SYNAPTICS Inc quarterly report, Q2 FY2015

Business Context and Reporting Period

Synaptics Incorporated develops and sells human-interface semiconductor solutions for mobile, computing, communications, and other electronic devices. This unaudited Form 10-Q covers the 13-week quarter ended December 27, 2014 and six months ended December 27, 2014, presented as December 31, 2014 for financial statement purposes. The fiscal year ends in June.

The results include Renesas SP Drivers, Inc. (RSP) from its October 1, 2014 acquisition date. RSP contributed approximately $238.6 million of revenue and $16.5 million of operating income during the quarter.

Key Financial Metrics

Metric	Three months ended Dec. 31, 2014	Three months ended Dec. 31, 2013	Six months ended Dec. 31, 2014	Six months ended Dec. 31, 2013
Net revenue	$463.7 million	$205.8 million	$746.4 million	$428.4 million
Gross margin	$126.8 million; 27.4%	$94.5 million; 45.9%	$247.0 million; 33.1%	$203.8 million; 47.6%
Operating income	$28.5 million; 6.1%	$22.1 million; 10.7%	$64.7 million; 8.7%	$69.3 million; 16.2%
Net income	$20.0 million	$17.3 million	$46.6 million	$52.3 million
Diluted EPS	$0.52	$0.48	$1.20	$1.47
Operating cash flow	Not separately provided	Not separately provided	$44.4 million	$85.8 million

Quarterly revenue increased 125.4%; six-month revenue increased 74.3%.
Mobile product revenue was $398.3 million in the quarter, up 198.1%, and $598.0 million for six months, up 101.9%. PC product revenue declined 9.4% in the quarter but increased 12.3% for six months.
Research and development expense increased 68.1% in the quarter and 56.0% for six months, primarily from RSP-related staffing, annual merit increases, and expanded product development.
Share-based compensation was $10.7 million in the quarter and $20.2 million for six months.
The quarterly effective tax rate was 39.0%; the six-month provision was $18.1 million.

Liquidity, Capital Resources, and Debt

Cash and cash equivalents were $327.5 million at December 31, 2014, down from $447.2 million at June 30, 2014. Approximately $245.8 million was held by foreign subsidiaries.
Six-month cash uses included $293.8 million for the RSP acquisition, $34.3 million for capital expenditures, and $90.6 million for repurchases of 1.29 million shares. These uses were partly funded by $250.0 million of debt proceeds and $44.4 million of operating cash flow.
Debt outstanding was $250.0 million, consisting of a $150.0 million term loan and $100.0 million drawn under a $150.0 million revolving facility. Debt is variable-rate and secured by substantially all personal property of the credit parties.
The term loan requires quarterly amortization beginning in the March 2015 quarter, with a $90.0 million final payment due September 30, 2019. The revolving facility matures on September 30, 2019.
Management stated that existing cash, expected operating cash flow, and available revolving credit should meet working-capital, acquisition-related, debt, and other requirements for at least the next 12 months. The company was in compliance with its debt covenants at December 31, 2014.
The company had $109.0 million remaining under its $730.0 million share-repurchase authorization, which expires in July 2016.

Material Changes Versus the Prior Comparable Period

Revenue growth was driven primarily by the RSP acquisition and higher sales of biometric fingerprint solutions. RSP made Japan the largest reported customer-location market for the quarter, with $231.3 million of revenue.
Gross margin declined 1,850 basis points in the quarter and 1,450 basis points for six months. Management attributed the decline mainly to amortization of acquired intangibles and lower margins on RSP display-driver products.
Acquired-intangible amortization increased to $45.1 million in the quarter and $49.4 million for six months, compared with $1.9 million and $2.1 million, respectively, in the prior periods.
Operating income rose 29.0% in the quarter but declined 6.6% for six months. Six-month net income declined 10.9%, reflecting acquisition-related amortization, higher research and development costs, and interest expense.
Contingent-consideration expense changed from expense of $3.4 million in the prior-year quarter to a $7.1 million credit; for six months, it changed from expense of $3.7 million to an $11.6 million credit. The change reflected lower estimated future unit sales for Validity and Pacinian technologies.
RSP added approximately $250.6 million of acquired intangible assets and $153.4 million of goodwill on a preliminary basis. The acquisition accounting remains subject to measurement-period adjustments.

Guidance, Outlook, Commentary, and Risks

The filing does not provide specific company revenue, earnings, or margin guidance. Management cited industry estimates of approximately 12% smartphone-market growth, 5% tablet-market growth, and less than 1% notebook-market growth for calendar 2015.
Management expects continuing product development, expanded customer support, and integration of RSP to affect expenses and capital needs. The filing states that product life cycles can be short and margins vary substantially by customer-specific design.
RSP integration creates control and reporting considerations: RSP was excluded from the first-year internal-control assessment, although RSP represented approximately 52% of quarterly sales and 20% of total assets. Management stated that disclosure controls and internal control over financial reporting were effective.
Contingent consideration may require additional cash payments of up to $130.9 million for Validity through March 2016 and up to $10.0 million for Pacinian through June 2016. The recorded fair value of these liabilities was approximately $69.3 million at December 31, 2014.
RSP-related liabilities included a working-capital holdback expected to be settled in the March 2015 quarter and an indemnification holdback expected to be settled in fiscal 2016. Total RSP acquisition-related holdbacks were denominated in Japanese yen.
Foreign-currency exposure increased materially after the RSP acquisition. A hypothetical 10% adverse currency movement would have reduced six-month pretax operating income by approximately $4.4 million, assuming no hedging.
Variable-rate debt creates interest-rate risk; a one-percentage-point increase in rates would increase annual interest expense by approximately $2.5 million.
Failed auction-rate securities had a fair value of $15.3 million and are illiquid. Management does not expect their lack of liquidity to affect ordinary operations, but their valuation depends on significant estimates.
The company faces semiconductor supply, customer concentration, product-demand, intellectual-property litigation, inventory-obsolescence, tax, acquisition-integration, and execution risks. The filing notes that infringement claims could result in significant costs and damages.

Most Important Facts for an Investor to Verify

Whether RSP revenue and earnings can be sustained after the acquisition-related initial contribution and whether display-driver margins improve.
The recurring impact of approximately $283.3 million of remaining acquired-intangible amortization and its effect on GAAP margins and earnings.
Cash conversion, particularly the effect of higher receivables and inventory; six-month operating cash flow fell to $44.4 million from $85.8 million.
Debt repayment capacity, variable-rate exposure, covenant compliance, and the $90.0 million term-loan maturity payment due in 2019.
Settlement timing and ultimate amounts for RSP holdbacks and Validity and Pacinian contingent consideration.
Customer concentration and geographic concentration, including the quarter’s 24% contribution from Customer A and 13% from Customer B, with additional unnamed customers each representing 12% to 13%.
Progress in integrating RSP’s financial controls and the effect of foreign-exchange movements on yen-denominated liabilities.