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INPHI CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this Report. This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this report, the terms "may," "might," "will," "objective," "intend," "should," "could," "can," "would," "expect," "believe," "estimate," "predict," "potential," "plan," or the negative of these terms, and similar expressions intended to identify forward-looking statements. These statements relate to future periods and include statements regarding our anticipated trends and challenges in our business and the markets in which we operate, including the market for 100G high-speed analog semiconductor solutions, our plans and strategy for future products, expansion of our product offerings and enhancements of existing products, the anticipated benefits of our acquisition of Cortina, our expectations regarding our expenses and revenue, our continuing investment in resources to develop more products and to support the growth of our business, our tax benefits, the benefits of our products and services, timing of the development of our products, our anticipated cash needs and our estimates regarding our capital requirements and our needs for additional financing, including our expectations regarding operating and capital expenditures, repatriation of cash, our anticipated growth and growth strategies, interest rate sensitivity, adequacy of our disclosure controls, customer concentration, foundry constraints, competition, protection of our intellectual property, our dividend policy and our legal proceedings. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by these or any other forward-looking statements. These risks and uncertainties include, but are not limited to, those risks discussed below, as well as factors affecting our results of operations, our ability to manage our growth, our ability to sustain or increase profitability, demand for our solutions, the effect of declines in average selling prices for our products, our ability to compete, our ability to realize the anticipated benefits of our acquisition of Cortina, our ability to rapidly develop new technology and introduce new products, our ability to safeguard our intellectual property, trends in the semiconductor industry and fluctuations in general economic conditions, and the risks set forth throughout this Report, including the risks set forth under Part II, " Item 1A, Risk Factors". Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management's opinions only as of the date hereof. These forward-looking statements speak only as of the date of this Report. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any changes in events, conditions or circumstances on which any such statement is based. All references to "Inphi," "we," "us" or "our" mean Inphi Corporation. Inphi®, iMB™, iKON™ and the Inphi logo are trademarks or service marks owned by Inphi. All other trademarks, service marks and trade names appearing in this report are the property of their respective owners. Overview Our Company We are a fabless provider of high-speed analog and mixed signal semiconductor solutions for the communications, data center and computing markets. Our semiconductor solutions provide high signal integrity at leading-edge data speeds while reducing system power consumption. Our semiconductor solutions are designed to address bandwidth bottlenecks in networks, maximize throughput and minimize latency in computing environments and enable the rollout of next generation communications, data center and computing infrastructures. Our solutions provide a vital high-speed interface between analog signals and digital information in high-performance systems such as telecommunications transport systems, enterprise networking equipment, data centers and enterprise servers, storage platforms, test and measurement equipment and military systems. We provide 100G high-speed analog semiconductor solutions for the communications market and high-speed memory interface solutions for the computing market. We have a product portfolio with many products sold in communication and data center markets as of September 30, 2014, including our 100 GbE CMOS SerDes architecture, or iPHY, which is designed to enable the development of next generation low power and high port density 100 Gigabit Ethernet, or 100 GbE, solutions to address bandwidth bottlenecks in next generation data center and communications infrastructures. Highlights in the third quarter of 2014 include the following: ? We announced the production availability of the first generation new iKON™ family of 100G Clock and Data Recovery Retimer integrated circuits (IC) targeted at next-generation 2-Terabit line cards. The first product in this series, the IN112525-LC 100G CMOS CDR Retimer IC is designed to accelerate deployment for higher density 100G in service provider and data center networks. 18-------------------------------------------------------------------------------- ? We announced the availability of IN3216DZ, the first single chip quad channel linear Mach Zehnder driver in bare die form to address the network needs for 100G coherent systems in small form factors for the metro market. Specifically designed to be co-packaged with MZ modulators, the IN3216DZ will reduce size and cost of 100G coherent systems to enable higher density metro solutions. ? We started sampling 45GBaud Linear Coherent Product Family, the industry's first linear ICs enabling 400G coherent solutions for next-generation metro to long haul applications. The initial product offerings includes IN4514SZ, a high-performance octal linear differential to single-ended Mach-Zehnder Modulator Driver and IN4550TA, a quad linear TIA/VGA Amplifier. A detailed discussion of our business may be found in Part I, Item 1, "Business," of our 2013 Annual Report on Form 10-K. Quarterly Update As discussed in more detail below, for the three and nine months ended September 30, 2014 compared to the three and nine months ended September 30, 2013, we delivered the following financial performance: • Total revenue increased by $9.7 million, or 36%, to $36.3 million in the three months ended September 30, 2014. In the nine months ended September 30, 2014, total revenue increased by $27.9 million, or 38%, to $101.4 million. • Gross profit as a percentage of revenue increased to 64.2% from 63.2% in the three months ended September 30, 2014. In the nine months ended September 30, 2014, gross profit as a percentage of revenue increased to 64.1% from 63.3%. • Total operating expenses increased by $5.4 million, or 27%, to $25.3 million in the three months ended September 30, 2014. In the nine months ended September 30, 2014, total operating expenses increased by $11.4 million, or 20%, to $69.4 million. • Loss from operations decreased by $1.1 million, or 34%, to a loss from operations of $2.0 million in the three months ended September 30, 2014. In the nine months ended September 30, 2014, loss from operations decreased by $7.0 million, or 62%, to a loss from operations of $4.3 million. • Diluted earnings per share decreased by $0.13 to ($0.22) in the three months ended September 30, 2014. In the nine months ended September 30, 2014, diluted earnings per share increased by $0.24 to ($0.17). The increase in our revenue was primarily due to increased consumption of our isolation memory buffer or iMB, dual linear transimpedance amplifier or TIA, quad linear driver products and iPHY products. Our loss from operations decreased due to higher revenue, partially offset by increased operating expenses. Total operating expenses increased due primarily to an increase in headcount and stock-based compensation expense. Our expenses primarily consist of personnel costs, which include compensation, benefits, payroll related taxes and stock-based compensation. From October 2013 to September 2014, we hired 109 new employees, primarily in the engineering department. We expect expenses to continue to increase in absolute dollars due to the acquisition of Cortina Systems, Inc. as discussed below, and our continuing investment in resources to develop more products and to support the growth of our business. Our diluted earnings per share decreased during the three months ended September 30, 2014, primarily due to provision for income taxes. Our diluted earnings per share increased during the nine months ended September 30, 2014 due to a decrease in loss from operations mainly from increase in revenue. Our cash and cash equivalents were $79.6 million at September 30, 2014, compared with $31.7 million at December 31, 2013. We generated cash flow from operations of $9.0 million during the nine months ended September 30, 2014 compared to $11.2 million during the nine months ended September 30, 2013. Cash provided by investing activities during the nine months ended September 30, 2014 was $36.8 million primarily due to sales and maturities of marketable securities offset by purchases of marketable securities and property and equipment. We generated cash flow from financing activities of $2.1 million primarily due to proceeds from exercise of stock options and employee stock purchase plan of $5.6 million and excess tax benefit related to stock-based compensation of $0.8 million offset by minimum tax withholding paid on behalf of employees of $4.3 million. Recent Developments On October 3, 2014, we completed the acquisition of Cortina Systems, Inc.'s high-speed interconnect and optical transport product lines (Cortina) for approximately $52.7 million in cash and approximately 5.3 million shares of our common stock in accordance with the Agreement and Plan of Merger dated July 30, 2014 as amended by Amendment No. 1 to the Agreement and Plan of Merger dated September 25, 2014. We purchased Cortina to expand the Company's market share of the high-speed optical and networking interconnects. The acquisition was financed through existing cash. Cash of $16.5 million was placed in an escrow fund for up to 12 months following the closing for the satisfaction of certain indemnification claims. We are in the process of determining the purchase price allocation for this acquisition. 19 -------------------------------------------------------------------------------- On October 16, 2014, the Compensation Committee of the Board of Directors granted one-time employment restricted stock unit awards of 1,000,000 shares to certain Cortina employees who entered employment with us commencing upon the closing of the acquisition. The awards vest over four years with vesting contingent upon continuous service. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to allowances for doubtful accounts, warranty reserves, inventory reserves, stock-based compensation expense, goodwill valuation, deferred income tax asset valuation allowances, uncertain tax positions, litigation and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. For a description of our critical accounting policies and estimates, please refer to the "Critical Accounting Policies and Estimates" section of our Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no material changes in any of our critical accounting policies during the nine months ended September 30, 2014. Results of Operations The following table sets forth a summary of our statement of operations as a percentage of each line item to the revenue: Three Months Nine Months Ended September 30, Ended September 30, 2014 2013 2014 2013 Total revenue 100 % 100 % 100 % 100 % Cost of revenue 36 37 36 37 Gross profit 64 63 64 63 Operating expenses: Research and development 44 49 44 51 Sales and marketing 13 16 13 16 General and administrative 13 10 11 12 Total operating expenses 70 75 68 79 Loss from operations (6 ) (12 ) (4 ) (16 ) Other income 1 1 - 1 Loss before income taxes (5 ) (11 ) (4 ) (15 ) Provision (benefit) for income taxes 15 (1 ) 2 1 Net loss 20 % (10 )% (6 )% (16 )% Comparison of Three and Nine Months Ended September 30, 2014 and 2013 Revenue Three Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Total revenue $ 36,278 $ 26,611 $ 9,667 36 % Nine Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Total revenue $ 101,389 $ 73,534 $ 27,855 38 % 20-------------------------------------------------------------------------------- Total revenue for the three and nine months ended September 30, 2014 increased compared to corresponding 2013 periods due to changes in average selling price and number of units sold. For the three and nine months ended September 30, 2014, the average selling price increased by 74% and 54%, respectively, due to product mix, mainly from sales of our higher priced products which includes dual linear TIA and quad linear driver products. For the three and nine months ended September 30, 2014, the number of units sold decreased by 22% and 11%, respectively, mainly from a decrease in consumption of our other high speed memory interface products. We believe the reduction in the unit consumption of high speed memory is the natural result of migration to higher capacity DiMM cards at economic prices made possible in part by the availability of higher capacity DRAM at economic prices. In effect, a requirement for the same or more memory capacity can now be placed on a single card, thereby naturally absorbing the same or more aggregate memory requirement into a smaller number of cards. Cost of Revenue and Gross Profit Three Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Cost of revenue $ 13,003 $ 9,796 $ 3,207 33 % Gross profit $ 23,275 $ 16,815 $ 6,460 38 % Gross profit as a percentage of revenue 64 % 63 % - 1 % Nine Months Ended September 30, Change 2014 R2013 Amount % (dollars in thousands) Cost of revenue $ 36,362 $ 26,981 $ 9,381 35 % Gross profit $ 65,027 $ 46,553 $ 18,474 40 % Gross profit as a percentage of revenue 64 % 63 % - 1 % Gross profit for the three and nine months ended September 30, 2014 increased primarily due to increases in revenue as` described above. Gross profit as a percentage of revenue was relatively unchanged for both periods as compared to the prior year. Research and Development Three Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Research and development $ 15,795 $ 12,995 $ 2,800 22 % Nine Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands)Research and development $ 45,263 $ 37,389 $ 7,874 21 % Research and development expenses for the three and nine months ended September 30, 2014 increased primarily due to the increase in research and development headcount and equity awards, which resulted in a $4.0 million and $8.6 million increase in personnel costs and stock-based compensation expense, respectively. Consulting fees increased by $0.8 million and $1.0 million for the three and nine months ended September 30, 2014 as a result of an increase in engineering activities. CAD software tool license expense increased by $0.2 million and $0.6 million for the three and nine months ended September 30, 2014, respectively, due mainly to increased headcount in engineering. In addition, depreciation and allocated expenses increased by $1.6 million and $3.3 million for the three and nine months ended September 30, 2014, respectively, due to an increase in equipment and research and development activities. The increases were partially offset by increase in reimbursement from customers related to research and development contracts of $4.5 million and $6.4 million for the three and nine months ended September 30, 2014, respectively. The increase in research and development expense was primarily driven by our strategy to expand our product offerings and enhance our existing product offerings. 21 -------------------------------------------------------------------------------- Sales and Marketing Three Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Sales and marketing $ 4,828 $ 4,118 $ 710 17 % Nine Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Sales and marketing $ 13,140 $ 11,771 $ 1,369 12 % Sales and marketing expenses for the three and nine months ended September 30, 2014 increased primarily due to an increase in personnel costs, including stock-based compensation expense of $0.7 million and $1.3 million, respectively to support increasing sales activities. General and Administrative Three Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) General and administrative $ 4,671 $ 2,779 $ 1,892 68 % Nine Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands)General and administrative $ 10,970 $ 8,776 $ 2,194 25 % General and administrative expenses for the three and nine months ended September 30, 2014 increased due to primarily to an increase in legal fees of $1.1 million and $1.3 million, respectively, in connection with the acquisition of Cortina. In addition, for the three and nine months ended September 30, 2014, personnel costs and stock-based compensation expense increased by $0.3 million and $0.6 million, respectively. Provision (benefit) for Income Taxes Three Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Provision (benefit) for income taxes $ 5,083 $ (107 ) $ 5,190 N/M Nine Months Ended September 30, Change 2014 2013 Amount % (dollars in thousands) Provision (benefit) for income taxes $ 1,449 $ 1,158 $ 291 25 % We normally determine our interim provision using an estimated single annual effective tax rate for all tax jurisdictions. ASC 740 provides that when an entity operates in a jurisdiction that has generated ordinary losses on a year-to-date basis or on the basis of the results anticipated for the full fiscal year and no benefit can be recognized on those losses, a separate effective tax rate should be computed and applied to ordinary income (or loss) in that jurisdiction. We incurred pretax loss during the three and nine months ended September 30, 2014 from the Singapore operation and will not recognize tax benefit of the losses due to full valuation allowance established against deferred tax assets. Thus, separate effective tax rate was applied to losses from each loss jurisdiction to compute the Company's interim tax expense. For the three and nine months ended September 30, 2014, the discrete method was used to calculate the interim tax expense for the U.S. operations. We determined that a calculation of an annual effective tax rate would not represent a reliable estimate due to the sensitivity of the annual effective tax rate estimate to even minimal changes to forecasted earnings of the U.S. operations for the year. Under the discrete method, we determine the tax expense based upon actual results as if the interim period were an annual period. 22 -------------------------------------------------------------------------------- The income tax expense for the three and nine months ended September 30, 2014 reflects an effective tax rate of (287%) and (38%), respectively. The effective tax rates for the three and nine months ended September 30, 2014 differs from the statutory rate of 34% primarily due to the change in valuation allowance, foreign income taxes provided at lower rates, geographic mix in operating results, unrecognized tax benefits, stock-based compensation adjustments, transaction cost adjustment and recognition of state research and development credits. The income tax expense (benefit) for the three and nine months ended September 30, 2013 reflects an effective tax rate of 4% and (11%), respectively. The effective tax rates for the three and nine months ended September 30, 2013 differs from the statutory rate of 35% primarily due to the change in valuation allowance (originally established in the fourth quarter of 2012), foreign income taxes provided at lower rates, geographic mix in profitability, unrecognized tax benefits and stock-based compensation adjustments. Liquidity and Capital Resources As of September 30, 2014, we had cash, cash equivalents and investments in marketable securities of $119.2 million. Our primary uses of cash are to fund operating expenses, purchase inventory and acquire property and equipment. A portion of the cash and cash equivalents as of September 30, 2014 was used to finance the acquisition of Cortina. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, as reflected in the changes in our outstanding accounts payable and accrued expenses. Our primary sources of cash are cash receipts on accounts receivable from our revenue. Aside from the growth in amounts billed to our customers, net cash collections of accounts receivable are impacted by the efficiency of our cash collections process, which can vary from period to period, depending on the payment cycles of our major customers. The following table summarizes our cash flows for the periods indicated: Nine Months Ended September 30, 2014 2013 (in thousands) Net cash provided by operating activities $ 9,032 $ 11,235 Net cash provided by (used in) investing activities 36,788 (16,314 ) Net cash provided by financing activities 2,125 2,763 Net increase (decrease) in cash and cash equivalents $ 47,945 $ (2,316 ) Net Cash Provided by Operating Activities Net cash provided by operating activities during the nine months ended September 30, 2014 primarily reflected increases in accrued expenses of $1.4 million and deferred revenue of $1.7 million, change in income tax payable/receivable of $0.8 million, depreciation and amortization of $7.9 million and stock-based compensation of $16.0 million, offset by net loss of $5.2 million, increases in accounts receivable of $9.4 million, inventories of $2.4 million and prepaid expenses and other assets of $1.8 million. Our accrued expenses increased due to accrual of employee benefits. Our deferred revenue increased as distributors increased their inventory level for shipment to customers in the fourth quarter of 2014. Accounts receivable increased due to shipments made in the last month of the quarter and billings for non-recurring engineering contracts with customers. Our inventories increased a result of growing production for expected delivery to customers in the fourth quarter of 2014. Our prepaid expenses and other assets increased due to new subscriptions for software, maintenance and insurance prepayments. Net cash provided by operating activities during the nine months ended September 30, 2013 primarily reflected a decrease in accounts receivable of $0.9 million, change in income tax payable/receivable of $2.5 million, depreciation and amortization of $5.5 million and stock-based compensation of $13.0 million offset by net loss of $11.9 million and increase in inventories of $0.6 million. Our receivables decreased due to collections. Our inventories increased a result of growing production for expected delivery to customers in the fourth quarter of 2013. Net Cash Provided by (Used in) Investing Activities Net cash provided by investing activities during the nine months ended September 30, 2014, consisted of sales and maturities of marketable securities of $87.9 million, offset by purchases property and equipment of $13.0 million, purchase of intangible assets of $1.1 million and purchases of marketable securities of $37.0 million. 23-------------------------------------------------------------------------------- Net cash used in investing activities during the nine months ended September 30, 2013, consisted of cash used to purchase property and equipment of $12.5 million, mainly for laboratory, production equipment and leasehold improvements for our offices in California, purchase of minority interest in an early stage private company for $2.6 million and purchases of marketable securities of $32.1 million, offset by sales and maturities of marketable securities of $31.0 million. Net Cash Provided by Financing Activities Net cash provided by financing activities during the nine months ended September 30, 2014 consisted of proceeds from exercises of stock options and employee stock purchase plan of $5.6 million and excess tax benefit related to stock-based compensation of $0.8 million, offset by minimum tax withholding paid on behalf of employees for restricted stock units of $4.3 million. Net cash provided by financing activities during the nine months ended September 30, 2013 consisted of proceeds from exercise of stock options and employee stock purchase plan of $4.4 million, offset by minimum tax withholding paid on behalf of employees for restricted stock units of $1.8 million. Operating and Capital Expenditure Requirements Our principal source of liquidity as of September 30, 2014 consisted of $119.2 million of cash, cash equivalents and investments in marketable securities, of which $8.3 million is held by our foreign subsidiaries. Based on our current operating plan, we believe that our existing cash and cash equivalents from operations will be sufficient to finance our operational cash needs through at least the next 12 to 18 months. In the future, we expect our operating and capital expenditures to increase as we increase headcount, expand our business activities and grow our end customer base which will result in higher needs for working capital. Our ability to generate cash from operations is also subject to substantial risks described in Part II, Item 1A, Risk Factors. If any of these risks occur, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash and cash equivalents to support our working capital and other cash requirements. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through debt financing or from other sources. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders could be significantly diluted, and these newly-issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operating flexibility, and would also require us to incur interest expense. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us. We do not plan to repatriate cash balances from foreign subsidiaries to fund our operations in the United States. There may be adverse tax effects upon repatriation of these funds to the United States. Recent Authoritative Accounting Guidance See note 2 of the notes to our unaudited condensed consolidated financial statements for information regarding recently issued accounting pronouncements. |