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SMTC > SEC Filings for SMTC > Form 10-K on 28-Mar-2013All Recent SEC Filings

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Form 10-K for SEMTECH CORP


28-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6 "Selected Consolidated Financial Data" and our audited consolidated financial statements and related notes included elsewhere in this Form 10-K.
As discussed in "Special Note Regarding Forward-Looking and Cautionary Statements" earlier in this report, this Form 10-K contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward looking statements, including as a result of the risks described in the cautionary statements in Item 1A "Risk Factors" and elsewhere in this Form 10-K, in our other filings with the SEC, and in material incorporated herein and therein by reference. We undertake no duty to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview
We are a leading supplier of analog and mixed-signal semiconductor products and were incorporated in Delaware in 1960. We design, produce and market a broad range of products that are sold principally into applications within the high-end consumer, industrial, enterprise computing and communications end-markets. The high-end consumer market includes handheld products, tablet computers, set-top boxes, digital televisions, digital video recorders, thunderbolt and fiberless high-speed interfaces and other consumer equipment. Applications for the industrial market include broadcast studio equipment, automated meter reading, military and aerospace, medical, security systems, automotive, industrial and home automation, video security and surveillance and other industrial equipment. Enterprise computing product markets include optical receiver and transceiver, desktops, notebooks, servers, graphic boards, monitors, printers, and other computer peripherals. Communications market applications include base stations, backplane, optical networks, carrier networks, switches and routers, servers, cable modems, signal conditioners, wireless LAN, and other communication infrastructure equipment. Our end-customers are primarily original equipment manufacturers and their suppliers, including Alcatel-Lucent, Cisco Systems, Inc., Huawei Technologies Co., Ltd., LG Electronics, Motorola, Nokia Siemens Networks, Itron, Apple, Phonak International, Research In Motion Limited, Samsung Electronics Co., and ZTE Corporation.
On March 20, 2012, we, through our wholly-owned subsidiary Semtech Canada Inc., completed the acquisition of all outstanding equity interests of Gennum Corporation ("Gennum") (TSX: GND), a leading supplier of high speed analog and mixed-signal semiconductors for the optical communications and video broadcast markets.
Upon consummation of the acquisition, which constituted a change in control of Gennum, Gennum's stock option awards and restricted shares became fully vested. We acquired 100% of the outstanding shares and vested stock options, restricted shares, and deferred share units of Gennum for CDN$13.55 per share for a total purchase price of $506.5 million. The acquisition was financed with a combination of cash from our international cash reserves and $347 million (net of original issue discount of $3 million) of five-year secured term loans with a combined interest rate of approximately 4% (see Note 10 to our audited consolidated financial statements included in Item 8 of this report). Our primary reasons for the acquisition were to broaden our existing portfolio of high-speed communications platforms with Gennum's 1 Gbps to 25 Gbps signal integrity platform, to complement our 40 Gbps to 100 Gbps SerDes solutions and to create one of the industry's most complete and robust analog and mixed signal portfolios. In addition, Gennum's strong position in video broadcast and the emerging HD video surveillance market further diversifies our portfolio of high-performance analog semiconductors and provides cross-selling potential with the combined customer base.
On March 7, 2012, we completed the acquisition of Cycleo SAS ("Cycleo"), a privately held company based in France that develops IP for wireless long-range semiconductor products used in smart metering and other industrial and consumer markets. This transaction, which was accounted for using the acquisition method of accounting, complements our current wireless offerings and will bring customers a set of high-end, digitally enhanced wireless solutions. Under the terms of the agreement, we paid the stockholders of Cycleo $5 million in cash at closing.
The audited consolidated financial statements for the fiscal year 2013 include the results of operations of Gennum and Cycleo commencing as of the acquisition dates.
We operate our business in one enterprise-wide reportable segment. Most of our sales to customers are made on the basis of individual customer purchase orders. Many customers include cancellation provisions in their purchase orders. Trends within the industry toward shorter lead-times and "just-in-time" deliveries have resulted in our reduced ability to predict future shipments. As a result, we rely on orders received and shipped within the same quarter for a significant portion of our sales. Orders received and shipped in fiscal years 2013 represented 41% of net sales. Sales made directly to customers during fiscal year 2013 were 61% of net sales. The remaining 39% of net sales were made through independent distributors.


Our business relies on foreign-based entities. Most of our outside subcontractors and suppliers, including third-party foundries that supply silicon wafers, are located in foreign countries, including China, Taiwan, the United States, Canada, Europe and Israel. For the fiscal year ended January 27, 2013, approximately 38% of our silicon, in terms of cost of wafers purchased, was manufactured in China. Foreign sales for fiscal year 2013 constituted approximately 83% of our net sales. Approximately 84% of foreign sales in fiscal year 2013 were to customers located in the Asia-Pacific region. The remaining foreign sales were primarily to customers in Europe and Canada.

Results of Operations
Fiscal Year 2013 Compared With Fiscal Year 2012 Presented below is our estimate of net sales by end-market.

                                                Fiscal Years
(in thousands, except percentages)        2013                 2012          Change
Enterprise Computing               $  85,945     15 %   $  41,716      9 %    106  %
Communications                       181,791     31 %     186,479     39 %     (3 )%
High-End Consumer                    169,847     29 %     168,520     35 %      1  %
Industrial and Other                 141,243     25 %      83,886     17 %     68  %
Total                              $ 578,826    100 %   $ 480,601    100 %     20  %

Net Sales. Net sales for fiscal year 2013 were $578.8 million, an increase of 20% compared to $480.6 million for fiscal year 2012. Fiscal year 2013 revenues increased driven by strengthening demand in the enterprise computing and industrial end markets and by the impact of approximately $129.6 million of Gennum sales in the current fiscal year, partially offset by a slight decrease in demand from the high-end consumer and communications end markets. Fiscal year 2012 was also impacted by softening global economic conditions that resulted in a reduction in orders of our component products during the fiscal year.

Higher revenue in the enterprise computing market is driven primarily by demand for the Gennum Product Group optical communications products. Within the communications category, lower revenue was attributed to softer demand for 40G communications products in our Advanced Communications product line, partially offset by increasing demand for 100G communication products. High-end consumer revenues were relatively flat due to softer demand in Protection products due to reduced demand from a North American Tier 1 smartphone customer offset by increasing demand for Gennum Product Group Thunderbolt cables. Higher revenue in the industrial category was attributed to video broadcast applications in the Gennum Product Group and continued strength in the medical business of our Wireless and Sensing Group.
Gross Profit. Gross profit was $314.6 million and $285.6 million in fiscal years 2013 and 2012, respectively. Our gross margin was 54.4% for fiscal year 2013, down from 59.4% in fiscal year 2012. Gross profit margins for fiscal year 2013 were negatively impacted by the amortization of $39.4 million of the fair value adjustment related to acquired inventory recorded to cost of sales from the Gennum acquisition which offset a favorable end-market product mix driven primarily by the impact of approximately $129.6 million of Gennum sales in fiscal year 2013.
Operating Costs and Expenses.

                                                     Fiscal Years
(in thousands, except
percentages)                             2013                            2012
                               Cost/Exp.      % net sales      Cost/Exp.      % net sales      Change
Selling, general and
administrative               $   149,070           26 %      $   100,629           21 %            48 %
Product development and
engineering                      120,009           21 %           80,577           17 %            49 %
Intangible amortization and
impairments                       29,944            5 %           10,853            2 %           176 %
Total operating costs and
expenses                     $   299,023           52 %      $   192,059           40 %            56 %

Selling, General & Administrative Expenses Selling, general and administrative ("SG&A") expenses for fiscal year 2013 increased by $48.4 million or 48% driven primarily by $11.4 million of transaction and integration expenses due to the acquisition of Gennum and Cycleo in March 2012 and the impact of incremental Gennum SG&A expenses.


Selling, general and administrative expenses for fiscal years 2013 include approximately $2.5 million environmental reserves and $13.4 million severance costs associated with the integration of the acquired Gennum business with the Company's pre-existing business (refer to Note 15 and Note 17 to our audited consolidated financial statements for details). Fiscal year 2012 includes $2.0 million for expenses attributed to a reorganization plan initiated during the third quarter of fiscal year 2012 which resulted in consolidation of research and development activities and reduction in workforce.
SG&A stock-based compensation expense was $15.0 million and $15.8 million in fiscal years 2013 and 2012, respectively. The year over year decrease in equity compensation was principally driven by staffing reductions associated with our reorganization actions in fiscal year 2012 partially offset by the increase in stock price in fiscal year 2013.
Product Development and Engineering Expenses Product development and engineering expenses for fiscal years 2013 and 2012 were $120.0 million and $80.6 million, respectively or an increase of 49%. The increase in fiscal year 2013 is principally driven primarily by the inclusion of Gennum expenses of $40.9 million since March 2012.
The levels of product development and engineering expenses reported in a fiscal period can be significantly impacted, and therefore experience period over period volatility, by the number of new product tape-outs and by the timing of recoveries from non-recurring engineering services which are typically recorded as a reduction to product development and engineering expense. Intangible Amortization and Impairments
Intangible amortization and impairments was $29.9 million and $10.9 million in fiscal years 2013 and 2012, respectively. The increase reflects the impact of $19.7 million intangible amortization related to the acquisition of Gennum and an impairment charge of $0.7 million attributed to assets acquired from SMI Inc. As of January 27, 2013, we had a total of $228.6 million of gross carrying amount of finite-lived intangible assets, which included $129.9 million related to the acquisition of Gennum.
The purchase price allocation for the Gennum acquisition included $29.1 million of acquired in-process research and development ("IPR&D") projects. Each project was analyzed to determine the unique technological innovations, the existence and reliance on core technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development.
The fair value of the IPR&D projects was determined using an income approach or replacement cost approach as applicable. The replacement cost approach was used for IPR&D projects that were considered long-term core investments and were not anticipated to be profitable for a period of time. IPR&D projects which were valued using an income approach, measured the returns attributable to each specific IPR&D project, discounted to present value using a risk-adjusted rate of return, including as appropriate, any tax benefits derived from amortizing the intangible asset for tax purposes. Significant factors considered in the calculation of the rate of return are the weighted average cost of capital and return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. For IPR&D projects valued using a replacement cost approach, value was estimated by developing the cost to either replace or reproduce (replicate) the IPR&D to its current state.
The top three IPR&D projects that comprise $21.0 million of the total $29.1 million IPR&D balance are for enterprise computing, communications and high-end consumer products. The following table summarizes the significant assumptions underlying the valuation for such three IPR&D projects at the acquisition date:

                                           Estimated   Estimated
                                            Time to     Cost to      Risk
                               Estimated   Complete    Complete    Adjusted
                                Percent       (in         (in      Discount    Valuation        IPR&D
Development Projects           Complete     years)     millions)     Rate      Approach     (In millions)
                                            1.7 to      $3.4 -
Video Platform                  10%-14%       1.9        $10.4       12%        Income          $4.0
                                            0.2 to      $18.4 -               Replacement
Backplane                       36%-40%       0.4        $20.2        NA         Cost           $12.0
                                                        $5.2 -                Replacement
Consumer                        44%-48%       0.2        $6.0         NA         Cost           $5.0

Costs, timing, and successful completion are subject to additional risk factors such as (i) increase in the projected technological risk of completion, (ii) decrease in the projected market size for the developed product, and (iii) subsequent decisions to postpone or delay the development of the IPR&D project. Actual results to date have been consistent, in all material respects, with our assumptions at the time of the acquisition.
Acquired in-process research and development was tested for impairment as of November 30, 2012, the date of our annual impairment review. With the exception of the impairment charge of $0.7 million recorded to write-off acquired IPR&D from


SMI, we concluded that the fair value of the acquired in-process research and developments exceeded the carrying value and no impairment existed as of January 27, 2013 (see Note 8 to our audited consolidated financial statements). Interest Expense. Interest expense was $14.4 million in fiscal year 2013. There was no interest expense in fiscal year 2012. The increase was due to interest expense and the amortization of the original issue discount and debt issuance costs related to the credit facilities to finance the acquisition of Gennum (see Notes 3 and 10 to our audited consolidated financial statements).
We are currently assessing our financing alternatives and may decide to replace our existing debt with lower interest debt in fiscal year 2014.
Interest Income and Other Expense, Net. Interest income and other expense, net was $(977,000) in fiscal year 2013, compared to $593,000 in fiscal year 2012. In fiscal year 2013, the interest income and other expense is primarily made of $(700,000) Swiss Stamp duty tax liabilities. In addition, interest income in fiscal year 2013 is lower as a result of a significant liquidation of investment to pay for acquisitions.
Provision for Taxes. The benefit for income taxes was $41.7 million for fiscal year 2013 compared to a provision of $5.1 million for fiscal year 2012. The effective tax rate for fiscal year 2013 reflects the impact of the one-time $23.4 million benefit related to our change in assertion regarding $70 million of foreign subsidiary earnings. Because income before taxes was near break-even for fiscal year 2013, comparison of year-over-year effective tax rates is meaningless.

In fiscal year 2010, we concluded that $120 million of foreign subsidiary earnings were no longer considered to be permanently reinvested offshore. In the first quarter of fiscal year 2013, in connection with the acquisition of Gennum, we reviewed our assertion regarding the amount of foreign subsidiary earnings that were considered to be permanently reinvested offshore and concluded that due to post-acquisition foreign operating cash needs, all of our foreign subsidiary earnings are considered to be permanently reinvested offshore. This change in assertion resulted in the recognition of a one-time tax benefit of $23.4 million in the first quarter of fiscal year 2013.

In fiscal year 2013, our tax provision was adversely affected by a net increase to our valuation allowance of $2.7 million. This net increase was primarily the result of concerns related to our ability to utilize our California net operating losses due to a projected lower California apportionment in future years.
Fiscal Year 2012 Compared With Fiscal Year 2011 Presented below is our estimate of net sales by end-market.

                                                Fiscal Years
(in thousands, except percentages)        2012                 2011          Change
Enterprise Computing               $  41,716      9 %   $  42,728      9 %     (2 )%
Communications                       186,479     39 %     166,419     37 %     12  %
High-End Consumer                    168,520     35 %     151,945     33 %     11  %
Industrial and Other                  83,886     17 %      93,410     21 %    (10 )%
Total                              $ 480,601    100 %   $ 454,502    100 %      6  %

Net Sales. Net sales for fiscal year 2012 were $480.6 million, an increase of 6% from $454.5 million for fiscal year 2011. Fiscal year 2012 revenues increased driven by strengthening demand in the communications and consumer end markets. Fiscal year 2012 was also impacted by softening global economic conditions that resulted in a reduction in orders of our component products during the fiscal year.
Higher revenue in the communications end market was attributed to the impact of strengthening demand for our 40G and 100G communications infrastructure products in our Advanced Communications product line. Higher revenues in the high-end consumer end market were driven by strengthening demand for Protection products in consumer applications including LCD TVs, smartphones and tablet computers. Enterprise computing revenues were roughly flat. Within the industrial category, lower revenue was attributed to softer demand from the military segment in our Power Management and High-Reliability and Advanced Communications product lines. Gross Profit. Gross profit was $285.6 million and $268.3 million for fiscal years 2012 and 2011, respectively. Our gross margin was 59.4% for fiscal year 2012, up from 59.0% in fiscal year 2011. Gross profit margins for fiscal year 2012 were positively impacted by higher revenues, increased manufacturing volumes and the impact of reduced equity compensation


expenses attributed to staffing reductions associated with a reduction in workforce. These factors offset the impact of a higher mix of consumer and enterprise computing revenues relative to communications and industrial revenues.
Operating Costs and Expenses.

                                                     Fiscal Years
(in thousands, except
percentages)                             2012                            2011
                               Cost/Exp.      % net sales      Cost/Exp.      % net sales       Change
Selling, general and
administrative               $   100,629           21 %      $   110,404           24 %            (9 )%
Product development and
engineering                       80,577           17 %           69,624           15 %            16  %
Intangible amortization and
impairments                       10,853            2 %            9,520            2 %            14  %
Total operating costs and
expenses                     $   192,059           40 %      $   189,548           41 %             1  %

Selling, General & Administrative Expenses Selling, general and administrative expenses for fiscal year 2012 decreased by $9.8 million or 9% driven by the reduction in class action lawsuit expenses as the Company settled the litigation in August 2011, and lower equity compensation expenses partially offset by the impact of transaction expenses, reorganization charges and the impact of higher staffing and information technology infrastructure upgrade spending. Approximately $2.9 million of transaction expenses attributed to the acquisition of Gennum and the evaluation of other acquisition candidates were recorded in fiscal year 2012.
Selling, general and administrative expenses for fiscal years 2012 and 2011 include approximately $0.2 million and $13.6 million (net of insurance recoveries of $10 million), respectively, for legal and other professional services incurred in connection with matters related to our historical stock option practices, including the government inquiries, the related litigation, and other associated matters. Fiscal year 2012 includes $2.0 million for expenses attributed to a reorganization plan initiated during the third quarter of fiscal year 2012 which resulted in consolidation of research and development activities and reduction in workforce.
SG&A stock-based compensation expense was $15.8 million and $19.3 million in fiscal years 2012 and 2011, respectively. The year over year decrease in equity compensation was principally driven by staffing reductions associated with our reorganization actions.
Product Development and Engineering Expenses Product development and engineering expenses for fiscal years 2012 and 2011 were $80.6 million and $69.6 million, respectively or an increase of 16%. The increase in fiscal year 2012 is principally driven by the impact of increased new product and process development expenditures primarily in the Advanced Communications and Protection product lines. In addition, fiscal year 2012 includes a $0.9 million expense associated with the impairment of a new process development initiative.
Intangible Amortization and Impairments
Intangible amortization and impairments, which reflects amortization costs associated with acquired intangibles, increased by $1.3 million in fiscal year 2012 compared to fiscal year 2011, as a result of the impact of impairment charges attributed to assets acquired from Leadis Technology Inc. During the third quarter of fiscal year 2012, we abandoned certain development efforts related to acquired intangible assets and recorded an impairment charge of $2.5 million.
Interest Expense. There was no interest expense in fiscal year 2012 and 2011. Interest Income and Other Expense, Net. Interest income and other expense, net was $593,000 for fiscal year 2012, up from $574,000 in fiscal year 2011. For fiscal years 2012 and 2011, the primary source of income was interest from investments offset by loss from foreign currency transactions.
Provision for Taxes. The provision for income taxes was $5.1 million for fiscal year 2012 compared to $6.8 million for fiscal year 2011. The effective tax rates for fiscal year 2012 and fiscal year 2011 were 5.4% and 8.5%, respectively. The rate for fiscal year 2012 reflects the impact of favorable trends in our regional mix of income. We expect our regional income trends to remain favorable. However, certain items which occurred in fiscal year 2012 are not expected to recur in fiscal year 2013. One such item includes a one-time benefit of $3.9 million related to a release of previously recorded reserves for uncertain tax positions, as a result of statutes of limitations for the taxing authority to challenge the positions expiring.


In fiscal year 2012, our tax provision was adversely affected by a net increase to our valuation allowance of $2.1 million. This net increase was primarily the result of concerns related to our ability to utilize our California net operating losses due to a projected lower California apportionment in future years.

Liquidity and Capital Resources
Our capital requirements depend on a variety of factors, including but not limited to, the rate of increase or decrease in our existing business base; the success, timing and amount of investment required to bring new products to market; revenue growth or decline; and potential acquisitions. We believe that we have the financial resources necessary to meet business requirements for the next 12 months, including funds needed for working capital requirements.

As of January 27, 2013, our total shareholders' equity was $694.8 million. At that date we also had approximately $228.2 million in cash and cash equivalents, $7.9 million in long-term investments, and total debt of $330.7 million. Our primary sources and uses of cash during the comparative fiscal years are presented below:

                                                                    Fiscal Year Ended
(in millions)                                   January 27, 2013     January 29, 2012     January 30, 2011
Sources of Cash
Operating activities                           $         102.0      $          99.8      $          93.8
Proceeds from exercise of stock options
including tax benefits                                    12.9                 45.0                 30.7
Proceeds from sale of investments                        112.5                131.7                111.0
Issuance of debt, net of original issue
discount and debt issuance cost                          338.0                    -                    -
                                               $         565.4      $         276.5      $         235.5
Uses of Cash
Capital expenditures, net of sale proceeds     $         (23.3 )    $         (21.5 )    $         (25.5 )
Acquisitions, net of cash acquired                      (491.7 )                  -                    -
Purchase of intangible assets                             (1.3 )               (3.0 )                  -
Purchases of investments                                 (24.7 )              (93.3 )             (168.8 )
Purchase of cost method investments                       (2.5 )                  -                    -
. . .
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