Semtech Corporation — Form 10-Q Summary
Reporting period: Third quarter of fiscal 2019, the 13 weeks ended October 28, 2018; comparisons are with the quarter ended October 29, 2017. Nine-month comparisons cover the same periods in each fiscal year. Amounts below are in U.S. dollars.
Business context and results
Semtech designs and sells analog and mixed-signal semiconductors and advanced algorithms. Its product lines are Signal Integrity, Protection, and Wireless and Sensing; all are reported as one segment. Management cited growth in China demand for LoRa products and stronger PON demand associated with the smart-home market.
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Net sales | $173.6m | $150.3m | $467.2m | $447.2m |
| Gross profit / margin | $106.6m / 61.4% | $89.4m / 59.5% | $278.2m / 59.5% | $266.6m / 59.6% |
| Operating income / margin | $41.9m / 24.1% | $17.6m / 11.7% | $71.7m / 15.3% | $54.7m / 12.2% |
| Net income | $12.2m | $13.3m | $49.7m | $37.7m |
| Diluted EPS | $0.18 | $0.20 | $0.73 | $0.56 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $136.4m | $72.9m |
Financial position, cash flow and capital allocation
- At October 28, 2018, cash and cash equivalents were $312.2m; current assets were $486.4m and current liabilities $120.6m.
- Total debt principal was $217.0m ($120.0m term loans and $97.0m revolving loans); the balance sheet reported $215.7m net of debt issuance costs. The weighted-average interest rate was 3.87%. The company had $153.0m of undrawn revolving capacity and was in compliance with credit covenants.
- Nine-month investing cash outflow was $25.2m, including $12.9m of capital expenditure, $7.3m for the ICI acquisition and $6.7m of investment purchases. Financing cash outflow was $106.9m, including $79.7m of share repurchases and $11.3m of term-loan payments. Cash increased $4.3m from the fiscal year-end balance.
- Semtech repurchased 1.68m shares for $79.7m in the first nine months. Remaining authorization was $217.3m at quarter-end.
- Foreign subsidiaries held approximately $217.6m of cash. The company expected to repatriate approximately $240m of foreign earnings over time and had remitted about $80m during the quarter.
Changes and unusual items
- Quarterly sales rose 15%; nine-month sales rose 4.5%. Q3 growth included increased industrial demand, while the company said smart-home-related PON demand was stronger than seasonal.
- Q3 gross margin improved to 61.4%, partly because the Comcast warrant-related revenue offset had ended. The warrant had reduced nine-month FY2019 sales by $21.5m, including $15.9m from accelerated vesting in Q1; no further warrant costs were expected.
- Q3 net income included a $30.0m impairment of the entire carrying value of Semtech’s Multiphy investment, following delayed expected adoption of 400G PAM4 DSP technology. The impairment weighed on pretax income despite higher sales and operating income.
- Operating results also reflected an $8.5m Q3 gain from changes in the fair value of contingent earn-out obligations. Nine-month results included a $6.6m benefit from the HiLight litigation settlement, recorded as a reduction to SG&A.
- Tax results were affected by a $15.8m first-quarter benefit from a partial release of a U.S. deferred-tax valuation allowance and a $4.7m third-quarter reduction to provisional Transition Tax expense. The company said its Tax Act accounting remained subject to potential adjustment.
- ASC 606 adoption increased reported Q3 sales by $3.3m and net income by $2.0m versus the prior revenue guidance; nine-month increases were $9.6m and $5.9m, respectively. Prior periods were not restated.
- Semtech acquired ICI for approximately $7.3m in May. It also obtained control of TrackNet in Q3; approximately $8.5m of consideration was treated as contingent pending regulatory approval, which the company expected in Q4.
Outlook, risks and contingencies
For Q4 FY2019, management estimated net sales of $155m–$165m and gross margin of 61.2%–62.2%, based on recent bookings and backlog. It expected credit-facility interest rates to be relatively stable. Management stated that available financial resources were sufficient for business requirements over the next 12 months; the filing did not provide broader full-year earnings guidance.
- Sales concentration and demand: China represented 55% of Q3 sales; three customers each accounted for at least 10% of quarterly sales. Orders received and shipped in the same quarter were 37% of sales, versus 50% a year earlier, and many customer orders may be cancellable.
- Operating exposure: approximately 90% of Q3 sales were foreign, and the company relies on foreign suppliers and subcontractors. Management cited competition, demand volatility, product qualification and development risks, and potential effects of trade restrictions and tariffs.
- Market risks: a 100-basis-point increase in interest rates was estimated to reduce annual net income and cash flow by about $1.7m. A 10% adverse currency movement was estimated to reduce pretax income by $6.2m after balance-sheet hedges.
- Contingencies: environmental remediation at a former California facility had an estimated probable-loss range of $5.3m–$7.2m; $2.6m had been paid, and the company had accrued the range minimum. Management said outstanding legal matters were not expected to have a material aggregate effect, while noting litigation outcomes are uncertain.
- Other exposures include variable-rate debt, earn-outs dependent on business targets, tax audits and uncertain tax positions. The company reported no material change in its previously disclosed risk factors and no material off-balance-sheet arrangements.
Important facts for investors to verify
- Whether Q4 sales and gross-margin estimates were achieved, and how demand in China, LoRa and PON developed.
- Whether the $30.0m Multiphy impairment fully captures the investment’s loss and whether delayed 400G PAM4 adoption affects other plans.
- How much of reported earnings growth reflects operating performance versus tax benefits, earn-out fair-value changes, the HiLight settlement and the ended warrant offset.
- Progress on TrackNet regulatory approval, final acquisition accounting and the expected foreign-earnings repatriation and related tax effects.
- Use of cash for repurchases, acquisitions and debt repayment, alongside liquidity, covenant compliance and the environmental remediation estimate.