Semtech Corporation — Q3 FY2017 Form 10-Q
Reporting period: 13 weeks ended October 30, 2016; comparisons are with the 13 weeks ended October 25, 2015. The nine-month period is also compared with the same period of the prior fiscal year. Semtech designs and sells analog and mixed-signal semiconductors. Beginning this quarter, it reported one segment after divesting its Snowbush IP business.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Net sales | $137.2 million | $115.8 million | $404.2 million | $371.6 million |
| Gross profit / margin | $81.1 million / 59.1% | $69.6 million / 60.1% | $241.4 million / 59.7% | $223.6 million / 60.2% |
| Operating income | $39.1 million | $18.9 million | $68.8 million | $26.9 million |
| Net income | $30.8 million | $10.7 million | $46.6 million | $10.3 million |
| Diluted EPS | $0.46 | $0.16 | $0.71 | $0.15 |
- Q3 sales rose 18%; management cited hyperscale datacenter demand for optical transceivers, growth in LoRa and proximity-sensing products, and mobile-device demand for protection products. Lower passive optical network sales and the Comcast warrant offset some growth.
- Q3 gross margin declined 1.0 percentage point year over year, partly due to the Comcast warrant. SG&A increased 14% to $35.1 million, including higher equity compensation and a $2.1 million bad-debt reserve for a customer that filed for bankruptcy. Product development and engineering expense declined 5% to $25.6 million.
- Reported Q3 and nine-month operating income included a $25.0 million gain from the Snowbush IP divestiture. The Q3 prior-year comparison also included a $14.2 million benefit from a change in contingent earn-out fair value; the nine-month prior-year period included a $13.6 million benefit and $4.5 million of restructuring charges. These items make reported profit comparisons less indicative of underlying operations.
- Cash and cash equivalents were $297.9 million at October 30, versus $211.8 million at January 31, 2016. Current assets were $438.7 million and current liabilities $117.8 million.
- Nine-month operating cash flow was $84.7 million, compared with $67.6 million a year earlier. Investing activities provided $15.6 million, including $32.0 million of Snowbush proceeds; financing activities used $14.2 million. Capital expenditures were $13.8 million.
- Debt at October 30 was approximately $247.9 million, including $181.0 million drawn on the revolver and $67.8 million of term loans. The company reported compliance with its then-current financial covenants.
Changes, outlook, and notable items
- Sales increased across the main product lines, led in Q3 by Signal Integrity ($60.6 million), Protection ($40.3 million), and Wireless and Sensing ($24.1 million). High-end consumer was 31% of Q3 sales; enterprise computing and industrial were each 27%.
- On October 5, Semtech issued Comcast a warrant for up to 1,086,957 shares, tied to deployment milestones for a LoRaWAN-based network. The company recorded $3.7 million as a reduction of Q3 and nine-month net sales; additional warrant cost may be recognized over the performance period.
- On August 5, Semtech sold Snowbush IP to Rambus for $32.0 million cash, with possible additional payments through 2022 based on product sales. The contingent future proceeds will be recognized if received.
- Management forecast Q4 FY2017 net sales of $133.2 million to $141.2 million based on bookings and backlog, and gross margins similar to Q3. It expected approximately $7.0 million of Q4 spending to expand test capacity and planned to buy its Burlington, Canada facility for approximately $12.0 million, with closing expected in December 2016.
- After quarter-end, Semtech refinanced its credit facilities. The amended agreement provides $150.0 million of term loans and a $250.0 million revolving facility, maturing November 2021. As of November 15, $247.0 million was drawn and $153.0 million remained undrawn. The agreement includes leverage and interest-coverage covenants and restrictions on, among other things, debt, dividends, repurchases, and capital expenditures.
- Management said cash and other resources were adequate for liquidity needs over the next 12 months. Approximately $228.7 million of cash was held by foreign subsidiaries; $588.2 million of unremitted foreign earnings were treated as permanently reinvested and had no U.S. tax provision.
Risks and contingencies
- Sales are exposed to short lead times, cancellable orders, customer and end-market volatility, and distributor dependence. Distributors accounted for approximately 64% of Q3 sales; Arrow and affiliates accounted for 11%. China represented 46% of Q3 sales by ship-to location.
- Semtech relies on a limited number of suppliers and subcontractors. A China-based foundry supplied approximately 24% of wafer cost in Q3. Supply disruption or delays qualifying alternatives could affect shipments.
- The company accrued $5.214 million for environmental remediation at its former Newbury Park site, the low end of a probable-loss range of $5.2 million to $7.5 million. It said the estimate could change as remediation plans and regulatory requirements develop. It also described a separate California site matter with settlement discussions underway and no clear estimate of potential exposure in the filing.
- The Cycleo earn-out liability was $8.264 million; up to approximately $16.0 million may be payable based on future revenue and operating-income milestones. Semtech said it did not expect Triune earn-out targets to be achieved, and recorded no Triune earn-out liability.
- Variable-rate debt exposes results to interest-rate changes: management estimated a 100-basis-point increase would reduce annual net income and cash flow by approximately $2.3 million, all else equal. Tax rates may also be volatile due to U.S. valuation allowances, foreign earnings, and tax audits.
Management reported that disclosure controls were effective as of October 30, 2016, and that risk factors had not materially changed from the prior annual report. It stated that pending legal matters were not expected to have a material adverse effect in aggregate, while noting that outcomes remain uncertain.
Investor verification checklist
- Assess how much of reported earnings growth reflects the $25.0 million Snowbush gain and prior-period earn-out valuation benefits, versus ongoing operating performance.
- Verify the effect of the Comcast warrant on reported revenue and margins, and the remaining milestone-related accounting expense.
- Track Q4 sales against the $133.2 million–$141.2 million outlook, particularly datacenter, LoRa, mobile-protection, and weaker product-market trends.
- Review post-refinancing borrowings, interest costs, covenant headroom, and the availability of foreign-held cash for U.S. needs.
- Monitor the Newbury Park remediation estimate, the Davis Chemical site matter, the bankrupt-customer receivable, and the Cycleo earn-out exposure.