SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal quarter ended December 31, 2001

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                     .

Commission File Number: 000-23193

APPLIED MICRO CIRCUITS CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware	94-2586591
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

6290 Sequence Drive, San Diego, CA 92121

(Address of principal executive offices)

Registrant’s telephone number, including area code: (858) 450-9333

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.   Yes x   No ¨

As of January 21, 2002, 299,345,227 shares of the Registrant’s Common Stock were issued and outstanding.

APPLIED MICRO CIRCUITS CORPORATION

INDEX

		Page
Part I	FINANCIAL INFORMATION
Item 1.	a)   Condensed Consolidated Balance Sheets at December 31, 2001 (unaudited) and March 31, 2001	3
	b)   Condensed Consolidated Statements of Operations (unaudited) for the three and nine months ended December 31, 2001 and 2000	4
	c)   Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended December 31, 2001 and 2000	5
	d)   Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
Part II	OTHER INFORMATION
Item 1.	Legal Proceedings	28
Item 6.	Exhibits and Reports on Form 8-K	28
	Signatures	29

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PART I.    FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

	December 31, 2001			March 31, 2001
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	95,333		$	58,197
Short-term investments—available-for-sale		987,439			1,073,896
Accounts receivable, net of allowance for doubtful accounts—$5,345 and $4,575 at December 31, 2001 (unaudited) and March 31, 2001, respectively		18,201			83,892
Inventories		19,070			32,740
Deferred income taxes		27,597			27,597
Other current assets		30,731			24,775
Total current assets		1,178,371			1,301,097
Property and equipment, net		109,270			112,953
Purchased intangibles, net		646,459			4,008,440
Strategic equity and convertible debt investments, net		14,523			28,023
Other assets		1,229			2,765
Total assets	$	1,949,852		$	5,453,278
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	23,830		$	38,069
Accrued payroll and related expenses		14,889			17,868
Other accrued liabilities		32,856			30,583
Deferred revenue		2,023			5,087
Current portion of long-term debt		702			668
Current portion of capital lease obligations		500			596
Total current liabilities		74,800			92,871
Long-term debt, less current portion		685			1,216
Long-term capital lease obligations, less current portion		748			1,050
Deferred income taxes		52,494			120,040
Stockholders’ equity:
Preferred stock, $0.01 par value:
Authorized shares—2,000 at December 31, 2001, none issued and outstanding		—			—
Common stock, $0.01 par value:
Authorized shares—630,000 at December 31, 2001
Issued and outstanding shares—299,110 at December 31, 2001 (unaudited) and 299,822 at March 31, 2001		2,991			2,998
Additional paid-in capital		5,931,599			5,947,682
Deferred compensation, net		(238,501	)		(348,894	)
Accumulated other comprehensive income		6,583			2,438
Accumulated deficit		(3,881,500	)		(366,076	)
Notes receivable from stockholders		(47	)		(47	)
Total stockholders’ equity		1,821,125			5,238,101
Total liabilities and stockholders’ equity	$	1,949,852		$	5,453,278

See accompanying Notes to Condensed Consolidated Financial Statements.

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APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)

	Three Months Ended December 31,						Nine Months Ended December 31,
	2001			2000			2001			2000
Net revenues	$	40,220		$	143,269		$	122,728		$	314,464
Cost of revenues(1)		31,307			61,196			112,732			105,042
Gross profit		8,913			82,073			9,996			209,422
Operating expenses:
Research and development(1)		38,275			31,285			117,098			65,342
Selling, general and administrative(1)		18,277			20,498			58,069			45,731
Stock-based compensation(1)		36,793			35,954			110,379			36,698
Goodwill impairment charge		—			—			3,101,817			—
Amortization of goodwill and purchased intangibles		23,339			127,574			216,226			138,421
Acquired in-process research and development		—			176,700			—			202,100
Restructuring costs		200			—			11,377			—
Total operating expenses		116,884			392,011			3,614,966			488,292
Operating loss		(107,971	)		(309,938	)		(3,604,970	)		(278,870	)
Other income (expense), net		(401	)		—			(14,176	)		—
Interest income, net		10,840			14,771			37,665			40,513
Loss before income taxes		(97,532	)		(295,167	)		(3,581,481	)		(238,357	)
Income tax expense (benefit)		(16,231	)		(25,680	)		(66,057	)		4,120
Net loss	$	(81,301	)	$	(269,487	)	$	(3,515,424	)	$	(242,477	)
Basic loss per share:
Loss per share	$	(0.27	)	$	(0.95	)	$	(11.78	)	$	(0.94	)
Shares used in calculating basic loss per share		297,360			282,313			298,381			257,688
Diluted loss per share:
Loss per share	$	(0.27	)	$	(0.95	)	$	(11.78	)	$	(0.94	)
Shares used in calculating diluted loss per share		297,360			282,313			298,381			257,688
(1)  For presentation purposes, the functional line items exclude stock-based compensation charges related to acquired companies as follows (in thousands):
Cost of revenues	$	1,227		$	1,203		$	3,681		$	1,203
Research and development		18,370			18,122			55,105			18,708
Selling, general and administrative		17,196			16,629			51,593			16,787
Total stock-based compensation	$	36,793		$	35,954		$	110,379		$	36,698

See accompanying Notes to Condensed Consolidated Financial Statements.

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APPLIED MICRO CIRCUITS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

	Nine Months Ended December 31,
	2001			2000
Operating Activities:
Net loss	$	(3,515,424	)	$	(242,477	)
Adjustments to reconcile net loss to net cash provided by (used for) operating activities:
Depreciation and amortization		22,019			9,589
Amortization of purchased intangibles		259,982			149,118
Goodwill impairment charge		3,101,817			—
Acquired in-process research and development		—			202,100
Amortization of deferred compensation		110,393			36,807
Tax benefit of disqualifying dispositions		—			140,620
Noncash restructuring costs		8,727			—
Net loss on strategic equity investments		13,775			—
Net loss on asset disposal		401			—
Changes in assets and liabilities:
Accounts receivables		65,691			(45,411	)
Inventories		13,670			14,669
Other assets		(9,449	)		(6,166	)
Accounts payable		(14,239	)		13,447
Accrued payroll and other accrued liabilities		(706	)		20,225
Deferred income taxes		(67,364	)		(136,973	)
Deferred revenue		(3,064	)		741
Net cash provided by (used for) operating activities		(13,771	)		156,289
Investing Activities:
Proceeds from sales and maturities of investments		2,160,455			1,496,588
Purchase of investments		(2,069,866	)		(1,750,830	)
Proceeds from sales of equity investments		2,902			—
Notes receivable from officers and employees		100			16
Cash received from purchase acquisitions, net of cash paid and merger expenses		—			13,970
Purchase of property and equipment		(25,711	)		(38,149	)
Net cash provided by (used for) investing activities		67,880			(278,405	)
Financing Activities:
Proceeds from issuance of common stock, net		13,339			43,909
Repurchase of Company stock		(29,428	)		(56	)
Payments on notes receivable from stockholders		—			455
Payments on capital lease obligations		(398	)		(579	)
Payments on long-term debt		(497	)		(2,948	)
Other		11			(20	)
Net cash provided by (used for) financing activities		(16,973	)		40,761
Net increase (decrease) in cash and cash equivalents		37,136			(81,355	)
Cash and cash equivalents at beginning of period		58,197			170,102
Cash and cash equivalents at end of period	$	95,333		$	88,747
Supplemental disclosure of cash flow information:
Cash paid for:
Interest	$	163		$	340
Income taxes	$	743		$	3,796

See accompanying Notes to Condensed Consolidated Financial Statements.

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APPLIED MICRO CIRCUITS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1.    BASIS OF PRESENTATION—INTERIM FINANCIAL INFORMATION (UNAUDITED)

The accompanying unaudited interim condensed consolidated financial statements of Applied Micro Circuits Corporation (“AMCC” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. The accompanying financial statements reflect all adjustments (consisting of normal recurring accruals), which are, in the opinion of management, considered necessary for a fair presentation of the results for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The Company has experienced significant quarterly fluctuations in net revenues and operating results, and expects that these fluctuations in sales, expenses and net income or losses will continue.

The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. These estimates include assessing the collectability of accounts receivable, the use and recoverability of inventory, costs of future product returns under warranty and provisions for contingencies expected to be incurred. Actual results could differ from those estimates.

The financial statements and related disclosures have been prepared with the presumption that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year. Accordingly, these financial statements should be read in conjunction with the audited financial statements and the related notes thereto contained in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended March 31, 2001.

Certain prior period amounts have been reclassified to conform to the current period presentation.

2.    LOSS PER SHARE

The computation of basic and diluted loss per share consists of the following (in thousands, except per share data):

	Three Months Ended December 31,						Nine Months Ended December 31,
	2001			2000			2001			2000
Shares used in basic and diluted loss per share computations—weighted average common shares outstanding		297,360			282,313			298,381			257,688
Net loss	$	(81,301	)	$	(269,487	)	$	(3,515,424	)	$	(242,477	)
Basic and diluted loss per share	$	(0.27	)	$	(0.95	)	$	(11.78	)	$	(0.94	)

Because the Company incurred losses for the three and nine months ended December 31, 2001 and 2000, the effect of dilutive securities has been excluded from the loss per share computation as its impact would be antidilutive. The dilutive securities (in thousands) totaled 8,297 and 10,502 equivalent shares for the three and nine months ended December 31, 2001, respectively, and 23,478 and 23,229 equivalent shares for the three and nine months ended December 31, 2000, respectively.

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3.    CERTAIN FINANCIAL STATEMENT INFORMATION

	December 31, 2001			March 31, 2001
Inventories (in thousands):
Finished goods	$	6,123		$	16,363
Work in process		12,221			14,560
Raw materials		726			1,817
	$	19,070		$	32,740
	December 31, 2001			March 31, 2001
Property and equipment (in thousands):
Machinery and equipment	$	79,443		$	70,358
Leasehold improvements		17,021			18,292
Computers, office furniture and equipment		80,434			73,181
Land		22,160			22,122
		199,058			183,953
Less accumulated depreciation and amortization		(89,788	)		(71,000	)
	$	109,270		$	112,953

Net goodwill and other acquisition-related intangibles were as follows (dollar amounts in thousands):

	Life in Years	December 31, 2001		March 31, 2001
Goodwill	1–6	$	396,950	$	3,708,191
Developed core technology	5		224,676		268,836
Other purchased intangibles	3–5		24,833		31,413
		$	646,459	$	4,008,440

Other purchased intangibles include items such as trademarks and workforce-in-place. Total intangibles are net of accumulated amortization and impairment charges of $3,695.9 million and $334.1 million at December 31, 2001 and March 31, 2001, respectively.

Amortization of goodwill and purchased intangibles, including amounts charged to cost of revenues, was $37.9 million and $260.0 million for the three and nine months ended December 31, 2001, respectively. In addition, as a result of industry conditions and lower market valuations, the Company determined that there were indicators of impairment to the carrying value of the goodwill and purchased intangibles. Based on a review and independent valuation, the Company recorded a charge of $3.1 billion in the nine months ended December 31, 2001 to write down the value of intangible assets associated with its purchase acquisitions.

In the nine months ended December 31, 2001, the Company realized a gain on its strategic equity investments of $1.2 million. This gain was offset by $15.0 million of recognized impairments and certain losses on fixed asset disposals.

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4.    COMPREHENSIVE LOSS

The components of comprehensive loss, net of tax, are as follows (in thousands):

	Three Months Ended December 31,						Nine Months Ended December 31,
	2001			2000			2001			2000
Net loss	$	(81,301	)	$	(269,487	)	$	(3,515,424	)	$	(242,477	)
Change in net unrealized gain (loss) on available-for-sale investments		(851	)		645			4,132			1,316
Foreign currency translation adjustment		(1	)		(3	)		13			(21	)
Comprehensive loss	$	(82,153	)	$	(268,845	)	$	(3,511,279	)	$	(241,182	)

5.    RESTRUCTURING COSTS

As a result of continuing weak industry conditions, the Company announced a restructuring plan in July 2001. The plan includes reducing the overall cost structure of the Company and aligning manufacturing capacity with demand. Restructuring costs of $200,000 and $11.4 million were recognized as operating expense in the three and nine months ended December 31, 2001, respectively.

The restructuring plan is comprised of the following components:

Workforce reduction—The Company is continuing to implement its workforce reduction plan, which has resulted in workforce reduction charges of approximately $200,000 and $700,000 in the three and nine months ended December 31, 2001, respectively. The charges primarily related to severance and benefits for terminated employees.

Consolidation of excess facilities—As a result of the Company’s acquisitions and significant internal growth in fiscal 2001, the Company expanded its number of locations throughout the world. In an effort to improve the efficiency of the workforce and reduce the Company’s cost structure, the Company has implemented a plan to consolidate its workforce into certain designated facilities. As a result, a charge of approximately $2.0 million was recognized in the second quarter primarily relating to non-cancelable lease commitments.

Property and equipment impairments—During fiscal 2000 and 2001, the Company aggressively expanded its manufacturing capacity in order to meet demand. As a result of the sharp decrease in demand in fiscal 2002, the Company recorded a charge of approximately $5.6 million in the second quarter for the elimination of certain excess manufacturing equipment related to its older process technologies. In addition, the company recorded a charge of approximately $3.1 million in the second quarter relating to the abandonment of certain leasehold improvements and software licenses in connection with the restructuring plan.

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A summary of the restructuring costs for the nine months ended December 31, 2001 is as follows (in thousands):

	Total Costs		Noncash Charges			Cash Payments			Liability, December 31, 2001
Workforce reduction	$	700	$	—		$	(593	)	$	107
Consolidation of excess facilities		1,950		—			(329	)		1,621
Property and equipment impairments		8,727		(8,727	)		—			—
Total restructuring costs	$	11,377	$	(8,727	)	$	(922	)	$	1,728

Remaining expenditures relating to workforce reductions and payments in conjunction with restructuring activities will be substantially paid by the end of fiscal 2002. Amounts related to expense due to the consolidation of facilities will be paid over the respective lease terms through fiscal 2006. The Company’s estimated costs to exit these facilities are based on available commercial rates and an estimate of the time required to sublet the facilities. The actual loss incurred in exiting these facilities may differ from the Company’s estimates.

6.    STOCK REPURCHASE

On September 17, 2001, the Company’s Board of Directors approved a stock repurchase program whereby the Company is authorized to purchase up to $200 million in shares of its common stock over the next 12 months. Through December 31, 2001, the Company had repurchased and retired 3,630,000 shares for approximately $29.4 million.

7.    CONTINGENCIES

The Company is party to various claims and legal actions arising in the normal course of business, including notification of possible infringement on the intellectual property rights of third parties.

Starting in April 2001, a series of similar federal complaints were filed against the Company and its chief executive officer, chief financial officer and certain other officers and directors of the Company. These complaints allege essentially identical violations of the Securities Exchange Act of 1934 (the “1934 Act”). The complaints have been brought as purported shareholder class actions under Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5 promulgated thereunder and seek unspecified monetary damages on behalf of the shareholder class. In general, the complaints allege that the Company and the individual defendants misrepresented the Company’s financial prospects for the fourth quarter of fiscal 2001 to inflate the value of the Company’s stock. The complaints have been consolidated into a single proceeding in the United States District Court for the Southern District of California (the “Federal Action”). An amended consolidated complaint is scheduled to be filed in the fourth fiscal quarter of fiscal 2002. The Company intends to file several motions seeking a dismissal of the Federal Action on various grounds. A briefing and hearing schedule has been set for these motions, which the Company expects will be heard and decided in the first or second quarter of fiscal 2003.

In May 2001, certain individuals filed derivative actions against the directors and certain executive officers in the California state courts. These state court derivative complaints allege overstatement of the financial prospects of the Company, mismanagement, inflation of stock value, and sale of stock at inflated prices for personal gain during the period from November 7, 2000 until February 5, 2001. The three state court derivative actions have been consolidated and assigned to the San Diego Superior Court (the “State Action”) and a consolidated derivative complaint was filed in December 2001. The Company has filed several motions seeking a

9

dismissal of the State Action on various grounds. In the alternative, the Company is also seeking to stay the State Action pending resolution of the Federal Action. A hearing and decision on the Company’s motions is expected to occur in the fourth quarter of fiscal 2002.

No discovery has been conducted in either the Federal Action or the State Action. The Company believes that the allegations in these actions are without merit and intends to defend the actions vigorously. The Company cannot predict the likely outcome of these actions, and an adverse result in either action could have a materially adverse effect on the Company. The actions have been tendered to the Company’s insurance carriers.

Since 1993, the Company has been named as a potentially responsible party (“PRP”) along with a large number of other companies that used Omega Chemical Corporation (“Omega”) in Whittier, California to handle and dispose of certain hazardous waste material. The Company is a member of a large group of PRPs that has agreed to fund certain remediation efforts at the Omega site for which the Company has accrued approximately $100,000. On September 14, 2000, the Company entered into a consent decree with the Environmental Protection Agency, pursuant to which the Company agreed to fund its proportionate share of the initial remediation efforts at the Whittier site. Although the ultimate outcome of these matters is not presently determinable, the Company believes that the resolution of all such pending matters, net of amounts accrued, will not have a material adverse effect on the Company’s financial position or liquidity; however, there can be no assurance that the ultimate resolution of these matters will not have a material impact on the Company’s results of operations in any period.

8.    NEW ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations (“FAS 141”) and No. 142, Goodwill and Other Intangible Assets (“FAS 142”). FAS 141 requires all business combinations initiated after June 30, 2001 to be accounted for using the purchase method. Under FAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed periodically for impairment. Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt FAS 142 effective April 1, 2002. The amortization provisions of FAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. For the three months ended December 31, 2001, the Company recorded a total of $37.9 million of amortization of goodwill and purchased intangibles. If the Company had given effect to the provisions of FAS 142, the resulting amortization for the three months ended December 31, 2001 would have been $15.9 million.

9.    STOCK OPTION EXCHANGE OFFER

On November 27, 2001, the Company completed the offering of a voluntary stock option exchange program to its employees, officers and board members. Under the program, participants were able to tender for cancellation stock options with an exercise price equal to or greater than $20 per share for replacement options to be granted on May 28, 2002 under certain terms & conditions as set forth in the Company’s offer. The exercise price of the replacement options will be equal to 100 percent of the market price of AMCC common stock on that date. The terms and conditions of the replacement options, including the vesting schedules, will be substantially the same as the terms and conditions of the options cancelled. The Company accepted options to purchase approximately 31.1 million shares of Company stock for exchange pursuant to this program.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the Consolidated Financial Statements and the notes thereto and with Management’s Discussion and Analysis of Financial Condition and Results of Operations that are included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2001. This Quarterly Report on Form 10-Q, and in particular Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements regarding future events or the future performance of the Company that involve certain risks and uncertainties including those discussed in “Risk Factors” below. Actual events or the actual future results of the Company may differ materially from any forward-looking statements due to such risks and uncertainties. Readers are cautioned not to place reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. The Company assumes no obligation to update these forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements.

Overview

We design, develop, manufacture and market high-performance, high-bandwidth silicon solutions empowering intelligent optical networks. We utilize a combination of digital, mixed-signal and high-frequency analog design expertise coupled with system-level knowledge and multiple silicon process technologies to offer integrated circuit (“IC”) products that enable the transport of voice and data over fiber optic networks. Our products target the Synchronous Optical Network (“SONET”), Synchronous Digital Hierarchy (“SDH”), Asynchronous Transfer Mode (“ATM”), Dense Wave Division Multiplexing (“DWDM”), Gigabit Ethernet and Fibre Channel semiconductor markets. We provide our customers with complete silicon IC solutions including higher layer processors such as network processors and switch fabrics, framer layer products such as framers and mappers, physical layer (“PHY”) products such as transceivers, and physical media dependent (“PMD”) devices such as laser drivers. Our products currently target data rates up to 40 gigabits per second.

Although we have focused our business and operations on communications markets, we continue to supply silicon ICs for the ATE, high-speed computing and military markets as well.

Results of Operations

Net Revenues.    Net revenues for the three and nine months ended December 31, 2001 were $40.2 million and $122.7 million, respectively, a decrease of 71.9% and 61.0% from net revenues of $143.3 million and $314.5 million for the three and nine months ended December 31, 2000, respectively. Revenues from sales of communications products decreased to 77.4% and 83.8% of net revenues for the three and nine months ended December 31, 2001 from 91.3% and 86.7% of net revenues for the three and nine months ended December 31, 2000.

Based on direct shipments, net revenues to customers exceeding 10% of net revenues were as follows:

	Three Months Ended December 31,				Nine Months Ended December 31,
	2001		2000		2001		2000
Insight	21	%	21	%	12	%	19	%

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Looking through product shipments to distributors and subcontractors, net revenues on an end-customer basis exceeding 10% of net revenues were as follows:

	Three Months Ended December 31,				Nine Months Ended December 31,
	2001		2000		2001		2000
Cisco	12	%	10	%	11	%	7	%
Nortel	9	%	18	%	11	%	23	%

Sales outside of North America accounted for 25.4% and 35.0% of net revenues for the three and nine months ended December 31, 2001, respectively, compared to 18.7% and 17.6% for the three and nine months ended December 31, 2000, respectively.

Gross Margin.    Gross margin was 22.2% and 8.1% for the three and nine months ended December 31, 2001, respectively, compared to 57.3% and 66.6% for the three and nine months ended December 31, 2000, respectively. The gross margin for the three and nine months ended December 31, 2001 was adversely affected by the recurring developed core technology amortization charge of $14.6 million per quarter and a special charge for excess and obsolete inventory of $15.9 million in the three months ended June 30, 2001. The gross margin for the three and nine months ended December 31, 2000 was adversely affected by a $16.1 million purchase accounting charge based on an increase in the value of the MMC inventory as of the acquisition date, as well as $10.7 million of developed core technology amortization. Excluding the effect of these items, gross profit was 58.4% and 56.7% for the three and nine months ended December 31, 2001, and 76.0% and 75.1% for the three and nine months ended December 31, 2000. The decrease in gross margin, exclusive of recurring amortization charges and one time charges, reflects the under-utilization of our manufacturing facilities as a result of the continued softness in demand for our products.

Research and Development.    Research and development (“R&D”) expenses were approximately $38.3 million, or 95.2% of net revenues, and $117.1 million, or 95.4% of net revenues, for the three and nine months ended December 31, 2001, as compared to approximately $31.3 million, or 21.8% of net revenues, and $65.3 million, or 20.8% of net revenues, for the three and nine months ended December 31, 2000. The year over year increase relates to new product and process development efforts, investments made in new design tools for the development of new products and an increase in personnel costs as a result of acquisitions and internal hiring of R&D personnel. We expect R&D expenses to decrease modestly in the fourth quarter of fiscal 2002 when compared to the third quarter of fiscal 2002, as we continue to streamline our cost structure. We believe that a continued commitment to R&D is vital to maintain a leadership position with innovative communications products. Our R&D expenses are concentrated on the development of products for the communications markets, and we expect to continue this focus.

Selling, General and Administrative.    Selling, general and administrative (“SG&A”) expenses were approximately $18.3 million, or 45.4% of net revenues, and $58.1 million, or 47.3% of net revenues, for the three and nine months ended December 31, 2001, as compared to approximately $20.5 million, or 14.3% of net revenues, and $45.7 million, or 14.5% of net revenues, for the three and nine months ended December 31, 2000. The year over year increase in SG&A expenses was attributable to investments made in our corporate infrastructure, an increase in the size of our sales force as a result of acquisitions and additional marketing investments associated with the introduction of new products. In aggregate dollar terms, we expect SG&A expenses to decrease modestly in the fourth quarter of fiscal 2002 when compared to the third quarter of fiscal 2002, as we continue to streamline our cost structure.

Stock-based Compensation.    Stock-based compensation charges were $36.8 million and $110.4 million for the three and nine months ended December 31, 2001, respectively, compared to $36.0 million and $36.7 million for the three and nine months ended December 31, 2000, respectively. The increase is directly related to our prior year acquisitions. We expect to record future amortization of deferred compensation of approximately

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$147.2 million, $134.1 million, $63.5 million and $4.1 million during the fiscal years ending March 31, 2002, 2003, 2004 and 2005, respectively. The actual charges could be reduced based on the level of employee turnover or future acquisitions of businesses may result in substantial additional charges.

Goodwill Impairment Charge.    As a result of industry conditions, lower market valuations and reduced estimates of carrier capital equipment spending in the future, we determined that there were indicators of impairment to the carrying value of our goodwill and purchased intangibles. Based on our review and an independent valuation, we recorded a charge of $3.1 billion in the three months ended June 30, 2001 to write down the value of intangible assets associated with our purchase acquisitions.

Amortization of Goodwill and Purchased Intangibles.    Excluding the amortization of developed core technology included in cost of revenues, amortization of goodwill and purchased intangible assets was $23.3 million and $216.2 million for the three and nine months ended December 31, 2001, respectively, as compared to $127.6 million and $138.4 million for the three and nine months ended December 31, 2000. These charges are related to fiscal 2001 acquisitions. We expect the total amortization expense of goodwill and purchased intangibles, exclusive of developed core technology included in cost of revenues, to be approximately $239.6 million for fiscal 2002. As a result of our adoption of FAS 142 effective April 1, 2002 for periods after fiscal 2002, we will no longer be required to amortize goodwill and certain other intangibles. However, we will continue to amortize certain purchased intangibles other than goodwill. There can be no assurance that acquisitions of businesses by us in the future will not result in substantial changes to the expected amortization of intangible assets that will be amortized in accordance with FAS 142, which may cause fluctuations in our interim and annual operating results.

Restructuring Charge.    As a result of industry conditions, the Company announced a restructuring plan in July 2001. The plan includes reducing the overall cost structure of the Company and aligning manufacturing capacity with current demand. Restructuring costs of approximately $200,000 and $11.4 million were recognized as an operating expense in the three and nine months ended December 31, 2001, respectively.

The restructuring plan is comprised of the following components:

• Workforce reduction—The Company is continuing to implement its workforce reduction plan, which has resulted in workforce reduction charges of approximately $200,000 and $700,000 in the three and nine months ended December 31, 2001.

• Consolidation of excess facilities—As a result of the Company’s acquisitions and significant internal growth in fiscal 2001, the Company expanded its number of locations throughout the world. In an effort to improve the efficiency of the workforce and reduce the Company’s cost structure, the Company has implemented a plan to consolidate its workforce into certain designated facilities. As a result, a charge of approximately $2.0 million was recognized in the three months ended September 30, 2001 primarily relating to non-cancelable lease commitments.

• Property and equipment impairments—During fiscal 2000 and 2001, the Company aggressively expanded its manufacturing capacity in order to meet demand. As a result of the sharp decrease in demand in fiscal 2002, the Company recorded a charge of approximately $5.6 million in three months ended September 30, 2001 for the elimination of certain excess manufacturing equipment related to its older process technologies. In addition, the company recorded a charge of approximately $3.1 million in the three months ended September 30, 2001 relating to the abandonment of certain leasehold improvements and software licenses in connection with the restructuring plan.

Remaining expenditures relating to workforce reductions and payments in conjunction with restructuring activities will be substantially paid by the end of fiscal 2002. Amounts related to expense due to the consolidation of facilities will be paid over the respective lease terms through fiscal 2006. The Company’s estimated costs to exit these facilities are based on available commercial rates and an estimate of the time required to sublet the facilities. The actual loss incurred in exiting these facilities may differ from the Company’s estimates.

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Net Interest Income.    Net interest income was $10.8 million and $37.7 million for the three and nine months ended December 31, 2001, respectively, as compared to $14.8 million and $40.5 million for the three and nine months ended December 31, 2000.

Other Income (Expense).    Other income (expense) includes a gain on our strategic equity investments of $1.2 million, an impairment charge of $15 million and certain losses on fixed asset disposals.

Income Taxes.    Income taxes for the three and nine months ended December 31, 2001 differed from statutory rates because we are establishing valuation allowances for the net operating loss carryforwards and tax credits which are being generated in the current year.

Liquidity and Capital Resources

Our financial condition remains strong. Our principal source of liquidity as of December 31, 2001 consists of $1.1 billion in cash, cash equivalents and short-term investments. Working capital as of December 31, 2001 was $1.1 billion, slightly decreasing from $1.2 billion at March 31, 2001.

For the nine months ended December 31, 2001 and 2000, net cash from operations was $(13.8) million and $156.3 million, respectively. Net cash used for operations for the nine months ended December 31, 2001 primarily reflected the net operating loss before depreciation and amortization and an increase in other assets.

Capital expenditures totaled $25.7 million and $38.1 million for the nine months ended December 31, 2001 and 2000, respectively, which primarily consisted of the purchase of engineering hardware and design software, and manufacturing and test equipment.

On September 17, 2001, the Company’s Board of Directors approved a stock repurchase program whereby the Company is authorized to purchase up to $200 million in shares of its common stock over the next 12 months. Through December 31, 2001, the Company had repurchased and retired 3,630,000 shares for approximately $29.4 million.

We believe that our available cash, cash equivalents and short-term investments, and cash generated from operations will be sufficient to meet our capital requirements for at least the next 12 months, although we could elect or could be required to raise additional capital during such period. There can be no assurance that such additional debt or equity financing will be available on commercially reasonable terms.

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RISK FACTORS

Our operating results may fluctuate because of a number of factors, many of which are beyond our control.

If our operating results are below the expectations of public market analysts or investors, then the market price of our common stock could decline. Some of the factors that affect our quarterly and annual results, but which are difficult to control or predict are:

• the reduction, rescheduling or cancellation of orders by customers, whether as a result of slowing demand for our customers’ products, stockpiling of our products or otherwise;

• fluctuations in the timing and amount of customer requests for product shipments;

• the availability of external foundry capacity, purchased parts and raw materials;

• increases in the costs of products or discontinuance of products by suppliers;

• fluctuations in product life cycles;

• fluctuations in manufacturing output, yields and inventory levels or other potential problems or delays in the fabrication, assembly, testing or delivery of our products;

• changes in the mix of products that our customers buy;

• our ability to introduce new products and technologies on a timely basis;

• the announcement or introduction of products and technologies by our competitors;

• competitive pressures on selling prices;

• market acceptance of our products and our customers’ products;

• the amounts and timing of costs associated with warranties and product returns;

• the amounts and timing of investments in research and development;

• the amounts and timing of the costs associated with payroll taxes related to stock option exercises;

• costs associated with acquisitions and the integration of acquired companies;

• costs associated with compliance with applicable environmental regulations or remediation;

• costs associated with litigation, including without limitation, litigation or settlements relating to the use or ownership of intellectual property or the pending litigation against us and certain of our executive officers and directors alleging violations of federal securities laws and various state claims;

• the ability of our customers to obtain components from their other suppliers;

• general communications equipment industry and semiconductor industry conditions;

• the effects of war or acts of terrorism, such as disruptions in general economic activity, changes in logistics and security arrangements, and reduced customer demand for our products and services; and

• general economic conditions.

Our business, financial condition and operating results would be harmed if we do not achieve anticipated revenues.

We can have revenue shortfalls for a variety of reasons, including:

• a decrease in demand for our customers’ products;

• a stockpiling of our products by our customers resulting in a reduction in their order patterns as they work through the excess inventory of our products;

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• the reduction, rescheduling or cancellation of customer orders;

• significant pricing pressures that occur because of declines in average selling prices over the life of a product;

• sudden shortages of raw materials or production capacity constraints that lead our suppliers to allocate available supplies or capacity to customers with resources greater than us and, in turn, interrupt our ability to meet our production obligations;

• delays in product availability; and

• fabrication, test or assembly capacity constraints for devices which interrupt our ability to meet our production obligations.

Our business is characterized by short-term orders and shipment schedules. Customer orders typically can be canceled or rescheduled without significant penalty to the customer. Because we do not have substantial noncancellable backlog, we typically plan our production and inventory levels based on internal forecasts of customer demand which are highly unpredictable and can fluctuate substantially. Our revenues are increasingly derived from sales of application specific standard products, or ASSPs, as compared to application specific integrated circuits, or ASICs. Customer orders for ASSPs typically have shorter lead times than orders for ASICs, which makes it more difficult for us to predict revenues and inventory levels and adjust production appropriately. If we are unable to plan inventory and production levels effectively, our business, financial condition and operating results could be materially harmed.

From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside suppliers and foundries, we may order materials in advance of anticipated customer demand. This advance ordering has in the past and may in the future result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize, or other factors render our customers’ products less marketable.

Our expense levels are relatively fixed and are based, in part, on our expectations of future revenues. We have limited ability to reduce expenses quickly in response to any revenue shortfalls.

The downturn in the communications equipment industry has negatively impacted our revenues and profitability.

We derive substantially all of our revenues from communications equipment manufacturers. The communications equipment industry, which is highly cyclical, is experiencing a significant downturn. This downturn has severely affected the demand for our products. We cannot predict how long this downturn will last. In addition, our need to continue investment in research and development during this downturn and to maintain extensive ongoing customer service and support capability, constrains our ability to reduce expenses.

Our business substantially depends upon the continued growth of the Internet.

A substantial portion of our business and revenue depends on the continued growth of the Internet. We sell our products primarily to communications equipment manufacturers that in turn sell their equipment to customers that depend on the growth of the Internet. As a result of the economic slowdown and the reduction in capital spending, spending on Internet infrastructure has declined. To the extent that the economic slowdown and reduction in capital spending continue to adversely affect spending on Internet infrastructure, our business, operating results, and financial condition will continue to be materially harmed.

Our customers are concentrated. The loss of one or more key customers or the diminished demand for our products from a key customer could significantly reduce our revenues and profits.

A relatively small number of customers have accounted for a significant portion of our revenues in any particular period. We have no long-term volume purchase commitments from any of our major customers. Many

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of our key customers have announced dramatic declines in demand for their products into which our products are incorporated. As a result, new orders from their customers have been deferred, and customers may have overstocked our products. Continued reductions, delays and cancellation of orders from our significant customers or the loss of one or more key customers could significantly further reduce our revenues and profits. We cannot assure you that our current customers will continue to place orders with us, that orders by existing customers will continue at current or historical levels or that we will be able to obtain orders from new customers.

Our ability to maintain or increase sales to key customers and attract new significant customers is subject to a variety of factors, including:

• customers may stop incorporating our products into their own products with limited notice to us and may suffer little or no penalty;

• customers or prospective customers may not incorporate our products in their future product designs;

• design wins with customers may not result in sales to such customers;

• the introduction of a customer’s new products may be late or less successful in the market than planned;

• a customer’s product line using our products may rapidly decline or be phased out;

• agreements with customers typically do not require them to purchase a minimum amount of our products;

• many of our customers have pre-existing relationships with current or potential competitors that may cause them to switch from our products to competing products;

• we may not be able to successfully develop relationships with additional network equipment vendors; and

• our relationship with some of our larger customers may deter other potential customers (who compete with these customers) from buying our products.

Any one of the factors above could have a material adverse effect on our business, financial condition and results of operations.

An important part of our strategy is to continue our focus on the markets for high-speed communications ICs. If we are unable to expand our share of these markets further, our revenues may not grow and could decline.

Our markets frequently undergo transitions in which products rapidly incorporate new features and performance standards on an industry-wide basis. If our products are unable to support the new features or performance levels required by OEMs in these markets, we would be likely to lose business from an existing or potential customer and, moreover, would not have the opportunity to compete for new design wins until the next product transition occurs. If we fail to develop products with required features or performance standards, or if we experience a delay as short as a few months in bringing a new product to market, or if our customers fail to achieve market acceptance of their products, our revenues could be significantly reduced for a substantial period.

A significant portion of our revenues in recent periods has been, and is expected to continue to be, derived from sales of products based on SONET, SDH, ATM and DWDM transmission standards. If the communications market evolves to new standards, we may not be able to successfully design and manufacture new products that address the needs of our customers or gain substantial market acceptance. Although we have developed products for the Gigabit Ethernet and Fibre Channel communications standards, sales volumes of these products are modest, and we may not be successful in addressing the market opportunities for products based on these standards.

Customers for network processors generally have substantial technological capabilities and financial resources. They traditionally use these resources to internally develop the ASIC components and develop programs for the general-purpose processors utilized in our network processor products. Our future prospects are

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dependent upon our customers’ acceptance of network processors as an alternative to ASIC components and general-purpose processors. Future prospects also are dependent upon acceptance of third-party sourcing for network processors as an alternative to in-house development. Network equipment vendors may in the future continue to use internally developed ASIC components and general-purpose processors. They also may decide to develop or acquire components, technologies or network processors that are similar to, or that may be substituted for, our network processor products.

If our network equipment vendor customers fail to accept network processors as an alternative, if they develop or acquire the technology to develop such components internally rather than purchase our network processor products, or if we are otherwise unable to develop strong relationships with network equipment vendors, our business, financial condition and results of operations would be materially and adversely affected.

Our industry is subject to consolidation.

There has been a trend toward industry consolidation among communications IC companies for several years. We expect this trend toward industry consolidation to continue as communications IC companies attempt to strengthen or hold their positions in evolving markets. Consolidation may result in stronger competitors, which in turn could have a material adverse effect on our business, operating results, and financial condition.

Our operating results are subject to fluctuations because we rely heavily on international sales.

International sales account for a significant part of our revenues and may account for an increasing portion of our future revenues. As a result, an increasing portion of our revenues may be subject to certain risks, including:

• foreign currency exchange fluctuations;

• changes in regulatory requirements;

• tariffs and other barriers;

• timing and availability of export licenses;

• political and economic instability;

• difficulties in accounts receivable collections;

• difficulties in staffing and managing foreign subsidiary operations;

• difficulties in managing distributors;

• difficulties in obtaining governmental approvals for communications and other products;

• the burden of complying with a wide variety of complex foreign laws and treaties; and

• potentially adverse tax consequences.

We are subject to risks associated with the imposition of legislation and regulations relating to the import or export of high technology products. We cannot predict whether quotas, duties, taxes or other charges or restrictions upon the importation or exportation of our products will be implemented by the United States or other countries. Because sales of our products have been denominated to date primarily in United States dollars, increases in the value of the United States dollar could increase the price of our products so that they become relatively more expensive to customers in the local currency of a particular country, leading to a reduction in sales and profitability in that country. Future international activity may result in increased foreign currency denominated sales. Gains and losses on the conversion to United States dollars of accounts receivable, accounts payable and other monetary assets and liabilities arising from international operations may contribute to fluctuations in our results of operations. Some of our customer purchase orders and agreements are governed by foreign laws, which may differ significantly from United States laws. Therefore, we may be limited in our ability to enforce our rights under such agreements and to collect damages, if awarded.

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Our markets are subject to rapid technological change, so our success depends heavily on our ability to develop and introduce new products.

The markets for our products are characterized by:

• rapidly changing technologies;

• evolving and competing industry standards;

• short product life cycles;

• changing customer needs;

• emerging competition;

• frequent new product introductions and enhancements;

• increased integration with other functions; and

• rapid product obsolescence.

To develop new products for the communications markets, we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to develop technical and design expertise. In addition, we must have our products designed into our customers’ future products and maintain close working relationships with key customers in order to develop new products that meet customers’ changing needs. We must respond to changing industry standards, trends towards increased integration and other technological changes on a timely and cost-effective basis. If we fail to achieve design wins with key customers, our business will significantly suffer because once a customer has designed a supplier’s product into its system, the customer typically is extremely reluctant to change its supply source due to significant costs associated with qualifying a new supplier.

Products for communications applications are based on industry standards that are continually evolving. Our ability to compete in the future will depend on our ability to identify and ensure compliance with these evolving industry standards. The emergence of new industry standards could render our products incompatible with products developed by major systems manufacturers. As a result, we could be required to invest significant time and effort and to incur significant expense to redesign our products to ensure compliance with relevant standards. If our products are not in compliance with prevailing industry standards for a significant period of time, we could miss opportunities to achieve crucial design wins. We may not be successful in developing or using new technologies or in developing new products or product enhancements that achieve market acceptance. Our pursuit of necessary technological advances may require substantial time and expense.

The markets in which we compete are highly competitive and subject to rapid technological change, price erosion and heightened international competition.

The communications IC markets are highly competitive and we expect that competition will increase in these markets. Our ability to compete successfully in our markets depends on a number of factors, including:

• success in designing and subcontracting the manufacture of new products that implement new technologies;

• product quality, reliability and performance;

• customer support;

• time-to-market;

• price;

• the efficiency of production;

• design wins;

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• expansion of production of our products for particular systems manufacturers;

• end-user acceptance of the systems manufacturers’ products;

• market acceptance of competitors’ products; and

• general economic conditions.

In addition, our competitors or customers may offer enhancements to our existing products or offer new products based on new technologies, industry standards or customer requirements including, but not limited to, all optical networking systems that are available to customers on a more timely basis than comparable products from us or that have the potential to replace or provide lower-cost or higher-performance alternatives to our products. The introduction of enhancements or new products by our competitors could render our existing and future products obsolete or unmarketable. We expect that certain of our competitors and other semiconductor companies may seek to develop and introduce products that integrate the functions performed by our IC products on a single chip, thus eliminating the need for our products.

In the communications markets, we compete primarily against companies such as Agere, Broadcom, Conexant, Infineon, Intel, Maxim, Multilink, PMC-Sierra, TriQuint and Vitesse. Some of these companies have significantly greater financial and other resources than us, and some of these companies use other process technologies, such as gallium arsenide, which may have certain advantages over technology we currently use. In certain circumstances, most notably with respect to ASICs supplied to Nortel, our customers or potential customers have internal IC manufacturing capabilities with which we compete.

Revenues that are currently derived from non-communications markets have been declining and we expect them to continue to decline in future periods.

We have derived significant revenues from product sales to customers in the ATE, high-speed computing and military markets and currently anticipate that we will continue to derive revenues from sales to customers in these markets in the near term. We are not currently funding product development efforts in these markets, and revenues from products in these markets have been declining and we expect them to continue to decline in future periods. The market for ATE and high-speed computing IC products is subject to extreme price competition, and we may not be able to reduce the costs of manufacturing high-speed computing IC products in response to declining average selling prices.

We expect that certain competitors will seek to develop and introduce products that integrate the functions performed by our ATE and high-speed computing IC products on single chips. One or more of our customers may choose to utilize discrete components to perform the functions served by our high-speed computing IC products or may use their own design and fabrication facilities to create a similar product. In either case, the need for ATE and high-speed computing customers to purchase our IC products could be eliminated.

Our future success depends in part on the continued service of our key design engineering, sales, marketing, manufacturing and executive personnel and our ability to identify, hire and retain additional personnel.

There is intense competition for qualified personnel in the semiconductor industry, in particular design engineers, and we may not be able to continue to attract and train engineers or other qualified personnel necessary for the development of our business or to replace engineers or other qualified personnel who may leave our employ in the future. Periods of contraction in our business may inhibit our ability to attract and retain our personnel. Loss of the services of, or failure to recruit, key design engineers or other technical and management personnel could be significantly detrimental to our product and process development programs.

In November 2001, we implemented a stock option exchange program. The sole purpose of the program was to improve our ability to retain and motivate employees, officers and board members. We cannot be certain that the program will result in increased retention of employees or board members.

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To manage operations effectively, we will be required to continue to improve our operational, financial and management systems and to successfully hire, train, motivate and manage our employees. The integration of past and future potential acquisitions will require significant additional management, technical and administrative resources. We cannot be certain that we will be able to manage our expanded operations effectively.

A disruption in the manufacturing capabilities of our outside foundries would negatively impact the production of certain of our products.

We rely on outside foundries for the manufacture of the majority of our products, including all of our products designed on complementary metal oxide semiconductor, or CMOS, and silicon germanium, or SiGe, processes. These outside foundries manufacture our products on a purchase order basis. A majority of our products are only qualified for production at a single foundry. These suppliers can allocate, and in the past have allocated, capacity to the production of other companies’ products while reducing deliveries to us on a short notice. Because establishing relationships and ramping production with new outside foundries may take over a year, there is no readily available alternative source of supply for these products. A manufacturing disruption experienced by one or more of our outside foundries or a disruption of our relationship with an outside foundry would negatively impact the production of certain of our products for a substantial period of time. The transition to the next generation of manufacturing technologies at one or more of our outside foundries could be unsuccessful or delayed.

Our operating results depend on manufacturing output and yields, which may not meet expectations.

We manufacture a portion of our ICs at our San Diego manufacturing facilities. Because the majority of our costs of manufacturing are relatively fixed, downturns in the volumes manufactured by our internal process such as wafer fabrication and test and assembly will result in substantially higher unit costs and may result in reduced gross profit and net income. The current downturn had a significant impact on our gross margin in the first three quarters of fiscal 2002.

Manufacturing ICs requires manufacturing tools which are unique to each product being produced. If one of these unique manufacturing tools was damaged or destroyed, then our ability to manufacture the related product would be impaired and our business would suffer until the tools were repaired or replaced.

Our yields decline whenever a substantial percentage of wafers must be rejected or a significant number of die on each wafer are nonfunctional. Such declines can be caused by many factors, including minute levels of contaminants in the manufacturing environment, design issues, defects in masks used to print circuits on a wafer and difficulties in the fabrication process. Design iterations and process changes by our suppliers can cause a risk of contamination. Many of these problems are difficult to diagnose, and are time consuming and expensive to remedy and can result in shipment delays.

We estimate yields per wafer in order to estimate the value of inventory. If yields are materially different than projected, work-in-process inventory may need to be revalued. We have in the past, and may in the future from time to time, take inventory write-downs as a result of decreases in manufacturing yields. We may suffer periodic yield problems in connection with new or existing products or in connection with the commencement of production at a new or expanded manufacturing facility.

In addition, our manufacturing output or yields may decline as a result of power outages, supply shortages, accidents, natural disasters or other disruptions to the manufacturing process.

Due to an industry transition to six-inch, eight-inch and twelve-inch wafer fabrication facilities, there is a limited number of suppliers of the four-inch wafers that we use to build products in our existing manufacturing facility, and we rely on a single supplier for these wafers. Although we believe that we will have sufficient access to four-inch wafers to support production in our existing fabrication facility for the foreseeable future, we cannot

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be certain that our current supplier will continue to supply us with four-inch wafers on a long-term basis. The availability of manufacturing equipment needed for a four-inch process is limited, and certain new equipment required for more advanced processes may not be available for a four-inch process.

Our dependence on third-party manufacturing and supply relationships increases the risk that we will not have an adequate supply of products to meet demand or that our cost of materials will be higher than expected.

The risks associated with our dependence upon third parties which manufacture, assemble or package certain of our products, include:

• reduced control over delivery schedules and quality;

• risks of inadequate manufacturing yields and excessive costs;

• difficulties selecting and integrating new subcontractors;

• the potential lack of adequate capacity during periods of excess demand;

• limited warranties on products supplied to us;

• potential increases in prices; and

• potential misappropriation of our intellectual property.

Difficulties associated with adapting our technology and product design to the proprietary process technology and design rules of outside foundries can lead to reduced yields. The process technology of an outside foundry is typically proprietary to the manufacturer. Since low yields may result from either design or process technology failures, yield problems may not be effectively determined or resolved until an actual product exists that can be analyzed and tested to identify process sensitivities relating to the design rules that are used. As a result, yield problems may not be identified until well into the production process, and resolution of yield problems may require cooperation between ourselves and our manufacturer. This risk could be compounded by the offshore location of certain of our manufacturers, increasing the effort and time required to identify, communicate and resolve manufacturing yield problems. Manufacturing defects that we do not discover during the manufacturing or testing process may lead to costly product recalls. These risks may lead to increased costs or delay product delivery, which would harm our profitability and customer relationships.

If the subcontractors we use to manufacture our products discontinue the manufacturing processes needed to meet our demands, or fail to upgrade their technologies needed to manufacture our products, we may face production delays.

Our requirements typically represent a very small portion of the total production of the third-party foundries. As a result, we are subject to the risk that a producer will cease production on an older or lower-volume process that it uses to produce our parts. We cannot be certain our external foundries will continue to devote resources to the production of our products or continue to advance the process design technologies on which the manufacturing of our products are based. Each of these events could increase our costs and materially impact our ability to deliver our products on time. In addition, a significant natural disaster or other catastrophic event, such as war or acts of terrorism, could have a material adverse impact on our business, financial condition and operating results.

We must develop or otherwise gain access to improved process technologies.

Our future success will depend upon our ability to continue to improve existing process technologies, to develop or acquire new process technologies including SiGe processes, and to adapt our process technologies to emerging industry standards. In the future, we may be required to transition one or more of our products to process technologies with smaller geometries, other materials or higher speeds in order to reduce costs and/or

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improve product performance. We may not be able to improve our process technologies and develop or otherwise gain access to new process technologies, including both SiGe and CMOS process technologies, in a timely or affordable manner. In addition, products based on these technologies may not achieve market acceptance.

The complexity of our products frequently leads to errors, defects and bugs when they are first introduced, which could negatively impact our reputation with customers.

Products as complex as ours frequently contain errors, defects and bugs when first introduced or as new versions are released. Our products have in the past experienced such errors, defects and bugs. Delivery of products with production defects or reliability, quality or compatibility problems could significantly delay or hinder market acceptance of the products. This, in turn, could damage our reputation and adversely affect our ability to retain existing customers and to attract new customers. Errors, defects or bugs could cause problems, interruptions, delays or cessation of sales to our customers.

We may be required to make significant expenditures of capital and resources to resolve such problems. There can be no assurance that problems will not be found in new products after commencement of commercial production, despite testing by us, our suppliers or our customers. This could result in:

• additional development costs;

• loss of, or delays in, market acceptance;

• diversion of technical and other resources from our other development efforts;

• claims by our customers or others against us; and

• loss of credibility with our current and prospective customers.

Any such event could have a material adverse effect on our business, financial condition and results of operations.

Our ability to manufacture a sufficient number of products to meet demand could be severely hampered by a shortage of water, electricity or other supplies, or by natural disasters or other catastrophes.

We use significant amounts of water throughout our manufacturing process. Previous droughts in California have resulted in restrictions being placed on water use by manufacturers and residents in California. In the event of future drought, reductions in water use may be mandated generally, and it is unclear how such reductions will be allocated among California’s different users.

California has experienced shortages in the available power supply. We equipped our internal manufacturing facilities with generators to minimize disruption in case of a power outage. Power outages at vendors we rely on could have material adverse consequences to our ability to meet demand, and thus our results of operations. Power outages at our customers may adversely affect their demand for our products.

Our internal manufacturing facilities are located in San Diego, California which is subject to natural disasters such as earthquakes or floods. We do not have earthquake insurance for these facilities, because adequate coverage is not offered at economically justifiable rates. A significant natural disaster or other catastrophic event, such as war or acts of terrorism, could have a material adverse impact on our business, financial condition and operating results.

In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition. The recent terrorist attacks in New York and Washington, D.C. on September 11, 2001 disrupted commerce throughout the world and intensified the uncertainty of the U.S. economy and other economies around the world. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these

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economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially an adversely affected.

We could incur substantial fines or litigation costs associated with our storage, use and disposal of hazardous materials.

We are subject to a variety of federal, state and local governmental regulations related to the use, storage, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in our manufacturing process. Any failure to comply with present or future regulations could result in the imposition of fines, the suspension of production or a cessation of operations. These regulations could restrict our ability to expand our facilities at the present location or construct or operate new facilities or could require us to acquire costly equipment or incur other significant expenses to comply with environmental regulations or clean up prior discharges. Since 1993, we have been named as a potentially responsible party, along with a large number of other companies that used Omega Chemical Corporation in Whittier, California to handle and dispose of certain hazardous waste material. We are a member of a large group of potentially responsible parties that has agreed to fund certain remediation efforts at the Omega site, which efforts are ongoing. To date, our payment obligations with respect to these funding efforts have not been material, and we believe that our future obligations to fund these efforts will not have a material adverse effect on our business, financial condition or operating results. Although we believe that we are currently in material compliance with applicable environmental laws and regulations, we cannot assure you that we are or will be in material compliance with these laws or regulations or that our future obligations to fund any remediation efforts, including those at the Omega site, will not have a material adverse effect on our business.

We have in the past and may in the future make acquisitions that will involve numerous risks. We may not be able to address these risks successfully without substantial expense, delay or other operational or financial problems.

The risks involved with acquisitions include:

• diversion of management’s attention;

• failure to retain key personnel;

• difficulty in completing an acquired company’s in-process research or development projects;

• amortization of acquired intangible assets and deferred compensation;

• client dissatisfaction or performance problems with an acquired company’s products or services;

• the cost associated with acquisitions and the integration of acquired operations;

• ability of the acquired companies to meet their financial projections; and

• assumption of unknown liabilities, or other unanticipated events or circumstances.

As with past purchase acquisitions, future acquisitions could adversely affect operating results. In particular, if we were to acquire a company or assets and record the acquisition as a purchase, we may capitalize a significant amount of purchased intangibles. These assets would be amortized over their expected period of benefit. The resulting amortization expense could seriously impact operating results for many years. We are required to periodically review the carrying value of our purchased intangible assets for impairment. In the first quarter of fiscal 2002, we recorded a $3.1 billion charge to write down the value of acquired intangible assets, the value of which had become impaired. There can be no assurance that we will not be required to take additional significant one-time charges as a result of an impairment to the carrying value of these and other intangible assets.

Any of these risks could materially harm our business, financial condition and results of operations. Any business that we acquire may not achieve anticipated revenues or operating results.

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We have been named as a defendant in recently initiated securities class action litigation that could result in substantial costs and divert management’s attention and resources.

We are aware of several lawsuits in which we, our chief executive officer, chief financial officer and certain of our other executive officers and directors, have been sued for alleged violations of federal securities laws related to alleged misrepresentations regarding our financial prospects for the fourth quarter of fiscal 2001. We believe that the claims being brought against us, our officers and directors are without merit, and we intend to engage in a vigorous defense of such claims. If we are not successful in our defense of such claims, we could be forced to make significant payments to our stockholders and their lawyers, and such payments could have a material adverse effect on our business, financial condition and results of operations if not covered by our insurance carriers. Even if such claims are not successful, the litigation could result in substantial costs and divert management’s attention and resources, which could have an adverse effect on our business.

We may not be able to protect our intellectual property adequately.

We rely in part on patents to protect our intellectual property. We cannot assure you that our pending patent applications or any future applications will be approved, or that any issued patents will provide us with competitive advantages or will not be challenged by third parties, or that if challenged, will be found to be valid or enforceable, or that the patents of others will not have an adverse effect on our ability to do business. Furthermore, others may independently develop similar products or processes, duplicate our products or processes or design around any patents that may be issued to us.

To protect our intellectual property, we also rely on the combination of mask work protection under the Federal Semiconductor Chip Protection Act of 1984, trademarks, copyrights, trade secret laws, employee and third-party nondisclosure agreements and licensing arrangements. Despite these efforts, we cannot be certain that others will not independently develop substantially equivalent intellectual property or otherwise gain access to our trade secrets or intellectual property, or disclose such intellectual property or trade secrets, or that we can meaningfully protect our intellectual property.

We could be harmed by litigation involving patents and proprietary rights.

Litigation may be necessary to enforce our intellectual property rights, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or misappropriation. The semiconductor industry is characterized by substantial litigation regarding patent and other intellectual property rights. Such litigation could result in substantial costs and diversion of resources, including the attention of our management and technical personnel and could have a material adverse effect on our business, financial condition and results of operations. We may be accused of infringing the intellectual property rights of third parties. We have certain indemnification obligations to customers with respect to the infringement of third-party intellectual property rights by our products. We cannot be certain that infringement claims by third parties or claims for indemnification by customers or end users resulting from infringement claims will not be asserted in the future or that such assertions, if proven to be true, will not harm our business.

Any litigation relating to the intellectual property rights of third parties, whether or not determined in our favor or settled by us, would at a minimum be costly and could divert the efforts and attention of our management and technical personnel. In the event of any adverse ruling in any such litigation, we could be required to pay substantial damages, cease the manufacturing, use and sale of infringing products, discontinue the use of certain processes or obtain a license under the intellectual property rights of the third party claiming infringement. A license might not be available on reasonable terms, or at all.

We cannot predict the impact of recent SEC actions and comments.

The Securities and Exchange Commission has been reviewing companies’ valuation methodologies for acquired in-process research and development. We believe that we are in compliance with the existing SEC rules

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related to acquired in-process research and development in connection with our acquisitions. The SEC may change these rules or issue new guidance applicable to our business. We cannot assure you that the SEC will not seek to reduce the amount of in-process research and development previously expensed by us. This could result in the restatement of our previously filed financial statements and have a material adverse effect on our operating results and financial condition for periods after the acquisitions.

Our stock price is volatile.

The market price of our common stock has fluctuated significantly. In the future, the market price of our common stock could be subject to significant fluctuations due to general economic and market conditions and in response to quarter-to-quarter variations in:

• our anticipated or actual operating results;

• announcements or introductions of new products;

• technological innovations or setbacks by us or our competitors;

• conditions in the semiconductor, telecommunications, data communications or high-speed computing markets;

• the commencement of litigation;

• changes in estimates of our performance by securities analysts;

• announcements of merger or acquisition transactions; and

• other events or factors.

In addition, the stock market in recent years has experienced extreme price and volume fluctuations that have affected the market prices of many high technology companies, particularly semiconductor companies, and that have often been unrelated or disproportionate to the operating performance of those companies. These fluctuations may harm the market price of our common stock.

The anti-takeover provisions of our certificate of incorporation and of the Delaware general corporation law may delay, defer or prevent a change of control.

Our board of directors has the authority to issue up to 2,000,000 shares of preferred stock and to determine the price, rights, preferences and privileges and restrictions, including voting rights, of those shares without any further vote or action by our stockholders. The rights of the holders of common stock will be subject to, and may be harmed by, the rights of the holders of any shares of preferred stock that may be issued in the future. The issuance of preferred stock may delay, defer or prevent a change in control, as the terms of the preferred stock that might be issued could potentially prohibit our consummation of any merger, reorganization, sale of substantially all of our assets, liquidation or other extraordinary corporate transaction without the approval of the holders of the outstanding shares of preferred stock. The issuance of preferred stock could have a dilutive effect on our stockholders.

If we issue additional shares of stock in the future, it may have a dilutive effect on our stockholders.

We have a significant number of authorized and unissued shares of our common stock available. These shares will provide us with the flexibility to issue our common stock for proper corporate purposes, which may include making acquisitions through the use of stock, adopting additional equity incentive plans and raising equity capital. Any subsequent issuance of our common stock may result in immediate dilution of our then current stockholders.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange, interest rates and a decline in the stock market. We do not enter into derivatives or other financial instruments for trading or speculative purposes. We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.

At December 31, 2001, our investment portfolio included fixed-income securities of $987.4 million. These securities are subject to interest rate risk and will decline in value if interest rates increase. Because the average maturity date of the investment portfolio is relatively short, an immediate 100 basis point increase in interest rates would have no material impact on our financial condition or results of operations.

We invest in equity instruments of private companies for business and strategic purposes, most of which are communications companies, specifically IC, software and high-end device. These investments are classified as long-term strategic equity and convertible debt investments and are valued based on prices recently paid, or expected to be paid, for the securities. In the nine months ended December 31, 2001, we recognized a charge of $15 million attributable to the impairment of certain of these investments. The estimated fair values are not necessarily representative of the amounts that the Company could realize in a current transaction.

We generally conduct business, including sales to foreign customers, in U.S. dollars and as a result, have limited foreign currency exchange rate risk. The effect of an immediate 10 percent change in foreign exchange rates would not have a material impact on our financial condition or results of operations.

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PART II.    OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

Starting in April 2001, a series of similar federal complaints were filed against the Company and its chief executive officer, chief financial officer and certain other officers and directors of the Company. These complaints allege essentially identical violations of the Securities Exchange Act of 1934 (the “1934 Act”). The complaints have been brought as purported shareholder class actions under Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5 promulgated thereunder and seek unspecified monetary damages on behalf of the shareholder class. In general, the complaints allege that the Company and the individual defendants misrepresented the Company’s financial prospects for the fourth quarter of fiscal 2001 to inflate the value of the Company’s stock. The complaints have been consolidated into a single proceeding in the United States District Court for the Southern District of California (the “Federal Action”). An amended consolidated complaint is scheduled to be filed in the fourth fiscal quarter of fiscal 2002. The Company intends to file several motions seeking a dismissal of the Federal Action on various grounds. A briefing and hearing schedule has been set for these motions, which the Company expects will be heard and decided in the first or second quarter of fiscal 2003.

In May 2001, certain individuals filed derivative actions against the directors and certain executive officers in the California state courts. These state court derivative complaints allege overstatement of the financial prospects of the Company, mismanagement, inflation of stock value, and sale of stock at inflated prices for personal gain during the period from November 7, 2000 until February 5, 2001. The three state court derivative actions have been consolidated and assigned to the San Diego Superior Court (the “State Action”) and a consolidated derivative complaint was filed in December 2001. The Company has filed several motions seeking a dismissal of the State Action on various grounds. In the alternative, the Company is also seeking to stay the State Action pending resolution of the Federal Action. A hearing and decision on the Company’s motions is expected to occur in the fourth quarter of fiscal 2002.

No discovery has been conducted in either the Federal Action or the State Action. The Company believes that the allegations in these actions are without merit and intends to defend the actions vigorously. The Company cannot predict the likely outcome of these actions, and an adverse result in either action could have a materially adverse effect on the Company. The actions have been tendered to the Company’s insurance carriers.

In addition, from time to time, the Company may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this Annual Report on Form 10-K, except as described herein, the Company is not engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on its business, financial condition or operating results.

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits

3.2 Amended and Restated Bylaws of the Company.

(b)  Reports on Form 8-K

The Company did not file any current reports on Form 8-K with the Commission during the quarter ended December 31, 2001.

* Naiditch v. Applied Micro Circuits Corporation, et al., case number 01-CV-0649 K (AJB), pending in the United States District Court for the Southern District of California; Congregation Givate v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0675 K (AJB), pending in United States District Court for the Southern District of California; Harris v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0675 K (AJB), pending in United States District Court for the Southern District of California; Shapiro v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0743 IEG (RBB), pending in the United States District Court for the Southern District of California; Kucera v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0772K (JAH), pending in United States District Court for the Southern District of California; Fairland Management v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0798 IEG (CGA), pending in United States District Court for the Southern District of California; Hsu & Graef v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0799 B (CGA), pending in United States District Court for the Southern District of California; Scofield v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0804 IEG (LAB), pending in United States District Court for the Southern District of California; Reed v. Applied Micro Circuits Corporation, et al., case no. 01-CV-0808 TW (JAH), pending in United States District Court for the Southern District of California; and Kregal v. Applied Micro Circuits Corporation, et al., case no. 01-CV 1034 BTM (JAH).

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date:  January 23, 2002

AP PLIED MICRO CIRCUITS CORPORATION

By :                  /s/    WILLIAM BENDUSH                      

            William Bendush  

Senior Vice President and Chief Financial Officer

(Duly Authorized Signatory and Principal Financial

and Accounting Officer)

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