MAXLINEAR, INC quarterly report, Q3 FY2017

MaxLinear, Inc. 10-Q Summary

Business context and reporting period

MaxLinear is a fabless semiconductor company providing radio-frequency, mixed-signal and high-performance analog integrated circuits for connected-home, wired and wireless infrastructure, industrial and multi-market applications. This unaudited report covers the three and nine months ended September 30, 2017, compared with the respective 2016 periods.

The period reflects the April 2017 acquisition of Marvell’s G.hn business and the May 2017 acquisition of Exar Corporation. Exar materially expanded the company’s analog, power-management and interface product portfolio.

Key financial metrics

Metric	Q3 2017	Q3 2016	9M 2017	9M 2016
Net revenue	$113.6 million	$96.3 million	$306.6 million	$300.7 million
Gross profit	$51.8 million	$55.5 million	$155.9 million	$179.6 million
Gross margin	46%	58%	51%	60%
Operating income (loss)	$(10.6) million	$10.7 million	$(16.0) million	$54.7 million
Net income (loss)	$(9.2) million	$9.7 million	$10.3 million	$52.9 million
Diluted EPS	$(0.14)	$0.14	$0.15	$0.79
Operating cash flow	Not separately provided	Not separately provided	$53.3 million	$89.7 million

Q3 revenue increased 18%, while nine-month revenue increased 2%. Q3 cost of revenue rose 51%, primarily because of acquired inventory step-up amortization and acquired-intangible amortization. Research and development expense increased 13% in Q3 and 11% year to date. Selling, general and administrative expense increased 65% in both periods, driven by acquisition-related amortization, personnel, professional fees and integration activities.

The Q3 tax benefit was $6.3 million and the nine-month tax benefit was $33.8 million. The nine-month benefit primarily reflected the release of $50.1 million of the U.S. federal deferred-tax valuation allowance during the second quarter. The remaining federal valuation allowance was $11.5 million at September 30, 2017.

Financial position, debt and liquidity

Cash and cash equivalents were $71.6 million; total cash, cash equivalents and restricted cash were $74.1 million at September 30, 2017.
Working capital was $121.0 million, compared with $158.3 million at December 31, 2016.
Accounts receivable were $75.6 million and inventory was $63.7 million, compared with $50.5 million and $26.6 million, respectively, at year-end 2016.
Long-term debt had $375.0 million of principal outstanding and a $367.3 million carrying value after discounts and issuance costs. The term loan matures May 12, 2024, with a weighted-average effective interest rate of 3.7% at quarter-end.
MaxLinear prepaid $50.0 million of term-loan principal during the nine months. The debt is secured by substantially all assets of the company and certain subsidiaries and includes operational covenants.
In November 2017, the company entered into a $350.0 million fixed-for-floating interest-rate swap at a fixed rate of 1.74685% to hedge most of the term-loan exposure.
Management stated that cash and cash equivalents at September 30, 2017 were expected to fund projected operating requirements for at least the next twelve months, although additional financing may be needed for acquisitions or other strategic initiatives.

Material changes versus the prior comparable period

Revenue mix shifted substantially. Q3 connected-home revenue declined 23% to $65.6 million, while infrastructure revenue increased 116% to $23.7 million and industrial and multi-market revenue increased to $24.2 million from $0.1 million, primarily due to Exar and G.hn contributions.
For the nine months, connected-home revenue declined 19% to $222.1 million, offset by 110% infrastructure growth to $50.7 million and industrial and multi-market growth to $33.9 million.
Gross margin declined 12 percentage points in Q3 and 9 percentage points year to date, principally due to acquisition-related inventory step-up and intangible amortization.
The company changed from operating income and net income in the 2016 comparable periods to an operating loss and net loss in Q3 2017. The nine-month net income remained positive largely because of the tax benefit, despite an operating loss.
Net cash used in investing activities increased to $429.1 million, including $452.3 million for Exar, net of cash acquired, and $21.0 million for G.hn. Financing activities provided $365.8 million, primarily from the Exar term loan.
Goodwill increased to $239.7 million from $76.0 million, and net intangible assets increased to $332.4 million from $104.3 million, primarily from the acquisitions.

Outlook, commentary, risks and unusual items

Management expected legacy video SoC and satellite analog channel-stacking revenue declines to become less significant because those products were nearing the end of their life cycles.
Management expected research and development and selling, general and administrative expenses to increase as the company expanded its product portfolio, sales organization and market presence.
Management expected material cost savings and synergies from Exar and believed the acquisition would be accretive to free cash flow and reported non-GAAP EPS excluding non-recurring charges, transaction expenses and purchased-intangible amortization. The filing cautions that these expectations depend on uncertain assumptions and may not be achieved.
Acquisition and integration-related costs were $1.0 million in Q3 and $10.0 million for the nine months. Restructuring charges were $2.2 million in Q3 and $8.7 million year to date, including accelerated stock-based compensation and Exar facility-exit costs.
The company recorded a $2.0 million IPR&D impairment charge in Q3 and year to date related to an abandoned Exar project.
Revenue concentration remains significant: Arris represented 26% of Q3 revenue and 27% of nine-month revenue; the ten largest customers represented 58% and 60%, respectively. Asia represented 86% of Q3 revenue and 90% of nine-month revenue, with China representing 68% and 72%, respectively.
Distributor sales represented 31% of nine-month revenue. Deferred revenue and deferred profit related to distributor transactions totaled $17.2 million at September 30, 2017.
Key risks include Exar integration, customer and distributor concentration, semiconductor cyclicality, pricing pressure, reliance on third-party manufacturing, acquisition-related goodwill and intangible impairment, debt service and interest-rate exposure, and dependence on future design wins.
CrestaTech patent litigation and related appeals remained unresolved, although the ITC investigation ended in MaxLinear’s favor and PTAB decisions found all 13 asserted claims unpatentable. Trango litigation also remained pending and could have a material adverse effect if decided adversely. Exar shareholder litigation was resolved after payment of a mootness fee.
The company expects adoption of the new revenue-recognition standard in 2018 to accelerate recognition for certain distributor sales and potentially materially affect revenue and comparative periods. Lease accounting adoption is expected to materially affect the balance sheet.

Most important facts for investors to verify

Whether Exar and G.hn integration produces the expected cost savings, revenue synergies and earnings accretion.
Normalized gross margin after acquisition-related inventory step-up and intangible amortization decline.
Cash generation relative to the $375.0 million debt balance, required amortization and interest expense.
Customer, distributor, geographic and connected-home concentration trends, particularly Arris, China and the legacy video product decline.
The impact of ASC 606 adoption on distributor revenue, deferred profit and retained earnings.
Potential goodwill, intangible-asset and IPR&D impairments, including the $239.7 million goodwill and $332.4 million net intangible balances.
Developments in CrestaTech and Trango litigation, Exar indemnification obligations, and any related financial exposure.
Whether the interest-rate swap receives cash-flow hedge accounting and how much term-loan exposure remains variable.