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SMTC > SEC Filings for SMTC > Form 10-Q on 6-Dec-2013All Recent SEC Filings

Show all filings for SEMTECH CORP

Form 10-Q for SEMTECH CORP


6-Dec-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 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 (input/output) 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 third quarter of fiscal years 2014 and 2013 represented 49% and 46% of net sales, respectively. Sales made directly to customers during the third quarter of fiscal years 2014 and 2013 were 58% and 64% 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 third quarter of fiscal year 2014, approximately 34% of our silicon, in terms of cost of wafers purchased, was manufactured in China. Foreign sales during the third quarter of fiscal year 2014 constituted approximately 83% of our net sales. Approximately 86% of foreign sales during the third quarter of fiscal year 2014 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 which is expected to approximate actual costs at the date of sale. 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 nine months of fiscal year 2014.
The following table summarizes the deferred net revenue balance:

                                                    October 27,      January 27,
(in thousands)                                          2013             2013
Deferred revenue                                   $       7,487    $       4,467
Deferred cost of revenue                                   1,718            1,099
Deferred revenue, net                                      5,769            3,368
Deferred product design and engineering recoveries         1,771              377
Total deferred revenue                             $       7,540    $       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                         Nine Months Ended
                                         October 27, 2013      October 28, 2012     October 27, 2013     October 28, 2012
Net sales                                     100.0  %               100.0  %            100.0  %              100.0  %
Cost of sales                                  40.9  %                39.8  %             39.9  %               47.1  %
Gross profit                                   59.1  %                60.2  %             60.1  %               52.9  %
Operating costs and expenses:
Selling, general and administrative            21.9  %                22.2  %             21.1  %               26.1  %
Product development and engineering            22.7  %                20.7  %             21.3  %               21.0  %
Intangible amortization and impairments         5.2  %                 5.1  %              5.3  %                5.1  %
Total operating costs and expenses             49.8  %                48.0  %             47.7  %               52.2  %
Operating income                                9.3  %                12.2  %             12.4  %                0.7  %
Interest expense                               (1.3 )%                (2.6 )%             (3.5 )%               (2.4 )%
Interest income and other (expense),
net                                            (0.2 )%                (0.7 )%             (0.3 )%               (0.2 )%
Income (loss) before taxes                      7.8  %                 8.9  %              8.6  %               (1.9 )%
Benefit for taxes                              (0.9 )%                (1.4 )%             (1.3 )%               (8.5 )%
Net income                                      8.7  %                10.3  %              9.9  %                6.6  %
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                         Nine Months Ended
(in thousands)        October 27, 2013      October 28, 2012     October 27, 2013     October 28, 2012
Domestic             $          (3,746 )   $        (9,185 )    $        (21,991 )   $        (26,910 )
Foreign                         14,934              23,523                62,065               19,160
Total                $          11,188     $        14,338      $         40,074     $         (7,750 )

Domestic loss 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 October 27, 2013 and October 28, 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 third 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)   October 27, 2013        October 28, 2012
Enterprise Computing               $     28,303     20 %   $     32,156     20 %
Communications                           39,925     28 %         46,241     29 %
High-end Consumer (1)                    38,560     28 %         44,773     28 %
Industrial and Other                     34,238     24 %         37,708     23 %
Total                              $    141,026    100 %   $    160,878    100 %

(1) Approximately $10.3 million and $12.4 million of our total sales to Samsung Electronics (and affiliates), one of our significant customers, in the third 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 third quarter of fiscal year 2014 were $141.0 million, a decrease of 12% compared to $160.9 million for the third quarter of fiscal year 2013.
Lower revenue in the third quarter of fiscal year 2014 is due to lower smart phone and 40G demand and insignificant IP revenue as compared to the same quarter of fiscal year 2013.

We expect revenue to slightly decline in the fourth quarter of fiscal year 2014 as compared to the third quarter of fiscal year 2014. The main drivers for this expected decline include softness in the smart phone market and the seasonal impact of the holidays and Chinese New Year. Compared to the fourth quarter of fiscal year 2013, revenue in the fourth quarter of fiscal year 2014 is expected to be slightly lower due to the softness of demand across all the end markets.

Gross Profit During the third quarter of fiscal year 2014, gross profit decreased to $83.4 million from $96.8 million in the third quarter of fiscal year 2013. Gross profit margins decreased to 59.1% in the third quarter of fiscal year 2014 from 60.2% in the third quarter of fiscal year 2013. The decline of gross profit in the third quarter of fiscal year 2014 was driven by insignificant levels of IP revenue, an unfavorable product mix toward higher sales of lower margin products, and lower products manufacturing.
In the fourth quarter of fiscal year 2014, we expect gross profit margin to be slightly higher as compared to the third quarter of fiscal year 2014 due to a more favorable product mix. Compared to the fourth quarter of fiscal year 2013, gross margin for the fourth quarter of fiscal year 2014 is expected to be slightly lower due to unfavorable product mix and broad-based average selling price erosion.

Operating Costs and Expenses
                                                      Three Months Ended
(in thousands, except
percentages)                           October 27, 2013                October 28, 2012            Change
Selling, general and
administrative                   $    30,849              44 %   $    35,646              46 %        (13 )%
Product development and
engineering                           31,948              46 %        33,354              43 %         (4 )%
Intangible amortization and
impairments                            7,349              10 %         8,212              11 %        (11 )%
Total operating costs and
expenses                         $    70,146             100 %   $    77,212             100 %         (9 )%

Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") expenses decreased by $4.8 million in the third quarter of fiscal year 2014 compared to the same quarter of fiscal year 2013. The decrease was attributable to our employee time off program, anticipated lower payout for supplemental compensation, and our focus on restrained discretionary spending.
We expect operating costs to increase slightly in the fourth quarter of fiscal year 2014 as compared to the third quarter of fiscal year 2014 due to an increase in amortization of intangible assets. Compared to the fourth quarter of fiscal year 2013, operating costs in the fourth quarter of fiscal year 2014 are expected to be lower due to anticipated lower payout for supplemental compensation and our focus on restrained discretionary spending.

Product Development and Engineering Expenses Product development and engineering expenses decreased by $1.4 million in the third quarter of fiscal year 2014 compared to the same quarter of fiscal year 2013 driven primarily by higher levels of product design and engineering recoveries and anticipated lower payout for supplemental compensation. 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 $7.3 million and $8.2 million in the third quarter of fiscal years 2014 and 2013, respectively. The $0.9 million decrease was due to service backlog intangible assets from the Gennum acquisition having been fully amortized in the first quarter of fiscal year 2014.
Intangible amortization is expected to be slightly higher in the fourth quarter of fiscal year 2014 as compared to the third quarter of fiscal year 2014 due to the anticipated completion of in-process research and development projects from the Gennum acquisition. Compared to the fourth quarter of fiscal year 2013, intangible amortization in the fourth quarter of fiscal


year 2014 is expected to be slightly lower due to service backlog intangible assets being fully amortized in the first quarter of fiscal year 2014 offset by the anticipated completion of in-process research and development projects from the Gennum acquisition.
Interest Expense
Interest expense was $1.8 million and $4.2 million in the third quarter of fiscal year 2014 and 2013, respectively. The $2.4 million decrease was due to lower interest expense and less debt issuance costs being amortized resulting from refinancing $350.0 million of debt in the second quarter of fiscal year 2014.
Interest expense is expected to be approximately $1.8 million for the fourth quarter of fiscal year 2014.
Interest Income and Other (Expense) Income, Net Interest income and other (expense) income, net was $(0.3) million in the third quarter of fiscal year 2014, compared to $(1.1) million in the third quarter of fiscal year 2013. In the third quarter of fiscal year 2013, the interest income and other expense is primarily made up of $(0.5) million Swiss Stamp duty tax liabilities compared to no such liabilities in the same quarter of fiscal year 2014. In addition, the decrease in interest income and other (expense) income in the third quarter of fiscal year 2014 as compared to the same quarter of fiscal year 2013 is primarily due to the volatility of foreign exchange related to cash holding by the Company in local currencies. Income Taxes
In the third quarter of fiscal year 2014, we recorded an income tax benefit of approximately $(1.3) million compared to a $(2.3) million income tax benefit in the third quarter of fiscal year 2013. In the third quarter of fiscal year 2014, we recognized a one-time tax benefit of $2.7 million related to the revaluation of our net Swiss deferred tax liabilities. The revaluation of these liabilities was required to record the impact of a new Swiss tax ruling, which was formally approved by Swiss tax authorities during the quarter. The effective tax rates for the third quarter of fiscal years 2014 and 2013 were (11.3)% and (15.7)%, respectively. Our effective tax rate in the third 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., the effects of the debt refinancing, and a change in the tax rates in Switzerland due to Swiss tax ruling.
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.


Comparison of the Nine Months Ended October 27, 2013 and October 28, 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 nine months of fiscal years 2013 and 2012 each consisted of 39 weeks.
Our sales by major end-market are detailed below:

                                                 Nine Months Ended
(in thousands, except percentages)   October 27, 2013        October 28, 2012
Enterprise Computing               $     85,515     18 %   $     71,210     17 %
Communications                          132,506     28 %        141,007     33 %
High-end Consumer (1)                   134,713     29 %        122,483     28 %
Industrial and Other                    115,709     25 %         93,524     22 %
Total                              $    468,443    100 %   $    428,224    100 %

(1) Approximately $35.5 million and $22.6 million of our total sales to Samsung Electronics (and affiliates), one of our significant customers, in the first nine months of fiscal years 2014 and 2013, respectively, were . . .

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