inventory is not recognized until the product is pulled from inventory stock by the customer.
The provision for estimated sales returns and allowances on product sales is recorded in the same period the related revenues are recorded. These estimates are based on historical sales returns, analysis of credit memo data and other known factors. Actual returns could differ from these estimates.
The Company also enters into development agreements with some of its customers. Under these development agreements, product revenue is recognized under the proportionate performance method. Revenue is recognized as related costs to complete the contract are incurred. These costs are included in research and development and other expense.
The provisions of the Emerging Issues Task Force (EITF) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, apply to sales arrangements with multiple arrangements that include a combination of hardware, software and /or services. For multiple element arrangements, revenue is allocated to the separate elements based on fair value. If an arrangement includes undelivered elements that are not essential to the functionality of the delivered elements, the Company defers the fair value of the undelivered elements and the residual revenue is allocated to the delivered elements. If the undelivered elements are essential to the functionality of the delivered elements, no revenue is recognized. Undelivered elements typically are software, warranty and maintenance services.
The Company accounts for rebates in accordance with EITF Issue No. 01-9, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendors Products), and, accordingly, records reductions to revenue for rebates in the same period that the related revenue is recorded. The amount of these reductions is based upon the terms included in the Companys various rebate agreements.
Accounting for income taxes
The Company accounts for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. Under this method, the Company determines deferred tax assets and liabilities based upon the difference between the income tax basis of assets and liabilities and their respective financial reporting amounts at enacted tax rates in effect for the periods in which the differences are expected to reverse. The tax consequences of most events recognized in the current years financial statements are included in determining income taxes currently payable. However, because tax laws and financial accounting standards differ in their recognition and measurement of assets, liabilities, equity, revenues, expenses, gains and losses, differences arise between the amount of taxable income and pretax financial income for a year and between the tax basis of assets or liabilities and their reported amounts in the financial statements. Because it is assumed that the reported amounts of assets and liabilities will be recovered or settled, a difference between the tax basis of an asset or liability and its reported amount on the balance sheet will result in a taxable or a deductible amount in some future years when the related liabilities are settled or assets are recovered, hence giving rise to a deferred tax liability or asset, respectively. The Company then assesses the likelihood that its deferred tax assets will be recovered from future taxable income and to the extent the Company believes that recovery is not likely, the Company would establish a valuation allowance. The Company accounts for uncertain tax positions in accordance with the Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Tax Positions (FIN 48). The Company classifies accrued interest and penalties as part of the accrued FIN 48 liability and records the expense within the provision for income taxes.
The application of income tax law is inherently complex. Laws and regulations in this area are voluminous and are often ambiguous. As such, the Company is required to make many subjective assumptions and judgments regarding its income tax exposures. Interpretations of and guidance surrounding income tax laws and regulations are subject to change over time. As such, changes in its subjective assumptions and judgments can materially affect amounts recognized in the consolidated balance sheets and statements of income. See Note 12 - Income Taxes of the notes to unaudited condensed consolidated financial statements for additional detail on the Companys uncertain tax positions.
The Companys products are generally subject to warranty, which provides for the estimated future costs of repair, replacement or customer accommodation upon shipment of the product in the accompanying statements of operations. The Companys products typically carry a standard 90-day warranty, with certain exceptions in which the warranty period can range from one to five years. The warranty accrual is estimated based on historical claims compared to historical revenues and assumes that the Company will have to replace products subject to a claim. For new products, the Company uses a historical percentage for the appropriate class of product.
Note 2. Recent Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (SFAS 141R). The standard changes the accounting for business combinations including the measurement of acquirer shares issued in consideration for a business combination, the recognition of contingent consideration, the accounting for pre-acquisition gain and loss contingencies, the recognition of capitalized in-process research and development, the accounting for acquisition-related restructuring cost accruals, the treatment of acquisition related transaction costs and the recognition of changes in the acquirers income tax valuation allowance. The adoption of SFAS 141R will change the Companys accounting treatment for business combinations on a prospective basis beginning on or after December 15, 2008.
In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, Effective Date of FASB Statement No. 157 (FSP 157-2), to partially defer SFAS No. 157, Fair Value Measurements (SFAS 157). FSP157-2 defers the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years, and interim periods within those fiscal years, beginning after November 15, 2008. The Company is currently evaluating the impact of the adoption of FSP157-2 and does not anticipate that FSP 157-2 will have a material impact on its financial position and results of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161). SFAS 161 amends and expands the disclosure requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Company will adopt SFAS 161 in the first quarter of fiscal 2010 and does not anticipate that SFAS 161 will have a significant impact on its financial position and results of operations.
In April 2008, the FASB issued FASB Staff Position FAS 142-3, Determination of Useful Life of Intangible Assets (FSP FAS 142-3). FSP FAS 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142, Goodwill and Other Intangible Assets. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008. Earlier adoption is not permitted. The Company does not anticipate that FSP FAS 142-3 will have a significant impact on its financial position and results of operations.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS 162 will become effective 60 days following the SECs approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. The Company does not expect the adoption of SFAS 162 will have a significant impact on its financial position and results of operations.
In October 2008, the FASB issued FASB Staff Position FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active (FSP 157-3). FSP 157-3 clarified the application of SFAS 157. FSP 157-3 demonstrated how the fair value of a financial asset is determined when the market for that financial asset is inactive. FSP 157-3 was effective upon issuance, including prior periods for which financial statements had not been issued. The implementation of this standard did not have an impact on the Companys financial position and results of operations.
Note 3. Available-For-Sale-Investments
Available-for-sale investments (in thousands)
As of November 1, 2008, the Companys investment portfolio included $41.8 million in par value of auction rate securities. Auction rate securities are usually found in the form of municipal bonds, preferred stock, pools of student loans or collateralized debt obligations with contractual maturities generally between 20 to 30 years and whose interest rates are reset every seven to 35 days through an auction process. At the end of each reset period, investors can sell or continue to hold the securities at par. The Companys auction rate securities are all backed by student loans originated under the Federal Family Education Loan Program and are over-collateralized, insured and guaranteed by the United States Federal Department of Education (the DOE). All auction rate securities held by the Company are rated by the major independent rating agencies as either AAA or Aaa at the time of purchase and their current ratings are still within the guidelines of the Companys investment policy.
Beginning in February 2008, liquidity issues in the global credit markets resulted in failure of the auctions representing all of the auction rate securities held by the Company, as the amount of securities submitted for sale in those auctions exceed the amount of bids. These failures are not believed to be a credit issue, but rather caused by a lack of liquidity. Observable market prices were not available for the valuation of these investments. Accordingly, the Company used a discounted cash flow model to estimate the fair value of the auction rate securities as of November 1, 2008. The assumptions used in preparing the discounted cash flow model included estimates for the amount and timing of future interest and principal payments, the collateralization of underlying security investments, the credit worthiness of the issuer of the securities, the probability of full repayment considering the guarantees by the DOE of the underlying student loans, guarantees by other third parties, additional credit enhancements included in the securities, and the rate of return required by investors to own these securities in the current environment. Utilizing these assumptions, the Company found that its auction rate securities had a fair value of $40.3 million, which indicated an impairment of approximately $1.5 million. During the nine months ended November 1, 2008, the Company recorded a temporary impairment charge for this amount in accumulated other comprehensive (loss), a component of shareholders equity. When evaluating whether the impairment is temporary or other than temporary, the Company reviewed factors such as the length of time and extent to which fair value has been below cost basis, the financial condition and near-term prospects of the issuer, and the Companys ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in the market value. The Company specifically noted that it had approximately 4% of its total cash invested in these auction rate securities, a cash balance of approximately $1.0 billion in cash and cash equivalents other than auction rate securities, and that the Company continues to generate positive cash flow on a quarterly basis.
While the recent auction failures limit the Companys ability to liquidate these investments, the Company does not believe that the auction failures will materially impact its ability to fund its working capital needs, capital expenditures or other business requirements, and that it has the ability to hold these securities for a period longer than 12 months. However, at the reporting date, it is not certain when liquidity will return to the markets or if any other secondary markets will become available, and the Company has continued to classify its auction rate securities in long-term investments as of November 1, 2008.
The Company will continue to evaluate the impact of these failed auctions on the fair value of its auction rate securities. If the issuer of the auction rate securities is unable to successfully close future auctions or does not redeem the auction rate securities, or the United States government fails to support its guaranty of the obligations, the Company may be required to adjust the carrying value of the auction rate securities and record other-than-temporary impairment charges in future periods, which could materially affect its results of operations and financial condition.
The contractual maturities of available-for-sale debt securities at November 1, 2008 and February 2, 2008 are presented in the following table (in thousands):
The following table shows the investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):
Note 4. Supplemental Financial Information
Inventories (in thousands)
Prepaid expenses and other current assets (in thousands)
Property and equipment, net (in thousands)
Other non-current assets (in thousands)
Accrued liabilities (in thousands)
Other long-term liabilities (in thousands)
Note 5. Net Income (Loss) Per Share
The Company reports both basic net income (loss) per share, which is based upon the weighted average number of common shares outstanding excluding contingently issuable or returnable shares, and diluted net income (loss) per share, which is based on the weighted average number of common shares outstanding and dilutive potential common shares. The computations of basic and diluted net income (loss) per share are presented in the following table (in thousands, except per share amounts):
Options to purchase 66,079,306 common shares at a weighted average exercise price of $19.34 have been excluded from the computation of diluted net income per share for the three months ended November 1, 2008 because the exercise price of the stock options was greater than the average share price of the Companys common shares and therefore, the effect would have been anti-dilutive. Warrants, common share options, restricted stock and other securities totaling 38,808,757 shares were excluded from diluted net loss per share for the three months ended October 27, 2007 as their impact would be anti-dilutive in a net loss period.
Options to purchase 60,499,458 common shares at a weighted average exercise price of $20.25 have been excluded from the computation of diluted net income per share for the nine months ended November 1, 2008because the exercise price of the stock options was greater than the average share price of the Companys common shares and therefore, the effect would have been anti-dilutive. Warrants, common stock options, restricted stock and other securities totaling 41,265,093 were excluded from diluted net loss per share for the nine months ended October 27, 2007 as their impact would be anti-dilutive in a net loss period.
Comprehensive income (loss) (in thousands)
Accumulated other comprehensive income (loss), as presented in the accompanying unaudited condensed consolidated balance sheets, consists of the unrealized gains and losses on available-for-sale investments and other, net of tax.
Note 6. Fair Value Measurements
Effective February 3, 2008, the Company adopted SFAS 157, except as it applies to the nonfinancial assets and nonfinancial liabilities subject to FSP 157-2. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. As a basis for considering such assumptions, SFAS 157 establishes a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Include other inputs that are directly or indirectly observable in the marketplace.
Level 3 - Unobservable inputs that are supported by little or no market activity.
The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
In accordance with SFAS 157, we measure our cash equivalents and marketable securities at fair value. Our cash equivalents and marketable securities are primarily classified within Level 1 with the exception of our investments in auction rate securities, which are classified within Level 3. Cash equivalents and marketable securities are valued primarily using quoted market prices utilizing market observable inputs. The Companys investments in auction rate securities are classified within Level 3 because there are no active markets for the auction rate securities and therefore the Company is unable to obtain independent valuations from market sources. Therefore, the auction rate securities were valued using a discounted cash flow model (see Note 3 above). Some of the inputs to the cash flow model are unobservable in the market. The total amount of assets measured using Level 3 valuation methodologies represented 1% of total assets as of November 1, 2008.
The table below sets forth, by level, our financial assets that were accounted for at fair value as of November 1, 2008. The table does not include assets and liabilities which are measured at historical cost or any basis other than fair value (in thousands):
The following table summarizes the change in fair values for Level 3 items for the nine months ended November 1, 2008:
Note 7. Business Combinations
During fiscal 2008, the Company completed the acquisition of two unrelated private companies. One of the companies was acquired for $9.7 million and designs and develops software for optical storage applications. The second company was acquired for $13.4 million and provides IP Multimedia Subsystem middleware and applications for multi-mode cellular mobile devices. Under the purchase method of accounting, the total purchase price of these acquisitions was allocated to net tangible and intangible assets based on their fair values with the remainder recorded as goodwill. In conjunction with these acquisitions, the Company recorded acquired net tangible assets of $4.1 million, deferred tax assets of $0.9 million, deferred tax liabilities of $3.8 million, amortizable intangible assets of $9.2 million and goodwill of $12.7 million. The intangible assets are being amortized over their useful lives ranging from one to seven years.
During the three months ended November 1, 2008, the Company paid $1.3 million in cash to shareholders of one of the unrelated private companies based on the achievement of certain defined milestones. Approximately $1.1 million of the amount paid was recorded to goodwill as additional purchase consideration. The remainder was recorded as compensation expense.
Note 8. Acquired Intangible Assets, Net
Purchased technologies are amortized on a straight-line basis over their estimated useful lives of one to six years. Core technologies are amortized on a straight-line basis over their estimated useful lives of one to eight years. Trade names are amortized on a straight-line basis over their estimate useful lives of one to five years. Customer contracts and related relationships are amortized on a straight-line basis over their estimated useful lives of four to seven years. The supply contract is amortized on a straight-line basis over its estimated useful life of four years. Non-competition is amortized on a straight-line basis over three years. The aggregate amortization expense of identified intangible assets was $34.8 million for the three months ended November 1, 2008 and $37.3 million for the three months ended October 27, 2007, $105.0 million for the nine months ended November 1, 2008 and $111.9 million for the nine months ended October 27, 2007.
Based on the identified intangible assets recorded at November 1, 2008, the future amortization expense of identified intangibles for the next five fiscal years is as follows (in thousands):
Note 9. Commitments and Contingencies
The following table presents changes in the warranty accrual included in accrued liabilities during the three and nine months ended November 1, 2008 and October 27, 2007 (in thousands):
Intellectual property indemnification
The Company has agreed to indemnify select customers for claims made against the Companys products, where such claims allege infringement of third party intellectual property rights, including, but not limited to, patents, registered trademarks, and/or copyrights. Under the aforementioned indemnification clauses, the Company may be obligated to defend the customer and pay for the damages awarded against the customer under an infringement claim, including paying for the customers attorneys fees and costs. The Companys indemnification obligations generally do not expire after termination or expiration of the agreement containing the indemnification obligation. In certain cases, there are limits on and exceptions to the Companys potential liability for
indemnification. Although, historically, the Company has not made significant payments under these indemnification obligations, the Company cannot estimate the amount of potential future payments, if any, that it might be required to make as a result of these agreements. However, the maximum potential amount of any future payments that the Company could be required to make under these indemnification obligations could be significant.
In connection with the acquisition of the communication and application processor business of Intel Corporation, the Company entered into a product supply agreement with Intel. Although the Company has met the contractual obligations under the original supply agreement and has transitioned certain products to its fabrication partners, the Company anticipates that it will continue to source certain legacy application processor cellular and handset inventory from Intel. Under terms of an amendment to the supply agreement, the Company has committed to purchase an additional minimum number of wafers through December 2008. The amendment had no impact on the accounting for the original acquisition. As of November 1, 2008, the Company had non-cancellable purchase orders outstanding of $11.4 million under the amended arrangement.
Under the Companys manufacturing relationships with its other foundries, cancellation of outstanding purchase orders is allowed but requires repayment of all expenses incurred through the date of cancellation. As of November 1, 2008, these foundries had incurred approximately $123.4 million of manufacturing expenses on the Companys outstanding purchase orders.
On February 28, 2005 and as amended on March 31, 2005, the Company entered into an agreement with a foundry to reserve and secure foundry fabrication capacity for a fixed number of wafers at agreed upon prices for a period of five and a half years beginning on October 1, 2005. In return, the Company agreed to pay the foundry $174.2 million over a period of 18 months. The amendment extends the term of the agreement and the agreed upon pricing terms until December 31, 2015. As of November 1, 2008, payments totaling $174.2 million, which is included in prepaid expenses and other current assets and other non-current assets have been made and approximately $146.2 million of the prepayment has been utilized as of November 1, 2008. At November 1, 2008, there were no outstanding commitments under the agreement.
As of November 1, 2008, the Company had approximately $58.1 million of other outstanding non-cancellable purchase orders for capital purchase obligations.
IPO Securities Litigation. On July 31, 2001, a putative class action suit was filed against two investment banks that participated in the underwriting of the Companys initial public offering (IPO) on June 29, 2000. That lawsuit, which did not name the Company or any of its officers or directors as defendants, was filed in the United States District Court for the Southern District of New York. Plaintiffs allege that the underwriters received excessive and undisclosed commissions and entered into unlawful tie-in agreements with certain of their clients in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended (the Exchange Act). Thereafter, on September 5, 2001, a second putative class action was filed in the Southern District of New York relating to the Companys IPO. In this second action, plaintiffs named three underwriters as defendants and also named as defendants the Company and two of its officers, one of whom is also a director. Relying on many of the same allegations contained in the initial complaint, plaintiffs allege that the defendants violated various provisions of the Securities Act of 1933, as amended, and the Exchange Act. In both actions, plaintiffs seek, among other items, unspecified damages, pre-judgment interest and reimbursement of attorneys and experts fees. These two actions have been consolidated and coordinated with hundreds of other lawsuits filed by plaintiffs against approximately 40 underwriters and approximately 300 issuers across the United States. Defendants in the coordinated proceedings moved to dismiss the actions. In February 2003, the trial court granted the motions in part and denied them in part, thus allowing the case to proceed against the Company and the underwriters. Claims against the individual officers have been voluntarily dismissed with prejudice by agreement with plaintiffs. In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including the Company, was submitted to the court for approval. On August 31, 2005, the Court preliminarily approved the settlement. In December 2006, the appellate court overturned the certification of classes in the six focus cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings (the action involving the Company is not one of the six cases). Because class certification was a condition of the settlement, it was unlikely that the settlement would receive final Court approval. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon a stipulation among the parties to the settlement. Plaintiffs filed amended master allegations and amended complaints in the six focus cases. Defendants motions to dismiss those new complaints were denied in part and granted in part.
Section 16(b) Litigation. On October 9, 2007, a purported shareholder of the Company filed a complaint for violation of Section 16(b) of the Exchange Act, which prohibits short swing trading, against the Companys IPO underwriters. The complaint Vanessa Simmonds v. The Goldman Sachs Group, et al., Case No. C07-1632 filed in District Court for the Western District of Washington, seeks the recovery of short-swing profits. The Company is named as a nominal defendant. No recovery is sought from the Company. Numerous similar suits were filed by the same plaintiff against other underwriters relating to other issuers. A hearing on motions to dismiss filed by the underwriter defendants and some of the issuer defendants (excluding the Company) is scheduled for January 16, 2009. All discovery is stayed pending resolution of the moving defendants motions to dismiss.
Jasmine Networks Litigation. On September 12, 2001, Jasmine Networks, Inc. (Jasmine) filed a lawsuit in the Santa Clara County Superior Court alleging claims against the Company and three of its officers for allegedly improperly obtaining and using information and technologies during the course of the negotiations with its personnel regarding the potential acquisition of certain Jasmine assets by the Company. The lawsuit claims that the Companys officers used such information and technologies after the Company signed a non-disclosure agreement with Jasmine. The Company believes the claims asserted against its officers and the Company are without merit and the Company intends to defend all claims vigorously.
On June 21, 2005, the Company filed a cross complaint in the above disclosed action in the Santa Clara County Superior Court asserting claims against Jasmine and unnamed Jasmine officers and employees. The cross complaint was later amended to name two individual officers of Jasmine. On May 15, 2007, the Company filed a second amended cross complaint to add additional causes of action for declaratory relief against Jasmine. Among other causes of action, the cross complaint alleges that Jasmine and its personnel engaged in fraud in connection with their effort to sell the Company technology that Jasmine and its personnel wrongfully obtained from a third party in violation of such third partys rights, and that such technology does not constitute trade secrets or property of Jasmine. The cross complaint seeks a declaratory judgment that the Companys technology does not incorporate any of Jasmines alleged technology. The cross complaint seeks further a declaratory judgment that Jasmine and its personnel misappropriated certain aspects of Jasmines allegedly proprietary technology. The Company intends to prosecute the cross complaint against Jasmine and its personnel vigorously, including, but not limited to, filing certain dispositive motions regarding the ownership of the technology which is the subject of the cross complaint. On June 13, 2007, Jasmine filed a demurrer to the fifth, sixth and seventh causes of action of the Companys second amended cross complaint. The demurrer was heard on July 19, 2007 and denied. On August 3, 2007, Jasmine filed its answer to the second amended cross complaint. The Company thereafter filed its motion for summary adjudication on its fifth and sixth causes of action for declaratory relief seeking, among other things, a determination that Jasmine held no proprietary interest in the JSLIP algorithm, which was one of the core technologies Jasmine asserts was misappropriated by the Company. The motion was denied on November 14, 2007. However, in its opposition, Jasmine admitted that JSLIP had been taken from the work of a third party and is embodied in patents held by the University of California and Cisco Systems. These admissions are significant with respect to both Jasmines assertion of trade secret rights and any damages claimed by Jasmine.
In addition, on December 28, 2001 and January 7, 2002, the trial court issued a preliminary injunction precluding Jasmine from using, disclosing or disseminating the contents of a privileged communication between certain officers of the Company and its counsel. The order granting injunctive relief was reversed by the California Court of Appeal, but review was granted by the California Supreme Court on a grant and hold basis pending the Courts decision on a case involving closely related issues, Rico v. Mitsubishi Motors Corp. (2004) 116 Cal.App.4th 51. The effect of the California Supreme Courts grant of review was to depublish the Court of Appeals decision. On December 13, 2007, the California Supreme Court ruled in the Rico v. Mitsubishi case in a manner consistent with the position asserted by the Company that attorney work product and attorney-client privileges are not waived by inadvertent disclosure of a privileged communication, and that any party receiving such information (i) is required to notify opposing counsel immediately; and (ii) may not read such document more closely than is necessary to determine it is privileged. Rico v. Mitsubishi Motors Corp. (2007) 42 Cal.4th 807. Following its decision in Rico v. Mitsubishi, on April 23, 2008, the California Supreme Court issued an order dismissing the Companys petition for review. As a result the decision of the Court of Appeal, which remains unpublished, became final.
The case is now proceeding in the trial court, and a trial date has been set for March 2, 2009. The parties are engaged in extensive discovery. The Company and its officers intend to seek summary judgment and/or summary adjudication of issues as to the claims alleged against them, and to vigorously assert their cross-claims and defenses in the trial court.
CSIRO Litigation. As of January 2007, Australias Commonwealth Scientific and Industrial Research Organisation (CSIRO) was involved in three patent litigations in the Eastern District of Texas in which it has accused a number of wireless LAN system manufacturers, including some of the Companys customers, of infringing CSIROs patent, U.S. Patent No. 5,487,069 (the 069 Patent). CSIROs claims of infringement relate to IEEE 802.11a, 802.11g and 802.11n wireless standards. As a result of CSIROs claims for patent infringement, a number of the Companys customers have sought indemnification from the Company. In response to these demands for indemnification, the Company has acknowledged the demands and incurred costs in response to them.
On May 4, 2007, the Company filed an action in the United States District Court for the Eastern District of Texas seeking a declaratory judgment against CSIRO that the 069 Patent is invalid and unenforceable and that the Company and its customers do not infringe the 069 Patent. The complaint also seeks damages and a license for the Company and its customers on reasonable and non-discriminatory terms in the event the Companys 802.11a/g/n wireless LAN products are found to infringe and the 069 Patent is found to be valid and enforceable.
On July 3, 2007, the Company moved to intervene in two of the actions described in the first paragraph above pending in the Eastern District of Texas, for the purposes of staying the actions as to products incorporating the Companys parts in favor of the separate action that the Company filed as described in the second paragraph above. Alternatively the Company moved to disqualify the firm of Townsend, Townsend and Crew from continuing to represent CSIRO because of a conflict of interest. CSIRO opposed these motions on August 3, 2007.
On August 3, 2007, CSIRO moved to dismiss the Companys complaint for lack of case or controversy and failure to state a claim upon which relief can be granted, or, in the alternative, to stay the case pending the resolution of the pending lawsuits described in the first paragraph above. On October 24, 2007, the Court issued an order denying CSIROs motion to dismiss. The Court also denied the Companys motions to stay/intervene/disqualify. The Company appealed the Courts denial of the motions to stay/intervene/disqualify to the United States Court of Appeals for the Federal Circuit (the CAFC). On October 23, 2008, the CAFC affirmed the Courts decision in a nonprecedential opinion.
On December 5, 2007, CSIRO filed its answer to the Companys complaint, as well as counterclaims against the Company for willful and deliberate infringement of the 069 Patent. CSIROs counterclaims included a claim for monetary damages, including triple damages based on its allegation of willful and deliberate infringement, attorneys fees and injunctive relief. On April 10, 2008, the Company filed a First Amended Complaint and First Amended Reply to CSIROs Answer and Counterclaims. On April 23, 2008, CSIRO filed its Answer and Counterclaims to the First Amended Complaint. On May 12, 2008, the Company filed a Reply and Affirmative Defenses to CSIROs amended counterclaims.
On May 22, 2008, the Company filed a motion for summary judgment seeking to invalidate the 069 Patent on indefiniteness grounds. The motion was denied on August 14, 2008.
The claim construction hearing was held on June 26, 2008 and the claim construction order was issued on August 14, 2008. Trial for the three actions described in the first paragraph is currently set to begin on April 13, 2009. Trial for the Companys declaratory judgment action is set to begin on May 10, 2010. CSIRO and the Company are currently engaging in discovery and motion practice. The Court has set a Case Management Conference for December 16, 2008 for the Marvell action and related CSIRO actions, including those actions involving the Companys customers. At the December 16 Case Management Conference, the Court may take some action that would affect the schedules and/or other aspects of the various CSIRO litigations.
Shareholder Derivative Litigation. Between June 22, 2006 and August 2, 2006, three purported shareholder derivative actions were filed in the United States District Court for the Northern District of California. Each of these lawsuits names the Company as a nominal defendant and a number of the Companys current and former directors and officers as defendants. Each lawsuit seeks to recover damages purportedly sustained by the Company in connection with its option granting processes, and seeks certain corporate governance and internal control changes. Pursuant to orders of the court dated August 17 and October 17, 2006, the three actions were consolidated as a single action, entitled In re Marvell Technology Group Ltd. Derivative Litigation. The plaintiffs filed an amended and consolidated complaint on November 1, 2006. On January 16, 2007, the Company filed a motion to dismiss the consolidated complaint for lack of standing or, in the alternative, stay proceedings.
On February 12, 2007, a new purported derivative action was filed in the United States District Court for the Northern District of California. As in In re Marvell Technology Group Ltd. Derivative Litigation, this lawsuit names the Company as a nominal defendant and a number of the Companys current and former directors and officers as defendants. It seeks to recover damages purportedly sustained by the Company in connection with its option granting processes, and seeks certain corporate governance and internal control changes. On May 1, 2007, the court entered an order consolidating this lawsuit with In re Marvell Technology Group Ltd.
Derivative Litigation. On May 29, 2007, the Court entered an order staying discovery in this matter pending resolution of the Companys motion to dismiss.
On January 25, 2008, the Court entered a stipulated order staying proceedings so that the parties could finalize a settlement that would resolve the actions. On or about March 5, 2008, the parties entered into a memorandum of understanding that tentatively settles and resolves the actions. The terms of the memorandum of understanding include certain corporate governance enhancements and an agreement by the Company to pay up to $16 million in plaintiffs attorneys fees, an amount less than the $24.5 million that the Company received from a settlement with its directors and officers liability insurers. This tentative settlement of the consolidated derivative actions requires court approval before it becomes final. The Company accrued the $16 million settlement amount in the fourth quarter of fiscal 2008. The Company anticipates that the parties will finalize and submit formal settlement documentation to the court in the next few months for both preliminary and final approval, at which time payment of the settlement amount will be made. The Company recorded the insurance settlement amount as restricted cash at the time it was received in the first quarter of fiscal 2009.
Class Action Securities Litigation. Between October 5, 2006 and November 13, 2006, four putative class actions were filed in the United States District Court for the Northern District of California against the Company and certain of its officers and directors. The complaints allege that the Company and certain of its officers and directors violated the federal securities laws by making false and misleading statements and omissions relating to the grants of stock options. The complaints seek, on behalf of persons who purchased the Companys common shares during the period from October 3, 2001 to October 3, 2006, unspecified damages, interest, and costs and expenses, including attorneys fees and disbursements. Pursuant to an order of the court dated February 2, 2007, these four putative class actions were consolidated as a single action entitled In re Marvell Technology Group Ltd. Securities Litigation. On August 16, 2007, plaintiffs filed a consolidated class action complaint. On October 18, 2007, the Company filed a motion to dismiss the consolidated class action complaint. On September 29, 2008, the District Court issued an order granting in part and denying in part Marvells motion to dismiss the consolidated class action complaint. The District Court gave the plaintiffs thirty days to amend their complaint. Plaintiffs elected not to amend the complaint and instead will proceed with the claims that the court did not dismiss. Defendants responses to the complaint are due on December 12, 2008.
SEC and United States Attorney Inquiries. In July 2006, the Company received a letter of informal inquiry from the SEC requesting certain documents relating to the Companys stock option grants and practices. The Company also received a grand jury subpoena from the office of the United States Attorney for the Northern District of California requesting substantially similar documents. On April 20, 2007, the Company was informed that the SEC was conducting a formal investigation into this matter. On June 8, 2007 and July 3, 2007, the Company received document subpoenas from the SEC. On October 11, 2007, the Company received a Wells Notice from the staff of the SEC. Weili Dai, Vice President of Sales for Communications and Consumer Business of Marvell Semiconductor, Inc. (MSI), who is not an officer or director of the Company, also received a Wells notice. The SEC staff also advised the Company that it is not at this time recommending enforcement action against any of the Companys current officers or directors. The Wells notices indicated that the staff intended to recommend to the staff of the SEC that it bring civil actions against the recipients for injunctive relief and civil monetary penalties. The Company responded in writing to the Wells Notice and sought to reach a resolution of this matter before any action was filed.
On May 8, 2008, the Company announced that it had reached an agreement with the SEC to settle this matter. Without admitting or denying the allegations in the SECs complaint, the Company agreed to settle the charges by consenting to a permanent injunction against any future violations of various provisions of the federal securities laws. The Company also agreed to pay a civil penalty of $10 million in connection with the settlement. On May 8, 2008, the SEC filed a complaint captioned SEC v. Marvell Technology Group, Ltd., et al., Case No. CV-08-2367-HRL, in the United States District Court for the Northern District of California. The Companys consent to entry of final judgment was also filed on May 8, 2008. In a related agreement, Ms. Dai also entered into a settlement with the SEC. Without admitting or denying the allegations in the SECs complaint, Ms. Dai consented to a permanent injunction against any future violations of various provisions of the federal securities laws, agreed not to serve as a director or officer of a public company for a period of five years, and agreed to pay a civil penalty of $500,000. The Court entered the final judgment against Ms. Dai on June 16, 2008 and against the Company on July 1, 2008. The Company accrued the $10 million civil penalty in the first quarter of fiscal 2009 and paid it to the SEC on July 8, 2008.
This settlement concludes the SECs formal investigation of the Company with respect to the Companys historic stock option granting practices.
Wi-Lan Litigation. On December 21, 2006, MSI received a letter from Wi-Lan, Inc. (Wi-Lan) accusing MSI of infringing four United States patents allegedly owned by Wi-Lan, and one Canadian patent also allegedly owned by Wi-Lan. On October 31, 2007, Wi-Lan sued two groups of system and chip manufacturers in the United States District Court for the Eastern District of Texas, in both cases naming MSI as a defendant and alleging patent infringement. In the first case, Wi-Lan alleges that defendants infringe two patents that allegedly relate to the 802.11 wireless standard. In the second case, Wi-Lan alleges that defendants infringe the same two patents asserted in the first case, and in addition Wi-Lan alleges that some of the defendants in the second case infringe a third patent that allegedly relates to Asymmetric Digital Subscriber Line (ADSL) technology. In the second case, MSI is not accused of infringing the ADSL patent.
On May 27, 2008, defendants in both cases jointly moved to consolidate the co-pending related cases and permit claims involving suppliers of the products to be litigated first. Wi-Lan filed its opposition on June 18, 2008. On September 10, 2008, the Court granted the defendants motion to consolidate both actions but denied as premature having the defendant suppliers case proceed first. The Claim Construction Hearing is scheduled for September 1, 2010, and the trial is set to begin on January 4, 2011. MSI believes it does not infringe the asserted Wi-Lan patents and will vigorously defend itself in these matters.
On November 5, 2007, MSI filed a complaint against Wi-Lan in the United States District Court for the Northern District of California asking the Court to find that it does not infringe three patents that Wi-Lan asserted against MSI in its December 21, 2006 letter. Two of these patents were not asserted against MSI in either of the two Texas litigations. These patents allegedly relate to Wideband Code Division Multiple Access technology. Also, MSI asks in the alternative that the Court find the patents invalid. Wi-Lan has filed a motion to dismiss, and the Company filed its opposition to that motion on June 9, 2008. On June 19, 2008, Marvell settled this declaratory judgment action. This settlement does not effect or in any way involve the ongoing litigations brought by Wi-LAN in the Eastern District of Texas.
Fujitsu et al. Litigation. On December 17, 2007, Fujitsu, Ltd., LG Electronics., Ltd., and U.S. Philips Corp., sued NETGEAR, Inc. in the United States District Court for the Western District of Wisconsin, alleging that NETGEARs 802.11 equipment infringed three United States patents allegedly owned individually by the plaintiffs. On March 17, 2008, NETGEAR filed a third-party complaint against three companies, including MSI, who allegedly supply 802.11 chips to NETGEAR. In the third-party action, NETGEAR alleges that whatever damages and compensation it is required to pay as a result of the underlying patent infringement litigation, the alleged suppliers owe to NETGEAR. The Company filed an answer and a motion to amend the schedule in the case on April 8, 2008. The Court, on its own, adjusted the schedule to account for the new parties added to the litigation and moved the trial date to April 27, 2009. The claim construction hearing was held on August 15, 2008. The Company believes that it does not owe NETGEAR any payment resulting from NETGEARs use of the Companys 802.11 parts in NETGEAR products, and the Company also believes that none of the patents in suit is infringed by NETGEAR. The Company entered into a stipulated dismissal from this litigation on November 3, 2008.
General. The Company is also party to other legal proceedings and claims arising in the normal course of business. The legal proceedings and claims described above could result in substantial costs and could divert the attention and resources of the Companys management. Although the legal responsibility and financial impact with respect to these proceedings and claims cannot currently be ascertained, an unfavorable outcome in such actions could have a material adverse effect on the Companys cash flows. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. An unfavorable ruling in litigation could require the Company to pay damages or one-time license fees or royalty payments, which could adversely impact gross margins in future periods, or could prevent the Company from manufacturing or selling some of its products or limit or restrict the type of work that employees involved in such litigation may perform for the Company. There can be no assurance that these matters will be resolved in a manner that is not adverse to the Companys business, financial condition, results of operations or cash flows.
Note 10. Stock-Based Compensation
The Company adopted SFAS 123R in its fiscal year beginning January 29, 2006. SFAS 123R requires the measurement and recognition of compensation expense for all share-based awards to employees and directors, including employee stock options, restricted stock units and employee stock purchase rights based on estimated fair values.
The following table presents details of stock-based compensation expenses by functional line item (in thousands):
Stock-based compensation of $2.5 million was capitalized into inventory as of November 1, 2008.
The following assumptions were used for each respective period to calculate the weighted average fair value of each option award on the date of grant using the Black-Scholes option pricing model:
In developing estimates used in the adoption of SFAS 123R, the Company established the expected term for employee options and awards, as well as expected forfeiture rates, based on the historical settlement experience and after giving consideration to vesting schedules. Assumptions for option exercises and pre-vesting terminations of options were stratified by employee groups with sufficiently distinct behavior patterns.
Expected volatility under SFAS 123R was developed based on the average of the Companys historical daily stock price volatility. The risk-free interest rate assumption is based on observed interest rates appropriate for the expected terms of our stock options.
SFAS 123R also requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from initial estimates.
Note 11. Shareholders Equity
In April 1995, the Company adopted the 1995 Stock Option Plan (the Option Plan). The Option Plan, as amended, had 383,675,842 common shares reserved for issuance thereunder as of November 1, 2008. Options granted under the Option Plan generally have a term of ten years and generally must be issued at prices not less than 100% and 85% for incentive and nonqualified stock options, respectively, of the fair market value of the stock on the date of grant. Incentive stock options granted to shareholders who own greater than 10% of the outstanding stock are for periods not to exceed five years and must be issued at prices not less than
110% of the fair market value of the stock on the date of grant. The options generally vest 20% one year after the vesting commencement date, and the remaining shares vest one-sixtieth per month over the remaining 48 months. Options granted under the Option Plan prior to March 1, 2000 may be exercised prior to vesting and the exercised shares remain unvested until vested in accordance with the terms of the grant. The Company has the right to repurchase such shares at their original purchase price if the optionee is terminated from service prior to vesting. Such right expires as the options vest over a five-year period. Options granted under the Option Plan subsequent to March 1, 2000 may only be exercised upon or after vesting.
In August 1997, the Company adopted the 1997 Directors Stock Option Plan (the Directors Plan). Under the Directors Plan, an outside director was granted an option to purchase 30,000 common shares upon appointment to the Companys Board of Directors. These options vested 20% one year after the vesting commencement date and remaining shares vest one-sixtieth per month over the remaining 48 months. An outside director was also granted an option to purchase 6,000 common shares on the date of each annual meeting of the shareholders. These options vested one-twelfth per month over 12 months after the fourth anniversary of the vesting commencement date. Options granted under the Directors Plan could be exercised prior to vesting. The Directors Plan was terminated in October 2007.