PMC Sierra (PMCS) 10-Q 2007 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10 - Q

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

for the quarterly period ended April 1, 2007

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the Transition Period From            to            

Commission File Number 0-19084

PMC-Sierra, Inc.

(Exact name of registrant as specified in its charter)

A Delaware Corporation - I.R.S. NO. 94-2925073

3975 Freedom Circle

Santa Clara, CA 95054

(408) 239-8000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

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

Common shares outstanding at May 2, 2007 – 213,663,127

INDEX

PART I - FINANCIAL INFORMATION
		Page
Item 1.	Financial Statements (unaudited)
	- Condensed consolidated statements of operations	3
	- Condensed consolidated balance sheets	4
	- Condensed consolidated statements of cash flows	5
	- Notes to the condensed consolidated financial statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4.	Controls and Procedures	36
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	38
Item 6.	Exhibits	52
Signatures		53

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Part I - FINANCIAL INFORMATION

Item 1 - Financial Statements

PMC-Sierra, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

(unaudited)

	Three Months Ended
	April 1, 2007			April 2, 2006
Net revenues	$	103,665		$	87,781
Cost of revenues		37,571			26,625
Gross profit		66,094			61,156
Other costs and expenses:
Research and development		44,524			33,749
Selling, general and administrative		26,698			19,593
Amortization of purchased intangible assets		9,835			2,110
In-process research and development		—			14,800
Restructuring costs and other charges		6,894			(738	)
Loss from operations		(21,857	)		(8,358	)
Other income (expense):
Interest income, net		1,837			3,566
Foreign exchange (loss) gain		(996	)		13
Amortization of debt issue costs		(242	)		(242	)
Gain on investments		—			1,849
Loss before recovery of (provision for) income taxes		(21,258	)		(3,172	)
Recovery of (provision for) income taxes		5,435			(11,161	)
Net loss	$	(15,823	)	$	(14,333	)
Net loss per common share—basic and diluted	$	(0.07	)	$	(0.08	)
Shares used in per share calculation—basic and diluted		213,881			187,218

See notes to the condensed consolidated financial statements.

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PMC-Sierra, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

(unaudited)

	April 1, 2007			December 31, 2006
ASSETS:
Current assets:
Cash and cash equivalents	$	280,701		$	258,914
Accounts receivable, net of allowance for doubtful accounts of $1,768 (2006—$ 1,768)		38,930			37,303
Inventories, net		30,601			34,505
Prepaid expenses and other current assets		15,888			17,164
Total current assets		366,120			347,886
Investments and other assets		13,382			14,653
Property and equipment, net		18,430			18,904
Deferred tax assets		37,164			397
Goodwill		396,143			395,943
Intangible assets, net		213,647			223,629
Deposits for wafer fabrication capacity		5,145			5,145
	$	1,050,031		$	1,006,557
LIABILITIES AND STOCKHOLDERS’ EQUITY:
Current liabilities:
Accounts payable	$	18,011		$	19,074
Accrued liabilities		51,624			51,199
Income taxes payable		132			722
Deferred income taxes		2,042			2,042
Liability for unrecognized tax benefit		57,240			58,706
Accrued restructuring costs		17,014			12,657
Deferred income		13,022			11,340
Total current liabilities		159,085			155,740
2.25% Senior convertible notes due October 15, 2025		225,000			225,000
Deferred income taxes		11,067			10,126
Liability for unrecognized tax benefit		75,274			42,531
PMC special shares convertible into 2,099 (2006—2,099) shares of common stock		2,732			2,732
Stockholders’ equity
Common stock, par value $.001: 900,000 shares authorized; 212,663 shares issued and outstanding (2006—210,650)		232			230
Additional paid in capital		1,344,590			1,327,578
Accumulated other comprehensive loss		(605	)		(1,127	)
Accumulated deficit		(767,344	)		(756,253	)
Total stockholders’ equity		576,873			570,428
	$	1,050,031		$	1,006,557

See notes to the condensed consolidated financial statements.

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PMC-Sierra, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended
	April 1, 2007			April 2, 2006
Cash flows from operating activities:
Net loss	$	(15,823	)	$	(14,333	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation of property and equipment		3,862			2,317
Amortization of intangible assets		11,374			2,853
Amortization of debt issuance costs		242			242
Stock-based compensation		9,418			5,901
Loss on disposal of property and equipment		484			—
In-process research and development		—			14,800
Loss (gain) on investments		—			(1,849	)
Changes in operating assets and liabilities, net of the effect of acquisition:
Accounts receivable		(1,627	)		(13,239	)
Inventories		3,904			(837	)
Prepaid expenses and other current assets		1,006			(19,310	)
Accounts payable and accrued liabilities		(47	)		7,045
Income taxes payable		(996	)		7,569
Accrued restructuring costs		4,357			(3,133	)
Deferred income		1,682			1,208
Net cash provided by (used in) operating activities		17,836			(10,766	)
Cash flows from investing activities:
Acquisition of business, net of cash acquired		—			(431,231	)
Proceeds from sales and maturities of short-term available-for-sale investments		—			173,010
Proceeds from sale of investments and other assets		—			5,118
Purchases of property and equipment		(2,257	)		(2,483	)
Purchase of intangible assets		(1,388	)		(587	)
Net cash used in investing activities		(3,645	)		(256,173	)
Cash flows from financing activities:
Proceeds from issuance of common stock		7,596			14,780
Net cash provided by financing activities		7,596			14,780
Net increase (decrease) in cash and cash equivalents		21,787			(252,159	)
Cash and cash equivalents, beginning of the period		258,914			405,566
Cash and cash equivalents, end of the period	$	280,701		$	153,407
Supplemental disclosures of cash flow information:
Cash refund of income taxes	$	4,000		$	513
Cash paid for income taxes		445			4,562
Supplemental disclosures of non-cash investing and financing activities:
Conversion of PMC-Sierra special shares into common stock	$	—		$	532

See notes to the condensed consolidated financial statements.

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PMC-Sierra, Inc.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

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 semiconductors, storage semiconductors and microprocessors for metro, access, Fiber To The Home, wireless infrastructure, storage, laser printers and customer premise 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 Condensed Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission (“SEC”) and United States Generally Accepted Accounting Principles. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules or regulations. The interim financial statements are unaudited, but reflect all adjustments that are, in the opinion of management, necessary to provide a fair statement of results for the interim periods presented. These financial statements should be read in conjunction with the consolidated financial statements and accompanying notes in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. Fiscal 2007 will consist of 52 weeks and will end on Sunday, December 30. Fiscal 2006 consisted of 52 weeks and ended on Sunday, December 31. The first three months of 2007 and 2006 consisted of 13 weeks.

Stock-based compensation.On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (SFAS 123(R)), which requires the recognition of compensation expense for all share-based payment awards. SFAS 123(R) requires the Company to measure the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The cost of such award will be recognized over the period during which services are provided in exchange for the award, generally the vesting period. The Company adopted SFAS 123(R) using the modified prospective transition method and therefore prior period results have not been restated.

During the three months ended April 1, 2007, the Company recognized $9.4 million in stock-based compensation expense. Where a tax deduction for stock-based compensation was available to the Company, a valuation allowance for the related deferred tax assets was recorded.

The Company uses the straight-line method for attributing stock-based compensation expense. See Note 3 to the Consolidated Financial Statements for further information on stock-based compensation.

Estimates.The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Estimates are used for, but not limited to, stock-based compensation, purchase accounting assumptions including those used to calculate the fair value of intangible assets and goodwill, the accounting for doubtful accounts, inventory reserves, depreciation and amortization, asset impairments, sales returns, warranty costs, income taxes, restructuring costs and contingencies. Actual results could differ from these estimates.

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Cash and cash equivalents.At April 1, 2007, Cash and cash equivalents included $0.8 million (December 31, 2006—$0.8 million) 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). Inventories (net of reserves of $8.3 million and $8.4 million at April 1, 2007 and December 31, 2006, respectively) were as follows:

(in thousands)	April 1, 2007		December 31, 2006
Work-in-progress	$	15,886	$	17,463
Finished goods		14,715		17,042
	$	30,601	$	34,505

Product warranties. The Company provides a one-year, limited warranty on most of its standard products and accrues for the cost at the time of shipment. The Company estimates its warranty costs based on historical failure rates and related repair or replacement costs. The change in the Company’s accrued warranty obligations from December 31, 2006 to April 1, 2007 and for the same period in the prior year were as follows:

	Three Months Ended
(in thousands)	April 1, 2007			April 2, 2006
Balance, beginning of the year	$	4,331		$	3,997
Accrual for new warranties issued		193			427
Reduction for payments (in cash or in kind)		(215	)		(74	)
Adjustments related to changes in estimate of warranty accrual		175			(145	)
Balance, end of the period	$	4,484		$	4,205

Other Indemnifications.From time to time, on a limited basis, PMC indemnifies its customers, as well as its suppliers, contractors, lessors, and others with whom it has contracts, against combinations of loss, expense, or liability arising from various triggering events related to the sale and use of its products, the use of their goods and services, the use of facilities, the state of assets that the Company sells and other matters covered by such contracts, normally up to a specified maximum amount. The Company evaluates estimated losses for such indemnifications under SFAS No. 5, “Accounting for Contingencies”, as interpreted by FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. The Company has not experienced material indemnification claims for such obligations in the past and has not accrued any liabilities related to such indemnifications in the consolidated financial statements.

Derivatives and Hedging Activities.Fluctuating foreign exchange rates may negatively impact PMC’s net income and cash flows. The Company periodically hedges foreign currency

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forecasted transactions related to certain operating expenses. All derivatives are recorded in the balance sheet at fair value. For a derivative designated as a fair value hedge, changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in net income. For a derivative designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in other comprehensive income and are recognized in net income when the hedged item affects net income. Ineffective portions of changes in the fair value of cash flow hedges are recognized in net income. If the derivative used in an economic hedging relationship is not designated in an accounting hedging relationship or if it becomes ineffective, changes in the fair value of the derivative are recognized in net income. During the quarter ended April 1, 2007, all hedges were designated as cash flow hedges.

Recent Accounting Pronouncements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). This Statement defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company expects that adoption of SFAS 157 will not have a material impact on its financial condition or results of operations.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 permits companies to record the cumulative effect of initially applying this approach in the first fiscal year ending after November 15, 2006 by recording necessary correcting adjustments to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of retained earnings. The adoption of SAB 108 did not have a material impact on its financial condition and results of operations.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (SFAS 159). This statement gives entities the option to measure certain financial assets and liabilities at fair value, with changes in fair value recorded in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company expects that adoption of SFAS 159 will not have a material impact on its financial condition or results of operations.

NOTE 2. Business Combinations

Storage Semiconductor Business

On February 28, 2006, the Company completed the acquisition of the former storage semiconductor business of Agilent Technologies, Inc. (the “Storage Semiconductor Business”) pursuant to the terms of the Purchase and Sale Agreement dated October 28, 2005 (the “Purchase Agreement”) between PMC and Avago Technologies Pte. Limited (“Avago”). These financial statements include the results of operations of the acquired business from the acquisition date.

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PMC purchased the Storage Semiconductor Business due to its strategic and product fit with PMC, the market position the Storage Semiconductor Business has in the Fibre Channel controller market, the design capabilities of its engineering team, and the growth opportunities for standard semiconductor solutions in the enterprise storage market. The Storage Semiconductor Business was part of Agilent’s Semiconductor Products Group (as defined in the Purchase Agreement), which Avago, an entity created by Kohlberg Kravis Roberts & Co. and Silver Lake Partners, acquired in December 2005. Under the terms of the Purchase Agreement, Palau Acquisition Corporation, a Delaware corporation and direct wholly owned subsidiary of PMC purchased the Storage Semiconductor Business for the following consideration:

(in thousands)
Cash paid on closing date	$	424,505
Additional cash for post-closing adjustments		6,822
Merger costs		5,602
Total consideration	$	436,929

Merger costs include investment banking, legal and accounting fees, and other external costs directly related to the acquisition.

The total purchase price has been allocated to the fair value of assets acquired and liabilities assumed, and the excess of the purchase price over the net assets acquired was recorded as goodwill, which for this acquisition is deductible for tax purposes. The allocation was determined by management based on a third-party valuation. Subsequent to the acquisition date, the initial purchase price and residual goodwill were adjusted by $1.1 million for additional inventory, by $4.0 million for design software licenses, and by $1.7 million for settlement of a legal matter. The allocation of the purchase price was as follows:

(in thousands)
In-process research and development	$	14,800
Inventory		10,720
Property and equipment		7,177
Intangible assets		167,400
Goodwill		244,052
Liabilities assumed		(7,220	)
Net assets acquired	$	436,929

Intangible assets acquired, and their respective estimated remaining useful lives, over which each asset will be amortized on a straight-line basis, are:

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(in thousands)	Estimated fair value		Estimated average remaining useful life
Core technology	$	114,300	8 years
Customer relationships		46,300	10 years
Trademarks		3,600	indefinite
Backlog		3,200	six months
In-process research and development		14,800	N/A
Total intangible assets acquired	$	182,200

Passave Inc.

On May 4, 2006, the Company acquired Passave, Inc. (“Passave”), a privately held Delaware corporation, pursuant to the Agreement and Plan of Merger (the “Merger Agreement”), dated April 4, 2006, among the Company, a newly formed direct wholly-owned subsidiary of the Company (“Merger Sub”), Passave, and a representative of certain securityholders of Passave. Under the terms of the Merger Agreement, the Company issued shares of its common stock and assumed stock options, and incurred merger costs having a total value of $304.0 million for all of the outstanding capital stock, warrants and outstanding stock options of Passave. Of this amount, $257.5 million was allocated to the purchase price, and $46.5 million related to unvested stock and stock options of Passave will be recorded as stock-based compensation over the requisite service period in accordance with FAS 123(R). The fair value of options assumed was calculated using a lattice-binomial method. Of the consideration received by stockholders of Passave, approximately 10% is being held in escrow to satisfy certain indemnification and other obligations. The Company and the security holders of Passave have each agreed to indemnify the other for, among other things, breaches of representations, warranties and covenants of the Company and Passave in the Merger Agreement. These financial statements include the results of operations of Passave from the acquisition date.

PMC purchased Passave due to its market share leadership in Passive Optical Networking solutions. This acquisition fits with PMC’s strategic intent to address the high-growth Fiber Access market and is aligned with PMC’s developments in Customer Premises Equipment. The preliminary purchase price is:

(in thousands)
PMC shares	$	224,411
Vested Passave stock options assumed by PMC		30,135
Merger costs		2,950
Total preliminary purchase price	$	257,496

The total purchase price has been allocated on a preliminary basis to the fair value of assets acquired and liabilities assumed, and the excess of the purchase price over the net assets acquired was recorded as goodwill. The preliminary allocation was determined by management based on a third-party valuation. Areas of the purchase price that are not yet finalized and may result in future amounts payable by PMC relate to settlement of a legal matter, and the residual goodwill (see Note 11 to the Consolidated Financial Statements). Merger costs include investment banking fees, legal and accounting fees and other external costs directly related to the merger.

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Net assets acquired consist of the following:

(in thousands)
Tangible assets, net of liabilities	$	10,512
Intangible assets		82,500
In-process research and development		20,500
Goodwill		143,984
Net assets acquired	$	257,496

Intangible assets acquired, and their respective estimated remaining useful lives, over which each asset will be amortized on a straight-line basis, are:

(in thousands)	Estimated fair value		Estimated average remaining useful life
Existing technology	$	46,000	4 years
Core technology		15,400	4 years
Customer relationships		20,300	4 years
Backlog		800	eight months
In-process research and development		20,500	N/A
Total intangible assets	$	103,000

Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired. In accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” goodwill will not be amortized but will instead be tested for impairment annually or more frequently if certain indicators are present.

Estimated future amortization expense for purchased intangible assets from both the acquisitions is as follows:

(in thousands)
2007	$	29,507
2008		39,343
2009		39,343
2010		25,726
2011		18,918
thereafter		50,248

NOTE 3. Stock-Based Compensation

At April 1, 2007, the Company has two stock-based compensation programs, which are described below. None of the Company’s stock-based awards are classified as liabilities. The Company did not capitalize any stock-based compensation cost, and recorded compensation expense for the three months ended April 1, 2007 and the three months ended April 2, 2006 as follows:

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	Three Months Ended
(in thousands)	April 1, 2007		April 2, 2006
Cost of revenues	$	517	$	423
Research and development		4,267		2,494
Selling, general and administrative		4,633		2,984
Total	$	9,417	$	5,901

The Company received cash of $7.6 million from stock-based awards during the three months ended April 1, 2007.

Equity Award Plans

The Company issues its common stock under the provisions of various stock award plans. Stock option awards are granted with an exercise price equal to the closing market price of the Company’s common stock at the grant date. The options generally expire in ten years and vest over four years. In 2001, the Company simplified its plan structure. The 2001 Stock Option Plan (the “2001 Plan”) was created to replace a number of stock option plans the Company had assumed in connection with mergers and acquisitions completed prior to 2001. The number of shares available for issuance under the 1994 Incentive Stock Plan (“1994 Plan”) were approved by stockholders. New stock options or other equity incentives may only be issued under the 1994 Plan and the 2001 Plan. On February 1, 2007, the Company amended its stock award plans to allow for the issuance of Restricted Stock Units (“RSU’s) to employees and directors. The first grant of RSU’s is expected to occur on May 25, 2007. These awards will vest over four years from the date of grant.

Activity under the option plans during the three months ended April 1, 2007 was as follows:

	Number of options		Weighted average exercise price per share		Weighted average remaining contractual term (years)	Aggregate intrinsic value per share at April 1, 2007
Outstanding, December 31, 2006	32,995,994		$	9.55
Granted	3,178,165		$	6.38
Exercised	(1,073,445	)	$	2.92
Forfeited	(1,018,881	)	$	8.64
Outstanding, April 1, 2007	34,081,833		$	9.50	6.75	$	0.71
Exercisable, April 1, 2007	20,120,785		$	10.70	5.46	$	0.69

No adjustment was required with respect to fully vested options that expired during the three months ended April 1, 2007. A reversal of $1.5 million was recorded for pre-vesting forfeitures.

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The fair value of the Company’s stock option awards granted to employees during the three months ended April 1, 2007 was estimated using a “lattice-binomial” valuation model. The binomial model considers the contractual term of the option, the probability that the option will be exercised prior to the end of its contractual life, and the probability of termination or retirement of the option holder in computing the value of the option. The model requires the input of highly subjective assumptions including the expected stock price volatility and expected life.

The Company’s estimates of expected volatilities are based on a weighted historical and market-based implied volatility. The Company uses historical data to estimate option exercises and employee terminations within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected term of options granted is derived from the output of the stock option valuation model and represents the period of time that granted options are expected to be outstanding. The risk-free rate for periods within the contractual life of the stock option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The fair values of the Company’s stock option awards were calculated for expense recognition in the three months ended April 1, 2007 and the three months ended April 2, 2006, respectively, using an estimated forfeiture rate, assuming no expected dividends and using the following weighted average assumptions:

	Three Months Ended
	April 1, 2007		April 2, 2006
Expected life (years)	3.9		3.8
Expected volatility	62.0	%	57.7	%
Risk-free interest rate	4.5	%	4.6	%

The weighted average grant-date fair value of stock options granted during the three months ended April 1, 2007 was $3.04 per stock option. The total intrinsic value of stock options exercised during the three months ended April 1, 2007 was $4.2 million.

As of April 1, 2007 there was $65.9 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the Company’s stock option plans, which is expected to be recognized over an average period of 2.6 years.

Employee Stock Purchase Plan

In 1991, the Company adopted an Employee Stock Purchase Plan (“ESPP”) under Section 423 of the Internal Revenue Code. Under the ESPP, the number of shares authorized to be available for issuance under the plan is 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.

During the first quarter of 2007, 940,083 shares were issued under the Plan at a weighted-average price of $4.75 per share. The total intrinsic value of ESPP shares issued during the three months ended April 1, 2007 was $1.9 million. As of April 1, 2007, 8,963,304 shares were available for future issuance under the ESPP (December 31, 2006—7,903,387).

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The fair values of share purchases through the Company’s ESPP were calculated using the Black-Scholes option pricing model, applying an estimated forfeiture rate, assuming no expected dividends and using the following weighted average assumptions:

	Three Months Ended
	April 1, 2007		April 2, 2006
Expected life (years)	1.3		1.3
Expected volatility	49.2	%	43.8	%
Risk-free interest rate	5.0	%	4.7	%

The weighted average grant-date fair value of ESPP awards during the three months ended April 1, 2007 was $2.50.

NOTE 4. Derivatives Instruments and Hedging Activities

PMC generates revenues in U.S. dollars and incurs a portion of its operating expenses in various foreign currencies, primarily the Canadian dollar. To minimize the short-term impact of foreign currency fluctuations, the Company uses currency forward contracts.

Currency forward contracts that are used to hedge exposures to variability in forecasted foreign currency cash flows are designated as cash flow hedges. The maturities of these instruments are less than twelve months. For these derivatives, the gain or loss from the effective portion of the hedge is initially reported as a component of other comprehensive income in stockholders’ equity and subsequently reclassified to earnings in the same period in which the hedged transaction affects earnings. The gain or loss from the ineffective portion of the hedge is recognized immediately as interest income or expense in Interest income, net on the Statement of Operations.

At April 1, 2007, the Company had four currency forward contracts outstanding that qualified and were designated as cash flow hedges. The U.S. dollar notional amount of these contracts was $39.6 million and the contracts had a fair value of $(0.9) million as of April 1, 2007. The gain or loss from the ineffective portion of the hedges was not significant.

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NOTE 5. Restructuring costs and other charges

The activity related to excess facility and severance accruals under the Company’s restructuring plans during the three months ended April 1, 2007, by year of plan, were as follows:

Excess facility costs

(in thousands)	2007			2006			2005			2003		2001			Total
Balance at December 31, 2006	$	—		$	2,111		$	4,268		$	549	$	5,096		$	12,024
New charges		2,013			—			—			—		—			2,013
Cash payments		—			(251	)		(351	)		—		(477	)		(1,079	)
Balance at April 1, 2007	$	2,013		$	1,860		$	3,917		$	549	$	4,619		$	12,958
Severance costs
(in thousands)	2007			2006			2005			2003		2001			Total
Balance at December 31, 2006	$	—		$	536		$	97		$	—	$	—		$	633
Adjustment		4,508			—			(29	)		—		—			4,479
Cash payments		(869	)		(149	)		(38	)		—		—			(1,056	)
Balance at April 1, 2007	$	3,639		$	387		$	30		$	—	$	—		$	4,056

2007

In the first quarter of 2007, the Company initiated a cost-reduction plan that involved staff reductions of 175 employees at various sites and the closure of design centers in Saskatoon, Saskatchewan and Winnipeg, Manitoba. In connection with this plan, the Company incurred termination benefit and relocation costs of $4.5 million, and $0.5 million in asset impairment. Further, the Company vacated excess office space at its Santa Clara facility in connection this restructuring plan, resulting in a charge of $2.0 million. To date, the Company has made payments relating to these activities of $0.9 million. Remaining severance costs will be paid by the end of 2007, and payments related to the excess facilities will extend to 2011.

2006

In the third quarter of 2006, the Company closed its Ottawa development site in order to reduce operating expenses. Approximately 35 positions were eliminated, primarily from research and development, resulting in termination benefit and relocation costs of $2.2 million, and $1.6 million for excess facilities. The Company also eliminated 10 positions from research and development in its Portland developments site, resulting in restructuring charges of $1.4 million. The charge is comprised of $0.8 million in severance, $0.3 million in excess facilities, $0.1 million for contract termination and $0.2 million in asset impairment. During the fourth quarter of 2006 the remaining portion of the Ottawa facility was vacated, resulting in a restructuring charge of $0.4 million.

To date, the Company has made payments relating to these activities of $3.4 million. The remaining severance costs were paid by the end of the first quarter of 2007, and payments related to the excess facilities will extend to 2010.

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2005

During 2005, the Company completed various restructuring activities aimed at streamlining production and reducing its operating expenses. In the first quarter of 2005, the Company recorded restructuring charges of $0.9 million in severance costs related to the termination of 24 employees across all business functions. In the second quarter of 2005, the Company expanded the workforce reduction activities initiated during the first quarter and terminated 63 research and development employees located in the Santa Clara facility. In addition, the Company consolidated its two manufacturing facilities (Santa Clara, California and Burnaby, British Columbia) into one facility (Burnaby), which involved the termination of 26 employees from production control, quality assurance, and product engineering. As a result, the Company recorded total second quarter restructuring charges of $7.6 million including $6.7 million for termination benefits and a $0.9 million write-down of equipment and software assets whose value was impaired as a result of these plans. In the third quarter of 2005, the Company consolidated its facilities and vacated excess office space in the Santa Clara location, and recorded a restructuring charge of $5.3 million for excess facilities and an additional $0.1 million in severance costs.

In the first quarter of 2006, the Company continued the workforce reduction plans initiated in 2005 and recorded $1.6 million in restructuring charges related to the termination of 19 employees, primarily from research and development in the Santa Clara facility. During the third quarter of 2006 the Company reduced its estimated severance accrual related to the 2005 workforce reduction activities by $0.4 million, and increased the accrual for excess facilities related to the 2005 restructuring by $0.8 million.

To date, the Company has made payments relating to these activities of $11.0 million. As of April 1, 2007, the software assets have been disposed of a nominal amount of severance cost remains to be paid in 2007. Payments related to the excess facilities will extend to 2011.

2003 and 2001

In 2003 and 2001, the Company implemented three restructuring plans aimed at focusing development efforts on key projects and reducing operating costs in response to the severe and prolonged economic downturn in the semiconductor industry. PMC’s assessment of the market demand for its products, and the development efforts necessary to meet this demand, were key factors in its decisions to implement these restructuring plans. As end markets for the Company’s products had contracted, certain projects were curtailed in an effort to cut costs. Cost reductions in all other functional areas were also implemented, as fewer resources were required to support the reduced level of development and sales activities during these periods.

The January 2003 restructuring included the termination of 175 employees, the closure of design centers in Maryland, Ireland and India, and vacating office space in the Santa Clara facility. To date, PMC has recorded a restructuring charge of $18.3 million, including $1.5 million for asset write-downs. These charges related to workforce reduction, lease and contract settlement costs, and the write-down of certain property, equipment and software assets whose value was impaired as a result of this restructuring plan. The Company has disposed of the property improvements and computer equipment, and software licenses have been cancelled or

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are no longer being used. In 2006, the Company reversed $2.3 million of its restructuring accrual because certain floors in the Santa Clara facility that had been vacated in 2003 were re-occupied in 2006 due to the acquisition of the Storage Semiconductor Business.

The October 2001 restructuring plan included the termination of 341 employees, the consolidation of excess facilities, and the curtailment of certain research and development projects, resulting in a restructuring charge of $175.3 million, including $12.2 million of asset write-downs. Due to a continued downturn in real estate markets, the Company recorded additional provisions for abandoned office facilities of $1.3 million in the fourth quarter of 2004.

In the first quarter of 2001, the Company recorded a charge of $19.9 million for a restructuring plan that included the termination of 223 employees across all business functions, the consolidation of a number of facilities and the curtailment of certain research and development projects. Due to the continued downturn in real estate markets, the Company recorded additional provisions for abandoned office facilities $2.2 million in the fourth quarter of 2004, and $0.8 million in the third quarter of 2006.

To date, the Company has made cash payments of $12.7 million and $175 million related to the 2003 and 2001 plans, respectively. The Company has completed the activities contemplated in these restructuring plans, but has not yet terminated the leases on its surplus facilities. Efforts to exit these sites are ongoing, but the payments related to these facilities could extend to 2011.

NOTE 6. Investments in debt securities

The following table summarizes the Company’s investments in debt securities:

(in thousands)	April 1, 2007		December 31, 2006
Available-for-sale:
Corporate bonds and notes	$	165,070	$	153,249

These debt securities are reported as cash equivalents in the balance sheet.

NOTE 7. Investments and other assets

During the three months ended April 2, 2006, the Company sold its investment in Ikanos Communications Inc. for proceeds of $5.1 million and recorded a gain of $3.1 million, included in Gain on investments on the Statement of Operations.

NOTE 8. Income Taxes

On July 13, 2006, the FASB issued interpretation No. 48, “Accounting for Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in

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accordance with FASB Statement No. 109, “Accounting for Income Taxes” and prescribes a recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Under FIN 48, the impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.

The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized a $4.7 million net decrease in the liability for unrecognized tax benefits which was accounted for as a reduction to the retained deficit and a $3.6 million decrease to the Company’s unrecognized tax benefit and a $1.1 million increase to the deferred tax asset. Included in this opening adjustment was a $6.9 million increase in the liability for unrecognized tax benefits relating to additional uncertain tax positions the Company identified as existing at December 31, 2006.

In addition, the Company had $44.2 million for the payment of interest and penalties accrued at December 31, 2006. Upon adoption of FIN 48 on January 1, 2007, the Company decreased its accrual for interest and penalties to $32.6 million. In Q1 2007, the Company recorded $3 million in additional interest expense. The Company recognizes interest and penalties related to income tax liabilities as a component of income tax expense.

Further, as part of the implementation of FIN 48, the Company reclassified $57 million from current income taxes payable to current liability for unrecognized tax benefit and $42 million from long term income taxes payable to long term liability for unrecognized tax benefit. In addition, the Company reclassified $27.5 million of tax benefits to the deferred tax asset account with a corresponding increase to the unrecognized tax benefit account.

Included in the balance of unrecognized tax benefits at January 1, 2007, are $125 million of tax benefits that, if recognized, would affect the effective tax rate. In the first quarter of 2007, there has been an increase in the balance of unrecognized tax benefits of $7.5 million, to bring the total unrecognized tax benefit at April 1, 2007 to $132.5 million. The Company does not reasonably estimate that the unrecognized tax benefit will change significantly within the next twelve months.

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The impact of the Company’s adoption of FIN 48 on accumulated deficit is as follows:

	Three months ended
(in thousands)	April 1, 2007
Balance, beginning of the year	$	(756,253	)
Net loss		(15,823	)
Adjustments related to adoption of FIN48		4,732
Balance, end of the period	$	(767,344	)

The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the years ending December 31, 2003 to 2006. A subsidiary of the Company is currently open to audit under the statute of limitations by the Canadian Revenue Agency for the years ending December 31, 2000 to 2006.

NOTE 9. Comprehensive Income (Loss)

The components of comprehensive income (loss), net of tax, are as follows:

	Three Months Ended
(in thousands)	April 1, 2007			April 2, 2006
Net loss	$	(15,823	)	$	(14,333	)
Other comprehensive (loss) income:
Change in net unrealized gains on investments		—			(110	)
Change in fair value of derivatives		522			(711	)
Total	$	(15,301	)	$	(15,154	)

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NOTE 10. Net Loss Per Share

The following table sets forth the computation of basic and diluted net loss per share:

	Three Months Ended
(in thousands, except per share amounts)	April 1, 2007			April 2, 2006
Numerator:
Net loss	$	(15,823	)	$	(14,333	)
Denominator:
Basic and diluted weighted average common shares outstanding (1)		213,881			187,218
Basic and diluted net loss per share	$	(0.07	)	$	(0.08	)

The Company had 1.2 million common stock equivalents related to stock options at April 1, 2007, that were not included in diluted net loss per share because they would be antidilutive. At April 2, 2006, 5.3 million common stock equivalents related to stock options, and 4.1 million common stock equivalents related to the 2.25% Senior Convertible Notes were excluded from 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 11. Contingencies

UTStarcom

On November 17, 2005, UTStarcom, Inc. filed a suit against Passave in the Santa Clara County Superior Court in California. In that claim, UTStarcom raised various demands regarding issues relating to the interaction of Passave’s PAS 5001 system-on-a-chip with a particular company’s switch used by UTStarcom in its Fiber-to-the-home (“FTTH”) products. In the suit, UTStarcom asserts various claims for breach of contract and breach of warranty and requests indemnity associated with the sale of Passave’s PAS 5001 products. UTStarcom claims that it incorporated those products into its FTTH products that were shipped to a particular customer, and that customer informed UTStarcom that those FTTH products supplied by UTStarcom were experiencing unacceptable data interruptions. UTStarcom further claims the data interruptions were caused by the failure of Passave’s PAS 5001 to properly interface with another company’s switch in the UTStarcom product. UTStarcom also claims that Passave breached certain warranties contained in its purchase orders and is obligated to indemnify UTStarcom and its customers for any damages that resulted from a breach of these warranties. UTStarcom further claims that its customers have submitted claims to UTStarcom, which UTStarcom also alleges stem from its product’s failure attributable to Passave’s chips. UTStarcom also claims that it has incurred costs and expenses in an amount exceeding $30 million in connection with the product defects it claims are attributable to the PAS 5001 products. On January 16, 2007, Passave filed its response to the amended complaint and also filed a cross-complaint against UTStarcom alleging interference with prospective economic advantage and breach of contract.

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The Company believes that Passave has meritorious defenses to UTStarcom’s claims and a valid basis for its cross-complaint. Although the Company has attempted to resolve this dispute, it may not be able to do so on reasonable terms, if at all. If the Company loses this litigation, a court could require the Company to pay substantial damages. Any negotiated resolution of the UTStarcom claim could also require the Company to make substantial payments. Either of these results could have a material adverse effect on the Company’s business, results of operations and financial condition. The Company has accrued the cost of replacement parts, however, this amount is not significant. The Company has not accrued any amounts related to settlement of this matter.

SEC Informal Inquiry

On August 18, 2006, PMC received an informal confidential request from the SEC advising that the SEC has commenced an informal inquiry into the Company’s historical stock option-granting practices. The Company has produced documents in response to the SEC request and is continuing to cooperate with the SEC. The Company has engaged outside counsel to represent it in the inquiry. On December 6, 2006, a meeting took place at the SEC in San Francisco during which the Audit Committee and its special counsel summarized the results of its investigation into the Company’s historical option-granting practices. The SEC requested certain documents following this meeting. There have been no further requests from or communications with the SEC regarding its informal inquiry since the Company made its submissions in February 2007.

Stockholder Derivative Lawsuits

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

The Consolidated Complaint generally alleges that various current and former Company directors and/or officers breached their duty of loyalty and/or duty of care to the Company and its stockholders, that these purported breaches of fiduciary duties caused harm to the Company, and the plaintiffs seek to recover damages on behalf of the Company. The Consolidated Complaint also alleges violations of federal securities laws. The Company is a nominal defendant in the case, but any award in the litigation would be paid to the Company, rather than to its stockholders. The Company has engaged independent legal counsel to prepare joint defense arrangements for the various defendants. On March 15, 2007, the Company filed three separate motions aimed at having the federal lawsuit dismissed on various legal grounds. The Court has set a hearing on these three motions for June 20, 2007.

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We have indemnification agreements with each of our present and former directors and officers. Under those agreements, the Company is required to indemnify each such director or officer against expenses, including attorneys’ fees, judgments, fines and settlements, paid by such individual in connection with the pending litigation (other than liabilities arising from willful misconduct or conduct that is knowingly fraudulent or deliberately dishonest).

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

This Quarterly Report contains forward-looking statements that involve risks and uncertainties. We use words such as “anticipates”, “believes”, “plans”, “expects”, “future”, “intends”, “may”, “should”, “estimates”, “predicts”, “potential”, “continue”, “becoming”, “transitioning” and similar expressions to identify such forward-looking statements. Our forward-looking statements include statements as to our business outlook, revenues, margins, expenses, tax provision rate, capital resources sufficiency, capital expenditures, interest income, restructuring activities and expenses.

Investors are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this Quarterly Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks described under “Item 1A. Risk Factors” and elsewhere in this Quarterly Report and our other filings with the SEC.

OVERVIEW

We generate revenues from the sale of semiconductor devices that we have designed and developed. Almost all of our revenues in any given year come from the sale of semiconductors that are developed prior to that year. For example, all of our revenues in the first three months of 2007 came from parts developed or acquired in 2006 and earlier. After an individual product is completed and announced it may take several years before that device generates any significant revenues. Our current revenue is generated by a portfolio of approximately 320 products.

In addition to incurring costs for the marketing, sales, and administration of selling existing products, we expend a substantial amount every year for the development of new semiconductor devices. We determine the amount to invest in the development of new semiconductors based on our assessment of the future market opportunities for those components, and the estimated return on investment. To compete globally we must invest in businesses and technologies that are both growing in demand and cost competitive in the geographic markets that we serve.

Going forward, we plan to continue to aggressively focus on the cost side of our business and find ways to improve on operational efficiencies. As part of this plan, we implemented a cost reduction plan in the first quarter of 2007 aimed at improving corporate performance and boosting productivity across the organization. We announced a reduction of our workforce by 175 people and the closure of two of our facilities in Canada. We estimate that the total costs and charges associated with the restructuring will be approximately $12-14 million, of which $7 million was recorded in the first quarter.

In 2006 we completed the integration of the Storage Semiconductor Business, which we acquired from Avago on February 28, 2006. Our consolidated results include the results of the Avago Storage Semiconductor Business from the acquisition date. We purchased the Avago Storage Semiconductor Business due to its market position in the Fibre Channel controller

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market and the growth opportunities for standard semiconductor solutions in the enterprise storage market. Since the acquisition we have experienced the benefits from product synergies between the Avago Storage Semiconductor Business’ Fibre Channel controllers and PMC’s Fibre Channel and SAS disk-interconnect products.

During the first quarter of 2007 we continued the financial and operational integration of Passave Inc., which we acquired on May 4, 2006. Passave develops system-on-chip semiconductor solutions for the Fiber To The Home (FTTH) access market. The results of Passave are included in our consolidated results from the date of acquisition. We purchased Passave due to its market share leadership in Passive Optical Networking (PON) solutions for central office and customer premise FTTH applications.

Results of Operations

First Quarters of 2007 and 2006

Net Revenues(in millions)

	First Quarter
	2007		2006		Change
Net revenues	$	103.7	$	87.8	18	%

Net revenues for the first quarter of 2007 were $103.7 million compared to $87.8 million for the same period in 2006, an increase of $15.9 million, or 18%. The increase was driven by $11.3 million of additional revenue from the acquisition of Passave and the inclusion of the Avago Storage Semiconductor Business for a full quarter versus only one month in 2006, which contributed $16.9 million, partially offset by decreased sales of our telecommunications products of $17.3 million. Apart from revenues from the acquisitions, in the first quarter of 2007, revenues from our laser printer business increased by $5 million over first quarter of 2006.

Gross Profit(in millions)

	First Quarter
	2007			2006			Change
Gross profit	$	66.1		$	61.2		8	%
Percentage of net revenues		64	%		70	%

Total gross profit increased $4.9 million, or 8%, in the first quarter of 2007 compared to the same period in 2006. Higher overall revenues due to the acquisitions drove this increase.

Gross profit as a percentage of revenues was 64% in the first quarter of 2007 compared with 70% in the first quarter of 2006. The decrease is primarily attributable to the fact that revenues from high margin communications products declined in the first quarter of 2007 compared to the same period in 2006. Also, PMC’s product mix changed as a result of the acquisitions. Since many of the acquired products sell at overall lower gross margins, particularly the Fiber To The Home products, our gross profit as a percentage of revenues decreased. If the proportion of revenues from Fiber To The Home products increases in future quarters, we expect this trend to

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continue. In addition, we recorded $0.5 million stock-based compensation expense in cost of revenues in the first quarter of 2007 compared to $0.4 million in the first quarter of 2006, which had an impact of less than one percentage point on our gross margin.

Other Costs and Expenses( in millions )

	First Quarter
	2007			2006			Change
Research and development	$	44.5		$	33.7		32	%
Percentage of net revenues		43	%		38	%
Selling, general and administrative	$	26.7		$	19.6		36	%
Percentage of net revenues		26	%		22	%
Amortization of purchased intangible assets	$	9.8			2.1		366	%
Percentage of net revenues		9	%		2	%
In-process research and development	$	—			14.8		(100	)%
Percentage of net revenues		0	%		17	%
Restructuring costs and other charges	$	6.9		$	(0.7	)	1,086	%
Percentage of net revenues		7	%		-1	%

Research and Development and Selling, General and Administrative Expenses

Our research and development, or R&D, expenses increased by $10.8 million, or 32%, in the first quarter of 2007 compared to the first quarter of 2006. Total payroll costs, including the acquired businesses, were higher by $5.2 million due to salary increases and additional headcount from Passave and the Storage Semiconductor Business. These were partially offset by savings from our workforce reduction initiatives. In addition, we recorded $4.0 million stock-based compensation expense compared to $2.2 million in the first quarter of 2006. Material costs were higher by $1.5 million, hardware and software rentals increased by $0.7 million and office and facilities costs were higher by $0.7 million, and training and travel costs also increased by $0.3 million due to the acquisitions. Depreciation expense and other costs comprised the remainder of the increase in R&D costs.

Our selling, general and administrative, or SG&A, expenses increased by $7.1 million, or 36%, in the first quarter of 2007 compared to the first quarter of 2006. The primary reasons for the increase in SG&A expense as a percentage of revenues were that payroll-related costs were higher by $3.3 million due to increased headcount from our 2006 acquisitions, we recorded $4.6 million of stock-based compensation expense compared to $3.0 million in the first quarter of 2006, professional fees increased by $1.3 million in conjunction with ongoing litigation and office and facilities support costs increased by $0.7 million.

Amortization of purchased intangible assets and in-process research and development

In the first and second quarters of 2006, we completed the acquisitions of the Storage Semiconductor Business from Avago, and of Passave, Inc. Amortization of intangible assets acquired from Passave and the Storage Semiconductor Business was $5.1 million and $4.7 million, respectively, in the first quarter of 2007.

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A portion of the purchase for Passave was allocated to in-process research and development projects and was expensed in the second quarter of 2006 because technological feasibility had not been established and no future alternative uses existed. Projects acquired from Passave included Ethernet Passive Optical Network (EPON) and Analog Front End (AFE) products, which are based on technology that provides a low-cost method of deploying optical access lines between a carrier’s central office and a customer site and which provide further enhancements and functionality to the existing EPON series, and Gigabit Passive Optical Network (GPON) products, which are more complex and support multiple protocols and provide further enhancements to the GPON series.

At the acquisition date, early revisions of the AFE products were in the final stage of testing and had been sent out to be manufactured or “taped out,” with estimated costs to complete of approximately $0.4 million. At the end of the first quarter of 2007, remaining efforts to complete the AFT products included production testing. The expected cost to complete is $0.1 million. The EPON products were in the design testing stage, with estimated costs to complete of approximately $1.9 million. By the end of the first quarter of 2007, the EPON 6301 was shipping to customers in production volumes and we expect the EPON 5201 to be formally released to production in the second quarter, with expected costs to complete this project of $0.1 million.

GPON products were in the early design and prototype stages at acquisition, with estimated costs to complete of approximately $4.5 million at the acquisition date. By the end of the first quarter of 2007, some of the products were in the design testing stage, while others were at the coding stage. Remaining efforts for completion are expected to continue through 2007-2008 and include final stages of development, design testing, tape out, and final testing, as well as customer acceptance.

A portion of the purchase for the Storage Semiconductor Business was allocated to in-process research and development projects and was expensed in the first quarter of 2006 because technological feasibility had not been established and no future alternative uses exist. Projects acquired and expensed include three next-generation Tachyon storage protocol products.

At the acquisition date, two of the next-generation Tachyon products had been taped out, with estimated costs to complete of approximately $0.8 million. These products were completed during the first quarter of 2007 and are now in production.

The third next-generation Tachyon product, a multi-protocol storage controller, was in the early design stage at acquisition, with estimated costs to complete of approximately $10 million. By the end of the first quarter of 2006, the product was still in the design stage, and based on feedback from our customers, we re-directed our design resources from this project to other Tachyon controller projects addressing the same application. Remaining efforts for completion of the product would include further design, tape out, testing, and final customer acceptance procedures.

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Restructuring costs and other charges

The activity related to excess facility and severance accruals under the Company’s restructuring plans during the three months ended April 1, 2007, by year of plan, were as follows:

Excess facility costs

(in thousands)	2007			2006			2005			2003		2001			Total
Balance at December 31, 2006	$	—		$	2,111		$	4,268		$	549	$	5,096		$	12,024
New charges		2,013			—			—			—		—			2,013
Cash payments		—			(251	)		(351	)		—		(477	)		(1,079	)
Balance at April 1, 2007	$	2,013		$	1,860		$	3,917		$	549	$	4,619		$	12,958
Severance costs
(in thousands)	2007			2006			2005			2003		2001			Total
Balance at December 31, 2006	$	—		$	536		$	97		$	—	$	—		$	633
Adjustment		4,508			—			(29	)		—		—			4,479
Cash payments		(869	)		(149	)		(38	)		—		—			(1,056	)
Balance at April 1, 2007	$	3,639		$	387		$	30		$	—	$	—		$	4,056

2007

In the first quarter of 2007, we initiated a cost-reduction plan that involved staff reductions of 175 employees at various sites and the closure of design centers in Saskatoon, Saskatchewan and Winnipeg, Manitoba. In connection with this plan, we incurred termination benefit and relocation costs of $4.5 million, and $0.5 million in asset impairment.

Further, we vacated excess office space at its Santa Clara facility in connection this restructuring plan, resulting in a charge of $2.0 million. To date, we have made payments relating to these activities of $0.9 million. We will pay the remaining severance costs by the end of 2007, and payments related to the excess facilities will extend to 2011.

2006

In the third quarter of 2006, we closed its Ottawa development site in order to reduce operating expenses and the space was vacated by the end of the fourth quarter of 2006. Approximately 35 positions were eliminated, primarily from research and development, resulting in termination benefit and relocation costs of $2.2 million, and $2.0 million for excess facilities. We also eliminated 10 positions from research and development in its Portland developments site, resulting in restructuring charges of $1.4 million. The charge is comprised of $0.8 million in severance, $0.3 million in excess facilities, $0.1 million for contract termination and $0.2 million in asset impairment.

We have made $3.4 million in payments relating to the 2006 plan. The remaining severance costs were paid by the end of the first quarter of 2007, and payments related to the excess facilities will extend to 2010.

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2005

During 2005, we completed various restructuring activities aimed at streamlining production and reducing our operating expenses. In the first quarter of 2005, we recorded restructuring charges of $0.9 million in severance costs related to the termination of 24 employees across all business functions. In the second quarter of 2005, we expanded the workforce reduction activities initiated during the first quarter and terminated 63 research and development employees located in the Santa Clara facility. In addition, we consolidated its two manufacturing facilities (Santa Clara, California and Burnaby, British Columbia) into one facility (Burnaby), which involved the termination of 26 employees from production control, quality assurance, and product engineering. As a result, we recorded total second quarter restructuring charges of $7.6 million including $6.7 million for termination benefits and a $0.9 million write-down of equipment and software assets whose value was impaired as a result of these plans. In the third quarter of 2005, we consolidated its facilities and vacated excess office space in the Santa Clara location, and recorded a restructuring charge of $5.3 million for excess facilities and an additional $0.1 million in severance costs.

In the first quarter of 2006, we continued the workforce reduction plans initiated in 2005 and recorded $1.6 million in restructuring charges related to the termination of 19 employees, primarily from research and development in the Santa Clara facility. During the third quarter of 2006, we reduced our estimated severance accrual related to the 2005 workforce reduction activities by $0.4 million, and increased our accrual for excess facilities related to the 2005 restructuring by $0.8 million.

To date, we have made payments relating to these activities of $11.0 million. As of April 1, 2007, the software assets have been disposed of a nominal amount of severance cost remains to be paid in 2007. Payments related to the excess facilities will extend to 2011.

2003 and 2001

In 2003 and 2001, we implemented three restructuring plans aimed at focusing development efforts on key projects and reducing operating costs in response to the severe and prolonged economic downturn in the semiconductor industry. Our assessment of the market demand for its products, and the development efforts necessary to meet this demand, were key factors in its decisions to implement these restructuring plans. As end markets for our products had contracted, certain projects were curtailed in an effort to cut costs. Cost reductions in all other functional areas were also implemented, as fewer resources were required to support the reduced level of development and sales activities during these periods.

The January 2003 restructuring included the termination of 175 employees, the closure of design centers in Maryland, Ireland and India, and vacating office space in the Santa Clara facility. To date, we have recorded restructuring charges of $18.3 million, including $1.5 million for asset write-downs. These charges related to workforce reduction, lease and contract settlement costs, and the write-down of certain property, equipment and software assets whose value was impaired as a result of this restructuring plan. We have disposed of the property improvements and computer equipment, and software licenses have been cancelled or are no longer being used. In 2006, we reversed $2.3 million of its restructuring accrual because certain floors in the Santa Clara facility that had been vacated in 2003 were re-occupied in 2006 due to the acquisition of the Storage Semiconductor Business.

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The October 2001 restructuring plan included the termination of 341 employees, the consolidation of excess facilities, and the curtailment of certain research and development projects, resulting in a restructuring charge of $175.3 million, including $12.2 million of asset write-downs. Due to a continued downturn in real estate markets, we recorded additional provisions for abandoned office facilities of $1.3 million in the fourth quarter of 2004.

In the first quarter of 2001, we recorded a charge of $19.9 million for a restructuring plan that included the termination of 223 employees across all business functions, the consolidation of a number of facilities and the curtailment of certain research and development projects. Due to the continued downturn in real estate markets, we recorded additional provisions for abandoned office facilities $2.2 million in the fourth quarter of 2004, and $0.8 million in the third quarter of 2006.

To date, we have made cash payments of $12.7 million and $175 million related to the 2003 and 2001 plans, respectively. We have completed the activities contemplated in these restructuring plans, but have not yet terminated the leases on its surplus facilities. Efforts to exit these sites are ongoing, but the payments related to these facilities could extend to 2011.

Other Income and Expenses( in millions )

	First Quarter
	2007			2006			Change
Interest income, net	$	1.8		$	3.6		(50	)%
Percentage of net revenues		2	%		4	%
Foreign exchange (loss) gain	$	(1.0	)	$	0.0		(100	)%
Percentage of net revenues		-1	%		0	%
Loss on extinguishment of debt and amortization of debt issue costs	$	(0.2	)	$	(0.2	)	0	%
Percentage of net revenues		0	%		0	%
Gain (loss) on investments	$	—		$	1.8		(100	)%
Percentage of net revenues		0	%		2	%

Interest income, net

Net interest income decreased by $1.7 million in the first quarter of 2007 compared to the first quarter of 2006. In February 2006, we paid approximately $431.2 million in cash for the acquisition of the Storage Semiconductor Business, thus reducing our interest income for part of the first quarter of 2006 and the entire first quarter of 2007. This reduction of $3.1 million was partially offset by increased interest income on increased cash from operations and an increase in overall yields.

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Foreign exchange loss

Our foreign exchange loss was $1 million in the first quarter of 2007, primarily related to the revaluation of our income tax payable denominated in Canadian dollars. In the first quarter of 2006, our foreign exchange gain was less than $0.1 million.

We have a significant design presence outside the United States, especially in Canada. The majority of our operating expense exposures to changes in the value of the Canadian Dollar relative to the United States Dollar have been hedged through the fourth quarter of 2008. We do not hedge our accrual for Canadian income taxes against fluctuations in foreign currency exchange rates (see Item 3. Quantitative and Qualitative Disclosures About Market Risk).

Provision for (recovery of) income taxes

We recorded a recovery of income taxes of $5.4 million in the first quarter of 2007 based on net income, excluding expenses for which we will not receive a tax benefit. Included in this amount is a $4.0 million tax recovery relating to the settlement of prior years tax credits.

We recorded a provision for income taxes of $11.2 million in the first quarter of 2006 based on net income, excluding expenses for which we will not receive a tax benefit. In addition, we recorded $7.1 million tax expense relating to withholding and other taxes on the repatriation of funds used to purchase the Storage Semiconductor Business.

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 our reported assets, liabilities, revenue and expenses, and related disclosure of our contingent assets and liabilities. Our significant accounting policies are outlined in Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the period ended December 31, 2006, which also provides commentary on our most critical accounting estimates. The following additional estimates were of note during the first three months of 2007:

Restructuring charges - Facilities

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

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In the first quarter of 2007, we recorded charges of $2.0 million for the restructuring of excess facilities in connection with our March 2007 restructuring plan. This estimate represents 100% of the estimated future operating costs and lease obligation for the exited space at our Santa Clara facility.

We believe our estimates of the obligations for the closing of sites remain 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. If our actual costs exceed our estimates, we would incur additional expenses in future periods.

Income Taxes

In estimating our annual effective tax rate we review our forecasted net income for the year by geographic area and apply the appropriate tax rates. We also consider the income tax credits available in each tax jurisdiction.

Our operations are conducted in a number of countries with complex tax legislation and regulations pertaining to our activities. We have recorded income tax liabilities based on our estimates and interpretations of those regulations for the countries we operate in. However, our estimates are subject to review and assessment by the tax authorities and the courts of those countries. For example, our estimated tax provision rate increased significantly at the end of 2006 due to an increase in our estimated tax liability following receipt in 2007 of a written communication from a tax authority concerning past transfer pricing policies and practices of certain companies within the PMC-Sierra group. As a result, we increased our provision for periods prior to 2006 by $29.9 million. The timing of any such review and final assessment of our liabilities by local authorities is substantially out of our control and is dependent on the actions by those authorities in the countries we operate in. Any re-assessment of our tax liabilities by tax authorities may result in adjustments of the income taxes we pay or refunds that are due to us.

In certain jurisdictions 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 and foreign deferred tax assets.

In the first quarter of 2007, we adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). We applied the more-likely-than-not threshold to our identified uncertain positions, as prescribed in FIN 48, resulting in a $4.7 million reduction to retained deficit that, in the absence of the adoption provisions of FIN 48, would have reduced our income tax expense.

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Business Outlook

We expect our revenues for the second quarter of 2007 to be in the range of $106 million to $109 million. As in the past, and consistent with business practice in the semiconductor industry, a significant portion of our revenues are likely to be derived from orders placed and shipped during the same quarter, which we call our “turns business”. Our revenue outlook for the second quarter of 2007 depends in part on achieving 27% of our revenues from our turns business to reach the mid-point of the revenue range. Our quarterly revenues may vary considerably as our customers adjust to fluctuating demand for products in their markets.

We anticipate our second quarter 2007 gross margins will remain at 64% including approximately $0.5 million stock-based compensation expense. As in past quarters this could vary depending on the volumes of products sold, since many of our costs are fixed. Margins will also vary depending on the mix of products sold.

We expect our second quarter research and development and selling, general and administrative expenses to be approximately $71 million to $72 million including stock-based compensation expense of approximately $9 million to $10 million. Therefore, we expect our second quarter operating research and development and selling, general and administrative expenses to be approximately $62 million.

We anticipate that interest and other income in the second quarter of 2007 will be approximately $2 million, and our income tax provision rate will range from 25% to 27%. This rate will vary depending on the mix of net income earned in the United States and other tax jurisdictions.

Liquidity & Capital Resources

Our principal source of liquidity at April 1, 2007, was $280.7 million in cash and cash equivalents.

In the first three months of 2007, we generated $17.8 million of cash in operating activities. Significant changes in working capital accounts included:

• a $1.6 million increase in accounts receivable, on which our calculated number of days outstanding at the end of the first quarter of 2007 was 34 days compared to 33 at the end of 2006;

• a $3.9 million decrease in inventory, reflecting a slight increase in our inventory turns from 4.3 in the fourth quarter of 2006 to 4.9 in the first quarter of 2007;

• a $1.0 million decrease in prepaid expenses due to renewals of design tool software contracts;

• a $1.0 million decrease in our payable for income taxes relating to tax recoveries recorded during the quarter, net of payments and tax accruals;

• a $4.4 million net increase in accrued restructuring costs due to additional charges recorded in the first quarter of 2007 and payments made during the first three months of 2007; and

• a $1.7 million increase in deferred income due to greater levels of shipments to our major distributor.

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In the first three months of 2007, cash flows from our investment activities included:

• investments of $3.6 million for the purchases of property, equipment and intangible assets.

In the first three months of 2007, cash flows from our financing activities included:

• cash proceeds of $7.6 million from the issuance of common stock under our equity-based compensation plans.

As of April 1, 2007, we had cash commitments made up of the following:

(in thousands)	Total		2007		2008		2009		2010		2011		After 2011
Contractual Obligations
Operating Lease Obligations:
Minimum Rental Payments	$	42,287	$	8,731	$	13,105	$	8,155	$	7,669	$	4,627	$	—
Estimated Operating Cost Payments		14,416		3,259		3,942		2,939		2,922		1,353		—
Long Term Debt:
Principal Repayment		225,000		—		—		—		—		—		225,000
Interest Payments		96,190		5,063		5,063		5,063		5,063		5,063		70,875
Purchase and other Obligations		24,778		9,444		5,803		7,568		1,964		—		—
	$	402,671	$	26,497	$	27,913	$	23,724	$	17,617	$	11,042	$	295,875

Purchase obligations as noted in the above table are comprised of commitments to purchase design tools and software for use in product development. Excluded from these purchase obligations are commitments for inventory or other expenses entered into in the normal course of business. We estimate these other commitments to be approximately $13.4 million at April 1, 2007 for inventory and other expenses that will be received in the coming 90 days and that will require settlement 30 days thereafter. In addition, excluded from the table above are potential additional payments from the finalization for the purchase price for Passave, Inc., which will be settled on resolution of the UTStarcom suit (See Note 11 to the Condensed Consolidated Financial Statements).

We expect to use approximately $14.7 million of cash in the remainder of 2007 for capital expenditures, including purchased intellectual property. Based on our current operating prospects, we believe that existing sources of liquidity will satisfy our projected operating, working capital, investing, capital expenditure, wafer deposit and remaining restructuring requirements through 2007.

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Item 3. 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 and Short-term Investments:

We regularly maintain a short and long-term investment portfolio of various types of government and corporate bonds and notes. Our investments are made in accordance with an investment policy approved by our Board of Directors. Maturities of these instruments are less than 30 months 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 available-for-sale and they are carried at fair market value.

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

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

Based on a sensitivity analysis performed on the financial instruments held at April 1, 2007, the impact to the fair value of our investment portfolio by a shift in the yield curve of plus, or minus, 50, 100 or 150 basis points would each result in a decline, or increase, in portfolio value of approximately $0.1 million or less.

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Senior Convertible Notes:

At April 1, 2007, $225 million of our 2.25% senior convertible notes were outstanding. 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 senior convertible notes will fluctuate as a result of changes in the price of our common stock, changes in market interest rates and changes in our credit worthiness.

Our 2.25% senior convertible notes are not listed on any securities exchange or included in any automated quotation system, but are registered for resale under the Securities Act of 1933.

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

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

Foreign Currency:

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

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

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At April 1, 2007, we had four currency forward contracts outstanding that qualified and were designated as cash flow hedges. The U.S. dollar notional amount of these contracts was $39.6 million and the contracts had a fair value of $(0.9) million.

We attempt to limit our exposure to foreign exchange rate fluctuations from our Canadian dollar net asset or liability positions. We do not hedge our accruals for Canadian income taxes in the ordinary course of business, and consequently in the first three months of 2007 we recorded a $1.0 million foreign exchange loss relating to this item. Our profitability would be materially impacted by a shift in the foreign exchange rates between United States and Canadian currencies. For example, if the value of the United States dollar decreased by an additional 5% relative to the Canadian dollar, our profitability would decrease by $5.4 million.

Other Investments:

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

Item 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

Our management evaluated, with the participation of our chief executive officer and our chief financial officer, our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our chief executive officer and our chief financial officer concluded that 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 Securities Exchange Act of 1934 is accumulated and communicated to management, including our chief executive officer and our chief financial officer, as appropriate to allow timely decisions regarding required disclosure, and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms.

Changes in internal control over financial reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) that occurred during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II – OTHER INFORMATION

Item 1. Legal Proceedings

UTStarcom

On November 17, 2005, UTStarcom, Inc. filed a suit against Passave in the Santa Clara County Superior Court in California. In that claim, UTStarcom raised various demands regarding issues relating to the interaction of Passave’s PAS 5001 system-on-a-chip with a particular company’s switch used by UTStarcom in its Fiber-to-the-home (“FTTH”) products. In the suit, UTStarcom asserts various claims for breach of contract and breach of warranty and requests indemnity associated with the sale of Passave’s PAS 5001 products. UTStarcom claims that it incorporated those products into its FTTH products that were shipped to a particular customer, and that customer informed UTStarcom that those FTTH products supplied by UTStarcom were experiencing unacceptable data interruptions. UTStarcom further claims the data interruptions were caused by the failure of Passave’s PAS 5001 to properly interface with another company’s switch in the UTStarcom product. UTStarcom also claims that Passave breached certain warranties contained in its purchase orders and is obligated to indemnify UTStarcom and its customers for any damages that resulted from a breach of these warranties. UTStarcom further claims that its customers have submitted claims to UTStarcom, which UTStarcom also alleges stem from its product’s failure attributable to Passave’s chips. UTStarcom also claims that it has incurred costs and expenses in an amount exceeding $30 million in connection with the product defects it claims are attributable to the PAS 5001 products. On January 16, 2007, Passave filed its response to the amended complaint and also filed a cross-complaint against UTStarcom alleging interference with prospective economic advantage and breach of contract.

We believe that Passave has meritorious defenses to UTStarcom’s claims and valid basis for its cross-complaint. Nevertheless, Passave has informed UTStarcom that it is prepared to replace a number of such system-on-a-chips that Passave had shipped to it as an accommodation to UTStarcom. Although we have attempted to try to resolve this dispute, we may not be able to do so on reasonable terms, if at all. If we lose this litigation, a court could require us to pay substantial damages. Any negotiated resolution of the UTStarcom claim could also require us to make substantial payments. Either of these results could have a material adverse effect on our business, results of operations and financial condition.

Stockholder Derivative Lawsuits

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

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The Consolidated Complaint generally allege that various current and former Company directors and/or officers breached their duty of loyalty and/or duty of care to the Company and its shareholders that these purported breaches of fiduciary duties caused harm to the Company, and the plaintiffs seek to recover damages on behalf of the Company. The Consolidated Complaint also alleges violations of federal securities laws. The Company is a nominal defendant in the cases, but any recovery in the litigation would be paid to the Company, rather than to its shareholders. The Company has engaged independent legal counsel to prepare joint defense arrangements for the various defendants.

On March 15, 2007, the Company filed three separate motions aimed at having the federal lawsuit dismissed on various legal grounds. The Court has set a hearing on these three motions for June 20, 2007.

Item 1A. Risk Factors

Our Company is subject to a number of risks affecting our operating results – some are normal to the fabless semiconductor industry, some are the same or similar to those disclosed in previous SEC filings, and some may be present in the future. You should carefully consider all of these risks and the other information in this report before investing in PMC. The fact that certain risks are endemic to the industry does not lessen the significance of the risk. The risk factors set forth below include any material changes to, and supersede the description, the risk factors disclosed in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

As a result of the following 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 short order lead times, customer inventory levels, production schedules, fluctuations in demand for networking equipment and our customer concentration.

Our revenues and profits may fluctuate because of factors that are beyond our control, including variation in our turns business.

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

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We may fail to meet our forecasts if our customers cancel or delay the purchase of our products.

Many of our customers have numerous product lines, numerous component requirements for each product, sizeable and complex supplier structures, and typically engage contract manufacturers for additional manufacturing capacity. In addition, our customers often shift buying patterns as they manage inventory levels, market different products, or change production schedules. This makes forecasting their production requirements difficult and can lead to an inventory surplus of certain of their components. This also reduces our visibility for revenues beyond the current quarter, so projections of full-year results based on current guidance from customers may not be realized.

We may be unable to deliver products to customers when they require them if we incorrectly estimate future demand, and this may cause the timing of shipments of our products to fluctuate. Our book-to-bill ratio in a quarter does not predict accurately revenues in the next quarter. Because a significant portion of our operating expenses are fixed, even a small revenue shortfall can have a disproportionately negative effect on our operating results.

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

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

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

We depend on a limited number of customers for a major portion of our revenues. Through direct, distributor and subcontractor purchases, Cisco Systems accounted for more than 10% of our revenues in the first quarter of 2007. The companies that constitute our largest customers may change due to the Storage Semiconductor Business and Passave acquisitions. We do not have long-term volume purchase commitments from any of our major customers. We sell our products solely on the basis of purchase orders. Those customers could decide to cease purchasing products with little or no notice and without significant penalties. A number of factors could cause our customers to cancel or defer orders, including interruptions to their operations due to a downturn in their industries, delays in manufacturing their own product offerings into which our products are incorporated and natural disasters. Accordingly, our future operating results will continue to depend on the success of our largest customers and on our ability to sell existing and new products to these customers in significant quantities.

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

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Product sales mix may adversely affect our profitability over time.

Our products range widely in terms of the margins they generate. A change in product sales mix could impact our operating results materially.

As a result of our internal review of our stock option practices and related restatement of financial results, we have become subject to an informal SEC inquiry and shareholder litigation, which may not be resolved favorably and will require significant management time and attention and accounting and legal resources, which could negatively affect our business, results of operations and cash flows.

As a result of our restatement of the 2005 10-K, the SEC has commenced an informal inquiry regarding the Company’s stock option practices, and we have been named as defendant in three derivative lawsuits. In addition, we may become the subject of government or further private litigation, including an investigation by the Department of Justice. There are no assurances that the SEC inquiry will result in the same conclusions as those reached in the Audit Committee’s review. This may result in different or additional materially adverse accounting or tax impacts on our historical financial statements relating to stock option grants. In addition, the SEC inquiry and shareholder litigation may require significant human and financial resources that could otherwise be devoted to the operation of our business. If we are subject to an adverse finding resulting from the SEC inquiry or shareholder litigation, we could be required to pay damages or penalties or have other remedies imposed upon us. An SEC investigation or litigation may also impair our ability to timely file reports with the Securities and Exchange Commission in the future, which could lead to our inability to continue to meet NASDAQ listing requirements and comply with contractual commitments to do so, and impair our ability to grant employee equity incentives. In addition, we could become the target of costly class-action securities litigation related to other matters in the future. Considerable legal and accounting expenses related to these matters have been incurred to date and significant expenditures may continue to be incurred in the future. Any new investigation or litigation could adversely affect our business, results of operations, financial position and cash flows.

Our 2006 acquisitions may adversely affect our results of operations and be dilutive to existing shareholders.

In addition to the risks the Company generally faces in connection with acquisitions, including difficulties in assimilating and integrating the operations, personnel, technologies, products and information systems of acquired businesses, there are several risks that the Company faces in connection with the acquisitions of Passave Inc., and the Avago Storage Semiconductor Business.

We purchased Passave in part based on projected growth in the Fiber To The Home market. This growth depends on many factors, including service provider capital expenditures, consumer adoption of FTTH-based services and government policy. The timing of development of the North American FTTH market is less certain than in Asian markets.

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Whether and when the Passave acquisition becomes accretive to PMC depends on growth in both Passave’s and PMC’s business. Projected tax rates for Passave’s business assume continued tax incentives from the state of Israel.

PMC must successfully integrate Passave’s personnel and operations with PMC’s personnel and operations to achieve the benefits of the acquisition.

The Storage Semiconductor Business acquisition may make the Company reliant on a limited number of customers for a major portion of its revenues. PMC may also be unsuccessful at either selling the existing products of the acquired business, or developing and selling new products of the combined company. PMC may not achieve its goal of improving time-to-market for integrated circuits using its existing technology and the acquired business’ technology.

If PMC fails to successfully address integration challenges in a timely manner, or at all, it may not realize the anticipated benefits or synergies of the acquisitions to the extent, or in the time frame, anticipated. Even if the acquired businesses are successfully integrated, the Company may not receive the expected benefits of the acquisitions, which are based on forecasts, which are subject to numerous assumptions, which may prove to be inaccurate. Any one of these integration challenges or any combination thereof could adversely affect PMC’s cash flow and results of operations, and as a result, the acquisitions may prove to be dilutive to existing shareholders.

We are involved in litigation with UTStarcom that is expensive and time consuming.

In November 2005, UTStarcom, Inc. filed a suit against Passave in the Santa Clara County Superior Court in California, which is more fully described above under Part II Item 1. “Legal Proceedings”. We believe that Passave has meritorious defenses to UTStarcom’s claims. Although we have attempted to try to resolve this claim, we may not be able to do so on reasonable terms, if at all. If PMC loses this litigation, a court could require us to pay substantial damages. Any negotiated resolution of the UTStarcom claim could also require PMC to make substantial payments. Either of these results could have a material adverse effect on our business, results of operations and financial condition.

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Changes in the political and economic climate in China and Taiwan may have a significant impact on our profitability.

China represents a significant portion of our net revenues (15% in the quarter ended April 1, 2007 and 16% in the quarter ended April 2, 2006) and substantially all of Passave’s revenues in 2006 were derived from sales of its products into Japan. Our financial condition and results of operations are becoming increasingly dependent on our sales in China and the majority of our wafer supply comes from Taiwan. China has large organizations with major programs that can start and stop quickly. For example, in 2004 our operating profits were adversely affected by a sudden slowdown in telecom infrastructure build-out in China. Instability in China’s economic environment could lead to a contraction of capital spending by our customers. Economic downturns, decreases in demand in these markets for our products and overall negative market conditions in Asia could have a disproportionate effect on our overall business results. Additional risks to us include economic sanctions imposed by the U.S. government, imposition of tariffs and other potential trade barriers or regulations, uncertain protection for intellectual property rights and generally longer receivable collection periods.

Hostilities in Israel may have a significant impact on our Israeli subsidiary’s ability to conduct its business.

One of our subsidiaries is located in Israel, and employs approximately 160 people. If regional hostilities resume, a significant number of the subsidiary’s employees may be called into active military duty at any time. As a result, while product development schedules have not to date been impacted, there may be delays in their ability to meet future development schedules. It is not clear if the hostilities will resume, and if so, how many of PMC employees may be called to military duty or otherwise affected by any potential hostilities.

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

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, enterprise storage, customer premise equipment, and generic microprocessor markets, which have established incumbents with substantial financial and technological resources. We expect more intense competition than that which we have traditionally faced as some of these incumbents derive a majority of their earnings from these markets.

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

Our customers are increasingly price conscious, as semiconductors sourced from third party suppliers comprise a greater portion of the total materials cost in networking equipment. We continue to experience aggressive price competition from competitors that wish to enter into the

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market segments in which we participate. These circumstances may make some of our products less competitive, and we may be forced to decrease our prices significantly to win a design. We may lose design opportunities or may experience overall declines in gross margins as a result of increased price competition.

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

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

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

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

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

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

Our products generally take between 12 and 24 months from initial conceptualization to development of a viable prototype, and another 3 to 18 months to be designed into our customers’ equipment and sold in production quantities. 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.

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We may have to redesign our products to meet evolving industry standards and customer specifications, which may prevent or delay future revenue growth.

We sell products to customers whose characteristics include evolving industry standards, short product lifespans, and new manufacturing and design technologies. Many of the standards and protocols for our products are based on networking technologies that may not have been widely adopted or ratified by one or more of the standard-setting bodies in our customers’ industries. Our customers may delay or alter their design demands during this standard-setting process. In response, we must redesign our products to suit these changing demands. Redesign is expensive and usually delays the production of our products. Our products may become obsolete during these delays.

Our strategy includes broadening our business into the Enterprise, Storage and Consumer markets. We may not be successful in achieving significant sales in these markets.

The Enterprise, Storage and Consumer markets are already serviced by incumbent suppliers who have established relationships with customers. We may be unsuccessful in displacing these suppliers, or having our products designed into products for different market needs. In order to compete against incumbents, we may need to lower our prices to win new business, which could lower our gross margin. We may incur increased research, development and sales costs to address these new markets. These markets typically are characterized by stronger price competition and, consequently, lower per unit profit margins. If we are successful in these markets, our overall profit margins could decline, as lower margin products may comprise a greater portion of our revenues.

We are subject to the risks of conducting business outside the United States, which may impair our sales, development or manufacturing of our products.

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.

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

We are subject to income taxes in both the United States and international jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions where the ultimate tax determination is uncertain. Additionally our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file. Although we believe our tax estimates are reasonable, there is no assurance that the final determination of our income tax liability will not be materially different than what is reflected in our income tax provisions and accruals. Should additional taxes be assessed as a result of new legislation, an audit or litigation, if our effective tax rate should change as a result of changes in federal, international or state and local tax laws, or if we were to change the locations where we operate, there could be a material effect on our income tax provision and net income in the period or

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periods in which that determination is made, and potentially to future periods as well. For instance, our estimated tax provision rate increased significantly at the end of 2006 due to an increase in our estimated tax liability following receipt in 2007 of a written communication from a tax authority examining the historic transfer pricing policies and practices of certain companies within the PMC-Sierra group. As a result, we increased our provision for periods prior to 2006 by $29.9 million and increased our 2006 expected tax rate from approximately 17% to 22%.

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, and selling and administrative costs are in Canadian dollars, and our selling costs are incurred in a variety of currencies around the world. The U.S. dollar has devalued significantly compared to the Canadian dollar and this trend may continue. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, we enter into foreign currency forward contracts. The contracts reduce, but do not eliminate, the impact of foreign currency exchange rate movements. In addition, this foreign currency risk management policy may not be effective in addressing long-term fluctuations since our contracts do not extend beyond a 12-month maturity.

We regularly limit our exposure to foreign exchange rate fluctuations from our Canadian dollar net asset or liability positions. We do not hedge our accrual for Canadian income taxes in the ordinary course of business, and consequently in the first three months of 2007 we recorded a $1.0 million foreign exchange loss relating to this item. Our profitability would be materially impacted by a 5% shift in the foreign exchange rates between United States and Canadian currencies.

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

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

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

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

Acquiring products, intellectual property, technologies, or businesses from third parties is a core part of our business strategy. That strategy depends on the availability of suitable acquisition candidates at reasonable prices and our ability to resolve challenges associated with integrating acquired businesses into our existing business. These challenges include integration of product lines, sales forces, customer lists and manufacturing facilities, development of expertise outside our existing business, diversion of management time and resources, possible divestitures, inventory write-offs and other charges. We also may be forced to replace key personnel who may leave our Company as a result of the acquisition. We cannot be certain that we will find suitable acquisition candidates or that we will be able to meet these challenges successfully.

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

From time to time, we license, or acquire, technology from third parties to incorporate into our products. Incorporating technology into our products may be more costly, or require additional management attention to achieve the desired functionality.

The complexity of our products could result in unforeseen or undetected defects or bugs, which could adversely affect the market acceptance of new products and damage our reputation with current or prospective customers.

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

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

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Our 2005 restructuring activities will increase our dependence on microprocessor cores licensed from third parties.

In June 2005, we implemented a workforce reduction plan that eliminated 63 positions from research and development in our Santa Clara design center. A significant portion of our revenues is derived from sales of microprocessors that have been developed at this location. In the future, our microprocessor road map will be dependent on successful acquisition and integration of microprocessor cores developed by third parties. If we experience difficulties in obtaining or integrating intellectual property from these third parties, it could delay or prevent the development of microprocessor-based products in the future.

The loss of personnel could delay 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. 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. As our stock price varies substantially, the stock options we grant to employees are effective as retention incentives only if they have economic value.

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 parts and 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, which could adversely affect our future operating results. In addition, if our customers’ relationships are disrupted for inability to deliver sufficient products or for any other reason, including reasons unrelated to us, it would have a significant negative impact on our business.

We depend on third-party subcontractors to assemble, obtain packaging materials for, and test substantially all of our current semiconductor products. If we lose the services of any of our subcontractors or if these subcontractors are unable to attain sufficient packaging materials, shipments of our products may be disrupted, which could harm our customer relationships and adversely affect our revenues.

Third-party contractors located primarily in Asia assemble, obtain packaging materials for, and test substantially all of our current semiconductor products. Because we rely on third-party subcontractors to perform these functions, we cannot directly control our product delivery

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schedules and quality assurance. This lack of control has in the past resulted, and could in the future result, in product shortages or quality assurance problems that could delay shipments of our products or increase our manufacturing, assembly or testing costs.

If our third-party subcontractors are unable to obtain sufficient packaging materials for our products in a timely manner, we may experience a significant product shortage or delay in product shipments, which could seriously harm our customer relationships and materially and adversely affect our net sales. If any of these subcontractors experiences capacity constraints or financial difficulties, suffers any damage to its facilities, experiences power outages or any other disruption of assembly or testing capacity, we may not be able to obtain alternative assembly and testing services in a timely manner. Due to the amount of time that it usually takes us to qualify assemblers and testers, we could experience significant delays in product shipments if we are required to find alternative assemblers or testers for our components. Any problems that we may encounter with the delivery, quality or cost of our products could damage our customer relationships and materially and adversely affect our results of operations. We are continuing to develop relationships with additional third-party subcontractors to assemble and test our products. However, even if we use these new subcontractors, we will continue to be subject to all of the risks described above.

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

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

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

We do not own or operate a wafer fabrication facility. Three outside wafer foundries supply more than 95% of our semiconductor wafer requirements. Our wafer foundry suppliers also make products for other companies and some make products for themselves, thus we may not have access to adequate capacity or certain process technologies. We have less control over delivery schedules, manufacturing yields and costs than competitors with their own fabrication facilities. If the wafer foundries we use are unable or unwilling to manufacture our products in required volumes, or at specified times, we may have to identify and qualify acceptable additional or alternative foundries. This qualification process could take six months or longer. We may not find sufficient capacity quickly enough, if ever, at an acceptable cost, to satisfy our production requirements.

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

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We depend on third parties in Asia for assembly of our semiconductor products that could delay and limit our product shipments.

Subcontractors in Asia assemble all of our semiconductor products into a variety of packages. 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. Capacity in the assembly industry has become scarce, lengthening lead times. This could become more severe, which could in turn adversely affect our revenues. We have less control over delivery schedules, assembly processes, quality assurances, raw material supplies, and costs than competitors that do not outsource these tasks.

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

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

Our estimated restructuring accruals may not be adequate.

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

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

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

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

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

To compete effectively, we must protect our intellectual property. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We hold numerous patents and have a number of pending patent applications.

We might not succeed in obtaining patents from any of our pending applications. Even if we are awarded patents, they may not provide any meaningful protection or commercial advantage to us, as they may not be of sufficient scope or strength, or may not be issued in all countries where our products can be sold. In addition, our competitors may be able to design around our patents.

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 intellectual property and the proprietary rights of third parties, which may expose us to litigation and prevent us from selling our products.

Vigorous protection and pursuit of intellectual property rights or positions characterize the semiconductor industry. This often results in expensive and lengthy litigation. We, and our customers or suppliers, may be accused of infringing on patents or other intellectual property rights owned by third parties in the future. An adverse result in any litigation could force us to pay substantial damages, stop manufacturing, using and selling the infringing products, spend significant resources to develop non-infringing technology, discontinue using certain processes or obtain licenses to the infringing technology. In addition, we may not be able to develop non-infringing technology, or find appropriate licenses on reasonable terms.

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.

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

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.

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

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

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

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

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

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

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

In addition, our Board of Directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer.

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Delaware law imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.

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

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission Of Matters To A Vote By Stockholders

None.

Item 5. Other Information

None.

Item 6. Exhibits

Exhibits –

•    11.1	Calculation of net income per share – included in Note 10 of the financial statements included in Item I of Part I of this Quarterly Report.
•    31.1	Certification of Chief Executive Officer pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002
•    31.2	Certification of Chief Financial Officer pursuant to Section 302 (a) of the Sarbanes-Oxley Act of 2002
•    32.1	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer)
•    32.2	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer)

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SIGNATURE

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.

	PMC-SIERRA, INC.
	(Registrant)
Date: May 10, 2007	/s/ Michael W. Zellner
	Michael W. Zellner
	Vice President, Chief Financial Officer and Principal Accounting Officer

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