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.
PMC-Sierrais a semiconductor and software solution innovator transforming networks that connect, move and store digital content. We generate revenues from the sale of semiconductor, embedded software and board level solutions that we have designed and developed or acquired. Almost all of our revenues in any given year come from the sale of products that are developed prior to that year. For example, 99% of our revenues in 2013 came from products developed or acquired in 2012 and earlier. After an individual product is released for production and announced it may take several years before that product generates any significant revenues.
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, Optical and Mobile networks.
1. Our Storage products enable high-speed communication servers, switches and
storage devices to store, manage and move large quantities of data securely;
2. Our Optical 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 products are used in wireless base stations, mobile backhaul, and
We invest a substantial amount every year for the research and development of new semiconductor solutions. We determine the amount to invest in each semiconductor development based on our assessment of the future market opportunities for those components and the estimated return on investment. To compete globally, we must invest in technologies, products and businesses that are both growing in demand and are cost competitive in the geographic markets that we serve. Going forward, we plan to continue to focus on finding innovative solutions to meet our customers' needs while maintaining our operational efficiencies.
We expect our microprocessor solutions to continue to ship into the laser printer market as well as the enterprise networking market.
Update to the Interim Condensed Consolidated Financial Statements Included in Earnings Press Release Dated
January 30, 2014for the Fourth Quarter and Year Ended December 28, 2013On January 30, 2014, the Company filed a Current Report on Form 8-K incorporating the Press Release announcing the Company's preliminary financial results for its fiscal fourth quarter and year ended December 28, 2013(the "Preliminary Results"). For presentation in this Annual Report on Form 10-K, the Company adjusted certain current and prior year annual and quarterly financial information presented in the Preliminary Results, including items related to balance sheet classification of valuation allowance against deferred tax balances as at the fiscal December 28, 2013and December 29, 2012year ends and capitalizing certain inventory related overhead costs previously expensed through Cost of Revenues. Further details related to these matters are included in Note 19. Error Corrections to the financial statements and in Item 9B. Other Information.
The fiscal 2012 consolidated financial information has been updated within this Management's Discussion and Analysis of Financial Condition and Results of Operations to reflect the corrections as more fully described
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in Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 19. Error Corrections within this Annual Report. RESULTS OF OPERATIONS NET REVENUES (in millions) 2013 Change 2012 Change 2011 Net revenues
$ 508.0(4 )% $ 531.0(19 )% $ 654.3Overall net revenues for 2013 decreased by $23.0 millioncompared to net revenues for 2012. This 4% decrease was mainly attributable to macro-economic uncertainty and continued cautious enterprise and carrier infrastructure spending, which primarily impacted sales volumes of each of the Storage, Optical and Mobile market segments, while average selling prices remained relatively stable. Storage represented 67% of our net revenues in 2013 and 2012. Storage net revenues decreased by 3% year-over-year mainly due to macro-economic uncertainty driving continued softness in enterprise spending. Accordingly, sales volume of our server and storage products were lower compared to 2012. This was partially offset by higher volumes of sales to Data Center customers and continued ramp of 6G and 12G SAS products and revenues from our flash controller products as a result of our acquisition of IDT's enterprise flash controller division during the year. Optical represented 19% of our net revenues in 2013 and 2012. Optical net revenues decreased by 6% compared to 2012 mainly due to continued weakness in the macro-economic environment, which drove lower levels of carrier spending. Sales volumes were down from our Legacy metro aggregation transport and routing and switching products. This was partially offset by higher volume of sales from our high-capacity system-on-a-chip solutions products. Mobile represented 14% of our net revenues in 2013 and 2012. Mobile net revenues decreased by 9% compared to 2012 mainly due to continued weakness in the macro-economic environment, which drove lower levels of carrier spending. Accordingly, sales volumes of our mobile backhaul products were lower compared to 2012. Overall net revenues for 2012 decreased by $123.3 million, or 19% compared to net revenues for 2011. This year-over-year decrease was mainly attributable to lower volumes shipped. We continued to be affected by 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 67% of our net revenues in 2012, compared to 60% in 2011. Storage net revenues decreased by 10% year-over-year mainly due to the macro-economic uncertainty noted above.
Optical represented 19% of our net revenues in 2012, compared to 25% in 2011. Optical net revenues decreased by 37% year-over-year mainly due to the overall macro-economic uncertainty noted above, lower carrier spending and delayed investment by carriers in packet-based technologies to address growth in video and mobile data. This led to a substantial drop in legacy volumes from
SONETand ATM but no corresponding increase in new OTN technology revenue. Mobile represented 14% of our net revenues in 2012, compared to 15% in 2011. Mobile net revenues decreased by 25% year-over-year due mainly to the factors above. GROSS PROFIT (in millions) 2013 Change 2012 Change 2011 Gross profit $ 358.8(4 )% $ 372.1(16 )% $ 443.1
Percentage of net revenues 71 % 70 % 68 % 33
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Gross profit for 2013 decreased by
$13.3 millionover 2012 due to lower volumes. Gross profit as a percentage of net revenues was 71% and 70% in 2013 and 2012, respectively. Our gross margin was favorably impacted during 2013 from warranty provision releases offset by acquisition-related costs and termination costs. The remainder of the change is mainly due to product mix. Gross profit for 2012 decreased by $71.0 millionover 2011. Gross profit as a percentage of net revenues increased 2% to 70% in 2012 from 68% in 2011. This increase is mainly due to $9 millionof expense related to our acquisition of Wintegrain November 2010, specifically, the effect of fair value adjustments related to inventory acquired from Wintegraand sold during the first half of 2011. As a result, gross profit as a percentage of net revenues would have been 69% in 2011 had it not been for this fair value adjustment. The remainder of the change is mainly due to product mix. We were able to offset the negative effect on gross margin percentage of fixed costs over the lower net revenues in 2012 through cost saving initiatives. OTHER COSTS AND EXPENSES ($ millions) 2013 Change 2012 Change 2011 Research and development $ 211.0(4 )% $ 220.9(3 )% $ 227.1Percentage of net revenues 40 % 42 % 35 % Selling, general and administrative $ 112.80 % $ 112.5(5 )% $ 118.6Percentage of net revenues 21 % 21 % 18 % Amortization of purchased intangible assets $ 48.26 % $ 45.32 % $ 44.2Percentage of net revenues 9 % 9 % 7 % Impairment of goodwill and purchased intangible assets $ - (100 )% $ 274.6- % $ - Percentage of net revenues - % 52 % - %
Research and Development Expenses
Our Research and Development ("R&D") expenses were
$211.0 millionin 2013. This was $9.9 million, or 4%, lower compared to 2012. This was primarily the result of the decrease in payroll-related costs, including termination costs, lower outside services due to the timing of projects and lower tape-out related costs incurred in 2013. In addition, R&D expenses in 2013 were favorably impacted by approximately $2.9 millionas a result of changes in estimates related to our patent contingency provisions. Our R&D expenses were $220.9 millionin 2012. This was $6.2 million, or 3%, lower compared to 2011. This was primarily the result of lower outside services costs due to the timing of projects and continued expense control, partially offset by higher payroll-related costs associated with planned hiring (although bonuses were lower) and some increased acquisition related costs.
Selling, General and Administrative Expenses
Our selling, general and administrative ("SG&A") expenses were
$112.8 millionin 2013. This was $0.3 millionhigher compared to 2012, mainly due to an increase in asset impairment of $2.2 millionand higher payroll related costs of $2.6 million, including termination costs of $1.8 million, partially offset by reversal of accruals of $1.3 million, lower lease and facilities expenses of $1.5 millionand certain other decreases including professional fees and lease exit costs. Our SG&A expenses were $112.5 millionin 2012. This was $6.1 million, or 5%, lower compared to 2011, mainly due to lower payroll-related costs, including lower commissions due to lower net revenues, and lower acquisition-related costs. 34
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Amortization of Purchased Intangible Assets
Amortization expense for acquired intangible assets increased by
Amortization expense for acquired intangible assets increased by
$1.1 million, or 2%, in 2012 compared to 2011. This was attributable to commencing amortization of core technology assets acquired in minor business combinations at the end of 2011 and in 2012.
Impairment of goodwill and purchased intangible assets
During the third quarter of 2012, the Company recognized impairment charges of
$274.6 milliondue to weaker quarterly results and lower future projections than previously expected in the former Fiber-to-the-Home ("FTTH") and Wintegrareporting units, respectively, related to the Company's 2006 acquisition of Passave and 2010 acquisition of Wintegra. This was driven by slower adoption rates of FTTH technology in markets outside of Asiaand prolonged weak carrier spending due to unfavorable macroeconomic conditions which negatively impacted Wintegra. These circumstances triggered the Company to perform step one of the impairment test and we determined that the estimated fair values of the reporting units were lower than their respective carrying values. The Company combined these two reporting units (formerly included in the Fiber-to-the-Home Products and Wireless Infrastructure and Networking Products operating segments) with the Communications Products operating segment, to form the new realigned Communications Business Unit operating segment near the end of 2012. This organizational realignment was made to capitalize on the many areas of synergy between the former three reporting units, to create an integrated and focused product roadmap, and to further strengthen the scale advantage we have in the area of network communications. It also allows us to become more efficient in our product development efforts, which is critical since research and development costs for each new device continue to climb while carrier end market growth has not kept pace in the recent past, and will take some time to return to normal levels as macroeconomic conditions recover. The Communications Business Unit operating segment will continue to introduce new products to grow the operating segment, and we have implemented structural changes to our research and development, and marketing and sales activities to better position the operating segment for growth as macroeconomic conditions recover. These products will be the foundation for our growth in the carrier market for the next several years. It is expected that the Company will continue to steadily increase sales and profitability with this newly realigned operating segment, to come in-line with our targeted financial operating metrics. Although the Company recorded impairment charges during 2012 for these former reporting units, their product technology continues to represent a core strategic part of our future technology road-map and portfolio of product offerings for communications network infrastructure equipment. The impairment loss recorded in 2012 did not have a significant impact on the Company's operations and/or liquidity in 2013, nor do we expect that it will in the future. We do note, however, that as a result of the write-down of purchased intangible assets of Wintegra(other than goodwill) of $7 million, there has been a corresponding reduction in quarterly amortization expense of approximately $0.8 million. See within Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 18. Impairment of Goodwill and Long-Lived Assets. OTHER INCOME AND EXPENSES ($ millions) 2013 Change 2012 Change 2011 Revaluation of liability for contingent consideration $ - - % $ - (100 )% $ 29.4Gain on investment securities and other investments $ 1.927 % $ 1.588 % $ 0.8Amortization of debt issue costs $ (0.1 )50 % $ (0.2 )- % $ (0.2 )Foreign exchange gain (loss) $ 4.0367 % $ (1.5 )(600 )% $ 0.3Interest income (expense), net $ 0.9156 % $ (1.6 )(30 )% $ (2.3 )Provision for income taxes $ (25.8 )31 % $ (37.3 )277 % $ (9.9 )35
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Revaluation of liability for contingent consideration
During 2011, we recognized a revaluation of liability for contingent consideration related to our acquisition of
Wintegra. We recognized a fair value adjustment relating to the liability based on the updated assessment during the third quarter of 2011 of Wintegra's2011 revenues, which were below earn-out levels due to delayed platform deployment from key suppliers in Chinaand Europe. See Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 2. Business Combinations. There is no other liability for contingent consideration.
Gain on investment securities and other
We recorded a gain on sale of investment securities and other investments of
$1.9 million, $1.5 million, and $0.8 million, related to the disposition of investment securities and other investments in 2013, 2012, and 2011, respectively. We also recognized recoveries of prior impairments of our investments in the Reserve Funds of $0.5 millionin 2011, based on distributions received from the Reserve Funds.
Amortization of debt issue costs
We recorded amortization of debt issue costs of
$0.1 millionin 2013 relating to our credit facility, and $0.2 millionin each of 2012 and 2011 relating to our senior convertible notes.
Foreign exchange gain (loss)
We have significant design presence outside
the United States, especially in Canada. The majority of our operating expense exposures to changes in the value of the Canadian dollar relative to the United Statesdollar have been hedged in accordance with our general practice of hedging. We recognized a net foreign exchange gain of $4.0 millionin 2013, a net foreign exchange loss of $1.5 millionin 2012, and a net foreign exchange gain of $0.3 millionin 2011. This was primarily due to foreign exchange gain and loss on the revaluation of our net foreign denominated assets and liabilities. This was partly driven by the United States Dollar appreciating by approximately 7% during 2013 compared to depreciating by approximately 1% during 2012, and depreciating by approximately 1% during 2011, against currencies applicable to our foreign operations.
Interest income (expense), net
Net interest income for 2013 was
$0.9 millionand net interest expense for 2012 and 2011 was $1.6 millionand $2.3 million, respectively. We retired our senior convertible notes in October 2012and we drew $30 millionin funds from our credit facility in November 2013. This resulted in a lower interest expense to offset interest income from cash in banks and short-term investments in 2013 compared to 2012. In 2012, the decrease in net interest expense of $0.7 million, compared to 2011 was primarily due to less interest expense as a result of retiring our senior convertible notes in October 2012, and no accretion of the liability for contingent consideration in 2012 compared to 2011, partially offset by lower investment yields on lower cash balances in 2012. In 2011, the increase in net interest expense of $1.1 million, compared to 2010, was due to lower investment yields and lower cash balances. In addition, we recognized $1.2 millionof interest expense related to the accretion of the liability for contingent consideration in 2011, which was offset by the decline of $0.8 millioninterest on our short-term loan related to our acquisition of Wintegrain 2011 compared to 2010. 36
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Provision for income taxes
On a consolidated basis, the Company recorded a provision for income taxes of
The difference between our effective tax rates and the 35% US federal statutory rate in each of 2013, 2012, and 2011, resulted primarily from foreign earnings eligible for tax rates lower than the federal statutory rate due to economic incentives subject to certain criteria granted by foreign jurisdictions and extending to approximately 2020, investment tax credits earned, changes in valuation allowance, and adjustments for prior years taxes and tax credits, partially offset by non-deductible intangible asset amortization and impairment of goodwill and purchased intangible assets, the effect of inter-company transactions, utilization of stock option related loss carryforwards recorded in equity, changes in accruals related to the unrecognized tax benefit liabilities, and permanent differences arising from stock-based compensation and other items. The Company's 2013 tax rate was higher than the 35% statutory rate primarily due to
$32.5 millionincrease in valuation allowance on deferred tax assets, $18.1 milliontax on intercompany transactions, $16.1 millionnon-deductible amortization and stock-based compensation expense, partially offset by $23.3 milliontax credits generated in 2013, $10.2 milliontax on profits earned in jurisdictions where the tax rate is lower than the U.S. tax rate, and the balance attributable to deferred tax timing differences and other items. The Company's 2012 tax rate was higher than the 35% statutory rate primarily due to the $104.8 milliontax impact of an intercompany dividend $109.8 millionnon-deductible amortization and stock-based compensation expense, and $17.6 millioneffect of stock option related loss carry-forwards recorded in equity, partially offset by a decrease in valuation allowance of $40.3 million, $19.2 milliontax credits generated in 2012, and the balance attributable to deferred tax timing differences and other items. The Company's 2011 tax rate was lower than the 35% statutory rate primarily due to $28.2 millionprofits earned in jurisdictions where the tax rate is lower than the U.S. tax rate and $18.4 milliontax credits generated in 2011, partially offset by the tax impact of $33.9 millioninter-company transactions, an adjustment of $25.9 millionprior year taxes, $9.0 millionnon-deductible stock-based compensation and amortization expense and write-down, and the balance attributable to deferred tax timing differences and other items.
See Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 15. Income Taxes.
The following is our outlook for the three months ending
Non-GAAP measure Reconciling items GAAP Measure (in millions, except for percentages) Net revenues
$120-$128N/A(a) $120-$128Gross profit % 70%-71% (0.2)%(b) 69.8%-70.8% Operating expenses $71-$73 $21-$22(c) $92-$95Provision for income taxes $1** **
(a) 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 first quarter of 2014 to be approximately 29%. A number of factors such as volatile macroeconomic conditions could impact achieving our revenue outlook. 37
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percentage can vary depending on a volume of products sold given certain
costs are fixed. The gross margin percentage will also vary depending on the
mix of products sold.
(c) The referenced amount consists of
compensation expense and
$15.1 millionof amortization of purchased intangible assets.
** The comparable GAAP measure is not available on a forward-looking basis
without unreasonable effort.
The above non-GAAP information is provided as a supplement to the Company's condensed consolidated financial statements presented in accordance with U.S. generally accepted accounting principles ("GAAP"). A non-GAAP financial measure is a numerical measure of a company's performance, financial position, or cash flows that either excludes or includes amounts that are not normally excluded or included in the most directly comparable measure calculated and presented in accordance with GAAP. The Company believes that the additional non-GAAP measures are useful to investors for the purpose of financial analysis. Management uses these measures internally to evaluate the Company's in-period operating performance before gains, losses and other charges that are considered by management to be outside of the Company's core operating results. In addition, the measures are used for planning and forecasting of the Company's future periods. However, non-GAAP measures are not in accordance with, nor are they a substitute for, GAAP measures. Other companies may use different non-GAAP measures and presentation of results.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of liquidity are cash from operations, our 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, cash equivalents, short-term investments and long-term investment securities at
December 28, 2013and December 29, 2012totaled $214.3 millionand $273.2 million, respectively.
In 2013, we obtained a revolving line of credit with a bank under which the Company may borrow up to
In the future, we expect our cash on hand and cash generated from operations, together with our short-term investments, long-term investment securities and revolving line of credit, to be our primary sources of liquidity (see Item 8. Financial Statements and Supplementary Data, the Notes to the Consolidated Financial Statements, Note 4. Fair Value Measurements).
Cash generated from operations was
$78.8 millionin fiscal 2013 compared to cash generated from operations of $58.8 millionin 2012. Our net loss for the year was $32.5 million. Net loss, after adding back non-cash expenses of $71.4 millionamortization and depreciation and $26.3 millionstock based compensation was the main driver of our positive operating cash flow, with some benefit from normal changes in working capital, including improvement in accounts receivable collections at 40 days sales outstanding (2012-43 days) and increase in deferred taxes and income taxes payable. In addition, partially offsetting these were $8.5 millionin working capital changes, driven mainly by $5.6 millionreduction in accounts payables and accrued liabilities and $3.6 millionincrease in inventory levels at the end of 2013. 38
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Cash used in investing activities was
$126.7 millionin fiscal 2013 compared to cash generated by investing activities of $166.3 millionin 2012. In 2013, we acquired IDT's Enterprise Flash Controller division for $96.1 millioncash, purchased $16.9 millionin property, equipment and intangible assets and purchased $179.80 millionof investment securities. This is offset by $162.8 millionand $8.5 millioncash generated from disposal of investment securities and redemption of short-term investments.
In 2012, we redeemed short-term investments and disposed of investment securities to fund our stock buyback programs and redemption of our Senior Convertible notes. We also used cash of
During 2013, we used
$76.3 millionto repurchase 12.6 million shares of our common stock. In 2012, we used $200 millionto repurchase 33.7 million shares of our common stock. During 2013, we drew $30 millionfrom our revolving line of credit to fund the share repurchases. During 2012, we redeemed our senior convertible notes at their face values of $68.3 million. During 2013, we also received $25.2 million(2012-$16 million) from issuances of common stock, and recognized $0.8 million(2012-$14.2 million) from excess tax benefits from stock option transactions.
In connection with the acquisition of
Payments due in: More Less than than 5 (in thousands) Total 1 year 1-3 years 3-5 years years Operating Lease Obligations: Minimum Rental Payments
$ 36,686 $ 9,268 $ 13,430 $ 8,430 $ 5,558Estimated Operating Cost Payments 16,545 3,903 6,535 4,384 1,723 Purchase and Other Obligations (1) 28,700 6,820 21,880 - - Total $ 81,931 $ 19,991 $ 41,845 $ 12,814 $ 7,281
(1) Included in the Purchase and Other Obligations is
software tools, which will be paid between 2014 and 2015. This amount
Balance Sheet for the year ended
purchase orders for inventory or other expenses issued in the normal course
of business in the purchase obligations shown above. We estimate these other
commitments to be approximately
inventory and other expenses that will be received in the coming 90 days and
that will require settlement 30 days thereafter.
We expect to spend approximately
$17.5 millionin 2013 for capital expenditures including purchases of intellectual property. Based on our current operating prospects, we believe that existing sources of liquidity will be sufficient to satisfy our projected operating, working capital, capital expenditure, purchase obligations and debt obligations through the next twelve months. In addition to the amounts shown in the table above, we have recorded a $82.1 millionliability for unrecognized tax benefits as of December 28, 2013, and we are uncertain as to if or when such amounts may be realized. 39
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OFF-BALANCE SHEET ARRANGEMENTS
RECENT ACCOUNTING PRONOUNCEMENTS
Recently Adopted Accounting Pronouncements
February 2013, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update ("ASU") No. 2013-12, "Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income". This new guidance requires companies to present, either in a single note or parenthetically on the face of the financial statements, the effect of significant amounts reclassified based on its source and is effective for public companies in interim and annual reporting periods beginning after December 15, 2012. Accordingly, we adopted these presentation requirements during the first quarter of 2013 and it did not have a material impact on our consolidated financial statements or related disclosures.
New Accounting Pronouncements Not Yet Adopted
July 2013, FASB issued ASU No. 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or Tax Credit Carryforward Exists". The new guidance requires entities to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. If the deferred tax asset is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use the deferred tax asset for such purpose, then the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2013, with early adoption permitted. Accordingly, we plan to adopt these presentation requirements during the first quarter of 2014. We are currently assessing the impact of this new guidance on our consolidated financial statements and related disclosures.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
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 we report as assets, liabilities, revenue and expenses, and the 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. These estimates could change under different assumptions or conditions. Our significant accounting policies are outlined in the notes 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.
Valuation of Goodwill and Intangible Assets
Purchase price allocations for business acquisitions often require significant judgments, particularly with regards to the determination of value for identifiable assets, liabilities and goodwill. Often third party specialists are used to assist in areas of valuation requiring complex estimation. 40
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We assess long-lived assets for possible impairment in the fourth quarter, or when events or changes in circumstances indicate that the carrying value of the assets or the asset grouping may not be recoverable. Factors that we may consider when determining when to conduct an impairment test include: (i) any declines in our forecasted operating results; (ii) a decline in the valuation of technology company stocks, including the valuation of our common stock; (iii) a further significant slowdown in the worldwide economy or the semiconductor industry; or (iv) any failure to meet the performance projections included in our forecasts of future operating results. The Company first assesses qualitative factors to determine whether the existence of events or circumstances exist, such as an adverse change in business climate or a decline in the overall industry that would indicate that it would more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill. If the Company determines that it is not more likely than not that the fair value of any of its reporting units is less than its carrying amount, no further assessment is performed. If the Company determines that it is more likely than not that the fair value of any of its reporting units is less than its carrying amount, a quantitative assessment will be performed which involves a two-step process to determine: 1) whether the fair value of the relevant reporting unit exceeds the carrying value and 2) the amount of an impairment loss, if any. To determine whether impairment exists for long-lived intangible assets, other than goodwill, we first compare the undiscounted cash flows of the assets to their carrying value. If the asset's carrying value exceeds its estimated undiscounted cash flows, we would write down the asset to its estimated fair value based on expected discounted cash flows. Significant management judgment is required in the forecasts of future operating results and discount rates used in the discounted cash flow method of valuation. It is possible, however, that the plans may change and estimates used may prove to be inaccurate. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur additional impairment charges. During the third quarter of 2012, we recognized
$274.6 millionin impairment of goodwill and purchased intangible assets related to the 2006 acquisition of Passave, Inc.and the 2010 acquisition of Wintegra. All of the goodwill of Passave was written down by $146.3 milliondue to weaker quarterly results and future projections than previously expected, driven by slower adoption rates of FTTH technology in markets outside of Asia. All of the goodwill and a portion of the other intangible assets of Wintegrawere determined to be impaired by $121.3 millionand $7 million, respectively, as a result of the continuing weak carrier spending, more so than previously expected. This impairment charge was included in the Consolidated statement of operations as Impairment of goodwill and purchased intangible assets. No goodwill impairment charges were recorded during the year ended December 28, 2013.
Changes in the estimated fair values of intangible assets in the future could result in significant impairment charges or changes to our expected amortization.
The Company has one reportable segment-semiconductor solutions for communications network infrastructure, comprised of the following operating segments: Communications Products, Enterprise Storage Products, Microprocessor Products, and Broadband Wireless Products. The aggregation of operating segments into one reportable segment requires the management to evaluate whether there are similar expected long-term economic characteristics for each operating segment, and is an area of significant judgment. If the expected long-term economic characteristics were to become dissimilar, then we could be required to re-evaluate the number of reportable segments. 41
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Calculating the fair value of stock-based compensation awards requires the input of highly subjective assumptions, including the expected life of the awards and expected volatility of our stock price. Expected volatility is a statistical measure of the amount by which a stock price is expected to fluctuate during a period. Our estimates of expected volatilities are based on a weighted historical and market-based implied volatility. In order to determine the expected life of the awards, we use historical data to estimate option exercises and employee terminations; separate groups of employees that have similar historical exercise behavior, such as directors or executives, are considered separately for valuation purposes. The expected forfeiture rate applied in calculating stock-based compensation cost is estimated using historical data and is updated annually. The assumptions used in calculating the fair value of stock-based awards involve estimates that require management judgment. If factors change and we use different assumptions, our stock-based compensation expense could change significantly in the future. In addition, if our actual forfeiture rate is different from our estimate, our stock-based compensation expense could change significantly in the future. Restricted Stock Units ("RSUs"). RSUs are stock awards that are granted to employees entitling the holder to shares of our common stock as the award vests. RSUs are measured at fair value based on the number of shares granted and the quoted price of our common stock at the date of grant. We amortize the fair value of RSUs over the vesting term of generally four years on a straight-line basis. Performance-based RSUs vest upon achievement of certain company-based performance conditions and a requisite service period. We then assess whether it is probable that the performance targets would be achieved. If assessed as probable, compensation expense is recorded for these awards over the estimated performance period. At each reporting period, we reassess the probability of achieving the performance targets and the performance period required to meet those targets. The estimation of whether the performance targets will be achieved and/or the performance period required to achieve the targets requires judgment, and to the extent actual results or updated estimates differ from our current estimates, the cumulative effect on the current and prior periods of those changes is recorded in the period estimates are revised. The ultimate number of shares issued and the related compensation expense recognized is based on a comparison of the final performance metrics to the specific targets.
PMC has operations in several tax jurisdictions, which subjects us to multiple income tax rates that impact our overall effective income tax rate. We use estimates and assumptions in allocating income to each tax jurisdiction. Certain foreign jurisdictions have granted economic incentives, which are subject to meeting certain criteria including levels of employment and investment. Accordingly, material changes in business activity that we conduct in foreign jurisdictions or failure to meet the aforementioned criteria could impact our effective income tax rates. We have recorded income tax liabilities based on our interpretation of income tax regulations for the countries in which we operate. We believe that the income tax return positions we have taken are fully supportable. However, our estimates are subject to review and assessment by the local tax authorities. Our income tax expense and related reserve for unrecognized income tax benefits reflect amounts that we believe will be adequate if challenged or subject to income tax assessment. Management uses judgment and estimates in determining income tax expense for these challenges in accordance with guidance for accounting for uncertainty in income taxes. Currently, our reserve for uncertain income tax positions is attributable primarily to uncertainties related to allocation of income among different income tax jurisdictions. The timing of any such review and final assessment of our income tax liabilities is substantially out of our control and is dependent on the actions by those local tax authorities. Any re-assessment of our income tax 42
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liabilities may result in adjustments of the income taxes we pay, with a resulting impact on our income tax expense, net income and cash flows. We review our reserves quarterly, and we may adjust such reserves because of changes in facts and circumstances, changes in tax regulations, negotiations between tax authorities and associated proposed tax assessments, the resolution of audits and the expiration of statutes of limitations. We must also assess the likelihood that we will be able to recover our deferred tax assets. If recovery is not deemed to be more likely than not, we must increase our provision for taxes by recording a reserve in the form of a valuation allowance against the deferred tax assets that we estimate will more likely than not ultimately be recoverable.