**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**Form 10- Q**

 

| **ý** | ** ** | **Quarterly Report Pursuant to Section 13 or  15(d) of  the Securities Exchange Act of 1934** |
|------------|------------|---------------------------------------------------------------------------------------------------------|

 

**for thequarterly period ended April 3, 2005**

 

| **o** | ** ** | **Transition report pursuant to Section 13 or  15(d) of  the Securities Exchange Act of 1934.** |
|-------|------------|-----------------------------------------------------------------------------------------------------------|

 

**For theTransition Period From          to         **

 

**CommissionFile Number 0-19084**

 

**PMC-Sierra, Inc.**

(Exact name ofregistrant as specified in its charter)

 

**ADelaware Corporation - I.R.S. NO. 94-2925073**

**3975Freedom Circle**

**SantaClara, CA  95054**

**(408) 239-8000**

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such period thatthe registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

| Yes         ý |   | No           o |
|------------------------------------------------------------|--------|------------------------------------------------------------------|

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act).

| Yes         ý |   | No           o |
|------------------------------------------------------------|--------|------------------------------------------------------------------|

 

**Commonshares outstanding at May 2, 2005 – 180,375,911**

 

 

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**INDEX**

 
| **PART I -  FINANCIAL INFORMATION** | ** **                                                                                  |
|------------------------------------------|---------------------------------------------------------------------------------------------|
| ** **                               | ** **                                                                                  | ** ** |
| **Item 1.**                              | **Financial Statements  (unaudited)**                                                       | ** ** |
| ** **                               | ** **                                                                                  | ** ** |
|                                     | -                                                                                           | Condensed  consolidated statements of operations |   |
|                                     |                                                                                        |   |
|                                     | -                                                                                           | Condensed  consolidated balance sheets |   |
|                                     |                                                                                        |   |
|                                     | -                                                                                           | Condensed  consolidated statements of cash flows |   |
|                                     |                                                                                        |   |
|                                     | -                                                                                           | Notes  to the condensed consolidated financial statements |   |
|                                     |                                                                                        |   |
| **Item  2.**                             | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | ** ** |
|                                     |                                                                                        |   |
| Item  3.                                 | Quantitative  and Qualitative Disclosures About Market Risk                                 |   |
|                                     |                                                                                        |   |
| Item 4.                                  | Controls and  Procedures                                                                    |   |
|                                     |                                                                                        |   |
| **PART II - OTHER INFORMATION**     |                                                                                        |
|                                     |                                                                                        |   |
| Item 1.                                  | Legal Proceedings                                                                           |   |
|                                     |                                                                                        |   |
| Item 5.                                  | Other Information                                                                           |   |
|                                     |                                                                                        |   |
| Item 6.                                  | Exhibits                                                                                    |   |
|                                     |                                                                                        |   |
| Signatures                               |                                                                                        |   |

 

2

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**Part I- FINANCIAL INFORMATION**

**Item1 - Financial Statements**

**PMC-Sierra,Inc.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

(in thousands,except for per share amounts)

(unaudited)

 
| ** **                                                        | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                        | ** ** | **Apr 3,  2005**       | ** ** | **Mar 28,  2004** | ** ** |
|                                                              |       |                   |       |   |   |
| Net revenues                                                      |       | $                      | 66,111     |   | $ | 78,660 |   |
|                                                              |       |                   |       |   |   |
| Cost of revenues                                                  |       | 19,621                 |       | 23,757 |   |
| Gross profit                                                      |       | 46,490                 |       | 54,903 |   |
|                                                              |       |                   |       |   |   |
| Other costs and  expenses:                                        |       |                   |       |   |   |
| Research and  development                                         |       | 31,416                 |       | 28,802 |   |
| Marketing,  general and administrative                            |       | 13,004                 |       | 11,925 |   |
| Amortization of  deferred stock compensation:                     |       |                   |       |   |   |
| Marketing,  general and administrative                            |       | —                 |       | 697 |   |
| Restructuring  costs                                              |       | 868                    |       | — |   |
|                                                              |       |                   |       |   |   |
| Income from operations                                            |       | 1,202                  |       | 13,479 |   |
|                                                              |       |                   |       |   |   |
| Other income:                                                     |       |                   |       |   |   |
| Interest income,  net                                             |       | 2,685                  |       | 956 |   |
| Foreign exchange  loss                                            |       | (590                   | )          | (33 | ) |
| Loss on debt  extinguishment and amortization of debt issue costs |       | (1,634                 | )          | (1,942 | ) |
| Gain on sale of  property and investments                         |       | 1,439                  |       | 8,587 |   |
|                                                              |       |                   |       |   |   |
| Income before  provision for income taxes                         |       | 3,102                  |       | 21,047 |   |
|                                                              |       |                   |       |   |   |
| Recovery of  (provision for) income taxes                         |       | 175                    |       | (4,200 | ) |
| Net income                                                        |       | $                      | 3,277      |   | $ | 16,847 |   |
|                                                              |       |                   |       |   |   |
| Net income per  common share - basic                              |       | $                      | 0.02       |   | $ | 0.09 |   |
| Net income per  common share - diluted                            |       | $                      | 0.02       |   | $ | 0.09 |   |
|                                                              |       |                   |       |   |   |
| Shares used in  per share calculation - basic                     |       | 182,192                |       | 178,409 |   |
| Shares used in  per share calculation - diluted                   |       | 188,678                |       | 192,300 |   |

 

See notes to thecondensed consolidated financial statements.

 

3

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**PMC-Sierra, Inc.**

**CONDENSED CONSOLIDATED BALANCESHEETS**

(in thousands, except parvalue)

(unaudited)

 
| ** **                                                                                                                                        | ** ** | **Apr 3,  2005** | ** ** | **Dec 26,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|
|                                                                                                                                              |       |             |       |              |       |
| ASSETS:                                                                                                                                           |       |             |       |              |       |
| Current assets:                                                                                                                                   |       |             |       |              |       |
| Cash and cash equivalents                                                                                                                         |       | $                | 153,970    |              | $          | 121,276 |   |
| Short-term  investments                                                                                                                           |       | 70,259           |       | 153,410           |       |
| Accounts  receivable, net of allowance for doubtful accounts of $2,665 (2004 - $2,665)                                                            |       | 23,946           |       | 19,931            |       |
| Inventories                                                                                                                                       |       | 15,803           |       | 15,823            |       |
| Prepaid expenses  and other current assets                                                                                                        |       | 17,977           |       | 17,042            |       |
| Total current  assets                                                                                                                             |       | 281,955          |       | 327,482           |       |
|                                                                                                                                              |       |             |       |              |       |
| Investment in  bonds and notes                                                                                                                    |       | 130,881          |       | 139,111           |       |
| Other  investments and assets                                                                                                                     |       | 5,169            |       | 4,565             |       |
| Property and  equipment, net                                                                                                                      |       | 14,382           |       | 16,177            |       |
| Goodwill                                                                                                                                          |       | 7,907            |       | 7,907             |       |
| Other intangible  assets, net                                                                                                                     |       | 4,818            |       | 5,003             |       |
| Deposits for  wafer fabrication capacity                                                                                                          |       | 5,145            |       | 6,779             |       |
|                                                                                                                                              |       | $                | 450,257    |              | $          | 507,024 |   |
|                                                                                                                                              |       |             |       |              |       |
| LIABILITIES AND  STOCKHOLDERS' EQUITY:                                                                                                            |       |             |       |              |       |
| Current  liabilities:                                                                                                                             |       |             |       |              |       |
| Accounts payable                                                                                                                                  |       | $                | 18,628     |              | $          | 16,598 |   |
| Accrued  liabilities                                                                                                                              |       | 39,110           |       | 40,195            |       |
| Income taxes  payable                                                                                                                             |       | 29,321           |       | 28,931            |       |
| Accrued  restructuring costs                                                                                                                      |       | 12,739           |       | 13,735            |       |
| Deferred income                                                                                                                                   |       | 8,413            |       | 7,646             |       |
| Current portion  of long-term debt                                                                                                                |       | —           |       | 68,071            |       |
| Total current  liabilities                                                                                                                        |       | 108,211          |       | 175,176           |       |
|                                                                                                                                              |       |             |       |              |       |
| Deferred taxes  and other tax liabilities                                                                                                         |       | 28,077           |       | 28,077            |       |
|                                                                                                                                              |       |             |       |              |       |
| PMC special  shares convertible into 2,815 (2004 - 2,897) shares of common stock                                                                  |       | 4,139            |       | 4,434             |       |
|                                                                                                                                              |       |             |       |              |       |
| Stockholders’  equity                                                                                                                        |       |             |       |              |       |
| Common stock and  additional paid in capital, par value $.001: 900,000 shares authorized;  180,230 shares issued and outstanding (2004 - 178,510) |       | 902,198          |       | 893,704           |       |
| Accumulated  other comprehensive income                                                                                                           |       | (928             | )          | 350               |       |
| Accumulated  deficit                                                                                                                              |       | (591,440         | )          | (594,717          | )          |
| Total  stockholders’ equity                                                                                                                  |       | 309,830          |       | 299,337           |       |
|                                                                                                                                              |       | $                | 450,257    |              | $          | 507,024 |   |

 

See notes to thecondensed consolidated financial statements.

 

4

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**PMC-Sierra,Inc.**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

(in thousands)

(unaudited)

 
| ** **                                                                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                          | ** ** | **Apr 3,  2005**       | ** ** | **Mar 28,  2004** | ** ** |
| **Cash  flows from operating activities:**                                                          |       |                   |       |   |   |
| Net income                                                                                          |       | $                      | 3,277      |   | $ | 16,847 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:                  |       |                   |       |   |   |
| Depreciation of  property and equipment                                                             |       | 2,688                  |       | 4,027 |   |
| Amortization of  other intangibles                                                                  |       | 520                    |       | 77 |   |
| Amortization of  deferred stock compensation                                                        |       | —                 |       | 697 |   |
| Amortization of  debt issuance costs                                                                |       | 16                     |       | 97 |   |
| Gain on disposal  of property and equipment                                                         |       | (184                   | )          |   |   |
| Loss on  extinguishment of debt                                                                     |       | 1,618                  |       | 1,845 |   |
| Gain on sale of  investments and other assets                                                       |       | (1,255                 | )          | (8,587 | ) |
| Changes in  operating assets and liabilities:                                                       |       |                   |       |   |   |
| Accounts  receivable                                                                                |       | (4,015                 | )          | (7,283 | ) |
| Inventories                                                                                         |       | 20                     |       | 1,394 |   |
| Prepaid expenses  and other current assets                                                          |       | (2,607                 | )          | (5,721 | ) |
| Accounts payable  and accrued liabilities                                                           |       | 2,028                  |       | (4,335 | ) |
| Income taxes  payable                                                                               |       | 769                    |       | 4,127 |   |
| Accrued  restructuring costs                                                                        |       | (996                   | )          | (1,661 | ) |
| Deferred income                                                                                     |       | 766                    |       | 2,138 |   |
| Net cash  provided by operating activities                                                          |       | 2,645                  |       | 3,662 |   |
|                                                                                                |       |                   |       |   |   |
| **Cash flows  from investing activities:**                                                          |       |                   |       |   |   |
| Purchases of  short term available-for-sale investments                                             |       | (66,950                | )          | — |   |
| Proceeds from  sales and maturities of short-term available-for-sale investments                    |       | 141,084                |       | 20,323 |   |
| Purchases of  long-term available-for-sale investments in bonds and notes                           |       | —                 |       | (37,788 | ) |
| Proceeds from  sales and maturities of long-term available-for-sale investments in bonds and  notes |       | 16,396                 |       | 51,935 |   |
| Purchases of  investments and other assets                                                          |       | (2,000                 | )          | (800 | ) |
| Proceeds from  sale of investments and other assets                                                 |       | 680                    |       | 9,916 |   |
| Proceeds from  sale of property                                                                     |       | 2,604                  |       | — |   |
| Proceeds from  refund of wafer fabrication deposits                                                 |       | 1,634                  |       | — |   |
| Purchases of  property and equipment                                                                |       | (1,085                 | )          | (3,713 | ) |
| Purchase of  intangible assets                                                                      |       | (335                   | )          | (663 | ) |
| Net cash provided  by investing activities                                                          |       | 92,028                 |       | 39,210 |   |
|                                                                                                |       |                   |       |   |   |
| **Cash  flows from financing activities:**                                                          |       |                   |       |   |   |
| Repurchase of  convertible subordinated notes                                                       |       | (70,177                | )          | (106,929 | ) |
| Proceeds from  issuance of common stock                                                             |       | 8,198                  |       | 11,180 |   |
| Net cash used in  financing activities                                                              |       | (61,979                | )          | (95,749 | ) |
|                                                                                                |       |                   |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                                               |       | 32,694                 |       | (52,877 | ) |
| Cash and cash  equivalents, beginning of the period                                                 |       | 121,276                |       | 225,959 |   |
| Cash and cash  equivalents, end of the period                                                       |       | $                      | 153,970    |   | $ | 173,082 |   |
|                                                                                                |       |                   |       |   |   |
| **Supplemental  disclosures of cash flow information:**                                             |       |                   |       |   |   |
| Cash paid for  interest                                                                             |       | $                      | 1,085      |   | $ | 2,858 |   |
| Cash refund of  income taxes                                                                        |       | 2,507                  |       | — |   |
| Cash paid for  income taxes                                                                         |       | 2,251                  |       | — |   |
|                                                                                                |       |                   |       |   |   |
| **Supplemental  disclosures of non-cash investing and financing activities:**                       |       |                   |       |   |   |
| Conversion of  PMC-Sierra special shares into common stock                                          |       | $                      | 295        |   | — |   |

 

See notes to thecondensed consolidated financial statements.

 

5

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**PMC-Sierra, Inc.**

**NOTES TOTHE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(unaudited)**

 

**NOTE1.   Summary of Significant AccountingPolicies**

* *

*Description of business*.PMC-Sierra, Inc (the “Company” or “PMC”) designs, develops, markets andsupports high-speed broadband communications and storage semiconductors andMIPS-based microprocessors for service provider, enterprise, storage, andwireless networking equipment.  TheCompany offers worldwide technical and sales support through a network ofoffices in North America, Europe and Asia.

 

*Basis of presentation*.The accompanying Condensed Consolidated Financial Statements have been preparedpursuant to the rules and regulations of the United States Securities andExchange Commission (“SEC”).  Certaininformation and footnote disclosures normally included in annual financialstatements prepared in accordance with generally accepted accounting principleshave been condensed or omitted pursuant to those rules orregulations.  The interim financialstatements are unaudited, but reflect all adjustments that are, in the opinionof management, necessary to provide a fair statement of results for the interimperiods presented.  These financialstatements should be read in conjunction with the consolidated financialstatements and accompanying notes in the Company’s Annual Report on Form 10-Kfor the year ended December 26, 2004. The results of operations for the interim periods are not necessarilyindicative of results to be expected in future periods. In order to align our fiscal year end with the calendar year end,fiscal 2005 will consist of 53 weeks compared to 52 weeks in 2004.  The first fiscal period of 2005 thereforeconsisted of 14 weeks compared to 13 in the first quarter of 2004.

 

*Estimates.*Thepreparation of financial statements and related disclosures in conformity withaccounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes.  Estimates are used for, but not limited to,the accounting for doubtful accounts, inventory reserves, depreciation andamortization, asset impairments, sales returns, warranty costs, income taxes,restructuring costs and contingencies. Actual results could differ from theseestimates.

 

*Cash and cash equivalents. *AtApril 3, 2005, Cash and cash equivalents included $1.3 million (December 28,2004 - $1.3 million) pledged with a bank as collateral for letters of creditissued as security for leased facilities.

 

*Inventories*.Inventories are stated at the lower of cost (first-in, first out) or market(estimated net realizable value). Inventories (net of reserves of $11.4 million and$12.2 million at April 3, 2005 and December 28, 2004,respectively) were as follows:

 
| **(in thousands)** | ** ** | **Apr 3,  2005** | ** ** | **Dec 28,  2004** | ** ** |
|--------------------|------------|------------------|------------|-------------------|------------|
|               |       |             |       |              |       |
| Work-in-progress   |       | $                | 8,766      |              | $          | 7,369 |   |
| Finished goods     |       | 7,037            |       | 8,454             |       |
|               |       | $                | 15,803     |              | $          | 15,823 |   |

 

6

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*Product warranties*.  The Company provides a one-year limited warrantyon most of its standard products and accrues for the cost of this warranty atthe time of shipment.  The Companyestimates its warranty costs based on historical failure rates and relatedrepair or replacement costs.  The changein the Company’s accrued warranty obligations from December 26, 2004 to April 3,2005 was as follows:

 
| **(in thousands)**                                              | ** ** | **Three Months Ended  April 3, 2005** | ** ** |
|-----------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                      |       |                                  |       |
| Beginning balance                                               |       | $                                     | 3,492      |   |
| Accruals for new  warranties issued                             |       | 87                                    |       |
| Adjustments  related to changes in estimate of warranty accrual |       | (3                                    | )          |
| Ending balance,  April 3, 2005                                  |       | $                                     | 3,576      |   |

 

*Other Indemnifications. *Fromtime to time, on a limited basis, PMC indemnifies its customers, as well as itssuppliers, contractors, lessors, and others with whom it enters into contracts,against combinations of loss, expense, or liability arising from varioustriggering events related to the sale and use of its products, the use of theirgoods and services, the use of facilities, the state of assets that the Companysells and other matters covered by such contracts, up to a specified maximumamount.

 

*Derivatives and Hedging Activities. *PMC’snet income and cash flows may be negatively impacted by fluctuating foreignexchange rates.  The Company periodicallyhedges foreign currency forecasted transactions related to certain operatingexpenses.  All derivatives are recordedin the balance sheet at fair value.  Fora derivative designated as a fair value hedge, changes in the fair value of thederivative and of the hedged item attributable to the hedged risk arerecognized in net income.  For aderivative designated as a cash flow hedge, the effective portions of changesin the fair value of the derivative are recorded in other comprehensive incomeand are recognized in net income when the hedged item affects net income.Ineffective portions of changes in the fair value of cash flow hedges arerecognized in net income. If the derivative used in an economic hedgingrelationship is not designated in an accounting hedging relationship or if itbecomes ineffective, changes in the fair value of the derivative are recognizedin net income.

 

*Stock based compensation.*TheCompany accounts for stock-based compensation in accordance with the intrinsicvalue method prescribed by APB Opinion No. 25 (APB 25), “Accounting forStock Issued to Employees”.  Under APB25, compensation is measured as the amount by which the market price of theunderlying stock exceeds the exercise price of the option on the date of grant;this compensation is amortized over the vesting period.

 

Thefollowing table summarizes the activity under all of our stock option plans forthe first three months of 2005:

 

7

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| **(in thousands, except per share amounts)** | ** ** | **Shares Available  for Options** | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted Average  Exercise Price  Per Share** | ** ** |
|----------------------------------------------|------------|-----------------------------------|------------|-------------------------------------|------------|-------------------------------------------------|------------|
|                                         |       |                              |       |                                |       |                                            |       |
| **Balance  at December 26, 2004**            | ** ** | **35,857**                        | ** ** | **25,515**                          | ** ** | **$**                                           | **10.40**  | ** ** |
| Granted                                      |       | (60                               | )          | 60                                  |       | $                                               | 10.49      |   |
| Exercised                                    |       | —                            |       | (789                                | )          | $                                               | 5.30       |   |
| Cancelled or  expired                        |       | 528                               |       | (528                                | )          | $                                               | 15.12      |   |
| **Balance  at April 3, 2005**                | ** ** | **36,325**                        | ** ** | **24,258**                          | ** ** | **$**                                           | **10.47**  | ** ** |

 

On April 18, 2005,we granted options to purchase approximately 5.9 million shares of common stockwith an exercise price of $7.87, which was the closing price of our stock onthe grant date.

 

Proforma information regarding net income (loss) and net income (loss) per shareis required by SFAS 123, “Accounting for Stock-Based Compensation” for awardsgranted or modified after December 31, 1994 as if the Company hadaccounted for its stock-based awards to employees under the fair value methodof SFAS 123. The fair value of the Company’s stock-based awards to employeeswas estimated using a Black-Scholes option pricing model. The Black-Scholesmodel was developed for use in estimating the fair value of traded options thathave no vesting restrictions and are fully transferable. In addition, theBlack-Scholes model requires the input of highly subjective assumptionsincluding the expected stock price volatility. Because the Company’sstock-based awards to employees have characteristics significantly differentfrom those of traded options, and because changes in the subjective inputassumptions can materially affect the fair value estimate, in management’sopinion, the existing models do not necessarily provide a reliable singlemeasure of the fair value of its stock-based awards to employees.  The fair value of the Company’s stock-basedawards to option participants was estimated using both the single and multipleoption approach, recognizing forfeitures as they occur, assuming no expecteddividends and using the following weighted average assumptions:

 
| ** **               | ** ** | **Three Months Ended** | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **Options**            | ** ** | **ESPP** | ** ** |
|                     |       | **Apr 3,****2005**     | ** ** | **Mar 28,****2004** | ** ** | **Apr 3,****2005** | ** ** | **Mar 28,****2004** |   |
| Expected life  (years)   |       | 6.4                    |       | 2.9 |   | 1.4 |   | 1.5 |   |
| Expected  volatility     |       | 64                     | %          | 100 | % | 63 | % | 105 | % |
| Risk-free  interest rate |       | 4.3                    | %          | 2.1 | % | 3.0 | % | 1.5 | % |

 

During the firstquarter of 2005, management re-examined certain assumptions related to thelevel of expected volatility used in the Company’s option pricing model.  As a result, volatility for the quarter endedApril 3, 2005 was calculated using a weighted historical and market-basedimplied volatility.  For the quarterended March 28, 2004, volatility was calculated using 5-year historicalvolatility.  Inaddition, stock options were granted to Directors only in the first quarter of2005, therefore the weighted average expected life increased in order toreflect historical exercise patterns.

 

Theweighted-average estimated fair values of stock options granted for the threemonths ended April 3, 2005 and March 28, 2004 were $6.66 and $12.02per share, respectively.

 

8

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Ifthe Company had accounted for stock-based compensation in accordance with thefair value method as prescribed by SFAS 123, net income (loss) and net income(loss) per share would have been:

 
| ** **                                                                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| **(in thousands, except per share amounts)**                                                        | ** ** | **April 3,  2005**     | ** ** | **Mar 28,  2004** | ** ** |
|                                                                                                |       |                   |       |   |   |
| Net income, as  reported                                                                            |       | $                      | 3,277      |   | $ | 16,847 |   |
| Adjustments:                                                                                        |       |                   |       |   |   |
| Additional  stock-based employee compensation expense under fair value based method for  all awards |       | (10,779                | )          | (18,948 | ) |
|                                                                                                |       |                   |       |   |   |
| Net loss,  adjusted                                                                                 |       | $                      | (7,502     | ) | $ | (2,101 | ) |
|                                                                                                |       |                   |       |   |   |
| Basic and  diluted net income (loss) per share, as reported                                         |       | $                      | 0.02       |   | $ | 0.09 |   |
|                                                                                                |       |                   |       |   |   |
| Basic and  diluted net income (loss) per share, adjusted                                            |       | $                      | (0.04      | ) | $ | (0.01 | ) |

 

*Recent Accounting Pronouncements. *InDecember 2004, the Financial Accounting Standard Board (“FASB”) issuedStatement of Financial Accounting Standard 123 (revised 2004), “Shared-BasedPayment” (SFAS 123R).  SFAS 123Raddresses the requirements of an entity to measure the cost of servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award. The cost of such award will be recognized over theperiod during which an option holder is required to provide services inexchange for the award. The provisions of this Standard will be effective forthe Company in the first quarter of fiscal 2006.  The Company is evaluating the impact thatthis pronouncement will have on its financial position and results ofoperations.

 

InMarch 2005 the Securities Exchange Commission (SEC) issued StaffAccounting Bulletin No. 107 (SAB 107). The interpretations in SAB 107 express the views of the SEC staffregarding the interaction between SFAS 123R and certain SEC rules andregulations and provide the staff’s views regarding the valuation ofshare-based payment arrangements for public companies.  The Company will apply the principles of SAB107 in connection with its adoption of SFAS 123R.

 

**NOTE2.   Derivative Instruments and HedgingActivities**

** **

PMCgenerates revenues in U.S. dollars but incurs a portion of its operatingexpenses in various foreign currencies, primarily the Canadian dollar.  To minimize the short-term impact of foreigncurrency fluctuations, the Company uses currency forward contracts.

 

Currencyforward contracts that are used to hedge exposures to variability in forecastedforeign currency cash flows are designated as cash flow hedges.  The maturities of these instruments are lessthan twelve months.  For thesederivatives, the gain or loss from the effective portion of the hedge isinitially reported as a component of other comprehensive income in stockholders’equity and subsequently reclassified to earnings in the same period in whichthe hedged

 

9

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transactionaffects earnings.  The gain or loss fromthe ineffective portion of the hedge is recognized in interest and other expenseimmediately.

 

AtApril 3, 2005, the Company had five currency forward contracts outstandingthat qualified and were designated as cash flow hedges.  The U.S. dollar notional amount of thesecontracts was $50.3 million and the contracts had a fair value of $0.9 millionas of April 3, 2005.  The gain orloss from the ineffective portion of the hedges had no impact on earnings.

 

**NOTE3.   Restructuring Costs**

** **

Restructurings - 2005

 

In the first quarter of 2005the Company implemented two workforce reduction initiatives aimed atstreamlining operations and reducing operating expenses.

 

The first initiativeincluded termination of 24 employees across all business functions in the firstquarter, which resulted in the Company recording a restructuring charge of $0.9million in accordance with SFAS 146, “Accounting for Costs Associated with Exitor Disposal Activities”.  All but $0.1million of this amount was paid in the first quarter.

 

The second initiativeincluded an announcement of the planned termination of 26 employees fromproduction control, quality assurance, and product engineering as a result ofconsolidation of the Company’s two manufacturing facilities (Santa Clara,California and Burnaby, Canada) into one facility (Burnaby) in the second andthird quarters of 2005.  The Companyexpects to expense approximately $2.2 million in termination costs related tothe second initiative during 2005 and to have substantially completed thisinitiative by the fourth quarter of 2005.

 

Restructurings– 2003 and 2001

 

In 2003 and 2001,the Company implemented three restructuring plans aimed at focusing developmentefforts on key projects and reducing operating costs in response to the severeand prolonged economic downturn in the semiconductor industry.  PMC’s assessment of the market demand for itsproducts, and the development efforts necessary to meet this demand, were keyfactors in its decisions to implement these restructuring plans.  As end markets for the Company’s products hadcontracted, certain projects were curtailed in an effort to cut costs.  Cost reductions in all other functional areaswere also implemented, as fewer resources were required to support the reducedlevel of development and sales activities during these periods*. *The Company hascompleted substantially all of the activities contemplated in theserestructuring plans, but as of April 3, 2005 had not yet terminated theleases on its surplus facilities.

 

January 16,2003

 

TheJanuary 2003 restructuring included the termination of 175 employees andthe closure of design centers in Maryland, Ireland and India.  To date, PMC has recorded a restructuringcharge of $18.3 million in accordance with SFAS 146, “Accounting for CostsAssociated with Exit or Disposal Activities”, including $1.5 million for assetwrite-downs.  These charges related

 

10

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toworkforce reduction, lease and contract settlement costs, and the write-down ofcertain property, equipment and software assets whose value was impaired as a resultof this restructuring plan.  The Companyhas disposed of the property improvements and computer equipment, and softwarelicenses have been cancelled or are no longer being used.  Cash payments made to date under this planwere $12.0 million.  A $0.9 millionreversal of excess restructure provision relating primarily to workforcereduction was recorded in 2003.

 

Theactivity under this plan in the three months ended April 3, 2005 was asfollows:

 
| **(in thousands)**                             | ** ** | **Balance at  Dec 26, 2004** | ** ** | **Cash  Payments** | ** ** | **Balance at  Apr 3, 2005** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|--------------------|------------|-----------------------------|------------|
| Excess facility  and contract settlement costs |       | $                            | 3,895      |               | $          | (107                        | )          | $ | 3,788 |   |
|                                                |            |                              |            |                    |            |                             |            |  |  |  |

 

October 18,2001

 

TheOctober 2001 restructuring plan included the termination of 341 employees,the consolidation of excess facilities, and the curtailment of certain researchand development projects, resulting in a restructuring charge of $175.3million, including $12.2 million of asset write-downs.  To date, the Company has made cash paymentsunder this plan of $153.3 million, including the purchase and sale of MissionTowers Two in Santa Clara, CA, for $133 million and $33 million, respectively,in the third quarter of 2003.  To date,PMC has reversed $5.3 million of excess restructure provision, primarily relatedto Mission Towers Two.  Due to the continueddownturn in real estate markets, the facilities costs are expected to be higherthan anticipated in the original plan and as a result, PMC recorded additionalprovisions for abandoned office facilities of $1.3 million in the fourthquarter of 2004.

 

Theactivity under this plan in the three months ended April 3, 2005 was asfollows:

 
| **(in thousands)**                             | ** ** | **Balance at  Dec 26, 2004** | ** ** | **Cash  Payments** | ** ** | **Balance at  Apr 3, 2005** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|--------------------|------------|-----------------------------|------------|
|                                           |       |                         |       |               |       |                        |       |
| Excess facility  and contract settlement costs |       | $                            | 6,458      |               | $          | (654                        | )          | $ | 5,804 |   |
|                                                |            |                              |            |                    |            |                             |            |  |  |  |

 

March 26,2001

 

Inthe first quarter of 2001, the Company recorded a charge of $19.9 million for arestructuring plan that included the termination of 223 employees across allbusiness functions, the consolidation of a number of facilities and the curtailmentof certain research and development projects. Due to the continued downturn in real estate markets, the Companyexpects these costs to be higher than anticipated in the original plan.  As a result, PMC recorded additionalprovisions for abandoned office facilities of $3.1 million in the third quarterof 2003 and $2.2 million in the fourth quarter of 2004.

 

11

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Theactivity under this plan in the three months ended April 3, 2005 was asfollows:

 
| **(in thousands)**     | ** ** | **Balance at  Dec 26, 2004** | ** ** | **Cash  Payments** | ** ** | **Balance at  Apr 3, 2005** | ** ** |
|------------------------|------------|------------------------------|------------|--------------------|------------|-----------------------------|------------|
|                   |       |                         |       |               |       |                        |       |
| Excess facility  costs |       | $                            | 3,382      |               | $          | (388                        | )          | $ | 2,994 |   |
|                        |            |                              |            |                    |            |                             |            |  |  |  |

 

**NOTE4.   Debt Investments**

** **

Thefollowing tables summarize the Company’s investments in debt securities:

 
| **(in thousands)**                       | ** ** | **Apr 3,  2005** | ** ** | **Dec 31,  2004** | ** ** |
|------------------------------------------|------------|------------------|------------|-------------------|------------|
|                                     |       |             |       |              |       |
| Available-for-sale:                      |       |             |       |              |       |
| US Government  Treasury and Agency notes |       | $                | 104,261    |              | $          | 104,722 |   |
| Corporate bonds  and notes               |       | 138,021          |       | 187,799           |       |
|                                     |       | $                | 242,282    |              | $          | 292,521 |   |
|                                     |       |             |       |              |       |
| Reported as:                             |       |             |       |              |       |
| Cash equivalents                         |       | $                | 41,142     |              | $          | — |   |
| Short-term  investments                  |       | 70,259           |       | 153,410           |       |
| Investments in  bonds and notes          |       | 130,881          |       | 139,111           |       |
|                                     |       | $                | 242,282    |              | $          | 292,521 |   |

 

**NOTE5.   Investments and Other Assets**

** **

In March 2005the Company received $2.2 million as final satisfaction of the mortgage owed tothe Company for a property it sold in 2003. As part of the agreement the Company surrendered an option to purchasethe property.  The difference between theproceeds and the carrying value of the mortgage receivable was recorded as again of $0.6 million on the Statement of Operations.

 

InFebruary 2005, the Company received $0.7 million that had been in escrowfor one year pending final settlement of the sale of its investment in aprivate technology company.  As a resultthe Company recorded a gain for this amount, which has been included in Gain onProperty and Investments on the Statement of Operations.  In February 2004, the Company recorded again of $8.6 million from this sale, excluding the deferred portion of theproceeds.

 

OnJanuary 7, 2005 the Company invested $2 million in a private technologycompany.  The investment is carried atcost and is included in Other investments and assets.

 

**NOTE6.   Convertible Subordinated Notes**

** **

On January 18, 2005 the Company redeemed its remaining outstanding 3.75% Convertible Subordinated Notes for a total of $70.2 million in cash, which included $1.1 million in accrued interest and a $1.0 million call premium.  In the first quarter of 2005, the Company expensed the remaining unamortized debt issue costs of $0.6 million, resulting in an aggregate loss of $1.6

 

12

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million. The aggregate principal amount of the Notes outstanding was $68.1 million at December 26, 2004.

 

**NOTE7.   Comprehensive Income**

** **

Thecomponents of comprehensive income, net of tax, are as follows:

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------|------------|------------------------|------------|
| **(in thousands)**                             | ** ** | **Apr 3,  2005**       | ** ** | **Mar 28,  2004** | ** ** |
|                                           |       |                   |       |   |   |
| Net income                                     |       | $                      | 3,277      |   | $ | 16,847 |   |
| Other  comprehensive income:                   |       |                   |       |   |   |
| Change in net  unrealized gains on investments |       | (596                   | )          | (302 | ) |
| Change in fair  value of derivatives           |       | (682                   | )          | (604 | ) |
| Total                                          |       | $                      | 1,999      |   | $ | 15,941 |   |

** **

**NOTE8.   Net Income Per Share**

** **

Thefollowing table sets forth the computation of basic and diluted net income pershare:

 
| ** **                                                        | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| **(in thousands, except per share amounts)**                      | ** ** | **Apr 3,  2005**       | ** ** | **Mar 28,  2004** | ** ** |
| Numerator:                                                        |       |                   |       |   |   |
| Net income                                                        |       | $                      | 3,277      |   | $ | 16,847 |   |
| Denominator:                                                      |       |                   |       |   |   |
| Basic weighted  average common shares outstanding (1)             |       | 182,192                |       | 178,409 |   |
| Effect of  dilutive securities:                                   |       |                   |       |   |   |
| Stock options                                                     |       | 6,486                  |       | 13,891 |   |
|                                                              |       |                   |       |   |   |
| Basic and  diluted weighted average common shares outstanding (1) |       | 188,678                |       | 192,300 |   |
|                                                              |       |                   |       |   |   |
| Basic net income  per share                                       |       | $                      | 0.02       |   | $ | 0.09 |   |
|                                                              |       |                   |       |   |   |
| Diluted net  income per share                                     |       | $                      | 0.02       |   | $ | 0.09 |   |

 

----

(1)          PMC-Sierra,Ltd. special shares are included in the calculation of basic weighted averagecommon shares outstanding.

 

13

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

** **

*This Quarterly Report contains forward-looking statementsthat involve risks and uncertainties. We use words such as “anticipates”, “believes”,“plans”, “expects”, “future”, “intends”, “may”, “will”, “should”, “estimates”, “predicts”,“potential”, “continue”, “becoming”, “transitioning” and similar expressions toidentify such forward-looking statements. Our forward-looking statements include statements as to our businessoutlook, revenues, margins, expenses, tax provision rate, capital resources sufficiency,capital expenditures, restructuring activities and expenses.*

 

*These forward-looking statements apply only as of the dateof this Quarterly Report.  We undertakeno obligation to publicly update or revise any forward-looking statements,whether as a result of new information, future events or otherwise.  Our actual results could differ materiallyfrom those anticipated in these forward-looking statements for many reasons,including the risks described under “Factors That You Should Consider Before Investingin PMC-Sierra” and elsewhere in this Quarterly Report.  Investors are cautioned not to place unduereliance on these forward-looking statements, which reflect management’sanalysis only as of the date hereof.*

 

Wegenerate revenues from the sale of semiconductor devices that we have designedand developed.  Almost all of ourrevenues in any given year come from the sale of semiconductors that aredeveloped prior to that year. For example, the majority of our revenues in thefirst quarter of 2005 came from parts developed in 2004 and earlier. After anindividual product is completed and announced it may take several years beforethat device generates any significant revenues. Our current revenue is generated by a portfolio of more than 230products.

 

Inaddition to incurring costs for the marketing, sales and administration of thesale of existing products, we expend a substantial amount every year for thedevelopment of new semiconductor devices. We determine the amount to invest in the development of newsemiconductors based on our assessment of the future market opportunities forthose components, and the estimated return on investment.

 

Inorder to align our fiscal year end with the calendar year end, the first fiscalperiod of 2005 consisted of 14 weeks compared to 13 in the first quarter of2004.

 

**Results of Operations**

 

**First Quarters of 2005 and 2004**

 

Net Revenues *(in millions)*

 
| ** **   | ** ** | **First Quarter** | ** ** | ** ** | ** ** |
|--------------|------------|-------------------|------------|------------|------------|
| ** **   | ** ** | **2005**          | ** ** | **2004**   | ** ** | **Change** | ** ** |
|         |       |              |       |       |       |   |   |
| Net revenues |       | $                 | 66.1       |       | $          | 78.7 |   | (16 | )% |
|              |            |                   |            |            |            |  |  |  |  |

 

Netrevenues for the first quarter of 2005 were $66.1 million compared to $78.7million for the same period in 2004, a decrease of $12.6 million, or 16%.  Although revenues were lower than

 

14

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thefirst quarter of 2004, revenues increased in the first quarter of 2005 from thelevel of revenue in the fourth quarter of 2004. The recovery in the first quarter of 2005 when compared to the fourthquarter of 2004 was due to reduced levels of inventory at end customers,improved activity levels in a number of end-user markets, including EnterpriseRouting and Multi-Service Switching, Storage, Laser Printers, and WirelessInfrastructure.  In addition, thepercentage of revenues from Asia grew significantly this quarter compared tothe fourth quarter of 2004.  Revenuegenerated during the extra week of the first quarter (the 14thweek), was approximately $2 million.

 

Gross Profit *(in millions)*

 
| ** **                    | ** ** | **First Quarter** | ** ** | ** ** | ** ** |
|-------------------------------|------------|-------------------|------------|------------|------------|
| ** **                    | ** ** | **2005**          | ** ** | **2004**   | ** ** | **Change** | ** ** |
|                          |       |              |       |       |       |   |   |
| Gross profit                  |       | $                 | 46.5       |       | $          | 54.9 |   | (15 | )% |
| *Percentage  of net revenues* |       | 70                | %          | 70         | %          |   |   |
|                               |            |                   |            |            |            |  |  |  |  |

 

Totalgross profit decreased $8.4 million, or 15%, in the first quarter of 2005compared to the same quarter of 2004. The decrease is due to lower unit sales.

 

Gross profit as a percentage of revenueswas consistent at 70% in the first quarter of 2005 and the same period in2004.  This resulted from a combinationof the following factors:

 

•                  fixedmanufacturing costs were allocated over a lower volume of shipments, reducinggross profit by approximately 1 percentage point; and

•                  agreater portion of our sales were from our higher margin products, whichincreased gross profit by approximately 1 percentage point.

 

15

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Operating Expenses and Charges *(inmillions)*

 
| ** **                                    | ** ** | **First Quarter** | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|-------------------|------------|------------|------------|
| ** **                                    | ** ** | **2005**          | ** ** | **2004**   | ** ** | **Change** | ** ** |
|                                          |       |              |       |       |       |   |   |
| Research and  development                     |       | $                 | 31.4       |       | $          | 28.8 |   | 9 | % |
| *Percentage  of net revenues*                 |       | 48                | %          | 37         | %          |   |   |
|                                          |       |              |       |       |       |   |   |
| Marketing,  general and administrative        |       | $                 | 13.0       |       | $          | 11.9 |   | 9 | % |
| *Percentage  of net revenues*                 |       | 20                | %          | 15         | %          |   |   |
|                                          |       |              |       |       |       |   |   |
| Amortization of  deferred stock compensation: |       |              |       |       |       |   |   |
| Marketing,  general and administrative        |       | —            |       | 0.7        |       |   |   |
|                                          |       | $                 | —     |       | $          | 0.7 |   | (100 | )% |
| *Percentage  of net revenues*                 |       | 0                 | %          | 1          | %          |   |   |
|                                          |       |              |       |       |       |   |   |
| Restructuring  costs                          |       | $                 | 0.9        |       | $          | — |   | 100 | % |
| *Percentage  of net revenues*                 |       | 1                 | %          | 0          | %          |   |   |

 

*Research and Developmentand Marketing, General and Administrative Expenses*

* *

Our research and development, or R&D,expenses were $2.6 million, or 9%, higher in the first quarter of 2005 comparedto the first quarter of 2004 due primarily to the incremental week in the firstquarter of 2005, which increased payroll-related costs by $2.1 and facilitiesexpenses by $0.1 million.  Developmentcosts in the first quarter of 2005 were $0.2 million higher than the firstquarter of 2004 due to the timing of design completions.  In addition, amortization of intellectualproperty was higher by $0.4 million due to an increase in purchases ofintellectual property in the second half of 2004.  These increases were offset by a $0.2reduction in depreciation expense for equipment and development tools thatbecame fully depreciated and were not replaced.

 

Our marketing, general andadministrative, or MG&A, expenses increased by $1.1 million, or 9%, in thefirst quarter of 2005 compared to the same quarter of 2004.  This increase was primarily attributable tothe incremental week in the first quarter of 2005, which increasedpayroll-related costs by $1.3 million. This increase was offset by a $0.2million reduction in depreciation expense for assets that became fullydepreciated and were not replaced.

 

*Restructuring*

* *

In the first quarter of 2005we implemented two workforce reduction initiatives aimed at streamliningoperations and reducing operating expenses.

 

The first initiativeincluded termination of 24 employees across all business functions in the firstquarter, which resulted in a restructuring charge of $0.9 million.  Of this amount, all but $0.1 million has beenpaid.

 

The second initiative included an announcementof the planned termination of 26 employees from production control, qualityassurance, and product engineering as a result of consolidation of our twomanufacturing facilities (Santa Clara, California and Burnaby, Canada) into onefacility (Burnaby) in the second and third quarters of 2005.  We expect to expense termination

 

16

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costs of approximately $2.2 million related tothis second initiative during 2005 and to have substantially completed thisinitiative by the fourth quarter of 2005.

 

Restructuring– 2003 and 2001

 

In 2003 and 2001,we implemented three restructuring plans aimed at focusing development effortson key projects and reducing operating costs in response to the severe andprolonged economic downturn in the semiconductor industry.  Our assessment of the market demand for ourproducts, and the development efforts necessary to meet this demand, were keyfactors in our decisions to implement these restructuring plans.  As end markets for our products hadcontracted, certain projects were curtailed in an effort to cut costs.  Cost reductions in all other functional areaswere also implemented, as fewer resources were required to support the reducedlevel of development and sales activities during these periods*. *We have completedsubstantially all of the activities contemplated in these restructuring plans,but as of April 3, 2005 have not yet terminated the leases on our surplusfacilities.  Upon the final dispositionof our surplus leased facilities, we expect to achieve annualized savings ofapproximately $15.9 million, $67.6 million, and $28.2 million in cost ofrevenues and operating expenses based on the expenditure levels at the time ofthe respective January 2003, October 2001 and March 2001restructurings.

 

January 16,2003

 

TheJanuary 2003 restructuring included the termination of 175 employees andthe closure of design centers in Maryland, Ireland and India.  To date, we have recorded a restructuringcharge of $18.3 million, including $1.5 million for asset write-downs.  These charges related to workforce reduction,lease and contract settlement costs, and the write-down of certain property,equipment and software assets whose value was impaired as a result of thisrestructuring plan.  We have disposed ofthe property improvements and computer equipment, and software licenses havebeen cancelled or are no longer being used. Cash payments made to date under this plan were $12.0 million.  A $0.9 million reversal of excess restructureprovision relating primarily to workforce reduction was recorded in 2003.

 

Theactivity under this plan in the three months ended April 3, 2005 was asfollows:

 
| **(in thousands)**                             | ** ** | **Balance at  Dec 26, 2004** | ** ** | **Cash  Payments** | ** ** | **Balance at  Apr 3, 2005** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|--------------------|------------|-----------------------------|------------|
| Excess facility  and contract settlement costs |       | $                            | 3,895      |               | $          | (107                        | )          | $ | 3,788 |   |
|                                                |            |                              |            |                    |            |                             |            |  |  |  |

 

October 18,2001

 

TheOctober 2001 restructuring plan included the termination of 341 employees,the consolidation of excess facilities, and the curtailment of certain researchand development projects, resulting in a restructuring charge of $175.3million, including $12.2 million of asset write-downs.  To date, we have made cash payments underthis plan of $153.3 million, including the purchase and sale of Mission TowersTwo in Santa Clara, CA, for $133 million and $33 million, respectively, in thethird quarter of 2003.  To date, we havereversed $5.3 million of 

 

17

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excessrestructure provision, primarily related to Mission Towers Two.  Due to the continued downturn in real estatemarkets, the facilities costs are expected to be higher than anticipated in theoriginal plan and as a result, we recorded additional provisions for abandonedoffice facilities of $1.3 million in the fourth quarter of 2004.

 

Theactivity under this plan in the three months ended April 3, 2005 was asfollows:

 
| **(in thousands)**                             | ** ** | **Balance at  Dec 26, 2004** | ** ** | **Cash  Payments** | ** ** | **Balance at  Apr 3, 2005** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|--------------------|------------|-----------------------------|------------|
|                                           |       |                         |       |               |       |                        |       |
| Excess facility  and contract settlement costs |       | $                            | 6,458      |               | $          | (654                        | )          | $ | 5,804 |   |
|                                                |            |                              |            |                    |            |                             |            |  |  |  |

 

March 26,2001

 

Inthe first quarter of 2001, we recorded a charge of $19.9 million for arestructuring plan that included the termination of 223 employees across allbusiness functions, the consolidation of a number of facilities and thecurtailment of certain research and development projects.  Due to the continued downturn in real estatemarkets, we expect these costs to be higher than anticipated in the originalplan.  As a result, we recordedadditional provisions for abandoned office facilities of $3.1 million in thethird quarter of 2003 and $2.2 million in the fourth quarter of 2004.

 

Theactivity under this plan in the three months ended April 3, 2005 was asfollows:

 
| **(in thousands)**     | ** ** | **Balance at  Dec 26, 2004** | ** ** | **Cash  Payments** | ** ** | **Balance at  Apr 3, 2005** | ** ** |
|------------------------|------------|------------------------------|------------|--------------------|------------|-----------------------------|------------|
|                   |       |                         |       |               |       |                        |       |
| Excess facility  costs |       | $                            | 3,382      |               | $          | (388                        | )          | $ | 2,994 |   |
|                        |            |                              |            |                    |            |                             |            |  |  |  |

 

18

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Other Income and Expenses *(**in millions)*

 
| ** **                                                           | ** ** | **First Quarter** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                           | ** ** | **2005**          | ** ** | **2004**   | ** ** | **Change** | ** ** |
|                                                                 |       |              |       |       |       |   |   |
| Interest income,  net                                                |       | $                 | 2.7        |       | $          | 1.0 |   | 169 | % |
| *Percentage  of net revenues*                                        |       | 4                 | %          | 1          | %          |   |   |
|                                                                 |       |              |       |       |       |   |   |
| Foreign exchange  loss                                               |       | $                 | (0.6       | )          | $          | — |   | 100 | % |
| *Percentage  of net revenues*                                        |       | -1                | %          | 0          | %          |   |   |
|                                                                 |       |              |       |       |       |   |   |
| Loss on  extinguishment of debt and amortization of debt issue costs |       | $                 | (1.6       | )          | $          | (1.9 | ) | 16 | % |
| *Percentage  of net revenues*                                        |       | -2                | %          | -2         | %          |   |   |
|                                                                 |       |              |       |       |       |   |   |
| Gain on property  and investments                                    |       | $                 | 1.4        |       | $          | 8.6 |   | (83 | )% |
| *Percentage  of net revenues*                                        |       | 2                 | %          | 11         | %          |   |   |

 

*Interest income, net*

 

Interestincome was $2.7 million in the first quarter of 2005 compared to $1.0 millionin the first quarter of 2004.  Our net interestincome increased in the first quarter of 2005 by $1.7 million compared to thefirst quarter of 2004 as a result of interest expense savings of $0.6 millionfrom the repurchase of our 3.75% Convertible Subordinated Notes, and $0.5million interest received as part of a tax settlement.   The remaining increase is due to increasesin our average cash balances, net of debt, improved investment yields and anadditional week in the first quarter of 2005 compared to the first quarter of2004.

 

*Foreign exchange loss*

 

Foreign exchange loss increased to $0.6 million in the first quarter of2005 compared to nil in the first quarter of 2004.

* *

Wehave a significant design presence outside the United States, especially inCanada.  The majority of our operatingexpense exposures to changes in the value of the Canadian Dollar relative tothe United States Dollar have been hedged through December 2005.  The foreign exchange loss incurred in thefirst quarter of 2005 relates primarily to the re-measurement of accrued incometax amounts in our Canadian subsidiary. We do not hedge our accrual for Canadian income taxes againstfluctuations in foreign currency exchange rates in the ordinary course ofbusiness (see Item 3.  Quantitative andQualitative Disclosures About Market Risk).

 

*Loss on extinguishment of debt and amortization ofdebt issue costs*

* *

On January 18, 2005we redeemed our remaining outstanding 3.75% Convertible Subordinated Notes fora total of $70.2 million in cash, which included $1.1 million in accrued interestand a $1.0 million call premium.   Weexpensed the remaining unamortized debt issue costs of $0.6 million, resultingin an aggregate net loss on redemption of $1.6 million.

 

19

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In the first quarter of2004, we repurchased $106.9 million face value of our convertible subordinatednotes at par and wrote off $1.5 million of related unamortized debt issuecosts.  We also incurred transaction relatedcosts of $0.3 million resulting in an aggregate net loss on the repurchase of$1.8 million.  

 

*Gain on sale of property and investments*

 

In February 2005, wereceived $0.7 million that had been in escrow for one year pending finalsettlement of the sale of our investment in a private technology company.  As a result we recorded a gain for thisamount, which has been included in Gain on Property and Investments on theStatement of Operations.  In February 2004we recorded a gain of $8.6 million from this sale, which excluded this deferredportion of the proceeds.

 

In March 2005 we received $2.2 million asfinal satisfaction of the mortgage owed to us for a property we sold in2003.  As part of the agreement wesurrendered an option to purchase the property. The difference between the proceeds and the carrying value of themortgage receivable was recorded as a gain of $0.6 million on the Statement ofOperations.

 

# Recovery of income taxes

 

Werecorded a recovery of income taxes of $0.2 million in the first quarter of2005.  Our provision for income taxes wasaffected by two factors.  First, wedecreased our expected annual effective tax rate from 25% to 20% based on asensitivity analysis that considered tax credits available to offset forecastlevels of net income, which illustrated that 20% was a more realistic rate forPMC.  Second, we reversed a $0.9 millionaccrual for state taxes based on the completion of a tax audit.

 

***Critical Accounting Estimates***

 

*General*

* *

Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased upon our Consolidated Financial Statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  The preparation of thesefinancial statements requires us to make estimates and assumptions that affectour reported assets, liabilities, revenue and expenses, and related disclosureof our contingent assets and liabilities. Our significant accounting policies are outlined in Note 1 to theConsolidated Financial Statements in our Annual Report on Form 10-K forthe period ended December 26, 2004, which also provides commentary on ourmost critical accounting estimates.  Thefollowing additional estimates were of note during the first three months of2005:

 

*Restructuring charges -Facilities*

* *

Incalculating the cost to dispose of our excess facilities, we had to estimatethe amount to be paid in lease termination payments, the future lease andoperating costs to be paid until the lease is terminated, and the amount, ifany, of sublease revenues for each location. This

 

20

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requiredus to estimate the timing and costs of each lease to be terminated, the amountof operating costs for the affected facilities, and the timing and rate atwhich we might be able to sublease or complete negotiations of a leasetermination agreement for each site.  Toform our estimates for these costs we performed an assessment of the affectedfacilities and considered the current market conditions for each site.

 

During2001, we recorded total charges of $155 million for the restructuring of excessfacilities as part of restructuring plans implemented that year.  The total remaining estimate of $8.8 millionrelated to the 2001 restructuring plans represents 90% of the estimated totalfuture operating costs and lease obligations for the effected sites.

 

Inthe first quarter of 2003, we announced a further restructuring of ouroperations, which resulted in the closing of an additional four productdevelopment sites and the recording of $9.6 million charge related to thesefacilities.  The total remaining estimateof $3.8 million related to the closing of all four sites represents just over57% of the estimated total future operating costs and lease obligations forthese sites.

 

Webelieve our estimates of the obligations for the closing of sites remainsufficient to cover anticipated settlement costs.  However, our assumptions on either the leasetermination payments, operating costs until terminated, or the amounts andtiming of offsetting sublease revenues may turn out to be incorrect and ouractual cost may be materially different from our estimates.  If our actual costs exceed our estimates, wewould incur additional expenses in future periods.

 

*Income Taxes*

* *

Inestimating our annual effective tax rate we review our forecasted net incomefor the year by geographic area and apply the appropriate tax rates.  We also consider the income tax creditsavailable in each tax jurisdiction. Based on the analysis performed in the first quarter of 2005 we reducedour effective tax rate from 25% to 20%.

 

Ouroperations are conducted in a number of countries with complex tax legislationand regulations pertaining to our activities.  We have recorded income tax liabilities based on our estimates andinterpretations of those regulations for the countries we operate in.  However our estimates are subject to reviewand assessment by the tax authorities and the courts of those countries.  The timing of any such review and finalassessment of our liabilities by local authorities is substantially out of ourcontrol and is dependent on the actions by those authorities in the countrieswe operate in. Any re-assessment of our tax liabilities by tax authorities mayresult in adjustments of the income taxes we pay or refunds that are due to us.

 

Incertain jurisdictions we have incurred losses and other costs that can beapplied against future taxable earnings to reduce our tax liability on thoseearnings. As we are uncertain of realizing the future benefit of those lossesand expenditures, we have taken a valuation allowance against all domestic andforeign deferred tax assets.

 

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***BusinessOutlook***

 

We expect our revenues for the secondquarter of 2005 to be in the range of $70 to $72 million.  As in the past, and consistent with businesspractice in the semiconductor industry, a significant portion of our revenuesare likely to be derived from orders placed and shipped during the samequarter, which we call our “turns business”. Our revenue forecast depends in part on returning to PMC’s normal rateof turns business.  In Q1 2005, netorders booked and shipped within the quarter (or net turns completed) wasapproximately $16 million or approximately 24% of quarterly sales.   Our average turns business is about 30% oftotal quarterly sales. We believe that given the steady increase in levels ofturns business over the past three quarters along with a reduction of customerinventory levels, our turns business will return to approximately a normalizedrate during the second quarter of 2005.  Our quarterly revenues may vary considerably as our customers adjust tofluctuating demand for products in their markets and continue to manage theirinventory levels.

 

Weanticipate our second quarter 2005 gross margins will be approximately 70%, butas in past quarters this could vary depending on the volumes of products sold,since many of our costs are fixed. Margins could also vary depending on the mix of products sold.

 

Weexpect our second quarter of 2005 operating expenses to be consistent with thefirst quarter.  The first half of eachcalendar year brings additional expenses such as salary increases, andadditional employer taxes and retirement plan contributions.

 

Weanticipate that interest and other income in the second quarter of 2005 will beapproximately $2.3 million, and our income tax provision rate will be 20%.

 

***Liquidity &Capital Resources***

 

Our principal source ofliquidity at April 3, 2005 was $355.1 million in cash and investments,which included $224.2 million in cash and cash equivalents and short-terminvestments and $130.9 million of long-term investments in bonds and notes.

 

In the first three monthsof 2005, we generated $2.6 million of cash from operating activities.Significant changes in working capital accounts included:

 

•                  a$4.0 million increase in accounts receivable, primarily due to increasedrevenues and the timing of payments near the end of our fiscal period;

•                  a$2.6 million increase in prepaid expenses and other assets, principally due tothe renewal of software maintenance contracts; and

•                  a$2.0 million increase in accounts payable and accrued liabilities, primarilydue to the receipt of a large invoice from a supplier at the end of thequarter.

 

In the first three monthsof 2005 cash flows from our investment activities included:

 

•                  cashproceeds of $157.5 million from the sale or maturity of short and long-termdebt investments;

•                  cashused for the purchase of $67.0 million of long and short-term debt investments;

•                  cashproceeds of $3.3 million from the sale of investments, property and otherassets;

•                  aninvestment of $2.0 million in a private technology company;

•                  cashproceeds of $1.6 million from the refund of wafer fabrication deposits; and

 

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•                  aninvestment of $1.4 million for the purchases of property, equipment andintangible assets.

 

Inthe first three months of 2005 cash flows from our financing activitiesincluded:

 

•                  $70.2million used to redeem our remaining outstanding 3.75% Convertible SubordinatedNotes; and

•                  cashproceeds of $8.2 million from the issuance of common stock under ourequity-based compensation plans.

 

Asof April 03, 2005, we had cash commitments made up of the following:

 
| **(in thousands)  Contractual Obligations** | ** ** | **Total** | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **After  2009** | ** ** |
|---------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|-----------------|------------|
|                                        |       |      |       |     |       |     |       |     |       |     |       |     |       |            |       |
| Operating Lease  Obligations:               |       |      |       |     |       |     |       |     |       |     |       |     |       |            |       |
| Minimum Rental  Payments                    |       | $         | 56,306     |     | $          | 7,647    |       | $        | 9,840      |     | $          | 9,981    |       | $               | 11,092     |   | $ | 6,663 |   | $ | 11,083 |   |
| Estimated  Operating Cost Payments          |       | 22,096    |       | 3,125    |       | 3,941    |       | 3,921    |       | 3,676    |       | 2,930    |       | 4,503           |       |
| Purchase and  other Obligations             |       | 4,265     |       | 3,812    |       | 453      |       | —   |       | —   |       | —   |       | —          |       |
|                                        |       | $         | 82,667     |     | $          | 14,584   |       | $        | 14,234     |     | $          | 13,902   |       | $               | 14,768     |   | $ | 9,593 |   | $ | 15,586 |   |

 

Purchaseobligations as noted in the above table are comprised of commitments topurchase design tools and software for use in product development.  Excluded from these purchase obligations arecommitments for inventory or other expenses entered into in the normal courseof business.  We estimate these othercommitments to be approximately $5.3 million at April 3, 2005 forinventory and other expenses that will be received in the coming 90 days andthat will require settlement 30 days thereafter.

 

We have a line of creditwith a bank that allows us to borrow up to $1.5 million provided we maintaineligible investments with the bank equal to the amount drawn on the line ofcredit.  At April 3, 2005 we hadcommitted $1.3 million under letters of credit as security for office leases.

 

We expect to useapproximately $16.0 million of cash in the remainder of 2005 for capitalexpenditures.  Based on our currentoperating prospects, we believe that existing sources of liquidity will satisfyour projected operating, working capital, venture investing, capitalexpenditure, wafer deposit and remaining restructuring requirements through theend of 2006.

 

Whilewe believe our current sources of liquidity will satisfy our long-term needsfor capital, we operate in an industry that is subject to the rapidtechnological and economic changes. In addition, we contemplate mergers andacquisitions of other companies or assets as part of our business strategy.Consequently in the future we may determine that our sources of liquidity areinsufficient and we may proceed with financing or other activities, which maydilute your investment or impact our liquidity and operating results.

 

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**FACTORS THAT YOU SHOULD CONSIDER BEFORE INVESTINGIN PMC-SIERRA**

 

Ourcompany is subject to a number of risks – some are normal to the fablesssemiconductor industry, some are the same or similar to those disclosed inprevious SEC filings, and some may be present in the future.  You should carefully consider all of theserisks and the other information in this report before investing in PMC.  The fact that certain risks are endemic tothe industry does not lessen the significance of the risk.

 

***We are subject to rapidchanges in demand for our products due to customer inventory levels, productionschedules, fluctuations in demand for networking equipment and our customerconcentration.***

*** ***

Asa result of these risks, our business, financial condition or operating resultscould be materially adversely affected. This could cause the trading price of our securities to decline, and youmay lose part or all of your investment.

 

***We have very limitedrevenue visibility.***

*** ***

Ourability to project revenues is limited because a significant portion of our quarterlyrevenues may be derived from orders placed and shipped in the same quarter,which we call our “turns business.”  Ourturns business varies widely quarter to quarter.  Although we have seen a steady improvement inour turns business during the past three quarters, uncertainty in our customers’end markets and our customers’ increased focus on cash management may cause ourcustomers to delay product orders and reduce delivery lead-time expectations,which reduces our ability to project revenues beyond the current quarter.

 

***Wemay fail to meet our demand forecasts if our customers cancel or delay thepurchase of our products.***

*** ***

Manyof our customers have numerous product lines, numerous component requirementsfor each product, sizeable and complex supplier structures, and typicallyengage contract manufacturers for additional manufacturing capacity.  In addition, our customers often shift buyingpatterns as they manage inventory levels, market different products, or changeproduction schedules.  This makesforecasting their production requirements difficult and can lead to aninventory surplus of certain of their components.

 

We may be unable to deliver products to customers whenthey require them if we incorrectly estimate future demand, and this may leadto higher fluctuations in shipments of our products.  We may also experience an increase in theproportion of our revenues in future periods that will be from orders placedand fulfilled within the same period, which would further decrease our abilityto accurately forecast operating results. As most of our costs are fixed in the short term, a reduction in demandfor our products may cause a proportionately greater decline in our operatingresults.

 

***Changes in the political and economic climate in China andTaiwan may have a significant impact on our profitability***.

*** ***

Chinarepresents a significant portion of our net revenues (17% and 13% for each ofthe quarters ended April 3, 2005 and March 28, 2004,respectively).  Our financial conditionand results of operations are becoming increasingly dependent on our sales inChina and the

 

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majorityof our wafer supply comes from Taiwan. China has large organizations with major programs that can start andstop quickly.  For example, in 2004 ouroperating profits were adversely affected by a sudden change in telecominfrastructure build-out in China.  Anyinstability in China’s economic environment could lead to a contraction ofcapital spending by our customers. Additional risks to us include economicsanctions imposed by the U.S. government, imposition of tariffs and otherpotential trade barriers or regulations, uncertain protection for intellectualproperty rights and generally longer receivable collection periods.

 

***Werely on a few customers for a major portion of our sales, any one of whichcould materially impact our revenues should they change their ordering pattern.***

*** ***

Wedepend on a limited number of customers for a major portion of ourrevenues.  Through direct, distributorand subcontractor purchases, Cisco Systems accounted for more than 10% of ourrevenues in the first quarter of 2005. We do not have long-term volume purchase commitments from any of ourmajor customers. Accordingly, our future operating results will continue todepend on the success of our largest customers and on our ability to sellexisting and new products to these customers in significant quantities.

 

Theloss of our key customer, or a reduction in our sales to any major customer orour inability to attract new significant customers could materially andadversely affect our business, financial condition or results of operations.

 

***Our revenues may declineif we do not maintain a competitive portfolio of products.***

*** ***

Weare experiencing significantly greater competition from many different marketparticipants as the market in which we participate matures.  In addition, we are expanding into markets,such as the wireless infrastructure, enterprise storage, customer premiseequipment, and generic microprocessor markets, which have establishedincumbents with substantial financial and technological resources.  We expect more intense competition than thatwhich we have traditionally faced as some of these incumbents derive a majorityof their earnings from these markets.

 

***Increasing competitioncan make it more difficult to achieve design wins.***

*** ***

Wetypically face competition at the design stage, where customers evaluatealternative design approaches requiring integrated circuits. The markets for ourproducts are intensely competitive and subject to rapid technologicaladvancement in design tools, wafer manufacturing techniques, process tools andalternate networking technologies.  Wemay not be able to develop new products at competitive pricing and performancelevels.  Even if we are able to do so, wemay not complete a new product and introduce it to market in a timelymanner.  Our customers may substitute useof our products in their next generation equipment with those of current orfuture competitors, reducing our future revenues.  With the shortening product life anddesign-in cycles in many of our customers’ products, our competitors may havemore opportunities to supplant our products in next generation systems.

 

Ourcustomers are increasingly price conscious, as semiconductors sourced fromthird party suppliers comprise a greater portion of the total materials cost innetworking equipment.   We continue toexperience more aggressive price competition from competitors that wish toenter into the market segments in which we participate.  These circumstances may make some of our

 

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productsless competitive and we may be forced to decrease our prices significantly towin a design.  We may lose designopportunities or may experience overall declines in gross margins as a resultof increased price competition.

 

Weface significant competition from two major fronts.  First, we compete against establishedpeer-group semiconductor companies that focus on the communicationssemiconductor business.  These companiesinclude Agere Systems, Applied Micro Circuits Corporation, Broadcom, ExarCorporation, Conexant Systems, Marvell Technology Group, Multilink TechnologyCorporation, Silicon Image, Transwitch and Vitesse Semiconductor.  These companies are well financed, havesignificant communications semiconductor technology assets, have establishedsales channels, and are dependent on the market in which we participate for thebulk of their revenues.

 

Othercompetitors include major domestic and international semiconductor companies,such as Agilent, Cypress Semiconductor, Intel, IBM, Infineon, Integrated DeviceTechnology, Maxim Integrated Products, Motorola, NEC, Texas Instruments, andToshiba.  These companies areconcentrating an increasing amount of their substantial financial and otherresources on the markets in which we participate.  This represents a serious competitive threatto us.

 

Overthe next few years, we expect additional competitors, some of which may alsohave greater financial and other resources, to enter the market with newproducts.  These companies, individuallyor collectively, could represent future competition for many design wins, andsubsequent product sales.

 

***We may have to redesign our products to meetevolving industry standards and customer specifications, which may prevent ordelay future revenue growth.***

*** ***

Wesell products to customers whose characteristics include evolving industrystandards, short product lifespans, and new manufacturing and designtechnologies.  Many of the standards andprotocols for our products are based on networking technologies that may nothave been widely adopted or ratified by one or more of the standard-settingbodies in our customers’ industry.  Ourcustomers may delay or alter their design demands during this standard-settingprocess.  In response, we must redesignour products to suit these changing demands. Redesign is expensive and usually delays the production of ourproducts.  Our products may becomeobsolete during these delays.

 

***Design wins do nottranslate into near-term revenues and the timing of revenues from newlydesigned products is often uncertain.***

*** ***

Fromtime to time, we announce new products and design wins for existing and newproducts. While some industry analysts may use design wins as a metric forfuture revenues, many design wins have not, and will not generate any revenuesfor us, as customer projects are cancelled or unsuccessful in their endmarket.  In the event a design win generatesrevenue, the amount of revenue will vary greatly from one design win toanother.  In addition, mostrevenue-generating design wins do not translate into near-term revenues.  Most revenue-generating design wins take morethan 2 years to generate meaningful revenue.

 

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***Our strategy includes broadening our businessinto the Enterprise, Storage and Consumer markets.  We may not be successful in achievingsignificant sales in these new markets.***

*** ***

TheEnterprise, Storage and Consumer markets are already serviced by incumbentsuppliers who have established relationships with customers.  We may be unsuccessful in displacing thesesuppliers, or having our products designed into products for different marketneeds.  In order to compete againstincumbents, we may need to lower our prices to win new business, which couldlower our gross margin.  We may incurincreased research, development and sales costs to address these new markets.

 

***We are subject to therisks of conducting business outside the United States, which may impair oursales, development or manufacturing of our products.***

*** ***

Inaddition to selling our products in a number of countries, a significantportion of our research and development and manufacturing is conducted outsidethe United States. The geographic diversity of our business operations couldhinder our ability to coordinate design and sales activities. If we are unableto develop systems and communication processes to support our geographic diversity,we may suffer product development delays or strained customer relationships.

 

***Weare exposed to the credit risk of some of our customers and we may havedifficulty collecting receivables from customers based in foreign countries.***

*** ***

Manyof our customers employ contract manufacturers to produce their products andmanage their inventories.  Many of thesecontract manufacturers represent greater credit risk than our networkingequipment customers, who generally do not guarantee our credit receivablesrelated to their contract manufacturers.

 

Inaddition, a significant portion of our sales flows through our distributionchannel, which generally represents a higher credit risk.  Should these companies enter into bankruptcyproceedings or breach their debt covenants, our revenues could decrease andcollection of our significant accounts receivables with these companies couldbe jeopardized.

 

***Wemay lose our ability to design or produce products, could face additionalunforeseen costs or could lose access to key customers if any of the nations inwhich we conduct business impose trade barriers or new communicationsstandards.***

*** ***

Wemay have difficulty obtaining export licenses for certain technology producedfor us outside the United States.  If aforeign country imposes new taxes, tariffs, quotas, and other trade barriersand restrictions or the United States and a foreign country develop hostilitiesor change diplomatic and trade relationships, we may not be able to continuemanufacturing or sub-assembly of our products in that country and may havefewer sales in that country. We may also have fewer sales in a country thatimposes new communications standards or technologies. This could inhibit ourability to meet our customers’ demand for our products and lower our revenues.

 

***Ifforeign exchange rates fluctuate significantly, our profitability may decline.***

 

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Weare exposed to foreign currency rate fluctuations because a significant part ofour development, test, marketing and administrative costs are in Canadiandollars, and our selling costs are incurred in a variety of currencies aroundthe world.  The US dollar has devaluedsignificantly compared to the Canadian dollar and this trend may continue.  To protect against reductions in value andthe volatility of future cash flows caused by changes in foreign exchangerates, we enter into foreign currency forward contracts. The contracts reduce,but do not eliminate, the impact of foreign currency exchange rate movements.  In addition, this foreign currency riskmanagement policy may not be effective in addressing long-term fluctuationssince our contracts do not extend beyond a 12-month maturity.

 

Weregularly limit our exposure to foreign exchange rate fluctuations from ourCanadian dollar net asset or liability positions.  We do not hedge our accrual for Canadianincome taxes in the ordinary course of business, and consequently in the firstquarter of 2005 we incurred a $0.7 million foreign exchange loss relating tothis item.  Our profitability would bematerially impacted by a 5% shift in the foreign exchange rates between UnitedStates and Canadian currencies.

 

***Our strategy of expansionin new markets may cause our profit margins to decline.***

*** ***

Ourbusiness strategy contemplates expansion of our product offerings in relativelyhigh volume target markets, such as storage and consumer applications.  These markets typically are characterized bystronger price competition and, consequently, lower per unit profitmargins.  If we are successful in thesemarkets, our overall profit margins could decline, as lower margin products maycomprise a greater portion of our revenues.

 

***Our business strategycontemplates acquisition of other companies or technologies, which couldadversely affect our operating performance.***

*** ***

Acquiringproducts, technologies or businesses from third parties is part of our businessstrategy.  Management may be divertedfrom our operations while they identify and negotiate these acquisitions andintegrate an acquired entity into our operations.  Also, we may be forced to develop expertiseoutside our existing businesses, and replace key personnel who leave due to anacquisition.

 

Anacquisition could absorb substantial cash resources, require us to incur or assumedebt obligations, or issue additional equity. If we issue more equity, we may dilute our common stock with securitiesthat have an equal or a senior interest in our Company.

 

Acquiredentities also may have unknown liabilities, and the combined entity may notachieve the results that were anticipated at the time of the acquisition.

 

Fromtime to time, we license, or acquire, technology from third parties toincorporate into our products. Incorporating technology into our products may be more costly, or resultin additional management attention to achieve the desired functionality.

 

***Product sales mix mayadversely affect our profitability over time.***

*** ***

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*** ***

Ourproducts range widely in terms of the margins they generate.  A change in product sales mix could impactour operating results materially.

 

***We may be unsuccessfulin transitioning the design of our new products to new manufacturing processes.***

*** ***

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

 

***Since many of the products we develop do notreach full production sales volumes for a number of years, we may incorrectlyanticipate market demand and develop products that achieve little or no marketacceptance.***

*** ***

***Our products generally take between 12 and 24 months from initialconceptualization to development of a viable prototype, and another 3 to 18months to be designed into our customers’ equipment and sold in productionquantities.  Our products often must beredesigned because manufacturing yields on prototypes are unacceptable orcustomers redefine their products to meet changing industry standards orcustomer specifications.  As a result, wedevelop products many years before volume production and may inaccuratelyanticipate our customers’ needs.***

*** ***

***The complexity of ourproducts could result in unforeseen or undetected defects or bugs, which couldadversely affect the market acceptance of new products and damage ourreputation with current or prospective customers.***

*** ***

Althoughwe, our customers and our suppliers rigorously test our products, our highlycomplex products may contain defects or bugs. We have in the past experienced, and may in the future, experiencedefects and bugs in our products. If any of our products contain defects orbugs, or have reliability, quality or compatibility problems that are significantto our customers, our reputation may be damaged and customers may be reluctantto buy our products.  This couldmaterially and adversely affect our ability to retain existing customers orattract new customers. In addition, these defects or bugs could interrupt ordelay sales to our customers.

 

Wemay have to invest significant capital and other resources to alleviateproblems with our products.  If any ofthese problems are not found until after we have commenced commercialproduction of a new product, we may be required to incur additional developmentcosts and product recall, repair or replacement costs.  These problems may also result in claimsagainst us by our customers or others. In addition, these problems may divert our technical and other resourcesfrom other development efforts. Moreover, we would likely lose, or experience a

 

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delayin, market acceptance of the affected product or products, and we could losecredibility with our current and prospective customers.

 

***The loss of personnelcould delay us from designing new products.***

*** ***

Tosucceed, we must retain and hire technical personnel highly skilled at thedesign and test functions needed to develop high-speed networkingproducts.  The competition for suchemployees is intense.

 

Wedo not have employment agreements in place with many of our key personnel.  As employee incentives, we issue common stockoptions that generally have exercise prices at the market value at the time ofgrant and that are subject to vesting. As our stock price varies substantially, the stock options we grant toemployees are effective as retention incentives only if they have economicvalue.

 

***We may not be able tomeet customer demand for our products if we do not accurately predict demand orif we fail to secure adequate wafer fabrication or assembly parts and capacity.***

*** ***

Wecurrently do not have the ability to accurately predict what products ourcustomers will need in the future. Anticipating demand is difficult because our customers face volatilepricing and demand for their end-user networking equipment, our customers arefocusing more on cash preservation and tighter inventory management, andbecause we supply a large number of products to a variety of customers andcontract manufacturers who have many equipment programs for which they purchaseour products.  Our customers arefrequently requesting shipment of our products earlier than our normal leadtimes.  If we do not accurately predictwhat mix of products our customers may order, we may not be able to meet ourcustomers’ demand in a timely manner or we may be left with unwanted inventory,which could adversely affect our future operating results.

 

***Werely on limited sources of wafer fabrication, the loss of which could delay andlimit our product shipments.***

*** ***

Wedo not own or operate a wafer fabrication facility.  Three outside wafer foundries supply morethan 95% of our semiconductor wafer requirements.  Our wafer foundry suppliers also makeproducts for other companies and some make products for themselves, thus we maynot have access to adequate capacity or certain process technologies.  We have less control over delivery schedules,manufacturing yields and costs than competitors with their own fabricationfacilities.  If the wafer foundries weuse are unable or unwilling to manufacture our products in required volumes, wemay have to identify and qualify acceptable additional or alternativefoundries.  This qualification processcould take six months or longer.  We maynot find sufficient capacity quickly enough, if ever, to satisfy our productionrequirements.

 

Somecompanies that supply our customers are similarly dependent on a limited numberof suppliers to produce their products. These other companies’ products may be designed into the same networkingequipment into which our products are designed. Our order levels could be reduced materially if these companies areunable to access sufficient production capacity to

 

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producein volumes demanded by our customers because our customers may be forced toslow down or halt production on the equipment into which our products aredesigned.

 

***Wedepend on third parties in Asia for assembly of our semiconductor products thatcould delay and limit our product shipments.***

*** ***

Subcontractorsin Asia assemble all of our semiconductor products into a variety ofpackages.  Raw material shortages,political and social instability, assembly house service disruptions, currencyfluctuations, or other circumstances in the region could force us to seekadditional or alternative sources of supply or assembly.  This could lead to supply constraints orproduct delivery delays that, in turn, may result in the loss of revenues.  We have less control over delivery schedules,assembly processes, quality assurances and costs than competitors that do notoutsource these tasks.

 

***Ourbusiness is vulnerable to interruption by earthquake, fire, power loss,telecommunications failure, terrorist activity and other events beyond ourcontrol.***

*** ***

Wedo not have sufficient business interruption insurance to compensate us foractual losses from interruption of our business that may occur, and any lossesor damages incurred by us could have a material adverse effect on ourbusiness.  We are vulnerable to a majorearthquake and other calamities.  We haveoperations in seismically active regions in California, and we rely on third-partywafer fabrication facilities in seismically active regions in Asia.  We have not undertaken a systematic analysisof the potential consequences to our business and financial results from amajor earthquake in either region.  Weare unable to predict the effects of any such event, but the effects could beseriously harmful to our business.

 

***Our estimatedrestructuring accruals may not be adequate.***

*** ***

In2005 we implemented a restructuring plan to streamline operations and reduceoperating costs.  In 2001 and 2003, weimplemented plans to restructure our operations in response to the decline indemand for our networking products.  Wereduced the work force and consolidated or shut down excess facilities in aneffort to bring our expenses into line with our reduced revenue expectations.

 

Whilemanagement uses all available information to estimate these restructuringcosts, particularly facilities costs, our accruals may prove to beinadequate.  If our actual subleaserevenues or exiting negotiations differ from our assumptions, we may have to recordadditional charges, which could materially affect our results of operations,financial position and cash flow.

 

***When we account foremployee stock options using the fair value method, it could significantlyreduce our net income.***

*** ***

InDecember 2004, the Financial Accounting Standard Board (“FASB”) issuedStatement of Financial Accounting Standard (“SFAS”) 123 (revised 2004), “Shared-BasedPayment” which will require us to measure the cost of employee servicesreceived in exchange for an award of equity instruments based on the grant-datefair value of the award. The cost of such award will be recognized over theperiod during which an employee is required to provide services in exchange forthe award. We will be required to adopt this Statement in the first quarter offiscal

 

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2006.We are currently evaluating the impact that this pronouncement will have on ourfinancial position and results of operations but expect that it will result insignificant and ongoing accounting charges.

 

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

*** ***

Webecome defendants in legal proceedings from time to time.  Companies in our industry have been subjectto claims related to patent infringement and product liability, as well ascontract and personal claims.  We may notbe able to accurately assess the risk related to these suits, and we may beunable to accurately assess our level of exposure.  These proceedings may result in materialcharges to our operating results in the future if our exposure is material andif our ability to assess our exposure becomes clearer.

 

***If we cannot protect ourproprietary technology, we may not be able to prevent competitors from copyingour technology and selling similar products, which would harm our revenues.***

*** ***

Tocompete effectively, we must protect our intellectual property.  We rely on a combination of patents,trademarks, copyrights, trade secret laws, confidentiality procedures andlicensing arrangements to protect our intellectual property rights.  We hold numerous patents and have a number ofpending patent applications.

 

Wemight not succeed in attaining patents from any of our pendingapplications.  Even if we are awardedpatents, they may not provide any meaningful protection or commercial advantageto us, as they may not be of sufficient scope or strength, or may not be issuedin all countries where our products can be sold.  In addition, our competitors may be able todesign around our patents.

 

Wedevelop, manufacture and sell our products in Asian and other countries thatmay not protect our products or intellectual property rights to the same extentas the laws of the United States.  Thismakes piracy of our technology and products more likely.  Steps we take to protect our proprietaryinformation may not be adequate to prevent theft of our technology.  We may not be able to prevent our competitorsfrom independently developing technologies that are similar to or better thanours.

 

***Our products employtechnology that may infringe on the intellectual property and the proprietaryrights of third parties, which may expose us to litigation and prevent us fromselling our products.***

*** ***

Vigorousprotection and pursuit of intellectual property rights or positionscharacterize the semiconductor industry. This often results in expensive and lengthy litigation.  Although we have neither received anymaterial claims relating to the infringement of patents or other intellectualproperty rights owned by third parties nor are we aware of any such potentialclaims, we, and our customers or suppliers, may be accused of infringing onpatents or other intellectual property rights owned by third parties in thefuture.  An adverse result in anylitigation could

 

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forceus to pay substantial damages, stop manufacturing, using and selling theinfringing products, spend significant resources to develop non-infringingtechnology, discontinue using certain processes or obtain licenses to theinfringing technology.  In addition, wemay not be able to develop non-infringing technology, or find appropriatelicenses on reasonable terms.

 

Patentdisputes in the semiconductor industry are often settled throughcross-licensing arrangements.  Because wecurrently do not have a substantial portfolio of patents compared to our largercompetitors, we may not be able to settle an alleged patent infringement claimthrough a cross-licensing arrangement. We are therefore more exposed to third party claims than some of ourlarger competitors and customers.

 

Themajority of our customers are required to obtain licenses from and payroyalties to third parties for the sale of systems incorporating oursemiconductor devices.  Customers mayalso make claims against us with respect to infringement.

 

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

 

***Securities we issue tofund our operations could dilute your ownership.***

*** ***

Wemay decide to raise additional funds through public or private debt or equityfinancing.  If we raise funds by issuingequity securities, the percentage ownership of current stockholders will bereduced and the new equity securities may have priority rights to yourinvestment.  We may not obtain sufficientfinancing on terms that are favorable to you or us.  We may delay, limit or eliminate some or allof our proposed operations if adequate funds are not available.

 

***Our stock price has beenand may continue to be volatile.***

*** ***

Weexpect that the price of our common stock will continue to fluctuatesignificantly, as it has in the past.  Inparticular, fluctuations in our stock price and our price-to-earnings multiplemay have made our stock attractive to momentum, hedge or day-trading investorswho often shift funds into and out of stocks rapidly, exacerbating pricefluctuations in either direction particularly when viewed on a quarterly basis.

 

Securitiesclass action litigation has often been instituted against a company followingperiods of volatility and decline in the market price of their securities.  If instituted against us, regardless of theoutcome, such litigation could result in substantial costs and diversion of ourmanagement’s attention and resources and have a material adverse effect on ourbusiness, financial condition and operating results.  In addition, we could incur substantialpunitive and other damages relating to this litigation.

 

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***Provisions in Delawarelaw, our charter documents and our stockholder rights plan may delay or preventanother entity from acquiring us without the consent of our Board of Directors.***

*** ***

Weadopted a stockholder rights plan in 2001, pursuant to which we declared adividend of one share purchase right for each outstanding share of commonstock.  If certain events occur,including if an investor tenders for or acquires more than 15% of ouroutstanding common stock, stockholders (other than the acquirer) may exercisetheir rights and receive $650 worth of our common stock in exchange for $325per right, or we may, at our option, issue one share of common stock inexchange for each right, or we may redeem the rights for $0.001 per right. Theissuance of the rights could have the effect of delaying or preventing a changein control of us.

 

Inaddition, our Board of Directors has the right to issue preferred stock withoutstockholder approval, which could be used to dilute the stock ownership of apotential hostile acquirer.  Delaware lawimposes some restrictions on mergers and other business combinations between usand any holder of 15% or more of our outstanding common stock.

 

Althoughwe believe these provisions of our charter documents, Delaware law and ourstockholder rights plan will provide for an opportunity to receive a higher bidby requiring potential acquirers to negotiate with our Board of Directors,these provisions apply even if the offer may be considered beneficial by somestockholders.

 

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### **Item 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

### ** **

Thefollowing discussion regarding our risk management activities contains “forward-lookingstatements” that involve risks and uncertainties.  Actual results may differ materially fromthose projected in the forward-looking statements.

 

*Cash Equivalents,Short-term Investments and Investments in Bonds and Notes:*

* *

Weregularly maintain a short and long term investment portfolio of various typesof government and corporate bonds and notes. Our investments are made in accordance with an investment policyapproved by our Board of Directors. Maturities of these instruments are less than 30 months with the majoritybeing within one year.  To minimizecredit risk, we diversify our investments and select minimum ratings of P-1 orA by Moody’s, or A-1 or A by Standard and Poor’s, or equivalent.  We classify these securities asavailable-for-sale and they are carried at fair market value.

 

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

 

Wedo not attempt to reduce or eliminate our exposure to interest rate riskthrough the use of derivative financial instruments.

 

Basedon a sensitivity analysis performed on the financial instruments held at April 3,2005, the impact to the fair value of our investment portfolio by a shift inthe yield curve of plus or minus 50, 100 or 150 basis points would result in adecline or increase in portfolio value of approximately $0.9 million, $1.8million and $2.7 million respectively.

 

*Other Investments:*

* *

Ourother investments include strategic investments in privately held companiesthat are carried on our balance sheet at cost, net of write-downs fornon-temporary declines in market value. We expect to make additional investments like these in the future.  These investments are inherently risky, asthey typically are comprised of investments in companies and partnerships thatare still in the start-up or development stages.  The market for the technologies or productsthat they have under development is typically in the early stages, and maynever materialize.  We could lose ourentire investment in these companies and partnerships or may incur anadditional expense if we determine that the value of these assets have beenimpaired.  We may record an impairmentcharge to our operating results should we determine that these funds haveincurred a non-temporary decline in value.

 

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*Foreign Currency:*

* *

Our sales and corresponding receivables aredenominated primarily in United States dollars. We generate a significant portion of our revenues from sales tocustomers located outside the United States including Canada, Europe, theMiddle East and Asia.  We are subject torisks typical of an international business including, but not limited to,differing economic conditions, changes in political climate, differing taxstructures, other regulations and restrictions and foreign exchange ratevolatility.  Accordingly, our futureresults could be materially adversely affected by changes in these or otherfactors.

 

Through our operations in Canada and elsewhere outsidethe United States, we incur research and development, customer support costsand administrative expenses in Canadian and other foreign currencies.  We are exposed, in the normal course ofbusiness, to foreign currency risks on these expenditures, particularly inCanada.  In our effort to manage suchrisks, we have adopted a foreign currency risk management policy intended toreduce the effects of potential short-term fluctuations on our operatingresults stemming from our exposure to these risks.  As part of this risk management, we enterinto foreign exchange forward contracts on behalf of our Canadian subsidiary. Theseforward contracts offset the impact of exchange rate fluctuations on forecastedcash flows or firm commitments.  We limitthe forward contracts operational period to 12 months or less and we do notenter into foreign exchange forward contracts for trading purposes.  Because we do not engage in foreign exchangerisk management techniques beyond these periods, our cost structure is subjectto long-term changes in foreign exchange rates.

 

As at April 3, 2005, we had five currency forwardcontracts outstanding that qualified and were designated as cash flowhedges.  The U.S. dollar notional amountof these contracts was $50.3 million and the contracts had a fair value of $0.9million.

 

We attempt to limit our exposure to foreign exchangerate fluctuations from our Canadian dollar net asset or liabilitypositions.  We do not hedge our accrualsfor Canadian income taxes in the ordinary course of business, and consequentlyin the first quarter of 2005 we incurred a $0.7 million foreign exchange lossrelating to this item.  Our profitabilitywould be materially impacted by a shift in the foreign exchange rates betweenUnited States and Canadian currencies. For example, if the value of the United States dollar decreased by 5%relative to the Canadian dollar, our profitability would decrease by $2.7 million.

 

### **Item 4.  CONTROLS AND PROCEDURES**

### ** **

*Evaluation of disclosurecontrols and procedures*

* *

Ourmanagement evaluated, with the participation of our chief executive officer andour chief financial officer, our disclosure controls and procedures as of theend of the period covered by this quarterly report.  Based on this evaluation, our chief executiveofficer and our chief financial officer concluded that our disclosure controlsand procedures are effective to ensure that information we are required todisclose in reports that we file or submit under the Securities Exchange Act of1934 is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission rules and forms.

 

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*Changes in internalcontrols*

* *

There was no change in our internal control overfinancial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) underthe Exchange Act) that occurred during the period covered by this quarterlyreport that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**Part II– OTHER INFORMATION**

** **

**Item 1.    LEGALPROCEEDINGS**

 

OnFebruary 11, 2004, we filed a lawsuit against ProgrammableMicroelectronics Corporation (“Programmable”) in the United States DistrictCourt, Northern District of California (Case No. C04 00582) for trademarkand trade name infringement, trademark dilution, cancellation of trademarkregistration and unfair competition due to Programmable’s use of the Company’s “PMC”mark.  In April 2004 Programmablefiled counterclaims for trademark and trade name infringement and unfaircompetition.  In April 2005 wesettled this matter with Programmable for an immaterial amount.

 

**Item 5.    OTHERINFORMATION**

 

In the first quarter of 2005, executive officer Alan Krock entered intoan individual Rule 10b5-1 trading plan pursuant to which stock of theCompany will be sold from his account from time to time in accordance with theprovisions of the plan without any further action or involvement by him.

 

**Item 6.    EXHIBITS**

 

Exhibits–

 
| • |   | 11.1   |   | Calculation  of net income per share – included in Note 8 of the financial statements  included in Item I of Part I of this Quarterly Report. |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                               |
| • |   | 31.1   |   | Certification  of Chief Executive Officer pursuant to Section 302 (a) of the  Sarbanes-Oxley Act of 2002                                 |
|   |   |   |   |                                                                                                                                               |
| • |   | 31.2   |   | Certification  of Chief Financial Officer pursuant to Section 302 (a) of the  Sarbanes-Oxley Act of 2002                                 |
|   |   |   |   |                                                                                                                                               |
| • |   | 32.1   |   | Certification  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief  Executive Officer)                                           |

 

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| • |   | 32.2 |   | Certification Pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Financial  Officer) |
|--------|--------|------|--------|----------------------------------------------------------------------------------------------------------|

 

***SIGNATURE***

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|   | PMC-SIERRA, INC.                                                                   |
|--------|------------------------------------------------------------------------------------|
|   | (Registrant)                                                                       |
|   |                                                                               |
|   |                                                                               |
| Date:  | May 3, 2005                                                                   |   | /s/ Alan F. Krock |   |
|   | Alan F. Krock                                                                      |
|   | Vice President, Finance  Chief Financial Officer and  Principal Accounting Officer |
|        |                                                                                    |  |  |  |

 

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