Notes to Consolidated Financial Statements

Note 2. Summary of Significant Accounting Policies and Concentrations of Credit Risk

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Xilinx and its wholly owned subsidiaries after elimination of all significant intercompany transactions.  The Company uses a 52- to 53-week fiscal year ending on the Saturday nearest March 31.  Fiscal 2004 was a 53-week year ended on April 3, 2004.  The additional week included in the third quarter of fiscal 2004 did not have a material effect on the results of operations.  Fiscal 2003 was a 52-week year ended on March 29, 2003.  Fiscal 2002 was a 52-week year ended on March 30, 2002.  Fiscal 2005 will be a 52-week year ending on April 2, 2005. 

The consolidated statement of operations for fiscal 2002 includes a reclassification of the Altera Corporation lawsuit settlement received of $19.4 million from a separate line after operating income (loss) to a separate line before operating income (loss). Certain other amounts from the prior years have been reclassified to conform to the current year presentation.  

Use of Estimates

The preparation of financial statements in conformity 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 and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period.  Such estimates relate to, among others, the useful lives of assets, assessment of recoverability of property, plant and equipment, intangible assets and goodwill, inventory write-downs, allowances for doubtful accounts and customer returns, potential reserves relating to litigation and tax matters as well as other accruals or reserves.  Actual results may differ from those estimates and such differences may be material to the financial statements.

Cash Equivalents and Investments

Cash equivalents consist of highly liquid investments with original maturities of three months or less.  Short-term investments consist of tax-advantaged municipal bonds, commercial paper, and tax-advantaged auction rate securities with maturities greater than 90 days but less than one year from the balance sheet date. Long-term investments consist of U.S. Treasury notes, corporate bonds, government agency bonds, tax-advantaged municipal bonds with maturities greater than one year, unless the investments are specifically identified to fund current operations, in which case they are classified as short-term investments, and equity investments. 

The Company invests its cash, cash equivalents, short-term and long-term investments through various banks and investment banking and asset management institutions.  This diversification of risk is consistent with its policy to maintain liquidity and ensure the ability to collect principal.  The Company maintains an offshore investment portfolio denominated in U.S. dollars with investments in non-U.S. based issuers.  All investments are made pursuant to corporate investment policy guidelines.  Investments include commercial paper, Euro dollar bonds, Euro dollar floaters (Euro dollar bonds with coupon resets at predetermined intervals) and offshore money market funds.

Management classifies investments as available-for-sale or held-to-maturity at the time of purchase and re-evaluates such designation at each balance sheet date, although classification is not generally changed.  Securities are classified as held-to-maturity when the Company has the positive intent and the ability to hold the securities until maturity.  Held-to-maturity securities are carried at cost adjusted for amortization of premiums and accretion of discounts to maturity.  Such amortization, as well as any interest on the securities, is included in interest income.  No investments were classified as held-to-maturity at April 3, 2004 or March 29, 2003. Available-for-sale securities are carried at fair value with the unrealized gains or losses, net of tax, included as a component of accumulated other comprehensive income (loss) in stockholders' equity.  Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income and other, net.  The fair values for marketable debt and equity securities are based on quoted market prices.  The cost of securities matured or sold is based on the specific identification method. 

Inventories

Inventories are stated at the lower of cost (determined using the first-in, first-out method), or market (estimated net realizable value) and are comprised of the following at fiscal year-ends:

The Company reviews and sets standard costs quarterly at current manufacturing costs. The Company's manufacturing overhead standards for product costs are calculated assuming full absorption of forecasted spending over projected volumes. Given the cyclicality of the market, the obsolescence of technology and product life cycles, the Company writes down inventory to net realizable value based on backlog, forecasted demand and technological obsolescence.  These factors are impacted by market and economic conditions, technology changes, new product introductions and changes in strategic direction and require estimates that may include uncertain elements.  In addition, backlog is subject to revisions, cancellations and rescheduling. Actual demand may differ from forecasted demand and such differences may have a material effect on the Company's gross margins.

Property, Plant and Equipment

Property, plant and equipment are recorded at cost, net of accumulated depreciation.  Depreciation for financial reporting purposes is computed using the straight-line method over the estimated useful lives of the assets of two to five years for machinery, equipment, furniture and fixtures and up to 30 years for buildings.  Depreciation expense totaled $53.7 million, $52.2 million and $51.7 million for fiscal year 2004, 2003 and 2002, respectively.

During the fourth quarter of fiscal 2004, the Company sold excess facilities consisting of two buildings and land near downtown San Jose, California for $33.8 million ($32.0 million, net of selling costs).  After recognizing previous impairment losses on these excess facilities of $53.8 million in fiscal 2003 and $3.4 million in fiscal 2004, there was no gain or loss on the sale of the buildings and land.

During fiscal 2003, the Company sold its former software facility in Boulder, Colorado for $6.5 million and recognized a gain of $508 thousand, which is included in interest income and other, net on the consolidated statement of operations.

Impairment of Long-Lived Assets Including Goodwill and Other Intangibles

The Company evaluates the carrying value of long-lived assets and acquired intangibles including goodwill on an annual basis, or more frequently if impairment indicators arise.  When indicators of impairment exist and assets are held for use, the Company estimates future undiscounted cash flows attributable to long-lived assets.  In the event such cash flows are not expected to be sufficient to recover the recorded value of the assets, the assets are written down to their estimated fair values based on the expected discounted future cash flows attributable to the assets.  When assets are removed from operations and held for sale, Xilinx estimates impairment losses as the excess of the carrying value of the assets over their fair value.

Effective the beginning of the first quarter of fiscal 2003, the Company completed the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). As required by SFAS 142, the Company stopped amortizing the remaining balances of goodwill as of the beginning of fiscal 2003. Goodwill is subject to impairment tests annually or earlier if indicators of potential impairment exist, using a fair-value-based approach. All other intangible assets continue to be amortized over their estimated useful lives and assessed for impairment under SFAS 144.  The Company completed the initial goodwill impairment review as of the beginning of fiscal 2003, and completed the annual review during the fourth quarter of fiscal 2003 and fiscal 2004, and found no impairment.  Unless there are indicators of impairment, our next impairment review for RocketChips and Triscend will be completed in the fourth quarter of fiscal 2005.

A reconciliation of previously reported net income (loss) and net income (loss) per share to the amounts adjusted for the exclusion of goodwill amortization, is as follows:

	2004		2003		2002
Net income (loss) as reported	$302,989		$125,705		$(113,607	)
Goodwill amortization, net of tax	—		—		29,821
Adjusted net income (loss)	$302,989		$125,705		$ (83,786	)
Per share - basic:
Reported net income (loss)	$0.89		$0.37		$(0.34	)
Goodwill amortization, net of tax	—		—		0.09
Adjusted net income (loss)	$0.89		$0.37		$(0.25	)
Per share - diluted:
Reported net income (loss)	$0.85		$0.36		$(0.34	)
Goodwill amortization, net of tax	—		—		0.09
Adjusted net income (loss)	$0.85		$0.36		$(0.25	)

Revenue Recognition

Sales to distributors are made under agreements providing distributor price adjustments and rights of return under certain circumstances.  Revenue and costs relating to distributor sales are deferred until products are sold by the distributors to customers. Revenue recognition depends on notification from the distributor that product has been sold to the end customer.  Accounts receivable from distributors are recognized and inventory is relieved when title to inventories transfers, typically upon shipment at which point the Company has a legally enforceable right to collection under normal payment terms.

Revenue from sales to the Company's direct customers is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations.  For each of the periods presented, there were no formal acceptance provisions with the Company's direct customers.

Revenue from software term licenses is deferred and recognized as revenue over the term of the licenses of one year.  Revenue from support services is recognized when the service is provided.

Allowances for end customer sales returns are recorded based on historical experience and for known pending customer returns or allowances.

Foreign Currency Translation

The U.S. dollar is the functional currency for the Company's Ireland manufacturing facility.  Assets and liabilities that are not denominated in the functional currency are remeasured into U.S. dollars, and the resulting gains or losses are included in interest income and other, net. 

The functional currency is the local currency for each of the Company's other foreign subsidiaries.  Assets and liabilities are translated from foreign currencies into U.S. dollars at month-end exchange rates and statements of operations are translated at the average monthly exchange rates.   Exchange gains or losses arising from translation of foreign currency denominated assets and liabilities are included as a component of accumulated other comprehensive income (loss) in stockholders' equity. 

Derivative Financial Instruments

As part of the Company's ongoing asset and liability management activities, it periodically enters into financial arrangements to reduce financial market risks.  Xilinx may use derivative financial instruments to hedge foreign currency, equity and interest rate market exposures of underlying assets and liabilities.  The Company does not enter into derivative financial instruments for trading or speculative purposes. For fiscal years 2004 and 2003, the use of derivative financial instruments was not material to the Company's results of operations or its financial position and there were no outstanding derivative financial instruments as of April 3, 2004 or March 29, 2003.     

Stock-Based Compensation

The Company accounts for stock-based compensation under Accounting Principles Board's Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related interpretations, using the intrinsic value method.  In addition, the Company has adopted the disclosure requirements related to its stock plans according to Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (SFAS 123), as amended by SFAS No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS 148).  

As required by SFAS 148, the following table shows the estimated effect on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based compensation:

	2004		2003		2002
	(In thousands, except per share amounts)
Net income (loss) as reported	$ 302,989		$ 125,705		$(113,607	)
Deduct: Stock-based employee compensation expense determined      under fair value based method for all awards, net of tax	(103,075	)	(114,334	)	(114,280	)
Pro forma net income (loss)	$ 199,914		$11,371		$(227,887	)
Net income (loss) per share:     Basic-as reported	$0.89		$0.37		$(0.34	)
Basic-pro forma	$0.59		$0.03		$(0.68	)
Diluted-as reported	$0.85		$0.36		$(0.34	)
Diluted-pro forma	$0.56		$0.03		$(0.68	)

The fair values of stock options and stock purchase plan rights under the stock option plans and employee stock purchase plan were estimated as of the grant date using the Black-Scholes option-pricing model. The Black-Scholes model was originally developed for use in estimating the fair value of traded options and requires the input of highly subjective assumptions including expected stock price volatility.  The Company's stock options and stock purchase plan rights have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate. Calculated under SFAS 123, the per share weighted-average fair values of stock options granted during 2004, 2003 and 2002 were $13.38, $19.73 and $19.22, respectively.  The per share weighted-average fair values of stock purchase rights granted under the Stock Purchase Plan during 2004, 2003 and 2002 were $12.53, $10.10 and $16.13, respectively. The fair value of stock options and stock purchase plan rights granted in fiscal years 2004, 2003 and 2002 were estimated at the date of grant using no expected dividends and the following weighted average assumptions:

On March 31, 2004, the FASB issued an Exposure Draft (ED), "Share-Based Payment - An Amendment of FASB Statements No. 123 and 95."  The proposed Statement addresses the accounting for transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments.  The proposed Statement would eliminate the ability to account for share-based compensation transactions using APB 25, and generally would require instead that such transactions be accounted for using a fair-value based method. As proposed, companies would be required to recognize an expense for compensation cost related to share-based payment arrangements including stock options and employee stock purchase plans. As proposed, the new rules would be applied on a modified prospective basis as defined in the ED, and would be effective for public companies for fiscal years beginning after December 15, 2004. Current estimates of option values using the Black Scholes method (as shown above) may not be indicative of results from valuation methodologies ultimately adopted in the final rules.

Income Taxes

All income tax amounts reflect the use of the liability method under SFAS No. 109, “Accounting for Income Taxes.”  Under this method, deferred tax assets and liabilities are determined based on the expected future tax consequences of temporary differences between the carrying amounts of assets and liabilities for financial and income tax reporting purposes.

Recent Accounting Pronouncements

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” which amends and clarifies accounting for derivative instruments and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (SFAS 149).  SFAS 149 provides guidance relating to decisions made (a) as part of the Derivatives Implementation Group process, (b) in connection with other FASB projects dealing with financial instruments and (c) regarding implementation issues raised in the application of the definition of a derivative and the characteristics of a derivative that contains financing components.  SFAS 149 was effective for contracts entered into or modified and for hedging relationships designated after June 30, 2003.  The adoption of SFAS 149 did not have a material impact on the Company's financial condition or results of operations.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” (SFAS 150) which requires freestanding financial instruments such as mandatorily redeemable shares, forward purchase contracts and written put options to be reported as liabilities by their issuers.  The provisions of SFAS 150 were effective for instruments entered into or modified after May 31, 2003 and to pre-existing instruments as of June 29, 2003.  The adoption of SFAS 150 did not have a material impact on the Company's financial condition or results of operations.

In May 2003, Emerging Issues Task Force (EITF) Issue No 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” (EITF 00-21) was finalized.  EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets.  The provisions of EITF 00-21 apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003.  In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 104, “Revenue Recognition,” which codifies and rescinds certain sections of SAB No. 101, “Revenue Recognition”, in order to make this interpretive guidance consistent with EITF No. 00-21.  The adoption of these standards did not have a material impact on the Company's financial condition or results of operations.

In December 2003, the FASB issued a revision to Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46R” or the “Interpretation”).  FIN 46R clarifies the application of ARB No. 51, “Consolidated Financial Statements,” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support provided by any parties, including the equity holders.  FIN 46R requires the consolidation of these entities, known as variable interest entities (“VIEs”), by the primary beneficiary of the entity.  The primary beneficiary is the entity, if any, that will absorb a majority of the entity's expected losses, receive a majority of the entity's expected residual returns, or both.

Among other changes, the revisions of FIN 46R (a) clarified some requirements of the original FIN 46, which had been issued in January 2003, (b) eased some implementation problems, and (c) added new scope exceptions.  FIN 46R deferred the effective date of the Interpretation for Xilinx, to the period ended April 3, 2004, except that the Company applied the unmodified provisions of the Interpretation to entities that were previously considered “special-purpose entities” in practice and under the FASB literature prior to the issuance of FIN 46R for the period ended January 3, 2004.

Among the scope exceptions, companies are not required to apply the modified Interpretation to an entity that meets the criteria to be considered a “business” as defined in the Interpretation unless one or more of four specified conditions exist. FIN 46R applies immediately to a VIE created or acquired after January 31, 2003.  The Company does not have any interests in VIEs.

Product Warranty and Indemnification

The Company generally sells products with a limited warranty for product quality.  The Company provides for known product issues and an estimate of incurred but unidentified product issues based on historical activity. The warranty accrual and related expense for known product issues, which were not significant for fiscal 2003,  increased in fiscal 2004 predominately due to a specific quality incident with one of our vendors.  The following table presents a reconciliation of the Company's product warranty liability, which is included in other accrued liabilities on the Company's consolidated balance sheet, for fiscal 2004:

The Company generally sells its products with a limited indemnification of customers against intellectual property infringement claims related to the Company's products.  Xilinx has historically received only a limited number of requests for indemnification under these provisions and has not been requested to make any significant payments pursuant to these provisions.

Concentrations of Credit Risk

As of April 3, 2004, two distributors (Memec and Avnet) accounted for 59% and 22% of total accounts receivable, respectively.  As of March 29, 2003, Memec and Avnet accounted for 49% and 34% of total accounts receivable, respectively.  Memec accounted for 47%, 45% and 44% of worldwide net revenues in fiscal 2004, 2003 and 2002, respectively.  Avnet accounted for 31%, 32% and 30% of worldwide net revenues in fiscal 2004, 2003 and 2002, respectively.  The Company continuously monitors the creditworthiness of its distributors and believes their sales to diverse end customers and to diverse geographies further serve to mitigate the Company's exposure to credit risk.

Xilinx is subject to concentrations of credit risk primarily in its trade accounts receivable and investments in debt securities to the extent of the amounts recorded on the consolidated balance sheet.  The Company attempts to mitigate the concentration of credit risk in its trade receivables through its credit evaluation process, collection terms, distributor sales to diverse end customers and through geographical dispersion of sales.  Xilinx generally does not require collateral for receivables from its end customers or from distributors.  In the event of termination of a distributor agreement, inventory held by the distributor must be returned.

No end customer accounted for more than 10% of net revenues in fiscal 2004, 2003 or 2002.

The Company mitigates concentrations of credit risk in its investments in debt securities by investing more than 90% of its portfolio in AA or higher grade securities as rated by Standard & Poor's.  Additionally, Xilinx limits its investments in the debt securities of a single issuer and attempts to further mitigate credit risk by diversifying risk across geographies and type of issuer.  At April 3, 2004, 55% and 45% of its investments in debt securities were domestic and foreign, respectively, and 39% were issued by corporate entities and 61% by government agencies and municipalities.