Semtech Corporation — Q1 FY2016 Form 10-Q
Reporting period: 13 weeks ended April 26, 2015; comparable period ended April 27, 2014. Semtech designs and sells analog and mixed-signal semiconductors. Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial performance
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Net sales | $130.1 | $132.9 |
| Gross profit / margin | $78.4 / 60.3% | $78.1 / 58.8% |
| Operating income / margin | $4.9 / 3.8% | $11.1 / 8.4% |
| Net income (loss) | $(0.1) | $7.9 |
| Net income (loss) per diluted share | $0.00 | $0.12 |
| Cash from operating activities | $14.7 | $22.8 |
Gross margin improved primarily because the prior-year quarter included inventory impairment charges and the current period had a more favorable product mix. Operating costs rose 10% to $73.5 million: SG&A increased $6.0 million, including higher ERP support, $2.3 million of additional environmental remediation costs, and about $1.0 million of Triune acquisition expenses. Product development and engineering expense rose $1.9 million, partly due to acquisitions and development timing.
Net sales declined 2%. Enterprise computing grew to $34.0 million from $25.2 million, while high-end consumer fell to $35.8 million from $42.1 million and communications to $25.9 million from $32.6 million. Protection product sales declined to $37.1 million from $48.7 million; Signal Integrity rose to $54.3 million from $51.3 million. Samsung represented 8% of sales, versus 14% a year earlier.
Cash, debt and liquidity
At April 26, 2015, cash and cash equivalents were $211.5 million, down from $230.3 million at fiscal year-end. Current assets were $399.1 million and current liabilities $132.9 million. Long-term debt, including current maturities, was $283.7 million net of debt discount: $91.2 million of term loans and $193.0 million drawn on the revolving facility. The company had $250 million of total revolving commitments and no outstanding letters of credit, swing-line loans or alternative-currency borrowings.
Operating cash flow was $14.7 million. Investing used $42.0 million, including $34.9 million for acquisitions and $4.8 million of capital expenditures. Financing provided $8.5 million, including $35.0 million of revolver borrowings, offset in part by $20.0 million of share repurchases and $4.7 million of debt payments. Cash decreased $18.8 million during the quarter. Management said available resources were sufficient for liquidity and capital needs over the next 12 months. Foreign subsidiaries held $175.3 million of cash and cash equivalents; $499.3 million of foreign earnings were treated as permanently reinvested.
Material developments and outlook
- Semtech acquired Triune Systems in March for a guaranteed minimum $45.0 million, comprising $35.0 million paid at closing and $10.0 million due six months later. Additional contingent consideration could reach $86.0 million; the recorded fair value of the non-employment-contingent earn-out was $16.2 million. Triune’s post-acquisition revenue and earnings were not material.
- Semtech acquired selected EnVerv assets in January for $4.9 million; post-acquisition revenue and earnings were not material.
- The company divested its defense and microwave communications infrastructure business in exchange for an approximately 21% preferred-equity interest in Jariet. The business contributed $4.1 million of revenue and non-recurring engineering reimbursements in the quarter, compared with $1.9 million a year earlier.
- Management forecast Q2 FY2016 net sales of $120 million to $130 million, citing bookings and backlog. It expected gross margin to decline from Q1 because of lower sales and a less favorable mix.
- Semtech repurchased 734,645 shares for $20.0 million in Q1. In May 2015, the board added $70.0 million of authorization, bringing remaining authorization to $100.0 million.
Risks, contingencies and unusual items
- Controls: Disclosure controls were deemed ineffective because of a previously reported material weakness in the review and documentation of inventory reserves. Remediation was underway, but management could not conclude that the weakness had been remediated. The new ERP financial, accounting and inventory systems had gone live, and testing of key controls was still in progress.
- Environmental exposure: For the Newbury Park site, Semtech recorded a $4.8 million reserve, the low end of an estimated probable-loss range of $4.8 million to $7.0 million. The company said estimates could change as remediation plans and regulatory actions develop.
- Legal matters: Intrigo Systems sought more than $2.7 million over an ERP consulting contract; Semtech filed a cross-complaint seeking more than $3.7 million. The company could not assess the outcome. Management said other current claims were not expected to have a material aggregate effect, but litigation outcomes remain uncertain.
- Taxes: The $2.7 million tax provision exceeded pretax income of $2.6 million, producing a 105.6% effective tax rate, compared with 17.0% a year earlier. Management attributed the elevated rate mainly to geographic earnings mix and a valuation reserve against deferred tax assets. The company was under IRS audit for fiscal 2013.
- Market and operating risks: Sales are concentrated in Asia-Pacific (74% of revenue), and distributors accounted for approximately 57% of sales. The company depends on a limited number of foreign suppliers and subcontractors; a China-based foundry supplied about 30% of silicon wafer costs. Demand weakness in Korean protection customers and declining 40Gbps/100Gbps SerDes demand affected results. Variable-rate debt, foreign exchange, customer demand, supplier interruptions and ERP implementation are among the stated risks.
- The company was in compliance with credit-facility financial covenants at quarter-end. It reported no material change in its stated risk factors from the prior Form 10-K.
Investor verification priorities
- Track whether the Q2 sales forecast and expected gross-margin decline materialize, and whether demand weakness in protection and SerDes continues.
- Review operating expense growth, especially ERP-related costs, acquisition expenses and environmental remediation charges, against future operating margins.
- Monitor operating cash generation, cash balances, debt and revolver utilization after the Triune acquisition, and compliance with debt covenants.
- Assess Triune’s integration, the preliminary purchase-price allocation, and the potential amount and timing of contingent earn-out payments.
- Follow remediation of the inventory-reserve control weakness and testing of the new ERP controls.
- Check developments in the Newbury Park environmental matter, the Intrigo dispute, and the fiscal 2013 IRS audit.