Semtech Corporation — Form 10-Q Summary
Business context and period. Semtech designs and sells analog and mixed-signal semiconductors and related technology. This report covers the 13 weeks ended July 30, 2017 (fiscal Q2 2018), with six-month comparisons to the period ended July 31, 2016. The company reports one segment, Semiconductor Products Group.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $153.1 million | $135.9 million | $296.9 million | $267.1 million |
| Gross profit / margin | $92.2 million / 60.2% | $81.8 million / 60.2% | $177.2 million / 59.7% | $160.3 million / 60.0% |
| Operating income | $18.9 million | $16.4 million | $37.1 million | $29.7 million |
| Net income | $12.6 million | $9.0 million | $24.4 million | $15.9 million |
| Diluted EPS | $0.19 | $0.14 | $0.36 | $0.24 |
Q2 sales rose 13%; six-month sales rose 11.2%. Management attributed growth principally to high-end consumer demand, including from its largest Korean customer, and increased demand for LoRa and proximity-sensing products. Product-line strength in Protection and Wireless and Sensing was partly offset by weaker Power and High-Reliability sales. Q2 selling, general and administrative expense increased 20%, mainly reflecting higher performance-based share compensation. The effective tax rate was 24.6% for Q2 and 24.4% for the six-month period, versus 37.0% and 37.9%, respectively, in the prior-year periods.
Cash flow, balance sheet and debt
- Six-month operating cash flow was $46.0 million, versus $45.5 million a year earlier. Investing cash use was $44.0 million and financing cash use was $21.3 million, producing a $19.3 million decrease in cash.
- Cash and cash equivalents were $277.9 million at July 30, 2017. Current assets were $438.8 million and current liabilities were $128.4 million.
- Debt consisted of $138.8 million of term loans and $97.0 million of revolving borrowings; the balance sheet reports $233.7 million of debt net of discount. The $250 million revolving facility had $153 million undrawn. The company reported compliance with its credit covenants.
- Capital expenditures were $19.0 million for the six months, compared with $5.3 million in the prior-year period. The company attributed cash use in part to acquisition spending, share repurchases, and increased inventory.
- Foreign subsidiaries held approximately $216.4 million of cash. Management stated that $626.6 million of foreign unremitted earnings were expected to remain permanently reinvested.
Material changes and notable items
- On July 1, 2017, Semtech acquired AptoVision for $17.6 million net cash at closing, plus contingent consideration of up to $47 million over three years. The recorded fair value of the earn-out was $17.0 million; the purchase-price allocation remained preliminary. AptoVision’s post-acquisition revenue and earnings were not material.
- The Comcast warrant, issued in connection with an intended LoRa network trial, reduced reported sales by $3.2 million in Q2 and $8.5 million year to date. Management expected the warrant’s cost to reduce Q3 gross margin by approximately 50 basis points.
- Q2 gross margin was unchanged year over year; six-month margin declined 0.3 percentage points, with the Comcast warrant’s effect partly offset by favorable product mix.
- Semtech repurchased 312,304 shares for $10.4 million during the first six months. Remaining authorization was $51.4 million.
- Capital spending and acquisitions drove investing cash use substantially higher than in the prior-year period. The company also recorded $429,000 of restructuring charges in the first six months.
Outlook, risks and contingencies
Management forecast Q3 fiscal 2018 net sales of $145 million to $153 million based on bookings and backlog. It expected gross margin to decrease by approximately 50 basis points from Q2, primarily because of higher Comcast warrant costs. Management said available financial resources were sufficient for business requirements over the next 12 months.
- Key disclosed exposures include demand volatility, short customer lead times, reliance on distributors and a limited number of suppliers, foreign operations and currency movements, competition, product qualification and development risks, and the possibility of losing significant customers. China represented 49% of Q2 sales; distributors accounted for approximately 65% of sales.
- The company had $4.8 million accrued for environmental remediation at its former Newbury Park site. Its estimated probable loss range was $4.8 million to $7.2 million, with no best estimate within the range. Management said the Los Angeles-area settlement amount was not material, while related proceedings remained subject to developments.
- Contingent consideration is sensitive to unobservable revenue and performance assumptions. The Cycleo earn-out liability was $7.2 million; the Triune earn-out was valued at zero, and management did not expect its remaining targets to be met.
- Variable-rate debt creates interest-rate exposure: a 100-basis-point increase was estimated to reduce annual net income and cash flow by approximately $2.3 million. Management also estimated that a 10% adverse currency move, after balance-sheet hedges, would have reduced Q2 pretax income by $1.5 million.
- The company reported effective disclosure controls and no material change in internal control over financial reporting. It said risk factors had not materially changed from its fiscal 2017 Form 10-K.
Important facts for investors to verify
- Whether Q3 sales meet the $145 million–$153 million outlook and whether the forecast margin pressure from the Comcast warrant materializes.
- How much of sales growth is sustained across end markets and product lines, particularly given customer, distributor, and geographic concentration.
- Cash conversion and working-capital trends, including inventory growth, capital spending, and foreign cash availability.
- The final AptoVision purchase-price allocation and any subsequent changes in earn-out fair value or payments.
- Developments in the Newbury Park environmental remediation estimate and the associated $4.8 million–$7.2 million loss range.