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

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Form 10-Q for PERICOM SEMICONDUCTOR CORP


2-Nov-2012

Quarterly Report


Item 2: Management's Discussion and Analysis

of Financial Condition and Results of Operations

Pericom Semiconductor Corporation

The following information should be read in conjunction with the unaudited financial statements and notes thereto included in Part 1 - Item 1 of this Quarterly Report and the audited financial statements and notes thereto and 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 June 30, 2012 (the "Form 10-K").

Factors That May Affect Operating Results

This Quarterly Report on Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements other than statements of historical fact are "forward-looking statements" for purposes of these provisions, including any statements regarding our sales to Taiwan and China, the continuation of a high level of turns orders, higher or lower levels of inventory, future gross profit and gross margin; the plans and objectives of management for future operations; our tax rate; currency fluctuations; the adequacy of allowances for returns, price protection and other concessions; the sufficiency of cash generated from operations and cash balances; our exposure to interest rate risk; expectations regarding our research and development and selling, general and administrative expenses; and our possible future acquisitions and assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "may," "will," "expects," "plans," "anticipates," "estimates," "potential," or "continue," or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained herein are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to risks and uncertainties, including but not limited to the factors set forth (i) in Item 1A, Risk Factors, of Part II of this Form 10-Q, and (ii) in Note 1 to the Notes to Condensed Consolidated Financial Statements. All forward-looking statements and reasons why results may differ included in this Quarterly Report are made as of the date hereof, and we assume no obligation to update any such forward-looking statement or reason why actual results may differ.


Results of Operations


The following table sets forth certain statement of operations data as a
percentage of net revenues for the periods indicated.


                                                           Three Months Ended
                                                       September 29,   October 1,
                                                           2012           2011

   Net revenues                                              100.0 %      100.0 %
   Cost of revenues                                           62.1 %       64.5 %
   Gross profit                                               37.9 %       35.5 %
   Operating expenses:
   Research and development                                   14.5 %       15.0 %
   Selling, general and administrative                        20.8 %       20.8 %
   Total                                                      35.3 %       35.8 %
   Income (loss) from operations                               2.6 %       (0.3)%
   Interest and other income, net                              1.7 %        3.0 %
   Income before income taxes                                  4.3 %        2.7 %
   Income tax expense                                          1.4 %        1.5 %
   Net income from consolidated companies                      2.9 %        1.2 %
   Equity in net income of unconsolidated affiliates           0.3 %        0.1 %
   Net income                                                  3.2 %        1.3 %

Net Revenues


The following table sets forth our revenues and the customer concentrations with
respect to such revenues for the periods indicated.


                                                      Three Months Ended
                                        September 29,               October 1,          %
(In thousands)                           2012                         2011            Change

Net revenues                       $          36,749            $          35,332       4.0%
% of net sales accounted for by
top 5 direct customers (1)                            41.7%                   51.0%

Number of direct customers that
each account for more than 10% of
net sales                                         2                            2

% of net sales accounted for by
top 5 end customers (2)                               29.1%                   28.9%

Number of end customers that each
account for more than 10% of net
sales                                                   -                       -

(1)

Direct customers purchase products directly from us and include distributors, contract manufacturers and original equipment manufacturers ("OEM"s).

(2)

End customers are OEMs and their products are manufactured using our products.
End customers may purchase directly from us or from distributors or contract manufacturers. For end customer data, we rely on information provided by our direct distribution and contract manufacturing customers.

We design, develop and market high-performance integrated circuits ("ICs" or IC products) and frequency control products ("FCPs" or FCP products) used in many of today's advanced electronic systems. Our IC products include products that support the connectivity, timing and signal conditioning of high-speed parallel and serial protocols that transfer data among a system's microprocessor, memory and various


peripherals, such as displays and monitors, and between interconnected systems. Our FCPs are electronic components that provide frequency references such as crystals, oscillators, and hybrid timing generation products for computer, communication and consumer electronic products. Our analog, digital and mixed-signal ICs, together with our FCP products enable higher system bandwidth and signal quality, resulting in better operating reliability, signal integrity, and lower overall system cost in applications such as notebook computers, servers, network switches and routers, storage area networks, digital TVs, cell phones, GPS and digital media players.

Net revenues consist of product sales, which we generally recognize upon shipment, less an estimate for returns and allowances.

Net revenues increased $1.4 million or 4.0% in the first three months of fiscal 2013 versus the first three months of fiscal 2012. Net revenue for IC and FCP products in the first three months of fiscal 2013 versus the first three months of fiscal 2012 reflected:

a $107,000 increase in sales of IC products to $22.6 million, a 0.5% increase, and
an increase of $1.3 million or 10.3% in sales of our FCP products to $14.1 million.

The following table sets forth net revenues by country as a percentage of total net revenues for the three months ended September 29, 2012 and October 1, 2011:

                                              Three Months Ended
                                          September 29,   October 1,
                                              2012           2011
              Taiwan                                42%          46%
              China (including Hong Kong)           40%          33%
              United States                          5%           5%
              Other (less than 10% each)            13%          16%

              Total                                100%         100%

Over the past several years, sales to Taiwan and China have constituted the majority of our sales. We expect this trend will continue in the future.

Our net revenue levels have been highly dependent on the number of new orders that are received for products to be delivered to the customer within the same quarter, also called "turns" orders. Because of our lack of visibility into demand when turns orders are high, it is difficult to predict which products to build to match future demand. We believe the current high level of turns orders will continue indefinitely. The sustainability of customer demand is uncertain and our markets are highly dependent on worldwide economic conditions. The high level of turns orders together with the uncertainty of product mix and pricing makes it difficult to predict future levels of sales and may require us to carry higher levels of inventory.

Gross Profit


The following table sets forth our gross profit for the periods indicated:


                                                Three Months Ended
                                   September 29,          October 1,          %
    (in thousands)                      2012                 2011          Change

    Net revenues                  $          36,749    $          35,332      4.0%
    Gross profit                             13,911               12,537     11.0%
    Gross profit as a
    percentage of net revenues
    (gross margin)                            37.9%                35.5%

The increase in gross profit in the first three months of fiscal 2013 as compared to the first three months of fiscal 2012 of $1.4 million is the result of:


a 4.0% increase in sales, which led to $536,000 of increased gross profit, and
a gross margin increase from 35.5% to 37.9%, resulting in an $836,000 improvement in gross profit.

The sales increase was primarily attributable to FCP products, as described above. The gross margin increase resulted primarily from our initiative to focus on higher-margin opportunities in server, storage, networking, telecom and embedded market segments.

Future gross profit and gross margin are highly dependent on the level and product mix of net revenues. This includes the mix of sales between lower margin FCP products and our higher margin integrated circuit products. Although we have been successful at favorably improving our integrated circuit product mix and penetrating new end markets, there can be no assurance that this will continue. Accordingly, we are not able to predict future gross profit levels or gross margins with certainty.

During the three months ended September 29, 2012 and October 1, 2011, gross profit and gross margin benefited as a result of the sale of inventory of $40,000 and $17,000 respectively, that we had previously identified as excess and written down to zero value.

Research and Development ("R&D")

                                                     Three Months Ended
                                          September 29,      October 1,        %
   (in thousands)                             2012              2011         Change

   Net revenues                           $       36,749    $       35,332     4.0%
   Research and development                        5,323             5,316     0.1%

   R&D as a percentage of net revenues             14.5%             15.0%

Research and development expenses consist primarily of costs related to personnel and overhead, non-recurring engineering charges, and other costs associated with the design, prototyping, testing, manufacturing process design support, and technical customer applications support of our products. Expenses for the three month period ended September 29, 2012 as compared to the same period of the prior year included increases of $216,000 in compensation and $128,000 for outside design consultants, partially offset by reductions of $159,000 in depreciation and amortization and $170,000 in departmental overhead expenses.

We believe that continued spending on research and development to develop new products and improve manufacturing processes is critical to our long-term success, and as a result we expect to continue to invest in research and development projects. In the short term, we intend to continue to focus on cost control as business conditions improve. If business conditions deteriorate or the rate of improvement does not meet our expectations, we may implement further cost-cutting actions.

Selling, General and Administrative ("SG&A")

                                                     Three Months Ended
                                          September 29,      October 1,        %
   (in thousands)                              2012             2011         Change

   Net revenues                            $      36,749    $      35,332      4.0%
   Selling, general and administrative             7,639            7,339      4.1%

   SG&A as a percentage of net revenues            20.8%            20.8%

Selling, general and administrative expenses consist primarily of personnel and related overhead costs for sales, marketing, finance, administration, human resources and general management. The expense increase


of approximately $300,000 for the three month period ended September 29, 2012 as compared to the same period of the prior year is attributable primarily to increased expenditures of $390,000 in compensation expenses, primarily salaries, wages and bonus accrual, partially offset by $83,000 of reduced charges for share-based compensation.

We anticipate that selling, general and administrative expenses will increase in future periods over the long term due to increased staffing levels, particularly in sales and marketing, as well as increased commission expense to the extent we achieve higher sales levels. We intend to continue our focus on controlling costs. If business conditions deteriorate or the rate of improvement does not meet our expectations, we may implement further cost-cutting actions.

Interest and Other Income, Net


                                                     Three Months Ended
                                          September 29,      October 1,         %
(in thousands)                                2012              2011          Change

Interest income                           $          854    $          933     -8.5%
Other income (expense)                                 4              (58)     NM
Foreign exchange transaction gain (loss)           (223)               195     NM
  Interest and other income, net          $          635    $        1,070    -40.7%
      NM = not meaningful

Interest and other income for the three month period ended September 29, 2012 decreased $435,000 as compared with the same period of the prior year due primarily to an exchange loss this year as compared with an exchange gain last year due to currency fluctuation combined with somewhat lower returns and realized gains on invested balances this year, partially offset by reductions in other expenses.

Income Tax Expense


                                           Three Months Ended
                                September 29,      October 1,       %
             (in thousands)          2012             2011        Change

             Pre-tax income      $       1,584    $         952    66.4%
             Income tax expense            500              534    -6.4%

             Effective tax rate          31.6%            56.1%

The decrease in the effective tax rate for the three months ended September 29, 2012 as compared with the same period of the prior year is due primarily to improved current period pre-tax income and reduced pre-tax losses in certain foreign entities.

Our effective tax rate may differ from the federal statutory rate primarily due to state income taxes, research and development tax credits, share-based compensation from incentive stock options, tax-exempt interest income, and differing tax rates in income-earning foreign jurisdictions.

Equity in Net Income of Unconsolidated Affiliate

Equity in net income of unconsolidated affiliate consists of our allocated portion of the net income of Jiyuan Crystal Photoelectric Frequency Technology Ltd. ("JCP"), an FCP manufacturing company located in Science Park of Jiyuan City, Henan Province, China. JCP is a key manufacturing partner of PSE-TW, and PSE-TW has acquired a 49% equity interest in JCP. For the three month periods ended September 29, 2012 and October 1, 2011, the Company's allocated portion of JCP's results was income of $108,000 and $27,000, respectively.


Liquidity and Capital Resources

As of September 29, 2012, our principal sources of liquidity included cash, cash equivalents and short-term and long-term investments of approximately $123.3 million as compared with $127.8 million on June 30, 2012.

Our investment in debt securities includes government securities, corporate debt securities and mortgage-backed and asset-backed securities. Government securities include US treasury securities, US federal agency securities, foreign government and agency securities, and US state and municipal bond obligations. Many of the municipal bonds are insured; those that are not are nearly all AAA/Aaa rated. The corporate debt securities are all investment grade and nearly all are single A-rated or better. The asset-backed securities are AAA/Aaa rated and are backed by auto loans, student loans, credit card balances and residential or commercial mortgages. Most of our mortgage-backed securities are collateralized by prime residential mortgages issued by government agencies including FNMA, FHLMC and FHLB. Those issued by banks are AAA-rated. At September 29, 2012, unrealized gains on marketable securities net of taxes were $665,000. When assessing marketable securities for other than temporary declines in value, we consider a number of factors. Our analyses of the severity and duration of price declines, portfolio manager reports, economic forecasts and the specific circumstances of issuers indicate that it is reasonable to expect marketable securities with unrealized losses at September 29, 2012 to recover in fair value up to our cost bases within a reasonable period of time. We have the ability and intent to hold investments with unrealized losses until maturity, when the obligors are required to redeem them at full face value or par, and we believe the obligors have the financial resources to redeem the debt securities. Accordingly, we do not consider our investments to be other than temporarily impaired at September 29, 2012.

As of September 29, 2012, $31.6 million was classified as cash and cash equivalents compared with $24.3 million as of June 30, 2012. The maturities of our short term investments are staggered throughout the year so that cash requirements are met. Because we are a fabless semiconductor manufacturer, we have lower capital equipment requirements than other semiconductor manufacturers who own wafer fabrication facilities. For the three month period ended September 29, 2012, we spent approximately $8.6 million on property and equipment which included $7.6 million for our new headquarters facility, compared to $1.6 million for the three month period ended October 1, 2011. We generated approximately $854,000 of interest income for the three month period ended September 29, 2012, as compared with $933,000 of interest income for the three month period ended October 1, 2011. In the longer term we may generate less interest income if our total invested balance decreases and these decreases are not offset by rising interest rates or increased cash generated from operations or other sources.

Our net cash provided by operating activities of $1.9 million for the three months ended September 29, 2012 was primarily the result of non-cash expenses of $2.9 million in depreciation and amortization, $841,000 of share-based compensation expense, and $159,000 of tax benefit from stock option transactions, partially offset by a $252,000 gain on sale of investments in marketable securities and $108,000 equity in net income of unconsolidated affiliate. An additional contribution to cash included an increase of $1.2 million in accrued liabilities. Such contributions were partially offset by increases of $788,000 in inventories, $196,000 in prepaid expenses and other current assets, $263,000 in other assets and $134,000 in accounts receivable, and decreases of $2.2 million in accounts payable and $327,000 in long-term liabilities. Our net cash provided by operating activities was $8.9 million in the three months ended October 1, 2011.

Our cash provided by investing activities of $3.9 million for the three months ended September 29, 2012 was the result of maturities and sales of available for sale investments exceeding purchases of available for sale investments by approximately $12.5 million, partially offset by additions to property and equipment of approximately $8.6 million. Our cash used in investing activities was $7.6 million for the three months ended October 1, 2011.

Our cash provided by financing activities for the three months ended September 29, 2012 of $765,000 was primarily the result of $2.9 million of short-term debt borrowings, partially offset by $1.4 million of repayments of short-term debt and expenditures of $708,000 for repurchase of our common stock. Our cash used in financing activities was $4.6 million for the three months ended October 1, 2011.

A portion of our cash may be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies.
From time to time, in the ordinary course of business, we may evaluate potential acquisitions of such businesses, products or technologies.


Our long-term future capital requirements will depend on many factors, including our level of revenues, the timing and extent of spending to support our product development efforts, the expansion of sales and marketing efforts, the timing of our introductions of new products, the costs to ensure access to adequate manufacturing capacity, and the continuing market acceptance of our products. We could be required, or could elect, to seek additional funding through public or private equity or debt financing and additional funds may not be available on terms acceptable to us or at all. We believe our current cash balances and cash flows generated by operations will be sufficient to satisfy our anticipated cash needs for working capital and capital expenditures.

Contractual Obligations and Commitments


Our contractual obligations and commitments at September 29, 2012 are as
follows:


                                                           Payments Due by Period
(in thousands)                       Total      Less than 1 Year   1 - 3 Years   3 - 5 Years   Thereafter
Short-term debt                    $    2,886    $     2,886        $      -      $     -       $        -
Operating lease payments               2,199          1,522            671             6                -
Yangzhou capital injection            15,000          7,000           8,000            -                -
Total obligations                  $   20,085    $    11,408        $  8,671      $     6       $        -

We lease certain facilities under operating leases with termination dates on or before December 2013. Generally, these leases have multiple options to extend for a period of years upon termination of the original lease term or previously exercised option to extend.

We have no purchase obligations other than routine purchase orders as of September 29, 2012.

We previously entered into an R&D Agreement for our Yangzhou facility that would require the capital injections shown in the table. We are currently negotiating with the Yangzhou government to terminate or modify the R&D Agreement. If the termination or modification is successful, some or all of the additional capital injections may not be made, although there may be additional terms or conditions involved in any settlement agreement.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements, defined by Regulation S-K Item 303(a)(4).

Critical Accounting Policies

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.
The preparation of such statements requires us to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period and the reported amounts of assets and liabilities as of the date of the financial statements. Our estimates are based on historical experience and other assumptions that we consider to be reasonable given the circumstances. Actual results may vary from our estimates.

The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we reports in our financial statements. The Securities and Exchange Commission has defined the most critical accounting policies as the ones that are most important to the portrayal of our financial condition and results of operations, and require us to make our most difficult and subjective accounting judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, our most critical accounting policies include revenue recognition and accounts receivable allowances, which impact the recording of revenues; valuation of inventories, which impacts costs of goods sold and gross margins; accounting for income taxes, which impacts the income tax provision and net income; impairment of goodwill, other intangible assets and investments, which impacts the goodwill, intangible asset and investment accounts; and stock-based compensation, which impacts costs of goods sold and operating expenses. These policies and the estimates and judgments involved are discussed further below.


REVENUE RECOGNITION. We recognize revenue from the sale of our products upon shipment, provided title and risk of loss has passed to the customer, the price is fixed or determinable and collection of the revenue is reasonably assured. A provision for estimated future returns and other charges against revenue is recorded at the time of shipment. For the three months ended September 29, 2012, the majority of our revenues were from sales to distributors.

We sell products to large, domestic distributors at the price listed in our price book for that distributor. We recognize revenue at the time of shipment. At the time of sale we record a sales reserve for ship from stock and debits ("SSD"s), stock rotations, return material authorizations ("RMA"s), authorized . . .

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