Silicon Laboratories Inc.
SILICON LABORATORIES INC (Form: 10-Q, Received: 07/26/2017 09:35:18)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended July 1, 2017

 

or

 

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to    

 

Commission file number:  000-29823

 

SILICON LABORATORIES INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

74-2793174

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

400 West Cesar Chavez, Austin, Texas

 

78701

(Address of principal executive offices)

 

(Zip Code)

 

(512) 416-8500

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   x  Yes  o  No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   þ  Yes  ¨  No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting company o

 

 

Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   o Yes x No

 

As of July 18, 2017, 42,546,889 shares of common stock of Silicon Laboratories Inc. were outstanding.

 

 

 



Table of Contents

 

Table of Co ntents

 

 

 

Page
Number

Part I. Financial Information

 

 

 

 

Item 1.

Financial Statements (Unaudited):

 

 

Condensed Consolidated Balance Sheets at July 1, 2017 and December 31, 2016

3

 

 

 

 

Condensed Consolidated Statements of Income for the three and six months ended July 1, 2017 and July 2, 2016

4

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income for the three and six months ended July 1, 2017 and July 2, 2016

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2017 and July 2, 2016

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

34

 

 

 

Item 4.

Controls and Procedures

34

 

 

 

Part II. Other Information

 

 

 

 

Item 1.

Legal Proceedings

34

 

 

 

Item 1A.

Risk Factors

35

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

 

Item 3.

Defaults Upon Senior Securities

49

 

 

 

Item 4.

Mine Safety Disclosures

49

 

 

 

Item 5.

Other Information

49

 

 

 

Item 6.

Exhibits

50

 

Cautionary Statement

 

Except for the historical financial information contained herein, the matters discussed in this report on Form 10-Q (as well as documents incorporated herein by reference) may be considered “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include declarations regarding the intent, belief or current expectations of Silicon Laboratories Inc. and its management and may be signified by the words “believe,” “estimate,” “expect,” “intend,” “anticipate,” “plan,” “project,” “will” or similar language. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties. Actual results could differ materially from those indicated by such forward-looking statements. Factors that could cause or contribute to such differences include those discussed under “Risk Factors” and elsewhere in this report. Silicon Laboratories disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

2



Table of Contents

 

Part I.  Financial Information

Item 1.  Financial Statements

 

Silicon Laboratories Inc.

Condensed Consolidated Balance Sheets

(In thousands, except per share data)

(Unaudited)

 

 

 

July 1,
2017

 

December 31,
2016

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

210,615

 

$

141,106

 

Short-term investments

 

451,114

 

153,961

 

Accounts receivable, net

 

75,488

 

74,401

 

Inventories

 

67,427

 

59,578

 

Prepaid expenses and other current assets

 

46,862

 

61,805

 

Total current assets

 

851,506

 

490,851

 

Long-term investments

 

5,379

 

5,196

 

Property and equipment, net

 

130,909

 

129,559

 

Goodwill

 

288,629

 

276,130

 

Other intangible assets, net

 

96,819

 

103,565

 

Other assets, net

 

61,085

 

76,543

 

Total assets

 

$

1,434,327

 

$

1,081,844

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

39,989

 

$

39,577

 

Accrued expenses

 

50,797

 

50,100

 

Deferred income on shipments to distributors

 

48,914

 

45,568

 

Income taxes

 

3,543

 

4,450

 

Total current liabilities

 

143,243

 

139,695

 

Long-term debt

 

 

72,500

 

Convertible debt

 

335,639

 

 

Other non-current liabilities

 

43,240

 

42,691

 

Total liabilities

 

522,122

 

254,886

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock — $0.0001 par value; 10,000 shares authorized; no shares issued

 

 

 

Common stock — $0.0001 par value; 250,000 shares authorized; 42,539 and 41,889 shares issued and outstanding at July 1, 2017 and December 31, 2016, respectively

 

4

 

4

 

Additional paid-in capital

 

76,409

 

24,463

 

Retained earnings

 

836,210

 

801,999

 

Accumulated other comprehensive income (loss)

 

(418

)

492

 

Total stockholders’ equity

 

912,205

 

826,958

 

Total liabilities and stockholders’ equity

 

$

1,434,327

 

$

1,081,844

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

3



Table of Contents

 

Silicon Laboratories Inc.

Condensed Consolidated Statements of Income

(In thousands, except per share data)

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

July 1,
2017

 

July 2,
2016

 

Revenues

 

$

190,098

 

$

174,908

 

$

369,126

 

$

336,933

 

Cost of revenues

 

76,906

 

66,614

 

150,773

 

133,108

 

Gross margin

 

113,192

 

108,294

 

218,353

 

203,825

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

52,432

 

51,635

 

104,756

 

100,681

 

Selling, general and administrative

 

39,826

 

39,045

 

79,981

 

78,682

 

Operating expenses

 

92,258

 

90,680

 

184,737

 

179,363

 

Operating income

 

20,934

 

17,614

 

33,616

 

24,462

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income and other, net

 

1,595

 

296

 

2,171

 

176

 

Interest expense

 

(4,699

)

(641

)

(4,501

)

(1,296

)

Income before income taxes

 

17,830

 

17,269

 

31,286

 

23,342

 

Provision (benefit) for income taxes

 

1,261

 

1,710

 

(709

)

1,975

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

16,569

 

$

15,559

 

$

31,995

 

$

21,367

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.39

 

$

0.37

 

$

0.76

 

$

0.51

 

Diluted

 

$

0.38

 

$

0.37

 

$

0.74

 

$

0.51

 

 

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

42,478

 

41,775

 

42,287

 

41,702

 

Diluted

 

43,178

 

42,284

 

43,104

 

42,242

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

 

Silicon Laboratories Inc.

Condensed Consolidated Statements of Comprehensive Income

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

July 1,
2017

 

July 2,
2016

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

16,569

 

$

15,559

 

$

31,995

 

$

21,367

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), before tax

 

 

 

 

 

 

 

 

 

Net changes to available-for-sale securities

 

 

 

 

 

 

 

 

 

Unrealized gains (losses) arising during the period

 

163

 

198

 

408

 

(53

)

 

 

 

 

 

 

 

 

 

 

Net changes to cash flow hedges

 

 

 

 

 

 

 

 

 

Unrealized losses arising during the period

 

 

(126

)

 

(412

)

Reclassification for (gains) losses included in net income

 

 

61

 

(1,808

)

127

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss), before tax

 

163

 

133

 

(1,400

)

(338

)

 

 

 

 

 

 

 

 

 

 

Provision (benefit) for income taxes

 

57

 

47

 

(490

)

(118

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

106

 

86

 

(910

)

(220

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

16,675

 

$

15,645

 

$

31,085

 

$

21,147

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

5



Table of Contents

 

Silicon Laboratories Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Six Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

Operating Activities

 

 

 

 

 

Net income

 

$

31,995

 

$

21,367

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation of property and equipment

 

7,308

 

6,675

 

Amortization of other intangible assets and other assets

 

13,571

 

15,534

 

Amortization of debt discount and debt issuance costs

 

3,907

 

 

Stock-based compensation expense

 

21,652

 

20,861

 

Income tax shortfall from stock-based awards

 

 

(1,218

)

Deferred income taxes

 

(6,242

)

817

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(887

)

1,611

 

Inventories

 

(7,737

)

(2,888

)

Prepaid expenses and other assets

 

12,539

 

3,282

 

Accounts payable

 

2,363

 

(1,680

)

Accrued expenses

 

141

 

4,372

 

Deferred income on shipments to distributors

 

3,251

 

3,773

 

Income taxes

 

(127

)

(1,338

)

Other non-current liabilities

 

(1,169

)

(10,737

)

Net cash provided by operating activities

 

80,565

 

60,431

 

 

 

 

 

 

 

Investing Activities

 

 

 

 

 

Purchases of available-for-sale investments

 

(389,234

)

(92,222

)

Sales and maturities of available-for-sale investments

 

92,307

 

78,950

 

Purchases of property and equipment

 

(8,390

)

(5,146

)

Purchases of other assets

 

(1,784

)

(2,215

)

Acquisition of business, net of cash acquired

 

(13,658

)

 

Net cash used in investing activities

 

(320,759

)

(20,633

)

 

 

 

 

 

 

Financing Activities

 

 

 

 

 

Proceeds from issuance of long-term debt, net

 

389,468

 

 

Payments on debt

 

(72,500

)

(5,000

)

Repurchases of common stock

 

 

(36,103

)

Payment of taxes withheld for vested stock awards

 

(14,101

)

(9,308

)

Proceeds from the issuance of common stock

 

6,836

 

7,362

 

Payment of acquisition-related contingent consideration

 

 

(9,500

)

Net cash provided by (used in) financing activities

 

309,703

 

(52,549

)

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

69,509

 

(12,751

)

Cash and cash equivalents at beginning of period

 

141,106

 

114,085

 

Cash and cash equivalents at end of period

 

$

210,615

 

$

101,334

 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

6



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.  Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The Condensed Consolidated Financial Statements included herein are unaudited; however, they contain all normal recurring accruals and adjustments which, in the opinion of management, are necessary to present fairly the condensed consolidated financial position of Silicon Laboratories Inc. and its subsidiaries (collectively, the “Company”) at July 1, 2017 and December 31, 2016, the condensed consolidated results of its operations for the three and six months ended July 1, 2017 and July 2, 2016, the Condensed Consolidated Statements of Comprehensive Income for the three and six months ended July 1, 2017 and July 2, 2016, and the Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2017 and July 2, 2016. All intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated results of operations for the three and six months ended July 1, 2017 are not necessarily indicative of the results to be expected for the full year.

 

The accompanying unaudited Condensed Consolidated Financial Statements do not include certain footnotes and financial presentations normally required under U.S. generally accepted accounting principles (GAAP). Therefore, these Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto for the year ended December 31, 2016, included in the Company’s Form 10-K filed with the Securities and Exchange Commission (SEC) on February 1, 2017.

 

The Company prepares financial statements on a 52- or 53-week fiscal year that ends on the Saturday closest to December 31. Fiscal 2017 will have 52 weeks and fiscal 2016 had 52 weeks. In a 52-week year, each fiscal quarter consists of 13 weeks.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Among the significant estimates affecting the financial statements are those related to inventories, stock-based compensation, investments in auction-rate securities, acquired intangible assets, goodwill, long-lived assets and income taxes. Actual results could differ from those estimates, and such differences could be material to the financial statements.

 

Reclassifications

 

Certain reclassifications have been made to prior year financial statements to conform to current year presentation.

 

Revenue Recognition

 

Revenues are generated predominately by sales of the Company’s products. The Company recognizes revenue when all of the following criteria are met: 1) there is persuasive evidence that an arrangement exists, 2) delivery of goods has occurred, 3) the sales price is fixed or determinable, and 4) collectibility is reasonably assured. Generally, revenue from product sales to direct customers and contract manufacturers is recognized upon shipment.

 

A portion of the Company’s sales are made to distributors under agreements allowing certain rights of return and price protection related to the final selling price to the end customers. Accordingly, the Company defers revenue and cost of revenue on such sales until the distributors sell the product to the end customers. The net balance of deferred revenue less deferred cost of revenue associated with inventory shipped to a distributor but not yet sold to an end customer is recorded in the deferred income on shipments to distributors liability on the Consolidated Balance Sheet. Such net deferred income balance reflects the Company’s estimate of the impact of rights of return and price protection.

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

A small portion of the Company’s revenues is derived from the sale of patents. The above revenue recognition criteria for patent sales are generally met upon the execution of the patent sale agreement.

 

Recent Accounting Pronouncements

 

In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-03 , Accounting Changes and Error Corrections (Topic 250) and Investments—Equity Method and Joint Ventures (Topic 323). This ASU amends the disclosure requirements for ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) , ASU No. 2016-02, Leases (Topic 842) and ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments . This ASU states that if a registrant does not know or cannot reasonably estimate the impact that the adoption of the above ASUs is expected to have on the financial statements, then in addition to making a statement to that effect, the registrant should consider additional qualitative financial statement disclosures to assist the reader in assessing the significance of the impact that the standard will have on the financial statements of the registrant when adopted. This ASU was effective upon issuance. The Company adopted this ASU and added qualitative financial statement disclosures as necessary.

 

In January 2017, the FASB issued ASU No. 2017-04 , Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This ASU eliminates Step 2 from the goodwill impairment test. Instead, an entity should recognize an impairment charge for the amount by which the carrying value exceeds the reporting unit’s fair value, not to exceed the total amount of goodwill allocated to that reporting unit. This ASU is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. The Company is currently evaluating the effect that the adoption of this ASU will have on its financial statements.

 

In January 2017, the FASB issued ASU No. 2017-01 , Business Combinations (Topic 805): Clarifying the Definition of a Business. This ASU clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This ASU is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. The Company is currently evaluating the effect that the adoption of this ASU will have on its financial statements.

 

In August 2016, the FASB issued ASU No. 2016-16,  Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. This ASU requires the recognition of the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The amendments in this ASU should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company early adopted this ASU on January 1, 2017. The adoption did not have a material impact on its financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments . This ASU provides guidance on statement of cash flows presentation for eight specific cash flow issues where diversity in practice exists. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company is currently evaluating the effect of the adoption of this ASU, but anticipates that the adoption will not have a material impact on its financial statements.

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic326): Measurement of Credit Losses on Financial Instruments. This ASU requires instruments measured at amortized cost to be presented at the net amount expected to be collected. Entities are also required to record allowances for available-for-sale debt securities rather than reduce the carrying amount. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the effect of the adoption of this ASU, but anticipates that the adoption will not have a material impact on its financial statements.

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The Company adopted this ASU on January 1, 2017. Amendments related to the classification of excess tax benefits on the statement of cash flows were applied prospectively. Prior periods have not been adjusted. In connection with its adoption of ASU 2016-09, the Company has recorded excess tax benefits of $3.9 million through the six months ended July 1, 2017. The adoption had no other material impact on the Company’s financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) . The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. For operating leases, a lessee is required to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is evaluating the effect that the adoption of this ASU will have on its financial statements. The Company currently expects that most of its operating lease commitments will be subject to the new standard and recognized as right-of-use assets and operating lease liabilities upon the adoption of ASU 2016-02, which will increase the total assets and total liabilities that it reports relative to such amounts prior to adoption.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is currently evaluating the effect of the adoption of this ASU, but anticipates that the adoption will not have a material impact on its financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09 , Revenue from Contracts with Customers (Topic 606) , which supersedes the revenue recognition requirements in Accounting Standards Codification (ASC) 605, Revenue Recognition . The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides a five-step process to achieve that core principle. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date , which deferred the effective date of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. In 2016, the FASB issued the following amendments to ASC 606: ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) , which clarifies the implementation guidance on principal versus agent considerations; ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies guidance on identification of performance obligations and licensing implementation; ASU No. 2016-12, Compensation—Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients , which provides clarifying guidance on assessing collectibility, presentation of sales taxes, noncash consideration, contract modifications and completed contracts; and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers , which clarifies narrow aspects of ASC 606 or corrects unintended application of the guidance. The standard may be applied retrospectively to each prior period presented (full retrospective method) or retrospectively with the cumulative effect recognized as of the date of initial application (modified retrospective method). Under the new standard, the Company expects the timing of revenue recognition from sales to distributors to be accelerated. The Company will recognize revenue at the time of sale to the distributor, net of the impact of estimated price adjustments and rights of return. The Company currently anticipates adopting this standard using the modified retrospective method. Under this method, incremental disclosures will be provided to present each financial statement line item for fiscal 2018 under the prior standard. The Company has completed an initial assessment of the new standard and is continuing to evaluate the effect that the adoption will have on its financial statements.

 

9



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

2. Earnings Per Share

 

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

July 1,
2017

 

July 2,
2016

 

Net income

 

$

16,569

 

$

15,559

 

$

31,995

 

$

21,367

 

 

 

 

 

 

 

 

 

 

 

Shares used in computing basic earnings per share

 

42,478

 

41,775

 

42,287

 

41,702

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and other stock-based awards

 

700

 

509

 

817

 

540

 

Shares used in computing diluted earnings per share

 

43,178

 

42,284

 

43,104

 

42,242

 

 

 

 

 

 

 

 

 

 

 

Earnings per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.39

 

$

0.37

 

$

0.76

 

$

0.51

 

Diluted

 

$

0.38

 

$

0.37

 

$

0.74

 

$

0.51

 

 

For the three months ended July 1, 2017 and July 2, 2016 and the six months ended July 1, 2017 and July 2, 2016, approximately 0.0 million, 0.2 million, 0.0 million and 0.3 million shares, respectively, consisting of restricted stock units (RSUs), market stock units (MSUs) and stock options, were not included in the diluted earnings per share calculation since the shares were anti-dilutive.

 

The Company intends to settle the principal amount of its convertible senior notes in cash and any excess value in shares in the event of a conversion. Accordingly, shares issuable upon conversion of the principal amount have been excluded from the calculation of diluted earnings per share. If the market value of the notes under certain prescribed conditions exceeds the conversion amount, the excess will be included in the denominator for the computation of diluted earnings per share using the treasury stock method. As of July 1, 2017, no such shares were included in the denominator for the calculation of diluted earnings per share.

 

3. Fair Value of Financial Instruments

 

The fair values of the Company’s financial instruments are recorded using a hierarchical disclosure framework based upon the level of subjectivity of the inputs used in measuring assets and liabilities. The three levels are described below:

 

Level 1 - Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

Level 2 - Inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

 

Level 3 - Inputs are unobservable for the asset or liability and are developed based on the best information available in the circumstances, which might include the Company’s own data.

 

10



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The following summarizes the valuation of the Company’s financial instruments (in thousands). The tables do not include either cash on hand or assets and liabilities that are measured at historical cost or any basis other than fair value.

 

 

 

Fair Value Measurements
at July 1, 2017 Using

 

 

 

Description

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

78,006

 

$

 

$

 

$

78,006

 

Corporate debt securities

 

 

31,827

 

 

31,827

 

Government debt securities

 

 

1,496

 

 

1,496

 

Total cash equivalents

 

$

78,006

 

$

33,323

 

$

 

$

111,329

 

 

 

 

 

 

 

 

 

 

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Government debt securities

 

$

60,769

 

$

215,086

 

$

 

$

275,855

 

Corporate debt securities

 

 

175,259

 

 

175,259

 

Total short-term investments

 

$

60,769

 

$

390,345

 

$

 

$

451,114

 

 

 

 

 

 

 

 

 

 

 

Long-term investments:

 

 

 

 

 

 

 

 

 

Auction rate securities

 

$

 

$

 

$

5,379

 

$

5,379

 

Total long-term investments

 

$

 

$

 

$

5,379

 

$

5,379

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

138,775

 

$

423,668

 

$

5,379

 

$

567,822

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Other non-current liabilities:

 

 

 

 

 

 

 

 

 

Contingent consideration

 

$

 

$

 

$

3,993

 

$

3,993

 

Total

 

$

 

$

 

$

3,993

 

$

3,993

 

 

11



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

 

 

Fair Value Measurements
at December 31, 2016 Using

 

 

 

Description

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 

Significant Other
Observable
Inputs
(Level 2)

 

Significant

Unobservable
Inputs
(Level 3)

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Cash equivalents:

 

 

 

 

 

 

 

 

 

Money market funds

 

$

69,432

 

$

 

$

 

$

69,432

 

Corporate debt securities

 

 

7,153

 

 

7,153

 

Government debt securities

 

 

3,904

 

 

3,904

 

Total cash equivalents

 

$

69,432

 

$

11,057

 

$

 

$

80,489

 

 

 

 

 

 

 

 

 

 

 

Short-term investments:

 

 

 

 

 

 

 

 

 

Government debt securities

 

$

12,416

 

$

97,103

 

$

 

$

109,519

 

Corporate debt securities

 

 

44,442

 

 

44,442

 

Total short-term investments

 

$

12,416

 

$

141,545

 

$

 

$

153,961

 

 

 

 

 

 

 

 

 

 

 

Long-term investments:

 

 

 

 

 

 

 

 

 

Auction rate securities

 

$

 

$

 

$

5,196

 

$

5,196

 

Total long-term investments

 

$

 

$

 

$

5,196

 

$

5,196

 

 

 

 

 

 

 

 

 

 

 

Other assets, net:

 

 

 

 

 

 

 

 

 

Derivative instruments

 

$

 

$

1,808

 

$

 

$

1,808

 

Total

 

$

 

$

1,808

 

$

 

$

1,808

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

81,848

 

$

154,410

 

$

5,196

 

$

241,454

 

 

Valuation methodology

 

The Company’s cash equivalents and short-term investments that are classified as Level 2 are valued using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments in active markets; or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Investments classified as Level 3 are valued using a discounted cash flow model. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, amount of cash flows, expected holding periods of the securities and a discount to reflect the Company’s inability to liquidate the securities. The Company’s derivative instruments are valued using discounted cash flow models. The assumptions used in preparing the valuation models include quoted interest swap rates, foreign exchange rates, forward and spot prices for currencies, and market observable data of similar instruments.

 

The Company’s contingent consideration is valued using a probability weighted discounted cash flow model. The assumptions used in preparing the discounted cash flow model include estimates for the outcome if the milestone goal is achieved, the probability of achieving each outcome and discount rates.

 

12



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Available-for-sale investments

 

The Company’s investments typically have original maturities greater than ninety days as of the date of purchase. Investments are reported at fair value, with unrealized gains and losses, net of tax, recorded as a component of accumulated other comprehensive income (loss) in the Consolidated Balance Sheet. The following summarizes the contractual underlying maturities of the Company’s available-for-sale investments at July 1, 2017 (in thousands):

 

 

 

Cost

 

Fair
Value

 

Due in one year or less

 

$

293,156

 

$

293,132

 

Due after one year through ten years

 

179,050

 

179,051

 

Due after ten years

 

96,260

 

95,639

 

 

 

$

568,466

 

$

567,822

 

 

The available-for-sale investments that were in a continuous unrealized loss position, aggregated by length of time that individual securities have been in a continuous loss position, were as follows (in thousands):

 

 

 

Less Than 12 Months

 

12 Months or Greater

 

Total

 

As of July 1, 2017

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized

Losses

 

Government debt securities

 

$

110,741

 

$

(97

)

$

 

$

 

$

110,741

 

$

(97

)

Corporate debt securities

 

84,486

 

(124

)

 

 

84,486

 

(124

)

Auction rate securities

 

 

 

5,379

 

(621

)

5,379

 

(621

)

 

 

$

195,227

 

$

(221

)

$

5,379

 

$

(621

)

$

200,606

 

$

(842

)

 

 

 

Less Than 12 Months

 

12 Months or Greater

 

Total

 

As of December 31, 2016

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Government debt securities

 

$

79,743

 

$

(156

)

$

 

$

 

$

79,743

 

$

(156

)

Corporate debt securities

 

21,737

 

(132

)

 

 

21,737

 

(132

)

Auction rate securities

 

 

 

5,196

 

(804

)

5,196

 

(804

)

 

 

$

101,480

 

$

(288

)

$

5,196

 

$

(804

)

$

106,676

 

$

(1,092

)

 

The gross unrealized losses as of July 1, 2017 and December 31, 2016 were due primarily to the illiquidity of the Company’s auction-rate securities and, to a lesser extent, to changes in market interest rates. The Company’s auction-rate securities have been illiquid since 2008 when auctions for the securities failed because sell orders exceeded buy orders. These securities have a contractual maturity date of 2046 at July 1, 2017. The Company is unable to predict if these funds will become available before their maturity date.

 

The Company does not expect to need access to the capital represented by any of its auction-rate securities prior to their maturities. The Company does not intend to sell, and believes it is not more likely than not that it will be required to sell, its auction-rate securities before their anticipated recovery in market value or final settlement at the underlying par value. The Company believes that the credit ratings and credit support of the security issuers indicate that they have the ability to settle the securities at par value. As such, the Company has determined that no other-than-temporary impairment losses existed as of July 1, 2017.

 

At July 1, 2017 and December 31, 2016, there were no material unrealized gains associated with the Company’s available-for-sale investments.

 

13



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Level 3 fair value measurements

 

The following summarizes quantitative information about Level 3 fair value measurements.

 

Auction rate securities

 

Fair Value at
July 1, 2017
(000s)

 

Valuation Technique

 

Unobservable Input

 

Weighted Average

 

$

5,379

 

Discounted cash flow

 

Estimated yield

 

0.88%

 

 

 

 

 

 

 

 

 

 

 

 

 

Expected holding period

 

10 years

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated discount rate

 

3.29%

 

 

The Company has followed an established internal control procedure used in valuing auction rate securities. The procedure involves the analysis of valuation techniques and evaluation of unobservable inputs commonly used by market participants to price similar instruments, and which have been demonstrated to provide reasonable estimates of prices obtained in actual market transactions. Outputs from the valuation process are assessed against various market sources when they are available, including marketplace quotes, recent trades of similar illiquid securities, benchmark indices and independent pricing services. The technique and unobservable input parameters may be recalibrated periodically to achieve an appropriate estimation of the fair value of the securities.

 

Significant changes in any of the unobservable inputs used in the fair value measurement of auction rate securities in isolation could result in a significantly lower or higher fair value measurement. An increase in expected yield would result in a higher fair value measurement, whereas an increase in expected holding period or estimated discount rate would result in a lower fair value measurement. Generally, a change in the assumptions used for expected holding period is accompanied by a directionally similar change in the assumptions used for estimated yield and discount rate.

 

Contingent consideration

 

Fair Value at
July 1, 2017
(000s)

 

Valuation Technique

 

Unobservable Input

 

Weighted Average

 

$

3,993

 

Discounted cash flow

 

Expected term

 

6 months

 

 

 

 

 

 

 

 

 

 

 

 

 

Estimated discount rate

 

12.0%

 

 

The Company has followed an established internal control procedure used in valuing contingent consideration. The valuation of contingent consideration for the Zentri acquisition is based on a discounted cash flow model. The fair value of this valuation is estimated on a quarterly basis through a collaborative effort by the Company’s sales, marketing and finance departments.

 

Significant changes in any of the unobservable inputs used in the fair value measurement of contingent consideration in isolation could result in a significantly lower or higher fair value. A change in projected revenue would be accompanied by a directionally similar change in fair value.

 

14



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The following summarizes the activity in Level 3 financial instruments for the three and six months ended July 1, 2017 (in thousands):

 

Assets

 

Auction Rate Securities

 

Three Months
Ended

 

Six Months
Ended

 

Beginning balance

 

$

5,257

 

$

5,196

 

Gain included in other comprehensive income (loss)

 

122

 

183

 

Balance at July 1, 2017

 

$

5,379

 

$

5,379

 

 

Liabilities

 

Contingent Consideration (1)

 

Three Months
Ended

 

Six Months
Ended

 

Beginning balance

 

$

3,829

 

$

 

Issues

 

 

3,829

 

Loss recognized in earnings

 

164

 

164

 

Balance at July 1, 2017

 

$

3,993

 

$

3,993

 

 

 

 

 

 

 

Net loss for the period included in earnings attributable to contingent consideration held at the end of the period:

 

$

(164

)

$

(164

)

 


(1)          In connection with the acquisition of Zentri, the Company recorded contingent consideration based upon the expected achievement of a milestone goal. Changes to the fair value of contingent consideration due to changes in assumptions used in preparing the valuation model are recorded in selling, general and administrative expenses in the Consolidated Statement of Income.

 

Fair values of other financial instruments

 

The Company’s debt is recorded at cost, but is measured at fair value for disclosure purposes. The fair value of the Company’s convertible senior notes is determined using observable market prices. The notes are traded in less active markets and are therefore classified as a Level 2 fair value measurement. The fair value of the convertible senior notes at July 1, 2017 was $414.8 million. The Company’s prior debt under the Credit Facility bore interest at the Eurodollar rate plus an applicable margin. Fair value was estimated based on Level 2 inputs, using a discounted cash flow analysis of future principal payments and projected interest based on current market rates. As of July 1, 2017 and December 31, 2016, the fair value of the Company’s debt under the Credit Facility was approximately $0.0 and $72.5 million, respectively.

 

The Company’s other financial instruments, including cash, accounts receivable and accounts payable, are recorded at amounts that approximate their fair values due to their short maturities.

 

4. Derivative Financial Instruments

 

The Company uses derivative financial instruments to manage certain exposures to the variability of interest rates and foreign currency exchange rates. The Company’s objective is to offset increases and decreases in expenses resulting from these exposures with gains and losses on the derivative contracts, thereby reducing volatility of earnings. The Company does not use derivative contracts for speculative or trading purposes. The Company recognizes derivatives, on a gross basis, in the Consolidated Balance Sheet at fair value. Cash flows from derivatives are classified according to the nature of the cash receipt or payment in the Consolidated Statement of Cash Flows.

 

15



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Interest Rate Swaps

 

The Company is exposed to interest rate fluctuations in the normal course of its business, including through its Credit Facility. The interest payments on the facility are calculated using a variable-rate of interest. The Company entered into an interest rate swap agreement with an original notional value of $72.5 million and, effectively, converted the Eurodollar portion of the variable-rate interest payments to fixed-rate interest payments through July 2020. The Company terminated the swap agreement on March 6, 2017 in connection with the payoff of its Credit Facility.

 

The Company’s interest rate swap agreement was designated and qualified as a cash flow hedge. The effective portion of the gain or loss on the interest rate swap was recorded in accumulated other comprehensive income (loss) as a separate component of stockholders’ equity and was subsequently recognized as interest expense in the Consolidated Statement of Income when the hedged exposure affected earnings. The termination of the swap agreement resulted in the reclassification of $1.8 million of unrealized gains that were previously recorded in accumulated other comprehensive income (loss) into earnings during the three months ended April 1, 2017. The Company did not discontinue any other cash flow hedges in any of the periods presented.

 

The Company’s derivative financial instrument in cash flow hedging relationships consisted of the following (in thousands):

 

 

 

 

 

Fair Value

 

 

 

Balance Sheet Location

 

July 1,
2017

 

December 31,

2016

 

Interest rate swap

 

Other assets, net

 

$

 

$

1,808

 

 

The before-tax effect of derivative instruments in cash flow hedging relationships was as follows (in thousands):

 

 

 

Gain (Loss) Recognized in
OCI on Derivatives
(Effective Portion)
during the:

 

 

 

Gain (Loss) Reclassified
from Accumulated
OCI into Income
(Effective Portion)
during the:

 

 

 

Three Months Ended

 

Location of Loss

 

Three Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

Reclassified into
Income

 

July 1,
2017

 

July 2,
2016

 

Interest rate swaps

 

$

 

$

(126

)

Interest expense

 

$

 

$

(61

)

 

 

 

Six Months Ended

 

 

 

Six Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

 

 

July 1,
2017

 

July 2,
2016

 

Interest rate swaps

 

$

 

$

(412

)

Interest expense

 

$

1,808

 

$

(127

)

 

Foreign Currency Forward Contracts

 

The Company uses foreign currency forward contracts to manage exposure to foreign exchange risk. These instruments are used to reduce the earnings impact that exchange rate fluctuations have on non-U.S. dollar balance sheet exposures. The Company recognizes gains and losses on the foreign currency forward contracts in interest income and other, net in the Consolidated Statement of Income in the same period as the remeasurement loss and gain of the related foreign currency denominated asset or liability. The Company does not apply hedge accounting to its foreign currency derivative instruments.

 

16



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

As of July 1, 2017 and July 2, 2016, the Company held one foreign currency forward contract denominated in Norwegian Krone with a notional value of $3.6 million and $4.7 million, respectively. The fair value of the contracts was not material as of July 1, 2017 or July 2, 2016. The contract held as of July 1, 2017 has a maturity date of September 28, 2017 and it was not designated as a hedging instrument.

 

The before-tax effect of derivative instruments not designated as hedging instruments was as follows (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

Gain (Loss) Recognized in Income

 

July 1,
2017

 

July 2,
2016

 

July 1,
2017

 

July 2,
2016

 

Location

 

Foreign currency forward contracts

 

$

(35

)

$

48

 

$

(129

)

$

(252

)

Interest income and other, net

 

 

5. Balance Sheet Details

 

The following shows the details of selected Condensed Consolidated Balance Sheet items (in thousands):

 

Inventories

 

 

 

July 1,
2017

 

December 31,
2016

 

Work in progress

 

$

47,053

 

$

40,755

 

Finished goods

 

20,374

 

18,823

 

 

 

$

67,427

 

$

59,578

 

 

6. Acquisitions

 

Zentri

 

On January 20, 2017, the Company acquired Zentri, Inc., a private company. Zentri is an innovator in low-power, cloud-connected Wi-Fi® technologies for the Internet of Things (IoT). The Company acquired Zentri for approximately $18.1 million, including initial cash consideration of approximately $14.3 million, and potential additional consideration with an estimated fair value of approximately $3.8 million at the date of acquisition. The amount of potential additional consideration is up to approximately $10.0 million based on fiscal 2017 revenue from certain Zentri products.

 

The purchase price was allocated as follows: intangible assets—$6.7 million; goodwill—$12.5 million; and other net liabilities—$1.1 million. T he goodwill is not deductible for tax purposes. The allocation of the purchase price is preliminary and subject to change, primarily for the finalization of income tax matters. Accordingly, adjustments may be made to the values of the assets acquired and liabilities assumed as additional information is obtained about the facts and circumstances that existed at the valuation date.

 

Pro forma information related to this acquisition has not been presented because it would not be materially different from amounts reported.

 

17



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

7.  Debt

 

1.375% Convertible Senior Notes

 

On March 6, 2017, the Company completed a private offering of $400 million principal amount convertible senior notes (the “Notes”). The Notes bear interest semi-annually at a rate of 1.375% per year and will mature on March 1, 2022, unless repurchased, redeemed or converted at an earlier date. The Company used $72.5 million of the proceeds to pay off the remaining balance of its Amended Credit Agreement.

 

The Notes are convertible at an initial conversion rate of 10.7744 shares of common stock per $1,000 principal amount of the Notes, which is equivalent to a conversion price of approximately $92.81 per share. The conversion rate is subject to adjustment under certain circumstances. Holders may convert the Notes under the following circumstances: during any calendar quarter after the calendar quarter ending on June 30, 2017 if the closing price of the Company’s common stock for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding calendar quarter is greater than or equal to 130% of the conversion price of the Notes; during the five business day period after any ten consecutive trading day period (the “measurement period”) in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the closing sale price of our common stock and the conversion rate on each such trading day; if specified distributions or corporate events occur; if the Notes are called for redemption; or at any time after December 1, 2021. The Company may redeem all or any portion of the Notes, at its option, on or after March 6, 2020, if the last reported sale price of the Company’s common stock has been at least 130% of the conversion price then in effect for at least 20 trading days during any 30 consecutive trading day period. Upon conversion, the Notes may be settled in cash, shares of the Company’s common stock or a combination of cash and shares, at the Company’s election.

 

The principal balance of the Notes was separated into liability and equity components, and was recorded initially at fair value. The excess of the principal amount of the liability component over its carrying amount represents the debt discount, which is amortized to interest expense over the term of the Notes using the effective interest method. The carrying amount of the liability component was estimated by discounting the contractual cash flows of similar non-convertible debt at an appropriate market rate at the date of issuance.

 

The Company incurred debt issuance costs of approximately $10.6 million, which was allocated to the liability and equity components in proportion to the allocation of the proceeds. The costs allocated to the liability component are being amortized as interest expense over the term of the Notes using the effective interest method.

 

The carrying amount of the Notes consisted of the following (in thousands):

 

 

 

July 1,
2017

 

Liability component

 

 

 

Principal

 

$

400,000

 

Unamortized debt discount

 

(55,921

)

Unamortized debt issuance costs

 

(8,440

)

Net carrying amount

 

$

335,639

 

 

 

 

 

Equity component

 

 

 

Net carrying amount

 

$

57,735

 

 

The liability component of the Notes is recorded in long-term debt on the Consolidated Balance Sheet. The equity component of the Notes is recorded in additional paid-in capital. The effective interest rate for the liability component was 4.75%. As of July 1, 2017, the remaining period over which the debt discount and debt issuance costs will be amortized was 4.7 years.

 

18



Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Interest expense related to the Notes was comprised of the following (in thousands):

 

 

 

Three Months
Ended

 

Six Months
Ended

 

 

 

July 1,
2017

 

July 1,
2017

 

Contractual interest expense

 

$

1,375

 

$

1,757

 

Amortization of debt discount

 

2,640

 

3,395

 

Amortization of debt issuance costs

 

398

 

512

 

 

 

$

4,413

 

$

5,664

 

 

Amended Credit Agreement

 

On July 31, 2012, the Company and certain of its domestic subsidiaries (the “Guarantors”) entered into a $230 million five-year Credit Agreement (the “Credit Agreement”), which consisted of a $100 million Term Loan Facility and a $130 million Revolving Credit Facility. On July 24, 2015, the Company and the Guarantors amended the Credit Agreement (the “Amended Credit Agreement”) in order to, among other things, increase the borrowing capacity under the Revolving Credit Facility to $300 million (the “Credit Facility”), eliminate the Term Loan Facility and extend the maturity date to five years from the closing date. On July 24, 2015, the Company borrowed $82.5 million under the Amended Credit Agreement and paid off the remaining balance of its Term Loan Facility. In connection with the Company’s offering of the Notes, it entered into a second amendment to the Credit Agreement (the “Second Amended Credit Agreement”) and paid off the remaining balance of $72.5 million.

 

The Second Amended Credit Agreement retained the key terms and provisions of the first Amended Credit Agreement, including a $25 million letter of credit sublimit and a $10 million swingline loan sublimit. The Company also has an option to increase the size of the borrowing capacity by up to an aggregate of $200 million in additional commitments, subject to certain conditions.

 

The Revolving Credit Facility, other than swingline loans, will bear interest at the Eurodollar rate plus an applicable margin or, at the option of the Company, a base rate (defined as the highest of the Wells Fargo prime rate, the Federal Funds rate plus 0.50% and the Eurodollar Base Rate plus 1.00%) plus an applicable margin. Swingline loans accrue interest at the base rate plus the applicable margin for base rate loans. The applicable margins for the Eurodollar rate loans range from 1.25% to 2.00% and for base rate loans range from 0.25% to 1.00%, depending in each case, on the leverage ratio as defined in the Agreement.

 

The Second Amended Credit Agreement contains various conditions, covenants and representations with which the Company must be in compliance in order to borrow funds and to avoid an event of default, including financial covenants that the Company must maintain a leverage ratio (funded debt/EBITDA) of no more than 3.00 to 1 and a minimum fixed charge coverage ratio (EBITDA/interest payments, income taxes and capital expenditures) of no less than 1.25 to 1. As of July 1, 2017, the Company was in compliance with all covenants of the Second Amended Credit Agreement . The Company’s obligations under the Second Amended Credit Agreement are guaranteed by the Guarantors and are secured by a security interest in substantially all assets of the Company and the Guarantors.

 

8. Stockholders’ Equity

 

Common Stock

 

The Company issued 0.6 million shares of common stock during the six months ended July 1, 2017.

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

Share Repurchase Programs

 

The Board of Directors authorized the following share repurchase programs (in thousands):

 

Program 
Authorization Date

 

Program
Termination Date

 

Program
Amount

 

January 2017

 

December 2017

 

$

100,000

 

August 2015

 

December 2016

 

$

100,000

 

 

These programs allow for repurchases to be made in the open market or in private transactions, including structured or accelerated transactions, subject to applicable legal requirements and market conditions. The Company did not repurchase any shares of its common stock during the six months ended July 1, 2017. The Company repurchased 0.8 million shares of its common stock for $38.1 million during the six months ended July 2, 2016. These shares were retired upon repurchase.

 

Reclassifications From Accumulated Other Comprehensive Income (Loss)

 

The following table summarizes the effect on net income from reclassifications out of accumulated other comprehensive income (loss) (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

Reclassification

 

July 1,
2017

 

July 2,
2016

 

July 1,
2017

 

July 2,
2016

 

Gains (losses) on cash flow hedges to:

 

 

 

 

 

 

 

 

 

Interest expense

 

$

 

$

(61

)

$

1,808

 

$

(127

)

 

 

 

 

 

 

 

 

 

 

Income tax benefit (provision)

 

 

22

 

(633

)

45

 

 

 

 

 

 

 

 

 

 

 

Total reclassifications

 

$

 

$

(39

)

$

1,175

 

$

(82

)

 

9. Stock-Based Compensation

 

In fiscal 2009, the stockholders of the Company approved the 2009 Stock Incentive Plan (the “2009 Plan”) and the 2009 Employee Stock Purchase Plan (the “2009 Purchase Plan”). In the second quarter of fiscal 2017, the stockholders of the Company approved amendments to both the 2009 Plan and the 2009 Purchase Plan. These amendments authorized additional shares of common stock for issuance, to comply with changes in applicable law, improve the Company’s corporate governance and to implement other best practices. The amended plans are currently effective.

 

Stock-based compensation costs are based on the fair values on the date of grant for stock awards and stock options and on the date of enrollment for the employee stock purchase plans. The fair values of stock awards (such as RSUs, performance stock units (PSUs) and restricted stock awards (RSAs)) are estimated based on their intrinsic values. The fair values of MSUs are estimated using a Monte Carlo simulation. The fair values of stock options and employee stock purchase plans are estimated using the Black-Scholes option-pricing model.

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The following table presents details of stock-based compensation costs recognized in the Condensed Consolidated Statements of Income (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

July 1,
2017

 

July 2,
2016

 

Cost of revenues

 

$

264

 

$

269

 

$

522

 

$

535

 

Research and development

 

5,503

 

5,205

 

10,750

 

10,114

 

Selling, general and administrative

 

5,399

 

5,044

 

10,380

 

10,212

 

 

 

11,166

 

10,518

 

21,652

 

20,861

 

Income tax benefit

 

3,175

 

2,270

 

8,457

 

4,506

 

 

 

$

7,991

 

$

8,248

 

$

13,195

 

$

16,355

 

 

The increases in income tax benefit in the three and six months ended July 1, 2017 were primarily due to the recognition of excess tax benefits in connection with the Company’s adoption of ASU 2016-09. The Company had approximately $81.0 million of total unrecognized compensation costs related to granted stock options and awards as of July 1, 2017 that are expected to be recognized over a weighted-average period of approximately 2.3 years. There were no significant stock-based compensation costs capitalized into assets in any of the periods presented.

 

10.  Commitments and Contingencies

 

Patent Litigation

 

On January  28 , 2014, Cresta Technology Corporation (“Cresta Technology”), a Delaware corporation, filed a lawsuit against the Company (among others) in the United States District Court in the District of Delaware, alleging infringement of three United States Patents (the “Cresta Patents”). Cresta Technology declared bankruptcy in 2016. One of its creditors, DBD Credit Funding LLC (“DBD”) and/or CF Crespe LLC (the “Cresta Successors”) claims to have assumed ownership of the Cresta Patents and has substituted in for Cresta Technology in related proceedings.

 

The Delaware proceedings are currently stayed. In 2014 and 2015, the Company challenged the validity of two sets of claims in the Cresta Patents at the Patent Trial and Appeal Board (PTAB) of the United States Patent and Trademark Office (USPTO). The PTAB found the first set of reviewed claims to be invalid, a determination that was affirmed by the Federal Circuit Court of Appeals and is now final. The PTAB similarly found the second set of claims to be invalid. An appeal to that second determination is currently pending at the Federal Circuit.

 

On July 16, 2014, the Company filed a lawsuit against Cresta Technology in the United States District Court in the Northern District of California alleging infringement of six United States Patents. These California proceedings are currently stayed pending resolution of an order by the Bankruptcy Court to substitute the Cresta Successors as defendants.

 

The Company intends to continue to vigorously defend the Delaware proceeding and to continue to pursue its claims against the Cresta Successors and their patents. At this time, the Company cannot predict the outcome of these matters or the resulting financial impact to it, if any.

 

Other

 

The Company is involved in various other legal proceedings that have arisen in the normal course of business. While the ultimate results of these matters cannot be predicted with certainty, the Company does not expect them to have a material adverse effect on its Consolidated Financial Statements.

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

11. Income Taxes

 

Provision (benefit) for income taxes includes both domestic and foreign income taxes at the applicable tax rates adjusted for non-deductible expenses, research and development tax credits and other permanent differences. Income tax expense was $1.3 million and $1.7 million for the three months ended July 1, 2017 and July 2, 2016, resulting in effective tax rates of 7.1% and 9.9%, respectively. Income tax expense was $(0.7) million and $2.0 million for the six months ended July 1, 2017 and July 2, 2016, resulting in effective tax rates of (2.3)% and 8.5%, respectively. The effective tax rates for both the three and six months ended July 1, 2017 decreased from the prior periods primarily due to excess tax benefits from stock-based compensation from the adoption of ASU 2016-09 and an increase in the realization of the U.S. federal research and development tax credit in the current year. These increases were partially offset by a decrease in the foreign tax rate benefit.

 

On July 27, 2015, the U.S. Tax Court (the “Court”) issued an opinion in Altera Corp. v. Commissioner related to the treatment of stock-based compensation expense in an intercompany cost-sharing arrangement. A final decision was entered by the Court on December 1, 2015. In its opinion, the Court accepted Altera’s position of excluding stock-based compensation from its cost-sharing arrangement and concluded that the related U.S. Treasury Regulations were invalid. In February 2016, the U.S. Internal Revenue Service (the “IRS”) appealed the decision to the U.S Court of Appeals for the Ninth Circuit. Although the IRS has appealed the decision, and the U.S. Treasury has not withdrawn the requirement to include stock-based compensation from its regulations, based on the facts and circumstances of the Tax Court Case, the Company believes that it is more likely than not that the Tax Court decision will be upheld. Therefore, the Company continues to reflect the effects of the decision in its Condensed Consolidated Financial Statements. This change to cost-sharing is expected to increase the Company’s cumulative foreign earnings at the time of final resolution of the case. As such, the Company continues to accrue a deferred tax liability for the U.S. tax cost of potential repatriation of the associated contingent foreign earnings because at this time, the Company cannot reasonably conclude that it will have the ability and intent to indefinitely reinvest these contingent earnings. The overall net impact on the Company’s Condensed Consolidated Financial Statements is not material. The Company will continue to monitor ongoing developments and potential impacts to its Consolidated Financial Statements.

 

The Company’s Norwegian subsidiary is currently under examination by the Norwegian Tax Administration (NTA) for income tax matters relating to fiscal years 2013, 2014 and 2015.  While it has not yet received a final assessment from the NTA, in June 2017, the Norwegian subsidiary received a proposed notice of reassessment from the NTA concerning an adjustment to its 2013 taxable income related to the pricing of an intercompany transaction.  The adjustment to 2013 taxable income would result in additional Norwegian tax of approximately $33 million, excluding interest and penalties. The Company disagrees with the NTA’s assessment and intends to defend itself vigorously in this matter. The Company plans to exhaust all available administrative remedies, and if unable to resolve this matter through administrative remedies with the NTA, the Company plans to pursue judicial remedies.

 

The Company believes that it has made adequate payments or accrued adequate reserves related to all matters contained in tax periods open to examination. Should the Company experience an unfavorable outcome in the NTA matter, however, such an outcome could have a material impact on its financial statements.

 

As of July 1, 2017, the Company had gross unrecognized tax benefits of $3.7 million, of which $2.3 million would affect the effective tax rate if recognized.

 

The Company recognizes interest and penalties related to unrecognized tax benefits in the provision (benefit) for income taxes. These amounts were not material for any of the periods presented.

 

Tax years 2012 through 2017 remain open to examination by the major taxing jurisdictions to which the Company is subject. The Company is not currently under audit in any major taxing jurisdiction, except Norway.

 

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Table of Contents

 

Silicon Laboratories Inc.

Notes to Condensed Consolidated Financial Statements (Continued)

(Unaudited)

 

The Company believes it is reasonably possible that the gross unrecognized tax benefits will decrease by approximately $1.9 million in the next 12 months due to the lapse of the statute of limitations applicable to tax deductions and tax credits claimed on prior year tax returns.

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Condensed Consolidated Financial Statements and related notes thereto included elsewhere in this report. This discussion contains forward-looking statements. Please see the “Cautionary Statement” above and “Risk Factors” below for discussions of the uncertainties, risks and assumptions associated with these statements. Our fiscal year-end financial reporting periods are a 52- or 53-week fiscal year that ends on the Saturday closest to December 31. Fiscal 2017 will have 52 weeks and fiscal 2016 had 52 weeks. Our second quarter of fiscal 2017 ended July 1, 2017. Our second quarter of fiscal 2016 ended July 2, 2016.

 

Overview

 

We are a provider of silicon, software and solutions for the Internet of Things (IoT), Internet infrastructure, industrial, consumer and automotive markets. We solve some of the electronics industry’s toughest problems, providing customers with significant advantages in performance, energy savings, connectivity and design simplicity. Mixed-signal integrated circuits (ICs) are electronic components that convert real-world analog signals, such as sound and radio waves, into digital signals that electronic products can process. Therefore, mixed-signal ICs are critical components in products addressing a variety of markets, including industrial, communications, consumer and automotive.

 

As a fabless semiconductor company, we rely on third-party semiconductor fabricators in Asia, and to a lesser extent the United States and Europe, to manufacture the silicon wafers that reflect our IC designs. Each wafer contains numerous die, which are cut from the wafer to create a chip for an IC. We rely on third parties in Asia to assemble, package, and, in most cases, test these devices and ship these units to our customers. Testing performed by such third parties facilitates faster delivery of products to our customers (particularly those located in Asia), shorter production cycle times, lower inventory requirements, lower costs and increased flexibility of test capacity.

 

Our expertise in analog-intensive, high-performance, mixed-signal ICs and software enables us to develop highly differentiated solutions that address multiple markets. We group our products into the following categories:

 

·                   Internet of Things (IoT) products, which include our microcontroller (MCU), wireless, sensor and analog products;

 

·                   Broadcast products, which include our broadcast consumer and automotive products;

 

·                   Infrastructure products, which include our timing products (clocks and oscillators), and isolation devices; and

 

·                   Access products, which include our Voice over IP (VoIP) products, embedded modems and our Power over Ethernet (PoE) devices.

 

Current Period Highlights

 

Revenues increased $15.2 million in the recent quarter compared to the second quarter of fiscal 2016, primarily due to increased revenues from our IoT products offset by decreases in revenues from our Infrastructure, Access and Broadcast products. Infrastructure revenues in the second quarter of fiscal 2016 included $5.0 million from the sale of patents. Gross margin increased $4.9 million during the recent period due primarily to increased product sales. Gross margin as a percent of revenues decreased to 59.5% in the recent quarter compared to 61.9% in the second quarter of fiscal 2016 primarily due to variations in product mix and the sale of patents in the prior period, which had no associated cost of revenues. Operating expenses increased by $1.6 million in the recent quarter compared to the second quarter of fiscal 2016 due primarily to increased personnel-related expenses, offset by decreased expenses for new product introduction costs and amortization of intangible assets.

 

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Table of Contents

 

We ended the second quarter with $661.7 million in cash, cash equivalents and short-term investments. Net cash provided by operating activities was $80.6 million during the recent six-month period. Accounts receivable was $75.5 million at July 1, 2017, representing 36 days sales outstanding (DSO). Inventory was $67.4 million at July 1, 2017, representing 79 days of inventory (DOI).

 

Through acquisitions and internal development efforts, we have continued to diversify our product portfolio and introduce new products and solutions with added functionality and further integration. On January 20, 2017, we acquired Zentri, Inc., an innovator in low-power, cloud-connected Wi-Fi technologies for the IoT. See Note 6, Acquisitions , to the Condensed Consolidated Financial Statements for additional information.

 

In the first six months of fiscal 2017, we introduced the Ultra Series™ family of crystal oscillators (XOs) delivering ultra-low jitter performance; EFR32xG13 Wireless Gecko SoCs supporting full Bluetooth® 5 connectivity and more memory options; a USB-to-I2S bridge chip that provides a simple, turnkey solution for transferring digital audio data; new EFR32 Wireless Gecko SoCs supporting a broad range of multiprotocol, multiband use cases; EFM32® Gecko MCUs offering new security features, large memory options, higher peripheral integration and ultra-low power consumption; and an enhanced Micrium® real-time operating system (RTOS) and new Platform Builder software to accelerate embedded design. We plan to continue to introduce products that increase the content we provide for existing applications, thereby enabling us to serve markets we do not currently address and expand our total available market opportunity.

 

During the six months ended July 1, 2017, we had no customer that represented more than 10% of our revenues. In addition to direct sales to customers, some of our end customers purchase products indirectly from us through distributors and contract manufacturers. An end customer purchasing through a contract manufacturer typically instructs such contract manufacturer to obtain our products and incorporate such products with other components for sale by such contract manufacturer to the end customer. Although we actually sell the products to, and are paid by, the distributors and contract manufacturers, we refer to such end customer as our customer. Three of our distributors, Edom Technology, Avnet and Arrow Electronics, each represented more than 10% of our revenues during the six months ended July 1, 2017. There were no other distributors or contract manufacturers that accounted for more than 10% of our revenues during the six months ended July 1, 2017.

 

The percentage of our revenues derived from outside of the United States was 85% during the six months ended July 1, 2017.  All of our revenues to date have been denominated in U.S. dollars. We believe that a majority of our revenues will continue to be derived from customers outside of the United States.

 

The sales cycle for our ICs can be as long as 12 months or more. An additional three to six months or more are usually required before a customer ships a significant volume of devices that incorporate our ICs. Due to this lengthy sales cycle, we typically experience a significant delay between incurring research and development and selling, general and administrative expenses, and the corresponding sales. Consequently, if sales in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and our operating results for that quarter and, potentially, future quarters would be adversely affected. Moreover, the amount of time between initial research and development and commercialization of a product, if ever, can be substantially longer than the sales cycle for the product. Accordingly, if we incur substantial research and development costs without developing a commercially successful product, our operating results, as well as our growth prospects, could be adversely affected.

 

Because many of our ICs are designed for use in consumer products such as televisions, set-top boxes, radios and wearables, we expect that the demand for our products will be typically subject to some degree of seasonal demand. However, rapid changes in our markets and across our product areas make it difficult for us to accurately estimate the impact of seasonal factors on our business.

 

24



Table of Contents

 

Results of Operations

 

The following describes the line items set forth in our Condensed Consolidated Statements of Income:

 

Revenues.   Revenues are generated predominately by sales of our products. A small portion of our revenues is derived from the sale of patents. Our revenues are subject to variation from period to period due to the volume of shipments made within a period, the mix of products we sell and the prices we charge for our products. The vast majority of our revenues were negotiated at prices that reflect a discount from the list prices for our products. These discounts are made for a variety of reasons, including: 1) to establish a relationship with a new customer, 2) as an incentive for customers to purchase products in larger volumes, 3) to provide profit margin to our distributors who resell our products or 4) in response to competition.

 

Cost of Revenues.   Cost of revenues includes the cost of purchasing finished silicon wafers processed by independent foundries; costs associated with assembly, test and shipping of those products; costs of personnel and equipment associated with manufacturing support, logistics and quality assurance; costs of software royalties, other intellectual property license costs and certain acquired intangible assets; and an allocated portion of our occupancy costs. Our gross margin as a percentage of revenue fluctuates depending on product mix, manufacturing yields, inventory valuation adjustments, average selling prices and other factors.

 

Research and Development.   Research and development expense consists primarily of personnel-related expenses, including stock-based compensation, as well as new product masks, external consulting and services costs, equipment tooling, equipment depreciation, amortization of intangible assets, and an allocated portion of our occupancy costs. Research and development activities include the design of new products, refinement of existing products and design of test methodologies to ensure compliance with required specifications.

 

Selling, General and Administrative.   Selling, general and administrative expense consists primarily of personnel-related expenses, including stock-based compensation, as well as an allocated portion of our occupancy costs, sales commissions to independent sales representatives, applications engineering support, professional fees, legal fees and promotional and marketing expenses.

 

Interest Income and Other, Net.   Interest income and other, net reflects interest earned on our cash, cash equivalents and investment balances, foreign currency remeasurement adjustments and other non-operating income and expenses.

 

Interest Expense.   Interest expense consists of interest on our short and long-term obligations, including our convertible senior notes and credit facility. Interest expense on our convertible senior notes includes contractual interest, amortization of the debt discount and amortization of debt issuance costs.

 

Provision (Benefit) for Income Taxes.   Provision (benefit) for income taxes includes both domestic and foreign income taxes at the applicable tax rates adjusted for non-deductible expenses, research and development tax credits and other permanent differences.

 

25



Table of Contents

 

The following table sets forth our Condensed Consolidated Statements of Income data as a percentage of revenues for the periods indicated:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

July 1,
2017

 

July 2,
2016

 

July 1,
2017

 

July 2,
2016

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

100.0

%

100.0

%

100.0

%

100.0

%

Cost of revenues

 

40.5

 

38.1

 

40.8

 

39.5

 

Gross margin

 

59.5

 

61.9

 

59.2

 

60.5

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

27.6

 

29.5

 

28.4

 

29.9

 

Selling, general and administrative

 

20.9

 

22.3

 

21.7

 

23.3

 

Operating expenses

 

48.5

 

51.8

 

50.1

 

53.2

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

11.0

 

10.1

 

9.1

 

7.3

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income and other, net

 

0.8

 

0.2

 

0.6

 

0.0

 

Interest expense

 

(2.4

)

(0.4

)

(1.2

)

(0.4

)

Income before income taxes

 

9.4

 

9.9

 

8.5

 

6.9

 

Provision (benefit) for income taxes

 

0.7

 

1.0

 

(0.2

)

0.6

 

Net income

 

8.7

%

8.9

%

8.7

%

6.3

%

 

Revenues

 

 

 

Three Months Ended

 

Six Months Ended

 

(in millions)

 

July 1,
2017

 

July 2,
2016

 

Change

 

%
Change

 

July 1,
2017

 

July 2,
2016

 

Change

 

%
Change

 

Internet of Things

 

$

97.7

 

$

76.7

 

$

21.0

 

27.3

%

$

185.6

 

$

147.6

 

$

38.0

 

25.7

%

Broadcast

 

36.7

 

38.0

 

(1.3

)

(3.6

)%

74.0

 

76.5

 

(2.5

)

(3.3

)%

Infrastructure

 

38.2

 

40.7

 

(2.5

)

(6.0

)%

74.2

 

72.2

 

2.0

 

2.7

%

Access

 

17.5

 

19.5

 

(2.0

)

(10.1

)%

35.3

 

40.6

 

(5.3

)

(12.8

)%

 

 

$

190.1

 

$

174.9

 

$

15.2

 

8.7

%

$

369.1

 

$

336.9

 

$

32.2

 

9.6

%

 

The change in revenues in the recent three month period was due primarily to:

 

·                   Increased revenues of $21.0 million for our IoT products, due primarily to increased demand for our products.

 

·                   Decreased revenues of $1.3 million for Broadcast products, due primarily to decreases in the market for our consumer products.

 

·                   Decreased revenues of $2.5 million for our Infrastructure products, due primarily to the sale of patents for $5.0 million in the prior year three month period with no patents sales in the current period. The decrease in Infrastructure revenues was offset by increased product revenues due primarily to increased demand.

 

·                   Decreased revenues of $2.0 million for our Access products, due primarily to decreased demand for our products and decreases in the market for such products.

 

The change in revenues in the recent six month period was due primarily to:

 

·                   Increased revenues of $38.0 million for our IoT products, due primarily to increased demand for our products.

 

·                   Decreased revenues of $2.5 million for Broadcast products, due primarily to decreases in the market for our consumer products.

 

·                   Increased revenues of $2.0 million for our Infrastructure products, due primarily to increased demand for our products offset by decreased patent sale revenue of $5.0 million.

 

·                   Decreased revenues of $5.3 million for our Access products, due primarily to decreased demand for our products and decreases in the market for such products.

 

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Table of Contents

 

Unit volumes of our products increased by 21.0% and average selling prices decreased by 7.8% compared to the three months ended July 2, 2016. Unit volumes of our products increased by 19.9% and average selling prices decreased by 7.5% compared to the six months ended July 2, 2016. The average selling prices of our products may fluctuate significantly from period to period. In general, as our products become more mature, we expect to experience decreases in average selling prices. We anticipate that newly announced, higher priced, next generation products and product derivatives will offset some of these decreases.

 

Gross Margin

 

 

 

Three Months Ended

 

Six Months Ended

 

(in millions)

 

July 1,
2017

 

July 2,
2016

 

Change

 

July 1,
2017

 

July 2,
2016

 

Change

 

Gross margin

 

$

113.2

 

$

108.3

 

$

4.9

 

$

218.4

 

$

203.8

 

$

14.6

 

Percent of revenue

 

59.5

%

61.9

%

(2.4

)%

59.2

%

60.5

%

(1.3

)%

 

The increased dollar amount of gross margin in the recent three month period was due to increases in gross margin of $12.0 million for our Internet of Things products, offset by decreases in gross margin of $3.2 million for our Infrastructure products, $2.0 million for our Access products and $1.9 million for our Broadcast products. The increased dollar amount of gross margin in the recent six month period was due to increases in gross margin of $21.9 million for our Internet of Things products, offset by decreases in gross margin of $4.3 million for our Access products and $3.1 million for our Broadcast products. Gross margin increased during the recent three and six month periods due primarily to increased product sales. Gross margin as a percent of revenues decreased during the recent three and six month periods primarily due to variations in product mix and the sale of patents in the second quarter of fiscal 2016, which had no associated cost of revenues.

 

We may experience declines in the average selling prices of certain of our products. This creates downward pressure on gross margin as a percentage of revenues and may be offset to the extent we are able to: 1) introduce higher margin new products and gain market share with our products; 2) reduce costs of existing products through improved design; 3) achieve lower production costs from our wafer suppliers and third-party assembly and test subcontractors; 4) achieve lower production costs per unit as a result of improved yields throughout the manufacturing process; or 5) reduce logistics costs.

 

Research and Development

 

 

 

Three Months Ended

 

Six Months Ended

 

(in millions)

 

July 1,
2017

 

July 2,
2016

 

Change

 

%
Change

 

July 1,
2017

 

July 2,
2016

 

Change

 

%
Change

 

Research and development

 

$

52.4

 

$

51.6

 

$

0.8

 

1.5

%

$

104.8

 

$

100.7

 

$

4.1

 

4.0

%

Percent of revenue

 

27.6

%

29.5

%

 

 

 

 

28.4

%

29.9

%

 

 

 

 

 

The increase in research and development expense in the recent three and six month periods was primarily due to increases of $3.2 million and $6.9 million, respectively, for personnel-related expenses, including costs associated with increased headcount and acquisitions. The increase in research and development expense in the recent three and six month periods was offset in part by decreases of $1.6 million and $1.3 million, respectively, for new product introduction costs, and $0.6 million and $1.3 million, respectively, for the amortization of intangible assets. The decrease in research and development expense as a percent of revenues in the recent three and six month periods was due to our increased revenues. We expect that research and development expense will increase in absolute dollars in the third quarter of fiscal 2017.

 

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Selling, General and Administrative

 

 

 

Three Months Ended

 

Six Months Ended

 

(in millions)

 

July 1,
2017

 

July 2,
2016

 

Change

 

%
Change

 

July 1,
2017

 

July 2,
2016

 

Change

 

%
Change

 

Selling, general and administrative

 

$

39.8

 

$

39.0

 

$

0.8

 

2.0

%

$

80.0

 

$

78.7

 

$

1.3

 

1.7

%

Percent of revenue

 

20.9

%

22.3

%

 

 

 

 

21.7

%

23.3

%

 

 

 

 

 

The increase in selling, general and administrative expense in the recent three and six month periods was primarily due to increases of $0.8 million and $1.2 million, respectively, for personnel-related expenses, including costs associated with increased headcount and acquisitions. The decrease in selling, general and administrative expense as a percent of revenues in the recent three and six month periods was due to our increased revenues. We expect that selling, general and administrative expense will decrease in absolute dollars in the third quarter of fiscal 2017.

 

Interest Income and Other, Net

 

Interest income and other, net for the three and six months ended July 1, 2017 was $1.6 million and $2.2 million, respectively, compared to $0.3 million and $0.2 million for the three and six months ended July 2, 2016, respectively. The increase in interest income and other, net in the recent three and six month periods was primarily due to increased interest income earned as a result of higher market interest rates and higher cash, cash equivalents and short-term investments balances.

 

Interest Expense

 

Interest expense for the three and six months ended July 1, 2017 was $4.7 million and $4.5 million, respectively, compared to $0.6 million and $1.3 million for the three and six months ended July 2, 2016, respectively. The increase in interest expense in the recent three and six month periods was primarily due to increased interest expense of $4.4 million and $5.7 million, respectively, on our convertible debt, including amortization of the debt discount and debt issuance costs. The increase in interest expense in the recent six month period was offset in part by a $2.0 million gain recorded in connection with the termination of our interest rate swap agreement.

 

Provision (Benefit) for Income Taxes

 

 

 

Three Months Ended

 

Six Months Ended

 

(in millions)

 

July 1,
2017

 

July 2,
2016

 

Change

 

July 1,
2017

 

July 2,
2016

 

Change

 

Provision (benefit) for income taxes

 

$

1.3

 

$

1.7

 

$

(0.4

)

$

(0.7

)

$

2.0

 

$

(2.7

)

Effective tax rate

 

7.1

%

9.9

%

 

 

(2.3

)%

8.5

%

 

 

 

The effective tax rates for both the three and six months ended July 1, 2017 decreased from the prior periods primarily due to excess tax benefits from stock-based compensation from the adoption of ASU 2016-09 and an increase in the realization of the U. S. federal research and development tax credit in the current year. These increases were partially offset by a decrease in the foreign tax rate benefit. The adoption of ASU 2016-09 resulted in a reduction to income tax expense of $0.6 million and $3.9 million for the three and six months ended July 1, 2017, respectively. See Note 11,  Income Taxes , to the Condensed Consolidated Financial Statements for additional information.

 

The effective tax rates for each of the periods presented differ from the federal statutory tax rate of 35% due to the amount of income earned in foreign jurisdictions where the tax rate may be lower than the federal statutory rate, excess tax benefits from stock-based compensation from the adoption of ASU 2016-09 and other permanent items including research and development tax credits and nondeductible compensation expenses.

 

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Business Outlook

 

The following represents our business outlook for the third quarter of fiscal 2017.

 

Income Statement Item

 

Estimate

 

 

 

Revenues

 

$193 million to $199 million

 

 

 

Gross margin

 

58.5%

 

 

 

Operating expenses

 

$92.5 million to $93 million

 

 

 

Effective tax rate

 

11.0%

 

 

 

Diluted earnings per share

 

$0.35 to $0.41

 

Liquidity and Capital Resources

 

Our principal sources of liquidity as of July 1, 2017 consisted of $661.7 million in cash, cash equivalents and short-term investments, of which approximately $512.5 million was held by our U.S. entities. The remaining balance was held by our foreign subsidiaries. Our cash equivalents and short-term investments consisted of government debt securities, which include agency bonds, municipal bonds, U.S. government bonds, international government bonds, international agency commercial paper and variable-rate demand notes; corporate debt securities, which include asset-backed securities, corporate bonds, commercial paper and certificates of deposit; and money market funds. Our long-term investments consisted of auction-rate securities. As of July 1, 2017, we held $6.0 million par value auction-rate securities, all of which have experienced failed auctions because sell orders exceeded buy orders. See Note 3, Fair Value of Financial Instruments , to the Condensed Consolidated Financial Statements for additional information.

 

Operating Activities

 

Net cash provided by operating activities was $80.6 million during the six months ended July 1, 2017, compared to net cash provided of $60.4 million during the six months ended July 2, 2016. Operating cash flows during the six months ended July 1, 2017 reflect our net income of $32.0 million, adjustments of $40.2 million for depreciation, amortization, stock-based compensation and deferred income taxes, and a net cash inflow of $8.4 million due to changes in our operating assets and liabilities.

 

Accounts receivable increased to $75.5 million at July 1, 2017 from $74.4 million at December 31, 2016. The increase in accounts receivable resulted primarily from normal variations in the timing of collections and billings. Our average DSO was 36 days at July 1, 2017 and 37 days at December 31, 2016.

 

Inventory increased to $67.4 million at July 1, 2017 from $59.6 million at December 31, 2016. Our inventory level is primarily impacted by our need to make purchase commitments to support forecasted demand and variations between forecasted and actual demand. Our DOI was 79 days at July 1, 2017 and 73 days at December 31, 2016.

 

Investing Activities

 

Net cash used in investing activities was $320.8 million during the six months ended July 1, 2017, compared to net cash used of $20.6 million during the six months ended July 2, 2016. The increase in cash outflows was principally due to an increase of $283.7 million in net purchases of marketable securities and a net payment of $13.7 million for the acquisition of Zentri. See Note 6, Acquisitions , to the Condensed Consolidated Financial Statements for additional information.

 

We anticipate capital expenditures of approximately $18 to $22 million for fiscal 2017. Additionally, as part of our growth strategy, we expect to evaluate opportunities to invest in or acquire other businesses, intellectual property or technologies that would complement or expand our current offerings, expand the breadth of our markets or enhance our technical capabilities.

 

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Table of Contents

 

Financing Activities

 

Net cash provided by financing activities was $309.7 million during the six months ended July 1, 2017, compared to net cash used of $52.5 million during the six months ended July 2, 2016. The increase in cash inflows was principally due to $389.5 million in net proceeds from the issuance of long-term debt and a decrease of $36.1 million for repurchases of our common stock, offset by an increase of $67.5 million in payments on debt. See Note 7, Debt , to the Condensed Consolidated Financial Statements for additional information. In January 2017, the Board of Directors authorized a program to repurchase up to $100 million of our common stock through December 2017.

 

Our debt facilities include $400 million principal amount convertible senior notes (the “Notes”) and a $300 million revolving credit facility. On March 6, 2017, we completed a private offering of the Notes. The Notes bear interest semi-annually at a rate of 1.375% per year and will mature on March 1, 2022, unless repurchased, redeemed or converted at an earlier date. In connection with our offering of the Notes, we entered into a second amendment to our prior credit agreement and paid off the remaining balance of $72.5 million. We have an option to increase the size of the borrowing capacity of the revolving credit facility by up to an aggregate of $200 million in additional commitments, subject to certain conditions. See Note 7, Debt , to the Condensed Consolidated Financial Statements for additional information.

 

Our future capital requirements will depend on many factors, including the rate of sales growth, market acceptance of our products, the timing and extent of research and development projects, potential acquisitions of companies or technologies and the expansion of our sales and marketing activities. We believe our existing cash, cash equivalents, investments and credit under our Credit Facility are sufficient to meet our capital requirements through at least the next 12 months, although we could be required, or could elect, to seek additional funding prior to that time. We may enter into acquisitions or strategic arrangements in the future which also could require us to seek additional equity or debt financing.

 

Critical Accounting Policies and Estimates

 

The preparation of financial statements and accompanying notes in conformity with U.S. generally accepted accounting principles requires that we make estimates and assumptions that affect the amounts reported. Changes in facts and circumstances could have a significant impact on the resulting estimated amounts included in the financial statements. We believe the following critical accounting policies affect our more complex judgments and estimates. We also have other policies that we consider to be key accounting policies, such as our policies for revenue recognition, including the deferral of revenues and cost of revenues on sales to distributors; however, these policies do not meet the definition of critical accounting estimates because they do not generally require us to make estimates or judgments that are difficult or subjective.

 

Inventory valuation — We assess the recoverability of inventories through the application of a set of methods, assumptions and estimates. In determining net realizable value, we write down inventory that may be slow moving or have some form of obsolescence, including inventory that has aged more than 12 months. We also adjust the valuation of inventory when its manufacturing cost exceeds the estimated selling price less costs of completion, disposal and transportation. We assess the potential for any unusual customer returns based on known quality or business issues and write-off inventory losses for scrap or non-saleable material. Inventory not otherwise identified to be written down is compared to an assessment of our 12-month forecasted demand. The result of this methodology is compared against the product life cycle and competitive situations in the marketplace to determine the appropriateness of the resulting inventory levels. Demand for our products may fluctuate significantly over time, and actual demand and market conditions may be more or less favorable than those that we project. In the event that actual demand is lower or market conditions are worse than originally projected, additional inventory write-downs may be required.

 

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Table of Contents

 

Stock-based compensation — We recognize the fair-value of stock-based compensation transactions in the Consolidated Statements of Income. The fair value of our full-value stock awards (with the exception of market-based performance awards) equals the fair market value of our stock on the date of grant. The fair value of our market-based performance awards is estimated at the date of grant using a Monte-Carlo simulation. The fair value of our stock option and employee stock purchase plan grants is estimated at the date of grant using the Black-Scholes option pricing model. In addition, we are required to estimate the expected forfeiture rate of our stock grants and only recognize the expense for those shares expected to vest. If our actual experience differs significantly from the assumptions used to compute our stock-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little stock-based compensation cost. See Note 9, Stock-Based Compensation , to the Condensed Consolidated Financial Statements for additional information.

 

Investments in auction-rate securities — We determine the fair value of our investments in auction-rate securities using a discounted cash flow model. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, amount of cash flows, expected holding periods of the securities and a discount to reflect our inability to liquidate the securities. For available-for-sale auction-rate securities, if the calculated value is below the carrying amount of the securities, we then determine if the decline in value is other-than-temporary. We consider various factors in determining whether an impairment is other-than-temporary, including the severity and duration of the impairment, changes in underlying credit ratings, forecasted recovery, our intent to sell or the likelihood that we would be required to sell the investment before its anticipated recovery in market value and the probability that the scheduled cash payments will continue to be made. When we conclude that an other-than-temporary impairment has occurred, we assess whether we intend to sell the security or if it is more likely than not that we will be required to sell the security before recovery. If either of these two conditions is met, we recognize a charge in earnings equal to the entire difference between the security’s amortized cost basis and its fair value. If we do not intend to sell a security and it is not more likely than not that we will be required to sell the security before recovery, the unrealized loss is separated into an amount representing the credit loss, which is recognized in earnings, and the amount related to all other factors, which is recorded in accumulated other comprehensive income (loss).

 

Acquired intangible assets — When we acquire a business, a portion of the purchase price is typically allocated to identifiable intangible assets, such as acquired technology and customer relationships. Fair value of these assets is determined primarily using the income approach, which requires us to project future cash flows and apply an appropriate discount rate. We amortize intangible assets with finite lives over their expected useful lives. Our estimates are based upon assumptions believed to be reasonable but which are inherently uncertain and unpredictable. Assumptions may be incomplete or inaccurate, and unanticipated events and circumstances may occur. Incorrect estimates could result in future impairment charges, and those charges could be material to our results of operations.

 

Impairment of goodwill and other long-lived assets — We review long-lived assets which are held and used, including fixed assets and purchased intangible assets, for impairment whenever changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Such evaluations compare the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset over its expected useful life and are significantly impacted by estimates of future prices and volumes for our products, capital needs, economic trends and other factors which are inherently difficult to forecast. If the asset is considered to be impaired, we record an impairment charge equal to the amount by which the carrying value of the asset exceeds its fair value determined by either a quoted market price, if any, or a value determined by utilizing a discounted cash flow technique.

 

We test our goodwill for impairment annually as of the first day of our fourth fiscal quarter and in interim periods if certain events occur indicating that the carrying value of goodwill may be impaired. The goodwill impairment test is a two-step process. The first step of the impairment analysis compares our fair value to our net book value. In determining fair value, the accounting guidance allows for the use of several valuation methodologies, although it states quoted market prices are the best evidence of fair value. If the fair value is less than the net book value, the second step of the analysis compares the implied fair value of our goodwill to its carrying amount. If the carrying amount of goodwill exceeds its implied fair value, we recognize an impairment loss equal to that excess amount.

 

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Income taxes — We are required to calculate income taxes in each of the jurisdictions in which we operate. This process involves calculating the actual current tax liability together with assessing temporary differences in recognition of income (loss) for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our Consolidated Balance Sheet. We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, we are required to estimate the amount of expected future taxable income. Judgment is inherent in this process and differences between the estimated and actual taxable income could result in a material impact on our Consolidated Financial Statements.

 

We recognize liabilities for uncertain tax positions based on a two-step process. The first step requires us to determine whether the weight of available evidence indicates that the tax position has met the threshold for re