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PMCS > SEC Filings for PMCS > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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Form 10-Q for PMC SIERRA INC


12-Nov-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Quarterly Report contains forward-looking statements that involve risks and uncertainties. We use words such as "anticipates," "believes," "plans," "expects," "future," "intends," "may," "could," "should," "estimates," "predicts," "potential," "continue," "becoming," "transitioning" and similar expressions to identify such forward-looking statements. Our forward-looking statements include statements as to our business outlook, revenues, margins, expenses, tax provision, capital resources and liquidity sufficiency, sources of liquidity, capital expenditures, interest income and expenses, restructuring activities, cash commitments, purchase commitments, use of cash, our expectation regarding our amortization of purchased intangible assets, our expectations regarding our business acquisitions, and our expectation regarding distribution from certain investments. Such statements, particularly in the "Business Outlook" section, are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing. (See also "Risk Factors" Part II, Item 1A. and our other filings with the Securities and Exchange Commission ("SEC")). Our actual results may differ materially, and these forward-looking statements do not reflect the potential impact of any divestitures, mergers, acquisitions, or other business combinations that had not been completed as of the filing date of this Quarterly Report.

Investors are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date of this Quarterly Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

OVERVIEW

PMC is a semiconductor innovator transforming networks that connect, move and store digital content. Building on a track record of technology leadership, we are driving innovation across storage, optical and mobile networks. Our highly integrated solutions increase performance and enable next generation services to accelerate the network transformation.

Our current revenues are generated by a portfolio of approximately 700 products which we have designed and developed or acquired. PMC's diverse product portfolio enables many different types of communications network infrastructure equipment in three market segments: Storage, Mobile and Optical networks.

1. Our Storage network products enable high-speed communication servers, switches and storage equipment to store, manage and move large quantities of data securely;

2. Our Optical network products are used in optical transport platforms, multi-services provisioning platforms, and edge routers where they gather, process and transmit disparate traffic to their next destination in the network; and

3. Our Mobile network products are used in wireless base stations, mobile backhaul, and aggregation equipment.

On July 15, 2013, we announced completion of the acquisition of Integrated Device Technology, Inc's Enterprise Flash Controller Business. With the addition of these controllers to our storage network products, PMC is positioned for leadership in the rapidly growing market for enterprise flash controllers.

The following discussion of the financial condition and results of our operations should be read in conjunction with the interim condensed consolidated financial statements and notes thereto included in this Form 10-Q, with certain comparatives restated as described in Part I. Financial Information, Item 1. Financial Statements, the Notes to the Condensed Consolidated Financial Statements, Note 11. Error Correction.


Table of Contents

Results of Operations

Third quarter of 2013 and 2012

Net revenues

Third Quarter ($ millions) 2013 2012 Change Net revenues $ 128.9 $ 131.7 (2 )%

Overall net revenues for the third quarter of 2013 were $128.9 million, a decrease of $2.9 million compared to the third quarter of 2012, mainly due to lower sales volumes. This 2% decrease in the current period compared to the same period of 2012 was mainly attributable to macro-economic uncertainty and continued cautious enterprise and carrier infrastructure spending which impacted each of the Storage, Optical and Mobile market segments.

Storage represented 66% of our net revenues in the third quarter of 2013 compared to 68% in the same period of 2012. The Storage net revenues decreased by 5% compared to the same quarter in 2012 mainly due to the factors described above. On a sequential basis, storage net revenues were up 2% mainly due to strength in storage and server Original Equipment Manufacturers ("OEM") at our large customers offset by lower datacenter revenues in the third quarter. We also benefited from new platform ramps at our large customers.

Optical represented 20% of our net revenues in the third quarter of 2013 and 2012. The Optical net revenues decreased by 2% compared to the same quarter in 2012 due mainly to the factors described above. On a sequential basis, Optical net revenues decreased by 3% mainly due to declines in the legacy business offset by Optical Transport Network ("OTN") growth driven mostly out of China.

Mobile represented 14% our net revenues for the third quarter of 2013 compared to 12% in the same period of 2012. The Mobile net revenues increased by 15% compared to the same quarter in 2012 due mainly to strength in the WinPath family of processors. On a sequential basis, mobile revenues were up 2% due to North America carrier recovery and customers in Europe and China are back to run rate on mobile-backhaul. In the third quarter of 2013, we announced the availability of our 4th generation WinPath4 mobile-backhaul processor, industry's first backhaul processor that enables mobile operators to scale capacity in their backhaul networks while transitioning to Layer 3 Packet Transport Networks (PTN).

Gross profit

                                             Third Quarter
              ($ millions)                  2013        2012       Change
              Gross profit                 $ 91.7      $ 92.7           (1 )%
              Percentage of net revenues       71 %        70 %

Our gross profit decreased by $1 million in the third quarter of 2013 on lower net revenues compared to the same period in 2012. Gross profit as a percentage of net revenues was 71% and 70% in the third quarter of 2013 and 2012, respectively. Our gross profit in the third quarter of 2013 was favorably impacted by approximately $2.3 million of warranty provision releases.

Operating expenses

                                                     Third Quarter
     ($ millions)                                   2013        2012       Change
     Research and development                      $ 50.7      $ 55.6           (9 )%
     Percentage of net revenues                        39 %        42 %
     Selling, general and administrative           $ 26.4      $ 27.8           (5 )%
     Percentage of net revenues                        20 %        21 %
     Amortization of purchased intangible assets   $ 13.1      $ 11.6           13 %
     Percentage of net revenues                        10 %         9 %


Table of Contents

Research and Development and Selling, General and Administrative Expenses

Our research and development ("R&D") expenses decreased $4.9 million, or 9% compared to the same period last year. This was primarily the result of the decrease in lower tape-out related and outside service costs. On a sequential basis, R&D expenses were $2 million higher in the third quarter of 2013 compared to the second quarter of 2013. This was mainly due a reduction in a contingency accrual estimate by $2.9 million due as a result of changes in estimates related to our contingency provisions.

Selling, general and administrative ("SG&A") expenses were $1.4 million, or 5% lower in the third quarter of 2013 compared to the same period last year, mainly due to lease exit costs recorded in the third quarter of 2012 with $nil in third quarter of 2013.

Amortization of purchased intangible assets

Amortization of acquired intangible assets related to developed technology, in-process research and development, customer relationships, and trademarks increased by $1.5 million in the third quarter of 2013 compared to the same period in 2012 mainly due to amortization of intangible assets acquired from Integrated Device Technology Inc.'s ("IDT") enterprise flash controller business.

Impairment of goodwill and purchased intangible assets

During the third quarter of 2012, the Company recognized impairment charges of $274.6 million due to weaker quarterly results and lower future projections than previously expected in the former Fiber-to-the-Home ("FTTH") and Wintegra reporting units, respectively, related to the Company's 2006 acquisition of Passave and 2010 acquisition of Wintegra. This was driven by slower adoption rates of FTTH technology in markets outside of Asia and prolonged weak carrier spending due to unfavorable macroeconomic conditions which negatively impacted Wintegra. These circumstances triggered the Company to perform step one of the impairment test and we determined that the estimated fair values of the reporting units were lower than their respective carrying values.

The Company combined these two reporting units (formerly included in the Fiber-to-the-Home Products and Wireless Infrastructure and Networking Products operating segments) with the Communications Products operating segment, to form the new realigned Communications Business Unit operating segment near the end of 2012. This organizational realignment was made to capitalize on the many areas of synergy between the former three reporting units, to create an integrated and focused product roadmap, and to further strengthen the scale advantage we have in the area of network communications. It also allows us to become more efficient in our product development efforts, which is critical since research and development costs for each new device continue to climb while carrier end market growth has not kept pace in the recent past, and will take some time to return to normal levels as macroeconomic conditions recover. The Communications Business Unit operating segment will continue to introduce new products to grow the operating segment, and we have implemented structural changes to our research and development, and marketing and sales activities to better position the operating segment for growth as macroeconomic conditions recover. These products will be the foundation for our growth in the carrier market for the next several years. It is expected that the Company will continue to steadily increase sales and profitability with this newly realigned operating segment, to come in-line with our targeted financial operating metrics. Although the Company recorded impairment charges during 2012 for these former reporting units, their product technology continues to represent a core strategic part of our future technology road-map and portfolio of product offerings for communications network infrastructure equipment. We do not believe that the impairment loss recorded in 2012 will have a significant impact on future operations of the Company and/or its liquidity. We do note, however, that as a result of the write-down of purchased intangible assets of Wintegra (other than goodwill) of $7 million, there has been a corresponding reduction in quarterly amortization expense of approximately $0.8 million.


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Other income (expense) and Provision for income taxes

                                                    Third Quarter
                                                              2012
   ($ millions)                               2013        (As Restated)       Change
   Gain on investment securities and other   $  1.8      $           0.2          800 %
   Amortization of debt issue costs          $   -       $          (0.1 )       (100 )%
   Foreign exchange gain                     $ (1.9 )    $          (2.5 )         24 %
   Interest income (expense), net            $  0.2      $          (0.8 )        125 %
   Provision for income taxes                $ (4.2 )    $           5.5          176 %

Gain on investment securities and other

We recorded a gain on sale of investment securities and other investments of $1.8 million and $0.2 million, related to the disposition of investments and investment securities in the third quarter of 2013 and 2012, respectively.

Amortization of debt issue costs

In the third quarter of 2012, we amortized $0.1 million of debt issue costs relating to our senior convertible notes. We retired the remainder of these notes in the fourth quarter of 2012, and accordingly recognized the remaining debt issue costs at that time.

Foreign exchange gain

We recognized a net foreign exchange loss of $1.9 million in the third quarter of 2013 compared to a net foreign exchange loss of $2.5 million in the third quarter of 2012. This was primarily due to foreign exchange gain and loss on the revaluation of our foreign denominated assets and liabilities. This was partly driven by the United States Dollar depreciating by approximately 2% during the third quarter of 2013 compared to approximately 3% depreciation during the third quarter of 2012, against currencies applicable to our foreign operations.

Interest income (expense), net

Net interest income was $0.2 million in the third quarter of 2013 compared to net interest expense of $0.8 million in the third quarter of 2012.

Provision for income taxes

See Part I. Financial Information, Item 1. Financial Statements, the Notes to the Condensed Consolidated Financial Statements, Note 8. Income Taxes and Note
11. Error Correction for details.

First Nine months of 2013 and 2012

Net revenues

First Nine Months ($ millions) 2013 2012 Change Net revenues $ 381.9 $ 401.6 (5 )%

Net revenues for the first nine months of 2013 were $381.9 million compared to $401.6 million for the same period of 2012. This 5% decrease was mainly attributable to macro-economic uncertainty and continued cautious enterprise and carrier infrastructure spending, which impacted each of the Storage, Optical and Mobile market segments.


Table of Contents

Storage represented 66% of our net revenues in the first nine months of 2013 compared to 65% in the same period of 2012. Storage net revenues decreased by 5% compared to the first nine months of 2012 mainly due to macro-economic uncertainty driving continued softness in enterprise spending. Accordingly, sales volume of our server and storage products were lower compared to the first nine months of 2012. This was partially offset by higher volumes of sales to Datacenter customers and continued ramp of 6G SAS products.

Optical represented 20% of our net revenues in the first nine months of 2013 compared to 21% in the same period of 2012. Optical net revenues decreased by 9% compared to the first nine months of 2012 mainly due to continued weakness in the macro-economic environment, which drove lower levels of carrier spending. Sales volumes were down from our Legacy metro aggregation transport and routing and switching products.

Mobile represented 14% of our net revenues in the first nine months of 2013 and 2012. Mobile net revenues decreased by 4% compared to the first nine months of 2012 mainly due to continued weakness in the macro-economic environment, which drove lower levels of carrier spending. Accordingly, sales volumes of our mobile backhaul products were lower compared to the first nine months of 2012.

Gross profit

                                           First Nine Months
            ($ millions)                   2013          2012        Change
            Gross profit                 $   269.6      $ 280.3           (4 )%
            Percentage of net revenues          71 %         70 %

Total gross profit decreased by $10.7 million in the first nine months of 2013 on lower net revenues compared to the same period in 2012. Gross profit as a percentage of net revenues was 71% and 70% in the first nine months of 2013 and 2012, respectively. Our gross margin was favorably impacted during the nine months ended September 28, 2013 by approximately $3.2 million of warranty provision releases.

Operating expenses

                                                   First Nine Months
   ($ millions)                                    2013          2012        Change
   Research and development                      $   157.0      $ 171.4           (8 )%
   Percentage of net revenues                           41 %         43 %
   Selling, general and administrative           $    85.0      $  86.0           (1 )%
   Percentage of net revenues                           22 %         21 %
   Amortization of purchased intangible assets   $    34.7      $  34.5            1 %
   Percentage of net revenues                            9 %          9 %

Research and Development and Selling, General and Administrative Expenses

Our R&D expense decreased by $14.4 million, or 8%, in the first nine months of 2013 compared to the same period in 2012. This was primarily the result of the decrease in payroll-related costs, including termination costs, lower outside services due to the timing of projects and lower tape-out related costs incurred in the first nine months of 2013. In addition, R&D expenses in 2013 were favorably impacted by approximately $2.9 million as a result of changes in estimates related to our contingency provisions.

SG&A expenses decreased by $1.0 million, or 1%, in the first nine months of 2013 compared to the same period in 2012, mainly due to reduced exit costs in Israel and lower professional fees.

Amortization of purchased intangible assets

Amortization of acquired intangible assets related to developed technology, in-process research and development, customer relationships, and trademarks increased by $0.2 million in the first nine months of 2013 compared to the same period in 2012. As described above, we wrote down the goodwill and intangible assets in third quarter of 2012 related to the 2006 acquisition of Passave and 2010 acquisition of Wintegra, Inc., by $274.6 million, resulting in this reduction of quarterly amortization charges offset by additional amortization of purchased intangible assets from IDT.


Table of Contents

Other income (expense) and provision for income taxes

                                                 First Nine Months
     ($ millions)                                2013          2012        Change
     Gain on investment securities and other   $     1.8      $   0.7          157 %
     Amortization of debt issue costs          $      -       $  (0.2 )       (100 )%
     Foreign exchange gain (loss)              $     1.7      $  (2.0 )       (185 )%
     Interest income (expense), net            $     0.8      $  (1.5 )        153 %
     Provision for income taxes                $   (13.0 )    $ (49.8 )         74 %

Gain on investment securities and other

We recorded a gain on sale of investment securities and other investments of $1.8 million related to the disposition of investment securities in the first nine months of 2013.

Amortization of debt issue costs

In the first nine months of 2012, we amortized $0.2 million of debt issue costs relating to our senior convertible notes. We retired the remainder of these notes in the fourth quarter of 2012, and accordingly recognized any remaining debt issue costs at that time.

Foreign exchange gain

We recognized a net foreign exchange gain of $1.7 million in the first nine months of 2013 compared to a net foreign exchange loss of $2.0 million in the first nine months of 2012. This was primarily due to foreign exchange gain and loss on the revaluation of our foreign denominated assets and liabilities. This was driven by the United States Dollar appreciating by approximately 3% during the first nine months of 2013 compared to approximately 2% depreciation during the first nine months of 2012, against currencies applicable to our foreign operations.

Interest income (expense), net

Net interest income was $0.8 million in the first nine months of 2013 compared to net interest expense of $1.5 million in the first nine months of 2012.

Provision for income taxes

See Part I. Financial Information, Item 1. Financial Statements, the Notes to the Condensed Consolidated Financial Statements, Note 8. Income Taxes and Note
11. Error Correction for details.


Table of Contents

Critical Accounting Estimates

General

Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect our reported assets, liabilities, revenue and expenses, and related disclosure of our contingent assets and liabilities. For a full discussion of our accounting estimates and assumptions that we have identified as critical in the preparation of our interim condensed consolidated financial statements, refer to our Annual Report on Form 10-K/A for the year ended December 29, 2012, which also provides commentary on our most critical accounting estimates.

As discussed more fully in our Form 10-K/A for the year ended December 29, 2012 in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in the Critical Accounting Policies and Estimates section and Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 1. Summary of Significant Accounting Policies, goodwill is reviewed for impairment annually and more frequently if an event occurs or circumstances change that could reduce the fair value below its carrying value.

Business Outlook

The following is our outlook for the three months ending December 28, 2013 and a
reconciliation of each non-GAAP financial measure to the most directly
comparable GAAP financial measure:



                                                         Reconciling
(in millions, except for percentages)   GAAP Measure        items                 Non-GAAP measure
Net revenues                            $118.5 - $129        $ -          (a)      $118.5 - $129
Gross profit %                          69.8% - 70.8%      (0.17)%        (b)        70% - 71%
Operating expenses                        $90 - $93     $20.9 - $21.9     (c)        $69 - $71
Provision for income taxes                   **              **                        $ nil

                                                         Reconciling
(in millions, except for percentages)   GAAP Measure        items                 Non-GAAP measure
Net revenues                            $118.5 - $129        $ -          (a)      $118.5 - $129
Gross profit %                          69.8% - 70.8%      (0.17)%        (b)        70% - 71%
Operating expenses                        $90 - $93     $20.9 - $21.9     (c)        $69 - $71
Provision for income taxes                   **              **                        $ nil

(a) As in the past, and consistent with business practice in the semiconductor industry, a portion of our revenue is 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. We expect the turns business percentage from the beginning of the third quarter of 2013 to be approximately 25%. A number of factors such as volatile macroeconomic conditions could impact achieving our revenue outlook.

(b) This percentage relates to stock-based compensation expense and can vary depending on the volume of products sold given that many of our costs are fixed. The gross margin percentage will also vary depending on the mix of products sold.

(c) The referenced amount consists of $6 million to $7 million of stock-based compensation expense and $15.1 million of amortization of purchased intangible assets.

** The comparable GAAP measure is not available on a forward-looking basis without unreasonable effort.


Table of Contents

The above non-GAAP information is provided as a supplement to the Company's condensed consolidated financial statements presented in accordance with generally accepted accounting principles ("GAAP"). A non-GAAP financial measure is a numerical measure of a company's performance, financial position, or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP. The Company believes that the additional non-GAAP measures are useful to investors for the purpose of financial analysis. Management uses these measures internally to evaluate the Company's in-period operating performance before gains, losses and other charges that are considered by management to be outside of the Company's core operating results. In addition, the measures are used for planning and forecasting of the Company's future periods. However, non-GAAP measures are not in accordance with, nor are they a substitute for, GAAP measures. Other companies may use different non-GAAP measures and presentation of results.

Liquidity & Capital Resources

Our principal sources of liquidity are cash from operations, 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, repay any short-term indebtedness, and finance working capital. Currently, our primary objective for use of discretionary cash has been to repurchase and retire a portion of our common stock. The combination of cash and cash equivalents, short-term investments, and long-term investment securities at September 28, 2013 totaled $210.0 million and is comprised of the following:

                                                                 September 28, 2013
                                                                Gross              Gross
                                                              Unrealized        Unrealized
. . .
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