Business context and reporting period
Semtech Corporation designs and sells analog and mixed-signal semiconductors and advanced algorithms for computing, communications, consumer and industrial applications. This unaudited Form 10-Q covers the 13-week second quarter and six months of fiscal 2020 ended July 28, 2019; comparisons are with the periods ended July 29, 2018.
Financial performance
Dollar amounts are in millions except per-share data. Margins are calculated from reported results.
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Net sales | $137.1 | $163.2 | $268.5 | $293.6 |
| Gross profit / margin | $84.9 / 61.9% | $100.1 / 61.3% | $166.2 / 61.9% | $171.6 / 58.4% |
| Operating income / margin | $15.5 / 11.3% | $32.9 / 20.1% | $28.4 / 10.6% | $29.8 / 10.2% |
| Net income | $5.4 | $25.2 | $18.7 | $37.6 |
| Diluted EPS | $0.08 | $0.37 | $0.28 | $0.55 |
| Operating cash flow | Not separately provided | Not separately provided | $40.1 | $84.4 |
- Q2 sales fell 16.0% year over year. Six-month sales fell 8.6%; the prior-year six-month comparison includes a $21.5 million revenue reduction for the Comcast warrant, including $15.9 million from accelerated vesting.
- Q2 gross margin improved 0.6 percentage points, which management attributed to favorable product mix. Six-month gross margin also benefited from the absence of the prior-year warrant-related revenue reduction.
- Q2 operating income and net income declined substantially. SG&A rose 19%, in part because Q2 FY2019 included $6.7 million of HiLight lawsuit recoveries; current-period restructuring and supplemental compensation also affected SG&A. Q2 income taxes were $9.0 million, an effective rate of 62.6%.
- For the six months, the effective tax rate was 26.3%, versus a 43.7% tax benefit in the prior-year period, which included a $15.8 million partial release of a U.S. deferred-tax valuation allowance.
Cash, debt and liquidity
- At July 28, 2019, cash and cash equivalents were $287.8 million, total debt was $202.9 million, and stockholders’ equity was $689.5 million. Cash was down from $312.1 million at fiscal year-end.
- Six-month investing cash use was $24.4 million, including $16.9 million of capital expenditures and $7.7 million of strategic investments. Financing cash use was $39.9 million, including $20.1 million of share repurchases and $9.4 million of term-loan repayments.
- The credit facility had $153.0 million of unused revolving capacity and matures November 12, 2021. The company reported compliance with its financial covenants. Management said available financial resources were sufficient for business requirements over the next 12 months.
- Foreign subsidiaries held approximately $204.1 million of cash. The company reported $513.1 million of unremitted foreign earnings for which no taxes had been provided, which it expects to remain permanently reinvested.
Changes, outlook and risks
- Management cited weaker China-based demand and geopolitical headwinds, including U.S. export restrictions and tariffs. Enterprise computing was affected by below-seasonal China PON demand and lower data-center demand; high-end consumer by weaker China demand for proximity-sensing products; and communications by softer base-station demand. Six-month industrial sales also reflected lower China-based LoRa demand.
- Q2 sales by product line were Signal Integrity $55.1 million, Wireless and Sensing $41.7 million, and Protection $40.4 million. China, including Hong Kong, accounted for 52% of Q2 sales; distributors accounted for approximately 72%.
- For fiscal Q3 2020, management forecast net sales of $135 million to $145 million and gross margin of 61.0% to 61.6%. The sales range reflects continued geopolitical uncertainty and approximately $4 million of potential reduced shipments and demand related to the Huawei export restrictions. No full-year financial guidance is stated in the filing.
- Huawei sales were less than 10% of Q2 net sales. The filing says the restrictions may prevent sales of U.S.-regulated products to Huawei; their duration and future business effects were uncertain. Tariffs may also raise component costs or weaken demand. Other notable exposures include customer and distributor concentration, reliance on a limited number of overseas suppliers and subcontractors, and foreign-currency and variable-rate debt risks.
- Six-month operating cash flow decreased to $40.1 million from $84.4 million. Management attributed pressure partly to lower sales. Capital spending included a $4.0 million Colorado facility purchase; the company expected to reduce capital investment in the remainder of FY2020 while continuing strategic investments in the LoRa ecosystem.
- Unusual items and contingencies: the AptoVision earn-out liability was fully released during the six months, reducing operating expense by $2.2 million. The company recorded $2.1 million of restructuring expense, predominantly related to wireless charging, and did not expect material further expense from that restructuring. For environmental remediation at a former California facility, estimated probable losses were $5.9 million to $7.5 million; $3.7 million had been paid and $2.2 million remained accrued. Management did not expect current legal matters, individually or in aggregate, to materially affect the financial statements, while noting litigation uncertainty.
- The company repurchased 448,481 shares for $20.1 million during the six months; $160.7 million remained authorized. It adopted lease accounting in fiscal Q1, recording $13.0 million of right-of-use assets and $13.8 million of lease liabilities, with no material reported effect on operations or cash flows.
- Management concluded disclosure controls were effective as of July 28, 2019; no material change in internal control over financial reporting was reported during the quarter.
Important facts for investors to verify
- Whether demand, particularly in China, stabilizes and whether the Q3 sales and gross-margin ranges are achieved.
- The actual effect and duration of Huawei export restrictions, tariffs and related customer or supplier responses.
- Drivers of the Q2 operating-income decline and the unusually high quarterly tax rate, including potential volatility from uncertain tax positions.
- Cash conversion, capital spending and progress on debt repayment, alongside the use of cash for share repurchases and strategic investments.
- Customer, distributor and supplier concentration, plus the eventual cost and outcome of the environmental remediation and other contingencies.