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SMTC > SEC Filings for SMTC > Form 10-Q on 7-Jun-2013All Recent SEC Filings

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Form 10-Q for SEMTECH CORP


7-Jun-2013

Quarterly Report


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

You should read the following discussion of our financial condition and results of operations together with the consolidated condensed financial statements and the notes to the consolidated condensed financial statements included elsewhere in this Quarterly Report on Form 10-Q (this "Quarterly Report"). Forward Looking Statements
This Quarterly Report contains forward-looking statements. Forward-looking statements are statements other than historical information or statements of current condition and relate to matters such as our future financial performance, future operational performance and our plans, objectives and expectations. Some forward-looking statements may be identified by use of terms such as "expects," "anticipates," "intends," "estimates," "believes," "projects," "should," "will," "plans" and similar words. In light of the risks and uncertainties inherent in all such projected matters, forward-looking statements should not be regarded as a representation by us or any other person that our objectives or plans will be achieved or that any of our operating expectations or financial forecasts will be realized. Results could differ materially from those projected in forward-looking statements, due to factors including, but not limited to, those set forth in the "Risk Factors" and "Quantitative and Qualitative Disclosures About Market Risk" sections of this Quarterly Report and the "Risk Factors" section of our Annual Report on Form 10-K for the fiscal year ended January 27, 2013 filed with the Securities and Exchange Commission (the "SEC") on March 28, 2013. We undertake no duty to update any forward-looking statements, whether as a result of new information, future events or otherwise.
In addition to regarding forward-looking statements with caution, you should consider that the preparation of financial statements requires us to draw conclusions and make interpretations, judgments, assumptions and estimates with respect to factual, legal, and accounting matters. Different conclusions, interpretations, judgments, assumptions, or estimates could result in materially different results. See Note 1 to the consolidated condensed financial statements included in Part I, Item 1 of this Quarterly Report.

Overview
We design, develop, manufacture and market high-performance analog and mixed signal semiconductor products. We operate and account for results in one reportable segment.

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 $347.0 million (net of original issue discount of $3.0 million) of five-year secured term loans with a combined interest rate of approximately 4% (see Note 10 to our consolidated condensed financial statements).
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 $5.0 million in cash at closing.

Our product lines include:
Protection Products. We design, develop and market high performance protection devices, which are often referred to as transient voltage suppressors ("TVS"). TVS devices provide protection for electronic systems where voltage spikes (called transients), such as electrostatic discharge or secondary lightning surge energy that can permanently damage voltage sensitive complementary metal-oxide-semiconductor ("CMOS") integrated circuits ("ICs"). Our portfolio includes filter and


termination devices that are integrated in with the transient voltage suppressor ("TVS") devices. Our protection products feature low capacitance, providing robust protection while preserving signal integrity in high-speed networking and video interfaces. These products also operate at very low voltage needed for today's low voltage ICs. Our protection products can be found in a broad range of applications including smart phones, LCD TVs, set-top boxes, tablet computers, notebooks, base stations, routers, and industrial instruments. Advanced Communications Products. We design, develop and market a portfolio of proprietary advanced wired communication, ultra-high speed Serializer/Deserializer ("SerDes") and modulator driver products for transport communication. These ICs perform transmission and amplification functions used in high-speed networks, at 40Gbps and 100Gbps. Our advanced communications products also feature a leading integrated timing solution for packet based communication networks. Our advanced communications products are used in a variety of communications and industrial applications.
Gennum Products. We design, develop and market a portfolio of optical communications, broadcast video, active cable transceiver and backplane products used in a wide variety of enterprise computing, industrial, communications and high-end consumer applications. Our broadcast video products offer advanced solutions for next generation video formats, ever increasing data rates and evolving I/O and distance requirements. Our security and surveillance products for HDcctv enable upgrade of analog cctv installations to full digital HD, leveraging the installed base of cabling, and our fully integrated transmit and receive products enable the highest performance, longest reach HDcctv standards-compliant designs. Our comprehensive portfolio of IC's for optical transceivers, backplane applications and consumer high-speed interfaces ranges from 100Mbps to 100Gbps and supports key industry standards such as Fibre Channel, Infiniband, Ethernet, PON, SONET and PCI Express.
Power Management and High-Reliability Products. Power management products control, alter, regulate and condition the power supplies within electronic systems. The highest volume product types within the power management product line are switching voltage regulators, combination switching and linear regulators, smart regulators and charge pumps. Our power management products feature highly integrated devices for the telecom industry and low-power, small form factor and high-efficiency products for mobile phones, notebook computers, computer peripherals and other portable devices. The primary application for these products is power regulation for computer, communications, high-end consumer and industrial systems. Our high-reliability discrete semiconductor products comprised of rectifiers, assemblies (packaged discrete rectifiers) and other products are typically used to convert alternating currents ("AC") into direct currents ("DC") and to protect circuits against very high voltage spikes or high current surges. Our high-reliability products can be found in a broad range of applications including industrial, military, medical, aerospace and defense systems, including satellite communications.
Wireless and Sensing Products. We design, develop and market a portfolio of specialized radio frequency ("RF") functions used in a wide variety of industrial, medical and networking applications, and specialized sensing functions used in industrial and consumer applications. Our wireless and sensing products feature industry leading and longest range industrial, scientific and medical ("ISM") radio, enabling low cost of ownership and increased reliability in all environments. Our unique sensing interface platforms can interface to any sensor and output digital data in any form. Our wireless and sensing products can be found in a broad range of applications in the industrial, medical and consumer markets.
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 the first quarter of fiscal years 2014 and 2013 represented 46% and 39% of net sales, respectively. Sales made directly to customers during the first quarter of fiscal years 2014 and 2013 were 61% and 63% of net sales, respectively. The remaining 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, Germany, Poland, United Kingdom and Israel. For the first quarter of fiscal year 2014, approximately 40% of our silicon, in terms of cost of wafers purchased, was manufactured in China. Foreign sales during the three month period ended April 28, 2013 constituted approximately 84% of our net sales, respectively. Approximately 87% of foreign sales during the three month period ended April 28, 2013, respectively, were to customers located in the Asia-Pacific region. The remaining foreign sales were primarily to customers in Europe, Canada, and Mexico.
Critical Accounting Policies and Estimates In addition to the discussion below, you should refer to the disclosures regarding our critical accounting policies in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of our Annual Report on Form 10-K for the fiscal year ended January 27, 2013 filed with the SEC on March 28, 2013.


Revenue and Cost of Sales
We recognize product revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured. Product design and engineering recoveries are recognized during the period in which services are performed. We include revenue related to granted technology licenses as part of "Net sales." Historically, revenue from these arrangements has not been significant though it is part of our recurring ordinary business.
We record a provision for estimated sales returns in the same period as the related revenues are recorded. We base these estimates on historical sales returns and other known factors. Actual returns could be different from our estimates and current provisions for sales returns and allowances, resulting in future charges to earnings.
We defer revenue recognition on shipment of products to certain customers, principally distributors, under agreements which provide for limited pricing credits or product return privileges, until these products are sold through to end-users or the return privileges lapse. For sales subject to certain pricing credits or return privileges, the amount of future pricing credits or inventory returns cannot be reasonably estimated given the relatively long period in which a particular product may be held by the customer. Therefore, we have concluded that sales to customers under these agreements are not fixed and determinable at the date of the sale and revenue recognition has been deferred. We estimate the deferred gross margin on these sales by applying an average gross profit margin to the actual gross sales. The average gross profit margin is calculated for each category of material using current standard costs. The estimated deferred gross margin on these sales, where there are no outstanding receivables, is recorded on the balance sheet under the heading of "Deferred revenue." There were no significant impairments of deferred cost of sales in fiscal year 2013 or the first three months of fiscal year 2014.
The following table summarizes the deferred net revenue balance:

                                                    April 28,      January 27,
(in thousands)                                         2013            2013
Deferred revenue                                   $     5,368    $       4,467
Deferred cost of revenue                                 1,227            1,099
Deferred revenue, net                                    4,141            3,368
Deferred product design and engineering recoveries         923              377
Total deferred revenue                             $     5,064    $       3,745

Gross Profit
Gross profit is equal to our net sales less our cost of sales. Our cost of sales includes materials, depreciation on fixed assets used in the manufacturing process, shipping costs, direct labor and overhead. We determine the cost of inventory by the first-in, first-out method. Operating Costs
Our operating costs and expenses generally consist of selling, general and administrative, product development and engineering costs, costs associated with acquisitions, and other operating related charges.


Results of Operations
The following table sets forth, for the periods indicated, our statements of
income data expressed as a percentage of revenues.
                                                                Three Months Ended
                                                        April 28, 2013       April 29, 2012
Net sales                                                    100.0  %              100.0  %
Cost of sales                                                 40.1  %               52.6  %
Gross Profit                                                  59.9  %               47.4  %
Operating costs and expenses:
Selling, general and administrative                           21.4  %               38.4  %
Product development and engineering                           21.3  %               20.6  %
Intangible amortization and impairments                        4.8  %                4.8  %
Total operating costs and expenses                            47.5  %               63.8  %
Operating income (loss)                                       12.4  %              (16.4 )%
Interest expense                                              (2.5 )%               (1.6 )%
Interest income and other (expense) income, net               (0.5 )%                0.2  %
Income (loss) before taxes                                     9.4  %              (17.8 )%
(Benefit) provision for taxes                                  0.3  %              (19.7 )%
Net income                                                     9.1  %                1.9  %
Percentages may not add precisely due to rounding.

Our regional mix of income (loss) from continuing operations before income taxes is as follows:
Three Months Ended

(in thousands)  April 28, 2013     April 29, 2012
Domestic       $       (6,414 )   $       (8,838 )
Foreign                21,625            (11,933 )
Total          $       15,211     $      (20,771 )

Domestic (loss) income from continuing operations includes amortization of acquired intangible assets, litigation expenses and higher levels of stock-based compensation compared to foreign operations.
Comparison of the Three Months Ended April 28, 2013 and April 29, 2012 We report results on the basis of 52 and 53 week periods and end our fiscal year on the last Sunday in January. The other quarters generally end on the last Sunday of April, July and October. All quarters consist of 13 weeks, except for one 14-week quarter in 53-week years. The first quarter of fiscal years 2014 and 2013 each consisted of 13 weeks.
Our sales by major end-market are detailed below:

                                              Three Months Ended
(in thousands, except percentages)   April 28, 2013        April 29, 2012
Enterprise Computing               $   25,726     16 %   $   13,965     12 %
Communications                         44,744     27 %       41,760     36 %
High-end Consumer (1)                  51,986     32 %       38,554     33 %
Industrial and Other                   39,951     25 %       22,363     19 %
Total                              $  162,407    100 %   $  116,642    100 %

(1) Approximately $14.5 million and $4.7 million of our total sales to Samsung Electronics (and affiliates), one of our significant customers, in the first quarter of fiscal years 2014 and 2013, respectively, were for products that target the handheld market (which includes mobile phones). This activity is included in the high-end consumer end-market category.


Net Sales Net sales for the first quarter of fiscal year 2014 were $162.4 million, an increase of 39% compared to $116.6 million for the first quarter of fiscal year 2013.
The higher revenue in the current quarter resulted primarily from a full quarter of Gennum sales, strong sales of protection devices into smart mobile phone applications and strength in 100Gbps products and timing synchronization platforms within our Advanced Communications group.

Gross Profit During the first quarter of fiscal year 2014, gross profit increased to $97.3 million from $55.3 million in the first quarter of fiscal year 2013. The increase in gross profit margin was driven by higher sales. Gross profit margins increased to 59.9% in the first quarter of fiscal year 2014 from 47.4% in the first quarter of fiscal year 2013. The increase in gross profit margin was due primarily to the $10.5 million reduction in costs related to the fair value adjustment associated with inventory acquired from the Gennum acquisition and the full quarter impact of higher margin sales of Gennum products.
The fair value adjustment related to acquired inventory from the Gennum acquisition was fully amortized in the first quarter of fiscal year 2014.

Operating Costs and Expenses
                                                   Three Months Ended
(in thousands, except percentages)        April 28, 2013        April 29, 2012      Change
Selling, general and administrative     $   34,794     45 %   $   44,818     60 %    (22 )%
Product development and engineering         34,559     45 %       24,083     32 %     43  %
Intangible amortization and impairments      7,856     10 %        5,578      7 %     41  %
Total operating costs and expenses      $   77,209    100 %   $   74,479    100 %      4  %

Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") expenses decreased by $10.0 million in the first quarter of fiscal year 2014 compared to the same quarter of fiscal year 2013 driven primarily by an $18.0 million reduction in transaction and integration related expenses, offset by the impact of a full quarter of Gennum results in the first quarter of fiscal year 2014 compared to the same quarter of fiscal year 2013.
Product Development and Engineering Expenses Product development and engineering expenses increased by $10.5 million in the first quarter of fiscal year 2014 compared to the same quarter of fiscal year 2013 driven primarily by the inclusion of a full quarter of Gennum results. 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 $7.9 million and $5.6 million in the first quarter of fiscal years 2014 and 2013, respectively. The $2.3 million increase was driven primarily by the full quarter impact of intangible amortization associated with acquired finite-lived intangible assets from the March 2012 Gennum acquisition.
Amortization expense related to acquired finite-lived intangible assets is expected to be $7.3 million in the second quarter of fiscal year 2014. Interest Expense
Interest expense was $4.1 million and $1.8 million in the first quarter of fiscal year 2014 and 2013, respectively. The $2.3 million increase was due to the full quarter impact of interest expense, and the amortization of the original issue discount and debt issuance costs related to the retired debt. Interest expense is expected to be approximately $10.3 million for the second quarter of fiscal year 2014, including $8.7 million related to the writeoff of unamortized original issue discount and debt issuance cost associated with the retired debt and $1.7 million interest expense associated with the New Credit Agreement.


Interest Income and Other (Expense) Income, Net Interest income and other (expense) income, net was $(0.8) million in the first quarter of fiscal year 2014, compared to $0.2 million in the first quarter of fiscal year 2013. The decrease is primarily due to the volatility of foreign exchange related to cash holding by the Company in local currencies. Income Taxes
In the first quarter of fiscal year 2014, we recorded an income tax expense of approximately $0.4 million compared to an income tax benefit of $23.0 million in the first quarter of fiscal year 2013. The effective tax rates for the first quarter of fiscal years 2014 and 2013 were 2.9% and 110.6%, respectively. Our effective tax rate in the first quarter of fiscal year 2014 differs from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings for which no U.S taxes are provided because such earnings are indefinitely reinvested outside of the U.S.
As a global organization, we are subject to audit by taxing authorities in various jurisdictions. To the extent that an audit, or the closure of a statute of limitations, results in our adjusting our reserves for uncertain tax positions, our effective tax rate could experience extreme volatility since any adjustment would be recorded as a discrete item in the period of adjustment. 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 April 28, 2013, our total shareholders' equity was $719.7 million. At that date we also had approximately $230.4 million in cash and temporary investments, $5.9 million in long-term investments, and total debt, net of original issue discount of $325.3 million.
Our primary sources and uses of cash for the corresponding periods are presented below:

                                                       Three Months Ended      Three Months Ended
(in millions)                                            April 28, 2013          April 29, 2012
Sources of Cash
Operating activities                                  $            17.1       $            (11.7 )
Proceeds from exercise of stock options including tax
benefits                                                            2.4                      3.5
Proceeds from sale of investments                                   8.0                     88.5
Issuance of debt, net of original issue discount and
debt issuance cost                                                    -                    338.0
                                                      $            27.5       $            418.3
Uses of Cash
Capital expenditures, net of sale proceeds            $           (10.8 )     $             (4.6 )
Acquisitions, net of cash acquired                                    -                   (491.7 )
Purchases of investments                                           (1.1 )                  (10.1 )
Payment of long-term debt                                          (5.6 )                      -
Repurchase of common stock                                            -                     (0.2 )
Purchase of intangible assets                                      (2.8 )                      -
                                                      $           (20.3 )     $           (506.6 )
Effect of exchange rate increase on cash and cash
equivalents                                                           -                      0.2
Net increase (decrease) in cash and cash equivalents  $             7.2       $            (88.1 )

We incur significant expenditures in order to fund the development, design, and manufacture of new products. We intend to continue to focus on those areas that have shown potential for viable and profitable market opportunities, which may require additional investment in equipment and the hiring of additional design and application engineers aimed at developing new products. Certain of these expenditures, particularly the addition of design engineers, do not generate significant payback in the short-term. We plan to finance these expenditures with cash generated by our operations and our existing cash balances.


A meaningful portion of our capital resources, and the liquidity they represent, are held by our foreign subsidiaries. As of April 28, 2013, our foreign subsidiaries held approximately $183.3 million of cash and cash equivalents compared to $180.2 million at January 27, 2013.
One of our primary goals is to improve the cash flows from our existing business activities. Our cash, cash equivalents and investments give us the flexibility to use our free cash flow to pay down debt, return value to shareholders (in the form of stock repurchases) and also pursue business improvement opportunities. Additionally, we will continue to seek to maintain and improve our existing business performance with capital expenditures and, potentially, acquisitions that meet our rate of return requirements. Acquisitions may be made for either cash or stock consideration, or a combination of both. Operating Activities
Net cash provided by operating activities is primarily due to net income adjusted for non-cash items plus fluctuations in operating assets and liabilities. . . .

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