Semtech Corporation — Form 10-Q Summary
Reporting period: Quarter ended July 29, 2018 (fiscal 2019 second quarter; 13 weeks), with six-month results compared with the six months ended July 30, 2017. Amounts are in U.S. dollars.
Business context and results
Semtech designs and sells analog and mixed-signal semiconductors and advanced algorithms. It reported one segment, the Semiconductor Products Group, comprising Signal Integrity, Protection, and Wireless and Sensing products. Management cited continued China-based demand, particularly for LoRa products, as a source of second-quarter growth. The company reorganized its operating segments in the first quarter, combining Power and High Reliability with Wireless and Sensing.
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Net sales | $163.2m | $153.1m | $293.6m | $296.9m |
| Gross profit / margin | $100.1m / 61.3% | $92.2m / 60.2% | $171.6m / 58.4% | $177.2m / 59.7% |
| Operating income / margin | $32.9m / 20.1% | $18.9m / 12.3% | $29.8m / 10.2% | $37.1m / 12.5% |
| Net income | $25.2m | $12.6m | $37.6m | $24.4m |
| Diluted EPS | $0.37 | $0.19 | $0.55 | $0.36 |
Cash flow, debt and liquidity
- Six-month operating cash flow was $84.4m, versus $46.0m in the prior-year period. Capital expenditures were $9.8m, versus $19.0m; operating cash flow less capital expenditures was approximately $74.5m, a calculated measure.
- Investing cash outflow was $21.1m and financing cash outflow was $59.8m. Financing included $49.7m of share repurchases and $7.5m of term-loan repayments. Cash increased $3.4m to $311.3m.
- At July 29, cash and cash equivalents were $311.3m; principal debt was $220.8m, with a net carrying value of approximately $219.3m. The weighted-average interest rate was 3.73%. The company had $153.0m of unused revolving credit capacity and reported compliance with its financial covenants.
- Foreign subsidiaries held $268.8m of cash. Management said it expects to remit approximately $240m of foreign earnings in the foreseeable future; $439.3m of unremitted foreign earnings had no taxes provided because they were expected to remain permanently reinvested.
Material changes and unusual items
- Second-quarter sales rose 7% year over year. Six-month sales declined 1.1%, reflecting lower China mobile sales and a $15.9m incremental sales offset from accelerated vesting of the Comcast warrant, partly offset by LoRa growth.
- The warrant-related sales offset totaled $21.5m for the first six months, including the $15.9m acceleration charge in Q1. The warrant is fully vested; no further warrant costs were expected after Q1. Its absence from Q2 helped reported quarterly sales and gross margin comparisons.
- Q2 SG&A included a $6.6m expense reduction from proceeds related to a HiLight Semiconductor lawsuit settlement. Semtech announced on August 1, 2018 that it would receive approximately $9.0m for damages, costs, and attorneys’ fees.
- Six-month results included a $15.8m first-quarter tax benefit from a partial release of the valuation allowance on U.S. deferred tax assets. This contributed to a $11.4m income tax benefit for the six months, compared with a $7.9m provision in the prior-year period. Q2 itself had a $6.1m tax provision and a 19.5% effective tax rate.
- Semtech adopted ASC 606 in fiscal 2019. The adoption increased Q2 sales by $1.9m and net income by $1.2m, and six-month sales by $6.3m and net income by $3.9m, versus prior revenue accounting; comparative periods were not restated. Opening retained earnings increased $11.1m net.
- The May 2018 acquisition of IC Interconnect cost approximately $7.3m, primarily supporting next-generation Z-Pak research and development. The purchase-price allocation remained under assessment.
Outlook, risks and contingencies
- Management forecast third-quarter FY2019 net sales of $168m–$178m and gross margin of 61%–62%, based on bookings trends and opening backlog. It expected credit-facility interest rates to remain relatively stable in Q3 and said it had resources to meet requirements for the next 12 months.
- Sales are concentrated geographically: China, including Hong Kong, accounted for 56% of Q2 sales; Asia-Pacific represented 75%. Foreign sales were approximately 90% of Q2 revenue. Arrow Electronics and Trend-tek accounted for 10% and 13% of Q2 sales, respectively.
- Key disclosed risks include demand and semiconductor-cycle volatility, customer and distributor concentration, dependence on foreign suppliers and subcontractors, pricing pressure, product qualification and development risks, foreign exchange exposure, tariffs and trade restrictions, and the ability to service debt and comply with credit covenants.
- The company accrued the minimum of a $3.6m–$7.2m estimated probable loss range for remediation at a former California facility; it could not identify a best estimate within the range. Management said current legal matters were not expected to have a material adverse effect overall, while noting litigation outcomes are uncertain.
- Contingent earn-out liabilities totaled $26.2m at quarter-end, including amounts tied to Cycleo and AptoVision targets. Their valuation depends on projections and other unobservable assumptions and may change materially.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It said risk factors had not materially changed from the latest Form 10-K.
Important facts for investors to verify
- How Q3 sales and margin performance compare with management’s $168m–$178m sales and 61%–62% gross-margin outlook, particularly given China and LoRa demand.
- The underlying trend in sales and margins after separating the Comcast warrant accounting, ASC 606 adoption effects, and the HiLight settlement benefit.
- The durability of the six-month earnings improvement, including the $15.8m tax benefit and the unusual share-based compensation and warrant effects.
- China, customer, and supplier concentration, and the potential effects of trade restrictions, tariffs, or demand changes.
- Use of cash for repurchases versus investment and debt reduction; remaining repurchase authorization was $247.3m.
- Potential changes in the environmental remediation estimate, earn-out liabilities, and tax reserves or foreign-earnings tax treatment.