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M/A-COM TECHNOLOGY SOLUTIONS HOLDINGS, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with the Company's combined consolidated financial statements and notes as of September 27, 2013 and September 28, 2012, and for each of the three years in the period ended September 27, 2013, included in the Company's Current Report on Form 8-K filed with the SEC on July 3, 2014. M/A-COM Technology Solutions Holdings, Inc. and its subsidiaries are collectively referred to herein as "MACOM," the "Company," "we," "us" or "our." Cautionary Note Regarding Forward-Looking Statements This Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other sections of this Quarterly Report on Form 10-Q contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such statements. Forward-looking statements include statements as to industry trends and our future expectations and other matters that do not relate strictly to historical facts. These statements are often identified by the use of words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "estimate," or "continue," and similar expressions or variations. These statements are based on management's beliefs and assumptions as of the date of this Quarterly Report on Form 10-Q, based on information currently available to us. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. Important factors that could cause actual results to differ materially from the forward-looking statements include, among others, the risks described herein in Part II. Item 1A, "Risk Factors" and in the section entitled "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended September 27, 2013 as filed with the SEC on December 5, 2013. We caution the reader to carefully consider such factors. Furthermore, such forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Overview We are a leading provider of high-performance analog semiconductor solutions for use in wireless and wireline applications across the radio frequency (RF), microwave and millimeterwave spectrum and in high speed communications. We leverage our system-level expertise to design and manufacture differentiated, high-value products for customers who demand high performance, quality and reliability. The diversity and depth of our business across technologies, products, applications, end markets, and geographies provide us with opportunities for growth and enable us to develop broad relationships with our customers. We offer over 3,000 standard and custom devices, which include integrated circuits (ICs), multi-chip modules, power pallets and transistors, diodes, switches and switch limiters, crosspoint switches, signal conditioners, optical physical media devices, passive and active components, and complete subsystems, across more than 50 product lines serving over 6,000 end customers in four large primary markets with opportunities for long-term future growth. Our semiconductor products are electronic components that our customers incorporate into their larger electronic systems, such as point-to-point radios, radar, optical transceivers, broadband access networking equipment, metropolitan and wide-area networking equipment, automobile navigation systems, cable television (CATV) set-top boxes, magnetic resonance imaging systems, and unmanned aerial vehicles. On December 18, 2013, we completed the acquisition of Mindspeed Technologies, Inc. (Mindspeed) (Mindspeed Acquisition), a supplier of high performance analog products previously headquartered in Southern California. We believe Mindspeed aligns with our core growth strategy in networking and optical markets, has a high-performance analog business model that is consistent with our target model for higher margin products with long product lifecycles and long-standing customer relationships, complements our existing business with an established footprint in the Asia-Pacific markets and expands our addressable market for silicon-germanium (SiGe) products and technology. The operations of Mindspeed have been included in our consolidated financial statements since the date of acquisition. Our primary markets are Networks, which includes CATV, cellular backhaul, cellular infrastructure, enterprise networking and broadcast video transmission applications, and optical communications applications; Aerospace and Defense (A&D); Automotive, which includes global positioning modules (GPS) we sell to the automotive industry; and, Multi-market, which includes industrial, medical, and scientific applications. With the acquisition of Mindspeed, we reported a fifth market in the first and second quarters of fiscal year 2014, Enterprise Networks. After further evaluation and following our integration of the Mindspeed business, we combined the Carrier Networks and Enterprise Networks markets as Networks due to the similarity of the products and overlapping customers, which makes separate tracking difficult. 19-------------------------------------------------------------------------------- Table of Contents We have one reportable operating segment, semiconductors and modules. We have a 52 or 53-week fiscal year ending on the Friday closest to September 30. The three and nine months ended July 4, 2014, includes 13 and 40 weeks, respectively, and fiscal year 2014 will include 53 weeks. The three and nine months ended June 28, 2013, included 13 and 39 weeks, respectively, and fiscal year 2013 included 52 weeks. To offset the effect of holidays, we include the extra week arising in our fiscal years in the first quarter, the effect of which was not material to the three and nine months ended July 4, 2014. Subsequent to closing the Mindspeed Acquisition, in February 2014, we divested the wireless business of Mindspeed. The operations of the wireless business are included in discontinued operations. On February 13, 2014, we completed the acquisition of Nitronex, LLC (Nitronex) (the Nitronex Acquisition). Nitronex designs, develops, manufactures and markets gallium nitride (GaN) semiconductors and is headquartered in the Raleigh, North Carolina area. We completed the Nitronex Acquisition through a cash payment of $26.1 million for all of the outstanding membership interests of Nitronex. We funded the Nitronex Acquisition through the use of available cash and borrowings under our revolving credit facility. On May 9, 2014, Mindspeed completed the sale of its CPE communication processor product line for $12.0 million and a potential additional $2.0 million based upon the achievement of certain revenue related milestones through December 31, 2014. Because we and Nitronex were controlled by the same majority owner since June 25, 2012, we present combined financial statements in a manner similar to a pooling-of-interests for all periods since June 25, 2012, the earliest date of common control. Accordingly, our historical financial statements have been retroactively combined as if Nitronex was acquired on June 25, 2012. All periods from June 25, 2012, have been combined using historical amounts of each entity. Since February 13, 2014, the results of Nitronex are included on a consolidated basis. Description of Our Revenue, Cost of Revenue and Expenses Revenue. Substantially all of our revenue is derived from sales of high-performance analog semiconductor solutions for use in wireless and wireline applications across the RF, microwave and millimeterwave spectrum and in high speed communications. We design, integrate, manufacture, and package differentiated product solutions that we sell to customers through our direct sales organization, our network of independent sales representatives, and our distributors. We believe the primary drivers of our future revenue growth will include: • engaging early with our lead customers to develop products and solutions that can be driven across multiple growth markets; • leveraging our core strength and leadership position in standard, catalog products that service all of our end applications; • increasing content of our semiconductor solutions in our customers' systems through cross-selling of our more than 50 product lines; • introducing new products through internal development and acquisitions with market reception that command higher prices based on the application of advanced technologies such as GaN, added features, higher levels of integration and improved performance; and, • realizing growth in the market for high-performance analog semiconductors generally, and in our four primary markets in particular. Our core strategy is to develop innovative, high-performance products that address our customers' most difficult technical challenges in our primary markets: Networks, A&D, Automotive and Multi-market. While sales in any or all of our primary markets may slow or decline from period to period, over the long-term we generally expect to benefit from strength in these markets. We expect growth in the Networks market to be primarily driven by continued upgrades and expansion of communications equipment to support expansion in Internet traffic, driven by the proliferation of mobile computing devices such as smartphones and tablets, coupled with bandwidth rich services such as video on demand and cloud computing, as well as demand for higher bandwidth wired and wireless services, the rapid adoption of cloud-based services, and the migration to an application centric architecture, which we expect will drive faster adoption of higher speed, low latency optical and wireless links. 20-------------------------------------------------------------------------------- Table of Contents We expect growth in the A&D market to be driven by the upgrading of radar applications and battlefield communications devices designed to improve situational awareness. Growth in this market is subject to changes in governmental programs and budget funding, which is difficult to predict. We expect continued strength in the Automotive market subject to fluctuations in our largest customer's market share and overall macroeconomic conditions. The Multi-market is our most diverse market, and we expect steady growth over the long-term in this market for our multi-purpose catalog products. We believe GaN technology will be a key long-term enabler in growth applications across a number of our commercial and defense-related markets, and that we are well-positioned to differentiate ourselves from competitors in the GaN market in the future by providing customers with a secure, dual source supply chain for high-performance GaN devices. Cost of revenue. Cost of revenue primarily consists of the cost of semiconductor wafers and other materials used in the manufacture of our products, and the cost of assembly and testing of our products, whether performed by our internal manufacturing personnel or outsourced vendors. Cost of revenue also includes costs associated with personnel engaged in our manufacturing operations, such as wages and share-based compensation expense, as well as costs and overhead related to our manufacturing operations, including lease occupancy and utility expense related to our manufacturing operations, depreciation, production computer services and equipment costs, and the cost of our manufacturing quality assurance and supply chain activities. Further, cost of revenue includes the impact of warranty and inventory adjustments, including write-downs for excess and obsolete inventory, and for value adjustments related to the accounting for acquisitions, as well as amortization of intangible assets related to acquired technology. Our gross margin in any period is significantly affected by industry demand and competitive factors in the markets into which we sell our products. Gross margin is also significantly affected by our product mix, that is, the percentage of our revenue in that period that is attributable to relatively higher or lower-margin products. Additional factors affecting our gross margin include fluctuations in the cost of wafers and materials, including precious metals, utilization of our wafer fabrication operation, or fab, level of usage of outsourced manufacturing, assembly and test services, changes in our manufacturing yields, changes in foreign currencies, and numerous other factors, some of which are not under our control. As a result of these or other factors, we may be unable to maintain or increase our gross margin in future periods and our gross margin may fluctuate from period to period. Research and development. Research and development (R&D) expense consists primarily of costs relating to our employees engaged in the design and development of our products and technologies, including wages and share-based compensation. R&D expense also includes costs for consultants, facilities, services related to supporting computer design tools used in the engineering and design process, prototype development, and project materials. We expense all research and development costs as incurred. We have made a significant investment in R&D since March 2009, and expect to maintain or increase the dollar amount of R&D investment in future periods as we continue to invest in new product development, although amounts may increase or decrease in any individual quarter. Selling, general and administrative. Selling, general and administrative (SG&A) expense consists primarily of costs of our management, sales and marketing, finance, human resources, and administrative organizations, including wages and share-based compensation. SG&A expense also includes costs associated with being a public company, professional fees, sales commissions paid to independent sales representatives, costs of advertising, trade shows, marketing, promotion, travel, occupancy and equipment costs, computer services costs, costs of providing customer samples, amortization of certain acquisition-related intangible assets relating to customer relationships, and costs and expenses to acquire businesses. 21 -------------------------------------------------------------------------------- Table of Contents Contingent consideration. We have partially funded the acquisition of businesses through contingent earn-out consideration in which we have agreed to pay contingent amounts to the previous owners of acquired businesses based upon those businesses achieving contractual milestones. We record these obligations as liabilities at fair value and any changes in fair value are reflected in our earnings. As of July 4, 2014, we had no outstanding earn-out obligations. Restructuring charges. Restructuring expense consists of severance and related costs incurred in connection with reductions in staff relating to initiatives designed to lower our manufacturing and operating costs and integrate acquired businesses, including restructuring actions taken following the Mindspeed and Nitronex acquisitions. Other income (expense). Other income (expense) consists of our stock warrant liability expense and/or gain, interest expense, income from transition services provided related to sales of businesses and assets, and income from our administrative and business development services agreement with GaAs Labs, which is one of our stockholders and an affiliate of our directors and majority stockholders John and Susan Ocampo. We expect interest expense to be higher in future periods due to increased borrowing to partially fund the Mindspeed and Nitronex acquisitions as well as provide additional liquidity. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements. The preparation of financial statements, in conformity with generally accepted accounting principles in the U.S. (GAAP) requires management to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty. On an ongoing basis, we re-evaluate our estimates and judgments. We base our estimates and judgments on our historical experience and on other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making the judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The accounting policies which our management believes involve the most significant application of judgment, or involve complex estimation, include revenue recognition, inventory, warranty obligations, share-based compensation, income taxes, and fair value measurements related to acquisitions of businesses and common stock warrant liabilities. Actual results could differ from those estimates, and material effects on our operating results and financial position may result. For a description of the accounting policies which, in our opinion, involve the most significant application of judgment, or involve complex estimation, and which could, if different judgments or estimates were made, materially affect our reported results of operations, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the fiscal year ended September 27, 2013. As discussed in Part II, Item 1A. "Risk Factors", as an emerging growth company and pursuant to Section 102(6)(1) of the JOBS Act, we have elected to delay adoption of new or revised accounting standards that have different effective dates for public and private companies until those standards apply to private companies, and thus our financial statements may not be comparable to those of other companies that comply with public company effective dates. Results of Operations We acquired Nitronex on February 13, 2014. Because we and Nitronex were under common control since June 25, 2012, we present combined financial statements in a manner similar to a pooling-of-interests for all periods since June 25, 2012, the earliest date of common control. Accordingly, our historical financial statements have been retroactively combined as if Nitronex was acquired on June 25, 2012. All periods from June 25, 2012, have been combined using historical amounts of each entity. In addition, our financial results include 13 and 40 weeks, respectively, for the three and nine months ended July 4, 2014, and 13 and 39 weeks, respectively, for the three and nine months ended June 28, 2013. 22 -------------------------------------------------------------------------------- Table of Contents The following table sets forth, for the periods indicated, our statement of operations data (in thousands): Three Months Ended Nine Months Ended July 4, June 28, July 4, June 28, 2014 2013 2014 2013 Revenue $ 112,364 $ 83,477 $ 304,345 $ 238,396 Cost of revenue (1) 62,150 47,973 191,546 138,573 Gross profit 50,214 35,504 112,799 99,823 Operating expenses: Research and development (1) 20,810 12,139 53,587 33,938 Selling, general and administrative (1) (3) 22,065 13,449 65,952 38,106 Contingent consideration - - - (577 ) Restructuring charges - 1,060 15,725 1,060 Total operating expenses 42,875 26,648 135,264 72,527 Income (loss) from operations 7,339 8,856 (22,465 ) 27,296 Other income (expense): Warrant liability (expense) gain (2) (2,782 ) 1,060 (5,566 ) (2,035 ) Interest expense (1) (5,625 ) (190 ) (7,833 ) (616 ) Other income 1,354 123 2,441 293 Total other income (expense) (7,053 ) 993 (10,958 ) (2,358 ) Income (loss) before income taxes 286 9,849 (33,423 ) 24,938 Income tax provision (benefit) (897 ) 2,869 (8,168 ) 8,482 Income (loss) from continuing operations 1,183 6,980 (25,255 ) 16,456 Loss from discontinued operations - - (4,605 ) - Net income (loss) $ 1,183 $ 6,980 $ (29,860 ) $ 16,456 (1) Amortization expense related to intangible assets arising from acquisitions and amortization of deferred financing costs recorded as interest expense included in our consolidated statements of operations is set forth below (in thousands): Three Months Ended Nine Months Ended July 4, June 28, July 4, June 28, 2014 2013 2014 2013 Amortization expense: Cost of revenue $ 6,270 $ 745 $ 14,292 $ 2,235 Selling, general and administrative 505 334 1,374 1,002 Share-based compensation expense: Cost of revenue 646 243 1,355 823 Research and development 893 421 2,105 1,226 Selling, general and administrative 1,851 756 5,065 2,317 Potential earn-out payments: Research and development - 1,021 - 1,021 Selling, general and administrative - 569 - 569 Amortization of deferred financing costs - interest expense 2,402 74 2,640 247 (2) Represents changes in the fair value of common stock warrants recorded as liabilities and adjusted each reporting period to fair value. (3) Includes transaction expenses of $4.7 million in the nine months ended July 4, 2014, and litigation costs of $1.8 million and $3.2 million, respectively, in the three and nine months ended July 4, 2014. 23 -------------------------------------------------------------------------------- Table of Contents The following table sets forth, for the periods indicated, our statement of operations data expressed as a percentage of our revenue: Three Months Ended Nine Months Ended July 4, June 28, July 4, June 28, 2014 2013 2014 2013 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Cost of revenue 55.3 57.5 62.9 58.1 Gross margin 44.7 42.5 37.1 41.9 Operating expenses: Research and development 18.5 14.5 17.6 14.2 Selling, general and administrative 19.6 16.1 21.7 16.0 Contingent consideration - - - (0.2 ) Restructuring charges - 1.3 5.2 0.4 Total operating expenses 38.2 31.9 44.4 30.4 Income (loss) from operations 6.5 10.6 (7.4 ) 11.4 Other income (expense): Warrant liability (expense) gain (2.5 ) 1.3 (1.8 ) (0.9 ) Interest expense (5.0 ) (0.2 ) (2.6 ) (0.3 ) Other income 1.2 0.1 0.8 0.1 Total other income (expense) (6.3 ) 1.2 (3.6 ) (1.0 ) Income (loss) before income taxes 0.3 11.8 (11.0 ) 10.5 Income tax provision (benefit) (0.8 ) 3.4 (2.7 ) 3.6 Income (loss) from continuing operations 1.1 8.4 (8.3 ) 6.9 Loss from discontinued operations - - (1.5 ) - Net income (loss) 1.1 % 8.4 % (9.8 )% 6.9 % Comparison of the Three and Nine Months Ended July 4, 2014 to the Three and Nine Months Ended June 28, 2013 Revenue. Our revenue increased $28.9 million, or 34.6%, to $112.4 million for the three months ended July 4, 2014, from $83.5 million for the three months ended June 28, 2013. Our revenue increased $65.9 million, or 27.7%, to $304.3 million for the nine months ended July 4, 2014, from $238.4 million for the nine months ended June 28, 2013. The increase in revenue in the 2014 periods are described in the following paragraphs by end markets. 24-------------------------------------------------------------------------------- Table of Contents Revenue from our markets, the percentage of change between the periods, and revenue by primary markets expressed as a percentage of total revenue were (in thousands, except percentages): Three Months Ended Nine Months Ended July 4, June 28, % July 4, June 28, % 2014 2013 Change 2014 2013 Change Networks $ 53,828 $ 22,526 139.0 % $ 127,456 $ 61,921 105.8 % A&D 22,168 23,785 (6.8 )% 66,518 67,336 (1.2 )% Automotive 18,903 22,047 (14.3 )% 60,374 63,148 (4.4 )% Multi-market 17,465 15,119 15.5 % 49,997 45,991 8.7 % Total $ 112,364 $ 83,477 $ 304,345 $ 238,396 Networks 47.9 % 27.0 % 41.9 % 26.0 % A&D 19.7 % 28.5 % 21.9 % 28.2 % Automotive 16.8 % 26.4 % 19.8 % 26.5 % Multi-market 15.5 % 18.1 % 16.4 % 19.3 % Total 100.0 % 100.0 % 100.0 % 100.0 % In the three months ended July 4, 2014, our Networks market revenue increased by $31.3 million, or 139.0%, compared to the three months ended June 28, 2013. In the nine months ended July 4, 2014, our Networks market revenue increased by $65.5 million, or 105.8%, compared to the nine months ended June 28, 2013. The increase in revenue in the 2014 periods were primarily from sales of our newly acquired products addressing carrier infrastructure, fiber to the home access networks, physical media devices, crosspoint and chipsets for broadcast video, as well as increased sales of our products targeting wireless backhaul and optical applications, offset by continued weakness in our products targeting CATV set top box products. In the three months ended July 4, 2014, our A&D market revenue decreased by $1.6 million, or 6.8%, compared to the three months ended June 28, 2013. In the nine months ended July 4, 2014, our A&D market revenue decreased by $0.8 million, or 1.2%, compared to the nine months ended June 28, 2013. The modest changes in revenue in the 2014 periods were due primarily to softness in demand for satellite datalink products and fluctuations in demand for radar applications. In the three months ended July 4, 2014, our Automotive revenues decreased by $3.1 million, or 14.3%, compared to the three months ended June 28, 2013. In the nine months ended July 4, 2014, our Automotive revenues decreased by $2.8 million, or 4.4%, compared to the nine months ended June 28, 2013. We attribute the decreases in the 2014 periods to normal levels of fluctuation in demand by our largest automotive customer of our GPS modules. In the three months ended July 4, 2014, our Multi-market revenues increased by $2.3 million, or 15.5%, compared to the three months ended June 28, 2013. In the nine months ended July 4, 2014, our Multi-market revenues increased by $4.0 million, or 8.7%, compared to the nine months ended June 28, 2013. The increases in revenue in the 2014 periods were primarily due to a broad increase in catalog product sales. Gross margin. Gross margin was 44.7% and 37.1%, respectively, for the three and nine months ended July 4, 2014, and 42.5% and 41.9%, respectively, for the three and nine months ended June 28, 2013. Gross margin in the fiscal 2014 periods was positively impacted by a favorable product mix with increased sales of higher gross margin products, offset by increased amortization expense related to acquired intangible assets. Gross margin in the nine months ended July 4, 2014, was also negatively impacted by $18.1 million of additional expense related to the step-up to fair value of the value of Mindspeed's inventory related to purchase accounting that was expensed in the period. Research and development. R&D expense increased by $8.7 million, or 71.4%, to $20.8 million, or 18.5% of our revenue, for the three months ended July 4, 2014, compared with $12.1 million, or 14.5% of our revenue, for the three months ended June 28, 2013. R&D expense increased by $19.6 million, or 57.9%, to $53.6 million, or 17.6% of our revenue, for the nine months ended July 4, 2014, compared with $33.9 million, or 14.2% of our revenue, for the nine months ended June 28, 2013. R&D expense increased in the 2014 periods primarily as a result of research and development activities related to acquired businesses as well as from increase in compensation. Selling, general and administrative. SG&A expense increased $8.6 million, or 64.1%, to $22.1 million, or 19.6% of our revenue, for the three months ended July 4, 2014, compared with $13.4 million, or 16.1% of our revenue, for the three months 25 -------------------------------------------------------------------------------- Table of Contents ended June 28, 2013. SG&A expense increased $27.8 million, or 73.1%, to $66.0 million, or 21.7% of our revenue, for the nine months ended July 4, 2014, compared with $38.1 million, or 16.0% of our revenue, for the nine months ended June 28, 2013. SG&A expenses increased in the 2014 periods primarily due to acquisition and integration costs related to acquired businesses, increased compensation, and increased litigation costs. Contingent consideration. Contingent consideration income was $0.6 million for the nine months ended June 28, 2013. This was a result of changes in the fair value of the contingent consideration we paid related to previous acquisitions. Restructuring charges. Restructuring charges aggregated $15.7 million for the nine months ended July 4, 2014, compared to charges of $1.1 million for the three and nine months ended June 28, 2013. The fiscal year 2014 restructuring charges are related to contractual costs associated with Mindspeed employment agreements, as well as costs associated with a reduction of Mindspeed and Nitronex staffing subsequent to the acquisitions of these businesses, and related severance and benefits that we expect to pay through the first fiscal quarter of 2015. The fiscal year 2013 restructuring charges were related to reductions of staffing and included severance and related benefits that we subsequently paid. Income from operations. Income from operations decreased by $1.5 million to $7.3 million, or 6.5% of our revenue, for the three months ended July 4, 2014 compared with income of $8.9 million, or 10.6% of our revenue, for the three months ended June 28, 2013. There was a loss from operations of $22.5 million, or 7.4% of our revenue, for the nine months ended July 4, 2014, compared with income of $27.3 million, or 11.4% of our revenue, for the nine months ended June 28, 2013. Warrant liability. The warrant liability resulted in an expense of $2.8 million for the three months ended July 4, 2014, compared to a gain of $1.1 million for the three months ended June 28, 2013. The warrant liability resulted in an expense of $5.6 million for the nine months ended July 4, 2014, compared to an expense of $2.0 million for the nine months ended June 28, 2013. The changes relate to the changes in the estimated fair value of common stock warrants we issued in December 2010, which we carry as a liability at fair value. Interest expense. Interest expense was $5.6 million and $0.2 million for the three months ended July 4, 2014 and June 28, 2013, respectively. Interest expense was $7.8 million and $0.6 million for the nine months ended July 4, 2014 and June 28, 2013, respectively. The increase in interest expense in the 2014 periods is due to debt borrowed to partially fund the acquisitions of Mindspeed and Nitronex as well as to provide additional working capital. Other income. Other income was $1.4 million and $0.1 million for the three months ended July 4, 2013 and June 28, 2013, respectively. Other income was $2.4 million and $0.3 million for the nine months ended July 4, 2013 and June 28, 2013, respectively. Other income in the 2014 periods primarily relates to fees we earned under transition services agreements related to a business and a product line we sold during the periods. Other income in the 2013 periods primarily relates to fees we earned from GaAs Labs for services provided pursuant to our administrative and business development services agreement with it. Provision for income taxes. The benefit for income taxes was $0.9 million for the three months ended July 4, 2014, compared to a provision of $2.9 million for the three months ended June 28, 2013. The benefit for income taxes was $8.2 million for the nine months ended July 4, 2014, compared to a provision of $8.5 million for the nine months ended June 28, 2013. The benefit in the three and nine months ended July 4, 2014, results from the current period loss. The difference between the U.S. federal statutory income tax rate of 35% and the Company's effective income tax rates for the three and nine months ended July 4, 2014 and June 28, 2013, was primarily impacted by changes in fair values of the stock warrant liability which are not deductible nor taxable for tax purposes, income taxed in foreign jurisdictions at generally lower tax rates, offset by U.S. state income taxes, and, for the nine months ended July 4, 2014, by nondeductible expenses for tax purposes resulting from the Mindspeed Acquisition. At the date of the acquisition, Mindspeed had, on a preliminary basis, federal net operating loss (NOL) carryforwards of approximately $683.7 million, which will expire at various dates through 2033, and federal research and development tax credit carryforwards of $19.5 million. Both the NOL and the tax credits are subject to change-in-control limitations within the Internal Revenue Code and, accordingly, these carryforwards were reduced to $305.9 million, the estimated realizable amount after consideration of the limitations. The NOL carryforwards and tax credits are included in the computation of net deferred income tax assets arising from the acquisition. The aggregate net deferred income tax assets acquired in the Mindspeed Acquisition is estimated to be $84.3 million, which includes a net deferred income tax liability of $68.0 million related to the difference between the book and tax bases of the intangible and other assets acquired in the acquisition. A valuation allowance of $16.8 million was also recorded to reduce the overall net deferred tax assets to estimated realizable value. 26 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of July 4, 2014, we held $173.5 million of cash and cash equivalents, all deposited with financial institutions, including in money market accounts. Cash provided by operations was $9.7 million in the nine months ended July 4, 2014, of which the principal components were a net loss of $29.9 million, plus non-cash expenses of $47.7 million, and cash decreases from operating assets and liabilities of $8.1 million. The change in operating assets and liabilities includes decreases in accounts receivable of $1.3 million, increase in inventory of $6.2 million, and income taxes of $3.7 million, as well as net decreases in accounts payable, accrued liabilities, and other of $6.2 million and an increase in deferred revenue of $6.7 million. Cash used in investing activities was $258.1 million in the nine months ended July 4, 2014, of which $232.0 million was used in the Mindspeed Acquisition and $26.1 million was used in the Nitronex Acquisition. In addition, $10.3 million and $5.1 million related to purchases of property and equipment and acquisitions of intellectual property, respectively. The Company received $8.6 million from the sale of Mindspeed's wireless business and $12.0 million from the sale of the Mindspeed CPE communication processor product line. The Company also purchased securities of $5.3 million during the period. Cash from financing activities was $311.4 million in the nine months ended July 4, 2014, of which $347.4 million related to borrowings under our credit facility. Proceeds from stock option exercises, employee stock purchases, and excess tax benefits related to restricted stock awards, totaled $5.7 million during the period. Payment of assumed Mindspeed debt totaled $35.0 million. We have presented payments received by Nitronex prior to our acquisition from Gaas Labs, LLC as capital contributions. On May 8, 2014, we refinanced our outstanding indebtedness under a prior revolving credit facility (Prior Facility) and discharged its obligations thereunder by entering into a credit agreement (Credit Agreement) with Goldman Sachs Bank USA and a syndicate of lenders. Concurrent with the execution of the Credit Agreement, the Company terminated the Prior Facility and repaid the outstanding $245.0 million principal and interest due. The Credit Agreement provides for term loans in an aggregate principal amount of $350.0 million, which mature in May 2021 (Term Loans) and a revolving credit facility of up to $100.0 million, which matures in May 2019 (Revolving Facility). The Term Loans were issued with an original issue discount (OID) of 0.75%, which is being amortized over the term of the Term Loans using the effective interest rate method. Borrowings under both the Term Loans and the Revolving Facility bear interest at variable rates payable quarterly. The Term Loans are payable in quarterly principal installments of 0.25% of the Term Loans on the last business day of each calendar quarter, beginning on the last business day of September 2014, with the remainder due on the maturity date. At the signing of the Credit Agreement, the entire $350.0 million principal, less the OID, amount of the Term Loans, was funded and no draws were made on the Revolving Facility. The Term Loans and Revolving Facility are secured by a first priority lien on substantially all of the Company's assets and provide that the Company must comply with certain financial and non-financial covenants. As of July 4, 2014, we were in compliance with all financial and non-financial covenants under the Credit Agreement. As of July 4, 2014, we had $350.0 million of outstanding borrowings under the Credit Agreement with $100.0 million of borrowing availability as of that date. As of July 4, 2014, we had $3.5 million of outstanding notes assumed in the Mindspeed Acquisition, which accrue interest at 6.5% per annum. The notes are payable at $4.5 million plus accrued and unpaid interest upon demand by the holder and, if not paid earlier, become due in June 2017. We have a long-term technology licensing and transfer commitment that calls for remaining potential payments by us, as of July 4, 2014, of up to $5.3 million through July 2016. The undistributed earnings of our foreign subsidiaries are indefinitely reinvested and we do not intend to repatriate such earnings. We believe the decision to reinvest these earnings will not have a significant impact on our liquidity. As of July 4, 2014, cash held by our foreign subsidiaries was $29.7 million, which, along with cash generated from foreign operations, is expected to be used in the support of international growth and working capital requirements. We plan to use our available cash and cash equivalents and potential remaining borrowing capacity under our Revolving Facility for general corporate purposes, including working capital. We may also use a portion of our cash and cash equivalents and our Revolving Facility, which we may draw on from time to time, for the acquisition of, or investment in, complementary technologies, design teams, products and companies. We believe that our cash and cash equivalents, cash generated from operations, and borrowing availability under the Revolving Facility will be sufficient to meet our working capital requirements for at least the next 12 months. Recent Accounting Pronouncements See Note 1 to Condensed Consolidated Financial Statements contained in Part I. Item 1, "Financial Statements" in this Quarterly Report on Form 10-Q. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of July 4, 2014. 27-------------------------------------------------------------------------------- Table of Contents |