UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 29, 2002
[ ] 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)
Delaware 94-2925073
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
3975 Freedom Circle
Santa Clara, CA 95054
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (408) 239-8000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001
Preferred Stock Purchase Rights
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 shorter 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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
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The aggregate market value of the voting stock held by nonaffiliates of the
Registrant, based upon the closing sale price of the Common Stock on June 28th,
2002, as reported by the Nasdaq National Market, was approximately $822 million.
Shares of Common Stock held by each executive officer and director and by each
person known to the Registrant who owns 5% or more of the outstanding voting
stock have been excluded in that such persons may be deemed to be affiliates.
This determination of affiliate status is not necessarily a conclusive
determination for other purposes.
As of March 11, 2003, the Registrant had 168,520,260 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for Registrant's 2003 Annual Meeting of
Stockholders are incorporated by reference into Part III, Items 10, 11, 12
and 13 of this Form 10-K Report.
PART I
ITEM 1. Business
PMC-Sierra, Inc. designs, develops, markets and supports a broad range of
high-performance integrated circuits primarily used in the telecommunications
and data networking industries. We have more than 120 different semiconductor
devices that are sold to leading equipment manufacturers, who in turn supply
their equipment principally to communications network service providers and
enterprises. We provide superior semiconductor solutions for our customers by
leveraging our intellectual property, design expertise and systems knowledge
across a broad range of applications.
PMC-Sierra was incorporated in the State of California in 1983 and
reincorporated in the State of Delaware in 1997. Our Common Stock trades on the
Nasdaq National Market under the symbol "PMCS" and is included in the S&P 500
index.
Our principal executive offices are located at 3975 Freedom Circle, Santa Clara,
California 95054, and our phone number is (408) 239-8000. Our internet homepage
is located at www.pmc-sierra.com; however, the information in, or that can be
accessed through, our home page is not part of this report. Our annual reports
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to such reports are available, free of charge, on our Internet
homepage as soon as reasonably practicable after we electronically file such
material with, or furnish it to, the Securities and Exchange Commission, or SEC.
Our fiscal year ends on the last Sunday of the calendar year. Fiscal years 2002
and 2001 each consisted of 52 weeks. Fiscal year 2000 consisted of 53 weeks. For
ease of presentation, we have referred to December 31 as our fiscal year end for
all years.
In this Annual Report on Form 10-K, "PMC-Sierra", "PMC", "the Company", "us",
"our" or "we", means PMC-Sierra, Inc. together with our subsidiary companies.
FORWARD-LOOKING STATEMENTS
This Annual Report and the portions of our Proxy Statement incorporated by
reference into this Annual Report contain forward-looking statements that
involve risks and uncertainties. We use words such as "anticipates", "believes",
"plans", "expects", "future", "intends", "may", "will", "should", "estimates",
"predicts", "potential", "continue", "becoming", "transitioning" and similar
expressions to identify such forward-looking statements.
These forward-looking statements apply only as of the date of this Annual
Report. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. Our actual results could differ materially from those
anticipated in these forward-looking statements for many reasons, including the
risks we face as described under "Factors That You Should Consider Before
Investing in PMC-Sierra" and elsewhere in this Annual Report. Investors are
cautioned not to place undue reliance on these forward-looking statements, which
reflect management's analysis only as of the date hereof. Such forward-looking
statements include statements as to, among others:
o business strategy;
o sales, marketing and distribution;
o wafer fabrication capacity;
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o competition and pricing;
o significant accounting policies and accounting estimates;
o customer networking product inventory levels, needs and order levels;
o demand for networking equipment;
o net revenues;
o gross profit;
o research and development expenses;
o marketing, general and administrative expenditures;
o interest and other income;
o capital resources sufficiency;
o capital expenditures;
o restructuring activities, expenses and associated annualized savings;
and
o our business outlook.
INDUSTRY OVERVIEW
The global markets for communications equipment that contain our products
continued to decline in 2002 primarily due to excess capacity in communication
service provider infrastructures, excess inventory levels in the supply chain
and a slowing global macro-economy. Despite the fact that connectivity to the
Internet increased and web-based applications drove higher data transmission
volumes, service providers in North America and Europe reduced spending on new
networking equipment in 2002. This was largely the result of an overbuilding of
the network infrastructure in the late 1990's and early 2000 when capital
markets fueled rapid expansion of data networks and start-up competitive
services. Following this expansionary period, many of the incumbent service
providers realized they had excess capacity in their systems and could not
sustain such high levels of spending on new equipment. In addition, many
competitive service providers were unable to generate sufficient revenues to pay
for their new systems and were subsequently acquired, broken up and divested, or
filed for bankruptcy.
The contraction in capital spending on networking equipment in 2001 and 2002
resulted in fewer orders for our customers' equipment, and therefore a reduction
in demand for our products. We sell more than 120 different semiconductor
devices to the leading original equipment manufacturers (OEMs) that, in turn,
sell their equipment to end customers such as telecommunications service
providers and enterprises. The overall reduction in service provider capital
spending, combined with high levels of inventories throughout the industry
supply chain, resulted in lower demand for our devices. While equipment spending
in the enterprise market (primarily corporations, institutions and governments)
was relatively stable compared to service providers, it was not enough to offset
a broader decline in activity across the global communications equipment
industry.
Many service providers consider it important to add capacity and technology
capability to limited aspects of their networks as data traffic and the
associated revenues are key growth drivers for their operations going forward.
To capture a growing portion of this competitive market, service providers are
transitioning their networks from voice-centric to data-centric systems. In
addition, network utilization rates are increasing, absorbing excess capacity,
but also slowing data transmission speed through service providers' networks. In
this environment, it is critical for service providers to upgrade their networks
with more efficient equipment enabling them to lower operating costs while
handling the increasing amount of traffic. The service providers must also
upgrade equipment while lowering capital spending.
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In simple terms, the Internet is a hybrid series of networks comprised of copper
wires, coaxial cables, and fiber optic cables. These networks carry high-speed
traffic in the form of electrical and optical signals that are transmitted and
received by complex networking equipment. To ensure this equipment and the
various networks can easily communicate with each other, the OEMs and makers of
communications semiconductors have developed numerous communications standards
and protocols for the industry. These communications protocols make it easier
for complex high-speed data traffic to be sent and received reliably and
efficiently - - whether intra-office, across the country, or internationally.
One industry standard that packages information into a fixed-size cell format
for transportation across networks is ATM or Asynchronous Transfer Mode. Many
service providers deploy equipment that handles this protocol because it can
support voice, video, data, and multimedia applications simultaneously.
Another established industry standard is called SONET or Synchronous Optical
Network for high capacity data communication over fiber optic systems. This is
used in the Americas and parts of Asia, with the equivalent standard in the rest
of the world called SDH or Synchronous Digital Hierarchy.
In addition to using SONET to increase the bandwidth, or capacity of, in their
networks, many system operators have also deployed equipment that uses a
technology called dense wave division multiplexing. Rather than transmitting a
single light signal over an optical fiber, dense wave division multiplexing
allows many different light signals (each of a different wavelength) to be
transmitted simultaneously. By deploying this technique at higher transmission
rates, carriers can move more signals across transmission lines.
IP is a transport protocol that maintains network information and routes packets
across networks. While IP packets are larger and can hold more data than ATM
cells, service providers often have difficulty providing the same quality of
service with IP because it is not optimized for time-sensitive signals such as
video and voice services.
Ethernet is another protocol that is used extensively in data transmission in
local area networks (LAN) and is now being used in wide area networks (WAN) as
well. Service providers are beginning to deploy ethernet because they are
familiar with the protocol and it is a relatively efficient way to handle
increasing amounts of data moving from the LAN to the WAN.
In some service provider networks, a traffic bottleneck can occur where the
high-speed long-haul traffic is handed off to networking equipment in the metro
area or where storage networks are being inter-connected. In general, service
providers have invested less to enhance the infrastructure in these areas and as
a result, many of these systems have insufficient capacity to handle the
increasing level of data traffic.
In response, many OEMs are designing faster and more complex equipment to handle
the higher volumes in the network. This equipment must be able to accommodate
various protocols and formats, including cell-based ATM and packet-based
Internet Protocol (IP).
To accommodate these different protocols and the growing demand for services,
many service providers are requiring OEMs to provide more complex, integrated
solutions in a shorter time period. At the same time, some of the OEMs have
undergone significant corporate restructurings and have fewer resources and
technical staff internally to design their own custom solutions. This, coupled
with the rising cost of custom semiconductors, has resulted in the OEMs
outsourcing more of their communications integrated circuit requirements to
companies such as PMC-Sierra. This has brought about the acceleration of the use
of standard products of the kind that PMC-Sierra designs and develops.
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By leveraging the knowledge and technical expertise of companies such as
PMC-Sierra, the OEMs are able to focus their efforts on their core competencies.
In many cases, it can take several years before a new silicon chip or chip set
can be designed, manufactured, tested, and released to full production for a
customer. It is essential, therefore, that companies like PMC-Sierra that
develop the chips to be incorporated into the OEM equipment work very closely
with their OEM customers so that together they can optimally meet the equipment
needs of the service providers.
PRODUCTS
We have more than 120 revenue-producing products in our portfolio. Our
networking products comprise communications semiconductors - - including
microprocessors - - that are used in many different types of equipment
throughout the network infrastructure. While our current networking product
development efforts are focusing on all the four areas of the network
infrastructure described below, less than 10% of our current revenues are
derived from the storage and consumer markets. One of our key strategies is to
broaden into these markets.
Our non-networking segment, comprised of a single chip used in a consumer
medical device, wound down in the second quarter of 2002, with only
insignificant revenues thereafter to meet remaining customer requirements.
Our networking products are sold primarily into four areas of the worldwide
network infrastructure, which we call Metro, Access, Enterprise/Storage, and
Consumer-related markets. Many of our products are designed with standardized
interfaces between chips so our customers can easily develop and implement
solutions involving multiple PMC-Sierra products.
The following briefly describes PMC-Sierra's view of the Metro, Access,
Enterprise/Storage and Consumer-related areas of the internet infrastructure and
some typical equipment that may include our chips and chipsets. Due to the
complexity of the telecommunications network, it is not possible to sharply
delineate the networking functions or markets served. In addition, many of our
products may be used in multiple classes of networking equipment that are
deployed across all of the market areas identified below, while some of our
other products have highly specialized applications. For example, our
microprocessors can be used in many networking equipment applications (such as
high-speed routers or networked printers), while our Paladin chip may only be
used in a single application (power amplification for wireless base stations).
In some situations, different OEMs might use our chips or chipsets in equipment
addressing more than one of the market areas noted below.
o Access: this area of the telecommunications network infrastructure
encompasses wired and wireless equipment that aggregates transmissions
from the home or office and connects that traffic to the metro and the
wide area network (WAN). For example, our semiconductors would be used
in equipment such as digital subscriber line access multiplexers,
wireless base stations, add-drop multiplexers (which add and drop
signals and streams of data from optical networks) and switches (which
direct the data traffic to other destinations within the network).
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o Metro: the metropolitan, or metro area, of the internet infrastructure
is predominantly a fiber optic-based network that provides high-speed
communications and data transfer over a city center or regional area.
This portion of the network manages traffic inside its own region and
manages traffic between the access and long-haul transport networks for
inter-city or international transmission. Our products are used in
metro equipment such as switches and routers that gather and process
signals in different protocols, and then transmit them to the next
destination as quickly and efficiently as possible.
o Enterprise/Storage: this area of the network includes equipment that is
deployed primarily in the office for data communications and other
local area network applications. Our products are used in equipment
such as medium to high-end laser jet printers in the office, as well as
switches and storage devices that enable data to be transferred to
local telecommunications networks. It includes network attached storage
equipment and storage area networks for the management, transmission
and storage of large amounts of data utilized by enterprises,
corporations and government agencies.
o Consumer: this area includes telecommunications equipment used
primarily by individuals in their homes for entertainment purposes. For
example, some of our lower-end microprocessors are used in equipment
such as set-top boxes, high-definition TVs and personal video
recorders.
Our chips and chipsets can also be divided into the broadly defined functional
categories identified below. As with descriptions of the network, particular
categories may overlap and a device may be present in more than one category. In
addition, some products, particularly multiple chip sets, integrate different
functions and could be classified in one or more categories. For example, some
of our products both convert high-speed analog signals to digital signals, and
also split or combine various transmission signals.
o Line interface units: these devices, also referred to as transceivers,
transmit and receive signals over a physical medium such as wire, cable
or fiber. The line interface unit determines the speed and timing
characteristics of the signals, and may also convert them from a serial
stream of data into a parallel stream before they are further processed
for transmission to the next destination.
o Framers and mappers: before the data can be sent to the next
destination, it must be converted into a proper format for transmission
in the network. For example, the framing function arranges the bits
into different size formats, commonly referred to as "cell" or "packet"
formats, and attaches the appropriate information to the formats to
ensure they reach their destinations. In turn, this data may be
inserted into other frames, such as SONET frames, for transmission
across high-speed fiber optics.
o Packet and cell processors: these devices examine the contents of
cells, or packets, and perform various management and reporting
functions. For instance, a switch or router may use a packet or cell
processor to determine if a signal is voice or video in order to
allocate the proper amount of bandwidth. Service providers can use
information gathered by the cell or packet processor to determine
customers' network usage and charge the appropriate service fee.
o Traffic managers and switch fabrics: traffic managers organize,
schedule and queue cells and packets into and out of switches. Switch
fabrics interconnect the wires and fibers, allowing the data to be
routed to its intended destination.
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o Serializers/Deserializers: these devices convert networking traffic
between slower speed parallel streams and higher speed serial streams.
OEMs use serial streams to reduce networking equipment line
connections, and parallel streams to allow them to apply lower cost
traffic management technologies.
o Microprocessors: these devices perform the high-speed computations that
help identify and control the flow of signals and data in the many
different types of network equipment used in the communications,
enterprise and consumer markets.
STRATEGY
Our high-speed semiconductor solutions are based on our strong knowledge of
network applications, system requirements and networking protocols. To achieve
our goal of growing and profitably expanding our business, we are pursuing the
following key strategies:
Leverage technical expertise across diverse base of applications:
We have a history of analog, digital, mixed signal and microprocessor expertise
and we integrate many functions and protocols into our products. We leverage our
common technologies and intellectual property across a broad range of networking
equipment. Many OEMs recognize they can obtain highly complex, broadband
communications technology "off the shelf" from companies such as PMC-Sierra
rather than dedicating their own resources to develop custom chips. We intend to
take advantage of our customers' growing requirements to outsource more of the
silicon content in their networking equipment which will allow the OEMs to
reduce their development costs and improve time-to-market while differentiating
their products in other ways.
Broaden our business into the Enterprise, Storage and Consumer markets:
The majority of our products are used by OEMs that sell their networking
equipment to telecommunications service providers worldwide. Over the past year,
however, we have been focused on directing many of our existing and newly
designed products into new markets. For example, our advanced
serialization/de-serialization devices are now being used in transceiver and
serial backplane applications in storage area networking and enterprise
networking equipment. Our lower-speed microprocessors are being designed into
advanced multi-function devices as well as going into consumer applications such
as personal video recorders, set-top boxes and high-definition TVs. We are
working closely with some of the largest players in the enterprise and storage
markets to help these customers design and develop standard semiconductor
solutions that will lower their costs and improve their time to market.
Increase our presence in Asian markets:
Over the past decade, we have been developing strong relationships with our
Asian customers. In 2002, just under one-third of our total revenues were
generated in the Asia Pacific region. Some of our largest customers in Japan and
Korea include Fujitsu, Ricoh, NEC, Samsung and LG Electronics. In addition, we
are gaining new customers, many of which are located in the People's Republic of
China, such as ZTE, Huawei Technologies, Fiberhome Telecommunciation
Technologies, and Alcatel Shanghai Bell. These customers are broadening their
product offerings to meet the growing network infrastructure requirements in
China and other Asian markets. To improve our customer service and penetration
into this region, we appointed a new vice president to head our Asia Pacific
sales and support team, headquartered in Shanghai. PMC-Sierra plans to continue
increasing the number of sales/marketing personnel in our Asia Pacific
operations and to add new distribution capabilities in the regional markets.
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Provide first-class products, customer service and technical support:
We work very closely with our customers to ensure they get the best service and
technical support required to assist them with their development efforts. As the
marketplace for telecommunications equipment suppliers slowly consolidates, we
believe our largest customers and their products will take an increasing
percentage of the overall market in their areas of expertise. Customers such as
Cisco, Hewlett Packard, Lucent, Nortel, Alcatel, Samsung, Fujitsu, Ricoh, ZTE,
Huawei and Juniper are aligning their design and manufacturing operations with
key suppliers like PMC-Sierra.
SALES, MARKETING AND DISTRIBUTION
Our sales and marketing strategy is to have our products designed into our
customers' equipment by developing superior products for which we provide
premium service and technical support. We maintain close working relationships
with many of our customers. Our marketing team is focused on developing new
products that meet the needs of our customers in our target markets. We are
often involved in the early stages of design concerning our customers' plans for
new equipment. This helps us determine if our existing products can be used in
their new equipment or if new devices need to be considered for the application.
To assist us in our planning process, we are in regular contact with our largest
customers to discuss industry trends, emerging standards and their new product
requirements.
To promote our products, our marketing team is actively involved in
demonstrating our devices with other industry suppliers and providing technical
information at trade shows held in North America, Asia and Europe. Technical
support is essential to our customers' success, and we provide this through
field application engineers, technical marketing and factory systems engineers.
We also provide more detailed information and support for our product line
through our corporate website and special customer-accessible extranet sites. We
believe that providing comprehensive product service and support is critical to
shortening customers' design cycles and maintaining a competitive position in
the networking market.
We sell our products both directly and through distributors and independent
manufacturers' representatives. In 2002, approximately 36% of our orders were
shipped through our distributors; approximately 45% were sent by us directly to
contract manufacturers selected by OEMs; and the balance were sent directly to
our OEM customers.
Our largest distributor is Memec Group Holdings Ltd. which represents our
products worldwide (excluding Japan, Israel, Taiwan and Australia). Many of our
customers are seeking to reduce supply chain costs and are requesting that we
ship more of our products directly to the contract manufacturers they have
selected. Based on this trend, we expect that over time our largest customers
will require that we ship a higher percentage of their orders directly to
contract manufacturers and a lower percentage will be shipped through our
distributors.
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A summary of our domestic and international net revenues and long-lived assets
is presented in Note 13 to the Consolidated Financial Statements in Item 8. More
than half of our net revenues were generated in the United States in each of the
three years ended December 31, 2002.
For a discussion of risks we face due to our international operations, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Factors That You Should Consider Before Investing in PMC-Sierra" in
Item 7.
Cisco Systems and Hewlett-Packard each represented more than 10% of our 2002
revenues based on total sales to end customers through distributors, contract
manufacturers or direct sales. Our sales outside of the United States accounted
for 45% of total revenue in 2002, 42% in 2001, and 38% in 2000.
MANUFACTURING
We are a fabless company, meaning we do not own or operate foundries for the
production of silicon wafers from which our products our made. Instead, we use
independent foundries and chip assemblers for the manufacture of our products.
Typically, the manufacture of our chips requires 12-16 weeks. We refer to this
as our lead-time. Based on this lead-time, our team of production planners will
initiate a purchase order with an independent foundry to fabricate the required
wafers. The wafers once fabricated must be probed, or inspected, to determine
usable from unusable chip parts, referred to as die, on the wafer. The wafers
are sent to an outside assembly house where they are cut and the good die are in
turn packaged into chips. The chips are then run through various electrical and
visual tests before delivery to the customer. With most of our products, we have
the option to probe the wafers or test the final chips in-house or subcontract
the probing or testing to independent subcontractors.
We receive more than 90% of the silicon wafers from which we derive our products
from Chartered Semiconductor Manufacturing Ltd. ("Chartered"), Taiwan
Semiconductor Manufacturing Corporation ("TSMC"), and IBM. These independent
foundries produce our networking products at feature sizes down to 0.13 micron.
By using independent foundries to fabricate our wafers, we are better able to
concentrate our resources on designing, development and testing of new products.
In addition, we avoid much of the fixed capital and operating costs associated
with owning and operating fabrication or chip assembly facilities.
We have supply agreements with both Chartered and TSMC. We have made deposits to
secure access to wafer fabrication capacity under both of these agreements. At
December 31, 2002 and 2001, we had $22 million in deposits with these companies.
Under these agreements, the foundries must supply certain quantities of wafers
per year. Neither of these agreements have minimum unit volume requirements but
we are obliged under one of the agreements to purchase a minimum percentage of
our total annual wafer requirements provided that the foundry is able to
continue to offer competitive technology, pricing, quality and delivery. The
agreements may be terminated if either party does not comply with the terms.
Wafers supplied by outside foundries must meet our incoming quality and test
standards. We conduct a portion of our test operations on advanced mixed signal
and digital test equipment in our Burnaby facility. The remainder of our testing
is performed predominantly by independent U.S. and Asian companies.
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RESEARCH AND DEVELOPMENT
Our current research and development efforts are targeted at integrating
multiple channels or functions on single chips, broadening the number of
products we provide to address varying protocols and networking functions, and
increasing the speeds at which our chips operate.
At the end of fiscal 2002, we had design centers in the United States
(California, Oregon, Maryland, and Pennsylvania), Canada (British Columbia,
Saskatchewan, Manitoba, Ontario and Quebec), Ireland, and India. On January 16,
2003, we announced a corporate restructuring to further reduce our operating
expenses. As a result of this restructuring, we will be closing our design
centers in Maryland, Ireland and India during 2003.
We spent $137.7 million in 2002, $201.1 million in 2001, and $178.8 million in
2000 on research and development.
In 2000, we also expensed $38.2 million of in process research and development,
$31.5 million of which related to the acquisition of Malleable Technologies and
$6.7 million of which related to the acquisition of Datum Telegraphic.
BACKLOG
We sell primarily pursuant to standard purchase orders. Our customers frequently
revise the quantity actually purchased and the shipment schedules to reflect
changes in their needs. We believe orders placed for delivery in excess of six
months are not firm orders. As of December 31, 2002, our backlog of products
scheduled for shipment within six months totaled $36.6 million. Unless our
customers cancel or defer to a subsequent year a portion of this backlog, we
expect this entire backlog to be filled in 2003. Our backlog of products as of
December 31, 2001 for shipment within six months totaled $35.7 million.
Our backlog includes backlog to our major distributor, which may not result in
revenue, as we do not recognize shipments to our major distributor as revenue
until our distributor has sold our products through to the end customer. Also,
our customers may cancel, or defer to a future period, a significant portion of
the backlog at their discretion without penalty. Accordingly, we believe that
our backlog at any given time is not a meaningful indicator of future revenues.
COMPETITION
We typically face competition at the design stage when our networking customers
determine which communications semiconductor components to use in their next
generation equipment designs.
Most of our customers choose a particular semiconductor component primarily
based on whether the component:
o meets the functional requirements,
o addresses the required protocols,
o interfaces easily with other components in a design,
o meets power usage requirements, and
o is priced competitively.
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OEMs are becoming more price conscious than in the past as a result of the
downturn in the telecommunications industry, and as semiconductors sourced from
third party suppliers comprise a greater portion of the total materials cost in
OEM equipment. We have also experienced aggressive price competition from
competitors that are seeking to enter into the markets in which we participate.
These circumstances may make some of our products less competitive, and we may
be forced to decrease our prices significantly to win a design.
In addition to price, OEMs will also consider the quality of the supplier when
determining which component to include in a design. Many of our customers will
consider the breadth and depth of the supplier's technology, as using one
supplier for a broad range of technologies can often simplify and accelerate the
design of next generation equipment. OEMs will also consider a supplier's design
execution reputation, as many OEMs design their next generation equipment
concurrently with the component design. As well, consideration is given to
whether the OEM has pre-qualified the supplier, as this ensures that components
made by that supplier will meet the OEM's quality standards.
Our competitors may be classified into three major groups. First, we compete
against established peer-group semiconductor companies that focus on the
communications semiconductor business. These companies include Agere Systems,
Applied Micro Circuits Corporation, Broadcom, Exar Corporation, Conexant
Systems, Marvell Technology Group, Multilink Technology Corporation, Silicon
Image, Transwitch and Vitesse Semiconductor. These companies are well financed,
have significant communications semiconductor technology assets, have
established sales channels, and depend on the market in which we participate for
the bulk of their revenues.
Other competitors include major domestic and international semiconductor
companies, such as Agilent, Cypress Semiconductor, Intel, IBM, Infineon,
Integrated Device Technology, Maxim Integrated Products, Motorola, Nortel
Networks and Texas Instruments. These companies are concentrating an increasing
amount of their substantial financial and other resources on the markets in
which we participate.
Emerging companies also provide competition in our segment of the semiconductor
market. We are aware of venture-backed companies that focus on specific portions
of our broad range of products. These companies could introduce technologies
that may make one or more of our integrated circuits obsolete.
Over the next few years, we expect additional competitors, some of which may
also have greater financial and other resources, to enter the market with new
products.
We are also expanding into some markets, such as the storage and wireless
infrastructure and generic microprocessor markets, that have established
incumbents with substantial financial and other resources. Some of these
incumbents derive a majority of their earnings from these markets. We expect a
strong increase in competition in these markets.
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LICENSES, PATENTS AND TRADEMARKS
We rely in part on patents to protect our intellectual property and have been
awarded 137 U.S. and 63 foreign patents for circuit designs and other
innovations used in the design and architecture of our products. In addition, we
have 102 patent applications pending in the U.S. Patent and Trademark office,
and 8 patent applications pending in other countries. Our patents expire
typically 20 years from the patent application date if accepted, with our
existing patents expiring between 2010 and 2021.
We do not consider our business to be materially dependent upon any one patent,
although we believe that a strong portfolio of patents combined with other
factors such as our innovative ability, technological expertise and the
experience of our personnel are important to compete effectively in the
industry. A portfolio of patents also provides the flexibility to negotiate or
cross license intellectual property with other semiconductor companies to
incorporate other features in our products.
To protect our other intellectual property we rely on mask work protection,
trademarks, copyrights, trade secret laws, employee and third-party
nondisclosure agreements, and licensing arrangements.
Our only material license is the MIPS microprocessor architecture license from
MIPS Technologies Inc., on which our microprocessor-based products are based.
While the desktop microprocessor market is dominated by the Intel Corporation's
"x86" complex instruction set computing, or CISC, architecture, several
microprocessor architectures have emerged for other microprocessor markets.
Because of their higher performance and smaller space requirements, most of the
competing architectures, like the MIPS architecture, are reduced instruction set
computing, or RISC architectures. The MIPS architecture is widely supported
through semiconductor design software, operating systems and companion
integrated circuits. Because this license is the architecture behind our
microprocessors, we must be able to retain the MIPS license in order to produce
our follow-on microprocessor products.
PMC and its logo are our registered trademarks and service marks. We own other
trademarks and service marks not appearing in this Annual Report. Any other
trademarks used in this Annual Report are owned by other entities.
EMPLOYEES
As of December 31, 2002, we had 1,099 employees, including 679 in Research and
Development, 118 in Production and Quality Assurance, 203 in Marketing and Sales
and 99 in Administration. In January 2003, we announced a restructuring which we
expect to reduce our headcount to 924 employees. Our employees are not
represented by a collective bargaining agreement and we have never experienced
any related work stoppage. We believe our employee relations are good.
ITEM 2. Properties.
PMC leases or owns properties in twenty-seven locations worldwide. Approximately
45% of the space leased by PMC was unoccupied at December 31, 2002. We are
actively trying to sublease or negotiate our exit from these excess facilities.
We lease a total of 431,000 square feet in four separate buildings in Santa
Clara, California, to house the majority of our US design, engineering, product
test, sales and marketing operations.
12
Our Canadian operations are located in Burnaby, British Columbia where we lease
241,000 square feet of office space in five separate buildings. These locations
support a significant portion of our product development, manufacturing,
marketing, sales and test activities. We also operate ten additional research &
development centers: four in Canada, three in the US, two in Ireland and one in
India.
We have fourteen sales offices worldwide, with locations in Europe, Asia, and
North America.
All of our offices are in leased premises. We also own two buildings on
approximately 19 acres of land near our Canadian headquarters in Burnaby. The
property was purchased as a development site and is being held with the eventual
potential of building our own facility to replace our existing leased Burnaby
premises.
In January 2003, we announced our intention to close four of our research and
development sites located in the US, Ireland and India. We will also close five
of our sales offices located in the US and Europe.
ITEM 3. Legal Proceedings.
We are currently not engaged in legal proceedings that require disclosure under
this item.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
13
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Stock Price Information. Our common stock trades on the Nasdaq National Market
under the symbol PMCS. The following table sets forth, for the periods
indicated, the high and low closing sale prices for our Common Stock as reported
by the Nasdaq National Market:
2001 High Low
First Quarter.................................... $ 105.94 $ 24.74
Second Quarter................................... 44.81 19.12
Third Quarter.................................... 36.87 10.05
Fourth Quarter................................... 29.24 9.87
2002 High Low
First Quarter.................................... $ 25.98 $ 14.61
Second Quarter................................... 18.05 8.91
Third Quarter.................................... 10.46 3.88
Fourth Quarter................................... 8.85 2.72
To maintain consistency, the information provided above is based on calendar
quarter ends rather than fiscal quarter ends. As of March 11, 2003, there were
approximately 1,726 holders of record of our Common Stock.
We have never paid cash dividends on our Common Stock. We currently intend to
retain earnings, if any, for use in our business and do not anticipate paying
any cash dividends in the foreseeable future.
14
ITEM 6. Selected Financial Data
Year Ended December 31, (1)
(in thousands, except for per share data)
----------------------------------------------------------------
2002(2) 2001(3) 2000 1999 1998
STATEMENT OF OPERATIONS DATA:
Net revenues $ 218,093 $ 322,738 $ 694,684 $ 295,768 $ 174,288
Cost of revenues 89,542 137,262 166,161 73,439 45,290
Gross profit 128,551 185,476 528,523 222,329 128,998
Research and development 137,734 201,087 178,806 83,676 50,890
Marketing, general and administrative 63,419 90,302 100,589 52,301 33,842
Amortization of deferred stock compensation
Research and development 2,645 32,506 32,258 3,738 1,329
Marketing, general and administrative 168 8,678 4,006 1,383 140
Impairment of property and equipment 1,824 - - - -
Restructuring costs and other special charges - 195,186 - - -
Impairment of goodwill and purchased intangible assets - 269,827 - - 4,311
Amortization of goodwill - 44,010 36,397 1,912 915
Costs of merger - - 37,974 866 -
Acquisition of in process research and development - - 38,200 - 39,176
Income (loss) from operations (77,239) (656,120) 100,293 78,453 (1,605)
Gain (loss) on investments (11,579) (14,591) 58,491 26,800 -
Provision for (recovery of) income taxes (18,858) (17,763) 102,412 41,346 22,997
Net income (loss) (65,007) (639,054) 75,298 71,829 (21,699)
Net income (loss) per share - basic: (4) $ (0.38) $ (3.80) $ 0.46 $ 0.49 $ (0.16)
Net income (loss) per share - diluted: (4) $ (0.38) $ (3.80) $ 0.41 $ 0.45 $ (0.16)
Shares used in per share calculation - basic 170,107 167,967 162,377 146,818 137,750
Shares used in per share calculation - diluted 170,107 167,967 181,891 160,523 137,750
BALANCE SHEET DATA: As of December 31, (1)
(in thousands)
----------------------------------------------------------------
Working capital $ 229,021 $ 214,471 $ 340,986 $ 191,019 $ 83,039
Cash, cash equivalents, short-term investments, and restricted cash 416,659 410,729 375,116 214,265 100,578
Long-term investment in bonds and notes 148,894 171,025 - - -
Total assets 728,716 855,341 1,126,090 388,750 225,303
Long-term debt (including current portion) 275,000 275,470 2,333 9,198 16,807
Stockholders' equity 198,639 272,227 851,318 224,842 119,225
(1) The Company's fiscal year ends on the last Sunday of the calendar year.
December 31 has been used as the fiscal year end for ease of presentation.
(2) Results for the year ended December 31, 2002 include a $4.0 million
allowance for inventories in excess of twelve-month demand recorded in cost
of revenues and a $15.3 million charge for impairment of other investments
recorded in gain (loss) on investments. In accordance with the adoption of
Statement of Financial Accounting Standard No. 142, "Goodwill and Other
Intangible Assets", we ceased amortizing goodwill at the beginning of 2002,
thereby eliminating amortization expense of approximately $2 million. See
Note 1 of the Consolidated Financial Statements.
(3) Results for the year ended December 31, 2001 include a $20.7 million
allowance for inventories in excess of twelve-month demand recorded in cost
of revenues and a $17.5 million charge for impairment of other investments
recorded in gain (loss) on investments.
(4) Reflects two 2-for-1 stock splits, in the form of 100% stock dividends,
effective May 1999 and February 2000.
15
Quarterly Comparisons
The following tables set forth the consolidated statements of operations for
each of the Company's last eight quarters. This quarterly information is derived
from unaudited interim financial statements and has been prepared on the same
basis as the annual Consolidated Financial Statements. In management's opinion,
this quarterly information reflects all adjustments necessary for fair
presentation of the information for the periods presented. The operating results
for any quarter are not necessarily indicative of results for any future period.
Quarterly Data
(in thousands except for per share data)
Year Ended December 31, 2002 Year Ended December 31, 2001
------------------------------------------ -------------------------------------------
Fourth (1) Third Second First Fourth (2) Third Second (3) First (4)
STATEMENT OF OPERATIONS DATA:
Net revenues $ 52,556 $ 59,584 $ 54,511 $ 51,442 $ 47,157 $ 61,556 $ 94,130 $ 119,895
Cost of revenues 24,996 23,229 20,774 20,543 26,142 24,359 48,834 37,927
Gross profit 27,560 36,355 33,737 30,899 21,015 37,197 45,296 81,968
Research and development 33,085 33,977 34,438 36,234 41,145 48,705 53,769 57,468
Marketing, general and administrative 13,827 16,030 16,451 17,111 18,445 22,697 24,067 25,093
Amortization of deferred stock compensation:
Research and development 507 453 764 921 1,130 1,386 2,090 27,900
Marketing, general and administrative 18 23 61 66 7,480 254 425 519
Impairment of property and equipment 1,824 - - - - - - -
Restructuring costs and other special charges - - - - 175,286 - - 19,900
Impairment of goodwill and purchased
intangible assets - - - - 80,785 - 189,042 -
Amortization of goodwill - - - - 2,392 5,996 17,811 17,811
Income (loss) from operations (21,701) (14,128) (17,977) (23,433) (305,648) (41,841) (241,908) (66,723)
Gain (loss) on investments (14,714) 71 619 2,445 (14,992) - - 401
Provision for (recovery of) income taxes (5,105) (3,438) (4,428) (5,887) (10,922) (4,733) (4,179) 2,071
Net income (loss) $(30,491) $ (9,245) $(11,591) $(13,680) $(308,028) $(34,455) $(233,045) $(63,526)
Net income (loss) per share - basic $ (0.18) $ (0.05) $ (0.07) $ (0.08) $ (1.82) $ (0.20) $ (1.39) $ (0.38)
Net income (loss) per share - diluted $ (0.18) $ (0.05) $ (0.07) $ (0.08) $ (1.82) $ (0.20) $ (1.39) $ (0.38)
Shares used in per share calculation - basic 170,594 170,525 169,798 169,513 168,874 168,389 167,817 166,786
Shares used in per share calculation - diluted 170,594 170,525 169,798 169,513 168,874 168,389 167,817 166,786
(1) Results include a $4.0 million allowance for inventories in excess of
twelve-month demand recorded in cost of revenues and a charge of $15.3
million for impairment of other investments recorded in gain (loss) on
investments.
(2) Results include a $6.5 million allowance for inventories in excess of
twelve-month demand recorded in cost of revenues and a charge of $17.5
million for impairment of other investments recorded in gain (loss) on
investments.
(3) Results include a $12.1 million allowance for inventories in excess of
twelve-month demand recorded in cost of revenues.
(4) Results include a $2.1 million allowance for inventories in excess of
twelve-month demand recorded in cost of revenues.
16
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion of the financial condition and results of our
operations should be read in conjunction with the Consolidated Financial
Statements and notes thereto included elsewhere in this Annual Report.
Net Revenues ($000,000)
2002 Change 2001 Change 2000
- --------------------------------------------------------------------------------
Networking products $ 212.7 (29%) $ 300.2 (55%) $ 665.7
Non-networking products $ 5.4 (76%) $ 22.5 (22%) $ 29.0
Total net revenues $ 218.1 (32%) $ 322.7 (54%) $ 694.7
Net revenues for 2002 decreased by $104.6 million, or 32%, from net revenues in
2001, which decreased by $372.0 million, or 54%, from net revenues in 2000.
Networking
In 2001 and 2002, our net revenues were impacted by several factors:
o weakness in the US and global economies
o depressed spending levels by telecommunications companies and
enterprises that incorporate our products into their networking
equipment
o excess inventory levels at OEM's
Prior to the onset of these adverse market conditions, our customers had
accumulated significant inventories of our products in anticipation of rapid
networking equipment sales growth. In 2001, rather than grow, the market for our
customers' products contracted, causing a sharp decline in the demand for our
products. Consequently, our networking revenues declined $87.5 million, or 29%
in 2002 from 2001 and declined $365.5 million, or 55%, in 2001 from 2000. The
lower demand of our products in 2002 was not as severe as the decline in 2001
from 2000, as our customers consumed a portion of the excess inventories of our
products they held.
The majority of the revenue decline resulted from reduced volume shipments of
our parts, however price reductions for high volume products also reduced
revenues by 4% and 5% in 2002 and 2001 respectively.
Non-networking
Non-networking revenues declined $17.1 million, or 76%, in 2002 and $6.5
million, or 22%, in 2001 due to decreased unit sales to our principal customer
in this segment. This product reached the end of its life after the first
quarter of 2002, with only insignificant revenues thereafter.
17
Gross Profit ($000,000)
2002 Change 2001 Change 2000
- -------------------------------------------------------------------------------------------------
Networking products $ 126.2 (28%) $ 176.1 (66%) $ 515.7
Percentage of networking revenues 59% 59% 77%
Non-networking products $ 2.3 (76%) $ 9.4 (27%) $ 12.8
Percentage of non-networking revenues 43% 42% 44%
Total gross profit $ 128.5 (31%) $ 185.5 (65%) $ 528.5
Percentage of net revenues 59% 57% 76%
Total gross profit for 2002 decreased by $57.0 million, or 31%, from gross
profit in 2001, which decreased by $343.0 million, or 65%, from gross profit in
2000.
Networking
Our networking gross profit for 2002 decreased by $49.9 million from 2001. The
decrease in networking gross profit related primarily to lower sales volume in
2002 compared to 2001 partially offset by a lower write-down of excess inventory
of $4.0 million in 2002 compared with a $20.7 million write-down of excess
inventory in 2001.
Our networking gross profit for 2001 decreased by $339.6 million from 2000.
Excluding the $20.7 million write-down of excess inventory in 2001, the decrease
in networking gross profit in 2001 related primarily to the reduced sales
volume.
While networking gross profit as a percentage of networking revenues remained
constant at 59% for 2002 and 2001, the following factors impacted the margin in
2002:
o a write-down of excess inventory in 2002 was $16.7 million lower than a
similar write-down in 2001, increasing gross profit by 8 percentage
points,
o reduced shipment volumes resulted in manufacturing costs being spread
over fewer units resulting in lowering gross margin by 5 percentage
points, despite reducing manufacturing costs by $3.9 million.
o a shift in mix from the higher margin networking products to those sold
into higher volume lower margin applications further reduced gross
profit by 3 percentage points.
Our networking gross profit as a percentage of networking revenues decreased 18
percentage points from 77% in 2000 to 59% in 2001. This decrease resulted from
the following factors:
o a $20.7 million write-down of excess inventory which lowered gross
profit by 7 percentage points,
o a shift in product mix towards lower margin products, which lowered
gross profit by 6 percentage points, and
o the effect of applying fixed manufacturing costs over reduced shipment
volumes which lowered margins by 5 percentage points.
Non-networking
Non-networking gross profit for both 2002 and 2001 decreased as a result of
declining sales volume. This product reached the end of its life in 2002.
18
Other Costs and Expenses ($000,000)
2002 Change 2001 Change 2000
- --------------------------------------------------------------------------------------------------------------
Research and development $ 137.7 (32%) $ 201.1 12% $ 178.8
Percentage of net revenues 63% 62% 26%
Marketing, general and administrative $ 63.4 (30%) $ 90.3 (10%) $ 100.6
Percentage of net revenues 29% 28% 14%
Amortization of deferred stock compensation:
Research and development $ 2.6 (92%) $ 32.5 1% $ 32.3
Marketing, general and administrative 0.2 (98%) 8.7 118% 4.0
------------------------------------------------------
$ 2.8 (93%) $ 41.2 13% $ 36.3
Percentage of net revenues 1% 13% 5%
Impairment of property and equipment $ 1.8 - -
Percentage of net revenues 1% - -
Restructuring costs and other special charges - $ 195.2 -
Percentage of net revenues - 60% -
Impairment of goodwill and purchased intangible assets - $ 269.8 -
Percentage of net revenues - 84% -
Amortization of goodwill - $ 44.0 $ 36.4
Percentage of net revenues - 14% 5%
Costs of merger - - $ 38.0
Percentage of net revenues - - 5%
In process research and development - - $ 38.2
Percentage of net revenues - - 5%
Research and Development Expenses
Our research and development, or R&D, expenses decreased $63.4 million, or 32%,
in 2002 compared to 2001 due to the Company's restructuring and cost reduction
programs implemented in the first and fourth quarters of 2001. As a result of
these programs, we reduced our R&D personnel and related costs by $34.0 million
and other R&D expenses by $29.4 million compared to 2001.
Our R&D expenses for 2001 were $22.3 million, or 12%, higher than 2000 as the
effect of increased hiring and expansion of development programs and costs
during 2000 was only partially offset by the restructuring and cost reduction
programs implemented in 2001. We reduced our R&D personnel by 34% by the end of
2001 from the end of 2000 but because we made substantial additions to our
personnel and tools during the latter part of 2000 and because we realized less
than 3 months' savings from our fourth-quarter restructuring, our R&D personnel
and related costs for 2001 exceeded 2000 by $7.2 million and our tools and
equipment costs for 2001 exceeded 2000 by $11.8 million.
Acquisitions that we completed during 2000 and accounted for under the purchase
method increased our 2001 R&D expenses by $4.2 million compared to 2000.
19
Marketing, General and Administrative Expenses
Our marketing, general and administrative, or MG&A, expenses decreased by $26.9
million, or 30%, in 2002 compared to 2001. Of this decrease, $4.2 million was
attributable to lower variable sales commissions as a result of lower revenues.
The remainder was attributable to the restructuring and cost reduction programs
implemented in 2001, which reduced our MG&A personnel and related costs by $9.7
million and other MG&A expenses by $13.0 million compared to 2001.
Our MG&A expenses decreased by $10.3 million, or 10%, in 2001 compared to 2000
due primarily to a $12.0 million reduction in sales commissions resulting from
the decline in our revenues. The restructuring programs implemented in 2001
reduced our MG&A personnel by 30% from the end of 2000, but due to growth in the
latter part of 2000 resulted in only a 3% year-over-year decrease in our MG&A
personnel costs. This decrease in personnel costs combined with the decrease in
recruitment costs resulting from less hiring activity in 2001 was more than
offset by increases in the cost of facilities due to the prior year's expansion.
Acquisitions that we completed during 2000 and accounted for under the purchase
method increased our 2001 MG&A expenses by $1.2 million compared to 2000.
Amortization of Deferred Stock Compensation
We recorded a non-cash charge of $2.8 million for amortization of deferred stock
compensation in 2002 compared to a non-cash charge of $41.2 million in 2001 and
$36.3 million in 2000.
Deferred stock compensation charges decreased by $38.4 million in 2002 compared
to 2001 because we accelerated vesting for certain employees terminated as part
of our 2001 restructurings. This acceleration of vesting also resulted in higher
charges in 2001 compared to 2000.
Impairment of Property and Equipment
In 2002, we recorded an impairment charge of $1.8 million reflecting a reduction
in the estimated fair value of a product tester. This equipment was removed from
service because lower manufacturing and product development volumes resulted in
excess product tester capacity.
There were no impairments of property and equipment in 2001 or 2000, other than
those assets impaired as a result of our 2001 restructurings as described below.
Restructuring Costs and other Special Charges
On January 16, 2003, we announced that we are undertaking a further corporate
restructuring to further reduce our operating expenses. The restructuring plan
includes the termination of approximately 175 employees and the closure of
design centers in Maryland, Ireland and India. We expect that we will record a
restructuring charge for workforce reduction, facility lease costs and related
asset impairments as these liabilities will be incurred in the first and second
quarters of 2003.
During the year, we paid out $27.5 million in connection with October 2001
restructuring activities. See "Critical Accounting Policies and Significant
Estimates".
20
Cash payments made in 2002 for restructuring activities related to the March
2001 restructuring plan were $2.7 million.
We did not have any additional restructurings in 2002. During 2002, we did not
have any changes in estimates related to 2001 restructurings that affected the
Statement of Operations.
Restructuring - October 18, 2001
Due to a continued decline in market conditions, we implemented a second
restructuring plan in the fourth quarter of 2001 to reduce our operating cost
structure. This restructuring plan included the termination of 341 employees,
the consolidation of additional excess facilities, and the curtailment of
additional research and development projects. As a result, we recorded a second
restructuring charge of $175.3 million in the fourth quarter of 2001.
The following summarizes the activity in the October 2001 restructuring
liability:
Write-down of
Facility Lease Software Licenses
and and
Workforce Contract Settlement Property and
(in thousands) Reduction Costs Equipment, Net Total
- -------------------------------------------------------------------------------------------------------------
Total charge - October 18, 2001 $ 12,435 $ 150,610 $ 12,241 $ 175,286
Noncash charges - - (12,241) (12,241)
Cash payments (5,651) (400) - (6,051)
- -------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 6,784 150,210 - 156,994
Adjustments (3,465) 3,465 - -
Cash payments (3,319) (24,176) - (27,495)
- -------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 - 129,499 - 129,499
======================================================================
We have completed the restructuring activities contemplated in the October 2001
plan, but have not yet disposed of all of our surplus leased facilities. Upon
the final disposition of our surplus leased facilities, we expect to achieve
annualized savings of approximately $67.6 million in cost of revenues and
operating expenses based on the expenditure levels at the time of this
restructuring.
Restructuring - March 26, 2001
In the first quarter of 2001, we implemented a restructuring plan in response to
the decline in demand for our networking products and consequently recorded a
restructuring charge of $19.9 million. The restructuring plan included the
involuntary termination of 223 employees across all business functions, the
consolidation of a number of facilities and the curtailment of certain research
and development projects.
The following summarizes the activity in the March 2001 restructuring liability:
21
Facility Lease Write-down of
and Property
Workforce Contract Settlement and
(in thousands) Reduction Costs Equipment, Net Total
- -----------------------------------------------------------------------------------------------------------
Total charge - March 26, 2001 $ 9,367 $ 6,545 $ 3,988 $ 19,900
Noncash charges - - (3,988) (3,988)
Cash payments (7,791) (3,917) - (11,708)
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 1,576 2,628 - 4,204
======================================================================
We completed the restructuring activities contemplated in the March 2001 plan by
June 30, 2002 and achieved annualized savings of approximately $28.2 million in
cost of revenues and operating expenses based on the expenditure levels at the
time of this restructuring.
During the first six months of fiscal 2002, we made cash payments of $2.8
million in connection with the March restructuring. The remaining restructuring
liability of $1.4 million at June 30, 2002 related primarily to facility lease
payments, net of estimated sublease revenues, and was classified as accrued
liabilities on the balance sheet. We do not expect this restructuring to have
any impact on our Statement of Operations in the future.
Amortization of Goodwill and Impairment of Goodwill and Purchased
Intangibles
We adopted the Statement of Financial Accounting Standard No. 142 (SFAS 142),
"Goodwill and Other Intangible Assets" on a prospective basis at the beginning
of 2002 and stopped amortizing goodwill in accordance with the provisions of
SFAS 142. The impact of not amortizing goodwill on the net income and net income
per share for 2001 and 2000 is provided in Note 1 to the Consolidated Financial
Statements.
In conjunction with the implementation of SFAS 142, we completed the
transitional impairment test as of the beginning of 2002 and determined that a
transitional impairment charge would not be required. We also completed our
annual impairment test in December 2002 and determined that there was no
impairment of goodwill.
Amortization of goodwill increased to $44.0 million in 2001 from $36.4 million
in 2000 primarily as a result of the goodwill recorded in connection with the
Malleable and Datum acquisitions, which were completed in mid 2000.
During the second quarter of 2001, we discontinued further development of the
technology acquired in the purchase of Malleable. We did not expect to have any
future cash flows related to the Malleable assets and had no alternative use for
the technology. Accordingly, we recorded an impairment charge of $189.0 million,
equal to the remaining net book value of goodwill and intangible assets related
to Malleable. As a result, there was no remaining Malleable goodwill or
intangibles to amortize in the second half of 2001.
In the fourth quarter of 2001, due to a continued decline in current market
conditions and a delay in the introduction of certain products to the market, we
completed an assessment of the future revenue potential and estimated costs
associated with all acquired technologies. As a result of this review, we
recorded an impairment charge of $79.3 million related to the acquired goodwill
and intangibles recognized in the purchase of Datum. The impairment charge was
calculated by the excess of the carrying value of assets over the present value
of estimated future cash flow related to these assets. The impairment charge
reduced the amounts subject to amortization for the remainder of 2001.
22
Costs of Merger
We did not make any pooling acquisitions, and therefore did not incur any merger
costs in 2002 or 2001. The $38.0 million of merger costs that were incurred in
2000 related to five pooling acquisitions and consisted primarily of investment
banking and other professional fees.
In Process Research and Development ("IPR&D")
We did not make any acquisitions that were accounted for using the purchase
method in 2002 or 2001, and therefore did not incur any IPR&D charges in either
of those years.
The $38.2 million expensed to in process research and development in 2000 arose
from the acquisitions of Malleable and Datum.
We calculated the charge for IPR&D related to Malleable and Datum by determining
the fair value of the existing products as well as the technology that was
currently under development using the income approach. Under the income
approach, expected future after-tax cash flows from each of the projects under
development are estimated and discounted to their net present value at an
appropriate risk-adjusted rate of return. Revenues were estimated based on
relevant market size and growth factors, expected industry trends, individual
product sales cycles and the estimated life of each product's underlying
technology. Estimated operating expenses, income taxes and charges for the use
of contributory assets were deducted from estimated revenues to determine
estimated after-tax cash flows for each project. These projected future cash
flows were further adjusted for the value contributed by any core technology and
development efforts expected to be completed post acquisition.
These forecasted cash flows were then discounted based on rates derived from our
weighted average cost of capital, weighted average return on assets and venture
capital rates of return adjusted upward to reflect additional risks inherent in
the development life cycle. The risk adjusted discount rates used involved
consideration of the characteristics and applications of each product, the
inherent uncertainties in achieving technological feasibility, anticipated
levels of market acceptance and penetration, market growth rates and risks
related to the impact of potential changes in future target markets. After
considering these factors, we determined risk adjusted discount rates of 35% for
Malleable and 30% for Datum.
In our opinion, the pricing model used for products related to these
acquisitions were standard within the high-technology industry and the estimated
IPR&D amounts so determined represented fair value and did not exceed the
amounts that a third party would have paid for these projects. When we acquired
these companies, we did not expect to achieve a material amount of expense
reduction or synergies as a result of integrating the acquired in process
technology. Therefore, the valuation assumptions did not include anticipated
cost savings.
A description of the IPR&D projects acquired is set forth below:
The in process technology acquired from Malleable was planned to detect incoming
voice channels and process them using voice compression algorithms. The
compressed voice was to be converted, using the appropriate protocols, to ATM
cells or IP packets to achieve higher channel density and support multiple
speech compression protocols and different packetization requirements. At the
date of acquisition we estimated that Malleable's technology was 58% complete
and the costs to complete the project to be $4.4 million.
23
The technology acquired from Datum is a digitally controlled amplifier
architecture, which was designed to increase base station system capacities,
while reducing cost, size and power consumption of radio networks. At the date
of acquisition, we estimated that Datum's technology was 59% complete and the
costs to complete the project to be $1.8 million.
The above estimates were determined by comparing the time and costs spent to
date and the complexity of the technologies achieved to date to the total costs,
time and complexities that were expected to be expended to bring the
technologies to completion.
Progress on the technology acquired from Malleable was slower than originally
estimated and as a result, costs incurred on this project exceeded our original
estimates. In the second quarter of 2001, we discontinued development of this
technology and recorded an impairment charge related to the Malleable goodwill
and purchased intangible assets (see "Amortization of Goodwill and Impairment of
Intangibles").
Development of the chip incorporating the technology acquired from Datum was
completed in the fourth quarter of 2000 and the costs incurred to that date were
in line with our initial expectations. Since then, we have completed the
required firmware related to this chip and have extended development of the
Datum technology to a follow-on product. The general economic slowdown has
delayed our customers' introduction of the third generation base stations into
which we had expected the Datum technology to be incorporated. It is currently
uncertain when the Datum products will begin to generate significant revenues.
As a result of the delay in introduction of the third generation base stations,
we failed to achieve the revenues, net income, and return on investment expected
at the time that the acquisition was completed. We recorded an impairment charge
related to the Datum goodwill and purchased intangible assets during the fourth
quarter of 2001 (see "Amortization of Goodwill and Impairment of Intangibles").
Interest and Other Income, Net ($ 000,000)
2002 Change 2001 Change 2000
- --------------------------------------------------------------------------------
Interest and other income, net $ 5.0 (64%) $ 13.9 (26%) $ 18.9
Percentage of net revenues 2% 4% 3%
Net interest and other income declined in 2002 by $8.9 million, or 64%.
Excluding interest expense and the amortization of debt financing costs,
interest and other income for 2002 was $17.1 million as compared to $19.0
million in 2001. While our interest income declined by approximately $5.5
million as a result of a decline of average yields on our cash, short term and
long term investments, this decline was partially offset by an additional $3.6
million in interest income from an overall increase in our average cash
balances.
Our interest expense and amortization of our debt issuance costs increased to
$12.1 million in 2002, from $5.0 million in 2001, because our convertible
subordinated notes were outstanding for the entire year of 2002 compared to less
than five months in 2001.
Our net interest income decreased to $13.9 million in 2001 from $18.9 million in
2000. While our interest income declined by approximately $3.2 million as a
result of a decline of average yields on our cash, short term and long term
investments, this decline was offset by an additional $3.0 million in interest
income from an overall increase in our cash balances. Interest expense increased
by $3.6 million and we incurred $0.6 million in amortized debt issuance costs in
2001 compared to 2000 due to the issuance of our convertible subordinated notes
in August 2001. Other income in 2000 included income from an equity interest in
another company of $0.6 million.
24
Gain (Loss) on Investments ($000,000)
2002 Change 2001 Change 2000
- --------------------------------------------------------------------------------
Gain (loss) on investments $ (11.6) 21% $ (14.6) (125%) $ 58.5
Percentage of net revenues (5%) (5%) 8%
We reported a net loss on investments of $11.6 million in 2002, $14.6 million in
2001 and a gain on investments of $58.5 million in 2000.
In 2002, we recorded a $3.7 million gain on the sale of a portion of our
investment in Sierra Wireless, Inc., a public company, as well as other
investments. This gain was offset by a $15.3 million charge to recognize the
impairment of our investments in non-public entities. See "Critical Accounting
Policies and Significant Estimates".
In 2001, we recorded a $2.9 million gain on the sale of a portion of our
investment in Sierra Wireless, as well as other investments. This gain was
offset by a $17.5 million charge to recognize the impairment of our investments
in non-public entities. See "Critical Accounting Policies and Significant
Estimates".
In 2000, gains of $54.4 million and $4.1 million resulted from the sale of a
portion of our investment in Sierra Wireless and our investment in Cypress
Semiconductor, Inc., respectively. Our investment in Cypress Semiconductor was
received through its acquisition of IC Works, a company in which we had
invested.
Provision for Income Taxes.
Our annual effective tax rate for the year ended December 31, 2002 was a
recovery of 22.5%. Excluding the effects of non-deductible amortization of
purchased intangibles and deferred stock compensation, and incremental taxes on
foreign earnings, the effective income tax rate for 2001 was a recovery of 24.1%
compared to the statutory tax rate of 35%. Our effective tax rate was lower than
the statutory rate as a result of a valuation allowance provided on deferred tax
assets, where timing of realization is uncertain.
Our annual effective tax rate for the year ended December 31, 2001 was a
recovery of 2.7%. Excluding the effects of non-deductible goodwill, deferred
stock compensation amortization, impairment of purchased intangibles, and
incremental taxes on foreign earnings, the effective income tax rate for 2001
was a recovery of 21.7% compared to the statutory tax rate of 35%. Our effective
tax rate was lower than the statutory rate for the same reason as in 2002. Our
annual effective tax rate for the year ended December 31, 2000 was an expense of
57.6% compared to a statutory tax rate of 35%. Our increased effective tax rate
primarily reflects the higher provision for income taxes for our Canadian
subsidiary and the non-tax deductible charges for in process research and
development, goodwill amortization, deferred stock compensation and acquisition
costs related to acquisitions completed during the year. These factors were
partially offset by the utilization of tax losses and other deferred tax assets
for which benefits were previously not recognized.
25
See Note 12 to the Consolidated Financial Statements for additional information
regarding income taxes.
Recently issued accounting standards.
In June 2002, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 146 (SFAS 146), "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS 146 requires that the
liability for a cost associated with an exit or disposal activity be recognized
at its fair value when the liability is incurred. Under previous guidance, a
liability for certain exit costs was recognized at the date that management
committed to an exit plan. As SFAS 146 is effective only for exit or disposal
activities initiated after December 31, 2002, the adoption of this statement
will not impact our financial statements for 2002, but will affect the
accounting for any restructurings initiated after 2002. In January 2003, we
announced a third restructuring plan, the costs of which will be accounted for
in accordance with SFAS 146.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN 45 will be effective for any guarantees that are
issued or modified after December 31, 2002. We adopted the disclosure
requirements and are currently evaluating the effects of the recognition
provisions of FIN 45; however, we do not expect that the adoption will have a
material impact on our results of operations or financial position.
In December 2002, the FASB issued Statement of Financial Accounting Standard No.
148 (SFAS 148), "Accounting for Stock-Based Compensation - Transition and
Disclosure". SFAS 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. SFAS 148 also requires prominent disclosure in the "Summary of
Significant Accounting Policies" of both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. We adopted SFAS 148 for our 2002
fiscal year end. Adoption of this statement has affected the location of this
disclosure within our Consolidated Financial Statements, but will not impact our
results of operation or financial position unless we change to the fair value
method of accounting for stock-based employee compensation.
26
Critical Accounting Estimates
General
Management's Discussion and Analysis of Financial Condition and Results of
Operations is based upon our Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the amounts reported by us of assets,
liabilities, revenue and expenses, and related disclosure of contingent assets
and liabilities. Management bases its estimates on historical experience and on
various other assumptions that are reasonable in the circumstances. Senior
management has discussed the development, selection and disclosure of these
estimates with the Audit Committee of PMC's Board of Directors. Actual results
may differ from these estimates under different assumptions or conditions.
Our significant accounting policies are outlined in Note 1 to the Consolidated
Financial Statements. In management's opinion the following critical accounting
policies require the most significant judgment and involve complex estimation.
We also have other policies that we consider to be key accounting policies, such
as our policies of revenue recognition, including the deferral of revenues on
sales to major distributors; however these policies do not meet the definition
of critical accounting estimates as they do not generally require us to make
estimates or judgments that are difficult or subjective.
Restructuring charges - Facilities
In calculating the cost to dispose of our excess facilities we had to estimate
for each location the amount to be paid in lease termination payments, the
future lease and operating costs to be paid until the lease is terminated, and
the amount, if any, of sublease revenues. This required us to estimate the
timing and costs of each lease to be terminated, the amount of operating costs
for the affected facilities, and the timing and rate at which we might be able
to sublease each site. To form our estimates for these costs we performed an
assessment of the affected facilities and considered the current market
conditions for each site.
During 2001, we recorded total charges of $155 million for the restructuring of
excess facilities as part of restructuring plans, which was approximately 53% of
the estimated total future operating cost and lease obligation for those sites.
As at the end of 2002, the remaining restructuring accrual is 50% of the
estimated total future operating costs and lease obligations for the remaining
sites. To the best of our knowledge, this estimate remains sufficient to cover
anticipated settlement costs. However, our assumptions on either the lease
termination payments, operating costs until terminated, or the amounts and
timing of offsetting sublease revenues may turn out to be incorrect and our
actual cost may be materially different from our estimates.
Inventory
We periodically compare our inventory levels to sales forecasts for the future
twelve months on a part-by-part basis and record a charge for inventory on hand
in excess of the estimated twelve-month demand. In 2002, our inventory of
networking products exceeded estimated 12-month demand by $4 million and we
recorded a charge of that amount. If future demand for our products continues to
decline, we may have to take an additional write-down of inventory.
27
Income Taxes
We have incurred losses and other costs that can be applied against future
taxable earnings to reduce our tax liability on those earnings. As we are
uncertain of realizing the future benefit of those losses and expenditures, we
have taken a valuation allowance against all domestic deferred tax assets and
recorded only deferred tax assets that can be applied in currently taxable
foreign jurisdictions.
Investment in Non-Public Entities
We have invested in non-public companies and in venture capital funds, which we
review periodically to determine if there has been a non-temporary decline in
the market value of those investments below our carrying value. Our assessment
of impairment in carrying value is based on the market value trends of similar
public companies, the current business performance of the entities in which we
have invested, and if available, the estimated future market potential of the
companies and venture funds. We recorded an impairment of our investments in
non-public entities of $15.3 million in the fourth quarter of 2002. When we
perform future assessments of these investments, a further decline in the value
of these companies and venture funds may require us to recognize additional
impairment on the remaining $7.1 million investment.
Valuation of Long-Lived Assets Including Goodwill and Purchased
Intangible Assets
We review property and equipment, goodwill and purchased intangible assets for
impairment on an annual basis and between annual tests when events or changes in
circumstances indicate the carrying value of an asset may not be recoverable.
Such events may include a change in business strategy, significant declines in
our sales forecast or prolonged negative industry or economic trends.
Our asset impairment review assesses the fair value of the assets based on the
future cash flows the assets are expected to generate. For long-lived assets, an
impairment loss is recognized when estimated undiscounted future cash flows
expected to result from the use of the asset plus net proceeds expected from
disposition of the asset (if any) are less than the carrying value of the asset.
For goodwill, an impairment loss will be recorded to the extent than the
carrying value of the goodwill exceeds its implied fair value.
In 2002, we recorded an impairment charge of $1.8 million reflecting the
reduction in fair value of a product tester. We did not identify any impairment
to goodwill or purchased intangibles during our annual assessment in 2002.
Business Outlook
Our annual networking revenues are impacted by short and longer-term trends in
the demand for the networking equipment that incorporate our products. Future
demand for our customers' products is in turn affected by the plans of their
customers. Our customers' demand for our products is also impacted by levels of
inventories of our parts held by them or their supply chain partners.
In 2001 and 2002, many of our customers experienced significant declines in
demand for their products, and accumulated significant inventories of our
products that exceed the amounts required to meet current production levels.
Consequently, the demand for our products declined in 2001 from approximately
$120 million in the first quarter to approximately $47 million in the fourth
quarter. Quarterly revenues during 2002 ranged from $50 million to $60 million.
28
Because the level of demand for the networking equipment that our customers sell
depends upon global economic conditions, it is difficult to predict when end
market demand for our products will improve. However, we believe that our
customers may consume much of their inventories of some of our older products in
2003 and begin to purchase more of our products as their inventories become
depleted.
We expect our networking revenues for the first quarter of 2003 to increase
slightly from the fourth quarter of 2002. Beyond the first quarter of 2003, we
anticipate revenues will vary depending on changes in the demand environment and
customer component inventory levels. We do not anticipate any meaningful revenue
from our non-networking products in the future as the single product in this
revenue category has reached end-of-life.
We anticipate our gross margins will be in the high 50% to low 60% range in 2003
but could vary significantly depending on the volumes and mix of products sold.
Excluding the impact of any restructuring activities that are reflected in R&D
and MG&A expenses, we expect these costs to decline in 2003 as compared to 2002
due to our cost cutting initiatives, including the restructuring we announced in
January 2003. We anticipate that interest and other income will decline
significantly in 2003 compared to 2002 because we expect to earn lower average
yields on our cash balances and expect to consume cash throughout 2003 to
primarily meet restructuring obligations accrued as current liabilities.
Liquidity and Capital Resources
Our principal sources of liquidity at December 31, 2002 were our cash, cash
equivalents and short-term investments of $416.7 million. We also held $148.9
million of investments in bonds and notes with maturities ranging from 1 to 2.5
years. The aggregate cash and investments of $565.6 million at December 31, 2002
was $16.2 million lower than it was on December 31, 2001 and included $5.3
million of restricted cash (see note 6 to the Consolidated Financial
Statements).
In 2002, we used $19.7 million of cash for operating activities, $3.1 million
for purchases of property and equipment and $2.3 million, net of proceeds on
sales, for other investments. We generated $9.4 million of cash through
financing activities, primarily through the issuance of common stock.
We invested our portfolio of short and long term bonds and notes in corporate
and US and Canadian government securities having an S&P, Moody's or equivalent
rating of A or better. All of our bond and note investments mature in less than
2.5 years. We invest these capital resources primarily for preservation of
capital and secondarily for yield.
We have a line of credit with a bank that allows us to borrow up to $5.3 million
at the bank's alternate base rate as long as the Company maintains eligible
investments with the bank in an amount equal to its drawings. At December 31,
2002 we had committed all of this facility under letters of credit as security
for office leases. These letters of credit renew automatically each year and
expire in 2011.
29
We have commitments made up of the following:
As at December 31, 2002 (in thousands) Payments Due
- -----------------------------------------------------------------------------------------------------------------------------------
After
Contractual Obligations Total 2003 2004 2005 2006 2007 2007
Operating Lease Obligations:
Minimum Rental Payments 273,329 31,839 31,470 30,628 31,964 29,166 118,262
Estimated Operating Cost Payments 59,072 7,470 7,061 6,971 6,447 6,258 24,865
Long Term Debt:
Principal Repayment 275,000 - - - 275,000 - -
Interest Payments 41,252 10,313 10,313 10,313 10,313 - -
Purchase Obligations 4,057 2,871 1,186 - - - -
-------------------------------------------------------------------------------------
652,710 52,493 50,030 47,912 323,724 35,424 143,127
=========================================================================
Venture Investment Commitments (see below) 38,103
------------
Total Contractual Cash Obligations 690,813
============
Approximately $260 million of the minimum rental payments and estimated
operating costs identified in the table above relate to operating leases for
vacant and excess office facilities. We are currently negotiating settlements of
these leases and may incur significant related cash expenditures. We expect to
expend the majority of the $129.5 million we have accrued for restructuring
costs in settlement of these obligations in 2003. See Note 3 to the Consolidated
Financial Statements for additional information regarding restructuring and
other costs.
We participate in four professionally managed venture funds that invest in
early-stage private technology companies in markets of strategic interest to us.
From time to time these funds request additional capital for private placements.
We have committed to invest an additional $38.1 million into these funds, which
may be requested by the fund managers at any time over the next seven years.
We have not entered into any derivative contracts other than our convertible
notes and through our stock option plans, and we have not entered into any
synthetic leases.
We believe that existing sources of liquidity will satisfy our projected
restructuring, operating, working capital, venture investing, debt interest,
capital expenditure and wafer deposit requirements through the end of 2003. We
expect to spend approximately $8 million on new capital additions during 2003.
FACTORS THAT YOU SHOULD CONSIDER BEFORE INVESTING IN PMC-SIERRA
Our company is subject to a number of risks - some are normal to the fabless
networking semiconductor industry, some are the same or similar to those
disclosed in previous SEC filings, and some may be present in the future. You
should carefully consider all of these risks and the other information in this
report before investing in PMC. The fact that certain risks are endemic to the
industry does not lessen the significance of the risk.
As a result of these risks, our business, financial condition or operating
results could be materially adversely affected. This could cause the trading
price of our securities to decline, and you may lose part or all of your
investment.
We are subject to rapid changes in demand for our products due to customer
inventory levels, production schedules, fluctuations in demand for networking
equipment and our customer concentration.
30
As a result of these factors, we have very limited revenue visibility and the
rate by which revenues are booked and shipped within the same reporting period
is typically volatile. In addition, our net bookings can vary sharply up and
down within a quarter.
Our revenues have declined due to reduced demand in the markets we
serve, and may decline further in 2003.
Several of our customers' clients have reported lower than expected demand for
their services or products, which has resulted in poor operating results and
difficulty in accessing the capital needed to build their networks or survive to
profitability. Many of these companies are facing increased competition and have
either filed for bankruptcy or may become insolvent in the near future.
Concurrently, many of our customers' more viable network service provider
clients have accumulated significant debt loads to finance capital projects that
have yet to generate significant positive cash flows. In addition, most of our
customers' clients have announced a shift in forecasted expenditures on the
equipment our customers sell, which may generate financial return in a shorter
time horizon. This equipment to which they shift may not incorporate, or may
incorporate fewer, of our products.
In response to the actual and anticipated declines in networking equipment
demand, many of our customers and their contract manufacturers have undertaken
initiatives to significantly reduce expenditures and excess component
inventories. Many platforms in which our products are designed have been
cancelled as our customers cancel or restructure product development initiatives
or as venture-financed startup companies fail. Our revenues may be materially
and adversely impacted in 2003 if these conditions continue or worsen.
Our customers' actions have materially and adversely impacted our revenues,
reduced our visibility of future revenue streams, caused an increase in our
inventory levels, and made a portion of our inventory obsolete. As most of our
costs are fixed in the short term, a further reduction in demand for our
products may cause a further decline in our gross and net margins.
While we believe that our customers and their contract manufacturers are
consuming a portion of their inventory of PMC products, we believe that those
inventories, as well as the weakened demand that our customers are experiencing
for their products, may further depress our revenues and profit margins beyond
2002 (see "Business Outlook" above). We cannot accurately predict when demand
for our products will strengthen or how quickly our customers will consume their
inventories of our products.
Our customers may cancel or delay the purchase of our products for
reasons other than the industry downturn described above.
Many of our customers have numerous product lines, numerous component
requirements for each product, sizeable and complex supplier structures, and
often engage contract manufacturers to supplement their manufacturing capacity.
This makes forecasting their production requirements difficult and can lead to
an inventory surplus of certain of their components.
Our customers often shift buying patterns as they manage inventory levels,
decide to use competing products, are acquired or divested, market different
products, or change production schedules.
31
In addition, we believe that uncertainty in our customers' end markets and our
customers' increased focus on cash management has caused our customers to delay
product orders and reduce delivery lead-time expectations. We expect this will
increase the proportion of our revenues in future periods that will be from
orders placed and fulfilled within the same period. This will decrease our
ability to accurately forecast and may lead to greater fluctuations in operating
results.
We rely on a few customers for a major portion of our sales, any one of
which could materially impact our revenues should
they change their ordering pattern.
We depend on a limited number of customers for a major portion of our revenues.
Through direct, distributor and subcontractor purchases, Cisco Systems and
Hewlett Packard each accounted for more than 10% of our fiscal 2002 revenues.
Both of these customers have announced order shortfalls for some of their
products.
We do not have long-term volume purchase commitments from any of our major
customers. Accordingly, our future operating results will continue to depend on
the success of our largest customers and on our ability to sell existing and new
products to these customers in significant quantities. The loss of a key
customer, or a reduction in our sales to any key customer or our inability to
attract new significant customers could materially and adversely affect our
business, financial condition or results of operations.
If the current downturn continues, we may have to add to our inventory
reserve, which would lead to a further decline in our operating
profits.
As a result of the industry-wide reduction in capital spending and resulting
significant decrease in demand for our products, we determined that we had
inventory levels that exceeded our anticipated demand over the next twelve
months. Accordingly, in 2002 we recorded an inventory write-down of $4 million
related to excess inventory on hand. The inventory reserve was based on our
revenue expectations through 2003. If future demand of our products does not
meet our expectations, we may need to take an additional write-down of
inventory.
We anticipate lower margins on high volume products, which could adversely
affect our profitability.
We expect the average selling prices of our products to decline as they mature.
Historically, competition in the semiconductor industry has driven down the
average selling prices of products. If we price our products too high, our
customers may use a competitor's product or an in-house solution. To maintain
profit margins, we must reduce our costs sufficiently to offset declines in
average selling prices, or successfully sell proportionately more new products
with higher average selling prices. Yield or other production problems, or
shortages of supply may preclude us from lowering or maintaining current
operating costs.
OEMs are becoming more price conscious than in the past as a result of the
industry downturn, and as semiconductors sourced from third party suppliers
comprise a greater portion of the total materials cost in OEM equipment. We have
also experienced more aggressive price competition from competitors that wish to
enter into the market segments in which we participate. These circumstances may
make some of our products less competitive and we may be forced to decrease our
prices significantly to win a design. We may lose design opportunities or may
experience overall declines in gross margins as a result of increased price
competition.
32
In addition, our networking products range widely in terms of the margins they
generate. A change in product sales mix could impact our operating results
materially.
Design wins do not translate into near-term revenues and the timing of revenues
from newly designed products is often uncertain.
We have announced a number of new products and design wins for existing and new
products. While some industry analysts may use design wins as a metric for
future revenues, many design wins have not, nor will not generate any revenues
as customer projects are cancelled or rejected by their end market. In the event
a design win generates revenue, the amount of revenue will vary greatly from one
design win to another. In addition, most revenue-generating design wins do not
translate into near term revenues. Most revenue-generating design wins take
greater than 2 years to generate meaningful revenue.
Our revenue expectations may include growing sales of newer semiconductors based
on early adoption of those products by customers. These expectations would not
be achieved if early sales of new system level products by our customers do not
increase over time. We may experience this more with design wins from early
stage companies, who tend to focus on leading-edge technologies that may be
adopted less rapidly in the current environment by telecommunications service
providers.
Our restructurings have curtailed our resources and may have insufficiently
addressed market conditions.
We announced in 2001 plans to restructure our operations in response to the
decline in demand for our networking products. The restructuring plans included
a workforce reduction of 564 employees, consolidation of excess facilities, and
contract settlement activities. As a result of our restructuring plans, we
recorded a charge of $195.2 million in 2001. On January 16th, 2003, we announced
plans to further restructure our operations through a workforce reduction of 175
employees and the shutdown of four of our research and development sites. We
will record a charge in the first two quarters of 2003 of our estimate of the
costs for the restructuring.
We reduced the work force and consolidated or shut down excess facilities in an
effort to bring our expenses into line with our reduced revenue expectations.
However, for much of 2003, we do not expect that these measures will be
sufficient to offset lower revenues, and as such, we expect to continue to incur
net losses.
While management uses all available information to estimate these restructuring
costs, particularly facilities costs, our accruals may prove to be inadequate.
If our actual sublease revenues or exiting negotiations differ from our original
assumptions, we may have to record additional charges, which could materially
affect our results of operations, financial position and cash flow.
33
Restructuring plans require significant management resources to execute and we
may fail to achieve our targeted goals and our expected annualized savings. We
may have incorrectly anticipated the demand for our products, we may be forced
to restructure further or may incur further operating charges due to poor
business conditions and some of our product development initiatives may be
delayed due to the reduction in our development resources.
Our revenues may decline if our customers use our competitors' products instead
of ours, suffer further reductions in demand for their products or are acquired
or sold.
We are experiencing significantly greater competition from many different market
participants as the market in which we participate matures. In addition, we are
expanding into markets, such as the wireless infrastructure and generic
microprocessor markets, which have established incumbents with substantial
financial and technological resources. We expect fiercer competition than that
which we have traditionally faced as some of these incumbents derive a majority
of their earnings from these markets.
All of our competitors pose the following threats to us:
As our customers design next generation systems and select the chips
for those new systems, our competitors have an opportunity to convince
our customers to use their products, which may cause our revenues to
decline.
We typically face competition at the design stage, where customers evaluate
alternative design approaches requiring integrated circuits. Our competitors may
have more opportunities to supplant our products in next generation systems
because of the shortening product life and design-in cycles in many of our
customers' products.
In addition, as a result of the industry downturn, and as semiconductors sourced
from third party suppliers comprise a greater portion of the total materials
cost in OEM equipment, OEMs are becoming more price conscious than in the past.
We have also experienced increased price aggressiveness from some competitors
that wish to enter into the market segments in which we participate. These
circumstances may make some of our products price-uncompetitive or force us to
match low prices. We may lose design opportunities or may experience overall
declines in gross margins as a result of increased price competition.
The markets for our products are intensely competitive and subject to rapid
technological advancement in design tools, wafer manufacturing techniques,
process tools and alternate networking technologies. We may not be able to
develop new products at competitive pricing and performance levels. Even if we
are able to do so, we may not complete a new product and introduce it to market
in a timely manner. Our customers may substitute use of our products in their
next generation equipment with those of current or future competitors.
Increasing competition in our industry will make it more difficult to
achieve design wins.
We face significant competition from three major fronts. First, we compete
against established peer-group semiconductor companies that focus on the
communications semiconductor business. These companies include Agere Systems,
Applied Micro Circuits Corporation, Broadcom, Exar Corporation, Conexant
Systems, Marvell Technology Group, Multilink Technology Corporation, Silicon
Image, Transwitch and Vitesse Semiconductor. These companies are well financed,
have significant communications semiconductor technology assets, have
established sales channels, and are dependent on the market in which we
participate for the bulk of their revenues.
34
Other competitors include major domestic and international semiconductor
companies, such as Agilent, Cypress Semiconductor, Intel, IBM, Infineon,
Integrated Device Technology, Maxim Integrated Products, Motorola, Nortel
Networks, and Texas Instruments. These companies are concentrating an increasing
amount of their substantial financial and other resources on the markets in
which we participate. This represents a serious competitive threat to us.
Emerging venture-backed companies also provide significant competition in our
segment of the semiconductor market. These companies tend to focus on specific
portions of our broad range of products and in the aggregate, represent a
significant threat to our product lines. In addition, these companies could
introduce disruptive technologies that may make our technologies and products
obsolete.
Over the next few years, we expect additional competitors, some of which may
also have greater financial and other resources, to enter the market with new
products. These companies, individually or collectively, could represent future
competition for many design wins, and subsequent product sales.
We must often redesign our products to meet evolving industry standards
and customer specifications, which may prevent or delay future revenue
growth.
We sell products to a market whose characteristics include evolving industry
standards, product obsolescence, and new manufacturing and design technologies.
Many of the standards and protocols for our products are based on high-speed
networking technologies that have not been widely adopted or ratified by one or
more of the standard-setting bodies in our customers' industry. Our customers
often delay or alter their design demands during this standard-setting process.
In response, we must redesign our products to suit these changing demands.
Redesign usually delays the production of our products. Our products may become
obsolete during these delays.
Since many of the products we develop do not reach full production
sales volumes for a number of years, we may incorrectly anticipate
market demand and develop products that achieve little or no market
acceptance.
Our products generally take between 18 and 24 months from initial
conceptualization to development of a viable prototype, and another 6 to 18
months to be designed into our customers' equipment and into production. Our
products often must be redesigned because manufacturing yields on prototypes are
unacceptable or customers redefine their products to meet changing industry
standards or customer specifications. As a result, we develop products many
years before volume production and may inaccurately anticipate our customers'
needs.
Our strategy includes broadening our business into the Enterprise, Storage and
Consumer markets. We may not be successful in achieving significant sales in
these new markets.
The Enterprise, Storage and Consumer markets are already addressed by incumbent
suppliers which have established relationships with customers. We may be
unsuccessful in displacing these suppliers, or having our products designed into
products for different market needs. We may incur increased research,
development and sales costs to address these new markets.
35
We are exposed to the credit risk of some of our customers and we may have
difficulty collecting receivables from customers based in foreign countries.
Many of our customers employ contract manufacturers to produce their products
and manage their inventories. Many of these contract manufacturers represent
greater credit risk than our networking equipment customers, who generally do
not guarantee our credit receivables related to their contract manufacturers.
In addition, international debt rating agencies have significantly downgraded
the bond ratings on a number of our larger customers, which had traditionally
been considered financially stable. Should these companies enter into bankruptcy
proceedings or breach their debt covenants, our significant accounts receivables
with these companies could be jeopardized.
The complexity of our products could result in unforeseen delays or expenses and
in undetected defects or bugs, which could adversely affect the market
acceptance of new products and damage our reputation with current or prospective
customers.
Although we, or our customers and our suppliers rigorously test our products,
our highly complex products regularly contain defects or bugs. We have in the
past experienced, and may in the future experience, these defects and bugs. If
any of our products contain defects or bugs, or have reliability, quality or
compatibility problems that are significant to our customers, our reputation may
be damaged and customers may be reluctant to buy our products. This could
materially and adversely affect our ability to retain existing customers or
attract new customers. In addition, these defects or bugs could interrupt or
delay sales to our customers.
We may have to invest significant capital and other resources to alleviate
problems with our products. If any of these problems are not found until after
we have commenced commercial production of a new product, we may be required to
incur additional development costs and product recall, repair or replacement
costs. These problems may also result in claims against us by our customers or
others. In addition, these problems may divert our technical and other resources
from other development efforts. Moreover, we would likely lose, or experience a
delay in, market acceptance of the affected product or products, and we could
lose credibility with our current and prospective customers.
We may be unsuccessful in transitioning the design of our new products to new
manufacturing processes.
Many of our new products are designed to take advantage of new manufacturing
processes offering smaller manufacturing geometries as they become available, as
the smaller geometry products can provide a product with improved features such
as lower power requirements, more functionality and lower cost. We believe that
the transition of our products to smaller geometries is critical for us to
remain competitive. We could experience difficulties in migrating to future
geometries or manufacturing processes, which would result in the delay of the
production of our products. Our products may become obsolete during these
delays, or allow competitors' parts to be chosen by customers during the design
process.
Our business strategy contemplates acquisition of other companies or
technologies, which could adversely affect our operating performance.
36
Acquiring products, technologies or businesses from third parties is part of our
business strategy. Management may be diverted from our operations while they
identify and negotiate these acquisitions and integrate an acquired entity into
our operations. Also, we may be forced to develop expertise outside our existing
businesses, and replace key personnel who leave due to an acquisition.
An acquisition could absorb substantial cash resources, require us to incur or
assume debt obligations, or issue additional equity. If we issue more equity, we
may dilute our common stock with securities that have an equal or a senior
interest.
Acquired entities also may have unknown liabilities, and the combined entity may
not achieve the results that were anticipated at the time of the acquisition.
The timing of revenues from newly designed products is often uncertain. In the
past, we have had to redesign products that we acquired when buying other
businesses, resulting in increased expenses and delayed revenues. This may occur
in the future as we commercialize the new products resulting from acquisitions.
We participate in funds that invest in early-stage private technology companies
to gain access to emerging technologies. These companies possess unproven
technologies and our investments may or may not yield positive returns. We
currently have commitments to invest $38.1 million in such funds. In addition to
consuming significant amounts of cash, these investments are risky because the
technologies that these companies are developing may not reach
commercialization. We may record an impairment charge to our operating results
should we determine that these funds have incurred a non-temporary decline in
value.
The loss of personnel could preclude us from designing new products.
To succeed, we must retain and hire technical personnel highly skilled at the
design and test functions needed to develop high-speed networking products and
related software. The competition for such employees is intense.
We do not have employment agreements in place with many of our key personnel. As
employee incentives, we issue common stock options that generally have exercise
prices at the market value at the time of grant and that are subject to vesting.
Recently, our stock price has declined substantially. The stock options we grant
to employees are effective as retention incentives only if they have economic
value.
Our recent restructurings have significantly reduced the number of our technical
employees. We may experience customer dissatisfaction as a result of delayed or
cancelled product development initiatives.
We may not be able to meet customer demand for our products if we do not
accurately predict demand or if we fail to secure adequate wafer fabrication or
assembly capacity.
37
We currently do not have the ability to accurately predict what products our
customers will need in the future. Anticipating demand is difficult because our
customers face volatile pricing and demand for their end-user networking
equipment, our customers are focusing more on cash preservation and tighter
inventory management, and because we supply a large number of products to a
variety of customers and contract manufacturers who have many equipment programs
for which they purchase our products. Our customers are frequently requesting
shipment of our products earlier than our normal lead times. If we do not
accurately predict what mix of products our customers may order, we may not be
able to meet our customers' demand in a timely manner or we may be left with
unwanted inventory.
A shortage in supply could adversely impact our ability to satisfy customer
demand, which could adversely affect our customer relationships along with our
current and future operating results.
We rely on limited sources of wafer fabrication, the loss of which
could delay and limit our product shipments.
We do not own or operate a wafer fabrication facility. Three outside foundries
supply greater than 90% of our semiconductor device requirements. Our foundry
suppliers also produce products for themselves and other companies. In addition,
we may not have access to adequate capacity or certain process technologies. We
have less control over delivery schedules, manufacturing yields and costs than
competitors with their own fabrication facilities. If the foundries we use are
unable or unwilling to manufacture our products in required volumes, we may have
to identify and qualify acceptable additional or alternative foundries. This
qualification process could take six months or longer. We may not find
sufficient capacity quickly enough, if ever, to satisfy our production
requirements.
Some companies that supply our customers are similarly dependent on a limited
number of suppliers to produce their products. These other companies' products
may be designed into the same networking equipment into which our products are
designed. Our order levels could be reduced materially if these companies are
unable to access sufficient production capacity to produce in volumes demanded
by our customers because our customers may be forced to slow down or halt
production on the equipment into which our products are designed.
We depend on third parties in Asia for assembly of our semiconductor
products that could delay and limit our product shipments.
Sub-assemblers in Asia assemble all of our semiconductor products. Raw material
shortages, political and social instability, assembly house service disruptions,
currency fluctuations, or other circumstances in the region could force us to
seek additional or alternative sources of supply or assembly. This could lead to
supply constraints or product delivery delays that, in turn, may result in the
loss of revenues. We have less control over delivery schedules, assembly
processes, quality assurances and costs than competitors that do not outsource
these tasks.
We depend on a limited number of design software suppliers, the loss of
which could impede our product development.
A limited number of suppliers provide the computer aided design, or CAD,
software we use to design our products. Factors affecting the price,
availability or technical capability of these products could affect our ability
to access appropriate CAD tools for the development of highly complex products.
In particular, the CAD software industry has been the subject of extensive
intellectual property rights litigation, the results of which could materially
change the pricing and nature of the software we use. We also have limited
control over whether our software suppliers will be able to overcome technical
barriers in time to fulfill our needs.
38
We are subject to the risks of conducting business outside the United States to
a greater extent than companies that operate their businesses mostly in the
United States, which may impair our sales, development or manufacturing of our
products.
We are subject to the risks of conducting business outside the United States to
a greater extent than most companies because, in addition to selling our
products in a number of countries, a significant portion of our research and
development and manufacturing is conducted outside the United States.
The geographic diversity of our business operations could hinder our ability to
coordinate design and sales activities. If we are unable to develop systems and
communication processes to support our geographic diversity, we may suffer
product development delays or strained customer relationships.
We may lose our ability to design or produce products, could face
additional unforeseen costs or could lose access to key customers if
any of the nations in which we conduct business impose trade barriers
or new communications standards.
We may have difficulty obtaining export licenses for certain technology produced
for us outside the United States. If a foreign country imposes new taxes,
tariffs, quotas, and other trade barriers and restrictions or the United States
and a foreign country develop hostilities or change diplomatic and trade
relationships, we may not be able to continue manufacturing or sub-assembly of
our products in that country and may have fewer sales in that country. We may
also have fewer sales in a country that imposes new communications standards or
technologies. This could inhibit our ability to meet our customers' demand for
our products and lower our revenues.
If foreign exchange rates fluctuate significantly, our profitability
may decline.
We are exposed to foreign currency rate fluctuations because a significant part
of our development, test, marketing and administrative costs are denominated in
Canadian dollars, and our selling costs are denominated in a variety of
currencies around the world. While we have adopted a foreign currency risk
management policy, which is intended to reduce the effects of short-term
fluctuations, our policy may not be effective and it does not address long-term
fluctuations.
In addition, while all of our sales are denominated in US dollars, our
customers' products are sold worldwide. Any further decline in the world
networking markets could seriously depress our customers' order levels for our
products. This effect could be exacerbated if fluctuations in currency exchange
rates decrease the demand for our customers' products.
From time to time, we become defendants in legal proceedings about which we are
unable to assess our exposure and which could become significant liabilities
upon judgment.
39
We become defendants in legal proceedings from time to time. Companies in our
industry have been subject to claims related to patent infringement and product
liability, as well as contract and personal claims. We may not be able to
accurately assess the risk related to these suits, and we may be unable to
accurately assess our level of exposure. These proceedings may result in
material charges to our operating results in the future if our exposure is
material and if our ability to assess our exposure becomes clearer.
If we cannot protect our proprietary technology, we may not be able to prevent
competitors from copying our technology and selling similar products, which
would harm our revenues.
To compete effectively, we must protect our proprietary information. We rely on
a combination of patents, trademarks, copyrights, trade secret laws,
confidentiality procedures and licensing arrangements to protect our
intellectual property rights. We hold several patents and have a number of
pending patent applications.
We might not succeed in attaining patents from any of our pending applications.
Even if we are awarded patents, they may not provide any meaningful protection
or commercial advantage to us, as they may not be of sufficient scope or
strength, or may not be issued in all countries where our products can be sold.
In addition, our competitors may be able to design around our patents.
We develop, manufacture and sell our products in Asian and other countries that
may not protect our products or intellectual property rights to the same extent
as the laws of the United States. This makes piracy of our technology and
products more likely. Steps we take to protect our proprietary information may
not be adequate to prevent theft of our technology. We may not be able to
prevent our competitors from independently developing technologies that are
similar to or better than ours.
Our products employ technology that may infringe on the proprietary rights of
third parties, which may expose us to litigation and prevent us from selling our
products.
Vigorous protection and pursuit of intellectual property rights or positions
characterize the semiconductor industry. This often results in expensive and
lengthy litigation. We, and our customers or suppliers, may be accused of
infringing on patents or other intellectual property rights owned by third
parties. This has happened in the past. An adverse result in any litigation
could force us to pay substantial damages, stop manufacturing, using and selling
the infringing products, spend significant resources to develop non-infringing
technology, discontinue using certain processes or obtain licenses to the
infringing technology. In addition, we may not be able to develop non-infringing
technology, nor might we be able to find appropriate licenses on reasonable
terms.
Patent disputes in the semiconductor industry are often settled through
cross-licensing arrangements. Because we currently do not have a substantial
portfolio of patents compared to our larger competitors, we may not be able to
settle an alleged patent infringement claim through a cross-licensing
arrangement. We are therefore more exposed to third party claims than some of
our larger competitors and customers.
In the past, our customers have been required to obtain licenses from and pay
royalties to third parties for the sale of systems incorporating our
semiconductor devices. Customers may also make claims against us with respect to
infringement.
40
Furthermore, we may initiate claims or litigation against third parties for
infringing our proprietary rights or to establish the validity of our
proprietary rights. This could consume significant resources and divert the
efforts of our technical and management personnel, regardless of the
litigation's outcome.
We have significantly increased our debt level as a result of the sale of
convertible subordinated notes.
On August 6, 2001, we raised $275 million through the issuance of convertible
subordinated notes. As a result, our interest payment obligations have increased
substantially. The degree to which we are leveraged could materially and
adversely affect our ability to obtain financing for working capital,
acquisitions or other purposes and could make us more vulnerable to industry
downturns and competitive pressures. Our ability to meet our debt service
obligations will be dependent upon our future performance, which will be subject
to financial, business and other factors affecting our operations, many of which
are beyond our control. On August 15, 2006, we are obliged to repay the full
remaining principal amount of the notes that have not been converted into our
common stock.
Securities we issue to fund our operations could dilute your ownership.
We may decide to raise additional funds through public or private debt or equity
financing to fund our operations. If we raise funds by issuing equity
securities, the percentage ownership of current stockholders will be reduced and
the new equity securities may have priority rights to your investment. We may
not obtain sufficient financing on terms that are favorable to you or us. We may
delay, limit or eliminate some or all of our proposed operations if adequate
funds are not available.
Our stock price has been and may continue to be volatile.
In the past, our common stock price has fluctuated significantly. In particular,
our stock price declined significantly in the context of announcements made by
us and other semiconductor suppliers of reduced revenue expectations and of a
general slowdown in the markets we serve. Given these general economic
conditions and the reduced demand for our products that we have experienced, we
expect that our stock price will continue to be volatile.
In addition, fluctuations in our stock price and our price-to-earnings multiple
may have made our stock attractive to momentum, hedge or day-trading investors
who often shift funds into and out of stocks rapidly, exacerbating price
fluctuations in either direction particularly when viewed on a quarterly basis.
Securities class action litigation has often been instituted against a company
following periods of volatility and decline in the market price of their
securities. If instituted against us, regardless of the outcome, such litigation
could result in substantial costs and diversion of our management's attention
and resources and have a material adverse effect on our business, financial
condition and operating results. We could be required to pay substantial
damages, including punitive damages, if we were to lose such a lawsuit.
41
Provisions in our charter documents and Delaware law and our adoption of a
stockholder rights plan may delay or prevent acquisition of us, which could
decrease the value of our common stock.
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could make it harder for a third party to acquire us without the consent of
our board of directors. Delaware law also imposes some restrictions on mergers
and other business combinations between us and any holder of 15% or more of our
outstanding common stock. In addition, our board of directors has the right to
issue preferred stock without stockholder approval, which could be used to
dilute the stock ownership of a potential hostile acquirer. Although we believe
these provisions of our certificate of incorporation and bylaws and Delaware law
and our stockholder rights plan will provide for an opportunity to receive a
higher bid by requiring potential acquirers to negotiate with our board of
directors, these provisions apply even if the offer may be considered beneficial
by some stockholders.
Our board of directors adopted a stockholder rights plan, pursuant to which we
declared and paid a dividend of one right for each share of common stock held by
stockholders of record as of May 25, 2001. Unless redeemed by us prior to the
time the rights are exercised, upon the occurrence of certain events, the rights
will entitle the holders to receive upon exercise thereof shares of our
preferred stock, or shares of an acquiring entity, having a value equal to twice
the then-current exercise price of the right. The issuance of the rights could
have the effect of delaying or preventing a change in control of us.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
The following discussion regarding our risk management activities contains
"forward-looking statements" that involve risks and uncertainties. Actual
results may differ materially from those projected in the forward-looking
statements.
Cash Equivalents, Short-term Investments and Investments in Bonds and
Notes:
We regularly maintain a short and long term investment portfolio of various
types of government and corporate debt instruments. Our investments are made in
accordance with an investment policy approved by our Board of Directors.
Maturities of these instruments are less than two and one half years, with the
majority being within one year. To minimize credit risk, we diversify our
investments and select minimum ratings of P-1 or A by Moody's, or A-1 or A by
Standard and Poor's, or equivalent. We classify these securities as
held-to-maturity or available-for-sale depending on our investment intention.
Held-to-maturity investments are held at amortized cost, while
available-for-sale investments are held at fair market value. Available-for-sale
securities represented approximately 17% of our investment portfolio as of
December 31, 2002.
Investments in both fixed rate and floating rate interest earning instruments
carry a degree of interest rate risk. Fixed rate securities may have their fair
market value adversely impacted because of a rise in interest rates, while
floating rate securities may produce less income than expected if interest rates
fall. Due in part to these factors, our future investment income may fall short
of expectations because of changes in interest rates or we may suffer losses in
principal if we were to sell securities that have declined in market value
because of changes in interest rates.
42
We do not attempt to reduce or eliminate our exposure to interest rate risk
through the use of derivative financial instruments.
Based on a sensitivity analysis performed on the financial instruments held at
December 31, 2002 that are sensitive to changes in interest rates, the impact to
the fair value of our investment portfolio by an immediate hypothetical parallel
shift in the yield curve of plus or minus 50, 100 or 150 basis points would
result in a decline or increase in portfolio value of approximately $2.5
million, $5 million and $7.4 million respectively.
Other Investments
Other investments at December 31, 2002 include a minority investment of
approximately 2 million shares of Sierra Wireless Inc., a publicly traded
company. The securities are recorded on the balance sheet at fair value with
unrealized gains or losses reported as a separate component of accumulated other
comprehensive income, net of income taxes.
We also periodically receive distributions of public company stock as a result
of venture investments. These shares are usually subject to resale restrictions
and typically include a number of shares held in escrow that may or may not be
released at a later date. At December 31, 2002, we held approximately 16,000
shares of Intel Corporation, which we received when Intel acquired a private
company in which we had an investment. It is our intention to sell these
securities in the first quarter of 2003.
Our public company investments are subject to considerable market price
volatility and are additionally risky due to resale restrictions. We may lose
some or all of our investment in these shares.
Our other investments also include numerous strategic investments in privately
held companies or venture funds that are carried on our balance sheet at cost.
We expect to make additional investments like these in the future. These
investments are inherently risky, as they typically are comprised of investments
in companies and partnerships that are still in the start-up or development
stages. The market for the technologies or products that they have under
development is typically in the early stages, and may never materialize. In the
fourth quarter of 2002, we recorded an impairment of our other investments of
$15.3 million in response to declining market valuations for these investments.
We could lose our entire investment in these companies and partnerships or may
incur an additional expense if we determine that the value of these assets have
been further impaired.
Foreign Currency
We generate a significant portion of our revenues from sales to customers
located outside of the United States including Canada, Europe, the Middle East
and Asia. We are subject to risks typical of an international business
including, but not limited to, differing economic conditions, changes in
political climate, differing tax structures, other regulations and restrictions
and foreign exchange rate volatility. Accordingly, our future results could be
materially adversely affected by changes in these or other factors.
43
Our sales and corresponding receivables are made primarily in United States
dollars. Through our operations in Canada and elsewhere outside of the United
States, we incur research and development, customer support costs and
administrative expenses in Canadian and other local currencies. We are exposed,
in the normal course of business, to foreign currency risks on these
expenditures. In our effort to manage such risks, we have adopted a foreign
currency risk management policy intended to reduce the effects of potential
short-term fluctuations on the results of operations stemming from our exposure
to these risks. As part of this risk management, we typically forecast our
operational currency needs, purchase such currency on the open market at the
beginning of an operational period, and hold these funds as a hedge against
currency fluctuations. We usually limit the operational period to 3 months or
less. Because we do not engage in foreign currency exchange rate fluctuation
risk management techniques beyond these periods, our cost structure is subject
to long-term changes in foreign exchange rates.
While we expect to continue to use this method to manage our foreign currency
risk, in the future we may decide to use foreign exchange contracts to manage
this risk.
We regularly analyze the sensitivity of our foreign exchange positions to
measure our foreign exchange risk. At December 31, 2002, a 10% shift in foreign
exchange rates would not have materially impacted our foreign exchange income
because our foreign currency net asset position was immaterial.
Debt
We issued $275,000,000 of convertible subordinated notes in August 2001. Because
we pay fixed interest coupons on our notes, market interest rate fluctuations do
not impact our debt interest payments. However, the fair value of our
convertible subordinated notes will fluctuate as a result of changes in the
price of our common stock, changes in market interest rates and changes in our
credit worthiness.
Our convertible subordinated notes are not listed on any securities exchange or
included in any automated quotation system, but have been traded over the
counter, on the Portal Market or under Rule 144 of the Securities Act of 1933.
The exchange prices from these trades are not always available to us and may not
be reliable. Trades under the Portal Market do not reflect all trades of the
securities and the figures recorded are not independently verified. The average
bid and ask price of our convertible subordinated notes on the Portal Market on
December 27, 2002 was $75.50 per $100 in face value, resulting in an aggregate
fair value of approximately $207.6 million. There were no reported trades on
December 28 or December 29, 2002.
44
Item 8. Financial Statements and Supplementary Data
The chart entitled "Quarterly Data" contained in Item 6 Part II hereof is hereby
incorporated by reference into the Item 8 of Part II of this Form 10-K.
Consolidated Financial Statements Included in Item 8:
Page
Independent Auditors' Report 46
Consolidated Balance Sheets at December 31, 2002 and 2001 47
Consolidated Statements of Operations for each of the three years in the period
ended December 31, 2002 48
Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 2002 49
Consolidated Statements of Stockholders' Equity for each of the three years in
the period ended December 31, 2002 50
Notes to Consolidated Financial Statements 51
Schedules for each of the three years in the period ended December 31, 2002
included in Item 15 (a):
II Valuation and Qualifying Accounts 88
Schedules not listed above have been omitted because they are not applicable or
are not required, or the information required to be set forth therein is
included in the financial statements or the notes thereto.
45
Independent Auditors' Report
The Board of Directors of PMC-Sierra, Inc.
We have audited the accompanying consolidated balance sheets of PMC-Sierra, Inc.
and subsidiaries ("the Company") as of December 31, 2002 and 2001 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2002. Our
audits also included the financial statement schedule listed in the Index at
Item 15(a). These consolidated financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the consolidated financial position of PMC-Sierra, Inc. and
subsidiaries at December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America. Also, in our opinion, such financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 2002, the Company changed its method of accounting for goodwill in
accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
and Other Intangible Assets".
/s/ DELOITTE & TOUCHE LLP
Vancouver, British Columbia
January 17, 2003
46
PMC-Sierra, Inc.
CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)
December 31,
------------------------------
2002 2001
ASSETS:
Current assets:
Cash and cash equivalents $ 70,504 $ 152,120
Short-term investments 340,826 258,609
Restricted cash 5,329 -
Accounts receivable, net of allowance for doubtful
accounts of $2,781 ($2,625 in 2001) 16,621 16,004
Inventories 26,420 34,246
Deferred tax assets 1,083 14,812
Prepaid expenses and other current assets 15,499 18,435
-------------- --------------
Total current assets 476,282 494,226
Investment in bonds and notes 148,894 171,025
Other investments and assets 21,978 68,863
Deposits for wafer fabrication capacity 21,992 21,992
Property and equipment, net 51,189 89,715
Goodwill and other intangible assets, net 8,381 9,520
-------------- --------------
$ 728,716 $ 855,341
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable $ 24,697 $ 21,320
Accrued liabilities 53,530 49,348
Income taxes payable 21,553 19,742
Accrued restructuring costs 129,499 161,198
Deferred income 17,982 27,677
Current portion of obligations under capital leases and long-term debt - 470
-------------- --------------
Total current liabilities 247,261 279,755
Convertible subordinated notes 275,000 275,000
Deferred tax liabilities 2,764 23,042
Commitments and contingencies (Note 8)
PMC special shares convertible into 3,196 (2001 - 3,373)
shares of common stock 5,052 5,317
Stockholders' equity
Common stock and additional paid in capital, par value $.001:
900,000 shares authorized; 167,400 shares issued and
outstanding (2001 - 165,702) 834,265 824,321
Deferred stock compensation (1,158) (4,186)
Accumulated other comprehensive income 3,939 25,492
Accumulated deficit (638,407) (573,400)
-------------- --------------
Total stockholders' equity 198,639 272,227
-------------- --------------
$ 728,716 $ 855,341
============== ==============
See notes to the Consolidated Financial Statements.
47
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except for per share amounts)
(unaudited)
Year Ended December 31,
----------------------------------------------
2002 2001 2000
Net revenues 218,093 322,738 694,684
Cost of revenues 89,542 137,262 166,161
-------------- -------------- --------------
Gross profit 128,551 185,476 528,523
Other costs and expenses:
Research and development 137,734 201,087 178,806
Marketing, general and administrative 63,419 90,302 100,589
Amortization of deferred stock compensation:
Research and development 2,645 32,506 32,258
Marketing, general and administrative 168 8,678 4,006
Impairment of property and equipment 1,824 - -
Restructuring costs and other special charges - 195,186 -
Impairment of goodwill and purchased intangible assets - 269,827 -
Amortization of goodwill - 44,010 36,397
Costs of merger - - 37,974
Acquisition of in process research and development - - 38,200
-------------- -------------- --------------
Income (loss) from operations (77,239) (656,120) 100,293
Interest and other income, net 4,953 13,894 18,926
Gain (loss) on investments (11,579) (14,591) 58,491
-------------- -------------- --------------
Income (loss) before provision for income taxes (83,865) (656,817) 177,710
Provision for (recovery of) income taxes (18,858) (17,763) 102,412
-------------- -------------- --------------
Net income (loss) $ (65,007) $ (639,054) $ 75,298
============== ============== ==============
Net income (loss) per common share - basic $ (0.38) $ (3.80) $ 0.46
============== ============== ==============
Net income (loss) per common share - diluted $ (0.38) $ (3.80) $ 0.41
============== ============== ==============
Shares used in per share calculation - basic 170,107 167,967 162,377
Shares used in per share calculation - diluted 170,107 167,967 181,891
See notes to the consolidated financial statements.
48
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
-------------------------------------------------
2002 2001 2000
Cash flows from operating activities:
Net income (loss) $ (65,007) $ (639,054) $ 75,298
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation of property and equipment 39,708 51,212 35,424
Amortization of goodwill and other intangibles 1,139 46,803 38,757
Amortization of deferred stock compensation 2,813 41,184 36,264
Amortization of debt issuance costs 1,564 652 -
Deferred income taxes 8,429 (10,733) 1,268
Gain on sale of investments and other assets (3,725) (2,479) (59,065)
Acquisition of in process research and development - - 38,200
Noncash restructuring costs - 16,229 -
Impairment of goodwill and purchased intangible assets - 269,827 -
Impairment of other investments 15,337 17,500 -
Impairment of property and equipment 1,824 - -
Write-down of excess inventory 4,020 20,660 -
Changes in operating assets and liabilities:
Accounts receivable (617) 77,848 (51,580)
Inventories 3,806 7 (40,668)
Prepaid expenses and other current assets 2,936 6,146 (18,233)
Accounts payable and accrued liabilities 6,239 (30,034) 59,417
Income taxes payable 1,811 (43,749) 38,062
Accrued restructuring costs (30,253) 161,198 -
Deferred income (9,695) (36,378) 29,397
-------------- ---------------- ----------------
Net cash (used in) provided by operating activities (19,671) (53,161) 182,541
-------------- ---------------- ----------------
Cash flows from investing activities:
Change in restricted cash (5,329) - -
Purchases of short-term investments (262,217) (305,357) (309,269)
Proceeds from sales and maturities of short-term investments 234,344 192,386 303,102
Purchases of long-term bonds and notes (199,797) (197,135) -
Proceeds from sales and maturities of long-term bonds and notes 167,111 - -
Purchases of other investments (10,139) (7,532) (24,834)
Proceeds from sales of other investments 7,799 3,317 59,737
Investment in wafer fabrication deposits - (5,188) (8,584)
Proceeds from refund of wafer fabrication deposits - 6,197 4,703
Purchases of property and equipment (3,141) (27,840) (104,296)
Acquisition of businesses, net of cash acquired - - (15,473)
-------------- ---------------- ----------------
Net cash used in investing activities (71,369) (341,152) (94,914)
-------------- ---------------- ----------------
Cash flows from financing activities:
Proceeds from notes payable and long-term debt - - 2,066
Repayment of capital leases and long-term debt (470) (1,746) (13,435)
Proceeds from issuance of convertible subordinated notes - 275,000 -
Payment of debt issuance costs - (7,819) -
Proceeds from issuance of common stock 9,894 24,800 78,426
-------------- ---------------- ----------------
Net cash provided by financing activities 9,424 290,235 67,057
-------------- ---------------- ----------------
Net increase (decrease) in cash and cash equivalents (81,616) (104,078) 154,684
Cash and cash equivalents, beginning of the year 152,120 256,198 101,514
-------------- ---------------- ----------------
Cash and cash equivalents, end of the year $ 70,504 $ 152,120 $ 256,198
============== ================ ================
Supplemental disclosures of cash flow information:
Cash paid for interest $ 10,762 $ 211 $ 698
Cash paid for income taxes 411 41,177 61,519
Supplemental disclosures of non-cash investing and financing activities:
Equity securities received in exchange for other long-term investment - 1,713 -
Capital lease obligations incurred for purchase of property and equipment - - 3,634
Conversion of PMC-Sierra special shares into common stock 265 1,050 631
Issuance of common stock and stock options for acquisitions under the
purchase method of accounting - - 414,938
See notes to the consolidated financial statements.
49
PMC-Sierra, Inc.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Common Stock Accumulated Retained
Shares of and Deferred Other Earnings Total
Common Additional Stock Comprehensive (Accumulated Stockholders'
Stock (1) Paid in Capital (1) Compensation Income Deficit) Equity
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1999 148,009 240,373 (5,887) - (9,644) 224,842
Net income - - - - 75,298 75,298
Change in net unrealized gains
on investments - - - 32,563 - 32,563
--------------
Comprehensive income - - - - - 107,861
--------------
Conversion of special shares
into common stock 496 631 - - - 631
Conversion of preferred stock
into common stock 5,243 39,949 - - - 39,949
Issuance of common stock
under stock benefit plans 4,421 27,359 - - - 27,359
Issuance of common stock
for cash 1,949 50,804 - - - 50,804
Issuance of common stock on
acquisition of subsidiaries 1,896 414,938 - - - 414,938
Conversion of warrants
into common stock 270 263 - - - 263
Deferred stock compensation - 21,912 (21,912) - - -
Deferred stock compensation
on acquisition of subsidiaries - - (51,593) - - (51,593)
Amortization of deferred - - 36,264 - - 36,264
stock compensation
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 2000 162,284 796,229 (43,128) 32,563 65,654 851,318
Net loss - - - - (639,054) (639,054)
Change in net unrealized gains
on investments - - - (7,071) - (7,071)
--------------
Comprehensive loss - - - - - (646,125)
--------------
Conversion of special shares
into common stock 373 1,050 - - - 1,050
Issuance of common stock
under stock benefit plans 3,045 24,800 - - - 24,800
Deferred stock compensation - 2,242 (2,242) - - -
Amortization of deferred - - 41,184 - - 41,184
stock compensation
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 2001 165,702 824,321 (4,186) 25,492 (573,400) 272,227
Net loss - - - - (65,007) (65,007)
Change in net unrealized gains
on investments - - - (21,553) - (21,553)
--------------
Comprehensive loss - - - - - (86,560)
--------------
Conversion of special shares
into common stock 177 265 - - - 265
Issuance of common stock
under stock benefit plans 1,509 9,874 - - - 9,874
Conversion of warrants
into common stock 12 20 - - - 20
Deferred stock compensation - (215) 215 - - -
Amortization of deferred - - 2,813 - - 2,813
stock compensation
- ------------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 2002 167,400 $ 834,265 $ (1,158) $ 3,939 $ (638,407) $ 198,639
==================================================================================================
(1) includes exchangeable shares
See notes to the consolidated financial statements.
50
NOTE 1. Summary of Significant Accounting Policies
Description of business. PMC-Sierra, Inc (the "Company" or "PMC") designs,
develops, markets and supports high-speed broadband communications and storage
semiconductors and MIPS-based processors for service provider, enterprise,
storage, and wireless networking equipment. The Company offers worldwide
technical and sales support through a network of offices in North America,
Europe and Asia.
Basis of presentation. The accompanying Consolidated Financial Statements
include the accounts of PMC-Sierra, Inc. and its wholly owned subsidiaries. All
significant inter-company accounts and transactions have been eliminated. The
Company's fiscal year ends on the last Sunday of the calendar year. For ease of
presentation, the reference to December 31 has been utilized as the fiscal year
end for all financial statement captions. Fiscal years 2002 and 2001 each
consisted of 52 weeks. Fiscal year 2000 consisted of 53 weeks. The Company's
reporting currency is the United States dollar.
Estimates. The preparation of financial statements and related disclosures in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Estimates
are used for, but not limited to, the accounting for doubtful accounts,
inventory reserves, depreciation and amortization, asset impairments, sales
returns, warranty costs, income taxes, restructuring costs and other special
charges, and contingencies. Actual results could differ from these estimates.
Cash equivalents, short-term investments and investments in bonds and notes.
Cash equivalents are defined as highly liquid debt instruments with maturities
at the date of purchase of 90 days or less. Short-term investments are defined
as money market instruments or bonds and notes with original maturities greater
than 90 days, but less than one year. Investments in bonds and notes are defined
as bonds and notes with original or remaining maturities greater than 365 days.
Any investments in bonds and notes maturing within one year of the balance sheet
date are reclassified to and reported as short-term investments.
Under Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities", management classifies
investments as available-for-sale or held-to-maturity at the time of purchase
and re-evaluates such designation as of each balance sheet date. Investments
classified as held-to-maturity securities are stated at amortized cost with
corresponding premiums or discounts amortized against interest income over the
life of the investment. Marketable equity and debt securities not classified as
held-to-maturity are classified as available-for-sale and reported at fair
value. The cost of securities sold is based on the specific identification
method. Unrealized gains and losses on these investments, net of any related tax
effect are included in equity as a separate component of stockholders' equity.
Restricted cash. Restricted cash consists of cash pledged with a bank as
collateral for letters of credit issued as security for leased facilities.
Inventories. Inventories are stated at the lower of cost (first-in, first out)
or market (estimated net realizable value). Cost is computed using standard
cost, which approximates actual average cost. The Company provides inventory
allowances on obsolete inventories and inventories in excess of twelve-month
demand for each specific part.
51
The components of net inventories are as follows:
December 31,
-----------------------------------
(in thousands) 2002 2001
- -----------------------------------------------------------------------
Work-in-progress $ 11,409 $ 10,973
Finished goods 15,011 23,273
- -----------------------------------------------------------------------
$ 26,420 $ 34,246
===================================
Investments in non-public entities. The Company has certain investments in
non-publicly traded companies and venture capital funds in which it has less
than 20% of the voting rights and in which it does not exercise significant
influence. The Company monitors these investments for impairment and makes
appropriate reductions in carrying values when necessary. These investments are
included in Other investments and assets on the Company's balance sheet and are
carried at cost, net of write-downs for impairment.
Investments in public companies. The Company has certain investments in publicly
traded companies in which it has less than 20% of the voting rights and in which
it does not exercise significant influence. Certain of these investments are
subject to resale restrictions. Securities restricted for more than one year are
carried at cost. Securities restricted for less than one year from the balance
sheet date and securities not subject to resale restrictions are classified as
available-for-sale and reported at fair value, based upon quoted market prices,
with the unrealized gains or losses, net of any related tax effect, included in
equity as a separate component of stockholders' equity. The Company evaluates
its investments in public companies for factors indicating an other than
temporary impairment and makes appropriate reductions in carrying value where
necessary.
Investments in equity accounted investees. Investees in which the Company has
between 20% and 50% of the voting rights, and in which the Company exercises
significant influence, are accounted for using the equity method. The Company
sold a portion of its only investment in an equity accounted investee during
2000 and since that disposition has held less than 20% of the voting rights of
this investee.
Deposits for wafer fabrication capacity. The Company has wafer supply agreements
with two independent foundries. Under these agreements, the Company has deposits
of $22.0 million (2001 - $22.0 million) to secure access to wafer fabrication
capacity. During 2002, the Company purchased $32.3 million ($42.7 million and
$81.1 million in 2001 and 2000, respectively) from these foundries. Purchases in
any year may or may not be indicative of any future period since wafers are
purchased based on current market pricing and the Company's volume requirements
change in relation to sales of its products.
In each year, the Company is entitled to receive a refund of a portion of the
deposits based on the annual purchases from these suppliers compared to the
target levels in the wafer supply agreements. Based on 2002 purchases and the
current agreements, the Company is not entitled to a refund from these suppliers
in 2003. If the Company does not receive back the balance of its deposits during
the term of the agreements, then the outstanding deposits will be refunded to
the Company after the termination of the agreements at the end of 2003.
Property and equipment, net. Property and equipment are stated at cost, net of
write-downs for impairment, and depreciated using the straight-line method over
the estimated useful lives of the assets, ranging from two to five years, or the
applicable lease term, whichever is shorter.
52
The components of property and equipment are as follows:
December 31,
--------------------------------
(in thousands) 2002 2001
- --------------------------------------------------------------------------------
Machinery and equipment $ 172,227 $ 172,735
Land 13,448 14,507
Leasehold improvements 11,765 13,176
Furniture and fixtures 15,305 13,971
Building - 701
Construction-in-progress 1,027 1,027
- --------------------------------------------------------------------------------
213,772 216,117
Less accumulated depreciation and amortization (162,583) (126,402)
--------------------------------
Total $ 51,189 $ 89,715
================================
In 2002, the Company recorded an impairment charge of $1.8 million for machinery
and equipment that was removed from service.
Goodwill and other intangible assets. Goodwill, developed technology and other
intangible assets are carried at cost less accumulated amortization, which had
been computed on a straight-line basis over the economic lives, ranging from
three to seven years, of the respective assets.
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard No. 141 (SFAS 141), "Business Combinations" and
Statement of Financial Accounting Standard No. 142 (SFAS 142), "Goodwill and
Other Intangible Assets".
SFAS 141 requires that business combinations be accounted for under the purchase
method of accounting and addresses the initial recognition and measurement of
assets acquired, including goodwill and intangibles, and liabilities assumed in
a business combination. The Company adopted SFAS 141 on a prospective basis
effective July 1, 2001. The adoption of SFAS 141 did not have a material effect
on the Company's financial statements, but will impact the accounting treatment
of future acquisitions.
SFAS 142 requires goodwill to be allocated to, and assessed as part of, a
reporting unit. In accordance with SFAS 142, goodwill will no longer be
amortized but instead will be subject to impairment tests at least annually. In
conjunction with the implementation of SFAS 142, the Company completed the
transitional impairment test as of the beginning of 2002 and determined that a
transitional impairment charge would not be required. The Company also completed
its annual impairment test in December 2002 and determined that there was no
impairment of goodwill.
The Company adopted SFAS 142 on a prospective basis at the beginning of fiscal
2002 and stopped amortizing goodwill totaling $7.1 million, thereby eliminating
goodwill amortization of approximately $2.0 million in 2002. Net loss and net
loss per share adjusted to exclude goodwill and workforce amortization for 2002,
2001 and 2000 are as follows:
53
Year Ended December 31,
-------------------------------------------
(in thousands, except per share amounts) 2002 2001 2000
- ---------------------------------------------------------------------------------------------
Net income (loss), as reported $ (65,007) $ (639,054) $ 75,298
Adjustments:
Amortization of goodwill - 44,010 36,397
Amortization of other intangibles - 564 741
------------- ------------- -------------
Net income (loss) $ (65,007) $ (594,480) $ 112,436
============= ============= =============
Basic net income (loss) per share, as reported $ (0.38) $ (3.80) $ 0.46
============= ============= =============
Basic net income (loss) per share, adjusted $ (0.38) $ (3.54) $ 0.69
============= ============= =============
Diluted net income (loss) per share, as reported $ (0.38) $ (3.80) $ 0.41
============= ============= =============
Diluted net income (loss) per share, adjusted $ (0.38) $ (3.54) $ 0.62
============= ============= =============
The components of goodwill and other intangible assets, net of write-downs for
impairment, at December 31, 2002 and 2001 are as follows:
December 31,
--------------------------------
(in thousands) 2002 2001
- -----------------------------------------------------------------------
Goodwill $ 93,119 $ 93,119
Developed technology 9,311 9,311
Other 1,294 1,294
- -----------------------------------------------------------------------
103,724 103,724
Accumulated amortization (95,343) (94,204)
- -----------------------------------------------------------------------
$ 8,381 $ 9,520
================================
In 2001, the Company recorded a total impairment charge of $269.8 million
related to goodwill (see Note 3) and $925,000 related to developed technology
and other intangible assets.
Impairment of long-lived assets. The Company reviews its long-lived assets,
other than goodwill, for impairment whenever events or changes in circumstances
indicate that the carrying value of such assets may not be recoverable. To
determine recoverability, the Company compares the carrying value of the assets
to the estimated future undiscounted cash flows. Measurement of an impairment
loss for long-lived assets held for use is based on the fair value of the asset.
Long-lived assets classified as held for sale are reported at the lower of
carrying value and fair value less estimated selling costs. For assets to be
disposed of other than by sale, an impairment loss is recognized when the
carrying value is not recoverable and exceeds the fair value of the asset.
For goodwill, an impairment loss will be recorded to the extent that the
carrying amount of the goodwill exceeds its implied fair value.
Accrued liabilities. The components of accrued liabilities are as follows:
December 31,
---------------------------------
(in thousands) 2002 2001
- -------------------------------------------------------------------------------
Accrued compensation and benefits $ 18,962 $ 21,193
Other accrued liabilities 34,568 28,155
- -------------------------------------------------------------------------------
$ 53,530 $ 49,348
=================================
54
Foreign currency translation. For all foreign operations, the U.S. dollar is the
functional currency. Assets and liabilities in foreign currencies are translated
into U.S. dollars using the exchange rate at the balance sheet date. Revenues
and expenses are translated at average rates of exchange during the year. Gains
and losses from foreign currency transactions are included in Interest and other
income, net.
Fair value of financial instruments. The estimated fair value of financial
instruments has been determined by the Company using available market
information and appropriate valuation methodologies. However, considerable
judgment is required in interpreting market data to develop the estimates of
fair value. Accordingly, the estimates presented herein are not necessarily
indicative of the amounts that the Company could realize in a current market
exchange.
The Company's carrying value of cash equivalents, accounts receivable, accounts
payable and other accrued liabilities approximates fair value because of their
short maturities.
The fair value of the Company's short-term investments, and investment in bonds
and notes are determined using estimated market prices provided for those
securities (see Note 4). The fair value of investments in public companies is
determined using quoted market prices for those securities. The fair value of
investments in non-public entities and the fair value of the deposits for wafer
fabrication capacity are not readily determinable.
The fair value of the Company's obligations under capital leases and long-term
debt other than the convertible subordinated notes approximated their carrying
value.
The fair value of the convertible subordinated notes at December 31, 2002 was
approximately $207.6 million, based on the average bid and ask price of these
notes. The fair value of these notes at December 31, 2001 was not readily
determinable as there was no established public training market for them. These
notes are not listed on any securities exchange or included in any automated
quotation system. The recorded bid and ask price may not be reliable as the
figures cannot be independently verified and not all trades are reflected.
On January 1, 2001 PMC adopted Financial Accounting Standards Board FASB
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 requires that all
derivatives be recorded on the balance sheet at fair value. SFAS 133 did not
have a material impact on the date of adoption and did not result in a
cumulative transition adjustment. As of and for the year ended December 31,
2002, the use of derivative financial instruments was not material to our
results of operations or our financial position.
Concentrations. The Company maintains its cash, cash equivalents, short-term
investments and long-term investments in investment grade financial instruments
with high-quality financial institutions, thereby reducing credit risk
concentrations.
At December 31, 2002, approximately 22% (2001 - 20%) of accounts receivable
represented amounts due from one of the Company's distributors. The Company
believes that this concentration and the concentration of credit risk resulting
from trade receivables owing from high-technology industry customers is
substantially mitigated by the Company's credit evaluation process, relatively
short collection terms and the geographical dispersion of the Company's sales.
The Company generally does not require collateral security for outstanding
amounts.
55
The Company relies on a limited number of suppliers for wafer fabrication
capacity.
Revenue recognition. Revenues from product sales direct to customers and minor
distributors are recognized at the time of shipment. The Company accrues for
warranty costs, sales returns and other allowances at the time of shipment based
on its experience. Certain of the Company's product sales are made to major
distributors under agreements allowing for price protection and/or right of
return on products unsold. Accordingly, the Company defers recognition of
revenue on such sales until a distributor sell the products.
Product warranties. The Company provides a one-year limited warranty on most of
its standard products and accrues for the cost of this warranty based on its
experience at the time of shipment. Reconciliation of the product warranty
liability for the year ended December 31, 2002 is as follows:
(in thousands)
- ----------------------------------------------------------------
Beginning balance $ 2,421
Accrual for new warranties issued 946
Reduction for payments (in cash or in kind) (576)
Adjustments related to changes in estimate
of warranty accrual (392)
- ----------------------------------------------------------------
$ 2,399
================
The semiconductor industry is subject to volatility in shipment levels and the
rate of warranty returns tends to fluctuate depending on whether the industry is
in times of growth or contraction. The Company adjusts its rate of accrual to
reflect the level of returns typical of the industry cycle.
Stock-based compensation. The Company accounts for stock-based compensation in
accordance with the intrinsic value method prescribed by APB Opinion No. 25 (APB
25), "Accounting for Stock Issued to Employees". Under APB 25, compensation is
measured as the amount by which the market price of the underlying stock exceeds
the exercise price of the option on the date of grant; this compensation is
amortized over the vesting period.
Pro forma information regarding net income (loss) and net income (loss) per
share is required by SFAS 123 for awards granted or modified after December 31,
1994 as if the Company had accounted for its stock-based awards to employees
under the fair value method of SFAS 123. The fair value of the Company's
stock-based awards to employees was estimated using a Black-Scholes option
pricing model. The Black-Scholes model was developed for use in estimating the
fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, the Black-Scholes model requires the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's stock-based awards to employees have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its stock-based awards to employees. The fair value
of the Company's stock-based awards to employees was estimated using the
multiple option approach, recognizing forfeitures as they occur, assuming no
expected dividends and using the following weighted average assumptions:
56
Options ESPP
---------------------- ----------------------
2002 2001 2000 2002 2001 2000
- ------------------------------------------------------------------------------
Expected life (years) 2.1 3.0 3.1 0.6 0.9 1.4
Expected volatility 101% 90% 70% 122% 110% 90%
Risk-free interest rate 2.6% 4.0% 6.1% 2.4% 4.5% 5.9%
The weighted-average estimated fair values of employee stock options granted
during fiscal 2002, 2001, and 2000 were $4.07, $10.98 and $74.32 per share,
respectively.
If the computed fair values of 2002, 2001, and 2000 awards had been amortized to
expense over the vesting period of the awards as prescribed by SFAS 123, net
income (loss) and net income (loss) per share would have been:
Year Ended December 31
----------------------------------------------
(in thousands, except per share amounts) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported (65,007) (639,054) 75,298
Adjustments:
Additional stock-based employee compensation expense under fair
value based method for all awards, net of related tax effects (101,124) (108,696) (56,616)
------------- -------------- --------------
Net income (loss), adjusted $ (166,131) $ (747,750) $ 18,682
============= ============== ==============
Basic net income (loss) per share, as reported $ (0.38) $ (3.80) $ 0.46
============= ============== ==============
Basic net income (loss) per share, adjusted $ (0.98) $ (4.45) $ 0.12
============= ============== ==============
Diluted net income (loss) per share, as reported $ (0.38) $ (3.80) $ 0.41
============= ============== ==============
Diluted net income (loss) per share, adjusted $ (0.98) $ (4.45) $ 0.10
============= ============== ==============
Interest and other income, net. The components of interest and other income, net
are as follows:
Year Ended December 31,
--------------------------------------------
(in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------
Interest income $ 17,152 $ 18,998 $ 19,243
Interest expense on long-term debt
and capital leases (10,540) (4,335) (808)
Amortization of debt issue costs (1,564) (652) -
Other (95) (117) 491
- -------------------------------------------------------------------------------
$ 4,953 $ 13,894 $ 18,926
============================================
Income taxes. Income taxes are reported under Statement of Financial Accounting
Standards No. 109 and, accordingly, deferred income taxes are recognized using
the asset and liability method, whereby deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases, and operating loss and tax credit carry forwards.
Valuation allowances are provided if, after considering available evidence, it
is more likely than not that some or all of the deferred tax assets will not be
realized.
57
Net income (loss) per common share. Basic net income (loss) per share is
computed using the weighted average number of common shares outstanding during
the period. The PMC-Sierra Ltd. Special Shares have been included in the
calculation of basic net income (loss) per share. Diluted net income (loss) per
share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of stock options and warrants.
Share and per common share data presented reflect the two-for-one stock split in
the form of a 100% stock dividend effective February 2000.
Segment reporting. Segmented information is reported under Statement of
Financial Accounting Standards No. 131 (SFAS 131), "Disclosures about Segments
of an Enterprise and Related Information". SFAS 131 uses a management approach
to report financial and descriptive information about a company's operating
segments. Operating segments are revenue-producing components of a company for
which separate financial information is produced internally for the company's
management. Under this definition, the Company operated, for all periods
presented, in two segments: networking and non-networking products.
Recently issued accounting standards. In June 2002, the Financial Accounting
Standards Board (FASB) issued Statement of Financial Accounting Standard No. 146
(SFAS 146), "Accounting for Costs Associated with Exit or Disposal Activities".
SFAS 146 requires that the liability for a cost associated with an exit or
disposal activity be recognized at its fair value when the liability is
incurred. Under previous guidance, a liability for certain exit costs was
recognized at the date that management committed to an exit plan. As SFAS 146 is
effective only for exit or disposal activities initiated after December 31,
2002, the adoption of this statement will not impact the Company's financial
statements for 2002, but will affect the accounting for any restructurings
initiated after 2002. In January 2003, the Company announced a further
restructuring plan, the costs of which will be accounted for in accordance with
SFAS 146.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN 45 will be effective for any guarantees that are
issued or modified after December 31, 2002. The Company has adopted the
disclosure requirements and is currently evaluating the effects of the
recognition provisions of FIN 45; however, it does not expect that the adoption
will have a material impact on the Company's results of operations or financial
position.
In December 2002, the FASB issued Statement of Financial Accounting Standard No.
148 (SFAS 148), "Accounting for Stock-Based Compensation - Transition and
Disclosure". SFAS 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. SFAS 148 also requires prominent disclosure in the "Summary of
Significant Accounting Policies" of both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The Company has adopted SFAS 148
for the 2002 fiscal year end. Adoption of this statement has affected the
location of the Company's disclosure within the Consolidated Financial
Statements, but will not impact the Company's results of operation or financial
position unless the Company changes to the fair value method of accounting for
stock-based employee compensation.
58
Reclassifications. Certain prior year amounts have been reclassified in order to
conform to the 2002 presentation.
NOTE 2. Business Combinations
Poolings of Interests:
Fiscal 2000
Acquisition of SwitchOn Networks Inc.
In September 2000, the Company acquired SwitchOn Networks Inc., a privately held
packet content processor company, with offices in the United States and India.
Under the terms of the agreement, approximately 2,112,000 shares of common stock
were exchanged and options assumed to acquire SwitchOn.
PMC recorded merger related transaction costs of $1.1 million related to the
acquisition of SwitchOn. These charges, which consisted primarily of legal and
accounting fees, were included under costs of merger in the Consolidated
Statement of Operations for the year ended December 31, 2000.
Acquisition of Quantum Effect Devices, Inc.
In August 2000, the Company acquired Quantum Effect Devices, Inc., a public
company located in the United States. QED developed embedded microprocessors
that perform information processing in networking equipment. Under the terms of
the agreement, approximately 12,300,000 shares of common stock were exchanged
and options assumed to acquire QED.
PMC recorded merger-related transaction costs of $23.2 million related to the
acquisition of QED. These charges, which consisted primarily of investment
banking and other professional fees, were included under costs of merger in the
Consolidated Statements of Operations for the year ended December 31, 2000.
Acquisition of Extreme Packet Devices, Inc.
In April 2000, the Company acquired Extreme Packet Devices, Inc., a privately
held fabless semiconductor company located in Canada. Extreme specialized in
developing semiconductors for high speed IP and ATM traffic management at 10
Gigabits per second rates. Under the terms of the agreement, approximately
2,000,000 exchangeable shares (see Note 10) were exchanged and options assumed
to acquire Extreme.
PMC recorded merger-related transaction costs of $5.8 million related to the
acquisition of Extreme. These charges, which consisted primarily of investment
banking and other professional fees, were included under costs of merger in the
Consolidated Statements of Operations for the year ended December 31, 2000.
Acquisition of AANetcom, Inc.
59
In March 2000, the Company acquired AANetcom, Inc., a privately held fabless
semiconductor company located in the United States. AANetcom developed
technology used in gigabit or terabit switches and routers, telecommunication
access equipment, and optical networking switches in applications ranging from
the enterprise to the core of the Internet. Under the terms of the agreement,
approximately 4,800,000 shares of common stock were exchanged and options
assumed to acquire AANetcom.
PMC recorded merger-related transaction costs of $7.4 million related to the
acquisition of AANetcom. These charges, which consisted primarily of investment
banking and other professional fees, were included under costs of merger in the
Consolidated Statements of Operations for the year ended December 31, 2000.
Acquisition of Toucan Technology Ltd.
In January 2000, the Company acquired Toucan Technology Ltd., a privately held
integrated circuit design company located in Ireland. Toucan offered expertise
in telecommunications semiconductor design. At December 31, 1999, the Company
owned seven per cent of Toucan and purchased the remainder for approximately
300,000 shares of common stock and stock options.
PMC recorded merger-related transaction costs of $534,000 related to the
acquisition of Toucan. These charges, which consisted primarily of legal and
accounting fees, were included under costs of merger in the Consolidated
Statements of Operations for the year ended December 31, 2000.
The acquisitions of SwitchOn, QED, Extreme, AANetcom and Toucan were accounted
for as poolings of interests and accordingly, all prior periods were restated.
The historical results of operations of the Company, Toucan, AANetcom, Extreme,
QED and SwitchOn for the periods prior to the mergers were as follows:
60
Nine Months
Ended
September 30,
(in thousands) 2000
- -----------------------------------------------------------------
Net revenues
PMC $ 411,046
Toucan -
AANetcom 68
Extreme 50
QED 51,407
SwitchOn 461
- -----------------------------------------------------------------
Combined $ 463,032
==================
Net income (loss)
PMC $ 83,691
Toucan (1,963)
AANetcom (17,965)
Extreme (11,327)
QED (11,954)
SwitchOn (9,038)
- -----------------------------------------------------------------
Combined $ 31,444
==================
Purchase Combinations:
Fiscal 2000
Octera Corporation.
On December 12, 2000, the Company completed the purchase of Octera Corporation,
a privately held company located in San Diego, CA, that provided digital design
services for Application Specific Integrated Circuits ("ASICs"), boards and
systems with its primary focus on ASIC design. The Company paid cash and issued
common stock with an aggregate fair value of approximately $16 million to effect
this transaction.
Datum Telegraphic, Inc.
On July 21, 2000, the Company completed the purchase of the 92% interest of
Datum Telegraphic, Inc. that it did not already own in exchange for the issuance
of approximately 681,000 exchangeable shares (see Note 10) and options with a
fair value of $107.4 million, cash of $17 million and acquisition related
expenditures of $875,000. Datum, a wireless semiconductor company located in
Vancouver, Canada, made digital signal processors that allow traffic for all
major digital wireless standards to be transmitted using a single digitally
controlled power amplifier architecture.
Malleable Technologies, Inc.
On June 27, 2000, the Company exercised an option to acquire the 85% interest of
Malleable Technologies, Inc. that it did not already own in exchange for the
issuance of approximately 1,250,000 common shares and 443,000 options and
warrants with a fair value totaling $293 million and acquisition related costs
of $825,000. Malleable, a fabless semiconductor company located in San Jose, CA,
made digital signal processors for voice-over-packet processing applications
which bridge voice and high-speed data networks by compressing voice traffic
into ATM or IP packets.
61
The acquisitions of Octera, Datum and Malleable were accounted for using the
purchase method of accounting and accordingly, the Consolidated Financial
Statements include the operating results of each acquisition from the respective
acquisition dates.
The fair value of the common shares of the Company issued to acquire Malleable,
Datum, and Octera was based on the closing market price of the Company's stock a
short period before and after the date the terms of the acquisitions were agreed
to by the parties and announced to the public.
The total consideration, including acquisition costs, was allocated based on the
estimated fair values of the net assets acquired on the respective acquisition
dates as follows:
(in thousands) Octera Datum Malleable Total
- --------------------------------------------------------------------------------------------------------
Tangible assets $ 258 $ 3,788 $ 2,031 $ 6,077
Intangible assets:
Internally developed software - - 500 500
Assembled workforce - 250 400 650
Goodwill 1,881 106,356 232,303 340,540
Unearned compensation 14,197 8,363 29,033 51,593
In process research and development - 6,700 31,500 38,200
Liabilities assumed (316) (143) (1,932) (2,391)
- --------------------------------------------------------------------------------------------------------
$ 16,020 $ 125,314 $ 293,835 $ 435,169
============== =============== =============== ===============
A portion of the purchase price of each acquisition was allocated to unearned
compensation based on the value of certain unvested shares and options of the
Company issued to effect each acquisition. The fair value of the common shares
that were issued to acquire Malleable and that were subject to vesting
provisions based on continuing employment was recorded as unearned compensation.
The intrinsic value of the unvested shares and options issued to acquire Datum
and Octera, which were acquired after July 1, 2000, was allocated to unearned
compensation. Unearned compensation will be recognized as compensation cost over
the respective remaining future service periods.
Purchased In Process Research and Development
The amounts allocated to in process research and development ("IPR&D") were
determined through independent valuations using established valuation techniques
in the high-technology industry. The value allocated to IPR&D was based upon the
forecasted operating after-tax cash flows from the technology acquired, giving
effect to the stage of completion at the acquisition date. Estimated future cash
flows related to the IPR&D were made for each project based on the Company's
estimates of revenues, operating expenses and income taxes from the project.
These estimates were consistent with historical pricing, margins and expense
levels for similar products.
Revenues were estimated based on relevant market size and growth factors,
expected industry trends, individual product sales cycles and the estimated life
of each product's underlying technology. Estimated operating expenses, income
taxes and charges for the use of contributory assets were deducted from
estimated revenues to determine estimated after-tax cash flows for each project.
These future cash flows were further adjusted for the value contributed by any
core technology and development efforts expected to be completed post
acquisition.
62
These forecasted cash flows were then discounted based on rates derived from the
Company's weighted average cost of capital, weighted average return on assets
and venture capital rates of return adjusted upward to reflect additional risks
inherent in the development life cycle. The risk adjusted discount rate used
involved consideration of the characteristics and applications of each product,
the inherent uncertainties in achieving technological feasibility, anticipated
levels of market acceptance and penetration, market growth rates and risks
related to the impact of potential changes in future target markets.
Based on this analysis, the acquired technology that had reached technological
feasibility was capitalized. Acquired technology that had not yet reached
technological feasibility and for which no alternative future uses existed was
expensed upon acquisition.
Malleable and Datum:
Malleable developed programmable integrated circuits that perform high-density
Voice Over Packet applications. The in process technology acquired from
Malleable was designed to detect incoming voice channels and process them using
voice compression algorithms. The compressed voice was converted, using the
appropriate protocols, to ATM cells or IP packets to achieve higher channel
density and to support multiple speech compression protocols and different
packetization requirements. At the date of acquisition the Company estimated
that Malleable's technology was 58% complete and the costs to complete the
project to be $4.4 million.
Datum designed power amplifiers for use in wireless communications network
equipment. The technology acquired from Datum was a digitally controlled
amplifier architecture, which was designed to increase base station system
capacities, while reducing cost, size and power consumption of radio networks.
At the date of acquisition, the Company estimated that Datum's technology was
59% complete and the costs to complete the project to be $1.8 million.
These estimates were determined by comparing the time and costs spent to date
and the complexity of the technologies achieved to date to the total costs, time
and complexities that PMC expected to expend to bring the technologies to
completion.
The amounts allocated to IPR&D for Malleable and Datum of $31.5 million and $6.7
million, respectively, were expensed upon acquisition, as it was determined that
the underlying projects had not reached technological feasibility, had no
alternative future uses and successful development was uncertain. The
risk-adjusted discount rates used to determine the value of IPR&D for Malleable
was 35% and for Datum was 30%.
The Company discontinued development of the technology acquired from Malleable
in the second quarter of 2001. See Note 3 "Restructuring and other costs".
Development of the chip incorporating the technology acquired from Datum was
completed in the fourth quarter of 2000 and the costs incurred to that date were
in line with the Company's initial expectations. Since then, the Company has
completed the required firmware related to this chip and has extended
development of the Datum technology to a follow-on product. The general economic
slowdown has delayed the introduction of the third generation base stations into
which the Company had expected the Datum technology to be incorporated. It is
currently uncertain when the Datum products will begin to generate significant
revenues.
63
NOTE 3. Restructuring and Other Costs
On January 16, 2003, the Company announced that it was undertaking a corporate
restructuring to further reduce operating expenses. The restructuring plan
includes the termination of approximately 175 employees and the closure of
design centers in Maryland, Ireland and India. PMC will record a restructuring
charge for workforce reduction, facility lease costs and related asset
impairments as these liabilities will be incurred in the first and second
quarters of 2003.
During 2002, the Company paid out $27.5 million in connection with October 2001
restructuring activities.
Cash payments made in 2002 for restructuring activities related to the March
2001 restructuring plan were $2.7 million.
There were no additional restructurings in 2002 nor were there any changes in
estimates related to 2001 restructurings that affected the Statement of
Operations.
Restructuring - October 18, 2001
Due to a continued decline in market conditions, the Company implemented a
restructuring plan in the fourth quarter of 2001 to reduce the operating cost
structure. This restructuring plan included the termination of 341 employees,
the consolidation of additional excess facilities, and the curtailment of
additional research and development projects. As a result, PMC recorded a second
restructuring charge of $175.3 million in the fourth quarter of 2001.
The following summarizes the activity in the October 2001 restructuring
liability:
Write-down of
Facility Lease Software Licenses
and and
Workforce Contract Settlement Property and
(in thousands) Reduction Costs Equipment, Net Total
- -------------------------------------------------------------------------------------------------------------
Total charge - October 18, 2001 $ 12,435 $ 150,610 $ 12,241 $ 175,286
Noncash charges - - (12,241) (12,241)
Cash payments (5,651) (400) - (6,051)
- -------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 6,784 150,210 - 156,994
Adjustments (3,465) 3,465 - -
Cash payments (3,319) (24,176) - (27,495)
- -------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 - 129,499 - 129,499
======================================================================
The Company has completed the restructuring activities contemplated in the
October 2001 plan, but have not yet disposed of all of our surplus leased
facilities
Restructuring - March 26, 2001
64
In the first quarter of 2001, PMC implemented a restructuring plan in response
to the decline in demand for our networking products and consequently recorded a
restructuring charge of $19.9 million. The restructuring plan included the
involuntary termination of 223 employees across all business functions, the
consolidation of a number of facilities and the curtailment of certain research
and development projects.
The following summarizes the activity in the March 2001 restructuring liability:
Facility Lease Write-down of
and Property
Workforce Contract Settlement and
(in thousands) Reduction Costs Equipment, Net Total
- -----------------------------------------------------------------------------------------------------------
Total charge - March 26, 2001 $ 9,367 $ 6,545 $ 3,988 $ 19,900
Noncash charges - - (3,988) (3,988)
Cash payments (7,791) (3,917) - (11,708)
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 1,576 2,628 - 4,204
======================================================================
The Company completed the restructuring activities contemplated in the March
2001 plan by June 30, 2002.
During the first six months of fiscal 2002, the Company made cash payments of
$2.8 million in connection with this restructuring. The remaining restructuring
liability of $1.4 million at June 30, 2002 related primarily to facility lease
payments, net of estimated sublease revenues, and was classified as accrued
liabilities on the balance sheet. The Company does not expect this restructuring
to have any impact on its Statement of Operations in the future.
Impairment of Goodwill and Intangible Assets
During the second quarter of 2001, PMC made a decision to discontinue further
development of the technology acquired in the purchase of Malleable. The Company
did not expect to have any future cash flows related to these assets and had no
alternative use for the technology. Accordingly, the Company recorded an
impairment charge of $189 million, equal to the remaining net book value of
goodwill and intangible assets related to Malleable.
In the fourth quarter of 2001, due to a continued decline in market conditions
and a delay in introduction of certain products to the market, the Company
completed an assessment of the future revenue potential and estimated costs
associated with all acquired technologies. As a result of this review, the
Company recorded a further impairment charge of $80.8 million related to the
acquired goodwill and other intangibles recognized in the purchase of Datum and
Octera. The Company recorded a charge of $79.3 million, measured as the amount
by which the carrying value of the goodwill and intangibles exceeded the present
value of estimated future cash flows related to these assets, to impair the
goodwill and intangibles acquired in the purchase of Datum. The remaining $1.5
million impairment of goodwill resulted from the cancellation of Octera's
research and development activities during 2001.
Write-down of Inventory
The Company recorded a write-down of excess inventory of $4.0 million in 2002
and $20.7 million in 2001. The continued industry wide reduction in capital
spending and resulting decrease in demand for the Company's products prompted
the Company to assess its current inventory levels compared to sales forecasts
for the next twelve months. The excess inventory charge, which was included in
cost of revenues, was calculated in accordance with the Company's policy, which
is based on inventory levels in excess of estimated 12-month demand.
65
NOTE 4. Debt Investments
The following tables summarize the Company's investments in debt securities:
December 31,
------------------------------
(in thousands) 2002 2001
- ------------------------------------------------------------------------------
Held to maturity:
US Government Treasury and Agency notes $ 92,039 $ 50,163
Corporate bonds and notes 303,169 307,352
------------------------------
395,208 357,515
Available-for-sale:
US Government Treasury and Agency notes 94,512 86,352
- ------------------------------------------------------------------------------
$ 489,720 $ 443,867
==============================
Reported as:
Cash equivalents $ - $ 14,233
Short-term investments 340,826 258,609
Investments in bonds and notes 148,894 171,025
- ------------------------------------------------------------------------------
$ 489,720 $ 443,867
==============================
The total fair value of held-to-maturity investments at December 31, 2002 was
$397.8 million (2001 - $358.1 million), with remaining maturities ranging from 1
month to 28 months.
The total fair value of available-for-sale investments at December 31, 2002 was
$94.5 million (2001 - $86.3 million) with remaining maturities ranging from 22
to 25 months.
In 2002 the Company sold investments in bonds and notes with a total amortized
cost of $10.1 million that were classified as held-to-maturity. The securities
were downgraded in credit quality and as a result no longer met the Company's
internal investment policy. The realized gain or loss on these sales was
immaterial.
NOTE 5. Other Investments and Assets
The components of other investments and assets are as follows:
66
December 31,
---------------------------------
(in thousands) 2002 2001
- -----------------------------------------------------------------------------
Investment in Sierra Wireless Inc. $ 8,707 $ 44,317
Other investments in public companies 264 2,744
Investments in non-public entities 7,098 12,392
Deferred debt issue costs (Note 7) 5,603 7,167
Other assets (Note 16) 306 2,243
- -----------------------------------------------------------------------------
$ 21,978 $ 68,863
=================================
At December 31, 2002, the Company held 2.0 million shares (2001 - 2.3 million
shares) of Sierra Wireless, Inc., of which 1.2 million were previously subject
to resale restrictions and could not be sold until May 2002. The Company has
classified these shares as available-for-sale and has recorded a related
unrealized holding gain at December 31, 2002 of $6.3 million (2001 - $41.6
million).
The Company also has investments in non-public entities, either directly or
through venture funds, which include investments in early-stage private
technology companies of strategic interest to the Company. The Company has
commitments to invest additional capital into venture funds (see Note 8). In
2002, the Company made additional cash investments of $10.1 million (2001 - $5.7
million; 2000 - $24.8 million) in non-public entity investments.
During the year ended December 31, 2002, the Company sold some of its
investments in public and non-public companies for cash proceeds of $5.8 million
(2001 - $3.3 million; 2000 - $59.7 million) and recorded gross realized gains of
$3.7 million (2001 - $2.9 million; 2000 - $58.5 million). There were no non-cash
proceeds from sales of investments in 2002 (2001 - $1.7 million; 2000 - nil). Of
these amounts, cash proceeds of $5.3 million (2001 - $2.1 million; 2000 - $59.7
million) and gross realized gains of $3.3 million (2001 - $1.9 million; 2000 -
$58.5 million) related to the disposition of investments classified as available
for sale.
The Company monitors the value of its investments for impairment and records an
impairment charge to reflect any decline in value below its cost basis, if that
decline is considered to be other than temporary. The assessment of impairment
in carrying value is based on the market value trends of similar public
companies, the current business performance of the entities in which we have
invested, and if available, the estimated future market potential of the
companies and venture funds. In 2002, the Company recorded an impairment charge
of $15.3 million (2001 - $17.5 million) related to its investments in non-public
entities. This charge is included in "Gain (loss) on investments" on the
Consolidated Statement of Operations.
NOTE 6. Lines of credit
At December 31, 2002, the Company had available a revolving line of credit with
a bank under which the Company may borrow up to $5.3 million with interest at
the bank's alternate base rate (annual rate of 4.75% at December 31, 2002) as
long as the Company maintains eligible investments with the bank in an amount
equal to its drawings. This agreement expires in December 2004. At December 31,
2002, $5.3 million cash was deposited with the bank to offset the amount
committed under letters of credit.
67
The existing line of credit replaces the $25 million revolving line of credit
that was available to the Company at the end of 2001. At December 31, 2001, $5.3
million of the available $25 million line of credit was committed under letters
of credit.
NOTE 7. Convertible subordinated notes
In August 2001, the Company issued $275 million of convertible subordinated
notes maturing on August 15, 2006. In connection with the issuance of these
convertible subordinated notes, the Company incurred approximately $7.8 million
of issuance costs, which consisted primarily of investment banker fees, legal
and other professional fees, which have been deferred and are being amortized
over the term of the notes. The five-year term notes bear interest at a rate of
3.75% per annum and are convertible into an aggregate of approximately 6,480,650
shares of PMC's common stock at any time prior to maturity, at a conversion
price of approximately $42.43 per share.
The Company may redeem the notes, in whole or in part, at any time after August
19, 2004 at a redemption price ranging from 100.75% to 101.5% of the principal
amount of notes outstanding depending on the redemption date. Under certain
conditions prior to August 19, 2004, the Company may redeem any portion of the
notes at a price of 100% of the principal amount of notes, plus a "make whole"
amount for accrued and unpaid interest to the redemption date. The fair value of
this make whole provision was determined to be immaterial at the time the debt
was issued and at December 31, 2002.
These notes are subject to restrictive covenants including those concerning
payments on the notes and other indebtedness. In the event of a change in
control of the Company, the noteholders may require the Company to repurchase
their notes.
NOTE 8. Commitments and Contingencies
Operating leases. The Company leases its facilities under operating lease
agreements, which expire at various dates through December 31, 2011.
Rent expense including operating costs for the years ended December 31, 2002,
2001 and 2000 was $12.4 million, $15.9 million and $8.3 million, respectively.
Excluded from rent expense for 2002 was additional rent and operating costs of
$27.5 million (2001 - $3.4 million) related to excess facilities, which were
accrued as part of the restructuring charges in 2001.
In connection with the restructuring charges recorded in 2001, the Company
recorded a charge of $128.3 million for exiting and terminating certain lease
facilities that are included in the table below.
Minimum future rental payments under operating leases are as follows:
Year Ending December 31 (in thousands)
- ------------------------------------------------------------------------------
2003 $ 31,839
2004 31,470
2005 30,628
2006 31,964
2007 29,166
Thereafter 118,262
- ------------------------------------------------------------------------------
Total minimum future rental payments under operating leases $ 273,329
=============
68
Supply agreements. The Company has wafer supply agreements with two independent
foundries, which expire in December 2003. Under these agreements, the suppliers
are obligated to provide certain quantities of wafers per year. Neither of the
agreements have minimum unit volume purchase requirements but the Company is
obligated under one of the agreements to purchase in future periods a minimum
percentage of its total annual wafer requirements, provided that the foundry is
able to continue to offer competitive technology, pricing, quality and delivery.
Investment agreements. The Company participates in four professionally managed
venture funds that invest in early-stage private technology companies which
participate in markets of strategic interest to the Company. From time to time
these funds request additional capital for private placements. The Company has
committed to invest an additional $38.1 million in these funds, which may be
requested by the fund managers at any time over the next seven years.
Contingencies. In the normal course of business, the Company receives and makes
inquiries with regard to possible patent infringements. Where deemed advisable,
the Company may seek or extend licenses or negotiate settlements. Outcomes of
such negotiations may not be determinable at any point in time; however,
management does not believe that such licenses or settlements will, individually
or in the aggregate, have a material adverse effect on the Company's financial
position, results of operations or cash flows.
NOTE 9. Special Shares
At December 31, 2002 and 2001, the Company maintained a reserve of 3,196,000 and
3,373,000 shares, respectively, of PMC common stock to be issued to holders of
PMC-Sierra, Ltd. (LTD) special shares.
The special shares of LTD, the Company's principal Canadian subsidiary, are
redeemable or exchangeable for PMC common stock. Special shares do not vote on
matters presented to the Company's stockholders, but in all other respects
represent the economic and functional equivalent of PMC common stock for which
they can be redeemed or exchanged at the option of the holders. The special
shares have class voting rights with respect to transactions that affect the
rights of the special shares as a class and for certain extraordinary corporate
transactions involving LTD. If LTD files for bankruptcy, is liquidated or
dissolved, the special shares receive as a preference the number of shares of
PMC common stock issuable on conversion plus a nominal amount per share plus
unpaid dividends, or at the holder's option convert into LTD ordinary shares,
which are the functional equivalent of voting common stock. If the Company files
for bankruptcy, is liquidated, or dissolved, special shares of LTD receive the
cash equivalent of the value of PMC common stock into which the special shares
could be converted, plus unpaid dividends, or at the holder's option convert
into LTD ordinary shares. If the Company materially breaches its obligations to
special shareholders of LTD (primarily to permit conversion of special shares
into PMC common stock), the special shareholders may convert their shares into
LTD ordinary shares.
These special shares of LTD are classified outside of stockholders' equity until
such shares are exchanged for PMC common stock. Upon exchange, amounts will be
transferred from the LTD special shares account to the Company's common stock
and additional paid-in capital on the consolidated balance sheet.
69
NOTE 10. Stockholders' Equity
Authorized capital stock of PMC. At December 31, 2002 and 2001, the Company had
an authorized capital of 905,000,000 shares, 900,000,000 of which are designated
"Common Stock", $0.001 par value, and 5,000,000 of which are designated
"Preferred Stock", $0.001 par value.
Stock Splits. In January 2000, the Company's Board of Directors approved a
two-for-one split of the Company's common stock in the form of a stock dividend
that was applicable to shareholders of record on January 31, 2000, and effective
on February 14, 2000. All references to share and per share data for all periods
presented have been adjusted to give effect to this stock dividend.
Warrants. During 1996, the Company issued a warrant to purchase 100,000 shares
of common stock at $2.31 per share to an investment banking firm in settlement
for services previously expensed. This warrant was fully exercised in August
2000.
In 1999, as a result of the Company's acquisition of Abrizio, the Company
assumed warrants to purchase 174,580 shares of common stock at $1.66 per share.
In 2000, as a result of the Company's acquisitions of AANetcom, Extreme, QED and
SwitchOn, the Company assumed warrants to purchase 50,759, 63,162, 68,434 and
780 shares of common stock at $9.36, $3.06, $5.26 and $89.76 per share,
respectively. In 2001, 50,759 of these warrants were cancelled. At December 31,
2002, 2001, and 2000, there were 30,100 warrants outstanding at a weighted
average exercise price of $1.66 per share, 42,138 warrants outstanding at a
weighted average exercise price of $1.66 per share, and 92,897 warrants
outstanding at a weighted average exercise price of $5.87 per share,
respectively. All warrants outstanding at December 31, 2002 expire in March
2003.
Convertible Preferred Stock of QED. QED, which was acquired by PMC in August
2000 in a transaction accounted for under the pooling method (see Note 2), had
preferred stock comprised of $0.001 par value per share Series A, B, C, D
convertible preferred shares. Simultaneously with the closing of QED's initial
public offering on February 1, 2000, all issued and outstanding shares of QED's
convertible preferred stock, with a carrying value of $39.9 million, were
automatically converted into 13,619,000 shares of QED common stock. All shares
of common stock of QED were exchanged for shares of PMC common stock at an
exchange ratio of 0.385 (see Note 2) per QED common share.
Exchangeable Shares. As a result of the acquisitions of Extreme and Datum in
2000, each holder of the Extreme and Datum common stock received shares
exchangeable into PMC common stock. The shares are exchangeable, at the option
of the holder, for PMC common stock on a share-for-share basis. The exchangeable
shares remain securities of the Company and entitle the holders to dividend and
other rights economically equivalent to that of PMC common stock and, through a
voting trust, to vote at shareholder meetings of the Company. At December 31,
2002, 2001, and 2000, these shares were exchangeable into 636,000, 712,000 and
1,386,000 PMC shares, respectively.
Stockholders' Rights Plan. On April 26, 2001, PMC adopted a stockholders' rights
plan. Under the rights plan, the Company issued a dividend of one right for each
share of common stock of the Company held by stockholders of record as of May
25, 2001. Each right will initially entitle stockholders to purchase a
fractional share of the Company's preferred stock for $325. However, the rights
are not immediately exercisable and will become exercisable only upon the
occurrence of certain events. Upon occurrence of these events, unless redeemed
for $0.001 per right, the rights will become exercisable by holders, other than
rights held by a potential unsolicited third party acquirer, for shares of the
Company or for shares of the third party acquirer having a value of twice the
right's then-current exercise price.
70
NOTE 11. Employee Equity Benefit Plans
Employee Stock Purchase Plan. In 1991, the Company adopted an Employee Stock
Purchase Plan ("PMC ESPP") under Section 423 of the Internal Revenue Code. Under
the PMC ESPP, the number of shares authorized to be available for issuance under
the plan are increased automatically on January 1 of each year until the
expiration of the plan. The increase will be limited to the lesser of (i) 1% of
the outstanding shares on January 1 of each year, (ii) 2,000,000 shares (after
adjusting for stock dividends), or (iii) an amount to be determined by the Board
of Directors.
In 2000, in connection with the acquisition of QED, the Company assumed the QED
Employee Stock Purchase Plan ("QED ESPP"). A total of 115,000 shares of common
stock were reserved for issuance under this Plan. Under this Plan, eligible
employees were able to purchase a limited amount of common stock at a minimum of
85% of the market value at certain plan-defined dates. As of December 31, 2001,
all employees had converted to the PMC ESPP.
During 2002, 2001, and 2000, there were 610,331 shares, 245,946 shares, and
235,104 shares, respectively, issued under the Plans at weighted-average prices
of $11.73, $31.93, and $16.21 per share, respectively. The weighted-average fair
value of the 2002, 2001, and 2000 awards was $13.80, $31.25, and $41.90 per
share, respectively. During 2002, an additional 1,656,939 shares became
available under the PMC ESPP and no additional shares were authorized for the
QED ESPP. As of December 31, 2002, 5,834,285 shares were available for future
issuance under the PMC ESPP.
Stock Option Plans. The Company has various stock option plans that cover grants
of options to purchase the Company's common stock. The options generally expire
within five to ten years and vest over four years.
During 2000, the Company's stockholders elected to add a provision to the 1994
Incentive Stock Plan, under which plan most of the outstanding options have been
issued. Under the new terms, the number of shares authorized to be available for
issuance under the plan shall be increased automatically on January 1, 2001 and
every year thereafter until January 1, 2004. The increase will be limited to the
lesser of (i) 5% of the outstanding shares on January 1 of each year, (ii)
45,000,000 shares, or (iii) an amount to be determined by the Board of
Directors.
In 2001, the company simplified its plan structure. The 2001 Stock Option Plan
(the "2001 Plan") was created to replace certain stock option plans assumed by
us in connection with mergers and acquisitions completed prior to 2001 (See Item
12). All option activity related to the 2001 Plan and all other assumed plans
are included in the following tables.
Option activity under the option plans was as follows:
71
Weighted
Average
Options Number of Exercise
Available Options Price
For Issuance Outstanding Per Share
- --------------------------------------------------------------------------------
Balance at December 31, 1999 2,329,651 25,114,344 $ 15.20
Additional shares reserved 6,442,687
Granted (3,855,369) 3,855,369 $ 132.97
Exercised - (4,059,790) $ 5.46
Expired (12,214) - -
Repurchased 2,012 - -
Cancelled 873,870 (873,870) $ 32.59
- --------------------------------------------------------------------------------
Balance at December 31, 2000 5,780,637 24,036,053 $ 34.91
Additional shares reserved 8,111,005
Granted (14,838,436) 14,838,436 $ 18.51
Exercised - (2,995,129) $ 6.30
Expired (4,504) - -
Repurchased 86,658 - -
Cancelled 3,774,971 (3,774,971) $ 61.92
Cancelled but unavailable (117,285) - -
- --------------------------------------------------------------------------------
Balance at December 31, 2001 2,793,046 32,104,389 $ 26.82
Additional shares reserved 8,284,696
Granted (658,111) 658,111 $ 7.39
Exercised - (964,794) $ 2.76
Expired - - -
Repurchased 14,367 - -
Cancelled 20,652,984 (20,652,984) $ 36.77
Cancelled but unavailable (230,181)
- --------------------------------------------------------------------------------
Balance at December 31, 2002 30,856,801 11,144,722 $ 9.51
===========================================
The following table summarizes information concerning options outstanding and
exercisable for the combined option plans at December 31, 2002:
Options Outstanding Options Exercisable
------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Remaining Exercise Exercise
Range of Options Contractual Price per Options Price per
Exercise Prices Outstanding Life (years) Share Exercisable Share
- --------------------------------------------------------------------------------------------------
$ 0.17 -- $ 3.66 2,529,701 4.10 $ 2.75 2,425,027 $ 2.75
$ 3.77 -- $ 7.02 3,719,076 4.55 5.46 3,604,672 5.50
$ 7.05 -- $ 14.61 2,090,661 5.58 9.26 1,949,739 9.16
$ 15.98 2,319,373 6.02 15.98 2,270,572 15.98
$ 18.13 -- $ 189.94 485,911 7.64 45.81 277,940 48.62
- --------------------------------------------------------------------------------------------------
$ 0.17 -- $ 189.94 11,144,722 5.08 $ 9.51 10,527,950 $ 8.95
==============================================================================
Voluntary stock option exchange offer. On September 26, 2002, the Company
completed an offering to all eligible option holders of an opportunity to
voluntarily exchange certain stock options.
72
Under the program, participants were able to tender for cancellation stock
options granted within the specified period with exercise prices at or above
$8.00 per share, in exchange for new options to be granted at least six months
and one day after the cancellation of the tendered options. Pursuant to the
terms and conditions set forth in the Company's offer, each eligible participant
will receive a new option to purchase an equivalent number of PMC shares for
each tendered option with an exercise price of less than $60.00. For each
tendered option with an exercise price of $60.00 or more, each eligible
participant will receive a new option to purchase a number of PMC shares equal
to one share for each four unexercised shares subject to the tendered option.
On September 26, 2002, the Company accepted and cancelled 19.3 million options
with a weighted average exercise price of $35.98 and expects to grant
approximately 16.5 million new options no earlier than March 27, 2003 and no
later than April 30, 2003. The new options will have an exercise price equal to
the closing price of the Company's common stock on the date of grant and will be
subject to a new vesting schedule.
NOTE 12. Income Taxes
The income tax provisions, calculated under Statement of Financial Accounting
Standard No. 109 (SFAS 109), consist of the following:
Year Ended December 31,
--------------------------------------------------
(in thousands) 2002 2001 2000
- --------------------------------------------------------------------------------
Current:
Federal $ - $ - $ 40
State 4 4 224
Foreign (27,291) (7,034) 100,880
- --------------------------------------------------------------------------------
(27,287) (7,030) 101,144
- --------------------------------------------------------------------------------
Deferred:
Federal - - (72)
Foreign 8,429 (10,733) 1,340
- --------------------------------------------------------------------------------
8,429 (10,733) 1,268
- --------------------------------------------------------------------------------
Provision for income taxes $ (18,858) $ (17,763) $ 102,412
==================================================
A reconciliation between the Company's effective tax rate and the U.S. Federal
statutory rate is as follows:
73
Year Ended December 31,
---------------------------------------------
(in thousands) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
Income (loss) before provision for income taxes $ (83,865) $ (656,817) $ 177,710
Federal statutory tax rate 35% 35% 35%
Income taxes at U.S. Federal statutory rate $ (29,353) $ (229,886) $ 62,198
State taxes, net of federal benefit - - 224
In process research and development costs - - 13,370
Goodwill and other intangible assets 398 16,188 11,297
Impairment of goodwill and purchased intangible assets - 94,440 -
Acquisition costs - - 13,291
Deferred stock compensation 984 14,414 9,576
Incremental taxes on foreign earnings 1,971 1,535 9,093
Other 421 (97) 530
Valuation allowance 6,721 85,643 (17,167)
- ----------------------------------------------------------------------------------------------------
Provision for (recovery of) income taxes $ (18,858) $ (17,763) $ 102,412
=============================================
Significant components of the Company's deferred tax assets and liabilities are
as follows:
December 31,
--------------------------------
(in thousands) 2002 2001
- ----------------------------------------------------------------------
Deferred tax assets:
Net operating loss carryforwards $ 198,215 $ 176,838
State tax loss carryforwards 12,975 10,926
Credit carryforwards 29,900 26,180
Reserves and accrued expenses 20,652 19,058
Restructuring and other charges 52,979 67,207
Depreciation and amortization 9,262 10,553
Deferred income 3,809 4,800
Deferred stock compensation - 221
- ----------------------------------------------------------------------
Total deferred tax assets 327,792 315,783
Valuation allowance (326,238) (305,929)
- ----------------------------------------------------------------------
Total net deferred tax assets 1,554 9,854
- ----------------------------------------------------------------------
Deferred tax liabilities:
Capitalized technology (498) (369)
Unrealized gain on investments (2,737) (17,715)
- ----------------------------------------------------------------------
Total deferred tax liabilities (3,235) (18,084)
- ----------------------------------------------------------------------
Total net deferred taxes $ (1,681) $ (8,230)
================================
At December 31, 2002, the Company has approximately $583.4 million of federal
net operating losses, which will expire through 2022. Approximately $6.4 million
of the federal net operating losses is subject to ownership change limitations
provided by the Internal Revenue Code of 1986. The Company also has
approximately $216.2 million of state tax loss carryforwards, which expire
through 2022. The utilization of a portion of these state losses is also subject
to ownership change limitations provided by the various states' income tax
legislation.
Included in the credit carryforwards are $18.9 million of federal research and
development credits which expire through 2022, $549,000 of foreign tax credits
which expire in 2003, $497,000 of federal AMT credits which carryforward
indefinitely, $11.1 million of state research and development credits which do
not expire, $1.3 million of state research and development credits which expire
through 2007, and $1.5 million of state manufacturer's investment credits which
expire through 2012.
74
Included in the above net operating loss carryforwards are $23.8 million and
$8.6 million of federal and state net operating losses related to acquisitions
accounted for under the purchase method of accounting. The benefit of such
losses, if and when realized, will be credited first to reduce to zero any
goodwill related to the respective acquisition, second to reduce to zero other
non-current intangible assets related to the respective acquisition, and third
to reduce income tax expense.
Included in the deferred tax assets before valuation allowance are approximately
$147.1 million of cumulative tax benefits related to equity transactions, which
will be credited to stockholder's equity if and when realized.
The pretax income (loss) from foreign operations was ($32.6 million), ($154.1
million) and $254.5 million in 2002, 2001, and 2000, respectively. Undistributed
earnings of the Company's foreign subsidiaries are considered to be indefinitely
reinvested and accordingly, no provision for federal and state income taxes has
been provided thereon. Upon distribution of those earnings in the form of a
dividend or otherwise, the Company would be subject to both US income taxes
(subject to an adjustment for foreign tax credits) and withholding taxes payable
to the various foreign countries. It is not practical to estimate the income tax
liability that might be incurred on the remittance of such earnings.
NOTE 13. Segment Information
The Company has two operating segments: networking and non-networking products.
The networking segment consists of internetworking semiconductor devices and
related technical service and support to equipment manufacturers for use in
their communications and networking equipment. The non-networking segment
consists of custom user interface products. The Company is supporting the
non-networking products for existing customers, but has decided not to develop
any further products of this type.
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on gross profits from operations of the two segments.
Summarized financial information by segment is as follows:
Year Ended December 31,
----------------------------------------
(in thousands) 2002 2001 2000
- --------------------------------------------------------------------
Net revenues
Networking $ 212,651 $ 300,173 $ 665,700
Non-networking 5,442 22,565 28,984
- --------------------------------------------------------------------
Total $ 218,093 $ 322,738 $ 694,684
========================================
Gross profit
Networking $ 126,222 $ 176,068 $ 515,712
Non-networking 2,329 9,408 12,811
- --------------------------------------------------------------------
-
Total $ 128,551 $ 185,476 $ 528,523
========================================
Enterprise-wide information is provided in accordance with SFAS 131. Geographic
revenue information is based on the location of the customer invoiced.
Long-lived assets include investments and other assets, property and equipment,
and goodwill and other intangible assets. Geographic information about
long-lived assets is based on the physical location of the assets.
75
Year Ended December 31,
-------------------------------------------
(in thousands) 2002 2001 2000
- ------------------------------------------------------------------------
Net revenues
United States $ 120,083 $ 187,723 $ 432,649
Asia - excluding China 39,302 32,501 87,554
Canada 24,822 35,448 83,747
China 18,959 34,746 46,485
Europe and Middle East 11,554 31,825 43,101
Other foreign 3,373 495 1,148
- ------------------------------------------------------------------------
Total $ 218,093 $ 322,738 $ 694,684
===========================================
Long-lived assets
Canada $ 38,412 $ 65,634 $ 193,143
United States 25,497 37,968 256,850
Other 1,268 2,803 3,690
- ------------------------------------------------------------------------
Total $ 65,177 $ 106,405 $ 453,683
===========================================
During 2002, the Company had two customers whose purchases represented a
significant portion of net revenues, based on billing, including contract
manufacturers and distributors. Net revenues from one customer represented
approximately 15.9% of the Company's net revenues in 2002 but less than 10% of
net revenues in 2001 and 2000. Net revenues from a second customer were 13.4% in
2002, 12.3% in 2001 and 18.6% of the Company's net revenues for the respective
year. Net revenues for a third customer were approximately 12.8% of the
Company's net revenues in 2001, but were less than 10% of the Company's net
revenues in 2002 and 2000.
NOTE 14. Net Income (Loss) Per Share
The following table sets forth the computation of basic and diluted net income
(loss) per share:
Year ended December 31,
------------------------------------------------
(in thousands, except per share amounts) 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------
Numerator:
Net income (loss) $ (65,007) $ (639,054) $ 75,298
================================================
Denominator:
Basic weighted average common shares outstanding (1) 170,107 167,967 162,377
Effect of dilutive securities:
Stock options - - 19,341
Stock warrants - - 173
------------------------------------------------
Diluted weighted average common shares outstanding 170,107 167,967 181,891
================================================
Basic net income (loss) per share $ (0.38) $ (3.80) $ 0.46
================================================
Diluted net income (loss) per share $ (0.38) $ (3.80) $ 0.41
================================================
76
The Company had approximately 4.4 million and 11.0 million options outstanding
at December 31, 2002 and 2001, respectively, that were not included in diluted
net loss per share because they would be antidilutive.
(1) PMC-Sierra, Ltd. Special Shares are included in the calculation of basic
weighted average common shares outstanding.
NOTE 15. Comprehensive Income
The components of comprehensive income, net of tax, are as follows:
Year Ended December 31,
-----------------------------------------------
(in thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------
Net income (loss) $ (65,007) $ (639,054) $ 75,298
Other comprehensive income:
Change in net unrealized gains on investments,
net of tax of $14,978 in 2002
(2001 - $4,914 and 2000 - $22,629) (21,553) (7,071) 32,563
- -------------------------------------------------------------------------------------------------
Total $ (86,560) $ (646,125) $ 107,861
===============================================
NOTE 16. Related Party Transactions
In 2001, the Company made a real estate loan of approximately $2 million to a
former officer of a subsidiary company. The loan, which was included in other
investments and assets, was repaid in full in December 2002 prior to its
maturity date of December 31, 2002.
77
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
78
PART III
ITEM 10. Directors and Executive Officers of the Registrant
The information concerning the Company's directors and executive officers
required by this Item is incorporated by reference from the information set
forth in the sections entitled "Election of Directors", "Executive Officers",
and "Section 16(a) Beneficial Ownership Reporting Compliance" in our Proxy
Statement for the 2003 Annual Stockholder Meeting.
ITEM 11. Executive Compensation.
The information required by this Item is incorporated by reference from the
information set forth in the sections entitled "Director Compensation" and
"Executive Compensation and Other Matters" in our Proxy Statement for the 2003
Annual Stockholder Meeting.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.
The information concerning security ownership of certain beneficial owners that
is required by this Item is incorporated by reference from the information set
forth in the section entitled "Common Stock Ownership of Certain Beneficial
Owners and Management" in our Proxy Statement for the 2003 Annual Stockholder
Meeting.
Equity Compensation Plan Information:
The following table provides information as of December 31, 2002 with respect to
the shares of our common stock that may be issued under our existing equity
compensation plans.
Number of Securities to Number of securities
Plan Category be issued upon Weighted-average remaining available for
exercise of outstanding exercise price of future issuance under
options, warrants and outstanding options, equity compensation
rights (5) warrants and rights plans(1)
- -----------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders (2) 9,850,838 $ 10.18 33,659,647(3)
Equity compensation plans not
approved by security holders (4) 1,245,495 $ 4.44 3,031,119
- -----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 11,096,333 $ 9.54 36,690,766
==============================================================================
(1) In connection with the voluntary cancellation of options to purchase
approximately 19.3 million shares in September 2002, we promised to grant
new options for approximately 18.0 million shares from our stock plans
between March 27, 2003 and April 30, 2003. The new options will have an
exercise price equal to the closing price of our common stock on the date
they are granted. These options are reflected in the above chart as
remaining available for future issuance. As a result of workforce
reductions we currently plan on issuing 16.5 million options under this
option exchange program (See Note 11 to Consolidated Financial
Statements).
(2) Consists of the 1994 Stock Incentive Plan and the 1991 Employee Stock
Purchase Plan.
79
(3) Includes 5,834,285 shares available for issuance in the 1991 Employee
Stock Purchase Plan. In January 2003, we issued 478,279 shares relating
to the purchase period that began in July 2002.
(4) Consists of the 2001 Stock Option Plan (the "2001 Plan") and outstanding
options that were granted pursuant to assumed stock plans that were
subsequently made part of the 2001 Plan. The 2001 Plan was created to
replace certain stock option plans assumed by us in connection with
mergers and acquisitions completed prior to 2001. The number of options
that may be granted under the 2001 Plan equals (i) the number of shares
reserved under the assumed stock option plans that were not subject to
outstanding or exercised options (1,830,641 shares) plus (ii) the number
of options that were outstanding at the time the plans were assumed but
that have subsequently been cancelled.
(5) This table does not include information for stock option plans assumed by
us which were not made part of the 2001 Plan or any outstanding warrants.
As of December 31, 2002, a total of 48,398 shares of our stock were
issuable upon exercise under those other assumed plans. The weighted
average exercise price of those outstanding options is $4.55. No
additional options may be granted under those plans. As of December 31,
2002, warrants to purchase a total of 30,100 shares of our stock were
outstanding with a weighted average price of $1.66.
ITEM 13. Certain Relationships and Related Transactions.
The information required by this Item is incorporated by reference from the
information set forth in the section entitled "Executive Compensation and Other
Matters - Employment Agreements" in our Proxy Statement for the 2003 Annual
Stockholder Meeting.
ITEM 14. Controls and Procedures
Evaluation of disclosure controls and procedures
Our chief executive officer and our chief financial officer evaluated our
"disclosure controls and procedures" (as defined in Rule 13a-14(c) of the
Securities Exchange Act of 1934 (the "Exchange Act") as of a date within 90 days
before the filing date of this annual report. They concluded that as of the
evaluation date, our disclosure controls and procedures are effective to ensure
that information we are required to disclose in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission rules and
forms.
Changes in internal controls
Subsequent to the date of their evaluation, there were no significant changes in
our internal controls or in other factors that could significantly affect these
controls. There were no significant deficiencies or material weaknesses in our
internal controls so no corrective actions were taken.
PART IV
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
80
(a) 1. Consolidated Financial Statements
The financial statements (including the notes thereto) listed in
the accompanying index to financial statements and financial
statement schedules are filed within this Annual Report on Form
10-K.
2. Financial Statement Schedules
Financial Statement Schedules required by this item are listed on
page 89 of this Annual Report on Form 10-K.
3. Exhibits
The exhibits listed under Item 15(c) are filed as part of this Form
10-K Annual Report.
(b) Reports on Form 8-K
- A Current Report on Form 8-K was filed on November 15, 2002 to
announce the appointment of Alan Krock to the positions of Vice
President of Finance and Chief Financial Officer of PMC-Sierra,
Inc. effective November 11, 2002.
(c) Exhibits pursuant to Item 601 of Regulation S-K.
Exhibit
Number Description
3.1 Restated Certificate of Incorporation of the Registrant, as amended on May 11, 2001 (1)................
3.2 Certificate of Designation of Rights, Preferences and Privileges of Series A Participating
Preferred Stock of the Registrant (2)..................................................................
3.3 Bylaws of the Registrant, as amended (3)...............................................................
4.1 Specimen of Common Stock Certificate of the Registrant (4).............................................
4.2 Exchange Agreement dated September 2, 1994 by and between the Registrant and PMC-Sierra, Ltd.
(5)....................................................................................................
4.3 Amendment to Exchange Agreement effective August 9, 1995 (6)...........................................
4.4 Terms of PMC-Sierra, Ltd. Special Shares (7)...........................................................
4.5 Preferred Stock Rights Agreement, as amended and restated as of July 27, 2001, by and between
the Registrant and American Stock Transfer and Trust Company (8).......................................
4.6 Form of Convertible Note and Indenture dated August 6, 2001 by and between the Registrant and
State Street Bank and Trust Company of California, N.A (9).............................................
10.1^ 1991 Employee Stock Purchase Plan (10) ................................................................
10.2^ 1994 Incentive Stock Plan, as amended (11) ............................................................
10.3^ 2001 Stock Option Plan, as amended (12) ...............................................................
10.4^ Form of Indemnification Agreement between the Registrant and its directors and officers, as
amended and restated ..................................................................................
10.5^ Form of Executive Employment Agreement by and between the Registrant and the executive officers .......
10.6 Net Building Lease dated May 15, 1996 by and between PMC-Sierra, Ltd. and Pilot Pacific
Developments Inc. (13) ................................................................................
81
10.7 Building Lease Agreements between WHTS Freedom Circle Partners, LLC and the Registrant (14)............
10.7 First Amendment to Building Lease Agreements between WHTS Freedom Circle Partners, LLC and the
Registrant (15)........................................................................................
10.8 Building Lease Agreement between Kanata Research Park Corporation and PMC-Sierra, Ltd. (16)............
10.9 Building Lease Agreement between Transwestern - Robinson I, LLC and PMC-Sierra US, Inc. (17)...........
10.10* Forecast and Option Agreement by and among the Registrant, PMC-Sierra, Ltd., and Taiwan
Semiconductor Manufacturing Corporation. (18)..........................................................
10.11* Deposit agreement dated January 31, 2000 by and between Chartered Semiconductor Manufacturing
Ltd. and the Registrant. (19)..........................................................................
10.12 Registration Rights Agreement dated August 6, 2001 by and between the Registrant and Goldman,
Sachs & Co. (20).......................................................................................
10.13* Technology License Agreement, by and between Weitek Corporation and MIPS Computer Systems, Inc.
Assignment Agreement, by and between Weitek Corporation and PMC-Sierra US, Inc. (formerly Quantum
Effect Design, Inc.)
Amendment No. 1 to the Technology License Agreement, by and between MIPS Technologies, Inc. and
PMC-Sierra US, Inc. (formerly Quantum Effect Design, Inc.) dated March 31, 1997 (21)...................
11.1 Calculation of earnings per share (22).................................................................
12.1 Statement of Computation of Ratio of Earnings to Fixed Charges.........................................
21.1 Subsidiaries of the Registrant .......................................................................
23.1 Consent of Deloitte & Touche LLP, Independent Auditors.................................................
24.1 Power of Attorney (23).................................................................................
99.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive
Officer)...............................................................................................
99.2 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial
Officer)...............................................................................................
* Confidential portions of this exhibit have been omitted and filed
separately with the Commission.
^ Indicates management compensatory plan or arrangement required to be filed
as an exhibit pursuant to Item 15(c) of Form 10K.
- ---------------------------
1. Incorporated by reference from Exhibit 3.1 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on May 16,
2001.
2. Incorporated by reference from Exhibit 3.2 filed with the Registrant's
amended Registration Statement on Form S-3 filed with the Commission on
November 8, 2001 (No. 333-70248).
3. Incorporated by reference from Exhibit 3.2 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on November 14,
2001.
4. Incorporated by reference from Exhibit 4.4 filed with the Registrant's
amended Registration Statement on Form S-3 filed with the Commission on
August 27, 1997 (No. 333-15519).
82
5. Incorporated by reference from Exhibit 2.1 filed with the Registrant's
Current Report on Form 8-K, filed with the Commission on September 19,
1994, as amended on October 4, 1995.
6. Incorporated by reference from Exhibit 2.1 filed with Registrant's
Current Report on Form 8-K, filed with the Commission on September 6,
1995, as amended on October 6, 1995.
7. Incorporated by reference from Exhibit 4.3 filed with the Registrant's
Registration Statement on Form S-3, filed with the Commission on
September 19, 1995 (No. 33-97110).
8. Incorporated by reference from Exhibit 4.3 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on November 14,
2001.
9. Incorporated by reference from Exhibit 4.1 filed with the Registrant's
amended Registration Statement on Form S3 filed with the Commission on
November 8, 2001 (No. 333-70248).
10. Incorporated by reference from Exhibit 10.2 filed with the Registrant's
Annual Report on Form 10K filed with the Commission on March 26, 1999.
11. Incorporated by reference from Exhibit 10.2 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on November 8,
2002.
12. Incorporated by reference from Exhibit 10.3 filed with the Registrant's
Quarterly Report on Form 10-Q filed with the Commission on November 8,
2002.
13. Incorporated by reference from Exhibit 10.20 filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 14, 1997.
14. Incorporated by reference from Exhibit 10.36 filed with the
Registrant's Quarterly Report on Form 10-Q filed with the Commission on
August 8, 2000.
15. Incorporated by reference from Exhibit 10.46 filed with the
Registrant's Quarterly Report on Form 10-Q filed with the Commission on
November 14, 2001.
16. Incorporated by reference from Exhibit 10.44 filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 2, 2001.
17. Incorporated by reference from Exhibit 10.45 filed with the
Registrant's Annual Report on Form 10-K filed with the Commission on
April 2, 2001.
18. Incorporated by reference from Exhibit 10.31 filed with the
Registrant's amended Annual Report on Form 10-K filed with the
Commission on March 30, 2000.
19. Incorporated by reference from Exhibit 10.35 filed with the
Registrant's Quarterly Report on Form 10-Q filed with the Commission on
May 10, 2000.
20. Incorporated by reference from Exhibit 10.1 from the Registrant's
amended Registration Statement on Form S-3, filed with the Commission
on November 8, 2001. (No. 333-70248).
21. Incorporated by reference from Exhibit 10.47 from the Registrant's
amended Registration Statement on Form S-3, filed with the Commission
on January 4, 2002. (No. 333-70248).
22. Refer to Note 14 of the financial statements included in Item 8 of Part
II of this Annual Report on Form 10-K.
23. Refer to the Signatures page of this Annual Report.
(d) Financial Statement Schedules required by this item are listed on page
45 of this Annual Report on Form 10k.
83
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PMC-SIERRA, INC.
(Registrant)
Date: March 27, 2003 /s/ Alan F. Krock
-------------------------------------------------
Alan F. Krock
Vice President, Finance (duly authorized officer)
Chief Financial Officer and
Principal Accounting Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Robert L. Bailey and Alan F. Krock, jointly and
severally, his attorneys-in-fact, each with the power of substitution, for him
in any and all capacities, to sign any amendments to this Report on Form 10-K,
and to file the same, with exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his substitute or
substitutes, may or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Name Title Date
/s/ Robert L. Bailey President, Chief Executive Officer (Principal Executive March 27, 2003
- ----------------------------- Officer)
Robert L. Bailey
/s/ Alan F. Krock Vice President, Finance, Chief Financial Officer (and March 27, 2003
- ----------------------------- Principal Accounting Officer)
Alan F. Krock
/s/ Alexandre Balkanski Chairman of the Board of Directors March 27, 2003
- -----------------------------
Alexandre Balkanski
/s/ Colin Beaumont Director March 27, 2003
- ------------------------
Colin Beaumont
/s/ James V. Diller Vice Chairman March 27, 2003
- -----------------------------
James V. Diller
84
/s/ Frank Marshall Director March 27, 2003
- ------------------------
Frank Marshall
/s/ Lewis O. Wilks Director March 27, 2003
- ------------------------
Lewis O. Wilks
85
CERTIFICATIONS
I, Robert L. Bailey, certify that:
1. I have reviewed this annual report on Form 10-K of PMC-Sierra, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 27, 2003 /s/ Robert L. Bailey
-------------- ----------------------------------------
Robert L. Bailey
President and
Chief Executive Officer
86
I, Alan F. Krock, certify that:
1. I have reviewed this annual report on Form 10-K of PMC-Sierra, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 27, 2003 /s/ Alan F. Krock
-------------- ----------------------------------------
Alan F. Krock
Vice President, Finance
Chief Financial Officer and
Principal Accounting Officer
87
SCHEDULE II - Valuation and Qualifying Accounts
Years ended December 31, 2002, 2001, and 2000
(in thousands)
Charged to
Balance at expenses or
beginning of other Balance at
year accounts Write-offs end of year
Allowance for doubtful accounts:
2002 $ 2,625 179 23 $ 2,781
2001 $ 1,934 810 119 $ 2,625
2000 $ 1,553 420 39 $ 1,934
Allowance for obsolete inventory and excess inventory:
2002 $ 28,421 6,992 5,271 $ 30,142
2001 $ 7,223 25,794 4,596 $ 28,421
2000 $ 4,207 5,042 2,026 $ 7,223
88
INDEX TO EXHIBITS
Exhibit Description Page
Number Number
- ----------- ------------------------------------------------------- ----------
10.4 Form of Indemnification Agreement between
the Registrant and its directors and
officers, as amended and restated
10.5 Form of Executive Employment Agreement by
and between the Registrant and the
executive officers
12.1 Statement of Computation of Ratio of
Earnings to Fixed Charges
21.1 Subsidiaries of the Registrant
23.1 Consent of Deloitte & Touche LLP
99.1 Certification Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Chief
Executive Officer)
99.2 Certification Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Chief
Financial Officer)
89