UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

 

 

for the quarterly period ended June 27, 2015   

  

or  

 

 

For the transition period from              to              

  

Commission File Number 0-19084

 

PMC-Sierra, Inc.

(Exact name of registrant as specified in its charter)

 

 

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

  

1380 Bordeaux Drive

Sunnyvale, CA 94089

(408) 239-8000

  

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒   No  ☐

 

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

 

  

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

  

As of July 29, 2015, the registrant had 193,417,198 shares of Common Stock, $0.001 par value, outstanding.

 

 

    

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TABLE OF CONTENTS

 

 

 

 

 

   

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Part I—FINANCIAL INFORMATION

Item 1—Financial Statements (Unaudited)

  

PMC-Sierra, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except for per share amounts)

 

 

 

 

 

 

 

 

 

   

  

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PMC-Sierra, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

 

 

 

 

 

   

 

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PMC-Sierra, Inc.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value)

 

 

  

  

  

  

   

 

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PMC-Sierra, Inc.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

 

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PMC-Sierra, Inc.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

  

NOTE 1.  Summary of Significant Accounting Policies  

  

Description of business.  PMC-Sierra, Inc. (the “Company” or “PMC”) is a fabless semiconductor and software solution innovator transforming networks that connect, move, and store Big Data. The Company designs, develops, markets and supports semiconductor, embedded software, and board level solutions by integrating its mixed-signal, software and systems expertise through a network of offices in North America, Europe and Asia. Building on a track record of technology leadership, the Company is driving innovation across storage, optical and mobile networks.  PMC’s highly integrated solutions increase performance and enable next generation services to accelerate the network transformation.

 

Basis of presentation. The accompanying interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) and United States Generally Accepted Accounting Principles (“GAAP”).  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules or regulations.  These interim condensed consolidated financial statements are unaudited, but reflect all adjustments which are normal and recurring in nature and are, in the opinion of management, necessary to provide a fair statement of results for the interim periods presented.  These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes in the Company’s Annual Report on Form 10-K for the year ended December 27, 2014 filed with the SEC on February 24, 2015.  The results of operations for the interim periods are not necessarily indicative of results to be expected in future periods.  Fiscal 2015 will consist of 52 weeks and will end on Saturday, December 26, 2015.  Fiscal 2014 consisted of 52 weeks and ended on Saturday, December 27, 2014.  The second quarter of each of 2015 and 2014 consisted of 13 weeks.  The Company’s reporting currency is the United States (“U.S.”) dollar and presented in thousands unless otherwise stated.

 

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

 

Recent Accounting Pronouncements

 

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires that debt issuance costs related to recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  This ASU requires retrospective adoption and will be effective for us beginning in our first quarter of 2017.  Early adoption is permitted. ASU 2015-13 is not expected to have a material impact on the Company’s condensed consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, or ASU 2014-09, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The standard will replace most existing revenue recognition guidance in GAAP when it becomes effective. The standard allows for either full retrospective or modified retrospective adoption method. In July 2015, the FASB voted to defer the effective date to January 1, 2018 with early adoption beginning January 1, 2017.  The Company is currently evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method, adoption date, or determined the effect of the standard on its ongoing financial reporting.

 

 

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NOTE 2. Business Combinations  

 

Acquisition of RAID Software License

 

On September 4, 2014 (“Effective Date”), PMC completed a transaction agreement with Hewlett-Packard Company (“HP”) to license core HP Smart Array (“RAID”) software, firmware and management technology (the “Transaction”) for total acquisition consideration of $52 million, accounted for using the acquisition method. With this technology, as well as with certain key employees who worked for HP as lead RAID software development engineers and who were transferred to PMC, PMC can provide more system value to new and existing enterprise, Hyperscale data center and channel customers.

 

The $52 million total acquisition consideration is payable in installments.  An initial payment of $10 million was made on the Effective Date and $18 million was paid on January 10, 2015.  The remaining $24 million is payable in two installments of $12 million each on January 10, 2016 and January 10, 2017.  Such installment payments are classified as financing activities in our condensed consolidated statement of cash flows.

 

Other Agreement with HP

 

Upon the closing of the Transaction, the Company also entered into an agreement with HP related to services and non-recurring engineering (“NRE”) which provides the framework for the development of future generations of RAID software for HP for a period of approximately two years from the Effective Date. During this period, HP will make cost reimbursement payments to the Company totaling $25 million, which are receivable in installments through April 2016. The Company received $3.25 million of the $25 million total cost reimbursement payments from HP in the second quarter of 2015 ($6.5 million in the first six months of 2015 and $10.5 million since the Effective Date). Payments to the Company in accordance with this agreement are recorded as a reduction of research and development expense.

     

NOTE 3.  Derivative Instruments  

  

The Company generates revenues in U.S. dollars but incurs a portion of its operating expenses in foreign currencies, primarily the Canadian dollar.  To minimize the short-term impact of foreign currency fluctuations on the Company’s operating expenses, the Company purchases forward currency contracts.  The Company’s accounting policies for these instruments are based on whether the instruments are classified as designated or non-designated hedging instruments. The Company records all derivatives in the Condensed Consolidated Balance Sheets at fair value. The changes in the fair values of the effective portions of designated cash flow hedges are recorded in Accumulated other comprehensive income (loss) until the hedged item is recognized in earnings. Derivatives that are not designated as hedging instruments and the ineffective portion of cash flow hedges are adjusted to fair value through earnings. The Company de-designates its cash flow hedges when the forecasted hedged transactions are realized or it is probable the forecasted hedged transactions will not occur in the initially identified time period. At such time, the associated gains and losses deferred in Accumulated other comprehensive income (loss) are reclassified immediately into earnings and any subsequent changes in the fair value of such derivative instruments are immediately recorded in earnings. The fair value of our derivative instruments are included in prepaid expenses and other assets or accrued liabilities.

  

The Company did not recognize any net gains or losses related to the de-designation of discontinued cash flow hedges during the six months ended June 27, 2015.  As at June 27, 2015 the Company had 122 forward currency contracts outstanding (June 28, 2014 - 14), all with maturities of less than 12 months, which qualified and were designated as cash flow hedges.  As of June 27, 2015, the U.S. dollar notional amount of these contracts was $55.0 million (June 28, 2014 - $13.0 million), and the contracts had an aggregate fair value gain of $2.4 million and $0.7 million for the three months ended June 27, 2015 and June 28, 2014, respectively (aggregate fair value gain of $2.0 million and $0.5 million for the six months ended June 27, 2015 and June 28, 2014, respectively).  These were recorded in Accumulated other comprehensive loss, net of taxes.

   

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NOTE 4.  Fair Value Measurements   

 

ASC Topic 820 specifies a hierarchy of valuation techniques which requires an entity to maximize the use of observable inputs that may be used to measure fair value.  The hierarchy is prioritized into three levels (with Level 3 being the lowest) defined as follows:

Level 1: Inputs are based on quoted market prices for identical assets and liabilities in active markets at the measurement date.

Level 2: Inputs include similar quoted prices for similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3: Pricing inputs include significant inputs that are generally not observable in the marketplace. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

The Company’s valuation techniques used to measure the fair value of money market funds and other financial instruments were derived from quoted prices in active markets for identical assets. The valuation techniques used to measure the fair value of all other financial instruments, all of which have counterparties with high credit ratings, were valued based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data.

 

In the second quarter of 2015, the Company reviewed and evaluated the observable market pricing data and volume of trading activity used in determining Level 1 and Level 2 assets and classified $13.7 million of investments as Level 2 that were reported as Level 1 at December 27, 2014.  The Company also classified $8.9 million of investments as Level 1 that were reported as Level 2 at December 27, 2014.  The Company’s derivative instruments are classified as Level 2 as of June 27, 2015 and December 27, 2014, as they are not actively traded and are valued using pricing models that use observable market inputs.  There were no Level 3 assets or liabilities at June 27, 2015 or December 27, 2014.

 

Assets/Liabilities Measured and Recorded at Fair Value on a Recurring Basis

  

Financial assets measured on a recurring basis as at June 27, 2015 and December 27, 2014, are summarized below:  

 

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Financial liabilities measured on a recurring basis are summarized below:  

 

 

There were no assets or liabilities measured and recorded at fair value on a non-recurring basis as of June 27, 2015 and December 27, 2014.

 

 

NOTE 5.  Stock-Based Compensation  

 

The Company has two stock-based compensation plans.  Neither of the Company’s stock-based awards under these plans are classified as liabilities.  The Company recorded stock-based compensation expense for the three and six months ended June 27, 2015 and June 28, 2014 as follows:

 

The Company received cash of $31.3 million related to the issuance of stock-based awards during the six months ended June 27, 2015 (June 28, 2014 - $10.6 million).

 

Equity Award Plans

  

The Company issues its equity awards under the provisions of its equity plans. Stock options are granted with an exercise price equal to the closing market price of the Company’s common stock at the grant date. The options generally expire within 10 years and vest over four years.

Activity under the option plans during the six months ended June 27, 2015 was as follows:

 

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The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying options and the quoted price of the Company’s common stock for the options that were in-the-money at June 27, 2015.  Total forfeitures recorded amounted to $0.5 million and $1.4 million during the six months ended June 27, 2015, and June 28, 2014, respectively.

  

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

  

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

  

The fair values of the Company’s stock option awards were calculated for expense recognition using an estimated forfeiture rate, assuming no expected dividends and using the following weighted average assumptions:

 

 

The weighted average grant-date fair value per stock options granted during the six months ended June 27, 2015 was $2.81.  No stock options were granted during the three months ended June 27, 2015 and six months ended June 28, 2014. The total intrinsic value of stock options exercised during the six months ended June 27, 2015 was $9.3 million (June 28, 2014 - $1.6 million).

  

As of June 27, 2015, there was $2.5 million of total unrecognized compensation costs related to unvested stock options granted under the plans, which is expected to be recognized over an average period of 2.4 years.   

  

Restricted Stock Units  

  

The Company has various stock award plans that allow for the issuance of Restricted Stock Units (“RSUs”) to employees and directors. 

 

On February 25, 2015, the Company made its annual grant of RSU awards to Executives based on the second performance-based program tied to Non-GAAP operating income targets for 2015-2017. The total fair value of these 2015 grants was estimated at $3.8 million and will be recognized as compensation expense over the award’s vesting terms, with 34% vesting on February 25, 2016, 33% on February 25, 2017 and 33% vesting on February 25, 2018.

 

A summary of RSU activity during the six months ended June 27, 2015 is as follows:

 

 

 

 

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The intrinsic value of RSUs vested during the six months ended June 27, 2015 was $5.3 million. As of June 27, 2015, total unrecognized compensation expense, adjusted for estimated forfeitures, related to unvested RSUs was $32.9 million, which is expected to be recognized over the next 2.4 years.  

 

Employee Stock Purchase Plan (“ESPP”)

 

The Company’s 2011 Employee Stock Purchase Plan (the “2011 Plan”) was approved by stockholders at the 2010 Annual Meeting.  The 2011 Plan became effective on February 11, 2011.  Up to 12,000,000 shares of our Common Stock have been initially reserved for issuance under the 2011 Plan.   At the Company’s 2015 annual stockholders meeting, the stockholders approved an increase of 7,000,000 shares of Common Stock to the 2011 Plan.

 

During the six months ended June 27, 2015, 909,832 shares were issued under the 2011 Plan at a weighted average price of $6.00 per share.  As of June 27, 2015, 3,470,376 shares were available for future issuance under the 2011 Plan compared to 4,380,208 as at December 27, 2014. The valuation inputs utilized to determine the grant date fair value per ESPP award granted were as follows:

 

 

The weighted average grant date fair value per ESPP award granted during the first six months of 2015 was $2.24.  The total intrinsic value of ESPP shares issued during the first six months of 2015 was $2.8 million.   No ESPP awards were granted during the three months ended June 27, 2015 and June 28, 2014.

 

As of June 27, 2015, total unrecognized compensation costs, adjusted for estimated forfeitures, related to non-vested ESPP awards was $0.4 million which is expected to be recognized in the third quarter of 2015.

 

NOTE 6.  Balance Sheet Items

  

 

Inventories (net of reserves of $7.9 million and $7.8 million at June 27, 2015 and December 27, 2014, respectively) were as follows:

 

 

  

The Company provides a limited warranty on most of its standard products and accrues for the estimated cost at the time of shipment.  The Company estimates its warranty costs based on historical failure rates and related repair or replacement costs and periodically reassess these estimates as actual warranty activities occur.  The changes in the Company’s accrued warranty obligations from December 27, 2014 to June 27, 2015, and from December 28, 2013 to June 28, 2014 were as follows:  

 

The Company’s accrual for warranty obligations is included in Accrued liabilities in the interim Condensed Consolidated Balance Sheet. 

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During the second quarter of 2015, we implemented a restructuring plan to reduce spending across the organization.  This involves a reduction in force of approximately 200 employees worldwide and other targeted spending reductions.  In connection with this plan, the Company expects to incur charges of approximately $15 million to $16 million, including approximately $13 million to $14 million in charges related to employee severance and related compensation benefits and approximately $2 million in charges related to site closures, asset impairments, and completion costs.   The Company expects to complete activities under its cost reduction plan by end of fourth quarter 2016. 

 

Restructuring costs at the end of each period were as follows:

 

 

The following summarizes the restructuring activity for the 2015 restructuring plan:

 

 

The accrued employee severance and related compensation benefits are expected to be paid by end of fourth quarter 2015 and were recorded in Accrued liabilities in the Company’s Condensed and Consolidated Balance Sheet.

 

NOTE 7.  Investment Securities  

 

The Company’s available for sale investments, by investment type, consists of the following at June 27, 2015 and December 27, 2014:

 

 

  

 

As of June 27, 2015 and December 27, 2014, the fair value of certain of the Company’s available-for-sale securities was less than their cost basis.  Management reviews various factors in determining whether to recognize an impairment charge related to these unrealized losses, including the current financial and credit market environment, the financial condition, near-term prospects of the issuer of the investment security, the magnitude of the unrealized loss compared to the cost of the investment, length of time the investment has been in a loss position and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of market value.  As of June 27, 2015, the Company determined that all the unrealized losses are temporary in nature and recorded them as a component of Accumulated other comprehensive income (loss).

 

Contractual maturities as of June 27, 2015 of the Company’s investment securities do not exceed three years.  The majority of the contractual maturities are two to three years, and the balance has maturities of one year or less.

 

NOTE 8. Credit Facility

 

As of June 27, 2015, the Company had an available revolving line of credit with a group of banks under which the Company may borrow up to $100 million, of which $37 million was drawn (December 27, 2014 - nil). The Company may request, from time to time, and subject to customary conditions, including receipt of commitments, that the revolving credit facility be increased by an aggregate amount not to exceed $150 million.  Interest payments are based on LIBOR plus margins, where margins range from 1.75% to 2.25% per annum based on the Company’s leverage ratio.  The revolving credit facility is available for general corporate purposes. The credit facility is collateralized by substantially all of the Company’s personal property. The Company’s obligations under the credit facility are jointly and severally guaranteed by material wholly-owned domestic subsidiaries of the Company.

 

On July 15, 2015, the Company repaid $2 million of the outstanding balance as of June 27, 2015.

 

NOTE 9.  Income Taxes  

  

The Company recorded a benefit from income taxes of $1.5 million and a provision for income taxes of $1.2 million for the three and six months ended June 27, 2015, respectively.  The Company recorded a provision for income taxes of $4.5 million and $6.3 million for the three and six months ended June 28, 2014, respectively.

 

The Company’s effective tax rate was 15% and 451% for the three months ended June 27, 2015 and June 28, 2014, respectively.  For the second quarter of 2015, the difference between the Company’s effective tax rate and the 35% federal statutory

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rate results primarily from changes in accruals related to unrecognized tax benefits and non-deductible amortization of intangible assets, partially offset by foreign earnings eligible for tax rates lower than the federal statutory rate.  For the second quarter of 2014, the difference between the Company’s effective tax rate and the 35% federal statutory rate results primarily from changes in accruals related to unrecognized tax benefits and non-deductible amortization of intangible assets, partially offset by foreign earnings eligible for tax rates lower than the federal statutory rate and book losses that are not benefited for tax purposes. 

 

The Company’s effective tax rate was (45%) and (450%) for the six months ended June 27, 2015 and June 28, 2014, respectively.  For the first six months of 2015, the difference between the Company’s tax rate and the 35% federal statutory rate results primarily from changes in accruals related to unrecognized tax benefits and non-deductible amortization of intangible assets, partially offset by foreign earnings eligible for tax rates lower than the federal statutory rate.  For the first six months of 2014, the difference between the Company’s tax rate and the 35% federal statutory rate results primarily from changes in accruals related to unrecognized tax benefits and non-deductible amortization of intangible assets, partially offset by foreign earnings eligible for tax rates lower than the federal statutory rate and book losses that are not benefited for tax purposes.

 

 As of June 27, 2015 and December 27, 2014, the Company’s liability for unrecognized tax benefits on a world-wide consolidated basis was $41.2 million and $41.3 million, respectively. The ultimate recognition of an amount different from this estimate would affect the Company’s effective tax rate. 

 

NOTE 10.  Net Loss Per Share  

  

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

 

 

  

In the three and six months ended June 27, 2015, the Company had approximately 4.8 million and 5.1 million, respectively of stock options and Restricted Stock Units that were not included in the diluted net loss per share because they would have been anti-dilutive.  In the three and six months ended June 28, 2014, the Company had approximately 3.5 million and 3.3 million, respectively of stock options and Restricted Stock Units that were not included in the diluted net loss per share because they would have been anti-dilutive.

 

NOTE 11.  Stock Repurchase

 

 On February 9, 2015, the Board of Directors of the Company authorized a share repurchase for up to $75 million of its common stock.  This program increased the total remaining repurchase authorization to $102.1 million, including the $27.1 million that remained available for repurchases under the $275 million 2012 share repurchase authorization as of December 27, 2014. 

 

On May 21, 2015, the Board of Directors of the Company authorized up to $75 million of its common stock for share repurchases, which is the authorization amount that remained available for repurchases as of June 27, 2015.

 

For the six months ended June 27, 2015 and June 28, 2014, the Company repurchased 11.6 million and 1.4 million shares for a total cash cost of $102.1 million and $8.9 million, respectively. The repurchased shares were retired immediately.  Accordingly, the repurchased shares were recorded as a reduction of common stock, additional paid-in capital and accumulated deficit.  As of June 27, 2015, the Company had completed $430.0 million of the total announced $505.0 million stock repurchases since 2011.

 

 

 

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

  

This Quarterly Report contains forward-looking statements that involve risks and uncertainties. We use words such as “anticipates,” “believes,” “plans,” “expects,” “future,” “intends,” “may,” “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 and other financial 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 Securities and 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 fabless semiconductor and software solution innovator transforming networks that connect, move and store Big Data. The Company designs, develops, markets and supports semiconductor, embedded software, and board level solutions by integrating its mixed-signal, software and systems expertise through a network of offices in North America, Europe and Asia.  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.    

  

 

 

 

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Results of Operations

  

Second quarters of 2015 and 2014   

 

Net revenues

 

 

  

Overall net revenues for the second quarter of 2015 were $124.8 million, a decrease of $2.0 million, or 2% compared to the second quarter of 2014, mainly due to lower sales volumes of our Mobile network products, partially offset by higher sales volumes of our Storage and Optical network products.

 

 Storage represented 70% of our net revenues in the second quarter of 2015 compared to 65% in the same period of 2014. Storage net revenues increased by $4.1 million compared to the same quarter in 2014 mainly due to an increase in sales volume of our Serial Attached SCSI (“SAS”) products, related to market share gain in the transition from 6G to 12G SAS interconnect products.  On a sequential basis, Storage net revenues were lower by $9.5 million mainly due to lower sales volumes attributable to inventory corrections at three of our large customers and a  weak macroeconomic spending environment.

 

Optical represented 20% of our net revenues in the second quarter of 2015 and 2014. Optical net revenues increased by $0.2 million compared to the same quarter in 2014 mainly due to an increase in volume of sales from our Optical Transport Network (“OTN”) products due to Long-Term Evolution (“LTE”) deployments in the China and U.S. markets, partially offset by a decline in sales volumes of our legacy SONET and metro aggregation transport products.  On a sequential basis, Optical net revenues increased by $2.6 million mainly due to a higher volume of sales from our OTN products due to strong demand from 100G deployments by our customers in China.  

 

Mobile represented 10% of our net revenues for the second quarter of 2015 compared to 15% in the same period of 2014. Mobile net revenues decreased by $6.4 million compared to the second quarter of 2014 mainly due to lower sales volumes of our WinPath family of processors due to weak infrastructure spending in North America.  On a sequential basis, Mobile revenues decreased by $1.4 million mainly due to lower sales volumes of our WinPath family of processes due to weak infrastructure spending in North America.

 

Gross profit

 

 

Our gross profit decreased by $3.7 million in the second quarter of 2015 mainly due to lower net revenues compared to the same period in 2014.  Gross profit as a percentage of net revenues decreased by 2% mainly due to a restructuring charge in the second quarter of 2015 of approximately $1.2 million related to employee severance and related compensation benefits, a  change in write-down of inventory of $0.2 million, and lower net revenues.

 

Operating expenses

  

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Research and Development, net and Selling, General and Administrative Expenses

 

Our research and development, net (“R&D”) expenses increased in the second quarter of 2015 by $6.4 million, or 13% compared to the same period last year.  This was primarily due to a restructuring charge of approximately $7.9 million related to employee severance and related compensation benefits, partially offset by lower outside services costs and acquisition-related costs.  On a sequential basis, R&D expenses were $6.9 million higher in the second quarter of 2015 compared to the first quarter of 2015.  This was mainly due to the $7.9 million restructuring charge related to employee severance and related compensation benefits, partially offset by lower outside services costs and reduced employee benefits related costs that typically peak in the first quarter of each year.

 

Selling, general and administrative (“SG&A”) expenses were $1.5 million, or 5% higher in the second quarter of 2015 compared to the same period last year, mainly due to a restructuring charge of approximately $4.0 million related to employee severance and related compensation benefits compared to approximately $1.3 million termination costs incurred in the second quarter of 2014, partially offset by the net gain from lease exit activity earned in the second quarter of 2015 not earned in 2014.  On a sequential basis, SG&A expenses were $0.4 million higher in the second quarter of 2015 compared to the first quarter of 2015.  This is mainly due to the $4.0 million restructuring charge related to employee severance and related compensation benefits, partially offset by a decrease in commission expense due to lower sales and  a net gain of $0.4 million from lease exit activity recognized in the second quarter of 2015.

  

Amortization of purchased intangible assets

 

Amortization of acquired intangible assets related to license of existing technologies, developed technology, in-process research and development, customer relationships, and trademarks decreased by $0.6 million in the second quarter of 2015 compared to the same period in 2014 mainly due to certain intangible assets that reached the end of their amortization period during 2014, partially offset by amortization of intangible assets acquired from HP during the third quarter of 2014.    

 

Other income (expense) and Benefit from (provision for) income taxes

 

 

 

Foreign exchange loss

  

We recorded a net foreign exchange loss of $0.9 million in the second quarter of 2015 compared to $0.8 million in the second quarter of 2014.  This was primarily due to a foreign exchange revaluation of our foreign denominated assets and liabilities which are primarily denominated in the Canadian dollar and Israeli Shekel driven in part by the U.S. dollar depreciating by approximately 1.8% during the second quarter of 2015 compared to approximately 3.5% during the second quarter of 2014, against currencies applicable to our foreign operations.

 

Interest and other financial income, net

  

Interest and other financial income, net was $0.3 million in the second quarter of 2015 compared to $0.1 in the second quarter of 2014. 

Gain on investment securities and other investments

 

We recorded a gain on sale of investment securities and other investments of $0.1 million related to the disposition of investment securities and other investments in the second quarters of 2015 and 2014.

 

Amortization of debt issuance costs

  

In the second quarters of 2015 and 2014, we amortized $0.1 million of debt issuance costs relating to our credit facility obtained during the third quarter of 2013.

  

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Accretion of discount on short-term and long-term obligations

 

In the second quarter of 2015, we recorded accretion of discount on short-term and long-term obligations of $0.2 million relating to our obligation from the acquisition of HP RAID software license during the third quarter of 2014.

 

Benefit from (provision for) income taxes

  

The benefit from income taxes was $1.5 million in the second quarter of 2015 compared to a provision for income taxes of $4.5 million in the second quarter of 2014.  This was mainly due to changes in quarterly pre-tax (loss) income, amortization of prepaid income tax, non-deductible amortization of intangible assets, and uncertain tax positions.

 

First six months of 2015 and 2014

 

Net revenues

 

 

 

Net revenues for the first six months of 2015 were $257.8 million compared to $253.3 million for the same period of 2014.  This slight increase was mainly attributable to higher sales volumes of our Storage network products driven by our SAS products partially offset by lower sales volumes in our Mobile network products driven by our WinPath family of processors. 

 

Storage represented 71% of our net revenues in the first six months of 2015 compared to 67% in the same period of 2014.  Storage net revenues increased by $13.6 million compared to the first six months of 2014 mainly due to increased sales volumes related to market share gain in the transition from 6G to 12G SAS interconnect products.  

 

Optical represented 19% of our net revenues in the first six months of 2015 and 2014.  Optical net revenues decreased by $0.8 million compared to the first six months of 2014 mainly due to lower sales volumes from our FTTH and legacy SONET and metro aggregation transport products partially offset by higher volume of sales from our OTN products.

 

Mobile represented 10% of our net revenues in the first six months of 2015 compared to 14% in the same period of 2014.  Mobile net revenues decreased by $8.2 million compared to the first six months of 2014 mainly due to lower sales volumes attributable to weak infrastructure spending in North America.

 

Gross profit

 

 

Total gross profit increased by $0.5 million in the first six months of 2015 compared to the same period in 2014 mainly due to slightly higher revenues.  Gross profit as a percentage of net revenues decreased by 1% compared to the same period in 2014 mainly due to a restructuring charge in the second quarter of 2015 of approximately $1.2 million related to employee severance and related compensation benefits.

 

Operating expenses

 

 

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Research and Development, net and Selling, General and Administrative Expenses

Our R&D expense increased by $5.2 million, or 5%, in the first six months of 2015 compared to the same period in 2014.  This was primarily due to a restructuring charge of approximately $7.9 million related to employee severance and related compensation benefits, partially offset by lower acquisition-related and lower tape-out related costs.

 

SG&A expenses increased by $2.2 million, or 4%, in the first six months of 2015 compared to the same period in 2014, mainly due to higher termination costs of $4.4 million, including a restructuring charge of approximately $4.0 million related to employee severance and related compensation benefits, compared to approximately $1.3 million termination costs incurred in the same period in 2014. This was partially offset by a decrease in asset impairments of $0.5 million and a $0.4 million net gain from lease exit activity recognized in the second quarter of 2015.

   

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 $3.7 million in the first six months of 2015 compared to the same period in 2014.  This was mainly due to certain intangible assets that reached the end of their amortization period during 2014, partially offset by amortization of intangible assets acquired from HP during the third quarter of 2014.

 

Other income (expense) and provision for income taxes

 

 

Foreign exchange gain (loss)

 

We recognized a net foreign exchange gain of $1.6 million in the first six months of 2015 compared to a net foreign exchange loss of $0.3 million in the first six months of 2014.  This was primarily due to a foreign exchange revaluation of our foreign denominated assets and liabilities, which are primarily denominated in the Canadian dollar and Israeli Shekel, driven in part by the U.S. dollar appreciating by approximately 6.3% during the first six months of 2015, compared to approximately 0.2% depreciation during the first six months of 2014, against currencies applicable to our foreign operations.

 

Interest and other financial income, net

 

Net interest and other financial income was $0.5 million in the first six months of 2015 compared to $0.1 million in the first six months of 2014.

 

Gain on investment securities and other investments

 

We recorded a gain on sale of investment securities and other investments of $0.1 million related to the disposition of investment securities and other investments in each of the first six months of 2015 and 2014.

 

Amortization of debt issue costs

 

In each of the first six months of 2015 and 2014, we amortized $0.1 million of debt issue costs relating to our credit facility obtained during the third quarter of 2013.   

 

Provision for income taxes

 

In the first six months of 2015, provision for income taxes was $1.2 million, compared to $6.3 million in the first six months of 2014.  This was mainly due to changes in accruals related to unrecognized tax benefits, non-deductible amortization of intangible assets, and the amortization of prepaid taxes.

 

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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 GAAP.  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 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 in our Annual Report on Form 10-K for the year ended December 27, 2014, which also provides commentary on our most critical accounting estimates.  Since our fiscal year ended December 27, 2014, there have been no material changes in our critical accounting policies and estimates.

 

Business Outlook

 

The following is our outlook for the three months ending September 26, 2015 and a reconciliation of each non-GAAP financial measure to the most directly comparable GAAP financial measure:

 

 

 

 

 

The above non-GAAP information is provided as a supplement to the Company's condensed consolidated financial statements presented in accordance with 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, short-term investments, long-term investment securities, and our credit facility. 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 June 27, 2015 and December 27, 2014 totaled $241.8 million and $266.0 million, respectively, net of $37.0 million and $nil outstanding on our credit facility as of June 27, 2015 and December 27, 2014, respectively.  On July 15, 2015, we repaid the $2 million outstanding balance on our credit facility as of June 27, 2015.

 

Our credit facility is a revolving line of credit with a group of banks under which we may borrow up to $100 million.  The credit agreement contains customary representations and warranties, affirmative covenants and negative covenants with which the Company must be in compliance in order to borrow funds and to avoid an event of default, including, without limitation, restrictions

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and limitations on dividends, asset sales, the ability to incur additional debt and additional liens and certain financial covenants.  As of June 27, 2015, the Company was in compliance with these covenants.

 

As of June 27, 2015, the amount of cash and short-term and long-term investments held by our foreign subsidiaries was $240.5 million.  Our intent is and we have the ability to indefinitely reinvest these funds outside the U.S.  If the funds held by our foreign subsidiaries are needed for our operations in the U.S., or are otherwise repatriated into the U.S., we could be required to accrue and pay taxes to repatriate these funds, which could reduce the net funds available to the Company.

 

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 1. Financial Statements, the Notes to the Condensed Consolidated Financial Statements, Note 4. Fair Value Measurements).

  

Operating Activities

  

We generated cash from operations of $41.4 million in the first six months of 2015 compared to $39.0 million in the first six months of 2014.  Our positive operating cash flows in the first six months of 2015 were mainly driven by the favorable impact of non-cash adjustments of $42.9 million, which are comprised of $30.1 million of amortization and depreciation expense (first six months of 2014 - $33.3 million) and $12.8 million of stock-based compensation (first six months of 2014 - $11.1 million), and by a net increase in working capital due primarily due to restructuring cost accrual.

 

Investing Activities

  

We had a net outflow of cash of $36.8 million from investing activities in the first six months of 2015 compared to a net cash outflow of $21.7 million in the same period in 2014. During the first six months of 2015, we used $67.5 million to purchase investment securities (first six months of 2014 - $42.0 million), and generated $43.4 million from redemptions and sales of such investments securities compared to $29.1 million in the first six months of 2014.  We also invested $12.7 million through the purchase of property and equipment and intangible assets in the first six months of 2015 compared to $8.8 million in the same period in 2014. 

  

Financing Activities

   

We had a net outflow of cash of $51.8 million from financing activities in the first six months of 2015 compared to a net cash outflow of $30.9 million in the first six months of 2014.  During the first six months of 2015, we borrowed $102 million from our credit facility and repaid $65 million compared to $30 million and $60 million borrowed and repaid during the first six months of 2014.  We also repurchased common stock for $102.1 million in the first six months of 2015 compared to $11.5 million in the first six months of 2014.  This was partially offset by $31.3 million in proceeds from employee related stock issuances in the first six months of 2015 compared to $10.6 million during the first six months of 2014.  In addition, on January 10, 2015, the Company made an $18 million second installment payment related to the Company’s acquisition of HP’s RAID software license (see Note 2. Business Combinations).

 

Contractual Obligations

  

As of June 27, 2015 we had cash commitments comprised of the following:  

 

 

In addition to the amounts shown in the table above, as of June 27, 2015 we have $41.2 million recorded as a liability for unrecognized tax benefits and $9.1 million recorded long-term obligations for employee severance, health, and pension benefits that are payable only upon termination, retirement or death of the respective employee, and we are uncertain as to the ultimate amount and timing of settlement of these potential liabilities.

 

Purchase obligations, as noted in the above table, are comprised of commitments to purchase design tools and software for use in product development and other long term purchase obligations.  Excluded from these purchase obligations are commitments for

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inventory or other expenses entered into in the normal course of business.  We estimate these other commitments to be approximately $61.2 million at June 27, 2015 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 $5.6 million of cash in the remainder of 2015 for purchases of property and equipment and intellectual property.

  

We continue to expect that our cash from operations, short-term investments, long-term investment securities and credit facility 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.    

  

Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

  

The following discussion regarding our risk management activities contains “forward-looking statements” that involve risks and uncertainties.  Actual results may differ materially from those included in the forward-looking statements.

  

Cash Equivalents, Short-Term Investments and Long-Term Investment Securities:

  

We regularly maintain a portfolio of short and long-term investments comprised of various types of money market funds, United States treasury and government agency notes including FDIC-insured corporate notes, United States state and municipal securities, foreign government and agency notes, and corporate bonds and notes.  Our investments are made in accordance with an investment policy approved by our Board of Directors.  Our investment policy sets guidelines for diversification and maturities that intend to preserve principal, while meeting liquidity needs.  Maturities of these instruments are 36 months or less.  To minimize credit risk, we diversify our investments and select minimum ratings of P-1 or A3 by Moody’s, or A-1 or A- by Standard and Poor’s, or equivalent.  We classify these securities as available-for-sale and they are carried at fair market value.  Our corporate policies prevent us from holding material amounts of asset-backed commercial paper.  

  

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

  

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

  

Based on a sensitivity analysis performed on the financial instruments held at June 27, 2015, the impact to the fair value of our investment portfolio by a shift in the yield curve of plus or minus 100 basis points would result in a decline of approximately $2.7 million or an increase of approximately $2.4 million, respectively.  The selected hypothetical change in interest rates does not reflect what could be considered the best or worst case scenarios.

  

Foreign Currency:

  

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

  

Through our operations in Canada and elsewhere outside of the United States, we incur research and development, sales, customer support and administrative expenses in various foreign currencies.  We are exposed, in the normal course of business, to foreign currency risks on these expenditures, primarily in Canada.  In our effort to manage such risks, we have adopted a foreign currency risk management policy intended to reduce the effects of potential short-term fluctuations on our operating results stemming from our exposure to these risks.  As part of this risk management, we enter into foreign exchange forward contracts. These forward contracts offset the impact of exchange rate fluctuations on forecasted cash flows or firm commitments.  We limit the forward contracts operational period to 24 months or less and we do not enter into foreign exchange forward contracts for trading purposes. Because we do not engage in foreign exchange risk management techniques beyond these periods, our cost structure is subject to long-term changes in foreign exchange rates.  In the event that one of the counterparties to our forward currency contracts failed to complete the terms of their contracts, we would purchase foreign currencies at the spot rate as of the date the funds were required.  If the counterparties to our foreign forward currency contracts that matured in the second quarter ended June 27, 2015 had not fulfilled their contractual obligations and we were required to purchase the foreign currencies at the spot market rate on respective settlement dates, our operating income for the second quarter of 2015 would have increased by $0.8 million.  See Part I. Financial Information,

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Item 1. Financial Statements, the Notes to the Condensed Consolidated Financial Statements, Note 3. Derivative Instruments for further details.

  

We attempt to limit our exposure to foreign exchange rate fluctuations from our foreign currency net asset or liability positions.  In the first six months of 2015, we recorded a $1.4 million foreign exchange gain on the revaluation of our net tax liabilities in a foreign jurisdiction.  The revaluation of our foreign income tax liabilities was required because of fluctuations in the value of the U.S. dollar against other currencies.  Our operating income would be materially impacted by a shift in the foreign exchange rates between U.S. and foreign currencies that are material to our business.  For example, a five percent shift in the foreign exchange rates between United States dollar and Canadian dollar would impact our second quarter 2015 pre-tax income by approximately $1.5 million.

 

Item 4.  CONTROLS AND PROCEDURES

  

Evaluation of disclosure controls and procedures

  

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified by the SEC and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Based on this evaluation, our chief executive officer and chief financial officer concluded that, as of June 27, 2015 our disclosure controls and procedures are designed at a reasonable assurance level and are effective at that reasonable assurance level. 

  

Changes in internal control over financial reporting

  

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange Act) that occurred during the second quarter ended June 27, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.   

  

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Part II – OTHER INFORMATION

  

Item 1. Legal Proceedings

  

None.  

  

ITEM 1A. RISK FACTORS

 

Our company is subject to a number of risks.  Some of these risks are common in the fabless semiconductor industry, some are the same or similar to those disclosed in previous SEC filings, and some may be present in the future. You should carefully consider all of these risks and the other information in this report before investing in PMC. The fact that certain risks are endemic to the industry does not lessen the significance of the risk.

As a result of the following risks, our business, financial condition, operating results and/or liquidity could be materially adversely affected. This could cause the trading price of our securities to decline, and you may lose part or all of your investment.

 

Our global business is subject to a number of economic risks.

 

We conduct business throughout the world, including in Asia, North America, Europe and the Middle East.  Instability in the global credit markets, including the recent European economic and financial turmoil related to sovereign debt issues in certain countries, the instability in the geopolitical environment in many parts of the world and other disruptions, such as changes in energy costs, may continue to put pressure on global economic conditions. The world has recently experienced a global macroeconomic downturn. To the extent global economic and market conditions, or economic conditions in key markets, remain uncertain or deteriorate further, business, operating results, and financial condition may be materially adversely impacted.

 

Additionally, given the greater credit restrictions that are being invoked by lenders around the world, our ability to access the capital markets may be severely restricted at a time when we would like, or need, to access such capital markets, which could have an impact on our flexibility to pursue additional expansion opportunities and maintain our desired level of revenue growth in the future.

 

Our operating results may be impacted by rapid changes in demand due to the following:

 

•variations in our turns business;

•short order lead-time;

•customer inventory levels;

•production schedules; and

•fluctuations in demand.

 

As a result, there could be significant variability in the demand for our products, and our past operating results may not be indicative of our future operating results.

 

Fluctuation in demand is dependent on, among other things, the size of the markets for our products, the rate at which such markets develop, and the level of capital spending by end customers. We cannot assure you of the rate, or extent to which, capital spending by end customers will grow, if at all.

 

Our revenues and profits may fluctuate because of factors that are beyond our control. As a result, we may fail to meet the expectations of securities analysts and investors, which could cause our stock price to decline.

 

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

 

We may fail to meet our forecasts if our customers cancel or delay the purchase of our products or if we are unable to meet their demand.

 

We rely on customer forecasts in order to estimate the appropriate levels of inventory to build and to project our future revenues. Many of our customers have numerous product lines, numerous component requirements for each product, sizeable and complex supplier structures, and typically engage contract manufacturers for additional manufacturing capacity. This complex supply chain creates several variables that make it difficult to accurately forecast our customers’ demand and accurately monitor their inventory

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levels of our products. If customer forecasts are not accurate, we may build too much inventory, potentially leaving us with excess and obsolete inventory, which would reduce our profit margins and adversely affect our operating results. Conversely, we may build too little inventory to meet customer demand causing us to miss revenue-generating opportunities. The cancellation or deferral of product orders, the return of previously sold products or overproduction due to the failure of anticipated orders to materialize, could result in our holding excess or obsolete inventory, which could in turn result in write-downs of inventory. This difficulty may be compounded when we sell to OEMs indirectly through distributors and other resellers or contract manufacturers, or both, as our forecasts of demand are then based on estimates provided by multiple parties.

 

Our customers often shift buying patterns as they manage inventory levels, market different products, or change production schedules. This makes forecasting their production requirements difficult and can lead to an inventory surplus or shortage of certain components. In addition, our products vary in terms of the profit margins they generate. If our customers purchase a greater proportion of our lower margin parts in a particular period, it would adversely impact our results of operations.

 

Further, our distributors provide us with periodic reports of their backlog to end customers, sales to end customers and quantities of our products that they have on hand. If the data that is provided to us is inaccurate, it could lead to inaccurate forecasting of our revenues or errors in our reported revenues, gross profit and net income.

 

While backlog is our best estimate of our next quarter’s expectations of revenues, it is industry practice to allow customers to cancel, change or defer orders with limited advance notice prior to shipment. As such, backlog may be an unreliable indicator of future revenue levels. Because a significant portion of our operating expenses is fixed, even a small revenue shortfall can have a disproportionately negative effect on our operating results.

 

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

 

We depend on a limited number of customers for large portions of our net revenues. During the first six months of 2015 and in fiscal years 2014, 2013, and 2012, we had two end customers that accounted for more than 10% of our net revenues, namely HP and EMC.

 

During the first six months of 2015 and in fiscal years 2014, 2013, and 2012, our top ten customers accounted for more than 60% of our net revenues. We do not have long-term volume purchase commitments from any of our major customers. We sell our products solely on the basis of purchase orders. Those customers could decide to cease purchasing products with little or no notice and without significant penalties. A number of factors could cause our customers to cancel or defer orders, including interruptions to their operations due to a downturn in their industries, delays in manufacturing their own product offerings into which our products are incorporated, and natural disasters. Accordingly, our future operating results will continue to depend on the success of our largest customers and on our ability to sell existing and new products to these customers in significant quantities.

 

The loss of a key customer, or a reduction in our sales to any major customer or our inability to attract new significant customers could materially and adversely affect our business, financial condition or results of operations. In addition, if we fail to win new product designs from our major customers, our business and results of operations may be harmed.

 

We use indirect channels of product distribution in many locations across the world and over which we have limited control.

 

We generate a portion of our sales through third-party distribution and reseller agreements. Termination of a distributor agreement, either by us or a distributor, could result in a temporary or permanent loss of revenue, if we cannot establish an alternative distributor to manage this portion of our business or if we are unable to service the related end customers directly.  Further, if we terminate a distributor agreement, we may be required to repurchase unsold inventory held by the distributor. We maintain a reserve for estimated returns.  If actual returns exceed estimated returns, there may be an adverse effect on our operating results. Our distributors are located all over the world and are of various sizes and financial profiles. Lower sales or earnings, debt downgrades, an inability to access capital markets or higher interest rates could potentially affect our distributors’ operations. 

 

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

 

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

 

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Changes in the political and economic climate in the countries in which we do business may adversely affect our operating results.

 

We earn a substantial proportion of our revenues in Asia. We conduct an increasing portion of our research and development and manufacturing activities outside North America. We procure substantially all of our wafers from Taiwan and use assemblers and testers throughout Asia.

 

Given the depth of our sales and operations in Asia, we face risks that could negatively impact our results of operations, including economic sanctions imposed by the U.S. government, imposition of tariffs and other potential trade barriers or regulations, uncertain protection for intellectual property rights and generally longer receivable collection periods. In addition, fluctuations in foreign currency exchange rates could adversely affect the revenues, net income, earnings per share and cash flow of our operations in affected markets. Similarly, fluctuations in exchange rates may affect demand for our products in foreign markets or our cost competitiveness and may adversely affect our profitability.

 

Our results of operations continue to be influenced by our sales to customers in Asia.  Government agencies in this region have broad discretion and authority over many aspects of the telecommunications and information technology industry.  Accordingly, their decisions may impact our ability to do business in this region, and significant changes in this region’s political and economic conditions and governmental policies could have a substantial negative impact on our business.

 

Laws and regulations to which we are subject, as well as customer requirements in the area of environmental protection and social responsibility, could impose substantial costs on us and may adversely affect our business.

 

Our business is subject to or may be impacted by various environmental protection and social responsibility legal and customer requirements. For example, we are subject to the European Union Directive on the Restriction of the use of certain Hazardous Substances in Electrical & Electronic Equipment (RoHS) and the Registration, Evaluation, Authorization and Restriction of Chemicals (REACH) Regulation in the European Union. Such regulations could require us to redesign our products in order to ensure compliance and require the development and/or maintenance of compliance administration systems. Redesigned products could be more costly to manufacture or require more costly or less efficient raw materials. If we cannot develop compliant products on a timely basis or properly administer our compliance programs, our revenues could decline due to lower sales. In addition, under certain environmental laws, we could be held responsible, without regard to fault, for costs relating to any contamination at our current or past facilities and at third-party waste-disposal sites. We could also be held liable for consequences arising out of human exposure to such substances or other environmental damage.

 

Recently there has been increased focus on environmental protection and social responsibility initiatives. We may choose or be required to implement various standards due to the adoption of rules or regulations that result from these initiatives. Our customers may also require us to implement environmental or social responsibility procedures or standards before they will continue to do business with us or order new products from us. Our adoption of these procedures or standards could be costly, and our failure to adopt these standards or procedures could result in the loss of business or fines or other costs.

 

The conflict minerals provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act could result in additional costs and liabilities.

 

In accordance with the Dodd-Frank Wall Street Reform and Consumer Protection Act, the SEC established disclosure and reporting requirements for those companies who use “conflict minerals” mined from the Democratic Republic of the Congo and adjoining countries in their products, whether or not these products are manufactured by third parties.  These requirements could affect the sourcing and availability of minerals used in the manufacture of our semiconductor products.  We also have incurred and will continue to incur costs associated with complying with the disclosure requirements, including identifying the sources of any conflict minerals used in our products, in addition to the cost of remediation and other changes to products, processes, or sources of supply as a consequence of such verification activities.

 

The loss of key personnel could delay us from designing new products.

 

To succeed, we must retain and hire technical personnel highly skilled at design and test functions needed to develop high-speed networking products. The competition for such employees is intense.

 

We do not have employment agreements in place with many of our key personnel. As employee incentives, we issue common stock options, restricted stock, and performance-based restricted stock which are subject to vesting.  In addition, stock options are granted with an exercise price equal to the closing market price of the Company’s common stock at the grant date. The equity awards to employees are effective as retention incentives only if they have economic value, which at times could be difficult to maintain given the substantial variability in our stock price.

 

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Our revenues may decline if we do not maintain a competitive portfolio of products or if we fail to secure design wins.

 

We are experiencing significantly greater competition in the markets in which we participate. We are expanding into market segments, such as the Storage, Optical, and Mobile market segments, which have established incumbents with substantial financial and technological resources. We expect more intense competition than we have traditionally faced as some of these incumbents derive a majority of their earnings from these markets.

 

We typically face competition at the design stage, where customers evaluate alternative design approaches requiring integrated circuits. We often compete in bid selection processes to achieve design wins. These selection processes can be lengthy and require us to invest significant effort and incur significant design and development costs. We may not be successful in competing in bid selection processes or, if successful, we may not generate the expected level of revenue despite incurring significant design and development costs. Because the life cycles of our customers’ products can last several years and changing suppliers involves significant cost, time, effort and risk, our failure to win a competitive bid can result in our foregoing revenue from a given customer’s product line for the life of that product.

 

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

 

Our customers are increasingly price conscious, as semiconductors sourced from third party suppliers comprise a greater portion of the total materials cost in networking equipment. We continue to experience aggressive price competition from other companies that wish to enter into the market segments in which we participate. These circumstances may make some of our products less competitive, and we may be forced to decrease our prices significantly to win a design. We may lose design opportunities or may experience overall declines in gross margins as a result of increased price competition.

 

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

 

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

 

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

 

Product quality problems could result in reduced revenues and claims against us.

 

We produce highly complex products that incorporate leading-edge technology. Despite our testing efforts and those of our subcontractors, defects may be found in existing or new products. Because our product warranties against materials and workmanship defects and non-conformance to our specifications cover varying lengths of time, we may incur significant warranty, support and repair or replacement costs. The resolution of any defects could also divert the attention of our engineering personnel from other product development efforts. If the costs for customer or warranty claims increase significantly compared with our historical experience, our revenue, gross margins and net income may be adversely affected.

 

Increasingly our customers require warranty protection for periods beyond our standard warranty and for expansive remedies that include direct and indirect damages.  We negotiate these “epidemic failure warranty” provisions rigorously and seek liability caps but, nonetheless, this extraordinary warranty exposure may adversely affect our financial results.

 

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

 

Our products generally take between 12 and 24 months from initial conceptualization to development of a viable prototype, and another three to 18 months to be designed into our customers’ equipment and sold in production quantities. We sell products whose characteristics include evolving industry standards, short product life spans and new manufacturing and design technologies. As a result, we develop products many years before volume production and may inaccurately anticipate our customers’ needs. From initial product design-in to volume production, many factors, such as unacceptable manufacturing yields on prototypes or our customers’

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redefinition of their products, can affect the timing and/or delivery of our products. Our products may become obsolete during these delays, resulting in our inability to recoup our initial investments in product development.

 

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

 

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

 

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

 

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

 

The ultimate resolution of outstanding tax matters could be for amounts in excess of our reserves established. Such events could have a material adverse effect on our liquidity or cash flows in the quarter in which an adjustment is recorded or the tax payment is due.

 

If foreign exchange rates fluctuate significantly, our profitability may decline.

 

We are exposed to foreign currency rate fluctuations because a significant part of our development, test, and selling and administrative costs are incurred in foreign currencies. The U.S. dollar has fluctuated significantly compared to other foreign currencies and this trend may continue. To protect against reductions in value and the volatility of future cash flows caused by changes in foreign exchange rates, we enter into foreign currency forward contracts. The contracts reduce, but do not eliminate, the impact of foreign currency exchange rate movements. In addition, this foreign currency risk management policy may not be effective in addressing long-term fluctuations since our contracts do not extend beyond a 24-month maturity.

 

We regularly limit our exposure to foreign exchange rate fluctuations from our foreign net asset or liability positions. We recorded a net $1.4 million foreign exchange gain on the revaluation of our income tax liability in the first six months of 2015 because of the fluctuations in the U.S. dollar against certain foreign currencies. A five percent shift in the foreign exchange rates between the U.S. and Canadian dollar would cause an approximately $1.5 million impact to our second quarter 2015 pre-tax net income.

 

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

 

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

 

In addition, a significant portion of our sales flow through our distribution channel.  This generally represents a higher credit risk. Should these companies encounter financial difficulties, our revenues could decrease, and collection of our significant accounts receivables with these companies or other customers could be jeopardized.

 

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

 

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

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to meet these challenges successfully. Acquisitions could also result in customer dissatisfaction, performance problems with the acquired company, investment, or technology, the assumption of contingent liabilities, or other unanticipated events or circumstances, any of which could harm our business. Consequently, we might not be successful in integrating any acquired businesses, products or technologies and may not achieve anticipated revenues and cost benefits.

 

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

 

From time to time, we license, or acquire, technology from third parties to incorporate into our products. Incorporating technology into our products may be more costly or more difficult than expected, or require additional management attention to achieve the desired functionality. The complexity of our products could result in unforeseen or undetected defects or bugs, which could adversely affect the market acceptance of new products and damage our reputation with current or prospective customers.

 

Our current product roadmap is dependent, in part, on successful acquisition and integration of intellectual property cores developed by third parties. If we experience difficulties in obtaining or integrating intellectual property from these third parties, it could delay or prevent the development of our products in the future.

 

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

 

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

 

Industry consolidation may lead to increased competition and may harm our operating results.

 

There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to improve the leverage of growing research and development costs, strengthen or hold their market positions in an evolving industry or are unable to continue operations. Companies that are strategic alliance partners in some areas of our business may acquire or form alliances with our competitors, thereby reducing their business with us. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. This could lead to more variability in our operating results and could have a material adverse effect on our business, operating results and financial condition.

 

Our business may be adversely affected if our customers or suppliers cannot obtain sufficient supplies of other components necessary to meet their projected production levels.

 

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

 

Moreover, if any of our suppliers experience capacity constraints or component shortages, encounters financial difficulties, or experiences any other major disruption of its operations, we may need to qualify an alternate supplier, which may take an extended period of time and could result in delays in product shipments. These delays could cause our customers to seek alternate semiconductor companies to provide them with products previously purchased from us, which could harm our operating results, cash flow and financial condition.

 

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

 

We do not own or operate a wafer fabrication facility. In the first six months of 2015, three outside wafer foundries supplied approximately 99% of our semiconductor wafer requirements. Our wafer foundry suppliers also make products for other companies and some make products for themselves.  As a result, we may not have access to adequate capacity or certain process technologies. We also have less control over delivery schedules, manufacturing yields and costs than competitors with their own fabrication

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facilities. If the wafer foundries we use are unable or unwilling to manufacture our products in required volumes, or at specified times, we may have to identify and qualify acceptable additional or alternative foundries. This qualification process could take six months or longer. We may not find sufficient capacity quickly enough or at an acceptable cost to satisfy our production requirements.

 

Some companies that supply products to our customers are similarly dependent on a limited number of suppliers. These other companies’ products may represent important components of networking equipment into which our products are designed. If these companies are unable to produce the volumes demanded by our customers, our customers may be forced to slow down or halt production on the equipment for which our products are designed, which could materially reduce our order levels.

 

We depend on third parties for the assembly and testing of our semiconductor products, which could delay and limit our product shipments.

 

We depend on third parties in Asia for the assembly and testing of our semiconductor products. In addition, subcontractors in Asia assemble all of our semiconductor products into a variety of packages. Raw material shortages, political, economic and social instability, assembly and testing house service disruptions, currency fluctuations, or other circumstances in the region could force us to seek additional or alternative sources of supply, assembly or testing. This could lead to supply constraints or product delivery delays that, in turn, may result in the loss of revenues. At times, capacity in the assembly industry has become scarce and lead times have lengthened. This capacity shortage may become more severe, which could in turn adversely affect our revenues. We have less control over delivery schedules, assembly processes, testing processes, quality assurances, raw material supplies and costs than competitors that do not outsource these tasks.

 

Due to the amount of time that it usually takes us to qualify assemblers and testers, we could experience significant delays in product shipments if we are required to find alternative assemblers or testers for our components. Any problems that we may encounter with the delivery, quality or cost of our products could damage our customer relationships and materially and adversely affect our results of operations. We are continuing to develop relationships with additional third-party subcontractors to assemble and test our products. However, even if we use these new subcontractors, we will continue to be subject to all of the risks described above.

 

If we fail to maintain effective internal over financial reporting, our ability to produce accurate and timely financial statements could be impaired, which could adversely affect investor perceptions of us and the value of our common stock.

 

We are subject to Section 404 of the Sarbanes-Oxley Act of 2002 and, as such, are required to maintain internal control over financial reporting adequate to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements in accordance with generally accepted accounting principles. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. As a result, we cannot assure you that a material weakness in our internal control over financial reporting will not be identified in the future. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. The existence of a material weakness can cause us to fail to timely meet our periodic reporting obligations or result in material misstatements in our consolidated financial statements. Any such failure could adversely affect the results of periodic management control evaluations and annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting, cause us to incur unforeseen costs, negatively impact our results of operations, or cause the market price of our common stock to decline.

 

Our estimated restructuring accruals may not be adequate.

 

During the second quarter of 2015, we implemented a restructuring plan to reduce spending across the organization.  This involves a reduction in force of approximately 200 employees worldwide and other reductions, including site closures and asset impairments. 

 

While management uses all available information to estimate these restructuring costs, particularly employee severance and related compensation benefits, our estimated accruals may prove to be inadequate.  If our actual payout differs from our estimates, we may have to record additional charges, which could materially affect our results of operations, financial position and cash flow.

 

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

 

We do not have sufficient business interruption insurance to compensate us for actual losses from interruption of our business that may occur, and any losses or damages incurred by us could have a material adverse effect on our business. We are vulnerable to a major earthquake and other calamities. We have operations in seismically active regions in California, Japan and British Columbia, Canada, and we rely on third-party suppliers, including wafer fabrication and testing facilities, in seismically active regions in Asia, which have recently experienced natural disasters.  To the extent that manufacturing issues and any related component shortages result 

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in delayed shipments in the future, and particularly in periods in which we and our contract manufacturers are operating at higher levels of capacity, it is possible that our revenue could be adversely affected if such matters occur and are not remediated. 

 

We are unable to predict the effects of any such events, but the effects could be seriously harmful to our business.

 

Hostilities in the Middle East and India may have a significant impact on our Israeli and Indian subsidiaries’ ability to conduct their business.

 

As at June 27, 2015, we have operations, concentrated primarily on research and development, located in Israel and India that employ approximately 98 and 169 people, respectively. A catastrophic event, such as a terrorist attack or the outbreak of hostilities that results in the destruction or disruption of any of our critical business or information technology systems in Israel or India could harm our ability to conduct normal business operations and therefore negatively impact our operating results.

 

On an on-going basis, some of our Israeli employees are periodically called into active military duty. In the event of severe hostilities breaking out, a significant number of our Israeli employees may be called into active military duty, resulting in delays in various aspects of production, including product development schedules.

 

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

 

We become defendants in legal proceedings from time to time. Companies in our industry have been subject to claims related to patent infringement and product liability, as well as contract and personal claims. We may not be able to accurately assess the risk related to these suits and we may be unable to accurately assess our level of exposure. An infringement or product liability claim brought against us, even if unsuccessful, would likely be time-consuming and costly to defend and could divert the efforts of our technical and management personnel. These proceedings may result in material charges to our operating results in the future if our exposure is material and if our ability to assess our exposure becomes clearer.

 

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

 

To compete effectively, we must protect our intellectual property. We rely on a combination of patents, trademarks, copyrights, trade secret laws, confidentiality procedures and licensing arrangements to protect our intellectual property rights. We hold numerous patents and have a number of pending patent applications. However, our portfolio of patents evolves as new patents are issued and older patents expire and the expiration of patents could have a negative effect on our ability to prevent competitors from duplicating certain of our products.

 

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

 

To protect our product technology, documentation and other proprietary information, we enter into confidentiality agreements with our employees, customers, consultants and strategic partners. We require our employees to acknowledge their obligation to maintain confidentiality with respect to PMC’s products. Despite these efforts, we cannot guarantee that these parties will maintain the confidentiality of our proprietary information in the course of future employment or working with other business partners. We develop, manufacture and sell our products in Asia and other countries that may not protect our intellectual property rights to the same extent as the laws of the United States. This makes piracy of our technology and products more likely. Steps we take to protect our proprietary information may not be adequate to prevent theft of our technology. We may not be able to prevent our competitors from independently developing technologies that are similar to or better than ours.

 

Our products employ technology that may infringe on the intellectual property and the proprietary rights of third parties, which may expose us to litigation and prevent us from selling our products.

 

Vigorous protection and pursuit of intellectual property rights or positions characterize the semiconductor industry. This often results in expensive and lengthy litigation. We, and our customers or suppliers, may be accused of infringing patents or other intellectual property rights owned by third parties in the future. An adverse result in any litigation against us or a customer or supplier could force us to pay substantial damages, stop manufacturing, using and selling the infringing products, spend significant resources to develop non-infringing technology, discontinue using certain processes or obtain licenses to use the infringing technology. In addition, we may not be able to develop non-infringing technology or find appropriate licenses on reasonable terms or at all. Although some of our suppliers have agreed to indemnify us against certain intellectual property infringement claims or other losses relating to their products, these contractual indemnification rights may not cover the full extent of losses we incur as a result of these suppliers’ products. 

 

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Patent disputes in the semiconductor industry  between industry participants are often settled through cross-licensing arrangements. Our portfolio of patents may not have the breadth to enable us to settle an alleged patent infringement claim through a cross-licensing arrangement. Patent disputes brought by non-practicing entities (patent holders who do not manufacture products but only seek to monetize patent rights) cannot be settled through cross-licensing and cannot be avoided through cross-licensing with industry practitioners. We may therefore be more exposed to third party claims than some of our larger competitors and customers.

 

Customers may make claims against us in connection with infringement claims made against them that are alleged to relate to our products or components included in our products, even where we obtain the components from a supplier. In such cases, we may incur monetary losses due to cost of defense, settlement or damage award and non-monetary losses as a result of diverting valuable internal resources to litigation support.  To the extent that claims against us or our customers relate to third party intellectual property integrated into our products, there is no assurance that we will be fully indemnified by our suppliers against any losses.

 

Furthermore, we may initiate claims or litigation against third parties for infringing our proprietary rights or to establish the validity of our proprietary rights. This could consume significant resources and divert the efforts of our technical and management personnel, regardless of the litigation’s outcome.

 

We may be subject to intellectual property theft or misuse, which could result in third-party claims and harm our business and results of operations.

 

We regularly face attempts by others to gain unauthorized access through the Internet to our information technology systems, such as when such parties masquerade as authorized users or surreptitiously introduce software. We might become a target of computer hackers who create viruses to sabotage or otherwise attack our products and services. Hackers might attempt to penetrate our network security and gain access to our network and our data centers, misappropriate our or our customers’ proprietary information, including personally identifiable information, or cause interruptions of our internal systems and services. We seek to detect and investigate these security incidents and to prevent their recurrence, but in some cases we might be unaware of an incident or its magnitude and effects. The theft or unauthorized use or publication of our trade secrets and other confidential business information as a result of such an incident could adversely affect our competitive position and reduce marketplace acceptance of our products; reduce the value of our investment in R&D, product development, and marketing; and could motivate third parties to assert against us or our customers claims related to loss of confidential or proprietary information, end-user data, or system reliability. Our business could be subject to significant disruption, and we could suffer monetary and other losses, including the cost of product recalls and returns and reputational harm, in the event of such incidents and claims.

 

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

 

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

 

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

 

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

 

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

 

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

 

Our Board of Directors has the right to issue preferred stock without stockholder approval, which could be used to dilute the stock ownership of a potential hostile acquirer. Delaware law imposes some restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.

 

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

 

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

 

The table below provides information about purchases of equity securities that are registered by us pursuant to Section 12 of the Exchange Act during the three months ended June 27, 2015:

 

 

Item 3.  Defaults Upon Senior Securities

 

None.  

  

Item 4.  Mine Safety Disclosures

 

Not applicable.  

  

Item 5.  Other Information

  

None.

 

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Item 6.  Exhibits

 

 

  

  

  

  

  

  

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SIGNATURES

  

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.  

  

 

 

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