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PLX TECHNOLOGY INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This Report on Form 10-Q contains forward-looking statements within the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, including statements regarding our expectations, hopes, intentions, beliefs or strategies regarding the future. Forward-looking statements include statements regarding our revenue growth in the second quarter of 2013, our future research and development expenses, our future unrecognized tax benefits, our ability to meet our capital requirements for the next twelve months, our future capital requirements, that current high turns fill requirements will continue indefinitely and our anticipation that sales to a small number of customers will account for a significant portion of our sales. Actual results could differ materially from those projected in such forward-looking statements. Factors that could cause actual results to differ include unexpected changes in the mix of our product sales, unexpected pricing pressures, unexpected capital requirements that may arise due to other possible acquisitions or other events, unanticipated changes in the businesses of our suppliers, and unanticipated cash shortfalls. Actual results could also differ for the reasons noted under the sub-heading "Factors That May Affect Future Operating Results" in Item 1A, Risk Factors in Part II of this report on Form 10-Q and in other sections of this report on Form 10-Q. All forward-looking statements included in this Form 10-Q are based on information available to us on the date of this report on Form 10-Q, and we assume no obligation to update the forward-looking statements, or to update the reasons why actual results could differ from those projected in the forward-looking statements. The following discussion should be read in conjunction with the audited consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. OVERVIEW PLX Technology, Inc. ("PLX" or the "Company"), a Delaware corporation established in 1986, designs, develops, manufactures, and sells integrated circuits that perform critical system connectivity functions. These interconnect products are fundamental building blocks for standards-based electronic equipment. We market our products to major customers that sell electronic systems in the enterprise, consumer, server, storage, communications, PC peripheral and embedded markets. The explosive growth of cloud-based computing has provided a significant opportunity for PLX, since the data centers that house these systems are limited by their ability to offer high performance, low cost, low power, scalable interconnections. The level of integration is increasing, and the need for rapid expansion forces these customers to build their systems using standard-based, off-the-shelf devices. PLX is a market share leader in stand-alone PCI Express switches and bridges. We recognized the trend towards this serial, switched interconnect technology early, launched products for this market long before our competitors, and have deployed multiple generations of products to serve a general-purpose market. In addition to enabling customer differentiation through our product features, the breadth of our product offering is in itself a significant benefit to our customers, since we can serve the complete needs of our customers with cost-effective solutions tailored to specific system requirements. PLX supplies an extensive portfolio of PCI Express switches; PCI Express bridges that allow backward compatibility to the previous PCI standard; and our newest bridges enable seamless interoperability between two of the most popular mainstream interconnects: PCI Express and USB. Our long experience with PCI Express connectivity products enables PLX to deliver reliable devices that operate in non-ideal, real-world system environments. 18 -------------------------------------------------------------------------------- PLX offers a complete solution consisting of semiconductor devices, software development kits, hardware design kits, software drivers, and firmware solutions that enable added-value features in our products. We differentiate our products by offering higher performance at lower power, by enabling a richer customer experience based on proprietary features that enable system-level customer advantages, and by providing capabilities that enable a customer to get to market more quickly. We utilize a "fabless" semiconductor business model whereby we purchase wafers and packaged and tested semiconductor devices from independent manufacturing foundries. This approach allows us to focus on defining, developing, and marketing our products and eliminates the need for us to invest large amounts of capital in manufacturing facilities and work-in-process inventory. We rely on a combination of direct sales personnel, distributors and manufacturers' representatives throughout the world to sell a significant portion of our products. We pay manufacturers' representatives a commission on sales while we sell products to distributors at a discount from the selling price. The time period between initial customer evaluation and design completion is generally between six and twelve months, though it can be longer in some circumstances. Furthermore, there is typically an additional six to twelve month or greater period after design completion before a customer requests volume production of our products. Due to the variability and length of these design cycles and variable demand from customers, we may experience significant fluctuations in new orders from month to month. In addition, we typically make inventory purchases prior to receiving customer orders. Consequently, if anticipated sales and shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our results for that quarter and potentially future quarters would be materially and adversely affected. Our long-term success will depend on our ability to introduce new products. While new products typically generate little or no revenues during the first twelve months following their introduction, our revenues in subsequent periods depend upon these new products. Due to the lengthy sales cycle and additional time before our customers request volume production, significant revenues from our new products typically occur twelve to twenty-four months after product introduction. As a result, revenues from newly introduced products have, in the past, produced a small percentage of our total revenues in the year the product was introduced. See -"Our Lengthy Sales Cycle Can Result in Uncertainty and Delays with Regard to Our Expected Revenues" in Item 1A, Risk Factors, in Part II of this report on Form 10-Q. Discontinued operations On September 20, 2012, the Company completed the sale of a portion of its physical layer 10GBase-T integrated circuit ("PHY") family of products pursuant to an Asset Purchase Agreement between the Company and Aquantia Corporation dated September 14, 2012. The Company had also entered into an Asset Purchase Agreement (the "Entropic APA") with Entropic Communications, Inc., on July 6, 2012, as amended on November 21, 2012, pursuant to which the Company completed the sale of its digital channel stacking switch product line within the PHY product family, including certain assets exclusively related to the product line. Together, these divestitures completed the sale of the PHY business. The 10G Ethernet market developed more slowly than had previously been anticipated and the divestitures were intended to reduce future spending and operating losses associated with this business. The operations of the PHY related business have been segregated from continuing operations and are presented as discontinued operations in the Company's consolidated statement of operations. Unless otherwise indicated, the following discussions in Results of Operations pertain only to our continuing operations. 19 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2013 AND MARCH 31, 2012 Net Revenues The following table shows the revenue by type (in thousands) and as a percentage of net revenues: Three Months Ended March 31, 2013 2012 PCI Express Revenue $ 18,644 71.1 % $ 15,907 64.8 % Connectivity Revenue 7,574 28.9 % 8,625 35.2 % $ 26,218 $ 24,532 Net revenues consist primarily of product revenues generated principally by sales of our semiconductor devices. Net revenues for the three months ended March 31, 2013 increased 6.9%, or $1.7 million, compared to the same period in 2012. The increase was due to higher sales of our PCI Express because of the ramp of our Gen 2 and Gen 3 products, partially offset by lower sales of our Connectivity products as a result of the decline in demand for products used in systems nearing end of life and the customer transition from our legacy products to our PCI Express products. There were no direct end customers that accounted for more than 10% of net revenues. Sales to the following distributors accounted for 10% or more of net revenues: Three Months Ended March 31, 2013 2012 Excelpoint Systems Pte Ltd 34 % 25 % Avnet, Inc. 27 % 25 % Answer Technology, Inc. 11 % 22 % We currently expect to see revenue growth in the second quarter of 2013 for our PCI Express products and continued declines in the revenues of our Connectivity products. Future demand for our products is uncertain and is highly dependent on general economic conditions and the demand for products that contain our chips. Customer demand for semiconductors can change quickly and unexpectedly. Our revenue levels have been highly dependent on the amount of new orders that are received for products to be delivered to the customer within the same quarter, also called "turns fill" orders. Because of the long cycle time to build our products and our lack of visibility into demand when turns fill orders are high, it is difficult to predict which products to build to match future demand. We believe the current high turns fill requirements will continue indefinitely. The high turns fill orders pattern, together with the uncertainty of product mix and pricing, makes it difficult to predict future levels of sales and profitability and may require us to carry higher levels of inventory. Gross Margin Gross margin represents net revenues less the cost of revenues. Cost of revenues includes the cost of (1) purchasing semiconductor devices or wafers from our independent foundries, (2) packaging, assembly and test services from our independent foundries, assembly contractors and test contractors and (3) our operating costs associated with the procurement, storage, and shipment of products as allocated to production. Three Months Ended March 31, 2013 2012 in thousands Gross profit $ 15,525 $ 13,977 Gross margin 59.2 % 57.0 % 20-------------------------------------------------------------------------------- Gross profit for the three months ended March 31, 2013 increased by 11.1%, or $1.5 million compared to the same period in 2012 while gross margin increased 2.2 percentage points or 3.8%. The increase in absolute dollars was due to the increase in overall product sales. The increase in product gross margin percentage was due primarily to increased sales, product and customer mix and reduced costs on our PCI Express Gen 3 builds as we move from our early revision products to our production revision products and into production volume builds. Future gross profit and gross margin are highly dependent on the product and customer mix, provisions and sales of previously written down inventory, the position of our products in their respective life cycles and specific manufacturing costs. Accordingly, we are not able to predict future gross profit levels or gross margins with certainty. Research and Development Expenses Research and development ("R&D") expenses consist primarily of tape-out costs at our independent foundries, salaries and related costs, including share-based compensation and expenses for outside engineering consultants. Three Months Ended March 31, 2013 2012 in thousands R&D expenses $ 5,961 $ 6,545 As a percentage of revenues 22.7 % 26.7 % R&D expenses decreased by $0.6 million or 8.9% in the three months ended March 31, 2013 compared to the same period in 2012. The decrease in R&D in absolute dollars and as a percentage of revenue was primarily due to decreases in R&D spending on tape-out related activities of $0.4 million and consulting services of $0.2 million due to timing of projects taped-out. We believe continued spending on research and development to develop new products is critical to our success. R&D spending will continue to fluctuate due to timing of projects and tape-out related activities. Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") expenses consist primarily of salaries and related costs, including share-based compensation, commissions to manufactures' representatives and professional fees, as well as trade show and other promotional expenses. Three Months Ended March 31, 2013 2012 in thousands SG&A expenses $ 6,419 $ 8,522 As a percentage of revenues 24.5 % 34.7 % SG&A expenses decreased by $2.1 million or 24.7% in the three months ended March 31, 2013 compared to the same period in 2012. The decrease in SG&A in absolute dollars and a percentage of revenue was due primarily to a decrease in legal fees of $2.0 million due to the charges incurred in the three months ended March 31, 2012 in connection with the Internet Machines patent infringement lawsuit and the February 2012 trial of the First Suit. 21 -------------------------------------------------------------------------------- Acquisition and Restructuring Related Costs Three Months Ended March 31, 2013 2012 in thousands Severance costs $ 279 $ - Deal costs 12 - $ 291 $ - In the three months ended March 31, 2013, we recorded approximately $0.3 million of severance and benefit related costs, included in acquisition and restructuring related costs in the Condensed Consolidated Statement of Operations, related to the termination of 4 employees worldwide as part of the restructuring of SG&A activities as a result of the divestiture of the PHY business. In the three months ended March 31, 2013, we recorded $12,000 of outside legal and accounting costs associated with the wrap up of the IDT acquisition activities, which were terminated in December 2012. These expenses were also included in operating expenses under acquisition and restructuring related costs in the Condensed Consolidated Statement of Operations. Amortization of Acquired Intangible Assets Amortization of acquired intangible assets consists of amortization expense related to developed core technology, trade name and customer base acquired as a result of the Oxford acquisition in January 2009. Three Months Ended March 31, 2013 2012 in thousands Amortization of acquired intangible assets $ - $ 81 As a percentage of revenues 0.0 % 0.3 % Amortization of acquired intangible assets in the three months ended March 31, 2012 was related to the Oxford NAS developed core technology which became fully amortized in December 2012. There was no amortization expense in the three months ended March 31, 2013. Interest Income (Expense) and Other, Net Three Months Ended March 31, 2013 2012 in thousands Interest income $ 4 $ 10 Interest expense (65 ) (24 ) Other income (expense) (10 ) 9 $ (71 ) $ (5 ) Interest income reflects interest earned on cash, cash equivalents and short-term and long-term investment balances. Interest expense for the three months ended March 31, 2013 was due to interest recorded on the line of credit borrowings. For the same periods in 2012, interest expense consisted of interest recorded on the line of credit borrowings and our capital lease obligations. 22 -------------------------------------------------------------------------------- Other income includes foreign currency transaction gains and losses and other miscellaneous transactions. Other income may fluctuate significantly due to currency fluctuations. Provision for Income Taxes A provision for income tax of $84,000 has been recorded for the three month period ended March 31, 2013, compared to a provision of $48,000 million for the same period in 2012. Income tax expense for the three months ended March 31, 2013 is a result of applying the estimated annual effective tax rate to cumulative profit before taxes. Income tax expense for the three months ended March 31, 2012 is a result of applying the estimated annual effective tax rate to cumulative profit before taxes adjusted for certain discrete items which are fully recognized in the period they occur and miscellaneous state income taxes. We excluded from our 2012 calculation of the effective tax rate losses in the US since we cannot benefit those losses. We have determined that negative evidence supports the need for a full valuation allowance against our net deferred tax assets at this time. We will maintain a full valuation allowance until sufficient positive evidence exists to support a reversal of the valuation allowance. As of March 31, 2013, we had unrecognized tax benefits of approximately $5.4 million of which none, if recognized, would result in a reduction of our effective tax rate. There were no material changes in the amount of unrecognized tax benefits during the three months ended March 31, 2013. Future changes in the balance of unrecognized tax benefits will have no impact on the effective tax rate as they are subject to a full valuation allowance. We do not believe the amount of our unrecognized tax benefits will significantly change within the next twelve months. The Company is subject to taxation in the United States and various state and foreign jurisdictions. The tax years 2008 through 2012 remain open to examination by the federal and most state tax authorities. Net operating loss and tax credit carryforwards generated in prior periods remain open to examination. Liquidity and Capital Resources Cash and Investments We invest excess cash predominantly in certificate of deposits and debt instruments that are highly liquid, of high-quality investment grade, and predominantly have maturities of less than one year with the intent to make such funds readily available for operating purposes. As of March 31, 2013 cash, cash equivalents, short and long-term marketable securities were $13.6 million, a decrease of $3.1 million from $16.7 million at December 31, 2012. Operating Activities Three Months Ended March 31, 2013 2012 in thousandsIncome from continuing operations, net of non-cash items $ 4,072 $ 94 Loss from discontinued operations, net of non-cash items (111 ) (4,266 ) Changes in working capital (7,736 ) (366 ) Net cash used in operating activities $ (3,775 ) $ (4,538 ) Cash used in operating activities primarily consists of net income (loss) adjusted for certain non-cash items including depreciation, amortization, share-based compensation expense, provisions for excess and obsolete inventories, other non-cash items, and the effect of changes in working capital and other activities. Cash used in operating activities for the three months ended March 31, 2013 was $3.8 million compared to cash used in operating activities of $4.5 million in the same period in 2012. 2012 included loss from discontinued operations, adjusted for non-cash items, of $4.3 million. The increase in cash flow used in continuing operations was primarily due to changes in our working capital as a result of larger vendor payments related to the IDT acquisition activities and employee variable compensation payments in the first quarter of 2013 compared to 2012, partially offset by an increase in income from continuing operations, net of non-cash items. Our days sales outstanding and days payable outstanding were relatively flat. The increase in inventory from March 31, 2012 reflects the strong demand for our PCI Express products. 23 -------------------------------------------------------------------------------- Investing Activities Our investing activities are primarily driven by investment of our excess cash, sales of investments, business acquisitions and divestitures and capital expenditures. Capital expenditures have generally been comprised of purchases of engineering equipment, computer hardware, software, server equipment and furniture and fixtures. The cash used in investing activities for the three months ended March 31, 2013 of $0.4 million was due to purchases of investments (net of sales and maturities) of $0.3 million and capital expenditures of $0.1 million. Cash provided by investing activities for the three months ended March 31, 2012 of $2.0 million was due to the sales and maturities of investments (net of purchases) of $3.0 million, partially offset by capital expenditures of $1.0 million. Financing Activities Cash provided by financing activities for the three months ended March 31, 2013 of $0.8 million was due to proceeds from the exercise of stock options of $1.1 million, partially offset by taxes paid related to net share settlements of restricted stock units of $0.3 million. Cash provided by financing activities for the three month ended March 31, 2012 of $2.1 million was primarily due to borrowings against the line of credit of $7.0 million, partially offset by the payment of the note associated with the 2010 acquisition of Teranetics of $4.8 million. Obligations As of March 31, 2013, we had the following significant contractual obligations and commercial commitments (in thousands): Payments due in Less than 1-3 More than Total 1 Year Years 3 Years Operating leases - facilities and equipment $ 553 $ 258 $ 295 $ - Software licenses 6,266 4,102 2,164 - Inventory purchase commitments 9,000 9,000 - - Borrowing against line of credit 8,000 8,000 - - Total cash obligations $ 23,819 $ 21,360 $ 2,459 $ - On September 30, 2011, we entered into an agreement with Silicon Valley Bank to establish a two-year $10.0 million revolving loan facility. Borrowings under the credit facility bear interest at rates equal to the prime rate announced from time to time in The Wall Street Journal. As of March 31, 2013 the prime rate was 3.25%. The facility also provides for commitment, unused facility and letter-of-credit fees. As of March 31, 2013, we have outstanding borrowings of $8.0 million. The facility is subject to certain financial covenants for EBITDA, as defined in the agreement, and a monthly quick ratio computation (PLX's cash, investments and accounts receivable divided by current liabilities). We were in compliance with all financial covenants associated with this facility as of March 31, 2013. See Note 9 of the condensed consolidated financial statements for additional information. On April 22, 2013, the agreement was amended to increase the facility to $15.0 million and extend the maturity date to September 30, 2015. We believe that our existing resources, together with cash generated from our operations will be sufficient to meet our capital requirements for at least the next twelve months. Our future capital requirements will depend on many factors, including the level of investment we make in new technologies and improvements to existing technologies and the levels of monthly expenses required to launch new products. To the extent that existing resources and future earnings are insufficient to fund our future activities, we may need to raise additional funds through public or private financings. Additional funds may be difficult to obtain and may not be available or, if available, we may not be able to obtain them on terms favorable to us and our stockholders. 24 -------------------------------------------------------------------------------- Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and related disclosures of contingent assets and liabilities in the condensed consolidated financial statements and accompanying notes. The U.S. Securities and Exchange Commission ("SEC") has defined a company's critical accounting policies as the ones that are most important to the portrayal of the company's financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments addressed below. We also have other key accounting policies which involve the use of estimates, judgments and assumptions that are significant to understanding our results. Although we believe that our estimates, assumptions and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgments or conditions. Revenue Recognition We recognize revenue when persuasive evidence of an arrangement exists, delivery or customer acceptance, where applicable, has occurred, the fee is fixed or determinable, and collection is reasonably assured. Revenue from product sales to direct customers and distributors is recognized upon shipment and transfer of risk of loss, if we believe collection is reasonably assured and all other revenue recognition criteria are met. We assess the probability of collection based on a number of factors, including past transaction history and the customer's creditworthiness. At the end of each reporting period, the sufficiency of allowances for doubtful accounts is assessed based on the age of the receivable and the individual customer's creditworthiness. As of March 31, 2013, we offer pricing protection to two distributors whereby the Company supports the distributor's resale product margin on certain products held in the distributor's inventory. We analyze current requests for credit in process, also known as ship and debits, and inventory at the distributor to determine the ending sales reserve required for this program. We also offer stock rotation rights to three distributors such that they can return up to a total of 5% of products purchased every six months in exchange for other PLX products of equal value. We analyze inventory at distributors, current stock rotation requests and past experience, which has historically been insignificant, to determine the ending sales reserve required for this program. Provisions for reserves are charged directly against revenue and related reserves are recorded as a reduction to accounts receivable. Inventory Valuation We evaluate the need for potential inventory provisions by considering a combination of factors, including the life of the product, sales history, obsolescence, sales forecasts and expected sales prices. Any adverse changes to our future product demand may result in increased provisions, resulting in decreased gross margin. In addition, future sales on any of our previously written down inventory may result in increased gross margin in the period of sale. Allowance for Doubtful Accounts We evaluate the collectibility of our accounts receivable based on length of time the receivables are past due. Generally, our customers have between thirty and forty five days to remit payment of invoices. We record reserves for bad debts against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. Once we have exhausted collection efforts, we will reduce the related accounts receivable against the allowance established for that receivable. We have certain customers with individually large amounts due at any given balance sheet date. Any unanticipated change in one of those customers' creditworthiness or other matters affecting the collectibility of amounts due from such customers could have a material adverse effect on our results of operations in the period in which such changes or events occur. Historically, our write-offs have been insignificant. Goodwill Our methodology for allocating the purchase price related to business acquisitions is determined through established valuation techniques. Goodwill is measured as the excess of the cost of the acquisition over the amounts assigned to identifiable tangible and intangible assets acquired less assumed liabilities. We have one operating segment and business reporting unit, the sales of semiconductor devices, and we perform goodwill impairment tests annually during the fourth quarter and between annual tests if indicators of potential impairment exist. 25 -------------------------------------------------------------------------------- Long-lived Assets We review long-lived assets, principally property and equipment, for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable. We evaluate recoverability of assets to be held and used by comparing the carrying amount of an asset to estimated future net undiscounted cash flows generated by the asset. If such assets are considered to be impaired, the impairment recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. In addition, if we determine the useful life of an asset is shorter than we had originally estimated, we accelerate the rate of depreciation over the assets' new, shorter useful life. Share-Based Compensation We estimate the value of employee stock options on the date of grant using the Black-Scholes model. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to the expected stock price volatility over the term of the awards and the actual and projected employee stock option exercise behaviors. The expected term of options granted is derived from historical data on employee exercises and post-vesting employment termination behavior. We calculate expected volatility using the historical volatility of stock. We estimate the amount of forfeitures at the time of grant and revise, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The fair value of employee restricted stock units is equal to the market value of our common stock on the date the award is granted. Taxes We account for income taxes using the asset and liability method. Deferred taxes are determined based on the differences between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. As of March 31, 2013, we carried a valuation allowance for the entire deferred tax asset as a result of uncertainties regarding the realization of the asset balance. We will maintain a full valuation allowance against our deferred tax assets until sufficient positive evidence exists to support a reversal of the valuation allowance. Future taxable income and/or tax planning strategies may eliminate all or a portion of the need for the valuation allowance. In the event we determine we are able to realize our deferred tax asset, an adjustment to the valuation allowance may increase income in the period such determination is made. |