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PMCS > SEC Filings for PMCS > Form 10-K on 26-Feb-2014All Recent SEC Filings

Show all filings for PMC SIERRA INC

Form 10-K for PMC SIERRA INC


26-Feb-2014

Annual Report


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

PMC-Sierra is a semiconductor and software solution innovator transforming networks that connect, move and store digital content. We generate revenues from the sale of semiconductor, embedded software and board level solutions that we have designed and developed or acquired. Almost all of our revenues in any given year come from the sale of products that are developed prior to that year. For example, 99% of our revenues in 2013 came from products developed or acquired in 2012 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 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, Optical and Mobile networks.

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

2. Our Optical 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 products are used in wireless base stations, mobile backhaul, and aggregation equipment.

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.

We expect our microprocessor solutions to continue to ship into the laser printer market as well as the enterprise networking market.

Update to the Interim Condensed Consolidated Financial Statements Included in Earnings Press Release Dated January 30, 2014 for the Fourth Quarter and Year Ended December 28, 2013

On January 30, 2014, the Company filed a Current Report on Form 8-K incorporating the Press Release announcing the Company's preliminary financial results for its fiscal fourth quarter and year ended December 28, 2013 (the "Preliminary Results"). For presentation in this Annual Report on Form 10-K, the Company adjusted certain current and prior year annual and quarterly financial information presented in the Preliminary Results, including items related to balance sheet classification of valuation allowance against deferred tax balances as at the fiscal December 28, 2013 and December 29, 2012 year ends and capitalizing certain inventory related overhead costs previously expensed through Cost of Revenues. Further details related to these matters are included in Note 19. Error Corrections to the financial statements and in Item 9B. Other Information.

The fiscal 2012 consolidated financial information has been updated within this Management's Discussion and Analysis of Financial Condition and Results of Operations to reflect the corrections as more fully described


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in Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 19. Error Corrections within this Annual Report.

RESULTS OF OPERATIONS

NET REVENUES

(in millions) 2013 Change 2012 Change 2011 Net revenues $ 508.0 (4 )% $ 531.0 (19 )% $ 654.3

Overall net revenues for 2013 decreased by $23.0 million compared to net revenues for 2012. This 4% decrease was mainly attributable to macro-economic uncertainty and continued cautious enterprise and carrier infrastructure spending, which primarily impacted sales volumes of each of the Storage, Optical and Mobile market segments, while average selling prices remained relatively stable.

Storage represented 67% of our net revenues in 2013 and 2012. Storage net revenues decreased by 3% year-over-year 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 2012. This was partially offset by higher volumes of sales to Data Center customers and continued ramp of 6G and 12G SAS products and revenues from our flash controller products as a result of our acquisition of IDT's enterprise flash controller division during the year.

Optical represented 19% of our net revenues in 2013 and 2012. Optical net revenues decreased by 6% compared to 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. This was partially offset by higher volume of sales from our high-capacity system-on-a-chip solutions products.

Mobile represented 14% of our net revenues in 2013 and 2012. Mobile net revenues decreased by 9% compared to 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 2012.

Overall net revenues for 2012 decreased by $123.3 million, or 19% compared to net revenues for 2011. This year-over-year decrease was mainly attributable to lower volumes shipped. We continued to be affected by macro-economic uncertainty, which has our customers delaying investments in network infrastructure, and has impacted each of the Storage, Optical and Mobile market segments.

Storage represented 67% of our net revenues in 2012, compared to 60% in 2011. Storage net revenues decreased by 10% year-over-year mainly due to the macro-economic uncertainty noted above.

Optical represented 19% of our net revenues in 2012, compared to 25% in 2011. Optical net revenues decreased by 37% year-over-year mainly due to the overall macro-economic uncertainty noted above, lower carrier spending and delayed investment by carriers in packet-based technologies to address growth in video and mobile data. This led to a substantial drop in legacy volumes from SONET and ATM but no corresponding increase in new OTN technology revenue.

Mobile represented 14% of our net revenues in 2012, compared to 15% in 2011. Mobile net revenues decreased by 25% year-over-year due mainly to the factors above.

GROSS PROFIT



   (in millions)                 2013        Change         2012         Change         2011
   Gross profit                 $ 358.8           (4 )%    $ 372.1           (16 )%    $ 443.1
   Percentage of net revenues        71 %                       70 %                        68 %


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Gross profit for 2013 decreased by $13.3 million over 2012 due to lower volumes. Gross profit as a percentage of net revenues was 71% and 70% in 2013 and 2012, respectively. Our gross margin was favorably impacted during 2013 from warranty provision releases offset by acquisition-related costs and termination costs. The remainder of the change is mainly due to product mix.

Gross profit for 2012 decreased by $71.0 million over 2011. Gross profit as a percentage of net revenues increased 2% to 70% in 2012 from 68% in 2011. This increase is mainly due to $9 million of expense related to our acquisition of Wintegra in November 2010, specifically, the effect of fair value adjustments related to inventory acquired from Wintegra and sold during the first half of 2011. As a result, gross profit as a percentage of net revenues would have been 69% in 2011 had it not been for this fair value adjustment. The remainder of the change is mainly due to product mix. We were able to offset the negative effect on gross margin percentage of fixed costs over the lower net revenues in 2012 through cost saving initiatives.

OTHER COSTS AND EXPENSES



($ millions)                              2013          Change           2012          Change           2011
Research and development                 $ 211.0             (4 )%      $ 220.9             (3 )%      $ 227.1
Percentage of net revenues                    40 %                           42 %                           35 %

Selling, general and administrative      $ 112.8              0 %       $ 112.5             (5 )%      $ 118.6
Percentage of net revenues                    21 %                           21 %                           18 %

Amortization of purchased intangible
assets                                   $  48.2              6 %       $  45.3              2 %       $  44.2
Percentage of net revenues                     9 %                            9 %                            7 %

Impairment of goodwill and purchased
intangible assets                        $    -            (100 )%      $ 274.6             -  %       $    -
Percentage of net revenues                    -  %                           52 %                           -  %

Research and Development Expenses

Our Research and Development ("R&D") expenses were $211.0 million in 2013. This was $9.9 million, or 4%, lower compared to 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 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 patent contingency provisions.

Our R&D expenses were $220.9 million in 2012. This was $6.2 million, or 3%, lower compared to 2011. This was primarily the result of lower outside services costs due to the timing of projects and continued expense control, partially offset by higher payroll-related costs associated with planned hiring (although bonuses were lower) and some increased acquisition related costs.

Selling, General and Administrative Expenses

Our selling, general and administrative ("SG&A") expenses were $112.8 million in 2013. This was $0.3 million higher compared to 2012, mainly due to an increase in asset impairment of $2.2 million and higher payroll related costs of $2.6 million, including termination costs of $1.8 million, partially offset by reversal of accruals of $1.3 million, lower lease and facilities expenses of $1.5 million and certain other decreases including professional fees and lease exit costs.

Our SG&A expenses were $112.5 million in 2012. This was $6.1 million, or 5%, lower compared to 2011, mainly due to lower payroll-related costs, including lower commissions due to lower net revenues, and lower acquisition-related costs.


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Amortization of Purchased Intangible Assets

Amortization expense for acquired intangible assets increased by $2.9 million, or 6%, in 2013 compared to 2012. This was attributable to commencing amortization of intangible assets acquired from IDT during the year.

Amortization expense for acquired intangible assets increased by $1.1 million, or 2%, in 2012 compared to 2011. This was attributable to commencing amortization of core technology assets acquired in minor business combinations at the end of 2011 and in 2012.

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. The impairment loss recorded in 2012 did not have a significant impact on the Company's operations and/or liquidity in 2013, nor do we expect that it will in the future. 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. See within Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 18. Impairment of Goodwill and Long-Lived Assets.

OTHER INCOME AND EXPENSES



($ millions)                              2013           Change          2012          Change           2011
Revaluation of liability for
contingent consideration                 $    -               -  %      $    -            (100 )%      $ 29.4
Gain on investment securities and
other investments                        $   1.9              27 %      $   1.5             88 %       $  0.8
Amortization of debt issue costs         $  (0.1 )            50 %      $  (0.2 )           -  %       $ (0.2 )
Foreign exchange gain (loss)             $   4.0             367 %      $  (1.5 )         (600 )%      $  0.3
Interest income (expense), net           $   0.9             156 %      $  (1.6 )          (30 )%      $ (2.3 )
Provision for income taxes               $ (25.8 )            31 %      $ (37.3 )          277 %       $ (9.9 )


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Revaluation of liability for contingent consideration

During 2011, we recognized a revaluation of liability for contingent consideration related to our acquisition of Wintegra. We recognized a fair value adjustment relating to the liability based on the updated assessment during the third quarter of 2011 of Wintegra's 2011 revenues, which were below earn-out levels due to delayed platform deployment from key suppliers in China and Europe. See Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 2. Business Combinations. There is no other liability for contingent consideration.

Gain on investment securities and other

We recorded a gain on sale of investment securities and other investments of $1.9 million, $1.5 million, and $0.8 million, related to the disposition of investment securities and other investments in 2013, 2012, and 2011, respectively. We also recognized recoveries of prior impairments of our investments in the Reserve Funds of $0.5 million in 2011, based on distributions received from the Reserve Funds.

Amortization of debt issue costs

We recorded amortization of debt issue costs of $0.1 million in 2013 relating to our credit facility, and $0.2 million in each of 2012 and 2011 relating to our senior convertible notes.

Foreign exchange gain (loss)

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.

We recognized a net foreign exchange gain of $4.0 million in 2013, a net foreign exchange loss of $1.5 million in 2012, and a net foreign exchange gain of $0.3 million in 2011. This was primarily due to foreign exchange gain and loss on the revaluation of our net foreign denominated assets and liabilities. This was partly driven by the United States Dollar appreciating by approximately 7% during 2013 compared to depreciating by approximately 1% during 2012, and depreciating by approximately 1% during 2011, against currencies applicable to our foreign operations.

Interest income (expense), net

Net interest income for 2013 was $0.9 million and net interest expense for 2012 and 2011 was $1.6 million and $2.3 million, respectively. We retired our senior convertible notes in October 2012 and we drew $30 million in funds from our credit facility in November 2013. This resulted in a lower interest expense to offset interest income from cash in banks and short-term investments in 2013 compared to 2012.

In 2012, the decrease in net interest expense of $0.7 million, compared to 2011 was primarily due to less interest expense as a result of retiring our senior convertible notes in October 2012, and no accretion of the liability for contingent consideration in 2012 compared to 2011, partially offset by lower investment yields on lower cash balances in 2012.

In 2011, the increase in net interest expense of $1.1 million, compared to 2010, was due to lower investment yields and lower cash balances. In addition, we recognized $1.2 million of interest expense related to the accretion of the liability for contingent consideration in 2011, which was offset by the decline of $0.8 million interest on our short-term loan related to our acquisition of Wintegra in 2011 compared to 2010.


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Provision for income taxes

On a consolidated basis, the Company recorded a provision for income taxes of $25.8 million, $37.3 million and $9.9 million for 2013, 2012, and 2011, respectively. The effective tax rates were negative 382%, negative 13% and positive 11% for 2013, 2012 and 2011, respectively.

The difference between our effective tax rates and the 35% US federal statutory rate in each of 2013, 2012, and 2011, resulted primarily from foreign earnings eligible for tax rates lower than the federal statutory rate due to economic incentives subject to certain criteria granted by foreign jurisdictions and extending to approximately 2020, investment tax credits earned, changes in valuation allowance, and adjustments for prior years taxes and tax credits, partially offset by non-deductible intangible asset amortization and impairment of goodwill and purchased intangible assets, the effect of inter-company transactions, utilization of stock option related loss carryforwards recorded in equity, changes in accruals related to the unrecognized tax benefit liabilities, and permanent differences arising from stock-based compensation and other items.

The Company's 2013 tax rate was higher than the 35% statutory rate primarily due to $32.5 million increase in valuation allowance on deferred tax assets, $18.1 million tax on intercompany transactions, $16.1 million non-deductible amortization and stock-based compensation expense, partially offset by $23.3 million tax credits generated in 2013, $10.2 million tax on profits earned in jurisdictions where the tax rate is lower than the U.S. tax rate, and the balance attributable to deferred tax timing differences and other items.

The Company's 2012 tax rate was higher than the 35% statutory rate primarily due to the $104.8 million tax impact of an intercompany dividend $109.8 million non-deductible amortization and stock-based compensation expense, and $17.6 million effect of stock option related loss carry-forwards recorded in equity, partially offset by a decrease in valuation allowance of $40.3 million, $19.2 million tax credits generated in 2012, and the balance attributable to deferred tax timing differences and other items.

The Company's 2011 tax rate was lower than the 35% statutory rate primarily due to $28.2 million profits earned in jurisdictions where the tax rate is lower than the U.S. tax rate and $18.4 million tax credits generated in 2011, partially offset by the tax impact of $33.9 million inter-company transactions, an adjustment of $25.9 million prior year taxes, $9.0 million non-deductible stock-based compensation and amortization expense and write-down, and the balance attributable to deferred tax timing differences and other items.

See Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 15. Income Taxes.

BUSINESS OUTLOOK

The following is our outlook for the three months ending March 29, 2014 and a
reconciliation of each non-GAAP financial measure to the most directly
comparable GAAP financial measure:



                                        Non-GAAP measure   Reconciling items   GAAP Measure
(in millions, except for percentages)
Net revenues                               $120-$128            N/A(a)          $120-$128
Gross profit %                              70%-71%            (0.2)%(b)       69.8%-70.8%
Operating expenses                          $71-$73           $21-$22(c)         $92-$95
Provision for income taxes                     $1                 **                **

(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 first quarter of 2014 to be approximately 29%. A number of factors such as volatile macroeconomic conditions could impact achieving our revenue outlook.


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

(c) The referenced amount consists of $5.7 million to $6.7 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.

The above non-GAAP information is provided as a supplement to the Company's condensed consolidated financial statements presented in accordance with U.S. 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 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, 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, cash equivalents, short-term investments and long-term investment securities at December 28, 2013 and December 29, 2012 totaled $214.3 million and $273.2 million, respectively.

In 2013, we obtained a revolving line of credit with a bank under which the Company may borrow up to $100 million, of which, $30 million was drawn and remained outstanding as at year-end.

In October 2012, we repurchased the remaining outstanding senior convertible notes at 100% of the outstanding principal amount, or $68.3 million.

In the future, we expect our cash on hand and cash generated from operations, together with our short-term investments, long-term investment securities and revolving line of credit, to be our primary sources of liquidity (see Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 4. Fair Value Measurements).

OPERATING ACTIVITIES

Cash generated from operations was $78.8 million in fiscal 2013 compared to cash generated from operations of $58.8 million in 2012. Our net loss for the year was $32.5 million. Net loss, after adding back non-cash expenses of $71.4 million amortization and depreciation and $26.3 million stock based compensation was the main driver of our positive operating cash flow, with some benefit from normal changes in working capital, including improvement in accounts receivable collections at 40 days sales outstanding (2012-43 days) and increase in deferred taxes and income taxes payable. In addition, partially offsetting these were $8.5 million in working capital changes, driven mainly by $5.6 million reduction in accounts payables and accrued liabilities and $3.6 million increase in inventory levels at the end of 2013.

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