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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 30, 2001
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: _____________ to
Commission File Number 0-19084
PMC-Sierra, Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-2925073
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
3975 Freedom Circle
Santa Clara, CA 95054
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 369-1176
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001
Preferred Stock Purchase Rights
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 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant, based upon the closing sale price of the Common Stock on February
15th, 2002, as reported by the Nasdaq National Market, was approximately
$1,898,781,000. Shares of Common Stock held by each executive officer and
director and by each person known to the Registrant who owns 5% or more of the
outstanding voting stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of February 15th, 2002, the Registrant had 166,203,216 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 2002 Annual Meeting of
Stockholders to be held on May 30, 2002 are incorporated by reference into Part
III, Items 10, 11, 12 and 13 of this Form 10-K Report.
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PART I
ITEM 1. Business
PMC-Sierra, Inc. designs, develops, markets and supports high-performance
semiconductor networking solutions. Our mission is to provide superior
high-speed internetworking semiconductor solutions to enable the restructuring
of the global information infrastructure.
We are a leading supplier of high-performance integrated circuits, principally
used by equipment manufacturers in the telecommunications industry. We sell more
than 100 different products to the world's leading equipment manufacturers, who
in turn supply their equipment to international and regional telecommunications
service providers. Our products are deployed in equipment that is used
throughout the global network infrastructure. We diversify our efforts across a
broad range of applications leveraging our intellectual property and expertise
in communications technologies.
PMC-Sierra was incorporated in the State of California in 1983 and
reincorporated in the State of Delaware in 1997. Our Common Stock trades on the
Nasdaq National Market under the symbol "PMCS" and is included in the Nasdaq-100
and the S&P 500 indices.
Our fiscal year ends on the last Sunday of the calendar year. Fiscal years 2001
and 1999 each consisted of 52 weeks. Fiscal year 2000 consisted of 53 weeks. For
ease of presentation, we have referred to December 31 as our fiscal year end for
all years.
In this Annual Report on Form 10-K, "PMC-Sierra", "PMC", "the Company", "us",
"our" or "we", includes PMC-Sierra, Inc. and all of our subsidiary companies.
FORWARD-LOOKING STATEMENTS
This Annual Report and the portions of our Proxy Statement incorporated by
reference into this Annual Report contain forward-looking statements that
involve risks and uncertainties. We use words such as "anticipates", "believes",
"plans", "expects", "future", "intends", "may", "will", "should", "estimates",
"predicts", "potential", "continue" and similar expressions to identify such
forward-looking statements. These forward-looking statements include, but are
not limited to, statements under "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
These forward-looking statements apply only as of the date of this Annual
Report. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties, and assumptions,
the forward-looking events discussed in this report might not occur. Our actual
results could differ materially from those anticipated in these forward-looking
statements for many reasons, including the risks we face as described in this
Annual Report and readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. Such forward-looking statements include statements as to, among
others:
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o customer networking product inventory levels, needs and order levels;
o revenues;
o the degree to which our future revenues are booked and shipped within the
same reporting period, or "turns business";
o gross profit;
o research and development expenses;
o marketing, general and administrative expenditures;
o interest and other income;
o capital resources sufficiency;
o capital expenditures;
o restructuring activities, expenses and associated annualized savings; and
o our business outlook.
This discussion contains forward-looking statements that are subject to known
and unknown risks, uncertainties and other factors that may cause our actual
results, levels of activity, performance, achievements and prospects to be
materially different from those expressed or implied by such forward-looking
statements. These risks, uncertainties and other factors include, among others,
those identified under "Factors That You Should Consider Before Investing In
PMC-Sierra" and elsewhere in this Annual Report.
INDUSTRY OVERVIEW
During the 1990's, the Internet experienced enormous growth as more households,
enterprises and corporations connected to and increased their utilization of the
Internet. Traffic on the network continued to increase due to a growing number
of web-based applications (such as e-commerce, e-mail, videoconferencing,
webcasting, virtual private networks and networked storage). Higher volumes of
data are being transmitted between local area networks (LANs), metro area
networks (MANs) and wide area networks (WANs) as a result of this increased
connectivity and usage of the Internet.
The growth in data traffic placed increasing pressure on the existing
telecommunications network infrastructure , which was originally constructed for
voice communication rather than data transmission. Many of the incumbent
telephone companies (such as AT&T, Sprint, WorldCom, NTT, British Telecom and
Deutsche Telekom) and Regional Bell Operating Companies (such as Verizon,
BellSouth, and SBC) began investing in data networks to meet the growing demands
of their customers. At the same time, deregulation of the telecommunications
industry and privatization of many European carriers resulted in increased
market competition. The abundance of capital available in the public and private
markets also accelerated a build out of new network infrastructure. Numerous
competitive carriers were launched with the intention of capturing significant
share of (i) long-haul and ultra long-haul data traffic (such as Global
Crossing, Level 3, Williams); and (ii) the local/regional data markets (such as
Covad, Northpoint and RhythmsNet). This caused a significant increase in capital
spending on networking equipment by both the incumbent and competitive carriers.
During this period of rapid expansion, our customers - - the networking
equipment companies ("OEMs") - - placed increased pressure on their suppliers to
ensure they had the components needed to fulfill the expected growth in demand.
With many of the semiconductor foundries at full capacity at the time, the OEMs
often ordered more devices than necessary in an attempt to secure component
delivery. This resulted in inventory levels expanding at the OEMs, contract
manufacturers, distributors and component suppliers at a faster rate than sales.
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This environment changed suddenly at the end of 2000. Capital markets began to
tighten, many e-commerce businesses failed, and the overall economy began to
slow down. Many of the competitive carriers who were unable to attract
sufficient customers to sustain their operations experienced financial hardship,
and in many cases were acquired or went into receivership. Many of the incumbent
carriers realized that increasing capital expenditures on networking equipment
as a percentage of total revenue was unsustainable. This resulted in a rapid
slowdown in total capital spending on networking equipment across the industry,
which in turn resulted in fewer orders for our customers' equipment. By the
first half of 2001, most of our customers had recognized that rapid growth in
demand was over. As revenues declined, a large number of our customers announced
corporate restructurings and inventory write-downs and cancelled various
equipment programs.
Due to this market downturn, we experienced a significant drop in sales of our
products. The impact of the downturn was magnified by the high levels of
inventory that existed at our distributors, the contract manufacturers, and the
OEMs at the beginning of 2001. As a result of the decrease in demand for our
products, we implemented two restructuring plans in 2001. We announced the first
restructuring in March 2001 when we terminated 223 employees, consolidated a
number of facilities, and cancelled certain development projects. We announced
the second restructuring in October 2001 when we terminated 341 employees,
consolidated additional facilities, and cancelled additional development
projects. The two restructurings reduced our workforce by approximately
one-third from our peak level in 2001. These restructurings have significantly
lowered our operating expenses and cost structure going forward (for a more
detailed description of the two restructurings see "Restructuring and other
special charges" in the Management's Discussion and Analysis section of this
report).
Despite the industry downturn, Internet traffic reportedly continues to grow.
Industry analysts estimate that total data traffic on the Internet could grow
annually between 100% and 300% each year. Moreover, the adoption of
next-generation wireless handsets (providing voice as well as text messaging,
web connectivity, and global positioning) is expected to drive additional data
traffic through the network infrastructure in the future.
For many of the incumbent and regional service providers, data traffic and the
associated revenue remains a key growth driver for their operations. To capture
a growing portion of this market, service providers are continuing to transition
their networks from voice-centric to data-centric systems. At the same time, the
market remains competitive as many cable and satellite operators are offering
high-speed connectivity services as well. In this environment, it is critical
for service providers to build their networks with more efficient equipment
enabling them to lower operating costs while handling the increasing amount of
traffic.
In simple terms, the Internet is a hybrid series of networks comprised of copper
wires, coaxial cables, and fiber optic cables. These networks carry high-speed
data traffic in the form of electrical and optical signals that are transmitted
and received by complex networking equipment. To ensure this equipment and the
various networks can easily communicate with each other, the OEMs and makers of
communications semiconductors have developed numerous communications standards
and protocols for the industry. These communications protocols make it easier
for complex high-speed data traffic in the form of electrical and optical
signals to be sent and received reliably and efficiently - - whether
intra-office, across the country, or internationally.
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One industry standard that packages information into a fixed-size cell format
for transportation across networks is ATM or Asynchronous Transfer Mode. Many
service providers deploy equipment that handles this protocol because it can
support voice, video, data, and multimedia applications simultaneously.
Another established industry standard is called SONET or Synchronous Optical
Network for data communication over fiber optic systems. This is used in the
Americas and parts of Asia, with the equivalent standard in the rest of the
world being SDH or Synchronous Digital Hierarchy. Many of the long-haul and
ultra long-haul fiber optic systems operate at higher speeds such as 10 gigabits
per second. In the metro area of the network, signals are transmitted primarily
at rates between 155 megabits per second and 2.5 gigabits per second.
In addition to using SONET to increase the bandwidth in their networks, many
system operators have also deployed equipment that uses dense wave division
multiplexing. Rather than transmitting a single light signal over an optical
fiber, dense wave division multiplexing allows many different light signals
(each of a different wavelength) to be transmitted simultaneously. By deploying
this technique at higher transmission rates, carriers have increased capacity to
move more signals across transmission lines.
In some service provider networks, a traffic bottleneck can occur where the
high-speed long-haul traffic is handed off to networking equipment in the metro
area. In general, less investment has been made to enhance the infrastructure in
the metro area and as a result, many of these systems have insufficient capacity
to handle the increased traffic.
In response, many OEMs are designing faster and more complex equipment to handle
the higher volumes in the network. This equipment must be able to accommodate
various protocols and formats, including cell-based ATM and packet-based
Internet Protocol (IP). While IP packets are larger and can hold more data than
ATM cells, service providers can have difficulty providing the same quality of
service with IP because it is not optimized for time-sensitive signals such as
video and voice services.
Another protocol that is used extensively in local area networks and is now
being deployed in the wide area network is Ethernet. Because many systems
operators are familiar with Ethernet, it is now transitioning into the wide area
of the network at higher speeds so that Ethernet packets can be sent
inter-office in a more efficient manner.
To accommodate these different protocols and growing demand for services, many
service providers are requiring OEMs to provide more complex, integrated
solutions in a shorter time period. This, coupled with rising cost of custom
semiconductors, has resulted in the OEMs outsourcing more of their
communications integrated circuit requirements to companies such as PMC-Sierra.
At the same time, some of the OEMs have undergone corporate restructurings and
have fewer resources and technical staff to dedicate to internally designed
custom solutions.
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By leveraging the knowledge and technical expertise of companies such as
PMC-Sierra, the OEMs are able to focus their efforts on differentiating factors.
In many cases, it can take several years before a new silicon chip or chip set
can be designed, manufactured, tested, and released to full production for a
customer. It is essential, therefore, that the companies like PMC-Sierra that
develop the chips to be incorporated into the OEM equipment work very closely
with their OEM customers so that together they can optimally solve the needs of
the service providers.
PRODUCTS
We have more than 100 revenue-producing products in our portfolio. Our
networking products are communications semiconductors, including
microprocessors, that are used in different types of equipment that form the
internet infrastructure. Our non-networking segment is comprised of a single
chip used in a consumer medical device.
Networking Products
Our products are sold into three areas of the telecommunications network: the
Access, Metro and Enterprise areas. We design many of our products with
standardized interfaces between chips so that our customers can easily develop
and implement solutions involving multiple PMC-Sierra products.
The following briefly describes the Access, Metro and Enterprise portions of the
internet infrastructure and some typical equipment that may include our chips
and chipsets. Due to the complexity of the telecommunications network, it is not
possible to sharply delineate networking functions or markets. In addition, many
of our products may be used in multiple classes of networking equipment that are
deployed across all of the market areas identified below, while some of our
other products have highly specialized applications. For example, our
microprocessors can be used in many networking equipment applications, while our
Paladin chip may only be used in wireless base station applications. In some
situations, different OEMs might use our chips or chipsets in equipment
addressing more than one of the market areas noted below.
o Access: this area of the telecommunications network infrastructure
encompasses technologies that connect the home or office to the internet.
This area includes wired and wireless networking equipment that aggregates
transmissions from the home or office and connects to the metro and wide
area networks. For example, our devices would be deployed in digital
subscriber line access multiplexers, wireless base stations, add-drop
multiplexers (which add and drop signals and streams of data from optical
networks) and switches (which direct the data traffic to other destinations
within the network).
o Metro: the metro, or metro, area of the internet infrastructure is
predominantly a fiber-based network that provides high-speed communications
and data transfer over a city center or local region. This portion of the
network manages traffic inside its own region and manages traffic between
the access and long-haul transport networks for inter-city or international
transmission. Our products are used in metro equipment such as switches and
routers that gather and process signals in different protocols, and then
transmit them to the next destination as quickly and efficiently as
possible.
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o Enterprise: this area of the network includes equipment that is deployed in
the home or office for data communications and other local area network
applications. Our products are used in equipment such as networked printers
in the office or home, as well as switches and storage devices that enable
data to be transferred to local telecommunications networks and storage
area networks.
Our chips and chipsets can also be divided into the broadly defined functional
categories identified below. As with descriptions of the network, particular
categories may overlap and a device may be present in more than one category. In
addition, some products, particularly multiple chip sets, integrate different
functions and could be classified in one or more categories. For example, some
of our products both convert high-speed analog signals to digital signals, and
also split or combine various transmission signals.
o Line interface units: these devices, also referred to as transceivers,
transmit and receive signals over a physical medium such as wire, cable or
fiber. The line interface unit determines the speed and timing
characteristics of the signals, and may also convert them from a serial
stream of data into a parallel stream before they are further processed for
transmission to the next destination.
o Framers & mappers: before the data can be sent to the next destination, it
must be converted into a proper format for transmission in the network. For
example, the framing function arranges the bits into different size
formats, commonly referred to as "cell" or "packet" formats, and attaches
the appropriate information to the formats to ensure they reach their
destinations. In turn, this data may be inserted into other frames, such as
SONET frames, for transmission across high-speed fiber optics.
o Packet & cell processors: these devices examine the contents of cells or
packets and performs various management and reporting functions. For
instance, a switch or router may use a packet or cell processor to
determine if a signal is voice or video in order to allocate the proper
amount of bandwidth. Service providers can use information gathered by the
cell or packet processor to determine a customers' network usage and charge
the appropriate service fee.
o Traffic managers & switch fabrics: traffic managers organize, schedule and
queue cells and packets into and out of switches. Switch fabrics
interconnect the wires and fibers, allowing the data to be routed to its
intended destination.
o Serializers/Deserializers: these devices convert networking traffic from
slower speed parallel streams into higher speed serial streams and visa
versa. OEMs use serial streams to reduce networking equipment line
connections. Conversely, OEMs use parallel streams to allow them to use
lower cost traffic management technologies.
o Microprocessors: these devices perform the high-speed computations that
help identify and control the flow of signals and data in the many
different types of network equipment used in the communications, enterprise
and consumer markets.
Our products help OEMs both aggregate and disaggregate network traffic at high
and low speeds. As signals move through the network, carriers aggregate millions
of slow-speed incoming signals through access devices into a few high-speed and
high-capacity signals. For example, slower-speed access lines such as T1 lines
(operating at 1.54 megabits per second) are aggregated and streamed into
high-speed lines (such as optical transmission at 2.5 gigabits per second). The
wide range of products we make operate at different speeds in many of the
product categories listed above.
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Non-Networking Products
In 1996, we announced our decision to discontinue the development of custom
non-networking chips. Our remaining non-networking product is still being sold
but no new development has been done since 1996. Our non-networking revenue is
generated by one custom semiconductor device used to control the user interface
in a consumer health-monitoring device.
STRATEGY
Our mission is to provide superior high-speed internetworking semiconductor
solutions to enable the restructuring of the global information infrastructure.
We facilitate the upgrade on the Internet infrastructure by designing and
selling complex chipset solutions based on our knowledge of network
applications, system requirements and networking protocols. To achieve our
mission, we are pursuing the following key strategies:
Leverage technical expertise across diverse base of applications:
We have a history of analog, digital, microprocessor and mixed signal design
expertise and we integrate many functions and protocols into our products. We
develop chips that are used in a broad range of networking equipment, such as
multi-service switches in the Access portion of the internet infrastructure,
routers in the Metro portion and networked printers in Enterprise networks. We
leverage our common technologies and intellectual property across a broad range
of networking equipment.
Many OEMs have recognized they can obtain highly complex, broadband
communications technology "off the shelf" from companies such as PMC-Sierra
rather than dedicating their own resources to develop custom chips. By
outsourcing more of the silicon content in their networking and telecom
equipment, OEMs can improve their time-to-market and reduce development risk
while differentiating their products in other ways.
Provide first-class products, customer service and technical support:
We work very closely with our customers to ensure they get the best service and
technical support required to assist them with their development efforts. As the
marketplace for telecommunications equipment suppliers slowly consolidates, we
believe our largest customers and their products will take an increasing
percentage of the overall market in their areas of expertise. This places even
more importance on our customer service efforts. Customers such as Cisco,
Lucent, Nortel, Alcatel, Samsung and Hewlett-Packard are aligning their design
and manufacturing operations with key suppliers. In 2001, Cisco selected
PMC-Sierra as its "Semiconductor Supplier of the Year" and Lucent Technologies
named us a strategic alliance partner.
Take a leading role in industry standards bodies and interoperability
initiatives:
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We continue to participate in many influential industry standards bodies so we
can assist in determining performance criteria and interoperability standards
for the industry. This is critical to helping us make chips that our customers
will be able to deploy easily. In addition, we work with the Saturn Development
Group (which we co-founded in 1992) to set new interface specifications. As a
result of these efforts, our products enable interoperable solutions for a broad
range of networking applications. To advance this process further, we have
participated with other leading semiconductor companies to demonstrate hardware
interoperability. For example, in 2001, we collaborated with Xilinx Inc. and
Altera Corp. (industry leading suppliers of programmable logic devices) to
successfully test the interoperability of our high-speed devices.
Maintain fabless business model:
We believe that investing in the research and development of new devices is
strategically more important than trying to differentiate ourselves through
manufacturing technologies. Consequently, we do not own or operate any foundries
and we design our products in complementary metal oxide silicon (CMOS) at
feature sizes down to 0.13 micron. We outsource approximately 90% of our
manufacturing requirements to Chartered Semiconductor Manufacturing, Taiwan
Semiconductor Manufacturing Corporation and IBM. By using independent foundries
to fabricate our wafers, we are better able to concentrate our resources on the
design, development and testing of new products. In addition, we avoid having to
commit the capital required to own and operate a fabrication facility.
SEGMENT PERFORMANCE
We evaluate our performance based on gross profits of the networking and
non-networking segments. For information concerning revenues and profit by
segment, see Note 13 to the Consolidated Financial Statements.
SALES, MARKETING AND DISTRIBUTION
Our sales and marketing strategy is to have our products designed into our
customers' equipment by developing superior products for which we provide
premium service and technical support. We maintain close working relationships
with many of our customers. Our marketing team is focused on developing new
products that meet the needs of our customers in the rapidly changing market of
the telecommunications industry. We are often involved in the early stages of
design concerning our customers' plans for new equipment. This helps us
determine if our existing products can be used in their new equipment or if more
complex devices need to be considered for the application. To assist us in our
planning process, we are in constant contact with our largest customers to
discuss industry trends, emerging standards and their new product requirements.
Based on their input and our feedback, we gain a better understanding of what
functions and features they want integrated into our chips or chip set
solutions.
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To promote our products, our marketing team is actively involved in
demonstrating our devices with other industry suppliers and providing technical
information at trade shows held in North America, Asia and Europe. Technical
support is essential to our customers' success, and we provide this through
field application engineers, technical marketing and factory systems engineers.
We also provide more detailed information and support for our product line
through our corporate website and special customer-accessible extranet sites. We
believe that providing comprehensive product service and support is critical to
shortening customers' design cycles and maintaining a competitive position in
the networking market.
We sell our products both directly and through distributors and independent
manufacturers' representatives. In 2001, approximately 40% of our orders were
shipped by our distributors; approximately 40% were sent by us directly to the
contract manufacturers as selected by the OEMs; and the balance of the shipments
were sent directly by us to our OEM customers.
Our largest distributor is Memec Group Holdings Ltd. who represents our products
worldwide (excluding Japan). We believe that on a going-forward basis many of
our customers will be seeking to reduce supply chain costs and will, therefore,
request that we ship more of our products to the contract manufacturers they
have selected. Based on this trend, we expect that our largest customers will
have us ship a higher percentage of their orders directly to the contract
manufacturers and a lower percentage will be shipped through our distributors
over time.
Cisco Systems and Lucent Technologies each represented more than 10% of our 2001
revenues based on total sales to end customers (i.e. based on shipments through
our distributors, to the sub-contractors as selected by our customers, or to the
OEMs directly). Our sales outside of the United States accounted for 42% of
total revenue in 2001, 38% in 2000, and 30% in 1999.
MANUFACTURING
We are a fabless company, meaning we do not own or operate foundries for the
production of silicon wafers from which our products our made. Instead, we use
independent foundries and chip assemblers for the manufacture of our products.
Typically, the manufacture of our chips requires 12-16 weeks. We refer to this
as our lead-time. Based on this lead-time, our team of production planners will
initiate a purchase order with an independent foundry to fabricate the required
wafers. The wafers once fabricated must be probed, or inspected, to determine
usable from unusable chip parts, referred to as die, on the wafer. The wafers
are sent to an outside assembly house where they are cut and the good die are in
turn packaged into chips. The chips are then run through various electrical and
visual tests before delivery to the customer. With most of our products, we have
the option to probe the wafers or test the final chips in-house or subcontract
the probing or testing out to independent subcontractors.
We receive more than 90% of the silicon wafers with which we derive our products
from Chartered Semiconductor Manufacturing Ltd. ("Chartered"), Taiwan
Semiconductor Manufacturing Corporation ("TSMC"), and IBM. These independent
foundries produce our networking products at feature sizes down to 0.13 micron.
By using independent foundries to fabricate our wafers, we are better able to
concentrate our resources on the designing, development and testing of new
products. In addition, we avoid much of the fixed capital cost associated with
owning and operating a fabrication facility.
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We have supply agreements with both Chartered and TSMC. We have made deposits to
secure access to wafer fabrication capacity under both of these agreements. At
December 31, 2001 and 2000, we had $22 million and $23 million, respectively, in
deposits with these companies. Under these agreements, the foundries must supply
certain quantities of wafers per year. Neither of these agreements have minimum
unit volume requirements but we are obliged under one of the agreements to
purchase a minimum percentage of our total annual wafer requirements provided
that the foundry is able to continue to offer competitive technology, pricing,
quality and delivery. The agreements may be terminated if either party does not
comply with the terms.
Wafers supplied by outside foundries must meet our incoming quality and test
standards. We conduct a portion of our test operations on advanced mixed signal
and digital test equipment in our Burnaby and Santa Clara facilities. The
remainder of our testing is performed predominantly by independent U.S. and
Asian companies.
RESEARCH AND DEVELOPMENT
Our current research and development efforts are targeted at integrating
multiple channels or functions on single chips, broadening the number of
products we provide to address varying protocols and networking functions, and
increasing the speeds at which our chips operate.
We have design centers in the United States (California, Oregon, Maryland, and
Pennsylvania), Canada (British Columbia, Saskatchewan, Ontario and Quebec),
Ireland, and India.
We spent $201.1 million in 2001, $178.8 million in 2000, and $83.7 million in
1999 on research and development.
In 2000, we also expensed $38.2 million of in process research and development,
$31.5 million of which related to the acquisition of Malleable Technologies and
$6.7 million of which related to the acquisition of Datum Telegraphic.
BACKLOG
We sell primarily pursuant to standard purchase orders. Our customers frequently
revise the quantity actually purchased and the shipment schedules to reflect
changes in their needs. We believe orders placed for delivery in excess of six
months are not firm orders. As of December 31, 2001, our backlog of products
scheduled for shipment within six months totaled $35.7 million. Unless our
customers cancel or defer to a subsequent year a portion of this backlog, we
expect this entire backlog to be filled in 2002. Our backlog of products as of
December 31, 2000 for shipment within six months totaled $216 million.
Our backlog includes backlog to our major distributor, which may not result in
revenue, as we do not recognize shipments to our major distributor as revenue
until our distributor has sold our products through to the end customer. Also,
our customers may cancel, or defer to a future period, a significant portion of
the backlog at their discretion without penalty. Accordingly, we believe that
our backlog at any given time is not a meaningful indicator of future revenues.
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COMPETITION
We typically face competition at the design stage when our networking customers
determine which communications semiconductor components to use in their next
generation equipment designs.
Most of our customers choose a particular semiconductor component primarily
based on whether the component:
o meets the functional requirements,
o addresses the communications protocols,
o interfaces easily with other components in a design,
o meets power usage requirements, and
o is priced competitively.
OEMs are becoming more price conscious than in the past as a result of the
downturn in the telecommunications industry, and as semiconductors sourced from
third party suppliers comprise a greater portion of the total materials cost in
OEM equipment. We have also experienced more aggressive price competition from
competitors that are seeking to enter into the market segments in which we
participate. These circumstances may make some of our products less competitive
and we may be forced to decrease our prices significantly to win a design.
In addition to price, OEMs will also consider the quality of the supplier when
determining which component to include in a design. Many of our customers will
consider the breadth and depth of the supplier's technology, as using one
supplier for a broad range of technologies can often simplify and accelerate the
design of next generation equipment. OEMs will also consider a supplier's design
execution reputation, as many OEMs design their next generation equipment
concurrently with the component design. As well, consideration is given to
whether the OEM has qualified the supplier, as this ensures that components made
by that supplier will meet the OEM's strict quality standards.
Our competitors may be classified into three major groups. First, we compete
against established peer-group semiconductor companies that focus on the
communications semiconductor business. These companies include Agere Systems,
Applied Micro Circuits Corporation, Broadcom, Exar Corporation, Conexant
Systems, Marvell Technology Group, Multilink Technology Corporation, Transwitch
and Vitesse Semiconductor. These companies are well financed, have significant
communications semiconductor technology assets, have established sales channels,
and depend on the market in which we participate for the bulk of their revenues.
12
Other competitors include major domestic and international semiconductor
companies, such as Cypress Semiconductor, Intel, IBM, Infineon, Integrated
Device Technology, Maxim Integrated Products, Motorola, Nortel Networks, and
Texas Instruments. These companies are concentrating an increasing amount of
their substantial financial and other resources on the markets in which we
participate.
Emerging companies also provide competition in our segment of the semiconductor
market. We are aware of venture-backed companies that focus on specific portions
of our broad range of products. These companies could introduce technologies
that may make one or more of our integrated circuits obsolete.
Over the next few years, we expect additional competitors, some of which may
also have greater financial and other resources, to enter the market with new
products.
We are also expanding into some markets, such as the wireless infrastructure and
generic microprocessor markets that have established incumbents that have
substantial financial and other resources. Some of these incumbents derive a
majority of their earnings from these markets. We expect a strong increase in
competition in these markets.
LICENSES, PATENTS AND TRADEMARKS
We rely in part on patents to protect our intellectual property and have been
awarded 112 U.S. patents for circuit designs and other innovations used in the
design and architecture of our products. In addition, we have 94 patent
applications pending in the U.S. Patent and Trademark office, and 3 patent
applications pending in other countries. Our patents expire typically 20 years
from the patent application date if accepted, with our existing patents expiring
between 2010 and 2020.
Our products, once designed are outlined in mask works that represent the
predetermined three-dimensional pattern of metallic, insulating, or
semiconducting material present or removed from the layers of a semiconductor
chip used to produce our product. To protect our intellectual property we rely
on a 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.
We do not consider our business to be materially dependent upon any one patent,
although we believe that a strong portfolio of patents combined with other
factors such as our innovative ability, technological expertise and the
experience of our personnel are important to compete effectively in the
industry. A portfolio of patents also provides the flexibility to negotiate or
cross license intellectual property with other semiconductor companies to
incorporate other features in our products.
Our only material license is the MIPS microprocessor architecture license from
MIPS Technologies Inc., on which our microprocessor-based products are based.
While the desktop microprocessor market is dominated by the Intel Corporation's
"x86" complex instruction set computing, or CISC, architecture, several
microprocessor architectures have emerged for other microprocessor markets.
Because of their higher performance and smaller space requirements, most of the
competing architectures, like the MIPSA architecture, are reduced instruction
set computing, or RISC architectures. The MIPS architecture is widely supported
through semiconductor design software, operating systems and companion
integrated circuits. Because this license is the architecture behind our
microprocessors, we must be able to retain the MIPS license in order to produce
our follow-on microprocessor products.
13
PMC and its logo are our registered trademarks and service marks. We own other
trademarks and service marks not appearing in this Annual Report. Any other
trademarks used in this Annual Report are owned by other entities.
EMPLOYEES
As of December 31, 2001, we had 1,141 employees, including 711 in Research &
Development, 125 in Production and Quality Assurance, 199 in Marketing and Sales
and 106 in Administration. Our employees are not represented by a collective
bargaining agreement. We have never experienced any work stoppage. We believe
our employee relations are good.
ITEM 2. Properties.
PMC leases or owns properties in twenty-six locations worldwide. Approximately
45% of the space leased by PMC is currently unoccupied. Pending sublease
transactions and lease expiries will reduce the excess, uncommitted space to
39%.
We lease a total of 462,000 square feet in seven separate buildings in Santa
Clara, California, to house the majority of our US design, engineering, product
test, sales and marketing operations.
Our Canadian headquarters are located in Burnaby, British Columbia where we
lease 254,000 square feet of office space in five separate buildings. These
locations support a significant portion of our product development,
manufacturing, marketing, sales and test activities. We also operate ten
additional research & development centers: four in Canada, three in the US, two
in Ireland and one in India.
We have twelve sales offices worldwide, with locations in Europe, Asia, and
North America.
All of our offices are in leased premises. We also own two buildings on
approximately 19 acres of land near our Canadian headquarters in Burnaby. The
property was purchased as a development site and is being held with the eventual
intention of building our own facility to replace our existing leased Burnaby
premises.
ITEM 3. Legal Proceedings.
We are currently not engaged in legal proceedings that require disclosure under
this item.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
14
Stock Price Information. Our common stock trades on the Nasdaq National Market
under the symbol PMCS. The following table sets forth, for the periods
indicated, the high and low closing sale prices for our Common Stock as reported
by the Nasdaq National Market:
2000 High Low
-
First Quarter...................................... $245.44 $ 62.75
Second Quarter..................................... 231.56 118.44
Third Quarter...................................... 245.00 169.81
Fourth Quarter..................................... 227.19 69.50
2001 High Low
-
First Quarter...................................... $105.94 $ 24.74
Second Quarter..................................... 44.81 19.12
Third Quarter...................................... 36.87 10.05
Fourth Quarter..................................... 29.24 9.87
The prices presented above reflect a two-for-one stock split in the form of a
100% stock dividend that we issued on February 14, 2000.
To maintain consistency, the information provided above is based on calendar
quarter ends rather than fiscal quarter ends. As of February 1, 2002, there were
approximately 2,307 holders of record of our Common Stock.
We have never paid cash dividends on our Common Stock. We currently intend to
retain earnings, if any, for use in our business and do not anticipate paying
any cash dividends in the foreseeable future. Our current bank credit agreement
prohibits the payment of cash dividends without the approval of the bank.
15
ITEM 6. Selected Financial Data
Year Ended December 31, (1)
(in thousands, except for per share data)
---------------------------------------------------------------------------
2001(2) 2000 1999 1998 1997 (3)
STATEMENT OF OPERATIONS DATA:
Net revenues $ 322,738 $ 694,684 $ 295,768 $ 174,288 $ 139,337
Cost of revenues 137,262 166,161 73,439 45,290 34,063
Gross profit 185,476 528,523 222,329 128,998 105,274
Research and development 201,087 178,806 83,676 50,890 34,608
Marketing, general and administrative 90,302 100,589 52,301 33,842 26,502
Amortization of deferred stock compensation
Research and development 32,506 32,258 3,738 1,329 -
Marketing, general and administrative 8,678 4,006 1,383 140 -
Amortization of goodwill 44,010 36,397 1,912 915 300
Restructuring costs and other special charges 195,186 - - - (1,383)
Impairment of goodwill and purchased intangible assets 269,827 - - 4,311 -
Costs of merger - 37,974 866 - -
Acquisition of in process research and development - 38,200 - 39,176 -
Income (loss) from operations (656,120) 100,293 78,453 (1,605) 45,247
Gain (loss) on investments (14,591) 58,491 26,800 - -
Net income (loss) (639,054) 75,298 71,829 (21,699) 30,535
Net income (loss) per share - basic: (4) $ (3.80) $ 0.46 $ 0.49 $ (0.16) $ 0.24
Net income (loss) per share - diluted:(4) $ (3.80) $ 0.41 $ 0.45 $ (0.16) $ 0.23
Shares used in per share calculation - basic 167,967 162,377 146,818 137,750 127,767
Shares used in per share calculation - diluted 167,967 181,891 160,523 137,750 134,133
BALANCE SHEET DATA: As of December 31, (1)
(in thousands)
---------------------------------------------------------------------------
Working capital $ 214,471 $ 340,986 $ 191,019 $ 83,039 $ 61,752
Cash, cash equivalents and short-term investments 410,729 375,116 214,265 100,578 76,060
Long-term investment in bonds and notes 171,025 - - - -
Total assets 855,341 1,126,090 388,750 225,303 161,454
Long-term debt (including current portion) 275,470 2,333 9,198 16,807 16,873
Stockholders' equity 272,227 851,318 224,842 119,225 94,309
(1) The Company's fiscal year ends on the last Sunday of the calendar year. The
reference to December 31 has been used as the fiscal year end for ease of
presentation.
(2) Results for the year ended December 31, 2001 include a $20.7 million
write-down of excess inventory recorded in cost of revenues and a $17.5
million charge for impairment of other investments recorded in gain (loss)
on investments.
(3) Results for the year ended December 31, 1997 include a recovery of $1.4
million from the reversal of the excess accrued restructure charge
resulting from the conclusion of a 1996 restructuring plan.
(4) Reflects 2-for-1 stock splits in the form of 100% stock dividends effective
February 2000 and May 1999.
16
Quarterly Comparisons
The following tables set forth the consolidated statements of operations for
each of the Company's last eight quarters. This quarterly information is
unaudited and has been prepared on the same basis as the annual consolidated
financial statements. In management's opinion, this quarterly information
reflects all adjustments necessary for fair presentation of the information for
the periods presented. The operating results for any quarter are not necessarily
indicative of results for any future period.
Quarterly Data (Unaudited)
(in thousands except for per share data)
Year Ended December 31, 2001 Year Ended December 31, 2000
------------------------------------------- ----------------------------------------
Fourth (1) Third Second (2) First (3) Fourth Third Second First
STATEMENT OF OPERATIONS DATA:
Net revenues $ 47,157 $ 61,556 $ 94,130 $ 119,895 $ 231,652 $ 198,152 $ 150,514 $ 114,366
Cost of revenues 26,142 24,359 48,834 37,927 57,718 46,582 35,689 26,172
Gross profit 21,015 37,197 45,296 81,968 173,934 151,570 114,825 88,194
Research and development 41,145 48,705 53,769 57,468 58,009 49,682 38,857 32,258
Marketing, general and administrative 18,445 22,697 24,067 25,093 30,085 28,703 23,676 18,125
Amortization of deferred stock compensation:
Research and development 1,130 1,386 2,090 27,900 10,082 15,201 3,296 3,679
Marketing, general and administrative 7,480 254 425 519 1,419 1,605 611 371
Amortization of goodwill 2,392 5,996 17,811 17,811 17,680 17,770 488 459
Restructuring costs and other special charges 175,286 - - 19,900 - - - -
Impairment of goodwill and purchased
intangible assets 80,785 - 189,042 - - - - -
Costs of merger - - - - 1,116 23,180 5,776 7,902
Acquisition of in process research and
development - - - - - 38,200 - -
Income (loss) from operations (305,648) (41,841) (241,908) (66,723) 55,543 (22,771) 42,121 25,400
Gain (loss) on investments (14,992) - - 401 17,208 14,173 22,993 4,117
Net income (loss) $(308,028) $(34,455) $(233,045) $ (63,526) $ 43,854 $ (34,645) $ 48,574 $ 17,515
Net income (loss) per share - basic (4) $ (1.82) $ (0.20) $ (1.39) $ (0.38) $ 0.26 $ (0.21) $ 0.30 $ 0.11
Net income (loss) per share - diluted (4) $ (1.82) $ (0.20) $ (1.39) $ (0.38) $ 0.24 $ (0.21) $ 0.27 $ 0.10
Shares used in per share calculation - basic 168,874 168,389 167,817 166,786 165,609 164,488 161,611 157,798
Shares used in per share calculation - diluted 168,874 168,389 167,817 166,786 184,245 164,488 180,694 177,658
(1) Results include a $6.5 million write-down of excess inventory recorded in
cost of revenues and a charge of $17.5 million for impairment of other
investments recorded in gain (loss) on investments.
(2) Results include a $12.1 million write-down of excess inventory recorded in
cost of revenues.
(3) Results include a $2.1 million write-down of excess inventory recorded in
cost of revenues.
(4) Reflects 2-for-1 stock splits in the form of 100% stock dividends effective
February 2000 and May 1999.
17
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion of the financial condition and results of our
operations should be read in conjunction with the consolidated financial
statements and notes thereto included elsewhere in this Annual Report. This
discussion contains forward-looking statements that are subject to known and
unknown risks, uncertainties and other factors that may cause our actual
results, levels of activity, performance, achievements and prospects to be
materially different from those expressed or implied by such forward-looking
statements. These risks, uncertainties and other factors include, among others,
those identified under "Factors That You Should Consider Before Investing In
PMC-Sierra" and elsewhere in this Annual Report.
These forward-looking statements apply only as of the date of this Annual
Report. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties, and assumptions,
the forward-looking events discussed in this report might not occur. Our actual
results could differ materially from those anticipated in these forward-looking
statements for many reasons, including the risks we face as described in this
Annual Report and readers are cautioned not to place undue reliance on these
forward-looking statements, which reflect management's analysis only as of the
date hereof. Such forward-looking statements include statements as to, among
others:
o customer networking product inventory levels, needs and order levels;
o revenues;
o the degree to which our future revenues are booked and shipped within the
same reporting period, or "turns business";
o gross profit;
o research and development expenses;
o marketing, general and administrative expenditures;
o interest and other income;
o capital resources sufficiency;
o capital expenditures;
o restructuring activities, expenses and associated annualized savings; and
o our business outlook.
PMC releases earnings at regularly scheduled times after the end of each
reporting period. Typically within one hour of the release, we will hold a
conference call to discuss our performance during the period. We welcome all PMC
stockholders to listen to these calls either by phone or over the Internet by
accessing our website at www.pmc-sierra.com.
18
Comparison of Fiscal 2001, 2000 and 1999
Net Revenues ($000,000)
2001 Change 2000 Change 1999
- ---------------------------------------------------------------------------------------
Networking products $ 300.2 (55%) $ 665.7 139% $ 278.5
Non-networking products $ 22.5 (22%) $ 29.0 68% $ 17.3
Total net revenues $ 322.7 (54%) $ 694.7 135% $ 295.8
Net revenues for 2001 decreased by $372.0 million, or 54%, from net revenues in
2000. In contrast, net revenues for 2000 were higher than net revenues in 1999
by $398.9 million, or 135%.
Networking
Our networking revenues declined 55% in 2001 due to decreased unit sales of our
networking products caused by reduced demand for our customers' products and
excess inventories of our products accumulated by our customers in the prior
year. Also included in the 55% decline in networking revenues was a 5% decline
in the selling price of our products.
2000 networking revenues were 139% higher than networking revenues in 1999 due
to an increase in customer demand that resulted from the growth of our
customers' networking equipment businesses, our customers' continued transition
from internally developed application specific semiconductors to our standard
semiconductors, our introduction and sale of networking products that addressed
additional network functions, and a significant increase in our customers'
inventory of our products.
Non-networking
Non-networking revenues declined 22% in 2001 compared to an increase of 68% in
2000. These changes reflect the volume of purchases made by our principal
customer in this segment. In 1996, we discontinued development of follow-on
products in this segment and we are now only fulfilling customer orders for
previously developed products.
19
Gross Profit ($000,000)
2001 Change 2000 Change 1999
- ---------------------------------------------------------------------------------------------
Networking products $ 176.1 (66%) $ 515.7 141% $ 214.4
Percentage of networking revenues 59% 77% 77%
Non-networking products $ 9.4 (27%) $ 12.8 62% $ 7.9
Percentage of non-networking revenues 42% 44% 46%
Total gross profit $ 185.5 (65%) $ 528.5 138% $ 222.3
Percentage of net revenues 57% 76% 75%
Total gross profit for 2001 decreased by $343.0 million, or 65%, from gross
profit in 2000. In contrast, 2000 gross profit was higher than gross profit in
1999 by $306.2 million, or 138%.
Networking
Our networking gross profit decreased by $339.6 million in 2001. Over 80% of
this dollar decrease was due to the reduction in our networking sales volume.
Our networking gross profit as a percentage of networking revenues decreased 18
percentage points from 77% in 2000 to 59% in 2001. This decrease resulted from
the following factors:
o a $20.7 million write-down of excess inventory which lowered gross profit
by 7 percentage points,
o a shift in product mix towards lower margin products, which lowered gross
profit by 6 percentage points, and
o the effect of applying fixed manufacturing costs over reduced shipment
volumes which lowered margins by 5 percentage points.
The $20.7 million write-down for excess inventory, which we recorded in cost of
revenues, consisted of a $2.1 million charge in response to the cancellation of
certain of our customers' programs plus a charge of $18.6 million for inventory
levels in excess of estimated 12-month demand (see "Critical Accounting Policies
and Significant Estimates").
Our networking gross profit increased by $301.3 million in 2000 due to increased
sales volumes but did not change as a percentage of networking revenues between
1999 and 2000.
Non-networking
Non-networking gross profit as a percentage of non-networking revenues decreased
to 42% in 2001 from 44% in 2000 and 46% in 1999 due to a reduction in the
selling price of our non-networking product.
20
Other Costs and Expenses ($000,000)
2001 Change 2000 Change 1999
- -----------------------------------------------------------------------------------------------------
Research and development $ 201.1 12% $ 178.8 114% $ 83.7
Percentage of net revenues 62% 26% 28%
Marketing, general and administrative $ 90.3 (10%) $ 100.6 92% $ 52.3
Percentage of net revenues 28% 14% 18%
Amortization of deferred stock compensation
Research and development $ 32.5 1% $ 32.3 773% $ 3.7
Marketing, general and administrative 8.7 118% 4.0 186% 1.4
------------------------------------------------------
$ 41.2 13% $ 36.3 612% $ 5.1
Percentage of net revenues 13% 5% 2%
Amortization of goodwill $ 44.0 $ 36.4 $ 1.9
Percentage of net revenues 14% 5% 1%
Costs of merger - $ 38.0 $ 0.9
Percentage of net revenues - 5% -
In process research and development - $ 38.2 -
Percentage of net revenues - 5% -
Restructuring costs and other special charges $ 195.2 - -
Percentage of net revenues 60% - -
Impairment of goodwill and purchased
intangible assets $ 269.8 - -
Percentage of net revenues 84% - -
Research and Development Expenses
Our research and development, or R&D, expenses were $201.1 million in 2001,
$178.8 million in 2000, and $83.7 million in 1999, an increase of 12% in 2001
compared to 2000 and an increase of 114% in 2000 compared to 1999.
R&D expenses for 2001 were higher than 2000 as the effect of increased hiring
and expansion of development programs and costs during 2000 was only partially
offset by the restructuring and cost reduction programs implemented in 2001.
(See "Restructuring and other special charges".)
Although we implemented two restructuring plans during the first and fourth
quarters of 2001, our total R&D expenses increased because we had made
substantial additions to our personnel and tools during the latter part of 2000
and we have realized less than 3 months' savings from our fourth-quarter
restructuring. While we reduced our R&D personnel by 34% by the end of 2001 from
the end of 2000, our personnel and related costs for 2001 exceeded 2000 by
approximately $7.2 million. We also increased our tools and equipment costs by
$11.8 million due to our continued investment in new tools and equipment in
support of our continuing research and development efforts.
Our 2001 R&D expenses also increased by $4.2 million as a result of acquisitions
that we completed during 2000 and accounted for under the purchase method.
21
In 2000, our R&D expenditures increased by 114% over 1999 due to a $51.5 million
increase in personnel and related costs as a result of internal hiring and
acquisitions, and a $36.1 million increase in service and material costs
associated with our expanding product development efforts. Our 2000 R&D expenses
also increased by $7.4 million as a result of acquisitions that we completed
during 2000 and accounted for under the purchase method.
Our R&D expenses increased as a percentage of net revenues in 2001 due to the
54% decline in our 2001 net revenues. The expenses decreased as a percentage of
net revenues in 2000 as a result of the 139% growth in our net revenues that
year.
Marketing, General and Administrative Expenses
Our marketing, general and administrative, or MG&A, expenses decreased by 10% to
$90.3 million in 2001 from $100.6 million in 2000.
The $10.3 million decrease in our MG&A expenses was largely due to a $12 million
reduction in sales commissions as a result of the decline in our revenues. MG&A
expenses increased by approximately $1.2 million in 2001 as a result of the full
year impact of acquisitions made during 2000 that were accounted for under the
purchase method.
Through our two restructuring programs in 2001, we reduced our MG&A personnel by
30% from the end of the preceding year. However, due to growth in the latter
part of 2000, this reduction in MG&A personnel resulted in only a 3%
year-over-year decrease in MG&A personnel costs. Recruitment costs decreased in
2001 due to less hiring activity. These savings were offset by increases in the
cost of facilities due to the prior year's expansion. Our restructurings
resulted in excess space when we reduced our personnel in 2001. (See
"Restructuring and other special charges".)
Our MG&A spending in 2000 increased 92% from 1999. In 2000, we increased our
personnel and recruitment costs by $20 million and expanded our facilities and
related costs by more than $8 million due to the addition of new personnel. We
also increased the size of our direct sales force in 2000 and incurred $10.7
million more in commissions as a result of our increased revenues. MG&A expenses
also increased by approximately $1.8 million in 2000 as a result of acquisitions
made during 2000 that were accounted for under the purchase method.
MG&A expenses as a percentage of net revenues increased in 2001 and decreased in
2000 because many of our MG&A costs are relatively fixed in the short term. As a
result, these expenses will generally decline as a percentage of revenue in
periods of rising revenues and may increase as a percentage of revenue in
periods of declining revenues.
22
Amortization of Deferred Stock Compensation
We recorded total deferred stock compensation expense of $41.2 million in 2001
compared to $36.3 million in 2000 and $5.1 million in 1999.
In 2001, our amortization of deferred stock compensation increased compared to
2000 due to accelerated vesting related to certain employees terminated as a
result of our two restructurings.
Our acquisitions of AANetcom, Abrizio, QED, SwitchOn, Toucan, and Extreme in
2000 contributed $16.2 million to deferred stock compensation amortization in
2000 and all of the expense in 1999. An additional, $20.1 million of the expense
in 2000 related to the unearned compensation recognized on the Malleable and
Datum purchase acquisitions.
Amortization of Goodwill and Impairment of Intangibles
Non-cash goodwill charges increased to $44.0 million in 2001 from $36.4 million
in 2000 and $1.9 million in 1999 primarily as a result of the goodwill recorded
in connection with the Malleable and Datum acquisitions, which were completed in
mid 2000.
During the second quarter of 2001, we discontinued further development of the
technology acquired in the purchase of Malleable. We do not expect to have any
future cash flows related to the Malleable assets and have no alternative use
for the technology. Accordingly, we recorded an impairment charge of $189.0
million, equal to the remaining net book value of goodwill and intangible assets
related to Malleable. As a result, there was no remaining Malleable goodwill or
intangibles to amortize in the second half of 2001.
In the fourth quarter of 2001, due to a continued decline in current market
conditions and a delay in the introduction of certain products to the market, we
completed an assessment of the future revenue potential and estimated costs
associated with all acquired technologies. As a result of this review, we
recorded an impairment charge of $79.3 million related to the acquired goodwill
and intangibles recognized in the purchase of Datum. The impairment charge was
calculated by the excess of the carrying value of assets over the present value
of estimated future cash flow related to these assets. The impairment charge
reduced the amounts subject to amortization for the remainder of the year.
Costs of Merger
We did not make any pooling acquisitions and therefore, did not incur any merger
costs in 2001.
In 2000, we completed five pooling acquisitions and incurred $38.0 million of
merger costs. In 1999, we completed one pooling acquisition and incurred $0.9
million of merger costs. These charges consist primarily of investment banking
and other professional fees.
23
In Process Research and Development ("IPR&D")
IPR&D charges were $38.2 million in 2000. There were no IPR&D charges in 2001 or
1999.
The amounts expensed to in process research and development in 2000 arose from
the acquisitions of Malleable and Datum. We did not make any acquisitions that
were accounted for using the purchase method in 2001 or 1999.
We calculated the charge for IPR&D related to Malleable and Datum by determining
the fair value of the existing products as well as the technology that was
currently under development using the income approach. Under the income
approach, expected future after-tax cash flows from each of the projects under
development are estimated and discounted to their net present value at an
appropriate risk-adjusted rate of return. Revenues were estimated based on
relevant market size and growth factors, expected industry trends, individual
product sales cycles and the estimated life of each product's underlying
technology. Estimated operating expenses, income taxes and charges for the use
of contributory assets were deducted from estimated revenues to determine
estimated after-tax cash flows for each project. These projected future cash
flows were further adjusted for the value contributed by any core technology and
development efforts expected to be completed post acquisition.
These forecasted cash flows were then discounted based on rates derived from our
weighted average cost of capital, weighted average return on assets and venture
capital rates of return adjusted upward to reflect additional risks inherent in
the development life cycle. The risk adjusted discount rates used involved
consideration of the characteristics and applications of each product, the
inherent uncertainties in achieving technological feasibility, anticipated
levels of market acceptance and penetration, market growth rates and risks
related to the impact of potential changes in future target markets. After
considering these factors, we determined risk adjusted discount rates of 35% and
30% for Malleable and Datum, respectively.
In our opinion, the pricing model used for products related to these
acquisitions were standard within the high-technology industry and the estimated
IPR&D amounts so determined represented fair value and did not exceed the
amounts that a third party would have paid for these projects. When we acquired
these companies, we did not expect to achieve a material amount of expense
reduction or synergies as a result of integrating the acquired in process
technology. Therefore, the valuation assumptions did not include anticipated
cost savings.
A description of the IPR&D projects acquired is set forth below:
The in process technology acquired from Malleable was planned to detect incoming
voice channels and process them using voice compression algorithms. The
compressed voice was to be converted, using the appropriate protocols, to ATM
cells or IP packets to achieve higher channel density and support multiple
speech compression protocols and different packetization requirements. At the
date of acquisition we estimated that Malleable's technology was 58% complete
and the costs to complete the project to be $4.4 million.
The technology acquired from Datum is a digitally controlled amplifier
architecture, which was designed to increase base station system capacities,
while reducing cost, size and power consumption of radio networks. At the date
of acquisition, we estimated that Datum's technology was 59% complete and the
costs to complete the project to be $1.8 million.
24
The above estimates were determined by comparing the time and costs spent to
date and the complexity of the technologies achieved to date to the total costs,
time and complexities that were expected to be expended to bring the
technologies to completion.
Progress on the technology acquired from Malleable was slower than originally
estimated and as a result, costs incurred on this project exceeded our original
estimates. In the second quarter of 2001, we discontinued development of this
technology and recorded an impairment charge related to the Malleable goodwill
and purchased intangible assets (see "Amortization of Goodwill and Impairment of
Intangibles").
Development of the chip incorporating the technology acquired from Datum was
completed in the fourth quarter of 2000 and the costs incurred to that date were
in line with our initial expectations. Since then, we have completed the
required firmware related to this chip and have extended development of the
Datum technology to a follow-on product. The general economic slowdown has
delayed the introduction of the third generation base stations into which we
expect to incorporate our technology, but we expect these products to begin
generating revenues in the second quarter of 2002.
As a result of the delay in introduction of the third generation base stations,
we failed to achieve the revenues, net income, and return on investment expected
at the time that the acquisition was completed. We recorded an impairment charge
related to the Datum goodwill and purchased intangible assets during the fourth
quarter of 2001 (see "Amortization of Goodwill and Impairment of Intangibles").
Restructuring and other special charges
Restructuring - March 26, 2001
In the first quarter of 2001, we implemented a restructuring plan in response to
the decline in demand for our networking products and consequently recorded a
restructuring charge of $19.9 million. Prior to the end of the first quarter,
management approved the restructuring plan committing PMC to the termination of
223 employees, the consolidation of a number of facilities and the curtailment
of certain research and development projects. Employees terminated under this
plan were advised prior to the end of the quarter of the termination benefits to
which they were entitled.
25
The elements of the accrued restructuring costs related to the March 2001
restructuring plan are as follows:
Total Charge Noncash Cash Restructuring Liability at
(in thousands) March 26, 2001 Charges Payments December 31, 2001
- --------------------------------------------------------------------------------------------------------------------
Workforce reduction $ 9,367 $ - $ (7,791) $ 1,576
Facility lease and contract settlement costs 6,545 - (3,917) 2,628
Write-down of property and equipment, net 3,988 (3,988) - -
- --------------------------------------------------------------------------------------------------------------------
Total $ 19,900 $(3,988) $ (11,708) $ 4,204
====================================================================
Workforce reduction includes the cost of severance and related benefits of 223
employees affected by the restructuring. These terminations were spread across
all business functions, with approximately 70% occurring in Research and
Development and the remainder occurring in Sales, Marketing and Administrative
and Production departments.
Facility lease and contract settlement costs include: (i) lease termination
payments and other costs related to the closure of certain corporate facilities,
sales offices and research and development centers for activities that have been
exited or restructured; and (ii) penalties incurred due to our withdrawal from
certain purchase contracts.
Certain leasehold improvements located at the closed facilities and computer
equipment and software licenses were determined to be impaired as a result of
the restructuring activities and were written down to estimated fair market
value, net of disposal costs.
We expect to complete the restructuring activities contemplated in the March
2001 plan by the end of March 2002. Upon conclusion of these restructuring
activities, we expect to achieve annualized savings of approximately $28.2
million in cost of revenues and operating expenses.
Restructuring - October 18, 2001
Due to the continued decline in market conditions, we implemented a second
restructuring plan in the fourth quarter of 2001 to reduce our operating cost
structure. Prior to the end of the fourth quarter, management approved the
second restructuring plan committing PMC to the termination of 341 employees,
the consolidation of additional excess facilities, and the curtailment of
additional research and development projects. Employees terminated under this
plan were advised prior to the end of the quarter of the termination benefits to
which they were entitled. As a result, we recorded a second restructuring charge
of $175.3 million in our fourth quarter.
26
The elements of the accrued restructuring costs related to the October 2001
restructuring plan are as follows:
Total Charge Noncash Cash Restructuring Liability at
(in thousands) October 18, 2001 Charges Payments December 31, 2001
- --------------------------------------------------------------------------------------------------------------------------------
Workforce reduction $ 12,435 $ - $ (5,651) $ 6,784
Facility lease and contract settlement costs 150,610 - (400) 150,210
Write-down of prepaid software licenses 2,329 (2,329) -
Write-down of property and equipment, net 9,912 (9,912) - -
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 175,286 $(12,241) $ (6,051) $ 156,994
===============================================================================
Workforce reduction includes the cost of severance and related benefits of 341
employees affected by the restructuring. These terminations were spread across
all business functions, with approximately 64% occurring in Research and
Development and the remainder occurring in Sales, Marketing and Administrative
and Production departments.
Facility lease and contract settlement costs include: (i) lease termination and
other costs related to the closure of corporate facilities as a result of this
restructuring; and (ii) penalties incurred due to our withdrawal from certain
purchase contracts. A significant component of this charge for excess facilities
relates to a 10-year Santa Clara, CA building lease committed to in 2000. The
charge for this excess facility is recorded net of expected future sublease
revenue. See "Critical Accounting Policies and Significant Estimates".
Certain leasehold improvements located at the closed facilities and computer
equipment, software licenses, and related software maintenance prepayments were
written down to estimated fair market value, net of disposal costs.
We expect to complete the restructuring activities contemplated in the October
2001 restructuring plan by the fourth quarter of 2002. Upon conclusion of these
restructuring activities, we expect to achieve additional annualized savings of
approximately $67.6 million in cost of revenues and operating expenses.
Interest and Other Income, Net ($000,000)
2001 Change 2000 Change 1999
- --------------------------------------------------------------------------------
Interest and other income, net $ 13.9 (26%) $ 18.9 139% $ 7.9
Percentage of net revenues 4% 3% 3%
Net interest and other income declined in 2001 by $5.0 million, or 26%.
27
Excluding interest expense and the amortization of debt financing costs,
interest and other income for 2001 was $19.0 million as compared to $19.8
million in 2000. The amount for 2000 included income of $0.6 million related to
an investee accounted for under the equity method in 2000. While our interest
income declined by approximately $3.2 million as a result of a decline of
average yields on our cash, short term and long term investments, or "cash
balances", this decline was offset by an additional $3.0 million in interest
income from an overall increase in our cash balances.
Our interest expense increased to $4.3 million in 2001 from $0.8 million in 2000
as a result of the interest expense incurred on convertible notes issued in
August 2001 (see "Liquidity and Capital Resources" below). We also incurred an
incremental $0.6 million in amortized debt issuance costs incurred in 2001 as a
result of the issuance of our convertible notes.
Our net interest income increased in 2000 compared to 1999 as a result of higher
cash balances available to earn interest. Other income in 2000 and 1999 included
income from an equity interest in another company of $0.6 million and $0.8
million, respectively. We decreased interest expense from loans and capital
leases to $0.8 million in 2000 from $1.5 million in 1999 by retiring debt from
loans and capital leases.
Gain (Loss) on Investments ($000,000)
2001 Change 2000 Change 1999
- --------------------------------------------------------------------------------
Gain(loss) on investments $(14.6) (125%) $ 58.5 118% $ 26.8
Percentage of net revenues -5% 8% 9%
We reported a net loss on investments of $14.6 million in 2001, and gains on
investments of $58.5 million in 2000 and $26.8 million in 1999.
In 2001, we recorded $2.9 million of gains on the sale of a portion of our
investment in Sierra Wireless, Inc., a public company, as well as other
investments. These gains were offset by a $17.5 million charge to recognize the
impairment of our investments in non-public entities. See "Critical Accounting
Policies and Significant Estimates".
In 2000, gains of $54.4 million resulted from the sale of a portion of our
investment in Sierra Wireless, Inc. Additionally, we sold our remaining shares
of Cypress Semiconductor, Inc. resulting in a gain of $4.1 million.
In 1999, we recorded gains of $14.5 million from the sale of a portion of our
Sierra Wireless shares. During the year, we also had an investment in IC Works,
Inc., or ICW, a private company that was subsequently purchased by Cypress
Semiconductor, a public company. As a result of that transaction, we exchanged
our preferred shares of ICW for common shares of Cypress Semiconductor. We
disposed of a portion of our shares in Cypress Semiconductor, resulting in a
gain of $12.3 million.
Provision for Income Taxes.
28
Our annual effective tax rate for the year ended December 31, 2001 was a
recovery of 2.7%. Excluding the effects of non-deductible goodwill, deferred
stock compensation amortization, and impairment of purchased intangibles, the
effective income tax rate for 2001 was a recovery of 21.7% compared to the
statutory tax rate of 35%. Our effective tax rate was lower than the statutory
rate as a result of a valuation allowance provided on deferred tax assets that
were uncertain of being realized.
Our annual effective tax rate for the year ended December 31, 2000 was an
expense of 57.6% compared to a statutory tax rate of 35%. Our increased
effective tax rate primarily reflects the higher provision for income taxes for
our Canadian subsidiary and the non-tax deductible charges for in process
research and development, goodwill amortization, deferred stock compensation and
acquisition costs related to acquisitions completed during the year. These
factors were partially offset by the utilization of tax losses and other
deferred tax assets for which benefits were previously not recognized.
Our annual effective tax rate for the year ended December 31, 1999 was 36.5%,
which approximated the statutory tax rate of 35%.
We have provided a valuation allowance on certain of our deferred tax assets
because of uncertainty regarding their realizability.
See Note 12 to the Consolidated Financial Statements for additional information
regarding income taxes.
Recently issued accounting standards.
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 141 (SFAS 141), "Business Combinations" and
Statement of Financial Accounting Standard No.142 (SFAS 142), "Goodwill and
Other Intangible Assets". SFAS 141 requires that business combinations be
accounted for under the purchase method of accounting and addresses the initial
recognition and measurement of assets acquired, including goodwill and
intangibles, and liabilities assumed in a business combination. SFAS 142
requires goodwill to be allocated to, and assessed as part of, a reporting unit.
Further, SFAS 142 specifies that goodwill will no longer be amortized but
instead will be subject to impairment tests at least annually. The impairment
test is a two-step process. First, the fair value of a reporting unit is
compared to its carrying value to identify possible impairment and then, if
necessary, the impairment is measured through a deemed purchase price
allocation. Under this standard, we will also be required to review the useful
lives of acquired goodwill and intangible assets at least annually.
We will adopt SFAS 141 and 142 on a prospective basis as of January 1, 2002. The
adoption of SFAS 141 is not expected to have a material effect on our financial
position, results of operations and cash flows unless we acquire significant
additional companies.
In 2002, we will no longer amortize goodwill pursuant to SFAS 142, thereby
eliminating annual goodwill amortization of approximately $2.0 million. Goodwill
amortization for the year ended December 31, 2001 was $44.0 million. Unamortized
goodwill as of December 31, 2001 was $7.1 million. We will complete an initial
goodwill impairment assessment in the second quarter of 2002 to determine if a
transition impairment charge should be recognized under SFAS 142.
29
In October 2001, the FASB issued Statement of Financial Accounting Standard No.
144 (SFAS 144), "Accounting for the Impairment or Disposal of Long-Lived
Assets". SFAS 144 supersedes Statement of Financial Accounting Standard No. 121
(SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions
of APB Opinion No. 30 for the disposal of a business segment. SFAS 144
establishes a single accounting model, based on the framework established in
SFAS 121, for long-lived assets to be disposed of by sale. The Statement also
broadens the presentation of discontinued operations to include disposals of a
component of an entity and provides additional implementation guidance with
respect to the classification of assets as held-for-sale and the calculation of
an impairment loss. We are required to adopt SFAS 144 effective January 1, 2002.
We do not expect the adoption of SFAS 144 to have a material impact on our
financial statements.
Critical Accounting Policies and Significant Estimates
Our significant accounting policies are outlined within Item 8 as Note
1 to the Financial Statements and Supplementary Data. Some of those accounting
policies require us to make estimates and assumptions that affect the amounts
reported by us. The following items require the most significant judgment and
involve complex estimation:
Restructuring charges - Facilities
In calculating the cost to dispose of our excess facilities we had to estimate
for each location the amount to be paid in lease termination payments, the
future lease and operating costs to be paid until the lease is terminated, and
the amount, if any, of sublease revenues. This required us to estimate the
timing and costs of each lease to be terminated, the amount of operating costs,
and the timing and rate at which we might be able to sublease the site. To form
our estimates for these costs we performed an assessment of the affected
facilities and considered the current market conditions for each site. We
recorded a charge of $155 million for the restructuring of excess facilities as
part of the restructuring plan, which was approximately 53% of the estimated
total future operating cost and lease obligation for those sites. Our
assumptions on either the lease termination payments, operating costs until
terminated, or the offsetting sublease revenues may turn out to be incorrect and
our actual cost may be materially different from our estimates.
Inventory
We periodically compare our inventory levels to sales forecasts for the future
twelve months on a part by part basis and record a charge for inventory on hand
in excess of the estimated twelve month demand. In 2001, our inventory of
networking products exceeded estimated 12-month demand by $20.7 million and we
recorded a charge of that amount. If future demand for our products continues to
decline, we may have to take an additional write-down of inventory.
Income Taxes
30
We have incurred losses and other costs that can be applied against future
taxable earnings to reduce our tax liability on those earnings. As we are
uncertain of realizing the future benefit of those losses and expenditures, we
have taken a valuation allowance against all domestic deferred tax assets and
recorded only deferred tax assets that can be applied in currently taxable
foreign jurisdictions.
Goodwill
As part of our restructuring plan, we discontinued further development of the
technology acquired in the purchase of Malleable Technologies, Inc. We estimated
that we would not receive any future cash flows related to these assets, and
recorded an impairment of the remaining net book value of the goodwill and
intangible assets related to Malleable of $189 million.
We also performed a review of the technology and assets acquired in the purchase
of Datum Telegraphic, Inc. We estimated the future cash flows of those assets in
light of continued weak industry conditions, lower market growth expectations,
and delays in our customers' clients moving to next generation wireless services
where the Datum technology can be used. Based on the discounted values of those
cash flows, we recorded an impairment charge of $79.3 million of the remaining
net book value of goodwill and intangible assets related to Datum. Failure to
achieve the revised levels of revenues and net income will negatively impact the
revised return on investment and may result in further impairment of the
goodwill and purchased intangible assets related to Datum.
Investment in Non-Public Entities
We have invested in non-public companies and in venture capital funds, which we
review periodically to determine if there has been a non-temporary decline in
the market value of those investments below our carrying value. Our assessment
of impairment in carrying value is based on the market value trends of similar
public companies, the current business performance of the entities in which we
have invested, and if available, the estimated future market potential of the
companies and venture funds. We recorded an impairment of our investments in
non-public entities of $17.5 million in the fourth quarter of 2001. When we
perform future assessments of these investments, a further decline in the value
of these companies and venture funds may require us to recognize additional
impairment on the remaining $12.4 million investment.
31
Business Outlook
Our networking revenues declined in 2001 compared to 2000 because:
o in reaction to lower than expected demand for network services and rising
debt levels, network service providers spent less on the networking
equipment that our customers sell and which include our networking
products, and
o our customers consumed a portion of the significant excess inventories of
our networking products that they accumulated in 2000 and the first quarter
of 2001.
Most of our networking customers' clients have announced further anticipated
declines in expenditures on our customers' equipment and some have either filed
or will soon file for bankruptcy protection. Most of our customers continue to
restructure their operations, cut significant product development efforts,
reduce their excess component inventories, and divest parts of their operations.
While we expect the networking equipment industry downturn to continue into
2002, we believe that our customers and their contract manufacturers have
depleted a significant portion of their inventories of our networking products.
In addition, we believe our customers have designed more of our next generation
networking semiconductors into their equipment than in prior years. This
suggests that our networking revenues will stabilize in 2002, albeit at lower
levels than in 2001. We expect to experience quarterly sequential growth in the
first quarter of 2002. We expect that the pattern of our quarterly networking
revenues to be volatile in 2002 as a result of fluctuating customer demand
forecasts and inventory levels. At any time our networking revenues may decline
further if our customers' clients announce further reductions in spending on our
customers' equipment. Recent news releases indicate that network service
providers continue to struggle financially and may further decrease expenditures
on our customers' products.
We expect sales of our non-networking device to decline significantly by the
second quarter of 2002 as the next generation product that our principal
customer has designed no longer incorporates our non-networking device.
We expect our total R&D and MG&A expenses to decline in 2002 as compared to 2001
as a result of the two restructurings we undertook in 2001. We estimate that our
quarterly overhead expenses will be in the mid $50 million range, excluding any
special charges, for the foreseeable future.
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No.142 (SFAS 142), "Goodwill and Other Intangible
Assets". SFAS 142 specifies that goodwill will no longer be amortized but
instead will be subject to impairment tests at least annually. We will not
amortize goodwill in 2002. We will complete an initial goodwill impairment
assessment in the second quarter of 2002 to determine if a transition impairment
charge should be recognized under SFAS 142.
We anticipate that interest and other income will decline significantly in 2002
as compared to 2001 because we expect to earn lower average yields on our cash
balances and expect to consume cash throughout 2002 for operations.
32
Liquidity and Capital Resources
We have no special purpose entities and no undisclosed borrowings or debt. We
have not entered into any derivative contracts other than our convertible notes
and through our stock option plans, and we have not entered into any synthetic
leases. We contribute only cash to our employees' 401 K and other pension plans.
Our principal source of liquidity at December 31, 2001 was our cash, cash
equivalents and short-term investments of $410.7 million, which increased from
$375.1 million at the end of 2000. At the end of 2001, we also held $171 million
in investments in bonds and notes with maturities between 12 and 30 months. We
had no such investments at the end of 2000.
During 2001, we used $53.2 million in cash for operating activities. Our net
loss of $639.1 million included non-cash charges of $269.8 million for
impairment of intangible assets, $46.8 million for amortization of intangibles,
$51.2 million for depreciation, $41.2 million for amortization of deferred stock
compensation, $20.7 million for an excess inventory write-down, $17.5 for
impairment of other investments, and $16.2 million of non-cash restructuring
costs. In addition, we recognized $2.9 million of gains on the sale of
investments.
With respect to changes in working capital, we generated cash by decreasing our
accounts receivable by $77.8 million and our prepaid expenses by $6.1 million.
We used cash to decrease our accounts payable and accrued liabilities by $30
million, deferred income by $36.4 million and income taxes payable by $43.7
million. By the end of 2001, we had $161.2 million in accrued restructuring
costs that we expect will consume cash in future periods.
Our year to date investing activities include the maturity of and reinvestment
in short-term investments. We also invested $197.1 million in bonds and notes
with maturities between 12 and 30 months, $26.1 million of which were
reclassified as short-term investments at the end of 2001. We purchased $27.8
million of property and equipment, $4.2 million in other investments and assets,
net of sales, and reduced total wafer fabrication deposits by $1 million.
Our financing activities in 2001 generated $290.2 million. We received $24.8
million of proceeds from issuing common stock upon exercise of stock options and
used $1.7 million for debt and capital lease repayments during 2001. In 2001 we
received net proceeds of $267.2 million by issuing $275.0 million of convertible
subordinated notes. The notes are subordinated to all of our senior debt, pay a
3.75% coupon of approximately $5.2 million on February 15 and August 15 of each
year, and mature on August 15, 2006. The notes are convertible into shares of
our common stock at a conversion price of approximately $42.43 per share, and
are subject to restrictive covenants including those concerning payments on the
notes and other indebtedness. In the event of a change in control of PMC, the
noteholders may require us to repurchase their notes.
We have a line of credit with a bank that allows us to borrow up to $25 million
provided, along with other restrictions, that we do not pay cash dividends or
make any material divestments without the bank's written consent. At December
31, 2001, we committed approximately $5.3 million of this facility under letters
of credit as security for a leased facility. These letters of credit renew
automatically each year and expire in 2011.
33
We have commitments made up of the following:
Year Ending December 31, 2001 (in thousands) Payments Due by Period
- --------------------------------------------------------------------------------------------------------
Less than After 5
Contractual Obligations Total 1 Year 1-3 Years 4-5 Years Years
Capital Lease Obligations 470 470 - - -
Operating Lease Obligations:
Minimum Rental Payments 303,357 31,747 63,306 60,996 147,308
Estimated Operating cost payments 69,466 7,513 14,725 15,927 31,301
Long Term Debt 275,000 - - 275,000 -
----------------------------------------------------------
648,293 39,730 78,031 351,923 178,609
Venture Investment Commitments (see below) 40,700 ===============================================
----------
Total Contractual Cash Obligations 688,993
==========
In connection with the restructuring plans implemented in 2001, we recorded a
charge of $128.3 million for exiting and terminating operating lease facilities
included in the above table.
We participate in four professionally managed venture funds that invest in
early-stage private technology companies in markets of strategic interest to us.
From time to time these funds request additional capital for private placements.
We have committed to invest an additional $40.7 million into these funds, which
may be requested by the fund managers at any time over the next eight years.
We believe that existing sources of liquidity will satisfy our projected
restructuring, operating, working capital, venture investing, debt interest,
capital expenditure and wafer deposit requirements through the end of 2002. We
expect to spend approximately $25 million on new capital additions during 2002.
FACTORS THAT YOU SHOULD CONSIDER BEFORE INVESTING IN PMC-SIERRA
Our company is subject to a number of risks - some are normal to the fabless
networking semiconductor industry, some are the same or similar to those
disclosed in previous SEC filings, and some may be present in the future. You
should carefully consider all of these risks and the other information in this
report before investing in PMC. The fact that certain risks are endemic to the
industry does not lessen the significance of the risk.
As a result of these risks, our business, financial condition or operating
results could be materially adversely affected. This could cause the trading
price of our securities to decline, and you may lose part or all of your
investment.
We are subject to rapid changes in demand for our products due to customer
inventory levels, production schedules, fluctuations in demand for networking
equipment and our customer concentration.
34
As a result of these factors, we have very limited revenue visibility and the
rate by which revenues are booked and shipped within the same reporting period
is typically volatile. In addition, our net bookings can vary sharply up and
down within a quarter.
Our revenues have declined due to reduced demand in the markets we
serve, and may decline further in 2002.
Several of our customers' clients have reported lower than expected demand for
their services or products, which has resulted in poor operating results and
difficulty in accessing the capital needed to build their networks or survive to
profitability. Many of these companies are facing increased competition and have
either filed for bankruptcy or may become insolvent in the near future.
Concurrently, many of our customers' more viable network service provider
clients have accumulated significant debt loads to finance capital projects that
have yet to generate significant positive cash flows. Recent news releases
further indicate that carriers continue to struggle financially and may further
decrease expenditures on our customers' products.
Consequently, most of our customers' clients have announced significant
reductions in current and forecasted expenditures on the equipment our customers
sell and have adjusted these expenditures toward equipment which may generate
financial return in a shorter time horizon. This equipment may not incorporate,
or may incorporate fewer, of our products.
In response to the actual and anticipated declines in networking equipment
demand, many of our customers and their contract manufacturers have undertaken
initiatives to significantly reduce expenditures and excess component
inventories. Consequently, they have canceled or rescheduled orders for our
networking products. Many platforms in which our products are designed have been
cancelled as our customers cancel or restructure product development initiatives
or as venture-financed startup companies fail. Our revenues may be materially
and adversely impacted beyond 2001 if these conditions continue or worsen.
Our customers' actions have materially and adversely impacted our revenues,
reduced our visibility of future revenue streams, caused an increase in our
inventory levels, and made a portion of our inventory obsolete. In addition,
because some of our costs are fixed in the short term, the reduction in demand
for our products has caused our gross and net profit margins to decline.
While we believe that our customers and their contract manufacturers are
consuming a portion of their inventory of PMC products, we believe that those
inventories as well as the weakened demand that our customers are experiencing
for their products, will continue to depress revenues and profit margins beyond
2001 (see "Business Outlook" above). We cannot accurately predict when demand
will strengthen or how quickly our customers will consume their inventories of
our products.
Our customers may cancel or delay the purchase of our products for
reasons other than the industry downturn described above.
Many of our customers have numerous product lines, numerous component
requirements for each product, sizeable and complex supplier structures, and
often engage contract manufacturers to supplement their manufacturing capacity.
This makes forecasting their production requirements difficult and can lead to
an inventory surplus of certain of their components.
35
Our customers often shift buying patterns as they manage inventory levels,
decide to use competing products, are acquired or divested, market different
products, or change production schedules.
In addition, we believe that uncertainty in our customers' end markets and our
customers' increased focus on cash management has caused our customers to delay
product orders and reduce delivery lead-time expectations. We expect this will
increase the proportion of our networking revenues in future periods that will
be from orders placed and fulfilled within the same period. This will decrease
our ability to accurately forecast, and may lead to greater fluctuations in,
operating results.
We occasionally estimate the size and consumption of our customers'
inventories of our products. These estimates are based on our limited
survey of selected contract manufacturers and our largest original
equipment manufacturer, or OEM, customers. Our analysis is intended
only to provide us with some information about our market to assist in
our forecasts, which are limited by the precision of the data we
obtain.
o Our surveys are not comprehensive. For instance, we do not include all
contract manufacturers or most of our other customers, so our overall
estimates may be understated and we cannot accurately forecast inventory
consumption by these customers.
o We are unable to obtain accurate data from survey respondents about the
degree to which our products are included in their work in progress and
finished goods inventories, so our estimates of their inventories of our
products may be understated.
o We do not verify or crosscheck the information we receive from the
companies we survey.
o We obtain this information over extended periods and do not adjust the
information for the time at which a response was received.
While we intend to monitor contract manufacturer and large OEM customer
inventories of our products, we may not do this consistently and we may not
provide updates of our expectations resulting from new data we obtain.
Even if our survey proves accurate, our estimate of when these contract
manufacturers and large OEM customers will consume their inventory and return to
purchasing products from us may not be accurate for the following reasons:
o Contract manufacturers and OEMs who consume their inventories of our
products may buy units from our distributors' existing inventories before
they start buying additional units from us. While we will recognize sales
by our major distributor as revenue, those sales will not result in
additional cash flow.
36
o Customer inventory consumption may not correlate with purchases of product
from our inventories or the inventories of our distributors. The PMC
products that our customers require may shift as the technologies
underlying their new products evolve.
We rely on a few customers for a major portion of our sales, any one of
which could materially impact our revenues should they change their
ordering pattern.
We depend on a limited number of customers for a major portion of our revenues.
Through direct, distributor and subcontractor purchases, Cisco Systems and
Lucent Technologies each accounted for more than 10% of our fiscal 2001
revenues. Both of these companies have recently announced order shortfalls for
some of their products.
We do not have long-term volume purchase commitments from any of our major
customers. Accordingly, our future operating results will continue to depend on
the success of our largest customers and on our ability to sell existing and new
products to these customers in significant quantities. The loss of a key
customer, or a reduction in our sales to any key customer or our inability to
attract new significant customers could materially and adversely affect our
business, financial condition or results of operations.
If the current downturn continues, we may have to add to our inventory
reserve, which would lead to a further decline in our operating
profits.
As a result of the industry-wide reduction in capital spending and resulting
significant decrease in demand for our products, we determined that we had
inventory levels that exceeded our anticipated demand over the next twelve
months. Accordingly, in 2001 we recorded an inventory write-down of $20.7
million related to excess inventory on hand. The inventory reserve was based on
our revenue expectations through 2002. If future demand of our products does not
meet our expectations, we may need to take an additional write-down of
inventory.
If the recent trend of consolidation in the networking industry
continues, many of our customers may be acquired, sold or may choose to
restructure their operations, which could lead those customers to
cancel product lines or development projects and our revenues could
decline.
The networking equipment industry is experiencing significant merger activity
and partnership programs. Through mergers or partnerships, our customers could
seek to remove duplication or overlap in their product lines or development
initiatives. This could lead to the cancellation of a product line into which
our products are designed or a development project in which we are
participating. In the case of a product line cancellation, our revenues could be
negatively impacted. In the case of a development project cancellation, we may
be forced to cancel development of one or more products, which could mean
opportunities for future revenues from this development initiative could be
lost.
Design wins do not translate into near-term revenues and the timing of revenues
from newly designed products is often uncertain.
37
We have announced a large number of new products and design wins for existing
and new products. While some industry analysts may use design wins as a metric
for future revenues, many design wins will not generate any revenues as customer
projects are cancelled or rejected by their end market. In the event a design
win generates revenue, the amount of revenue will vary greatly from one design
win to another. In addition, most revenue-generating design wins do not
translate into near term revenues. Most revenue-generating design wins take
greater than 2 years to generate meaningful revenue.
Our revenue expectations may include growing sales of newer semiconductors based
on early adoption of those products by customers. These expectations would not
be achieved if early sales of new system level products by our customers do not
increase over time. We may experience this more with design wins from early
stage companies, who tend to focus on leading-edge technologies which may be
adopted less rapidly in the current environment by telecommunications service
providers.
Our restructurings have curtailed our resources and may have insufficiently
addressed market conditions.
On March 26 and October 18, 2001, we announced plans to restructure our
operations in response to the decline in demand for our networking products. The
restructuring plans included a workforce reduction of 564 employees,
consolidation of excess facilities, and contract settlement activities. As a
result of our restructuring plans, we recorded a charge of $195.2 million in
2001, which represents management's best estimate, and which may require
adjustment in the future.
We implemented this restructuring in an effort to bring our expenses into line
with our reduced revenue expectations. However, for at least 2002, we do not
expect that these measures will be sufficient to offset lower revenues, and as
such, we expect to continue to incur net losses.
Restructuring plans require significant management resources to execute and we
may fail to achieve our targeted goals. We may have incorrectly anticipated the
demand for our products, we may be forced to restructure further or may incur
further operating charges due to poor business conditions and some of our
product development initiatives may be delayed due to the reduction in our
development resources.
Our revenues may decline if our customers use our competitors' products instead
of ours, suffer further reductions in demand for their products or are acquired
or sold.
We are experiencing significantly greater competition from many different market
participants as the market in which we participate matures. In addition, we are
expanding into markets, such as the wireless infrastructure and generic
microprocessor markets, which have established incumbents with substantial
financial and technological resources. We expect fiercer competition than that
which we have traditionally faced as some of these incumbents derive a majority
of their earnings from these markets.
All of our competitors pose the following threats to us:
38
As our customers increase the frequency with which they design next
generation systems and select the chips for those new systems, our
competitors have an increased opportunity to convince our customers to
use their products, which may cause our revenues to decline.
We typically face competition at the design stage, where customers evaluate
alternative design approaches requiring integrated circuits. Our competitors may
have more opportunities to supplant our products in next generation systems
because of the shortening product life and design-in cycles in many of our
customers' products.
In addition, as a result of the industry downturn, and as semiconductors sourced
from third party suppliers comprise a greater portion of the total materials
cost in OEM equipment, OEMs are becoming more price conscious than in the past.
We have also experienced increased price aggressiveness from some competitors
that wish to enter into the market segments in which we participate. These
circumstances may make some of our products price-uncompetitive or force us to
match low prices. We may lose design opportunities or may experience overall
declines in gross margins as a result of increased price competition.
The markets for our products are intensely competitive and subject to rapid
technological advancement in design tools, wafer manufacturing techniques,
process tools and alternate networking technologies. We may not be able to
develop new products at competitive pricing and performance levels. Even if we
are able to do so, we may not complete a new product and introduce it to market
in a timely manner. Our customers may substitute use of our products in their
next generation equipment with those of current or future competitors.
Increasing competition in our industry will make it more difficult to
achieve design wins.
We face significant competition from three major fronts. First, we compete
against established peer-group semiconductor companies that focus on the
communications semiconductor business. These companies include Agere Systems,
Applied Micro Circuits Corporation, Broadcom, Exar Corporation, Conexant
Systems, Marvell Technology Group, Multilink Technology Corporation, Transwitch
and Vitesse Semiconductor. These companies are well financed, have significant
communications semiconductor technology assets, have established sales channels,
and are dependent on the market in which we participate for the bulk of their
revenues.
Other competitors include major domestic and international semiconductor
companies, such as Cypress Semiconductor, Intel, IBM, Infineon, Integrated
Device Technology, Maxim Integrated Products, Motorola, Nortel Networks, and
Texas Instruments. These companies are concentrating an increasing amount of
their substantial financial and other resources on the markets in which we
participate. This represents a serious competitive threat to us.
Emerging venture-backed companies also provide significant competition in our
segment of the semiconductor market. These companies tend to focus on specific
portions of our broad range of products and in the aggregate, represent a
significant threat to our product lines. In addition, these companies could
introduce disruptive technologies that may make our technologies and products
obsolete.
39
Over the next few years, we expect additional competitors, some of which may
also have greater financial and other resources, to enter the market with new
products. These companies, individually or collectively, could represent future
competition for many design wins, and subsequent product sales.
We must often redesign our products to meet rapidly evolving industry
standards and customer specifications, which may prevent or delay
future revenue growth.
We sell products to a market whose characteristics include rapidly evolving
industry standards, product obsolescence, and new manufacturing and design
technologies. Many of the standards and protocols for our products are based on
high-speed networking technologies that have not been widely adopted or ratified
by one or more of the standard-setting bodies in our customers' industry. Our
customers often delay or alter their design demands during this standard-setting
process. In response, we must redesign our products to suit these changing
demands. Redesign usually delays the production of our products. Our products
may become obsolete during these delays.
Since many of the products we develop do not reach full production
sales volumes for a number of years, we may incorrectly anticipate
market demand and develop products that achieve little or no market
acceptance.
Our products generally take between 18 and 24 months from initial
conceptualization to development of a viable prototype, and another 6 to 18
months to be designed into our customers' equipment and into production. Our
products often must be redesigned because manufacturing yields on prototypes are
unacceptable or customers redefine their products to meet changing industry
standards or customer specifications. As a result, we develop products many
years before volume production and may inaccurately anticipate our customers'
needs.
We are exposed to the credit risk of some of our customers and we may have
difficulty collecting receivables from customers based in foreign countries.
Many of our customers employ contract manufacturers to produce their products
and manage their inventories. Many of these contract manufacturers represent
greater credit risk than our networking equipment customers, who generally do
not guarantee our credit receivables related to their contract manufacturers.
In addition, international debt rating agencies have significantly downgraded
the bond ratings on a number of our larger customers, which had traditionally
been considered financially stable. Should these companies enter into
receivership or breach debt covenants, our significant accounts receivables with
these companies could be jeopardized.
Our business strategy contemplates acquisition of other companies or
technologies, which could adversely affect our operating performance.
40
Acquiring products, technologies or businesses from third parties is part of our
business strategy. Management may be diverted from our operations while they
identify and negotiate these acquisitions and integrate an acquired entity into
our operations. Also, we may be forced to develop expertise outside our existing
businesses, and replace key personnel who leave due to an acquisition.
An acquisition could absorb substantial cash resources, require us to incur or
assume debt obligations, or issue additional equity. If we issue more equity, we
may dilute our common stock with securities that have an equal or a senior
interest.
Acquired entities also may have unknown liabilities, and the combined entity may
not achieve the results that were anticipated at the time of the acquisition.
The timing of revenues from newly designed products is often uncertain. In the
past, we have had to redesign products that we acquired when buying other
businesses, resulting in increased expenses and delayed revenues. This may occur
in the future as we commercialize the new products resulting from acquisitions.
The complexity of our products could result in unforeseen delays or expenses and
in undetected defects or bugs, which could adversely affect the market
acceptance of new products and damage our reputation with current or prospective
customers.
Although we, our customers and our suppliers rigorously test our products, our
highly complex products regularly contain defects or bugs. We have in the past
experienced, and may in the future experience, these defects and bugs. If any of
our products contain defects or bugs, or have reliability, quality or
compatibility problems that are significant to our customers, our reputation may
be damaged and customers may be reluctant to buy our products. This could
materially and adversely affect our ability to retain existing customers or
attract new customers. In addition, these defects or bugs could interrupt or
delay sales to our customers.
We may have to invest significant capital and other resources to alleviate
problems with our products. If any of these problems are not found until after
we have commenced commercial production of a new product, we may be required to
incur additional development costs and product recall, repair or replacement
costs. These problems may also result in claims against us by our customers or
others. In addition, these problems may divert our technical and other resources
from other development efforts. Moreover, we would likely lose, or experience a
delay in, market acceptance of the affected product or products, and we could
lose credibility with our current and prospective customers.
The loss of personnel could preclude us from designing new products.
To succeed, we must retain and hire technical personnel highly skilled at the
design and test functions needed to develop high-speed networking products and
related software. The competition for such employees is intense.
41
We do not have employment agreements in place with many of our key personnel. As
employee incentives, we issue common stock options that generally have exercise
prices at the market value at the time of grant and that are subject to vesting.
Recently, our stock price has declined substantially. The stock options we grant
to employees are effective as retention incentives only if they have economic
value.
Our recent restructurings have significantly reduced the number of our technical
employees. We may experience customer dissatisfaction as a result of delayed or
cancelled product development initiatives.
A significant portion of our revenues is derived from sales of microprocessors
based on the MIPS architecture that we license from MIPS Technologies, Inc. If
MIPS Technologies develops future generations of its technology, we may not be
able to obtain a license on reasonable terms.
Our only material license is the MIPS microprocessor architecture license from
MIPS Technologies Inc., which we use in the development of our
microprocessor-based products. While the desktop microprocessor market is
dominated by the Intel Corporation's "x86" complex instruction set computing, or
CISC, architecture, several microprocessor architectures have emerged for other
microprocessor markets. Because of their higher performance and smaller space
requirements, most of the competing architectures are reduced instruction set
computing, or RISC, architectures. The MIPS architecture is widely supported
through semiconductor design software, operating systems and companion
integrated circuits. Because this license is the architecture behind our
microprocessors, we must be able to retain the MIPS license in order to produce
our follow-on microprocessor products. If we fail to comply with any of the
terms of its license agreement, MIPS Technologies could terminate our rights,
preventing us from marketing our current and planned microprocessor products.
We anticipate lower margins on high volume products, which could adversely
affect our profitability.
We expect the average selling prices of our products to decline as they mature.
Historically, competition in the semiconductor industry has driven down the
average selling prices of products. If we price our products too high, our
customers may use a competitor's product or an in-house solution. To maintain
profit margins, we must reduce our costs sufficiently to offset declines in
average selling prices, or successfully sell proportionately more new products
with higher average selling prices. Yield or other production problems, or
shortages of supply may preclude us from lowering or maintaining current
operating costs.
OEMs are becoming more price conscious than in the past as a result of the
industry downturn, and as semiconductors sourced from third party suppliers
comprise a greater portion of the total materials cost in OEM equipment. We have
also experienced more aggressive price competition from competitors that wish to
enter into the market segments in which we participate. These circumstances may
make some of our products less competitive and we may be forced to decrease our
prices significantly to win a design. We may lose design opportunities or may
experience overall declines in gross margins as a result of increased price
competition.
42
In addition, our networking products range widely in terms of the margins they
generate. A change in product sales mix could impact our operating results
materially.
We may not be able to meet customer demand for our products if we do not
accurately predict demand or if we fail to secure adequate wafer fabrication or
assembly capacity.
We currently do not have the ability to accurately predict what products our
customers will need in the future. Anticipating demand is difficult because our
customers face volatile pricing and demand for their end-user networking
equipment, our customers are focusing more on cash preservation and tighter
inventory management, and because we supply a large number of products to a
variety of customers and contract manufacturers who have many equipment programs
for which they purchase our products. If we do not accurately predict what mix
of products our customers may order, we may not be able to meet our customers'
demand in a timely manner or we may be left with unwanted inventory.
A shortage in supply could adversely impact our ability to satisfy customer
demand, which could adversely affect our customer relationships along with our
current and future operating results.
We rely on limited sources of wafer fabrication, the loss of which
could delay and limit our product shipments.
We do not own or operate a wafer fabrication facility. Three outside foundries
supply greater than 90% of our semiconductor device requirements. Our foundry
suppliers also produce products for themselves and other companies. In addition,
we may not have access to adequate capacity or certain process technologies. We
have less control over delivery schedules, manufacturing yields and costs than
competitors with their own fabrication facilities. If the foundries we use are
unable or unwilling to manufacture our products in required volumes, we may have
to identify and qualify acceptable additional or alternative foundries. This
qualification process could take six months or longer. We may not find
sufficient capacity quickly enough, if ever, to satisfy our production
requirements.
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.
We depend on third parties in Asia for assembly of our semiconductor
products that could delay and limit our product shipments.
Sub-assemblers in Asia assemble all of our semiconductor products. Raw material
shortages, political and social instability, assembly house service disruptions,
currency fluctuations, or other circumstances in the region could force us to
seek additional or alternative sources of supply or assembly. This could lead to
supply constraints or product delivery delays that, in turn, may result in the
loss of revenues. We have less control over delivery schedules, assembly
processes, quality assurances and costs than competitors that do not outsource
these tasks.
43
We depend on a limited number of design software suppliers, the loss of
which could impede our product development.
A limited number of suppliers provide the computer aided design, or CAD,
software we use to design our products. Factors affecting the price,
availability or technical capability of these products could affect our ability
to access appropriate CAD tools for the development of highly complex products.
In particular, the CAD software industry has been the subject of extensive
intellectual property rights litigation, the results of which could materially
change the pricing and nature of the software we use. We also have limited
control over whether our software suppliers will be able to overcome technical
barriers in time to fulfill our needs.
We are subject to the risks of conducting business outside the United States to
a greater extent than companies that operate their businesses mostly in the
United States, which may impair our sales, development or manufacturing of our
products.
We are subject to the risks of conducting business outside the United States to
a greater extent than most companies because, in addition to selling our
products in a number of countries, a significant portion of our research and
development and manufacturing is conducted outside the United States.
The geographic diversity of our business operations could hinder our ability to
coordinate design and sales activities. If we are unable to develop systems and
communication processes to support our geographic diversity, we may suffer
product development delays or strained customer relationships.
We may lose our ability to design or produce products, could face
additional unforeseen costs or could lose access to key customers if
any of the nations in which we conduct business impose trade barriers
or new communications standards.
We may have difficulty obtaining export licenses for certain technology produced
for us outside the United States. If a foreign country imposes new taxes,
tariffs, quotas, and other trade barriers and restrictions or the United States
and a foreign country develop hostilities or change diplomatic and trade
relationships, we may not be able to continue manufacturing or sub-assembly of
our products in that country and may have fewer sales in that country. We may
also have fewer sales in a country that imposes new communications standards or
technologies. This could inhibit our ability to meet our customers' demand for
our products and lower our revenues.
If foreign exchange rates fluctuate significantly, our profitability
may decline.
We are exposed to foreign currency rate fluctuations because a significant part
of our development, test, marketing and administrative costs are denominated in
Canadian dollars, and our selling costs are denominated in a variety of
currencies around the world.
44
In addition, while all of our sales are denominated in US dollars, our
customers' products are sold worldwide. Any further decline in the world
networking markets could seriously depress our customers' order levels for our
products. This effect could be exacerbated if fluctuations in currency exchange
rates decrease the demand for our customers' products.
From time to time, we become defendants in legal proceedings about which we are
unable to assess our exposure and which could become significant liabilities
upon judgment.
We become defendants in legal proceedings from time to time. Companies in our
industry have been subject to claims related to patent infringement and product
liability, as well as contract and personal claims. We may not be able to
accurately assess the risk related to these suits, and we may be unable to
accurately assess our level of exposure. These proceedings may result in
material charges to our operating results in the future if our exposure is
material and if our ability to assess our exposure becomes clearer.
If we cannot protect our proprietary technology, we may not be able to prevent
competitors from copying our technology and selling similar products, which
would harm our revenues.
To compete effectively, we must protect our proprietary information. We rely on
a combination of patents, trademarks, copyrights, trade secret laws,
confidentiality procedures and licensing arrangements to protect our
intellectual property rights. We hold several patents and have a number of
pending patent applications.
We might not succeed in attaining patents from any of our pending applications.
Even if we are awarded patents, they may not provide any meaningful protection
or commercial advantage to us, as they may not be of sufficient scope or
strength, or may not be issued in all countries where our products can be sold.
In addition, our competitors may be able to design around our patents.
We develop, manufacture and sell our products in Asian and other countries that
may not protect our products or intellectual property rights to the same extent
as the laws of the United States. This makes piracy of our technology and
products more likely. Steps we take to protect our proprietary information may
not be adequate to prevent theft of our technology. We may not be able to
prevent our competitors from independently developing technologies that are
similar to or better than ours.
Our products employ technology that may infringe on the proprietary rights of
third parties, which may expose us to litigation and prevent us from selling our
products.
Vigorous protection and pursuit of intellectual property rights or positions
characterize the semiconductor industry. This often results in expensive and
lengthy litigation. We, as well as our customers or suppliers, may be accused of
infringing on patents or other intellectual property rights owned by third
parties. This has happened in the past. An adverse result in any litigation
could force us to pay substantial damages, stop manufacturing, using and selling
the infringing products, spend significant resources to develop non-infringing
technology, discontinue using certain processes or obtain licenses to the
infringing technology. In addition, we may not be able to develop non-infringing
technology, nor might we be able to find appropriate licenses on reasonable
terms.
45
Patent disputes in the semiconductor industry are often settled through
cross-licensing arrangements. Because we currently do not have a substantial
portfolio of patents compared to our larger competitors, we may not be able to
settle an alleged patent infringement claim through a cross-licensing
arrangement. We are therefore more exposed to third party claims than some of
our larger competitors and customers.
In the past, our customers have been required to obtain licenses from and pay
royalties to third parties for the sale of systems incorporating our
semiconductor devices. Customers may also make claims against us with respect to
infringement.
Furthermore, we may initiate claims or litigation against third parties for
infringing our proprietary rights or to establish the validity of our
proprietary rights. This could consume significant resources and divert the
efforts of our technical and management personnel, regardless of the
litigation's outcome.
We have significantly increased our leverage as a result of the sale of
convertible notes.
On August 6, 2001, we raised $275 million through the issuance of convertible
subordinated notes. As a result, our interest payment obligations have increased
substantially. The degree to which we are leveraged could materially and
adversely affect our ability to obtain financing for working capital,
acquisitions or other purposes and could make us more vulnerable to industry
downturns and competitive pressures. Our ability to meet our debt service
obligations will be dependent upon our future performance, which will be subject
to financial, business and other factors affecting our operations, many of which
are beyond our control. On August 15, 2006, we are obliged to repay the full
remaining principal amount of the notes that have not been converted into our
common stock.
Securities we issue to fund our operations could dilute your ownership.
We may decide to raise additional funds through public or private debt or equity
financing to fund our operations. If we raise funds by issuing equity
securities, the percentage ownership of current stockholders will be reduced and
the new equity securities may have priority rights to your investment. We may
not obtain sufficient financing on terms that are favorable to you or us. We may
delay, limit or eliminate some or all of our proposed operations if adequate
funds are not available.
Our stock price has been and may continue to be volatile.
In the past, our common stock price has fluctuated significantly. In particular,
our stock price declined significantly in the context of announcements made by
us and other semiconductor suppliers of reduced revenue expectations and of a
general slowdown in the markets we serve. Given these general economic
conditions and the reduced demand for our products that we have experienced, we
expect that our stock price will continue to be volatile.
46
In addition, fluctuations in our stock price and our price-to-earnings multiple
may have made our stock attractive to momentum, hedge or day-trading investors
who often shift funds into and out of stocks rapidly, exacerbating price
fluctuations in either direction particularly when viewed on a quarterly basis.
Securities class action litigation has often been instituted against a company
following periods of volatility and decline in the market price of their
securities. If instituted against us, regardless of the outcome, such litigation
could result in substantial costs and diversion of our management's attention
and resources and have a material adverse effect on our business, financial
condition and operating results. We could be required to pay substantial
damages, including punitive damages, if we were to lose such a lawsuit.
Provisions in our charter documents and Delaware law and our adoption of a
stockholder rights plan may delay or prevent acquisition of us, which could
decrease the value of our common stock.
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could make it harder for a third party to acquire us without the consent of
our board of directors. Delaware law also imposes some restrictions on mergers
and other business combinations between us and any holder of 15% or more of our
outstanding common stock. In addition, our board of directors has the right to
issue preferred stock without stockholder approval, which could be used to
dilute the stock ownership of a potential hostile acquirer. Although we believe
these provisions of our certificate of incorporation and bylaws and Delaware law
and our stockholder rights plan will provide for an opportunity to receive a
higher bid by requiring potential acquirers to negotiate with our board of
directors, these provisions apply even if the offer may be considered beneficial
by some stockholders.
Our board of directors adopted a stockholder rights plan, pursuant to which we
declared and paid a dividend of one right for each share of common stock held by
stockholders of record as of May 25, 2001. Unless redeemed by us prior to the
time the rights are exercised, upon the occurrence of certain events, the rights
will entitle the holders to receive upon exercise thereof shares of our
preferred stock, or shares of an acquiring entity, having a value equal to twice
the then-current exercise price of the right. The issuance of the rights could
have the effect of delaying or preventing a change in control of us.
47
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The following discussion regarding our risk management activities contains
"forward-looking statements" that involve risks and uncertainties. Actual
results may differ materially from those projected in the forward-looking
statements.
Cash Equivalents, Short-term Investments and Investments in Bonds and
Notes:
We regularly maintain a short and long term investment portfolio of various
types of government and corporate debt instruments. Our investments are made in
accordance with an investment policy approved by our Board of Directors.
Maturities of these instruments are less than two and one half years, with the
majority being within one year. To minimize credit risk, we diversify our
investments and select minimum ratings of P-1 or A by Moody's, or A-1 or A by
Standard and Poor's, or equivalent. We classify these securities as
held-to-maturity or available-for-sale depending on our investment intention.
Held-to-maturity investments are held at amortized cost, while
available-for-sale investments are held at fair market value. Available-for-sale
securities represented less than 15% of our investment portfolio as of December
31, 2001.
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate risk. Fixed rate securities may have their fair
market value adversely impacted because of a rise in interest rates, while
floating rate securities may produce less income than expected if interest rates
fall. Due in part to these factors, our future investment income may fall short
of expectations because of changes in interest rates or we may suffer losses in
principal if we were to sell securities that have declined in market value
because of changes in interest rates.
We do not attempt to reduce or eliminate our exposure to interest rate risk
through the use of derivative financial instruments.
Based on a sensitivity analysis performed on the financial instruments held at
December 31, 2001 that are sensitive to changes in interest rates, the impact to
the fair value of our investment portfolio by an immediate hypothetical parallel
shift in the yield curve of plus or minus 50, 100 or 150 basis points would
result in a decline or increase in portfolio value of approximately $2.6
million, $5.3 million and $7.9 million respectively.
Other Investments:
Other investments at December 31, 2001 include a minority investment of
approximately 2.3 million shares of Sierra Wireless Inc., a publicly traded
company. This investment is subject to certain resale restrictions. 1.2 million
shares will be released from these restrictions in May 2002 and the remaining
shares are currently classified as available-for-sale. Consequently, the
securities are recorded on the balance sheet at fair value with unrealized gains
or losses reported as a separate component of accumulated other comprehensive
income, net of income taxes.
We also regularly receive distributions of public company stock as a result of
venture investments. These shares are usually subject to resale restrictions and
typically include a number of shares held in escrow that may or may not be
released at a later date. At December 31, 2001, we held approximately 85,000
shares of Intel Corporation. It is our intention to sell these securities in the
first quarter of 2002.
48
Our public company investments are subject to considerable market price
volatility and are additionally risky due to resale restrictions. We may lose
some or all of our investment in these shares.
Our other investments also include numerous strategic investments in privately
held companies or venture funds that are carried on our balance sheet at cost.
We expect to make additional investments like these in the future. These
investments are inherently risky, as they typically are comprised of investments
in companies and partnerships that are still in the start-up or development
stages. The market for the technologies or products that they have under
development is typically in the early stages, and may never materialize. In the
fourth quarter of 2001, we recorded an impairment of our other investments of
$17.5 million in response to declining market valuations for these investments.
We could lose our entire investment in these companies and partnerships or may
incur an additional expense if we determine that the value of these assets have
been further impaired.
Foreign Currency
We generate a significant portion of our revenues from sales to customers
located outside of the United States including Canada, Europe, the Middle East
and Asia. We are subject to risks typical of an international business
including, but not limited to, differing economic conditions, changes in
political climate, differing tax structures, other regulations and restrictions
and foreign exchange rate volatility. Accordingly, our future results could be
materially adversely affected by changes in these or other factors.
Our sales and corresponding receivables are made primarily in United States
dollars. Through our operations in Canada and elsewhere outside of the United
States, we incur research and development, customer support costs and
administrative expenses in Canadian and other local currencies. We are exposed,
in the normal course of business, to foreign currency risks on these
expenditures. In our effort to manage such risks, we have adopted a foreign
currency risk management policy intended to reduce the effects of potential
short-term fluctuations on the results of operations stemming from our exposure
to these risks. As part of this risk management, we typically forecast our
operational currency needs, purchase such currency on the open market at the
beginning of an operational period, and hold these funds as a hedge against
currency fluctuations. We usually limit the operational period to 3 months or
less. Because we do not engage in foreign currency exchange rate fluctuation
risk management techniques beyond these periods, our cost structure is subject
to long-term changes in foreign exchange rates.
While we expect to utilize this method of managing our foreign currency risk in
the future, we may change our foreign currency risk management methodology and
utilize foreign exchange contracts that are currently available under our
operating line of credit agreement.
We regularly analyze the sensitivity of our foreign exchange positions to
measure our foreign exchange risk. At December 31, 2001, a 10% shift in foreign
exchange rates would not have materially impacted our foreign exchange income
because our foreign currency net asset position was immaterial.
49
Debt
We issued $275,000,000 of convertible subordinated notes in August 2001. Because
we pay fixed interest coupons on our notes, market interest rate fluctuations do
not impact our debt interest payments. However, the fair value of our
convertible subordinated notes will fluctuate as a result of changes in the
price of our common stock, changes in market interest rates and changes in our
credit worthiness. The fair value of the convertible subordinated notes at
December 31, 2001 was not readily determinable as there was no established
public trading market for the notes. Some of the convertible subordinated notes
have been traded on the Portal Market or under Rule 144 of the Securities Act of
1933. The exchange prices from these trades are not always available to us and
may not be reliable. Trades under the Portal Market do not reflect all trades of
the securities, the figures recorded are not independently verified and the
information only reflects the trades of pre-qualified Portal dealers.
50
Item 8. Financial Statements and Supplementary Data
The chart entitled "Quarterly Data (Unaudited)" contained in Item 6 Part II
hereof is hereby incorporated by reference into the Item 8 of Part II of this
Form 10-K.
Consolidated Financial Statements Included in Item 8:
Page
Independent Auditors Report 52
Consolidated Balance Sheets at December 31, 2001 and 2000 53
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 2001 54
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 2001 55
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 2001 56
Notes to Consolidated Financial Statements 57
Schedules for each of the three years in the period ended December 31, 2001
included in Item 14 (a):
II Valuation and Qualifying Accounts 92
Schedules not listed above have been omitted because they are not applicable or
are not required, or the information required to be set forth therein is
included in the financial statements or the notes thereto.
51
Independent Auditors Report
The Board of Directors of PMC-Sierra, Inc.
We have audited the accompanying consolidated balance sheets of PMC-Sierra, Inc.
as of December 31, 2001 and 2000 and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 2001. Our audits also included the financial
statement schedule listed in the index at Item 14(a). These consolidated
financial statements and financial statement schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of PMC-Sierra, Inc. at
December 31, 2001 and 2000, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
2001, in conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Vancouver, British Columbia
January 18, 2002
52
PMC-Sierra, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
December 31,
--------------------------------
2001 2001
ASSETS:
Current assets:
Cash and cash equivalents $ 152,120 $ 256,198
Short-term investments 258,609 118,918
Accounts receivable, net of allowance for doubtful
accounts of $2,625 ($1,934 in 2000) 16,004 93,852
Inventories, net 34,246 54,913
Deferred tax assets 14,812 13,947
Prepaid expenses and other current assets 18,435 26,910
Short-term deposits for wafer fabrication capacity - 6,265
-------------- ----------------
Total current assets 494,226 571,003
Investment in bonds and notes 171,025 -
Other investments and assets 68,863 84,667
Deposits for wafer fabrication capacity 21,992 16,736
Property and equipment, net 89,715 127,534
Goodwill and other intangible assets, net 9,520 326,150
-------------- ----------------
$ 855,341 $ 1,126,090
============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 21,320 $ 60,978
Accrued liabilities 49,348 39,724
Income taxes payable 19,742 63,491
Accrued restructuring costs 161,198 -
Deferred income 27,677 64,055
Current portion of obligations under capital leases and long-term debt 470 1,769
-------------- ----------------
Total current liabilities 279,755 230,017
Non-current obligations under capital leases and long-term debt - 564
Convertible subordinated notes 275,000 -
Deferred tax liabilities 23,042 37,824
Commitments and contingencies (Note 8)
PMC special shares convertible into 3,373 (2000 - 3,746)
shares of common stock 5,317 6,367
Stockholders' equity
Common stock and additional paid in capital, par value $.001:
900,000 shares authorized; 165,702 shares issued and
outstanding (2000 - 162,284) 824,321 796,229
Deferred stock compensation (4,186) (43,128)
Accumulated other comprehensive income 25,492 32,563
Retained earnings (accumulated deficit) (573,400) 65,654
-------------- ----------------
Total stockholders' equity 272,227 851,318
-------------- ----------------
$ 855,341 $ 1,126,090
============== ================
See notes to the consolidated financial statements.
53
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
Year Ended December 31,
---------------------------------------------
2001 2000 1999
Net revenues $ 322,738 $ 694,684 $ 295,768
Cost of revenues 137,262 166,161 73,439
--------------- -------------- --------------
Gross profit 185,476 528,523 222,329
Other costs and expenses:
Research and development 201,087 178,806 83,676
Marketing, general and administrative 90,302 100,589 52,301
Amortization of deferred stock compensation:
Research and development 32,506 32,258 3,738
Marketing, general and administrative 8,678 4,006 1,383
Amortization of goodwill 44,010 36,397 1,912
Restructuring costs and other special charges 195,186 - -
Impairment of goodwill and purchased intangible assets 269,827 - -
Costs of merger - 37,974 866
Acquisition of in process research and development - 38,200 -
--------------- -------------- --------------
Income (loss) from operations (656,120) 100,293 78,453
Interest and other income, net 13,894 18,926 7,922
Gain (loss) on investments (14,591) 58,491 26,800
--------------- -------------- --------------
Income (loss) before provision for income taxes (656,817) 177,710 113,175
Provision for (recovery of) income taxes (17,763) 102,412 41,346
--------------- -------------- --------------
Net income (loss) $ (639,054) $ 75,298 $ 71,829
=============== ============== ==============
Net income (loss) per common share - basic $ (3.80) $ 0.46 $ 0.49
=============== ============== ==============
Net income (loss) per common share - diluted $ (3.80) $ 0.41 $ 0.45
=============== ============== ==============
Shares used in per share calculation - basic 167,967 162,377 146,818
Shares used in per share calculation - diluted 167,967 181,891 160,523
See notes to the consolidated financial statements.
54
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
----------------------------------------------------
2001 2000 1999
Cash flows from operating activities:
Net income (loss) $ (639,054) $ 75,298 $ 71,829
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation of property and equipment 51,212 35,424 19,866
Amortization of goodwill and other intangibles 46,803 38,757 3,599
Amortization of deferred stock compensation 41,184 36,264 5,121
Amortization of debt issuance costs 652 - -
Deferred income taxes (10,733) 1,268 (2,921)
Equity in income of investee - (574) (792)
Gain on sale of investments (2,909) (58,491) (26,800)
Loss on disposal of property and equipment 430 - -
Acquisition of in process research and development - 38,200 -
Noncash restructuring costs 16,229 - -
Impairment of goodwill and purchased intangible assets 269,827 - -
Impairment of other investments 17,500 - -
Write down of excess inventory 20,660 - -
Changes in operating assets and liabilities:
Accounts receivable 77,848 (51,580) (13,435)
Inventories 7 (40,668) (9,061)
Prepaid expenses and other current assets 6,146 (18,233) (2,700)
Accounts payable and accrued liabilities (30,034) 59,417 9,426
Accrued restructuring costs 161,198 - -
Deferred income (36,378) 29,397 21,710
Income taxes payable (43,749) 38,062 11,821
---------------- ---------------- -----------------
Net cash provided by (used in) operating activities (53,161) 182,541 87,663
---------------- ---------------- -----------------
Cash flows from investing activities:
Purchases of short-term investments (305,357) (309,269) (137,556)
Proceeds from sales and maturities of short-term investments 192,386 303,102 75,697
Purchases of long-term bonds and notes (197,135) - -
Purchases of other investments (7,532) (24,834) (8,911)
Proceeds from sale of other investments 3,317 59,737 28,628
Investment in wafer fabrication deposits (5,188) (8,584) -
Proceeds from refund of wafer fabrication deposits 6,197 4,703 4,000
Purchases of property and equipment (27,840) (104,296) (34,731)
Acquisition of businesses, net of cash acquired - (15,473) -
---------------- ---------------- -----------------
Net cash used in investing activities (341,152) (94,914) (72,873)
---------------- ---------------- -----------------
Cash flows from financing activities:
Proceeds from notes payable and long-term debt - 2,066 2,971
Principal payments under capital leases and long-term debt (1,746) (13,435) (11,277)
Proceeds from issuance of convertible subordinated notes 275,000 - -
Payment of debt issuance costs (7,819) - -
Proceeds from issuance of preferred stock - - 19,479
Proceeds from issuance of common stock 24,800 78,426 25,866
---------------- ---------------- -----------------
Net cash provided by financing activities 290,235 67,057 37,039
---------------- ---------------- -----------------
Net increase (decrease) in cash and cash equivalents (104,078) 154,684 51,829
Cash and cash equivalents, beginning of the year 256,198 101,514 49,685
---------------- ---------------- -----------------
Cash and cash equivalents, end of the year $ 152,120 $ 256,198 $ 101,514
================ ================ =================
Supplemental disclosures of cash flow information:
Cash paid for interest $ 211 $ 698 $ 1,060
Cash paid for income taxes 41,177 61,519 33,203
Supplemental disclosures of non-cash investing and financing activities:
Equity securities received in exchange for other long-term investment 1,713 - -
Capital lease obligations incurred for purchase of property and equipment - 3,634 408
Notes payable issued for purchase of property and equipment - - 2,206
Conversion of PMC-Sierra special shares into common stock 1,050 631 1,389
Issuance of common stock and stock options for acquisitions under the
purchase method of accounting - 414,938 -
See notes to the consolidated financial statements.
55
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock Accumulated
and Deferred Other Retained Total
Shares of Additional Stock Comprehensive Earnings Stockholders'
Common Stock (1) Paid in Capital (1) Compensation Income (Deficit) Equity
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 133,931 $ 204,146 $ (3,448) $ - $ (81,473) $ 119,225
Net income and comprehensive income - - - - 71,829 71,829
Conversion of special shares
into common stock 792 1,389 - - - 1,389
Issuance of common stock
under stock benefit plans 12,432 18,643 - - - 18,643
Issuance of common stock
for services rendered 9 142 - - - 142
Issuance of common stock
for cash 757 8,418 - - - 8,418
Conversion of warrants
into common stock 88 75 - - - 75
Deferred stock compensation - 7,560 (7,560) - - -
Amortization of deferred - - 5,121 - - 5,121
stock compensation
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1999 148,009 240,373 (5,887) - (9,644) 224,842
Net income - - - - 75,298 75,298
Change in net unrealized gains
on investments - - - 32,563 - 32,563
------------
Comprehensive Income - - - - - 107,861
------------
Conversion of special shares
into common stock 496 631 - - - 631
Conversion of preferred stock
into common stock 5,243 39,949 - - - 39,949
Issuance of common stock
under stock benefit plans 4,421 27,359 - - - 27,359
Issuance of common stock
for cash 1,949 50,804 - - - 50,804
Issuance of common stock on
acquisition of subsidiaries 1,896 414,938 - - - 414,938
Conversion of warrants
into common stock 270 263 - - - 263
Deferred stock compensation - 21,912 (21,912) - - -
Deferred stock compensation
on acquisition of subsidiaries - - (51,593) - - (51,593)
Amortization of deferred - - 36,264 - - 36,264
stock compensation
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 2000 162,284 796,229 (43,128) 32,563 65,654 851,318
Net loss - - - - (639,054) (639,054)
Change in net unrealized gains
on investments - - - (7,071) - (7,071)
------------
Comprehensive loss - - - - - (646,125)
------------
Conversion of special shares
into common stock 373 1,050 - - - 1,050
Issuance of common stock
under stock benefit plans 3,045 24,800 - - - 24,800
Deferred stock compensation - 2,242 (2,242) - - -
Amortization of deferred - - 41,184 - - 41,184
stock compensation
- -----------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 2001 165,702 $ 824,321 $ (4,186) $ 25,492 $ (573,400) $ 272,227
===============================================================================================
(1) includes exchangeable shares
See notes to consolidated financial statements.
56
NOTE 1. Summary of Significant Accounting Policies
Description of business. PMC-Sierra, Inc (the "Company" or "PMC-Sierra" or
"PMC") designs, develops, markets and supports high-performance semiconductor
networking solutions. The Company's products are used in the high-speed
transmission and networking systems, which are being used to restructure the
global telecommunications and data communications infrastructure.
Basis of presentation. The accompanying consolidated financial statements
include the accounts of PMC-Sierra, Inc. and its wholly owned subsidiaries. All
significant inter-company accounts and transactions have been eliminated. The
Company's fiscal year ends on the last Sunday of the calendar year. For ease of
presentation, the reference to December 31 has been utilized as the fiscal year
end for all financial statement captions. Fiscal years 2001 and 1999 each
consisted of 52 weeks. Fiscal year 2000 consisted of 53 weeks. The Company's
reporting currency is the United States dollar.
Estimates. The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Estimates
are used for, but not limited to, the accounting for doubtful accounts,
inventory reserves, depreciation and amortization, asset impairments, sales
returns, warranty costs, income taxes, restructuring costs and other special
charges, and contingencies. Actual results could differ from these estimates.
Cash equivalents, short-term investments and investments in bonds and notes.
Cash equivalents are defined as highly liquid debt instruments with maturities
at the date of purchase of 90 days or less. Short-term investments are defined
as money market instruments or bonds and notes with original or remaining
maturities greater than 90 days, but less than one year. Long-term investments
are defined as bonds and notes with original or remaining maturities greater
than 365 days. Any long-term investments maturing within one year of the balance
sheet date are reclassified to and reported as short-term investments.
Under Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities", management classifies
investments as available-for-sale or held-to-maturity at the time of purchase
and re-evaluates such designation as of each balance sheet date. Investments
classified as held-to-maturity securities are stated at amortized cost with
corresponding premiums or discounts amortized against interest income over the
life of the investment. Marketable equity and debt securities not classified as
held-to-maturity are classified as available-for-sale and reported at fair
value. Unrealized gains and losses on these investments, net of any related tax
effect are included in equity as a separate component of stockholders' equity.
The cost of securities sold is based on the specific identification method. The
proceeds from sales and realized gains or losses on sales of short-term
investments classified as available-for-sale securities for all years presented
were immaterial.
57
Inventories. Inventories are stated at the lower of cost (first-in, first out)
or market (estimated net realizable value). Cost is computed using standard
cost, which approximates actual average cost. The Company provides inventory
allowances on obsolete inventories and inventories in excess of twelve-month
demand for each specific part.
The components of net inventories are as follows:
December 31,
--------------------------------
(in thousands) 2001 2000
- -----------------------------------------------------------------------------
Work-in-progress $ 10,973 $ 31,035
Finished goods 23,273 23,878
- -----------------------------------------------------------------------------
$ 34,246 $ 54,913
=================================
Investments in non-public entities. The Company has certain investments in
non-publicly traded companies and venture capital funds in which it has less
than 20% of the voting rights and in which it does not exercise significant
influence. The Company monitors these investments for impairment and makes
appropriate reductions in carrying values when necessary. These investments are
included in Other investments and assets on the Company's balance sheet and are
carried at cost, net of write-downs for impairment.
Investments in public companies. The Company has certain investments in publicly
traded companies in which it has less than 20% of the voting rights and in which
it does not exercise significant influence. Certain of these investments are
subject to resale restrictions. Securities restricted for more than one year are
carried at cost. Securities restricted for less than one year from the balance
sheet date and securities not subject to resale restrictions are classified as
available-for-sale and reported at fair value, based upon quoted market prices,
with the unrealized gains or losses, net of any related tax effect, included in
equity as a separate component of stockholders' equity. The Company evaluates
its investments in public companies for factors indicating an other than
temporary impairment and makes appropriate reductions in carrying value where
necessary.
Investments in equity accounted investees. Investees in which the Company has
between 20% and 50% of the voting rights, and in which the Company exercises
significant influence, are accounted for using the equity method. The Company
sold a portion of its only investment in an equity accounted investee during
2000 and as at December 31, 2000 and 2001, held less than 20% of the voting
rights of the investee.
Deposits for wafer fabrication capacity. The Company has wafer supply agreements
with two independent foundries. Under these agreements, the Company has deposits
of $22.0 million (2000 - $23.0 million) to secure access to wafer fabrication
capacity. During 2001, the Company purchased $42.7 million ($81.1 million and
$30.5 million in 2000 and 1999, respectively) from these foundries. Purchases in
any year may or may not be indicative of any future period since wafers are
purchased based on current market pricing and the Company's volume requirements
change in relation to sales of its products.
In each year, the Company is entitled to receive a refund of a portion of the
deposits based on the annual purchases from these suppliers compared to the
target levels in the wafer supply agreements. Based on 2001 purchases, the
Company is not entitled to a refund from these suppliers in 2002. If the Company
does not receive back the balance of its deposits during the term of the
agreements, then the outstanding deposits will be refunded to the Company at the
termination of the agreements.
58
Property and equipment, net. Property and equipment are stated at cost, net of
write-downs for impairment, and depreciated using the straight-line method over
the estimated useful lives of the assets, ranging from two to five years, or the
applicable lease term, whichever is shorter.
The components of property and equipment are as follows:
December 31,
-------------------------------
(in thousands) 2001 2000
- --------------------------------------------------------------------------------
Machinery and equipment $ 172,735 $ 170,757
Land 14,507 14,090
Leasehold improvements 13,176 13,794
Furniture and fixtures 13,971 13,612
Building 701 701
Construction-in-progress 1,027 2,256
- --------------------------------------------------------------------------------
216,117 215,210
Less accumulated depreciation and amortization (126,402) (87,676)
-------------------------------
Total $ 89,715 $ 127,534
===============================
Goodwill and other intangible assets. Goodwill, developed technology and other
intangible assets are carried at cost less accumulated amortization, which has
been computed on a straight-line basis over the economic lives, ranging from
three to seven years, of the respective assets.
The components of goodwill and other intangible assets, net of write-downs for
impairment, that arose through acquisitions are as follows:
December 31,
-------------------------------
(in thousands) 2001 2000
- --------------------------------------------------------------------------------
Goodwill $ 93,119 $ 362,946
Developed technology 9,311 9,830
Other 1,294 1,700
- --------------------------------------------------------------------------------
103,724 374,476
Accumulated amortization (94,204) (48,326)
- --------------------------------------------------------------------------------
$ 9,520 $ 326,150
===============================
In 2001, the Company recorded a total impairment charge of $269.8 million
related to goodwill (see Note 3) and $925,000 related to developed technology
and other intangible assets.
Impairment of long-lived assets. The Company periodically reviews its long-lived
assets and certain intangible assets for impairment whenever events or changes
in circumstances indicate that the carrying value of such assets may not be
recoverable. To determine recoverability, the Company compares the carrying
value of the assets to the estimated future undiscounted cash flows. Measurement
of an impairment loss for long-lived assets or certain identifiable intangible
assets held for use is based on the fair value of the asset. Long-lived assets
and certain identifiable intangible assets to be disposed of are reported at the
lower of carrying value or fair value.
59
Accrued liabilities. The components of accrued liabilities are as follows:
December 31,
-------------------------------
(in thousands) 2001 2000
- --------------------------------------------------------------------------------
Accrued compensation and benefits $ 21,193 $ 19,600
Other accrued liabilities 28,155 20,124
- --------------------------------------------------------------------------------
$ 49,348 $ 39,724
===============================
Foreign currency translation. For all foreign operations, the U.S. dollar is the
functional currency. Assets and liabilities in foreign currencies are translated
into U.S. dollars using the exchange rate at the balance sheet date. Revenues
and expenses are translated at average rates of exchange during the year. Gains
and losses from foreign currency transactions are included in Interest and other
income, net.
Fair value of financial instruments. The estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is required in
interpreting market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current market exchange.
The Company's carrying value of accounts receivable, accounts payable and other
accrued liabilities approximates fair value because of their short maturities.
The fair value of the Company's cash equivalents, short-term investments, and
investment in bonds and notes are determined using estimated market prices
provided for those securities (see Note 4). The fair value of investments in
public companies is determined using quoted market prices for those securities.
The fair value of investments in non-public entities and the fair value of the
deposits for wafer fabrication capacity are not readily determinable.
The fair value of the Company's obligations under capital leases and long-term
debt other than the convertible subordinated notes at December 31, 2001 and 2000
approximated their carrying value. The fair value of the convertible
subordinated notes at December 31, 2001 was not readily determinable as there
was no established public trading market for the notes.
Concentrations. The Company maintains its cash, cash equivalents, short-term
investments and long-term investments in investment grade financial instruments
with high-quality financial institutions, thereby reducing credit risk
concentrations.
At December 31, 2001, approximately 20% (2000 - 26%) of accounts receivable
represented amounts due from one of the Company's distributors. The Company
believes that this concentration and the concentration of credit risk resulting
from trade receivables owing from high-technology industry customers is
substantially mitigated by the Company's credit evaluation process, relatively
short collection terms and the geographical dispersion of the Company's sales.
The Company generally does not require collateral security for outstanding
amounts.
60
The Company relies on a limited number of suppliers for wafer fabrication
capacity.
Revenue recognition. Revenues from product sales direct to customers and minor
distributors are recognized at the time of shipment. The Company accrues for
warranty costs, sales returns and other allowances at the time of shipment based
on its experience. Certain of the Company's product sales are made to major
distributors under agreements allowing for price protection and/or right of
return on products unsold. Accordingly, the Company defers recognition of
revenue on such sales until the products are sold by the distributors.
Advertising costs. The Company expenses all advertising costs as incurred.
Interest and other income, net. The components of interest and other income, net
are as follows:
Year Ended December 31,
--------------------------------------------
(in thousands) 2001 2000 1999
- -------------------------------------------------------------------------------
Interest income $ 18,998 $ 19,243 $ 8,511
Interest expense on convertible
subordinated notes (4,124) - -
Other interest expense** (211) (808) (1,549)
Amortization of debt issue costs (652) - -
Equity in income of investee - 574 792
Other (117) (83) 168
- -------------------------------------------------------------------------------
$ 13,894 $ 18,926 $ 7,922
============================================
**Consists primarily of interest on long-term debt obligations under capital
leases.
Income taxes. Income taxes are reported under Statement of Financial Accounting
Standards No. 109 and, accordingly, deferred income taxes are recognized using
the asset and liability method, whereby deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases, and operating loss and tax credit carry forwards.
Valuation allowances are provided if, after considering available evidence, it
is more likely than not that some or all of the deferred tax assets will not be
realized.
Net income (loss) per common share. Basic net income (loss) per share is
computed using the weighted average number of common shares outstanding during
the period. The PMC-Sierra Ltd. Special Shares have been included in the
calculation of basic net income (loss) per share. Diluted net income (loss) per
share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of stock options and warrants.
Share and per common share data presented reflect the two-for-one stock splits
in the form of 100% stock dividends effective February 2000 and May 1999.
Segment reporting. Segmented information is reported under Statement of
Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments
of an Enterprise and Related Information". SFAS 131 uses a management approach
to report financial and descriptive information about a company's operating
segments. Operating segments are revenue-producing components of a company for
which separate financial information is produced internally for the company's
management. Under this definition, the Company operated, for all periods
presented, in two segments: networking and non-networking products.
61
Recently issued accounting standards. In July 2001, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standard No. 141
(SFAS 141), "Business Combinations" and Statement of Financial Accounting
Standard No. 142 (SFAS 142), "Goodwill and Other Intangible Assets". SFAS 141
requires that business combinations be accounted for under the purchase method
of accounting and addresses the initial recognition and measurement of assets
acquired, including goodwill and intangibles, and liabilities assumed in a
business combination. SFAS 142 requires goodwill to be allocated to, and
assessed as part of, a reporting unit. Further, SFAS 142 specifies that goodwill
will no longer be amortized but instead will be subject to impairment tests at
least annually. The impairment test is a two-step process. First, the fair value
of a reporting unit is compared to its carrying value to identify possible
impairment and then, if necessary, the impairment is measured through a deemed
purchase price allocation. Under this standard, the Company will also be
required to review the useful lives of acquired goodwill and intangible assets
at least annually.
The Company is required to adopt SFAS 141 and 142 on a prospective basis as of
January 1, 2002. The adoption of SFAS 141 is not expected to have a material
effect on the Company's financial position, results of operations and cash flows
unless the Company acquires significant additional companies.
In 2002, the Company will no longer amortize goodwill pursuant to SFAS 142,
thereby eliminating annual goodwill amortization of approximately $2.0 million.
Goodwill amortization for the year ended December 31, 2001 was $44.0 million.
Unamortized goodwill as of December 31, 2001 was $7.1 million. The Company will
complete an initial goodwill impairment assessment in the second quarter of 2002
to determine if a transition impairment charge should be recognized under SFAS
142.
In October 2001, the FASB issued Statement of Financial Accounting Standard No.
144 (SFAS 144), "Accounting for the Impairment or Disposal of Long-Lived
Assets". SFAS 144 supersedes Statement of Financial Accounting Standard No. 121
(SFAS 121), "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" and the accounting and reporting provisions
of APB Opinion No. 30 for the disposal of a business segment. SFAS 144
establishes a single accounting model, based on the framework established in
SFAS 121, for long-lived assets to be disposed of by sale. The Statement also
broadens the presentation of discontinued operations to include disposals of a
component of an entity and provides additional implementation guidance with
respect to the classification of assets as held-for-sale and the calculation of
an impairment loss. The Company is required to adopt SFAS 144 effective January
1, 2002. The adoption of SFAS 144 is not expected to have a material impact on
the Company's financial statements.
Reclassifications. Certain prior year amounts have been reclassified in order to
conform to the 2001 presentation.
62
NOTE 2. Business Combinations
Poolings of Interests:
Fiscal 2000
Acquisition of SwitchOn Networks Inc.
In September 2000, the Company acquired SwitchOn Networks Inc., a privately held
packet content processor company, with offices in the United States and India.
Under the terms of the agreement, approximately 2,112,000 shares of common stock
were exchanged and options assumed to acquire SwitchOn.
PMC-Sierra recorded merger related transaction costs of $1.1 million related to
the acquisition of SwitchOn. These charges, which consisted primarily of legal
and accounting fees, were included under costs of merger in the Consolidated
Statement of Operations for the year ended December 31, 2000.
Acquisition of Quantum Effect Devices, Inc.
In August 2000, the Company acquired Quantum Effect Devices, Inc., a public
company located in the United States. QED developed embedded microprocessors
that perform information processing in networking equipment. Under the terms of
the agreement, approximately 12,300,000 shares of common stock were exchanged
and options assumed to acquire QED.
PMC-Sierra recorded merger-related transaction costs of $23.2 million related to
the acquisition of QED. These charges, which consisted primarily of investment
banking and other professional fees, were included under costs of merger in the
Consolidated Statements of Operations for the year ended December 31, 2000.
Acquisition of Extreme Packet Devices, Inc.
In April 2000, the Company acquired Extreme Packet Devices, Inc., a privately
held fabless semiconductor company located in Canada. Extreme specialized in
developing semiconductors for high speed IP and ATM traffic management at 10
Gigabits per second rates. Under the terms of the agreement, approximately
2,000,000 exchangeable shares (see Note 10) were exchanged and options assumed
to acquire Extreme.
PMC-Sierra recorded merger-related transaction costs of $5.8 million related to
the acquisition of Extreme. These charges, which consisted primarily of
investment banking and other professional fees, were included under costs of
merger in the Consolidated Statements of Operations for the year ended December
31, 2000.
Acquisition of AANetcom, Inc.
In March 2000, the Company acquired AANetcom, Inc., a privately held fabless
semiconductor company located in the United States. AANetcom developed
technology used in gigabit or terabit switches and routers, telecommunication
access equipment, and optical networking switches in applications ranging from
the enterprise to the core of the Internet. Under the terms of the agreement,
approximately 4,800,000 shares of common stock were exchanged and options
assumed to acquire AANetcom.
63
PMC-Sierra recorded merger-related transaction costs of $7.4 million related to
the acquisition of AANetcom. These charges, which consisted primarily of
investment banking and other professional fees, were included under costs of
merger in the Consolidated Statements of Operations for the year ended December
31, 2000.
Acquisition of Toucan Technology Ltd.
In January 2000, the Company acquired Toucan Technology Ltd., a privately held
integrated circuit design company located in Ireland. Toucan offered expertise
in telecommunications semiconductor design. At December 31, 1999, the Company
owned seven per cent of Toucan and purchased the remainder for approximately
300,000 shares of common stock and stock options.
PMC-Sierra recorded merger-related transaction costs of $534,000 related to the
acquisition of Toucan. These charges, which consisted primarily of legal and
accounting fees, were included under costs of merger in the Consolidated
Statements of Operations for the year ended December 31, 2000.
The acquisitions of SwitchOn, QED, Extreme, AANetcom and Toucan were accounted
for as poolings of interests and accordingly, all prior periods have been
restated.
64
The historical results of operations of the Company, Toucan, AANetcom, Extreme,
QED and SwitchOn for the periods prior to the mergers were as follows:
Nine Months
Ended Year Ended
September 30, December 31,
(in thousands) 2000 1999
- --------------------------------------------------------------------
Net revenues
PMC (including Abrizio) $ 411,046 $ 262,477
Toucan - 24
AANetcom 68 780
Extreme 50 -
QED 51,407 31,462
SwitchOn 461 1,025
- --------------------------------------------------------------------
Combined $ 463,032 $ 295,768
==================================
Net income (loss)
PMC (including Abrizio) $ 83,691 $ 90,020
Toucan (1,963) (221)
AANetcom (17,965) (6,210)
Extreme (11,327) (1,987)
QED (11,954) (7,163)
SwitchOn (9,038) (2,610)
- --------------------------------------------------------------------
Combined $ 31,444 $ 71,829
==================================
Fiscal 1999
Acquisition of Abrizio, Inc.
In 1999, the Company acquired Abrizio, Inc., a fabless semiconductor company
that specialized in broadband switch chip fabrics used in core ATM switches,
digital cross connects, and terabit routers. Under the terms of the agreement,
approximately 8,704,000 shares of common stock were exchanged and options
assumed to acquire Abrizio.
PMC-Sierra recorded merger-related transaction costs of $866,000 related to the
acquisition of Abrizio. These charges, which consisted primarily of investment
banking and other professional fees, have been included under costs of merger in
the Consolidated Statements of Operations for the year ended December 31, 1999.
The transaction was accounted for as a pooling of interests and accordingly, all
prior periods have been restated.
65
The historical results of operations of the Company and Abrizio for the periods
prior to the merger were as follows:
Six Months
Ended June 30,
(in thousands) 1999
- -----------------------------------------
Net revenues
PMC $ 109,426
Abrizio 850
- -----------------------------------------
Combined $ 110,276
================
Net income (loss)
PMC $ 51,715
Abrizio (3,670)
- -----------------------------------------
Combined $ 48,045
================
Purchase Combinations:
Fiscal 2000
Octera Corporation.
On December 12, 2000, the Company completed the purchase of Octera Corporation,
a privately held company located in San Diego, CA, that provided digital design
services for Application Specific Integrated Circuits ("ASICs"), boards and
systems with its primary focus on ASIC design. The Company paid cash and issued
common stock with an aggregate fair value of approximately $16 million to effect
this transaction.
Datum Telegraphic, Inc.
On July 21, 2000, the Company completed the purchase of the 92% interest of
Datum Telegraphic, Inc. that it did not already own in exchange for the issuance
of approximately 681,000 exchangeable shares (see Note 10) and options with a
fair value of $107.4 million, cash of $17 million and acquisition related
expenditures of $875,000. Datum, a wireless semiconductor company located in
Vancouver, Canada, made digital signal processors that allow traffic for all
major digital wireless standards to be transmitted using a single digitally
controlled power amplifier architecture.
Malleable Technologies, Inc.
On June 27, 2000, the Company exercised an option to acquire the 85% interest of
Malleable Technologies, Inc. that it did not already own in exchange for the
issuance of approximately 1,250,000 common shares and 443,000 options and
warrants with a fair value totaling $293 million and acquisition related costs
of $825,000. Malleable, a fabless semiconductor company located in San Jose, CA,
made digital signal processors for voice-over-packet processing applications
which bridge voice and high-speed data networks by compressing voice traffic
into ATM or IP packets.
66
The acquisitions of Octera, Datum and Malleable were accounted for using the
purchase method of accounting and accordingly, the consolidated financial
statements include the operating results of each acquisition from the respective
acquisition dates.
The fair value of the common shares of the Company issued to acquire Malleable,
Datum, and Octera was based on the closing market price of the Company's stock a
short period before and after the date the terms of the acquisitions were agreed
to by the parties and announced to the public.
The total consideration, including acquisition costs, was allocated based on the
estimated fair values of the net assets acquired on the respective acquisition
dates as follows:
(in thousands) Octera Datum Malleable Total
- --------------------------------------------------------------------------------
Tangible assets $ 258 $ 3,788 $ 2,031 $ 6,077
Intangible assets:
Internally developed software - - 500 500
Assembled workforce - 250 400 650
Goodwill 1,881 106,356 232,303 340,540
Unearned compensation 14,197 8,363 29,033 51,593
In process research and
development - 6,700 31,500 38,200
Liabilities assumed (316) (143) (1,932) (2,391)
- --------------------------------------------------------------------------------
$ 16,020 $ 125,314 $ 293,835 $ 435,169
================================================
A portion of the purchase price of each acquisition was allocated to unearned
compensation based on the value of certain unvested shares and options of the
Company issued to effect each acquisition. The fair value of the common shares
that were issued to acquire Malleable and that were subject to vesting
provisions based on continuing employment was recorded as unearned compensation.
The intrinsic value of the unvested shares and options issued to acquire Datum
and Octera, which were acquired after July 1, 2000, was allocated to unearned
compensation. Unearned compensation will be recognized as compensation cost over
the respective remaining future service periods.
Purchased In Process Research and Development
The amounts allocated to in process research and development ("IPR&D") were
determined through independent valuations using established valuation techniques
in the high-technology industry. The value allocated to IPR&D was based upon the
forecasted operating after-tax cash flows from the technology acquired, giving
effect to the stage of completion at the acquisition date. Estimated future cash
flows related to the IPR&D were made for each project based on the Company's
estimates of revenues, operating expenses and income taxes from the project.
These estimates were consistent with historical pricing, margins and expense
levels for similar products.
Revenues were estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles and the estimated life
of each product's underlying technology. Estimated operating expenses, income
taxes and charges for the use of contributory assets were deducted from
estimated revenues to determine estimated after-tax cash flows for each project.
These future cash flows were further adjusted for the value contributed by any
core technology and development efforts expected to be completed post
acquisition.
67
These forecasted cash flows were then discounted based on rates derived from the
Company's weighted average cost of capital, weighted average return on assets
and venture capital rates of return adjusted upward to reflect additional risks
inherent in the development life cycle. The risk adjusted discount rate used
involved consideration of the characteristics and applications of each product,
the inherent uncertainties in achieving technological feasibility, anticipated
levels of market acceptance and penetration, market growth rates and risks
related to the impact of potential changes in future target markets.
Based on this analysis, the acquired technology that had reached technological
feasibility was capitalized. Acquired technology that had not yet reached
technological feasibility and for which no alternative future uses existed was
expensed upon acquisition.
Malleable and Datum:
Malleable developed programmable integrated circuits that perform high-density
Voice Over Packet applications. The in process technology acquired from
Malleable was designed to detect incoming voice channels and process them using
voice compression algorithms. The compressed voice was converted, using the
appropriate protocols, to ATM cells or IP packets to achieve higher channel
density and to support multiple speech compression protocols and different
packetization requirements. At the date of acquisition the Company estimated
that Malleable's technology was 58% complete and the costs to complete the
project to be $4.4 million.
Datum designed power amplifiers for use in wireless communications network
equipment. The technology acquired from Datum was a digitally controlled
amplifier architecture, which was designed to increase base station system
capacities, while reducing cost, size and power consumption of radio networks.
At the date of acquisition, the Company estimated that Datum's technology was
59% complete and the costs to complete the project to be $1.8 million.
These estimates were determined by comparing the time and costs spent to date
and the complexity of the technologies achieved to date to the total costs, time
and complexities that were expected to be expended to bring the technologies to
completion.
The amounts allocated to IPR&D for Malleable and Datum of $31.5 million and $6.7
million, respectively, were expensed upon acquisition, as it was determined that
the underlying projects had not reached technological feasibility, had no
alternative future uses and successful development was uncertain. The
risk-adjusted discount rates used to determine the value of IPR&D for Malleable
was 35% and for Datum was 30%.
The Company discontinued development of the technology acquired from Malleable
in the second quarter of 2001. See Note 3 "Restructuring and other costs".
68
Development of the chip incorporating the technology acquired from Datum was
completed in the fourth quarter of 2000 and the costs incurred to that date were
in line with the Company's initial expectations. Since then, the Company has
completed the required firmware related to this chip and has extended
development of the Datum technology to a follow-on product. The general economic
slowdown has delayed the introduction of the third generation base stations into
which the Company expects to incorporate this technology, but the Company
expects these products to begin generating revenues in the second quarter of
2002.
Other Intangible Assets
A description of the other intangible assets acquired is set out below:
Internally developed software acquired facilitates the completion of in process
research and development projects and can be utilized in future development
projects. The Company was amortizing the value assigned to internally developed
software acquired from Malleable on a straight-line basis over an estimated
useful life of three years. At the acquisition date, Datum had no developed
products.
The acquired assembled workforce was comprised of skilled employees across each
of Malleable and Datum's executive, research and development and general and
administrative groups. The Company was amortizing the value assigned to the
assembled workforces on a straight-line basis over their estimated useful life
of three years.
Goodwill, which represents the excess of the purchase price of an investment in
an acquired business over the fair value of the underlying net identifiable
assets, was being amortized on a straight-line basis over its estimated
remaining useful life of five years.
In the second quarter of 2001, the Company discontinued development of the
technology acquired in the purchase of Malleable and recorded an impairment
charge equal to the remaining net book value of the related goodwill, developed
technology, and assembled workforce. See Note 3 "Restructuring and other costs".
Due to a decline in current market conditions and a delay in introduction of
products to the market, the Company completed an assessment of the goodwill and
intangibles acquired in the purchase of Datum and recorded a total impairment
charge of $79.3 million, measured as the amount by which the carrying value of
the goodwill and intangibles exceeded the present value of estimated future cash
flows related to these assets. See Note 3 "Restructuring and other costs".
Pro Forma Information:
The following table presents the unaudited pro forma results of operations for
informational purposes, assuming that the Company had acquired Malleable and
Datum at the beginning of the 1999 fiscal year.
69
Year Ended December 31,
-----------------------------
(in thousands, except for per share amounts) 2000 1999
- ----------------------------------------------------------------------------
Net Revenues $ 696,094 $ 297,643
Net income(loss) $ 26,733 $ (31,017)
Pro forma basic earnings(loss) per share $ 0.16 $ (0.21)
Pro forma diluted earnings(loss) per share $ 0.15 $ (0.21)
The pro forma results of operations give effect to certain adjustments including
amortization of purchased intangibles, goodwill and unearned compensation.
Included in the pro forma net income for the year ended December 31, 2000 is a
$38.2 million charge for IPR&D. The pro forma results do not include the results
of operations for Octera because the effect of the acquisition was not material.
This information may not necessarily be indicative of the future combined
results of operations of the Company.
NOTE 3. Restructuring and Other Costs
Restructuring - March 26, 2001
In the first quarter of 2001, PMC implemented a restructuring plan in response
to the decline in demand for its networking products and consequently recorded a
restructuring charge of $19.9 million. Prior to the end of the first quarter,
management approved the restructuring plan committing the Company to the
termination of 223 employees, the consolidation of a number of facilities and
the curtailment of certain research and development projects. Employees
terminated under this plan were advised prior to the end of the quarter of the
termination benefits to which they were entitled.
The elements of the accrued restructuring costs related to the March 2001
restructuring plan are as follows:
Total Charge Noncash Cash Restructuring Liability at
(in thousands) March 26, 2001 Charges Payments December 31, 2001
- --------------------------------------------------------------------------------------------------------------------
Workforce reduction $ 9,367 $ - $ (7,791) $ 1,576
Facility lease and contract settlement costs 6,545 - (3,917) 2,628
Write-down of property and equipment, net 3,988 (3,988) - -
- --------------------------------------------------------------------------------------------------------------------
Total $ 19,900 $(3,988) $ (11,708) $ 4,204
=====================================================================
Workforce reduction includes the cost of severance and related benefits of 223
employees affected by the restructuring. These terminations were spread across
all business functions, with approximately 70% occurring in Research and
Development and the remainder occurring in Sales, Marketing, Administrative and
Production departments.
70
Facility lease and contract settlement costs include: (i) lease termination
payments and other costs related to the closure of certain corporate facilities,
sales offices and research and development centers for activities that have been
exited or restructured; and (ii) penalties incurred due to the Company's
withdrawal from certain purchase contracts.
Certain leasehold improvements located at the closed facilities and computer
equipment and software licenses were determined to be impaired as a result of
the restructuring activities and were written down to estimated fair market
value, net of disposal costs.
PMC expects to complete the restructuring activities contemplated in the March
2001 plan by the end of March 2002.
Restructuring - October 18, 2001
Due to the continued decline in market conditions, PMC implemented a second
restructuring plan in the fourth quarter of 2001 to reduce its operating cost
structure. Prior to the end of the fourth quarter, management approved the
second restructuring plan committing the Company to the termination of 341
employees, the consolidation of additional excess facilities, and the
curtailment of additional research and development projects. Employees
terminated under this plan were advised prior to the end of the quarter of the
termination benefits to which they were entitled. As a result, the Company
recorded a second restructuring charge of $175.3 million in its fourth quarter.
The elements of the accrued restructuring costs related to the October 2001
restructuring plan are as follows:
Total Charge Noncash Cash Restructuring Liability at
(in thousands) October 18, 2001 Charges Payments December 31, 2001
- --------------------------------------------------------------------------------------------------------------------------------
Workforce reduction $ 12,435 $ - $ (5,651) $ 6,784
Facility lease and contract settlement costs 150,610 - (400) 150,210
Write-down of prepaid software licenses 2,329 (2,329) -
Write-down of property and equipment, net 9,912 (9,912) - -
- --------------------------------------------------------------------------------------------------------------------------------
Total $ 175,286 $(12,241) $ (6,051) $ 156,994
===============================================================================
Workforce reduction charges include the cost of severance and related benefits
of 341 employees affected by the restructuring activities. These terminations
were spread across all business functions, with approximately 64% occurring in
Research and Development and the remainder occurring in Sales, Marketing and
Administrative and Production departments.
Facility lease and contract settlement costs include: (i) lease termination and
other costs related to the closure of corporate facilities as a result of this
restructuring; and (ii) penalties incurred due to the Company's withdrawal from
certain purchase contracts. A significant component of the charge for excess
facilities relates to a Santa Clara, CA building lease committed to in 2000. To
form the plan for the termination of excess lease facilities, the Company
considered local market conditions for each site and estimated the timing and
amount of sublease revenues. The charge for operating and lease termination
costs was recorded net of expected future sublease revenues.
71
Certain leasehold improvements located at the closed facilities and computer
equipment, software licenses, and related software maintenance prepayments were
written down to estimated fair market value, net of disposal costs.
PMC expects to complete the restructuring activities contemplated in the October
2001 plan by the fourth quarter of 2002.
Impairment of Goodwill and Intangible Assets
During the second quarter of 2001, PMC made a decision to discontinue further
development of the technology acquired in the purchase of Malleable. The Company
does not expect to have any future cash flows related to these assets and has no
alternative use for the technology. Accordingly, the Company has recorded an
impairment charge of $189 million, equal to the remaining net book value of
goodwill and intangible assets related to Malleable.
In the fourth quarter of 2001, due to a continued decline in market conditions
and a delay in introduction of certain products to the market, the Company
completed an assessment of the future revenue potential and estimated costs
associated with all acquired technologies. As a result of this review, the
Company recorded a further impairment charge of $80.8 million related to the
acquired goodwill and other intangibles recognized in the purchase of Datum and
Octera. The Company recorded a charge of $79.3 million, measured as the amount
by which the carrying value of the goodwill and intangibles exceeded the present
value of estimated future cash flows related to these assets, to impair the
goodwill and intangibles acquired in the purchase of Datum. The remaining $1.5
million impairment of goodwill resulted from the cancellation of Octera's
research and development activities during 2001.
Write-down of Inventory
The Company recorded a write-down of excess inventory totaling $20.7 million
during the year ended December 31, 2001. The continued industry wide reduction
in capital spending and resulting decrease in demand for the Company's products
prompted the Company to assess its current inventory levels compared to sales
forecasts for the next twelve months. This excess inventory charge, which was
included in cost of revenues, was calculated in accordance with the Company's
policy, which is based on inventory levels in excess of estimated 12-month
demand.
72
NOTE 4. Debt Investments
The following tables summarize the Company's investments in debt securities:
December 31,
------------------------------
(in thousands) 2001 2000
- -----------------------------------------------------------------------------
Held to maturity:
US Government Treasury and Agency notes $ 50,163 $ -
Corporate bonds and notes 307,352 173,993
------------------------------
357,515 173,993
Available-for-sale:
US Government Treasury and Agency notes 86,352 -
- -----------------------------------------------------------------------------
$ 443,867 $ 173,993
==============================
Reported as:
Cash equivalents $ 14,233 $ 55,075
Short-term investments 258,609 118,918
Investments in bonds and notes 171,025 -
- -----------------------------------------------------------------------------
$ 443,867 $ 173,993
==============================
The total fair value of held-to-maturity investments at December 31, 2001 was
$358.1 million, with remaining maturities ranging from 1 month to 30 months. At
December 31, 2000 the fair value of held-to-maturity investments approximated
cost.
The total fair value of available-for-sale investments at December 31, 2001 was
$86.3 million with remaining maturities ranging from 16 to 20 months.
NOTE 5. Other Investments and Assets
The components of other investments and assets are as follows:
December 31,
-----------------------------
(in thousands) 2001 2000
- -------------------------------------------------------------------------
Investment in Sierra Wireless Inc. $ 44,317 $ 58,082
Other investments in public companies 2,744 -
Investments in non-public companies 12,392 26,378
Deferred debt issue costs (Note 7) 7,167 -
Other assets (Note 16) 2,243 207
- -------------------------------------------------------------------------
$ 68,863 $ 84,667
=============================
At December 31, 2001, the Company held 2.3 million shares (2000 - 2.4 million
shares) of Sierra Wireless, Inc., of which 1.2 million shares were subject to
resale restrictions and could not be sold until May 2002. The Company has
classified the shares as available-for-sale and has reported the entire
investment at the end of 2001 at fair value. At the end of 2000, 1.2 million
shares were restricted beyond one year. As a result, the investment at December
31, 2000 comprised 1.2 million shares recorded at cost and 1.2 million shares
that were unrestricted and recorded at fair value. The total unrealized holding
gain related to these shares on December 31, 2001, was $41.6 million (2000 -
$55.2 million).
73
The Company also has investments in non-public entities, which include venture
funds that invest in early-stage private technology companies of strategic
interest to the Company. The Company has commitments to invest additional
capital into these funds (see Note 8). In 2001, the Company made additional cash
investments of $5.7 million (2000 - $24.8 million; 1999 - $8.5 million) in these
non-public entities.
During the year ended December 31, 2001, the Company sold some of its
investments in public and non-public companies for cash proceeds of $3.3 million
(2000 - $59.7 million; 1999 - $28.6 million) and non-cash proceeds of $1.7
million (2000 and 1999 - nil) and recorded gross realized gains of $2.9 million
(2000 - $58.5 million; 1999 - $26.8 million). Of these amounts, cash proceeds of
$2.1 million (2000 - $59.7 million; 1999 - $28.6 million) and gross realized
gains of $1.9 million (2000 - $58.5 million; 1999 - $26.8 million) related to
the disposition of investments classified as available for sale.
The Company monitors the value of its investments for impairment and writes them
down to reflect any decline in value below its cost basis, if that decline is
considered to be other than temporary. In 2001, the Company recorded an
impairment charge of $17.5 million related to its investments in non-public
entities. This charge is included in Gain (loss) on investments on the
Consolidated Statement of Operations.
NOTE 6. Lines of credit
At December 31, 2001, the Company had available a revolving line of credit with
a bank under which the Company may borrow up to $25 million with interest at the
bank's alternate base rate (annual rate of 5.25% at December 31, 2001). The
Company cannot pay cash dividends, or make material divestments without the
prior written consent of the bank. The agreement expires in May 2003. At
December 31, 2001, $5.3 million of the available line of credit was committed
under letters of credit.
NOTE 7. Convertible subordinated notes
In August 2001, the Company issued $275 million of convertible subordinated
notes maturing on August 15, 2006. In connection with the issuance of these
convertible subordinated notes, the Company incurred approximately $7.8 million
of issuance costs, which consisted primarily of investment banker fees, legal
and other professional fees, which have been deferred and are being amortized
over the term of the notes. The five-year term notes bear interest at a rate of
3.75% per annum and are convertible into an aggregate of approximately 6,480,650
shares of PMC's common stock at any time prior to maturity, at a conversion
price of approximately $42.43 per share.
The Company may redeem the notes, in whole or in part, at any time after August
19, 2004 at a redemption price ranging from 100.75% to 101.5% of the principal
amount of notes outstanding depending on the redemption date. Under certain
conditions prior to August 19, 2004, the Company may redeem any portion of the
notes at a price of 100% of the principal amount of notes, plus a "make whole"
amount for accrued and unpaid interest to the redemption date.
74
These notes are subject to restrictive covenants including those concerning
payments on the notes and other indebtedness. In the event of a change in
control of the Company, the noteholders may require the Company to repurchase
their notes.
NOTE 8. Commitments and Contingencies
Operating leases. The Company leases its facilities under operating lease
agreements, which expire at various dates through December 31, 2011.
Rent expense for the years ended December 31, 2001, 2000 and 1999 was $15.9
million, $8.3 million and $4.4 million, respectively. Excluded from rent expense
for 2001 was additional rent of $3.4 million related to excess facilities, which
have been accrued in the restructuring charges for 2001.
In connection with the restructuring charges recorded in 2001, the Company
recorded a charge of $128.3 million for exiting and terminating certain lease
facilities included in the table below.
Minimum future rental payments under these leases are as follows:
Year Ending December 31 (in thousands)
- ----------------------------------------------------------------------------
2002 $ 31,747
2003 31,747
2004 31,559
2005 30,909
2006 30,087
Thereafter 147,308
- ----------------------------------------------------------------------------
Total minimum future rental payments under operating leases 303,357
=============
Supply agreements. The Company has wafer supply agreements with two independent
foundries, which expire in December 2003. Under these agreements, the suppliers
are obligated to provide certain quantities of wafers per year. Neither of the
agreements have minimum unit volume purchase requirements but the Company is
obligated under one of the agreements to purchase in future periods a minimum
percentage of its total annual wafer requirements, provided that the foundry is
able to continue to offer competitive technology, pricing, quality and delivery.
Investment agreements. The Company participates in four professionally managed
venture funds that invest in early-stage private technology companies which
participate in markets of strategic interest to the Company. From time to time
these funds request additional capital for private placements. The Company has
committed to invest an additional $40.7 million into these funds, which may be
requested by the fund managers at any time over the next eight years.
Contingencies. In the normal course of business, the Company receives and makes
inquiries with regard to possible patent infringements. Where deemed advisable,
the Company may seek or extend licenses or negotiate settlements. Outcomes of
such negotiations may not be determinable at any point in time; however,
management does not believe that such licenses or settlements will, individually
or in the aggregate, have a material adverse effect on the Company's financial
position, results of operations or cash flows.
75
NOTE 9. Special Shares
At December 31, 2001 and 2000, the Company maintained a reserve of 3,373,000 and
3,746,000 shares, respectively, of PMC-Sierra common stock to be issued to
holders of PMC-Sierra, Ltd. (LTD) special shares.
The special shares of LTD, the Company's principal Canadian subsidiary, are
redeemable or exchangeable for PMC common stock. Special shares do not vote on
matters presented to the Company's stockholders, but in all other respects
represent the economic and functional equivalent of PMC common stock for which
they can be redeemed or exchanged at the option of the holders. The special
shares have class voting rights with respect to transactions that affect the
rights of the special shares as a class and for certain extraordinary corporate
transactions involving LTD. If LTD files for bankruptcy, is liquidated or
dissolved, the special shares receive as a preference the number of shares of
PMC common stock issuable on conversion plus a nominal amount per share plus
unpaid dividends, or at the holder's option convert into LTD ordinary shares,
which are the functional equivalent of voting common stock. If the Company files
for bankruptcy, is liquidated or dissolved, special shares of LTD receive the
cash equivalent of the value of PMC common stock into which the special shares
could be converted, plus unpaid dividends, or at the holder's option convert
into LTD ordinary shares. If the Company materially breaches its obligations to
special shareholders of LTD (primarily to permit conversion of special shares
into PMC common stock), the special shareholders may convert their shares into
LTD ordinary shares.
These special shares of LTD are classified outside of stockholders' equity until
such shares are exchanged for PMC common stock. Upon exchange, amounts will be
transferred from the LTD special shares account to the Company's common stock
and additional paid-in capital on the consolidated balance sheet.
NOTE 10. Stockholders' Equity
Authorized capital stock of PMC. At December 31, 1998, the Company had an
authorized capital of 105,000,000 shares, 100,000,000 of which were designated
"Common Stock", $0.001 par value, and 5,000,000 of which were designated
"Preferred Stock", $0.001 par value.
During 2000 and 1999 the Company's stockholders elected to add an additional
700,000,000 and 100,000,000 authorized shares of common stock, respectively, to
the 100,000,000 shares of common stock authorized at the end of 1998. The
Company currently has an authorized capital of 905,000,000 shares, 900,000,000
of which are designated "Common Stock", $0.001 par value, and 5,000,000 of which
are designated "Preferred Stock", $0.001 par value.
Stock Splits. In April 1999, the Company's Board of Directors approved a
two-for-one split of the Company's common stock in the form of a stock dividend
that was applicable to shareholders of record on April 30, 1999, and effective
on May 14, 1999.
76
In January 2000, the Company's Board of Directors approved another two-for-one
split of the Company's common stock in the form of a stock dividend that was
applicable to shareholders of record on January 31, 2000, and effective on
February 14, 2000.
All references to share and per share data for all periods presented have been
adjusted to give effect to these stock dividends.
Warrants. During 1996, the Company issued a warrant to purchase 100,000 shares
of common stock at $2.31 per share to an investment banking firm in settlement
for services previously expensed. This warrant was fully exercised in August
2000.
In 1999, as a result of the Company's acquisition of Abrizio, the Company
assumed warrants to purchase 174,580 shares of common stock at $1.66 per share.
In 2000, as a result of the Company's acquisitions of AANetcom, Extreme, QED and
SwitchOn, the Company assumed warrants to purchase 50,759, 63,162, 68,434 and
780 shares of common stock at $9.36, $3.06, $5.26 and $89.76 per share,
respectively. These warrants expire between October 2002 and December 2005. In
2001, 50,759 of these warrants were cancelled. At December 31, 2001, 2000 and
1999, there were 42,138 warrants outstanding at a weighted average exercise
price of $1.66, 92,897 warrants outstanding at a weighted average exercise price
of $5.87 per share and 366,633 warrants outstanding at a weighted average
exercise price of $3.87 per share, respectively.
Convertible Preferred Stock of QED. QED, which was acquired by PMC in August
2000 in a transaction accounted for under the pooling method (see Note 2), had
preferred stock comprised of $0.001 par value per share Series A, B, C, D
convertible preferred shares. At December 31, 1999, QED had a total of
13,619,000 preferred shares outstanding. Proceeds of these shares net of
issuance costs were approximately $39.9 million. On February 1, 2000, QED
completed its initial public offering of common stock. Simultaneously with the
closing of the initial public offering, all issued and outstanding shares of
QED's convertible preferred stock were automatically converted into 13,619,000
shares of QED common stock. All shares of common stock of QED were exchanged for
shares of PMC common stock at an exchange ratio of 0.385 (see Note 2) per QED
common share.
Exchangeable Shares. As a result of the acquisitions of Extreme and Datum, each
holder of the Extreme and Datum common stock received shares exchangeable into
PMC common stock. The shares are exchangeable, at the option of the holder, for
PMC common stock on a share-for-share basis. The exchangeable shares remain
securities of the Company and entitle the holders to dividend and other rights
economically equivalent to that of PMC common stock and, through a voting trust,
to vote at shareholder meetings of the Company. At December 31, 2001 and 2000,
these shares were exchangeable into 712,000 and 1,386,000 PMC shares,
respectively.
Stockholders' Rights Plan. On April 26, 2001, PMC adopted a stockholders' rights
plan. Under the rights plan, the Company issued a dividend of one right for each
share of common stock of the Company held by stockholders of record as of May
25, 2001. Each right will initially entitle stockholders to purchase a
fractional share of the Company's preferred stock for $325. However, the rights
are not immediately exercisable and will become exercisable only upon the
occurrence of certain events. Upon occurrence of these events, unless redeemed
for $0.001 per right, the rights will become exercisable by holders, other than
rights held by a potential unsolicited third party acquirer, for shares of the
Company or for shares of the third party acquirer having a value of twice the
right's then-current exercise price.
77
NOTE 11. Employee Benefit Plans
Employee Stock Purchase Plan. In 1991, the Company adopted an Employee Stock
Purchase Plan ("PMC ESPP") under Section 423 of the Internal Revenue Code.
During 1998, the Company's stockholders elected to add a provision to the ESPP.
Under the new terms, the number of shares authorized to be available for
issuance under the plan shall be increased automatically on January 1, 1999, and
every year thereafter until the expiration of the plan. The increase will be
limited to the lesser of (i) 1% of the outstanding shares on January 1 of each
year, (ii) 2,000,000 shares (after adjusting for stock dividends), or (iii) an
amount to be determined by the Board of Directors.
In 2000, in connection with the acquisition of QED, the Company assumed the QED
Employee Stock Purchase Plan ("QED ESPP"). A total of 115,000 shares of common
stock have been reserved for issuance under this Plan. Under this Plan, eligible
employees may purchase a limited amount of common stock at a minimum of 85% of
the market value at certain plan-defined dates. As of December 31, 2001, all
employees had converted to the PMC ESPP.
During 2001, 2000, and 1999, there were 245,946 shares, 235,104 shares, and
229,518 shares, respectively, issued under the Plans at weighted-average prices
of $31.93, $16.21, and $8.12 per share, respectively. The weighted-average fair
value of the 2001, 2000, and 1999 awards was $31.25, $41.90, and $9.32 per
share, respectively. During 2001, an additional 1,622,201 shares became
available under the PMC ESPP and no additional shares were authorized for the
QED ESPP. As of December 31, 2001, 4,846,149 shares were available for future
issuance under the PMC ESPP.
Stock Option Plans. The Company has various stock option plans that cover grants
of options to purchase the Company's common stock. The options generally expire
within five to ten years and vest over four years.
During 2000, the Company's stockholders elected to add a provision to the 1994
Incentive Stock Plan, under which plan most of the outstanding options have been
issued. Under the new terms, the number of shares authorized to be available for
issuance under the plan shall be increased automatically on January 1, 2001 and
every year thereafter until the expiration of the plan. The increase will be
limited to the lesser of (i) 5% of the outstanding shares on January 1 of each
year, (ii) 45,000,000 shares, or (iii) an amount to be determined by the Board
of Directors.
In addition, the Company assumed the stock option plans of each of the companies
it acquired prior to 2001 (see Note 2). In 2001, the company simplified its plan
structure by merging these plans into one plan. All option activity related to
these plans is included in the following tables.
Option activity under the option plans was as follows:
78
Weighted
Average
Options Available Number of Options Exercise Price
For Issuance Outstanding Per Share
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1998 6,983,081 18,118,251 $ 4.30
Additional shares reserved 5,999,487
Granted (11,053,619) 11,053,619 $ 28.83
Exercised - (3,658,690) $ 2.73
Expired (2,702) - -
Cancelled/Repurchased 403,404 (398,836) $ 11.96
- -------------------------------------------------------------------------------------------------
Balance at December 31, 1999 2,329,651 25,114,344 $ 15.20
Additional shares reserved 6,442,687 -
Granted (3,855,369) 3,855,369 $132.97
Exercised - (4,059,790) $ 5.46
Expired (12,214) - -
Cancelled/Repurchased 875,882 (873,870) $ 32.59
- -------------------------------------------------------------------------------------------------
Balance at December 31, 2000 5,780,637 24,036,053 $ 34.91
Additional shares reserved 8,111,005
Granted (14,838,436) 14,838,436 $ 18.51
Exercised - (2,995,129) $ 6.30
Expired (4,504) - -
Cancelled/Repurchased 3,861,629 (3,774,971) $ 61.92
Cancelled but unavailable (117,285) - -
- -------------------------------------------------------------------------------------------------
Balance at December 31, 2001 2,793,046 32,104,389 $ 26.82
===========================================================
The following table summarizes information concerning options outstanding and
exercisable for the combined option plans at December 31, 2001:
Options Outstanding Options Exercisable
-------------------------------------------------- ----------------------------------
Weighted Weighted Weighted Average
Average Average Exercise Price
Remaining Exercise per Share
Range of Number Contractual Price per Number
Exercise Prices Outstanding Life (years) Share Exercisable
-------------------------------------------------------------------------------------------------------------
$0.02 - $3.95 3,718,569 5.08 $ 2.65 3,496,519 $ 2.73
$3.98 - $15.98 8,719,649 6.20 $ 10.51 7,335,182 $ 9.92
$16.55 - $18.26 7,465,982 9.92 $ 18.26 40,059 $ 18.13
$18.50 - $48.31 7,041,307 8.91 $ 21.71 755,711 $ 28.61
$52.38 - $245.00 5,158,882 8.12 $ 91.18 2,358,927 $ 85.64
-------------------------------------------------------------------------------------------------------------
$0.02 - $245.00 32,104,389 7.84 $ 26.82 13,986,398 $ 22.02
=====================================================================================
Stock-based compensation. In accordance with the provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), the Company applies APB Opinion 25 and related
interpretations in accounting for its stock-based awards. The Company's ESPP is
non-compensatory under Accounting Principles Board (APB) Opinion 25. The Company
also does not recognize compensation expense for employee stock options that are
granted with exercise prices equal to the fair market value of the Company's
common stock at the date of grant.
79
Pro forma information regarding net income (loss) and net income (loss) per
share is required by SFAS 123 for awards granted or modified after December 31,
1994 as if the Company had accounted for its stock-based awards to employees
under the fair value method of SFAS 123. The fair value of the Company's
stock-based awards to employees was estimated using a Black-Scholes option
pricing model. The Black-Scholes model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, the Black-Scholes model requires the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock-based awards to employees have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock-based awards to employees. The fair value
of the Company's stock-based awards to employees was estimated using the
multiple option approach, recognizing forfeitures as they occur, assuming no
expected dividends and using the following weighted average assumptions:
Options ESPP
-------------------------------- --------------------------------
2001 2000 1999 2001 2000 1999
Expected life (years) 3.0 3.1 3.4 0.9 1.4 1.4
Expected volatility 0.9 0.7 0.6 1.1 0.9 0.7
Risk-free interest rate 4.0% 6.1% 5.4% 4.5% 5.9% 5.2%
The weighted-average estimated fair values of employee stock options granted
during fiscal 2001, 2000, and 1999 were $10.98, $74.32 and $14.27 per share,
respectively.
If the computed fair values of 2001, 2000, and 1999 awards had been amortized to
expense over the vesting period of the awards as prescribed by SFAS 123, net
income (loss) and net income (loss) per share would have been:
(in thousands, except for per share amounts) 2001 2000 1999
- -------------------------------------------------------------------------------------------
Net income (loss) $(747,445) $18,682 $51,238
Basic net income (loss) per share $ (4.45) $ 0.12 $ 0.35
Diluted net income (loss) per share $ (4.45) $ 0.10 $ 0.32
Because SFAS 123 is applicable only to awards granted or modified subsequent to
December 31, 1994, the pro forma effect is not indicative of future pro forma
adjustments, when the calculation will apply to all applicable stock awards.
80
NOTE 12. Income Taxes
The income tax provisions, calculated under Statement of Financial Accounting
Standard No. 109 (SFAS 109), consist of the following:
Year Ended December 31,
----------------------------------------
(in thousands) 2001 2000 1999
- ----------------------------------------------------------------------
Current:
Federal $ - $ 40 $ (102)
State 4 224 526
Foreign (7,034) 100,880 43,843
- ----------------------------------------------------------------------
(7,030) 101,144 44,267
- ----------------------------------------------------------------------
Deferred:
Federal - (72) (23)
Foreign (10,733) 1,340 (2,898)
- ----------------------------------------------------------------------
(10,733) 1,268 (2,921)
- ----------------------------------------------------------------------
Provision for income taxes $ (17,763) $ 102,412 $ 41,346
=======================================
A reconciliation between the Company's effective tax rate and the U.S. Federal
statutory rate is as follows:
Year Ended December 31,
------------------------------------
(in thousands) 2001 2000 1999
- --------------------------------------------------------------------------------
Income before provision for income taxes $ (656,817) $ 177,710 $ 113,175
Federal statutory tax rate 35% 35% 35%
Income taxes at U.S. Federal statutory rate $ (229,886) $ 62,198 $ 39,611
State taxes, net of federal benefit - 224 526
In process research and development costs - 13,370 -
Goodwill 16,188 11,297 -
Impairment of goodwill and purchased
intangible assets 94,440 - -
Acquisition costs - 13,291 -
Deferred stock compensation 14,414 9,576 -
Incremental taxes on foreign earnings 1,535 9,093 (697)
Other (97) 530 1,933
Valuation allowance 85,643 (17,167) (27)
- --------------------------------------------------------------------------------
Provision for income taxes $ (17,763) $ 102,412 $ 41,346
====================================
81
Significant components of the Company's deferred tax assets and liabilities are
as follows:
December 31,
------------------------------
(in thousands) 2001 2000
- -------------------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 176,838 $ 117,416
State tax loss carryforwards 10,926 8,126
Credit carryforwards 26,180 14,407
Reserves and accrued expenses 19,058 12,186
Restructuring and other charges 67,207 -
Depreciation and amortization 10,553 -
Deferred income 4,800 13,525
Deferred stock compensation 221 221
- -------------------------------------------------------------------------
Total deferred tax assets 315,783 165,881
Valuation allowance (305,929) (154,409)
- -------------------------------------------------------------------------
Total net deferred tax assets 9,854 11,472
- -------------------------------------------------------------------------
Deferred tax liabilities:
Depreciation - (8,995)
Capitalized technology (369) (1,600)
Unrealized gain on investments (17,715) (22,629)
Other - (2,125)
- -------------------------------------------------------------------------
Total deferred tax liabilities (18,084) (35,349)
- -------------------------------------------------------------------------
Total net deferred taxes $ (8,230) $ (23,877)
==============================
At December 31, 2001, the Company has approximately $491.7 million of federal
net operating losses, which will expire through 2021. Approximately $10.3
million of the federal net operating losses is subject to ownership change
limitations provided by the Internal Revenue Code of 1986. The Company also has
approximately $182.1 million of state tax loss carryforwards, which expire
through 2021. The utilization of a portion of these state losses is also subject
to ownership change limitations provided by the various states' income tax
legislation.
Included in the credit carryfowards are $14.5 million of federal research and
development credits which expire through 2021, $549,000 of foreign tax credits
which expire in 2003, $410,000 of federal AMT credits which carryforward
indefinitely, $8.4 million of state research and development credits which do
not expire, $1.2 million of state research and development credits which expire
through 2006, and $1.1 million of state manufacturer's investment credits which
expire through 2010.
Included in the above net operating loss carryforwards are $23.8 million and
$8.6 million of federal and state net operating losses related to acquisitions
accounted for under the purchase method of accounting. The benefit of such
losses, if and when realized, will be credited first to reduce to zero any
goodwill related to the respective acquisition, second to reduce to zero other
non-current intangible assets related to the respective acquisition, and third
to reduce income tax expense.
Included in the deferred tax assets before valuation allowance are approximately
$144.8 million of cumulative tax benefits related to equity transactions, which
will be credited to stockholder's equity if and when realized.
82
The pretax income (loss) from foreign operations was ($154.1 million), $254.5
million, and $119.3 million in 2001, 2000, and 1999, respectively. Undistributed
earnings of the Company's foreign subsidiaries are considered to be indefinitely
reinvested and accordingly, no provision for federal and state income taxes has
been provided thereon. Upon distribution of those earnings in the form of a
dividend or otherwise, the Company would be subject to both US income taxes
(subject to an adjustment for foreign tax credits) and withholding taxes payable
to the various foreign countries. It is not practical to estimate the income tax
liability that might be incurred on the remittance of such earnings.
NOTE 13. Segment Information
The Company has two operating segments: networking and non-networking products.
The networking segment consists of internetworking semiconductor devices and
related technical service and support to equipment manufacturers for use in
their communications and networking equipment. The non-networking segment
includes custom user interface products. The Company is supporting a
non-networking product for an existing customer, but has decided not to develop
any further products of this type.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on gross profits from operations of the two segments.
Summarized financial information by segment is as follows:
Year Ended December 31,
------------------------------------------
(in thousands) 2001 2000 1999
- ----------------------------------------------------------------------------
Net revenues
Networking $ 300,173 $ 665,700 $ 278,477
Non-networking 22,565 28,984 17,291
- ----------------------------------------------------------------------------
Total $ 322,738 $ 694,684 $ 295,768
==========================================
Gross profit
Networking $ 176,068 $ 515,712 $ 214,401
Non-networking 9,408 12,811 7,928
- ----------------------------------------------------------------------------
Total $ 185,476 $ 528,523 $ 222,329
==========================================
Enterprise-wide information is provided in accordance with SFAS 131. Geographic
revenue information is based on the location of the customer invoiced.
Long-lived assets include investment in bonds and notes, other investments and
assets, deposits for wafer fabrication capacity, property and equipment, and
goodwill and other intangible assets. Geographic information about long-lived
assets is based on the physical location of the assets.
83
Year Ended December 31,
----------------------------------------
(in thousands) 2001 2000 1999
- ---------------------------------------------------------------------------
Net revenues
United States $ 187,723 $ 432,649 $ 206,498
Canada 35,448 83,747 42,731
China 34,746 46,485 14,901
Europe and Middle East 31,825 43,101 14,830
Asia - other 32,501 87,554 16,620
Other foreign 495 1,148 188
- --------------------------------------------------------------------------
Total $ 322,738 $ 694,684 $ 295,768
========================================
Long-lived assets
United States $ 267,298 $ 341,361
Canada 89,684 210,006
Other 4,133 3,720
- ------------------------------------------------------------
Total $ 361,115 $ 555,087
==========================
The Company's largest customers based on billings are contract manufacturing
companies and distributors of the Company's products. Revenues from external
customers (2001 - 2, 2000 - 1, 1999 - 3) that exceed 10% of total net revenues
as follows:
Year Ended December 31,
-----------------------------------------
(in thousands) 2001 2000 1999
- -------------------------------------------------------------------------
Networking $ 80,359 $ 128,997 $ 110,392
Non-networking - - 17,208
NOTE 14. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income
(loss) per share:
Year ended December 31,
-------------------------------------
(in thousands except per share amounts) 2001 2000 1999
- ------------------------------------------------------------------------------
Numerator:
Net income (loss) $ (639,054) $ 75,298 $ 71,829
=====================================
Denominator:
Basic weighted average common
shares outstanding (1) 167,967 162,377 146,818
Effect of dilutive securities:
Stock options - 19,341 13,590
Stock warrants - 173 115
-------------------------------------
Diluted weighted average common
shares outstanding 167,967 181,891 160,523
=====================================
Basic net income (loss) per share $ (3.80) $ 0.46 $ 0.49
=====================================
Diluted net income (loss) per share $ (3.80) $ 0.41 $ 0.45
=====================================
84
(1) PMC-Sierra, Ltd. Special Shares are included in the calculation of basic
weighted average common shares outstanding.
NOTE 15. Comprehensive Income
The components of comprehensive income, net of tax, are as follows:
Year Ended December 31,
---------------------------------------
(in thousands) 2001 2000 1999
- ----------------------------------------------------------------------------
Net income (loss) $ (639,054) $ 75,298 $ 71,829
Other comprehensive income:
Change in net unrealized gains
on investments, net of tax
of $4,914 in 2001
(2000 - $22,629 and 1999 - nil) (7,071) 32,563 -
- ----------------------------------------------------------------------------
Total $ (646,125) $ 107,861 $ 71,829
=======================================
NOTE 16. Related Party Transactions
During the year, the Company made a real estate loan of approximately $2 million
to a former officer of a subsidiary company. This interest-bearing loan is
secured by real estate assets and the equivalent of approximately 76,000 common
shares of the Company, and matures on December 31, 2002. As at December 31,
2001, the full amount of the loan remains outstanding and is included in other
investments and assets.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
85
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The information concerning the Company's directors and executive officers
required by this Item is incorporated by reference from the information set
forth in the sections entitled "Election of Directors", "Executive Officers",
and "Section 16(a) Beneficial Ownership Reporting Compliance" in our Proxy
Statement for the 2002 Annual Stockholder Meeting.
ITEM 11. Executive Compensation.
The information required by this Item is incorporated by reference from the
information set forth in the sections entitled "Director Compensation" and
"Executive Compensation and Other Matters" in our Proxy Statement for the 2002
Annual Stockholder Meeting.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item is incorporated by reference from the
information set forth in the section entitled "Common Stock Ownership of Certain
Beneficial Owners and Management" in our Proxy Statement for the 2002 Annual
Stockholder Meeting.
ITEM 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated by reference from the
information set forth in Note 16 to the Financial Statements and Supplementary
Data under Item 8 of this Form 10-K.
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Consolidated Financial Statements
The financial statements (including the notes thereto) listed in
the accompanying index to financial statements and financial
statement schedules are filed within this Annual Report on Form
10-K.
2. Financial Statement Schedules
Financial Statement Schedules required by this item are listed on
page 51 of this Annual Report on Form 10k.
3. Exhibits
The exhibits listed under Item 14(c) are filed as part of this Form
10-K Annual Report.
(b) Reports on Form 8-K
- None.
86
(c) Exhibits pursuant to Item 601 of Regulation S-K.
Exhibit
Number Description
3.1 Restated Certificate of Incorporation of the Registrant, as amended on
May 11, 2001 (1)......................................................
3.2 Certificate of Designation of Rights, Preferences and Privileges of
Series A Participating Preferred Stock of the Registrant
(2)...................................................................
3.3 Bylaws of the Registrant, as amended (3)..............................
4.1 Specimen of Common Stock Certificate of the Registrant (4)............
4.2 Exchange Agreement dated September 2, 1994 by and between the
Registrant and PMC-Sierra, Ltd.(5)....................................
4.3 Amendment to Exchange Agreement effective August 9, 1995 (6)..........
4.4 Terms of PMC-Sierra, Ltd. Special Shares (7)..........................
4.5 Preferred Stock Rights Agreement, as amended and restated as of July
27, 2001, by and between the Registrant and American Stock Transfer
and Trust Company (8).................................................
4.6 Form of Convertible Note and Indenture dated August 6, 2001 by and
between the Registrant and State Street Trust and Bank Company of
California, N.A (9)...................................................
10.1 1991 Employee Stock Purchase Plan, as amended (10)....................
10.2 1994 Incentive Stock Plan, as amended (11)............................
10.3 2001 (Nonstatutory) Incentive Stock Plan. ............................
10.4 Form of Indemnification Agreement between the Registrant and its
directors and officers (12)...........................................
10.5 Executive Employment Agreement by and between the Registrant and
Robert L. Bailey (13).................................................
10.6 Form of Executive Employment Agreement by and between the Registrant
and each of Gregory Aasen, Steffan Perna, and Haresh Patel
(14)..................................................................
10.7 Executive Employment Agreement by and between the Registrant and John
W. Sullivan (15)......................................................
10.8 Net Building Lease dated May 15, 1996 by and between PMC-Sierra, Ltd.
and Pilot Pacific Developments Inc. (16) .............................
10.9 Building Lease Agreements between WHTS Freedom Circle Partners and
PMC-Sierra, Inc. (17).................................................
10.9A First Amendment to Building Lease Agreements between WHTS Freedom
Circle Partners and the Registrant. (18)..............................
10.10 Building Lease Agreement Kanata Research Park Corporation and
PMC-Sierra, Ltd. (19).................................................
10.11 Building Lease Agreement between Transwestern - Robinson I, LLC and
PMC-Sierra US, Inc. (20)..............................................
10.12 Revolving Operating Line of Credit Agreement dated December 28, 2000
by and between the Registrant and CIBC Inc. (21)......................
10.13 Guarantee Agreement dated April 27, 1998 by and between the Registrant
and CIBC. (22)........................................................
10.14* Forecast and Option Agreement by and among the Registrant, PMC-Sierra,
Ltd., and Taiwan Semiconductor Manufacturing Corporation.
(23)..................................................................
10.15* Deposit agreement dated January 31, 2000 by and between Chartered
Semiconductor Manufacturing Ltd. and the Registrant.
(24)..................................................................
87
10.16 Registration Rights Agreement dated August 6, 2001 by and between the
Registrant and Goldman, Sachs & Co. (25)..............................
Technology License Agreement, by and between Weitek Corporation and
MIPS Computer Systems, Inc............................................
10.17* Assignment Agreement, by and between Weitek Corporation and PMC-Sierra
US, Inc. (formerly Quantum Effect Devices, Inc.)......................
Amendment No. 1 to the Technology License Agreement, by and between
MIPS Technology, Inc. and PMC-Sierra US, Inc. (formerly Quantum Effect
Devices, Inc.) dated March 31, 1997. (26).............................
11.1 Calculation of earnings per share. (27)...............................
21.1 Subsidiaries of the Registrant........................................
23.1 Consent of Deloitte & Touche LLP, Independent Auditors................
24.1 Power of Attorney. (28)...............................................
* Confidential portions of this exhibit have been omitted and filed separately
with the Commission.
- ---------------------------
1. Incorporated by reference from Exhibit 3.1 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on May 16,
2001.
2. Incorporated by reference from Exhibit 3.2 filed with the Registrant's
amended Registration Statement on Form S-3 filed with the Commission on
November 8, 2001 (No. 333-70248).
3. Incorporated by reference from Exhibit 3.2 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on November 14,
2001.
4. Incorporated by reference from Exhibit 4.4 filed with the Registrant's
amended Registration Statement on Form S-3 filed with the Commission on
August 27, 1997 (No. 333-15519).
5. Incorporated by reference from Exhibit 2.1 filed with the Registrant's
Current Report on Form 8-K, filed with the Commission on September 19,
1994, as amended on October 4, 1995.
6. Incorporated by reference from Exhibit 2.1 filed with Registrant's
Current Report on Form 8-K, filed with the Commission on September 6,
1995, as amended on October 6, 1995.
7. Incorporated by reference from Exhibit 4.3 filed with the Registrant's
Registration Statement on Form S-3, filed with the Commission on
September 19, 1995 (No. 33-97110).
8. Incorporated by reference from Exhibit 4.3 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on November 14,
2001.
9. Incorporated by reference from Exhibit 4.1 filed with the Registrant's
amended Registration Statement on Form S?3 filed with the Commission on
November 8, 2001 (No. 333-70248).
10. Incorporated by reference from Exhibit 10.2 filed with the Registrant's
Annual Report on Form 10-K filed with the Commission on March 26, 1999.
11. Incorporated by reference from Exhibit 10.17 filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 2, 2001.
12. Incorporated by reference from Exhibit 10.21 filed with the
Registrant's Quarterly Report on Form 10-Q filed with the Commission on
August 14, 1997.
13. Incorporated by reference from Exhibit 10.32 filed with the
Registrant's amended Annual Report on Form 10-K filed with the
Commission on March 30, 2000.
88
14. Incorporated by reference from Exhibit 10.33 filed with the
Registrant's amended Annual Report on Form 10-K filed with the
Commission on March 30, 2000. Except for the names and dates, Mr.
Perna's and Mr. Patel's Executive Employment Agreements are
substantially identical in all material respects to the Executive
Employment Agreement filed for Mr. Aasen.
15. Incorporated by reference from Exhibit 10.34 filed with the
Registrant's amended Annual Report on Form 10-K filed with the
Commission on March 30, 2000.
16. Incorporated by reference from Exhibit 99.4A filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 14, 1997.
17. Incorporated by reference from Exhibit 10.36 filed with the
Registrant's Quarterly Report on Form 10-Q filed with the Commission on
August 8, 2000.
18. Incorporated by reference from Exhibit 10.46 filed with the
Registrant's Quarterly Report on Form 10-Q filed with the Commission on
November 14, 2001.
19. Incorporated by reference from Exhibit 10.44 filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 2, 2001.
20. Incorporated by reference from Exhibit 10.45 filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 2, 2001.
21. Incorporated by reference from Exhibit 10.23 filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 2, 2001.
22. Incorporated by reference from Exhibit 10.27 filed with the
Registrant's Form 10-Q Quarterly Report filed with the Commission on
August 12, 1998.
23. Incorporated by reference from Exhibit 10.31 filed with the
Registrant's amended Annual Report on Form 10-K filed with the
Commission on March 30, 2000.
24. Incorporated by reference from Exhibit 10.35 filed with the
Registrant's Quarterly Report on Form 10-Q filed with the Commission on
May 10, 2000.
25. Incorporated by reference from Exhibit 10.1 from the Registrant's
amended Registration Statement on Form S-3, filed with the Commission
on November 8, 2001. (No. 333-70248).
26. Incorporated by reference from Exhibit 10.47 from the Registrant's
amended Registration Statement on Form S-3, filed with the Commission
on January 4, 2002. (No. 333-70248).
27. Refer to Note 14 of the financial statements included in Item 8 of Part
II of this Annual Report on Form 10-K.
28. Refer to the Signatures page of this Annual Report.
(d) Financial Statement Schedules required by this item are listed on page
52 of this Annual Report on Form 10k.
89
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
PMC-SIERRA, INC.
(Registrant)
Date: March 27, 2002 /s/ John Sullivan
--------------------------------------
John W. Sullivan
Vice President, Finance (duly authorized officer)
Principal Accounting Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Robert L. Bailey and John W. Sullivan, jointly
and severally, his attorneys-in-fact, each with the power of substitution, for
him in any and all capacities, to sign any amendments to this Report on Form
10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Name Title Date
/s/ Robert L. Bailey President, Chief Executive Officer (Principal Executive March 27, 2002
- ------------------------ Officer) and Chairman of the Board of Directors
Robert L. Bailey
/s/ John W. Sullivan Vice President Finance, Chief Financial Officer (and March 27, 2002
- ------------------------ Principal Accounting Officer)
John W. Sullivan
/s/ Alexandre Balkanski Director March 27, 2002
- ------------------------
Alexandre Balkanski
/s/ Colin Beaumont Director March 27, 2002
- ------------------------
Colin Beaumont
/s/ James V. Diller Vice Chairman March 27, 2002
- ------------------------
James V. Diller
90
/s/ Frank Marshall Director March 27, 2002
- ------------------------
Frank Marshall
/s/ Lewis O. Wilks Director March 27, 2002
- ------------------------
Lewis O. Wilks
91
SCHEDULE II - Valuation and Qualifying Accounts
Years ended December 31, 2001, 2000, and 1999
(in thousands)
Allowance for Doubtful Accounts
Additions Additions
Year Balance at charged to charged to
beginning of costs and other Balance at
year expenses accounts Write-offs end of year
2001 $ 1,934 810 - 119 $ 2,625
2000 $ 1,553 420 - 39 $ 1,934
1999 $ 1,128 439 - 14 $ 1,553
92
INDEX TO EXHIBITS
Exhibit Description
Number
------------ -----------------------------------------------
10.3 2001 (Nonstatutory) Incentive Stock Plan
21.1 Subsidiaries
23.1 Consent of Deloitte & Touche LLP
93