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LSI > SEC Filings for LSI > Form 10-Q on 1-May-2014All Recent SEC Filings

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Form 10-Q for LSI CORP


1-May-2014

Quarterly Report


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

This management's discussion and analysis should be read in conjunction with the other sections of this Form 10-Q, including Part 1, Item 1-"Financial Statements."

Where more than one significant factor contributed to changes in results from year to year, we have quantified these factors throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where practicable and material to understanding the discussion.

OVERVIEW

We design, develop and market complex, high-performance storage and networking semiconductors. We offer a broad portfolio of capabilities including custom and standard product integrated circuits that are used in hard disk drives, solid state drives, high-speed communications systems, computer servers, storage systems and personal computers. We deliver our products to our customers as stand-alone integrated circuits as well as incorporated onto circuit boards that offer additional functionality. We also license our intellectual property to other entities.

We derive the majority of our revenues from sales of products for the hard disk and solid state drive, server and networking equipment end markets and our revenues depend on market demand for these types of products. We believe that these markets offer us attractive opportunities because of the growing demand to create, store, manage and move digital content efficiently. Our products are sold primarily to original equipment manufacturers, or OEMs, in the storage, server and networking industries. We also sell some of our products through a network of resellers and distributors. The markets in which we operate are highly competitive and our revenues depend on our ability to compete successfully. We face competition not only from makers of products similar to ours, but also from competing technologies.


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On December 15, 2013, we entered into a definitive agreement with Avago and certain of its subsidiaries under which Avago will acquire LSI for $11.15 per share in an all-cash transaction valued at approximately $6.6 billion. On April 9, 2014, our stockholders adopted the merger agreement. The merger is expected to close in early May 2014, subject to satisfaction of customary closing conditions.

Sixteen purported class action complaints have been filed by alleged stockholders of LSI against us, our individual directors, and, in fifteen of the cases, against Avago. These actions generally allege that the members of our board of directors breached their fiduciary duties in connection with the merger because the merger was not in the best interest of the company, the merger consideration is unfair, and certain other terms of the merger agreement are unfair. Among other remedies, the lawsuits seek to enjoin the merger, or in the event that an injunction is not entered and the merger closes, to rescind the merger or obtain unspecified money damages, costs and attorneys' fees. After arm's-length negotiations, on March 7, 2014, the parties, through their respective counsel, reached a settlement, which was filed with the state court in Delaware on April 15, 2014. A hearing to approve the settlement is currently scheduled for June 10, 2014. We do not expect the settlement, if approved, to have a material impact on our results of operations.

Our results of operations were as follows:

                                                                 Three Months Ended
                                             March 30, 2014               March 31, 2013           Change
                                                   (Dollars in millions, except per share amounts)
Revenues                                   $             569.1           $          568.6          $   0.5
Gross profit margin as a percentage
of revenues                                               51.2 %                     50.9 %            0.3 %
Net income                                 $              33.2           $           18.4          $  14.8
Net income per diluted share               $              0.06           $           0.03          $  0.03

We are working to manage our operating expenses while at the same time continuing work on products under development. We are focusing our research and development operations on products that we believe provide favorable growth opportunities for our business. We are also working to expand our sales of products in newer areas such as flash memory-based server adapter cards, where we are working directly with large, Internet-based datacenter operators, in addition to our more traditional customer base of OEMs and distributors.

Our board of directors authorized a stock repurchase program of up to $500.0 million on August 1, 2012. Pursuant to the merger agreement entered into with Avago in December 2013, we discontinued share repurchases and our quarterly dividend. We ended the first quarter of 2014 with cash and cash equivalents, together with short-term investments, of $883.3 million, compared to $809.8 million at the end of 2013.

RESULTS OF OPERATIONS

Revenues

Three Months Ended
March 30, 2014 March 31, 2013 $ Change % Change
(Dollars in millions)

Revenues $ 569.1 $ 568.6 $ 0.5 0.1 %

Revenues were essentially flat as increased sales from the ramping of PCIe flash memory-based storage products and increased unit sales of semiconductors used in hard disk drives in the first quarter of 2014 were partially offset by lower unit sales of semiconductors used in our older networking products and lower unit sales of flash controllers.

Significant Customers:

The following table provides information about sales to Seagate, which was our only customer that accounted for 10% or more of our revenues in each of the three months ended March 30, 2014 and March 31, 2013:

Three Months Ended March 30, 2014 March 31, 2013 Percentage of revenues 21 % 27 %


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Revenues by Geography:

The following table summarizes our revenues by geography based on the ordering
location of the customer. Because we sell our products primarily to other
sellers of technology products and not to end users, the information in the
table below may not accurately reflect geographic end-user demand for our
products.



                                                                Three Months Ended
                                     March 30, 2014         March 31, 2013         $ Change          % Change
                                                              (Dollars in millions)
North America*                      $          148.4       $          146.6       $      1.8               1.2 %
Asia                                           353.7                  373.9            (20.2 )            (5.4 )%
Europe and the Middle East                      67.0                   48.1             18.9              39.3 %

Total                               $          569.1       $          568.6       $      0.5               0.1 %

* Primarily the United States.

The increase in revenues in North America was primarily attributable to increased sales from the ramping of PCIe flash memory-based storage products. The decrease in revenues in Asia was primarily attributable to lower unit sales of flash controllers and lower unit sales of semiconductors used in our older networking products, offset in part by increased unit sales of semiconductors used in hard disk drives. The increase in revenues in Europe and the Middle East was primarily due to higher unit sales of flash controllers.

Revenues by Product Groups:

The following table presents our revenues by product groups:



                                                Three Months Ended
                        March 30, 2014       March 31, 2013       $ Change        % Change
                                              (Dollars in millions)
 Storage products      $          446.8     $          437.9     $      8.9             2.0 %
 Networking products               84.1                 92.6           (8.5 )          (9.2 )%
 Other                             38.2                 38.1            0.1             0.3 %

 Total                 $          569.1     $          568.6     $      0.5             0.1 %

The increase in revenues from storage products was attributable to increased unit sales from the ramping of PCIe flash memory-based storage products and increased unit sales of semiconductors used in hard disk drives in the first quarter of 2014. The increase was partially offset by lower unit sales of flash controllers.

The decrease in revenues from networking products was primarily the result of lower unit sales of semiconductors used in our older networking products.

Other revenues consist primarily of fees from the licensing of our intellectual property.

Gross Profit Margin

Three Months Ended
Dollar Amount Percentage of Revenues
March 30, 2014 March 31, 2013 March 30, 2014 March 31, 2013
(Dollars in millions)

Gross profit margin $ 291.1 $ 289.5 51.2 % 50.9 %

Various factors affect and may continue to affect our product gross margin. These factors include, but are not limited to, changes in our production mix and volume of product sales, the timing of production ramps and margin structures for new products, the positions of our products in their life cycles, the effects of competition, the price of commodities used in our products, provisions for excess and obsolete inventories, changes in the costs charged by foundry, assembly and test subcontractors, and amortization of acquired intangible assets.

The 0.3% increase in gross profit margin as a percentage of revenues was primarily attributable to lower commodity costs used in manufacturing our products, offset in part by increased revenues from lower margin products.


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Research and Development



                                                                 Three Months Ended
                                     March 30, 2014           March 31, 2013          $ Change         % Change
                                                               (Dollars in millions)
Research and development            $          174.1         $          171.3         $     2.8              1.6 %
Percentage of revenues                          30.6 %                   30.1 %

The increase in R&D expense was primarily attributable to higher depreciation and licensing fees to support product development efforts.

Selling, General and Administrative



                                                               Three Months Ended
                                  March 30, 2014           March 31, 2013           $ Change           % Change
                                                              (Dollars in millions)
Selling, general and
administrative                   $           76.2         $           89.5         $    (13.3 )            (14.9 )%
Percentage of revenues                       13.4 %                   15.7 %

The decrease in SG&A expense was primarily attributable to decreases in general and administrative expenses as a result of our continuing focus on control of expenses.

Restructuring of Operations and Other Items, net

Restructuring:

The following table summarizes items included in restructuring expenses:



                                                 Three Months Ended
                                      March 30, 2014            March 31, 2013
                                                   (In millions)
   Leases                            $            4.1 (a)      $            1.8 (a)
   Employee severance and benefits                0.4                       4.4

   Total                             $            4.5          $            6.2

(a) Includes lease obligation costs and related changes in estimates, changes in time value and other ongoing expenditures.

Other Items:

We recorded net charges of $11.0 million during the three months ended March 30, 2014 primarily for legal and other transaction costs related to the merger with Avago. We recorded net charges of $14.3 million during the three months ended March 31, 2013 primarily for litigation settlements.

Interest Income and Other, net

The following table summarizes components of interest income and other, net:



                                               Three Months Ended
                       March 30, 2014       March 31, 2013       $ Change        % Change
                                             (Dollars in millions)
  Interest income     $            1.5     $            0.3     $      1.2           400.0 %
  Other income, net                1.2                  7.6           (6.4 )         (84.2 )%

  Total               $            2.7     $            7.9     $     (5.2 )         (65.8 )%

The increase in interest income primarily resulted from higher interest rates on investments in the first quarter of 2014 as compared to the first quarter of 2013.

Other income, net for the three months ended March 31, 2013 primarily included $6.1 million of insurance proceeds we received for covered losses related to the 2011 Thailand flooding.


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Income Taxes

We recorded income tax benefits of $5.2 million and $2.3 million for the three months ended March 30, 2014 and March 31, 2013, respectively.

The income tax benefit for the three months ended March 30, 2014 included a reversal of $11.2 million of liabilities for uncertain tax positions, which included previously unrecognized tax benefits of $5.7 million and interest and penalties of $5.5 million, as a result of the expiration of statutes of limitations in multiple jurisdictions and the settlement of an audit.

The income tax benefit for the three months ended March 31, 2013 included a reversal of $8.6 million of liabilities for uncertain tax positions, which included previously unrecognized tax benefits of $3.8 million and interest and penalties of $4.8 million, as a result of the expiration of statutes of limitations in multiple jurisdictions.

We compute our tax provision using an estimated annual tax rate. We exclude certain loss jurisdictions from the computation of the estimated annual rate when no benefit can be realized on those losses. Historically, we have sustained losses from our U.S. operations and, as a result, have maintained a full valuation allowance against U.S. net deferred tax assets. We do not believe there is sufficient positive evidence to reach a conclusion that it is more likely than not that we will generate sufficient future taxable income in the U.S. to realize the benefits of our deferred tax assets. Depending on future results and projected trends, it is reasonably possible that we may determine in the foreseeable future that it is more likely than not that a significant portion of our U.S. deferred tax assets will be realized, resulting in a release of a significant portion of the valuation allowance.

FINANCIAL CONDITION, CAPITAL RESOURCES AND LIQUIDITY

Cash, cash equivalents, short-term investments and cash generated from our operations are our primary sources of liquidity. Short-term investments consist primarily of U.S. government and agency securities. We believe that our existing liquid resources and cash generated from operations will be adequate to meet our operating and capital requirements and other obligations for more than the next 12 months. We may, however, find it desirable to obtain additional debt or equity financing. Such financing may not be available to us at all or on acceptable terms if we determine that it would be desirable to obtain additional financing.

Cash, cash equivalents and short-term investments increased to $883.3 million as of March 30, 2014 from $809.8 million as of December 31, 2013. The increase was mainly due to cash inflows generated from operating and financing activities, offset in part by purchases of property and equipment as described below.

Working Capital

Working capital increased by $101.9 million to $927.5 million as of March 30, 2014 from $825.6 million as of December 31, 2013. The increase was primarily attributable to the following:

Cash, cash equivalents and short-term investments increased by $73.5 million primarily due to net cash provided by operating activities of $43.0 million and proceeds from issuances of common stock of $52.0 million, offset in part by $20.5 million used for purchases of property and equipment;

Accrued salaries, wages and benefits decreased by $23.8 million primarily due to the timing of payments for salaries, benefits and performance-based compensation;

Prepaid expenses and other current assets increased by $13.4 million primarily as a result of the timing of certain prepayments and other receivables;

Inventories increased by $5.6 million as a result of increased inventory purchases to support expected demand in the second quarter of 2014; and

Other accrued liabilities decreased by $4.6 million primarily due to the utilization of restructuring reserves.

These increases in working capital were offset in part by a decrease in accounts receivable of $19.6 million primarily as a result of lower shipments toward the end of the first quarter of 2014 as compared to the fourth quarter of 2013.

Working capital decreased by $18.6 million to $691.3 million as of March 31, 2013 from $709.9 million as of December 31, 2012. The decrease was attributable to the following:

Accounts receivable decreased by $40.9 million primarily as a result of decreased revenues in the first quarter of 2013 as compared to the fourth quarter of 2012;

Inventories decreased by $25.3 million, which primarily reflects our continued proactive management of inventory levels;


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Cash, cash equivalents and short-term investments decreased by $17.5 million primarily due to $60.8 million used to repurchase our common stock; $30.0 million used for purchases of investments, net of proceeds from maturities and sales; and $25.0 million used for purchases of property and equipment, net of proceeds from sales, offset in part by net cash provided by operating activities of $62.8 million and proceeds from issuances of common stock of $8.2 million; and

Prepaid expenses and other current assets decreased by $10.3 million primarily as a result of decreases in prepaid software maintenance.

These decreases in working capital were offset in part by the following:

Accounts payable decreased by $39.4 million primarily due to a decrease in inventory purchases and the timing of invoice receipts and payments;

Accrued salaries, wages and benefits decreased by $24.8 million primarily as a result of the timing of payments for salaries, benefits and performance-based compensation; and

Other accrued liabilities decreased by $11.2 million primarily due to the utilization of restructuring reserves and decreases in tax and other accruals.

Operating Activities

During the three months ended March 30, 2014, we generated $43.0 million of cash from operating activities as a result of the following:

Net income adjusted for non-cash items and other non-operating adjustments, which are quantified in our statements of cash flows included in Item 1;

Offset in part by a net decrease of $58.0 million in assets and liabilities, including changes in working capital components, from December 31, 2013 to March 30, 2014, as discussed above.

During the three months ended March 31, 2013, we generated $62.8 million of cash from operating activities as a result of the following:

Net income adjusted for non-cash items and other non-operating adjustments, which are quantified in our statements of cash flows included in Item 1;

Offset in part by a net decrease of $32.6 million in assets and liabilities, including changes in working capital components, from December 31, 2012 to March 31, 2013, as discussed above.

Investing Activities

Cash provided by investing activities for the three months ended March 30, 2014 was $4.8 million. Our investing activities during the three months ended March 30, 2014 were the following:

Proceeds from maturities and sales of available-for-sale debt securities and other investments, net of purchases, of $25.3 million;

Substantially offset by purchases of property and equipment, net of proceeds from sales, totaling $20.5 million.

Cash used in investing activities for the three months ended March 31, 2013 was $55.0 million. Our investing activities during the three months ended March 31, 2013 were the following:

Purchases of available-for-sale debt securities and other investments, net of proceeds from maturities and sales, of $30.0 million; and

Purchases of property and equipment, net of proceeds from sales, totaling $25.0 million.

We expect capital expenditures to be approximately $55 million in 2014. We use semiconductor foundries and outside assembly and test companies to manufacture products, which enable us to have access to advanced manufacturing capacity without significant capital spending requirements.


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Financing Activities

Cash provided by financing activities for the three months ended March 30, 2014 was $52.0 million, representing cash received from issuances of common stock under our employee stock plans.

Cash used in financing activities for the three months ended March 31, 2013 was $52.6 million. This amount included $60.8 million used to repurchase our common stock, offset in part by $8.2 million of cash received from issuances of common stock under our employee stock plans.

CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual obligations as of March 30, 2014:



                                                                         Payments Due by Period
                                      Less Than 1 Year       1-3 Years       4-5 Years       After 5 Years      Other         Total
                                                                              (In millions)
Operating lease obligations          $             31.1     $      25.7     $      13.7     $           2.5     $   -        $  73.0
Purchase commitments                              351.2            21.9             3.0                  -          -          376.1
Pension contributions                              64.9               *               *                   *          *          64.9
Uncertain tax positions                              -               -               -                   -        63.7 **       63.7

Total                                $            447.2     $      47.6     $      16.7     $           2.5     $ 63.7       $ 577.7

* We have pension plans covering certain U.S. and international employees. Although additional future contributions will be required, the amount and timing of these contributions will be affected by actuarial assumptions, the actual rate of return on plan assets, the level of market interest rates, legislation changes and the amount of voluntary contributions to the plans. The amount shown in the table represents our planned contributions to our pension plans during the remainder of 2014. Because any contributions for 2015 and later will depend on the value of the plan assets in the future and thus are uncertain, we have not included any amounts for 2015 and beyond in the above table.

** This amount represents the non-current tax payable obligation. We are unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority may occur.

Operating Lease Obligations

We lease real estate and certain non-manufacturing equipment under non-cancellable operating leases. We also include non-cancellable obligations under certain software licensing arrangements in this category.

Purchase Commitments

We maintain purchase commitments with certain suppliers, primarily for raw materials and manufacturing services and for some non-production items. Purchase commitments for inventory materials are generally restricted to a forecasted time horizon as mutually agreed upon between the parties. This forecasted time horizon can vary for different suppliers.

Uncertain Tax Positions

As of March 30, 2014, we had $185.8 million of unrecognized tax benefits, for which we are unable to make a reasonably reliable estimate as to when cash settlement with a taxing authority may occur. It is reasonably possible that the total amount of unrecognized tax benefits will increase or decrease in the next 12 months. Such changes could occur based on the normal expiration of statutes of limitations, the possible conclusion of ongoing tax audits in various jurisdictions around the world or other negotiations with tax authorities. If those events occur within the next 12 months, we estimate that the unrecognized tax benefits, plus accrued interest and penalties, could decrease by up to $17.1 million.

Standby Letters of Credit

We had outstanding obligations relating to standby letters of credit of $6.1 million and $4.0 million, respectively, as of March 30, 2014 and December 31, 2013. Standby letters of credit are financial guarantees provided by third parties for leases, customs, taxes and certain self-insured risks. If the guarantees are called, we must reimburse the provider of the guarantee. The fair value of the letters of credit approximates the contract amounts. The standby letters of credit generally renew annually.


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CRITICAL ACCOUNTING POLICIES

There have been no significant changes in our critical accounting estimates or significant accounting policies during the three months ended March 30, 2014 as compared to the discussion in Part II, Item 7 and in Note 2 to our financial statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2013.

RECENT ACCOUNTING PRONOUNCEMENT

The information is included in Note 1 to our financial statements in Part I, Item 1 under the heading "Recent Accounting Pronouncement."

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