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SMTC > SEC Filings for SMTC > Form 10-Q on 6-Jun-2014All Recent SEC Filings

Show all filings for SEMTECH CORP

Form 10-Q for SEMTECH CORP


6-Jun-2014

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 unaudited consolidated condensed financial statements and the notes to the unaudited consolidated condensed financial statements included elsewhere in this Quarterly Report on Form 10-Q (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.

Our product lines include:
Protection, Power and High-Reliability 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 sensitive complementary metal-oxide-semiconductor integrated circuits ("ICs"). Our portfolio of protection solutions include filter and termination devices that are integrated with the TVS device. Our products provide robust protection while preserving signal integrity in high-speed communications, networking and video interfaces. These products also operate at very low voltage. 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.
Our Power products control, alter, regulate and condition the power 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 functionality 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 into direct currents 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, automotive, aerospace and defense systems, including satellite communications.
Signal Integrity Products. We design, develop and market a portfolio of optical communications, broadcast video, surveillance video, active cable transceiver and backplane products used in a wide variety of enterprise computing, industrial, communications and high-end consumer applications. Our comprehensive portfolio of ICs for optical transceivers, backplane applications and high-speed interfaces ranges from 100Mbps to 100Gbps and supports key industry standards such as Fibre Channel, Infiniband, Ethernet, PON and SONET. 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 high-definition closed circuit television ("HDcctv") enable upgrade of analog closed circuit television installations to full digital HD, leveraging the installed base of COAX cabling, and our fully integrated transmit and receive products enable the highest performance, longest reach HDcctv standards-compliant designs.
We also sell proprietary advanced wired communication, ultra-high speed Serializer/Deserializer ("SerDes") products for long-haul optical transport communication. These ICs perform transmission functions used in high-speed networks at 40Gbps and 100Gbps. We have ceased development of new products for this market, but we continue to service our existing customer base and we will continue to leverage the underlying IPR&D on other products.
Wireless Sensing and Timing Products. We design, develop and market a portfolio of specialized radio frequency products used in a wide variety of industrial, medical and networking applications, and specialized sensing products used in industrial and consumer applications. Our wireless products feature industry leading and longest range industrial, scientific and medical radio, enabling a lower total cost of ownership and increased reliability in all environments, making them particularly suitable for Machine to Machine (M2M) and Internet of Things (IoT) applications. Our unique sensing interface platforms can interface to any sensor and output digital data in any form. Specifically, the proximity sensing capability of our devices enable advanced user interface solutions for mobile and consumer products. Our wireless and sensing products can be found in a broad range of applications in the industrial, medical and consumer markets. The timing and synchronous products used in packet based communication networks provide leading edge timing solutions where IEEE1588 packet synchronization is used. We have also introduced several complementary, high-performance phase-lock-loop solutions that can be used either in conjunction with our synch products or in a number of other applications where high-speed, high-performance, timing solutions are required.


Our sales by product line are as follows:

                                               Three Months Ended
(in thousands)                         April 27, 2014       April 28, 2013
Protection, Power Management and
High-Reliability                     $         62,117     $         72,678
Signal Integrity                               52,394               72,797
Wireless, Sensing and Timing                   18,348               16,932
Total                                $        132,859     $        162,407

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 2015 and 2014 represented 47% and 46% of net sales, respectively. Sales made directly to customers during the first quarter of fiscal years 2015 and 2014 were 47% and 61% 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 2015, approximately 54% of our silicon, in terms of cost of wafers purchased, was manufactured in China. Foreign sales during the first quarter of fiscal year 2015 constituted approximately 87% of our net sales. Approximately 86% of foreign sales during the first quarter of fiscal year 2015 were to customers located in the Asia-Pacific region. The remaining foreign sales were primarily to customers in Europe, Canada, and Mexico.
We use several metrics as indicators of future potential growth. The indicators that we believe best correlate to potential future revenue growth are design wins and new product releases. There are many factors that may cause a design win or new product release not to result in revenue, including a customer decision not to go to system production, a change in a customer's perspective regarding a product's value or a customer's product failing in the end-market. As a result, although a design win or new product introduction is an important step towards generating future revenue, it does not inevitably result in us being awarded business or receiving a purchase commitment. Restructuring
In December 2013, after filing our Form 10-Q for the period ended October 27, 2013, we became aware of changes tied to the decision of a customer, disclosed in our filings as a key customer, to transition from our standard product to their internal application specific integrated circuit ("ASIC") solution. This decision by our key customer to utilize an internal ASIC solution was accelerated by continued delays in the release of capital investment tenders, primarily within China, which also provided other potential customers of ours with additional time to develop their internal solutions. While some of these potential customers had indicated an interest in transitioning to an internal ASIC solution, it was our key customer's decision to do so that prompted our strategic reassessment and resulting restructuring.

Upon completing the reassessment of our strategic options in January 2014, we decided to reduce the level of investments that we are making in the long-haul optical market. This reduction in investment is expected to significantly impact our ability to generate future revenue from the long-haul optical market. This anticipated reduction in potential future revenue resulted in us recording significant impairments of goodwill and other intangibles in the fourth quarter of fiscal year 2014. Additionally, certain long-lived assets were determined to be impaired. As a result of our communications to our customers regarding our operational changes, we expect our customers to take action to transition away from some of our current platforms, including certain products in the 40Gbps and 100Gbps SerDes class which resulted in us reducing the cost basis of inventories in the fourth quarter of fiscal year 2014. Additionally, we incurred $1.0 million and $3.1 million of restructuring costs in the first quarter of fiscal year 2015 and the fourth quarter of fiscal year 2014, respectively, to terminate certain contract commitments and to provide for certain severance benefits to employees who were terminated as a result of these investment reductions. We completed the restructuring activities in the first quarter of fiscal year 2015.

We do not expect any significant changes to our liquidity as a result of our restructuring activities as most of the charges associated with these actions do not require settlement in cash.

As a result of these restructuring actions, we have realized significant operating cost savings. For fiscal year 2015, we expect an annual reduction in compensation costs of approximately $10.0 million, development costs of approximately $10.0 million and depreciation and amortization costs of approximately $5.2 million. These savings are expected to be offset by an


anticipated $80.0 to $90.0 million reduction in revenues from long-haul optical products which are included in our Signal Integrity Products group. 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 26, 2014 filed with the Securities and Exchange Commission ("SEC") on March 27, 2014. 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 2014 or the first three months of fiscal year 2015.
The following table summarizes the deferred net revenue balance:

                                                    April 27,      January 26,
(in thousands)                                         2014            2014
Deferred revenue                                   $     5,835    $       7,179
Deferred cost of revenue                                 1,343            1,698
Deferred revenue, net                                    4,492            5,481
Deferred product design and engineering recoveries       1,202            1,786
Total deferred revenue                             $     5,694    $       7,267

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, restructuring charges, 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 27, 2014       April 28, 2013
Net sales                                                     100.0  %             100.0  %
Cost of sales                                                  41.2  %              40.1  %
Gross profit                                                   58.8  %              59.9  %
Operating costs and expenses:
Selling, general and administrative                            23.9  %              21.4  %
Product development and engineering                            20.9  %              21.3  %
Intangible amortization and impairments                         4.8  %               4.8  %
Restructuring charge                                            0.8  %                 -  %
Total operating costs and expenses                             50.4  %              47.5  %
Operating income                                                8.4  %              12.4  %
Interest and amortization of debt discount and expense         (1.0 )%              (2.5 )%
Non-operating expense, net                                     (0.2 )%              (0.5 )%
Income before taxes                                             7.1  %               9.4  %
Provision for taxes                                             1.2  %               0.3  %
Net income                                                      5.9  %               9.1  %
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 27, 2014      April 28, 2013
Domestic       $        (5,137 )   $       (6,414 )
Foreign                 14,621             21,625
Total          $         9,484     $       15,211

Domestic loss from continuing operations includes amortization of acquired intangible assets and higher levels of stock-based compensation compared to foreign operations.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize revenue from the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance addresses, in particular, contracts with more than one performance obligation, as well as the accounting for some costs to obtain or fulfill a contract with a customer, and provides for additional disclosures with respect to revenues and cash flows arising from contracts with customers. This update will be effective for us beginning in the first quarter of fiscal year 2017 with early adoption not permitted. We will begin to assess the impact of the adoption of this update on our consolidated financial statements beginning in the second quarter of fiscal year 2015.


Comparison of the Three Months Ended April 27, 2014 and April 28, 2013 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 2015 and 2014 each consisted of 13 weeks.
Concurrent with the realignment of our business into three product groups, we reclassified a limited number of products to better reflect the served end-markets. All periods presented in the following summary of sales by major end-market reflect our current classification methodology:

                                              Three Months Ended
(in thousands, except percentages)   April 27, 2014        April 28, 2013
High-end Consumer (1)              $   42,068     32 %   $   51,423     31 %
Industrial and Other                   33,018     25 %       40,094     25 %
Communications                         32,608     24 %       50,171     31 %
Enterprise Computing                   25,165     19 %       20,719     13 %
Total                              $  132,859    100 %   $  162,407    100 %

(1) Approximately $14.9 million and $14.5 million of our total sales to Samsung Electronics (and affiliates), one of our significant customers, in the first quarter of fiscal years 2015 and 2014, 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 2015 were $132.9 million, a decrease of 18% compared to $162.4 million for the first quarter of fiscal year 2014.
Lower revenue in the first quarter of fiscal year 2015 is due to the decline in revenue from the long-haul optical market, part of our Signal Integrity product line, as a result of lower customer capital spending as well as pricing pressures. We recognized $8.3 million in revenue for the long-haul optical market in the first quarter of fiscal year 2015 compared to $28.7 million in the same quarter of fiscal year 2014.

We expect revenue to increase between 4% and 10% in the second quarter of fiscal year 2015, as compared to the first quarter of fiscal year 2015. Revenue for our Protection, Power and High-Reliability Products is expected to benefit from particular strength from the high-end consumer, industrial and communications markets. Revenue for our Signal Integrity Products should continue to benefit from the current wireless infrastructure build-outs in China. Revenue for our Wireless, Sensing and Timing Products is expected to be up as we see growth across the high-end consumer, communications and industrial end-markets.

Gross Profit
During the first quarter of fiscal year 2015, gross profit decreased to $78.1 million from $97.3 million in the first quarter of fiscal year 2014. Gross profit margins decreased to 58.8% in the first quarter of fiscal year 2015 from 59.9% in the first quarter of fiscal year 2014. The decline of gross profit in the first quarter of fiscal year 2015 was driven by significantly lower revenue. In the first quarter of fiscal year 2015, we incurred $1.1 million of charges related to our decision to reduce investments in the long-haul optical market. In the second quarter of fiscal year 2015, we expect gross profit margin to be higher as compared to the first quarter of fiscal year 2015 due to a more favorable product mix, higher manufacturing volumes and non-reoccurrence of charges associated with our decision to reduce investments in the long-haul optical market .


Operating Costs and Expenses
                                                   Three Months Ended
(in thousands, except percentages)        April 27, 2014        April 28, 2013      Change
Selling, general and administrative     $   31,696     47 %   $   34,794     45 %     (9 )%
Product development and engineering         27,813     42 %       34,559     45 %    (20 )%
Intangible amortization and impairments      6,425     10 %        7,856     10 %    (18 )%
Restructuring charge                         1,001      1 %            -      - %      -  %
Total operating costs and expenses      $   66,935    100 %   $   77,209    100 %    (13 )%

Selling, General and Administrative Expenses Selling, general and administrative ("SG&A") expenses decreased by $3.1 million in the first quarter of fiscal year 2015 compared to the same quarter of fiscal year 2014. The decrease was primarily attributable to lower equity compensation and, as a result of lower expected achievement of performance objectives, lower supplemental compensation.
We expect SG&A costs to be flat in the second quarter of fiscal year 2015 as compared to the first quarter of fiscal year 2015.

Product Development and Engineering Expenses Product development and engineering expenses decreased by $6.7 million in the first quarter of fiscal year 2015 compared to the same quarter of fiscal year 2014 as a result of our lower levels of investment in the long-haul optical market.
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 $6.4 million and $7.9 million in the first quarter of fiscal years 2015 and 2014, respectively. The $1.5 million decrease is primarily the result of the $29.9 million of impairments that were recorded in the fourth quarter of fiscal year 2014 in connection with our restructuring actions in January 2014 discussed above. Intangible amortization is expected to be flat in the second quarter of fiscal year 2015 as compared to the first quarter of fiscal year 2015.
Restructuring
We incurred $1.0 million for restructuring charges in the first quarter of fiscal year 2015 for employee severance and lease termination costs related to our decision in January 2014 to reduce our investment in the long haul optical market, realign product groupings, and align spending with anticipated demand levels.
Interest and Amortization of Debt Discount and Expense Interest and amortization of debt discount and expense was $1.4 million and $4.1 million in the first quarter of fiscal year 2015 and 2014, respectively. The $2.7 million decrease was due to lower levels of outstanding debt under our credit facilities and more favorable interest rate terms resulting from the debt refinancing that occurred in the second quarter of fiscal year 2014. Interest and amortization of debt discount and expense is expected to be approximately $1.6 million for the second quarter of fiscal year 2015. Non-operating Expense, Net
Non-operating expense, net includes interest income from our investments and the impact of foreign exchange activity related to cash holding in local currencies. Income Taxes
In the first quarter of fiscal year 2015, we recorded an income tax provision of $1.6 million compared to a $0.4 million income tax provision in the first quarter of fiscal year 2014. The effective tax rates for the first quarter of fiscal years 2015 and 2014 were 17.0% and 2.9%, respectively. The effective tax rate in the first quarter of 2015 is higher than the effective tax rate in the first quarter of 2014 due the fact that we no longer benefit US based losses in our effective tax rate.


Our effective tax rate in the first quarter of fiscal year 2015 differs from the statutory federal income tax rate of 35% due primarily to a valuation reserve against our deferred tax assets and certain undistributed foreign earnings for which no U.S taxes are provided because such earnings are indefinitely reinvested outside of the U.S. We receive an income tax benefit from tax differentials due to our presence in foreign jurisdictions such as Switzerland and Canada where statutory rates are lower than U.S. federal tax rates. We are currently not aware of any uncertainties or trends relating to foreign tax differential that could significantly impact our income taxes in future periods. 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 27, 2014, our total stockholders' equity was $538.5 million. At that date we also had approximately $241.2 million in cash and temporary investments, $3.2 million in long-term investments, and $287.2 million of borrowings, net of debt discount. . . .

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