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QUICKLOGIC CORPORATION - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as information contained in "Risk Factors" in Part II, Item 1A and elsewhere in this Quarterly Report on 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. We intend that these forward-looking statements be subject to the safe harbor created by those provisions. Forward-looking statements are generally written in the future tense and/or are preceded by words such as "will," "may," "should," "forecast," "could," "expect," "suggest," "believe," "anticipate," "intend," "plan," or other similar words. Forward-looking statements include statements regarding our strategies as well as (1) our revenue levels, including the commercial success of our Customer Specific Standard Products, or CSSPs, and new products, (2) the conversion of our design opportunities into revenue, (3) our liquidity, (4) our research and development efforts, (5) our gross profit and factors that affect gross profit, (6) our level of operating expenses, (7) our partners and suppliers and (8) industry trends. The following discussion should be read in conjunction with the attached condensed unaudited consolidated financial statements and notes thereto, and with our audited consolidated financial statements and notes thereto for the fiscal year ended December 30, 2012, found in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 8, 2013. Although we believe that the assumptions underlying the forward-looking statements contained in this Quarterly Report are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements will be accurate. The risks, uncertainties and assumptions referred to above that could cause our results to differ materially from the results expressed or implied by such forward-looking statements include, but are not limited to, those discussed under the heading "Risk Factors" in Part II, Item 1A hereto and the risks, uncertainties and assumptions discussed from time to time in our other public filings and public announcements. All forward-looking statements included in this document are based on information available to us as of the date hereof. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved. Furthermore, past performance in operations and share price is not necessarily indicative of future performance. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Overview We develop and market low power customizable semiconductor solutions that enable customers to add new differentiated features to, extend battery life in and improve their visual experience with their mobile, consumer and enterprise products. Our targeted mobile market segment includes Tablets, Smartphones, Mobile Enterprise, Pico Projectors, Broadband Access Data cards, and Secure Access Data cards. Our solutions typically fall into one of three product categories: Display & Visual Enhancement, Smart Connectivity, and Security. We are a fabless semiconductor company designing Customer Specific Standard Products, or CSSPs, which are complete, customer-specific solutions that include a combination of silicon solution platforms; Proven System Blocks, or PSBs; customer-specific logic; software drivers; and firmware. Our main platform families, ArcticLink and PolarPro, are standard silicon products. PSBs that have been developed and that are available to customers include our Visual Enhancement Engine, or VEE, Display Power Optimizer, or DPO, and Background Color Compensator (BCC) technologies; Camera Interface, or CAMIF; SDHD/eMMC Host Controllers; USB 2.0 On-The-Go with PHY; MIPI Host/Device with DPHY, LVDS, MDDI Client with PHY; High Speed UARTs; Pulse Width Modulators; SPI and I2C hosts, display-specific functions such as RGB-split and Frame Recyclers; and Data Performance Manager, or DPM, for accelerated sideloading times. The variety of PSBs offered by us allows system designers to combine multiple discrete chips onto a single CSSP, simplifying design and board layout, lowering BOM cost, and accelerating time-to-market. The programmable logic of the platforms is used for adding differentiated features and provides flexibility to address hardware-based product requirements quickly. Utilizing a focused customer engagement model, we market CSSPs to Original Equipment Manufacturers, or OEMs, and Original Design Manufacturers, or ODMs, that offer differentiated mobile products, and to processor vendors wishing to expand their served available market through the deployment of reference designs to their customers. Our solutions enable OEMs and ODMs to add new features, extend battery life, and improve the visual experience of their handheld mobile devices. In addition to working directly with our customers, we partner with other companies with expertise in certain technologies to develop additional intellectual property, reference platforms and system software to provide application solutions. When we bring solutions to market with a partner company, we typically launch the solution as a Catalog CSSP. This enables us to sell the product as a 'catalog' device to any customer. In this manner, we are able to broaden the served available market for our CSSP solutions and leverage our R&D across multiple end customers. 19-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) We also work with mobile processor manufacturers in the development of reference designs or "Catalog" CSSPs. Through reference designs that incorporate our CSSPs, we believe mobile processor manufacturers can expand the served available market for their processors. Furthermore, should a CSSP development for a processor manufacturer be applicable to a set of common OEMs or ODMs, we can amortize our R&D investment over that set of OEMs/ODMs. We call this type of solution a Catalog CSSP. The first such Catalog CSSP was developed in conjunction with Texas Instruments, and introduced to the market during the second half of 2012. We are placing a greater emphasis on developing and marketing Catalog CSSPs in the future. In order to grow our revenue from its current level, we are dependent upon increased revenue from our new products including existing new product platforms and platforms currently in development. We expect our business growth to be driven by CSSPs and our CSSP revenue growth needs to be strong enough to enable us to sustain profitability while we continue to invest in the development, sales and marketing of our new solution platforms, PSBs and CSSPs. The gross margin associated with our CSSPs is generally lower than the gross margin of our FPGA products, due primarily to the price sensitive nature of the higher volume mobile consumer opportunities that we are pursuing with CSSPs. During the first quarter of 2013, we generated total revenue of $3.0 million which represents a 2% sequential decrease and a 27% decrease from the first quarter of 2012. Our new product revenue was $941,000 which represents a 6% sequential decrease and a 43% decrease year over year. Our mature product revenue was flat sequentially at $2.1 million and had a 17% decrease year over year. We shipped our new products into the Tablet, Smartphone and the Mobile Enterprise market. Since we introduced CSSPs to the market in early 2007, we have devoted substantially all of our development, sales, and marketing efforts on our new solution platforms, PSBs and CSSPs. We expect our revenue from mature products to continue to decline over time. Overall, we reported a net loss of $3.6 million for the first quarter of 2013. Critical Accounting Estimates The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our consolidated financial statements. The SEC has defined critical accounting policies as those that are most important to the portrayal of our financial condition and results of operations and require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our critical policies include revenue recognition, valuation of inventories including identification of excess quantities and product obsolescence, valuation of investments, valuation of long-lived assets, measurement of stock-based compensation and estimating accrued liabilities. We believe that we apply judgments and estimates in a consistent manner and that this consistent application results in consolidated financial statements and accompanying notes that fairly represent all periods presented. However, any factual errors or errors in these judgments and estimates may have a material impact on our financial statements. For a discussion of critical accounting policies and estimates, please see Item 7 in our Annual Report on Form 10-K for the fiscal year ended December 30, 2012, filed with the SEC on March 8, 2012. Results of Operations The following table sets forth the percentage of revenue for certain items in our statements of operations for the periods indicated: 20-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Three Months Ended March 31, April 1, 2013 2012 Revenue 100.0 % 100.0 % Cost of revenue 65.8 % 57.4 % Gross profit 34.2 % 42.6 % Operating expenses: Research and development 66.6 % 67.8 %Selling, general and administrative 83.9 % 65.3 % Restructuring costs * - % Income (loss) from operations (116.3 )% (90.5 )% Interest expense (0.3 )% (0.3 )% Interest income and other, net (0.1 )% (0.3 )% Income (loss) before income taxes (116.7 )% (91.1 )% Provision for (benefit from) income taxes 1.9 % (1.1 )% Net Income (loss) (118.6 )% (90.0 )% * Figure was not considered in the calculation due to the insignificant amount. 21-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Three Months Ended March 31, 2013 and April 1, 2012 Revenue The table below sets forth the changes in revenue for the three months ended March 31, 2013, as compared to the three months ended April 1, 2012 (in thousands, except percentage data): Three Months Ended March 31, 2013 April 1, 2012 Change % of Total % of Total Amount Revenues Amount Revenues Amount Percentage Revenue by product line (1): New products $ 941 31 % $ 1,639 40 % $ (698 ) (43 )% Mature products 2,076 69 % 2,491 60 % (415 ) (17 )% Total revenue $ 3,017 100 % $ 4,130 100 % $ (1,113 ) (27 )% _________________ (1) For all periods presented: New products represent products introduced since 2005, and include ArcticLink®, ArcticLink II, ArcticLink III, Eclipse™ II, PolarPro®, PolarPro II, and QuickPCI II. Mature products include Eclipse, EclipsePlus, pASIC® 1, pASIC 2, pASIC 3, QuickFC, QuickMIPS, QuickPCI, QuickRAM, and V3, as well as royalty revenue, programming hardware and software. The decrease in new product revenue was primarily due to a decline in shipments to broadband data card and pico projector market segment customers. The decrease in mature product revenue is due primarily to reduced orders from our customers in the aerospace, test and instrumentation sectors. In order to grow our revenue, we are dependent upon increased revenue from our new products, especially revenue from CSSPs designed using our ArcticLink, ArcticLink II, ArcticLink III, PolarPro and PolarPro II solution platforms and the development of additional new products and CSSPs. We continue to seek to expand our revenue through the pursuit of high volume sales opportunities in our target market segments and the sale of CSSPs incorporating our PSBs. Our industry is characterized by intense price competition and by lower margins as order volumes increase. While winning large volume sales opportunities will increase our revenue, due to the pricing negotiation leverage of large companies, these opportunities may decrease our gross profit as a percentage of revenue. Gross Profit The table below sets forth the changes in gross profit for the three months ended March 31, 2013 as compared to the three months ended April 1, 2012 (in thousands, except percentage data): Three Months Ended March 31, 2013 April 1, 2012 Change % of Total % of Total Amount Revenues Amount Revenues Amount Percentage Revenue $ 3,017 100 % $ 4,130 100 % $ (1,113 ) (27 )% Cost of revenue 1,986 66 % 2,371 57 % (385 ) (16 )% Gross Profit $ 1,031 34 % $ 1,759 43 % $ (728 ) (41 )% The $728,000 decrease in gross profit in the first quarter of 2013 as compared to the first quarter of 2012 was mainly due to lower revenue from our new and mature products and higher unabsorbed overhead. The inventory reserve was $343,000 and $329,000 in the first quarters of 2013 and 2012, respectively. In addition, the decrease in gross profit was partially offset by the sale of previously reserved inventories of $215,000 and $98,000 in the first quarters of 2013 and 2012, respectively. Our semiconductor products have historically had long product life cycles and obsolescence has not been a significant 22-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) factor in the valuation of inventories. However, as we pursue opportunities in the mobile market and continue to develop new CSSPs and products, we believe our product life cycle will be shorter and increase the potential for obsolescence. We also regularly review the cost of inventories against estimated market value and record a lower of cost or market reserve for inventories that have a cost in excess of estimated market value. This could have a material impact on our gross margin and inventory balances based on additional write-downs to net realizable value or a benefit from inventories previously written down. Operating Expenses The table below sets forth the changes in operating expenses for the three months ended March 31, 2013, as compared to the three months ended April 1, 2012 (in thousands, except percentage data): Three Months Ended March 31, 2013 April 1, 2012 Change % of Total % of Total Amount Revenues Amount Revenues Amount Percentage R&D expense $ 2,008 67 % $ 2,802 68 % $ (794 ) (28 )% SG&A expense 2,530 84 % 2,697 65 % (167 ) (6 )% Restructuring costs 7 - % - - % 7 - %Total operating expenses $ 4,545 151 % $ 5,499 133 % $ (954 ) (17 )% Research and Development Our research and development, or R&D, expenses consist primarily of personnel, overhead and other costs associated with engineering process improvements, programmable logic design, CSSP design and software development. The $794,000 decrease in R&D expenses in the first quarter of 2013 as compared to the first quarter of 2012 was attributable primarily to a $878,000 decrease in third party chip design costs and a $240,000 decrease in equipment and supplies. These expenses were partially offset by a $263,000 increase in compensation expenses due to an increase in headcount; a $30,000 increase in stock-based compensation expenses; a $12,000 increase in travel and entertainment expenses; a $8,000 increase in occupancy costs; and a $7,000 increase in depreciation expenses. Selling, General and Administrative Expense Our selling, general and administrative, or SG&A, expenses consist primarily of personnel and related overhead costs for sales, marketing, finance, administration, human resources and general management. The $167,000 decrease in SG&A expenses in the first quarter of 2013 as compared to the first quarter of 2012 was primarily due to a $129,000 decrease in stock-based compensation expenses; a $127,000 decrease in outside services primarily as a result of decreases in sales commissions; and a $37,000 decrease in travel and entertainment. These expenses were partially offset by a $72,000 increase in equipment and supplies; and a $42,000 increase in compensation expenses. Restructuring Costs On March 28, 2013, we implemented a restructuring plan to consolidate and streamline our engineering organization. The associated restructuring charges will be pro-rated over a three month period. Accordingly, we recorded an initial $7,000 restructuring charge for employee severance benefits in the first quarter of 2013. Interest Expense and Interest Income and Other, net The table below sets forth the changes in interest expense and interest income and other, net, for the three months ended March 31, 2013 as compared to the three months ended April 1, 2012 (in thousands, except percentage data): 23-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Three Months Ended Change March 31, April 1, 2013 2012 Amount Percentage Interest expense $ (9 ) $ (13 ) $ 4 (31 )% Interest income and other, net (4 ) (13 ) 9 (69 )% $ (13 ) $ (26 ) $ 13 (50 )% The decrease in interest expense was due primarily to the decrease in our average debt obligation to $400,000 in the first quarter of 2013 from $602,000 in the first quarter of 2012. The change in interest income and other, net, was due primarily to foreign exchange fluctuations in the first quarter of 2013 as compared to the first quarter of 2012. We conduct a portion of our research and development activities in Canada and India and we have sales and marketing activities in various countries outside of the United States. Most of these international expenses are incurred in local currency. Foreign currency transaction gains and losses are included in interest and other income (expense), net, as they occur. We do not use derivative financial instruments to hedge our exposure to fluctuations in foreign currency and, therefore, our results of operations are, and will continue to be, susceptible to fluctuations in foreign exchange gains or losses. Provision for (Benefit from) Income Taxes The table below sets forth the changes in provision for income taxes for the three months ended March 31, 2013 as compared to the three months ended April 1, 2012 (in thousands, except percentage data): Three Months Ended Change March 31, April 1, 2013 2012 Amount Percentage Provision for (benefit from) income taxes $ 57 $ (45 ) $ 102 (227 )% The provision for income taxes for the first quarters of 2013 and benefit from income taxes for the first quarter of 2012 were primarily from our foreign operations which are cost-plus entities, and due to an intraperiod tax allocation which resulted from the unrealized gain on our investment in TowerJazz offset by tax provision from our foreign operations, respectively. As of the end of the first quarter of 2013, our ability to utilize our income tax loss carryforwards in future periods is uncertain and, accordingly, we recorded a full valuation allowance against the related US tax provision. We will continue to assess the realizability of deferred tax assets in future periods. 24-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Liquidity and Capital Resources We have financed our operating losses and capital investments through sales of common stock, private equity investments, capital and operating leases, and cash flows from operations. As of March 31, 2013, our principal sources of liquidity consisted of our cash and cash equivalents of $19.7 million, available credit under our revolving line of credit with Silicon Valley Bank of $6.0 million, and our investment in TowerJazz with a market value of approximately $303,000. The borrowing under the Company's line of credit is subject to maintaining a tangible net worth of at least $15.0 million, unrestricted cash or cash equivalent balance of at least $8.0 million and a quick ratio of 2-to-1. The term of the revolving debt facility expires in June 2013. Upon each advance, the Company can elect a fixed interest rate, which is the prime rate plus the prime rate margin, or a fixed rate which is the LIBOR plus the LIBOR rate margin. We were in compliance with all loan covenants as of the end of the current reporting period. As of March 31, 2013, there were no borrowings against the line of credit. Most of our cash and cash equivalents were invested in a US Treasury money market fund rated AAAm/Aaa. Our interest-bearing debt consisted of $374,000 outstanding under capital leases (see Note 6 of the Condensed Unaudited Consolidated Financial Statements). As of March 31, 2013, the 42,970 shares of our investment in TowerJazz had a market value of approximately $303,000. Cash balances held at our foreign subsidiaries were approximately $675,000 and $461,000 at March 31, 2013 and December 30, 2012, respectively. Earnings from our foreign subsidiaries are currently deemed to be indefinitely reinvested. We do not expect such reinvestment to affect our liquidity and capital resources, and we continually evaluate our liquidity needs and ability to meet global cash requirements as a part of our overall capital deployment strategy. Factors which affect our global capital deployment strategy include anticipated cash flows, the ability to repatriate cash in a tax efficient manner, funding requirements for operations and investment activities, acquisitions and divestitures, and capital market conditions. Net cash from operating activities Net cash used for operating activities was $2.8 million in the first three months of 2013. The cash used for operating activities resulted from changes in working capital offset by a net loss of $3.6 million which included $1.1 million of net non-cash charges. These non-cash charges consisted primarily of stock-based compensation of $452,000, depreciation and amortization of $317,000, and a write-down of inventory of $343,000. In addition, changes in working capital provided cash of $388,000 in the first three months of 2013. Net cash used for operating activities was $2.8 million in the first three months of 2012. The cash used for operating activities was primarily derived from (1) a net loss of $3.7 million; (2) $1.0 million of net non-cash charges; and (3) net changes in working capital, which provided cash of $63,000 in the first three months of 2012. The non-cash charges consisted primarily of stock-based compensation of $384,000, depreciation and amortization of $290,000, and a write-down of inventory of $329,000. The net changes in working capital included an increase in other assets of $195,000; an increase in accrued liabilities of $336,000; and an increase in accounts receivable of $85,000. This was offset by a decrease in trade payables of $420,000 and a decrease in inventories of $318,000. Net cash from investing activities Net cash used by investing activities for the first three months of 2013 was $62,000, which was primarily used to acquire equipment and software used for the production and development of new products. Capital expenditures, which are largely driven by the development of new products and manufacturing levels, are projected to be approximately $1.4 million during the remainder of fiscal year 2013. Net cash used by investing activities for the first three months of 2012 was $69,000, resulting primarily from purchases of capital expenditures to acquire manufacturing equipment. Net cash from financing activities Net cash used by financing activities was $28,000 for the first three months of 2013, derived from $35,000 of scheduled payments under the terms of our capital lease obligations, offset by $7,000 in proceeds related to the issuance of common shares to employees under our equity plans. 25-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) Net cash used by financing activities was $77,000 for the first three months of 2012, resulting from $39,000 in proceeds related to the issuance of common shares to employees under our equity plans, partially offset by $116,000 of scheduled payments under the terms of our capital lease obligations. We require substantial cash to fund our business. However, we believe that our existing cash resources will be sufficient to fund operations and capital expenditures, and provide adequate working capital for at least the next twelve months. After the next twelve months, our cash requirements will depend on many factors including our level of revenue and gross profit, the market acceptance of our existing and new products, the levels at which we maintain inventories and accounts receivable, costs of securing access to adequate manufacturing capacity, new product development efforts, capital expenditures and the level of our operating expenses. Contractual Obligations and Commercial Commitments The following table summarizes our contractual obligations and commercial commitments as of March 31, 2013 and the effect such obligations and commitments are expected to have on our liquidity and cash flows in future fiscal periods (in thousands): Payments Due by Period Less than More than Total 1 Year 1-3 Years 3 Years Contractual obligations: Operating leases $ 2,531 $ 919 $ 1,580 $ 32 Wafer purchases (1) 3,521 3,521 - - Other purchase commitments 799 799 - - Total contractual cash obligations 6,851 5,239 1,580 32 Other commercial commitments (2): Revolving line of credit - - - - Capital lease obligations (3) 374 239 135 - Total commercial commitments 374 239 135 - Total contractual obligations and commercial commitments (4) $ 7,225 $ 5,478 $ 1,715 $ 32 _________________ (1) Certain of our wafer manufacturers require us to forecast wafer starts several months in advance. We are committed to take delivery of and pay for a portion of forecasted wafer volume. Wafer purchase commitments of $3.5 million include firm purchase commitments as of March 31, 2013. (2) Other commercial commitments are included as liabilities on our balance sheets as of March 31, 2013. (3) For detailed explanation, see Note 6 of the Condensed Unaudited Consolidated Financial Statements. (4) Does not include unrecognized tax benefits of $79,000 as of March 31, 2013. See Note 12 of the Condensed Unaudited Consolidated Financial Statements. Concentration of Suppliers We depend on a limited number of contract manufacturers, subcontractors and suppliers for wafer fabrication, assembly, programming and testing of our devices, and for the supply of programming equipment. These services are typically provided by one supplier for each of our devices. We generally purchase these single or limited source services through standard purchase orders. Because we rely on independent subcontractors to perform these services, we cannot directly control product delivery schedules, costs or quality levels. These subcontract manufacturers produce products for other companies and we must place orders in advance of expected delivery. As a result, we have only a limited ability to react to fluctuations in demand for our products, which could cause us to have an excess or a shortage of inventories of a particular product. Our ability to respond to changes in demand is limited by our supplier's ability to provide products with the quantity, quality, cost and timeliness that we require. A supplier's decision not to provide these services to us or its inability to supply these services to us, such as in the case of a natural or financial disaster, would have a significant impact on our business. Increased demand from other companies 26-------------------------------------------------------------------------------- Table of Contents Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - (Continued) could result in these subcontract manufacturers allocating available capacity to customers that are larger or have long-term supply contracts in place and we may be unable to obtain adequate foundry and other capacity at acceptable prices, or we may experience delays or interruption in supply. Additionally, volatility of economic, market, social and political conditions in countries where these suppliers operate may be unpredictable and could result in a reduction in product revenue or increase our cost of revenue and could adversely affect our business, financial condition and results of operations. Off-Balance Sheet Arrangements We do not maintain any off-balance sheet partnerships, arrangements or other relationships with unconsolidated entities or others, often referred to as structured finance or special purpose entities, which are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Recently Issued Accounting Pronouncements See Note 2 of the Condensed Unaudited Consolidated Financial Statements for a description of recent accounting pronouncements, including the respective dates of adoption and effects on results of operations and financial condition. 27-------------------------------------------------------------------------------- Table of Contents |