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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 27, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from: to
Commission File Number 0-19084
PMC-Sierra, Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-2925073
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation)
105-8555 BAXTER PLACE
BURNABY, BRITISH COLUMBIA, V5A 4V7
CANADA
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (604) 415-6000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes __X__ No _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant, based upon the closing sale price of the Common Stock on February
28, 1999, as reported by the Nasdaq National Market, was approximately
$1,592,084,000. Shares of Common Stock held by each executive officer and
director and by each person who owns 5% or more of the outstanding voting stock
have been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
As of February 28, 1999, the Registrant had 31,669,103 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Proxy Statement for Registrant's 1999
Annual Meeting of Stockholders are incorporated by
reference in Items 10, 11, 12 and 13 Part III of this
Form 10-K Report.
PART I
ITEM 1. Business.
GENERAL
- -------
In this Annual Report, when we refer to "PMC-Sierra", "PMC", "the Company",
"us", "our" or "we", we include PMC-Sierra, Inc. and all our subsidiary
companies.
We design, develop, market and support high-performance semiconductor networking
solutions. Our products are used in the high speed transmission and networking
systems which are being used to restructure the global telecommunications and
data communications infrastructure.
We provide components for equipment based on Asynchronous Transfer Mode ("ATM"),
Synchronized Optical Network ("SONET"), Synchronized Digital Hierarchy ("SDH"),
T1/E1/J1 and T3/E3/J2 access transmission and ethernet protocols. Our networking
products adhere to international standards and are sold on the merchant market
to over 100 customers either directly or through our worldwide distribution
channels.
In May of 1998, we expanded our portfolio of ATM layer and switching products by
acquiring Integrated Telecom Technology Inc. ("IGT") in exchange for
approximately $55 million in cash and PMC common stock and options to buy PMC
common stock. IGT was a fabless semiconductor company that had its headquarters
in Gaithersburg, MD and a development site in San Jose, CA. IGT made
segmentation-and-reassembly and ATM switching chipsets for wide area network
applications as well as ATM and other telecommunication chips.
In August 1996, we announced our decision to exit the personal computer modem
chipset business, to restructure our other non-networking business and focus on
networking semiconductors. By the end of 1997, we had changed our name from
Sierra Semiconductor to PMC-Sierra, disposed the remainder of our modem products
and completed all other material aspects of the restructuring. Our remaining
non-networking products are still being sold but we are not planning new
development or follow-on products.
PMC-Sierra was incorporated in the State of California in 1983 and
reincorporated in the State of Delaware in 1997. Our principal executive office
is located at 105-8555 Baxter Place, Burnaby, B.C., Canada V5A 4V7. Our Common
Stock trades on the Nasdaq National Market under the symbol "PMCS."
INDUSTRY BACKGROUND
- -------------------
The primary drivers of internetworking demand enabling PMC-Sierra's
semiconductor business are the emergence of the Internet, the upgrade of
corporate data networks and remote access. The common element to each of these
drivers is the high bandwidth demand for data. Whereas legacy telecom networks
were optimized for voice (circuit) processing, the newest network deployments
are being optimized for data transfer and packet processing.
The Internet and its increased usage by corporate and residential customers is
putting a tremendous strain on the public wide area network ("WAN")
telecommunications infrastructure. At the beginning of the decade, these Plain
Old Telephone Networks ("POTS") handled primarily voice traffic while the small
amount of data traffic which existed (from applications such as faxes, etc) was
supported by the readily capacity-available voice circuits. However, throughout
the decade, data traffic grew more quickly than voice traffic, eventually
exceeding voice traffic levels.
Thus, existing POTS circuits are no longer adequate in supporting the volume of
data traffic emerging from residential, customer premise and enterprise
networks. In fact, new data-optimized packet networks based on the Internet
Protocol ("IP") are being deployed specifically for the high volume data traffic
while supporting the relatively low volume voice applications (Voice-over-IP).
The Internet is creating the demand for more bandwidth for the network.
Statistics indicate that Internet IP data traffic is doubling every 100 days and
that overall IP traffic increases by over an order of magnitude every year. This
traffic must set-up and tear down Internet sessions several hundred times per
hour. Legacy telecom networks designed to set-up and tear down voice sessions
lasting 10 minutes or longer are inadequate to handle multiple Internet sessions
as short as a `point-and-click'.
The best ways to add bandwidth for the network include increasing the density of
the bandwidth pipes and utilizing traffic management and congestion control
techniques to make more effective use of the existing bandwidth pipes. Both
trends are occurring simultaneously as the global networking infrastructure
moves toward an equipment overhaul.
In 1998 there was more than 100 thousand miles of unused fiber bandwidth pipes
deployed by carriers such as Williams, Level 3, UUNET and IXC. This deployment
provides more capacity in the core of the WAN as well as for new Metropolitan
Area Network ("MAN") rings. An emerging trend called Wavelength Division
Multiplexing ("WDM") also increases capacity by providing for various 2.4
Gigabit and 10 Gigabit bandwidth color channels within a single optical fiber
strand.
Multi-service carriers seek to provide Service Level Agreements ("SLAs") to
their customers based on a certain guarantee of bandwidth for data/voice
transport or Internet access. These SLAs are very lucrative revenue drivers for
the carriers as the most critical traffic requirements can be guaranteed at a
high premium. Quality of Service ("QoS") traffic management techniques make SLAs
possible for the carriers. Protocols such as ATM have developed the capability
for providing QoS standard guarantees and, as such, these protocols are favored
by traditional service provider carriers. Protocols such as IP have less
developed QoS characteristics. The current lack of world-class QoS standards has
been one of the chief inhibitors to ubiquitous implementation of IP across the
emerging global network.
The following specific trends are important to PMC-Sierra's internetworking
semiconductor businesses:
o For LAN corporate data networks, existing unmanaged 10 megabit Ethernet
hubs are being upgraded to 10/100 megabit Ethernet workgroup switches with
advanced management features. These are, in turn, uplinked into advanced
Enterprise switches that can run combinations of 100 megabit and gigabit
Ethernet traffic. An emerging trend is the ability to provide Layer 3
switching protocol in firmware and hardware so as to increase performance
of Enterprise data switching and routing.
o Internet Service Providers (ISPs) utilize multi-platform Point-of-Presence
equipment to concentrate 64 kilobit DS0, n*64 kilobit fractional T1, 1.5
megabit T1, 2.0 megabit E1 and 45 megabit T3 into larger pipes. Typically
these are SONET/SDH pipes of 155 megabit or larger which form the MAN and
WAN core backbones of the new public network. The High-speed Data Link
Control ("HDLC") protocol is essential in connecting lower speed data/voice
Frame Relay streams into the WAN.
o For Remote Access data and voice networks, legacy Frame Relay networks are
being upgraded to aggregate increased densities of dial- and dedicated-
line traffic as well as to differentiate between specific traffic protocol
types such as ATM, Frame Relay and IP. These new applications are referred
to as Any-Service-Any-Port ("ASAP").
o For data, voice and video traffic which seek to define effective QoS
guarantees and traffic control predictability, ATM networks are being
created which can scale from low-rate 1.5 megabits to terabit-rates and
beyond. ATM networks adhere to standards created by the ATM Forum such as
TM4.1 that provide a complete range of network services from direct
connections and guaranteed CBR (Constant Bit Rate) bandwidth for a single
protocol to lower priority ABR (Available Bit Rate) traffic classes across
multiple protocols. ATM networks are being used increasingly in edge and
core switching and transmission systems that seek to provide QoS to users
on a per-connection basis.
o The current Internet infrastructure is dominated by router entry into WAN
backbone fiber pipes. Certain IP traffic requires maximum transmission
bandwidth over a point-to-point connection and is willing to trade-off QoS
and other management processing. For these applications, mapping IP traffic
directly into SONET/SDH frames is far more effective because it uses
valuable transmission bandwidth for extraneous management processing.
IP-Over-SONET/SDH ("POS") is used in fast Ethernet and gigabit Ethernet
switches as an uplink to MAN/WAN core fiber backbone rings, high-speed
terabit routers and remote access concentrators to map IP, Ethernet, Frame
Relay or other packet traffic directly into SONET/SDH pipes without
segmentation into fixed-length sizes.
o For residential Internet opportunities, the current 56 kilobit analog modem
is viewed by many consumers as inefficient. Emerging Digital Subscriber
Line ("DSL") technology enables up to several megabits of bandwidth for
Internet access while utilizing traditional copper `local loop' telephone
wiring. New DSL access multiplexer ("DSLAM") equipment is becoming
available which will take advantage of ATM Layer 2 switching and traffic
management to aggregate residential Internet data traffic into the WAN.
o Wireless voice and data opportunities are being generated by the deployment
of Base Transceiver Stations which convert waves of radio frequency air
traffic into wirelined backhaul pipes to Base Station Controllers which
provide aggregation, switching and processing intelligence. These backhaul
pipes operate at primarily 1.5 megabit T1 and 2.0 megabit E1 rates. HDLC
and ATM protocols are important for this equipment as they provide the
interface and processing for the aggregated T1 and E1 pipes.
NETWORKING PRODUCTS
- -------------------
We provide networking semiconductor devices and related technical service and
support to equipment manufacturers for use in their communications and
networking equipment. The Company's objective is to develop networking
semiconductors that enable network systems vendors to get to market quickly with
high performance, cost effective and scalable systems.
We provide networking semiconductor solutions that are used in key networking
and communications equipment. Our product offerings can be grouped into four
general areas: ATM, SONET/SDH [including Packet-over-SONET/SDH ("POS")], Remote
Access and Ethernet switching. These products are generally used in networking
equipment as follows:
Networking Equipment ATM SONET/SDH ACCESS ETHERNET
Wide Area Network (WAN)
Remote Access Equipment
Frame Relay Access Devices X
Access Multiplexers/DSLAMs* X X
Wireless Basestations X X
Voice Switches X X X
Digital Loop Carriers X X
Frame Relay Switches X X
Internet Access Concentrators X X
Transmission and Switching Equipment
WAN Edge Switches X X X X
Routers X X X X
WAN Core Switches X X X
Digital Cross - Connects X X X
Add-Drop Multiplexers X X X
Terminal Multiplexers X X X
Local Area Network (LAN)
Switches/Routers X X X
Network Interface Cards X
* DSLAM = Digital Subscriber Line Access Multiplexer
The following is a summary of some of our more significant products currently
available. The purpose of this table is only to provide a general understanding
of where our products fit. Our chips may not perform all the functions related
to a specific layer of the networking hierarchy. For example, we have a number
of single port OC-3 ATM physical layer products which perform different
functions within the first layer of the networking hierarchy and are generally
used in different applications. In addition, our ATM switching chipsets (refer
to the QRT and QSE below) and our Ethernet EXACT products primarily provide
layer 2 functionality, but have some limited layer 3 capabilities.
Product Description Voltage Clock Rates Networking Hierarchy
- ----------------- -------------------------------------- ------- ----------------------------------------- -------------------------
T1 E1 T3 E3 J2 OC3 OC12 >OC12 Layer 1 Layer 2 Layer 3
ATM
S/UNI-MPH Quad T1/E1 ATM Interface 5v x x x
S/UNI-PDH T1/E1/T3/E3 + ATM 5v x x x x x
S/UNI-155 1-port PHY 5v x x
S/UNI-155-LITE 1-port PHY + analog CRU/CSU 5v x x
S/UNI-PLUS enhanced 1-port PHY + analog CRU/CSU 5v x x
S/UNI-155-DUAL 2-port PHY + analog CRU/CSU 5v x x
S/UNI-QUAD 4-port PHY + analog CRU/CSU 3.3v x x
S/UNI-155-ULTRA 1-port PHY + UTP-5 + analog CRU/CSU 5v x x
S/UNI 622 1-port PHY 5v x x x
S/UNI-622 MAX 1-port PHY + analog CRU/CSU 3.3v x x
RCMP-800 Routing Control, Monitoring & Policing 5v x x x
RCMP-200 Routing Control, Monitoring & Policing 5v x x
AAL1gatorII AAL1 SAR 3.3v x x x x x x
LASAR-155 ATM PHY & SAR 5v x x x
QRT Quad Routing Table 3.3v x x x x x x x x limited
QSE Quad Switching Element 3.3v x x x x x x x x limited
SONET/SDH and POS
TUPP VT/TU Payload Alignor/Processor 5v x x x
TUPP-PLUS TUPP + Performance Monitor 5v x x x
TUDX VT/TU X-Connect Switch 5v x x x
STXC Transport Overhead Terminator 5v x x
STTX Transport Overhead Terminator 5v x x
SPECTRA-155 Payload Extractor/Aligner 5v x x
SPTX Path Terminating Tranceiver 5v x x
S/UNI TETRA 4-port ATM + POS PHY + analog CRU/CSU 3.3v x x
S/UNI-622-POS 1-port ATM + POS PHY + analog CRU/CSU 3.3v x x
Access
T1XC 1-port framer + analog 5v x x
COMET 1-port framer + long haul analog 3.3v x x x
E1XC 1-port framer + analog 5v x x
QDSX 4-port short haul analog LIU 5v x x x
TQUAD 4-port framer 5v x x
EQUAD 4-port framer 5v x x
TOCTL 8-port framer 3.3v x x
EOCTL 8-port framer 3.3v x x
S/UNI QJET 4-port framer or ATM UNI 3.3v x x x x x x
D3MX M13 Multiplexer/Demultiplexer 5v x x x
FREEDM-8 8 link, 128 channel HDLC Controller 3.3v x x x x x
FREEDM-32 32 link, 128 channel HDLC Controller 3.3v x x x x x
Ethernet
EXACT - PM3370 8x100 port controller 3.3v 100mb/s x limited
EXACT - PM3371 8x100 low cost port controller 3.3v 100mb/s x
EXACT - PM3380 1x1000 port controller 3.3v x x limited
EXACT - PM3390 8 to 16 port EXACT Switch Matrix 3.3v x x limited
EXACT - PM3391 6-port EXACT Bus Switch Matrix 3.3v x x
The S/UNI product line offers physical layer solutions in a range from 1.5
megabits to 622 megabits. We offer LAN, Edge and WAN core ATM switch chip sets.
We have been recognized by industry analysts as the market leader in ATM
physical layer solutions.
Our ATM physical layer products come in a variety of packages and provide the
interface to copper or fiber cabling along with framing and mapping functions.
Our line of RCMP/ATLAS ATM layer processors handle higher layer ATM protocols
such as policing, operations and management, fault and performance monitoring,
while our ATM Switch chips offer a routing table and switching element solution
capable of running at up to 10 gigabytes per second.
In 1998, we added two new ATM physical layer chips: the S/UNI-622-MAX, a single
channel 622 megabit per second device and the S/UNI-QUAD, a four channel 155
megabit per second device. Both offer integrated clock recovery and synthesis
and exceed the Bellcore GR-253 intrinsic transmit jitter and jitter tolerance
specification - a requirement for communications equipment developers. These
products may be used in ATM switches, routers, remote access concentrators and
up-links.
In 1998, PMC-Sierra worked closely with members of the SATURN development group
(a networking industry group we co-founded in 1992) to define and introduce a
specification for POS devices known as POS-PHY Level 2 and POS-PHY Level 3. We
introduced two POS devices in compliance with the new POS specifications: the
S/UNI-TETRA and the S/UNI-622-POS. The S/UNI-TETRA is the industry's first 155
megabit per second physical layer device to meet the POS-PHY Level 2 Interface
specification. The device is a four channel, dual-mode ATM cell processor and
POS frame processor. It is used in high-density OC-3c port card designs suitable
for multi-service ATM switches and Layer 3 routers.
The S/UNI-622-POS is a 622 megabit per second physical layer device that meets
the SATURN POS-PHY Level 3 Interface specification. The S/UNI-622-POS was
designed to allow enterprise and access equipment to support either
Packet-Over-SONET/SDH or ATM over SONET/SDH. POS is aimed at transporting
Internet traffic over the public network.
Our Remote Access products include T1/E1 framers, and high density Frame Relay
and HDLC controllers. Our devices are used in data communications applications
such as multi-service and digital subscriber line access multiplexers, frame
relay access devices, Internet Protocol routers, wireless base stations and
remote access concentrators. Our access products are also used for
telecommunications applications such as private branch exchanges, digital loop
carriers, Class 5 switches, digital access cross connect systems, add-drop
multiplexers and base transceiver stations.
In 1998, we introduced the COMET chip (COMbined E1,T1, J1 device). COMET
represents the fourth generation of our family of high-density framer and line
interface unit (LIU) telecom devices. A single COMET chip supports all three
global primary rate framing formats, T1, E1 and J1, and integrates a
shorthaul/longhaul analog LIU.
In 1998, we also introduced the EOCTL. The EOCTL is an eight-channel E1 framer.
E1 is the European/Asian equivalent of the T1 transmission technology. This low
power 3.3 volt device meets European standards and is pin-compatible to the
TOCTL product we introduced in 1997. The EOCTL can help increase card density
and reduce design time for our customers' Internet access equipment.
During 1998, we began sampling our EXACT chipset, which offers a variety of
ethernet switching configurations. We offer two 8-port 10/100 fast ethernet
single chip port controllers, a single port gigabit ethernet port controller,
and 6 and 8 port EXACT Bus Switch Matrices. All of our ethernet switching
chipsets offer layer 2 and some offer some layer 3 functionality. Gigabit
ethernet is a new product area for us. At the end of 1998, we were still
revising our products with the objective of having production worthy parts
available in the second quarter of 1999.
NON-NETWORKING PRODUCTS
- -----------------------
In the third quarter of 1996, we announced our decision to exit the modem
chipset business and discontinue development of our graphics, multimedia and
custom chipsets. We disposed of all modem-related inventories in 1997. Revenues
from other non-networking products declined rapidly in 1998. Due to the lack of
any follow-on products, these products are expected to experience a further
significant decline in 1999.
SALES, MARKETING AND DISTRIBUTION
- ---------------------------------
Our sales and marketing strategy is to achieve design wins by developing
superior products. We maintain close working relationships with our customers in
order to make products that address their needs. We provide technical support to
customers through field application engineers, technical marketing and factory
systems engineers. We believe that providing comprehensive product service and
support is critical to shortening customers' design cycles and maintaining a
competitive position in the networking market.
We sell our products directly, through distribution and through independent
manufacturers' representatives. Using these channels, Lucent Technologies
(including Ascend Communications) and Cisco Systems each represented greater
than 10% of our 1998 revenues. In 1998, the country purchasing the largest
percentage of our products outside of the US was Canada at 10%. Historically,
international sales accounted for the following percentages of our net revenues:
32% in 1998, 30% in 1997 and 46% in 1996. See "Factors You Should Consider
Before Investing In PMC-Sierra - `Our Customer Base is Concentrated' and `Our
Global Business Approach Subjects Us to Additional Risks'".
MANUFACTURING
- -------------
Independent foundries and chip assemblers manufacture all of our products. We
receive most of our wafers in finished form from Chartered Semiconductor
Manufacturing Ltd. ("Chartered"), and Taiwan Semiconductor Manufacturing
Corporation ("TSMC"). These independent foundries produce our networking
products at feature sizes down to 0.35 micron. We believe that by using
independent foundries to fabricate our wafers, we are better able to concentrate
our resources on designing and testing new products. In addition, we avoid much
of the capital cost associated with owning and operating a fabrication facility.
We have supply agreements with two independent foundries that supply
substantially all of the wafers for our products. We have made deposits to
secure access to wafer fabrication capacity under these agreements. At December
31, 1998 and 1997, we had $23.1 and $27.1 million, respectively, in deposits
with those foundries and we were in compliance with our foundry agreements.
There are no minimum unit volume requirements in these agreements. We are
obliged under one of the agreements to purchase a minimum percentage of our
total annual wafer requirements provided that the foundry is able to continue to
offer competitive technology, pricing, quality and delivery. The agreements may
be terminated if either party does not comply with the terms.
Wafers supplied by outside foundries must meet our incoming quality and test
standards. We conduct the majority of our test operations on advanced mixed
signal and digital test equipment in our Burnaby, British Columbia, Canada
facility. The remainder of our testing is performed predominantly by independent
Asian companies.
We face risks when we outsource the manufacture and assembly of our products.
See "Factors You Should Consider Before Investing in PMC-Sierra - We Must Have
Access to Wafer Fabrication and Other Manufacturing Capacity to Succeed."
RESEARCH AND DEVELOPMENT
- ------------------------
We undertake research and development to design new products, as we must
introduce new products to continue to grow. Our current efforts are targeted at
integrating multiple channels or functions on single chips, broadening the
number of products we provide to address varying protocols, and increasing the
speed at which our chips operate.
We have design centers in or near Vancouver (Canada), Portland (Oregon),
Gaithersburg (Maryland), San Jose (California), Montreal (Canada), and Saskatoon
(Canada).
As a result of our decision to exit from the modem chipset business and
restructure our non-networking operations, we discontinued research and
development on non-networking products.
We spent $34.3 million in 1998, $22.9 million in 1997, and $29.4 million in 1996
on research and development. We also expensed $39.2 million of in process
research and development, $37.8 million of which related to the acquisition of
IGT and $1.4 million of which related to the acquisition of other technology.
Similarly, in 1996 we expensed $7.8 million of in process research and
development related to our acquisition of certain assets of Bit, Inc. See
"Management, Discussion and Analysis of Financial Condition and Operating
Results - Other Costs and Expenses" and "Consolidated Financial Statements -
Note 2".
We may not successfully develop new products and our products may not achieve
market acceptance. See "Factors You Should Consider Before Investing In
PMC-Sierra - We Need to Successfully Develop and Introduce Our New Products to
Succeed".
BACKLOG
- -------
We sell primarily pursuant to standard short-term purchase orders. Our customers
frequently revise the quantity actually purchased and the shipment schedules to
reflect changes in their needs. As of December 31, 1998, our backlog of products
scheduled for shipment within six months totaled $56.3 million. As of December
31, 1997, our backlog of products scheduled for shipment within six months
totaled $36.3 million. Our customers may cancel a significant portion of the
backlog at their discretion without penalty. Accordingly, we believe that our
backlog at any given time is not a meaningful indicator of future revenues.
COMPETITION
- -----------
The markets for our products are intensely competitive and subject to rapid
technological change and price erosion.
We believe that our ability to compete successfully in these markets depends on:
o our product performance, quality and pricing;
o our, our competitors' and our customers' timing and success of new
product introductions;
o our ability to innovate;
o our ability to deliver working products on schedule;
o market acceptance of standards for which we have produced products;
o our ability to obtain adequate manufacturing capacity;
o our subcontractors' production efficiency;
o the rate at which our customers incorporate our products into their
designs; and
o our competitors' assertion of intellectual property rights.
We typically face competition at the design stage, where customers evaluate
alternative design approaches that require integrated circuits. Our competitors
have increasingly frequent opportunities to supplant our products in next
generation systems because of shortened product life and design-in cycles in
many of our customers' products.
Our competitors are major domestic and international semiconductor companies,
many of which have substantially greater financial and other resources than us.
Emerging companies also provide significant competition in our segment of the
semiconductor market. Our competitors include Advanced Micro Circuits
Corporation, Broadcom, Conexant Systems, Cypress Semiconductor, Dallas
Semiconductor, Galileo Technology, Intel Corporation, Integrated Device
Technology, Level One Communications, Lucent Technologies, Motorola, MMC
Networks, Siemens, Texas Instruments, Transwitch and Vitesse Semiconductor. Over
the next few years, we expect additional competitors, some of which also may
have greater financial and other resources, to enter the market with new
products.
LICENSES, PATENTS AND TRADEMARKS
- --------------------------------
We have granted Chartered Semiconductor a non-exclusive license to manufacture
and sell integrated circuits based on our designs and integrated circuits
designed by Chartered Semiconductor or its parent company. Chartered
Semiconductor also has a worldwide non-exclusive right to manufacture digital
integrated circuits for third parties, unless we designed the circuit or
previously supplied the circuit to the customer. Chartered Semiconductor has
also licensed its manufacturing technology to us for non-exclusive use outside
Singapore. The license agreement expires in November 1999. Upon termination of
the agreement, the licenses to use the technology continue, but obligations to
update licensed technology terminate.
We have several U.S. patents and a number of pending patent applications in the
U.S. and Europe. In addition to such factors as innovation, technological
expertise and experienced personnel, we believe that a strong patent position is
becoming increasingly important to compete effectively in the industry and we
have an active program to acquire additional patent protection.
We apply for mask work protection on our circuit designs. We attempt to protect
our software, trade secrets and other proprietary information by, among other
security measures, entering into proprietary information agreements with
employees. Although we intend to protect our rights vigorously, we cannot assure
that these measures will be successful. See "Factors You Should Consider Before
Investing In PMC-Sierra - Our Products Employ Proprietary Technology That We May
Not Be Able to Protect."
PMC and its logo are our registered trademarks and service marks. We own other
trademarks and service marks not appearing in this Form 10-K Annual Report.
Other trademarks used in this Form 10-K Annual Report are owned by other
entities.
EMPLOYEES
- ---------
As of December 31, 1998, the Company had 435 employees, including 255 in
research and development, 47 in production and quality assurance, 82 in
marketing and sales and 51 in administration. Our employees are not represented
by a collective bargaining agreement. We have never experienced any work
stoppage. We believe our employee relations are good.
ITEM 2. Properties.
Our executive offices and much of our test, sales and marketing, and design and
engineering operations are located in an approximately 100,000 square foot
leased facility in Burnaby, British Columbia, Canada. This facility is leased
through April 2006. The Company also leases offices for its staff in
Massachusetts, North Carolina, Illinois, Texas, Maryland, California, Ontario
(Canada), Quebec (Canada), Barbados, France, Germany and the United Kingdom.
PMC-Sierra (Maryland), Inc. leases approximately 23,000 square feet of office
space in Maryland and San Jose, while PMC-Sierra Inc. (Portland) leases
approximately 9,000 square feet of office space in Oregon. These facilities are
leased through June 2005, June 1999 and March 1999 respectively.
ITEM 3. Legal Proceedings.
In February 1999, a complaint naming PMC-Sierra, Inc. and a number of other
semiconductor companies was filed in United States District Court for the
District of Arizona (captioned Lemelson Medical, Education & Research
Foundation, Ltd. Partnership v Intel Corp. et al. Civ. 99-0377 PHX RGS) alleging
that each defendant manufactures or has had manufactured for it integrated
circuits using manufacturing processes that violate patents owned by plaintiff.
The litigation is in its initial stages, and the Company is not able to
reasonably estimate the potential losses, if any, that may be incurred in
relation to this litigation.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Stock Price Information. The Company's Common Stock trades on the Nasdaq
National Market under the symbol PMCS. The following table sets forth, for the
periods indicated, the high and low closing sale prices for the Company's Common
Stock as reported by the Nasdaq National Market:
1997 High Low
First Quarter.................................... $18.13 $13.88
Second Quarter................................... 26.38 13.88
Third Quarter.................................... 35.13 24.50
Fourth Quarter................................... 31.88 22.00
1998 High Low
First Quarter.................................... $39.06 $26.00
Second Quarter................................... 51.25 37.00
Third Quarter.................................... 47.75 26.63
Fourth Quarter................................... 65.63 22.88
To maintain consistency, the information provided above is based on calendar
quarters rather than fiscal quarters.
As of February 28, 1998, there were approximately 447 holders of record of the
Company's Common Stock.
The Company has never paid cash dividends on its Common Stock. The Company
currently intends to retain earnings, if any, for use in its business and does
not anticipate paying any cash dividends in the foreseeable future. The
Company's current bank credit agreement prohibits the payment of cash dividends.
ITEM 6. Selected Financial Data.
Summary Consolidated Financial Data
(in thousands, except for per share data)
Year Ended December 31,(1)
--------------------------------------------------------------------
STATEMENT OF OPERATIONS DATA: 1998 (2) 1997 (3) 1996 (4) 1995 (5)(7) 1994 (6)(7)
Net revenues $ 161,812 $ 127,166 $ 188,371 $ 188,724 $ 104,764
------------ ------------ ------------ ------------ ------------
Gross profit 123,592 94,101 93,423 91,614 46,960
Research and development 34,280 22,880 29,350 23,428 15,702
In process research and development (2), (4), (6) 39,176 - 7,783 - 12,748
Impairment of intangibles assets (2) 4,311 - - - -
Marketing, general and administrative 28,755 23,663 30,691 30,051 23,683
Purchase price adjustment - compensation - - - 10,624 -
Restructuring and other charges - (1,383) 64,670 - (1,559)
------------ ------------ ------------ ------------ ------------
Income (loss) from operations 17,070 48,941 (39,071) 27,511 (3,614)
============ ============ ============ ============ ============
Income (loss) from continuing operations (2,878) 34,258 (48,150) 23,976 (7,916)
Loss from discontinued operations - - - (22,497) (666)
------------ ------------ ------------ ------------ ------------
Net income (loss) $ (2,878) $ 34,258 $ (48,150) $ 1,479 $ (8,582)
============ ============ ============ ============ ============
Basic net income (loss) per share: (8)
from continuing operations $ (0.09) $ 1.10 $ (1.62) $ 0.89 $ (0.36)
from discontinued operations $ - $ - $ - $ (0.83) $ (0.03)
------------ ------------ ------------ ------------ ------------
Net income (loss) $ (0.09) $ 1.10 $ (1.62) $ 0.06 $ (0.39)
============ ============ ============ ============ ============
Diluted net income (loss) per share: (8)
from continuing operations $ (0.09) $ 1.05 $ (1.62) $ 0.84 $ (0.36)
from discontinued operations $ - $ - $ - $ (0.79) $ (0.03)
------------ ------------ ------------ ------------ ------------
Net income (loss) $ (0.09) $ 1.05 $ (1.62) $ 0.05 $ (0.39)
============ ============ ============ ============ ============
Shares used to calculate:
Basic net income (loss) per share 32,002 31,043 29,719 27,018 22,030
Diluted net income (loss) per share 32,002 32,642 29,719 28,620 22,030
As of December 31, (1)(2)
--------------------------------------------------------------------
BALANCE SHEET DATA: 1998 1997 1996 1995 1994
Cash, cash equivalents and short-term investments $ 84,836 $ 69,240 $ 42,062 $ 45,937 $ 15,830
Working capital 67,615 58,595 20,438 32,741 23,813
Total assets 197,298 149,378 129,914 184,860 85,959
Long term debt (including current portion) 10,132 13,744 24,637 12,718 9,069
Stockholders' equity 125,932 90,565 48,444 81,000 34,865
(1) The Company's fiscal year ends on the last Sunday of the calendar year.
December 31 has been used as the fiscal year end for ease of presentation.
See Note 1 to Consolidated Financial Statements.
(2) Results for the year ended December 31, 1998 include an in process research
and development charge of $39.2 million related primarily to the
acquisition of Integrated Telecom Technology and a charge for impairment
of intangible assets of $4.3 million.
See Note 2 to the consolidated financial statements.
(3) Results for the year ended December 31, 1997 include a recovery of $1.4
million from the reversal of the excess accrued restructure charge
resulting from the conclusion of the restructuring. See Note 9 to
Consolidated Financial Statements.
(4) Results for the year ended December 31, 1996 include a restructuring charge
of $69.4 million related to Company's exit from the modem chipset business
and the associated restructuring of its non-networking operations. $4.7
million of this charge was recorded in cost of sales as an inventory write
down, and $64.7 million was recorded as a restructuring cost in operating
expenses. See Note 9 to Consolidated Financial Statements. An in process
research and development charge of $7.8 million was recorded in the third
quarter for the acquisition of ethernet switching technology and other
assets from Bipolar Integrated Technology. Results of operations include
costs of continuing the development of ethernet switching products and
related activities from the date of the acquisition on September 3, 1996.
See Note 2 to Consolidated Financial Statements.
(5) Results for the year ended December 31, 1995 include the loss from
discontinued operations related to Prometheus Products, Inc. of $22.5
million, purchase price adjustment relating to the finalization of the
acquisition of the Company's Canadian networking product operations of
$10.6 million, and gain on sale of shares of SiTel Sierra B.V. of $6.7
million, which is not included in income from operations.
(6) Results for the year ended December 31, 1994 include the operations of the
networking business from the date of acquisition, September 2, 1994, and
include in process research and development of $12.7 million, settlement of
the class action lawsuit of $2.4 million, reversal of restructuring and
other charges of $1.6 million and a loss from discontinued operations of
Prometheus of $0.7 million, which is not included in loss from operations..
(7) For 1995, amounts related to Prometheus previously reported within net
revenues were $19.0 million; gross profit (loss) was ($0.1) million; and
net loss was ($4.6) million. For 1994, net revenues were $3.8 million;
gross profit was $0.3 million; and net loss was ($0.7) million. All
previously reported amounts have been included in "Loss from discontinued
operations". Net revenues, gross profit, research and development, and
marketing, general and administrative expenses have been restated to
exclude amounts relating to Prometheus Products, Inc. Balance sheet data
has been restated to exclude amounts relating to Prometheus.
(8) Share and per share information has been adjusted for the 2 for 1 stock
split effective October 5, 1995.
Quarterly Comparisons
The following tables set forth consolidated statements of operations for each of
the Company's last eight quarters and the percentage of the Company's net
revenues represented by each line item reflected in each consolidated statement
of operations. This quarterly information is unaudited and has been prepared on
the same basis as the annual consolidated financial statements. In management's
opinion, this quarterly information reflects all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the
information for the periods presented. The operating results for any quarter are
not necessarily indicative of results for any future period.
Quarterly Data (Unaudited)
(in thousands, except per share data)
Year Ended December 31, 1998 (1) Year Ended December 31, 1997 (2)
------------------------------------------ ------------------------------------------
Fourth Third Second First Fourth Third Second First
STATEMENT OF OPERATIONS DATA:
Net revenues $ 45,437 $ 42,105 $ 39,975 $ 34,295 $ 31,713 $ 27,815 $ 34,064 $ 33,574
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Gross profit 35,355 32,070 30,007 26,160 24,170 21,757 24,451 23,723
Research and development 10,705 9,739 7,820 6,016 6,395 5,136 5,309 6,040
In process research and development - - 39,176 - - - - -
Marketing, general and administrative 7,649 7,549 7,435 6,122 5,013 5,735 6,614 6,301
Impairment of intangible assets - 4,311 - - - - - -
Restructuring and other charges - - - - (1,383) - - -
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------
Income (loss) from operations 17,001 10,471 (24,424) 14,022 14,145 10,886 12,528 11,382
========== ========== ========== ========== ========== ========== ========== =========
Net income (loss) $ 11,381 $ 5,405 $(29,313) $ 9,649 $ 9,556 $ 7,291 $ 8,931 $ 8,480
========== ========== ========== ========== ========== ========== ========== =========
Basic net income (loss) per share $ 0.35 $ 0.17 $ (0.92) $ 0.31 $ 0.30 $ 0.23 $ 0.29 $ 0.28
Common shares outstanding (3) 32,460 32,193 31,829 31,524 31,334 31,146 30,918 30,774
Diluted net income (loss) per share $ 0.33 $ 0.16 $ (0.92) $ 0.29 $ 0.29 $ 0.22 $ 0.28 $ 0.27
Common shares outstanding assuming dilution 34,876 34,394 31,829 33,701 33,111 33,188 32,374 31,895
As a Percentage of Net Revenues (Unaudited)
Year Ended December 31, 1998 (1) Year Ended December 31, 1997 (2)
------------------------------------------ ------------------------------------------
Fourth Third Second First Fourth Third Second First
Net revenues 100% 100% 100% 100% 100% 100% 100% 100%
Gross profit 78% 76% 75% 76% 76% 78% 72% 71%
Research and development 24% 23% 20% 18% 20% 18% 16% 18%
In process research and development - - 98% - - - - -
Marketing, general and administrative 17% 18% 19% 18% 16% 21% 19% 19%
Impairment of intangible assets - 10% - - - - - -
Restructuring and other charges - - - - (4%) - - -
Income (loss) from operations 37% 25% (61%) 41% 45% 39% 37% 34%
Net income (loss) 25% 13% (73%) 28% 30% 26% 26% 25%
(1) Results for the year ended December 31, 1998 include an in process research
and development charge of $39.2 million related primarily to the
acquisition of Integrated Telecom Technology and a charge for impairment
of intangible assets of $4.3 million.
See Note 2 to the consolidated financial statements.
(2) Results for the year ended December 31, 1997 include a restructuring charge
recovery of $1.4 million from the reversal of the excess accrued
restructure charge from the conclusion of the restructuring in the fourth
quarter.
(3) PMC-Sierra, Ltd. Special Shares are included in the calculation of basic
net income (loss) per share.
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Description of Forward-looking Statements. This portion of this Annual Report
contains forward-looking statements relating to:
o revenues, o capital resources sufficiency; and
o gross margins, o market risk.
o expenditures on research and
development, selling and
administration;
Actual results may differ from those projected in the forward-looking statements
for a number of reasons, including those described in "Factors You Should
Consider Before Investing in PMC-Sierra." We present projected project revenue
estimates in the "In Process Research and Development" section of Item 7 of this
report. These estimates were made solely for the purposes of accounting for the
acquisition of Integrated Telecom Technology Inc. (see below) and should not be
construed as a projection of expected future performance of products resulting
from these projects.
General. We design, develop, market and support high-performance semiconductor
solutions for advanced telecommunications and data communications networking
markets. Our products are silicon based and are used in the broadband
communications infrastructure and high bandwidth networks. We supply ATM,
SONET/SDH, T1/E1, D3/E3 and ethernet semiconductors.
In the second quarter of 1998, we expanded our portfolio of ATM layer and
switching products by acquiring Integrated Telecom Technology Inc. ("IGT"). IGT
was a fabless semiconductor company headquartered in Gaithersburg, MD. IGT also
had a development site in San Jose, CA. IGT made ATM switching chipsets for wide
area network applications as well as ATM Segmentation-and-Reassembly and other
telecommunication chips.
The total consideration of $55.0 million paid to acquire IGT consisted of cash
paid to IGT shareholders of $17.8 million, cash paid to IGT creditors of $9.0
million, and the issuance of approximately 415,000 shares of common stock and
options to purchase approximately 214,000 shares of common stock.
The purchase price also included $850,000 in professional fees and other direct
acquisition costs. As part of the purchase, we acquired $0.5 million cash and
4.1 million of other tangible assets, and assumed IGT's current liabilities of
$3.1 million and interest-bearing capital lease obligations valued at $1.6
million (see note 2 of the Consolidated Financial Statements).
Subsequent to issuing our Quarterly Report on Form 10-Q for the period ended
June 28, 1998, the Securities and Exchange Commission ("SEC") released new
information to the market regarding acceptable methodologies for valuing in
process research and development ("IPR&D") in purchase transactions. In light of
this new information, we revalued certain identifiable assets acquired through
the IGT acquisition.
Our initial valuation of the IGT IPR&D was done using a methodology that focused
on the aggregate after-tax cash flows attributable to the purchased technology.
Using the SEC's guidelines, we subsequently considered the stage of completion
of individual projects and the risk associated with the stage of completion of
the technology. As a result of these additional considerations, we restated our
financial statements for the six month periods ended June 28, 1998 to reflect
the revaluation of assets acquired and to record the revised amounts for
intangible assets, goodwill, and IPR&D (See Note 2 to the Consolidated Financial
Statements).
We also restated our financial statements for the period ended September 27,
1998, to reflect the impairment of a portion of the restated intangible assets
recognized in connection with the IGT acquisition. During the third quarter, we
terminated development work on a project. We determined that the developed and
core technology related to this project was not technologically feasible and had
no alternative future use. As a result, we restated goodwill, core technology,
and related amortization from amounts initially reported and recorded an
impairment of intangible assets of $4.3 million.
In August 1996, we announced our decision to exit the personal computer modem
chipset business, restructure our other non-networking products and focus on our
networking products. In 1996, we recorded a charge of $69.4 million in
connection with this decision. We completed all material aspects of the
restructuring by the end of 1997. At that time, we recorded a recovery of $1.4
million from the reversal of the excess accrued restructure charge (See note 9
to Consolidated Financial Statements).
Also in 1996, we acquired ethernet switching assets, intellectual property and
certain other assets from Bipolar Integrated Technology ("BIT"). We acquired
these assets in exchange for 804,407 shares of common stock and other
consideration. The aggregate value of this transaction was approximately $8.1
million including the acquisition costs we incurred.
Results of Operations
Net Revenues ($000,000)
- -----------------------
1998 Change 1997 Change 1996
---- ------ ---- ------ ----
Networking products $ 139.5 63% $ 85.5 36% $ 62.8
Non-networking - other $ 22.3 (38%) $ 35.8 (46%) $ 66.6
Non-networking - modem - (100%) $ 5.9 (90%) $ 59.0
---------- ----------- ----------
Total net revenues $ 161.8 27% $ 127.2 (32%) $ 188.4
========== =========== ==========
Net revenues increased 27% in 1998 as the growth in networking product revenue
exceeded the reduction of revenues from non-networking products. Networking
product revenue grew 63% in 1998 and 36% in 1997 as a result of a strong market
for our customers' broadband equipment due to the growth of the Internet and
data communications in general, the move of many equipment manufacturers from
custom integrated circuits to application specific standard products and revenue
from products acquired in connection with the IGT acquisition.
Non-networking - other revenues, which include custom, graphic, and other
semiconductor revenues, declined 38% in 1998 compared to 1997 and declined 46%
in 1997 compared to 1996. This reflects our strategic decision to restructure
our other non-networking business and to focus on networking semiconductor
business. We are supporting non-networking products for existing customers, but
have decided not to develop any further products of this type. We expect the
non-networking revenues to continue to decline rapidly in 1999.
Consistent with our 1996 restructuring, we exited the modem chipset business and
sold all our modem chipset inventories in 1997. No future revenues are expected
from that business.
Gross Profit ($000,000)
- -----------------------
1998 Change 1997 Change 1996
---- ------ ---- ------ ----
Networking products $ 113.1 63% $ 69.5 48% $ 46.4
Percentage of networking revenues 81% 81% 74%
Non-networking products $ 10.5 (57%) $ 24.6 (46%) $ 47.0
Percentage of non-networking reveunes 47% 59% 37%
Total gross profit $ 123.6 31% $ 94.1 1% $ 93.4
Percentage of net revenues 76% 74% 50%
Total gross profit increased from 1997 to 1998 and from 1996 to 1997 because
increased sales of higher gross margin networking products offset a decline in
gross profit due to lower revenues from non-networking products. In addition,
lower wafer costs increased gross profit in 1997 relative to 1996.
Networking gross profit in 1998, as a percentage of revenues, was consistent
with 1997. The gross margins of these products were high relative to overall
gross margins in the semiconductor industry because our chips are highly complex
and are sold in relatively low volumes. In fact, in 1998, none of our networking
products accounted for more than 10% of networking revenue. We believe that, as
the market for our networking products grows and customers purchase in greater
volumes, gross profit as a percentage of revenues will decline.
We expect networking gross margins to decline if reductions in production costs
do not sufficiently offset decreases in average selling prices of existing
networking products, or increases in gross profit contributed by new higher
gross margin networking products do not sufficiently offset decreases in average
selling prices of existing networking products.
Non-networking gross profit decreased by 57% in 1998 compared to 1997.
Non-networking gross profit as a percentage of sales declined from 59% in 1997
to 47% in 1998. In 1999, we expect gross profit from non-networking products to
decrease in total dollars and as a percentage of sales. The continuation of
non-networking gross profit decline results from our decision to exit the modem
chipset business and restructure our other non-networking business.
Non-networking product gross profit was higher in 1997 than 1996 due to the
sales related to our modem chipset inventories. In 1996, our reserve for
write-down of the modem chipset inventory to market included both completion and
disposal costs. The higher amount of gross profit recognized during 1997
represents the reduction in the reserve for write-down to the extent necessary
to cover the relatively higher period expenses incurred relating to the disposal
effort. There was no overall operating profit from the sale of modem chipset
products in 1997.
Other Costs and Expenses ($000,000)
- -----------------------------------
1998 Change 1997 Change 1996
---- ------ ---- ------ ----
Research and development $ 34.3 50% $ 22.9 (22%) $ 29.4
Percentage of net revenues 21% 18% 16%
Marketing, general & administrative $ 28.8 22% $ 23.7 (23%) $ 30.7
Percentage of net revenues 18% 19% 16%
In process research & development acquired $ 39.2 - - - $ 7.8
Percentage of net revenues 24% - 4%
Impairment of intangible assets $ 4.3 - - - -
Percentage of net revenues 3% - -
Restructure and other costs - - $ (1.4) - $ 64.7
Percentage of net revenues - (1%) 34%
Research and Development and Marketing, General and Administrative Expenses.
- ----------------------------------------------------------------------------
In 1998, research and development ("R&D") expenses increased by 50% overall, to
21% of total revenue. Substantially all R&D activity carried out in 1998 related
to networking products.
Our increased R&D spending is a response to the array of opportunities presented
by the growth of the Internet, data networking and the convergence of voice and
data communications. We incur R&D expenditures in order to attain technological
leadership from a multi-year perspective. This has caused R&D spending to
fluctuate from quarter to quarter. We expect such fluctuations, particularly
when measured as a percentage of net revenues, to occur in the future, primarily
due to the timing of expenditures and changes in the level of net revenues. In
the future, we expect R&D expenses to increase and relate entirely to networking
products.
R&D expenditures decreased in 1997 compared to 1996 because we discontinued work
on non-networking products. This was partially offset by an increase in spending
on networking products. For all periods presented, R&D expenditures as a
percentage of net revenue were higher for networking products than for
non-networking products.
In 1998, we increased total marketing, general and administrative expenses but
decreased the expenses as a percentage of total revenue. From a short term
perspective, many marketing, general and administrative expenses are fixed.
Therefore, during periods of rising revenues, these expenses decline as a
percentage of revenues. The opposite holds true in periods of declining
revenues. We expect marketing, general and administrative costs to increase
during 1999 and beyond.
Marketing, general and administrative expenses declined in 1997 primarily due to
the reduction in expenses and personnel resulting from the 1996 restructuring of
the non-networking operations. The increase in these expenses as a percentage of
net sales reflects increased spending on networking products and a decline in
total net revenues.
In Process Research and Development ("IPR&D").
- ----------------------------------------------
IPR&D expenses of $39.2 million include $37.8 million related to the acquisition
of IGT and $1.4 million related to the acquisition of technology which had not
reached technological feasibility and had no alternative future use.
In our allocation of the IGT acquisition purchase price to IPR&D, we considered
the following for each in process project at the time of the acquisition:
(1) the present value of forecasted cash flows and income that were
expected to result from the projects;
(2) the status of projects;
(3) completion costs;
(4) project risks;
(5) the value of core technology; and
(6) the stage of completion of the individual project.
In valuing the core technology, we ensured that the relative allocations to core
technology and IPR&D were consistent with the relative contributions of each. In
the determination of the value of IPR&D, we ensured that the value of IPR&D only
considered efforts completed as of the date IGT was acquired.
The amount allocated to IPR&D of $37.8 million was expensed upon acquisition, as
it was determined that the underlying projects had not reached technological
feasibility, had no alternative future use and successful development was
uncertain.
As of the acquisition date, IGT had three development projects in process. In
order to develop these projects into commercially viable products, we had to
complete all planning, designing and testing activities necessary to establish
that the products could be produced to meet their design requirements.
The calculations of value assigned to the IPR&D reflect the efforts of IGT prior
to the close of the acquisition. The estimated completion percentage, estimated
technology life and projected introduction date of the three development
projects as of the acquisition date were as follows:
Percent Technology Introduction
Project Completed Life Date
Project A 78% 5 years 1999
Project B 83% 5 years 1999
Project C 65% 6 years 1998
Project A relates to the development of an ATM switching system. Projects B and
C relate to the segmentation and reassembly ("SAR") of data in an ATM network.
A brief description of the valuation of each in process project is set forth
below:
Revenue
- -------
We used discounted cash flow analysis on the anticipated income stream of
related product sales to compute the value of each acquired in process
technology. We determined the value assigned to purchased in process technology
by estimating the costs to develop the purchased in process technology into
commercially viable products, estimating the resulting net cash flows from the
projects and discounting the net cash flows to their present value. We based the
revenue projection on estimates of relevant market sizes and growth factors,
expected trends in technology and the nature and expected timing of our and our
competitors' new product introductions. These estimates were made solely for the
purposes of accounting for the IgT acquisition and should not be construed as a
projection of expected future performance of products resulting from these
projects.
We estimated that these in process projects would begin generating revenue in
1999. We estimated that revenues would generate revenue for 5 to 6 years and
then decline sharply as we expect that other new products and technologies would
enter the market.
Cost to Complete
- ----------------
We estimated that total research and development costs to complete the three
projects would amount to $1.4 million over a twelve-month period.
Expenses
- --------
We included selling, general and administrative expenses and research and
development expenses in our operating expense estimates. We based these
estimates on historical results and anticipated cost savings. Due to general
economies of scale, improved infrastructure, and greater management breadth, we
expected operating expense as a percentage of revenues to decrease after the
acquisition.
We estimated cost of sales, expressed as a percentage of revenue, for the
developed and in process technologies to be 29% increasing to 33% for all three
projects.
We estimated selling, general and administrative expenses, expressed as a
percentage of revenue for the developed and in process technologies, would be
14% in 1999 and would decrease to 10% by 2003.
Research and development expenses consist of the costs associated with
activities undertaken to develop new versions and to correct errors or to keep
products updated with current information. We estimated R&D expense would be 15%
of revenues in 1999 and would decline to 7% of revenues by 2003.
We used an effective income tax rate of 40% throughout the valuation period. The
40% reflects our estimated combined federal and state statutory income tax rate,
exclusive of nonrecurring charges, and our estimated future income tax provision
rate.
In valuing the IPR&D, we used the following discount rates:
Project A 28%
Project B 28%
Project C 29%
We considered the weighted average cost of capital when selecting an appropriate
discount rate. To determine this, we used a capital asset pricing model and
reviewed venture capital rates of return. The discount rate we used for the in
process technology was higher than our weighted average cost of capital due to
the risk of realizing cash flows from products that had yet to reach
technological feasibility as of the valuation date.
Allocation of Value
- -------------------
We allocated the fair market values of the assets acquired from IGT as follows:
Asset Fair Market Value
Intellectual Property:
In Process Research and Development
Project A $ 17,032
Project B 14,155
Project C 6,570
---------
$ 37,757
=========
Developed and Core Technology $ 7,830
Assembled Workforce $ 1,053
Goodwill $ 9,284
Comparison to Actual Results
- ----------------------------
We believed that the assumptions we used in the valuation of the acquired
intangible IGT assets were reasonable at the time of the acquisition. However,
we had no assurance that the underlying assumptions used to estimate expected
project sales, development costs or profitability, or the events associated with
such projects, would transpire as estimated.
Project A development was completed, and prototypes were in production, on the
date we filed this Annual Report. We completed development of Project B in the
fourth quarter of 1998. We were in full production as of the date we filed this
Annual Report. This was consistent with our initial estimates used in the
valuation of the project. We terminated development on Project C during the
third quarter (see `Impairment of Intangible Assets') of 1998.
If Project A does not reach full production, or if the products from Project A
or B are not accepted by the market, then there will be a loss of the expected
return inherent in the fair value allocation and the associated intangible
assets would be impaired. This may require us to shorten the time period over
which the related assets would be amortized, which may impact our operating
results materially and adversely.
IPR&D incurred in 1996 relate to the acquisition of the ethernet switching and
other assets from BIT (see Note 2 to the Consolidated Financial Statements).
Impairment of Intangible Assets.
- --------------------------------
During the third quarter of 1998, we abandoned a development project. We
determined that a portion of the restated intangible assets recognized in
connection with the IGT acquisition was impaired.
The terminated project related to ongoing development of a SAR chip used to
convert data packets to asynchronous transfer mode data cells (refer to Project
C in "In Process Research and Development" above). The few customers who were
using a predecessor chip were notified of the termination of all future
development of this technology. The technology was specialized and has no
alternative future use.
Restructure and Other Costs.
- ----------------------------
In 1996, we recorded a charge of $69.4 million in connection with our decision
to exit from the modem chipset business and restructure other non-networking
product operations. All material aspects of the restructuring were completed by
the end of 1997. At that time, we recorded a recovery of $1.4 million from the
reversal of the excess accrued restructure charge. (See Note 9 to Consolidated
Financial Statements).
Interest Income, Net ($000,000)
- -------------------------------
1998 Change 1997 Change 1996
---- ------ ---- ------ ----
Interest income, net $2.9 190% $1.0 54% $0.7
Percentage of net revenues 1.8% 0.8% 0.4%
Interest income increased in 1998, 1997 and 1996 due to higher cash balances
available to invest and earn interest. Interest expense decreased in 1998 due to
the retirement of debt associated with capital leases. This reduction was
partially offset by additional interest expense related to the assumption of
capital leases in our acquisition of IGT.
Provision for Income Taxes.
- ---------------------------
Our 1998 and 1997 income tax provision primarily reflects the provision for
income taxes for the Canadian subsidiary. Our U.S. taxes for 1998 and 1997 were
largely eliminated by tax losses realized from our 1996 restructuring charge.
The $39.2 million charge for IPR&D and the related $4.3 million impairment of
intangible assets taken in 1998 are non-deductible and will not result in any
future tax benefits.
The 1996 income tax rate reflects taxes on our foreign operations and the effect
of a non-deductible $7.8 million charge for the purchase of IPR&D relating to
the BIT acquisition. We used net operating losses and tax credit carry forwards
to reduce the 1996 U.S. tax provision. We did not recognize a tax benefit from
the 1996 restructure charge of $69.4 million because of the uncertainty of
future taxable income in the United States.
Recently issued accounting standards.
- -------------------------------------
In June 1998, the FASB issued Statement of Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities. We expect to adopt
the new Statement effective January 1, 2000. The Statement will require the
recognition of all derivatives on our consolidated balance sheet at fair value.
We anticipate that the adoption of this Statement will not have a significant
effect on our operating results or financial position.
Liquidity and Capital Resources.
- --------------------------------
Cash and cash equivalents and short term investments increased from $69.2
million at the end of 1997 to $84.8 million at the end of 1998. During 1998,
operating activities provided $59.3 million in cash. The net loss of $2.9
million in 1998 includes non-cash charges of $14.2 million in depreciation and
amortization, a $39.2 million charge for in process research and development and
a $4.3 million charge for impairment of intangible assets.
During 1998, our investing activities included $27.2 million of net cash
consumed in the acquisition of IGT and $21.5 million in purchases of new plant
and equipment. We also used cash to increase short-term investments by a net of
$9.6 million and to repay $5.2 million of our debt and capital lease
obligations. Proceeds from the issuance of common stock, principally under our
stock option and purchase plans, totaled $7.6 million.
As at December 31, 1998, our principal sources of liquidity included cash and
cash equivalents and short-term investments of $84.8 million. In the second
quarter of 1998, we entered into a new line of credit agreement with a bank.
This agreement allows us to borrow up to $15 million. We cannot pay cash
dividends, or make material divestments, without the prior written consent of
the bank. There were no amounts outstanding under the line of credit at the end
of either 1997 or 1998.
We have supply agreements with two independent foundries that supply
substantially all of the wafers for our products. We have made deposits to
secure access to wafer fabrication capacity under these agreements. At December
31, 1998 and 1997, we had $23.1 and $27.1 million, respectively, in deposits
with those foundries and we were in compliance with our foundry agreements.
There are no minimum unit volume requirements in these agreements. We are
obliged under one of the agreements to purchase a minimum percentage of our
total annual wafer requirements provided that the foundry is able to continue to
offer competitive technology, pricing, quality and delivery. The agreements may
be terminated if either party does not comply with the terms.
We purchased $18.3 million in wafers from our foundry suppliers during 1998
compared to $13.2 million in 1997. Those amounts may not be indicative of any
future period since wafer prices and our volume requirements may change.
In each year, we are entitled to receive a refund of a portion of these
deposits. The amount to be received is based on the annual purchases from those
foundries compared to the target levels in the agreements. Based on 1998
purchases, we expect to receive a $4.0 million refund from one of the foundries
in the first quarter of 1999. If we do not receive our deposits back during the
course of the agreements, then they will be returned to us at the end of the
agreement periods.
We believe that existing sources of liquidity and anticipated funds from
operations will satisfy our projected working capital and capital expenditure
requirements through the end of 1999. We expect to purchase or arrange capital
leases for approximately $33.0 million of new capital expenditures during 1999.
In 1998, actual capital expenditures totaled $21.5 million. No additional
deposits to secure foundry capacity are expected in 1999.
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. 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 common stock to decline, and you may lose part or all of your
investment.
OUR OPERATING RESULTS FLUCTUATE
Our operating results have fluctuated in the past and may fluctuate in the
future for any of the following reasons:
o our product introduction timing; o our average selling prices change;
o our customers' inventory levels o our customers are acquired or
fluctuate; divested;
o demand for our and our customers' o a networking industry downturn;
products changes;
o our suppliers' product and capacity o we are unable to acquire wafer or
availability changes; other manufacturing capacity;
o our product manufacturing yields o our competitors produce new products
change; or technologies;
o market acceptance or rejection of one o our product and process development
or more of our products; expenditures change; and
o our competitors change prices.
WE MAY BE LEFT WITH UNSALEABLE INVENTORY
We attempt to forecast and maintain a level of inventory in anticipation of
demand for our products. Anticipating demand is difficult because our customers
face volatile pricing and demand for their end-user networking equipment. If our
customers were to delay, cancel or otherwise change future ordering patterns, we
could be left with unwanted inventory.
WE ANTICIPATE LOWER MARGINS ON MATURE AND HIGH VOLUME PRODUCTS
Our gross and operating margins may change in the future as a result of any of
the following:
o changes in average selling prices;
o changes in production and wafer and other supply costs; and
o changes in our product mix.
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 ("ASPs") of products. If we price our products too high,
our customers may use a competitor's product or an in-house solution. Thus, our
ASPs will generally fall with the industry norms. To maintain profit margins, we
must reduce our costs sufficiently to offset declines in ASPs, or successfully
sell proportionately more new products with higher ASPs. Yield or other
production problems, or shortages of supply may preclude us from lowering or
maintaining current operating costs. Also, competitive, market and other
pressures may not allow us to increase our sales of our higher ASP products.
In addition, we are entering into an ethernet market of the networking industry
characterized by average volumes that are higher and gross margins that are
lower than the market in which we currently participate. To maintain our current
operating margins, we will have to sell higher volumes of these chips than in
our traditional markets. If we sell these chips in low volumes, our operating
margins may be adversely affected.
WE NEED TO SUCCESSFULLY DEVELOP AND INTRODUCE OUR NEW PRODUCTS
The success of our new products depends on a number of factors, including:
o our definition of new products to meet customer requirements;
o our completion of product development and introduction of new products to
market in a timely manner;
o our ability to judge product demand;
o competitive pricing and performance levels; and
o suitable fabrication yields by our independent foundries.
Many of these factors are outside our control. We may not be able to effectively
accomplish those factors that are in our control.
Some of our products adhere to specifications developed by industry groups. For
example, in the second half of 1998, we introduced two packet-over-Sonet devices
based on specifications developed by an industry group. These specifications may
not reach sufficient acceptance by the market to allow our products commercial
success.
In September 1996, we entered into a new product area. We acquired in-process
research and development and developed technology relating to ethernet
switching. It is possible that ethernet products may not be sufficiently
accepted by the market to achieve commercial success.
In May 1998, we acquired in-process research and development and developed
technology related to ATM segmentation and reassembly as well at ATM switching.
It is possible that these products may not achieve volumes sufficient to assure
their commercial success.
WE OPERATE IN AN INDUSTRY SUBJECT TO RAPID TECHNOLOGICAL CHANGE
We sell products to a market whose characteristics include rapidly evolving
industry standards, product obsolescence, and new manufacturing and design
technologies. Our complex semiconductors require extensive design and testing
before prototypes can be manufactured. They often need to be redesigned because
manufacturing yields on prototypes are unacceptable or customers redefine their
products to meet changing industry standards. Many of the standards and
protocols for our products are based on high speed networking technologies that
have not been widely adopted or ratified by one 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 due to these rapidly evolving
industry standards and customer preferences.
WE DEPEND ON THE ATM TELECOMMUNICATIONS AND NETWORKING MARKET
We focus a significant part of our business and research expenditures in the
Asynchronous Transfer Mode ("ATM") telecommunications and networking market. As
a result of our 1996 restructuring, revenues from non-networking products have
declined significantly over the last several years, making our results depend
primarily on ATM and related products. The percentage of net revenues to total
company sales derived from sales of ATM, T1/E1, DS3/E3 and SONET/SDH based
products amounted to 86% in 1998 compared to 67% in 1997.
The ATM market is in an early stage of deployment. If the industry adopts
industry standards that compete with ATM, our ATM products could be made
unmarketable or obsolete. The market for ATM equipment has not developed as
rapidly as industry observers had originally predicted, while alternative
networking technologies such as "packet-over-SONET" and "gigabit ethernet" have
developed to meet networking requirements.
WE FACE FIERCE COMPETITION
The markets for our products are intensely competitive and subject to rapid
technological change and price erosion. We may not be able to compete
successfully against current or future competitors.
We believe that our ability to compete successfully in these markets depends on:
o our product performance, quality and pricing;
o our, our competitors' and our customers' timing and success of new product
introductions;
o our ability to innovate;
o our ability to deliver working products on schedule;
o market acceptance of standards for which we have produced products;
o our ability to obtain adequate manufacturing capacity;
o our subcontractors' production efficiency;
o the rate at which our customers incorporate our products into their designs;
and
o our and our competitors' assertion of intellectual property rights.
We typically face competition at the design stage, where customers evaluate
alternative design approaches that require integrated circuits. Our competitors
have increasingly frequent opportunities to supplant our products in next
generation systems because of shortened product life and design-in cycles in
many of our customers' products.
Our competitors are major domestic and international semiconductor companies,
many of which have substantially greater financial and other resources than us.
Emerging companies also provide significant competition in our segment of the
semiconductor market. Our competitors include Advanced Micro Circuits
Corporation, Broadcom, Conexant Systems, Cypress Semiconductor, Dallas
Semiconductor, Galileo Technology, Integrated Device Technology, Level One
Communications, Lucent Technologies, Motorola, MMC Networks, Siemens, Texas
Instruments, Transwitch and Vitesse Semiconductor. Over the next few years, we
expect additional competitors, some of which also may have greater financial and
other resources, to enter the market with new products.
WE MUST HAVE ACCESS TO WAFER FABRICATION AND OTHER MANUFACTURING CAPACITY TO
SUCCEED
We do not own or operate a wafer fabrication facility. Two outside foundries
supply all our semiconductor device requirements. Our foundry suppliers also
produce products for themselves and other companies. 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 might not find enough capacity
quickly enough, if ever, to satisfy our production requirements.
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 which, in turn, may result in the
loss of customers. We have less control over delivery schedules, assembly
processes, quality assurances and costs than competitors that do not outsource
these tasks.
OUR CUSTOMER BASE IS CONCENTRATED
We depend on a limited number of customers for a major portion of our revenues.
Through direct, distributor and subcontractor purchases, Lucent Technologies
(including Ascend Communications) and Cisco Systems each accounted for more than
10% of our fiscal 1998 revenues. We do not have long-term volume purchase
commitments from any of our major customers. Our customers often shift buying
patterns as they manage inventory levels, decide to use competing products, or
change their orders for other reasons. If one or more customers were to delay,
reduce or cancel orders, our overall order levels may fluctuate greatly.
OUR GLOBAL BUSINESS APPROACH SUBJECTS US TO ADDITIONAL RISKS
We are subject to a number of risks of conducting business outside of the United
States.
Historically, international sales accounted for the following percentages of our
net revenues: 32% in 1998, 30% in 1997 and 46% in 1996. We expect international
sales will continue to represent a significant portion of our, and our
customers' net revenues for the foreseeable future.
We are subject to these risks 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 are conducted outside
of the United States. The majority of our development, test, marketing and
administrative functions occur in Canada and substantially all of our products
are manufactured and assembled by independent third parties in Asia.
Our international sales, research and development and manufacturing may subject
us to the following risks:
o changes to, or impositions of, legislative or regulatory requirements and
policy changes affecting the networking market;
o delays resulting from difficulty in obtaining export licenses for certain
technology, tariffs, quotas, exchange rates and other trade barriers
and restrictions;
o foreign currency rate fluctuations because our development, test, marketing
and administrative costs are denominated in Canadian dollars, and our
selling costs are denominated in a variety of currencies;
o greater difficulty in accounts receivable collection;
o longer payment cycles;
o taxes;
o political, social and economic instability;
o hostilities and changes in diplomatic and trade relationships; and
o the burdens of complying with a variety of foreign laws and communications
standards.
WE DEPEND ON KEY PERSONNEL
We must retain and hire key technical personnel to be successful. This is
particularly true with respect to those employees who are highly skilled at the
design and test functions used to develop high speed networking products and
related software. The competition for such employees is intense and we do not
have employment agreements in place with these key personnel. We issue common
stock options that are subject to vesting as employee incentives. These options,
however, are effective as retention incentives only if they have economic value.
OUR PRODUCTS EMPLOY PROPRIETARY TECHNOLOGY THAT WE MAY NOT BE ABLE TO PROTECT
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 PROPRIETARY TECHNOLOGY THAT MAY INFRINGE ON THE INTELLECTUAL
PROPERTY RIGHTS OF THIRD PARTIES
Vigorous protection and pursuit of intellectual property rights or positions
characterize the semiconductor industry. This often results in expensive and
lengthy litigation. We, as well as our customers or suppliers, may be accused of
infringing on patents or other intellectual property rights owned by third
parties. This has happened in the past. An adverse result in any litigation
could force us to pay substantial damages, stop manufacturing, using and selling
the infringing products, spend significant resources to develop non-infringing
technology, discontinue using certain processes or obtain licenses to the
infringing technology. In addition, we may not be able to develop non-infringing
technology, nor might we be able to find appropriate licenses on reasonable
terms.
Patent disputes in the semiconductor industry are often settled through
cross-licensing arrangements. Because we currently do not have a substantial
portfolio of patents, 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 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. Until December of 1997, we indemnified our customers up to the dollar
amount of their purchases of our products found to be infringing on technology
owned by third parties. 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 MAY BE INVOLVED IN ACQUISITIONS
We may acquire products, technologies or businesses from third parties.
Management may be diverted from our operations while they identify and negotiate
these acquisitions and integrate an acquired entity into our operations. Also,
we may be forced to develop expertise outside our existing businesses, and
replace key personnel who leave due to an acquisition. An acquisition could
absorb substantial cash resources, require us to incur or assume debt
obligations, or issue additional equity. If we issue more equity, we may dilute
our common stock with securities that have 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. An
acquisition that is accounted for as a purchase could involve significant
one-time write-offs, and could involve the amortization of goodwill over a
number of years. This was the accounting method used to record our acquisition
of a networking business in 1994, certain assets of Bipolar Integrated
Technology in September 1996, and the acquisition of Integrated Telecom
Technology in May 1998.
WE MAY NEED ADDITIONAL CAPITAL IN THE FUTURE
We must continue to make significant investments in research and development,
capital equipment and facilities for our operations. Our future capital
requirements will depend on many factors, including product development, working
capital investments, and acquisitions of businesses, products or technologies.
We may need 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 we or you will find favorable. 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 substantially. The reasons
this may continue include the following:
o our or our competitors' new product announcements;
o quarterly fluctuations in the financial results of our company and other
companies in the semiconductor, networking or computer industries;
o conditions in the networking or semiconductor industry; and
o investor sentiment toward technology stocks.
In addition, increases in our stock price and expansion of our price-to-earnings
multiple may have made our stock attractive to momentum investors who often
shift funds into and out of stocks rapidly, exacerbating price fluctuations in
either direction.
YEAR 2000 COMPUTER SYSTEMS ISSUES
The approach of the year 2000 presents significant issues for many financial,
information, and operational systems. Many systems in use today may not be able
to interpret dates after December 31, 1999 appropriately, because such systems
allow only two digits to indicate the year in a date. As a result, such systems
are unable to distinguish January 1, 2000, from January 1, 1900, which could
have adverse consequences on the operations of the entity.
Our State of Readiness
We have designated specific individuals to identify and resolve year 2000 issues
associated with our internal information technology (IT) systems, our internal
non-IT systems, and material third party relationships. We have completed the
identification of and are implementing our plans to address our year 2000
issues.
We use commercially available standard software for our critical operating and
design functions. Our primary software vendors have provided program updates
that are intended to rectify the year 2000 issues related to their software. We
upgraded all primary software by the second quarter of 1998. In addition, we are
currently implementing an enterprise-wide software system for operational
reasons. This system is scheduled to be fully implemented in 1999 and is year
2000 compliant.
We have secondary design and operating software that is not year 2000 compliant.
We have identified and intend to install or develop patches or workaround
solutions for this software during 1999.
We use other technology, such as semiconductor testers, which are not year 2000
compliant. These systems do not interface with our critical operating
applications. We have identified these systems and expect to conclude modifying
or replacing them in 1999.
The total cost of the software upgrade for our primary operating and financial
applications, the cost to purchase and install our other non-critical software,
and the cost for the modification and replacement of our other technology is not
expected to be material.
Our Year 2000 Risk
Our greatest year 2000 exposure comes from our product manufacturing, packaging
and delivery suppliers. Our worst case scenario would be if one or more critical
suppliers fail to become year 2000 compliant and fail to develop acceptable
workaround solutions. The majority of our product manufacturing, packaging and
delivery is outsourced to two wafer fabrication companies, three assembly
companies and one shipping company, respectively. These suppliers are generally
much larger than our company and we have little influence on their year 2000
preparedness schedules. While we have received written communication from our
critical suppliers that they have developed an action plan to address their year
2000 issues, we cannot be certain that these plans will be implemented or be
effective.
If our suppliers are unable to manufacture our products as a result of year 2000
issues, we may be forced to find and qualify other year 2000 compliant
suppliers. This qualification process could take six months or longer. We may
not find sufficient capacity quickly enough to satisfy our production
requirements, as we would expect that the many other companies with
manufacturing models similar to ours would be vying for production capacity.
We are also exposed to customers who may not be year 2000 compliant. If one or
more of our customers' operations is interrupted due to year 2000 issue
non-compliance, our revenues from these customers could be materially impacted.
Our Contingency Plans
While we do not have a formal contingency plan, we are monitoring our critical
suppliers to ensure they complete their year 2000 plans as scheduled. We would
implement a formal contingency plan should any of our critical suppliers
indicate that there would be any delays resulting from their own year 2000
plans. Such a plan could entail contacting and qualifying other potentially year
2000 compliant suppliers and stocking additional inventory to cover short term
operating needs. We can not ensure that this contingency plan would be effective
or completed in a timely manner.
SPECIAL NOTE ON FORWARD LOOKING STATEMENTS
Some statements in this report constitute "forward looking statements" within
the meaning of the federal securities laws. Our results, performance or
achievements may be materially different from those expressed or implied by
these statements. Our forward looking statements include projections relating to
trends in markets, long and short term revenues and gross margins. They also
include projections related to future expenditures on research and development,
marketing, general and administrative expense, new accounting pronouncements and
the year 2000 issue along with the impact of these issues. We may not, nor are
we obliged to, release revisions to forward-looking statements to reflect
subsequent events.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The following discussion regarding our risk management activities contains
"forward-looking statements" that involve risks and uncertainties. Actual
results may differ materially from those projected in the forward-looking
statements.
We are exposed to foreign currency fluctuations through our operations in Canada
and elsewhere. In our effort to hedge this risk, we typically forecast our
operational currency needs, purchase such currency on the open market at the
beginning of an operational period, and classify these funds as a hedge against
operations. We usually limit the operational period to less than 3 months to
avoid undue exposure of our asset position to further foreign currency
fluctuation. While we expect to utilize this method of hedging our foreign
currency risk in the future, we may change our hedging methodology and utilize
foreign exchange contracts which are currently available under our operating
line of credit agreement.
Occasionally, we may not be able to correctly forecast our operational needs. If
our forecasts are overstated or understated during periods of currency
volatility, we could experience unanticipated currency gains or losses. At the
end of our fiscal years 1998 and 1997, we did not have significant foreign
currency denominated net asset or net liability positions, and we had no
outstanding foreign exchange contracts.
We maintain investment portfolio holdings of various issuers, types, and
maturity dates with various banks and investment banking institutions. We
regularly hold investments beyond 120 days, and the market value of these
investments on any day during the investment term may vary as a result of market
interest rate fluctuations. We do not hedge this exposure because short-term
fluctuations in interest rates would not likely have a material impact on
interest earnings. We classify our investments as available-for-sale or
held-to-maturity at the time of purchase and re-evaluate this designation as of
each balance sheet date. At the end of 1998 and 1997, all outstanding short-term
investments were classified as held-to-maturity and recorded at amortized cost.
These investments were held until maturity in the first quarter of 1999 and
1998, respectively. In the future, we expect to continue holding our short-term
investments to maturity.
ITEM 8. Financial Statements and Supplementary Data.
The chart entitled "Quarterly Data (Unaudited)" contained in Item 6 Part II
hereof is hereby incorporated by reference into this Item 8 of Part II of this
Form 10-K.
PMC-Sierra, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Consolidated Financial Statements Included in Item 8:
Page
Report of Deloitte & Touche LLP, Independent Auditors.................... -
Report of Ernst & Young LLP, Independent Auditors........................ -
Consolidated Balance Sheets at December 31, 1998 and 1997................ -
Consolidated Statements of Operations for each of the three
years in the period ended December 31, 1998.......................... -
Consolidated Statements of Stockholders' Equity for each
of the three years in the period ended December 31, 1998............. -
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1998.......................... -
Notes to Consolidated Financial Statements............................... -
Schedules for each of the three years in the period ended December 31, 1998
included in Item 14 (d):
II Valuation and Qualifying Accounts.................................... -
Schedules not listed above have been omitted because they are not applicable or
are not required, or the information required to be set forth therein is
included in the financial statements or the notes thereto.
Report of Deloitte & Touche LLP, Independent Auditors
The Board of Directors and Stockholders of PMC-Sierra, Inc.
We have audited the accompanying consolidated balance sheet of PMC-Sierra, Inc.
as of December 31, 1998 and 1997 and the related consolidated statements of
operations, stockholders' equity and cash flows for the years then ended. Our
audit also included the financial statement schedule for the years ended
December 31, 1998 and 1997 listed in the index at Item 14(a). These consolidated
financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of the
Company at December 31, 1998 and 1997, and the results of its operations and its
cash flows for the years then ended, in conformity with generally accepted
accounting principles in the United States. Also, in our opinion, the related
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/S/ DELOITTE & TOUCHE LLP
Vancouver, British Columbia
January 21, 1999
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Shareholders
PMC-Sierra, Inc.(formerly Sierra Semiconductor Corporation)
We have audited the accompanying consolidated statements of operations,
shareholders' equity, and cash flows of PMC-Sierra, Inc. (formerly Sierra
Semiconductor Corporation) for the year ended December 31, 1996. Our audit also
included the financial statement schedule listed in the index at Item 14(a).
These financial statements and schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated results of operations and
cash flows of PMC-Sierra, Inc. (formerly Sierra Semiconductor Corporation) for
the year ended December 31, 1996, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial statements taken as
a whole, presents fairly in all material respects the information set forth
therein.
/S/ ERNST & YOUNG LLP
San Jose, California
January 22, 1997
PMC-Sierra, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31,
------------------------
1998 1997
ASSETS:
Current assets:
Cash and cash equivalents $ 33,943 $ 27,906
Short-term investments 50,893 41,334
Accounts receivable, net of allowance for doubtful accounts of $1,128
in 1998 and $1,070 in 1997 26,227 15,103
Short-term deposits for wafer fabrication capacity 4,000 4,000
Inventories 3,617 3,199
Prepaid expenses and other current assets 3,840 1,958
----------- -----------
Total current assets 122,520 93,500
Property and equipment, net 31,595 19,699
Goodwill and other intangible assets, net of accumulated
amortization of $6,455 ($3,668 in 1997) 19,629 8,635
Investments and other assets 4,434 4,424
Deposits for wafer fabrication capacity 19,120 23,120
----------- -----------
$ 197,298 $ 149,378
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 8,964 $ 7,421
Accrued liabilities 14,618 11,653
Deferred income 12,517 2,098
Accrued income taxes 13,897 8,780
Current portion of obligations under capital leases and long-term debt 4,909 4,652
Net liabilities of discontinued operations - 301
----------- -----------
Total current liabilities 54,905 34,905
Deferred income taxes 2,851 4,023
Noncurrent obligations under capital leases and long-term debt 5,223 9,092
Commitments and contingencies (Note 5) - -
Special shares of a subsidiary convertible into common stock
1,259 shares in 1998 (1,618 shares in 1997) 8,387 10,793
Stockholders' equity:
Preferred stock, par value $0.001; 5,000 shares authorized, none outstanding - -
Common stock, par value $0.001; 100,000 shares authorized (50,000 shares in 1997);
31,415 issued and outstanding in 1998 (29,750 in 1997) 31 30
Additional paid in capital 181,397 143,153
Accumulated deficit (55,496) (52,618)
----------- -----------
Total stockholders' equity 125,932 90,565
----------- -----------
$ 197,298 $ 149,378
=========== ===========
See notes to consolidated financial statements.
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
Year Ended December 31,
-------------------------------------
1998 1997 1996
Net revenues $ 161,812 $ 127,166 $ 188,371
Cost of revenues 38,220 33,065 94,948
----------- ----------- -----------
Gross profit 123,592 94,101 93,423
Other costs and expenses:
Research and development 34,280 22,880 29,350
Marketing, general and administrative 28,755 23,663 30,691
Acquisition of in process research and development 39,176 - 7,783
Impairment of intangible assets 4,311 - -
Restructure and other costs - (1,383) 64,670
----------- ----------- -----------
Income (loss) from operations 17,070 48,941 (39,071)
Interest income, net 2,923 1,044 679
----------- ----------- -----------
Income (loss) before provision for income taxes 19,993 49,985 (38,392)
Provision for income taxes 22,871 15,727 9,758
----------- ----------- -----------
Net income (loss) $ (2,878) $ 34,258 $ (48,150)
=========== =========== ===========
Basic net income (loss) per share: $ (0.09) $ 1.10 $ (1.62)
=========== =========== ===========
Diluted net income (loss) per share: $ (0.09) $ 1.05 $ (1.62)
=========== =========== ===========
Number of shares used to calculate:
Basic net income (loss) per share: 32,002 31,043 29,719
Diluted net income (loss) per share: 32,002 32,642 29,719
See notes to consolidated financial statements.
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock Additional Stockholders' Total
--------------------------- Paid in Accumulated Notes Stockholders'
Shares Amount Capital Deficit Receivable Equity
Balances at December 31, 1995 26,603 $ 119,758 $ - $ (38,726) $ (32) $ 81,000
Issuance of common stock
under stock benefit plans 604 3,072 - - - 3,072
Issuance of common stock to
capitalize PMC-Portland and
acquire assets of Bit, Inc. 804 6,788 - - - 6,788
Adjustment to prior year common
stock issuance costs - 38 - - - 38
Conversion of special shares
into common stock 636 3,036 - - - 3,036
Tax benefit of stock option
transactions - 2,628 - - - 2,628
Payment of stockholders' notes
receivable - - - - 32 32
Net loss - - - (48,150) - (48,150)
----------- ------------ ------------ ------------ ------------- --------------
Balances at December 31, 1996 28,647 135,320 - (86,876) - 48,444
Conversion of special shares
into common stock 784 1,701 - - - 1,701
Issuance of common stock
under stock benefit plans 319 6,162 - - - 6,162
Reclassification on reincorporation - (143,153) 143,153 - - -
Net income - - - 34,258 - 34,258
----------- ------------ ------------ ------------ ------------- --------------
Balances at December 31, 1997 29,750 30 143,153 (52,618) - 90,565
Conversion of special shares
into common stock 359 - 2,406 - - 2,406
Issuance of common stock
under stock benefit plans 891 1 7,617 - - 7,618
Issuance of common stock and
stock options to acquire Integrated
Telecom Technology, Inc. 415 - 28,221 - - 28,221
Net loss - - - (2,878) - (2,878)
----------- ------------ ------------ ------------ ------------- --------------
Balances at December 31, 1998 31,415 $ 31 $ 181,397 $ (55,496) $ - $ 125,932
=========== ============ ============ ============ ============= ==============
See notes to consolidated financial statements.
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in cash and cash equivalents
(in thousands)
Year Ended December 31,
----------------------------------------
1998 1997 1996
Cash flows from operating activities:
Net income (loss) $ (2,878) $ 34,258 $ (48,150)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 14,179 9,150 10,922
Acquisition of in process research and development 39,176 - 7,783
Impairment of intangible assets 4,311 - -
Loss on disposal of equipment - 258 -
Loss (recovery) related to restructure provision (note 9):
Accounts receivable - - 5,047
Inventories - 1,371 23,000
Prepaid expenses - - 1,061
Impairment of long-lived assets - (942) 16,425
Impairment of goodwill of Holland operations - - 2,459
Accruals for restructure related costs:
Severance and related costs - 376 6,985
Purchase commitments and other accruals - (2,340) 9,002
Excess facilities costs - (496) 3,411
Costs for closure of European subsidiaries - 648 1,980
Changes in operating assets and liabilities
Accounts receivable (9,861) (1,196) 20,023
Inventories 137 4,662 (17,389)
Prepaid expenses and other (1,245) 1,146 (711)
Accounts payable and accrued liabilities 236 1,552 (11,422)
Accrued income taxes 5,117 4,730 (3,687)
Deferred income 10,419 2,098 -
Accrued restructuring costs - (14,942) (4,624)
Net liabilities associated with discontinued operations (301) (1,299) (2,496)
------------ ------------ ------------
Net cash provided by operating activities 59,290 39,034 19,619
------------ ------------ ------------
Cash flows from investing activities:
Proceeds from sales and maturities of short-term investments 43,442 24,877 15,984
Purchases of short-term investments (53,001) (59,187) (19,004)
Proceeds from refund of wafer fabrication deposits 4,000 - -
Investments in other companies - (3,000) (3,162)
Purchase of Integrated Telecom Technology, Inc., net of cash acquired (27,165) - -
Purchase of other in process research and development (1,419) - -
Purchase of Bit, Inc. assets, net of cash acquired - - 71
Proceeds from sale of equipment and capacity assets - 7,631 -
Purchases of plant and equipment (21,545) (8,221) (4,000)
------------ ------------ ------------
Net cash used in investing activities (55,688) (37,900) (10,111)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from payment of notes receivable - - 32
Proceeds from issuance of long-term debt - - 353
Repayment of notes payable and long-term debt (153) (2,640) (17,588)
Proceeds from sale/leaseback of capital equipment - 1,107 -
Principal payments under capital lease obligations (5,030) (12,895) (2,310)
Proceeds from issuance of common stock 7,618 6,162 3,110
------------ ------------ ------------
Net cash provided by (used in) financing activities 2,435 (8,266) (16,403)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 6,037 (7,132) (6,895)
Cash and cash equivalents, beginning of the year 27,906 35,038 41,933
------------ ------------ ------------
Cash and cash equivalents, end of the year $ 33,943 $ 27,906 $ 35,038
============ ============ ============
See notes to consolidated financial statements.
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
--------------------------------------------
1998 1997 1996
Supplemental disclosures of cash flow information:
Cash paid for interest $ 958 $ 1,954 $ 1,278
Cash paid for income taxes 12,972 7,227 11,820
Supplemental disclosures of non-cash investing and financing activities:
Issuance of common stock and stock options
to acquire Integrated Telecom Technology, Inc. 28,221 - -
Issuance of common stock and stock options
to acquire assets of Bit, Inc. - - 6,788
Capital lease obligations incurred for purchase of property and equipment - 3,536 16,145
Conversion of PMC special shares into common stock 2,406 1,701 3,036
Cancellation of short-term debt obligations incurred for
wafer fabrication capacity - - (15,120)
See notes to consolidated financial statements.
PMC-Sierra, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1998, 1997, and 1996
NOTE 1. Summary of Significant Accounting Policies
Basis of presentation. The accompanying consolidated financial statements
include the accounts of PMC-Sierra, Inc. and its wholly owned subsidiaries ("the
Company" or "PMC"). All significant inter-company accounts and transactions have
been eliminated from the consolidated financial statements. The Company's fiscal
year ends on the last Sunday of the calendar year. For ease of presentation,
December 31 has been utilized as the fiscal year end for all financial statement
captions. Fiscal years 1998, 1997 and 1996 each consisted of 52 weeks. The
Company's reporting currency is the United States dollar.
Estimates. The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets, liabilities, revenues and
expense, and disclosure of contingent assets and liabilities as of the dates and
for the periods presented. Estimates are used for, but not limited to, the
accounting for doubtful accounts, depreciation and amortization, sales returns,
warranty costs, taxes and contingencies. Actual results may differ from those
estimates.
Cash, cash equivalents and short-term investments. Cash equivalents are defined
as highly liquid debt instruments with original maturities at the date of
acquisition of 90 days or less that have insignificant interest rate risk.
Short-term investments are defined as money market instruments with original
maturities greater than 90 days, but less than one year. The Company maintains
its cash, cash equivalents and short-term investments in various financial
instruments with various banks and investment banking institutions. The
diversification of risk is consistent with Company policy to preserve the
principal and maintain liquidity.
Under Financial Accounting Standards No. 115 "Accounting for Certain Investments
in Debt and Equity Securities" (SFAS 115), management classifies investments as
available-for-sale or held-to-maturity at the time of purchase and re-evaluates
such designation as of each balance sheet date. Investments classified as
held-to-maturity securities are stated at amortized cost with corresponding
premiums or discounts amortized against interest income over the life of the
investment.
Marketable equity and debt securities not classified as held-to-maturity are
classified as available-for-sale and reported at fair value. Unrealized gains
and losses on these investments are included in equity as a separate component
of stockholders' equity. The cost of securities sold is based on the specific
identification method.
As at December 31, 1998 and 1997, the Company's short-term investment portfolio
consisted solely of held-to-maturity investments and their carrying value was
substantially the same as their market value. Proceeds from sales and realized
gains or losses on sales of available-for-sale securities for all years
presented were immaterial.
Inventories. Inventories are stated at the lower of cost (first-in, first out)
or market (estimated net realizable value).
The components of inventories are as follows (in thousands)
December 31,
-------------------------
1998 1997
Work-in-progress $ 1,761 $ 2,316
Finished goods 1,856 883
----------- ------------
$ 3,617 $ 3,199
=========== ============
Property and equipment, net. Depreciation and amortization of property and
equipment are provided using the straight-line method over the estimated useful
lives of the assets, ranging from two to five years, or the applicable lease
term, whichever is shorter. The carrying value of property and equipment is
reviewed periodically for any permanent impairment in value.
The components of property and equipment are as follows (in thousands):
December 31,
--------------------------
1998 1997
Machinery and equipment $ 53,030 $ 31,353
Leasehold improvements 2,666 2,006
Furniture and fixtures 2,555 1,666
------------ ------------
Total cost 58,251 35,025
Accumulated depreciation (26,656) (15,326)
------------ ------------
$ 31,595 $ 19,699
============ ============
Goodwill and other intangible assets. Goodwill associated with acquisitions is
being amortized on a straight-line basis. Developed and core technology and
other intangible assets are being amortized on a straight-line basis over the
economic lives of the respective assets, generally three to seven years. Among
other considerations, to assess impairment, the Company periodically estimates
undiscounted future cash flows to determine if they exceed the unamortized
balance of the related intangible asset.
The components of goodwill and other intangible assets, net are as follows (in
thousands):
December 31,
------------------------
1998 1997
PMC-Sierra, Ltd. $ 6,665 $ 8,372
Bipolar Integrated Technology, Inc. 216 263
Integrated Telecom Technology, Inc. 12,748 -
----------- -----------
$ 19,629 $ 8,635
=========== ===========
Deposits for wafer fabrication capacity. The Company has wafer supply agreements
with two independent foundries that together supply substantially all of the
Company's products and include deposits made to secure access to wafer
fabrication capacity. At December 31, 1998, the Company had $23.1 million in
deposits with those foundries. Although there are no minimum unit volume
requirements under the agreements, the Company is obligated under one of the
agreements to purchase in future periods a minimum percentage of its total
annual wafer requirements, provided that the foundry is able to continue to
offer competitive technology, pricing, quality and delivery. The Company
purchased $18.3 million from its foundry suppliers during 1998 compared to $13.2
million under agreements in existence in 1997. Those amounts may or may not be
indicative of any future period since wafers are purchased based on current
market pricing and the Company's volume requirements change in relation to sales
of its products.
In each year, the Company is entitled to receive a portion of the deposits
provided to the foundries based on the annual purchases from those foundries as
compared to the target levels in the agreements. Based on 1998 purchases, the
Company is entitled to receive a $4.0 million refund from one of the foundries
in the first quarter of 1999. If the Company does not receive the balance of its
deposits back during the course of the agreements, then the deposits will be
returned to the Company at the termination of the agreements.
Accrued liabilities. The components of accrued liabilities are as follows (in
thousands):
December 31,
--------------------------
1998 1997
Accrued compensation and benefits $ 5,482 $ 4,590
Accrued royalties 175 521
Other accrued liabilities 8,961 6,542
------------ ------------
$ 14,618 $ 11,653
============ ============
Foreign currency translation. For all foreign operations, the U.S. dollar is the
functional currency. Foreign currency assets and liabilities are remeasured into
U.S. dollars using the year-end exchange rates. Statements of operations are
remeasured using the average exchange rates during the year. Gains and losses
from foreign currency remeasurement are included in interest income, net.
Concentration of credit risk. The Company believes that the concentration of
credit risk in its trade receivables with respect to the high-technology
industry is substantially mitigated by the Company's credit evaluation process,
large number of customers, relatively short collection terms, and the
geographical dispersion of sales. The Company generally does not require
collateral security for outstanding amounts.
Revenue recognition. Net revenues are stated net of provision for sales returns.
Revenues from product sales direct to customers and minor distributors are
recognized at the time of shipment. A provision is made for estimated product
returns. At December 31, 1998 and 1997, this provision was approximately
$943,000 and $725,000, respectively. Certain of the Company's product sales are
made to major distributors under agreements allowing price protection and/or
right of return on products unsold. Accordingly, the Company defers recognition
of revenue on such sales until the products are sold by the distributors.
Interest income, net. The components of interest income, net are as follows (in
thousands):
Year Ended December 31,
-------------------------------------
1998 1997 1996
Interest income $ 3,846 $ 3,146 $ 1,840
Interest expense (*) (958) (1,949) (1,278)
Other 35 (153) 117
----------- ----------- -----------
$ 2,923 $ 1,044 $ 679
=========== =========== ===========
* consists primarily of interest on long-term debt and capital leases.
Net income (loss) per common share. The Company has adopted Statement of
Financial Accounting Standards No.128, "Earnings per Share" (SFAS 128) in 1998.
This statement requires the presentation of both basic and diluted net income
per share. Basic net income per share is computed using the weighted average
number of shares outstanding during the period. The PMC-Sierra Ltd. Special
Shares have been included in the calculation of basic net income per share.
Diluted net income per share is computed using the weighted average number of
common and dilutive common equivalent shares outstanding during the period.
Dilutive common equivalent shares consist of stock options and warrants. The
Company has restated all prior period per-share data presented as required by
SFAS No. 128.
Income Taxes. Income taxes are reported under Statement of Financial Accounting
Standards No. 109 and, accordingly, deferred income taxes are recognized using
the asset and liability method, whereby deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax basis, and operating loss and tax credit carryforwards.
Stock Compensation. Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation," (SFAS 123) permits, but does not
require, companies to recognize compensation expense for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Accordingly, compensation expense for
stock options granted to employees is measured as the excess, if any, of the
quoted market price of the Company's stock at the date of the grant or
modification over the amount an employee must pay to acquire the stock.
As prescribed by SFAS 123, Note 6 to the Consolidated Financial Statements
contains a summary of the proforma effects to reported net income and net income
per share for 1998, 1997 and 1996, had the Company elected to recognize
compensation expense based on the fair value of the options granted at the grant
date. The effects of applying SFAS 123 proforma disclosures may not be
representative of the effects on reported net income for future years.
Segment reporting. In June 1997, the Financial Accounting Standards Board (the
FASB) issued Statement of Financial Accounting Standards No. 131, Disclosures
about Segments of an Enterprise and Related Information (SFAS 131). SFAS 131
uses a management approach to report financial and descriptive information about
a Company's operating segments. Operating segments are revenue-producing
components of the enterprise for which separate financial information is
produced internally for the Company's management. Under this definition, the
Company operated, for all periods presented, in two segments: networking and
non-networking products.
Comprehensive income. In June 1997, the FASB issued Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income (SFAS 130). SFAS
130 requires that total comprehensive income and comprehensive income per share
be disclosed with equal prominence as net income and net income per share.
Comprehensive income is defined as changes in stockholders' equity exclusive of
transactions with owners such as capital contributions and dividends. The
Company adopted this Statement in 1998. The Company has no comprehensive income
items, other than the net income in any of the years presented.
Recently issued accounting standards. In June 1998, the FASB issued Statement of
Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities. The Company expects to adopt the new Statement effective January 1,
2000. The Statement will require the recognition of all derivatives on the
Company's consolidated balance sheet at fair value. The Company anticipates that
the adoption of this Statement will not have a significant effect on its results
of operations or financial position.
Reclassifications. Certain prior year amounts have been reclassified in order to
conform with the 1998 presentation.
NOTE 2. Acquisitions, Divestitures and Investments in Other Companies and
Technology
Acquisition of Integrated Telecom Technology, Inc.
- --------------------------------------------------
On May 20, 1998, the Company acquired Integrated Telecom Technology, Inc.
("IGT") in exchange for total consideration of $55.0 million consisting of cash
paid to IGT stockholders of $17.8 million, cash paid to IGT creditors of $9.0
million and the balance of $28.2 million by the issuance of approximately
415,000 shares of common stock and options to purchase approximately 214,000
shares of common stock (based on the market value of PMC common stock on the
issuance date). The purchase price includes professional fees and other direct
costs of the acquisition totaling $850,000. IGT was a fabless semiconductor
company headquartered in Gaithersburg, MD with a development site in San Jose,
CA. IGT made Asynchronous Transfer Mode (ATM) switching chipsets for wide area
network applications as well as ATM Segmentation-and-Reassembly and other
telecommunication chips. Upon consumation of the transaction, IGT was merged
with a wholly-owned subsidiary of the Company.
The acquisition was accounted for using the purchase method of accounting and
the final allocation among tangible and intangible assets and liabilities is as
follows:
Tangible assets $ 4,598
Intangible assets:
Developed and core technology 7,830
Assembled workforce 1,050
Goodwill 9,284
In process research and development ("IPR&D") 37,757
Liabilities (4,669)
------------
$ 55,850
============
The amount allocated to IPR&D of $37.8 million was expensed upon acquisition, as
it was determined that the underlying projects had not reached technological
feasibility, had no alternative future use and successful development was
uncertain.
During the third quarter of 1998, the Company determined that a portion of the
intangible assets recognized in connection with the IGT acquisition was
impaired. The developed and core technology related to one of the three projects
in process at the time of acquisition was subsequently determined not to be
technologically feasible and had no alternative future use. As a result, the
Company recognized an impairment of $4.3 million in intangible assets and
related goodwill.
The operating results of IGT have been included in the consolidated financial
statements since the date of acquisition. The following table presents the
unaudited pro forma results of operations for informational purposes assuming
that the Company had acquired IGT at the beginning of the 1997 fiscal year. This
information may not necessarily be indicative of the future combined results of
operations of the Company and IGT.
Year Ended December 31,
-------------------------------
1998 1997
(in thousands, except for per share amounts - unaudited)
Net revenues $ 166,121 $ 139,769
Net income (loss) (see below) $ (6,766) $ 28,918
Basic net income (loss) per share: $ (0.21) $ 0.92
Diluted net income (loss) per share: $ (0.21) $ 0.87
The pro forma results of operations give effect to certain adjustments,
including the elimination of interest expense and amortization of purchased
intangibles and goodwill. Included in the pro forma net loss for the year ended
December 31, 1998 is a $37.8 million charge for purchased IPR&D and $4.3 million
for impairment of intangible assets.
Other Technology
- ----------------
On May 1, 1998 a subsidiary of the Company acquired certain technology for cash
consideration of $1.4 million. This technology has not reached technological
feasibility and has no alternative future use. Accordingly, this amount is
included in the in process research and development expensed in the year ended
December 31, 1998.
Bipolar Integrated Technology, Inc.
- -----------------------------------
During the third quarter of 1996, the Company acquired the ethernet switching
assets, intellectual property, and certain other assets of Bipolar Integrated
Technology, Inc. ("Bit") in exchange for shares of common stock of the Company
and other consideration. The aggregate value of this transaction was
approximately $8.1 million, which includes acquisition costs incurred by the
Company. The assets of Bit were acquired in exchange for 804,407 shares of PMC
common stock with a value of approximately $6.8 million (based on the market
value on the issuance date of PMC common stock issued subject to restrictions on
transfer), approximately $0.5 million of net liabilities assumed by the
Company's subsidiary, the value of options to purchase common stock of the
Company, forgiveness of principal and interest on loans provided by the Company,
and cash. The acquisition resulted in a $7.8 million charge for the purchase of
IPR&D. The remaining $0.3 million of technology assets have been capitalized as
long term assets which will be amortized over seven years. Results of operations
include the costs of continuing the development of products and related
activities acquired from Bit after the closure of the acquisition on September
3, 1996. The proforma effect of combining the Bit transaction with the Company's
operations in 1995 and prior to the acquisition in 1996 are not reported
separately because they are not considered to be material.
I.C. Works, Inc.
- ----------------
In order to secure additional access to wafer fabrication capacity, in 1996 the
Company acquired $3 million of preferred stock of I.C. Works Inc. ("ICW"), a
foundry located in San Jose, California. Under the arrangement with ICW, the
Company also provided semiconductor manufacturing equipment to ICW, which it
financed through capital leases. In 1996, as a result of the restructuring of
non-networking operations, the Company identified that it would not be able to
benefit from the arrangement with ICW and included a $6.9 million provision for
impairment of these assets in its restructuring charge.
In 1997, the Company advanced an additional $3 million to ICW and subsequently,
ICW sold substantially all of its assets, including the manufacturing assets
contributed by the Company. On settlement of its arrangement with ICW, the
Company received proceeds of $4.8 million, resulting in the requirement for an
additional provision for impairment of $3.5 million. This additional provision
was included in the overall recovery from disposal of excess fixed assets and
assets related to capacity commitments of $942,000 (see Note 9) recorded on
completion of the restructuring.
Sierra Wireless, Inc.
- ---------------------
On July 7, 1993, the Company and MPR Teltech Ltd. ("MPR") of British Columbia,
Canada announced an investment in a new company called Sierra Wireless Inc.
(Sierra Wireless). MPR contributed technology licenses in exchange for Sierra
Wireless's non-voting preferred stock. In 1993, the Company invested
approximately $2.5 million of cash in exchange for shares of Sierra Wireless's
non-voting preferred stock. This initial investment was expensed in 1993 as
Sierra Wireless was still in its development stage. In 1996, 1995 and 1994, the
Company invested an additional approximately $0.2, $1.4 and $2.5 million,
respectively, in Sierra Wireless. These investments were capitalized and are
being accounted for as an investment in equity shares recorded on the cost
basis, since Sierra Wireless is now an operating company.
PMC-Sierra, Ltd.
- ----------------
On September 2, 1994, the Company acquired voting control of PMC-Sierra, Ltd.
(formerly PMC-Sierra, Inc.) ("LTD") of Burnaby, British Columbia, Canada. LTD
supplies broadband transmission and networking chip set products for ATM,
SONET/SDH and T1/E1 applications. LTD was established in July 1992 by the
Company, which invested approximately $4.9 million of cash in exchange for LTD's
non-voting preferred stock representing approximately 61% of LTD's securities on
a fully diluted basis; MPR Teltech Ltd., a Canadian corporation, which
contributed assets and technology licenses in exchange for non-voting preferred
stock; a venture capital investor, which purchased non-voting preferred stock
for cash; and LTD's employees, who purchased voting common stock.
The Company acquired voting control of LTD through a recapitalization of LTD. In
the recapitalization, the Company exchanged its LTD non-voting preferred stock
for LTD's voting Ordinary A Shares and LTD's other stockholders exchanged their
preferred stock and common stock for LTD A Special Shares. Each LTD A Special
Share is currently convertible at the holder's option for two shares of the
Company's common stock. The Company reserved 5,000,000 shares of its common
stock for issuance in connection with requests to redeem LTD Special Shares then
outstanding. The acquisition of voting control through LTD's recapitalization
was accounted for as a purchase of the interests of the other stockholders in
LTD.
Under the terms of the recapitalization agreement, in the third quarter of 1995
the Company adjusted the 1994 purchase price paid to the other LTD stockholders.
Accordingly, the minority stockholders received additional consideration through
the right to acquire an additional 1,294,722 shares of common stock in exchange
for LTD B Special Shares. The issuance of these shares was reflected in the
Company's financial statements in 1995 as a special charge to income of $10.6
million relating to compensation expense and an increase in goodwill of $9.1
million.
The Special Shares of LTD will be classified outside of stockholders' equity
until such shares are exchanged for PMC common stock.
Before the recapitalization, the Company held only non-voting preferred stock in
LTD, and accordingly LTD's assets, liabilities and operating results were not
consolidated with those of the Company. From the date of the recapitalization,
LTD's balance sheet and operating results have been consolidated in the
Company's financial statements.
NOTE 3. Line of Credit
At December 31, 1998, the Company had available a revolving line of credit with
a bank under which the Company may borrow up to $15 million with interest at the
bank's alternate base rate (annual rate of 7.75% at December 31, 1998). The
Company cannot pay cash dividends, or make material divestments without the
prior written consent of the bank. The agreement expires in May 1999. At
December 31, 1998 and December 31, 1997, there were no amounts outstanding under
this agreement.
NOTE 4. Obligations Under Capital Leases and Long Term Debt
The Company leases furniture and equipment under long-term capital leases, which
have been accounted for as installment purchases. Accordingly, capitalized costs
of approximately $17,686,000 and $58,251,000 at December 31, 1998 and 1997,
respectively, and accumulated amortization of approximately $12,067,000 and
$26,656,000, respectively, are included in property and equipment.
Long-term debt and obligations under capital leases are as follows (in
thousands):
December 31,
------------------------
1998 1997
Obligations under capital leases with
interest ranging from 7.41% to 24.48% $ 9,479 $ 12,938
Various unsecured notes, payable in
various installments with interest
rates ranging from 0% to 9% 653 806
----------- -----------
10,132 13,744
Less current portion (4,909) (4,652)
----------- -----------
$ 5,223 $ 9,092
=========== ===========
Future minimum lease payments at December 31, 1998 under capital leases are as
follows (in thousands):
Year Ending December 31:
1999 $ 5,633
2000 4,115
2001 1,314
2002 -
2003 -
-----------
Total minimum lease payments 11,062
Less amount representing imputed interest (1,583)
-----------
Present value of future net minimum lease payments $ 9,479
===========
Maturities of the unsecured notes at December 31, 1998 are as follows (in
thousands):
Year Ending December 31:
1999 $ 93
2000 93
2001 93
2002 93
2003 93
thereafter 188
-------------
$ 653
=============
Fair value of financial instruments. The estimated fair value amounts have been
determined by the Company using available market information and appropriate
valuation methodologies. However, considerable judgment is required in
interpreting market data to develop the estimates of fair value. Accordingly,
the estimates presented herein are not necessarily indicative of the amounts
that the Company could realize in a current market exchange.
The Company's carrying value of cash equivalents, short-term investments,
accounts receivable, accounts payable and accrued liabilities approximates fair
value because the instruments have a short-term maturity.
The fair value of the Company's long-term debt and obligations under capital
leases at December 31, 1998 and 1997 also approximates their carrying value.
The fair value of the deposits for wafer fabrication capacity is not
determinable.
NOTE 5. Commitments and Contingencies
Operating leases. The Company leases its facilities under operating lease
agreements, which expire at various dates through April 30, 2006. Total rent
expense for the years ended December 31, 1998, 1997 and 1996 was $1.8 million,
$1.3 million and $2.1 million, respectively.
Minimum rental commitments under these leases are as follows (in thousands):
Year Ending December 31:
1999 $ 1,662
2000 1,556
2001 1,528
2002 1,419
2003 1,339
thereafter 2,420
--------------
$ 9,924
==============
Supply agreements. The Company's wafer supply agreement with Chartered
Semiconductor ("Chartered") expires on November 17, 1999. However, certain
provisions have been superceded by a wafer capacity agreement which expires in
December 2000 whereby Chartered is obligated to supply the Company with a
predetermined number of wafers per quarter. Taiwan Semiconductor Manufacturing
Corporation ("TSMC") is obligated to provide certain quantities of wafers per
year under an agreement that terminates on December 31, 2000. Neither of the
agreements have minimum unit volume requirements but the Company is obligated
under one of the agreements to purchase in future periods a minimum percentage
of its total annual wafer requirements, provided that the foundry is able to
continue to offer competitive technology, pricing, quality and delivery.
Contingencies. In the normal course of business, the Company receives and makes
inquiries with regard to possible patent infringements. Where deemed advisable,
the Company may seek or extend licenses or negotiate settlements. Outcomes of
such negotiations may not be determinable at any point in time; however,
management does not believe that such licenses or settlements will, individually
or in the aggregate, have a material adverse effect on the Company's financial
position, results of operations or liquidity.
Risks and Uncertainties. Technological change - the markets for the Company's
products are characterized by evolving industry standards, rapid technological
change and product obsolescence. The carrying value of the Company's products in
inventory may be materially impaired in the future should these changes occur
more quickly than the Company anticipates. Wafer capacity agreements as
discussed above, the Company has entered into various agreements to secure
future wafer capacity. Should the Company need more capacity or if there is a
decline in demand for the Company's products thereby reducing the need for this
contracted capacity, estimates related to the carrying value of deposits could
materially change.
NOTE 6. Stockholders' Equity
Authorized. On July 10, 1997, the Company was reincorporated in the State of
Delaware from the State of California. Prior to the reincorporation, the Company
had authorized capital of 55,405,916 shares, 50,000,000 of which were designated
"Common Stock", 5,000,000 of which were designated "Preferred Stock", and
405,916 of which were designated "Series D Preferred Stock". All authorized
shares had no par value. After the reincorporation, the Company had an
authorized capital of 55,000,000 shares, 50,000,000 of which were designated
"Common Stock", $0.001 par value, and 5,000,000 of which were designated
"Preferred Stock", $0.001 par value. The excess of the amount recorded as
capital stock over the par value of capital stock on reincorporation has been
recorded as additional paid in capital at December 31, 1997. The issued and
outstanding shares immediately before and after the reincorporation remained the
same. The reincorporation included no other significant changes with respect to
shares outstanding, reserved shares and various applicable options, rights and
warrants.
During 1998, the Company's stockholders elected to add an additional 50,000,000
authorized shares of common stock to the 50,000,000 shares of common stock
authorized at the end of 1997. The Company currently has an authorized capital
of 105,000,000 shares, 100,000,000 of which are designated "Common Stock",
$0.001 par value, and 5,000,000 of which are designated "Preferred Stock",
$0.001 par value.
Common Stock. At December 31, 1998 and 1997, the Company maintained a reserve of
1,259,000 and 1,618,000 shares, respectively, of common stock to be issued to
holders of LTD Special Shares and options to purchase LTD Special Shares. The
holders of the Special Shares have the right to exchange one A Special Share for
two shares of the Company's common stock, and one B Special Share for 0.54612
share of the Company's common stock. Upon exchange, amounts will be transferred
from the LTD Special Shares account to the Company's common stock and additional
paid-in capital on the consolidated balance sheet.
During 1996, the Company issued a warrant to purchase 25,000 shares of common
stock at $9.25 per share to an investment banking firm in settlement for
services previously expensed. The warrant expires in August 2000.
The Company has adopted a 1987 Incentive Stock Plan and a 1994 Incentive Stock
Plan. Its wholly owned subsidiaries, PMC-Sierra, Inc. (Portland) and PMC-Sierra
Maryland Inc. have adopted 1996 and 1998 Stock Option Plans, respectively. These
plans cover grants of options to purchase the Company's common stock. Under
these Plans, Incentive Stock Options may be granted to employees and Non
Statutory Options may be granted to employees, directors and consultants, to
purchase shares of the Company's common stock at not less than 100% and 85%,
respectively, of the fair value of the stock on the date granted. The options
generally expire within five to ten years and vest over four years.
During 1998, the Company's common stockholders elected to add a provision to the
1994 Incentive Stock Plan. Under the new terms, the number of shares authorized
to be available for issuance under the plan shall be increased automatically on
January 1, 1999, and every year thereafter until the expiration of the plan. The
increase will be limited to the lesser of (i) 4% of the outstanding shares on
January 1 of each year, (ii) 2,000,000 shares, or (iii) an amount to be
determined by the Board of Directors.
Option activity under the option plans was as follows:
Weighted
Number of Options Average
Options Available Outstanding Exercise Price
For Issuance Per Share
Outstanding at December 31, 1995
(1,037,181 options exercisable at a
weighted average price of $5.43) 1,252,225 2,715,151 $ 8.13
Authorized 1,250,000 - -
Granted (weighted average fair value of
$6.79 per share) (1,403,574) 1,403,574 $14.11
Exercised - (503,825) $ 4.74
Expired (85,980) - -
Cancelled 515,878 (515,878) $12.73
----------- -----------
Outstanding at December 31, 1996
(1,252,874 options exercisable at a
weighted average price of $7.44) 1,528,549 3,099,022 $10.63
Authorized 500,000 - -
Granted (weighted average fair value of
$7.97 per share) (1,426,450) 1,426,450 $17.48
Exercised - (693,450) $ 7.22
Expired (36,112) - -
Cancelled 484,216 (484,216) $14.96
----------- -----------
Outstanding at December 31, 1997
(1,324,173 options exercisable at a
weighted average price of $9.28) 1,050,203 3,347,806 $13.62
Authorized 1,314,414 - -
Granted (weighted average fair value of
$21.77 per share) (1,381,114) 1,381,114 $28.82
Exercised - (786,212) $ 7.61
Cancelled 149,699* (163,391)* $21.96
----------- -----------
Outstanding at December 31, 1998 1,133,202 3,779,317 $20.10
=========== ===========
* During 1998, 13,692 options granted under the 1998 Option Plan were cancelled.
Under this plan, stock allocated to options subsequently cancelled may not be
re-allocated to new grants.
The following table summarizes information concerning options outstanding for
the combined option plans at December 31, 1998:
Options Outstanding Options Exercisable
-------------------------------------------------------- -------------------------------
Weighted Average Weighted Weighted
Remaining Average Average
Range of Exercise Number Contractual Life Exercise Number Exercise
Outstanding (years) Price per share Exercisable Price per share
Prices
$ 0.89 - $10.94 774,252 6.30 $ 7.38 584,429 $ 7.25
$11.25 - $14.63 766,222 8.01 $ 14.19 350,413 $ 14.16
$15.06 - $18.13 755,048 7.56 $ 16.37 448,009 $ 16.41
$18.38 - $30.56 776,933 8.73 $ 26.72 124,332 $ 22.45
$31.88 - $56.19 706,862 9.23 $ 37.36 30,583 $ 32.75
---------- ----------
$ 0.89 - $56.19 3,779,317 7.94 $ 20.10 1,537,766 $ 13.23
========== ==========
Employee Stock Purchase Plan. In 1991, the Company adopted an Employee Stock
Purchase Plan (ESPP) under Section 423 of the Internal Revenue Code and reserved
1,060,000 shares of common stock for issuance under the Plan. Under this Plan,
qualified employees may authorize payroll deductions of up to 10% of their
compensation (as defined) to purchase common stock at 85% of the lower of fair
market value at the beginning or end of the related subscription period. During
1998, 1997 and 1996, respectively, there were 96,429, 105,149 and 79,863 shares
issued under the Plan at weighted-average prices of $12.26, $10.40 and $8.38 per
share. The weighted-average fair value of the 1998, 1997 and 1996 awards was
$11.41, $6.96 and $3.78 per share, respectively. During 1998, the Company's
stockholders authorized an additional 250,000 shares to be available under the
plan. As of December 31, 1998, there were 298,625 shares of common stock
available for issuance under the purchase plan.
During 1998, the Company's stockholders elected to add a provision to the ESPP.
Under the new terms, the number of shares authorized to be available for
issuance under the plan shall be increased automatically on January 1, 1999, and
every year thereafter until the expiration of the plan. The increase will be
limited to the lesser of (i) 1% of the outstanding shares on January 1 of each
year, (ii) 500,000 shares, or (iii) an amount to be determined by the Board of
Directors.
Stock-based compensation. In accordance with the provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), the Company applies APB
Opinion 25 and related interpretations in accounting for its stock-based awards.
The Company's ESPP is non-compensatory under APB Opinion 25. The Company does
not recognize compensation expense for employee stock options, which are granted
with exercise prices equal to the fair market value at the date of grant.
Pro forma information regarding net income (loss) and net income (loss) per
share is required by SFAS 123 for awards granted or modified after December 31,
1994 as if the Company had accounted for its stock-based awards to employees
under the fair value method of SFAS 123. The fair value of the Company's
stock-based awards to employees was estimated using a Black-Scholes option
pricing model. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, the Black-Scholes model requires the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock-based awards to employees have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its
stock-based awards to employees. The fair value of the Company's stock-based
awards to employees was estimated using the multiple option approach,
recognizing forfeitures as they occur, assuming no expected dividends and using
the following weighted average assumptions:
Options ESPP
------------------------ -----------------------
1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ----
Expected life (years) 3.4 2.6 2.2 1.5 1.4 0.5
Expected volatility 0.7 0.7 0.8 0.7 0.8 0.8
Risk-free interest rate 5.2% 6.0% 5.7% 5.2% 5.9% 5.3%
If the computed fair values of 1998, 1997 and 1996 awards had been amortized to
expense over the vesting period of the awards as prescribed by SFAS 123, net
income (loss) and net income (loss) per share would have been:
(in thousands except per share amounts):
1998 1997 1996
---- ---- ----
Net income (loss) $ (15,369) $ 29,639 $ (54,006)
Basic net income (loss) per share $ (0.48) $ 0.95 $ (1.82)
Diluted net income (loss) per share $ (0.48) $ 0.92 $ (1.82)
The pro forma disclosures above include the effect of SFAS 128 relating to the
calculation of net income per share and FASB Technical Bulletin 97-1, which
clarified the application of SFAS 123 to the estimation of fair value of awards
under ESPP plans with a multiple year look-back feature.
Because SFAS 123 is applicable only to awards granted or modified subsequent to
December 31, 1994, the pro forma effect is not indicative of future pro forma
adjustments, when the calculation will apply to all applicable stock awards.
NOTE 7. Income Taxes
The income tax provisions, calculated under Statement of Financial Accounting
Standard No. 109 ("SFAS 109"), consist of the following (in thousands):
Year Ended December 31,
-------------------------------------
1998 1997 1996
Current:
Federal $ 190 $ (1,289) $ 2,109
State - - 42
Foreign 23,854 13,934 8,844
----------- ----------- -----------
24,044 12,645 10,995
----------- ----------- -----------
Deferred:
Federal (132) 1,671 (1,799)
Foreign (1,041) 1,411 562
----------- ----------- -----------
(1,173) 3,082 (1,237)
----------- ----------- -----------
Provision for income taxes $ 22,871 $ 15,727 $ 9,758
=========== =========== ===========
A reconciliation between the Company's effective tax rate and the U.S. Federal
statutory rate (35% in 1998, 1997 and 1996) is as follows (in thousands):
Year Ended December 31,
--------------------------------------
1998 1997 1996
Income taxes (recovery) at U.S. Federal statutory rate $ 6,998 $ 17,495 $ (14,522)
Net operating losses (utilized) not utilized (71) (4,508) 11,257
In-process research and development costs
relating to Bit acquisition - - 2,724
In-process research and development costs
relating to IGT acquisition 13,214 - -
In-process research and development costs
relating to other acquisitions 497 - -
Impairment of intangible asset 1,509 - -
Incremental taxes on foreign earnings 234 2,258 9,406
Other 490 482 893
------------ ----------- -----------
Provision for income taxes $ 22,871 $ 15,727 $ 9,758
============ =========== ===========
Significant components of the Company's deferred tax assets and liabilities are
as follows (in thousands):
December 31,
----------------------------
1998 1997
Deferred tax assets:
Net operating loss carryforwards $ 23,351 $ 22,053
State tax loss carryforwards 1,500 1,250
Credit carryforwards 3,497 2,436
Inventory valuation 430 229
Restructuring and other charges 3,245 5,984
Deferred income 1,506 734
------------- -------------
Total deferred tax assets 33,529 32,686
Valuation allowance (32,023) (31,952)
------------- -------------
Total net deferred tax assets 1,506 734
------------- -------------
Deferred tax liabilities:
Depreciation (4,015) (4,288)
Capitalized technology (342) (469)
------------- -------------
Total deferred tax liabilities (4,357) (4,757)
------------- -------------
Total net deferred taxes $ (2,851) $ (4,023)
============= =============
During 1998, the valuation allowance decreased by approximately $71,000 as a
result of utilization of net operating losses. During 1997, the valuation
allowance decreased by approximately $3,401,000.
The pretax income from foreign operations was $62,355,000 in 1998, $37,391,000
in 1997 and $23,044,000 in 1996.
At December 31, 1998, the Company has approximately $66,716,000 (including
$7,317,000 from IGT and $6,409,000 from Bit) of federal net operating losses,
which will expire from 1999 to 2013. Utilization of the IGT and Bit net
operating losses are subject to a limitation due to ownership change limitations
provided by the Internal Revenue Code of 1986.
The Company also has approximately $25,428,000 of state tax loss carryforwards,
which expire from 1999 to 2003. Included in the credit carryforwards are state
research and development credits of $1,324,000 which carryforward indefinitely
and $2,173,000 of federal research and development credits, which will expire
from 1999 to 2013.
Not included in the deferred assets are approximately $9,598,000 of cumulative
tax deductions related to equity transactions, the benefit of which will be
credited to stockholders' equity, if and when realized after the other tax
deductions in the carryforwards have been realized.
NOTE 8. Segment Information
The Company has two operating segments: networking and non-networking products.
The networking segment consists of internetworking semiconductor devices and
related technical service and support to equipment manufacturers for use in
their communications and networking equipment. The non-networking segment
includes user interface products such as custom, graphic, modem and other
semiconductors. The Company is supporting these products for existing customers,
but has decided not to develop any further products of this type. (See note 9)
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on gross margins from operations of the two segments.
Year Ended December 31,
----------------------------------------
1998 1997 1996
Networking
Net revenues $ 139,539 $ 85,512 $ 62,878
Cost of revenues 26,476 15,983 16,509
------------ ------------ ------------
Gross profit $ 113,063 $ 69,529 $ 46,369
============ ============ ============
Non- Networking
Net revenues $ 22,273 $ 41,654 $ 125,493
Cost of revenues 11,744 17,082 $ 78,439
------------ ------------ ------------
Gross profit $ 10,529 $ 24,572 $ 47,054
============ ============ ============
Total
Net revenues $ 161,812 $ 127,166 $ 188,371
Cost of revenues 38,220 33,065 94,948
------------ ------------ ------------
Gross profit $ 123,592 $ 94,101 $ 93,423
============ ============ ============
Information related to geographical areas is as follows:
Net revenues:
Year Ended December 31,
-------------------------------------------
1998 1997 1996
United States $ 110,256 $ 89,371 $ 102,632
Canada 15,780 12,373 2,678
Europe and Middle East 12,431 11,430 23,684
Asia 23,246 13,693 59,377
Other foreign 99 299 -
------------- ------------- -------------
$ 161,812 $ 127,166 $ 188,371
============= ============= =============
The Company attributes revenue among the geographical areas based on the
location of the customer invoiced.
Long-lived assets:
Year Ended December 31,
-------------------------------------------
1998 1997 1996
United States $ 35,873 $ 26,581 $ 37,919
Canada 38,865 29,297 23,690
Other 40 - -
------------- ------------- -------------
$ 74,778 $ 55,878 $ 61,609
============= ============= =============
Long-lived assets include property and equipment, goodwill and other intangible
assets, investments and other assets and deposits for wafer fabrication
capacity.
The Company has revenues from external customers (1998 - 2, 1997 and 1996 - 1)
that exceed total net revenues by 10% as follows:
Year Ended December 31,
-------------------------------------------
1998 1997 1996
Networking $ 31,549 $ 1,757 $ -
Non-Networking 18,579 21,403 18,850
NOTE 9. Restructuring
On September 29, 1996, the Company recorded charges of $69,370,000 in connection
with the Company's decision to exit from the modem chipset business and the
associated restructuring of the Company's non-networking product operations. The
charges were recorded in cost of sales as an inventory write down ($4,700,000)
and as restructure costs in operating expenses ($64,670,000). In 1997, the
company recorded a recovery of $1,383,000 from the reversal of the excess
accrued restructuring charge related to the completion of the restructuring.
There were no additional amounts incurred related to this restructuring in 1998.
The elements of the restructuring charge are as follows (in thousands):
Shortfall
Accrued Recovery (excess) in
Restructuring restructuring (Additional accrued
charge Sept. Write-down Actual reserve Dec. write down) Actual restructuring
29, 1996 of Assets Expenditures 31, 1996 of assets Expenditures reserve
------------- ------------ ------------ ------------- ------------- ------------ -------------
Write down of inventories to net
realizable value $ 23,000 $ (23,000) $ - $ - $ (1,371) $ - $ 1,371
Employee termination benefits 6,985 - (2,411) 4,574 - (4,950) 376
Loss on supplier commitments
and write off of prepaid expenses 9,908 (905) (409) 8,594 - (6,254) (2,340)
Write down of excess fixed
assets and assets related
to capacity commitments 16,580 (16,580) - - 942 - (942)
Provision for price protection and
product returns 5,047 (5,047) - - - - -
Excess facility costs 3,411 - (408) 3,003 - (2,507) (496)
Write down of goodwill related to
Company's B.V. subsidiary in
Holland 2,459 (2,459) - - - - -
Severance and closure costs
related to Europe 1,980 - (1,397) 583 - (1,231) 648
------------- ------------ ------------- ------------- ------------- ------------ -------------
$ 69,370 $ (47,991) $ (4,625) $ 16,754 $ (429) $ (14,942) $ (1,383)
============= ============ ============= ============= ============= ============ =============
As part of this restructuring, the Company ceased manufacturing its modem
chipset products in September 1996 and completed the shutdown of the
non-networking operations in San Jose by the middle of 1997. As a result of its
decision to exit the modem chipset business, the Company identified incremental
impairments in the carrying value of its non-networking inventory resulting in a
$23,000,000 write down of inventories to net realizable value. In 1997, an
additional write down of $1,371,000 was required on disposal of the remaining
inventory. The write down was included in the recovery recorded in 1997.
Termination benefits for approximately 245 employees associated with the
Company's non-networking operations were paid to employees as they reached their
termination dates, between November 1996 and July 1997. As at December 31, 1996,
118 had reached their termination dates and had left the Company. In 1996, the
Company accrued $6,985,000 in costs relating to employee termination benefits
and incurred expenditures of $2,411,000. In 1997, the Company incurred
expenditures of $4,950,000 completing the payment of employee termination
benefits and the shortfall in the accrual of $376,000 was included in the
recovery recorded in 1997.
In 1996, the Company recorded charges of $9,908,000 including a write down of
$905,000 and expenditures of $409,000 arising from losses on supplier
commitments and write off of prepaid expenses. In 1997, the Company settled the
remaining supplier commitments and other charges related to the restructuring
through expenditures of $6,254,000 and an excess accrual of $2,340,000 was
included in the recovery recorded in 1997.
In connection with its decision in 1996 to discontinue non-networking
operations, the Company evaluated the ongoing value of the fixed assets and
assets related to capacity commitments associated with these operations. Based
on this evaluation, the Company identified approximately $2.1 million of
non-networking property and equipment that will continue to be utilized in the
Company's networking operations. The remaining non-networking assets with a
carrying amount of approximately $11.6 million were determined to be impaired
and were written down by approximately $9.7 million to their estimated fair
market value. In addition, the Company recorded an impairment provision of
approximately $6.9 million in the value of certain leased assets related to IC
Works Inc. In 1997, on disposal of these assets, the Company realized overall
proceeds of $942,000 in excess of the written down value. The excess was
included in the recovery recorded in 1997.
In conjunction with the decision to exit the modem chipset business, the Company
was subject to incremental pricing pressure and potential returns of modem
chipset products. In 1996, a non cash charge of $5,047,000 was recorded as a
write down of related assets to provide for the potential impact of price
protection and product returns.
In 1996, the Company accrued charges of $3,411,000 relating to excess facility
costs primarily consisting of amounts to be incurred by the Company under a
seven year non-cancelable operating lease expiring in 2003. In 1996, the Company
incurred expenditures of $408,000 related to the charge. In 1997, the Company
successfully cancelled the lease resulting in expenditures of $2,507,000 and an
adjustment of $496,000 was included in the recovery recorded.
The Company's operations in Europe were closed as a result of the 1996 decision
to exit the modem chipset business. The charges related to the shutdown of the
European subsidiaries, including severance payments and excess facilities costs,
totaled $1,980,000, with expenditures in 1996 totaling $1,397,000. Additionally,
the restructuring charge included a write down of the remaining goodwill of
$2,459,000 for the Company's Holland operation. In 1997, the Company competed
its closure of the European operations and incurred expenditures of $1,231,000
resulting in an under accrual of $648,000 which was included in the recovery
recorded.
In 1997, expenditures associated with the restructuring charge were
approximately $14.9 million (1996 - $4.6 million), which were funded by the
Company's cash flow from operations.
NOTE 10. Net Income (Loss) Per Share.
The following table sets forth the computation of basic and diluted net income
(loss) per share:
December 31,
---------------------------------------
1998 1997 1996
Numerator:
Net income (loss) $ (2,878) $ 34,258 $ (48,150)
------------ ----------- ------------
Denominator:
Basic weighted average common shares outstanding (1) 32,002 31,043 29,719
Effect of dilutive securities:
Stock options - 1,585 -
Stock warrants - 14 -
------------ ----------- ------------
Diluted weighted average common shares outstanding 32,002 32,642 29,719
============ =========== ============
Basic net income (loss) per share $ (0.09) $ 1.10 $ (1.62)
============ =========== ============
Diluted net income (loss) per share $ (0.09) $ 1.05 $ (1.62)
============ =========== ============
(1) PMC-Sierra, Ltd. Special Shares are included in the calculation of basic net
income per share.
PART III
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
ITEM 10. Directors and Executive Officers of the Registrant
The information concerning the Company's directors required by this Item is
incorporated by reference to the Company's Proxy Statement for its 1999 Annual
Meeting of Stockholders ("Proxy Statement"). The following sets forth
information regarding executive officers of the Company as of February 28, 1999.
Name Age Position
- ------------------ ----- ---------------------------------------------------
Robert L. Bailey 41 President and Chief Executive Officer
Greg Aasen 43 Chief Operating Officer
John W. Sullivan 52 Vice President, Finance and Chief Financial Officer
Officers serve at the discretion of the Board of Directors. There are no family
relationships between any of the directors or officers of the Company.
Mr. Bailey has served as Director of the Company since October 1996 and as
President and Chief Executive Officer since July 1997. In prior years, Mr.
Bailey acted as President and Chief Executive Officer of PMC-Sierra, Ltd. Prior
to joining the Company, Mr. Bailey was employed by AT&T-Microelectronics from
August 1989 to November 1993, where he served as Vice President of Integrated
Microperipheral Products. Mr. Bailey was formerly employed by Texas Instruments
in various management assignments from June 1979 to August 1989.
Mr. Aasen has served as Chief Operating Officer of the Company since February
1997. Mr. Aasen is a founder of PMC-Sierra, Ltd. and served as its Chief
Operating Officer and Secretary since its formation in June 1992. He has served
as a director of PMC-Sierra, Ltd. since August 1994. Prior to joining PMC-Sierra
Ltd., Mr. Aasen was a General Manager of PMC, a division of MPR Teltech, Ltd.
Mr. Sullivan joined the Company in April 1997 as Vice President, Finance and
Chief Financial Officer. Prior to joining the Company, he was employed by
Semitool Inc., a semiconductor equipment manufacturer, as VP Finance from 1993
to 1997. Prior to his employment with Semitool Inc., Mr. Sullivan was employed
by United Dominion Industries and Arthur Young & Company.
ITEM 11. Executive Compensation.
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
PART IV
ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Consolidated Financial Statements
The financial statements (including the notes thereto) listed in
the accompanying index to financial statements and financial
statement schedules are filed within this Annual Report on Form
10-K.
2. Financial Statement Schedules
The financial statement schedule listed on page 37 in the
accompanying index to financial statements and financial statement
schedule is filed within this Annual Report on Form 10-K.
3. Exhibits
The exhibits listed under Item 14(c) are filed as part of this Form
10-K Annual Report.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company in the quarter ended
December 31, 1998.
(c) Exhibits pursuant to Item 601 of Regulation S-K.
Exhibit Description Page
Number Number
- -------- ---------------------------------------------------------------------------- ------
2.1 Exchange Agreement dated September 2, 1994 between the Company and (C)
PMC-Sierra, Ltd.
2.2 Amended and Restated Shareholders' Agreement dated September 2, 1994 (C)
among the Shareholders of PMC-Sierra, Inc.
2.3 Amendment to Exchange Agreement effective August 9, 1995 (F)
3.1 Certificate of Incorporation (I)
3.1A Certificate of Amendment to the Certificate of Incorporation (N)
filed June 13, 1997
3.1B Certificate of Amendment to the Certificate of Incorporation (N)
filed July 11, 1997
3.1C Certificate of Amendment to Certificate of Incorporation of PMC-Sierra, (O)
Inc. filed on June 4, 1998.
3.2 Bylaws, as amended --
4.1 Specimen of Common Stock Certificate (K)
4.3 Terms of PMC-Sierra, Inc. Special Shares (D)
10.1B 1987 Incentive Stock Plan, as amended (B)
10.2 1991 Employee Stock Purchase plan, as amended --
10.4 Form of Indemnification Agreement between the Company and its directors (H)
and officers
10.8 Warrants to Purchase Common Stock (A)
10.8B Warrant Purchase Agreement and Warrants to Purchase Shares of Common (J)
Stock dated August 28, 1996
10.9D Technology License Agreement dated November 18, 1987, as amended (A)
July 17, 1990
10.17 PMC-Sierra, Inc. 1994 Incentive Stock Plan (E)
10.18 Deposit Agreement with Chartered Semiconductor Pte. Ltd.* (G)
10.18B Amendment Agreement (No. 1) to Deposit Agreement with Chartered (J)
Semiconductor Pte. Ltd.*
10.19 Option Agreement among Sierra Semiconductor Corporation, PMC-Sierra, (J)
Inc., and Taiwan Semiconductor Manufacturing Corporation*
10.21 PMC-Sierra Inc. (Portland) 1996 Stock Option Plan (O)
10.22 Net Building Lease (PMC-Sierra, Ltd.), dated May 15, 1996 (J)
10.23 Revolving Operating Line of Credit Agreement between PMC-Sierra, Inc. (O)
and CIBC Inc. dated 21st day of May 1998.
10.24 Revolving Operating Line of Credit Agreement between PMC-Sierra, Ltd. (O)
And CIBC dated 21st day of May 1998.
10.25 Pledge Agreement between PMC-Sierra, Inc and CIBC Inc. with respect to (O)
shares of PMC-Sierra Ltd. dated 11th day of March, 1998.
10.26 Pledge Agreement between PMC-Sierra, Inc and CIBC Inc. with respect to (O)
shares of PMC-Sierra International Inc. dated 27th day of April 1998.
10.27 Guarantee Agreement between PMC-Sierra, Inc. and CIBC dated 27th day of (O)
April, 1998.
10.28 1998 PMC-Sierra (Maryland), Inc. Stock Option Plan (O)
11.1 Calculation of earnings per share (M)
16.1 Letter regarding change in certifying accountant (L)
21.1 Subsidiaries --
23.1 Consent of Ernst & Young LLP, Independent Auditors --
23.2 Consent of Deloitte & Touche, Independent Auditors --
24.1 Power of Attorney (P)
* Confidential treatment has been granted as to a portion of this exhibit.
(A) Incorporated by reference from the same-numbered exhibit filed with the Registrant's
Registration Statement on Form S-1 (No. 33-39406).
(B) Incorporated by reference from the same-numbered exhibit filed with the Registrant's
Form 10-K Annual Report for the fiscal year ended January 3, 1993.
(C) Incorporated by reference from the same-numbered exhibit filed with the Registrant's
Current Report on Form 8-K, filed on September 16, 1994, as amended.
(D) Incorporated by reference from exhibit 4 of the Schedule 13-D filed on November 2,
1994 by GTE Corporation.
(E) Incorporated by reference from the same numbered exhibit filed with the Registrant's
Form 10-K Annual Report for the fiscal year ended January 2, 1994.
(F) Incorporated by reference from exhibit 2.1 filed with Registrant's Current Report on
Form 8-K, filed on September 6, 1995, as amended on October 6, 1995.
(G) Incorporated by reference from the same numbered exhibit filed with the Registrant's
Form 10-K Annual Report for the fiscal year ended December 31, 1995.
(H) Incorporated by reference from exhibit 10.21 filed with Registrant's Form 10-Q for
the quarter ended June 30, 1997.
(I) Incorporated by reference from exhibit 3.1 filed with Registrant's Form 10-Q for the
quarter ended June 30, 1997.
(J) Incorporated by reference from the same numbered exhibit filed with the Registrant's
Form 10-K Annual Report for the fiscal year ended December 31, 1996.
(K) Incorporated by reference from exhibit 4.4 filed with the Registrant's Current Report
on Form 8-K, filed on August 29, 1997.
(L) Incorporated by reference from exhibit 16.1 filed with the Registrant's Current
Report on Form 8-K, filed on April 18, 1997.
(M) Refer to Note 12 of the financial statements included in Item 8 of Part II of this
Annual Report.
(N) Incorporated by reference from the same numbered exhibit filed with the Registrant's
Form 10-K Annual Report for the fiscal year ended December 31, 1997.
(O) Incorporated by reference from same numbered exhibit filed with the Registrant's Form
10-Q Quarterly Report for the quarterly period ended June 28, 1998.
(P) Incorporated by reference from Signatures page of this Annual Report.
(d) Financial Statement Schedules required by this item are listed on page
22 in the accompanying index to the financial statements.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PMC-SIERRA, INC.
(Registrant)
Date: March 25, 1999 /s/ Robert L. Bailey
-----------------------------------------
Robert L. Bailey, Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Robert L. Bailey and John W. Sullivan, jointly
and severally, his attorneys-in-fact, each with the power of substitution, for
him in any and all capacities, to sign any amendments to this Report on Form
10-K, and to file the same, with exhibits thereto and other documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his
substitute or substitutes, may or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Name Title Date
/s/ James V. Diller Chairman of the Board and Director March 25, 1999
- ------------------- --------------
James V. Diller
/s/ Robert L. Bailey Director and Chief Executive Officer March 25, 1999
- -------------------- --------------
Robert L. Bailey
/s/ John W. Sullivan Vice President Finance, Chief Financial Officer March 25, 1999
- -------------------- (and Principal Accounting Officer) --------------
John W. Sullivan
/s/ Colin Beaumont Director March 25, 1999
- ------------------ --------------
Colin Beaumont
/s/ Frank Marshall Director March 25, 1999
- ------------------ --------------
Frank Marshall
/s/ Alexandre Balkanski Director March 25, 1999
- ----------------------- --------------
Alexandre Balkanski
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 1998, 1997 and 1996
(in thousands)
Allowance for Doubtful Accounts
Additions Additions
Year Balance at charged to charged to
beginning of costs and other Balance at
year expenses accounts Write-offs end of year
1998 $ 1,070 241 - 183 $ 1,128
1997 $ 842 500 - 272 $ 1,070
1996 $ 1,081 666 - 905 $ 842
INDEX TO EXHIBITS
Exhibit Page
Number Description Number
--------- -------------------------------------------------------- --------
3.2 Bylaws, as amended -
10.2 1991 Employee Stock Purchase plan, as amended -
21.1 Subsidiaries -
23.1 Consent of Ernst & Young LLP, Independent Auditors -
23.2 Consent of Deloitte & Touche LLP, Independent Auditors -