# SILICON LABORATORIES INC. (SLAB) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from SILICON LABORATORIES INC.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1038074/000110465922010931/slab-20220101x10k.htm
Accession: 0001104659-22-010931
Filing date: 2022-02-02
Report date: 2022-01-01
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SLAB/
All MD&A years: /company/SLAB/mda/
Next year: /company/SLAB/mda/fy2022/ (FY 2022)

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements. Please see the “Cautionary Statement” and “Risk Factors” above for discussions of the uncertainties, risks and assumptions associated with these statements. Our fiscal year-end financial reporting periods are a 52- or 53-week fiscal year that ends on the Saturday closest to December 31. Fiscal 2021 had 52 weeks. Fiscal 2020 had 53 weeks with the extra week occurring in the first quarter of the year. Fiscal 2019 had 52 weeks. Fiscal 2021, 2020 and 2019 ended on January 1, 2022, January 2, 2021 and December 28, 2019, respectively.

Impact of COVID-19

A new strain of novel coronavirus which causes a severe respiratory disease (“COVID-19”) was identified in 2019, and subsequently declared a worldwide pandemic by the World Health Organization. We implemented a response plan and continued operations while largely transitioning our global workforce to a remote work model. The third parties that perform our semiconductor manufacturing, assembly, packaging and testing have generally remained operational. The extent of the impact of the COVID-19 pandemic on our operational and financial performance will depend on future developments, including the duration, severity and spread of the pandemic, related restrictions on travel and transportation and other actions that may be taken by governmental authorities, the impact to the business of our suppliers or customers, and other items identified under “Risk Factors” above, all of which are uncertain and cannot be predicted. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, access to sources of liquidity and financial condition.

Overview

We are a leader in secure, intelligent wireless technology for a more connected world. Our integrated hardware and software platform, intuitive development tools, industry leading ecosystem and robust support enable customers in building advanced industrial, commercial, home and life applications. We make it easy for developers to solve complex wireless challenges throughout the product lifecycle and get to market quickly with innovative solutions that transform industries, grow economies and improve lives. We provide analog-intensive, mixed-signal solutions for use in a variety of electronic products in a broad range of applications for the Internet of Things (IoT) including connected home and security, industrial automation and control, smart metering, smart lighting, commercial building automation, consumer electronics, asset tracking and medical instrumentation.

As a fabless semiconductor company, we rely on third-party semiconductor fabricators in Asia, and to a lesser extent the United States and Europe, to manufacture the silicon wafers that reflect our IC designs. Each wafer contains numerous die, which are cut from the wafer to create a chip for an IC. We rely on third parties in Asia to assemble, package, and, in most cases, test these devices and ship these units to our customers. Testing performed by such third parties facilitates faster delivery of products to our customers (particularly those located in Asia), shorter production cycle times, lower inventory requirements, lower costs and increased flexibility of test capacity.

The sales cycle for our ICs can be as long as 12 months or more. An additional three to six months or more are usually required before a customer ships a significant volume of devices that incorporate our ICs. Due to this lengthy sales cycle, we typically experience a significant delay between incurring research and development and selling, general and administrative expenses, and the corresponding sales. Consequently, if sales in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter and, potentially, future quarters would be adversely affected. Moreover, the amount of time between initial research and development and commercialization of a product, if ever, can be substantially longer than the sales cycle for the product. Accordingly, if we incur substantial research and development costs without developing a commercially successful product, our operating results, as well as our growth prospects, could be adversely affected.

Because some of our ICs are designed for use in consumer products, we expect that the demand for our products will be typically subject to some degree of seasonal demand. However, rapid changes in our markets and across our product areas make it difficult for us to accurately estimate the impact of seasonal factors on our business.

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Discontinued Operations

On April 22, 2021, we entered into an Asset Purchase Agreement pursuant to which Skyworks Solutions, Inc. agreed to acquire certain assets, rights, and properties, and assume certain liabilities, comprising our infrastructure and automotive business for $2.75 billion in cash. The sale was completed pursuant to the terms of the Agreement on July 26, 2021. The results of operations of the sold component have been presented in the accompanying consolidated financial statements as discontinued operations and, therefore, are excluded from the following discussion of the results of our continuing operations.

Current Period Highlights of Continuing Operations

Revenues increased $209.9 million in fiscal 2021 compared to fiscal 2020 due to increased demand for our products. Gross profit increased $130.6 million during the same period due primarily to increased product sales. Gross margin increased to 59.0% in fiscal 2021 compared to 57.7% in fiscal 2020 primarily due to variations in product mix. Operating expenses increased $56.3 million in fiscal 2021 compared to fiscal 2020 due primarily to increased personnel-related expenses, new product introduction costs, occupancy costs and amortization of intangible assets. Operating loss in fiscal 2021 was $32.8 million compared to $107.1 million in fiscal 2020.

We ended fiscal 2021 with $2.0 billion in cash, cash equivalents and short-term investments. Net cash provided by operating activities was $91.2 million during fiscal 2021. Accounts receivable were $98.3 million at January 1, 2022, representing 42 days sales outstanding (DSO). Inventory was $49.3 million at January 1, 2022, representing 55 days of inventory (DOI). In fiscal 2021, we repurchased 6.5 million shares of our common stock for an aggregate cost of $1.15 billion, including 4.0 million shares through a tender offer, 1.7 million shares through an ASR agreement and 0.8 million shares through our existing share repurchase program. During fiscal 2021, we paid $140.6 million in cash and issued 528,022 shares of common stock in connection with the redemption of the remaining principal of our 2022 convertible senior notes.

Through acquisitions and internal development efforts, we have continued to diversify our portfolio and introduce new products and solutions with added functionality and integration. In fiscal 2021, we introduced a 3D virtual smart home platform that takes users through innovative smart home solutions, various applicable protocols, and ecosystem connections; Z-Wave 800 system-on-chips (SoCs) and modules for the Z-Wave smart home and automation ecosystem; Custom Part Manufacturing Service (CPMS) to support IoT companies with the implementation of ‘Zero Trust’ security architectures to meet emerging cybersecurity standards; the Unify Software Development Kit (SDK), which provides the common building blocks for connectivity across IoT ecosystems; new sub-1-GHz SoCs delivering wireless solutions that combine long-range RF and energy efficiency with certified ARM PSA Level 3 security; a fully integrated, certified Wi-SUN® solution simplifying Low Power Wide Area Network (LPWAN) deployment for smart cities; wireless solutions for development of Matter end products that support Thread, Wi-Fi, and Bluetooth protocols; and a new 32-bit MCU on our award-winning xG22 platform for IoT edge applications. We plan to continue introducing products that increase the content we provide for existing applications, thereby enabling us to serve markets we do not currently address and expand our total available market opportunity.

During fiscal 2021, 2020 and 2019, we had no customer that represented more than 10% of our revenues. In addition to direct sales to customers, some of our end customers purchase products indirectly from us through distributors and contract manufacturers. An end customer purchasing through a contract manufacturer typically instructs such contract manufacturer to obtain our products and incorporate such products with other components for sale by such contract manufacturer to the end customer. Although we actually sell the products to, and are paid by, the distributors and contract manufacturers, we refer to such end customer as our customer. Three of our distributors who sell to our customers, Arrow Electronics, Edom Technology and Sekorm, each represented 28%, 18% and 12% of our revenues during fiscal 2021, 28%, 19% and 14% of our revenues during fiscal 2020, and 26%, 18% and 10% of our revenues during fiscal 2019, respectively.

The percentage of our revenues derived from outside of the United States was 86% in fiscal 2021, 88% in fiscal 2020 and 87% in fiscal 2019. All of our revenues to date have been denominated in U.S. dollars. We believe that a majority of our revenues will continue to be derived from customers outside of the United States.

Results of Operations

The following describes the line items set forth in our Consolidated Statements of Income:

Revenues. Revenues are generated predominately by sales of our products. Our revenues are subject to variation from period to period due to the volume of shipments made within a period, the mix of products we sell and the prices we charge for our products.

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Cost of Revenues. Cost of revenues includes the cost of purchasing finished silicon wafers processed by independent foundries; costs associated with assembly, test and shipping of those products; costs of personnel and equipment associated with manufacturing support, logistics and quality assurance; costs of software royalties, other intellectual property license costs and certain acquired intangible assets; and an allocated portion of our occupancy costs. Our gross margin fluctuates depending on product mix, manufacturing yields, inventory valuation adjustments, average selling prices and other factors.

Research and Development. Research and development expense consists primarily of personnel-related expenses, including stock-based compensation, as well as new product masks, external consulting and services costs, equipment tooling, equipment depreciation, amortization of intangible assets and an allocated portion of our occupancy costs. Research and development activities include the design of new products, refinement of existing products and design of test methodologies to ensure compliance with required specifications.

Selling, General and Administrative. Selling, general and administrative expense consists primarily of personnel-related expenses, including stock-based compensation, as well as an allocated portion of our occupancy costs, sales commissions to independent sales representatives, amortization of intangible assets, professional fees, legal fees, and promotional and marketing expenses.

Interest Income and Other, Net. Interest income and other, net reflects interest earned on our cash, cash equivalents and investment balances, foreign currency remeasurement adjustments, and other non-operating income and expenses.

Interest Expense. Interest expense consists of interest on our short and long-term obligations, including our convertible senior notes and credit facility. Interest expense on our convertible senior notes includes contractual interest, amortization of the debt discount and amortization of debt issuance costs.

Equity-method Earnings. Equity-method earnings represents income or loss on our equity-method investment.

Provision (Benefit) for Income Taxes. Provision (benefit) for income taxes includes both domestic and foreign income taxes at the applicable tax rates adjusted for non-deductible expenses, research and development tax credits and other permanent differences.

The following table sets forth our Consolidated Statements of Income data as a percentage of revenues for the periods indicated:

​

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[[/GREPCENT_TABLE]]

​

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Comparison of Fiscal 2021 to Fiscal 2020

Revenues

​

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[[/GREPCENT_TABLE]]

​

The change in revenues in fiscal 2021 was due to increased demand for our IoT products. Unit shipment volumes of our products increased by 37.1% while average selling prices increased by 2.7% compared to fiscal 2020. The average selling prices of our products may fluctuate significantly from period to period due to changes in product mix, pricing decisions and other factors. In general, as our products become more mature, we expect to experience decreases in average selling prices.

Gross Profit

​

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[[/GREPCENT_TABLE]]

​

Gross profit increased in fiscal 2021 due primarily to increased product sales. Gross margin increased in fiscal 2021 primarily due to variations in product mix.

We may experience variations in the average selling prices of certain of our products. Increases in average selling prices may occur during periods of increased demand, but such demand may be short-lived and could be accompanied by higher product costs. Declines in average selling prices create downward pressure on gross margin and may be offset to the extent we are able to introduce higher margin new products and gain market share with our products; reduce costs of existing products through improved design; achieve lower production costs from our wafer suppliers and third-party assembly and test subcontractors; achieve lower production costs per unit as a result of improved yields throughout the manufacturing process; or reduce logistics costs.

Research and Development

​

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[[/GREPCENT_TABLE]]

​

The increase in research and development expense in fiscal 2021 was primarily due to increases of $23.9 million for personnel-related expenses, $8.8 million for new product introduction costs, $2.1 million for occupancy costs and $1.0 million for the amortization of intangible assets. The decrease in research and development expense as a percent of revenues in fiscal 2021 was due to our increased revenues. We expect that research and development expense will increase in absolute dollars in the first quarter of 2022 compared to the fourth quarter of 2021.

Selling, General and Administrative

​

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[[/GREPCENT_TABLE]]

​

The increase in selling, general and administrative expense in fiscal 2021 was primarily due to an increase of $18.9 million for personnel-related expenses. The decrease in selling, general and administrative expense as a percent of revenues in fiscal 2021 was due to our increased revenues. We expect that selling, general and administrative expense will decrease in absolute dollars in the first quarter of 2022 compared to the fourth quarter of 2021.

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Interest Income and Other, Net

Interest income and other, net in fiscal 2021 was $5.7 million compared to $9.0 million in fiscal 2020. The decrease in interest income and other, net in fiscal 2021 was primarily due to lower interest rates on the underlying instruments.

Interest Expense

Interest expense in fiscal 2021 was $31.0 million compared to $34.1 million in fiscal 2020. The decrease in interest expense in fiscal 2021 was primarily due to a net decrease of $2.7 million in interest resulting from the reduction in the aggregate balance of convertible notes outstanding and a decrease in borrowings from our existing credit facility.

Provision (Benefit) for Income Taxes

​

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[[/GREPCENT_TABLE]]

​

The provision for income taxes for fiscal 2021 compared to the benefit from income taxes in fiscal 2020 was primarily due to the reallocation of income tax benefit from continuing operations to discontinued operations under Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) 2019-12, Simplifying the Accounting for Income Taxes, and an increase in the beginning of year valuation allowance on deferred tax assets for state attribute carryforwards. Additionally, tax expense on the gain from the divestiture of the infrastructure and automotive business to Skyworks Solutions of $346.9 million was recorded in discontinued operations for the period, net of tax benefits associated with discontinued operations before the gain on sale of $7.2 million for fiscal 2021.

Equity-method Earnings

Equity-method earnings in fiscal 2021 were $13.7 million compared to $2.1 million in fiscal 2020. The increase in equity-method earnings in fiscal 2021 was due to an increase in the unrealized gain on an equity-method investment.

Income from discontinued operations, net of income taxes

​

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[[/GREPCENT_TABLE]]

​

The increase in income from discontinued operations, net of income taxes in fiscal 2021 was primarily due to a gain on sale of $2.1 billion, net of tax, in fiscal 2021. See Note 3, Discontinued Operations, to the Consolidated Financial Statements for additional information.

Comparison of Fiscal 2020 to Fiscal 2019

​

Revenues

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​

The change in revenues in fiscal 2020 was due to increased demand for our IoT products. Unit shipment volumes of our products increased by 17.0% while average selling prices decreased by 7.4% compared to fiscal 2019.

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Gross Profit

​

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[[/GREPCENT_TABLE]]

​

Gross profit increased in fiscal 2020 due primarily to increased product sales. Gross margin decreased in fiscal 2020 primarily due to variations in product mix.

Research and Development

​

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[[/GREPCENT_TABLE]]

​

The increase in research and development expense in fiscal 2020 was primarily due to increases of $18.0 million for personnel-related expenses, including costs associated with increased headcount and an acquisition, $5.2 million for new product introduction costs, $3.5 million for the amortization of intangible assets and $1.1 million for occupancy costs.

Selling, General and Administrative

​

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​

The increase in selling, general and administrative expense in fiscal 2020 was primarily due to an increase of $3.3 million for personnel-related expenses, including costs associated with increased headcount.

Interest Income and Other, Net

​

Interest income and other, net in fiscal 2020 was $9.0 million compared to $12.9 million in fiscal 2019. The decrease in interest income and other, net in fiscal 2020 was primarily due to lower interest rates on the underlying instruments.

Interest Expense

​

Interest expense in fiscal 2020 was $34.1 million compared to $20.2 million in fiscal 2019. The increase in interest expense in fiscal 2020 was primarily due to a net increase of $8.0 million in interest resulting from an increase in the aggregate balance of notes outstanding and a loss of $4.1 million recorded on the early extinguishment of a portion of the 2022 Notes.

Provision (Benefit) for Income Taxes

​

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​

The decrease in the provision for income taxes for fiscal 2020 as compared to fiscal 2019 was primarily due to the impact in fiscal 2019 of a change in our position related to the treatment of stock-based compensation within our intercompany cost-sharing arrangement offset by the increased impact of fiscal 2020 permanent tax differences. The incremental, discrete income tax expense recognized in fiscal 2019 for the cost-sharing change was $18.4 million.

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Equity-method Earnings

Equity-method earnings in fiscal 2020 were $2.1 million compared to $0.3 million in fiscal 2019. The increase in equity-method earnings in fiscal 2020 was due to an increase in the unrealized gain on an equity-method investment.

Income from discontinued operations, net of income taxes

​

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​

The increase in income from discontinued operations, net of income taxes in fiscal 2020 was primarily due to a decrease in the provision for income taxes in fiscal 2020.

Business Outlook

The following represents our business outlook for the first quarter of fiscal 2022.

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[[/GREPCENT_TABLE]]

​

Liquidity and Capital Resources

Our principal sources of liquidity as of January 1, 2022 consisted of $2.0 billion in cash, cash equivalents and short-term investments, of which approximately $730.7 million was held by our U.S. entities. The remaining balance was held by our foreign subsidiaries. Our cash equivalents and short-term investments consisted of government debt securities, which include agency bonds, agency discount notes, municipal bonds and U.S. government securities; corporate debt securities, which include asset-backed securities, corporate bonds, certificates of deposit and commercial paper; and money market funds. Our long-term investments consisted of auction-rate securities.

Operating Activities

Net cash provided by operating activities was $91.2 million during fiscal 2021, compared to net cash used of $8.8 million during fiscal 2020. Operating cash flows during fiscal 2021 reflect our net income of $2.1 billion, adjustments of $(2.0) billion for income from discontinued operations, depreciation, amortization, stock-based compensation, equity-method earnings and deferred income taxes, and a net cash inflow of $20.7 million due to changes in our operating assets and liabilities.

Net cash used in operating activities was $8.8 million during fiscal 2020, compared to net cash provided of $22.1 million during fiscal 2019. Operating cash flows during fiscal 2020 reflect our net income of $12.5 million, adjustments of $(2.8) million for income from discontinued operations, depreciation, amortization, stock-based compensation, equity-method earnings and deferred income taxes, and a net cash outflow of $18.5 million due to changes in our operating assets and liabilities.

Accounts receivable increased to $98.3 million at January 1, 2022 from $95.2 million at January 2, 2021. The increase in accounts receivable resulted primarily from normal variations in the timing of collections and billings. Our average DSO was 42 days at January 1, 2022 and 35 days at January 2, 2021.

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Inventory increased to $49.3 million at January 1, 2022 from $47.9 million at January 2, 2021. Our inventory levels will vary based on the availability of supply, and to a lesser extent, the impact of variations between forecasted demand used for purchasing inventory and actual demand. Our DOI was 55 days at January 1, 2022 and 70 days at January 2, 2021.

Investing Activities

Net cash used in investing activities was $476.7 million during fiscal 2021, compared to net cash used of $358.3 million during fiscal 2020. The increase in cash outflows was principally due to an increase in cash outflows of $424.7 million from net purchases and sales of marketable securities in fiscal 2021, offset by a cash payment of $316.8 million for the acquisition of the Wi-Fi and Bluetooth business of Redpine Signals in fiscal 2020.

Net cash used in investing activities was $358.3 million during fiscal 2020, compared to net cash used of $102.8 million during fiscal 2019. The increase in cash outflows was principally due a cash payment of $316.8 million for the acquisition of a business in fiscal 2020, offset by a decrease in cash outflows of $57.4 million from net purchases and sales of marketable securities in fiscal 2019.

Financing Activities

Net cash used in financing activities was $1.3 billion during fiscal 2021, compared to cash provided of $200.9 million during fiscal 2020. The increase in cash outflows was principally due to an increase of $1.1 billion for repurchases of our common stock in fiscal 2021 and $845.0 million in proceeds from the issuance of debt in fiscal 2020, offset by a decrease of $484.2 million in payments on debt in fiscal 2021. During fiscal 2021, we repurchased 6.5 million shares, including purchases of 4.0 million shares through a tender offer, 1.7 million shares through an ASR agreement and 0.8 million shares through our existing share repurchase program.

Net cash provided by financing activities was $200.9 million during fiscal 2020, compared to cash used of $29.6 million during fiscal 2019. The increase in cash inflows was principally due to $845.0 million in proceeds from the issuance of debt and a decrease of $10.4 million for repurchases of our common stock, offset by $623.6 million in payments on debt in fiscal 2020.

Discontinued Operations

Net cash provided by discontinued operations was $2.6 billion during fiscal 2021, compared to net cash provided of $141.9 million during fiscal 2020. The increase in cash inflows was principally due to $2.75 billion in proceeds from the sale of our infrastructure and automotive business, offset by a payment of $252.8 million for incomes taxes on the gain on sale.

Net cash provided by discontinued operations was $141.9 million during fiscal 2020, compared to net cash provided of $140.4 million during fiscal 2019.

Debt

As of January 1, 2022, our debt included $535 million principal amount of convertible senior notes (the “2025 Notes”). We also had an undrawn $400 million revolving credit facility. We have an option to increase the size of the borrowing capacity of the revolving credit facility by up to the greater of an aggregate of $250 million and 100% of EBITDA, plus an amount that would not cause a secured leverage ratio to exceed 3.25 to 1.00, subject to certain conditions. On January 1, 2022, a condition regarding early conversion of the 2025 Notes was met, and as a result, holders have the right to convert their notes at any time during the quarter ending March 31, 2022. On January 2, 2022, we irrevocably elected cash settlement for the principal amount of the 2025 Notes.

On January 6, 2021, we issued a notice of redemption for the remaining 2022 convertible senior notes (the “2022 Notes”). During fiscal 2021, we paid $140.6 million in cash and issued 528,022 shares of common stock in connection with the redemption of the remaining 2022 Notes. See Note 11, Debt, to the Consolidated Financial Statements for additional information.

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Capital Requirements

Our future capital requirements will depend on many factors, including the rate of sales growth, market acceptance of our products, the timing and extent of research and development projects, potential acquisitions of companies or technologies and the expansion of our sales and marketing activities. We believe our existing cash, cash equivalents, investments, credit under our Credit Facility, and cash generated from operations are sufficient to meet our short-term and long-term capital requirements, although we could be required, or could elect, to seek additional funding prior to that time. We may enter into acquisitions or strategic arrangements in the future which also could require us to seek additional equity or debt financing.

Contractual Obligations

Our purchase obligations primarily include contractual arrangements in the form of purchase orders with suppliers. As of January 1, 2022, such purchase obligations were $190.2 million. For a description of other contractual obligations, see Note 11, Debt, and Note, 12, Leases, to the Consolidated Financial Statements

Critical Accounting Policies and Estimates

The preparation of financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles requires that we make estimates and assumptions that affect the amounts reported. Changes in facts and circumstances could have a significant impact on the resulting estimated amounts included in the financial statements. We believe the following critical accounting policies affect our more complex judgments and estimates.

Inventory valuation – We assess the recoverability of inventories through the application of a set of methods, assumptions and estimates. In determining net realizable value, we write down inventory that may be slow moving or have some form of obsolescence, including inventory that has aged more than 12 months. We also adjust the valuation of inventory when its manufacturing cost exceeds the estimated selling price less costs of completion, disposal and transportation. We assess the potential for any unusual customer returns based on known quality or business issues and write-off inventory losses for scrap or non-saleable material. Inventory not otherwise identified to be written down is compared to an assessment of our 12-month forecasted demand. The result of this methodology is compared against the product life cycle and competitive situations in the marketplace to determine the appropriateness of the resulting inventory levels. Demand for our products may fluctuate significantly over time, and actual demand and market conditions may be more or less favorable than those that we project. In the event that actual demand is lower or market conditions are worse than originally projected, additional inventory write-downs may be required.

Impairment of goodwill and other long-lived assets – We review long-lived assets which are held and used, including fixed assets and purchased intangible assets, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors which are inherently difficult to forecast. If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique.

We test our goodwill for impairment annually as of the first day of our fourth fiscal quarter and in interim periods if certain events occur indicating that the carrying value of goodwill may be impaired. We assess goodwill for impairment by comparing the fair value of a reporting unit to its carrying amount. In determining fair value, several valuation methodologies are allowed, although quoted market prices are the best evidence of fair value. If the fair value of the reporting unit is less than its carrying amount, we recognize an impairment loss equal to that excess amount.

Acquired intangible assets – When we acquire a business, a portion of the purchase price is typically allocated to identifiable intangible assets, such as acquired technology and customer relationships. Fair value of these assets is determined primarily using the income approach, which requires us to project future cash flows and apply an appropriate discount rate. We amortize intangible assets with finite lives over their expected useful lives. Our estimates are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Incorrect estimates could result in future impairment charges, and those charges could be material to our results of operations.

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Revenue recognition – We recognize revenue when control of the promised goods or services is transferred to customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. In order to achieve this core principle, we apply a five-step process. As part of this process, we analyze the performance obligations in a customer contract and estimate the variable consideration we expect to receive. The evaluation of performance obligations requires that we identify the promised goods and services in the contract. For contracts that contain more than one promised good and service, we then must determine whether the promises are capable of being distinct and if they are separately identifiable from other promises in the contract. Variable consideration primarily includes sales made to distributors under agreements allowing certain rights of return, referred to as stock rotation, and credits issued to the distributor due to price protection. We estimate variable consideration at the most likely amount to which we expect to be entitled. We make these estimates based on available information, including recent sales activity and pricing data. We apply a constraint to our variable consideration estimate which considers both the likelihood of a return and the amount of a potential price concession. If our evaluation of performance obligations is incorrect, we may recognize revenue sooner or later than is appropriate. If our estimates of variable consideration are inaccurate, we may recognize too much or too little revenue in a period. We may adjust assumptions used to estimate consideration periodically based on analysis of prior estimates.

Stock-based compensation – We recognize the fair-value of stock-based compensation transactions in the Consolidated Statements of Income. The fair value of our full-value stock awards (with the exception of market-based performance awards) equals the fair market value of our stock on the date of grant. The fair value of our market-based performance awards is estimated at the date of grant using a Monte-Carlo simulation. The fair value of our stock option and employee stock purchase plan grants is estimated at the date of grant using the Black-Scholes option pricing model. In addition, we are required to estimate the expected forfeiture rate of our stock grants and only recognize the expense for those shares expected to vest. If our actual experience differs significantly from the assumptions used to compute our stock-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little stock-based compensation cost. See Note 16, Stock-Based Compensation, to the Consolidated Financial Statements for additional information.

Income taxes – We are required to calculate income taxes in each of the jurisdictions in which we operate. This process involves calculating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheets. We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, we are required to estimate the amount of expected future taxable income. Judgment is inherent in this process and differences between the estimated and actual taxable income could result in a material impact on our Consolidated Financial Statements.

We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine whether the weight of available evidence indicates that the tax position has met the threshold for recognition. Therefore, we must evaluate whether it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure the tax benefit of the tax position taken, or expected to be taken, in an income tax return as the largest amount that is more than 50% likely of being realized upon ultimate settlement. This measurement step is inherently complex and requires subjective estimations of such amounts to determine the probability of various possible outcomes. We re-evaluate the uncertain tax positions each quarter based on factors including, but not limited to, changes in facts or circumstances, changes in tax law, expirations of statutes of limitation, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

Although we believe the measurement of our liabilities for uncertain tax positions is reasonable, no assurance can be given that the final outcome of these matters will not be different than what is reflected in the historical income tax provisions and accruals. If additional taxes are assessed as a result of an audit or litigation, they could have a material effect on our income tax provision and net income in the period or periods for which that determination is made. We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues which may require an extended period of time to resolve and could result in additional assessments of income tax. We believe adequate provisions for income taxes have been made for all periods.

Recent Accounting Pronouncements

Information regarding recent accounting pronouncements is provided in Note 2, Significant Accounting Policies, to the Consolidated Financial Statements. Such information is incorporated by reference herein.

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