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EX-32.1 - CERTIFICATION PURSUANT TO SECTION 906 (CHIEF EXECUTIVE OFFICER) - PMC SIERRA INCdex321.htm
EX-10.6 - FORM OF CHANGE OF CONTROL AGREEMENT - PMC SIERRA INCdex106.htm
EX-23.1 - CONSENT OF DELOITTE & TOUCHE LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS - PMC SIERRA INCdex231.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 (CHIEF FINANCIAL OFFICER) - PMC SIERRA INCdex312.htm
EX-12.1 - STATEMENT OF COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - PMC SIERRA INCdex121.htm
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 (CHIEF EXECUTIVE OFFICER) - PMC SIERRA INCdex311.htm
EX-32.2 - CERTIFICATION PURSUANT TO SECTION 906 (CHIEF FINANCIAL OFFICER) - PMC SIERRA INCdex322.htm
EX-21.1 - SUBSIDIARIES OF THE REGISTRANT - PMC SIERRA INCdex211.htm
Table of Contents

 

 

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, 2009

 

¨ 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 of incorporation or organization)    (I.R.S. Employer Identification No.)

3975 Freedom Circle

Santa Clara, CA 95054

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (408) 239-8000

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

  

Name of exchange on which registered

Common Stock, $0.001 Par Value

Preferred Stock Purchase Rights

   The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    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.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

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

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 June 28, 2009 as reported by the NASDAQ Global Market, was approximately $1.1 billion. Shares of Common Stock held by each executive officer and director and by each person known to the Registrant who owns 5% or more of the outstanding voting stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of February 22, 2010, the Registrant had 228,774,352 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for Registrant’s 2010 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K Report.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page
PART I

Item 1.

  

Business

   3

Item 1A.

  

Risk Factors

   11

Item 1B.

  

Unresolved Staff Comments

   22

Item 2.

  

Properties

   22

Item 3.

  

Legal Proceedings

   22

Item 4.

  

Submission of Matters to a Vote of Security Holders

   23
PART II

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   24

Item 6.

  

Selected Financial Data

   26

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   32

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   49

Item 8.

  

Financial Statements and Supplementary Data

   51

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   88

Item 9A.

  

Controls and Procedures

   88

Item 9B.

  

Other Information

   91
PART III

Item 10.

  

Directors, Executive Officers and Corporate Governance

   92

Item 11.

  

Executive Compensation

   92

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   92

Item 13.

  

Certain Relationships and Related Transactions and Director Independence

   93

Item 14.

  

Principal Accountant Fees and Services

   93
PART IV

Item 15.

  

Exhibits and Financial Statement Schedules

   93

SIGNATURES

   96

 

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PART I

 

ITEM 1. BUSINESS.

OVERVIEW

PMC-Sierra, Inc. (“PMC” or the “Company”) designs, develops, markets and supports semiconductor solutions for the Enterprise Infrastructure market and the Communications Infrastructure market. The Company offers worldwide technical and sales support through a network of offices in North America, Europe and Asia. We have approximately 400 different semiconductor devices that are sold to leading equipment and design manufacturers, who in turn supply their equipment principally to service providers, carriers and enterprises globally. We provide semiconductor solutions for our customers by leveraging our intellectual property, design expertise and systems knowledge across a broad range of applications and industry protocols.

PMC was incorporated in the State of California in 1983 and reincorporated in the State of Delaware in 1997. Our Common Stock trades on the NASDAQ Global Select Market under the symbol “PMCS”.

Our principal executive offices are located at 3975 Freedom Circle, Santa Clara, California 95054. Our internet webpage is located at www.pmc-sierra.com; however, the information accessed on or through our webpage is not part of this report. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports are available, free of charge, on our webpage after we electronically file or furnish such material with the Securities and Exchange Commission (“SEC”). The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100F Street, NE., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

Our fiscal year normally ends on the last Sunday of the calendar year. Fiscal years 2009, 2008 and 2007 consisted of 52 weeks. In this Annual Report on Form 10-K, “PMC-Sierra”, “PMC”, “the Company”, “us”, “our” or “we”, mean PMC-Sierra, Inc. together with our subsidiary companies.

FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (this “Annual Report”) and the portions of our Proxy Statement incorporated by reference into this Annual Report contain forward-looking statements that involve risks and uncertainties. We use words such as “anticipates”, “believes”, “plans”, “expects”, “future”, “intends”, “may”, “should”, “estimates”, “predicts”, “potential”, “continue”, “becoming”, “transitioning” and similar expressions to identify such forward-looking statements.

These forward-looking statements apply only as of the date of this Annual Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks we face as described under “Item IA. Risk Factors” and elsewhere in this Annual Report and our other filings with the SEC. Investors are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. Such forward-looking statements include statements as to, among others:

 

   

business strategy;

 

   

business outlook;

 

   

sales, marketing and distribution;

 

   

wafer fabrication capacity;

 

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competition and pricing;

 

   

critical accounting policies and estimates;

 

   

customer product inventory levels, needs and order levels;

 

   

demand for networking, storage and consumer equipment;

 

   

net revenues;

 

   

gross profit;

 

   

research and development expenses;

 

   

selling, general and administrative expenses;

 

   

other income (expense), including interest income (expense);

 

   

foreign exchange rates;

 

   

taxation rates and tax provision;

 

   

sources of liquidity and liquidity sufficiency;

 

   

capital resources;

 

   

capital expenditures;

 

   

restructuring activities, expenses and associated annualized savings;

 

   

cash commitments;

 

   

purchase commitments;

 

   

use of cash;

 

   

expectation regarding our amortization of purchased intangible assets; and

 

   

expectations regarding distribution from certain investments.

This Annual Report should be read in conjunction with our periodic filings made with the SEC subsequent to the date of the original filing, including any amendments to those filings, as well as any current reports filed on Form 8-K subsequent to the date of the original filing.

INDUSTRY OVERVIEW

Growth in Internet usage and digital consumer devices continues to drive demand for bandwidth and efficient networks that can manage high levels of data and video traffic. At the same time, communication service providers are seeking ways to increase their revenues by bundling and delivering a range of services to their customers in a cost-effective manner. Applications such as Voice Over Internet Protocol (“VoIP”), video-on-demand and Internet Protocol Television (“IPTV”) are enabled by advanced technology such as third generation wireless services, network-attached storage, Fiber-To-The-Home access and Metro Optical Transport networks. This results in increasing requirements for carriers and enterprises to upgrade and improve their network infrastructure and storage management capabilities. Enterprises, governments, corporations, small offices and home offices are expanding their networks to better capture, store and access large quantities of data, efficiently and securely.

MARKETS THAT WE SERVE

We sell our semiconductor solutions primarily into two general markets: the Enterprise Infrastructure market and the Communications Infrastructure market. The products and solutions that we sell into the Communications infrastructure market are largely driven by the capital spending of service providers in the

 

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communications networking equipment industry. Our products and solutions that are sold into the Enterprise Infrastructure market are driven primarily by the capital spending of corporations, enterprises and smaller businesses. In 2009, our revenues were derived approximately 50% from the Communications Infrastructure market and 50% from the Enterprise Infrastructure market.

The general market areas that we currently serve and some typical equipment in those markets that contain our semiconductor solutions are described below. Due to the complexity of the global communications network, it is not possible to sharply delineate networking functions or markets served. In addition, many of our products may be used in multiple classes of networking equipment that are deployed across all of the market areas identified below, while others have highly specialized applications.

Communications Infrastructure

The Communications Infrastructure market encompasses wired, wireless and Passive Optical Networking (“PON”) devices used in access, aggregation and transport equipment such as optical transport platforms, edge routers, multi-service switches, and wireless base stations that gather and process signals in different protocols, and transmit them to the next destination.

For high-capacity data communication over fibre optic systems, the standard used is Synchronous Optical Networks (“SONET”) in North America and parts of Asia, and is Synchronous Digital Hierarchy (“SDH”) in the rest of the world. In addition to using SONET/SDH to increase the bandwidth or capacity, of their networks, many service providers have started implementing packet-based transport equipment in the core and access portions of the network using the new standard called Optical Transport Network (“OTN”).

With demands for access bandwidth increasing, PON is being deployed by carriers worldwide to facilitate higher speed service to residences and enterprises. Instead of copper cables, fibre is deployed to the neighborhood, the multi-dwelling unit or the residence, to increase bandwidth and improve the uploading and downloading files in both directions. The advantage of PON is that it provides high bandwidth without sensitivity to the distance between the central office and the subscriber. This technology is being deployed in Japan, China, Korea and the United States (“U.S.”).

Our solutions are used in equipment such as aggregation, multi-service provisioning platforms, routers and optical transport platforms that gather and process signals in different protocols, and then transmit them to the next destination as quickly and efficiently as possible. The next-generation networking equipment can efficiently handle different data protocols and is often referred to as “multi-service” because it can facilitate the transmission of Internet Protocol (“IP”) packets and Time-Division Multiplexing (“TDM”) signals over optical fibre. We are developing complex architectural silicon solutions to help our customers manage the increasing level of diverse traffic in the Wide Area Network to handle voice, video and data services. The Wide Area Network also involves the termination and distribution of separate higher speed data signals into lower speed data signals. Many of our devices that are used in wireline communications equipment can also be deployed in the backhaul transport of wireless data from base station transceivers and base station controllers.

Enterprise Infrastructure

Our products and solutions in the Enterprise Infrastructure market enable the high-speed interconnection of the servers, switches and storage devices that comprise these systems thus allowing large quantities of data to be stored, managed and moved securely. Our focus in this area is developing interconnect devices and controllers for Fibre Channel, Serial Attached SCSI (“SAS”) and Serial ATA (“SATA”). We are shipping next-generation solutions for 8 Gbps Fibre Channel controllers for high-performance storage systems in the Storage Area Network (“SAN”) and Network Attached Storage (“NAS”) markets, as well as 6 Gbps SAS/SATA controllers and expanders for this market. PMC-Sierra has also developed semiconductor and adaptor solutions for the 6 Gbps server-attached storage market.

 

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In another part of the Enterprise Infrastructure market, PMC provides integrated solutions for laser printers, switches and routers that are used by enterprises and small businesses to manage their data on an inter-office and intra-office basis. In the laser printer market, we sell our standalone microprocessors and integrated system-on-chip devices primarily into the mid-to high-end and multi-function segments of that market. We also have applications for network-attached storage for small and medium sized businesses.

OUR PRODUCTS

Most of our semiconductors can be divided into broadly defined functional categories as identified below. As with descriptions of the network, particular categories may overlap and a device may be present in more than one category. In addition, some products may integrate several different functions and therefore could be classified in one or more categories. For example, some of our products convert high-speed analog signals (“wired” or “wirelessly”) to digital signals and split or combine various transmission signals.

Controllers: rapid growth in data storage is driving a need for more cost-effective and larger capacity storage systems. Controller products based on Fibre Channel, SAS and SATA enable the development of external and server-attached storage systems that meet the cost and capacity requirements of our customers.

Framers and mappers: before data can be sent to the next destination, it must be converted into a proper format for transmission in the network. For example, the framing function arranges the bits into different size formats, commonly referred to as “cell” or “packet” formats, and attaches the appropriate information to the formats to ensure they reach their destinations. In turn, this data may be inserted into other frames, such as SONET/SDH frames, for transmission across high-speed fibre optic networks.

Line interface units: these devices, also referred to as transceivers, transmit and receive signals over a physical medium such as wire, cable or fibre. The line interface unit determines the speed and timing characteristics of the signals, and may also convert them from a serial stream of data into a parallel stream before they are further processed for transmission to the next destination.

Microprocessor-based System-On-Chips (“SOCs”): these devices perform the high-speed computations that help identify and control the flow of signals and data in many different types of networking equipment used in the communications, storage and enterprise markets. With greater demand for integration of features and functions on a single device, more highly-integrated system-on-chip solutions are being developed.

Packet and cell processors: these devices examine the contents of cells, or packets, and perform various management and reporting functions. For instance, a switch or router may use a packet or cell processor to determine if a signal is voice or video in order to allocate the proper amount of bandwidth for transmission.

Radio Frequency (“RF”) transceivers: the rapid growth of mobile and nomadic data services is accelerating the need for higher bandwidth RF transceivers (a.k.a. radios). These radios transmit and receive broadband signals over the air using Orthogonal Frequency-Division Multiple Access (“OFDMA”) based protocols and Multiple-Input-Multiple-Output (“MIMO”) antenna technology.

Serializers/Deserializers: these devices convert and multiplex traffic between slower speed parallel streams and higher speed serial streams. Original Equipment Manufacturers (“OEMs”) use serial streams to reduce networking equipment line connections and parallel streams to allow them to apply lower cost traffic management technologies.

 

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OUR BUSINESS FOCUS

The semiconductor solutions we develop are based on our knowledge of network applications, system requirements and networking protocols, and high-speed mixed-signal and system-on-chip design expertise. Our mission is to be the premier Internet infrastructure semiconductor solutions provider in the industry. To achieve this, while expanding our business profitably, we are focusing our efforts in the following five areas:

 

1. Provide best-in-class products, customer service and technical support.

We work very closely with our customers to intimately understand their application and product needs. Beyond striving to deliver best-in-class products, we aim to ensure they get the best service and technical support required to assist them with their product development efforts. We have a strong history of analog, digital, mixed-signal and microprocessor expertise that allows PMC to integrate many of these functions and protocols into complex devices. We leverage our common technologies and intellectual property across a broad range of communications and storage equipment. Our OEM customers include Alcatel-Lucent, Cisco Systems Inc., EMC Corp., Fiberhome Networks Company Ltd. (“FiberHome”), Fujitsu Ltd. (“Fujitsu”), Hewlett-Packard Company (“H-P”), Hitachi, Ltd. (“Hitachi”), Huawei Technologies Co., Ltd. (“Huawei”), Mitsubishi Electric Corp. (“Mitsubishi Electric”) and ZTE Corp (“ZTE”).

 

2. Expand our business in the enterprise storage systems markets.

We are broadening our product line for the external and server-attached storage markets, as new standards and integration takes place. With growth in cloud computing services, we see more demand in the storage and data center markets. Our focus remains on Fibre Channel products and high-performance interconnect devices and controllers that are based on SAS and SATA. We expect the need for faster and more complex devices will increase as next-generation storage systems are deployed. We offer controller and adaptor solutions for server-attached storage systems for customers.

 

3. Protect and extend our position in the Communications Infrastructure market.

PMC has a strong track record in developing semiconductor solutions for the access, aggregation and metro transport portion of the market. With more data and video moving on to the global network, we continue to develop new technologies that enable higher speed, lower latency, and more efficient systems for global service providers. As next-generation Optical Transport Platforms are introduced into the Metro area of the network, PMC is delivering solutions that enable this class of equipment.

 

4. Expand our business in the Fiber-To-The-Home (“FTTH”) market.

We are working very closely with carriers and OEMs around the world to help them design and develop solutions that enable speeds of 100 Mbps, 1 Gbps and greater to the customer premise to provide bandwidth that is required for video on demand and IPTV. We believe PON technology is the next major step in broadband access. We are investing to maintain our leadership position in the PON market and to help this new market expand across the globe.

 

5. Continue to increase our presence in Asian markets.

We continue to strengthen our relationships and business activity with our Asian customers. In November 2009, we opened our new International headquarters located in Penang, Malaysia. This step brings us closer to our suppliers and customers. In 2009, we expanded our sales, service and design center in Shanghai, China and continue to expand our technology center in Bangalore, India. Our revenues continued to increase in the Asia Pacific region in 2009, which includes China, Japan and Korea. Some of our largest customers in China include Huawei, ZTE and FiberHome. In Japan, our largest customers include Hitachi, Fujitsu, Mitsubishi Electric, Sumitomo Electric Industries Ltd. and Ricoh Company Ltd. Our customers in Asia are broadening their product offerings in FTTH, 3G wireless infrastructure, metro transport, edge routing and storage networking platforms.

 

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SALES, MARKETING AND DISTRIBUTION

Our sales and marketing strategy is to have our products designed into our customers’ equipment by developing superior products for which we provide best-in-class service and technical support. Our marketing team is focused on developing new products and solutions that meet the needs of our customers, including OEMs and original design manufacturers. We are often involved in the early stages of design concerning our customers’ plans for new equipment. This helps us determine if our existing products can be used in their new equipment or if new devices need to be developed for the application. To assist us in our planning process, we are in regular contact with our key customers to discuss industry trends, emerging standards and ways in which we can assist in their new product requirements.

Our sales team is focused on selling and supporting our chips and chipsets for equipment providers who are in turn selling their products to service providers, enterprises, or consumers. To better match our available sales resources to market opportunities, we also focus our sales and support efforts on targeted customers.

We sell our products to end customers directly and through distributors and independent manufacturers’ representatives. In 2009, less than 22% of our orders were shipped through distributors, approximately 43% were sent by us directly to contract manufacturers selected by OEMs, and the balance were sent directly to our OEM customers.

In 2009, our largest distributor was Avnet Inc. (“Avnet”), which represented our products worldwide (excluding Japan, Israel, and Taiwan). We recognize sales through Avnet on a sell-through basis, which occurs when Avnet ships our products to the end customer. In 2009, total sales shipped through Avnet worldwide were 14% of our total net revenues. Our second largest distributor is Macnica Inc. Sales shipped through this distributor in 2009 were approximately 11% of our total net revenues.

In 2009, we had one end customer that accounted for more than 10% of our revenues: H-P.

Our sales outside of the United States, based on customer billing location, accounted for 87%, 80% and 80% of total revenue in 2009, 2008 and 2007, respectively. Our sales to customers in Asia, including Japan and China, increased to 84% of sales in 2009 from 73% of sales in 2008 in part because many of our OEM customers increased the use of Asia-based contract manufacturers for the assembly of their products.

See Item 1A. Risk Factors for further information on risks attendant to our foreign operations and dependence.

MANUFACTURING

PMC-Sierra is a fabless company, meaning that we do not own or operate foundries for the production of the silicon wafers from which our products are made. Instead, we work with independent merchant foundries and chip assemblers for the manufacture of our products. We believe our fabless approach to manufacturing provides us with the benefit of superior manufacturing capability, scalability, as well as the flexibility to move wafer manufacture, assembly and test of our products to the vendors that offer the best technology and service at a competitive price.

Our lead-time, or the time required to manufacture our devices, is typically 12 to 16 weeks. Based on this lead-time, our team of production planners initiates purchase orders with our wafer suppliers and with our chip assemblers for the assembly and test of our parts so that, to the best of our ability, our products are available to meet customer demand.

 

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Wafer Fabrication

We manufacture our products at independent foundries using standard Complementary Metal Oxide Semiconductor (“CMOS”) process techniques. We have in the past purchased silicon wafers from which we manufacture our products from Globalfoundries Inc. (previously, Chartered Semiconductor Manufacturing Ltd.), Taiwan Semiconductor Manufacturing Corporation (“TSMC”) and United Microelectronics Corporation (“UMC”). These independent foundries produce the wafers for our networking semiconductor products ranging in sizes from 0.18 micron to 40 nanometer. By using independent foundries to fabricate our wafers, we are better able to concentrate our resources on designing, developing and testing of new products. In addition, we avoid the fixed costs associated with owning and operating fabrication and chip assembly facilities and the costs associated with updating these facilities to manage constantly evolving process technologies.

We have supply agreements with TSMC and UMC. Under these supply agreements, the foundries must supply certain quantities of wafers per year. Neither of these agreements have minimum unit volume requirements. These agreements may be terminated if either party does not comply with the terms. We have a history of renewing contracts on an annual basis with our foundries for those agreements that require renewals, and we do not anticipate any problems with renewing such agreements beyond their current expiry dates.

Assembly and Test

Once our wafers are fabricated, they must be probed or inspected, to identify which individual units, referred to as die, were properly manufactured. Most wafers that we purchase are sent directly to an outside assembly house where the die are individually cut and packaged into semiconductor devices. The individual devices are then run through various electrical, mechanical and visual tests before customer delivery. PMC has recently outsourced the remaining in-house portion of its wafer probe and final test capability to subcontract test providers.

Quality Assurance

The industries that we serve require high quality, reliable semiconductors for incorporation into their equipment. We pre-qualify each vendor, foundry, assembly and test subcontractor. Wafers supplied by outside foundries must meet our incoming quality and test standards. The testing function is performed predominantly by independent Asian and U.S. companies.

Since 2006, there has been an increase in the proportion of products being produced for PMC by turnkey application-specific integrated circuit (“ASIC”) vendors due to PMC’s acquisitions of the Storage Semiconductor Business and Passave. Although PMC does not physically manage the bulk of this production, these products follow approved and audited flows conforming to PMC’s Quality Assurance requirements.

RESEARCH AND DEVELOPMENT

Our research and development efforts are market- and customer-focused and can involve the development of both hardware and software. These devices and reference designs are targeted for use in enterprise, storage and service provider markets. Increasingly, our OEM customers that serve these end markets are demanding complete solutions with software support and complex feature sets and we are developing products to fill this need.

From time to time we announce new products to the public once development of the product is substantially completed and there are no longer significant technical risks and costs to be incurred. As we have a portfolio of approximately 400 products, we do not consider any individual new product or group of products released in a year to be material, beyond our continuing development of a portfolio of products that meet our customers’ future needs.

 

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At the end of fiscal 2009, we had design centers in the United States (California, Pennsylvania and Minnesota), Canada (British Columbia and Quebec), Israel (Herzliya), China (Shanghai) and India (Bangalore).

Our research and development spending was $149.2 million in 2009, $157.6 million in 2008 and $159.1 million in 2007.

BACKLOG

Our sales originate from customer purchase orders. However, our customers frequently revise order quantities and shipment schedules to reflect changes in their requirements. As of December 27, 2009, our backlog of products scheduled for shipment within three months totaled approximately $126.9 million (2008—$68.0 million). Unless our customers cancel or defer to a subsequent year a portion of this backlog, we expect this entire backlog to be filled in 2010.

Our backlog includes our backlog of shipments to direct customers, minor distributors and a portion of shipments by our major distributor to end customers. Our customers may cancel or defer backlog orders. Accordingly, we believe that our backlog

at any given time is not a meaningful indicator of future long-term revenues. Backlog is a non-GAAP measure and may not be comparable between companies.

COMPETITION

We typically face competition at the customer design stage when our customers are determining which semiconductor components to use in their equipment designs.

Most of our customers choose a particular semiconductor component primarily based on whether the component:

 

   

meets the functional requirements;

 

   

interfaces easily with other components in the product;

 

   

meets power usage requirements;

 

   

is priced competitively; and

 

   

is commercially available on a timely basis.

OEMs are becoming more price conscious as semiconductors sourced from third party suppliers start to comprise a larger portion of the total materials cost in OEM equipment. This price sensitivity from our customers can lead to aggressive price competition by competing suppliers that may force us to decrease our prices to win a design and therefore decrease our gross profit.

OEMs also consider the quality of the supplier when determining which component to include in a design. Many of our customers will consider the breadth and depth of the supplier’s technology, as using one supplier for a broad range of technologies can often simplify and accelerate the design of next generation equipment. OEMs will also consider a supplier’s design execution reputation, as many OEMs design their next generation equipment concurrently with the semiconductor component design. OEMs also consider whether a supplier has been pre-qualified, as this ensures that components made by that supplier will meet the OEM’s quality standards.

We compete against established peer-group semiconductor companies that focus on the communications and storage semiconductor business. These companies include the following: Altera Corp., Applied Micro Circuits Corp.; Broadcom Corp.; Cortina Systems, Inc.; Emulex Corp.; Exar Corp.; Infineon Technologies AG;

 

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Intel Corp.; LSI Corp.; Maxim Integrated Products, Inc.; Marvell Technology Group Ltd.; Mindspeed Technologies, Inc.; QLogic Corp.; and Xilinx, Inc. Many of these companies are well financed, have significant communications semiconductor technology assets and established sales channels, and depend on the market in which we participate for the bulk of their revenues.

Over the next few years, it is possible for additional competitors to enter the market with new products, some of which may also have greater financial and other resources than we do.

We are also continuing to expand into certain markets, such as the Enterprise Infrastructure market that have established incumbents with substantial financial and other resources. Some of these incumbents derive a majority of their earnings from these markets. We expect continued strong competition in these markets.

LICENSES, PATENTS AND TRADEMARKS

We rely in part on patents to protect our intellectual property and have a total of 287 U.S. and 87 foreign patents for circuit designs and other innovations used in the design and architecture of our products. In addition, we have 97 patent applications pending in the U.S. Patent and Trademark office. Our patents typically expire 20 years from the patent application date, with our existing patents expiring between 2010 and 2030.

We do not consider our business to be materially dependent upon any one patent. We believe that a strong portfolio of patents combined with other factors such as our ability to innovate, technological expertise and the experience of our personnel are important to compete effectively in our industry. Our patent portfolio also provides the flexibility to negotiate or cross license intellectual property with other semiconductor companies to broaden the features in our products.

We also rely on mask work protection, trademarks, copyrights, trade secret laws, employee and third-party nondisclosure agreements, and licensing arrangements to protect our intellectual property.

PMC, PMC-Sierra and our logo are registered trademarks and service marks. We own other trademarks and service marks not appearing in this Annual Report. Any other trademarks used in this Annual Report are owned by other entities.

EMPLOYEES

As of December 27, 2009, we had 1,079 employees, including 641 in Research and Development, 92 in Production and Quality Assurance, 212 in Sales and Marketing and 134 in Administration. Our employees are not represented by a collective bargaining agreement and we have never experienced any related work stoppage.

 

ITEM 1A. RISK FACTORS.

Our company is subject to a number of risks—some are normal to the fabless semiconductor industry, some are the same or similar to those disclosed in previous SEC filings, and some may be present in the future. You should carefully consider all of these risks and the other information in this report before investing in PMC. The fact that certain risks are endemic to the industry does not lessen the significance of the risk.

As a result of the following risks, our business, financial condition, operating results and/or liquidity could be materially adversely affected. This could cause the trading price of our securities to decline, and you may lose part or all of your investment.

 

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Our global growth is subject to a number of economic risks.

Over the past year and a half, financial markets in the United States, Europe and Asia experienced extreme disruption, including among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades of certain investments and declining valuations of others. Governments took unprecedented actions intended to address extreme market conditions that include severely restricted credit and declines in real estate values. We have experienced delays in redemptions of our money market funds and we have recognized an $11.8 million loss on investment securities on our shares of the Reserve International Liquidity Fund, Ltd. and the Reserve Primary Fund during 2008. As of December 27, 2009, the original underlying securities held by the Reserve Funds had matured, and with the exception of Lehman Brothers’ securities, the balances were held by the Reserve Funds in the form of overnight agency notes. Changes in market conditions and the method and timing of the liquidation process of the Reserve Funds could result in further adjustments to the fair value and classification of these investments (classified as short-term investments as at December 27, 2009), and these changes could be material.

Currently, these conditions have not impaired our liquidity for operational purposes. There can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies, which may impair our liquidity in the future. The tightening of credit in financial markets adversely affects the ability of customers and suppliers to obtain financing for significant purchases and operations and could result in a decrease in or cancellation of orders for our products and services. Our global business is also adversely affected by decreases in the general level of economic activity, such as decreases in business and consumer spending, and in the financial strength of our customers and suppliers. We are unable to predict the likely duration and severity of the disruptions in financial markets and adverse economic conditions in the U.S. and other countries.

Finally, our ability to access the capital markets may be severely restricted at a time when we would like, or need, to access such capital markets, which could have an impact on our flexibility to pursue additional expansion opportunities and maintain our desired level of revenue growth in the future.

We are subject to rapid changes in demand for our products due to:

 

   

variations in our turns business;

 

   

short order lead time;

 

   

customer inventory levels;

 

   

production schedules; and

 

   

fluctuations in demand.

As a result of this uncertainty in the demand for our products, our past operating results may not be indicative of our future operating results.

Our revenues and profits may fluctuate because of factors that are beyond our control. As a result, we may fail to meet the expectations of security analysts and investors, which could cause our stock price to decline.

Our ability to project revenues is limited because a significant portion of our quarterly revenues may be derived from orders placed and shipped in the same quarter, which we call our “turns business.” Our turns business varies widely from quarter to quarter. Our customers may delay product orders and reduce delivery lead-time expectations, which may reduce our ability to project revenues beyond the current quarter. While we regularly evaluate end users’ and contract manufacturers’ inventory levels of our products to assess the impact of their inventories on our projected turns business, we do not have complete information on their inventories. This could cause our projections of a quarter’s turns business to be inaccurate, leading to lower revenues than projected.

 

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We may fail to meet our forecasts if our customers cancel or delay the purchase of our products or if we are unable to meet their demand.

We rely on customer forecasts in order to estimate the appropriate levels of inventory to build and to project our future revenues. Many of our customers have numerous product lines, numerous component requirements for each product, sizeable and complex supplier structures, and typically engage contract manufacturers for additional manufacturing capacity. This complex supply chain creates several variables that make it complicated to accurately forecast our customers’ demand and accurately monitor their inventory levels of our products. If customer forecasts are not accurate, we may build too much inventory, potentially leaving us with excess and obsolete inventory, which would reduce our profit margins and adversely affect our operating results. Conversely, we may build too little inventory to meet customer demand causing us to miss revenue-generating opportunities. The cancellation or deferral of product orders, the return of previously sold products or overproduction due to the failure of anticipated orders to materialize, could result in our holding excess or obsolete inventory, which could in turn result in write-downs of inventory. This difficulty may be compounded when we sell to OEMs indirectly through distributors and other resellers or contract manufacturers, or both, as our forecasts of demand are then based on estimates provided by multiple parties.

Our customers often shift buying patterns as they manage inventory levels, market different products, or change production schedules. This makes forecasting their production requirements difficult and can lead to an inventory surplus or shortage of certain components. In addition, our products vary in terms of the profit margins they generate. If our customers purchase a greater proportion of our lower margin parts in a particular period, it would adversely impact our results of operations.

Further, our distributors provide us with periodic reports of their backlog to end customers, sales to end customers and quantities of our products that they have on hand. If the data that is provided to us is inaccurate, it could lead to inaccurate forecasting of our revenues or errors in our reported revenues, gross profit and net income.

While backlog is our best estimate of our next quarter’s expectations of revenues, it is industry practice to allow customers to cancel, change or defer orders with limited advance notice prior to shipment. As such, backlog may be an unreliable indicator of future revenue levels. Because a significant portion of our operating expenses are fixed, even a small revenue shortfall can have a disproportionately negative effect on our operating results.

If the demand for our customers’ products declines, demand for our products will be similarly affected and our revenues, gross margins and operating performance will be adversely affected.

Our customers are subject to their own business cycles, most of which are unpredictable in commencement, depth and duration. We cannot accurately predict the continued demand of our customers’ products and the demands of our customers for our products. In the past, networking customers have reduced capital spending without notice, adversely affecting our revenues. As a result of this uncertainty, our past operating results may not be indicative of our future operating results. It is possible that, in future periods, our results may be below the expectations of public market analysts and investors. This could cause the market price of our common stock to decline.

We rely on a few customers for a major portion of our sales, any one of which could materially impact our revenues should they change their ordering pattern. The loss of a key customer could materially impact our results of operations.

We depend on a limited number of customers for large portions of our revenues. In 2009, we had one end customers that accounted for more than 10% of our revenues, namely H-P. In 2008, we did not have any end customers that accounted for more than 10% of our revenues. In 2009, our top ten customers accounted for more

 

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than 70% of our revenues. In 2008, our top ten customers accounted for approximately 65% of our revenues. We do not have long-term volume purchase commitments from any of our major customers. We sell our products solely on the basis of purchase orders. Those customers could decide to cease purchasing products with little or no notice and without significant penalties. A number of factors could cause our customers to cancel or defer orders, including interruptions to their operations due to a downturn in their industries, delays in manufacturing their own product offerings into which our products are incorporated, and natural disasters. Accordingly, our future operating results will continue to depend on the success of our largest customers and on our ability to sell existing and new products to these customers in significant quantities.

The loss of a key customer, or a reduction in our sales to any major customer or our inability to attract new significant customers could materially and adversely affect our business, financial condition or results of operations.

The loss of key personnel could delay us from designing new products.

To succeed, we must retain and hire technical personnel highly skilled at design and test functions needed to develop high-speed networking products. The competition for such employees is intense.

We do not have employment agreements in place with many of our key personnel. As employee incentives, we issue common stock options and restricted stock grants that are subject to time vesting, and, in the case of options, have exercise prices at the market value on the grant date. As our stock price varies substantially, the equity awards to employees are effective as retention incentives only if they have economic value.

Changes in the political and economic climate in the countries we do business may adversely affect our operating results.

We earn a substantial proportion of our revenues in Asia. We conduct an increasing portion of our research and development and manufacturing activities outside North America. We procure substantially all of our wafers from Taiwan and use assemblers and testers throughout Asia.

Given the depth of our sales and operations in Asia, we face risks that could negatively impact our results of operations, including economic sanctions imposed by the U.S. government, imposition of tariffs and other potential trade barriers or regulations, uncertain protection for intellectual property rights and generally longer receivable collection periods. In addition, fluctuations in foreign currency exchange rates could adversely affect the revenues, net income, earnings per share and cash flow of our operations in affected markets. Similarly, fluctuations in exchange rates may affect demand for our products in foreign markets or our cost competitiveness and may adversely affect our profitability.

Our results of operations are increasingly dependent on our sales in China, which on a bill-to basis, accounted for over 40% of our revenues in 2009 compared to 30% in 2008. Government agencies in China have broad discretion and authority over all aspects of the telecommunications and information technology industry in China; accordingly their decisions may impact our ability to do business in China. Therefore, significant changes in China’s political and economic conditions and governmental policies could have a substantial negative impact on our business. While the growth of Fiber-To-The-Home technology in China has continued to be strong, a slowdown in that growth would have an adverse impact on our operating results.

In addition to selling our products in a number of countries, an increasing portion of our research and development and manufacturing is conducted outside North America, in particular, in India and China. The geographic diversity of our business operations could hinder our ability to coordinate design, manufacturing and sales activities. If we are unable to develop systems and communication processes to support our geographic diversity, we may suffer product development delays or strained customer relationships.

 

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Hostilities in the Middle East and India may have a significant impact on our Israeli and Indian subsidiaries’ ability to conduct their business.

We have research and development facilities located in Israel and India which employ approximately 170 and 70 people, respectively. A catastrophic event, such as a terrorist attack, that results in the destruction or disruption of any of our critical business or information technology systems in Israel or India could harm our ability to conduct normal business operations and our operating results.

On an on-going basis, some of our Israeli employees are periodically called into active military duty. In the event of severe hostilities breaking out, a significant number of our Israeli employees may be called into active military duty, resulting in delays in various aspects of production, including product development schedules.

Our revenues may decline if we do not maintain a competitive portfolio of products.

We are experiencing significantly greater competition in the markets in which we participate. We are expanding into markets, such as the Enterprise Infrastructure and Communications Infrastructure markets, which have established incumbents with substantial financial and technological resources. We expect more intense competition than that which we have traditionally faced as some of these incumbents derive a majority of their earnings from these markets.

We typically face competition at the design stage, where customers evaluate alternative design approaches requiring integrated circuits. The markets for our products are intensely competitive and subject to rapid technological advancement in design tools, wafer manufacturing techniques, process tools and alternate networking technologies. We may not be able to develop new products at competitive pricing and performance levels. Even if we are able to do so, we may not complete a new product and introduce it to market in a timely manner. Our customers may substitute use of our products in their next generation equipment with those of current or future competitors, reducing our future revenues. With the shortening product life and design-in cycles in many of our customers’ products, our competitors may have more opportunities to supplant our products in next generation systems.

Our customers are increasingly price conscious, as semiconductors sourced from third party suppliers comprise a greater portion of the total materials cost in networking equipment. We continue to experience aggressive price competition from competitors that wish to enter into the market segments in which we participate. These circumstances may make some of our products less competitive, and we may be forced to decrease our prices significantly to win a design. We may lose design opportunities or may experience overall declines in gross margins as a result of increased price competition.

Over the next few years, we expect additional competitors, some of which may also have greater financial and other resources, to enter these markets with new products. These companies, individually or collectively, could represent future competition for many design wins and subsequent product sales.

Design wins do not translate into near-term revenues and the timing of revenues from newly designed products is often uncertain.

From time to time, we announce new products and design wins for existing and new products. While some industry analysts may use design wins as a metric for future revenues, many design wins have not, and will not, generate any revenues for us, as customer projects are cancelled or unsuccessful in their end market. In the event a design win generates revenues, the amount of revenues will vary greatly from one design win to another. In addition, most revenue-generating design wins do not translate into near-term revenues. Most revenue-generating design wins take more than two years to generate meaningful revenues.

 

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We may be unsuccessful in transitioning the design of our new products to new manufacturing processes.

Many of our new products are designed to take advantage of new manufacturing processes offering smaller device geometries as they become available, since smaller geometries can provide a product with improved features such as lower power requirements, increased performance, more functionality and lower cost. We believe that the transition of our products to, and introduction of new products using, smaller device geometries is critical for us to remain competitive. We could experience difficulties in migrating to future smaller device geometries or manufacturing processes, which would result in the delay of the production of our products. Our products may become obsolete during these delays, or allow competitors’ parts to be chosen by customers during the design process.

Since many of the products we develop do not reach full production sales volumes for a number of years, we may incorrectly anticipate market demand and develop products that achieve little or no market acceptance.

Our products generally take between 12 and 24 months from initial conceptualization to development of a viable prototype, and another three to 18 months to be designed into our customers’ equipment and sold in production quantities. We sell products whose characteristics include evolving industry standards, short product life spans and new manufacturing and design technologies. Our products often must be redesigned because manufacturing yields on prototypes are unacceptable or customers redefine their products to meet changing industry standards or customer specifications. As a result, we develop products many years before volume production and may inaccurately anticipate our customers’ needs. Redesigning our products is expensive and may delay production of our products. Our products may become obsolete during these delays, resulting in our inability to recoup our initial investments in product development.

The final determination of our income tax liability may be materially different from our income tax provision.

We are subject to income taxes in both the United States and international jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions where the ultimate tax determination is uncertain. Additionally, our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file. Although we believe our tax estimates are reasonable, there is no assurance that the final determination of our income tax liability will not be materially different than what is reflected in our income tax provisions and accruals. Should additional taxes be assessed as a result of new legislation, an audit or litigation, if our effective tax rate should change as a result of changes in federal, international or state and local tax laws, or if we were to change the locations where we operate, there could be a material effect on our income tax provision and results of operations in the period or periods in which that determination is made, and potentially to future periods as well. During the second quarter of 2008, one of our foreign subsidiaries settled several ongoing tax matters for less than had been accrued as part of its liability for unrecognized tax benefits, resulting in the recognition of tax benefits of $124.1 million. As a result of this settlement, we agreed to pay $18.0 million in cash and utilize $31.6 million in investment tax credits.

The ultimate resolution of outstanding tax matters could be for amounts in excess of our reserves established. Such events could have a material adverse effect on our liquidity or cash flows in the quarter in which an adjustment is recorded or the tax payment is due.

If foreign exchange rates fluctuate significantly, our profitability may decline.

We are exposed to foreign currency rate fluctuations because a significant part of our development, test, and selling and administrative costs are incurred in foreign currencies. The U.S. dollar has fluctuated significantly compared to other foreign currencies and this trend may continue. To protect against reductions in value and the

 

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volatility of future cash flows caused by changes in foreign exchange rates, we enter into foreign currency forward contracts. The contracts reduce, but do not eliminate, the impact of foreign currency exchange rate movements. In addition, this foreign currency risk management policy may not be effective in addressing long-term fluctuations since our contracts do not extend beyond a 12-month maturity.

We regularly limit our exposure to foreign exchange rate fluctuations from our foreign net asset or liability positions. We recorded a net $2.7 million foreign exchange loss on the revaluation of our income tax liability, net of deferred tax assets, in 2009 because of the fluctuations in the U.S. dollar against certain foreign currencies. A five percent shift in the foreign exchange rates between the U.S. and Canadian dollar would cause an approximately $2.5 million impact to our pre-tax net income.

We are exposed to the credit risk of some of our customers.

Many of our customers employ contract manufacturers to produce their products and manage their inventories. Many of these contract manufacturers represent greater credit risk than our OEM customers, who do not guarantee our credit receivables related to their contract manufacturers.

In addition, a significant portion of our sales flow through our distribution channel, which generally represents a higher credit risk. Should these companies encounter financial difficulties, our revenues could decrease, and collection of our significant accounts receivables with these companies or other customers could be jeopardized.

Our business strategy contemplates acquisition of other products, technologies or businesses, which could adversely affect our operating performance.

Acquiring products, intellectual property, technologies and businesses from third parties is a core part of our business strategy. That strategy depends on the availability of suitable acquisition candidates at reasonable prices and our ability to resolve challenges associated with integrating acquired businesses into our existing business. These challenges include integration of product lines, sales forces, customer lists and manufacturing facilities, development of expertise outside our existing business, diversion of management time and resources, possible divestitures, inventory write-offs and other charges. We also may be forced to replace key personnel who may leave our company as a result of an acquisition. We cannot be certain that we will find suitable acquisition candidates or that we will be able to meet these challenges successfully. Acquisitions could also result in customer dissatisfaction, performance problems with the acquired company, investment, or technology, the assumption of contingent liabilities, or other unanticipated events or circumstances, any of which could harm our business. Consequently, we might not be successful in integrating any acquired businesses, products or technologies and may not achieve anticipated revenues and cost benefits.

An acquisition could absorb substantial cash resources, require us to incur or assume debt obligations, or issue additional equity. If we are not able to obtain financing, then we may not be in a position to consummate acquisitions. If we issue equity securities in connection with an acquisition, we may dilute our common stock with securities that have an equal or a senior interest in our company.

From time to time, we license, or acquire, technology from third parties to incorporate into our products. Incorporating technology into our products may be more costly or more difficult than expected, or require additional management attention to achieve the desired functionality. The complexity of our products could result in unforeseen or undetected defects or bugs, which could adversely affect the market acceptance of new products and damage our reputation with current or prospective customers.

Our current product roadmap will, in part, be dependent on successful acquisition and integration of intellectual property cores developed by third parties. If we experience difficulties in obtaining or integrating intellectual property from these third parties, it could delay or prevent the development of our products in the future.

 

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Although our customers, our suppliers and we rigorously test our products, our highly complex products may contain defects or bugs. We have in the past experienced, and may in the future experience defects and bugs in our products. If any of our products contain defects or bugs, or have reliability, quality or compatibility problems that are significant to our customers, our reputation may be damaged and customers may be reluctant to buy our products. This could materially and adversely affect our ability to retain existing customers or attract new customers. In addition, these defects or bugs could interrupt or delay sales to our customers.

We may have to invest significant capital and other resources to alleviate problems with our products. If any of these problems are not found until after we have commenced commercial production of a new product, we may be required to incur additional development costs and product recall, repair or replacement costs. These problems may also result in claims against us by our customers or others. In addition, these problems may divert our technical and other resources from other development efforts. Moreover, we would likely lose or experience a delay in, market acceptance of the affected product or products, and we could lose credibility with our current and prospective customers.

Industry consolidation may lead to increased competition and may harm our operating results.

There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to improve the leverage of growing research and development costs, strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in our operating results and could have a material adverse effect on our business, operating results and financial condition.

Our business may be adversely affected if our customers or suppliers cannot obtain sufficient supplies of other components needed in their product offerings to meet their production projections and target quantities.

Some of our products are used by customers in conjunction with a number of other components, such as transceivers, microcontrollers and digital signal processors. If, for any reason, our customers experience a shortage of any component, their ability to produce the forecasted quantity of their product offerings may be affected adversely and our product sales would decline until the shortage is remedied. Such a situation could harm our operating results, cash flow and financial condition.

We rely on limited sources of wafer fabrication, the loss of which could delay and limit our product shipments.

We do not own or operate a wafer fabrication facility. In 2009, two outside wafer foundries supplied more than 95% of our semiconductor wafer requirements. Our wafer foundry suppliers also make products for other companies and some make products for themselves, thus 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 wafer foundries we use are unable or unwilling to manufacture our products in required volumes, or at specified times, we may have to identify and qualify acceptable additional or alternative foundries. This qualification process could take six months or longer. We may not find sufficient capacity quickly enough, if ever, at an acceptable cost, to satisfy our production requirements.

Some companies that supply our customers are similarly dependent on a limited number of suppliers to produce their products. These other companies’ products may be designed into the same networking equipment into which our products are designed. Our order levels could be reduced materially if these companies are unable

 

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to access sufficient production capacity to produce in volumes demanded by our customers because our customers may be forced to slow down or halt production on the equipment into which our products are designed.

We depend on third parties for the assembly and testing of our semiconductor products which could delay and limit our product shipments.

We depend on third parties in Asia for the assembly and testing of our semiconductor products. In addition, subcontractors in Asia assemble all of our semiconductor products into a variety of packages. Raw material shortages, political and social instability, assembly and testing house service disruptions, currency fluctuations, or other circumstances in the region could force us to seek additional or alternative sources of supply, assembly or testing. This could lead to supply constraints or product delivery delays that, in turn, may result in the loss of revenues. At times, capacity in the assembly industry has become scarce and lead times have lengthened. This may become more severe, which could in turn adversely affect our revenues. We have less control over delivery schedules, assembly processes, testing processes, quality assurances, raw material supplies and costs than competitors that do not outsource these tasks.

Due to the amount of time that it usually takes us to qualify assemblers and testers, we could experience significant delays in product shipments if we are required to find alternative assemblers or testers for our components. Any problems that we may encounter with the delivery, quality or cost of our products could damage our customer relationships and materially and adversely affect our results of operations. We are continuing to develop relationships with additional third-party subcontractors to assemble and test our products. However, even if we use these new subcontractors, we will continue to be subject to all of the risks described above.

Our business is vulnerable to interruption by earthquake, fire, power loss, telecommunications failure, terrorist activity and other events beyond our control.

We do not have sufficient business interruption insurance to compensate us for actual losses from interruption of our business that may occur, and any losses or damages incurred by us could have a material adverse effect on our business. We are vulnerable to a major earthquake and other calamities. We have operations in seismically active regions in British Columbia, Canada and California, and we rely on third-party wafer fabrication and testing facilities in seismically active regions in Asia. We have not undertaken a systematic analysis of the potential consequences to our business and financial results from a major earthquake in either region. We are unable to predict the effects of any such event, but the effects could be seriously harmful to our business.

Our estimated restructuring accruals may not be adequate.

In 2005, 2006 and 2007, we implemented restructuring plans to streamline production and reduce and reallocate operating costs. In 2001 and 2003, we implemented plans to restructure our operations in response to the decline in demand for our networking products. We reduced the workforce and consolidated or shut down excess facilities in an effort to bring our expenses into line with our revenue expectations.

While management uses all available information to estimate these restructuring costs, particularly facilities costs, our estimated accruals may prove to be inadequate. If our actual sublease revenues or the results of our exiting negotiations differ from our assumptions, we may have to record additional charges, which could materially affect our results of operations, financial position and cash flow.

 

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From time to time, we become defendants in legal proceedings about which we are unable to assess our exposure and which could become significant liabilities upon judgment.

We become defendants in legal proceedings from time to time. Companies in our industry have been subject to claims related to patent infringement and product liability, as well as contract and personal claims. We may not be able to accurately assess the risk related to these suits and we may be unable to accurately assess our level of exposure. These proceedings may result in material charges to our operating results in the future if our exposure is material and if our ability to assess our exposure becomes clearer.

If we cannot protect our proprietary technology, we may not be able to prevent competitors from copying or misappropriating our technology and selling similar products, which would harm our business.

To compete effectively, we must protect our intellectual property. 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 numerous patents and have a number of pending patent applications. However, our portfolio of patents includes some that expired in 2009 and are expiring in subsequent years, which could have a negative effect on our ability to prevent competitors from duplicating certain of our products.

We might not succeed in obtaining 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.

To protect our product technology, documentation and other proprietary information, we enter into confidentiality agreements with our employees, customers, consultants and strategic partners. We require our employees to acknowledge their obligation to maintain confidentiality with respect to PMC’s products. Despite these efforts, we cannot guarantee that these parties will maintain the confidentiality of our proprietary information in the course of future employment or working with other business partners. We develop, manufacture and sell our products in Asia and other countries that may not protect our products or intellectual property rights to the same extent as the laws of the United States. This makes piracy of our technology and products more likely. Steps we take to protect our proprietary information may not be adequate to prevent theft of our technology. We may not be able to prevent our competitors from independently developing technologies that are similar to or better than ours.

Our products employ technology that may infringe on the intellectual property and the proprietary rights of third parties, which may expose us to litigation and prevent us from selling our products.

Vigorous protection and pursuit of intellectual property rights or positions characterize the semiconductor industry. This often results in expensive and lengthy litigation. We, and our customers or suppliers, may be accused of infringing patents or other intellectual property rights owned by third parties in the future. 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 or find appropriate licenses on reasonable terms or at all.

Patent disputes in the semiconductor industry are often settled through cross-licensing arrangements. Our portfolio of patents may not have the breadth to enable us to settle an alleged patent infringement claim through a cross-licensing arrangement. We may therefore be more exposed to third party claims than some of our larger competitors and customers.

The majority of our customers are required to obtain licenses from and pay royalties to third parties for the sale of systems incorporating our semiconductor devices. Customers may also make claims against us with respect to infringement.

 

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Furthermore, we may initiate claims or litigation against third parties for infringing our proprietary rights or to establish the validity of our proprietary rights. This could consume significant resources and divert the efforts of our technical and management personnel, regardless of the litigation’s outcome.

We have significant debt in the form of senior convertible notes.

We have $58.4 million carrying value ($68.3 million of face value) of our 2.25% senior convertible notes outstanding. Our debt could materially and adversely affect our ability to obtain financing for working capital, acquisitions or other purposes and could make us vulnerable to industry downturns and competitive pressures. Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. On October 15, 2025, we are obliged to repay the full remaining principal amount of the notes that have not been converted into our common stock, but we are also subject to certain triggering events that may cause the notes to be repaid earlier.

Securities we issue to fund our operations could dilute your ownership.

We may decide to raise additional funds through public or private debt or equity financing. If we raise funds by issuing equity securities, the percentage ownership of current stockholders will be reduced and the new equity securities may have priority rights to your investment. We may not obtain sufficient financing on terms that are favorable to you or us. We may delay, limit or eliminate some or all of our proposed operations if adequate funds are not available.

Our stock price has been and may continue to be volatile.

We expect that the price of our common stock will continue to fluctuate significantly, as it has in the past. In particular, fluctuations in our stock price and our price-to-earnings multiple may have made our stock attractive to momentum, hedge or day-trading investors who often shift funds into and out of stocks rapidly, exacerbating price fluctuations in either direction particularly when viewed on a quarterly basis.

Securities class action litigation has often been instituted against a company following periods of volatility and decline in the market price of their securities. If instituted against us, regardless of the outcome, such litigation could result in substantial costs and diversion of our management’s attention and resources and have a material adverse effect on our business, financial condition and operating results. In addition, we could incur substantial punitive and other damages relating to such litigation.

Provisions in Delaware law, our charter documents and our stockholder rights plan may delay or prevent another entity from acquiring us without the consent of our Board of Directors.

We adopted a stockholder rights plan in 2001, pursuant to which we declared a dividend of one share purchase right for each outstanding share of common stock. If certain events occur, including if an investor tenders for or acquires more than 15% of our outstanding common stock, stockholders (other than the acquirer) may exercise their rights and receive $650 worth of our common stock in exchange for $325 per right, or we may, at our option, issue one share of common stock in exchange for each right, or we may redeem the rights for $0.001 per right. The issuance of the rights could have the effect of delaying or preventing a change in control of us.

In addition, our Board of Directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. Delaware law imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.

 

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Although we believe these provisions of our charter documents, Delaware law and our stockholder rights plan will provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our Board of Directors, these provisions apply even if the offer may be considered beneficial by some stockholders.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

 

ITEM 2. PROPERTIES.

We lease properties in 22 locations worldwide totaling approximately 546,000 square feet. Approximately 26% of the space we leased was excess at December 27, 2009. Approximately 84% of the excess space has been subleased and we are actively pursuing opportunities to sublease or negotiate our exit from the remaining excess facilities.

We lease approximately 108,000 square feet in Santa Clara, California, to house our U.S. design, engineering, sales and marketing operations.

Our Canadian operations are primarily located in Burnaby, British Columbia where we lease approximately 149,000 square feet of office space in two separate buildings. This location supports a significant portion of our product development, manufacturing, marketing, sales and testing activities.

In addition to the two major sites in Santa Clara and Burnaby, during 2009 we also operated nine additional research and development centers: two in Canada, four in the U.S., one in Bangalore, India, one in Herzliya, Israel and one in Shanghai, China.

We have 11 sales/operations offices located in Europe, Asia, the Caribbean and North America.

 

ITEM 3. LEGAL PROCEEDINGS.

Stockholder Derivative Lawsuits

Three derivative actions have been filed against the Company, as a nominal defendant, and various current and former officers and/or directors: (1) Meissner v. Bailey, et al., Santa Clara Superior Court Case No. 1-06-CV-071329 (filed September 18, 2006); (2) Beiser v. Bailey, et al., United States District Court for the Northern District of California Case No. 5:06-CV-05330-RS (filed August 29, 2006); and (3) Barone v. Bailey, et al., United States District Court for the Northern District of California (the “Federal Court”) Case No. 4:06-CV-06473-SBA (filed October 16, 2006). On November 21, 2006, the Beiser and Barone actions were consolidated into one case. On January 18, 2007, the Santa Clara County Superior Court in California ordered that the Meissner action be stayed pending the outcome of the consolidated, federal Beiser/Barone action.

The Beiser/Barone plaintiffs generally allege that various current and former Company directors and/or officers breached their duty of loyalty and/or duty of care to the Company and its stockholders in connection with improperly dating certain employee stock option grants and that these purported breaches of fiduciary duties caused harm to the Company. The plaintiffs seek to recover damages on behalf of the Company. They also allege violations of federal securities laws. The Company is a nominal defendant, but any recovery in the litigation would be paid to the Company, rather than to its stockholders. The defendants have entered into joint defense arrangements.

The defendants moved to dismiss the Beiser/Barone action on various legal grounds including that the plaintiffs failed to state a claim and failed to plead with particularity facts establishing that a litigation demand on the board of directors of the Company would have been futile at the time they commenced the derivative

 

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lawsuit. The Federal Court dismissed the consolidated complaint on August 22, 2007 and gave plaintiffs leave to amend. The Federal Court dismissed the plaintiffs’ first amended consolidated complaint on May 8, 2008 and permitted plaintiffs leave to amend “one last time”. Defendants moved to dismiss the second amended complaint which motions were to be heard on August 20, 2008.

On July 15, 2008, Ian Beiser, a named plaintiff in the Beiser/Barone action, filed a complaint in the Delaware Court of Chancery, and it was served on July 18, 2008, compelling the Company to permit plaintiff to inspect and make copies of the Company’s books and records. On August 5, 2008, the plaintiffs moved to stay the Federal Court action pending the books and records action. The Federal Court granted the motion to stay on August 13, 2008, which removed from the calendar the hearing on defendants’ motions to dismiss, previously scheduled for August 20, 2008.

On February 26, 2009, the Delaware Chancery Court granted the Company’s motion to dismiss the plaintiff’s books and records demand. This result has lifted the stay on the motion to dismiss the second amended complaint in the Federal Court.

While the briefing on defendants’ motions was under way, the parties engaged in mediation and on November 5, 2009 entered into a stipulation of settlement under which the parties have agreed, subject to court approval, to resolve both the Beiser/Barone action and the Meissner action. Under the stipulation of settlement, the Company expressly denies any wrong doing but, in the interest of settlement, agreed to adopt certain corporate governance reforms and to maintain these and other reforms put in place while the litigation was pending for a period of three years. The Company has agreed, subject to court approval, to pay plaintiffs’ counsel $1.6 million in attorneys’ fees, half of which will be paid by the Company and the other half by the Company’s insurance carrier. In light of the stipulated settlement, the parties have agreed to suspend the briefing on defendants’ renewed motions to dismiss the Beiser/Barone action. On January 26, 2010, the Federal Court issued an order (the “Preliminary Order”) granting preliminary approval of the settlement. The stipulation of settlement is subject to final approval by the Federal Court, which has scheduled for hearing on April 29, 2010.

The Company has accrued costs of $800,000 to reflect its share of the attorneys’ fees to be paid to plaintiffs’ counsel pursuant to the settlement. As with the rest of the settlement, the agreement to pay attorneys’ fees and the amount of fees to be paid remain subject to final approval by the Federal Court.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Stock Price Information

Our Common Stock trades on the NASDAQ Global Select Market under the symbol PMCS. The following table sets forth, for the periods indicated, the high and low closing sale prices for our Common Stock as reported by the NASDAQ Select Global Market:

 

Fiscal 2009

   High    Low

First Quarter

   $ 6.86    $ 4.26

Second Quarter

     8.48      6.34

Third Quarter

     9.97      7.34

Fourth Quarter

     9.99      7.93

Fiscal 2008

   High    Low

First Quarter

   $ 6.54    $ 4.36

Second Quarter

     8.98      5.70

Third Quarter

     9.22      6.89

Fourth Quarter

     7.42      3.31

To maintain consistency, the information provided above is based on the last day of the calendar quarter rather than the last day of the fiscal quarter.

Stockholders

As of February 22, 2010, there were 969 holders of record of our Common Stock.

Dividends

We have never paid cash dividends on our Common Stock. We currently intend to retain earnings, if any, for use in our business or to fund acquisitions and do not anticipate paying any cash dividends in the foreseeable future.

 

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Stock Performance Graph

The following graph shows a comparison of cumulative total stockholder returns for PMC, the line-of-business index for semiconductors and related devices (SIC code 3674) furnished by Research Data Group, Inc., and the S&P 500 Index. The graph assumes the investment of $100 on December 31, 2004. The performance shown is not necessarily indicative of future performance.

LOGO

SOURCE: RESEARCH DATA GROUP, INC.

 

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ITEM 6. SELECTED FINANCIAL DATA

The following tables set forth data from our consolidated financial statements for each of the last five fiscal years.

 

    Year Ended
(in thousands, except for per share data)
 
    December 27,
2009(1)
    December 28,
2008(2)

As adjusted*
    December 30,
2007(3)

As adjusted*
    December 31,
2006(4)

As adjusted*
    December 31,
2005(5)

As adjusted*
 

STATEMENT OF OPERATIONS DATA:

         

Net revenues

  $ 496,139      $ 525,075      $ 449,381      $ 424,992      $ 291,411   

Cost of revenues

    165,231        181,642        158,297        146,456        80,963   

Gross profit

    330,908        343,433        291,084        278,536        210,448   

Research and development

    149,184        157,642        159,134        158,660        118,720   

Selling, general and administrative

    84,942        93,532        100,486        102,364        56,278   

Amortization of purchased intangible assets

    39,344        39,344        39,343        33,381        —     

In-process research and development

    —          —          —          35,300        —     

Restructuring costs and other charges

    888        824        14,837        6,119        13,833   
                                       

Income (loss) from operations

    56,550        52,091        (22,716     (57,288     21,617   

Interest (expense) income, net

    (2,511     (757     1,497        1,206        10,753   

Foreign exchange (loss) gain

    (2,371     8,068        (18,486     (109     (3,259

Loss on subleased facilities

    (538     —          —          —          —     

Gain (loss) on extinguishment of debt and amortization of debt issue costs

    (200     14,568        (680     (680     (1,756

Gain (loss) on investments

    171        (11,790     —          (1,269     1,439   

Asset impairment

    —          (4,300     —          —          —     

Recovery on investments

    —          400        —          —          —     

(Provision for) recovery of income taxes

    (4,224     70,017        (16,848     (49,237     (2,108
                                       

Net income (loss)

  $ 46,877      $ 128,297      $ (57,233   $ (107,377   $ 26,686   
                                       

Net income (loss) per share—basic

  $ 0.21      $ 0.58      $ (0.26   $ (0.53   $ 0.14   

Net income (loss) per share—diluted

  $ 0.20      $ 0.57      $ (0.26   $ (0.53   $ 0.14   

Shares used in per share calculation— basic

    226,225        221,659        216,330        203,470        184,098   

Shares used in per share calculation— diluted

    229,567        223,687        216,330        203,470        189,132   
    As at  
    December 27,
2009(1)*
    December 28,
2008(2)

As adjusted*
    December 30,
2007(3)

As adjusted*
    December 31,
2006(4)

As adjusted*
    December 31,
2005(5)

As adjusted*
 
    (in thousands)  

BALANCE SHEET DATA:

         

Working capital

  $ 229,547      $ 284,316      $ 280,575      $ 192,146      $ 565,501   

Cash, cash equivalents, and short-term investments

    260,769        307,524        364,922        258,914        627,476   

Long-term investment securities

    192,636        —          —          —          —     

Total assets

    1,115,477        969,965        1,130,535        1,004,805        730,907   

Convertible notes

    58,356        55,357        173,130        164,711        156,938   

Long-term obligations

    6,211        503        958        —          —     

Stockholders’ equity

    880,523        779,258        646,403        628,965        420,067   

 

There were no cash dividends issued during the years ended December 27, 2009, December 28, 2008, December 30, 2007, December 31, 2006 and December 31, 2005.

 

  *

Effective December 29, 2008, the Company retrospectively adopted Financial Accounting Standards Board Accounting Standards Codification 470, the Debt Topic for the accounting of convertible debt instruments

 

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that may be settled in cash upon conversion (including partial cash settlements). Accordingly, the comparative consolidated financial statements have been adjusted.

The equity portion of the senior convertible notes, included in stockholders' equity is $35.2 million for the years ended December 27, 2009 and December 28, 2008, respectively. The equity portion of the senior convertible notes, included in stockholders' equity is $67.3 million for the years ended December 30, 2007, December 31, 2006 and December 31, 2005, respectively.

 

(1) Results for the year ended December 27, 2009 include $0.8 million stock-based compensation expense included in Cost of revenues; $8.7 million stock-based compensation expense and $1.0 million termination costs included in Research and development expenses; $12.0 million stock-based compensation expense and $0.6 million termination costs included in Selling, general and administrative expenses; $3.0 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $2.7 million foreign exchange loss on foreign tax liabilities; $0.5 million loss on subleased facilities; and $0.6 million income tax recovery which includes $6.5 million net deferred tax recovery relating to foreign exchange translation of a foreign subsidiary, $5.0 million tax effect on intercompany transactions, $1.5 million year end tax adjustments including those based on completed filings and assessments received from tax authorities and $1.5 million arrears interest relating to unrecognized tax benefits.

 

(2) Results for the year ended December 28, 2008 include $1.1 million stock-based compensation expense included in Cost of revenues; $11.2 million stock-based compensation expense included in Research and development expenses; $12.5 million stock based compensation expense included in Selling, general and administrative expenses; $5.6 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $8.2 million foreign exchange gain on foreign tax liabilities; $15.0 million gain on repurchase of senior convertible notes, net; and $92.1 million net income tax recovery including $98.0 million related to the net adjustment to accrual for unrecognized tax benefits, $5.6 million deferred tax expense relating to unrealized gain on foreign exchange translation of a foreign subsidiary, $2.0 million tax adjustments based on completed tax filings and assessments and $2.3 million tax impact relating to repatriation of earnings from a foreign jurisdiction.

 

(3) Results for the year ended December 30, 2007 include $1.7 million stock-based compensation expense included in Cost of revenues; $16.6 million stock-based compensation expense included in Research and development expenses; $17.1 million stock-based compensation expense and $2.2 million reversal of an accrual for payroll-related taxes, included in Selling, general and administrative expenses; $8.4 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $18.2 million foreign exchange loss on our income tax liability; and $4.0 million recovery of prior years’ income taxes and $3.8 million recovery of future income taxes, offset by $13.1 million of interest relating to the liability for unrecognized tax benefit of prior years.

 

(4) Results for the year ended December 31, 2006 include $8.2 million purchase accounting adjustments to inventory, $1.8 million stock-based compensation expense and $0.8 million in additional contractor costs included in Cost of revenues; $16.2 million stock-based compensation expense included in Research and development expenses; $2.4 million for employee-related taxes; $19.9 million stock-based compensation expense and $0.2 million acquisition-related relocation expenses included in Selling, general and administrative expenses; $7.8 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $0.5 million foreign exchange gain on our income tax liability; $29.9 million increase in our estimated tax provision for previous years as a result of a written communication received in 2007 from a tax authority; and $7.0 million withholding and other taxes on repatriation of funds included in the provision for income taxes.

 

(5) Results for the year ended December 31, 2005 include $0.9 million reversal of provision for doubtful accounts receivable and $0.2 million stock-based compensation included in Selling, general and administrative expenses; $1.4 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $6.3 million tax benefits comprised of $5.3 million excess research and development tax credits and $1.0 million recovery of prior year sales tax; and $3.4 million foreign exchange loss on an income tax liability.

 

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Quarterly Comparisons

 

    Quarterly Data
(in thousands except for per share data)
 
  Year Ended December 27, 2009     Year Ended December 28, 2008  
  Fourth(1)     Third(2)     Second(3)     First(4)     Fourth(5)
As adjusted*
    Third(6)
As adjusted*
    Second(7)
As adjusted*
    First(8)
As adjusted*
 
               

STATEMENT OF OPERATIONS DATA:

               

Net revenues

  $ 139,497      $ 130,876      $ 123,194      $ 102,572      $ 120,840      $ 139,356      $ 139,839      $ 125,040   

Cost of revenues

    44,583        44,432        39,413        36,803        41,890        47,373        49,073        43,306   

Gross profit

    94,914        86,444        83,781        65,769        78,950        91,983        90,766        81,734   

Research and development

    38,350        35,823        36,383        38,628        40,649        39,688        39,995        37,310   

Selling, general and administrative

    21,088        19,743        22,222        21,889        21,578        23,565        24,180        24,209   

Amortization of purchased intangible assets

    9,836        9,836        9,836        9,836        9,836        9,836        9,836        9,836   

Restructuring costs and other charges

    75        175        303        335        39        (259     157        887   
                                                               

Income (loss) from operations

    25,565        20,867        15,037        (4,919     6,848        19,153        16,598        9,492   

Gain on sale of investment securities

    171        —          —          —          —          —          —          —     

Gain on repurchase of senior convertible notes and amortization of debt issue costs

    (50     (50     (50     (50     9,969        (94     (93     4,786   

Loss on subleased facilities

    —          —          —          (538     —          —          —          —     

Asset impairment

    —          —          —          —          (4,300     —          —          —     

Interest income, net

    (372     (487     (841     (811     (1,379     181        114        327   

Foreign exchange gain (loss)

    (2,480     (1,094     (2,867     4,070        5,103        873        (1,066     3,158   

Recovery on investments

    —          —          —          —          —          400        —          —     

Loss on investment securities

    —          —          —          —          —          (11,790     —          —     

(Provision for) recovery of income taxes

    (7,708     8,583        (3,430     (1,669     (7,428     (4,266     120,397        (38,686
                                                               

Net income (loss)

  $ 15,126      $ 27,819      $ 7,849      $ (3,917   $ 8,813      $ 4,457      $ 135,950      $ (20,923
                                                               

Net income (loss) per share—basic

  $ 0.07      $ 0.12      $ 0.03      $ (0.02   $ 0.04      $ 0.02      $ 0.62      $ (0.10

Net income (loss) per share—diluted

  $ 0.06      $ 0.12      $ 0.03      $ (0.02   $ 0.04      $ 0.02      $ 0.60      $ (0.10

Shares used in per share calculation—basic

    229,070        227,123        224,861        223,844        223,363        222,335        221,008        219,931   

Shares used in per share calculation—diluted

    233,751        231,863        227,883        223,844        224,029        225,803        224,984        219,931   

 

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* Effective December 29, 2008, the Company retrospectively adopted Financial Accounting Standards Board Accounting Standards Codification 470, the Debt Topic for the accounting of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlements). Accordingly, the comparative consolidated financial statements have been adjusted.

 

(1) Results include $0.2 million stock-based compensation expense included in Cost of revenues; $2.1 million stock-based compensation included in Research and development expense; $2.9 million stock-based compensation included in Selling, general and administrative expense; $0.8 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $2.4 million foreign exchange loss on foreign tax liabilities; and $5.8 million net income tax effects including $1.9 million net deferred tax provision relating to foreign exchange translation of a foreign subsidiary, $1.8 million tax effect on inter-company transactions, $1.8 million year-end tax adjustments including those based on completed filings and assessments received from tax authorities and $0.5 million arrears interest relating to unrecognized tax benefits.

 

(2) Results include $0.1 million stock-based compensation expense included in Cost of revenues; $2.2 million stock-based compensation expense and $0.1 million recovery of previously accrued termination costs included in Research and development expense; $2.8 million stock-based compensation expense and $0.1 million recovery of previously accrued termination costs included in Selling, general and administrative expense; $0.8 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $1.0 million foreign exchange loss on foreign tax liabilities; and $9.9 million net income tax recovery including $9.4 million net deferred tax recovery relating to foreign exchange translation of a foreign subsidiary, $0.3 million arrears interest relating to unrecognized tax benefits, $1.0 million tax effect on inter-company transactions and $0.8 million tax adjustments based on completed filings and assessments received from tax authorities.

 

(3) Results include $0.2 million stock-based compensation expense included in Cost of revenues; $2.1 million stock-based compensation expense included in Research and development expense; $3.3 million stock-based compensation expense included in Selling, general and administrative expense; $0.7 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $2.9 million foreign exchange loss on foreign tax liabilities; and $2.5 million net income tax provision which includes $1.5 million net deferred tax expense relating to foreign exchange translation of a foreign subsidiary, $0.3 million arrears interest relating to unrecognized tax benefits and $1.2 million tax effect on inter-company transactions.

 

(4) Results include $0.2 million stock-based compensation expense included in Cost of revenues; $2.3 million stock-based compensation expense and $1.2 million termination costs included in Research and development expense; $2.9 million stock-based compensation expense and $0.8 million termination costs included in Selling, general and administrative expense; $0.7 million of non-cash interest for the accretion of the debt discount related to the senior convertible notes; $3.6 million foreign exchange gain on foreign tax liabilities; and $1.0 income tax provision which includes $0.9 million net deferred tax recovery relating to foreign exchange translation of a foreign subsidiary, $0.4 million arrears interest relating to unrecognized tax benefits, $0.7 million tax adjustments relating to prior periods, $0.3 million income tax related to foreign exchange gain on a foreign tax liability and $1.0 million tax effect on inter-company transactions.

 

(5) Results include $0.2 million stock-based compensation expense included in Cost of revenues; $2.4 million stock-based compensation expense included in Research and development expenses; $2.6 million stock-based compensation expense included in Selling, general and administrative expenses; $10.0 million gain on repurchase of senior convertible notes, net; $1.1 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $4.5 million foreign exchange gain on foreign tax liabilities; and $2.2 million net income tax effects including $5.6 million deferred tax expense relating to unrealized gain on foreign exchange translation of a foreign subsidiary, $4.3 million reversal of unrecognized tax benefits and related interest and $1.3 million tax adjustments based on completed filings and assessments received from tax authorities.

 

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(6) Results include $0.2 million stock-based compensation expense included in Cost of revenues; $2.4 million stock-based compensation expense included in Research and development expenses; $2.7 million stock-based compensation expense included in Selling, general and administrative expenses; $1.3 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $0.8 million foreign exchange gain on foreign tax liabilities; and $2.0 million net income tax recovery including $0.7 million tax adjustments based on completed filings and assessments received from tax authorities and $0.3 million interest relating to unrecognized tax benefits.

 

(7) Results include $0.4 million stock-based compensation expense included in Cost of revenues; $3.2 million stock-based compensation expense included in Research and development expenses; $3.7 million stock-based compensation expense included in Selling, general and administrative expenses; $1.3 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $0.8 million foreign exchange loss on foreign tax liabilities; and $124.3 million related to an adjustment to the accrual for unrecognized tax benefits.

 

(8) Results include $0.3 million stock-based compensation expense included in Cost of revenues; $3.2 million stock-based compensation expense included in Research and development expenses; $3.5 million stock-based compensation expense included in Selling, general and administrative expenses; $1.9 million of non-cash interest expense for the accretion of the debt discount related to the senior convertible notes; $4.9 million gain on repurchase of senior convertible notes, net; $3.6 million foreign exchange loss on our income tax liabilities; and $33.4 million income tax recovery including $30.3 million relating to the liability for unrecognized tax benefits arising in prior years and related interest and $2.3 million tax impact relating to repatriation of earnings from a foreign jurisdiction.

Cash Flow Presentation

The following tables represent the impact of the correction of an immaterial presentation error in the statement of cash flows included in previously filed Form 10-Qs for fiscal 2009, 2008 and 2007. The error relates to the presentation of the effect of exchange rate changes on operating assets and liabilities and cash and cash equivalents. There was no impact on previously reported net change in cash and cash equivalents, net income (loss), net income (loss) per common share or financial position as a result of this change in presentation for any of the periods presents. The adjustment had the following impact on our quarterly cash flows:

 

    Quarterly Data for the Year Ended December 27, 2009  
    Third     Second     First     Third     Second     First  

(in thousands)

  As reported     As restated  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

           

Unrealized foreign exchange (gain) loss, net

  $ 292      $ (687   $ (3,576   $ 97      $ (1,087   $ (3,900

Changes in operating assets and liabilities:

           

Prepaid expenses and other current assets

    2,403        (916     923        2,475        (851     971   

Accounts payable and accrued liabilities

    6,598        (2,843     (5,182     4,562        (3,790     (5,647

Deferred income taxes and income taxes payable

    (6,893     3,086        135        (6,624     3,329        135   

Accrued restructuring costs

    (1,373     (919     (542     (1,445     (958     (557

Net cash provided by operating activities

    92,229        43,385        8,625        90,267        42,307        7,869   

Effect of exchange rate changes on cash and cash equivalents

  $ —        $ —        $ —        $ 1,962      $ 1,078      $ 756   

 

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    Quarterly Data for the Year Ended December 28, 2008  
    Fourth     Third     Second     First     Fourth     Third     Second     First  

(in thousands)

  As reported     As restated  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

               

Unrealized foreign exchange (gain) loss, net

  $ (7,853   $ (3,311   $ (2,527   $ (3,605   $ (8,362   $ (3,320   $ (2,267   $ (3,288

Changes in operating assets and liabilities:

               

Prepaid expenses and other current assets

    6,945        4,972        895        711        6,743        4,914        885        680   

Accounts payable and accrued liabilities

    (42,679     (22,069     (6,101     (7,464     (40,240     (21,654     (6,216     (7,144

Deferred income taxes and income taxes payable

    (72,163     (79,718     (82,381     38,556        (70,491     (78,075     (81,441     39,555   

Accrued restructuring costs

    (4,973     (3,971     (2,461     (1,218     (4,720     (3,850     (2,352     (1,098

Net cash provided by operating activities

    78,806        64,216        53,141        18,863        82,459        66,328        54,325        20,588   

Effect of exchange rate changes on cash and cash equivalents

  $ (658   $ (658   $ (658   $ (971   $ (4,311   $ (2,770   $ (1,842   $ (2,696
    Quarterly Data for the Year Ended December 30, 2007  
    Fourth     Third     Second     First     Fourth     Third     Second     First  

(in thousands)

  As reported     As restated  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

               

Unrealized foreign exchange (gain) loss, net

  $ 18,221      $ 16,075      $ 9,286      $ 979      $ 18,246      $ 15,849      $ 8,849      $ 953   

Changes in operating assets and liabilities:

               

Prepaid expenses and other current assets

    1,998        462        478        1,159        2,226        624        546        1,182   

Accounts payable and accrued liabilities

    6,933        5,700        410        (47     5,027        4,169        (224     (46

Deferred income taxes and income taxes payable

    13,710        10,277        3,813        (1,615     12,353        9,152        3,845        (1,577

Accrued restructuring costs

    (1,595     223        2,406        4,357        (2,106     (281     2,057        4,361   

Net cash provided by operating activities

    91,210        60,660        35,946        17,836        87,689        57,436        34,626        17,876   

Effect of exchange rate changes on cash and cash equivalents

  $ 1,396      $ 1,170      $ —        $ —        $ 4,917      $ 4,394      $ 1,320      $ (40

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion of the financial condition and results of our operations should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this Annual Report.

OVERVIEW

We generate revenues from the sale of semiconductor solutions that we have designed and developed or acquired. Almost all of our revenues in any given year come from the sale of semiconductors that are developed prior to that year. For example, 100% of our revenues in 2009 came from products developed or acquired in 2008 and earlier. After an individual product is released for production and announced it may take several years before that product generates any significant revenues.

Our current revenues are generated by a portfolio of approximately 400 products. Our diverse product portfolio services a number of key end markets: the Enterprise Infrastructure market which includes our products and solutions that enable the high-speed interconnection of servers, switches and storage devices that comprise these systems thus allowing large quantities of data to be stored, managed and moved securely; and the Communications Infrastructure market which encompasses wired, wireless and Passive Optical Networking (“PON”) devices used in access, aggregation and transport equipment such as optical transport platforms, edge routers, multi-service switches and wireless base stations that gather and process signals in different protocols, and transmit them to the next destinations.

We invest a substantial amount every year for the research and development of new semiconductor solutions. We determine the amount to invest in each semiconductor development based on our assessment of the future market opportunities for those components and the estimated return on investment. To compete globally, we must invest in technologies, products and businesses that are both growing in demand and are cost competitive in the geographic markets that we serve. Going forward, we plan to continue to focus on finding innovative solutions to meet our customers’ needs while maintaining our operational efficiencies.

At PMC-Sierra, we continue to expand our storage product offerings, such as our 6 Gb SAS RAID-on-Chip, which we began shipping to one of our largest OEM customers in 2009. And we continue to benefit from our acquisition of the Storage Semiconductor Business from Avago in 2006, as we combine the Fibre Channel controllers we acquired in that acquisition with the SAS controllers and disk-interconnect products that we have designed internally. For example, internally designed follow-on products include our 8 gigabit Fibre Channel controller products, which improve data access times in data virtualization and fixed content storage.

With regard to our communications business, we continue to see the convergence of networks and build-outs by service providers who need to handle increasing levels of data and video traffic, as well as reduce their network operating costs. We are seeing growth in demand for our wireline and wireless access product, as well as our metro optical transport solutions.

We continue to penetrate Asian markets with our Fiber-To-The-Home (“FTTH”) products. Our Ethernet Passive Optical Network (“EPON”) solutions are firmly entrenched in Japan, China and Korea. In each market, our EPON products are shipping into OEMs who in turn are supplying several carriers, such as China Telecommunications Corporation, KT Corporation and Nippon Telegraph and Telephone Corporation, who are expanding their EPON deployments.

We expect our microprocessor solutions to continue to ship into the laser printer market as well as the enterprise networking market, and we are developing solutions for the video surveillance market as well.

 

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Net Revenues

 

(in millions)

   2009    Change     2008    Change     2007

Net revenues

   $ 496.1    (6 )%    $ 525.1    17   $ 449.4

Net revenues for 2009 decreased $29.0 million, or 6% compared to net revenues for 2008. Revenues generated from the Enterprise Infrastructure market decreased by 2% compared to 2008. The Enterprise Infrastructure market is served by our storage and microprocessor-based SOC products. Revenues related to the Communications Infrastructure market, which is served by our wireline, wireless, and PON devices decreased by 9% compared to 2008.

The decline in net revenues noted above from our Enterprise Infrastructure products was due a 35% decline in net revenues from lower shipments of our microprocessor products, largely offset by a 12% increase in net revenues from our enterprise storage products. The decline in net revenues from our microprocessor products was mainly due to the working down of inventories by our customers and the effects of the general economic slowdown on enterprise spending. The increase in our enterprise storage net revenues was mainly attributable to our 6 Gb/SAS RAID-on-Chip, which began shipping in production volumes in the second quarter of 2009, as well as the increased demand for our 3 Gb SAS expander products.

The decline in net revenues noted above from our Communications Infrastructure products was mainly due to consumption of excess inventory by our customers and lower levels of capital spending by carriers in those end markets. As a partial offset to this decline in net revenues we experienced increased demand from our Chinese OEM customers for the wireless and wireline build out in that market.

Net revenues for 2008 increased $75.7 million, or 17%, compared to net revenues for 2007. Revenues generated from the Enterprise Infrastructure market increased 19% compared to 2007. Revenue generated from the Communication Infrastructure market increased by 15%.

The growth in our Enterprise Infrastructure net revenues was generally attributable to an increase in storage capacity upgrades and information management solutions expenditures in the marketplace in 2008 compared to 2007. The sales of our microprocessor-based SOC products increased in 2008 compared to 2007 primarily due to increased activity in the laser printer market. The net revenues from our Communications Infrastructure products increased due to the PON market growth in Asia and the emerging markets, particularly China. In 2008, there was an increase in shipments to our Chinese customers using EPON devices for field trials in the China market. In addition, shipments of our FTTH products to Japan and Korea increased as carriers continue to build out their networks. The revenues for the wired devices remained flat when comparing 2008 to 2007.

An increase in net revenue of $4.2 million is also attributable to changes in 2007 in how we conducted business with one of the international entities of a certain distributor resulting in a change in revenue recognition to a sell-through basis.

Over the past three years, we have seen significant growth in net revenues generated in Asia. Net revenues from Asia were 84% of total net revenues in 2009, 73% of total net revenues in 2008 and 65% of total net revenues in 2007. We attribute this trend primarily to our increasing presence in the FTTH market, which is concentrated in Japan, Korea, China and Taiwan, and increased manufacturing outsourcing into Asia by our OEM customers.

 

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Gross Profit

 

(in millions)

   2009     Change     2008     Change     2007  

Gross profit

   $ 330.9      (4 )%    $ 343.4      18   $ 291.1   

Percentage of net revenues

     67       65       65

Total gross profit for 2009 decreased by $12.5 million over gross profit in 2008. The gross profit as a percentage of net revenues was 67% in 2009 and 65% in 2008.

The increase in gross profit as a percentage is attributable to product mix, as well as cost reductions achieved in 2009 as compared to 2008. This was offset by an approximately 1% decrease mainly due to having customer funded ASIC mask sets at zero margin during 2009, which we did not have in 2008.

Total gross profit for 2008 increased by $52.3 million over gross profit in 2007. The gross profit as a percentage of revenues was approximately 65% in 2008 and 2007.

While product mix can influence our gross profit as a percentage of revenue from period to period, our underlying gross profit percentage in 2008 remained consistent with that in 2007 as changes in average selling price decreased in approximately the same proportion as decreases in manufacturing costs.

Other Costs and Expenses

 

(in millions)

   2009     Change     2008     Change     2007  

Research and development

   $ 149.2      (5 )%    $ 157.6      (1 )%    $ 159.1   

Percentage of net revenues

     30       30       35

Selling, general and administrative

   $ 84.9      (9 )%    $ 93.5      (7 )%    $ 100.5   

Percentage of net revenues

     17       18       22

Amortization of purchased intangible assets

   $ 39.3      —     $ 39.3      —     $ 39.3   

Percentage of net revenues

     8       7       9

Impairment of goodwill and purchased intangible assets

   $ 0.9      13   $ 0.8      (95 )%    $ 14.8   

Percentage of net revenues

     —         —         3

Research and Development Expenses

Our research and development (“R&D”), expenses were $149.2 million in 2009. This was $8.4 million, or 5%, lower compared to 2008. Payroll costs decreased by $8.6 million mainly due to the effect of foreign exchange in our foreign operations, partially offset by an increase in headcount. Total material costs, including outside consultant services, wafer and photomask costs increased by $3.0 million mainly due to higher investment in R&D related to our storage products, partially offset by a decrease in costs related to fewer tapeouts in 2009 compared to 2008. The remaining $2.8 million reduction in expenses relates to the reduction in other expenses due to cost reduction activities.

Our R&D expenses were $157.6 million, or $1.5 million and 1% lower in 2008 compared to 2007. Due to restructuring activities undertaken in the first quarter of 2007, our payroll-related costs decreased $5.9 million in 2008. Offsetting these decreases, we incurred $0.8 million in higher materials costs, including higher outside consultant services due to completing more tapeouts on smaller geometries in 2008 compared to 2007, as well as, the RAID R&D programs which began in first quarter of 2008, added additional costs in 2008. In addition, there was a $1.9 million increase in infrastructure related expenses due to normal maintenance of equipment and design related software tools, $1.7 million increase in the amortization of purchased intangibles mainly due to increased tools relating to the RAID project.

 

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Selling, General and Administrative Expenses

Our selling, general and administrative (“SG&A”) expenses were $8.6 million, or 9%, lower in 2009 compared to 2008. Payroll costs decreased by $4.9 million mainly due to the effect of foreign exchange in our foreign operations. The remaining $3.7 million reduction in expenses relates to the reduction in other expenses due to cost reduction activities.

Our selling, general and administrative (“SG&A”) expenses were $7.0 million, or 7% lower in 2008 compared to 2007. The primary reason for the net decrease in SG&A expenses is the restructuring activities undertaken in the first quarter of 2007. As a result, payroll-related costs and facilities-related costs were lower by $4.9 million and $2.5 million, respectively. Professional fees were $2.1 million lower in 2008 compared to 2007, mainly due to settlement of a litigation matter in August 2007. Other SG&A costs were $2.5 million higher in 2008 compared to 2007. The primary reasons for the increase were that in 2007 we received a credit of $2.8 million arising from the favorable settlements of both a payroll tax matter with the United Kingdom tax authorities and a capital tax refund.

Amortization of Purchased Intangible Assets

The annual amortization of intangible assets acquired from Storage Semiconductor Business and Passave was $18.9 million and $20.4 million, respectively, for each of 2009, 2008, and 2007.

Restructuring Costs and Other Charges

The activity related to excess facility and severance accruals under our restructuring plans during the three years ended December 27, 2009, by year of plan, were as follows:

Excess Facility Costs

 

(in thousands)

   2007     2006     2005     2003     2001     Total  

Balance at December 31, 2006

   $ —        $ 2,111      $ 4,268      $ 549      $ 5,096      $ 12,024   

Reversals and adjustments

     23        (441     —          (549     128        (839

New charges

     2,768        —          450        —          850        4,068   

Cash payments

     (860     (1,081     (1,389     —          (2,130     (5,460
                                                

Balance at December 30, 2007

     1,931        589        3,329        —          3,944        9,793   

Reversals and adjustments

     (393     (51     —          —          (747     (1,191

New charges

     230        130        1,085        —          —          1,445   

Cash payments

     (938     (490     (1,366     —          (1,322     (4,116
                                                

Balance at December 28, 2008

     830        178        3,048        —          1,875        5,931   

Reversals and adjustments

     28        15        —          —          88        131   

New charges

     25        117        700        —          —          842   

Cash payments

     (357     (216     (1,404     —          (933     (2,910
                                                

Balance at December 27, 2009

   $ 526      $ 94      $ 2,344      $ —        $ 1,030      $ 3,994   
                                                

 

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Severance Costs

 

(in thousands)

   2007     2006     2005     2003    2001    Total  

Balance at December 31, 2006

   $ —        $ 536      $ 97      $ —      $ —      $ 633   

Reversals and adjustments

     144        (409     (59     —        —        (324

New charges

     9,863        —          —          —        —        9,863   

Cash payments

     (8,889     (127     (38     —        —        (9,054
                                              

Balance at December 30, 2007

     1,118        —          —          —        —        1,118   

Reversals and adjustments

     (378     —          —          —        —        (378

New charges

     696        —          —          —        —        696   

Cash payments

     (1,429     —          —          —        —        (1,429
                                              

Balance at December 28, 2008

     7        —          —          —        —        7   

Reversals and adjustments

     1        —          —          —        —        1   

New charges

     —          —          —          —        —        —     

Cash payments

     (8     —          —          —        —        (8
                                              

Balance at December 27, 2009

   $ —        $ —        $ —        $ —      $ —      $ —     
                                              

During 2009, we made payments totaling $2.9 million for excess facilities costs and severance incurred in connection with past restructuring plans. In addition, we recorded an additional $0.8 million for excess facilities as original assumptions regarding possible sublease on exited facilities were not realized.

During 2008, we made payments totaling $5.5 million for excess facilities costs and severance incurred in connection with past restructuring plans. In addition, we recorded an additional $1.4 million for excess facilities as original assumptions regarding possible sublease on exited facilities were not realized.

During 2007, we initiated a cost-reduction plan that involved staff reductions of 175 employees at various sites and the closure of design centers in Saskatoon, Saskatchewan and Winnipeg, Manitoba. We also vacated excess office space at our Santa Clara facility. PMC continued to lower costs in the fourth quarter of 2007 by reducing headcount by 18 employees primarily at the Burnaby facility. In 2007, we incurred $12.6 million for excess facilities costs and severance incurred in connection with the 2007 plan. In addition we made payments of $9.7 million in connection with this plan in 2007. In connection with restructuring plans initiated prior to 2007, we made payments totaling $4.8 million for excess facilities costs and severance incurred in connection with past restructuring plans and we recorded additional $1.3 million for excess facilities as original assumptions regarding possible sublease on exited facilities were not realized.

 

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Other Income and Expenses

 

(in millions)

   2009     Change     2008     Change     2007  

Gain on repurchase of senior convertible notes, net and amortization of debt issue costs

   $ (0.2   (101 )%    $ 14.6      2,186   $ (0.7

Percentage of net revenues

     —         3       —  

Foreign exchange (loss) gain

   $ (2.4   (129 )%    $ 8.1      144   $ (18.5

Percentage of net revenues

     —         2       (4 )% 

Loss on subleased facilities

   $ (0.5   (100 )%    $ —        —     $ —     

Percentage of net revenues

     —         —         —  

Asset impairment

   $ —        100   $ (4.3   (100 )%    $ —     

Percentage of net revenues

     —         (1 )%        —  

Interest (expense) income, net

   $ (2.5   (213 )%    $ (0.8   (153 )%    $ 1.5   

Percentage of net revenues

     (1 )%        —         —  

Recovery on investments

   $ —        (100 )%    $ 0.4      100   $ —     

Percentage of net revenues

     —         —         —  

Gain (loss) on investment securities

   $ 0.2      (102 )%    $ (11.8   (100 )%    $ —     

Percentage of net revenues

     —         (2 )%        —  

(Provision for) recovery of income taxes

   $ (4.2   (106 )%    $ 70.0      516   $ (16.8

Percentage of net revenues

     (1 )%        13       (4 )% 

Gain on Repurchase of Senior Convertible Notes and Amortization of Debt Issue Costs

In 2005, we issued $225.0 million of 2.25% senior convertible notes. In 2008, we repurchased $156.7 million principal amount of our senior convertible notes for $138.3 million and expensed $3.2 million of related unamortized debt issue costs and transactions costs resulting in a net gain of $15.0 million. We also recognized amortization of debt issue costs of $0.2 million, $0.4 million and $0.7 million for 2009, 2008 and 2007 respectively. The amounts have been adjusted for the adoption of ASC Topic 470, the Debt Topic, see Recent Accounting Pronouncements.

Foreign Exchange Gain (Loss)

Foreign exchange loss was $2.4 million in 2009 compared to a gain of $8.1 million in 2008 and a loss of $18.5 million in 2007. The foreign exchange gain (loss) for all years presented relates primarily to the re-measurement each period of accrued income tax amounts.

We have significant design presence outside the United States, especially in Canada. The majority of our operating expense exposures to changes in the value of the Canadian Dollar relative to the United States Dollar have been hedged in accordance with our general practice of hedging approximately three quarters in advance.

Our net foreign exchange gain (loss) was $2.4 million foreign exchange loss, $8.1 million foreign exchange gain and $18.5 million foreign exchange loss, in 2009, 2008 and 2007, respectively, which was primarily due to foreign exchange gain (loss) on the revaluation of our net foreign tax liability. We do not hedge our income tax accruals against fluctuations in foreign currency exchange rates (see Item 3. Quantitative and Qualitative Disclosures About Market Risk). The revaluation of this foreign tax liability was required because of the foreign exchange rate fluctuations of other currencies against the United States Dollar. The foreign exchange rate between the United States Dollar and the currencies of countries where we have significant tax liabilities depreciated 4% during the fourth quarter of 2009 and depreciated 14% for the year in 2009.

 

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Loss on Subleased Facilities

We recorded a $0.5 million loss on subleased facilities during 2009.

Asset Impairment

In 2008, we recorded $4.3 million for an asset impairment related to a supplier contract termination. There was no asset impairment in 2009.

Interest (Expense) Income, Net

Our net interest income for 2009, 2008 and 2007 was $2.5 million interest expense, $0.8 million interest expense and $1.5 million interest income, respectively.

In 2009, the interest expense of $2.5 million includes $3.0 million interest expense relating to our senior convertible notes and net interest revenue of $0.5 million. Net interest income decreased by $1.7 million in 2009 compared to 2008 due mainly to lower investment yields, partially offset by higher cash balance in 2009 and by the decrease in interest expense relating to the accretion of the discount as a result of partial repurchases of the senior convertible notes in 2008.

Recovery on Investments

In 2008, we received $0.4 million from an investment in a private company, previously written off.

Gain (Loss) on Investment Securities

In 2009, we realized a gain of $0.2 million related to disposition of investment securities. At December 27, 2009, we held $23.2 million in investments in shares of the Reserve Funds, net of the recorded impairment of $11.8 million that we recognized in the third quarter of 2008, see Critical Accounting Policies and Estimates—Investments in Cash Equivalents, Short-Term Investments and Long-Term Investment Securities.

(Provision for) Recovery of Income Taxes

Our provision for income taxes for the year ended December 27, 2009 was $4.2 million resulting in an effective tax rate of 9% on net income of $46.9 million. The provision for income taxes of $4.2 million for the year ended December 27, 2009 consisted of $9.9 million recovery associated with the change in deferred tax relating to unrealized foreign exchange loss arising from the foreign currency translation pertaining to a foreign subsidiary, $4.9 million tax expense relating to the amortization of the tax effects relating to inter-company transactions relating to sale of certain assets, as discussed below, $4.5 million relating to the liability for unrecognized tax benefits (including associated interest), $3.8 million increase in deferred income tax related to past acquisitions and $0.9 million increase in tax expense from operations, net of investment tax credits earned.

The consolidated financial statements for the year ended December 27, 2009 include the tax effects associated with the sale of certain assets between our wholly-owned subsidiaries. GAAP requires the tax expense associated with gains on such inter-company transactions to be recognized over the estimated life of the related assets. Accordingly, the $26.2 million recorded as long-term prepaid expenses as at December 27, 2009 represents the remaining tax expense to be recognized over periods of up to six years, with corresponding amounts recorded as current and deferred income taxes payable and as liability for unrecognized tax benefits. The tax expense during the year ended December 27, 2009 resulting from these transactions was $4.9 million.

Our provision for income taxes for the year ended December 28, 2008 was a $70.0 million recovery, resulting in an effective tax rate of negative 120% on net income of $58.3 million. The recovery was primarily as a result of one of our foreign subsidiaries settling several ongoing tax matters for less than had been accrued as part of its

 

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liability for unrecognized tax benefits, resulting in the recognition of a $124.1 million tax benefit. In addition, we accrued $35.2 million (including associated interest) relating to an ongoing liability arising from the examination of our existing transfer pricing practices prior to the settlement noted above, $28.1 million of income tax from normal operations (offset by investment tax credits of $19.5 million), $5.8 million deferred tax expense from an unrealized gain arising from foreign currency translation pertaining to a foreign subsidiary, and $4.5 million increase in tax from various items, including deferred taxes, minimum taxes and revisions of prior estimates.

Our provision for income taxes for the year ended December 30, 2007 was $16.8 million, resulting in an effective tax rate of 52% on a net loss of $32.3 million. Despite this net loss, income taxes were incurred primarily from a $28.0 million additional accrual relating to an ongoing liability for unrecognized tax benefits arising from the examination by a foreign tax authority of the historic transfer pricing policies and practices of certain foreign subsidiaries. Of the $28.0 million increase in our liability for unrecognized tax benefits, $13.0 million is related to arrears interest. Our liability for unrecognized tax benefits is partially offset by available investment tax credits of $18.0 million. The remainder of the provision for income taxes primarily relates to $6.0 million of deferred taxes recorded with respect to a past acquisition and net $1.0 million due to various items, including revisions of prior estimates.

Critical Accounting Policies and Estimates

General

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts we report as assets, liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that are reasonable in the circumstances. These estimates could change under different assumptions or conditions.

Our significant accounting policies are outlined in the notes to the consolidated financial statements. In management’s opinion the following critical accounting policies require the most significant judgment and involve complex estimation. We also have other policies that we consider to be key accounting policies, such as our policies of revenue recognition, including the deferral of revenues on sales to major distributors; however these policies do not meet the definition of critical accounting estimates as they do not generally require us to make estimates or judgments that are difficult or subjective.

Valuation of Goodwill and Intangible Assets

We assess the impairment of long-lived assets in the fourth quarter, or when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors that we may consider when determining when to conduct an impairment test include: (i) any future declines in our operating results; (ii) a decline in the valuation of technology company stocks, including the valuation of our common stock; (iii) a further significant slowdown in the worldwide economy or the semiconductor industry; or (iv) any failure to meet the performance projections included in our forecasts of future operating results.

To determine whether impairment exists, we first compare the undiscounted cash flows of the assets to their carrying value. If the asset’s carrying value exceeds its estimated undiscounted cash flows, we would write the asset to its estimated fair value based on expected discounted cash flows. Significant management judgment is required in the forecasts of future operating results and discount rates used in the discounted cash flow method of valuation. It is possible, however, that the plans may change and estimates used may prove to be inaccurate. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges.

 

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There were no indications of impairment to goodwill or intangible assets in 2009. Changes in the estimated fair values of these assets in the future could result in significant impairment charges or changes to our expected amortization.

Stock-Based Compensation

Since January 1, 2006, we have recognized compensation expense for all share-based payment awards. Under ASC Topic 718, Compensation—Stock Compensation, we measure the fair value of awards of equity instruments and recognize the cost, net of an estimated forfeiture rate, on a straight-line basis over the period during which services are provided in exchange for the award, generally the vesting period.

Calculating the fair value of stock-based compensation awards requires the input of highly subjective assumptions, including the expected life of the awards and expected volatility of our stock price. Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. Our estimates of expected volatilities are based on a weighted historical and market-based implied volatility. In order to determine the expected life of the awards, we use historical data to estimate option exercises and employee terminations; separate groups of employees that have similar historical exercise behavior, such as directors or executives, are considered separately for valuation purposes. The expected forfeiture rate applied in calculating stock-based compensation cost is estimated using historical data and is updated annually.

The assumptions used in calculating the fair value of stock-based awards involve estimates that require management judgment. If factors change and we use different assumptions, our stock-based compensation expense could change significantly in the future. In addition, if our actual forfeiture rate is different from our estimate, our stock-based compensation expense could change significantly in the future.

Restructuring Charges—Facilities

In calculating the cost to dispose of our excess facilities, we had to estimate the amount to be paid in lease termination payments, the future lease and operating costs to be paid until the lease is terminated, and the amount, if any, of sublease revenues for each location. This required us to estimate the timing and costs of each lease to be terminated, the amount of operating costs for the affected facilities and the timing and rate at which we might be able to sublease or complete negotiations of a lease termination agreement for each site. To form our estimates for these costs we performed an assessment of the affected facilities and considered the current market conditions for each site.

We believe our estimates of the obligations for the closing of sites remain sufficient to cover anticipated settlement costs. However, our assumptions on the lease termination payments, operating costs until termination, or the amounts and timing of offsetting sublease revenues may turn out to be incorrect and our actual cost may be materially different from our estimates. If our actual costs exceed our estimates, we would incur additional expenses in future periods.

Income Taxes

PMC has operations in several tax jurisdictions, which subjects us to multiple tax rates that impact our overall effective tax rate. We use estimates and assumptions in allocating income to each tax jurisdiction. As a result of certain business activities carried out in certain countries, such as employment and capital investment activities, income earned in those countries may be subject to reduced tax rates, or exempt from tax. Material changes in business activity that we conduct in these tax jurisdictions could impact our effective tax rates.

We have recorded income tax liabilities based on our interpretation of tax regulations for the countries in which we operate. We believe that the tax return positions we have taken are fully supportable. However, our estimates are subject to review and assessment by the local tax authorities. Our tax expense and related reserves

 

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reflect amounts that we believe will be adequate if challenged or subject to income tax assessment. Management uses judgment and estimates in determining tax expense for these challenges in accordance with guidance for accounting for uncertainty in income taxes. Currently, our reserve for uncertain tax positions is attributable primarily to uncertainties related to the tax treatment of our international operations, including the allocation on income among different jurisdictions.

The timing of any such review and final assessment of our liabilities is substantially out of our control and is dependent on the actions by those local tax authorities. Any re-assessment of our tax liabilities may result in adjustments of the income taxes we pay, with a resulting impact on our tax expense, net income and cash flows. We review our reserves quarterly, and we may adjust such reserves because changes in facts and circumstances, changes in tax regulations, negotiations between tax authorities and associated proposed tax assessments, the resolution of audits and the expiration of statutes of limitations.

We must also assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not likely, we must increase our provision for taxes by recording a reserve in the form of a valuation allowance for the deferred tax assets that we estimate will not ultimately be recoverable.

Investment in Cash Equivalents, Short-Term Investments and Long-Term Investment Securities

Our cash equivalents, short-term investments and long-term investment securities are comprised of money market funds, United States Treasury and Government Agency notes, Federal Deposit Insurance Corporation (“FDIC”)-insured corporate notes, United States State and Municipal Securities, foreign government and agency notes and corporate bonds and notes with minimum ratings of P-1 or A3 by Moody’s, or A-1 or A- by Standard and Poor’s, or equivalent. At December 27, 2009, these securities had an estimated fair value of $423.6 million.

Beginning in the first quarter of fiscal 2008, the assessment of fair value is based on the provisions of ASC Topic 820, the Fair Value Measurements and Disclosure Topic. We determined the fair value of our investment securities, which include money market funds, United States Treasury and Government Agency notes, Federal FDIC-insured corporate notes, United States State and Municipal Securities, foreign government and agency notes and corporate bonds and notes, using quoted prices from active markets, quoted prices for similar assets from third-party sources and by performing valuation analyses. In determining if and when a decline in market value below the carrying value of our investment securities is other-than-temporary, we evaluate on an ongoing basis the market conditions, trends of earnings, financial condition and other key measures for our investments. We assess impairment of our investment securities in accordance with GAAP.

During 2008, we assessed the fair value of certain of our investment securities by giving consideration to Level 2 and Level 3 inputs (see Note 3. Fair Value Measurements), for the shares of the Reserve Funds, and their underlying securities. Based on this assessment, we recorded an impairment of the Reserve Funds of $11.8 million during the third quarter of 2008, incorporating the Reserve Funds’ valuation at zero for debt securities of Lehman Brothers held, and a net asset value of $0.97 per share as communicated by the Reserve Funds’ Primary Fund. We reassessed the fair value of our investments in money market funds for the year ended December 27, 2009, and concluded there were no further impairments.

We reclassified our investment in shares of the Reserve Funds from Level 1 to Level 3 of the fair value hierarchy due to the inherent subjectivity and significant judgment related to the fair value of the shares of the Reserve Funds and their underlying securities. Accordingly, we changed the valuation method from a market approach to an income approach.

In addition, due to the continuing redemption delays associated with the liquidation proceedings of the Reserve Funds, we reclassified all of these shares from cash and cash equivalents to short-term investments (see Liquidity and Capital Resources).

 

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As of December 27, 2009, the original underlying securities held by the Reserve Funds had matured, and with the exception of Lehman Brothers’ securities, the balances were held by the Reserve Funds in the form of overnight agency notes. Changes in market conditions and the method and timing of the liquidation process of the Reserve Funds could result in further adjustments to the fair value and classification of these investments, and these changes could be material.

Business Outlook

We expect our revenues for the first quarter of 2010 to be approximately $148 million to $152 million based on typical order patterns. As in the past, and consistent with business practice in the semiconductor industry, a portion of our revenues are likely to be derived from orders placed and shipped during the same quarter, which we call our “turns business.” Our turns business varies from quarter to quarter. In the fourth quarter of 2009, net orders booked and shipped within the quarter were approximately 23% of quarterly sales, and we expect the turns percentage to be lower in the first quarter of 2010 compared with the fourth quarter of 2009.

We anticipate our first quarter 2010 gross margin percentage to be in the range of 66% plus or minus 100 basis points including approximately $0.2 million stock-based compensation expense. As in past quarters this could vary depending on the volumes of products sold, since many of our costs are fixed. Margins will also vary depending on the mix of products sold.

We expect our first quarter 2010 research and development and selling, general and administrative expenses to be approximately $63.0 million to $64.1 million respectively including stock-based compensation expense of approximately $4.6 million to $5.6 million. Therefore, we expect our first quarter core operating research and development and selling, general and administrative expenses to be approximately $58.5 million.

We expect that we will continue to incur significant amortization of purchased intangible assets related to our 2006 acquisitions in the first quarter of 2010.

We anticipate that net interest income will be approximately $0.5 million in the first quarter of 2010 as interest income earned from our cash position will be offset by interest expense incurred on our outstanding senior convertible notes.

Liquidity and Capital Resources

Our principal sources of liquidity are cash from operations, our short-term investments and long-term investment securities. We employ these sources of liquidity to support ongoing business activities, acquire or invest in critical or complementary technologies, purchase capital equipment, repurchase and repay our senior convertible notes and finance working capital. The combination of cash, cash equivalents, short-term investments and long-term investment securities at December 27, 2009 and December 28, 2008 totaled $453.4 million and $307.5 million, respectively. As of both December 27, 2009 and December 28, 2008, we had $68.3 million of senior convertible notes outstanding. In the future, we expect our cash on hand, from operations, our short-term investments, and long-term investment securities to be our primary source of liquidity.

 

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The composition of our cash, cash equivalents and short-term investments and long-term investment securities, as classified in our consolidated balance sheet at December 27, 2009 is as follows:

 

     December 27, 2009

(in thousands)

   Amortized
Cost
   Gross
Unrealized
Gains*
   Gross
Unrealized
Losses*
    Fair Value

Cash and cash equivalents:

          

Cash

   $ 29,757    $ —      $ —        $ 29,757

Money market funds

     163,068      16      —          163,084
                            

Total cash and cash equivalents

     192,825      16      —          192,841
                            

Short-term investments:

          

Money market funds

     23,242      —        —          23,242

US Treasury and Government Agency notes

     20,376      804      (1     21,179

Corporate bonds and notes

     14,760      1,426      (4     16,182

US States and Municipal securities

     7,300      25      —          7,325
                            

Total short-term investments

     65,678      2,255      (5     67,928
                            

Long-term investment securities:

          

US Treasury and Government Agency notes

     52,594      389      (53     52,930

Corporate bonds and notes

     108,102      669      (306     108,465

US States and Municipal securities

     1,019      2      —          1,021

Foreign Government and Agency notes

     30,179      123      (82     30,220
                            

Total long-term investment securities

     191,894      1,183      (441     192,636
                            

Total

   $ 450,397    $ 3,454    $ (446   $ 453,405
                            

 

* Gross unrealized gains include accrued interest on investments of $2,129K. The remainder of the gross unrealized gains and losses is included in the consolidated balance sheet as other comprehensive income.

 

     December 28, 2008

(in thousands)

   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value

Cash and cash equivalents:

           

Cash

   $ 28,626    $ —      $ —      $ 28,626

Money market funds

     69,213      —        —        69,213
                           

Total cash and cash equivalents

     97,839      —        —        97,839
                           

Short-term investments:

           

Money market funds

     209,685      —        —        209,685
                           

Total short-term investments

     209,685      —        —        209,685
                           

Total

   $ 307,524    $ —      $ —      $ 307,524
                           

The short-term investments of $23.2 million held at December 27, 2009 relate to shares of the Reserve International Liquidity Fund, Ltd. (the “International Fund”) and the Reserve Primary Fund (the “Primary Fund”, together the “Reserve Funds”). The Reserve Funds were AAA-rated money market funds which announced redemption delays and suspended trading in September 2008, during the severe disruption in financial markets. The Reserve Funds are in the process of liquidating their portfolio of investments, which included securities of Lehman Brothers Holdings, Inc. (“Lehman Brothers”) which was downgraded and has filed for Chapter 11 bankruptcy protection. The Primary Fund has received an U.S. Securities and Exchange Commission order providing that the SEC will supervise the distribution of assets from the fund. The redemptions from the International Fund are subject to pending litigation which could cause further delay in any redemption of our investments.

 

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As at December 27, 2009, all the underlying investments held in the Reserve Funds have matured, and securities are held only in overnight notes. Partial distributions received in 2009 from the Reserve Funds totaled $186.4 million. Subsequent to December 27, 2009, we received $4.3 million as a partial distribution from the Reserve Funds.

As of December 27, 2009, the original underlying securities held by the Reserve Funds had matured, and with the exception of Lehman Brothers’ securities, the balances were held by the Reserve Funds in the form of overnight agency notes. Changes in market conditions and the method and timing of the liquidation process of the Reserve Funds could result in further adjustments to the fair value and classification of these investments, and these changes could be material.

See Critical Accounting Estimates—Investment in Cash Equivalents, Short-Term Investments and Long-Term Investment Securities for additional information.

Operating Activities

During the fiscal year 2009, we generated positive net operating cash flows of $121.8 million, which was $39.3 million higher than the $82.5 million generated in fiscal 2008. We implemented cost reductions and operational efficiencies, resulting in increased operating cash flow despite generating $29 million less in revenue than 2008. The positive cash flow from operations generated in 2009 was primarily from net income, net of addbacks of non-cash expenses. As revenues increased sequentially throughout 2009, our accounts receivables also increased, causing an outflow of cash. We also made payments against our restructuring accruals throughout the year. The remaining fluctuations in working capital accounts are attributable to timing of transactions rather than particular events or trends.

In 2008, we generated positive net cash flow of $82.5 million on net income of $128.3 million. This is due to our net income in 2008 including $15.0 million of non-cash gains on the repurchase of our senior convertible notes and the addback of $8.4 million of unrealized foreign exchange gains. Our non-cash working capital items also generated a net outflow of cash as we reduced our accrual for uncertain tax positions by $94.3 million due to settling a tax matter and reduced our accounts payable by $40.2 million.

Investing Activities

We used $57.4 million for investing activities in 2009, which included $295.4 million for the purchase of investment securities, receipts of $59.3 for the disposal of investment securities, and $186.4 million in distributions from the Reserve Funds and $7.8 million for the purchase of property, plant and equipment and intellectual property.

In 2008, we used $222.4 million for investing activities, including $209.7 million for the purchase of investment securities and $12.7 million for the purchase of property, plant and equipment and intellectual property.

Financing activities

In 2009, we generated $28.3 million from the issuance of common shares under our employee stock plans. We did not conduct any transactions with respect to our senior convertible notes during 2009, other than make interest payments in accordance with the terms of the debt.

In 2008, we used $122.8 million for financing activities. These activities included the repurchase of our senior convertible notes of $139.3 million and collecting proceeds of $16.5 million from the issuance of our common stock under our employee stock option plans.

 

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As of December 27, 2009, we have the following commitments:

 

(in thousands)

   Total    2010    2011    2012    2013    2014    After
2014

CONTRACTUAL OBLIGATIONS

                    

Operating Lease Obligations:

                    

Minimum rental payments

   $ 27,131    $ 8,901    $ 6,908    $ 2,901    $ 2,607    $ 2,442    $ 3,372

Estimated operating cost payments

     12,310      4,059      2,698      1,287      1,142      1,136      1,988

Long Term Debt:

                    

Principal repayment

     68,340      —        —        —        —        —        68,340

Interest payments

     24,605      1,538      1,538      1,538      1,538      1,538      16,915

Purchase and other Obligations

     12,562      4,670      6,598      1,294      —        —        —  
                                                
   $ 144,948    $ 19,168    $ 17,742    $ 7,020    $ 5,287    $ 5,116    $ 90,615
                                                

In addition to the amounts shown in the table above, we have recorded a $46.0 million liability for unrecognized tax benefits as of December 27, 2009 and we are uncertain as to if or when such amounts may be realized.

On October 26, 2005, we issued $225 million aggregate principal amount of 2.25% senior convertible notes due 2025 (the “Notes”) and have recorded these Notes as long-term debt. Issuance costs of $6.8 million have been deferred and are being amortized over seven years. During 2008, we repurchased $156.7 million principal amount of our Notes for $138.3 million and expensed $3.2 million related to unamortized debt issue costs and transaction costs resulting in a net gain of $15.0 million. At December 27, 2009, $68.3 million of these Notes remained outstanding and $0.6 million of unamortized debt issue costs were included in investments and other assets.

The Notes rank equal in right of payment with our other unsecured senior indebtedness and mature on October 15, 2025 unless earlier redeemed by us at our option, or converted or put to us at the option of the holders. Interest is payable semi-annually in arrears on April 15 and October 15 of each year, commencing on April 15, 2006. We may redeem all or a portion of the Notes at par on and after October 20, 2012. The holders may require that we repurchase Notes on October 15 of each of 2012, 2015 and 2020.

Holders may convert the Notes into the right to receive the conversion value (i) when our stock price exceeds 120% of the approximately $8.80 per share initial conversion price for a specified period, (ii) in certain change in control transactions and (iii) when the trading price of the Notes does not exceed a minimum price level. For each $1,000 principal amount of Notes, the conversion value represents the amount equal to 113.6687 shares multiplied by the per share price of our common stock at the time of conversion. If the conversion value exceeds $1,000 per $1,000 in principal of Notes, we will pay $1,000 in cash and may pay the amount exceeding $1,000 in cash, stock or a combination of cash and stock, at our election.

We entered into a Registration Rights Agreement with the holders of the Notes, under which we are required to keep the shelf registration statement effective until the earlier of (i) the sale pursuant to the shelf registration statement of all of the Notes and/or shares of common stock issuable upon conversion of the Notes and (ii) the expiration of the holding period applicable to such securities held by non-affiliates under Rule 144 under the Securities Act, or any successor provision, subject to certain permitted exceptions.

We will be required to pay liquidated damages, subject to some limitations, to the holders of the Notes if we fail to comply with our obligations to register the Notes and the common stock issuable upon conversion of the Notes or the registration statement does not become effective within the specified time periods. In no event will liquidated damages accrue after the second anniversary of the date of issuance of the Notes or at a rate exceeding

 

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0.50% of the issue price of the Notes. We will have no other liabilities or monetary damages with respect to any registration default. If the holder has converted some or all of its Notes into common stock, the holder will not be entitled to receive any liquidated damages with respect to such common stock or the principal amount of the Notes converted.

Purchase obligations are comprised of commitments to purchase design tools and software for use in product development. Included in the purchase commitments above is $12.6 million in design software tools, which will be spent between 2010 and 2012. We have not included open purchase orders for inventory or other expenses issued in the normal course of business in the purchase obligations shown above. We estimate these other commitments to be approximately $17.0 million at December 27, 2009 for inventory and other expenses that will be received in the coming 90 days and that will require settlement 30 days thereafter.

We have a line of credit with a bank that allows us to borrow up to $0.7 million provided we maintain eligible investments with the bank equal to the amount drawn on the line of credit. At December 27, 2009, we had committed $0.7 million under letters of credit as security for office leases.

We expect to use approximately $17.1 million of cash in 2010 for capital expenditures including purchases of intellectual property. Based on our current operating prospects, we believe that existing sources of liquidity will be sufficient to satisfy our projected operating, working capital, capital expenditure, purchase obligations and remaining restructuring requirements through the end of 2010.

Off-Balance Sheet Arrangements

As of December 27, 2009, we had no off-balance sheet financing arrangements.

Recent Accounting Pronouncements

Impact of ASC Topic 470

Effective December 29, 2008, we retrospectively adopted the ASC Topic 470, the Debt Topic for the accounting of convertible debt instruments that may be settled in cash upon conversion (including partial settlements), as required, which changed the treatment for our convertible securities, which may be settled fully or partially in cash. Under ASC Topic 470, cash settled convertible securities are separated into their debt and equity components. The value assigned to the debt component is the estimated fair value, as of the issuance date, of a similar debt instrument without the conversion feature and the difference between the proceeds for the convertible debt and the amount reflected as debt, is recorded as equity. As a result, the debt component is recorded at a discount from its face value, reflecting its below market coupon interest rate. The debt is subsequently accreted to its face value over its expected term, with the accretion being reflected as additional interest expense in the consolidated statement of operations.

We issued senior convertible notes with a face value of $225.0 million and bearing interest at a rate of 2.25% per annum in October 2005. At the date of issuance, our borrowing rate for similar debt instruments without any equity conversion features was estimated to be 8.0% per annum. This borrowing rate of 8.0% was estimated using assumptions that market participants would use in pricing the liability component, including market interest rates, credit standing, yield curves and volatilities; all of which are defined as Level 2 observable inputs. Under ASC Topic 470, at the issuance date, the debt and equity components would have been $155.6 million and $69.4 million, respectively, before considering related issuance costs. The debt, which is recorded at a discount from its face value at issuance, is accreted to its face value over seven years, which is the earliest date at which the holders of these Notes may redeem them, with accretion being reflected as additional interest expense in the consolidated statement of operations.

We recorded issuance costs of $6.8 million of which $4.7 million were deferred and are being amortized over seven years, which is the earliest date at which the holders of these Notes may redeem them, which approximates the effective interest method. The remaining $2.1 million was recorded as equity.

 

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The following tables are reconciliations between amounts reported in the previous filing of the Form 10-K as of the year ended December 28, 2008, which was filed with the Securities and Exchange Commission (“SEC”) on February 26, 2009, to the amounts reported in the current filing for these same periods to reflect retroactive adjustments:

 

     Year Ended  
     December 28, 2008     December 30, 2007  

(in thousands, except for per share amounts)

   As adjusted     As reported***     As adjusted     As reported***  

Deferred debt issue costs*

   $ 774      $ 1,127      $ 3,214      $ 4,677   

2.25% senior convertible notes due October 15, 2025

     55,357        68,340        173,130        225,000   

Additional paid in capital

     1,471,476        1,436,306        1,462,267        1,394,946   

Deficit

     (689,241     (666,701     (817,538     (800,624

Interest expense **

     (8,682     (3,065     (13,481     (5,064

Gain on repurchase of senior convertible notes, net of amortization of debt issue costs

     14,568        14,577        (680     (968

Net income (loss)

   $ 128,297      $ 133,923      $ (57,233   $ (49,104

Net (loss) income per common share—basic

   $ 0.58      $ 0.60      $ (0.26   $ (0.23

Net (loss) income per common share—diluted

   $ 0.57      $ 0.60      $ (0.26   $ (0.23

Shares used in per share calculation—basic

     221,659        221,659        216,330        216,330   

Shares used in per share calculation—diluted

     223,687        223,687        216,330        216,330   
     Year Ended  
     December 28, 2008     December 30, 2007  

(in thousands)

   As adjusted     As reported***     As adjusted     As reported***  

CONSOLIDATED STATEMENTS OF CASH FLOWS

        

Cash flows from operating activities:

        

Net income (loss)

   $ 128,297      $ 133,923      $ (57,233   $ (49,104

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

        

Depreciation and amortization

     59,796        54,422        71,356        63,227   

Gain on repurchase of senior convertible notes, net

   $ (14,980   $ (15,172   $ —        $ —     

 

* Deferred debt issue costs are included in the consolidated balance sheets as Investments and other assets.
** Interest expense is included in the consolidated statements of operations as Interest (expense) income, net.
*** Balances are as reported in the Company’s Form 10-K for the year ended December 28, 2008.

Fair Value Accounting

Effective April 26, 2009, we adopted ASC Topic 320-10-65, which amends other-than-temporary impairment guidance relating to debt securities. If the fair value of a debt security is less than its amortized cost, we assess whether the impairment is other than temporary. An impairment is considered other than temporary if (i) we have the intent to sell the security, (ii) it is more likely than not that we will be required to sell the security before recovery of the entire amortized cost basis or (iii) we do not expect to recover the entire amortized cost basis of the security. If an impairment is considered other than temporary based on condition (i) or (ii) described above, the entire difference between the amortized cost and the fair value of the debt security is recognized in earnings. If an impairment is considered other than temporary based on condition (iii), the amount representing credit losses (defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security) will be recognized in earnings and the amount relating to all other factors will be recognized in Other Comprehensive Income. There was no financial reporting impact due to the adoption of this standard.

 

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Business Combinations and Noncontrolling interests

In December 2007, the FASB issued ASC Topic 805, the Business Combinations Topic. ASC Topic 805 changes the accounting for acquisitions that close beginning in 2009. More transactions and events qualify as business combinations and are accounted for at fair value under the new standard. ASC Topic 805 promotes greater use of fair values in financial reporting. Some of the changes introduce more volatility into earnings. ASC Topic 805 is effective for fiscal years beginning on or after December 15, 2008. There was no financial reporting impact due to this new standard. We will apply this new standard on any future business combinations.

In April 2009, the FASB issued ASC Topic 805-20, the Accounting for Assets Acquired and Liabilities Assumed in a Business Combination that Arise from Contingencies Topic. This updated guidance amended the accounting treatment for assets and liabilities arising from contingencies in a business combination and requires that pre-acquisition contingencies be recognized at fair value, if fair value can be reasonably estimated. If fair value cannot be readily determined, measurement should be based on best estimates in accordance with ASC Topic 405, the Accounting for Contingencies Topic. This guidance was effective January 1, 2009. There was no financial reporting impact due to this new standard. We will apply this new standard on any future business combinations.

In December 2007, the FASB issued ASC Topic 810-10-65, a part of the Consolidation Topic, which changes the accounting and reporting for minority interests which are recharacterized as noncontrolling interests and classified as a component of equity. This is effective for fiscal years beginning on or after December 15, 2008. ASC Topic 810 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. There was no financial reporting impact due to this new standard.

In June 2009, the FASB issued ASC Topic 810-10-65, as a part of the Consolidation Topic, which replaces the quantitative-based risks and rewards approach with a qualitative approach that focuses on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance. It also requires an ongoing reassessment of whether an entity is the primary beneficiary, and it requires additional disclosures about an enterprise’s involvement in variable interest entities. ASC 810-10-65 is effective for us beginning in the first quarter of fiscal 2010. There is expected to be no financial reporting impact to us due to the adoption of this new standard.

Other Accounting Changes

In May 2009, the FASB issued FASB ASC Topic 855, the Subsequent Events Topic. This standard is intended to establish general standards of accounting for and the disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, this standard sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. ASC Topic 855 is effective for fiscal years and interim periods ended after June 15, 2009, to be applied prospectively. There was no financial reporting impact due to the adoption of this standard. The Company has evaluated subsequent events through February 23, 2010, the date of issuance of the consolidated financial position and results of operations.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The following discussion regarding our risk management activities contains “forward-looking statements” that involve risks and uncertainties. Actual results may differ materially from those projected in the forward-looking statements.

Cash, Cash Equivalents, Short-term Investments and Long-term Investment Securities

We regularly maintain a portfolio of short- and long-term investments comprised of various types of money market funds, United States Treasury and Government Agency notes, FDIC-insured corporate notes, United States State and Municipal Securities, foreign government and agency notes and corporate bonds and notes. Our investments are made in accordance with an investment policy approved by our Board of Directors. Maturities of these instruments are less than 36 months with the majority being within one year. To minimize credit risk, we diversify our investments and select minimum ratings of P-1 or A3 by Moody’s, or A-1 or A- by Standard and Poor’s or equivalent. We classify these securities as available-for-sale and they are carried at fair market value. Our corporate policies prevent us from holding material amounts of asset-backed commercial paper.

Investments in instruments with both fixed and floating rates carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted because of a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations because of changes in interest rates, or we may suffer losses in principal if we were to sell securities that have declined in market value because of changes in interest rates.

We do not attempt to reduce or eliminate our exposure to interest rate risk through the use of derivative financial instruments.

A 1% shift in interest rates would impact our annual pre-tax income by approximately $3.8 million.

Senior Convertible Notes:

At December 27, 2009, a principal amount of $68.3 million of these Notes remained outstanding and $0.6 million of unamortized debt issue costs were included in Investments and Other Assets. The Notes were originally issued for $225 million in aggregate principal amount. During 2008, we repurchased $156.7 million principal amount of our Notes for $138.3 million and expensed $3.2 million of related unamortized debt issue costs and transaction costs resulting in a net gain of $15.0 million.

Because we pay fixed interest coupons on these Notes, market interest rate fluctuations do not impact our debt interest payments. However, the fair value of the senior convertible Notes will fluctuate as a result of changes in the price of our common stock, changes in market interest rates and changes in our credit worthiness.

Our Notes are not listed on any exchange or included in any automated quotation system but are registered for resale under the Securities Act of 1933.

The Notes rank equal in right of payment with our other unsecured senior indebtedness and mature on October 15, 2025 unless earlier redeemed by us at our option, or converted or put to us at the option of the holders. Interest is payable semi-annually in arrears on April 15 and October 15 of each year, commencing on April 15, 2006. We may redeem all or a portion of the Notes at par on and after October 20, 2012. The holders may require that we repurchase Notes on October 15 of each of 2012, 2015 and 2020.

Holders may convert the Notes into the right to receive the conversion value (i) when our stock price exceeds 120% of the approximately $8.80 per share initial conversion price for a specified period, (ii) in certain change in control transactions and (iii) when the trading price of the Notes does not exceed a minimum price

 

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level. For each $1,000 principal amount of Notes, the conversion value represents the amount equal to 113.6687 shares multiplied by the per share price of our common stock at the time of conversion. If the conversion value exceeds $1,000 per $1,000 in principal of Notes, we will pay $1,000 in cash and may pay the amount exceeding $1,000 in cash, stock or a combination of cash and stock, at our election.

Foreign Currency

Our sales and corresponding receivables are denominated primarily in U.S. dollars. We generate a significant portion of our revenues from sales to customers located outside the United States including Canada, Europe, the Middle East and Asia. We are subject to risks typical of an international business including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors.

Through our operations in Canada and elsewhere outside the United States, we incur research and development, sales, customer support and administrative expenses in Canadian and other foreign currencies. We are exposed, in the normal course of business, to foreign currency risks on these expenditures, particularly in Canada. In our effort to manage such risks, we have adopted a foreign currency risk management policy intended to reduce the effects of potential short-term fluctuations on our operating results stemming from our exposure to these risks. As part of this risk management strategy, we enter into foreign exchange forward contracts on behalf of our Canadian subsidiary. These forward contracts offset the impact of exchange rate fluctuations on forecasted cash flows or firm commitments. We limit the forward contracts operational period to 12 months or less and we do not enter into foreign exchange forward contracts for trading purposes. Because we do not engage in foreign exchange risk management techniques beyond these periods, our cost structure is subject to long-term changes in foreign exchange rates.

As at December 27, 2009, we had 18 currency forward contracts outstanding that qualified and were designated as cash flow hedges. The U.S. dollar notional amount of these contracts was $27.8 million and the contracts had a fair value of $0.8 million.

We attempt to limit our exposure to foreign exchange rate fluctuations from our Canadian dollar net asset or liability positions. A 5% shift in the foreign exchange rates between U.S. dollar and the Canadian dollar would impact pre-tax income by approximately $1.2 million.

Other Investments

Our other investments include strategic investments in privately held companies that are carried on our balance sheet at cost, net of write-downs for non-temporary declines in market value. We expect to make additional investments like these in the future. These investments are inherently risky, as they typically are comprised of investments in companies and partnerships that are still in the start-up or development stages. The market for the technologies or products that they have under development is typically in the early stages, and may never materialize. We could lose our entire investment in these companies and partnerships or may incur an additional expense if we determine that the value of these assets has been impaired. For example, in the second quarter of 2006 we recorded a charge of $3.2 million for impairment of an investment in a private company. We may record additional impairment charges should we determine that our investments have incurred a non-temporary decline in value.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The chart entitled “Quarterly Data” contained in Item 6 Part II hereof is hereby incorporated by reference into the Item 8 of Part II of this Form 10-K.

 

Consolidated Financial Statements Included in Item 8:

  
     Page

Report of Independent Registered Public Accounting Firm

   52

Consolidated Balance Sheets

   53

Consolidated Statements of Operations

   54

Consolidated Statements of Cash Flows

   55

Consolidated Statements of Stockholders’ Equity

   56

Notes to Consolidated Financial Statements

   57

Reports on Internal Control Over Financial Reporting included in Item 9A:

  

Management’s Annual Report on Internal Control over Financial Reporting

   88

Report of Independent Registered Public Accounting Firm

   90

Schedules for each of the three years in the period ended December 27, 2009 included in Item 15 (a):

  

Valuation and Qualifying Accounts

   98

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.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of PMC-Sierra, Inc.

We have audited the accompanying consolidated balance sheets of PMC-Sierra, Inc. and subsidiaries (the “Company”) as of December 27, 2009 and December 28, 2008, and the related consolidated statements of operations, cash flows, and stockholders’ equity for each of the three years in the period ended December 27, 2009. Our audits also included the financial statement schedules listed in the Index at Item 15(a). These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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, such consolidated financial statements present fairly, in all material respects, the financial position of PMC-Sierra, Inc. and subsidiaries as of December 27, 2009 and December 28, 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 27, 2009 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, the accompanying 2008 and 2007 consolidated financial statements have been retrospectively adjusted for the adoption of Financial Accounting Standards Codification 470-20-65 Debt Topic for the Accounting of Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlements).

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 27, 2009, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2010 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

/s/ DELOITTE & TOUCHE LLP

Vancouver, Canada

February 24, 2010

 

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PMC-Sierra, Inc.

CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

 

     December 27,
2009
    December 28, 2008
As adjusted-Note 1
 

ASSETS:

    

Current assets:

    

Cash and cash equivalents

   $ 192,841      $ 97,839   

Short-term investments

     67,928        209,685   

Accounts receivable, net of allowance for doubtful accounts of $1,259 (2008—$1,148)

     50,745        40,191   

Inventories, net

     31,531        34,003   

Prepaid expenses and other current assets

     14,476        9,683   

Deferred tax assets

     3,052        3,949   
                

Total current assets

     360,573        395,350   

Property and equipment, net

     13,909        15,858   

Investment securities

     192,636        —     

Goodwill

     396,144        396,144   

Intangible assets, net

     110,458        153,956   

Deferred tax assets

     250        —     

Prepaid expenses

     26,187        —     

Investments and other assets

     10,175        3,512   

Deposits for wafer fabrication capacity

     5,145        5,145   
                
   $ 1,115,477      $ 969,965   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY:

    

Current liabilities:

    

Accounts payable

   $ 22,266      $ 17,066   

Accrued liabilities

     52,996        51,390   

Liability for unrecognized tax benefit

     31,330        23,398   

Income taxes payable

     7,261        —     

Deferred income taxes

     681        2,042   

Accrued restructuring costs

     3,994        5,938   

Deferred income

     12,498        11,200   
                

Total current liabilities

     131,026        111,034   

2.25% senior convertible notes due October 15, 2025

     58,356        55,357   

Long-term obligations

     6,211        503   

Deferred taxes

     22,695        17,806   

Liability for unrecognized tax benefit

     14,663        3,352   

PMC special shares convertible into 1,570 (2008—2,045) shares of common stock

     2,003        2,655   

Contingencies (Note 10)

    

Stockholders’ equity:

    

Common stock, par value $.001: 900,000 shares authorized; 227,655 shares issued and outstanding (2008—221,335)

     247        241   

Additional paid in capital

     1,521,476        1,471,476   

Accumulated other comprehensive income (loss)

     1,164        (3,218

Accumulated deficit

     (642,364     (689,241
                

Total stockholders’ equity

     880,523        779,258   
                
   $ 1,115,477      $ 969,965   
                

See notes to the consolidated financial statements.

 

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PMC-Sierra, Inc.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

 

     Year Ended  
   December 27,
2009
    December 28, 2008
As adjusted-Note 1
    December 30, 2007
As adjusted-Note 1
 

Net revenues

   $ 496,139      $ 525,075      $ 449,381   

Cost of revenues

     165,231        181,642        158,297   
                        

Gross profit

     330,908        343,433        291,084   

Other costs and expenses:

      

Research and development

     149,184        157,642        159,134   

Selling, general and administrative

     84,942        93,532        100,486   

Amortization of purchased intangible assets

     39,344        39,344        39,343   

Restructuring costs and other charges

     888        824        14,837   
                        

Income (loss) from operations

     56,550        52,091        (22,716

Other income (expense):

      

Gain on repurchase of senior convertible notes, net and amortization of debt issue costs

     (200     14,568        (680

Foreign exchange (loss) gain

     (2,371     8,068        (18,486

Loss on subleased facilities

     (538     —          —     

Asset impairment

     —          (4,300     —     

Interest (expense) income, net

     (2,511     (757     1,497   

Recovery on investments

     —          400        —     

Gain (loss) on investment securities

     171        (11,790     —     
                        

Income before (provision for) recovery of income taxes

     51,101        58,280        (40,385

(Provision for) recovery of income taxes

     (4,224     70,017        (16,848
                        

Net income (loss)

   $ 46,877      $ 128,297      $ (57,233
                        

Net income (loss) per common share—basic

   $ 0.21      $ 0.58      $ (0.26

Net income (loss) per common share—diluted

   $ 0.20      $ 0.57      $ (0.26

Shares used in per share calculation—basic

     226,225        221,659        216,330   

Shares used in per share calculation—diluted

     229,567        223,687        216,330   

See notes to the consolidated financial statements.

 

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PMC-Sierra, Inc.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

     Year Ended  
   December 27,
2009
    December 28, 2008
As adjusted-Note 1
    December 30, 2007
As adjusted-Note 1
 

Cash flows from operating activities:

      

Net income (loss)

   $ 46,877      $ 128,297      $ (57,233

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation and amortization

     56,577        59,796        71,356   

Stock-based compensation

     21,396        24,838        35,334   

Unrealized foreign exchange loss (gain), net

     2,542        (8,362     18,246   

Non-cash accretion of investment securities

     (359     —          —     

Asset impairment

     —          4,300        —     

Gain on repurchase of senior convertible notes, net

     —          (14,980     —     

Gain on disposal of property and equipment

     —          (32     512   

Impairment of purchased intangible assets

     —          —          1,855   

Loss on subleased facilities

     538        —          —     

Changes in operating assets and liabilities:

      

Accounts receivable

     (10,554     (829     (2,059

Inventories

     2,723        613        (156

Prepaid expenses and other current assets

     1,132        6,743        2,226   

Accounts payable and accrued liabilities

     (2,531     (40,240     5,027   

Deferred income taxes and income taxes payable

     4,147        (70,491     12,353   

Accrued restructuring costs

     (2,029     (4,720     (2,106

Deferred income

     1,298        (2,474     2,334   
                        

Net cash provided by operating activities

     121,757        82,459        87,689   
                        

Cash flows from investing activities:

      

Purchases of property and equipment

     (6,215     (6,802     (9,824

Proceeds from sale of property and equipment

     31        —          —     

Purchase of intangible assets

     (1,590     (5,913     (8,754

Redemption of short-term investments

     186,443        —          —     

Disposals of investment securities

     59,298        —          —     

Purchases of investment securities

     (295,365     (209,685     —     
                        

Net cash used in investing activities

     (57,398     (222,400     (18,578
                        

Cash flows from financing activities:

      

Repurchase of senior convertible notes

     —          (139,341     —     

Proceeds from issuance of common stock

     28,293        16,510        31,980   
                        

Net cash provided by (used in) financing activities

     28,293        (122,831     31,980   
                        

Effect of exchange rate changes on cash and cash equivalents

     2,350        (4,311     4,917   

Net increase (decrease) in cash and cash equivalents

     95,002        (267,083     106,008   

Cash and cash equivalents, beginning of the year

     97,839        364,922        258,914   
                        

Cash and cash equivalents, end of the year

   $ 192,841      $ 97,839      $ 364,922   
                        

Supplemental disclosures of cash flow information:

      

Cash paid for interest

   $ 1,538      $ 3,813      $ 5,063   

Cash refund of income taxes

     5,695        1,316        4,975   

Cash paid for income taxes

     1,464        23,195        1,596   

Supplemental disclosures of non-cash investing and financing activities:

      

Conversion of PMC-Sierra special shares into common stock

   $ 652      $ 17      $ 61   

See notes to the consolidated financial statements.

 

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PMC-Sierra, Inc.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands)

 

    Shares of
Common
Stock
  Common
Stock
  Additional
Paid in
Capital As
adjusted-

Note 1
    Accumulated
Other
Comprehensive
Income (Loss)
    Retained
Earnings
(Accumulated
Deficit) As
adjusted-

Note 1
    Total
Stockholders’
Equity
 

Balances at December 31, 2006

  210,650   $ 230   $ 1,394,900      $ (1,127   $ (765,038   $ 628,965   

Net loss

  —       —       —          —          (57,233     (57,233

Adjustments related to adoption of FIN48

  —       —       —          —          4,733        4,733   

Other comprehensive income (loss):

           

Change in fair value of derivatives

  —       —       —          2,564        —          2,564   
                 

Comprehensive loss

              (49,936
                 

Conversion of special shares into common stock

  34     —       61        —          —          61   

Issuance of common stock under stock benefit plans

  6,601     7     31,974        —          —          31,981   

Stock-based compensation expense

  —       —       35,333        —          —          35,333   
                                         

Balances at December 30, 2007

  217,285     237     1,462,268        1,437        (817,538     646,404   

Net income

  —       —       —          —          128,297        128,297   

Other comprehensive income (loss):

           

Change in fair value of derivatives

  —       —       —          (4,655     —          (4,655
                 

Comprehensive income

              123,642   
                 

Conversion of special shares into common shares

  20     —       17        —          —          17   

Issuance of common stock under stock benefit plans

  3,905     4     16,580        —          —          16,584   

Issuance of restricted stock units

  125     —       (75     —          —          (75

Stock-based compensation expense

  —       —       24,838        —          —          24,838   

Repurchase of senior convertible notes—equity portion

  —       —       (48,331     —          —          (48,331

Gain on the repurchase of senior convertible notes —equity portion

  —       —       16,179        —          —          16,179   
                                         

Balances at December 28, 2008

  221,335     241     1,471,476        (3,218     (689,241     779,258   

Net income

  —       —       —          —          46,877        46,877   

Other comprehensive income (loss):

           

Change in fair value of derivatives

  —       —       —          3,766        —          3,766   

Change in fair values of investment securities

  —       —       —          616        —          616   
                 

Comprehensive income

              51,259   
                 

Conversion of special shares into common shares

  474     1     651        —          —          652   

Issuance of common stock under stock benefit plans

  5,491     5     28,287        —          —          28,292   

Issuance of restricted stock units

  355     —       (336     —          —          (336

Stock-based compensation expense

  —       —       21,398        —          —          21,398   
                                         

Balances at December 27, 2009

  227,655   $ 247   $ 1,521,476      $ 1,164      $ (642,364   $ 880,523   
                                         

See notes to the consolidated financial statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 27, 2009

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of business. PMC-Sierra, Inc (the “Company” or “PMC”) designs, develops, markets and supports semiconductor solutions for the Enterprise Infrastructure market and the Communications Infrastructure market. The Company offers worldwide technical and sales support through a network of offices in North America, Europe and Asia.

Basis of presentation. The accompanying consolidated financial statements have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) and United States Generally Accepted Accounting Principles (“GAAP”). Fiscal 2009, 2008, and 2007 consisted of 52 weeks and ended on the last Sunday in December. The Company’s reporting currency is the U.S. dollar. The accompanying consolidated financial statements include the accounts of PMC-Sierra, Inc. and any of its subsidiaries or investees in which PMC exercises control. As at December 27, 2009 and December 28, 2008, all subsidiaries included in these consolidated financial statements were wholly owned by PMC. All inter-company accounts and transactions have been eliminated.

Estimates. The preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, stock-based compensation, purchase accounting assumptions including those used to calculate the fair value of intangible assets and goodwill, the valuation of investments, accounting for doubtful accounts, inventory reserves, depreciation and amortization, asset impairments, sales returns, warranty costs, income taxes including uncertain tax positions, restructuring costs, assumptions used to measure the fair value of the debt component of our senior convertible notes, accounting for employee benefit plans, and contingencies. Actual results could differ from these estimates.

Cash and cash equivalents, short-term investments and long-term investment securities. At December 27, 2009, cash and cash equivalents included $0.7 million (2008—$0.8 million) pledged with a bank as collateral for letters of credit issued as security for leased facilities. Cash equivalents are defined as highly liquid interest-earning instruments with maturities at the date of purchase of three months or less. Short-term investments are investments with original maturities greater than three months, but less than one year. Investments with maturities beyond one year are classified as long-term investment securities.

Management classifies investments as available-for-sale or held-to-maturity at the time of purchase and re-evaluates such designation as of each balance sheet date. Investments classified as held-to-maturity securities are stated at amortized cost with corresponding premiums or discounts amortized against interest income over the life of the investment. Marketable equity and debt securities not classified as held-to-maturity are classified as available-for-sale and reported at fair value. The cost of securities sold is based on the specific identification method. Unrealized gains and losses on these investments, net of any related tax effect are included in equity as a separate component of stockholders’ equity. For debt securities, if an impairment is considered other than temporary, the entire difference between the amortized cost and the fair value is recognized in earnings in the period this determination is made.

Allowance for Doubtful Accounts. The allowance for doubtful accounts is based on the Company’s assessment of the collectibility of customer accounts. The Company regularly reviews the allowance by considering factors such as historical experience, credit quality, age of the accounts receivable balances, and economic conditions that may affect a customer’s ability to pay.

Inventories. Inventories are stated at the lower of cost (first-in, first-out) or market (estimated net realizable value). Cost is computed using standard cost, which approximates actual average cost. The Company provides inventory allowances on obsolete inventories and inventories in excess of twelve-month demand for each specific part.

 

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Inventories (net of reserves of $6.8 million and $9.3 million at December 27, 2009 and December 28, 2008, respectively) were as follows:

 

(in thousands)

   December 27,
2009
   December 28,
2008

Work-in-progress

   $ 14,452    $ 11,391

Finished goods

     17,079      22,612
             
   $ 31,531    $ 34,003
             

In 2009, the Company decreased inventory reserves by $2.6 million (2008—$3.1 million, 2007—$1.5 million) for inventory that was scrapped during the year.

Investments in private entities. The Company has investments in privately traded companies in which it has less than 20% of the voting rights and in which it does not exercise significant influence. The Company monitors these investments for impairment and makes appropriate reductions in carrying values when necessary. These investments are included in Investments and other assets on the Company’s consolidated balance sheet and are carried at cost, net of write-downs for impairment.

Deposits for wafer fabrication capacity. The Company has wafer supply agreements with two independent foundries. Under these agreements, the Company has deposits of $5.1 million (2008—$5.1 million) to secure access to wafer fabrication capacity. These are classified as long-term assets in the consolidated balance sheets. Also, see related comments under Concentrations.

Property and equipment, net. Property and equipment is stated at cost, net of write-downs for impairment, and accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets, ranging from two to five years. Leasehold improvements are capitalized and amortized over the shorter of their estimated useful lives or the lease term.

The components of property and equipment, net are as follows:

 

December 27, 2009 (in thousands)

   Gross    Accumulated
Amortization
    Net

Software

   $ 57,525    $ (54,040   $ 3,485

Machinery and equipment

     132,203      (123,858     8,345

Leasehold improvements

     15,442      (13,363     2,079

Furniture and fixtures

     13,657      (13,657     —  
                     

Total

   $ 218,827    $ (204,918   $ 13,909
                     

December 28, 2008 (in thousands)

   Gross    Accumulated
Amortization
    Net

Software

   $ 57,273    $ (52,706   $ 4,567

Machinery and equipment

     127,492      (119,048     8,444

Leasehold improvements

     14,895      (12,804     2,091

Furniture and fixtures

     13,742      (12,986     756
                     

Total

   $ 213,402    $ (197,544   $ 15,858
                     

Goodwill. Goodwill is recorded when the purchase price paid for an acquisition exceeds the estimated fair value of the net identified tangible and intangible assets acquired. The Company performs a two-step process on an annual basis, or more frequently if necessary, to determine 1) whether the fair value of the relevant reporting unit exceeds the carrying value and 2) the amount of an impairment loss, if any. The Company completed this process in December 2009, 2008 and 2007, and determined that there was no impairment to goodwill.

 

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Intangible assets, net. Intangible assets, net, consist of intangible assets acquired through business combinations, which are amortized over their estimated useful lives ranging from four to ten years or have indefinite lives, and purchased developed technology assets that are amortized over their economic lives, which are normally three years. The components of intangible assets, net are as follows:

 

December 27, 2009 (in thousands)

   Gross    Accumulated
Amortization
    Net    Estimated
life

Core technology

   $ 129,700    $ (68,885   $ 60,815    8 years

Customer relationships

     66,600      (36,356     30,244    4-10 years

Existing technology

     46,000      (42,167     3,833    4 years

Trademarks

     3,600      —          3,600    indefinite

Developed technology assets

     39,256      (27,290     11,966    3 years
                        

Total

   $ 289,156    $ (178,698   $ 110,458   
                        

December 30, 2008 (in thousands)

   Gross    Accumulated
Amortization
    Net    Estimated
life

Core technology

   $ 129,700    $ (50,748   $ 78,952    8 years

Customer relationships

     66,600      (26,651     39,949    4-10 years

Existing technology

     46,000      (30,667     15,333    4 years

Trademarks

     3,600      —          3,600    indefinite

Developed technology assets

     36,987      (20,865     16,122    3 years
                        

Total

   $ 286,887    $ (132,931   $ 153,956   
                        

Estimated future amortization expense for intangible assets is as follows:

 

(in thousands)

   $

2010

   $ 31,071

2011

     23,115

2012

     20,942

2013

     19,318

2014

     7,011

Thereafter

     5,401
      

Total

   $ 106,858
      

Impairment of long-lived assets. The Company reviews its long-lived assets, other than goodwill and other indefinite-lived assets, for impairment annually or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. To determine recoverability, the Company compares the carrying value of the assets to the estimated future undiscounted cash flows. Measurement of an impairment loss for long-lived assets held for use is based on the fair value of the asset determined through discounted cash flows. Long-lived assets classified as held for sale are reported at the lower of carrying value and fair value less estimated selling costs. For assets to be disposed of other than by sale, an impairment loss is recognized when the carrying value is not recoverable and exceeds the fair value of the asset.

Accrued liabilities. The components of accrued liabilities are as follows:

 

(in thousands)

   December 27,
2009
   December 28,
2008

Accrued compensation and benefits

   $ 24,086    $ 22,079

Other accrued liabilities

     28,910      29,311
             

Total

   $ 52,996    $ 51,390
             

 

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Foreign currency translation. For all foreign operations, the U.S. dollar is used as the functional currency. Monetary assets and liabilities in foreign currencies are translated into U.S. dollars using the exchange rate as of the balance sheet date. Revenues and expenses are translated at average rates of exchange during the year. Gains and losses from foreign currency transactions are reported separately as Foreign exchange (loss) gain under Other income (expense) on the consolidated statements of operations.

Derivatives and Hedging Activities. Fluctuating foreign exchange rates may significantly impact PMC’s net income (loss) and cash flows. The Company periodically hedges forecasted foreign currency transactions related to certain operating expenses. All derivatives are recorded in the balance sheet at fair value. For a derivative designated as a fair value hedge, changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in net income (loss). For a derivative designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in net income (loss) when the hedged item affects net (loss) income. Ineffective portions of changes in the fair value of cash flow hedges are recognized in net income (loss). If the derivative used in an economic hedging relationship is not designated in an accounting hedging relationship or if it becomes ineffective, changes in the fair value of the derivative are recognized in net income (loss). During the years ended December 27, 2009, December 28, 2008 and December 30, 2007, all hedges were designated as cash flow hedges.

Fair value of financial instruments. The estimated fair value of financial instruments has been determined by the Company using available market information and appropriate valuation methodologies as prescribed under GAAP. 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 use of different market assumptions and/or estimation methodologies could have a significant effect on the estimated fair value amounts. The fair value of the Company’s cash equivalents, short-term investments, long-term investment securities, derivative instruments, debt component of its senior convertible notes, and employee post-retirement healthcare benefits are estimated using available market information and appropriate valuation. The fair value of investments in public companies is determined using quoted market prices for those securities. The fair value of investments in private entities is not readily determinable due to the illiquid market for these investments. The fair value of the deposits for wafer fabrication capacity is not readily determinable because the timing of the related future cash flows is not determinable and there is no market for the sale of these deposits (see Note 3. Fair Value Measurements).

The carrying values of accounts receivable and accounts payable approximate fair value because of their short term to maturities.

Our 2.25% senior convertible notes are not listed on any securities exchange or included in any automated quotation system, but has been traded over the counter on the Portal Market or under Rule 144 of the Securities Act of 1933. The exchange prices from these trades are not always available to us and may not be reliable. Trades under the Portal Market do not reflect all trades of the securities and the figures recorded are not independently verified. The Company has incorporated independent market quotes in estimating the fair value of the debt to be $86.6 million, or $126.75 per $100 face value as of December 27, 2009.

As of and for the year ended December 27, 2009, the use of derivative financial instruments was not material to the results of operations or the Company’s financial position (see “Derivatives and Hedging Activities” in this Note).

Concentrations. The Company maintains its cash, cash equivalents, short-term investments, and long-term investment securities in investment grade financial instruments with high-quality financial institutions, thereby reducing credit risk concentrations.

 

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At December 27, 2009, there was one distributor and one other customer that accounted for 18% and 12% of accounts receivables, respectively. At December 28, 2008, there were two distributors that accounted for 14% and 11% of accounts receivables and three other customers that each accounted for 11%, 11%, and 10% of accounts receivables, respectively. The Company believes that this concentration and the concentration of credit risk resulting from trade receivables owing from high-technology industry customers is substantially mitigated by the Company’s credit evaluation process, relatively short collection periods and the geographical dispersion of the Company’s sales. The Company generally does not require collateral security for outstanding amounts.

The Company relies on a limited number of suppliers for wafer fabrication capacity. In 2009 and 2008, two outside wafer foundries supplied more than 95% of our semiconductor wafer requirements.

Revenue recognition. The Company recognizes product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collectibility is reasonably assured. PMC generates revenues from direct sales, sales to distributors and sales of consignment inventory. The Company recognizes revenues on goods shipped directly to customers at the time of shipping as that is when title passes to the customer and all revenue recognition criteria specified above are met.

PMC has a two-tier distribution network. There are sales to distributors for which revenues are recognized on a sell-through basis, utilizing information provided by the distributor. These distributors are given business terms to return a portion of inventory and receive credits for changes in selling prices to end customers, the magnitude of which is not known at the time goods are shipped to these distributors. PMC personnel are often involved in the sales from these distributors to end customers and the Company may utilize inventory at these distributors to satisfy product demand by other customers.

PMC recognizes revenues from some distributors at the time of shipment. These distributors are also given business terms to return a portion of inventory and receive credits for changes in selling prices to end customers. At the time of shipment, product prices are fixed or determinable and the amount of future returns and pricing allowances to be granted in the future can be reasonably estimated and are accrued. Accordingly, revenues are recorded net of these estimated amounts.

The Company has consignment inventory which is held for specific customers, either at the Company’s warehouse facility or at the customer’s premises. PMC recognizes revenue on these goods when the customer uses them in production, as that is when title passes to the customer. These sales from consignment inventory are subject to the same warranty terms that are applied to direct sales.

PMC’s product sales are subject to warranty claims against regular mechanical or electrical failure. PMC maintains accruals for potential returns based on its historical experience.

Research and development expenses. The Company expenses research and development (“R&D”) costs as incurred. R&D costs include payroll and related costs, materials, services and design tools used in product development, depreciation, and other overhead costs including facilities and computer equipment costs. Intellectual property (“IP”) purchased from third parties is capitalized and amortized over the expected useful life of the IP. For the years ended December 27, 2009, December 28, 2008, and December 30, 2007 research and development expenses were $149.2 million, $157.6 million, and $159.1 million.

 

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Product warranties. The Company provides a limited warranty on most of its standard products and accrues for the expected cost at the time of shipment. The Company estimates its warranty costs based on historical failure rates and related repair or replacement costs. The following table summarizes the activity related to the product warranty liability during fiscal 2009, 2008, and 2007:

 

(in thousands)

   Year Ended  
   December 27,
2009
    December 28,
2008
    December 30,
2007
 

Balance, beginning of the year

   $ 6,031      $ 6,239      $ 4,331   

Accrual for new warranties issued

     1,642        1,139        2,098   

Reduction for payments and product replacements

     (204     (1,303     (584

Adjustments related to changes in estimate of warranty accrual

     (1,372     (44