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PERICOM SEMICONDUCTOR CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) CRITICAL ACCOUNTING POLICIES Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such statements requires us to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period and the reported amounts of assets and liabilities as of the date of the financial statements. Our estimates are based on historical experience and other assumptions that we consider to be reasonable given the circumstances. Actual results may vary from our estimates. The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our financial statements. The Securities and Exchange Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of a company's financial condition and results of operations, and require the company to make its most difficult and subjective accounting judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include revenue recognition and accounts receivable allowances, which impact the recording of revenues; valuation of inventories, which impacts costs of goods sold and gross margins; accounting for income taxes, which impacts the income tax provision and net income; impairment of goodwill, other intangible assets and investments, which impacts the goodwill, intangible asset and investment accounts; and share-based compensation, which impacts costs of goods sold and operating expenses. These policies and the estimates and judgments involved are discussed further below. We also have other important policies that we discuss in Note 1 to the Consolidated Financial Statements. REVENUE RECOGNITION. We recognize revenue from the sale of our products when: • Persuasive evidence of an arrangement exists; • Delivery has occurred; • The sales price is fixed or determinable; and • Collectability is reasonably assured. Generally, the Company meets these conditions upon shipment because, in most cases, title and risk of loss passes to the customer at that time. In addition, the Company estimates and records provisions for future returns and other charges against revenue at the time of shipment. We sell products to both large domestic and international distributors. We sell our products to domestic distributors at the price listed in our price book for that distributor. At the time of shipment, we record a sales reserve for the entire amount if the customer has the right to return the product. In addition, at the time of sale we record a sales reserve for ship from stock and debits ("SSD"s), stock rotation amounts expected to be returned, return material authorizations ("RMA"s), authorized price protection programs, and any special programs approved by management. These sales reserves offset revenues, which produces the net revenues amount we report in our consolidated financial statements. The market price for our products can be significantly different from the book price at which we sold the product to the distributor. When the market price, as compared with the book price, of a particular sales opportunity from our distributor to their customer would result in low or negative margins to our distributor, we negotiate a ship from stock and debit with the distributor. We analyze our SSD history and use the history to develop SSD rates that form the basis of the SSD sales reserve we record each period. We use historical SSD rates to estimate the ultimate net sales price to the distributor. Our distribution agreements provide for semi-annual stock rotation privileges in a range from 1% to 10% of net sales for the previous six-month period. The contractual stock rotation applies only to shipments at book price. Asian distributors typically buy our product at less than book price and therefore are not entitled to the 10% stock rotation privilege. In order to provide for routine inventory refreshing, for our benefit as well as theirs, we typically grant Asian distributors stock rotation privileges between 1% and 10% even though we are not contractually obligated 30 --------------------------------------------------------------------------------to do so. Each month we adjust the sales reserve for the estimated stock rotation privilege anticipated to be utilized by our distributors. From time to time, customers may request to return parts for various reasons including the customers' belief that the parts are not performing to specification. Many such return requests are the result of customers incorrectly using the parts, not because the parts are defective. Our management reviews these requests and, if approved, we establish a RMA. We are only obligated to accept returns of defective parts. For customer convenience, we may approve a particular return request, even though we are not obligated to do so. Each month, we record a sales reserve for the approved RMAs that have not yet been returned. In the past, we have not kept a general warranty reserve because historically valid warranty returns, which are the result of a part not meeting specifications or being non-functional, have been immaterial and frequently we can resell parts to other customers for use in other applications. We monitor and assess RMA activity and overall materiality to assess whether a general warranty reserve has become appropriate. We grant price protection solely at the discretion of our management. The purpose of price protection is to reduce our distributors' cost of inventory as market prices fall, which reduces our SSD rates. Our sales management team prepares price protection proposals for individual products located at individual distributors. Our general management reviews these proposals and if a particular price protection arrangement is approved, we estimate the dollar impact based on the book price reduction per unit for the products approved and the number of units of those products in that distributor's inventory. We record a sales reserve in that period for the estimated amount at the time revenue is recognized. At the discretion of our management, we may offer rebates on specific products sold to specific end customers. The purpose of the rebates is to allow for pricing adjustments for large programs without affecting the pricing we charge our distributor customers. We record the customer's rebate at the time of shipment. Customers are typically granted payment terms of between 30 and 60 days and they generally pay within those terms. We grant relatively few customers any sales terms that include cash discounts. We invoice our distributors for shipments at our listed book price. When our distributors pay those invoices, they may claim debits for SSDs, stock rotations, cash discounts, RMAs and price protection when appropriate. Once claimed, we confirm these debits are in line with our management's prior authorizations and reduce the reserve we previously established for that customer. The revenue we record for sales to our distributors is net of estimated provisions for these programs. When determining this net revenue, we must make significant judgments and estimates. We base our estimates on historical experience rates, inventory levels in the distribution channel, current trends and other related factors. However, because of the inherent nature of estimates, there is a risk that there could be significant differences between actual amounts and our estimates. Our financial condition and operating results depend on our ability to make reliable estimates and we believe that our estimates are reasonable. CASH AND CASH EQUIVALENTS. Cash and cash equivalents consist of cash on hand and in banks and all highly liquid investments with an original or remaining maturity of three months or less at the time of purchase. SHORT-TERM INVESTMENTS. Our policy is to invest excess funds in instruments with investment grade credit ratings. We classify our investments as "available-for-sale". We recognize unrealized gains and losses in our available-for sale securities as an increase or reduction in shareholders' equity. We report our available-for-sale securities at their fair values. We evaluate our available-for-sale securities for impairment quarterly. We recognize the credit portion of an impairment loss as other than temporary decline in the value of investment in our consolidated statement of operations in the period in which we discover the impairment. Any non-credit portion of an impairment loss is recorded in other comprehensive income in our consolidated balance sheet for the period in which we discover the impairment. We have also made other investments including loans and bridge loans convertible to equity as well as direct equity investments. We make these loans and investments with strategic intentions and, historically, are in privately held technology companies, which by their nature are high risk. These investments are included in other assets in the consolidated balance sheet and we carry them at the lower of cost or market if the investment has experienced an 31 -------------------------------------------------------------------------------- "other than temporary" decline in value. We monitor these investments quarterly and make appropriate reductions in carrying value if we deem a decline in value is other than temporary. ALLOWANCE FOR DOUBTFUL ACCOUNTS. We evaluate our allowance for doubtful accounts using a combination of factors. We record a specific allowance in cases where we become aware of circumstances that may impair a specific customer's ability to pay fully their financial obligation to us. For all other customers, we recognize an allowance based on the length of time the receivable balances are past due, based on the current economic environment and our historical experience. INVENTORIES. For our IC and certain FCP products we record inventories at the lower of standard cost (which approximates actual cost on a first-in, first-out basis) or market value. We adjust the carrying value of inventory for excess and obsolete inventory based on inventory age, shipment history and our forecast of demand over a specific future period. The semiconductor markets that we serve are volatile and actual results may vary from our forecast or other assumptions, potentially affecting our assessment of excess and obsolete inventory resulting in material effects on our gross margin. We record the inventories of the remainder of our FCP products at the lower of weighted-average cost (which approximates actual cost) or market value. Weighted average cost is comprised of average manufacturing costs weighted by the volume produced in each production run. We define market value as the net realizable value for our finished goods and replacement cost for raw materials and work in process. We consider raw material inventory slow moving and fully reserve for it if it has not moved in 365 days. For assembled devices, we disaggregate the inventory by part number. We compare the quantities on hand in each part number category to the quantity we shipped in the previous twelve months, the quantity in backlog and to the quantity we expect to ship in the next twelve months. We record a reserve to the extent the value of each quantity on hand is in excess of the lesser of the three comparisons. In certain circumstances, management will determine, based on expected usage or other factors, that inventory considered excess by these guidelines should not be reserved. The Company does occasionally determine that last twelve months' sales levels will not continue and reserves inventory in line with the quantity forecasted. We believe our method of evaluating our inventory fairly represents market conditions. We consider the reserved material to be available for sale. We do not revalue the reserved inventory should market conditions change or if a market develops for the obsolete inventory. In the past, we have sold obsolete inventory that we have previously fully reserved. Refer to the discussion under the caption "Gross Profit" in this Management's Discussion and Analysis of Financial Condition and Results of Operations for further discussion of sales of our obsolete inventory. PROPERTY, PLANT AND EQUIPMENT. We record our property, plant and equipment at cost and depreciate the cost over the estimated useful lives of each asset classification, ranging between 3 and 40 years. Cost includes purchase cost, applicable taxes, freight, installation costs and interest incurred in the acquisition of any asset that requires a period of time to make it ready for use. In addition, we capitalize the cost of major replacements, improvements and betterments, while we expense normal maintenance and repair. INVESTMENTS IN UNCONSOLIDATED AFFILIATES. We hold and have held ownership interests in various investees. Our ownership in these affiliates has varied from 20% to approximately 49%, which we classify as investments in unconsolidated affiliates in our consolidated balance sheets. We account for long-term investments in companies in which we have an ownership share larger than 20% and in which we have significant influence over the activities of the investee using the equity method. We recognize our proportionate share of each investee's income or loss in the period in which the investee reports the income or loss. We eliminate all intercompany transactions in accounting for our equity method investments. IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE ASSETS. Goodwill and indefinite-lived intangible assets are tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The provisions of the accounting standard for goodwill and other intangibles require that we perform a two-step impairment test on goodwill. In the first step, we compare the fair value of each to its carrying value. In general, our reporting units are one step below the segment level. We determine the fair value of our reporting units based on a weighting of income and market approaches. Under the income approach, we 32 -------------------------------------------------------------------------------- calculate the fair value of a reporting unit based on the present value of estimated future cash flows. Under the market approach, we estimate the fair value based on market multiples of revenue or earnings for comparable companies. Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, and future economic and market conditions and determination of appropriate market comparables. The Company bases these fair value estimates on reasonable assumptions but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. In addition, the Company makes certain judgments and assumptions in allocating shared assets and liabilities to determine the carrying values for each reporting unit. If the fair value of the reporting unit exceeds the carrying value of the net assets assigned to that unit, goodwill is not impaired and we are not required to perform further testing. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must perform the second step of the impairment test in order to determine the implied fair value of the reporting unit's goodwill. If the carrying value of a reporting unit's goodwill exceeds its implied fair value, then we record an impairment loss equal to the difference. We determined that no impairment of our other indefinite-lived intangible assets existed as of June 28, 2014. We also evaluate other definite-lived intangible assets for impairment when events or changes in circumstances indicate that the assets might be impaired. We determined that no impairment for these other definite-lived intangible assets existed at June 28, 2014. SHARE-BASED COMPENSATION. The Company recognizes employee share-based compensation through measurement at grant date based on the fair value of the award, and the fair value is recognized as an expense over the employee's requisite service period. See Note 14 for further discussion of share-based compensation. INCOME TAXES. We account for income taxes using an asset and liability approach to recording deferred taxes. Our deferred income tax assets represent temporary differences between the financial statement carrying amount and the tax basis of existing assets and liabilities that will result in deductible amounts in future years, including net operating loss carry forwards. Based on estimates, the carrying value of our net deferred tax assets assumes that it is more likely than not that we will be able to generate sufficient future taxable income in certain tax jurisdictions. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. If, in the future, we experience losses for a sustained period of time, we may not be able to conclude that it is more likely than not that we will be able to generate sufficient future taxable income to realize our deferred tax assets. If this occurs, we may be required to increase the valuation allowance against the deferred tax assets resulting in additional income tax expense. Our income tax calculations are based on application of the respective U.S. federal, state or foreign tax laws. Our tax filings, however, are subject to audit by the respective tax authorities. Accordingly, we recognize tax liabilities based on its estimates of whether, and the extent to which, additional taxes will be due when such estimates are more-likely-than-not to be sustained. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. To the extent the final tax liabilities are different than the amounts originally accrued, the increases or decreases are recorded as income tax expense or benefit in the Consolidated Statements of Operations. EXECUTIVE OVERVIEW We incorporated Pericom Semiconductor Corporation in June 1990 in California. We design, develop and market high-performance integrated circuits and frequency control products used in many of today's advanced electronic systems. In recent years, our revenues have declined in the computing market segment as sales of our products used in personal computers and laptops declined with the transition to mobile devices such as tablets and smart phones where we have lower market share. Our strategy to target the ultramobility and embedded markets, including automotive, has produced revenue growth that has not yet surpassed the revenue decline in the computing market segment. 33 -------------------------------------------------------------------------------- During fiscal year 2014, net sales decreased 1% as compared with fiscal year 2013; however, we continued to grow revenues in our target markets of ultramobility, which approximately doubled from fiscal 2013, and embedded, which was up a little over 10%, offset by further declines in the networking and computing market segments, with each decreasing approximately 10%. We increased gross profit in fiscal year 2014 to $51.1 million for an increase of $3.2 million from $47.9 million in fiscal year 2013, primarily due to improved product mix in both IC and FCP products. The resulting gross margin for fiscal year 2014 was 39.9%, a 290 basis point improvement, as compared to 37.0% in fiscal year 2013. Operating income was $1.0 million in fiscal year 2014, including a charge of $0.8 million related to the write-off of an uncollected government subsidy, as compared with an operating loss of $19.6 million in fiscal year 2013 that included a charge of $16.9 million related to the impairment of goodwill associated with the acquisition of PTI. Net income for fiscal year 2014 was $4.1 million, or $0.18 per diluted share as compared to a net loss of $21.6 million or a loss of $0.93 per share for fiscal 2013. In summary, our progress in the execution of our market segment transition and gross margin expansion activities are evident in our financial results for fiscal year 2014. RESULTS OF OPERATIONS The following table sets forth certain statement of operations data as a percentage of net revenues for the periods indicated: Fiscal Year Ended ------------------------------------------- June 28, June 29, June 30, 2014 2013 2012 ----------- ------------ ------------ Net revenues 100.0 % 100.0 % 100.0 % Cost of revenues 60.1 63.0 64.5 Gross margin 39.9 37.0 35.5 Operating expenses: Research and development 15.5 16.2 15.9 Selling, general and administrative 23.7 22.9 21.6 Goodwill impairment - 13.1 - Total operating expenses 39.2 52.2 37.5 Income (loss) from operations 0.7 (15.2 ) (2.0 ) Interest and other income, net 2.2 3.1 2.7 Income (loss) before income taxes 2.9 (12.1 ) 0.7 Income tax expense (benefit) (0.2 ) 4.8 2.3 Net income (loss) from consolidated companies 3.1 (16.9 ) (1.6 ) Equity in net income of unconsolidated affiliates 0.1 0.2 0.1 Net income (loss) 3.2 % (16.7 )% (1.5 )% 34 --------------------------------------------------------------------------------COMPARISON OF FISCAL 2014, 2013 AND 2012 NET REVENUES The following table sets forth our revenues and the customer concentrations with respect to such revenues for the periods indicated: Fiscal Year Ended Fiscal Year Ended -------------------------------------------- -------------------------------------------- June 28, June 29, % June 29, June 30, % 2014 2013 Change 2013 2012 Change (in thousands) ------------- ------------- ---------- ------------- ------------- ---------- Net revenues $ 128,068 $129,255 -0.9 % $ 129,255 $ 137,135 -5.7 % Percentage of net revenues accounted for by top 5 direct customers(1) 47 % 42 % 42 % 47 % Number of direct customers that each account for more than 10% of net revenues 2 2 2 2 Percentage of net revenues accounted for by top 5 end customers(2) 32 % 29 % 29 % 28 % Number of end customers that each account for more than 10% of net revenues 1 1 1 - -------------------------------------------------------------------------------- (1) Direct customers include distributors, contract manufacturers and OEMs. (2) End customers are OEMs and their products are manufactured using the Company's products. End customers may purchase directly from the Company or from distributors or contract manufacturers. For end customer sales data, we rely on information provided by our direct distribution and contract manufacturing customers. Net revenues consist of product sales, which we generally recognize upon shipment, less an estimate for returns and allowances. Our order backlog stood at $18.2 million as of June 28, 2014 and $20.6 million as of June 29, 2013. We expect to fulfill most of our backlogged orders as of June 28, 2014 within the first quarter of fiscal 2015. We remain heavily reliant on orders that book and ship in the same quarter ("turns orders"). Our reliance on turns orders, the uncertain strength of our end-markets and the uncertain growth rate of the world economy make it difficult to predict near-term demand. Net revenue decreased $1.2 million or 0.9% in fiscal 2014 versus 2013 primarily as the result of: • An increase of $1.1 million or 1.5% in sales of our IC products to $78.3 million, which included $13.5 million from PTI, which was offset by • a $2.3 million decrease in sales of FCP products to $49.8 million, for a 4.4% decrease. The increased sales of IC products was driven by a $6.8 million gain in sales of ultramobility (cell phone) products, partially offset by declines in sales of PC/notebook and network products. The decreases in FCP product revenues were primarily in networking, PC/notebook, server and storage products. Net revenue decreased $7.9 million or 5.7% in fiscal 2013 versus 2012 primarily as the result of: • A decrease of $8.3 million or 9.7% in sales of our IC products to $77.2 million, which included $14.4 million from the acquisition of PTI, partially offset by • a $393,000 increase in sales of FCP products to $52.1 million, for a 0.8% increase. The sales decreases are primarily the result of declines in unit sales volumes of existing products, as opposed to price decreases, and occurred for the most part in the markets for PC's and notebook computers. For the years ended June 28, 2014 and June 29, 2013, gross revenues were impacted by sales reserves in the amount of $4.9 million and $4.5 million, respectively. In the future, market conditions could become more difficult as other companies compete more aggressively for business. Pricing for our higher margin IC Analog Switch, Clock and Connect products, many of which are proprietary, is more stable, and new product introductions and cost reductions generally offset price declines. 35 -------------------------------------------------------------------------------- The following table sets forth net revenues by country as a percentage of total net revenues for the fiscal years ended June 28, 2014, June 29, 2013, and June 30, 2012: Fiscal Year Ended ----------------------------------------- June 28, June 29, June 30, 2014 2013 2012 (in thousands) ----------- ----------- ----------- Net revenues by country: China (including Hong Kong) 47.7 % 47.6 % 35.1 % Taiwan 30.8 33.4 46.2 United States 4.6 5.0 5.3 Others (less than 10% each) 16.9 14.0 13.4 Total net revenues 100.0 % 100.0 % 100.0 % Over the past three years, sales to China and Taiwan have constituted the majority of our sales. We expect this trend will continue in the future. GROSS PROFIT Fiscal Year Ended Fiscal Year Ended -------------------------------------------- -------------------------------------------- June 28, June 29, % June 29, June 30, % 2014 2013 Change 2013 2012 Change (in thousands) ------------- ------------- ---------- ------------- ------------- ---------- Net revenues $ 128,068 $ 129,255 -0.9 % $ 129,255 $ 137,135 -5.7 % Gross profit 51,085 47,867 6.7 % 47,867 48,651 -1.6 % Gross profit percentage 39.9 % 37.0 % 37.0 % 35.5 % The $3.2 million increase in gross profit in fiscal 2014 as compared to fiscal 2013 is primarily the result of: • Higher margins at 39.9%, resulting in a $3.7 million increase in gross profit, partially offset by • A 0.9% decrease in sales, resulting in $439,000 of reduced gross profit. Gross margins improved in both IC and FCP products, from 47.9% to 49.3% for IC and from 20.9% to 25.2% for FCP from fiscal 2013 to fiscal 2014, respectively. The $784,000 decrease in gross profit in fiscal 2013 as compared to fiscal 2012 is primarily the result of: • A 5.7% decrease in sales, which led to $2.8 million of decreased gross profit, partially offset by • higher margins at 37.0%, due primarily to a higher-margin product mix, resulting in a $2.0 million increase in gross profit. During fiscal years 2014, 2013 and 2012, gross profits and gross margins benefited from the sale of inventory of $327,000, $306,000 and $188,000, respectively, that we had previously identified as excess and reserved. Future gross profit and gross margin are highly dependent on the level and product mix included in net revenues. This includes the mix of sales between lower margin FCP products and our higher margin integrated circuit products. Although we have been successful at favorably improving our integrated circuit product mix and penetrating new end markets, there can be no assurance that this will continue. Accordingly, we are not able to predict future gross profit levels or gross margins with certainty. RESEARCH AND DEVELOPMENT Fiscal Year Ended Fiscal Year Ended -------------------------------------------- -------------------------------------------- June 28, June 29, % June 29, June 30, % 2014 2013 Change 2013 2012 Change (in thousands) ------------- ------------- ---------- ------------- ------------- ---------- Net revenues $ 128,068 $ 129,255 -0.9 % $ 129,255 $ 137,135 -5.7 % Research and development 19,795 21,017 -5.8 % 21,017 21,722 -3.2 % R&D as a percentage of net revenues 15.5 % 16.3 % 16.3 % 15.9 % 36 -------------------------------------------------------------------------------- Research and development ("R&D") expenses consist primarily of costs related to personnel and overhead, non-recurring engineering charges and other costs associated with the design, prototyping and testing of new product concepts, manufacturing process support and customer applications support. The approximately $1.2 million expense decrease for fiscal 2014 as compared with fiscal 2013 is primarily attributable to decreases of $684,000 in depreciation and amortization charges, and reductions of $517,000 for outside consultants and recruiting expenses. The approximately $705,000 expense decrease for fiscal 2013 as compared with fiscal 2012 is primarily attributable to decreases of $678,000 for masks, assembly, design consultants and freight expenditures, $556,000 in depreciation and amortization charges, and $200,000 in facilities-related expenses, partially offset by increased compensation expenses of $735,000. We believe that continued investment in research and development to develop new products and improve manufacturing processes is critical to our success and, consequently, we expect to increase research and development expenses in future periods over the long term. SELLING, GENERAL AND ADMINISTRATIVE Fiscal Year Ended Fiscal Year Ended -------------------------------------------- -------------------------------------------- June 28, June 29, % June 29, June 30, % 2014 2013 Change 2013 2012 Change (in thousands) ------------- ------------- ---------- ------------- ------------- ---------- Net revenues $ 128,068 $129,255 -0.9 % $ 129,255 $ 137,135 -5.7 % Selling, general and administrative 30,320 29,581 2.5 % 29,581 29,648 -0.2 % SG&A as a percentage of net revenues 23.7 % 22.9 % 22.9 % 21.6 % Selling, general and administrative ("SG&A") expenses consist primarily of personnel and related overhead costs for sales, marketing, finance, administration, human resources and general management. The $739,000 expense increase for fiscal 2014 as compared with fiscal 2013 is primarily attributable to increases of $1.5 million in compensation-related expenses and $843,000 of government subsidy receivable write-off, partially offset by reductions of $848,000 in facilities expenses and $702,000 for outside consultants. The $67,000 expense decrease for fiscal 2013 as compared with fiscal 2012 is primarily attributable to decreases of $844,000 in notes receivable write-offs and $194,000 in recruiting expenses, partially offset by increases of $386,000 in facilities expenses, $282,000 in compensation-related expenses and $282,000 in outside accounting services. We anticipate that selling, general and administrative expenses will increase in future periods as we add to our support and administrative staff, particularly in sales and marketing, and as we face increasing commission expense to the extent we achieve higher sales levels. We intend to continue to focus on controlling selling, general and administrative expenses. GOODWILL IMPAIRMENT We test goodwill for impairment annually. We first assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying value. If the carrying value exceeds its fair value, then the second step is performed to determine the implied fair value of the reporting unit's goodwill, and an impairment loss is recorded for an amount equal to the difference between the implied fair value and the carrying value of the goodwill. The fiscal 2013 goodwill impairment analysis resulted in an impairment charge of $16.9 million, in which we wrote-off the goodwill associated with the acquisition of PTI in 2010 and Pericom Taiwan Limited in 2009. This was based on a combination of factors including a decline in the net present value of expected future cash flows from our three reporting units as well as a decline in our market capitalization. There was no goodwill impairment for the years ended June 28, 2014 and June 30, 2012. 37 --------------------------------------------------------------------------------INTEREST AND OTHER INCOME, NET Fiscal Year Ended Fiscal Year Ended --------------------------------------------- --------------------------------------------- June 28, June 29, % June 29, June 30, % 2014 2013 Change 2013 2012 Change (in thousands) ------------- ------------- ----------- ------------- ------------- ----------- Net revenues $ 128,068 $ 129,255 -0.9 % $ 129,255 $ 137,135 -5.7 % Interest income 2,656 3,442 -22.8 % 3,442 3,460 -0.5 % Other income 136 601 -77.4 % 601 224 168.3 % Total interest and other income, net $ 2,792 $ 4,043 $ 4,043 $ 3,684 The decrease in interest income including realized gains for fiscal 2014, as compared to fiscal 2013, was primarily the result of an $890,000 decrease in realized gains from the sale of investment securities, partially offset by a modest increase in interest earned. The $465,000 decrease in other income for fiscal 2014 included a $573,000 decrease in currency exchange gains and a $108,000 increase in other income. The $377,000 increase in other income for fiscal 2013, as compared to fiscal 2012, was primarily the result of a $228,000 increase in currency exchange gains and a $150,000 increase in other income. INTEREST EXPENSE Less than $1,000 of interest expense was recorded in fiscal 2014, as compared with $19,000 in fiscal 2013. There was no debt outstanding at the end of fiscal 2014. Interest expense decreased to $19,000 in fiscal 2013 from $70,000 in fiscal 2012 as a result of reduced levels of debt outstanding during the year. There was no debt outstanding at the end of fiscal 2013. PROVISION FOR INCOME TAXES Fiscal Year Ended Fiscal Year Ended -------------------------------------------- --------------------------------------------- June 28, June 29, % June 29, June 30, % 2014 2013 Change 2013 2012 Change (in thousands) ----------- ------------- ------------ ------------- ----------- ------------- Pre-tax income (loss) $ 3,762 $ (15,606 ) 124.1 % $ (15,606 ) $ 895 -1843.7 % Income tax provision (benefit) (230 ) 6,223 -103.7 % 6,223 3,097 100.9 % Effective tax rate -6.1 % -39.9 % -39.9 % 346.0 % Our effective tax rate differs from the federal statutory rate primarily due to state income taxes, the effect of foreign income tax and foreign losses, the utilization of research and development tax credits and changes in the deferred tax asset valuation allowance. The effective tax rate for fiscal 2014 resulted in a 6.1% tax benefit primarily due to the release of $1.8 million of tax reserves during the year. A reconciliation of our tax rates for fiscal years 2014, 2013 and 2012 is detailed in Note 17 to the Consolidated Financial Statements contained in this report on Form 10-K. The income tax provision for fiscal 2013 increased from fiscal 2012 primarily as a result of our implementation of an operating structure to more efficiently align our transaction flows with our geographic business operations, resulting in a taxable gain in the U.S. for which we booked a $5.0 million income tax provision. Further, the pre-tax loss in fiscal 2013 is primarily the result of the $16.9 million charge for goodwill impairment, which is not deductible for tax purposes. EQUITY IN NET INCOME OF UNCONSOLIDATED AFFILIATE Fiscal Year Ended Fiscal Year Ended --------------------------------------- -------------------------------------- June 28, June 29, % June 29, June 30, % 2014 2013 Change 2013 2012 Change (in thousands) ---------- ---------- ----------- ---------- ---------- ---------- Equity in net income of unconsolidated affiliate $ 132 $ 215 -38.6 % $ 215 $ 134 60.4 % Equity in net income of unconsolidated affiliate consists of the Company's allocated portion of the net income of Jiyuan Crystal Photoelectric Frequency Technology Ltd. ("JCP"), an FCP manufacturing company located in Science Park of Jiyuan City, Henan Province, China. JCP is a key manufacturing partner of PSE-TW, and PSE-TW 38 --------------------------------------------------------------------------------has acquired a 49% equity interest in JCP. For fiscal 2014, the Company's allocated portion of JCP's results was income of $132,000, as compared with $215,000 and $134,000 for fiscal 2013 and 2012, respectively. LIQUIDITY AND CAPITAL RESOURCES As of June 28, 2014, our principal sources of liquidity included continuing operations as well as cash, cash equivalents, and short-term investments of approximately $119.1 million, as compared with $117.7 million at June 29, 2013 and $127.8 million at June 30, 2012. The Company's investment in debt securities includes government securities, corporate debt securities and mortgage backed and asset backed securities. Government securities include US treasury securities, US federal agency securities, foreign government and agency securities, and US state and municipal bond obligations. Many of the municipal bonds are insured; those that are not are nearly all AAA/Aaa rated. The corporate debt securities are all investment grade and nearly all are single A-rated or better. The asset-backed securities are AAA/Aaa rated and are backed by auto loans, student loans, credit card balances and residential or commercial mortgages. Most of our mortgage-backed securities are collateralized by prime residential mortgages issued by government agencies including the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation and Federal Home Loan Banks. Those issued by commercial banks are AAA-rated. As of June 28, 2014, unrealized gains on marketable securities, net of taxes were $132,000. When assessing marketable securities for other-than-temporary declines in value, we consider a number of factors. Our analyses of the severity and duration of price declines, portfolio manager reports, economic forecasts and the specific circumstances of issuers indicate that it is reasonable to expect marketable securities with unrealized losses as of June 28, 2014 to recover in fair value up to our cost basis within a reasonable period of time. We have the ability and intent to hold investments with unrealized losses until maturity, when the obligors are required to redeem them at full face value or par, and we believe the obligors have the financial resources to redeem the debt securities. Accordingly, we do not consider our investments to be other than temporarily impaired as of June 28, 2014. As of June 28, 2014, we owned assets classified as cash and cash equivalents of $33.0 million as compared to $30.8 million at June 29, 2013 and $24.3 million at June 30, 2012. The maturities of our short-term investments are staggered throughout the year to ensure we meet our cash requirements. Because we are primarily a fabless semiconductor manufacturer, we have lower capital equipment requirements than other semiconductor manufacturers that own fabrication foundries. During the 2014 fiscal year, we purchased $5.0 million of property and equipment as compared to $13.2 million and $4.3 million in fiscal 2013 and 2012, respectively. We generated approximately $2.8 million of interest and other income, net during the fiscal year ended June 28, 2014 compared to $4.0 million and $3.7 million in the fiscal years ended June 29, 2013 and June 30, 2012, respectively. In the longer term, we may generate less interest and other income if our total invested balance decreases and the decrease is not offset by rising interest rates or realized gains on the sale of investment securities. In fiscal 2014, our net cash provided by operating activities of $14.5 million was the result of net income of $4.1 million plus $14.4 million in net favorable non-cash adjustments to net income, partially offset by unfavorable changes in assets and liabilities of $4.0 million. The favorable adjustments to net income were primarily comprised of depreciation and amortization of $10.0 million, stock based compensation of $2.8 million, $843,000 write-off of government subsidy, $343,000 of property and equipment write-offs and stock compensation tax benefit of $700,000, partially offset by $179,000 of realized gain on investments and $132,000 of non-cash equity in net income of our unconsolidated affiliate. The favorable changes in assets and liabilities primarily included a $2.6 million decrease in net inventory, a $245,000 decrease in prepaids and other current assets, a $338,000 decrease in other long-term assets and a $349,000 increase in accrued liabilities, partially offset by a $2.2 million increase in accounts receivable and a $3.4 million decrease in accounts payable. In fiscal 2013, our net cash provided by operating activities of $11.0 million was the result of $31.0 million in net favorable non-cash adjustments to a net loss of $21.6 million, and favorable changes in assets and liabilities of $1.6 million. The favorable adjustments to the net loss were primarily comprised of goodwill impairment charge of $16.9 million, depreciation and amortization of $11.2 million, share-based compensation of $3.3 million, share-based compensation tax benefit of $492,000 and $475,000 of property and equipment writeoffs, partially offset by $1.0 million of realized gain on investments and $215,000 of non-cash equity in net income of our 39 --------------------------------------------------------------------------------unconsolidated affiliates. The favorable changes in assets and liabilities primarily included a $2.5 million decrease in accounts receivable, a $1.9 million decrease in net inventory and a $654,000 increase in long-term liabilities, partially offset by a $2.8 million decrease in accounts payable and a $956,000 decrease in accrued liabilities. In fiscal 2012, our net cash provided by operating activities of $27.7 million was the result of $18.3 million in net favorable non-cash adjustments to a net loss of $2.1 million, and favorable changes in assets and liabilities of $11.5 million. The favorable adjustments to the net loss were primarily comprised of depreciation and amortization of $11.9 million, share-based compensation of $3.7 million, $1.8 million in deferred taxes, $856,000 in notes receivable writeoffs, share-based compensation tax benefit of $512,000 and $354,000 of property and equipment writeoffs, partially offset by $673,000 of realized gain on investments and $134,000 of non-cash equity in net income of our unconsolidated affiliates. The favorable changes in assets and liabilities primarily included a $6.3 million decrease in accounts receivable, a $5.0 million decrease in net inventory, a $676,000 decrease in other assets, a $2.7 million increase in accounts payable and a $453,000 increase in long-term liabilities, partially offset by an $883,000 increase in prepaid expenses and other current assets and a $2.7 million decrease in accrued liabilities. In fiscal 2014, we used cash in our investing activities of $3.5 million, which was primarily the result of purchases of property and equipment of $5.0 million, partially offset by net maturities of investments of approximately $1.5 million. In fiscal 2013, our investing activities provided cash of $3.3 million, which was primarily comprised of maturities and sales of investments exceeding purchases by $16.5 million, partially offset by purchases of property and equipment of $13.2 million. In fiscal 2012, we used $15.2 million of cash in our investing activities, which was primarily comprised of final payouts of $8.1 million to complete the PTI acquisition, purchases of property and equipment of $4.3 million, and net purchases of investments of $5.7 million, partially offset by a $2.9 million reduction in restricted cash balances. In fiscal 2014, we used cash in financing activities of $8.9 million, which consisted of $11.3 million used to repurchase common stock, partially offset by $2.4 million of proceeds from employee stock option exercises and purchases under the Employee Stock Purchase Plan. In fiscal 2013, we used cash in financing activities of $8.4 million, which consisted of $7.8 million used to repurchase common stock and $1.4 million of net paydowns of short-term bank loans, partially offset by $797,000 of proceeds from employee stock option exercises and purchases under the Employee Stock Purchase Plan. In fiscal 2012, we used cash in financing activities of $17.6 million, which consisted of $11.6 million used to repurchase common stock and $6.9 million of net paydowns of short-term bank loans, partially offset by $918,000 of proceeds from employee stock option exercises and purchases under the Employee Stock Purchase Plan. We believe our existing cash and investment balances, as well as cash expected to be generated from operating activities, will be sufficient to meet our anticipated cash needs for at least the next 12 months. On April 26, 2012, the Board of Directors authorized a share repurchase program for up to $25 million of shares of the Company's common stock, and on April 24, 2014, the Board authorized an additional $20 million for the share repurchase program. During the year ended June 28, 2014, the Company repurchased 1,354,511 shares for an aggregate cost of $11.3 million. During the year ended June 29, 2013, the Company repurchased 1,100,306 shares for an aggregate cost of $7.8 million. During the year ended June 30, 2012, the Company repurchased 1,482,572 shares for an aggregate cost of $11.6 million. As of June 28, 2014, approximately $26.6 million may still be purchased under the 2012 and 2014 authorizations. We may use a portion of our cash to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, we may evaluate potential acquisitions of such businesses, products or technologies. Our long-term future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support our product development efforts, the expansion of sales and marketing activities, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our products. We could be required, or could elect, to seek additional 40 --------------------------------------------------------------------------------funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us or at all. CONTRACTUAL OBLIGATIONS AND COMMITMENTS The following table depicts our contractual obligations as of June 28, 2014: Payments Due by Period --------------------------------------------------------------- (in thousands) Less than 1-3 3-5 Contractual obligation Total 1 Year Years Years Thereafter ------------------------------------------- --------- ----------- -------- ------- ------------ Operating leases and operating expense commitments $ 540 $ 485 $ 55 $ - $ - Capital equipment purchase commitments 4 4 - - - Facility modification commitments 12 12 - - - Total contractual obligations $ 556 $ 501 $ 55 $ - $ - The operating lease commitments are primarily facility leases at certain of the Company's Asian subsidiaries. The Company has no purchase obligations other than routine purchase orders and the facility modifications shown in the table as of June 28, 2014. OFF-BALANCE SHEET ARRANGEMENTS As of June 28, 2014, the Company did not have any off-balance sheet arrangements, as defined in Item 303(a)(4) of SEC Regulation S-K. RECENTLY ISSUED ACCOUNTING STANDARDS In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2013-11, Income Taxes (Topic 740)-Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. ASU 2013-11 provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. This new standard requires the netting of unrecognized tax benefits ("UTBs") against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. UTBs will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the UTBs. ASU 2013-11 will be effective for annual reporting periods, and interim reporting periods within those years, beginning after December 15, 2013. Early adoption is permitted. Since ASU 2013-11 only impacts financial statement disclosure requirements for unrecognized tax benefits, the Company does not expect its adoption to have an impact on the Company's financial position or results of operations. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers. ASU 2014-09 outlines a single comprehensive model for accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. ASU 2014-09 requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 will be effective for annual and interim reporting periods beginning after December 15, 2016. The impact on our financial condition, results of operations and cash flows as a result of the adoption of ASU 2014-09 has not yet been determined. 41-------------------------------------------------------------------------------- |