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INPHI CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this Report. This Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, terms "objective," "should," "can," "believe," "expect," "estimate," "predict," "potential," "anticipate," "will," "contemplate," "would," "project," "plan," "may," "could," "intend," "likely," "might," "continue" or the negative of these terms, and similar expressions that contemplate future events may identify forward-looking statements, including statements regarding our expectation of revenue and operating expenses, sources of revenue, our tax benefits, the benefits of our products and services, timing of the development of our products, our anticipated cash needs and our estimates regarding our capital requirements and our needs for additional financing, our anticipated growth and growth strategies, our ability to retain and attract customers, particularly in light of our dependence on a limited number of customers for a substantial portion of our revenue, our expectations regarding competition, interest rate sensitivity, adequacy of our disclosure controls, our legal proceedings and warranty claims. These forward-looking statements involved known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these or any other forward-looking statements. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as factors affecting our quarterly results, our ability to manage our growth, our ability to sustain or increase profitability, demand for our solutions, the effect of declines in average selling prices for our products, our ability to compete, our ability to rapidly develop new technology and introduce new products, our ability to safeguard our intellectual property, trends in the semiconductor industry and fluctuations in general economic conditions, and the risks set forth throughout this Report, including the risks set forth under Part II, Item 1A, "Risk Factors". Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management's opinions only as of the date hereof. These forward-looking statements speak only as of the date of this Report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any changes in events, conditions or circumstances on which any such statement is based. Finally, our historic results should not be viewed as indicative of future performance. All references to "Inphi," "we," "us" or "our" mean Inphi Corporation. Inphi®, iMB™ and the Inphi logo are trademarks or service marks owned by Inphi. All other trademarks, service marks and trade names appearing in this report are the property of their respective owners. Overview Our Company We are a fabless provider of high-speed analog semiconductor solutions for the communications and computing markets. Our analog semiconductor solutions provide high signal integrity at leading-edge data speeds while reducing system power consumption. Our semiconductor solutions are designed to address bandwidth bottlenecks in networks, maximize throughput and minimize latency in computing environments and enable the rollout of next generation communications and computing infrastructures. Our solutions provide a vital high-speed interface between analog signals and digital information in high-performance systems such as telecommunications transport systems, enterprise networking equipment, datacenters and enterprise servers, storage platforms, test and measurement equipment and military systems. We provide 40G and 100G high-speed analog semiconductor solutions for the communications market and high-speed memory interface solutions for the computing market. We have a broad product portfolio with 17 product lines and over 170 products as of June 30, 2011, including our new 100 GbE CMOS SerDes architecture, or iPHY, which is designed to enable the development of next generation low power and high port density 100 Gigabit Ethernet (100 GbE) solutions to address bandwidth bottlenecks in next generation data center and communications infrastructures. We also introduced in the first quarter of 2011 our 2850TA dual-channel transimpedance amplifier, or TIA, which enables the deployment of industry standard single wavelength 100G coherent transport systems. A detailed discussion of our business may be found in Part I, Item 1, "Business," of our 2010 Annual Report on Form 10-K. Quarterly Update As discussed in more detail below, for the three and six months ended June 30, 2011 compared to the three and six months ended June 30, 2010, we delivered the following financial performance: • Total revenues increased by $2.9 million, or 14%, to $24 million in the three months ended June 30, 2011 as compared to three months ended June 30, 2010. In the six months ended June 30, 2011, total revenues increased by $5.3 million, or 13%, to $45.5 million as compared to six months ended June 30, 2010. • Total operating expenses increased by $3.1 million, or 31%, to $12.8 million in the three months ended June 30, 2011 as compared to three months ended June 30, 2010. In the six months ended June 30, 2011, total operating expenses increased by $5.0 million, or 27%, to $23.8 million as compared to six months ended June 30, 2010. 18 -------------------------------------------------------------------------------- Table of Contents • Income from operations decreased by $1.3 million, or 32%, to $2.7 million in the three months ended June 30, 2011 as compared to three months ended June 30, 2010. In the six months ended June 30, 2011, income from operations decreased by $1.0 million, or 15%, to $5.9 million as compared to six months ended June 30, 2010. • Diluted earnings per share decreased by $0.06, or 43%, to $0.08 in the three months ended June 30, 2011 as compared to three months ended June 30, 2010. In the six months ended June 30, 2011, diluted earnings per share decreased by $0.25, or 61%, to $0.16 as compared to six months ended June 30, 2010. • Cash flow from operations decreased by $6.3 million, or 72%, to $2.4 million in the six months ended June 30, 2011 as compared to six months ended June 30, 2010. The increase in our revenue in both periods was a result of increase in demand of our high speed memory interface products and to a lesser degree the sale of our storage products as a result of acquisition of Winyatek Technology Inc. Over the remainder of the fiscal year, we expect revenue will continue to increase due to new products that we plan to introduce in 2011. Our income from operations decreased due to increased operating expenses in both periods. Total operating expenses increased in both periods compared to the same period in 2010 due primarily to an increase in headcount and stock-based compensation. Our expenses primarily consist of personnel costs, which include compensation, benefits, payroll related taxes and stock-based compensation. The acquisition of Winyatek Technology Inc. on June 30, 2010 increased our headcount by 29. In addition, we also hired 29 new employees, primarily in the engineering department. We expect expenses to continue to increase in absolute dollars as we continue to invest resources to develop more products, to support the growth of our business and the cost associated with being a public company including, compliance with Sarbanes-Oxley Act of 2002. Our diluted earnings per share decreased primarily due to the reversal of deferred tax assets valuation allowance of $7 million and $17 million during the three and six months ended June 30, 2010, respectively, new issuance of common stock as a result of initial public offering in November 2010 and due to preferred stock outstanding as of June 30, 2010, which was excluded from the diluted earnings per share calculation as they were antidilutive. Shares of our preferred stock were converted into common stock in November 2010 upon completion of our initial public offering. Our cash and cash equivalents were $32.6 million at June 30, 2011, compared with $110 million at December 31, 2010. We generated cash flow from operations of $2.4 million during the six months ended June 30, 2011 compared to $8.7 million during the six months ended June 30, 2010. Cash used in investing activities during the six months ended June 30, 2011 was $89.6 million primarily due to purchases of marketable securities. We generated cash flow from financing activities of $9.6 million primarily due to proceeds from exercise of stock options and warrants of $3.3 million and excess tax benefit on stock-based compensation of $6.1 million. We received net proceeds of $1.3 million from the completion of our secondary public offering in April 2011. We also paid $1 million cost of initial public offering. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to allowances for doubtful accounts, warranty reserves, inventory reserves, stock-based compensation expense, goodwill and purchased intangible asset valuations, deferred income tax asset valuation allowances, uncertain tax positions, litigation and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. For a description of our critical accounting policies and estimates, please refer to the "Critical Accounting Policies and Estimates" section of our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2010. There have been no material changes in any of our critical accounting policies during the six months ended June 30, 2011. 19 -------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth a summary of our statement of operations as a percentage of each line item to the revenue: Three Months Six Months Ended June 30, Ended June 30, 2011 2010 2011 2010 Total revenue 100% 100% 100% 100% Cost of revenue 35 35 35 36 Gross profit 65 65 65 64 Operating expense: Research and development 30 24 30 26 Sales and marketing 13 10 12 10 General and administrative 10 12 10 11 Total operating expenses 53 46 52 47 Income from operations 12 19 13 17 Other income - - - - Income before income taxes 12 19 13 17 Provision (benefit) for income taxes 2 (17) 2 (32) Net income 10% 36% 11% 49% Comparison of Three and Six Months Ended June 30, 2011 and 2010 Revenue Three Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Total revenue $24,001 $21,099 $2,902 14 % Six Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Total revenue $45,505 $40,185 $5,320 13 % Total revenue for three and six months ended June 30, 2011 increased compared to corresponding 2010 periods due to increases in the number of units sold of 55% and 33%, respectively. The increases in number of units sold were mainly due to storage products sold by our Taiwan subsidiary, which we acquired on June 30, 2010 and sale of our high speed memory interface products. The increases were partially offset by a year over year decrease in average selling price of approximately 26% and 15% for three and six months ended June 30, 2011, respectively. The decrease in average selling price was due to change in product mix, mainly from the storage products of our Taiwan subsidiary sold at lower prices. Cost of Revenue and Gross Profit Three Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Cost of revenue $8,458 $7,344 $1,114 15% Gross profit $15,543 $13,755 $1,788 13% Gross profit as a percentage of revenue 65% 65% - - 20 -------------------------------------------------------------------------------- Table of Contents Six Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Cost of revenue $15,845 $14,531 $1,314 9% Gross profit $29,660 $25,654 $4,006 16% Gross profit as a percentage of revenue 65% 64% - 1% Cost of revenue for the three and six months ended June 30, 2011 increased primarily due to an increase in the number of units purchased by customers as described above. Product costs as a percentage of revenue were relatively unchanged for both periods as compared to the prior year. Research and Development Three Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Research and development $7,292 $5,126 $2,166 42 % Six Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Research and development $13,661 $10,192 $3,469 34 % Research and development expenses for three and six months ended June 30, 2011 increased compared to corresponding 2010 periods due to the increase in research and development headcount and the acquisition of Winyatek Technology Inc. in June 2010, which resulted in increase in personnel costs, including stock-based compensation expense of $1.5 million and $2.3 million, respectively. In addition, pre-production engineering mask costs increased by $0.4 million and $0.6 million, and consulting fees increased by $0.2 million and $0.5 million for the three and six months ended June 30, 2011, respectively. The increase in research and development expense was primarily driven by our strategy to expand our product offerings and enhance our existing products. Specifically, we accelerated the development of our products for next generation communications networks and high-speed memory interfaces. Sales and Marketing Three Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Sales and marketing $3,138 $2,049 $1,089 53 % Six Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Sales and marketing $5,719 $4,124 $1,595 39% Sales and marketing expenses for three and six months ended June 30, 2011 increased compared to corresponding 2010 periods primarily due to an increase in personnel costs, including stock-based compensation expense of $0.8 million and $1.0 million, respectively, to support increased sales activities. In addition, commission expense increased by $0.1 million and $0.2 million for the three and six months ended June 30, 2011, respectively, as a result of increase in revenue. 21 -------------------------------------------------------------------------------- Table of Contents General and Administrative Three Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) General and administrative $2,377 $2,568 $(191) (7) % Six Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) General and administrative $4,419 $4,471 $(52) (1) % General and administrative expenses for the three and six months ended June 30, 2011 decreased compared to corresponding 2010 periods primarily due to a reduction in legal fees. Legal fees decreased by $0.8 million and $1.2 million for the three and six months ended June 30, 2011, respectively, primarily related to litigation matters described in note 15 of the notes to our financial statements. The decrease was offset by increase in personnel costs, including stock-based compensation expense of $0.4 million and $0.6 million for the three and six months ended June 30, 2011, respectively, due to an increase headcount. Our directors' fees increased by $0.1 million for the three and six months ended June 30, 2011 due to the addition of two directors in 2010 as we transitioned to a public company. In addition, for the six months ended June 30, 2011, other consulting fees increased by $0.1 million for consulting services in information technology and human resource functions. Provision (benefit) for Income Tax Three Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Provision (benefit) for income tax $383 $(3,600) $3,983 111% Six Months Ended June 30, Change 2011 2010 Amount % (dollars in thousands) Provision (benefit) for income tax $1,149 $(12,717) $13,866 109% The income tax expense for the three and six months ended June 30, 2011 reflects an effective tax rate of 14% and 19%, respectively. The effective tax rates for the three and six months ended June 30, 2011 differs from the statutory rate of 35% primarily due to foreign income taxes provided at lower rates, geographic mix in profitability, recognition of research and development credits, and unrecognized tax benefits. During the three and six months ended June 30, 2010, we recorded an income tax benefit of $3.6 million and $12.7 million that reflects an effective tax rate benefit of 91% and 185%, respectively. The effective tax rate benefit differs from the statutory rate of 35% due to a release of our valuation allowance and, to a lesser extent, foreign income taxes provided at lower rates, geographic mix in profitability, recognition of California research and development credits, and unrecognized tax benefits. Liquidity and Capital Resources As of June 30, 2011, we had cash and cash equivalents and investments in marketable securities of $119.1 million. Our primary uses of cash are to fund operating expenses, purchase inventory and acquire property and equipment. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, as reflected in the changes in our outstanding accounts payable and accrued expenses. Our primary sources of cash are cash receipts on accounts receivable from our revenue. Aside from the growth in amounts billed to our customers, net cash collections of accounts receivable are impacted by the efficiency of our cash collections process, which can vary from period to period, depending on the payment cycles of our major customers. 22-------------------------------------------------------------------------------- Table of Contents The following table summarizes our cash flows for the periods indicated: Six Months Ended June 30, 2011 2010 (in thousands) Net cash provided by operating activities $ 2,407 $ 8,714 Net cash used in investing activities (89,590) (3,998 ) Net cash provided by financing activities 9,574 354 Effect of currency exchange rate on cash (1) - Net increase (decrease) in cash and cash equivalents $ (77,610 ) $ 5,070 Net Cash Provided by Operating Activities Net cash provided by operating activities for the six months ended June 30, 2011 primarily reflected net income of $4.8 million, change in income tax payable/receivable of $1.9 million, increase in accrued expenses of $2.0 million, depreciation and amortization of $1.6 million and stock-based compensation of $2.9 million, offset by increases to accounts receivable of $0.8 million and inventories of $1.2 million, decreases to accounts payable of $0.7 million and deferred revenue of $0.6 million, deferred income taxes of $0.8 million and excess tax benefit related to stock-based compensation of $6.1 million. Accrued expenses increased as a result of inventories received not yet invoiced by the vendors. Our accounts receivable increased due to higher product shipments in the second quarter of 2011. Our inventories increased as a result of growing production for expected delivery to customers in the third quarter of 2011. Our accounts payable decreased due to payments to vendors. Our deferred revenue decreased as distributors reduced their inventory levels and shipped parts to end customers to meet their demand. Net cash provided by operating activities during the six months ended June 30, 2010 primarily reflected net income of $19.6 million, increases to accounts payable and accrued expenses of $1.6 million, deferred revenue of $3.2 million, depreciation and amortization of $0.7 million and stock-based compensation of $0.8 million offset by increases in inventory of $1.1 million, accounts receivable of $1.7 million and deferred income taxes of $14.1 million. Our accounts payable and accrued expenses increased as a result of increased production volumes. Our deferred revenue increased because of shipments made to distributors close to the end of the period to meet delivery requirements of end customers. Our inventories increased as a result of growing production for immediate delivery to customers in the third quarter of 2010, and accounts receivable increased as a result of increased shipments. Net Cash Used in Investing Activities During the six months ended June 30, 2011, net cash used in investing activities consisted of cash used to purchase investments in marketable securities of $87 million and property and equipment of $2.6 million mainly for laboratory equipment and leasehold improvements for our offices in California. Net cash used in investing activities during the six months ended June 30, 2010 consisted of net cash used to acquire all of the outstanding shares of Winyatek Technology Inc. of $2.5 million and purchases of property and equipment of $1.5 million. Net Cash Provided by Financing Activities Net cash provided by financing activities in 2011 consisted primarily of $6.1 million excess tax benefit related to stock-based compensation, net proceeds from secondary offering of $1.3 million and proceeds from the exercise of stock options and warrants of $3.3 million. In addition, we also paid $1.1 million of expenses related to initial public offering. Net cash provided by financing activities during the six months ended June 30, 2010 consisted primarily of $0.4 million proceeds from the exercise of stock options. 23 -------------------------------------------------------------------------------- Table of Contents Operating and Capital Expenditure Requirements Our principal source of liquidity as of June 30, 2011 consisted of $119.1 million of cash, cash equivalents and investments in marketable securities. Based on our current operating plan, we believe that our existing cash and cash equivalents and investments in marketable securities from operations will be sufficient to finance our operational cash needs through at least the next 12 to 18 months. In the future, we expect our operating and capital expenditures to increase as we increase headcount, expand our business activities and grow our end customer base which will result in higher needs for working capital. Our ability to generate cash from operations is also subject to substantial risks described in Part II, Item 1A, Risk Factors. If any of these risks occur, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash and cash equivalents to support our working capital and other cash requirements. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through debt financing or from other sources. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility, and would also require us to incur interest expense. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us. Off-Balance Sheet Arrangements As of June 30, 2011, we have not engaged in any off-balance sheet arrangements, such as the use of structured finance, special purpose entities or variable interest entities. Recent Authoritative Accounting Guidance See note 2 of the notes to our unaudited condensed consolidated financial statements for information regarding recently issued accounting pronouncements. 24 -------------------------------------------------------------------------------- Table of Contents |