LSI CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) This management's discussion and analysis should be read in conjunction with the other sections of this Form 10-K, including Part 1, Item 1- "Business"; Part I, Item 1A- "Risk Factors"; Part II, Item 6- "Selected Financial Data"; and Part II, Item 8- "Financial Statements and Supplementary Data." Where more than one significant factor contributed to changes in results from year to year, we have quantified these factors throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where practicable and material to understanding the discussion.

OVERVIEW We design, develop and market complex, high-performance storage and networking semiconductors. We offer a broad portfolio of capabilities including custom and standard product integrated circuits that are used in hard disk drives, solid state drives, high-speed communications systems, computer servers, storage systems and personal computers. We deliver our products to our customers as stand-alone integrated circuits as well as incorporated onto circuit boards that offer additional functionality. We also license our intellectual property to other entities.

On January 3, 2012, we acquired SandForce, Inc. a provider of flash storage processors for enterprise and client flash solutions and solid state drives, for total consideration of approximately $346.4 million, net of cash acquired. We acquired SandForce to enhance our competitive position in the PCIe ® flash adapter market where LSI's products already used SandForce flash storage processors. Additionally, the combination of LSI's custom capability and SandForce's standard product offerings allows us to offer a full range of products aimed at the growing flash storage processor market for ultrabook, notebook and enterprise solid state drives and flash solutions.

On May 6, 2011, we sold our external storage systems business to NetApp, Inc.

for $480.0 million in cash. That business sold external storage systems, primarily to original equipment manufacturers, or OEMs, who resold these products to end customers under their own brand name. The external storage systems business is reflected as discontinued operations in our consolidated statements of operations and, as such, the results of that business have been excluded from all line items other than "Income from discontinued operations" for all periods presented.

We derive the majority of our revenues from sales of products for the hard disk and solid state drive, server and networking equipment end markets and our revenues depend on market demand for these types of products. We believe that these markets offer us attractive opportunities because of the growing demand to create, store, manage and move digital content. We believe that this growth is occurring as a result of a number of trends, including: • The increasing popularity of mobile devices, such as smart phones and media tablets, and the increasing use of the internet for streaming media, such as videos and music, which together are driving the need for more network capacity; • Consumer and business demand for hard disks to store increasing amounts of digital data, including music, video, pictures and medical and other business records; and • Enterprises refreshing their data centers to provide higher levels of business support and analytics, which drives demand for new servers and storage systems and associated equipment.

Our products are sold primarily to OEMs in the server, storage and networking industries. We also sell some of our products through a network of resellers and distributors.

The markets in which we operate are highly competitive and our revenues depend on our ability to compete successfully. We face competition not only from makers of products similar to ours, but also from competing technologies.

In 2012, we reported revenues of $2,506.1 million compared to $2,044.0 million in 2011. In 2012, we reported net income of $196.2 million, or $0.34 per diluted share, compared to $331.5 million, or $0.55 per diluted share, in 2011. Net income for 2011 included a $260.1 million gain on the sale of our external storage systems business while our results in 2012 reflect the acquisition of SandForce.

23 -------------------------------------------------------------------------------- Table of Contents Our board of directors authorized stock repurchase programs of up to $750.0 million on March 9, 2011 and an additional $500.0 million on August 1, 2012.

During 2012, we repurchased 36.0 million shares for $272.6 million and completed the 2011 program. As of December 31, 2012, $478.6 million remained available for stock repurchases. Future purchases under the 2012 program are expected to be funded with available cash, cash equivalents and short term investments. We ended 2012 with cash and cash equivalents, together with short-term investments, of $676.0 million, a decline from $935.5 million at the end of 2011 which was primarily attributable to the cash we used for the acquisition of SandForce.

A number of hard disk drive manufacturers have production facilities in Thailand. In the fall of 2011, flooding there forced many of these facilities to stop production, which had an adverse impact on our revenues from semiconductors for hard disk drives. As the industry recovered in early 2012, our revenues benefited. More recently, we believe that there has been weakness in sales of personal computers, which has affected sales of hard disk and solid state drives and our revenues from semiconductors for hard disk and solid state drives. We believe that general economic weakness has also affected our revenues, including networking revenues, which has been affected by weak capital spending by wireless telecommunications carriers.

We believe that the weakness in both personal computer sales and general economic conditions is continuing into early 2013. In light of this environment, we are working to manage our operating expenses while at the same time continuing work on products under development. We are focusing our research and development operations on products that we believe provide favorable growth opportunities for our business. We are also working to expand our sales of products in newer areas such as flash memory-based server adapter cards, where we are working directly with large, internet-based datacenter operators, in addition to our more traditional customer base of OEMs and distributors.

RESULTS OF OPERATIONS Revenues Year Ended December 31, 2012 2011 2010 (In millions) Revenues $ 2,506.1 $ 2,044.0 $ 1,869.7 Revenues increased by $462.1 million, or 22.6%, in 2012 as compared to 2011, driven by higher unit sales of semiconductors used in storage applications, such as hard disk drives, as the hard disk drive industry recovered from the flooding in Thailand in late 2011, and the ramping of new products to existing customers.

The increase also reflects $159.7 million of revenues from flash storage processors as a result of the acquisition of SandForce. These increases were offset in part by a decrease in unit sales of legacy networking products.

Revenues increased by $174.3 million, or 9.3%, in 2011 as compared to 2010. The increase was primarily attributable to higher unit sales of semiconductors used in storage applications to existing customers and higher revenues from the licensing of our intellectual property. These increases were offset in part by a decrease in unit sales of legacy networking products.

Significant Customers: The following table provides information about sales to Seagate Technology, which was our only customer that accounted for 10% or more of our consolidated revenues in each of 2012, 2011 and 2010: Year Ended December 31, 2012 2011 2010 Percentage of consolidated revenues 31 % 25 % 19 % 24 -------------------------------------------------------------------------------- Table of Contents Revenues by Geography: The following table summarizes our revenues by geography based on the ordering location of our customer. Because we sell our products primarily to other sellers of technology products and not to end users, the information in the table below may not accurately reflect geographic end-user demand for our products.

Year Ended December 31, 2012 2011 2010 (In millions) North America* $ 635.9 $ 520.2 $ 431.2 Asia: China (including Hong Kong) 788.1 569.7 402.8 Singapore 306.0 256.8 283.5 Taiwan 290.3 272.1 296.0 Other 300.7 224.9 240.8 Total Asia 1,685.1 1,323.5 1,223.1 Europe and the Middle East 185.1 200.3 215.4 Total $ 2,506.1 $ 2,044.0 $ 1,869.7 * Primarily the United States.

Revenues in Asia and North America increased by $361.6 million, or 27.3%, and $115.7 million, or 22.2%, respectively, in 2012 as compared to 2011. The increases in both regions were primarily attributable to higher unit sales of semiconductors used in storage applications, such as hard disk drives, as the hard disk drive industry recovered from the flooding in Thailand in late 2011, and the ramping of new products to existing customers. The increases were also due to higher unit sales of flash storage processors as a result of the acquisition of SandForce. The increases were offset in part by a decrease in unit sales of legacy networking products. Revenues in Europe and the Middle East decreased by $15.2 million, or 7.6%, in 2012 as compared to 2011. The decrease was primarily attributable to a decrease in unit sales of legacy networking products.

Revenues in North America increased by $89.0 million, or 20.6%, in 2011 as compared to 2010. The increase was primarily attributable to higher unit sales of semiconductors used in storage applications, and higher revenues from the licensing of our intellectual property. Revenues in Asia increased by $100.4 million, or 8.2%, in 2011 as compared to 2010. The increase was primarily attributable to higher unit sales of semiconductors used in storage applications, partially offset by a decrease in unit sales of legacy networking products. Revenues in Europe and the Middle East decreased by $15.1 million, or 7.0%, in 2011 as compared to 2010. The decrease was primarily attributable to a decrease in unit sales of semiconductors used in storage applications.

Revenues by Product Groups: The following table presents our revenues by product groups: Year Ended December 31, 2012 2011 2010 (In millions) Storage products $ 1,994.4 $ 1,487.1 $ 1,302.1 Networking products 407.2 453.7 473.3 Other 104.5 103.2 94.3 Total $ 2,506.1 $ 2,044.0 $ 1,869.7 Revenues from storage products increased by $507.3 million, or 34.1%, in 2012 as compared to 2011. The increase was primarily attributable to higher unit sales of semiconductors used in hard disk drives, as the hard disk drive industry recovered from the flooding in Thailand in late 2011 and an increase in sales of new products to existing customers. The increase was also the result of higher unit sales of flash storage processors due to the 25-------------------------------------------------------------------------------- Table of Contents acquisition of SandForce. Revenues from storage products increased by $185.0 million, or 14.2%, in 2011 as compared to 2010. The increase was primarily attributable to increased unit demand for semiconductors used in hard disk drives, server RAID adapters and storage area network applications.

Revenues from networking products decreased by $46.5 million, or 10.2%, in 2012 as compared to 2011. The decrease was primarily the result of lower unit sales of semiconductors used in legacy networking products. Revenues from networking products decreased by $19.6 million, or 4.1%, in 2011 as compared to 2010. The decrease was primarily due to lower unit sales of legacy networking products.

Other revenues consist primarily of fees from the licensing of our intellectual property. Therefore, such revenues are typically expected to remain relatively consistent over time and any fluctuations may result from new or expiring license agreements.

Gross Profit Margin Year Ended December 31, 2012 2011 2010 (Dollars in millions) Gross profit $ 1,231.9 $ 962.5 $ 880.6 Percentage of revenues 49.2 % 47.1 % 47.1 % Various factors affect and may continue to affect our product gross margin.

These factors include, but are not limited to, changes in our production mix and volume of product sales, the timing of production ramps and margin structures of new products, the positions of our products in their respective life cycles, the effects of competition, the price of commodities used in our products, provisions for excess and obsolete inventories, changes in the costs charged by foundry, assembly and test subcontractors, and amortization of acquired intangible assets.

Gross profit margin as a percentage of revenues increased by 2.1% in 2012 as compared to 2011. The increase was primarily attributable to favorable product mix, that is, more sales of higher margin products, and higher revenues enabling better absorption of fixed costs. The increases were offset in part by a 0.6% adverse effect on gross profit margin resulting from fair valuing inventories acquired from SandForce.

Gross profit margin as a percentage of revenues remained flat in 2011 as compared to 2010. Decreased amortization of intangible assets benefited our gross margin in 2011, which was offset by higher costs of commodities used in our products, a one-time inventory charge of $7.5 million as a result of the flooding in Thailand, an unfavorable shift in product mix, and the absence of a gross margin benefit recognized in 2010 upon termination of a contract associated with our former Mobility Products Group.

Research and Development Year Ended December 31, 2012 2011 2010 (Dollars in millions) Research and development $ 690.3 $ 576.0 $ 563.0 Percentage of revenues 27.5 % 28.2 % 30.1 % R&D expense consists primarily of employee salaries, contractor expenses and materials used in product development, costs related to third-party design tools and materials used in the design of custom silicon and standard products, as well as depreciation of capital equipment and facilities-related expenditures.

In addition to the significant resources we devote to hardware development, we also devote resources to the development of software for our products.

R&D expense increased by $114.3 million, or 19.8%, in 2012 as compared to 2011.

The increase was primarily attributable to higher compensation-related expense, which includes stock-based compensation, resulting from headcount additions associated with the acquisition of SandForce and headcount additions to support our ongoing product development efforts, higher performance-based compensation expense as a result of improved financial performance and increased spending to support new design wins.

26 -------------------------------------------------------------------------------- Table of Contents R&D expense increased by $13.0 million, or 2.3%, in 2011 as compared to 2010.

The increase was primarily attributable to higher compensation-related expense and facilities-related expenditures as a result of headcount additions and increased material costs for R&D projects, offset in part by lower costs for shared development engineering projects due to higher contributions from customers associated with existing R&D projects.

Selling, General and Administrative Year Ended December 31, 2012 2011 2010 (Dollars in millions) Selling, general and administrative $ 354.9 $ 295.4 $ 279.1 Percentage of revenues 14.2 % 14.5 % 14.9 % SG&A expense consists primarily of compensation related expenditures for sales, marketing and administrative employees, costs related to third party services, depreciation and facilities-related expenditures.

SG&A expense increased by $59.5 million, or 20.1%, in 2012 as compared to 2011.

The increase was primarily attributable to higher compensation-related expense, which includes stock-based compensation, resulting from headcount additions associated with the acquisition of SandForce and headcount additions to support revenue growth, along with higher performance-based compensation expense as a result of improved financial performance.

SG&A expense increased by $16.3 million, or 5.8%, in 2011 as compared to 2010.

The increase was primarily due to an increase in litigation costs and higher sales and marketing expenses, including higher compensation-related expenses as a result of headcount additions, to support increased revenues and design activity. These increases were partially offset by lower stock-based compensation and decreases in general and administrative expenses as a result of our continuing focus on control of expenses.

Restructuring of Operations and Other Items, net In 2012, 2011 and 2010, we initiated restructuring plans designed to focus our business on targeted end markets and to improve operational efficiency and financial results. These plans primarily involved the termination of employees and consolidation of facilities. The restructuring charges recorded in conjunction with these plans primarily represented severance and costs related to the continuation of certain employee benefits, exit costs for facility consolidations and closures, contract termination costs, research and development program cancellations and asset impairment charges. Other items included expenses related to acquisitions and dispositions as well as certain other non-recurring items described below.

The following table summarizes items included in restructuring of operations and other items, net: Year Ended December 31, 2012 2011 2010 (In millions) Lease and contract terminations $ 10.3 (a) $ 6.2 (a) $ 3.7 (a) Employee severance and benefits 8.2 11.3 8.2 Other exit costs 4.5 (b) (1.0 )(c) - Total restructuring expenses 23.0 16.5 11.9 Other items, net 26.1 (d) 7.2 (e) (2.7 )(f) Total restructuring of operations and other items, net $ 49.1 $ 23.7 $ 9.2 (a) Includes lease obligation costs for facilities that we ceased to use, changes in estimates, changes in time value and on-going expenditures related to previously vacated facilities. The 2012 amount includes $6.2 million related to our former headquarters.

(b) Consists of a $2.7 million loss on the sale of property in the U.S. and $1.8 million of other asset impairment and exit costs.

27 -------------------------------------------------------------------------------- Table of Contents (c) Includes a $6.4 million gain on the sale of land in Gresham, Oregon, substantially offset by a $5.5 million write-off of intellectual property in connection with the restructuring actions.

(d) Primarily consists of $9.3 million in litigation settlements, $8.4 million of SandForce acquisition-related costs, and $6.8 million of costs related to the transition service agreements associated with the sale of the external storage systems business.

(e) Primarily consists of $12.2 million of transition service agreement costs associated with the sale of the external storage systems business, a $4.5 million intellectual property write-off, $3.4 million of litigation settlements and a $2.2 million loss on the disposition of fixed assets, substantially offset by a $15.5 million reversal of a sales and use tax related liability.

(f) Primarily consists of a $4.4 million reversal of litigation accruals due to a favorable court ruling, offset in part by $1.6 million of depreciation for assets reclassified from held for sale to held and used.

Interest Expense, Interest Income and Other, net The following table summarizes interest expense and components of interest income and other, net: Year Ended December 31, 2012 2011 2010 (In millions) Interest expense $ - $ - $ (5.6 ) Interest income 6.6 11.1 13.7 Other income, net 31.1 15.4 0.1 Total $ 37.7 $ 26.5 $ 8.2 Interest expense decreased by $5.6 million in 2011 as compared to 2010 as a result of the repayment of our 4% Convertible Subordinated Notes in May 2010.

The $4.5 million decrease in interest income in 2012 as compared to 2011 primarily resulted from the absence of interest income in 2012 on a note we received in connection with the sale of a business in 2007 and lower interest rates in 2012 than in 2011. The $2.6 million decrease in interest income in 2011 as compared to 2010 primarily resulted from lower interest rates in 2011 than in 2010.

Other income, net in 2012 primarily included $10.8 million of insurance proceeds for covered losses from the 2011 Thailand flooding, $6.4 million of transition services income related to the external storage systems disposition, a $5.8 million gain on our pre-acquisition equity interest in SandForce, and a $2.6 million gain on sale of non-marketable securities. Other income, net in 2011 primarily included $13.6 million of transition services income related to the external storage systems disposition.

Benefit from/ Provision for Income Taxes During 2012, we recorded an income tax benefit of $21.0 million, which represents an effective tax rate of approximately (12.0) % on our income before income taxes of $175.3 million. This rate differs from the U.S. statutory rate primarily due to the benefit realized from deferred tax assets not previously recognized in the U.S. and lower tax rates in foreign jurisdictions. The income tax benefit in 2012 included a tax benefit of approximately $42.4 million due to the release of valuation allowance resulting from the net deferred tax liabilities recorded as part of the SandForce purchase price allocation. The income tax benefit in 2012 also included a reversal of $18.9 million in liabilities for uncertain tax positions, which included previously unrecognized tax benefits of $9.4 million and interest and penalties of $9.5 million, as a result of the expiration of statutes of limitations in multiple jurisdictions.

Management continues to monitor the realizability of our deferred tax assets.

Historically, we have sustained losses from our U.S. operations, however, based on recent and projected trends of profitability, it is reasonably possible we will determine that a significant portion of our U.S. deferred tax assets are more likely than not to be realized in the foreseeable future.

28-------------------------------------------------------------------------------- Table of Contents The American Taxpayers Relief Act of 2012 was signed into law on January 2, 2013. The act retroactively extends research credits for a two year period beginning January 1, 2012 through December 31, 2013. The provisions of the act are not expected to have a material impact on our effective tax rate.

During 2011, we recorded an income tax provision of $3.8 million, which represents an effective tax rate of approximately 4% on our income before income taxes of $93.8 million. This rate differs from the U.S. statutory rate primarily due to the benefit realized from deferred tax assets not previously recognized in the U.S. and lower tax rates in foreign jurisdictions. In addition, the income in discontinued operations resulted in an intraperiod allocation of tax benefit of $11.7 million related to a loss in the domestic continuing operations for the year ended December 31, 2011. The income tax provision in 2011 included $24.2 million of additional accrual for uncertain tax positions, offset by a reversal of $18.1 million in liabilities for uncertain tax positions, which included interest and penalties as a result of the expiration of statutes of limitations in multiple jurisdictions.

During 2010, we recorded an income tax provision of $3.2 million, which represents an effective tax rate of approximately 9% on our income before income taxes of $37.6 million. This rate differs from the U.S. statutory rate primarily due to lower tax rates in foreign jurisdictions offset by certain foreign earnings taxed in the U.S. and an increase in valuation allowance against the U.S. deferred tax assets. The income tax provision in 2010 included $14.1 million of additional accrual for uncertain tax positions, offset by a reversal of $31.8 million in liabilities for uncertain tax positions, which included interest and penalties as a result of the expiration of statutes of limitations in multiple jurisdictions.

With the exception of certain foreign jurisdictions, we believe it is not more likely than not that the future benefit of deferred tax assets will be realized.

Discontinued Operations Discontinued operations consists of the external storage systems business that we sold in 2011. Following is selected financial information included in income from discontinued operations: Year Ended December 31, 2011 2010 (In millions) Revenues $ 210.6 $ 700.4 (Loss)/income before gain on sale of external storage systems business and income taxes $ (27.6 ) $ 7.8 Gain on sale of external storage systems business 260.1 - (Benefit from)/provision for income taxes (9.0 ) 2.2 Income from discontinued operations $ 241.5 $ 5.6 There was no income or loss from discontinued operations for the year ended December 31, 2012.

During the years ended December 31, 2011 and 2010, we recognized $40.9 million and $49.7 million, respectively, of restructuring expense as we terminated employees, closed several office locations, terminated contracts, discontinued various development projects and wrote off intangible assets and software due to the cancellation of development programs in connection with the exit of the external storage systems business. Further, we released $21.0 million of deferred tax liabilities related to tax deductible goodwill in connection with the sale of the external storage systems business in 2011, which is included in the $9.0 million benefit from income taxes.

FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY Cash, cash equivalents, short-term investments and cash generated from our operations are our primary source of liquidity. Short-term investments consist primarily of U.S. government and agency securities. We believe that our existing liquid resources and cash generated from operations will be adequate to meet our operating and capital requirements and other obligations for more than the next 12 months. We may, however, find it desirable to obtain additional debt or equity financing. Such financing may not be available to us at all or on acceptable terms if we determine that it would be desirable to obtain additional financing.

29 -------------------------------------------------------------------------------- Table of Contents Cash, cash equivalents and short-term investments decreased to $676.0 million as of December 31, 2012 from $935.5 million as of December 31, 2011. The decrease was mainly due to $319.2 million of cash used in connection with the acquisition of SandForce, net of cash acquired and cash outflows for other investing activities and financing activities, offset in part by cash inflows generated from operating activities, as described below.

Working Capital Working capital decreased by $251.9 million to $709.9 million as of December 31, 2012 from $961.8 million as of December 31, 2011. The decrease was primarily attributable to the following: • Cash, cash equivalents and short-term investments decreased by $259.5 million primarily due to $319.2 million used in connection with the acquisition of SandForce in January 2012, net of cash acquired, $272.6 million used to repurchase our common stock, and $129.1 million used for purchases of property and equipment, net of proceeds from sales, offset in part by net cash provided by operating activities of $374.2 million, and proceeds from issuances of common stock of $111.6 million; • Accounts payable increased by $34.6 million primarily due to an increase in inventory purchases and the timing of invoice receipts and payments; and • Accrued salaries, wages, and benefits increased by $22.6 million primarily as a result of the timing of payments for salaries and benefits and higher performance-based compensation as a result of improved financial performance and headcount additions.

These decreases in working capital were offset in part by the following: • Prepaid expenses and other current assets increased by $19.7 million primarily as a result of increases in prepaid licenses for intellectual property and technology, and an increase in deferred tax assets; • Inventories increased by $26.3 million as a result of increased inventory purchases to support new product introductions and higher revenues in 2012 as compared to 2011; and • Accounts receivable increased by $17.6 million primarily as a result of increased revenues in the fourth quarter of 2012 as compared to the fourth quarter of 2011.

Working capital increased by $182.6 million to $961.8 million as of December 31, 2011 from $779.2 million as of December 31, 2010. The increase was primarily attributable to the following: • Cash, cash equivalents and short-term investments increased by $258.8 million primarily due to $475.2 million of net proceeds from the sale of our external storage systems business and net cash provided by operating activities of $246.8 million, offset in part by the use of $498.8 million to repurchase our common stock; • Accrued salaries, wages and benefits decreased by $19.4 million primarily as a result of the sale of our external storage systems business and the timing of payments for salaries, benefits and performance-based compensation; and • Other accrued liabilities decreased by $5.6 million as a result of the sale of our external storage systems business.

These increases in working capital were offset in part by the following: • Accounts receivable decreased by $80.1 million primarily as a result of the sale of our external storage systems business; • Prepaid expenses and other current assets decreased by $13.1 million primarily due to the maturity of notes receivable associated with the sale of our Thailand assembly and test operations in 2007; and • Inventories decreased by $6.7 million primarily due to the sale of our external storage systems business and the write-down of inventories damaged as a result of the flooding in Thailand in late 2011, offset by higher inventory to support product demand.

30 -------------------------------------------------------------------------------- Table of Contents Cash Provided by Operating Activities During the year ended December 31, 2012, we generated $374.2 million of cash from operating activities as a result of the following: • Net income adjusted for non-cash items and other non-operating adjustments, which are quantified in our consolidated statements of cash flows included in Item 8; • Offset in part by a net decrease of $57.2 million in assets and liabilities, including changes in working capital components, from December 31, 2011 to December 31, 2012, as discussed above.

During the year ended December 31, 2011, we generated $246.8 million of cash from operating activities as a result of the following: • Net income adjusted for non-cash items and other non-operating adjustments, which are quantified in our consolidated statements of cash flows included in Item 8; • Offset in part by a net decrease of $68.3 million in assets and liabilities, including changes in working capital components, from December 31, 2010 to December 31, 2011, as discussed above.

During the year ended December 31, 2010, we generated $367.2 million of cash from operating activities as a result of the following: • Net income adjusted for non-cash items and other non-operating adjustments, which are quantified in our consolidated statements of cash flows included in Item 8; • Offset in part by a net decrease of $66.2 million in assets and liabilities, including changes in working capital components, from December 31, 2009 to December 31, 2010.

Cash Used in/Provided by Investing Activities Cash used in investing activities for the year ended December 31, 2012 was $520.1 million. Our investing activities during 2012 were the following: • $319.2 million of cash used in connection with the acquisition of SandForce; • Purchases of property and equipment, net of proceeds from sales, totaling $129.1 million, including $73.7 million for our new headquarters; and • Purchases of available-for-sale debt securities and other investments, net of proceeds from maturities and sales, of $71.8 million.

Cash provided by investing activities for the year ended December 31, 2011 was $430.3 million. Our investing activities during 2011 were the following: • Proceeds from the sale of our external storage systems business, net of transaction fees, of $475.2 million; • Purchases of property and equipment, net of proceeds from sales, totaling $37.4 million; • Purchases of available-for-sale debt securities and other investments, net of proceeds from maturities and sales, of $17.5 million; and • Proceeds of $10.0 million from the maturity of notes receivable associated with the sale of our Thailand assembly and test operations in 2007.

Cash used in investing activities for the year ended December 31, 2010 was $60.1 million. Our investing activities during 2010 were the following: • Purchases of property and equipment, net of proceeds from sales, totaling $91.5 million; • Proceeds from maturities and sales of available-for-sale debt and other investments, net of purchases, of $21.4 million; and • Proceeds of $10.0 million from the maturity of notes receivable associated with the sale of our Thailand assembly and test operations in 2007.

31 -------------------------------------------------------------------------------- Table of Contents We expect capital expenditures to be approximately $80 million in 2013. We use semiconductor foundries and outside assembly and test companies to manufacture products, which enables us to have access to advanced manufacturing capacity without having to increase our capital spending requirements.

Cash Used in Financing Activities Cash used in financing activities for the year ended December 31, 2012 was $161.0 million. This amount included $272.6 million to repurchase our common stock, offset in part by $111.6 million of cash received from issuances of common stock under our employee stock plans.

Cash used in financing activities for the year ended December 31, 2011 was $417.7 million. This amount included $498.8 million to repurchase our common stock, offset in part by proceeds of $81.0 million from issuances of common stock under our employee stock plans.

Cash used in financing activities for the year ended December 31, 2010 was $559.1 million. This amount included $350.0 million to repay our outstanding 4% Convertible Subordinated Notes upon their maturity in May 2010 and $249.9 million to repurchase our common stock, offset in part by proceeds of $40.9 million from issuances of common stock under our employee stock plans.

We do not currently pay any cash dividends to our stockholders.

CONTRACTUAL OBLIGATIONS The following table summarizes our contractual obligations as of December 31, 2012: Payments Due by Period Less Than 1 Year 1-3 Years 4-5 Years After 5 Years Other Total (In millions) Operating lease obligations $ 34.7 $ 32.0 $ 10.3 $ 5.5 $ - $ 82.5 Purchase commitments 310.9 29.9 7.2 - - 348.0 Pension contributions 51.7 * * * * 51.7 Uncertain tax positions - - - - 102.2 ** 102.2 Total $ 397.3 $ 61.9 $ 17.5 $ 5.5 $ 102.2 $ 584.4 * We have pension plans covering certain U.S. employees and international employees. Although additional future contributions will be required, the amount and timing of these contributions will be affected by actuarial assumptions, the actual rate of return on plan assets, the level of market interest rates, legislation changes and the amount of voluntary contributions to the plans. The amount shown in the table represents our planned contributions to our pension plans within a year. Because any contributions for 2014 and later will depend on the value of the plan assets in the future and thus are uncertain, we have not included any amounts for 2014 and beyond in the above table. As of December 31, 2012, our projected pension benefit obligation exceeded the fair value of our plan assets by $558.3 million. See Note 7 to our consolidated financial statements in Item 8.

** This amount represents the non-current tax payable obligation. We are unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority may occur.

Operating Lease Obligations We lease real estate and certain non-manufacturing equipment under non-cancelable operating leases. We also include non-cancelable obligations under certain software licensing arrangements in this category.

Purchase Commitments We maintain purchase commitments with certain suppliers, primarily for raw materials and manufacturing services and for some non-production items. Purchase commitments for inventory materials are generally restricted to a forecasted time horizon as mutually agreed upon between the parties. This forecasted time horizon can vary for different suppliers.

32-------------------------------------------------------------------------------- Table of Contents Uncertain Tax Positions As of December 31, 2012, we had $193.9 million of unrecognized tax benefits, for which we are unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority may occur. It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next 12 months. Such changes could occur based on the normal expiration of statutes of limitations or the possible conclusion of ongoing tax audits in various jurisdictions around the world. If those events occur within the next 12 months, we estimate that the unrecognized tax benefits, plus accrued interest and penalties, could decrease by up to $22.2 million.

Standby Letters of Credit We had outstanding obligations relating to standby letters of credit of $4.1 million and $3.5 million, respectively, as of December 31, 2012 and 2011.

Standby letters of credit are financial guarantees provided by third parties for leases, customs and certain self-insured risks. If the guarantees are called, we must reimburse the provider of the guarantee. The fair value of the letters of credit approximates the contract amounts. The standby letters of credit generally renew annually.

CRITICAL ACCOUNTING ESTIMATES The discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles, or GAAP, in the United States of America. Note 2 to our consolidated financial statements in Item 8 describes our significant accounting policies. The preparation of our consolidated financial statements requires estimates and assumptions that affect the reported amounts and disclosures.

We believe the following to be critical accounting estimates. They are important to the portrayal of our financial condition and results, and they require significant management judgment and estimates about matters that are inherently uncertain. As a result of the inherent uncertainty, there is a likelihood that materially different amounts would be reported under different conditions or using different assumptions. Although we believe that our judgments and estimates are reasonable, appropriate and correct, different amounts could have been reported if different estimates were made.

Stock-Based Compensation Determining the fair value of stock-based awards at the grant date requires considerable judgment, including estimating expected volatility, expected term and risk-free interest rate.

Stock Options: The fair value of each option grant is estimated as of the date of grant using a reduced-form calibrated binomial lattice model, or the lattice model. The lattice model requires the use of historical data for employee exercise behavior and the use of assumptions, including expected life, risk-free interest rate and expected stock price volatility over the term of our employee stock options. The expected life of employee stock options is affected by all of the underlying assumptions and calibration of our model. The risk-free interest rate assumption is based upon observed interest rates for constant maturity U.S. Treasury securities appropriate for the term of our employee stock options; however, this may not accurately reflect future interest rates.

We use an equally weighted combination of historical and implied volatilities as of the grant date. Although we believe that the equally weighted combination of historical and implied volatilities is more representative of future stock price trends than sole use of historical or implied volatilities, there is no way of accurately predicting the future stock price.

The lattice model estimates the probability of exercise by an employee as a function of two variables based on the entire history of exercises and cancellations for all past option grants made by us since our initial public offering. This estimate may not be a reliable indicator of future employee behavior.

33 -------------------------------------------------------------------------------- Table of Contents Forfeitures are estimated based on historical experience, which may not hold true in the future.

Our determination of the fair value of stock option awards on the date of grant using an option-pricing model is affected by our stock price as well as a number of highly complex and subjective assumptions. We use third-party consultants to assist in developing the assumptions used in, as well as calibrating, the lattice model. We are responsible for determining the assumptions used in estimating the fair value of our stock option awards. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because our employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management's opinion, the existing valuation models may not provide an accurate measure of the fair value of our employee stock options. Although the fair value of employee stock options is determined in accordance with the Financial Accounting Standards Board, or FASB, guidance using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Restricted Stock Units: The cost of service-based and performance-based restricted stock units is determined using the fair value of our common stock on the date of grant.

For performance-based restricted stock unit awards, we also consider the probability that those restricted stock units will vest. The vesting of performance-based restricted stock unit awards is contingent upon us meeting specified performance criteria and requires that the employee remain employed for a specified period of time.

Employee Stock Purchase Plan: Compensation expense for our employee stock purchase plan is calculated using the fair value of the employees' purchase rights under the Black-Scholes model.

This model requires the use of historical data for employee exercise behavior and the use of assumptions, including expected life, risk-free interest rate and expected stock price volatility. As such, it is subject to similar risks to those relating to stock options.

Inventory Valuation Methodology Inventories are valued at the lower of cost or market using the first-in, first-out, or FIFO, method. We write down our inventories for estimated obsolescence based upon assumptions about future demand and market conditions.

Inventory impairment charges create a new cost basis for inventory.

We balance the need to maintain strategic inventory levels to ensure competitive delivery performance to our customers with the risk of inventory obsolescence due to rapidly changing technology and customer requirements, product life-cycles, last-time buys at the end of supplier product runs and a shift of production to outsourcing. If actual demand or market conditions are less favorable than we project or our customers' demands fail to meet our projections, inventory write-downs may be required.

If market conditions are more favorable than expected, we could experience more favorable gross profit margins going forward as we sell inventory that was previously written down.

Valuation of Long-Lived Assets, Intangible Assets and Goodwill We have historically pursued the acquisition of businesses, which has resulted in the accumulation of a significant amount of goodwill and intangible assets.

We assess the impairment of long-lived assets and identified intangible assets whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We assess the impairment of goodwill annually or sooner if events or changes in circumstances indicate that the carrying value may not be recoverable. When we determine that there is an indicator that the carrying value of long-lived assets, identified intangibles or related goodwill may not be recoverable, we measure impairment based on estimates of future cash flows. Impairment of goodwill, if any, is measured based on an implied fair value model that determines the carrying value of goodwill.

34-------------------------------------------------------------------------------- Table of Contents To evaluate the recoverability of goodwill, we first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of any of our reporting units is less than its carrying amount. Our qualitative assessment of the recoverability of goodwill, whether performed annually or based on specific events or circumstances, considers various macroeconomic, industry-specific and company-specific factors. Those factors include: (i) severe adverse industry or economic trends; (ii) significant company-specific actions, including exiting an activity in conjunction with restructuring of operations; (iii) current, historical or projected deterioration of our financial performance; or (iv) a sustained decrease in our market capitalization below our net book value. After assessing the totality of events and circumstances, if we determine that it is not more likely than not that the fair value of any of our reporting units is less than its carrying amount, no further assessment is performed. If we determine that it is more likely than not that the fair value of any of our reporting units is less than its carrying amount, we calculate the fair value of that reporting unit and compare the fair value to the reporting unit's net book value. If the fair value of the reporting unit is greater than its net book value, there is no impairment. Otherwise, we calculate the implied fair value of goodwill by deducting the fair value of all tangible and intangible assets, excluding goodwill, of the reporting unit from the fair value of the reporting unit. The implied fair value of goodwill is compared to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss is recognized equal to the difference.

In determining the fair value of our reporting units, we rely solely on a discounted cash-flow analysis. We perform research and analyze peer multiples for comparison purposes, but we do not rely directly upon such data due to the lack of specific comparability between the peer companies and our reporting units. Instead we employ the peer multiple data as a general check on the results of our discounted cash-flow analysis. The material assumptions used in performing the discounted cash-flow analysis include forecasts of expected future cash flows, including elements such as revenues, cost of sales, operating expenses, tax expenses, working capital, investment and capital expenditures.

Key assumptions also include expected near- and long-term growth rates, as well as expected profitability levels and capital investment. Since the forecasted cash flows of the business, as well as those allocated to individual assets, need to be discounted to present value in order to arrive at estimates of fair value, discount rates must also be estimated and applied in the valuation models. These discount rates are based on estimates of a market weighted-average cost-of-capital for the reporting units, with adjustments made to account for the relative risk of individual assets valued.

Although we believe that our methods of evaluating goodwill impairment are reasonable, future changes in economic and other conditions could force us to take additional charges. Our next annual test for the impairment of goodwill is expected to be performed in the fourth quarter of 2013 or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable.

We assess the recoverability of our identified intangible assets based on management's estimates of undiscounted projected future operating cash flows compared to the net book value of the identified intangible assets. In cases where the net book value exceeds undiscounted projected future operating cash flows, impairment exists. The impairment charge is measured as the difference between the net book value of the identified intangible assets and the fair value of such assets. The fair value is determined using a discounted cash-flow approach for each asset grouping.

Restructuring Reserves We have recorded reserves/accruals for restructuring costs related to our restructuring of operations. The restructuring reserves include estimated payments to employees for severance, termination fees associated with leases and other contracts and selling costs associated with assets held for sale, and other costs related to the closure of facilities. The restructuring reserves are based upon management estimates at the time they are recorded. These estimates can change depending upon changes in facts and circumstances subsequent to when the original liability was recorded. For example, existing accruals for severance may be modified if employees are redeployed due to circumstances not foreseen when the original plans were initiated, accruals for outplacement services may not be fully utilized by former employees, and severance accruals could change for statutory reasons in countries other than the United States.

Accruals for facility leases under which we ceased using the benefits conveyed to us under the lease may change if market conditions for subleases change or if we later negotiate a termination of the lease.

35-------------------------------------------------------------------------------- Table of Contents Income Taxes The calculation of our tax liabilities involves the application of complex tax rules and regulations in multiple jurisdictions throughout the world. We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of deductions, benefits and tax credits, and in the calculation of specific tax assets and liabilities, which arise from differences in the timing of recognition of revenues and expenses for tax and financial statement purposes, as well as tax liabilities associated with uncertain tax positions. The calculation of tax liabilities involves uncertainties in the application of complex tax rules and the potential for future adjustment of our uncertain tax positions by various tax jurisdictions. Significant changes to these estimates may result in an increase or a decrease to our tax provision in a subsequent period. The deferred tax assets we record each period depend primarily on our ability to generate future taxable income in the United States and certain non-U.S. jurisdictions. Each period, we evaluate the need for a valuation allowance for our deferred tax assets and, if necessary, we adjust the valuation allowance so that net deferred tax assets will be realized. If our outlook for future taxable income changes significantly, our assessment of the need for a valuation allowance may also change. Historically, we have sustained losses from our U.S. operations, however, based on recent and projected trends of profitability, it is reasonably possible we will determine that a significant portion of our U.S. deferred tax assets are more likely than not to be realized in the foreseeable future.

Retirement Benefits Post-retirement assets and liabilities are estimates of benefits that we expect to pay to eligible retirees. We consider various factors in determining the value of our post-retirement net assets, including the number of employees that we expect to receive benefits and other actuarial assumptions.

For defined benefit pension plans, we consider various factors in determining our pension liability and net periodic benefit cost, including the number of employees that we expect to receive benefits, their salary levels and years of service, the expected return on plan assets, the discount rate, the timing of the payment of benefits, and other actuarial assumptions. If the actual results and events of our pension plans differ from our current assumptions, our benefit obligations may be over- or under-valued.

The key benefit plan assumptions are the discount rate and the expected rate of return on plan assets. The assumptions discussed below are for our U.S. retirement benefit plans. For our international plans, we chose assumptions specific to each country.

We base our discount rate estimates on a cash-flow analysis which considers externally published rate curves for periods approximating the expected duration of payments to be made under our plans. We base our salary increase assumptions on historical experience and future expectations. In developing the expected rate of return, we consider long-term compound annualized returns based on historical market data, historical and expected returns on the various categories of plan assets, and the target investment portfolio allocation among debt, equity securities and other investments.

For 2012, we used an expected rate of return on plan assets of 7.75% for our U.S. pension plans. For our U.S. post-retirement benefit plan, we used a weighted-average long-term rate of return on assets of 5.70%. For the U.S. plans, we used a calculated market-related value of assets, or MRVA, in determining the estimated return on plan assets. The MRVA smoothes the recognition of asset gains and losses over a five-year period. Because of this smoothing, the MRVA also affects the determination of amortization of gains or losses. As of December 31, 2012, the MRVA for the U.S. plans was $986.0 million, as compared to a fair value of $1,051.3 million. If we used the fair value, the net periodic benefit cost would decrease by $7.3 million for 2013.

Actuarial assumptions are based on our best estimates and judgment. Material changes may occur in retirement benefit costs in the future if these assumptions differ from actual events or experience. We performed a sensitivity analysis on the discount rate, which is the key assumption in calculating the pension and post-retirement benefit obligations. Each change of 25 basis points in the discount rate assumption would have had an estimated $48 million impact on the benefit obligation as of December 31, 2012. Each change of 25 basis points in the discount rate assumption and expected rate of return assumption would have an estimated decrease of $0.3 million and an increase of $2.5 million, respectively, on annual net retirement benefit costs for the year ending December 31, 2013.

36 -------------------------------------------------------------------------------- Table of Contents Fair Value Measurements GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (i.e., an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

We determine the estimated fair value of financial assets and liabilities using the market approach and the income approach as considered appropriate. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The income approach uses discounted cash flow models by considering market expectations about future cash flows and other inputs that are observable or can be corroborated by observable market data.

The fair value inputs are reviewed by management for reasonableness. These inputs may be further validated by comparison to publicly available information and could be adjusted based on market indices or other information that management deems material to their estimate of fair value. In the current market environment, the assessment of fair value can be difficult and subjective.

However, given the relative reliability of the inputs we use to value our investment portfolio, and because substantially all of our valuation inputs are obtained using quoted market prices for identical or similar assets, we do not believe that the nature of estimates and assumptions affected by levels of subjectivity and judgment is material to the valuation of our investment portfolio.

We do not estimate the fair value for a non-marketable investment unless there are identified events or changes in circumstances that may have a significant adverse effect on the investment. If management determines that any non-marketable investment is impaired, losses are generally measured by using pricing reflected in current rounds of financing.

Other than Temporary Impairment We recognize an impairment charge when declines in the fair values of our investments in debt and equity securities below their cost basis are judged to be other than temporary. We evaluate both qualitative and quantitative factors, such as duration and severity of the unrealized loss, credit ratings, prepayment speeds, default and loss rates of the underlying collateral, structure and credit enhancements, to determine if a credit loss may exist.

For investments in equity securities, to determine if impairment has occurred, we review the financial performance of each investee, industry performance and outlook for each investee, and the trading price of each marketable equity security. For non-marketable equity securities, we review recent financing activities of the investees, movements in equity value, venture capital markets, the investee's capital structure, liquidation preferences of the investee's capital and other economic variables. If an unrealized loss is determined to be other than temporary, a loss is recognized as a component of interest income and other, net in the consolidated statements of operations. For marketable equity securities, an impairment loss is measured using the closing trading price of the marketable security on the date management determines that the investment is impaired. For non-marketable equity securities, an impairment loss is generally measured by using pricing reflected in current rounds of financing. We do not estimate the fair value of a non-marketable equity investment unless there are identified events or changes in circumstances that may have a significant adverse effect on the investment.

RECENT ACCOUNTING PRONOUNCEMENTS The information contained in Note 2 to our financial statements in Part II, Item 8 under the heading "Recent Accounting Pronouncements" is incorporated by reference into this Part II, Item 7.

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