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HITTITE MICROWAVE CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) This information should be read in conjunction with our audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in our Annual Report on Form 10-K for the year ended December 31, 2010. Description of Our Revenue, Costs and Expenses Revenue. Our revenue is derived primarily from the sale of standard and custom products. We develop standard products from our own specifications, which we sell through our direct sales organization, our network of independent sales representatives, a distributor and our website. We also develop custom products to meet the specialized requirements of individual customers, which are sold by our direct sales organization. We sell our products to original equipment manufacturers, or OEMs, that supply advanced electronic systems to commercial and military end users, and to these OEMs' contract manufacturers. In general, the decision to purchase our product is made by the OEM, which has designed our product into its system. In the event that we sell to an OEM's contract manufacturer, the contract manufacturer typically does not have discretion to replace our product with one from a different supplier. Our sales cycle varies substantially, ranging from a period of a month or less when a customer selects a standard product from our catalog or website, to as long as two years or more for custom products. In the sales process, our sales and application engineers work closely with the OEM customer to analyze the customer's system requirements and select an appropriate standard product or establish a technical specification for a custom product. In the case of a custom product, we also select a semiconductor process and foundry, and evaluate test wafers and finished components before manufacturing in commercial quantities can begin. Volume purchases of our products by an OEM customer, or its contract manufacturer, generally do not occur until the OEM customer has made the decision to begin production of the system incorporating our product. Our receipt of substantial revenue from sales of a product to an OEM customer depends on that customer's commercial success in manufacturing and selling its system incorporating our product. It may take several years for a newly introduced standard product to generate substantial revenue, if ever. However, the life cycles of our standard products tend to be lengthy. Although most of our revenue is derived from sales of our products, we also receive a small percentage of our revenue from customer-sponsored research and development activities. These activities range from pure research, in which we investigate IC design techniques on new semiconductor technologies at the request of a government agency or commercial customer, to custom development projects in which we are paid to enhance or modify an existing product or develop a new product to meet a customer's specifications. Cost of revenue. Cost of revenue consists primarily of the cost of semiconductor wafers that we purchase from our third-party foundries and other materials such as packages, epoxies, connectors and production masks. Cost of revenue also includes personnel costs and overhead related to our manufacturing and engineering operations, including occupancy and equipment costs, inbound shipping costs, charges for inventory obsolescence and warranty obligations and amortization of certain intangible assets. Research and development. Research and development expense consists primarily of personnel costs of our research and development organization, costs of development wafers, license fees for computer-aided design software, costs of development testing and evaluation, costs of developing automated test software, related occupancy and equipment costs and amortization of certain intangible assets. We expense all research and development costs as incurred. Sales and marketing. Sales and marketing expense consists primarily of personnel costs of our sales and marketing organization, sales commissions paid to independent sales representatives, costs of advertising, trade shows, corporate marketing, promotion, travel, related occupancy and equipment costs, amortization of certain intangible assets and other marketing costs. General and administrative. General and administrative expense consists primarily of personnel costs of our executive management, finance, and other administrative staff, outside professional fees, related occupancy and equipment costs and other corporate expenses. Trends and Uncertainties We have been advised by one of our foundries, from which we source a substantial portion of our GaAs wafers, that it currently does not intend to renew its wafer supply agreement with us when it expires in June 2015. Given this change and resulting uncertainty regarding the availability of future supply, we plan to reduce our use of this foundry for new products, and, over time, to reduce or eliminate our wafer purchases from this foundry. We will seek to work with the foundry to manage this transition so that we can maintain adequate supplies of the affected products over their natural life cycles, which are typically five to ten years. The impact of this transition on our business is uncertain. In the near term, we do not expect the transition to have a material adverse effect on our results of operations. In the longer term, we may need to increase our raw materials inventory levels in order to support the products which have the longest life cycles, which would consume cash and could expose us to increased risk of inventory write-offs. During this transition, we could also experience adverse reactions from customers, which could affect our revenues, and the productivity of our new product development efforts could suffer as we seek to translate certain existing products to other foundries, which could affect our profitability. Products translated to other foundries could have inferior performance, production yields or costs. If any of these events were to occur to a significant degree, our business, revenues, profitability and financial condition could be adversely affected. 11 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements. The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. On an ongoing basis, we re-evaluate our judgments and estimates including those related to uncollectible accounts receivable, inventories, intangible assets, stock-based compensation, income taxes, warranty obligations, accrued expenses and other contingencies. We base our estimates and judgments on our historical experience and on other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates, and material effects on our operating results and financial position may result. 12 -------------------------------------------------------------------------------- Table of Contents For a description of the accounting policies which, in our opinion, involve the most significant application of judgment, or involve complex estimation, and which could, if different judgments or estimates were made, materially affect our reported results of operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the year ended December 31, 2010. Results of Operations Comparison of the Three Month Periods Ended June 30, 2011 and 2010 Revenue. In the three months ended June 30, 2011, our revenue increased $8.2 million, or 13.6%, to $68.5 million, compared with $60.3 million in the corresponding period of 2010. Revenue from sales to customers outside the United States accounted for 54.3% of our total revenue in the three months ended June 30, 2011, compared with 54.4% in the corresponding period of 2010. Our revenue increase was primarily attributable to increased sales to the military and test and measurement markets in comparison to the corresponding period of 2010. The growth in sales to the test and measurement market was primarily due to the increased breadth of our product offerings and the increased market acceptance of the products we introduced in prior years. The increase in sales to the military market was primarily due to shipments under a production order for microwave subsystems that we announced in February 2009. Gross margin. In the three months ended June 30, 2011, our gross margin was 72.7%, compared with 74.8% in the corresponding period of 2010. The decrease in gross margin was primarily attributable to unfavorable changes in pricing and to a lesser extent, manufacturing costs, partially offset by a favorable change in product mix. Research and development expense. In the three months ended June 30, 2011, our research and development expense increased $1.5 million, or 19.5%, to $9.4 million, and represented 13.7% of our revenue, compared with $7.8 million, or 13.0% of our revenue, in the corresponding period of 2010. The increase in our research and development expense was primarily attributable to a $0.7 million increase in personnel costs, a $0.3 million increase in intangible asset amortization, a $0.3 million increase in equipment costs, and a $0.2 million increase in travel and other costs. The increase in personnel costs was primarily due to the growth of our engineering organization, partially due to the acquisition of Arctic Silicon Devices in January 2011. We believe that a significant amount of research and development activity will be required for us to remain competitive in the future. As a result, we expect our research and development expense to increase as we add personnel and other costs to invest in the development of new products and, to a lesser extent, to support the translation of certain existing products to other GaAs foundries. Sales and marketing expense. In the three months ended June 30, 2011, our sales and marketing expense increased $0.6 million, or 11.6%, to $5.5 million, and represented 8.0% of our revenue, compared with $4.9 million, or 8.1% of our revenue, in the corresponding period of 2010. The increase in our sales and marketing expense was primarily attributable to a $0.5 million increase in personnel costs and a $0.1 million increase in other costs. The increase in personnel costs related primarily to the growth of our worldwide direct sales and marketing organization as well as an increase in equity compensation expense. We expect sales and marketing expense will increase as we hire additional personnel, continue to expand our worldwide sales and marketing activities and, to the extent that our revenue increases, pay additional commissions. General and administrative expense. In the three months ended June 30, 2011, our general and administrative expense increased $0.3 million, or 9.4%, to $2.9 million, and represented 4.3% of our revenue, compared with $2.7 million, or 4.4% of our revenue, in the corresponding period of 2010. The increase in our general and administrative expense was primarily attributable to a $0.2 million increase in personnel costs and a $0.3 million increase in other costs, partially offset by a decrease in professional fees of $0.2 million. Interest income. In the three months ended June 30, 2011, our interest income was $43,000 compared with $25,000 in the corresponding period of 2010. Interest income in both periods reflects the low effective yields that are available due to the market conditions that continue to prevail. Provision for income taxes. Our provision for income taxes increased $0.9 million to $11.4 million in the three months ended June 30, 2011, from $10.5 million in the corresponding period of 2010, representing an effective tax rate of 35.4% in both 2011 and 2010. Generally, the effective tax rates differ from the federal and state statutory tax rates primarily due to the impact of federal and state tax credits and incentives provided for under the American Jobs Creation Act of 2004, offset by the impact of non-deductible stock-based compensation. 13 -------------------------------------------------------------------------------- Table of Contents Comparison of the Six Month Periods Ended June 30, 2011 and 2010 Revenue. In the six months ended June 30, 2011, our revenue increased $21.2 million, or 18.6%, to $135.8 million, compared with $114.5 million in the corresponding period of 2010. Revenue from sales to customers outside the United States accounted for 54.8% of our total revenue in the six months ended June 30, 2011, compared with 55.0% in the corresponding period of 2010. Our revenue increase was primarily attributable to increased sales to the military and test and measurement markets in comparison to the corresponding period of 2010. The growth in sales to the test and measurement market was primarily due to the increased breadth of our product offerings and the increased market acceptance of the products we introduced in prior years. The increase in sales to the military market was primarily due to shipments under a production order for microwave subsystems that we announced in February 2009. These increases were partially offset by a decrease in sales to the microwave and millimeter wave communications market. Gross margin. In the six months ended June 30, 2011, our gross margin was 72.8%, compared with 74.1% in the corresponding period of 2010. The decrease in gross margin was primarily attributable to unfavorable changes in pricing and, to a lesser extent, manufacturing costs, partially offset by a favorable change in product mix. Research and development expense. In the six months ended June 30, 2011, our research and development expense increased $4.0 million, or 27.1%, to $18.8 million, and represented 13.8% of our revenue, compared with $14.8 million, or 12.9% of our revenue, in the corresponding period of 2010. The increase in our research and development expense was attributable to a $2.1 million increase in personnel costs, a $0.7 million increase in depreciation and amortization, a $0.6 million increase in equipment costs, a $0.3 million increase in occupancy costs and a $0.3 million increase in travel and other costs. The increase in personnel costs was primarily due to the growth of our engineering organization, partially due to the acquisition of Arctic Silicon Devices in January 2011, as well as an increase in equity compensation expense. Sales and marketing expense. In the six months ended June 30, 2011, our sales and marketing expense increased $1.4 million, or 14.6%, to $10.9 million, and represented 8.0% of our revenue, compared with $9.5 million, or 8.3% of our revenue, in the corresponding period of 2010. The increase in our sales and marketing expense was primarily attributable to a $1.0 million increase in personnel costs, a $0.3 million increase in travel costs and a $0.3 million increase in depreciation, partially offset by a $0.2 million decrease in commissions. The increase in personnel costs related primarily to the growth of our worldwide direct sales and marketing organization as well as an increase in equity compensation expense. General and administrative expense. In the six months ended June 30, 2011, our general and administrative expense increased $0.2 million, or 2.7%, to $5.9 million, and represented 4.4% of our revenue, compared with $5.8 million, or 5.0% of our revenue, in the corresponding period of 2010. The increase in our general and administrative expense was primarily attributable to a $0.4 million increase in personnel costs partially offset by a $0.2 million decrease in professional fees and other related costs. Interest income. In the six months ended June 30, 2011, our interest income was $83,000 compared with $54,000 in the corresponding period of 2010. Interest income in both periods reflects the low effective yields that are available due to the market conditions that continue to prevail. Provision for income taxes. Our provision for income taxes increased $3.0 million to $22.5 million in the six months ended June 30, 2011, from $19.5 million in the corresponding period of 2010, representing an effective tax rate of 35.4% and 35.6% in 2011 and 2010, respectively. Generally, the effective tax rates differ from the federal and state statutory tax rates primarily due to the impact of federal and state tax credits and incentives provided for under the American Jobs Creation Act of 2004, offset by the impact of non-deductible stock-based compensation. 14 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of June 30, 2011, we held $325.6 million of cash and cash equivalents. Cash provided by our operations was $45.8 million in 2011, of which the principal components were our net income of $41.0 million and non-cash charges of $12.2 million, partially offset by a net increase in operating assets and liabilities of $5.3 million and a net increase in deferred taxes of $2.2 million. The net increase in operating assets and liabilities includes an increase in accounts receivable of $2.8 million, related to our increase in revenue and the timing of customer shipments, a $5.7 million decrease in deferred revenue and customer advances, due to the timing of customer invoices, and an increase in inventory of $1.7 million, related to the growth of our business. These increases were partially offset by a $2.8 million net decrease in taxes receivable, due to the timing of tax payments and receipts, and a $2.2 million increase in accounts payable and accrued expenses, due to the growth of our business and the timing of disbursements. We invested $6.1 million in the purchase of property and capital equipment in the six months ended June 30, 2011, primarily related to building renovations, production tooling and production test equipment. In addition, we received $0.5 million from the exercise of stock options and $0.8 million from the excess tax benefit related to our stock-based compensation plans. We maintain a stock repurchase program that is designed to offset the dilutive impact of equity-based compensation granted to our employees. The shares may be repurchased from time to time on the open market or in privately negotiated transactions. We did not repurchase any shares during the six months ended June 30, 2011. The timing, price and volume of any additional repurchases will be based on market conditions, relevant securities law and other factors, as appropriate, and repurchases may be suspended or discontinued at any time. During the six months ended June 30, 2011, shares issued upon vesting of restricted stock were net of 8,078 shares retained by us to cover employee tax withholdings of $0.5 million. On January 14, 2011, we acquired all of the outstanding stock of Arctic Silicon Devices, a privately held company, for $10.4 million in cash and the assumption of a $232,000 note payable that was repaid during the six months ended June 30, 2011. We believe that our cash, cash equivalents and cash generated from operations will be sufficient to meet our anticipated cash requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support product development efforts, the expansion of our sales and marketing activities, the timing and introduction of new products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. There is no assurance that additional financing, if required or desired, will be available in amounts or on terms acceptable to us, if at all. 15 -------------------------------------------------------------------------------- Table of Contents Recent Accounting Pronouncements In April 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-17, "Milestone Method of Revenue Recognition," which amends Accounting Standards Codification (ASC) 605. ASU 2010-17 provides guidance for determining when the milestone method of revenue recognition is appropriate and how this method should be applied, and specifies related disclosure requirements. We adopted ASU 2010-17 effective January 1, 2011. Such adoption did not have a material effect on our financial position or results of operations. In December 2010, the FASB issued ASU 2010-29, "Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the EITF)." ASU 2010-29 clarifies that when presenting comparative financial statements, an entity should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only, and expands the related disclosure requirements. We adopted ASU 2010-29 effective January 1, 2011 and have applied it to business combinations for which the acquisition date is subsequent to that date. Such adoption did not have a material effect on our financial position or results of operations. In May 2011, the FASB issued ASU 2011-04, "Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS." ASU 2011-04 results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. ASU 2011-04 will be effective for us on January 1, 2012. We do not believe that the adoption of ASU 2011-04 will have a material effect on our financial condition or results of operations. In June 2011, the FASB issued ASU 2011-05, "Presentation of Comprehensive Income." ASU 2011-05 requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of equity. ASU 2011-05 will be effective for us on January 1, 2012. We do not believe that the adoption of ASU 2011-05 will have a material effect on our financial condition or results of operations. |