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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10 - Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
for the quarterly period ended September 28, 2003
[ ] 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)
A Delaware Corporation - I.R.S. NO. 94-2925073
3975 Freedom Circle
Santa Clara, CA 95054
(408) 239-8000
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 period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days.
Yes ___X____ No _______
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes ___X____ No _______
Common shares outstanding at October 31, 2003 - 172,767,594
------------------------------------------------
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements Page
- Condensed consolidated statements of operations 3
- Condensed consolidated balance sheets 4
- Condensed consolidated statements of cash flows 5
- Notes to the condensed consolidated
financial statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 39
Item 4. Controls and Procedures 40
PART II - OTHER INFORMATION
Item 5. Other Information 41
Item 6. Exhibits and Reports on Form 8 - K 42
Signatures 42
2
Part I - FINANCIAL INFORMATION
Item 1 - Financial Statements
PMC-Sierra, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
-------------------------------- -------------------------------
Sep 28, Sep 29, Sep 28, Sep 29,
2003 2002 2003 2002
Net revenues
Networking $ 63,100 $ 59,358 $ 178,096 $ 160,095
Non-networking - 226 768 5,442
-------------- -------------- --------------- ---------------
Total 63,100 59,584 178,864 165,537
Cost of revenues 21,868 23,229 65,054 64,546
-------------- -------------- --------------- ---------------
Gross profit 41,232 36,355 113,810 100,991
Other costs and expenses:
Research and development 27,759 33,977 90,880 104,649
Marketing, general and administrative 12,031 16,030 36,798 49,592
Amortization of deferred stock compensation:
Research and development - 453 317 2,138
Marketing, general and administrative 313 23 421 150
Restructuring costs (1,093) - 12,811 -
-------------- -------------- --------------- ---------------
Income (loss) from operations 2,222 (14,128) (27,417) (55,538)
Interest and other income (expense), net (267) 1,374 175 4,134
Gain on extinguishment of debt 1,700 - 1,700 -
Net gain (loss) on investments (162) 71 2,331 3,135
-------------- -------------- --------------- ---------------
Income (loss) before provision for income taxes 3,493 (12,683) (23,211) (48,269)
Provision for (recovery of) income taxes 329 (3,438) (5,695) (13,753)
-------------- -------------- --------------- ---------------
Net income (loss) $ 3,164 $ (9,245) $ (17,516) $ (34,516)
============== ============== =============== ===============
Net income (loss) per common share - basic $ 0.02 $ (0.05) $ (0.10) $ (0.20)
Net income (loss) per common share - diluted $ 0.02 $ (0.05) $ (0.10) $ (0.20)
Shares used in per share calculation - basic 174,118 170,525 172,603 169,945
Shares used in per share calculation - diluted 186,137 170,525 172,603 169,945
See notes to the consolidated financial statements.
3
PMC-Sierra, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
Sep 28, Dec 29,
2003 2002
(unaudited)
ASSETS:
Current assets:
Cash and cash equivalents $ 204,048 $ 70,504
Short-term investments 144,550 340,826
Restricted cash 2,544 5,329
Accounts receivable, net of allowance for doubtful
accounts of $2,848 (2002 - $2,781) 18,449 16,621
Inventories 19,690 26,420
Deferred tax assets 1,131 1,083
Prepaid expenses and other current assets 12,691 15,499
-------------- --------------
Total current assets 403,103 476,282
Investment in bonds and notes 54,073 148,894
Other investments and assets 8,010 21,978
Property and equipment, net 25,124 51,189
Property held for sale 14,203 -
Goodwill and other intangible assets, net 7,907 8,381
Deposits for wafer fabrication capacity 6,779 21,992
-------------- --------------
$ 519,199 $ 728,716
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 22,188 $ 24,697
Accrued liabilities 44,255 53,530
Income taxes payable 38,578 21,553
Accrued restructuring costs 15,274 129,499
Deferred income 15,704 17,982
-------------- --------------
Total current liabilities 135,999 247,261
Convertible subordinated notes 175,000 275,000
Deferred tax liabilities 74 2,764
PMC special shares convertible into 2,961 (2002 - 3,196)
shares of common stock 4,636 5,052
Stockholders' equity
Common stock and additional paid in capital, par value $.001:
900,000 shares authorized; 172,190 shares issued and
outstanding (2002 - 167,400) 857,263 834,265
Deferred stock compensation (212) (1,158)
Accumulated other comprehensive income 2,362 3,939
Accumulated deficit (655,923) (638,407)
-------------- --------------
Total stockholders' equity 203,490 198,639
-------------- --------------
$ 519,199 $ 728,716
============== ==============
See notes to the consolidated financial statements.
4
PMC-Sierra, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months Ended
---------------------------------
Sep 28, Sep 29,
2003 2002
Cash flows from operating activities:
Net loss $ (17,516) $ (34,516)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation of property and equipment 21,252 30,941
Amortization of other intangibles 474 854
Amortization of deferred stock compensation 738 2,288
Amortization of debt issuance costs 1,164 1,173
Impairment of other investments 3,500 -
Noncash restructuring costs 1,490 -
Gain on extinguishment of debt (1,700) -
Gain on sale of investments and other assets (5,818) (3,126)
Changes in operating assets and liabilities:
Accounts receivable (1,828) (952)
Inventories 6,730 6,116
Prepaid expenses and other current assets 3,216 671
Accounts payable and accrued liabilities (11,784) (2,033)
Income taxes payable 17,025 12,454
Accrued restructuring costs (114,200) (24,386)
Deferred income (2,278) (5,361)
--------------- ----------------
Net cash used in operating activities (99,535) (15,877)
--------------- ----------------
Cash flows from investing activities:
Change in restricted cash 2,785 -
Purchases of short-term held-to-maturity investments (16,538) (94,512)
Purchases of short term available-for-sale investments (54,701) (24,375)
Proceeds from sales and maturities of short-term held-to-maturity
investments 120,459 92,023
Proceeds from sales and maturities of short-term available for sale
investments 149,098 15,578
Purchases of long-term held-to-maturity investments in bonds and notes (95,874) (141,863)
Proceeds from sales and maturities of long-term held-to-maturity
investments in bonds and notes 189,973 93,249
Purchases of investments and other assets (1,300) (8,734)
Proceeds from sale of investments and other assets 8,402 5,125
Proceeds from refund of wafer fabrication deposits 15,213 -
Purchases of property and equipment (10,547) (2,946)
--------------- ----------------
Net cash provided by (used in) investing activities 306,970 (66,455)
--------------- ----------------
Cash flows from financing activities:
Repayment of capital leases and long-term debt - (377)
Repurchase of convertible subordinated notes (96,680) -
Proceeds from issuance of common stock 22,789 9,867
--------------- ----------------
Net cash provided by (used in) financing activities (73,891) 9,490
--------------- ----------------
Net increase (decrease) in cash and cash equivalents 133,544 (72,842)
Cash and cash equivalents, beginning of the period 70,504 152,120
--------------- ----------------
Cash and cash equivalents, end of the period $ 204,048 $ 79,278
=============== ================
Supplemental disclosures of cash flow information:
Cash paid for interest $ 10,568 $ 10,759
Cash refund of income taxes 23,228 -
Cash paid for income taxes 407 384
See notes to the consolidated financial statements.
5
PMC-Sierra, Inc.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1. Summary of Significant Accounting Policies
Description of business. PMC-Sierra, Inc (the "Company" or "PMC") designs,
develops, markets and supports high-speed broadband communications and storage
semiconductors and MIPS-based processors for service provider, enterprise,
storage, and wireless networking equipment. The Company offers worldwide
technical and sales support through a network of offices in North America,
Europe and Asia.
Basis of presentation. The accompanying Condensed Consolidated Financial
Statements have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission ("SEC"). Certain information and footnote
disclosures normally included in annual financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to those rules or regulations. The interim financial statements
are unaudited, but reflect all adjustments that are, in the opinion of
management, necessary to provide a fair statement of results for the interim
periods presented. These financial statements should be read in conjunction with
the consolidated financial statements and related notes thereto in the Company's
Annual Report on Form 10-K for the year ended December 29, 2002. The results of
operations for the interim periods are not necessarily indicative of results to
be expected in future periods.
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 contingencies.
Actual results could differ from these estimates.
Inventories. Inventories are stated at the lower of cost (first-in, first out)
or market (estimated net realizable value). Inventories (net of reserves of
$26.4 million and $30.1 million at September 28, 2003 and December 29, 2002,
respectively) were as follows:
Sep 28, Dec 29,
(in thousands) 2003 2002
- -----------------------------------------------------------------------------
Work-in-progress $ 6,910 $ 11,409
Finished goods 12,780 15,011
- -----------------------------------------------------------------------------
$ 19,690 $ 26,420
========================================
Product warranties. The Company provides a one-year limited warranty on most of
its standard products and accrues for the cost of this warranty at the time of
shipment. The Company estimates its warranty costs based on historical failure
rates and related repair or replacement costs. The change in the Company's
accrued warranty obligations from December 31, 2002 to September 28, 2003 is as
follows:
6
Nine months
ended
(in thousands) Sep 28, 2003
- --------------------------------------------------------------------------------
Beginning balance, December 30, 2002 $ 2,399
Accrual for new warranties issued 848
Reduction for payments (in cash or in kind) (224)
Adjustments related to changes in estimate of warranty accrual (267)
- --------------------------------------------------------------------------------
Ending balance, September 28, 2003 $ 2,756
=============
Other Indemnifications. From time to time, on a limited basis, we indemnify
customers, as well as our suppliers, contractors, lessors, and others with whom
we enter into contracts, against combinations of loss, expense, or liability
arising from various triggering events related to the sale and use of our
products, the use of their goods and services, the use of facilities, the state
of assets that we sell and other matters covered by such contracts, usually up
to a specified maximum amount.
Derivatives and Hedging Activities. PMC's net income (loss) and cash flows may
be negatively impacted by fluctuating foreign exchange rates. The Company
periodically hedges foreign currency forecasted transactions related to certain
operating expenses. All derivatives are recorded in the balance sheet at fair
value. For a derivative designated as a fair value hedge, changes in the fair
value of the derivative and of the hedged item attributable to the hedged risk
are recognized in net income (loss). For a derivative designated as a cash flow
hedge, the effective portions of changes in the fair value of the derivative are
recorded in other comprehensive income and are recognized in net income (loss)
when the hedged item affects net income (loss). Ineffective portions of changes
in the fair value of cash flow hedges are recognized in net income (loss). If
the derivative used in an economic hedging relationship is not designated in an
accounting hedging relationship or if it becomes ineffective, changes in the
fair value of the derivative are recognized in net income (loss).
Stock based compensation. The Company accounts for stock-based compensation in
accordance with the intrinsic value method prescribed by APB Opinion No. 25 (APB
25), "Accounting for Stock Issued to Employees". Under APB 25, compensation is
measured as the amount by which the market price of the underlying stock exceeds
the exercise price of the option on the date of grant; this compensation is
amortized over the vesting period.
Pro forma information regarding net income (loss) and net income (loss) per
share is required by SFAS 123, " Accounting for Stock-Based Compensation" 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 both the single and multiple option
approach, recognizing forfeitures as they occur, assuming no expected dividends
and using the following weighted average assumptions:
7
Three Months Ended
---------------------------------------------------
Options ESPP
------------------------ -----------------------
Sep 28, Sep 29, Sep 28, Sep 29,
2003 2002 2003 2002
- --------------------------------------------------------------------------------
Expected life (years) 2.8 1.7 1.1 0.5
Expected volatility 101% 101% 105% 123%
Risk-free interest rate 2.1% 2.4% 1.4% 2.1%
Nine Months Ended
---------------------------------------------------
Options ESPP
------------------------ -----------------------
Sep 28, Sep 29, Sep 28, Sep 29,
2003 2002 2003 2002
- --------------------------------------------------------------------------------
Expected life (years) 2.8 2.0 1.0 0.6
Expected volatility 101% 101% 107% 122%
Risk-free interest rate 1.9% 2.5% 1.5% 2.4%
The weighted-average estimated fair values of employee stock options granted for
the three months ending September 28, 2003 and September 29, 2002 were $6.63 and
$2.90 per share, respectively. The weighted-average estimated fair values of
employee stock options granted for the nine months ending September 28, 2003 and
September 29, 2002 were $4.33 and $4.46 per share, respectively.
If the Company had accounted for stock-based compensation in accordance with the
fair value method as prescribed by SFAS 123, net loss and net loss per share
would have been:
Three Months Ended Nine Months Ended
----------------------------- --------------------------------
Sep 28, Sep 29, Sep 28, Sep 29,
(in thousands, except per share amounts) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------- --------------------------------
Net income (loss), as reported $ 3,164 $ (9,245) $ (17,516) $ (34,516)
Adjustments:
Additional stock-based employee compensation expense
under fair value based method for all awards (12,511) (11,954) (48,275) (70,347)
-------------- ------------- -------------- ---------------
Net loss, adjusted $ (9,347) $ (21,199) $ (65,791) $ (104,863)
============== ============= ============== ===============
Basic and diluted net income (loss) per share, as reported $ 0.02 $ (0.05) $ (0.10) $ (0.20)
============== ============= ============== ===============
Basic and diluted net income (loss) per share, adjusted $ (0.05) $ (0.12) $ (0.38) $ (0.62)
============== ============= ============== ===============
Recently issued accounting standards. In May 2003, the Financial Accounting
Standards Board (FASB) issued Statement No. 150 (SFAS No. 150), "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equities". SFAS No. 150 requires certain financial instruments that were
accounted for as equity under previous guidance to now be accounted for as a
liability. SFAS No. 150 applies to mandatorily redeemable stock and certain
financial instruments that require or may require settlement by transferring
cash or other assets. SFAS No. 150 is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The Company
has not issued any financial instruments that fall under the scope of SFAS No.
150. The Company adopted SFAS No. 150 in the third quarter of 2003. The adoption
of this Statement has had no material impact on PMC's results of operations and
financial position.
8
In April 2003, SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," was issued. In general, this statement
amends and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133. The Company adopted SFAS No. 149 on July 1, 2003. The
adoption of SFAS No. 149 did not have a material impact on the Company's
consolidated financial position or disclosures.
In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No.13, and Technical Corrections" was issued,
rescinding SFAS 4, which required gains and losses from extinguishment of debt
to be aggregated and, if material, classified as an extraordinary item, net of
the related income tax effect. The Company adopted SFAS 145 as of the beginning
of fiscal 2003. Compliance with this standard resulted in the classification of
the $1.7 million gain on extinguishment of debt in income from continuing
operations in the consolidated statement of operations.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities", an Interpretation of ARB No. 51. FIN 46 requires
certain variable interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after December 15, 2003 however, earlier adoption is permitted. PMC
adopted FIN 46 in the third quarter of 2003. Adoption of this standard did not
have a material effect on the Company's results of operations, financial
condition or disclosures.
NOTE 2. Derivatives Instruments and Hedging Activities
PMC generates revenues in U.S. dollars but incurs certain operating expenses in
various foreign currencies, primarily the Canadian dollar. To minimize the
short-term impact of foreign currency fluctuations, the Company uses currency
forward contracts.
Currency forward contracts that are used to hedge exposures to variability in
forecasted foreign currency cash flows are designated as cash flow hedges. The
maturities of these instruments are less than twelve months. For these
derivatives, the gain or loss from the effective portion of the hedge is
initially reported as a component of other comprehensive income in stockholders'
equity and subsequently reclassified to earnings in the same period in which the
hedged transaction affects earnings. The gain or loss from the ineffective
portion of the hedge is recognized in interest and other expense immediately.
9
Currency forward contracts that are used to offset the currency risk of
non-U.S.-dollar denominated firm commitments are designated as fair value
hedges. Changes in the fair value of underlying firm commitments are generally
offset by changes in fair value of the related derivative designated as a hedge,
with the resulting net gain or loss, if any, recorded in interest and other
expense.
At September 28, 2003, the Company had two currency forward contracts
outstanding that qualified and were designated as cash flow hedges. The U.S.
dollar notional amount of these two contracts was $26.9 million and the
contracts had a fair value of $0.8 million as of September 28, 2003. No portion
of the hedging instrument's gain was excluded from the assessment of
effectiveness and the ineffective portions of hedges had an insignificant impact
on earnings.
NOTE 3. Restructuring and Other Costs
In response to the severe economic downturn in the semiconductor industry in
2001, PMC implemented two restructuring plans aimed at focusing development
efforts on key projects and reducing operating costs. By the first quarter of
2003, the Company was still operating in a challenging economic climate, making
it necessary to again streamline operations and announce a further
restructuring. PMC's assessment of market demand for its products and the
development efforts necessary to meet this demand were key factors in its
decisions to implement these restructuring plans. Because end markets for the
Company's products had contracted to such a great degree, certain projects were
curtailed in an effort to cut costs. Cost reductions in all other functional
areas were also implemented, as fewer resources were required to support the
reduced level of development and sales activities during this period.
PMC has completed substantially all of the activities contemplated in the
original restructuring plans, but has not yet disposed of all its surplus leased
facilities as of September 28, 2003.
Restructuring - March 26, 2001
PMC had completed the restructuring activities contemplated in its March 2001
restructuring plan by June 2002. However, the Company still has ongoing rental
commitments for office space abandoned under this plan. Due to the continued
downturn in real estate markets, the Company expects these costs to be higher
than anticipated in the original plan. As a result, PMC recorded an additional
provision for abandoned office facilities of $3.1 million in the third quarter
of 2003. Payments made in connection with these leases in the three months ended
September 28, 2003 were $0.2 million.
Restructuring
Additional Liability at
(in thousands) Charges Cash Payments September 28, 2003
- --------------------------------------------------------------------------------
Excess facility costs $ 3,082 $ (213) $ 2,869
================================================================================
Restructuring - October 18, 2001
PMC implemented a restructuring plan in the fourth quarter of 2001 to reduce its
operating cost structure. This restructuring plan included the termination of
341 employees, the consolidation of excess facilities, and the curtailment of
certain research and development projects. As a result, the Company recorded a
restructuring charge of $175.3 million in the fourth quarter of 2001.
10
Activity in the restructuring reserve during the nine-month period ended
September 28, 2003 was as follows:
Restructuring Restructuring
Liability at Cash Liability at
(in thousands) December 31, 2002 Payments Reversals September 28, 2003
- --------------------------------------------------------------------------------------------------------
Facility lease and
contract settlement costs $ 129,499 $ (116,287) $ (4,500) $ 8,712
===========================================================================
On July 7, 2003, PMC terminated its remaining rental commitment for Mission
Towers Two, located in Santa Clara, CA, by purchasing the facility for $133
million and then immediately reselling it for $33 million. PMC incurred fees of
approximately $1 million on these transactions. Upon completion of the sale of
Mission Towers Two, PMC reversed $4.5 million of excess restructure provision.
The remainder of cash payments made in 2003 and the remaining accrual at
September 28, 2003 related to other facilities abandoned in the October 2001
restructuring.
Restructuring - January 16, 2003
As a result of the prolonged economic downturn in the semiconductor industry,
the Company implemented another corporate restructuring aimed at further
reducing operating expenses in the first quarter of 2003. The restructuring
included the termination of approximately 175 employees and the closure of
design centers in Maryland, Ireland and India. To date, PMC has recorded a
restructuring charge of $14.2 million in accordance with SFAS 146, "Accounting
for Costs Associated with Exit or Disposal Activities". These charges related to
workforce reduction, lease and contract settlement costs and the write-down of
certain property, equipment and software assets whose value was impaired as a
result of this restructuring plan.
Activity in this restructuring reserve during the nine-month period ended
September 28, 2003 was as follows:
Restructuring
Total Charge Additional Non-cash Cash Liability at
(in thousands) January 16, 2003 Charges Charges Payments September 28, 2003
- -----------------------------------------------------------------------------------------------------------------------------
Workforce reduction $ 6,384 $ 812 - $ (5,845) $ 1,351
Excess facility and contract
settlement costs 260 4,184 - (3,150) 1,294
Obligations related to closure
of development sites - 1,099 - (51) 1,048
Asset write-downs - 1,491 (1,491) - -
- ----------------------------------------------------------------------------------------------------------------------------
Total $ 6,644 $ 7,586 $ (1,491) $ (9,046) $ 3,693
=====================================================================================
The Company recorded $0.3 million of restructuring charges under this plan in
the third fiscal quarter. To date, the Company has made cash payments of $9.0
million under this plan.
NOTE 4. Debt Investments
11
The following tables summarize the Company's investments in debt securities:
Sep 28, Dec 29,
(in thousands) 2003 2002
- -----------------------------------------------------------------------------
Held to maturity:
US Government Agency notes $ - $ 92,039
Corporate bonds and notes - 303,169
--------------------------------
- 395,208
Available-for-sale:
US Government Treasury and Agency notes 61,078 94,512
Corporate bonds and notes 137,545 -
- -----------------------------------------------------------------------------
$ 198,623 $ 489,720
================================
Reported as:
Short-term investments $ 144,550 $ 340,826
Investments in bonds and notes 54,073 148,894
- -----------------------------------------------------------------------------
$ 198,623 $ 489,720
================================
During the third fiscal quarter, PMC sold $29.9 million of its long-term
held-to-maturity debt investments and recorded a loss on sale of $0.2 million.
The proceeds of this sale were used to fund the partial repurchase of PMC's
convertible subordinated notes during the quarter. As a result of this sale, the
Company reclassified its remaining portfolio of held-to-maturity debt
investments as available-for-sale and recorded an unrealized gain of $1.6
million in other comprehensive income.
NOTE 5. Convertible Subordinated Notes
In August 2001, we issued $275 million of convertible subordinated notes
maturing on August 15, 2006. These notes bear interest at 3.75% payable
semi-annually and are convertible into an aggregate of approximately 6.5 million
shares of PMC's common stock at any time prior to maturity at a conversion price
of approximately $42.43 per share. We may redeem the notes at any time after
August 19, 2004. In addition, a holder may require us to repurchase the notes if
a change of control, as defined in the indenture, occurs. These notes also
become payable upon events of bankruptcy, insolvency or reorganization, or if we
fail to pay amounts due on the notes or any other indebtedness of at least $40
million, or we fail to perform various procedural covenants detailed in the
indenture. Under the terms of the indenture relating to our convertible
subordinated notes, we may not merge into another entity, permit another entity
to merge into us, sell substantially all of our assets to another entity, or
purchase substantially all of the assets of another entity, unless the entity
formed by the merger, sale or purchase is a company, partnership or trust formed
in the United States, and the surviving entity assumes our obligations under the
indenture, including the payment of principal and interest on the notes and, no
event of default has occurred and is continuing.
During the third fiscal quarter of 2003, the Company repurchased $100 million
principal amount of these notes for $96.7 million and wrote off $1.6 million of
related unamortized debt issue costs, resulting in a net gain of $1.7 million.
12
NOTE 6. Segment Information
The Company has two operating segments: networking and non-networking products.
The networking segment consists of semiconductor devices and related technical
service and support to equipment manufacturers for use in service provider,
enterprise, and storage area networking equipment. The non-networking segment
consists of a single custom user interface product. The Company is supporting
the non-networking products for existing customers, 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 contained in the Company's Annual
Report on Form 10-K. The Company evaluates performance based on net revenues and
gross profits from operations of the two segments.
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
Sep 28, Sep 29, Sep 28, Sep 29,
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------- -----------------------------
Net revenues
Networking $ 63,100 $ 59,358 $ 178,096 $ 160,095
Non-networking - 226 768 5,442
- ------------------------------------------------- -------------- --------------
Total $ 63,100 $ 59,584 $ 178,864 $ 165,537
============================= ============== ==============
Gross profit
Networking $ 41,232 $ 36,259 $ 113,481 $ 98,662
Non-networking - 96 329 2,329
- ------------------------------------------------- -------------- --------------
Total $ 41,232 $ 36,355 $ 113,810 $ 100,991
============================= ============== ==============
NOTE 7. Comprehensive Income (Loss)
The components of comprehensive income (loss), net of tax, are as follows:
Three Months Ended Nine Months Ended
---------------------------- ------------------------------
Sep 28, Sep 29, Sep 28, Sep 29,
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------- ------------------------------
Net income (loss) $ 3,164 $ (9,245) $ (17,516) $ (34,516)
Other comprehensive income (loss):
Change in net unrealized gains
(losses) on investments 1,584 (1,954) (2,287) (24,398)
Change in fair value of derivatives 710 - 710 -
- ------------------------------------------------------------------- ------------------------------
Total $ 5,458 $ (11,199) $ (19,093) $ (58,914)
============================ ============= ==============
NOTE 8. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income
loss per share:
13
Three Months Ended Nine Months Ended
----------------------------------- -----------------------------------
Sep 28, Sep 29, Sep 28, Sep 29,
(in thousands, except per share amounts) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------- -----------------------------------
Numerator:
Net income (loss) $ 3,164 $ (9,245) $ (17,516) $ (34,516)
=================================== ================ ================
Denominator:
Basic weighted average common shares outstanding (1) 174,118 170,525 172,603 169,945
Effect of dilutive securities:
Stock options 12,019 - - -
---------------- ----------------- ---------------- ----------------
Diluted weighted average common shares outstanding (1) 186,137 170,525 172,603 169,945
=================================== ================ ================
Basic net income (loss) per share $ 0.02 $ (0.05) $ (0.10) $ (0.20)
=================================== ================ ================
Diluted net income (loss) per share $ 0.02 $ (0.05) $ (0.10) $ (0.20)
=================================== ================ ================
The Company had 2.6 million common stock equivalents outstanding at September
29, 2002 that were not included in diluted net loss per share because they would
be antidilutive.
(1) PMC-Sierra, Ltd. special shares are included in the calculation of basic
weighted average common shares outstanding.
NOTE 9. Voluntary Stock Option Exchange Offer
In August 2002, the Company offered to eligible stock option holders an
opportunity to voluntarily exchange certain stock options outstanding under the
Company's equity-based incentive plans. Under the program, participants were
able to tender for cancellation stock options granted within a specified period
with exercise prices at or above $8.00 per share, in exchange for new options to
be granted at least six months and one day after the cancellation of the
tendered options. Pursuant to the terms and conditions set forth in the
Company's offer, each eligible participant received new options to purchase an
equivalent number of PMC shares for each tendered option with an exercise price
of less than $60.00. For each tendered option with an exercise price of $60.00
or more, each eligible participant received a new option to purchase a number of
PMC shares equal to one share for each four unexercised shares subject to the
tendered option.
On September 26, 2002, the Company cancelled options to purchase approximately
19.3 million shares of common stock with a weighted average exercise price of
$35.98. In exchange for these stock options and pursuant to the terms and
conditions set forth in the Company's offer, the Company granted options to
purchase approximately 16.6 million shares of common stock on March 31, 2003
with an exercise price of $5.95, which was the closing price of the Company's
stock on the grant date.
NOTE 10. Subsequent Event
Subsequent to September 28, 2003, the Company sold a property it held in
Burnaby, Canada, for total proceeds of approximately $15.3 million. The proceeds
consist of $ 12.7 million cash and a $ 2.6 million vendor take-back mortgage.
The mortgage is non-interest bearing and is due on September 30, 2008. The
Company recognized a nominal net gain on sale of this property. At September 28,
2003, this property was classified as property held for sale in accordance with
SFAS 144.
14
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report contains 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", "becoming", "transitioning" and similar
expressions to identify such forward-looking statements.
These forward-looking statements apply only as of the date of this Quarterly
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. Our actual results could differ materially from those
anticipated in these forward-looking statements for many reasons, including the
risks we face as described under "Factors That You Should Consider Before
Investing in PMC-Sierra" and elsewhere in this Quarterly Report. Investors 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, our business outlook,
revenues, capital resources sufficiency, capital expenditures, restructuring
activities, and expenses.
Results of Operations
Third Quarters of 2003 and 2002
Net Revenues ($000,000)
Third Quarter
--------------------------
2003 2002 Change
Networking products $ 63.1 $ 59.4 6%
Non-networking products - 0.2 ( 100%)
--------------------------
Total net revenues $ 63.1 $ 59.6 6%
==========================
Net revenues for the third quarter of 2003 were $63.1 million compared to $59.6
for the third quarter of 2003.
Networking revenues increased $3.7 million, 6% over the third quarter of 2002
due to increased unit demand, primarily in storage and enterprise equipment
markets.
Non-networking revenues declined to zero in the third quarter of 2003 from $0.2
million in the same period a year ago. Our non-networking product is a single
medical chip near end of life and we have not developed any new products of this
type.
15
Gross Profit ($000,000)
Third Quarter
--------------------------
2003 2002 Change
Networking products $ 41.2 $ 36.3 14%
Non-networking products 0.1 ( 100%)
--------------------------
Total gross profit $ 41.2 $ 36.4 13%
==========================
Percentage of net revenues 65% 61%
Total gross profit increased $4.8 million, or 13%, in the third quarter of 2003
compared to the same quarter a year ago.
Networking gross profit for the third quarter of 2003 increased by $4.9 million
from the third quarter of 2002 primarily due to increased unit sales and a
reduction in product material costs.
Networking gross profit as a percentage of networking revenues increased 4
percentage points, from 61% in the third quarter of 2002 to 65% in the third
quarter of 2003. This increase resulted from the following factors:
* product material costs decreased, improving gross profit by 7
percentage points;
* fixed manufacturing costs were allocated over a higher volume of
shipments, improving gross profit by approximately 2 percentage points;
* a greater portion of our sales were from higher volume but lower margin
applications, reducing networking gross profit by approximately 3
percentage points; and
* the average selling price of our high volume products decreased,
reducing gross profit by 2 percentage points.
Operating Expenses and Charges ($000,000)
Third Quarter
--------------------------
2003 2002 Change
Research and development $ 27.8 $ 34.0 ( 18%)
Percentage of net revenues 44% 57%
Marketing, general and administrative $ 12.0 $ 16.0 ( 25%)
Percentage of net revenues 19% 27%
Amortization of deferred stock compensation:
Research and development $ - $ 0.5
Marketing, general and administrative 0.3 -
--------------------------
$ 0.3 $ 0.5
--------------------------
Percentage of net revenues 0% 1%
Restructuring costs $ (1.1) $ - 100%
16
Research and Development and Marketing, General and Administrative Expenses:
Our research and development, or R&D, expenses were $6.2 million, or 18%, lower
in the third quarter of 2003 compared to the same quarter a year ago due to the
restructuring program implemented in the first quarter of 2003 and ongoing cost
reduction initiatives. Headcount reductions resulting from the first quarter
restructuring program and attrition have decreased our R&D personnel and related
costs by $1.9 million. Of the $4.3 million decrease in other R&D expenses since
the third quarter of 2002, $2.1 million related to reduced depreciation expense
as more property and equipment became fully depreciated and was not replaced.
Additionally, costs incurred for product development materials were $1.4 million
lower in the third quarter of 2003 than the same period a year ago. This
fluctuation in costs is due, in part, to the timing of purchases of prototype
wafers and masks used in the development of new products.
Our marketing, general and administrative, or MG&A, expenses decreased by $4.0
million, or 25%, in the third quarter of 2003 compared to the same quarter a
year ago. Reductions in headcount due to our first quarter restructuring program
resulted in a decrease of personnel-related costs of $1.2 million. The $2.8
million decrease in Other MG&A expenses was primarily attributable to reduced
sales commissions and legal expenses.
Amortization of Deferred Stock Compensation
The non-cash charge for amortization of deferred stock compensation in the third
quarter of 2003 was $0.3 million compared to $0.5 million in the third quarter
of 2002.
Restructuring
In response to the severe economic downturn in the semiconductor industry in
2001, we implemented two restructuring plans aimed at focusing development
efforts on key projects and reducing operating costs. By the first quarter of
2003, we were still operating in a challenging economic climate, making it
necessary for us to again streamline operations and announce a further
restructuring. Our assessment of market demand for our products and the
development efforts necessary to meet this demand were key factors in our
decisions to implement these restructuring plans. Because end markets for our
products had contracted to such a great degree, certain projects were curtailed
in an effort to cut costs. Cost reductions in all other functional areas were
also implemented, as fewer resources were required to support the reduced level
of development and sales activities during this period.
We have completed substantially all of the activities contemplated in the
original restructuring plans, but have not yet disposed of all our surplus
leased facilities as of September 28, 2003.
During the third quarter of 2003, we recorded an additional $3.1 million for
costs relating to facilities abandoned in our March 2001 restructuring plan. The
continued downturn in real estate markets has resulted in higher expected costs
than anticipated in the original plan. Payments made in connection with these
leases in the third quarter were $0.2 million. We expect to make cash payments
of $0.3 million related to these facilities in the fourth quarter of 2003.
Efforts to exit these sites are ongoing, however, the payments related to these
facilities could extend to 2010.
17
On July 7, 2003, we terminated our remaining rental commitment for Mission
Towers Two, located in Santa Clara, CA, by purchasing the facility for $133
million and then immediately reselling it for $33 million. We incurred fees of
approximately $1 million on these transactions. Upon completion of the sale of
Mission Towers Two, we reversed $4.5 million of excess restructure provision. We
have completed the restructuring activities contemplated in the October 2001
plan, but have not yet disposed of all of its surplus leased facilities as of
September 28, 2003. The remainder of cash payments made in 2003 related to other
facilities abandoned in the October 2001 restructuring. We expect to make cash
payments of $0.6 million related to this restructuring in the fourth quarter of
2003. We continue our efforts to exit the remaining sites, however, payments
relating to these facilities could extend to 2009.
In the first quarter of fiscal 2003, we implemented a corporate restructuring to
further reduce operating expenses. The restructuring plan included the
termination of approximately 175 employees and the closure of four product
development centers in Maryland, Ireland and India. We recorded a charge of $0.3
million in the third quarter of 2003. We have substantially completed activities
contemplated in this plan and do not expect to record further related
restructuring charges. We made cash payments of $1.0 million in the third
quarter of 2003 and expect to make cash payments of approximately $0.6 million
in the fourth quarter. We continue our efforts to exit the remaining sites,
however, payments relating to these facilities could extend to 2006. As a result
of this restructuring, we expect to save approximately $21 million of annual
operating costs.
Interest and other income (expense), net
Net interest and other expense was $0.3 million in the third quarter of 2003
compared to income of $1.4 million in the third quarter of 2002. We incurred net
interest expense in the current quarter due to declining cash balances as well
as declining reinvestment yields on our maturing longer term investments.
Gain on extinguishment of debt
In the third quarter of 2003, we repurchased $100 million face value of our
convertible subordinated notes for $96.7 million and wrote off $1.6 million of
related unamortized debt issue costs, resulting in a net gain of $1.7 million.
Gain (loss) on investments
In the third quarter of 2003, we sold debt investments totaling $29.9 million
resulting in a loss of $0.2 million. The proceeds were used to fund a portion of
the repurchase of our convertible debt. These investments were previously
classified as held-to-maturity. As a result of these sales all debt investments
were reclassified as available for sale at the end of the third quarter. In the
same period a year ago, we recorded a $0.1 million gain on the sale of a portion
our investment in Sierra Wireless, Inc., a public company.
18
Provision for income taxes
We recorded a provision for income taxes of $0.3 million in the third quarter of
2003 relating to income generated in Canada.
First Nine Months of 2003 and 2002
Net Revenues ($000,000)
First Nine Months
---------------------------
2003 2002 Change
Networking products $ 178.1 $ 160.1 11%
Non-networking products 0.8 5.4 ( 86%)
---------------------------
Total net revenues $ 178.9 $ 165.5 8%
===========================
Net revenues increased by 8% in the first nine months of 2003 compared to the
same period a year ago.
Networking revenues increased 11% over the same period a year ago due to
increased unit demand. The increased unit demand resulted from improved demand,
particularly in Asia, for telecommunications equipment that incorporates our
networking equipment and a decrease in component supply chain inventories.
Non-networking revenues declined 86% in the first nine months of 2003 compared
to the first nine months of 2002. Our non-networking product is a single medical
chip near end of life and we have not developed any new products of this type.
Gross Profit($000,000)
First Nine Months
---------------------------
2003 2002 Change
Networking products $ 113.5 $ 98.7 15%
Non-networking products 0.3 2.3 ( 86%)
----------------------------
Total gross profit $ 113.8 $ 101.0 13%
============================
Percentage of net revenues 64% 61%
Total gross profit increased $12.8 million, or 13%, in the first nine months of
2003 compared to the same period a year ago.
Networking gross profit for the first nine months of 2003 increased by $14.8
million from the first nine months of 2002.
Networking gross profit as a percentage of networking revenues increased to 64%
from 62% a year ago. This increase resulted from the following factors:
* product material costs decreased, improving gross profit by 7
percentage points;
* fixed manufacturing costs were allocated over a higher volume of
shipments, improving gross profit by approximately 2 percentage points;
19
* a greater portion of our sales from higher volume but lower margin
applications, reducing networking gross profit by approximately 4
percentage points; and
* the average selling price of our high volume products decreased,
reducing gross profit by 3 percentage points.
Non-networking gross profit for the first nine months of 2003 decreased by $2.3
million from the first nine months of 2002 due to a reduction in sales volume.
Operating Expenses and Charges ($000,000)
First Nine Months
-----------------------
2003 2002 Change
Research and development $ 90.9 $ 104.6 ( 13%)
Percentage of net revenues 51% 63%
Marketing, general and administrative $ 36.8 $ 49.6 ( 26%)
Percentage of net revenues 21% 30%
Amortization of deferred stock compensation:
Research and development $ 0.3 $ 2.1
Marketing, general and administrative 0.4 0.2
-----------------------
Total $ 0.7 $ 2.3 ( 67%)
-----------------------
Percentage of net revenues 0% 1%
Restructuring costs $ 12.8 $ - 100%
Research and Development and Marketing, General and Administrative Expenses:
Our research and development, or R&D, expenses decreased by $13.7 million, or
13%, in the first nine months of 2003 compared to the same period a year ago due
to the restructuring and cost reduction programs implemented in 2001 and January
2003. As a result of these restructuring and cost reduction initiatives, we
reduced our R&D personnel and related costs by $4.4 million. Other R&D expenses
decreased by $9.3 million, which was attributable to a $5.5 million decrease in
depreciation due to property and equipment becoming fully depreciated and not
replaced and to a $2.8 million decrease in product development tools and
equipment as part of our cost reduction initiatives.
Our marketing, general and administrative, or MG&A, expenses decreased by $12.8
million, or 26%, in the first nine months of 2003 compared to the same period a
year ago. Of this decrease, $1.5 million was attributable to lower sales
commissions due to reduced use of external sales representatives and a reduction
in our internal sales force. The remainder was attributable to the restructuring
and cost reduction programs implemented in 2003 and 2001, which reduced our MG&A
personnel and related costs by $5.4 million and other MG&A expenses by $5.9
million compared to the first nine months of 2003. Included in the $5.9 million
reduction in other MG&A expenses were a $3.1 million decrease in corporate
communication and professional fees, $0.7 million decrease in depreciation due
to property and equipment becoming fully depreciated and not being replaced, and
$0.6 million reduction in facilities costs as a result of our restructuring
activities.
20
Amortization of Deferred Stock Compensation
We recorded a non-cash charge of $0.7 million for amortization of deferred stock
compensation in the first nine months of 2003 compared to a $2.3 million charge
in the same period a year ago. The decline is due to amortizing a continually
declining balance of deferred stock compensation, without entering transactions
that would have required us to record offsetting additions.
Restructuring
In response to the severe economic downturn in the semiconductor industry in
2001, we implemented two restructuring plans aimed at focusing development
efforts on key projects and reducing operating costs. By the first quarter of
2003, we were still operating in a challenging economic climate, making it
necessary for us to again streamline operations and announce a further
restructuring. Our assessment of market demand for our products and the
development efforts necessary to meet this demand were key factors in our
decisions to implement these restructuring plans. Because end markets for our
products had contracted to such a great degree, certain projects were curtailed
in an effort to cut costs. Cost reductions in all other functional areas were
also implemented, as fewer resources were required to support the reduced level
of development and sales activities during this period.
We have completed substantially all of the activities contemplated in the
original restructuring plans, but have not yet disposed of all its surplus
leased facilities as of September 28, 2003.
During the third quarter of 2003, we recorded an additional $3.1 million for
costs relating to facilities abandoned in our March 2001 restructuring plan. The
continued downturn in real estate markets have resulted in higher expected costs
than anticipated in the original plan. Payments made in connection with these
leases in the nine months ended September 28, 2003 were $1.3 million. Efforts to
exit these sites are ongoing, however, the payments related to these facilities
could extend to 2010.
During the first nine months of 2003, we paid out $116.4 million in connection
with our October 2001 restructuring activities. We paid net cash of $102 million
to terminate our rental commitment for Mission Towers Two, located in Santa
Clara, CA by purchasing and then immediately reselling the facility. Upon
settlement of the sale of Mission Towers Two, we reversed $4.5 million of
related excess restructure provision. We have completed the restructuring
activities contemplated in the October 2001 plan, but have not yet disposed of
all of its surplus leased facilities as of September 28, 2003. The remainder of
cash payments made in 2003 related to other facilities abandoned in the October
2001 restructuring. While we continue our efforts to exit the remaining sites,
payments relating to these facilities could extend to 2009.
In the first quarter of fiscal 2003, we implemented a corporate restructuring to
further reduce operating expenses. The restructuring plan included the
termination of approximately 175 employees and the closure of four product
development centers in Maryland, Ireland and India. To date, we have recorded
charges of $14.2 million in conjunction with this plan, including $7.2 million
for workforce reduction, $4.4 million for lease exit and contract settlement
costs, $1.5 million for asset write downs and $1.1 million to settle obligations
in connection with the closure of development sites. The restructuring
activities contemplated in this plan are substantially complete and we do not
expect to have further material charges with respect to this restructuring.
While we continue our efforts to exit the remaining sites, payments relating to
these facilities could extend to 2006. We made cash payments of $9.0 million in
the first nine months of 2003 in connection with this restructuring. As a result
of this restructuring, we expect to save approximately $21 million of annual
operating costs.
21
Interest and other income, net
Net interest and other income was $0.2 million in the first nine months of 2003
compared to $4.1 million in the same period a year ago. The decrease in interest
income resulted from declining cash and investment balances and declining
reinvestment yields on our maturing longer term investments.
Gain on extinguishment of debt
During the first nine months of 2003, we recorded a gain of $1.7 million from
the repurchase of $100 million face value of our convertible subordinated notes
for $96.7 million and wrote off $1.6 million of related unamortized debt issue
costs.
Net gain on investments
We had a net gain of $2.3 million from investments in the first nine months of
2003 compared to $3.1 million 2002. In 2003, we sold our remaining investment in
Sierra Wireless Inc., a public company, resulting in a gain of $6.0 million that
was partially offset by a $3.5 million charge for the impairment of a portion of
our investments in non-public companies. We also sold long-term debt investments
that resulted in a loss of $0.2 million. In the first nine months of 2002, we
realized a $3.1 million gain on the sale of a portion of our investment in
Sierra Wireless Inc. and another public company.
Provision for income taxes
We recorded a tax recovery of $5.7 million in the first nine months of 2003
relating to losses and tax credits generated in Canada, which will result in a
recovery of taxes paid in prior periods. We have provided a valuation allowance
on other deferred tax assets generated in the quarter because of uncertainty
regarding their realization.
Critical Accounting Estimates
General
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based upon our Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect our reported assets, liabilities, revenue
and expenses, and related disclosure of our contingent assets and liabilities.
Our significant accounting policies are outlined in Note 1 to the Consolidated
Financial Statements in our Annual Report on Form 10-K for the period ended
December 29, 2002, which also provides commentary on our most critical
accounting estimates. The following estimates were of note during the first nine
months of 2003.
22
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
for the affected facilities, and the timing and rate at which we might be able
to sublease or complete negotiations of a lease termination agreement for each
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.
During 2001, we recorded total charges of $155 million for the restructuring of
excess facilities as part of restructuring plans. After elimination of the lease
obligation related to Mission Towers Two during the third quarter, we performed
a review of our assumptions relating to the remaining lease commitments using
current market trends for the timing and rates to sublet or cancel the lease for
each of the remaining facilities. Based on this analysis we determined that an
additional charge of $3.1 million was required for facilities related to the
March 26, 2001 restructuring due to further deterioration in facilities leasing
markets, with the total estimate representing 66% of the estimated total future
operating costs and lease obligations for the effected sites. For the facilities
related to the October 18, 2001 restructuring we determined that we could lower
the estimate to meet lease termination costs by $4.5 million and made an
adjustment of that amount. The total remaining estimate represents 92% of the
estimated total future operating costs and lease obligations for the effected
sites.
In the first quarter of 2003, we announced a further restructuring of our
operations, which resulted in the closing of an additional four product
development sites. Our current estimate of costs for the closing of all four
sites represents just over 58% of the estimated total future operating costs and
lease obligations for the effected sites.
We believe our estimates of the obligations for the closing of sites remain
sufficient to cover anticipated settlement costs. However, our assumptions on
either the lease termination payments, operating costs until terminated, or the
amounts and timing of offsetting sublease revenues may turn out to be incorrect
and our actual cost may be materially different from our estimates. If our
actual costs exceed our estimates, we would incur additional expenses in future
periods.
Business Outlook
Forecasting our revenue outlook in the current economic climate remains
difficult. Many of our customers delay ordering of our products until the last
possible moment, and are still limiting their orders to the minimum required to
produce equipment to meet specific customer demand. Our quarterly revenues may
continue to vary considerably as our customers adjust to fluctuating demand for
products in their markets.
23
We anticipate that our fourth quarter 2003 revenues will increase by 8% to 11%
compared with the third quarter of 2003 resulting estimated revenues of $68
million to $70 million. Our estimate regarding fourth quarter revenues is based
on orders already shipped at the date of this report, order backlog scheduled
for shipment during the remainder of the quarter, and an estimate of new orders
we expect to receive and ship before the end of the quarter (turns orders). We
have estimated turns orders for the fourth quarter to be consistent with
previous quarters of fiscal 2003. As our customers still do not place orders for
delivery beyond our lead times, we are unable to estimate revenues beyond the
fourth quarter of 2003.
We expect aggregate spending on research and development (R&D) and marketing,
general and administrative (MG&A) expenses to remain at the same level in the
fourth quarter as the third quarter of 2003, as we have now implemented the
restructuring program announced on January 16, 2003. We anticipate recording
only non-material amounts related to the January 2003 restructuring in the
fourth quarter.
We expect our interest costs to exceed the interest income on our cash balances
by $0.2 million as the yields we earn on our cash, short-term investments and
long-term investments in bonds and notes continue to decline, while the interest
rate associated with our convertible subordinated debt, the largest component of
interest expense, is fixed.
Liquidity & Capital Resources
Our principal source of liquidity at September 28, 2003 was $405.2 million in
cash and investments, which included $351.1 million in cash and cash
equivalents, short-term investments and restricted cash and $54.1 million of
long-term investments in bonds and notes, which mature within the next 12 to 27
months.
In the first nine months of 2003, we used $99.5 million of cash for operating
activities. Changes in working capital accounts included:
o a $114.2 million reduction in accrued restructuring costs, primarily
due to the settlement of a long-term lease obligation at a Santa Clara,
CA. office facility;
o an $11.8 million decrease in accounts payable and accrued liabilities,
principally due to the settlement of $5.3 million of personnel related
costs such as the employee stock purchase plan, accrued payroll and
accrued vacation costs during third quarter of 2003, the payment of
$3.1 million of accrued interest on our convertible subordinated notes
in August 2003, and reduced operating expenses which has decreased our
trade accounts payable balance;
24
o a $6.7 million reduction in inventories, as we continued our efforts to
reduce our networking product inventories; and
o a $2.3 million decrease in deferred income, as PMC product shipments by
our major distributor exceeded PMC product shipments to our major
distributor.
In the first nine months of 2003 cash flows from our investment activities
included:
o the purchase of $167.1 million of long- and short-term debt
investments;
o cash proceeds of $459.5 million from the sale or maturities of short-
and long-term debt investments;
o cash proceeds of $8.4 million from the sale of the remainder of our
investment in Sierra Wireless Inc., a public company;
o cash proceeds of $15.2 million in wafer fabrication deposit refunds;
o an investment of $10.5 million for the purchases of property and
equipment; and
In the first nine months of 2003 cash flows from our financing activities
included:
o cash proceeds of $22.8 million from the issuance of common stock under
our equity-based compensation plans and
o $96.7 million used to repurchase $100 million face value of our
convertible subordinated notes.
As of September 28, 2003, we had cash commitments made up of the following:
(in thousands)
- ---------------------------------------------------------------------------------------------------------------------------------
After
Contractual Obligations Total 2003 2004 2005 2006 2007 2007
Operating Lease Obligations:
Minimum Rental Payments $ 62,783 $ 2,944 $ 11,075 $ 9,475 $ 7,941 $ 7,536 $ 23,812
Estimated Operating Cost Payments 25,328 1,091 4,103 3,881 3,211 2,905 10,137
Long Term Debt:
Principal Repayment 175,000 - - - 175,000 - -
Interest Payments 19,689 - 6,563 6,563 6,563 - -
Purchase Obligations 11,636 3,035 6,192 2,409 - - -
-----------------------------------------------------------------------------------
294,436 $ 7,070 $ 27,933 $ 22,328 $ 192,715 $ 10,441 $ 33,949
======================================================================
Venture Investment Commitments (see below) 21,119
-----------
Total Contractual Cash Obligations $ 315,555
===========
Subsequent to the end of the third quarter of 2003, we extended the lease
agreement for our facility in Burnaby, Canada. This will increase the total
commitments in the above table by $1.4 million, $2.2 million and $4.8 million
for the years 2006, 2007 and 2008 respectively. In addition we sold a property
held in Burnaby, Canada, for total proceeds of approximately $15.3 million. The
proceeds consist of $ 12.7 million cash and a $ 2.6 million vendor take-back
mortgage. The mortgage is non-interest bearing and is due on September 30, 2008.
In 1999 and 2000 we established passive investments, like many of our peers, in
four professionally managed venture funds as an opportunity to be kept abreast
of technological and market developments in the rapidly evolving market in which
we participate. From time to time these funds request additional capital. We
have committed to invest an additional $21.1 million into these funds, which may
be requested by the fund managers at any time over the next seven years.
We have a line of credit with a bank that allows us to borrow up to $5.3 million
provided we maintain eligible investments with the bank equal to the amount
drawn on the line of credit. At September 28, 2003 we had committed $2.5 million
under letters of credit as security for office leases.
We are committed to semi-annual interest payments of approximately $3.3 million
to holders of our convertible notes. These interest payments are due on February
15 and August 15 of each year, with the last payment of interest and $175
million in principal being due on August 15, 2006.
25
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 2003 and
2004.
While we believe our current sources of liquidity will satisfy our long-term
needs for capital, we operate in an industry that is subject to the rapid
technological and economic changes. In addition, we contemplate mergers and
acquisitions of other companies or assets as part of our business strategy.
Consequently in the future we may determine that our sources of liquidity are
insufficient and we may proceed with financing or other activities, which may
dilute your investment or impact our liquidity and operating results.
Recently issued accounting standards
In May 2003, the Financial Accounting Standards Board (FASB) issued Statement
No. 150 (SFAS No. 150), "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equities". SFAS No. 150 requires certain
financial instruments that were accounted for as equity under previous guidance
to now be accounted for as liability. SFAS No. 150 applies to mandatorily
redeemable stock and certain financial instruments that require or may require
settlement by transferring cash or other assets. SFAS No. 150 is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. We have not issued any financial instruments that fall under the scope
of SFAS No. 150. We adopted SFAS No. 150 in the third quarter of 2003. The
adoption of this Statement has not had a material impact on our results of
operations and financial position.
In April 2003, SFAS No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities," was issued. In general, this statement
amends and clarifies accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133. We adopted SFAS No. 149 on July 1, 2003. The adoption of
SFAS No.149 did not have material impact on our consolidated financial position
or disclosures.
In April 2002, SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No.13, and Technical Corrections" was issued,
rescinding SFAS 4, which required gains and losses from extinguishment of debt
to be aggregated and, if material, classified as an extraordinary item, net of
the related income tax effect. We adopted SFAS 145 as of the beginning of fiscal
2003. Compliance with this standard resulted in the classification of the $1.7
million gain on extinguishment of debt in income from continuing operations in
our consolidated statement of operations.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), "Consolidation
of Variable Interest Entities", an Interpretation of ARB No. 51. FIN 46 requires
certain variable interest entities to be consolidated by the primary beneficiary
of the entity if the equity investors in the entity do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN 46 is effective for all
new variable interest entities created or acquired after January 31, 2003. For
variable interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual period
beginning after December 15, 2003 however, earlier adoption is permitted. We
adopted FIN 46 in the third quarter of 2003. Adoption of this standard did not
have a material effect on our results of operations, financial condition or
disclosures.
26
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.
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 may decline as our customers face unpredictable and
volatile demand for their products.
While some of our customers have reported that demand for some of their products
has improved, demand may fluctuate from current levels depending on their
customers' specific needs. Several of our customers' clients carefully manage
their cash usage and expense levels, purchasing equipment which may generate a
financial return on a shorter time horizon. The equipment to which our
customers' clients shift may not incorporate, or may incorporate fewer, of our
products.
In response to the actual declines in networking equipment demand, many of our
customers and their contract manufacturers have undertaken initiatives to
significantly reduce expenditures and excess component inventories. 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 in future quarters if these conditions continue or worsen.
Our customers' actions have reduced our visibility of future revenue streams. As
most of our costs are fixed in the short term, a further reduction in demand for
our products may cause a decline in our gross and net margins.
While we believe that our customers and their contract manufacturers are
consuming a portion of their inventory of PMC products, we believe that our
revenues will continue to be affected by: variability in flat aggregate end
market demand trends for our customers' products which include our components as
well as seasonal variability in customer order patterns. We cannot accurately
predict when demand for our products will strengthen or how quickly our
customers will consume their inventories of our products.
27
We may fail to meet our demand forecasts if our customers cancel or
delay the purchase of our products.
Many of our customers have numerous product lines, numerous component
requirements for each product, sizeable and complex supplier structures, and
often engage contract manufacturers for additional manufacturing capacity. This
makes forecasting their production requirements difficult and can lead to an
inventory surplus of certain of their components.
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. Customers frequently request shipment
of our products at less than our normal lead times. We may be unable to deliver
products to customers when they require them if we incorrectly estimate future
demand, and this may lead to higher fluctuations in shipments of our products.
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. This may increase the
proportion of our 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 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
Hewlett Packard each accounted for more than 10% of our third quarter 2003
revenues. 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.
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.
28
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.
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.
Design wins do not translate into near-term revenues and the timing of revenues
from newly designed products is often uncertain.
We have announced a 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 do not generate revenues, as customer projects
are cancelled or are not adopted by their end customers. In the event a design
win generates revenue, the amount of revenue will vary greatly from one design
win to another. Most revenue-generating design wins take greater than two years
to generate meaningful revenue.
Our restructurings have curtailed our resources and may have insufficiently
addressed market conditions.
On January 16th, 2003, we implemented plans to restructure our operations
through a workforce reduction of approximately 175 employees and the shutdown of
four of our product development sites. We recorded a charge of $14.2 million in
the first nine months of 2003. While we expect to record only immaterial further
costs in the fourth quarter of 2003, actual costs may exceed our estimates.
We reduced the work force and consolidated or closed excess facilities in an
effort to bring our expenses into line with our reduced revenue expectations.
However, if revenues decline we may again incur net losses.
Restructuring plans require significant management resources to execute and we
may fail to achieve our targeted goals and our expected annualized savings. 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 we do not maintain a competitive portfolio of
products.
29
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 enterprise storage semiconductors 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:
As our customers design next generation systems and select the chips
for those new systems, our competitors have an 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.
We are facing additional competition from companies who have excess capacity and
who are able to offer our OEM customers similar products to ours. Excess
capacity, in tandem with the significant decrease in demand for OEM equipment,
has created downward pricing pressure on our products.
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
semiconductor markets that we target. These companies include Agere Systems,
Applied Micro Circuits Corporation, Broadcom, Conexant Systems, Exar
Corporation, Marvell Technology Group, Multilink Technology Corporation, Silicon
Image, 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 Agilent, Altera, Cypress Semiconductor, Intel, IBM, Infineon,
Integrated Device Technology, Maxim Integrated Products, Motorola, Nortel
Networks, Texas Instruments, and Xilinx. 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.
30
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.
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 evolving industry standards
and customer specifications, which may prevent or delay future
revenues.
We sell products to a market whose characteristics include evolving industry
standards, product obsolescence, and new manufacturing and design technologies.
Many of the standards and protocols for our products are based on 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.
Our strategy includes broadening our business into the Enterprise, Storage and
Consumer markets. We may not be successful in achieving significant sales in
these new markets.
The Enterprise, Storage and Consumer markets are already serviced by incumbent
suppliers who have established relationships with customers. We may be
unsuccessful in displacing these suppliers, or having our products designed into
products for different market needs. In order to compete against incumbents, we
may need to lower our prices to win new business, which could lower our gross
margin. We may incur increased research, development and sales costs to address
these new markets.
If foreign exchange rates fluctuate significantly, our profitability may
decline.
31
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. The US dollar has and may continue to devalue
compared to the Canadian dollar. To protect against reductions in value and the
volatility of future cash flows caused by changes in foreign exchange rates, we
enter into foreign currency forward contracts. The contracts reduce, but do not
always entirely eliminate, the impact of foreign currency exchange rate
movements. In addition, this foreign currency risk management policy may not be
effective in addressing long-term fluctuations since our contracts do not extend
beyond a 12-month maturity.
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.
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.
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.
32
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 bankruptcy
proceedings or breach their debt covenants, our significant accounts receivables
with these companies could be jeopardized.
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, and 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.
We may be unsuccessful in transitioning the design of our new products to new
manufacturing processes.
Many of our new products are designed to take advantage of new manufacturing
processes offering smaller manufacturing geometries as they become available, as
the smaller geometry products can provide a product with improved features such
as lower power requirements, more functionality and lower cost. We believe that
the transition of our products to smaller geometries is critical for us to
remain competitive. We could experience difficulties in migrating to future
geometries or manufacturing processes, which would result in the delay of the
production of our products. Our products may become obsolete during these
delays, or allow competitors' parts to be chosen by customers during the design
process.
Our business strategy contemplates acquisition of other companies or
technologies, which could adversely affect our operating performance.
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.
33
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.
We are passive investors in funds that in turn invest in early-stage private
technology companies to gain access to emerging technologies. These companies
possess unproven technologies and our investments may or may not yield positive
returns. We currently have commitments to invest $21.1 million in such funds. In
addition to consuming significant amounts of cash, these investments are risky
because the technologies that these companies are developing may not reach
commercialization. We may record an impairment charge to our operating results
should we determine that these funds have incurred a non-temporary decline in
value.
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. 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. 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.
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. Our customers are frequently requesting
shipment of our products earlier than our normal lead times. 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.
34
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
in Asia 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.
Severe acute respiratory syndrome, or SARS, may disrupt our wafer fabrication or
assembly manufacturers located in Asia which could adversely impact our ability
to ship orders, reducing our revenues in that quarter
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.
35
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. Although we have neither received any material claims
relating to the infringement of patents or other intellectual property rights
owned by third parties nor are we aware of any such potential claims, we, and
our customers or suppliers, may be accused of infringing on patents or other
intellectual property rights owned by third parties in the future. 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.
36
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 debt level as a result of the sale of
convertible subordinated notes.
We currently owe $175 million in convertible subordinated notes. Our debt 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.
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.
37
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.
We adopted a stockholder rights plan in 2001, pursuant to which we declared a
dividend of one share purchase right for each outstanding share of common stock.
If certain events occur, including if an investor tenders for or acquires more
than 15% of our outstanding common stock, stockholders (other than the acquirer)
may exercise their rights and receive $650 worth of our common stock in exchange
for $325 per right, or we may, at our option, issue one share of common stock in
exchange for each right, or we may redeem the rights for $0.001 per right.
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Item 3. 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 bonds and notes. Our investments are made in
accordance with an investment policy approved by our Board of Directors.
Maturities of these instruments are less than 30 months 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 available-for-sale and
they are held at fair market value.
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate and credit rating 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. In addition, the value of all types of
securities may be impaired if bond rating agencies decrease the credit ratings
of the entities which issue those securities. 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 or a decrease in credit ratings.
We do not use derivative financial instruments to reduce or eliminate our
exposure to changes in interest rates or credit ratings.
Based on a sensitivity analysis performed on the financial instruments held at
September 28, 2003, 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 $0.8 million, $1.4 million and $2.1 million respectively.
Other Investments:
Our other investments also include numerous strategic investments in privately
held companies or venture funds that are carried on our balance sheet at cost,
net of write-downs for non-temporary declines in market value. 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. 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 impaired.
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Foreign Currency
Our sales and corresponding receivables are made primarily in United States
dollars. We generate a significant portion of our revenues from sales to
customers located outside 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.
Through our operations in Canada and elsewhere outside the United States, we
incur research and development, customer support costs and administrative
expenses in Canadian and other foreign 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
our operating results stemming from our exposure to these risks. As part of this
risk management, we enter into foreign exchange forward contracts on behalf of
our foreign subsidiaries. These forward contracts offset the impact of U.S.
dollar currency fluctuations on forecasted cash flows or firm commitments. We
limit the forward contracts operational period to 12 months or less and we do
not enter into foreign exchange forward contracts for trading purposes. Because
we do not engage in foreign exchange risk management techniques beyond these
periods, our cost structure is subject to long-term changes in foreign exchange
rates.
At September 28, 2003, the Company had two currency forward contracts
outstanding that qualified and were designated as cash flow hedges. The U.S.
dollar notional amount of these two contracts was $26.9 million and the contract
had a fair value of $0.8 million as of September 28, 2003. A 10% shift in
foreign exchange rates would not have materially impacted our other income
because our foreign currency net asset position was immaterial.
Item 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Our chief executive officer and our chief financial officer evaluated our
"disclosure controls and procedures" (as defined in Rule 13a-14(c) of the
Securities Exchange Act of 1934 (the "Exchange Act") as of of the end of the
period covered by this quarterly report. They concluded that as of the
evaluation date, our disclosure controls and procedures are effective to provide
reasonable assurance that information we are required to disclose in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission rules and forms.
Changes in internal controls
There was no change in our internal control over financial reporting that
occurred during the period covered by this quarterly report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
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Part II - OTHER INFORMATION
Item 5. Other Information
Stock Option Plans
Our equity-based compensation program is a broad-based, long-term retention
program intended to attract, motivate, and retain talented employees as well as
align stockholder and employee interests. We currently grant stock options from
two plans: 1994 Incentive Stock Plan and 2001 Stock Option Plan. The majority of
options granted under these plans generally vest over four years and have a
maximum term of ten years.
The following table summarizes the activity under all of our stock option plans
for the first nine months of 2003:
Number of Weighted Average
Shares Available Options Exercise Price
(in thousands, except per share amounts) for Options Outstanding Per Share
- ----------------------------------------------------------------------------------------------------
Balance at December 31, 2002 30,857 11,145 $ 9.51
Additional shares reserved (1) 18,372 - -
Granted (2) (17,594) 17,594 $ 6.02
Exercised - (2,921) $ 5.21
Cancelled and available for regrant 1,614 (1,614) $ 12.07
- ----------------------------------------------------------------------------------------------------
Balance at September 28, 2003 33,248 24,204 $ 7.38
=========================================================
(1) On January 1, 2003, 8.4 million shares were automatically
authorized for issuance under the "evergreen" provisions in the
1994 Incentive Stock Plan. On June 9, 2003, 10 million additional
shares were authorized for issuance under the company's 2001
Stock Option Plan.
(2) On September 26, 2002, we cancelled options to purchase
approximately 19.3 million shares of common stock with a weighted
average exercise price of $35.98. In exchange for these stock
options and pursuant to the terms and conditions set forth in our
Voluntary Stock Option Exchange Offer, we granted options to
purchase approximately 16.6 million shares of common stock on
March 31, 2003 with an exercise price of $5.95, which was the
closing price of our stock on the grant date. In the first 9
months of 2003, we also granted options to purchase approximately
1 million shares primarily to new employees.
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits -
o 11.1 Calculation of income (loss) per share (1)
o 10.1 Sixth Amendment to Building Lease Agreement between
PMC-Sierra, Ltd. and Production Court Property Holdings
Inc.
o 10.2 Agreement for Purchase and Sale of Real Property between
WHTS Freedom Circle Partners II, L.L.C. and PMC-Sierra,
Inc.
o 10.3 Agreement for Purchase and Sale of Real Property between
PMC-Sierra, Inc. and WB Mission Towers, L.L.C.
o 31.1 Certification of Chief Executive Officer pursuant to
Section 302 (a) of the Sarbanes-Oxley Act of 2002
o 31.2 Certification of Chief Financial Officer pursuant to
Section 302 (a) of the Sarbanes-Oxley Act of 2002
o 32.1 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Chief Executive Officer)
o 32.2 Certification Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (Chief Financial Officer)
(b) Reports on Form 8-K -
- On October 16, 2003, we furnished a Current Report on Form 8-K
to announce our third quarter results.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PMC-SIERRA, INC.
(Registrant)
Date: November 7, 2003 /s/ Alan F. Krock
---------------- ---------------------------------
Alan F. Krock
Vice President, Finance
Chief Financial Officer and
Principal Accounting Officer
- --------
(1) Refer to Note 8 of the financial statements included in Item I of Part I of
this Quarterly Report.
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