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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 31, 2012
For the Transition Period from ____________ to ____________
Commission File Number 0-27026
Pericom Semiconductor Corporation
(Exact Name of Registrant as Specified in Its Charter)
3545 North First Street
San Jose, California 95134
(Address of Principal Executive Offices and
Issuers Telephone Number, Including Area Code)
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 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] 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 definitions 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 126-2 of the Exchange Act)
Yes [ ] No [X]
As of May 2, 2012 the Registrant had outstanding 23,619,000 shares of Common Stock.
Pericom Semiconductor Corporation
Form 10-Q for the Quarter Ended March 31, 2012
PART I. FINANCIAL INFORMATION
Item 1: Condensed Consolidated Financial Statements
Pericom Semiconductor Corporation
Condensed Consolidated Balance Sheets
(In thousands, except share data)
See notes to condensed consolidated financial statements.
Pericom Semiconductor Corporation
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
See notes to condensed consolidated financial statements.
Pericom Semiconductor Corporation
Condensed Consolidated Statements of Cash Flows
See notes to condensed consolidated financial statements.
Pericom Semiconductor Corporation
Notes To Condensed Consolidated Financial Statements
1. BASIS OF PRESENTATION
The condensed consolidated financial statements have been prepared by Pericom Semiconductor Corporation (Pericom or the Company) pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments and accruals, necessary for a fair presentation of the Companys financial position as of March 31, 2012, the results of operations for the three and nine months ended March 31, 2012 and April 2, 2011 and cash flows for the nine months ended March 31, 2012 and April 2, 2011. This unaudited quarterly information should be read in conjunction with the audited consolidated financial statements of Pericom and the notes thereto included in the Companys Annual Report on Form 10-K as filed with the Securities and Exchange Commission on August 30, 2011.
The preparation of the interim condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the interim condensed consolidated financial statements and the reported amounts of revenue and expenses during the period. Actual amounts could differ from these estimates. The results of operations for the three and nine months ended March 31, 2012 are not necessarily indicative of the results to be expected for the entire year. The three and nine month periods ended March 31, 2012 and April 2, 2011 each had 13 and 39 week periods, respectively.
The Company participates in a dynamic high technology industry and believes that changes in any of the following areas could have a material adverse effect on the Companys future financial position or results of operations: advances and trends in new technologies; competitive pressures in the form of new products or price reductions on current products; changes in the overall demand for products offered by the Company; changes in customer relationships; acquisitions and the subsequent integration of the acquired entity with the Company; litigation or claims against the Company based on intellectual property, patent, product, regulatory or other factors; risks associated with changes in domestic and international economic and/or political conditions or regulations and environmental laws; availability of necessary components; interruptions at wafer suppliers and subcontractors; fluctuations in currencies given the Companys sales and operations being heavily weighted and paid in foreign currencies; and the Companys ability to attract and retain employees necessary to support its growth.
These interim condensed consolidated financial statements include the accounts of Pericom Semiconductor Corporation and its wholly owned subsidiaries, PSE Technology Corporation (PSE-TW), Pericom Semiconductor Hong Kong Limited (PSC-HK) and Pericom Asia Limited (PAL). In addition, PAL has three wholly-owned subsidiaries, PSE Technology (Shandong) Corporation (PSE-SD) and Pericom Technology Yangzhou Corporation (PSC-YZ) for the Jinan, China and Yangzhou, China operations, respectively, and Pericom Technology Inc. (PTI). The Company eliminates all intercompany balances and transactions in consolidation.
FISCAL PERIOD For purposes of reporting the financial results, the Companys fiscal years end on the Saturday closest to the end of June. The year ended July 2, 2011 is referred to as fiscal year 2011 or fiscal 2011, whereas the current fiscal year 2012 or fiscal 2012 will end on June 30, 2012. Both fiscal 2011 and fiscal 2012 contain 52 weeks or 364 days. Periodically, the Company adds a 53rd week to a year in order to end that year on the Saturday closest to the end of June.
WARRANTY The Company offers a standard one-year product replacement warranty. In the past, the Company has not had to accrue for a general warranty reserve, but assesses the level and materiality of return material authorizations (RMAs) and determines whether it is appropriate to accrue for estimated returns of defective products at the time revenue is recognized. On occasion, management may determine to accept product returns beyond the standard one-year warranty period. In those instances, the Company accrues for the estimated cost at the time management decides to accept the return. Because of the
Companys standardized manufacturing processes and product testing procedures, returns of defective product are infrequent and the quantities have not been significant. Accordingly, historical warranty costs have not been material.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, which requires comprehensive income to be reported in either a single statement or in two consecutive statements reporting net income and other comprehensive income, rather than in a footnote or as part of a statement of changes to shareholder equity. The amendment does not change what items are reported in other comprehensive income or the requirement to report reclassification of items from other comprehensive income to net income. This standard will be effective for the Companys fiscal year beginning July 1, 2012 with retrospective application required. As this standard impacts presentation requirements only, the adoption of this guidance is not expected to have a material impact on the consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350) Testing Goodwill for Impairment, which provides updated guidance on the periodic testing of goodwill for impairment. This guidance will allow companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. This new guidance is effective for the Companys fiscal year beginning July 1, 2012, with early adoption permitted. The Company is currently evaluating this guidance, but it is not expected that the adoption will have a material effect on the consolidated financial statements.
2. GOODWILL AND INTANGIBLE ASSETS
The following table summarizes the activity related to the carrying value of the Companys goodwill during the nine months ended March 31, 2012 and April 2, 2011:
The adjustments to goodwill primarily relate to indemnification amounts due to the Company pursuant to the PTI acquisition merger agreement, effectively reducing the merger consideration.
The following table summarizes the components of other intangible assets and related accumulated amortization balances for each of the period-ending dates shown, which were recorded as a result of business combinations:
Amortization expense related to finite-lived purchased intangible assets was approximately $778,000 and $2.4 million for the three and nine month periods ended March 31, 2012 and $628,000 and $1.9 million for the three and nine month periods ended April 2, 2011, respectively. Amortization of intangible assets for the nine month period ended March 31, 2012 included accelerated amortization related to a supplier relationship of approximately $125,000 and subsequent asset write-off.
The Company performs an impairment review of its intangible assets at least annually. Based on the results of its most recent impairment review, the Company determined that no impairment of its intangible assets existed as of July 2, 2011. However, future impairment reviews could result in a charge to earnings.
The finite-lived purchased intangible assets consist of supplier and customer relationships, trade names and existing and core technology, which have remaining useful lives from one to five years. The Company expects future amortization expense associated with its intangible assets to be:
3. INCOME (LOSS) PER SHARE
Basic income (loss) per share is based upon the weighted average number of common shares outstanding. Diluted income (loss) per share reflects the additional potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
Basic and diluted income (loss) per share for the three and nine month periods ended March 31, 2012 and April 2, 2011 are computed as follows:
Options to purchase 2,611,000 and 2,724,000 shares of common stock, and restricted stock units of 518,000 and 548,000 were outstanding during the three and nine months ended March 31, 2012 respectively, but not included in the computation of diluted earnings per share because the options and units would be anti-dilutive under the treasury stock method. Options to purchase 2,417,000 and 2,442,000 shares of common stock, and restricted stock units of 95 and 54,000 were outstanding during the three and nine months ended April 2, 2011 respectively, but not included in the computation of diluted earnings per share because the options and units would be anti-dilutive under the treasury stock method. As the Company incurred a net loss for the three and nine months ended March 31, 2012, diluted loss per share is the same as basic loss per share since the addition of any contingently issuable shares would be anti-dilutive.
Inventories consist of:
The Company considers raw material inventory obsolete and reserves it if the raw material has not moved in 365 days. The Company reviews its assembled devices for excess and records a reserve if the quantity of assembled devices in inventory is in excess of the greater of the quantity shipped in the previous twelve months, the quantity in backlog or the quantity forecasted to be shipped in the following twelve months. In certain circumstances, management will determine, based on expected usage or other factors, that inventory considered excess by these guidelines should not be reserved. The Company does occasionally determine that the last twelve months sales levels will not continue and reserves inventory in line with the quantity forecasted. As of March 31, 2012, the Company had reserved for $4.2 million of inventory which was the same as $4.2 million of inventory reserves at July 2, 2011.
5. ACCRUED LIABILITIES
Accrued liabilities consist of:
6. BUSINESS COMBINATION
Acquisition of PTI
On August 31, 2010, the Company completed the acquisition and obtained control of PTI pursuant to the terms of the Agreement and Plan of Merger (the Merger Agreement) for cash consideration of $30.2 million. An additional approximately $6 million in earn-out consideration and bonus payments were the
Companys obligation pursuant to the Merger Agreement for the achievement of gross profit milestones during fiscal year 2011, and the payout of this amount was completed in the third quarter.
Fair Value of Consideration Transferred (in thousands):
Immediately prior to the acquisition, remeasurement of the Companys interest in PTI led to a gain of $11 million, which amount was recorded in interest and other income in the fiscal 2011 condensed consolidated statement of operations. This fair value measurement was based on the per share consideration paid in the transaction, including the fair value of the earn-out, applied to the number of shares held by the Company immediately prior to closing.
In accordance with Accounting Standards Codification (ASC) 805, a liability was recognized for the estimated acquisition date fair value of $4.1 million for the contingent consideration based on the probability of the achievement of PTIs gross profit target. Actual achievement of PTIs gross profit target exceeded 100% of the threshold, and the PTI stockholders earned the maximum consideration of $4.8 million, and the payout of this amount was completed in the third quarter of fiscal year 2012.
Allocation of Consideration Transferred
The acquisition was accounted for as a business combination under ASC 805. The purchase price of $58.0 million was allocated to the net tangible and intangible assets acquired and liabilities assumed based on their fair values as of the date of the completion of the acquisition as follows (in thousands):
As of the date of acquisition, inventories are required to be measured at fair value. The fair value of inventory of $3.4 million was based on assumptions applied to the PTI acquired inventory balance. In estimating the fair value of finished goods and work-in-progress inventory, the Company made assumptions about the selling prices and selling cost associated with the inventory. The Company assumed that estimated selling prices would yield gross margins consistent with actual margins earned by PTI during the second half of fiscal year 2010. The Company assumed that selling cost as a percentage of revenue would be consistent with actual rates experienced by PTI during the second half of fiscal year 2010.
The fair value of the acquired land and buildings in Shanghai, China was estimated based on the recent real estate transactions of comparable properties in the same geographic area. The acquired land and buildings are being depreciated over estimated useful lives of 15 to 48 years.
Existing and core technology consisted of products which have reached technological feasibility and relate to the PTI products. The value of the developed technology was determined by discounting estimated net future cash flows of these products. The Company is amortizing the existing and core technology on a straight-line basis over an estimated life of 6 years.
Customer relationships relate to the Companys ability to sell existing and future versions of products to existing PTI customers. The fair value of the customer relationships was determined by discounting estimated net future cash flows from the customer contracts. The Company is amortizing customer relationships on a straight-line basis over an estimated life of 6 years.
The backlog fair value relates to the estimated selling cost to generate backlog at August 31, 2010. The fair value of backlog at closing was amortized over an estimated life of 3 months and is fully amortized.
In-process research and development (IPRD) consisted of the in-process projects to complete development of certain PTI products. The value assigned to IPRD was determined by considering the importance of products under development to the overall development plan, estimating costs to develop the purchased IPRD into commercially viable products, estimating the resulting net cash flows from the projects when completed and discounting the net cash flows to their present value. This methodology is referred to as the income approach, which discounts expected future cash flows to present value. The discount rate used in the present value calculations was derived from a weighted-average cost of capital analysis, adjusted to reflect additional risks related to the products development and success as well as the products stage of completion. Acquired IPRD assets are initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. Accordingly, during the development period after the acquisition date, these assets will not be amortized as charges to earnings; instead this asset will be subject to periodic impairment testing. Upon successful completion of the development process for the acquired IPRD projects, the asset would then be considered a finite-lived intangible asset and amortization of the asset will commence over an expected life of 6 years. Development of the PTI IPRD products was completed during the three months ended March 31, 2012.
The deferred tax liability of $3.0 million associated with the estimated fair value adjustments of assets acquired and liabilities assumed was recorded using the estimated statutory tax rate in the jurisdictions where the fair value adjustments occurred.
Of the total estimated purchase price paid at the time of acquisition, approximately $15.5 million was allocated to goodwill. Subsequently, goodwill has been reduced by approximately $334,000 as a result of working capital adjustments and indemnification claims pursuant to the Merger Agreement. Goodwill represents the excess of the purchase price of an acquired business over the fair value of the underlying net tangible and intangible assets and is not deductible for tax purposes. Among the factors that contributed to a purchase price in excess of the fair value of the net tangible and intangible assets was the acquisition of an assembled workforce of experienced semiconductor engineers, synergies in products, technologies, skill sets, operations, customer base and organizational cultures that can be leveraged to enable the Company to build an enterprise greater than the sum of its parts. In accordance with Accounting Standards Codification (ASC) 350, IntangiblesGoodwill and Other, goodwill will not be amortized but instead will be tested for impairment at least annually and more frequently if certain indicators of impairment are present. In the event that management determines that the value of goodwill has become impaired, the Company will record an expense for the amount impaired during the fiscal quarter in which the determination is made.
The amount of PTI net revenues included in the Companys condensed consolidated statement of operations for the nine months ended March 31, 2012 was $9.1 million, and from the PTI acquisition date of August 31, 2010 to April 2, 2011, was approximately $11.3 million.
Pro Forma Data for the PTI Acquisition
The following table presents the unaudited pro forma results of the Company as though the PTI acquisition described above occurred at the beginning of the fiscal year on July 4, 2010. The data below includes the
historical results of the Company and PTI on a standalone basis through the closing date of acquisition, with adjustments as noted in the supplemental information. The pro forma results presented do not purport to be indicative of the results that would have been achieved had the acquisition been made as of that date nor of the results which may occur in the future.
7. COMMITMENTS AND CONTINGENCIES
The Companys future minimum commitments at March 31, 2012 are as follows:
The operating lease commitments are primarily the lease on the Companys corporate headquarters, which expires in 2013 but with two consecutive options to extend for an additional five years each.
The Company has no purchase obligations other than routine purchase orders and the capital equipment purchase commitments shown in the table as of March 31, 2012.
The Company previously entered into an R&D Agreement for its Yangzhou facility that would require the capital injections shown in the table. The Company is currently negotiating with the Yangzhou government to terminate the R&D Agreement. If the termination is successful, the above capital injections would not be made.
8. INDUSTRY AND SEGMENT INFORMATION
The Company operates and tracks its results in one reportable segment. The Company designs, develops, manufactures and markets a broad range of interface integrated circuits and frequency control products.
The following table indicates the percentage of the Companys net revenues and accounts receivable in excess of 10 percent with any single customer:
For geographical reporting, the Company attributes net revenues to the country where customers are located (the bill to location). The Company neither conducts business in nor sells to persons in Iran, Syria, Sudan, or North Korea, countries located in referenced regions identified as state sponsors of terrorism by the U.S. Department of State and subject to U.S. economic sanctions and export controls. The following table sets forth net revenues by country for the three and nine month periods ended March 31, 2012 and April 2, 2011:
Long-lived assets consist of all non-monetary assets, excluding financial assets, deferred taxes, goodwill and intangible assets. The Company attributes long-lived assets to the country where they are located. The following table sets forth the Companys long-lived assets by country of location as of March 31, 2012 and July 2, 2011:
9. STOCK REPURCHASE PROGRAM
On April 26, 2007, the Companys Board of Directors authorized the repurchase of 2.0 million shares of the Companys common stock, and on April 29, 2008, the Board of Directors authorized the repurchase of an additional $30 million of common stock. The Company may repurchase the shares from time to time in open market or private transactions, at the discretion of the Companys management.
During the three and nine month periods ended March 31, 2012, the Company repurchased 425,766 and 1,184,229 shares for an aggregate cost of approximately $3.4 million and $9.2 million, respectively. During the three and nine month periods ended April 2, 2011, the Company repurchased 115,718 and 278,879 shares for an aggregate cost of approximately $1.1 million and $2.5 million, respectively. Current cash balances and the proceeds from stock option exercises and purchases in the stock purchase plan have funded stock repurchases in the past, and the Company expects to fund future stock repurchases from these same sources. As of March 31, 2012, the Company had approximately $3.1 million of repurchase authority remaining.
10. SHAREHOLDERS EQUITY AND SHARE-BASED COMPENSATION
The Companys shareholders have authorized the Board of Directors to issue 5,000,000 shares of preferred stock from time to time in one or more series and to fix the rights, privileges and restrictions of each series. As of March 31, 2012, the Company has issued no shares of preferred stock.
STOCK OPTION PLANS
At March 31, 2012 the Company had four stock incentive plans and an employee stock purchase plan, consisting of the 1995 Stock Option Plan, 2001 Stock Option Plan, SaRonix Acquisition Stock Option Plan, 2004 Stock Incentive Plan and the 2010 Employee Stock Purchase Plan.
Under the four stock incentive plans, the Company has reserved an aggregate of 5.6 million shares of common stock as of March 31, 2012 for issuance to employees, officers, directors, independent contractors and consultants of the Company in the form of incentive or nonqualified stock options, or grants of restricted stock.
The Company may grant stock options at the fair value on the grant date for incentive stock options and nonqualified stock options. Options vest over periods of generally 48 months as determined by the Board of Directors. Options granted under the Plans expire 10 years from the grant date.
The Company estimates the fair value of each employee stock option on the date of grant using the Black-Scholes option valuation model and expenses that value as compensation using a straight-line method over the options vesting period, which corresponds to the requisite employee service period. The Company estimates expected stock price volatility based on actual historical volatility for periods that the Company believes represent predictors of future volatility. The Company uses historical data to estimate option exercises, expected option holding periods and option forfeitures. The Company bases the risk-free interest rate for periods within the contractual life of the option on the U.S. Treasury yield corresponding to the expected life of the underlying option.
No stock options were granted during the three months ended March 31, 2012 or April 2, 2011.
The following table summarizes the Companys stock option activity for the nine months ended March 31, 2012:
At March 31, 2012, 2.1 million shares were available for future grants under the incentive plans. The aggregate intrinsic value of options exercised during the nine months ended March 31, 2012 was approximately $6,000.
At March 31, 2012, expected future compensation expense relating to options outstanding is $1.7 million, which will be amortized to expense over a weighted average period of 2.3 years.
Additional information regarding options outstanding and exercisable as of March 31, 2012 is as follows:
Restricted Stock Units
Restricted stock units (RSUs) are converted into shares of the Companys common stock upon vesting on a one-for-one basis. Typically, vesting of RSUs is subject to the employees continuing service to the Company. RSUs generally vest over a period of 4 years and are expensed ratably on a straight-line basis over their respective vesting period net of estimated forfeitures. The fair value of RSUs granted pursuant to the Companys 2004 Stock Incentive Plan is the product of the number of shares granted and the grant date fair value of the common stock. A summary of activity of RSUs for the nine months ended March 31, 2012 is presented below:
At March 31, 2012, expected future compensation expense relating to RSUs is $3.1 million, which will be amortized to expense over a weighted average remaining recognition period of 2.3 years.
2010 EMPLOYEE STOCK PURCHASE PLAN
The Companys 2010 Employee Stock Purchase Plan (the Stock Purchase Plan) allows eligible employees of the Company to purchase shares of Common Stock through payroll deductions. The Company reserved 2.0 million shares of the Companys Common Stock for issuance under this Plan, of which 1.9 million remain available at March 31, 2012. The Stock Purchase Plan permits eligible employees to purchase Common Stock at a discount through payroll deductions during six-month purchase periods. The six-month periods come to an end on or about May 1 and November 1 and the purchases are then made. Thus there were no purchases under the Stock Purchase Plan for the three months ended March 31, 2012 and April 2, 2011. Participants in the Stock Purchase Plan may purchase stock at 85% of the lower of the stocks fair market value on the first day and last day of the offering period. The maximum number of shares of Common Stock that any employee may purchase during any offering period under the plan is 1,000 shares, and an employee may not accrue more than $10,000 for share purchases in any offering period. During the first nine months of fiscal years 2012 and 2011, the Company issued 55,915 and 101,452 shares of common stock under the Stock Purchase Plan and the predecessor 2000 Stock Purchase Plan at weighted average prices of $7.22 and $5.41, respectively. The weighted average fair value of the awards for the first nine months of fiscal 2012 and 2011 were $2.43 and $2.49 per share, respectively.
The Company estimates the fair value of stock purchase rights granted under the Companys Stock Purchase Plan on the date of grant using the Black-Scholes option valuation model. ASC Topic 718 states that a lookback pricing provision with a share limit should be considered a combination of stock and a call option. The valuation results for these elements have been combined to value the specific features of the stock purchase rights. The Company bases volatility on the expected volatility of the Companys stock during the offering period. The expected term is determined by the time from enrollment until purchase, and the Company uses the U.S. Treasury yield for the risk-free interest rate for the offering period.
The following table summarizes activity in the Companys employee stock purchase plan during the nine months ended March 31, 2012:
At March 31, 2012, the Company had $24,000 in unamortized share-based compensation related to its employee stock purchase plan which will be amortized and recognized in the consolidated statement of operations over the next month.
The following table shows total share-based compensation expense classified by Consolidated Statements of Operations reporting caption for the three and nine months ended March 31, 2012 and April 2, 2011 generated from the plans described above:
Share-based compensation by type of award is as follows:
The amount of share-based compensation expense capitalized in inventory at March 31, 2012 and July 2, 2011 is immaterial.
11. INCOME TAXES
Accounting for Uncertainty in Income Taxes
The Companys total amount of unrecognized tax benefits as of March 31, 2012 was $818,000. All of this amount would affect the Companys tax rate if recognized. In addition, as of March 31, 2012 the Company had accrued $84,000 for any interest and penalties related to unrecognized tax benefits.
The Companys effective tax rate may differ from the federal statutory rate primarily due to state income taxes, research and development tax credits, stock-based compensation from incentive stock options, differing tax rates in income-earning foreign jurisdictions, and the inability to utilize losses in certain foreign entities to offset domestic income.
The Company is subject to examination by Federal, foreign, and various state jurisdictions for the years 2005 through 2010. To the Companys knowledge, there are currently no examinations underway.
Income Tax Expense
Income tax expense for the nine months ended March 31, 2012 and April 2, 2011 was $123,000 and $6.3 million, respectively, and was comprised of domestic federal and state income tax and foreign income and withholding tax. The effective tax rate for the nine months ended March 31, 2012 is not meaningful since the Company had a pretax loss for the period, and the tax resulted from the allocation of earnings between different tax jurisdictions. The effective tax rate for the nine months ended April 2, 2011 was 36%. As of March 31, 2012, the Company has recorded a valuation allowance of $1.1 million against its deferred tax assets.
12. INVESTMENT IN UNCONSOLIDATED AFFILIATE
The Companys investment in an unconsolidated affiliate is as follows:
PSE-TW has a 49% equity interest in Jiyuan Crystal Photoelectric Frequency Technology Ltd. (JCP), an FCP manufacturing company located in Science Park of Jiyuan City, Henan Province, China. JCP is a key manufacturing partner of PSE-TW and supplies PSE-TW with blanks for its surface mount device (SMD) production lines. For the first nine months of fiscal 2012 and 2011, the Companys allocated portion of JCPs results was income of $83,000 and $184,000, respectively.
13. EQUITY AND COMPREHENSIVE INCOME
Comprehensive income consists of net income, changes in net unrealized gains (losses) on available-for-sale investments and changes in cumulative currency translation adjustments at consolidated subsidiaries. Changes in equity including comprehensive income for the nine months ended April 2, 2011 and March 31, 2012 are as follows:
As of March 31, 2012, accumulated other comprehensive income consists of $338,000 of unrealized gains net of tax and $9.8 million of accumulated currency translation gains.
14. SHORT-TERM DEBT
As of March 31, 2012, the Companys subsidiary PSE-TW has made short-term borrowings under its credit facilities totaling approximately $3.8 million. The loans are denominated in U.S. Dollars and Japanese Yen and carry variable rates of interest currently ranging from 1.30% to 1.74% per annum. The loans have maturities ranging from 43 to 175 days. PSE-TW has pledged $4.4 million in land and buildings for the loan and credit facilities.
15. INDUSTRIAL DEVELOPMENT SUBSIDY
As of March 31, 2012, industrial development subsidies in the amount of $11.7 million have been earned and applied for by PSE-SD from the Jinan Hi-Tech Industries Development Zone Commission based on meeting certain pre-defined criteria. The subsidies may be used for the acquisition of assets or to cover business expenses. When a subsidy is used to acquire assets, the subsidy will be amortized over the useful life of the asset. When a subsidy is used for expenses incurred, the subsidy is regarded as earned upon the incurrence of the expenditure. The remaining balance of the subsidies at March 31, 2012 was $8.3 million, which amount is expected to be recognized over the next three to twenty years.
The Company recognized $191,000 and $880,000 of industrial development subsidy as a reduction of cost of goods sold and $45,000 and $135,000 of industrial development subsidy as a reduction of operating expenses in the consolidated statements of operations for the three and nine month periods ended March 31, 2012, respectively. The Company recognized $316,000 and $914,000 of industrial development subsidy as a reduction of cost of goods sold and $58,000 and $185,000 of industrial development subsidy as a reduction of operating expenses in the consolidated statements of operations for the three and nine month periods ended April 2, 2011, respectively.
The Companys policy is to invest in instruments with investment grade credit ratings. The Company classifies its short-term investments as available-for-sale securities and the Company bases the cost of securities sold using the specific identification method. The Company accounts for unrealized gains and losses on its available-for-sale securities as a separate component of shareholders equity in the consolidated balance sheets in the period in which the gain or loss occurs. The Company classifies its available-for-sale securities as current or noncurrent based on each securitys attributes. At March 31, 2012, a summary of investments by major security type is as follows:
At July 2, 2011 a summary of investments by major security type is as follows:
The above investments are included in short-term and long-term investments in marketable securities on the Companys condensed consolidated balance sheets.
The following tables show the unrealized losses and fair market values of the Companys investments that have unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at March 31, 2012 and July 2, 2011:
The unrealized losses are of a temporary nature due to the Companys intent and ability to hold the investments until maturity or until the cost is recoverable. The unrealized losses are primarily due to fluctuations in market interest rates. The Company reports unrealized gains and losses on its available-for-sale securities in accumulated other comprehensive income in shareholders equity.
The Company records gains or losses realized on sales of available-for-sale securities in interest and other income, net on its condensed consolidated statements of operations. The cost of securities sold is based on the specific identification of the security and its amortized cost. For the nine months ended March 31, 2012 and April 2, 2011, proceeds from sales and maturities of available-for-sale securities were $76.7 million and $161.4 million, respectively, and realized gains were $556,000 and $1.5 million, respectively. Securities sales were higher than normal for the nine months ended April 2, 2011 both to raise cash for the PTI acquisition and to reposition the portfolio for changing market conditions and opportunities.
The following table lists the fair market value of the Companys short- and long-term investments by length of time to maturity as of March 31, 2012. Securities with maturities over multiple dates are mortgage-backed (MBS) or asset-backed securities (ABS) featuring periodic principle paydowns through 2052.
17. FAIR VALUE MEASUREMENTS
The Company defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs that may be used to
measure fair value, of which the first two are considered observable and the last is considered unobservable:
The following table represents the Companys fair value hierarchy for financial assets measured at fair value on a recurring basis. Most of the investments are classified as Level 2 at March 31, 2012. Level 2 pricing is provided by third party sources of market information obtained through the Companys investment advisors. The Company does not adjust for or apply any additional assumptions or estimates to the pricing information it receives from advisors. The Companys investment advisors obtain pricing data from independent sources, such as Standard & Poors, Bloomberg and Interactive Data Corporation, and rely on comparable pricing of other securities because the Level 2 securities it holds are not actively traded and have fewer observable transactions. The Company considers this the most reliable information available for the valuation of the securities.
The Companys Level 2 securities include time deposits, government securities, corporate debt securities and mortgage-backed and asset-backed securities. Government securities include US federal agency securities, foreign government and agency securities, and US state and municipal bond obligations. Many of the municipal bonds are insured; those that are not are nearly all AAA/Aaa rated. The corporate debt securities are all investment grade and most are single A-rated or better. The asset-backed securities are AAA/Aaa rated and are backed by auto loans, student loans, credit card balances and residential or commercial mortgages.
The Company had no transfers into or out of Level 2 during the nine months ended March 31, 2012.
When assessing marketable securities for other-than-temporary declines in value, a number of factors are considered. Analyses of the severity and duration of price declines, remaining years to maturity, portfolio manager reports, economic forecasts, and the specific circumstances of issuers indicate that it is reasonable to expect marketable securities with unrealized losses at March 31, 2012 to recover in fair value up to the Companys cost bases within a reasonable period of time. The Company does not intend to sell investments with unrealized losses before maturity, when the obligors are required to redeem them at full face value or par. The Company believes the obligors have the financial resources to redeem the debt securities. Accordingly, the Company does not consider the investments to be other-than-temporarily impaired at March 31, 2012.
The Company has determined that the amounts reported for cash and cash equivalents, accounts receivable, deposits, accounts payable, accrued liabilities and debt approximate fair value because of their short maturities and/or variable interest rates.
18. SUBSEQUENT EVENT
On April 26, 2012, the Board of Directors authorized an additional share repurchase program for up to $25 million of shares of the Companys common stock. Shares may be repurchased from time to time in the open market or through private transactions, at the discretion of Pericom management. As of April 27, 2012, Pericom had approximately 23.6 million shares of common stock outstanding.
Item 2: Managements Discussion and Analysis
of Financial Condition and Results of Operations
Pericom Semiconductor Corporation
The following information should be read in conjunction with the unaudited financial statements and notes thereto included in Part 1 Item 1 of this Quarterly Report and the audited financial statements and notes thereto and Managements Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended July 2, 2011 (the Form 10-K).
Factors That May Affect Operating Results
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical fact are forward-looking statements for purposes of these provisions, including any statements regarding our sales to Taiwan and China, the effect on supply chain and our operations of the 2011 Japan earthquake and tsunami, the continuation of a high level of turns orders, higher or lower levels of inventory, future gross profit and gross margin; the plans and objectives of management for future operations; our tax rate; currency fluctuations; the adequacy of allowances for returns, price protection and other concessions; the sufficiency of cash generated from operations and cash balances; our exposure to interest rate risk; expectations regarding our research and development and selling, general and administrative expenses; and our possible future acquisitions and assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as may, will, expects, plans, anticipates, estimates, potential, or continue, or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to risks and uncertainties, including but not limited to the factors set forth (i) in Item 1A, Risk Factors, of Part II of this Form 10-Q, and (ii) in Note 1 to the Notes to Condensed Consolidated Financial Statements. All forward-looking statements and reasons why results may differ included in this Quarterly Report are made as of the date hereof, and we assume no obligation to update any such forward-looking statement or reason why actual results may differ.
Results of Operations
The following table sets forth certain statement of operations data as a percentage of net revenues for the periods indicated.
The following table sets forth our revenues and the customer concentrations with respect to such revenues for the periods indicated.
We design, develop and market high-performance integrated circuits (ICs or IC products) and frequency control products (FCPs or FCP products) used in many of todays advanced electronic systems. Our IC products include products that support the connectivity, timing and signal conditioning of high-speed parallel and serial protocols that transfer data among a systems microprocessor, memory and various peripherals, such as displays and monitors, and between interconnected systems. Our FCPs are electronic components that provide frequency references such as crystals, oscillators, and hybrid timing generation products for computer, communication and consumer electronic products. Our analog, digital and mixed-signal ICs, together with our FCP products enable higher system bandwidth and signal quality, resulting in better operating reliability, signal integrity, and lower overall system cost in applications such as notebook computers, servers, network switches and routers, storage area networks, digital TVs, cell phones, GPS and digital media players.
Net revenues consist of product sales, which we generally recognize upon shipment, less an estimate for returns and allowances.
Net revenues decreased $6.2 million or 15.6% in the third quarter of fiscal 2012 versus the third quarter of fiscal 2011. This decrease is primarily the result of reduced end user demand due to economic softness in the PC, notebook, and consumer-product end markets. Net revenue for IC and FCP products in the third quarter of fiscal 2012 versus the third quarter of fiscal 2011 reflected:
Net revenue decreased $23.8 million or 19.4% in the first nine months of fiscal 2012 versus the first nine months of fiscal 2011. This decrease reflects reductions in IC and FCP product sales:
The following table sets forth net revenues by country as a percentage of total net revenues for the three and nine months ended March 31, 2012 and April 2, 2011:
Over the past several years, sales to Taiwan and China have constituted the majority of our sales. We expect this trend will continue in the future.
Our net revenue levels have been highly dependent on the number of new orders that are received for products to be delivered to the customer within the same quarter, also called turns orders. Because of our lack of visibility into demand when turns orders are high, it is difficult to predict which products to build to match future demand. We believe the current high level of turns orders will continue indefinitely. The sustainability of customer demand is uncertain and our markets are highly dependent on worldwide economic conditions. The high level of turns orders together with the uncertainty of product mix and pricing makes it difficult to predict future levels of sales and may require us to carry higher levels of inventory.
The following table sets forth our gross profit for the periods indicated:
The decrease in gross profit in the third quarter of fiscal 2012 as compared to the third quarter of fiscal 2011 of $776,000 is the result of:
The decrease in gross profit in the first nine months of fiscal 2012 as compared to the first nine months of fiscal 2011 of $5.4 million is primarily the result of:
Future gross profit and gross margin are highly dependent on the level and product mix of net revenues. This includes the mix of sales between lower margin FCP products and our higher margin integrated circuit products. Although we have been successful at favorably improving our integrated circuit product mix and penetrating new end markets, there can be no assurance that this will continue. Accordingly, we are not able to predict future gross profit levels or gross margins with certainty.
During the three and nine months ended March 31, 2012, gross profit and gross margin benefited as a result of the sale of inventory of $30,000 and $171,000 respectively, that we had previously identified as excess and written down to zero value, as compared with benefits of $14,000 and $42,000, respectively, for the same periods of the prior year.
Research and Development (R&D)
Research and development expenses consist primarily of costs related to personnel and overhead, non-recurring engineering charges, and other costs associated with the design, prototyping, testing, manufacturing process design support, and technical customer applications support of our products. The $431,000 expense increase for the three month period ended March 31, 2012 as compared to the same period of the prior year is primarily attributable to increases of $235,000 in consulting services and $164,000 in severance costs related to personnel reductions made by the Company in the three months ended March 31, 2012. The $1.6 million expense increase for the nine month period ended March 31, 2012 as compared to the same period of the prior year is primarily attributable to increases of $441,000 in depreciation and amortization, $380,000 in consulting services, $326,000 for masks and assembly expenditures, $156,000 in severance costs and 151,000 in facilities-related expenses.
We believe that continued spending on research and development to develop new products and improve manufacturing processes is critical to our long-term success, and as a result we expect to continue to invest in research and development projects. In the short term, we intend to continue to focus on cost control as business conditions improve. If business conditions deteriorate or the rate of improvement does not meet our expectations, we may implement further cost-cutting actions.
Selling, General and Administrative (SG&A)
Selling, general and administrative expenses consist primarily of personnel and related overhead costs for sales, marketing, finance, administration, human resources and general management. The expense reduction of approximately $117,000 for the three month period ended March 31, 2012 as compared to the same period of the prior year is attributable primarily to a $247,000 reduction in compensation expenses,
partially offset by a $100,000 increase in severance costs related to personnel reductions made by the Company in the three months ended March 31, 2012. The expense decrease of approximately $447,000 for the nine month period ended March 31, 2012 as compared to the same period of the prior year is attributable primarily to decreased expenditures of $782,000 in compensation expenses, partially offset by $300,000 of charges for receivables write-offs.
We anticipate that selling, general and administrative expenses will increase in future periods over the long term due to increased staffing levels, particularly in sales and marketing, as well as increased commission expense to the extent we achieve higher sales levels. We intend to continue our focus on controlling costs. If business conditions deteriorate or the rate of improvement does not meet our expectations, we may implement further cost-cutting actions.
Interest and Other Income, Net
Interest and other income for the three month period ended March 31, 2012 decreased $285,000 as compared with the same period of the prior year due primarily to an exchange loss this year compared with an exchange gain last year due to currency fluctuation, and somewhat lower returns and realized gains on invested balances this year, partially offset by reductions in other expenses. Interest and other income for the nine month period ended March 31, 2012 decreased $11.1 million as compared with the same period of the prior year due primarily to an $11.0 million gain recorded on our previously held interest in Pericom Technology Inc. (PTI) last year and somewhat lower returns on invested balances this year, partially offset by reductions in other expenses and an exchange gain this year compared with an exchange loss last year.
Income Tax Expense (Benefit)
The tax benefit of $76,000 in the quarter adjusted our year-to-date taxes to the appropriate level based on fiscal year-to-date projected results. The $123,000 of income taxes for the nine month period ended March 31, 2012 despite having $117,000 of pretax losses is due primarily to the allocation of earnings between different tax jurisdictions.
Our effective tax rate may differ from the federal statutory rate primarily due to state income taxes, research and development tax credits, share-based compensation from incentive stock options, tax-exempt interest income, and differing tax rates in income-earning foreign jurisdictions.
Equity in Net Income of Unconsolidated Affiliates
Equity in net income of unconsolidated affiliates consists of our allocated portion of the net income of Jiyuan Crystal Photoelectric Frequency Technology Ltd. (JCP), an FCP manufacturing company located in Science Park of Jiyuan City, Henan Province, China. JCP is a key manufacturing partner of PSE-TW, and PSE-TW has acquired a 49% equity interest in JCP. For the three and nine month periods ended March 31, 2012, the Companys allocated portion of JCPs results was income of $4,000 and $83,000, respectively, as compared with income of $17,000 and $184,000 for the three and nine month periods ended April 2, 2011, respectively.
Equity in net income of unconsolidated affiliates for the nine month period ended April 2, 2011 also includes our allocated portion of the net income of PTI prior to the acquisition of the rest of PTI at the end of August 2010. Our allocated portion of PTIs results was income of $467,000 for July and August 2010.
Liquidity and Capital Resources
As of March 31, 2012, our principal sources of liquidity included cash, cash equivalents and short-term and long-term investments of approximately $125.0 million as compared with $127.6 million on July 2, 2011.
Our investment in debt securities includes government securities, corporate debt securities and mortgage-backed and asset-backed securities. Government securities include US treasury securities, US federal agency securities, foreign government and agency securities, and US state and municipal bond obligations. Many of the municipal bonds are insured; those that are not are nearly all AAA/Aaa rated. The corporate debt securities are all investment grade and nearly all are single A-rated or better. The asset-backed securities are AAA/Aaa rated and are backed by auto loans, student loans, credit card balances and residential or commercial mortgages. Most of our mortgage-backed securities are collateralized by prime residential mortgages issued by government agencies including FNMA, FHLMC and FHLB. Those issued by banks are AAA-rated. At March 31, 2012, unrealized gains on marketable securities net of taxes were $338,000. When assessing marketable securities for other than temporary declines in value, we consider a number of factors. Our analyses of the severity and duration of price declines, portfolio manager reports, economic forecasts and the specific circumstances of issuers indicate that it is reasonable to expect marketable securities with unrealized losses at March 31, 2012 to recover in fair value up to our cost bases within a reasonable period of time. We have the ability and intent to hold investments with unrealized losses until maturity, when the obligors are required to redeem them at full face value or par, and we believe the obligors have the financial resources to redeem the debt securities. Accordingly, we do not consider our investments to be other than temporarily impaired at March 31, 2012.
As of March 31, 2012, $19.8 million was classified as cash and cash equivalents compared with $30.0 million as of July 2, 2011. The maturities of our short term investments are staggered throughout the year so that cash requirements are met. Because we are a fabless semiconductor manufacturer, we have lower capital equipment requirements than other semiconductor manufacturers who own wafer fabrication facilities. For the nine month period ended March 31, 2012, we spent approximately $5.1 million on property and equipment compared to $9.7 million for the nine month period ended April 2, 2011. We generated approximately $2.6 million of interest income for the nine month period ended March 31, 2012, as compared with $3.4 million of interest income for the nine month period ended April 2, 2011. In the longer term we may generate less interest income if our total invested balance decreases and these decreases are not offset by rising interest rates or increased cash generated from operations or other sources.
Our net cash provided by operating activities of $20.0 million for the nine months ended March 31, 2012 was primarily the result of non-cash expenses of $9.0 million in depreciation and amortization, $2.8 million of share-based compensation expense, $382,000 of tax benefit from stock option transactions and
$300,000 of receivables write off, partially offset by a $556,000 gain on sale of investments in marketable securities and $83,000 equity in net income of unconsolidated affiliates. Additional contributions to cash included decreases of $8.2 million in accounts receivable and $4.6 million in inventory. Such contributions were partially offset by a net loss of $157,000, increases of $2.0 million in prepaid expenses and other current assets, and decreases of $451,000 in accounts payable and $2.4 million in accrued liabilities. Our net cash provided by operating activities was $14.8 million in the nine months ended April 2, 2011.
Our cash used in investing activities of $17.6 million for the nine months ended March 31, 2012 was the result of additions to property and equipment of approximately $5.1 million, payment of PTI earnout and purchase consideration of $8.1 million, and purchases of available for sale investments exceeding sales and maturities of available for sale investments by approximately $7.3 million, partially offset by a $2.9 million decrease in restricted cash balances. Our cash used in investing activities was $26.9 million for the nine months ended April 2, 2011.
Our cash used in financing activities for the nine months ended March 31, 2012 of $13.2 million was primarily the result of using $9.2 million for repurchase of our common stock and repayments of short-term debt exceeding draws by $4.5 million, partially offset by $525,000 of proceeds from common stock issuance under stock plans. Our cash provided by financing activities was $5.1 million for the nine months ended April 2, 2011.
A portion of our cash may be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, we may evaluate potential acquisitions of such businesses, products or technologies.
Our long-term future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support our product development efforts, the expansion of sales and marketing efforts, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our products. We could be required, or could elect, to seek additional funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us or at all. We believe our current cash balances and cash flows generated by operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures.
Contractual Obligations and Commitments
Our contractual obligations and commitments at March 31, 2012 are as follows:
We lease certain facilities under operating leases with termination dates on or before December 2013. Generally, these leases have multiple options to extend for a period of years upon termination of the original lease term or previously exercised option to extend.
We have no purchase obligations other than routine purchase orders and the capital equipment purchase commitments shown in the table as of March 31, 2012.
We previously entered into an R&D Agreement for our Yangzhou facility that would require the capital injections shown in the table. We are currently negotiating with the Yangzhou government to terminate the R&D Agreement. If the termination is successful, the additional capital injections would not be made.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements, defined by Regulation S-K Item 303(a)(4).
Critical Accounting Policies
Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such statements requires us to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period and the reported amounts of assets and liabilities as of the date of the financial statements. Our estimates are based on historical experience and other assumptions that we consider to be reasonable given the circumstances. Actual results may vary from our estimates.
The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we reports in our financial statements. The Securities and Exchange Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of our financial condition and results of operations, and require us to make our most difficult and subjective accounting judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include revenue recognition and accounts receivable allowances, which impact the recording of revenues; valuation of inventories, which impacts costs of goods sold and gross margins; accounting for income taxes, which impacts the income tax provision and net income; impairment of goodwill, other intangible assets and investments, which impacts the goodwill, intangible asset and investment accounts; and stock-based compensation, which impacts costs of goods sold and operating expenses. These policies and the estimates and judgments involved are discussed further below.
REVENUE RECOGNITION. We recognize revenue from the sale of our products upon shipment, provided title and risk of loss has passed to the customer, the price is fixed or determinable and collection of the revenue is reasonably assured. A provision for estimated future returns and other charges against revenue is recorded at the time of shipment. For the nine months ended March 31, 2012, the majority of our revenues were from sales to distributors.
We sell products to large, domestic distributors at the price listed in our price book for that distributor. We recognize revenue at the time of shipment. At the time of sale we record a sales reserve for ship from stock and debits (SSDs), stock rotations, return material authorizations (RMAs), authorized price protection programs, and any special programs approved by management. The sales reserve is offset against revenues, which then leads to the net revenue amount reported.
The market price for our products can be significantly different from the book price at which the product was sold to the distributor. When the market price, as compared with the book price, of a particular sales opportunity from the distributor to their customer would result in low or negative margins to the distributor, a ship from stock and debit is negotiated with the distributor. SSD history is analyzed and used to develop SSD rates that form the basis of the SSD sales reserve recorded each period. We capture these historical SSD rates from our historical records to estimate the ultimate net sales price to the distributor.
Our distribution agreements provide for semi-annual stock rotation privileges of typically 10% of net sales for the previous three-month period. The contractual stock rotation applies only to shipments at book price. Asian distributors typically buy our product at less than book price and therefore are not entitled to the 10% stock rotation privilege. In order to provide for routine inventory refreshing, for our benefit as well as theirs, we grant Asian distributors stock rotation privileges between 1% and 5% even though we are not contractually obligated to do so. Each month a sales reserve is recorded for the estimated stock rotation privilege anticipated to be utilized by the distributors that month. This reserve is the sum of product of each distributors net sales for the month and their stock rotation percentage.
From time to time, customers may request to return parts for various reasons including the customers belief that the parts are not performing to specification. Many such return requests are the result of customers incorrectly using the parts, not because the parts are defective. These requests are reviewed by management and when approved result in a RMA being established. We are only obligated to accept returns of defective parts. For customer convenience, we may approve a particular return request even though we are not obligated to do so. Each month a sales reserve is recorded for the approved RMAs that have not yet been returned. We do not keep a general warranty reserve because historically valid warranty
returns, which are the result of a part not meeting specifications or being non-functional, have been immaterial and parts can frequently be re-sold to other customers for use in other applications.
Price protection is granted solely at the discretion of our management. The purpose of price protection is to reduce the distributors cost of inventory as market prices fall, thus reducing SSD rates. Our sales management prepares price protection proposals for individual products located at individual distributors. Our general management reviews these proposals and if a particular price protection arrangement is approved, the dollar impact will be estimated based on the book price reduction per unit for the products approved and the number of units of those products in the distributors inventory. A sales reserve is then recorded in that period for the estimated amount.
At the discretion of our management, we may offer rebates on specific products sold to specific end customers. The purpose of the rebates is to allow for pricing adjustments for large programs without affecting the pricing we charge our distributor customers. The rebate is recorded at the time of shipment.
Customers are typically granted payment terms of between 30 and 60 days and they generally pay within those terms. Relatively few customers have been granted terms with cash discounts. Distributors are invoiced for shipments at book price. When they pay those invoices, they claim debits for SSDs, stock rotations, cash discounts, RMAs and price protection when appropriate. Once claimed, these debits are then processed against the approvals.
The revenue we record for sales to our distributors is net of estimated provisions for these programs. When determining this net revenue, we must make significant judgments and estimates. Our estimates are based on historical experience rates, inventory levels in the distribution channel, current trends and other related factors. However, because of the inherent nature of estimates, there is a risk that there could be significant differences between actual amounts and our estimates. Our financial condition and operating results depend on our ability to make reliable estimates and management believes such estimates are reasonable.
PRODUCT WARRANTY. We offer a standard one-year product replacement warranty. In the past we have not had to accrue for a general warranty reserve, but assess the level and materiality of RMAs and determines whether it is appropriate to accrue for estimated returns of defective products at the time revenue is recognized. On occasion, we may determine to accept product returns beyond the standard one-year warranty period. In those instances, we accrue for the estimated cost at the time the decision to accept the return is made. As a consequence of our standardized manufacturing processes and product testing procedures, returns of defective product are infrequent and the quantities have not been significant. Accordingly, historical warranty costs have not been material.
SHIPPING COSTS. Shipping costs are charged to cost of revenues as incurred.
INVENTORIES. Inventories are recorded at the lower of standard cost (which generally approximates actual cost on a first-in, first-out basis) or market value. We adjust the carrying value of inventory for excess and obsolete inventory based on inventory age, shipment history and our forecast of demand over a specific future period of time. Raw material inventory is considered obsolete and reserved if it has not moved in 365 days. We review our assembled devices for excess and write them off if the quantity of assembled devices in inventory is in excess of the greater of the quantity shipped in the previous twelve months, the quantity in backlog or the quantity forecasted to be shipped in the following twelve months. In certain circumstances, we will determine, based on expected usage or other factors, that inventory considered obsolete by these guidelines should not be written off. We occasionally determine that the last twelve months sales levels will not continue and reserve inventory in line with the quantity forecasted. The semiconductor markets that we serve are volatile and actual results may vary from our forecast or other assumptions, potentially impacting our assessment of excess and obsolete inventory and resulting in material effects on our gross margin.
IMPAIRMENT OF GOODWILL AND INTANGIBLE ASSETS. We perform an impairment review of our goodwill and intangible assets at least annually and more frequently if certain indicators of impairment are present. In the event that management determines that the value of goodwill or intangible assets has become impaired, we will record an expense for the amount impaired during the fiscal quarter in which the determination is made. Based on the results of our most recent impairment review, we determined that no impairment of our goodwill and intangible assets existed as of July 2, 2011. However, future impairment reviews could result in a charge to earnings.
INVESTMENTS. We have made investments including loans, bridge loans convertible to equity, or asset purchases as well as direct equity investments. These loans and investments are made with strategic intentions and have been in privately held technology companies, which by their nature are high risk. These investments are included in other assets in the balance sheet and are carried at the lower of cost, or market if the investment has experienced an other-than-temporary decline in value. We monitor these investments quarterly and make appropriate reductions in carrying value if a decline in value is deemed to be other than temporary.
DEFERRED TAX ASSETS. Our deferred income tax assets represent temporary differences between the financial statement carrying amount and the tax basis of existing assets and liabilities that will result in deductible amounts in future years, including net operating loss carryforwards. Based on estimates, the carrying value of our net deferred tax assets assumes that it is more likely than not that we will be able to generate sufficient future taxable income in certain tax jurisdictions. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. If, in the future, we experience losses for a sustained period of time, we may not be able to conclude that it is more likely than not that we will be able to generate sufficient future taxable income to realize our deferred tax assets. If this occurs, we may be required to increase the valuation allowance against the deferred tax assets resulting in additional income tax expense.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
At March 31, 2012 our investment portfolio consisted of investment-grade fixed income securities, excluding those classified as cash equivalents, of $105.2 million. These securities are subject to interest rate risk and will decline in value if market interest rates increase. However, we do not believe that such a decrease would have a material effect on our results of operations over the next fiscal year. Due to the short duration and conservative nature of these instruments, we do not believe that we have a material exposure to interest rate risk.
When the general economy weakens significantly, as it did in 2008 and 2009, the credit profile, financial strength and growth prospects of certain issuers of interest-bearing securities held in our investment portfolios may deteriorate, and our interest-bearing securities may lose value either temporarily or other than temporarily. We may implement investment strategies of different types with varying duration and risk/return trade-offs that do not perform well. At March 31, 2012, we held a significant portion of our corporate cash in diversified portfolios of investment-grade marketable securities, mortgage- and asset-backed securities, and other securities that had unrealized gains net of tax of $338,000. Although we consider unrealized gains and losses on individual securities to be temporary, there is a risk that we may incur other-than-temporary impairment charges if credit and equity markets are unstable and adversely impact securities issuers.
We transact business in various non-U.S. currencies, primarily the New Taiwan Dollar, the Hong Kong Dollar and the Chinese Renminbi. We are exposed to fluctuations in foreign currency exchange rates on accounts receivable and accounts payable from sales and purchases in these foreign currencies and the net monetary assets and liabilities of our foreign subsidiaries. A hypothetical 10% favorable or unfavorable change in foreign currency exchange rates would have a material impact on our financial position and results of operations.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Our management, with the participation of our principal executive officer and principal financial officer has evaluated the effectiveness of our disclosure controls and procedures. Based on such evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective as of March 31, 2012.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1A: Risk Factors
This quarterly report on Form 10-Q contains forward-looking statements which involve risks and uncertainties. Our actual results could differ materially from those anticipated by such forward-looking statement as a result of various factors, including those set forth below. The listing below includes any material changes to and supersedes the description of the risk factors affecting our business previously disclosed in Part I, Item 1A. Risk Factors of our Annual Report on Form 10-K for the fiscal year ended July 2, 2011.
FACTORS THAT MAY AFFECT OPERATING RESULTS‘
In the past, our operating results have varied significantly and are likely to fluctuate in the future, making it difficult to predict our future operating results.
We continue to face a challenging business environment and limited visibility on end-market demands.
Wide varieties of factors affect our operating results, many of which are beyond our control. These factors and risks include, but are not limited to, the following:
All of these factors are difficult to forecast and could seriously harm our operating results. Our expense levels are based in part on our expectations regarding future sales and are largely fixed in the short term. Therefore, we may be unable to reduce our expenses fast enough to compensate for any unexpected
shortfall in sales. Any significant decline in demand relative to our expectations or any material delay of customer orders could harm our operating results. In addition, if our operating results in future quarters fall below public market analysts and investors expectations, the market price of our common stock would likely decrease.
The demand for our products depends on the growth of our end users markets.
Our continued success depends in large part on the continued growth of markets for the products into which our semiconductor and frequency control products are incorporated. These markets include the following:
Any decline in the demand for products in these markets could seriously harm our business, financial condition and operating results. These markets have also historically experienced significant fluctuations in demand. We may also be seriously harmed by slower growth in the other markets in which we sell our products.
Customer demands for our products are volatile and difficult to predict.
Our customers continuously adjust their inventories in response to changes in end market demand for their products and the availability of semiconductor components. This results in frequent changes in demand for our products. The volatility of customer demand limits our ability to predict future levels of sales and profitability. The supply of semiconductors can quickly and unexpectedly match or exceed demand because end customer demand can change very quickly. Also, semiconductor suppliers can rapidly increase production output. This can lead to a sudden oversupply situation and a subsequent reduction in order rates and revenues as customers adjust their inventories to true demand rates. A rapid and sudden decline in customer demand for our products can result in excess quantities of certain of our products relative to demand. In this event, our operating results might be adversely affected as a result of charges to reduce the carrying value of our inventory to the estimated demand level or market price.
We may have difficulty accurately predicting revenues for future periods.
Our expense levels are based in part on anticipated future revenue levels, which can be difficult to predict. Our business is characterized by short-term orders and shipment schedules. We do not have long-term purchase agreements with any of our customers. Customers can typically cancel or reschedule their orders without significant penalty. We typically plan production and inventory levels based on forecasts of customer demand generated with input from customers and sales representatives. Customer demand is highly unpredictable and can fluctuate substantially. If customer demand falls significantly below anticipated levels, our gross profit would be reduced.
The markets for our products are characterized by rapidly changing technology, and our financial results could be harmed if we do not successfully develop and implement new manufacturing technologies or develop, introduce and sell new products.
The markets for our products are characterized by rapidly changing technology, frequent new product introductions and declining selling prices over product life cycles. We currently offer a comprehensive portfolio of silicon and quartz based products. Our future success depends upon the timely completion and introduction of new products, across all our product lines, at competitive price and performance levels. The success of new products depends on a variety of factors, including the following:
We may also experience delays, difficulty in procuring adequate fabrication capacity for the development and manufacture of new products, or other difficulties in achieving volume production of these products. Even relatively minor errors may significantly affect the development and manufacture of new products. If we fail to complete and introduce new products in a timely manner at competitive price and performance levels, our business would be significantly harmed.
If we do not develop products that our customers and end-users design into their products, or if their products do not sell successfully, our business and operating results would be harmed.
We have relied in the past and continue to rely upon our relationships with our customers and end-users for insights into product development strategies for emerging system requirements. We generally incorporate new products into a customers or end-users product or system at the design stage. However, these design efforts, which can often require significant expenditures by us, may precede product sales, if any, by a year or more. Moreover, the value to us of any design win will depend in large part on the ultimate success of the customer or end-users product and on the extent to which the systems design accommodates components manufactured by our competitors. If we fail to achieve design wins or if the design wins fail to result in significant future revenues, our operating results would be harmed. If we have problems developing or maintaining our relationships with our customers and end-users, our ability to develop well-accepted new products may be impaired.
Intense competition in the semiconductor industry may reduce the demand for our products or the prices of our products, which could reduce our revenues and gross profits.
The semiconductor industry is intensely competitive. Our competitors include Analog Devices, Cypress Semiconductor, Fairchild Semiconductor, Hitachi, Integrated Device Technology, Maxim Integrated Products, Motorola, On Semiconductor, NXP, Parade Technologies, PLX Technology, Silicon Laboratories, STMicroelectronics, Texas Instruments, and Toshiba. Most of those competitors have substantially greater financial, technical, marketing, distribution and other resources, broader product lines and longer-standing customer relationships than we do. We also compete with other major or emerging companies that sell products to certain segments of our markets. Competitors with greater financial resources or broader product lines may have a greater ability to sustain price reductions in our primary markets in order to gain or maintain market share.
We believe that our future success will depend on our ability to continue to improve and develop our products and processes. Unlike us, many of our competitors maintain internal manufacturing capacity for the fabrication and assembly of semiconductor products. This ability may provide them with more reliable manufacturing capability, shorter development and manufacturing cycles and time-to-market advantages. In addition, competitors with their own wafer fabrication facilities that are capable of producing products with the same design geometries as ours may be able to manufacture and sell competitive products at lower prices. Any introduction of products by our competitors that are manufactured with improved process technology could seriously harm our business. As is typical in the semiconductor industry, our competitors have developed and marketed products that function similarly or identically to ours. If our products do not achieve performance, price, size or other advantages over products offered by our competitors, we might lose market share. Competitive pressures could also reduce market acceptance of our products, reduce our prices and increase our expenses.
We also face competition from the makers of ASICs and other system devices. These devices may include interface logic functions that may eliminate the need or sharply reduce the demand for our products in particular applications.
Downturns in the semiconductor industry, rapidly changing technology, accelerated selling price erosion and evolving industry standards can harm our operating results.
The semiconductor industry has historically been cyclical and periodically subject to significant economic downturns, characterized by diminished product demand, accelerated erosion of selling prices and overcapacity, as well as rapidly changing technology and evolving industry standards. In the future, we may experience substantial period-to-period fluctuations in our business and operating results due to general semiconductor industry conditions, overall economic conditions or other factors. Our business is
also subject to the risks associated with the effects of legislation and regulations relating to the import or export of semiconductor products.
Our earnings are subject to substantial quarterly and annual fluctuations and to adverse economic conditions and market downturns
Our revenues and earnings have fluctuated significantly in the past and may fluctuate significantly in the future. General economic or other conditions could cause a downturn in the market for our products or technology. The 2008-2009 financial disruption affecting the banking system, investment banks, insurance companies and financial markets resulted in a tightening in the credit markets, a low level of liquidity in many financial markets and extreme volatility in fixed income, credit and equity markets. In 2011 and 2012, concerns over European sovereign debt and the ability of countries to borrow funds have again raised questions about the loan portfolios of large international banks, and low economic growth rates have increased the possibility of an economic downturn. In addition to the potential impact of such disruptions on our marketable securities portfolio, there could be a number of follow-on effects on our business that could also adversely affect our operating results. Disruptions may result in the insolvency of key suppliers resulting in product delays; the inability of our customers to obtain credit to finance purchases of our products and/or customer insolvencies that cause our customers to change delivery schedules, cancel or reduce orders; a slowdown in global economies which could result in lower end-user demand for our products; and increased impairments of our investments. Net investment income could vary from expectations depending on the gains or losses realized on the sale or exchange of securities, gains or losses from equity method investments, and impairment charges related to marketable securities. Our cash and marketable securities investments represent significant assets that may be subject to fluctuating or even negative returns depending upon interest rate movements and financial market conditions in fixed income securities. Volatility in the financial markets and overall economic uncertainty increases the risk of substantial quarterly and annual fluctuations in our earnings.
Our contracts with our wafer suppliers do not obligate them to a minimum supply or set prices. Any inability or unwillingness of our wafer suppliers generally, and GlobalFoundries, Inc. and MagnaChip Semiconductor, Inc. in particular, to meet our manufacturing requirements would delay our production and product shipments and harm our business.
In recent years, we have purchased over 65% of our wafers from MagnaChip and GlobalFoundries, with the balance coming from three to five other suppliers. Our reliance on independent wafer suppliers to fabricate our wafers at their production facilities subjects us to possible risks such as:
Any inability or unwillingness of our wafer suppliers generally, and GlobalFoundries and MagnaChip in particular, to provide adequate quantities of finished wafers to meet our needs in a timely manner would delay our production and product shipments and seriously harm our business. In March 2004, GlobalFoundries shut down one of their production facilities that was used to manufacture our products. We transitioned the production of these products to different facilities. The transfer of production of our products to other facilities subjects us to the above listed risks as well as potential yield or other production problems, which could arise as a result of any change.
At present, we purchase wafers from our suppliers through the issuance of purchase orders based on our rolling three-month forecasts. The purchase orders are subject to acceptance by each wafer supplier. We do not have long-term supply contracts that obligate our suppliers to a minimum supply or set prices. We also depend upon our wafer suppliers to participate in process improvement efforts, such as the transition to finer geometries. If our suppliers are unable or unwilling to do so, our development and introduction of new products could be delayed. Furthermore, sudden shortages of raw materials or production capacity constraints can lead wafer suppliers to allocate available capacity to customers other than us or for the suppliers internal uses, interrupting our ability to meet our product delivery obligations. Any significant interruption in our wafer supply would seriously harm our operating results and our customer relations. Our reliance on independent wafer suppliers may also lengthen the development cycle for our products, providing time-to-market advantages to our competitors that have in-house fabrication capacity.
In the event that our suppliers are unable or unwilling to manufacture our key products in required volumes, we will have to identify and qualify additional wafer foundries. The qualification process can take up to three and nine months or longer. Furthermore, we are unable to predict whether additional wafer foundries will become available to us or will be in a position to satisfy any of our requirements on a timely basis.
We depend on single or limited source assembly subcontractors with whom we do not have written contracts. Any inability or unwillingness of our assembly subcontractors to meet our assembly requirements would delay our product shipments and harm our business.
We primarily rely on foreign subcontractors for the assembly and packaging of our products and, to a lesser extent, for the testing of finished products. Some of these subcontractors are our single source supplier for some of our packages. In addition, changes in our or a subcontractors business could cause us to become materially dependent on a single subcontractor. We have from time to time experienced difficulties in the timeliness and quality of product deliveries from our subcontractors and may experience similar or more severe difficulties in the future. We generally purchase these single or limited source components or services pursuant to purchase orders and have no guaranteed arrangements with these subcontractors. These subcontractors could cease to meet our requirements for components or services, or there could be a significant disruption in supplies from them, or degradation in the quality of components or services supplied by them. Any circumstance that would require us to qualify alternative supply sources could delay shipments, result in the loss of customers and limit or reduce our revenues.
The complexity of our products makes us susceptible to manufacturing problems, which could increase our costs and delay our product shipments.
The manufacture and assembly of our products is highly complex and sensitive to a wide variety of factors, including:
In a typical semiconductor manufacturing process, silicon wafers produced by a foundry are cut into individual die. These die are assembled into individual packages and tested for performance. Our wafer fabrication suppliers have from time to time experienced lower than anticipated yields of suitable die. In the event of such decreased yields, we would incur additional costs to sort wafers, an increase in average cost per usable die and an increase in the time to market or availability of our products. These conditions could reduce our net revenues and gross margin and harm our customer relations.
We rely on independent manufacturers who may not be able to meet our manufacturing requirements.
We do not manufacture any of our IC products. Therefore, we are referred to in the semiconductor industry as a fabless producer. We depend upon third party foundries to produce wafers and subcontractors to manufacture IC products that meet our specifications. We currently have third party manufacturers located in China, Taiwan, Singapore, Malaysia, India, Korea and Japan that can produce products which meet our needs. However, as the industry continues to progress to smaller manufacturing and design geometries, the complexities of producing semiconductors will increase. Decreasing geometries may introduce new problems and delays that may affect product development and deliveries. Due to the nature of the industry and our status as a fabless IC semiconductor company, we could encounter fabrication-related problems that may affect the availability of our products, delay our shipments or increase our costs. We are directly involved in the manufacture of our FCP products. As technologies continue to evolve there may be manufacturing related problems that affect our FCP products. In addition, we have opened up a new FCP facility located in the Jinan Development Zone in Shandong Province, China, which also involves the uncertainties of staffing and operating a new facility in a country where we have no previous operating experience.
In March 2011, an earthquake and tsunami occurred off the northeast coast of Japan which has disrupted the global supply chain for core materials manufactured in Japan that are incorporated in our products and
manufacturing equipment. While we believe our supply requirements are relatively secure, we are closely monitoring the effect of the events in Japan on end demand patterns and inventory levels throughout the supply chain. Such supply chain disruptions stemming from the occurrences in Japan could negatively impact our ability to procure an adequate supply to fulfill our customers demand for our products.
Only a small number of our semiconductor products are currently manufactured by more than one supplier. We place our orders on a purchase order basis and do not have a long term purchase agreement with any of our existing suppliers. In the event that a supplier was unable or unwilling to continue to manufacture our products in the required volumes, we would have to identify and qualify a substitute supplier. Introducing new products or transferring existing products to a new third party manufacturer or process may result in unforeseen product specification and operating problems. These problems may affect our shipments and may be costly to correct. Silicon fabrication capacity may also change, or the costs per silicon wafer may increase. Manufacturing-related problems may have a material adverse effect on our business.
Our acquisitions may not be successful.
Our previous and potential future acquisitions could result in the following:
In the first quarter of fiscal 2011, we completed the acquisition of outstanding PTI shares not owned by us, as described in Note 6 of Notes to Condensed Consolidated Financial Statements. We are in the process of integrating PTI as a wholly-owned subsidiary and may experience one or more of the risks summarized above in the process of completing that integration.
As part of our business strategy, we may seek acquisition prospects that would complement our existing product offerings, improve our market coverage or enhance our technological capabilities. In addition, from time to time, we invest in other companies, without actually acquiring them, and such investments involve many of the same risks as are involved with acquisitions.
The trading price of our common stock and our operating results are likely to fluctuate substantially in the future.
The trading price of our common stock has been and is likely to continue to be highly volatile. Our stock price could fluctuate widely in response to factors some of which are not within our control, including:
Implementation of new Financial Accounting Standards Board (FASB) rules and the issuance of new laws or other accounting regulations, or reinterpretation of existing laws or regulations, could materially impact our business or stated results.
In general, from time to time, the government, courts and the financial accounting boards may issue new laws or accounting regulations, or modify or reinterpret existing ones. There may be future changes in laws, interpretations or regulations that would affect our financial results or the way in which we present them. Additionally, changes in the laws or regulations could have adverse effects on hiring and many other aspects of our business that would affect our ability to compete, both nationally and internationally.
In the past, we and our independent registered public accounting firm determined that we had material weaknesses in our internal control over financial reporting. There can be no assurance that a material weakness will not arise in the future. As a result, current and potential stockholders could lose confidence in our financial reporting, which would harm our business and the trading price of our stock.
Under SEC rules, we are required to maintain, and evaluate the effectiveness of, our internal control over financial reporting and disclosure controls and procedures. In our annual reports on Form 10-K for the years ended July 3, 2010, June 27, 2009, June 30, 2007 and July 2, 2005, we reported material weaknesses in our internal control over financial reporting. We have since remediated these deficiencies and continue to spend a significant amount of time and resources to ensure compliance with Section 404 of the Sarbanes-Oxley Act of 2002. However, we have and will continue to evolve our business in a changing marketplace. In addition, we are expanding our overseas operations, and as we grow in these locations, we may have difficulty in recruiting and retaining a complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of U.S. generally accepted accounting principles commensurate with our financial reporting requirements. Due to these factors, there can be no assurance that other material weaknesses or significant deficiencies will not arise in the future. Should we or our independent registered public accounting firm determine in future periods that we have a material weakness in our internal control over financial reporting, the reliability of our financial reports may be impacted, and investors could lose confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price and we could suffer other materially adverse consequences.
Our finance department has undergone, and continues to undergo, significant changes.
In the past three years, we have undergone significant turnover of personnel in the finance department, including in significant positions. During fiscal 2010, we hired a new Chief Financial Officer and Corporate Controller. During fiscal 2011, we hired a new Accounting Manager and outsourced internal auditing activities to an independent consultant. There can be no assurance that these changes will improve our finance functions, or that the finance personnel turnover we have experienced will not continue. In either event, the reliability of our financial reports may be impacted, and investors may lose confidence in the accuracy or completeness of our financial reports, which could have an adverse impact on our stock price.
Changes to environmental laws and regulations applicable to manufacturers of electrical and electronic equipment are causing us to redesign our products, and may increase our costs and expose us to liability.
The implementation of new environmental regulatory legal requirements, such as lead free initiatives, may affect our product designs and manufacturing processes. The impact of such regulations on our product designs and manufacturing processes could affect the timing of compliant product introductions as well as their commercial success. Redesigning our products to comply with new regulations may result in increased research and development and manufacturing and quality control costs. In addition, the products we manufacture that comply with new regulatory standards may not perform as well as our current products. Moreover, if we are unable to successfully and timely redesign existing products and introduce new products that meet new standards set by environmental regulation and our customers, sales of our products could decline, which could materially adversely affect our business, financial condition and results of operations.
We compete with others to attract and retain key personnel, and any loss of or inability to attract key personnel would harm us.
To a greater degree than non-technology companies, our future success will depend on the continued contributions of our executive officers and other key management and technical personnel. None of these individuals has an employment agreement with us and each one would be difficult to replace. We do not maintain any key person life insurance policies on any of these individuals. The loss of the services of one or more of our executive officers or key personnel or the inability to continue to attract qualified personnel could delay product development cycles or otherwise harm our business, financial condition and results of operations.
Our future success also will depend on our ability to attract and retain qualified technical, marketing and management personnel, particularly highly skilled design, process and test engineers, for whom competition can be intense. During strong business cycles, we expect to experience difficulty in filling our needs for qualified engineers and other personnel.
Our limited ability to protect our intellectual property and proprietary rights could harm our competitive position.
Our success depends in part on our ability to obtain patents and licenses and preserve other intellectual property rights covering our products and development and testing tools. In the United States, we currently hold 106 patents covering certain aspects of our product designs and have seven additional patent applications pending. Copyrights, mask work protection, trade secrets and confidential technological know-how are also key to our business. Additional patents may not be issued to us or our patents or other intellectual property may not provide meaningful protection. We may be subject to, or initiate, interference proceedings in the U.S. Patent and Trademark Office. These proceedings can consume significant financial and management resources. We may become involved in litigation relating to alleged infringement by us of others patents or other intellectual property rights. This type of litigation is frequently expensive to both the winning party and the losing party and takes up significant amounts of managements time and attention. In addition, if we lose such a lawsuit, a court could require us to pay substantial damages and/or royalties or prohibit us from using essential technologies. For these and other reasons, this type of litigation could seriously harm our business. Also, although we may seek to obtain a license under a third partys intellectual property rights in order to bring an end to certain claims or actions asserted against us, we may not be able to obtain such a license on reasonable terms or at all.
Because it is important to our success that we are able to prevent competitors from copying our innovations, we intend to continue to seek patent, trade secret and mask work protection for our technologies. The process of seeking patent protection can be long and expensive, and we cannot be certain that any currently pending or future applications will actually result in issued patents, or that, even if patents are issued, they will be of sufficient scope or strength to provide meaningful protection or any commercial advantage to us. Furthermore, others may develop technologies that are similar or superior to our technology or design around the patents we own.
We also rely on trade secret protection for our technology, in part through confidentiality agreements with our employees, consultants and third parties. However, these parties may breach these agreements. In addition, the laws of some territories in which we develop, manufacture or sell our products may not protect our intellectual property rights to the same extent as do the laws of the United States.
Our independent foundries use a process technology that may include technology we helped develop with them, that may generally be used by those foundries to produce their own products or to manufacture products for other companies, including our competitors. In addition, we may not have the right to implement key process technologies used to manufacture some of our products with foundries other than our present foundries.
We may not provide adequate allowances for exchanges, returns and concessions.
We recognize revenue from the sale of products when shipped, less an allowance based on future authorized and historical patterns of returns, price protection, exchanges and other concessions. We believe our methodology and approach are appropriate. However, if the actual amounts we incur exceed the allowances, it could decrease our revenue and corresponding gross profit.
We are subject to risks related to taxes.
A number of factors, including unanticipated changes in the mix of earnings in countries with differing statutory tax rates or by unexpected changes in existing tax laws or our interpretation of them, could unfavorably affect our future effective tax rate. In the event our management determines it is no longer more likely than not that we will realize a portion of our deferred tax assets we will be required to increase our valuation allowance which will result in an increase in our effective tax rate. Furthermore, our tax returns are subject to examination in all the jurisdictions in which we operate which subjects us to potential increases in our tax liabilities. All of these factors could have an adverse effect on our financial condition and results of operations.
A large portion of our revenues is derived from sales to a few customers, who may cease purchasing from us at any time.
A relatively small number of customers have accounted for a significant portion of our net revenues in each of the past several fiscal years. In general we expect this to continue for the foreseeable future. We had two direct customers who each accounted for more than 10% of net revenues during the nine months ended March 31, 2012. As a percentage of net revenues, sales to our top five direct customers during the nine months ended March 31, 2012 totaled 47%.
We do not have long-term sales agreements with any of our customers. Our customers are not subject to minimum purchase requirements, may reduce or delay orders periodically due to excess inventory and may discontinue purchasing our products at any time. Our distributors typically offer competing products in addition to ours. For the nine months ended March 31, 2012 and the fiscal year ended July 2, 2011, sales to our distributors were approximately 67% and 69% of net revenues, respectively, as compared to approximately 62% of net revenues in the fiscal year ended July 3, 2010 and approximately 56% of net revenues in the fiscal year ended June 27, 2009. The increase in the percentage of sales to our distributors as compared with the prior periods was due to growth in sales to Asian distributor customers. The loss of one or more significant customers, or the decision by a significant distributor to carry additional product lines of our competitors could decrease our revenues.
Almost all of our wafer suppliers and assembly subcontractors are located in Southeast Asia, as are our FCP manufacturing facilities, which exposes us to the problems associated with international operations.
Risks associated with international business operations include the following:
Although most of our products are sold in U.S. dollars, we incur a significant amount of certain types of expenses, such as payroll, utilities, capital equipment purchases and taxes in local currencies. The impact of currency exchange rate movements could harm our results and financial condition. In addition, changes in tariff and import regulations and in U.S. and non-U.S. monetary policies could harm our results and financial condition by increasing our expenses and reducing our revenue. Varying tax rates in different jurisdictions could harm our results of operations and financial condition by increasing our overall tax rate.
In addition, there is a potential risk of conflict and further instability in the relationship between Taiwan and the Peoples Republic of China (PRC). Conflict or instability could disrupt the operations of one of our principal wafer suppliers, several of our assembly subcontractors located in Taiwan, and our FCP manufacturing operations in Taiwan and the PRC.
We are expanding our presence in China with manufacturing and research and development activities. We will be subject to increased risks relating to foreign currency exchange rate fluctuations that could have a material adverse affect on our business, financial condition and operating results. The value of the Chinese renminbi against the United States dollar and other currencies may fluctuate and is affected by, among other things, changes in Chinas political and economic conditions. Significant future appreciation of the renminbi could increase our component and other raw material costs as well as our labor costs, and could adversely affect our financial results. To the extent that we need to convert United States dollars into renminbi for our operations, appreciation of renminbi against the United States dollar could have a material adverse effect on our business, financial condition and results of operations. Conversely, if we decide to convert our renminbi into United States dollars for other business purposes and the United States dollar appreciates against the renminbi, the United States dollar equivalent of the renminbi we convert would be reduced. The Chinese government recently announced that it is pegging the exchange rate of the renminbi against a number of currencies, rather than just the United States dollar. Fluctuations in the renminbi exchange rate could increase and could adversely affect our ability to operate our business.
Because we sell products in foreign markets and have operations outside of the United States, we face foreign business, political, economic and currency risks that could seriously harm us.
In the nine months ended March 31, 2012, we generated approximately 90% of our net revenues from sales in Asia and approximately 4% from sales outside of Asia and the United States. In fiscal year 2011, we generated approximately 90% of our net revenues from sales in Asia and approximately 4% from sales outside of Asia and the United States. In fiscal year 2010, we generated approximately 87% of our net revenues from sales in Asia and approximately 4% from sales outside of Asia and the United States. We expect that export sales will continue to represent the majority of net revenues. We intend to continue the expansion of our sales efforts outside the United States. This expansion will require significant management attention and financial resources and further subject us to international operating risks. These risks include:
We have subsidiaries located in Asia. We manufacture certain of our frequency control products in Taiwan as well as a recently completed factory in the Jinan Development Zone in the Shandong Province of the PRC. We are also in the process of developing a research and development and manufacturing center in Yangzhou, PRC. The development of these facilities depends upon various tax concessions, tax rebates and other support from the local governmental bodies in the areas where the facilities are located. There can be no assurance that these local governmental bodies will not change their position regarding such tax and other support and such a change might adversely affect the successful completion and profitability of these projects.
Regulatory, geopolitical and other factors could seriously harm our business or require us to modify our current business practices. We are subject to general geopolitical risks in connection with our international operations, such as political and economic instability and changes in diplomatic and trade relationships.
In addition, because our international sales are often denominated in U.S. dollars, fluctuations between the value of the U.S. dollar and local currencies can negatively affect our financial results.
Our shareholder rights plan may adversely affect existing shareholders.
On March 6, 2012, we adopted a shareholder rights plan that may have the effect of deterring, delaying, or preventing a change in control that otherwise might be in the best interests of our shareholders. Under the rights plan, we declared a dividend of one preferred share purchase right for each share of our common stock held by shareholders of record as of March 6, 2012. Each right entitles shareholders, after the rights become exercisable, to purchase one one-thousandth of a share of our Series D Junior Participating Preferred Stock.
In general, the rights become exercisable when a person or group acquires 15% or more of our common stock or a tender offer for 15% or more of our common stock is announced or commenced. After such
event, our other stockholders may purchase from us additional shares of our common stock at a 50% discount to the then-current market price. The rights will cause substantial dilution to a person or group that attempts to acquire us on terms not approved by our Board of Directors. The rights should not interfere with any merger or other business combination approved by our Board of Directors since the rights may be redeemed by us at $0.001 per right at any time before any person or group acquires 15% or more of our outstanding common stock. These rights expire in March 2022.
Our operations and financial results could be severely harmed by natural disasters.
Our headquarters and some of our major suppliers manufacturing facilities are located near major earthquake faults. One of the foundries we use is located in Taiwan, which suffered a severe earthquake during fiscal 2000. We did not experience significant disruption to our operations as a result of that earthquake. Taiwan is also exposed to typhoons and tsunamis, which can affect not only foundries we rely upon but also our PSE-TW subsidiary. Thailand experienced floods in the quarter ended December 31, 2012, which interrupted the industrys supply chain for storage products and impacted our sales as well. If a major earthquake, flood, typhoon, tsunami or other natural disaster were to affect our operations or those of our suppliers, our product supply could be interrupted, which would seriously harm our business. Natural disasters could also affect the operations of the distributors and contract manufacturers we sell to, as well as the operations of our end use customers, which would adversely affect our operations and financial results. Natural disasters anywhere in the world may potentially adversely affect us by harming or causing interruptions to our supply chain or the supply chains of our suppliers, direct customers or end use customers.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On April 29, 2008, the Board authorized the repurchase of $30 million worth of common stock. We were authorized to repurchase the shares from time to time in the open market or private transactions, at the discretion of our management. The following table summarizes the stock repurchase activity during the three months ended March 31, 2012.
Current cash balances and the proceeds from stock option exercises and purchases in the stock purchase plan have funded stock repurchases in the past, and we expect to fund future stock repurchases from these same sources.
Item 6. Exhibits.
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.
Pericom Semiconductor Corporation
Date: May 4, 2012