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ATMEL CORP - 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 in conjunction with our Condensed Consolidated Financial Statements and the related Notes included in this Form 10-Q. The information contained in this Form 10-Q is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to review and consider carefully the various disclosures made by us in this Form 10-Q and in our other reports filed with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2013. Atmel's Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to such reports are available, free of charge, through the "Investors" section of www.atmel.com. We make these reports available as soon as reasonably practicable after we electronically file them with, or furnish them to, the SEC. The SEC also maintains a website located at www.sec.gov that contains Atmel's reports filed with, or furnished to, the SEC. The information disclosed on our website is not incorporated herein and does not form a part of this Form 10-Q. 26-------------------------------------------------------------------------------- Table of Contents This discussion contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, particularly statements regarding our outlook for fiscal 2014 and beyond. Such forward looking statements include, but are not limited to, statements about: the expansion of the market for microcontrollers, revenue for our maXTouch products, expectations for our XSense products, our gross margin expectations and trends, anticipated revenue by geographic area and the ongoing transition of our revenue base to Asia, expectations or trends involving our operating expenses, capital expenditures, cash flow and liquidity, our factory utilization rates, the effect and timing of new product introductions, our ability to access independent foundry capacity and the corresponding financial condition and operational performance of those foundry partners, including insolvencies of, and litigation related to European foundry suppliers, the effects of our strategic transactions and restructuring efforts, the estimates we use in respect of the amount and/or timing for expensing unearned share-based compensation and similar estimates related to our performance-based restricted stock units, our expectations regarding tax matters and related tax audits, the outcome of litigation (including intellectual property litigation in which we may be involved or in which our customers may be involved, especially in the mobile device sector) and the effects of exchange rates and our ongoing efforts to manage exposure to exchange rate fluctuation. Our actual results could differ materially from those projected in any forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in this discussion and in Item 1A - Risk Factors, and elsewhere in this Form 10-Q. Generally, the words "may," "will," "could," "should," "would," "anticipate," "expect," "intend," "believe," "seek," "estimate," "plan," "view," "continue," the plural of such terms, the negatives of such terms, or other comparable terminology and similar expressions identify forward-looking statements. The information included in this Form 10-Q is provided as of the filing date with the Securities and Exchange Commission and future events or circumstances could differ significantly from the forward-looking statements included herein. Accordingly, we caution readers not to place undue reliance on such statements. We undertake no obligation to update any forward-looking statements in this Form 10-Q. OVERVIEW We are one of the world's leading designers, developers and suppliers of microcontrollers, which are self-contained computers-on-a-chip. Microcontrollers are generally less expensive, consume less power and offer enhanced programming capabilities compared to traditional microprocessors. Our microcontrollers and related products are used in many of the world's leading industrial and automotive electronics, mobile computing and communications devices, including smartphones, tablets and personal computers, and other electronics products in which they provide core, embedded processing functionalities for, among other things, touch and proximity sensing, sensor management, security and encryption, wireless connectivity, lighting and system controls and battery management. Our recently completed acquisition of Newport Media, Inc. allows us to add 802.11n Wi-Fi and Bluetooth technologies to our broad portfolio of wireless solutions. With our microcontroller, encryption and wireless technologies, and the systems, combinations and modules we can offer with those stand-alone or integrated capabilities, we believe that we have a compelling set of products for the so-called "Internet of Things," where smart, connected devices and appliances must seamlessly and securely share data and information. These products are also well suited for the quickly evolving "wearables" sector, where our microcontrollers may be used to manage multiple accelerometers or sensors within a device, to communicate information from that device to a gateway, or to track or monitor other activities. In parallel, we continue to enable and enhance human computer interaction by leveraging our market leading capacitive touch products, our microcontroller know-how and our significant intellectual property ("IP") portfolio. We continuously seek new market opportunities that benefit from our corporate and technology strengths, as we did when we launched our XSense product, a proprietary metal mesh technology for touch sensors. Beyond these evolving market sectors, we also design and sell other semiconductor products that complement our microcontroller business, including nonvolatile memory, radio frequency and mixed-signal components and application specific integrated circuits. Our product portfolio allows us to address a broad range of high growth applications, including, for example, industrial, building and home electronics systems, smart meters used for utility monitoring and billing, commercial, residential and architectural LED-based lighting systems, touch panels used on household and industrial appliances, medical devices, aerospace and military products and systems, and a growing universe of electronic-based automotive systems where semiconductor content continues to grow rapidly. . We expect the market for microcontrollers to continue to expand over time as tactile, gesture and proximity-based user interfaces become increasingly prevalent, as additional intelligence is built into an ever-growing universe of everyday products for the "Internet of Things" or integrated within "wearable" devices, as industrial and automotive customers accelerate the replacement of mechanical or passive controls in their products, and as power management, authentication, cryptographic, security and similar capabilities become increasingly critical to many industrial, automotive, consumer and medical products. 27-------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Three Months Ended Nine Months Ended September 30, 2014 September 30, 2013 September 30, 2014 September 30, 2013 (in thousands, except for percentage of net revenue) Net revenue $ 374,485 100 % $ 356,268 100 % $ 1,067,380 100 % $ 1,033,227 100 % Gross margin 176,843 47 % 143,467 40 % 478,071 45 % 422,697 41 % Research and 69,917 19 % 66,790 19 % 209,751 20 % 202,460 20 % development Selling, general and 65,324 17 % 55,793 16 % 194,186 18 % 178,282 17 % administrative Acquisition-related 7,162 2 % 1,685 - % 10,287 1 % 5,699 1 % charges Restructuring 840 - % 8,149 2 % (967 ) - % 51,545 5 % (credits) charges Recovery of receivables from - - % - - % - - % (522 ) - % foundry supplier Gain on sale of - - % - - % - - % (4,430 ) - % assets Settlement charges - - % - - % - - % 21,600 2 % Income (loss) from $ 33,600 9 % $ 11,050 3 % $ 64,814 6 % $ (31,937 ) (3 )% operations Net Revenue Our net revenue totaled $374.5 million for the three months ended September 30, 2014, an increase of 5%, or $18.2 million, from $356.3 million in net revenue for the three months ended September 30, 2013. Our net revenue totaled $1,067.4 million for the nine months ended September 30, 2014, an increase of 3%, or $34.2 million, from $1,033.2 million in net revenue for the nine months ended September 30, 2013. Our revenue for the three and nine months ended September 30, 2014 was higher than the three and nine months ended September 30, 2013 primarily due to revenue growth in the microcontroller and nonvolatile memory segments. Net Revenue - By Operating Segment Our net revenue by operating segment is summarized as follows: Three Months Ended September 30, 2014 September 30, 2013 Change % Change (in thousands, except for percentages) Microcontroller $ 264,432 $ 244,061 $ 20,371 8 % Nonvolatile Memory 46,908 43,265 3,643 8 % Automotive 37,273 39,954 (2,681 ) (7 )% Multi-Market and Other 25,872 28,988 (3,116 ) (11 )% Total net revenue $ 374,485 $ 356,268 $ 18,217 5 % Nine Months Ended September 30, 2014 September 30, 2013 Change % Change (in thousands, except for percentages) Microcontroller $ 754,348 $ 719,443 $ 34,905 5 % Nonvolatile Memory 122,739 114,773 7,966 7 % Automotive 114,238 115,752 (1,514 ) (1 )% Multi-Market and Other 76,055 83,259 (7,204 ) (9 )% Total net revenue $ 1,067,380 $ 1,033,227 $ 34,153 3 % Microcontroller Microcontroller segment net revenue increased 8% to $264.4 million for the three months ended September 30, 2014 compared to $244.1 million for the three months ended September 30, 2013. Microcontroller segment net revenue increased 5% to $754.3 million for the nine months ended September 30, 2014 compared to $719.4 million for the nine months ended 28-------------------------------------------------------------------------------- Table of Contents September 30, 2013. Microcontroller net revenue represented 71% of total net revenue for each of the three and nine months ended September 30, 2014. Microcontroller net revenue represented 69% and 70% of total net revenue for the three and nine months ended September 30, 2013, respectively. Revenue increased primarily as a result of stronger demand from the industrial, automotive and communications end markets and the inclusion of revenue from NMI. Nonvolatile Memory Nonvolatile Memory segment net revenue increased 8% to $46.9 million for the three months ended September 30, 2014 compared to $43.3 million for the three months ended September 30, 2013. Nonvolatile Memory segment net revenue increased 7% to $122.7 million for the nine months ended September 30, 2014 compared to $114.8 million for the nine months ended September 30, 2013. The increase was mainly due to stronger demand for our EEPROM products and secure cryptographic products. Automotive Automotive segment net revenue decreased 7% to $37.3 million for the three months ended September 30, 2014 compared to $40.0 million for the three months ended September 30, 2013. Automotive segment net revenue decreased 1% to $114.2 million for the nine months ended September 30, 2014 from $115.8 million for the nine months ended September 30, 2013. This decrease was primarily related to a decline in our legacy products that are approaching end-of-life, partially offset by an increase in demand for our RF automotive products. Multi-Market and Other Multi-Market and Other segment net revenue decreased to $25.9 million for the three months ended September 30, 2014 compared to $29.0 million for the three months ended September 30, 2013. Multi-Market and Other segment net revenue decreased to $76.1 million for the nine months ended September 30, 2014 compared to $83.3 million for the nine months ended September 30, 2013. The decrease resulted primarily from a decline in our Aerospace business. Net Revenue by Geographic Area Our net revenue by geographic area for the three and nine months ended September 30, 2014, compared to the three and nine months ended September 30, 2013, is summarized in the table below. Revenue is attributed to regions based on the location to which we ship. See Note 11 of Notes to Condensed Consolidated Financial Statements for further discussion. Three Months Ended September 30, 2014 September 30, 2013 Change % Change (in thousands, except for percentages) Asia $ 219,515 $ 212,263 $ 7,252 3 % Europe 89,197 86,519 2,678 3 % United States 58,969 51,515 7,454 14 % Other* 6,804 5,971 833 14 % Total net revenue $ 374,485 $ 356,268 $ 18,217 5 % Nine Months Ended September 30, 2014 September 30, 2013 Change % Change (in thousands, except for percentages) Asia $ 608,078 $ 615,080 $ (7,002 ) (1 )% Europe 278,529 261,885 16,644 6 % United States 162,227 140,909 21,318 15 % Other* 18,546 15,353 3,193 21 % Total net revenue $ 1,067,380 $ 1,033,227 $ 34,153 3 % _________________________________________ * Primarily includes South Africa, and Central and South America Net revenue outside the United States accounted for 84% and 85% of our net revenue for the three and nine months ended September 30, 2014, respectively, and 86% of our net revenue for both the three and nine months ended September 30, 2013. 29-------------------------------------------------------------------------------- Table of Contents Our net revenue in Asia increased $7.3 million, or 3%, for the three months ended September 30, 2014, compared to the three months ended September 30, 2013. The increase resulted primarily from stronger demand in the industrial, automotive and communications end markets in Asia. Net revenue in Asia decreased $7.0 million, or 1%, for the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013. The decrease was primarily due to weaker demand for the mobility and consumer end markets, partially offset by stronger demand for the industrial end market. Net revenue for the Asia region was 59% and 57% of total net revenue for three and nine months ended September 30, 2014, respectively, compared to 60% of total net revenue for both the three and nine months ended September 30, 2013. Our net revenue in Europe increased $2.7 million, or 3% for the three months ended September 30, 2014, compared to the three months ended September 30, 2013. Net revenue in Europe increased $16.6 million, or 6%, for the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013. The increase resulted primarily from stronger demand in the automotive and consumer end markets. Net revenue for the Europe region was 24% and 26% of total net revenue for the three and nine months ended September 30, 2014, respectively, compared to 24% and 25% of total net revenue for the three and nine months ended September 30, 2013, respectively. Our net revenue in the United States increased by $7.5 million, or 14%, for the three months ended September 30, 2014, compared to the three months ended September 30, 2013 and increased by $21.3 million, or 15%, for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, primarily due to increased demand in the automotive, consumer and industrial end markets. Net revenue for the U.S. region was 16% and 15% of total net revenue for the three and nine months ended September 30, 2014, respectively, compared to 14% of total net revenue for both the three and nine months ended September 30, 2013. Revenue and Costs - Impact from Changes to Foreign Exchange Rates Changes in foreign exchange rates have historically had an effect on our net revenue and operating costs. Net revenue denominated in foreign currencies were 19% and 21% of our total net revenue for the three months ended September 30, 2014 and 2013, respectively, and 21% and 22% of our total net revenue for the nine months ended September 30, 2014 and 2013, respectively. Costs denominated in foreign currencies were 17% and 18% of our total costs for the three months ended September 30, 2014 and 2013, respectively, and 18% of our total costs for each of the nine months ended September 30, 2014 and 2013. For the three months ended September 30, 2014, changes in foreign exchange rates had a favorable overall effect on our operating results. Our net revenue for the three months ended September 30, 2014 would have been approximately $1.3 million lower had the average exchange rate in the three months ended September 30, 2014 remained the same as the average exchange rate in effect for the three months ended September 30, 2013. Our income from operations would have been approximately $0.4 million lower had the average exchange rate in the three months ended September 30, 2014 remained the same as the average exchange rate in the three months ended September 30, 2013. For the nine months ended September 30, 2014, changes in foreign exchange rates had a favorable overall effect on our operating results. Our net revenue for the nine months ended September 30, 2014 would have been approximately $7.7 million lower had the average exchange rate in the nine months ended September 30, 2014 remained the same as the average exchange rate in effect for the nine months ended September 30, 2013. Our income from operations would have been approximately $4.5 million lower had the average exchange rate in the nine months ended September 30, 2014 remained the same as the average exchange rate in the nine months ended September 30, 2013. Gross Margin Gross margin was 47.2% and 44.8% for the three and nine months ended September 30, 2014, respectively, compared to 40.3% and 40.9% for the three and nine months ended September 30, 2013, respectively, primarily due to manufacturing cost improvements and conclusion of our legacy "take-or-pay" wafer supply agreements. These improvements were partially offset by a $3.5 million loss, net of insurance recovery, related to the manufacturing facility damage and unplanned shutdown at our Colorado Springs plant that occurred in December 2013 and continued into early 2014. We expect to realize further gross margin benefit through the remainder of 2014 from ongoing cost reductions and improved utilization. Inventory decreased to $263.4 million at September 30, 2014 from $275.0 million at December 31, 2013, primarily from a reduction in inventory build related to the conclusion of our legacy "take-or-pay" wafer supply agreements and improved alignment, throughout the first nine months of 2014, between customer demand and inventory on hand. For the nine months ended September 30, 2014, we manufactured approximately 57% of our products in our own wafer fabrication facility compared to 51% for the nine months ended September 30, 2013. Our cost of revenue includes the costs of wafer fabrication, assembly and test operations, inventory write-downs, royalty expense, freight costs and share-based compensation expense. Our gross margin as a percentage of net revenue fluctuates 30-------------------------------------------------------------------------------- Table of Contents depending on product mix, manufacturing yields, utilization of manufacturing capacity, reserves for excess and obsolete inventory, and average selling prices, among other factors. Research and Development Research and development ("R&D") expenses increased 5%, or $3.1 million, to $69.9 million for the three months ended September 30, 2014 from $66.8 million for the three months ended September 30, 2013. R&D expenses increased 4%, or $7.3 million, to $209.8 million for the nine months ended September 30, 2014 from $202.5 million for the nine months ended September 30, 2013. R&D expenses increased, compared to the same period in 2013, as we did not meet our performance targets under our expired 2011 Long-Term Incentive Plan, which resulted in the reversal of share-based compensation expense allocated to R&D in the three and nine month periods ended September 30, 2013. As a percentage of net revenue, R&D expenses totaled 19% and 20% for the three and nine months ended September 30, 2014, respectively, compared to 19% and 20% for the three and nine months ended September 30, 2013, respectively. We believe that continued strategic investments in R&D, primarily related to new product and process development are essential for us to remain competitive in the markets we serve. Selling, General and Administrative Selling, general and administrative ("SG&A") expenses increased 17%, or $9.5 million, to $65.3 million for the three months ended September 30, 2014 from $55.8 million for the three months ended September 30, 2013. SG&A expenses increased 9%, or $15.9 million, to $194.2 million for the nine months ended September 30, 2014 from $178.3 million for the nine months ended September 30, 2013. The increase of SG&A expenses, compared to the same period in 2013, primarily related to the reversal of share-based compensation expense allocated to SG&A in the three and nine month periods ended September 30, 2013 as we did not meet our performance targets under our expired 2011 Long-Term Incentive Plan. As a percentage of net revenue, SG&A expenses totaled 17% and 18% for the three and nine months ended September 30, 2014, compared to 16% and 17% for the three and nine months ended September 30, 2013. Share-Based Compensation We primarily issue restricted stock units to our employees as equity compensation. Employees may also participate in an Employee Stock Purchase Program ("ESPP") that offers the ability to purchase stock through payroll withholdings at a discount to the market price. We did not issue stock options to our employees as equity compensation during the three and nine months ended September 30, 2014 and 2013. Share-based compensation expense for any stock options and ESPP shares is based on the fair value of the award at the measurement date (grant date). The compensation amount for those options is calculated using a Black-Scholes option valuation model. For restricted stock unit awards, the compensation amount is determined based upon the market price of our common stock on the grant date. Share-based compensation for restricted stock units, other than performance-based units described below, is recognized as an expense over the applicable vesting term for each employee receiving restricted stock units. The recognition as expense of the fair value of performance-related share-based awards is determined based upon management's estimate of the probability and timing for achieving the associated performance criteria, utilizing the fair value of the common stock on the grant date. Share-based compensation for performance-related awards is recognized over the estimated performance period, which may vary from period to period based upon management's estimates of achievement and the timing to achieve the related performance goals. These awards vest once the performance criteria are met. The following table summarizes share-based compensation, net of the amount capitalized in inventory included in operating results: Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2014 2013 2014 2013 (in thousands) Cost of revenue $ 1,605 $ 1,136 $ 4,892 $ 4,589 Research and development 4,632 3,100 13,744 10,724 Selling, general and administrative 8,680 3,858 27,176 15,023 Total share-based compensation 14,917 8,094 45,812 30,336 expense, before income taxes Tax benefit (3,760 ) (1,581 ) (10,005 ) (4,750 ) Total share-based compensation expense, net of income taxes $ 11,157 $ 6,513 $ 35,807 $ 25,586 31-------------------------------------------------------------------------------- Table of Contents In December 2013, we adopted the Atmel 2014 Long-Term Performance-Based Incentive Plan (the "2014 Plan"), which provides for the grant of performance-based restricted stock units to Company participants. Performance metrics for the 2014 Plan are based principally on corporate level and business unit non-GAAP gross margin metrics, calculated at the end of each 2014 calendar quarter. Vesting of performance-based restricted stock units under the 2014 Plan is expected to commence, assuming achievement of the underlying performance metrics, in the first calendar quarter of 2015. We recorded total share-based compensation expense related to performance-based restricted stock units of $0.7 million and $2.7 million under the 2014 Plan in the three and nine months ended September 30, 2014, respectively. Until restricted stock units are vested, they do not have the voting rights of common stock and the shares underlying the awards are not considered issued and outstanding. Acquisition-Related Charges We recorded total acquisition-related charges of $7.2 million and $10.3 million for the three and nine months ended September 30, 2014, respectively, compared to $1.7 million and $5.7 million for the three and nine months ended September 30, 2013, respectively. Included in those acquisition-related charges for the three months ended September 30, 2014 and 2013, was the amortization of intangible assets amounting to $3.3 million and $1.3 million, respectively, of which $1.2 million and $0.7 million, respectively, pertained to developed technology. The amortization of intangible assets for the nine months ended September 30, 2014 and 2013, was $5.9 million and $4.7 million, respectively, of which $2.6 million and $2.3 million, respectively, pertained to developed technology. We estimate that charges related to amortization of intangible assets will be approximately $4.2 million for the remainder of 2014. We also recorded other compensation related charges for these acquisitions of $1.1 million and $0.4 million for the three months ended September 30, 2014 and September 30, 2013, respectively, and $1.6 million and $1.0 million for the nine months ended September 30, 2014 and September 30, 2013, respectively. We expensed $2.2 million and $2.5 million of advisory, legal, and consulting fees and other costs directly related to the acquisition of NMI, which were recorded in the acquisition-related charges for the three and nine months ended September 30, 2014, respectively. Gain on Sale of Assets On September 28, 2012, we completed the sale of our Serial Flash product line. Under the terms of the sale agreement, we transferred assets to the buyer, which assumed certain liabilities, in return for cash consideration of $25.0 million. As part of the sale transaction, we granted the buyer an exclusive option to purchase our remaining $7.0 million of Serial Flash inventory, which the buyer fully exercised during the first quarter of 2013. As a result of the sale of that $7.0 million of remaining inventory, we recorded a gain of $4.4 million in the three months ended March 31, 2013 to reflect receipt of payment upon exercise of the related purchase option and the completion of the sale of the Serial Flash product line. Restructuring Charges See Note 13 of Notes to Condensed Consolidated Financial Statements for the summary of activity related to the accrual for restructuring charges detailed by event. We record restructuring liabilities related to workforce reductions when the accounting recognition criteria are met and consistent with management's approval and commitment to the restructuring plans in each particular quarter. The restructuring plans identify the number of employees to be terminated, job classifications and functions, location and the date the plan is expected to be completed. 2014 Restructuring Charges For the three months ended September 30, 2014, we recorded restructuring charges of $1.1 million primarily related to workforce reductions in France intended to align operating expenses with macroeconomic conditions and revenue outlooks, and to improve operational efficiency, competitiveness and business profitability. 2013 Restructuring Charges Restructuring charges in the first quarter of 2013 were primarily related to workforce reductions at our subsidiaries in Rousset, France ("Rousset"), Nantes, France ("Nantes"), and Heilbronn, Germany ("Heilbronn"). Rousset and Nantes 32-------------------------------------------------------------------------------- Table of Contents In 2013, each of Rousset and Nantes restructured operations to further align operating expenses with macroeconomic conditions and revenue outlooks, and to improve operational efficiency, competitiveness and business profitability. In connection with formulating these restructuring plans, during the first quarter of 2013, Rousset and Nantes each confidentially negotiated and developed "social plans" in coordination and consultation with their respective local Works Councils. These social plans, which are subject to French law, set forth general parameters, terms and benefits for both voluntary and involuntary employee dismissals. The restructuring charges related to Rousset and Nantes were $26.6 million. Substantially all of the affected employees ceased active service as of June 30, 2014. There were no significant changes to the plan and no material modifications or changes were made after implementation began. Heilbronn In 2013, Heilbronn, and a related site in Ulm, Germany, restructured operations to further align operating expenses with macroeconomic conditions and revenue outlooks, and to improve operational efficiency, competitiveness and business profitability. In connection with formulating this restructuring plan, initial discussions with local Works Councils in Heilbronn and Ulm began in the first quarter of 2013. The restructuring charges related to Heilbronn were $15.8 million. We anticipate all affected employees will cease active service on or before the end of the fourth quarter of 2015. We are not expecting significant changes to the plan or material modifications or changes after implementation. The restructuring charges recorded in the first quarter of 2013 also included $0.9 million related to the U.S. and other countries. The restructuring accrual is expected to be substantially paid out by the end of 2015. Restructuring charges recorded in the third quarter of 2013 were primarily related to the impairment in value of our buildings located in France and Greece amounting to $5.1 million and $1.6 million, respectively, and workforce reductions in the U.S. and Norway amounting to $1.5 million. The workforce reductions were designed to align our global operating expenses with macroeconomic conditions and revenue outlook, and to improve operational efficiency, competitiveness and business profitability. Based on the information available to us as of the date of this Form 10-Q, the dates on which employees affected by the restructuring are currently expected to cease their service with us, and assuming the absence of material labor discord, litigation or other unforeseen issues arising with respect to those matters, we believe that the estimated annual savings as a result of the restructuring actions will be approximately $42.5 million to $51.0 million, comprising approximately $17.0 million to $20.5 million from cost of sales, approximately $17.0 million to $20.0 million from research and development expense and approximately $8.5 million to $10.5 million from selling, general and administrative expense. Actual savings realized may differ, however, if our assumptions are incorrect or if other unanticipated events occur. Savings may also be offset, or additional expenses incurred, if, and when, we make additional investments in labor, materials or capital in our business in the future. Savings achieved in connection with one series of restructuring activities may not necessarily be indicative of savings that may be realized in other restructuring activities nor may the timing of savings realized in connection with our restructuring actions be similar to, or consistent with, the timing of benefits realized in other restructuring activities that we may undertake at any time. Settlement In the three months ended March 31, 2013, we recorded settlement charges of $21.6 million related to legal settlements undertaken in connection with actual, contemplated or anticipated litigation, or activities undertaken in preparation for, or anticipation of, possible litigation related to intellectual property. Interest and Other Expense, Net Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2014 2013 2014 2013 (in thousands)Interest and other (expense) income $ (1,796 ) $ 854 $ (1,706 ) $ 1,394 Interest expense (731 ) (519 ) (1,722 ) (1,799 ) Foreign exchange transaction (losses) gains (2,204 ) 1,079 (2,428 ) 1,433 Total $ (4,731 ) $ 1,414 $ (5,856 ) $ 1,028 Interest and other expense, net, resulted in expense of $4.7 million and $5.9 million for the three and nine months ended September 30, 2014, respectively, compared to an income of $1.4 million and $1.0 million for the three and nine months ended September 30, 2013, respectively, primarily due to higher interest and other expense and higher net foreign exchange losses. Included in interest and other expense, net, was our proportionate share of losses from an investment in a privately-held company that provides facilities services to our site in Heilbronn Germany; these losses were accounted for under the equity method and 33-------------------------------------------------------------------------------- Table of Contents equaled $1.8 million and $2.1 million for the three and nine months ended September 30, 2014, respectively. We continue to have balance sheet exposures in foreign currencies subject to exchange rate fluctuations and may incur further gains or losses in the future as a result of such foreign exchange exposures. Provision for Income Taxes For the three and nine months ended September 30, 2014, we recorded an income tax provision of $11.6 million and $20.3 million, respectively. For the three and nine months ended September 30, 2014, the significant components of the tax provision were from operations in jurisdictions with operating profits. Our effective tax rate for the nine months ended September 30, 2014 was lower than the statutory federal income tax rate of 35%, primarily due to income recognized in lower tax jurisdictions. For the three and nine months ended September 30, 2013, we recorded an income tax provision of $7.0 million and an income tax benefit of $1.6 million, respectively. For the three months ended September 30, 2013, the significant components of the tax provision were from operations in jurisdictions with operating profits. For the nine months ended September 30, 2013, the tax benefit included discrete benefits from restructuring costs incurred in various jurisdictions, settlement charges and the federal research and development tax credit which was reinstated on January 2, 2013 for two years, partially offset by a discrete charge from gain recognized on the sale of the serial flash product line. Our effective tax rate for the nine months ended September 30, 2013 was lower than the statutory federal income tax rate of 35%, primarily due to income recognized in lower tax jurisdictions. We file U.S., state, and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2003 through 2013 tax years generally remain subject to examination by federal and most state tax authorities. For significant foreign jurisdictions, the 2003 through 2013 tax years generally remain subject to examination by their respective tax authorities. Currently, we have tax audits in progress in various foreign jurisdictions. To the extent the final tax liabilities are different from the amounts originally accrued, the increases or decreases are recorded as income tax expense or benefit in the consolidated statements of operations. While we believe that the resolution of these audits will not have a material adverse impact on our results of operations, the outcome is subject to uncertainty. At September 30, 2014 and December 31, 2013, we had $88.0 million and $87.5 million of unrecognized tax benefits, respectively, which, if recognized, would affect the effective tax rate. Increases or decreases in unrecognized tax benefits could occur over the next 12 months due to tax law changes, unrecognized tax benefits established in the normal course of business, or the conclusion of ongoing tax audits in various jurisdictions around the world. We believe that before September 30, 2015, it is reasonably possible that either certain audits will conclude or the statutes of limitations relating to certain income tax examination periods will expire, or both. If we reach settlement with the tax authorities and/or such statutes of limitation expire, we expect to record a corresponding adjustment to the applicable unrecognized tax benefits. Given the uncertainty as to settlement terms, the timing of payments and the impact of such settlements on other uncertain tax positions, we estimate that the range of potential decreases in underlying uncertain tax positions may be between $0 and $5.0 million over the next 12 months, although those estimates are subject to various factors beyond our control. The calculation of unrecognized tax benefits involves dealing with uncertainties in the application of complex global tax regulations. We regularly assess our tax positions in light of legislative, bilateral tax treaty, regulatory and judicial developments in the countries in which we do business. Liquidity and Capital Resources At September 30, 2014, we had $219.9 million of cash, cash equivalents and short-term investments, compared to $279.1 million at December 31, 2013. The decrease in cash balances in the nine months ended September 30, 2014 resulted primarily from our acquisition of NMI, the acquisition of fixed assets, timing of vendor payables and customer receivables and common stock repurchases. Our current asset to liability ratio, calculated as total current assets divided by total current liabilities, was 2.80 at September 30, 2014 compared to 2.90 at December 31, 2013. Working capital, calculated as total current assets less total current liabilities, decreased to $507.7 million at September 30, 2014, compared to $559.1 million at December 31, 2013. Cash provided by operating activities was $142.6 million for the nine months ended September 30, 2014 compared to cash provided by operating activities of $78.7 million for the nine months ended September 30, 2013, and capital expenditures totaled $37.8 million and $28.0 million for the nine months ended September 30, 2014 and 2013, respectively. As of September 30, 2014, of the $219.9 million aggregate cash and cash equivalents held by us, the amount of cash and cash equivalents held by our foreign subsidiaries was $193.8 million. If the funds held by our foreign subsidiaries were needed for our operations in the United States, the repatriation of some of these funds to the United States could require payment of additional U.S. taxes. Senior Secured Revolving Credit Facility On July 29, 2014, we borrowed $90.0 million under the Facility to assist with the acquisition of NMI. Interest on the borrowed amount equals the applicable periodic LIBOR rate, plus 1.25% per annum, and was $0.3 million and $0.5 million for the three and nine months ended September 30, 2014, respectively. The Facility matures on December 6, 2018. As of the date of this Form 10-Q, we were in compliance with all financial covenants. 34-------------------------------------------------------------------------------- Table of Contents Operating Activities Net cash provided by operating activities was $142.6 million for the nine months ended September 30, 2014, compared to cash provided by operating activities of $78.7 million for the nine months ended September 30, 2013. Net cash provided by operating activities for the nine months ended September 30, 2014 was determined primarily by adjusting net income of $38.7 million for non-cash depreciation and amortization charges of $43.7 million and share-based compensation charges of $45.8 million. Accounts receivable increased by 4% or $9.1 million to $215.8 million at September 30, 2014, from $206.8 million at December 31, 2013. The average number of days of accounts receivable outstanding was 52 days for the three months ended September 30, 2014 compared to 53 days for the three months ended December 31, 2013. Inventories decreased to $263.4 million at September 30, 2014 from $275.0 million at December 31, 2013. Inventories consist of raw wafers, purchased foundry wafers, work-in-progress and finished units. Our number of days of inventory decreased to 121 days for the three months ended September 30, 2014 from 124 days for the three months ended December 31, 2013. Accrued and other liabilities decreased to $123.5 million at September 30, 2014 from $155.4 million at December 31, 2013. The decrease was primarily due to the timing of bonus payments and cash payments related to restructuring plans. Investing Activities Net cash used in investing activities was $176.9 million and $50.2 million for the nine months ended September 30, 2014 and 2013, respectively. For the nine months ended September 30, 2014, we paid $139.6 million in cash for the acquisition of NMI and $37.8 million for acquisitions of fixed assets as compared to cash used of $28.0 million in the nine months ended September 30, 2013. For the nine months ended September 30, 2014, we sold marketable securities for total proceeds of $3.1 million. For the nine months ended September 30, 2013, we paid $25.9 million for acquisitions of businesses, net of cash acquired and received $5.1 million representing proceeds from the sale of inventory in relation to the disposal of a business. We anticipate expenditures for capital purchases in 2014 to be higher than expenditures in 2013, and to be used principally to maintain existing manufacturing operations and improve our IT systems. Financing Activities Net cash used in financing activities was $20.9 million and $56.0 million for the nine months ended September 30, 2014 and 2013, respectively. The cash used was primarily related to stock repurchases of $108.5 million in the nine months ended September 30, 2014, compared to $63.6 million in the nine months ended September 30, 2013 and tax payments related to shares withheld for vested restricted stock units of $15.7 million for the nine months ended September 30, 2014, compared to $12.4 million for the nine months ended September 30, 2013. During the nine months ended September 30, 2014, we borrowed $90.0 million under the Facility to assist with the acquisition of NMI and repurchased 13.4 million shares of our common stock in the open market and subsequently retired those shares under our existing stock repurchase program (except for a limited number of shares used for restricted stock grants in foreign jurisdictions for local, foreign tax benefit). As of September 30, 2014, $231.0 million remained available for repurchases under this program. Proceeds from the issuance of common stock related to exercises of stock options and our employee stock purchase plan totaled $13.2 million and $18.1 million for the nine months ended September 30, 2014 and 2013, respectively. We believe our existing balances of cash, cash equivalents and short-term investments, together with anticipated cash flow from operations, and borrowing availability under our credit facility will be sufficient to meet our liquidity and capital requirements over the next twelve months. Since a substantial portion of our operations is conducted through our foreign subsidiaries, our cash flow, ability to service debt, and payments to vendors are partially dependent upon the liquidity and earnings of our subsidiaries as well as the distribution of those earnings, or repayment of loans or other payments of funds by those subsidiaries, to us. Our foreign subsidiaries are separate and distinct legal entities and may be subject to local legal or tax requirements, or other restrictions that may limit their ability to transfer funds to other group entities including the U.S. parent entity, whether by dividends, distributions, loans or other payments. During the next twelve months, we expect our operations to continue to generate positive cash flow. However, a portion of cash balances may be used to make capital expenditures, repurchase common stock, or make acquisitions. During 2014 and in future years, our ability to make necessary capital investments or strategic acquisitions will depend on our ability to continue to generate sufficient cash flow from operations and to obtain adequate financing if necessary. Off-Balance Sheet Arrangements (Including Guarantees) See the paragraph under the heading "Guarantees" in Note 8 of Notes to Condensed Consolidated Financial Statements for a discussion of off-balance sheet arrangements. 35-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates Management's Discussion and Analysis of Financial Condition and Results of Operations are based upon our Condensed Consolidated Financial Statements, which we have prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe that the estimates, assumptions and judgments involved in provisions for revenue, excess and obsolete inventory, sales reserves and allowances, share-based compensation expense, allowances for doubtful accounts receivable, estimates for useful lives associated with long-lived assets, recoverability of goodwill and intangible assets, restructuring charges, liabilities for uncertain tax positions, deferred tax asset valuation allowances and litigation have the greatest potential impact on our Condensed Consolidated Financial Statements, so we consider these to be our critical accounting policies. Historically, our estimates, assumptions and judgments relative to our critical accounting policies have not differed materially from actual results, although there can be no assurance that results will not differ in the future. The critical accounting estimates associated with these policies are described in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation" of our Annual Report on Form 10-K filed with the SEC on February 28, 2014. Change in Accounting Estimate During the first quarter of 2014, we revised our accounting estimate for the expected useful life of manufacturing equipment from five years to seven years. In reviewing the useful life of our remaining manufacturing equipment during the fourth quarter of 2013, we determined that the adoption of our manufacturing "lite" strategy, the consolidation of our back-end subcontracting activities during the prior several years and the transition of our business to common test platforms had resulted in an extension of the economic life of those assets. We believe that this change better reflects the expected economic benefits from the use of our manufacturing equipment over time based on an analysis of historical experience and general industry practices. The revised useful life of the manufacturing equipment decreased depreciation by approximately $4.6 million and $13.8 million for the three and nine months ended September 30, 2014, respectively. This change had the effect of increasing net income by $4.5 million and $8.6 million for the three and nine months ended September 30, 2014, respectively. As the inventory turns, the quarterly benefit of the depreciation change will be recognized. The total estimated reduction in depreciation for the year 2014 is approximately $18.0 million. The savings from the change in depreciation decreases to zero by the end of 2015. Recent Accounting Pronouncements See Note 1 of Notes to Condensed Consolidated Financial Statements for information regarding recent accounting pronouncements. |