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HITT > SEC Filings for HITT > Form 10-Q on 2-Nov-2012All Recent SEC Filings

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Form 10-Q for HITTITE MICROWAVE CORP


2-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This information should be read in conjunction with our audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in our Annual Report on Form 10-K for the year ended December 31, 2011.

Description of Our Revenue, Costs and Expenses

Revenue. Our revenue is derived primarily from the sale of standard and custom products. We develop standard products from our own specifications, which we sell through our direct sales organization, our network of independent sales representatives, two distributors and our website. We also develop custom products to meet the specialized requirements of individual customers, which are sold by our direct sales organization.

We sell our products to original equipment manufacturers, or OEMs, that supply advanced electronic systems to commercial and military end users, and to these OEMs' contract manufacturers. In general, the decision to purchase our product is made by the OEM, which has designed our product into its system. In the event that we sell to an OEM's contract manufacturer, the contract manufacturer typically does not have discretion to replace our product with one from a different supplier.

Our sales cycle varies substantially, ranging from a period of a month or less when a customer selects a standard product from our selection guide or website, to as long as two years or more for custom products. In the sales process, our sales and application engineers work closely with the OEM customer to analyze the customer's system requirements and select an appropriate standard product or establish a technical specification for a custom product. In the case of a custom product, we also select a semiconductor process and foundry, and evaluate test wafers and finished components before manufacturing in commercial quantities can begin. Volume purchases of our products by an OEM customer, or its contract manufacturer, generally do not occur until the OEM customer has made the decision to begin production of the system incorporating our product. Our receipt of substantial revenue from sales of a product to an OEM customer depends on that customer's commercial success in manufacturing and selling its system incorporating our product. It may take several years for a newly introduced standard product to generate substantial revenue, if ever. However, the life cycles of our standard products tend to be lengthy.

Although most of our revenue is derived from sales of our products, we also receive a small percentage of our revenue from customer-sponsored research and development activities. These activities range from pure research, in which we investigate integrated circuit, or IC, design techniques on new semiconductor technologies at the request of a government agency or commercial customer, to custom development projects in which we are paid to enhance or modify an existing product or develop a new product to meet a customer's specifications.

Cost of revenue. Cost of revenue consists primarily of the cost of semiconductor wafers that we purchase from our third-party foundries and other materials such as packages, epoxies, connectors and production masks. Cost of revenue also includes personnel costs and overhead related to our manufacturing and engineering operations, including occupancy and equipment costs, shipping costs, charges for inventory excess and obsolescence and warranty obligations and amortization of related intangible assets.

Research and development. Research and development expense consists primarily of personnel costs of our research and development organization, third-party consulting costs, costs of development wafers, license fees for computer-aided design software, costs of development testing and evaluation, costs of developing automated test software, related occupancy and equipment costs and amortization of related intangible assets. We expense all research and development costs as incurred.

Sales and marketing. Sales and marketing expense consists primarily of personnel costs of our sales and marketing organization, sales commissions paid to independent sales representatives, costs of advertising, trade shows, corporate marketing, promotion, travel, related occupancy and equipment costs, amortization of related intangible assets and other marketing costs.

General and administrative. General and administrative expense consists primarily of personnel costs of our executive management, finance, and other administrative staff, outside professional fees, related occupancy and equipment costs and other corporate expenses.

Trends and Uncertainties

We are transitioning away from one of our foundries from which we source a substantial portion of our GaAs wafers. We have been working with the foundry to manage this transition with the goal of maintaining adequate supplies of the affected products over their natural life cycles, which are typically five to ten years. The impact of this transition on our business is uncertain. We have increased, and will continue to increase, our purchases of raw materials inventory from this foundry in order to support the products which have the longest life cycles. This will consume cash and could expose us to increased risk of inventory write-offs. At September 30, 2012, raw material inventory includes $27.5 million of advance purchases of wafers from this foundry. During this transition, we could also experience adverse reactions from customers, which could affect our revenues, and the productivity of our new product development efforts has been, and may continue to be, adversely affected as we divert engineering resources in order to translate certain existing products to other foundries, which could affect our profitability. Further, products translated to other foundries could have inferior performance, production yields or costs. If any of these events were to occur to a more significant degree than they have to date, our business, revenues, profitability and financial condition could be adversely affected.


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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 accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions 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 judgments and estimates including those related to revenue recognition, uncollectible accounts receivable, inventories, intangible assets, stock-based compensation, income taxes, warranty obligations, accrued expenses and other contingencies. 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. Actual results could differ from those estimates, and material effects on our operating results and financial position may result.


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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 year ended December 31, 2011.

Results of Operations

Comparison of the Three Month Periods Ended September 30, 2012 and 2011

Revenue. In the three months ended September 30, 2012, our revenue decreased $1.0 million, or 1.4%, to $67.2 million, compared with $68.1 million in the corresponding period of 2011. Revenue from sales to customers outside the United States accounted for 51.3% of our total revenue in the three months ended September 30, 2012, compared with 55.6% in the corresponding period of 2011. Our revenue decrease was primarily attributable to a $1.9 million decrease in sales to the microwave and millimeterwave communications market, a $1.4 million decrease in sales to the cellular market and a $1.3 million decrease in sales to the military market, which were partially offset by a $2.5 million increase in sales to the space market and a $1.0 million increase in sales to the test and measurement market. The decrease in sales to the microwave and millimeterwave communications and cellular markets reflects weaker demand for our products used in infrastructure projects by our telecommunications customers. The decrease in sales to the military market primarily relates to our completion of a systems contract in 2011, as well as lower pricing on certain military programs partially offset by increased volume. We believe that the growth in sales to the test and measurement and space markets reflects increased market share due to the broader range of our product offerings and increased market acceptance of products we introduced in prior years.

Gross margin. In the three months ended September 30, 2012, our gross margin was 73.6%, compared with 74.5% in the corresponding period of 2011. The decrease in our aggregate gross margin across all products was attributable to a net 320 basis point decrease due to pricing partially offset by a net 130 basis point improvement due to lower manufacturing costs and a net 100 basis point improvement due to product mix. Our gross margin for the three months ended September 30, 2012 was within a normal range and consistent with our historical results.

Research and development expense. In the three months ended September 30, 2012, our research and development expense increased $3.4 million, or 37.8%, to $12.5 million, and represented 18.7% of our revenue, compared with $9.1 million, or 13.4% of our revenue, in the corresponding period of 2011. The increase in our research and development expense was primarily attributable to a $0.9 million increase in professional fees, a $0.8 million reduction in funding received from various foreign government research and development incentive programs, a $0.5 million increase in personnel costs, a $0.5 million increase in supplies and materials, a $0.4 million increase in equipment costs and a $0.3 million increase in other costs. The increase in costs was primarily due to the growth of our engineering organization, including the opening of our new design centers in Virginia and Egypt in the fourth quarter of 2011, and costs of translation of certain existing products to other GaAs foundries.

Sales and marketing expense. In the three months ended September 30, 2012, our sales and marketing expense increased $0.6 million, or 10.9%, to $6.0 million, and represented 9.0% of our revenue, compared with $5.4 million, or 8.0% of our revenue, in the corresponding period of 2011. The increase in our sales and marketing expense was primarily attributable to a $0.7 million increase in personnel costs and a $0.1 million increase in travel costs partially offset by a $0.2 million decrease in commissions and other costs.

General and administrative expense. In the three months ended September 30, 2012, our general and administrative expense increased $0.4 million, or 12.5%, to $3.3 million, and represented 4.9% of our revenue, compared with $2.9 million, or 4.3% of our revenue, in the corresponding period of 2011. The increase in our general and administrative expense was primarily attributable to a $0.2 million increase in personnel costs and a $0.2 million increase in professional fees.

Interest income. In the three months ended September 30, 2012, our interest income was $39,000 compared with $37,000 in the corresponding period of 2011. Interest income in both periods reflects the low effective yields that were available due to the current market conditions.

Other income (expense), net. In the three months ended September 30, 2012, our other income, net was $13,000 compared with $199,000 in the corresponding period of 2011. The change was primarily due to reduced net foreign currency gains.

Provision for income taxes. Our provision for income taxes decreased $1.2 million to $9.9 million in the three months ended September 30, 2012, from $11.1 million in the corresponding period of 2011, representing an effective tax rate of 35.9% and 33.1% in 2012 and 2011, respectively. The effective tax rate increased as a result of


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a decrease in tax benefits related to U.S. manufacturing activities. Additionally, in the second quarter of 2012, we completed the initial phase of a global expansion project. The objective of this project is to better service our international customers and better manage our global suppliers. The impact of this project caused our effective tax rate to increase due to the ongoing implementation of the new global corporate structure.

Comparison of the Nine Month Periods Ended September 30, 2012 and 2011

Revenue. In the nine months ended September 30, 2012, our revenue decreased $8.0 million, or 3.9%, to $195.9 million, compared with $203.9 million in the corresponding period of 2011. Revenue from sales to customers outside the United States accounted for 51.9% of our total revenue in the nine months ended September 30, 2012, compared with 55.1% in the corresponding period of 2011. Our revenue decrease was primarily attributable to a $7.7 million decrease in sales to the cellular market, a $5.3 million decrease in sales to the military market and a $4.5 million decrease in sales to the microwave and millimeterwave communications market, which were partially offset by a $5.5 million increase in sales to the test and measurement market and a $4.2 million increase in sales to the space market. The decrease in sales to the cellular and microwave and millimeterwave communications markets reflects weaker demand for our products used in infrastructure projects by our telecommunications customers. The decrease in sales to the military market reflects our completion of a systems contract in 2011, as well as lower pricing on certain military programs, partially offset by increased volume. We believe that the growth in sales to the test and measurement and space markets reflects increased market share due to the broader range of our product offerings and increased market acceptance of products we introduced in prior years.

Gross margin. In the nine months ended September 30, 2012, our gross margin was 73.9%, compared with 73.4% in the corresponding period of 2011. The increase in our aggregate gross margin across all products was attributable to a net 190 basis point improvement due to product mix and a net 70 basis point improvement due to lower manufacturing costs, partially offset by a net 210 basis point decrease due to pricing. Our gross margin for the nine months ended September 30, 2012 was within a normal range and consistent with our historical results.

Research and development expense. In the nine months ended September 30, 2012, our research and development expense increased $8.9 million, or 31.7%, to $36.8 million, and represented 18.8% of our revenue, compared with $27.9 million, or 13.7% of our revenue, in the corresponding period of 2011. The increase in our research and development expense was primarily attributable to a $2.6 million increase in personnel costs, a $1.8 million increase in supplies and materials, a $1.3 million increase in professional fees, a $1.2 million increase in equipment costs, a $0.9 million reduction in funding received from various foreign government research and development incentive programs, a $0.4 million increase in depreciation and a $0.7 million increase in occupancy and other costs. The increase in costs was primarily due to the growth of our engineering organization, including the opening of our new design centers in Virginia and Egypt in the fourth quarter of 2011, and the costs of translation of certain existing products to other GaAs foundries.

Sales and marketing expense. In the nine months ended September 30, 2012, our sales and marketing expense increased $1.3 million, or 8.0%, to $17.6 million, and represented 9.0% of our revenue, compared with $16.3 million, or 8.0% of our revenue, in the corresponding period of 2011. The increase in our sales and marketing expense was primarily attributable to a $1.5 million increase in personnel cost partially offset by a $0.2 million decrease in depreciation and other costs.

General and administrative expense. In the nine months ended September 30, 2012, our general and administrative expense increased $2.3 million, or 25.7%, to $11.1 million, and represented 5.7% of our revenue, compared with $8.9 million, or 4.3% of our revenue, in the corresponding period of 2011. The increase in our general and administrative expense was primarily attributable to a $1.0 million increase in professional fees and other legal costs, a $0.8 million increase in personnel costs and a $0.5 million charge related to a U.S. payroll tax audit. The increase in professional fees primarily related to our global expansion project.

Interest income. In the nine months ended September 30, 2012, our interest income was $103,000 compared with $120,000 in the corresponding period of 2011. Interest income in both periods reflects the low effective yields that are available due to the current market conditions.


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Other income (expense), net. In the nine months ended September 30, 2012, our other expense, net was $114,000 compared with other income, net of $406,000 in the corresponding period of 2011. The change was primarily due to net foreign currency losses.

Provision for income taxes. Our provision for income taxes decreased $5.2 million to $28.4 million in the nine months ended September 30, 2012, from $33.6 million in the corresponding period of 2011, representing an effective tax rate of 35.8% and 34.6% in 2012 and 2011, respectively. The decrease in the provision for income taxes includes a $0.7 million benefit related to the resolution of the U.S. Internal Revenue Service's examination of our fiscal 2008 through 2010 income tax returns and the related decrease in reserves for uncertain tax positions. The effective tax rate increased primarily as a result of a decrease in tax benefits related to U.S. manufacturing activities partially offset by the resolution of the U.S. tax examination. Additionally, in the second quarter of 2012, we completed the initial phase of a global expansion project. The objective of this project is to better service our international customers and better manage our global suppliers. The impact of this project caused our effective tax rate to increase due to the ongoing implementation of the new global corporate structure.

Liquidity and Capital Resources

As of September 30, 2012, we held $342.7 million of cash and cash equivalents. Cash provided by our operations was $48.2 million in the nine months ended September 30, 2012, of which the principal components were our net income of $50.9 million and non-cash charges of $21.1 million, partially offset by a net increase in operating assets and liabilities of $18.8 million and a net increase in deferred taxes of $4.9 million. The increase in net operating assets and liabilities includes an increase in inventory of $23.4 million primarily related to the advance purchases of wafers from a foundry we are transitioning from, a $3.2 million net increase in income taxes receivable, due to the timing of tax payments and receipts and a $0.8 million increase in other assets, partially offset by a $6.2 million increase in accounts payable and accrued expenses, due to the timing of disbursements and a $2.3 million decrease in accounts receivable, related to the timing of customer shipments and collections.

We invested $9.5 million in the purchase of property and equipment in the nine months ended September 30, 2012, primarily related to building renovations, production tooling and production test equipment. We purchased $50.1 million of marketable securities in the nine months ended September 30, 2012, comprised of United States government treasury notes and bills.

During the nine months ended September 30, 2012, shares issued upon vesting of restricted stock were net of 6,189 shares retained by us to cover employee tax withholdings of $0.3 million paid by us. In addition, we received $0.3 million from the exercise of stock options and $0.3 million from the excess tax benefit related to our stock-based compensation plans.

We maintain a stock repurchase program that is intended to offset the dilutive impact of equity-based compensation granted to our employees. Shares may be repurchased from time to time on the open market or in privately negotiated transactions. We did not repurchase any shares during the nine months ended September 30, 2012. The timing, price and volume of any additional repurchases will be based on market conditions, relevant securities law and other factors, as appropriate, and repurchases may be suspended or discontinued at any time.

We believe that our cash, cash equivalents and cash generated from operations will be sufficient to meet our anticipated cash requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support product development efforts, the expansion of our sales and marketing activities, the timing and introduction of new products, the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. There is no assurance that additional financing, if required or desired, will be available in amounts or on terms acceptable to us, if at all.


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Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board, or FASB, issued ASU 2011-04, "Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS." ASU 2011-04 results in common fair value measurement and disclosure requirements in U.S. GAAP and International Financial Reporting Standards, or IFRS. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. We adopted ASU 2011-04 effective January 1, 2012. Such adoption did not have a material effect on our financial position or results of operations.

In June 2011, the FASB issued ASU 2011-05, "Presentation of Comprehensive Income." ASU 2011-05 requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income, or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present components of other comprehensive income as part of the statement of equity. We adopted ASU 2011-05 effective January 1, 2012. Such adoption did not have a material effect on our financial position or results of operations.

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