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SEMTECH CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion of our financial condition and results of operations together with the consolidated condensed financial statements and the notes to the consolidated condensed financial statements included elsewhere in this Quarterly Report on Form 10-Q (this "Quarterly Report"). Forward Looking Statements This Quarterly Report contains forward-looking statements. Forward-looking statements are statements other than historical information or statements of current condition and relate to matters such as our future financial performance, future operational performance and our plans, objectives and expectations. Some forward-looking statements may be identified by use of terms such as "expects," "anticipates," "intends," "estimates," "believes," "projects," "should," "will," "plans" and similar words. In light of the risks and uncertainties inherent in all such projected matters, forward-looking statements should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that any of our operating expectations or financial forecasts will be realized. Results could differ materially from those projected in forward-looking statements, due to factors including, but not limited to, those set forth in the "Risk Factors" and "Quantitative and Qualitative Disclosures About Market Risk" sections of this Quarterly Report and the "Risk Factors" section of our Annual Report on Form 10-K for the fiscal year ended January 30, 2011 filed with the Securities and Exchange Commission (the "SEC") on March 31, 2011. We undertake no duty to update any forward-looking statements, whether as a result of new information, future events or otherwise. In addition to regarding forward-looking statements with caution, you should consider that the preparation of financial statements requires us to draw conclusions and make interpretations, judgments, assumptions and estimates with respect to factual, legal, and accounting matters. Different conclusions, interpretations, judgments, assumptions, or estimates could result in materially different results. See Note 1 to the consolidated condensed financial statements included in Part I, Item 1 of this Quarterly Report. Overview We design, develop, manufacture and market high-performance analog and mixed signal semiconductor products. We operate and report our results in one reportable segment. Our product lines include: Protection Products. We design, develop and market high performance protection devices, which are often referred to as transient voltage suppressors ("TVS"). TVS devices provide protection for electronic systems where voltage spikes (called transients), such as electrostatic discharge generated by the human body, can permanently damage voltage-sensitive components. Our portfolio includes filter and termination devices that can be sold as a complement to TVS devices. Our protection products feature low capacitance, providing robust protection while preserving signal integrity in high-speed voice and video interfaces and are low leakage, thus increasing battery life in electronic devices. Our protection products can be found in a broad range of applications including computer, data-communications, telecommunications and industrial applications. Advanced Communication and Sensing Products. We design, develop and market a portfolio of proprietary advanced wired communication, wireless communication, sensing integrated circuits ("ICs") and ultra-high speed Serializer/Deserializer ("SerDes") products for transport communication. These ICs perform specialized timing and synchronization functions used in high-speed networks, specialized radio frequency ("RF") functions used in a wide variety of industrial, medical and networking applications, and specialized sensing functions used in industrial and consumer applications and 40Gbps and 100Gbps chips and transceivers for short reach, metro and long haul applications and high performance transceivers for datacenter applications. Our advanced communications products feature a leading integrated timing solution for packet based communications networks. Our wireless and sensing products feature industry leading and longest range industrial, scientific and medical ("ISM") radio, enabling low cost of ownership and increased reliability in all environments. Our unique sensing interface platforms can interface to any sensor and output digital data in any form. Our advanced communications and sensing products can be found in a broad range of applications including communications, industrial, medical and consumer applications. Power Management Products. Power management products control, alter, regulate and condition the power supplies within electronic systems. The highest volume product types within the power management product line are switching voltage regulators, combination switching and linear regulators, smart regulators and charge pumps. Our power management products feature highly integrated devices for the telecom industry and low-power, small form factor and high-efficiency products for mobile phones, notebook computers, computer peripherals and other portable devices. The primary application for these products is power regulation for computer, communications, high-end consumer and industrial systems. Microwave and High-Reliability Products. We design, develop and market transceivers for wireless communications infrastructure, including 2G/3G/4G cellular repeaters, WiMAX CPE and base stations and defense and aerospace products, including satellite communication, ground to air beacons and unmanned air vehicles ("UAV"). This product segment also includes our line of high-reliability discrete semiconductor products comprised of rectifiers, assemblies (packaged discrete rectifiers) and other products. These products are typically used to convert alternating currents ("AC") into direct currents ("DC") and to protect circuits against very high voltage spikes or high current surges. Our microwave and high-reliability products can be found in a broad range of applications including industrial, military, medical and communications systems. 18 -------------------------------------------------------------------------------- Table of Contents Most of our sales to customers are made on the basis of individual customer purchase orders. Many customers include liberal cancellation provisions in their purchase orders. Trends within the industry toward shorter lead-times and "just-in-time" deliveries have resulted in our reduced ability to predict future shipments. As a result, we rely on orders received and shipped within the same quarter for a significant portion of our sales. Orders received and shipped in the first quarter of fiscal years 2012 and 2011 represented 36% and 43% of net sales, respectively. Sales made directly to customers during the first quarter of fiscal years 2012 and 2011 were 58% and 53% of net sales, respectively. The remaining sales were made through independent distributors. Our business involves reliance on foreign-based entities. Most of our outside subcontractors and suppliers, including third-party foundries that supply silicon wafers, are located in foreign countries, including China, Taiwan, United Kingdom, Hong Kong, Malaysia, Germany, Israel and Canada. For the first quarter of fiscal year 2012, approximately 57% of our silicon, in terms of cost of wafers purchased, was manufactured in China. Foreign sales during the first quarter of fiscal year 2012 constituted approximately 77% of our net sales. Approximately 60% of sales during the first quarter of fiscal year 2012 were to customers located in the Asia-Pacific region. The remaining foreign sales were primarily to customers in Europe, Canada, and Mexico. Critical Accounting Policies and Estimates In addition to the discussion below, you should refer to the disclosures regarding our critical accounting policies in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 30, 2011 filed with the SEC on March 31, 2011. Revenue and Cost of Sales We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is probable. Product design and engineering revenue is recognized during the period in which services are performed. We record a provision for estimated sales returns in the same period as the related revenues are recorded. We base these estimates on historical sales returns and other known factors. Actual returns could be different from our estimates and current provisions for sales returns and allowances, resulting in future charges to earnings. We defer revenue recognition on shipment of products to certain customers, principally distributors, under agreements which provide for limited pricing credits or product return privileges, until these products are sold through to end-users or the return privileges lapse. For sales subject to certain pricing credits or return privileges, the amount of future pricing credits or inventory returns cannot be reasonably estimated given the relatively long period in which a particular product may be held by the customer. Therefore, we have concluded that sales to customers under these agreements are not fixed and determinable at the date of the sale and revenue recognition has been deferred. We estimate the deferred gross margin on these sales by applying an average gross profit margin to the actual gross sales. The average gross profit margin is calculated for each category of products using current standard costs. The deferred gross margin does not include any adjustments for sales returns. The estimated deferred gross margin on these sales, where there are no outstanding receivables, is recorded on the balance sheet under the heading of "Deferred revenue." There were no significant impairments of deferred cost of sales in fiscal year 2011 or the first three months of fiscal year 2012. 19 -------------------------------------------------------------------------------- Table of Contents The following table summarizes the deferred net revenue balance: Deferred net revenue May 1, January 30, (in thousands) 2011 2011 Deferred revenues $ 5,748 $ 6,369 Less: Deferred cost of revenues (1,364 ) (1,560 ) Deferred revenues, net $ 4,384 $ 4,809 Deferred product design and enginering revenue 528 211 Total deferred revenue $ 4,912 $ 5,020 Gross Profit Gross profit is equal to our net sales less our cost of sales. Our cost of sales includes materials, depreciation on fixed assets used in the manufacturing process, shipping costs, direct labor and overhead. We determine the cost of inventory by the first-in, first-out method. Operating Costs Our operating costs and expenses generally consist of selling, general and administrative, product development and engineering costs, costs associated with acquisitions, and other operating related charges. Results of Operations The following table sets forth, for the periods indicated, our statements of operations data expressed as a percentage of revenues. Three Months Ended May 1, May 2, 2011 2010 Net Sales 100.0 % 100.0 % Cost of Sales 39.6 % 44.0 % Gross Profit 60.4 % 56.0 % Operating costs and expenses: Selling, general & administrative 21.8 % 25.9 % Product development & engineering 15.1 % 15.0 % Intangible amortization 1.7 % 2.4 % Total operating costs and expenses 38.7 % 43.2 % Operating income 21.7 % 12.7 % Interest and other income, net -0.4 % 0.2 % Income before taxes 21.3 % 12.9 % Provision for taxes 2.9 % 2.3 % Net income 18.5 % 10.6 % Percentages may not add precisely due to rounding. Our regional mix of income (loss) from continuing operations before income taxes is as follows: Three Months Ended May 1, May 2, (in thousands) 2011 2010 Domestic $ 5,549 $ (3,890 ) Foreign 20,533 17,075 Total $ 26,082 $ 13,185 Domestic income (loss) from continuing operations include amortization of acquired intangible assets, litigation expenses and higher levels of stock-based compensation compared to foreign operations. 20 -------------------------------------------------------------------------------- Table of Contents Comparison of the Three Months Ended May 1, 2011 and May 2, 2010 We report on the basis of 52 and 53 week periods and end our fiscal year on the last Sunday in January. All quarters consist of 13 weeks, except for one 14-week quarter in 53-week years. The first quarter of fiscal years 2012 and 2011 were both 13-week periods. Our estimates of sales by major end-market are detailed below: (dollars in thousands; % of net sales) Three Months Ended May 1, May 2, 2011 2010 Computing $ 9,600 7 % $ 11,233 11 % Communications 49,892 41 % 34,496 34 % High-end Consumer (1) 41,053 34 % 34,580 34 % Industrial 21,826 18 % 21,571 21 % Total $ 122,371 100 % $ 101,880 100 % (1) Approximately $3.4 million and $5.0 million of our total sales to Samsung Electronics (and affiliates), one of our significant customers, in the first quarter of fiscal years 2012 and 2011, respectively, were for products that target the handheld market (which includes mobile phones). This activity is included in the high-end consumer end-market category. Net Sales. Net sales for the first quarter of fiscal year 2012 were $122.4 million, an increase of 20% compared to $101.9 million for the first quarter of fiscal year 2011. The higher revenue in the current quarter resulted primarily from higher demand for products in the communications and high-end consumer end-markets. Gross Profit. During the first quarter of fiscal year 2012, gross profit increased to $73.9 million from $57.0 million in the first quarter of fiscal year 2011. Gross profit margins increased to 60.4% in the first quarter of fiscal year 2012 from 56.0% in the first quarter of fiscal year 2011. This increase in gross profit reflects the impact of substantially higher sales, and specifically a more favorable end-market product mix, and the benefit of higher manufacturing volumes. Also contributing to the higher margins was the impact of the transition away from lower margin Computing products within Power Management and the impact of lower stock-based compensation expense. Additionally, gross profit in the first quarter of fiscal year 2011 was negatively impacted by the sale of inventory acquired as part of the acquisition of Sierra Monolithics Inc. ("SMI"). Operating Costs and Expenses. (dollars in thousands) Three Months Ended May 1, May 2, 2011 2010 Change Selling, general and administrative $ 26,705 56 % $ 26,351 60 % 1 % Product development and engineering 18,525 39 % 15,303 35 % 21 % Intangible amortization 2,102 5 % 2,405 5 % -13 % Total operating costs and expenses $ 47,332 100 % $ 44,059 100 % 7 % Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses in the first quarter of fiscal year 2012 were impacted by higher selling costs attributable to higher sales volumes and higher salary costs associated with an overall increase in personnel. 21 -------------------------------------------------------------------------------- Table of Contents SG&A expenses for the first quarter of fiscal years 2012 and 2011 include approximately $131,000 and $1.6 million, respectively, for legal and other professional services incurred in connection with matters related to our historical stock option practices, including the related litigation, and other associated matters. These expenses also include claims for advancement of legal expenses to current and former directors, officers and employees. See Note 13 to our consolidated condensed financial statements included in Item 1 of this Quarterly Report for additional information regarding expenses related to the class action lawsuit and historical stock option matters. Product Development and Engineering Expenses The increase in product development and engineering expenses was principally driven by investments in new product and process development expenses across a majority of our product lines. The levels of product development and engineering expenses reported in a fiscal period can be significantly impacted, and therefore experience period over period volatility, by the number of new product tape-outs and by the timing of revenue from non-recurring engineering services which are typically milestone based and recorded as an off-set to product development and engineering expense. Intangible Amortization Intangible amortization reflects amortization costs associated with acquired intangibles. The decrease reflects the impact of certain intangibles that have been fully amortized. Interest and Other, Net Interest and other netted to an expense of $440,000 in the first quarter of fiscal year 2012 compared to income of $197,000 in the first quarter of fiscal year 2011. The net expense resulted from higher losses related to foreign currency transactions due to the weakening of the U.S. dollar, partially offset by a modest increase in interest income due to higher investment balances. Provision for Taxes Provision for income taxes was $3.5 million for the first quarter of fiscal year 2012, compared to $2.4 million in the first quarter of fiscal year 2011. The effective tax rates for the first quarter of fiscal years 2012 and 2011 were 13% and 18%, respectively. As a global organization, we are subject to audit by taxing authorities in various jurisdictions. To the extent that an audit, or the closure of a statute of limitations, results in our adjusting our reserves for uncertain tax positions, our effective tax rate could experience extreme volatility since any adjustment would be recorded as a discrete item in the period of adjustment. Business Outlook On May 25, 2011, we announced our outlook for the second quarter of fiscal year 2012. At that time, we expected sequential revenue to be up approximately 4% to 7% from the first quarter in line with normal seasonality and we expected earnings per diluted share of approximately $0.38 to $0.40. Refer to Exhibit 99.1 of our Current Report on Form 8-K filed with the SEC on May 25, 2011 for the complete announcement. Liquidity and Capital Resources Our capital requirements depend on a variety of factors, including but not limited to, the rate of increase or decrease in our existing business base; the success, timing and amount of investment required to bring new products to market; revenue growth or decline; and potential acquisitions. We believe that we have the financial resources necessary to meet business requirements for the next 12 months, including funds needed for working capital requirements. As of May 1, 2011, our total shareholders' equity was $574.9 million. At that date we also had approximately $264.4 million in cash and short-term investments, as well as $11.9 million in long-term investments. We have no outstanding debt. 22 -------------------------------------------------------------------------------- Table of Contents Our primary sources and uses of cash during the comparative three month periods are presented below: (in millions) Three Months Ended May 1, May 2, 2011 2010 Sources of Cash Operating activities, including changes in working capital $ 6.3 $ 8.2 Proceeds from exercise of compensatory stock plans, including tax benefits 19.6 5.3 $ 25.9 $ 13.5 Uses of Cash Capital expenditures, net of sale proceeds $ (7.5 ) $ (4.5 ) Net increase in investments (2.4 ) (34.8 ) Repurchase of outstanding common stock (0.4 ) (0.4 ) $ (10.3 ) $ (39.7 ) Net increase (decrease) in cash and cash equivalents $ 15.6 $ (26.2 ) We incur significant expenditures in order to fund the development, design, and manufacture of new products. We intend to continue to focus on those areas that have shown potential for viable and profitable market opportunities, which may require additional investment in equipment and the hiring of additional design and application engineers aimed at developing new products. Certain of these expenditures, particularly the addition of design engineers, do not generate significant payback in the short-term. We plan to finance these expenditures with cash generated by our operations and our existing cash balances. A meaningful portion of our capital resources, and the liquidity they represent, are held by our foreign subsidiaries. As of May 1, 2011, our foreign subsidiaries held approximately $210.2 million of cash, cash equivalents, and short-term investments compared to $165.7 million at January 30, 2011. If we needed these funds for investment in domestic operations, any repatriation could result in increased tax liabilities. One of our primary goals is to improve the cash flows from our existing business activities. Our cash, cash equivalents and investments, when combined with the lack of any outstanding debt obligations, give us the flexibility to use our free cash flow to return value to shareholders (in the form of stock repurchases) and also pursue business improvement opportunities. Additionally, we will continue to seek to maintain and improve our existing business performance with capital expenditures and, potentially, acquisitions that meet our rate of return requirements. Acquisitions might be made for either cash or stock consideration, or a combination of both. Operating Activities Net cash provided by operating activities is primarily due to net income adjusted for non-cash items plus fluctuations in operating assets and liabilities. Non-cash adjustments include deferred income taxes, stock-based compensation expense, depreciation, amortization of intangible assets, tax benefits from stock-based awards and gain or loss from sale of property, plant and equipment, if any. Depreciation and amortization expense was $4.3 million and $3.9 million for the first quarter of fiscal years 2012 and 2011, respectively. The increase is primarily attributable to the increase in capital expenditures in fiscal year 2011 to support the growth of the business. Changes in operating assets and liabilities used cash on a net basis in the first quarter of fiscal year 2012, driven primarily by the following: • Inventory increased by $2.4 million to support higher levels of product demand. • Prepaid expenses and other assets increased by $1.2 million primarily due to the payment of annual insurance premiums. • Accrued liabilities decreased by $29.0 million primarily due to the $20 million payment related to the stock option litigation settlement and the payment of annual bonuses earned in fiscal year 2011. • Accounts payable increased by $3.9 million due to higher operating expenses and capital expenditures required to support the overall increase in revenue and related business activities. 23 -------------------------------------------------------------------------------- Table of Contents Investing Activities Cash used for investing activities is primarily attributable to capital expenditures and purchases of investments net of proceeds from the sales/maturities of investments. Capital expenditures, net of sales proceeds were $7.5 million for the first three months of fiscal year 2012 compared to $4.5 million for the first three months of fiscal year 2011. The increase in capital expenditures was primarily to maintain and expand our test capacity, to support engineering and manufacturing functions and to improve our various facilities. Financing Activities Cash provided by financing activities is primarily attributable to the proceeds from the exercise of stock options. These proceeds were offset by the payment of statutory tax withholding obligations resulting from the vesting of restricted stock settled by withholding shares. In the first quarter of fiscal year 2012, cash proceeds from the exercise of stock options were $18.5 million compared to $5.1 million in the first quarter of fiscal year 2011. We do not directly control the timing of the exercise of stock options. Such exercises are independent decisions made by grantees and are influenced most directly by the stock price and the expiration dates of stock awards. Such proceeds are difficult to forecast since they are influenced by several factors which are outside our control. We believe that such proceeds will remain an important secondary source of cash after cash flow from operating activities. However, our business plans do not include estimates of cash receipts upon exercise of stock options. We currently have in effect a stock repurchase program. This program represents one of our principal efforts to return value to our shareholders. No shares were repurchased in the first quarter of fiscal years 2012 or 2011. In addition to the stock repurchase program, shares valued at $450,000 and $376,000 were withheld in connection with the vesting of restricted stock to cover statutory tax withholding obligations in the first quarter of fiscal years 2012 and 2011, respectively. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements, as those arrangements are defined by the SEC, that are reasonably likely to have a material effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. We do not have any unconsolidated subsidiaries or affiliated entities. We have no special purpose or limited purpose entities that provide off-balance sheet financing, liquidity or market or credit risk support. We do not engage in leasing, hedging, research and development services, or other relationships that expose us to liability that is not reflected on the face of the financial statements. Certain contractual obligations, representing various commitments we have associated with our business, such as lease commitments and open purchase obligations, are not recorded as liabilities on our balance sheet because we have not yet received the related goods or services as of May 1, 2011. Contractual Obligations There were no material changes in our contractual obligations during the first three months of fiscal year 2012 from those disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 30, 2011 filed with the SEC on March 31, 2011. Inflation Inflationary factors have not had a significant effect on our performance over the past several years. A significant increase in inflation would affect our future performance. 24 -------------------------------------------------------------------------------- Table of Contents Available Information General information about us can be found on our website at www.semtech.com. The information on our website is for informational purposes only and should not be relied on for investment purposes. The information on our website is not incorporated by reference into this Quarterly Report and should not be considered part of this or any other report filed with the SEC. We make available free of charge, either by direct access on our website or by a link to the SEC website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the SEC. Our reports filed with, or furnished to, the SEC are also available directly at the SEC's website at www.sec.gov. |