Semtech Corporation — Form 10-Q Summary
Reporting period: Second quarter and six months of fiscal 2015, ended July 27, 2014. Comparisons are to the corresponding periods ended July 28, 2013. Semtech supplies high-performance analog and mixed-signal semiconductors; its results are reported in one reportable segment, the Semiconductor Products Group, plus “All others.”
Financial performance
| Metric | Q2 FY2015 | Q2 FY2014 | Six months FY2015 | Six months FY2014 |
|---|---|---|---|---|
| Net sales | $145.7 million | $165.0 million | $278.6 million | $327.4 million |
| Gross profit / margin | $88.2 million / 60.5% | $100.7 million / 61.0% | $166.3 million / 59.7% | $198.0 million / 60.5% |
| Operating income / margin | $22.1 million / 15.1% | $24.5 million / 14.7% | $33.2 million / 11.9% | $44.5 million / 13.6% |
| Net income | $17.9 million | $19.1 million | $25.8 million | $33.9 million |
| Diluted EPS | $0.26 | $0.28 | $0.38 | $0.49 |
| Operating cash flow | Not separately presented | Not separately presented | $61.1 million | $58.4 million |
Six-month investing cash outflow was $13.7 million, including $12.7 million of capital expenditures and a $3.3 million cost-method investment. Financing cash outflow was $51.9 million, including $34.4 million of debt payments and $20.0 million of share repurchases. Cash decreased $4.5 million to $238.7 million.
At July 27, 2014, current assets were $387.8 million and current liabilities were $104.2 million. Debt was approximately $257.6 million, net of debt discount; the company also reported $238.7 million of cash and cash equivalents and $0.6 million of long-term investments. The $250 million revolving facility had $153.0 million outstanding, leaving approximately $97 million undrawn, subject to facility terms. The company reported compliance with its debt covenants.
Material changes and drivers
- Q2 sales declined 11.7% year over year; six-month sales declined 14.9%. Management attributed the principal decline to customer transitions away from its 40Gbps and 100Gbps long-haul optical products: related sales were $5.8 million in Q2 versus $28.6 million, and $14.2 million for six months versus $57.3 million.
- Communications revenue fell $17.2 million in Q2 and $34.1 million for six months. Enterprise computing grew $5.8 million in Q2 and $10.3 million for six months, supported by datacenter, PON and SAN demand. Wireless, Sensing and Timing benefited in Q2 from a one-time prototype-volume sale of its 3D Touch Sensing platform.
- Q2 gross margin eased 0.5 percentage points year over year; six-month gross margin eased 0.8 points. Lower revenue drove the gross-profit decline, and the six-month period also included $1.1 million of inventory write-downs tied to the long-haul optical strategy.
- Operating expenses fell 13% in both Q2 and the six-month period, reflecting lower engineering investment, lower SG&A, and reduced amortization. Six-month results included $1.0 million of restructuring charges. Prior-year comparisons included a $2.6 million intangible impairment in Q2 and a $7.1 million debt-refinancing-related charge within interest expense, contributing to the large year-over-year decline in interest expense.
- Q2 Samsung sales were 9% of revenue, down from 11%; for six months they were 11%, down from 13%. Authorized distributors accounted for about 60% of Q2 sales, versus 44% a year earlier.
Outlook, risks and unusual items
- For Q3 FY2015, management expected revenue to increase approximately 1% sequentially, gross margin to remain relatively flat, SG&A to rise about 1%, engineering expense to rise about 3%, and interest expense to be approximately $1.5 million. It expected Signal Integrity revenue to decline, Wireless, Sensing and Timing to be flat, and Protection, Power and High-Reliability products to benefit from handheld strength.
- Following its restructuring and reduced investment in long-haul optical, Semtech expected annual savings of approximately $10 million in compensation, $10 million in development costs and $5.2 million in depreciation and amortization, offset by an anticipated $80–$90 million annual revenue reduction from long-haul optical products. Management said restructuring was completed and no additional costs were expected for that event.
- Management stated that available resources were sufficient for liquidity and capital needs over the next 12 months. However, $119.8 million of cash was held by foreign subsidiaries, and $505.7 million of foreign earnings was treated as permanently reinvested. The filing identifies foreign currency, variable interest rates, suppliers, customer demand and product transitions as risks. A 100-basis-point interest-rate increase was estimated to reduce annual net income and cash flow by about $0.9 million after the hedge.
- Environmental exposure at the former Newbury Park, California site was estimated at a probable-loss range of $2.5–$5.7 million; Semtech had accrued the $2.5 million minimum and said it could not determine a best estimate. Management did not expect outstanding legal matters, individually or collectively, to materially affect the financial statements, while cautioning that outcomes remain uncertain.
- Gross unrecognized tax benefits were $9.9 million at quarter-end. The company was under IRS audits for fiscal 2011–2013 and Canadian tax audits for fiscal 2010, 2011 and the short year ended March 19, 2012. U.S. and Canadian deferred tax assets remained subject to a full valuation allowance established in the prior fiscal year.
- The company was assessing the impact and adoption approach for the new revenue-recognition standard, Topic 606, effective for it beginning in fiscal 2018; early adoption was not permitted.
Important facts for investors to verify
- Whether the expected long-haul optical revenue decline and restructuring savings materialize, and whether other products offset the lost sales.
- Whether Q3 sequential revenue, gross-margin and expense expectations were achieved; this filing provides no broader full-year revenue or earnings guidance.
- Debt balances, repayment schedule, covenant headroom and remaining revolver availability, particularly as cash is used for debt reduction and repurchases.
- Customer and distributor concentration, exposure to the China-based wafer foundry, and the effect of product transitions on demand and inventory.
- Developments in the Newbury Park environmental matter and tax audits, including any change to recorded reserves or tax benefits.