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CYPRESS SEMICONDUCTOR CORP /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The Management's Discussion and Analysis of Financial Condition and Results of Operations in this Quarterly Report of Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve risks and uncertainties, which are discussed in the "Forward-Looking Statements" section under Part I of this Quarterly Report on Form 10-Q. Adjustment to Previously Announced Preliminary Quarterly Results On April 19, 2012, we issued a press release announcing our preliminary quarterly results for the three months ended April 1, 2012. In the press release, we reported cost of revenues of $86.2 million, net loss of $12.4 million and $0.08 net loss per share in the Condensed Consolidated Statement of Operations for the three months ended April 1, 2012. Subsequent to the issuance of our press release, we recorded an adjustment to our reported results relating to the signing of a strategic Patent License Agreement which covers prior years. The adjustment was a charge to cost of revenues of approximately $7.1 million which increased our cost of revenues to $93.3 million, our net loss to $19.5 million and our net loss per share to $0.13 for the three months ended April 1, 2012. Refer to Note 15 of Notes to Condensed Consolidated Financial Statements under Part I, Item 1 for more information on this adjustment. EXECUTIVE SUMMARY General Cypress Semiconductor Corporation ("Cypress") delivers high-performance, mixed-signal, programmable solutions that provide customers with rapid time-to-market and exceptional system value. Our offerings include the flagship PSoC® families and derivatives such as CapSense® touch sensing and TrueTouch™ solutions for touchscreens. We are the world leader in USB controllers, including the high-performance West Bridge® solution that enhances connectivity and performance in multimedia handsets. In addition we are the industry leader in the high-performance SRAM memory market and a market leader in programmable timing devices. We serve numerous markets including consumer, mobile handsets, computation, data communications, automotive, industrial and military. Cypress programmable products can be found in a wide array of the world's leading end products, including cell phones, tablets, PCs and PC peripherals, audio and gaming devices, household appliances, and communications devices. As discussed in Note 14 of Notes to Condensed Consolidated Financial Statements under Part I, Item 1 - Financial Statements, we have realigned our business segments as outlined below. Business Segments Description MPD: Memory Products Division An existing division that will continue to focus on our four SRAM business units, general-purpose programmable clocks and process technology licensing. DCD: Data Communications Division An existing division realigned to focus solely on USB controllers, WirelessUSB™ and West Bridge® peripheral controllers for handsets, PCs and tablets. PSD: Programmable Systems Division A new division focusing primarily on our PSoC® and PSoC-based products. This business segment focuses on (1) the PSoC platform family of devices including PSoC 1, PSoC 3 and PSoC 5 and all derivatives; (2) PSoC-based user interface products such as CapSense® touch-sensing and TrueTouch touchscreen products; (3) PSoC-based module solutions including Trackpad and Ovation™ Optical Navigation Sensors (ONS); (4) automotive products; and (5) certain legacy product lines. ETD: Emerging Technologies Division Our "startup" division, which includes Cypress Envirosystems, AgigA Tech Inc. and Deca Technologies Inc., all majority-owned subsidiaries of Cypress. ETD also includes our foundry business and other development-stage activities. 31 -------------------------------------------------------------------------------- Table of Contents Manufacturing Strategy Our core manufacturing strategy-"flexible manufacturing"-combines capacity from foundries with output from our internal manufacturing facilities. This initiative is intended to allow us to meet rapid swings in customer demand while lessening the burden of high fixed costs, a capability that is particularly important in high-volume consumer markets that we serve with our leading programmable product portfolio. Results of Operations Revenues The following table summarizes our consolidated revenues by segments under the new reporting structure: Three Months Ended April 1, April 3, 2012 2011 (In thousands) Programmable Systems Division $ 81,535 $ 94,848 Memory Products Division 81,879 104,867 Data Communications Division 19,946 32,812 Emerging Technologies Division 1,729 583 Total Revenues $ 185,089 $ 233,110 Programmable Systems Division: Revenues from the Programmable Systems Division decreased by $13.3 million in the first quarter of fiscal 2012, or approximately 14%, compared to the same prior-year period. The decrease was primarily attributable to a decline in sales of our TrueTouch® touchscreen products and a decrease in sales of our PSoC platform family of devices. The decreases were partially offset by an increase in sales of our legacy controller communication products. The decrease in our TrueTouch® revenue stream was primarily due to a decrease in revenue from our handset customers and lower average selling prices. Memory Products Division: Revenues from the Memory Products Division decreased by approximately $23 million in the first quarter of fiscal 2012 or approximately 21.9%, compared to the same prior-year period. The decrease in MPD revenue was primarily attributable to (1) $10.8 million decrease in revenue of our SRAM products driven by the decreased demand from wireless and wireline end customers; (2) $7.6 million decrease in revenue due to the divestiture of our Image Sensors business unit during the three months ended April 3, 2011; (3) $2.7 million decrease in revenue of our general-purpose programmable clocks; and (4) $2.1 million decrease in revenue of our dual-port memories. Data Communications Division: Revenues from the Data Communications Division decreased by $12.9 million in the first quarter of fiscal 2012 or approximately 39.2%, compared to the same prior-year period primarily due to the decreases in sales of our West Bridge controllers and other USB related products. Emerging Technologies Division: Revenues from Emerging Technologies Division increased by $1.1 million in the first quarter of fiscal 2012 compared to the same prior-year period primarily due to the overall increase in demand as certain of our Emerging Technologies have begun initial production ramps. 32-------------------------------------------------------------------------------- Table of Contents Cost of Revenues/Gross Margins Three Months Ended April 1, April 3, 2012 2011 (In thousands) Cost of revenues $ 93,308 $ 104,334 Gross Margin 49.6 % 55.2 % Gross margin percentage decreased to 49.6% in the first quarter of fiscal 2012 from 55.2% in the first quarter of fiscal 2011. Gross margin decreased by 5.6 percentage points primarily due to (i) $7.1 million patent license fee recorded during the three months ended April 1,2012 related to a Patent License Agreement discussed in Note 15 of Notes to Condensed Consolidated Financial Statements under Part I, Item 1 and (ii) the impact of the negative gross margins of our majority-owned subsidiaries (i.e., emerging technologies), particularly Deca Technologies, Inc. which has commenced revenue generating activities during the first quarter of fiscal 2012. Research and Development ("R&D") Expenses Three Months Ended April 1, 2012 April 3, 2011 (In thousands) R&D expenses $ 47,968 $ 47,865 As a percentage of revenues 25.9 % 20.5 % Our future operating results depend to a considerable extent on our ability to maintain a competitive advantage. Our research and development efforts are focused on the development and design of new semiconductor products, as well as the continued development of advanced software platforms primarily for our programmable solutions and investments in new products for our Emerging Technologies Division. Our goal is to increase efficiency in order to maintain our competitive advantage. R&D expenditures during the first quarter of fiscal 2012 were relatively flat compared to the same prior-year period. As a percentage of revenues, R&D expenses were higher in the first quarter of 2012 driven by the decrease in total revenues in the same quarter. We continue to make substantial investments in R&D to ensure the availability of innovative products that meet the current and projected requirements of our customers' most advanced designs. Selling, General and Administrative ("SG&A") Expenses Three Months Ended April 1, 2012 April 3, 2011 (In thousands) SG&A expenses $ 60,494 $ 58,652 As a percentage of revenues 32.7 % 25.2 % SG&A expenses increased by $1.8 million in the first quarter of fiscal 2012 compared to the same prior-year period. The increase was primarily attributable to $1.3 million increase in professional and legal fees due mainly to our legal efforts to protect our intellectual property and $8.8 million increase in stock-based compensation which was primarily due to the additional compensation expense related to the vesting acceleration of certain performance-based awards discussed in Note 7 of Notes to Condensed Consolidated Financial Statements under Part I, Item 1. The said increases were partially offset by (i) $4.1 million donation of a building to a charitable organization in the first quarter of fiscal 2011; (ii) $2.0 million decrease in direct and indirect labor expenses, particularly bonus-related expenses and (iii) $1.5 million decrease in marketing and advertising expenses primarily due to the annual sales conference which took place in the first quarter of fiscal 2011 which did not take place in the first quarter of fiscal 2012. 33-------------------------------------------------------------------------------- Table of Contents Gain on Divestiture As part of our continued efforts to focus on programmable products including our flagship PSoC ® programmable system-on-chip solutions and our TrueTouch™ touch-sensing controllers, we divested our image sensors product families and sold them to ON Semiconductor Corporation for a total cash consideration of $34.0 million during the three months ended April 3, 2011. In connection with the divestiture, we recorded a gain of $34.3 million in our Condensed Statement of Operations for the three months ended April 3, 2011. We did not have any divestitures during the three months ended April 1, 2012. Income Taxes Our income tax expense was $2.5 million and $1.4 million for the three months ended April 1, 2012 and April 3, 2011, respectively. The tax provision for the first quarter of fiscal 2012 and fiscal 2011 was primarily attributable to income taxes associated with our non-U.S. operations. LIQUIDITY AND CAPITAL RESOURCES The following table summarizes information regarding our cash and investments and working capital: As of April 1, 2012 January 1, 2012 (In thousands) Cash and cash equivalents $ 61,284 $ 99,717 Short-term investments 47,434 66,613 Total cash, cash equivalents and short-term investments $ 108,718 $ 166,330 Total current assets $ 359,990 $ 405,650 Total current liabilities 369,883 326,460 Working capital (deficit) $ (9,893 ) $ 79,190 Key Components of Cash Flows Three Months Ended April 1, 2012 April 3, 2011 (In thousands) Net cash provided by operating activities $ 16,327 $ 35,343 Net cash provided by investing activities $ 1,493 $ 30,711 Net cash used in financing activities $ (56,253 ) $ (209,639 ) Three Months Ended April 1, 2012: During the three months ended April 1, 2012, cash and cash equivalents decreased by approximately $38.4 million primarily due to the $56.3 million cash we used in our financing activities (principally related to our cash dividend and stock buyback programs), partially offset by the cash we generated from our operating and investing activities of approximately $16.3 million and $1.5 million, respectively. 34 -------------------------------------------------------------------------------- Table of Contents Operating Activities The $16.3 million cash generated from our operating activities during the three months ended April 1, 2012 was primarily due to $44.9 million in net favorable non-cash adjustments to our net loss, an increase in accounts payable and other liabilities and a decrease in accounts receivable, partially offset by the decrease in deferred margin on sales to distributors, an increase in inventories and increase in other current and long-term assets. The key changes in our working capital as of April 1, 2012 compared to January 1, 2012 were as follows: • Total cash, cash equivalents and short-term investments decreased by $57.6 million primarily due to cash dividend and stock buyback programs. • Deferred margin on sales to distributors decreased by $23.1 million due to the decrease in distributor shipments. • Borrowings of $50 million in the first quarter of fiscal 2012 from a line of credit. • Deferred margin on sales to distributors decreased by $23.1 million due to the decrease in distributor shipments. • Other current liabilities increased by $9.6 million primarily due to the accrual of a patent license fee related to a Patent License Agreement discussed in Note 15 of Notes to Condensed Consolidated Financial Statements under Part I, Item 1. • Dividends payable increased by $2.9 million due to the increase in dividend per share from $0.09 to $0.11. Investing Activities During the three months ended April 1, 2012, we generated approximately $1.5 million of cash from our investing activities which was primarily due to $18.7 million net proceeds from the sales or maturities and purchases of available for sale investments, partially offset by $10.0 million cash we used for property and equipment expenditures and $7.2 million cash used for other investing activities. Financing Activities During the three months ended April 1, 2012, we used approximately $56.3 million cash in our financing activities. The net cash used in our financing activities was primarily due to $78.3 million cash we used to repurchase shares of our stock in the open market, $19.7 million payment related to statutory income tax withholdings on vested restricted stock awards in lieu of issuing shares of stock (considered as part of the our stock buyback program) and $13.8 million dividends paid, partially offset by the $50.0 million cash we drew from a line of credit and $6.2 million net proceeds from the issuance of common shares under our employee stock plans. Three Months Ended April 3, 2011: During the three months ended April 3, 2011, cash and cash equivalents decreased by approximately $143.6 million primarily due to the $209.6 million cash we used in our financing activities (principally related to our stock buyback programs), partially offset by the cash we generated from our operating and investing activities of approximately $35.3 million and $30.7 million, respectively. Operating Activities The $35.3 million cash we generated from our operating activities during the three months ended April 3, 2011 was primarily driven by net income adjusted for certain non-cash items including depreciation and amortization, stock-based compensation and partially offset by the gain on the divestiture of our Image Sensors business unit. Investing Activities During the three months ended April 3, 2011, we generated approximately $30.7 million cash from our investing activities which was primarily due to $34.9 million net proceeds from the sales or maturities and purchases of available for sale investments, and the receipt of approximately $15.0 million from the divestiture of our Image Sensors business unit, partially offset by $19.3 million cash we used for property and equipment expenditures. Financing Activities During the three months ended April 3, 2011, we used approximately $209.6 million cash in our financing activities. The net cash we used in our financing activities was primarily due to $116.4 million net cash we used related to our yield enhancement program, $76.4 million to repurchase shares of our stock and $40.7 million payment related to statutory income tax withholdings on vested restricted stock awards in lieu of issuing shares of stock, partially offset by $23.9 million proceeds from the issuance of common shares under our employee stock plans. 35 -------------------------------------------------------------------------------- Table of Contents Liquidity and Contractual Obligations Liquidity Stock Buyback Programs: On September 20, 2011, our Board of Directors authorized a new $400 million stock buyback program. The program allows us to purchase our common stock or enter into equity derivative transactions related to our common stock. The timing and actual amount expended with the new authorized funds will depend on a variety of factors including the market price of our common stock, regulatory, legal, and contractual requirements, other uses of cash, and other market factors. The program does not obligate us to repurchase any particular amount of common stock and may be modified or suspended at any time at the discretion of our board of directors. For the three months ended April 1, 2012, we used approximately $98 million from this program to repurchase approximately 6.1 million shares at an average share price of $16.15. Since we announced the new $400 million stock buyback program in September 2012 through the end of the first quarter of fiscal 2012, we used approximately $177.8 million from this program to repurchase approximately 11.1 million shares at an average share price of $15.98. As of April 1, 2012, the total dollar value of the shares that may be repurchased under the program was approximately $222.2 million. Contractual Obligations The following table summarizes our contractual obligations as of April 1, 2012: 2013 and 2015 and After Total 2012 2014 2016 2016 (In thousands) Purchase obligations (1) $ 78,368 $ 77,392 $ 976 $ - $ - Operating lease commitments 23,722 5,195 9,172 5,986 3,369 Capital lease commitments 16,578 2,011 5,362 9,205 - Patent license fee commitments (2) 14,000 14,000 - - - Total contractual obligations $ 132,668 $ 98,598 $ 15,510 $ 15,191 $ 3,369 (1) Purchase obligations primarily include non-cancelable purchase orders for materials, services, manufacturing equipment, building improvements and supplies in the ordinary course of business. Purchase obligations are defined as enforceable agreements that are legally binding on us and that specify all significant terms, including quantity, price and timing. (2) On April 30, 2012, we entered into a patent license agreement whereby we have committed to pay a total patent license fee of $14 million in fiscal 2012. We have also committed to pay another $5.8 million on or before April 30, 2016 representing fees for future purchases of patents and patent related services. As of April 1, 2012, our unrecognized tax benefits were $27.9 million, which were classified as long-term liabilities. We believe it is possible that we may recognize approximately $2.5 million to $3.5 million of our existing unrecognized tax benefits within the next twelve months as a result of the lapse of statutes of limitations and the resolution of agreements with domestic and various foreign tax authorities. Equity Investment Commitments As disclosed in Note 5 of Notes to Condensed Consolidated Financial Statements under Part I, Item 1 - Financial Statements, we have committed to purchase additional preferred stock from a company that works in the area of advanced battery storage in a series of subsequent closings subject to certain performance milestones that must be fulfilled within a defined and agreed upon timeline. Our future commitment to purchase additional preferred stock is approximately $0.6 million in fiscal 2012, $60.8 million in fiscal 2013 and $17.8 million in fiscal 2014 subject to the attainment of certain milestones and the timing of additional capital requests which could vary substantially. 36-------------------------------------------------------------------------------- Table of Contents Capital Resources and Financial Condition Our long-term strategy is to maintain a minimum amount of cash and cash equivalents for operational purposes and to invest the remaining amount of our cash in interest-bearing and highly liquid cash equivalents, debt securities and the purchase of our stock through our stock buyback program and payments of regularly scheduled cash dividends. As of April 1, 2012, in addition to $61.3 million in cash and cash equivalents, we had $47.4 million invested in short-term investments for a total cash and short-term investment position of $108.7 million that is available for use in our current operations. As of April 1, 2012, approximately 9% of our cash, cash equivalents and available-for-sale investments are offshore funds. While these amounts are primarily invested in U.S. dollars, a portion is held in foreign currencies. All offshore balances are exposed to local political, banking, currency control and other risks. In addition, these amounts, if repatriated may be subject to tax and other transfer restrictions. We believe that liquidity provided by existing cash, cash equivalents and available-for-sale investments and our borrowing arrangements will provide sufficient capital to meet our requirements for at least the next twelve months. However, should prevailing economic conditions and/or financial, business and other factors beyond our control adversely affect the estimates of our future cash requirements, we could be required to fund our cash requirements by alternative financing. There can be no assurance that additional financing, if needed, would be available on terms acceptable to us or at all. We may choose at any time to raise additional capital or debt to strengthen our financial position, facilitate growth, enter into strategic initiatives including the acquisition of other companies and provide us with additional flexibility to take advantage of other business opportunities that arise. 37-------------------------------------------------------------------------------- Table of Contents Non-GAAP Financial Measures Regulation G, conditions for use of Non-Generally Accepted Accounting Principles ("Non-GAAP") financial measures, and other SEC regulations define and prescribe the conditions for use of certain Non-GAAP financial information. To supplement our condensed consolidated financial results presented in accordance with GAAP, we use Non-GAAP financial measures which are adjusted from the most directly comparable GAAP financial measures to exclude certain items, as described below. Management believes that these Non-GAAP financial measures reflect an additional and useful way of viewing aspects of our operations that, when viewed in conjunction with our GAAP results, provide a more comprehensive understanding of the various factors and trends affecting our business and operations. Non-GAAP financial measures used by us include gross margin, research and development expenses, selling, general and administrative expenses, operating income or loss, net income or loss and basic and diluted net income or loss per share. Our Non-GAAP measures primarily exclude stock-based compensation, acquisition-related charges, impairments to goodwill, gain or losses on divestiture, investment-related gains and losses, discontinued operations, restructuring costs and other special charges and credits. Management believes these Non-GAAP financial measures provide meaningful supplemental information regarding our strategic and business decision making, internal budgeting, forecasting and resource allocation processes. In addition, these Non-GAAP financial measures facilitate management's internal comparisons to our historical operating results and comparisons to competitors' operating results. We use each of these Non-GAAP financial measures for internal managerial purposes, when providing our financial results and business outlook to the public, to facilitate period-to-period comparisons and are used to formulate our formula driven cash bonus plan and any milestone based stock awards. Management believes that these Non-GAAP measures provide meaningful supplemental information regarding our operational and financial performance of current and historical results. Management uses these Non-GAAP measures for strategic and business decision making, internal budgeting, forecasting and resource allocation processes. In addition, these Non-GAAP financial measures facilitate management's internal comparisons to our historical operating results and comparisons to competitors' operating results. The following table shows our Non-GAAP financial measures: Three Months Ended April 1, 2012 April 3, 2011 (In thousands, except per share amounts) Non-GAAP gross margin $ 103,182 $ 135,427 Non-GAAP research and development expenses $ 40,632 $ 41,883 Non-GAAP selling, general and administrative expenses $ 41,502 $ 44,750 Non-GAAP operating income $ 21,048 $ 48,794 Non-GAAP net income attributable to Cypress $ 20,530 $ 48,483 Non-GAAP net income per share attributable to Cypress- diluted $ 0.12 $ 0.24 We believe that providing these Non-GAAP financial measures, in addition to the GAAP financial results, are useful to investors because they allow investors to see our results "through the eyes" of management as these Non-GAAP financial measures reflect our internal measurement processes. Management believes that these Non-GAAP financial measures enable investors to better assess changes in each key element of our operating results across different reporting periods on a consistent basis and provides investors with another method for assessing our operating results in a manner that is focused on the performance of our ongoing operations. 38 -------------------------------------------------------------------------------- Table of Contents CYPRESS SEMICONDUCTOR CORPORATION RECONCILIATION OF GAAP FINANCIAL MEASURES TO NON-GAAP FINANCIAL MEASURES (In thousands, except per-share data) (Unaudited) Three Months Ended April 1, 2012 April 3, 2011 (In thousands, except per share amounts) GAAP gross margin $ 91,781 $ 128,776 Patent license fee 7,100 - Stock-based compensation expense 4,039 6,510 Changes in value of deferred compensation plan 262 203 Impairment of assets and others - (62 ) Non-GAAP gross margin $ 103,182 $ 135,427 GAAP research and development expenses $ 47,968 $ 47,865 Stock-based compensation expense (6,913 ) (5,473 ) Changes in value of deferred compensation plan (423 ) (509 ) Non-GAAP research and development expenses $ 40,632 $ 41,883 GAAP selling, general and administrative expenses $ 60,494 $ 58,652 Stock-based compensation expense (17,785 ) (8,854 ) Changes in value of deferred compensation plan (1,254 ) (923 ) Building donation - (4,125 ) Impairment of assets and other 47 - Non-GAAP selling, general and administrative expenses $ 41,502 $ 44,750 GAAP operating income (loss) $ (17,640 ) $ 55,118 Stock-based compensation expense 28,737 20,837 Patent license fee 7,100 - Changes in value of deferred compensation plan 1,939 1,635 Acquisition-related expenses 731 698 Restructuring charges 228 734 Gain on divestiture - (34,291 ) Building donation - 4,125 Impairment of assets and others (47 ) (62 ) Non-GAAP operating income $ 21,048 $ 48,794 39 -------------------------------------------------------------------------------- Table of Contents CYPRESS SEMICONDUCTOR CORPORATION RECONCILIATION OF GAAP FINANCIAL MEASURES TO NON-GAAP FINANCIAL MEASURES -(Continued) (In thousands, except per-share data) (Unaudited) GAAP net income (loss) attributable to Cypress $ (19,460 ) $ 55,374 Stock-based compensation 28,737 20,837 Patent license fee 7,100 - Impairment of assets and other 2,022 (62 ) Acquisition-related expenses 731 698 Restructuring charges 228 734 Changes in value of deferred compensation plan (555 ) 162 Gain on divestiture - (34,291 ) Investment-related gains/losses - 71 Building donation - 4,125 Tax effects 1,727 835 Non-GAAP net income attributable to Cypress $ 20,530 $ 48,483 GAAP net income (loss) per share attributable to Cypress-diluted $ (0.13 ) $ 0.28 Stock-based compensation expense and other 0.17 0.10 Patent license fee 0.04 - Impairment of assets and other 0.01 - Acquisition-related expenses 0.01 0.01 Gain on divestiture - (0.17 ) Building donation - 0.02 Tax effects 0.01 - Non-GAAP share count adjustment 0.01 - Non-GAAP net income attributable to Cypress- diluted $ 0.12 $ 0.24 |