ITEM 1. Business
PMC-Sierra, Inc. designs, develops, markets and supports a broad range of high-performance integrated circuits primarily used in the telecommunications and data networking industries. We have more than 120 different semiconductor devices that are sold to leading equipment manufacturers, who in turn supply their equipment principally to communications network service providers and enterprises. We provide superior semiconductor solutions for our customers by leveraging our intellectual property, design expertise and systems knowledge across a broad range of applications.
PMC-Sierra 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 National Market under the symbol "PMCS" and is included in the S&P 500 index.
Our principal executive offices are located at 3975 Freedom Circle, Santa Clara, California 95054, and our phone number is (408) 239-8000. Our internet homepage is located at www.pmc-sierra.com; however, the information in, or that can be accessed through, our home page 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 Internet homepage as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission, or SEC.
Our fiscal year ends on the last Sunday of the calendar year. Fiscal years 2002 and 2001 each consisted of 52 weeks. Fiscal year 2000 consisted of 53 weeks. For ease of presentation, we have referred to December 31 as our fiscal year end for all years.
In this Annual Report on Form 10-K, "PMC-Sierra", "PMC", "the Company", "us", "our" or "we", means PMC-Sierra, Inc. together with our subsidiary companies.
FORWARD-LOOKING STATEMENTS
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", "will", "should", "estimates", "predicts", "potential", "continue", "becoming", "transitioning" and similar expressions to identify such forward-looking statements.
These forward-looking statements apply only as of the date of this 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 "Factors That You Should Consider Before Investing in PMC-Sierra" and elsewhere in this Annual Report. Investors are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. Such forward-looking statements include statements as to, among others:
o business strategy;
o sales, marketing and distribution;
o wafer fabrication capacity;
o competition and pricing;
o significant accounting policies and accounting estimates;
o customer networking product inventory levels, needs and order levels;
o demand for networking equipment;
o net revenues;
o gross profit;
o research and development expenses;
o marketing, general and administrative expenditures;
o interest and other income;
o capital resources sufficiency;
o capital expenditures;
o restructuring activities, expenses and associated annualized savings; and
o our business outlook.
INDUSTRY OVERVIEW
The global markets for communications equipment that contain our products continued to decline in 2002 primarily due to excess capacity in communication service provider infrastructures, excess inventory levels in the supply chain and a slowing global macro-economy. Despite the fact that connectivity to the Internet increased and web-based applications drove higher data transmission volumes, service providers in North America and Europe reduced spending on new networking equipment in 2002. This was largely the result of an overbuilding of the network infrastructure in the late 1990's and early 2000 when capital markets fueled rapid expansion of data networks and start-up competitive services. Following this expansionary period, many of the incumbent service providers realized they had excess capacity in their systems and could not sustain such high levels of spending on new equipment. In addition, many competitive service providers were unable to generate sufficient revenues to pay for their new systems and were subsequently acquired, broken up and divested, or filed for bankruptcy.
The contraction in capital spending on networking equipment in 2001 and 2002 resulted in fewer orders for our customers' equipment, and therefore a reduction in demand for our products. We sell more than 120 different semiconductor devices to the leading original equipment manufacturers (OEMs) that, in turn, sell their equipment to end customers such as telecommunications service providers and enterprises. The overall reduction in service provider capital spending, combined with high levels of inventories throughout the industry supply chain, resulted in lower demand for our devices. While equipment spending in the enterprise market (primarily corporations, institutions and governments) was relatively stable compared to service providers, it was not enough to offset a broader decline in activity across the global communications equipment industry.
Many service providers consider it important to add capacity and technology capability to limited aspects of their networks as data traffic and the associated revenues are key growth drivers for their operations going forward. To capture a growing portion of this competitive market, service providers are transitioning their networks from voice-centric to data-centric systems. In addition, network utilization rates are increasing, absorbing excess capacity, but also slowing data transmission speed through service providers' networks. In this environment, it is critical for service providers to upgrade their networks with more efficient equipment enabling them to lower operating costs while handling the increasing amount of traffic. The service providers must also upgrade equipment while lowering capital spending.
In simple terms, the Internet is a hybrid series of networks comprised of copper wires, coaxial cables, and fiber optic cables. These networks carry high-speed traffic in the form of electrical and optical signals that are transmitted and received by complex networking equipment. To ensure this equipment and the various networks can easily communicate with each other, the OEMs and makers of communications semiconductors have developed numerous communications standards and protocols for the industry. These communications protocols make it easier for complex high-speed data traffic to be sent and received reliably and efficiently - - whether intra-office, across the country, or internationally.
One industry standard that packages information into a fixed-size cell format for transportation across networks is ATM or Asynchronous Transfer Mode. Many service providers deploy equipment that handles this protocol because it can support voice, video, data, and multimedia applications simultaneously.
Another established industry standard is called SONET or Synchronous Optical Network for high capacity data communication over fiber optic systems. This is used in the Americas and parts of Asia, with the equivalent standard in the rest of the world called SDH or Synchronous Digital Hierarchy.
In addition to using SONET to increase the bandwidth, or capacity of, in their networks, many system operators have also deployed equipment that uses a technology called dense wave division multiplexing. Rather than transmitting a single light signal over an optical fiber, dense wave division multiplexing allows many different light signals (each of a different wavelength) to be transmitted simultaneously. By deploying this technique at higher transmission rates, carriers can move more signals across transmission lines.
IP is a transport protocol that maintains network information and routes packets across networks. While IP packets are larger and can hold more data than ATM cells, service providers often have difficulty providing the same quality of service with IP because it is not optimized for time-sensitive signals such as video and voice services.
Ethernet is another protocol that is used extensively in data transmission in local area networks (LAN) and is now being used in wide area networks (WAN) as well. Service providers are beginning to deploy ethernet because they are familiar with the protocol and it is a relatively efficient way to handle increasing amounts of data moving from the LAN to the WAN.
In some service provider networks, a traffic bottleneck can occur where the high-speed long-haul traffic is handed off to networking equipment in the metro area or where storage networks are being inter-connected. In general, service providers have invested less to enhance the infrastructure in these areas and as a result, many of these systems have insufficient capacity to handle the increasing level of data traffic.
In response, many OEMs are designing faster and more complex equipment to handle the higher volumes in the network. This equipment must be able to accommodate various protocols and formats, including cell-based ATM and packet-based Internet Protocol (IP).
To accommodate these different protocols and the growing demand for services, many service providers are requiring OEMs to provide more complex, integrated solutions in a shorter time period. At the same time, some of the OEMs have undergone significant corporate restructurings and have fewer resources and technical staff internally to design their own custom solutions. This, coupled with the rising cost of custom semiconductors, has resulted in the OEMs outsourcing more of their communications integrated circuit requirements to companies such as PMC-Sierra. This has brought about the acceleration of the use of standard products of the kind that PMC-Sierra designs and develops.
By leveraging the knowledge and technical expertise of companies such as PMC-Sierra, the OEMs are able to focus their efforts on their core competencies. In many cases, it can take several years before a new silicon chip or chip set can be designed, manufactured, tested, and released to full production for a customer. It is essential, therefore, that companies like PMC-Sierra that develop the chips to be incorporated into the OEM equipment work very closely with their OEM customers so that together they can optimally meet the equipment needs of the service providers.
PRODUCTS
We have more than 120 revenue-producing products in our portfolio. Our networking products comprise communications semiconductors - - including microprocessors - - that are used in many different types of equipment throughout the network infrastructure. While our current networking product development efforts are focusing on all the four areas of the network infrastructure described below, less than 10% of our current revenues are derived from the storage and consumer markets. One of our key strategies is to broaden into these markets.
Our non-networking segment, comprised of a single chip used in a consumer medical device, wound down in the second quarter of 2002, with only insignificant revenues thereafter to meet remaining customer requirements.
Our networking products are sold primarily into four areas of the worldwide network infrastructure, which we call Metro, Access, Enterprise/Storage, and Consumer-related markets. Many of our products are designed with standardized interfaces between chips so our customers can easily develop and implement solutions involving multiple PMC-Sierra products.
The following briefly describes PMC-Sierra's view of the Metro, Access, Enterprise/Storage and Consumer-related areas of the internet infrastructure and some typical equipment that may include our chips and chipsets. Due to the complexity of the telecommunications network, it is not possible to sharply delineate the 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 some of our other products have highly specialized applications. For example, our microprocessors can be used in many networking equipment applications (such as high-speed routers or networked printers), while our Paladin chip may only be used in a single application (power amplification for wireless base stations). In some situations, different OEMs might use our chips or chipsets in equipment addressing more than one of the market areas noted below.
o Access: this area of the telecommunications network infrastructure encompasses wired and wireless equipment that aggregates transmissions from the home or office and connects that traffic to the metro and the wide area network (WAN). For example, our semiconductors would be used in equipment such as digital subscriber line access multiplexers, wireless base stations, add-drop multiplexers (which add and drop signals and streams of data from optical networks) and switches (which direct the data traffic to other destinations within the network).
o Metro: the metropolitan, or metro area, of the internet infrastructure is predominantly a fiber optic-based network that provides high-speed communications and data transfer over a city center or regional area. This portion of the network manages traffic inside its own region and manages traffic between the access and long-haul transport networks for inter-city or international transmission. Our products are used in metro equipment such as switches and routers that gather and process signals in different protocols, and then transmit them to the next destination as quickly and efficiently as possible.
o Enterprise/Storage: this area of the network includes equipment that is deployed primarily in the office for data communications and other local area network applications. Our products are used in equipment such as medium to high-end laser jet printers in the office, as well as switches and storage devices that enable data to be transferred to local telecommunications networks. It includes network attached storage equipment and storage area networks for the management, transmission and storage of large amounts of data utilized by enterprises, corporations and government agencies.
o Consumer: this area includes telecommunications equipment used primarily by individuals in their homes for entertainment purposes. For example, some of our lower-end microprocessors are used in equipment such as set-top boxes, high-definition TVs and personal video recorders.
Our chips and chipsets can also be divided into the broadly defined functional categories 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, particularly multiple chip sets, integrate different functions and could be classified in one or more categories. For example, some of our products both convert high-speed analog signals to digital signals, and also split or combine various transmission signals.
o Line interface units: these devices, also referred to as transceivers, transmit and receive signals over a physical medium such as wire, cable or fiber. 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.
o Framers and mappers: before the 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 frames, for transmission across high-speed fiber optics.
o 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. Service providers can use information gathered by the cell or packet processor to determine customers' network usage and charge the appropriate service fee.
o Traffic managers and switch fabrics: traffic managers organize, schedule and queue cells and packets into and out of switches. Switch fabrics interconnect the wires and fibers, allowing the data to be routed to its intended destination.
o Serializers/Deserializers: these devices convert networking traffic between slower speed parallel streams and higher speed serial streams. OEMs use serial streams to reduce networking equipment line connections, and parallel streams to allow them to apply lower cost traffic management technologies.
o Microprocessors: these devices perform the high-speed computations that help identify and control the flow of signals and data in the many different types of network equipment used in the communications, enterprise and consumer markets.
STRATEGY
Our high-speed semiconductor solutions are based on our strong knowledge of network applications, system requirements and networking protocols. To achieve our goal of growing and profitably expanding our business, we are pursuing the following key strategies:
Leverage technical expertise across diverse base of applications:
We have a history of analog, digital, mixed signal and microprocessor expertise and we integrate many functions and protocols into our products. We leverage our common technologies and intellectual property across a broad range of networking equipment. Many OEMs recognize they can obtain highly complex, broadband communications technology "off the shelf" from companies such as PMC-Sierra rather than dedicating their own resources to develop custom chips. We intend to take advantage of our customers' growing requirements to outsource more of the silicon content in their networking equipment which will allow the OEMs to reduce their development costs and improve time-to-market while differentiating their products in other ways.
Broaden our business into the Enterprise, Storage and Consumer markets:
The majority of our products are used by OEMs that sell their networking equipment to telecommunications service providers worldwide. Over the past year, however, we have been focused on directing many of our existing and newly designed products into new markets. For example, our advanced serialization/de-serialization devices are now being used in transceiver and serial backplane applications in storage area networking and enterprise networking equipment. Our lower-speed microprocessors are being designed into advanced multi-function devices as well as going into consumer applications such as personal video recorders, set-top boxes and high-definition TVs. We are working closely with some of the largest players in the enterprise and storage markets to help these customers design and develop standard semiconductor solutions that will lower their costs and improve their time to market.
Increase our presence in Asian markets:
Over the past decade, we have been developing strong relationships with our Asian customers. In 2002, just under one-third of our total revenues were generated in the Asia Pacific region. Some of our largest customers in Japan and Korea include Fujitsu, Ricoh, NEC, Samsung and LG Electronics. In addition, we are gaining new customers, many of which are located in the People's Republic of China, such as ZTE, Huawei Technologies, Fiberhome Telecommunciation Technologies, and Alcatel Shanghai Bell. These customers are broadening their product offerings to meet the growing network infrastructure requirements in China and other Asian markets. To improve our customer service and penetration into this region, we appointed a new vice president to head our Asia Pacific sales and support team, headquartered in Shanghai. PMC-Sierra plans to continue increasing the number of sales/marketing personnel in our Asia Pacific operations and to add new distribution capabilities in the regional markets.
Provide first-class products, customer service and technical support:
We work very closely with our customers to ensure they get the best service and technical support required to assist them with their development efforts. As the marketplace for telecommunications equipment suppliers slowly consolidates, we believe our largest customers and their products will take an increasing percentage of the overall market in their areas of expertise. Customers such as Cisco, Hewlett Packard, Lucent, Nortel, Alcatel, Samsung, Fujitsu, Ricoh, ZTE, Huawei and Juniper are aligning their design and manufacturing operations with key suppliers like PMC-Sierra.
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 premium service and technical support. We maintain close working relationships with many of our customers. Our marketing team is focused on developing new products that meet the needs of our customers in our target markets. 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 considered for the application. To assist us in our planning process, we are in regular contact with our largest customers to discuss industry trends, emerging standards and their new product requirements.
To promote our products, our marketing team is actively involved in demonstrating our devices with other industry suppliers and providing technical information at trade shows held in North America, Asia and Europe. Technical support is essential to our customers' success, and we provide this through field application engineers, technical marketing and factory systems engineers. We also provide more detailed information and support for our product line through our corporate website and special customer-accessible extranet sites. We believe that providing comprehensive product service and support is critical to shortening customers' design cycles and maintaining a competitive position in the networking market.
We sell our products both directly and through distributors and independent manufacturers' representatives. In 2002, approximately 36% of our orders were shipped through our distributors; approximately 45% were sent by us directly to contract manufacturers selected by OEMs; and the balance were sent directly to our OEM customers.
Our largest distributor is Memec Group Holdings Ltd. which represents our products worldwide (excluding Japan, Israel, Taiwan and Australia). Many of our customers are seeking to reduce supply chain costs and are requesting that we ship more of our products directly to the contract manufacturers they have selected. Based on this trend, we expect that over time our largest customers will require that we ship a higher percentage of their orders directly to contract manufacturers and a lower percentage will be shipped through our distributors.
A summary of our domestic and international net revenues and long-lived assets is presented in Note 13 to the Consolidated Financial Statements in Item 8. More than half of our net revenues were generated in the United States in each of the three years ended December 31, 2002.
For a discussion of risks we face due to our international operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That You Should Consider Before Investing in PMC-Sierra" in Item 7.
Cisco Systems and Hewlett-Packard each represented more than 10% of our 2002 revenues based on total sales to end customers through distributors, contract manufacturers or direct sales. Our sales outside of the United States accounted for 45% of total revenue in 2002, 42% in 2001, and 38% in 2000.
MANUFACTURING
We are a fabless company, meaning we do not own or operate foundries for the production of silicon wafers from which our products our made. Instead, we use independent foundries and chip assemblers for the manufacture of our products.
Typically, the manufacture of our chips requires 12-16 weeks. We refer to this as our lead-time. Based on this lead-time, our team of production planners will initiate a purchase order with an independent foundry to fabricate the required wafers. The wafers once fabricated must be probed, or inspected, to determine usable from unusable chip parts, referred to as die, on the wafer. The wafers are sent to an outside assembly house where they are cut and the good die are in turn packaged into chips. The chips are then run through various electrical and visual tests before delivery to the customer. With most of our products, we have the option to probe the wafers or test the final chips in-house or subcontract the probing or testing to independent subcontractors.
We receive more than 90% of the silicon wafers from which we derive our products from Chartered Semiconductor Manufacturing Ltd. ("Chartered"), Taiwan Semiconductor Manufacturing Corporation ("TSMC"), and IBM. These independent foundries produce our networking products at feature sizes down to 0.13 micron. By using independent foundries to fabricate our wafers, we are better able to concentrate our resources on designing, development and testing of new products. In addition, we avoid much of the fixed capital and operating costs associated with owning and operating fabrication or chip assembly facilities.
We have supply agreements with both Chartered and TSMC. We have made deposits to secure access to wafer fabrication capacity under both of these agreements. At December 31, 2002 and 2001, we had $22 million in deposits with these companies. Under these agreements, the foundries must supply certain quantities of wafers per year. Neither of these agreements have minimum unit volume requirements but we are obliged under one of the agreements to purchase a minimum percentage of our total annual wafer requirements provided that the foundry is able to continue to offer competitive technology, pricing, quality and delivery. The agreements may be terminated if either party does not comply with the terms.
Wafers supplied by outside foundries must meet our incoming quality and test standards. We conduct a portion of our test operations on advanced mixed signal and digital test equipment in our Burnaby facility. The remainder of our testing is performed predominantly by independent U.S. and Asian companies.
RESEARCH AND DEVELOPMENT
Our current research and development efforts are targeted at integrating multiple channels or functions on single chips, broadening the number of products we provide to address varying protocols and networking functions, and increasing the speeds at which our chips operate.
At the end of fiscal 2002, we had design centers in the United States (California, Oregon, Maryland, and Pennsylvania), Canada (British Columbia, Saskatchewan, Manitoba, Ontario and Quebec), Ireland, and India. On January 16, 2003, we announced a corporate restructuring to further reduce our operating expenses. As a result of this restructuring, we will be closing our design centers in Maryland, Ireland and India during 2003.
We spent $137.7 million in 2002, $201.1 million in 2001, and $178.8 million in 2000 on research and development.
In 2000, we also expensed $38.2 million of in process research and development, $31.5 million of which related to the acquisition of Malleable Technologies and $6.7 million of which related to the acquisition of Datum Telegraphic.
BACKLOG
We sell primarily pursuant to standard purchase orders. Our customers frequently revise the quantity actually purchased and the shipment schedules to reflect changes in their needs. We believe orders placed for delivery in excess of six months are not firm orders. As of December 31, 2002, our backlog of products scheduled for shipment within six months totaled $36.6 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 2003. Our backlog of products as of December 31, 2001 for shipment within six months totaled $35.7 million.
Our backlog includes backlog to our major distributor, which may not result in revenue, as we do not recognize shipments to our major distributor as revenue until our distributor has sold our products through to the end customer. Also, our customers may cancel, or defer to a future period, a significant portion of the backlog at their discretion without penalty. Accordingly, we believe that our backlog at any given time is not a meaningful indicator of future revenues.
COMPETITION
We typically face competition at the design stage when our networking customers determine which communications semiconductor components to use in their next generation equipment designs.
Most of our customers choose a particular semiconductor component primarily based on whether the component:
o meets the functional requirements,
o addresses the required protocols,
o interfaces easily with other components in a design,
o meets power usage requirements, and
o is priced competitively.
OEMs are becoming more price conscious than in the past as a result of the downturn in the telecommunications industry, and as semiconductors sourced from third party suppliers comprise a greater portion of the total materials cost in OEM equipment. We have also experienced aggressive price competition from competitors that are seeking to enter into the markets 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.
In addition to price, OEMs will 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 component design. As well, consideration is given to whether the OEM has pre-qualified the supplier, as this ensures that components made by that supplier will meet the OEM's quality standards.
Our competitors may be classified into three major groups. First, we compete against established peer-group semiconductor companies that focus on the communications semiconductor business. These companies include Agere Systems, Applied Micro Circuits Corporation, Broadcom, Exar Corporation, Conexant Systems, Marvell Technology Group, Multilink Technology Corporation, Silicon Image, Transwitch and Vitesse Semiconductor. These companies are well financed, have significant communications semiconductor technology assets, have established sales channels, and depend on the market in which we participate for the bulk of their revenues.
Other competitors include major domestic and international semiconductor companies, such as Agilent, Cypress Semiconductor, Intel, IBM, Infineon, Integrated Device Technology, Maxim Integrated Products, Motorola, Nortel Networks and Texas Instruments. These companies are concentrating an increasing amount of their substantial financial and other resources on the markets in which we participate.
Emerging companies also provide competition in our segment of the semiconductor market. We are aware of venture-backed companies that focus on specific portions of our broad range of products. These companies could introduce technologies that may make one or more of our integrated circuits obsolete.
Over the next few years, we expect additional competitors, some of which may also have greater financial and other resources, to enter the market with new products.
We are also expanding into some markets, such as the storage and wireless infrastructure and generic microprocessor markets, 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 a strong increase in competition in these markets.
LICENSES, PATENTS AND TRADEMARKS
We rely in part on patents to protect our intellectual property and have been awarded 137 U.S. and 63 foreign patents for circuit designs and other innovations used in the design and architecture of our products. In addition, we have 102 patent applications pending in the U.S. Patent and Trademark office, and 8 patent applications pending in other countries. Our patents expire typically 20 years from the patent application date if accepted, with our existing patents expiring between 2010 and 2021.
We do not consider our business to be materially dependent upon any one patent, although we believe that a strong portfolio of patents combined with other factors such as our innovative ability, technological expertise and the experience of our personnel are important to compete effectively in the industry. A portfolio of patents also provides the flexibility to negotiate or cross license intellectual property with other semiconductor companies to incorporate other features in our products.
To protect our other intellectual property we rely on mask work protection, trademarks, copyrights, trade secret laws, employee and third-party nondisclosure agreements, and licensing arrangements.
Our only material license is the MIPS microprocessor architecture license from MIPS Technologies Inc., on which our microprocessor-based products are based. While the desktop microprocessor market is dominated by the Intel Corporation's "x86" complex instruction set computing, or CISC, architecture, several microprocessor architectures have emerged for other microprocessor markets. Because of their higher performance and smaller space requirements, most of the competing architectures, like the MIPS architecture, are reduced instruction set computing, or RISC architectures. The MIPS architecture is widely supported through semiconductor design software, operating systems and companion integrated circuits. Because this license is the architecture behind our microprocessors, we must be able to retain the MIPS license in order to produce our follow-on microprocessor products.
PMC and its logo are our 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 31, 2002, we had 1,099 employees, including 679 in Research and Development, 118 in Production and Quality Assurance, 203 in Marketing and Sales and 99 in Administration. In January 2003, we announced a restructuring which we expect to reduce our headcount to 924 employees. Our employees are not represented by a collective bargaining agreement and we have never experienced any related work stoppage. We believe our employee relations are good.
ITEM 2.
ITEM 2. Properties.
PMC leases or owns properties in twenty-seven locations worldwide. Approximately 45% of the space leased by PMC was unoccupied at December 31, 2002. We are actively trying to sublease or negotiate our exit from these excess facilities.
We lease a total of 431,000 square feet in four separate buildings in Santa Clara, California, to house the majority of our US design, engineering, product test, sales and marketing operations.
Our Canadian operations are located in Burnaby, British Columbia where we lease 241,000 square feet of office space in five separate buildings. These locations support a significant portion of our product development, manufacturing, marketing, sales and test activities. We also operate ten additional research & development centers: four in Canada, three in the US, two in Ireland and one in India.
We have fourteen sales offices worldwide, with locations in Europe, Asia, and North America.
All of our offices are in leased premises. We also own two buildings on approximately 19 acres of land near our Canadian headquarters in Burnaby. The property was purchased as a development site and is being held with the eventual potential of building our own facility to replace our existing leased Burnaby premises.
In January 2003, we announced our intention to close four of our research and development sites located in the US, Ireland and India. We will also close five of our sales offices located in the US and Europe.
ITEM 3.
ITEM 3. Legal Proceedings.
We are currently not engaged in legal proceedings that require disclosure under this item.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
ITEM 5.
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Stock Price Information. Our common stock trades on the Nasdaq National Market under the symbol PMCS. The following table sets forth, for the periods indicated, the high and low closing sale prices for our Common Stock as reported by the Nasdaq National Market:
2001 High Low
First Quarter.................................... $ 105.94 $ 24.74 Second Quarter................................... 44.81 19.12 Third Quarter.................................... 36.87 10.05 Fourth Quarter................................... 29.24 9.87
2002 High Low
First Quarter.................................... $ 25.98 $ 14.61 Second Quarter................................... 18.05 8.91 Third Quarter.................................... 10.46 3.88 Fourth Quarter................................... 8.85 2.72
To maintain consistency, the information provided above is based on calendar quarter ends rather than fiscal quarter ends. As of March 11, 2003, there were approximately 1,726 holders of record of our Common Stock.
We have never paid cash dividends on our Common Stock. We currently intend to retain earnings, if any, for use in our business and do not anticipate paying any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. Selected Financial Data
(1) The Company's fiscal year ends on the last Sunday of the calendar year. December 31 has been used as the fiscal year end for ease of presentation.
(2) Results for the year ended December 31, 2002 include a $4.0 million allowance for inventories in excess of twelve-month demand recorded in cost of revenues and a $15.3 million charge for impairment of other investments recorded in gain (loss) on investments. In accordance with the adoption of Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets", we ceased amortizing goodwill at the beginning of 2002, thereby eliminating amortization expense of approximately $2 million. See Note 1 of the Consolidated Financial Statements.
(3) Results for the year ended December 31, 2001 include a $20.7 million allowance for inventories in excess of twelve-month demand recorded in cost of revenues and a $17.5 million charge for impairment of other investments recorded in gain (loss) on investments.
(4) Reflects two 2-for-1 stock splits, in the form of 100% stock dividends, effective May 1999 and February 2000.
Quarterly Comparisons
The following tables set forth the consolidated statements of operations for each of the Company's last eight quarters. This quarterly information is derived from unaudited interim financial statements and has been prepared on the same basis as the annual Consolidated Financial Statements. In management's opinion, this quarterly information reflects all adjustments necessary for fair presentation of the information for the periods presented. The operating results for any quarter are not necessarily indicative of results for any future period.
(1) Results include a $4.0 million allowance for inventories in excess of twelve-month demand recorded in cost of revenues and a charge of $15.3 million for impairment of other investments recorded in gain (loss) on investments.
(2) Results include a $6.5 million allowance for inventories in excess of twelve-month demand recorded in cost of revenues and a charge of $17.5 million for impairment of other investments recorded in gain (loss) on investments.
(3) Results include a $12.1 million allowance for inventories in excess of twelve-month demand recorded in cost of revenues.
(4) Results include a $2.1 million allowance for inventories in excess of twelve-month demand recorded in cost of revenues.
ITEM 7.
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.
Net Revenues ($000,000)
2002 Change 2001 Change 2000 - --------------------------------------------------------------------------------
Networking products $ 212.7 (29%) $ 300.2 (55%) $ 665.7
Non-networking products $ 5.4 (76%) $ 22.5 (22%) $ 29.0
Total net revenues $ 218.1 (32%) $ 322.7 (54%) $ 694.7
Net revenues for 2002 decreased by $104.6 million, or 32%, from net revenues in 2001, which decreased by $372.0 million, or 54%, from net revenues in 2000.
Networking
In 2001 and 2002, our net revenues were impacted by several factors:
o weakness in the US and global economies
o depressed spending levels by telecommunications companies and enterprises that incorporate our products into their networking equipment
o excess inventory levels at OEM's
Prior to the onset of these adverse market conditions, our customers had accumulated significant inventories of our products in anticipation of rapid networking equipment sales growth. In 2001, rather than grow, the market for our customers' products contracted, causing a sharp decline in the demand for our products. Consequently, our networking revenues declined $87.5 million, or 29% in 2002 from 2001 and declined $365.5 million, or 55%, in 2001 from 2000. The lower demand of our products in 2002 was not as severe as the decline in 2001 from 2000, as our customers consumed a portion of the excess inventories of our products they held.
The majority of the revenue decline resulted from reduced volume shipments of our parts, however price reductions for high volume products also reduced revenues by 4% and 5% in 2002 and 2001 respectively.
Non-networking
Non-networking revenues declined $17.1 million, or 76%, in 2002 and $6.5 million, or 22%, in 2001 due to decreased unit sales to our principal customer in this segment. This product reached the end of its life after the first quarter of 2002, with only insignificant revenues thereafter.
Gross Profit ($000,000)
Total gross profit for 2002 decreased by $57.0 million, or 31%, from gross profit in 2001, which decreased by $343.0 million, or 65%, from gross profit in 2000.
Networking
Our networking gross profit for 2002 decreased by $49.9 million from 2001. The decrease in networking gross profit related primarily to lower sales volume in 2002 compared to 2001 partially offset by a lower write-down of excess inventory of $4.0 million in 2002 compared with a $20.7 million write-down of excess inventory in 2001.
Our networking gross profit for 2001 decreased by $339.6 million from 2000. Excluding the $20.7 million write-down of excess inventory in 2001, the decrease in networking gross profit in 2001 related primarily to the reduced sales volume.
While networking gross profit as a percentage of networking revenues remained constant at 59% for 2002 and 2001, the following factors impacted the margin in 2002:
o a write-down of excess inventory in 2002 was $16.7 million lower than a similar write-down in 2001, increasing gross profit by 8 percentage points,
o reduced shipment volumes resulted in manufacturing costs being spread over fewer units resulting in lowering gross margin by 5 percentage points, despite reducing manufacturing costs by $3.9 million.
o a shift in mix from the higher margin networking products to those sold into higher volume lower margin applications further reduced gross profit by 3 percentage points.
Our networking gross profit as a percentage of networking revenues decreased 18 percentage points from 77% in 2000 to 59% in 2001. This decrease resulted from the following factors:
o a $20.7 million write-down of excess inventory which lowered gross profit by 7 percentage points,
o a shift in product mix towards lower margin products, which lowered gross profit by 6 percentage points, and
o the effect of applying fixed manufacturing costs over reduced shipment volumes which lowered margins by 5 percentage points.
Non-networking
Non-networking gross profit for both 2002 and 2001 decreased as a result of declining sales volume. This product reached the end of its life in 2002.
Other Costs and Expenses ($000,000)
Research and Development Expenses
Our research and development, or R&D, expenses decreased $63.4 million, or 32%, in 2002 compared to 2001 due to the Company's restructuring and cost reduction programs implemented in the first and fourth quarters of 2001. As a result of these programs, we reduced our R&D personnel and related costs by $34.0 million and other R&D expenses by $29.4 million compared to 2001.
Our R&D expenses for 2001 were $22.3 million, or 12%, higher than 2000 as the effect of increased hiring and expansion of development programs and costs during 2000 was only partially offset by the restructuring and cost reduction programs implemented in 2001. We reduced our R&D personnel by 34% by the end of 2001 from the end of 2000 but because we made substantial additions to our personnel and tools during the latter part of 2000 and because we realized less than 3 months' savings from our fourth-quarter restructuring, our R&D personnel and related costs for 2001 exceeded 2000 by $7.2 million and our tools and equipment costs for 2001 exceeded 2000 by $11.8 million.
Acquisitions that we completed during 2000 and accounted for under the purchase method increased our 2001 R&D expenses by $4.2 million compared to 2000.
Marketing, General and Administrative Expenses
Our marketing, general and administrative, or MG&A, expenses decreased by $26.9 million, or 30%, in 2002 compared to 2001. Of this decrease, $4.2 million was attributable to lower variable sales commissions as a result of lower revenues. The remainder was attributable to the restructuring and cost reduction programs implemented in 2001, which reduced our MG&A personnel and related costs by $9.7 million and other MG&A expenses by $13.0 million compared to 2001.
Our MG&A expenses decreased by $10.3 million, or 10%, in 2001 compared to 2000 due primarily to a $12.0 million reduction in sales commissions resulting from the decline in our revenues. The restructuring programs implemented in 2001 reduced our MG&A personnel by 30% from the end of 2000, but due to growth in the latter part of 2000 resulted in only a 3% year-over-year decrease in our MG&A personnel costs. This decrease in personnel costs combined with the decrease in recruitment costs resulting from less hiring activity in 2001 was more than offset by increases in the cost of facilities due to the prior year's expansion.
Acquisitions that we completed during 2000 and accounted for under the purchase method increased our 2001 MG&A expenses by $1.2 million compared to 2000.
Amortization of Deferred Stock Compensation
We recorded a non-cash charge of $2.8 million for amortization of deferred stock compensation in 2002 compared to a non-cash charge of $41.2 million in 2001 and $36.3 million in 2000.
Deferred stock compensation charges decreased by $38.4 million in 2002 compared to 2001 because we accelerated vesting for certain employees terminated as part of our 2001 restructurings. This acceleration of vesting also resulted in higher charges in 2001 compared to 2000.
Impairment of Property and Equipment
In 2002, we recorded an impairment charge of $1.8 million reflecting a reduction in the estimated fair value of a product tester. This equipment was removed from service because lower manufacturing and product development volumes resulted in excess product tester capacity.
There were no impairments of property and equipment in 2001 or 2000, other than those assets impaired as a result of our 2001 restructurings as described below.
Restructuring Costs and other Special Charges
On January 16, 2003, we announced that we are undertaking a further corporate restructuring to further reduce our operating expenses. The restructuring plan includes the termination of approximately 175 employees and the closure of design centers in Maryland, Ireland and India. We expect that we will record a restructuring charge for workforce reduction, facility lease costs and related asset impairments as these liabilities will be incurred in the first and second quarters of 2003.
During the year, we paid out $27.5 million in connection with October 2001 restructuring activities. See "Critical Accounting Policies and Significant Estimates".
Cash payments made in 2002 for restructuring activities related to the March 2001 restructuring plan were $2.7 million.
We did not have any additional restructurings in 2002. During 2002, we did not have any changes in estimates related to 2001 restructurings that affected the Statement of Operations.
Restructuring - October 18, 2001
Due to a continued decline in market conditions, we implemented a second restructuring plan in the fourth quarter of 2001 to reduce our operating cost structure. This restructuring plan included the termination of 341 employees, the consolidation of additional excess facilities, and the curtailment of additional research and development projects. As a result, we recorded a second restructuring charge of $175.3 million in the fourth quarter of 2001.
The following summarizes the activity in the October 2001 restructuring liability:
We have completed the restructuring activities contemplated in the October 2001 plan, but have not yet disposed of all of our surplus leased facilities. Upon the final disposition of our surplus leased facilities, we expect to achieve annualized savings of approximately $67.6 million in cost of revenues and operating expenses based on the expenditure levels at the time of this restructuring.
Restructuring - March 26, 2001
In the first quarter of 2001, we implemented a restructuring plan in response to the decline in demand for our networking products and consequently recorded a restructuring charge of $19.9 million. The restructuring plan included the involuntary termination of 223 employees across all business functions, the consolidation of a number of facilities and the curtailment of certain research and development projects.
The following summarizes the activity in the March 2001 restructuring liability:
We completed the restructuring activities contemplated in the March 2001 plan by June 30, 2002 and achieved annualized savings of approximately $28.2 million in cost of revenues and operating expenses based on the expenditure levels at the time of this restructuring.
During the first six months of fiscal 2002, we made cash payments of $2.8 million in connection with the March restructuring. The remaining restructuring liability of $1.4 million at June 30, 2002 related primarily to facility lease payments, net of estimated sublease revenues, and was classified as accrued liabilities on the balance sheet. We do not expect this restructuring to have any impact on our Statement of Operations in the future.
Amortization of Goodwill and Impairment of Goodwill and Purchased Intangibles
We adopted the Statement of Financial Accounting Standard No. 142 (SFAS 142), "Goodwill and Other Intangible Assets" on a prospective basis at the beginning of 2002 and stopped amortizing goodwill in accordance with the provisions of SFAS 142. The impact of not amortizing goodwill on the net income and net income per share for 2001 and 2000 is provided in Note 1 to the Consolidated Financial Statements.
In conjunction with the implementation of SFAS 142, we completed the transitional impairment test as of the beginning of 2002 and determined that a transitional impairment charge would not be required. We also completed our annual impairment test in December 2002 and determined that there was no impairment of goodwill.
Amortization of goodwill increased to $44.0 million in 2001 from $36.4 million in 2000 primarily as a result of the goodwill recorded in connection with the Malleable and Datum acquisitions, which were completed in mid 2000.
During the second quarter of 2001, we discontinued further development of the technology acquired in the purchase of Malleable. We did not expect to have any future cash flows related to the Malleable assets and had no alternative use for the technology. Accordingly, we recorded an impairment charge of $189.0 million, equal to the remaining net book value of goodwill and intangible assets related to Malleable. As a result, there was no remaining Malleable goodwill or intangibles to amortize in the second half of 2001.
In the fourth quarter of 2001, due to a continued decline in current market conditions and a delay in the introduction of certain products to the market, we completed an assessment of the future revenue potential and estimated costs associated with all acquired technologies. As a result of this review, we recorded an impairment charge of $79.3 million related to the acquired goodwill and intangibles recognized in the purchase of Datum. The impairment charge was calculated by the excess of the carrying value of assets over the present value of estimated future cash flow related to these assets. The impairment charge reduced the amounts subject to amortization for the remainder of 2001.
Costs of Merger
We did not make any pooling acquisitions, and therefore did not incur any merger costs in 2002 or 2001. The $38.0 million of merger costs that were incurred in 2000 related to five pooling acquisitions and consisted primarily of investment banking and other professional fees.
In Process Research and Development ("IPR&D")
We did not make any acquisitions that were accounted for using the purchase method in 2002 or 2001, and therefore did not incur any IPR&D charges in either of those years.
The $38.2 million expensed to in process research and development in 2000 arose from the acquisitions of Malleable and Datum.
We calculated the charge for IPR&D related to Malleable and Datum by determining the fair value of the existing products as well as the technology that was currently under development using the income approach. Under the income approach, expected future after-tax cash flows from each of the projects under development are estimated and discounted to their net present value at an appropriate risk-adjusted rate of return. Revenues were estimated based on relevant market size and growth factors, expected industry trends, individual product sales cycles and the estimated life of each product's underlying technology. Estimated operating expenses, income taxes and charges for the use of contributory assets were deducted from estimated revenues to determine estimated after-tax cash flows for each project. These projected future cash flows were further adjusted for the value contributed by any core technology and development efforts expected to be completed post acquisition.
These forecasted cash flows were then discounted based on rates derived from our weighted average cost of capital, weighted average return on assets and venture capital rates of return adjusted upward to reflect additional risks inherent in the development life cycle. The risk adjusted discount rates used involved consideration of the characteristics and applications of each product, the inherent uncertainties in achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. After considering these factors, we determined risk adjusted discount rates of 35% for Malleable and 30% for Datum.
In our opinion, the pricing model used for products related to these acquisitions were standard within the high-technology industry and the estimated IPR&D amounts so determined represented fair value and did not exceed the amounts that a third party would have paid for these projects. When we acquired these companies, we did not expect to achieve a material amount of expense reduction or synergies as a result of integrating the acquired in process technology. Therefore, the valuation assumptions did not include anticipated cost savings.
A description of the IPR&D projects acquired is set forth below:
The in process technology acquired from Malleable was planned to detect incoming voice channels and process them using voice compression algorithms. The compressed voice was to be converted, using the appropriate protocols, to ATM cells or IP packets to achieve higher channel density and support multiple speech compression protocols and different packetization requirements. At the date of acquisition we estimated that Malleable's technology was 58% complete and the costs to complete the project to be $4.4 million.
The technology acquired from Datum is a digitally controlled amplifier architecture, which was designed to increase base station system capacities, while reducing cost, size and power consumption of radio networks. At the date of acquisition, we estimated that Datum's technology was 59% complete and the costs to complete the project to be $1.8 million.
The above estimates were determined by comparing the time and costs spent to date and the complexity of the technologies achieved to date to the total costs, time and complexities that were expected to be expended to bring the technologies to completion.
Progress on the technology acquired from Malleable was slower than originally estimated and as a result, costs incurred on this project exceeded our original estimates. In the second quarter of 2001, we discontinued development of this technology and recorded an impairment charge related to the Malleable goodwill and purchased intangible assets (see "Amortization of Goodwill and Impairment of Intangibles").
Development of the chip incorporating the technology acquired from Datum was completed in the fourth quarter of 2000 and the costs incurred to that date were in line with our initial expectations. Since then, we have completed the required firmware related to this chip and have extended development of the Datum technology to a follow-on product. The general economic slowdown has delayed our customers' introduction of the third generation base stations into which we had expected the Datum technology to be incorporated. It is currently uncertain when the Datum products will begin to generate significant revenues.
As a result of the delay in introduction of the third generation base stations, we failed to achieve the revenues, net income, and return on investment expected at the time that the acquisition was completed. We recorded an impairment charge related to the Datum goodwill and purchased intangible assets during the fourth quarter of 2001 (see "Amortization of Goodwill and Impairment of Intangibles").
Interest and Other Income, Net ($ 000,000)
2002 Change 2001 Change 2000 - --------------------------------------------------------------------------------
Interest and other income, net $ 5.0 (64%) $ 13.9 (26%) $ 18.9 Percentage of net revenues 2% 4% 3%
Net interest and other income declined in 2002 by $8.9 million, or 64%.
Excluding interest expense and the amortization of debt financing costs, interest and other income for 2002 was $17.1 million as compared to $19.0 million in 2001. While our interest income declined by approximately $5.5 million as a result of a decline of average yields on our cash, short term and long term investments, this decline was partially offset by an additional $3.6 million in interest income from an overall increase in our average cash balances.
Our interest expense and amortization of our debt issuance costs increased to $12.1 million in 2002, from $5.0 million in 2001, because our convertible subordinated notes were outstanding for the entire year of 2002 compared to less than five months in 2001.
Our net interest income decreased to $13.9 million in 2001 from $18.9 million in 2000. While our interest income declined by approximately $3.2 million as a result of a decline of average yields on our cash, short term and long term investments, this decline was offset by an additional $3.0 million in interest income from an overall increase in our cash balances. Interest expense increased by $3.6 million and we incurred $0.6 million in amortized debt issuance costs in 2001 compared to 2000 due to the issuance of our convertible subordinated notes in August 2001. Other income in 2000 included income from an equity interest in another company of $0.6 million.
Gain (Loss) on Investments ($000,000)
2002 Change 2001 Change 2000 - --------------------------------------------------------------------------------
Gain (loss) on investments $ (11.6) 21% $ (14.6) (125%) $ 58.5 Percentage of net revenues (5%) (5%) 8%
We reported a net loss on investments of $11.6 million in 2002, $14.6 million in 2001 and a gain on investments of $58.5 million in 2000.
In 2002, we recorded a $3.7 million gain on the sale of a portion of our investment in Sierra Wireless, Inc., a public company, as well as other investments. This gain was offset by a $15.3 million charge to recognize the impairment of our investments in non-public entities. See "Critical Accounting Policies and Significant Estimates".
In 2001, we recorded a $2.9 million gain on the sale of a portion of our investment in Sierra Wireless, as well as other investments. This gain was offset by a $17.5 million charge to recognize the impairment of our investments in non-public entities. See "Critical Accounting Policies and Significant Estimates".
In 2000, gains of $54.4 million and $4.1 million resulted from the sale of a portion of our investment in Sierra Wireless and our investment in Cypress Semiconductor, Inc., respectively. Our investment in Cypress Semiconductor was received through its acquisition of IC Works, a company in which we had invested.
Provision for Income Taxes.
Our annual effective tax rate for the year ended December 31, 2002 was a recovery of 22.5%. Excluding the effects of non-deductible amortization of purchased intangibles and deferred stock compensation, and incremental taxes on foreign earnings, the effective income tax rate for 2001 was a recovery of 24.1% compared to the statutory tax rate of 35%. Our effective tax rate was lower than the statutory rate as a result of a valuation allowance provided on deferred tax assets, where timing of realization is uncertain.
Our annual effective tax rate for the year ended December 31, 2001 was a recovery of 2.7%. Excluding the effects of non-deductible goodwill, deferred stock compensation amortization, impairment of purchased intangibles, and incremental taxes on foreign earnings, the effective income tax rate for 2001 was a recovery of 21.7% compared to the statutory tax rate of 35%. Our effective tax rate was lower than the statutory rate for the same reason as in 2002. Our annual effective tax rate for the year ended December 31, 2000 was an expense of 57.6% compared to a statutory tax rate of 35%. Our increased effective tax rate primarily reflects the higher provision for income taxes for our Canadian subsidiary and the non-tax deductible charges for in process research and development, goodwill amortization, deferred stock compensation and acquisition costs related to acquisitions completed during the year. These factors were partially offset by the utilization of tax losses and other deferred tax assets for which benefits were previously not recognized.
See Note 12 to the Consolidated Financial Statements for additional information regarding income taxes.
Recently issued accounting standards.
In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 146 (SFAS 146), "Accounting for Costs Associated with Exit or Disposal Activities". SFAS 146 requires that the liability for a cost associated with an exit or disposal activity be recognized at its fair value when the liability is incurred. Under previous guidance, a liability for certain exit costs was recognized at the date that management committed to an exit plan. As SFAS 146 is effective only for exit or disposal activities initiated after December 31, 2002, the adoption of this statement will not impact our financial statements for 2002, but will affect the accounting for any restructurings initiated after 2002. In January 2003, we announced a third restructuring plan, the costs of which will be accounted for in accordance with SFAS 146.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 will be effective for any guarantees that are issued or modified after December 31, 2002. We adopted the disclosure requirements and are currently evaluating the effects of the recognition provisions of FIN 45; however, we do not expect that the adoption will have a material impact on our results of operations or financial position.
In December 2002, the FASB issued Statement of Financial Accounting Standard No. 148 (SFAS 148), "Accounting for Stock-Based Compensation - Transition and Disclosure". SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also requires prominent disclosure in the "Summary of Significant Accounting Policies" of both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We adopted SFAS 148 for our 2002 fiscal year end. Adoption of this statement has affected the location of this disclosure within our Consolidated Financial Statements, but will not impact our results of operation or financial position unless we change to the fair value method of accounting for stock-based employee compensation.
Critical Accounting Estimates
General
Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts reported by us of assets, liabilities, revenue and expenses, and 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. Senior management has discussed the development, selection and disclosure of these estimates with the Audit Committee of PMC's Board of Directors. Actual results may differ from these estimates under different assumptions or conditions.
Our significant accounting policies are outlined in Note 1 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.
Restructuring charges - Facilities
In calculating the cost to dispose of our excess facilities we had to estimate for each location the amount to be paid in lease termination payments, the future lease and operating costs to be paid until the lease is terminated, and the amount, if any, of sublease revenues. This required us to estimate the timing and costs of each lease to be terminated, the amount of operating costs for the affected facilities, and the timing and rate at which we might be able to sublease each site. To form our estimates for these costs we performed an assessment of the affected facilities and considered the current market conditions for each site.
During 2001, we recorded total charges of $155 million for the restructuring of excess facilities as part of restructuring plans, which was approximately 53% of the estimated total future operating cost and lease obligation for those sites. As at the end of 2002, the remaining restructuring accrual is 50% of the estimated total future operating costs and lease obligations for the remaining sites. To the best of our knowledge, this estimate remains sufficient to cover anticipated settlement costs. However, our assumptions on either the lease termination payments, operating costs until terminated, or the amounts and timing of offsetting sublease revenues may turn out to be incorrect and our actual cost may be materially different from our estimates.
Inventory
We periodically compare our inventory levels to sales forecasts for the future twelve months on a part-by-part basis and record a charge for inventory on hand in excess of the estimated twelve-month demand. In 2002, our inventory of networking products exceeded estimated 12-month demand by $4 million and we recorded a charge of that amount. If future demand for our products continues to decline, we may have to take an additional write-down of inventory.
Income Taxes
We have incurred losses and other costs that can be applied against future taxable earnings to reduce our tax liability on those earnings. As we are uncertain of realizing the future benefit of those losses and expenditures, we have taken a valuation allowance against all domestic deferred tax assets and recorded only deferred tax assets that can be applied in currently taxable foreign jurisdictions.
Investment in Non-Public Entities
We have invested in non-public companies and in venture capital funds, which we review periodically to determine if there has been a non-temporary decline in the market value of those investments below our carrying value. Our assessment of impairment in carrying value is based on the market value trends of similar public companies, the current business performance of the entities in which we have invested, and if available, the estimated future market potential of the companies and venture funds. We recorded an impairment of our investments in non-public entities of $15.3 million in the fourth quarter of 2002. When we perform future assessments of these investments, a further decline in the value of these companies and venture funds may require us to recognize additional impairment on the remaining $7.1 million investment.
Valuation of Long-Lived Assets Including Goodwill and Purchased Intangible Assets
We review property and equipment, goodwill and purchased intangible assets for impairment on an annual basis and between annual tests when events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Such events may include a change in business strategy, significant declines in our sales forecast or prolonged negative industry or economic trends.
Our asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. For long-lived assets, an impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. For goodwill, an impairment loss will be recorded to the extent than the carrying value of the goodwill exceeds its implied fair value.
In 2002, we recorded an impairment charge of $1.8 million reflecting the reduction in fair value of a product tester. We did not identify any impairment to goodwill or purchased intangibles during our annual assessment in 2002.
Business Outlook
Our annual networking revenues are impacted by short and longer-term trends in the demand for the networking equipment that incorporate our products. Future demand for our customers' products is in turn affected by the plans of their customers. Our customers' demand for our products is also impacted by levels of inventories of our parts held by them or their supply chain partners.
In 2001 and 2002, many of our customers experienced significant declines in demand for their products, and accumulated significant inventories of our products that exceed the amounts required to meet current production levels. Consequently, the demand for our products declined in 2001 from approximately $120 million in the first quarter to approximately $47 million in the fourth quarter. Quarterly revenues during 2002 ranged from $50 million to $60 million.
Because the level of demand for the networking equipment that our customers sell depends upon global economic conditions, it is difficult to predict when end market demand for our products will improve. However, we believe that our customers may consume much of their inventories of some of our older products in 2003 and begin to purchase more of our products as their inventories become depleted.
We expect our networking revenues for the first quarter of 2003 to increase slightly from the fourth quarter of 2002. Beyond the first quarter of 2003, we anticipate revenues will vary depending on changes in the demand environment and customer component inventory levels. We do not anticipate any meaningful revenue from our non-networking products in the future as the single product in this revenue category has reached end-of-life.
We anticipate our gross margins will be in the high 50% to low 60% range in 2003 but could vary significantly depending on the volumes and mix of products sold.
Excluding the impact of any restructuring activities that are reflected in R&D and MG&A expenses, we expect these costs to decline in 2003 as compared to 2002 due to our cost cutting initiatives, including the restructuring we announced in January 2003. We anticipate that interest and other income will decline significantly in 2003 compared to 2002 because we expect to earn lower average yields on our cash balances and expect to consume cash throughout 2003 to primarily meet restructuring obligations accrued as current liabilities.
Liquidity and Capital Resources
Our principal sources of liquidity at December 31, 2002 were our cash, cash equivalents and short-term investments of $416.7 million. We also held $148.9 million of investments in bonds and notes with maturities ranging from 1 to 2.5 years. The aggregate cash and investments of $565.6 million at December 31, 2002 was $16.2 million lower than it was on December 31, 2001 and included $5.3 million of restricted cash (see note 6 to the Consolidated Financial Statements).
In 2002, we used $19.7 million of cash for operating activities, $3.1 million for purchases of property and equipment and $2.3 million, net of proceeds on sales, for other investments. We generated $9.4 million of cash through financing activities, primarily through the issuance of common stock.
We invested our portfolio of short and long term bonds and notes in corporate and US and Canadian government securities having an S&P, Moody's or equivalent rating of A or better. All of our bond and note investments mature in less than 2.5 years. We invest these capital resources primarily for preservation of capital and secondarily for yield.
We have a line of credit with a bank that allows us to borrow up to $5.3 million at the bank's alternate base rate as long as the Company maintains eligible investments with the bank in an amount equal to its drawings. At December 31, 2002 we had committed all of this facility under letters of credit as security for office leases. These letters of credit renew automatically each year and expire in 2011.
We have commitments made up of the following:
Approximately $260 million of the minimum rental payments and estimated operating costs identified in the table above relate to operating leases for vacant and excess office facilities. We are currently negotiating settlements of these leases and may incur significant related cash expenditures. We expect to expend the majority of the $129.5 million we have accrued for restructuring costs in settlement of these obligations in 2003. See Note 3 to the Consolidated Financial Statements for additional information regarding restructuring and other costs.
We participate in four professionally managed venture funds that invest in early-stage private technology companies in markets of strategic interest to us. From time to time these funds request additional capital for private placements. We have committed to invest an additional $38.1 million into these funds, which may be requested by the fund managers at any time over the next seven years.
We have not entered into any derivative contracts other than our convertible notes and through our stock option plans, and we have not entered into any synthetic leases.
We believe that existing sources of liquidity will satisfy our projected restructuring, operating, working capital, venture investing, debt interest, capital expenditure and wafer deposit requirements through the end of 2003. We expect to spend approximately $8 million on new capital additions during 2003.
FACTORS THAT YOU SHOULD CONSIDER BEFORE INVESTING IN PMC-SIERRA
Our company is subject to a number of risks - some are normal to the fabless networking semiconductor industry, some are the same or similar to those disclosed in previous SEC filings, and some may be present in the future. You should carefully consider all of these risks and the other information in this report before investing in PMC. The fact that certain risks are endemic to the industry does not lessen the significance of the risk.
As a result of these risks, our business, financial condition or operating results could be materially adversely affected. This could cause the trading price of our securities to decline, and you may lose part or all of your investment.
We are subject to rapid changes in demand for our products due to customer inventory levels, production schedules, fluctuations in demand for networking equipment and our customer concentration.
As a result of these factors, we have very limited revenue visibility and the rate by which revenues are booked and shipped within the same reporting period is typically volatile. In addition, our net bookings can vary sharply up and down within a quarter.
Our revenues have declined due to reduced demand in the markets we serve, and may decline further in 2003.
Several of our customers' clients have reported lower than expected demand for their services or products, which has resulted in poor operating results and difficulty in accessing the capital needed to build their networks or survive to profitability. Many of these companies are facing increased competition and have either filed for bankruptcy or may become insolvent in the near future. Concurrently, many of our customers' more viable network service provider clients have accumulated significant debt loads to finance capital projects that have yet to generate significant positive cash flows. In addition, most of our customers' clients have announced a shift in forecasted expenditures on the equipment our customers sell, which may generate financial return in a shorter time horizon. This equipment to which they shift may not incorporate, or may incorporate fewer, of our products.
In response to the actual and anticipated declines in networking equipment demand, many of our customers and their contract manufacturers have undertaken initiatives to significantly reduce expenditures and excess component inventories. Many platforms in which our products are designed have been cancelled as our customers cancel or restructure product development initiatives or as venture-financed startup companies fail. Our revenues may be materially and adversely impacted in 2003 if these conditions continue or worsen.
Our customers' actions have materially and adversely impacted our revenues, reduced our visibility of future revenue streams, caused an increase in our inventory levels, and made a portion of our inventory obsolete. As most of our costs are fixed in the short term, a further reduction in demand for our products may cause a further decline in our gross and net margins.
While we believe that our customers and their contract manufacturers are consuming a portion of their inventory of PMC products, we believe that those inventories, as well as the weakened demand that our customers are experiencing for their products, may further depress our revenues and profit margins beyond 2002 (see "Business Outlook" above). We cannot accurately predict when demand for our products will strengthen or how quickly our customers will consume their inventories of our products.
Our customers may cancel or delay the purchase of our products for reasons other than the industry downturn described above.
Many of our customers have numerous product lines, numerous component requirements for each product, sizeable and complex supplier structures, and often engage contract manufacturers to supplement their manufacturing capacity. This makes forecasting their production requirements difficult and can lead to an inventory surplus of certain of their components.
Our customers often shift buying patterns as they manage inventory levels, decide to use competing products, are acquired or divested, market different products, or change production schedules.
In addition, we believe that uncertainty in our customers' end markets and our customers' increased focus on cash management has caused our customers to delay product orders and reduce delivery lead-time expectations. We expect this will increase the proportion of our revenues in future periods that will be from orders placed and fulfilled within the same period. This will decrease our ability to accurately forecast and may lead to greater fluctuations in operating results.
We rely on a few customers for a major portion of our sales, any one of which could materially impact our revenues should they change their ordering pattern.
We depend on a limited number of customers for a major portion of our revenues. Through direct, distributor and subcontractor purchases, Cisco Systems and Hewlett Packard each accounted for more than 10% of our fiscal 2002 revenues. Both of these customers have announced order shortfalls for some of their products.
We do not have long-term volume purchase commitments from any of our major customers. Accordingly, our future operating results will continue to depend on the success of our largest customers and on our ability to sell existing and new products to these customers in significant quantities. The loss of a key customer, or a reduction in our sales to any key customer or our inability to attract new significant customers could materially and adversely affect our business, financial condition or results of operations.
If the current downturn continues, we may have to add to our inventory reserve, which would lead to a further decline in our operating profits.
As a result of the industry-wide reduction in capital spending and resulting significant decrease in demand for our products, we determined that we had inventory levels that exceeded our anticipated demand over the next twelve months. Accordingly, in 2002 we recorded an inventory write-down of $4 million related to excess inventory on hand. The inventory reserve was based on our revenue expectations through 2003. If future demand of our products does not meet our expectations, we may need to take an additional write-down of inventory.
We anticipate lower margins on high volume products, which could adversely affect our profitability.
We expect the average selling prices of our products to decline as they mature. Historically, competition in the semiconductor industry has driven down the average selling prices of products. If we price our products too high, our customers may use a competitor's product or an in-house solution. To maintain profit margins, we must reduce our costs sufficiently to offset declines in average selling prices, or successfully sell proportionately more new products with higher average selling prices. Yield or other production problems, or shortages of supply may preclude us from lowering or maintaining current operating costs.
OEMs are becoming more price conscious than in the past as a result of the industry downturn, and as semiconductors sourced from third party suppliers comprise a greater portion of the total materials cost in OEM equipment. We have also experienced more aggressive price competition from competitors that wish to enter into the market segments in which we participate. These circumstances may make some of our products less competitive and we may be forced to decrease our prices significantly to win a design. We may lose design opportunities or may experience overall declines in gross margins as a result of increased price competition.
In addition, our networking products range widely in terms of the margins they generate. A change in product sales mix could impact our operating results materially.
Design wins do not translate into near-term revenues and the timing of revenues from newly designed products is often uncertain.
We have announced a number of new products and design wins for existing and new products. While some industry analysts may use design wins as a metric for future revenues, many design wins have not, nor will not generate any revenues as customer projects are cancelled or rejected by their end market. In the event a design win generates revenue, the amount of revenue 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 greater than 2 years to generate meaningful revenue.
Our revenue expectations may include growing sales of newer semiconductors based on early adoption of those products by customers. These expectations would not be achieved if early sales of new system level products by our customers do not increase over time. We may experience this more with design wins from early stage companies, who tend to focus on leading-edge technologies that may be adopted less rapidly in the current environment by telecommunications service providers.
Our restructurings have curtailed our resources and may have insufficiently addressed market conditions.
We announced in 2001 plans to restructure our operations in response to the decline in demand for our networking products. The restructuring plans included a workforce reduction of 564 employees, consolidation of excess facilities, and contract settlement activities. As a result of our restructuring plans, we recorded a charge of $195.2 million in 2001. On January 16th, 2003, we announced plans to further restructure our operations through a workforce reduction of 175 employees and the shutdown of four of our research and development sites. We will record a charge in the first two quarters of 2003 of our estimate of the costs for the restructuring.
We reduced the work force and consolidated or shut down excess facilities in an effort to bring our expenses into line with our reduced revenue expectations. However, for much of 2003, we do not expect that these measures will be sufficient to offset lower revenues, and as such, we expect to continue to incur net losses.
While management uses all available information to estimate these restructuring costs, particularly facilities costs, our accruals may prove to be inadequate. If our actual sublease revenues or exiting negotiations differ from our original assumptions, we may have to record additional charges, which could materially affect our results of operations, financial position and cash flow.
Restructuring plans require significant management resources to execute and we may fail to achieve our targeted goals and our expected annualized savings. We may have incorrectly anticipated the demand for our products, we may be forced to restructure further or may incur further operating charges due to poor business conditions and some of our product development initiatives may be delayed due to the reduction in our development resources.
Our revenues may decline if our customers use our competitors' products instead of ours, suffer further reductions in demand for their products or are acquired or sold.
We are experiencing significantly greater competition from many different market participants as the market in which we participate matures. In addition, we are expanding into markets, such as the wireless infrastructure and generic microprocessor markets, which have established incumbents with substantial financial and technological resources. We expect fiercer competition than that which we have traditionally faced as some of these incumbents derive a majority of their earnings from these markets.
All of our competitors pose the following threats to us:
As our customers design next generation systems and select the chips for those new systems, our competitors have an opportunity to convince our customers to use their products, which may cause our revenues to decline.
We typically face competition at the design stage, where customers evaluate alternative design approaches requiring integrated circuits. Our competitors may have more opportunities to supplant our products in next generation systems because of the shortening product life and design-in cycles in many of our customers' products.
In addition, as a result of the industry downturn, and as semiconductors sourced from third party suppliers comprise a greater portion of the total materials cost in OEM equipment, OEMs are becoming more price conscious than in the past. We have also experienced increased price aggressiveness from some competitors that wish to enter into the market segments in which we participate. These circumstances may make some of our products price-uncompetitive or force us to match low prices. We may lose design opportunities or may experience overall declines in gross margins as a result of increased price competition.
The markets for our products are intensely competitive and subject to rapid technological advancement in design tools, wafer manufacturing techniques, process tools and alternate networking technologies. We may not be able to develop new products at competitive pricing and performance levels. Even if we are able to do so, we may not complete a new product and introduce it to market in a timely manner. Our customers may substitute use of our products in their next generation equipment with those of current or future competitors.
Increasing competition in our industry will make it more difficult to achieve design wins.
We face significant competition from three major fronts. First, we compete against established peer-group semiconductor companies that focus on the communications semiconductor business. These companies include Agere Systems, Applied Micro Circuits Corporation, Broadcom, Exar Corporation, Conexant Systems, Marvell Technology Group, Multilink Technology Corporation, Silicon Image, Transwitch and Vitesse Semiconductor. These companies are well financed, have significant communications semiconductor technology assets, have established sales channels, and are dependent on the market in which we participate for the bulk of their revenues.
Other competitors include major domestic and international semiconductor companies, such as Agilent, Cypress Semiconductor, Intel, IBM, Infineon, Integrated Device Technology, Maxim Integrated Products, Motorola, Nortel Networks, and Texas Instruments. These companies are concentrating an increasing amount of their substantial financial and other resources on the markets in which we participate. This represents a serious competitive threat to us.
Emerging venture-backed companies also provide significant competition in our segment of the semiconductor market. These companies tend to focus on specific portions of our broad range of products and in the aggregate, represent a significant threat to our product lines. In addition, these companies could introduce disruptive technologies that may make our technologies and products obsolete.
Over the next few years, we expect additional competitors, some of which may also have greater financial and other resources, to enter the market with new products. These companies, individually or collectively, could represent future competition for many design wins, and subsequent product sales.
We must often redesign our products to meet evolving industry standards and customer specifications, which may prevent or delay future revenue growth.
We sell products to a market whose characteristics include evolving industry standards, product obsolescence, and new manufacturing and design technologies. Many of the standards and protocols for our products are based on high-speed networking technologies that have not been widely adopted or ratified by one or more of the standard-setting bodies in our customers' industry. Our customers often delay or alter their design demands during this standard-setting process. In response, we must redesign our products to suit these changing demands. Redesign usually delays the production of our products. Our products may become obsolete during these delays.
Since many of the products we develop do not reach full production sales volumes for a number of years, we may incorrectly anticipate market demand and develop products that achieve little or no market acceptance.
Our products generally take between 18 and 24 months from initial conceptualization to development of a viable prototype, and another 6 to 18 months to be designed into our customers' equipment and into production. Our products often must be redesigned because manufacturing yields on prototypes are unacceptable or customers redefine their products to meet changing industry standards or customer specifications. As a result, we develop products many years before volume production and may inaccurately anticipate our customers' needs.
Our strategy includes broadening our business into the Enterprise, Storage and Consumer markets. We may not be successful in achieving significant sales in these new markets.
The Enterprise, Storage and Consumer markets are already addressed by incumbent suppliers which have established relationships with customers. We may be unsuccessful in displacing these suppliers, or having our products designed into products for different market needs. We may incur increased research, development and sales costs to address these new markets.
We are exposed to the credit risk of some of our customers and we may have difficulty collecting receivables from customers based in foreign countries.
Many of our customers employ contract manufacturers to produce their products and manage their inventories. Many of these contract manufacturers represent greater credit risk than our networking equipment customers, who generally do not guarantee our credit receivables related to their contract manufacturers.
In addition, international debt rating agencies have significantly downgraded the bond ratings on a number of our larger customers, which had traditionally been considered financially stable. Should these companies enter into bankruptcy proceedings or breach their debt covenants, our significant accounts receivables with these companies could be jeopardized.
The complexity of our products could result in unforeseen delays or expenses and in undetected defects or bugs, which could adversely affect the market acceptance of new products and damage our reputation with current or prospective customers.
Although we, or our customers and our suppliers rigorously test our products, our highly complex products regularly contain defects or bugs. We have in the past experienced, and may in the future experience, these defects and bugs. If any of our products contain defects or bugs, or have reliability, quality or compatibility problems that are significant to our customers, our reputation may be damaged and customers may be reluctant to buy our products. This could materially and adversely affect our ability to retain existing customers or attract new customers. In addition, these defects or bugs could interrupt or delay sales to our customers.
We may have to invest significant capital and other resources to alleviate problems with our products. If any of these problems are not found until after we have commenced commercial production of a new product, we may be required to incur additional development costs and product recall, repair or replacement costs. These problems may also result in claims against us by our customers or others. In addition, these problems may divert our technical and other resources from other development efforts. Moreover, we would likely lose, or experience a delay in, market acceptance of the affected product or products, and we could lose credibility with our current and prospective customers.
We may be unsuccessful in transitioning the design of our new products to new manufacturing processes.
Many of our new products are designed to take advantage of new manufacturing processes offering smaller manufacturing geometries as they become available, as the smaller geometry products can provide a product with improved features such as lower power requirements, more functionality and lower cost. We believe that the transition of our products to smaller geometries is critical for us to remain competitive. We could experience difficulties in migrating to future geometries or manufacturing processes, which would result in the delay of the production of our products. Our products may become obsolete during these delays, or allow competitors' parts to be chosen by customers during the design process.
Our business strategy contemplates acquisition of other companies or technologies, which could adversely affect our operating performance.
Acquiring products, technologies or businesses from third parties is part of our business strategy. Management may be diverted from our operations while they identify and negotiate these acquisitions and integrate an acquired entity into our operations. Also, we may be forced to develop expertise outside our existing businesses, and replace key personnel who leave due to an acquisition.
An acquisition could absorb substantial cash resources, require us to incur or assume debt obligations, or issue additional equity. If we issue more equity, we may dilute our common stock with securities that have an equal or a senior interest.
Acquired entities also may have unknown liabilities, and the combined entity may not achieve the results that were anticipated at the time of the acquisition.
The timing of revenues from newly designed products is often uncertain. In the past, we have had to redesign products that we acquired when buying other businesses, resulting in increased expenses and delayed revenues. This may occur in the future as we commercialize the new products resulting from acquisitions.
We participate in funds that invest in early-stage private technology companies to gain access to emerging technologies. These companies possess unproven technologies and our investments may or may not yield positive returns. We currently have commitments to invest $38.1 million in such funds. In addition to consuming significant amounts of cash, these investments are risky because the technologies that these companies are developing may not reach commercialization. We may record an impairment charge to our operating results should we determine that these funds have incurred a non-temporary decline in value.
The loss of personnel could preclude us from designing new products.
To succeed, we must retain and hire technical personnel highly skilled at the design and test functions needed to develop high-speed networking products and related software. 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 that generally have exercise prices at the market value at the time of grant and that are subject to vesting. Recently, our stock price has declined substantially. The stock options we grant to employees are effective as retention incentives only if they have economic value.
Our recent restructurings have significantly reduced the number of our technical employees. We may experience customer dissatisfaction as a result of delayed or cancelled product development initiatives.
We may not be able to meet customer demand for our products if we do not accurately predict demand or if we fail to secure adequate wafer fabrication or assembly capacity.
We currently do not have the ability to accurately predict what products our customers will need in the future. Anticipating demand is difficult because our customers face volatile pricing and demand for their end-user networking equipment, our customers are focusing more on cash preservation and tighter inventory management, and because we supply a large number of products to a variety of customers and contract manufacturers who have many equipment programs for which they purchase our products. Our customers are frequently requesting shipment of our products earlier than our normal lead times. If we do not accurately predict what mix of products our customers may order, we may not be able to meet our customers' demand in a timely manner or we may be left with unwanted inventory.
A shortage in supply could adversely impact our ability to satisfy customer demand, which could adversely affect our customer relationships along with our current and future operating results.
We rely on limited sources of wafer fabrication, the loss of which could delay and limit our product shipments.
We do not own or operate a wafer fabrication facility. Three outside foundries supply greater than 90% of our semiconductor device requirements. Our foundry suppliers also produce products for themselves and other companies. In addition, we may not have access to adequate capacity or certain process technologies. We have less control over delivery schedules, manufacturing yields and costs than competitors with their own fabrication facilities. If the foundries we use are unable or unwilling to manufacture our products in required volumes, we may have to identify and qualify acceptable additional or alternative foundries. This qualification process could take six months or longer. We may not find sufficient capacity quickly enough, if ever, to satisfy our production requirements.
Some companies that supply our customers are similarly dependent on a limited number of suppliers to produce their products. These other companies' products may be designed into the same networking equipment into which our products are designed. Our order levels could be reduced materially if these companies are unable to access sufficient production capacity to produce in volumes demanded by our customers because our customers may be forced to slow down or halt production on the equipment into which our products are designed.
We depend on third parties in Asia for assembly of our semiconductor products that could delay and limit our product shipments.
Sub-assemblers in Asia assemble all of our semiconductor products. Raw material shortages, political and social instability, assembly house service disruptions, currency fluctuations, or other circumstances in the region could force us to seek additional or alternative sources of supply or assembly. This could lead to supply constraints or product delivery delays that, in turn, may result in the loss of revenues. We have less control over delivery schedules, assembly processes, quality assurances and costs than competitors that do not outsource these tasks.
We depend on a limited number of design software suppliers, the loss of which could impede our product development.
A limited number of suppliers provide the computer aided design, or CAD, software we use to design our products. Factors affecting the price, availability or technical capability of these products could affect our ability to access appropriate CAD tools for the development of highly complex products. In particular, the CAD software industry has been the subject of extensive intellectual property rights litigation, the results of which could materially change the pricing and nature of the software we use. We also have limited control over whether our software suppliers will be able to overcome technical barriers in time to fulfill our needs.
We are subject to the risks of conducting business outside the United States to a greater extent than companies that operate their businesses mostly in the United States, which may impair our sales, development or manufacturing of our products.
We are subject to the risks of conducting business outside the United States to a greater extent than most companies because, in addition to selling our products in a number of countries, a significant portion of our research and development and manufacturing is conducted outside the United States.
The geographic diversity of our business operations could hinder our ability to coordinate design and sales activities. If we are unable to develop systems and communication processes to support our geographic diversity, we may suffer product development delays or strained customer relationships.
We may lose our ability to design or produce products, could face additional unforeseen costs or could lose access to key customers if any of the nations in which we conduct business impose trade barriers or new communications standards.
We may have difficulty obtaining export licenses for certain technology produced for us outside the United States. If a foreign country imposes new taxes, tariffs, quotas, and other trade barriers and restrictions or the United States and a foreign country develop hostilities or change diplomatic and trade relationships, we may not be able to continue manufacturing or sub-assembly of our products in that country and may have fewer sales in that country. We may also have fewer sales in a country that imposes new communications standards or technologies. This could inhibit our ability to meet our customers' demand for our products and lower our revenues.
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, marketing and administrative costs are denominated in Canadian dollars, and our selling costs are denominated in a variety of currencies around the world. While we have adopted a foreign currency risk management policy, which is intended to reduce the effects of short-term fluctuations, our policy may not be effective and it does not address long-term fluctuations.
In addition, while all of our sales are denominated in US dollars, our customers' products are sold worldwide. Any further decline in the world networking markets could seriously depress our customers' order levels for our products. This effect could be exacerbated if fluctuations in currency exchange rates decrease the demand for our customers' products.
From time to time, we become defendants in legal proceedings about which we are unable to assess our exposure and which could become significant liabilities upon judgment.
We become defendants in legal proceedings from time to time. Companies in our industry have been subject to claims related to patent infringement and product liability, as well as contract and personal claims. We may not be able to accurately assess the risk related to these suits, and we may be unable to accurately assess our level of exposure. These proceedings may result in material charges to our operating results in the future if our exposure is material and if our ability to assess our exposure becomes clearer.
If we cannot protect our proprietary technology, we may not be able to prevent competitors from copying our technology and selling similar products, which would harm our revenues.
To compete effectively, we must protect our proprietary information. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We hold several patents and have a number of pending patent applications.
We might not succeed in attaining patents from any of our pending applications. Even if we are awarded patents, they may not provide any meaningful protection or commercial advantage to us, as they may not be of sufficient scope or strength, or may not be issued in all countries where our products can be sold. In addition, our competitors may be able to design around our patents.
We develop, manufacture and sell our products in Asian and other countries that may not protect our products or intellectual property rights to the same extent as the laws of the United States. This makes piracy of our technology and products more likely. Steps we take to protect our proprietary information may not be adequate to prevent theft of our technology. We may not be able to prevent our competitors from independently developing technologies that are similar to or better than ours.
Our products employ technology that may infringe on the proprietary rights of third parties, which may expose us to litigation and prevent us from selling our products.
Vigorous protection and pursuit of intellectual property rights or positions characterize the semiconductor industry. This often results in expensive and lengthy litigation. We, and our customers or suppliers, may be accused of infringing on patents or other intellectual property rights owned by third parties. This has happened in the past. An adverse result in any litigation could force us to pay substantial damages, stop manufacturing, using and selling the infringing products, spend significant resources to develop non-infringing technology, discontinue using certain processes or obtain licenses to the infringing technology. In addition, we may not be able to develop non-infringing technology, nor might we be able to find appropriate licenses on reasonable terms.
Patent disputes in the semiconductor industry are often settled through cross-licensing arrangements. Because we currently do not have a substantial portfolio of patents compared to our larger competitors, we may not be able to settle an alleged patent infringement claim through a cross-licensing arrangement. We are therefore more exposed to third party claims than some of our larger competitors and customers.
In the past, our customers have been required to obtain licenses from and pay royalties to third parties for the sale of systems incorporating our semiconductor devices. Customers may also make claims against us with respect to infringement.
Furthermore, we may initiate claims or litigation against third parties for infringing our proprietary rights or to establish the validity of our proprietary rights. This could consume significant resources and divert the efforts of our technical and management personnel, regardless of the litigation's outcome.
We have significantly increased our debt level as a result of the sale of convertible subordinated notes.
On August 6, 2001, we raised $275 million through the issuance of convertible subordinated notes. As a result, our interest payment obligations have increased substantially. The degree to which we are leveraged could materially and adversely affect our ability to obtain financing for working capital, acquisitions or other purposes and could make us more vulnerable to industry downturns and competitive pressures. Our ability to meet our debt service obligations will be dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. On August 15, 2006, we are obliged to repay the full remaining principal amount of the notes that have not been converted into our common stock.
Securities we issue to fund our operations could dilute your ownership.
We may decide to raise additional funds through public or private debt or equity financing to fund our operations. If we raise funds by issuing equity securities, the percentage ownership of current stockholders will be reduced and the new equity securities may have priority rights to your investment. We may not obtain sufficient financing on terms that are favorable to you or us. We may delay, limit or eliminate some or all of our proposed operations if adequate funds are not available.
Our stock price has been and may continue to be volatile.
In the past, our common stock price has fluctuated significantly. In particular, our stock price declined significantly in the context of announcements made by us and other semiconductor suppliers of reduced revenue expectations and of a general slowdown in the markets we serve. Given these general economic conditions and the reduced demand for our products that we have experienced, we expect that our stock price will continue to be volatile.
In addition, fluctuations in our stock price and our price-to-earnings multiple may have made our stock attractive to momentum, hedge or day-trading investors who often shift funds into and out of stocks rapidly, exacerbating price fluctuations in either direction particularly when viewed on a quarterly basis.
Securities class action litigation has often been instituted against a company following periods of volatility and decline in the market price of their securities. If instituted against us, regardless of the outcome, such litigation could result in substantial costs and diversion of our management's attention and resources and have a material adverse effect on our business, financial condition and operating results. We could be required to pay substantial damages, including punitive damages, if we were to lose such a lawsuit.
Provisions in our charter documents and Delaware law and our adoption of a stockholder rights plan may delay or prevent acquisition of us, which could decrease the value of our common stock.
Our certificate of incorporation and bylaws and Delaware law contain provisions that could make it harder for a third party to acquire us without the consent of our board of directors. Delaware law also imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock. In addition, our board of directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. Although we believe these provisions of our certificate of incorporation and bylaws and Delaware law and our stockholder rights plan will provide for an opportunity to receive a higher bid by requiring potential acquirers to negotiate with our board of directors, these provisions apply even if the offer may be considered beneficial by some stockholders.
Our board of directors adopted a stockholder rights plan, pursuant to which we declared and paid a dividend of one right for each share of common stock held by stockholders of record as of May 25, 2001. Unless redeemed by us prior to the time the rights are exercised, upon the occurrence of certain events, the rights will entitle the holders to receive upon exercise thereof shares of our preferred stock, or shares of an acquiring entity, having a value equal to twice the then-current exercise price of the right. The issuance of the rights could have the effect of delaying or preventing a change in control of us.
Item 7a.
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 Equivalents, Short-term Investments and Investments in Bonds and Notes:
We regularly maintain a short and long term investment portfolio of various types of government and corporate debt instruments. Our investments are made in accordance with an investment policy approved by our Board of Directors. Maturities of these instruments are less than two and one half years, with the majority being within one year. To minimize credit risk, we diversify our investments and select minimum ratings of P-1 or A by Moody's, or A-1 or A by Standard and Poor's, or equivalent. We classify these securities as held-to-maturity or available-for-sale depending on our investment intention. Held-to-maturity investments are held at amortized cost, while available-for-sale investments are held at fair market value. Available-for-sale securities represented approximately 17% of our investment portfolio as of December 31, 2002.
Investments in both fixed rate and floating rate interest earning instruments 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.
Based on a sensitivity analysis performed on the financial instruments held at December 31, 2002 that are sensitive to changes in interest rates, the impact to the fair value of our investment portfolio by an immediate hypothetical parallel shift in the yield curve of plus or minus 50, 100 or 150 basis points would result in a decline or increase in portfolio value of approximately $2.5 million, $5 million and $7.4 million respectively.
Other Investments
Other investments at December 31, 2002 include a minority investment of approximately 2 million shares of Sierra Wireless Inc., a publicly traded company. The securities are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of income taxes.
We also periodically receive distributions of public company stock as a result of venture investments. These shares are usually subject to resale restrictions and typically include a number of shares held in escrow that may or may not be released at a later date. At December 31, 2002, we held approximately 16,000 shares of Intel Corporation, which we received when Intel acquired a private company in which we had an investment. It is our intention to sell these securities in the first quarter of 2003.
Our public company investments are subject to considerable market price volatility and are additionally risky due to resale restrictions. We may lose some or all of our investment in these shares.
Our other investments also include numerous strategic investments in privately held companies or venture funds that are carried on our balance sheet at cost. 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. In the fourth quarter of 2002, we recorded an impairment of our other investments of $15.3 million in response to declining market valuations for these investments. We could lose our entire investment in these companies and partnerships or may incur an additional expense if we determine that the value of these assets have been further impaired.
Foreign Currency
We generate a significant portion of our revenues from sales to customers located outside of 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.
Our sales and corresponding receivables are made primarily in United States dollars. Through our operations in Canada and elsewhere outside of the United States, we incur research and development, customer support costs and administrative expenses in Canadian and other local currencies. We are exposed, in the normal course of business, to foreign currency risks on these expenditures. In our effort to manage such risks, we have adopted a foreign currency risk management policy intended to reduce the effects of potential short-term fluctuations on the results of operations stemming from our exposure to these risks. As part of this risk management, we typically forecast our operational currency needs, purchase such currency on the open market at the beginning of an operational period, and hold these funds as a hedge against currency fluctuations. We usually limit the operational period to 3 months or less. Because we do not engage in foreign currency exchange rate fluctuation risk management techniques beyond these periods, our cost structure is subject to long-term changes in foreign exchange rates.
While we expect to continue to use this method to manage our foreign currency risk, in the future we may decide to use foreign exchange contracts to manage this risk.
We regularly analyze the sensitivity of our foreign exchange positions to measure our foreign exchange risk. At December 31, 2002, a 10% shift in foreign exchange rates would not have materially impacted our foreign exchange income because our foreign currency net asset position was immaterial.
Debt
We issued $275,000,000 of convertible subordinated notes in August 2001. Because we pay fixed interest coupons on our notes, market interest rate fluctuations do not impact our debt interest payments. However, the fair value of our convertible subordinated 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 convertible subordinated notes are not listed on any securities exchange or included in any automated quotation system, but have 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 average bid and ask price of our convertible subordinated notes on the Portal Market on December 27, 2002 was $75.50 per $100 in face value, resulting in an aggregate fair value of approximately $207.6 million. There were no reported trades on December 28 or December 29, 2002.
Item 8.
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:
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.
Independent Auditors' Report
The Board of Directors of PMC-Sierra, Inc.
We have audited the accompanying consolidated balance sheets of PMC-Sierra, Inc. and subsidiaries ("the Company") as of December 31, 2002 and 2001 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial position of PMC-Sierra, Inc. and subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill in accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
/s/ DELOITTE & TOUCHE LLP
Vancouver, British Columbia January 17, 2003
See notes to the Consolidated Financial Statements.
PMC-Sierra, Inc. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
NOTE 1. Summary of Significant Accounting Policies
Description of business. PMC-Sierra, Inc (the "Company" or "PMC") designs, develops, markets and supports high-speed broadband communications and storage semiconductors and MIPS-based processors for service provider, enterprise, storage, and wireless networking equipment. The Company offers worldwide technical and sales support through a network of offices in North America, Europe and Asia.
Basis of presentation. The accompanying Consolidated Financial Statements include the accounts of PMC-Sierra, Inc. and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated. The Company's fiscal year ends on the last Sunday of the calendar year. For ease of presentation, the reference to December 31 has been utilized as the fiscal year end for all financial statement captions. Fiscal years 2002 and 2001 each consisted of 52 weeks. Fiscal year 2000 consisted of 53 weeks. The Company's reporting currency is the United States dollar.
Estimates. The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, the accounting for doubtful accounts, inventory reserves, depreciation and amortization, asset impairments, sales returns, warranty costs, income taxes, restructuring costs and other special charges, and contingencies. Actual results could differ from these estimates.
Cash equivalents, short-term investments and investments in bonds and notes. Cash equivalents are defined as highly liquid debt instruments with maturities at the date of purchase of 90 days or less. Short-term investments are defined as money market instruments or bonds and notes with original maturities greater than 90 days, but less than one year. Investments in bonds and notes are defined as bonds and notes with original or remaining maturities greater than 365 days. Any investments in bonds and notes maturing within one year of the balance sheet date are reclassified to and reported as short-term investments.
Under Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity 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.
Restricted cash. Restricted cash consists of cash pledged with a bank as collateral for letters of credit issued as security for leased facilities.
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.
The components of net inventories are as follows:
December 31, ----------------------------------- (in thousands) 2002 2001 - ----------------------------------------------------------------------- Work-in-progress $ 11,409 $ 10,973 Finished goods 15,011 23,273 - -----------------------------------------------------------------------
$ 26,420 $ 34,246 ===================================
Investments in non-public entities. The Company has certain investments in non-publicly traded companies and venture capital funds 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 Other investments and assets on the Company's balance sheet and are carried at cost, net of write-downs for impairment.
Investments in public companies. The Company has certain investments in publicly traded companies in which it has less than 20% of the voting rights and in which it does not exercise significant influence. Certain of these investments are subject to resale restrictions. Securities restricted for more than one year are carried at cost. Securities restricted for less than one year from the balance sheet date and securities not subject to resale restrictions are classified as available-for-sale and reported at fair value, based upon quoted market prices, with the unrealized gains or losses, net of any related tax effect, included in equity as a separate component of stockholders' equity. The Company evaluates its investments in public companies for factors indicating an other than temporary impairment and makes appropriate reductions in carrying value where necessary.
Investments in equity accounted investees. Investees in which the Company has between 20% and 50% of the voting rights, and in which the Company exercises significant influence, are accounted for using the equity method. The Company sold a portion of its only investment in an equity accounted investee during 2000 and since that disposition has held less than 20% of the voting rights of this investee.
Deposits for wafer fabrication capacity. The Company has wafer supply agreements with two independent foundries. Under these agreements, the Company has deposits of $22.0 million (2001 - $22.0 million) to secure access to wafer fabrication capacity. During 2002, the Company purchased $32.3 million ($42.7 million and $81.1 million in 2001 and 2000, respectively) from these foundries. Purchases in any year may or may not be indicative of any future period since wafers are purchased based on current market pricing and the Company's volume requirements change in relation to sales of its products.
In each year, the Company is entitled to receive a refund of a portion of the deposits based on the annual purchases from these suppliers compared to the target levels in the wafer supply agreements. Based on 2002 purchases and the current agreements, the Company is not entitled to a refund from these suppliers in 2003. If the Company does not receive back the balance of its deposits during the term of the agreements, then the outstanding deposits will be refunded to the Company after the termination of the agreements at the end of 2003.
Property and equipment, net. Property and equipment are stated at cost, net of write-downs for impairment, and depreciated using the straight-line method over the estimated useful lives of the assets, ranging from two to five years, or the applicable lease term, whichever is shorter.
The components of property and equipment are as follows:
December 31, -------------------------------- (in thousands) 2002 2001 - -------------------------------------------------------------------------------- Machinery and equipment $ 172,227 $ 172,735 Land 13,448 14,507 Leasehold improvements 11,765 13,176 Furniture and fixtures 15,305 13,971 Building - 701 Construction-in-progress 1,027 1,027 - -------------------------------------------------------------------------------- 213,772 216,117 Less accumulated depreciation and amortization (162,583) (126,402) -------------------------------- Total $ 51,189 $ 89,715 ================================
In 2002, the Company recorded an impairment charge of $1.8 million for machinery and equipment that was removed from service.
Goodwill and other intangible assets. Goodwill, developed technology and other intangible assets are carried at cost less accumulated amortization, which had been computed on a straight-line basis over the economic lives, ranging from three to seven years, of the respective assets.
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 141 (SFAS 141), "Business Combinations" and Statement of Financial Accounting Standard No. 142 (SFAS 142), "Goodwill and Other Intangible Assets".
SFAS 141 requires that business combinations be accounted for under the purchase method of accounting and addresses the initial recognition and measurement of assets acquired, including goodwill and intangibles, and liabilities assumed in a business combination. The Company adopted SFAS 141 on a prospective basis effective July 1, 2001. The adoption of SFAS 141 did not have a material effect on the Company's financial statements, but will impact the accounting treatment of future acquisitions.
SFAS 142 requires goodwill to be allocated to, and assessed as part of, a reporting unit. In accordance with SFAS 142, goodwill will no longer be amortized but instead will be subject to impairment tests at least annually. In conjunction with the implementation of SFAS 142, the Company completed the transitional impairment test as of the beginning of 2002 and determined that a transitional impairment charge would not be required. The Company also completed its annual impairment test in December 2002 and determined that there was no impairment of goodwill.
The Company adopted SFAS 142 on a prospective basis at the beginning of fiscal 2002 and stopped amortizing goodwill totaling $7.1 million, thereby eliminating goodwill amortization of approximately $2.0 million in 2002. Net loss and net loss per share adjusted to exclude goodwill and workforce amortization for 2002, 2001 and 2000 are as follows:
The components of goodwill and other intangible assets, net of write-downs for impairment, at December 31, 2002 and 2001 are as follows:
December 31, -------------------------------- (in thousands) 2002 2001 - ----------------------------------------------------------------------- Goodwill $ 93,119 $ 93,119 Developed technology 9,311 9,311 Other 1,294 1,294 - ----------------------------------------------------------------------- 103,724 103,724 Accumulated amortization (95,343) (94,204) - ----------------------------------------------------------------------- $ 8,381 $ 9,520 ================================
In 2001, the Company recorded a total impairment charge of $269.8 million related to goodwill (see Note 3) and $925,000 related to developed technology and other intangible assets.
Impairment of long-lived assets. The Company reviews its long-lived assets, other than goodwill, for impairment 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. 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.
For goodwill, an impairment loss will be recorded to the extent that the carrying amount of the goodwill exceeds its implied fair value.
Accrued liabilities. The components of accrued liabilities are as follows:
December 31, --------------------------------- (in thousands) 2002 2001 - ------------------------------------------------------------------------------- Accrued compensation and benefits $ 18,962 $ 21,193 Other accrued liabilities 34,568 28,155 - ------------------------------------------------------------------------------- $ 53,530 $ 49,348 =================================
Foreign currency translation. For all foreign operations, the U.S. dollar is the functional currency. Assets and liabilities in foreign currencies are translated into U.S. dollars using the exchange rate at 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 included in Interest and other income, net.
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. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange.
The Company's carrying value of cash equivalents, accounts receivable, accounts payable and other accrued liabilities approximates fair value because of their short maturities.
The fair value of the Company's short-term investments, and investment in bonds and notes are determined using estimated market prices provided for those securities (see Note 4). The fair value of investments in public companies is determined using quoted market prices for those securities. The fair value of investments in non-public entities and the fair value of the deposits for wafer fabrication capacity are not readily determinable.
The fair value of the Company's obligations under capital leases and long-term debt other than the convertible subordinated notes approximated their carrying value.
The fair value of the convertible subordinated notes at December 31, 2002 was approximately $207.6 million, based on the average bid and ask price of these notes. The fair value of these notes at December 31, 2001 was not readily determinable as there was no established public training market for them. These notes are not listed on any securities exchange or included in any automated quotation system. The recorded bid and ask price may not be reliable as the figures cannot be independently verified and not all trades are reflected.
On January 1, 2001 PMC adopted Financial Accounting Standards Board FASB Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 requires that all derivatives be recorded on the balance sheet at fair value. SFAS 133 did not have a material impact on the date of adoption and did not result in a cumulative transition adjustment. As of and for the year ended December 31, 2002, the use of derivative financial instruments was not material to our results of operations or our financial position.
Concentrations. The Company maintains its cash, cash equivalents, short-term investments and long-term investments in investment grade financial instruments with high-quality financial institutions, thereby reducing credit risk concentrations.
At December 31, 2002, approximately 22% (2001 - 20%) of accounts receivable represented amounts due from one of the Company's distributors. 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 terms 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.
Revenue recognition. Revenues from product sales direct to customers and minor distributors are recognized at the time of shipment. The Company accrues for warranty costs, sales returns and other allowances at the time of shipment based on its experience. Certain of the Company's product sales are made to major distributors under agreements allowing for price protection and/or right of return on products unsold. Accordingly, the Company defers recognition of revenue on such sales until a distributor sell the products.
Product warranties. The Company provides a one-year limited warranty on most of its standard products and accrues for the cost of this warranty based on its experience at the time of shipment. Reconciliation of the product warranty liability for the year ended December 31, 2002 is as follows:
(in thousands) - ---------------------------------------------------------------- Beginning balance $ 2,421 Accrual for new warranties issued 946 Reduction for payments (in cash or in kind) (576) Adjustments related to changes in estimate of warranty accrual (392) - ---------------------------------------------------------------- $ 2,399 ================
The semiconductor industry is subject to volatility in shipment levels and the rate of warranty returns tends to fluctuate depending on whether the industry is in times of growth or contraction. The Company adjusts its rate of accrual to reflect the level of returns typical of the industry cycle.
Stock-based compensation. The Company accounts for stock-based compensation in accordance with the intrinsic value method prescribed by APB Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees". Under APB 25, compensation is measured as the amount by which the market price of the underlying stock exceeds the exercise price of the option on the date of grant; this compensation is amortized over the vesting period.
Pro forma information regarding net income (loss) and net income (loss) per share is required by SFAS 123 for awards granted or modified after December 31, 1994 as if the Company had accounted for its stock-based awards to employees under the fair value method of SFAS 123. The fair value of the Company's stock-based awards to employees was estimated using a Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, the Black-Scholes model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock-based awards to employees have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards to employees. The fair value of the Company's stock-based awards to employees was estimated using the multiple option approach, recognizing forfeitures as they occur, assuming no expected dividends and using the following weighted average assumptions:
Options ESPP ---------------------- ---------------------- 2002 2001 2000 2002 2001 2000 - ------------------------------------------------------------------------------
Expected life (years) 2.1 3.0 3.1 0.6 0.9 1.4 Expected volatility 101% 90% 70% 122% 110% 90% Risk-free interest rate 2.6% 4.0% 6.1% 2.4% 4.5% 5.9%
The weighted-average estimated fair values of employee stock options granted during fiscal 2002, 2001, and 2000 were $4.07, $10.98 and $74.32 per share, respectively.
If the computed fair values of 2002, 2001, and 2000 awards had been amortized to expense over the vesting period of the awards as prescribed by SFAS 123, net income (loss) and net income (loss) per share would have been:
Interest and other income, net. The components of interest and other income, net are as follows:
Year Ended December 31, -------------------------------------------- (in thousands) 2002 2001 2000 - ------------------------------------------------------------------------------- Interest income $ 17,152 $ 18,998 $ 19,243 Interest expense on long-term debt and capital leases (10,540) (4,335) (808) Amortization of debt issue costs (1,564) (652) - Other (95) (117) 491 - ------------------------------------------------------------------------------- $ 4,953 $ 13,894 $ 18,926 ============================================
Income taxes. Income taxes are reported under Statement of Financial Accounting Standards No. 109 and, accordingly, deferred income taxes are recognized using the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carry forwards. Valuation allowances are provided if, after considering available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
Net income (loss) per common share. Basic net income (loss) per share is computed using the weighted average number of common shares outstanding during the period. The PMC-Sierra Ltd. Special Shares have been included in the calculation of basic net income (loss) per share. Diluted net income (loss) per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of stock options and warrants.
Share and per common share data presented reflect the two-for-one stock split in the form of a 100% stock dividend effective February 2000.
Segment reporting. Segmented information is reported under Statement of Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments of an Enterprise and Related Information". SFAS 131 uses a management approach to report financial and descriptive information about a company's operating segments. Operating segments are revenue-producing components of a company for which separate financial information is produced internally for the company's management. Under this definition, the Company operated, for all periods presented, in two segments: networking and non-networking products.
Recently issued accounting standards. In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard No. 146 (SFAS 146), "Accounting for Costs Associated with Exit or Disposal Activities". SFAS 146 requires that the liability for a cost associated with an exit or disposal activity be recognized at its fair value when the liability is incurred. Under previous guidance, a liability for certain exit costs was recognized at the date that management committed to an exit plan. As SFAS 146 is effective only for exit or disposal activities initiated after December 31, 2002, the adoption of this statement will not impact the Company's financial statements for 2002, but will affect the accounting for any restructurings initiated after 2002. In January 2003, the Company announced a further restructuring plan, the costs of which will be accounted for in accordance with SFAS 146.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of an obligation assumed under a guarantee. FIN 45 also requires additional disclosures by a guarantor in its interim and annual financial statements about the obligations associated with guarantees issued. The recognition provisions of FIN 45 will be effective for any guarantees that are issued or modified after December 31, 2002. The Company has adopted the disclosure requirements and is currently evaluating the effects of the recognition provisions of FIN 45; however, it does not expect that the adoption will have a material impact on the Company's results of operations or financial position.
In December 2002, the FASB issued Statement of Financial Accounting Standard No. 148 (SFAS 148), "Accounting for Stock-Based Compensation - Transition and Disclosure". SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also requires prominent disclosure in the "Summary of Significant Accounting Policies" of both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has adopted SFAS 148 for the 2002 fiscal year end. Adoption of this statement has affected the location of the Company's disclosure within the Consolidated Financial Statements, but will not impact the Company's results of operation or financial position unless the Company changes to the fair value method of accounting for stock-based employee compensation.
Reclassifications. Certain prior year amounts have been reclassified in order to conform to the 2002 presentation.
NOTE 2. Business Combinations
Poolings of Interests:
Fiscal 2000
Acquisition of SwitchOn Networks Inc.
In September 2000, the Company acquired SwitchOn Networks Inc., a privately held packet content processor company, with offices in the United States and India. Under the terms of the agreement, approximately 2,112,000 shares of common stock were exchanged and options assumed to acquire SwitchOn.
PMC recorded merger related transaction costs of $1.1 million related to the acquisition of SwitchOn. These charges, which consisted primarily of legal and accounting fees, were included under costs of merger in the Consolidated Statement of Operations for the year ended December 31, 2000.
Acquisition of Quantum Effect Devices, Inc.
In August 2000, the Company acquired Quantum Effect Devices, Inc., a public company located in the United States. QED developed embedded microprocessors that perform information processing in networking equipment. Under the terms of the agreement, approximately 12,300,000 shares of common stock were exchanged and options assumed to acquire QED.
PMC recorded merger-related transaction costs of $23.2 million related to the acquisition of QED. These charges, which consisted primarily of investment banking and other professional fees, were included under costs of merger in the Consolidated Statements of Operations for the year ended December 31, 2000.
Acquisition of Extreme Packet Devices, Inc.
In April 2000, the Company acquired Extreme Packet Devices, Inc., a privately held fabless semiconductor company located in Canada. Extreme specialized in developing semiconductors for high speed IP and ATM traffic management at 10 Gigabits per second rates. Under the terms of the agreement, approximately 2,000,000 exchangeable shares (see Note 10) were exchanged and options assumed to acquire Extreme.
PMC recorded merger-related transaction costs of $5.8 million related to the acquisition of Extreme. These charges, which consisted primarily of investment banking and other professional fees, were included under costs of merger in the Consolidated Statements of Operations for the year ended December 31, 2000.
Acquisition of AANetcom, Inc.
In March 2000, the Company acquired AANetcom, Inc., a privately held fabless semiconductor company located in the United States. AANetcom developed technology used in gigabit or terabit switches and routers, telecommunication access equipment, and optical networking switches in applications ranging from the enterprise to the core of the Internet. Under the terms of the agreement, approximately 4,800,000 shares of common stock were exchanged and options assumed to acquire AANetcom.
PMC recorded merger-related transaction costs of $7.4 million related to the acquisition of AANetcom. These charges, which consisted primarily of investment banking and other professional fees, were included under costs of merger in the Consolidated Statements of Operations for the year ended December 31, 2000.
Acquisition of Toucan Technology Ltd.
In January 2000, the Company acquired Toucan Technology Ltd., a privately held integrated circuit design company located in Ireland. Toucan offered expertise in telecommunications semiconductor design. At December 31, 1999, the Company owned seven per cent of Toucan and purchased the remainder for approximately 300,000 shares of common stock and stock options.
PMC recorded merger-related transaction costs of $534,000 related to the acquisition of Toucan. These charges, which consisted primarily of legal and accounting fees, were included under costs of merger in the Consolidated Statements of Operations for the year ended December 31, 2000.
The acquisitions of SwitchOn, QED, Extreme, AANetcom and Toucan were accounted for as poolings of interests and accordingly, all prior periods were restated.
The historical results of operations of the Company, Toucan, AANetcom, Extreme, QED and SwitchOn for the periods prior to the mergers were as follows:
Nine Months Ended September 30, (in thousands) 2000 - ----------------------------------------------------------------- Net revenues
PMC $ 411,046 Toucan - AANetcom 68 Extreme 50 QED 51,407 SwitchOn 461 - ----------------------------------------------------------------- Combined $ 463,032 ==================
Net income (loss)
PMC $ 83,691 Toucan (1,963) AANetcom (17,965) Extreme (11,327) QED (11,954) SwitchOn (9,038) - ----------------------------------------------------------------- Combined $ 31,444 ==================
Purchase Combinations:
Fiscal 2000
Octera Corporation.
On December 12, 2000, the Company completed the purchase of Octera Corporation, a privately held company located in San Diego, CA, that provided digital design services for Application Specific Integrated Circuits ("ASICs"), boards and systems with its primary focus on ASIC design. The Company paid cash and issued common stock with an aggregate fair value of approximately $16 million to effect this transaction.
Datum Telegraphic, Inc.
On July 21, 2000, the Company completed the purchase of the 92% interest of Datum Telegraphic, Inc. that it did not already own in exchange for the issuance of approximately 681,000 exchangeable shares (see Note 10) and options with a fair value of $107.4 million, cash of $17 million and acquisition related expenditures of $875,000. Datum, a wireless semiconductor company located in Vancouver, Canada, made digital signal processors that allow traffic for all major digital wireless standards to be transmitted using a single digitally controlled power amplifier architecture.
Malleable Technologies, Inc.
On June 27, 2000, the Company exercised an option to acquire the 85% interest of Malleable Technologies, Inc. that it did not already own in exchange for the issuance of approximately 1,250,000 common shares and 443,000 options and warrants with a fair value totaling $293 million and acquisition related costs of $825,000. Malleable, a fabless semiconductor company located in San Jose, CA, made digital signal processors for voice-over-packet processing applications which bridge voice and high-speed data networks by compressing voice traffic into ATM or IP packets.
The acquisitions of Octera, Datum and Malleable were accounted for using the purchase method of accounting and accordingly, the Consolidated Financial Statements include the operating results of each acquisition from the respective acquisition dates.
The fair value of the common shares of the Company issued to acquire Malleable, Datum, and Octera was based on the closing market price of the Company's stock a short period before and after the date the terms of the acquisitions were agreed to by the parties and announced to the public.
The total consideration, including acquisition costs, was allocated based on the estimated fair values of the net assets acquired on the respective acquisition dates as follows:
A portion of the purchase price of each acquisition was allocated to unearned compensation based on the value of certain unvested shares and options of the Company issued to effect each acquisition. The fair value of the common shares that were issued to acquire Malleable and that were subject to vesting provisions based on continuing employment was recorded as unearned compensation. The intrinsic value of the unvested shares and options issued to acquire Datum and Octera, which were acquired after July 1, 2000, was allocated to unearned compensation. Unearned compensation will be recognized as compensation cost over the respective remaining future service periods.
Purchased In Process Research and Development
The amounts allocated to in process research and development ("IPR&D") were determined through independent valuations using established valuation techniques in the high-technology industry. The value allocated to IPR&D was based upon the forecasted operating after-tax cash flows from the technology acquired, giving effect to the stage of completion at the acquisition date. Estimated future cash flows related to the IPR&D were made for each project based on the Company's estimates of revenues, operating expenses and income taxes from the project. These estimates were consistent with historical pricing, margins and expense levels for similar products.
Revenues were estimated based on relevant market size and growth factors, expected industry trends, individual product sales cycles and the estimated life of each product's underlying technology. Estimated operating expenses, income taxes and charges for the use of contributory assets were deducted from estimated revenues to determine estimated after-tax cash flows for each project. These future cash flows were further adjusted for the value contributed by any core technology and development efforts expected to be completed post acquisition.
These forecasted cash flows were then discounted based on rates derived from the Company's weighted average cost of capital, weighted average return on assets and venture capital rates of return adjusted upward to reflect additional risks inherent in the development life cycle. The risk adjusted discount rate used involved consideration of the characteristics and applications of each product, the inherent uncertainties in achieving technological feasibility, anticipated levels of market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets.
Based on this analysis, the acquired technology that had reached technological feasibility was capitalized. Acquired technology that had not yet reached technological feasibility and for which no alternative future uses existed was expensed upon acquisition.
Malleable and Datum:
Malleable developed programmable integrated circuits that perform high-density Voice Over Packet applications. The in process technology acquired from Malleable was designed to detect incoming voice channels and process them using voice compression algorithms. The compressed voice was converted, using the appropriate protocols, to ATM cells or IP packets to achieve higher channel density and to support multiple speech compression protocols and different packetization requirements. At the date of acquisition the Company estimated that Malleable's technology was 58% complete and the costs to complete the project to be $4.4 million.
Datum designed power amplifiers for use in wireless communications network equipment. The technology acquired from Datum was a digitally controlled amplifier architecture, which was designed to increase base station system capacities, while reducing cost, size and power consumption of radio networks. At the date of acquisition, the Company estimated that Datum's technology was 59% complete and the costs to complete the project to be $1.8 million.
These estimates were determined by comparing the time and costs spent to date and the complexity of the technologies achieved to date to the total costs, time and complexities that PMC expected to expend to bring the technologies to completion.
The amounts allocated to IPR&D for Malleable and Datum of $31.5 million and $6.7 million, respectively, were expensed upon acquisition, as it was determined that the underlying projects had not reached technological feasibility, had no alternative future uses and successful development was uncertain. The risk-adjusted discount rates used to determine the value of IPR&D for Malleable was 35% and for Datum was 30%.
The Company discontinued development of the technology acquired from Malleable in the second quarter of 2001. See Note 3 "Restructuring and other costs".
Development of the chip incorporating the technology acquired from Datum was completed in the fourth quarter of 2000 and the costs incurred to that date were in line with the Company's initial expectations. Since then, the Company has completed the required firmware related to this chip and has extended development of the Datum technology to a follow-on product. The general economic slowdown has delayed the introduction of the third generation base stations into which the Company had expected the Datum technology to be incorporated. It is currently uncertain when the Datum products will begin to generate significant revenues.
NOTE 3. Restructuring and Other Costs
On January 16, 2003, the Company announced that it was undertaking a corporate restructuring to further reduce operating expenses. The restructuring plan includes the termination of approximately 175 employees and the closure of design centers in Maryland, Ireland and India. PMC will record a restructuring charge for workforce reduction, facility lease costs and related asset impairments as these liabilities will be incurred in the first and second quarters of 2003.
During 2002, the Company paid out $27.5 million in connection with October 2001 restructuring activities.
Cash payments made in 2002 for restructuring activities related to the March 2001 restructuring plan were $2.7 million.
There were no additional restructurings in 2002 nor were there any changes in estimates related to 2001 restructurings that affected the Statement of Operations.
Restructuring - October 18, 2001
Due to a continued decline in market conditions, the Company implemented a restructuring plan in the fourth quarter of 2001 to reduce the operating cost structure. This restructuring plan included the termination of 341 employees, the consolidation of additional excess facilities, and the curtailment of additional research and development projects. As a result, PMC recorded a second restructuring charge of $175.3 million in the fourth quarter of 2001.
The following summarizes the activity in the October 2001 restructuring liability:
The Company has completed the restructuring activities contemplated in the October 2001 plan, but have not yet disposed of all of our surplus leased facilities
Restructuring - March 26, 2001
In the first quarter of 2001, PMC implemented a restructuring plan in response to the decline in demand for our networking products and consequently recorded a restructuring charge of $19.9 million. The restructuring plan included the involuntary termination of 223 employees across all business functions, the consolidation of a number of facilities and the curtailment of certain research and development projects.
The following summarizes the activity in the March 2001 restructuring liability:
The Company completed the restructuring activities contemplated in the March 2001 plan by June 30, 2002.
During the first six months of fiscal 2002, the Company made cash payments of $2.8 million in connection with this restructuring. The remaining restructuring liability of $1.4 million at June 30, 2002 related primarily to facility lease payments, net of estimated sublease revenues, and was classified as accrued liabilities on the balance sheet. The Company does not expect this restructuring to have any impact on its Statement of Operations in the future.
Impairment of Goodwill and Intangible Assets
During the second quarter of 2001, PMC made a decision to discontinue further development of the technology acquired in the purchase of Malleable. The Company did not expect to have any future cash flows related to these assets and had no alternative use for the technology. Accordingly, the Company recorded an impairment charge of $189 million, equal to the remaining net book value of goodwill and intangible assets related to Malleable.
In the fourth quarter of 2001, due to a continued decline in market conditions and a delay in introduction of certain products to the market, the Company completed an assessment of the future revenue potential and estimated costs associated with all acquired technologies. As a result of this review, the Company recorded a further impairment charge of $80.8 million related to the acquired goodwill and other intangibles recognized in the purchase of Datum and Octera. The Company recorded a charge of $79.3 million, measured as the amount by which the carrying value of the goodwill and intangibles exceeded the present value of estimated future cash flows related to these assets, to impair the goodwill and intangibles acquired in the purchase of Datum. The remaining $1.5 million impairment of goodwill resulted from the cancellation of Octera's research and development activities during 2001.
Write-down of Inventory
The Company recorded a write-down of excess inventory of $4.0 million in 2002 and $20.7 million in 2001. The continued industry wide reduction in capital spending and resulting decrease in demand for the Company's products prompted the Company to assess its current inventory levels compared to sales forecasts for the next twelve months. The excess inventory charge, which was included in cost of revenues, was calculated in accordance with the Company's policy, which is based on inventory levels in excess of estimated 12-month demand.
NOTE 4. Debt Investments
The following tables summarize the Company's investments in debt securities:
December 31, ------------------------------ (in thousands) 2002 2001 - ------------------------------------------------------------------------------
Held to maturity: US Government Treasury and Agency notes $ 92,039 $ 50,163 Corporate bonds and notes 303,169 307,352 ------------------------------ 395,208 357,515 Available-for-sale: US Government Treasury and Agency notes 94,512 86,352 - ------------------------------------------------------------------------------ $ 489,720 $ 443,867 ============================== Reported as: Cash equivalents $ - $ 14,233 Short-term investments 340,826 258,609 Investments in bonds and notes 148,894 171,025 - ------------------------------------------------------------------------------ $ 489,720 $ 443,867 ==============================
The total fair value of held-to-maturity investments at December 31, 2002 was $397.8 million (2001 - $358.1 million), with remaining maturities ranging from 1 month to 28 months.
The total fair value of available-for-sale investments at December 31, 2002 was $94.5 million (2001 - $86.3 million) with remaining maturities ranging from 22 to 25 months.
In 2002 the Company sold investments in bonds and notes with a total amortized cost of $10.1 million that were classified as held-to-maturity. The securities were downgraded in credit quality and as a result no longer met the Company's internal investment policy. The realized gain or loss on these sales was immaterial.
NOTE 5. Other Investments and Assets
The components of other investments and assets are as follows:
December 31, --------------------------------- (in thousands) 2002 2001 - -----------------------------------------------------------------------------
Investment in Sierra Wireless Inc. $ 8,707 $ 44,317 Other investments in public companies 264 2,744 Investments in non-public entities 7,098 12,392 Deferred debt issue costs (Note 7) 5,603 7,167 Other assets (Note 16) 306 2,243 - ----------------------------------------------------------------------------- $ 21,978 $ 68,863 =================================
At December 31, 2002, the Company held 2.0 million shares (2001 - 2.3 million shares) of Sierra Wireless, Inc., of which 1.2 million were previously subject to resale restrictions and could not be sold until May 2002. The Company has classified these shares as available-for-sale and has recorded a related unrealized holding gain at December 31, 2002 of $6.3 million (2001 - $41.6 million).
The Company also has investments in non-public entities, either directly or through venture funds, which include investments in early-stage private technology companies of strategic interest to the Company. The Company has commitments to invest additional capital into venture funds (see Note 8). In 2002, the Company made additional cash investments of $10.1 million (2001 - $5.7 million; 2000 - $24.8 million) in non-public entity investments.
During the year ended December 31, 2002, the Company sold some of its investments in public and non-public companies for cash proceeds of $5.8 million (2001 - $3.3 million; 2000 - $59.7 million) and recorded gross realized gains of $3.7 million (2001 - $2.9 million; 2000 - $58.5 million). There were no non-cash proceeds from sales of investments in 2002 (2001 - $1.7 million; 2000 - nil). Of these amounts, cash proceeds of $5.3 million (2001 - $2.1 million; 2000 - $59.7 million) and gross realized gains of $3.3 million (2001 - $1.9 million; 2000 - $58.5 million) related to the disposition of investments classified as available for sale.
The Company monitors the value of its investments for impairment and records an impairment charge to reflect any decline in value below its cost basis, if that decline is considered to be other than temporary. The assessment of impairment in carrying value is based on the market value trends of similar public companies, the current business performance of the entities in which we have invested, and if available, the estimated future market potential of the companies and venture funds. In 2002, the Company recorded an impairment charge of $15.3 million (2001 - $17.5 million) related to its investments in non-public entities. This charge is included in "Gain (loss) on investments" on the Consolidated Statement of Operations.
NOTE 6. Lines of credit
At December 31, 2002, the Company had available a revolving line of credit with a bank under which the Company may borrow up to $5.3 million with interest at the bank's alternate base rate (annual rate of 4.75% at December 31, 2002) as long as the Company maintains eligible investments with the bank in an amount equal to its drawings. This agreement expires in December 2004. At December 31, 2002, $5.3 million cash was deposited with the bank to offset the amount committed under letters of credit.
The existing line of credit replaces the $25 million revolving line of credit that was available to the Company at the end of 2001. At December 31, 2001, $5.3 million of the available $25 million line of credit was committed under letters of credit.
NOTE 7. Convertible subordinated notes
In August 2001, the Company issued $275 million of convertible subordinated notes maturing on August 15, 2006. In connection with the issuance of these convertible subordinated notes, the Company incurred approximately $7.8 million of issuance costs, which consisted primarily of investment banker fees, legal and other professional fees, which have been deferred and are being amortized over the term of the notes. The five-year term notes bear interest at a rate of 3.75% per annum and are convertible into an aggregate of approximately 6,480,650 shares of PMC's common stock at any time prior to maturity, at a conversion price of approximately $42.43 per share.
The Company may redeem the notes, in whole or in part, at any time after August 19, 2004 at a redemption price ranging from 100.75% to 101.5% of the principal amount of notes outstanding depending on the redemption date. Under certain conditions prior to August 19, 2004, the Company may redeem any portion of the notes at a price of 100% of the principal amount of notes, plus a "make whole" amount for accrued and unpaid interest to the redemption date. The fair value of this make whole provision was determined to be immaterial at the time the debt was issued and at December 31, 2002.
These notes are subject to restrictive covenants including those concerning payments on the notes and other indebtedness. In the event of a change in control of the Company, the noteholders may require the Company to repurchase their notes.
NOTE 8. Commitments and Contingencies
Operating leases. The Company leases its facilities under operating lease agreements, which expire at various dates through December 31, 2011.
Rent expense including operating costs for the years ended December 31, 2002, 2001 and 2000 was $12.4 million, $15.9 million and $8.3 million, respectively. Excluded from rent expense for 2002 was additional rent and operating costs of $27.5 million (2001 - $3.4 million) related to excess facilities, which were accrued as part of the restructuring charges in 2001.
In connection with the restructuring charges recorded in 2001, the Company recorded a charge of $128.3 million for exiting and terminating certain lease facilities that are included in the table below.
Minimum future rental payments under operating leases are as follows:
Year Ending December 31 (in thousands) - ------------------------------------------------------------------------------ 2003 $ 31,839 2004 31,470 2005 30,628 2006 31,964 2007 29,166 Thereafter 118,262 - ------------------------------------------------------------------------------ Total minimum future rental payments under operating leases $ 273,329 =============
Supply agreements. The Company has wafer supply agreements with two independent foundries, which expire in December 2003. Under these agreements, the suppliers are obligated to provide certain quantities of wafers per year. Neither of the agreements have minimum unit volume purchase requirements but the Company is obligated under one of the agreements to purchase in future periods a minimum percentage of its total annual wafer requirements, provided that the foundry is able to continue to offer competitive technology, pricing, quality and delivery.
Investment agreements. The Company participates in four professionally managed venture funds that invest in early-stage private technology companies which participate in markets of strategic interest to the Company. From time to time these funds request additional capital for private placements. The Company has committed to invest an additional $38.1 million in these funds, which may be requested by the fund managers at any time over the next seven years.
Contingencies. In the normal course of business, the Company receives and makes inquiries with regard to possible patent infringements. Where deemed advisable, the Company may seek or extend licenses or negotiate settlements. Outcomes of such negotiations may not be determinable at any point in time; however, management does not believe that such licenses or settlements will, individually or in the aggregate, have a material adverse effect on the Company's financial position, results of operations or cash flows.
NOTE 9. Special Shares
At December 31, 2002 and 2001, the Company maintained a reserve of 3,196,000 and 3,373,000 shares, respectively, of PMC common stock to be issued to holders of PMC-Sierra, Ltd. (LTD) special shares.
The special shares of LTD, the Company's principal Canadian subsidiary, are redeemable or exchangeable for PMC common stock. Special shares do not vote on matters presented to the Company's stockholders, but in all other respects represent the economic and functional equivalent of PMC common stock for which they can be redeemed or exchanged at the option of the holders. The special shares have class voting rights with respect to transactions that affect the rights of the special shares as a class and for certain extraordinary corporate transactions involving LTD. If LTD files for bankruptcy, is liquidated or dissolved, the special shares receive as a preference the number of shares of PMC common stock issuable on conversion plus a nominal amount per share plus unpaid dividends, or at the holder's option convert into LTD ordinary shares, which are the functional equivalent of voting common stock. If the Company files for bankruptcy, is liquidated, or dissolved, special shares of LTD receive the cash equivalent of the value of PMC common stock into which the special shares could be converted, plus unpaid dividends, or at the holder's option convert into LTD ordinary shares. If the Company materially breaches its obligations to special shareholders of LTD (primarily to permit conversion of special shares into PMC common stock), the special shareholders may convert their shares into LTD ordinary shares.
These special shares of LTD are classified outside of stockholders' equity until such shares are exchanged for PMC common stock. Upon exchange, amounts will be transferred from the LTD special shares account to the Company's common stock and additional paid-in capital on the consolidated balance sheet.
NOTE 10. Stockholders' Equity
Authorized capital stock of PMC. At December 31, 2002 and 2001, the Company had an authorized capital of 905,000,000 shares, 900,000,000 of which are designated "Common Stock", $0.001 par value, and 5,000,000 of which are designated "Preferred Stock", $0.001 par value.
Stock Splits. In January 2000, the Company's Board of Directors approved a two-for-one split of the Company's common stock in the form of a stock dividend that was applicable to shareholders of record on January 31, 2000, and effective on February 14, 2000. All references to share and per share data for all periods presented have been adjusted to give effect to this stock dividend.
Warrants. During 1996, the Company issued a warrant to purchase 100,000 shares of common stock at $2.31 per share to an investment banking firm in settlement for services previously expensed. This warrant was fully exercised in August 2000.
In 1999, as a result of the Company's acquisition of Abrizio, the Company assumed warrants to purchase 174,580 shares of common stock at $1.66 per share. In 2000, as a result of the Company's acquisitions of AANetcom, Extreme, QED and SwitchOn, the Company assumed warrants to purchase 50,759, 63,162, 68,434 and 780 shares of common stock at $9.36, $3.06, $5.26 and $89.76 per share, respectively. In 2001, 50,759 of these warrants were cancelled. At December 31, 2002, 2001, and 2000, there were 30,100 warrants outstanding at a weighted average exercise price of $1.66 per share, 42,138 warrants outstanding at a weighted average exercise price of $1.66 per share, and 92,897 warrants outstanding at a weighted average exercise price of $5.87 per share, respectively. All warrants outstanding at December 31, 2002 expire in March 2003.
Convertible Preferred Stock of QED. QED, which was acquired by PMC in August 2000 in a transaction accounted for under the pooling method (see Note 2), had preferred stock comprised of $0.001 par value per share Series A, B, C, D convertible preferred shares. Simultaneously with the closing of QED's initial public offering on February 1, 2000, all issued and outstanding shares of QED's convertible preferred stock, with a carrying value of $39.9 million, were automatically converted into 13,619,000 shares of QED common stock. All shares of common stock of QED were exchanged for shares of PMC common stock at an exchange ratio of 0.385 (see Note 2) per QED common share.
Exchangeable Shares. As a result of the acquisitions of Extreme and Datum in 2000, each holder of the Extreme and Datum common stock received shares exchangeable into PMC common stock. The shares are exchangeable, at the option of the holder, for PMC common stock on a share-for-share basis. The exchangeable shares remain securities of the Company and entitle the holders to dividend and other rights economically equivalent to that of PMC common stock and, through a voting trust, to vote at shareholder meetings of the Company. At December 31, 2002, 2001, and 2000, these shares were exchangeable into 636,000, 712,000 and 1,386,000 PMC shares, respectively.
Stockholders' Rights Plan. On April 26, 2001, PMC adopted a stockholders' rights plan. Under the rights plan, the Company issued a dividend of one right for each share of common stock of the Company held by stockholders of record as of May 25, 2001. Each right will initially entitle stockholders to purchase a fractional share of the Company's preferred stock for $325. However, the rights are not immediately exercisable and will become exercisable only upon the occurrence of certain events. Upon occurrence of these events, unless redeemed for $0.001 per right, the rights will become exercisable by holders, other than rights held by a potential unsolicited third party acquirer, for shares of the Company or for shares of the third party acquirer having a value of twice the right's then-current exercise price.
NOTE 11. Employee Equity Benefit Plans
Employee Stock Purchase Plan. In 1991, the Company adopted an Employee Stock Purchase Plan ("PMC ESPP") under Section 423 of the Internal Revenue Code. Under the PMC ESPP, the number of shares authorized to be available for issuance under the plan are increased automatically on January 1 of each year until the expiration of the plan. The increase will be limited to the lesser of (i) 1% of the outstanding shares on January 1 of each year, (ii) 2,000,000 shares (after adjusting for stock dividends), or (iii) an amount to be determined by the Board of Directors.
In 2000, in connection with the acquisition of QED, the Company assumed the QED Employee Stock Purchase Plan ("QED ESPP"). A total of 115,000 shares of common stock were reserved for issuance under this Plan. Under this Plan, eligible employees were able to purchase a limited amount of common stock at a minimum of 85% of the market value at certain plan-defined dates. As of December 31, 2001, all employees had converted to the PMC ESPP.
During 2002, 2001, and 2000, there were 610,331 shares, 245,946 shares, and 235,104 shares, respectively, issued under the Plans at weighted-average prices of $11.73, $31.93, and $16.21 per share, respectively. The weighted-average fair value of the 2002, 2001, and 2000 awards was $13.80, $31.25, and $41.90 per share, respectively. During 2002, an additional 1,656,939 shares became available under the PMC ESPP and no additional shares were authorized for the QED ESPP. As of December 31, 2002, 5,834,285 shares were available for future issuance under the PMC ESPP.
Stock Option Plans. The Company has various stock option plans that cover grants of options to purchase the Company's common stock. The options generally expire within five to ten years and vest over four years.
During 2000, the Company's stockholders elected to add a provision to the 1994 Incentive Stock Plan, under which plan most of the outstanding options have been issued. Under the new terms, the number of shares authorized to be available for issuance under the plan shall be increased automatically on January 1, 2001 and every year thereafter until January 1, 2004. The increase will be limited to the lesser of (i) 5% of the outstanding shares on January 1 of each year, (ii) 45,000,000 shares, or (iii) an amount to be determined by the Board of Directors.
In 2001, the company simplified its plan structure. The 2001 Stock Option Plan (the "2001 Plan") was created to replace certain stock option plans assumed by us in connection with mergers and acquisitions completed prior to 2001 (See Item 12). All option activity related to the 2001 Plan and all other assumed plans are included in the following tables.
Option activity under the option plans was as follows:
Weighted Average Options Number of Exercise Available Options Price For Issuance Outstanding Per Share - --------------------------------------------------------------------------------
Balance at December 31, 1999 2,329,651 25,114,344 $ 15.20 Additional shares reserved 6,442,687 Granted (3,855,369) 3,855,369 $ 132.97 Exercised - (4,059,790) $ 5.46 Expired (12,214) - - Repurchased 2,012 - - Cancelled 873,870 (873,870) $ 32.59 - -------------------------------------------------------------------------------- Balance at December 31, 2000 5,780,637 24,036,053 $ 34.91 Additional shares reserved 8,111,005 Granted (14,838,436) 14,838,436 $ 18.51 Exercised - (2,995,129) $ 6.30 Expired (4,504) - - Repurchased 86,658 - - Cancelled 3,774,971 (3,774,971) $ 61.92 Cancelled but unavailable (117,285) - - - -------------------------------------------------------------------------------- Balance at December 31, 2001 2,793,046 32,104,389 $ 26.82 Additional shares reserved 8,284,696 Granted (658,111) 658,111 $ 7.39 Exercised - (964,794) $ 2.76 Expired - - - Repurchased 14,367 - - Cancelled 20,652,984 (20,652,984) $ 36.77 Cancelled but unavailable (230,181) - -------------------------------------------------------------------------------- Balance at December 31, 2002 30,856,801 11,144,722 $ 9.51 ===========================================
The following table summarizes information concerning options outstanding and exercisable for the combined option plans at December 31, 2002:
Voluntary stock option exchange offer. On September 26, 2002, the Company completed an offering to all eligible option holders of an opportunity to voluntarily exchange certain stock options.
Under the program, participants were able to tender for cancellation stock options granted within the specified period with exercise prices at or above $8.00 per share, in exchange for new options to be granted at least six months and one day after the cancellation of the tendered options. Pursuant to the terms and conditions set forth in the Company's offer, each eligible participant will receive a new option to purchase an equivalent number of PMC shares for each tendered option with an exercise price of less than $60.00. For each tendered option with an exercise price of $60.00 or more, each eligible participant will receive a new option to purchase a number of PMC shares equal to one share for each four unexercised shares subject to the tendered option.
On September 26, 2002, the Company accepted and cancelled 19.3 million options with a weighted average exercise price of $35.98 and expects to grant approximately 16.5 million new options no earlier than March 27, 2003 and no later than April 30, 2003. The new options will have an exercise price equal to the closing price of the Company's common stock on the date of grant and will be subject to a new vesting schedule.
NOTE 12. Income Taxes
The income tax provisions, calculated under Statement of Financial Accounting Standard No. 109 (SFAS 109), consist of the following:
Year Ended December 31, --------------------------------------------------
(in thousands) 2002 2001 2000 - -------------------------------------------------------------------------------- Current: Federal $ - $ - $ 40 State 4 4 224 Foreign (27,291) (7,034) 100,880 - -------------------------------------------------------------------------------- (27,287) (7,030) 101,144 - --------------------------------------------------------------------------------
Deferred: Federal - - (72) Foreign 8,429 (10,733) 1,340 - -------------------------------------------------------------------------------- 8,429 (10,733) 1,268 - -------------------------------------------------------------------------------- Provision for income taxes $ (18,858) $ (17,763) $ 102,412 ==================================================
A reconciliation between the Company's effective tax rate and the U.S. Federal statutory rate is as follows:
Significant components of the Company's deferred tax assets and liabilities are as follows:
December 31, -------------------------------- (in thousands) 2002 2001 - ---------------------------------------------------------------------- Deferred tax assets: Net operating loss carryforwards $ 198,215 $ 176,838 State tax loss carryforwards 12,975 10,926 Credit carryforwards 29,900 26,180 Reserves and accrued expenses 20,652 19,058 Restructuring and other charges 52,979 67,207 Depreciation and amortization 9,262 10,553 Deferred income 3,809 4,800 Deferred stock compensation - 221 - ---------------------------------------------------------------------- Total deferred tax assets 327,792 315,783 Valuation allowance (326,238) (305,929) - ---------------------------------------------------------------------- Total net deferred tax assets 1,554 9,854 - ---------------------------------------------------------------------- Deferred tax liabilities: Capitalized technology (498) (369) Unrealized gain on investments (2,737) (17,715) - ---------------------------------------------------------------------- Total deferred tax liabilities (3,235) (18,084) - ---------------------------------------------------------------------- Total net deferred taxes $ (1,681) $ (8,230) ================================
At December 31, 2002, the Company has approximately $583.4 million of federal net operating losses, which will expire through 2022. Approximately $6.4 million of the federal net operating losses is subject to ownership change limitations provided by the Internal Revenue Code of 1986. The Company also has approximately $216.2 million of state tax loss carryforwards, which expire through 2022. The utilization of a portion of these state losses is also subject to ownership change limitations provided by the various states' income tax legislation.
Included in the credit carryforwards are $18.9 million of federal research and development credits which expire through 2022, $549,000 of foreign tax credits which expire in 2003, $497,000 of federal AMT credits which carryforward indefinitely, $11.1 million of state research and development credits which do not expire, $1.3 million of state research and development credits which expire through 2007, and $1.5 million of state manufacturer's investment credits which expire through 2012.
Included in the above net operating loss carryforwards are $23.8 million and $8.6 million of federal and state net operating losses related to acquisitions accounted for under the purchase method of accounting. The benefit of such losses, if and when realized, will be credited first to reduce to zero any goodwill related to the respective acquisition, second to reduce to zero other non-current intangible assets related to the respective acquisition, and third to reduce income tax expense.
Included in the deferred tax assets before valuation allowance are approximately $147.1 million of cumulative tax benefits related to equity transactions, which will be credited to stockholder's equity if and when realized.
The pretax income (loss) from foreign operations was ($32.6 million), ($154.1 million) and $254.5 million in 2002, 2001, and 2000, respectively. Undistributed earnings of the Company's foreign subsidiaries are considered to be indefinitely reinvested and accordingly, no provision for federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of a dividend or otherwise, the Company would be subject to both US income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. It is not practical to estimate the income tax liability that might be incurred on the remittance of such earnings.
NOTE 13. Segment Information
The Company has two operating segments: networking and non-networking products. The networking segment consists of internetworking semiconductor devices and related technical service and support to equipment manufacturers for use in their communications and networking equipment. The non-networking segment consists of custom user interface products. The Company is supporting the non-networking products for existing customers, but has decided not to develop any further products of this type.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on gross profits from operations of the two segments.
Summarized financial information by segment is as follows:
Year Ended December 31, ---------------------------------------- (in thousands) 2002 2001 2000 - -------------------------------------------------------------------- Net revenues
Networking $ 212,651 $ 300,173 $ 665,700 Non-networking 5,442 22,565 28,984 - -------------------------------------------------------------------- Total $ 218,093 $ 322,738 $ 694,684 ========================================
Gross profit
Networking $ 126,222 $ 176,068 $ 515,712 Non-networking 2,329 9,408 12,811 - -------------------------------------------------------------------- - Total $ 128,551 $ 185,476 $ 528,523 ========================================
Enterprise-wide information is provided in accordance with SFAS 131. Geographic revenue information is based on the location of the customer invoiced. Long-lived assets include investments and other assets, property and equipment, and goodwill and other intangible assets. Geographic information about long-lived assets is based on the physical location of the assets.
Year Ended December 31, ------------------------------------------- (in thousands) 2002 2001 2000 - ------------------------------------------------------------------------ Net revenues United States $ 120,083 $ 187,723 $ 432,649 Asia - excluding China 39,302 32,501 87,554 Canada 24,822 35,448 83,747 China 18,959 34,746 46,485 Europe and Middle East 11,554 31,825 43,101 Other foreign 3,373 495 1,148 - ------------------------------------------------------------------------ Total $ 218,093 $ 322,738 $ 694,684 ===========================================
Long-lived assets Canada $ 38,412 $ 65,634 $ 193,143 United States 25,497 37,968 256,850 Other 1,268 2,803 3,690 - ------------------------------------------------------------------------ Total $ 65,177 $ 106,405 $ 453,683 ===========================================
During 2002, the Company had two customers whose purchases represented a significant portion of net revenues, based on billing, including contract manufacturers and distributors. Net revenues from one customer represented approximately 15.9% of the Company's net revenues in 2002 but less than 10% of net revenues in 2001 and 2000. Net revenues from a second customer were 13.4% in 2002, 12.3% in 2001 and 18.6% of the Company's net revenues for the respective year. Net revenues for a third customer were approximately 12.8% of the Company's net revenues in 2001, but were less than 10% of the Company's net revenues in 2002 and 2000.
NOTE 14. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income (loss) per share:
The Company had approximately 4.4 million and 11.0 million options outstanding at December 31, 2002 and 2001, respectively, that were not included in diluted net loss per share because they would be antidilutive.
(1) PMC-Sierra, Ltd. Special Shares are included in the calculation of basic weighted average common shares outstanding.
NOTE 15. Comprehensive Income
The components of comprehensive income, net of tax, are as follows:
NOTE 16. Related Party Transactions
In 2001, the Company made a real estate loan of approximately $2 million to a former officer of a subsidiary company. The loan, which was included in other investments and assets, was repaid in full in December 2002 prior to its maturity date of December 31, 2002.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
PART III
ITEM 10.
ITEM 10. Directors and Executive Officers of the Registrant
The information concerning the Company's directors and executive officers required by this Item is incorporated by reference from the information set forth in the sections entitled "Election of Directors", "Executive Officers", and "Section 16(a) Beneficial Ownership Reporting Compliance" in our Proxy Statement for the 2003 Annual Stockholder Meeting.
ITEM 11.
ITEM 11. Executive Compensation.
The information required by this Item is incorporated by reference from the information set forth in the sections entitled "Director Compensation" and "Executive Compensation and Other Matters" in our Proxy Statement for the 2003 Annual Stockholder Meeting.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information concerning security ownership of certain beneficial owners that is required by this Item is incorporated by reference from the information set forth in the section entitled "Common Stock Ownership of Certain Beneficial Owners and Management" in our Proxy Statement for the 2003 Annual Stockholder Meeting.
Equity Compensation Plan Information:
The following table provides information as of December 31, 2002 with respect to the shares of our common stock that may be issued under our existing equity compensation plans.
(1) In connection with the voluntary cancellation of options to purchase approximately 19.3 million shares in September 2002, we promised to grant new options for approximately 18.0 million shares from our stock plans between March 27, 2003 and April 30, 2003. The new options will have an exercise price equal to the closing price of our common stock on the date they are granted. These options are reflected in the above chart as remaining available for future issuance. As a result of workforce reductions we currently plan on issuing 16.5 million options under this option exchange program (See Note 11 to Consolidated Financial Statements).
(2) Consists of the 1994 Stock Incentive Plan and the 1991 Employee Stock Purchase Plan.
(3) Includes 5,834,285 shares available for issuance in the 1991 Employee Stock Purchase Plan. In January 2003, we issued 478,279 shares relating to the purchase period that began in July 2002.
(4) Consists of the 2001 Stock Option Plan (the "2001 Plan") and outstanding options that were granted pursuant to assumed stock plans that were subsequently made part of the 2001 Plan. The 2001 Plan was created to replace certain stock option plans assumed by us in connection with mergers and acquisitions completed prior to 2001. The number of options that may be granted under the 2001 Plan equals (i) the number of shares reserved under the assumed stock option plans that were not subject to outstanding or exercised options (1,830,641 shares) plus (ii) the number of options that were outstanding at the time the plans were assumed but that have subsequently been cancelled.
(5) This table does not include information for stock option plans assumed by us which were not made part of the 2001 Plan or any outstanding warrants. As of December 31, 2002, a total of 48,398 shares of our stock were issuable upon exercise under those other assumed plans. The weighted average exercise price of those outstanding options is $4.55. No additional options may be granted under those plans. As of December 31, 2002, warrants to purchase a total of 30,100 shares of our stock were outstanding with a weighted average price of $1.66.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated by reference from the information set forth in the section entitled "Executive Compensation and Other Matters - Employment Agreements" in our Proxy Statement for the 2003 Annual Stockholder Meeting.
ITEM 14.
ITEM 14. Controls and Procedures
Evaluation of disclosure controls and procedures
Our chief executive officer and our chief financial officer evaluated our "disclosure controls and procedures" (as defined in Rule 13a-14(c) of the Securities Exchange Act of 1934 (the "Exchange Act") as of a date within 90 days before the filing date of this annual report. They concluded that as of the evaluation date, our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.
Changes in internal controls
Subsequent to the date of their evaluation, there were no significant changes in our internal controls or in other factors that could significantly affect these controls. There were no significant deficiencies or material weaknesses in our internal controls so no corrective actions were taken.
PART IV
ITEM 15.
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Consolidated Financial Statements The financial statements (including the notes thereto) listed in the accompanying index to financial statements and financial statement schedules are filed within this Annual Report on Form 10-K.
2. Financial Statement Schedules Financial Statement Schedules required by this item are listed on page 89 of this Annual Report on Form 10-K.
3. Exhibits The exhibits listed under Item 15(c) are filed as part of this Form 10-K Annual Report.
(b) Reports on Form 8-K
- A Current Report on Form 8-K was filed on November 15, 2002 to announce the appointment of Alan Krock to the positions of Vice President of Finance and Chief Financial Officer of PMC-Sierra, Inc. effective November 11, 2002.
(c) Exhibits pursuant to Item 601 of Regulation S-K.
* Confidential portions of this exhibit have been omitted and filed separately with the Commission.
^ Indicates management compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 15(c) of Form 10K.
- --------------------------- 1. Incorporated by reference from Exhibit 3.1 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on May 16, 2001.
2. Incorporated by reference from Exhibit 3.2 filed with the Registrant's amended Registration Statement on Form S-3 filed with the Commission on November 8, 2001 (No. 333-70248).
3. Incorporated by reference from Exhibit 3.2 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on November 14, 2001.
4. Incorporated by reference from Exhibit 4.4 filed with the Registrant's amended Registration Statement on Form S-3 filed with the Commission on August 27, 1997 (No. 333-15519).
5. Incorporated by reference from Exhibit 2.1 filed with the Registrant's Current Report on Form 8-K, filed with the Commission on September 19, 1994, as amended on October 4, 1995.
6. Incorporated by reference from Exhibit 2.1 filed with Registrant's Current Report on Form 8-K, filed with the Commission on September 6, 1995, as amended on October 6, 1995.
7. Incorporated by reference from Exhibit 4.3 filed with the Registrant's Registration Statement on Form S-3, filed with the Commission on September 19, 1995 (No. 33-97110).
8. Incorporated by reference from Exhibit 4.3 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on November 14, 2001.
9. Incorporated by reference from Exhibit 4.1 filed with the Registrant's amended Registration Statement on Form S3 filed with the Commission on November 8, 2001 (No. 333-70248).
10. Incorporated by reference from Exhibit 10.2 filed with the Registrant's Annual Report on Form 10K filed with the Commission on March 26, 1999.
11. Incorporated by reference from Exhibit 10.2 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on November 8, 2002.
12. Incorporated by reference from Exhibit 10.3 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on November 8, 2002.
13. Incorporated by reference from Exhibit 10.20 filed with the Registrant's Annual Report on Form 10-K filed with the Commission on April 14, 1997.
14. Incorporated by reference from Exhibit 10.36 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on August 8, 2000.
15. Incorporated by reference from Exhibit 10.46 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on November 14, 2001.
16. Incorporated by reference from Exhibit 10.44 filed with the Registrant's Annual Report on Form 10-K filed with the Commission on April 2, 2001.
17. Incorporated by reference from Exhibit 10.45 filed with the Registrant's Annual Report on Form 10-K filed with the Commission on April 2, 2001.
18. Incorporated by reference from Exhibit 10.31 filed with the Registrant's amended Annual Report on Form 10-K filed with the Commission on March 30, 2000.
19. Incorporated by reference from Exhibit 10.35 filed with the Registrant's Quarterly Report on Form 10-Q filed with the Commission on May 10, 2000.
20. Incorporated by reference from Exhibit 10.1 from the Registrant's amended Registration Statement on Form S-3, filed with the Commission on November 8, 2001. (No. 333-70248).
21. Incorporated by reference from Exhibit 10.47 from the Registrant's amended Registration Statement on Form S-3, filed with the Commission on January 4, 2002. (No. 333-70248).
22. Refer to Note 14 of the financial statements included in Item 8 of Part II of this Annual Report on Form 10-K.
23. Refer to the Signatures page of this Annual Report.
(d) Financial Statement Schedules required by this item are listed on page 45 of this Annual Report on Form 10k.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PMC-SIERRA, INC. (Registrant)
Date: March 27, 2003 /s/ Alan F. Krock ------------------------------------------------- Alan F. Krock Vice President, Finance (duly authorized officer) Chief Financial Officer and Principal Accounting Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert L. Bailey and Alan F. Krock, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
CERTIFICATIONS
I, Robert L. Bailey, certify that:
1. I have reviewed this annual report on Form 10-K of PMC-Sierra, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003 /s/ Robert L. Bailey -------------- ---------------------------------------- Robert L. Bailey President and Chief Executive Officer
I, Alan F. Krock, certify that:
1. I have reviewed this annual report on Form 10-K of PMC-Sierra, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: March 27, 2003 /s/ Alan F. Krock -------------- ---------------------------------------- Alan F. Krock Vice President, Finance Chief Financial Officer and Principal Accounting Officer
SCHEDULE II - Valuation and Qualifying Accounts
Years ended December 31, 2002, 2001, and 2000 (in thousands)
INDEX TO EXHIBITS
Exhibit Description Page Number Number - ----------- ------------------------------------------------------- ----------
10.4 Form of Indemnification Agreement between the Registrant and its directors and officers, as amended and restated
10.5 Form of Executive Employment Agreement by and between the Registrant and the executive officers
12.1 Statement of Computation of Ratio of Earnings to Fixed Charges
21.1 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)
99.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)