Form 10-Q

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, 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 ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of January 31, 2006, 282,214,335 shares of the registrant’s common stock were issued and outstanding.

The accompanying unaudited interim condensed consolidated financial statements of Applied Micro Circuits Corporation (“AMCC” or the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles 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 these fluctuations could continue.

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 (“SEC”) for the fiscal year ended March 31, 2006.

Certain amounts in the condensed consolidated financial statements have been reclassified to conform to the current period presentation.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. The Company regularly evaluates estimates and assumptions related to inventory valuation and warranty liabilities, which affects its cost of sales and gross margin; the valuation of purchased intangibles and goodwill, which affects its amortization and impairments of goodwill and other intangibles; the valuation of restructuring liabilities, which affects the amount and timing of restructuring charges; and the valuation of deferred income taxes, which affects its income tax expense and benefit. The Company bases its estimates and assumptions on historical experience and on various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by the Company may differ materially and adversely from management’s estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued a revised Statement of Financial Accounting Standards No. 123 (“SFAS 123(R)”), Share-Based Payment. Under SFAS 123(R), the estimated fair value of share-based payments is measured at the grant date and is recognized as stock-based compensation expense over the employee’s requisite service period. The Company adopted the provisions of SFAS 123(R) on April 1, 2006 using the modified prospective method, which provides for certain changes to the method for valuing stock-based compensation. Under the modified prospective method, prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123(R) apply both to new stock-based awards issued beginning April 1, 2006 and to awards that were already outstanding on April 1, 2006, but are subsequently modified or cancelled. The estimated fair value of new stock-based awards is recognized as stock-based compensation over the requisite service period associated with the award. For awards already outstanding at April 1, 2006, the estimated stock-based compensation will be recognized over the remaining service period using the compensation cost calculated for pro forma purposes under FASB Statement of Financial Accounting Standards No. 123 (“SFAS 123”), Accounting for Stock-Based Compensation.

As a result of the adoption of SFAS 123(R), the Company recorded $7.9 million of stock-based compensation expense during the first nine months of fiscal 2007. The Company has not recognized, and does not expect to recognize in the near future, any tax benefit related to stock-based compensation cost as a result of the full valuation allowance of its net deferred tax assets and its net operating loss carryforwards.

Prior to the adoption of SFAS 123(R), the Company accounted for share-based payment awards to employees and non-employee directors in accordance with Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and related interpretations, and had adopted the disclosure-only alternative of SFAS 123 and FASB Statement of Financial Accounting Standards No. 148 (“SFAS 148”), Accounting for Stock-Based Compensation—Transition and Disclosure. In accordance with APB 25, stock-based compensation expense was not recorded in connection with share-based payment awards granted with exercise prices equal to or greater than the fair market value of the Company’s common stock on the date of grant. The Company recorded deferred compensation in connection with stock options assumed in acquisitions with exercise prices less than the fair market value of the common stock on the date of assumption. The amount of such deferred compensation per share was equal to the excess of the fair market value over the exercise price on such date. Recorded deferred compensation was recognized as stock-based compensation expense ratably over the applicable vesting periods. In accordance with the provisions of SFAS 123(R), all deferred compensation previously recorded has been eliminated with a corresponding reduction in additional paid in capital.

The Company uses foreign exchange forward contracts to hedge expense commitments that are denominated in currencies other than the U.S. dollar. The purpose of the Company’s foreign currency hedging activities is to fix the dollar value of specific commitments and payments to foreign vendors. At December 31, 2006, the Company did not have any foreign exchange contracts outstanding. The Company accounts for derivatives pursuant to FASB Statement of Financial Accounting Standards No. 133 (“SFAS 133”), Accounting for Derivative Instruments and Hedging Activities, as amended. This standard requires that all derivative instruments be recognized in the financial statements and measured at fair value regardless of the purpose or intent for holding them. The classification of gains and losses resulting from changes in the fair values of derivatives is dependent on the intended use of the derivative and its resulting designation. The change in fair value of the ineffective portion of a hedge, and changes in fair values of derivatives that are not considered highly effective hedges, are immediately recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are subsequently recognized in earnings when the hedged item affects earnings.

FASB Statement of Financial Accounting Standards No. 131 (“SFAS 131”), Disclosures about Segments of an Enterprise and Related Information, establishes standards for the way public business enterprises report information about operating segments in annual consolidated financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas and major customers.

Under SFAS 131, two or more operating segments may be aggregated into a single reportable operating segment for financial reporting purposes if aggregation is consistent with the objective and basic principles of SFAS 131, if the segments have similar economic characteristics, and if the segments are similar in each of the following areas:

Although the Company had three operating segments at December 31, 2006, the Company met each of the criteria set forth in SFAS 131 and the three operating segments as of December 31, 2006 share similar economic characteristics. Therefore, the Company aggregates its results of operations into one reportable operating segment, communications.

In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, which clarifies the accounting for uncertainty in tax positions. FIN 48 requires that the Company recognize in its financial statements, the impact of a tax position, if that position is more likely than not to be sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective in the first quarter of fiscal 2008, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting FIN 48 on its consolidated financial statements.

In September 2006, the SEC released Staff Accounting Bulletin No. 108 (“SAB 108”), Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides interpretive guidance on the SEC’s views regarding the process of quantifying materiality of financial statement misstatements. SAB 108 is effective for fiscal years ending after November 15, 2006. The issuance of SAB 108 did not have a material impact on the Company’s financial statements.

In September 2006, the FASB issued Statement No. 157 (“SFAS 157”), Fair Value Measurements. SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact of adopting SFAS 157 on its consolidated financial statements.

Goodwill and other acquisition-related intangibles were as follows (in thousands):

As of December 31, 2006, the estimated future amortization expense of purchased intangible assets to be charged to cost of sales and operating expenses was as follows (in thousands):

The Company generally provides a one-year warranty on production released integrated circuit (“IC”) products and up to three years on board level products. Estimated expenses for warranty obligations are accrued as revenue is recognized. Reserve estimates are adjusted periodically to reflect actual experience and/or changes to contracted obligations entered into with our customers.

The following table summarizes the activity related to the warranty reserve activity (in thousands):

Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the year. Diluted net income (loss) per share also includes any dilutive effects of outstanding stock options and restricted stock units calculated using the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock results in a greater dilutive effect from outstanding stock options and restricted stock units. Additionally, the exercise of stock options and the vesting of restricted stock units results in a greater dilutive effect on net income (loss) per share. The reconciliation of shares used to calculate basic and diluted net income (loss) per share consists of the following (in thousands, except per share data):

Because the Company incurred losses for the three and nine months ended December 31, 2006 and nine months ended December 31, 2005, the effect of dilutive securities totaling 1,260,000 and 1,011,000 equivalent shares for the three and nine months ended December 31, 2006, respectively, and 1,546,000 equivalent shares for the nine months ended December 31, 2005, respectively, have been excluded from the net loss per share computations as their impact would be antidilutive.

Over the last several years, the Company has undertaken significant restructuring activities under several plans in an effort to reduce operating costs. A combined summary of the restructuring programs initiated by the Company is as follows (in thousands):

The following tables provide detailed activity related to the four most recent restructuring programs during the nine months ended December 31, 2006 (in thousands):

In April 2003, the Company announced a restructuring program. The April 2003 restructuring program consisted of a workforce reduction of 185 employees, consolidation of excess facilities and fixed asset disposals. The Company recognized a total of $23.8 million in restructuring costs related to this restructuring program. The restructuring costs consisted of approximately $5.7 million for employee severances, $7.2 million representing the discounted cash flow of lease payments on exited facilities, $3.4 million for the disposal of certain software licenses, and $7.5 million for the write-off of leasehold improvements and property and equipment. This restructuring charge was offset by a $2.6 million restructuring benefit in November 2003 related to the reoccupation of a portion of a building in San Diego and an adjustment for overestimated severance to be paid.

In July 2005, the Company implemented another restructuring program. The July 2005 restructuring program was implemented to reduce job redundancies and reduce ongoing operating expenses. This restructuring program consisted of the elimination of approximately 40 employees, the disposal of idle fixed assets, and the consolidation of San Diego facilities. As a result of the July 2005 restructuring program, the Company recorded a charge of approximately $5.0 million, consisting of $1.4 million for employee severances, $2.6 million for property and equipment write-offs and $1.0 million representing expenses relating to the consolidation of facilities.

In March 2006, the Company communicated and began implementation of a plan to exit its operations in France and India and reorganize part of its manufacturing operations. The restructuring program included the elimination of approximately 68 employees. In fiscal 2006, the Company recorded a charge of approximately $7.6 million, consisting of $6.0 million for employee severances, $1.0 million for operating lease write-offs, and $0.6 million for asset impairments. For the nine months ended December 31, 2006, the Company recorded an additional charge of approximately $2.2 million, consisting of $0.3 million for excess lease liability, $0.1 million for operating lease commitments and $2.5 million for asset impairments, offset by $0.7 million in workforce

reduction liability adjustments. These actions are not anticipated to affect revenues from current products. We anticipate saving approximately $9.0 million annually as a result of this restructuring program.

In June 2006, the Company implemented another restructuring program. The June 2006 restructuring program was implemented to reduce job redundancies. This restructuring program consisted of the elimination of approximately 20 employees. As a result of the June 2006 restructuring program, the Company recorded a charge of approximately $0.5 million, consisting of employee severances. We anticipate saving approximately $4.0 million annually as a result of this restructuring program.

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

The Company’s Certificate of Incorporation allows for the issuance of up to 2.0 million shares of preferred stock in one or more series and permits the Company’s Board of Directors (“Board”) to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences, and the number of shares constituting any series so designated by the Board of Directors, without further vote or action by the stockholders.

At December 31, 2006 the Company had 630.0 million shares of common stock authorized for issuance. Issued and outstanding shares at December 31, 2006 and March 31, 2006, were approximately 281.8 million and 295.4 million, respectively.

The Company has in effect an employee stock purchase plan under which 19.2 million shares of common stock have been reserved for issuance. Under the terms of this plan, purchases are made semiannually and the purchase price of the common stock is equal to 85% of the fair market value of the common stock on the first or last day of the offering period, whichever is lower. At December 31, 2006, approximately 10.0 million shares had been issued under this plan and approximately 9.2 million shares were available for future issuance.

On August 12, 2004, the Board authorized a stock repurchase program for the repurchase of up to $200.0 million of its common stock. Under the program, the Company is authorized to make purchases in the open market or enter into structured repurchase agreements. During the nine months ended December 31, 2006, the

Company repurchased 6.2 million shares on the open market at a weighted average price of $3.23 per share. From the time the program was first implemented through December 31, 2006, the Company repurchased 15.6 million shares on the open market at a weighted average price of $3.01 per share. At December 31, 2006, $85.5 million remained available to repurchase shares under the stock repurchase program.

The Company also utilizes structured stock repurchase agreements consisting of prepaid written put options on the Company’s common stock. The Company pays a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or stock depending on the closing market price of the Company’s common stock on the expiration date of the agreement. Upon expiration of each agreement, if the closing market price of the Company’s common stock is above the pre-determined price, the Company will have its investment returned with a premium. If the closing market price is at or below the pre-determined price, the Company will receive the number of shares specified at the inception of the agreement. Any cash received, including the premium, is treated as an increase to additional paid in capital on the balance sheet in accordance with the guidance issued in FASB Emerging Issues Task Force Issue No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.

During the nine months ended December 31, 2006, the Company received $17.4 million in cash and 7.7 million shares of its common stock from open structured stock repurchase programs. At December 31, 2006, the Company had no structured stock repurchase agreements open. From the time of the stock repurchase program inception through December 31, 2006, the Company entered into structured stock repurchase agreements totaling $164.5 million. Upon settlement of these underlying agreements, the Company received $105.9 million in cash and 23.0 million shares of its common stock at an effective purchase price of $2.55 per share.

The table below is a summary of the Company’s repurchase program share activity for the nine months ended December 31, 2006 and 2005 (in thousands, except per share data):

The Company has in effect several stock option plans under which stock options have been granted to employees and non-employee directors. Certain of these plans allow the grant of restricted stock units. The option plans include two stockholder-approved plans (the 1992 Stock Option Plan and 1997 Directors’ Stock Option Plan) and four plans not approved by stockholders (the 2000 Equity Incentive Plan, Cimaron Communications Corporation’s 1998 Stock Incentive Plan assumed in the fiscal 1999 merger, and JNI Corporation’s 1997 and 1999 Stock Option Plans assumed in the fiscal 2004 merger). Certain other outstanding options were assumed through the Company’s various acquisitions.

The Board has delegated administration of these plans to the Compensation Committee, which generally determines eligibility, vesting schedules and exercise prices for options granted under the plans. Options and other stock awards under the plans expire not more than ten years from the date of grant and are generally exercisable upon vesting. Vesting generally occurs over four years. In fiscal 2006, stock options covering 5.1 million shares were granted with a 2.5-year vesting schedule. New hire grants generally vest and become exercisable at the rate of 25% on the first anniversary of the date of grant and ratably on a monthly basis over a period of 36 months thereafter; subsequent option grants to existing employees generally vest and become exercisable ratably on a monthly basis over a period of 48 months measured from the date of grant.

In connection with its annual review of officer compensation in April 2006, the Compensation Committee granted to each of the Company’s executive officers performance options that vest based on pre-determined Company goals. There are two types of performance options. The first type vests in 48 equal monthly installments beginning one month after the grant date; provided, however, if the Company achieves specific stretch goals under its fiscal 2007 operating plan, the vesting of the option will accelerate such that the option will be fully exercisable at the end of two years instead of four years. The second type becomes exercisable only if the Company achieves specific revenue and non-GAAP pre-tax profit targets in any fiscal quarter before fiscal 2010.

In addition, the Company grants restricted stock units pursuant to its 2000 Equity Incentive Plan as part of its regular annual employee equity compensation review program as well as to new hires and non-employee members of the Company’s Board. Restricted stock units are share awards that upon vesting, will deliver to the holder, shares of the Company’s common stock. Generally, restricted stock units vest ratably on a quarterly basis over four years from the date of grant. For employees hired after May 15, 2006, restricted stock units will vest on a quarterly basis over four years from the date of hire provided that no shares will vest during the first year, at the end of which the shares that would have vested during that year will vest and the remaining shares will vest over the remaining 12 quarters.

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

The total pretax intrinsic value of options exercised during the nine months ended December 31, 2006 was $762,000. This intrinsic value represents the excess of the fair market value of the Company’s common stock on the date of exercise over the exercise price of such options.

The aggregate pretax intrinsic value, weighted average remaining contractual life, and weighted average per share exercise price of options outstanding and of options exercisable as of December 31, 2006 were as follows (in thousands, except exercise prices and years):

The aggregate pretax intrinsic values in the preceding table were calculated based on the closing price of the Company’s common stock of $3.56 on December 31, 2006.

Restricted stock unit activity under the 2000 Equity Incentive Plan in the nine months ended December 31, 2006 is set forth below:

Based on the closing price of the Company’s common stock of $3.56 on December 31, 2006, the total pretax intrinsic value of all outstanding restricted stock units on that date was $370,000.

Effective April 1, 2006, the Company adopted SFAS 123(R), using the modified prospective method. This method does not require a revision of prior periods for comparative purposes. No change to the value of the awards granted prior to the adoption of SFAS 123(R) is required. However, awards granted and still unvested on the date of adoption will be attributed to expense under SFAS 123(R), including the application of the forfeiture rate on a prospective basis. The Company’s Condensed Consolidated Financial Statements as of and for the three and nine months ended December 31, 2006 reflect the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the three and nine months ended December 31, 2006 was $2.7 million and $7.9 million, respectively.

Prior to the adoption of SFAS 123(R), the Company accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with APB 25 as permitted under SFAS 123. Under

SFAS 123, stock-based compensation expense had been disclosed but not recognized in the Company’s Consolidated Statement of Operations. In the Company’s pro forma disclosure required under SFAS 123 for the periods prior to fiscal 2007, the Company accounted for forfeitures as they occurred.

SFAS 123(R) requires companies to estimate the fair value of stock-based compensation on the date of grant using an option-pricing model. The Company uses the Black-Scholes model to value stock-based compensation. This is the same model which it previously used in preparing its pro forma disclosure required under SFAS 123. The Black-Scholes model determines the fair value of share-based payment awards based on the stock price on the date of grant and is affected by assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Although the fair value of stock options granted by the Company is determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

The following table summarizes stock-based compensation expense related to stock options and restricted stock units under SFAS 123(R) for the three and nine months ended December 31, 2006, which is allocated as follows (in thousands, except per share data):

The fair value of the options granted is estimated as of the grant date using the Black-Scholes option-pricing model assuming the weighted-average assumptions listed in the following table:

Compensation Amortization Period. All stock-based compensation is amortized over the requisite service period of the awards, which is generally the same as the vesting period of the awards. For all stock options, the Company amortizes the fair value on a straight-line basis over the service periods.

Expected Term or Life. The expected term or life of stock options granted represents the expected weighted average period of time from the date of grant to the estimated date that the stock option would be fully exercised. To calculate the expected term, the Company assumes that unexercised stock options would be exercised at the midpoint of the valuation date of its analysis and the full contractual term of the option.

Expected Volatility. Expected volatility is a measure of the amount by which the stock price is expected to fluctuate. The Company estimates the expected volatility of its stock options at their grant date by equally weighting the historical volatility and the implied volatility of its stock. The historical volatility is calculated using the weekly stock price of its stock over a recent historical period equal to its expected term. The implied volatility is calculated from the implied market volatility of exchange-traded call options on its common stock.

Risk-Free Interest Rate. The risk-free interest rate is the implied yield currently available on zero-coupon government issues with a remaining term equal to the expected term.

Expected Dividends. The Company has never paid any cash dividends on our common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero percent in valuation models.

Expected Forfeitures. As stock-based compensation expense recognized in the Condensed Consolidated Statements of Income for the three and nine months ended December 31, 2006 is based on awards that are ultimately expected to vest, it should be reduced for estimated forfeitures. FAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Pre-vesting forfeitures were estimated to be 5.73% for all stock options granted in fiscal 2007 based upon the average of expected forfeitures data using the Company’s current demographics and standard probabilities of employee turnover and the annual forfeiture rate based on the Company’s historical forfeiture rates.

The following table summarizes stock-based compensation expense as it relates to the Company’s statement of operations (in thousands):

The weighted average fair value per share of the restricted stock units awarded in the nine months ended December 31, 2006 was $3.20, calculated based on the fair market value of the Company’s common stock on the respective grant dates.

The adoption of SFAS 123(R) will continue to have a significant adverse impact on the Company’s reported results of operations, although it will have no impact on its overall financial position. The amount of unearned stock-based compensation currently estimated to be expensed from now through fiscal 2011 related to unvested share-based payment awards at December 31, 2006 is $16.7 million. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 1.4 years. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that the Company grants additional equity awards or assumes unvested equity awards in connection with acquisitions.

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

In October 2001, a shareholder derivative lawsuit was filed against JNI Corporation (“JNI”) and certain of its former officers and directors in the Superior Court of the State of California in the County of San Diego, case no. GIC 775153. The complaint alleged that between October 16, 2000 and January 24, 2001, the defendants breached their fiduciary duty by failing to adequately oversee the activities of management and that JNI allegedly made false statements about its business and results causing its stock to trade at artificially inflated levels. The court sustained JNI’s demurrers to each of the plaintiff’s complaints and dismissed the complaint in June 2002. In June 2002, the court granted Sik-Lin Huang’s motion to intervene. Huang filed a complaint in intervention in July 2002. In September 2002, JNI’s board of directors appointed a special litigation committee to investigate the allegations. In February 2003, the special litigation committee issued a report of its investigation, which concluded that it was not in JNI’s best interests to pursue the litigation. In November 2003, the court dismissed the complaint with prejudice. In January 2004, the plaintiff filed a notice of appeal. A motion to dismiss the appeal was filed by the defendants on the grounds that the plaintiff had lost standing because he no longer owned JNI shares. In October 2005, the court dismissed the appeal, finding the plaintiff had no standing to maintain the lawsuit. The California Supreme Court granted review of the Court of Appeal’s decision on January 4, 2006. On April 4, 2006, plaintiff filed his opening brief. The Company filed its answer brief on May 26, 2006. Plaintiff’s reply brief was filed on August 17, 2006. No date has been set for a hearing on this appeal.

In November 2001, a class action lawsuit was filed against JNI and the underwriters of its initial and secondary public offerings of common stock in the U.S. District Court for the Southern District of New York, case no. 01 Civ 10740 (SAS). The complaint alleges that defendants violated the Securities Exchange Act of 1934, as amended (“Exchange Act”) in connection with JNI’s public offerings. This lawsuit is among more than 300 class action lawsuits pending in this court that have come to be known as the “IPO laddering cases.”

In June 2003, a proposed partial global settlement, subsequently approved by JNI’s board of directors, was announced between the issuer defendants and the plaintiffs that would guarantee at least $1 billion to investors who are class members from the insurers of the issuers. The proposed settlement, if approved by the court and by the issuers, would be funded by insurers of the issuers, and would not result in any payment by JNI or the Company. The Court has granted its preliminary approval of settlement subject to defendants’ agreement to modify certain provisions of the settlement agreements regarding contractual indemnification. JNI has accepted the Court’s proposed modifications. The court held a hearing for final approval of the settlement on April 24, 2006. On December 5, 2006, the U.S. Court of Appeals for the Second Circuit vacated the District Court’s

decision certifying as class actions the six lawsuits designated as “focus cases.” The Circuit Court has ordered a stay of all proceedings in all of the lawsuits pending the outcome of plaintiffs’ petition to the Second Circuit for rehearing en banc. Accordingly, the District Court’s decision on final approval of the settlement remains pending.

Various current and former directors and officers of the Company have been named as defendants in two consolidated stockholder derivative actions filed in the United States District Court for the Northern District of California, captioned In re Applied Micro Circuits Derivative Litigation (N.D. Cal.) (The “Federal Action”); and three substantially similar consolidated stockholder derivative actions filed in California state court, captioned In re Applied Micro Circuits Corporation Shareholder Derivative Litigation (Santa Clara County Superior Court) (the “State Action”). Plaintiffs in the Federal and State Actions allege that the defendant directors and officers backdated stock option grants during the period from 1997 through 2005. Both actions assert claims for breach of fiduciary duty, gross mismanagement, waste of corporate assets, unjust enrichment, imposition of a constructive trust over the option contracts, and violations of Section 25402 of the California Corporations Code. The Federal Action also alleges that the defendants violated Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder, and Section 20(a) of the Exchange Act. Both Actions seek to recover unspecified monetary damages against the individual defendants on behalf of the Company, restitution, rescission of the option contracts, disgorgement of profits and benefits, equitable relief and attorneys’ fees and costs. The Company is named as a nominal defendant in both the Federal and State Actions, thus no recovery against the Company is currently sought.

The Company and the individual defendants have filed motions to dismiss in both the Federal and State Actions. The hearing on the motion to dismiss, or in the alternative stay, the State Action is currently scheduled for February 13, 2007. The hearing on the motions to dismiss in the Federal Action is currently scheduled for February 26, 2007. The Company has also moved to stay discovery in the State Action, and discovery is currently stayed in the Federal Action. No trial date has been set in either Action.

In June 2006, the Company received a request from the SEC to produce voluntarily certain documents concerning our historical stock option grant practices. The Company produced responsive documents and indicated its intent to cooperate fully with the SEC’s investigation.

In June 2006, the Company announced in a press release that it had received a Grand Jury subpoena from the U.S. Attorney’s Office for the Northern District of California relating to its historical stock option practices and that a parallel investigation had been initiated by the U.S. Attorney’s Office for the Southern District of California. The U.S. Attorney’s Office for the Northern District of California subsequently deferred the criminal investigation to the Southern District of California and withdrew its Grand Jury subpoena. In July 2006, the U.S. Attorney’s Office for the Southern District of California served the Company with a Grand Jury subpoena substantially similar to the subpoena previously issued by the Northern District of California.

The Company has been cooperating with the SEC and Department of Justice in connection with their investigations, including through in-person and telephone meetings between Company representatives and the staff of the SEC and Department of Justice, and through the provision of information and documents.

On August 25, 2006, the Company acquired Quake Technologies, Inc. (“Quake”), a Delaware corporation, for $81.2 million in cash including merger costs. Of the amount paid, $12.0 million will be placed in escrow for at least one year in order to secure the indemnification obligations of Quake to the Company. In addition, the

Company assumed unvested stock options covering 1.7 million shares of the Company’s common stock that had a fair value of $3.5 million. The fair value of the unvested options was calculated using a Black-Scholes method and is being recorded as stock-based compensation over the requisite service period.

In connection with this transaction, the Company conducted valuations of the intangible assets acquired in order to allocate the purchase price in accordance with FASB Statement of Financial Accounting No. 141 (“SFAS 141”), Business Combinations. In accordance with SFAS 141, the Company has allocated the excess purchase price over the fair value of net tangible assets acquired to the identifiable intangible assets. The Company recorded a charge of $13.3 million for purchased in-process research and development (“IPR&D”) expense. The amounts allocated to IPR&D were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed. The purchase price in the transaction was allocated as follows (in thousands):

The total consideration issued in the acquisition was as follows (in thousands):

No supplemental pro forma information is presented for the acquisition due to the immaterial effect of the acquisition on the Company’s results of operations.

On January 29, 2007, the Company filed a definitive proxy statement with the SEC for its annual meeting of stockholders to be held on March 9, 2007. The proxy statement describes proposals to approve an exchange of certain stock options for a reduced number of restricted stock units granted under its 2000 Equity Incentive Plan, to amend and restate the Company’s 1992 Stock Option Plan (thereafter to be referred to as the 1992 Equity Incentive Plan) and to amend the Company’s Certificate of Incorporation to allow for a reverse stock split of its common stock in which any whole number of outstanding shares, between two and four, would be combined into one share of common stock and authorize our Board of Directors to select and file such amendment.

Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of our operations. The MD&A is organized as follows:

The MD&A should be read in conjunction with the consolidated financial statements and notes thereto included in this report. This discussion contains forward-looking statements. These forward-looking statements are made as of the date of this report. Any statement that refers to an expectation, projection or other characterization of future events or circumstances, including the underlying assumptions, is a forward-looking statement. We use certain words and their derivatives such as “anticipate”, “believe”, “plan”, “expect”, “estimate”, “predict”, “intend”, “may”, “will”, “should”, “could”, “future”, “potential”, and similar expressions in many of the forward-looking statements. The forward-looking statements are based on our current expectations, estimates and projections about our industry, management’s beliefs, and other assumptions made by us. These statements and the expectations, estimates, projections, beliefs and other assumptions on which they are based are subject to many risks and uncertainties and are inherently subject to change. We describe many of the risks and uncertainties that we face in Part II, Item 1A, “Risk Factors” in this report. We update our descriptions of the risks and uncertainties facing us in our periodic reports filed with the SEC in which we report our financial condition and results for the quarter and fiscal year-to-date. Our actual results and actual events could differ materially from those anticipated in any forward-looking statement. Readers should not place undue reliance on any forward-looking statement.

We are a leader in semiconductors and printed circuit board assemblies (“PCBAs”) for the communications and storage markets. We design, develop, market and support high-performance ICs and storage components, which are essential for the processing, transporting and storing of information worldwide. In the communications market, we utilize a combination of design expertise coupled with system-level knowledge and multiple technologies to offer IC products and PCBAs, for wireline and wireless communications equipment such as wireless base stations, edge switches, routers, and gateways, metro transport platforms and core switches and routers. In the storage market, we blend systems and software expertise with high-performance, high-bandwidth silicon integration to deliver high-performance, high capacity serial advanced technology attachment (“SATA”) redundant array of integrated disks (“RAID”) controllers for emerging storage applications such as disk-to-disk

backup, near-line storage, network-attached storage, video, and high-performance computing. Our corporate headquarters are located in Sunnyvale, California. Sales and engineering offices are located throughout the world.

The following tables present a summary of our results of operations for the three and nine months ended December 31, 2006 and 2005 (dollars in thousands):

Net Revenue. We generate revenues primarily through sales of our IC products, embedded processors and PCBAs to original equipment manufacturers (“OEMs”), such as Alcatel, Ciena, Cisco, Brocade, Fujitsu, Hitachi, Huawei, Juniper, Lucent, Ericsson, NEC, Nortel, Siemens, and Tellabs, who in turn supply their equipment principally to communications service providers. In the storage market we generate revenues primarily through sales of our SATA RAID controllers to our distribution channel partners who in turn sell to enterprises, small and mid-size businesses, value added resellers, systems integrators and retail consumers.

The demand for our products has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:

For these and other reasons, our net revenue and results of operations for the three and nine months ended December 31, 2006 and 2005 may not necessarily be indicative of future net revenue and results of operations.

Based on direct shipments, net revenues to customers that exceeded 10% of total net revenues for the three and nine months ended December 31, 2006 and 2005 were as follows:

On July 5, 2005, Avnet acquired Insight Electronics. For purposes of the table above, the shipments to Insight Electronics and Avnet were retroactively combined for all periods presented.

Looking through product shipments to distributors and subcontractors to the end customers, to the best of our knowledge, net revenues to end customers that exceeded 10% of total net revenues for the three and nine months ended December 31, 2006 and 2005 were as follows:

We expect that our largest customers will continue to account for a substantial portion of our net revenue in 2007 and for the foreseeable future.

Net Loss. Our net loss was $4.2 million and $18.9 million for the three and nine months ended December 31, 2006, respectively, compared to net income of $0.6 million and net loss of $10.0 million for the three and nine months ended December 31, 2005, respectively, representing an increase in our net loss of $4.8 million and $8.9 million, respectively. This increase in our net loss was primarily as a result of a $13.3 million charge for acquired in-process research and development from our acquisition of Quake in August 2006. In addition, we had higher operating expenses for the three and nine months ended December 31, 2006 when compared to the three and nine months ended December 31, 2005 which included a $5.0 million and $7.9 million increase in selling, general and administrative expenses, respectively and a $1.1 million and $1.3 million increase in research and development expenses, respectively, resulting primarily from the impact of the acquisition of Quake. This increase was offset by the impact of higher gross profits resulting from higher revenues and a decline in restructuring charges of $1.3 million and $2.2 million during the three and nine months ended December 31, 2006, respectively, when compared to the three and nine months ended December 31, 2005. For a detailed analysis of the components that contribute to our net loss, refer to the section titled “Results of Operations”.

Our net loss has been affected in the past, and may continue to be affected in the future, by various factors, including, but not limited to, the following:

Since the start of fiscal 2004, we have invested a total of approximately $391.7 million (excluding stock compensation) in the research and development of new products, including higher-speed, lower-power and lower cost products, products that combine the functions of multiple existing products into single highly-integrated products, and other products to complete our portfolio of communications and storage products. We have not generated significant revenues from products developed during this time because for most of the products developed by us, due to their complexity and the complexity of our OEM customers’ equipment, it often takes several years to complete development and qualification. In addition, the downturn in the telecommunications market has severely impacted our customers and has resulted in significantly less demand for the quantity of

these products than expected when some of the developments commenced and, as a result of restructuring activities, we discontinued development of several products that were in process and slowed down development of others as we realized that demand for these products would not materialize as originally anticipated.

Over the last several years, we have undertaken significant restructuring activities in an effort to reduce operating costs. In addition, in an effort to diversify our customer base and markets that we serve and to maintain revenue growth, we have also made several acquisitions. In September 2003 and January 2004, we purchased assets and licensed intellectual property associated with IBM’s PowerPRS Switch Fabric product line, or the PRS Business, for approximately $51.0 million in cash to complement our existing communications products portfolio. In October 2003, we completed the acquisition of all outstanding shares of JNI, a provider of Fibre Channel hardware and software products for storage networks, for approximately $196.4 million in cash. In April 2004, we completed the acquisition of 3ware, Inc., a provider of high-performance, high-capacity SATA storage solutions, for a purchase price of approximately $145.0 million in cash. In May 2004 and December 2004, we acquired intellectual property and a portfolio of assets associated with IBM’s 400 series of embedded PowerPC standard products for approximately $232.0 million in cash. The PowerPC 400 series product line targets Internet, communication, data storage, consumer and imaging applications. In August 2006, we acquired Quake, a leader in 10 Gigabit Ethernet (10GE) physical layer technology for approximately $81.2 million in cash.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to inventory valuation and warranty liabilities, which affects our cost of sales and gross margin; the valuation of purchased intangibles and goodwill, which affects our amortization and impairments of goodwill and other intangibles; the valuation of restructuring liabilities, which affects the amount and timing of restructuring charges; and the valuation of deferred income taxes, which affects our income tax expense and benefit. We also have other key accounting policies, such as our policies for stock based compensation, revenue recognition, including the deferral of a portion of revenues on sales to distributors, and allowance for bad debts. The methods, estimates and judgments we use in applying these most critical accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and assumptions on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from management’s estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

We believe the following critical accounting policies require us to make significant judgments and estimates in the preparation of our consolidated financial statements.

Our policy is to value inventories at the lower of cost or market on a part-by-part basis. This policy requires us to make estimates regarding the market value of our inventories, including an assessment of excess or obsolete inventories. We determine excess and obsolete inventories based on an estimate of the future demand for our products within a specified time horizon, generally 12 months. The estimates we use for future demand are also used for near-term capacity planning and inventory purchasing and are consistent with our revenue forecasts. If our demand forecast is greater than our actual demand we may be required to take additional excess inventory charges, which would decrease gross margin and net operating results. For example, reducing our future demand estimate to six months could increase our current reserve balance by approximately $11.2 million as of December 31, 2006. Alternatively, increasing our future demand forecast to 18 months could reduce our exposure by approximately $0.2 million as of December 31, 2006. Our products typically carry a one to three

year warranty. We establish reserves for estimated product warranty costs at the time revenue is recognized. Although we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, use of materials and service delivery costs incurred in correcting any product failure and changes to master purchase agreements with our larger customers. Should actual product failure rates, use of materials or service delivery costs differ from our estimates, additional warranty reserves could be required, which could reduce our gross margins. Additional change to negotiated master purchase agreements could result in increased warranty reserves and unfavorably impact present and future gross margins.

The purchase method of accounting for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair value of the net tangible and intangible assets acquired, including in-process research and development (“IPR&D”). Goodwill and intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment tests. The amounts and useful lives assigned to other intangible assets impact future amortization, and the amount assigned to IPR&D is expensed immediately. Determining the fair values and useful lives of intangible assets requires the use of estimates and the exercise of judgment. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets acquired, we primarily use the discounted cash flow method and the market comparison approach. These methods require significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required such as residual growth rates and discount factors. The estimates we use to value and amortize intangible assets are consistent with the plans and estimates that we use to manage our business and are based on available historical information and industry estimates and averages. These judgments can significantly affect our net operating results.

We are required to assess goodwill impairment annually using the methodology prescribed by Statement of Financial Accounting Standards No. 142 (“SFAS 142”), Goodwill and Other Intangible Assets. SFAS 142 requires that goodwill be tested for impairment at the reporting unit level on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units and determining the fair value of each reporting unit. In fiscal 2006 and 2005, in accordance with SFAS 142, we determined that there were three reporting units to be tested. The goodwill impairment test compares the implied fair value of the reporting unit with the carrying value of the reporting unit. The implied fair value of goodwill is determined in the same manner as in a business combination. Determining the fair value of the implied goodwill is judgmental in nature and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant impact on whether or not an impairment charge is recognized and also the magnitude of any such charge. Estimates of fair value are primarily determined using discounted cash flows and market comparisons. These approaches use significant estimates and assumptions, including projection and timing of future cash flows, discount rates reflecting the risk inherent in future cash flows, perpetual growth rates, determination of appropriate market comparables, and determination of whether a premium or discount should be applied to comparables. It is possible that the plans and estimates used

to value these assets may be incorrect. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

Over the last several years we have undertaken significant restructuring initiatives, which have required us to develop formalized plans for exiting certain business activities and reducing spending levels. We have had to record estimated expenses for employee severance, long-term asset write downs, lease cancellations, facilities consolidation costs, and other restructuring costs. Given the significance, and the timing of the execution, of such activities, this process is complex and involves periodic reassessments of estimates made at the time the original decisions were made. In calculating the charges for our excess facilities, we have to estimate the timing of exiting

certain facilities and then estimate the future lease and operating costs to be paid until the lease is terminated and the amount of any sublease income. To form our estimates for these costs, we performed an assessment of the affected facilities and considered the current market conditions for each site. Our assumptions for the operating costs until termination or the offsetting sublease revenues may turn out to be incorrect, and our actual costs may be materially different from our estimates, which could result in the need to record additional costs or to reverse previously recorded liabilities. Our policies require us to periodically evaluate, at least semiannually, the adequacy of the remaining liabilities under our restructuring initiatives.

We record valuation allowances to reduce our deferred tax assets to an amount that we believe is more likely than not to be realized. We consider estimated future taxable income and ongoing prudent and feasible tax planning strategies, including reversals of deferred tax liabilities, in assessing the need for a valuation allowance. If we were to determine that we will not realize all or part of our deferred tax assets in the future, we would make an adjustment to the carrying value of the deferred tax asset, which would be reflected as income tax expense. Conversely, if we were to determine that we will realize a deferred tax asset, which currently has a valuation allowance, we would reverse the valuation allowance which would be reflected as an income tax benefit or as an adjustment to stockholders’ equity, for tax assets related to stock options, or goodwill, for tax assets related to acquired businesses.

Effective April 1, 2006 we adopted SFAS 123 (revised 2004), Share-Based Payment, or SFAS 123(R). SFAS 123(R) requires the cost of all share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, to be recorded in our financial statements based on their respective grant date fair values. Under this standard, the fair value of each employee stock option and employee stock purchase right is estimated on the date of grant using an option pricing model that meets certain requirements. We use the Black-Scholes option pricing model to estimate the fair value of our share-based payments. The Black-Scholes model meets the requirements of SFAS 123(R), but the fair values generated by the model may not be indicative of the actual fair values of our stock-based awards as the model does not consider certain factors important to stock-based awards, such as continued employment, periodic vesting requirements and limited transferability. The determination of the fair value of share based payment awards utilizing the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We estimate the expected volatility of our stock options at their grant date, placing equal weighting on the historical volatility and the implied volatility of our stock. The expected life of the awards is based on the assumption that unexercised options will be exercised at the midpoint of our valuation date and the full contractual life of the option. The risk-free interest rate assumption is based on the implied yield on zero-coupon government issues with a remaining term equal to the expected term of the stock options. The dividend yield assumption is based on our history and expectation of dividend payouts. The fair value of our restricted stock units is based on the fair market value of our common stock on the date of grant. Stock-based compensation expense recorded in our financial statements in fiscal 2007 and thereafter will be based on awards that are ultimately expected to vest. The amount of stock-based compensation expense in fiscal 2007 and thereafter will be reduced for estimated forfeitures based on historical experience and standard probabilities of employee turnover. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We will evaluate the assumptions used to value stock awards on a quarterly basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. To the extent that we grant additional equity securities to employees or we assume unvested securities in connection with any acquisitions, our stock-based compensation expense will be increased by the additional unearned compensation resulting from those additional grants or acquisitions. Had we adopted SFAS 123(R) in prior periods, the magnitude of the impact of that standard on our results of operations would have approximated the pro forma number impact of SFAS 123 described in Note 6 of our Notes to Consolidated Financial Statements under SFAS 123.

We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 101 (“SAB 101”), Revenue Recognition in Financial Statements as well as SAB 104, Revenue Recognition. These pronouncements require that four basic criteria be met before revenue can be recognized: 1) there is evidence that an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is reasonably assured. We recognize revenue upon determination that all criteria for revenue recognition have been met. In addition, we do not recognize revenue until all customers’ acceptance criteria have been met. The criteria are usually met at the time of product shipment, except for shipments to distributors with rights of return. The portion of revenue from shipments to distributors subject to rights of return is deferred until all return or cancellation privileges lapse. Revenue from shipments to distributors without return rights is recognized upon shipment. In addition, we record reductions to revenue for estimated allowances such as returns, competitive pricing programs and marketing development programs. These estimates are based on our experience with product returns and the contractual terms of the competitive pricing and rebate programs. Shipping terms are generally FCA shipping point. If actual returns or pricing adjustments exceed our estimates, we would record additional reductions to revenue.

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. Our allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts, the aging of accounts receivable, our history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or our customers’ actual defaults exceed our historical experience, our estimates could change and impact our reported results.

Net Revenues. Net revenues for the three and nine months ended December 31, 2006 were $76.6 million and $222.7 million, respectively, representing an increase of 17.5% and 14.3% from the net revenues of $65.2 million and $194.9 million for the three and nine months ended December 31, 2005, respectively. We classified our revenues into three categories based on markets that the underlying products serve. The categories were integrated communication products (“ICP”), storage and other. We use this information to analyze the performance and success in these markets. The increase in total net revenues was primarily attributable to an increase in our ICP revenues. See the following tables (dollars in thousands):

The ICP revenue increased for the three and nine months ended December 31, 2006, largely due to an increase in the sales volume of our ICP products and in particular, an increase in sales of our new embedded products. In addition, storage revenues increased 17.6% for the three months ended December 31, 2006, compared to the three months ended December 31, 2005. Storage revenues increased primarily due to new product introductions and our efforts to enhance our sales channels in Europe. This revenue increase was offset by a decline due to the discontinuance of our Fibre Channel Host Adapter business. Storage revenues for the nine months ended December 31, 2006, compared with the nine months ended December 31, 2005, declined marginally due to the effect of the discontinuance of our Fibre Channel Host Adapter business which was offset by new product introductions and our efforts to enhance our sales channels in Europe. Our other revenues increased by 39.2% during the three months ended December 31, 2006 compared to the three months ended December 31, 2005. However, our other revenues for the nine months ended December 31, 2006 decreased by 28.8% compared to the nine months ended December 31, 2005. This decrease was due to our focus on new product development. We will continue to see our other revenues decline as we focus our efforts on new product development.

As a result of our efforts to reduce ongoing operating expenses, we have refocused our product development efforts on higher growth opportunities (“focus” products) and away from certain legacy products (“nonfocus” products). Product areas we have focused on are products that process, transport and store information. Our process technology products focus on utilizing our sixth generation of network processor cores and our Power Architecture portfolio to meet the needs of the converged internet protocol (“IP”)/Ethernet network while the transport technology products focus on Metro Ethernet, Triple Play access technologies and error correction solutions. The storage technology products address the needs of mass storage based on high performance sequential input/output (I/O). The nonfocus product areas are our legacy switching products, application-specific integrated circuits (“ASICs”), Fibre Channel host bus adapters (“HBAs”), storage area network (“SAN”) ICs, pointer processors, and legacy framers. We expect the revenues from our nonfocus products to continue to decline in the future.

The following tables illustrate revenue from our focus and nonfocus areas (dollars in thousands):

Gross Profit. The following tables present net revenues, cost of revenues and gross profit for the three and nine months ended December 31, 2006 and 2005 (dollars in thousands):

The increase in gross profit for the three and nine months ended December 31, 2006 was primarily attributable to the overall increase in net revenues. The gross profit percentage for the three months ended December 31, 2006 declined to 50.7% compared to 54.0% for the three months ended December 31, 2005. This decline was primarily due to product mix changes and inventory write downs offset by cost improvements and $2.0 million in additional gross profit relating to an arrangement with a customer to buy down a part of its future commitment to purchase products from us. There was no significant change in the gross profit percentage for the nine month period ended December 31, 2006 and 2005.

The amortization of purchased intangible assets included in cost of revenues during the three and nine months ended December 31, 2006 was $4.9 million and $12.5 million, respectively, compared to $3.6 million and $14.0 million for the three and nine months ended December 31, 2005, respectively. Based on the amount of capitalized purchased intangible assets on the balance sheet as of December 31, 2006, we expect amortization expense for purchased intangibles charged to cost of revenues to be $17.4 million in fiscal 2007, $18.4 million in fiscal 2008, and $41.3 million for fiscal periods thereafter. Future acquisitions of businesses may result in substantial additional charges which would impact the gross margin in future periods.

Research and Development and Selling, General and Administrative Expenses. The following tables present research and development and selling, general and administrative expenses for the three and nine months ended December 31, 2006 and 2005 (dollars in thousands):

Research and Development. Research and development (“R&D”) expenses consist primarily of salaries and related costs (including stock-based compensation) of employees engaged in research, design and development activities, costs related to engineering design tools, subcontracting costs and facilities expenses. The increase in R&D expenses for the three and nine month periods ended December 31, 2006, compared to the three and nine months ended December 31, 2005, was primarily due to increased personnel and other expenses related to the acquisition of Quake, offset by a decrease in project expenses. For the three month ended December 31, 2006, R&D expenses increased by 4.8%compared to the three months ended December 31, 2005, primarily due to an increase of $1.3 million in personnel expenses and $1.4 million in intellectual property expenses, offset by a decrease of $1.3 million in foundry expenses and $0.3 million in software expenses. For the nine months ended December 31, 2006, R&D expenses increased by 1.8% compared to the nine months ended December 31, 2005, primarily due to an increase of $3.3 million for intellectual property, $1.0 million for outside contractor expenses and $1.0 million for stock-based compensation expense, offset by a decrease of $1.8 million in foundry expenses, $1.4 million in software costs and $0.7 million in test expenses. We believe that a continued commitment to R&D is vital to our goal of maintaining a leadership position with innovative ICP and storage products. Currently, R&D expenses are focused on the development of ICP and storage products and we expect to continue this focus. Future acquisitions of businesses may result in substantial additional on-going costs.

Selling, General and Administrative. Selling, general and administrative (“SG&A”) expenses consist primarily of personnel-related expenses, professional and legal fees, corporate branding and facilities expenses. The increase in SG&A expenses of 33.5% for the three months ended December 31, 2006 compared to the three months ended December 31, 2005, was primarily due an increase of $2.7 million in professional and legal fees as a result of our self-initiated review of the historical stock option granting policies, $1.3 million in personnel-related expenses, principally related to our newly acquired Quake operations, and $0.9 million for stock-based compensation. The increase in SG&A expenses of 17.0% for the nine months ended December 31, 2006 compared to the nine months ended December 31, 2005, was primarily due to an increase of $4.4 million in professional and legal fees as a result of our self-initiated review of the historical stock option granting policies, $2.1 million in personnel-related expenses, $2.1 million related to stock based compensation and $0.9 million sales commissions, offset by a decrease of $1.6 million in facilities cost. We expect to continue to incur professional and legal fees as we have pending derivative litigation and regulatory proceedings related to our review of our stock option granting practices. Future acquisitions of businesses may result in substantial additional on-going costs.

Stock-Based Compensation. The following tables present stock-based compensation expense for employees engaged in R&D and SG&A activities, which expense is included in the tables above, for the three and nine months ended December 31, 2006 and 2005 (dollars in thousands):

The adoption of SFAS 123(R) will continue to have a significant adverse impact on our reported results of operations, although it will have no impact on our overall liquidity. The amount of unearned stock-based compensation currently estimated to be expensed from now through fiscal 2011 related to unvested share-based payment awards at December 31, 2006 is $16.7 million. This expense relates to equity instruments already issued and will not be affected by our future stock price. The weighted-average period over which the unearned stock-based compensation is expected to be recognized is approximately 1.4 years. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional equity awards to employees or assume unvested equity awards in connection with acquisitions.

For the three and nine months ended December 31, 2005, stock-based compensation expense represents the amortization of deferred compensation related to acquisitions. Deferred compensation is the difference between the fair value of our common stock at the date of each acquisition and the exercise price of the unvested stock options assumed in the acquisition. Stock-based compensation charges, including amounts charged to cost of revenues, were $1.5 million and $4.4 million for the three and nine months ended December 31, 2005, respectively.

Restructuring Charges. The following tables present restructuring charges for the three and nine months ended December 31, 2006 and 2005 (dollars in thousands):

In April 2003, we announced a restructuring program that consisted of a workforce reduction of 185 employees, consolidation of excess facilities and fixed asset disposals. We recognized a total of $23.8 million restructuring cost related to this restructuring program. The restructuring costs consisted of approximately $5.7 million for employee severances, $7.2 million representing the discounted cash flow of lease payments on exited facilities, $3.4 million for the disposal of certain software licenses, and $7.5 million for the write-off of leasehold improvements and property and equipment. This restructuring charge was offset by a $2.6 million restructuring benefit in November 2003 related to the reoccupation of a portion of a building in San Diego and an adjustment for overestimated severance to be paid.

In July 2005, we implemented another restructuring program. The July 2005 restructuring program was implemented to reduce job redundancies and reduce ongoing operating expenses. This restructuring program consisted of the elimination of approximately 40 employees, the disposal of idle fixed assets, and the consolidation of San Diego facilities. As a result of the July 2005 restructuring, we recorded a charge of approximately $5.0 million, consisting of $1.4 million for employee severances, $2.6 million for property and equipment write-offs and $1.0 million representing expenses relating to the consolidation of facilities.

In March 2006, we communicated and began implementation of a plan to exit our operations in France and India and reorganize part of our manufacturing operations. The restructuring program included the elimination of approximately 68 employees. In fiscal year 2006, we recorded a charge of approximately $7.6 million, consisting of $6.0 million for employee severance, $1.0 million for operating leases write-offs, and $0.6 million for asset impairments. For the nine months ended December 31, 2006, the Company recorded an additional charge of approximately $2.2 million, consisting of $0.3 million for excess lease liability, $0.1 million for operating lease commitments and $2.5 million for asset impairments, offset by $0.7 million in workforce reduction liability adjustments. These actions are not anticipated to affect revenues from current products. We anticipate saving approximately $9.0 million annually as a result of this restructuring program.

In June 2006, we implemented another restructuring program. The June 2006 restructuring program was implemented to reduce job redundancies. This restructuring program consisted of the elimination of approximately 20 employees. As a result of the June 2006 restructuring, we recorded a charge of approximately $0.5 million, consisting of employee severances. We anticipate saving approximately $4.0 million annually as a result of this restructuring program.

Interest and Other Income, net. The following tables present interest and other income (expense), net for the three and nine months ended December 31, 2006 and 2005 (dollars in thousands):

Net Interest Income. Net interest income, net of management fees, reflects interest earned on cash and cash equivalents and short-term investment balances as well as realized gains and losses from the sale of short-term investments, less interest expense on our debt and capital lease obligations. The decrease for the three and nine months ended December 31, 2006 is primarily due to lower coupon interest rates and from lower cash and short-term investment balances.

Other Income (Expense), net. Other income (expense), net for the three and nine months ended December 31, 2006 includes income from subleased property and for the three and nine months ended December 31, 2005 includes realized losses on foreign currency hedges and net gains on disposals of property and equipment.

Income Taxes. The following tables present our income tax expense for the three and nine months ended December 31, 2006 and 2005 (dollars in thousands):

The federal statutory income tax rate was 35% for the three and nine months ended December 31, 2006 and 2005. Our income tax expense in fiscal 2007 and 2006 primarily reflects estimated foreign taxes and alternative minimum taxes. Our income tax benefit in the three and nine months ended December 31, 2005 relates to the reversal of a $1.1 million tax contingency accrual at our Israeli subsidiary. The contingency was originally set up in fiscal 2005 when we violated the terms of a tax holiday when we decided to exit our operations in Israel. As a result of a letter we received from the Israeli authorities which cleared us of any tax exposure, we reversed the contingent accrual.

As of December 31, 2006, our principal source of liquidity consisted of $261.0 million in cash, cash equivalents and short-term investments. Working capital as of December 31, 2006 was $290.4 million. Total

cash, cash equivalents, and short-term investments decreased by $9.1 million during the nine months ended

December 31, 2006 primarily as a result of our purchases of equipment, stock repurchase program and net cash paid for acquisitions. At December 31, 2006, we had contractual obligations not included on our balance sheet totaling $47.4 million, primarily related to facilities leases, engineering design software tool licenses and inventory purchase commitments.

For the nine months ended December 31, 2006, we generated $0.1 million in cash from our operations compared to using $1.9 million for our operations in the nine months ended December 31, 2005. Our net loss of $18.9 for the nine months ended December 31, 2006 included $48.8 million of non-cash charges such as $6.5 million of depreciation, $18.6 million of amortization of purchased intangibles, $13.3 million in acquired in-process research and development, $7.9 million of stock-based compensation charges recorded in accordance with SFAS 123(R) and $2.5 million in non-cash restructuring charges. The remaining change in operating cash flows for the nine months ended December 31, 2006 primarily reflected increases in our accounts receivable, inventories and other assets and decreases in accounts payable, accrued payroll and other accrued liabilities and deferred revenue. The increase in our accounts receivable balance is attributable primarily to accounts receivable relating to the acquisition of Quake of $1.9 million in August 2006, change in days sales outstanding from 35 days for the period ended March 31, 2006 to 42 days for the period ended December 31, 2006, and an increase attributable to higher revenues. The increase in our inventory is attributable primarily to inventories related to the acquisition of Quake of $2.9 million in August 2006 and organic growth to serve our longer term inventory requirements. Our net loss of $10.0 million for the nine months ended December 31, 2005 included $34.8 million of non-cash charges such as $10.1 million of depreciation, $17.5 million of amortization of purchased intangibles, $4.4 million of stock-based compensation charges recorded in accordance with SFAS 123(R) and $2.8 million in non-cash restructuring charges. Included in operating cash flows for the nine months ended December 31, 2005 was a payment of $29.3 million for the settlement of the shareholder lawsuit filed in April 2005. The remaining change in operating cash flows for the nine months ended December 31, 2005 primarily reflected increases in our inventories and accounts payable offset by decreases in accounts receivable, other assets, accrued payroll and other accrued liabilities, and deferred revenue.

We used $6.6 million of cash in investing activities during the nine months ended December 31, 2006, compared to generating cash of $25.4 million during the nine months ended December 31, 2005. During the nine months ended December 31, 2006, we used $72.0 million net cash for the Quake acquisition, $1.5 million for strategic investments and $5.8 million for the purchase of property, equipment and other assets, offset by net proceeds of $72.7 million from short-term investment activities. During the nine months ended December 31, 2005, we generated net proceeds of $35.5 million from short-term investment activities offset by strategic investments of $3.5 million and net purchases of property, equipment and other assets of $6.6 million.

We used $2.6 million of cash for the nine months ended December 31, 2006 for financing activities compared to using $57.9 million for the nine months ended December 31, 2005. The major financing use of cash for the nine months ended December 31, 2006 was open market repurchase of our stock for $20.1 million offset by funds received from structured stock repurchase programs of $17.4 million and the sales of common stock through employee stock options. The major financing use of cash for the nine months ended December 31, 2005 was related to the funding of structured stock repurchase programs offset by sales of common stock through employee stock options and employee stock purchase plan.

On August 25, 2006, we acquired Quake. Under the terms of the Merger Agreement, we acquired Quake’s net tangible assets and intellectual property for $81.2 million in cash, including merger costs. Of the amount paid, $12.0 million will be placed in escrow for at least one year in order to secure the indemnification obligation of Quake.

On August 12, 2004, our board of directors authorized a stock repurchase program for the repurchase of up to $200.0 million of our common stock. Under the program, we are authorized to make purchases in the open market or enter into structured agreements. During the nine months ended December 31, 2006, we repurchased 6.2 million shares on the open market at a weighted average price of $3.23. From the time the program was first implemented through December 31, 2006, we repurchased on the open market 15.6 million shares at a weighted average price of $3.01 per share. At December 31, 2006, $85.5 million remained available to repurchase shares under the authorized program, as amended.

We also utilize structured stock repurchase agreements to buy back shares which are prepaid written put options on our common stock. We pay a fixed sum of cash upon execution of each agreement in exchange for the right to receive either a pre-determined amount of cash or stock depending on the closing market price of our common stock on the expiration date of the agreement. Upon expiration of each agreement, if the closing market price of our common stock is above the pre-determined price, we will have our investment returned with a premium. If the closing market price is at or below the pre-determined price, we will receive the number of shares specified at the agreement inception. Any cash received, including the premium, is treated as an increase to additional paid-in capital on the balance sheet in accordance with the guidance issued in EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.

During the nine months ended December 31, 2006, we received $17.4 million in cash and 7.7 million in shares from open structured stock repurchase programs. At December 31, 2006, we had no structured stock repurchase agreements open. From the time of the stock repurchase program inception through December 31, 2006, the Company entered into structured stock repurchase agreements totaling $164.5 million. Upon settlement of these underlying agreements, the Company received $105.9 million in cash and 23.0 million shares of its common stock at an effective purchase price of $2.55 per share.

The table below is a summary of our repurchase program share activity for the nine months ended December 31, 2006 and 2005 (in thousands, except per share data):

We believe that our available cash, cash equivalents and short-term investments will be sufficient to meet our capital requirements and fund our operations 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 or at all.

The following table summarizes our contractual obligations not included on the balance sheet as of December 31, 2006 (in thousands):

Market risk is the potential loss arising from adverse changes in market rates and prices, such as foreign currency exchange rates, interest rates and a decline in the stock market. We are exposed to market risks related to changes in interest rates and foreign currency exchange rates.

We maintain an investment portfolio of various holdings, types and maturities. These securities are classified as available-for-sale and, consequently, are recorded on the consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (or loss). We have established guidelines relative to diversification and maturities that attempt to maintain safety and liquidity. These guidelines are periodically reviewed and modified to take advantage of interest rate trends. We invest our excess cash in debt instruments of the U.S. Treasury, corporate bonds, mortgage-backed and asset backed securities and closed-end bond funds, with credit ratings as specified in our investment policy. We also have invested in preferred stocks, which pay quarterly fixed rate dividends. We generally do not utilize derivatives to hedge against increases in interest rates which decrease market values, except for investments managed by one investment manager who utilizes U.S. Treasury bond futures options (“futures options”) as a protection against the impact of increases in interest rates on the fair value of preferred stocks managed by that investment manager.

We are exposed to market risk as it relates to changes in the market value of our investments. At December 31, 2006, our investment portfolio included fixed-income securities classified as available-for-sale investments with a fair market value of $221.0 million and a cost basis of $225.9 million. These securities are subject to interest rate risk, as well as credit risk, and will decline in value if interest rates increase or an issuer’s credit rating or financial condition is decreased. The following table presents the hypothetical changes in fair value of our short-term investments held at December 31, 2006 (in thousands):

The modeling technique used measures the change in fair market value arising from selected potential changes in interest rates. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points, 100 basis points, and 150 basis points.

We invest in equity instruments of private companies for business and strategic purposes. These investments are valued based on our historical cost, less any recognized impairments. The estimated fair values are not necessarily representative of the amounts that we could realize in a current transaction.

We generally conduct business, including sales to foreign customers, in U.S. dollars, and as a result, we have limited foreign currency exchange rate risk. However, we have entered into forward currency exchange contracts to hedge our overseas monthly operating expenses when deemed appropriate. Gains and losses on foreign currency forward contracts that are designated and effective as hedges of anticipated transactions, for which a firm commitment has been attained, are deferred and included in the basis of the transaction in the same period that the underlying transaction is settled. Gains and losses on any instruments not meeting the above criteria are recognized in income or expenses in the consolidated statement of operations in the current period. 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.

Our chief executive officer and chief financial officer performed an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of December 31, 2006. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective and sufficient to ensure that the information required to be disclosed in the reports that we file under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

There was no change in our internal control over financial reporting that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

The information set forth under Note 7 of Notes to Consolidated Financial Statements, included in Part I, Item 1 of this report, is incorporated herein by reference.

Before deciding to invest in us or to maintain or increase your investment, you should carefully consider the risks described below, in addition to the other information contained in this report and in our other filings with the SEC. The risks and uncertainties described below and in our other filings are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business. If any of these known or unknown risks or uncertainties actually occurs, our business, financial condition and results of operations could be seriously harmed. In that event, the market price for our common stock could decline and you may lose your investment. The risks and uncertainties set forth below with an asterisk (“*”) next to the title contain changes to the description of the risks and uncertainties associated with our business as previously disclosed in Item 1A to our Annual Report on Form 10-K for the fiscal year ended March 31, 2006.

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:

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

Our business is characterized by short-term orders and shipment schedules. Customer orders typically can be cancelled 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 is highly unpredictable and can fluctuate substantially. Customer orders for our products typically have non-standard lead times, which makes it difficult for us to predict revenues and plan inventory levels and production schedules. If we are unable to plan inventory levels and production schedules 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 contract manufacturers, 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 products less marketable. If we are forced to hold excess inventory or we incur unanticipated inventory write-downs, our financial condition and operating results could be materially harmed.

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

Our business substantially depends upon the continued growth of the technology sector and the Internet.

The technology equipment industry is cyclical and has experienced significant and extended downturns in the past. A substantial portion of our business and revenue depends on the continued growth of the technology sector and the Internet. We sell our communications IC products primarily to communications equipment manufacturers that in turn sell their equipment to customers that depend on the growth of the Internet. OEMs and other customers that buy our storage products are similarly dependent on continued internet growth and information technology spending. If there is an economic slowdown or reduction in capital spending, our business, operating results, and financial condition may be materially harmed.

The loss of one or more key customers, the diminished demand for our products from a key customer, or the failure to obtain certifications from a key customer or its distribution channel 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 our key customers. One or more of our key customers may discontinue operations as a result of consolidation, liquidation or otherwise. Continued reductions, delays and cancellation of orders from our key 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:

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

In addition, before we can sell our storage products to an OEM, either directly or through the OEM’s associated distribution channel, that OEM must certify our products. The certification process can take up to 12 months. This process requires the commitment of OEM personnel and test equipment, and we compete with other suppliers for these resources. Any delays in obtaining these certifications or any failure to obtain these certifications would adversely affect our ability to sell our storage products.

Any significant order cancellations or order deferrals could adversely affect our operating results.

We typically sell products pursuant to purchase orders that customers can generally cancel or defer on short notice without incurring a significant penalty. Any significant cancellations or deferrals in the future could materially and adversely affect our business, financial condition and results of operations. Cancellations or deferrals could cause us to hold excess inventory, which could reduce our profit margins, increase product obsolescence and restrict our ability to fund our operations. We generally recognize revenue upon shipment of products to a customer. If a customer refuses to accept shipped products or does not pay for these products, we could miss future revenue projections or incur significant charges against our income, which could materially and adversely affect our operating results.

Our products typically have lengthy design cycles. A customer may decide to cancel or change its product plans, which could cause us to lose anticipated sales.

After we have developed and delivered a product to a customer, the customer will usually test and evaluate our product prior to designing its own equipment to incorporate our product. Our customers may need three to more than six months to test, evaluate and adopt our product and an additional three to more than nine months to begin volume production of equipment that incorporates our product. Due to this lengthy design cycle, we may experience significant delays from the time we increase our operating expenses and make investments in inventory until the time that we generate revenue from these products. It is possible that we may never generate any revenue from these products after incurring such expenditures. Even if a customer selects our product to incorporate into its equipment, we cannot assure you that the customer will ultimately market and sell its

equipment or that such efforts by our customer will be successful. The delays inherent in our lengthy design cycle increase the risk that a customer will decide to cancel or change its product plans. Such a cancellation or change in plans by a customer could cause us to lose sales that we had anticipated.

While our design cycles are typically long, some of our product life cycles tend to be short as a result of the rapidly changing technology environment in which we operate. As a result, the resources devoted to product sales and marketing may not generate material revenue for us, and from time to time, we may need to write off excess and obsolete inventory. If we incur significant marketing expenses and investments in inventory in the future that we are not able to recover, and we are not able to mitigate those expenses, our operating results could be adversely affected. In addition, if we sell our products at reduced prices in anticipation of cost reductions but still hold higher cost products in inventory, our operating results would be harmed.

An important part of our strategy is to continue our focus on the markets for communications and storage equipment. If we are unable to further expand our share of these markets, our revenues may not grow and could further 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, or if our products fail to be certified by OEMs, we would lose business from an existing or potential customer and would not have the opportunity to compete for new design wins or certification 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 certifying or 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.

We expect a significant portion of our revenues to continue to be derived from sales of products based on current, widely accepted 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.

Customers for our products generally have substantial technological capabilities and financial resources. They traditionally use these resources to internally develop their own products. The future prospects for our products in these markets are dependent upon our customers’ acceptance of our products as an alternative to their internally developed products. Future prospects also are dependent upon acceptance of third-party sourcing for products as an alternative to in-house development. Network equipment vendors may in the future continue to use internally developed components. They also may decide to develop or acquire components, technologies or products that are similar to, or that may be substituted for, our products.

If our network equipment vendor customers fail to accept our products as an alternative, if they develop or acquire the technology to develop such components internally rather than purchase our 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.

The discontinuance of our Fibre Channel host bus adapter products have resulted in a decline in revenue that we realize from sales of these products and we may incur significant costs due to customer obligations relating to these products.

In fiscal 2005, we discontinued our Fibre Channel host bus adaptor products designed to operate on Sun’s Solaris servers. These products accounted for a significant portion of our revenue from sales of storage products during fiscal 2005. Although sales of these products are no longer material, we continue to have obligations to customers that relate to these products, including obligations for warranty support, maintenance and repairs. Our ability to fulfill these obligations has been limited by previous reductions in force. These obligations while currently being met could expand and result in significantly increased liability, costs, and expenses.

Our industry and markets are subject to consolidation, which may result in stronger competitors, fewer customers and reduced demand.

There has been industry consolidation among communications IC companies, network equipment companies and telecommunications companies in the past. We expect this consolidation to continue as companies attempt to strengthen or hold their positions in evolving markets. Consolidation may result in stronger competitors, fewer customers and reduced demand, 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. The revenues we derive from international sales may be subject to certain risks, including:

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 laws in the United States. As a result, our ability to enforce our rights under such agreements may be limited compared with our ability to enforce our rights under agreements governed by laws in the United States.

Our cash and cash equivalents and portfolio of short-term investments are exposed to certain market risks.

We maintain an investment portfolio of various holdings, types of instruments and maturities. These securities are recorded on our consolidated balance sheets at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income (loss), net of tax. Our investment portfolio is exposed to market risks related to changes in interest rates and credit ratings of the issuers, as well as to the risks of default by the issuers. Substantially all of these securities are subject to interest rate and credit rating risk and will decline in value if interest rates increase or one of the issuers’ credit ratings is reduced. Increases in interest rates or decreases in the credit worthiness of one or more of the issuers in our investment portfolio could have a material adverse impact on our financial condition or results of operations.

Our restructuring activities could result in management distractions, operational disruptions and other difficulties.

Over the past several years, we have initiated several restructuring activities in an effort to reduce operating costs. Employees whose positions were eliminated in connection with these restructuring plans may seek future employment with our customers or competitors. Although all employees are required to sign a confidentiality agreement with us at the time of hire, we cannot assure you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Any additional restructuring efforts could divert the attention of our management away from our operations, harm our reputation and increase our expenses. We cannot assure you that we will not undertake additional restructuring activities, that any future restructuring efforts will be successful, or that we will be able to realize the cost savings and other anticipated benefits from our previous or future restructuring plans. In addition, if we continue to reduce our workforce, it may adversely impact our ability to respond rapidly to any new growth opportunities.

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

To develop new products for the communications, storage or other technology 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. 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. Our pursuit of technological advances may require substantial time and expense and may ultimately prove unsuccessful. If we are not successful in introducing such advances, we will be unable to timely bring to market new products and our revenues will suffer.

Many of our products 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 or requirements, we could miss opportunities to achieve crucial design wins. If we fail to do so, we may not achieve design wins with key customers or may subsequently lose such design wins, and 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.

The markets in which we compete are highly competitive, and we expect competition to increase in these markets in the future.

The markets in which we compete are highly competitive, and we expect that domestic and international competition will increase in these markets, due in part to deregulation, rapid technological advances, price erosion, changing customer preferences and evolving industry standards. Increased competition could result in significant price competition, reduced revenues, lower profit margins or loss of market share. Our ability to compete successfully in our markets depends on a number of factors, including:

Our competitors may offer enhancements to existing products, or offer new products based on new technologies, industry standards or customer requirements, 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 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. Each of these factors could have a material adverse effect on our business, financial condition and results of operations.

In the communications IC markets, we compete primarily against companies such as Agere, Broadcom, Intel, Mindspeed, PMC-Sierra and Vitesse. In the storage market, we primarily compete against companies such as Adaptec, Areca, Hewlett-Packard, LSI Logic, and Promise. Our embedded processor products compete against products from Freescale Semiconductor, IBM and Intel. Many of these companies have substantially greater financial, marketing and distribution resources than we have. Certain of our customers or potential customers have internal IC design or manufacturing capabilities with which we compete. We may also face competition

from new entrants to the storage market, including larger technology companies that may develop or acquire differentiating technology and then apply their resources to our detriment. Any failure by us to compete successfully in these target markets, would have a material adverse effect on our business, financial condition and results of operations.

The storage market continues to mature and become commoditized. To the extent that commoditization leads to significant pricing declines, whether initiated by us or by a competitor, we will be required to increase our product volumes and reduce our costs of goods sold to avoid resulting pressure on our profit margin for these products, and we cannot assure you that we will be successful in responding to these competitive pricing pressures.

We do not have an internal wafer fabrication capability, which could result in unanticipated liability and reduced revenues.

During fiscal 2003, we closed our internal wafer fabrication facility and no longer have the ability to manufacture products internally. As a result, we are subject to substantial risks, including:

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.

We depend upon third parties to manufacture, assemble or package certain of our products. As a result, we are subject to risks associated with these third parties, including:

Our outside foundries generally manufacture our products on a purchase order basis, and we have very few long-term supply arrangements with these suppliers. We have less control over delivery schedules, manufacturing yields and costs than competitors with their own fabrication facilities. A manufacturing disruption experienced by one or more of our outside foundries or a disruption of our relationship with an outside foundry, including discontinuance of our products by that foundry, would negatively impact the production of certain of our products for a substantial period of time.

Our IC products are generally 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 short notice. There is also the potential that they may discontinue manufacturing our products or go out of business. Because establishing relationships, designing or redesigning ICs, and ramping production with new outside foundries may take over a year, there is no readily available alternative source of supply for these products.

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 of our IC products. 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 us 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 delayed product delivery, which would harm our profitability and customer relationships.

If the foundries or 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 be unable to deliver products to our customers, which could materially adversely affect our operating results. The transition to the next generation of manufacturing technologies at one or more of our outside foundries could be unsuccessful or delayed.

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 of an older or lower-volume process that it uses to produce our parts. We cannot assure you that 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.

Some companies that supply our customers are similarly dependent on a limited number of suppliers to produce their products. These other companies’ products may be designed into the same networking equipment into which our products are designed. Our order levels could be reduced materially if these companies are unable to access sufficient production capacity to produce in volumes demanded by our customers because our customers may be forced to slow down or halt production on the equipment into which our products are designed.

Our operating results depend on manufacturing output and yields of our ICs and printed circuit board assemblies, which may not meet expectations.

The yields on wafers we have manufactured 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 defects. Many of these problems are difficult to diagnose, are time consuming and expensive to remedy, and can result in shipment delays.

We estimate yields per wafer and final packaged parts 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 may have to 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 manufacturing facility.

We may experience difficulties in transitioning to smaller geometry process technologies or in achieving higher levels of design integration and that may result in reduced manufacturing yields, delays in product deliveries and increased expenses.

As smaller line width geometry processes become more prevalent, we expect to integrate greater levels of functionality into our IC products and to transition our IC products to increasingly smaller geometries. This

transition will require us to redesign certain products and will require us and our foundries to migrate to new manufacturing processes for our products. We may not be able to achieve higher levels of design integration or deliver new integrated products on a timely basis. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies to reduce our costs and increase performance, and we have designed IC products to be manufactured at as little as .13 micron geometry processes. We have experienced some difficulties in shifting to smaller geometry process technologies and new manufacturing processes. These difficulties resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our IC products to smaller geometry processes. We are dependent on our relationships with our foundries to transition to smaller geometry processes successfully. We cannot assure you that our foundries will be able to effectively manage the transition or that we will be able to maintain our relationships with our foundries. If we or our foundries experience significant delays in this transition or fail to implement this transition, our business, financial condition and results of operations could be materially and adversely affected.

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

Our future success will depend upon our ability to improve existing IC process technologies or acquire new IC process technologies. In the future, we may be required to transition one or more of our IC products to process technologies with smaller geometries, other materials or higher speeds in order to reduce costs or improve product performance. We may not be able to improve our process technologies or otherwise gain access to new process technologies in a timely or affordable manner. Products based on these technologies may not achieve market acceptance.

The complexity of our products may lead to errors, defects and bugs, which could negatively impact our reputation with customers and result in liability.

Products as complex as ours may 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 or result in a costly recall and 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 with device functionality, resulting in interruptions, delays or cessation of sales to our customers.

We may also be required to make significant expenditures of capital and resources to resolve such problems. We cannot assure you that problems will not be found in new products after commencement of commercial production, despite testing by us, our suppliers or our customers. Any problem could result in:

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

A change in the accounting treatment of stock-based awards will adversely affect our results of operations.

In December 2004, the Financial Accounting Standards Board issued revised Statement of Financial Accounting Standards 123 (“SFAS 123(R)”), Share-Based Payment which requires companies to expense employee stock options and other stock-based awards for financial reporting purposes. Pursuant to SFAS 123(R),

in April 2006 we began valuing our employee stock option grants pursuant to an option valuation model, and then amortizing that value against our reported earnings over the vesting period in effect for those options. Prior to our adoption of SFAS 123(R), we accounted for stock-based awards to employees in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and utilized the disclosure-only alternative of SFAS 123 and SFAS 128, each of which was superseded by SFAS 123(R). The change in accounting treatment resulting from SFAS 123(R) will materially and adversely affect our reported results of operations as stock-based compensation expense is charged directly against our reported earnings. For an illustration of the effect of the new accounting treatment on our recent results of operations, see Note 1 of our Notes to Consolidated Financial Statements.

If our internal controls over financial reporting are not considered effective, our business and stock price could be adversely affected.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal controls over financial reporting as of the end of each fiscal year, and to include a management report assessing the effectiveness of our internal controls over financial reporting in our annual report on Form 10-K for that fiscal year. Section 404 also requires our independent registered public accounting firm to attest to, and report on, management’s assessment of our internal controls over financial reporting.

Our management, including our chief executive officer and chief financial officer, does not expect that our internal controls over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud involving a company have been, or will be, detected. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Our management has concluded, and our independent registered public accounting firm has attested, that our internal control over financial reporting was effective as of March 31, 2006. In connection with the investigation of our historical stock option grant practices, we did identify material weaknesses in our internal control over financial reporting that existed in fiscal years prior to fiscal 2005. We cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our internal controls in the future. A material weakness in our internal controls over financial reporting would require management and our independent registered public accounting firm to evaluate our internal controls as ineffective. If our internal controls over financial reporting are not considered effective, we may experience a loss of public confidence, which could have an adverse effect on our business and on the market price of our common stock.

If we are unable to transition our accounting function smoothly, our ability to report our financial results accurately or on a timely basis may be adversely affected. *

We are in the process of transitioning a majority of our accounting function from San Diego to Sunnyvale. This also involves rebuilding the accounting team for positions that do not relocate to Sunnyvale. If we are unable to complete the transition to the new team in a smooth and effective manner, it may adversely impact our ability to report our financial results accurately or in a timely fashion. The inability to transition in an effective manner could also have an adverse impact on our internal control environment and may cause us to have material weaknesses in our internal controls over financial reporting and consequently may cause our management or our independent registered public accounting firm to determine our internal controls are ineffective. The existence of

any or all of the conditions detailed above may cause us to lose public confidence, may jeopardize the continued listing of our common stock, could have an adverse impact on our business and adversely impact the market price of our common stock.

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

Our future success depends to a significant extent upon the continued service of our senior management personnel. The loss of key senior executives could have a material adverse effect on us. There is intense competition for qualified personnel in the semiconductor industry, in particular design, product and test engineers, and we may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business, or to replace engineers or other qualified personnel who may leave our employment in the future. There may be significant costs associated with recruiting, hiring and retention of personnel. 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 development or other aspects of our business.

In May 2004, we acquired IBM’s Embedded PowerPC business. In conjunction with that transaction, IBM transferred 51 of its PowerPC employees in France to us. The transfer was made pursuant to the “forced march” provisions of the French Labor Code. In October 2004, the IBM Works Council together with the trade union sued IBM, challenging the transfer of employees to us. In December 2005, the Court of Appeals in France ruled that the IBM PowerPC employees should not have been transferred to us. As a result, all of our PowerPC employees in France returned to IBM. IBM is currently providing transitional services to us from the employees who returned to IBM. We are in the process of hiring permanent replacements for these employees. However, we may be unable to locate and recruit qualified employees for these positions and the cost to re-staff the workforce may be significant and time-consuming.

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 future acquisitions would require significant additional management, technical and administrative resources. We cannot assure you that we would be able to manage our expanded operations effectively.

Our ability to supply 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.

The manufacture of our products requires significant amounts of water. Previous droughts have resulted in restrictions being placed on water use by manufacturers. In the event of a future drought, reductions in water use may be mandated generally and our external foundries’ ability to manufacture our products could be impaired.

Several of our facilities, including our principal executive offices, are located in California. In 2001, California experienced prolonged energy alerts and blackouts caused by disruption in energy supplies. As a consequence, California continues to experience substantially increased costs of electricity and natural gas. We are unsure whether these alerts and blackouts will reoccur or how severe they may become in the future. Many of our customers and suppliers are also headquartered or have substantial operations in California. If we, or any of our major customers or suppliers located in California, experience a sustained disruption in energy supplies, our results of operations could be materially and adversely affected.

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

The effects of war, acts of terrorism or global threats, including, but not limited to, the outbreak of epidemic disease, could have a material adverse effect on our business, operating results and financial condition. 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 local and global 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 and adversely affected.

We have been named as a party to several derivative action lawsuits arising from our internal option review, and we may be named in additional litigation, all of which could require significant management time and attention and result in significant legal expenses and may result in an unfavorable outcome which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

We are subject to a number of lawsuits purportedly on behalf of Applied Micro Circuits Corporation against certain of our current and former executive officers and board members, and we may become the subject of additional private or government actions. The expense of defending such litigation may be significant. The amount of time to resolve these lawsuits is unpredictable and defending ourselves may divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows. In addition, an unfavorable outcome in such litigation could have a material adverse effect on our business, results of operations and cash flows.

As a result of our option review and restatement, we are subject to investigations by the SEC and Department of Justice (“DOJ”), which may not be resolved favorably and has required, and may continue to require, a significant amount of management time and attention and accounting and legal resources, which could adversely affect our business, results of operations and cash flows.

The SEC and the DOJ are currently conducting investigations relating to our historical stock option grant practices. We have been responding to, and continue to respond to, inquiries from the SEC and DOJ. The period of time necessary to resolve the SEC and DOJ investigations is uncertain, and these matters could require significant management and financial resources which could otherwise be devoted to the operation of our business. If we are subject to an adverse finding resulting from the SEC and DOJ investigations, we could be required to pay damages or penalties or have other remedies imposed upon us. The restatement of our financial statements, the ongoing SEC and DOJ investigations and any negative outcome that may occur from these investigations could impact our relationships with customers and our ability to generate revenue. In addition, considerable legal and accounting expenses related to these matters have been incurred to date and significant expenditures may continue to be incurred in the future. The SEC and DOJ investigations could adversely affect our business, results of operations, financial position and cash flows.

The process of restating our financial statements, making the associated disclosures, and complying with SEC requirements was subject to uncertainty and evolving requirements. *

We worked with our independent registered public accounting firm and the SEC to make our filings comply with all related requirements. The issues surrounding the historical stock option grant practices are complex and the regulatory guidelines or requirements continue to evolve. There can be no assurance that further SEC and other requirements will not evolve and that we will not be required to further amend this filing. In addition to the cost and time to amend financial reports, such an amendment may have a material adverse affect on investors and our common stock price.

If we do not maintain compliance with Nasdaq listing requirements, our common stock could be delisted, which could have a material adverse effect on the trading price of our common stock and cause some investors to lose interest in our company. *

As a result of our option investigation, we were delinquent in filing certain of our periodic reports with the SEC, and consequently we were not in compliance with Nasdaq’s Marketplace Rules. As a result, we underwent

a review and hearing process with Nasdaq to determine our listing status. Once we filed the delinquent periodic reports with the SEC, Nasdaq permitted our securities to remain listed on the Nasdaq Global Select Market, but our securities could be delisted in the future if we do not maintain compliance with applicable listing requirements. Being delisted could affect our access to the capital markets and our ability to raise capital through alternative financing sources on terms acceptable to us or at all and could cause our investors, suppliers, customers and employees to lose confidence in us.

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 that were 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 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 (“PRP”) 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 PRPs that has agreed to fund certain on-going remediation efforts at the Omega Chemical site. 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 Chemical site, will not have a material adverse effect on our business.

Environmental laws and regulations could cause a disruption in our business and operations.

We are subject to various state, federal and international laws and regulations governing the environment, including those restricting the presence of certain substances in electronic products and making manufacturers of those products financially responsible for the collection, treatment, recycling and disposal of certain products. Such laws and regulations have been passed in several jurisdictions in which we operate, including various European Union (“EU”) member countries. For example, the European Union has enacted the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (“RoHS”) and the Waste Electrical and Electronic Equipment (“WEEE”) directives. RoHS prohibits the use of lead and other substances, in semiconductors and other products put on the market after July 1, 2006. The WEEE directive obligates parties that place electrical and electronic equipment on the market in the EU to put a clearly identifiable mark on the equipment, register with and report to EU member countries regarding distribution of the equipment, and provide a mechanism to take back and properly dispose of the equipment. There can be no assurance that similar programs will not be implemented in other jurisdictions resulting in additional costs, possible delays in delivering products, and even the discontinuance of existing and planned future product replacements if cost were to become prohibitive.

Our business strategy contemplates the acquisition of other companies, products and technologies. Merger and acquisition activities involve numerous risks and we may not be able to address these risks successfully without substantial expense, delay or other operational or financial problems.

Acquiring products, technologies or businesses from third parties is part of our business strategy. The risks involved with merger and acquisition activities include:

Any of these risks could materially harm our business, financial condition and results of operations.

As with past acquisitions, future acquisitions could adversely affect operating results. In particular, acquisitions may materially and adversely affect our results of operations because they may require large one-time charges or could result in increased debt or contingent liabilities, adverse tax consequences, substantial additional depreciation or deferred compensation charges. Our past purchase acquisitions required us to capitalize significant amounts of goodwill and purchased intangible assets. As a result of the slowdown in our industry and reduction of our market capitalization, we have been required to record significant impairment charges against these assets as noted in our financial statements. At December 31, 2006, we had $422.0 million of goodwill and purchased intangible assets. We cannot assure you that we will not be required to take additional significant charges as a result of an impairment to the carrying value of these assets, due to further declines in market conditions.

Any acquisitions we make could disrupt our business and harm our results of operation and financial condition.

In August 2006, we acquired Quake Technologies, Inc. (“Quake”), and we may make additional investments in or acquire other companies, products or technologies. These acquisitions involve numerous risks, including:

We cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire. For example, with the acquisition of Quake, we acquired the technology necessary to introduce 10 Gigabit Ethernet physical layer chips and advance our efforts in the enterprise part of the market. 10 Gigabit Ethernet is an emerging technology, and we cannot assure you that this technology will be successful. In addition, several of our competitors have introduced similar products in the last quarter. If our customers do not purchase our new power amplifier modules, our development and integration efforts will have been unsuccessful, and our business may suffer.

Our subsidiary has been named as a defendant in litigation that could result in substantial costs and divert management’s attention and resources.

JNI, which we acquired in October 2003, has a number of pending lawsuits relating to alleged securities law violations and alleged breaches of fiduciary duty. We believe that the claims pending against JNI are without merit, and we have engaged in a vigorous defense against such claims. If we are not successful in our defense against such claims, we could be forced to make significant payments to the plaintiffs 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 including, but not limited to, attorney and expert fees, and divert management’s attention and resources, which could have an adverse effect on our business. Although insurers have paid defense costs to date, we cannot assure you that insurers will continue to pay such costs, judgments or other expenses associated with the lawsuit.

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 adequately protect the intellectual property in our products, will provide us with competitive advantages or will not be challenged by third parties, or that if challenged, any such patent will be found to be valid or enforceable. 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 assure you 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. A failure by us to meaningfully protect our intellectual property could have a material adverse effect on our business, financial condition and operating results.

We generally enter into confidentiality agreements with our employees, consultants and strategic partners. We also try to control access to and distribution of our technologies, documentation and other proprietary information. Despite these efforts, parties may attempt to copy, disclose, obtain or use our products, services or technology without our authorization. Also, former employees may seek employment with our business partners, customers or competitors and we you that the confidential nature of our proprietary information will be maintained in the course of such future employment. Additionally, former employees or third parties could attempt to penetrate our network to misappropriate our proprietary information or interrupt our business. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. As a result, our technologies and processes may be misappropriated, particularly in foreign countries where laws may not protect our proprietary rights as fully as in the United States.

We could be harmed by litigation involving patents, proprietary rights or other claims.

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 on 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 assure you 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 will not harm our business.

Any litigation relating to the intellectual property rights of third parties 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.

From time to time, we may be involved in litigation relating to other claims arising out of our operations in the normal course of business. We cannot assure you that the ultimate outcome of any such matters will not have a material, adverse effect on our business, financial condition or operating results.

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:

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. In some instances, these fluctuations appear to have been unrelated or disproportionate to the operating performance of the affected companies. Any such fluctuation could 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 issuance of our common stock may result in immediate dilution of our stockholders.

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.


APPLIED MICRO CIRCUITS CORPORATION

By:		/s/ ROBERT G. GARGUS
		Robert G. Gargus
		Senior Vice President and Chief Financial Officer (Duly Authorized Signatory and Principal Financial and Accounting Officer)


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

215 Moffett Park Drive, Sunnyvale, CA		94089
(Address of principal executive offices)		(Zip code)


		Page
Part I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Balance Sheets at December 31, 2006 (unaudited) and March 31, 2006	3

	Condensed Consolidated Statements of Operations (unaudited) for the three and nine months ended December 31, 2006 and 2005	4

	Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended December 31, 2006 and 2005	5

	Notes to Condensed Consolidated Financial Statements (unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38

Item 4.	Controls and Procedures	39

Part II.	OTHER INFORMATION

Item 1.	Legal Proceedings	40

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	58

Item 3.	Defaults Upon Senior Securities	58

Item 4.	Submission of Matters to a Vote of Security Holders	58

Item 5.	Other Information	58

Item 6.	Exhibits	58

Signatures		59


	December 31, 2006			March 31, 2006
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	40,045		$	49,125
Short-term investments-available-for-sale		220,995			286,540
Accounts receivable		35,741			26,324
Inventories		37,273			24,941
Other current assets		16,351			12,618

Total current assets		350,405			399,548
Property and equipment, net		32,010			36,127
Goodwill and purchased intangibles, net		422,009			381,066
Other assets		12,099			8,685

Total assets	$	816,523		$	825,426


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	24,960		$	24,656
Accrued payroll and related expenses		8,428			7,409
Other accrued liabilities		23,321			27,017
Deferred revenue		3,321			3,536

Total current liabilities		60,030			62,618
Stockholders’ equity:
Preferred stock, $0.01 par value:
Authorized shares—2,000, none issued and outstanding		—			—
Common stock, $0.01 par value:
Authorized shares—630,000 at December 31, 2006 and March 31, 2006 Issued and outstanding shares—281,826 at December 31, 2006 and 295,440 at March 31, 2006		2,817			2,954
Additional paid-in capital		5,948,995			5,945,555
Deferred compensation, net		—			(2,087	)
Accumulated other comprehensive loss		(4,193	)		(11,367	)
Accumulated deficit		(5,191,126	)		(5,172,247	)

Total stockholders’ equity		756,493			762,808

Total liabilities and stockholders’ equity	$	816,523		$	825,426


	Three Months Ended December 31,						Nine Months Ended December 31,
	2006			2005			2006			2005
Net revenues	$	76,642		$	65,243		$	222,685		$	194,851
Cost of revenues		37,799			30,017			104,863			91,943

Gross profit		38,843			35,226			117,822			102,908
Operating expenses:
Research and development		24,550			23,429			72,242			70,934
Selling, general and administrative		20,056			15,022			54,368			46,484
Acquired in-process research and development		—			—			13,300			—
Amortization of purchased intangible assets		1,350			1,107			3,645			3,481
Restructuring charges		67			1,339			2,733			4,898

Total operating expenses		46,023			40,897			146,288			125,797

Operating loss		(7,180	)		(5,671	)		(28,466	)		(22,889	)
Interest income, net		3,028			4,251			9,623			11,724
Other income, net		93			689			292			157

Loss before income taxes		(4,059	)		(731	)		(18,551	)		(11,008	)
Income tax expense (benefit)		113			(1,315	)		327			(964	)

Net income (loss)	$	(4,172	)	$	584		$	(18,878	)	$	(10,044	)

Basic net income (loss) per share:
Net income (loss) per share	$	(0.01	)	$	0.00		$	(0.07	)	$	(0.03	)

Shares used in calculating basic net income (loss) per share		281,799			297,119			284,913			302,974

Diluted net income (loss) per share:
Net income (loss) per share	$	(0.01	)	$	0.00		$	(0.07	)	$	(0.03	)

Shares used in calculating diluted net income (loss) per share		281,799			299,049			284,913			302,974


	Nine Months Ended December 30,
	2006			2005
Operating activities:
Net loss	$	(18,878	)	$	(10,044	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities
Depreciation and amortization		6,518			10,111
Amortization of purchased intangibles		18,551			17,500
Acquired in-process research and development		13,300			—
Stock-based compensation expense
Stock options		7,854			4,443
Restricted stock units		59			—
Non-cash restructuring charges		2,521			2,804
Net (gain) loss on disposals of property and equipment		34			(4	)
Changes in operating assets and liabilities
Accounts receivable		(7,973	)		6,211
Inventories		(11,294	)		(2,634	)
Other assets		(3,148	)		33,452
Accounts payable		(719	)		4,252
Accrued payroll and other accrued liabilities		(6,315	)		(67,394	)
Deferred revenue		(372	)		(581	)

Net cash provided by (used in) operating activities		138			(1,884	)

Investing activities:
Proceeds from sales and maturities of short-term investments		379,413			923,685
Purchases of short-term investments		(306,744	)		(888,231	)
Purchase of strategic investments		(1,500	)		(3,500	)
Purchase of property, equipment and other assets		(5,783	)		(6,705	)
Proceeds from sale of property, equipment and other assets		—			101
Net cash paid for acquisitions		(71,971	)		—

Net cash provided by (used in) investing activities		(6,585	)		25,350

Financing activities:
Proceeds from issuance of common stock		248			3,023
Repurchase of common stock		(20,137	)		(9,947	)
Funding of structured stock repurchase programs		—			(54,000	)
Funds received from structured stock repurchases, including gains		17,379			3,210
Payments on capital lease obligations		—			(34	)
Payments on long-term debt		(289	)		—
Other		166			(150	)

Net cash used in financing activities		(2,633	)		(57,898	)

Net decrease in cash and cash equivalents		(9,080	)		(34,432	)
Cash and cash equivalents at beginning of period		49,125			75,396

Cash and cash equivalents at end of period	$	40,045		$	40,964

Supplementary cash flow disclosure:
Cash paid for:
Interest	$	4		$	86
Income taxes	$	488		$	861


	December 31, 2006			March 31, 2006
Accounts receivable	$	37,346		$	27,678
Less: allowance for doubtful accounts		(1,605	)		(1,354	)

	$	35,741		$	26,324


	December 31, 2006		March 31, 2006
Finished goods	$	22,122	$	17,883
Work in process		10,490		5,277
Raw materials		4,661		1,781

	$	37,273	$	24,941


	December 31, 2006		March 31, 2006
Deposits	$	502	$	933
Prepaid expenses		11,307		8,882
Interest receivable		1,243		1,630
Other		3,299		1,173

	$	16,351	$	12,618


	Useful Life	December 31, 2006			March 31, 2006
	(in years)
Machinery and equipment	5-7	$	42,845		$	41,634
Leasehold improvements	1-15		11,033			11,225
Computers, office furniture and equipment	3-7		75,939			74,760
Buildings	31.5		5,860			5,860
Land	N/A		12,202			12,202

			147,879			145,681
Less: accumulated depreciation and amortization			(115,869	)		(109,554	)

		$	32,010		$	36,127


	December 31, 2006							March 31, 2006
	Gross		Accumulated Amortization and Impairments			Net		Gross		Accumulated Amortization and Impairments			Net
Goodwill	$	4,441,259	$	(4,105,402	)	$	335,857	$	4,401,662	$	(4,105,402	)	$	296,260
Developed technology		425,000		(360,828	)		64,172		413,500		(348,675	)		64,825
Backlog/customer relationships		6,400		(3,949	)		2,451		3,600		(3,480	)		120
Patents/core technology rights/tradename		62,400		(42,871	)		19,529		59,200		(39,339	)		19,861

	$	4,935,059	$	(4,513,050	)	$	422,009	$	4,877,962	$	(4,496,896	)	$	381,066


	Cost of Sales		Operating Expenses		Total
Fiscal year 2007	$	4,860	$	1,340	$	6,200
Fiscal year 2008		18,551		5,301		23,852
Fiscal year 2009		17,823		5,260		23,083
Fiscal year 2010		12,097		4,040		16,137
Fiscal year 2011		10,500		4,040		14,540
Thereafter		876		1,464		2,340

Total	$	64,707	$	21,445	$	86,152


	December 31, 2006		March 31, 2006
Warranty and excess purchase commitments	$	4,430	$	5,407
Executive deferred compensation		4,006		3,294
Employee related liabilities		2,655		2,871
Professional fees		2,204		1,106
Restructuring liabilities		2,188		7,644
Current income taxes		1,016		1,177
Other taxes		832		863
Other liabilities		5,990		4,655

	$	23,321	$	27,017


	Workforce Reduction			Facilities Consolidation and Operating Lease Commitments			Property and Equipment Impairments			Total
Liability, March 31, 2006	$	5,830		$	1,814		$	—		$	7,644
Charged to expense		(168	)		380			2,521			2,733
Cash payments		(5,164	)		(504	)		—			(5,668	)
Noncash charges		—			—			(2,521	)		(2,521	)

Liability, December 31, 2006	$	498		$	1,690		$	—		$	2,188


	Number of Shares (in thousands)		Weighted Average Exercise Price Per Share		Weighted Average Remaining Contractual Term (in years)
Outstanding at the beginning of the period	54,096		$	5.82	—
Granted and assumed	6,430			3.06	—
Exercises	(316	)		0.80	—
Cancellations	(7,299	)		6.24	—

Outstanding at the end of the period	52,911		$	5.46	5.73

Vested at the end of the period	41,522		$	6.12	5.21


	Options Outstanding						Options Exercisable
Range of Exercise Prices	Number of Shares	Weighted Average Exercise Price		Aggregate Pretax Intrinsic Value		Weighted Average Remaining Contractual Term (in years)	Number of Shares	Weighted Average Exercise Price		Aggregate Pretax Intrinsic Value
$ 0.05 - $ 2.98	10,084	$	2.34	$	—	6.13	5,325	$	2.30	$	—
2.99 - 3.67	12,096		3.44		—	7.62	6,400		3.43		—
3.67 - 5.65	10,976		4.65		—	6.76	10,042		4.71		—
5.69 - 6.48	3,485		6.21		—	4.63	3,485		6.21		—
6.54 - 6.54	12,613		6.54		—	3.56	12,613		6.54		—
6.55 - 87.24	3,657		18.67		—	3.84	3,657		18.67		—

$ 0.05 - $87.24	52,911	$	5.46	$	14,188	5.73	41,522	$	6.12	$	7,692


	Restricted Stock Units Outstanding
	Number of Shares (in thousands)		Weighted Average Grant-Date Fair Value Per Share		Weighted Average Remaining Contractual Term (in years)
Balance at beginning of period	—		$	—	—
Awarded during the period	125			3.20	—
Vested during the period	(9	)		3.20	—
Cancelled during the period	(12	)		3.20	—

Balance at end of period	104		$	3.20	1.7


	Three Months Ended December 31, 2006			Nine Months Ended December 31, 2006
Stock-based compensation expense by type of awards
Stock options	$	2,701		$	7,854
Restricted stock units		23			59

Total stock-based compensation expense	$	2,724		$	7,913

Effect on basic and diluted net loss per share:	$	(.01	)	$	(.03	)


	Stock Options
	Three Months Ended December 31,						Nine Months Ended December 31,
	2006			2005			2006			2005
Expected life (years)		4.4			4.0			4.4			3.1
Volatility		56	%		49	%		55	%		52	%
Risk-free interest rate		4.6	%		4.4	%		4.8	%		4.0	%
Dividend yield		—	%		—	%		—	%		—	%
Weighted average fair value per share	$	1.69		$	1.09		$	1.79		$	1.12


	Three Months Ended December 31, 2006		Nine Months Ended December 31, 2006
Stock-based compensation included in operating expenses:
Cost of revenues	$	148	$	439
Research and development		882		2,979
Selling, general and administrative		1,694		4,495

Total stock-based compensation expense	$	2,724	$	7,913


	Three Months Ended December 31, 2005			Nine Months Ended December 31, 2005
Net income (loss)—as reported	$	584		$	(10,044	)
Plus: Reported stock-based compensation		1,458			4,443
Less: Fair value stock-based compensation		(8,661	)		(23,380	)

Net loss—pro forma	$	(6,619	)	$	(28,981	)

Reported basic net income (loss) per share	$	0.00		$	(0.03	)

Reported diluted net income (loss) per share	$	0.00		$	(0.03	)

Pro forma basic and diluted net loss per share	$	(0.02	)	$	(0.10	)


Net tangible assets	$	8,411
Purchased inventory fair market value		2,395
Existing technology		11,500
In-process research and development		13,300
Patents/trademarks		3,200
Customer relationships/backlog		2,800
Goodwill		39,597

	$	81,203


	Three Months Ended December 31,
	2006					2005
	Amount			% of Net Revenue		Amount			% of Net Revenue		Increase			Change
Net revenues	$	76,642		100.0	%	$	65,243		100.0	%	$	11,399		17.5	%
Cost of revenues		37,799		49.3			30,017		46.0			7,782		25.9

Gross profit		38,843		50.7			35,226		54.0			3,617		10.3
Total operating expenses		46,023		60.1			40,897		62.7			5,126		12.5

Operating loss		(7,180	)	(9.4	)		(5,671	)	(8.7	)		1,509		26.6
Interest and other income, net		3,121		4.1			4,940		7.6			(1,819	)	(36.8	)

Loss before income taxes		(4,059	)	(5.3	)		(731	)	(1.1	)		3,328		455.3
Income tax expense (benefit)		113		0.1			(1,315	)	(2.0	)		1,428		108.6

Net income (loss)	$	(4,172	)	(5.4	)%	$	584		0.9	%	$	(4,756	)	(814.4	)


	Nine Months Ended December 31,
	2006					2005
	Amount			% of Net Revenue		Amount			% of Net Revenue		Increase			Change
Net revenues	$	222,685		100.0	%	$	194,851		100.0	%	$	27,834		14.3	%
Cost of revenues		104,863		47.1			91,943		47.2			12,920		14.1

Gross profit		117,822		52.9			102,908		52.8			14,914		14.5
Total operating expenses		146,288		65.7			125,797		64.5			20,491		16.3

Operating loss		(28,466	)	(12.8	)		(22,889	)	(11.7	)		5,577		24.4
Interest and other income, net		9,915		4.5			11,881		6.1			(1,966	)	(16.5	)

Loss before income taxes		(18,551	)	(8.3	)		(11,008	)	(5.6	)		7,543		68.5
Income tax expense (benefit)		327		0.1			(964	)	(0.5	)		1,291		133.9

Net loss	$	(18,878	)	(8.4	)%	$	(10,044	)	(5.1	)%	$	8,834		88.0


	Three Months Ended December 31,
	2006(1)				2005
	Amount		% of Net Revenue		Amount		% of Net Revenue		Increase		Change
Cost of revenues	$	148	0.2	%	$	21	0.0	%	$	127	604.8	%
Research and development		882	1.2			654	1.0			228	34.9
Selling, general and administrative		1,694	2.2			783	1.2			911	116.3

	$	2,724	3.6	%	$	1,458	2.2	%	$	1,266	86.8


	Nine Months Ended December 31,
	2006(1)				2005
	Amount		% of Net Revenue		Amount		% of Net Revenue		Increase		Change
Cost of revenues	$	439	0.2	%	$	68	0.0	%	$	371	545.6	%
Research and development		2,979	1.3			2,024	1.0			955	47.2
Selling, general and administrative		4,495	2.1			2,351	1.2			2,144	91.2

	$	7,913	3.6	%	$	4,443	2.2	%	$	3,470	78.1


	Operating Leases		Other Purchase Commitments		Total
Fiscal years ending:

Three months ending March 31, 2007	$	565	$	23,508	$	24,073
2008		6,523		—		6,523
2009		13,029		—		13,029
2010		3,283		—		3,283
2011		448		—		448

Total	$	23,848	$	23,508	$	47,356


	Valuation of Securities Given an Interest Rate Decrease of X Basis Points (“BPS”)						Fair Value as of December 31, 2006		Valuation of Securities Given an Interest Rate Increase of X Basis Points (“BPS”)
	(150 BPS)		(100 BPS)		(50 BPS)		Fair Value as of December 31, 2006		50 BPS		100 BPS		150 BPS
Available-for-sale investments	$	235,185	$	230,258	$	225,503	$	220,995	$	216,757	$	212,831	$	209,130


31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.

32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.