The Company designs, develops and markets high-performance integrated circuits (“ICs” or IC products) and frequency control products (“FCPs” or FCP products) used in many of today's advanced electronic systems. Our IC products include products that support the connectivity, timing and signal conditioning of high-speed parallel and serial protocols that transfer data among a system's microprocessor, memory and various peripherals, such as displays and monitors, and between interconnected systems. Our FCPs are electronic components that provide frequency references such as crystals, oscillators, and hybrid timing generation products for computer, communication and consumer electronic products. Our analog, digital and mixed-signal ICs, together with our FCP products enable higher system bandwidth and signal quality, resulting in better operating reliability, signal integrity, and lower overall system cost in applications such as notebook computers, servers, network switches and routers, storage area networks, digital TVs, cell phones, GPS and digital media players.
Net revenues consist of product sales, which are recognized upon shipment, less an estimate for returns and allowances. Over the past two quarters we have experienced a sharp decline in revenue, which is consistent with declining end-market demand and inventory reduction initiatives across the supply chain. Net revenue decreased $16.8 million or 40.8% in the third quarter of fiscal 2009 versus the third quarter of fiscal 2008 primarily as the result of:
| | | |
| | · | a decrease of $7.4 million or 44.1% in sales of our FCP products to $9.3 million and |
| | · | a $9.4 million decline in sales of IC products to $15.1 million, for a 38.4% sales decrease. |
Net revenue declined $21.4 million or 17.8% for the first nine months of fiscal 2009 versus the first nine months of fiscal 2008 primarily as the result of:
| | | |
| | · | a decrease of $8.7 million or 17.9% in sales of our FCP products to $40.0 million and |
| | · | a decline in sales of IC products to $59.0 million, for a $12.7 million or 17.7% decrease. |
The following table sets forth net revenues by country as a percentage of total net revenues for the three and nine month periods ended March 28, 2009 and March 29, 2008:
| | | Three Months Ended | | | Nine Months Ended | |
| | | March 28, | | | March 29, | | | March 28, | | | March 29, | |
| | | 2009 | | | 2008 | | | 2009 | | | 2008 | |
| | | | | | | | | (As Restated) | | | | |
| | | | | | | | | | | | | |
| Taiwan | | | 42 | % | | | 32 | % | | | 42 | % | | | 30 | % |
| China (including Hong Kong) | | | 35 | % | | | 39 | % | | | 34 | % | | | 39 | % |
| United States | | | 9 | % | | | 9 | % | | | 8 | % | | | 9 | % |
| Singapore | | | 2 | % | | | 4 | % | | | 3 | % | | | 5 | % |
| Other (less than 10% each) | | | 12 | % | | | 15 | % | | | 13 | % | | | 17 | % |
| Total net revenues | | | 100 | % | | | 100 | % | | | 100 | % | | | 100 | % |
For the three and nine months ended March 28, 2009, as compared with the same periods of the prior year, the percentage of our net revenues derived from sales to Taiwan increased as a result of continued demand for technological devices and an increasing concentration of contract manufacturing there. We expect our future sales to continue to grow, as a percentage of net revenues, in Asian countries.
Gross Profit
The following table sets forth our gross profit for the periods indicated.
| | | Three Months Ended | | | Nine Months Ended | |
| | | March 28, | | | March 29, | | | % | | | March 28, | | | March 29, | | | % | |
| (In thousands) | | 2009 | | | 2008 | | | Change | | | 2009 | | | 2008 | | | Change | |
| | | | | | | | | | | | (As Restated) | | | | | | | |
| Net revenues | | $ | 24,394 | | | $ | 41,177 | | | | -40.8 | % | | $ | 98,924 | | | $ | 120,371 | | | | -17.8 | % |
| Gross profit | | | 8,663 | | | | 15,468 | | | | -44.0 | % | | | 34,603 | | | | 44,501 | | | | -22.2 | % |
| Gross profit as a percentage of net revenues (gross margin) | | | 35.5 | % | | | 37.6 | % | | | | | | | 35.0 | % | | | 37.0 | % | | | | |
The decrease in gross profit for the three and nine month periods ended March 28, 2009 as compared with the same periods of the prior year was primarily due to significant sales declines in the second and third quarters in both IC and FCP products. To a lesser extent margin decreases also contributed, and reflect both the long-term downward trend in prices as well as somewhat higher production costs due to lower volumes and higher overhead absorption rates.
Specifically, the decrease in gross profit in the third quarter of fiscal 2009 as compared to the third quarter of fiscal 2008 of $6.8 million is the result of:
| | | |
| | · | decreased sales of the FCP product family, which led to $1.8 million of decreased gross profit, |
| | · | decreased sales of IC products, which led to $4.0 million of decreased gross profit, and |
| | · | margin declines which led to $1.0 million of decreased gross profit. |
With respect to the decrease in gross profit in the first nine months of fiscal 2009 as compared to the first nine months of fiscal 2008 of $9.9 million, the decrease is the result of:
| | | |
| | · | decreased sales of the FCP product family, which led to $2.2 million of decreased gross profit, |
| | · | decreased sales of IC products, which led to $5.3 million of decreased gross profit, and |
| | · | margin declines which led to $2.4 million of decreased gross profit. |
Future gross profit and gross margin are highly dependent on the level and product mix of net revenues. This includes the mix of sales between lower margin FCP products and our higher margin integrated circuit products. Although we have been successful at favorably improving our integrated circuit product mix and penetrating new end markets, there can be no assurance that this will continue. Accordingly, we are not able to predict future gross profit levels or gross margins with certainty.
During the three and nine months ended March 28, 2009, gross profit and gross margin benefited as a result of the sale of inventory of $23,000 and $100,000, respectively, that we had previously identified as excess and written down to zero value, as compared with $364,000 and $954,000, respectively, for the same periods of the prior year.
Research and Development (“R&D”)
| | | Three Months Ended | | | Nine Months Ended | |
| | | March 28, | | | March 29, | | | % | | | March 28, | | | March 29, | | | % | |
| (In thousands) | | 2009 | | | 2008 | | | Change | | | 2009 | | | 2008 | | | Change | |
| | | | | | | | | | | | (As Restated) | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Net revenues | | $ | 24,394 | | | $ | 41,177 | | | | -40.8 | % | | $ | 98,924 | | | $ | 120,371 | | | | -17.8 | % |
| Research and development | | | 3,996 | | | | 4,503 | | | | -11.3 | % | | | 12,580 | | | | 12,863 | | | | -2.2 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| R&D as a percentage of net revenues | | | 16.4 | % | | | 10.9 | % | | | | | | | 12.7 | % | | | 10.7 | % | | | | |
Research and development expenses consist primarily of costs related to personnel and overhead, non-recurring engineering charges, and other costs associated with the design, prototyping, testing, manufacturing process design support, and technical customer applications support of our products. The $507,000 expense reduction for the three month period ended March 28, 2009 as compared to the same period of the prior year reflects the restructuring program and cost saving efforts, with reductions of $176,000 in salaries and $439,000 in expenses related to masks, engineering and consultants, partially offset by a $162,000 increase in share-based compensation costs. The $283,000 expense decrease for the nine month period ended March 28, 2009 as compared to the same period of the prior year is similarly attributable to the restructuring program and cost saving efforts, with reductions of $368,000 in expenses related to masks, engineering and consultants.
The Company believes that continued spending on research and development to develop new products and improve manufacturing processes is critical to the Company’s success, and as a result expects to increase research and development expenses in future periods over the long term. In the short term, the Company intends to continue to focus on cost control until business conditions improve. If business conditions deteriorate or the rate of improvement does not meet our expectations, the Company may implement further cost-cutting actions.
Selling, General and Administrative (“SG&A”)
| | | Three Months Ended | | | Nine Months Ended | |
| | | March 28, | | | March 29, | | | % | | | March 28, | | | March 29, | | | % | |
| (In thousands) | | 2009 | | | 2008 | | | Change | | | 2009 | | | 2008 | | | Change | |
| | | | | | | | | | | | (As Restated) | | | | | | | |
| Net revenues | | $ | 24,394 | | | $ | 41,177 | | | | -40.8 | % | | $ | 98,924 | | | $ | 120,371 | | | | -17.8 | % |
| Selling, general and administration | | | 5,136 | | | | 5,705 | | | | -10.0 | % | | | 17,490 | | | | 17,330 | | | | 0.9 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| SG&A as a percentage of net revenues | | | 21.1 | % | | | 13.9 | % | | | | | | | 17.7 | % | | | 14.4 | % | | | | |
Selling, general and administrative expenses consist primarily of personnel and related overhead costs for sales, marketing, finance, administration, human resources and general management. The expense decrease of $569,000 for the three month period ended March 28, 2009 as compared to the same period of the prior year is attributable primarily to reduced sales volumes, as commissions and bonus expenses have declined by $493,000. The expense increase of $161,000 for the nine month period ended March 28, 2009 as compared to the same period of the prior year is attributable to increased salaries of $829,000 and share-based compensation expense of $419,000, partially offset by reductions in sales volume-related costs of commissions and bonus accruals, down $810,000, and product samples provided to prospective customers, down $368,000.
The Company anticipates that selling, general and administrative expenses will increase in future periods over the long term due to increased staffing levels, particularly in sales and marketing, as well as increased commission expense to the extent the Company achieves higher sales levels. The Company intends to continue its focus on controlling costs. If business conditions deteriorate or the rate of improvement does not meet our expectations, the Company may implement further cost-cutting actions.
Interest and Other Income, Net
| | | Three Months Ended | | | Nine Months Ended | |
| | | March 28, | | | March 29, | | | % | | | March 28, | | | March 29, | | | % | |
| (In thousands) | | 2009 | | | 2008 | | | Change | | | 2009 | | | 2008 | | | Change | |
| | | | | | | | | | | | | | | | | | | |
| Interest and other income, net | | $ | 1,501 | | | $ | 903 | | | | 66.2 | % | | $ | 3,871 | | | $ | 3,895 | | | | -0.6 | % |
The $598,000 increase in interest and other income for the three month period ended March 28, 2009 as compared with the same period of the prior year was primarily the result of $571,000 of realized gains on sales of short-term investments. Interest and other income for the nine month period ended March 28, 2009 was essentially unchanged from the same period of the prior year.
Income Tax Expense
| | | Three Months Ended | | | Nine Months Ended | |
| | | March 28, | | | March 29, | | | % | | | March 28, | | | March 29, | | | % | |
| (In thousands) | | 2009 | | | 2008 | | | Change | | | 2009 | | | 2008 | | | Change | |
| | | | | | | | | | | | (As Restated) | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Pre-tax income | | $ | 691 | | | $ | 6,111 | | | | -88.7 | % | | $ | 7,388 | | | $ | 18,151 | | | | -59.3 | % |
| Income tax | | | 460 | | | | 2,054 | | | | -77.6 | % | | | 2,344 | | | | 6,089 | | | | -61.5 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Effective tax rate | | | 67 | % | | | 34 | % | | | | | | | 32 | % | | | 34 | % | | | | |
The decrease in income tax expense for the three and nine months ended March 29, 2008 over the same periods of the prior year is due to the significant decreases in income before income taxes in the second and third quarters as well as the reinstatement of the research and development tax credit. The high effective tax rate for the quarter ended March 28, 2009 is due to adjustments to reflect management’s current estimate of the annual effective tax rate of 32%. The 32% year-to-date effective tax rate is reduced from the rate in fiscal 2008 primarily as a result of the reduced level of pretax income and the earnings mix between tax jurisdictions.
Our effective tax rate differs from the federal statutory rate primarily due to state income taxes, research and development tax credits, stock-based compensation from incentive stock options, tax-exempt interest income, and differing tax rates in income-earning jurisdictions.
Equity in Net Income of Unconsolidated Affiliates
| | | Three Months Ended | | | | | | Nine Months Ended | | | | |
| | | March 28, | | | March 29, | | | | | | March 28, | | | March 29, | | | | |
| (In thousands) | | 2009 | | | 2008 | | | Change | | | 2009 | | | 2008 | | | Change | |
| | | | | | | | | | | | | | | | | | | |
| Equity in net income of PTI | | $ | 64 | | | $ | 54 | | | $ | 10 | | | $ | 64 | | | $ | 232 | | | $ | (168 | ) |
| Equity in net income (loss) of JCP | | | (15 | ) | | | 78 | | | | (93 | ) | | | 31 | | | | 218 | | | | (187 | ) |
| Equity in net lossess of other investees | | | - | | | | (1 | ) | | | 1 | | | | - | | | | (29 | ) | | | 29 | |
| Total | | $ | 49 | | | $ | 131 | | | $ | (82 | ) | | $ | 95 | | | $ | 421 | | | $ | (326 | ) |
Equity in net income of unconsolidated affiliates includes our allocated portion of the net income of Pericom Technology, Inc. (“PTI”), a British Virgin Islands corporation based in Shanghai, People’s Republic of China and Hong Kong. Our allocated portion of PTI’s results was income of $64,000 for the three and nine months ended March 28, 2009, as compared with income of $54,000 and $232,000 for the same periods of the prior year.
Equity in net income of unconsolidated affiliates also includes the Company’s allocated portion of the net income of Jiyuan Crystal Photoelectric Frequency Technology Ltd. (“JCP”), an FCP manufacturing company located in Science Park of Jiyuan City, Henan Province, China. JCP is a key manufacturing partner of SRe, and SRe has acquired a 49% equity interest in JCP. For the three and nine month periods ended March 28, 2009, the Company’s allocated portion of JCP’s results were a loss of $15,000 and income of $31,000, respectively, as compared with income of $78,000 and $218,000 for the same periods of the prior year.
Liquidity and Capital Resources
As restated of March 28, 2009, the Company’s principal sources of liquidity included cash, cash equivalents and short-term and long-term investments of approximately $122.9 million as compared with $123.9 million on June 28, 2008.
The Company’s investments in debt securities include government securities, commercial paper, corporate debt securities and mortgage-backed and asset-backed securities. Government securities include federal agencies and municipal bonds. Many of the municipal bonds are insured; those that are not are nearly all AAA/Aaa rated. The corporate debt securities are all investment grade and nearly all are single A-rated or better. The asset-backed securities are AAA/Aaa rated and are backed by auto loans. Most of our mortgage-backed securities are collateralized by prime residential mortgages issued by government agencies including FNMA, FHLMC and FHLB. Those issued by banks are AAA-rated. At March 28, 2009, unrealized losses on marketable securities were $13,000. When assessing marketable securities for other-than-temporary declines in value, we consider a number of factors. Our analyses of the severity and duration of price declines, portfolio manager reports, economic forecasts and the specific circumstances of issuers indicate that it is reasonable to expect marketable securities with unrealized losses at March 28, 2009 to recover in fair value up to our cost bases within a reasonable period of time. We have the ability and intent to hold these investments until maturity, when the obligors are required to redeem them at full face value or par, and we believe the obligors have the financial resources to redeem the debt securities. Accordingly, we do not consider our investments to be other-than-temporarily impaired at March 28, 2009.
As of March 28, 2009, $29.6 million was classified as cash and cash equivalents compared with $41.6 million as of June 28, 2008. The maturities of the Company’s short term investments are staggered throughout the year so that cash requirements are met. Because the Company is a fabless semiconductor manufacturer, it has lower capital equipment requirements than other semiconductor manufacturers that own wafer fabrication facilities. For the nine month period ended March 28, 2009, the Company spent approximately $12.7 million on property and equipment compared to $7.5 million for the nine month period ended March 29, 2008. The Company generated approximately $3.9 million of interest and other income, net for the nine month period ended March 28, 2009, unchanged from the $3.9 million of interest and other income, net for the nine month period ended March 29, 2008. In the longer term the Company may generate less interest income if its total invested balance decreases and these decreases are not offset by rising interest rates or increased cash generated from operations or other sources.
The Company’s net cash provided by operating activities of $16.0 million for the nine months ended March 28, 2009 was primarily the result of net income of $5.0 million, non-cash expenses of $5.8 million in depreciation and amortization and $2.7 million of share-based compensation expense, partially offset by a $677,000 increase in net deferred taxes and a $1.1 million gain on sale of investments in marketable securities. Additional contributions to cash included a $5.3 million decrease in accounts receivable and a $4.5 million decrease in prepaid expenses and other current assets. Partially offsetting these were a $4.7 million decrease in accounts payable and a $1.6 million decrease in other current liabilities. The Company’s net cash provided by operating activities was $4.4 million in the nine months ended March 29, 2008.
Generally, as sales levels fall, the Company expects accounts receivable and accounts payable, and to a lesser extent inventories, to decrease. Inventories react more slowly because we outsource much of our production, and reduced demand takes time to be reflected back through our supply chain. Further, there will be routine fluctuations in these accounts from period to period that may be significant in amount.
The Company’s cash used in investing activities of $24.8 million for the nine months ended March 28, 2009 was primarily due to the Company’s additions to property and equipment of approximately $12.7 million as well as purchases of short term investments exceeding sales and maturities of short-term investments by approximately $10.8 million and $1.3 million paid for the acquisition of PTL’s minority interest. The Company’s cash used in investing activities was $4.8 million for the nine months ended March 29, 2008.
The Company’s cash used in financing activities for the nine months ended March 28, 2009 of $2.2 million was the result of repurchases of the Company’s common stock at a cost of $5.5 million, partially offset by $1.7 million in proceeds from borrowings of long-term debt by a wholly-owned subsidiary and $1.5 million in proceeds generated from the issuance of common stock in the Company’s employee stock plans. The Company used $11.9 million of cash in financing activities for the nine months ended March 29, 2008.
A portion of our cash may be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, we may evaluate potential acquisitions of such businesses, products or technologies.
Our long-term future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support our product development efforts, the expansion of sales and marketing efforts, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our products. We could be required, or could elect, to seek additional funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us or at all. We believe our current cash balances and cash flows generated by operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures.
Contractual Obligations and Commitments
The Company leases certain facilities under operating leases with termination dates on or before December 2013. Generally, these leases have multiple options to extend for a period of years upon termination of the original lease term or previously exercised option to extend.
PTL incurred a 15-year mortgage on its building in December 2008 in the amount of $1.7 million. The debt carries a variable rate of interest at the 1-year time deposit rate plus 0.64% for the first two years and plus 1.34% afterwards. The loan is denominated in New Taiwanese Dollars and only interest is required to be paid for the first 12 months.
The Company’s contractual obligations and commitments at March 28, 2009 are as follows:
| | | Payments Due by Period | |
| (in thousands) | | Total | | | 1 Year or Less | | | 2 – 3 Years | | | 4 – 5 Years | | | Thereafter | |
| Operating leases and operating expense commitments | | $ | 5,854 | | | $ | 1,348 | | | $ | 2,538 | | | $ | 1,968 | | | $ | - | |
| Capital equipment purchase commitments | | | 18,874 | | | | 15,272 | | | | 3,602 | | | | - | | | | - | |
| PTL debt payments | | | 1,852 | | | | 57 | | | | 285 | | | | 277 | | | | 1,233 | |
| Total | | $ | 26,580 | | | $ | 16,677 | | | $ | 6,425 | | | $ | 2,245 | | | $ | 1,233 | |
Jinan Cooperation Agreement
On January 26, 2008, the Company entered into a Cooperation Agreement with the Jinan Hi-Tech Industries Development Zone Commission (the “Commission”) in the People’s Republic of China (the “PRC”) for the Company’s investment in the Jinan Hi-Tech Industries Development Zone (the “Zone”) that is located in Shandong Province, PRC. Under the Cooperation Agreement, the Company will, through a wholly-owned Hong Kong subsidiary, Pericom Asia Ltd., build a factory in the Zone for the development and manufacturing of frequency control products. It is expected that the Company’s total gross investment will be approximately $35 million over the next few years. We have land use rights for 75 acres, and the factory is being designed for 13 surface mount device (SMD) production lines. Phase I consists of an administration building, workers dormitory and fabrication plant, and is scheduled for completion late in fiscal 2009 at an estimated cost of approximately $15 million. Expenditures through March 28, 2009 totaled approximately $5.8 million. We have included the Phase I commitments in the above contractual obligations and commitments table, but the timing of subsequent development is uncertain at this time.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements, defined by Regulation S-K item 303(a)(4), other than operating leases.
Critical Accounting Policies
Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such statements requires us to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period and the reported amounts of assets and liabilities as of the date of the financial statements. Our estimates are based on historical experience and other assumptions that we consider to be reasonable given the circumstances. Actual results may vary from our estimates.
The methods, estimates and judgments the Company uses in applying its most critical accounting policies have a significant impact on the results the Company reports in its financial statements. The Securities and Exchange Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of the Company’s financial condition and results of operations, and require the Company to make its most difficult and subjective accounting judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, the Company’s most critical accounting policies include revenue recognition and accounts receivable allowances, which impact the recording of revenues; valuation of inventories, which impacts costs of goods sold and gross margins; accounting for income taxes, which impacts the income tax provision and net income; impairment of goodwill, other intangible assets and investments, which impacts the goodwill, intangible asset and investment accounts; and stock-based compensation, which impacts costs of goods sold and operating expenses. These policies and the estimates and judgments involved are discussed further below.
REVENUE RECOGNITION. The Company recognizes revenue from the sale of its products upon shipment, provided title and risk of loss has passed to the customer, the price is fixed or determinable and collection of the revenue is reasonably assured. A provision for estimated future returns and other charges against revenue is recorded at the time of shipment. For the nine months ended March 28, 2009 the majority of the Company’s revenues were from sales to distributors.
The Company sells products to large, domestic distributors at the price listed in its price book for that distributor. The Company recognizes revenue at the time of shipment. At the time of sale the Company books a sales reserve for ship from stock and debits (“SSD”s), stock rotations, return material authorizations (“RMA”s), authorized price protection programs, and any special programs approved by management. The sales reserve is offset against revenues, which then leads to the net revenue amount reported.
The market price for the Company’s products can be significantly different from the book price at which the product was sold to the distributor. When the market price, as compared with the book price, of a particular sales opportunity from the distributor to their customer would result in low or negative margins to the distributor, a ship from stock and debit is negotiated with the distributor. SSD history is analyzed and used to develop SSD rates that form the basis of the SSD sales reserve booked each period. The Company captures these historical SSD rates from its historical records to estimate the ultimate net sales price to the distributor.
The Company’s distribution agreements provide for semi-annual stock rotation privileges of typically 10% of net sales for the previous six-month period. The contractual stock rotation applies only to shipments at book price. Asian distributors typically buy the Company’s product at less than book price and therefore are not entitled to the 10% stock rotation privilege. In order to provide for routine inventory refreshing, for the Company’s benefit as well as theirs, the Company grants Asian distributors stock rotation privileges between 1% and 5% even though the Company is not contractually obligated to do so. Each month a sales reserve is recorded for the estimated stock rotation privilege anticipated to be utilized by the distributors that month. This reserve is the sum of product of each distributor’s net sales for the month and their stock rotation percentage.
From time to time, customers may request to return parts for various reasons including the customers’ belief that the parts are not performing to specification. Many such return requests are the result of customers incorrectly using the parts, not because the parts are defective. These requests are reviewed by management and when approved result in a RMA being established. The Company is only obligated to accept returns of defective parts. For customer convenience, the Company may approve a particular return request even though it is not obligated to do so. Each month a sales reserve is recorded for the approved RMAs that have not yet been returned. The Company does not keep a general warranty reserve because historically valid warranty returns, which are the result of a part not meeting specifications or being non-functional, have been immaterial and parts can frequently be re-sold to other customers for use in other applications.
Price protection is granted solely at the discretion of Pericom management. The purpose of price protection is to reduce the distributor’s cost of inventory as market prices fall, thus reducing SSD rates. Pericom sales management prepares price protection proposals for individual products located at individual distributors. Pericom general management reviews these proposals and if a particular price protection arrangement is approved, the dollar impact will be estimated based on the book price reduction per unit for the products approved and the number of units of those products in the distributor’s inventory. A sales reserve is then recorded in that period for the estimated amount in accordance with Issue 4 of Emerging Issues Task Force Issue No. 01-09, Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).
At the discretion of Pericom management, the Company may offer rebates on specific products sold to specific end customers. The purpose of the rebates is to allow for pricing adjustments for large programs without affecting the pricing the Company charges its distributor customers. The rebate is recorded at the time of shipment.
Customers are typically granted payment terms of between 30 and 60 days and they generally pay within those terms. Relatively few customers have been granted terms with cash discounts. Distributors are invoiced for shipments at book price. When they pay those invoices, they claim debits for SSDs, stock rotations, cash discounts, RMAs and price protection when appropriate. Once claimed, these debits are then processed against the approvals.
The revenue the Company records for sales to its distributors is net of estimated provisions for these programs. When determining this net revenue, the Company must make significant judgments and estimates. The Company’s estimates are based on historical experience rates, inventory levels in the distribution channel, current trends and other related factors. However, because of the inherent nature of estimates, there is a risk that there could be significant differences between actual amounts and the Company’s estimates. The Company’s financial condition and operating results depend on its ability to make reliable estimates and management believes such estimates are reasonable.
PRODUCT WARRANTY. The Company offers a standard one-year product replacement warranty. In the past the Company has not had to accrue for a general warranty reserve, but assesses the level and materiality of RMAs and determines whether it is appropriate to accrue for estimated returns of defective products at the time revenue is recognized. On occasion, management may determine to accept product returns beyond the standard one-year warranty period. In those instances, the Company accrues for the estimated cost at the time the decision to accept the return is made. As a consequence of the Company’s standardized manufacturing processes and product testing procedures, returns of defective product are infrequent and the quantities have not been significant. Accordingly, historical warranty costs have not been material.
SHIPPING COSTS. Shipping costs are charged to cost of revenues as incurred.
INVENTORIES. Inventories are recorded at the lower of standard cost (which generally approximates actual cost on a first-in, first-out basis) or market value. We adjust the carrying value of inventory for excess and obsolete inventory based on inventory age, shipment history and our forecast of demand over a specific future period of time. Raw material inventory is considered obsolete and written off if it has not moved in 365 days. The Company reviews its assembled devices for excess and writes them off if the quantity of assembled devices in inventory is in excess of the greater of the quantity shipped in the previous twelve months, the quantity in backlog or the quantity forecasted to be shipped in the following twelve months. In certain circumstances, management will determine, based on expected usage or other factors, that inventory considered obsolete by these guidelines should not be written off. The Company does occasionally determine that the last twelve months’ sales levels will not continue and reserves inventory in line with the quantity forecasted. The semiconductor markets that we serve are volatile and actual results may vary from our forecast or other assumptions, potentially impacting our assessment of excess and obsolete inventory and resulting in material effects on our gross margin.
IMPAIRMENT OF INTANGIBLE ASSETS. The Company performs an impairment review of its intangible assets at least annually, in conformity with SFAS No. 142, Goodwill and Other Intangible Assets. Based on the results of its most recent impairment review, the Company determined that no impairment of its intangible assets existed as of June 28, 2008. However, future impairment reviews could result in a charge to earnings.
INVESTMENTS. We have made investments including loans, bridge loans convertible to equity, or asset purchases as well as direct equity investments. These loans and investments are made with strategic intentions and have been in privately held technology companies, which by their nature are high risk. These investments are included in other assets in the balance sheet and are carried at the lower of cost, or market if the investment has experienced an other-than-temporary decline in value. We monitor these investments quarterly and make appropriate reductions in carrying value if a decline in value is deemed to be other than temporary.
DEFERRED TAX ASSETS. The Company’s deferred income tax assets represent temporary differences between the financial statement carrying amount and the tax basis of existing assets and liabilities that will result in deductible amounts in future years, including net operating loss carryforwards. Based on estimates, the carrying value of our net deferred tax assets assumes that it is more likely than not that the Company will be able to generate sufficient future taxable income in certain tax jurisdictions. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. If, in the future, the Company experiences losses for a sustained period of time, the Company may not be able to conclude that it is more likely than not that the Company will be able to generate sufficient future taxable income to realize our deferred tax assets. If this occurs, the Company may be required to increase the valuation allowance against the deferred tax assets resulting in additional income tax expense.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
At March 28, 2009 our investment portfolio consisted of investment-grade fixed income securities, excluding those classified as cash equivalents, of $93.3 million. These securities are subject to interest rate risk and will decline in value if market interest rates increase. However, we do not believe that such a decrease would have a material effect on our results of operations over the next fiscal year. Due to the short duration and conservative nature of these instruments, we do not believe that we have a material exposure to interest rate risk.
When the general economy weakens significantly, as it has recently, the credit profile, financial strength and growth prospects of certain issuers of interest-bearing securities held in our investment portfolios may deteriorate, and our interest-bearing securities may lose value either temporarily or other than temporarily. We may implement investment strategies of different types with varying duration and risk/return trade-offs that do not perform well. At March 28, 2009, we held a significant portion of our corporate cash in diversified portfolios of investment-grade marketable securities, mortgage- and asset-backed securities, and other securities that have been affected by recent credit market concerns and had unrealized losses of $13,000. Although we consider these unrealized losses to be temporary, there is a risk that we may incur other-than-temporary impairment charges or realized losses on the values of these and other similarly affected securities if U.S. credit and equity markets do not stabilize and recover to previous levels in the coming quarters.
The Company transacts business in various non-U.S. currencies, primarily the New Taiwan Dollar. The Company is exposed to fluctuations in foreign currency exchange rates on accounts receivable from sales in these foreign currencies and the net monetary assets and liabilities of the related foreign subsidiary. A hypothetical 10% favorable or unfavorable change in foreign currency exchange rates would have a material impact on our financial position or results of operations.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“the Exchange Act”)) that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
At the time that our Quarterly Report on Form 10-Q for the quarterly period ended March 28, 2009 was originally filed, our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures and concluded that as of the end of such period, our disclosure controls and procedures were effective.
In connection with the restatement discussed above in Note 2 to our consolidated financial statements in Item 1 of this amended report, our management, with the participation of our principal executive officer and principal financial officer reevaluated our disclosure controls and procedures. Based on that reevaluation and solely as a result of the material weaknesses in our internal control over financial reporting described below, our principal executive officer and principal financial officer have now concluded that our disclosure controls and procedures were not effective as of March 28, 2009.
Notwithstanding the material weaknesses that existed at March 28, 2009, management believes, based on its knowledge, that our restated consolidated financial statements and other financial information included in this report, fairly present, in all material respects in accordance with GAAP, our financial condition, results of operations and cash flows as of and for the periods presented in this report.
Material Weakness
In connection with the matters described above, our company’s management identified and reported to our Audit Committee the following control deficiencies, each of which constitutes a material weakness in our internal control over financial reporting as of March 28, 2009:
| | · | The Company concluded that certain controls over period-end inventory accounting did not operate with sufficient precision. Misstatements were detected relating to inventory valuation and inventory reserves. In addition, the Company’s new enterprise resource planning (“ERP”) system, which was implemented in the second quarter of fiscal 2009, contained programming errors that caused certain inventory items to be incorrectly valued. |
| | · | The Company did not maintain a sufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with the Company’s financial reporting requirements. As a result, the Company concluded that controls over the financial statement close process related to account reconciliations and analyses, including investment accounts, accounts receivable reserves, inventories, accounts payable and accrued liabilities, were not effective. |
As a result of these misstatements, we have concluded that we did not maintain effective controls as of March 28, 2009 over financial reporting. Our processes, procedures and controls were not effective to ensure that the these amounts were accurately reflected in our consolidated financial statements as of and for the period ended March 28, 2009 as previously reported. This control deficiency resulted in the restatement of our March 28, 2009 financial statements by a material amount. Therefore, we concluded that this control deficiency, as of March 28, 2009, constitutes a material weakness.
We intend to remediate these material weaknesses by making a number of improvements to our finance department, including the implementation of improved processes and systems, as well as additions to and upgrades of key finance personnel. We also plan to review our training and oversight policies and re-examine our documentation and review procedures as soon as is reasonably practical. We also intend to engage the help of outside consultants to revamp the processes in the cost module of the ERP system. We may also consider implementing other remediation measures.
Changes in Internal Control Over Financial Reporting
Other than as noted above in this Item 4, there has been no change in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) that occurred during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1A: Risk Factors
This quarterly report on Form 10-Q contains forward-looking statements which involve risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking statement as a result of various factors, including those set forth below. The listing below includes any material changes to and supersedes the description of the risk factors affecting our business previously disclosed in “Part I, Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended June 28, 2008.
FACTORS THAT MAY AFFECT OPERATING RESULTS`
In the past, our operating results have varied significantly and are likely to fluctuate in the future.
Although we currently have an improving outlook on our fiscal fourth quarter ending June 27, 2009, we continue to face a challenging business environment and limited visibility on end-market demands. Revenues in the fiscal second and third quarters were down significantly from revenues in the first fiscal quarter.
Wide varieties of factors affect our operating results. These factors include the following:
| | · | changes in the quantity of our products sold; |
| | · | changes in the average selling price of our products; |
| | · | general conditions in the semiconductor industry; |
| | · | changes in our product mix; |
| | · | a change in the gross margins of our products; |
| | · | the operating results of the FCP product line, which normally has a lower profit margin than IC products; |
| | · | expenses incurred in obtaining, enforcing, and defending intellectual property rights; |
| | · | the timing of new product introductions and announcements by us and by our competitors; |
| | · | customer acceptance of new products introduced by us; |
| | · | delay or decline in orders received from distributors; |
| | · | growth or reduction in the size of the market for interface ICs; |
| | · | the availability of manufacturing capacity with our wafer suppliers; |
| | · | changes in manufacturing costs; |
| | · | fluctuations in manufacturing yields; |
| | · | disqualification by our customers for quality or performance related issues; |
| | · | the ability of customers to pay us; and |
| | · | increased research and development expenses associated with new product introductions or process changes. |
All of these factors are difficult to forecast and could seriously harm our operating results. Our expense levels are based in part on our expectations regarding future sales and are largely fixed in the short term. Therefore, we may be unable to reduce our expenses fast enough to compensate for any unexpected shortfall in sales. Any significant decline in demand relative to our expectations or any material delay of customer orders could harm our operating results. In addition, if our operating results in future quarters fall below public market analysts' and investors' expectations, the market price of our common stock would likely decrease.
The demand for our products depends on the growth of our end users' markets.
Our continued success depends in large part on the continued growth of markets for the products into which our semiconductor and frequency control products are incorporated. These markets include the following:
| · | computers and computer related peripherals; |
| · | data communications and telecommunications equipment; |
| · | electronic commerce and the Internet; and |
| · | consumer electronics equipment. |
Any decline in the demand for products in these markets could seriously harm our business, financial condition and operating results. These markets have also historically experienced significant fluctuations in demand. We may also be seriously harmed by slower growth in the other markets in which we sell our products.
Our earnings are subject to substantial quarterly and annual fluctuations and to adverse economic conditions and market downturns
Our revenues and earnings have fluctuated significantly in the past and may fluctuate significantly in the future. General economic or other conditions could cause a downturn in the market for our products or technology. The recent financial disruption affecting the banking system, investment banks, insurance companies and financial markets have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets and extreme volatility in fixed income, credit and equity markets. In addition to the potential impact on our marketable securities portfolio, there could be a number of follow-on effects from the credit crisis on our business that could also adversely affect our operating results. The credit crisis may result in the insolvency of key suppliers resulting in product delays; the inability of our customers to obtain credit to finance purchases of our products and/or customer insolvencies that cause our customers to change delivery schedules, cancel or reduce orders; a slowdown in global economies which could result in lower end-user demand for our products; and increased impairments of our investments. Net investment income could vary from expectations depending on the gains or losses realized on the sale or exchange of securities, gains or losses from equity method investments, and impairment charges related to marketable securities. Our cash and marketable securities investments represent significant assets that may be subject to fluctuating or even negative returns depending upon interest rate movements and financial market conditions in fixed income securities. The current volatility in the financial markets and overall economic uncertainty increase the risk of substantial quarterly and annual fluctuations in our earnings.
If we do not develop products that our customers and end-users design into their products, or if their products do not sell successfully, our business and operating results would be harmed.
We have relied in the past and continue to rely upon our relationships with our customers and end-users for insights into product development strategies for emerging system requirements. We generally incorporate new products into a customer's or end-user's product or system at the design stage. However, these design efforts, which can often require significant expenditures by us, may precede product sales, if any, by a year or more. Moreover, the value to us of any design win will depend in large part on the ultimate success of the customer or end-user's product and on the extent to which the system's design accommodates components manufactured by our competitors. If we fail to achieve design wins or if the design wins fail to result in significant future revenues, our operating results would be harmed. If we have problems developing or maintaining our relationships with our customers and end-users, our ability to develop well-accepted new products may be impaired.
The markets for our products are characterized by rapidly changing technology, and our financial results could be harmed if we do not successfully develop and implement new manufacturing technologies or develop, introduce and sell new products.
The markets for our products are characterized by rapidly changing technology, frequent new product introductions and declining selling prices over product life cycles. We currently offer a comprehensive portfolio of silicon and quartz based products. Our future success depends upon the timely completion and introduction of new products, across all our product lines, at competitive price and performance levels. The success of new products depends on a variety of factors, including the following:
| · | product performance and functionality; |
| · | competitive cost structure and pricing; |
| · | successful and timely completion of product development; |
| · | sufficient wafer fabrication capacity; and |
| · | achievement of acceptable manufacturing yields by our wafer suppliers. |
We may also experience delays, difficulty in procuring adequate fabrication capacity for the development and manufacture of new products, or other difficulties in achieving volume production of these products. Even relatively minor errors may significantly affect the development and manufacture of new products. If we fail to complete and introduce new products in a timely manner at competitive price and performance levels, our business would be significantly harmed.
Intense competition in the semiconductor industry may reduce the demand for our products or the prices of our products, which could reduce our revenues and gross profits.
The semiconductor industry is intensely competitive. Our competitors include Analog Devices, Cypress Semiconductor Corporation, Fairchild Semiconductor, Int'l., Hitachi, Integrated Device Technology, Inc., Intel Corp., Maxim Integrated Products, Inc., Motorola, On Semiconductor Corp., Tundra Semiconductor Corp., PLX Technology, STMicroelectronics, Texas Instruments, Inc., and Toshiba. Most of those competitors have substantially greater financial, technical, marketing, distribution and other resources, broader product lines and longer-standing customer relationships than we do. We also compete with other major or emerging companies that sell products to certain segments of our markets. Competitors with greater financial resources or broader product lines may have a greater ability to sustain price reductions in our primary markets in order to gain or maintain market share.
We believe that our future success will depend on our ability to continue to improve and develop our products and processes. Unlike us, many of our competitors maintain internal manufacturing capacity for the fabrication and assembly of semiconductor products. This ability may provide them with more reliable manufacturing capability, shorter development and manufacturing cycles and time-to-market advantages. In addition, competitors with their own wafer fabrication facilities that are capable of producing products with the same design geometries as ours may be able to manufacture and sell competitive products at lower prices. Any introduction of products by our competitors that are manufactured with improved process technology could seriously harm our business. As is typical in the semiconductor industry, our competitors have developed and marketed products that function similarly or identically to ours. If our products do not achieve performance, price, size or other advantages over products offered by our competitors, our products may lose market share. Competitive pressures could also reduce market acceptance of our products, reduce our prices and increase our expenses.
We also face competition from the makers of ASICs and other system devices. These devices may include interface logic functions which may eliminate the need or sharply reduce the demand for our products in particular applications.
Our results of operations have been adversely affected by the global economic slowdowns in the past.
In the past, the global economy has experienced economic slowdowns that were due to many factors, including decreased consumer confidence, unemployment, the threat of terrorism, and reduced corporate profits and capital spending. These unfavorable conditions have resulted in significant declines in our new customer order rates. Any future global economic slowing may materially and adversely affect our business, financial condition and results of operations.
Currently there is a general slowdown in the global economy and it may last for an unpredictable period with adverse impacts on credit availability, ability of our company and our customers to maintain or grow revenues and profits, and end-user demand across our customer base.
Downturns in the semiconductor industry, rapidly changing technology, accelerated selling price erosion and evolving industry standards can harm our operating results.
The semiconductor industry has historically been cyclical and periodically subject to significant economic downturns--characterized by diminished product demand, accelerated erosion of selling prices and overcapacity--as well as rapidly changing technology and evolving industry standards. In the future, we may experience substantial period-to-period fluctuations in our business and operating results due to general semiconductor industry conditions, overall economic conditions or other factors. Our business is also subject to the risks associated with the effects of legislation and regulations relating to the import or export of semiconductor products.
Our potential future acquisitions may not be successful.
Our potential future acquisitions could result in the following:
| · | large one-time write-offs; |
| · | the difficulty in integrating newly-acquired businesses and operations in an efficient and effective manner; |
| · | the challenges in achieving strategic objectives, cost savings, and other benefits from acquisitions as anticipated; |
| · | the risk of diverting the attention of senior management from other business concerns; |
| · | risks of entering geographic and business markets in which we have no or limited prior experience and potential loss of key employees of acquired organizations; |
| · | the risk that our markets do not evolve as anticipated and that the technologies and capabilities acquired do not prove to be those needed to be successful in those markets; |
| · | potentially dilutive issuances of equity securities; |
| · | the incurrence of debt and contingent liabilities or amortization expenses related to intangible assets; |
| · | difficulties in the assimilation of operations, personnel, technologies, products and the information systems of the acquired companies; and |
| · | difficulties in expanding information technology systems and other business processes to accommodate the acquired businesses. |
As part of our business strategy, we expect to seek acquisition prospects that would complement our existing product offerings, improve our market coverage or enhance our technological capabilities. Although we are evaluating acquisition and strategic investment opportunities on an ongoing basis, we may not be able to locate suitable acquisition or investment opportunities. In addition, from time to time, we invest in other companies, without actually acquiring them, and such investments involve many of the same risks as are involved with acquisitions.
The trading price of our common stock and our operating results are likely to fluctuate substantially in the future.
The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price could fluctuate widely in response to factors some of which are not within our control, including:
| · | general conditions in the semiconductor and electronic systems industries; |
| · | quarter-to-quarter variations in operating results; |
| · | announcements of technological innovations or new products by us or our competitors; and |
| · | changes in earnings estimates by analysts; and price and volume fluctuations in the overall stock market, which have particularly affected the market prices of many high technology companies. |
Implementation of FASB rules for the accounting of equity instruments and the issuance of new laws or other accounting regulations, or reinterpretation of existing laws or regulations, could materially impact our business or stated results.
Statement of Accounting Standards (“SFAS”) No. 123(R) Share-Based Payments required the Company to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The adoption of this statement resulted in a negative impact on the Company’s reported results of operations. In general, from time to time, the government, courts and the financial accounting boards may issue new laws or accounting regulations, or modify or reinterpret existing ones. There may be future changes in laws, interpretations or regulations that would affect our financial results or the way in which we present them. Additionally, changes in the laws or regulations could have adverse effects on hiring and many other aspects of our business that would affect our ability to compete, both nationally and internationally.
We and our independent registered public accounting firm previously determined that we had material weaknesses in our internal control over financial reporting, that have since been remediated. There can be no assurance that a material weakness will not arise in the future. Should such a material weakness arise, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.
Under Section 404 of the Sarbanes-Oxley Act of 2002, we are required to evaluate and determine the effectiveness of our internal control over financial reporting. In our annual reports on Form 10-K for the years ended June 30, 2007 and July 2, 2005 we reported material weaknesses in our internal control over financial reporting. We have since remediated these deficiencies and continue to spend a significant amount of time and resources to ensure compliance with Section 404 of the Sarbanes-Oxley Act of 2002 to maintain internal control over financial reporting. As reported in Item 9A of the Company’s Form 10-K for the year ended June 28, 2008, our management does not believe we had any material weakness in our internal control over financial reporting as of June 28, 2008, and management has determined that as of June 28, 2008, our internal control over financial reporting was effective. However, considering we will continue to evolve our business in a changing marketplace and will continue to make corresponding changes in our internal control in financial reporting, there can be no assurance that material weaknesses or significant deficiencies will not arise in the future. Should we or our independent registered public accounting firm determine in future periods that we have a material weakness in our internal control over financial reporting, the reliability of our financial reports may be impacted or impaired, and investors could lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.
Customer demand for the Company’s products is volatile and difficult to predict.
The Company’s customers continuously adjust their inventories in response to changes in end market demand for their products and the availability of semiconductor components. This results in frequent changes in demand for the Company’s products. The volatility of customer demand limits the Company’s ability to predict future levels of sales and profitability. The supply of semiconductors can quickly and unexpectedly match or exceed demand because end customer demand can change very quickly. Also, semiconductor suppliers can rapidly increase production output. This can lead to a sudden oversupply situation and a subsequent reduction in order rates and revenues as customers adjust their inventories to true demand rates. A rapid and sudden decline in customer demand for the Company’s products can result in excess quantities of certain of the Company’s products relative to demand. In this event, the Company’s operating results might be adversely affected as a result of charges to reduce the carrying value of the Company’s inventory to the estimated demand level or market price.
Changes to environmental laws and regulations applicable to manufacturers of electrical and electronic equipment are causing us to redesign our products, and may increase our costs and expose us to liability.
The implementation of new environmental regulatory legal requirements, such as lead free initiatives, may affect our product designs and manufacturing processes. The impact of such regulations on our product designs and manufacturing processes could affect the timing of compliant product introductions as well as their commercial success. Redesigning our products to comply with new regulations may result in increased research and development and manufacturing and quality control costs. In addition, the products we manufacture that comply with new regulatory standards may not perform as well as our current products. Moreover, if we are unable to successfully and timely redesign existing products and introduce new products that meet new standards set by environmental regulation and our customers, sales of our products could decline, which could materially adversely affect our business, financial condition and results of operations.
Our contracts with our wafer suppliers do not obligate them to a minimum supply or set prices. Any inability or unwillingness of our wafer suppliers generally, and Chartered Semiconductor Manufacturing Ltd. and MagnaChip Semiconductor, Inc. in particular, to meet our manufacturing requirements would delay our production and product shipments and harm our business.
In recent years, we purchased approximately 80 to 90% of our wafers from MagnaChip and Chartered, with the balance coming from three to six other suppliers. Our reliance on independent wafer suppliers to fabricate our wafers at their production facilities subjects us to possible risks such as:
| · | lack of adequate capacity; |
| · | lack of available manufactured products; |
| · | lack of control over delivery schedules; and |
| · | unanticipated changes in wafer prices. |
Any inability or unwillingness of our wafer suppliers generally, and Chartered and MagnaChip in particular, to provide adequate quantities of finished wafers to meet our needs in a timely manner would delay our production and product shipments and seriously harm our business. In March 2004, Chartered shut down one of their production facilities that was used to manufacture our products. We transitioned the production of these products to different facilities. The transfer of production of our products to other facilities subjects us to the above listed risks as well as potential yield or other production problems, which could arise as a result of any change.
At present, we purchase wafers from our suppliers through the issuance of purchase orders based on our rolling six-month forecasts. The purchase orders are subject to acceptance by each wafer supplier. We do not have long-term supply contracts that obligate our suppliers to a minimum supply or set prices. We also depend upon our wafer suppliers to participate in process improvement efforts, such as the transition to finer geometries. If our suppliers are unable or unwilling to do so, our development and introduction of new products could be delayed. Furthermore, sudden shortages of raw materials or production capacity constraints can lead wafer suppliers to allocate available capacity to customers other than us or for the suppliers' internal uses, interrupting our ability to meet our product delivery obligations. Any significant interruption in our wafer supply would seriously harm our operating results and our customer relations. Our reliance on independent wafer suppliers may also lengthen the development cycle for our products, providing time-to-market advantages to our competitors that have in-house fabrication capacity.
In the event that our suppliers are unable or unwilling to manufacture our key products in required volumes, we will have to identify and qualify additional wafer foundries. The qualification process can take up to six months or longer. Furthermore, we are unable to predict whether additional wafer foundries will become available to us or will be in a position to satisfy any of our requirements on a timely basis.
We depend on single or limited source assembly subcontractors with whom we do not have written contracts. Any inability or unwillingness of our assembly subcontractors to meet our assembly requirements would delay our product shipments and harm our business.
We primarily rely on foreign subcontractors for the assembly and packaging of our products and, to a lesser extent, for the testing of finished products. Some of these subcontractors are our single source supplier for some of our new packages. In addition, changes in our or a subcontractor's business could cause us to become materially dependent on a single subcontractor. We have from time to time experienced difficulties in the timeliness and quality of product deliveries from our subcontractors and may experience similar or more severe difficulties in the future. We generally purchase these single or limited source components or services pursuant to purchase orders and have no guaranteed arrangements with these subcontractors. These subcontractors could cease to meet our requirements for components or services, or there could be a significant disruption in supplies from them, or degradation in the quality of components or services supplied by them. Any circumstance that would require us to qualify alternative supply sources could delay shipments, result in the loss of customers and limit or reduce our revenues.
We may have difficulty accurately predicting revenues for future periods.
Our expense levels are based in part on anticipated future revenue levels, which can be difficult to predict. Our business is characterized by short-term orders and shipment schedules. We do not have long-term purchase agreements with any of our customers, and customers can typically cancel or reschedule their orders without significant penalty. We typically plan production and inventory levels based on forecasts of customer demand generated with input from customers and sales representatives. Customer demand is highly unpredictable and can fluctuate substantially. If customer demand falls significantly below anticipated levels, our gross profit would be reduced.
We compete with others to attract and retain key personnel, and any loss of or inability to attract key personnel would harm us.
To a greater degree than non-technology companies, our future success will depend on the continued contributions of our executive officers and other key management and technical personnel. None of these individuals has an employment agreement with us and each one would be difficult to replace. We do not maintain any key person life insurance policies on any of these individuals. The loss of the services of one or more of our executive officers or key personnel or the inability to continue to attract qualified personnel could delay product development cycles or otherwise harm our business, financial condition and results of operations.
Our future success also will depend on our ability to attract and retain qualified technical, marketing and management personnel, particularly highly skilled design, process and test engineers, for whom competition can be intense. During strong business cycles, we expect to experience difficulty in filling our needs for qualified engineers and other personnel.
Our limited ability to protect our intellectual property and proprietary rights could harm our competitive position.
Our success depends in part on our ability to obtain patents and licenses and preserve other intellectual property rights covering our products and development and testing tools. In the United States, we currently hold 110 patents covering certain aspects of our product designs and have 10 additional patent applications pending. Copyrights, mask work protection, trade secrets and confidential technological know-how are also key to our business. Additional patents may not be issued to us or our patents or other intellectual property may not provide meaningful protection. We may be subject to, or initiate, interference proceedings in the U.S. Patent and Trademark Office. These proceedings can consume significant financial and management resources. We may become involved in litigation relating to alleged infringement by us of others' patents or other intellectual property rights. This type of litigation is frequently expensive to both the winning party and the losing party and takes up significant amounts of management's time and attention. In addition, if we lose such a lawsuit, a court could require us to pay substantial damages and/or royalties or prohibit us from using essential technologies. For these and other reasons, this type of litigation could seriously harm our business. Also, although we may seek to obtain a license under a third party's intellectual property rights in order to bring an end to certain claims or actions asserted against us, we may not be able to obtain such a license on reasonable terms or at all.
Because it is important to our success that we are able to prevent competitors from copying our innovations, we intend to continue to seek patent, trade secret and mask work protection for our technologies. The process of seeking patent protection can be long and expensive, and we cannot be certain that any currently pending or future applications will actually result in issued patents, or that, even if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Furthermore, others may develop technologies that are similar or superior to our technology or design around the patents we own.
We also rely on trade secret protection for our technology, in part through confidentiality agreements with our employees, consultants and third parties. However, these parties may breach these agreements. In addition, the laws of some territories in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as do the laws of the United States.
Our independent foundries use a process technology that may include technology we helped develop with them, that may generally be used by those foundries to produce their own products or to manufacture products for other companies, including our competitors. In addition, we may not have the right to implement key process technologies used to manufacture some of our products with foundries other than our present foundries.
We may not provide adequate allowances for exchanges, returns and concessions.
We recognize revenue from the sale of products when shipped, less an allowance based on future authorized and historical patterns of returns, price protection, exchanges and other concessions. We believe our methodology and approach are appropriate. However, if the actual amounts we incur exceed the allowances, it could decrease our revenue and corresponding gross profit.
We are subject to risks related to taxes.
A number of factors, including unanticipated changes in the mix of earnings in countries with differing statutory tax rates or by unexpected changes in existing tax laws or our interpretation of them, could unfavorably affect our future effective tax rate. In the event our management determines it is no longer more likely than not that we will realize a portion of our deferred tax assets we will be required to increase our valuation allowance which will result in an increase in our effective tax rate. Furthermore, our tax returns are subject to examination in all the jurisdictions in which we operate which subjects us to potential increases in our tax liabilities. All of these factors could have an adverse effect on our financial condition and results of operations.
The complexity of our products makes us susceptible to manufacturing problems, which could increase our costs and delay our product shipments.
The manufacture and assembly of our products is highly complex and sensitive to a wide variety of factors, including:
| · | the level of contaminants in the manufacturing environment; |
| · | impurities in the materials used; and |
| · | the performance of manufacturing personnel and production equipment. |
In a typical semiconductor manufacturing process, silicon wafers produced by a foundry are cut into individual die. These die are assembled into individual packages and tested for performance. Our wafer fabrication suppliers have from time to time experienced lower than anticipated yields of suitable die. In the event of such decreased yields, we would incur additional costs to sort wafers, an increase in average cost per usable die and an increase in the time to market or availability of our products. These conditions could reduce our net revenues and gross margin and harm our customer relations.
We do not manufacture any of our IC products. Therefore, we are referred to in the semiconductor industry as a "fabless" producer. Consequently, we depend upon third party manufacturers to produce semiconductors that meet our specifications. We currently have third party manufacturers that can produce semiconductors that meet our needs. However, as the industry continues to progress to smaller manufacturing and design geometries, the complexities of producing semiconductors will increase. Decreasing geometries may introduce new problems and delays that may affect product development and deliveries. Due to the nature of the industry and our status as a "fabless" IC semiconductor company, we could encounter fabrication-related problems that may affect the availability of our products, delay our shipments or increase our costs. We are directly involved in the manufacture of our FCP products. As technologies continue to evolve there may be manufacturing related problems that affect our FCP products. In addition, we have committed to the construction of a new FCP facility located in the Jinan Development Zone in Shandong Province, China, which adds the uncertainties involved with staffing and starting up a new facility in a country where we have no previous operating experience.
A large portion of our revenues is derived from sales to a few customers, who may cease purchasing from us at any time.
A relatively small number of customers have accounted for a significant portion of our net revenues in each of the past several fiscal years. In general we expect this to continue for the foreseeable future. We had two direct customers that each accounted for more than 10% of net revenues during the nine months ended March 28, 2009. As a percentage of net revenues, sales to our top five direct customers during the nine months ended March 28, 2009 totaled 50.1%.
We do not have long-term sales agreements with any of our customers. Our customers are not subject to minimum purchase requirements, may reduce or delay orders periodically due to excess inventory and may discontinue purchasing our products at any time. Our distributors typically offer competing products in addition to ours. For the nine months ended March 28, 2009 and the fiscal year ended June 28, 2008, sales to our distributors were approximately 55% and 49% of net revenues, respectively as compared to approximately 40% of net revenues in the fiscal year ended June 30, 2007 and 39% for the fiscal year ended July 1, 2006. The increase in the percentage of sales to our distributors as compared with the prior periods was due to growth in sales to Asian distributor customers. The loss of one or more significant customers, or the decision by a significant distributor to carry additional product lines of our competitors could decrease our revenues.
Almost all of our wafer suppliers and assembly subcontractors are located in Southeast Asia, which exposes us to the problems associated with international operations.
Risks associated with international business operations include the following:
| · | disruptions or delays in shipments; |
| · | changes in economic conditions in the countries where these subcontractors are located; |
| · | changes in political conditions; |
| · | potentially reduced protection for intellectual property; |
| · | foreign governmental regulations; |
| · | import and export controls; and |
| · | changes in tax laws, tariffs and freight rates. |
In particular, there is a potential risk of conflict and further instability in the relationship between Taiwan and the People's Republic of China. Conflict or instability could disrupt the operations of one of our principal wafer suppliers and several of our assembly subcontractors located in Taiwan.
Because we sell our products to customers outside of the United States, we face foreign business, political and economic risks that could seriously harm us.
In the nine months ended March 28, 2009, we derived approximately 85% of our net revenues from sales in Asia and approximately 7% from sales outside of Asia and the United States. In fiscal year 2008, we derived approximately 88% of our net revenues from sales in Asia and approximately 3% from sales outside of Asia and the United States. In fiscal year 2007, we derived approximately 82% of our net revenues from sales in Asia and approximately 4% from sales outside of Asia and the United States. In fiscal year 2006, we generated approximately 64% of our net revenues from sales in Asia and approximately 17% from sales outside of Asia and the United States. We expect that export sales will continue to represent a significant portion of net revenues. We intend to continue the expansion of our sales efforts outside the United States. This expansion will require significant management attention and financial resources and further subject us to international operating risks. These risks include:
| · | tariffs and other barriers and restrictions; |
| · | unexpected changes in regulatory requirements; |
| · | the burdens of complying with a variety of foreign laws; and |
| · | delays resulting from difficulty in obtaining export licenses for technology. |
We are also subject to general geopolitical risks in connection with our international operations, such as political and economic instability and changes in diplomatic and trade relationships. In addition, because our international sales are denominated in U.S. dollars, increases in the value of the U.S. dollar could increase the price in local currencies of our products in foreign markets and make our products relatively more expensive than competitors' products that are denominated in local currencies. Regulatory, geopolitical and other factors could seriously harm our business or require us to modify our current business practices.
Our shareholder rights plan may adversely affect existing shareholders.
On March 6, 2002, we adopted a shareholder rights plan that may have the effect of deterring, delaying, or preventing a change in control that otherwise might be in the best interests of our shareholders. Under the rights plan, we issued a dividend of one preferred share purchase right for each share of our common stock held by shareholders of record as of March 21, 2002. Each right entitles shareholders to purchase one one-hundredth of our Series D Junior Participating Preferred Stock.
In general, the share purchase rights become exercisable when a person or group acquires 15% or more of our common stock or a tender offer for 15% or more of our common stock is announced or commenced. After such event, our other stockholders may purchase additional shares of our common stock at 50% off of the then-current market price. The rights will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our Board of Directors. The rights should not interfere with any merger or other business combination approved by our Board of Directors since the rights may be redeemed by us at $0.001 per right at any time before any person or group acquire 15% or more of our outstanding common stock. These rights expire in March 2012.
Our operations and financial results could be severely harmed by natural disasters.
Our headquarters and some of our major suppliers' manufacturing facilities are located near major earthquake faults. One of the foundries we use is located in Taiwan, which suffered a severe earthquake during fiscal 2000. We did not experience significant disruption to our operations as a result of that earthquake. However, if a major earthquake or other natural disaster were to affect our suppliers, our sources of supply could be interrupted, which would seriously harm our business.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On April 29, 2008, our Board of Directors authorized the repurchase of an additional $30 million of our common stock, as announced May 1, 2008.
The repurchases may be made from time to time in the open market or through private transactions at the discretion of Company management. Current cash balances and the proceeds from stock option exercises and employee stock purchase plan purchases have funded stock repurchases in the past, and we expect to fund future stock repurchases from these same sources.
See Note 9 of Notes to Condensed Consolidated Financial Statements (Unaudited) for additional historical information on our stock purchase activity.
The following table describes the shares repurchased under the authorization described above for the fiscal quarter ended March 28, 2009:
| Period | | | Total Number of Shares Purchased | | | | Average Price Paid per Share | | | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | | | Maximum Value That May Yet be Purchased Under the Plans or Programs (In Thousands) | |
| | | | | | | | | | | | | | | | | |
| December 28, 2008 - January 24, 2009 | | | - | | | $ | - | | | | - | | | $ | 26,928 | |
| January 25, 2009 - February 21, 2009 | | | - | | | | - | | | | - | | | | 26,928 | |
| February 22, 2009 - March 28, 2009 | | | 85,803 | | | | 5.50 | | | | 85,803 | | | | 26,456 | |
| | | | | | | | | | | | | | | | | |
| Total | | | 85,803 | | | $ | 5.50 | | | | 85,803 | | | $ | 26,456 | |
| Item 6. | | Exhibits. |
| | | |
| Exhibit | | Exhibit |
| Number | | Description |
| | | |
| 31.1 | | Certification of Alex C. Hui, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2 | | Certification of Angela Chen, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1 | | Certification of Alex C. Hui, Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | | Certification of Angela Chen, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
SIGNATURES
Pursuant to the requirements 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.
| | | Pericom Semiconductor Corporation |
| | | (Registrant) |
| | | |
| | | |
| | | |
Date: September 25, 2009 | By: | /s/ Alex C. Hui |
| | | Alex C. Hui |
| | | Chief Executive Officer |
| | | |
| | | |
| | By: | /s/ Angela Chen |
| | | Angela Chen |
| | | Chief Financial Officer |
