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PMC SIERRA INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Quarterly Report contains forward-looking statements that involve risks and uncertainties. We use words such as "anticipates", "believes", "plans", "expects", "future", "intends", "may", "could", "should", "estimates", "predicts", "potential", "continue", "becoming", "transitioning" and similar expressions to identify such forward-looking statements. Our forward-looking statements include statements as to our business outlook, revenues, margins, expenses, tax provision, capital resources and liquidity sufficiency, sources of liquidity, capital expenditures, interest income and expenses, restructuring activities, cash commitments, purchase commitments, use of cash, our expectation regarding our amortization of purchased intangible assets, our expectations regarding our business acquisitions, and our expectation regarding distribution from certain investments. Such statements, particularly in the "Business Outlook" section, are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing. (See also "Risk Factors" Part II, Item 1A. and our other filings with the Security Exchange Commission ("SEC")). Our actual results may differ materially, and these forward-looking statements do not reflect the potential impact of any divestitures, mergers, acquisitions, or other business combinations that had not been completed as of the filing date of this Quarterly Report. Investors are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date of this Quarterly Report. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. OVERVIEW PMC is a semiconductor innovator transforming networks that connect, move and store digital content. Building on a track record of technology leadership, we are driving innovation across storage, optical and mobile networks. Our highly integrated solutions increase performance and enable next generation services to accelerate the network transformation. Our current revenues are generated by a portfolio of approximately 700 products which we have designed and developed or acquired. PMC's diverse product portfolio enables many different types of communications network infrastructure equipment in three market segments: Storage, Mobile and Optical networks. 1. Our Storage network products enable high-speed communication servers, switches and storage equipment to store, manage and move large quantities of data securely; 2. Our Optical network products are used in optical transport platforms, multi-services provisioning platforms, and edge routers where they gather, process and transmit disparate traffic to their next destination in the network; and 3. Our Mobile network products are used in wireless base stations, mobile backhaul, and aggregation equipment. The following discussion of the financial condition and results of our operations should be read in conjunction with the interim condensed consolidated financial statements and notes thereto included in this Form 10-Q, with certain comparatives restated as described in Part I. Financial Information, Item 1. Financial Statements, the Notes to the Condensed Consolidated Financial Statements, Note 10. Error Correction related to accounting for income taxes. 20 -------------------------------------------------------------------------------- Table of Contents Results of Operations First Quarter of 2013 and 2012 Net revenues First Quarter ($ millions) 2013 2012 Change Net revenues $ 125.2 $ 132.1 (5 )% Overall net revenues for the first quarter of 2013 were $125.2 million, a decrease of $6.9 million compared to the first quarter of 2012, mainly due to lower product volumes. This 5% decrease in the current period compared to the same period of 2012 was mainly attributable to macro-economic uncertainty, which has our customers delaying investments in network infrastructure and has impacted each of the Storage, Optical and Mobile market segments. Storage represented 68% of our net revenues in the first quarter of 2013 compared to 66% in the same period of 2012. Storage net revenues decreased by 3% compared to the same quarter in 2012 due mainly to the factors described above. On a sequential basis, storage net revenues were down 6%, a less than typical seasonal decline. Optical represented 20% of our net revenues in the first quarter of 2013 and 2012. The Optical net revenues decreased by 5% compared to the same quarter in 2012 due mainly to the factors described above. On a sequential basis, Optical net revenues were up 32%, reflecting record quarterly sales of our Optical Transport Network products and our Passive Optical Network products to normal levels after a new marketing initiative by a customer in Japan spurred new growth. Mobile represented 12% our net revenues for the first quarter of 2013 compared to 14% in the same period of 2012. The Mobile net revenues decreased by 15% compared to the same quarter in 2012 due mainly to the factors described above. On a sequential basis, mobile revenues were down 22% as we experienced weak sales in North America, following a strong fourth quarter in 2012. Gross profit First Quarter ($ millions) 2013 2012 Change Gross profit $ 87.9 $ 91.1 (4 )% Percentage of net revenues 70 % 69 % Total gross profit decreased by $3.2 million in the first quarter of 2013 on lower net revenues compared to the same period in 2012. Gross profit as a percentage of net revenues was 70% compared to 69% in the same period last year. On a year over year basis as we were able to offset the negative effect on gross margin percentage of fixed costs over the lower net revenues in the first quarter of 2013, through cost saving initiatives. Operating expenses First Quarter ($ millions) 2013 2012 Change Research and development $ 54.6 $ 59.1 (8 )% Percentage of net revenues 44 % 45 % Selling, general and administrative $ 28.3 $ 29.0 (2 )% Percentage of net revenues 23 % 22 % Amortization of purchased intangible assets $ 10.8 $ 11.3 (4 )% Percentage of net revenues 9 % 9 % 21 -------------------------------------------------------------------------------- Table of Contents Research and Development and Selling, General and Administrative Expenses Our research and development ("R&D") expenses decreased $4.5 million, or 8% compared to the same period last year. This was primarily the result of the decrease in payroll-related costs, including termination costs, and lower tape-out related costs. On a sequential basis, R&D expenses were $5.0 million higher in the first quarter of 2013 compared to the fourth quarter of 2012. This was mainly due to the payroll-related benefits reset at the beginning of the calendar year, and decrease in amount of vacation taken compared to the fourth quarter of 2012, as well as higher tape-out related expenses in the first quarter of 2013. Selling, general and administrative ("SG&A") expenses were $0.7 million, or 2%, lower in the first quarter of 2013 compared to the same period last year, mainly due to the reductions in payroll-related costs, and incurring lease exit and termination costs in the first quarter of 2012 that did not re-occur in the first quarter of 2013. On a sequential basis, these expenses increased $1.1 million primarily due to the reset of certain benefits which is typical at the beginning of the fiscal year, and to an increase in vacation expense as many employees utilize accrued vacation in the fourth quarter of 2012. Amortization of purchased intangible assets Amortization of acquired intangible assets related to developed technology, in-process research and development, customer relationships, and trademarks decreased by $0.5 million in the first quarter of 2013 compared to the same period in 2012. In the third quarter of 2012, we wrote down the goodwill and intangible assets related to the 2006 acquisition of Passave, Inc. and 2010 acquisition of Wintegra, Inc., in the third quarter of 2012, by $276.1 million, resulting in this reduction of quarterly amortization charges. Other income (expense) and Provision for income taxes First Quarter 2012 ($ millions) 2013 (As Restated) Change Amortization of debt issue costs $ - $ (0.1 ) (100 )% Foreign exchange gain (loss) $ 1.4 $ (1.1 ) 227 % Interest income (expense), net $ 0.3 $ (0.2 ) 250 % Provision for income taxes $ (2.6 ) $ (57.8 ) 96 % Amortization of debt issue costs In the first quarter of 2012, we amortized $0.1 million of debt issue costs relating to our senior convertible notes. We retired the remainder of these notes in the fourth quarter of 2012, and accordingly recognized any remaining debt issue costs at that time. 22-------------------------------------------------------------------------------- Table of Contents Foreign exchange gain (loss) We recognized a net foreign exchange gain of $1.4 million in the first quarter of 2013 compared to a net foreign exchange loss of $1.1 million in the first quarter of 2012. This was primarily due to foreign exchange gain and loss on the revaluation of our foreign denominated assets and liabilities. This was partly driven by the United States Dollar appreciating by approximately 2% during the first quarter of 2013 compared to depreciating by approximately 1% during the first quarter of 2012, against currencies applicable to our foreign operations. Interest income expense, net Net interest income was $0.3 million in the first quarter of 2013 compared to net interest expense of $0.2 million in the first quarter of 2012. Provision for income taxes See Part I. Financial Information, Item 1. Financial Statements, the Notes to the Condensed Consolidated Financial Statements, Note 8. Income Taxes and Note 10. Error Correction for details. 23-------------------------------------------------------------------------------- Table of Contents Critical Accounting Estimates General Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our interim condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect our reported assets, liabilities, revenue and expenses, and related disclosure of our contingent assets and liabilities. For a full discussion of our accounting estimates and assumptions that we have identified as critical in the preparation of our interim condensed consolidated financial statements, refer to our Annual Report on Form 10-K for the year ended December 29, 2012, which also provides commentary on our most critical accounting estimates. As discussed more fully in our Form 10-K for the year ended December 29, 2012 in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in the Critical Accounting Policies and Estimates section and Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 1. Summary of Significant Accounting Policies, goodwill is reviewed for impairment annually and more frequently if an event occurs or circumstances change that could reduce the fair value below its carrying value. Business Outlook We expect our net revenues for the second quarter of 2013 to be approximately $126.5 million to $134 million. As in the past, and consistent with business practice in the semiconductor industry, a portion of our revenue is likely to be derived from orders placed and shipped during the same quarter, which we call our "turns business". Our turns business varies from quarter to quarter. We expect the turns business percentage from the beginning of the second quarter of 2013 to be approximately 27%. A number of factors such as volatile macroeconomic conditions could impact achieving our revenue outlook. We anticipate our second quarter 2013 gross margin percentage to be in the range of 70% to 71%, minus approximately 0.2% related to stock-based compensation expense. This could vary depending on the volumes of products sold, since many of our costs are fixed. The gross margin percentage will also vary depending on the mix of products sold. In the second quarter of 2013, we expect operating expenses to be approximately $75.5 million to $77.5 million plus stock-based compensation expense of approximately $6.7 to $7.7 million, and amortization of purchased intangible assets related to our past acquisitions of $10.8 million. On a sequential basis, operating expenses are higher due mainly to an expectation of a multi-year record level of tape-out activity in the second quarter of 2013. We anticipate that net interest income will be approximately $0.3 million in the first quarter of 2013, consisting of income earned from our cash and cash equivalents, short-term investments and long-term investment securities. 24-------------------------------------------------------------------------------- Table of Contents Liquidity & Capital Resources Our principal sources of liquidity are cash from operations, short-term investments and long-term investment securities. We employ these sources of liquidity to support ongoing business activities, acquire or invest in critical or complementary technologies, purchase capital equipment, repay any short-term indebtedness, and finance working capital. Currently, our primary objective for use of discretionary cash has been to repurchase and retire a portion of our common stock. The combination of cash and cash equivalents, short-term investments, and long-term investment securities at March 30, 2013 totaled $296.9 million and is comprised of the following: March 30, 2013 Gross Gross Unrealized Unrealized (in thousands) Amortized Cost Gains* Losses* Fair ValueCash and cash equivalents: Cash $ 69,733 $ - $ - $ 69,733 Money market funds 15,164 - - 15,164 Total cash and cash equivalents 84,897 - - 84,897 Short-term investments: Corporate bonds and notes 19,410 903 (1 ) 20,312 US Treasury and Government Agency notes 1,350 73 - 1,423 Foreign Government and Agency notes - - - - US States and Municipal securities 220 3 - 223 Total short-term investments 20,980 979 (1 ) 21,958 Long-term investment securities: Corporate bonds and notes 131,338 270 (86 ) 131,522 US Treasury and Government Agency notes 52,009 47 (1 ) 52,055 Foreign Government and Agency notes 5,805 20 (1 ) 5,824 Total long-term investment securities 189,793 338 (88 ) 190,043 Total $ 295,670 $ 1,317 $ (89 ) $ 296,898 * Gross unrealized gains include accrued interest on investments of $1.2 million. The remainder of the gross unrealized gains and losses are included in the interim Condensed Consolidated Balance Sheet as Accumulated other comprehensive income (loss). Most of our cash and cash equivalents, short-term investments, and long-term investment securities balances at March 30, 2013 were held by our United States parent company and our Canadian subsidiary. Operating Activities In the first quarter of 2013, cash generated from operations was $14.4 million. Net income, after adding back non-cash expenses of $15.7 million amortization and depreciation and $7.4 million stock based compensation, was the main driver of our positive operating cashflow, with some benefit from normal changes in working capital, including improvement in accounts receivable collections at 41 days sales outstanding (Q1 2012 - 43 days). Investing Activities We had a net outflow of cash of $113.9 million from investing activities in the first three months of 2013, $94.2 million higher than the use of cash in the same period in 2012. During this period, we used $135.3 million to purchase investment securities, which is a typical use for our excess cash, and generated $26.5 million from redemptions and disposals of such investments securities. We also invested $5 million in property and equipment and intangible assets in the first quarter of 2013. Financing Activities Proceeds from employee related stock issuances in the first quarter of 2013 were $14.8 million. 25 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations As of March 30, 2013, we had cash commitments made up of the following: Payments due in: Less than More than (in thousands) Total 1 year 1-3 years 3-5 years 5 years Operating Lease Obligations: Minimum Rental Payments $ 41,308 $ 7,081 $ 15,328 $ 9,680 $ 9,219 Estimated Operating Cost Payments 18,084 2,979 6,677 4,910 3,518 Purchase and Other Obligations 26,336 12,451 13,885 - - Total $ 85,728 $ 22,511 $ 35,890 $ 14,590 $ 12,737 In addition to the amounts shown in the table above, we have recorded a $81.9 million liability for unrecognized tax benefits as of March 30, 2013, and we are uncertain as to if or when such amounts may be realized. Purchase obligations, as noted in the above table, are comprised of commitments to purchase design tools and software for use in product development. Excluded from these purchase obligations are commitments for inventory or other expenses entered into in the normal course of business. We estimate these other commitments to be approximately $57.9 million at March 30, 2013 for inventory and other expenses that will be received within 90 days and that will require settlement 30 days thereafter. Also, in addition to the amounts shown in the table above, we expect to use approximately $13 million of cash in the remainder of 2013 for property and equipment and purchases of intellectual property. We continue to expect that our cash from operations, short-term investments and long-term investment securities will continue to be our primary sources of liquidity. Based on our current operating prospects, we believe that existing sources of liquidity will satisfy our projected operating, working capital, investing, and capital expenditures through the next twelve months. |