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IXYS CORP /DE/ - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) This discussion contains forward-looking statements, which are subject to certain risks and uncertainties, including, without limitation, those described elsewhere in this Form 10-Q and, in particular, in Item 1A of Part II hereof. Actual results may differ materially from the results discussed in the forward-looking statements. For a discussion of risks that could affect future results, see "Item 1A. Risk Factors." All forward-looking statements included in this document are made as of the date hereof, based on the information available to us as of the date hereof, and we assume no obligation to update any forward-looking statement, except as may be required by law. Overview We are a multi-market integrated semiconductor company. Our three principal product groups are: power semiconductors; integrated circuits, or ICs; and systems and radio frequency, or RF, power semiconductors. Our power semiconductors improve system efficiency and reliability by converting electricity at relatively high voltage and current levels into the finely regulated power required by electronic products. We focus on the market for power semiconductors that are capable of processing greater than 200 watts of power. We also design, manufacture and sell integrated circuits for a variety of applications. Our analog and mixed-signal ICs are principally used in telecommunications applications. Our mixed signal application-specific ICs, or ASICs, address the requirements of the medical imaging equipment and display markets. Our power management and control ICs are used in conjunction with our power semiconductors. Included among our ICs, our microcontrollers provide application-specific, embedded system-on-chip, or SoC, solutions for the industrial and consumer markets. Our systems include laser diode drivers, high voltage pulse generators and modulators, and high power subsystems, sometimes known as stacks, that are principally based on our high power semiconductor devices. Our RF power semiconductors enable circuitry that amplifies or receives radio frequencies in wireless and other microwave communication applications, medical imaging applications and defense and space applications. Over the past two quarters, our net revenues have decreased. Our revenues from sales of power semiconductors and ICs decreased, while our revenues from sales of RF power semiconductors and systems increased. Comparing the same periods, sales to major application markets decreased, except that sales to the industrial and commercial market fluctuated from quarter to quarter. Geographically, sales to the United States and Asia Pacific areas decreased while sales to Europe increased. From the quarter ended June 30, 2014 to the quarter ended September 30, 2014, gross profit margin increased slightly due to an improvement in production efficiency and a shift in product mix. The proportion of our revenues obtained through distribution decreased primarily because revenues shifted away from applications that are traditionally purchased through distributors, such as industrial and commercial applications. We expect our selling, general and administrative expenses, or SG&A expenses, and our research, development and engineering expenses, or R&D expenses, to remain relatively flat in the quarter ended December 31, 2014. Critical Accounting Policies and Significant Management Estimates The discussion and analysis of our financial condition and results of operations are based upon our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, management evaluates the reasonableness of its estimates. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. We believe the following critical accounting policies require that we make significant judgments and estimates in preparing our consolidated financial statements. Revenue recognition. Revenue is recognized when there is persuasive evidence that an arrangement exists, when delivery has occurred, when the price to the buyer is fixed or determinable and when collectability of the receivable is reasonably assured. These elements are met when title to the products is passed to the buyer, which is generally when product is shipped to the customer with sale terms ex-works, or EXW, or when product is delivered to the customer with sales terms delivered duty paid, or DDP. 19-------------------------------------------------------------------------------- Table of Contents We sell to distributors and original equipment manufacturers, or OEMs. Approximately 54.9% of our revenues in the six months ended September 30, 2014 and 56.9% of our net revenues in the six months ended September 30, 2013 were from distributors. We provide some of our distributors with the following programs: stock rotation and ship and debit. Reserves for sales returns and allowances, including allowances for so called "ship and debit" transactions, are recorded at the time of shipment, and are based on historical levels of returns and current economic trends and changes in customer demand. Accounts receivable from distributors are recognized and inventory is relieved when title to inventories transfer, typically upon shipment from us, at which point we have a legally enforceable right to collection under normal payment terms. Under certain circumstances, where we are not able to reasonably and reliably estimate the actual returns, revenues and costs relating to distributor sales are deferred until products are sold by the distributors to the distributors' end customers. Deferred amounts are presented net and included under "Accrued expenses and other liabilities." We state our revenues net of any taxes collected from customers that are required to be remitted to various government agencies. The amount of taxes collected from customers and payable to governmental entities is included under "Accrued expenses and other liabilities." Shipping and handling costs are included in cost of sales. Allowance for sales returns. We maintain an allowance for sales returns based on estimated product returns by our customers. We estimate our allowance for sales returns based on our historical return experience, current economic trends, changes in customer demand, known returns we have not received and other assumptions. If we were to make different judgments or utilize different estimates, the amount and timing of our revenue could be materially different. Given that our revenues consist of a high volume of relatively similar products, to date our actual returns and allowances have not fluctuated significantly from period to period, and our returns provisions have historically been reasonably accurate. This allowance is included as part of the accounts receivable allowance on the balance sheet and as a reduction of revenues in the statement of operations. Allowance for stock rotation. We also provide "stock rotation" to select distributors. The rotation allows distributors to return a percentage of the previous six months' sales in exchange for orders of an equal or greater amount. In the six months ended September 30, 2014 and 2013, approximately $1.1 million and $754,000, respectively, of products were returned to us under the program. We establish the allowance for sales to distributors except in cases where the revenue recognition is deferred and recognized upon sale by the distributor of products to the end-customer. The allowance, which is management's best estimate of future returns, is based upon the historical experience of returns and inventory levels at the distributors. This allowance is included as part of the accounts receivable allowance on the balance sheet and as a reduction of revenues in the statement of operations. Should distributors increase stock rotations beyond our estimates, our statements would be adversely affected. Allowance for ship and debit. Ship and debit is a program designed to assist distributors in meeting competitive prices in the marketplace on sales to their end-customers. Ship and debit requires a request from the distributor for a pricing adjustment for a specific part for a customer sale to be shipped from the distributor's stock. We have no obligation to accept this request. However, it is our historical practice to allow some companies to obtain pricing adjustments for inventory held. We receive periodic statements regarding our products held by our distributors. Ship and debit authorizations may cover current and future distributor activity for a specific part for sale to a distributor's customer. At the time we record sales to distributors, we provide an allowance for the estimated future distributor activity related to such sales since it is probable that such sales to distributors will result in ship and debit activity. The sales allowance requirement is based on sales during the period, credits issued to distributors, distributor inventory levels, historical trends, market conditions, pricing trends we see in our direct sales activity with original equipment manufacturers and other customers, and input from sales, marketing and other key management. We believe that the analysis of these inputs enables us to make reliable estimates of future credits under the ship and debit program. This analysis requires the exercise of significant judgments. Our actual results to date have approximated our estimates. At the time the distributor ships the part from stock, the distributor debits us for the authorized pricing adjustment. This allowance is included as part of the accounts receivable allowance on the balance sheet and as a reduction of revenues in the statement of operations. If competitive pricing were to decrease sharply and unexpectedly, our estimates might be insufficient, which could significantly adversely affect our operating results. 20-------------------------------------------------------------------------------- Table of Contents Additions to the ship and debit allowance are estimates of the amount of expected future ship and debit activity related to sales during the period. Additional allowances reduce revenues and gross profit in the period. The following table sets forth the beginning and ending balances of, additions to, and deductions from, our allowance for ship and debit during the six months ended September 30, 2014 (in thousands): (unaudited) Balance at March 31, 2014 $ 1,071 Additions 1,575 Deductions (1,474 ) Balance at June 30, 2014 1,172 Additions 1,316 Deductions (1,303 ) Balance at September 30, 2014 1,185 Allowance for doubtful accounts. We maintain an allowance for doubtful accounts for estimated losses from the inability of our customers to make required payments. We evaluate our allowance for doubtful accounts based on the aging of our accounts receivable, the financial condition of our customers and their payment history, our historical write-off experience and other assumptions. If we were to make different judgments of the financial condition of our customers or the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. This allowance is reported on the balance sheet as part of the accounts receivable allowance and is included on the statement of operations as part of selling, general and administrative expenses. This allowance is based on historical losses and management's estimates of future losses. Inventories.Inventories are recorded at the lower of standard cost, which approximates actual cost on a first-in-first-out basis, or market value. Our accounting for inventory costing is based on the applicable expenditure incurred, directly or indirectly, in bringing the inventory to its existing condition. Such expenditures include acquisition costs, production costs and other costs incurred to bring the inventory to its use. As it is impractical to track inventory from the time of purchase to the time of sale for the purpose of specifically identifying inventory cost, our inventory is, therefore, valued based on a standard cost, given that the materials purchased are identical and interchangeable at various production processes. We review our standard costs on an as-needed basis, but in any event at least once a year, and update them as appropriate to approximate actual costs. The authoritative guidance provided by FASB requires certain abnormal expenditures to be recognized as expenses in the current period instead of capitalized in inventory. It also requires that the amount of fixed production overhead allocated to inventory be based on the normal capacity of the production facilities. We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. The value of our inventories is dependent on our estimate of future demand as it relates to historical sales. If our projected demand is overestimated, we may be required to reduce the valuation of our inventories below cost. We regularly review inventory quantities on hand and record an estimated provision for excess inventory based primarily on our historical sales and expectations for future use. We also recognize a reserve based on known technological obsolescence, when appropriate. Actual demand and market conditions may be different from those projected by our management. This could have a material effect on our operating results and financial position. If we were to make different judgments or utilize different estimates, the amount and timing of our write-down of inventories could be materially different. For example, during the fourth quarter of fiscal 2009, we examined our inventory and as a consequence of the dramatic retrenchment in some of our markets, certain of our inventory that normally would not be considered excess was considered as such. Therefore, we booked additional charges of about $14.9 million to recognize this exposure. Excess inventory frequently remains saleable. When excess inventory is sold, it yields a gross profit margin of up to 100%. Sales of excess inventory have the effect of increasing the gross profit margin beyond that which would otherwise occur, because of previous write-downs. Once we have written down inventory below cost, we do not write it up when it is subsequently utilized, sold or scrapped. We do not physically segregate excess inventory nor do we assign unique tracking numbers to it in our accounting systems. Consequently, we cannot isolate the sales prices of excess inventory from the sales prices of non-excess inventory. Therefore, we are unable to report the amount of gross profit resulting from the sale of excess inventory or quantify the favorable impact of such gross profit on our gross profit margin. 21-------------------------------------------------------------------------------- Table of Contents The following table provides information on our excess and obsolete inventory reserve charged against inventory at cost (in thousands): (unaudited) Balance at March 31, 2014 $ 24,304 Utilization or sale (282 ) Scrap (1,401 ) Additional accrual 1,102 Foreign currency translation adjustments (20 ) Balance at June 30, 2014 23,703 Utilization or sale (622 ) Scrap (352 ) Additional accrual 1,514 Foreign currency translation adjustments (504 ) Balance at September 30, 2014 $ 23,739 The practical efficiencies of wafer fabrication require the manufacture of semiconductor wafers in minimum lot sizes. Often, when manufactured, we do not know whether or when all the semiconductors resulting from a lot of wafers will sell. With more than 10,000 different part numbers for semiconductors, excess inventory resulting from the manufacture of some of those semiconductors will be continual and ordinary. Because the cost of storage is minimal when compared to potential value and because our products do not quickly become obsolete, we expect to hold excess inventory for potential future sale. Consequently, we have no set time line for the utilization, sale or scrapping of excess inventory. In addition, our inventory is also being written down to the lower of cost or market or net realizable value. We review our inventory listing on a quarterly basis for an indication of losses being sustained for costs that exceed selling prices less direct costs to sell. When it is evident that our selling price is lower than current cost, inventory is marked down accordingly. At September 30, 2014, our lower of cost or market reserve was $402,000. Furthermore, we perform an annual inventory count and periodic cycle counts for specific parts that have a high turnover. We also periodically identify any inventory that is no longer usable and write it off. Valuation of Goodwill and Intangible Assets. Goodwill represents the excess of the purchase price over the estimated fair value of the net assets acquired. The costs of acquired intangible assets are recorded at fair value at acquisition. Intangible assets with finite lives are amortized using the straight-line method or accelerated method over their estimated useful lives and evaluated for impairment in accordance with the authoritative guidance provided by FASB. Goodwill and intangible assets with indefinite lives are carried at fair value and reviewed at least annually for an impairment charge during the quarter ending March 31, or more frequently if events and circumstances indicate that the asset might be impaired, in accordance with the authoritative guidance provided by FASB. We first assess qualitative factors to determine whether it is necessary to perform the two-step fair value-based impairment test described below. If we believe that, as a result of its qualitative assessment, it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. Under the quantitative approach, there are two steps in the determination of the impairment of goodwill. The first step compares the carrying amount of the net assets to the fair value of the reporting unit. The second step, if necessary, recognizes an impairment loss to the extent the carrying value of the reporting unit's net assets exceed the implied fair value of goodwill. An impairment loss would be recognized to the extent that the carrying amount exceeds the fair value of the reporting unit. We use the income approach, based on estimated future cash flows, to perform the quantitative goodwill impairment test when and if required. Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, discount rates and future economic and market conditions. Our estimates are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. By their nature, these assumptions would not reflect unanticipated events and circumstances that may occur. Due to the significant unobservable inputs inherent in discounted cash flow methodologies, this method is classified as Level 3 in the fair value hierarchy. We assess the recoverability of the finite-lived intangible assets by examining the occurrences of certain events or changes of circumstances that indicate that the carrying amounts may not be recoverable. After our initial assessment, if it is necessary, we perform the impairment test by determining whether the estimated undiscounted cash flows attributable to the assets in question are less than their carrying values. Impairment losses, if any, are measured as the amount by which the carrying values of the assets exceed their fair value and are recognized in operating results. If a useful life is determined to be shorter than originally estimated, we accelerate the rate of amortization and amortize the remaining carrying value over the new shorter useful life. 22-------------------------------------------------------------------------------- Table of Contents See Note 8, "Goodwill and Intangible Assets" for a further discussion of the impairment analysis of goodwill and the related charges recorded. Income tax. In preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our unaudited condensed consolidated balance sheets. We then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we establish a valuation allowance. A valuation allowance reduces our deferred tax assets to the amount that management estimates is more likely than not to be realized. In determining the amount of the valuation allowance, we consider income over recent years, estimated future taxable income, feasible tax planning strategies and other factors in each taxing jurisdiction in which we operate. If we determine that it is more likely than not that we will not realize all or a portion of our remaining deferred tax assets, then we will increase our valuation allowance with a charge to income tax expense. Conversely, if we determine that it is likely that we will ultimately be able to utilize all or a portion of the deferred tax assets for which a valuation allowance has been provided, then the related portion of the valuation allowance will reduce income tax expense. Significant management judgment is required in determining our provision for income taxes and potential tax exposures, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish a valuation allowance, which could materially impact our financial position and results of operations. Our ability to utilize our deferred tax assets and the need for a related valuation allowance are monitored on an ongoing basis. Furthermore, computation of our tax liabilities involves examining uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on the two-step process as prescribed by the authoritative guidance provided by FASB. The first step is to evaluate the tax position to determine whether there is sufficient available evidence to indicate if it is more likely than not that the position will be sustained on audit, including resolution of any related appeals or litigation processes. The second step requires us to measure and determine the approximate amount of the tax benefit at the largest amount that is more than 50% likely of being realized upon ultimate settlement with the tax authorities. It is inherently difficult and requires significant judgment to estimate such amounts, as this requires us to determine the probability of various possible outcomes. We reexamine these uncertain tax positions on a quarterly basis. This reassessment is based on various factors during the period including, but not limited to, changes in worldwide tax laws and treaties, changes in facts or circumstances, effectively settled issues under audit and any new audit activity. A change in recognition or measurement would result in the recognition of a tax benefit or an additional charge to the tax provision in the period. Recent Accounting Pronouncements For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our unaudited condensed consolidated financial statements, see Note 2, "Recent Accounting Pronouncements and Accounting Changes" in the Notes to Unaudited Condensed Consolidated Financial Statements of this Form 10-Q. 23-------------------------------------------------------------------------------- Table of Contents Results of Operations - Three and Six Months Ended September 30, 2014 and 2013 The following table sets forth selected consolidated statements of operations data for the fiscal periods indicated and the percentage change in such data from period to period. These historical operating results may not be indicative of the results for any future period. Three Months Ended Six Months Ended September 30, September 30, 2014 % change 2013 2014 % change 2013 (unaudited) (unaudited) (000) (000) (000) (000) Net revenues $ 86,435 0.6 $ 85,901 $ 174,515 11.1 $ 157,087 Cost of goods sold 60,265 3.9 58,000 123,345 14.2 108,049 Gross profit $ 26,170 (6.2 ) $ 27,901 $ 51,170 4.3 $ 49,038 Operating expenses: Research, development and engineering $ 6,948 (6.8 ) $ 7,453 $ 14,198 (6.2 ) $ 15,140 Selling, general and administrative 10,713 1.2 10,583 21,477 4.1 20,626 Amortization of acquired intangible assets 1,419 (58.6 ) 3,425 3,126 (14.8 ) 3,671 Total operating expenses $ 19,080 (11.1 ) $ 21,461 $ 38,801 (1.6 ) $ 39,437 The following table sets forth selected statements of operations data as a percentage of net revenues for the fiscal periods indicated. These historical operating results may not be indicative of the results for any future period. % of Net Revenues % of Net Revenues Three Months Ended Six Months Ended September 30, September 30, 2014 2013 2014 2013 (unaudited) (unaudited) Net revenues 100.0 100.0 100.0 100.0 Cost of goods sold 69.7 67.5 70.7 68.8 Gross profit 30.3 32.5 29.3 31.2 Operating expenses: Research, development and engineering 8.0 8.7 8.1 9.6 Selling, general and administrative 12.5 12.3 12.3 13.2 Amortization of acquired intangible assets 1.6 4.0 1.8 2.3 Total operating expenses 22.1 25.0 22.2 25.1 Operating income 8.2 7.5 7.1 6.1 Other income (expense), net 2.2 (2.0 ) 0.9 (1.2 ) Income before income tax 10.4 5.5 8.0 4.9 Provision for income tax (3.7 ) (1.6 ) (2.7 ) (1.5 ) Net income 6.7 3.9 5.3 3.4 24 -------------------------------------------------------------------------------- Table of Contents Net Revenues The following table sets forth the revenues for each of our product groups for the fiscal periods indicated: Revenues (1) Three Months Ended September 30, Six Months Ended September 30, 2014 % change 2013 2014 % change 2013 (unaudited) (unaudited) (000) (000) (000) (000) Power semiconductors $ 55,780 (6.6 ) $ 59,720 $ 113,748 2.1 $ 111,386 Integrated circuits 23,438 11.9 20,945 47,320 36.8 34,600 Systems and RF power semiconductors 7,217 37.8 5,236 13,447 21.1 11,101 Total $ 86,435 0.6 $ 85,901 $ 174,515 11.1 $ 157,087 (1) Revenue information includes intellectual property and consulting revenues that are not included in average selling prices. The following tables set forth the average selling prices, or ASPs, and units for the fiscal periods indicated: Average Selling Prices Three Months Ended September 30, Six Months Ended September 30, 2014 % change 2013 2014 % change 2013 (unaudited) (unaudited) Power semiconductors $ 2.15 9.1 $ 1.97 $ 2.15 16.2 $ 1.85 Integrated circuits $ 0.47 (7.8 ) $ 0.51 $ 0.47 (20.3 ) $ 0.59 Systems and RF power semiconductors $ 37.59 51.5 $ 24.82 $ 31.49 13.2 $ 27.82 Units Three Months Ended September 30, Six Months Ended September 30, 2014 % change 2013 2014 % change 2013 (unaudited) (unaudited) (000) (000) (000) (000) Power semiconductors 25,930 (14.5 ) 30,333 52,835 (12.1 ) 60,111 Integrated circuits 49,157 37.5 35,762 98,534 86.8 52,743 Systems and RF power semiconductors 192 (9.0 ) 211 427 7.0 399 Total 75,279 13.5 66,306 151,796 34.0 113,253 The following table sets forth the net revenue by geographic region for the fiscal periods indicated: Three Months Ended September 30, Six Months Ended September 30, 2014 2013 2014 2013 Net % of Net Net % of Net Net % of Net Net % of Net Revenue Revenue Revenue Revenue Revenue Revenue Revenue Revenue (unaudited) (unaudited) (000) (000) (000) (000) Europe and Middle East $ 26,930 31.1 $ 26,580 30.9 $ 53,155 30.5 $ 50,499 32.1 Asia Pacific 35,418 41.0 34,069 39.7 72,007 41.3 57,107 36.4 Rest of world 2,585 3.0 2,726 3.2 5,347 3.0 5,397 3.4 International revenues $ 64,933 75.1 $ 63,375 73.8 $ 130,509 74.8 $ 113,003 71.9 USA 21,502 24.9 22,526 26.2 44,006 25.2 44,084 28.1 Total revenues $ 86,435 100.0 $ 85,901 100.0 $ 174,515 100.0 $ 157,087 100.0 25 -------------------------------------------------------------------------------- Table of Contents The 0.6% increase in net revenues in the three months ended September 30, 2014 as compared to the three months ended September 30, 2013 reflected an increase of $2.5 million, or 11.9%, in the sale of ICs and an increase of $2.0 million, or 37.8%, in the sale of systems and RF power semiconductors, offset by a decrease of $3.9 million, or 6.6%, in the sale of power semiconductors. The decrease in power semiconductors was principally the result of a $2.5 million decrease in the sale of bipolar products, primarily in the industrial and commercial market, and a $1.6 million decrease in MOS products, principally in the medical market and the industrial and commercial market, offset by slight increases in other power products. The increase in revenues from the sale of ICs was driven by our Acquired MCU Business, which sells primarily to the consumer products market, and by increased sales of solid state relays, primarily to the telecommunications market, partially offset by reduced sales of ASICs. The revenues from the sale of systems and RF power semiconductors increased mainly due to growth in the sale of subassemblies to the industrial and commercial market. The 11.1% increase in net revenues in the six months ended September 30, 2014 as compared to the six months ended September 30, 2013 reflected an increase of $2.4 million, or 2.1%, in the sale of power semiconductors, an increase of $12.7 million, or 36.8%, in the sale of ICs and an increase of $2.3 million, or 21.1%, in the sale of systems and RF power semiconductors. The increase in power semiconductors included a $3.1 million increase in the sale of MOS products, principally to the medical market and the industrial and commercial market, offset by a $513,000 decrease in the sale of bipolar products, primarily in the industrial and commercial market. The increase in revenues from the sale of ICs was primarily from the Acquired MCU Business and increased sales of solid state relays, primarily to the telecommunications market, offset by decreased sales of ASICs. The revenues from the sale of systems and RF power semiconductors increased primarily due to a $2.7 million increase in the sale of subassemblies to the industrial and commercial market. For the three and six months ended September 30, 2014 as compared to the comparable periods of the previous fiscal year, the increases in ASPs in power semiconductors were due to shifts in product mix toward higher-priced products. The increases in ASPs in systems and RF power semiconductors were due to changes in product mix among subassemblies. The reductions in the ASPs of ICs were mainly due to shifts in our product mix among microcontrollers. For the three and six months ended September 30, 2014 as compared to the three and six months ended September 30, 2013, the decreases in unit shipments of our power semiconductors were broad-based across product lines. The increase in IC units was principally driven by the addition of the Acquired MCU Business. In systems and RF power semiconductors, for the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, the unit reduction was caused by lower shipments of RF power devices; for the six months ended September 30, 2014 as compared to the six months ended September 30, 2013, the unit growth was the result of higher shipments of RF power semiconductors. Intellectual property revenues, consisting of sales, licensing fees and royalties, for the three and six months ended September 30, 2014 were $306,000 and $674,000, respectively, as compared to $632,000 and $1.2 million for the three and six months ended September 30, 2013. For the three months ended September 30, 2014 as compared to the three months ended September 30, 2013, we experienced decreased sales to all of our major application markets except the consumer market. For the six months ended September 30, 2014 as compared to the six months ended September 30, 2013, sales to the consumer market and industrial and commercial market increased while sales to the medical and telecom markets declined. For the three and six months ended September 30, 2014 as compared to the three and six months ended September 30, 2013, our sales to Europe and the Middle East and the Asia Pacific Area increased and our sales to the United States decreased. For the three and six months ended September 30, 2014, a distributor accounted for 11.4% and 10.9% of our net revenues, respectively. For the six months ended September 30, 2013, this distributor accounted for 10.6% of our net revenues. For the three and six months ended September 30, 2013, another distributor accounted for 12.1% and 12.5% of our net revenues, respectively. Our net revenues were reduced by allowances for sales returns, stock rotations and ship and debit. See "Critical Accounting Policies and Significant Management Estimates" elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations. Gross Profit Gross profit margin decreased to 30.3% in the three months ended September 30, 2014 from 32.5% in the three months ended September 30, 2013. Gross profit margin fell to 29.3% in the six months ended September 30, 2014 from 31.2% in the six months ended September 30, 2013. For both the three and six months ended September 30, 2014 as compared to comparable periods of the prior fiscal year, the gross profit margins were negatively affected by lower utilization of certain facilities, offset by favorable changes in product mix towards higher-margin products. Further, during the prior year periods, the gross profit margin was positively affected by the impact of transitioning the Acquired MCU Business. 26 -------------------------------------------------------------------------------- Table of Contents Our gross profit and gross profit margin were positively affected by the sale of excess inventory, which had previously been written down. See "Critical Accounting Policies and Significant Management Estimates-Inventories" elsewhere in this Management's Discussion and Analysis of Financial Condition and Results of Operations. Research, Development and Engineering R&D expenses typically consist of internal engineering efforts for product design and development. As a percentage of net revenues, our R&D expenses for the three and six months ended September 30, 2014 were 8.0% and 8.1%, respectively, as compared to 8.7% and 9.6% for the three and six months ended September 30, 2013. For the three and six months ended September 30, 2014 as compared to the same periods of the prior year, the decreases in the percentages related to higher revenues as well as lower development expenses. Expressed in dollars, R&D expenses decreased primarily because of the completion of the development phase of a new manufacturing process. Selling, General and Administrative As a percentage of net revenues, our SG&A expenses for the three and six months ended September 30, 2014 were 12.5% and 12.3% as compared to 12.3% and 13.2% for the three and six months ended September 30, 2013. Expressed in dollars, SG&A expenses increased for the three and six months ended September 30, 2014 as compared to the same periods in the prior fiscal year due to increased selling expenses corresponding to increased revenues, partially offset by lower professional and consulting expenses. Amortization of Acquired Intangible Assets During the quarter ended June 30, 2013, we completed the acquisition of the Acquired MCU Business. As a result, we recorded $24.0 million of intangible assets. We also recorded certain intangible assets during fiscal 2010 in connection with the acquisition of Zilog. For the three and six months ended September 30, 2014, we recorded amortization expenses on acquired intangible assets of $1.4 million and $3.1 million, respectively. For the three and six months ended September 30, 2013, we recorded amortization expenses on acquired intangible assets of $3.4 million and $3.7 million, respectively. Interest Expense During the three and six months ended September 30, 2014, our interest expenses were $322,000 and $732,000, respectively, as compared to $480,000 and $693,000 for the three and six months ended September 30, 2013. The interest expenses during both fiscal years included the accrual of interest on the installment payments for the Acquired MCU Business. Other Income (Expense), net In the quarter ended September 30, 2014, other income, net was $2.2 million as compared to other expense, net of $1.3 million in the quarter ended September 30, 2013. The other income, net in the three months ended September 30, 2014 principally consisted of $2.1 million in gains associated with changes in exchange rates for foreign currency transactions. The other expense, net in the three months ended September 30, 2013 consisted principally of $1.3 million in losses associated with changes in exchange rates for foreign currency transactions. For the six months ended September 30, 2014, other income, net was $2.4 million, as compared to other expense, net of $1.3 million in the six months ended September 30, 2013. For the six months ended September 30, 2014, other income, net consisted principally of $2.4 million in gains associated with changes in exchange rates for foreign currency transactions. For the six months ended September 30, 2013, other expense, net included losses associated with changes in exchange rates for foreign currency transactions of $1.5 million. Provision for Income Tax For the three and six months ended September 30, 2014, we recorded income tax provisions of $3.2 million and $4.8 million, reflecting effective tax rates of 36.0% and 33.9%, respectively. For the three and six months ended September 30, 2013, we recorded income tax provisions of $1.4 million and $2.3 million, reflecting effective tax rates of 28.7% and 29.9%, respectively. For the three and six months ended September 30, 2014, the effective tax rates were affected by changes in estimates of annual income in domestic and foreign jurisdictions. For the three and six months ended September 30, 2013, the effective tax rates were affected by changes in estimates of annual income in domestic and foreign jurisdictions and certain discrete items. 27-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources At September 30, 2014, cash and cash equivalents were $124.9 million as compared to $98.4 million at March 31, 2014. Our cash provided by operating activities for the six months ended September 30, 2014 was $22.7 million, an increase of $11.4 million as compared to the $11.3 million of cash provided by operating activities in the comparable period of the prior year. The change in our operating cash flow was primarily due to an increase of $7.6 million in net changes in operating assets and liabilities and an increase of $3.8 million in net income and adjustments to reconcile net income. The increase in net income and total adjustments to reconcile net income was principally caused by the growth in net revenues. The changes in operating assets and liabilities for the six months ended September 30, 2014 compared to the six months ended September 30, 2013 were primarily caused by the following: accounts receivable changed in large part because of differences in the timing of recognition of revenues, accounts payable decreased due to the timing of payments; prepaid expenses and other current assets decreased due to the timing of a tax refund; and inventory purchases increased to meet our production plans. Our net cash used in investing activities for the six months ended September 30, 2014 was $7.2 million, as compared to net cash used in investing activities of $23.6 million during the six months ended September 30, 2013. During the six months ended September 30, 2014, our uses of cash for investing activities principally reflected capital expenditures of $4.6 million and an acquisition of $2.3 million. During the six months ended September 30, 2013, we made a payment of $20.0 million for the Acquired MCU Business and we spent $3.9 million on the purchase of property and equipment. For the six months ended September 30, 2014, net cash provided by financing activities was $12.4 million as compared to net cash used in financing activities of $1.8 million in the six months ended September 30, 2013. During the six months ended September 30, 2014, we drew an additional $30.0 million from the line of credit with BOTW and we paid the first $15.0 million deferred payment for the Acquired MCU Business. In addition, we used $2.0 million for payments of cash dividends to stockholders and $2.0 million for principal repayments on capital lease and loan obligations, offset by proceeds from employee equity plans of $1.4 million. During the six months ended September 30, 2013, we used $1.9 million for dividends, $1.7 million for principal repayments on capital lease and loan obligations and $433,000 for the purchase of treasury stock, offset by proceeds from employee equity plans of $2.2 million. At September 30, 2014, capital lease obligations, loans payable and the remaining installment payment totalled $67.8 million. This represented 54.3% of our cash and cash equivalents and 25.0% of our stockholders' equity. We are obligated on a €3.8 million, or $4.9 million, loan. The loan has a term ending in June 2020, and bears a variable interest rate, dependent upon the current Euribor rate and the ratio of indebtedness to cash flow for the German subsidiary. Each fiscal quarter a principal payment of €167,000, or about $212,000, and a payment of accrued interest are required. Financial covenants for a ratio of indebtedness to cash flow, a ratio of equity to total assets and a minimum stockholders' equity for the German subsidiary must be satisfied for the loan to remain in good standing. At September 30, 2014, we complied with all of these financial covenants. The loan may be prepaid in whole or in part at the end of a fiscal quarter without penalty. The loan is collateralized by a security interest in the facility in Lampertheim, Germany. On December 6, 2013, we entered into an Amended and Restated Credit Agreement with BOTW for a revolving line of credit of $50.0 million. All amounts owed under the credit agreement are due and payable on November 30, 2015. Borrowings may be repaid and re-borrowed during the term of the credit agreement. The obligations are guaranteed by two of our subsidiaries. At September 30, 2014, the outstanding principal under the credit agreement was $45.0 million. The credit agreement is subject to a set of financial covenants, including minimum total net worth, the ratio of cash, cash equivalents and accounts receivable to current liabilities, profitability, a leverage ratio and a minimum amount of U.S. domestic cash on hand. At September 30, 2014, we complied with all of these financial covenants. See Note 9, "Borrowing and Deferred Payment Arrangements" in the Notes to Unaudited Condensed Consolidated Financial Statements of this Form 10-Q for further information regarding the credit agreement. The credit agreement also includes a $3.0 million letter of credit subfacility. See Note 16, "Commitments and Contingencies" and Note 9, "Borrowing and Deferred Payment Arrangements" in the Notes to Unaudited Condensed Consolidated Financial Statements of this Form 10-Q for further information regarding the terms of our credit arrangements. During the six months ended September 30, 2014, we declared $2.0 million in cash dividends, consisting of a dividend of $0.03 per share for the quarter ended June 30, 2014 and a dividend of $0.035 per share for the quarter ended September 30, 2014. The quarterly dividend is at the discretion of the Board of Directors. On June 27, 2013, we purchased the Acquired MCU Business. The aggregate purchase price for the transferred assets was $50.0 million. The closing payment was $20.0 million and we were obligated to pay $30.0 million in two installment payments of $15.0 million each. The first installment was paid on June 26, 2014 and the second installment is due on December 31, 2014. The remaining installment payment bears simple interest at a variable annual rate equal to six-month LIBOR plus a 3 percentage point margin. We expect to fund the remaining installment payment through cash on hand and future cash flow generated from operations. See Note 9, "Borrowing and Deferred Payment Arrangements" in the Notes to Unaudited Condensed Consolidated Financial Statements of this Form 10-Q for further information regarding the terms of the installment payments. 28 -------------------------------------------------------------------------------- Table of Contents We assumed loans of approximately $723,000 related to an acquisition completed during the quarter ended June 30, 2014. The assumed borrowings were non-interest loans from government agencies to support the research and development activities with maturity dates varying from fiscal 2017 to fiscal 2021, other than a loan of $99,000 that we paid in full during the quarter ended September 30, 2014. Additionally, we maintain three defined benefit pension plans: one in the United Kingdom, one in Germany and one in the Philippines. Benefits are based on years of service and the employees' compensation. We either deposit funds for these plans with financial institutions, consistent with the requirements of local law, or accrue for the unfunded portion of the obligations. The United Kingdom and German plans have been curtailed. As such, the plans are closed to new entrants and no credit is provided for additional periods of service. The total pension liability accrued for the three plans at September 30, 2014 was $13.9 million. We believe that our cash and cash equivalents, together with cash generated from operations, will be sufficient to meet our anticipated cash requirements for the next 12 months. Our liquidity could be negatively affected by a decline in demand for our products, increases in the cost of materials or labor, investments in new product development or one or more acquisitions. From time to time, we use derivative contracts in the normal course of business to manage our foreign currency exchange and interest rate risks. We did not have any significant open derivative contracts as of September 30, 2014. There can be no assurance that additional debt or equity financing will be available when required or, if available, can be secured on terms satisfactory to us. 29-------------------------------------------------------------------------------- Table of Contents |