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ISSI > SEC Filings for ISSI > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Quarterly Report

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

We have made forward-looking statements in this report that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of our operations. Also, when we use words such as "believes," "expects," "anticipates" or similar expressions, we are making forward-looking statements. You should note that an investment in our securities involves certain risks and uncertainties that could affect our future financial results. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth in "Risk Factors" and elsewhere in this report. We believe it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risks described in "Risk Factors" included in this report, as well as any other cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. Before you invest in our common stock, you should be aware that the occurrence of the events described in "Risk Factors" and elsewhere in this report could harm our business and adversely affect our results.
All forward-looking statements made by us or persons acting on our behalf are expressly qualified in their entirety by the "Risk Factors" and other cautionary statements set forth in this report. Except as required by federal securities laws, we are under no obligation to update any forward-looking statement, whether as a result of new information, future events, or otherwise.

We are a fabless semiconductor company that designs and markets high performance integrated circuits for the following key markets: (i) automotive,
(ii) communications, (iii) industrial, medical and military, and (iv) digital consumer. Our primary products are low and medium density DRAM and high speed and low power SRAM. In the first nine months of fiscal 2013 and in fiscal 2012, approximately 87% and 96%, respectively, of our revenue was derived from our DRAM and SRAM products. Sales of our DRAM products have represented a majority of our net sales in each year since fiscal 2003. On September 14, 2012, we acquired approximately 94.1% of Chingis Technology Corporation (Chingis) for approximately $32 million, or $13 million net of the approximately $19 million in cash and cash equivalents on Chingis' balance sheet at closing. In May 2013, we acquired an additional 4.8% of Chingis for approximately $1.6 million. At June 30, 2013, we owned approximately 98.9% of Chingis. Founded in 1995, Chingis provides a variety of NOR flash memory technologies used in standalone and embedded applications. Chingis is headquartered in HsinChu, Taiwan and has offices in Taiwan, Korea, China and the U.S. Our financial results reflect accounting for Chingis on a consolidated basis beginning September 14, 2012. On January 31, 2011, we acquired Si En Integration Holdings Limited (Si En), a privately held fabless provider of high performance analog and mixed signal integrated circuits headquartered in Xiamen, China. Si En targets the mobile communications, digital consumer, networking, and automotive markets with high quality analog products. Si En's current products include audio power amplifiers, LED drivers, voltage converters and temperature sensors. In order to control our operating expenses, for the past several years we have limited our headcount in the U.S. and maintained much of our operations in Taiwan and China. We believe this strategy has enabled us to limit our operating expenses while simultaneously locating these operations closer to our manufacturing partners and our customers. As a result of these efforts, we currently have significantly more employees in Asia than we do in the U.S. We intend to continue these strategies going forward. As a fabless semiconductor company, our business model is less capital intensive because we rely on third parties to manufacture, assemble and test our products. Because of our dependence on third-party wafer foundries, our ability to increase our unit sales volumes depends on our ability to increase our wafer capacity allocation from current foundries, add additional foundries and improve yields of good die per wafer. In recent years, it has become more difficult for us to secure long-term foundry capacity (particularly for our DRAM products) due to industry consolidation affecting foundries and adverse financial conditions at foundries. In this regard, in September 2012, we invested approximately $27.1 million in Nanya and entered into an agreement with Nanya to provide us with access to leading edge process technologies and certain wafer volume guarantees. In addition, certain of our foundries have decided from time to time not to produce the type of wafers that we need (especially certain types of DRAM wafers) so we have been forced to rely on alternative sources of supply and to place large last time buy orders which expose us to the risk of inventory obsolescence. Once a product is in production at a particular foundry, it is time consuming and costly to have such product manufactured at a different foundry. Although such matters have not had a material adverse impact

on our business or financial results in recent periods, there can be no assurance as to the future impact that such matters will have on our business, customer relationships or results of operations.
The average selling prices of our DRAM and SRAM products are sensitive to supply and demand conditions in our target markets and have generally declined over time. We experienced declines in the average selling prices for certain of our products in the first nine months of fiscal 2013 and in fiscal 2012. We expect average selling prices for our products to decline in the future, principally due to market demand, market competition and the supply of competitive products in the market. Any future decreases in our average selling prices could have an adverse impact on our revenue growth rate, gross margins and operating margins. Our ability to maintain or increase revenues will be highly dependent upon our ability to increase unit sales volumes of existing products and to introduce and sell new products in quantities sufficient to compensate for the anticipated declines in average selling prices of existing products. Declining average selling prices will adversely affect our gross margins unless we are able to offset such declines with commensurate reductions in per unit costs or changes in product mix in favor of higher margin products. Revenue from product sales to our direct customers is recognized upon shipment provided that persuasive evidence of a sales arrangement exists, the price is fixed or determinable, title has transferred, collection of resulting receivables is reasonably assured, there are no customer acceptance requirements and there are no remaining significant obligations. A portion of our sales is made to distributors under agreements that provide for the possibility of certain sales price rebates and limited product return privileges. Given the uncertainties associated with credits that will be issued to these distributors, we defer recognition of such sales until our products are sold by the distributors to their end customers. Revenue from sales to distributors who do not have sales price rebates or product return privileges is recognized at the time our products are sold by us to the distributors.
We market and sell our products in Asia, the U.S., Europe and other locations through our direct sales force, distributors and sales representatives. The percentage of our sales shipped outside the U.S. was approximately 88% in the first nine months of fiscal 2013, approximately 83% in the first nine months of fiscal 2012, approximately 84% in fiscal 2012 and approximately 85% in fiscal 2011. We measure sales location by the shipping destination. We anticipate that sales to international customers will continue to represent a significant percentage of our net sales. The percentages of our net sales by region are set forth in the following table:

           Nine Months Ended       Fiscal Years Ended
               June 30,              September 30,
           2013         2012       2012         2011
Asia         67 %         60 %       62 %         64 %
Europe       20           22         21           20
U.S.         12           17         16           15
Other         1            1          1            1
Total       100 %        100 %      100 %        100 %

Our sales are generally made by purchase orders. Because industry practice allows customers to reschedule or cancel orders on relatively short notice, backlog may not be a good indicator of our future sales. Cancellations of customer orders or changes in product specifications could result in the loss of anticipated sales without allowing us sufficient time to reduce our inventory and operating expenses.
Due to the complex nature of the markets we serve and the broad fluctuations in economic conditions in the U.S. and other countries, it is difficult for us to assess the impact of seasonal factors on our business.
We are subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan and China, changes in trade policy and regulatory requirements, duties, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws and, possibly, political instability. Most of our foundries and all of our assembly and test subcontractors are located in Asia. Although our international sales are largely denominated in U.S. dollars, we do have sales transactions in New Taiwan dollars, in Hong Kong dollars and in Chinese renminbi. In addition, we have foreign operations where expenses are generally denominated in the local currency. Such transactions expose us to the risk of exchange rate fluctuations. We monitor our exposure to foreign currency fluctuations, but have not adopted any hedging strategies to date. There can be no assurance that exchange rate fluctuations will not harm our business and operating results in the future. Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make difficult and subjective estimates, judgments and assumptions. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reporting period. The estimates and judgments

that we use in applying our accounting policies have a significant impact on the results we report in our financial statements. We base our estimates and judgments on our historical experience combined with knowledge of current conditions and our beliefs of what could occur in the future, considering the information available at the time. Actual results could differ from those estimates and such differences may be material to our financial statements. We reevaluate our estimates and judgments on an ongoing basis.
Our critical accounting policies which are impacted by our estimates are:
(i) the valuation of our inventory, which impacts cost of goods sold and gross profit; (ii) the valuation of our allowance for sales returns and allowances, which impacts net sales; (iii) the valuation of our allowance for doubtful accounts, which impacts general and administrative expense; (iv) accounting for acquisitions and goodwill, which impacts cost of goods sold and operating expense when we record impairments; (v) accounting for stock-based compensation which impacts costs of goods sold, research and development expense and selling, general and administrative expense and (vi) accounting for income taxes. Each of these policies is described in more detail below. We also have other key accounting policies that may not require us to make estimates and judgments that are as subjective or difficult. For instance, our policies with regard to revenue recognition, including the deferral of revenues on sales to distributors with sales price rebates and product return privileges. These policies are described in the notes to our financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012. Valuation of inventory. Our inventories are stated at the lower of cost or market value. Determining the market value of inventories on hand and at distributors as of the balance sheet date involves numerous judgments, including projecting average selling prices and sales volumes for future periods and costs to complete products in work in process inventories. When market values are below our costs, we record a charge to cost of goods sold to write down our inventories to their estimated market value in advance of when the inventories are actually sold. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required that may adversely affect our operating results. If actual market conditions are more favorable, we may have higher gross margins when the written down products are sold. In addition to lower of cost or market write-downs, we also analyze inventory to determine whether any of it is excess, obsolete or defective. We write down to zero dollars (which is a charge to cost of goods sold) the carrying value of inventory on hand that has aged over one year (two years for wafer and die bank) to cover estimated excess and obsolete exposures, unless adjustments are made based on management's judgments for newer products, end of life products, planned inventory increases or strategic customer supply. In making such judgments to write down inventory, we take into account the product life cycles which can range from six to 30 months, the stage in the life cycle of the product, and the impact of competitors' announcements and product introductions on our products. Once established, these write-downs are considered permanent. Valuation of allowance for sales returns and allowances. Net sales consist principally of total product sales less estimated sales returns and allowances. To estimate sales returns and allowances, we analyze potential customer specific product application issues, potential quality and reliability issues and historical returns. We evaluate quarterly the adequacy of the allowance for sales returns and allowances. This allowance is reflected as a reduction to accounts receivable in our consolidated balance sheets. Increases to the allowance are recorded as a reduction to net sales. Because the allowance for sales returns and allowances is based on our judgments and estimates, particularly as to product application, quality and reliability issues, our allowances may not be adequate to cover actual sales returns and other allowances. If our allowances are not adequate, our net sales could be adversely affected. Valuation of allowance for doubtful accounts. We maintain an allowance for doubtful accounts for losses that we estimate will arise from our customers' inability to make required payments for goods and services purchased from us. We make our estimates of the uncollectibility of our accounts receivable by analyzing historical bad debts, specific customer creditworthiness and current economic trends. Once an account is deemed unlikely to be fully collected, we write down the carrying value of the receivable to the estimated recoverable value, which results in a charge to general and administrative expense, which decreases our profitability. Accounting for acquisitions and goodwill. We account for acquisitions using the purchase accounting method. Under this method, the total consideration paid is allocated over the fair value of the net assets acquired, including in-process research and development, with any excess allocated to goodwill. Goodwill is defined as the excess of the purchase price over the fair value allocated to the net assets. Our judgments as to fair value of the assets will, therefore, affect the amount of goodwill that we record. Management is responsible for the valuation of tangible and intangible assets. For tangible assets acquired in any acquisition, such as plant and equipment, the useful lives are estimated by considering comparable lives of similar assets, past history, the intended use of the assets and their condition. In estimating the useful life of the acquired intangible assets with definite lives, we consider the industry environment and unique factors relating to each product relative to our business strategy and the likelihood of technological obsolescence. Acquired intangible assets primarily include developed and in-process technology (IPR&D), customer relationships, trade names and non-compete agreements. The amounts allocated to IPR&D projects are not expensed until technological feasibility is reached for each project. Upon completion of development for each project, the acquired IPR&D will be amortized over its useful life. We are currently amortizing our acquired intangible assets with definite lives over periods generally ranging from three to six years.

We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances where indicators of impairment may exist. For instance, in response to changes in industry and market conditions, we could be required to strategically realign our resources and consider restructuring, disposing of, or otherwise exiting businesses, which could result in an impairment of tangible and intangible assets, including goodwill. In this regard, in fiscal 2012, we recorded impairment charges of $13.1 million for intangible assets and goodwill from our acquisition of Si En and $1.2 million for the impairment of certain tangible assets.
Accounting for stock-based compensation. Stock option fair value is calculated on the date of grant using the Black-Scholes valuation model. The compensation cost is then recognized on a straight-line basis over the requisite service period of the option, which is generally the option vesting term of four years. The Black-Scholes valuation model requires us to estimate key assumptions such as expected term, volatility, dividend yield and risk-free interest rates that determine the stock option fair value. In addition, we estimate forfeitures at the time of grant. In subsequent periods, if actual forfeitures differ from the estimate, the forfeiture rate may be revised. We estimate our expected forfeitures rate based on our historical activity and judgment regarding trends. We estimate the expected term for option grants based upon historical exercise data. If we determined that another method used to estimate expected life was more reasonable than our current method, or if another method for calculating these input assumptions was prescribed by authoritative guidance, the fair value calculated could change materially.
Accounting for income taxes. We account for income taxes under the asset and liability approach. We record a valuation allowance to reduce our net deferred tax assets to the amount that we believe is more likely than not to be realized. In assessing the need for a valuation allowance, we consider historical levels of income, projections of future income, expectations and risks associated with estimates of future taxable income, and ongoing prudent and practical tax planning strategies. To the extent we believe it is more likely than not that some portion of our deferred tax assets will not be realized, we would increase the valuation allowance against the deferred tax assets. Realization of our deferred tax assets is dependent primarily upon future U.S. and foreign taxable income. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. These changes, if any, may require possible material adjustments to these deferred tax assets, resulting in a reduction in net income or an increase in net loss in the period when such determinations are made.
We are subject to income taxes in the U.S. and foreign countries, and we are subject to routine corporate income tax audits in certain of these jurisdictions. We believe that our tax return positions are fully supported, but tax authorities may challenge certain positions, which may not be fully sustained. Our income tax expense includes amounts intended to satisfy income tax assessments that result from these challenges. Determining the income tax expense for these potential assessments and recording the related assets and liabilities requires management judgment and estimates. We evaluate our uncertain tax positions and believe that our provision for uncertain tax positions, including related interest and penalties, is adequate based on information currently available to us. However, the amount ultimately paid upon resolution of audits could be materially different from the amounts previously included in income tax expense and therefore could have a material impact on our tax provision, net income and cash flows. Our overall tax provision requirement could change due to the issuance of new regulations or new case law, management's judgments on undistributed foreign earnings including judgments about and intentions concerning our future operations, negotiations with tax authorities, resolution with respect to individual audit issues, or the entire audit, or the expiration of statutes of limitations. Accounting Changes and Recent Accounting Pronouncements For a description of accounting changes and recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated condensed financial statements, see "Note 3: Impact of Recently Issued Accounting Pronouncements and Standards" in the Notes to Condensed Consolidated Financial Statements of this Form 10-Q. Results of Operations
Three Months Ended June 30, 2013 Compared to Three Months Ended June 30, 2012 Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales increased to $77.8 million in the three months ended June 30, 2013 from $64.8 million in the three months ended June 30, 2012. The increase of $13.0 million in net sales was primarily the result of $8.4 million of NOR Flash revenue from our acquisition of Chingis which closed on September 14, 2012. Our DRAM and SRAM revenue increased by $4.8 million in the three months ended June 30, 2013 compared to the three months ended June 30, 2012 principally as a result of changes in the type of DRAM and SRAM products sold. However, our analog revenue decreased by $0.2 million in the three months ended June 30, 2013 compared to the three months ended June 30, 2012. We anticipate that the average selling prices of our existing products will generally decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that any future price declines will be offset by higher volumes or by higher prices on newer products.

In the three months ended June 30, 2013, revenue from our largest and second largest distributor accounted for approximately 13% and 10%, respectively, of our total net sales. In the three months ended June 30, 2012, revenue from our largest and second largest distributor accounted for approximately 15% and 13%, respectively, of our total net sales.
Gross profit. Cost of sales includes die cost from wafers acquired from foundries, subcontracted package, assembly and test costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit increased by $4.7 million to $26.0 million in the three months ended June 30, 2013 from $21.3 million in the three months ended June 30, 2012 primarily as a result of sales of our NOR Flash products and a shift in product mix for our DRAM products. Our gross margin was 33.5% in the three months ended June 30, 2013 which included a charge of 1.6% for inventory write-downs compared to 32.9% in the three months ended June 30, 2012 which included a charge of 2.7% for inventory write-downs. Excluding the impact of the inventory write-downs, the decrease in gross margin in the three months ended June 30, 2013 compared to the three months ended June 30, 2012 can be attributed to the unfavorable impact in the current period of lower margin NOR flash products. We believe that the average selling prices of our products will decline over time and, unless we are able to reduce our cost per unit to the extent necessary to offset such declines, the decline in average selling prices could result in a material decline in our gross margin. In addition, our product costs could increase if our suppliers raise prices, which could result in a material decline in our gross margin. Although we have product cost reduction programs in place that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. We do not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of our products or the level of service provided by us. Research and Development. Research and development expenses increased by 57% to $10.6 million in the three months ended June 30, 2013 compared to $6.7 million in the three months ended June 30, 2012. As a percentage of net sales, research and development expenses increased to 13.6% in the three months ended June 30, 2013 from 10.4% in the three months ended June 30, 2012. The increase in research and development expenses of $3.9 million was primarily the result of a $2.0 million increase in research and development expenses for our NOR flash products as a result of our acquisition of Chingis. In addition, headcount related and product development costs increased in the three months ended June 30, 2013 compared to the three months ended June 30, 2012. We expect the dollar amount of our research and development expenses to decrease slightly in the September 2013 quarter and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.
Selling, General and Administrative. Selling, general and administrative expenses increased by 15% to $10.8 million in the three months ended June 30, 2013 from $9.4 million in the three months ended June 30, 2012. As a percentage of net sales, selling, general and administrative expenses decreased to 13.9% in the three months ended June 30, 2013 from 14.5% in the three months ended June 30, 2012. The increase in selling, general and administrative expenses of $1.4 million was primarily the result of a $0.9 million increase in expenses as a result of our acquisition of Chingis. In addition, increases in headcount related expenses and sales commissions in the three months ended June 30, 2013 compared to the three months ended June 30, 2012 were partially offset by a reduction in amortization of certain intangible assets from our acquisition of Si En which were written-off in the September 2012 quarter. We expect the dollar amount of our selling, general and administrative expenses to remain relatively flat in the September 2013 quarter and expect such expenses to fluctuate as a percentage of net sales depending on our overall level of sales.
Interest and other income (expense), net. Interest and other income (expense), net was income of $0.5 million in the three months ended June 30, 2013 compared to income of $0.4 million in the three months ended June 30, 2012. The $0.5 million of interest and other income in the three months ended June 30, 2013 is comprised primarily of $0.3 million in rental income from the lease of excess space in our Taiwan facility and an exchange gain of $0.3 million as a result of the appreciation of the U.S. dollar compared to the New Taiwan dollar partially . . .

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